NCERT Book Business Studies Class XI

CONTENTS

FOREWORD iii

PART I FOUNDATIONS OF BUSINESS 1

CHAPTER 1 Nature and Purpose of Business 2

CHAPTER 2 Forms of Business Organisation 21

CHAPTER 3 Private, Public and Global Enterprises 55

CHAPTER 4 Business Services 77

CHAPTER 5 Emerging Modes of Business 110

CHAPTER 6 Social Responsibilities of Businessand Business Ethics 140

PART II CORPORATE ORGANISATION, FINANCE AND TRADE 159

CHAPTER 7 Formation of a Company 160

CHAPTER 8 Sources of Business Finance 181

CHAPTER 9 Small Business 207

CHAPTER 10 Internal Trade 225

CHAPTER 11 International Business - I 251

CHAPTER 12 International Business - II 278

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PART I

Foundations of Business

CHAPTER 1

NATURE AND PURPOSE OF BUSINESS

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

• explain the concept and characteristics of business;

• compare the distinctive features of business, profession andemployment;

• classify business activities and clarify the meaning of industry andcommerce;

• state various types of industry;

• explain the activities relating to commerce;

• analyse the objectives of business;

• describe the nature of business risks and their causes; and

• discuss the basic factors to be considered while starting a business.

3NATURE AND PURPOSE OF BUSINESS

influence on our daily lives. It,therefore, becomes important that weunderstand the concept, nature andpurpose of business.

1.2 CONCEPT OF BUSINESS

The term business is derived from theword ‘busy’. Thus, business meansbeing busy. However, in a specificsense, business refers to anyoccupation in which people regularlyengage in an activity with a view toearning profit. The activity may consistof production or purchase of goods forsale, or exchange of goods or supply ofservices to satisfy the needs of otherpeople.

In every society people undertakevarious activities to satisfy their needs.These activities may be broadlyclassified into two groups — economicand non-economic. Economic activitiesare those by which we can earn ourlivelihood whereas non-economic

1.1 INTRODUCTION

The conversation among the fourclassmates is obviously focused on themeaning, nature and purpose ofbusiness. All human beings, whereverthey may be, require different types ofgoods and services to satisfy theirneeds. The necessity of supplying goodsand services has led to certain activitiesbeing undertaken by people to produceand sell what is needed by others.Business is a major economic activityin all modern societies concerned as itis with the production and sale ofgoods and services required by people.The purpose behind most businessactivities is to earn money by meetingpeople’s demands for goods andservices. Business is central to our lives.Although our lives are influenced bymany other institutions in modernsociety such as schools, colleges,hospitals, political parties and religiousbodies, business has the major

Imran, Manpreet, Joseph and Priyanka have been classmates in Class X. Aftertheir exams are over, they happen to meet at a common friend Ruchika’s house.Just when they are sharing their experiences of examination days, Ruchika’sfather, Mr. Raghuraj Chaudhury intervenes and asks about their well-being. Healso enquires from each one of them about their career plans. But none of themhas a definite reply. Mr. Raghuraj, who himself is a businessman, suggests tothem that they can opt for business as a promising and challenging career.Joseph gets excited by the idea and says, “Yes, business is really good for makinglots of money even more than is possible by becoming an engineer or a doctor.”Mr. Raghuraj opines, “Let me tell you, young man, there is a lot more to businessthan merely money”. He then gets busy with some other guests. However, thefour classmates begin raising many questions: What exactly business is all about?What else is there in business besides money? How is business different fromnon-business activities? What does one require to start a business? And, so on.

4 BUSINESS STUDIES

activities are those performed out oflove, sympathy, sentiments, patriotism,etc. For example, a worker working ina factory, a doctor operating in hisclinic, a manager working in the officeand a teacher teaching in a school—are doing so to earn their livelihood andare, therefore, engaged in an economicactivity. On the other hand, a housewifecooking food for her family or a boyhelping an old man cross the road areperforming non-economic activitiessince they are doing so out of love orsympathy. Economic activities may befurther divided into three categories,namely business, profession andemployment. Business may be definedas an economic activity involving theproduction and sale of goods andservices undertaken with a motive ofearning profit by satisfying humanneeds in society.

1.3 CHARACTERISTICS OF BUSINESS

ACTIVITIES

In order to appreciate how businessactivity is different from other activitiesin society, the nature of business or itsfundamental character must beexplained in terms of its distinguishingcharacteristics, which are as follows:(i) An economic activity: Business isconsidered to be an economic activitybecause it is undertaken with the objectof earning money or livelihood and notbecause of love, affection, sympathy orany other sentimental reason.(ii) Production or procurement ofgoods and services: Before goods areoffered to people for consumption they

must be either produced or procuredby business enterprises. Thus, everybusiness enterprise either manu-factures the goods it deals in or itacquires them from producers, to befurther sold to consumers or users.Goods may consist of consumableitems of daily use such as sugar, ghee,pen, notebook, etc. or capital goods likemachinery, furniture, etc. Services mayinclude facilities offered to consumersin the form of transportation, banking,electricity, etc.(iii) Sale or exchange of goods andservices for the satisfaction ofhuman needs: Directly or indirectly,business involves transfer or exchangeof goods and services for value. If goodsare produced not for the purpose ofsale but say for internal consumption,it cannot be called a business activity.Cooking food at home for the family isnot business, but cooking food andselling it to others in a restaurant isbusiness. Thus, one essentialcharacteristic of business is that thereshould be sale or exchange of goodsor services between the seller andthe buyer.(iv) Dealings in goods and serviceson a regular basis: Business involvesdealings in goods or services on aregular basis. One single transactionof sale or purchase, therefore, does notconstitute business. Thus, for example,if a person sells his/her domestic radioset even at a profit, it will not beconsidered a business activity. But ifhe/she sells radio sets regularly eitherthrough a shop or from his/her


residence, it will be regarded as abusiness activity.(v) Profit earning: One of the mainpurpose of business is to earn incomeby way of profit. No business cansurvive for long without earning profit.That is why businessmen make allpossible efforts to maximise profits, byincreasing the volume of sales orreducing costs.(vi) Uncertainty of return: Uncertaintyof return refers to the lack of knowledgerelating to the amount of money thatthe business is going to earn in a givenperiod. Every business invests money(capital) to run its activities with theobjective of earning profit. But it is not

certain as to what amount of profit willbe earned. Also, there is always apossibility of losses being incurred, inspite of the best efforts put into thebusiness.(vii) Element of risk: Risk is theuncertainty associated with anexposure to loss. It is caused by someunfavourable or undesirable event. Therisks are related with certain factors like

Business refers to those economicactivities, which are connected with theproduction or purchase and sale ofgoods or supply of services with themain object of earning profit. Peopleengaged in business earn income in theform of profit.

Profession includes those activities,which require special knowledge andskill to be applied by individuals in

changes in consumer tastes andfashions, changes in methods ofproduction, strike or lockout in thework place, increased competition inthe market, fire, theft, accidents,natural calamities, etc. No businesscan altogether do away with risks.

1.4 COMPARISON OF BUSINESS,PROFESSION AND EMPLOYMENT

As has been mentioned earlier,economic activities may be divided intothree major categories viz.,(i) Business(ii) Profession(iii) Employment

Business Functions at Enterprise Level

Business includes a wide variety of functions performed by many different kindsof organisations called business enterprises or firms. Financing, productionmarketing and human resource management are the four major functions whichare performed by business enterprises to carry on business. Financing isconcerned with mobilising and utilising funds for running a business enterprise.Production involves the conversion of raw materials into finished products orgeneration of services. Marketing refers to all those activities which facilitateexchange of goods and services from producers to the people who need them, ata place they want, at a time they require and at a price they are prepared to pay.Human resource management aims at ensuring the availability of working peoplewho have necessary skills to perform various tasks in enterprises.

6 BUSINESS STUDIES

their occupation. Such activities aregenerally subject to guidelines or codesof conduct laid down by professionalbodies. Those engaged in professionsare known as professionals. Forexample, doctors are engaged in themedical profession and are subject tothe regulations of the Medical Councilof India, the concerned professionalbody. Similarly, lawyers are engagedin the legal profession, governed by the

Bar Council of India and CharteredAccountants belong to the accountingprofession and are subject to theregulations of the Institute of CharteredAccountants of India.

Employment refers to theoccupation in which people work forothers and get remunerated in return.Those who are employed by others areknown as employees. Thus, people whowork in factories and receive wages and

COMPARISON OF BUSINESS, PROFESSION AND EMPLOYMENT

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salaries are in the employment offactory owners and are employees ofthe factory. Similarly, people who workin the offices of banks, insurancecompanies or government department,as managers, assistants, clerks, peonsor security guards are the employeesof these organisations.

1.5 CLASSIFICATION OF BUSINESS

ACTIVITIES

Various business activities may beclassified into two broad categories —industry and commerce. Industry isconcerned with the production orprocessing of goods and materials.Commerce includes all those activitieswhich are necessary for facilitating the

exchange of goods and services. On thebasis of these two categories, we mayclassify business firms into industrialand commercial enterprises.

Let us examine in detail theactivities relating to business.

1.6 INDUSTRY

Industry refers to economic activities,which are connected with conversionof resources into useful goods. Theterm industry is used for activities inwhich mechanical appliances andtechnical skills are involved. Theseinclude activities relating to producingor processing of goods as well asbreeding and raising of animals. Theterm industry is also used to mean

8 BUSINESS STUDIES

groups of firms producing similar orrelated goods. For example, cottontextile industry refers to allmanufacturing units producing textilegoods from cotton. Similarly, electronicindustry would include all firmsproducing electronic goods, and so on.Further, in common parlance, certainservices like banking and insuranceare also referred to as industry,say banking industry, insuranceindustry etc.

Industries may be divided intothree broad categories namely primary,secondary and tertiary.(a) Primary industries: These include

all those activities, which areconnected with the extraction andproduction of natural resources andreproduction and development ofliving organisms, plants etc. Theseindustries may be further sub-divided as follows:(i) Extractive industries: These

industries extract or draw outproducts from natural sources.Extractive industries supplysome basic raw materials thatare mostly products of the soil.Products of these industries areusually transformed into manyother useful goods bymanufacturing industries.Important extractive industriesinclude farming, mining,lumbering, hunting and fishingoperations.

(ii) Genetic industries: Theseindustries remain engaged inbreeding plants and animalsfor their use in further

reproduction. For the breedingof plants, the seeds and nurserycompanies are typical examplesof genetic industries. Inaddition, activities of cattle-breeding farms, poultry farms,and fish hatchery come underthe class of genetic industries.

(b) Secondary industries: These areconcerned with using the materials,which have already been extractedat the primary stage. Theseindustries process such materials toproduce goods for finalconsumption or for furtherprocessing by other industrial units.For example, the mining of an ironore is a primary industry, butmanufacturing of steel is asecondary industry. Secondaryindustries may be further divided asfollows:(i) Manufacturing industries: These

industries are engaged inproducing goods throughprocessing of raw materials andthus creating form utilities. Theyturn out diverse finishedproducts, that we consume,through the conversion of rawmaterials or partly finishedmaterials in their manufacturingoperations. Manufacturingindustries may be furtherdivided into four categories onthe basis of method of operationfor production.• Analytical industry which

analyses and separatesdifferent elements from thesame materials, as in the caseof oil refinery.


• Synthetical industry whichcombines various ingredientsinto a new product, as in thecase of cement.

• Processing industry whichinvolves successive stages formanufacturing finishedproducts, as in the case ofsugar and paper.

• Assembling industry whichassembles different compo-nent parts to make a newproduct, as in the case oftelevision, car, computer, etc.

(ii) Construction industries: Theseindustries are involved in theconstruction of buildings, dams,bridges, roads as well as tunnelsand canals. Engineering andarchitectural skills are animportant part in constructionindustries.

(c) Tertiary industries: These areconcerned with providing supportservices to primary and secondaryindustries as well as activitiesrelating to trade. These industriesprovide service facilities. Asbusiness activities these may beconsidered part of commercebecause as auxiliaries to tradethey assist trade. Included inthis category are transport,banking, insurance, warehousing,communication, packaging andadvertising.

1.7 COMMERCE

Commerce includes two types of acti-vities, viz., (i) trade and (ii) auxiliaries

to trade. Buying and selling of goods istermed as trade. But there are a lot ofactivities that are required to facilitatethe purchase and sale of goods. Theseare called services or auxiliaries to tradeand include transport, banking,insurance, communication, advertise-ment, packaging and warehousing.Commerce, therefore, includes both,buying and selling of goods i.e., tradeas well as auxiliaries such astransport, banking, etc. Commerceprovides the necessary link betweenproducers and consumers. It embracesall those activities, which are necessaryfor maintaining a free flow of goods andservices. Thus, all activities involvingthe removal of hindrances in theprocess of exchange are included incommerce. The hindrances may be inrespect of persons, place, time, risk,finance, etc. The hindrance of personsis removed by trade thereby makinggoods available to the consumers fromthe producers. Transport removes thehindrances of place by moving goodsfrom the places of production to themarkets for sale. Storage andwarehousing activities remove thehindrance of time by facilitatingholding of stocks of goods to be sold asand when required. Goods held in stockas well as goods in course of transportare subject to the risk of loss or damagedue to theft, fire, accidents, etc.Protection against these risks isprovided by insurance of goods. Capitalrequired to undertake the aboveactivities is provided by banking andfinancing institutions. Advertising

10 BUSINESS STUDIES

makes it possible for producers andtraders to inform consumers about thegoods and services available in themarket. Hence, commerce is said toconsist of activities of removing thehindrances of persons, place, time, risk,finance and information in the processof exchange of goods and services.

1.7.1 Trade

Trade is an essential part of commerce.It refers to sale, transfer or exchange ofgoods. It helps in making the goodsproduced available to ultimateconsumers or users. These days goodsare produced on a large scale and it isdifficult for producers to themselvesreach individual buyers for sale of theirproducts. Businessmen are engaged intrading activities as middlemen to makethe goods available to consumers indifferent markets. In the absence oftrade, it would not be possible toundertake production activities on alarge scale.

Trade may be classified into twobroad categories — internal andexternal. Internal or home trade isconcerned with the buying and sellingof goods and services within thegeographical boundaries of a country.This may further be divided intowholesale and retail trade. When goodsare purchased and sold in bulk, it isknown as wholesale trade. When goodsare purchased and sold incomparatively smaller quantities, it isreferred to as retail trade. External orforeign trade consists of the exchangeof goods and services between persons

or organisations operating in two ormore countries. If goods are purchasedfrom another country, it is called importtrade. If they are sold to other countries,it is known as export trade. When goodsare imported for export to othercountries, it is known as entrepot trade.

1.7.2 Auxiliaries to Trade

Activities which are meant for assistingtrade are known as auxiliaries to trade.These activities are generally, referredto as services because these are in thenature of facilitating the activitiesrelating to industry and trade.Transport, banking, insurance,warehousing, and advertising areregarded as auxiliaries to trade, i.e.,activities playing a supportive role. Infact, these activities not only supporttrade but also industry and hence, theentire business activity. However,auxiliaries are an integral part ofcommerce in particular and businessactivity in general. These activities helpin removing various hindrances whicharise in connection with the productionand distribution of goods. Transportfacilitates movement of goods from oneplace to another. Banking providesfinancial assistance to the trader.Insurance covers various kinds ofbusiness risks. Warehousing createstime utility with storage facility.Advertising provides information. Inother words, these activities facilitatemovement, storage, financing, riskcoverage and sales promotion of goods.Auxiliaries to trade are brieflydiscussed below:


(i) Transport and Communication:Production of goods generally takesplace in particular locations. Forinstance, tea is mainly produced inAssam; cotton in Gujarat andMaharashtra; jute in West Bengal andOrissa; sugar in U.P, Bihar andMaharashtra and so on. But thesegoods are required for consumption indifferent part of the country. Theobstacle of place is removed bytransport — road, rail or coastalshipping. Transport facilitatesmovement of raw material to the placeof production and the finishedproducts from factories to the place ofconsumption. Along with the transportfacility, there is also a need forcommunication facilities so thatproducers, traders and consumersmay exchange information with oneanother. Thus, postal services andtelephone facilities may also beregarded as auxiliaries to businessactivities.(ii) Banking and Finance: Businessactivities cannot be undertaken unlessfunds are available for acquiring assetsand meeting the day-to-day expenses.Necessary funds can be obtained bybusinessmen from a bank. Thus,banking helps business activities toovercome the problem of finance.Commercial banks generally lendmoney by providing overdraft and cashcredit facilities, loans and advances.Banks also undertake collection ofcheques, remittance of funds todifferent places, and discounting of billson behalf of traders. In foreign trade,payments are arranged by commercial

banks on behalf of importers andexporters. Commercial banks also helppromoters of companies to raise capitalfrom the public.(iii) Insurance: Business involvesvarious types of risks. Factory building,machinery, furniture etc. must beprotected against fire, theft and otherrisks. Materials and goods held in stockor in transit are subject to the risk ofloss or damage. Employees are alsorequired to be protected against therisks of accident and occupationalhazards. Insurance provides protectionin all such cases. On payment of anominal premium, the amount of lossor damage and compensation forinjury, if any, can be recovered fromthe insurance company.(iv) Warehousing: Usually, goods arenot sold or consumed immediately afterproduction. They are held in stock tobe available as and when required.Special arrangement must be made forstorage of goods to prevent loss ordamage. Warehousing helps businessfirms to overcome the problem of storageand facilitates the availability of goodswhen needed. Prices are therebymaintained at a reasonable levelthrough continuous supply of goods.(v) Advertising: Advertising is one ofthe most important methods ofpromoting the sale of products,particularly, consumers goods likeelectronic goods, automobiles, soaps,detergents etc. Most of these goods aremanufactured and supplied in themarket by numerous firms — big orsmall. It is practically impossible forproducers and traders to contact each

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and every customer. Thus, for salespromotion, information about thegoods available, its features, price, etc.,must reach potential buyers. Also thereis a need to persuade potential buyersabout the uses, quality, prices,competitive information about thegoods etc. Advertising helps inproviding information about availablegoods and inducing customers to buyparticular items.

1.8 OBJECTIVES OF BUSINESS

An objective is the starting point ofbusiness. Every business is directed tothe achievement of certain objectives,which refer to all that the businesspeople want to get in return for whatthey do. It is generally believed thatbusiness activity is carried on only forprofit. Business persons themselvesproclaim that their primary objective isto produce or distribute goods orservices for a profit. Every business issaid to be an attempt on the part ofbusiness people to get more than whathas been spent or invested or, in otherwords, to earn profit which is the excessof revenue over cost. However, it iswidely accepted nowadays thatbusiness enterprises are part of societyand need to have several objectives,including social responsibility tosurvive and prosper in the long run.Profit is found to be the leading objectivebut not the only one.

Although earning profit cannot bethe only objective of business, itsimportance cannot be ignored. Everybusiness is an attempt to reap morethan what has been invested and profit

is the excess of revenue over cost. Profitmay be regarded as an essentialobjective of business for variousreasons: (i) it is a source of income forbusiness persons, (ii) it can be a sourceof finance for meeting expansionrequirements of business, (iii) itindicates the efficient working ofbusiness, (iv) it can be taken as society’sapproval of the utility of business and(v) it builds up the reputation of abusiness enterprise.

However, too much emphasis onprofit to the exclusion of other objectivescan be dangerous for good business.Obsessed with profit businessmanagers may neglect all otherresponsibilities towards customers,employees, investors and society atlarge. They may even be inclined toexploit various sections of society toearn immediate profit. This may resultin the non-cooperation or evenopposition from the affected peopleagainst the malpractices of businessenterprises. The enterprises might losebusiness and may be unable to earnprofit. That is the reason why there ishardly any sizable business enterprisewhose only objective is maximisationof profit.

1.8.1 Multiple Objectives of Business

Continuous increase in the profitsof any enterprise is possible onlythrough performing useful servicesto society. In fact, objectives areneeded in every area that influencesthe survival and prosperity ofbusiness. Since a business has tobalance a number of needs and


goals it requires multiple objectives.It cannot follow only one objectiveand expect to achieve excellence.Objectives have to be specific in everyarea and sphere of business. Forexample, sales figures have to be set,the amount of capital to be raised hasto be estimated and the target numberof units to be produced should bedefined. The objectives define what thebusiness is going to do in concreteterms that enable the business toanalyse their own experience and as aresult improve their performance.Objectives are needed in every areawhere performance and results affectthe survival and prosperity ofbusiness. Some of these areas aredescribed below:(a) Market standing: Market standing

refers to the position of an enterprisein relation to its competitors. Abusiness enterprise must aim atstanding on stronger footing interms of offering competitiveproducts to its customers andserving them to their satisfaction.

(b) Innovation: Innovation is theintroduction of new ideas ormethods in the way something isdone or made. There are two kindsof innovation in every business i.e.,(i) innovation in product or service;and (ii) innovation in the variousskills and activities needed tosupply them. No businessenterprise can flourish in acompetitive world withoutinnovation. Therefore, innovationbecomes an important objective.

(c) Productivity: Productivity iscalculated by comparing the valueof outputs with the value of inputs.It is used as a measure of efficiency.In order to ensure continuoussurvival and progress, everyenterprise must aim at greaterproductivity by the best use ofavailable resources.

(d) Physical and financial resources:Any business requires physicalresources like plants, machines,offices, etc., and financial resources,i.e., funds to be able to produce andsupply goods and services to itscustomers. The business enterprisemust aim at acquiring theseresources according to theirrequirements and use themefficiently.

(e) Earning profits: One of theobjectives of business is to earn profitson the capital employed. Profitabilityrefers to profit in relation to capitalinvestment. Every business mustearn a reasonable profit which is soimportant for its survival and growth.

(f) Manager performance anddevelopment: Business enterprisesneed managers to conduct andcoordinate business activity.Various programmes for motivatingmanagers need to be implemented.Manager performance anddevelopment therefore, is animportant objective. The enterprisesmust actively work for this purpose.

(g) Worker performance and attitude:Worker’s performance and attitudesdetermine their contribution towardsproductivity and profitability of any

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enterprise. Therefore, everyenterprise must aim at improving itsworkers performance. It should alsotry to ensure a positive attitude onthe part of workers.

(h)Social responsibility: Socialresponsibility refers to the obligationof business firms to contributeresources for solving social problemsand work in a socially desirablemanner.

Thus, a business enterprise must havemultiple objectives to satisfy differentindividuals and groups, for its ownsurvival and prosperity.

1.8.2 Business Risks

The term ‘business risks’ refers to thepossibility of inadequate profits or evenlosses due to uncertainties orunexpected events. For example,demand for a particular product maydecline due to change in tastes andpreferences of consumers or due toincreased competition from otherproducers. Decrease in demand willresult in lesser sales and profits. Inanother situation, the shortage of rawmaterials in the market may shoot upits price. The firm using these rawmaterials will have to pay more forbuying them. As a result, cost ofproduction may increase which, inturn, may reduce profits.

Business enterprises constantlyface two types of risk: speculative andpure. Speculative risks involve both thepossibility of gain as well as thepossibility of loss. Speculative risksarise due to changes in market

conditions including fluctuations indemand and supply, changes in pricesor changes in fashion and tastes ofcustomers. Favourable marketconditions are likely to result in gainswhereas unfavourable ones may resultin losses. Pure risks involve only thepossibility of loss or no loss. The chanceof fire, theft or strike are examples ofpure risks. Their occurrence may resultin loss whereas non-occurrence mayexplain absence of loss, instead of gain.

1.9 NATURE OF BUSINESS RISKS

Nature of business risks can beunderstood in terms of their peculiarcharacteristics:(i) Business risks arise due touncertainties: Uncertainty refers tothe lack of knowledge about what isgoing to happen in the future. Naturalcalamities, change in demand andprices, changes in government policy,improvement in technology, etc., aresome of the examples of uncertaintywhich create risks for business becausethe outcome of these future events isnot known in advance.(ii) Risk is an essential part of everybusiness: Every business has somerisk. No business can avoid risk,although the amount of risk may varyfrom business to business. Risk can beminimised but cannot be eliminated.(iii) Degree of risk depends mainlyupon the nature and size ofbusiness: Nature of business (i.e., typeof goods and services produced andsold) and size of business (i.e., volumeof production and sale) are the main


factors which determine the amount ofrisk in a business. For example, abusiness dealing in fashionable itemshas a high degree of risk. Similarly, alarge-scale business has a higher riskthan what a small scale has.(iv) Profit is the reward for risktaking: No risk, no gain is an age-oldprinciple, which applies to all types ofbusiness. Greater the risk involved ina business, higher is the chance ofprofit. An entrepreneur undertakesrisks under the expectation of higherprofit. Profit is thus the reward forrisk taking.

1.9.1 Causes of Business Risks

Business risks arise due to a variety ofcauses, which are classified as follows:

power failure, strikes, riots,management inefficiency, etc.(iii) Economic causes: These includeuncertainties relating to demand forgoods, competition, price, collection ofdues from customers, change oftechnology or method of production,etc. Financial problems like rise ininterest rate for borrowing, levy of highertaxes, etc., also come under these typeof causes as they result in higherunexpected cost of operation ofbusiness.(iv) Other causes: These areunforeseen events like politicaldisturbances, mechanical failures suchas the bursting of boiler, fluctuationsin exchange rates, etc., which lead tothe possibility of business risks.

Methods of Dealing with Risks

Although no business enterprise can escape the presence of risk, there aremany methods it can use to deal with risk situations. For instance, the enterprisemay (a) decide not to enter into too risky transaction; (b) take preventive measureslike firefighting devices to reduce risk; (c) take insurance policy to transfer riskto insurance company; (d) assume risk by making provisions in the currentearnings as is the case of provision for bad and doubtful debts; or (e) share riskswith other enterprises as manufacturers and wholesalers may do by agreeing toshare losses which may be caused by falling prices.

(i) Natural causes: Human beingshave little control over naturalcalamities like flood, earthquake,lightning, heavy rains, famine, etc. Theyresult in heavy loss of life, property andincome in business.(ii) Human causes: Human causesinclude such unexpected events likedishonesty, carelessness or negligenceof employees, stoppage of work due to

1.9.2 Starting a Business — BasicFactors

Starting a business enterprise is similarto any other human effort in whichresources are employed to achievecertain objectives. Successful results inbusiness depend largely upon theability of the entrepreneurs or thestarters of a new business to anticipateproblems and solve them with

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minimum cost. This is especially trueof the modern business world wherecompetition is very tough and risks arehigh. Some of the problems, whichbusiness firms encounter, are of a basicnature. For example, to start a factory,plans must be made and implementedabout such problems as the locationof the business, the possible numberof customers, the kind and amount ofequipment, the shop layout, purchasingand financing needs, and hiring ofworkers. These problems become morecomplex in a big business. However,some of the basic factors, which mustbe considered by anybody who is tostart the business are as follows:(i) Selection of line of business: Thefirst thing to be decided by anyentrepreneur of a new business is thenature and type of business to beundertaken. He will obviously like toenter that branch of industry andcommerce, which has the possibility ofgreater amount of profits. The decisionwill be influenced by the customerrequirements in the market and alsothe kind of technical knowledge andinterest the entrepreneur has forproducing a particular product.(ii) Size of the firm: Size of the firmor scale of its operation is anotherimportant decision to be taken at thestart of the business. Some factorsfavour a large size whereas others tendto restrict the scale of operation. If theentrepreneur is confident that thedemand for the proposed product islikely to be good over time and he canarrange the necessary capital for

business, he will start the operation ata large scale. If the market conditionsare uncertain and risks are high, asmall size business would be betterchoice.(iii) Choice of form of ownership:With respect to ownership, thebusiness organisation may take theform of a sale proprietorship,partnership, or a joint stock company.Each form has its own merits anddemerits. The choice of the suitableform of ownership will depend on suchfactors as the line of business, capitalrequirements, liability of owners,division of profit, legal formalities,continuity of business, transferabilityof interest and so on.(iv) Location of business enterprise:An important factor to be consideredat the start of the business is the placewhere the enterprise will be located.Any mistake in this regard can resultin high cost of production,inconvenience in getting right kind ofproduction inputs or serving thecustomers in the best possible way.Availability of raw materialsand labour; power supply andservices like banking, transportation,communication, warehousing, etc., areimportant factors while making achoice of location.(v) Financing the proposition:Financing is concerned with providingthe necessary capital for starting as wellas for continuing the proposedbusiness. Capital is required forinvestment in fixed assets like land,building, machinery and equipment


and in current assets like raw materials,book debts, stock of finished goods, etc.Capital is also required for meetingday-to-day expenses. Proper financialplanning must be done to determine(a) the requirement of capital,(b) source from which capital will beraised and (c) the best ways of utilisingthe capital in the firm.(vi) Physical facilities: Availability ofphysical facilities including machinesand equipment, building andsupportive services is a very importantfactor to be considered at the start ofthe business. The decision relating tothis factor will depend on the natureand size of business, availability offunds and the process of production.(vii) Plant layout: Once therequirement of physical facilities hasbeen determined, the entrepreneurshould draw a layout plan showing thearrangement of these facilities. Layoutmeans the physical arrangement ofmachines and equipment needed tomanufacture a product.(viii) Competent and committedworked force: Every enterprise needscompetent and committed work force

to perform various activities so thatphysical and financial resources areconverted into desired outputs. Sinceno individual entrepreneur can doeverything himself, he must identify therequirement of skilled and unskilledworkers and managerial staff. Plansshould also be made about how theemployees will be trained and motivatedto give their best performance.(ix) Tax planning: Tax planning hasbecome necessary these days becausethere are a number of tax laws in thecountry and they influence almostevery aspect of the functioning ofmodern business. The founder of thebusiness has to consider in advancethe tax liability under various tax lawsand its impact on business decisions.(x) Launching the enterprise: Afterthe decisions relating to the abovementioned factors have been taken,the entrepreneur can go ahead withactual launching of the enterprisewhich would mean mobilising variousresources, fulfilling necessary legalformalities, starting the productionprocess and initiating the salespromotion campaign.

Key Terms

Business Profession Primary Innovation Warehousing

Profit Employment Secondary Insurance Social responsibility

Risk Industry Tertiary Mining Manufacturing

18 BUSINESS STUDIES

SUMMARY

Concept and characteristics of business: Business may be defined as aneconomic activity involving the production and sale of goods and servicesundertaken with the motive of earning profit by satisfying human needs insociety. It’s distinguished characteristics are: (i) an economic activity,(ii) production or procurement of goods and services, (iii) sale or exchangeof goods and services for the satisfaction of human needs, (iv) dealings ingoods and services on a regular basis, (v) profit earning, (vi) uncertainty ofreturn, and (vii) element of risk.

Comparison of business, profession and employment: Business refersto those economic activities which are connected with the production orpurchase and sale of goods or supply of services with the main object ofearning profit. Profession includes those activities, which require specialknowledge and skill to be applied by individuals in their occupation.Employment refers to the occupation in which people work for others andget remunerated in return. The three can be compared on the basis ofmode of establishment, nature of work, qualification required, reward orreturn, capital investment, risk, transfer of interest and code of conduct.

Classification of business activities: Business activities may be classifiedinto broad categories: industry and commerce. Industry refers to economicactivities which are connected with conversion of resources into usefulgoods. Industries may be: primary, secondary or tertiary. Primary industriesare connected with the extraction and production of natural resources andreproduction and development of living organisms, plants, etc. Primaryindustries may be: extractive (like mining) or genetic (like poultry farms).Secondary industries are concerned with using the materials which havealready been extracted at the primary stage. These industries could be:manufacturing or construction. Manufacturing industries may be furtherclassified into analytical, synthetical, processing and assembling industries.Tertiary industries are concerned with providing support services to primaryand secondary industries as well as activities relating to trade.

Commerce includes activities relating to trade and auxiliaries to trade.Trade refers to sale, transfer or exchange of goods. It could be classified asinternal (domestic) and external (foreign) trade. Internal trade may bewholesale trade or retail trade. External trade could be import, export orentrepot trade. Auxiliaries to trade are activities which assist trade. Theseinclude transport and communication, banking and finance, insurance,warehousing, and advertising.

Objectives of business: Although earning of profit is considered to be theprimary objective, objectives are needed in every area where performanceresults affect the survival and prosperity of business. Some of these areasare: market standing, innovation, productivity, physical and financial


resources, earning profits manager performance and development, workerperformance and attitude, and social responsibility.

Business risks: The term ‘risk’ refers to the possibility of inadequate profitsor even losses due to uncertainties or unexpected events. Its nature can beexplained with the help of its peculiar characteristics which are:

(i) Business risks arise due to uncertainties,(ii) Risk is an essential part of every business,(iii) Degree of risk depends mainly upon the nature and size of business,

and(iv) Profit is the reward for risk taking. Business risks arise due to a variety

of causes including natural, human, economic and other causes.Starting a business — basic factors: Some of the basic factors which mustbe considered by anybody who is to start the business are: selection of lineof business, size of the firm, choice of form of ownership, location of businessenterprise, financing the proposition, physical facilities, plant layoutcompetent and committed workforce, tax planning and launching theenterprise.

EXERCISES

Multiple Choice Questions

1. Which of the following does not characterise business activity?(a) Production of goods (b) Presence of risk

and services(c) Sale or exchange of (d) Salary or wages

goods and services

2. Which of the broad categories of industries covers oil refinery and sugarmills?(a) Primary (b) Secondary(c) Tertiary (d) None of them

3. Which of the following cannot be classified as an auxilliary to trade?(a) Mining (b) Insurance(c) Warehousing (d) Transport

4. The occupation in which people work for others and get remunerated inreturn is known as(a) Business (b) Employment(c) Profession (d) None of them

5. The industries which provide support services to other industries areknown as(a) Primary industries (b) Secondary industries(c) Commercial industries (d) Tertiary industries

20 BUSINESS STUDIES

6. Which of the following cannot be classified as an objective of business?(a) Investment (b) Productivity(c) Innovation (d) Profit earning

7. Business risk is not likely to arise due to(a) Changes in government policy (b) Good management(c) Employee dishonesty (d) Power failure

Short Answer Questions

1. State the different types of economic activities.

2. Why is business considered an economic activity?

3. Explain the concept of business.

4. How would you classify business activities?

5. What are various types of industries?

6. Explain any two business activities which are auxiliaries to trade.

7. What is the role of profit in business?

8. What is business risk? What is its nature?

Long Answer Questions

1. Explain the characteristics of business.

2. Compare business with profession and employment.

3. Explain with examples the various types of industries.

4. Describe the activities relating to commerce.

5. Why does business need multiple objective? Explain any five suchobjectives.

6. Explain the concept of business risk and its causes.

7. What factors are important to be considered while starting a business?Explain.

Projects/Assignments

1. Choose a locally operated trading or business unit. Find out the kind ofrisks it faces in business and the way it deals with them.

2. Select a local business enterprise and find out the objectives it pursues.Check why it does not pursue other objectives.

CHAPTER 2

FORMS OF BUSINESS

ORGANISATION

LEARNING OBJECTIVES


• identify different forms of business organisation;

• explain features, merits and limitations of select forms of businessorganisation;

• distinguish between various forms of organisation; and

• analyse factors determining choice of an appropriate form ofbusiness organisation.

22 BUSINESS STUDIES

2.1 INTRODUCTION

If one is planning to start a business oris interested in expanding an existingone, an important decision relates tothe choice of the form of organisation.The most appropriate form isdetermined by weighing theadvantages and disadvantages of eachtype of organisation against one’s ownrequirements.

Various forms of businessorganisations from which one canchoose the right one include:(a) Sole proprietorship,(b) Joint Hindu family business,(c) Partnership,(d) Cooperative societies, and(e) Joint stock company.

Let us start our discussion withsole proprietorship — the simplest formof business organisation, and thenmove on to analysing more complexforms of organisations.

2.2 SOLE PROPRIETORSHIP

Do you often go in the evenings to buyregisters, pens, chart papers, etc., froma small neighbourhood stationerystore? Well, in all probability in thecourse of your transactions, you haveinteracted with a sole proprietor.

Sole proprietorship is a popularform of business organisation and isthe most suitable form for smallbusinesses, especially in their initialyears of operation. Sole proprietorship

Neha, a bright final year student was waiting for her results to be declared.While at home she decided to put her free time to use. Having an aptitude forpainting, she tried her hand at decorating clay pots and bowls with designs.She was excited at the praise showered on her by her friends and acquaintanceson her work. She even managed to sell a few pieces of unique hand pottery fromher home to people living in and around her colony. Operating from home, shewas able to save on rental payments. She gained a lot of popularity by word ofmouth publicity as a sole proprietor. She further perfected her skills of paintingpottery and created new motifs and designs. All this generated great interestamong her customers and provided a boost to the demand for her products. Bythe end of summer, she found that she had been able to make a profit of Rs.2500 from her paltry investment in colours, pottery and drawing sheets. She feltmotivated to take up this work as a career. She has, therefore, decided to set upher own artwork business. She can continue running the business on her ownas a sole proprietor, but she needs more money for doing business on a largerscale. Her father has suggested that she should form a partnership with hercousin to meet the need for additional funds and for sharing the responsibilitiesand risks. Side by side, he is of the opinion that it is possible that the businessmight grow further and may require the formation of a company. She is in a fixas to what form of business organisation she should go in for?

23FORMS OF BUSINESS ORGANISATION

refers to a form of business organisationwhich is owned, managed andcontrolled by an individual who is therecipient of all profits and bearer of allrisks. This is evident from the termitself. The word “sole” implies “only”,and “proprietor” refers to “owner”.Hence, a sole proprietor is the one whois the only owner of a business.

This form of business is particularlycommon in areas of personalisedservices such as beauty parlours, hairsaloons and small scale activities likerunning a retail shop in a locality.

payment of debts in case the assets ofthe business are not sufficient to meetall the debts. As such the owner’spersonal possessions such as his/herpersonal car and other assets could besold for repaying the debt. Suppose thetotal outside liabilities of XYZ drycleaner, a sole proprietorship firm, areRs. 80,000 at the time of dissolution, butits assets are Rs. 60,000 only. In such asituation the proprietor will have to bringin Rs. 20,000 from her personal sourceseven if she has to sell her personalproperty to repay the firm’s debts.

Features

Salient characteristics of the soleproprietorship form of organisation areas follows:

(i) Formation and closure: Hardlyany legal formalities are required tostart a sole proprietary business,though in some cases one may requirea license. There is no separate law thatgoverns sole proprietorship. Closure ofthe business can also be done easily.Thus, there is ease in formation as wellas closure of business.

(ii) Liability: Sole proprietors haveunlimited liability. This implies that theowner is personally responsible for

(iii) Sole risk bearer and profitrecipient: The risk of failure ofbusiness is borne all alone by the soleproprietor. However, if the business issuccessful, the proprietor enjoys all thebenefits. He receives all the businessprofits which become a direct rewardfor his risk bearing.(iv) Control: The right to run thebusiness and make all decisions liesabsolutely with the sole proprietor. Hecan carry out his plans without anyinterference from others.(v) No separate entity: In the eyes ofthe law, no distinction is made betweenthe sole trader and his business, asbusiness does not have an identity

Sole trader is a type of business unit where a person is solely responsible forproviding the capital, for bearing the risk of the enterprise and for the managementof business.

J.L. HansenThe individual proprietorship is the form of business organisation at the head ofwhich stands an individual as one who is responsible, who directs its operationsand who alone runs the risk of failure.

L.H. Haney

24 BUSINESS STUDIES

separate from the owner. The owner is,therefore, held responsible for all theactivities of the business.(vi) Lack of business continuity:Since the owner and business are oneand the same entity, death, insanity,imprisonment, physical ailment orbankruptcy of the sole proprietor willhave a direct and detrimental effect onthe business and may even causeclosure of the business.

consult others. This may lead to timelycapitalisation of market opportunitiesas and when they arise.(ii) Confidentiality of information:Sole decision making authority enablesthe proprietor to keep all theinformation related to businessoperations confidential and maintainsecrecy. A sole trader is also not boundby law to publish firm’s accounts.(iii) Direct incentive: A soleproprietor directly reaps the benefits

Merits

Sole proprietorship offers manyadvantages. Some of the important onesare as follows:(i) Quick decision making: A soleproprietor enjoys considerable degreeof freedom in making businessdecisions. Further the decision makingis prompt because there is no need to

of his/her efforts as he/she is the solerecipient of all the profit. The need toshare profits does not arise as he/sheis the single owner. This providesmaximum incentive to the sole traderto work hard.(iv) Sense of accomplishment: Thereis a personal satisfaction involved inworking for oneself. The knowledgethat one is responsible for the success

A Refreshing Start: Coca Cola Owes its Origin to a Sole Proprietor!

The product that has given the world its best-known taste was born in Atlanta,Georgia, on May 8, 1886. Dr. John Stith Pemberton, a local pharmacist, producedthe syrup for Coca-Cola®, and carried a jug of the new product down the street toJacobs’ Pharmacy, where it was sampled, pronounced “excellent” and placed onsale for five cents a glass as a soda fountain drink. Dr. Pemberton never realisedthe potential of the beverage he created. He gradually sold portions of his businessto various partners and, just prior to his death in 1888, sold his remaining interestin Coca-Cola to Asa G. Candler. An Atlantan with great business acumen, Mr.Candler proceeded to buy additional business rights and acquire complete control.On May 1, 1889, Asa Candler published a full-page advertisement in The AtlantaJournal, proclaiming his wholesale and retail drug business as “sole proprietorsof Coca-Cola ... Delicious. Refreshing. Exhilarating. Invigorating.” Soleownership, which Mr. Candler did not actually achieve until 1891, needed aninvestment of $ 2,300.

It was only in 1892 that Mr. Candler formed a company called The Coca-ColaCorporation.

Source: Website of Coca Cola company.


of the business not only contributes toself-satisfaction but also instils in theindividual a sense of accomplishmentand confidence in one’s abilities.(v) Ease of formation and closure:An important merit of soleproprietorship is the possibility ofentering into business with minimallegal formalities. There is no separatelaw that governs sole proprietorship. Assole proprietorship is the leastregulated form of business, it is easyto start and close the business as perthe wish of the owner.

Limitations

Notwithstanding various advantages,the sole proprietorship form oforganisation is not free fromlimitations. Some of the majorlimitations of sole proprietorship areas follows:(i) Limited resources: Resources ofa sole proprietor are limited to his/herpersonal savings and borrowings fromothers. Banks and other lendinginstitutions may hesitate to extend along term loan to a sole proprietor.Lack of resources is one of the majorreasons why the size of the businessrarely grows much and generallyremains small.(ii) Limited life of a businessconcern: In the eyes of the law theproprietorship and the owner areconsidered one and the same. Death,insolvency or illness of a proprietoraffects the business and can lead toits closure.

(iii) Unlimited liability: A majordisadvantage of sole proprietorship isthat the owner has unlimited liability. Ifthe business fails, the creditors canrecover their dues not merely from thebusiness assets, but also from thepersonal assets of the proprietor. Apoor decision or an unfavourablecircumstance can create seriousfinancial burden on the owners. That iswhy a sole proprietor is less inclined totake risks in the form of innovationor expansion.(iv) Limited managerial ability: Theowner has to assume the responsibilityof varied managerial tasks such aspurchasing, selling, financing, etc. It israre to find an individual who excels inall these areas. Thus decision makingmay not be balanced in all the cases.Also, due to limited resources, soleproprietor may not be able to employand retain talented and ambitiousemployees.

Though sole proprietorship suffersfrom various shortcomings, manyentrepreneurs opt for this form oforganisation because of its inherentadvantages. It requires less amount ofcapital. It is best suited for businesseswhich are carried out on a small scaleand where customers demandpersonalised services.

2.3 JOINT HINDU FAMILY BUSINESS

Joint Hindu family business is aspecific form of business organisationfound only in India. It is one of theoldest forms of business organisationin the country. It refers to a form oforganisation wherein the business is

26 BUSINESS STUDIES

owned and carried on by the membersof the Hindu Undivided Family (HUF).It is governed by the Hindu Law. Thebasis of membership in the business isbirth in a particular family and threesuccessive generations can be membersin the business.

The business is controlled by thehead of the family who is the eldestmember and is called karta. Allmembers have equal ownership rightover the property of an ancestor andthey are known as co-parceners.

systems. Dayabhaga system prevailsin West Bengal and allows both themale and female members of the familyto be co-parceners. Mitakasharasystem, on the other hand, prevails allover India except West Bengal andallows only the male members to beco-parceners in the business.

Features

The following points highlight theessential characteristics of the jointHindu family business.

There are two systems which governmembership in the family business,viz., Dayabhaga and Mitakashara

(i) Formation: For a joint Hindu familybusiness, there should be at least twomembers in the family and ancestral

Gender Equality in the Joint Hindu Family a Reality

With the introduction of the Hindu Succession (Amendment) Bill 2004 inParliament on December 20, 2004, the Government has gone a step further infulfilling its commitment towards gender equality made in National CommonMinimum Programme (NCMP). The Bill to amend the Hindu Succession Act of1956 gives women equal rights in the inheritance of ancestral wealth, somethingreserved only for male heirs earlier. It, indeed, is a significant step in bringingthe Hindu Law of inheritance in accord with the constitutional principle ofequality. The enactment of the proposed legislation would also implement therecommendations of the National Commission for Women (NCW) substantiallyto help bring social change in society. The Bill seeks to remove the discriminationas contained in section 6 of the Hindu Succession Act, 1956 by giving equalrights to daughters in the Hindu Mitakshara coparcenary property as thesons have.

In what is known as the Kerala model, the concept of coparcenary was abolishedand according to the Kerala Joint Family System (Abolition) Act, 1975, the heirs(male and female) do not acquire property by birth but only hold it as tenants asif a partition has taken place. Andhra Pradesh (1986), Tamil Nadu (1989),Karnataka (1994) and Maharashtra (1994) also enacted laws, where daughterswere granted ‘coparcener’ rights or a claim on ancestral property by birth asthe sons.

Equality for women is not just a matter of equity for the so-called weaker sex,but a measure of the modernity of Indian society and the pragmatic nature ofour civilisation. (PIB Features)

Source: Adapted from E C Thomas, “The Road to Gender Equality”.


property to be inherited by them. Thebusiness does not require anyagreement as membership is by birth.It is governed by the Hindu SuccessionAct, 1956.(ii) Liability: The liability of allmembers except the karta is limited totheir share of co-parcenery property ofthe business. The karta, however, hasunlimited liability.(iii) Control: The control of the familybusiness lies with the karta. He takesall the decisions and is authorised tomanage the business. His decisions arebinding on the other members.(iv) Continuity: The businesscontinues even after the death of thekarta as the next eldest member takesup the position of karta, leaving thebusiness stable. The business can,however, be terminated with themutual consent of the members.(v) Minor Members: The inclusion ofan individual into the business occursdue to birth in a Hindu UndividedFamily. Hence, minors can also bemembers of the business.

Merits

The advantages of the joint Hindufamily business are as follows:(i) Effective control: The karta hasabsolute decision making power. Thisavoids conflicts among members as noone can interfere with his right todecide. This also leads to prompt andflexible decision making.(ii) Continued business existence:The death of the karta will not affectthe business as the next eldest memberwill then take up the position. Hence,

operations are not terminated andcontinuity of business is notthreatened.(iii) Limited liability of members:The liability of all the co-parcenersexcept the karta is limited to their sharein the business, and consequently theirrisk is well-defined and precise.(iv) Increased loyalty andcooperation: Since the business is runby the members of a family, there is agreater sense of loyalty towards oneother. Pride in the growth of businessis linked to the achievements of thefamily. This helps in securing bettercooperation from all the members.

Limitation

The following are some of thelimitations of a joint Hindu familybusiness.(i) Limited resources: The joint Hindufamily business faces the problem oflimited capital as it depends mainly onancestral property. This limits thescope for expansion of business.(ii) Unlimited liability of karta: Thekarta is burdened not only with theresponsibility of decision making andmanagement of business, but alsosuffers from the disadvantage ofhaving unlimited liability. His personalproperty can be used to repay businessdebts.(iii) Dominance of karta: The kartaindividually manages the businesswhich may at times not be acceptableto other members. This may causeconflict amongst them and may evenlead to break down of the family unit.

28 BUSINESS STUDIES

(iv) Limited managerial skills: Sincethe karta cannot be an expert in allareas of management, the businessmay suffer as a result of his unwisedecisions. His inability to decideeffectively may result into poor profitsor even losses for the organisation.

The joint Hindu family business ison the decline because of thediminishing number of joint Hindufamilies in the country.

2.4 PARTNERSHIP

The inherent disadvantage of the soleproprietorship in financing andmanaging an expanding business pavedthe way for partnership as a viable option.Partnership serves as an answer to theneeds of greater capital investment,varied skills and sharing of risks.

(i) Formation: The partnership formof business organisation is governed bythe Indian Partnership Act, 1932. Itcomes into existence through a legalagreement wherein the terms andconditions governing the relationshipamong the partners, sharing of profitsand losses and the manner ofconducting the business are specified.It may be pointed out that the businessmust be lawful and run with the motiveof profit. Thus, two people comingtogether for charitable purposes willnot constitute a partnership.(ii) Liability: The partners of a firmhave unlimited liability. Personal assetsmay be used for repaying debts in casethe business assets are insufficient.Further, the partners are jointly andindividually liable for payment of debts.

The Indian Partnership Act, 1932defines partnership as “the relationbetween persons who have agreed toshare the profit of the businesscarried on by all or any one of themacting for all.”

Features

Definitions given above point to thefollowing major characteristics ofthe partnership form of businessorganisation.

Jointly, all the partners are responsiblefor the debts and they contribute inproportion to their share in businessand as such are liable to that extent.Individually too, each partner can beheld responsible repaying the debts ofthe business. However, such a partnercan later recover from other partnersan amount of money equivalent to theshares in liability defined as per thepartnership agreement.

Partnership is the relation between persons competent to make contracts whohave agreed to carry on a lawful business in common with a view to private gain.

L H HaneyPartnership is the relation which subsists between persons who have agreed tocombine their property, labour or skill in some business and to share the profitstherefrom between them.

The Indian Contract Act


(iii) Risk bearing: The partners bearthe risks involved in running a businessas a team. The reward comes in theform of profits which are shared by thepartners in an agreed ratio. However,they also share losses in the same ratioin the event of the firm incurring losses.(iv) Decision making and control:The partners share amongst themselvesthe responsibility of decision makingand control of day to day activities.Decisions are generally taken withmutual consent. Thus, the activities ofa partnership firm are managedthrough the joint efforts of all thepartners.(v) Continuity: Partnership ischaracterised by lack of continuity ofbusiness since the death, retirement,insolvency or insanity of any partnercan bring an end to the business.However, the remaining partners mayif they so desire continue the businesson the basis of a new agreement.(vi) Membership: The minimumnumber of members needed to start apartnership firm is two, while themaximum number, in case of bankingindustry is ten and in case of otherbusinesses it is twenty.(vii) Mutual agency: The definition ofpartnership highlights the fact that itis a business carried on by all or anyone of the partners acting for all. Inother words, every partner is both anagent and a principal. He is an agent ofother partners as he represents themand thereby binds them through hisacts. He is a principal as he too can bebound by the acts of other partners.

Merits

The following points describe theadvantages of a partnership firm.(i) Ease of formation and closure:A partnership firm can be formedeasily by putting an agreementbetween the prospective partners intoplace whereby they agree to carryoutthe business of the firm and sharerisks. There is no compulsion withrespect to registration of the firm.Closure of the firm too is an easy task.(ii) Balanced decision making: Thepartners can oversee differentfunctions according to their areas ofexpertise. Because an individual is notforced to handle different activities, thisnot only reduces the burden of workbut also leads to fewer errors injudgements. As a consequence,decisions are likely to be morebalanced.(iii) More funds: In a partnership, thecapital is contributed by a number ofpartners. This makes it possible toraise larger amount of funds ascompared to a sole proprietor andundertake additional operations whenneeded.(iv) Sharing of risks: The risksinvolved in running a partnership firmare shared by all the partners. Thisreduces the anxiety, burden andstress on individual partners.(v) Secrecy: A partnership firm is notlegally required to publish itsaccounts and submit its reports.Hence it is able to maintainconfidentiality of information relatingto its operations.

30 BUSINESS STUDIES

Limitations

A partnership firm of businessorganisation suffers from the followinglimitations:(i) Unlimited liability: Partners areliable to repay debts even from theirpersonal resources in case the businessassets are not sufficient to meet its debts.The liability of partners is both joint andseveral which may prove to be adrawback for those partners who havegreater personal wealth. They will haveto repay the entire debt in case the otherpartners are unable to do so.(ii) Limited resources: There is arestriction on the number of partners,and hence contribution in terms ofcapital investment is usually notsufficient to support large scale businessoperations. As a result, partnership firmsface problems in expansion beyond acertain size.(iii) Possibility of conflicts:Partnership is run by a group of personswherein decision making authority isshared. Difference in opinion on someissues may lead to disputes betweenpartners. Further, decisions of onepartner are binding on other partners.Thus an unwise decision by some onemay result in financial ruin for all others.In case a partner desires to leave thefirm, this can result in termination ofpartnership as there is a restriction ontransfer of ownership.(iv) Lack of continuity: Partnershipcomes to an end with the death,retirement, insolvency or lunacy of anypartner. It may result in lack of

continuity. However, the remainingpartners can enter into a fresh agreementand continue to run the business.(v) Lack of public confidence: Apartnership firm is not legally requiredto publish its financial reports or makeother related information public. It is,therefore, difficult for any member of thepublic to ascertain the true financialstatus of a partnership firm. As a result,the confidence of the public inpartnership firms is generally low.

2.4.1 Types of Partners

A partnership firm can have differenttypes of partners with different roles andliabilities. An understanding of thesetypes is important for a clearunderstanding of their rights andresponsibilities. These are described asfollows:(i) Active partner: An active partner isone who contributes capital,participates in the management of thefirm, shares its profits and losses, andis liable to an unlimited extent to thecreditors of the firm. These partnerstake actual part in carrying outbusiness of the firm on behalf of otherpartners.(ii) Sleeping or dormant partner:Partners who do not take part in the dayto day activities of the business arecalled sleeping partners. A sleepingpartner, however, contributes capital tothe firm, shares its profits and losses,and has unlimited liability.(iii) Secret partner: A secret partner isone whose association with the firm isunknown to the general public. Otherthan this distinct feature, in all other


aspects he is like the rest of the partners.He contributes to the capital of the firm,takes part in the management, sharesits profits and losses, and has unlimitedliability towards the creditors.(iv) Nominal partner: A nominalpartner is one who allows the use ofhis/her name by a firm, but does notcontribute to its capital. He/she doesnot take active part in managing thefirm, does not share its profit or lossesbut is liable, like other partners, to thethird parties, for the repayments of thefirm’s debts.(v) Partner by estoppel: A person isconsidered a partner by estoppel if,through his/her own initiative, conductor behaviour, he/she gives animpression to others that he/she is apartner of the firm. Such partners are

held liable for the debts of the firmbecause in the eyes of the third partythey are considered partners, eventhough they do not contribute capitalor take part in its management.Suppose Rani is a friend of Seema whois a partner in a software firm —Simplex Solutions. On Seema’s request,Rani accompanies her to a businessmeeting with Mohan Softwares andactively participates in the negotiationprocess for a business deal and givesthe impression that she is also a partnerin Simplex Solutions. If credit isextended to Simplex Solutions on thebasis of these negotiations, Rani wouldalso be liable for repayment of suchdebt, as if she is a partner of the firm.(vi) Partner by holding out: A partnerby ‘holding out’ is a person who though

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32 BUSINESS STUDIES

is not a partner in a firm butknowingly allows himself/herself to berepresented as a partner in a firm.Such a person becomes liable tooutside creditors for repayment of anydebts which have been extended to thefirm on the basis of suchrepresentation. In case he is not reallya partner and wants to save himselffrom such a liability, he shouldimmediately issue a denial, clarifyinghis position that he is not a partner inthe firm. If he does not do so, he willbe responsible to the third party forany such debts.

2.4.2 Types of Partnerships

Partnerships can be classified on thebasis of two factors, viz., duration andliability. On the basis of duration, therecan be two types of partnerships :‘partnership at will’ and ‘particularpartnership’. On the basis of liability,

the two types of partnership include:one ‘with limited liability’ and the otherone ‘with unlimited liability’. These typesare described in the following sections.

Classification on the basis ofduration

(i) Partnership at will: This type ofpartnership exists at the will of thepartners. It can continue as long asthe partners want and is terminatedwhen any partner gives a notice ofwithdrawal from partnership to thefirm.(ii) Particular partnership: Partner-ship formed for the accomplishment ofa particular project say constructionof a building or an activity to be carriedon for a specified time period is calledparticular partnership. It dissolvesautomatically when the purpose forwhich it was formed is fulfilled or whenthe time duration expires.

Minor as a Partner

Partnership is based on legal contract between two persons who agree to sharethe profits or losses of a business carried on by them. As such a minor isincompetent to enter into a valid contract with others, he cannot become apartner in any firm. However, a minor can be admitted to the benefits of apartnership firm with the mutual consent of all other partners. In such cases,his liability will be limited to the extent of the capital contributed by him and inthe firm. He will not be eligible to take an active part in the management of thefirm. Thus, a minor can share only the profits and can not be asked to bear thelosses. However, he can if he wishes, inspect the accounts of the firm. The statusof a minor changes when he attains majority. In fact, on attaining majority, theminor has to decide whether he would like to become a partner in the firm. Hehas to give a public notice of his decision within six months of attaining majority.If he fails to do so, within the stipulated time, he will be treated as a full-fledgedpartner and will become liable to the debts of the firm to an unlimited extent, inthe same way as other active partners are.


Classification on the basis ofliability

(i) General Partnership: In generalpartnership, the liability of partners isunlimited and joint. The partners enjoythe right to participate in themanagement of the firm and their actsare binding on each other as well ason the firm. Registration of the firm isoptional. The existence of the firm isaffected by the death, lunacy,insolvency or retirement of the partners.(ii) Limited Partnership: In limitedpartnership, the liability of at least onepartner is unlimited whereas the restmay have limited liability. Such apartnership does not get terminatedwith the death, lunacy or insolvency ofthe limited partners. The limitedpartners do not enjoy the right ofmanagement and their acts do not bindthe firm or the other partners.Registration of such partnership iscompulsory.

This form of partnership was notpermitted in India earlier. Thepermission to form partnership firmswith limited liability has been grantedafter introduction of New Small

Enterprise Policy in 1991. The ideabehind such a move has been to enablethe partnership firms to attract equitycapital from friends and relatives ofsmall scale entrepreneurs who wereearlier reluctant to help, due to theexistence of unlimited liability clausein the partnership form of business.

2.4.3 Partnership Deed

A partnership is a voluntary associationof people who come together forachieving common objectives. In orderto enter into partnership, a clearagreement with respect to the terms,conditions and all aspects concerningthe partners is essential so that thereis no misunderstanding later amongthe partners. Such an agreement canbe oral or written. Even though it is notessential to have a written agreement,it is advisable to have a writtenagreement as it constitutes an evidenceof the conditions agreed upon. Thewritten agreement which specifies theterms and conditions that govern thepartnership is called the partnershipdeed.

The partnership deed generallyincludes the following aspects:

Price Waterhouse Coopers was a Partnership Firm earlier

Price Waterhouse Coopers, one of the world’s top accountancy firms has beencreated in 1998 by the merger of two companies, Price Waterhouse and Coopersand Lybrand — each with historical roots going back some 150 years to the19th century Great Britain. In 1850, Samuel Lowell Price set up his accountingbusiness in London. In 1865, he was joined in partnership by William H. Holylandand Edwin Waterhouse. As the firm grew, qualified members of its professionalstaff were admitted to the partnership. By the late 1800s, Price Waterhouse hadgained significant recognition as an accounting firm.

Source: Price Waterhouse Coopers archives in Columbia University.

34 BUSINESS STUDIES

• Name of firm• Nature of business and location of

business• Duration of business• Investment made by each partner• Distribution of profits and losses• Duties and obligations of the

partners• Salaries and withdrawals of the

partners• Terms governing admission,

retirement and expulsion of apartner

• Interest on capital and interest ondrawings

• Procedure for dissolution of thefirm

• Preparation of accounts and theirauditing

• Method of solving disputes

2.4.4 Registration

Registration of a partnership firmmeans the entering of the firm’s name,along with the relevant prescribed par-ticulars, in the Register of firms keptwith the Registrar of Firms. It providesconclusive proof of the existence of apartnership firm.

It is optional for a partnership firmto get registered. In case a firm doesnot get registered, it is deprived ofmany benefits. The consequences ofnon-registration of a firm are as follows:(a) A partner of an unregistered firm

cannot file a suit against the firmor other partners,

(b) The firm cannot file a suit againstthird parties, and

(c) The firm cannot file a case againstthe partners.

In view of these consequences, it istherefore advisable to get the firm reg-istered. According to the Indian Part-nership Act 1932, the partners may getthe firm registered with the Registrarof firms of the state in which the firm issituated. The registration can be at thetime of formation or at any time duringits existence. The procedure for gettinga firm registered is as follows:1. Submission of application in the

prescribed form to the Registrar offirms. The application shouldcontain the following particulars:

• Name of the firm• Location of the firm• Names of other places where the

firm carries on business• The date when each partner joined

the firm• Names and addresses of the

partners• Duration of partnership

This application should be signed byall the partners.2. Deposit of required fees with the

Registrar of Firms.3. The Registrar after approval will

make an entry in the register offirms and will subsequently issuea certificate of registration.

2.5 COOPERATIVE SOCIETY

The word cooperative means workingtogether and with others for a commonpurpose.

The cooperative society is avoluntary association of persons, whojoin together with the motive of welfareof the members. They are driven by the


need to protect their economic interestsin the face of possible exploitation atthe hands of middlemen obsessed withthe desire to earn greater profits.

The cooperative society iscompulsorily required to be registeredunder the Cooperative Societies Act1912. The process of setting up acooperative society is simple enoughand at the most what is required is theconsent of at least ten adult personsto form a society. The capital of asociety is raised from its membersthrough issue of shares. The societyacquires a distinct legal identity afterits registration.

Features

The characteristics of a cooperativesociety are listed below.(i) Voluntary membership: Themembership of a cooperative societyis voluntary. A person is free to join acooperative society, and can also leaveanytime as per his desire. Therecannot be any compulsion for him tojoin or quit a society. Althoughprocedurally a member is required toserve a notice before leaving thesociety, there is no compulsion toremain a member. Membership is opento all, irrespective of their religion,caste, and gender.

(ii) Legal status: Registration of acooperative society is compulsory. Thisaccords a separate identity to the societywhich is distinct from its members. Thesociety can enter into contracts andhold property in its name, sue and besued by others. As a result of being aseparate legal entity, it is not affectedby the entry or exit of its members.(iii) Limited liability: The liability ofthe members of a cooperative society islimited to the extent of the amountcontributed by them as capital. Thisdefines the maximum risk that amember can be asked to bear.(iv) Control: In a cooperative society,the power to take decisions lies in thehands of an elected managingcommittee. The right to vote gives themembers a chance to choose themembers who will constitute themanaging committee and this lends thecooperative society a democraticcharacter.(v) Service motive: The cooperativesociety through its purpose laysemphasis on the values of mutual helpand welfare. Hence, the motive of servicedominates its working. If any surplusis generated as a result of itsoperations, it is distributed amongstthe members as dividend in conformitywith the bye-laws of the society.

Cooperative is a form of organisation wherein persons voluntarily associatetogether as human beings on the basis of equality for the promotion of an economicinterest for themselves.

E. H. CalvertCooperative organisation is “a society which has its objectives for the promotionof economic interests of its members in accordance with cooperative principles.

The Indian Cooperative Societies Act 1912

36 BUSINESS STUDIES

Merits

The cooperative society offers manybenefits to its members. Some of theadvantages of the cooperative form oforganisation are as follows.(i) Equality in voting status: Theprinciple of ‘one man one vote’ governsthe cooperative society. Irrespective ofthe amount of capital contribution bya member, each member is entitled toequal voting rights.(ii) Limited liability: The liability ofmembers of a cooperative society islimited to the extent of their capitalcontribution. The personal assets of themembers are, therefore, safe from beingused to repay business debts.(iii) Stable existence: Death,bankruptcy or insanity of the membersdo not affect continuity of a cooperativesociety. A society, therefore, operatesunaffected by any change in themembership.(iv) Economy in operations: Themembers generally offer honoraryservices to the society. As the focus ison elimination of middlemen, this helpsin reducing costs. The customers orproducers themselves are members ofthe society, and hence the risk of baddebts is lower.(v) Support from government: Thecooperative society exemplifies the ideaof democracy and hence finds supportfrom the Government in the form of lowtaxes, subsidies, and low interest rateson loans.(vi) Ease of formation: Thecooperative society can be started witha minimum of ten members. The

registration procedure is simpleinvolving a few legal formalities. Itsformation is governed by the provisionsof Cooperative Societies Act 1912.

Limitations

The cooperative form of organisationsuffers from the following limitations:(i) Limited resources: Resources of acooperative society consists of capitalcontributions of the members withlimited means. The low rate of dividendoffered on investment also acts as adeterrent in attracting membership ormore capital from the members.(ii) Inefficiency in management:Cooperative societies are unable toattract and employ expert managersbecause of their inability to pay themhigh salaries. The members who offerhonorary services on a voluntary basisare generally not professionallyequipped to handle the managementfunctions effectively.(iii) Lack of secrecy: As a result ofopen discussions in the meetings ofmembers as well as disclosureobligations as per the Societies Act (7),it is difficult to maintain secrecy aboutthe operations of a cooperative society.(iv) Government control: In return ofthe privileges offered by thegovernment, cooperative societies haveto comply with several rules andregulations related to auditing ofaccounts, submission of accounts, etc.Interference in the functioning of thecooperative organisation through thecontrol exercised by the statecooperative departments also negativelyaffects its freedom of operation.


(v) Differences of opinion: Internalquarrels arising as a result of contraryviewpoints may lead to difficulties indecision making. Personal interestsmay start to dominate the welfaremotive and the benefit of othermembers may take a backseat ifpersonal gain is given preference bycertain members.

2.5.1 Types of CooperativeSocieties

Various types of cooperative societiesbased on the nature of their operationsare described below:(i) Consumer’s cooperative societies:The consumer cooperative societies areformed to protect the interests ofconsumers. The members comprise ofconsumers desirous of obtaining goodquality products at reasonable prices.The society aims at eliminatingmiddlemen to achieve economy in

operations. It purchases goods in bulkdirectly from the wholesalers and sellsgoods to the members, therebyeliminating the middlemen. Profits, ifany, are distributed on the basis ofeither their capital contributions to thesociety or purchases made byindividual members.(ii) Producer’s cooperative societies:These societies are set up to protect theinterest of small producers. Themembers comprise of producersdesirous of procuring inputs forproduction of goods to meet thedemands of consumers. The societyaims to fight against the big capitalistsand enhance the bargaining power ofthe small producers. It supplies rawmaterials, equipment and other inputsto the members and also buys theiroutput for sale. Profits among themembers are generally distributed on

Amul’s amazing Cooperative ventures!

Every day Amul collects 4,47,000 litres of milk from 2.12 million farmers (manyilliterate), converts the milk into branded, packaged products, and delivers goodsworth Rs. 6 crore (Rs. 60 million) to over 5,00,000 retail outlets across the country.It all started in December 1946 with a group of farmers keen to free themselvesfrom intermediaries, gain access to markets and thereby ensure maximum returnsfor their efforts. Based in the village of Anand, the Khera District Milk CooperativeUnion (better known as Amul) expanded exponentially. It joined hands with othermilk cooperatives, and the Gujarat network now covers 2.12 million farmers, 10,411village level milk collection centres and fourteen district level plants (unions).Amul is the common brand for most product categories produced by various unions:liquid milk, milk powder, butter, ghee, cheese, cocoa products, sweets, ice-creamand condensed milk. Amul’s sub-brands include variants such as Amulspray,Amulspree, Amulya and Nutramul. The edible oil products are grouped aroundDhara and Lokdhara, mineral water is sold under the Jal Dhara brand whilefruit drinks bear the name Safal.

Source: Adapted from Pankaj Chandra, “Rediff.com”, Business Special, September 2005.

38 BUSINESS STUDIES

the basis of their contributions to thetotal pool of goods produced or soldby the society.(iii) Marketing cooperative societies:Such societies are established to helpsmall producers in selling theirproducts. The members consist ofproducers who wish to obtainreasonable prices for their output. Thesociety aims to eliminate middlemenand improve competitive position of itsmembers by securing a favourablemarket for the products. It pools theoutput of individual members andperforms marketing functions like

(iv) Farmer’s cooperative societies:These societies are established toprotect the interests of farmers byproviding better inputs at a reasonablecost. The members comprise of farmerswho wish to jointly take up farmingactivities. The aim is to gain the benefitsof large scale farming and increase theproductivity. Such societies providebetter quality seeds, fertilisers,machinery and other moderntechniques for use in the cultivation ofcrops. This helps not only in improvingthe yield and returns to the farmers,but also solves the problems associated

transportation, warehousing, packaging,etc., to sell the output at the bestpossible price. Profits are distributedaccording to each member’scontribution to the pool of output.

with the farming on fragmented landholdings.(v) Credit cooperative societies:Credit cooperative societies areestablished for providing easy credit

Table 2.2 Indian Companies in League ofFORTUNE GLOBAL 500 Organisations

Source: Adapted from The Fortune Global 500, July 25, 2005.

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on reasonable terms to the members.The members comprise of persons whoseek financial help in the form of loans.The aim of such societies is to protectthe members from the exploitation oflenders who charge high rates ofinterest on loans. Such societies provideloans to members out of the amountscollected as capital and deposits fromthe members and charge low ratesof interest.(vi) Cooperative housing societies:Cooperative housing societies areestablished to help people with limitedincome to construct houses atreasonable costs. The members of thesesocieties consist of people who aredesirous of procuring residentialaccommodation at lower costs. The aimis to solve the housing problems of themembers by constructing houses andgiving the option of paying ininstalments. These societies constructflats or provide plots to members onwhich the members themselves canconstruct the houses as per their choice.

2.6 JOINT STOCK COMPANY

A company is an association of personsformed for carrying out businessactivities and has a legal statusindependent of its members. Thecompany form of organisation isgoverned by The Companies Act, 1956.A company can be described as anartificial person having a separate legal

entity, perpetual succession and acommon seal.

The shareholders are the owners ofthe company while the Board ofDirectors is the chief managing bodyelected by the shareholders. Usually,the owners exercise an indirect controlover the business. The capital of thecompany is divided into smaller partscalled ‘shares’ which can be transferredfreely from one shareholder to anotherperson (except in a private company).

Features

The definition of a joint stock companyhighlights the following features of acompany.(i) Artificial person: A company is acreation of law and exists independentof its members. Like natural persons,a company can own property, incurdebts, borrow money, enter intocontracts, sue and be sued but unlikethem it cannot breathe, eat, run, talkand so on. It is, therefore, called anartificial person.(ii) Separate legal entity: From theday of its incorporation, a companyacquires an identity, distinct from itsmembers. Its assets and liabilities areseparate from those of its owners. Thelaw does not recognise the businessand owners to be one and the same.(iii) Formation: The formation of acompany is a time consuming,expensive and complicated process. It

Joint stock company is a voluntary association of individuals for profit, havinga capital divided into transferable shares, the ownership of which is the conditionof membership.

Prof. Haney

40 BUSINESS STUDIES

involves the preparation of severaldocuments and compliance with severallegal requirements before it can startfunctioning. Registration of a companyis compulsory as provided under theIndian Companies Act, 1956.

(iv) Perpetual succession: A companybeing a creation of the law, can bebrought to an end only by law. It willonly cease to exist when a specificprocedure for its closure, called windingup, is completed. Members may come

From Strength to Strength — Tata Group of Companies

The Tata Group comprises 91 operating companies in seven business sectors:information systems and communications, engineering, materials, services, energy,consumer products, and chemicals. The Group was founded by Jamsetji Tata inthe last quarter of the 19th century — a period when India had just set out on theroad to gaining independence from British rule. Consequently, Jamsetji Tata andthose who followed him aligned business opportunities with the objective of nationbuilding. This approach remains enshrined in the Group’s ethos to this day.

The Tata Group is one of India’s largest and most respected businessconglomerates, with revenues to the tune of $ 17.6 billion (Rs. 769, 296 million)in the year 2004-05, the equivalent of about 2.9 per cent of the country’s GDP.Tata companies together employ some 2,20,000 people. The Tata Group hasoperations in more than 40 countries across six continents, and its companiesexport products and services to 140 nations.

Five core valuesThe Tata Group has always sought to be a value-driven organisation. These valuescontinue to direct the Group’s growth and businesses. The five core Tata valuesunderpinning the way we do business are:• Integrity: We must conduct our business fairly, with honesty and transparency.

Everything we do must stand the test of public scrutiny.• Understanding: We must be caring, show respect, compassion and humanity

towards our colleagues and customers around the world, and always work forthe benefit of the communities we serve.

• Excellence: We must constantly strive to achieve the highest possible standardsin our day-to-day work and in the quality of the goods and services we provide.

• Unity: We must work cohesively with our colleagues across the Group and withour customers and partners around the world, building strong relationshipsbased on tolerance, understanding and mutual cooperation.

• Responsibility: We must continue to be responsible, sensitive to the countries,communities and environments in which we work, always ensuring that whatcomes from the people goes back to the people many times over.

The Tata Group’s business activities are conducted through 91 companiesoperating in seven business sectors. It has a presence in six continents andholds leadership positions in many industry segments, among them tea, software,automobiles, energy and hospitality. The Tata Group is headed by Group chairmanRatan Tata.

Source: Website of the Tata Group.


and members may go, but the companycontinues to exist.(v) Control: The management andcontrol of the affairs of the company isundertaken by the Board of Directors,which appoints the top managementofficials for running the business. Thedirectors hold a position of immensesignificance as they are directlyaccountable to the shareholders for theworking of the company. Theshareholders, however, do not have theright to be involved in the day-to-dayrunning of the business.(vi) Liability: The liability of themembers is limited to the extent of thecapital contributed by them in acompany. The creditors can use only theassets of the company to settle theirclaims since it is the company and notthe members that owes the debt. Themembers can be asked to contribute tothe loss only to the extent of the unpaidamount of share held by them. SupposeAkshay is a shareholder in a companyholding 2,000 shares of Rs.10 each onwhich he has already paid Rs. 7 pershare. His liability in the event of lossesor company’s failure to pay debts canbe only up to Rs. 6,000 — the unpaidamount of his share capital (Rs. 3 pershare on 2,000 shares held in thecompany). Beyond this, he is not liableto pay anything towards the debts orlosses of the company.(vii) Common seal: The companybeing an artificial person acts throughits Board of Directors. The Board ofDirectors enters into an agreement withothers by indicating the company’sapproval through a common seal. The

common seal is the engraved equivalentof an official signature. Any agreementwhich does not have the company sealput on it is not legally binding onthe company.(viii) Risk bearing: The risk of lossesin a company is borne by all the shareholders. This is unlike the case of soleproprietorship or partnership firmwhere one or few persons respectivelybear the losses. In the face of financialdifficulties, all shareholders in acompany have to contribute to thedebts to the extent of their shares inthe company’s capital. The risk of lossthus gets spread over a large numberof shareholders.

Merits

The company form of organisationoffers a multitude of advantages, someof which are discussed below.(i) Limited liability: The shareholdersare liable to the extent of the amountunpaid on the shares held by them.Also, only the assets of the companycan be used to settle the debts, leavingthe owner’s personal property free fromany charge. This reduces the degree ofrisk borne by an investor.(ii) Transfer of interest: The ease oftransfer of ownership adds to theadvantage of investing in a companyas the share of a public limitedcompany can be sold in the market andas such can be easily converted intocash in case the need arises. Thisavoids blockage of investment andpresents the company as a favourableavenue for investment purposes.

42 BUSINESS STUDIES

(iii) Perpetual existence: Existence ofa company is not affected by the death,retirement, resignation, insolvency orinsanity of its members as it has aseparate entity from its members. Acompany will continue to exist even ifall the members die. It can be liquidatedonly as per the provisions of theCompanies Act.(iv) Scope for expansion: Ascompared to the sole proprietorship andpartnership forms of organisation, acompany has large financial resources.Further, capital can be attracted fromthe public as well as through loans frombanks and financial institutions. Thusthere is greater scope for expansion. Theinvestors are inclined to invest in sharesbecause of the limited liability,transferable ownership and possibilityof high returns in a company.

(v) Professional management: Acompany can afford to pay highersalaries to specialists and professionals.It can, therefore, employ people whoare experts in their area ofspecialisations. The scale of operationsin a company leads to division of work.Each department deals with aparticular activity and is headed by anexpert. This leads to balanced decisionmaking as well as greater efficiency inthe company’s operations.

Limitations

The major limitations of a companyform of organisation are as follows:(i) Complexity in formation: Theformation of a company requiresgreater time, effort and extensiveknowledge of legal requirements andthe procedures involved. As compared

Pen is mightier than the Sword:The Case of Luxor Writing Instruments Pvt. Ltd.

In the year 1963, a young gentleman armed with the power of hard work andambition, started a new era in the field of writing instruments. At a tender age of19, he started a small manual assembly shop in Sadar Bazaar area in Delhiwhere he manufactured fountain pens under the name Luxor WritingInstruments Pvt. Ltd. (LWIPL).

Being awarded the coveted ‘Number One Writing Instruments Exporter’ awardconsecutively for three years, LWIPL has been given the exclusive rights ofmanufacturing and distributing four international brands in India, viz., Pilot,Papermate, Parker and Waterman.

Luxor Writing Instruments Pvt. Ltd. has the largest share of this market of over20 percent, with a turnover pushing way beyond the Rs. 150 crore mark. As oftoday Luxor is a leading manufacturer and exporter of writing instrumentsfrom India. It is currently exporting over 15 percent of the output and hasfour manufacturing facilities in New Delhi and three at Mumbai. It employs over600 people. It is the leader in most segments of the market, manufacturing anddistributing a wide variety of pens for various applications and needs.

Source: http://www.luxorparker.com


to sole proprietorship and partnershipform of organisations, formation of acompany is more complex.(ii) Lack of secrecy: The CompaniesAct requires each public company toprovide from time-to-time a lot ofinformation to the office of the registrarof companies. Such information isavailable to the general public also. Itis, therefore, difficult to maintaincomplete secrecy about the operationsof company.(iii) Impersonal work environment:Separation of ownership andmanagement leads to situations inwhich there is lack of effort as well aspersonal involvement on the part of theofficers of a company. The large size ofa company further makes it difficult forthe owners and top management tomaintain personal contact with theemployees, customers and creditors.(iv) Numerous regulations: Thefunctioning of a company is subject tomany legal provisions and compulsions.A company is burdened with numerousrestrictions in respect of aspects

including audit, voting, filing of reportsand preparation of documents, and isrequired to obtain various certificatesfrom different agencies, viz., registrar,SEBI, etc. This reduces the freedom ofoperations of a company and takes awaya lot of time, effort and money.(v) Delay in decision making:Companies are democratically managedthrough the Board of Directors which isfollowed by the top management, middlemanagement and lower levelmanagement. Communication as well asapproval of various proposals maycause delays not only in takingdecisions but also in acting upon them.(vi) Oligarchic management: Intheory, a company is a democraticinstitution wherein the Board ofDirectors are representatives of theshareholders who are the owners. Inpractice, however, in most large sizedorganisations having a multitude ofshareholders; the owners have minimalinfluence in terms of controlling orrunning the business. It is so becausethe shareholders are spread all over the

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44 BUSINESS STUDIES

country and a very small percentageattend the general meetings. The Boardof Directors as such enjoy considerablefreedom in exercising their power whichthey sometimes use even contrary tothe interests of the shareholders.Dissatisfied shareholders in such a

situation have no option but to sell theirshares and exit the company. As thedirectors virtually enjoy the rights totake all major decisions, it leads to ruleby a few.(vii) Conflict in interests: There maybe conflict of interest amongst various

Bharat Heavy Electricals Limited — A Public Company’s Journey in Quality

Bharat Heavy Electricals Limited (BHEL) is the largest engineering andmanufacturing enterprise in India today in the energy-related/infrastructure sector.BHEL was established more than 40 years ago, ushering in the indigenous heavyelectrical equipment industry in India — a dream that has been more than realisedwith a well-recognised track record of performance. The company has been earningprofits continuously since 1971-72 and paying dividends since 1976-77.

BHEL manufactures over 180 products under 30 major product groups and catersto core sectors of the Indian economy, viz., power generation and transmission,transportation, telecommunication, renewable energy, etc.

BHEL has acquired certifications to Quality Management Systems (ISO 9001),Environmental Management Systems (ISO 14001) and Occupational Health andSafety Management Systems (OHSAS 18001) and is also well on its journey towardsTotal Quality Management.

Major achievements of BHEL include:• Installed equipment for over 90,000 MW of power generation — for utilities,

captive and industrial users.• Supplied over 2,25,000 MVA transformer capacity and other equipment

operating in transmission and distribution network up to 400 kV (AC and DC).• Supplied over 25,000 motors with Drive Control System to power projects,

petrochemicals, refineries, steel, aluminium, fertiliser, cement plants, etc.• Supplied traction electrics and AC/DC locos to power over 12,000 kms railway

network.• Supplied over one million valves to power plants and other industries.

BHEL’s vision is to become a world-class engineering enterprise, committed toenhancing stakeholder value. The company is striving to give shape to its aspirationsand fulfil the expectations of the country to become a global player.

The greatest strength of BHEL is its highly skilled and committed 43,500 employees.Every employee is given an equal opportunity to develop himself and grow in hiscareer. Continuous training and retraining, career planning, a positive work cultureand participative style of management — all these have engendered developmentof a committed and motivated workforce setting new benchmarks in terms ofproductivity, quality and responsiveness.

Source: website of BHEL


stakeholders of a company. Theemployees, for example, may beinterested in higher salaries, consumersdesire higher quality products at lowerprices, and the shareholders wanthigher returns in the form of dividendsand increase in the intrinsic value oftheir shares. These demands poseproblems in managing the company asit often becomes difficult to satisfy suchdiverse interests.

2.6.1 Types of Companies

A company can be either a private or apublic company. These two types ofcompanies are discussed in detail in thefollowing paragraphs.

Private Company

A private company means a companywhich:(a) restricts the right of members to

transfer its shares;(b) has a minimum of 2 and a

maximum of 50 members,excluding the present and pastemployees;

(c) does not invite public to subscribeto its share capital; and

(d) must have a minimum paid upcapital of Rs.1 lakh or such higheramount which may be prescribedfrom time-to-time.

It is necessary for a private companyto use the word private limited after itsname. If a private company contravenesany of the aforesaid provisions, it ceasesto be a private company and loses allthe exemptions and privileges to whichit is entitled.

The following are some of the privilegesof a private limited company as againsta public limited company:1. A private company can be formed

by only two members whereasseven people are needed to form apublic company.

2. There is no need to issue aprospectus as public is not invitedto subscribe to the shares of aprivate company.

3. Allotment of shares can be donewithout receiving the minimumsubscription.

4. A private company can startbusiness as soon as it receives thecertificate of incorporation. Thepublic company, on the otherhand, has to wait for the receipt ofcertificate of commencement beforeit can start a business.

5. A private company needs to haveonly two directors as against theminimum of three directors in thecase of a public company.

6. A private company is not requiredto keep an index of members whilethe same is necessary in the caseof a public company.

7. There is no restriction on theamount of loans to directors in aprivate company. Therefore, thereis no need to take permission fromthe government for granting thesame, as is required in the case ofa public company.

Public Company

A public company means a companywhich is not a private company. As perthe Indian Companies Act, a publiccompany is one which:

46 BUSINESS STUDIES

(a) has a minimum paid-up capital ofRs. 5 lakhs or a higher amountwhich may be prescribed fromtime-to-time;

(b) has a minimum of 7 members andno limit on maximum members;

(c) has no restriction on transfer ofshares; and

(d) is not prohibited from inviting thepublic to subscribe to its sharecapital or public deposits.

A private company which is a subsid-iary of a public company is also treatedas a public company.

2.7 CHOICE OF FORM OF BUSINESS

ORGANISATION

After studying various forms ofbusiness organisations, it is evidentthat each form has certain advantagesas well as disadvantages. It, therefore,becomes vital that certain basicconsiderations are kept in mind whilechoosing an appropriate form of

organisation. The important factorsdetermining the choice of organisationare listed in Table 2.4 and are discussedbelow:(i) Cost and ease in setting up theorganisation: As far as initial businesssetting-up costs are concerned, soleproprietorship is the most inexpensiveway of starting a business. However, thelegal requirements are minimum andthe scale of operations is small. In caseof partnership also, the advantage ofless legal formalities and lower cost isthere because of limited scale ofoperations. Cooperative societies andcompanies have to be compulsorilyregistered. Formation of a companyinvolves a lengthy and expensive legalprocedure. From the point of view ofinitial cost, therefore, sole proprietorshipis the preferred form as it involves leastexpenditure. Company form oforganisation, on the other hand, is morecomplex and involves greater costs.

Table 2.4 Factors influencing the choice of form of Business Organisation

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48 BUSINESS STUDIES

(ii) Liability: In case of soleproprietorship and partnership firms, theliability of the owners/partners isunlimited. This may call for paying thedebt from personal assets of the owners.In joint Hindu family business, only thekarta has unlimited liability. Incooperative societies and companies,however, liability is limited and creditorscan force payment of their claims only tothe extent of the company’s assets.Hence, from the point of view of investors,the company form of organisation is moresuitable as the risk involved is limited.(iii) Continuity: The continuity of soleproprietorship and partnership firms isaffected by such events as death,insolvency or insanity of the owners.However, such factors do not affect thecontinuity of business in the case oforganisations like joint Hindu familybusiness, cooperative societies andcompanies. In case the business needsa permanent structure, company formis more suitable. For short termventures, proprietorship or partnershipmay be preferred.(iv) Management ability: A soleproprietor may find it difficult to haveexpertise in all functional areas ofmanagement. In other forms oforganisations like partnership andcompany, there is no such problem.Division of work among the membersin such organisations allows themanagers to specialise in specific areas,leading to better decision making. Butthis may lead to situations of conflictsbecause of differences of opinionamongst people. Further, if theorganisation’s operations are complex

in nature and require professionalisedmanagement, company form oforganisation is a better alternative.Proprietorship or partnership may besuitable, where simplicity of operationsallow even people with limited skills torun the business. Thus, the nature ofoperations and the need forprofessionalised management affect thechoice of the form of organisation.(v) Capital considerations: Companiesare in a better position to collect largeamounts of capital by issuing sharesto a large number of investors.Partnership firms also have theadvantage of combined resources of allpartners. But the resources of a soleproprietor are limited. Thus, if the scaleof operations is large, company formmay be suitable whereas for mediumand small sized business one can optfor partnership or sole proprietorship.Further, from the point of view ofexpansion, a company is more suitablebecause of its capability to raise morefunds and invest in expansion plans.It is precisely for this purpose that inour opening case Neha’s fathersuggested she should considerswitching over to the company form oforganisation.(vi) Degree of control: If direct controlover operations and absolute decisionmaking power is required,proprietorship may be preferred. Butif the owners do not mind sharingcontrol and decision making,partnership or company form oforganisation can be adopted. Theadded advantage in the case ofcompany form of organisation is that


there is complete separation ofownership and management and it isprofessionals who are appointed toindependently manage the affairs ofa company.(vii) Nature of business: If directpersonal contact is needed with thecustomers such as in the case of a grocerystore, proprietorship may be moresuitable. For large manufacturing units,however, when direct personal contactwith the customer is not required, thecompany form of organisation may beadopted. Similarly, in cases where servicesof a professional nature are required,partnership form is much more suitable.

It would not be out of place tomention here that the factors statedabove are inter-related. Factors likecapital contribution and risk vary withthe size and nature of business, andhence a form of business organisationthat is suitable from the point of viewof the risks for a given business whenrun on a small scale might not be

appropriate when the same businessis carried on a large scale. It is,therefore, suggested that all the relevantfactors must be taken intoconsideration while making a decisionwith respect to the form of organisationthat should be adopted.

2.8 A COMPARATIVE ASSESSMENT OF

DIFFERENT FORMS OF BUSINESS

ORGANISATIONS

By now it is clear to you as to what thedifferent forms of organisations are andin what ways they help or hamper thecommencement and conduct of thebusiness. The discussion so far hasbeen on a piecemeal basis, examiningfeatures of each form of businessorganisations one by one. In Table 2.5,we analysed characteristics of differentforms of organisations taken togetherso as to enable you to understand on acomparative basis as to where a formof organisation stands in comparisonto others in respect of select features.

Key Terms

Sole proprietorship Partnership Karta Mutual agency

Unlimited liability Company Perpetual succession Artificial person

Common seal Subsidiary Holding company Registration

Dayabhaga Mitakashara Co-parceners Joint Hindufamily business

SUMMARY

Forms of business organisation refers to the types of organisations whichdiffer in terms of ownership and management. The major forms oforganisation include proprietorship, partnership, joint Hindu familybusiness, cooperative society and company.

50 BUSINESS STUDIES

Sole proprietorship refers to a form of organisation where business is owned,managed and controlled by a single individual who bears all the risks andis the only recipient of all the profits. Merits of this form of organisationinclude quick decision making, direct incentive, personal satisfaction, andease of formation and closure. But this form of organisation suffers fromlimitations of limited resources, unstable life span of business, unlimitedliability of sole proprietor and his/her limited managerial ability.

Partnership is defined as an association of two or more persons who agreeto carry on a business together and share the profits as well as bear riskscollectively. Major advantages of partnership are: ease of formation andclosure, benefits of specialisation, greater funds, and reduction of risk. Majorlimitations of partnership are unlimited liability, possibility of conflicts,lack of continuity and lack of public confidence. As there are different typesof partners such as active, sleeping, secret and nominal partners; so is thecase with types of partnerships which can vary from general partnership,limited partnership, partnership at will to particular partnership.

Joint Hindu family business is a business owned and carried on by themembers of a Hindu Undivided Family, which is governed by the Hindulaw. Karta — the oldest male member of the family — controls the business.The strong points of joint Hindu family business include effective control,stability in existence, limited liability and increased loyalty among familymembers. But this form of organisation too suffers from certain limitationssuch as limited resources, lack of incentives, dominance of the karta andlimited managerial ability.

A cooperative society is a voluntary association of persons who get togetherto protect their economic interests. The major advantages of a cooperativesociety are equality in voting, members’ limited liability, stable existence,economy in operations, support from government, and ease of formation.But this form of organisation suffers from weaknesses such as limitedresources, inefficiency in management, lack of secrecy, government control,and differences among members in regard to the way society should bemanaged and organised. Based on their purpose and nature of members,various types of societies that can be formed include: consumers cooperativesociety, producers cooperative society, marketing cooperative society, farmerscooperative society, credit cooperative society, and cooperative housingsociety.

A company, on the other hand, may be defined as an artificial person,existing only in the eyes of the law with perpetual succession, having aseparate legal identity and a common seal. While major advantages of acompany form of organisation are members’ limited liability, transfer ofinterest, stable existence, scope for expansion, and professionalmanagement; its key limitations are: complexity in formation, lack of secrecy,impersonal work environment, numerous regulations, delay in decision


making, oligarchic management, and conflict of interests among differentshareholders.

Companies can be of two types — private and public. A private company isone which restricts transfer of shares and does not invite the public tosubscribe to its shares. A public company, on the other hand, is allowed toraise its funds by inviting the public to subscribe to its share capital.Furthermore, there is a free transferability of shares in the case of a publiccompany.

Choice of form of organisation: Selection of an appropriate form oforganisation can be made after taking various factors into consideration.Initial costs, liability, continuity, capital considerations, managerial ability,degree of control and nature of business are the key factors that need totaken into account while deciding about the suitable form of organisationfor one’s business.

EXERCISES


Tick the appropriate answer

1. The structure in which there is separation of ownership and managementis called(a) Sole proprietorship (b) Partnership(c) Company (d) All business

organisations

2. The karta in Joint Hindu family business has(a) Limited liability (b) Unlimited liability(c) No liability for debts (d) Joint liability

3. In a cooperative society the principle followed is(a) One share one vote (b) One man one vote(c) No vote (d) Multiple votes

4. The board of directors of a joint stock company is elected by(a) General public (b) Government bodies(c) Shareholders (d) Employees

5. The maximum number of partners allowed in the banking business are(a) Twenty (b) Ten(c) No limit (d) Two

6. Profits do not have to be shared. This statement refers to(a) Partnership (b) Joint Hindu family business(c) Sole proprietorship (d) Company

52 BUSINESS STUDIES

7. The capital of a company is divided into number of parts each one ofwhich are called(a) Dividend (b) Profit(c) Interest (d) Share

8. The Head of the joint Hindu family business is called(a) Proprietor (b) Director(c) Karta (d) Manager

9. Provision of residential accommodation to the members at reasonablerates is the objective of(a) Producer’s cooperative (b) Consumer’s cooperative(c) Housing cooperative (d) Credit cooperative

10. A partner whose association with the firm is unknown to the generalpublic is called(a) Active partner (b) Sleeping partner(c) Nominal partner (d) Secret partner


1. For which of the following types of business do you think a soleproprietorship form of organisation would be more suitable, and why?(a) Grocery store (b) Medical store(c) Legal consultancy (d) Craft centre(e) Internet café (f) Chartered accountancy

firm.

2. For which of the following types of business do you think a partnershipform of organisation would be more suitable, and why?(a) Grocery store (b) Medical clinic(c) Legal consultancy (d) Craft centre(e) Internet café (f) Chartered accountancy

firm3. Explain the following terms in brief

(a) Perpetual succession (b) Common seal(c) Karta (d) Artificial person

4. Compare the status of a minor in a Joint Hindu Family Business withthat in a partnership firm.

5. If registration is optional, why do partnership firms willingly go throughthis legal formality and get themselves registered? Explain.

6. State the important privileges available to a private company.

7. How does a cooperative society exemplify democracy and secularism?Explain.

8. What is meant by ‘partner by estoppel’? Explain.



1. What do you understand by a sole proprietorship firm? Explain its meritsand limitation?

2. Why is partnership considered by some to be a relatively unpopularform of business ownership? Explain the merits and limitations ofpartnership.

3. Why is it important to choose an appropriate form of organisation?Discuss the factors that determine the choice of form of organisation.

4. Discuss the characteristics, merits and limitation of cooperative formof organisation. Also describe briefly different types of cooperativesocieties.

5. Distinguish between a Joint Hindu family business and partnership.

6. Despite limitations of size and resources, many people continue to prefersole proprietorship over other forms of organisation? Why?

Application Questions

1. In which form of organisation is a trade agreement made by one ownerbinding on the others? Give reasons to support your answer.

2. The business assets of an organisation amount to Rs. 50,000 but thedebts that remain unpaid are Rs. 80,000. What course of action canthe creditors take if(a) The organisation is a sole proprietorship firm(b) The organisation is a partnership firm with Anthony and Akbar as

partners. Which of the two partners can the creditors approachfor repayment of debt? Explain giving reasons

3. Kiran is a sole proprietor. Over the past decade, her business has grownfrom operating a neighbourhood corner shop selling accessories suchas artificial jewellery, bags, hair clips and nail art to a retail chain withthree branches in the city. Although she looks after the varied functionsin all the branches, she is wondering whether she should form acompany to better manage the business. She also has plans to openbranches countrywide.

(a) Explain two benefits of remaining a sole proprietor(b) Explain two benefits of converting to a joint stock company(c) What role will her decision to go nationwide play in her choice of

form of the organisation?(d) What legal formalities will she have to undergo to operate business

as a company?

54 BUSINESS STUDIES


Divide students into teams to work on the following(a) To study the profiles of any five neighbourhood grocery/stationery

store(b) To conduct a study into the functioning of a Joint Hindu family

businesses(c) To enquire into the profile of five partnerships firms(d) To study the ideology and working of cooperative societies in the

area(e) To study the profiles of any five companies (inclusive of both private

and public companies)

Notes

1. Some of the following aspects can be assigned to the students forundertaking above mentioned studies.

Nature of business, size of the business measured in terms of capitalemployed, number of persons working, or sales turnover, problems faced,Incentive, reason behind choice of a particular form, decision makingpattern, willingness to expand and relevant considerations, Usefulnessof a form, etc.

2. Students teams should be encouraged to submit their findings andconclusions in the form of project reports and multi-media presentations.

CHAPTER 3

PRIVATE, PUBLIC AND GLOBAL ENTERPRISES

LEARNING OBJECTIVES


• explain the concept and characteristics of business;

• explain the features of different forms of public enterprises viz.,departmental, statutory corporations and government companies;

• critically examine the changing role of the public sector;

• explain the features of global enterprises; and

• appreciate the benefits of joint ventures.

56 BUSINESS STUDIES

3.1 INTRODUCTION

You must have come across all typesof business organisations in your dailylife. In your neighbourhood market,there are shops owned by soleproprietors or big retail organisationsrun by a company. Then there arepeople providing you services like legalservices, medical services, being ownedby more than one person i.e.,partnership firms. These are allprivately owned organisations.Similarly, there are other offices orplaces of business which may be ownedby the government. For example,Railways is an organisation whollyowned and managed by thegovernment. The post office, in yourlocality is owned by the Post andTelegraph Department, Government ofIndia, though our dependence on theirpostal services, particularly in cities

and towns has been greatly reduced.This is because of plenty of privatecourier services firms operating inbigger towns. Then there are businesseswhich operate in more than one countryknown as global enterprises. Therefore,you may have observed that all typesof organisations are doing business inthe country whether they are public,private or global. In this chapter weshall be studying how the economy isdivided into two sectors, public andprivate, the different types of publicenterprises, their role and that of theglobal enterprises.

3.2 PRIVATE SECTOR AND PUBLIC

SECTOR

There are all kinds of businessorganisations — small or large,industrial or trading, privately ownedor government owned existing in our

Anita, a student of class XI, was going through some newspapers. The headlinesstared at her face, Government plans to disinvest its shares in a few companies.The next day there was another news item on one public sector company incurringheavy losses and the proposal for closing the same. In contrast to this, she readanother item on how some of the companies under the private sector were doingso well. She was actually curious to know what these terms like public sector,disinvestment, privatisation meant. She realised that in certain areas therewas only the government which operates like the railways and in some areasboth the privately owned and government run business were operating. Forexample, in the heavy industry sector SAIL, BHEL and TISCO, Reliance, Birlasall were there and in the telecom sector, companies like Tata, Reliance, Airteloperate and in airlines Sahara and Jet have recently gained entry. Thesecompanies along with the Government-owned companies like MTNL, BSNL, IndianAirlines, Air India. She then started wondering where from companies like Cocacola, Pepsi, Hyundai came? Were they always here or did they operate somewhereelse, in some other country. She went to the library and was surprised to knowthat there was so much information about all these in books, business magazinesand newspapers.

57PRIVATE, PUBLIC AND GLOBAL ENTERPRISES

country. These organisations affect ourdaily economic life and thereforebecome part of the Indian economy.Since the Indian economy consists ofboth privately owned and governmentowned business enterprises, it isknown as a mixed economy. TheGovernment of India has opted for amixed economy where both private andgovernment enterprises are allowed tooperate. The economy, therefore, maybe classified into two sectors viz.,private sector and public sector.

The private sector consists ofbusiness owned by individuals or agroup of individuals, as you havelearnt in the previous chapter. Thevarious forms of organisation aresole proprietorship, partnership,joint Hindu family, cooperativeand company.

The public sector consists ofvarious organisations owned andmanaged by the government. Theseorganisations may either be partly orwholly owned by the central or stategovernment. They may also be a partof the ministry or come into existenceby a Special Act of the Parliament. Thegovernment, through these enterprisesparticipates in the economic activitiesof the country.

The government in its industrialpolicy resolutions, from time-to-time,defines the area of activities in whichthe private sector and public sector areallowed to operate. In the IndustrialPolicy Resolution 1948, theGovernment of India had specified theapproach towards development of theindustrial sector. The roles of the

private and public sector were clearlydefined and the government throughvarious Acts and Regulations wasoverseeing the economic activities ofboth the private and public sector. TheIndustrial Policy Resolution, 1956 hadalso laid down certain objectives for thepublic sector to follow so as toaccelerate the rate of growth andindustrialisation. The public sector wasgiven a lot of importance but at thesame time mutual dependency ofpublic and private sectors wasemphasised. The 1991 industrialpolicy was radically different from allthe earlier policies where thegovernment was deliberatingdisinvestment of public sector andallowing greater freedom to the privatesector. At the same time, foreign directinvestment was invited from businesshouses outside India. Thus,multinational corporations or globalenterprises which operate in more thanone country gained entry into theIndian economy. Thus, we have publicsector units, private sector enterprisesand global enterprises coexisting in theIndian economy.

3.3 FORMS OF ORGANISING PUBLIC

SECTOR ENTERPRISES

Government’s participation in businessand economic sectors of the countryneeds some kind of organisationalframework to function. You havestudied about the forms of businessorganisation in the private sector viz.,sole proprietorship, partnership, Hinduundivided family, cooperative andcompany.

58 BUSINESS STUDIES

In the public sector, as it grows, animportant question arises in respect ofhow it is to be organised or what formof organisation it should take. Thegovernment has a major role to play inthe formation of the public sector. Butthe government acts through its people,its offices, employees and they takedecisions on behalf of the government.For this purpose, public enterpriseswere formed by the government toparticipate in the economic activities ofthe country. They are expected tocontribute to the economic deve-lopment of the country in today’sliberalised, competitive world. Thesepublic enterprises are owned by thepublic and are accountable to thepublic through the Parliament. Theyare characterised by public ownership,public funds being used for its activitiesand public accountability.

A public enterprise may take anyparticular form of organisationdepending upon the nature of itsoperations and their relationship withthe government. The suitability of aparticular form of organisation woulddepend upon its requirements. At thesame time, in accordance with generalprinciples, any organisation in thepublic sector should ensure organisationalperformance productivity and qualitystandards.

The forms of organisation which apublic enterprise may take are asfollows:(i) Departmental undertaking(ii) Statutory corporation(iii) Government company

3.3.1 Departmental Undertakings

This is the oldest and most traditionalform of organising public enterprises.

Indian Economy

Public Sector Private Sector

DepartmentalUndertakings

StatutoryCorporation

GovernmentCompanies

Private(Ltd.)

SoleProperietorship

Partnership JointHinduFamily

Cooperative

Company

Public(Ltd.)

MultinationalCorporations


These enterprises are established asdepartments of the ministry and areconsidered part or an extension of theministry itself. The Governmentfunctions through these departmentsand the activities performed by themare an integral part of the functioningof the government. They have not beenconstituted as autonomous orindependent institutions and as suchare not independent legal entities. Theyact through the officers of theGovernment and its employees areGovernment employees. Theseundertakings may be under the centralor the state government and the rulesof central/state government areapplicable. Examples of theseundertakings are railways and postand telegraph department.

Features

The main characteristics ofDepartmental undertakings are asfollows:

(i) The funding of these enterprisescome directly from the Govern-ment Treasury and are an annualappropriation from the budget ofthe Government. The revenueearned by these is also paid intothe treasury;

(ii) They are subject to accountingand audit controls applicable toother Government activities;

(iii) The employees of the enterprise areGovernment servants and theirrecruitment and conditions ofservice are the same as that ofother employees directly under theGovernment. They are headed by

Indian Administrative Service (IAS)officers and civil servants who aretransferable from one ministry toanother;

(iv) It is generally considered to bea major subdivision of theGovernment department and issubject to direct control of theministry;

(v) They are accountable to theministry since their managementis directly under the concernedministry.

Merits

Departmental undertakings havecertain advantages which are as follows:

(i) These undertakings facilitate theParliament to exercise effectivecontrol over their operations;

(ii) These ensure a high degree ofpublic accountability;

(iii) The revenue earned by theenterprise goes directly to thetreasury and hence is a source ofincome for the Government;

(iv) Where national security isconcerned, this form is mostsuitable since it is under the directcontrol and supervision of theconcerned Ministry.

Limitations

This form of organisation suffers fromserious drawbacks, some of which areas follows:

(i) Departmental undertakings fail toprovide flexibility, which is essentialfor the smooth operation of business;

(ii) The employees or heads of depart-ments of such undertakings are

60 BUSINESS STUDIES

not allowed to take independentdecisions, without the approval ofthe ministry concerned. This leadsto delays, in matters whereprompt decisions are required;

(iii) These enterprises are unable totake advantage of businessopportunities. The bureaucrat’sover-cautious and conservativeapproval does not allow them totake risky ventures;

(iv) There is red tapism in day-to-dayoperations and no action can betaken unless it goes through theproper channels of authority;

(v) There is a lot of political inter-ference through the ministry;

(vi) These organisations are usuallyinsensitive to consumer needs anddo not provide adequate servicesto them.

3.3.2 Statutory Corporations

Statutory corporations are publicenterprises brought into existence bya Special Act of the Parliament. The Actdefines its powers and functions, rulesand regulations governing itsemployees and its relationship withgovernment departments.

This is a corporate body created bythe legislature with defined powers andfunctions and is financially independentwith a clear control over a specifiedarea or a particular type of commercialactivity. It is a corporate person andhas the capacity of acting in its ownname. Statutory corporations thereforehave the power of the government andconsiderable amount of operatingflexibility of private enterprises.

Features

Statutory corporations have certaindistinct features, which are discussedas below:

(i) Statutory corporations are set upunder an Act of Parliament andare governed by the provisions ofthe Act. The Act defines the objects,powers and privileges of astatutory corporation;

(ii) This type of organisation is whollyowned by the state. Thegovernment has the ultimatefinancial responsibility and hasthe power to appropriate itsprofits. At the same time, the statealso has to bear the losses, if any;

(iii) A statutory corporation is a bodycorporate and can sue and besued, enter into contract andacquire property in its own name;

(iv) This type of enterprise is usuallyindependently financed. It obtainsfunds by borrowings from thegovernment or from the publicthrough revenues, derived fromsale of goods and services. It hasthe authority to use its revenues;

(v) A statutory corporation is notsubject to the same accountingand audit procedures applicableto government departments. It isalso not concerned with the centralbudget of the Government;

(vi) The employees of these enterprisesare not government or civilservants and are not governed bygovernment rules and regulations.The conditions of service of theemployees are governed by theprovisions of the Act itself. At


times, some officers are takenfrom government departments,on deputation, to head theseorganisations.

Merits

This form of organisation enjoys certainadvantages in its working, which areas follows:

(i) They enjoy independence in theirfunctioning and a high degree ofoperational flexibility. They are freefrom undesirable governmentregulation and control;

(ii) Since the funds of these organi-sations do not come from thecentral budget, the governmentgenerally does not interfere in theirfinancial matters, including theirincome and receipts;

(iii) Since they are autonomousorganisations they frame their ownpolicies and procedures within thepowers assigned to them by theAct. The Act may, however,provide few issues/matters whichrequire prior approval of aparticular ministry;

(vi) A statutory corporation is avaluable instrument for economicdevelopment. It has the power ofthe government, combined withthe initiative of private enterprises.

Limitations

This type of organisation suffers fromseveral limitations, which are as follows:

(i) In reality, a statutory corporationdoes not enjoy as much operational

flexibility as stated above. Allactions are subject to many rulesand regulations;

(ii) Government and political inter-ference has always been there inmajor decisions or where hugefunds are involved;

(iii) Where there is dealing with public,rampant corruption exists;

(iv) The government has a practice ofappointing advisors to theCorporation Board. This curbs thefreedom of the corporation inentering into contracts andother decisions. If there is anydisagreement, the matter isreferred to the government for finaldecisions. This further delays action.

3.3.3 Government Company

A Government company is establishedunder the Indian Companies Act, 1956and is registered and governed by theprovisions of the Indian Companies Act.These are established for purelybusiness purposes and in true spiritcompete with companies in the privatesector.

According to the Indian CompaniesAct 1956, a government companymeans any company in which not lessthan 51 percent of the paid up capitalis held by the central government, orby any state government or partly bycentral government and partly by oneor more state governments.

From the above definition, it is clearthat the government exercises controlover the paid up share capital of thecompany. The shares of the companyare purchased in the name of the

62 BUSINESS STUDIES

President of India. Since thegovernment is the major shareholderand exercises control over themanagement of these companies, theyare known as government companies.

Features

Government companies have certaincharacteristics which makes themdistinct from other forms oforganisations. These are discussed asfollows:

(i) It is an organisation created by theIndian Companies Act, 1956;

(ii) The company can file a suit in acourt of law against any thirdparty and be sued;

(iii) The company can enter into acontract and can acquire propertyin its own name;

(iv) The management of the companyis regulated by the provisions ofthe Companies Act, like any otherpublic limited company;

(v) The employees of the company areappointed according to their ownrules and regulations as containedin the Memorandum and Articlesof Association of the company.The Memorandum and Articles ofAssociation are the maindocuments of the company,containing the objects of thecompany and its rules andregulations;

(vi) These companies are exemptedfrom the accounting and auditrules and procedures. An auditoris appointed by the CentralGovernment and the Annual

Report is to be presented in theparliament or the state legislature;

(vii) The government company obtainsits funds from governmentshareholdings and other privateshareholders. It is also permittedto raise funds from the capitalmarket.

Merits

Government companies enjoy severaladvantages, which are as follows:

(i) A government company can beestablished by fulfilling therequirements of the IndianCompanies Act. A separate Act inthe Parliament is not required;

(ii) It has a separate legal entity, apartfrom the Government;

(iii) It enjoys autonomy in allmanagement decisions and takesactions according to businessprudence;

(iv) These companies by providinggoods and services at reasonableprices are able to control themarket and curb unhealthybusiness practices.

Limitations

Despite the autonomy given to thesecompanies, they have certain dis-advantages:

(i) Since the Government is the onlyshareholder in some of theCompanies, the provisions of theCompanies Act does not havemuch relevance;

(ii) It evades constitutional res-ponsibility, which a company


financed by the governmentshould have. It is not answerabledirectly to the Parliament;

(iii) The government being the soleshareholder, the management andadministration rests in the handsof the government. The mainpurpose of a government com-pany, registered like othercompanies, is defeated.

The Indian economy is in a stageof transition. The Five Year Plans inthe initial stages of development gavelot of importance to the public sector.In the post 90’s period, the neweconomic policies, emphasisedliberalisation, privatisation andglobalisation. The role of public sectorwas redefined. It was not supposedto play a passive role but to actively

3.4 CHANGING ROLE OF PUBLIC SECTOR

At the time of Independence, it wasexpected that the public sectorenterprises would play an importantrole in achieving certain objectives ofthe economy either by directparticipation in business or by actingas a catalyst. The public sector wouldbuild up infrastructure for other sectorsof the economy and invest in key areas.The private sector was unwilling toinvest in projects which required heavyinvestment and had long gestationperiods. The government then took itupon itself to develop infrastructuralfacilities and provide for goods andservices essential for the economy.

participate and compete in the marketwith other private sector companiesin the same industry. They were alsoheld accountable for losses andreturn on investment. If a publicsector was making lossescontinuously, it was referred to theBoard for Industrial and FinancialReconstruction (BIFR) for completeoverhauling or shut down. Variouscommittees were set up to study theworking of inefficient public sectorunits with reports on how to improvetheir managerial efficiency andprofitability. The role of public sectoris definitely not what was envisagedin the early 60’s or 70’s.

State Bank of India

Which bank has the most number of ATMs across India? Which bank has thelargest coverage network across India? State Bank of India is one such bank. Itspenetration, particularly in the rural sectors, and its sheer tonnage of customershas been well documented in the past. SBI undertook an enormous imageoverhauling effort in 2005. SBI has revamped its operations to make itself morecontemporary, tech-savy and customer friendly, shedding the slipshod style ofworking that has been the bane of PSU banks growing at an annual rate of 16percent, indicating that all is well for the time being. If SBI is able to sustain thisrate of growth, modernise its operations and increase its visibility among theurban populace, the image of public sector banks will definitely improve.

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(i) Development of infrastructure:The development of infrastructure is aprerequisite for industrialisation in anycountry. In the pre-Independenceperiod, basic infrastructure was notdeveloped and therefore, industrialisationprogressed at a very slow pace. Theprocess of industrialisation cannotbe sustained without adequatetransportation and communicationfacilities, fuel and energy, and basic andheavy industries. The private sector didnot show any initiative to invest in heavyindustries or develop it in any manner.They did not have trained personnel orfinances to immediately establish heavyindustries which was the requirementof the economy.

It was only the government whichcould mobilise huge capital, coordinateindustrial construction and traintechnicians and workforce. Rail, road,sea and air transport was theresponsibility of the government, andtheir expansion has contributed to thepace of industrialisation and ensuredfuture economic growth. The publicsector enterprises were to operate incertain spheres. Investments were to bemade to:(a) Give infrastructure to the core

sector, which requires huge capitalinvestment, complex and upgradedtechnology, big and effectiveorganisation structures like steelplants, power generation plants,civil aviation, railways, petroleum,state trading, coal, etc;

(b) Give a lead in investment to the coresector where private sector

enterprises are not functioning inthe desired direction, like fertilizers,pharmaceuticals, petro-chemicals,newsprint, medium and heavyengineering;

(c) Give direction to future investmentslike hotels, project management,consultancies, textiles, auto-mobiles, etc.

(ii) Regional balance: The governmentis responsible for developing all regionsand states in a balanced way andremoving regional disparties. Most ofthe industrial progress was limited toa few areas like the port towns in thepre-Independence period. After 1951,the government laid down in its FiveYear Plans, that particular attentionwould be paid to those regions whichwere lagging behind and public sectorindustries were deliberately set up.Four major steel plants were set up inthe backward areas to accelerateeconomic development, provideemployment to the workforce anddevelop ancilliary industries. This wasachieved to some extent but there isscope for a lot more. Development ofbackward regions so as to ensure aregional balance in the country is oneof the major objectives of planneddevelopment. Therefore, the govern-ment had to locate new enterprises inbackward areas and at the same timeprevent the mushrooming growth ofprivate sector units in alreadyadvanced areas.(iii) Economies of scale: Where largescale industries are required to be setup with huge capital outlay, the public


sector had to step in to take advantageof economies of scale. Electric powerplants, natural gas, petroleum andtelephone industries are someexamples of the public sector settingup large scale units. These unitsrequired a larger base to functioneconomically which was only possiblewith government resources and massscale production.(iv) Check over concentration ofeconomic power: The public sectoracts as a check over the private sector.In the private sector there are very fewindustrial houses which would bewilling to invest in heavy industrieswith the result that wealth getsconcentrated in a few hands andmonopolostic practices are encouraged.This gives rise to inequalities in income,which is detrimental to society.

The public sector is able to set largeindustries which requires heavyinvestment and thus the income andbenefits that accrue are shared by alarge of number of employees andworkers. This prevents concentrationof wealth and economic power in theprivate sector.(v) Import substitution: During thesecond and third Five Year Plan period,India was aiming to be self-reliant inmany spheres. Obtaining foreignexchange was also a problem and itwas difficult to import heavy machineryrequired for a strong industrial base.At that time, public sector companiesinvolved in heavy engineering whichwould help in import substitution wereestablished. Simultaneously, several

public sector companies like STC andMMTC have played an important rolein expanding exports of the country.(vi) Government policy towards thepublic sector since 1991: TheGovernment of India had introducedfour major reforms in the public sectorin its new industrial policy in 1991. Themain elements of the Government policyare as follows:

• Restructure and revive potentiallyviable PSUs

• Close down PSUs, which cannotbe revived

• Bring down governments equity inall non-strategic PSUs to 26 percent or lower, if necessary; and

• Fully protect the interest ofworkers.

(a) Reduction in the number ofindustries reserved for the publicsector from 17 to 8 (and then to 3):In the 1956 resolution on Industrialpolicy, 17 industries were reservedfor the public sector. In 1991, only8 industries were reserved forthe public sector, they were restrictedto atomic energy, arms andcommunication, mining, andrailways. In 2001, only threeindustries were reserved exclusivelyfor the public sector. These areatomic energy, arms and railtransport. This meant that the privatesector could enter all areas (exceptthe three) and the public sectorwould have to compete with them.The public sector has played a vital

role in the development of theeconomy. However, the private sector

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is also quite capable of contributingsubstantially to the nation buildingprocess. Therefore, both the publicsector and the private sector need tobe viewed as mutually complementaryparts of the national sector. Privatesector units also have to assumegreater public responsibilities.Simultaneously, the public sectorneeds to focus on achieving more in ahighly competitive market.(b) Disinvestment of shares of

a select set of public sectorenterprises: Disinvestment involvesthe sale of the equity shares to theprivate sector and the public. Theobjective was to raise resources andencourage wider participation of thegeneral public and workers in theownership of these enterprises. Thegovernment had taken a decision towithdraw from the industrial sectorand reduce its equity in allundertakings. It was expected that

this would lead to improvingmanagerial performance andensuring financial discipline. Butthere remains a lot to be done inthis area.

The primary objectives of privatisingpublic sector enterprises are:

• Releasing the large amount ofpublic resources locked up in non-strategic Public Sector Enterprises(PSEs), so that they may be utilisedon other social priority areas suchas basic health, family welfare andprimary education.

• Reducing the huge amount ofpublic debt and interest burden;

• Transferring the commercial riskto the private sector so that thefunds are invested in able projects;

• Freeing these enterprises fromgovernment control andintroduction of corporategovernance; and

• In many areas where the public

Privatisation in India

The Lagan Jute Machinery Company Limited (LJMC) was the first case ofsuccessful privatisation of a Central Public Sector Undertaking, carried out bythe Government. LJMC is a Calcutta-based company, and manufactures jutemachinery (mainly spinning and drawing frames). It employed around 400employees prior to privatisation. It started incurring losses from 1996-97 onwardand the turnover was on a decline. LJMC’s net worth as on March 1998 wasaround Rs. 5 crore and its annual turnover was also around Rs. 5 crore atthat time.

In the initial stages of disinvestment, LJMC was approved for privatisationthrough sale of 74 per cent stake to a strategic partner. The disinvestment processwas handled by LJMC’s holding company, Bharat Bhari Udyog Nigam LImited(BBUNL), under the administrative control and directions of the then Departmentof Heavy Industries (DHI), Ministry of Industry, Government of India.


sector had a monopoly, forexample, telecom sector theconsumers have benefitted by morechoices, lower prices and betterquality of products and services.

(c) Policy regarding sick units to bethe same as that for the privatesector: All public sector units werereferred to the Board of Industrialand Financial Reconstruction todecide whether a sick unit was tobe restructured or closed down. TheBoard has reconsidered revival andrehabilitation schemes for somecases and winding up for a numberof units. There is a lot of resentmentamongst workers of the units whichare to be closed down. A NationalRenewal Fund was set up by thegovernment to retrain or redeployretrenched labour and to providecompensation to public sectoremployees seeking voluntaryretirement.

There are many enterpriseswhich are sick and not capable ofbeing revived as they haveaccumulated huge losses. Withpublic finances under intensepressure, both central and stategovernment are just not able tosustain them much longer. Theonly option available to thegovernment in such cases is to closedown these undertakings afterproviding a safety net for theemployees and workers. Resourcesunder the National Renewal Fundhave not been sufficient to meet the costof Voluntary Separation Scheme orVoluntary Retirement Scheme.

(d) Memorandum of Understanding:Improvement of performancethrough a MoU (Memorandum ofUnderstanding) system by whichmanagements are to be grantedgreater autonomy but heldaccountable for specified results.Under this system, public sectorunits were given clear targets andoperational autonomy for achievingthose targets. The MoU was betweenthe particular public sector unit andtheir administrative ministriesdefining their relationship andautonomy.

3.5 GLOBAL ENTERPRISES

At some time you must have comeacross products produced by MultiNational Corporations (MNCs). In thelast ten years MNCs have played animportant role in the Indian economy.They have become a common featureof most developing economies in theworld. MNCs as is evident from whatwe see around us, are giganticcorporations which have theiroperations in a number of countries.They are characterised by their hugesize, large number of products,advanced technology, marketingstrategies and network of operations allover the world. Global enterprises thusare huge industrial organisations whichextend their industrial and marketingoperations through a network of theirbranches in several countries. Theirbranches are also called MajorityOwned Foreign Affiliates (MOFA). Theseenterprises operate in several areas

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producing multiple products with theirbusiness strategy extending over anumber of countries. They do not aimat maximising profits from one or twoproducts but instead spread theirbranches all over. They have an impacton the international economy also. Thisis evident from the fact that the sales oftop 200 corporations were equivalentto 28.3 percent of the world’s GDP in1998. This shows that top 200 MNCscontrol over a quarter of the worldeconomy. Therefore, MNCs are in aposition to exercise massive control onthe world economy because of theircapital resources, latest technology andgoodwill. By virtue of this, they are ableto sell any product in differentcountries. Some of these corporationsmay be slightly exploitative in natureand concentrate more on sellingconsumer goods and luxury itemswhich are not always desirable fordeveloping countries.

Features

These corporations have distinctfeatures which distinguish them fromother private sector companies, publicsector companies and public sectorenterprises. These are as follows:(i) Huge capital resources: Theseenterprises are characterised bypossessing huge financial resourcesand the ability to raise funds fromdifferent sources. They are able to tapfunds from various sources. They mayissue equity shares, debentures orbonds to the public. They are also in aposition to borrow from financialinstitutions and international banks.

They enjoy credibility in the capitalmarket. Even investors and banks ofthe host country are willing to invest inthem. Because of their financialstrength they are able to survive underall circumstances.(ii) Foreign collaboration: Globalenterprises usually enter intoagreements with Indian companiespertaining to the sale of technology,production of goods, use of brandnames for the final products, etc. TheseMNCs may collaborate with companiesin the public and private sector. Thereare usually various restrictive clausesin the agreement relating to transferof technology, pricing, dividendpayments, tight control by foreigntechnicians, etc. Big industrial houseswanting to diversify and expand havegained by collaborating with MNCs interms of patents, resources, foreignexchange etc. But at the same timethese foreign collaborations have givenrise to the growth of monopolies andconcentration of power in few hands.(iii) Advanced technology: Theseenterprises possess technologicalsuperiorities in their methods ofproduction. They are able to conformto international standards and qualityspecifications. This leads to industrialprogress of the country in which suchcorporations operate since they areable to optimally exploit local resourcesand raw materials. Computerisationand other inventions have come due tothe technological advancementsprovided by MNCs.(iv) Product innovation: Theseenterprises are characterised by having


highly sophisticated research anddevelopment departments engaged inthe task of developing new productsand superior designs of existingproducts. Qualitative research requireshuge investment which only globalenterprises can afford.(v) Marketing strategies: Themarketing strategies of globalcompanies are far more effective thanother companies. They use aggressivemarketing strategies in order to increasetheir sales in a short period. They possesa more reliable and up-to-date marketinformation system. Their advertisingand sales promotion techniques arenormally very effective. Since theyalready have carved out a place forthemselves in the global market, andtheir brands are well-known, sellingtheir products is not a problem.(vi) Expansion of market territory:Their operations and activities extendbeyond the physical boundaries of theirown countries. Their internationalimage also builds up and their marketterritory expands enabling them tobecome international brands. They

operate through a network ofsubsidiaries, branches and affiliates inhost countries. Due to their giant sizethey occupy a dominant position in themarket.(vii) Centralised control: They havetheir headquaters in their homecountry and exercise control over allbranches and subsidiaries. However,this control is limited to the broadpolicy framework of the parentcompany. There is no interference inday-to-day operations.

3.6 JOINT VENTURES

Meaning

Business organisations as you havestudied earlier can be of various typesprivate or government owned or globalenterprises. Now, any businessorganisation if it so desires canjoin hands with another businessorganisation for mutual benefit. Thesetwo organisations may be private,government-owned or a foreigncompany. When two businesses agreeto join together for a common purpose

Joint Venture — Bharti and Airtel

Bharti and Airtel entered 2005 as the biggest players in the telecom sector.Airtel, with 15 million customers, is only one of Bharti’s ventures. Beetel, thetelephone brand under Bharti Teletech, keeps them firmly grounded on thelandline front as well. Additionally, Bharti Telesoft, established in 1999 to providevalue added services and solutions to wireless and wireline carriers across theglobe, today finds presence in 25 countries, with over 100 networks and powerservices to 50 million subscribers. They’re on the outsourcing bandwagon aswell as TeleTech Services India, a collaboration between Bharti and TeleTechholding Inc, which provides standard customer solutions and back-office support.Field Fresh Foods, is Bharti’s venture with ELRO holding to export farm freshagricultural products exclusively to markets in Europe and USA.

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and mutual benefit, it gives rise to ajoint venture. Businesses of any sizecan use joint ventures to strengthenlong-term relationships or tocollaborate on short term projects. Ajoint venture can be flexible dependingupon the party’s requirements. Theseneed to be clearly stated in a jointventure agreement to avoid conflict ata later stage.

A joint venture may also be theresult of an agreement between twobusinesses in different countries. In thiscase, there are certain provisionsprovided by the governments of the twocountries, which will have to beadhered to.

Thus, we see that joint venturesmay mean many things, dependingupon the context we are using it in. Butin a broader sense, a joint venture isthe pooling of resources and expertiseby two or more businesses, to achievea particular goal. The risks andrewards of the business are alsoshared. The reasons behind the jointventure often include businessexpansion, development of newproducts or moving into new markets,particularly in another country. It isbecoming increasingly common forcompanies to create joint ventures withother businesses/companies and formstrategic alliances with them. Thereasons for these alliances may becomplementary capabilities andresources such as distributionchannels, technology or finance. In thiskind of a joint venture, two or more(parent) companies agree to sharecapital, technology, human resources,

risks and rewards in the formation of anew entity, under shared control.

In India, joint venture companiesare the best way of doing business.There are no separate laws for thesejoint ventures. The companiesincorporated in India are treated thesame as domestic companies.

A joint venture company can beformed in any of the following ways:

(i) Two parties (individuals orcompanies), incorporate acompany in India. Business of oneparty is transferred to a newcompany. For consideration ofsuch transfer, shares are issued bythe new company and subscribedby the above party. The othersubscribes for the shares in cash;

(ii) The above two parties subscribeto the shares of the joint venturecompany in agreed proportion, incash and start a new business;

(iii) Promoter shareholder of anexisting Indian company andanother party which may be eitheran individual or a company maycollaborate to jointly carry on thebusiness of that company. Theother party may be non-residentor resident and may take upshares of the company throughpayment in cash.All joint venturesin India require governmentapprovals if a foreign partner or aNon-Resident Indian (NRI) isinvolved. The approval can beobtained either from the ReserveBank of India or Foreign InvestmentPromotion Board (FIPB), dependingupon particular circumstances.


(a) If the joint venture is covered underautomatic route, then the approval ofthe Reserve Bank of India is required.

(b) In other special cases not coveredunder the automatic route, a specialapproval of FIPB is required.A joint venture must be based on a

memorandum of understanding signedby both the parties highlighting thebasis of a joint venture agreement. Theterms should be thoroughly discussedand negotiated to avoid any legalcomplications at a later stage.Negotiations and terms must take intoaccount the cultural and legalbackground of the parties. The jointventure agreement must also state thatall necessary governmental approvalsand licenses will be obtained within aspecified period.

3.6.1 Benefits

Business can achieve unexpected gainsthrough joint ventures with a partner.Joint ventures can prove to beextremely beneficial for both partiesinvolved. One party may have strongpotential for growth and innovativeideas, but is still likely to benefit fromentering into a joint venture because itenhances its capacity, resources andtechnical expertise. The major benefitsof joint ventures are as follows:(i) Increased resources andcapacity: Joining hands with anotheror teaming up adds to existingresources and capacity enabling thejoint venture company to grow andexpand more quickly and efficiently.The new business pools in financialand human resources and is able to

face market challenges and takeadvantage of new opportunities.(ii) Access to new markets anddistribution networks: When abusiness enters into a joint venture witha partner from another country, itopens up a vast growing market. Forexample, when foreign companies formjoint venture companies in India theygain access to the vast Indian market.Their products which have reachedsaturation point in their home marketscan be easily sold in new markets.

They can also take advantage of theestablished distribution channels i.e.,the retail outlets in different localmarkets. Otherwise establishing theirown retail outlets may prove to bevery expensive.(iii) Access to technology:Technology is a major factor for mostbusinesses to enter into joint ventures.Advanced techniques of productionleading to superior quality productssaves a lot of time, energy andinvestment as they do not have todevelop their own technology.Technology also adds to efficiency andeffectiveness, thus leading to reductionin costs.(iv) Innovation: The marketsare increasingly becoming moredemanding in terms of new andinnovative products. Joint venturesallow business to come up withsomething new and creative forthe same market. Specially foreignpartners can come up with innovativeproducts because of new ideas andtechnology.

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(v) Low cost of production: Wheninternational corporations invest inIndia, they benefit immensely due to thelower cost of production. They are ableto get quality products for their globalrequirements. India is becoming animportant global source and extremelycompetitive in many products.

There are many reasons for this, lowcost of raw materials and labour,technically qualified workforce;management professionals, excellentmanpower in different cadres likelawyers, chartered accountants,engineers, scientists. The internationalpartner thus, gets the products of

required quality and specifications at amuch lower cost than what is prevailingin the home country.(vi) Established brand name: Whentwo businesses enter into a joint ventureone of the parties benefits from theother’s goodwill which has already beenestablished in the market. If the jointventure is in India and with an Indiancompany, the Indian company does nothave to spend time or money indeveloping a brand name for theproduct or even a distribution system.There is a ready market waiting for theproduct to be launched. A lot ofinvestment is saved in the process.

Key Terms

Public sector Departmental undertaking Privatisation

Public enterprises Government companies Globalisation

Statutory corporation Disinvestment Global enterprises

Joint ventures Public accountability Public SectorUndertakings

SUMMARY

Private sector and public sector: There are all kinds of businessorganisations — small or large, industrial or trading, privately owned orgovernment owned existing in our country. These organisations affect ourdaily economic life and therefore become part of the Indian economy. Thegovernment of India has opted for a mixed economy where both private andgovernment enterprises are allowed to operate. The economy therefore maybe classified into two sectors viz., private sector and public sector. Theprivate sector consists of business owned by individuals or a group ofindividuals. Various forms of organisation are sole proprietorship,partnership, joint Hindu family, cooperative and company. The public sectorconsists of various organisations owned and managed by the government.These organisations may either be partly or wholly owned by the central orstate government.


Forms of organising public sector enterprises: Government’s participationin business and economic sectors of the country needs some kind oforganisational framework to function. A public enterprise may take anyparticular form of organisation depending upon the nature of it’s operationsand their relationship with the government. The suitability of a particularform of organisation would depend upon its requirements. The forms oforganisation which a public enterprise may take are as follows:(i) Departmental undertaking(ii) Statutory corporation(iii) Government company

Departmental undertakings: These enterprises are established asdepartments of the ministry and are considered part or an extension of theministry itself. The Government functions through these departments andthe activities performed by them are an integral part of the functioning ofthe government.

Statutory corporations: Statutory corporations are public enterprisesbrought into existence by a Special Act of the Parliament. The Act definesits powers and functions, rules and regulations governing its employeesand its relationship with Government departments. This is a corporate bodycreated by legislature with defined powers and functions and financiallyindependent with a clear control over a specified area or a particular typeof commercial activity.

Government company: These companies are established under the IndianCompanies Act, 1956. These are Government companies and like all othercompanies in the private sector are registered and governed by theprovisions of the Indian companies Act. According to the Indian CompaniesAct 1956, a government company means any company in which not lessthan 51 percent of the paid up capital is held by the central government, orby any state Governments or Government or partly by central Governmentand partly by one or more state Governments.

Changing role of public sector: At the time of Independence, it was expectedthat the public sector enterprises would play an important role in achievingcertain objectives of the economy either by direct participation in businessor by acting as a catalyst. The Indian economy is in a stage of transition.In the post 90’s period, the new economic policies emphasised liberalisation,privatisation and globalisation. The role of the public sector was redefined.It was not supposed to play a passive role but to actively participateand compete in the market with other private sector companies in thesame industry.

Development of infrastructure: The process of industrialisation cannotbe sustained without adequate transportation and communication facilities,fuel and energy, and basic and heavy industries. It is only the governmentwhich could mobilise huge capital, coordinate industrial construction andtrain technicians and workforce.

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Regional balance: The government is responsible for developing all regionsand states in a balanced way and removing regional disparties. Developmentof backward regions so as to ensure a regional balance in the country isone of the major objectives of planned development. Therefore, thegovernment had to locate new enterprises in backward areas and at thesame time prevent the mushrooming growth of private sector unit in alreadyadvanced areas.

Economies of scale: Where large scale industries are required to be set upwith huge capital outlay, the public sector had to step in to take advantageof economies of scale.

Check over concentration of economic power: The public sector acts asa check over the private sector. In the private sector there are very fewindustrial houses which would be willing to invest in heavy industries withthe result that wealth gets concentrated in a few hands and monopolosticpractices are encouraged.

Import substitution: During the second and third Five Year Plan period,India was aiming to be self-reliant in many spheres. Public sector companiesinvolved in heavy engineering which would help in import substitution wereestablished.

Government policy towards public sector since 1991. Itsmain elements are: Restructure and revive potentially viable PSUs, Closedown PSUs, which cannot be revived. Bring down governments equity inall non-strategic PSUs to 26 per cent or lower if necessary; and fully protectthe interest of workers.(a) Reduction in the number of industries reserved for the public sector from

17 to 8 (and then to 3): This meant that the private sector could enter allareas (except 3) and the public sector would have to compete with them.

(b) Disinvestment of shares of a select set of public sector enterprises:Disinvestment involves the sale of the equity shares to the private sectorand the public. The objective was to raise resources and encouragewider participation of the general public and workers in the ownershipof these enterprises. The government had taken a decision to withdrawfrom the industrial sector and reduce its equity in all undertakings.

(c) Policy regarding sick units to be the same as that for the private sector: Allpublic sector units were referred to the Board of Industrial and FinancialReconstruction to decide whether a sick unit was to be restructured orclosed down.

Memorandum of Understanding: Improvement of performance through aMoU (Memorandum of Understanding) system by which managements areto be granted greater autonomy but held accountable for specified results.

Global enterprises: In the last ten years MNCs have played an importantrole in the Indian economy. They are characterised by their huge size, large


number of products, advanced technology, marketing strategies and networkof operations all over the world. Global enterprises thus are huge industrialorganisations which extend their industrial and marketing operationsthrough a network of their branches in several countries.

Features: These corporations have distinct features which distinguishesthem from other private sector companies, public sector companies and publicsector enterprises i.e., (i) Huge capital resources, (ii) Foreign collaboration,(iii) Advanced Technology, (iv) Product innovation, (v) Marketing strategies,(vi) Expansion of market territory, (vii) Centralised control.

Joint ventures: Joint ventures may mean many things, depending uponthe context we are using it in. But in a broader sense, a joint venture is thepooling of resources and expertise by two or more businesses, to achieve aparticular goal. The risks and rewards of the business are also shared. Thereasons behind the joint venture often include business expansion,development of new products or moving into new markets, particularly inanother country.

Benefits: Business can achieve unexpected gains through joint ventureswith a partner. The major benefits of joint venture are as follows:(i) Increased resources and capacity (ii) Access to new markets anddistribution networks (iii) Access to technology (iv) Innovation (v) Low costof production (vi) Established brand name.

EXERCISES

Multiple Type Questions

1. A government company is any company in which the paid up capitalheld by the government is not less than(a) 49 per cent (b) 51 per cent(c) 50 per cent (d) 25 per cent

2. Centralised control in MNC’s implies control exercised by(a) Branches (b) Subsidiaries(c) Headquarters (d) Parliament

3. PSE’s are organisations owned by(a) Joint Hindu family (b) Government(c) Foreign Companies (d) Private entrepreneurs

4. Reconstruction of sick public sector units is taken up by(a) MOFA (b) MoU(c) BIFR (d) NRF

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5. Disinvestments of PSE’s implies(a) Sale of equity shares to (b) Closing down

private sector/public operations(c) Investing in new areas (d) Buying shares PSE’s


1. Explain the concept of public sector and private sector.

2. State the various types of organisations in the private sector.

3. What are the different kinds of organisations that come under the publicsector?

4. List the names of some enterprises under the public sector and classifythem.

5. Why is the government company form of organisation preferred to othertypes in the public sector?

6. How does the government maintain a regional balance in the country?


1. Describe the Industrial Policy 1991, towards the public sector.

2. What was the role of the public sector before 1991?

3. Can the public sector companies compete with the private sector interms of profits and efficiency? Give reasons for your answer.

4. Why are global enterprises considered superior to other businessorganisations?

5. What are the benefits of entering into joint ventures?


1. Collect information on companies in the public sector which have beenselected for disinvestment in the last 2-3 years. Also examine thecontroversies surrounding these decisions. Prepare a project report.

2. Make a list of Indian companies entering into joint ventures with foreigncompanies. Find out the apparent benefits derived out of such ventures.

CHAPTER 4

BUSINESS SERVICES

LEARNING OBJECTIVES


• state the characteristics of services;

• distinguish services from goods;

• classify different types of business services;

• explain the concept of e-banking;

• identify and classify different types of insurance policies; and

• describe different types of warehouses.

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4.1 INTRODUCTION

You must all have, at some time or theother experienced the effect of businessactivities on your lives. Let us examinefew examples of business activity i.e.,purchasing ice cream from a store andeating ice cream in a restaurant,watching a movie in a cinema hall orpurchasing a video cassette/CD,purchasing a school bus and leasing itfrom a transporter. If you analyse allthese activities, you will observe thatthere is a difference between purchasingand eating, purchasing and watchingand purchasing and leasing. What iscommon in all of them is that one ispurchasing an item and the other is

experiencing a service. But there isdefinitely a difference between the itemor good and the service performed.

For a layperson, services areessentially intangibles. Their purchasedoes not result in the ownership ofanything physical. For example, you canonly seek advice from the doctor, youcannot purchase him. Services are allthose economic activities that areintangible and imply an interaction tobe realised between the service providerand the consumer.

Services are those separatelyidentifiable, essentially intangibleactivities that provides satisfaction ofwants, and are not necessarily linked tothe sale of a product or another service.

All of us have seen a petrol pump. Have your ever thought how a petrol pumpowner does his business in a village? How he gets the petrol and diesel to thevillages in the interior? How he gets the money to purchase large quantities ofpetrol and diesel? How he communicates to petrol depots for requirement andalso to customers? How he safeguards himself from various risks associatedwith this business? The answer to all the above questions lies in theunderstanding of business services. The transportation of petrol and dieselfrom oil refineries to petrol pumps is carried out by train and tankers (transportservices). They are then stored at various depots of oil companies situated inall major towns across India (warehousing services). Petrol pump owners usepostal, mail and telephone facilities to be in touch with customers, banks andthe depots for the availability of their requirements on regular basis(communication services). As oil companies always sell the petrol and dieselon advance payment, the owners have to take loans and advances from banksto fund their purchases (banking services). Petrol and diesel being highly riskyproducts, the owners have to safeguard themselves from various risks by gettingthe business, the products, the life of people working there, etc., insure(insurance services). Thus, we see that a single business of providing petroland diesel at a petrol pump is actually a collective outcome of various businessservices. These services are being utilised in the entire process of shipment ofpetrol and diesel from oil refineries to the point of sale at petrol pumps, spreadacross the length and breath of India.

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A good is a physical productcapable of being delivered to apurchaser and involves the transfer ofownership from seller to customer.Goods are also generally used to referto commodities or items of all types,except services, involved in trade orcommerce.

4.2 NATURE OF SERVICES

There are five basic features of services.These features also distinguish themfrom goods and are known as the five Isof services. These are discussed asbelow:(i) Intangibility: Services areintangible, i.e., they cannot be touched.They are experiential in nature. Onecannot taste a doctor’s treatment, ortouch entertainment. One can onlyexperience it. An important implicationof this is that quality of the offer canoften not be determined beforeconsumption and, therefore, purchase.It is, therefore, important for the serviceproviders that they consciously workon creating a desired service so that thecustomer undergoes a favourableexperience. For example, treatment by adoctor should be a favourable experience.(ii) Inconsistency: The secondimportant characteristic of services isinconsistency. Since there is nostandard tangible product, serviceshave to be performed exclusively eachtime. Different customers have differentdemands and expectations. Serviceproviders need to have an opportunityto alter their offer to closely meet therequirements of the customers. This is

happening, for example, in the case ofmobile services.(iii) Inseparability: Anotherimportant characteristic of services isthe simultaneous activity of productionand consumption being performed.This makes the production andconsumption of services seem to beinseparable. While we can manufacturea car today and sell it after, say, amonth; this is often not possible withservices that have to be consumed asand when they are produced. Serviceproviders may design a substitute forthe person by using appropriatetechnology but the interaction with thecustomer remains a key feature ofservices. Automated Teller Machines(ATMs) may replace the banking clerkfor the front office activities like cashwithdrawal and cheque deposit. But,at the same time, the presence of thecustomer, is required and his/herinteraction with the process has to bemanaged.(iv) Inventory (Less): Services havelittle or no tangible components and,therefore, cannot be stored for a futureuse. That is, services are perishableand providers can, at best, store someassociated goods but not the serviceitself. This means that the demand andsupply needs to be managed as theservice has to be performed as andwhen the customer asks for it. Theycannot be performed earlier to beconsumed at a later date. For example,a railway ticket can be stored but therailway journey will be experiencedonly when the railways provides it.

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(v) Involvement: One of the mostimportant characteristics of services isthe participation of the customer in theservice delivery process. A customerhas the opportunity to get the servicesmodified according to specificrequirements.

4.2.1 Difference between Servicesand Goods

From the above, it is clear that the twomain differentiating characteristics ofservices and goods are non-transferability of ownership andpresence of both provider as well asconsumer. While goods are produced,services are performed. A service is anact which cannot be taken home. Whatwe can take home is the effect of theservices. And as the services are sold

at the consumption point, there are noinventories. On the basis of abovefeatures, we can have followingpoints of distinction between goodsand services.

4.3 TYPES OF SERVICES

When speaking of the service sector,services can be classified into threebroad categories, viz., businessservices, social services and personalservices. These have been explained inthe following pages.

(i) Business Services: Businessservices are those services which areused by business enterprises for theconduct of their activities. Forexample, banking, insurance,transportation, warehousing andcommunication services.

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An Introduction to the GATS

The agreement on trade in services reached in the Uruguay Round is perhapsthe most important single development in the multilateral trading system. Thenew General Agreement on Trade in Services (GATS) for the first time framedinternationally agreed rules and commitments, broadly comparable with thoseof the General Agreement on Tarrif and Trade (GATT). The most important elementof GATS is the classification of services used in making commitments. The GATSschedule largely follows a classification, which identifies 11 basic service sectors(plus a twelfth category for miscellaneous services). These sectors are subdividedinto some 160 subsectors or separate service activities. As an example, thetourism category breaks down into subsectors for hotel and restaurants.The twelve sectors are:1. Business services (including professional and computer)2. Communication services3. Construction and related engineering services4. Distribution services5. Educational services6. Environmental services7. Financial services (Insurance and Banking)8. Health related and social services9. Tourism and travel related services10. Recreational, cultural and sporting services11. Transport services and12. Other services not included elsewhere

(ii) Social Services: Social servicesare those services that are generallyprovided voluntarily in pursuit ofcertain social goals. These social goalsmay be to improve the standard ofliving for weaker sections of society, toprovide educational services to theirchildren, or to provide health care andhygienic conditions in slum areas.These services are usually providedvoluntarily but for some considerationto cover their costs. For example,health care and education servicesprovided by certain Non-governmentorganisations (NGOs) and governmentagencies.

(iii) Personal Services: Personalservices are those services which areexperienced differently by differentcustomers. These services cannot beconsistent in nature. They will differdepending upon the service provider.They will also depend uponcustomer’s preferences and demands.For example, tourism, recreationalservices, restaurants.

In the context of betterunderstanding of the businessworld, we will be limiting ourfurther discussions to the firstcategory of the service sector i.e.,business services.

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4.3.1 Business Services

Today’s world is of tough competition,where the survival of the fittest is therule. There is no room for non-performance, and hence companiestend to stick to what they can do best.In order to be competitive, businessenterprises, are becoming more andmore dependant on specialisedbusiness services. Business enterpriseslook towards banks for availability offunds; insurance companies for gettingtheir plant, machinery, goods, etc.,insured; transport companies fortransporting raw material; and finished

goods, and telecom and postal servicesfor being in touch with their vendors,suppliers and customers. Today’sglobalised world has ushered in a rapidchange in the service industry in India.India has been gaining a highlycompetitive edge over other countrieswhen it comes to providing services tothe developed economies of the world.Many foreign companies are looking toIndia for performing a host of businessservices. They are even transferring apart of their business operations to beperformed in India. We will discussthese in detail in the next chapter.

Role of Services in an Economy

• The services sector — including power, telecom and transport account for60-65 per cent of the economy in most OECD (Organisation for EconomicCooperation and Development) countries. While that may be surprising, evendeveloping countries have significant proportion of their GDP coming fromthe services sector.

• Sustained, high and broad-based growth is essential for economic developmentand poverty alleviation. What is needed for such growth is an increase ininvestment in the economy. There are encouraging signs on both the growthand investment fronts in recent years. India is the second largest country inthe world, measured by a population of purchasing power parity. It ranksamong the top 5 economies of the world and expects to become the third largesteconomy in the world by 2025.

• As with any growing economy the sectoral composition of GDP has beenchanging with the services showing an increased share of above 50 per centand that of agriculture declining to 25 per cent. The services sector continuedto be the mainstay of the expansion during 2003-04, contributing 57.6 percent to real GDP growth. Leading the upsurge was ‘trade, hotels, transportand communication’. This was in consonance with the improved performanceof the commodity producing sectors. The strong expansion in cargo handledat major ports as well as the rise in freight and passenger traffic of the railwaysboosted the performance of the transport sector.

• According to the latest estimates, services account for about 63 per cent ofthe world economy. Industry accounts for 32 per cent and agriculture just 5per cent. Nearly 70 per cent of the labour force in developed economies isemployed in the services sector.

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4.4 BANKING

Commercial banks are an importantinstitution of the economy for providinginstitutional credit to its customers. Abanking company in India is the onewhich transacts the business ofbanking which means accepting, for thepurpose of lending and investment ofdeposits of money from the public,repayable on demand or otherwise andwithdrawable by cheques, draft, orderor otherwise. In simple terms, a bankaccepts money on deposits, repayableon demand and also earns a margin ofprofit by lending money. A bankstimulates economic activity in themarket by dealing in money. It mobilisesthe savings of people and makes fundsavailable to business financing theircapital and revenue expenditure. Italso deals in financial instruments andprovides financial services for a pricei.e., interest, discount, commission, etc.

Banks can be classified into thefollowing:

1. Commercial banks2. Cooperative banks3. Specialised banks4. Central bank

(i) Commercial Banks: Commercialbanks are institutions dealing inmoney. These are governed by IndianBanking Regulation Act 1949 andaccording to it banking meansaccepting deposits of money from thepublic for the purpose of lending orinvestment. There are two types ofcommercial banks, public sector andprivate sector banks.

Public sectors banks are those inwhich the government has a majorstake and they usually need toemphasise on social objectives than onprofitability. Private sector banks areowned, managed and controlled byprivate promoters and they are free

4.4.1 Type of Banks

The focus of banking is varied, theneeds diverse and methods different.Thus, we need distinctive kinds ofbanks to cater to the above-mentionedcomplexities.

to operate as per market forces. Thereare 20 nationalised public sector bankslike SBI, PNB, IOB etc., and otherprivate sector banks represented byHDFC Bank, ICICI Bank, KotakMahindra Bank and Jammu andKashmir Bank.

Banking and Social Objectives

In the recent past there has been a concerted effort by the policy makers inreorienting banking towards achieving social objectives. There has been a majorshift in the banking policy of the country:

from to(i) Urban orientation — Rural orientation(ii) Class banking — Mass banking(iii) Traditional — Innovative practices(iv) Short term objectives — Development objectives

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(ii) Cooperative Banks: CooperativeBanks are governed by the provisionsof State Cooperative Societies Act andmeant essentially for providing cheapcredit to their members. It is animportant source of rural credit i.e.,agricultural financing in India.(iii) Specialised Banks: Specialisedbanks are foreign exchange banks,industrial banks, development banks,export-import banks catering tospecific needs of these unique activities.These banks provide financial aid toindustries, heavy turnkey projects andforeign trade.(iv) Central Bank: The Central bankof any country supervises, controls andregulates the activities of all thecommercial banks of that country. Italso acts as a government banker. Itcontrols and coordinates currency andcredit policies of any country. TheReserve Bank of India is the centralbank of our country.

4.4.2 Functions of CommercialBanks

Banks perform a variety of functions.Some of them are the basic or primaryfunctions of a bank while others areagency or general utility services innature. The important functions arebriefly discussed below:(i) Acceptance of deposits: Depositsare the basis of the loan operationssince banks are both borrowers andlenders of money. As borrowers theypay interest and as lenders they grantloans and get interest. These depositsare generally taken through currentaccount, savings account and fixed

deposits. Current account deposits canbe withdrawn to the extent of thebalance at any time without any priornotice.

Savings accounts are forencouraging savings by individuals.Banks pay rate of interest as decidedby RBI on these deposits. Withdrawalfrom these accounts has somerestrictions in relation to the amountas well as number of times in a givenperiod. Fixed accounts are timedeposits with higher rate of interest ascompared to the savings accounts. Apremature withdrawal is permissiblewith a percentage of interest beingforfeited.(ii) Lending of funds: Second majoractivity of commercial banks is toprovide loans and advances out of themoney received through deposits.These advances can be made in the formof overdrafts, cash credits, discountingtrade bills, term loans, consumercredits and other miscellaneousadvances. The funds lent out by bankscontribute a great deal to trade,industry, transport and other businessactivities.(iii) Cheque facility: Banks render avery important service to theircustomers by collecting their chequesdrawn on other banks. The cheque isthe most developed credit instrument,a unique feature and function of banksfor the withdrawal of deposits. It is themost convenient and an inexpensivemedium of exchange. There are twotypes of cheques mainly (a) bearercheques, which are encashableimmediately at bank counters and

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(b) crossed cheques which are to bedeposited only in the payees account.(iv) Remittance of funds: Anothersalient function of commercial banksis of providing the facility of fundtransfer from one place to another, onaccount of the interconnectivity ofbranches. The transfer of funds isadministered by using bank drafts, payorders or mail transfers, on nominalcommission charges. The bank issuesa draft for the amount on its ownbranches at other places or other banksat those places. The payee can presentthe draft on the drawee bank at hisplace and collect the amount.(v) Allied services: In addition toabove functions, banks also provideallied services such as bill payments,locker facilities, underwriting services.They also perform other services like buyingand selling of shares and debentureson instructions and other personalservices like payment of insurancepremium, collection of dividend etc.

4.4.3 e-Banking

The growth of Internet and e-commerceis dramatically changing everydaylife, with the world wide web ande-commerce transforming the worldinto a digital global village. The latestwave in information technology isinternet banking. It is a part of virtualbanking and another delivery channelfor customers.

In simple terms, internet bankingmeans any user with a PC and abrowser can get connected to the bankswebsite to perform any of the virtualbanking functions and avail of any of

the bank’s services. There is no humanoperator to respond to the needs of thecustomer. The bank has a centraliseddata base that is web-enabled. All theservices that the bank has permittedon the internet are displayed on amenu. Any service can be selected andfurther interaction is dictated by thenature of service.

In this new digital market placebanks and financial institutions havestarted providing services over theinternet. These type of services providedby the banks on the internet, callede-banking, lowers the transaction cost,adds value to the banking relationshipand empowers customers. e-bankingis electronic banking or banking usingelectronic media. Thus, e-banking is aservice provided by many banks, thatallows, a customer to conduct bankingtransactions, such as managingsavings, checking accounts, applyingfor loans or paying bills over theinternet using a personal computer,mobile telephone or handheldcomputer (personal digital assistant)The range of services offered bye-banking are: Electronic FundsTransfer (EFT), Automated TellerMachines (ATM) and Point of Sales(PoS), Electronic Data Interchange(EDI) and Credit Cards Electronic orDigital cash.

Benefits

There are various benefits of e-bankingprovided to customers which are:(i) e-banking provides 24 hours,

365 days a year services to thecustomers of the bank;

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(ii) Customers can make some of thepermitted transactions from officeor house or while travelling viamobile telephone;

(iii) It inculcates a sense of financialdiscipline by recording each andevery transaction;

(iv) Greater customer satisfaction byoffering unlimited access to thebank, not limited by the walls of thebranch and less risk and greatersecurity to the customer as theycan avoid travelling with cash.The banks also stand to gain by

e-banking. The benefits are:(i) e-banking provides competitive

advantage to the bank;

(ii) e-banking provides unlimitednetwork to the bank and is notlimited to the number of branches,Any PC connected to a modem anda telephone having an internetconnection can provide cashwithdrawl needs of the customer;

(iii) Load on branches can beconsiderably reduced byestablishing centralised data baseand by taking over some of theaccounting functions.

4.5 INSURANCE

Life is full of uncertainties. The chancesof occurrence of an event causing lossesare quite uncertain. There are risks of

Indian Insurance Sector

It is a well-known fact that the Indian economy has been amongst the fastestgrowing economies of the world. It is triggered by better performances of all thethree sectors i.e., agriculture, industry and services. With an increase inmanufacturing and service sector activities, a directly proportional higherinsurance penetration is the need of the hour.

With the initiation of financial sector reforms, the Indian insurance sector whichwas till now under the government control has to set open for competition tomeet the global challenge. The first step taken by the government was to establishIRDA Act with the objective of streamlining the development process. The Indianinsurance market is a mega market with a huge potential. Since the opening ofthe insurance sector in December 1999 the insurance industry is changingrapidly. Today 13 companies operate in the life and 13 in non-life segment. LICof India has dominated the life segment for over four decades although only25 per cent of the insurable population was insured.

From the year 2000 onwards IRDA started granting licenses to private players.Thus general insurance sector has seen considerable expansion over the pastfew years. The premium income has recorded a growth rate of 20 per cent. Adepartment wise split shows that in the year 2002-03, 21 per cent of business isderived from fire, 9 per cent from marine insurance, 39 per cent from motorinsurance, 8 per cent from health schemes, 5 per cent from re-engineering andremaining 18 per cent from other miscellaneous insurances. Amongst the fastestgrowing companies are the National Insurance, Bajaj Allianz, Tata-AIG and ICICILombard. Currently, over 70 per cent of the business underwritten (fire, marine,motor and engineering) is subject to tariff controls.

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death and disability for human life; fireand burglary risk for property; perils ofthe sea for shipment of goods and, soon. If any of these takes place, theindividuals and/or, organisations maysuffer a great loss, sometimes beyondtheir capacities to bear the same. Itis to minimise the impact of suchuncertainties that there is a need forinsurance. Investment in factorybuildings or heavy equipments or otherassets is not possible unless there isarrangement for covering the risks, withthe help of insurance. Keeping this inmind, people facing common risks cometogether and make small contributionsto a common fund, which helps tospread the loss caused to an individualby a particular risk over a number ofpersons who are exposed to it.

Insurance is thus a device by whichthe loss likely to be caused by anuncertain event is spread over anumber of persons who are exposed toit and who prepare to insure themselvesagainst such an event. It is a contractor agreement under which one partyagrees in return for a consideration topay an agreed amount of money toanother party to make a loss, damageor injury to something of value inwhich the insured has a pecuniaryinterest as a result of some uncertainevent. The agreement/contract is putin writing and is known as ‘policy’. Theperson whose risk is insured is called‘insured’ and the firm which insures therisk of loss is known as insurer/assurance underwriter.

4.5.1 Fundamental principle ofInsurance

The basic principle of insurance is thatan individual or a business concernchooses to spend a definitely knownsum in place of a possible huge amountinvolved in an indefinite future loss.Thus insurance is the substitution ofa small periodic payment (premium) fora risk of large possible loss. The loss ofrisk still remains but the loss is spreadover a large number of policyholdersexposed to the same risk. The premiumpaid by them are pooled out of whichthe loss sustained by any policy holderis compensated. Thus, risks are sharedwith others. From the analysis of pastevents the insurer (an insurancecompany or an underwriter) knows theprobable losses caused by each typeof risk covered by insurance.

Insurance, therefore, is a form of riskmanagement primarily used to safeguard against the risk of potentialfinancial loss. Ideally, insurance isdefined as the equitable transfer of the riskof a potential loss, from one entity toanother, in exchange for a reasonablefee. Insurance company, therefore, isan association, corporation or anorganisation engaged in the businessof paying all legitimate claims that mayarise, in exchange for a fee (known aspremium).

Insurance is a social device in whicha group of individuals (insured)transfers risk to another party (insurer)in order to combine loss experience, whichprovides for payment of losses from

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funds contributed (premium) by allmembers. Insurance is meant to protectthe insured, against uncertain events,which may cause disadvantage to him.

4.5.2 Functions of Insurance

The various functions of insurance areas follows:(i) Providing certainty: Insuranceprovides certainity of payment for therisk of loss. There are uncertainties ofhappenings of time and amount of loss.Insurance removes these uncertaintiesand the assured receives payment ofloss. The insurer charges premium forproviding the certainity.(ii) Protection: The second mainfunction of insurance is to provideprotection from probable chances ofloss. Insurance cannot stop thehappening of a risk or event but cancompensate for losses arising out of it.(iii) Risk sharing: On the happeningof a risk event, the loss is shared by allthe persons exposed to it. The share isobtained from every insured memberby way of premiums.(iv) Assist in capital formation: Theaccumulated funds of the insurerreceived by way of premium paymentsmade by the insured are invested invarious income generating schemes.

4.5.3 Principles of Insurance

The principles of insurance are therules of action or conduct adopted bythe stakeholders involved in theinsurance business. The specificprinciples of utmost significance to avalid insurance contract consists of thefollowing:(i) Utmost good faith: A contract ofinsurance is a contract of uberrimaefidei i.e., a contract found on utmostgood faith. Both the insurer and theinsured should display good faithtowards each other in regard to thecontract. It is the duty of the insuredto voluntarily make full, accuratedisclosure of all facts, material to therisk being proposed and the insurer tomake clear all the terms and conditionsin the insurance contract. Thus, it isbinding on the proposer to disclose allmaterial facts about the subject matterof the proposed insurance. Any fact,which is likely to affect the mind of aprudent insurer in deciding to acceptthe proposal of insurance or in fixingthe rate of premium is material for thispurpose. Failure to make disclosure ofmaterial facts by the insured makes thecontract of insurance voidable at thediscretion of the insurer.

Examples of facts to be disclosed

Fire insurance: Construction of building, fire detection and fire fightingequipment; nature of its use.Motor insurance: Type of vehicle; driver details.Personal Accident insurance: Age, height, weight, occupation, previous medicalhistory.Life insurance: Age, previous medical history, smoking/drinking habits.

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(ii) Insurable Interest: The insuredmust have an insurable interest in thesubject matter of insurance. Onefundamental fact of this principle isthat ‘it is not the house, ship,machinery, potential liability of life thatis insured, but it is the pecuniaryinterest of the insured in them, whichis insured.’ Insurable interest meanssome pecuniary interest in the subjectmatter of the insurance contract. Theinsured must have an interest in thepreservation of the thing or life insured,so that he/she will suffer financially onthe happening of the event againstwhich he/she is insured. In case ofinsurance of property, insurableinterest of the insured in the subjectmatter of the insurance must exist atthe time of happening of the event. Inorder to name insurable interesthowever, it is not necessary that oneshould be the owner of the property.For example, a trustee holdingproperty on behalf of others has aninsurable interest in the property.(iii) Indemnity: All insurancecontracts of fire or marine insuranceare contracts of indemnity. Accordingto it, the insurer undertakes to put theinsured, in the event of loss, in the sameposition that he occupied immediatelybefore the happening of the eventinsured against. In other words theinsurer undertakes to compensate theinsured for the loss caused to him/herdue to damage or destruction ofproperty insured. The compensationpayable and the loss suffered are to bemeasured in terms of money. Theprinciple of indemnity is not applicableto life insurance.

(iv) Proximate Cause: According tothis principle, an insurance policy isdesigned to provide compensation onlyfor such losses as are caused by theperils which are stated in the policy.When the loss is the result of two ormore causes, the proximate causemeans the direct, the most dominantand most effective cause of which theloss is the natural consequence. In caseof loss arising out of any mishap, themost proximate cause of the mishapshould be taken into consideration.(v) Subrogation: It refers to the rightof the insurer to stand in the place ofthe insured, after settlement of a claim,as far as the right of insured in respectof recovery from an alternative sourceis involved. After the insured iscompensated for the loss or damage tothe property insured by him/her theright of ownership of such propertypasses on to the insurer. This isbecause the insured should not beallowed to make any profit, by sellingthe damaged property or in the case oflost property being recovered.(vi) Contribution: As per this principleit is the right of an insurer who has paidclaim under an insurance, to call uponother liable insurers to contribute forthe loss of payment. It implies, that incase of double insurance, the insurersare to share the losses in proportion tothe amount assured by each of them.In case there is a loss, when there ismore than one policy on the sameproperty, the insured will have no rightto recover more than the full amountof his actual loss. If the full amount isrecovered from one insurer the right toobtain further payment from the otherinsurer will cease.

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(vii) Mitigation: This principle statesthat it is the duty of the insured to takereasonable steps to minimise the lossor damage to the insured property.Suppose goods kept in a store housecatch fire then the owner of the goodsshould try to recover the goods andsave them from fire to minimise theloss or damage. The insured mustbehave with great prudence and notbe careless just because there is aninsurance cover. If reasonable care is

not taken like any prudent personthen the claim from the insurancecompany may be lost.

4.5.4 Types of Insurance

Various types of insurance exist byvirtue of practice of insurancecompanies and the influence of legalenactments controlling the insurancebusiness. Broadly speaking, insurancemay be classified as follows:

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LIFE INSURANCE

Since life itself is uncertain, allindividuals try to assure themselves ofa certain sum of money in the future totake care of unforeseen events orhappenings. Individuals in the courseof their life are always exposed to somekind of risks.

The risk may be of an event whichis certain that is death. In that case,what will happen to the other membersof the family who are dependent on aparticular individuals income. Theother risk may be living too long inwhich an individual may become tooold to earn i.e., retirement. In this casealso, the earnings will decline or end.Under such circumstances, individualsseek protection against these risksand life insurance companies offerprotection against such risks.

A life insurance policy wasintroduced as a protection against theuncertainity of life. But gradually itsscope has widened and there arevarious types of insurance policiesavailable to suit the requirements of anindividual. For example, disabilityinsurance, health/medical insurance,annuity insurance and life insuranceproper.

Life insurance may be defined as acontract in which the insurer inconsideration of a certain premium,either in a lump sum or by otherperiodical payments, agrees to pay tothe assured, or to the person for whosebenefit the policy is taken, the assuredsum of money, on the happening of aspecified event contingent on the

human life or at the expiry of certainperiod. Thus, the insurance companyundertakes to insure the life of a personin exchange for a sum of money calledpremium. This premium may be paidin one lump sum, or periodically i.e.,monthly, quarterly, half yearly oryearly. At the same time, the companypromises to pay a certain sum of moneyeither on the death of the person or onhis attaining a certain age (i.e., theexpiry of certain period). Thus, theperson is sure that a specified amountwill be given to him when he attains acertain age or that his dependents willget that sum in the event of his death.

This agreement or contract whichcontains all the terms and conditionsis put in writing and such document iscalled the policy. The person whose lifeis insured is called the assured. Theinsurance company is the insurer andthe consideration paid by the assuredis the premium. The premium can bepaid periodically in instalments.

This insurance provides protectionto the family at the premature death orgives adequate amount at old age whenearning capacities are reduced. Theinsurance is not only a protection butis a sort of investment because a certainsum is returnable to the insured atthe time of death or at the expiry of acertain period.

Life insurance also encouragessavings as the amount of premium hasto be paid regularly. It thus, providesa sense of security to the insured andhis dependents.

The general principles of insurancediscussed in the previous section apply

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to life insurance also with a fewexceptions. The main elements of a lifeinsurance contract are:(i) The life insurance contract must

have all the essentials of a validcontract. Certain elements like offerand acceptance, free consent,capacity to enter into a contract,lawful consideration and lawfulobject must be present for thecontract to be valid;

(ii) The contract of life insurance is acontract of utmost good faith. Theassured should be honest andtruthful in giving information to theinsurance company. He mustdisclose all material facts about hishealth to the insurer. It is his dutyto disclose accurately all materialfacts known to him even if theinsurer does not ask him;

(iii) In life insurance, the insured musthave insurable interest in the lifeassured. Without insurable interestthe contract of insurance is void. Incase of life insurance, insurableinterest must be present at the timewhen the insurance is affected. It isnot necessary that the assuredshould have insurable interest atthe time of maturity also. Forexample, a person is presumed tohave an interest in his own life andevery part of it, a creditor has aninsurable interest in the life of hisdebtor, and a proprietor of a dramacompany has an insurable interestin the lives of the actors;

(iv) Life insurance contract is not acontract of indemnity. The lifeof a human being cannot be

compensated and only a specifiedsum of money is paid. That is whythe amount payable in lifeinsurance on the happening of theevent is fixed in advance. The sumof money payable is fixed, at thetime of entering into the contract. Acontract of life insurance, therefore,is not a contract of indemnity.

Types of life insurance policies

The document containing the writtencontract between the insurer and theinsured alongwith the terms andconditions of insurance is called thePolicy. After the proposal form is filledby the insured (or the proposer) andthe insurer (insurance company)accepts the form and the premium, apolicy is issued to the insurer.

People have different requirementsand therefore they would like a policyto fulfill all their needs. The needs ofpeople for life insurance can be familyneeds, children’s needs, old age andspecial needs. To meet the needs ofpeople the insurers have developeddifferent types of products such asWhole Life Assurance, Endowment typeplans, combination of Whole Life andEndowment type plans, Children’sAssurance plans and Annuity plans.Some of these are explained below:(i) Whole Life Policy: In this kind ofpolicy, the amount payable to theinsured will not be paid before thedeath of the assured. The sum thenbecomes payable only to thebeneficiaries or heir of the deceased.

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The premium will be payable for afixed period (20 or 30 years) or for thewhole life of the assured. If the premiumis payable for a fixed period, the policy willcontinue till the death of the assured.(ii) Endowment Life AssurancePolicy: The insurer (InsuranceCompany) undertakes to pay a specifiedsum when the insured attains aparticular age or on his death whichever is earlier. The sum is payable to hislegal heir/s or nominee named thereinin case of death of the assured.Otherwise, the sum will be paid to theassured after a fixed period i.e., till he/she attains a particular age. Thus, theendowment policy matures after alimted number of years.(iii) Joint Life Policy: This policy istaken up by two or more persons. Thepremium is paid jointly or by either ofthem in instalments or lump sum. Theassured sum or policy money is payableupon the death of any one person to theother survivor or survivors. Usually thispolicy is taken up by husband and wifejointly or by two partners in apartnership firm where the amount ispayable to the survivor on the death ofeither of the two.(iv) Annuity Policy: Under this policy,the assured sum or policy money ispayable after the assured attains acertain age in monthly, quarterly, halfyearly or annual instalments. Thepremium is paid in instalments over acertain period or single premium maybe paid by the assured. This is usefulto those who prefer a regular incomeafter a certain age.

(v) Children’s Endowment Policy:This policy is taken by a person for his/her children to meet the expenses oftheir education or marriage. Theagreement states that a certain sum willbe paid by the insurer when thechildren attain a particular age. Thepremium is paid by the person enteringinto the contract. However, no premiumwil be paid, if he dies before the maturityof the policy.

FIRE INSURANCE

Fire insurance is a contract wherebythe insurer, in consideration of thepremium paid, undertakes to makegood any loss or damage caused by fireduring a specified period upto theamount specified in the policy.Normally, the fire insurance policy isfor a period of one year after which it isto be renewed from time to time. Thepremium may be paid either in lumpsum or instalments. A claim for lossby fire must satisfy the two followingconditions:

(i) There must be actual loss; and(ii) Fire must be accidental and non-

intentional.The risk covered by a fire insurance

contract is the loss resulting from fireor some other cause, and which is theproximate cause of the loss. Ifoverheating without ignition causesdamage, it will not be regarded as a fireloss within the meaning of fireinsurance and the loss will not berecoverable from the insurer.

A fire insurance contract is basedon certain fundamental principles

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Difference between Life, Fire and Marine Insurance

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which have been discussed in generalprinciples. The main elements of a fireinsurance contract are:(i) In fire insurance, the insured must

have insurable interest in the subjectmatter of the insurance. Withoutinsurable interest the contract ofinsurance is void. In case of fireinsurance, unlike life insuranceinsurable interest must be presentboth at the time of insurance and atthe time of loss. For example, aperson has insurable interest in theproperty he owns, a businessmanhas insurable interest in his stock,plant, machinery and building, anagent has an insurable interest inthe property of his principal, apartner has insurable interest in theproperty of a partnership firm, anda mortgagee has insurable interestin the property, which is mortgaged.

(ii) Similar to the life insurancecontract, the contract of fireinsurance is a contract of utmostgood faith i.e., uberrimae fidei. The

insured should be truthful andhonest in giving information to theinsurance company regarding thesubject matter of the insurance. Heis duty-bound to discloseaccurately all facts regarding thenature of property and risksattached to it. The insurancecompany should also disclose thefacts of the policy to the proposer.

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(iv) The insurer is liable to compensateonly when fire is the proximatecause of damage or loss.

MARINE INSURANCE

A marine insurance contract is anagreement whereby the insurerundertakes to indemnify the insuredin the manner and to the extent therebyagreed against marine losses. Marineinsurance provides protection againstloss by marine perils or perils of the sea.Marine perils are collision of ship withthe rock, or ship attacked by theenemies, fire and captured by piratesand actions of the captains and crew ofthe ship. These perils cause damage,destruction or disappearance of theship and cargo and non-payment offreight. So, marine insurance insuresship hull, cargo and freight. Thus, it isa device wherein the insurer undertakesto compensate the owner of a ship orcargo for complete or partial loss at sea.The insurer gurantees to make good thelosses due to damage to the ship or cargoarising out of the risks incidental to seavoyages. The insurer in this case is knownas the underwriter and a certain sum ofmoney is paid by the insured inconsideration for the guarantee/protection he gets. Marine insurance isslightly different from other types. Thereare three things involved i.e., ship or hull,cargo or goods, and freight.(a) Ship or hull insurance: Since the

ship is exposed to many dangers atsea, the insurance policy is forindemnifying the insured for lossescaused by damage to the ship.

(b) Cargo insurance: The cargo whilebeing transported by ship is subjectto many risks. These may be at porti.e., risk of theft, lost goods or onvoyage etc. Thus, an insurancepolicy can be issued to cover againstsuch risks to cargo.

(c) Freight insurance: If the cargo doesnot reach the destination due todamage or loss in transit, theshipping company is not paid freightcharges. Freight insurance is forreimbursing the loss of freight to theshipping company i.e., the insured.

The fundamental principles ofmarine insurance are the same as thegeneral principles. The main elementsof a marine insurance contract are:(i) Unlike life insurance, the contract

of marine insurance is a contract ofindemnity. The insured can, in theevent of loss recover the actualamount of loss from the insurer.Under no circumstances, theinsured is allowed to make profitout of the marine insurancecontract. But cargo policies providecommercial indemnity rather thanstrict indemnity. The insurerspromise to indemnify the insured“in the manner and to the extentagreed.” In case of ‘Hull Policy’, theamount insured is fixed at a levelabove the current market value;

(ii) Similar to life and fire insurance, thecontract of marine insurance is acontract of utmost good faith. Boththe insured and insurer mustdisclose everything, which is in theirknowledge and can affect theinsurance contract. The insured is

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duty-bound to accurately discloseall facts which include the natureof shipment and the risk of damageit is exposed to;

(iii) Insurable interest must exist at thetime of loss but not necessary at thetime when the policy was taken;

(iv) The principle of causa proxima willapply to it. The insurance companywill be liable to pay only if thatparticular or nearest cause iscovered by the policy. For example,if a loss is caused by severalreasons then nearest cause of losswill be considered.

4.6 COMMUNICATION SERVICES

Communication services are helpful tothe business for establishing links withthe outside world viz., suppliers,customers, competitors etc. Businessdoes not exist in isolation, it has tocommunicate with others fortransmission of ideas and information.Communication services need to bevery efficient, accurate and fast for themto be effective. In this fast moving andcompetitive world it is essential to have

advanced technology for quickexchange of information. The electronicmedia is mainly responsible for thistransformation. The main serviceswhich help business can be classifiedinto postal and telecom.

Postal Services

Indian post and telegraph departmentprovides various postal services acrossIndia. For providing these services thewhole country has been divided into 22postal circles. These circles manage theday-to-day functioning of the varioushead post offices, sub-post offices andbranch post offices. Through theirregional and divisional levelarrangements the various facilitiesprovided by postal department arebroadly categorised into:(i) Financial facilities: These facilitiesare provided through the post office’ssavings schemes like Public ProvidentFund (PPF), Kisan Vikas Patra, andNational Saving Certificates in additionto normal retail banking functions ofmonthly income schemes, recurringdeposits, savings account, timedeposits and money order facility.

Indian Postal Network Realities

• 1,54,149 post offices• 5,64,701 letter boxes• 1,575 crore mails every year• 5,01,716 villages with public telephones (84 per cent of total villages)• 26,000 post offices already connected through network• Post Office Savings Bank is the largest retail bank of 1,50,000 plus branches• Total collections at Rs. 200,000 crores• Dedicated VSAT network via satellite of over 1200 post offices• Speed Post facility for over 1000 destinations in India• Links 97 major countries around the globe

Source: www.indiapost.gov.in

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(ii) Mail facilities: Mail services consistof parcel facilities that is trans-missionof articles from one place to another;registration facility to provide securityof the transmitted articles andinsurance facility to provide insurancecover for all risks in the course oftransmission by post.

Postal department also offers alliedfacilities of the following types:

1. Greeting post — A range ofdelightful greeting cards forevery occasion.

2. Media post — An innovativeand ef fect ive vehicle forIndian corporates to advertisetheir brand through postcards,envelopes, aerograms, tele-grams, and also throughletterboxes.

General Insurance

1. Health InsuranceHealth Insurance is a safeguard against rising medical costs. A health insurancepolicy is a contract between an insurer and an individual or group, in which theinsurer agrees to provide specified health insurance at an agreed-upon price(the premium). Depending upon the policy, premium may be payable either in alump sum or in instalments. Health insurance usually provides either directpayment or reimbursement for expenses associated with illness and injuries.The cost and range of protection provided by health insurance depends on theprovider and the policy purchased. In India, presently the health insuranceexists primarily in the form of Mediclaim policy offered to an individual or to anygroup, association or corporate bodies.

2. Motor Vehicle InsuranceMotor Vehicle Insurance falls under the classification of General Insurance.This insurance is becoming very popular and its importance increasing day-by-day. In motor insurance the owner’s liability to compensate people who werekilled or insured through negligence of the motorists or drivers is passed on tothe insurance company. The rate of premium under motor insurance isstandardised.

3. Burglary InsuranceBurglary insurance falls under the classification of insurance of property. Incase of burglary policy, the loss of damages of household goods and propertiesand personal effects due to theft, larceny, burglary, house-breaking and acts ofsuch nature are covered. The actual loss is compensated.(i) Insurable interest must exist at the time of loss but not necessarily at the

time when the policy was taken.

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(ii) The principle of causa proxima will apply to it. The insurance company willbe liable to pay only that particular or nearest cause that is covered by thepolicy. For example, if a loss is caused by several reasons then the nearestcause of loss will be considered.

4. Cattle InsuranceA contract of cattle insurance is a contract whereby a sum of money is secured tothe assured in the event of death of animals like bulls, buffaloes, cows and heifers.It is a contract against death resulting from accident, disease, or pregnantcondition as the case may be. The insurer usually undertakes to pay the excessin the event of loss.

5. Crop InsuranceA contract of crop insurance is a contract to provide a measure of financialsupport to farmers in the event of a crop failure due to drought or flood. Thisinsurance covers against all risks of loss or damages relating to production ofrice, wheat, millets, oil seeds and pulses etc.

6. Sports InsuranceThis policy assures a comprehensive cover available to amateur sportsmencovering their sporting equipment, personal effects, legal liability and personalaccident risks. If desired the cover can also be made available in respect of thenamed member of insured’s family residing with him. This cover is not availableto professional sportsmen. The cover is available in respect of any one or more ofthe following sports: angling, badminton, cricket, golf, lawn tennis, squash, use ofsporting guns.

7. Amartya Sen Siksha YojanaThis policy offered by the General Insurance Company secures the education ofdependent children. If the insured parent/legal guardian sustains any bodilyinjury resulting solely and directly from an accident, caused by external, violentand visible means and if such injury shall within twelve calendar months of itsoccurrence be the sole and direct cause of his/her death or permanent totaldisablement, the insurer shall indemnify the insured student, in respect of allcovered expenses to be incurred from the date of occurrence of such accident tillthe expiry date of policy or completion of the duration of covered course whicheveroccurs first and such indemnity shall not exceed the sum insured as stated in thepolicy schedule.

8. Rajeswari Mahila Kalyan Bima YojanaThis policy has been designed to provide relief to the family members of insuredwomen in case of their death or disablement arising due to all kinds of accidentsand/or death and/or disablement arising out of problems incidental to women only.

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3. Direct post is for direct advertising.It can be both addressed as wellas unaddressed.

4. International Money Transferthrough collaboration withWestern Union financial services,USA, which enables remittance ofmoney from 185 countries to India.

5. Passport facilities — A uniquepartnership with the ministry ofexternal affairs for facilitatingpassport application.

6. Speed Post: It has over 1000destinations in India and links with97 major countries across the globe.

7. e-bill post is the latest offering ofthe department to collect billpayment across the counter forBSNL and Bharti Airtel.

Telecom Services

World class telecommunicationsinfrastructure is the key to rapideconomic and social development of thecountry. It is in fact the backbone ofevery business activity. In today’s worldthe dream of doing business acrosscontinents will remain a dream in theabsence of telecom infrastructure.There have been far reachingdevelopments in the convergence oftelecom, IT, consumer electronics andmedia industries worldwide.Recognising the potential in enhancingquality of life and to facilitate India’svision of becoming IT super power bythe year 2025, new Telecom PolicyFramework 1999 and BroadbandPolicy 2004 were developed by theGovernment of India. Through thisframework the government intends to

provide both universal services toall uncovered areas and high-levelservices for meeting the needs of thecountry’s economy.

The various types of telecomservices are:(i) Cellular mobile services: These areall types of mobile telecom servicesincluding voice and non-voicemessages, data services and PCOservices utilising any type of networkequipment within their service area.They can also provide direct interconnectivity with any other type oftelecom service provider.(ii) Radio paging services: RadioPaging Service is an affordable meansof transmitting information to personseven when they are mobile. It is a one-way information broadcasting solution,and has spread its reach far and wide.Radio paging services are availableincluding tone only, numeric only andalpha/numeric paging.(iii) Fixed line services: These are alltypes of fixed services including voiceand non-voice messages and dataservices to establish linkages for longdistance traffic. These utilise any typeof network equipment primarilyconnected through fiber optic cableslaid across the length and breadth ofthe country. The also provide interconnectivity with other types of telecomservices.(iv) Cable services: These are linkagesand switched services within a licensedarea of operation to operate mediaservices, which are essentially one wayentertainment related services. The twoway communication including voice,


data and information services throughcable network would emerge significantlyin the future. Offering services throughthe cable network would be similar toproviding fixed services.(v) VSAT services: VSAT (Very SmallAperture Terminal) is a satellite-basedcommunications service. It offersbusinesses and government agenciesa highly flexible and reliablecommunication solution in bothurban and rural areas. Compared toland-based services, VSAT offersthe assurance of reliable anduninterrupted service that is equal toor better than land-based services. Itcan be used to provide innovativeapplications such as tele-medicine,newspapers-on-line, market rates andtele-education even in the most remoteareas of our country.(vi) DTH services: DTH (Direct toHome) is again a satellite based mediaservices provided by cellularcompanies. One can receive mediaservices directly through a satellite withthe help of a small dish antenna and a

set top box. The service provider of DTHservices provides a bouquet of multiplechannels. It can be viewed on ourtelevision without being dependent onthe services provided by the cablenetwork services provider.

4.7 TRANSPORTATION

Transportation comprises freightservices together with supporting andauxiliary services by all modes oftransportation i.e., rail, road, air andsea for the movement of goods andinternational carriage of passengers.You have already studied thecomparative advantages anddisadvantages of different modes oftransportation in earlier classes. Theirservices are considered to be importantfor business since speed is of essencein any business transaction. Alsotransportation removes the hindranceof place, i.e., it makes goods availableto the consumer from the place ofproduction. We need to develop ourtransportation system to keep pace

Infrastructure in Transportation

In the first, 50 years of independence, India saw the construction of around13, 000 kilometers of national highways. The ambitious NHAI, Government ofIndia’s project consisting of Golden Quadrilateral connecting Delhi-Kolkata-Chennai-Mumbai and the North-South, East-West corridors linking Srinagar toKanyakumari and Silchar to Porbandar will see the construction of 13,151 kmsof National Highways within a span of eight years. This project will not onlychange the face of road transport in India, but it will also have a lasting impacton our economy. The Ministry of Railways have also done massive innovationsin their movement and monitoring of goods trains to facilitate the needs of thebusiness community.

The Government of India is also serious in ensuring better and more facilities atthe seaports and airports to provide an impetus to business activities. Thegovernment plans not only to enhance capacities of existing ports but also todevelop modern and new ports at strategic locations.


with the requirements of our economy.We need better infrastructure of roadswith sufficient width and high quality.We have few ports and they too arecongested. Both government andindustry needs to be proactive and viewthe effective functioning of this serviceas a necessity for providing a lifeline toa business services. In sectors likeagriculture and food, there are massivelosses of product in the process oftransportation and storage.

Warehousing

Storage has always been an importantaspect of economic development. Thewarehouse was initially viewed as astatic unit for keeping and storinggoods in a scientific and systematicmanner so as to maintain their originalquality, value and usefulness.The typical warehouse receivedmerchandise by rail, truck or bullockcart. The items were moved manuallyto a storage within the warehouse andhand piled in stacks on the floor. Theyare used by manufacturers, importers,exporters, wholesalers, transportbusiness, customs etc., in India.

Today’s warehouses have ceased tobe a mere storage service providers andhave really become logistical serviceproviders in a cost efficient manner.That is making available the rightquantity, at the right place, in the righttime, in the right physical form at theright cost. Modern warehouses areautomated with automatic conveyors,computer operated cranes and forkliftsfor moving goods and also usage of

logistics automation software’s forwarehouse management.

Types of Warehouses

(i) Private warehouses: Privatewarehouses are operated, owned orleased by a company handling theirown goods, such as retail chainstores or multi-brand multi-productcompanies. As a general rule an efficientwarehouse is planned around amaterial handling system in order toencourage maximum efficiency ofproduct movement. The benefit ofprivate warehousing includes control,flexibility, and other benefits likeimproved dealer relations.(ii) Public warehouses: Publicwarehouses can be used for storage ofgoods by traders, manufacturers orany member of the public after thepayment of a storage fee or charges.The government regulates the operationof these warehouses by issuing licencesfor them to private parties.

The owner of the warehouse standsas an agent of the owner of the goodsand is expected to take appropriate careof the goods.

These warehouses provide otherfacilities also like transportation by railand road. They are responsible for thefull safety of the goods. Smallmanufacturers find it very convenientas they cannot afford to construct theirown warehouses.

The other benefits include flexibilityin the number of locations, no fixed costand capability of offering value addedservices like packaging and labelling.


(iii) Bonded warehouses: Bondedwarehouses are licensed by thegovernment to accept imported goodsprior to payment of tax and customsduty. These are goods which areimported from other countries.Importers are not permitted to removegoods from the docks or the airport tillcustoms duty is paid.

At times, importers are not in aposition to pay the duty in full or doesnot require all the goods immediately.The goods are kept in bondedwarehouses by the customs authoritiestill the customs duty is paid. Thesegoods are said to be in bond.

These warehouses have facilities forbranding, packaging, grading andblending. Importers may bring theirbuyers for inspection of goods andrepackage them according to theirrequirements. Thus, it facilitatesmarketing of goods.

Goods can be removed in part asand when required by the importersand buyers, and import duty can bepaid in instalments.

The importer need not block fundsfor payment of import duties before thegoods are sold or used. Even if he wishesto export the goods kept in the bondedwarehouse he may do so withoutpayment of customs duty. Thus, bondedwarehouses facilitate entrepot trade.(iv) Government warehouses: Thesewarehouses are fully owned andmanaged by the government. Thegovernment manages them throughorganisations set up in the publicsector. For example, Food Corporationof India, State Trading Corporation,and Central Warehousing Corporation.

(v) Cooperative warehouses: Somemarketing cooperative societies oragricultural cooperative socities haveset up their own warehouses formembers of their cooperative society.

Functions of warehousing

The functions of warehousing arediscussed as follows:(a) Consolidation: In this function

the warehouse receives andconsolidates, materials/goods fromdifferent production plants anddispatches the same to a particularcustomer on a single transportationshipment.

(b) Break the bulk: The warehouseperforms the function of dividingthe bulk quantity of goods receivedfrom the production plants intosmaller quantities. These smallerquantities are then transportedaccording to the requirements ofclients to their places of business.

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(c) Stock piling: The next function ofwarehousing is the seasonal storageof goods to select businesses. Goodsor raw materials which are notrequired immediately for sale ormanufacturing are stored inwarehouses. They are made availableto business depending on customersdemand. Agricultural productswhich are harvested at specific timeswith subsequent consumptionthrough out the year also need to bestored and released in lots.

(d) Value added services: Certainvalue added services are alsoprovided by the warehouses, suchas in transit mixing, packaging andlabelling. Goods sometimes need to

Central Warehousing Corporation

At present a central government undertaking CWC i.e., Central WarehousingCorporation provides these services for businessmen across the country. Privatewarehousing companies like TCI, Shanker International, Blue Dart, DHL etc.,are providing cargo facilities of both transportation and warehousing.

be opened and repackaged andlabelled again at the time ofinspection by prospective buyers.Grading according to quantity anddividing goods in smaller lots isanother function.

(e) Price stablisation: By adjustingthe supply of goods with thedemand situation, warehousingperforms the function of stabilisingprices. Thus, prices are controlledwhen supply is increasing anddemand is slack and vice versa.

(f) Financing: Warehouse ownersadvance money to the owners onsecurity of goods and furthersupply goods on credit terms tocustomers.


Key Terms

Business services Insurance Subrogation Fire insurance

Banking Insurable interest Contribution Marine insurance

e-Banking Indemnity Mitigation Telecom services

Commercial banks Proximate cause Life insurance Warehousing

SUMMARY

Nature of services: Services are those separately identifiable, essentiallyintangible activities that provide satisfaction of wants, and are notnecessarily linked to the sale of a product or another service. There are fivebasic features of services. These features also distinguish them from goodsand are known as the five Is of services i.e., Intangibility, Inconsistency,Inseparability, Inventory (less), Involvement.

Difference between services and goods: While goods are produced,services are performed. A service is an act which cannot be taken home.What we can take home is the effect of the services. And as the services aresold at the consumption point, there are no inventories.

Types of services: Business Services, Social Services, Personal Services.

Business services: In order to be competitive, business enterprises arebecoming more and more dependent on specialised business services.Business enterprises look towards banks for availability of funds; insurancecompanies for getting their plant, machinery, goods, etc., insured; transportcompanies for transporting raw material and finished goods; and telecomand postal services for being in touch with their vendors, suppliers andcustomers.

Banking: A banking company in India is one which transacts the businessof banking which means accepting, for the purpose of lending and investmentof deposits of money from the public, repayable on demand or otherwise andwithdrawable by cheques, draft, order or otherwise.

Type of banks: Banks can be classified into the following i.e., commercialbanks, cooperative banks, specialised banks, central bank.

Functions of commercial bank: Some of them are the basic or primaryfunctions of a bank while others are agency services or general utility servicesin nature. Acceptance of deposits, lending of funds, cheque facility, remittanceof funds, allied services.

e-Banking: The latest wave in information technology is internet banking. Itis a part of virtual banking and another delivery channel for customers.e-banking is electronic banking or banking using the electronic media. Thus,


e-banking is a service provided by many banks, that allows a customer toconduct banking transactions, such as managing savings, checkingaccounts, applying for loans or paying bills over the internet using a personalcomputer, mobile telephone or handheld computer (personal digital assistant)

Insurance: Insurance is thus a device by which the loss likely to be causedby an uncertain event is spread over a number of persons who are exposedto it and who are prepared to insure themselves against such an event. It isa contract or agreement under which one party agrees in return for aconsideration to pay an agreed amount of money to another party to makegood a loss, damage or injury to something of value in which the insured hasa pecuniary interest as a result of some uncertain event.

Fundamental principle of insurance: The basic principle of insurance isthat an individual or a business concern chooses to spend a definitely knownsum in place of a possible huge amount involved in an indefinite future loss.Insurance, therefore, is a form of risk management primarily used to safeguard against the risk of potential financial loss.

Functions of insurance: Providing certainty, Protection, Risk sharing, Assistin capital formation.

Principles of Insurance

Utmost good faith: A contract of insurance is a contract of uberrimae fideii.e. a contract found on utmost good faith. Both the insurer and the insureddisplay good faith towards each other in regard to the contract.

Insurable interest: The insured must have an insurable interest in thesubject matter of insurance.

Insurable interest means some pecuniary interest in the subject matter ofthe insurance contract.

Indemnity: According to it, the insurer undertakes to put the insured, inthe event of loss, in the same position that he occupied immediately beforethe happening of the event insured against.

Proximate cause: When the loss is the result of two or more causes, theproximate cause means the direct, the most dominant and most effectivecause of which the loss is a natural consequence.

Subrogation: It refers to the right of the insurer to stand in the place of theinsured, after settlement of a claim, as far as the right of the insured inrespect of recovery from an alternative source is involved.

Contribution: As per this principle it is the right of an insurer who has paidclaim under an insurance, to call upon other liable insurers to contributefor the loss payment.

Mitigation: This principles states that it is the duty of the insured to takereasonable steps to minimise the loss or damage to the insured property.


Types of Insurance

Life insurance: Life insurance may be defined as a contract in which theinsurer, in consideration of a certain premium, either in a lump sum or byother periodical payments, agrees to pay to the assured, or to the personfor whose benefit the policy is taken, the assured sum of money, on thehappening of a specified event contingent on the human life or at the expiryof a certain period.

This insurance provides protection to the family at premature death of anindividual or gives adequate amount at an old age when earning capacitiesare reduced. The insurance is not only a protection but is a sort of investmentbecause a certain sum is returnable to the insured at the time of death or atthe expiry of a certain period.

The main elements of a life insurance contract are:

(i) The life insurance contract must have all the essentials of a validcontract.

(ii) The contract of life insurance is a contract of utmost good faith.

(iii) In life insurance, the insured must have insurable interest in the lifeassured.

(iv) Life insurance contract is not a contract of indemnity.

Types of life insurance policies: People have different requirements andtherefore they would like a policy to fulfill all their needs. The needs of peoplefor life insurance can be family needs, children’s needs, old age and specialneeds. To meet the needs of people the insurer’s have developed differenttypes of products such as Whole Life Assurance, Endowment type plans,combination of Whole Life and Endowment type plans, Children’s Assuranceplans and Annuity plans.

Fire insurance: Fire insurance is a contract whereby the insurer, inconsideration of the premium paid, undertakes to make good any loss ordamage caused by a fire during a specified period upto the amount specifiedin the policy.

The main elements of a fire insurance contract are:

(i) In fire insurance, the insured must have insurable interest in thesubject matter of the insurance.

(ii) Similar to the life insurance contract, the contract of fire insurance is acontract of utmost good faith i.e uberrimae fidei.

(iii) The contract of fire insurance is a contract of strict indemnity.

(iv) The insurer is liable to compensate only when fire is the proximatecause of damage or loss.

Marine insurance: A marine insurance contract is an agreement wherebythe insurer undertakes to indemnify the insured in the manner and to theextent thereby agreed against marine losses. Marine insurance provides


protection against loss by marine perils or perils of the sea. Marine insuranceis slightly different from other types. There are three things involved i.e. shipor hull, cargo or goods and freight.

The main elements of a marine insurance contract are:

(i) Unlike life insurance, the contract of marine insurance is a contractof indemnity.

(ii) Similar to life and fire insurance, the contract of marine insurance isa contract of utmost good faith.

(iii) Insurable interest must exist at the time of loss.

(iv) The principle of causa proxima will apply to it.

Communication services: Communication services are helpful to businessfor establishing links with the outside world viz., suppliers, customers,competitors etc. The main services which help business can be classifiedinto postal and telecom.

Postal services: Various facilities provided by postal department are broadlycategorised into financial facilities, mail facilities.

Telecom services: The various types of telecom services are of the followingtypes: Cellular Mobile Services, Radio Paging Services, Fixed line services,Cable Services, VSAT Services, DTH services.

Transportation: Transportation comprises freight services together withsupporting and auxiliary services by all modes of transportation i.e. rail,road, air and sea for the movement of goods and international carriage ofpassengers.

Warehousing: The warehouse was initially viewed as a static unit for keepingand storing goods in a scientific and systematic manner so as to maintaintheir original quality, value and usefulness.

Today’s warehouses have ceased to be mere storage service providers andhave really become logistical service providers in a cost efficient manner.

Types of warehouses: private warehouses, public warehouses,bondedwarehouses, government warehouses, cooperative warehouses.

Functions of warehousing: The functions of warehousing are normallydiscussed as follows : consolidation, break the bulk, stock piling, value addedservices, price stablisation, financing.

EXERCISES


1. DTH services are provided by________.

a. Transport companies. b. Banksc. Cellular companies d. None of the above


2. The benefits of public warehousing includes_______.

a. Control b. Flexibilityc. Dealer relationship d. None of the above

3. Which of the following is not a function of insurance?

a. Risk sharing b. Assist in capitalformation

c. Lending of funds d. None of the above

4. Which of the following is not applicable in life insurance contract?

a. Conditional contract b. Unilateral contractc. Indemnity contract d. None of the above

5. CWC stands for_______.

a. Central Water Commission b. Central WarehousingCommission

c. Central Warehousing Corporation d. Central WaterCorporation


1. Define services and goods.

2. What is e-banking. What are the advantages of e-banking?

3. Write a note on various telecom services available for enhancingbusiness.

4. Explain briefly the principles of insurance with suitable examples.

5. Explain warehousing and its functions.


1. What are services? Explain their distinct characteristics?

2. Explain the functions of commercial banks with an example of each.

3. Write a detailed note on various facilities offered by Indian PostalDepartment.

4. Describe various types of insurance and examine the nature of risksprotected by each type of insurance.

5. Explain in detail the warehousing services.


1. Identify a list of various services you use on a regular basis and identifytheir distinct characteristics.

2. Do a project on banking services. Approach a nearby bank and collectinformation about various facilities offered by them and also collectleaflets about salient features of different schemes. Compile and suggestwhat extra services you feel the bank should be providing.

CHAPTER 5

EMERGING MODES OF BUSINESS

LEARNING OBJECTIVES


• state the meaning of e-business;

• explain the process of online buying and selling as a part ofe-business;

• distinguish e-business from traditional business;

• state benefits of switching over to electronic mode;

• explain requirements for a firm’s initiation into e-business;

• identify major security concerns of electronic mode of doingbusiness;

• discuss the need for business process outsourcing; and

• appreciate the scope of business process outsourcing.

111EMERGING MODES OF BUSINESS

5.1 INTRODUCTION

The way business is done hasundergone fundamental changesduring the last decade or so. Themanner of conducting business isreferred to as the ‘mode of business,’and, the prefix ‘emerging’ underlinesthe fact, that these changes arehappening here and now, and, thatthese trends are likely to continue.In fact, if one were to list thethree strongest trends that areshaping business, these would be:(i) digitisation — the conversion of text,sound, images, video, and othercontent into a series of ones and zeroesthat can be transmitted electronically,(ii) outsourcing, and, (iii) inter -nationalisation and globalisation. Youwill read about international businessin Chapter 11. In this chapter, we willbe familiarising you with the first twodevelopments, i.e., digitisation (a termfrom electronics) of business — alsoreferred to as electronic business(e-business), and Business ProcessOutsourcing (BPO). Before we do so, abrief discussion about the factors

responsible for these two new modesof business would be in order.

The newer modes of business arenot new business. These are rathersimply the new ways of doing businessattributable to a number of factors.You are aware that business as anactivity is aimed at creating utilities orvalue in the form of goods and serviceswhich the household and industrialbuyers purchase for meeting theirneeds and wants. In an effort toimprove the business processes — beit purchase and production,marketing, finance or human resourcesbusiness managers and businessthinkers keep evolving newer and betterways of doing things. Business firmshave to strengthen their capabilities ofcreating utilities and delivering valueto successfully meet the competitivepressures and ever-growing demandsof consumers for better quality, lowerprices, speedier deliveries and bettercustomer care. Besides, the quest forbenefitting from emerging technologiesmeans that business as an activitykeeps evolving.

“Let us do some shopping,” Rita woke up Rekha, her friend from the home-village who had come to Delhi during the vacations. “At this hour well pastmidnight,” said Rekha rubbing her eyes, “Who would be sitting with his shopopen for you?” “Oh! Perhaps I could not convey it properly. We are not goinganywhere! I am talking about online shopping over the internet!” told Rita.“Oh yes! I have heard of online shopping, but have never done any,” Rekhasaid, “What would they be selling over the internet, how will they deliver,What about payment… and why is it that internet has not yet become aspopular in the villages? As Rekha was grappling with these questions, Ritahad already logged on to one of India’s largest online shopping mall.

112 BUSINESS STUDIES

5.2 e-BUSINESS

If the term business is taken to meana wide range of activities comprisingindustry, trade and commerce;e-business may be defined as theconduct of industry, trade andcommerce using the computernetworks. The network you are mostfamiliar with as a student or consumeris the internet. Whereas internet is apublic thorough way, firms use moreprivate, and, hence more securenetworks for more effective and efficientmanagement of their internal functions.e-business versus e-commerce:Though, many a times, the termse-business and e-commerce are usedinterchangeably, yet more precisedefinitions would distinguish betweenthe two. Just as the term ‘business’ isa broader term than ‘commerce’,e-business is a more elaborate termand comprises various business

transactions and functions conductedelectronically, including the morepopular gamut of transactions called‘e-commerce.’ e-commerce covers afirm’s interactions with its customersand suppliers over the internet.e-business includes not onlye-commerce, but also otherelectronically conducted businessfunctions such as production,inventory management, productdevelopment, accounting and financeand human resource management.e-business is, therefore, clearly muchmore than buying and selling over theinternet, i.e., e-commerce.

5.2.1 Scope of e-Business

We have mentioned above that thescope of e-business is quite vast.Almost all types of business functionssuch as production, finance, marketingand personnel administration as well

Figure 5.1 Firm as a link between Network of Suppliers and Customers

B2Btransactions

B2CTransactions

S1

S2

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C1

C2

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C2C

Suppliers CustomersFirm

R & D

Production

Purchase

HR

Finance

Marketing

Intra-firmB transactions


as managerial activities like planning,organising and controlling can becarried out over computer networks.The other way of looking at the scopeof e-business is to examine it in termsof people or parties involved inelectronic transactions. Viewed fromthis perspective, a firm’s electronictransactions and networks can bevisualised as extending into threedirections viz., (i) B2B which is a firm’sinteractions with other businesses,(ii) B2C i.e., a firm’s interactions withits customers and (iii) intra-B or a firm’sinternal processes.

Figure 5.1 summarises the networkof parties and interactions thatcomprises e-business.

A brief discussion of variousconstituents of e-business and inter-and intra-transactions among them isgiven as below:(i) B2B Commerce: Here, both theparties involved in e-commercetransactions are business firms, and,hence the name B2B, i.e., business-to-business. Creation of utilities ordelivering value requires a business tointeract with a number of other businessfirms which may be suppliers or vendorsof diverse inputs; or else they may bea part of the channel through whicha firm distributes its products tothe consumers. For example, themanufacture of an automobile requiresassembly of a large number ofcomponents which in turn are beingmanufactured elsewhere — within thevicinity of the automobile factory or evenoverseas. To reduce dependence on asingle supplier, the automobile factory

has to cultivate more than one vendorfor each of the components. A networkof computers is used for placing orders,monitoring production and delivery ofcomponents, and making payments.Likewise, a firm may strengthen andimprove its distribution system byexercising a real time (as it happens)control over its stock-in-transit as wellas that with different middlemen indifferent locations. For example, eachconsignment of goods from a warehouseand the stock-at-hand can be monitoredand replenishments and reinforcementscan be set in motion as andwhen needed. Or else, a customer’sspecifications may be routed throughthe dealers to the factory and fedinto the manufacturing system forcustomised production. Use ofe-commerce expedites the movement ofthe information and documents; and oflate, money transfers as well.

Historically, the term e-commerceoriginally meant facilitation of B2Btransactions using Electronic DataInterchange (EDI) technology to sendand receive commercial documents likepurchase orders or invoices.(ii) B2C Commerce: As the nameimplies, B2C (business-to-customers)transactions have business firms atone end and its customers on the otherend. Although, what comes to one’smind instantaneously is onlineshopping, it must be appreciated that‘selling’ is the outcome of the marketingprocess. And, marketing begins wellbefore a product is offered for sale andcontinues even after the product has


History of e-commerce

e-commerce began before personal computers were prevalent and has growninto a multi-billion dollar industry, but where did it come from? By looking at theevolution of e-commerce, it will be easier to judge its trends for the future.

Year Event

1984 EDI, or electronic data interchange, was standardised throughASC X12.* This guaranteed that companies would be able tocomplete transactions with one another reliably.

1992 ‘Compuserve’ offers online retail products to its customers. Thisgives people the first chance to buy things off their computer.

1994 Netscape arrived. Providing users a simple browser** to surf theinternet and a safe online transaction technology called SecureSockets Layer.***

1995 Two of the biggest names in e-commerce are launched:Amazon.com and e-Bay dot. com

1998 DSL, or Digital Subscriber Line, provides fast, always-on Internetservice to subscribers across California. This prompts people tospend more time, and money, online.

1999 Retail spending over the Internet reaches $20 billion, accordingto Business.com.

2000 The U.S government extended the moratorium on internet taxesuntil at least 2005.

Source: Glossary of e-commerce Terms,http://www.uta.edu/infosys/e_comm/terms/term_a.htm

* American Standard Code for Information Interchange (ASCII): A widely used andinternationally recognised coding system to represent characters in a standard way.ASCII is commonly used for storage within computer systems, and for exchange betweenthem.

** Browser: The generic term for software programs that retrieve, display, and printinformation on World Wide Web. The most popular browsers are Microsoft Internet Explorer,Netscape Navigator and Mosaic. Mosaic was the first browser to introduce graphics.Previously, users were only allowed to view the text of web pages.

*** Secure Socket Layer (SSL): SSL was designed by Netscape for use in electronic commercefor transactions involving confidential information such as credit card numbers. SecureSocket Layer uses a system of public and private key authentication combined with otherschemes to verify electronic signatures. The ability to conduct secure and confidentialtransactions over the internet is critical to the success of electronic commerce. Public key isthe password that the sender uses to encrypt the data and the private key is used by thereceiver of a message to decrypt the data.


been sold. B2C commerce, therefore,entails a wide gamut of marketingactivities such as identifying activities,promotion and sometimes even deliveryof products (e.g., music or films) thatare carried out online. e-commercepermits conduct of these activities at amuch lower cost but high speed. Forexample, ATM speeds up withdrawalof money.

freedom of shopping-at-will. Customerscan also make use of call centres setup by companies to make toll free callsto make queries and lodge complaintsround the clock at no extra cost tothem. The beauty of the process is thatone need not set up these call centresor help lines; they may be outsourced.We shall discuss this aspect later in thesection devoted to Business ProcessOutsourcing (BPO).

ATM speeds up withdrawal of Money

e-commerce greatly facilitates and speeds up the entire B2C process. Withdrawalof one’s own money from banks was, for example, a tedious process in the past.One had to go through a series of procedural formalities before he or she wasable to get the payment. After the introduction of ATMs, all that is fast becominghistory now. The first thing that occurs is that the customer is able to withdrawhis money, and the rest of the back-end processes take place later.

Customers these days are becomingvery choosy and desire individualattention to be given to them. Not onlydo they require the product features betailor-made to suit their requirements,but also the convenience of delivery andpayment at their pleasure. With theonset of e-commerce, all this hasbecome a reality.

Further, B2C variant of e-commerceenables a business to be in touch withits customers on round-the-clockbasis. Companies can conduct onlinesurveys to ascertain as to who isbuying what and what the customersatisfaction level is.

By now, you might have formed theopinion that B2C is a one-way traffic,i.e., from business-to-customers. Butdo remember that its corollary, C2Bcommerce is very much a reality whichprovides the consumers with the

(iii) Intra-B Commerce: Here, partiesinvolved in the electronic transactionsare from within a given business firm,hence, the name intra-B commerce. Asnoted earlier too, one critical differencebetween e-commerce and e-businessis that, e-commerce comprises abusiness firm’s interaction with itssuppliers, and distributors/otherbusiness firms (hence, the name B2B)and customers (B2C) over the internet.While e-business is a much wider termand also includes the use of intranetfor managing interactions anddealings among various departmentsand persons within a firm. It is largelydue to use of intra-B commerce thattoday it has become possible forthe firms to go in for flexiblemanufacturing. Use of computernetworks makes it possible for themarketing department to interact


constantly with the productiondepartment and get the customisedproducts made as per therequirements of the individualcustomer. In a similar vein, closercomputer-based interactions amongthe other departments makes itpossible for the firm to reapadvantages of efficient inventoryand cash management, greaterutilisation of plant and machinery,effective handling of customers’orders, and effective human resourcemanagement.

Just as intercom facilitated voicecommunication within the office,intranet facilitates multimedia and even3-D graphic communication amongorganisational units for well-informed decisions, permitting bettercoordination, faster decisions andspeedier workflows. Take for example,a firm’s interactions with its employees,sometimes referred to as B2Ecommerce. Companies are resorting topersonnel recruitment, interviewingand selection, training, developmentand education via e-commerce(captured in a catch-all phrase‘e-learning’). Employees can useelectronic catalogues and orderingforms and access inventory informationfor better interaction with thecustomers. They can send field reportsvia e-mail and the management canhave them on real time basis. In fact,Virtual Private Network (VPN)technology would mean that employeesdo not have to come to office. Instead,in a way the office goes to them andthey can work from wherever they are,

and at their own speed and timeconvenience. Meetings can be heldonline via tele/ video conferencing.(iv) C2C Commerce: Here, thebusiness originates from the consumerand the ultimate destination is alsoconsumers, thus the name C2Ccommerce. This type of commerce isbest suited for dealing in goods forwhich there is no established marketmechanism, for example, selling usedbooks or clothes either on cash orbarter basis. The vast space ofthe internet allows persons to globallysearch for potential buyers.Additionally, e-commerce technologyprovides market system security tosuch transactions which otherwisewould have been missing ifthe buyers and sellers were tointeract in anonymity of one-to-onetransactions? An excellent example ofthis is found at eBay where consumerssell their goods and services to otherconsumers. To make this activitymore secure and robust, severaltechnologies have emerged. Firstly,eBay allows all the sellers and buyersto rate one another. In this manner,future prospective purchasers may seethat a particular seller has sold to morethan 2,000 customers — all of whomrate the seller as excellent. In anotherexample, a prospective purchaser maysee a seller who has previously soldonly four times and all four rate theseller poorly. This type of informationis helpful. Another technology that hasemerged to support C2C activities isthat of the payment intermediary.PayPal is a good example of this kind.


e-commerce makes flexible Manufacturing andMass Customisation possible

Customised products have traditionally been made to order by craftsmen andhave, therefore, been expensive and delivery times have been long. Industrialrevolution meant that organisations could engage in mass production and couldsell homogeneous products rolled out of the factory at a lower cost due to theeconomies of scale. Thanks to e-commerce, now organisations can offercustomised products/ services at lower costs, that previously were only associatedwith mass produced commodity items. Here are a few examples:

401(k) Forum (US) Customises educational content and investment advice basedon individual interviews.

Acumin Corp. (US) Customises vitamin pills specified by using the Internet.Customers fill in lifestyle and health questionnaire.

Dell (US) Build your own PC.

Green Mountain Electricity supplier (but not generator). Customers could selectEnergy Resources sources for their electricity, e.g., hydro, solar, etc.(US)

Levi Jeans Tailored jeans service. Web service suspended after complaints(Original Spin) by retailers but service now offered through retailers. Offers(US) 49,500 different sizes and 30 styles for a total of nearly 1.5

million options for a cost of just $55. Orders are sent by netand jeans are produced and shipped in 2-3 weeks.

N.V. Nutsbedrijf Westland supplies natural gas to many tulip growers in theWestland Netherlands. Computers in the greenhouse help greenhouse(Newzealand) owners maintain temperature, CO2 output, humidity, light and

other factors in the most cost-efficient manner.

National Bicycle Custom built bicycles within 2/3 days of taking the order.(Japan)

Simon and Teachers can order customised books specifically matched toSchuster (US) individual course and student needs. Xerox DocuTech printers

are generating in excess of 125,000 customised books a month.

Skyway (US) Skyway is a logistics company offering whole order delivery.Shipments from multiple origins with different modes oftransport can be merged in transit and delivered as a singleorder with one set of paperwork to the store or consumer.

SmithKline Creates customised stop smoking programme for customers.Beecham (US) Uses call centre questionnaire to generate a series of

personalised communications.

Source: Adapted from http://www.managingchange.com


Facilitating C2C Commerce — The Way Does it

eBay’s Trust and Safety team is responsible for keeping the marketplace a safe,well-lit place for people around the world to trade with one other.

Actively working to enable members to trade safely, eBay fosters trust betweenmembers through the development and enforcement of rules and policies, thecreation of reputation-building programs, and the prevention of fraud.

eBay also works behind-the-scenes to prevent fraud and, in the event a problemoccurs, eBay proactively works with law enforcement and government agenciesthroughout the world to enforce its policies. Rooted in the values of the marketplace,eBay’s policies are aimed at offering a level playing field, encouraging open, honest,and accountable transactions, and creating economic opportunities for everyone.

To help the community trade safely and build trust with one another, eBay offersthe following tools, programs, and resources:

eBay FeedbackeBay feedback is each user’s reputation on eBay. Through positive, negative, andneutral ratings and comments, each eBay member has a Feedback score. Allsellers display this score in the Seller Information box of the item listing page.eBay Feedback fosters trust between people by acting as both an incentive to dothe right thing and as a mark of distinction for those who conduct transactionswith respect, honesty, and fairness.

Buyer ProtectionUsers who see the PayPal Buyer Protection shield buy with confidence knowingthat their purchase is covered up to $500 at no additional cost. For users who arenot using PayPal as their payment system, there is also the eBay StandardPurchase Protection Program which provides up to $200 coverage (minus a $25processing cost) for either items that are not received or items that are not asdescribed in the listing.

Spoof (Fraudulent) Web Site ProtectionThe eBay Toolbar with Account Guard enables eBay members to protect theiraccounts by indicating when they are on an eBay or PayPal site and warningthem when they are on a potentially fraudulent, or spoof, Web site. In addition,eBay helps users prevent and combat fraud by conducting online tutorials onspoof email and educating members on how to report issues to [email protected].

eBay Security CenterThe eBay Security Center provides guidance on buying safely, selling safely, andpaying safely, as well as valuable third-party, government and law-enforcementresources. The Security Center is a valuable resource for all users, from first-timebuyers who want information on safeguarding online transactions to high-volumesellers who want to protect their copyrights.

Source: ww w.ebay.com


Instead of purchasing items directlyfrom an unknown, untrusted seller; thebuyer can instead send the money toPay Pal. From there, PayPal notifies theseller that they will hold the money forthem until the goods have been shippedand accepted by the buyer.

An important C2C area ofinteractive commerce can be theformation of consumers’ forum andpressure groups. You might have heardof Yahoo groups. Like a vehicle ownerin a traffic jam can alert others viamessage on radio (you must haveheard traffic alerts on FM) about thetraffic situation of the area he is stuckin; an aggrieved customer can share hisexperience with a product/service/vendor and warn others by writing justa message and making it known to theentire group. And, it is quite possiblethat the group pressure might resultin a solution of this problem.

From the foregoing discussionconcerning scope of e-business, it isclear that e-business applications arevaried and many.

e-Business versus TraditionalBusiness

By now, you must have formed an ideaas to how e-enabling has radicallytransformed the mode of doingbusiness. Table 5.1 provides a featureon comparison between traditionalbusiness and e-business.

A comparative assessment of thefeatures of traditional and e-businessas listed in Table 5.1 points towardsthe distinct benefits and limitations ofe-business that we shall discuss in thefollowing paragraphs.

5.3 BENEFITS OF e-BUSINESS

(i) Ease of formation and lowerinvestment requirements: Unlike ahost of procedural requirements forsetting up an industry, e-business isrelatively easy to start. The benefits ofinternet technology accrue to big orsmall business alike. In fact, internetis responsible for the popularity of thephrase: ‘networked individuals andfirms are more efficient thannetworthed individuals.’ This meansthat even if you do not have much ofthe investment (networth) but havecontacts (network), you can dofabulous business.

Imagine a restaurant that does nothave any requirement of a physicalspace. Yes, you may have an online‘menu’ representing the best of cuisinesfrom the best of restaurants the world-over that you have networked with. Thecustomer visits your website, decidesthe menu, places the order that in turnis routed to the restaurant locatedclosest to his location. The food isdelivered and the payment collected bythe restaurant staff and the amount dueto you as a client solicitor is credited toyour account through an electronicclearing system.(ii) Convenience: Internet offers theconvenience of ‘24 hours ××××× 7 days aweek ××××× 365 days’ a year business thatallowed Rita and Rekha to go forshopping well after midnight. Suchflexibility is available even to theorganisational personnel whereby theycan do work from wherever they are,and whenever they may want to do it.


Yes, e-business is truly a businessas enabled and enhanced byelectronics and offers the advantageof accessing anything, anywhere,anytime.(iii) Speed: As already noted, much ofthe buying or selling involves exchangeof information that internet allows atthe click of a mouse. This benefitbecomes all the more attractive in thecase of information-intensive productssuch as softwares, movies, music,e-books and journals that can even bedelivered online. Cycle time, i.e., thetime taken to complete a cycle from theorigin of demand to its fulfilment,is substantially reduced due totransformation of the business

processes from being sequential tobecoming parallel or simultaneous.You know that in the digital era, moneyis defined as electronic pulses atthe speed of light, thanks to theelectronic funds transfer technology ofe-commerce.(iv) Global reach/access: Internet istruly without boundaries. On the onehand, it allows the seller an access tothe global market; on the other hand,it affords to the buyer a freedom tochoose products from almost any partof the world. It would not be anexaggeration to say that in the absenceof internet, globalisation would havebeen considerably restricted in scopeand speed.

Box ASome e-Business Applications

e-Procurement: It involves internet-based sales transactions between businessfirms, including both, “reverse auctions” that facilitate online trade between asingle business purchaser and many sellers, and, digital marketplaces thatfacilitate online trading between multiple buyers and sellers.

e-Bidding/e-Auction: Most shopping sites have ‘Quote your price’ whereby youcan bid for the goods and services (such as airline tickets!). It also includese-tendering whereby one may submit tender quotations online.

e-Communication/e-Promotion: Right from e-mail, it includes publication ofonline catalogues displaying images of goods, advertisement through banners,pop-ups, opinion poles and customer surveys, etc. Meetings and conferencesmay be held by the means of video conferencing.

e-Delivery: It includes electronic delivery of computer software, photographs,videos, books (e-books) and journals (e-journals) and other multimedia contentto the user’s computer. It also includes rendering of legal, accounting, medical,and other consulting services electronically. In fact, internet provides the firmswith the opportunities for outsourcing of a host of Information Technology EnabledServices (ITES) that we will be discussing under business process outsourcing.Now, you can even print the airlines and railway tickets at home!

e-Trading: It involves securities trading, that is online buying and selling ofshares and other financial instruments. For example, sharekhan.com is India’slargest online trading firm.


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(v) Movement towards a paperlesssociety: Use of internet hasconsiderably reduced dependence onpaperwork and the attendant ‘red tape.’You know that Maruti Udyog does bulkof its sourcing of supplies of materialsand components in a paper less fashion.Even the government departments andregulatory authorities are increasinglymoving in this direction whereby theyallow electronic filing of returns andreports. In fact, e-commerce tools areeffecting the administrative reformsaimed at speeding up the process ofgranting permissions, approvals andlicences. In this respect, the provisionsof Information Technology Act 2000are quite noteworthy.

5.4 LIMITATIONS OF e-BUSINESS

e-business is not all that rosy. Doingbusiness in the electronic mode suffersfrom certain limitations. It is advisableto be aware of these limitations as well.(i) Low personal touch: High-tech itmay be, e-business, however, lackswarmth of interpersonal interactions. Tothis extent, it is relatively less suitablemode of business in respect of product

categories requiring high personaltouch such as garments, toiletries, etc.(ii) Incongruence between ordertaking/giving and order fulfilmentspeed: Information can flow at the clickof a mouse, but the physical delivery ofthe product takes time. Thisincongruence may play on the patienceof the customers. At times, due totechnical reasons, web sites takeunusually long time to open. This mayfurther frustrate the user.(iii) Need for technology capabilityand competence of parties toe-business: Apart from the traditional3R’s (Reading, WRiting, andARithmetic), e-business requires afairly high degree of familiarity of theparties with the world of computers.And, this requirement is responsible forwhat is known as digital divide, that isthe division of society on the basis offamiliarity and non-familiarity withdigital technology.(iv) Increased risk due to anonymityand non-traceability of parties:Internet transactions occur betweencyber personalities. As such, it becomesdifficult to establish the identity of theparties. Moreover, one does not know

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even the location from where the partiesmay be operating. It is riskier, therefore,transacting through internet.e-business is riskier also in the sensethat there are additional hazards ofimpersonation (someone else maytransact in your name) and leakage ofconfidential information such as credit

card details. Then, there also areproblems of ‘virus,’ and ‘hacking,’ thatyou must have heard of. If not, we willbe dealing with security and safetyconcerns of online business.(v) People resistance: The process ofadjustment to new technology and newway of doing things causes stress and

Information Technology Act 2000 paves way for Paperless Society

Below are given some of the provisions of Information Technology Act 2000 thathave made it possible to have paper less dealings in the business world as wellas in the government domain.

Legal recognition of electronic records (Section 4): Where any law providesthat information or any other matter shall be in writing or in the typewritten orprinted form, then, notwithstanding anything contained in such law, suchrequirement shall be deemed to have been satisfied if such information or matteris rendered or made available in an electronic form; and accessible so as to beusable for a subsequent reference.

Legal recognition of digital signatures (Section 5): Where any law providesthat information or any other matter shall be authenticated by affixing thesignature or any document shall be signed or bear the signature of any person,hence notwithstanding anything contained in such law, such requirement shallbe deemed to have been satisfied, if such information or matter is authenticatedby means of digital signature affixed in such a manner as may be prescribed bythe Central Government.

Use of electronic records and digital signatures in Government and itsagencies (Section 6-1): Where any law provides for the filing of any form,application or any other document with any office, authority, body or agencyowned or controlled by the appropriate Government in a particular manner; theissue or grant of any licence, permit, sanction or approval by whatever namecalled in a particular manner; the receipt or payment of money in a particularmanner, then, notwithstanding anything contained in any other law for thetime being in force, such requirement shall be deemed to have been satisfied ifsuch filing, issue, grant, receipt or payment, as the case may be, is effected bymeans of such electronic form as may be prescribed by the appropriateGovernment.

Retention of electronic records (Section 7-1): Where any law provides thatdocuments, records or information shall be retained for any specific period, then,that requirement shall be deemed to have been satisfied if such documents,records or information are retained in the electronic form.

Source: Information Technology Act, 2000


a sense of insecurity. As a result, peoplemay resist an organisation’s plans ofentry into e-business.(vi) Ethical fallouts: “So, you areplanning to quit, you may as well quitright now”, said the HR managershowing her a copy of the e-mail thatshe had written to her friend. Sabeenawas both shocked and stunned as tohow her boss got through to her e-mailaccount. Nowadays, companies use an‘electronic eye’ to keep track of thecomputer files you use, your e-mailaccount, the websites you visit etc. Is itethical?

Despite limitations, e-commerceis the way

It may be pointed out that most of thelimitations of e-business discussedabove are in the process of beingovercome. Websites are becoming more

and more interactive to overcome theproblem of ‘low touch.’ Communicationtechnology is continually evolving toincrease the speed and quality ofcommunication through internet.Efforts are on to overcome the digitaldivide, for example, by resorting to suchstrategies as setting up of communitytelecentres in villages and rural areasin India with the involvement ofgovernment agencies, NGOs andinternational institutions. In order todiffuse e-commerce in all nooks andcorners, India has undertaken about150 such projects.

In view of the above discussion, itis clear that e-business is here to stayand is poised to reshape the businesses,governance and the economies. It is,therefore, appropriate that wefamiliarise ourselves with howe-business is conducted.

Digital Divide: The Facts

First the figures. The statistics on the basic building block of connectivity —that is the phone lines — are stark.

According to the latest UN Human Development Report, industrialised countries,with only 15 per cent of the world’s population, are home to 88 per cent of allInternet users. Less than 1 per cent of people in South Asia are online eventhough it is home to one-fifth of the world’s population.

The situation is even worse in Africa. With 739 million people, there are only 14million phone lines. That’s fewer than in Manhattan or Tokyo. Eighty percent ofthose lines are in only six countries. There are only 1 million Internet users onthe entire continent compared with 10.5 million in the UK.

Even if telecommunication systems were in place, most of the world’s poor wouldstill be excluded from the information revolution because of illiteracy and a lackof basic computer skills. In Benin, for example, more than 60 per cent ofthe population is illiterate. The other 40 per cent are similarly out of luck.Four-fifths of the Websites are in English, a language understood by only one in10 people on the planet.

Source: http://www.news.bbc.co.uk/.../special_report/1999/10/


5.5 ONLINE TRANSACTIONS

Operationally, one may visualise threestages involved in online transactions.Firstly, the pre-purchase/sale stageincluding advertising and information-seeking; secondly, the purchase/salestage comprised of steps such as pricenegotiation, closing of purchase/salesdeal and payment; and thirdly, thedelivery stage (see Figure 5.2). It maybe observed from Figure 5.2 that, exceptthe stage relating to delivery, all otherstages involve flow of information. Theinformation is exchanged in thetraditional business mode too, but atsevere time and cost constraints. In face-to-face interaction in traditionalbusiness mode, for example, one needsto travel to be able to talk to the otherparty, requiring travel effort, greater timeand costs. Exchange of informationthrough the telephone is alsocumbersome. It requires simultaneouspresence of both the parties for verbalexchange of information. Informationcan be transmitted by post too, but thisagain is quite a time consuming andexpensive process. Internet comes in asthe fourth channel which is free frommost of the problems referred to above.In the case of information-intensiveproducts and services such as softwareand music, even delivery can take placeonline.

What is described here is theprocess of online trading from acustomer’s standpoint. We will bediscussing the seller’s perspective in theparagraphs on resource-requirementsfor e-business. So, are you ready withthe shopping list or would you like to

rely on your instincts as you takea tour of the shopping mall? Letus follow Rita and Rekha browsingindiatimes.com (Exhibit 5.1).(i) Registration: Before onlineshopping, one has to register with theonline vendor by filling-up aregistration form. Registration meansthat you have an ‘account’ with theonline vendor. Among various detailsthat need to be filled in is a ‘password’as the sections relating to your‘account’, and ‘shopping cart’ arepassword protected. Otherwise, anyonecan login using your name and shop inyour name. This can put you in trouble.(ii) Placing an order: You can pickand drop the items in the shopping cart.Shopping cart is an online record ofwhat you have picked up whilebrowsing the online store. Just as in aphysical store you can put in and takeitems out of your cart, likewise, you cando so even while shopping online. Afterbeing sure of what you want to buy,you can ‘checkout’ and choose yourpayment options.(iii) Payment mechanism: It is clearfrom Exhibit 5.1 that payment for thepurchases through online shoppingmay be done in a number of ways:

• Cash-on Delivery (CoD): As isclear from the name, payment forthe goods ordered online may bemade in cash at the time ofphysical delivery of goods.

• Cheque: Alternatively, the onlinevendor may arrange for the pickupof the cheque from the customer’send. Upon realisation, the deliveryof goods may be made.


• Net-banking Transfer: Modernbanks provide to their customers thefacility of electronic transfer of fundsover the net. In this case, therefore,the buyer may transfer the amountfor the agreed price of the transactionto the account of the online vendorwho may, then, proceed to arrangefor the delivery of goods.

• Credit or Debit Cards: Popularlyreferred to as ‘plastic money,’ thesecards are the most widely usedmedium for online transactions. Infact, about 95 per cent of onlineconsumer transactions areexecuted with a credit card. Creditcard allows its holder to makepurchase on credit. The amountdue from the card holder to theonline seller is assumed by the cardissuing bank, who later transfersthe amount involved in the

transaction to the credit of the seller.Buyer’s account is debited, whooften enjoys the freedom to depositthe amount in instalments and athis convenience. Debit card allowsits holder to make purchasesthrough it to the extent of theamount lying in the correspondingaccount. The moment anytransaction is made, the amountdue as payment is deductedelectronically from the card.

To accept credit card as anonline payment type, the seller firstneeds a secure means of collectingcredit card information from itscustomer. Payments through creditcards can be processed eithermanually, or through an onlineauthorisation system, such as SSLCertificate (see box on, History ofe-commerce).

Table 5.2 Telecenters Project in India

Name Number Agency Activityof kiosks

Bhoomi 30 Government of Karnataka Land title

e-chaupal 3500 ITC Procurement

Warna 72 National Informatics Centre (NIC) Cane Factory

Akshaya 617 Kerala e-literacy

Tara Haat 18 Development Alternatives e-training, marketinformation

Drishtee 90 Digital Partners Mandi prices, landtitles

Milk Coops 5000 National Dairy

Development Board Milk Collection

CIC (NE) 30 NIC Internet AccessSource: IIM, Workshop on Scaling up ICT for Poverty Alleviation in India, Ahmedabad,

February 26-27, 2004.


5.6 SECURITY AND SAFETY OF

e-TRANSACTIONS: e-BUSINESS

RISKS

Online transactions, unlike arm’slength transactions in physicalexchange, are prone to a number ofrisks. Risk refers to the probability ofany mishappening that can resultinto f inancial, reputational orpsychological losses to the partiesinvolved in a transaction. Because ofgreater probability of such risks inthe case of online transactions,security and safety issues becomesthe most crucial concern ine-business. One may broadly discussthese issues under three headings:transaction risks, data storageand transmission risks, andthreat to intellectual property andprivacy risks.

• Digital Cash: This is a form ofelectronic currency that exists onlyin cyberspace. This type ofcurrency has no real physicalproperties, but offers the ability touse real currency in an electronicformat. First you need to pay to abank (vide cheque, draft, etc.) anamount equivalent to the digitalcash that you want to get issuedin your favour. Then the bankdealing in e-cash will send you aspecial software (you candownload on your hard disk) thatwill allow you to draw digital cashfrom your account with the bank.You may then use the digital fundsto make purchases over the web.This type of payment system hopesto resolve the security problemsrelated to the use of credit cardnumbers on the internet.

Figure 5.2 Buying / Selling Process


Notes: 1. Typing of URL address in the address window of the browser leads one to the addressee’shome page, in this case indiatimes.com. From there one can move on to ‘Shopping.’ Home pagemeans the introductory or menu page of a website. A home page usually contains the site’s nameand a directory of its contents. All other pages on a server are usually accessible by following linksfrom the home page. 2. URL, i.e., ‘Uniform Resource Locator’ refers to a world wide web addressthat specifies a specific site, page, graphic, or document on the internet. It is www.indiatimes.comin the present case.

Exhibit 5.1 An Adaptation of ‘Shopping’ Page ofindiatimes.com — India’s Biggest Shopping Mall

Source: adapted from indiatimes.com


(i) Transaction risks: Onlinetransactions are vulnerable to thefollowing types of transaction risks:

• Seller denies that the customerever placed the order or thecustomer denies that he everplaced the order. This may bereferred to as ‘default on ordertaking/giving.’

• The intended delivery does nottake place, goods are delivered atwrong address, or goods otherthan ordered may be delivered.This may be regarded as ‘defaulton delivery’.

• Seller does not get the payment forthe goods supplied whereas thecustomer claims that the paymentwas made. This may be referredto as ‘default on payment’.

Thus, in e-business risk may arisefor the seller or the buyer on accountof default on order taking/giving,delivery as well as payment. Suchsituations can be averted by providingfor identity and location/addressverification at the time of registration,and obtaining authorisation as to theorder confirmation and paymentrealisation. For example, in order toconfirm that the customer has correctlyentered his details in the registrationform, the seller may verify the samefrom the ‘cookies’. Cookies are verysimilar to the caller ID in telephonesthat provide telemarketers with suchrelevant information as: the consumer’sname, address and previous purchasepayment record. As for customer’sprotection from anonymous sellers, itis always advisable to shop from well-

established shopping sites. Whileallowing advertisers to sell theirproducts online, these sites assurecustomers of the sellers’ identities,locations and service records. Sitessuch as eBay even provide for rating ofthe sellers. These sites provideprotection to the customers againstdefault on delivery and reimburse thepayments made up to some extent.

As for the payments, we havealready seen that in almost 95 per centof the cases people use credit cards fortheir online purchases. At the time ofconfirming the order, the buyer isrequired to furnish the details such asthe card number, card issuer and cardvalidity online. These details may beprocessed offline; and only aftersatisfying himself or herself about theavailability of the credit limits, etc., theseller may go ahead with the deliveryof goods. Alternatively, e-commercetechnology today permits even onlineprocessing of the credit cardinformation. For protecting the creditcard details from being misused,shopping malls these days use theencryption technology such asNetscape’s Secure Sockets Layer (SSL).You can gain some information aboutSSL from box on history of e-commerce.In the succeeding section, we willfamiliarise you with the encryption orcryptography — an important toolused for safeguarding against datatransmission risks in onlinetransactions.(ii) Data storage and transmissionrisks: Information is power indeed. Butthink for a moment if the power goes


into the wrong hands. Data stored inthe systems and en-route is exposedto a number of risks. Vital informationmay be stolen or modified to pursuesome selfish motives or simply for fun/adventure. You must have heard of‘virus’ and ‘hacking’. Do you know thefull form of the acronym ‘VIRUS?’ Itmeans Vital Information Under Siege.Actually, virus is a program (a series ofcommands) which replicates itself on theother computer systems. The effect ofcomputer viruses can range from mereannoyance in terms of some on-screendisplay (Level-1 virus), disruption offunctioning (Level-2 virus) damage totarget data files (Level-3 virus), tocomplete destruction of the system(Level-4 virus). Installing and timelyupdating anti-virus programmes andscanning the files and disks with themprovides protection to your data files,folders and systems from virus attacks.

Data may be intercepted in thecourse of transmission. For this, onemay use cryptography. It refers to theart of protecting information bytransforming it (encrypting it) into anunreadable format called ‘cyphertext’.Only those who possess a secret keycan decipher (or decrypt) the messageinto ‘plaintext’. This is similar to using‘code words’ with some one so thatothers do not understand yourconversation.(iii) Risks of threat to intellectualproperty and privacy: Internet is anopen space. Once the information isavailable over the internet, it moves outof the private domain. It then becomesdifficult to protect it from being copied.

Data furnished in the course of onlinetransactions may be supplied to otherswho may start dumping a host ofadvertising and promotional literatureinto your e-mail box. You are then atthe receiving end, with little respite fromreceiving junk mails.

5.7 RESOURCES REQUIRED FOR

SUCCESSFUL e-BUSINESS

IMPLEMENTATION

Setting up of any business requiresmoney, men and machines (hardware).For e-business, you require additionalresources for developing, operating,maintaining and enhancing a websitewhere ‘site’ means location and ‘web’means world wide web (www). Simplyspeaking, a website is a firm’s locationon the world wide web. Obviously,website is not a physical location.Rather, it is an online embodiment ofall the content that a firm may like toprovide to others.

5.8 OUTSOURCING: CONCEPT

Outsourcing is yet another trend thatis radically reshaping business. Itrefers to a long-term contracting outgenerally the non-core and of late evensome of the core activities to captiveor third party specialists with aview to benefitting from theirexperience, expertise, efficiency and,even investment.

This simple definition leads one tothe salient features of the concept thatare not peculiar to an industry/business or country, but have becomea global phenomenon.


Figure 5.3 Types of Outsourcing Service Providers

(i) Outsourcing involves contractingout: Literally, outsourcing means tosource from outside what you havehitherto been doing in-house. Forexample, most companies have so farappointed their own sanitation staff formaintaining neatness, cleanliness andoverall housekeeping of their premises.That is, sanitation and housekeepingfunctions were being performed in-house. But of late, many companieshave started outsourcing theseactivities, i.e., they have entrustedoutside agencies to perform theseactivities for their organisations on acontractual basis.(ii) Generally non-core businessactivities are outsourced: Sanitationand housekeeping functions are non-core for most organisations. Of course,for municipalities and sanitationsservices providers, these activitiescomprise the core of their businessactivity. Housekeeping is a core activityfor a hotel. In other words, dependingupon what business a company is in,there will be some activities that arecentral and critical to its basic businesspurpose. Other activities may beregarded as secondary or incidental to

fulfilling that basic purpose. Thepurpose of a school, for example, is todevelop a child by means of curricularand co-curricular activities. Clearly,these activities comprise the ‘core’activities. Running a cafeteria/canteenor a book store is non-core activity fora school.

As the organisations venture toexperiment with outsourcing, they mayinitially outsource only the non-core activities. But later on, as theybecome comfortable with managinginterdependencies, they may startgetting even the core activitiesperformed by the outsiders. Forexample, a school may tie-up with somecomputer training institute to impartcomputer education to its students.(iii) Processes may be outsourced toa captive unit or a third party: Thinkof a large multinational corporationthat deals in diverse products andmarkets them to a large number ofcountries. A number of processes suchas recruitment, selection, training,record and payroll (Human Resources),management of accounts receivableand accounts payable (accounting andfinance), customer support/grievance


handling /troubleshooting (marketing)are common to all its subsidiariesoperating in different countries. If theseprocesses could be centralised andparcelled out to a business unit createdespecially for this purpose, this wouldresult in avoidance of duplication ofresources, realisation of efficiency andeconomy’s performance of same activityon a large scale at one or a few selectlocations, thereby resulting insubstantial reduction in costs. Clearly,therefore, if the task of performing someactivity internally is sufficiently large,it may be beneficial for the firm to havea captive service provider, i.e., a serviceprovider set up for providing servicesof a given kind to only one firm. GeneralElectric (GE) is, for instance, the largestcaptive BPO unit in India for providingcertain kinds of services to the parentcompany in the United States as wellas to its subsidiaries in other countries.Or else, these processes may beparcelled out to third party serviceproviders who operate independentlyin the market and provide services toother firms too.

Figure 5.3 provides a synopticalview of how a firm can outsource someof its activities to the captive and thirdparty service providers. The hired partyservice providers are the persons/firmswhich specialise in some processessuch as Human Resource Management(HRM) and provide their services to awide base of clients, cutting acrossindustries. Such service providers arecalled ‘horizontals’ in the outsourcingterminology. Else, they may specialisein one or two industries and scale upto doing a number of processes from

non-core to core. These are called‘verticals.’ As the service providersmature, they move simultaneouslyhorizontal and vertical.

The most important reasonunderlying the use of outsourcing isto benefit from the expertise andexperience of others. Institutions likeschools, companies and hospitals canoutsource the cafeteria activity to thecatering and nutrition firms for whomthese activities comprise the core orheart of their operations. The idea ofoutsourcing is valuable as you tend togain not only in terms of their expertiseand experience and the resultantefficiency, but it also allows you to limityour investment and focus attention towhat your core processes are.

Little wonder that outsourcing isfast becoming an emerging mode ofbusiness. Firms have startedincreasingly outsourcing one or moreof their processes which can be moreefficiently and effectively carried out byothers. What qualifies outsourcingas an emerging mode of businessis its increasing acceptance as afundamental business policy andphilosophy, as opposed to the earlierphilosophy of ‘doing it all by yourself ’.

5.8.1 Scope of Outsourcing

Outsourcing comprises four keysegments: contract manufacturing,contract research, contract sales andinformatics (see Figure 5.4).

The term outsourcing has morepopularly come to be associated withIT -enabled services or BusinessProcess Outsourcing (BPO). In fact,


even more popular term is ‘call centres’providing customer-oriented voicebased services. About 70 per cent ofthe BPO industry’s revenue comesfrom call-centers, 20 per cent fromhigh-volume, low-value data work andthe remaining 10 per cent from higher-value information work. ‘Customer Care’accounts for the bulk of the call centeractivities with 24 hrs × 7 days handlingof in-bound (customer queries andgrievances) and out-bound (customersurveys, payment follow-up andtelemarketing) traffic. Figure 5.5 outlinesvarious types of outsourcing activities.

5.8.2 Need for Outsourcing

Necessity, they say, is the mother of allinventions. This can be said to be trueeven in case of the idea of outsourcing.As discussed in the introduction to thechapter, global competitive pressures

for higher quality products at lowercosts, ever demanding customers, andemerging technologies are the threemajor drivers causing a rethink orre-look at business processes. Thesemay be regarded as factors responsiblefor the continuing emergence ofoutsourcing as a mode of business. Infact, today outsourcing is beingresorted to not out of compulsion,but also out of choice. Some of themajor reasons (and also benefits) ofoutsourcing are discussed below.(i) Focusing of attention: You may begood at doing so many things inacademics and extra-curricularactivities, yet you would be better off byfocusing your limited time and moneyon just a few things for better efficiencyand effectiveness. Likewise, businessfirms are realising the usefulness offocusing on just a few areas where they

Figure 5.4 Scope of Outsourcing

Source: www.cygnusindia.com


have distinct capability or corecompetence, and contracting out therest of the activities to their outsourcingpartners. You are aware, that, in orderto create utilities or value, a businessengages in a number of processes, viz.,purchase and production, marketingand sales, R&D, accounting andfinance, HR and administration etc.Firms need to define or redefine

themselves. They, for example, need toconsider as to whether they would liketo be called a manufacturing ormarketing organisation. Such a way ofdelimiting the scope of businessenables them to focus their attentionand resources on select activities forbetter efficiency and effectiveness.(ii) Quest for excellence: You areaware of the benefits of division of labour

Figure 5.5 Anatomy of Outsourcing


and specialisation. Outsourcingenables the firms to pursue excellencein two ways. One, they excel themselvesin the activities that they can do thebest by virtue of limited focus. And,they excel by extending theircapabilities through contracting outthe remaining activities to those whoexcel in performing them. In the questfor excellence, it is necessary not onlyto know what you would like to focuson, but also what you would likeothers to do for you.(iii) Cost reduction: Globalcompetitiveness necessitates not onlyglobal quality, but also globalcompetitive pricing. As the prices turnsouthwards due to competitivepressures, the only way to survival andprofitability is cost reduction. Divisionof labour and specialisation, besidesimproving quality, reduces cost too.This happens due to the economies oflarge scale accruing to the outsourcingpartners as they deliver the sameservice to a number of organisations.Differences in prices of factors ofproduction across the countriesare also a factor contributing tocost reduction. For example, Indiais a preferred destination forglobal outsourcing of Research andDevelopment, manufacturing, softwaredevelopment and IT enabled services(ITES) because of large scale availabilityof required manpower at lower costs.(iv) Growth through alliance: To theextent you can avail of the services ofothers, your investment requirementsare reduced, others have invested inthose activities for you. Even if you may

like to have a stake in the business ofyour outsourcing partners, you profitfrom not only the low-cost and betterquality services provided by them toyou but also by virtue of a share in theprofit from the overall business they do.Therefore, you can expand rapidly asthe same amount of investible fundsresult in creation of a large number ofbusinesses. Apart from financialreturns, outsourcing facilitates inter-organisational knowledge sharing andcollaborative learning. This may alsoexplain the reasons why the firms todayare outsourcing not only their routine,non-core processes, but also seekingto benefit from outsourcing suchstrategic and core processes asResearch and Development.(v) Fillip to economic development:Outsourcing, more so offshore out-sourcing, stimulates entrepreneurship,employment and exports in the hostcountries (i.e., the countries from whereoutsourcing is done). In India in the ITsector alone, for example, there hasbeen such a tremendous growth ofentrepreneurship, employment andexports that today we are theundisputed leaders as far as globaloutsourcing in software developmentand IT-enabled services are concerned.Presently, we have 60 per cent of the$150 billion (1 billion = Rs. 100 crores)global outsourcing share in theinformatics sector.

5.8.3 Concerns over Outsourcing

It will not be out of place to be aware ofsome of the concerns that outsourcingis besieged with.(i) Confidentiality: Outsourcingdepends on sharing a lot of vital


information and knowledge. If theoutsourcing partner does not preservethe confidentiality, and, say, forexample, passes it on to competitors, itcan harm the interest of the party thatoutsources its processes. If outsourcinginvolves complete processes/products,there is a further risk of the outsourcingpartner starting up a competitivebusiness.(ii) Sweat-shopping: As the firms thatoutsource seek to lower their costs,they try to get maximum benefit fromthe low-cost manpower of the hostcountries. Moreover, it is observed thatwhether in the manufacturing sector orthe IT-sector, what is outsourced is thekind of components or work that doesnot much build the competency andcapability of the outsourcing partnerbeyond the skills needed to complywith a rigidly prescribed procedure/method. So, what the firm that go infor outsourcing look for is the ‘doing’skills rather than development of the‘thinking’ skills.(iii) Ethical concerns: Think of a shoecompany that, in order to cut costs,outsources manufacturing to adeveloping country where they usechild labour/women in the factories.

Back home, the company cannot do sodue to stringent laws forbidding use ofchild labour. Is cost cutting by usingchild labour in countries where it is notoutlawed or where the laws are ‘weak’,ethical? Similarly, is it ethical tooutsource the work to countries wherethere exists wage-discrimination on thebasis of sex of the worker?(iv) Resentment in the homecountries: In the course of contractingout manufacturing, marketing,Research and Development orIT-based services, what is ultimatelycontracted out is ‘employment’ or jobs.This may cause resentment back in thehome country (i.e., the country fromwhich the job is being sourced out)particularly if the home country issuffering from the problem ofunemployment.

The aforementioned concerns,however, do not seem to matter muchas the global outsourcing continues toflourish. As India emerges as a globaloutsourcing hub, the industry isforecast to explode at exponentialrates — from 23,000 people and $ 10million per annum in 1998 to over amillion people and revenues in excessof $ 20 billion by 2008.

Key Terms

e-Business e-Commerce Browser

Virus Secure Sockets Layer (SSL) Online trading

e-Trading e-Procurement e-Bidding

e-Cash Business Process Outsourcing Call Centres

Verticals Horizontals Captive BPO units

Sweat-shopping


SUMMARY

The world of business is changing. e-business and outsourcing are the twomost obvious expressions of this change. The trigger for the change owesits origin to both internal and external forces. Internally, it is the businessfirm’s own quest for improvement and efficiency that has propelled it intoe-business and outsourcing. Externally, the ever mounting competitivepressures and ever demanding customers have been the force behind thechange.

Electronic mode of doing business, or e-business as it is referred to, presentsthe firm with promising opportunities for anything, anywhere and anytimeto its customers, thereby, dismantling the time and space/locationalconstraints on its performance. Though e-business is high-tech, it suffersfrom the limitation of being low in personal touch. The customers as aresult do not get attended to on an interpersonal basis. Besides, there areconcerns over security of e-transactions and privacy of those who transactbusiness over the internet. The benefits of e-commerce also seem to haveaccrued unevenly across countries and across regions within a country.

Apart from becoming digital, the firms are also resorting to a departurefrom the erstwhile ‘do it all by yourself’ mindset. They are increasinglycontracting out manufacturing, R and D as well as of business processesirrespective of whether these are IT enabled or not. India is riding high onthe global outsourcing business and has gained considerably in termsof employment generation, capability building and contribution to exportsand GDP.

Together, the two trends of e-business and outsourcing are reshaping theway business is and will be conducted. Interestingly, both e-business andoutsourcing are continuing to evolve, and that is why these are referred toas the emerging modes of business.

EXERCISES


Tick mark ( ) the most appropriate answer to the following questions

1. e-commerce does not include

a. A business’s interactions with its suppliers

b. A business’s interactions with its customers

c. Interactions among the various departments within thebusiness

d. Interactions among the geographically dispersed units of thebusiness


2. Outsourcing

a. Restricts only to the contracting out of Information TechnologyEnabled Services (ITES)

b. Restricts only to the contracting out of non-core businessprocesses

c. Includes contracting out of manufacturing and R&D as well asservice processes — both core and non-core — but restricts onlyto domestic territory

d. Includes off-shoring

3. The payment mechanism typical to e-business

a. Cash on Delivery (CoD) b. Cheques

c. Credit and Debit Cards d. e-Cash

4. A Call Centre handles

a. Only in-bound voice based business

b. Only out-bound voice based business

c. Both voice based and non-voice based business

d. Both customer facing and back-end business

5. It is not an application of e-business

a. Online bidding b. Online procurement

c. Online trading d. Contract R&D

Short Answer Questions (50 Words)

1. State any three differences between e-business and traditionalbusiness.

2. How does outsourcing represent a new mode of business?

3. Describe briefly any two applications of e-business.

4. What are the ethical concerns involved in outsourcing?

5. Describe briefly the data storage and transmission risks in e-business.


1. Why are e-business and outsourcing referred to as the emerging modesof business? Discuss the factors responsible for the growing importanceof these trends.

2. Elaborate the steps involved in on-line trading.

3. Evaluate the need for outsourcing and discuss its limitations.


4. Discuss the salient aspects of B2C commerce.

5. Discuss the limitations of electronic mode of doing business. Are theselimitations severe enough to restrict its scope? Give reasons for youranswer.


1. Compare and contrast the products and their prices available on theinternet and in retail shops. Is the quality, customer satisfaction andother factors the same?

2. Study any business unit/company which is using e-commerce,e-business as a way of doing business. Interview some people workingthere and find out the advantages in practical business in terms of itscosts also.

CHAPTER 6

SOCIAL RESPONSIBILITIES OF BUSINESS AND

BUSINESS ETHICS

LEARNING OBJECTIVES


• explain the concept of social responsibility;

• discuss the need for social responsibility;

• identify the social responsibility towards different interest groups;

• analyse the relationship between business and environmentalprotection; and

• define the concept of business ethics and state the elements ofbusiness ethics.

141SOCIAL RESPONSIBILITIES OF BUSINESS AND BUSINESS ETHICS

6.1 INTRODUCTION

A business enterprise should dobusiness and earn money in ways thatfulfill the expectations of the society.Every individual living in society hascertain obligations towards society. Hehas to respect social values and normsof behaviour. A business enterprise ispermitted by society to carry onindustrial or commercial activities andthereby earn profits. But it is obligatoryon part of the business enterprise notto do anything, that is undesirable fromsociety’s point of view. Manufactureand sale of adulterated goods, makingdeceptive advertisements, not payingtaxes which are due, polluting theenvironment and exploiting workersare some examples of sociallyundesirable practices which mayincrease the profit of enterprises butwhich have adverse effect on society atlarge. On the other hand, supplyinggood quality goods, creating healthyworking conditions, honestly payingtaxes prevention/installing pollution

devices in the factory, and sincerelyattending to customer complaints areexamples of socially desirable practiceswhich improve the image of enterprisesand also make them profitable. In fact,it is through socially responsible andethically upright behaviour thatbusiness enterprises can get durablesuccess.

6.2 CONCEPT OF SOCIAL RESPONSIBILITY

Social responsibility of business refersto its obligation to take those decisionsand perform those actions which aredesirable in terms of the objectives andvalues of our society. The assumptionof social responsibilities by businessenterprises implies that they respectthe aspirations of society and would trytheir best to contribute to theachievement of these aspirations alongwith their profit interests. This idea isin contrast to the common notion thatbusiness exists only for maximisingprofits for its owners and it is irrelevantto talk of public good. It follows that a

Mani is a young newspaper reporter and has been writing for almost six monthson malpractices by business enterprises including such issues as misleadingadvertisements, supply of adulterated products, poor working conditions,environmental pollution, bribing government officials, and so on. He has startedbelieving that business people tend to do anything to mint money. He happensto take an interview of Mr. Raman Jhunjhunwala, chairman of a leading truckmanufacturing company which is known for its fair dealing with customers,employees, investors as well as other social groups. Through this interview,Mani develops the understanding that it is possible for a business enterpriseto be socially responsible and ethically upright and, at the same time, be highlyprofitable. He then gets busy with studying more about the social responsibilityof business and business ethics.


responsible business, and indeed anyresponsible member of society, mustact with due concern for the effects onthe lives of other people.

In this sense, social responsibilityis broader than legal responsibility ofbusiness. Legal responsibility may befulfilled by mere compliance with thelaw. Social responsibility is more thanthat. It is a firm’s recognition of socialobligations even though not covered bylaw, along with the obligations laiddown by law. In other words, socialresponsibility involves an element ofvoluntary action on the part of businesspeople for the benefit of society.

6.3 NEED FOR SOCIAL RESPONSIBILITY

What is the right thing to do when itcomes to social responsibility? Shoulda business enterprise be run for thebenefit of its owners who may desire toget as much profit as is possible or else,

it needs to be responsible for servingthe interest of other sections of societysuch as customers, employees,suppliers, government and community?The very concept of social responsibilityimplies that it is essentially an ethicalissue, since it involves the question ofwhat is morally right or wrong inrelation to the firm’s responsibilities.Social responsibility also has anelement of voluntary action on the partof the business person who may feelfree to perform or not to perform suchresponsibilities. They may also exercisetheir freedom for deciding the extent towhich they would like to serve varioussections of society. In fact, all businesspeople do not feel equally responsibletowards society. There has been adebate, for some time now whetherbusiness should assume socialresponsibilities or not. Some peoplestrongly believe that a firm’s only social

Corporate Social Responsibility (CSR)

Whereas it is the responsibility of every form of business enterprise — be it soleproprietorship, partnership, joint Hindu family, cooperative, or a joint stockcompany to act in a socially desirable manner, the concept of CSR, usedparticularly with reference to a company, has recently gained popularity.Corporate social responsibility can be defined as achieving commercial successin ways that honour ethical values and respect people, communities and thenatural environment. CSR means addressing the legal, ethical, commercial andother expectations that society has from corporates who should take decisionsand actions that fairly balance the claims of all the stakeholders (i.e., the peoplewho have interest in the life of a corporate including shareholders, creditors,consumers, competitors, workers, government and society at large)

CSR is viewed as a comprehensive set of policies, practices and programmesthat are integrated into business operations, supply claims and decision makingprocess throughout the company — wherever the company does business — andincludes responsibility for current and past actions as well as future impact.


responsibility is towards its owners.Some others, however, hold an oppositeview and argue that the firm has a socialresponsibility to serve all sections ofsociety who are affected by its decisionsand actions. It would be useful tounderstand the arguments offeredboth in favour of and against theassumption of social responsibilitiesby business.

6.3.1 Arguments for SocialResponsibility

(i) Justification for existence andgrowth: Business exists for providinggoods and services to satisfy humanneeds. Though, profit motive is animportant justification for undertakingbusiness activity, it should be lookedupon as an outcome of service to thepeople. In fact, the prosperity andgrowth of business is possible onlythrough continuous service to society.Thus, assumption of socialresponsibility by business providesjustifications for its existence andgrowth.(ii) Long-term interest of the firm:A firm and its image stands to gainmaximum profits in the long run whenit has its highest goal as ‘service tosociety’. When increasing number ofmembers of society — includingworkers, consumers, shareholders,government officials, feel that businessenterprise is not serving its bestinterest, they will tend to withdraw theircooperation to the enterpriseconcerned. Therefore, it is in its owninterest if a firm fulfills it’s socialresponsibility. The public image of any

firm would also be improved when itsupports social goals.(iii) Avoidance of governmentregulation: From the point of view of abusiness, government regulations areundesirable because they limitfreedom. Therefore, it is believed thatbusinessmen can avoid the problem ofgovernment regulations by voluntarilyassuming social responsibilities, whichhelps to reduce the need for new laws.(iv) Maintenance of society: Theargument here is that laws cannot bepassed for all possible circumstances.People who feel that they are not gettingtheir due from the business may resortto anti-social activities, not necessarilygoverned by law. This may harm theinterest of business itself. Therefore, itis desirable that business enterprisesshould assume social responsibilities.(v) Availability of resources withbusiness: This argument holds thatbusiness institutions have valuablefinancial and human resources whichcan be effectively used for solvingproblems. For example, business hasa pool of managerial talent and capitalresources, supported by years ofexperience in organising businessactivities. It can help society to tackleits problems better, given the hugefinancial and human resources at itsdisposal.(vi) Converting problems intoopportunities: Related with thepreceding argument is the argumentthat business with its glorious historyof converting risky situations intoprofitable deals, can not only solvesocial problems but it can also make


them effectively useful by accepting thechallenge.(vii) Better environment for doingbusiness: If business is to operate in asociety which is full of diverse andcomplicated problems, it may have littlechance of success. Therefore, it isargued that the business systemshould do something to meet needsbefore it is confronted with a situationwhen its own survival is endangereddue to enormous social illnesses. Asociety with fewer problems providesbetter environment for a firm toconduct its business.(viii) Holding business responsiblefor social problems: It is argued thatsome of the social problems have eitherbeen created or perpetuated bybusiness enterprises themselves.Environmental pollution, unsafeworkplaces, corruption in publicinstitutions, and discriminatorypractices in employment are some ofthese problems. Therefore, it is themoral obligation of business to getinvolved in solving these problems,instead of merely expecting that othersocial agencies will deal with them ontheir own.

6.3.2 Arguments against SocialResponsibility

Major arguments against socialresponsibility are:(i) Violation of profit maximisationobjective: According to this argument,business exists only for profitmaximisation. Therefore, any talk ofsocial responsibility is against thisobjective. In fact, business can best

fulfill its social responsibility if itmaximises profits through increasedefficiency and reduced costs.(ii) Burden on consumers: It is arguedthat social responsibilities like pollutioncontrol and environmental protectionare very costly and often require hugefinancial investments. In suchcircumstances, businessmen are likelyto simply shift this burden of socialresponsibility by charging higher pricesfrom the consumers instead of bearingit themselves. Therefore, it is unfair totax the consumers in the name of socialresponsibility.(iii) Lack of social skills: All socialproblems cannot be solved the waybusiness problems are solved. In fact,businessmen do not have the necessaryunderstanding and training to solvesocial problems. Therefore, accordingto this argument, social problemsshould be solved by other specialisedagencies.(iv) Lack of broad public support:Here the argument is that the public ingeneral does not like businessinvolvement or interference in socialprogrammes. Therefore, businesscannot operate successfully because oflack of public confidence andcooperation in solving social problems.

6.3.3 Reality of Social Responsibility

On the basis of the above argumentsfor and against social responsibility,one may wonder what the businessmendo in reality. Do they concentrate onprofit maximisation? Or, do theysupport social goals? The fact is thatone of the most important recent


changes in the attitude of businesspeople has been the realisation thatthey have social obligations to fulfillbesides ensuring their own existencethrough profitable activity. Of course,part of this realisation is not genuineand takes the form of lip service, whichis thought necessary to ensure thesurvival of private enterprise. But at thesame time it cannot be denied thatprivate business does partly realise andrecognise the hard reality that aprivately owned firm has to meet thechallenge of a democratic society,where all people have certain humanrights and therefore, can demandresponsible conduct from business.Unless the business sets its house inorder, changes its outlook and isprepared to play its legitimate role asan organ of society, it has little chanceof success. It will be useful here to gointo some of the reasons and factors,which have forced and persuadedbusinessmen to consider theirresponsibilities and the conditionswhich were favourable to thedevelopment of business concern withsocial responsibility. Some of the moreimportant among them are:(i) Threat of public regulation:Democratically elected governments oftoday are expected to act as welfarestates whereby they have to take careof all sections of society. Thus, wherebusiness institutions operate in asocially irresponsible manner, action istaken to regulate them for safeguardingpeople’s interest. This threat of publicregulation is one important reason dueto which business enterprise feelsconcerned with social responsibility.

(ii) Pressure of labour movement:Over the last century or so, labour hasbecome far more educated andorganised. Accordingly, labourmovement for extracting gains for theworking class throughout the worldhas become very powerful. This hasforced business enterprises to pay dueregard to the welfare of workers insteadof following a policy of ‘hire and fire’under which they could deal withworkers at their will.(iii) Impact of consumer conscious-ness: Development of education andmass media and increasingcompetition in the market have madethe consumer conscious of his rightand power in determining marketforces. The principle of caveat emptor(or let the buyer beware) has beensubstituted by the principle of‘customer is king’. Business enterpriseshave started following customer-oriented policies.(iv) Development of social standardfor business: Businesses are no longerconsidered merely money crazy entitieswhich can be allowed to mint money atany cost and get away with any kindof business practices. New socialstandards consider economic activityof business enterprises as legitimatebut with the condition that they mustalso serve social needs. No businesscan be done in isolation from society.It is the society that permits businessto exist and grow and it is on the basisof social standards that businessfunctioning is to be ultimately judged.(v) Development of businesseducation: Development of businesseducation with its rich content of social


responsibility has made more andmore people aware of the socialpurpose of business. Educatedpersons as consumers, investors,employees, or owners have becomemore sensitive towards social issuesthan was the case earlier, when sucheducation was not available.(vi) Relationship between socialinterest and business interest:Business enterprises have startedrealising the fact that social interest andbusiness interest are not contradictory.Instead, these are complementary toeach other. The feeling that businesscan grow only through exploitation ofsociety has given way to the belief thatlong-term benefit of business lies inserving the society well. So also, auseful institution like business isrecognised as an essential element of amodern civilised society.(vii) Development of professional,managerial class: Professionalmanagement education in universitiesand specialised management instituteshave created a separate class ofprofessional managers who have got analtogether different attitude towardssocial responsibility as compared to theearlier class of owner manager.Professional managers are moreinterested in satisfying a multiplicity ofinterest groups in society for runningtheir enterprises successfully thanmerely following profit goals.

These and a number of other socialand economic forces have combinedtogether to make business a socio-economic activity. Business is no longera mere occupation; it is an economic

institution that has to reconcile itsshort-term and long range economicinterests with the demands of thesociety in which it functions.Essentially, it is this which gives rise tothe general and specific socialresponsibilities of business. While thereis no denial of the fact that business isessentially an economic enterprise andthat it must ultimately justify itself oneconomic performance, it is also truethat business is an organ of society andas such it must justify its continuanceby fulfilling its roles and responsibilitiesof society.

6.4 KINDS OF SOCIAL RESPONSIBILITY

Social responsibility of business canbroadly be divided into four categories,which are as follows:(a) Economic responsibility: A

business enterprise is basically aneconomic entity and, therefore, itsprimary social responsibility iseconomic i.e., produce goods andservices that society wants and sellthem at a profit. There is littlediscretion in performing thisresponsibility.

(b) Legal responsibility: Everybusiness has a responsibility tooperate within the laws of the land.Since these laws are meant for thegood of the society, a law abidingenterprise is a socially responsibleenterprise as well.

(c) Ethical responsibility: Thisincludes the behaviour of the firmthat is expected by society but notcodified in law. For example,respecting the religious sentiments


and dignity of people whileadvertising for a product. There isan element of voluntary action inperforming this responsibility.

(d) Discretionary responsibility.This refers to purely voluntaryobligation that an enterpriseassumes, for instance, providingcharitable contributions toeducational institutions orhelping the affected people duringfloods or earthquakes. It is theresponsibility of the companymanagement to safeguardthe capital investment byavoiding speculative activity andundertaking only healthy businessventures which give good returnson investment.

6.5 SOCIAL RESPONSIBILITY TOWARDS

DIFFERENT INTEREST GROUPS

Once the social objective of business isrecognised, it is important to know towhom and for what the business andits management are responsible.Obviously, a business unit has todecide in which areas it should carryout social goals. Some of the specificresponsibilities and enterprise may beoutlined as under:(i) Responsibility towards theshareholders or owners: A businessenterprise has the responsibility toprovide a fair return to the shareholdersor owners on their capital investmentand to ensure the safety of suchinvestment. The corporate enterprise ona company form of organisation mustalso provide the shareholders withregular, accurate and full information

about its working as well as schemesof future growth.(ii) Responsibility towards theworkers: Management of an enterpriseis also responsible for providingopportunities to the workers formeaningful work. It should try to createthe right kind of working conditions sothat it can win the cooperation ofworkers. The enterprise must respectthe democratic rights of the workers toform unions. The worker must also beensured of a fair wage and a fair dealfrom the management.(iii) Responsibility towards theconsumers: Supply of right qualityand quantity of goods and services toconsumers at reasonable pricesconstitutes the responsibility of anenterprise toward its customers. Theenterprise must take proper precautionagainst adulteration, poor quality, lackof desired service and courtesy tocustomers, misleading and dishonestadvertising, and so on. They must alsohave the right of information about theproduct, the company and othermatters having a bearing on theirpurchasing decision.(iv) Responsibility towards thegovernment and community: Anenterprise must respect the laws of thecountry and pay taxes regularly andhonestly. It must behave as a goodcitizen and act according to the wellaccepted values of the society. It mustprotect the natural environment andshould avoid bad, effluent, smokychimneys, ugly buildings dirty workingconditions. It must also develop aproper image in society through


continuous interaction with variousgroups of people.

6.6 BUSINESS AND ENVIRONMENTAL

PROTECTION

Protection of the environment is aserious issue that confronts businessmanagers and decision makers. Theenvironment is defined as the totalityof man’s surroundings — both naturaland man-made. These surroundingsare also in the nature of resources, thatare useful for human life. The resourcesmay also be called natural resourceslike land, water, air, fauna and flora andraw materials; or man-made resourcessuch as cultural heritage, socio-economic institutions and the people.It is widely recognised that the qualityof the environment is fast deterioratingparticularly due to industrial activity.This is a common sight around majorcities like Kanpur, Jaipur, Delhi,Panipat, Kolkata, and others, invarious states of our country. Theiremissions are seriously affecting thehealth of the people. Pollution — theinjection of harmful substances intothe environment is, in fact, largely theresult of industrial production. Sincesome waste is inevitable in the useof materials and energy, themanufacturers face a great challengein minimising the adverse impactof this waste by using propertechnologies. Protection of theenvironment is good for all of us.

Pollution changes the physical,chemical and biological characteristicsof air, land and water. Pollution harmshuman life and the life of other species.

It also degrades living conditions whilewasting or depleting raw materialresources. The country’s culturalheritage is also affected and it isbecoming increasingly difficult toprotect all historical monuments.Pollution exists because theenvironment can absorb only a limitedamount of pollutants and wastes.Some hazardous wastes or toxicby-products and chemicals are termedas hazardous pollutants because theyhave toxic characteristics that theenvironment can not assimilate.Pollution thus causes risks toenvironmental quality, human healthand damage to natural and man-maderesources. Protection of theenvironment is directly related to thecontrol of pollution.

6.6.1 Causes of Pollution

It must be recognised that all sectorsof our society viz., industry,government, agriculture, mining,energy, transportation, construction,and consumers generate waste. Wastescontain pollutants which are thematerials of chemicals that have beendiscarded during the process ofproduction or consumption. Pollutionis caused by these pollutants which arereleased into the environment beyondits assimilation capacity. Among thevarious sources of pollution, industryis a major generator of waste in termsof both its quantity and toxicity.Business activities such as production,distribution, transport, storage,consumption of goods and services areknown to be the most critical sources


of environmental pollution problems.Many business enterprises have beenresponsible for causing (i) air, (ii) water(iii) land, and (iv) noise pollution.

These types of pollution arediscussed as follows:(i) Air pollution: Air pollution is theresult of a combination of factors whichlowers the air quality. It is mainly dueto carbon monoxide emitted byautomobiles which contributes to airpollution. Similarly, smoke and otherchemicals from manufacturing plantspollute the air. Resultant air pollutionhas created a hole in the ozone layerleading to dangerous warming ofthe earth.(ii) Water pollution: Water becomespolluted primarily from chemical andwaste dumping. For years, businessenterprises have been dumping wasteinto rivers, streams and lakes with littleregard for the consequences. Waterpollution has led to the death of severalanimals and posed a serious threat tohuman life.(iii) Land pollution: Dumping of toxicwastes on land causes land pollution.This damages the quality of landmaking it unfit for agriculture orplantation. Restoring the quality of theland that has already been damaged isa big problem.

(iv) Noise pollution: Noise caused bythe running of factories and vehiclesis not merely a source of annoyancebut is also a serious health hazard.Noise pollution can be responsiblefor many diseases like loss of hearing,malfunctioning of the heart andmental disorder.

6.6.2 Need for Pollution Control

Pollution prevention or control isneeded to preserve preciousenvironmental resources and toimprove the environmental quality sothat the preserved resources can beutilised for the benefit of mankind andthe improvement of health and well-being of the people. The amount ofdamage to a particular medium (air,water, land) varies according to the typeof pollutant, the amount of pollutantdisposed of, and the distance from thesource of pollution. But all pollutantsalter the quality of the environment andrender it, to some degree, unfit topreserve normal life. People are nowraising their voice loudly againstpollution generating activities.Business enterprises cannot remainunaffected by environmentaldestruction. They need to take suitablemeasures for pollution control not

Environmental Problems

The united nations has identified eight problems that cause damage to the naturalenvironment. These are:(i) Ozone depletion (v) Fresh water quality and quantity(ii) Global warming (vi) Deforestation(iii) Solid and hazardous wastes (vii) Land degradation(iv) Water pollution (viii) Danger to biological diversity


merely to avoid criticisms against thembut also to enjoy other benefits of suchmeasures. Some of the importantreasons which make a case for pollutioncontrol are as follows:(i) Reduction of health hazards:There is increasing evidence that manydiseases like cancer, heart attacks andlung complications are caused bypollutants in the environment.Pollution control measures can notonly check the seriousness of suchdiseases but can also be supportive ofa healthy life on earth.(ii) Reduced risk of liability: It ispossible that an enterprise is held liableto pay compensation to people affectedby the toxicity of gaseous, liquid andsolid wastes it has released into theenvironment. Therefore, it is soundbusiness policy to install pollutioncontrol devices in its premises to reducethe risk of liability.(iii) Cost savings: An effective pollutioncontrol programme is also needed tosave costs of operating business. Costsavings are particularly noticeablewhen improper production technologyresults in greater wastes which leadsto higher cost of waste disposal andcost of cleaning the plants.(iv) Improved public image: Associety becomes increasingly consciousof environmental quality, a firm’spolicies and practices for controllingwastes will increasingly influencepeople’s attitude towards its working.A firm that promotes the cause forenvironment will be able to enjoy a goodreputation and will be perceived as asocially responsible enterprise.

(v) Other social benefits: Pollutioncontrol results in many other benefitslike clearer visibility, cleaner buildings,better quality of life, and the availabilityof natural products in a purer form.

6.6.3 Role of Business inEnvironmental Protection

Since the quality of the environment isimportant for all of us, we have acollective responsibility to protect itfrom being spoiled. Whether it isgovernment, business enterprises,consumers, workers, or other membersof society, each one can do somethingto stop polluting the environment.Government can enact laws to banhazardous products. Consumers,workers and the members of societycan avoid using certain productsand doing things that are notenvironment friendly.

The business enterprises should,however, take the lead in providing theirown solutions to environmentalproblems. It is the social responsibilityof every business to take steps not onlyto check all sorts of pollution but alsoto protect environmental resources.Business enterprises are leadingcreators of wealth, employment, tradeand technology. They also commandhuge financial, physical and humanresources. They also have the know-how to solve environmental pollutionproblems with a preventive approachby controlling pollutants at the source.In most cases, a modification or changein the process of production, redesignof equipment, substituting poor qualitymaterials with better ones or other


innovative approaches could greatlyreduce or even eliminate pollutionentirely. Some of the specific steps whichcan be taken by business enterprisesfor environmental protection are asstated below:

(i) A definite commitment by topmanagement of the enterpriseto create, maintain and developwork culture for environmentalprotection and pollutionprevention.

(ii) Ensuring that commitment toenvironmental protection is sharedthroughout the enterprise by alldivisions and employees.

(iii) Developing clear-cut policies andprogrammes for purchasing goodquality raw materials, employingsuperior technology, usingscientific techniques of disposaland treatment of wastes anddeveloping employee skills for thepurpose of pollution control.

(iv) Complying with the laws andregulations enacted by theGovernment for prevention ofpollution.

(v) Participation in govern-ment programmes relating tomanagement of hazardoussubstances, clearing up of pollutedrivers, plantation of trees, andchecking deforestation.

(vi) Periodical assessment of pollutioncontrol programmes in terms ofcosts and benefits so as to increasethe progress with respect toenvironmental protection.

(vii) Arranging educational workshopsand training materials to sharetechnical information and

experience with suppliers, dealersand customers to get them activelyinvolved in pollution controlprogrammes.

6.7 BUSINESS ETHICS

From the social point of view, businessexists to supply goods and services tothe people. From the individual point ofview, the primary objective of a businessfirm is to earn profit. One may expectthat the individual goals of the firmwould not be in conflict with theobjectives of society. However, businessenterprises are run by human beingswhose decisions and actions may notalways be in accordance with theexpectations of society. An enterprisemay be good in terms of economicperformance (like revenue, costs andprofits) but poor in terms of socialperformance like supplying products ofreasonable quality and at reasonableprices. This raises the question of whatis right or wrong from society’s point ofview. The answer to this question isimportant because business enterprisesare products of and are influenced bysociety. They have to interpret andadjust to the preferences or valuesof society. The subject matter of ethicsis concerned with establishing linkagesbetween individual good and socialgood.

6.7.1 Concept of Business Ethics

The word ‘ethics’ has its origin in theGreek word ‘ethics’ meaning character;norms, ideals or morals prevailing in agroup or society. Ethics is concernedwith what is right and what is wrong in


human behaviour judged on the basisof a standard form of conduct/ehaviourof individuals, as approved by societyin a particular field of activity. Ethicsmay be viewed as the entire body ofmoral values that society attaches tothe actions of human beings. Ethics canalso refer to codes or other system forcontrolling means so that they servehuman ends. Ethical standards areoften enacted into laws. But ethicalbehaviour is just and fair conductwhich goes beyond observing laws andgovernment regulations. It means

adhering to moral principles, beingguided by particular values, andbehaving in a way people ought to act.The set of principles called ethics maybe written or unwritten codes orprinciples governing a professional orhuman activity.

Business ethics concerns itself withthe relationship between businessobjectives, practices, and techniquesand the good of society. Businessethics refer to the socially determinedmoral principles which should governbusiness activities. A few examples of

Environmental Protection in India(Steps by the Government)

1. Laws: The directive principles of state policy in the Constitution of India layemphasis on protection of environment. Some of the laws enacted are asunder:i. The Wildlife Protection Act, 1972ii. The Water (Prevention and Control of Pollution) Act, 1974 amended in

1974 and 1988iii. The Air (Prevention and Control of Pollution) Act, 1974 amended in 1974

and 1988iv. The Environment (Protection) Act, 1986v. The Forests (Conservation Act, 1980 amended in 1988vi. The Hazardous Wastes Act, 1989

2. Regulations: Administrative orders/policy guidelines have been laid downby the government. A separate Department of Environment, Government ofIndia was created in 1980.

3. Certain regulatory bodies or quasi-judicial authorities have been establishedsuch as:• National Afforestation and Eco-development Board, and• National Wastelands Development Board

4. Manufacturing units have been closed in cities. High Court of Delhi orderedshifting of manufacturing units out of Delhi and closing them. Similarly,courts have ordered removal of foundaries from Agra city, and shifting ofmanufacturing factories from Kanpur.

5. Various programmes on environment education, and seminars on creatingawareness and resource are being organised regularly.

6. Government has also laid down Environment Action Plan (EAP).


business ethics are: charging fair pricesfrom customers, using fair weights formeasurement of commodities, givingfair treatment to workers and earningreasonable profits. A businesspersonbehaves ethically when her or hisactions are upright and serve theinterest of society. This, of course, alsoapplies to those not in business. Theessential difference is perhaps thatbusinesspersons by virtue of theirwidespread control over society’sresources have a much greater effecton what happens in a society thanpersons in other areas of activity do.Business people and politicians areexpected to have higher standards overand above other people. This is perhapsthe price they pay for being allowed tomake decisions on behalf of society.

There is a growing realisation allover the world that ethics is vitallyimportant for every business and forthe progress of any society. Ethicalbusiness is good business. Ethicalbusiness behaviour improves publicimage, earns people’s confidence and

trust, and leads to greater success.Ethics and profits go together in the longrun. Ethics alone, and not governmentor laws, can make a society great. Anethically responsible enterprise developsa culture of caring for people andenvironment and commands a highdegree of integrity in dealing with others.Ethical activity is indeed valuable initself, for its own sake, because itenhances the quality of our lives andthat of the work we do.

6.7.2 Elements of Business Ethics

Since ethical business behavior is goodfor both the business enterprise andsociety, it makes sense to discuss howthe enterprises can foster ethics in theirday-to-day working. Some of the basicelements of business ethics whilerunning a business enterprise are asunder:(i) Top management commitment:Top management has a crucial role inguiding the entire organisation towardsethically upright behaviour. To achieve

Origin of Three Similar Concepts

(a) Corporate Social Responsibility: It originated in U.S.A where Governmenthad passed Anti-Trust Act against monopolistic practices, so as to protectand improve the welfare of society.

(b) Business Ethics: This also originated in U.S.A in the 1970s. Business ethicshighlighted social values and society’s concerns in relation to business andforced the corporates in that country to abstain from policies and practiceswhich were hostile to consumers and environmental protection.

(c) Corporate Governance: It originated in the U.K. for the purpose of improvedaccountability of directors to shareholders, emphasis on more transparentauditing and increased responsibilities of independent directors, and divisionof roles of chairman and managing directors for safeguarding interests ofshareholders.


results, the Chief Executive Officer (orCEO) and other higher level managersneed to be openly and stronglycommitted to ethical conduct. Theymust give continuous leadership fordeveloping and upholding the valuesof the organisation.(ii) Publication of a ‘Code’: Enter-prises with effective ethics programmesdo define the principles of conduct forthe whole organisation in the form ofwritten documents which is referred toas the “code”. This generally coversareas such as fundamental honestyand adherence to laws; product safetyand quality; health and safety in theworkplace; conflicts of interest;employment practices; fairness inselling/marketing practices; andfinancial reporting.(iii) Establishment of compliancemechanisms: In order to ensure thatactual decisions and actions complywith the firm’s ethical standards,suitable mechanisms should beestablished. Some examples of suchmechanisms are: paying attention to

values and ethics in recruiting andhiring; emphasising corporate ethics intraining; auditing performanceregularly to analyse the degreeof compliance; and institutingcommunication systems to helpemployees report incidents of unethicalbehaviour.(iv) Involving employees at alllevels: It is the employees at differentlevels who implement ethics policies tomake ethical business a reality.Therefore, their involvement in ethicsprogrammes becomes a must. Forexample, small groups of employeescan be formed to discuss the importantethics policies of firms and examineattitudes of employees towards thesepolicies.(v) Measuring results: Although it isdifficult to accurately measure the endresults of ethics programmes, the firmscan certainly audit to monitorcompliance with ethical standards. Thetop management team and otheremployees should then discuss theresults for further course of action.

Ground Rules of Ethics

The following are some of the universal virtues which every human being shouldimbibe, develop and practice to be ethical in life:

(a) Be trustworthy

(b) Have respect for others

(c) Own responsibility

(d) Be fair in dealings

(e) Be caring towards well being of others

(f) Prove to be a good citizen — through civil virtues and duties


SUMMARY

Concept of social responsibility: Social responsibility of business refersto its obligation to take those decisions and perform those actions whichare desirable in terms of the objectives and values of our society.

Need for social responsibility: Need for social responsibility of businessarises both because of firm’s interest and the interest of society. However,there are arguments both for and against social responsibility.

Arguments for social responsibility: Major arguments are: (i) justificationfor existence and growth, (ii) long-term interest and image of the firm,(iii) avoidance of government regulation, (iv) maintenance of orderly society,(v) availability of resources with business, (vi) converting problems intoopportunity, (vii) better environment for doing business, and (viii) holdingthe business responsible for social problems.

Arguments against social responsibility: Major arguments against socialresponsibility are: (i) violation of profit maximisation objective, (ii) burdenon consumers, (iii) lack of social skills and (iv) lack of broad public support.

Reality of social responsibility: Reality of social responsibility is that,despite differing arguments relating to social responsibility, businessenterprises are concerned with social responsibility because of the influenceof certain external forces. These forces are: (i) threat of public regulation,(ii) pressure of labour movement, (iii) impact of consumer consciousness,(vi) development of social standard for businessmen, (v) development ofbusiness education, (vi) relationship between social interest and businessinterest, and (vii) development of professional, managerial class.

Social responsibility towards different interest groups: Businessenterprises have responsibility towards (i) shareholders or owners,(ii) workers, (iii) consumers and (iv) government and community giving fairreturn on and safety of investment to shareholders, providing opportunitiesto workers for meaningful work, supplying right quality and quantity ofgoods and services to consumers and paying to the government, andprotecting natural environment are some of the social responsibilities ofbusiness.

Key Terms

Social responsibility Water pollution Business ethics

Environment Noise pollution Legal responsibility

Environmental protection Air pollution Ethics

Pollution Land pollution Code of ethics


Business and environment protection: Protection of the environment isa serious issue that confronts managers and decision makers. Theenvironment is defined as the totality of man’s surroundings — both naturaland man-made. Pollution — the injection of harmful substances into theenvironment is, in fact, largely the result of industrial production. Pollutionhas harmful effects both for human life and the life of other species.

Causes of Pollution: Among the various sources of pollutions, industry isa major generator of waste in terms of both its quantity and toxicity. Manybusiness enterprises have been responsible for causing air, water, landand noise pollution.

Need for pollution control: Important reasons which make a case forpollution control are: (i) reduction of health hazards, (ii) reduced riskof liability, (iii) cost savings (iv) improved public image, and (v) othersocial benefits.

Role of business in environmental protection: Each member of societycan do something to protect the environment. The business enterprisesshould, however, take the lead in providing their own solutions toenvironmental problems. Some of the steps that they can take are: topmanagement commitment, clear-out policies and programmes, abiding bygovernment regulations, participation in government programmes, periodicalassessment of pollution control programmes, and proper education andtraining of concerned people.

Concept of business ethics: Ethics is concerned with what is right andwhat is wrong in human behaviour judged on the basis of sociallydetermined standards of behaviour. Business ethics concerns itself withrelationship between objectives, practices, and techniques and the good ofsociety. Ethics is important for every business.

Elements of business ethics: An enterprise can foster ethics at theworkplace by following basic elements of business ethics, such as (i) topmanagement’s commitment, (ii) publication of a establishment of compliancemechanism, (iv) involving employees at all levels and (v) measuring results.

EXERCISES


1. Social responsibility is

a. Same as legal responsibility b. Broader than legalresponsibility

c. Narrower thanlegal responsibility d. None of them


2. If business is to operate in a society which is full of diverse andcomplicated problems, it may have

a. Little chance of success b. Great chance of successc. Little chance of failure d. No relation with success

or failure.

3. Business people have the skills to solve

a. All social problems b. Some social problemsb. No social problems d. All economic problems

4. That an enterprise must behave as a good citizen is an example of itsresponsibility towards

a. Owners b. Workersc. Consumers d. Community

5. Environmental protection can best be done by the efforts of

a. Business people b. Governmentc. Scientists d. All the people

6. Carbon monoxide emitted by automobiles directly contributes to

a. Water pollution b. Noise pollutionc. Land pollution d. All the people

7. Which of the following can explain the need for pollution control?

a. Cost savings b. Reduced risk of liabilityc. Reduction of health hazards d. All of them

8. Which of the following is capable of doing maximum good to society?

a. Business success b. Laws and regulationsc. Ethics d. Professional management

9. Ethics is important for

a. Top management b. Middle-level managersc. Non-managerial employees d. All of them

10. Which of the following alone can ensure effective ethics programme in abusiness enterprise?

a. Publication of a code b. Involvement of employeesc. Establishment of compliance d. None of them

mechanisms


1. What do you understand by social responsibility of business? How is itdifferent from legal responsibility?


2. What is environment? What is environmental pollution?

3. What is business ethics? Mention the basic elements of business ethics.

4. Briefly explain (a) Air Pollution, (b) Water pollution, and (c) Land pollution.

5. What are the major areas of social responsibility of business?


1. Build up arguments for and against social responsibilities.

2. Discuss the forces which are responsible for increasing concern ofbusiness enterprises toward social responsibility.

3. ‘Business is essentially a social institution and not merely a profitmaking activity’. Explain.

4. Why do the enterprises need to adopt pollution control measures?

5. What steps can an enterprise take to protect the environment from thedangers of pollution?

6. Explain the various elements of business ethics.

Projects/Assignment

1. Develop and put in writing a code of ethics for use in the classroom.Your document should include guidelines for students, teachers, andthe principal.

2. Using newspapers, magazines and other business references, identifyand describe at least three companies that you think are sociallyresponsible and three that you think are socially irresponsible.

PART-II

Corporate Organisation,Finance and Trade


CHAPTER 7

FORMATION OF A COMPANY

LEARNING OBJECTIVES


• specify the important stages in the formation of a company;

• describe the steps involved in each stage of company formation;

• specify the documents to be submitted to the registrar ofcompanies; and

• state the need of certificate of incorporation and certificate tocommence business.

161FORMATION OF A COMPANY

7.1 INTRODUCTION

Modern day business requires largeamount of money. Also, due toincreasing competition and fastchanging technological environment,the element of risk is increasing. As aresult, the company form oforganisation is being preferred by moreand more business firms, particularlyfor setting up medium and large sizedorganisations.

The steps which are required fromthe time a business idea originates tothe time, a company is legally ready tocommence business are referred to asstages in the formation of a company.Those who are taking these steps andthe associated risks are promoting acompany and are called its promoters.

The present chapter describes insome details the stages in the formationof a company and also the stepsrequired to be taken in each stage sothat a fair idea about these aspects canbe made.

7.2 FORMATION OF A COMPANY

As discussed in an earlier chapter on‘Forms of organisations’, formation of

a company is a complex activityinvolving completion of a lot of legalformalities and procedures. To fullyunderstand the process one candivide the formalities into four distinctstages, which are: (i) P r o m o t i o n ;(ii) Incorporation; (iii) Subscription ofcapital; and (iv) Commencement ofbusiness.

It may, however, be noted that thesestages are appropriate from the pointof view of formation of a public limitedcompany. As far as the private limitedcompanies are concerned only the firsttwo stages mentioned above areappropriate. In other words, a privatecompany can start its businessimmediately after obtaining thecertificate of incorporation. As it isprohibited to raise funds from public,it does not need to issue a prospectusand complete the formality of minimumsubscription. A public company, on theother hand, goes through the capitalsubscription stage and then receivesthe certificate of commencement. Thus,it has to undergo all the four stages.

In the next section, we shall discussthese four stages in the formation of acompany in some detail.

Avtar, a brilliant automobile engineer, has recently developed a new carburettorin his factory which he is running as a sole proprietor. The new carburettor cancut down petrol consumption of a car engine by 40 percent. He is now thinkingof producing it on a large scale for which he requires a large amount of money.He is to evaluate different forms of organisations for doing the business ofmanufacturing and marketing his carburettor. He decides against convertinghis sole proprietorship to partnership as the requirement of funds for the projectis large and the product being new, there is a lot of risk involved. He is advisedto form a company. He wants to know about the formalities required for theformation of a company.


7.2.1 Promotion of a Company

Promotion is the first stage in theformation of a company. It involvesconceiving a business opportunity andtaking an initiative to form a companyso that practical shape can be given toexploiting the available businessopportunity. Thus, it begins withsomebody having discovered a potentialbusiness opportunity. Any person ora group of persons or even a companymay have discovered an opportunity.If such a person or a group of personsor a company proceeds to form acompany, then, they are said to be thepromoters of the company.

There is no statutory definition ofa promoter. A promoter is said to bethe one who undertakes to form acompany with reference to a givenproject and to set it going and whotakes the necessary steps to accomplishthat purpose. Thus, apart fromconceiving a business opportunity thepromoters analyse its prospects andbring together the men, materials,machinery, managerial abilities andfinancial resources and set theorganisation going.

After thoroughly examining thefeasibility of the idea, the promotersassemble resources, prepare necessarydocuments, give a name and performvarious other activities to get acompany registered and obtain thenecessary certificate enabling thecompany to commence business.Thus, the promoters perform variousfunctions to bring a company intoexistence.

Functions of a Promoter

The important functions of promotersmay be listed as below:(i) Identification of businessopportunity: The first and foremostactivity of a promoter is to identify abusiness opportunity. The opportunitymay be in respect of producing a newproduct or service or making someproduct available through a differentchannel or any other opportunityhaving an investment potential. Suchopportunity is then analysed to see itstechnical and economic feasibility.(ii) Feasibility studies: It may not befeasible or profitable to convert allidentified business opportunities intoreal projects. The promoters, therefore,undertake detailed feasibility studiesto investigate all aspects of the businessthey intend to start. Depending uponthe nature of the project, the followingfeasibility studies may be undertaken,with the help of the specialists likeengineers, chartered accountants etc.,to examine whether the perceivedbusiness opportunity can be profitablyexploited.(a) Technical feasibility: Sometimes

an idea may be good buttechnically not possible to execute.It may be so because the requiredraw material or technology is noteasily available. For example, in ourearlier story suppose Avtar needsa particular metal to produce thecarburettor. If that metal is notproduced in the country andbecause of poor political relations,it can not be imported from the


country which produces it, theproject would be technicallyunfeasible until arrangements aremade to make the metal availablefrom alternative sources.

(b) Financial feasibility: Everybusiness activity requires funds.The promoters have to estimate thefund requirements for the identifiedbusiness opportunity. If therequired outlay for the project is solarge that it cannot easily bearranged within the availablemeans, the project has to be givenup. For example, one may thinkthat developing townships is verylucrative. It may turn out that therequired funds are in several croresof rupees, which cannot bearranged by floating a company bythe promoters. The idea may beabandoned because of the lack offinancial feasibility of the project.

(c) Economic feasibility: Sometimesit so happens that a project istechnically viable and financially

feasible but the chance of it beingprofitable is very little. In such casesas well, the idea may have to beabondoned. Promoters usually takethe help of experts to conduct thesestudies. It may be noted that theseexperts do not become promotersjust because they are assisting thepromoters in these studies.Only when these investigations

throw up positive results, thepromoters may decide to actuallylaunch a company.(iii) Name approval: Having decidedto launch a company, the promotershave to select a name for it and submit,an application to the registrar ofcompanies of the state in which theregistered office of the company is tobe situated, for its approval. Theproposed name may be approved if itis not considered undesirable. It mayhappen that another company existswith the same name or a very similarname or the preferred name ismisleading, say, to suggest that the

Name Clause

A name is considered undesirable in the following cases:(a) If it is identical with or too closely resembles the name of an existing

company(b) If it is misleading. It is so considered if the name suggests that the company

is in a particular business or it is an association of a particular type whenit is not true

(c) If it is violative of the provisions of ‘The Emblem and Names (Prevention ofImproper Use) Act 1950, as given in the schedule to this Act. This schedulespecifies, inter alia, the name, emblem or official seal of the UNO and itsbodies like WHO, UNESCO etc. Government of India, State Governments,President of India or Governer of any State, the Indian National Flag. TheAct also prohibits use of any name which may suggest patronage ofGovernment of India, or any state government or any local authority


company is in a particular business whenit is not true. In such cases the proposedname is not accepted but some alternatename may be approved. Therefore, threenames, in order of their priority are givenin the application to the Registrar ofCompanies. (Performa Application foravailability of names (Form 1A) is givenat the end of the chapter.)(iv) Fixing up Signatories to theMemorandum of Association:Promoters have to decide about themembers who will be signing theMemorandum of Association of theproposed company. Usually the peoplesigning memorandum are also the firstDirectors of the Company. Their writtenconsent to act as Directors and to takeup the qualification shares in thecompany is necessary.(v) Appointment of professionals:Certain professionals such asmercantile bankers, auditors etc., areappointed by the promoters to assistthem in the preparation of necessarydocuments which are required to bewith the Registrar of Companies. Thenames and addresses of shareholdersand the number of shares allotted toeach is submitted to the Registrar in astatement called return of allotment.(vi) Preparation of necessarydocuments: The promoter takes upsteps to prepare certain legaldocuments, which have to besubmitted under the law, to theRegistrar of the Companies for gettingthe company registered. Thesedocuments are Memorandum ofAssociation, Articles of Association andConsent of Directors.

Documents Required to beSubmitted

A. Memorandum of Association:Memorandum of Association is themost important document as itdefines the objectives of thecompany. No company can legallyundertake activities that are notcontained in its Memorandum ofAssociation. The Memorandum ofAssociation contains differentclauses, which are given as follows:

(i) The name clause: This clausecontains the name of the company withwhich the company will be known,which has already been approved bythe Registrar of Companies.(ii) Registered office clause: Thisclause contains the name of the state,in which the registered office of thecompany is proposed to be situated.The exact address of the registeredoffice is not required at this stage butthe same must be notified to theRegistrar within thirty days of theincorporation of the company.(iii) Objects clause: This is probablythe most important clause of thememorandum. It defines the purposefor which the company is formed. Acompany is not legally entitled toundertake an activity, which is beyondthe objects stated in this clause. Theobject clause is divided into two sub-clauses, which are:• The main objects: The main

objects for which the company isformed are listed in this sub-clause.It must be observed that an actwhich is either essential or incidental


for the attainment of the main objectsof the company is deemed to bevalid, although it may not have beenstated explicitly in the sub-clause.

• Other objects: Objects not includedin the main objects could be statedin this sub-clause. However, if acompany wishes to undertake abusiness included in this sub-clause, it has to either pass a specialresolution or pass an ordinaryresolution and get centralgovernment’s approval for the same.

(iv) Liability clause: This clause limitsthe liability of the members to theamount unpaid on the shares ownedby them.

For example, if a shareholder haspurchased 1000 shares of Rs.10 eachand has already paid Rs. 6 per share,his/her liability is limited to Rs. 4 pershare. Thus, even in the worst case,he/she may be called upon to payRs. 4, 000 only.(v) Capital clause: This clausespecifies the maximum capital whichthe company will be authorised to raisethrough the issue of shares. Theauthorised share capital of theproposed company along with itsdivision into the number of shareshaving a fixed face value is specified inthis clause. For example, theauthorised share capital of thecompany may be Rs. 25 with divided

into 2.5 lakh shares of Rs.10 each. Thesaid company cannot issue sharecapital in excess of the amountmentioned in this clause.(vi) Association clause: In thisclause, the signatories to theMemorandum of Association state theirintention to be associated with thecompany and also give their consentto purchase qualification shares.

The Memorandum of Associationmust be signed by at least sevenpersons in case of a public companyand by two persons in case of a privatecompany.

A copy of a Memorandum ofAssociation is given at the end of thechapter.B. Articles of Association: Articles of

Association are the rules regardinginternal management of a company.These rules are subsidiary to theMemorandum of Association andhence, should not contradict orexceed anything stated in theMemorandum of Association. Apublic limited company may adoptTable A which is a model set ofarticles given in the Companies Act.Table A is a document containingrules and regulations for the internalmanagement of a company. If acompany adopts Table A, there is noneed to prepare separate Articles ofAssociation. For companies not

Association Clause

The association clause reads as under:“We, the several persons whose names and addresses are subscribed, are desirousof being formed into a company in pursuance of this Memorandum of Association,and we respectively agree to take the number of shares in the capital of thecompany set opposite our respective names.”


adopting Table A, a copy of theArticles of Association, stamped andduly signed by signatories to theMemorandum of Association isrequired for registration.

C. Consent of Proposed Directors:Apart from the Memorandum andArticles of Association, a writtenconsent of each person named as adirector is required confirming thatthey agree to act in that capacityand undertake to buy and pay forqualification shares, as mentionedin the Articles of Association.

D. Agreement: The agreement, if any,which the company proposes toenter with any individual forappointment as its ManagingDirector or a whole time Director orManager is another documentwhich is required to be submittedto the Registrar for getting thecompany registered under the Act.

E. Statutory Declaration: Adeclaration stating that all the legalrequirements pertaining toregistration have been compliedwith is to be submitted to theRegistrar with the above mentioneddocuments for getting the companyregistered under the law. Thisstatement can be signed by anadvocate of High Court or SupremeCourt or by a Chartered Accountantin full time practice or by a personnamed in the articles as a director

or manager or secretary of thecompany. Performa of statutorydeclaration given.

F. Payment of fee: Along with theabove-mentioned documents,necessary fees has to be paid for theregistration of the company. Theamount of such fees shall depend onthe authorised share capital ofthe company.

Position of Promoters

Promoters undertake various activitiesto get a company registered and get itto the position of commencement ofbusiness. But they are neither theagents nor the trustees of the company.They can’t be the agents as thecompany is yet to be incorporated.Therefore, they are personally liable forall the contracts which are entered bythem, for the company before itsincorporation, in case the same are notratified by the company later on. Alsopromoters are not the trustees ofthe company.

Promoters of a company enjoy afiduciary position with the company,which they must not misuse. They canmake a profit only if it is disclosed butmust not make any secret profits. Inthe event of a non-disclosure, thecompany can rescind the contract andrecover the purchase price paid to thepromoters. It can also claim damages

Qualification Shares

To ensure that the directors have some stake in the proposed company, theArticles usually have a provision requiring them to buy a certain number ofshares. They have to pay for these shares before the company obtains Certificateof Commencement of Business. These are called Qualification Shares.


for the loss suffered due to thenon-disclosure of material information.

Promoters are not legally entitled toclaim the expenses incurred in thepromotion of the company. However,the company may choose to reimbursethem for the pre-incorporationexpenses. The company may alsoremunerate the promoters for theirefforts by paying a lump sum amount

or a commission on the purchase priceof property purchased through themor on the shares sold. The companymay also allot them shares ordebentures or give them an option topurchase the securities at a future date.

7.2.2 Incorporation

After completing the aforesaidformalities, promoters make an

Performa for Statutory Declaration

“FORM NO.1”

The Companies Act. 1956

Declaration of Compliance with requirements of the Companies Act, 1956

on Application for Registration of a Company.

PURSUANT TO SECTION 33 (2)

NAME OF THE COMPANY : M/S.

PRESENTED BY : SUSHIL KR.

CHARTERED ACCOUNTANT.

I, ........(NAME OF CA).......Partner of... (NAME OF CA FIRM & ITS ADDRESS)...,

do solemnly and sincerely declare that I am a Chartered Accountant in whole

time practice in India, who is engaged in the formation of the company

“M/s.———————————————— PRIVATE LIMITED”.

And that all the requirements of the Companies Act, 1956 and the rules

thereunder in respect of matters precedent to the registration of the said

company and incidental thereto have been complied with and I make this

solemn declaration conscientiously believing the same to be true.

PLACE : NEW DELHI (NAME OF CA)

DATED : CHARTERED ACCOUNTANTS


application for the incorporation ofthe company. The application is to befiled with the Registrar of Companiesof the state within which they plan toestablish the registered office of thecompany. The application forregistration must be accompaniedwith certain documents about whichwe have already discussed in theprevious sections. These may bebriefly mentioned again:

1. The Memorandum of Associationduly stamped, signed andwitnessed. In case of a publiccompany, at least seven membersmust sign it. For a private

statement in lieu of the prospectusis submitted, instead of Articlesof Association.

3. Written consent of the proposeddirectors to act as directors andan undertaking to purchasequalification shares.

4. The agreement, if any, with theproposed Managing Director,Manager or whole-time director.

5. A copy of the Registrar’s letterapproving the name of thecompany.

6. A statutory declaration affirmingthat all legal requirements forregistration have been complied

company however the signaturesof two members are sufficient.The signatories must also giveinformation about their address,occupation and the number ofshares subscribed by them.

2. The Articles of Association dulystamped and witnessed as in caseof the Memorandum. However, asstated earlier, a public companymay adopt Table A, which is amodel set of Articles, given in theCompanies Act. In that case a

with. This must be signed by anadvocate of a High court orSupreme Court or a signatory tothe Memorandum of Associationor a Chartered Accountant orCompany Secretary in whole timepractice in India.

7. A notice about the exact addressof the registered office may also besubmitted along with thesedocuments. However, if the sameis not submitted at the time ofincorporation, it can be submitted

Preliminary Contracts

During the promotion of the company, promoters enter into certain contractswith third parties on behalf of the company. These are called preliminary contractsor pre-incorporation contracts. These are not legally binding on the company. Acompany after coming into existence may, if it so chooses, decide to enter intofresh contracts with the same terms and conditions to honour the contractsmade by the promoters. Note that it cannot ratify a preliminary contract. Acompany thus cannot be forced to honour a preliminary contract. Promoters,however, remain personally liable to third parties for these contracts.


within 30 days of the receipt of thecertificate of incorporation.

8. Documentary evidence of paymentof registration fees.

The Registrar upon submission ofthe application along with the requireddocuments has to be satisfied that thedocuments are in order and that all thestatutory requirements regarding theregistration have been complied with.However, it is not his duty to carry outa thorough investigation about theauthenticity of the facts mentioned inthe documents.

When the Registrar is satisfied,about the completion of formalities

for registration, a Certificate ofIncorporation is issued to the company,which signify the birth of the company.The certificate of incorporation maytherefore be called the birth certificateof the company.

With effect from November 1, 2000,the Registrar of Companies allots aCIN (Corporate Identity Number) tothe Company.

Effect of the Certificate ofIncorporation

A company is legally born on the dateprinted on the Certificate of

SPECIMEN OF

CERTIFICATE OF INCORPORATION

I hereby certify that ....................................................... (name of the company)

is this day incorporated under the Companies Act 1956, and that the

Company is limited.

Given under my hand at Delhi, this seventh day of November, two

thousand and five.

Fees: Deed Stamp Rs. ..........................

Stamp Duty on Capital Rs. .........................

Sd/-

Registrar of Companies

Delhi

Corporate Identity Number

of Company : 1352 of 2005

SEAL


Incorporation. It becomes a legal entitywith perpetual succession on suchdate. It becomes entitled to enter intovalid contracts. The Certificate ofIncorporation is a conclusive evidenceof the regularity of the incorporation ofa company. Imagine, what wouldhappen to an unsuspecting party withwhich the company enters into acontract, if it is later found that theincorporation of the company wasimproper and hence invalid. Therefore,the legal situation is that once aCertificate of Incorporation has beenissued, the company has become alegal business entity irrespective of anyflaw in its registration. The Certificateof Incorporation is thus conclusiveevidence of the legal existence of thecompany. Some interesting examplesshowing the impact of theconclusiveness of the Certificate ofIncorporation are as under:(a) Documents for registration were

filed on 6th January. Certificate ofIncorporation was issued on 8thJanuary. But the date mentionedon the Certificate was 6th January.It was decided that the companywas in existence and the contractssigned on 6th January wereconsidered valid.

(b) A person forged the signaturesof others on the Memorandum.The Incorporation was stillconsidered valid.Thus, whatever be the deficiency in

the formalities, the Certificate ofIncorporation once issued, is aconclusive evidence of the existence ofthe company. Even when a company

gets registered with illegal objects, thebirth of the company cannot bequestioned. The only remedy availableis to wind it up. Because the Certificateof Incorporation is so crucial, theRegistrar has to go very carefully beforeissuing it.

On the issue of Certificate ofIncorporation, a private company canimmediately commence its business. Itcan raise necessary funds fromfriends, relatives or through privatearrangement and proceed to startbusiness. A public company, however,has to undergo two more stages inits formation.

7.2.3 Capital Subscription

A public company can raise therequired funds from the public bymeans of issue of shares anddebentures. For doing the same, it hasto issue a prospectus which is aninvitation to the public to subscribe tothe capital of the company and undergovarious other formalities. The followingsteps are required for raising fundsfrom the public:(i) SEBI Approval: SEBI (Securitiesand Exchange Board of India) which isthe regulatory authority in our countryhas issued guidelines for the disclosureof information and investor protection.A company inviting funds from thegeneral public must make adequatedisclosure of all relevant informationand must not conceal any materialinformation from the potentialinvestors. This is necessary forprotecting the interest of the investors.


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Prior approval from SEBI is, therefore,required before going ahead withraising funds from public.(ii) Filing of Prospectus: A copy ofthe prospectus or statement in lieu ofprospectus is filed with the Registrarof Companies. A prospectus is ‘anydocument described or issued as aprospectus including any notice,

circular, advertisement or otherdocument inviting deposits from thepublic or inviting offers from the publicfor the subscription or purchase of anyshares or debentures of, a bodycorporate’. In other words, it is aninvitation to the public to apply forshares or debentures of the companyor to make deposits in the company.


Investors make up their minds aboutinvestment in a company primarily onthe basis of the information containedin this document. Therefore, theremust not be a mis-statement inthe prospectus and all significantinformation must be fully disclosed.(iii) Appointment of Bankers,Brokers, Underwriters: Raising fundsfrom the public is a stupendous task.The application money is to be receivedby the bankers of the company. Thebrokers try to sell the sharesby distributing the forms andencouraging the public to apply for theshares. If the company is notreasonably assured of a good publicresponse to the issue, it may appointunderwriters to the issue. Underwritersundertake to buy the shares if theseare not subscribed by the public. Theyreceive a commission for underwritingthe issue. Appointment of underwritersis not necessary.(iv) Minimum Subscription: Inorder to prevent companies fromcommencing business with inadequateresources, it has been provided that thecompany must receive applications fora certain minimum number of sharesbefore going ahead with the allotmentof shares. According to the CompaniesAct, this is called the ‘minimumsubscription’. The limit of minimumsubscription is 90 per cent of the size

of the issue. Thus, if applicationsreceived for the shares are for anamount less than 90 per cent of theissue size, the allotment cannot bemade and the application moneyreceived must be returned to theapplicants.(v) Application to Stock Exchange:An application is made to at least onestock exchange for permission to dealin its shares or debentures. If suchpermission is not granted before theexpiry of ten weeks from the date ofclosure of subscription list, theallotment shall become void and allmoney received from the applicants willhave to be returned to them withineight days.(vi) Allotment of Shares: In case thenumber of shares allotted is less thanthe number applied for, or where noshares are allotted to the applicant, theexcess application money, if any, is tobe returned to applicants or adjustedtowards allotment money due fromthem. Allotment letters are issued tothe successful allottees. Return ofallotment, signed by a director orsecretary is filed with the Registrar ofCompanies within 30 days of allotment.

A public company may not invitepublic to subscribe to its shares ordebentures. Instead, it can raise thefunds through friends, relatives orsome private arrangements as done by

Provisional Contract

These are contracts which are signed after incorporation but before thecommencement of business. These become enforceable only after the companygets the Certificate of Commencement of Business.


a private company. In such cases, thereis no need to issue a prospectus. A‘Statement in Lieu of Prospectus’ is filedwith the Registrar at least three daysbefore making the allotment.

7.2.4 Commencement of Business

If the amount of minimum subscriptionis raised through new issue of shares, apublic company applies to the Registrarof Companies for the issue of Certificateof Commencement of Business. Thefollowing documents are required:

1. A declaration that shares payablein cash have been subscribed forand allotted up to the minimumsubscription mentioned in theprospectus;

2. A declaration that every directorhas paid in cash, the applicationand allotment money on his sharesin the same proportion as others;

3. A declaration that no money ispayable or liable to become

payable to the applicants becauseof the failure of the company toeither apply for or obtainpermission to deal in its securitieson a stock exchange; and

4. A statutory declaration that theabove requirements have beencomplied with. This declaration canbe signed by a director or secretaryof the company.

A public company raising fundsprivately, which has earlier filed aStatement in lieu of prospectus, has tosubmit only documents 2 and 4 listedabove.

The Registrar shall examinethese documents. If these arefound satisfactory, a ‘Certificate ofCommencement of Business’ will beissued. This certificate is conclusiveevidence that the company is entitledto do business. With the grant of thiscertificate the formation of a publiccompany is complete and the companycan legally start doing business.

Certificate of commencement of Business(Specimen)

I hereby certify that ........................ ltd. of ......................... which wasincorporated under The Companies Act, 1956, on the ................ day of.................... 200.......... and which has this day filed a statutory declaration inthe prescribed form that the conditions of section 149 have been compliedwith, is entitled to commence business.

Given under my hand at ........................... this day of .................. twothousand ..................

SEAL

Registrar Joint Stock Companies

.............................(State)


Memorandum of Association(Specimen)

1. Name: The name of the company is Excellent Educational Services Limited.It is hereinafter referred to as EES Ltd.

2. Registered Office: The Registered office of the company shall be situated inthe NCT of Delhi and at present it is at: Sri Aurobindo Marg, New Delhi-16.

3. (A) Main Objectives:(a) To engage in the design, development and delivery of world class service

products in the sphere of education for domestic as well as global markets.

(b) To establish and strengthen presence/market share in the various segmentsrepresenting various stages in the education/re-education process in thelife-long learning context, viz., identification of prospects, curriculum-design,pedagogy, examination and evaluation, anticipating societal/market needs,content-delivery, placement services and human resource development andrenewal.

(c) To develop, publish/produce teaching, training and study materials,journals, periodicals, reports, books, monographs and other multilingualliterature/multimedia products for promoting the objectives of the company.

(d) To organise programmes, conferences, lectures, seminars, symposia andworkshops on issues impacting education, industry, business and society.

(B) Ancillary Objectives:

(a) To develop special competencies and capabilities for designing, developing anddelivering service products for persons with physical and mental disabilities;

(b) To liaison and network with various individuals and institutions ingovernment and non-government sectors and fostering mutually beneficialrelationship in the field of education;

(c) To host a website for virtual learning;

(d) To build up a research and reference library and to undertake documentationservices;

(e) To own, purchase, lease, movable and immovable property in furtherance ofthe aims and objectives of the company;

(f) To offer prizes, grants, stipends and scholarships in furtherance of theobjectives of company;

(g) To provide a forum for raising, discussing and resolving of issues, problemsand challenges in the field of education; and

(h) To do generally all such other lawful things as are conducive or incidental tothe attainment of the above objectives.

4. Liability Clause: Liability of the members would be limited to the amount ofunpaid value of the share.

5. Capital Subscription Clause: The company shall be registered with a capitalof Rs. 2.5 crore divided into Rs. 25 lakh shares of Rs.10 each.


We the following persons voluntarily agreed to be the signatories to theMemorandum of Association:

Sunita Vinita

Anil Kumar Sunil Kumar

Avtar Singh Renu

Anita Usha

The name and address of the company signatures to Memorandum havebeen modified.

FORM NO. 1-A

The Companies Act. 1961

(Application Form for Availability of Names*)

The Registrar of Companies,

Sir,

Subject: Availability of Names-information Furnishing of:

We, the following applicants are desirous of forming a company to beregistered under the Companies Act, 1956, in the State Union Territory of

1. Name and full address of the person(s) applying for availability, of the name(IN BLOCK LETTERS).

2. Proposed name of the Company.

3. State whether Public or Private.

4. In case the proposed name mentioned in item 2 is not available, 3 names tobe considered, in the order of preference.

5. Main objectives of the proposed Company.

6. Name and address of the prospective Directors of Promoters, etc.

7. Particulars of the names and situation of registered office of other companiesin the same group or under the same management.

8. Proposed authorised capital.

9. Please furnish particulars and results of any application moved to this orany other Registrar previously for availability of name.

10. Particulars of remittance of fee

Situation

Dated Signature of the applicant

* Refer Rule 4 A of the Companies/Central Government’s/General Rules and Forms, 1956


Key Terms

Promotion Articles of Association Prospectus

Incorporation Capital subscription Memorandum of Association

Preliminary contracts Statutory declaration Certificate of Commencement

SUMMARY

There are two stages in the formation of a private company, promotion andincorporation. A public company has to undergo capital subscription stageand then get certificate of commencement of business, to begin operations.

1. Promotion: It begins with a potential business idea. Certain feasibilitystudies e.g. technical, financial and economic, are conducted todetermine whether the idea can be profitably exploited. In case, theinvestigations yield favourable results, promoters may decide to formthe company. Persons who conceive the business idea, decide to form acompany, take necessary steps for the same, and assume associatedrisks, are called promoters.

Steps in Promotion

i. Approval of company’s name is taken from the Registrar ofCompanies

ii. Signatories to the Memorandum of Association are fixed

iii. Certain professionals are appropriated to assist the promoters

iv. Documents necessary for registration are prepared

Necessary Documents

a. Memorandum of Association

b. Articles of Association

c. Consent of proposed directors

d. Agreement, if any, with proposed managing or whole time director

e. Statutory declaration

2. Incorporation: An application is made by promoters to the Registrar ofCompanies alongwith necessary documents and registration fees. TheRegistrar, after due scrutiny, issues certificate of incorporation. Theregistration may be refused only in case of a major defect in thedocuments. The certificate of incorporation is a conclusive evidence ofthe legal existence of the company. Even if there has been a major


defect in the incorporation, legal existence of the company can not berejected.

3. Capital Subscription: A public company raising funds from the publicneeds to take following steps for fund raising:

(i) SEBI approval;

(ii) File a copy of prospectus with the Registrar of Companies;

(iii) Appointment of brokers, bankers and underwriters etc.;

(iv) Ensure that minimum subscription is received;

(v) Application for listing of company’s securities;

(vi) Refund/adjust excess application money received;

(vii) Issue allotment letters to successful applicants; and

(viii) File return of allotment with the Registrar of Companies (ROC).

A public company, raising funds, raising funds from friends/relatives (notpublic) has to file a statement in lieu of prospectus with the ROC at leastthree days before allotment of shares and returns of allotment aftercompleting the allotment.

4. Commencement of Business: A public company raising funds frompublic has to apply to the Registrar of Companies for the certificate ofcommencement of business alongwith the following documents.

(i) A declaration about meeting minimum subscription requirement;

(ii) A declaration about details in respect of allotment to directors;

(iii) A declaration about no money being payable to applicants; and

(iv) A statutory declaration.

A public company raising funds privately has to submit only documents(ii) and (iv) listed above.

The Registrar, upon satisfaction, issues Certificate of Commencement ofBusiness. This certificate is also a conclusive evidence of completion offormation requirements.

Preliminary Contracts: Contracts signed by promoters with third partiesbefore the incorporation of company.

Provisional Contracts: Contracts signed after incorporation but beforecommencement of business.


EXERCISES


1. Minimum number of members to form a private company is

(a) 2 (b) 3(c) 5 (d) 7

2. Minimum number of members to form a public company is

(a) 5 (b) 7(c) 12 (d) 21

3. Application for approval of name of a company is to be made to

(a) SEBI (b) Registrar of Companies(c) Government of India (d) Government of the State

in which Company is tobe registered

4. A proposed name of Company is considered undesirable if

(a) It is identical with the name (b) It resembles closely withof an existing company the name of an existing

company(c) It is an emblem of Government (d) In case of any of the above

of India, United Nations etc.

5. A prospectus is issued by

(a) A private company (b) A public company seekinginvestment frompublic

(c) A public enterprise (d) A public company

6. Stages in the formation of a public company are in the following order

(a) Promotion, Commencement (b) Incorporation, Capitalof Business, Incorporation, Subscription,Capital Subscription Commencement of

Business, Promotion(c) Promotion, Incorporation, (d) Capital Subscription,

Capital Subscription, Promotion, Incorporation,Commencement of Business Commencement of

Business

7. Preliminary Contracts are signed

(a) Before the incorporation (b) After incorporation butbefore capital subscription

(c) After incorporation but before (d) After commencement ofcommencement of business business


8. Preliminary Contracts are

(a) binding on the Company (b) binding on the Company, ifratified after incorporation

(c) binding on the (d) not binding on theCompany, after incorporation Company

True/False Answer Questions

1. It is necessary to get every company incorporated, whether private orpublic.

2. Statement in lieu of prospectus can be filed by a public company goingfor a public issue.

3. A private company can commence business after incorporation.

4. Experts who help promoters in the promotion of a company are alsocalled promoters.

5. A company can ratify preliminary contracts after incorporation.

6. If a company is registered on the basis of fictitious names, itsincorporation is invalid.

7. ‘Articles of Association’ is the main document of a company.

8. Every company must file Articles of Association.

9. A provisional contract is signed by promoters before the incorporationof the company.

10. If a company suffers heavy issues and its assets are not enough to payoff its liabilities, the balance can be recovered from the private assets ofits members.


1. Name the stages in the formation of a company.

2. List the documents required for the incorporation of a company.

3. What is a prospectus? Is it necessary for every company to file aprospectus?

4. Explain the term, ‘Minimum Subscription’.

5. Briefly explain the term ‘Return of Allotment’.

6. At which stage in the formation of a company does it interact with SEBI.

7. Distinguish between ‘preliminary contracts’ and ‘provisional contracts’.



1. What is meant by the term ‘Promotion’. Discuss the legal position ofpromoters with respect to a company promoted by them.

2. Explain the steps taken by promoters in the promotion of a company.

3. What is a ‘Memorandum of Association’? Briefly explain its clauses.

4. Distinguish between ‘Memorandum of Association’ and ‘Articles ofAssociation.’

5. What is the effect of conclusiveness of the ‘Certificates of Incorporation’and ‘Commencement of Business’?

6. Is it necessary for a public company to get its share listed on a stockexchange? What happens if a public company going for a public issuefails to apply to a stock exchange for permission to deal in its securitiesor fails to get such permission?

Projects/Assignment

Find out from the office of the Registrar of Companies, the actual procedurefor formation of companies. Does it match with what you have studied.What are the obstacles which companies face in getting themselvesregistered.

CHAPTER 8

SOURCES OF BUSINESS FINANCE

LEARNING OBJECTIVES


• state the meaning, nature and importance of business finance;

• classify the various sources of business finance;

• evaluate merits and limitations of various sources of finance;

• identify the international sources of finance; and

• examine the factors that affect the choice of an appropriate sourceof finance.


8.1 INTRODUCTION

This chapter provides an overview of thevarious sources from where funds canbe procured for starting as also forrunning a business. It also discussesthe advantages and limitations ofvarious sources and points out thefactors that determine the choice of asuitable source of business finance.

It is important for any person whowants to start a business to know aboutthe different sources from where moneycan be raised. It is also important toknow the relative merits and demeritsof different sources so that choice of anappropriate source can be made.

8.2 MEANING, NATURE AND

SIGNIFICANCE OF BUSINESS

FINANCE

Business is concerned with theproduction and distribution of goodsand services for the satisfaction of needs

of society. For carrying out variousactivities, business requires money.Finance, therefore, is called thelife blood of any business. Therequirements of funds by business tocarry out its various activities is calledbusiness finance.

A business cannot function unlessadequate funds are made available toit. The initial capital contributed by theentrepreneur is not always sufficient totake care of all financial requirementsof the business. A business person,therefore, has to look for different othersources from where the need for fundscan be met. A clear assessment of thefinancial needs and the identificationof various sources of finance, therefore,is a significant aspect of running abusiness organisation.

The need for funds arises from thestage when an entrepreneur makes adecision to start a business. Somefunds are needed immediately say for

Mr. Anil Singh has been running a restaurant for the last two years. The excellentquality of food has made the restaurant popular in no time. Motivated by thesuccess of his business, Mr. Singh is now contemplating the idea of opening achain of similar restaurants at different places. However, the money availablewith him from his personal sources is not sufficient to meet the expansionrequirements of his business. His father told him that he can enter into apartnership with the owner of another restaurant, who will bring in more fundsbut it would also require sharing of profits and control of business. He is alsothinking of getting a bank loan. He is worried and confused, as he has no ideaas to how and from where he should obtain additional funds. He discusses theproblem with his friend Ramesh, who tells him about some other methods likeissue of shares and debentures, which are available only to a company form oforganisation. He further cautions him that each method has its own advantagesand limitations and his final choice should be based on factors like the purposeand period for which funds are required. He wants to learn about these methods.

183SOURCES OF BUSINESS FINANCE

the purchase of plant and machinery,furniture, and other fixed assets.Similarly, some funds are required forday-to-day operations, say to purchaseraw materials, pay salaries toemployees, etc. Also when the businessexpands, it needs funds.

The financial needs of a business canbe categorised as follows:(a) Fixed capital requirements: In

order to start business, funds arerequired to purchase fixed assets likeland and building, plant andmachinery, and furniture andfixtures. This is known as fixedcapital requirements of theenterprise. The funds required infixed assets remain invested in thebusiness for a long period of time.Different business units need varyingamount of fixed capital depending onvarious factors such as the nature ofbusiness, etc. A trading concern forexample, may require small amountof fixed capital as compared to amanufacturing concern. Likewise,the need for fixed capital investmentwould be greater for a largeenterprise, as compared to that of asmall enterprise.

(b) Working Capital requirements:The financial requirements of anenterprise do not end with theprocurement of fixed assets. Nomatter how small or large a businessis, it needs funds for its day-to-dayoperations. This is known as workingcapital of an enterprise, which is usedfor holding current assets such asstock of material, bills receivables andfor meeting current expenses likesalaries, wages, taxes, and rent.

The amount of working capitalrequired varies from one businessconcern to another depending on variousfactors. A business unit selling goods oncredit, or having a slow sales turnover,for example, would require moreworking capital as compared to aconcern selling its goods and services oncash basis or having a speedier turnover.

The requirement for fixed andworking capital increases with thegrowth and expansion of business. Attimes additional funds are required forupgrading the technology employed sothat the cost of production or operationscan be reduced. Similarly, larger fundsmay be required for building higherinventories for the festive season or tomeet current debts or expand thebusiness or to shift to a new location. Itis, therefore, important to evaluate thedifferent sources from where funds canbe raised.

8.3 CLASSIFICATION OF SOURCES OF

FUNDS

In case of proprietary and partnershipconcerns, the funds may be raised eitherfrom personal sources or borrowingsfrom banks, friends etc. In case ofcompany form of organisation, thedifferent sources of business financewhich are available may be categorisedas given in Table 8.1

As shown in the table, the sourcesof funds can be categorised usingdifferent basis viz., on the basis of theperiod, source of generation and theownership. A brief explanation of theseclassifications and the sources isprovided as follows:


Tab

le 8

.1 C

lass

ific

atio

n o

f Sourc

es o

f F

un

ds


8.3.1 Period Basis

On the basis of period, the differentsources of funds can be categorisedinto three parts. These are long-termsources, medium-term sources andshort-term sources.

The long-term sources fulfil thefinancial requirements of an enterprisefor a period exceeding 5 years andinclude sources such as shares anddebentures, long-term borrowings andloans from financial institutions. Suchfinancing is generally required for theacquisition of fixed assets such asequipment, plant, etc.

Where the funds are required for aperiod of more than one year but lessthan five years, medium-term sourcesof finance are used. These sourcesinclude borrowings from commercialbanks, public deposits, lease financingand loans from financial institutions.

Short-term funds are those whichare required for a period not exceedingone year. Trade credit, loans fromcommercial banks and commercialpapers are some of the examples of thesources that provide funds for shortduration.

Short-term financing is mostcommon for financing of current assetssuch as accounts receivable andinventories. Seasonal businesses thatmust build inventories in anticipationof selling requirements often need short-term financing for the interim periodbetween seasons. Wholesalers andmanufacturers with a major portion oftheir assets tied up in inventories orreceivables also require large amountof funds for a short period.

8.3.2 Ownership Basis

On the basis of ownership, the sourcescan be classified into ‘owner’s funds’and ‘borrowed funds’. Owner’s fundsmeans funds that are provided by theowners of an enterprise, which maybe a sole trader or partners orshareholders of a company. Apartfrom capital, it also includes profitsreinvested in the business. Theowner’s capital remains invested in thebusiness for a longer duration and isnot required to be refunded during thelife period of the business. Such capitalforms the basis on which ownersacquire their right of control ofmanagement. Issue of equity sharesand retained earnings are the twoimportant sources from where owner’sfunds can be obtained.

‘Borrowed funds’ on the otherhand, refer to the funds raised throughloans or borrowings. The sources forraising borrowed funds include loansfrom commercial banks, loans fromfinancial institutions, issue ofdebentures, public deposits and tradecredit. Such sources provide funds fora specified period, on certain termsand conditions and have to be repaidafter the expiry of that period. A fixedrate of interest is paid by theborrowers on such funds. At times itputs a lot of burden on the businessas payment of interest is to be madeeven when the earnings are low orwhen loss is incurred. Generally,borrowed funds are provided on thesecurity of some fixed assets.


8.3.3 Source of Generation Basis

Another basis of categorising the sourcesof funds can be whether the funds aregenerated from within the organisation orfrom external sources. Internal sourcesof funds are those that are generated fromwithin the business. A business, forexample, can generate funds internally byaccelerating collection of receivables,disposing of surplus inventories andploughing back its profit. The internalsources of funds can fulfill only limitedneeds of the business.

External sources of funds includethose sources that lie outside anorganisation, such as suppliers,lenders, and investors. When largeamount of money is required to beraised, it is generally done through theuse of external sources. External fundsmay be costly as compared to thoseraised through internal sources. Insome cases, business is required tomortgage its assets as security whileobtaining funds from external sources.Issue of debentures, borrowing fromcommercial banks and financialinstitutions and accepting publicdeposits are some of the examples ofexternal sources of funds commonlyused by business organisations.

8.4 SOURCES OF FINANCE

A business can raise funds fromvarious sources. Each of the source hasunique characteristics, which must beproperly understood so that the bestavailable source of raising funds canbe identified. There is not a single bestsource of funds for all organisations.Depending on the situation, purpose,

cost and associated risk, a choice maybe made about the source to be used.For example, if a business wants toraise funds for meeting fixed capitalrequirements, long term funds may berequired which can be raised in the formof owned funds or borrowed funds.Similarly, if the purpose is to meet theday-to-day requirements of business,the short term sources may be tapped.A brief description of various sources,along with their advantages andlimitations is given below.

8.4.1 Retained Earnings

A company generally does not distributeall its earnings amongst theshareholders as dividends. A portion ofthe net earnings may be retained in thebusiness for use in the future. This isknown as retained earnings. It is asource of internal financing or self-financing or ‘ploughing back of profits’.The profit available for ploughing backin an organisation depends on manyfactors like net profits, dividend policyand age of the organisation.

Merits

The merits of retained earning as asource of finance are as follows:

(i) Retained earnings is a permanentsource of funds available to anorganisation;

(ii) It does not involve any explicit costin the form of interest, dividend orfloatation cost;

(iii) As the funds are generatedinternally, there is a greater degreeof operational freedom andflexibility;


(iv) It enhances the capacity of thebusiness to absorb unexpectedlosses;

(v) It may lead to increase in themarket price of the equity sharesof a company.

Limitations

Retained earning as a source of fundshas the following limitations:

(i) Excessive ploughing back maycause dissatisfaction amongst theshareholders as they would getlower dividends;

(ii) It is an uncertain source of fundsas the profits of business arefluctuating;

(iii) The opportunity cost associatedwith these funds is not recognisedby many firms. This may lead tosub-optimal use of the funds.

8.4.2 Trade Credit

Trade credit is the credit extended byone trader to another for the purchaseof goods and services. Trade creditfacilitates the purchase of supplieswithout immediate payment. Suchcredit appears in the records of thebuyer of goods as ‘sundry creditors’ or‘accounts payable’. Trade credit iscommonly used by businessorganisations as a source of short-termfinancing. It is granted to thosecustomers who have reasonable amountof financial standing and goodwill. Thevolume and period of credit extendeddepends on factors such as reputationof the purchasing firm, financial positionof the seller, volume of purchases, past

record of payment and degree ofcompetition in the market. Terms oftrade credit may vary from one industryto another and from one person toanother. A firm may also offer differentcredit terms to different customers.

Merits

The important merits of trade credit areas follows:

(i) Trade credit is a convenient andcontinuous source of funds;

(ii) Trade credit may be readilyavailable in case the creditworthiness of the customers isknown to the seller;

(iii) Trade credit needs to promote thesales of an organisation;

(iv) If an organisation wants to increaseits inventory level in order to meetexpected rise in the sales volumein the near future, it may use tradecredit to, finance the same;

(v) It does not create any charge onthe assets of the firm whileproviding funds.

Limitations

Trade credit as a source of funds hascertain limitations, which are given asfollows:

(i) Availability of easy and flexibletrade credit facilities may induce afirm to indulge in overtrading,which may add to the risks of thefirm;

(ii) Only limited amount of funds canbe generated through trade credit;

(iii) It is generally a costly source offunds as compared to most othersources of raising money.


8.4.3 Factoring

Factoring is a financial service underwhich the ‘factor’ renders variousservices which includes:(a) Discounting of bills (with or without

recourse) and collection of the client’sdebts. Under this, the receivables onaccount of sale of goods or servicesare sold to the factor at a certaindiscount. The factor becomesresponsible for all credit control anddebt collection from the buyer andprovides protection against any baddebt losses to the firm. There are twomethods of factoring — recourse andnon-recourse. Under recoursefactoring, the client is not protectedagainst the risk of bad debts. On theother hand, the factor assumes theentire credit risk under non-recoursefactoring i.e., full amount of invoiceis paid to the client in the event ofthe debt becoming bad.

(b) Providing information about creditworthiness of prospective client’s etc.,Factors hold large amounts ofinformation about the tradinghistories of the firms. This can bevaluable to those who are usingfactoring services and can therebyavoid doing business with customershaving poor payment record. Factorsmay also offer relevant consultancyservices in the areas of finance,marketing, etc.

The factor charges fees for theservices rendered. Factoringappeared on the Indian financialscene only in the early nineties as aresult of RBI initiatives. Theorganisations that provides such

services include SBI Factors andCommercial Services Ltd., CanbankFactors Ltd., Foremost Factors Ltd.,State Bank of India, Canara Bank,Punjab National Bank, AllahabadBank. In addition, many non-bankingfinance companies and otheragencies provide factoring service.

Merits

The merits of factoring as a source offinance are as follows:

(i) Obtaining funds through factoringis cheaper than financing throughother means such as bank credit;

(ii) With cash flow accelerated byfactoring, the client is able to meethis/her liabilities promptly as andwhen these arise;

(iii) Factoring as a source of funds isflexible and ensures a definitepattern of cash inflows from creditsales. It provides security for adebt that a firm might otherwisebe unable to obtain;

(iv) It does not create any charge onthe assets of the firm;

(v) The client can concentrate on otherfunctional areas of business as theresponsibility of credit control isshouldered by the factor.

Limitations

The limitations of factoring as a sourceof finance are as follows:

(i) This source is expensive when theinvoices are numerous andsmaller in amount;

(ii) The advance finance provided bythe factor firm is generally availableat a higher interest cost than theusual rate of interest;


(iii) The factor is a third party to thecustomer who may not feelcomfortable while dealing with it.

8.4.4 Lease Financing

A lease is a contractual agreementwhereby one party i.e., the owner of anasset grants the other party the rightto use the asset in return for a periodicpayment. In other words it is a rentingof an asset for some specified period.The owner of the assets is called the‘lessor’ while the party that uses theassets is known as the ‘lessee’ (seeBox A). The lessee pays a fixed periodicamount called lease rental to the lessorfor the use of the asset. The terms andconditions regulating the leasearrangements are given in the leasecontract. At the end of the lease period,the asset goes back to the lessor. Leasefinance provides an important meansof modernisation and diversification tothe firm. Such type of financing is moreprevalent in the acquisition of suchassets as computers and electronicequipment which become obsoletequicker because of the fast changingtechnological developments. Whilemaking the leasing decision, the costof leasing an asset must be comparedwith the cost of owning the same.

Merits

The important merits of lease financingare as follows:

(i) It enables the lessee to acquire theasset with a lower investment;

(ii) Simple documentation makes iteasier to finance assets;

(iii) Lease rentals paid by the lessee aredeductible for computing taxableprofits;

(iv) It provides finance withoutdiluting the ownership or controlof business;

(v) The lease agreement does not affectthe debt raising capacity of anenterprise;

(vi) The risk of obsolescence is borneby the lesser. This allows greaterflexibility to the lessee to replacethe asset.

Limitations

The limitations of lease financing aregiven as below:

(i) A lease arrangement may imposecertain restrictions on the use ofassets. For example, it may notallow the lessee to make anyalteration or modification in theasset;

(ii) The normal business operationsmay be affected in case the leaseis not renewed;

(iii) It may result in higher payoutobligation in case the equipmentis not found useful and the lesseeopts for premature termination ofthe lease agreement; and

(iv) The lessee never becomes theowner of the asset. It deprives himof the residual value of the asset.

8.4.5 Public Deposits

The deposits that are raised byorganisations directly from the publicare known as public deposits. Rates ofinterest offered on public deposits are


usually higher than that offered onbank deposits. Any person who isinterested in depositing money in anorganisation can do so by filling up aprescribed form. The organisation inreturn issues a deposit receipt asacknowledgment of the debt. Publicdeposits can take care of both mediumand short-term financial requirementsof a business. The deposits are

beneficial to both the depositor as wellas to the organisation. While thedepositors get higher interest rate thanthat offered by banks, the cost ofdeposits to the company is less thanthe cost of borrowings from banks.Companies generally invite publicdeposits for a period upto three years.The acceptance of public deposits isregulated by the Reserve Bank of India.

Box AThe Lessors

1. Specialised leasing companies: There are about 400-odd large companieswhich have an organisational focus on leasing, and hence, are known asleasing companies.

2. Banks and bank-subsidiaries: In February 1994, the RBI allowed banks todirectly enter leasing. Till then, only bank subsidiaries were allowed to engagein leasing operations, which was regarded by the RBI as a non-banking activity.

3. Specialised financial institutions: A number of financial institutions, atthe Central as well as the State level in India, use the lease instrument alongwith traditional financing instruments. Significantly, the ICICI is one of thepioneers in Indian leasing.

4. Manufacturer-lessors: As competition forces the manufacturer to add valueto his sales, he finds the best way to sell the product on lease. Vendor leasingis gaining increasing importance. Presently, vendors of automobiles, consumerdurables, etc., have alliances or joint ventures with leasing companies to offerlease finance against their products.

The Lessees1. Public sector undertakings: This market has witnessed a good rate of growth

in the past. There is an increasing number of both centrally as well as State-owned entities which have resorted to lease financing.

2. Mid-market companies: The mid-market companies (i.e. companies withreasonably good creditworthiness but with lower public profile) have resortedto lease financing basically as an alternative to bank/institutional financing.

3. Consumers: Recent bad experience with corporate financing has focussedattention towards retail funding of consumer durables. For instance, carleasing is a big market in India today.

4. Government deptts. and authorities: One of the latest entrants in leasingmarkets is the government itself. Recently the Department ofTelecommunications of the central government took the lead by floating tendersfor lease finance worth about Rs. 1000 crores.


Merits

The merits of public deposits are:(i) The procedure of obtaining

deposits is simple and does notcontain restrictive conditions as aregenerally there in a loan agreement;

(ii) Cost of public deposits is generallylower than the cost of borrowingsfrom banks and financialinstitutions;

(iii) Public deposits do not usuallycreate any charge on the assets ofthe company. The assets can beused as security for raising loansfrom other sources;

(iv) As the depositors do not havevoting rights, the control of thecompany is not diluted.

Limitations

The major limitation of public depositsare as follows:

(i) New companies generally find itdifficult to raise funds throughpublic deposits;

(ii) It is an unreliable source of financeas the public may not respondwhen the company needs money;

(iii) Collection of public deposits mayprove difficult, particularly whenthe size of deposits required is large.

8.4.6 Commercial Paper (CP)

Commercial Paper emerged as a sourceof short term finance in our country inthe early nineties. Commercial paper isan unsecured promissory note issuedby a firm to raise funds for a shortperiod, varying from 90 days to 364days. It is issued by one firm to other

business firms, insurance companies,pension funds and banks. The amountraised by CP is generally very large. Asthe debt is totally unsecured, the firmshaving good credit rating can issue theCP. Its regulation comes under thepurview of the Reserve Bank of India.

The merits and limitations of aCommercial Paper are as follows:

Merits

(i) A commercial paper is sold on anunsecured basis and does notcontain any restrictive conditions;

(ii) As it is a freely transferableinstrument, it has high liquidity;

(iii) It provides more funds comparedto other sources. Generally, thecost of CP to the issuing firm islower than the cost of commercialbank loans;

(iv) A commercial paper provides acontinuous source of funds. Thisis because their maturity can betailored to suit the requirementsof the issuing firm. Further,maturing commercial paper canbe repaid by selling newcommercial paper;

(v) Companies can park their excessfunds in commercial paperthereby earning some good returnon the same.

Limitations

(i) Only financially sound and highlyrated firms can raise moneythrough commercial papers. Newand moderately rated firms arenot in a position to raise funds bythis method;


(ii) The size of money that can beraised through commercial paperis limited to the excess liquidityavailable with the suppliers offunds at a particular time;

(iii) Commercial paper is an impersonalmethod of financing. As such if afirm is not in a position to redeemits paper due to financialdifficulties, extending the maturityof a CP is not possible.

8.4.7 Issue of Shares

The capital obtained by issue of sharesis known as share capital. The capitalof a company is divided into small unitscalled shares. Each share has itsnominal value. For example, acompany can issue 1,00,000 sharesof Rs. 10 each for a total value ofRs. 10,00,000. The person holding theshare is known as shareholder. Thereare two types of shares normally issuedby a company. These are equity sharesand preference shares. The moneyraised by issue of equity shares is calledequity share capital, while the moneyraised by issue of preference shares iscalled preference share capital.

(a) Equity SharesEquity shares is the mostimportant source of raising longterm capital by a company. Equityshares represent the ownership ofa company and thus the capitalraised by issue of such shares isknown as ownership capital orowner’s funds. Equity sharecapital is a prerequisite to thecreation of a company. Equityshareholders do not get a fixed

dividend but are paid on the basisof earnings by the company. Theyare referred to as ‘residual owners’since they receive what is left afterall other claims on the company’sincome and assets have beensettled. They enjoy the reward aswell as bear the risk of ownership.Their liability, however, is limitedto the extent of capital contributedby them in the company. Further,through their right to vote, theseshareholders have a right toparticipate in the management ofthe company.

Merits

The important merits of raising fundsthrough issuing equity shares are givenas below:

(i) Equity shares are suitable forinvestors who are willing toassume risk for higher returns;

(ii) Payment of dividend to the equityshareholders is not compulsory.Therefore, there is no burden onthe company in this respect;

(iii) Equity capital serves aspermanent capital as it is to berepaid only at the time ofliquidation of a company. As itstands last in the list of claims, itprovides a cushion for creditors,in the event of winding up of acompany;

(iv) Equity capital provides creditworthiness to the company andconfidence to prospective loanproviders;

(v) Funds can be raised throughequity issue without creating


any charge on the assets of thecompany. The assets of a companyare, therefore, free to be mortgagedfor the purpose of borrowings, if theneed be;

(vi) Democratic control overmanagement of the company isassured due to voting rights ofequity shareholders.

Limitations

The major limitations of raising fundsthrough issue of equity shares are asfollows:

(i) Investors who want steady incomemay not prefer equity shares asequity shares get fluctuatingreturns;

(ii) The cost of equity shares isgenerally more as compared to thecost of raising funds through othersources;

(iii) Issue of additional equity sharesdilutes the voting power, andearnings of existing equityshareholders;

(iv) More formalities and proceduraldelays are involved while raisingfunds through issue of equityshare.

(b) Preference SharesThe capital raised by issue ofpreference shares is calledpreference share capital. Thepreference shareholders enjoy apreferential position over equityshareholders in two ways:(i) receiving a fixed rate of dividend,out of the net profits of thecompany, before any dividend isdeclared for equity shareholders;

and (ii) receiving their capital afterthe claims of the company’screditors have been settled, at thetime of liquidation. In other words,as compared to the equityshareholders, the preferenceshareholders have a preferentialclaim over dividend and repaymentof capital. Preference sharesresemble debentures as they bearfixed rate of return. Also as thedividend is payable only at thediscretion of the directors and onlyout of profit after tax, to that extent,these resemble equity shares.Thus, preference shares have somecharacteristics of both equityshares and debentures. Preferenceshareholders generally do notenjoy any voting rights. A companycan issue different types ofpreference shares (see Box B).

Merits

The merits of preference shares are givenas follows:

(i) Preference shares providereasonably steady income in theform of fixed rate of return andsafety of investment;

(ii) Preference shares are useful forthose investors who want fixedrate of return with comparativelylow risk;

(iii) It does not affect the control ofequity shareholders over themanagement as preferenceshareholders don’t have votingrights;

(iv) Payment of fixed rate of dividendto preference shares may enable a


company to declare higher ratesof dividend for the equityshareholders in good times;

(v) Preference shareholders have apreferential right of repaymentover equity shareholders in the eventof liquidation of a company;

(vi) Preference capital does not createany sort of charge against theassets of a company.

Limitations

The major limitations of preferenceshares as source of business financeare as follows:

(i) Preference shares are not suitablefor those investors who are willingto take risk and are interested inhigher returns;

(ii) Preference capital dilutes theclaims of equity shareholders overassets of the company;

(iii) The rate of dividend on preferenceshares is generally higher than therate of interest on debentures;

(iv) As the dividend on these shares isto be paid only when the companyearns profit, there is no assuredreturn for the investors. Thus,these shares may not be veryattractive to the investors;

(v) The dividend paid is notdeductible from profits as expense.Thus, there is no tax saving as inthe case of interest on loans.

8.4.8 Debentures

Debentures are an importantinstrument for raising long term debtcapital. A company can raise fundsthrough issue of debentures, whichbear a fixed rate of interest. Thedebenture issued by a company is anacknowledgment that the company hasborrowed a certain amount of money,which it promises to repay at a futuredate. Debenture holders are, therefore,termed as creditors of the company.Debenture holders are paid a fixedstated amount of interest at specified

Box BTypes of Preference Shares

1. Cumulative and Non-Cumulative: The preference shares which enjoy theright to accumulate unpaid dividends in the future years, in case the sameis not paid during a year are known as cumulative preference shares. Onthe other hand, on non-cumulative shares, dividend is not accumulated if itis not paid in a particular year.

2. Participating and Non-Participating: Preference shares which have a rightto participate in the further surplus of a company shares which after dividendat a certain rate has been paid on equity shares are called participatingpreference shares. The non-participating preference are such which do notenjoy such rights of participation in the profits of the company.

3. Convertible and Non-Convertible: Preference shares that can be convertedinto equity shares within a specified period of time are known as convertiblepreference shares. On the other hand, non-convertible shares are such thatcannot be converted into equity shares.


intervals say six months or one year.Public issue of debentures requiresthat the issue be rated by a credit ratingagency like CRISIL (Credit Rating andInformation Services of India Ltd.) onaspects like track record of thecompany, its profitability, debtservicing capacity, credit worthinessand the perceived risk of lending. Acompany can issue different types ofdebentures (see Box C and D). Issue ofZero Interest Debentures (ZID) whichdo not carry any explicit rate of interesthas also become popular in recentyears. The difference between the facevalue of the debenture and its purchaseprice is the return to the investor.

Merits

The merits of raising funds throughdebentures are given as follows:(i) It is preferred by investors who

want fixed income at lesser risk;(ii) Debentures are fixed charge funds

and do not participate in profits ofthe company;

(iii) The issue of debentures is suitablein the situation when the sales andearnings are relatively stable;

(iv) As debentures do not carryvoting rights, financing throughdebentures does not dilute controlof equity shareholders onmanagement;

(v) Financing through debentures isless costly as compared to cost ofpreference or equity capital as theinterest payment on debentures istax deductible.

Limitations

Debentures as source of funds hascertain limitations. These are given asfollows:(i) As fixed charge instruments,

debentures put a permanentburden on the earnings of acompany. There is a greater riskwhen earnings of the companyfluctuate;

(ii) In case of redeemable debentures,the company has to makeprovisions for repayment on thespecified date, even during periodsof financial difficulty;

(iii) Each company has certainborrowing capacity. With the issueof debentures, the capacity of acompany to further borrow fundsreduces.

8.4.9 Commercial Banks

Commercial banks occupy a vitalposition as they provide funds fordifferent purposes as well as for differenttime periods. Banks extend loans to

Box CCompanies issuing different Debentures

Mahindra and Mahindra was the first company in India to issue convertibleZero Interest Debentures in January 1990. Recently, the board of Titan Industrieshas approved the issue of partly convertible debentures on a rights basis toraise around Rs. 126.83 crore. The issue will comprise 21 lakh partly convertibledebentures of Rs. 600 each in the ratio of one partly convertible debenture forevery 20 equity shares held in the company to the shareholders.


firms of all sizes and in many ways, like,cash credits, overdrafts, term loans,purchase/discounting of bills, andissue of letter of credit. The rate ofinterest charged by banks dependson various factors such as thecharacteristics of the firm and the levelof interest rates in the economy. Theloan is repaid either in lump sum or ininstallments.

Bank credit is not a permanentsource of funds. Though banks havestarted extending loans for longerperiods, generally such loans are usedfor medium to short periods. Theborrower is required to provide somesecurity or create a charge on the assetsof the firm before a loan is sanctionedby a commercial bank.

Merits

The merits of raising funds from acommercial bank are as follows:

(i) Banks provide timely assistance tobusiness by providing funds asand when needed by it.

(ii) Secrecy of business can bemaintained as the informationsupplied to the bank by theborrowers is kept confidential;

(iii) Formalities such as issue ofprospectus and underwriting arenot required for raising loans froma bank. This, therefore, is an easiersource of funds;

(iv) Loan from a bank is a flexiblesource of finance as the loanamount can be increasedaccording to business needs andcan be repaid in advance whenfunds are not needed.

Limitations

The major limitations of commercialbanks as a source of finance are asfollows:

Box DTypes of Debentures

1. Secured and Unsecured: Secured debentures are such which create a chargeon the assets of the company, thereby mortgaging the assets of the company.Unsecured debentures on the other hand do not carry any charge or securityon the assets of the company.

2. Registered and Bearer: Registered debentures are those which are dulyrecorded in the register of debenture holders maintained by the company.These can be transferred only through a regular instrument of transfer. Incontrast, the debentures which are transferable by mere delivery are calledbearer debentures.

3. Convertible and Non-Convertible: Convertible debentures are thosedebentures that can be converted into equity shares after the expiry of aspecified period. On the other hand, non-convertible debentures are thosewhich cannot be converted into equity shares.

4. First and Second: Debentures that are repaid before other debentures arerepaid are known as first debentures. The second debentures are those whichare paid after the first debentures have been paid back.


(i) Funds are generally available forshort periods and its extension orrenewal is uncertain and difficult;

(ii) Banks make detailed investigationof the company’s affairs, financialstructure etc., and may also ask forsecurity of assets and personalsureties. This makes the procedureof obtaining funds slightlydifficult;

(iii) In some cases, difficult terms andconditions are imposed by banks.for the grant of loan. For example,restrictions may be imposed on thesale of mortgaged goods, thusmaking normal business workingdifficult.

8.4.10 Financial Institutions

The government has established anumber of financial institutions all overthe country to provide finance tobusiness organisations (see Box E).These institutions are established bythe central as well as state governments.They provide both owned capital andloan capital for long and medium termrequirements and supplement thetraditional financial agencies likecommercial banks. As theseinstitutions aim at promoting theindustrial development of a country,these are also called ‘developmentbanks’. In addition to providingfinancial assistance, these institutionsalso conduct market surveys andprovide technical assistance andmanagerial services to people who runthe enterprises. This source of financingis considered suitable when large fundsfor longer duration are required for

expansion, reorganisation andmodernisation of an enterprise.

Merits

The merits of raising funds throughfinancial institutions are as follows:(i) Financial institutions provide long-

term finance, which are notprovided by commercial banks;

(ii) Besides providing funds, many ofthese institutions provide financial,managerial and technical adviceand consultancy to business firms;

(iii) Obtaining loan from financialinstitutions increases the goodwillof the borrowing company in thecapital market. Consequently,such a company can raise fundseasily from other sources as well;

(iv) As repayment of loan can be madein easy instalments, it does notprove to be much of a burden onthe business;

(v) The funds are made available evenduring periods of depression, whenother sources of finance are notavailable.

Limitations

The major limitations of raising fundsfrom financial institutions are as givenbelow:(i) Financial institutions follow rigid

criteria for grant of loans. Too manyformalities make the proceduretime consuming and expensive;

(ii) Certain restrictions such asrestriction on dividend payment areimposed on the powers of theborrowing company by thefinancial institutions;


Box ESpecial Financial Institutions

1. Industrial Finance Corporation of India (IFCI): It was established in July1948 as a statutory corporation under the Industrial Finance CorporationAct, 1948. Its objectives include assistance towards balanced regionaldevelopment and encouraging new entrepreneurs to enter into the prioritysectors of the economy. IFCI has also contributed to the development ofmanagement education in the country.

2. State Financial Corporations (SFC): The State Financial Corporations Act,1951 empowered the State Governments to establish State FinancialCorporations in their respective regions for providing medium and short termfinance to industries which are outside the scope of the IFCI. Its scope is widerthan IFCI, since the former covers not only public limited companies but alsoprivate limited companies, partnership firms and proprietary concerns.

3. Industrial Credit and Investment Corporation of India (ICICI): This wasestablished in 1955 as a public limited company under the Companies Act.ICICI assists the creation, expansion and modernisation of industrialenterprises exclusively in the private sector. The corporation has alsoencouraged the participation of foreign capital in the country.

4. Industrial Development Bank of India (IDBI): It was established in 1964under the Industrial Development Bank of India Act, 1964 with an objective tocoordinate the activities of other financial institutions including commercialbanks. The bank performs three types of functions, namely, assistance toother financial institutions, direct assistance to industrial concerns, andpromotion and coordination of financial-technical services.

5. State Industrial Development Corporations (SIDC): Many state governmentshave set up State Industrial Development Corporations for the purpose ofpromoting industrial development in their respective states. The objectives ofthe SIDCs differ from one state to another.

6. Unit Trust of India (UTI): It was established by the Government of India in1964 under the Unit Trust of India Act, 1963. The basic objective of UTI is tomobilise the community’s savings and channelise them into productiveventures. For this purpose, it sanctions direct assistance to industrialconcerns, invests in their shares and debentures, and participates with otherfinancial institutions.

7. Industrial Investment Bank of India Ltd.: It was initially set up as a primaryagency for rehabilitation of sick units and was known as IndustrialReconstruction Corporation of India. It was reconstituted and renamed as theIndustrial Reconstruction Bank of India in 1985 and again in 1997 its namewas changed to Industrial Investment Bank of India. The Bank assists sickunits in the reorganisation of their share capital, improvement in managementsystem, and provision of finance at liberal terms.

8. Life Insurance Corporation of India (LIC): LIC was set up in 1956 under theLIC Act, 1956 after nationalising 245 existing insurance companies. It mobilisesthe community’s savings in the form of insurance premia and makes it availableto industrial concerns, both public as well as private, in the form of directloans and underwriting of and subscription to shares and debentures.


(iii) Financial institutions may havetheir nominees on the Board ofDirectors of the borrowingcompany thereby restricting thepowers of the company.

8.5 INTERNATIONAL FINANCING

In addition to the sources discussedabove, there are various avenues fororganisations to raise fundsinternationally. With the opening up ofan economy and the operations of thebusiness organisations becomingglobal, Indian companies have anaccess to funds in global capital market.Various international sources fromwhere funds may be generated include:(i) Commercial Banks: Commercialbanks all over the world extend foreigncurrency loans for business purposes.They are an important source offinancing non-trade internationaloperations. The types of loans andservices provided by banks vary fromcountry to country. For example,Standard Chartered emerged as amajor source of foreign currency loansto the Indian industry.(ii) International Agencies andDevelopment Banks: A numberof international agencies anddevelopment banks have emerged overthe years to finance international tradeand business. These bodies providelong and medium term loans andgrants to promote the development ofeconomically backward areas in theworld. These bodies were set up by theGovernments of developed countries ofthe world at national, regional andinternational levels for funding various

projects. The more notable among theminclude International FinanceCorporation (IFC), EXIM Bank andAsian Development Bank.(iii) International Capital Markets:Modern organisations includingmultinational companies depend uponsizeable borrowings in rupees as wellas in foreign currency. Prominentfinancial instruments used for thispurpose are:(a) Global Depository Receipts

(GDR’s): The local currency sharesof a company are delivered to thedepository bank. The depositorybank issues depository receiptsagainst these shares. Suchdepository receipts denominated inUS dollars are known as GlobalDepository Receipts (GDR). GDR isa negotiable instrument and can betraded freely like any other security.In the Indian context, a GDR is aninstrument issued abroad by anIndian company to raise funds insome foreign currency and is listedand traded on a foreign stockexchange. A holder of GDR can atany time convert it into the numberof shares it represents. The holdersof GDRs do not carry any votingrights but only dividends andcapital appreciation. Many Indiancompanies such as Infosys,Reliance, Wipro and ICICI haveraised money through issue ofGDRs (see Box F).

(b) American Depository Receipts(ADR’s): The depository receiptsissued by a company in the USAare known as American DepositoryReceipts. ADRs are bought and sold


in American markets like regularstocks. It is similar to a GDR exceptthat it can be issued only toAmerican citizens and can be listedand traded on a stock exchangeof USA.

(c) Foreign Currency ConvertibleBonds (FCCB’s): Foreign currencyconvertible bonds are equity linkeddebt securities that are to beconverted into equity or depositoryreceipts after a specific period. Thus,a holder of FCCB has the option ofeither converting them into equityshares at a predetermined price orexchange rate, or retaining thebonds. The FCCB’s are issued in aforeign currency and carry a fixedinterest rate which is lower than the

rate of any other similar non-convertible debt instrument.FCCB’s are listed and traded inforeign stock exchanges. FCCB’sare very similar to the convertibledebentures issued in India.

8.6 FACTORS AFFECTING THE CHOICE

OF THE SOURCE OF FUNDS

Financial needs of a business are ofdifferent types — long term, short term,fixed and fluctuating. Therefore,business firms resort to different typesof sources for raising funds. Short-termborrowings offer the benefit of reducedcost due to reduction of idle capital, butlong – term borrowings are considereda necessity on many grounds. Similarly

Box FCompanies rush to float GDR issues

It’s not the IPO (initial public offer) market alone which is humming with activity.Companies — mostly small and medium-sized — are rushing to the overseasmarket to raise funds through Global Depository Receipts (GDRs). Five firmshave already raised $464 million (around Rs 2,040 crore) from the internationalmarkets through GDR offerings this year. This is almost double of $228.6 mnraised by nine companies in 2004 and $63.09 mn mobilised by four companiesin 2003. Nearly 20 companies are waiting in the wings to launch GDR issuesworth over $1 bn in the coming months. On the other hand, though the numberof companies going for FCCB (Foreign Currency Convertible Bonds) issues hascome down, several companies are still in the FCCB race, thanks to lax rulesand disclosure norms. For example, Aarti Drugs Ltd. has decided to raise$12 mn by issuing FCCBs.

Significantly, small and medium companies are now taking the GDR route toraise funds this time even for a small amount. For example, Opto Circuits hasdecided to go for a GDR issue of $20 mn with a green-shoe option of $5 mn. Theshare price of this company shot up by 370 per cent from Rs 34 on May 17, 2004to around Rs 160 on the BSE recently. Videocon Industries, Lyka Labs, IndianOverseas Bank, Jubilant Organosys, Maharashtra Seamless, MoschipSemiconductors, and Crew BOS are planning GDR issues. Two banks — UTIBank ($240 million) and Centurion Bank ($70 million) — raised funds from theGDR market recently. Companies now prefer GDR over FCCB issues in view ofthe rise in interest rates abroad.


equity capital has a role to play in thescheme for raising funds in thecorporate sector.

As no source of funds is devoid oflimitations, it is advisable to use acombination of sources, instead ofrelying only on a single source. Anumber of factors affect the choice ofthis combination, making it a verycomplex decision for the business. Thefactors that affect the choice of sourceof finance are briefly discussed below:(i) Cost: There are two types of cost viz.,the cost of procurement of funds andcost of utilising the funds. Both thesecosts should be taken into accountwhile deciding about the source offunds that will be used by anorganisation.(ii) Financial strength and stabilityof operations: The financial strengthof a business is also a key determinant.In the choice of source of fundsbusiness should be in a sound financialposition so as to be able to repay theprincipal amount and interest on theborrowed amount. When the earningsof the organisation are not stable, fixedcharged funds like preference sharesand debentures should be carefullyselected as these add to the financialburden of the organisation.(iii) Form of organisation and legalstatus: The form of businessorganisation and status influences thechoice of a source for raising money. Apartnership firm, for example, cannotraise money by issue of equity sharesas these can be issued only by a jointstock company.

(iv) Purpose and time period:Business should plan according to thetime period for which the funds arerequired. A short-term need forexample can be met through borrowingfunds at low rate of interest throughtrade credit, commercial paper, etc. Forlong term finance, sources such asissue of shares and debentures aremore appropriate. Similarly, thepurpose for which funds are requiredneed to be considered so that thesource is matched with the use. Forexample, a long-term businessexpansion plan should not be financedby a bank overdraft which will berequired to be repaid in the short term.(v) Risk profile: Business shouldevaluate each of the source of financein terms of the risk involved. Forexample, there is a least risk in equityas the share capital has to be repaidonly at the time of winding up anddividends need not be paid if no profitsare available. A loan on the other hand,has a repayment schedule for both theprincipal and the interest. The interestis required to be paid irrespective of thefirm earning a profit or incurring a loss.(vi) Control: A particular source offund may affect the control and powerof the owners on the management of afirm. Issue of equity shares may meandilution of the control. For example, asequity share holders enjoy votingrights, financial institutions may takecontrol of the assets or imposeconditions as part of the loanagreement. Thus, business firm shouldchoose a source keeping in mind the


extent to which they are willing to sharetheir control over business.(vii) Effect on credit worthiness: Thedependence of business on certainsources may affect its credit worthinessin the market. For example, issue ofsecured debentures may affect theinterest of unsecured creditors of thecompany and may adversely affecttheir willingness to extend furtherloans as credit to the company.(viii) Flexibility and ease: Anotheraspect affecting the choice of asource of finance is the flexibility andease of obtaining funds. Restrictive

provisions, detailed investigation anddocumentation in case of borrowingsfrom banks and financial institutionsfor example may be the reason that abusiness organisations may notprefer it, if other options are readilyavailable.(ix) Tax benefits: Various sourcesmay also be weighed in terms of theirtax benefits. For example, while thedividend on preference shares is nottax deductible, interest paid ondebentures and loan is tax deductibleand may, therefore, be preferred byorganisations seeking tax advantage.

Key Terms

Finance Owned capital Fixed capital

Working capital Borrowed capital Short term sources

Restrictive conditions Long term sources Charge on assets

Voting power Fixed charge funds Accounts receivable

Bill discounting Factoring GDRs

FCCBs ADRs

SUMMARY

Meaning and significance of business finance: Finance required bybusiness to establish and run its operations is known as business finance.No business can function without adequate amount of funds for undertakingvarious activities. The funds are required for purchasing fixed assets (fixedcapital requirement), for running day-to-day operations (working capitalrequirement), and for undertaking growth and expansion plans in a businessorganisation.

Classification of sources of funds: Various sources of funds available to abusiness can be classified according to three major basis, which are(i) time period (long, medium and short term), (ii) ownership (owner’s fundsand borrowed funds), and (iii) source of generation (internal sources andexternal sources).


Long, medium and short-term sources of funds: The sources that providefunds for a period exceeding 5 years are called long-term sources. Thesources that fulfill the financial requirements for the period of more thanone year but not exceeding 5 years are called medium term sources andthe sources that provide funds for a period not exceeding one year aretermed as short term sources.

Owner’s funds and borrowed funds: Owner’s funds refer to the funds thatare provided by the owners of an enterprise. Borrowed capital, on the otherhand, refers to the funds that are generated through loans or borrowingsfrom other individuals or institutions.

Internal and external sources: Internal sources of capital are those sourcesthat are generated within the business say through ploughing back of profits.External sources of capital, on the other hand are those that are outsidethe business such as finance provided by suppliers, lenders, and investors.

Sources of business finance: The sources of funds available to a businessinclude retained earnings, trade credit, factoring, lease financing, publicdeposits, commercial paper, issue of shares and debentures, loans fromcommercial banks, financial institutions and international sources offinance.

Retained earnings: The portion of the net earnings of the company that isnot distributed as dividends is known as retained earnings. The amount ofretained earnings available depends on the dividend policy of the company.It is generally used for growth and expansion of the company.

Trade credit: The credit extended by one trader to another for purchasinggoods or services is known as trade credit. Trade credit facilitates thepurchase of supplies on credit. The terms of trade credit vary from oneindustry to another and are specified on the invoice. Small and new firmsare usually more dependent on trade credit, as they find it relatively difficultto obtain funds from other sources.

Factoring: Factoring has emerged as a popular source of short-term fundsin recent years. It is a financial service whereby the factor is responsiblefor all credit control and debt collection from the buyer and providesprotection against any bad-debt losses to the firm. There are two methodsof factoring — recourse and non-recourse factoring.

Lease financing: A lease is a contractual agreement whereby the owner ofan asset (lessor) grants the right to use the asset to the other party (lessee).The lessor charges a periodic payment for renting of an asset for somespecified period called lease rent.

Public deposits: A company can raise funds by inviting the public to deposittheir savings with their company. Pubic deposits may take care of both longand short-term financial requirements of business. Rate of interest on depositsis usually higher than that offered by banks and other financial institutions.


Commercial paper (CP): It is an unsecured promissory note issued by afirm to raise funds for a short period The maturity period of commercialpaper usually ranges from 90 days to 364 days. Being unsecured, onlyfirms having good credit rating can issue the CP and its regulation comesunder the purview of the Reserve Bank of India.

Issue of equity shares: Equity shares represents the ownership capital ofa company. Due to their fluctuating earnings, equity shareholders are calledrisk bearers of the company. These shareholders enjoy higher returns duringprosperity and have a say in the management of a company, throughexercising their voting rights.

Issue of preference shares: These shares provide a preferential right tothe shareholders with respect to payment of earnings and the repaymentof capital. Investors who prefer steady income without undertaking higherrisks prefer these shares. A company can issue different types of preferenceshares.

Issue of debentures: Debenture represents the loan capital of a companyand the holders of debentures are the creditors. These are the fixed chargedfunds that carry a fixed rate of interest. The issue of debentures is suitablein the situation when the sales and earnings of the company are relativelystable.

Commercial banks: Banks provide short and medium-term loans to firmsof all sizes. The loan is repaid either in lump sum or in instalments. Therate of interest charged by a bank depends upon factors including thecharacteristics of the borrowing firm and the level of interest rates in theeconomy.

Financial institutions: Both central and state governments haveestablished a number of financial institutions all over the country to provideindustrial finance to companies engaged in business. They are also calleddevelopment banks. This source of financing is considered suitable whenlarge funds are required for expansion, reorganisation and modernisationof the enterprise.

International financing: With liberalisation and globalisation of theeconomy, Indian companies have started generating funds frominternational markets. The international sources from where the fundscan be procured include foreign currency loans from commercial banks,financial assistance provided by international agencies and developmentbanks, and issue of financial instruments (GDRs/ ADRs/ FCCBs) ininternational capital markets.

Factors affecting choice: An effective appraisal of various sources mustbe instituted by the business to achieve its main objectives. The selectionof a source of business finance depends on factors such as cost, financialstrength, risk profile, tax benefits and flexibility of obtaining funds. Thesefactors should be analysed together while making the decision for the choiceof an appropriate source of funds.


EXERCISES


Tick ( ) the correct answer out of the given alternatives

1. Equity shareholders are called

(a) Owners of the company (b) Partners of the company(c) Executives of the company (d) Guardian of the company

2. The term ‘redeemable’ is used for

(a) Preference shares (b) Commercial paper(c) Equity shares (d) Public deposits

3. Funds required for purchasing current assets is an example of

(a) Fixed capital requirement (b) Ploughing back of profits(c) Working capital requirement (d) Lease financing

4. ADRs are issued in

(a) Canada (b) China(c) India (d) USA

5. Public deposits are the deposits that are raised directly from

(a) The public (b) The directors(c) The auditors (d) The owners

6. Under the lease agreement, the lessee gets the right to

(a) Share profits earned (b) Participate in theby the lessor management of the

organisation(c) Use the asset for a (d) Sell the assets

specified period

7. Debentures represent

(a) Fixed capital of the company (b) Permanent capital of thecompany

(c) Fluctuating capital of (d) Loan capital of thethe company company

8. Under the factoring arrangement, the factor

(a) Produces and distributes (b) Makes the payment onthe goods or services behalf of the client

(c) Collects the client’s debt (d) Transfer the goods fromor account receivables one place to another

9. The maturity period of a commercial paper usually ranges from

(a) 20 to 40 days (b) 60 to 90 days(c) 120 to 365 days (d) 90 to 364 days


10. Internal sources of capital are those that are

(a) generated through outsiders (b) generated through loanssuch as suppliers from commercial banks

(c) generated through issue (d) generated withinof shares the business


1. What is business finance? Why do businesses need funds? Explain.

2. List sources of raising long-term and short-term finance.

3. What is the difference between internal and external sources of raisingfunds? Explain.

4. What preferential rights are enjoyed by preference shareholders.Explain.

5. Name any three special financial institutions and state their objectives.

6. What is the difference between GDR and ADR? Explain.


1. Explain trade credit and bank credit as sources of short-term financefor business enterprises.

2. Discuss the sources from which a large industrial enterprise can raisecapital for financing modernisation and expansion.

3. What advantages does issue of debentures provide over the issue ofequity shares?

4. State the merits and demerits of public deposits and retained earningsas methods of business finance.

5. Discuss the financial instruments used in international financing.

6. What is a commercial paper? What are its advantages and limitations.

Projects/Assignment

1. Collect information about the companies that have issued debenturesin recent years. Give suggestions to make debentures more popular.

2. Institutional financing has gained importance in recent years. In ascrapbook paste detailed information about various financialinstitutions that provide financial assistance to Indian companies.

3. On the basis of the sources discussed in the chapter, suggest suitableoptions to solve the financial problem of the restaurant owner.

4. Prepare a comparative chart of all the sources of finance.

CHAPTER 9

SMALL BUSINESS

LEARNING OBJECTIVES


• explain the meaning and nature of small business;

• appreciate the role of small business in India;

• analyse the problems of small business; and

• classify the different forms of assistance provided by thegovernment to small business, particularly in rural and hilly areas.


9.1 INTRODUCTION

In the pervious chapters, the conceptsof business, trade, commerce andindustry were discussed. The presentchapter discusses the issue of size ofbusiness, with reference to smallindustries and small businessestablishments. It also describes therole of small business and the majorproblems faced by the small sectorunits. Further, the assistance providedby the government to small business,particularly in the rural and hilly areashas been discussed.

9.2 MEANING AND NATURE OF SMALL

BUSINESS

In India, the ‘village and smallindustries sector’ consists of both‘traditional’ and ‘modern’ smallindustries. This sector has eightsubgroups. They are handlooms,

handicrafts, coir, sericulture, khadi andvillage industries, small scaleindustries and powerlooms. The lasttwo come under the modern smallindustries, while the others come undertraditional industries. Village and smallindustries together provide the largestemployment opportunities in India.

Before understanding the natureand meaning of small business, it isimportant to know how size is definedin our country, with reference to smallindustries and small businessestablishments. Several parameters canbe used to measure the size of businessunits. These include the number ofpersons employed in business, capitalinvested in business, volume of outputor value of output of business andpower consumed for business activities.However, there is no parameter whichis without limitations. Depending on theneed the measures can vary.

Amar, Akbar and Anthony are three good friends who have completed a vocationalcourse in entrepreneurship, after their school education. Finding the job markettough, they were contemplating the idea of setting up a small business, using theskills they had learnt in their course. However, they knew very little about business.They were wondering what business to start, where to locate it, how to procuremachinery and materials needed for the business, how to raise money and howto market. They came across a notification given by the District Industries Centrelocated near the Industrial Estate in Balanagar, Ranga Reddy district of AndhraPradesh regarding a seminar on government’s assistance for a small business,aimed at young entrepreneurs. Excited with the news, the three friends decidedto attend the seminar. They were told about the financial and other assistanceoffered by the Central and State Governments under the Rural EmploymentGeneration Programme to the educated youth. They found that toys were indemand and decided to manufacture toys. They started a small scale industry intheir village by taking financial assistance with the help of Khadi and VillageIndustries Commission. Today, they are successful makers of toys and in thenear future, they plan to get into export market as well.

209SMALL BUSINESS

The definition used by theGovernment of India to describe smallindustries is based on the investmentin plant and machinery. This measureseeks to keep in view the socio-economicenvironment in India where capital isscarce and labour is abundant. Onemore important point to note is that adefinition exists only for small and tinyunits but not for large and mediumunits. Medium and large sizedenterprises are not defined. Anythingthat does not fall under the definitionof small can be large or medium.Taking capital invested as the basis thesmall business units in India can fallunder any of the following categories:(i) Small scale industry: A small scaleindustrial undertaking is defined asone in which the investment in fixedassets of plant and machinery does notexceed rupees one crore. However, tocater to the needs of small industrieswhose thrust is on export promotionand modernisation, investment ceilingin plant and machinery is rupeesfive crores.(ii) Ancillary small industrial unit:The small scale industry can enjoy thestatus of an ancillary small industry ifit supplies not less than 50 per cent ofits production to another industry,referred to as the parent unit. Theancillary small industry canmanufacture parts, components, sub-assemblies, tools or intermediateproducts for the parent unit. Apart fromcatering to the needs of the parent unit,it can do business on its own. Ancillaryunits have the advantage of assureddemand from parent units. Normally,

the parent unit assists the ancillaryunit by giving technical guidance aswell as financial help.(iii) Export oriented units: The smallscale industry can enjoy the status ofan export oriented unit if it exportsmore than 50 per cent of its production.It can avail the incentives like exportsubsidies and other concessions offeredby the government for exporting units.(iv) Small scale industries ownedand managed by women entre-preneurs: An enterprise promoted bywomen entrepreneurs is a small scaleindustrial unit in which she/theyindividually or jointly have sharecapital of not less than 51 per cent.Such units can avail the specialconcessions offered by the government,like low interest rates on loans, etc.(v) Tiny industrial units: A tiny unit isdefined as an industrial or businessenterprise whose investment in plant andmachinery is not more than Rs. 25 lakhs.(vi) Small scale service and business(Industry related) enterprises: Asmall scale service and businessenterprise is one whose investment infixed assets of plant and machineryexcluding land and building does notexceed Rs. 10 lakhs.(vii) Micro business enterprises:Within the tiny and small businesssector, micro enterprises are those whoseinvestment in plant and machinerydoes not exceed rupees one lakh.(viii) Village industries: VillageIndustry has been defined as anyindustry located in a rural area whichproduces any goods, renders anyservice with or without the use of power


and in which the fixed capital investmentper head or artisan or worker does notexceed Rs. 50,000 or such other sum asmay be specified by the centralgovernment, from time to time.(ix) Cottage industries: These are alsoknown as Rural Industries orTraditional industries. They are notdefined by capital investment criteriaas in the case of other small scaleindustries. However, cottage industriesare characterised by certain featureslike the following:

• these are organised byindividuals, with privateresources;

• normally use family labour andlocally available talent;

• the equipment used is simple;• capital investment is small;• produce simple products,

normally in their ownpremises;

• production of goods usingindigenous technology.

9.3 ADMINISTRATIVE SETUP FOR THE

SMALL SCALE, AGRO AND RURAL

INDUSTRIES

The Government of India created theministry of Small Scale Industries andAgro and Rural Industries as the nodalministry for formulation of policy andcoordination of central assistance for thepromotion and development of smallscale industries in India. The Ministrywas bifurcated into two separateministries, viz., Ministry of Small ScaleIndustries and Ministry of Agro andRural Industries in September, 2001.

The Ministry of Small Scale Indus-tries designs policies, programmes, andschemes for the promotion and growthof SSIs. The Small IndustriesDevelopment Organisation (SIDO), alsoknown as the Office of the DevelopmentCommissioner (SSI) which is attachedto this ministry is responsible forimplementing and monitoring ofvarious policies and programmesformulated.

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211SMALL BUSINESS

Ministry of Agro and RuralIndustries is the nodal agency forcoordination and development ofVillage and Khadi industries, tiny andmicro enterprises in both urban andrural areas. It also implements PrimeMinister’s Rojgar Yojana. The variouspolicies, programmes and schemesrelated to agro and rural industries areimplemented by the ministry throughthe Khadi and Village IndustriesCommission (KVIC), Handicrafts Board,Coir Board, Silk Board etc.

State Governments also executedifferent promotional anddevelopmental projects and schemes toprovide number of supportingincentives for development andpromotion of SSIs in their respectivestates. These are executed through theState Directorate of Industries, who hasDistrict Industries Centers (DICs)under it to implement central/statelevel schemes.

9.4 ROLE OF SMALL BUSINESS IN INDIA

Small Scale Industries in India enjoy adistinct position in view of theircontribution to the socio-economicdevelopment of the country. Thefollowing points highlight theircontribution.

(i) Small industries in India accountfor 95 per cent of the industrialunits in the country. Theycontribute almost 40 per cent ofthe gross industrial value addedand 45 per cent of the total exports(direct and indirect exports) fromIndia.

(ii) Small industries are the secondlargest employers of humanresources, after agriculture.They generate more number ofemployment opportunities perunit of capital invested comparedto large industries. They are,therefore, considered to be morelabour intensive and less capitalintensive. This is a boon for alabour surplus country like India.

(iii) Small industries in our countrysupply an enormous variety ofproducts which include massconsumption goods, readymadegarments, hosiery goods,stationery items, soaps anddetergents, domestic utensils,leather, plastic and rubber goods,processed foods and vegetables,wood and steel furniture, paints,varnishes, safety matches, etc.Among the sophisticated itemsmanufactured are electric andelectronic goods like televisions,calculators, electro-medicalequipment, electronic teachingaids like overhead projectors, airconditioning equipment, drugsand pharmaceuticals, agriculturaltools and equipment and severalother engineering products. Aspecial mention should be made ofhandlooms, handicrafts and otherproducts from traditional villageindustries in view of their exportvalue. (see Box A which highlightsthe major industry groups thatcome under the purview of smallindustries as per the classificationlaid down by the government.)


(iv) The contribution of smallindustries to the balanced regionaldevelopment of our country isnoteworthy. Small industrieswhich produce simple productsusing simple technologies anddepend on locally availableresources both material and labourcan be set up anywhere in thecountry. Since they can be widelyspread without any locationalconstraints, the benefits ofindustrialisation can be reaped byevery region. They, thus, contributesignificantly to the balanceddevelopment of the country.

(v) Small industries provide ampleopportunity for entrepreneurship.The latent skills and talents ofpeople can be channelled intobusiness ideas which can beconverted into reality with littlecapital investment and almost nilformalities to start a small business.Amar, Akbar and Anthony in ourstory proved that a small businesscan be started, if one has thedetermination to achieve.

(vi) Small industries also enjoythe advantage of low cost ofproduction. Locally availableresources are less expensive.Establishment and running costsof small industries are on the lowerside because of low overheadexpenses. Infact, the low cost ofproduction which small industriesenjoy is their competitive strength.

(vii) Due to the small size of theorganisations, quick and timely

decisions can be taken withoutconsulting many people asit happens in large sizedorganisations. New businessopportunities can be captured atthe right time.

(viii) Small industries are best suitedfor customised production. i.e.designing the product as per thetastes/preferences/needs ofindividual customers, say for anexample tailor -made shirt ortrouser. The recent trend in themarket is to go in for customisedproduction of even non-traditionalproducts such as computers andother such products. They canproduce according to the needsof the customers as they usesimple and flexible productiontechniques.

(ix) Last but not the least, smallindustries have inherent strengthof adaptability and a personaltouch and therefore maintain goodpersonal relations with bothcustomers and employees. Thegovernment does not have tointerfere in the functioning of asmall scale unit. Due to the smallsize of the organisation quick andtimely decision can be takenwithout consulting many peopleas in large sized organisations.New business opportunities canbe captured at the right time, thusproviding healthy competition tobig business which is good for theeconomy.

213SMALL BUSINESS

9.5 ROLE OF SMALL BUSINESS IN

RURAL INDIA

Traditionally, rural households indeveloping countries have been viewedas exclusively engaged in agriculture.There is an increasing evidence thatrural households can have highlyvaried and multiple sources of incomeand that, rural households can and doparticipate in a wide range of non-agricultural activities such as wageemployment and self-employment incommerce, manufacturing andservices, along with the traditional ruralactivities of farming and agriculturallabour. This can be largely attributedto the policy initiatives taken by theGovernment of India, to encourage andpromote the setting up of agro-basedrural industries.

The emphasis on village and smallscale industries has always been anintegral part of India’s industrialstrategy, more so, after the second FiveYear Plan. Cottage and rural industriesplay an important role in providingemployment opportunities in the ruralareas, especially for the traditionalartisans and the weaker sections ofsociety. Development of rural andvillage industries can also preventmigration of rural population to urbanareas in search of employment.

Village and small industries aresignificant as producers of consumergoods and absorbers of surplus labour,thereby addressing the problems ofpoverty and unemployment. Theseindustries contribute amply to othersocio-economic aspects, such as

Box AMajor Industry Groups in the Small Scale Sector

• Food Products

• Chemical and ChemicalProducts

• Basic Metal Industries

• Metal Products

• Electrical Machinery and Parts

• Rubber and Plastic Products

• Machinery and Parts exceptElectrical Goods

• Hosiery and Garments — WoolProducts

• Non-metallic Mineral Products

• Paper Products and Printing

• Transport Equipment andParts

• Leather and Leather Products

• Miscellaneous ManufacturingIndustries

• Beverages, Tobacco andTobacco Products

• Repair Services

• Cotton Textiles

• Wool, Silk, Synthetic Fibre andTextiles

• Jute, Hemp and Mesta Textiles

• Other Services


reduction in income inequalities,dispersed development of industriesand linkage with other sectors of theeconomy.

In fact promotion of small scaleindustries and rural industrialisationhas been considered by theGovernment of India as a powerfulinstrument for realising the twinobjectives of ‘accelerated industrialgrowth and creating additionalproductive employment potential inrural and backward areas.’

However, the potential of smallindustries is often not realised fully,because of several problems related tosize. We shall now examine some of themajor problems that small businesseswhether in urban or in rural areas areencountering in their day-to-dayfunctioning.

9.6 PROBLEMS OF SMALL BUSINESS

Small scale industries are at a distinctdisadvantage as compared to largescale industries. The scale ofoperations, availability of finance,ability to use modern technology,procurement of raw materials are someof these areas. This gives rise to severalproblems.

Most of these problems can beattributed to the small size of theirbusiness, which prevents them fromtaking advantages, which accrue tolarge business organisations. However,the problems faced are not similar toall the categories of small businesses.For instance, in the case of smallancillary units, the major problemsinclude delayed payments, uncertainty

of getting orders from the parent unitsand frequent changes in productionprocesses. The problems of traditionalsmall scale units include remotelocation with less developedinfrastructural facilities, lack ofmanagerial talent, poor quality,traditional technology and inadequateavailability of finance.

The problems of exporting smallscale units include lack of adequatedata on foreign markets, lack ofmarket intelligence, exchange ratefluctuations, quality standards, andpre-shipment finance. In general thesmall businesses are faced with thefollowing problems:(i) Finance: One of the severeproblems faced by SSIs is that of non-availability of adequate finance to carryout its operations.

Generally a small business beginswith a small capital base. Many of theunits in the small sector lack the creditworthiness required to raise as capitalfrom the capital markets. As a result,they heavily depend on local financialresources and are frequently thevictims of exploitation by the moneylenders. These units frequently sufferfrom lack of adequate working capital,either due to delayed payment of duesto them or locking up of their capital inunsold stocks. Banks also do not lendmoney without adequate collateralsecurity or guarantees and marginmoney, which many of them are not ina position to provide.(ii) Raw materials: Another majorproblem of small business is theprocurement of raw materials. If the

215SMALL BUSINESS

required materials are not available,they have to compromise on the qualityor have to pay a high price to get goodquality materials. Their bargainingpower is relatively low due to the smallquantity of purchases made by them.Also, they cannot afford to take the riskof buying in bulk as they have nofacilities to store the materials. Becauseof general scarcity of metals, chemicalsand extractive raw materials in theeconomy, the small scale sector suffersthe most. This also means a waste ofproduction capacity for the economyand loss of further units.(iii) Managerial skills: Small businessis generally promoted and operated bya single person, who may not possessall the managerial skills required to runthe business. Many of the smallbusiness entrepreneurs possess soundtechnical knowledge but are lesssuccessful in marketing the output.Moreover, they may not find enoughtime to take care of all functionalactivities. At the same time they are notin a position to afford professionalmanagers.(iv) Labour: Small business firmscannot afford to pay higher salaries tothe employees, which affects employeewillingness to work hard and producemore. Thus, productivity per employeeis relatively low and employee turn overis generally high. Because of lowerremuneration offered, attractingtalented people is a major problem insmall business organisations.Unskilled workers join for lowremuneration but training them is a

time consuming process. Also, unlikelarge organisations, division of labourcannot be practised, which resultsin lack of specialisation andconcentration.(v) Marketing: Marketing is one of themost important activities as it generatesrevenue. Effective marketing of goodsrequires a thorough understandingof the customer’s needs andrequirements. In most cases, marketingis a weaker area of small organisations.These organisations have, therefore, todepend excessively on middlemen, whoat times exploit them by paying lowprice and delayed payments. Further,direct marketing may not be feasiblefor small business firms as they lackthe necessary infrastructure.(vi) Quality: Many small businessorganisations do not adhere to desiredstandards of quality. Instead theyconcentrate on cutting the cost andkeeping the prices low. They do nothave adequate resources to invest inquality research and maintain thestandards of the industry, nor do theyhave the expertise to upgradetechnology. In fact maintaining qualityis their weakest point, when competingin global markets.(vii) Capacity utilisation: Due to lackof marketing skills or lack of demand,many small business firms have tooperate below full capacity due to whichtheir operating costs tend to increase.Gradually this leads to sickness andclosure of the business.(viii) Technology: Use of outdatedtechnology is often stated as serious


lacunae in the case of small industries,resulting in low productivity anduneconomical production.(ix) Sickness: Prevalence of sickness insmall industries has become a point ofworry to both the policy makers and theentrepreneurs. The causes of sicknessare both internal and external. Internalproblems include lack of skilled andtrained labour and managerial andmarketing skills. Some of the externalproblems include delayed payment,shortage of working capital, inadequateloans and lack of demand for theirproducts.(x) Global competition: Apart from theproblems stated above small businessesare not without fears, especially in thepresent context of liberalisation,privatisation and globalisation (LPG)policies being followed by severalcountries across the world. Remember,India too has taken the LPG path since1991. Let us look into the areas wheresmall businesses feel threatened withthe onslaught of global competition.(a) Competition is not only from

medium and large industries, butalso from multinational companieswhich are giants in terms of theirsize and business volumes.Opening up of trade results in cutthroat competition for small scaleunits.

(b) It is difficult to withstand thequality standards, technologicalskills, financial creditworthiness,managerial and marketing capa-bilities of the large industries andmultinationals.

(c) There is limited access to marketsof developed countries due to thestringent requirements of qualitycertification like ISO 9000.

9.7 GOVERNMENT ASSISTANCE TO

SMALL INDUSTRIES AND SMALL

BUSINESS UNITS

Keeping in view the contribution ofsmall business to employmentgeneration, balanced regionaldevelopment of the country, andpromotion of exports, the Governmentof India’s policy thrust has been onestablishing, promoting and developingthe small business sector, particularlythe rural industries and the cottage andvillage industries in backward areas.Governments both at the central andstate level have been activelyparticipating in promoting self-employment opportunities in ruralareas by providing assistance in respectof infrastructure, finance, technology,training, raw-materials, and marketing.The various policies and schemes ofGovernment assistance for thedevelopment of rural industries insiston the utilisation of local resources andraw materials and locally availablemanpower. These are translated intoaction through various agencies,departments, corporations, etc., allcoming under the purview of theindustries department. All these areprimarily concerned with the promotionof small and rural industries.

Some of the support measures andprogrammes meant for the promotion

217SMALL BUSINESS

of small and rural industries arediscussed below:

A. INSTITUTIONAL SUPPORT

1. National Bank for Agricultureand Rural Development(NABARD)

NABARD was setup in 1982 topromote integrated rural development.Since then, it has been adopting amulti-pronged, multi-purpose strategyfor the promotion of rural businessenterprises in the country. Apart fromagriculture, it supports smallindustries, cottage and villageindustries, and rural artisans usingcredit and non-credit approaches. Itoffers counselling and consultancyservices and organises training anddevelopment programmes for ruralentrepreneurs.

2. The Rural Small BusinessDevelopment Centre (RSBDC)

It is the first of its kind set up by theworld association for small andmedium enterprises and is sponsoredby NABARD. It works for the benefitof socially and economicallydisadvantaged individuals and groups.It aims at providing management andtechnical support to current andprospective micro and smallentrepreneurs in rural areas. Since itsinception, RSBDC has organisedseveral programmes on ruralentrepreneurship, skill upgradationworkshops, mobile clinics and trainerstraining programmes, awareness

and counselling camps in variousvillages of Noida, Greater Noidaand Ghaziabad. Through theseprogrammes it covers a largenumber of rural unemployed youthand women in several trades, whichincludes food processing, soft toysmaking, ready-made garments,candle making, incense stickmaking, two-wheeler repairing andservicing, vermicomposting, and nonconventional building materials.

3. National Small IndustriesCorporation (NSIC)

This was set up in1955 with a view topromote, aid and foster the growth ofsmall business units in the country.This focuses on the commercial aspectsof these functions.

• Supply indigenous and importedmachines on easy hire-purchaseterms.

• Procure, supply and distributeindigenous and imported rawmaterials.

• Export the products of smallbusiness units and developexport-worthiness.

• Mentoring and advisory services.• Serve as technology business

incubators.• Creating awareness on techno-

logical upgradation.• Developing software technology

parks and technology transfercentres.

A new scheme of ‘performanceand credit rating’ of small businessesis implemented through National Small


Industries Corporation (NSIC) with thetwin objectives of (i) sensitising the smallindustries about the need for creditrating and (ii) encouraging the smallbusiness units to maintain goodfinancial track record. This is to ensurethat they score higher rating for theircredit requirements as and when theyapproach the financial institutions fortheir working capital and investmentrequirements.

4. Small Industries DevelopmentBank of India (SIDBI)

• Set up as an apex bank to providedirect/indirect financial assistanceunder different schemes, to meetcredit needs of small businessorganisations.

• To coordinate the functions ofother institutions in similaractivities.

Thus so far, we have learnt aboutthe various institutions operating at thecentral level and state level in supportof the small industries.

5. The National Commission forEnterprises in the UnorganisedSector (NCEUS)

The NCEUS was constituted inSeptember, 2004, with the followingobjectives:

• To recommend measuresconsidered necessary forimproving the productivity ofsmall enterprises in the informalsector.

• To generate more employmentopportunities on a sustainable

basis, particularly in the ruralareas.

• To enhance the competitiveness ofthe sector in the emerging globalenvironment.

• To develop linkages of the sectorwith other institutions in theareas of credit, raw materials,infrastructure, technologyupgradation, marketing andformulation of suitable arrange-ments for skill development.

The commission has identifiedthe following issues for detailedconsideration:

• Growth poles for the informalsector in the form of clusters/hubs, in order to get externaleconomic aid.

• Potential for public-privatepartnerships in imparting the skillsrequired by the informal sector.

• Provision of micro-finance andrelated services to the informalsector.

• Providing social security for theworkers in the informal sector.

6. Rural and WomenEntrepreneurshipDevelopment (RWED)

The Rural and Women Entrepreneur-ship Development programme aims atpromoting a conducive businessenvironment and at buildinginstitutional and human capacities thatwill encourage and support theentrepreneurial initiatives of ruralpeople and women. RWE provides thefollowing services:

219SMALL BUSINESS

• Creating a business environmentthat encourages initiatives of ruraland women entrepreneurs.

• Enhancing the human andinstitutional capacities required tofoster entrepreneurial dynamismand enhance productivity.

• Providing training manuals forwomen entrepreneurs andtraining them.

• Rendering any other advisoryservices.

7. World Association for Smalland Medium Enterprises(WASME)

It is the only International Non-Governmental Organisation of micro,small and medium enterprises basedin India, which set up an InternationalCommittee for Rural Industrialisation.Its aim is to develop an action planmodel for sustained growth of ruralenterprises.

Apart from these, there are severalschemes to promote the non-farmsector, mostly initiated by theGovernment of India. For instance,there are schemes for entrepreneurshipthrough subsidised loans likeIntegrated Rural DevelopmentProgramme (IRDP), Prime MinisterRojgar Yojana (PMRY), schemes toprovide skills like Training of RuralYouth for Self Employment (TRYSEM),and schemes to strengthen the gendercomponent like Development of Womenand Children in Rural Areas (DWCRA).There are schemes to provide wage

employment like Jawahar RojgarYojana (JRY), food for work etc., onrural works programmes to achieve thetwin objectives of creation of ruralinfrastructure and generationof additional income for the ruralpoor, particularly during the leanagricultural season. Last, but not theleast, there are schemes for specificgroups of industries such as khadi,handlooms and handicrafts.

8. Scheme of Fund for Re-generation of TraditionalIndustries (SFURTI)

To make the traditional industriesmore productive and competitive andto facilitate their sustainabledevelopment, the Central Governmentset up this fund with Rs. 100 croresallocation to begin within the year2005. This has to be implemented bythe Ministry of Agro and RuralIndustries in collaboration with StateGovernments. The main objectives ofthe scheme are as follows:

• To develop clusters of traditionalindustries in various parts of thecountry;

• To build innovative and traditionalskills, improve technologiesand encourage public-privatepartnerships, develop marketintelligence etc., to make themcompetitive, profitable andsustainable; and

• To create sustained employmentopportunities in traditionalindustries.


9. The District Industries Centers(DICs)

The District Industries CentersProgramme was launched on May 1,1978, with a view to providing anintegrated administrative framework atthe district level, which would look atthe problems of industrialisation in thedistrict, in a composite manner. Inother words District Industries Centersis the institution at the district levelwhich provides all the services andsupport facilities to the entrepreneursfor setting up small and villageindustries. Identification of suitableschemes, preparation of feasibilityreports, arranging for credit, machineryand equipment, provision of rawmaterials and other extension servicesare the main activities undertaken bythese centers. Broadly DICs are tryingto bring change in the attitude of therural entrepreneurs and all otherconnected with economic developmentin the rural areas. Even within thenarrow spectrum, an attempt is beingmade to look at some of the neglectedfactors such as the rural artisan, theskilled craftsman and the handloomoperator and to tune up these activitieswith the general process of ruraldevelopment being taken up throughother national programmes. The DICis thus emerging as the focal point foreconomic and industrial growth at thedistrict level.

B. INCENTIVES

Special emphasis on the industrialdevelopment of backward, tribal and

hilly areas has been the concern of theGovernment of India expressed in allthe Five Year Plans and industrial policystatements. Realising that backwardareas development is a long-termprocess, several committees wereappointed to identify the criteria foridentifying backward areas and also tosuggest schemes to take up theHerculean task of balanced regionaldevelopment. The implementation ofintegrated rural developmentprogramme is one such attempt madeby the government to developbackward areas. The rural industriesproject programme initiated by theGovernment of India was meant todevelop small business units in selectrural areas. Though the backward areadevelopment programmes varied fromstate to state, they cumulativelyrepresented a significant package ofincentives to attract industries inbackward areas.

Some of the common incentivesoffered are discussed as below:Land: Every state offers developed plotsfor setting up of industries. The termsand conditions may vary. Some statesdon’t charge rent in the initial years,while some allow payment ininstalments.Power: Power is supplied at aconcessional rate of 50 per cent, whilesome states exempt such units frompayment in the initial years.Water: Water is supplied on a no-profit,no-loss basis or with 50 per centconcession or exemption from watercharges for a period of 5 years.

221SMALL BUSINESS

Sales Tax: In all union territories,industries are exempted from sales tax,while some states extend exemption for5 years period.Octroi: Most states have abolishedoctroi.Raw materials: Units located inbackward areas get preferentialtreatment in the matter of allotment ofscarce raw materials like cement, ironand steel etc.Finance: Subsidy of 10-15 per cent isgiven for building capital assets. Loansare also offered at concessional rates.Industrial estates: Some statesencourage setting up of industrialestates in backward areas.Tax holiday: Exemption from payingtaxes for 5 or 10 years is given toindustries established in backward,hilly and tribal areas.

To sum up, it may be stated that thesmall business sector in India is gettingthe support of government throughvarious institutions in different formsfor different purposes. Despite specialattention being given to backwardareas, it is observed that imbalances indevelopment are still there. There is aneed to develop infrastructural facilitiesin these areas, as no amount of

subsidies or concessions can overcomethe natural handicaps caused by a lackof such facilities.

9.8 THE FUTURE

The present era is the regime of theWorld Trade Organisation (WTO), inwhich the rules of trade are subject tofrequent changes as per globalexpectations. As a founder member ofWTO, India too has committed itself tothe policy framework of WTO. As aresult, small business is also movingaway from the pre-liberalisation era ofprotection. With the Indian economygetting integrated with the globaleconomy, it is inevitable for the smallbusinesses to gear up their capabilitiesto explore, penetrate and develop newmarkets. They have to steadily reorientthemselves to face the challenges posedby increased competition, domesticallyand internationally too. With theirdynamism, flexibility and innovativeentrepreneurial spirit, small businesseshave to adapt themselves to the fastchanging needs of the market driveneconomy. Government should reorientits assistance to the small businesssector by acting as a facilitator andpromoter and not as a regulator. New

Forms of Support Offered to Small Industries by the Government

• Institutional support in respect of credit facilities• Provision of developed sites for construction of sheds• Provision of training facilities• Supply of machinery on hire purchase terms• Assistance for domestic and export marketing• Technical and financial assistance for technological up-gradation• Special incentives for setting up of enterprises in backward areas


strategies have to be evolved to fosterpartnership between large and smallindustries, adopt cluster approach,develop creative marketing, improvetechnological skills by upgradation,building export competitiveness byidentifying the core competencies ofthe small businesses.

In fact small business sectorshould view globalisation as anopportunity for its active participationas suppliers of specialised component

Key Terms

Small scale industries Cottage industries Micro business enterprises

Expert oriented units Rural industries Women enterprises

Ancillary Khadi industries Tiny industries

SUMMARY

On the basis of the capital invested, small business units can be categorisedinto various categories, which include Small Scale Industry, Ancilliary SmallIndustrial Units, Export Oriented Units, Small Scale Industries owned andmanaged by Women Entrepreneurs, Tiny Industrial Units, Small ScaleServices and Business (Industry related) Enterprises, Micro BusinessEnterprises, Village Industries and Cottage Industries.

Administrative setup: The administrative set up for small scale industryconsists of two ministries viz., the Ministry of Small Scale Industries andMinistry of Agricultural and Rural Industry, Government of India, theMinistry of SSIs is the nodal ministry for formulation of policy andcoordination of central assistance, for the promotion and development ofSSIs in India.

Similarly, the ministry of Agro and Rural Industries is the nodal agency forcoordination and development of village and Khadi Industries, Tiny andMicro Enterprises in both urban and rural area. State Governments alsoexecute different promotional development projected schemes to provide anumber of supporting incentives for development and promotion of SSIs intheir respective states.

and parts. If small businesses are tomaintain their market share andhealthy growth, they have to createa level-playing field for themselves.The long-term competitive positionfor the small businesses will dependon how well they learn to manage,adopt and improve their competitivestrength.

In short the mantra of success forsmall businesses in this modern erahas to be ‘think global, act local.’

223SMALL BUSINESS

Role of small business in India: Small Scale Industries play a veryimportant role in the socio economic development of the country. Theseindustries account for 95 per cent of industrial units, contributing up to 40per cent of the gross industrial value added and 45 per cent of the totalexports. SSIs are the second largest employers of human resources, afteragriculture and produce a variety of products for the economy. These unitscontribute to the balanced regional development of the country by usinglocally available material and indigenous technology. These provide amplescope for entrepreneurship; enjoy the advantage of low cost of production;quick decision making, and have quick adaptability and are best suited tocustomised production.

Role of small business in rural India: Small business units provide multiplesource of income, in wide range of non agricultural activities and provideemployment opportunities in rural areas, especially for the traditionalartisan and weaker sections of the society.

Problems of small industries: Small Industries suffer from various problemsincluding that of (i) Finance, (ii) Non-availability of raw material,(iii) Managerial skills (iv) Skilled labour (v) Marketing of their goods(vi) Maintaining Quality standards (vii) Low capacity utilisation, (viii) Useof traditional technology (ix) Prevalence of sickness and (x) Facing globalcompetition.

Governmental assistance to small industries: In view of the contributionof small business in various areas including employment generation,balanced regional development, and promotion of export the central andstate government have been providing assistance in respect ofinfrastructure, finance, technology, training etc., to SSI units.

Some of the major institutions providing support include National Bank forAgriculture and Rural Development, Rural Small Business DevelopmentCentre, National Small Industries Corporation, Small IndustriesDevelopment Bank of India (SIDBI)), The National Commission forEnterprises in Unorganised Sector (NCEUS), Rural and WomenEntrepreneurship Development (RWE), World Association for Small andMedium Enterprises (WASME), Scheme of Fund for Regeneration ofTraditional Industries (SFURM) and the District Industries centre (DIC).

EXERCISES


1. What are the different parameters used to measure the size of business?

2. What is the definition used by Government of India for Small ScaleIndustries?


3. How would you differentiate between an ancillary unit and a tiny unit?

4. State the features of cottage industries.


1. How do small scale industries contribute to the socio-economicdevelopment of india?

2. Describe the role of small business in rural India.

3. Discuss the problems faced by small scale industries.

4. What measures has the government taken to solve the problem offinance and marketing in the small scale sector?

5. What are the incentives provided by the Government for industries inbackward and hilly areas?


1. Prepare a questionnaire to find out the actual problems faced by anowner of a small scale unit. Prepare a project report on it.

2. Survey about five small scale units in your vicinity and find out if theyhave received any assistance by the institutions set up by theGovernment.

CHAPTER 10

INTERNAL TRADE

LEARNING OBJECTIVES


• describe the meaning and types of internal trade;

• specify the services of wholesalers to manufactures and retailers;

• explain the services of retailers;

• classify the types of retailers;

• explain the forms of small scale and large scale retailers; and

• state the role of Chambers of Commerce and industry in thepromotion of internal trade.


10.1 INTRODUCTION

Trade refers to buying and selling ofgoods and services with the objectiveof earning profit. Mankind has beenengaged in trading, in some form orthe other, since early days ofcivilisation. The importance of tradein modern times has increased as newproducts are being developed everyday and are being made available forconsumption throughout the world.No individual or country can claim tobe self-sufficient in producing all thegoods and services required by it.Thus, each one is engaged inproducing what it is best suited toproduce and exchanging the excessproduce with others.

On the basis of geographicallocation of buyers and sellers, trade canbroadly be classified into two categories(i) Internal trade; and (ii) External trade.Trade which takes place within a

country is called internal trade. Tradebetween two or more countries, on theother hand, is called external trade. Thepresent chapter discusses in detail themeaning and nature of internal tradeand explains its different types and therole of chambers of commerce inpromoting internal trade.

10.2 INTERNAL TRADE

Buying and selling of goods andservices within the boundaries of anation are referred to as internal trade.Whether the products are purchasedfrom a neighbourhood shop in a localityor a central market or a departmentalstore or a mall or even from any door-to-door salesperson or from anexhibition, all these would beconsidered to be examples of internaltrade as the goods are purchased froman individual or establishment withina country. No custom duty or import

Have you ever thought if there were no markets, how products of differentmanufacturers would reach us? We are all aware of our general provisions storeround the corner which is selling items of our daily need. But is that enough?When we need to buy items of a specialised nature, we like to look at biggermarkets or shops with variety. Our observation tells us that there are differenttypes of shops selling different items or specialised goods and depending on ourrequirements we purchase from certain shops or markets. In rural areas, wemay have noticed people selling their goods on the streets, these goods mayrange from vegetables to clothes. This is a completely different scene from whatwe see in the urban areas. In our country, all kinds of markets co-exist inharmony. With the advent of imported goods and multinational corporations, wehave shops selling these products too. In big towns and cities, there are manyretail shops selling particular branded products only. Another aspect of all thisis, how these products reach the shops from the manufacturers? There must besome middlemen doing this job. Are they really useful or do prices increasebecause of them?

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duty is levied on such trade as goodsare part of domestic production and aremeant for domestic consumption.Generally, payment has to be made inthe legal tender of the country or anyother acceptable currency.

Internal trade can be classified intotwo broad categories viz., (i) wholesaletrade and (ii) retail trade. Generally, forproducts, which are to be distributedto a large number of buyers who arelocated over a wide geographical area,it becomes very difficult for theproducers to reach all consumers orusers directly. For example, if vegetableoil or bathing soap or salt produced ina factory in any part of the country areto be reached to millions of consumersthroughout the country, the help ofwholesalers and retailers becomes veryimportant. Purchase and sale of goodsand services in large quantities, for thepurpose of resale or intermediate useis referred to as wholesale trade.

On the other hand, purchase andsale of goods in relatively smallquantities, generally to the ultimateconsumers, is referred to as retail trade.Traders dealing in wholesale trade arecalled wholesale traders and thosedealing in retail trade are calledretailers. Both retailers and wholesalersare important marketing intermediarieswho perform very useful functions inthe process of exchange of goods andservices between producers and usersor ultimate consumers. Internal tradeaims at equitable distribution of goodswithin a nation speedily and atreasonable cost.

10.3 WHOLESALE TRADE

As discussed in the previous section,wholesale trade refers to buying andselling of goods and services in largequantities for the purpose of resale orintermediate use.

Wholesaling is concerned with theactivities of those persons orestablishments which sell to retailersand other merchants, and/or toindustrial institutional and commercialusers but who don’t sell in significantamount to ultimate consumers.Wholesalers serve as an important linkbetween manufacturers and retailers.They not only enable the producers toreach large number of buyers spreadover a wide geographical area (throughretailers) but perform a variety offunctions in the process of distributionof goods and services. They generallytake title of the goods and bear thebusiness risks by purchasing andselling the goods in their own name.They purchase in bulk and sell in smalllots to retailers or industrial users.They undertake various activities suchas grading of products, packing intosmaller lots, storage, transportation,promotion of goods, collection ofmarket information, collection of smalland scattered orders of retailers anddistribution of supplies to them. Theyalso relieve the retailers of maintaininglarge stock of articles and extend creditfacilities to them. Most of the functionsperformed by wholesalers are suchwhich cannot be eliminated. If there areno wholesalers, these functions shallhave to be performed either by themanufacturers or the retailers.


Services of Wholesalers

Wholesalers provide various services tothe manufacturers as well as theretailers and provide immense help inthe distribution of goods and services.By making the products available at aplace where these are needed and at atime when these are needed forconsumption or use, they provide bothtime and place utility. The variousservices of wholesalers to differentsections are listed as follows:

10.3.1 Services to Manufacturers

The major services offered bywholesalers to the producers of goodsand services are given as below:(i) Facilitating large scale production:Wholesalers collect small orders fromnumber of retailers and pass on the poolof such orders to manufacturers andmake purchases in bulk quantities. Thisenables the producers to undertakeproduction on a large scale and takeadvantage of the economies of scale.(ii) Bearing risk: The wholesalemerchants deal in goods in their ownname, take delivery of the goods andkeep the goods purchased in large lotsin their warehouses. In the process theybear lots of risks such as the risk of fallin prices, theft, pilferage, spoilage, fire,etc. To that extent, they relieve themanufacturers from bearing these risks.(iii) Financial assistance: Thewholesalers provide financial assistanceto the manufacturers in the sense thatthey generally make cash payment forthe goods purchased by them. To thatextent, the manufacturers need not

block their capital in the stocks.Sometimes they also advance money tothe producers for bulk orders placedby them.(iv) Expert advice: As the wholesalersare in direct contact with the retailers,they are in a position to advice themanufacturers about various aspectsincluding customer’s tastes andpreferences, market conditions,competitive activities and the featurespreferred by the buyers. They serve asan important source of marketinformation on these and relatedaspects.(v) Help in the marketing function:The wholesalers take care of thedistribution of goods to a number ofretailers who, in turn, sell to largenumber of customers spread over alarge geographical area. This relieves themanufacturers of many of the marketingactivities and enable them toconcentrate on the production activity.(vi) Facilitate continuity: Thewholesalers facilitate continuity ofproduction activity throughout theyear by purchasing the goods as andwhen these are produced.(vii) Storage: Wholesalers take deliveryof goods when these are produced infactory and keep them in theirgodowns/warehouses. This reducesthe burden of manufacturers ofproviding for storage facilities for thefinished products.

10.3.2 Services to Retailers

The important services offered bymanufacturers to the retailers are listedas below:

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(i) Availability of goods: Retailershave to maintain adequate stock ofvaried commodities so that they canoffer variety to their customers. Thewholesalers make the products ofvarious manufacturers readilyavailable to the retailers. This relievesthe retailers of the work of collectinggoods from several producers andkeeping big inventory of the same.(ii) Marketing support: The whole-salers perform various marketingfunctions and provide support to theretailers. They undertake advertise-ments and other sales promotionalactivities to induce customers topurchase the goods. The retailers arebenefitted as it helps them in increasingthe demand for various new products.(iii) Grant of credit: The wholesalersgenerally extend credit facilities to theirregular customers. This enables theretailers to manage their business withrelatively small amount of workingcapital.(iv) Specialised knowledge: Thewholesalers specialise in one line ofproducts and know the pulse of themarket. They pass on the benefit oftheir specialised knowledge to theretailers. They inform the retailersabout the new products, their uses,quality, prices, etc. They may alsoadvise on the decor of the retail outlet,allocation of shelf space anddemonstration of certain products.(v) Risk sharing: The wholesalerspurchase in bulk and sell in relativelysmall quantities to the retailers. Beingable to manage with purchase of

merchandise in smaller quantities,retailers are in a position to avoid therisk of storage, pilferage, obsolescence,reduction in prices and demandfluctuations in respect of the additionalgoods that they would have topurchase in case the services ofwholesalers are not available.

10.4 RETAIL TRADE

A retailer is a business enterprise thatis engaged in the sale of goods andservices directly to the ultimateconsumers. He/she normally buysgoods in large quantities fromwholesalers and sells them in smallquantities to the ultimate consumers.He/she represents the final stage inthe distribution where goods aretransferred from the hands of tradersto final consumers or users. Retailingis, thus, that branch of business whichis devoted to the sale of goods andservices to the ultimate consumers, fortheir personal, non-business use.

There may be different ways ofselling the goods viz., personally, ontelephone, or by vending machines.Also, the products may be sold atdifferent places viz., in a store, at thecustomer’s house or any other place.Some of the common situations that weencounter in our daily life for example,are the sale of ball pens or some magicmedicine or book of jokes in theroadways buses; the sale of cosmetics/detergent powder, door-to-door sales;and the sale of vegetables by the roadside by a small farmer. But as long asthe goods are sold to ultimate


consumers, these will be treated ascases of retail selling. Thus, irrespectiveof ‘how’ the products are sold or ‘where’the sale is made, if the sales are madedirectly to the consumers, it will beconsidered as retailing.

A retailer performs differentfunctions in the distribution of goodsand services. He/she purchases avariety of products from wholesaledistributors and others, arranges forproper storage of the goods, sells thegoods in small quantities, bearsbusiness risks, grades the products,collects market information, extendscredit to the buyers and promotes thesale of products through displays,participation in various schemes, etc.

Services of Retailers

Retailers serve as an important linkbetween the producers and finalconsumers in the distribution ofproducts and services in this process.They provide useful services tothe consumers, wholesalers andmanufacturers. Some of the importantservices of retailers are described asbelow:

10.4.1 Services to Manufacturersand Wholesalers

The invaluable services that theretailers render to the wholesalers andproducers are given as here under:(i) Help in distribution of goods: Aretailer’s most important service to thewholesalers and manufacturers is toprovide help in the distribution of theirproducts by making these available to

the final consumers, who may bescattered over a large geographic area.(ii) Personal selling: In the process ofsale of most consumer goods, someamount of personal selling effort isnecessary. By undertaking personalselling efforts, the retailers relieve theproducers of this activity and greatlyhelp them in the process of actualisingthe sale of the products.(iii) Enabling large-scale operations:On account of retailer’s services, themanufacturers and wholesalers arefreed from the botheration of makingindividual sales to consumers in smallquantities. This enables them tooperate at relatively large scale, andthereby fully concentrate on their otheractivities.(iv) Collecting market information:As retailers remain in direct andconstant touch with the buyers, theyserve as an important source ofcollecting market information aboutthe tastes, preferences and attitudes ofcustomers. Such information isconsidered very useful in takingimportant marketing decisions in anorganisation.(v) Help in promotion: From time-to-time, manufacturers and distributorshave to carry on various promotionalactivities in order to increase the saleof their products. For example, theyhave to advertise their products andoffer short-term incentives in the formof coupons, free gifts, sales contests,and so on. Retailers participate in theseactivities in various ways and, thereby,help in promoting the sale of theproducts.

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10.4.2 Services to Consumers

Some of the important services ofretailers from the point of view ofconsumers are as follows :(i) Regular availability of products:The most important service of a retailerto consumers is to maintain regularavailability of various productsproduced by different manufacturers.This enables the buyers to chooseproducts according to their tastes froma wide variety and buy them whenneeded.(ii) New products information: Byarranging for effective display ofproducts and through their personalselling efforts, retailers provideimportant information about thearrival, special features, etc., of newproducts to the customers. This servesas an important factor in the decisionmaking process for the purchase ofthose goods.(iii) Convenience in buying: Retailersgenerally buy goods in large quantitiesand sell these in small quantities,according to the requirements of theircustomers. Also, they are normallysituated very near to the residential areasand remain open for long hours. Thisoffers great convenience to thecustomers in buying products of theirrequirements.(iv) Wide selection: Retailers generallykeep 0stock of a variety of products ofdifferent manufacturers. This enables theconsumers to make their choice out of awide selection of goods.(v) After-sales services: Retailersprovide important after-sales services

in the form of home delivery, supply ofspare parts and attending tocustomers. This becomes an importantfactor in the buyers’ decision for repeatpurchase of the products.(vi) Provide credit facilities: Theretailers sometimes provide creditfacilities to their regular buyers. Thisenables the latter to increase their levelof consumption and, thereby, theirstandard of living.

10.5 TYPES OF RETAILING TRADE

There are many types of retailers inIndia. For proper understanding, itwould be useful, to classify them intocertain common categories. Differentclassifications have been used byexperts to categorise retailers intodifferent types. For example, on thebasis of ‘size of business’, they may becategorised into large, medium andsmall retailers. On the basis of ‘type ofownership’, they may be categorisedinto ‘sole trader’, ‘partnership firm’,‘cooperative store’ and ‘company’.Similarly, on the basis of ‘merchandisehandled’, the different classificationsmay be ‘speciality store’, ‘supermarket’and ‘departmental store’. Anothercommon basis of classification iswhether or not they have a fixed placeof business. On this basis, there aretwo categories of retailers:

(a) Itinerant retailers, and(b) Fixed shop retailersBoth these types of retailers have

been described in detail in the sectionsthat follow here after.


10.5.1 Itinerant Retailers

Itinerant retailers are traders who donot have a fixed place of business tooperate from. They keep on moving withtheir wares from street to street or placeto place, in search of customers.

Characteristics

(a) They are small traders operatingwith limited resources;

(b) They normally deal in consumerproducts of daily use such astoiletry products, fruits andvegetables, and so on;

(c) The emphasis of such traders ison providing greater customerservice by making the productsavailable at the very doorstep ofthe customers; and

(d) As they do not have any fixedbusiness establishment to operatefrom, these retailers have to keeptheir limited inventory ofmerchandise either at home or atsome other place.

Some of the most common types ofitinerant retailers operating in India areas below:(i) Peddlers and hawkers: Peddlersand hawkers are probably amongst theoldest form of retailers in the marketplace who have not lost their utility evenduring modern times. They are smallproducers or petty traders who carrythe products on a bicycle, a hand cart,a cycle-rickshaw or on their heads, andmove from place to place to sell theirmerchandise at the doorstep of thecustomers. They generally deal in non-standardised and low-value products

such as toys, vegetables and fruits,fabrics, carpets, snacks and ice creams,etc. They are also found in streets ofresidential areas, places of exhibitionsor meals, and outside schools, duringa lunch break.

The main advantage of this form ofretailing is the provision of convenientservice to the consumers. However,one should be careful in dealing withthem, as the products they deal in arenot always reliable in terms of qualityand price.(ii) Market traders: Market traders arethe small retailers who open their shopsat different places on fixed days ordates, such as every Saturday oralternate Saturdays, and so on. Thesetraders may be dealing in oneparticular line of merchandise, sayfabrics or ready-made garments, toys,or crockery, or alternatively, they maybe general merchants. They are mainlycatering to lower-income group ofcustomers and deal in low-pricedconsumer items of daily use.(iii) Street traders (pavementvendors): Street traders are the smallretailers who are commonly found atplaces where huge floating populationgathers, for example, near railwaystations and bus stands, and sellconsumer items of common use, suchas stationery items, eatables, ready-made garments, newspapers andmagazines. They are different frommarket traders in the sense that theydo not change their place of businessso frequently.(iv) Cheap jacks: Cheap jacks arepetty retailers who have independent

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shops of a temporary nature in abusiness locality. They keep onchanging their business from onelocality to another, depending upon thepotentiality of the area. However, thechange of place is not as frequent as inthe case of hawkers or market traders.They also deal in consumer items andprovide service to consumers interms of making the products availablewhere needed.

10.5.2 Fixed Shop Retailers

This is the most common type ofretailing in the market place. As isevident from the name, these are retailshops who maintain permanentestablishment to sell their merchandise.They, therefore, do not move fromplace to place to serve their customers.Some of the other characteristics ofsuch traders are:

Characteristics

(a) Compared with the itinerant traders,normally they have greater resourcesand operate at a relatively largescale. However, there are differentsize groups of fixed shop retailers,varying from very small to verylarge;

(b) These retailers may be dealing indifferent products, includingconsumer durables as well as non-durables; and

(c) This category of retailers has greatercredibility in the minds ofcustomers, and they are in a positionto provide greater services to thecustomers such as home delivery,

guarantees, repairs, credit facilities,availability of spares, etc.

Types

The fixed-shop retailers can beclassified into two distinct types on thebasis of the size of their operations.These are:

(a) small shop-keepers, and(b) large retailers.The different types of retailers falling

under the above two broad heads aredescribed below:

Fixed Shop Small Retailers

(i) General stores: General stores aremost commonly found in a localmarket and residential areas. As thename indicates, these shops carry stockof a variety of products needed tosatisfy the day-to-day needs of theconsumers residing in nearby localities.Such stores remain open for long hoursat convenient timings and often providecredit facilities to some of their regularcustomers. The biggest advantage ofsuch stores is in terms of convenienceto the customers in buying productsof daily use such as grocery items, softdrinks, toiletry products, stationeryand confectionery. As most of theircustomers are residents of thesame locality, an important factorcontributing to their success is theimage of the owner and the rapport hehas established with them.(ii) Speciality shops: This type of retailstore is, of late, becoming very popular,particularly in urban areas. Instead ofselling a variety of products of different


types, these retail stores specialise inthe sale of a specific line of products.For example, shops selling children’sgarments, men’s wear, ladies shoes,toys and gifts, school uniforms,college books or consumer electronicgoods, etc. These are some of thecommonly found stores of this type inthe market place.

The speciality shops are generallylocated in a central place where a largenumber of customers can be attracted,and they provide a wide choice to thecustomers in the selection of goods.(iii) Street stall holders: These smallvendors are commonly found at streetcrossings or other places where flow oftraffic is heavy. They attract floatingcustomers and deal mainly in goods ofcheap variety like hosiery products,toys, cigarettes, soft drinks, etc. Theyget their supplies from local suppliersas well as wholesalers. The total areacovered by a stall is very limited and,therefore, they handle goods on a verysmall scale. Their main advantage is inproviding convenient service to thecustomers in buying some of the itemsof their needs.(iv) Secondhand goods shop: Theseshops deal in secondhand or usedgoods, like books, clothes,automobiles, furniture and otherhousehold goods. Generally personswith modest means purchase goodsfrom such shops. The goods are soldat lower prices. Such shops may alsostock rare objects of historical valueand antique items which are sold atrather heavy prices to people who havespecial interest in such antique goods.

The shops, selling second handgoods may be located at streetcrossings or in busy streets in the formof a stall having very little structure —a table or a temporary platform todisplay the books or may havereasonably good infrastructure, as inthe case of those selling furniture orused cars or scooters or motorcycles.(v) Single line stores: Single linestores are those shops which deal in asingle product line such as readymadegarments, watches, textiles, shoes,automobiles, tyres, computers, books,and stationery. These shops keep awide variety of items of the same lineand are situated at a central location.Most of these stores are organised asindependent retail outlets in the formof sole traders or partnership firms.

Fixed shop — Large stores

1. Departmental storesA departmental store is a largeestablishment offering a widevariety of products, classified intowell-defined departments, aimedat satisfying practically everycustomer’s need under one roof. Ithas a number of departments, eachone confining its activities to onekind of product. For example, theremay be separate departments fortoiletries, medicines, furniture,groceries, electronics, clothing anddress material. Thus, they satisfydiverse market segments with awide variety of goods and services.It is not uncommon for adepartment store in the UnitedStates of America to carry ‘needle

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to an aeroplane’ or ‘all shoppingunder one roof.’ Everything from‘a pin to an elephant’ is the spiritbehind a typical department store.In India real departmental storeshave not yet come in a big wayin the retailing business. However,some stores on this line inIndia include ‘Akberally’ in Mumbaiand ‘Spencers’ in Chennai.Some of the important featuresof a departmental store areas follows:

(a) A modern departmental store mayprovide all facilities such asrestaurant, travel and informationbureau, telephone booth, rest-rooms, etc. As such they try toprovide maximum service to higherclass of customers for whom priceis of secondary importance.

(b) These stores are generally locatedat a central place in the heart of acity, which caters to a large numberof customers.

(c) As the size of these stores is verylarge, they are generally formed asa joint stock company managed bya board of directors. There is amanaging director assisted by ageneral manager and severaldepartment managers;

(d) A departmental store combinesboth the functions of retailingas well as warehousing.They purchase directly frommanufacturers and operateseparate warehouses. That way theyhelp in eliminating undesirablemiddlemen between the producersand the customers; and

(e) They have centralised purchasingarrangements. All the purchases ina department store are madecentrally by the purchasedepartment of the store, whereassales are decentralised in differentdepartments.

Advantages

The major advantages of retailingthrough departmental stores may belisted as follows:(i) Attract large number ofcustomers: As these stores are usuallylocated at central places they attract alarge number of customers during thebest part of the day.(ii) Convenience in buying: By offeringlarge variety of goods under one roof thedepartmental stores provide greatconvenience to customers in buyingalmost all goods of their requirementsat one place. As a result, they do nothave to run from one place to theanother to complete their shopping.(iii) Attractive services: A depart-mental store aims at providingmaximum services to the customers.Some of the services offered by itinclude home delivery of goods,execution of telephone orders, grant ofcredit facilities and provision for rest-rooms, telephone booths, restaurants,saloons etc.(iv) Economy of large-scaleoperations: As these stores areorganised at a very large-scale, thebenefits of large-scale operations,particularly, in respect of purchase ofgoods are available to them.


(v) Promotion of sales: The depart-mental stores are in a position tospend considerable amount of moneyon advertising and other promotionalactivities, which help in boostingtheir sales.

Limitations

However, there are certain limitationsof this type of retailing. These aredescribed as follows:(i) Lack of personal attention:Because of the large-scale operations,it is very difficult to provide adequatepersonal attention to the customers inthese stores.(ii) High operating cost: As thesestores give more emphasis on providingservices, their operating costs tend tobe on the higher side. These costs, inturn, make the prices of the goods high.They are, therefore, not attractive to thelower income group of people.(iii) High possibility of loss: As aresult of high operating costs and large-scale operations, the chances ofincurring losses in a departmental storeare high. For example, if there is anychange in the tastes of customers orlatest fashions, it necessitates selling ofsuch out-of-fashion articles inclearance sale, to reduce the hugeinventory of goods built up.(iv) Inconvenient location: As adepartmental store is generally situatedat a central location, it is not convenientfor the purchase of goods that areneeded at short notice.

In spite of some of these limitationsthe departmental stores have been

popular in some of the westerncountries of the world because of theirbenefits to a certain class of customers.2. Chain Stores or Multiple Shops:

Chain stores or multiple shops arenetworks of retail shops that areowned and operated by manu-facturers or intermediaries. Underthis type of arrangement, a numberof shops with similar appearance areestablished in localities, spread overdifferent parts of the country. Thesedifferent types of shops normallydeal in standardised and brandedconsumer products, which haverapid sales turnover. These shopsare run by the same organisationand have identical merchandisingstrategies, with identical productsand displays. Some of the importantfeatures of such shops may bedescribed here under:

(a) These shops are located in fairlypopulous localities, wheresufficient number of customerscan be approached. The idea is toserve the customers at a pointwhich is nearest to their residenceor work place, rather thanattracting them to a central place;

(b) The manufacturing/procurementof merchandise for all the retailunits is centralised at the headoffice, from where the goods aredespatched to each of these shopsaccording to their requirements.This results in savings in the costof operation of these stores;

(c) Each retail shop is under the directsupervision of a Branch Manager,who is held responsible for its day-

237INTERNAL TRADE

to-day management. The BranchManager sends daily reports to thehead office in respect of the sales,cash deposits, and the require-ments of the stock;

(d) All the branches are controlled bythe head office, which is concernedwith formulating the policies andgetting them implemented;

(e) The prices of goods in such shopsare fixed and all sales are made oncash basis. The cash realised fromthe sales of merchandise isdeposited daily into a local bankaccount on behalf of the headoffice, and a report is sent to thehead office in this regard.

(f) The head office normally appointsinspectors, who are concerned withday-to-day supervision of theshops, in respect of quality ofcustomer service provided,adherence to the policies of thehead office, and so on.The chain operation is most

effective in handling high-volumemerchandise, whose sales are relativelyconstant throughout the year. In India,Bata Shoe stores are typical examplesof such shops. Similar type of retailoutlets are coming up in other productsalso. For example, the exclusiveshowrooms of D.C.M., Raymonds andthe fast food chains of Nirula’s andMcDonald.

Advantages

Multiple shops are offering variousadvantages to the consumers, whichare described as follows:

(i) Economies of scale: As there iscentral procurement/manufacturing,the multiple-shop organisation enjoysthe economies of scale.(ii) Elimination of middlemen: Byselling directly to the consumers, themultiple-shop organisation is able toeliminate unnecessary middlemen inthe sale of goods and services.(iii) No bad debts: Since all the salesin these shops are made on cash basis,there are no losses on account of baddebts.(iv) Transfer of goods: The goods notin demand in a particular locality maybe transferred to another locality whereit is in demand. This reduces thechances of dead stock in these shops.(v) Diffusion of risk: The lossesincurred by one shop may be coveredby profits in other shops, reducing thetotal risk of an organisation.(vi) Low cost: Because of centraliseda purchasing, elimination of middle-men, centralised promotion of sales andincreased sales, the multiple shopshave lower cost of business.(vii) Flexibility: Under this system, ifa shop is not operating at a profit, themanagement may decide to close it orshift it to some other place withoutreally affecting the profitability of theorganisation as a whole.

Limitations

(i) Limited selection of goods: Themultiple shops deal only in limitedrange of products, mostly thoseproduced by the marketers. Theydo not sell products of other


manufacturers. In that way theconsumers get only a limited choiceof goods.(ii) Lack of initiative: The personnelmanaging the multiple shops have toobey the instructions received from thehead office. This makes them habitualof looking up to the head office forguidance on all matters, and takes awaythe initiative from them to use theircreative skills to satisfy the customers.(iii) Lack of personal touch: Lack ofinitiative in the employees sometimesleads to indifference and lack ofpersonal touch in them.(iv) Difficult to change demand: Ifthe demand for the merchandisehandled by multiple shops changerapidly, the management may haveto sustain huge losses because oflarge stocks lying unsold at thecentral depot.

Difference between Departmentalstores and Multiple shops

Although both these types of retailorganisations are large establishments,there are certain differencesbetween the two. Such differences aregiven here below:(i) Location: A departmental store islocated at a central place, where a largenumber of customers can be attractedto it. However, the multiple stores arelocated at a number of places forapproaching a large number ofcustomers. Thus, central location isnot necessary for a multiple shop.(ii) Range of products: Departmentalstores aim at satisfying all the needs of

customers under one roof. As such,they have to carry a variety of productsof different types. However, the multiplestores aim to satisfy the requirementsof customers relating to a specifiedrange of their products only.(iii) Services offered: The depart-mental stores lay great emphasis onproviding maximum service to theircustomers. Some of the services,provided by them include post office,restaurant and so on. As against this,the multiple shops provide very limitedservice confined to guarantees andrepairs if the sold out goods turn outto be defective.(iv) Pricing: The multiple shop chainssell goods at fixed prices and maintainuniform pricing policies for all theshops. The departmental stores,however, do not have uniform pricingpolicy for all the departments; ratherthey have to occasionally offerdiscounts on certain products andvarieties to clear their stock.(v) Class of customers: The depart-mental stores cater to the needs ofrelatively high income group ofcustomers who care more for theservices provided rather than the pricesof the product. The multiple shops, onthe other hand, cater to differenttypes of customers, including thosebelonging to the lower income groups,who are interested in buying qualitygoods at reasonable prices.(vi) Credit facilities: All sales in themultiple shops are made strictly on cashbasis. In contrast, the departmentalstores may provide credit facilities tosome of their regular customers.

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(vii) Flexibility: As the departmentalstores deal in a wide variety ofproducts, they have certain flexibilityin respect of the line of goods marketed.However, there is not much scope forflexibility in the chain stores, which dealonly in limited line of products.

Mail Order Houses

Mail order houses are the retail outletsthat sell their merchandise throughmail. There is generally no directpersonal contact between the buyersand the sellers in this type of trading.For obtaining orders, potential customersare approached through advertisementsin newspapers or magazines, circulars,catalogues, samples and bills, and pricelists sent to them by post. All the relevantinformation about the products such asthe price, features, delivery terms, termsof payment, etc., are described in theadvertisement. On receiving the orders,the items are carefully scrutinised withrespect to the specifications asked forby the buyers and are complied withthrough the post office.

There can be different alternatives forreceiving payments. First, the customersmay be asked to make full payment inadvance. Second, the goods may be sentby Value Payable Post (VPP). Under thisarrangement, the goods are sent throughpost and are delivered to the customersonly on making full payment for thesame. Third, the goods may be sentthrough a bank, which is instructed todeliver the articles to the customers. Inthis arrangement there is no risk of baddebt, as the goods are handed over tothe buyers only after he makes full

payment. However, there is a need toensure the buyers that the goodsdespatched are in accordance with theirspecifications.

This type of business is not suitablefor all types of products. For example,goods that are perishable in nature orare bulky and cannot be easily handled,are not recommended for mail-housetrading. Only the goods that can be(i) graded and standardised, (ii) easilytransported at low cost, (iii) have readydemand in the market, (iv) are availablein large quantity throughout the year,(v) involve least possible competition inthe market and (vi) can be describedthrough pictures etc., are suitable forthis type of trading. Another importantpoint in this regard is that mail housebusiness cannot be successfully carriedout unless education is wide spread.It is so because only the literatepeople can be reached throughadvertisements and other forms ofwritten communication.

Advantages

(i) Limited capital requirement: Mailorder business does not require heavyexpenditure on building and otherinfrastructural facilities. Therefore, itcan be started with relatively lowamount of capital.(ii) Elimination of middle men: Thebiggest advantage of mail-orderbusiness from the point of view ofconsumers is that unnecessarymiddlemen between the buyers andsellers are eliminated. This may resultin lot of savings both to the buyers aswell as to the sellers.


(iii) Absence of bad debt: Since themail order houses do not extend creditfacilities to the customers, there areno chances of any bad debt on accountof non payment of cash by thecustomers.(iv) Wide reach: Under this system thegoods can be sent to all the placeshaving postal services. This opens widescope for business as a large numberof people throughout the country canbe served through mail.(v) Convenience: Under this systemgoods are delivered at the doorstep ofthe customers. This results in greatconvenience to the customers in buyingthese products.

Limitations

(i) Lack of personal contact: As thereis no personal contact between thebuyers and the sellers under thesystem of mail order selling, thereare greater possibilities of mis-understanding and mistrust betweenthe two. The buyers are not in a positionto examine the products before buyingand the sellers cannot pay personalattention to the likes and dislikes of thebuyers and cannot clear all their doubtsthrough catalogues and advertisements.(ii) High promotion cost: The mailorder business has to rely heavily onadvertisements and other methods ofpromotion in order to inform andpersuade the potential buyers to buytheir products. As a result, there isheavy expenditure on promotion of theproducts.(iii) No after sales service: In mailorder selling, the buyers and sellers

may be located very far away from eachother and there is no personal contactbetween the two. As a result, there isabsence of after sales services which isso important for the satisfaction of thecustomers.(iv) No credit facilities: The mail orderhouses do not provide credit facilitiesto the buyers. Thus, customers withlimited means may not be interested inthis type of trading.(v) Delayed delivery: There is noimmediate delivery of goods to thecustomers, as receipt and execution oforder through mail takes its own time.(vi) Possibility of abuse: This type ofbusiness provides greater possibility ofabuse to dishonest traders to cheat thecustomers by making false claimsabout the products or not honouringthe commitments made through handbills or advertisements.(vii) High dependence on postalservices: The success of mail orderbusiness depends heavily on theavailability of efficient postal services ata place. But in a vast country like ours,where many places are still withoutpostal facilities, this type of businesshas limited prospects.

Consumer Cooperative Store

A consumer cooperative store is anorganisation owned, managed andcontrolled by consumers themselves.The objective of such stores is to reducethe number of middlemen who increasethe cost of produce, and therebyprovide service to the members.The cooperative stores generallybuy in large quantity, directly from

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manufacturers or wholesalers and sellthem to the consumers at reasonableprices. Since the middleman areeliminated or reduced, the members getproducts of good quality at cheaperrates. The profits earned by consumercooperative stores during a year areutilised for declaring bonus tomembers according to purchasesmade by them and for strengtheningthe general reserves and general welfarefunds or similar funds for social andeducational benefits of the members.

To start a consumer cooperativestore, at least 10 people have to cometogether and form a voluntaryassociation and get it registered underthe Cooperative Societies Act. Thecapital of a cooperative store is raisedby issue of shares to members. Themanagement of the store is democraticand entrusted to an elected managingcommittee where one man one vote isthe rule. The liability of the membersof a cooperative store is generallylimited to the extent of the capitalcontributed by them. To ensure fairmanagement of funds the accounts ofthe stores are audited by the Registrarof Cooperative Societies or a personauthorised by him/her.

Advantages

The major advantages of a consumercooperative store are as follows:(i) Ease information: It is easy to forma consumer cooperative society. Any 10people can come together to form avoluntary association and getthemselves registered with the Registrar

of Cooperative Societies by completingcertain formalities.(ii) Limited liability: The liability ofthe members in a cooperative store islimited to the extent of the capitalcontributed by them. Over and abovethat amount, they are not liablepersonally to pay for the debts ofsociety, in case the liabilities aregreater than its assets.(iii) Democratic management:Cooperative societies are democrati-cally managed through managementcommittees which are elected by themembers. Each member has one vote,irrespective of the number of sharesheld by him/her.(iv) Lower prices: A cooperative storepurchases goods directly from themanufacturers or wholesalers andsells them to members and others.Elimination of middlemen results inlower prices for the consumer goods tothe members.(v) Cash sales: The consumercooperative stores normally sell goods oncash basis. As a result, the requirementfor working capital is reduced.(vi) Convenient location: Theconsumer cooperative stores aregenerally opened at convenient publicplaces where the members and otherscan easily buy the products as per theirrequirements.

Limitations

The limitations of consumer cooperativestores are given as below:(i) Lack of initiative: As the cooperativestores are managed by people who work


on honorary basis there is a lack ofsufficient initiative and motivationamongst them to work more effectively.(ii) Shortage of funds: The primarysource of funds for a cooperative storeis the money raised from members byissue of shares. The stores generally faceshortage of funds as membership islimited. This comes in the way of growthand expansion of the cooperative stores.(iii) Lack of patronage: The membersof the cooperative stores generally don’tpatronise them regularly. As a resultof this, the stores are not able to operatesuccessfully.(iv) Lack of business training: Thepeople entrusted with the managementof cooperative stores lack expertise asthey are not trained in running thestores efficiently.

Super Markets

A super market is a large retailingbusiness unit selling wide variety ofconsumer goods on the basis of lowmargin appeal, wide variety andassortment, self-service and heavyemphasis on merchandising appeal. Thegoods traded are generally food productsand other low priced, branded and widelyused consumer products such asgrocery, utensils, clothes, electronicappliances, household goods, andmedicines. Super markets are generallysituated at the main shopping centres.Goods are kept on racks with clearlylabelled price and quality tags in suchstores. The customers move into the storeto pick up goods of their requirements,bring them to the cash counter, makepayment and take home the delivery.

Super markets are organised ondepartmental basis where customerscan buy various types of goods underone roof. However, as compared todepartmental stores, these marketsdon’t offer certain services such as freehome delivery, credit facilities, etc., andalso don’t appoint sales persons toconvince customers about the qualityof products. Some of the importantcharacteristics of a super market areas follows:

(i) A super market generally carriesa complete line of food items andgroceries, in addition to non-foodconvenience goods;

(ii) The buyers can purchase differentproducts as per their requirementsunder one roof in such markets;

(iii) A super market operates on theprinciple of self-service. Thedistribution cost is, therefore,lower;

(iv) The prices of the products aregenerally lower than other typesof retail stores because of bulkpurchasing, lower operationalcost, and low profit margins;

(v) The goods are sold on cash basisonly; and

(vi) The super markets are generallylocated at central locations tosecure high turnover.

Advantages

The following are the merits of supermarkets:(i) One roof, low cost: Super marketsoffer a wide variety of products at lowcost, under one roof. These outlets are,therefore, not only convenient but also

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economical to the buyers for makingtheir purchases.(ii) Central location: The supermarkets are generally located in theheart of the city. As a result, these areeasily accessible to large number ofpeople staying in the surroundinglocalities.(iii) Wide selection: Super marketskeep a wide variety of goods of differentdesigns, colour, etc., which enables thebuyers to make better selection.(iv) No bad debts: As generally thesales are made on cash basis, there areno bad debts in super markets.(v) Benefits of being large scale: Asuper market is a large scale retailingstore. It enjoys all the benefits of largescale buying and selling because ofwhich its operating costs are lower.

Limitations

The major limitations of super marketsare as follows:(i) No credit: Super markets sell theirproducts on cash basis only. No creditfacilities are made available to thebuyers. This restricts the purchasingpower of buyers from such markets.(ii) No personal attention: Supermarkets work on the principle of self-service. The customers, therefore, don’tget any personal attention. As a result,such commodities that requirepersonal attention by sales peoplecannot be handled effectively in supermarkets.(iii) Mishandling of goods: Somecustomers handle the goods kept in theshelf carelessly. This may raise costsin super markets.

(iv) High overhead expenses: Supermarket incur high overhead expenses.As a result these have not been able tocreate low price appeal among thecustomers.(v) Huge capital requirement:Establishing and running a supermarket requires huge investment. Theturnover of a store should be high sothat the overheads are kept underreasonable level. This can be possiblein bigger towns but not in small towns.

Vending Machines

Vending machines are the newestrevolution in marketing methods.Coin operated vending machines areproving useful in selling severalproducts such as hot beverages,platform tickets, milk, soft drinks,chocolates, newspaper, etc., in manycountries. Apart from some of theproducts mentioned here, the latestarea in which this concept is gettingpopular in many parts of our country(particularly in the urban areas) isthe case of Automated Teller Machines(ATM) in the banking service. As thename suggests, these machines havealtogether changed the concept ofbanking and made it possible towithdraw money at any time withoutvisiting any branch of a bank.

Vending machines can be useful forselling pre-packed brands of low pricedproducts which have high turnoverand which are uniform in size andweight. However, the initial cost ofinstalling a vending machine and theexpenditure on regular maintenance


and repair is quite high. Alsoconsumers cannot feel or see theproduct before buying and don’t havethe opportunity of returning unwantedgoods. Apart from that, special packshave to be developed for the machines.The machines have to be made reliablein their operations. In spite of theselimitations, with the growth in theeconomy, vending machines havea promising future in retail sales ofhigh turnover and low pricedconsumer products.

10.6 ROLE OF INDIAN CHAMBERS OF

COMMERCE AND INDUSTRY IN

PROMOTION OF INTERNAL TRADE

The Chambers of Commerce andIndustry was formed as an associationof business and industrial houses topromote and protect their commoninterest and goals. Many suchchambers where formed and arepresent in the country. For example,ASSOCHAM, Confederation of IndianIndustry (CII) and Federation of IndianChambers of Commerce and Industry(FICCI). These associations orchambers regard themselves as thenational guardians of trade, commerceand industry.

The Indian Chambers of Commerceand Industry has been playinga catalytic role in strengtheninginternal trade to make it an importantpart of overall economic activity.The Chambers interact with thegovernment at different levels toreorient or put in place policies whichreduce hindrances, increase interstate

movement of goods, introducetransparency and remove multiplelayers of inspection and bureaucratichurdles. Besides, the chambers alsoaims at erecting sound infrastructureand simplifying and harmonising thetax structures. The interventions aremainly in the following areas:(i) Transportation or inter statemovement of goods: The Chambersof Commerce and Industry help inmany activities concerning inter statemovement of goods which includesregistration of vehicles, surfacetransport policies, construction ofhighways and roads. For example, theconstruction of golden quadrilateralcorridor announced by the PrimeMinister of India in one of the AnnualGeneral Meetings of the Federation ofIndian Chambers of Commerce andIndustry (FICCI) will facilitateinternal trade.(ii) Octroi and other local levies:Octroi and local taxes are the importantsources of revenue of the localgovernment. These are collected on thegoods and from people entering thestate or the municipal limits. Thegovernment and Chambers ofCommerce should ensure that theirimposition is not at the cost of smoothtransportation and local trade.(iii) Harmonisation of sales taxstructure and Value Added Tax:The Chambers of Commerce andIndustry play an important role ininteracting with the government toharmonise the sales tax structure indifferent states. The sales tax is animportant part of the state revenue. A

245INTERNAL TRADE

rational structure of the sales tax andits uniform rates across states, areimportant for promoting a balance intrade. As per the new policy of thegovernment, the Value Added Tax isbeing levied in place of the sales taxto remove the cascading effect of thesales tax.(iv) Marketing of agro products andrelated issues: The associations ofagriculturists and other federationsplay an important role in themarketing of agro products.Streamlining of local subsidies andmarketing policies of organisationsselling agro products are some of theareas where the Chambers ofCommerce and Industry can reallyintervene and interact with concernedagencies like farming cooperatives.(v) Weights and Measures andprevention of duplication brands:Laws relating to Weights andMeasures and protection of brands arenecessary to protect the interest of theconsumers as well as the traders. Theyneed to be enforced strictly. TheChambers of Commerce and Industry

interact with the government toformulate such laws and take actionagainst those who violate rulesand regulations.(vi) Excise duty: Central excise is thechief source of the Governmentrevenue levied across states by thecentral government. The excise policyplays an important role in pricingmechanism and hence the associationsneed to interact with the governmentto ensure streamlining of excise duties.(vii) Promoting sound infrastructure:A sound infrastructure like road, port,electricity, railways etc., play a catalyticrole in promoting trade. The Chambersof Commerce and Industry incollaboration with the governmentneeds to take up heavy investmentprojects.(viii) Labour legislation: A simpleand flexible labour legislation ishelpful in running industries,maximising production and generatingemployment. The Chambers ofCommerce and Industry the governmentare constantly interacting on issues likelabour laws, retrenchment etc.

Key Terms

Internal trade Wholesales Market traders

Wholesale trade Retailers Cheap jacks

Retail trade Internal retailers Speciality stores

Single line stores Chain stores Vending machines

Departmental stores Super markets Chambers of Commerce


SUMMARY

Trade refers to buying and selling of goods and services with the objective ofearning profit on the basis of geographical location of buyers and sellers. Itcan be classified into two categories (i) internal trade; and (ii) external trade.

Internal trade: Buying and selling of goods and services within theboundaries of a nation are referred to as internal trade. No custom duties orimport duties are levied on such trade as goods are part of domestic productionand are meant for domestic consumption. Internal trade can be categorisedinto two broad categories (i) wholesale trade; and (ii) retailing trade.

Wholesale trade: Purchase and sale of goods and services in large quantitiesfor the purposes of resale or intermediate use is referred to as wholesaletrade. Wholesalers perform a number of functions in the process ofdistribution of goods and services and provide valuable services tomanufacturers and retailers.

Services of wholesalers: Wholesalers are an important link betweenmanufacturers and retailers. They add value by creating time and place utility.

Services of manufacturers: The services provided by wholesalers tomanufacturers include (i) facilitating large scale production; (ii) bearingrisk; (iii) providing financial assistance; (iv) expert advice; (v) help inmarketing function; (vi) facilitating continuity; and (vii) storage.

Services to retailers: The services provided by wholesalers to retailersinclude (i) availability of goods (ii) marketing support (iii) grant of credit (iv)specialised knowledge (v) risk sharing

Retail trade: A retailer is a business enterprise that is engaged in the saleof goods and services directly to the ultimate consumers.

Services of retailers: Retailers are an important link between the producersand final consumers. They provide useful service to consumers wholesalersand manufacturers in the distribution of products and services.

Services to manufacturers/wholesalers: Different services provided byretailers to wholesalers and manufacturers include (i) helping distributionof goods; (ii) personal selling; (iii) enabling large scale operations; (iv) collectingmarket information; and (v) help in promotion of goods and services.

Services to consumers: The different services provided by retailers toconsumers include (i) regular availability of products (ii) new productinformation (iii) convenience of buying (iv) trade selection (v) after salesservices and (vi) providing credit facilities.

Types of retail trade: Retail trade can be classified into different typesaccording to their size, type of ownership, on the basis of merchandise

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handled and whether they have fixed place of business or not. Retailerscan be categorised as (i) itinerant retailers; and (ii) fixed shop retailers.

Itinerant retailers: Itinerant retailers are traders who don’t have a fixedplace of business to operate from. They are small traders operating withlimited resources who keep on moving with their wares from street to streetor place to place in search of customers. The major types of such retailersare:

(i) Peddlers and hawkers: They are small producers or petty traders whocarry the products on a bicycle or handcart or on their heads and movefrom place to place, to sell their goods at the doorstep of the customers.

(ii) Market traders: Market traders are small retailers who open their shopsat different places on fixed days/dates, catering mainly to lower income groupof customers and dealing in low priced consumer items of daily use.

(iii) Street trades: Street traders are the small retailers who are commonlyfound at places where huge floating population gathers.

(iv) Cheap jacks: Cheap jacks are those petty retailers who have independentshops of a temporary nature in a business location. They deal in consumeritems and provide services to consumers in terms of making the productsavailable where needed.

Fixed shop retailers: On the basis of size of operations, (fixed shop retailerscan be classified as a) small shopkeepers and (b) large retailers.

Fixed shop small retailers

(i) General stores: General stores carry stock of a variety of products such asgrocery items, soft drinks, toiletry products, confectionery, and stationery,needed to satisfy day-to-day needs of consumers, residing in nearby localities.

(ii) Speciality shops: Speciality shops specialise in the sale of specific lineof products such as children’s garments, men’s wear, ladies shoes, schooluniform, college books or consumer electronic goods, etc.,

(iii) Street stall holders: These small vendors are commonly found atstreet crossing or other places where flow of traffic is heavy and dealmainly in goods of cheap variety like hosiery products, toys, cigarettes,soft drinks, etc.

(iv) Second hand goods shop: These shops deals in second hand or usedgoods of different kinds like furniture, books, clothes and other householdarticles which are sold at lower prices.

(v) Single line stores: Single line stores deal in a single product line such asready made garments, watches, shoes etc., and keep variety of items of thesame line and are situated at central location.


Fixed shop large stores: In fixed shop large stores, the volume and varietyof goods stocked is large.

Departmental stores: A departmental store is a large establishment offeringa wide variety of products, classified into well-designed departments, aimedat satisfying practically every customer’s need under one roof.

Advantages: (a) attracts large number of customers (b) convenience inbuying (c) attractive services (d) economy of large scale operation(e) promotion of sales.

Limitations: (a) lacks personal attention (b) high operating cost (c) highpossibility of loss (d) inconvenient location.

Chain stores or multiple shops: These shops are networks of retail shopsthat are owned and operated by manufacturers or intermediaries dealingin standardised and branded consumer products having rapid salesturnover.

Advantages: (a) economies of scale (b) elimination of middlemen (c) no baddebts (d) transfer of goods (e) diffusion of risk (e) low cost (f) flexibility.

Limitations: (a) limited selection of goods (b) lack of initiative (c) lack ofpersonal touch (d) difficult to change demand.

Difference between Departmental Stores and Multiple Shops: (a) location(b) range of products (c) services offered (d) pricing (e) class of customers(f) credit facilities (g) flexibility.

Mail order houses: Mail order houses are retail outlets that sell theirmerchandise through mail, without any direct personal contact with thebuyers.

Advantages: (a) limited capital requirements (b) elimination of middlemen,(c) absence of bad debts (d) wide reach (e) convenience.

Limitations: (a) lack of personal contact, (b) high promotion cost (c) no aftersales services (d) no credit facilities (e) delayed delivery (f) possibility ofabuse (g) high dependence on postal services.

Consumer cooperative stores: A consumer cooperative store is anorganisation owned managed and controlled by consumers themselvesformed with the objective of reducing the number of middlemen and therebyproviding services to members.

Advantages: (i) ease in formation (ii) limited liability (iii) democraticmanagement (iv) lower prices (v) cash sales (vi) convenient location.

Limitations: (i) lack of initiative (ii)shortage of funds (iii) lack of patronage(iv) lack of business training.

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Super markets: A super market is a large retailing business unit sellingwide variety of consumer goods on the basis of low margin appeal, widevariety and assortment and heavy emphasis on merchandising appeal.

Advantages: (i) one roof, low cost (ii) central location (iii) wide selection (iv)no bad debts (v) benefits of large scale.

Limitations: (a) no credit (b) no personal attention (c) mishandling of goods(d) high over head expenses (e) huge capital requirements.

Vending Machines: Vending machines are proving useful in sellingpre-packed brands of low priced products which have high turnover andwhich are uniform in size and weight.

EXERCISES


1. What is meant by internal trade?

2. Specify the characteristics of fixed shop retailers.

3. What purpose is served by wholesalers providing warehousing facilities?

4. How does market information provided by the wholesalers benefit themanufacturers?

5. How does the wholesaler help the manufacturer in availing the economiesof scale?

6. Distinguish between single line stores and speciality stores. Can youidentify such stores in your locality?

7. How would you differentiate between street traders and street shops?

8. Explain the services offered by wholesalers to manufacturers.

9. What are the services offered by retailers to wholesalers and consumers?


1. Itinerant traders have been an integral part of internal trade in India.Analyse the reasons for their survival in spite of competition from largescale retailers.

2. Discuss the features of a departmental store. How are they different frommultiple shops or chain stores.

3. Why are consumer cooperative stores considered to be less expensive?What are its relative advantages over other large scale retailers?


4. Imagine life without your local market. What difficulties would a consumerface if there is no retail shop?

5. Explain the usefulness of mail orders houses. What type of products aregenerally handled by them? Specify.


1. Identify various fixed shop retailers in your locality and classify themaccording to the different types you have studied.

2. Do you know any retailers selling second-hand goods in your area? Findout the category of the product that they deal in ? Which products aresuitable for resale? List some of your findings. What conclusions do youdraw?

3. Do you observe any difference in the retail business of yesterday and thetimes to come. Prepare a brief write-up and discuss it in class.

4. From you own experience, compare the features of two retail stores sellingthe same product. For example, the same products being sold at a smallscale retailer like a general store and in a big store like a departmentalstore. What similarities and differences can you identify in terms of price,service, variety, convenience, etc.

CHAPTER 11

INTERNATIONAL BUSINESS - I

LEARNING OBJECTIVES


• explain the meaning of international business;

• state as to why international business takes place and how doesit differ from domestic business;

• describe the scope of international business and its benefits tothe nation and business firms;

• identify and evaluate various modes of entry into internationalbusiness; and

• analyse trends in India’s involvement in international business.


11.1 INTRODUCTION

Countries all over the world areundergoing a fundamental shift in theway they produce and market variousproducts and services. The nationaleconomies which so far were pursuingthe goal of self-reliance are nowbecoming increasingly dependent uponothers for procuring as well assupplying various kinds of goods andservices. Due to increased cross bordertrade and investments, countries areno more isolated.

The prime reason behind thisradical change is the developmentof communication, technology,infrastructure etc. Emergence of newermodes of communication anddevelopment of faster and more efficientmeans of transportation have broughtnations closer to one another.Countries that were cut-off from oneanother due to geographical distancesand socio-economic differences havenow started increasingly interactingwith others. World Trade Organisation(WTO) and reforms carried out by the

Mr. Sudhir Manchanda is a small manufacturer of automobile components. Hisfactory is located in Gurgaon and employs about 55 workers with an investmentof Rs. 9.2 million in plant and machinery. Due to recession in the domesticmarket, he foresees prospects of his sales going up in the next few years in thedomestic market. He is exploring the possibility of going international. Some ofhis competitors are already in export business. A casual talk with one of hisclose friends in the tyre business reveals that there is a substantial market forautomobile components and accessories in South-East Asia and Middle East.But his friend also tells him, “Doing business internationally is not the same ascarrying out business within the home country. International business is morecomplex as one has to operate under market conditions that are different fromthose that one faces in domestic business”. Mr. Manchanda is, moreover, notsure as to how he should go about setting up international business. Should hehimself identify and contact some overseas customers and start exporting directlyto them or else route his products through export houses which specialise inexporting products made by others?

Mr. Manchanda’s son who has just returned after an MBA in USA suggests thatthey should set up a fully owned factory in Bangkok for supplying to customersin South-East Asia and Middle East. Setting up a manufacturing plant therewill help them save costs of transporting goods from India. This would also helpthem coming closer to the overseas customers. Mr. Manchanda is in a fix as towhat to do. In the face of difficulties involved in overseas ventures as pointed outby his friend, he is wondering about the desirability of entering into globalbusiness. He is also not sure as to what the different ways of entering intointernational market are and which one will best suit his purpose.

253INTERNATIONAL BUSINESS - I

governments of different countrieshave also been a major contributoryfactor to the increased interactions andbusiness relations amongst thenations.

We are today living in a worldwhere the obstacles to cross-bordermovement of goods and persons havesubstantially come down. The nationaleconomies are increasingly becomingborderless and getting integrated intothe world economy. Little wonder thatthe world has today come to be knownas a ‘global village’. Business in thepresent day is no longer restricted tothe boundaries of the domesticcountry. More and more firms aremaking forays into internationalbusiness which presents them withnumerous opportunities for growthand increased profits.

India has been trading with othercountries for a long time. But it has oflate considerably speeded up itsprocess of integrating with the worldeconomy and increasing its foreigntrade and investments (see Box A:India Embarks on the Path toGlobalisation).

11.1.1 Meaning of InternationalBusiness

Business transaction taking placewithin the geographical boundaries ofa nation is known as domestic ornational business. It is also referred toas internal business or home trade.Manufacturing and trade beyond theboundaries of one’s own country isknown as international business.International or external business can,therefore, be defined as those businessactivities that take place across the

Box AIndia Embarks on the Path to Globalisation

International business has entered into a new era of reforms. India too did notremain cut-off from these developments. India was under a severe debt trap andwas facing crippling balance of payment crisis. In 1991, it approached theInternational Monetary Fund (IMF) for raising funds to tide over its balance ofpayment deficits. IMF agreed to lend money to India subject to the condition thatIndia would undergo structural changes to be able to ensure repayment ofborrowed funds.India had no alternative but to agree to the proposal. It was the very conditionsimposed by IMF which more or less forced India to liberalise its economic policies.Since then a fairly large amount of liberalisation at the economic front hastaken place.Though the process of reforms has somewhat slowed down, India is very muchon the path to globalisation and integrating with the world economy. While, onthe one hand, many multinational corporations (MNCs) have ventured into Indianmarket for selling their products and services; many Indian companies too havestepped out of the country to market their products and services to consumersin foreign countries.


national frontiers. It involves not onlythe international movements of goodsand services, but also of capital,personnel, technology and intellectualproperty like patents, trademarks,know-how and copyrights.

It may be mentioned here thatmostly people think of internationalbusiness as international trade. Butthis is not true. No doubt internationaltrade, comprising exports and importsof goods, has historically been animportant component of internationalbusiness. But of late, the scopeof international business hassubstantially expanded. Internationaltrade in services such as internationaltravel and tourism, transportation,communication, banking, ware-housing, distribution and advertisinghas considerably grown. The otherequally important developments areincreased foreign investments andoverseas production of goods andservices. Companies have startedincreasingly making investments intoforeign countries and undertakingproduction of goods and services in

foreign countries to come closer toforeign customers and serve themmore effectively at lower costs. All theseactivities form part of internationalbusiness. To conclude, we can say thatinternational business is a muchbroader term and is comprised of boththe trade and production of goods andservices across frontiers.

11.1.2 Reason for InternationalBusiness

The fundamental reason behindinternational business is that thecountries cannot produce equally wellor cheaply all that they need. This isbecause of the unequal distribution ofnatural resources among them ordifferences in their productivity levels.Availability of various factors ofproduction such as labour, capital andraw materials that are required forproducing different goods and servicesdiffer among nations. Moreover, labourproductivity and production costsdiffer among nations due to varioussocio-economic, geographical andpolitical reasons.

International business involves commercial activities that cross national frontiers.Roger Bennett

International business consists of transactions that are devised and carriedout across national borders to satisfy the objectives of the individuals, companiesand organisations. These transactions take on various forms which are ofteninterrelated.

Michael R. Czinkota

International business is all business transactions — private andgovernmental — that involve two or more countries. Private companies undertakesuch transactions for profits; governments may or may not do the same in theirtransactions.

John D. Daniels and Lee H. Radebaugh


Due to these differences, it is notuncommon to find one particularcountry being in a better position toproduce better quality products and/or at lower costs than what othernations can do. In other words, we cansay that some countries are in anadvantageous position in producingselect goods and services which othercountries cannot produce thateffectively and efficiently, and vice-versa. As a result, each country finds itadvantageous to produce those selectgoods and services that it can producemore effectively and efficiently at home,and procuring the rest through tradewith other countries which the othercountries can produce at lower costs.This is precisely the reason as to whycountries trade with others and engagein what is known as internationalbusiness.

The international business as itexists today is to a great extent theresult of geographical specialisation aspointed out above. Fundamentally, itis for the same reason that domestictrade between two states or regionswithin a country takes place. Moststates or regions within a country tendto specialise in the production of goodsand services for which they are bestsuited. In India, for example, whileWest Bengal specialises in juteproducts; Mumbai and neighbouringareas in Maharashtra are more involvedwith the production of cotton textiles.The same principle of territorial divisionof labour is applicable at theinternational level too. Most developingcountries which are labour abundant,

for instance, specialise in producing andexporting garments. Since they lackcapital and technology, they importtextile machinery from the developednations which the latter are in a positionto produce more efficiently.

What is true for the nation is moreor less true for firms. Firms too engagein international business to import whatis available at lower prices in othercountries, and export goods to othercountries where they can fetch betterprices for their products. Besides priceconsiderations, there are several otherbenefits which nations and firms derivefrom international business. In a way,these other benefits too provide animpetus to nations and firms to engagein international business. We shall turnour attention to some of these benefitsaccruing to nations and firms fromengaging in international business in alater section.

11.1.3 International Business vs.Domestic Business

Conducting and managing internationalbusiness operations is more complexthan undertaking domestic business.Because of variations in political, social,cultural and economic environmentsacross countries, business firms find itdifficult to extend their domesticbusiness strategy to foreign markets. Tobe successful in the overseas markets,they need to adapt their product,pricing, promotion and distributionstrategies and overall business plans tosuit the specific requirements of thetarget foreign markets (see Box B onFirms need to be Cognisant of


Environmental Differences). Key aspectsin respect of which domestic andinternational businesses differ from eachother are discussed below.(i) Nationality of buyers and sellers:Nationality of the key participants (i.e.,buyers and sellers) to the business dealsdiffers between domestic andinternational businesses. In the case ofdomestic business, both the buyers andsellers are from the same country. Thismakes it easier for both the parties tounderstand each other and enter intobusiness deals. But this is not the casewith international business wherebuyers and sellers come from differentcountries. Because of differences in theirlanguages, attitudes, social customsand business goals and practices, itbecomes relatively more difficult for

them to interact with one another andfinalise business transactions.(ii) Nationality of other stakeholders:Domestic and international businessesalso differ in respect of the nationalitiesof the other stakeholders such asemployees, suppliers, shareholders/partners and general public whointeract with business firms. While inthe case of domestic business all suchfactors belong to one country, andtherefore relatively speaking depictmore consistency in their value systemsand behaviours; decision making ininternational business becomes muchmore complex as the concernedbusiness firms have to take intoaccount a wider set of values andaspirations of the stakeholdersbelonging to different nations.

Box BFirms need to be Cognisant of Environmental Differences

It is to be kept in mind that conducting and managing international business isnot an easy venture. It is more difficult to manage international business operationsdue to variations in the political, social, cultural and economic environmentsthat differ from country to country.

Simply being aware of these differences is not sufficient. One also needs to besensitive and responsive to these changes by way of introducing adaptations intheir marketing programmes and business strategies. It is, for instance, a wellknown fact that because of poor lower per capita income, consumers in most ofthe developing African and Asian countries are price sensitive and prefer to buyless expensive products. But consumers in the developed countries like Japan,United States, Canada, France, Germany and Switzerland have a markedpreference for high quality and high priced products due to their better ability topay. Business prudence, therefore, demands that the firms interested in marketingto these countries are aware of such differences among the countries, and designtheir strategies accordingly. It will be in the fitness of things if the firms interestedin exporting to these countries produce less expensive products for the consumersin the African and Asian regions, and design and develop high quality productsfor consumers in Japan and most of the European and North American countries.


(iii) Mobility of factors ofproduction: The degree of mobility offactors like labour and capital isgenerally less between countries thanwithin a country. While these factors ofmovement can move freely within thecountry, there exist various restrictionsto their movement across nations.Apart from legal restrictions, even thevariations in socio-culturalenvironments, geographic influencesand economic conditions come in a bigway in their movement acrosscountries. This is especially true of thelabour which finds it difficult to adjustto the climatic, economic and socio-cultural conditions that differ fromcountry to country.(iv) Customer heterogeneity acrossmarkets: Since buyers in internationalmarkets hail from different countries,they differ in their socio-culturalbackground. Differences in their tastes,fashions, languages, beliefs andcustoms, attitudes and productpreferences cause variations in not onlytheir demand for different products andservices, but also in variations in theircommunication patterns and purchasebehaviours. It is precisely because ofthe socio-cultural differences that whilepeople in China prefer bicycles, theJapanese in contrast like to ride bikes.Similarly, while people in India useright-hand driven cars, Americans drivecars fitted with steering, brakes, etc.,on the left side. Moreover, while peoplein the United States change their TV,bike and other consumer durables veryfrequently — within two to three yearsof their purchase, Indians mostly do not

go in for such replacements until theproducts currently with them havetotally worn out.

Such variations greatly complicatethe task of designing products andevolving strategies appropriate forcustomers in different countries.Though to some extent customerswithin a country too differ in their tastesand preferences. These differencesbecome more striking when wecompare customers across nations.(v) Differences in business systemsand practices: The differences inbusiness systems and practices areconsiderably much more amongcountries than within a country.Countries differ from one another interms of their socio-economicdevelopment, availability, cost andefficiency of economic infrastructureand market support services, andbusiness customs and practices due totheir socio-economic milieu andhistorical coincidences. All suchdifferences make it necessary for firmsinterested in entering into internationalmarkets to adapt their production,finance, human resource andmarketing plans as per the conditionsprevailing in the international markets.(vi) Political system and risks:Political factors such as the type ofgovernment, political party system,political ideology, political risks, etc.,have a profound impact on businessoperations. Since a business person isfamiliar with the political environmentof his/her country, he/she can wellunderstand it and predict its impact onbusiness operations. But this is not the


case with international business.Political environment differs from onecountry to another. One needs to makespecial efforts to understand the differingpolitical environments and theirbusiness implications. Since politicalenvironment keeps on changing, oneneeds to monitor political changes onan ongoing basis in the concernedcountries and devise strategies to dealwith diverse political risks.

A major problem with a foreigncountry’s political environment is atendency among nations to favourproducts and services originating intheir own countries to those comingfrom other countries. While this is nota problem for business firms operatingdomestically, it quite often becomes asevere problem for the firms interestedin exporting their goods and services toother nations or setting up their plantsin the overseas markets.(vii) Business regulations andpolicies: Coupled with its socio-economic environment and politicalphilosophy, each country evolves itsown set of business laws andregulations. Though these laws,regulations and economic policies aremore or less uniformly applicable withina country, they differ widely amongnations. Tariff and taxation policies,import quota system, subsidies andother controls adopted by a nation arenot the same as in other countries andoften discriminate against foreignproducts, services and capital.(viii) Currency used in businesstransactions: Another importantdifference between domestic and

international business is that the latterinvolves the use of different currencies.Since the exchange rate, i.e., the price ofone currency expressed in relation tothat of another country’s currency,keeps on fluctuating, it adds to theproblems of international business firmsin fixing prices of their products andhedging against foreign exchange risks.

11.1.4 Scope of InternationalBusiness

As pointed out earlier, internationalbusiness is much broader thaninternational trade. It includes not onlyinternational trade (i.e., export andimport of goods and services), but alsoa wide variety of other ways in whichthe firms operate internationally. Majorforms of business operations thatconstitute international business are asfollows.(i) Merchandise exports and imports:Merchandise means goods that aretangible, i.e., those that can be seen andtouched. When viewed from thisperceptive, it is clear that whilemerchandise exports means sendingtangible goods abroad, merchandiseimports means bringing tangible goodsfrom a foreign country to one’s owncountry. Merchandise exports andimports, also known as trade in goods,include only tangible goods andexclude trade in services.(ii) Service exports and imports:Service exports and imports involvetrade in intangibles. It is because of theintangible aspect of services that tradein services is also known as invisibletrade. A wide variety of services are


Basis

1. Nationality ofbuyers andsellers

2. Nationality ofotherstakeholders

3. Mobility offactors ofproduction

4. Customerheterogeneityacross markets

5. Differencesin businesssystems andpractices

6. Politicalsystem andrisks

7. Businessregulationsand policies

8. Currencyused inbusinesstransactions

Domestic business

People or organisations

from one nation parti-cipate in domesticbusiness transactions.

Various other stake-holders such as suppliers,employees, middlemen,shareholders and partnersare usually citizens of thesame country.

The degree of mobility offactors of production likelabour and capital isrelatively more within acountry.

Domestic markets arerelatively more homo-geneous in nature.

Business systems andpractices are relativelymore homogeneous withina country.

Domestic business issubject to political systemand risks of one singlecountry.

Domestic business issubject to rules, laws andpolicies, taxation system,etc., of a single country.

Currency of domesticcountry is used.

International business

People or organisations ofdifferent countries participatein international businesstransactions.

Various other stakeholderssuch as suppliers, employees,middlemen, shareholders andpartners are from differentnations.

The degree of mobility of factorsof production like labour andcapital across nations isrelatively less.

International markets lackhomogeneity due to differencesin language, preferences,customs, etc., across markets.

Business systems andpractices vary considerablyacross countries.

Different countries have differentforms of political systems anddifferent degrees of risks whichoften become a barrier tointernational business.

International business trans-actions are subject to rules, lawsand policies, tariffs and quotas,etc. of multiple countries.

International business trans-actions involve use ofcurrencies of more than onecountry.

Table 11.1 Major Difference between Domesticand International Business


traded internationally and theseinclude: tourism and travel, boardingand lodging (hotel and restaurants),entertainment and recreation,transportation, professional services(such as training, recruitment,consultancy and research),communication (postal, telephone, fax,courier and other audio-visualservices), construction and engineering,marketing (e.g., wholesaling, retailing,advertising, marketing researchand warehousing), educational andfinancial services (such as bankingand insurance). Of these, tourism,transportation and business servicesare major constituents of world tradein services (see Box C).(iii) Licensing and franchising:Permitting another party in a foreigncountry to produce and sell goodsunder your trademarks, patents or

copy rights in lieu of some fee isanother way of entering intointernational business. It is under thelicensing system that Pepsi and CocaCola are produced and sold all over theworld by local bottlers in foreigncountries. Franchising is similar tolicensing, but it is a term used inconnection with the provision ofservices. McDonalds, for instance,operates fast food restaurants the worldover through its franchising system.(iv) Foreign investments: Foreigninvestment is another important formof international business. Foreigninvestment involves investments offunds abroad in exchange for financialreturn. Foreign investment can be oftwo types: direct and portfolioinvestments.

Direct investment takes place whena company directly invests in properties

Box CTourism, Transportation and Business Services dominate

International Trade in Services

Tourism and transportation have emerged as major components ofinternational trade in services. Most of the airlines, shipping companies, travelagencies and hotels get their major share of revenues from their overseascustomers and operations abroad. Several countries have come to heavily dependon services as an important source of foreign exchange earnings andemployment. India, for example, earns a sizeable amount of foreign exchangefrom exports of services related to travel and tourism.Business services: When one country provides services to other country and inthe process earns foreign exchange, this is also treated as a form of internationalbusiness activity. Fee received for services like banking, insurance, rentals,engineering and management services form part of country’s foreign exchangeearnings. Undertaking of construction projects in foreign countries is also anexample of export of business services. The other examples of such servicesinclude overseas management contracts where arrangements are made by onecompany of a country which provides personnel to perform general or specialisedmanagement functions for another company in a foreign country in lieu of theother country.


such as plant and machinery in foreigncountries with a view to undertakingproduction and marketing of goodsand services in those countries. Directinvestment provides the investor acontrolling interest in a foreigncompany. This is otherwise known asForeign Direct Investment, i.e., FDI.When investments in production andmarketing facilities are made jointlywith one or more foreign parties, suchan operation is known as a jointventure. A company, if it so desires, canalso set up a wholly owned subsidiaryabroad by making 100 per centinvestment in foreign ventures, andthus acquiring full control oversubsidiary’s operations in the foreignmarket.

A portfolio investment, on the otherhand, is an investment that a companymakes into another company by theway of acquiring shares or providingloans to the latter, and earns incomeby way of dividends or interest onloans. Unlike foreign direct investments,the investor under portfolio investmentdoes not get directly involved intoproduction and marketing operations.It simply earns an income by investingin shares, bonds, bills, or notes in aforeign country or providing loans toforeign business firms.

11.1.5 Benefits of InternationalBusiness

Notwithstanding greater complexitiesand risks, international business isimportant to both nations and businessfirms. It offers them several benefits.

Growing realisation of these benefitsover time has in fact been a contributoryfactor to the expansion of trade andinvestment amongst nations, resultingin the phenomenon of globalisation.Some of the benefits of internationalbusiness to the nations and businessfirms are discussed below.

Benefits to Nations

(i) Earning of foreign exchange:International business helps a countryto earn foreign exchange which it canlater use for meeting its imports ofcapital goods, technology, petroleumproducts and fertilisers, pharma-ceutical products and a host of otherconsumer products which otherwisemight not be available domestically.(ii) More efficient use of resources:As stated earlier, international businessoperates on a simple principle —produce what your country canproduce more efficiently, and trade thesurplus production so generated withother countries to procure what they canproduce more efficiently. Whencountries trade on this principle, theyend up producing much more thanwhat they can when each of themattempts to produce all the goods andservices on its own. If such an enhancedpool of goods and services is distributedequitably amongst nations, it benefitsall the trading nations.(iii) Improving growth prospects andemployment potentials: Producingsolely for the purposes of domesticconsumption severely restricts acountry’s prospects for growth and


employment. Many countries, espe-cially the developing ones, could notexecute their plans to produce on alarger scale, and thus createemployment for people because theirdomestic market was not large enoughto absorb all that extra production.Later on a few countries such asSingapore, South Korea and Chinawhich saw markets for their productsin the foreign countries embarked uponthe strategy ‘export and flourish’, andsoon became the star performers on theworld map. This helped them not onlyin improving their growth prospects,but also created opportunities foremployment of people living in thesecountries.(iv) Increased standard of living: Inthe absence of international trade of goodsand services, it would not have beenpossible for the world community toconsume goods and services producedin other countries that the people in thesecountries are able to consume and enjoya higher standard of living.

Benefits to Firms

(i) Prospects for higher profits:International business can be moreprofitable than the domestic business.When the domestic prices are lower,business firms can earn more profitsby selling their products in countrieswhere prices are high.(ii) Increased capacity utilisation:Many firms setup productioncapacities for their products whichare in excess of demand in thedomestic market. By planning overseas

expansion and procuring orders fromforeign customers, they can think ofmaking use of their surplus productioncapacities and also improving theprofitability of their operations.Production on a larger scale often leadsto economies of scale, which in turnlowers production cost and improvesper unit profit margin.(iii) Prospects for growth: Businessfirms find it quite frustrating whendemand for their products startsgetting saturated in the domesticmarket. Such firms can considerablyimprove prospects of their growth byplunging into overseas markets. Thisis precisely what has prompted manyof the multinationals from thedeveloped countries to enter intomarkets of developing countries. Whiledemand in their home countries has gotalmost saturated, they realised theirproducts were in demand in thedeveloping countries and demand waspicking up quite fast.(iv) Way out to intense compe-tition in domestic market: Whencompetition in the domestic market isvery intense, internationalisation seemsto be the only way to achieve significantgrowth. Highly competitive domesticmarket drives many companies to gointernational in search of markets fortheir products. International businessthus acts as a catalyst of growth forfirms facing tough market conditionson the domestic turf.(v) Improved business vision: Thegrowth of international business ofmany companies is essentially a partof their business policies or strategic


management. The vision to becomeinternational comes from the urge togrow, the need to become morecompetitive, the need to diversify andto gain strategic advantages ofinternationalisation.

11.2 MODES OF ENTRY INTO

INTERNATIONAL BUSINESS

Simply speaking, the term mode meansthe manner or way. The phrase ‘modesof entry into international business’,therefore, means various ways in whicha company can enter into internationalbusiness. While discussing themeaning and scope of internationalbusiness, we have already familiarisedyou with some of the modes of entryinto international business. In thefollowing sections, we shall discuss indetail important ways of entering intointernational business along with theiradvantages and limitations. Such adiscussion will enable you to know asto which mode is more suitable underwhat conditions.

11.2.1 Exporting and Importing

Exporting refers to sending of goodsand services from the home country toa foreign country. In a similar vein,importing is purchase of foreignproducts and bringing them into one’shome country. There are two importantways in which a firm can export orimport products: direct and indirectexporting/importing. In the case ofdirect exporting/importing, a firmitself approaches the overseas buyers/suppliers and looks after all the

formalities related to exporting/importing activities including thoserelated to shipment and financing ofgoods and services. Indirect exporting/importing, on the other hand, is onewhere the firm’s participation inthe export/import operations isminimum, and most of the tasksrelating to export/import of the goodsare carried out by some middle mensuch as export houses or buyingoffices of overseas customers locatedin the home country or wholesaleimporters in the case of importoperations. Such firms do not directlydeal with overseas customers in thecase of exports and suppliers in thecase of imports.

Advantages

Major advantages of exporting include:• As compared to other modes of

entry, exporting/importing is theeasiest way of gaining entry intointernational markets. It is lesscomplex an activity than settingup and managing joint-venturesor wholly owned subsidiariesabroad.

• Exporting/importing is lessinvolving in the sense thatbusiness firms are not required toinvest that much time and moneyas is needed when they desire toenter into joint ventures or set upmanufacturing plants andfacilities in host countries.

• Since exporting/importing doesnot require much of investment inforeign countries, exposure to


foreign investment risks is nil ormuch lower than that is presentwhen firms opt for other modes ofentry into international business.

Limitations

Major limitations of exporting/importing as an entry mode ofinternational business are as follows:

• Since the goods physically movefrom one country to another,exporting/importing involvesadditional packaging, trans-portation and insurance costs.Especially in the case of heavyitems, transportation costs alonebecome an inhibiting factor totheir exports and imports. Onreaching the shores of foreigncountries, such products aresubject to custom duty and avariety of other levies and charges.Taken together, all these expensesand payments substantiallyincrease product costs and makethem less competitive.

• Exporting is not a feasible optionwhen import restrictions exist ina foreign country. In such asituation, firms have no alternativebut to opt for other entry modessuch as licensing/franchising orjoint venture which makes itfeasible to make the productavailable by way of producing andmarketing it locally in foreigncountries.

• Export firms basically operatefrom their home country. Theyproduce in the home country andthen ship the goods to foreign

countries. Except a few visits madeby the executives of export firmsto foreign countries to promotetheir products, the export firms ingeneral do not have much contactwith the foreign markets. This putsthe export firms in a disadvan-tageous position vis-à-vis the localfirms which are very near thecustomers and are able to betterunderstand and serve them.

Despite the above mentionedlimitations, exporting/importing is themost preferred way for business firmswhen they are getting initially involvedwith international business. As usuallyis the case, firms start their overseasoperations with exports and imports,and later having gained familiarity withthe foreign market operations switchover to other forms of internationalbusiness operations.

11.2.2 Contract Manufacturing

Contract manufacturing refers to a typeof international business where a firmenters into a contract with one or a fewlocal manufacturers in foreign countriesto get certain components or goodsproduced as per its specifications.Contract manufacturing, also known asoutsourcing, can take three major forms:

• Production of certain componentssuch as automobile componentsor shoe uppers to be used later forproducing final products such ascars and shoes;

• Assembly of components into finalproducts such as assembly of harddisk, mother board, floppy diskdrive and modem chip intocomputers; and


• Complete manufacture of theproducts such as garments.

The goods are produced or assembledby the local manufacturers as per thetechnology and management guidanceprovided to them by the foreigncompany. The goods so manufacturedor assembled by the local producersare delivered to the international firmfor use in its final products or outrightly sold as finished products by theinternational firm under its brandnames in various countries includingthe home, host and other countries. Allthe major international companies suchas Nike, Reebok, Levis and Wranglertoday get their products or componentsproduced in the developing countriesunder contract manufacturing.

Advantages

Contract manufacturing offers severaladvantages to both the internationalcompany and local producers in theforeign countries.

• Contract manufacturing permitsthe international firms to get thegoods produced on a large scalewithout requiring investment insetting up production facilities.These firms make use of theproduction facilities alreadyexisting in the foreign countries.

• Since there is no or littleinvestment in the foreigncountries, there is hardly anyinvestment risk involved in theforeign countries.

• Contract manufacturing also givesan advantage to the internationalcompany of getting products

manufactured or assembled atlower costs especially if the localproducers happen to be situatedin countries which have lowermaterial and labour costs.

• Local producers in foreigncountries also gain from contractmanufacturing. If they have anyidle production capacities,manufacturing jobs obtained oncontract basis in a way provide aready market for their productsand ensure greater utilisation oftheir production capacities. This ishow the Godrej group is benefittingfrom contract manufacturing inIndia. It is manufacturing soapsunder contract for manymultinationals including Dettolsoap for Reckitt and Colman. Thishas considerably helped it inmaking use of its excess soapmanufacturing capacity.

• The local manufacturer also getsthe opportunity to get involved withinternational business and availincentives, if any, available to theexport firms in case the internationalfirm desires goods so produced bedelivered to its home country or tosome other foreign countries.

Limitations

The major disadvantages of contractmanufacturing to international firmand local producer in foreign countriesare as follows:

• Local firms might not adhere toproduction design and qualitystandards, thus causing seriousproduct quality problems to theinternational firm.


• Local manufacturer in the foreigncountry loses his control over themanufacturing process becausegoods are produced strictly as perthe terms and specifications of thecontract.

• The local firm producing undercontract manufacturing is not freeto sell the contracted output asper its will. It has to sell the goodsto the international company atpredetermined prices. This resultsin lower profits for the local firm ifthe open market prices for suchgoods happen to be higher thanthe prices agreed upon under thecontract.

11.2.3 Licensing and Franchising

Licensing is a contractual arrangementin which one firm grants access to itspatents, trade secrets or technology toanother firm in a foreign country for afee called royalty. The firm that grantssuch permission to the other firm isknown as licensor and the other firmin the foreign country that acquiressuch rights to use technology orpatents is called the licensee. It maybe mentioned here that it is not only

technology that is licensed. In thefashion industry, a number ofdesigners license the use of theirnames. In some cases, there isexchange of technology between thetwo firms. Sometimes there is mutualexchange of knowledge, technologyand/or patents between the firmswhich is known as cross-licensing.

Franchising is a term very similarto licensing. One major distinctionbetween the two is that while the formeris used in connection with productionand marketing of goods, the termfranchising applies to service business.The other point of difference betweenthe two is that franchising is relativelymore stringent than licensing.Franchisers usually set strict rules andregulations as to how the franchiseesshould operate while running theirbusiness. Barring these two differences,franchising is pretty much the same aslicensing. Like in the case of licensing,a franchising agreement too involvesgrant of rights by one party to anotherfor use of technology, trademark andpatents in return of the agreedpayment for a certain period of time.The parent company is called thefranchiser and the other party to the

“Franchising is basically a specialised form of licensing in which the franchisornot only sells intangible property (normally a trademark) to the franchisee, butalso insists that the franchisee agrees to abide by strict rules as to how it doesbusiness.”

Charles W.L. Hill

Franchising is a “form of licensing in which a parent company (the franchisor)grants another independent entity (the franchisee) the right to do business in aprescribed manner. This right can take the form of selling the franchisersproducts, ‘using its name, production and marketing technique, or generalbusiness approach.”

Donald W. Hackett


agreement is called franchisee. Thefranchiser can be any service providerbe it a restaurant, hotel, travel agency,bank wholesaler or even a retailer - whohas developed a unique technique forcreating and marketing of servicesunder its own name and trade mark. Itis the uniqueness of the technique thatgives the franchiser an edge over itscompetitors in the field, and makes thewould-be-service providers interestedin joining the franchising system.McDonald, Pizza Hut and Wal-Mart areexamples of some of the leadingfranchisers operating worldwide.

Advantages

As compared to joint ventures andwholly owned subsidiaries, licensing/franchising is relatively a much easiermode of entering into foreign marketswith proven product/technologywithout much business risks andinvestments. Some of the specificadvantages of licensing are as follows:

• Under the licensing/franchisingsystem, it is the licensor/franchiser who sets up thebusiness unit and invests his/herown money in the business. Assuch, the licensor/franchiser hasto virtually make no investmentsabroad. Licensing/franchising is,therefore, considered a lessexpensive mode of entering intointernational business.

• Since no or very little foreigninvestment is involved, licensor/franchiser is not a party to the losses,if any, that occur to foreign business.Licensor/franchiser is paid by the

licensee/franchisee by way of feesfixed in advance as a percentage ofproduction or sales turnover. Thisroyalty or fee keeps accruing to thelicensor/franchiser so long as theproduction and sales keep on takingplace in the licensee’s/franchisee’sbusiness unit.

• Since the business in the foreigncountry is managed by thelicensee/franchisee who is a localperson, there are lower risks ofbusiness takeovers or governmentinterventions.

• Licensee/franchisee being a localperson has greater marketknowledge and contacts whichcan prove quite helpful to thelicensor/franchiser in successfullyconducting its marketingoperations.

• As per the terms of the licensing/franchising agreement, only theparties to the licensing/franchisingagreement are legally entitled tomake use of the licensor’s/franchiser’s copyrights, patentsand brand names in foreigncountries. As a result, other firmsin the foreign market cannot makeuse of such trademarks andpatents.

Limitations

Licensing/franchising as a mode ofinternational business suffers from thefollowing weaknesses.

• When a licensee/franchiseebecomes skilled in the manu-facture and marketing of thelicensed/franchised products,


there is a danger that the licenseecan start marketing an identicalproduct under a slightly differentbrand name. This can causesevere competition to the licenser/franchiser.

• If not maintained properly, tradesecrets can get divulged to othersin the foreign markets. Suchlapses on the part of the licensee/franchisee can cause severe lossesto the licensor/franchiser.

• Over time, conflicts often developbetween the licensor/franchiserand licensee/franchisee overissues such as maintenance ofaccounts, payment of royalty andnon-adherence to norms relatingto production of quality products.These differences often result incostly litigations, causing harm toboth the parties.

11.2.4 Joint Ventures

Joint venture is a very commonstrategy for entering into foreignmarkets. A joint venture meansestablishing a firm that is jointlyowned by two or more otherwiseindependent firms. In the widest senseof the term, it can also be describedas any form of association whichimplies collaboration for more than atransitory period. A joint ownershipventure may be brought about inthree major ways:

(i) Foreign investor buying aninterest in a local company

(ii) Local firm acquiring an interest inan existing foreign firm

(iii) Both the foreign and localentrepreneurs jointly forming anew enterprise.

Advantages

Major advantages of joint ventureinclude:

• Since the local partner alsocontributes to the equity capitalof such a venture, theinternational firm finds itfinancially less burdensome toexpand globally.

• Joint ventures make it possibleto execute large projectsrequiring huge capital outlaysand manpower.

• The foreign business f irmbenefits from a local partner’sknowledge of the host countriesregarding the competitiveconditions, culture, language,political systems and businesssystems.

• In many cases entering into aforeign market is very costly andrisky. This can be avoided bysharing costs and/or risks witha local partner under jointventure agreements.

Limitations

Major limitations of a joint venture arediscussed below:

• Foreign firms entering into jointventures share the technology andtrade secrets with local firms inforeign countries, thus alwaysrunning the risks of such a


technology and secrets beingdisclosed to others.

• The dual ownership arrangementmay lead to conflicts, resulting inbattle for control between theinvesting firms.

11.2.5 Wholly Owned Subsidiaries

This entry mode of internationalbusiness is preferred by companieswhich want to exercise full control overtheir overseas operations. The parentcompany acquires full control over theforeign company by making 100 percent investment in its equity capital. Awholly owned subsidiary in a foreignmarket can be established in either ofthe two ways:

(i) Setting up a new firm altogetherto start operations in a foreigncountry — also referred to as agreen field venture, or

(ii) Acquiring an established firm inthe foreign country and using thatfirm to manufacture and/orpromote its products in the hostnation.

Advantages

Major advantages of a wholly ownedsubsidiary in a foreign country are asfollows:

• The parent firm is able to exercisefull control over its operations inforeign countries.

• Since the parent company on itsown looks after the entire operationsof foreign subsidiary, it is notrequired to disclose its technologyor trade secrets to others.

Limitations

The limitations of setting up a whollyowned subsidiary abroad include:

• The parent company has to make100 per cent equity investmentsin the foreign subsidiaries. Thisform of international business is,therefore, not suitable for smalland medium size firms which donot have enough funds with themto invest abroad.

• Since the parent company owns100 per cent equity in the foreigncompany, it alone has to bear theentire losses resulting from failureof its foreign operations.

• Some countries are averse tosetting up of 100 per cent whollyowned subsidiaries by foreignersin their countries. This form ofinternational business operations,therefore, becomes subject tohigher political risks.

11.3 INDIA’S INVOLVEMENT IN WORLD

BUSINESS

India is now the 10th largest economyin the world and the fastest growingeconomy, next only to China. As perthe Goldman Sach Report 2004, Indiais poised to be the second largesteconomy by 2050. Despite thesefeatures, India’s involvement withinternational business is not veryimpressive. India’s share in world tradein 2003 was abysmally low i.e., just 0.8per cent as compared to those of otherdeveloping countries such as China(5.9 per cent), Hong Kong (3.0 per cent),South Korea (2.6 per cent), Malaysia


(1.3 per cent), Singapore (1.9 per cent),and Thailand (1.1 per cent). Even inrespect of foreign investments, Indiahas been considerably lagging behindother countries. The following sectionsprovide an overview of the major trendsand developments in India’s foreigntrade and investments.

11.3.1 India’s Foreign Trade inGoods

India accounts for a small share inworld trade, its exports and imports

Rs. 606 crores in 1950-51 whichincreased to Rs. 2,93,367 crores in2003-04, representing an increase ofover 480 times over the last five decadesor so (see Table 11.2). The country’simports too depict a similarlyphenomenal growth. Total imports whichstood at Rs. 608 crores in 1950-51increased to Rs. 3,59,108 crores in2003-04, thus registering a growth ofabout 590 times during the same period.

Compostion wise, textiles andgarments, gems and jewellery,

constitute major economic activities forthe country. Due to faster growthachieved at the external front, share offoreign trade in the country’s GrossDomestic Product (GDP) hasconsiderably increased from 14.6 percent in 1990-91 to 24.1 per cent in2003-04.

In absolute terms, both theexports and imports have witnessedphenomenal growth over the years.India’s total merchandise exports were

engineering products and chemicalsand related products and agriculturaland allied products are India’smajor items of India’s exports (seeTable 11.3). Although in overall termsIndia accounts for just 0.8 per centof world exports, in many individualproduct items such as tea, pearls,precious and semi-precious stones,medicinal and pharmaceuticalproducts, rice, spices, iron ore andconcentrates, leather and leather

Table 11.2 India’s Exports and Imports: 1950-51 to 2003-04

(Value: Rs. crores)Year Exports* Imports Trade balance

1950-51 606 608 -21960-61 642 1122 -4801970-71 1535 1634 -991980-81 6711 12549 -58381990-91 32553 43198 -106451995-96 106353 122678 -163252000-01 203571 230873 -273022001-02 209018 245200 -361822002-03 255137 297206 -420692003-04 293367 359108 -65741

Source: DGCIS* Including re-exports.


manufactures, textile yarns fabrics,garments and tobacco, its share ismuch higher and ranges between 3per cent to13 per cent. India evenholds the distinct position of being thelargest exporter in the world in selectcommodities such as basmati rice,tea, and ayurvedic products.

So far as imports are concerned,products likes crude oil and petroleumproducts, capital goods (i.e.,machinery), electronic goods, pearl,precious and semi-precious stones,gold, silver and chemicals constitutemajor items of India’s imports(Table 11.4).

Table 11.4 Commodity Composition of India’s Imports

Product Percentage share2002-03 2003-04

1. Petroleum, oil and lubricants (POL) 28.7 26.32. Pearl, precious and semi-precious stones 9.9 9.13. Capital goods 12.1 13.34. Electronic goods 9.1 9.65. Gold and silver 7.0 8.86. Chemicals 6.9 7.47. Edible oils 3.0 3.38. Coke, coal and briquettes 2.0 1.89. Metal ferrous ores and metal scrap 1.7 1.710. Professional equipments and optical goods 1.8 1.611. Others 17.8 17.1

Total imports 100.0 100.0

Source: DGCIS, Calcutta as reported in Government of India, Economic Survey:2004-2005, New Delhi.

Table 11.3 Commodity Composition of India’s Exports

Product Percentage share2002-03 2003-04

I Primary products 16.6 15.5• Agricultural and allied 12.8 11.8• Ores and minerals 3.8 3.7

II Manufactured goods 76.6 76.0• Textiles including garments 21.1 19.0• Gems and jewellery 17.2 16.6• Engineering goods 17.2 19.4• Chemicals and related products 14.2 14.8• Leather and manufactures 3.5 3.4

III Petroleum, crude and related products 4.9 5.6IV Others 1.9 2.9

Total exports 100.0 100.0



India’s eleven major tradingpartners include USA, UK, Belgium,Germany, Japan, Switzerland, HongKong, UAE, China, Singapore andMalaysia. While USA has been India’sleading trade partner with a share of11.6 per cent in India’s total trade(including both exports and imports),shares of other ten countries have beenin the range of 2.1 per cent to 4.4 percent in 2003-04 (see Table 11.5).

11.3.2 India’s Trade in Services

India’s trade in services have alsogrown manifold over the years.Table 11.6 contains data on exportsand imports of India’s three serviceswhich have been historically importantto India. It is obvious from the table thatboth the exports and imports of servicesrelating to foreign travel, transportationand insurance have increased

Table 11.5 India’s Major Trading Partners

Country Percentage share in India’stotal trade (exports + imports)

2002-03 2003-04

1. USA 13.4 11.62. UK 4.6 4.43. Belgium 4.7 4.14. Germany 4.0 3.95. Japan 3.2 3.16. Switzerland 2.4 2.77. Hong Kong 3.1 3.48. UAE 3.8 5.19. China 4.2 5.010. Singapore 2.5 3.011. Malaysia 1.9 2.1

Sub total (1 to 11) 47.9 47.6Others 52.1 52.4Total imports 100.0 100.0


1960-61 1970-71 1980-81 1990-91 2000-01 2002-03 2004-05Exports• Foreign travel 15 36 964 2613 16064 15991 18873• Transportation 45 109 361 1765 9364 12261 14958• Insurance 8 12 51 199 1234 1783 1927Imports• Foreign travel 12 18 90 703 12741 16155 16111•Transportation 25 78 355 1961 16172 15826 10703• Insurance 6 12 34 159 1004 1687 1672

Table 11.6 India’s Trade in Services


spectacularly during the last fourdecades. What is more remarkable isthe change in the composition ofservices exports. Software and othermiscellaneous services (includingprofessional technical and businessservices) have emerged as the maincategories of India’s exports of services.While the relative share of travel andtransportation has declined from 64.3per cent in 1995-96 to 29.6 per cent in2003-2004, the share of softwareexports has gone up from 10.2 per centto around 49 per cent in thecorresponding period (see Table 11.7).

Key Terms

International business FDI Licensing

International trade Portfolio investment Franchising

Merchandise trade Exporting Outsourcing

Invisible trade Importing Joint ventures

Foreign investment Contract- Wholly owned subsidiariesmanufacturing

11.3.3 India’s Foreign Investments

Data relating to India’s foreigninvestments — both inward andoutward — are provided in Table 11.8.It can be seen that there has been aphenomenal increase in foreigninvestments flow into and from India.While the inward foreign investmentshave grown more than 750 times fromjust Rs. 201 crores in 1990-91 to Rs.1,51,406 crores in 2003-04, India’sinvestments abroad have increased muchmore exponentially — around 4,927times — from Rs. 19 crores in 1990-91to Rs. 8,3,616 crores in 2003-04.

Table 11.8 Foreign Investment flows into and out of India

Value: Rs. crores1990-91 2000-01 2001-02 2002-03 2003-04

Inflows 201 80824 73907 67756 151406Outflows 19 54080 41987 47658 83616

Net 182 26744 31920 22098 67592

Table 11.7 Percentage Shares of Major Services to Total Services Exports

Year Travel Transportation Software Miscellaneous

1995-96 36.9 27.4 10.2 22.92000-01 21.5 12.6 39.0 21.32001-02 18.3 12.6 44.1 20.32002-03 16.0 12.2 46.2 22.42003-04 16.5 13.1 48.9 18.7


SUMMARY

International Business: International business refers to business activitiesthat take place across national frontiers. Though many people use the termsinternational business and international trade synonymously, the formeris a much broader term. International business involves not only trade ingoods and services, but also other operations such as production andmarketing of goods and services in foreign countries.

Reasons: The primary reason for international business is that nationscannot efficiently produce all that they require. Due to differences in resourceendowments and labour productivity, countries find it much moreadvantageous to produce goods and services in which they have costadvantage and trade the surplus in such goods and services with othernations in exchange of goods and services which others can produce moreefficiently.

International vs Domestic business: Conducting and managinginternational business operations is more complex than undertakingdomestic business. Differences in the nationality of parties involved,relatively less mobility of factors of production, customer heterogeneity acrossmarkets, variations in business practises and political systems, variedbusiness regulations and policies, use of different currencies are the keyaspects that differentiate international businesses from domestic business.These, moreover, are the factors that make international business muchmore complex and a difficult activity.

Scope: Scope of international business is quite wide. It includes not onlymerchandise exports, but also trade in services, licensing and franchisingas well as foreign investments.

Benefits: International business benefits both the nations and firms. Nationsgain by way of earning foreign exchange, more efficient use of domesticresources, greater prospects of growth and creation of employmentopportunities. The advantages to the business firms include: prospects forhigher profits, greater utilisation of production capacities, way out to intensecompetition in domestic market and improved business vision.

Modes of entry: A firm desirous of entering into international business hasseveral options available to it. These range from exporting/importing tocontract manufacturing abroad, licensing and franchising, joint venturesand setting up wholly owned subsidiaries abroad. Each entry mode has itsown advantages and disadvantages which the firm needs to take intoaccount while deciding as to which mode of entry it should prefer.

India’s involvement in world business: Since time immemorial, India hasbeen trading with foreign countries. Over the years, India’s trade hasregistered spectacular growth. Currently, foreign trade accounts for about24 per of the country’s Gross Domestic Product (GDP). Textiles and garments,gems and jewellery, engineering products and chemicals and related


products and agricultural and allied products are India’s major items ofexports. Important items of its imports include: crude oil and petroleumproducts, capital goods (i.e., machinery), electronic goods, pearls, preciousand semi-precious stones, gold, silver and chemicals.

USA, UK, Belgium, Germany, Japan, Switzerland, Hong Kong, UAE, China,Singapore and Malaysia are the major trading partners. These elevencountries together accounted for about 48 per cent of India’s total trade(comprising of both the exports and imports) in 2003-04.

Trade in Services: India’s trade in services have also undergone significantchanges over the years in terms of both the volume and composition oftrade. The most conspicuous change relates to emergence of softwareexports which of late have to account for about 49 per cent of India’s totalservices exports.

Data relating to India’s foreign investments (both inward and outward) tooshow remarkable growth. While the inward foreign investments have grownmore than 750 times, from just Rs. 201 crores in 1990-91 to Rs. 1,51,406in 2003-04, India’s investments abroad have increased much moreexponentially, around 4,927 times, from Rs. 19 crores in 1990-91 toRs. 83,616 crores in 2003-04.

India’s performance, however, does not appear very satisfactory in terms ofinternational comparison. India’s share in world trade is a mere 0.8 percent. Its position in respect of foreign investments too is poor. India continuesto lag considerably behind other developing countries which have emergedas major destinations for foreign investments.

EXERCISES


1. In which of the following modes of entry, does the domestic manufacturergive the right to use intellectual property such as patent and trademarkto a manufacturer in a foreign country for a fee

a. Licensing b. Contractmanufacturing

c. Joint venture d. None of these

2. Outsourcing a part of or entire production and concentrating onmarketing operations in international business is known as

a. Licensing b. Franchisingc. Contract manufacturing d. Joint venture


3. When two or more firms come together to create a new business entitythat is legally separate and distinct from its parents it is known as

a. Contract manufacturing b. Franchisingc. Joint ventures d. Licensing

4. Which of the following is not an advantage of exporting?

a. Easier way to enter into b. Comparatively lowerinternational markets risks

c. Limited presence in d. Less investmentforeign markets requirements

5. Which one of the following modes of entry requires higher level of risks?


6. Which one of the following modes of entry permits greatest degree ofcontrol over overseas operations?

a. Licensing/franchising b. Wholly ownedsubsidiary

c. Contract manufacturing d. Joint venture

7. Which one of the following modes of entry brings the firm closer tointernational markets?


8. Which one of the following is not amongst India’s major export items?

a. Textiles and garments b. Gems and jewelleryc. Oil and petroleum products d. Basmati rice

9. Which one of the following is not amongst India’s major import items?

a. Ayurvedic medicines b. Oil and petroleumproducts

c. Pearls and precious stones d. Machinery

10. Which one of the following is not amongst India’s major trading partners?

a. USA b. UKc. Germany d. New Zealand



1. Differentiate between international trade and international business.

2. Discuss any three advantages of international business.

3. What is the major reason underlying trade between nations?

4. Discuss as to why nations trade.

5. Enumerate limitations of contract manufacturing.

6. Why is it said that licensing is an easier way to expand globally?

7. Differentiate between contract manufacturing and setting up whollyowned production subsidiary abroad.

8. Distinguish between licensing and franchising.

9. List major items of India’s exports.

10. What are the major items that are exported from India?

11. List the major countries with whom India trades.


1. What is international business? How is it different from domesticbusiness?

2. “International business is more than international trade”. Comment.

3. What benefits do firms derive by entering into international business?

4. In what ways is exporting a better way of entering into internationalmarkets than setting up wholly owned subsidiaries abroad.

5. Discuss briefly the factors that govern the choice of mode of entry intointernational business.

6. Discuss the major trends in India’s foreign trade. Also list the majorproducts that India trades with other countries.

7. What is invisible trade? Discuss salient aspects of India’s trade inservices.

CHAPTER 12

INTERNATIONAL BUSINESS - II

LEARNING OBJECTIVES


• discuss important steps and documents involved in executingexport transactions;

• explain major steps and documents involved in carrying outimport transactions;

• identify various incentives and schemes available to internationalfirms;

• identify and state the role of various organisations that have beenset up in the country to promote foreign trade; and

• list major international institutions and agreements existing atthe global level and discuss their role in promoting internationaltrade and development.

279INTERNATIONAL BUSINESS - II

12.1 INTRODUCTION

Exporting goods to foreign countries isquite different from marketing productsdomestically. One needs to be familiarwith various procedural formalities thatneed to be complied with before goodsare actually shipped to foreigndestinations or imported from overseas

suppliers. In order to facilitate andpromote trade, government providesseveral incentives schemes forinternational firms to import goods atzero or concessional rates of customsduty for use in manufacture ofproducts meant for exports; exemptthem from payment of various other

After deliberations with his friend and son, Mr. Sudhir Manchanda feels convincedthat this is the right time for him to step into international markets. This willenable him not only to tide over the problems of demand saturation for hisautomotive parts in the domestic market, but would also help him reap variousbenefits that accrue to international firms.

Since he has limited capital available with him right now and does not have anypast experience of overseas operations, he has decided to opt for exporting asthe mode of entry into international markets.

But the problem with him is that he does not know as to how to get into exportbusiness. His friend in the tyre business tells him that exporting and importingis not that simple an activity as operating domestically.

A number of formalities are needed to be performed and documents to be filledin before goods are finally dispatched to export markets. A similar and somewhattedious process is needed in case he desires to import some of the tools and rawmaterials for producing export quality products. Mr. Manchanda is once againin a fix. He does not have any idea of what the various formalities and documentsinvolved in exporting and importing are.

Mr. Manchanda is also wondering as to how he will protect himself againstexport risks. He is, moreover, worried about the additional costs that he wouldhave to incur in making goods export worthy. He is contemplating making use ofsome imported machines and raw materials.

But would not the import duties on such imports substantially increase hisproduct cost? In addition, he will be incurring additional costs on transportation,packaging and insurance as required in connection with export to foreigndestinations.

Mr. Manchanda’s friend in the tyre business tells him he need not worry thatmuch about these problems. After all, so many firms from India are alreadyengaged in export business and have soaring exports.

He should have patience and not get disturbed by these hiccups. He can seekadvice from some trade expert for faimiliarising himself with the export importprocedures and documentation. He also tells him that though he does not haveany specific details with him, he is aware there exist various foreign tradepromotion measures and organisations that can be helpful to him in overcominghis problem and making his products more competitive in the world markets!


duties and taxes; and carry out theirimport-export transactions in a lesscumbersome environment. Thegovernment has also set up a widevariety of organisations to collect anddisseminate information aboutinternational markets, promote exportsof specific products, train executives ofinternational business firms, andensure proper quality and packagingof export goods. At the internationallevel, various organisations such as theWorld Bank, International MonetaryFund (IMF) and World TradeOrganisation (WTO) exist foraccelerating the pace of developmentand trade amongst the nations.

This chapter is devoted to thediscussion of major steps anddocuments involved in foreign trade.The chapter also identifies andexamines the role of various tradepromotion measures and organisationsset up for promotion of internationalbusiness. The concluding section of thechapter is devoted to an analysis ofmajor international institutions thatoperate at the global level to promoteworld development and trade.

12.2 EXPORT-IMPORT PROCEDURES

AND DOCUMENTATION

A major distinction between domesticand international operations is thecomplexity of the latter. Export andimport of goods is not that straightforward as buying and selling in thedomestic market. Since foreign tradetransactions involves movement ofgoods across frontiers and use of

foreign exchange, a number offormalities are needed to be performedbefore the goods leave the boundariesof a country and enter into that ofanother. Following sections are devotedto a discussion of major steps that needto be undertaken for completing exportand import transactions.

12.2.1 Export Procedure

The number of steps and the sequencein which these are taken vary from oneexport transaction to another. Stepsinvolved in a typical export transactionare as follows.(i) Receipt of enquiry and sendingquotations: The prospective buyer of aproduct sends an enquiry to differentexporters requesting them to sendinformation regarding price, quality andterms and conditions for export ofgoods. Exporters can be informed ofsuch an enquiry even by way ofadvertisement in the press put in by theimporter. The exporter sends a reply tothe enquiry in the form of a quotation —referred to as proforma invoice. Theproforma invoice contains informationabout the price at which the exporter isready to sell the goods and also providesinformation about the quality, grade,size, weight, mode of delivery, type ofpacking and payment terms.(ii) Receipt of order or indent: Incase the prospective buyer (i.e.,importing firm) finds the export priceand other terms and conditionsacceptable, it places an order for thegoods to be despatched. This order, alsoknown as indent, contains a description


of the goods ordered, prices to be paid,delivery terms, packing and markingdetails and delivery instructions.(iii) Assessing importer’s credit-worthiness and securing a guaranteefor payments: After receipt of theindent, the exporter makes necessaryenquiry about the creditworthiness ofthe importer. The purpose underlyingthe enquiry is to assess the risks of nonpayment by the importer once thegoods reach the import destination. Tominimise such risks, most exportersdemand a letter of credit from theimporter. A letter of credit is a guaranteeissued by the importer’s bank that itwill honour payment up to a certainamount of export bills to the bank ofthe exporter. Letter of credit is the mostappropriate and secure method ofpayment adopted to settle internationaltransactions(iv) Obtaining export licence: Havingbecome assured about payments, theexporting firm initiates the stepsrelating to compliance of exportregulations. Export of goods in Indiais subject to custom laws whichdemand that the export firm must havean export licence before it proceedswith exports. Important pre-requisitesfor getting an export licence are asfollows:

• Opening a bank account in anybank authorised by the ReserveBank of India (RBI) and getting anaccount number.

• Obtaining Import Export Code(IEC) number from the DirectorateGeneral Foreign Trade (DGFT) or

Regional Import Export LicensingAuthority.

• Registering with appropriateexport promotion council.

• Registering with Export Credit andGuarantee Corporation (ECGC) inorder to safeguard against risksof non payments.

An export firm needs to have theImport Export Code (IEC) number asit needs to be filled in various export/import documents. For obtaining theIEC number, a firm has to apply to theDirector General for Foreign Trade(DGFT) with documents such asexporter/importer profile, bank receiptfor requisite fee, certificate from thebanker on the prescribed form, twocopies of photographs attested by thebanker, details of the non-residentinterest and declaration about theapplicant’s non association withcaution listed firms.

It is obligatory for every exporter toget registered with the appropriateexport promotion council. Variousexport promotion councils such asEngineering Export Promotion Council(EEPC) and Apparel Export PromotionCouncil (AEPC) have been set up by theGovernment of India to promote anddevelop exports of different categoriesof products. We shall discuss aboutexport promotion councils in a latersection. But it may be mentioned herethat it is necessary for the exporter tobecome a member of the appropriateexport promotion council and obtaina Registration cum MembershipCertificate (RCMC) for availing benefits


available to export firms from theGovernment.

Registration with the ECGC isnecessary in order to protect overseaspayments from political andcommercial risks. Such a registrationalso helps the export firm in gettingfinancial assistance from commercialbanks and other financial institutions.(v) Obtaining pre-shipment finance:Once a confirmed order and also a letterof credit have been received, theexporter approaches his banker forobtaining pre-shipment finance toundertake export production. Pre-shipment finance is the finance that theexporter needs for procuring rawmaterials and other components,processing and packing of goods andtransportation of goods to the port ofshipment.(vi) Production or procurement ofgoods: Having obtained the pre-shipment finance from the bank, theexporter proceeds to get the goodsready as per the specifications of theimporter. Either the firm itself goes infor producing the goods or else it buysfrom the market.(vii) Pre-shipment inspection: TheGovernment of India has initiated manysteps to ensure that only good qualityproducts are exported from thecountry. One such step is compulsoryinspection of certain products by acompetent agency as designated by thegovernment. The government haspassed Export Quality Control andInspection Act, 1963 for this purpose.and has authorised some agencies to

act as inspection agencies. If theproduct to be exported comes undersuch a category, the exporter needs tocontact the Export Inspection Agency(EIA) or the other designated agency forobtaining inspection certificate. Thepre-shipment inspection report isrequired to be submitted along withother export documents at the time ofexports. Such an inspection is notcompulsory in case the goods are beingexported by star trading houses,trading houses, export houses,industrial units setup in exportprocessing zones/special economiczones (EPZs/SEZs) and 100 per centexport oriented units (EOUs). We shalldiscuss about these special types ofexport firms in a later section.(viii) Excise clearance: As per theCentral Excise Tariff Act, excise duty ispayable on the materials used inmanufacturing goods. The exporter,therefore, has to apply to the concernedExcise Commissioner in the region withan invoice. If the Excise Commissioneris satisfied, he may issue the exciseclearance. But in many cases thegovernment exempts payment of exciseduty or later on refunds it if the goodsso manufactured are meant for exports.The idea underlying such exemptionor refund is to provide an incentive tothe exporters to export more and alsoto make the export products morecompetitive in the world markets. Therefund of excise duty is known as dutydrawback. This scheme of dutydrawback is presently administered bythe Directorate of Drawback under the


Ministry of Finance which is responsiblefor fixing the rates of drawback fordifferent products. The work relatingto sanction and payment of drawbackis, however, looked after by theCommissioner of Customs or CentralExcise Incharge of the concerned port/airport/land custom station fromwhere the export of goods is consideredto have taken place.(ix) Obtaining certificate of origin:Some importing countries provide tariffconcessions or other exemptions to thegoods coming from a particularcountry. For availing such benefits, theimporter may ask the exporter to senda certificate of origin. The certificate oforigin acts as a proof that the goodshave actually been manufactured in thecountry from where the export istaking place. This certificate can beobtained from the trade consulatelocated in the exporter’s country.(x) Reservation of shipping space:The exporting firm applies to theshipping company for provision ofshipping space. It has to specify thetypes of goods to be exported, probabledate of shipment and the port ofdestination. On acceptance ofapplication for shipping, the shippingcompany issues a shipping order. Ashipping order is an instruction to thecaptain of the ship that the specifiedgoods after their customs clearance ata designated port be received on board.(xi) Packing and forwarding: Thegoods are then properly packed andmarked with necessary details such asname and address of the importer, grossand net weight, port of shipment and

destination, country of origin, etc. Theexporter then makes necessaryarrangement for transportation of goodsto the port. On loading goods into therailway wagon, the railway authoritiesissue a ‘railway receipt’ which serves asa title to the goods. The exporterendorses the railway receipt in favourof his agent to enable him to takedelivery of goods at the port of shipment.(xii) Insurance of goods: The exporterthen gets the goods insured with aninsurance company to protect againstthe risks of loss or damage of the goodsdue to the perils of the sea during thetransit.(xiii) Customs clearance: The goodsmust be cleared from the customsbefore these can be loaded on the ship.For obtaining customs clearance, theexporter prepares the shipping bill.Shipping bill is the main document onthe basis of which the customs officegives the permission for export.Shipping bill contains particulars of thegoods being exported, the name of thevessel, the port at which goods are tobe discharged, country of finaldestination, exporter’s name andaddress, etc.

Five copies of the shipping bill alongwith the following documents are thensubmitted to the Customs Appraiser atthe Customs House:

• Export Contract or Export Order• Letter of Credit• Commercial Invoice• Certificate of Origin• Certificate of Inspection, where

necessary• Marine Insurance Policy


After submission of these docu-ments, the Superintendent of theconcerned port trust is approached forobtaining the carting order. Cartingorder is the instruction to the staff atthe gate of the port to permit the entryof the cargo inside the dock. Afterobtaining the carting order, the cargois physically moved into the port areaand stored in the appropriate shed.Since the exporter cannot make himselfor herself available all the time forperforming all these formalities, thesetasks are entrusted to an agent —referred to as Clearing and Forwarding(C&F) agent.(xiv) Obtaining mates receipt: Thegoods are then loaded on board theship for which the mate or the captainof the ship issues mate’s receipt to theport superintendent. A mate receipt isa receipt issued by the commandingofficer of the ship when the cargo isloaded on board, and contains theinformation about the name of thevessel, berth, date of shipment,descripton of packages, marks andnumbers, condition of the cargo at thetime of receipt on board the ship, etc.The port superintendent, on receipt ofport dues, hands over the mate’sreceipt to the C&F agent.

(xv) Payment of freight and issuanceof bill of lading: The C&F agentsurrenders the mates receipt to theshipping company for computation offreight. After receipt of the freight, theshipping company issues a bill oflading which serves as an evidence thatthe shipping company has accepted the

goods for carrying to the designateddestination. In the case the goods arebeing sent by air, this document isreferred to as airway bill.

(xvi) Preparation of invoice: Aftersending the goods, an invoice of thedespatched goods is prepared. Theinvoice states the quantity of goods sentand the amount to be paid by theimporter. The C&F agent gets it dulyattested by the customs.

(xvii) Securing payment: Afterthe shipment of goods, the exporterinforms the importer about theshipment of goods. The importer needsvarious documents to claim the title ofgoods on their arrival at his/hercountry and getting them customscleared. The documents that areneeded in this connection includecertified copy of invoice, bill of lading,packing list, insurance policy,certificate of origin and letter of credit.The exporter sends these documentsthrough his/her banker with theinstruction that these may be deliveredto the importer after acceptance of thebill of exchange — a document whichis sent along with the above mentioneddocuments. Submission of the relevantdocuments to the bank for the purposeof getting the payment from the bankis called ‘negotiation of the documents’.

Bill of exchange is an order to theimporter to pay a certain amount ofmoney to, or to the order of, a certainperson or to the bearer of theinstrument. It can be of two types:document against sight (sight draft) ordocument against acceptance (usance


draft). In case of sight draft, thedocuments are handed over to theimporter only against payment. Themoment the importer agrees to sign thesight draft, the relevant documents aredelivered. In the case of usance draft,on the other hand, the documents aredelivered to the importer against his orher acceptance of the bill of exchangefor making payment at the end of aspecified period, say three months.

On receiving the bill of exchange,the importer releases the payment incase of sight draft or accepts the usancedraft for making payment on maturityof the bill of exchange. The exporter’sbank receives the payment through theimporter’s bank and is credited to theexporter’s account.

The exporter, however, need notwait for the payment till the release ofmoney by the importer. The exportercan get immediate payment from his/her bank on the submission ofdocuments by signing a letter ofindemnity. By signing the letter, theexporter undertakes to indemnify thebank in the event of non-receipt ofpayment from the importer along withaccrued interest.

Having received the payment forexports, the exporter needs to get a bankcertificate of payment. Bank certificate ofpayment is a certificate which says thatthe necessary documents (including billof exchange) relating to the particularexport consignment has been negotiated(i.e., presented to the importer forpayment) and the payment has beenreceived in accordance with the exchangecontrol regulations.

12.2.2 Import Procedure

Import trade refers to purchase ofgoods from a foreign country. Importprocedure differs from country tocountry depending upon the country’simport and custom policies and otherstatutory requirements. The followingparagraphs discuss various stepsinvolved in a typical import transactionfor bringing goods into Indian territory.(i) Trade enquiry: The first thing thatthe importing firm has to do is to gatherinformation about the countries andfirms which export the given product.The importer can gather suchinformation from the trade directoriesand/or trade associations andorganisations. Having identified thecountries and firms that exportthe product, the importing firmapproaches the export firms with thehelp of a trade enquiry for collectinginformation about their export pricesand terms of exports. A trade enquiryis a written request by an importingfirm to the exporter for supply ofinformation regarding the price andvarious terms and conditions on whichthe latter is ready to exports goods.

After receiving a trade enquiry, theexporter prepares a quotation andsends it to the importer. The quotationis known as proforma invoice. Aproforma invoice is a document thatcontains details as to the quality, grade,design, size, weight and price of theexport product, and the terms andconditions on which their export willtake place.


Major Documents needed in Connection with Export Transaction

A. Documents related to goodsExport invoice: Export invoice is a sellers’ bill for merchandise and containsinformation about goods such as quantity, total value, number of packages, markson packing, port of destination, name of ship, bill of lading number, terms of deliveryand payments, etc.Packing list: A packing list is a statement of the number of cases or packs and thedetails of the goods contained in these packs. It gives details of the nature ofgoods which are being exported and the form in which these are being sent.Certificate of origin: This is a certificate which specifies the country in which thegoods are being produced. This certificate entitles the importer to claim tariffconcessions or other exemptions such as non-applicability of quota restrictionson goods originating from certain pre-specified countries. This certificate is alsorequired when there is a ban on imports of certain goods from select countries.The goods are allowed to be brought into the importing country if these are notoriginating from the banned countries.Certificate of inspection: For ensuring quality, the government has made itcompulsory for certain products that these be inspected by some authorisedagency. Export Inspection Council of India (EICI) is one such agency which carriesout such inspections and issues the certificate that the consignment has beeninspected as required under the Export (Quality Control and Inspection) Act, 1963,and satisfies the conditions relating to quality control and inspection as applicableto it, and is export worthy. Some countries have made this certificate mandatoryfor the goods being imported to their countries.

B. Documents related to shipmentMate’s receipt: This receipt is given by the commanding officer of the ship to theexporter after the cargo is loaded on the ship. The mate’s receipt indicates thename of the vessel, berth, date of shipment, description of packages, marks andnumbers, condition of the cargo at the time of receipt on board the ship, etc. Theshipping company does not issue the bill of lading unless it receives the mate’sreceipt.Shipping Bill: The shipping bill is the main document on the basis of which customsoffice grants permission for the export. The shipping bill contains particulars ofthe goods being exported, the name of the vessel, the port at which goods are to bedischarged, country of final destination, exporter’s name and address, etc.Bill of lading: Bill of lading is a document wherein a shipping company gives itsofficial receipt of the goods put on board its vessel and at the same time gives anundertaking to carry them to the port of destination. It is also a document of titleto the goods and as such is freely transferable by the endorsement and delivery.Airway Bill: Like a bill of lading, an airway bill is a document wherein an airlinecompany gives its official receipt of the goods on board its aircraft and at the sametime gives an undertaking to carry them to the port of destination. It is also adocument of title to the goods and as such is freely transferable by the endorsementand delivery.


(ii) Procurement of import licence:There are certain goods that can beimported freely, while others needlicensing. The importer needs toconsult the Export Import (EXIM)policy in force to know whether thegoods that he or she wants to importare subject to import licensing. In casegoods can be imported only against thelicence, the importer needs to procurean import licence. In India, it isobligatory for every importer (and alsofor exporter) to get registered with theDirectorate General Foreign Trade(DGFT) or Regional Import ExportLicensing Authority, and obtain anImport Export Code (IEC) number. This

number is required to be mentioned onmost of the import documents.(iii) Obtaining foreign exchange:Since the supplier in the context of animport transaction resides in a foreigncountry, he/she demands payment ina foreign currency. Payment in foreigncurrency involves exchange of Indiancurrency into foreign currency. In India,all foreign exchange transactions areregulated by the Exchange ControlDepartment of the Reserve Bank ofIndia (RBI). As per the rules in force,every importer is required to secure thesanction of foreign exchange. Forobtaining such a sanction, the importerhas to make an application to a bank

Marine insurance policy: It is a certificate of insurance contract whereby theinsurance company agrees in consideration of a payment called premium toindemnify the insured against loss incurred by the latter in respect of goodsexposed to perils of the sea.Cart ticket: A cart ticket is also known as a cart chit, vehicle or gate pass. It isprepared by the exporter and includes details of the export cargo in terms of theshipper’s name, number of packages, shipping bill number, port of destinationand the number of the vehicle carrying the cargo.

C. Documents related to paymentLetter of credit: A letter of credit is a guarantee issued by the importer’s bankthat it will honour up to a certain amount the payment of export bills to thebank of the exporter. Letter of credit is the most appropriate and secure methodof payment adopted to settle international transactionsBill of exchange: It is a written instrument whereby the person issuing theinstrument directs the other party to pay a specified amount to a certain personor the bearer of the instrument. In the context of an export-import transaction,bill of exchange is drawn by exporter on the importer asking the latter to pay acertain amount to a certain person or the bearer of the bill of exchange. Thedocuments giving title to the export consignment are passed on to the importeronly when the importer accepts the order contained in the bill of exchange.Bank certificate of payment: Bank certificate of payment is a certificate that thenecessary documents (including bill of exchange) relating to the particular exportconsignment has been negotiated (i.e., presented to the importer for payment)and the payment has been received in accordance with the exchange controlregulations.


authorised by RBI to issue foreignexchange. The application is made in aprescribed form along with the importlicence as per the provisions ofExchange Control Act. After properscrutiny of the application, the banksanctions the necessary foreignexchange for the import transaction.(iv) Placing order or indent: Afterobtaining the import licence, theimporter places an import order orindent with the exporter for supply ofthe specified products. The importorder contains information about theprice, quantity size, grade and qualityof goods ordered and the instructionsrelating to packing, shipping, ports ofshipment and destination, deliveryschedule, insurance and mode ofpayment. The import order should becarefully drafted so as to avoid anyambiguity and consequent conflictbetween the importer and exporter.(v) Obtaining letter of credit: If thepayment terms agreed between theimporter and the overseas supplier isa letter of credit, then the importershould obtain the letter of credit fromits bank and forward it to the overseassupplier. As stated previously, a letterof credit is a guarantee issued by theimporter’s bank that it will honourpayment up to a certain amount ofexport bills to the bank of the exporter.Letter of credit is the most appropriateand secured method of paymentadopted to settle internationaltransactions. The exporter wants thisdocument to be sure that there is norisk of non-payment.

(vi) Arranging for finance: Theimporter should make arrangements inadvance to pay to the exporter onarrival of goods at the port. Advancedplanning for financing imports isnecessary so as to avoid hugedemurrages (i.e., penalties) on theimported goods lying uncleared at theport for want of payments.(vii) Receipt of shipment advice:After loading the goods on the vessel,the overseas supplier dispatches theshipment advice to the importer. Ashipment advice contains informationabout the shipment of goods. Theinformation provided in the shipmentadvice includes details such as invoicenumber, bill of lading/airways billnumber and date, name of the vesselwith date, the port of export,description of goods and quantity, andthe date of sailing of vessel.(viii) Retirement of import docu-ments: Having shipped the goods, theoverseas supplier prepares a set ofnecessary documents as per the termsof contract and letter of credit andhands it over to his or her banker fortheir onward transmission andnegotiation to the importer in themanner as specified in the letter ofcredit. The set of documents normallycontains bill of exchange, commercialinvoice, bill of lading/airway bill,packing list, certificate of origin, marineinsurance policy, etc.

The bill of exchange accompanyingthe above documents is known as thedocumentary bill of exchange. Asmentioned earlier in connection with


the export procedure, documentary billof exchange can be of two types:documents against payment (sightdraft) and documents againstacceptance (usance draft). In the caseof sight draft, the drawer instructs thebank to hand over the relevantdocuments to the importer only againstpayment. But in the case of usancedraft, the drawer instructs the bank tohand over the relevant documents tothe importer against acceptance of thebill of exchange. The acceptance of billof exchange for the purpose of gettingdelivery of the documents is known asretirement of import documents. Oncethe retirement is over, the bank handsover the import documents to theimporter.(ix) Arrival of goods: Goods areshipped by the overseas supplier as perthe contract. The person in charge ofthe carrier (ship or airway) informs theofficer in charge at the dock or theairport about the arrival of goods in theimporting country. He provides thedocument called import generalmanifest. Import general manifest is adocument that contains the details ofthe imported goods. It is a documenton the basis of which unloading ofcargo takes place.(x) Customs clearance and releaseof goods: All the goods imported intoIndia have to pass through customsclearance after they cross the Indianborders. Customs clearance is asomewhat tedious process and calls forcompleting a number of formalities. Itis, therefore, advised that importersappoint C&F agents who are well

versed with such formalities and playan important role in getting the goodscustoms cleared.

Firstly, the importer has to obtaina delivery order which is otherwiseknown as endorsement for delivery.Generally when the ship arrives at theport, the importer obtains theendorsement on the back of the bill oflading. This endorsement is done bythe concerned shipping company. Insome cases instead of endorsing the bill,the shipping company issues a deliveryorder. This order entitles the importerto take the delivery of goods. Of course,the importer has to first pay the freightcharges (if these have not been paid bythe exporter) before he or she can takepossession of the goods.

The importer has to also pay dockdues and obtain port trust duesreceipt. For this, the importer has tosubmit to the ‘Landing and ShippingDues Office’ two copies of a duly filledin form — known as ‘application toimport’. The ‘Landing and ShippingDues Office’ levies a charge for servicesof dock authorities which has to beborne by the importer. After paymentof dock charges, the importer is givenback one copy of the application as areceipt. This receipt is known as ‘porttrust dues receipt’.

The importer then fills in a form ‘billof entry’ for assessment of customsimport duty. One appraiser examinesthe document carefully and gives theexamination order. The importerprocures the said document preparedby the appraiser and pays the duty,if any.


Major Documents used in an Import Transaction

Trade enquiry: A trade enquiry is a written request by an importing firm to theexporter for supply of information regarding the price and various terms andconditions on which the latter exports goods.

Proforma invoice: A proforma invoice is a document that contains details as to thequality, grade, design, size, weight and price of the export product, and the termsand conditions on which their export will take place.

Import order or indent: It is a document in which the buyer (importer) orders forsupply of requisite goods to the supplier (exporter). The order or indent contains theinformation such as quantity and quality of goods to be imported, price to be charged,method of forwarding the goods, nature of packing, mode of payment, etc.

Letter of credit: It is document that contains a guarantee from the importer bankto the exporter’s bank that it is undertaking to honour the payment up to a certainamount of the bills issued by the exporter for exports of the goods to the importer.

Shipment advice: The shipment advice is a document that the exporter sends tothe importer informing him that the shipment of goods has been made. Shipmentof advice contains invoice number, bill of lading/airways bill number and date,name of the vessel with date, the port of export, description of goods and quantity,and the date of sailing of the vessel.

Bill of lading: It is a document prepared and signed by the master of the shipacknowledging the receipt of goods on board. It contains terms and conditions onwhich the goods are to be taken to the port of destination.

Airway Bill: Like a bill of lading, an airway bill is a document wherein an airline/shipping company gives its official receipt of the goods on board its aircraft and atthe same time gives an undertaking to carry them to the port of destination. It isalso a document of title to the goods and as such is freely transferable by theendorsement and delivery.

Bill of entry: Bill of entry is a form supplied by the customs office to the importer. It isto be filled in by the importer at the time of receiving the goods. It has to be in triplicateand is to be submitted to the customs office. The bill of entry contains informationsuch as name and address of the importer, name of the ship, number of packages,marks on the package, description of goods, quantity and value of goods, name andaddress of the exporter, port of destination, and customs duty payable.

Bill of exchange: It is a written instrument whereby the person issuing theinstrument directs the other party to pay a specified amount to a certain personor the bearer of the instrument. In the context of an export-import transaction,bill of exchange is drawn by the exporter on the importer asking the latter to paya certain amount to a certain person or the bearer of the bill of exchange. Thedocuments giving title to the export consignment are passed on to the importeronly when the importer accepts the order contained in the bill of exchange.

Sight draft: It is a type of bill of exchange wherein the drawer of the bill of exchangeinstructs the bank to hand over the relevant documents to the importer onlyagainst payment.


After payment of the import duty,the bill of entry has to be presented tothe dock superintendent. The same hasto be marked by the superintendentand an examiner will be asked tophysically examine the goods imported.The examiner gives his report on thebill of entry. The importer or his agentpresents the bill of entry to the portauthority. After receiving necessarycharges, the port authority issues therelease order.

12.3 FOREIGN TRADE PROMOTION:INCENTIVES AND

ORGANISATIONAL SUPPORT

Various incentives and schemes areoperational in the country to helpbusiness firms improve competitivenessof their exports. From time-to-time, thegovernment has also setup a numberof organisations to provide infra-structural support and marketingassistance to firms engaged ininternational business. Major foreigntrade promotion schemes andorganisations are discussed in thefollowing sections.

12.3.1 Foreign Trade PromotionMeasures and Schemes

Details of various trade promotionmeasures and schemes available tobusiness firms to facilitate their exportand import operations are announcedby the government in its export-import(EXIM) policy. Major trade promotionmeasures (especially those related toexports) are as follows:(i) Duty drawback scheme: Sincegoods meant for exports are notconsumed domestically, these are notsubjected to payment of various exciseand customs duties. Any such dutiespaid on export goods are, therefore,refunded to exporters on production ofproof of exports of these goods to theconcerned authorities. Such refundsare called duty draw backs. Somemajor duty draw backs include refundof excise duties paid on goods meantfor exports, refund of customs dutiespaid on raw materials and machinesimported for export production. Thelatter is also called customs drawback.(ii) Export manufacturing underbond scheme: This facility entitlesfirms to produce goods without

Usance draft: It is a type of bill of exchange wherein the drawer of the bill of exchangeinstructs the bank to hand over the relevant documents to the importer onlyagainst acceptance of the bill of exchange.

Import general manifest. Import general manifest is a document that contains thedetails of the imported good. It is the document on the basis of which unloading ofcargo takes place.Dock challan: Dock charges are to be paid when all the formalities of the customsare completed. While paying the dock dues, the importer or his clearing agentspecifies the amount of dock dues in a challan or form which is known as dockchallan.


payment of excise and other duties.The firms desirous of availing suchfacility have to give an undertaking(i.e., bond) that they are manufacturinggoods for export purposes andwill export such products on theirproduction.(iii) Exemption from payment ofsales taxes: Goods meant for exportpurposes are not subject to sales tax.Even for a long time, income derivedfrom export operations had beenexempt from payment of income tax.Now this benefit of exemption fromincome tax is available only to 100 percent Export Oriented Units (100 percent EOUs) and units set up in ExportProcessing Zones (EPZs)/SpecialEconomic Zones (SEZs) for select years.We shall shortly discuss about the 100per cent Export Oriented Units (100 percent EOUs) and units set up in ExportProcessing Zones (EPZs)/SpecialEconomic Zones (SEZs) in thesucceeding paragraphs.(iv) Advance licence scheme: It is ascheme under which an exporter isallowed duty free supply of domestic aswell as imported inputs required for themanufacture of export goods. As suchthe exporter is not required to paycustoms duty on goods imported foruse in the manufacture of export goods.The advance licences are available toboth the types of exporters — those whoexport on a regular basis and also tothose who export on an adhoc basis. Theregular exporters can avail suchlicences against their productionprogrammes. The firms exporting

intermittently can also obtain theselicences against specific export orders.(v) Export Promotion Capital GoodsScheme (EPCG): The main objective ofthis scheme is to encourage the importof capital goods for export production.This scheme allows export firms toimport capital goods at negligible orlower rates of customs duties subjectto actual user condition and fulfilmentof specified export obligations. If thesaid conditions are fulfilled by themanufacturers, then they can import thecapital goods either at zero orconcessional rate of import duty.Supporting manufacturers and serviceproviders are also eligible to importcapital goods under this scheme. Thisscheme is especially beneficial to theindustrial units interested inmodernisation and upgradation of theirexisting plant and machinery. Nowservice export firms can also avail of thisfacility for importing items such ascomputer software systems required fordeveloping softwares for purposesof exports.(vi) Scheme of recognising exportfirms as export house, trading houseand superstar trading house: Withan objective to promote establishedexporters and assist them in marketingtheir products in internationalmarkets, the government grants thestatus of Export House, TradingHouse, Star Trading House to selectexport firms. This status is granted toa firm on its achieving a prescribedaverage export of performance in pastselect years. Besides attaining a


minimum of past average exportperformance, such export firms have toalso fulfill other conditions as laiddown in the import-export policy.Various categories of export houseshave been recognised with a view tobuilding marketing infrastructureand expertise required for exportpromotion. These houses are givennational recognition for exportpromotion. They are required to operateas highly professional and dynamicinstitutions and act as an importantinstrument of export growth.(vii) Export of Services: In order toboost the export of services, variouscategories of service houses have beenrecognised. These houses are recognisedon the basis of the export performanceof the service providers. They arereferred to as Service Export House,International Service Export House,International Star Service Export Housebased on their export performance.(viii) Export finance: Exportersrequire finance for the manufacture ofgoods. Finance is also needed after theshipment of the goods because it maytake sometime to receive payment fromthe importers. Therefore, two types ofexport finances are made available tothe exporters by authorised banks.They are termed as pre-shipmentfinance or packaging credit and post-shipment finance. Under the pre-shipment finance, finance is providedto an exporter for financing thepurchase, processing, manufacturingor packaging of goods for exportpurpose. Under the post-shipmentfinance scheme, finance is provided to

the exporter from the date of extendingthe credit after the shipment of goodsto the export country. The finance isavailable at concessional rates ofinterest to the exporters.(ix) Export Processing Zones (EPZs):Export Processing Zones are industrialestates, which form enclaves from theDomestic Tariff Areas (DTA). These areusually situated near seaports orairports. They are intended to providean internationally competitive duty freeenvironment for export production atlow cost. This enables the products ofEPZs to be competitive, both quality-wise and price-wise, in the internationalmarkets. These zones have been setup at various places in India whichinclude: Kandla (Gujarat), Santa Cruz(Mumbai), Falta (West Bengal), Noida(Uttar Pradesh), Cochin (Kerala),Chennai (Tamil Nadu), andVishakapatnam (Andhra Pradesh).

Santa Cruz zone is exclusivelymeant for electronic goods and gem andjewellery items. All other EPZs deal withmultifarious items. Recently the EPZshave been converted to SpecialEconomic Zones (SEZs) which are moreadvanced form of export processingzones. These SEZs are free from allrules and regulations governingimports and exports units exceptrelating to labour and banking

Government has also permitteddevelopment of EPZs by private, stateor joint sector. The inter-ministerialcommittee on private EPZs has alreadycleared proposals for setting up ofprivate EPZs in Mumbai, Surat andKanchipuram.


(x) 100 per cent Export OrientedUnits (100 per cent EOUs): The100 per cent Export Oriented Unitsscheme, introduced in early 1981, iscomplementary to the EPZ scheme. Itadopts the same production regime,but offers a wider option in locationwith reference to factors like source ofraw materials, ports, hinterlandfacilities, availability of technologicalskills, existence of an industrial baseand the need for a larger area of landfor the project. EOUs have beenestablished with a view to generatingadditional production capacity forexports by providing an appropriatepolicy framework, flexibility ofoperations and incentives.

12.3.2 Organisational Support

Government of India has also set upfrom time-to-time various institutionsin order to facilitate the process offoreign trade in our country. Some ofthe important institutions are as follows:Department of Commerce: Depart-ment of Commerce in the Ministry ofCommerce, Government of India is theapex body responsible for the country’sexternal trade and all mattersconnected with it. This may be in theform of increasing commercial relationswith other countries, state trading,export promotional measures and thedevelopment, and regulation of certainexport oriented industries andcommodities. The Department ofCommerce formulates policies in thesphere of foreign trade. It also framesthe import and export policy of thecountry in general.

Export Promotion Councils (EPCs):Export Promotion Councils are nonprofit organisations registered underthe Companies Act or the SocietiesRegistration Act, as the case may be.The basic objective of the exportpromotion councils is to promote anddevelop the country’s exports ofparticular products falling under theirjurisdiction. At present there are21 EPC’s dealing with differentcommodities.Commodity Boards: CommodityBoards are the boards which havebeen specially established by theGovernment of India for thedevelopment of production oftraditional commodities andtheir exports. These boards aresupplementary to the EPCs. Thefunctions of commodity boards aresimilar to those of EPCs. At presentthere are seven commodity boardsin India: Coffee Board, Rubber Board,Tobacco Board, Spice Board, CentralSilk Board, Tea Board, and Coir Board.Export Inspection Council (EIC):Export Inspection Council of India wassetup by the Government of Indiaunder Section 3 of the Export QualityControl and Inspection Act 1963. Thecouncil aims at sound development ofexport trade through quality controland pre-shipment inspection. Thecouncil is an apex body for controllingthe activities related to quality controland pre-shipment inspection ofcommodities meant for export. Barringa few exceptions, all the commoditiesdestined for exports must be passedby EIC.


Indian Trade Promotion Organi-sation (ITPO): Indian TradePromotion Organisation was setupon 1st January 1992 under theCompanies Act 1956 by the Ministryof Commerce, Government of India. Itsheadquarter is at New Delhi. ITPO wasformed by merging the two erstwhileagencies viz., Trade DevelopmentAuthority and Trade Fair Authority ofIndia. ITPO is a service organisationand maintains regular and closeinteraction with trade, industry andGovernment. It serves the industry byorganising trade fairs and exhibitions—both within the country and outside, Ithelps export firms participate ininternational trade fairs andexhibitions, developing exports of newitems, providing support and updatedcommercial business information. ITPOhas five regional offices at Mumbai,Bangalore, Kolkata, Kanpur andChennai and four international officesat Germany, Japan, UAE and USA.Indian Institute of Foreign Trade(IIFT): Indian Institute of ForeignTrade is an institution that was setupin 1963 by the Government of India asan autonomous body registered underthe Societies Registration Act with theprime objective of professionalising thecountry’s foreign trade management. Ithas recently been recognised asDeemed University. It provides trainingin international trade, conductresearches in areas of internationalbusiness, and analysing anddisseminating data relating tointernational trade and investments.

Indian Institute of Packaging (IIP):The Indian Institute of Packaging wasset up as a national institute jointly bythe Ministry of Commerce, Governmentof India, and the Indian Packagingindustry and allied interests in 1966.Its headquarters and principallaboratory is situated at Mumbai andthree regional laboratories are locatedat Kolkata, Delhi and Chennai. It is atraining-cum-research institutepertaining to packaging and testing. Ithas excellent infrastructural facilitiesthat cater to the various needs of thepackage manufacturing and packageuser industries. It caters to thepackaging needs with regard to boththe domestic and export markets. Italso undertakes technical consultancy,testing services on packagingdevelopments, training and edu-cational programmes, promotionalaward contests, information servicesand other allied activities.State Trading Organisations: A largenumber of domestic firms in Indiafound it very difficult to compete in theworld market. At the same time, theexisting trade channels wereunsuitable for promotion of exportsand bringing about diversification oftrade with countries other thanEuropean countries. It was under thesecircumstances that the State TradingOrganisation (STC) was setup in May1956. The main objective of the STC isto stimulate trade, primarily exporttrade among different trading partnersof the world. Later the government setup many more organisations such as


Metals and Minerals TradingCorporation (MMTC), Handloom andHandicrafts Export Corporation(HHEC).

12.4 INTERNATIONAL TRADE

INSTITUTIONS AND TRADE

AGREEMENTS

The First World War (1914-1919) andthe Second World War (1939-45) wereaccompanied by massive destructionof life and property the world over.Almost all the economies of the worldwere adversely affected. Due to scarcityof resources, countries were not in aposition to take up any reconstructionor developmental works. Even theinternational trade amongst nations gotadversely affected because of thedisruption of the world’s currencysystem. There was no system ofgenerally accepted exchange rate. Itwas at that juncture that representativeof forty-four nations under theleadership of J.M. Keynes — a notedeconomist joined together at BrettonWoods, New Hampshire to identifymeasures to restore peace andnormalcy in the world.

The meeting was concluded withthe setting up of three internationalinstitutions, namely the InternationalMonetary Fund (IMF), InternationalBank for Reconstruction andDevelopment (IBRD) and theInternational Trade Organisation (ITO).They considered these threeorganisations as three pillars ofeconomic development of the world.While the World Bank was assigned

with the task of reconstructing war-torneconomies — especially the ones inEurope, the IMF was entrusted with theresponsibility of ensuring stabilisationof exchange rates to pave way for theexpansion of world trade. The mainobjective of the ITO as they couldforesee at that time was to promote andfacilitate international trade among themember countries by overcomingvarious restrictions and discrimi-nations that were being practiced atthat time.

The first two institutions, viz., IBRDand IMF, came into existenceimmediately. The idea of setting up ofITO, however, could not materialise dueto stiff opposition from the UnitedStates. Instead of an organisation,what eventually emerged was anarrangement to liberalise internationaltrade from high customs tariffs andvarious other types of restrictions. Thisarrangement came to be known as theGeneral Agreement for Tariffs andTrade (GATT). India was one of thefounding members of these threeinternational bodies. The majorobjectives and functions of these threeinternational institutions are discussedin more detail in the following sections.

12.4.1 World Bank

The International Bank for Re-construction and Development (IBRD),commonly known as World Bank, wasresult of the Bretton Woods Conference.The main objectives behind setting upthis international organisation were toaid the task of reconstruction of the


war-affected economies of Europe andassist in the development of theunderdeveloped nations of the world.For the first few years, the World Bankremained preoccupied with the task ofrestoring war-torn nations in Europe.Having achieved success inaccomplishing this task by late 1950s,the World Bank turned its attention tothe development of underdevelopednations. It realised that by investingmore and more in these countries,especially in social sectors likehealth and education; it could bringabout the needed social andeconomic transformation of thedeveloping countries. To give shapeto this investment aspect inthe underdeveloped nations, theInternational Development Association(IDA) was formed in the year 1960. Themain objective underlying setting upIDA has been to provide loans onconcessional terms and conditions tothose countries whose per capitaincomes are below a critical level.Concessional terms and conditionsmean that (i) repayment period is muchlonger than the repayment period ofIBRD, and (ii) the borrowing nationneed not pay any interest on theborrowed amount. IDA, thus, provides

interest free long-term loans to the poornations. IBRD also provides loans butthese carry interest charged oncommercial basis.

Over the time, additional organi-sations have been set up under theumbrella of the World Bank. As oftoday, the World Bank is a group of fiveinternational organisations responsiblefor providing finance to differentcountries. The group and its affiliatesheadquartered in Washington DCcatering to various financial needs arelisted in the Box A on World Bank andits affiliates.

Functions of the World Bank

As mentioned earlier, the World Bankis entrusted with the task of economicgrowth and widening of the scope ofinternational trade. During its initialyears of inception, it placed moreemphasis on developing infrastructurefacilities like energy, transportation andothers. No doubt all this has benefitedthe under-developed nations too, butthe results were not found to be verysatisfactory due to poor administrativestructure, lack of institutionalframework and non-availability ofskilled labour in these countries.Moreover, since the underdeveloped

Box AWorld Bank and its Affiliates

InstitutionInternational Bank for Reconstruction and Development (IBRD) 1945International Financial Corporation (IFC) 1956International Development Association (IDA) 1960Multilateral Investment Guarantee Agency (MIGA) 1988International Centre for Settlement of Investment Disputes (ICSID) 1966

Year ofestablishment


countries depend heavily onagriculture and small industries, theattempt to develop infrastructure hadhardly any effect on these two sectors.Realising these problems, the WorldBank later decided to divert resourcesto bring about industrial andagricultural development in thesecountries. Assistance is extended todifferent countries for raising cashcrops so that their incomes rise andthey may export the same for earningforeign exchange. The bank has alsobeen providing resources for education,sanitation, health care and small scaleenterprises.

Today, the services provided by theWorld Bank have increased manifold.The World Bank is no longer confined tosimply providing financial assistance forinfrastructure development, agriculture,industry, health and sanitation. It israther significantly involved in areas likeremoval of rural poverty through raisingproductivity, increasing income of therural poor, providing technical support,and initiating research and cooperativeventures.

12.4.2 International DevelopmentAssociation

International Development Association(IDA) was set up in 1960 as an affiliateof the World Bank. IDA was establishedprimarily to provide finance to the lessdeveloped member countries on a softloan basis. It is due to its objective ofproviding soft loans that it is called theSoft Loan Window of the IBRD.

Major objectives of IDA include

• To provide development financeon easy terms to the lessdeveloped member countries,

• To provide assistance for povertyalleviation in the poorestcountries,

• To provide finance at concessionalinterest rates in order to promoteeconomic development, raiseproductivity and living standardsin less developed nations, and

• To extend macro economicmanagement services such asthose relating to health, edu-cation, nutrition, human resourcedevelopment and populationcontrol.

12.4.3 International FinanceCorporation (IFC)

IFC was established in July 1956 inorder to provide finance to the privatesector of developing countries. IFC isalso an affiliate of the World Bank, butit has its own separate legal entity,funds and functions. All the membersof the World Bank are eligible tobecome members of IFC.

12.4.4 The MultinationalInvestment GuaranteeAgency (MIGA)

The Multinational Investment Gua-rantee Agency was established in April1988 to supplement the functions ofthe World Bank and IFC.


Major objectives of MIGA are

• To encourage flow of directforeign investment into the lessdeveloped member countries;

• To provide insurance cover toinvestors against political risks;

• To provide guarantee against non-commercial risks (like dangersinvolved in currency transfer, warand civil disturbances and breachof contract);

• To insure new investments,expansion of existing investments,privatisation and financial re-structuring;

• To provide promotional andadvisory services; and

• To establish credibility.

12.4.5 International MonetaryFund

International Monetary Fund (IMF) isthe second international organisationnext to the World Bank. IMF whichcame into existence in 1945 has itsheadquarters located in Washington DC.In 2005, it had 191 countries as itsmembers. The major idea underlyingthe setting up of the IMF is to evolve anorderly international monetary system,i.e., facilitating system of internationalpayments and adjustments inexchange rates among nationalcurrencies.

Major objectives of IMF include

• To promote internationalmonetary cooperation through apermanent institution,

• To facilitate expansion of balancedgrowth of international trade andto contribute thereby to thepromotion and maintenance ofhigh levels of employment and realincome,

• To promote exchange stabilitywith a view to maintain orderlyexchange arrangements amongmember countries, and

• To assist in the establishment of amultilateral system of paymentsin respect of current transactionsbetween members.

Functions of IMF

Various functions are performed by theIMF to achieve the aforesaid objectives.Some of the important functions of IMFinclude:

• Acting as a short-term creditinstitution;

• Providing machinery for theorderly adjustment of exchangerates;

• Acting as a reservoir of thecurrencies of all the membercountries, from which a borrowernation can borrow the currency ofother nations;

• Acting as a lending institution offoreign currency and currenttransaction;

• Determining the value of acountry’s currency and altering it,if needed, so as to bring about anorderly adjustment of exchangerates of member countries; and

• Providing machinery for inter-national consultations.


12.4.6 World Trade Organisation(WTO) and MajorAgreements

Like on the lines of IMF and the WorldBank, it was initially decided at theBretton Woods conference to set up theInternational Trade Organisation (ITO)to promote and facilitate internationaltrade among the member countriesand to overcome various restrictionsand discriminations as were beingpracticed at that time. But the ideacould not materialise due to stiffopposition from the United States.Instead of altogether abandoning theidea, the countries that wereparticipants to the Bretton Woodsconference agreed upon having somearrangement among themselves so asto liberalise the world from highcustoms tariffs and various other typesof restrictions that were in vogue at thattime. This arrangement came to beknown as the General Agreement forTariffs and Trade (GATT).

GATT came into existence witheffect from 1st January 1948 andremained in force till December 1994.Various rounds of negotiations havetaken place under the auspices ofGATT to reduce tariff and non-tariffbarriers. The last one, known as theUruguay Round, was the mostcomprehensive one in terms of coverageof issues, and also the lengthiest onefrom the point of view of duration ofnegotiations which lasted over a periodof seven years from 1986 to 1994.

One of the key achievements of theUruguay Round of GATT negotiations

was the decision to set up a permanentinstitution for looking after thepromotion of free and fair tradeamongst nations. Consequent to thisdecision, the GATT was transformed intoWorld Trade Organisation (WTO) witheffect from 1st January 1995. The headquarters of WTO are situated at Geneva,Switzerland. Establishment of WTO,thus, represents the implementation ofthe original proposal of setting up of theITO as evolved almost five decades back.

Though, WTO is a successor toGATT, it is a much more powerful bodythan GATT. It governs trade not only ingoods, but also in services andintellectual property rights. UnlikeGATT, the WTO is a permanentorganisation created by an internationaltreaty ratified by the governments andlegislatures of member states. It is,moreover, a member driven rule-basedorganisation in the sense that allthe decisions are taken by themember governments on the basis of ageneral consensus. As the principalinternational body concerned withsolving trade problems betweencountries and providing a forum formultilateral trade negotiations, it has aglobal status similar to that of the IMFand the World Bank. India is a foundingmember of WTO. As on 11th December2005, there were 149 members in WTO.

Objectives of WTOThe basic objectives of WTO are similarto those of GATT, i.e., raising standardsof living and incomes, ensuring fullemployment, expanding production andtrade, and optimal use of the world’s


resources. The major difference betweenthe objectives of GATT and WTO is thatthe objectives of WTO are more specificand also extend the scope of WTO to covertrade in services. WTO objectives,moreover, talk of the idea of ‘sustainabledevelopment’ in relation to the optimaluse of the world’s resources so as toensure protection and preservation of theenvironment. Keeping in view the abovediscussion, we can state more explicitlythe following as the major objectives ofWTO:

• To ensure reduction of tariffs andother trade barriers imposed bydifferent countries;

• To engage in such activities whichimprove the standards of living,create employment, increaseincome and effective demand andfacilitate higher production andtrade;

• To facilitate the optimal use of theworld’s resources for sustainabledevelopment; and

• To promote an integrated, moreviable and durable trading system.

Functions of WTO

The major functions of WTO include:• Promoting an environment that is

encouraging to its membercountries to come forward to WTOin mitigating their grievances;

• Laying down a commonlyaccepted code of conduct with aview to reducing trade barriersincluding tariffs and eliminatingdiscriminations in internationaltrade relations;

• Acting as a dispute settlementbody;

• Ensuring that all the rulesregulations prescribed in the Actare duly followed by the membercountries for the settlement of theirdisputes;

• Holding consultations with IMFand IBRD and its affiliatedagencies so as to bring betterunderstanding and cooperationin global economic policy making;and

• Supervising on a regular basis theoperations of the revised Agree-ments and Ministerial declarationsrelating to goods, services andTrade Related IntellectualProperty Rights (TRIPS).

Benefits of WTO

Since its inception in 1995, WTO hascome a long way in constituting thelegal and institutional foundation of thepresent day multilateral tradingsystem. It has been instrumental notonly in facilitating trade, but also inimproving living standards andcooperation among membercountries. Some of the major benefitsof WTO are as follows:

• WTO helps promote internationalpeace and facilitates internationalbusiness.

• All disputes between membernations are settled with mutualconsultations.

• Rules make international tradeand relations very smooth andpredictable.


• Free trade improves the livingstandard of the people byincreasing the income level.

• Free trade provides ample scopeof getting varieties of qualitativeproducts.

• Economic growth has beenfastened because of free trade.

• The system encourages goodgovernment.

• WTO helps fostering growth ofdeveloping countries by providingthem with special and preferentialtreatment in trade relatedmatters.

WTO Agreements

As against GATT which covered onlyrules relating to trade in goods, theWTO agreements cover trade in goods,services as well as intellectual property.The agreements contain the procedurefor settling disputes and also haveprovisions for special treatment todeveloping countries. The agreementsrequire the governments to make theirtrade policies transparent by notifyingto the WTO office about the laws andmeasures adopted towards tradeliberalisation. Major WTO agreementsare discussed below:Agreements Forming Part of GATT:The erstwhile General Agreement onTariffs and Trade (GATT) after itssubstantial modification in 1994(effected as part of the Uruguay Roundof negotiations) is very much part of theWTO agreements. Besides the generalprinciples of trade liberalisation,GATT also includes certain special

agreements evolved to deal with specificnon-tariff barriers. Some of the specificagreements contained in the GATTare listed in the bank on GATT 1994major agreements.Agreement on Textile and Clothing(ATC): This agreement was evolvedunder WTO to phase out the quotarestrictions as imposed by thedeveloped countries on exports oftextiles and clothing from thedeveloping countries. The developedcountries were imposing various kindsof quota restrictions under the Multi-Fibre Arrangement (MFA) that itself wasa major departure from the GATT’sbasic principle of free trade in goods.Under the ATC, the developed countriesagreed to remove quota restrictions ina phased manner during a period often years starting from 1995. ATC isconsidered as a landmark achievementof the WTO. It is due to the ATC thatthe world trade in textile and clothinghas become virtually quota free since1st January 2005, thus, benefitingimmensely the developing countriesto expand their textiles andclothing exports.Agreement on Agriculture (AoA): Itis an agreement to ensure free and fairtrade in agriculture. Though originalGATT rules were applicable to trade inagriculture, these suffered from certainloopholes such as exemption tomember countries to use some non-tariff measures such as customs tariffs,import quotas and subsidies to protectinterests of the farmers in the homecountry. Trade in agriculture becamehighly distorted especially due to use


of subsidies by some of the developedcountries. AoA is a significant steptowards an orderly and fair trade inagricultural products. The developedcountries have agreed to lower downthe customs duties on their importsand subsidies to the exports ofagricultural products. Due to theirhigher dependence on agriculture, thedeveloping countries have beenexempted from making similarreciprocal offers.General Agreement on Trade inServices (GATS): Services means actsor performances that are essentiallyintangible and cannot be touched orsmelt as goods. GATS is regarded as alandmark achievement of the UruguayRound as it extends the multilateralrules and disciplines to services. It isbecause of GATS that the basic rulesgoverning ‘trade in goods’ have becomeapplicable to ‘trade in services’.

Three major provisions of GATSgoverning trade in services are asfollows:

• All member countries are requiredto remove restrictions on trade inservices in a phased manner. Thedeveloping countries, however,have been given a greater freedomto decide about the period bywhich they would liberalise andalso the services they would liketo liberalise by that period

• GATS provides that trade inservices is governed by ‘MostFavoured Nations’ (MFN)obligation that prevents countriesfrom discriminating among foreignsuppliers and services.

• Each member country shallpromptly publish all its relevantlaws and regulations pertaining toservices including internationalagreements pertaining to tradeand services to which the memberis a signatory.

Agreement on Trade RelatedAspects of Intellectual PropertyRights (TRIPS): The WTO’s agree-ment on Trade Related Aspects of

GATT 1994: Major Agreements

• Agreement on Customs Valuation i.e., Agreement on Implementation ofArticle VII (Customs Valuation) of GATT 1994

• Agreement on Pre-shipment Inspection

• Agreement on Technical Barriers to Trade

• Agreement on Import Licensing Procedures

• Agreement on Application of Sanitary and Phytosanitary Measures

• Agreement on Safeguards

• Agreement on Subsidies and Countervailing Measures

• Agreement on Anti-dumping Duties, i.e., Agreement on Implementation ofArticle VI (Anti-dumping) of GATT 1994

• Agreement on Rules of Origin


SUMMARY

Introduction: Exporting and importing are not such straight forwardactivities as buying and selling in the domestic market. Since foreign tradetransactions involve movement of goods across frontiers and use of foreignexchange, a number of formalities are needed to be performed before thegoods leave the boundaries of a country and enter into that of another.

Export Procedures: The starting point in an export transaction is the receiptof an enquiry from the overseas buyer. In response, the exporter preparesan export quotation — called proforma invoice, giving details about the exportgoods and the terms and conditions of export. In case the importer finds

Proforma invoiceOrder or intentExport licenceIEC numberRegistration cummembershipcertificatePre-shipment financePre-shipmentinspectionExport inspectionagencyExcise clearanceCertificate of originCustoms clearanceLetter of creditShipping billMate receipt

Bill of ladingAirway billInvoiceBill of exchangeSight draftUsance draftNegotiation of billsMarine insurancepolicyCart ticketBank certificate ofpaymentCertificate ofinspectionTrade enquiryShipment adviceImport generalmanifest

Delivery orderBill of entryC&F agentPort trust dues receiptDuty drawback schemeExport manufacturingunder bond schemeAdvance licence schemeExport Promotion CapitalGoods Scheme (EPCG)Export financePost-shipment financeExport processing zone(EPZ)100% Export OrientedUnit (100% EOU)Department of CommerceExport promotion council

Key Terms

Intellectual Property Rights (TRIPS)was negotiated in 1986-1994. It wasthe Uruguay Round of GATTnegotiations where for the first timethe rules relating to intellectualproperty rights were discussed andintroduced as part of the multilateraltrading system. Intellectual propertymeans information with commercialvalues such as ideas, inventions,

creative expression and others. Theagreement sets out the minimumstandards of protection to be adoptedby the parties in respect of sevenintellectual properties, viz., copyrights and related rights, trade marks,geographical indication, industrialdesigns, patents, layout design ofintegrated circuits, and undisclosedinformation (trade secrets).

CommodityboardsIIFTIndianInstitute ofPackagingITPOExportInspectionCouncilStatetradingorganisations


the quotation acceptable, he places an order or indent and gets a letter ofcredit issued from his bank to the exporter. The exporter then proceedswith the formalities related to obtaining an export licence from the DirectorGeneral of Foreign Trade and getting a registration-cum-membershipcertificate from the export promotion council looking after the export of theconcerned product. In case the exporter requires funds, he/she can availof pre-shipment finance from a bank. The exporter then proceeds with theproduction or procurement of the goods and gets them inspected from ExportInspection Council. If required by the importer, the exporter approachesthe foreign consulate for obtaining the certificate of origin to enable theimporter to claim tariff or quota concessions at the time of clearance ofcargo at the import destination. The exporter then makes arrangement forreserving space on the ship and insuring goods against transit perils. Afterobtaining the excise clearance, goods are sent to the concerned port forcustoms clearance. Since customs clearance is a tedious process, exportersoften employ C&F agents for availing their services in preparation of variouscustoms documents and getting the goods customs cleared.

After customs clearance and payment of dock charges to the port authoritiesand freight charges to the shipping company, goods are loaded on the ship.The captain of the ship issues a mate’s receipt. This mate’s receipt issubmitted to the shipping company’s office for payment of freight. Afterreceiving the freight charges, the shipping company issues a bill of ladingwhich is a document of contract relating to shipment of the goods by theshipping company. Once the goods are despatched, the exporter preparesan invoice and sends the necessary documents such as certified copy ofinvoice, bill of lading, packing list, insurance policy, certificate of origin,letter of credit and bill of exchange to the importer through his/her bank.The bank presents these documents to the importer. On getting acceptanceof the bill of exchange by the importer, the documents are handed over tothe importer to enable him/her to claim the imported goods. Once thepayment is received, the exporter requests his/her bank to release acertificate of payment. Certificate of payment is a document that certifiesthat the export transaction is over and the payment has been received.

Import Procedure: The procedure to import is also beset with severalformalities. The process starts with a search for export firms and making atrade enquiry about the product, its price and terms and conditions ofexports. Having selected an export firm, the importer asks the exporter tosend him/her a formal quotation — called proforma invoice. The importerthen proceeds to obtain the import licence, if required, from the office of theDirectorate General Foreign Trade (DGFT) or Regional Import ExportLicensing Authority. The importer also applies for the Import Export Code(IEC) number. This number is required to be mentioned on most of theimport documents. Since payment for imports requires foreign currency,the importer has to also make an application to a bank authorised forsanction of the necessary foreign exchange.


After obtaining an import licence, the importer places an import order orindent with the exporter for supply of the specified products. If required asper the terms of contract, the importer arranges for the issuance of a letterof credit to the exporter from the bank. Having shipped the goods undershipment advice to the importer, the exporter sends a set of necessarydocuments containing bill of exchange, commercial invoice, bill of lading/airway bill, packing list, certificate of origin, marine insurance policy, etc.,to enable the importer claim title to the goods on their arrival at the port ofdestination. The exporter sends these documents through his/her bankto the importer. The bank presents these documents to the importer andafter obtaining his/her acceptance of the bill of exchange, delivers thedocuments to the importer.

After the arrival of the goods in the importing country, the person in chargeof the carrier (ship or airway) prepares import general manifest to informthe officer in charge at the dock or the airport that the goods have reachedthe ports of the importing country. The importer or his/her C&F agent paysthe freight (if not already paid by exporter) to the shipping company andobtains delivery order from it which entitles the importer to take the deliveryof the goods at the port. At this time, port dock dues are also paid and aport trust dues receipt is obtained. The importer then fills in a form ‘bill ofentry’ for assessment of customs import duty. After payment of the importduty, the bill of entry has to be presented to the dock superintendent forphysical examination of the goods. The examiner gives his report on the billof entry. The importer or his agent presents the bill of entry to the portauthority for issuance of the release order.

Foreign Trade Promotion: A number of schemes such as duty drawback,export manufacturing under bond, exemption from payment of sales tax,advance licence, Export Promotion Capital Goods (EPCG), 100 per cent ExportOriented Units (100 per cent EOUs) and Export Processing Zones (EPZs)/Special Economic Zones (SEZs) are in operation in the country to help theexport firms compete more effectively in world markets. The schemes permitthe exporters either to make outrightly duty free imports of raw materialsand machinery as needed for producing goods and services for exports orto later claim refund of duties, if already paid, on such imports. The exportersare, moreover, either outrightly exempted from payment of excise dutiesand other taxes or else they can later claim refund of such duties onsubmitting proof of export to the concerned authorities.

There also exist in the country the scheme of recognising certain firms asexport house, trading house and super star trading house, and bestowingupon them certain advantages such as permission to maintain officesabroad, liberal grant of foreign exchange to enable them to meet the expenses


of participating in international trade fairs and exhibitions and travelabroad. As of today, even the firms engaged in exports of services are entitledto such recognition subject to attaining a minimum of past average exportperformance and fulfilling other conditions as laid down in the import-exportpolicy. Exporters are also entitled to pre-shipment and post-shipmentfinance to meet their financial requirements relating to export transactions.

International Trade Institutions: The Government of India hasside-by- side setup various organisations to facilitate and promote thecountry’s foreign trade. While the Department of Commerce in the Ministryof Commerce is the apex body responsible for regulation and administrationof the country’s external trade, other organisations like export promotioncouncils, commodity boards, Export Inspection Council (EIC), IndianInstitute of Foreign Trade (IIFT), India Trade Promotion Organisation (ITPO),Indian Institute of Packaging (IIP) help exporters by way of promotion ofspecific export products, quality inspection, participation in trade fairs andexhibitions, conducting training programmes, carrying out overseasresearches, disseminating product and market information, and providingpackaging consultancy and testing. The government has also set up statetrading organisations such as STC, MMTC and HHEC for trading in differentcommodities and promotion of country’s exports.

Trade Agreements: At the global level, there exist various internationalorganisations such as the World Bank, IMF and WTO for fostering economiccooperation, trade and investments among the countries. While the WorldBank and its four affiliates, viz., IDA, MIGA, IFC and ICSID, are concernedwith providing long term finance and finance related assistance such asprotection from risks to the member countries, IMF is devoted to maintenanceof exchange rates and providing short term loans to the countries facingshort term foreign exchange problems. In matters relating to trade, it wasoriginally conceived at the Bretton Woods conference to establishInternational Trade Organisation (ITO). But the idea somehow could notmaterialise. Instead an arrangement called General Agreement for Tariffsand Trade (GATT) was evolved to promote trade through reduction of tariffand non-tariff barriers. GATT came into existence with effect from 1st January1948 and remained in force till December 1994. Since 1st January 1995,GATT has been transformed into World Trade Organisation (WTO). UnlikeGATT, WTO is a permanent body and has a global status similar to that ofIMF and World Bank. WTO agreements cover trade in not only goods butalso in services and intellectual property through various agreements suchas Agreement on Textiles on Clothing (ATC), General Agreement on Tradein Services (GATS), Agreement Relating to Trade in Intellectual Property(TRIP) and Agreement on Agriculture (AoA).


EXERCISES


1. Which of the following documents are not required for obtaining anexport license?

a. IEC number b. Letter of creditc. Registration cum d. Bank account number

membership certificate

2. Which of the following documents is not required in connection with animport transaction?

a. Bill of lading b. Shipping billc. Certificate of origin d. Shipment advice

3. Which of the following do not form part of duty drawback scheme?

a. Refund of excise duties b. Refund of customs dutiesc. Refund of export duties d. Refund of income dock

charges at the port ofshipment

4. Which one of the following is not a document related to fulfill the customsformalities

a. Shipping bill b. Export licencec. Letter of insurance d. Proforma invoice

5. Which one of the following is not a part of export documents?

a. Commercial invoice b. Certificate of originc. Bill of entry d. Mate’s receipt

6. A receipt issued by the commanding officer of the ship when the cargois loaded on the ship is known as

a. Shipping receipt b. Mate receiptc. Cargo receipt d. Charter receipt


7. Which of the following document is prepared by the exporter andincludes details of the cargo in terms of the shippers name, the numberof packages, the shipping bill, port of destination, name of the vehiclecarrying the cargo?

a. Shipping bill b. Packaging listc. Mate’s receipt d. Bill of exchange

8. The document containing the guarantee of a bank to honour draftsdrawn on it by an exporter is

a. Letter of hypothetication b. Letter of creditc. Bill of lading d. Bill of exchange

9. Which of the following does not belong to the World Bank group?

a. IBRD b. IDAc. MIGA d. IMF

10. TRIP is one of the WTO agreements that deal with

a. Trade in agriculture b. Trade in servicesc. Trade related d. None of these

investment measures


1. Discuss the formalities involved in getting an export licence.

2. Why is it necessary to get registered with an export promotion council?

3. What is IEC number?

4. What is pre-shipment finance?

5. Why is it necessary for an export firm to go in for pre-shipmentinspection?

6. Discuss the procedure related to excise clearance of goods.

7. Explain briefly the process of customs clearance of export goods.

8. What is bill of lading? How does it differ from bill of entry?

9. What is shipping bill?


10. Explain the meaning of mate’s receipt.

11. What is a letter of credit? Why does an exporter need this document?

12. Discuss the process involved in securing payment for exports.

13. Differentiate between the following

(i) Sight and usance drafts (ii) Bill of lading and airway bill(iii) Pre-shipment and post-shipment finance

14. Explain the meaning of the following documents used in connectionwith import transactions

(i) trade enquiry (ii) Import licence (iii) Shipment of advice(iv) Import general manifest (v) Bill of entry

15. List out major affiliated bodies of the World Bank.

16. Write short notes on the following

(i) UNCTAD (ii) MIGA (iii) World Bank(iv) ITPO (v) IMF


1. Rekha Garments has received an order to export 2000 men’s trousersto Swift Imports Ltd. located in Australia. Discuss the procedure thatRekha Garments would need to go through for executing the exportorder.

2. Your firm is planning to import textile machinery from Canada. Describethe procedure involved in importing.

3. Discuss the principal documents used in exporting.

4. List and explain various incentives and schemes that the governmenthas evolved for promoting the country’s export.

5. Identify various organisations that have been set up in the country bythe government for promoting country’s foreign trade.

6. What is World Bank? Discuss its various objectives and role of itsaffiliated agencies.

7. What is IMF? Discuss its various objectives and functions.

8. Write a detailed note on features, structure, objectives and functioningof WTO.