B100 Introduction To Business Management (The Open University)

B100 An introduction to business and management
Block 1
Readings 1–11
By Anja Schaefer, with contributions from Chris Cornforth
This publication forms part of the Open University module B100 An introduction to business and management. Details of
this and other Open University modules can be obtained from Student Recruitment, The Open University, PO Box 197,
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First published 2015. Second edition 2017
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2.1
Contents
Reading 1: What is a business? 5
Introduction 5
1 Defining the meaning of business 5
Summary 7
References 8
Reading 2: Different types of business 9
Introduction 9
1 Classifying businesses by size 10
2 Classifying businesses by industry sector 12
3 Ownership structures and legal forms 13
4 Examples of different businesses 15
Summary 17
References 18
Reading 3: Businesses and other types of organisation 19
Introduction 19
1 The differences between organisations in the three sectors 20
2 Hybrid organisations 22
Summary 24
References 25
Reading 4: What is management? 26
Introduction 26
1 What managers do 27
2 What others think managers do 29
Summary 32
References 33
Reading 5: The external environment of a business 34
Introduction 34
1 Sociological factors 34
2 Technological factors 35
3 Economic factors 38
4 Environmental factors 40
5 Political and legal factors 42
6 Ethical factors 44
Summary 44
References 45
Reading 6: Business, society, stakeholders and ethics 46
Introduction 46
1 Business and society 46
2 Stakeholders 48
3 Business ethics 51
Summary 53
Reading 7: The business functions 54
Introduction 54
1 Human resource management 54
2 Marketing 55
3 Accounting and finance 56
4 Operations 58
5 Information management 58
Summary 59
Reading 8: SWOT analysis 60
Introduction 60
1 Strengths, weaknesses, opportunities and threats 60
2 Conducting a SWOT analysis 62
Summary 67
References 68
Reading 9: Organisational structure 69
Introduction 69
1 Types of organisational structure 70
2 The importance of structure 71
3 Formal and informal structures 74
4 Dimensions of structure 75
5 Virtual organisations 77
Summary 79
References 80
Reading 10: Organisational culture 81
Introduction 81
1 Definitions of culture 82
2 Elements and types of organisational culture 84
3 Informal elements of culture and subcultures 87
4 Factors influencing organisational culture 89
Summary 91
References 92
Reading 11: Values and beliefs 93
Introduction 93
1 What are values? 93
2 Different value types 94
Summary 97
References 98
Acknowledgements 99
Reading 1: What is a business?

Introduction
We all have some idea of what we mean by business, but what exactly is
meant by the term ‘business’, how it is similar to or different from related
terms such as ‘firm’ and ‘organisation’, and how businesses are different
from other types of organisation is a little more complex than it might first
appear. It is therefore useful to start with the question of what we mean by
business.
1 Defining the meaning of business

When people think of business they often think in terms of large, well-
known, successful businesses, for example multinational companies like
Shell, Coca-Cola or Apple. In fact, business is everywhere. Businesses
come in all shapes, forms and sizes and sell a multitude of different
products and services to highly diverse customer groups. This means that
you will also have come into contact with various businesses as a consumer,
a client or an employee.
As you have come into contact with various businesses and as you have
chosen to study business, you will surely have your own ideas of what the
word means. In fact, business is so much all around us that most people
would probably be able to give some answer to the question: What is a
business? Let’s start by thinking about some common characteristics of
business.
Exercise 1
Spend approximately 15 minutes on this exercise.
This exercise will help you think about the characteristics that make up a
business. Consider the list below and note any common characteristics that,
for you, define them as businesses:
. a branch of a national bank

. an electricity supply company
. a post office
. a single person offering computing services from her own home
. a car sales firm
. a hairdressing salon
. a museum with a souvenir shop attached
. a shop that sells second-hand clothes and other goods in order to make
money for charity.
5
Readings 1–11
Comment
Perhaps you have started by thinking about some formal characteristics of
businesses, such as whether they employ staff and keep accounts of income
and expenditure. Here are some characteristics the module team thought of.
You may have listed more.
. They offer goods or services to customers.

. They mostly (but not always) consist of a number of people.
. The people who work in a business will probably share some values and
views about the purpose(s) of the business.
. They will have some income and some costs.
. They are likely to need to coordinate a number of different activities
undertaken by individuals.
The very fact that business is all around us can actually make it harder to
give the word a precise meaning that also distinguishes it from other terms,
such as organisation, company, enterprise or firm. The key characteristic of
a business is that it offers goods or services to customers for payment and
that it expects to make an income from these activities. Mostly, when we
think of business, we think of privately owned firms that provide goods and
services to customers for profit. However, businesses do not have to be
privately owned or run for profit. They may also be not-for-profit or state-
owned organisations, but still provide goods and services to customers for
payment and be expected to provide an income to the owner. In the case of
a not-for-profit business, this income may be used to support a charitable
purpose, for example.
The terms ‘business’, ‘firm’ and ‘enterprise’ are generally used as synonyms
(they mean the same thing). This is not true for ‘organisation’ and
‘company’, though. An organisation is an organised group of people with a
collective purpose. Most businesses, except those which are run by a single
person (also called ‘sole traders’), are therefore organisations – but not all
organisations are businesses. There are many organisations that do not trade
goods and services and therefore are not businesses, for example
government departments, city councils, most publicly owned hospitals and
schools, clubs, charitable organisations, and so forth. Often the distinction
between such organisations and a business can be a bit unclear. For
example, many charities also sell goods in order to raise money for their
charitable purpose. You will learn more about the distinction between a
business and other – public sector and voluntary – organisations later in the
module. At the moment it is worth bearing in mind that, although there are
differences between businesses and other kinds of organisations, many
management tasks and challenges are, in fact, quite similar across different
types of organisation.
Organisations enable objectives to be achieved that could not be achieved
by the efforts of individuals on their own. Organisations come in all shapes
6
and sizes but have three factors in common: people, objectives and
structure. It is the interaction of people to achieve objectives that forms the
basis of an organisation, and some form of structure is needed within which
people’s interactions and efforts are focused. The direction and control of
these interactions form the role of management. We will look at the
meaning and characteristics of management later.
The word ‘company’ is also often used as a synonym for business but –
under English law – it also has a specific legal definition as an incorporated
company registered under Section 1 of the Companies Act (Great Britain.
Companies Act 2006). There is more to learn about the various legal forms
of business and how they vary between countries but this reading is not the
place to do so.
Summary
This very short reading has defined business and distinguished it from
related terms, such as organisation, company, firm, and so forth. It has
shown that some of the key characteristics of businesses are that they offer
a good or a service to customers for payment, and that this activity is
supposed to provide an income for the business.
7
Readings 1–11
References
Great Britain. Companies Act 2006: Elizabeth II. Chapter 46 (2006)
London, The Stationery Office.
8
Reading 2: Different types of business
Reading 2: Different types of

business
Introduction
Businesses come in all shapes and sizes. This reading looks at some of the
different types of business on the basis of size, industry sectors, and
ownership structures and legal forms. It is helpful to think about a number
of different types of business because they have different characteristics and
behave differently. Let’s start with an exercise to get you thinking about
these different types of business.
Exercise 1
Spend approximately 30 minutes on this exercise, not including any time spent
travelling, walking or shopping.
This exercise will help you start thinking about different types of business
and what characterises them. Next time you are walking through your
nearest town or city, make a note of the various businesses you come across
and some of their most obvious characteristics. You can do this from memory
if you prefer. Think about the criteria by which you might categorise these
businesses. Make a note of these criteria and any examples you have
thought of.
Comment
You may have thought about a number of different criteria, such as size, the
type of business they do, where they are located, who owns them, etc. Here
are some commonly used criteria for categorising businesses:
Size – this is a fairly obvious but important category. A local

greengrocer’s store, run by the owner and employing perhaps two further
people, would be an example of a so-called micro-business. A large
supermarket chain with stores in multiple locations in several countries
and employing dozens of people in each store, as well as many more in
its headquarters, warehouses and transportation fleet, would be an
example of a large multinational business. And then there are many
medium-sized enterprises in between.
Industry sector – a fashion retailer, a hairdresser, someone running a
market stall, a farm, a machine tool manufacturer and a commercial
cleaning business are all very different businesses, and what they do to a
large extent influences how they operate.
Ownership – this is not always obvious from the outside but different
businesses often have very different ownership structures. Some are
owned by private individuals, others by groups of shareholders, others
are owned by the state, and some have yet different types of owners,
such as their own employees or customers, or charitable foundations.
9
Readings 1–11
There are other ways of classifying businesses but size, industry sector and
ownership structure are some of the more obvious categories to start with.
1 Classifying businesses by size

One of the most obvious ways in which businesses differ is their size. Most
of us know some businesses that are very small – one-person businesses or
micro-businesses of fewer than five people. Examples may include a single
person running, for example, a web design company, a hairdresser’s or a
small catering business, or a small retailer, such as a craft shop or a florist,
employing just one or two other people. Small and medium-sized
enterprises actually make up over 90% of the number of businesses in most
countries (although they do not employ over 90% of all employees or make
over 90% of all business deals). At the other end of the scale are businesses
that are very large – multinational corporations employing thousands of
people and operating in many different countries. We are familiar with at
least the names of some, such as Microsoft, Samsung, Siemens, Renault,
and many more both well-known and less well-known large corporations.
And then there are many businesses of all sorts of sizes in between.
Figure 1 Examples of small businesses
It is less obvious how we should measure the size of a business. There are
several different measurements available, not all of which are suitable for
measuring the size of all types of business. For example, measuring a
business’s size on the basis of how much profit it makes assumes that it is a
for-profit enterprise. Measuring the stock market value of a business
assumes that its shares are traded on the stock market, which is by no
means true for all businesses.
Two measures that are applicable to nearly all businesses are number of
employees and annual turnover, i.e. the total value of sales made over the
10
period of a year. These two measurements are not always in accord with
each other: there are some businesses with very few employees that
nonetheless produce quite a large annual turnover. For example, a single
person trading shares on the stock market could make a very large turnover
in a year if they were very successful. The European Commission uses a
combination of number of employees and turnover to define the size of a
business (EC, n.d.):
. Large enterprises employ 250 people or more and have an annual

turnover of more than €50 million.
. Medium-sized enterprises employ fewer than 250 people and have an
annual turnover of no more than €50 million.
. Small enterprises employ fewer than 50 people and have an annual
turnover of no more than €10 million.
. Microenterprises employ fewer than 10 people and have an annual
turnover of no more than €2 million.
Businesses with fewer than 250 employees are often collectively classified
as small and medium-sized enterprises (SMEs).
In some ways the challenges for small and for large businesses are not so
different. All businesses need to make sure they offer goods or services that
people want to buy, that they have enough income to cover their costs and
something left over, and that people working for them are motivated, well
qualified and work well together. In other ways, however, small businesses
operate very differently from large businesses.
. Small businesses are often owned and managed by the same person.
This ‘owner-manager’ may be the founder of the business, or sometimes
a relative, perhaps a son or daughter of the founder. Owner-managers are
often more emotionally involved in their business than the managers of
large enterprises owned by anonymous shareholders.
. Because of the small size, managers are often very closely involved in
the day-to-day running of the business. They also tend to know many –
often all – employees personally. This is different in a large business,
where top managers cannot possibly know all their employees
personally. It also often makes for a different, more personal
management style.
. Small businesses have flatter hierarchies. In a small organisation there is
no need for many layers of management. In a very small business, it
may be just the ‘boss’ and a number of employees. Again, this tends to
make for more informal management styles. It can also be useful in
terms of innovation, as people across the business can find it easier to
work with each other and new ideas can be developed and implemented
more quickly than in larger organisations, which are often more
bureaucratic. This is one reason why many innovations come out of
small businesses (often new ones) rather than larger ones, although this
is of course not always so.
. Smaller businesses often have more limited financial resources. They
need to be very careful how they spend their money and that they have
11
Readings 1–11
enough money coming in each month to pay staff and all their bills.
This also means that they sometimes do not have the money to make
further investments, even if these investments would repay themselves in
a relatively short period of time by saving costs (e.g. investment in new,
energy-efficient machinery) or bringing in more money (e.g. investment
in product development to attract more customers).
. Smaller businesses also usually have limited management resources. A
single manager, or a very small management team, only has so much
time to attend to all the business and the same will be true of a small
number of employees. This can be a problem as it can limit a business’s
ability to seek out new opportunities – for example developing new
product ideas – or address new challenges – for example dealing with
new competition or new business legislation – simply because nobody
has time to do so.
There is much more that could be said about the differences between large
and small businesses and also about the differences between businesses of a
similar size. Some of these will be picked up later in the module. For the
moment, it is enough to be aware that size does matter in business and
management, not because bigger or smaller is better but because they pose
different challenges and different opportunities.
2 Classifying businesses by industry

sector
Businesses also obviously differ by what they do. It is very common to
distinguish businesses by industry or sector. An industry is a group of
businesses that are related in terms of their main activity, for example
manufacturing cars or selling groceries. Smaller industries (for example, the
car manufacturing industry) can be grouped into larger industry sectors (for
example, the manufacturing sector in general). An individual business is
classified as belonging to a certain industry on the basis of its main activity.
So, for example, a car manufacturing business may also have a small
financial services arm (to provide finance to customers to help them buy a
new car) but that financial services arm would probably only be about 10%
of the business’s overall activity, whereas car manufacturing might be 80%.
Therefore, this business would be classified as belonging to the car
manufacturing industry, and not financial services.
Economists often distinguish three broad sectors of the economy:
. The primary sector involves extracting and harvesting natural products

from the earth (for example, agriculture, fishing and mining).
. The secondary sector consists of processing (for example, the processing
of food stuffs produced by agriculture), manufacturing and construction.
That is to say, the secondary sector takes the products from the primary
sector and does something more with them.
. The tertiary sector provides services, such as retail services,
entertainment or financial services.
12
Some people also distinguish a fourth sector, which is made up of

intellectual activities, such as education.
Figure 2 A steelworks
It is useful to distinguish these broad economic sectors as we can see that

there will be important differences between a business operating in the
primary sector and one that provides a service. Nonetheless, it would also
seem obvious that there may be big differences between businesses within
the same broad economic sector. A farm and a coal mine will be very
different although they are both in the primary sector; and a business that
makes, say, potato chips and one that builds railway tunnels will also differ
along many lines. There are quite a number of different classifications of
industries and some of them go into very fine detail. Some of these coding
systems have been developed to help government agencies to classify
industry groups; others have been developed by financial ratings agencies to
help financial investment companies make investment decisions. There is no
need to go into detail on any of these classification systems here. What is
important, however, is to be aware that the industry a business is in will
have an important influence on how that business operates. For example, the
operations of a fisheries business, a manufacturing plant or a service
provider such as a telesales company, will be very different in terms of
complexity, the kind of technology used and the level of investment
required to set it up. There are also big differences in marketing a primary
agricultural product to food manufacturers and marketing a service such as,
say, carpet cleaning to consumers. You will come across a wide variety of
businesses in different industries during your studies and will see that, while
they face similar issues in some respects, many of the particular
opportunities and challenges are strongly shaped by their industry context.
3 Ownership structures and legal forms

Businesses not only vary in size and industry but also in their ownership.
Some are owned by just one person or a small group of people, some are
owned by large numbers of shareholders, some are owned by charitable
foundations or trusts, and some are even owned by the state. Different
ownership structures overlap with different legal forms that a business can
take. A business’s legal and ownership structure determines many of its
13
Readings 1–11
legal responsibilities, including the paperwork that the owners need to

complete in order to set up the business, the taxes the business has to pay,
how profits from the business are distributed, and the owners’ personal
responsibilities if the business makes a loss or goes bankrupt.
It is not necessary to go into great detail on legal forms and ownership
structures here but a short overview will help you to appreciate the diversity
of businesses. At the broadest level it is possible to distinguish between
organisations that are owned and run by private owners, those that are
owned and run by the state and those that are run by voluntary
organisations. Here we will first look at different types of privately owned
businesses.
Legal forms and ownership structures of businesses are different from
country to country. In the United Kingdom the majority of businesses (but
not all) are sole traders, limited companies or business partnerships (UK
Government, n.d.).
Sole trader – a person who is running a business as an individual. Sole
traders can keep all the business’s profits after paying tax on them but
they are personally responsible for any losses the business makes
(i.e. they would have to cover them out of their private money if
necessary), paying the bills incurred by the business (e.g. stock or
equipment), and keeping a record of all sales and expenditures. Sole
traders can take on employees – the term implies that they own the
business on their own, not that they must work there alone.
Limited company – an organisation set up by its owners to run their
business. A limited company is a legal person. Of course, a company is
not a person in the sense we commonly understand it. What the term
means is that the law regards a limited company as having the same
legal standing as a person, i.e. it has legal rights and obligations in
itself, which are independent from the rights and obligations of its
owners as individuals. For example, a limited company can own
property. A limited company’s finances are separate from the finances of
its owners. Any profit made after taxes belongs to the company. The
company can then share its profits, most commonly among all the
owners. Limited companies have ‘members’, i.e. the people who own the
shares. A limited company also has ‘directors’. Directors may be share
owners but they don’t have to be. Shareholders’ and directors’
responsibilities for the company’s financial liabilities (such as losses or
debts) are limited to the value of their shareholdings. This means that
they do not have to pay out of their personal income or assets if the
company runs into financial difficulties. There are two main types of
limited company: private limited companies and public limited
companies. The shares of public limited companies (PLCs) are traded in
the stock market, where anybody can buy shares in the company if they
wish to do so. Private limited companies are not traded in the stock
market and other people can only buy shares in them with the approval
of the current owners (for example, if they are invited to invest in the
company by the current owners).
14
Business partnerships – an arrangement where two or more individuals

share the ownership of a business. There are two main types of
partnership: general partnerships and limited partnerships. In a general
partnership all partners are personally responsible for the business,
meaning they are liable for any losses or debts with their personal
income or wealth if necessary. In a limited partnership partners are not
personally liable if the business incurs any losses or debts. Profits from a
partnership are shared between the partners and each partner then pays
taxes on their share. There are a lot of fine details and several possible
permutations in the structure of business partnerships, which are
important when setting one up but need not concern us any further here.
There are some other legal ownership structures for businesses in the UK
(including some different laws relating to partnerships in Scotland) but the
three introduced above are the most common. Similar business ownership
structures exist in many other countries although the precise legal
implications can differ in important ways.
Legal and ownership structures, business size and industry sector are not
entirely independent of each other. For example, most sole traders tend to
be small businesses, not least because a single individual rarely has the
financial capacity to finance a very large business, nor the desire to be
personally liable with all that they own if a large business were to run into
financial troubles. Certain industry sectors require large businesses. For
example, it is not viable to run a small steel works because the physical and
financial investment required are so large. In other cases, industry sector
and legal form are closely related. For example, law firms and some other
professional service firms with more than one professional working in them
in the United Kingdom are legally required to be set up as partnerships and
no other ownership or legal structure is permitted.
4 Examples of different businesses

In this section you will look at some examples of businesses and consider
how the different categories of business introduced above apply to them.
Example of small, family-owned, private limited company:

Merrythought Teddybears
Merrythought is a business that makes teddy bears, located in Ironbridge,
Shropshire, in the United Kingdom. The business was founded in 1930 by
Gordon Holmes. It is a private limited company, still owned by the Holmes
family and is currently run by Gordon Holmes’s great-granddaughters, Sarah
and Hannah Holmes.
The business has approximately 25 employees and does all its

manufacturing in England. It makes a large number of different styles of
teddy bears, ranging from ‘traditional’ British bears, to special occasion bears
(for example Merrythought provided the official commemorative bears for the
2012 London Olympics) and various ‘novelty’ bears. Merrythought bears are
sold all over the world and there is a particularly thriving export market in
Japan, where they have a ‘cult’ following. Antique bears and limited edition
15
Readings 1–11
bears are collectors’ items and there are even Merrythought collector clubs
and events.
(based on Merrythought, n.d.; Manta, n.d.)
Example of large, shareholder-owned, public limited company:

Reliance Industries Ltd
Reliance Industries Limited (RIL) is a conglomerate holding company with
headquarters in Mumbai, India. It is the largest private sector business in
India and operates in five major industry sectors: exploration and production,
refining and marketing, petrochemicals, retail and telecommunications.
The business was founded in 1960 by Dhirubhai Ambani together with his
cousin Champaklal Damani. In 1966 it was transformed into a public limited
company. The business started out as a manufacturer of man-made fibres
and textiles and later moved into telecommunications, and subsequently
natural gas and mineral oil exploitation, and retail, as well as petrochemicals.
There is a very large group of shareholders but over 40% of the shares
remain in the hands of the founding family. The business has over 20,000
employees worldwide and an annual turnover of over 28 billion US dollars.
(based on Reliance Industries Ltd., n.d. and 2011; The Economic Times, n.d.)
Example of large, family-owned, private limited company:

Mercadona supermarkets
Mercadona is a Spanish supermarket chain, which employs over 74,000
people in total. In 2014 it had 1,499 supermarkets all over Spain. It was
founded in 1977 by married couple Francisco Roig Ballester and Trinidad
Alfonso Mocholi as a small butcher’s shop and is still owned by the family.
Figure 3 Mercadona supermarket
Mercadona competes successfully against international supermarket chains

operating in Spain by keeping its prices low through long-term contracts with
suppliers, little paid advertising and reduced packaging, and by increasing
16
productivity through extensive employee training. It is now the largest

Spanish food retailer by sales.
(based on Mercadona, n.d.; The Economist, 2011)
Exercise 2
After having read through the three examples of businesses above, think
about each one’s size, industry and ownership structure. For each example,
answer the following questions:
. Is this a large, medium-sized, small or microbusiness?

. What would you say is the industry to which the business belongs?
. What does the example tell you about the ownership structure of the
business?
Comment
The three examples above are very different businesses, situated in different
countries, in very different industries, of different sizes and ownership. They
include two large enterprises and one small firm. Of the two large
enterprises, one is a public limited company, traded on the stock market, and
the other is family owned. The small firm is also family owned. Two of the
businesses are manufacturing companies (although Reliance is also a
significant service provider to other organisations) and one is a retail
services business. You may also have noticed that two of the businesses
(Merrythought and Mercadona) sell directly to consumers, whereas Reliance
sells to other businesses and other large organisations.
Summary
After working through this reading, you should now have a basic idea of
the diversity of businesses and some of the key differences between
businesses in terms of size, industry and ownership.
17
Readings 1–11
References
The Economic Times (n.d.) ‘Company history: Reliance Industries Ltd.’
[online]. Available at http://economictimes.indiatimes.com/reliance-
industries-ltd/infocompanyhistory/companyid-13215.cms (Accessed 22
August 2014).
The Economist (2011) ‘Spanish aisles: why a low-price retailer is thriving’,
The Economist, [online]. Available at www.economist.com/node/18775460
(Accessed 21 November 2013).
European Commission (EC) (n.d.) ‘What is an SME?’ Brussels, EC,
Enterprise and Industry DG, [online]. Available at http://ec.europa.eu/
enterprise/policies/sme/facts-figures-analysis/sme-definition/ (Accessed 28
January 2014).
Manta Media (n.d.) ‘Merrythought Ltd’ [online]. Available at www.manta.
com/ic/mtznkgm/gb/merrythought-ltd (Accessed 28 January 2014).
Mercadona (n.d.) ‘What is Mercadona?’ Valencia, Mercadona [online].
Available at www.mercadona.es/corp/ing-html/empresa.html (Accessed 28
January 2014).
Merrythought (n.d.) Ironbridge, Merrythought Ltd [online]. Available at
www.merrythought.co.uk (Accessed 28 January 2014).
Reliance Industries (n.d.) ‘About us’ [online]. Available at www.ril.com/
html/aboutus/aboutus.html (Accessed 10 June 2014).
Reliance Industries (2011) Sustainability Report 2010/11, Mumbai, Reliance
Industries.
UK Government (n.d.) ‘Choose a legal structure for a new business’
[online]. Available at www.gov.uk/business-legal-structures/overview
18
Reading 3: Businesses and other types of organisation
Reading 3: Businesses and other

types of organisation
Introduction
The businesses that you have been thinking about so far belong to what is
often called the private sector of the economy. (Note that this is a different
use of the term ‘sector’ from those you have already encountered in
Reading 2. This just underlines that it is quite a multipurpose term.) The
private sector consists of enterprises that are owned by private individuals
or groups and are run to make a profit for their owners. This includes all
businesses, apart from those owned by government, from small businesses
to larger multinational firms. However, the economy is made up of two
other sectors, too, with their own distinctive types of organisation. These
are the public sector and what is frequently called the third sector. In this
reading we will take a closer look at public and third sector organisations
and what distinguishes them from business organisations. This is important
because working in and managing public or third sector organisations can
often be quite different from working in or managing private sector
businesses, even though there are many similarities.
The public sector refers to those parts of the economy concerned with the
provision of public services and government. The extent of the public sector
varies between countries and may change over time, but usually includes
services that are funded by taxpayers, such as the armed forces, police,
public education, roads and footpaths, public health and social care services,
welfare services and waste disposal. Typically these services provide a
benefit to society as a whole rather than just to the individuals who receive
the service, or are designed to protect the disadvantaged in society.
However, the public sector can also include extensive manufacturing
businesses, depending on historical and political circumstances. For
example, in the UK the state used to own automobile manufacturers, sugar
refineries, steel works and similar.
The third sector is trickier to define. Sometimes it is defined in relationship
to the other sectors and people talk about the not-for-profit or nonprofit
sector, to distinguish it from the private sector, or the non-governmental
sector and non-governmental organisations (NGOs) to distinguish it from
the public sector and government. However, it is perhaps better to think of
the third sector as consisting of organisations that people form to provide
some kind of benefit to a particular group of people or to provide some
wider social or environmental mission. This may be done by people to help
themselves, to help others, to campaign or to promote the interests of a
particular group. The third sector covers a very wide range of organisations,
including the following: small, relatively informal local groups such as
community groups, sports and recreation clubs; voluntary organisations and
charities that range from small local organisations, such as an advice centre,
to large charities like Oxfam that operate in many countries; trade unions
and professional associations.
19
Readings 1–11
1 The differences between organisations

in the three sectors
We will now look in a bit more detail at the differences between
organisations in these three sectors. David Billis (2010) suggests that one
way of doing this is to think about some of the key characteristics of
organisations:
. Who has ultimate control or ownership of the organisation?

. Governance, that is to say, who has overall responsibility for running the
organisation?
. What is the main purpose of the organisation?
. What are the human resources the organisation can deploy?
. How is the organisation funded?
Table 1 compares the main characteristics of organisations in the three
sectors.
Table 1 Characteristics of private, public and third sector organisations
Characteristics Private sector Public sector Third sector

Ultimate control Shareholders/ Citizens Members
owners of the
business
Governance Owners or their Representatives Representatives
representatives elected through elected by
public elections membership
Main purpose To make a profit To govern and To further social or
through trading in provide public environmental
the marketplace services mission
Human Paid employees Paid public Members,
resources servants volunteers and
paid staff
Main funding Sales and fees Taxes Dues, donations
and other forms of
fundraising
(Source: adapted from Billis, 2010, p. 55)
In the private sector, businesses are ultimately controlled by their owners. In

a for-profit corporation (which, for our purposes, is another term for a
public limited company) the owners are called shareholders. These
shareholders elect a board that has overall responsibility for the governance
of the organisation. Typically the number of votes a shareholder has
depends on the number of shares they hold. The board will usually delegate
the day-to-day management of the organisation to a chief executive and
management team. The work of the organisation is carried out by paid staff.
The main source of income is from the sale of goods and/or services in the
marketplace.
20
In the public sector, ultimate control rests with citizens, who elect
representatives in public elections; these elected representatives have overall
responsibility for government and public services. The main purpose of
government is to make laws and policy and to oversee the delivery of
public services. The implementation of public policy and the delivery of
public services are carried out by paid public servants. The main source of
income to fund the public sector is taxation.
In the third sector, organisations are ultimately controlled by their members
rather than shareholders or citizens. Members normally elect a board to
govern the organisation on the basis of one member, one vote. The main
purpose is to achieve its social or environmental mission designed to benefit
a particular group of members or the wider public in some way. Many third-
sector organisations rely on their members or volunteers to carry out at least
some of the work, and may or may not employ paid staff. Income is
typically derived from voluntary donations, membership dues or other forms
of fundraising.
It is important to note that characterising organisations from the three
sectors in this way forms what the sociologist Max Weber called ‘ideal
types’, a concept he introduced in a treatise on objectivity in the social
sciences in 1904 (Weber, 1904/1949). This means that these characteristics
are typical of organisations in a sector, but that any particular organisation
in the sector may not have all of these ‘ideal’ characteristics. So, for
example, some public services, such as public sports and recreation
facilities, may also charge a fee to clients for their services as well
receiving funding that comes from taxation, while some private businesses
may receive a public subsidy, for example to support research and
development, that comes via government and out of taxation.
Exercise 1
Describe the characteristic features of an organisation that you are familiar

with in terms of Billis’s five categories: ownership, governance, main
purpose, human resources and main sources of funds. This may be an
organisation you work or volunteer for or another organisation you are
familiar with. Explain what type of organisation it is and where you would
locate it in terms of the three sectors of the economy.
Comment
We don’t know how you will answer this question. However, it is quite likely
you will work for an organisation that is firmly located in one sector. It is
possible that you may have felt your organisation does belong to one sector
but does not have all the characteristics typical of organisations in that
sector. For example, some small firms such as sole proprietors and
partnerships may clearly be part of the private sector, but may not have
external shareholders. It is important to remember that any typology like this
is a simplification and won’t necessarily cover all cases exactly, hence a
degree of judgement will be required in its use. It is also possible that the
21
Readings 1–11
organisation you chose had characteristics from more than one sector: a
hybrid organisation.
2 Hybrid organisations
The neat division of the economy into three self-contained sectors (the
private, public and third sectors) is a simplification that is increasingly
breaking down. The boundaries between sectors are not clear cut and are
becoming increasingly blurred. Many organisations are ‘hybrids’ embodying
some of the characteristics of organisations from more than one sector. For
example there has recently been a growth in social enterprises. These are
organisations that trade but whose primary purpose is to meet their social
and or environmental objectives. One example is CaféDirect, which sells
coffee, tea and drinking chocolate through independent shops and
supermarkets. However, it aims to pay producers in developing countries a
fair price for their produce irrespective of the market rate and uses a
proportion of its profits to support the businesses and communities where it
gets its coffee, tea and cocoa (CaféDirect, n.d.). Another example is the Big
Issue, a magazine whose primary aim is to provide an income for homeless
people who sell it on the streets.
Figure 1 shows one way of depicting the three main sectors and the
different sorts of hybrid organisations. The three main circles represent the
three sectors and the areas of overlap show the different types of hybrid.
Importantly an organisation’s sectoral location and identity may change over
time so, for example, the banks that were partly nationalised (i.e. taken into
state ownership) after the financial crash of 2008 have ‘moved’ from the
private sector to become private/public sector hybrids. When the
government sells its shares back to private investors, the banks will move
back to the private sector. Another example comes from the area of social
housing, where under pressure from central government in the UK much
council or public housing was transferred to housing associations in the
1980s and 1990s. Although housing associations are formally independent,
the development of new social housing often relies on public subsidises and
they increasingly engage in commercial activity (Mullins and
Pawson, 2010). As such they can be regarded as third/public/private sector
hybrids.
22
Key
Public 1 4 Third 1 Public/third

2 Public/private/third
3 Public/private
2 5
4 Third/public
3 8 6 5 Third/public/private
7 9 6 Third/private
7 Private/public
8 Private/public/third
Private 9 Private/third
Figure 1 Different sorts of hybrid organisation (source: based on Billis, 2010)
Exercise 2
Using Figure 1, what sort of hybrid would you say the following organisations
are?
1 A charity that provides a counselling service to people in need but that

raises a proportion of its income from charging its clients.
2 A credit union whose main purpose is to provide its members with access
to low-cost loans and a savings facility.
3 A local authority’s recreational services that are spun out into a separate
charitable organisation to run local leisure facilities, such as sports
centres. The charity is funded partly by the local authority and from
customers’ fees.
4 A business that is rescued from failure by government through acquiring
a substantial shareholding.
5 A former state school that has opted out of local government control and
is self-governed, by a board elected from parents and other stakeholder
groups, but is predominantly publicly funded by central government.
Comment
1 Third/private sector hybrid – charities belong to the third sector, but
selling services means in this case it also has to operate partly in the
marketplace to raise some of its income.
2 Third/private sector hybrid – credit unions are owned and controlled by
their members, which are characteristics of third-sector organisations, but
have to compete in the marketplace for savings and loans.
3 Public/third/private sector hybrid – the new organisation has its origins in
the public sector, continues to provide a public service and still receives
funding from the local authority, but has been transformed into a charity,
23
Readings 1–11
typical of the third sector, and part of its income also comes from selling
its services to the public, typical of the private sector.
4 Private/public sector hybrid – the bank has its origins in the private sector
and still has to operate in the marketplace; however, the public
shareholding means that it is potentially open to influence by government.
5 Public/third sector hybrid – the school has its origins in the public sector
and is still largely funded by taxpayers, but is self-governed which is
characteristic of the third sector.
Summary
This reading has looked at organisations in the public and the third sectors
and seen how they are different from business organisations in the private
sector. In particular, it has shown that organisations in the three sectors
differ according to control, governance, purpose, human resources and
funding. Also, there increasingly are hybrid organisations that do not fit
neatly into any of the three categories but take characteristics from two or
all of them. There is a lot more to be said about the differences between the
private, public and third sectors and how they operate and are managed.
However, what has been covered in this reading will suffice to give you a
first impression.
24
References
Billis, D. (2010) ‘Towards a theory of hybrid organizations’ in Billis, D.
(ed.) Hybrid Organizations in the Third Sector: Challenges of Practice,
Policy and Theory, Basingstoke, Palgrave.
CaféDirect (n.d.) ‘About us’ [online]. Available at www.cafedirect.co.uk
(Accessed 28 January 2014).
Mullins, D. and Pawson, H. (2010) ‘Housing associations: agents of policy
or profits in disguise?’ in Billis, D. (ed.) Hybrid Organizations in the Third
Sector: Challenges of Practice, Policy and Theory, Basingstoke, Palgrave.
Weber, M. (1949) ‘Objectivity in social science and social policy’ in Shils,
E. A. and Finch, H. A. (ed. and trans.) The Methodology of the Social
Sciences, New York, Free Press.
25
Readings 1–11
Reading 4: What is management?

Introduction
This reading provides an introductory answer to this question, focusing
particularly on what it is that managers do. Most people have an idea of
what the term ‘management’ means and what managers do; the following
exercise asks you to think about your own understanding of it.
Exercise 1
Spend a few minutes thinking about what you think managers do and what
‘management’ is. Keep a record of your thoughts.
Comment
As often with these exercises, there is no right or wrong answer to these
questions. The point of the exercise is to find out what you understand by
the terms ‘manager’ and ‘management’ at this moment in time and there are
many valid answers.
Some of the things that managers do are:
. making things happen through other people, i.e. leading and directing
people to achieve the goals of the organisation
. making things happen for other people, e.g. for customers, clients,
shareholders, etc.
. making sure the organisation performs well
. improving and developing things
. making change happen.
The process of ‘management’ could then be defined as doing any of the
things above.
As with ‘business’ there are quite a few definitions of ‘management’; here

are two examples:
The process of dealing with or controlling things or people [...] 1. The

people managing a company or organization, regarded collectively [...]
2. The responsibility for and control of a company or organization [...].
(Oxford Dictionary, n.d.)
Management in business and organizations is the function that

coordinates the efforts of people to accomplish goals and objectives
using available resources efficiently and effectively. Management
26
comprises planning, organizing, staffing, leading or directing, and

controlling an organization or initiative to accomplish a goal.
(Wikipedia, n.d.)
From these definitions we can see that management has to do with

organising and coordinating. It takes place in organisations, including
businesses, and it involves leading and coordinating the work of other
people. It is also to do with achieving the objectives of the organisation.
1 What managers do
In some ways, the best way of understanding what management is, is to
think about what managers do. This has been the subject of writing about
management for 100 years. Although books written 50 or 100 years ago at
first sight seem very outdated, many of the ideas proposed by some early
management thinkers are still relevant today and many managers would
recognise themselves – at least partly – in their descriptions of what
managers do. In 1916, Henri Fayol, a French mining engineer, published a
book in which he stated that being a manager involved the following
activities (Fayol, 1916):
. forecasting and planning

. organising
. commanding (modern management scholars would not talk of
‘commanding’ but would refer instead to ‘leading’, which is less based
on hierarchy and more on inspiring and providing a vision)
. coordinating
. controlling.
Peter Drucker, an Austrian-born management scholar, also identified five
common tasks that managers do in his various writings (Drucker was a very
prolific writer on management until his death in 2005). These were
summarised by Murray (2010) as follows:
1 Setting objectives – deciding what the goals of the group (team,
department, organisation, etc.) should be and what needs to be done to
achieve these goals.
2 Organising – dividing the work into manageable tasks and allocating
people to do these tasks.
3 Motivating and communicating – turning people into a team through the
right kind of communication and incentives.
4 Measuring – deciding on the right kinds of targets and measurements to
make sure that objectives are being met.
5 Developing people – devising informal and formal means of making sure
that people are able to perform new tasks and meet new challenges,
including mentoring, training, etc.
These ‘lists’ of management tasks are a good starting point for
understanding what management is about. We can notice that Drucker’s five
27
Readings 1–11
tasks include several that seem very objective and have to do with what are
sometimes called the ‘hard’ aspects of management: setting objectives and
targets, allocating tasks, measuring performance. But equally important for
Drucker are the ‘soft’ aspects of management, those that have to do with
people: communication, motivation, development. Drucker was very clear
that managers only achieve things through the efforts of other people and he
considered it one of the paramount tasks of managers to make sure that
these other people were able to perform well. Similarly, Fayol’s list contains
elements which seem quite objective and might be based on quantitative
measures, such as forecasting, planning and controlling (although even such
aspects of management contain a lot of qualitative judgement) but
organising, leading (commanding in Fayol’s language) and coordinating all
seem to be about working with other people and getting the best out of
them.
The works of Fayol and Drucker and many other books and articles on
managerial work are quite normative in nature. This means that they set out
what the authors think managers ought to do. They are not necessarily
accurate descriptions of what managers actually do in their day-to-day
working lives. If you have ever worked as a manager (even quite a junior
one) or have observed the work of a manager in any detail, you may well
have noticed that the reality of managerial work often seems quite different
from the ideas presented above. Canadian management scholar Henry
Mintzberg has spent much time observing what managers actually do in
their real working lives and has written about this. Mintzberg first published
a book on what managers really do in 1973 and he has revisited the topic
several times since then. In an article for the Harvard Business Review,
which was first published in 1975 and later re-printed in 1990, he contrasted
what he called the ‘myths’ of management with what empirical research
suggested was the reality. One of his key points was that managers spend
far less time planning, strategising and thinking than one might assume, and
rather spend the majority of their time on regular duties and on things such
as fielding day-to-day queries, solving short-term problems and firefighting.
Mintzberg argues that managers perform 10 different types of roles, which
can be categorised into interpersonal roles, informational roles and
decisional roles.
Interpersonal roles
These are roles that arise directly out of a manager’s formal authority; there
are three:
Figurehead – these vary depending on the manager’s level in the
organisational hierarchy and can range from greeting visiting dignitaries
to taking customers out for lunch.
Leader – one characteristic of managers is that they are responsible for
other people at work. Leadership includes formal aspects, such as line
management tasks, and informal aspects, such as motivating and
encouraging (note how this is similar to some of the managerial tasks
identified by Drucker).
28
Liaison – managers spend much time making contact and dealing with
people outside the hierarchical chain of command. Liaison may take
place with people in other units in the organisation as well as people
outside the organisation, including potential customers, competitors,
people in government and local authorities and many others.
Informational roles
These are roles that arise out of the interpersonal roles. Because managers
spend so much time with employees, with peers in other organisational units
and with people outside the organisation, they often become the lynchpin of
information for their work unit. There are three informational roles:
Monitor – the manager is scanning the environment for information,
extracting information from contacts, and so forth.
Disseminator – the manager passes on information to employees, who
would otherwise not have access to it.
Spokesperson – the manager sends information to others outside the
work unit.
Decisional roles
These are roles that form a large part of managerial work and the decisions
that managers have to make on a regular basis. These can be both formal
and informal in nature; there are four:
Entrepreneur – the manager seeks actively to improve the
organisational unit and to adapt it to changing conditions in the
environment.
Disturbance handler – managers respond to pressures that are outside
their control. This is a much less planned or voluntary role than that of
the entrepreneur.
Resource allocator – the manager must decide who or what task gets
what resources. Resources include the manager’s own time, as well as
financial, technical or other resources.
Negotiator – the manager negotiates with others regarding a multitude
of different issues, many of which do include the allocation of resources.
2 What others think managers do

As you can see from the selection of lists of managerial roles and tasks,
there is by no means consensus on what it is that managers do (or what
scholars and consultants think they should be doing). Compare the views of
Fayol, Drucker and Mintzberg to the views expressed by children in the
following entry from a blog on Bloomberg Businessweek.
29
Readings 1–11
What do managers do at work?

Hal Gregersen, Bloomberg Businessweek, 16 July 2012
Recently [...] my mind raced back 25 years to my first encounter with

a few maverick companies attempting to manage without managers and
a subsequent Saturday morning conversation while watching Yogi Bear
cartoons with my three-year-old son.
Halfway through the cartoon program, the park ranger stood up and
said, ‘Wait a minute, I’m the manager around here, and I don’t do
things like this [picking up garbage].’ He promptly put the bears in the
park to work and went back to his office, where he fell fast asleep. A
commercial break came on, and I asked my son, ‘What do managers
do at work?’ He immediately replied, ‘They throw kids’ toys away.’ At
first I thought, ‘Where did that answer come from?’ Then I
remembered that the manager in our apartment complex hated kids.
Everyday around 6 p.m. she would walk the grounds, pick up any
stray toys, and toss them in the garbage dumpster. No wonder my son
concluded, ‘managers throw kids’ toys away.’
The next week I wondered if my son was unique in knowing what
managers do at work, long before he would ever have a job. To tackle
this question, I collaborated with my colleague, Warner Woodworth, on
collecting data from more than 1,000 kids, ages 5 to 18, about what
they thought managers did at work (using a combination of interviews,
surveys, and for the younger children, drawings.) Here’s a quick
snapshot of the results:
. 55%: Managers control people’s actions at work, making sure they

do what they’re supposed to do when they’re supposed to do it.
. 39%: Managers fix problems at work, any problem (and more often
than not, they fix every problem).
. 6%: Managers develop people’s capabilities by coaching them to
become better at what they do.
. Less than 1%: Managers understand and serve customer needs.
. Less than 1%: Managers make a profit for their companies.
Innovation (developing new ideas that make a difference) by definition
demands that people challenge the status quo, which is not something
most managers get thrilled about, especially those holding onto old
school maps of what managers do (i.e., No. 1 controlling others, and
No. 2 fixing all problems).
I don’t expect the recent push for popularism or the call for companies
without bosses to catch hold quite yet, or at least not a strong hold.
We have an older generation of leaders who often like the perks of
managing (telling others what to do and how to do it) and a younger
generation of leaders who don’t have the greatest role models to
challenge their image of what managers act like at work. Indeed, for
the power of innovation to take deep root, it will take some serious
30
uprooting of how we all think about work and what role managers
should play to help great ideas escape the iron grip of authority.
Clearly, Hal Gregerson (author of the blog entry you have just read) also
has ideas about what managers should do: he thinks their job is to promote
innovation in their firms. But he feels that there are a lot of ingrained views
on what managers’ jobs are, most of which seem to paint quite an
authoritarian picture of people’s (in this case children’s) experience of
management.
You have now learned about quite a few different aspects of what managers
do. It is outside the scope of this reading to go into depth about what these
different managers’ tasks and roles involve and how best to go about them.
However, you now at least have some idea of what managers do, which will
be useful for your future studies.
31
Readings 1–11
Exercise 2
Do you have a formal managerial role? Do you consider yourself a manager?

This may well be the case but even if it isn’t, you may have some managerial
responsibilities somewhere in your life, whether you are called a manager or
not. Think about the 10 managerial roles identified by Mintzberg and whether
you fulfil any of these in any part of your life. This could be at work but it
could also be in a voluntary role in your spare time, or perhaps even in your
family role. Make a note of each of the 10 roles that you think applies to you
to some extent somewhere in your life.
Comment
You will probably find that you have some managerial roles somewhere in
your life. Perhaps you have a formal figurehead role or you are responsible
for leading others in some other way (this could include your children,
although most parents would probably prefer to think of themselves as
parents rather than managers of their family). You may be gathering
information about changes in the environment that affect your local authority,
your sports club or voluntary organisation and passing on such information to
others in the same organisation. Or you may have to take decisions on how
to spend (parts of) the budget of a firm or a drama society, or when to hold
the annual charity fair organised by your club or your religious association.
Performing these roles may mean you are a manager in a formal sense, but
even if that is not the case it means you perform some managerial roles,
which could well translate into a formal managerial role at work in the future.
Summary
This reading has looked at definitions of management and at what it is that
managers do. Managers do a range of things and many of these seem a lot
less strategic and hands-off than one might think. If you have ever been in
any managerial position yourself, you will probably have recognised quite a
lot of those roles, particularly those dealing with people, trying to gather
information and making decisions (often based on fairly limited
information).
32
References
Fayol, H. (1916) General and Industrial Management (trans.[1949] Storrs,
C.), New York, Pitman..
Gregersen, H. (2012) ‘What do managers do at work?’ Bloomberg
Businessweek: Companies & Industries, The Management Blog, Bloomberg
L.P. [online]. Available at www.businessweek.com/articles/2012-07-16/what-
do-managers-do-at-work (Accessed 15 April 2014).
Mintzberg, H. (1973) The Nature of Managerial Work, New York, Harper &
Row.
Mintzberg, H. (1990) ‘The manager’s job: folklore and fact’, Harvard
Business Review, vol. 61, no. 2, pp. 163–76.
Murray, A. (2010) The Wall Street Journal Essential Guide to Management,
New York, Harper Collins.
Oxford Dictionary (n.d.) ‘Management’ [online]. Available at www.
oxforddictionaries.com/definition/english/management (Accessed 12
June 2014).
Wikipedia (n.d.) ‘Management’ [online]. Available at http://en.wikipedia.
org/wiki/Management (Accessed 21 November 2013).
33
Readings 1–11
Reading 5: The external

environment of a business
Introduction
Organisations are not worlds to themselves or islands; they operate in a
wider context made up of society at large and its various constituents, such
as other organisations, customers, suppliers, citizens, governments, pressure
groups, and many more. Understanding the external environment is key to
running a successful business and is also highly important in other types of
organisations. An organisation cannot operate without being influenced by,
and impacting upon, the external environment.
External environments can be defined and analysed using the STEEPLE
model, which stands for seven factors in the external environment:
sociological, technological, economic, environmental, political, legal and
ethical. You may find variations on STEEPLE in some business and
management textbooks, for example PESTLE (omitting ethical), STEEP
(omitting legal and ethical), and STEP or PEST (omitting ethical, legal and
environmental). The idea is the same: that there are several, main external
influences on an organisation.
1 Sociological factors
Sociological factors that are likely to affect organisations include
demographic changes in the age and structure of populations, patterns of
work, gender roles, patterns of consumption and the ways in which the
culture of a population or country changes and develops. In the United
Kingdom, for example, many households now have a woman as the main
breadwinner. This is due to a number of different reasons: improved career
opportunities for women; the rise of single-parent families; a decline in
traditional industries in some regions; and changes in family roles, where
fathers are more likely than in the past to want to spend time raising their
children. There are also many more individuals aged 60 and over these
days. This has brought a number of changes in employment patterns.
Because there are more older people, both in absolute numbers and in
comparison with younger people, the age at which people can draw their
state pension in the UK has been increased and this rise is expected to
continue. Also, because many older people prefer to continue working there
is now no longer a compulsory retirement age and people can choose to
work well beyond the traditional retirement age of 65. The UK population
(again, similar to many populations in other countries) has also become
more diverse over the decades since the middle of the twentieth century.
Immigration has increased ethnic and cultural diversity, which is reflected in
the diversity of the workforce. This increased diversity is generally
considered a good thing: if there are more people from different national,
ethnic and cultural backgrounds, they are likely to bring a greater variety of
ideas and viewpoints. This can be very good for an organisation’s creativity.
34
Reading 5: The external environment of a business
The variety of businesses in the country has also increased; many

businesses are run by people who came from other parts of the world (or
their parents or grandparents did) and these may provide services and goods
that were not commonly found in the UK before their arrival. The great
variety of restaurants offering food from the Indian subcontinent, China, the
Caribbean, Africa and many other parts of the world are perhaps the most
obvious example. At the same time, public sector organisations such as
schools have changed in many ways to take account of the fact that a
proportion of their students now come from families who originated outside
the UK and have brought their own languages, cultural backgrounds and
understandings of education.
2 Technological factors
Organisations are also influenced by the technologies they employ to
achieve their own purposes and many organisations influence technological
change in turn. Change in recent decades has been particularly dramatic in
information and communications technology (ICT), so that it is sometimes
easy to forget how much it has changed lives in less than a generation. We
now often forget what life was like before mobile phones, laptop computers,
internet shopping, computerised work systems, and so on.
Here are some of the key ways in which ICT has changed organisational
practices over the last 20 years:
. ICT has lowered the barriers of time and place. This has opened up
global opportunities for many businesses, not just the largest firms.
However, it also means that in many cases organisations can no longer
expect the protection from national boundaries that they have received in
the past, although this varies between countries and industries. Even
small businesses that used to operate in local markets can now be
subject to international competition.
. ICT has created new industries. There are obvious new business
opportunities in the areas of hardware, software and telecommunications.
For example, the entire mobile phone industry hardly existed two
decades ago. But many other new businesses are also made possible
through new technology, for example e-commerce business models based
on web technology, such as e-Bay, Amazon and many others.
. ICT has also changed the way in which we interact with many public
sector organisations. In the UK it is now possible to pay tax or renew
library books online rather than visiting the tax office or the public
library. In the same way, it is possible to book travel, conduct banking
affairs, or order grocery shopping online.
. This has also led to considerable changes in the nature of most jobs.
Many jobs and internal organisational functions are now based largely
on ICT systems. This has had a major impact on the structure of
organisations and the nature of work. It has also led to a shift in the
skills needed for many jobs.
35
Readings 1–11
The following extract, from a newspaper article, gives an example of a

business selling flowers that makes extensive use of ICT.
Arena Flowers’ Valentine’s display

wins hearts, not profits
James Hurley, Daily Telegraph, 14 February 2012
[...]
[For Arena Flowers, Valentine’s Day] is an opportunity to win new
customers and provide evidence that Arena Flowers has the systems in
place of a much larger business. The company made around £2m in
the past week. Its projection for this year as a whole is £8m.
[Will Wynne, co-founder of Arena Flowers, says] ‘We’ve got to build
a business with a £50m turnover run rate in a week. For the rest of the
year, you’re running a relaxed small business. It’s weird.’
Wynne and his team have spent the past three days preparing 45,000
orders for dispatch, when an average day would be closer to 500. An
extra warehouse and 180 temporary staff were hired, split between the
company’s Dutch production facility and ‘fulfilment’ of orders in
London. [...]
He is hoping the manic period will provide useful discipline for when
Arena Flowers, which runs websites in six European countries,
becomes a permanently bigger business. To get there, it cannot simply
[rely] on using internet marketing to win sales during the ‘bun fight’
around Valentine’s Day and Mother’s Day, he says.
‘We’ve got a very competitive market. I want the business to be here
in five years’ time and it won’t be if we’re only focused on ranking in
Google.’
To that end, the company has just won a deal with American flower
retailer Provide Commerce to run its European distribution service.
It also runs flower deliveries for a web-based greetings card business,
a deal which provides 40pc of Arena Flowers’ revenues.
Arrangements like those, and the manic Valentine’s Day period, are
possible to manage because of the 18 months the company has spent
building a control system that Wynne’s staff have given an obscene
name to because of its complexity.
‘We’ve now got screens showing live updates of orders coming in,
where they are in the fulfilment process, how production’s going: real-
time, supply-chain updates.
‘Ours is a low-margin business with loads of little pieces that you need
to get right. If you don’t, you end up with big losses instead of small
profits,’ he says. If Wynne is hungry for a blueprint Arena Flowers can
follow, he need only look at his American partner. Provide Commerce
36
was started as an e-commerce flower business in 1998 by entrepreneur

Jared Polis.
It was purchased for $477m (£302m) by John C Malone’s giant
Liberty Media in 2006, the year Wynne and [co-founder Steve] France
started Arena Flowers. When Wynne visited Provide Commerce’s San
Diego headquarters last year, he asked them how they had managed to
grow so quickly. Their response was an underwhelming steer to ‘focus
on product’. Then Wynne happened to look at the company’s potted
history chart on the office wall and spotted the $35m the company had
raised from venture capitalists. ‘They said, “oh yeah, that as well”’.
[...]
Wynne, who worked at eBay before starting Arena Flowers, is trying
to raise a rather more modest £1.5m to spend on new staff, technology
and products, the latter being necessary to separate the company from
the crowd, he says.
Exercise 1
Answer the following questions based on the extract above:
1 How does Arena Flowers differ from a traditional florist’s shop?

2 What are the main uses of information technology by Arena Flowers?
3 What does information technology enable Arena Flowers to do that it
would not otherwise be able to do?
Comment
1 There are a number of things one could mention here but the most
obvious point to make is probably that Arena Flowers sells flowers online
rather than through a physical shop, like traditional florists do. For a
highly perishable good like fresh flowers, which people often buy on the
day as a gift for someone or to treat themselves, this is a fairly new way
of doing business.
2 There are two areas of ICT use that come out strongly from the case: (a)
the use of online marketing and selling – all orders seem to be taken
online and are then delivered to customers, with the business operating
six websites in Europe; (b) a complex computerised control system that is
used to organise the interactions between the Dutch production facility
and the order fulfilment site in London (i.e. where flowers are dispatched
to customers).
3 Clearly, the business model is built on e-commerce and could not exist
without the ability to market and sell through the internet. Likewise, the
case gives the strong impression that the operations could not work in the
way they do if the business didn’t have the complex computerised control
37
Readings 1–11
systems that keep track of orders and stock flows between the Dutch
production facility and the dispatch operations in London.
3 Economic factors
The economic environment is extremely influential on all types of
organisations. The activities of world money markets and financial
institutions affect businesses in a number of ways. Important factors include
the rate of economic growth, interest rates, inflation, energy prices,
exchange rates and levels of employment. The economy affects the level of
demand for goods and services, the availability and cost of raw materials,
buildings and land and, most importantly, labour.
Both businesses and individuals behave according to their expectations of

economic trends. If they expect growth to be high, businesses and
individuals alike often feel more optimistic about the future and businesses
may invest and expand, and individuals spend more. These actions stimulate
economic growth and so ensure that the expectations are met. Of course, the
same happens in reverse. If the economy is seen to slow, businesses tend to
invest less, which may mean job losses and general economic uncertainty,
so individuals may spend less. This highly simplified account of economic
trends shows how these trends influence individuals and businesses and how
their actions, in turn, influence economic trends. Governments use various
mechanisms to try to influence these trends. In times of economic crisis
they may lower interest rates, thus making money cheaper to borrow, in the
expectation that this will increase consumer and business spending.
Conversely, if an economy is growing so much it is considered to be in
danger of over-heating, government may increase interest rates in order to
38
make borrowing more expensive and thus discourage consumers from

spending more and more.
Another important economic variable that can have a major impact on
business is the exchange rate. This refers to the prices of a particular
currency in relation to another currency, and is generally based on the
supply and demand for that currency. Varying exchange rates cause
problems for businesses because it becomes harder to predict how much a
business will have to pay for supplies that are bought in a different
currency, or what it will earn on goods and services sold to areas using a
different currency. If the domestic currency strengthens, exporting becomes
more difficult because the price of goods exported is higher and foreign
products are more competitive in the home market. If the currency weakens,
exports are easier and opportunities may open up for new markets, while
imports become more expensive. The example in Box 1 illustrates this.
Box 1 The effect of changes in exchange rates

The following worked example uses the fictitious Milton Keynes Toys
Company to illustrate the effect of foreign exchange on costs and
revenue.
Milton Keynes Toys makes and sells wooden toys, both in the UK and
to other European countries. At the same time it imports a certain
quantity of a particular wood from another European country each
month. Each month Milton Keynes Toys has the exports and imports
shown in Table 5.1, which vary according to the exchange rate.
Table 1 Export and import costs and revenue for Milton Keynes Toys
Month Exchange Cost of toys exported Cost of wood imported

rate to the Eurozone from the Eurozone
(£10.00 each) (€1.00 per kg)
A £1.00 = €1,200 per 100 £833.33 per 1000 kg
€1.20
B £1.00 = €1,300 per 100 £769.23 per 1000 kg
€1.30
In Month B the exchange rate changed, with the euro worth less in
relation to sterling than in Month A. Therefore, the cost of toys to Milton
Keynes Toys’ customers in the Eurozone rose and Milton Keynes Toys
paid less for wood. This sounds like good news for Milton Keynes Toys
but it may not be in the long run. If the value of the euro continues to
be low in comparison to sterling, this may make the toys too expensive
in the Eurozone market and the customer may start looking for a
supplier of similar toys within the Eurozone in the hope of getting a
better deal.
39
Readings 1–11
4 Environmental factors
Environmental issues are of growing importance to businesses. Business
activity as a whole has significant impacts on the natural environment, in
terms of resource use, pollution, etc. Businesses themselves are affected by
changes in the natural environment, such as shortage of natural resources
(for example mineral oil or copper) or adverse environmental events (for
example flooding attributed to building in flood plains and global climate
change). Environmental factors also impact on political factors: people
around the world are increasingly concerned about environmental changes
and businesses’ impacts on the natural environment. Governments, pressure
groups and consumers, to name just a few, are expecting businesses to
reduce their impact on the environment and work for greater environmental
sustainability of their operations.
Figure 1 Power station
Exercise 2
This exercise asks you to think about how environmental awareness can be
used as part of the marketing strategy of a business. List any ‘green’
business you can think of, that is, businesses that have attempted to attract
and keep customers by establishing and promoting a green image.
Comment
‘Green’ can relate to the ecological impact of a business or its products, or to
a more generally ethical or wholesome image. The number of businesses
trying to market themselves as green relates to the demands for
environmentally and ethically responsible goods and services, such as
organic foodstuffs, ecologically benign cleaning products, and similar. For
example, Ecover produces a range of cleaning products that it claims have a
significantly lower impact on the environment than ordinary cleaning
products. They claim that the products themselves are less environmentally
harmful than many conventional cleaning products and that the factories in
which they are produced also produce fewer environmental impacts. This
40
brand has been successful for quite a few years and the demand for
environmentally responsible products has grown during this time, so that
other cleaning brands, including supermarkets’ own labels, also market
cleaning products that are claimed to be environmentally less harmful.
However, the drive for green marketing credentials can also be problematic if
consumers perceive companies’ environmental claims as ‘greenwash’,
meaning that they think a company is merely trying to sell a few more goods
on the basis of environmental concerns without really changing its products
or processes to make them more environmentally responsible.
Some issues around environmental concerns that businesses need to

consider are:
Environmental impact – businesses, almost by necessity, have an
impact on the natural environment: they consume natural resources such
as energy and raw materials, and they often produce waste materials
which end up in the environment, in landfills, in the air or in the water.
Many businesses now have environmental management systems through
which they monitor and manage their environmental impacts but it is
very hard for most businesses to get to a state of zero or very low
impacts.
Dependence on natural resources – businesses need natural resources,
including energy to run their plants and premises, raw materials to make
their products from, water to run production processes (a lot of
production processes are very water intensive, for example in food
production). If these resources become scarce and thus very expensive,
or qualitatively degraded and thus unusable, businesses relying on them
must find expensive substitutes or may be hindered in continuing
operations.
Danger from adverse events in the natural environment – any
business person whose premises have been flooded or damaged through
environmental events such as hurricanes will tell you that this causes
major disruption to work and may drive a small business into
bankruptcy. Climate change is thought to lead to greater frequency and
severity of such adverse weather events and businesses need to make
preparations to adapt.
Stakeholder pressure – an increasing number of stakeholders are
becoming interested in a business’s environmental performance. This
includes legislators (environmental legislation is now an important factor
that most businesses have to take account of); customers (there is an
increasing segment of consumers who take environmental credentials
into account when buying things, and business customers are
increasingly incorporating environmental criteria into their purchasing
decisions); employees (good environmental credentials attract well-
qualified staff, and attention to environmental issues within an
organisation tends to raise staff morale); pressure groups (large
businesses in particular are often subject to demands and sometimes
direct action by environmental pressure groups).
41
Readings 1–11
Impact on financial performance – not attending properly to

environmental performance can have significant impacts on financial
performance, for example through fines or clean-up costs in the case of
environmental pollution, reduced sales in the case of negative publicity
around environmental problems, etc.
Legislation – in many countries, environmental legislation is increasing
and is now a significant factor for many industries. The main emphasis
of environmental legislation used to be on pollution control and waste
disposal but increasingly regulation is also concerned with packaging,
transport and distribution, and sources of materials. Energy policy and
carbon trading are two aspects of environmental regulation which are
highly important to many businesses, particularly in the European Union.
5 Political and legal factors

Political influences control or affect most of what we all do. There are
political influences on business and other organisations in terms of rules and
regulations imposed by the government (local, national and global), as well
as the influences from such organisations as chambers of commerce, trade
unions or the pressure groups already mentioned above. In a broader sense,
the political system in which an organisation operates has a huge impact on
how this organisation is formed and how it operates. Just consider the fact
that under certain political systems private enterprise is not allowed,
meaning that there can be no privately owned businesses. This used to be
the case in all communist countries. With the end of communist regimes in
Eastern Europe this has, of course, changed there. It has also changed in
China, where private enterprise is increasingly common even though the
political system in China continues to be officially a communist one.
Some important political factors are:
. Legislation affects many aspects of business life, such as health and

safety at work, equal opportunities and employee protection. The
Chartered Institute of Personnel and Development’s website (enter CIPD
into an internet search engine) contains information on the ever-changing
area of employment law.
. Trading relationships are strongly influenced by political factors. The
World Trade Organization (WTO) and the European Union are examples
of this.
. Government is a major party to many business transactions. In all
countries, the government is one of the largest employers and usually
the largest single purchaser of goods and services.
. The level and nature of public services – for example health services,
education and the police force – are determined on political grounds.
This has obvious immediate implications for the organisations delivering
these services but it also has wider impacts on society as a whole and
other kinds of organisations. For example, the level of health services
provided by the state has important implications for private businesses.
In the United Kingdom, where universal healthcare is provided by the
42
state and paid for by taxes, employers do not need to do much in order
to make sure their employees receive health cover. In other countries,
where there is no state-provided or mediated health service, many
employers offer health insurance as part of the benefit package for their
employees.
. Governments determine levels of taxation – on the individual, on
businesses, on property and on goods and services.
Spotlight On Research
Public policy to promote corporate social responsibility
by Anja Schaefer
In 2012/13 I was able to contribute to a cross-European study – funded

by the Bertelsmann Foundation in Germany – that looked at various
public sector initiatives that aimed to increase responsible business
behaviour in five different industry sectors: chemicals;
telecommunications; financial services; retail; and construction. In each
country three case studies of such public sector initiatives for
responsible business behaviour were conducted. I was responsible for
the case studies in the UK. We wanted to know about the nature of
these initiatives, who were the main stakeholders involved, whether the
initiatives were entirely voluntary on the side of business or whether
there was some form of regulation in place, and how successful the
initiatives were in terms of achieving their original purpose. I looked at
three initiatives: one in the retail sector that aimed to reduce the
amount of packaging and other waste in the food retail chain; one in the
construction industry, which was a very ambitious, wide reaching
strategy to increase economic, social and environmental sustainability
in construction; and one in the financial services industry which aimed
to ensure that customers’ interests were at the heart of financial
services provision and people would not be sold unsuitable or
unaffordable financial products. In each case, a government agency (or
an arms-length organisation formed by the government for just that
purpose) worked quite closely with individual companies and with
industry associations (i.e. the associations that represent companies in
one industry) in order to achieve the goals of waste reduction, the
introduction of practices designed to lead to greater sustainability, or the
fairer treatment of customers respectively. These case studies showed
that governments quite frequently influence businesses not just through
laws, regulations, taxation and other highly formal means but also by
involving them in voluntary and semi-voluntary projects designed to
achieve the government’s aims but without the cost and administrative
burden of formal regulation.
43
Readings 1–11
6 Ethical factors
It is a matter of debate whether ethical issues should be considered mostly
from the perspective of the external environment or from the perspective of
the internal workings of an organisation. They are a matter of both. The
same does, of course, also apply to some extent to the other environmental
factors. For example, a business is affected by the economic trends in its
external environment but also affects economic trends.
No matter where precisely we locate ethical issues, it cannot be doubted
that questions of ethics are increasingly being asked of organisations,
particularly business organisations. A number of business scandals (such as
fraudulent accounting practices that ultimately deprived shareholders and
customers of their dues, as in the case of the WorldCom and Enron
scandals), the financial crisis of 2008 (to a large extent blamed on
unregulated and irresponsible practices by leading banks), recurring
problems with food safety (remember the BSE crisis or the dioxin in wine
scandals?) and many more have eroded trust in business and its regulators
in many countries. Therefore, there are increasingly more vociferous
demands from numerous stakeholders that businesses need to temper their
pursuit of financial gain with ethical considerations of what is and what is
not acceptable and responsible practice.
The topic of business ethics is touched upon again later in this block and it
is covered in greater detail in Block 6.
Summary
The STEEPLE model provides a useful structure for the discussion of the
external environment. As you will have noted, however, the distinction
between the factors is rather artificial. Many political decisions have an
economic impact and almost all economic factors have a political
dimension. Social behaviour is influenced by new technology, and it in turn
influences political decisions. Environmental issues have strong social,
political and economic dimensions, and the introduction of environmentally
acceptable solutions often depends on the development and adoption of new
technology.
44
References
Hurley, J. (2012) ‘Arena flowers’ Valentine’s display wins hearts, not
profits’, Daily Telegraph, 14 February 2012, [online]. Available at www.
telegraph.co.uk/finance/businessclub/9081740/Arena-Flowers-Valentines-
display-wins-hearts-not-profits.html (Accessed 29 July 2014).
Schaefer, A. (2013) ‘Sector-specific corporate responsibility in the United
Kingdom’, in Beschorner, T., Hajduk, T. and Simeonov, S. (eds) Corporate
Responsibility in Europe: Government Involvement in Sector-specific
Initiatives, Gütersloh, Verlag Bertelsmann Stiftung, pp. 241–62.
45
Readings 1–11
Reading 6: Business, society,

stakeholders and ethics
Introduction
This reading will look at the relationship of organisations, particularly
businesses, with society as a whole and with individual stakeholders and
stakeholder groups. The role of business in society is frequently a question
of debate. If business is not seen to have a largely constructive and benign
role in society then this can lead to severe long-term consequences in terms
of loss of trust and difficulties to operate. Likewise, all organisations need
to be aware of their relationships with key stakeholder groups, which are
affected by what the organisation does and sometimes have the ability to
seriously impact on the organisation in return. The reading also introduces
the idea of business ethics and why ethical conduct is important for
businesses.
1 Business and society

This reading starts with a look at the relationship between organisations and
wider society, focusing particularly on businesses. This is not to say that the
relation between public- and third-sector organisations and society is not
important or interesting, but it is an area that has been little explored by
research.
It is easy to take a simplified view on the relationship between business and
society. On one hand, some people argue that the aim of business must be
to do good in the world. On the other hand, some others – mainly
economists – argue that ‘the business of business is business’, namely that
the purpose of business is simply to make profits and that it is not for
business managers to make judgements on the needs of society, which is the
concern of others, such as politicians. Like most simplified views, both of
these probably contain a grain of truth but are overstated and lack subtlety.
The reality is that business and society depend on each other. Business is an
integral part of society and societal trends have profound impacts on how
business is and can be conducted.
The role of business is primarily economic. At least this is true for for-
profit business organisations. Unless a for-profit business performs its
economic functions it will not have the resources to perform any other
roles, nor will it survive long enough to play any significant part in societal
development. Stated simply, for-profit businesses exist to produce goods and
services that society needs and/or wants, at a profit, and they cannot take on
any other societal responsibilities – at least not in the long run – unless they
perform these economic tasks successfully. At the same time, business
depends for its survival and long-term prosperity on society providing the
resources – such as people, raw materials, services and infrastructures –
which it needs to operate successfully.
46
Reading 6: Business, society, stakeholders and ethics
All this depends on the members of the society supporting the values and
norms that the business endorses. There is therefore an implied contract
between businesses and the communities in which they operate. A business
is expected to create wealth, supply markets, generate employment, innovate
and contribute to the maintenance of the community in which it is situated.
In return, a business, including its shareholders and other stakeholders,
depends on the community in which it operates for its existence and
prosperity. It can be argued that one important role of business in a market
economy is to provide the means by which the needs of the community are
met, in the form of goods and services, jobs and income from taxes paid by
the companies and their employees. The infrastructure on which industry
depends requires long-term commitments (hospitals, schools and so on), and
communities expect that businesses will match this with long-term
investments. Business is also required to act legally and responsibly with
respect to health and safety at work, employment conditions and
environmental issues.
In practice, how do businesses reconcile the demand for greater profit,
lower costs, or ‘more for less’, with the interests of society to secure
employment, protection of the environment and tax income? There is not a
simple answer to this question, but the following points may be of help.
. The degree of conflict between maximising profit and serving the

interests of the community will depend on the type of business and its
relationship with the community. If a business is a major employer in
the area, or a major customer of local suppliers, then its actions are
going to have a substantial impact on the community. Communities are
an important stakeholder for many or perhaps even most businesses, in
as much as they can provide many of the resources that a business needs
(such as employees, land, local suppliers, raw materials) and are also
often significantly affected by what the business does (through
employment, taxes, pollution, use of infrastructure, etc.). It can therefore
be argued that a business has an obligation to consider the interests and
views of the local community when making decisions. This is likely to
be in its interests because it will probably depend on local support for
business plans. However, increasing globalisation can weaken a
business’s ties with its local community. Its headquarters may be in one
country, its plant managers from another, its suppliers from yet another,
and its profits accounted for wherever it is most tax efficient to do so.
. It is important that there is communication between a business and its
stakeholders. This can be at both the formal and the informal level.
Many businesses, for example, encourage their employees to participate
in local activities. Typically, companies are good at communicating
when they want something, such as planning permission, but allow
communication links to lapse when there are no pressing needs.
. Many decisions that may seem quite trivial to a business may be of
great importance to the local community. An example would be the
routing of delivery trucks: unnecessary bad feeling can be avoided if the
community’s interests are taken into account.
. Environmental issues often create tension. Businesses may seek to
operate to the lowest legally permissible standards, and may thereby
47
Readings 1–11
create distrust and suspicion among local residents. On the other hand,
local opposition may be voiced through pressure groups that are overtly
anti-industry and whose arguments are therefore instinctively rejected by
companies, even when they express valid concerns.
Many large businesses have corporate social responsibility (CSR) policies,
and these are often clearly stated on the business’s website. The UK retail
giant Tesco, for example, dedicates several pages to CSR policies on its
corporate website. The increase in CSR policies and disclosure of some
aspects of social performance on corporate websites and in annual reports is
surely a sign that large corporations are recognising that society expects
them to be transparent and to take account of social and environmental
responsibilities. However, the publication of CSR policies and some positive
social and environmental stories can also be largely a public relations
exercise rather than a reflection of genuine action to improve social and
environmental performance.
2 Stakeholders
Stakeholders are people, or groups, who have a legitimate interest in the
activities of businesses and other organisations in their society. Employees,
customers and shareholders are all examples of stakeholders. Others include
managers, suppliers, local communities and the State (in the form of
institutions, citizens and taxpayers). Voluntary sector stakeholders include
funders, sponsors and donors. In the public sector they include the general
public in their capacity as citizens (for example through elected
representatives), as taxpayers (funders) and as beneficiaries of public
services.
Table 1 Stakeholders and their expectations
Stakeholders Primary expectations Secondary expectations

Owners Financial return Capital growth
Employees Pay Work satisfaction, training, social
integration
Customers Supply of goods/ Quality, value for money, etc.
services
Creditors Creditworthiness Security
Suppliers Payment Long-term supplier relationship
Community Safety and security Contribution to the community, local
employment
Government Compliance Improved competitiveness
A stakeholder framework for a for-profit business is shown in Table 1. The

table distinguishes between the main or primary interest of stakeholders and
their secondary interests, which are often also very important to them but
perhaps not quite as central as their primary expectations. It should, of
course, be noted that what is the main interest may differ between
stakeholders in the same category. For example, some employees may be
48
more interested in work satisfaction and social integration than pay and may
forego higher pay to work in a job that really interests and satisfies them.
The concept of stakeholders is important for two reasons. First, it
emphasises that stakeholder groups have different interests. Second, it
illustrates the relationship between organisations and their external
environment (as explained through the STEEPLE model).
There are four important points that you should bear in mind with regard to
the stakeholders of an organisation:
1 All organisations have internal stakeholders: shareholders, employees,
managers, directors, trustees. They also have stakeholders external to the
organisation, such as customers, clients, suppliers, funders, competitors
and members of the community or the general public.
2 Different stakeholders have different interests, and these interests may be
in conflict.
3 The culture, structure and control systems within a business will
influence how these conflicts, or trade-offs, are resolved, and in practice
the interests of one stakeholder group often have a dominant position.
Although commercial businesses are conventionally considered to be led
by the interests of their owners, in large corporations the reality is
generally that directors and senior managers may be the dominant
interest.
4 Some stakeholder interests are protected by law but not all. Owners and
shareholders are protected by property and company law, whereas the
interests of other stakeholders are often only protected by regulation or
management discretion. However, employment legislation provides
increasing protection for employees, while environmental legislation and
regulation protect the interests of the natural environment.
Exercise 1
This exercise is designed to develop your understanding of stakeholder

interests and levels of power of stakeholders. Consider the four statements
below and attempt the following two questions:
What does each statement say about conflicting stakeholder interests?
Which is the dominant stakeholder group in each case?
1 A senior nurse: ‘The health service has always been customer-focused,

but it has always defined its customers as the doctors’.
2 A head teacher to a colleague, following a conversation with a parent:
‘These people – they think they own the place’.
3 Henry Ford, the car manufacturer about the early Model T car: ‘You can
have any colour you like, as long as it’s black’.
4 From a fictional company’s annual report: ‘Our people are our greatest
assets – and the fewer of them the better’.
49
Readings 1–11
Comment
1 Senior nurse: there is clearly a conflict here between the interests of
doctors, other clinical staff and patients. The implication is that the
dominant stakeholders are the doctors.
2 Head teacher: Who does ‘own the place’? The professionals (teachers in
this case) may see the school as theirs. But so may parents, students,
the local community and taxpayers – they are all stakeholders with a
claim to ownership.
3 Henry Ford: On one hand, his statement is actually quite witty. On the
other hand, it can also be read as the classic statement of industrial
arrogance: the presumption of the dominant interests of shareholders and
directors over those of customers. Henry Ford believed that there would
be enough potential customers for the first mass-produced, achievable
car without need to take account of any further wishes or preferences that
potential customers might have.
4 Fictional annual report: in this example, lip service is paid to one
stakeholder group, the employees, but the real dominance lies with the
shareholders and directors.
It is important to note that there is always potential for conflict between the
interests of different stakeholders. Possible conflicts include those between
the following groups:
Shareholders and customers – customers want high quality and low
prices while shareholders are interested in minimising costs and
maximising profits. In reality, however, these differences will be
primarily about timescales. In the long term, shareholders and customers
are interdependent and therefore have a shared interest in value for
money.
Managers and shareholders – attitudes towards salaries, perks and
business risk are likely to be different in large businesses that are not
also managed by their owners. Ultimately the interests of shareholders
are likely to be dominant as they employ directors and managers as
agents to run the business on their behalf.
Funding agencies and service users – in public or voluntary service
providers there is typically a greater demand for services than the
available funds can support, and choices have to be made to ration the
services provided or compromise on their quality. A good example is the
availability of expensive new drugs to treat certain serious health
conditions, particularly if these drugs seem to improve or prolong lives
to a certain degree but not massively so. Where patients are treated
under a tax-financed state health system (such as the UK National Health
Service) or through widely available health insurance schemes, the
providers of the health service may well come to the conclusion that it is
a better use of limited financial resources to concentrate on well-known
50
treatments for common illnesses that affect many people than to finance
the use of these expensive new drugs for very few people.
3 Business ethics
During recent years, a number of high-profile scandals have cast the public
gaze firmly on the way in which businesses conduct their affairs. An
example is the unethical accounting practices, risky trade practices and
misrepresentation of the firm’s financial health at US utilities company
Enron, which led to a drastic de-valuing of the company’s share-price and
its eventual bankruptcy in 2001, during which shareholders and creditors
lost their money. Another fairly recent example is the explosion of the
British Petroleum (BP) owned Deepwater Horizon oil drilling platform in
the Gulf of Mexico in 2010, where the resultant oil leak took weeks to stop
and large areas of the ocean were polluted. An older example, which
however still has repercussions today, is the fatal gas leak at Union
Carbide’s chemical plant in Bhopal in India in 1984, when at least 2,000
people died of gas poisoning (other sources estimate over 8,000 deaths).
The disaster led to the criminal prosecution of the then chairman of Union
Carbide as well as that of several other directors, contributed to the eventual
demise of Union Carbide as an independent company, and has left people
suffering ill health as a consequence of gas exposure until the present day.
People in business confront ethical decisions on a regular basis. The quality
of their decision making has a significant impact on people inside and
outside those businesses. The way in which people deal with ethical
decisions – and even whether they consider a decision to be a question of
ethics or not – is to some extent related to their own values and to some
extent also to the ethical pressures from the external environment.
Business ethics is concerned with the study of how we ought to conduct

business; the study of what makes certain actions within the business
context the right, rather than the wrong, thing to do. When we use terms
such as ‘ought’, ‘right’ and ‘wrong’ in an ethical sense, we are using them
in a particular way.
To a certain extent, the laws of any democratically constituted society define
the ethical standards that are widely accepted within that society. They
codify the values that a society holds dear, and therefore provide minimum
standards of ethical conduct. Many of the activities undertaken by
individuals and businesses fall outside the scope of the law, yet still present
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Readings 1–11
ethical challenges. For example, there is no law against telling lies to a

friend, although most of us would accept that to do so is unethical if these
lies have the potential of harming the friend. Similarly, although there may
be not always be laws requiring businesses to adopt environmentally
friendly policies or to refrain from using live animals for research purposes,
most of us would agree that these are ethically charged subjects. Although
members of a society, or businesses that operate within it, have a
responsibility to abide by its laws, abiding by the law is not a complete
recipe for ethical conduct.
Ethics is important for businesses, as well as other organisations, for a
number of reasons:
1 Businesses need to conform to the expectations of their stakeholders.
Business success depends on the support of a number of key
stakeholders. These include investors, customers, employees and
suppliers. All of these stakeholder groups are becoming increasingly
interested in the ethical performance of the businesses that they support.
For example, many private investors will only purchase shares in
businesses that meet certain ethical criteria. Customers are also
becoming increasingly interested in ethical aspects of the sourcing and
manufacture of goods. Businesses that have their own ethical codes will
sometimes only do business with partners who observe similar standards.
Furthermore, many people only wish to work for employers who
conform to certain ethical principles. Therefore, in order to be
successful, businesses must meet the ethical expectations of these key
stakeholders. It is a task of business ethics to help business people to
understand and respond to those expectations.
2 Business depends on society, so it must respond to the needs of society.
Business and society are linked in a symbiotic relationship, which means
that each depends upon the other. In our capitalist economy, business
depends on society for its success and society depends on business
success to ensure the affluence and material comforts that make life
pleasurable. Business does not operate in a vacuum and business values
cannot be separated from social values. It is a task of business ethics to
help business people identify and respond to those societal needs.
3 Business can only operate effectively if certain norms are respected.
Businesses can only operate effectively if those who take part in them
follow certain common norms – or usual ways of doing things – and
procedures. Businesses, and some individuals within them, may derive
short-term gain from going against commonly accepted norms. In the
longer term, however, businesses and those who work within them will
only be successful if they observe shared standards of honesty,
trustworthiness and cooperation. It is a task of business ethics to help
business people define and understand these shared norms.
4 Business has considerable impact on the lives of people. Business
activity has a substantial impact on every person’s life. For example, the
way that products are made affects communities and the natural
environment. The way in which products are marketed can have a
significant impact on how we think and behave. Furthermore, most of us
spend a substantial part of our lives at work. The work environment has
a massive impact on our quality of life, as do the financial and non-
52
financial rewards that work provides. Therefore businesses, and business

managers in particular, exercise considerable power over everyone’s
quality of life. It is reasonable to expect businesses to exercise that
power in a responsible manner. It is a task of business ethics to consider
what constitutes responsible use of the power that business wields.
Summary
In this reading you have learned about the relationship between business
and society and about stakeholders and their importance for organisations.
Managing a business’s role in society and its relationships with stakeholders
is an important task for managers at many different levels in an
organisation, and it tends to become a more important part of a manager’s
role as the manager becomes more senior in the organisation’s hierarchy.
Business ethics is an important issue for everyone who makes decisions in
all types of businesses. The effects of decisions and outcomes on
individuals, stakeholders and the wider society must be considered.
Academic research into the ethics of business is a growing area, and you
will notice how many business news stories from around the world are
prompted or influenced by an ethical dimension.
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Readings 1–11
Reading 7: The business functions

Introduction
This reading considers some aspects of what goes on inside an organisation,
namely the different functions of an organisation. There are also other
aspects of the internal workings of an organisation, such as organisational
structure and culture, which are not covered here. We look at the functions
mostly from the perspective of a business, although many aspects of this
reading are also relevant to public- and third-sector organisations.
Business functions deal with different aspects of keeping a business
profitable and sustainable and of achieving business goals. The main
business functions are human resource management, marketing, accounting
and finance, operations, and information management. Of these, human
resource management, accounting and finance, and marketing are covered in
more detail in Blocks 2, 3 and 4 respectively, and you will learn more about
operations and information management as you progress in your business
and management studies. It should be noted that although human resource
management, marketing and operations, for example, are separate functions,
the activities and decisions in each will affect all the others, and there needs
to be close collaboration and communication between the different
functions.
1 Human resource management

The human resource management (HRM) function is responsible for all the
activities concerned with the employment of the people within a business. It
was, and is sometimes still, called personnel, a name that is often associated
with a very administrative and bureaucratic image. Despite this image,
personnel departments had their roots in a real concern for people at work
and brought about some important changes in working conditions following
the Industrial Revolution. The change to HRM was more than a change of
name; it involved a wide, ongoing debate about different approaches to the
management of people. However, many people object to the idea of people
being just another ‘resource’ that a business uses to achieve its objectives.
The management of human resources does not, of course, happen solely
within the HRM function; many individuals have to manage and deal with
other people within a business.
Exercise 1
This exercise is designed to help you think about the different activities in the
HRM function. What do you know about the HRM function? Do you have
personal experience of being an employee, at the ‘receiving’ end of HRM
policies? Even if you do not have any work experience, have a go at this
exercise.
54
Make a list of the types of activities you would imagine an HRM department
to be involved in.
Comment
The HRM function is concerned with all aspects of managing people within a
business. When someone joins a business, they enter into an employment
contract, offering certain skills for agreed rewards and conditions. HRM deals
with all parts of this employment contract, from the time it begins
(recruitment and selection), through its ongoing maintenance and control
(socialisation, performance management, job design, rewards, motivation), to
the time either party terminates the contract (redundancy, resignation,
dismissal, retirement).
Here is a list of examples:
. staffing policy and planning

. drawing up contracts
. deciding how many and what type of people and skills are needed to help
the business start/run/grow
. job design – who does what and how
. recruitment and selection
. induction and socialisation
. performance management – job appraisal
. motivation
. health and safety
. industrial relations
. training and development
. downsizing, redundancy, dismissal.
Different businesses will give different prominence to the HR function,

perhaps depending on their size, structure and organisational culture. Small
businesses do not necessarily have a distinct HR function, but the value of
having a separate HR department or representative lies mainly in the
objectivity they can bring to business processes such as selection and
performance appraisal; that is, decision making that is not influenced by
emotion or prejudice.
2 Marketing
Marketing is the term given to the activities that occur at the interface
between the business and its customers. The name comes from the concept
of a marketplace, and marketing is concerned with matching what customers
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Readings 1–11
want to buy with what products or services the business is offering. The
aim of marketing as a function is to ensure that customers will conduct
exchanges with your business rather than with someone else’s. Marketing is
often associated with the negative image of getting people to buy things
they do not want. Marketing practitioners, however, would argue that they
have responsibility for ensuring that the customer comes first in the
business’s thinking.
Effective marketing is based on a good understanding of how consumers
behave and make decisions. There is a need to identify gaps in the market
and anticipate opportunities. Once a business has a good understanding of
its customers’ requirements it can tailor the products or services it offers to
make sure they meet these customer requirements (and do so at least as well
or better than competitors’ products and services).
As well as understanding their local or national market, marketing
practitioners need to be aware of international and cultural differences in
factors such as customers’ preferences and how goods and services are
promoted.
3 Accounting and finance

Finance, or money, is an important resource for all businesses. The financial
aims of a private-sector business will include making a profit. In the public
sector, the main objective will be to make the best use of financial
resources. The accounting and finance (A&F) function is responsible for
communicating appropriate financial information to internal and external
stakeholders, many of whom will not be financial experts.
Exercise 2
This exercise is designed to help you start thinking about the ways in which
money comes into a business and leaves it.
Imagine that you are about to open a small café in your local town. What will
be your main source(s) of income? On what kind of things will you have to
spend money?
Comment
All businesses are different and have somewhat different costs and
expenditures. Here are some typical sources of revenue and expenditure for
this type of business:
Revenue – the main income for this type of business will come from
customers who pay for the food and drink they receive. This could be
customers who buy and consume food and drink at the premises of the
café or customers who buy the food and drink to take away. In time, there
may be other sources of income, perhaps from delivering food to people’s
homes.
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Expenditures – these are going to be many. You will have to pay rent on
the premises of your café. You will need kitchen equipment, furniture,
furnishings for the café, and so on. Then you will need to buy supplies,
such as food stuffs, cleaning products, and so forth. If you are successful
you may consider employing someone to help you in either preparing
food and drink or serving customers. Wages then become another
expenditure. In addition to that there are business taxes, charges for
things like rubbish disposal, and many more expenses.
From this very short and incomplete list it will already be obvious how
important it is for a business to keep track of its finances.
The detailed activities of the A&F function will vary in nature from the
operational to the strategic – that is, from costing future plans to calculating
actual income and expenditure – and will be influenced by the external
environment of the business. The nature and particularly the size of a
business has an impact on the complexity of its accounting and finance
function but all businesses need to account for their finances. The nature
and purpose of the A&F information produced within a business fall into
two main categories: management accounting and financial accounting.
Management accounting provides financial information for the managers of
a business to help them with planning, budgeting, operational control,
performance evaluation and making various kinds of decisions.
Financial accounting provides information for people outside of the
business: for example, external stakeholders such as shareholders, investors,
suppliers, providers of loan capital, government, and competitors. Providing
financial information for external stakeholders is particularly important for
public limited companies, and there are laws and professional standards that
set out how these businesses need to provide this kind of information. It can
also be important for private companies, where financial information may be
requested by banks or an investor.
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Readings 1–11
4 Operations
The operations part of a business can best be thought of as the activities
that produce the goods and/or deliver the services required by its customers.
This function is often seen as a transformation process, changing inputs into
outputs. The success of any business is related to its ability to manage its
operations efficiently, to make the best use of resources, and to meet the
requirements of its customers effectively. As the ‘doing’ part of the
business, operations is central to achieving the business’s aims. It is
responsible for producing the goods, or delivering the services.
There is often a misconception that operations management is concerned
only with manufacturing activities. Although much of the academic study of
operations management does have its origins in the manufacturing
industries, many of the key concepts are equally applicable to services. The
distinction between manufacturing and services is, in many respects,
artificial and increasingly irrelevant. Service transactions do have distinctive
characteristics. They may, for example, be intangible: you cannot store a
haircut. But, from the point of view of operations management, even the
most basic product will have some element of service accompanying it.
Conversely, most services have some tangible product as an integral part of
what is delivered to the customer. A hairdresser stocks and sells hair
products, for example.
5 Information management
Information management is concerned with identifying, gathering and
analysing information that an organisation needs in order to function well.
All kinds of organisations need a great deal of information in order to
analyse their external environment and their internal processes. In this
section we concentrate mostly on the information needs of businesses but
much of what is said here can also apply – with some modifications – to
other types of organisation.
Businesses obtain information through a variety of formal and informal
sources. The conjunction of these sources of information and the processes
by which businesses collect, access, analyse, interpret and use this
information is called a business information system. The process of
collecting, analysing, interpreting and using the information is called
information management. As the business changes over time, business
processes and information systems need to be built and maintained. Every
business function has a role in these activities, but the information
management function has a more active role because many of the processes
and systems incorporate information and communications technology (ICT).
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Summary
This reading has provided you with a very brief introduction to the business
functions of human resources management, marketing, accounting and
finance, operations and information management. It is important to bear in
mind that, while these are treated as separate functions in most businesses
(except very small ones) they are in fact closely interlinked and must work
together. For example, finance managers need to make forecasts of income
in conjunction with marketing managers, who make the marketing plans that
should result in sales and thus income. Marketing and operations
departments should work together when developing new products, and so
forth.
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Readings 1–11
Reading 8: SWOT analysis

Introduction
An organisation needs to keep track of the trends in its external
environment and monitor them for their likely impact on the organisation.
(Note that the relationship between an organisation and its external
environment is not entirely one way; organisations, particularly large ones,
also can impact factors in the environment, for example through significant
technological innovation, environmental impacts or their input into
collective bargaining negotiations over wages and employment conditions.
However, in this reading we are concentrating on the impacts of the
external environment on the organisation.) It will also seem immediately
plausible that organisations need to keep track on what is going on inside
the organisation and how its current resources, processes, capabilities,
structures, etc. influence its possible future development. There are several
tools that enable managers to analyse the internal and external factors that
impact on an organisation. SWOT analysis is one of the conceptually more
straightforward tools (although a full SWOT analysis for a real company is
not necessarily an easy or uncomplicated undertaking).
1 Strengths, weaknesses, opportunities

and threats
SWOT stands for strengths, weaknesses, opportunities and threats. An
analysis of these gives the organisation an overview of its position in
relation to its external and internal environment. The strengths and
weaknesses of a business arise from its internal environment; that is,
resources and their use, structure, culture and the different business
functions. The opportunities and threats arise from its external environment.
Which strengths a business decides to build upon and which weaknesses it
seeks to minimise depends on the impact of opportunities and threats from
the external environment. Once the external influences on a business have
been identified, they can then be judged to be either a threat or an
opportunity and can be dealt with, or taken advantage of, as appropriate.
Strengths
A strength is a competence, a valuable resource or any other positive
attribute that an organisation uses to take advantage of opportunities or to
counter threats arising from the external environment. Strengths could
include a resource such as a well-motivated and skilled workforce, with low
turnover, or an attribute such as a strongly established brand image or
reputation. Strengths, as well as weaknesses, are intrinsic to an organisation,
i.e. they are not automatically shared by all the businesses in an industry.
The same feature can be a strength for some businesses but a weakness in
other circumstances. For example, the existence of a well-established, loyal
customer base can be a strength for a business operating in a stable market
60
but could be a weakness if those customers are unwilling to try new

products and thus stop the business from innovating.
Weaknesses
A weakness is the lack of a competence, resource or attribute that an
organisation needs to take advantage of opportunities or counter threats or
to perform better than its competitors. Relying on old products or processes
can be a weakness if the market calls for product innovation or if new
processes are needed to produce goods or services more efficiently. A lack
of skilled employees, insufficient knowledge of customer preferences, lack
of financial resources or cash-flow problems, and old machinery can all
constitute weaknesses. Some things would be weaknesses in almost any
organisation; for example, a lack of funds will nearly always be problematic
for a business as well as for public sector and voluntary organisations.
Other things can be weaknesses in some contexts but not in others. A long-
standing, experienced workforce can be a weakness if it means employees
are unwilling to learn new skills and change but it can be a strength if they
have a lot of experience which is needed in order to, say, produce complex
goods or deal with long-standing customers.
Opportunities
Opportunities are chances in the external environment that an organisation
may use to gain benefits. Opportunities can arise from all aspects of the
external environment. For example, the invention and rapid dissemination of
mobile telephony has provided opportunities not only for businesses making
and selling mobile phones and providing mobile telephony services (the
obvious candidates) but also for many other organisations that can use the
new technology to communicate with their customers and other
stakeholders. Many businesses now use mobile text messages to advertise
new products or services to existing customers or to confirm bookings or
other transactions. Educators are interested in using mobile phones to
communicate with their students and deliver learning materials to them (for
example through iTunesU). You can probably think of many other instances
where you communicate with businesses or other organisations through your
mobile phone. As another example, the political changes in China since the
1990s have provided opportunities for many Western companies to establish
production facilities in China and win Chinese customers.
Threats
Threats have the potential to damage an organisation’s performance. Threats
often arise from competitors or factors that are outside the control of the
organisation. Competitors may reduce prices on very similar products or
services or may introduce a new, technologically advanced product or
enhanced customer service. Threats may also arise from any aspect of the
external environment, such as changes in legislation or taxation,
technological changes that an organisation finds it difficult to adopt, lack of
natural resources, adverse weather events due to environmental problems,
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Readings 1–11
and many more. Clearly, threats from the external environment may pose a
direct danger for the wellbeing or even survival of an organisation, but
threats may also jeopardise an organisation’s ability to take advantage of
good opportunities. If a business had been planning to develop a new
product based on a new technology and a competitor gets there faster, then
the opportunity is no longer as attractive.
2 Conducting a SWOT analysis

The most basic SWOT analysis will examine how threats and opportunities
can be dealt with while allowing the organisation to utilise its strengths and
weaknesses to meet its objectives. This can take the form of lists of
strengths, weaknesses, opportunities and threats. Such lists need to be brief
and specific, indicating the key and important issues. A basic SWOT
analysis will include an assessment of the company’s current situation and
where it wishes to be at some point in the future. The organisation also
needs to decide how far away that future is – it will vary from a few
months to many years depending on the organisation, its business and its
current situation.
A slightly more complex method of undertaking a SWOT analysis is to
consider strengths, weaknesses, opportunities and threats in relation to key
business functions. These consist of marketing, operations, human resources
and accounting and finance, and sometimes information management is also
included. Consider the following extract, which will be followed by an
example of a SWOT analysis conducted using the information in this
extract.
Merrythought sisters battle to

protect the British bear
James Hurley, Daily Telegraph, 3 July 2012, p. 8
The bosses of Britain’s last remaining teddy factory,

Merrythought, want to keep production in UK, but must find a
way to lift capacity to meet growing demand.
Once visitors to the Olympics have spent a small fortune on tickets
and travel – the official canal boat ride costs £95 per person, for
example – they might need deep pockets to be willing to fork out a
further £85 for the Games’ teddy bear. Until recently, even one of the
directors of Merrythought, the British manufacturer behind the bears,
may have regarded that as rather steep for a soft toy.
Hannah Holmes was working as a chartered surveyor in London when
her father, the third generation director of Britain’s only remaining
teddy bear factory, died suddenly last year. The 28 year-old returned to
Shropshire to help her sister, Sarah, run the business.
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Learning the ropes has proved a forbidding task, she says, but at least
she now understands why even the cheapest bears cost about £50.
‘Understanding how to make a teddy is surprisingly complex if you’ve
never experienced it,’ she says. ‘£85 can seem a lot but the bear takes
an hour to make and the raw material [mohair] costs £85 a metre –
and it should last a lifetime. So it seems better value than a pocket-
money toy made in the Far East.’
While Sarah, a former PR and recruitment consultant, had been
working in the 82-year-old business for a year when her father, Oliver,
passed away, the new management team readily admits to
inexperience.
‘The previous [directors] always worked alongside their father for 10
years before taking over,’ says Hannah. ‘You’re suddenly dealing with
every single aspect of the business; we manage everything, production,
sources, sales … and something Sarah [and] I have never done is
manage a workforce.’
‘Running your own enterprise, you suddenly appreciate all those years
of working for someone else,’ Sarah adds. ‘You can’t walk out and
forget about it – it’s on your mind the whole time. I hadn’t prepared
myself for the fact that it’s the main thing in your life and it has to be
if you’re going to be successful.’ She says that it’s unusual for the
company’s 25 staff to ‘be managed by two young girls’ – the previous
directors were all male. ‘It’s hard to assert authority while also finding
our feet. We haven’t really earned it yet.’
Not that they’ve got much time to settle into their roles. The
company’s fortunes have stabilised after years of decline in the
Nineties, and its projected revenues of around £1m this year represent
an improvement on last year, partly thanks to the Olympics deal but
also because of strong export sales in Japan as well as demand for
dual-branded bears from the likes of Fortnum & Mason and the Royal
Collection.
‘It’s still difficult to make a profit’, Hannah concedes, with the
company’s Victorian factory, which it has operated from since it was
founded in 1930, partly to blame.
The company, which supplies department stores and independent
retailers, is based in Ironbridge, Shropshire, which rather grandly
claims to be the ‘birthplace of the industrial revolution’. ‘We’re the
only survivor,’ Hannah jokes. ‘The rest are museums.’
Now, a break from the company’s past might be necessary. ‘People
love to visit and it’s an integral part of our heritage, but it is costly to
maintain – this year alone we are having to invest circa £250,000 in
roofing work, which is of no intrinsic benefit to Merrythought as a
business and does not produce a return on investment.’
Moving to a more efficient factory space is being carefully considered
by the new directors. ‘We want to maintain our values, but if we’re
going to survive for the next generation we’ve got to modernise.’
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Merrythought still uses roughly the same production techniques as

when it was founded by the directors’ great grandfather. The closest it
has got to automation, Hannah says, is a 1950s stuffing machine.
Figure 1 Merrythought teddy bear
‘It’s hardly cutting edge. [Production] is very labour intensive – it’s by

far and away our biggest overhead. That’s why none of our
competitors do this – we’re the only soft toy manufacturer of any scale
left. Most were sensible enough to … jump ship and manufacture in
the Far East.’
Moving upmarket has allowed the business to carve out a niche, but
the company’s plans to capitalise on growing demand and find new
overseas markets is being frustrated by fears over how it can increase
capacity in its factory.
‘The potential is there to grow the business at home and abroad. But
because manufacturing here has declined so much, if we wanted to
expand, finding those skills locally is very, very difficult and becoming
even more so,’ Hannah says.
The firm currently has two trainees, who work at approximately a
quarter of the speed of experienced workers – it can take as long as
two years for new recruits to reach the required standard.
‘Increasing production would require a lot of in-house training which
is very expensive.’
So is outsourcing a possibility? ‘We’ve built our brand on being the
quintessential English teddy bear – we need to produce that in Britain,’
Sarah says. ‘I would like to avoid going offshore. We’ll have to see
what our options are, but we take great pride in making them in
England from start to finish.’
The young directors are also busy overhauling the marketing of the
business, and are keen to turn their website into an easy method of
selling directly to customers, around half of whom are collectors.
‘Trade customers don’t like it but they accept it’s necessary. It’s
another opportunity to sell but also to test new products and have a
portal for people to ask about the business,’ Hannah says.
64
‘Traditional companies like ours used to be product led and could

survive just by designing and producing. Times have changed. You
have to be more market led. For this company to survive we need to
raise our awareness among consumers – it has to be desirable and not
just to collectors, which has been our bread and butter for the last 20
years.’
SWOT analysis is often presented in the form of a table that shows

strengths, weaknesses, opportunities and threats for each of several business
functions, followed by a discussion of the key points from that SWOT
analysis that need to be addressed by the organisation. A basic SWOT
analysis for the human resource management, accounting and finance, and
marketing functions of the Merrythought example above could look like
Table 1.
Table 1 SWOT analysis for Merrythought
Human resource Accounting and Marketing

management finance
Strengths Well-established Finances have Strong niche for the
family business stabilised after ‘traditional’ bear
with strong values decline, with Branding with
and culture which projected revenues special events like
feed into the of £1m (an the Olympics
‘brand’ improvement)
Strong export
‘Next generation’ Strong export sales markets
leadership showing to Japan
enthusiasm for Dual branded bears
Sales links with with established
taking the business Fortnum & Mason
forward (not always high-end outlets
and the Royal
the case with family Collection
businesses)
Growing demand
Weaknesses Inexperienced Shortage of High end, high
senior staff who financial resources price niche
have had to quickly to implement plans vulnerable to
learn multiple to increase market conditions
aspects of the new production capacity e.g. recession
business High cost of raw Commitment to
Very labour materials and home production
intensive, high production process leaves company
labour cost, and Difficult to make a exposed to
skilled staff difficult profit at current competition on
to find and train levels of activity price
New staff are slow £250k investment Limited distribution
to reach required in roofing required channels
standards. (with no return) Somewhat
Increasing dependent on the
production would Out-of-date
production collector market
make this even segment
more of a problem techniques, highly
labour-intensive,
expensive and
protracted training
processes
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Opportunities Possibility of using More efficient Develop branding

less labour- factory space, of bears
intensive methods modernisation Develop distribution
of distribution Outsourcing/ channels
(through the offshore production e.g. internet
internet)
Website selling Extend export
Outsourcing a way directly to market
of reducing labour customers/
costs – it’s an Find new customer
collectors segments
option they might
consider but would Far East
prefer to resist manufacture
Threats Likely future labour Lack of capability Increased

shortages/ to raise finance to competition from
increased labour achieve increase in low-cost producers
costs in a labour- production capacity Inability to
intensive business Decline in sales modernise affects
Company cultural after end of 2012 ability to refresh
ties might inhibit Olympic period product line
necessary change Cultural demand to
(i.e. moving to a maintain values at
more cost-efficient odds with
factory) requirement to
modernise and
become more
efficient
66
Key points to consider:
. Merrythought should build on its strengths in having a traditional British

product and continue to exploit this.
. The business needs to address its production weaknesses, particularly the
outmoded production facilities and difficulties in finding and training
good staff.
. It also needs to work on its financial basis so that it has enough financial
resources for future expansion.
. Merrythought needs to find a way of reconciling the traditional image
and values with the demands of modern production and market access
requirements.
There is more to a fully realised SWOT analysis in real business life. In
particular, it is usually considered necessary to attach figures to much of the
analysis of strengths, weaknesses, opportunities and threats. Quantifying
some of this analysis can help organisations to distinguish between, for
example, different opportunities on the basis of which can give the greatest
benefit if successfully pursued. At this stage, however, it is sufficient for
you to gain a basic understanding of the idea of SWOT analysis and how to
conduct one.
Summary
SWOT analysis is a way of bringing together the internal and external
factors influencing a business’s success. SWOT is by no means the only
method that can be used to analyse a business – quite the contrary. There
are many other tools and techniques for business analysis, which do,
however, go beyond the scope of this reading. SWOT analysis is useful for
businesses but it needs to be borne in mind that, in order to be really useful,
some numbers need to be attached to the analysis, and that there are other,
more sophisticated analysis tools, which are sometimes preferable.
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Readings 1–11
References
Hurley, J. (2012), ‘Merrythought sisters battle to protect the British bear’
Daily Telegraph, 3 July, [online]. Available at www.telegraph.co.uk/finance/
businessclub/9371070/Merrythought-sisters-battle-to-protect-the-British-bear.
html (Accessed 1 May 2014).
68
Reading 9: Organisational structure
Reading 9: Organisational
structure
Introduction
A structure gives an organisation an identity and provides continuity. It also
provides a framework for the allocation of roles and responsibilities. All
organisations will have some sort of structure, depending on the product or
service they provide, but also influenced by the history, size and culture of
that organisation.
Most organisations have some sort of organisational chart, and that chart
will provide clues about the organisation’s structure. The chart will show
the formal relationships between different individuals and departments, and
provide an outline of the official decision-making structure. Those positions
higher in the chart usually have more power and authority than those lower
down. The shape of the organisational chart can tell us much about the way
in which the organisation works, and perhaps the values behind this. For
example, some organisational charts are narrow and tall, with many levels
of authority, while a wider, flatter chart might suggest an organisation where
there are fewer levels of authority and the distance between higher and
lower level positions is perhaps less important to how the organisation
operates. Structure also includes the arrangements by which various
activities are divided between the members of the organisation and the ways
in which their efforts are coordinated.
Issues about structure are recurring matters of debate and dispute in most
organisations. This is because they include matters relating to departmental
and sectional groups, the pattern of reporting relationships, the cycle of
meetings, information systems, and rules and procedures.
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Readings 1–11
1 Types of organisational structure

An organisation might be structured in various ways. Some basic structures
are organised by function, product, service or geography; Figure 1 shows an
example of each of these.
A functional structure
Board
Marketing Finance Operations Personnel
Management Finance
Marketing Sales Production Maintenance
accounts accounts
A product structure
Head office
Pots Pans Cutlery Plates
A service structure
Head office
Mortgages Insurance Assurance Credit cards
A geographic structure
Head office
Europe America Africa Asia
EU Remainder North South Central China Japan India Remainder
Figure 1 Examples of organisation by function, product, service and geography
There are also other types of structures, such as team structures or matrix
structures, which combine more than one way of structuring, for example by
mixing a functional structure with a geographical structure. As is the case
with most aspects of organisations and business, it is unlikely that there is
any one ‘best’ model for structure. You would not expect organisations with
a professional orientation, such as a legal or medical practice, to have the
same organisational or management structure as a not-for-profit organisation
70
such as a church or theatre company, or a supermarket, or a high street

bank. The structure of a cooperative would enable the broadbased
participation and involvement of its members, while a legal practice would
need a more collectivist or collegiate structure. The challenge facing all
types of organisations is to develop a structure that recognises what is
required while still achieving an efficient use of resources and providing
effective services to customers.
Functional structures might work best when departments need regular
communication with each other. However, a disadvantage may be that
functions and the people who work in them may become rather insular.
Structuring by product or service can help to achieve better responsiveness
to customer needs, although it might mean professional or functional
expertise becomes fragmented. A geographic structure has advantages for a
large international business because there are likely to be differences
between the markets it serves. There are also likely to be language and
cultural differences. However, structuring by location may be problematic in
terms of communication and information flows, and support functions such
as finance and ICT may have to be duplicated.
2 The importance of structure

Why do organisations need structures? Structure is concerned with the most
appropriate way to group activities in the organisation to be able to achieve
desired objectives. Considerable variation is possible in terms of the types
of structure. Structure will be influenced by the size of the organisation, the
technology it employs, the behaviour of groups within it, management
strategy, the external environment, and the history and culture of the
organisation. The importance of structure becomes immediately obvious if
you imagine what it would be like to run a sizeable organisation that had no
structure at all.
Exercise 1
Imagine what the problems would be if one tried to run an organisation

without any structure. Make a list of some possible problems that might be
faced in trying to run a structureless organisation.
Comment
Trying to run an organisation (or group or team) of any size without any
structure at all raises numerous problems. Here are some that you may have
considered.
. It would not be clear who was and who was not a part of the
organisation.
. There would be no way of getting objectives agreed and hence of
measuring success.
. There would be no agreed way of making decisions.
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Readings 1–11
. All decisions would be open to reconsideration whenever anyone was

unhappy with them.
. It would not be clear who should do what work.
. Individuals and other bodies in the external environment would not know
whom to contact.
The need for structure in organisations and in life in general has been long
recognised. Ancient civilisations like the ancient Chinese, the Egyptians, the
Greeks, the Romans and the Maya had elaborate social and organisational
structures, without which it would have been impossible to build the
complex civilisations they had. Hunter-gatherer tribes have structures which
enable them to organise hunting and gathering activities, provide justice
within the tribe and organise family life. In the 1970s, Jo Freeman provided
the following strong rationale for the need for formal organisational
structure. This is no different today.
Contrary to what we would like to believe, there is no such thing as a

structureless group. Any group of people of whatever nature that
comes together for any length of time for any purpose will inevitably
structure itself in some fashion. The structure may be flexible; it may
vary over time; it may evenly or unevenly distribute tasks, power and
resources over the members of the group. But it will be formed
regardless of the abilities, personalities, or intentions of the people
involved …
For everyone to have the opportunity to be involved in a given group
and to participate in its activities the structure must be explicit, not
implicit. The rules of decision-making must be open and available to
everyone, and this can happen only if they are formalized. This is not
to say that formalization of a structure of a group will destroy the
informal structure. It usually doesn’t. But it does hinder the informal
structure from having predominant control and make available some
means of attacking it. … ‘Structurelessness’ is organizationally
impossible. We cannot decide whether to have a structured or a
structureless group; only whether or not to have a formally structured
one.
(Freeman, 1972–3, pp. 152–3)
By pulling these arguments together, we can identify four advantages of

having a clear and public organisational structure.
1 Enabling participation – The structure of any business will determine
how all the relevant sections and parties join in its activities and
influence its decisions. In other words, the structure underpins how
power and accountability, internal and external, operate within the
business. Indeed, the more complex the stakeholder pattern, and the
more contested the control over the business’s purposes, the more
complex the structures. It is no accident that a business such as Unilever,
the European Union, or a university all have highly complex structures
72
and procedures. The rules generally enable people to find their way
around, coordinate activity, make decisions and participate. Without
them, there might be anarchy and chaos.
2 Providing a framework for the allocation of responsibilities and
authority – Structure is at the heart of the differentiation and integration
of work. More simply, it is structure that makes it clear who is doing
what and this helps people to work together. The more appropriate the
structure, the more effective the working relationships between
individuals and departments. Defining the responsibilities of sections,
their staff and their managers, and establishing patterns of
communication and information flows between them, are aspects of
structure that are likely to impinge most immediately and obviously on
people’s work.
3 Establishing an identity for the business – Any business will need to
allocate responsibilities for external contacts. For example, suppliers and
customers need to be able to identify whom to contact within the
business. Legal documents have to be signed and procedures established
for the recruitment of staff. More broadly, the structure of the business
and the way people work within it convey messages to the outside world
about the values and character of that business.
4 Continuity and change – Many businesses deal with change and
uncertainty. Structure can provide continuity. Without a structure, there
is a tendency for people to constantly set up new systems and
procedures – to reinvent the wheel – in response to new situations.
There are, of course, disadvantages to well-established structures. They can,
for example, be difficult to change. This underlines the importance of seeing
structure as dynamic, and not static. As in most aspects of business and
management, there is no such thing as a ‘one size fits all’ model. Some
organisations claim to have very flat structures with no strong hierarchies
and no real lines of command. An example is Valve, a company making
video games, which claims that the lack of a hierarchical structure fosters
greater creativity as all members of staff choose the projects they want to
work on.
The challenge is to develop an organisational structure that meets the
requirements of the business and still achieves an efficient use of resources
and the provision of effective services to customers.
People who establish new organisations or projects often pay scant attention
to structure. The strong motivation people feel when they are involved in a
new project can mean that the organisation, team or group functions more
by goodwill than by well thought-out structures and procedures. As the
organisation (or group or team) grows, however, problems that stem from
this lack of attention to structure will become apparent.
It should by now be apparent why the structure of an organisation is
fundamental, not only to its effective functioning and the achievement of its
objectives, but also to its meaning and identity.
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Readings 1–11
3 Formal and informal structures

An organisational chart provides a pictorial and formal – that is, agreed and
written down – explanation of the different parts of the organisation and the
different jobs within it. A chart will show the distribution of, and
relationship between, the roles in the organisation rather than say anything
about the individuals who fill them. The other side of the structure of any
organisation is the informal one, which is less likely to be written down on
the organisational chart. The informal structure is more about the
relationships between individuals. This can be complicated because it
involves ‘human’ elements such as respect, compatibility, motivation and
commitment; in other words, it is about the ‘chemistry’ that exists between
people, which always affects both relationships and results.
This next exercise will help you to explore the distinction between formal
and informal structures.
Exercise 2
This exercise is designed to allow you to consider formal and informal

structures by reflecting on your experience of differences with someone ‘in
charge’ of you. Think of a situation from your life or work experience where
you were working with a person who was officially in charge of you and/or
the group. You were formally expected to do what they asked you to do, but
they appeared to have different values from you and/or you did not feel they
were the right person for the job. Think very carefully about the situation and
the person and make notes about the context and the personalities involved.
Reflect on the following questions:
1 What was it about the individual’s attitudes and behaviour that made you
feel that they were the wrong person for the job?
2 What happened in terms of your relationship? Did their behaviour change
over time?
3 Did you begin to see some of the reasons behind their decisions and
instructions?
4 How did you and/or the group cope with this situation?
Comment
A chart may tell us about ‘official’ levels of authority, but we have probably all
experienced or witnessed an occasion where a boss was unable to exert
their authority, and was not actually in charge. This could be for all sorts of
reasons: a particular management style, lack of confidence, etc. They may
have been recruited to the wrong job, or promoted above their capabilities, or
it could be that they were simply not respected or liked. The BBC comedy
programme The Office, for example, has a manager, David Brent, who thinks
his style of running his department, by having fun, is the way to get the best
74
performance and highest level of liking from his team. He is, in fact,
considered to be a bit of a joke.
4 Dimensions of structure
Research conducted at Aston University during the 1960s and 1970s
attempted to identify the main dimensions of business structure (Pugh and
Hickson, 1968). Although this research is now several decades old, the
basic dimensions of structure that it identified still form the basis of how
organisational structures are designed and understood today. Pugh and
Hickson examined the following factors, or structural variables, that may be
helpful in identifying the type of structure within a business, and the
reasons for it:
Specialisation – The extent to which specialised tasks and roles are
allocated to individuals who work in the business.
Standardisation – The extent to which a business has standard
procedures.
Formalisation – The extent to which rules, procedures, instructions and
so on are written down, or formalised.
Centralisation – The extent to which decision making and authority are
located at the top of the hierarchical structure and/or at the centre of the
business if, for example, there is more than one site.
Configuration – The shape of the role structure, whether the chain of
command is short or long.
A further dimension to consider is:
Span of control – this refers to the number of subordinates who report
directly to a single superior, and for whose work that person is
responsible.
Researchers can use these variables to investigate how and why an
organisation is structured as it is. This is useful for our understanding but
explicit, written down clues, such as those in organisational charts, do not
always tell us how individuals within the business behave in practice.
Let us now go on to consider some more questions about these different
aspects and how they might be implemented practically. First, in terms of
specialisation, or the way in which specialised jobs are allocated to groups
or individuals in the business, we could ask: ‘how much specialisation
within the business structure is desirable?’
Organisations need to devise ways of sharing out the work so that it can be
done as effectively as possible. Traditionally, there have been two ways in
which jobs have been allocated: first, on the basis of job specialisation,
making use of individual expertise, distinctive knowledge, training, skills
and competences; and second, by breaking down complex tasks and
processes into simpler, routine elements and requiring each worker to
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Readings 1–11
concentrate on one or more of these. Conventionally, allocation through job

specialisation has been associated with professional, expert work and relies
on the skills and judgement of individual workers. In contrast, task
breakdown is widely used for production and clerical operations; it provides
little opportunity to develop individual workers’ skills and judgement.
Specialists can be difficult to manage and their perspectives on the business
may be narrow, making it difficult to integrate their contributions with the
overall processes of the business. For example, accountants and nurses may
see themselves as representatives of their profession and only secondarily as
members of the business that employs them. Thus, they may have different
loyalties and priorities.
Another question we could ask in relation to structuring jobs is: ‘how can
the business achieve coordination?’ Coordination is about how the
organisation can align the activities and objectives of the different
departments and project teams. As organisations decentralise their activities
to improve responsiveness and flexibility in an increasingly volatile and
competitive environment, so coordination becomes correspondingly more
important. For example, few organisations would want each project team or
business area to establish its own policy on health and safety or equal
opportunities. Teams and business functions are interdependent and rely on
the effective coordination of their work to achieve organisational objectives.
Coordination does not necessarily mean increased centralisation or direct
control. Irrespective of the size or complexity of an organisation, the key to
effective coordination is information. For example, how do service delivery
teams share information about their customers and the areas of work they
are planning to develop? How can an organisation that has devolved
responsibility for service delivery to regional groups ensure that minimum
standards are maintained? How are managers, employees and other
stakeholders kept adequately informed about what is going on? How well
organisational activities are coordinated depends on how far its staff can
obtain and process the necessary information.
Like most aspects of business and management, structure will depend on the
particular circumstances – size, history, technology, the degree of
uncertainty in the external environment – as well as on the values and
culture of the organisation. Most organisations, regardless of size, have
rules and procedures for referral and setting goals and targets. The
formalisation of these procedures and standards – that is, the extent to
which they are written down and made formal – will vary but will always
be important. It is worth repeating that the ideas we have introduced here
about organisational structure are not a set of levers that you pull to achieve
certain automatic results. All structures have advantages and disadvantages
and how they are implemented in a particular organisational setting will
depend on how power is exercised generally and how decisions are taken.
There is no right answer in such matters; the way work is organised and
structured is always open to renegotiation.
76
5 Virtual organisations
So far we have considered organisations in the traditional sense;
organisations that have a defined membership and premises in which these
members come together and work. Increasingly, however, there are
organisations where these criteria do not apply. They may not operate out of
fixed premises (or at least many of their members may never or rarely
attend the organisational premises) and they may not have a clearly defined
membership. Such organisations are often given the label ‘virtual
organisation’. This can mean a variety of things. Shekhar and Ganesh
(2007) collected a number of definitions of virtual organisations used by
academic researchers. Paraphrasing their work slightly, here is their list of
what virtual organisation can mean:
. A temporary network of independent companies that come together

quickly to exploit fast-changing opportunities.
. A dispersed set of groups and individuals organised and coordinated
based on the knowledge that each of them brings to a project.
. A grouping not of people or organisations but of the competencies that
they hold and which may be drawn upon to complete a project in a web
of personal and organisational relationships (this is a very abstract idea,
outside the scope of this material).
. Less a discrete enterprise and more an ever-varying cluster of common
activities in the midst of a vast fabric of relationships.
. A way of structuring, managing and operating dynamically, using mostly
information technology.
The following article expands on the idea of a virtual organisation.
The virtual organisation

Tim Hindle, The Economist, 23 November 2009
The virtual organisation has an almost infinite variety of

structures, all of them fluid and changing
It is widely alleged that the business organisation of the future will be
virtual. But precise definitions of what it means to be a virtual
organisation are hard to find. The origin of the phrase, though, is clear.
It comes from the expression ‘virtual reality’, an experience in which
electronically created sounds and images are made to resemble reality.
A virtual company resembles a normal traditional company in its
inputs and its outputs. It differs in the way in which it adds value
during the journey in between.
The virtual organisation has an almost infinite variety of structures, all
of them fluid and changing. Most of them need virtually no employees.
A New York insurance company was once started from scratch by
someone whose overriding aim was to employ nobody but himself.
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Readings 1–11
The UK’s Virgin Group briefly held 5% of the British cola market with
just five employees. This was achieved by tightly focusing on the
company’s core competence: its marketing. Everything else, from the
production of the drink to the distribution of it, was done by someone
else. A virtual organisation relies for the most part on a network of
part-time electronically connected freelances, sometimes referred to as
e-lances.
The virtual organisation has few physical assets, reflecting the fact that
adding value is becoming more dependent on (mobile) knowledge and
less dependent on (immobile) plant and machinery. Hollywood is often
cited as a template for the virtual organisation. The way that movies
have been made since the industry freed itself from the studio system
(where everyone from Bette Davis down to the doorman was a full-
time employee) has been virtual. A number of freelances, from actors
to directors via set builders and publicity agents, come together with a
common purpose: to make a movie, to tell a story on celluloid. They
then go their separate ways and another (unrelated) bunch of people
(with a similar set of skills) comes together to make another movie.
And so it goes on, very productively.
Linked to the idea of the virtual organisation is the idea of the virtual
office, a place where space is not allocated uniquely to individual
employees. People work as and when they need to, wherever space is
available. This practice is commonly referred to as hot-desking. The
virtual office has the advantage of providing a different vista every
day. But it makes it difficult to form close relationships with
colleagues.
In ‘Rethinking the Future’, Lester Thurow, a former dean of Sloan
School of Management, gave a vivid portrayal of the virtual office:
You walk in and there’s an electronic board that says room 1021 is
empty. You go to 1021. You have your personal telephone number.
You call up your computer code. You press a button and your
family picture is up on the flat-screen TV set on the wall. And
that’s your office for as long as you’re there. The minute you
leave, it ceases to be your office.
We know why you don’t do that at the moment; human beings like
to have a cave. But the first company that figures out how to make
this work will save 25% on office space, 25% on telephones, 25%
on computers. These will be the low-cost producers, and low-cost
producers will inherit the earth.
AT&T, an American telecoms company, reckons that it saved over

$500m between 1991 and 1998 by reorganising its office space along
virtual lines.
The process of defining the virtual organisation is a gradual one. As
companies withdraw more and more into their core competencies, so
they become more virtual. The virtual organisation is able to leverage
this core into almost any industrial sector. Thus it can be in the
78
pensions business and the railway business at the same time (as is the
Virgin organisation in the UK). It can then rapidly desert any one of
those businesses, and equally rapidly move into something completely
different by establishing strategic alliances with organisations that have
the essential skills that it lacks. It can do this anywhere in the world.
The virtual organisation is inevitably ephemeral because it has no
repository of long-term memory, no individuals who have worked for
the same organisation for years and years. Nor has it any long-term
geographical presence or a local community that remembers ‘Old Mr
Chambers from way back’.
[…]
This article is adapted from [Hindle, T. (2008)].
[References]
[Hindle, T. (2008) The Economist Guide to Management Ideas and
Gurus, London, Profile Books]
[Thurow, L. (1996) ‘Changing the nature of capitalism’, in Gibson, R.
(ed.), Rethinking the Future, London, Nicholas Brealey Publishing,
pp. 228–49.]
We will not go into greater detail on virtual organisations at this stage. Here
it is important to recognise their existence and increasing prevalence.
Working in a virtual organisation can be quite different from working in a
conventional organisation. For a start, people may or may not work from
some kind of office (many people now work remotely from their home) but
they will certainly work with people who do not sit in the same building as
themselves and may not be employed by the same organisation.
Summary
This reading explored the structural dimension of businesses. There are
important reasons for having a structure, not least so that everyone in the
business knows what it is she or he is supposed to be doing. However, as in
most types of organisation, the written down, or formal, structure does not
tell us everything about how things may operate in practice. The informal
structure of a business is about unwritten rules.
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Readings 1–11
References
Freeman, J. (1972–3) ‘The tyranny of structurelessness’, Berkeley Journal
of Sociology, vol. 17, pp. 151–65 [online]. Available at http://www.
jofreeman.com/joreen/tyranny.htm (Accessed 8 September 2014).
Hindle, T. (2009) ‘The virtual organisation’ [online], The Economist, 23
November, http://www.economist.com/node/14301746 (accessed 11
Februrary 2014).
Pugh, D. and Hickson, D. (1968) ‘The comparative study of organizations’
in Pym, D. (ed.), Industrial Society, Harmondsworth, Penguin.
Shekhar, S. and Ganesh, L. S. (2007) ‘A morphological framework for
virtual organisations’, IIMB Management Review, vol. 19, no. 4,
pp. 355–64.
80
Reading 10: Organisational culture

Introduction
Anybody who has ever been a member of more than one organisation will
probably be well aware of the fact that different organisations have different
cultures. They feel different, the way in which people interact in them is
different, the way things get done is different, and the stories and symbols
in them are different. To some extent this is to do with the nature of
different types of organisation. A football club will have a different culture
from a school, which in turn will have a different culture from a business.
Even within one type of organisation, though, cultures can vary quite
widely.
This reading first discusses what we mean by organisational culture. It will
then look at the elements that make up organisational culture and at
different types of organisational culture, before looking at the factors that
influence organisational culture.
Exercise 1
Think about an organisation of which you are currently a member or have

been a member in the past. This could be an organisation for which you
worked, it could be a leisure organisation such as a sports club, or it could
even be the school you went to. Without having read more about what
influences organisational culture, how would you describe this organisation’s
culture?
Comment
How you answered this question will, of course, not only depend on the
organisation you chose but also on your own personal experience of it.
Perhaps you were thinking of the school you went to. Its culture could have
been very formal, with uniform being worn at all times, teachers addressed
formally, strict rules about punctuality and behaviour in class. Or it could
have been a bit more informal, without school uniforms or uniforms not worn
on certain days, teachers addressed less formally (sometimes even by their
first names), and a slightly more relaxed standard of behaviour in class,
dependent less on formal rules of behaviour and more on an emphasis of
participation. Schools also vary depending on whether they are very focused
on academic achievement, place more emphasis on sports or are more
oriented towards the arts.
Let us now consider how we can define and describe organisational culture
in more academic terms.
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Readings 1–11
1 Definitions of culture
The Oxford Dictionary (n.d.) offers several meanings of the word ‘culture’.
The two that are relevant for us here are:
The ideas, customs, and social behaviour of a particular people or

society, as in ‘Afro-Caribbean culture’ or ‘people from many different
cultures’.
The attitudes and behaviour characteristic of a particular social group:

the emerging drug culture.
From a business and management perspective, culture is important at

several different levels: the national level, the regional level (in some
instances), the organisational level, and the professional level. National
culture refers to the shared ideas, customs and practices of people living in
one country or nation. The influence of national culture on business and
management practices has been discussed extensively by scholars and
business practitioners alike and is an important part of any course or
textbook on international management. In this reading we are mostly
concerned with organisational culture, i.e. the shared ideas, customs and
behaviour of people working in a particular organisation. Professional
cultures apply to professions such as lawyers, doctors, engineers, teachers,
and so forth. Often, professional culture is instilled in people during their
training to become a member of that profession and may be reinforced by
signing up to a particular professional code of conduct. For example, all
doctors commit to using their knowledge only for the good of patients when
entering the profession.
The cultural perspective has become popular in business studies because it

offers a way of understanding difference. It is only one way of analysing
business, but it is an interesting one as it focuses particularly on the insider
point of view, or on what it is ‘really’ like to work in an organisation. There
have been many definitions of organisational culture. One definition that is
often cited is:
82
Culture is a pattern of beliefs and expectations shared by the

organisational members. These beliefs and expectations produce norms
that powerfully shape the behaviour of individuals and groups within
the organisation.
(Schwartz and Davis, 1981, p. 33)
Another central idea about organisational culture is that it has to be learnt

by newcomers and that it takes time to understand. The term ‘socialisation’
is sometimes used to describe how new employees learn the less obvious
rules about what is acceptable and what is not. An example of socialisation
into a business is provided in the example below.
Example of socialisation into a business: Disneyland

First opened in 1955 in Anaheim, California, Disneyland has been a
consistent money maker for Walt Disney Enterprises. Most of those who
apply for work at Disneyland are aware that if accepted on to the payroll they
will be expected to conform to the large number of rules that are supposed
to guarantee that the theme park is the ‘Happiest Place on Earth’. In fact,
ride operators and other hourly paid employees are a well-screened and
fairly homogeneous group: white males and females, generally in their early
twenties, of above average height, without facial blemish, and radiating good
health. While ethnic minorities are employed, apart from their colour they
tend to be close copies of the standard Disneyland employee.
Once in paid employment new recruits are enrolled at the University of

Disneyland where they undergo a forty-hour apprenticeship programme. In
the classroom employees learn about the history and philosophy of
Disneyland, and the regulations and procedures that govern work there.
Some of the most important of these concern the use of language. For
example, employees are generally on first name terms, customers must be
referred to as ‘guests’, rides are called ‘attractions’ and Disneyland itself is a
‘park’ not an amusement centre. At work employees are encouraged to think
of themselves as ‘back-stage’, ‘on-stage’, and ‘staging’ and their uniforms as
‘costumes’. Classroom instruction also covers approved responses to
probable questions ride operators will face from customers, and how to
summon assistance when accidents (always called ‘incidents’) arise or
particularly difficult ‘guests’ cannot be mollified. The curriculum includes the
inculcation of particular Disneyland values like ‘the customer is king’ and
‘everyone is a child at heart when at Disneyland’. Great emphasis is also
placed on checklists of appearance standards that must be learned, and
which ban the wearing of facial hair, fancy jewellery or more than very
modest amounts of make-up. Motivation levels are hyped by inspirational
films, and pep talks exhort employees to be happy and cheerful while ‘on-
stage’. What is more, all relevant essential information is contained in a
training manual, so no one can forget.
Informal socialisation measures are equally well developed. New recruits

soon learn that the job they are assigned to, the costume they are allocated,
and the area of the park in which they work, determine their social status.
Generally speaking the more highly skilled the work and glamorous the
costume, the higher an individual’s status. Employees also learn that there
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are strict limits to which the company line has to be taken seriously, and
there is much satirical banter about the artificiality of Disneyland. Good
performance on-stage is, however, a necessity. Individuals soon realise that
supervisors are not just there to help them, but to monitor and evaluate their
performance: most old hands can be counted on to relate tales of employees
who have been fired for taking too long a break, not wearing part of the
official uniform, or providing longer than usual rides. At the same time
employees are taught by their peers how to get back at misbehaving ‘guests’
by tightening seat belts, slamming on the brakes unexpectedly, and
drenching those standing on the banks of rivers. On the downside, although
pranks are rarely played on newcomers, all are carefully scrutinised, and
those deemed not to ‘fit’ are the subject of gossip and/or ostracism.
The formal and informal socialisation processes are not just fascinating to
observe but commercially effective. Employees are generally willing to play
the roles expected of them with good humour and kindly smiles, and this
despite the fact that Disneyland does not pay well, the jobs require minimal
intelligence and supervision is strict. Enculturation at Disneyland is thus a
major feat of social engineering.
(Source: adapted from van Maanen, 1991, cited in Brown, 1995, p.56)
Reading the example above you may already have noticed that strong
organisational cultures are not necessarily unequivocally benign. Did you
think that some of the strong enculturation at Disneyland sounded a bit
sinister? The fact that they only seem to employ people who are very
similar to each other and that every aspect of their working life seems to be
scripted in a very detailed way suggests that diversity and individual
creativity are perhaps not valued very strongly as part of the organisational
culture. While some may find comfort in the fact that their working life is
very strongly planned and they do not need to make many decisions on
their own, others may find this stifling. Jane Kuenz (1995) from Duke
University wrote a report on what it is like to work at Disney, which paints
quite a disturbing picture of an organisation that controls not only its
employees’ working lives down to minute detail but also exerts extensive
control over their private lives. The point is not that strong or weak
organisational cultures are in themselves a good or a bad thing but that any
organisational culture can have benign and not so benign effects.
2 Elements and types of organisational

culture
How have academics and managers attempted to diagnose these largely
hidden aspects of business? Johnson and Scholes (1988) used the metaphor
of the ‘cultural web’, identifying a number of elements that make up
organisational culture. Figure 1 depicts this cultural web.
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Stories
Rituals
Symbols
and routines
The paradigm
Control Power
systems structures
Organisational
structures
Figure 1 The cultural web (source: adapted from Johnson and Scholes, 1988)
The paradigm is what the organisation is about; what it does; its mission;
its values. The other elements all influence and support the paradigm.
. Control systems refer to the processes that are in place in the

organisation to monitor what is going on.
. Organisational structures are also part of an organisation’s culture. For
example, organisations that have many structural hierarchies usually
have different communication channels and different ways in which
people interact with each other than in organisations with flat
hierarchies.
. Power structures relate to who makes the decisions in the organisation,
how widely spread power is and on what power is based,
e.g. hierarchical position, technical expertise, personal influence and
charisma, etc.
. Symbols include organisational logos and designs, but also extend to
symbols of power such as parking spaces and executive washrooms.
. Rituals and routines refer to certain habitual activities that are part of
the organisational culture. Management meetings, board reports and so
on may become more habitual than necessary to the running of the
organisation.
. Stories and myths build up about people and events, and convey a
message about what is valued within the organisation. For example,
there may be powerful myths about the founder(s) of an organisation,
their legacy, and how they wanted the organisation to develop.
These elements often overlap. Power structures may be based on control
systems or may arise out of myths and stories and be reinforced by rituals
and routines, for example if it is necessary to go through a complex set of
gatekeepers (such as secretaries, assistants, etc.) in order to be able to talk
to the chief executive.
Symbols are often considered to be a particularly important embodiment of
organisational culture. Trice and Beyer (1984) divided these into two
groups: high-level symbols, which are the more obvious ones such as
company buildings and logos; and low-level symbols. They suggested four
categories of low-level symbols: practices, communications, physical forms
and a common language. These are explained below.
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. Practices – the rites, rituals and ceremonies of the business. These can
take many forms, and would include the annual office party, employee
awards and inter-site competitions.
. Communications – the stories, myths and slogans that are circulated in
the business. Stories about notable events in the past tend to become
part of the culture of the business and can influence behaviour. How the
business started, for example, or a period of particular success, can say
something about preferred ways of performing and goals to aim for.
. Physical forms – include location, layout of factory floors, open-plan or
individual offices, types of eating areas, work uniforms, business suits or
casual attire, flipcharts or whiteboards, and factory machinery and office
furniture.
. A common language – jargon is common to many businesses. It is a
convenient shorthand form of communication, but it also affects
behaviour. Disney employees are ‘cast members’, while McDonald’s
employees are ‘crew members’. The Open University is rife with
acronyms: TMAs, TGFs, module codes, and so on. This might suggest a
rather technical and closed culture, but ‘open and equal’, the
University’s motto, is, in the experience of many of the staff, reflected
throughout its organisational practices and values.
Clearly, not all organisational cultures are alike (that is the whole point of
studying them) and many features of organisational cultures will be very
specific to an individual organisation. Nonetheless it is possible to
distinguish several broad types of organisational culture. Charles Handy
(1976) distinguished four types of culture: power culture, role culture, task
culture and people culture. As with so much fundamental business and
management theory, Handy developed this classification several decades ago
but it is still widely used in management today to describe and think about
organisational cultures.
. Power cultures concentrate power in a central figure of authority (such

as a chief executive) or a small group of people at the centre of the
organisation. From there power radiates out like a web. Power cultures
rely more on individuals than on formal structures and can result in fast
decision making. According to Handy, power cultures are common in
family-run businesses where few outside the family get a chance to
influence key decisions.
. Role cultures delegate authority through a formal, hierarchical structure.
Power is based on position within the hierarchy and rarely on expertise
or personal characteristics. Role cultures are seen to be highly
bureaucratic. It is most typical of public sector organisations, such as
government departments, local authorities, public utilities and other
public services.
. Task cultures rely on teams to perform jobs and solve problems. Power
tends to be based on expertise rather than formal role or personal
characteristics. Task cultures are typical of organisations that need to be
dynamic and flexible to cope with frequently changing demands.
Research institutions or businesses where research and development is a
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key part of the way in which the business operates may have this kind
of task culture and team structure.
. People or person cultures are characterised by significant power
residing in individuals independent of formal position and often based
on personal expertise. Person cultures tend to rely on consensual
management and are often found in partnerships, where each partner is
supposed to have an equal say in the decision made. Person cultures can,
however, make organisations harder to manage as individuals often
consider their own expertise and professional identity more important
than the collective identity of the organisation.
Sometimes organisational cultures are considered to be problematic, as they
no longer seem to fit the requirements for the organisation to succeed in the
external environment. This could be because the external environment has
changed and now makes different demands. Consequently, the need for
culture change is often talked or written about. For example, over the last
20 years or so there have been several instances where financial services
organisations in the UK were found to have sold financial products that
were expensive and unsuitable to people who did not need or could not
really afford them (these included payment protection for credit cards and
mortgages where customers invested in stocks – relying on rises in the
share price to pay off their mortgage – rather than paying off the mortgage
directly). As a consequence, the financial services regulator, the Financial
Services Authority, introduced the new regulatory scheme ‘Treating
Customers Fairly’, which instructed banks, insurances and all other financial
service providers that they must make sure they only sold financial products
that were fit for purpose and affordable. At the heart of the regulatory
scheme lay the idea that financial service providers needed to change their
organisational culture to become much more customer oriented. After
‘Treating Customers Fairly’ had been running for two or three years,
industry insiders concluded that it had made some difference in practice but
had failed to promote real culture change (Schaefer, 2013). In short,
attempting to change an organisation’s culture is difficult and often results
in failure or only very partial success.
3 Informal elements of culture and

subcultures
Informal elements play as great a role in defining organisational culture as
formal elements, sometimes more so. Many of the symbols, practices, myths
and stories that are such an important part of organisational culture are not
formally established or maintained but arise out of the informal
communications and interactions of members of the organisation. All but
the smallest organisations also tend to have subcultures. These subcultures
relate to membership of different groups within the organisation and vary
between these. Subcultures can be beneficial for the working of a particular
part of an organisation. For example, the research and development team in
an otherwise fairly hierarchical organisation may develop a more task-
oriented subculture that allows them to perform their tasks in an appropriate
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fashion. However, subcultures can also become destructive if they operate

contrary to important overall standards in an organisation. Pettinger (2007)
describes the following forms of subcultures:
. The canteen culture – this refers to the shared values and practices of
smaller groups of people who gather away from work situations and in
such places as the canteen or the smoking corner of the car park.
. Elites and cliques – some groups tend to have more influence than
others and develop their own subcultures. Examples may include the top
management tier of an organisation, which can develop a culture quite
different from the rest of the organisation. A group of people with
particular types of important expertise may form their own subculture,
for example the doctors in a hospital, or the scientists in a research-
focused organisation. If such elite groups manage to direct critical
resources away from the rest of the organisation and towards their own
group, this can have detrimental effects on the organisation. The
formation of elites and cliques can also lead to resentment from other
organisational members who are not part of that subgroup.
. Informal norming – this happens if individuals are pressurised to adopt
the attitudes and norms of those working around them rather than those
of the organisation. If these informal norms are in conflict with the
organisational norms as a whole this can lead to conflict and negative
effects on the organisation.
. A culture of fear – very few organisations will have a formal culture of
fear but many have informal (sub-) cultures of fear. This happens if –
through threats, bullying and victimisation – a culture is created where
people are frightened to use their own initiative, take any actions that
are not regulated, or participate in decision-making processes.
. A culture of blame – again, this is not something that any organisation
will set out to create officially and on purpose but it is quite common in
informal (sub-) cultures. In cultures of blame, organisations or their
managers blame particular individuals or groups if something goes
wrong rather than looking for deeper causes of problems and ways of
addressing these.
. Personality cults – here, (sub-) cultures are formed around the
powerful, dominant or expert personality of a particular individual. This
can – but need not be – a characteristic of a power culture but can also
form in subgroups of an organisation with a different overall culture.
Subcultures can have beneficial effects on the functioning of a particular
group or the organisation as a whole but they can also be detrimental to the
overall performance of the organisation. In this context, consider the
example below.
Example of subcultures within organisations: the UK police

service
In recent years, the UK police service in all parts of the country has suffered
a series of mistakes and errors. Many of these mistakes and errors can be
put down to the inability to set and maintain overall standards in all aspects
88
of police work. The informal elements and subcultures have become

dominant in specific situations. For example:
. In the north of England, a woman police constable suffered serious

sexual harassment, resulting on three occasions in assault. The particular
police force refused to listen to her complaint. It eventually settled at
employment tribunal, paying her £300,000 in damages.
. An anti-terrorist unit pursued and shot the wrong person. Despite having
procedures to follow which would have resulted in checks being made in
advance of the individual being confronted and shot, the collective
behaviour that drove the response to real and perceived terrorist threats
took over. The subsequent inquiry took years to resolve.
. A police sergeant from the Asian community was vilified for trying to
establish a community relations liaison function. When he pointed out that
all he was doing was creating something that was already available to the
white and Afro-Caribbean communities, he was disciplined and then
transferred to other duties. The police force eventually paid him £250,000
in compensation.
Each of these events occurred despite the very strong perceived and
assumed culture of commitment to service held by the public at large, and
the very strong collective and cohesive culture assumed by members of the
police force as a whole; and in spite of the fact that policies and procedures
exist to ensure that these things can never happen.
Before concluding this reading on organisational culture we will consider

the factors that shape an organisational culture.
4 Factors influencing organisational culture

Where the culture of a business comes from, and how it develops, is the
subject of much discussion within business studies. Every commentator
seems to have their own list of key factors. One example is from Drennan
(1992), who proposes 12 key factors that shape the culture of a business.
Although this list is 20 years old, the main features of organisational culture
have not changed and as it is both comprehensive and quite clear, this list
of key factors will still be useful for our purposes. The key factors on
Drennan’s list are:
1 the influence of a dominant leader – the vision, management style and
personality of the founder or leader in a business often has a significant
influence on the values that the business tries to promote
2 the history and tradition of the business – how things have always been
done (and why)
3 the type of technology used by the business and the types of goods and/
or services it produces
4 which industry or sector the business is in, and how much and what type
of competition it faces
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5 the customers of the business – who they are and what they expect
6 company expectations – based to a large extent on past performance
7 the types of information and control systems used
8 the legislation and wider business environment – these influence the
external conditions under which a business operates and will therefore
often have an influence on its internal culture
9 the procedures and policies within the business – ever-evolving, but
often a good indicator of underlying values
10 the reward systems and the measurement of performance
11 how the business is organised and resourced
12 goals, values and beliefs – reflected in objects, actions and language.
It could be argued that some of the 12 factors in Drennan’s list are integral
parts of the culture of a business rather than influences that shape it. You
may, or may not, agree with this list, and it might be worth considering the
helpfulness of such lists. What lists such as this do show us, however, is
that culture in business, as in society, pervades every aspect of its
operations.
Exercise 2
This exercise is designed to help you understand Drennan’s 12 factors of

organisational culture better and to apply them to a case study. Go back to
the example on the Merrythought Teddy Bear Company in Reading 8. Read
through it again and make notes on the cultural factors that you can detect in
the case. Now answer the following question:
What are the factors influencing the organisational culture of Merrythought?
Comment
Interpretations of case studies are never entirely clear cut and there are
quite a number of factors influencing the organisational culture of
Merrythought. Here is a list of the ones that seem most important:
. Influence of the leaders – this is a family business; the current directors

are the fourth generation to have run the company. However, one might
also point out that the background and gender of the current directors
may have presented a challenge to the established culture.
. The history and tradition of the business – this is clearly strong. The
company was founded in 1930, operates in a ‘heritage’ area and
occupies a Victorian factory which is seen as part of the identity of the
company.
. Type of business/products – the company makes teddy bears. Not only is
this a traditional product, but they also make it using traditional methods,
i.e. by hand or using old machinery. They describe it as the
‘quintessential teddy bear’.
90
. Goals, values and beliefs – the business identifies itself as a ‘traditional’

company. These values affect the business in a number of different ways,
for example their reluctance to consider outsourcing production.
. The customers of the business – traditionaly these have been collectors.
Such customers will have a strong identification with the product and
company.
. Employees of the business – it seems that many of the staff have been
for the company for many years. Staff in the past worked alongside
senior staff for many years before taking over. This enabled them to
develop knowledge of every aspect of the business.
Summary
Culture is just one perspective that can help us to understand more about a
business. Many cultural elements of a business are not obvious, but there
have been some attempts in the academic literature to develop definitions
and identify influencing factors. It is possible to see, or ‘feel’, that one
business is different from another, and that this involves more than just how
it presents itself to the outside world. Business values and accepted ways of
doing things are often reflected in a business’s socialisation programmes.
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References
Brown, A. (1995) Organisational Culture, London, Pitman.
Drennan, D. (1992) Transforming Company Culture, London, McGraw Hill.
Handy, C. (1976) ‘So you want to change your organisation? Then first
identify its culture.’, Management Learning, vol. 7, no. 2, pp. 67–84.
Johnson, G. and Scholes, K. (1988) Exploring Corporate Strategy, 2nd edn.,
London, Prentice Hall International UK.
Kuenz, J. (1995) Inside the Mouse: Work and Play at Disney World,
Durham, NC, Duke University Press.
Oxford Dictionary (n.d.) ‘culture’ [online]. Available at www.
oxforddictionaries.com/definition/english/culture (Accessed 28
January 2014).
Pettinger, R. (2007) Introduction to Management, 4th edn., London,
Palgrave.
Schaefer, A. (2013) ‘Sector-specific corporate responsibility in the United
Kingdom’, in Beschorner, T., Hajduk, T. and Simeonov, S. (eds.) Corporate
Responsibility in Europe: Government Involvement in Sector-specific
Initiatives, Gütersloh, Verlag Bertelsmann Stiftung, pp. 241–62.
Schwartz, H. and Davis, S. (1981) ‘Matching corporate culture and business
strategy’, Organizational Dynamics, summer, pp. 30–48.
Trice, H. M. and Beyer, J. M. (1984) ‘Studying organizational cultures
through rites and rituals’, Academy of Management Review, vol. 9, no. 4,
pp. 653–66.
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Reading 11: Values and beliefs

Introduction
How we think about business and management, how we act as employees,
managers or entrepreneurs, and how we understand the relationship between
business and society depends partly on the values we hold. This does not
mean that we constantly think about our values or that our actions always
match a consistent set of values. But the values we hold inform who we
think we are and how we behave at a fundamental level, so fundamental in
fact that we are often not aware of it. This reading looks at what values are,
how they can be classified, and how they underlie business and management
practice.
1 What are values?

Values can be defined as enduring normative beliefs about proper standards
of conduct (Nystrom, 1990) and preferred or desired outcomes
(Rokeach, 1968) and drive motivational goals (Schwartz and Bilsky, 1987).
This tells us a number of things about values:
. Values are enduring – they do not change all the time. A person’s values
may change but tend to do so only slowly and not very often.
. Values are related to how people behave. A person who believes it is
important to always be honest and act with integrity can be expected to
behave in a manner that is consistent with that belief (although they may
not always succeed).
. Values are about desired outcomes – values shape our views of the
things that are important in life and what would be a desirable outcome
in any given situation. For example, whether we pursue a highly paid
career in, say, banking, or whether we prefer to work in a career like
nursing will depend on the relative value we put on wealth or care for
others.
The psychologist Milton Rokeach is one of the most influential figures in
values research. According to Rokeach (1968), people hold more than one
value and the different values held can be in tension with each other.
Different values are activated in different situations, which is one of the
reasons why people sometimes act in a way that seems inconsistent with the
values they say they hold.
Depending on people’s underlying values and beliefs they may respond
quite differently to particular situations. If a person values hard work, self-
reliance and wealth, they may choose a different career from someone who
values creativity, contact with other people and the achievement of personal
goals. A person who places a strong value on the future security of their
family or on the protection of nature may feel it is more important to
combat climate change than to accumulate wealth through increased
industrial production. Placing a high value on status and recognition from
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other people may lead someone to seek political office or another high-
profile position.
It is worth pointing out that there is no such thing as a value-free
organisation, situation or activity. You will sometimes hear the phrase
‘value-based’ business or organisation. When people use the phrase ‘value-
based’ they tend to refer to particular values, such as care for others,
environmental concerns, concerns for justice and fairness, etc. This could
lead us to believe that – by contrast – there must also be organisations,
businesses and activities that are not based on values. However, most
researchers on values argue that this is not the case. What people seem to
mean by the opposite of a ‘values-based’ business, for example, is a
business based on such values as power, wealth, economic growth,
competition, and so forth. These are also values. However, they are often
not explicitly articulated because many people assume that these are the
natural values of any business (this is not necessarily true, as we shall see
in a little while). Many managers find it difficult to articulate their values as
it is not something which they have been expected to do in the past. The
idea that business and management have somehow nothing to do with
values is pervasive but it can only be held if we have quite a narrow view
of values and of business and management.
2 Different value types

When considering values it is useful to have a system that allows us to
categorise different types of values and put them in some kind of relation to
each other. One such system is the Schwartz Value System, developed by
psychologist Shalom Schwartz and colleagues (Schwartz and Bilsky, 1987;
Schwartz et al., 2012). Schwartz and his colleagues built on earlier work by
Milton Rokeach (1968), who identified 36 different values. Schwartz and
colleagues argue that values form a dynamic, interdependent system, where
some values are closely related and thus compatible, whereas other values
stand in opposition to each other. The Schwartz Value System defines 10
broad value types, each comprising several specific values (see Figure 1).
The value types are further grouped into two pairs of opposing dimensions:
self-enhancement vs self-transcendence and conservation vs openness to
change.
In this figure you can see the ten value types and, for each of them, one or
two of the specific values that fall under this type. So, if someone attaches
importance to wealth or authority and considers these to be good things
worth striving for, these are examples of that person’s power values. You
can also see that the ten value types are grouped into four categories: self-
enhancement values (power, achievement, hedonism), self-transcendence
(universalism, benevolence), openness to change (self-direction, stimulation,
hedonism), and conservation (conformity, tradition, security). Note that
‘hedonism’ is considered to fall into both self-enhancement and openness to
change. It is also possible to place two axes over this figure: on one of them
would be placed the opposing dimensions of self-enhancement and self-
transcendence; on the other would be the opposing dimensions of openness
to change and conservation. There is a lot of empirical psychological
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180 degrees
opposition/conflict
Openness Self-transcedence
to change
Self-direction Universalism
creativity social justice
freedom equality
Stimulation Benevolence
exciting life helpfulness
Conformity Tradition
Hedonism
obedience humility
pleasure devoutness
Achievement Security
Power
success social order
ambition authority Conservation
wealth
Self-
enhancement
0 degrees
Figure 1 The Schwartz Value System (source: adapted from a re-drawing by Crompton, 2010)
research behind the development of this system of classifying values but

you will not need to understand in detail how it was developed in order to
start using it to think about your own values or the impact of values on
business and management practice.
So what does the Schwartz Value System mean for understanding business
and management? It is easy to assume that business organisations as a
whole are mostly built on power values and that power values are the main
motivators for people working in business. Investors make decisions about
the businesses in which to invest on the basis of forecast returns on
investment and other financial measures, including estimates of how the
share price of a business is going to develop or what dividends it is likely
to pay to its shareholders over the next 12 months. The performance of top
managers of large public limited companies is judged by the quarterly profit
figures of the business, and bonuses for many employees in industries such
as financial services are based on the profits the business has earned. There
seems to be an imperative for businesses to grow or else they will become
uncompetitive and eventually go out of business. The huge salaries earned
by top managers in some industries are justified on the grounds that it
would otherwise be impossible to hire the best people for the job as they
would prefer to work for another organisation that paid them more. A
glance at the financial pages of a newspaper will bring up any number of
articles concerned with share prices, the financial performance of large
corporations, news of business takeovers and mergers, or that another
business is in danger of going bankrupt. There may also be news about
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fights to gain control of large corporations or about top managers being

dismissed because of the poor financial performance of the business they
were running. All these are indicative of power values, such as seeking
wealth, hierarchical and social power, and trying to be more competitive
than rival managers or businesses.
However, power is not the only value type that can motivate businesses and
their managers. Many people go into business for different reasons and are
guided by different values (instead of or in addition to power). Many people
who start their own business are motivated by values relating to self-
direction, that is they like to be their own boss and shape their own destiny,
perhaps in addition to being creative in setting up something new. Managers
of family-owned businesses, particularly those that have been in the family
for several generations, are often driven by their sense of tradition and
sometimes by filial responsibility. Many people working in all sorts of
organisations are driven by achievement, meaning they want to do well and
to be seen to be doing well, but they are less concerned with money or
social status or the other power paraphernalia that can come with being seen
as successful.
Managerial engagement with climate change in small- and
medium-sized enterprises
Research conducted by Sarah Williams
This spotlight on research features the doctoral research done by Sarah

Williams at the Open University Business School from 2009 to 2013.
She had come from a background as an environmental advisor to small
and medium-sized businesses and was interested in gaining a deeper
understanding of how the managers of such businesses understood
environmental issues in general and climate change in particular, and
what motivated them to introduce pro-environmental measures in their
businesses.
Sarah used two main theories to frame her research. One was the
Schwartz Value System (Schwartz and Bilsky, 1987; Schwartz
et al., 2012), and the other one was Weick’s (1995) ideas on
organisational sensemaking, which argues that people do not so much
understand the world objectively and passively but ‘make sense’ of it in
active and subjective ways. This sense-making is grounded in their own
self-identity, including their values, and is a social and ongoing process
with no clear beginning or end.
Sarah found that managers were motivated by different values. Some

placed a high value on self-direction and independence, others were
primarily motivated by wealth and social influence, whereas yet others
found it particularly important to achieve goals and get the recognition
for this. Nobody was motivated by only one particular value type. For
example, many managers who were motivated by power values such as
wealth and competitiveness also had a strong sense of responsibility to
their family and/or their employees. Managers who seemed to hold
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achievement values were also often motivated by benevolence values

as well as by universalist values such as the importance of
environmental protection or social justice.
Sarah’s research looked at a specialised aspect of business

management, namely the businesses’ engagement with environmental
and climate change issues. She found that managers talked differently
about environmental issues depending on the values that they mostly
seemed to draw upon. For example, managers who seemed to value
competitiveness and business growth seemed more impressed with
arguments that putting in environmental measures might reduce costs
or win them new customers. By contrast, managers who seemed more
motivated by achievement and recognition were less likely to be
swayed by the win-win argument of saving costs through saving the
planet. They were more likely to be motivated by the challenge of
putting in an environmental programme and persuading others to
contribute to the business’s environmental efforts.
(Williams, 2013; Williams and Schaefer, 2013)
So far we have been considering individual values, i.e. the values that
motivate individuals, be that at work or in their private lives. It is also
possible to speak of collective values; that is, values shared by a group of
people. In the context of business and management, you will often hear
about organisational values, or the values of a company. This refers to those
values in an organisation which are shared by most people who work in that
organisation. That does not mean that everybody working there shares all of
the values of the organisation – they may only share some of them – but
enough of the values are shared by a sufficient proportion of the people in
an organisation that one can speak of the organisation having certain values.
These values tend to be quite stable over time, even if people leave and
others join (otherwise one couldn’t really speak of organisational values).
The new people joining often choose that organisation (and are selected by
it) precisely because they think they will share the organisation’s values.
Alternatively, they may become socialised into the organisation in such a
way that they start to share its values.
There are, however, also often people who work in an organisation but who
share none or few of its values. Such people are often frustrated and
unhappy in that organisation and are frequently seen as not being a good fit
by their superiors and colleagues. Many people who find that they do not
share an organisation’s values try to leave it as soon as they can.
Summary
This reading has provided a brief introduction to the concept of values and
how they relate to business and management, showing that values underpin
much of what we do, even though we are not necessarily conscious of this.
It is possible and useful to categorise values into different types and note
how we can recognise these value types. Values are an extensive field of
97
Readings 1–11
study in their own right. The important thing is to understand that business
and management are built on values and that these values can differ from
person to person and from organisation to organisation.
References
Crompton, T. (2010) Common Cause: The Case for Working with our
Cultural Values, published in partnership by Climate Information Outreach
Project, Campaign for the Protection of Rural England, Friends of the Earth,
Oxfam and WWF [online]. Available at www.foe.co.uk/sites/default/files/
downloads/common_cause_report.pdf (Accessed 8 August 2014).
Nystrom, P. C. (1990) ‘Differences in moral values between corporations’,
Journal of Business Ethics, vol. 9, no. 12, pp. 971–9.
Rokeach, M. (1968) Beliefs, Attitudes and Values: a Theory of Organization
and Change, San Francisco, CA, Jossey-Bass.
Schwartz, S. H. and Bilsky, W. (1987) ‘Toward a universal psychological
structure of human values’, Journal of Personality and Social Psychology,
vol. 53, no. 3, pp. 550-562.
Schwartz, S. H., Vecchione, M., Fischer, R., Ramos, A., Demirutku, K.,
Dirilen-Gumus, O., Cieciuch, J., Davidov, E., Beierlein, C., Verkasalo, M.,
Lonnqvist, J.-E. and Konty, M. (2012) ‘Refining the theory of basic
individual values’, Journal of Personality and Social Psychology, vol. 103,
no. 4, pp. 663–88.
Weick, K.E. (1995) Sensemaking in Organizations, London, Sage.
Williams, S. and Schaefer, A. (2013). ‘Small and medium sized enterprises
and sustainability: managers' values and engagement with environmental
and climate change issues’, Business Strategy and the Environment, vol. 22,
no. 3, pp. 173–186.
Williams, S. (2013) ‘Managerial engagement with climate change in small
and medium sized enterprises’, Thesis (PhD), Milton Keynes, The Open
University.
98
Acknowledgements
Acknowledgements
Grateful acknowledgement is made to the following sources:
Every effort has been made to contact copyright holders. If any have been
inadvertently overlooked the publishers will be pleased to make the
necessary arrangements at the first opportunity.
Figures
Reading 2
Figure 1: Hairdresser: © Johann Helgason/Shutterstock.com
Figure 1: Florist: © Candybox Images/Dreamstime.com
Figure 1: Business meeting: © Photodisc Getty
Figure 1: Cleaner: © Dmitry Kalinovsky/Shutterstock.com
Figure 2: © iStockphoto.com/tirc83
Figure 3: © Peter Forsberg/Shopping/Alamy
Illustrations
Reading 3
Page 31: © Hal Gregersen. Founder of http://4-24project.org
Reading 5
Page 38: © Mike Baldwin/CartoonStock Ltd
Page 40: © Dudarev Mikhail/Shutterstock.com
Reading 6
Page 51: © Mike Shapiro/Cartoon Resource
Reading 7
Page 57: © Ted Goff
Page 59: © Randy Glasbergen
Reading 8
Figure 1: © Victoria and Albert Museum, London
Reading 9
Page 69: © John Morris/CartoonStock Ltd
Reading 10
Text
Reading 4
Page 30: Gregersen, H. (2012) ‘What do managers do at work?’ Bloomberg
Businessweek: Companies & Industries, The Management Blog, Bloomberg
L.P. [online]. Available at www.businessweek.com/articles/2012-07-16/what-
do-managers-do-at-work (Accessed 15 April 2014).
99
Readings 1–11
Reading 5
Page 36: Hurley, J., (2012) Arena Flowers’ Valentine’s display wins hearts,
not profits. © Telegraph Media Group Limited 2012
Reading 8
Page 62: Hurley, J., (2012) Merrythought sisters battle to protect the British
bear. © Telegraph Media Group Limited 2012
Reading 9
Page 77: The virtual organisation from The Economist, 23 November 2009,
adapted from Hindle, T., (2008). The Economist Guide to management
Ideas and Gurus, London Profile Books. © The Economist Newspaper
Limited, London 2009.
100
Block 2
Readings 12–20
By Valérie Fournier
Milton Keynes MK7 6BJ, United Kingdom (tel. +44 (0)845 300 60 90; email general-enquiries@open.ac.uk).

First published 2015. Second edition 2017.
Act 1988.
3WX
ISBN 978 1 4730 03477
2.1
Contents
Reading 12: Why do people go to work? 5
Introduction 5
1 The development of managerial interest in motivation 6
2 Theories of motivation 8
Summary 14
References 15
Reading 13: Finding people 16
Introduction 16
1 The recruitment and selection process 16
Summary 25
References 26
Reading 14: Designing jobs 27
Introduction 27
1 Taylor and scientific management 28
2 The socio-technical approach 32
3 The job characteristics model (JCM) 33
Summary 35
References 37
Reading 15: Assessing people at work 38
Introduction 38
1 Performance management as a monitoring device 39
2 Performance management as a mechanism for rewarding staff44
3 Performance management as a developmental tool 44
Summary 45
References 47
Reading 16: Rewarding people for work 48
Introduction 48
1 Payment by time 49
2 Payment by results 51
Summary 56
References 57
Reading 17: Developing people at work 58
Introduction 58
1 Training and development in context 58
2 Training provision: the reality 61
3 Best practices for training and development 64
Summary 66
References 67
Reading 18: Designing flexible working patterns 68
Introduction 68
1 Conceptualising flexibility 69
2 Flexibility, employee empowerment and insecurity 74
Summary 77
References 78
Reading 19: Working with others 80
Introduction 80
1 Types of group 81
2 Why do groups form? 82
3 Understanding group behaviour 83
4 Teamwork in contemporary organisations 85
Summary 89
References 90
Reading 20: Equality at work 91
Introduction 91
1 Equality at work: the evidence 92
2 Promoting equality 94
Summary 99
References 100
Acknowledgements 101
Reading 12: Why do people go to work?
Reading 12: Why do people go to

work?
Introduction
Motivating people at work is both a challenging and central task for
managers. There are many good reasons why people may not feel
motivated: monotonous work, incompetent management, personal conflicts,
poor pay, job insecurity, etc. All of these can have damaging consequences
not only for individuals, but also for organisations (e.g. causing poor
performance, high staff turnover, absenteeism). So motivating staff is a key
skill for management. Whilst money may be an important factor here, it is
not the only one. People may be motivated by a range of factors that may
vary between individuals, but also across a person’s lifespan. For some
people, going to work is a way of meeting people and making friends,
others may be drawn to work by a sense of vocation or the desire to do
good for others. For other people, work might be a way of developing
themselves, or getting recognition.
Churchard (2013) reported on a study conducted by the Institute of
Leadership and Management (ILM, 2013) that revealed that only 13% of the
people surveyed agreed that a bonus would have an effect on their
motivation. However, having a good basic salary and pension was viewed
as an important incentive by almost half of the respondents. For 59% of
respondents, the top motivator was ‘job enjoyment’, while other factors
such as good working relationships and fair treatment and autonomy were
also rated highly. The survey highlights how important good managers are
to staff motivation. When asked to identify one thing that would motivate
them to do more, 31% of employees said ‘better treatment from their
employer’, ‘more praise’ and ‘a greater sense of being valued’. The survey
led Charles Elvin, chief executive of the ILM to suggest:
In the past year UK companies have collectively spent an astronomical

amount on financial incentives for their staff. But this report is telling
us there are far more effective, and cost-effective, ways to motivate
people. These include giving regular feedback, allowing people to have
autonomy in a role, the opportunity to innovate and improved office
environments.
(Cited in Churchard, 2013)
The different theories reviewed in this reading confirm there are many
factors motivating people to work beside money, and taken together, they
provide a picture of motivation as a complex and diverse phenomenon.
5
Readings 12–20
Figure 1 ‘People often say that motivation doesn't last. Well, neither does bathing
– that's why we recommend it daily.’ Zig Ziglar
1 The development of managerial interest

in motivation
Maybe the first person to look at motivation as a managerial problem was
Frederick Taylor at the beginning of the 20th century. His book The
Principles of Scientific Management (Taylor, 1911) is based on the
assumption that people are inherently lazy and will try to minimise effort,
hence they need to be tightly controlled and directed if they are to perform
to organisational standards. (Scientific management is also known as
‘Taylorism’.) But, according to Taylor, people would work and accept
control if they were paid a reasonable rate for the job. So financial
incentives emerged as the key motivator.
However this assumption was later challenged by what became known as
the Human Relations School, which suggested that people sought to satisfy
other needs at work besides financial ones. In particular it emerged that
people tried to satisfy emotional and social needs at work, and that these
needs may have greater influence on their behaviour than financial rewards.
For example, people have needs for security, recognition and belonging that
could influence their work behaviour and performance. These studies
prompted further research into motivation, and the next section reviews
some of the most influential theories that came out in the second half of the
20th century.
Exercise 1
Think about your own motivation to work by considering the following

questions:
1 What motivates you to work? Make a list of up to three things.

2 What could an organisation do to increase your motivation?
6
Comment
You may have thought of a range of factors influencing your motivation to
work, money may be one of them but is unlikely to be the only one; other
possible factors may include the satisfaction of a job well done, the chance
to make a difference, the chance to interact with others (customers,
colleagues, etc.) or a good holiday entitlement. Since we are all likely to be
motivated by different factors, organisations may need to provide a range of
motivational strategies to cater for all needs, for example offering financial
incentives for some, or time off work for others, or ensuring that people have
a sense of their contribution to organisational objectives. As we’ll see below,
different theories have different implications for the ways organisations can
motivate their employees.
Spotlight on research – What do we work for?

Following the financial crisis in Greece, many people had to find alternative
ways of working and earning a living. With jobs being more and more
difficult to come by, some people decided to join forces and set up their
own business on a cooperative basis. This means that as workers in these
cooperatives, they also owned and managed the business.
Research based on three of these small cooperatives: a coffee shop, a
monthly political magazine, and a fair trade shop, throws some interesting
light on the ways people can work together as well as on what they work
for (Kokkinidis and Fournier, forthcoming). These three cooperatives, each
counting between 5 and 11 members, emerged as more than just a way of
earning a living; they also provided the opportunity for members to find
new ways of working based on equality, solidarity and democracy. A
common idea in all three cooperatives is that work is a collective effort and
that all tasks and activities, from those requiring minimum skills to those
relying on expert knowledge, are equally important for the effective
operation and viability of the business. On this basis, all workers should be
rewarded and allowed to participate equally in decision making. Indeed, in
all three cooperatives, workers had opted to have equal pay for all.
Members also decided to do away with hierarchical structure and the
division between workers and managers. Following the principle of equality
and democratic decision making, all workers participate in the decisions
concerning both internal organisation and relations with the environment.
For example, decisions about how to organise work or relations with
customers are taken by all members through consensus. Whilst this is a
time-consuming process, it ensures that all members understand and support
the rationale behind the choices made.
The way work is divided and organised is also decided collectively and
democratically. In the case of the magazine, members decided to have some
specialisation, so some were responsible for writing articles, some for the
7
Readings 12–20
editorial process, and others for administrative tasks. In both the coffee shop
and the fair trade shop, members decided to operate on a job rotation basis
so they could share knowledge and encourage greater participation. In these
two cooperatives, members also decided that each worker would work no
more than 6 hours a day, 5 days a week, for which they receive 8 euros per
hour. This restriction of working time is to make space for other social
activities and family life.
With these three cooperatives, we are far from the image of individuals
trying to maximise their self-interest by seeking to earn more or to get
promotion. Indeed, people working in these cooperatives have decided
collectively to work on something they value – a political magazine, fair
trade, and a coffee shop that also acts as a space for local cultural and
political events – in ways that reflect the principles of equality, solidarity
and democracy. They also decided to limit their working time to what is
necessary to cover their living expenses.
2 Theories of motivation
The main question that theories of motivation seek to address is: ‘Why do
people do what they do?’ In the context of work, managers may want to
understand what makes people come to work every day, and what makes
them perform to satisfactory levels.
As already intimated, there are no easy answers to these questions. So it is
important to bear in mind that no one theory has the perfect answer to
motivation, but each can contribute a piece of the puzzle. It is usual to
distinguish between theories that explain motivation in terms of people’s
needs (content theories), and theories that explain motivation in terms of the
thinking process people go through to decide how much effort to put into a
task (process theories). Below, we review the most influential content and
process theories.
2.1 Content theories of motivation

Content theories suggest that people are motivated by inherent human
needs.
Maslow’s hierarchy of needs

Abraham Maslow (1943) suggested that motivation was based on
psychological needs. When our needs are unmet, we experience tension that
we try to put right by satisfying the currently unmet need(s). In other
words, we behave in ways that satisfy our needs. According to Maslow, all
people have the same types of needs, but these are organised in a hierarchy
of five levels. When one set or level of needs in the hierarchy has been
satisfied, we become motivated to fulfil the next level. Maslow’s hierarchy
of needs is shown in Figure 2.
8
Self-
actualisation
Creativity
Fulfilment
Persue inner talent
Esteem
Achievement Recognition
Mastery Respect
Belonging
Friends Spouse Family Lover
Safety
Freedom from fear Security Stability
Physiological
Shelter Food Water Warmth
Figure 2 Maslow’s hierarchy of needs (source: Maslow, 1970)
. Physiological needs refer to basic survival needs such as water, food and
shelter. In the work situation, these can be met through pay, or working
conditions.
. Safety and security needs relate to feelings of security and freedom from
threats to one’s existence. At work, these could be satisfied through
health and safety policies, insurance schemes or pensions.
. The third level of needs – belonging – relates to the needs for affection
and love from others, which in organisations could be met through
teamwork, for example.
. Esteem needs refer to the need for self-respect and the respect of others;
at work this could be achieved through public recognition of one’s work.
. The highest level of needs, self-actualisation, is the need for personal
growth; this could be satisfied through development opportunities.
According to Maslow, the needs in the hierarchy have several properties:
. A need is not effective as a motivator until the ‘lower level’ needs are
met.
So, for example, getting respect or recognition from others will not be
motivating if we have not met more basic needs related to safety or
belonging.
. A satisfied need is not a motivator.
If you are safe and well fed, you are no longer motivated by more safety
or food, rather you will look for the next level up. Only unmet needs
motivate people.
. Self-actualisation needs are ongoing and can never be satisfied in the
way the other needs can.
9
Readings 12–20
The experience of self-actualisation, the ultimate human goal according

to Maslow, stimulates the desire for more self-actualisation.
Maslow’s theory has been criticised because it suggests a set of universal
needs that in fact may reflect values from the United States of America
(USA) and may not hold up across cultures. For example, Cianci and
Gambrel (2003) suggest that Maslow’s pyramid stresses individualistic
needs and may not hold true in collectivist societies where the need for
acceptance and community may be more important than self-centred needs
such as self-actualisation. Maslow’s theory also suggests a rather rigid
structure, but people may have different priorities at different times or
stages of their lives, or according to the economic environment. For
example, in times of economic crisis and austerity, safety needs may
become more important. Despite these limitations, Maslow’s theory has
proved very influential in business studies and provides a useful framework
for managers in several ways (Kremer and Hammond, 2013). It suggests
that individuals differ in what they want to achieve from work and hence
will be motivated by different factors. It can also be used as a guide to
suggest motivational factors in organisational settings that might influence
employees’ behaviour. For example, human resource management (HRM)
policies could be arranged to meet the various needs in the pyramid. Maybe
its most important contribution is to suggest that money, or external rewards
generally, are not the only motivational factor; people are also motivated by
internal needs. As such it puts forward a more humanistic approach to
motivation that has strongly influenced later theories.
McGregor’s Theory X and Theory Y

In his book The Human Side of Enterprise, McGregor (1960) contrasted two
broad approaches to motivation: traditional managerial styles (Theory X)
and a more people-centred approach inspired by Maslow (Theory Y).
Theory X reflects the perspective of Taylor and scientific management we
saw earlier. It is based on the idea that people dislike work and will avoid it
if they can, so they need to be strongly directed and can only be motivated
by money. According to McGregor, this perspective is typical of traditional
management practices but does not reflect human nature. McGregor argues
that if people behave as in Theory X, it is because they are treated this way
by management. However, for McGregor, people are capable of different
forms of behaviour that he refers to as Theory Y, and which is based on
different assumptions:
. People have no inherent dislike of work although conditions and

practices in organisations may make work distasteful.
. People are capable of being self-directed and creative.
. Industrialisation has meant that such capabilities are under-employed.
From a Theory Y perspective, the main motivating factors would relate to
the possibility to satisfy higher order needs such as esteem and self-
development by being able to exercise responsibility and self-direction. So
for McGregor, the task of management should be to arrange organisational
and work conditions so people could achieve organisational goals by
directing their own effort.
10
Herzberg’s two-factor theory

Herzberg (1959) suggested that the factors that lead to motivation are not
the same as the ones that lead to demotivation. He distinguished between:
Satisfiers (or motivators) – these relate to the job itself and include
achievement, the nature of the work, responsibility and advancement.
Dissatisfiers (or hygiene factors) – these relate to the working
environment, such as company policy and administration, supervision,
salary, interpersonal relations and working conditions.
According to Herzberg, hygiene factors such as a decent salary could lead
to a state of ‘no dissatisfaction’ but could not act as motivators. Only
motivators can lead individuals to greater effort and performance.
Intrinsic and extrinsic motivation

Altogether, the three content theories reviewed above served to establish an
important distinction between intrinsic and extrinsic motivation. Extrinsic
motivation refers to motivation that is driven by external rewards, be it pay
or social status for example. Intrinsic motivation refers to motivation that is
driven by an interest or enjoyment in the task itself, rather than by external
rewards. For example, working hard on an academic essay to obtain a good
grade would reflect extrinsic motivation, whilst working hard on the same
essay because of an interest in the subject itself would reflect intrinsic
motivation.
For McGregor and Herzberg in particular, extrinsic rewards may not be the
primary motivating factors at work. For example, inadequate pay may make
us feel dissatisfied but the promise of additional financial incentives may
not be motivating. This is certainly consistent with the findings of the ILM
(2013) outlined earlier according to which job enjoyment, or having the
opportunity to learn and develop, seemed more important than financial
incentives in motivating people. In addition, in some cases at least, pay may
not be important at all. Consider, for example, the voluntary sector; here
people work not for money but a combination of reasons that may include
altruistic motives, the chance to gain self-confidence, or the opportunity to
learn.
Exercise 2
Consider your own motivation to study this module. Would you say your
motivation is intrinsic or extrinsic, or both?
Comment
Intrinsic motivation to undertake some studies could include:
. the desire to learn new things

. a personal interest in the particular subject
. the need to challenge yourself and get some sense of achievement.
11
Readings 12–20
Extrinsic motivation could include:
. the need for a qualification to get a particular job, or a promotion

. the status attached to obtaining a qualification
. social pressures to gain some qualification.
2.2 Process theories of motivation

Process theories focus on the thinking process people go through as they
decide, or not, to perform a particular activity. Here behaviour and
motivation are seen as the product of beliefs, expectations and values rather
than universal needs.
Adams' equity theory

Adams' (1965) equity theory is based on the idea that people strive for
fairness and justice. As such they will make an evaluation of the fairness of
their exchange with the organisation where they work by taking into
account two elements:
. inputs – what they take to the job, e.g. skills, education, experience,
working hours
. outputs – what they receive in exchange, e.g. pay, recognition.
Overall, people will be expecting a fair return (outputs) for their inputs, that
is, to get the same rewards as others in similar situations (for example,
colleagues doing a similar job and with similar experience and
qualifications). However, if they think they receive less for the same
contribution, they will feel unfairly treated and this will affect their
motivation (Huseman et al., 1987). In such situations, in order to reduce
‘inequity’, people may decide to reduce the effort they put into their jobs.
For example, sales representatives who feel they are working as hard as
their colleagues may feel they are being treated unfairly if they are not
getting a bonus given to others, and, consequently, they may become
disgruntled.
Although Adams’ equity theory tends to be rather abstract, it does suggest
that equity is an important factor when considering the possible
motivational impacts of rewards systems.
Vroom’s expectancy theory

Expectancy theory suggests that people behave in ways that they believe
will produce valued outcomes. It is based on the assumption that employees
are rational and think about what they have to do to get rewards, and how
much the rewards mean to them, before they perform their job. In making
this calculation, there are three relevant components according to Vroom
(1964):
12
Expectancy – the belief that if we put effort into an activity, it will lead
to better performance. (For example, if you took French lessons, would
you be able to speak French? If you study hard for this module, will you
get good grades?)
Instrumentality – the belief that performing an activity or one’s job well
would actually be rewarded (through pay or recognition). (Would being
able to speak French help you get promotion or recognition at work?
Would getting good grades for this module help you get a better job?)
Valence – the value people place on the rewards offered for good
performance. (For example, how important are promotion, recognition or
a better job to you?)
According to Vroom, motivation is the product of these three elements. So
expectancy theory suggests it is not just having a reward that is important in
motivating people at work, but rather the link between effort and reward; in
particular people will feel motivated when they perceive clear relationships
between effort, performance and rewards.
In the work context, Vroom’s theory would suggest that to motivate their
workforce, organisations will need to make sure that employees are
equipped to perform to the best of their abilities so they can expect their
effort to lead to good performance; this means providing them with
adequate training, support, technology and facilities for the job.
Organisations also need to communicate clearly to employees how good
performance is to be rewarded.
Vroom’s theory also suggests there are various factors that could get in the
way of motivation. For example, inadequate training, technologies, or
support from management may make employees feel that however hard they
work, they will not be able to do their job well as they are not provided
with the necessary resources. In addition, several factors could affect the
belief that good performance will be rewarded (instrumentality), for
example: employees may not believe that their performance will be assessed
objectively or accurately, and hence rewarded appropriately; the link
between performance and rewards may not have been made clear to
employees and so they don’t know how difference in performance would be
reflected in pay differential.
Criticism of motivation theories

Before concluding this reading, we need to consider a general criticism of
motivation theories: that they tend to reflect Western, and more specifically
US, values of the context in which they were developed. Cultural values
may have an important impact on motivation. What is valued in
individualistic societies such as the UK or the USA (for example, individual
recognition, bonus or promotion) may be frowned upon in more collectivist
societies such as Thailand or Japan where performance is deemed to be a
collective effort and individual bonuses based on merit would have an
adverse effect on motivation. So what motivates one group of workers may
not necessarily be the same as what motivates another group from a
different culture.
13
Readings 12–20
Summary
Working through this reading, you will have learned that motivation is a
complex and dynamic phenomenon that cannot be addressed through a
single answer or standard policy; what motivates people will differ between
individuals, between cultures, and possibly across a person’s lifespan or
changing circumstances. The needs and process theories you have just read
about help bring this complexity to light by suggesting people can be
motivated by a wide range of factors besides money: for example, the need
for self-achievement, for belonging, for recognition, or the belief they are
being treated equally, or that their effort will be rewarded. None of the
theories considered here has the answer to what motivates people; but
considered together, these theories point to the wide range of issues and
factors that managers need to take into account to motivate employees. As
was suggested recently, it is best to see all these theories as complementing
each other rather than as competing explanations of human motivation
(Steel and Konig, 2006).
Motivation theories suggest that understanding how to motivate staff is of
great importance as employees’ motivation, or lack of it, will affect both
their performance as well as general sense of well-being. Indeed, think of a
time when you were particularly motivated to do something, and how much
this must have helped your performance; or compare what you can achieve
and what you feel when you are motivated or when you are demotivated. In
work organisations, managers have several strategies at their disposal to
motivate employees: the way they recruit staff, design jobs, assess
employees’ performance, design pay systems, offer training and
development, or organise teamwork.
14
References
Adams, J. S. (1965) ‘Inequity in social exchange’, in Berkowitz, L. (ed.)
Advances in Experimental Social Psychology, New York, Academic Press.
Churchard, C. (2013) ‘Job satisfaction beats bonuses in staff motivation
stakes’ People Management, 21 October, London, Chartered Institute of
Personnel and Development, [online]. Available at www.cipd.co.uk/pm/
peoplemanagement/b/weblog/archive/2013/10/21/job-satisfaction-beats-
bonuses-in-staff-motivation-stakes.aspx (Accessed 28 July 2014).
Cianci, R. and Gambrel, P. (2003) Maslow’s hierarchy of needs: Does it
apply in a collectivist culture’, Journal of Applied Management and
Entrepreneurship, vol. 8, no. 2, pp. 143–61.
Herzberg, F. (1959) The Motivation to Work, New York, John Wiley and
Sons.
Huseman, R., Hatfield, J. and Miles, E. (1987) ‘A new perspective on
equity theory: the equity sensitivity construct’, The Academy of
Management Review, vol. 12, no. 2, pp. 222–34.
ILM (2013) Beyond the bonus: Driving employee performance, ILMBTB/
V1/1013, London, Institute of Leadership & Management; [online].
Available at www.i-l-m.com/%7E/media/ILM%20Website/Downloads/
Insight/Reports_from_ILM_website/ILM-BeyondTheBonus-Oct13.ashx
(Accessed 28 July 2014).
Kokkinidis, G. and Fournier, V. (forthcoming) ‘Spaces of possibilities:
workers’ self-management in Greece’. Organization .
Kremer, W. and Hammond, C. (2013) ‘Abraham Maslow and the pyramid
that beguiled business’ BBC World Service, 31 August, [online]. Available
at www.bbc.com/news/magazine-23902918 (Accessed 28 July 2014).
Maslow, A. (1943) ‘A theory of human motivation’, Psychological Review,
vol. 50, no. 4, pp. 370–96.
Maslow, A. (1970) Motivation and Personality, New York, Harper and Row.
McGregor, D. (1960) The Human Side of Enterprise, New York,
McGrawHill.
Steel, P. and Konig, C.J. (2006) ‘Integrating theories of motivation’,
Academy of Management Review, vol. 31, no. 4, pp. 889–913.
Taylor, F. (1911) The Principles of Scientific Management, New York,
Harper and Brothers.
Vroom, V. H. (1964) Work and Motivation, San Francisco, CA, Jossey-Bass.
15
Readings 12–20
Reading 13: Finding people

Introduction
Attracting people and being able to select the right mix of skills and
personalities is crucial to the continuation of any organisation. Indeed
failing to attract and select the right people could have very damaging
consequences for both the organisation and the individuals, for example,
poor performance, employees lacking commitment and motivation and so
feeling demoralised, new recruits leaving after a short period because they
don’t fit in or the reality of the organisation doesn’t match their
expectations. Added to this, the recruitment process involves a significant
investment in time and money that would be wasted if it didn’t lead to the
selection of suitable candidates. A study by the Chartered Institute of
Personnel and Development (CIPD) in the UK found that the average
recruitment cost of filling a vacancy was £8,000 for senior managers/
directors and £3,000 for other employees (CIPD, 2013).
In light of the high stakes involved in recruitment and selection, you will
not be surprised to find there has been quite a lot of research into how the
process could be made as accurate as possible. This reading draws on this
research and reviews how the various stages and methods of selection can
best be managed.
Before we explore the recruitment and selection process in more detail, it is
important to remember that besides the issues of cost and accuracy, there
are other important considerations to bear in mind when evaluating selection
practices. Firstly, selection and recruitment is a two-way process, it is not
just about the organisation finding out about the candidates, but also about
the candidates finding out about the organisation and whether this is the sort
of place where they would like to work. So the way in which the
recruitment and selection process is conducted will be important in shaping
candidates’ impressions of the organisation, and their willingness to work
for it. Secondly, in many countries, organisations have a legal (and some
would claim moral) obligation to remove discrimination from their
recruitment practices. This reading will begin to consider the ways in which
discrimination and stereotyping can creep in at various stages of the
recruitment and selection process.
1 The recruitment and selection process

The recruitment and selection process is concerned with identifying,
attracting and choosing suitable people to meet an organisation’s human
resource requirements. The aim of recruitment is to attract potential job
candidates in sufficient number and quality so that the organisation can
select the most appropriate people to fill its vacancies. Selection is
concerned with predicting which candidates will make the most appropriate
contribution to the organisation – now and in the future (Newell and
Shackleton, 2009). In short the aim is to attract and identify the ‘best’
candidates, a process that is central to an organisation’s good functioning,
16
and which has profound implications for the working lives of the
individuals who will be evaluated and eventually selected.
The human resource management (HRM) literature emphasises the need to
adopt a rational and objective approach; however, as you will see below,
organisational practices may fall short of such objectivity. In what follows,
you will learn about the various steps involved in recruitment and selection,
identify best practices and potential pitfalls.
1.1 Job analysis and description

The first stage in the recruitment process is to clearly identify the nature of
the job to be filled. This is what is referred to as a job description: a written
statement of what the job holder is responsible for and what s/he is required
to do. An accurate job description has various uses outside the recruitment
process: for example, it can be used to review staff performance in
appraisals or to assess training needs. One is shown in the following
example.
Example of a job description

Community Leisure Centre General Manager
Job purpose
The General Manager will have a key leadership and management role in
developing leisure, sport facilities and programmes to meet social and
financial objectives.
Main duties
Operational
. Lead the day-to-day management of the activities of the centre to
promote social inclusion, health and well-being in the community.
. Prepare any necessary reports, and relevant management information in
accordance with agreed formats and timescales.
. Ensure a proactive approach to forming partnerships with the community
and the key stakeholder groups in the interest of enhancing provision,
and maximising usage and income.
. Market and promote the Centre in the community.
Staffing
. Planning, monitoring and control of HR including recruitment and
selection, attendance management and disciplinary action.
. Daily supervision of staff working practices, rotas, and job allocations in
line with health and safety.
. Ensure that staff members are fully trained and competent to carry out
their roles.
. Promote a positive working environment where staff are valued and
supported in their day-to-day work.
17
Readings 12–20
Health and safety

. Assume responsibility for health and safety and the safe operation of the
working practices.
. Ensure that water quality complies with health and safety and industry
standards.
Finance
. Exercise sound financial control of activities and resources including
meeting financial targets.
. Monitor the budget and take action where necessary to maintain financial
target.
Exercise 1
Make a list of three or four core competencies required for the job of
Community Leisure Centre General Manager as described in the above
example.
Comment
Besides some qualification in sport and leisure management, the following
competencies would seem essential to the job:
. communication skills
. negotiation skills
. ability to focus on customer needs
. organisational and prioritisation skills
. leadership skills
. knowledge of budgetary control
. in-depth knowledge of health and safety regulations.
1.2 Person specification

On the basis of the job description, the next step is to draw a person
specification; this is a profile of the ‘ideal candidate’ that includes a list of
characteristics (skills, knowledge, experience, qualifications and personal
attributes) considered necessary to perform the job well.
An increasingly popular way to draw the person specification is to focus on
the generic qualities and behaviours required to do well in the organisation,
rather than merely to complete a particular job or task (Iles and Salaman,
1995; Rodriguez et al., 2002). These more generic qualities have been
18
referred to as competencies. The competency approach is based on the

identification of behaviours, skills, knowledge, and attributes that underline
successful performance and differentiate excellent performers from poor
ones. It provides a more flexible approach to selection than a job-oriented
approach because it can be used to identify characteristics that are relevant
to organisational competitiveness across the board. Thus competency
frameworks are usually seen as being compatible with greater flexibility,
team working, and multi-skilling because they are not constrained by
particular jobs but rather relate more broadly to the general qualities
associated with effectiveness in the organisation. The following example
provides an illustration of a competency framework used in an organisation.
Example of assessing against competency: Centrica’s graduate

programme
Centrica, an international energy company headquartered in the UK,
assesses potential recruits to its graduate programme in terms of the
following competencies:
. Being one team – build and maintain effective working relationships

. Creating a positive environment – have a positive impact through self-
awareness and social skills
. Putting our customers first – deliver excellent customer service
. Seizing responsibility – take initiative and set high standards for self
. Seeing beyond our own goals – look at the bigger picture and
recognise the impact of your actions
. Learning agility – learn from experience to perform in new or changing
situations
. Drive – focus energy on what will make a difference and deliver
exceptionally
. Managing relationships – communicate/collaborate effectively to get the
best from people.
(Centrica, 2014)
1.3 Discrimination and equality

Equal opportunity considerations will also be particularly important at this
stage as preconceived judgements or prejudices could lead, consciously or
not, to identifying personal characteristics that are not job related but rather
relate to those who have done the job in the past, or preconceived ideas
about how the job should be done, thus perpetuating discrimination. For
example a requirement that recruits be ‘able to work long hours’ (which
assumes that candidates have no domestic responsibilities or have someone
else to take care of that) may discriminate against those with dependants or
other responsibilities, whilst being unnecessary to doing the job well.
There are other ways in which the person specification could raise ethical
questions and be discriminatory. The growing importance of service jobs,
19
Readings 12–20
and in particular customer-facing jobs, has meant that employers place

increasing value on ‘emotional and aesthetic characteristics’; and as a study
by Warhurst and Nickson (2007) demonstrates, this can easily lead to
discriminatory practices. Service jobs now account for around three-quarters
of all jobs in the UK, with retail and hospitality featuring prominently and
expected to continue to do so. To fill these front line service jobs,
employers attempt to recruit workers with the right attitudes, with
personalities that are typically ‘good-natured, helpful and friendly’ and
‘positive, joyful and even playful’ (Warhurst and Nickson, 2007; Warhurst
et al., 2009). But Warhurst and Nickson also noted a growing number of job
advertisements listing necessary attributes such as being ‘well-spoken and
of smart appearance’, ‘sounding right’, ‘well presented’ or just more bluntly
‘good looking’.
Exercise 2
The implications of this increasing focus on appearance as a central

selection criteria for service interactive jobs are discussed in the following
article which you should read now.
Only the young and stylish need

apply
Hadley Freeman
The Guardian, 13 February 2001
More and more companies are hiring new

staff for their image rather than their ability
All manner of fears can dissuade people from applying for a job: a
lack of self-confidence, for example, or concerns about fitting in with
their future colleagues. My friend's joke that she ‘could never work at
French Connection because my hair is too frizzy’ is perhaps less
common, but no longer does it seem whimsical. Style is now more
important than substance – or at least, more important than skills.
That is the message of a report published this month that questions the
image employees project and how it compares to the one your would-
be employer wants to promote. According to Looking Good, Sounding
Right by Chris Warhurst and Dennis Nickson, it is now more important
to employers that their employees reflect the lifestyle being sold by the
restaurant, cafe or shop in which they work than that they have any
technical skills. Job notices often resemble lonely hearts adverts in
their bids for ‘young’, ‘stylish’, ‘attractive’ or ‘trendy’ applicants. …
… According to Warhurst and Nickson, employers now rely more on
appearance and accent … than on qualifications.
20
So is getting a job all a matter of style? At coffee house chain, Caffe

Nero, the answer would seem to be yes. ‘It is definitely more
important that the employees reflect what Caffe Nero stands for than
that they have experience,’ says Jerry Ford, chairman of Caffe Nero.
‘We want someone who reflects the Caffe Nero brand, and it's much
easier to train someone how to make a cup of coffee than to revamp
their personalities.’
Such statements put a new spin on the idea of the objectification of
employees. It is not that workers are seen as mere commodities for the
business, but they are expected to be walking billboards for it. No
longer is it sufficient to have the name of the cafe or store plastered
across your T-shirt or baseball cap; it must also be exuded by your
whole being. As Rachel Hall, Creative and PR Manager of the
womens' clothing store Morgan, says simply, ‘We like [our employees]
to reflect the Morgan image so the customer has a complete feel for
the brand.’ Ford agrees: ‘What we are selling to the customer is a
whole service, not just a cup of coffee.’
So if you are applying to work as a barista in a coffee house, ascertain
beforehand the style of the company. One might promote the ‘young,
dynamic, probably-work-for-a-successful-dot.com’ experience, another
might pitch itself more as a ‘sexy, continental, cultured’ place. Caffe
Nero, for example, likes to have Italian employees because ‘it is an
Italian coffee house’, Ford explains (although it is registered in the
UK).
[…]
The most worrying aspect of this trend is the discrimination it entails
against the long-term unemployed and others who might not be as
‘sexy and trendy’, to quote one employment notice, as young British
(or Italian) students. And heaven forbid that you should be served by
someone in a chain coffee house with a grating regional accent. That
would surely jolt you into the realisation that your coffee was being
made by someone from Manchester instead of Milan, and wouldn't that
be a turn-off?
‘Unemployment levels are staying the same in many areas, such as the
east end of Glasgow, despite the fact that the service industry is
growing so rapidly,’ says Warhurst. ‘This is because the long-term
unemployed who live in the area are being overlooked in favour of
middle-class kids from the surrounding suburbs who have more
cultural capital.’
This is not a matter of restaurants not hiring people with poor personal
hygiene, or other such understandable objections; Warhurst and
Dickson cite incredibly unfair examples of employee discrimination,
such as one woman who was sent home and told to shave her legs.
‘There are now employers who are clearly discriminating against
people who aren't unskilled or unqualified, but who just don't fit the
company's package,’ says Max Nathan from the Industrial Society.
‘Certainly you can have a brand image,’ Nathan concedes, ‘but that
can't involve unfair discrimination.’
21
Readings 12–20
But herein lies the problem, because that is exactly what creating an
image means – promoting certain qualities at the expense of others. In
this case, these qualities happen to be employees, and this is the
inevitable result when capitalism meets the concept of selling a
lifestyle in a coffee cup. Britain in the 21st century is pretty used to
the idea of image-making. From the government to the Post Office we
have seen big corporations rename and re-logo themselves, but perhaps
we are not quite ready for the coldly pragmatic measures such moves
require, nor for the accompanying cold business-speak.
When The Wise Group ran a course in 1999 training the long-term
unemployed to project a more positive lifestyle (or ‘an aesthetic skills
training programme’), the press seized on it scornfully and the course
was quickly dropped after a week. Such haste suggests a tacit
awareness that this emphasis on style still leaves a bad taste in many
people’s mouths. But more importantly, and more obviously, when it
comes to places like cafes and restaurants, the customer wants to be
served, simple as that. If the takeaway latte you bought was watery
and the service was slow, it is unlikely you’ll go back there, no matter
how young, stylish and Italian the barista was.
Figure 1 A coffee shop
Now draft some notes on the following questions:
1 The trends in recruitment practices highlighted by Freeman (2001) are

sometimes referred to as ‘employee branding’. What do you think
‘employee branding’ means?
2 Can you think of other examples of ‘employee branding’, i.e. employees
being selected to embody the brand or image of the company?
3 What ethical issues do you think are raised by the contemporary trends in
recruitment and selection described in the article? How would you feel if
faced with this kind of discrimination and evaluation based on personality
and appearance?
22
Comment
Employee branding refers to the ways in which employees may be selected
and trained to reflect the image or brand the company wants to project.
Research has highlighted many other examples besides those provided by

Freeman. For example, Grey (1994) illustrates how consultants working in
large accounting and consultancy firms in the city of London were expected
to reflect the lean culture of the companies through lean bodies. Looking fit
was an essential criterion.
Whilst selection on the basis of look is not new, there is evidence to suggest
that as the service sector is becoming more prevalent in advanced
economies, employers appear to be increasingly discriminating in favour of
workers perceived to be either ‘good looking’ or who have the ‘right look’ and
penalise those workers perceived as less ‘physically appropriate’ (Warhurst
et al., 2009). And this raises serious ethical questions. For example, how
important are candidates’ looks during recruitment and selection? Can/should
employees be trained to improve their appearance? Such questions in turn
raise wider issues about the potential for employment discrimination, for
example, are some workers being excluded from employment because they
have a perceived ‘skill deficit’ regarding their appearance (Warhurst
et al., 2009)?
1.4 Selection methods

There is a vast range of selection methods, from psychometric tests to
interviews, references or assessment centres. However, surveys show that
employers tend to be quite conservative in terms of the range of methods
they use, mostly a combination of interviews, references and CVs (Newell
and Shackleton, 2009). In what follows, we briefly look at the most
commonly used selection methods.
References
References are commonly used for screening candidates, irrespective of
organisational size and hiring level (Newell and Shackleton, 2009).
However, references are notoriously unhelpful and unreliable in predicting
performance. They are frequently biased because referees are nominated by
the candidates and unlikely to give a negative reference. Some organisations
try to get around this by asking the referees to rate the candidate on specific
dimensions.
Interviews
The interview is by far the most popular method of selection with both
employers and candidates. For the candidates, it is a way to find out
whether the organisation is the sort of place where they would like to work;
so ideally interviews should give candidates the opportunity to ask questions
23
Readings 12–20
and to find out more about the organisation. For the organisation, the
interview provides the opportunity to assess not only candidates’ aptitude
for the job but also the extent to which they would fit in.
However, interviews vary greatly in their ability to predict job performance,
and can be open to bias and discrimination. Recent research
(e.g. Macan, 2009) suggests that interviews become more reliable tools for
selecting people if:
. There are at least two people conducting the interviews; these ‘panel’
interviews can increase the objectivity of the selection process.
. The interviews are structured in a way that all candidates are asked job-
related questions; this ensures that all candidates are asked for similar
information, and it minimises the chance of irrelevant information or
prejudice influencing interviewers’ decisions. For example, one approach
would be to use the person specification to draw up a list of areas that
need to be covered in the interview (e.g. experiences reflecting the
different skills or competencies required for the post) and to decide on a
set of questions to explore these areas.
. Interviewers are provided with training in the interviewing process.
Psychometric tests
There are two main types of tests that can be used in selection: cognitive
and personality tests.
Cognitive tests assess attributes such as intelligence, special ability, or
numerical ability; they have been found to be good predictors of certain
aspects of performance, such as the ability to deal with numbers, or
complex information. However, as we saw above with the discussion of
competencies, there are other important elements of performance, such as
the ability to work in a team or to take initiative, which do not really lend
themselves to this kind of cognitive testing.
Personality tests assess individuals against a model of underlying
personality factors. Many personality tests are available, with different
levels of predictive accuracy. The use of psychometric tests has increased
recently, however this increasing popularity raises questions about the ways
they are used and manipulated by both organisations and candidates
(e.g. Newell and Shackleton, 2009). For example, it is often easy for
candidates to guess the sort of ideal answers the organisation is looking for
and fill in the test accordingly.
Assessment centres
Assessment centres are based on the use of multiple methods over a period
of time (typically 1 to 2 days) to assess a group of candidates on a number
of pre-determined criteria (often defined in terms of competencies).
Candidates are observed and evaluated by several assessors as they go
through the various tests and exercises. Exercises may include group
decision-making, presentation, role play, in-tray tests, psychometric tests,
and interviews. Assessment centres have become increasingly popular
within larger businesses (particularly for management positions) and they
24
have been found to be a good predictor of performance. However, they are

an expensive method and unlikely to be used by small- and medium-sized
organisations.
Summary
This reading has shown that, in theory at least, recruitment and selection are
supposed to be driven by concerns for objectivity and rational decision-
making. However, the practices associated with each step of the recruitment
and selection process may well fall short of this ideal of objectivity. Thus
the ways in which the profiles of ideal candidates are drawn may be
influenced by subjective decisions that reflect management’s values or
preferences. Furthermore, the selection methods that are typically used in
organisations may not always be very accurate in predicting people’s
performance; the methods that provide for more accurate evaluation such as
assessment centres, whilst increasingly popular, tend to be expensive and
therefore only accessible to large organisations.
But selection is not just about objectively measuring a pool of passive
candidates against an ‘ideal profile’; it is an interactive social process
through which both candidates and organisations are manipulating and
sending information to each other, and are trying to sell themselves by
managing impressions (Newell and Shackleton, 2009). This process of
mutual selling can have some important impacts not just on the selection of
candidates but also on the new recruits’ impressions of the organisations,
willingness to accept a job in the organisation, and future commitment to
the organisation.
For example, if organisations try to give an unrealistically positive image of
themselves (through glossy recruitment brochures, the deployment of
friendly and young staff in the recruitment process, the promise of
stimulating jobs and great development opportunities) but are then unable to
deliver, they may encourage the best applicants to take a job with them.
However, these new recruits are likely to develop negative attitudes as they
realise that reality falls short of promises and expectations. Job design is
one aspect of work that may be of particular importance in determining new
recruits’ attitudes and commitment to the organisation.
25
Readings 12–20
References
Centrica (2014) ‘Who we’re looking for’ [online]. Available at www.
centrica.com/index.asp?pageid=937 (Accessed 31 July 2014).
CIPD (2013) A Barometer of HR Trends and Prospects 2013, London,
Chartered Institute of Personnel and Development.
Freeman, H. (2001) ‘Only the young and stylish need apply’ The Guardian,
[online]. Available at http://www.theguardian.com/money/2001/feb/13/
workandcareers.fashion, 13 February 2001 (Accessed 30 July 2014).
Grey, C. (1994) ‘Career as a project of the self’, Sociology, vol. 28, no. 2,
pp. 479–97.
Iles, P. and Salaman, G. (1995) ‘Recruitment, selection and assessment’, in
Storey, J. (ed.) Human Resource Management, London: Routledge.
Macan, T. (2009) ‘The employment interview: a review of current studies
and directions for future research’, Human Resource Management Review,
vol. 19, no. 3, pp. 203–18.
Newell, S. and Shackleton, V. (2009) ‘Selection and assessment as an
interactive decision–action process’, in Redman, T. and Wilkinson, A. (eds.)
Contemporary HRM: Text and cases, 3rd edn., Harlow: Pearson.
Rodriguez, D., Patel, R., Bright, A., Gregory, D. and Gowing, M. (2002)
‘Developing competency models to promote integrated human resource
practices’, Human Resource Management, vol. 41, no. 3, pp. 309–24.
Warhurst, C. and Nickson, D. (2001) Looking Good and Sounding Right:
Style Counselling and the Aesthetics of the New Economy, London:
Industrial Society.
Warhurst, C. and Nickson, D. (2007) ‘Employee experience of
aesthetic labour in retail and hospitality’, Work, Employment and Society,
vol. 21, no. 1, pp. 103–20.
Warhurst, C., Van der Broek, D., Hall, R. and Nickson, D. (2009) ‘Lookism:
the new frontier of employment discrimination?’, Journal of Industrial
Relations, vol. 51, no. 1, pp. 131–6.
26
Reading 14: Designing jobs

Introduction
Job design is about the way work is organised to meet both the needs of
employees (for example for satisfying work), and the operational needs of
the organisation. It is an important element that will shape people’s
experience of work and well-being; for example a factory job that involves
monotonous, repetitive tasks and little chance to interact with others may be
soul destroying, whilst a job that enables people to use their talents and
skills, or to help others may provide a great sense of satisfaction. You may
have experienced well-designed, motivating jobs or, conversely, poorly
designed, monotonous and demotivating jobs yourself.
Designing jobs requires addressing many different questions. Does the job
involve a small or large number of tasks? Does it leave people some degree
of choice over how they complete their tasks or is this determined by
company rules or technology? Does it enable people to complete a piece of
work from start to finish, or just a small part of a bigger project or task? To
what extent does it enable people to make a significant impact?
The answers to these questions will vary greatly between jobs. For example,
an accountant in a company may have a limited number of tasks that are
highly prescribed by accounting conventions (and hence limited choice), but
will complete this task from start to finish (say prepare the company’s end
of year financial accounts), and the accuracy of the account will be very
important for the company (for tax purposes, in relations with banks and
other investors, etc.). On the other hand, the job of a regional sales manager
for a manufacturing firm may have more variety (e.g. travelling and seeing
different customers who all need to be treated differently) and be less
structured by rules but may not have the same sense of completion if, for
example, the sales manager doesn’t handle after sales service. Even the
same job could be designed in different ways, for example the job of a shop
assistant could be designed so that she handles only a particular section of
the shop, or only operates the till, or so that she deals with customers from
start to finish. This suggests that the ways jobs are designed are open to a
range of possibilities, and this will have an important impact on how people
perform in the organisation as well as on their job satisfaction.
In this reading, we consider how our jobs affect us, and how they can be
designed to increase employees’ productivity and satisfaction. After
examining the continuing influence of scientific management on the design
of work, we will look at alternative approaches that take greater account of
the human factor in job design: the socio-technical approach, and the job
characteristic model.
Before you move on to looking at these approaches to job design, you may
want to take a moment to think about what is important to you in a job.
27
Readings 12–20
Exercise 1
Make a list of three things that are important to you in a job.
Comment
Here are some possible things people may look for in a job:
. doing something worthwhile

. getting a sense of responsibility for getting things done
. having the opportunity to use one’s talents and skills
. having the chance to learn
. doing something one finds interesting
. working with interesting people.
What we find satisfying in a job may be the result of many factors and is
likely to vary across individuals, as well as according to our particular
circumstances at a particular time. For example, it could be that as people
start a family, they are looking for less demanding work to leave them time
and energy to deal with the demands of their family lives, but that they later
look for more challenging work that would enable them to develop their skills
and potential.
1 Taylor and scientific management

Taylor was one of the first writers who tried to theorise management at the
beginning of the 20th century. The main focus of his principles of scientific
management was the analysis and design of individual tasks to make their
performance as effective as possible. The starting point was a methodical
study of tasks to establish the one best way of carrying out a job. The main
ideas were:
. the breaking down of jobs into small and simple components

. the creation of standard procedures and times for performing these tasks
. the removal of worker discretion and control over their activities
. close supervision of workers’ performance of their tasks.
Taylor believed that people had a tendency to minimise effort. To prevent
this he thought managers had to set out a detailed way of performing work
and to closely supervise workers to make sure they accomplished their
tasks. The simplification of work into simple, standardised tasks also went
in this direction of greater managerial control because it reduced the degree
of skills and knowledge workers needed; workers were simply to
accomplish the tasks designed by managers. Brain work was thus to be
28
clearly separated from manual work, and to be concentrated among

managers.
Taylor’s scientific management has since been heavily criticised, and the
problems it raises for workers have been particularly well illustrated in
Charlie Chaplin’s film ‘Modern Times’.
Box 1 Charlie Chaplin, Modern Times

‘Modern Times’, a film made in 1936 by Charlie Chaplin, portrays a
factory worker on an assembly line who is subjected to inhuman
conditions. For example, the accelerating assembly line forces him to
screw nuts and bolts at an ever-increasing pace, leading to his nervous
breakdown. The film has become iconic as a critique of work in
industrial society.
Figure 1 A still from Modern Times
Highly routinised and repetitive tasks lead to health problems, boredom and
dissatisfaction, and this, in turn, can lead to high rates of employees’ unrest,
turnover or absenteeism.
Yet scientific management remains influential in contemporary
organisations. The worldwide fast-food chain McDonald’s is a perfect
example. Here work in a restaurant is divided up into a number of simple,
small and highly standardised tasks (e.g. making a burger, preparing fries,
taking an order) and each task is itself highly prescribed, with step-by-step
checklists stipulating how to do it. For example, the job of taking a
customer’s order involves pre-set steps and scripts (including standard
questions to be asked to customers such as ‘would you like fries with
that?’). Call centres offer another prime example of scientific management
in contemporary organisations. Here the close supervision of employees is
enabled by technology that allows for the electronic surveillance of workers.
Tasks are highly repetitive and prescribed, employees follow a standard
script, and are meant to complete calls within a set time (e.g. Bain and
Taylor, 2000).
29
Readings 12–20
Exercise 2
First read the excerpt below on Taylorisation at HMRC.
Taylorisation at HMRC
HMRC (Her Majesty's Revenue and Customs) is a UK civil service
department which deals, among other things, with the processing of tax
returns. Under pressure from the government to increase productivity,
it launched a programme of job redesign for its administrative staff
working with tax returns.
Prior to the job redesign, staff retained elements of control, and task
discretion. They were allocated a range of cases by their line managers
which they saw through from beginning to completion, thereby
developing their skills and proficiencies. Although there were no
specific targets, managers had reasonable expectations of what was
achievable and could allocate work accordingly. Several workers and
managers stated that they enjoyed a variety of interesting work, which
gave a sense of achievement in providing a good service to the public.
Workers could interact with colleagues and take informal breaks,
creating a sense of community in the workplace.
In order to redesign jobs, HMRC brought in consultants who first
reconfigured the desk layout into a horseshoe design so that there
could be a sequenced and continuous flow of work between work
stations. The consultants also conducted detailed time and motion
studies of workers. During these work measurement studies,
consultants used stopwatches to time specific work tasks which
intimidated staff and was unrealistic as there was no social interaction,
rest or comfort breaks. Many workers were acutely aware that the use
of time and motion studies and rearrangements of desks resembled
factory assembly lines and that they were being deskilled.
Staff now have to complete tasks in accordance with standard
operating procedures. Teams typically consist of one team leader and
twelve administrative staff, with separate team members working on
differing aspects of a tax return. In addition, time and motion studies
were also used to set performance targets for each team, and
individuals within the teams. A visual system of whiteboards located at
the head of every team details the hourly productivity statistics of each
team member; the team leader is supposed to collate and post these
hourly productivity statistics. This creates relentless pressure on staff
to perform to their maximum capacity, as they are now accountable for
every minute of every working day.
By following these strict pre-determined guidelines and targets,
employees are now limited in their application of discretion and
initiative, and there is no real ownership of work. Overall, the job
redesign programme had a negative impact on relationships and
30
satisfaction at work. The following quote expresses the sense of loss

experienced by staff since the implementation of job redesign.
I used to have great pride in the job. I was very good at it, very
experienced and enjoyed helping trainees. I felt like I made a
difference to people’s lives (as in made sure that they paid the
right tax). I dealt with the same individuals for years and I built
up a rapport with them. Now I feel like a cog in a machine. The
standard of work at HMRC is now desperately poor. There is no
taking responsibility any more. The job is so fragmented that no
one cares about the whole picture, just their little bit. This feeling
is encouraged by senior management pressuring us to complete so
many tasks an hour. We never see the finished product. … We are
treated like imbeciles.
(Administrative Officer)
(based on Carter et al., 2011)
Now make some notes on the following questions:
1 How do Taylor’s principles apply to the job redesign programme at

HMRC?
2 Have you ever held such a taylorised job?
3 How did you feel about working in these highly routinised and prescribed
jobs?
Comment
The job redesign programme at HMRC reflects all the taylorist principles:
. The jobs were simplified and fragmented so that individual employees no

longer worked on a whole case but on a small fragment.
. The tasks were codified and measured, with standard procedures and
times set for performing these tasks.
. Employees could no longer exercise discretion in completing their work.
. Employees’ productivity was closely monitored through hourly
measurements posted on whiteboards.
As illustrated with the case of HMRC, scientific management has long
extended its reach from manufacturing to the service sector where the work
of administrative or customer-facing employees has become highly
standardised, be it in the fast food industry, restaurant chains, coffee bar
chains, call centres, or in the sports industry where fitness instructors
increasingly have to give standardised aerobic or Zumba classes
(e.g. Felstead et al., 2007). Even the professional work of, for example,
health professionals, teachers, social workers or probation officers, is being
increasingly ‘Taylorised’ and subject to quantification, standardisation and
control (Mather and Seifert, 2014). For example, school teachers having to
teach standardised curriculum rather than design their own lessons, or being
31
Readings 12–20
assessed in terms of the exam results of their pupils are increasingly losing
their autonomy and being subjected to performance measures and control.
2 The socio-technical approach

Whilst scientific management sees people as cogs in a machine, the socio-
technical approach aims to put people back to the core of job design by
recognising their social needs.
This approach was developed at the Tavistock Institute of Human Relations
in London by Eric Trist and his colleagues, and has since been influential in
Britain, the USA, and even more so in Scandinavia. The seminal study
conducted by Trist and Bamforth in the middle of the 20th century was an
investigation of the causes behind the failure of the mechanisation of coal
mining (Trist and Bamforth, 1951). The introduction of more efficient
technology, together with higher pay did not deliver the expected results:
productivity fell whilst absenteeism and resentment among miners
increased. Before mechanisation, coal had been extracted by small teams of
miners. Each team worked relatively autonomously and tended to develop
its own structure usually built around a hierarchy based on length of
service. These teams became highly cohesive social units that helped them
deal with the dangerous and difficult situations in the mine. However, the
arrival of new technology (conveyor belts and coal-cutting machinery)
transformed the operation and work of teams: each shift now consisted of a
larger group of miners working under a supervisor. The team was divided
into specialists, and an elaborate pay structure led to status hierarchy among
the miners. Production and industrial relations problems followed.
Trist and Bamforth (1951) drew the conclusion that the problems were
largely the result of a poor match between the new technology and the
social structures, or group practices, which had been built over the years.
They argued that solutions would have to integrate the demands of both the
social and the technical systems.
So the socio-technical approach seeks to balance human needs, such as the
need for meaningful work and relations with others, with technological
requirements. Innovation is often obsessed with technical aspects, and not
with the impacts on the social nature of work. The concept of socio-
technical systems implies that both the social and the technical elements are
important; and it puts forward the following principles for job redesign:
. It should not be determined by technology but should take into account

broader factors, such as culture and group working practices.
. It should involve employees.
. A balance should be found between social criteria of meaningful work
and technical-economic criteria of productivity.
32
In short the socio-technical approach is about putting the people element

back into the design of work, and it has had a considerable influence
particularly in the manufacturing sector. Its strongest legacy is the
autonomous work group that was pioneered by the Swedish car
manufacturer Volvo in the 1970s (see example). Autonomous work groups
refer to teams of typically 8 to 10 employees who are responsible for a
whole product or service, and have autonomy as to how they organise
themselves to complete their tasks. In contemporary organisations, we see
the influence of semi-autonomous groups in what has become more
commonly referred to as self-managed teams.
Figure 2 A Volvo factory
Example of an autonomous working group: Volvo

Volvo’s experiment with autonomous working groups in their Swedish plants
from the mid-1970s is maybe the most often cited example. Volvo shifted
from traditional assembly line to autonomous work groups of 8 to 10
members in order to make work more meaningful for employees. Groups
assembled larger components of vehicles than on the assembly line, and
had responsibility for production, planning, quality control, maintenance, and
some personnel issues such as recruitment and training. They operated
without supervision and elected their own spokesperson to coordinate
activities among themselves and liaise with management. The autonomous
work group design was associated with increased productivity. Yet Volvo
returned to the traditional assembly line in the mid-1990s. Research
suggests that this was not for economic or productivity reasons but because
of fear of loss of control on the part of senior management.
(Wallace, 2008)
3 The job characteristics model (JCM)

Hackman and Oldham’s (1980) influential work also put the human element
at the centre of job design and proposed a model to understand the complex
33
Readings 12–20
relationships between job characteristics and employees’ ‘psychological

states’, that is the way people experience work. As described in Figure 3,
the job characteristics model (JCM) suggests that particular job
characteristics influence particular ‘critical psychological states’, which in
turn influence outcomes, such as employee satisfaction, intrinsic motivation
and productivity.
Core
dimensions Skill variety
Task identity Autonomy Feedback
Task significance
Psychological
states
Meaningfulness Responsibility Knowledge
of work for outcomes of results
Outcomes
High intrinsic motivation
High job performance
High job satisfaction
Low absenteeism and turnover
Figure 3 Hackman and Oldham’s job characteristics model (source: adapted from
Hackman and Oldham, 1980)
Experienced meaningfulness of the work

‘Experienced meaningfulness’ refers to the degree to which the jobholder
experiences the work as meaningful, that is as being of value to themselves
and others. This is influenced by three job characteristics:
Skill variety – the extent to which a job includes a variety of activities
and therefore requires the employee to use a number of different skills
and talents.
Task identity – the extent to which the job requires the completion of a
whole and identifiable piece of work from start to finish.
Task significance − the degree to which the job is perceived by the
employee to have an impact on the lives or work of other people, in the
organisation or the wider environment.
Experienced responsibility for work outcome

Refers to the degree to which the employee feels he or she is accountable
and responsible for the results of the work. This is influenced by one job
characteristic:
Autonomy − the extent to which the job allows employees to exercise
choice in the way they plan and conduct their work – for jobs with a
high level of autonomy, the outcomes of the work depend on the
employees’ own initiatives and decisions, rather than on the instructions
34
from a manager or a manual of job procedures. In such cases, employees

will experience greater personal responsibility for their own successes
and failures at work.
Knowledge of results of the work activities

The degree to which the jobholder knows how well he or she is performing.
This is influenced by one task characteristic:
. Feedback − the degree to which the job can provide direct and clear
information to employees about the effectiveness of their performance;
when employees receive direct and clear information about their work
performance, they have better overall knowledge of the results of the
work activities.
The JCM has set the stage for contemporary perspectives on job design; but
over the years, it has been extended to include a broader range of job
characteristics and moderating factors that reflect the changing nature of
work (Grant et al., 2011). For example, considering the increased inter-
dependence of tasks within complex modern organisations, and the growing
importance of working in teams, Humphrey et al. (2007) added ‘social
characteristics’ as one of the job dimensions influencing job satisfaction;
this includes social support, interactions outside the organisation, or having
contact with the beneficiaries of one’s work. They also added characteristics
to reflect the increased flexibility of working patterns such as the ability to
work remotely, from home for example, at non-standardised hours. They
suggested that whilst this increased autonomy to decide on one’s working
patterns may lead to greater satisfaction, it can also lead to work overload
and burnout. Another important characteristic that influences job satisfaction
in contemporary organisations is the use of technology. For example, Grant
et al. (2011) argue that whilst the growing use of technology can provide
opportunities for immediate electronic feedback on performance, this could
also become excessive and lead to information overload and burnout.
The JCM, together with its contemporary developments, offers a practical
model for job redesign: it suggests that by introducing certain working
practices, e.g. improving feedback, combining tasks, forming work groups,
that the motivational potential of jobs can be increased.
Summary
In this reading, we saw that the ways jobs are designed can have profound
effects on people’s satisfaction, motivation and productivity. The various
theories we reviewed are all based on particular assumptions about what
motivates people to work and what they are looking for in a job.
For scientific management, people will seek to expend minimum effort at
work and are only interested in money, so jobs should be simplified and
standardised, and employees should be heavily supervised.
For the socio-technical approach, people are looking for meaningfulness and
relationships with others in their work, and jobs should be designed to
35
Readings 12–20
satisfy these needs rather than just determined by technology. The job
characteristics model takes a more individual rather than social approach,
and identifies some important psychological states that employees can
experience if jobs are designed appropriately: a sense of meaningfulness,
responsibility, and knowledge of the results of one’s work.
Recently, the job characteristics model was expanded to reflect factors of
increasing relevance with the changing nature of work, in particular the
social context of work and flexible working patterns.
Whilst the various models we saw in this reading have different, and at
times conflicting, implications for the ways jobs are designed, they may
each have relevance in different organisational settings; taken together, they
suggest there are choices in the way work is organised.
36
References
Bain, P. and Taylor, P. (2000) Entrapped by the ‘electronic panopticon’?
Worker resistance in the call centre, New Technology, Work and
Employment, vol. 15, no. 1, pp. 2–18.
Carter, B., Danford, A., Howcroft, D., Richardson, H., Smith, A. and
Taylor, P. (2011) ‘All they lack is a chain’: lean and the new performance
management in the British Civil Service’, New Technology, Work and
Employment, vol. 26, no. 2, pp. 83–97.
Felstead, A., Fuller, A., Jewson, N., Kakavelakis, K. and Unwin, L. (2007)
‘Grooving to the same tune? Learning, training and productive systems in
the aerobics studio’, Work, Employment & Society, vol. 21, no. 2,
pp. 189–208.
Grant, A., Fried, Y. and Juillerat, T. (2011) ‘Work matters: Job design in
classic and contemporary perspectives’, in Zedeck, S. (ed.) APA Handbook
of Industrial and Organizational Psychology, Vol 1: Building and
developing the organization, Washington, DC, American Psychological
Association.
Hackman, J. and Oldham, G. (1980) Work Redesign, Reading, MA:
Addison-Wesley.
Humphrey, S., Nahrgang, D. and Morgeson, F. (2007) ‘Integrating
motivational, social, and contextual work design features: A meta-analytic
summary and theoretical extension of the work design literature’ Journal of
Applied Psychology, vol. 92, no. 5, pp. 1332–56.
Mather, K. and Seifert, R. (2014) ‘The close supervision of further
education lecturers: “You have been weighed, measured and found
wanting”’, Work, Employment & Society, vol. 28, no. 1, pp. 95–111.
Trist, E. and Bamforth, K. (1951) ‘Some social and psychological
consequences of the longwall method of coal-getting’, Human Relations,
vol. 4, no. 1, pp. 3–38.
Wallace, T. (2008) ‘Cycles of production: from assembly lines to cells to
assembly lines in the Volvo cab plant’, New Technology, Work and
Employment, vol. 23, no. 1–2, pp. 111–24.
37
Readings 12–20
Reading 15: Assessing people at

work
Introduction
Performance management aims to establish a shared understanding about
what employees are to achieve, how well they are doing in their job, and
how they can be developed to improve (Armstrong and Baron, 2004). For
employers, performance management is a way of ensuring that people are
doing their job adequately; for employees, it can be a way of confirming
they are doing well, and of getting recognition for their effort. Whilst some
forms of performance evaluation have always existed in most organisations,
since the 1990s performance management has become more formalised and
systematic, often measuring individuals’ performance against set objectives
and competencies, and linking pay with performance. Moreover, whilst
performance management tended to be traditionally associated with
managerial jobs in the private sector, it has been extended to include
employees at all levels and in all sectors, be it the private, public or
voluntary sectors, or small or large organisations. As the following example
suggests, civil servants and even cabinet ministers are increasingly subjected
to performance evaluation against targets they are meant to achieve.
Example of performance management in the public sector: the

French government
In 2007, the French government introduced a performance management
system for its cabinet ministers designed by a private consultancy firm. Each
minister was to be assessed in terms of a set of 30 criteria. For example, the
Education minister was to be evaluated in terms of ‘the amount of overtime
done by teachers’, the immigration minister in terms of ‘the number of illegal
immigrants repatriated’, the culture minister in terms of ‘the market share of
French films in France’.
(based on Vidaillet, 2013)
Performance management can, in theory, serve several positive functions. It

can be used as a means of communicating organisational objectives to
employees and of making sure that organisational objectives are cascaded
down to individual levels. It is also a way of providing feedback to
individual employees. Getting feedback on how well we are doing is one
important element impacting on our sense of satisfaction at work.
Performance management can also be used to promote employee
development by identifying individual employees’ potential and the sort of
training they would benefit from. Finally, performance management can be
used to decide about employees’ pay and promotion.
However, in practice, performance management can also raise many
problems for both managers and staff. For example, line managers may feel
uncomfortable about evaluating people in their team as this could damage
interpersonal relationships. People who are assessed may also dislike
38
Reading 15: Assessing people at work
appraisal because of the possibility for bias and distortion. Maybe you have
experienced this problem yourself: feeling you were not evaluated fairly
because of bias on the part of your line manager, or because you were not
given adequate resources to perform to the best of your abilities. So
performance management could leave employees with a sense of
satisfaction and achievement if they feel they were recognised for their
effort, or it could leave them disgruntled if they feel they were not assessed
fairly.
In order to understand the potential benefits and dangers of performance
management systems, it is important to explore the various elements
involved in the process, and the way each of these elements may serve
different, and possibly conflicting, objectives. Performance management
systems can be designed to serve three main objectives:
. to monitor and improve performance

. to establish pay
. to develop staff.
Whilst the three objectives are not necessarily incompatible, they may
require different approaches. We are now going to look at each of these in
turn.
1 Performance management as a
monitoring device
When performance management is used to monitor staff performance it is
usually referred to as performance appraisal; and this is the one most
commonly used element of performance management in organisations. The
aim is to make sure that employees perform to required standards by
evaluating their performance, exposing any inadequacies or deficiencies, and
remedying them (Redman, 2009).
Performance appraisal usually involves collecting information on past
performance and evaluating this against objectives. This is typically
followed by an appraisal meeting that should provide feedback to
individuals on their performance and progress, and involves a discussion of
plans for future improvements. At the end of this meeting, an agreement
should be reached between the appraiser and appraisee about objectives for
the next period, and any actions that need to be taken to improve
performance or achieve the agreed objectives (for example, undertaking
some training).
One of the key issues for performance appraisal is to find a way of
measuring employees’ performance fairly and accurately. This problem of
fair and accurate measurement can be broken down into two issues: one
related to the type of criteria or measures used for evaluation, the other
related to who is to conduct the evaluation.
39
Readings 12–20
1.1 Performance measures

The issue here is for management to decide on the type of information that
would provide the most accurate representation of employees’ performance.
Typically there are two types of measure: those based on outputs and those
based on inputs.
Outputs
Output-based measures involve defining objectives. Many organisations set
performance objectives or ‘goals’ to be accomplished by individuals,
departments and the organisation over a period of time. These can be
expressed as targets to be met (such as sales levels, measures of customer
satisfaction) or as tasks to be completed by specified dates. But in all cases,
objectives need to be clearly defined and agreed with individuals. Indeed, it
is often argued that objectives should be SMART: specific, measurable,
achievable, relevant, time bound (Armstrong and Baron, 2004) (see
Table 1).
Table 1 SMART objectives
Description Example
Specific The objectives should state a Improve customer satisfaction

desired outcome that the
employee needs to achieve
Measurable The objective should be Improve customer satisfaction
quantified by 10%
Achievable The employee should have the Would the employee need to
capabilities and resources to go on a particular training
achieve the objective programme to enable him/her
to achieve the objective?
Relevant Goals should be relevant to Does the employee’s job
the employees’ job, involve customer interaction?
department, organisation
Time The goals should have a time Improve customer satisfaction
bound frame stating when the by 10% over the next 12
objective has to be achieved months
Inputs
Input-based measures use competencies or skills. If objectives describe the
output achieved by an employee or the ‘ends’, competencies and skills
describe the qualities an employee needs to have to achieve these ends or
the ‘means’. Typical competencies that may be assessed include:
communication skills; analytical skills; ability to adapt; willingness to take
responsibility.
Combining measures
Employers may combine objectives, competencies and skills in their
appraisal systems, as illustrated in the following example.
40
Example of performance appraisal criteria: hotel receptionist

The job of a hotel receptionist involves looking after guests as they arrive.
Performance on this job could be assessed in terms of a combination of
objectives and competencies, such as:
Objectives
◦ checking in each guest within five minutes of arrival

◦ answering all calls within three rings.
Competencies
For example ‘customer care’, which, in turn, could be broken down in
terms of:
◦ politeness
◦ oral and written communication skills.
Figure 1 Hotel receptionists
Exercise 1
Go back to the example of the cabinet ministers in the French government

(in ‘Introduction’). Would you say that the criteria used for their evaluation
reflected objectives or competencies?
Comment
In the case of the French ministers, appraisal is based on measurable
objectives or targets they are meant to achieve (e.g. ‘the number of illegal
immigrants repatriated’, ‘the market share of French films in France’). In
many jobs however, performance appraisal could involve a combination of
input- and output-based measures. For example, many managerial jobs may
involve the achievement of targets for their team (e.g. sales, cost saving,
41
Readings 12–20
quality of service delivered) as well as managerial competencies such as

communication skills, problem-solving skills, or the ability to motivate staff.
1.2 Who is to appraise?

The second issue in performance appraisal involves identifying who is in
the best position to evaluate staff performance. Traditionally, the appraisal
has been conducted by the line manager, and this continues to be the most
common pattern. However, with the reduction in the number of management
layers, the increasing flexibility of jobs and the greater use of teamwork,
this may prove more difficult. A manager may have too many subordinates
to deal with, or see them too infrequently to be in a position to evaluate
their performance. Furthermore, employees may be working on projects that
overlap with different managers and departments; they may have several
line managers. Who then should be the appraiser?
In response to this problem, organisations are increasingly using alternative
sources of information, in particular from peers, subordinates and customers
(Redman, 2009). With peer appraisal, members of a team or unit evaluate
each other. Upward appraisal is the appraisal of line managers by their
subordinates. With the increasing focus on customer and quality in many
organisations, ‘satisfying the customer’ has become a key dimension of staff
evaluation, and customers themselves have been drawn into the appraisal
process in different ways, for example through customers’ questionnaires
that are then used in staff appraisals.
Finally, it is becoming increasingly popular to use 360-degree appraisal; this
involves a combination of information collected from people positioned all
around the employee: peers, superiors, subordinates and occasionally
customers (Redman, 2009).
Exercise 2
Consider your current job or a job you performed in the past and think about
who would be in the best position to assess your performance. In particular,
make some notes on the following questions:
1 Considering the various perspectives described above (line managers,

peers, subordinates, customers), which would be most relevant to assess
your performance accurately?
2 Would a combination of perspectives, as in 360-degree appraisal, be
useful?
Comment
Whether or not you felt that using non-traditional sources of information to
evaluate performance was appropriate may depend on the way work is
designed in the organisation, and the culture of the organisation. Peer
42
appraisal makes sense when employees work collaboratively and therefore

the ability to operate as part of a team is important. Upward appraisal is only
likely to be beneficial if there is a culture of open communication and trust in
the organisation; otherwise it could create tensions between managers and
their subordinates and lead to resentment and suspicion.
1.3 An evaluation of performance appraisal

Carried out well, performance appraisal can significantly enhance
relationships between individuals and line managers, as well as provide an
effective vehicle for objective setting and review (Armstrong and
Baron, 2004). But considering the potential problems in measuring
performance accurately, perhaps it is not surprising to find that many have
questioned its benefits. Indeed a recent survey by the Chartered Institute of
Personnel and Development (CIPD) in the UK found that nearly a third of
the employees surveyed felt that the performance management systems they
were subjected to were unfair (CIPD, 2014). More specifically, there are
three main lines of criticism of performance appraisal: bias; lack of
objectivity; too much focus on the quantifiable.
Potential bias
Appraisal in practice rarely lives up to the ideal of objectivity and accuracy
and is open to many forms of bias and distortion. The most common
problems here include personal bias, and the tendency on the part of line
managers to give similar ratings to all their staff in order to avoid
interpersonal tensions (Schneider et al., 2012).
Putting the blame in the wrong place

Appraisal may inappropriately attribute variation in performance to
individuals rather than to other factors (say poor management, lack of
technical support, problems of organisational structure, etc.) Indeed, the
quality movement has strongly criticised appraisal as one of the ‘deadly
diseases’ of current management practices (Walton, 1986). The main
argument is that appraisal tends to put the blame or responsibility for poor
quality on individual employees when the problems may, in fact, lie in the
organisational systems within which individual employees operate. For
example, it could be that despite their best effort, employees handling
customer enquiries in a call centre could not process queries from customers
in a timely and effective manner because of problems with the information
technology system. This can lead not only to low morale and demotivation
among staff, but also prevent the identification of the real problems.
Unintended consequences: means become ends

Performance appraisal tends to reduce performance to what can be measured
and neglects other non-tangible aspects of the job. As a result, the measures
on which performance is assessed can become ends in themselves. So for
43
Readings 12–20
example, school teachers evaluated in terms of their students’ pass rate may
spend much effort improving their students’ examination techniques, at the
expense of providing a more critical education. Similarly, a hospital
manager assessed in terms of the patients’ waiting list may get patients in
and out of hospital speedily, at the expense of the quality of care provided
(Vidaillet, 2013).
mechanism for rewarding staff
The performance appraisal process we have just discussed can be used as a
basis to determine at least part of employees’ pay. Performance-related pay
(PRP) is a method of remuneration that links pay progression to an
assessment of individual performance, usually measured against pre-agreed
objectives. In such schemes, an employee’s salary increase is, at least partly,
dependent on their appraisal ratings.
PRP has become more widespread since the 1980s. Employers have used it
as a way of driving high performance levels by linking employee reward to
business objectives; the rationale being that this should increase staff
motivation and commitment. However, empirical studies suggest that PRP
may not always have the desired impact on motivation in practice
(Lewis, 2009). This is because the potential problems discussed in relation
to performance appraisal above are not only likely to be reproduced when
appraisal is used for establishing pay, but also to be exacerbated. If the
outcome of the appraisal process affects their pay, employees are even more
likely to become sensitive to, and resentful about, any possibility of bias,
distortion and subjectivity in the assessment process.
Another potential concern in linking pay with performance appraisal is that
it may inhibit open discussion of an individual’s training and development
needs. We now turn to this developmental function of performance
management.
developmental tool
The idea here is to find out the aspirations, interests and potential of
individual employees, and to match this with the organisation’s needs.
Performance management is here linked to career development and
succession planning. For the individuals, this type of developmental review
provides help and guidance in exploring potential and relating it to career
planning. For organisations, this process ensures that staff will develop the
skills required in the future, and that current staff are retained and
developed to take leadership positions.
Performance development systems encourage employees to think about how
they want to develop. This can lead to the drawing up of a personal
44
development plan (PDP) setting out the actions to be taken (for example in
terms of training, or being given different job assignments) to meet their
development objectives.
The process of developmental review differs from that involved in
performance appraisal designed to monitor and reward staff. One of the key
issues here is how to facilitate the exploration and development of
employees’ potential. This, in turn, has implications for the methods used.
It has been argued that the use of competency-based frameworks, rather
than job-related dimensions, are particularly suited to developmental review
because they can take a broader perspective and assess individuals on their
potential rather than on their current job performance (Armstrong and
Baron, 2004). It is also argued that line managers may not be the best
people to assess their staff potential beyond their current position; potential
may be better explored by multiple assessors on the basis of a variety of
methods.
A developmental review may also require a different set of skills and
approaches from the appraiser. If the aim of the developmental review is to
explore and develop employees’ potential, the appraisers should adopt a
facilitating approach rather than an evaluative approach. During the
developmental review, individual employees will be encouraged to talk
about their strengths and weaknesses, to identify areas for improvement and
training, and to articulate their aspirations. This requires an enabling
relationship; one of trust where the appraiser is called upon as a coach or
counsellor rather than as a judge.
These points about methods and approaches suggest there is some potential
conflict when the same appraisal system is used for monitoring, rewarding
and developmental purposes. Performance management systems are often
criticised for being made to serve incompatible ends, placing conflicting
demands on both appraisers and employees (Redman, 2009). For example,
an appraisal system designed to monitor or reward performance will focus
on employees’ past performance whilst a developmental review will be
more future-oriented. In addition, performance appraisal and developmental
review may require different styles and skills from the appraisers. Finally, a
developmental review may require employees to identify weaknesses and
performance problems, which they may be reluctant to do if the appraisal is
related to pay. To keep development discussions separate from appraisal of
PRP, it is often recommended that development reviews be held at different
times to the appraisal and pay review (e.g. Armstrong and Baron, 2004).
Summary
This reading has suggested that performance management is increasingly
used at all levels of organisations, and has been extended to new sectors, in
particular the public sector. Performance management can be used to serve
three objectives: for monitoring staff, as a basis for pay, and for
developmental purposes. Performance management has a significant role to
play in driving organisational performance, and can do so by ensuring that
all individuals understand their expected contribution to the organisation’s
45
Readings 12–20
objectives and are equipped with the skills to achieve this. Performance
management systems can, in theory, provide an effective mechanism for
linking organisation and employees’ objectives, for communicating
objectives throughout the organisation, and for providing a way of
motivating staff.
However, despite its increasing use, performance management can raise
various problems. It is open to bias and distortion and employees may not
feel the process is fair. Employees’ performance may be hindered by
broader organisational factors, but performance appraisal places the
responsibility for poor performance on the shoulders of individuals. This
again may lead to problems of perceived unfairness. In addition,
performance appraisal may encourage employees to concentrate their effort
on what is being measured and to neglect less tangible aspects of their
work. All these problems may become particularly intense when
performance appraisal is used to reward staff, as in PRP. Finally, whilst the
same system is often used to serve both developmental and monitoring
purposes, it has been argued that these are incompatible ends, placing
conflicting demands on both appraisers and employees, and that ideally
different systems should be used for appraising and developing employees.
46
References
Armstrong, M. and Baron, A. (2004) Managing performance: performance
management in action, London: Chartered Institute of Personnel and
Development. Available at www.cipd.co.uk/Bookstore/_catalogue/
HRPractice/1843981017.htm (Accessed 31 July 2014).
CIPD (2014) Industrial Strategy and the Future of Skills Policy: The High
Road to Sustainable Growth, London: Chartered Institute of Personnel and
Development.
Lewis, P. (2009) ‘Reward management’, in Redman, T. and Wilkinson, A.
(eds) Contemporary HRM: Texts and Cases, 3rd edn., Harlow: Prentice
Hall.
Redman, T. (2009) ‘Performance appraisal’, in Redman, T. and Wilkinson,
A. (eds) Contemporary Human Resource Management, 3rd edn., Harlow:
Pearson.
Schneider, F., Gruman, J. and Coutts, L. (2012) Applied Social Psychology,
London: Sage.
Vidaillet, B. (2013) Evaluez Moi, Paris: Seuil.
Walton, M. (1986) The Deming Management Method, New York: Perigee
Books.
47
Readings 12–20
Reading 16: Rewarding people for

work
Introduction
Pay is probably one of the most important and yet one of the most
contentious aspects of work. Although most people are motivated by more
than just money, money is still important. Receiving ‘fair’ pay for their
work will be a significant aspect of motivation and job satisfaction for many
people. Indeed, for employees, pay is central to their standard of living but
also to the value that is placed on their service or performance; as such it
can have an important impact on their self-esteem, motivation and
behaviour. Getting the pay right is equally important for employers. Not
only is it a significant cost, it is also a potential tool to increase employees’
motivation and performance, as well as to attract and retain high-performing
staff. Employers and employees will probably expect different things from a
payment system: to be an effective way of enhancing performance, or to
provide fair compensation. Whilst pay may not be the only, or even the
prime motivating factor, being treated (and paid) fairly in comparison with
others is likely to have a significant impact on employees’ behaviour and
satisfaction.
While rewards or a compensation system include fringe and non-cash
benefits, the basic wage or pay remains the core component and will form
our main focus here. We can distinguish between two main systems for pay
determination: payment by time and payment by results. In a payment by
time system, employees are paid to work for stipulated periods of time: an
hourly rate, a weekly wage or an annual salary, and these rates are, in turn,
based on an evaluation of the contribution of their jobs to the organisation.
In payment by results systems, employees’ pay is based (at least partly) on
how well they perform their job, rather than just the nature or value of their
job. Very often, however, organisations use a combination of these systems.
48
Reading 16: Rewarding people for work
1 Payment by time
Here pay is based on a time rate. This time rate (hourly, weekly, monthly,
or yearly) is, in turn, based on an evaluation of the contribution or value of
the job to the organisation. This payment system therefore requires a way of
evaluating jobs: of measuring their relative importance to the organisation
and placing a financial value on them. The starting point to job evaluation is
a job description: an analysis of the job content and the demands of the job
in terms of skills, training, or responsibility.
Jobs can then be rated in terms of a common set of criteria, for example
technical knowledge, problem-solving, responsibility and working
conditions involved in the job. Each job within the organisation would then
receive a total score that can be used to determine their relative position on
a salary scale. For example, it could determine that the role of plant
manager is of higher value than the role of a team supervisor and should be
associated with higher salary grades.
1.1 An evaluation of payment by time systems

One of the main advantages of payment by time systems is that they have
the appearance of objectivity, and as such provide justification for different
jobs being paid different rates. In addition, they recognise people’s desires
(and needs) for a constant and predictable income. Finally, payment by time
systems avoid the potential conflicts and tensions created by performance-
based systems, particularly in those occupations where performance cannot
be easily measured.
However, the process of job evaluation is highly subjective and therefore
can be contested (Lewis, 2009). Value judgements have to be made at each
step of the process: in the description of the jobs, the choice of the criteria
on which jobs are assessed, and the rating of jobs. For example, those
working towards equal opportunities have long argued that one of the
reasons for the pay gap between men and women is the fact that jobs
typically carried out by women – and that includes a high emphasis on care
work – tend to be undervalued (and hence underpaid) as ‘care’ is not given
the same value as other attributes, such as management skills or physical
work. However, there is no objective reason for valuing ‘management skills’
more than ‘caring skills’. In fact, a report by the New Economic Foundation
(NEF, 2009) on pay differentials between jobs argues that if we consider
jobs’ social and environmental contributions, rather than just their economic
contributions, then pay structures would be fundamentally different. More
specifically, NEF compares the positive as well as negative social and
environmental contributions of three of the most highly paid jobs (city
banker, accountant, advertising executive) and three of the most poorly paid
jobs in the UK (hospital cleaner, childcare worker, waste recycling worker);
it concludes that jobs that are the most highly paid benefit society least,
whilst the lowest paid jobs benefit society most. So for NEF, if we take into
account social contributions as well as economic ones, the salary scale
should be reversed and hospital cleaners should be paid more than city
bankers (NEF, 2009). The main point here is not so much to argue that
49
Readings 12–20
bankers should be paid more or less than hospital cleaners, but rather to
suggest that job evaluation is a subjective process, and depends on what we
decide to value.
Exercise 1
Read the following text.
In the wake of the controversies over City Bankers’ bonuses, the New
Economic Foundation (2009) conducted a study that explored the
relative value of senior executives and public servants’ jobs to society
compared to the value of other jobs. [At the time] prevailing wisdom
[suggested] that pay is a reward that reflects contribution, or the value
of jobs. Those who contribute more ‘value’ get more in return.
In the private sector ‘value’ is closely associated with economic value
or profit. The ‘worth’ of an employee is measured in terms of his or
her contribution to the bottom line, whether directly or indirectly.
However, even focusing on this narrow definition of economic value
could be problematic, as it doesn’t account for any impact on a
company’s long-term viability. In addition, some of the most valuable
staff – in terms of the day-to-day running of a company
(e.g. administrators) – are the most poorly paid. This occurs simply
because their skills are relatively plentiful. So pay often fails to reflect
the real value of employees to a company.
In the UK today there are huge disparities in levels of pay for different
occupations. Over the past decade the ratio between the average rate of
pay for chief executives and the average earnings of employees has
risen from 47:1 to 128:1. Executive pay has risen by 295% in this
period, compared with a rise of 44% for employees. The rise of the
‘super rich’ is very much an Anglo-American phenomenon, with the
USA leading the way: average chief executive annual earnings were
500 times the level of the average worker’s earnings in 2007.
Differentials between top and lowest earnings in a number of European
nations, including France, Germany and Sweden, are typically lower
than in the USA and UK. There is a growing sense that the real value
of different jobs is not being captured in pay scales.
(based on NEF, 2009)
Now consider the following questions:
1 Do you think that growing pay differentials can be justified on the basis of
differences in contribution?
2 The NEF report raises questions about how we should evaluate the
contributions of various jobs. What factors do you think should be taken
into account to produce a fair evaluation of jobs’ contributions?
50
3 The report goes on to advocate the setting of maximum pay differentials

between top and lowest earners. What do you think about this
suggestion?
Comment
One of the problems with the growing pay differentials we have been seeing
over the past two to three decades is that they do not really reflect
corresponding differences in contributions, even if we focus solely on
economic contributions. The handing out of massive bonuses just after the
financial crisis suggests there is a growing disconnection between executive
remuneration and corporate performance, so that high pay differentials
cannot be justified by contributions to organisational performance. The NEF
report also notes that while French and German chief executives are paid
less than their UK counterparts, business productivity is higher in France and
Germany.
NEF suggests we should take other factors besides economic ones into
account when assessing jobs’ contributions, such as the positive and
negative effects jobs have on society and the environment. For example,
NEF suggests we should count the positive contributions that the provision of
services such as childcare, education and healthcare make to society as a
whole; but we should also count the negative contributions to society of, for
example, advertising executives who encourage overconsumption that could
have adverse effects on people’s health as well as on the environment.
Growing income inequalities not only have damaging effects on society at

large, but also on business performance. A survey of human resources
professionals found that respondents believed that overpaying top executives
was detrimental to staff morale and commitment. Some organisations have
recognised this; for example, some Japanese firms impose pay ratios limiting
the gap between the top and bottom pay; in Mondragon, a Spanish network
of cooperatives, the average wage ratios between executives and those on
minimum wage is 5:1. The Royal Navy, the John Lewis department store and
the Ben & Jerry’s ice-cream company have also all at times imposed limits
on wage differentials in the belief that a measure of equality would benefit
organisational performance (NEF, 2009).
2 Payment by results
First, to clarify some terminology, performance-related pay (PRP) is
sometimes used as a generic term to refer to all payment by results systems,
and sometimes to refer to one particular type of payment by result – merit
pay. Payment by results is sometimes referred to as ‘payment for
performance’.
In PRP systems, a proportion of employees’ pay is linked to their
performance rather than just the position they hold. The main idea here is
51
Readings 12–20
that making pay contingent upon performance will have a motivational

effect. The motivational impact of linking pay to performance has long been
recognised by management; in fact, it reflects the principles of scientific
management developed at the beginning of the 20th century. But PRP has
attracted renewed interest (Lewis, 2009). A study by the Chartered Institute
of Personnel and Development (CIPD) found that over two-thirds of the UK
organisations surveyed used some form of PRP (CIPD, 2013).
There are many different types of PRP. For example, we can distinguish
between payment systems that have an individual or a collective focus, and
between those that reward inputs (e.g. skills, experience, competencies) or
outputs (e.g. sales, productivity or quality measures). Table 1 provides an
illustration of different payment by result systems according to these two
dimensions.
Table 1 Different types of payment by results
Individual Collective
Output Piecework Team bonus
Commission Profit-related pay
Individual bonus
Merit pay
Input
Merit pay
Skills-based pay
Piecework is a payment system in which workers are paid a fixed rate for
each unit produced or task performed regardless of the time it takes them.
Whilst it tends to be associated with assembly line work typical of scientific
management, it is still used today, for example, for telemarketers paid on
the number of calls made, as well as in factories that have been relocated in
low-wage economies, for example in the garment industry where workers
may be paid on the basis of the number of shirts they complete.
Commissions are typically used for sales people and involve paying
employees a percentage of what they have sold (usually on top of a fixed
salary). A bonus is a payment made to employees over and above their
basic salary in recognition for good performance; it can be based on
individual performance, team performance, or the performance of the
organisation as a whole. As we saw above, it is a method that has become
widespread in the banking industry and for senior executives, but which has
attracted a lot of controversy.
In skills-based payment systems, a pay increase is dependent on the
employee acquiring a broader or deeper set of skills. The aim is usually to
make employees multi-skilled and more flexible. Profit-related pay means
that employees are rewarded at the end of the financial year with a share of
the profit in the form of a cash bonus, or with shares in the company.
But the most common form of payment by results is PRP, which will now
be discussed in more detail.
52
2.1 Performance-related pay (PRP)

Performance-related pay (PRP) (also known as merit pay) is a system
whereby an individual’s increase in salary is dependent on his or her
appraisal rating. The appraisal can be based on individual outputs
(e.g. sales, measures of customer satisfaction, or quality of service), or
inputs (e.g. competencies, or skills).
Organisations may have several objectives when introducing PRP:
motivating staff, helping recruitment and retention by offering higher
salaries to high performers, as well as encouraging greater communication
between line managers and their staff (with the introduction of PRP, line
managers have to pay greater attention to communicating with, monitoring
and evaluating their staff) (Lewis, 2009).
However, empirical studies suggest that unless salary levels are very low to
begin with, the work is very simple and performance can be easily assessed,
PRP may have little impact on performance and motivation in practice, and
in some cases can have a negative effect (Beer and Cannon, 2004; Lewis,
2009; Marsden et al., 2006). There are several reasons for this:
. PRP obviously draws upon an appraisal system, and is open to the same
problems and criticisms as appraisal. The potential for perceived
distortion and bias in the assessment process can create particularly
severe problems when appraisal is related to pay. One particular issue is
knowing how to measure performance. This is especially difficult in jobs
that do not involve the production of tangible results (as would be the
case in, for example, assembly line jobs where the number of units
produced can be easily measured, or maybe call centre jobs where the
number of calls answered can be counted). Many jobs, be they
managerial jobs or professional jobs such as those of teachers, nurses,
quality managers, or engineers working in a research lab, for example,
are too complex for performance to be reduced to a few measurable
dimensions, and attempting to do so can have detrimental effects.
. PRP could encourage employees to focus on aspects of the job that are
assessed at the expense of other perhaps less tangible aspects. This
relates to one of the criticisms of performance appraisal more generally:
the transformation of means (or measures) into ends. In addition, pay
could inhibit innovation and change, and encourage employees to stick
to what they know. Employees may be reluctant to engage in innovative
practices in case their efforts are not acknowledged and their assessment
is adversely affected. Thus PRP could foster a culture of conformity.
. The difference in pay rises between high and low performers may not be
meaningful. Indeed, financial constraints may limit the extent to which
performance can be rewarded. As a result PRP can lead to very small
differentials in pay rises between high and low performers, and
employees may feel insulted by the low level of extra pay they receive.
. By rewarding some individuals and not others, PRP could endanger
cohesion and cooperation among colleagues. To counter these effects,
some companies have incorporated factors such as ‘contribution to team
working’ in their appraisal criteria.
53
Readings 12–20
. Finally, PRP assumes a rather narrow view of motivation. Individuals

are motivated by a wide range of factors. Implying that the manipulation
of pay alone will be motivating is simplistic and in some cases insulting.
In addition, research has shown that providing extrinsic motivation (such
as financial incentives) may undermine people’s intrinsic motivation
(motivation that is driven by an interest or enjoyment in the task itself).
Example of how extrinsic motivation can undermine intrinsic

motivation
In a famous psychology study (Lepper et al., 1973), children were given felt
pens and encouraged to do some drawings. One group of children was told
they would be given some rewards for their drawing, whilst the other group
had no prospect of rewards. After a few weeks, it was observed that those
children who received rewards were drawing with less enthusiasm and that
their drawings were of lesser quality than those who had no prospect of
rewards. The psychologists conducting the experiment concluded that when
children’s interests moved towards extrinsic factors (the rewards), it
diminished their intrinsic interest in the task. This could be for several
reasons: giving a reward could send the signal that the task has no interest
in itself; providing external incentives can also lead to a loss of control and
autonomy, people no longer feel in charge of evaluating when they have
done a good job.
Some of the potential problems with PRP discussed above are illustrated
with the case of Hewlett Packard in the following example.
Example of problems with PRP: Hewlett Packard

Hewlett Packard introduced PRP in the mid-90s as a tool to drive
performance. However, many managers found that implementing and
managing PRP had unintended consequences that meant its costs in the end
outweighed its benefits, for example:
. Employees came to expect the additional payment related to PRP and

were distraught when this was no longer forthcoming.
54
. Employees’ attention shifted from their work to their pay.

. Factors outside the individual or team’s control negatively affected
performance (e.g. mechanical breakdown) which made the system feel
unfair.
. Some employees felt insulted that the company tried to ‘bribe’ them to do
something they would have done anyway.
Whilst PRP was not without some benefits in terms of short-term increase in
motivation, many managers abandoned PRP as they felt other tools would
be more effective in increasing performance: good supervision; clear goals;
training. Managers had over-estimated the potential benefits of PRP and
underestimated its costs, in particular the time required to design and
administer performance standards that would strike the right balance
between paying out enough to make the incentives motivating without paying
out too much. Finding this balance required some adjustments over time, but
employees resented these adjustments as the payouts were fluctuating as a
result, and this undermined the trust and good relations between managers
and staff. This suggests that monetary incentives could undermine an
organisation’s capacity to build trust and commitment.
(based on Beer and Cannon, 2004)
Exercise 2
Considering the example of Hewlett Packard, and maybe your own

experience of PRP, make a list of the potential pitfalls of PRP.
Comment
For PRP to be effective, employees need to be able to see a clear link
between their effort, the evaluation of their performance, and their rewards.
This means there needs to be a way of appraising performance that is based
on clear and transparent criteria or targets that are agreed by employers and
employees. Unfortunately, many jobs cannot be reduced to a set of clear
targets or criteria, and this is where organisations may encounter various
problems with PRP.
PRP may motivate employees to focus exclusively on doing what they need
to gain rewards (i.e. achieving their targets), at the expense of doing less
tangible parts of their job. It also encourages a focus on short-term results.
PRP can also create frustration if factors outside employees’ control
negatively affect their performance (for example, the parts they need are not
delivered on time, or there is a mechanical breakdown). In addition, it can
damage trust between colleagues, and between employees and their
managers. Finally, some employees may feel offended to be offered money
55
Readings 12–20
to do something they would have done anyway out of a sense of interest or

dedication.
Summary
Reward systems can be a powerful tool through which organisations cannot
only compensate staff, but also attract and motivate them. However it is a
double-edged sword that can easily slip out of control and produce
unintended effects. Pay is a sensitive issue for many people; even if it is not
always a prime motivator, it remains an important symbol of status and
esteem, and is essential to our livelihood and standards of living. Initiatives
that threaten to introduce some fluctuation in employees’ salaries may be
met with suspicion. Pay is also an area where issues of perceived fairness
will be of great importance to employees’ motivation and behaviour.
Time-based systems may avoid the problem of pay fluctuation and of the
potential tensions created by performance-related systems; they also appear
rational in the sense that people are supposedly compensated in relation to
the contributions their jobs make to the organisation. However, evaluating
this contribution is a highly subjective and controversial process.
PRP systems also try to establish some close relationship between
contributions and rewards, but here the focus is on individuals’ performance
rather than the value of jobs to the organisation. Whilst performance-based
systems are often introduced to increase staff motivation, organisations may
over-estimate the motivational potential of financial incentives, and
underestimate the tensions and resentment such systems can create.
56
References
Beer, M. and Cannon, M. (2004) ‘Promise and peril in implementing pay
for performance’, Human Resource Management, vol. 43, no. 1, pp. 3–48.
CIPD (2013) A Barometer of HR Trends and Prospects 2013, London:
Chartered Institute of Personnel and Development.
Lepper, M., Greene, D. and Nisbet, R. (1973) ‘Undermining children’s
intrinsic interest with extrinsic reward; a test of ‘overjustification’
hypothesis’, Journal of Personality and Social Psychology, vol. 28, no. 1,
pp. 129–37.
Lewis, P. (2009) ‘Reward management’, in Redman, T. and Wilkinson, A.
(eds) Contemporary HRM: Texts and cases, 3rd edn., Harlow: Prentice Hall.
Marsden, D. and Belfield, R. (2006) ‘Pay for Performance where Output is
Hard to Measure: the Case of Performance Pay for School Teachers’ in
Kaufman, B. and Lewin, D. (eds) Advances in Industrial and Labor
Relations.pp. 1-34 JAI Press, London.
NEF (2009) A Bit Rich, London: New Economics Foundation.
57
Readings 12–20
Reading 17: Developing people at

work
Introduction
Training and development (T&D) is about enhancing and widening
employees’ skills, knowledge and competencies, and enabling them to make
better use of their skills and abilities (Grugulis, 2009). It is one aspect of
people management on which there is a consensus at least in principle: it is
important and can bring benefits to:
. employers in terms of higher performance and quality

. national economies in terms of increased competitiveness
. employees in terms of increased employability and development.
However, the consensus often stops at this statement of principle. How
T&D should be implemented, what form it should take, who should bear the
cost, and who actually benefits from training are all questions open to
debate. Despite its recognised importance, the reality of T&D practices
often falls short of the rhetoric.
The first part of this reading looks at the potential benefits of T&D
especially within the context of a supposedly emerging ‘knowledge
economy’. We’ll then review evidence suggesting that this emphasis on the
value of T&D is not always reflected in practice. The third section looks at
best practices in the implementation of T&D. In the concluding section,
we’ll question the extent to which T&D does indeed deliver on the promise
of organisational and individual development and review the conditions
under which it does so.
1 Training and development in context

In recent years T&D has been high on the political and managerial agenda.
This increased interest has been driven by the belief that it can influence
performance and competitiveness, and is becoming increasingly essential in
the ‘knowledge economy’.
1.1 Training, performance and competitiveness

Training is considered as highly important not just to individual employees
and organisations but to entire countries. The centrality of training to
national and organisational competitiveness was perhaps most clearly
established by a series of reports based on international comparisons of
training and performance that came out in the 1980s in the UK. These
studies all seemed to support the view that the skill level of the workforce
had a crucial impact on performance and competitiveness, but that Britain
was lagging behind in terms of training and was therefore badly equipped to
compete internationally (Grugulis, 2009).
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Reading 17: Developing people at work
For example, it was found that British employers were systematically failing
to invest in the T&D of their workforce (e.g. whilst British employers were
spending on average 0.15% of their turnover on training, German, Japanese
and US employers were spending about 3%. In France, organisations have
to spend a statutory minimum of 1.1% of their turnover on training. On the
basis of these findings, a report by Coopers & Lybrand Associates (1985)
concluded that few employers considered training to be an important
element of their corporate strategy.
The emphasis on the importance of T&D to competitiveness has been
repeated ever since these influential studies of the 1980s; and it is widely
believed that continuous learning and skill development are key levers to
enhance productivity and raise living standards (Felstead et al., 2008). In
particular, T&D can have the following benefits:
. helping employees learn the job more quickly and efficiently

. improving work performance of employees and keeping them up to date
in specialist skills
. freeing management time, less of which is spent correcting errors
. reducing wastage as employees can be trained to monitor the quality of
their work
. reducing labour turnover
. reducing recruitment cost through retraining and retaining existing staff
. attracting talented employees
. enabling flexible working where employees may be expected to deal
with different jobs or tasks, or to take on additional responsibilities
. enabling organisations to equip their staff to adapt more easily to
changes in the environment.
The following example provides an illustration of some of these positive
effects.
Example of the benefits of T&D: Braun Oral-B

Braun Oral-B Ireland is part of The Gillette Company and employs over 1000
people. In its manufacturing plants, it produces a wide range of products
including various refill cartridges, personal care products, and most recently
oral care products for worldwide markets. Technical and product innovation,
speed to market and teamwork are key contributors to the success.
59
Readings 12–20
Braun Oral-B used a training programme to encourage people across the

organisation to work in multifunctional teams and to solve problems on the
job rather than pass them up the line. This facilitated the cross-fertilisation of
ideas, improved employees’ understanding of and involvement in the
business at all levels, and promoted a more innovative approach to problem
solving. For example, junior technicians designed a new system to record
and deal with scrap. As a result, scrap levels fell dramatically, and
supervisors were able to adopt a different role, acting more as leaders than
problem solvers.
(based on Skillnets, 2005)
Investment in T&D can also serve an important symbolic function by

signalling to employees that they are worth investing in and their
contribution is important to organisational success. As such, it can have a
positive impact on commitment and intention to stay. In short, T&D has
emerged as an important tool for securing a skilled, committed and flexible
workforce.
However, the relationships between training, commitment and performance
are far more complex than suggested above. Research suggests that training
has the potential to influence commitment, motivation and performance
positively but only to the extent that it is linked to career development, pay,
and the chance to use the skills developed during training whilst on the job
(e.g. Grugulis, 2003; Wong et al., 1997).
The importance of training for organisations’ competitiveness and
employees’ career prospects has become even more evident as we are
moving into what has been termed the ‘knowledge economy’.
1.2 Training and the ‘knowledge economy’

It is often argued that economic and technological changes over the past
few decades have increased the demand for skilled, educated workers
(Adams and Demaiter, 2008). In particular, the expanding use of
information technologies is said to increase the need for problem-solving
and analytical skills. For many observers, we are now in a knowledge
economy, where workers are supposed to be flexible, highly skilled, and
able to engage in self-learning (Castells, 2000).
However, many have questioned the extent to which we are moving towards
a high skill or knowledge economy by pointing out that the main area of
employment growth comes from relatively low-skill, front-line service jobs.
Evidence in the UK suggests that much of the British labour market is still
trapped in a ‘low-skills equilibrium’. As Felstead et al.’s (2008) extensive
survey of work skills in Britain showed, most jobs in the UK do not require
skilled people to carry them out; 77% of UK jobs are now in the service
sector, and whilst some of these jobs are highly skilled (e.g. IT
professionals, teachers), a far greater number are low-paid, low-skilled, part-
time jobs (e.g. retail staff, security staff, cleaners, care staff, call centre
workers) (Labour Force Survey, 2008). These service jobs may require some
skills, especially ‘soft skills’ (such as communication skills, team-working
60
skills, enthusiasm); but these tend not to be recognised or valued, nor do

they form the basis for career progression (Lindsay, 2005). Furthermore,
work that involves computers is not necessarily highly skilled. Call centres
are extremely technologically sophisticated workplaces, but few could be
considered sites of ‘knowledge work’ (Felstead et al., 2008).
In addition, talk of the knowledge economy and the skills it requires has to
be set against competitive pressures for cost reduction, and this means that
management may try to minimise the costs involved in training employees.
Indeed, a report commissioned by the CIPD, Industrial Strategy and the
Future of Skills Policy, found that a low-cost employment strategy was
predominant in the UK, and had dire social and economic consequences
(CIPD, 2014). For the CIPD, this reliance on low-skilled jobs is a major
factor explaining the UK’s relatively poor productivity levels.
2 Training provision: the reality

There is some evidence that organisations in the UK have started to take
training more seriously, and that an increasing proportion of employees are
engaging in some form of training (e.g. Felstead et al., 2008).
Indeed, there are many companies offering good training opportunities for
their staff, the case of Tesco in the following example provides an
illustration.
Example of good training opportunities: Tesco

Tesco is the largest British retailer and is one of the world’s biggest grocery
retailers with outlets across Europe and Asia. In the UK, Tesco now has over
2200 stores ranging from the large Extra hypermarket style stores to small
Tesco Express high street outlets. Tesco’s original product range of grocery
and general merchandise has diversified to include banking, insurance
services, electrical goods as well as telephone equipment and airtime. As the
company has grown, so has its workforce. Tesco now has approximately
280,000 employees in the UK and over 460,000 worldwide. To serve its
widening markets it needs flexible and well-trained staff that can recognise
the needs of the customer.
Tesco recognises that increasing knowledge, improving skills and job

satisfaction of employees are all vital to the continued growth of the
company, and has designed its training and development programmes
accordingly. The aim of the training and development is to make sure that
Tesco has the right people, with the right skills in the right place to expand
and diversify.
The performance of employees is evaluated through annual reviews. This

helps managers and employees decide whether they have the correct
knowledge, skills, understanding and resources to carry out their job
effectively, and to identify gaps in their knowledge and skills. The gaps
identified are logged in a Personal Development Plan (PDP). Employees and
line managers decide how they will fill these gaps by training or development
activities.
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Readings 12–20
Tesco offers employees both on-the-job training and off-the-job training. On-
the-job training methods at Tesco include:
. shadowing where a person already in the job shows the employee how to
do it
. coaching where a manager or designated colleague helps trainees work
through problems
. mentoring where a more experienced member of staff acts as an adviser
. job rotation or secondment where the trainee has the opportunity to take
a different role in the company on a temporary or limited basis.
Off-the-job training is often more appropriate for developing specific skills
such as team-building, communications (for example, making presentations),
or organisation and planning. It usually involves attending external courses
run by professional training organisations or qualified Tesco training staff.
But PDPs are not just about equipping employees to perform their current
jobs effectively, they also aim to develop and extend employees’ skills and
abilities to fill management positions. The great majority (85%) of the
managers appointed in the UK over the past year were internal promotions.
Tesco provides a long-term strategy for development that aims to enhance
employees’ competencies, for example workshops on leadership skills. The
employee’s PDP includes activity plans, a learning log (to record what the
key learning points of the training were and how they are going to be used)
and a ‘Plan, Do, Review’ checklist to monitor when plans are completed.
Tesco’s structured approach to training and developing provides a strong

foundation for its continuing growth. The expansion of Tesco relies on
retaining existing customers and acquiring new ones, and this requires
committed and flexible employees delivering the highest standards of
service.
(based on Business Case Studies LLP, 2014)
Figure 1 Trainees
62
However, despite some notable examples of good practices, there remain

many limitations in training provisions. There are indications that the
increase in training provision remains limited both in its coverage and in its
impact. For example, access to training tends to privilege those who occupy
higher positions in the organisational hierarchy; the further down an
organisation ladder one goes, the less money is spent on training (Grugulis,
2009; Labour Force Survey, 2008).
The nature and quality of training also vary widely; we should remember
that both a three-year graduate trainee programme in accounting in a large
organisation and a three-day induction programme for call centre workers
will count as training yet have very different value for both employees and
employers.
A survey of employees reveals that despite an increase in the number of
employees experiencing training, training provision is still perceived to be
deficient (Grugulis, 2009):
. training courses tend to be of a short duration

. much of the training is ‘personal training’ initiated by employees
themselves and carried out in their own time
. training is perceived to be inadequate to deal with new technology and
new job demands
. training is rarely linked to recognised qualifications
. there is little evidence that training is integrated into an overall strategic
approach and closely linked to rewards or career
. many employees feel that training is the preserve of management.
In summary, although awareness about the strategic importance of training
has increased over the past couple of decades or so, survey evidence
consistently reveals there is a gap between this growing awareness and
actual investment in training. T&D is usually not regarded as a central
element of business planning and strategy and often remains an ad hoc
activity.
Exercise 1
Think about some training experiences you have had in work organisations
and what these were like. In particular, make some short notes on the
following questions:
1 Was the training you received helpful in doing your job?

2 Did you get any recognition for this training (in the form of maybe a
qualification, or pay, or promotion)?
3 Did you get a sense that training was equally available to all levels in the
organisations?
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Readings 12–20
Comment
In addressing this question, you may have asked yourself whether or not the
training available was adequate to deal with new technology or demands on
your job. Moreover, it would also be relevant to think about whether training
provision was integrated with other human resource management (HRM)
policies: Was training related to rewards or promotion? Were you
encouraged to use your training on the job? You may also have considered
to whom training was made available in the organisation: Did it privilege one
group of employees over another?
A final set of issues when considering training concerns the way training
provision is planned: Is there some systematic way of determining the sort of
training necessary in the organisation, of identifying who would require what
sort of training? It is to these issues of planning that we turn to in the
following section.
3 Best practices for training and

development
The literature stresses that for training to be effective, it should be viewed
as an integral part of the organisation’s strategy rather than as an ad hoc
issue or a luxury that organisations can only afford during times of growth
(Grugulis, 2009). This emphasis on the strategic rather than ad hoc, on the
long-term development of people at work as opposed to a short-term focus
on job demands, are central to best practices. This strategic perspective has
led to the identification of the following step-by-step approach to T&D
provision.
3.1 Identifying organisational training needs

For training to be effective, it needs to be closely integrated with the
organisational objectives. Although this integration between T&D and
organisational objectives seems obvious, it is rarely practised. So in effect,
many organisations invest considerable resources in training and
development but never really examine how training and development can
most effectively promote organisational objectives.
An organisational training need analysis starts with the organisational goals
and strategy, and translates these in terms of required human resources: the
attributes, skills, and knowledge needed to achieve the organisational
strategy. This close integration of training with strategy has often led to the
analysis of core competencies: the key skills, knowledge and attributes that
the organisation will require of its staff, at various levels, to achieve its
objectives.
64
3.2 The identification of individual training needs

Whilst the organisational need analysis aims at identifying the skills,
knowledge and attributes required by organisations, the individual analysis
aims at identifying the actual level of employees’ skills, and the gaps that
exist between actual and required levels. An individual need analysis
attempts to answer the question of who needs training in the company. The
individual training need analysis would usually be based on a performance
appraisal or development review.
3.3 Planning and designing training programmes

This involves choosing from a range of on-the-job and off-the-job training
methods.
On-the-job training is probably the most common approach, and can range
from relatively unsophisticated ‘observe and copy’ methods to highly
structured programmes of job rotation, shadowing and mentoring as we saw
with the example of Tesco earlier. For example, with job rotation, members
of a team are encouraged to perform each other’s roles, thus creating greater
flexibility and skills within the team as a whole. Mentoring programmes
allow for the transfer of skills and knowledge from an experienced member
of the organisation to a less experienced employee. Overall, the main
benefits of on-the-job training are that it facilitates the transfer of learning
(learning is relevant) and involves limited cost. The limitations are that its
effectiveness depends on trainers’ (mentors, line managers) skills and
willingness, it can be disruptive, and in practice it is often haphazard (Gibb
and Megginson, 2001).
Off-the-job training can take different forms, from informational methods
(such as lectures, distance learning pack, e-learning) to experiential methods
(e.g. role playing, team sports, paintballing). The main advantage of off-the-
job training is that it may be helpful to get people away from their work
environment to facilitate exposure to new ideas. The main problems with
these methods though are that unlike on-the-job training it may be difficult
to transfer the new skills and knowledge acquired to the job situation and
they tend to be expensive.
Exercise 2
Go back to the example of Tesco and think about the extent to which it
reflects the strategic approach to training you have just read about. In
particular, make some notes on the following questions:
1 How is training and development aligned with organisational and

individual needs?
2 What training methods are used?
3 How is Tesco taking a long-term approach to training and development?
65
Readings 12–20
Comment
This example suggests that Tesco recognises that employees’ skill
development is essential to keeping and acquiring customers. It is a central
pillar of its growth strategy. In addition, the company takes a structured
approach to the identification of individual training needs, starting with an
annual review between employees and their line managers during which
gaps in skills and knowledge are identified, and PDPs are drawn out.
Tesco uses a combination of on-the-job and off-the-job methods. On the job

methods, such as shadowing or mentoring, help employees learn whilst
performing their duties. Off-the-job methods involve taking the employees out
of their work context, which can be useful to develop specific skills such as
team-building or planning.
Through a series of activities from PDPs to activity plans and learning logs,
employees are encouraged to take a long-term approach to their
development, and to extend their competencies, skills and knowledge to be
able to fill leadership positions in the future.
Summary
In this reading we have reviewed studies that highlight the strategic
importance of T&D for organisational competitiveness and performance,
and suggest that it is a vital element to developing a competent, committed
and flexible workforce. We have also reviewed evidence suggesting that
whilst there has been a growing recognition of the importance and benefits
of T&D, employers remain reluctant to invest in it. In practice, training
provision often remains limited in scope, tends to privilege higher levels in
the organisations, and is rarely integrated with other HRM policies such as
rewards or career development, or the organisation’s overall strategy.
Against this ad hoc approach to T&D in practice, the HRM literature
advocates a close integration between training and strategy.
Another important consideration that emerged from the material reviewed
here is that training cannot be considered in isolation but has to be part of a
broader strategy that includes job design, rewards systems and career
development. Thus whilst T&D is essential to harnessing staff potential and
talents, this will only make sense if it forms part of a system designed to
encourage the development and use of high levels of skills among
employees.
66
References
Adams, T. and Demaiter, E. (2008) ‘Skill, education and credentials in the
new economy: The case of information technology workers’, Work,
Employment & Society, vol. 22, no. 2, pp. 351–62.
Business Case Studies LLP (2014) ‘How training and development supports
business growth: A Tesco case study’ [online]. Available at http://
businesscasestudies.co.uk/tesco/how-training-and-development-supports-
business-growth/training.html#ixzz33f7hQbUC (Accessed 31 July 2014).
Castells, M. (2000) The Information Age., Oxford: Blackwell.
CIPD (2014) Industrial strategy and the future of skills policy: the high
road to sustainable growth. London: CIPD.
Coopers & Lybrand (1985) A Challenge to complacency: Changing attitudes
to training. Sheffield: Manpower Service Commission / National Economic
Development Office.
Felstead, A., Gallie, D., Green, F. and Zhou, Y. (2008) Employee
Involvement, the Quality of Training and the Learning Environment: an
Individual Level Analysis, SKOPE Research Paper No. 80, Oxford, Centre
on Skills, Knowledge and Organisational Performance.
Gibb, S. and Megginson, D. (2001) ‘Employee development’, in Redman T.
and Wilkinson A. (eds) Contemporary Human Resource Management,
Harlow: Pearson.
Grugulis, I. (2003) ‘Putting skills to work: learning and employment at the
start of the century’, Human Resource Management Journal, vol. 13, no. 2,
pp. 2–12.
Grugulis, I. (2009) ‘Training and Development’, in Redman T. and
Wilkinson A. (eds) Contemporary Human Resource Management, 3rd
edition. Harlow: Pearson.
Labour Force Survey (2008) Office for National Statistics: Newport.
Lindsay, C. (2005) ‘McJobs’, ‘good jobs’ and skills: job-seekers’ attitudes
to low-skilled service work’, Human Resource Management Journal,
vol. 15, no. 2, pp. 50–65.
Skillnets (2005) Measuring the impact of Training and Development in the
workplace, Dublin: Skillnets.
Wong, C., Marshall, J., Alderman, N. and Thwaites, A. (1997)
‘Management training in small and medium-sized enterprises:
methodological and conceptual issues’, The International Journal of Human
Resource Management, vol. 8, no. 1, pp. 44–65.
67
Readings 12–20
Reading 18: Designing flexible

working patterns
Introduction
If you compare the workplace of just a generation ago to that of today, you
will see many notable differences. You may have experienced some of these
changes yourself: working away from the office thanks to information
technology, working part-time or flexible hours, working on a freelance
basis rather than as a salaried employee, or job-sharing, to mention just a
few examples. This means the way we work has changed dramatically over
the past few decades, offering both new opportunities to better balance work
and the rest of our lives, but also a greater sense of insecurity for some
people.
These new ways of organising work are said to break away from
hierarchical control and the division of labour, and to embrace more flexible
practices that favour workers’ empowerment, multi-skilling, and better
work–life balance (e.g. Lash and Urry, 1987; Sabel, 1997; Toffler, 1980).
This shift towards a more flexible organisation of work is supposed to be
triggered by increasing demands for customised, quality goods (that make
assembly line jobs typical of mass production redundant), and facilitated by
new production and information technology. Many have argued that the
fragmented and repetitive work characteristic of scientific management and
mass production is no longer appropriate, and is giving way to craft
production, involving reskilling and a more flexible organisation and
distribution of tasks (for example among members of self-managing teams).
Within organisations, practices such as designing work around multi-
functional teams, increasing the number of non-permanent staff, introducing
new working time patterns, or contracting out some services can provide for
greater flexibility; this in turn can help reduce labour costs and improve
responsiveness to market changes. Flexibility is not only supposed to benefit
organisations, but also employees who will be given responsibility for
broader sets of tasks, as well as more choice about where and when they
work (for example working from home, or working at times that can be
fitted around other commitments).
This reading provides an overview of the various forms flexibility can take
in organisations. The discussion then moves on to debate two contrasting
perspectives on the effects of flexibility on employees’ experience of work.
The first celebrates flexibility for empowering individuals and freeing them
from the stifling constraints of bureaucratic rules. The other sees flexibility
as creating precarious and insecure jobs, and deepening the control that
organisations exercise over workers.
68
Reading 18: Designing flexible working patterns
1 Conceptualising flexibility
What do we mean when we talk about ‘flexibility’ in organisations and
‘flexible’ work? At its simplest, flexibility means adaptability or
responsiveness to pressure. However, in practice flexibility seems to mean
quite a lot of different things. The term has been used to cover a wide range
of practices such as the use of part-time and temporary employment,
telecommuting, multi-skilling, ‘hot-desking’ (when several workers use a
single physical workstation or desk at different times, hence saving on
office space), the setting up of autonomous work groups, or zero-hour
contracts, to mention only a few examples.
One influential attempt to make sense of the various forms that flexibility
can take in the workplace is Atkinson’s seminal work on the ‘flexible firm’
(Atkinson, 1984). For Atkinson, the flexible firm has replaced homogeneous
employment patterns, standardised contracts and uniform payment systems
with more varied and flexible working arrangements that allow for a closer
match between the type and amount of labour available and the nature and
volume of work demands. The flexible firm model identifies three types of
flexibility that can be used for different groups of workers. These are
reviewed below.
1.1 Functional flexibility

Functional flexibility means that employees can be deployed across different
tasks or jobs within the organisation according to needs (Atkinson, 1984).
Often cited examples of functional flexibility are the schemes introduced by
Japanese companies, such as Nissan and Sony, which specify complete
flexibility within teams, and seek to remove job demarcation, for example
between maintenance, skilled and unskilled production work. Autonomous
work group and self-managed teams also tend to rely on this type of
flexibility whereby members can perform several, if not all, tasks within the
team and are expected to rotate between jobs. The design of work around
projects rather than fixed jobs is another way of providing functional
flexibility, as illustrated with the case of WL-Gore in the following
example.
Example of ‘smart-working’: WL-Gore

WL-Gore was founded in 1958 by Bill and Vieve Gore, who set out to
explore the possible uses, benefits and marketability of fluorocarbon
polymers. Nowadays Gore is probably best known for its GORE-TEX®
fabrics. However, it also operates in several other markets including
electronics, the automotive industry, and the manufacturing of high-
performance fabrics. Today, the enterprise employs approximately 8000
associates in more than 45 locations around the world. Gore has embraced
flexible work design, and has a non-hierarchical, flat organisation structure.
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Readings 12–20
Figure 1 Gore-tex garments
There are no traditional organisational charts, no ranks or job titles and no

chains of command nor predetermined channels of communication. What is
important when recruiting new people is that they have the right fit with
Gore’s culture. There are no rigid job specifications at Gore. Instead,
employees make a commitment to contribute individually and collectively to
work areas or projects according to their skills. Individuals are encouraged to
take an interest in a wide variety of job areas or projects. Provided the core
responsibilities within their role are carried out, associates can then stretch
and build on their role to suit their interests and the business needs.
(based on CIPD, 2008)
1.2 Numerical flexibility

Numerical flexibility refers to the ability of the organisation to vary the
amount of labour, either by adjusting the number of workers, or their
working hours (Atkinson, 1984). There are many different types of working
arrangements that can provide for numerical flexibility and allow for a
closer relation between working times and work demand, or reflect
employees’ demands for a better work-life balance:
. Temporary work where the employee is hired for a fixed period of time.
. Job sharing where two employees share a full-time position.
. Part-time working where employees are contracted to work fewer hours
than the standard number of contractual hours.
. Staggered working hours that allow for start and finish times other than
the normal business hours (typically 9 a.m. to 5 p.m.). The organisation
would usually stipulate a period when employees can start (say between
8 a.m. and 10 p.m.), and a period during which they can end (say
between 4 a.m. and 6 p.m.) provided they complete a full working day.
. Annualised hours is a system whereby the employee’s contractual
working hours are expressed as the total number of hours to be worked
70
over the year, allowing for flexible working patterns throughout this
period.
. Compressed hours enable employees to work their total number of
contractual hours over fewer working days, for example to complete a 5-
day week in 4 days, leaving them an additional day for other activities,
such as a hobby, study, or family commitments.
. Term-time working is a system whereby the employee may work under a
permanent contract, but can take unpaid leave of absence during the
school holidays.
. Zero-hour contracts enable employers to call on, and pay, employees
only when demand arises. With such contracts, the employee agrees to
be available for work as and when required, but no particular number of
hours or times of work are specified. The employee is expected to be on
call and receives compensation only for hours worked. This is a
controversial practice that we will come back to shortly.
Increasingly, these patterns of temporal flexibility are also accompanied by
spatial flexibility that enables employees to work from home or different
locations thanks to information and communication technologies. This
enables employees to save on commuting time, as well as to work more
flexible hours. For the organisation, it can reduce the cost of office space as
employees working partially away from the office can share desk and office
space (through, for example, hot desking). This combination of temporal
and spatial flexibility is illustrated in the following example.
Example of flexible working: Centrica

Centrica is an international energy organisation, headquartered in the UK; its
brands include British Gas, British Gas Business, Dyno, Centrica Energy,
Centrica Storage and Direct Energy. Centrica employs approximately 29,000
people in the UK and 4,000 overseas.
Figure 2 Centrica staff
Work:wise is a work design project established to identify and implement

new flexible working practices. The business case for flexible working was
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Readings 12–20
built on the idea of significant commercial property savings and promoting

Centrica’s image as an employer of choice.
The project is designed to reflect a shift to ‘anytime, anyplace, anywhere’

working, in line with the project’s motto that ‘work is something you do, not
somewhere you go’. The project implemented several physical work
environment changes. Hot-desking removed static desks, creating team
‘footprints’ (areas of hot desks allocated to teams), ‘touch down zones’
(kiosks for printing and checking email) and collaborative work zones (areas
for group working or meetings, for example). The provision of laptops and
home printers was extended across employee groups, and new mobile
phones with email capabilities were introduced to the business. The intranet
site was upgraded and relaunched, enabling employees to better collaborate
and share documents through the web. These tools enabled employees to
work effectively wherever they happened to be. Work:wise also includes
greater flexibility with regard to working hours. In agreement with their line
managers, employees can now have some autonomy in deciding where and
when to work.
1.3 Distancing and financial flexibility
Distancing
Distancing (or sub-contracting) refers to the replacement of employment
contracts by commercial contracts; this means that the organisation sub-
contracts other firms or individuals to perform certain tasks or activities
rather than having them done in-house (Atkinson, 1984). This is another
way of achieving numerical flexibility by replacing the number of direct
employees by outside contractors. For example, organisations may decide to
contract out non-core activities such as catering, cleaning or security, and
indeed many organisations in the public and private sectors have done so in
the past two decades through, for example, competitive tendering. But in
several industries, it is not just peripheral activities that have been
contracted out, but also core activities; this is particularly the case where
complex projects are the norm, such as construction, information technology
or media. For example, freelance workers represent 60% of people working
on the production side in the UK media industry. Large corporations such as
the BBC or ITV have tended to cut full-time permanent staff and rely on
freelance workers instead (Storey et al., 2005).
Financial flexibility
Financial flexibility refers to the move away from single payment systems,
towards more varied, variable and individualised payment systems, seeking
a closer relationship between individual contributions and reward. This
involves for example the increasing use of performance-related pay that was
discussed in Reading 16.
72
1.4 Considering the different forms of flexibility
Exercise 1
This exercise asks you to think about the different forms of work flexibility
discussed above, and maybe consider additional examples from your own
experience.
Considering the examples of WL-Gore and Centrica, and the data on the
media industry discussed above, and any other examples you are familiar
with, draw a list of practices that provide for:
. functional flexibility
. numerical flexibility
. distancing.
Comment
Flexible work has now become common practice and there certainly are
many examples in all sorts of organisations. WL-Gore promotes functional
flexibility by encouraging employees to work across different teams on
different projects, rather than in fixed roles. Other examples of functional
flexibility would include bank managers in the French Banque Populaire who
are made to work at the front desk half a day a week to get a better sense of
the bank’s customer base.
Examples of numerical flexibility in Centrica includes hot-desking, teleworking

and flexible working hours. Numerical flexibility is now becoming so
commonplace that few people would expect a five-day-a-week, nine-to-five
job, and many are demanding more flexible working arrangements in order to
enjoy a better balance between life and work. Consequently there are now
websites dedicated to the search for ‘flexible jobs’.
Freelancing has also become more widespread, in large part because of the
new opportunities for remote working created by the internet. As described
above, the creative industry is one that relies heavily on freelancers
(e.g. journalism, music, publishing, film making, web design, translation), but
the financial crisis and unemployment rates have meant that for many,
freelancing has become the only avenue for paid work. For example, in
Spain, with an overall unemployment rate of 25% and approaching 54% for
young women, many young Spanish women are setting up their own
businesses, mostly selling services such as advertising design, translating,
accounting, that organisations would have done in-house before
(Kassam, 2014).
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Readings 12–20
2 Flexibility, employee empowerment and

insecurity
In this section, we consider the impact of flexibility on employees’
experience of work. There are conflicting views about the meaning of
flexible working practices for employees and the debate has been framed
around two opposing perspectives:
Optimistic view − draws upon notions of employees’ empowerment and
multi-skilling, also sometimes referred to as the ‘high road to flexibility’
(Bone, 2006).
Pessimistic view − anticipates a polarisation between a privileged
minority enjoying high status, pay, prospects, training and education, and
a majority of low-paid, casual, insecure labour: the ‘low road to
flexibility’ (Bone, 2006).
2.1 The empowerment version: the ‘high road’ to

flexibility
Many writers in management and business studies (e.g. Handy, 1995;
Kanter, 1990; Peters, 1992) have tended to celebrate flexibility as holding
the promise of greater workers’ empowerment and participation at work. In
this version, flexibility offers individuals new freedom in controlling their
working lives, and balancing home and work. Here it is argued that whilst
job security and predictable careers have been lost, this is not something to
regret since flexibility opens up new possibilities for inter-organisational
and inter-occupational moves, and for combining work, family, study and
leisure. Thus individuals are less constrained by rules and structures
imposed by one organisation; they are left free to renegotiate their working
lives on their own terms, and to enjoy a variety of work through re-training
and multi-skilling. In addition, flexible working arrangements are presented
as providing opportunities for employees to tailor their working hours to
achieve a healthier work–life balance. Overall, this upbeat vision of
flexibility is presented as a desirable, progressive trend, increasing workers’
autonomy and providing more stimulating work, enhancing both employees’
lives and company performance through improved worker commitment and
productivity.
There is evidence that in some cases at least, flexibility can be empowering
and enable workers to exercise more control over their work. For example,
a study showed that freelance workers in the media industry acknowledged
the financial risks involved in freelancing, but valued the autonomy and
independence they had in managing their working lives, the possibility to
balance work and other activities, and the variety in their work (Storey
et al., 2005). Similar stories of autonomy, of enjoying work variety, of being
able to choose how and when to work, of balancing work and life, and for
women in particular to be able to develop their career whilst looking after
children are echoed in other reports of flexibility (see for example Kini,
2013; Rattigan, 2012).
74
2.2 Flexibility and casualisation: the ‘low road’ to

flexibility
Flexibility can also involve work arrangements that are very different to
those described in the previous section. What has been termed ‘low road’
flexibility refers to a movement towards increased cost-cutting, casualisation
and work intensification (Cooper, 2008; Lambert, 2008; Procter and
Ackroyd, 2009). The main targets of criticism here are numerical flexibility
and distancing, both leaving workers with fewer rights and lower levels of
security. Whilst various forms of numerical flexibility were once reserved to
cover for special periods (seasonal work for example), they are increasingly
used as a managerial strategy to keep costs down and pass on business risk
to employees (Lambert, 2008).
For example, in a study of work scheduling practices for workers on hourly
jobs in four industries in the USA (hospitality, retail, transportation, and
financial services), Lambert (2008) found that line managers regularly
changed the number of hours employees worked from one week to the next,
and did so at short notice. Such practices not only helped reduce costs for
the organisation, but also moved the risk of fluctuating business from the
organisation onto workers. A common practice in all four industries was
posting schedules with limited advance notice, typically on a Thursday or
Friday for the week beginning the following Monday. This created a great
level of instability for workers, and made it difficult for them to secure
reliable childcare or establish family routines such as homework monitoring
and regular mealtimes (Lambert, 2008).
Lambert’s conclusions echo a more recent debate around the surge of zero-
hour contracts in the UK. The CIPD reported in August 2013 that as many
as 1 million workers in the United Kingdom, 3–4% of the workforce,
worked under a zero-hour contract. Highly publicised and controversial
cases include McDonald’s and SportsDirect (a sports clothing and
equipment retailer) both employing about 90% of their workforce on zero-
hour contracts, but also some public sector services (Goodley and Inman,
2013; Orr, 2013). Whilst employers’ representatives are defending zero-hour
contracts as a way of increasing firms’ competitiveness and creating jobs,
critics argue they constitute a form of workers’ exploitation. Zero-hour
contracts leave employees with no guarantee of work or income from one
week to the next.
These different scenarios about the effects of flexibility on workers’
empowerment or casualisation suggest it is difficult to talk about flexibility
as a whole. As many writers have stressed, it can take many different forms
and mean different things. One factor that is particularly important in
understanding the different effects of flexibility is the skill level of workers.
Cooper (2008) found that those with high educational credentials were well-
equipped for a flexible career, and could benefit from the increased
autonomy and choice over working arrangements that flexibility can
provide. However, those with little educational credentials were usually left
with only the increased risk and insecurity of flexibility.
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Readings 12–20
Exercise 2
This exercise is meant to get you to think about the potential benefits and
problems of flexibility in your own working life. If you haven’t experienced
flexible working practices yourself you probably know someone who has.
Make some notes on the following questions:
1 List some flexible working arrangements that you are familiar with (either
having experienced them yourself or because you know someone who
has).
2 Would you say these arrangements are ‘empowering’ or leading to
insecurity and casualisation?
3 If you had a choice, what forms of flexible working arrangements would
suit you (if any)? What would attract you to these forms of flexible
working?
Comment
Whether flexibility is empowering or more exploitative will to a large extent
depend on the degree of choice employees have in determining their working
patterns. At one extreme, zero-hour contracts are often imposed by
employers and leave employees with little choice or control over when and
how much they work (Hardy, 2013). On the other hand, someone employed
in an advertising agency, allowed to work from home at least some of the
time and to choose their working hours in discussion with their managers
would feel far more empowered to control their working lives.
Many people are attracted to ways of working that enable them to combine
work with other parts of their lives, be it family, studies, leisure pursuits or
involvement in community organisations. What forms these ideal working
arrangements take will very much depend on individuals’ circumstances; it
could be part-time or term-time working for parents with young children, or
compressed hours in a four-day week for people who may need three clear
days for studies; or it could be teleworking for people who choose or have to
live in remote locations.
76
Summary
Working through this reading, you will have developed an understanding of
the complexity of flexibility, both the forms it can take, and the effects it
can have. Whilst there is no doubt that the traditional five-day week, with
fixed working hours, is being eroded, there remain many questions as to
what forms flexible working arrangements will take, what sort of choice and
freedom they will give workers, and who will benefit from increased
flexibility.
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Readings 12–20
References
Atkinson, J. (1984) Flexibility, Uncertainty and Manpower Management,
IMS Report No. 89, Institute of Manpower Studies, Brighton.
Bone, J, (2006) ‘The longest day’: ‘flexible’ contracts, performance-related
pay and risk shifting in the UK direct selling sector, Work, Employment &
Society, vol. 20, no. 1. pp. 109–27.
CIPD, (2008) Smart Working: The Impact of Work Organisation and Job
Design, London: Chartered Institute of Personnel and Development.
Cooper, M. (2008) ‘The inequality of security: winners and losers in the
risk society’, Human Relations, vol. 61, no. 9, pp. 1229–52.
Goodley, S. and Inman, P. (2013) ‘Zero-hours contracts cover more than 1m
UK workers’, The Guardian, 5 August 2013, [online]. Available at www.
theguardian.com/uk-news/2013/aug/05/zero-hours-contracts-cover-1m-uk-
workers
Handy, C. (1995) The Empty Raincoat: Making Sense of the Future,
London: Hutchinson.
Hardy, R. (2013) It’s not zero-hours contracts that are the problem, it’s the
bosses who abuse them’, The Guardian, 19 December 2013.
Kanter, R.M. (1990) When Giants Learn to Dance, London: Unwyn Hyman.
Kassam, A. (2014) ‘Spain’s jobless women become the boss to beat the
recession’, The Guardian, 3 February 2014.
Kini, J. (2013) ‘How flexible working can save the economy’, The
Guardian, 19 July 2013.
Lambert, S. (2008) ‘Passing the buck: labour flexibility practices that
transfer risk onto hourly workers’, Human Relations, vol. 61, no. 9,
pp. 1203–27.
Lash, S. and Urry, J. (1987). The End of Organized Capitalism, Cambridge:
Polity.
Orr, D. (2013) ‘Zero-hours contracts will not create a sustainable economy’,
The Guardian, 9 August 2013 [online]. Available at www.theguardian.com/
commentisfree/2013/aug/09/zero-hours-contracts-lousy-recovery
Peters, T. (1982) Liberation Management, New York: A.A. Knopf.
Procter, S. and Ackroyd, S. (2009) ‘Flexibility’, in Redman T. and
Wilkinson A. (eds) Contemporary Human Resource Management, 3rd edn.,
Harlow: Pearson.
Rattigan, L. (2012) ‘Flexible working for employers and employees’, The
Guardian, 13 November 2012.
Sabel, C. (1997) World of Possibilities: Flexibility and Mass Production in
Western Industrialisation, Cambridge: Cambridge University Press.
78
Storey, J., Salaman, G. and Platman, K. (2005) ‘Living with enterprise in an

enterprise economy: freelance and contract workers in the media’ Human
Relations, vol. 58, no. 8, pp. 1033–54.
Toffler, A. (1980) The Third Wave, London: Collins.
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Reading 19: Working with others

Introduction
Groups are important elements of organisational life. Work is often
organised around groups, be they teams formed for a particular project or
more permanent departments, functions or committees. In addition, in recent
years, teamwork has become increasingly popular in organisations as a way
of challenging more rigid structures and divisions of work between
departments or functions (Procter and Mueller, 2000), or of providing
greater functional flexibility. However, as you may have experienced
yourself, working effectively in groups or teams requires some organisation:
some distribution and coordination of the tasks to be accomplished;
otherwise you may find different team members duplicating their effort, or
working at cross-purposes, or maybe lacking a sense of what they are
supposed to accomplish together. Conversely, you may have been part of
teams, maybe in sports or at work, where everything seemed to flow
harmoniously and everyone knew what they were doing. Understanding how
groups function, how they impact on their members, and what increases or
inhibits their performance is essential for making sense of, and managing,
work in organisations.
In this reading we shall look at what makes a group, what affects groups’
behaviour, and discuss the role of teamwork in contemporary organisations.
The term ‘team’ has become more popular in management studies over the
past decade or so with the rise of ‘team work’; however, in this reading we
shall use ‘team’ and ‘group’ as synonymous.
Figure 1 Team work
80
1 Types of group
Although we all have some ideas of what a group is, it is worth defining the
key features of work groups or teams. Adair (1986) defines a work group in
terms of a number of people who share the following characteristics:
. perceive themselves to be a group

. have a definable membership
. have a shared purpose
. interact with each other
. are dependent on each other
. have the ability to act in a unitary manner.
But beyond these common characteristics, groups can emerge in different
ways. Some groups will be the result of organisational structure that divides
and organises work around sections, units or departments, for example.
These are formal groups and are created by management. They can be
permanent (based on, for example, functional units such as marketing, HR,
sales) or temporary (e.g. a task group or project team set up to accomplish a
particular aim).
Informal groups emerge out of people’s daily interactions, irrespective of
management’s plans. These groups serve social needs rather than the
organisation’s operational goals (although the two are not necessarily
incompatible). Membership in these informal groups is voluntary and
depends on the consent of existing members. These groups may have
leaders; however these will not be formally appointed but emerge out of
members’ consent. These groups may have more influence on members’
behaviour than formal groups, as was suggested by the Tavistock Institute
studies of informal groups among coal miners (Trist and Bamforth, 1951).
It is important to distinguish between these two types of groups as they may
serve different purposes and exert different influences on members’
behaviour.
Exercise 1
It is very likely that you are either working as part of one or several groups or
teams now or have done so in the past. You are probably also a member of
one or several groups outside work. Consider these groups briefly and make
some notes on the following questions:
1 To which groups at work and elsewhere do you belong?

2 Would you classify these groups as formal or informal?
3 What role would you say these groups play in your working life?
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Comment
You may have identified a range of groups to which you belong. For
example, you may be part of a particular functional unit, say the accounting
department, or customer service team; you may be on a cross-functional
committee or taskforce looking into a particular project, say the
implementation of a new information technology system; you may belong to
a trade union. These would all be formal groups. On the informal side,
maybe you play football, or go running with some people at work, regularly
have lunch together, or go out for a drink every Friday.
Formal groups would ensure that your work is coordinated with that of others
around you so a task that would be too large for one individual, say the
accounts for a medium-size company, is divided up between several people
working together. Working in groups can also ensure that various
perspectives are represented on a particular issue leading to a more
comprehensive assessment; for example a taskforce looking into the
implementation of a new information technology system and including people
from different units such as accounts, marketing, sales or human resource
management (HRM) would be able to think about needs and problems from
multiple perspectives. Formal groups can also serve social needs, providing
for a sense of belonging and support between colleagues.
Conversely, informal groups may go beyond fulfilling social needs; you may
have found that the informal groups to which you belong at work also serve a
more functional purpose, for example by acting as a channel of
communication and information about what is going on in the organisation, or
maybe providing you with the moral support or confidence you need to
complete your work.
2 Why do groups form?

Groups can serve different functions. They can be a source of motivation
and satisfaction for members, but also a major determinant of organisational
effectiveness. As was illustrated with the coal mine studied by the Tavistock
Institute (Trist and Bamforth, 1951), it is important for managers to
understand the functions that groups serve (for example in terms of
satisfying social needs as well as operational ones) as failing to do so can
have damaging consequences not only for members but also for the
organisation as a whole. (If you recall, the disbanding of informal groups
among miners led not only to dissatisfaction and unrest among the miners,
but also to a fall in productivity.)
According to Schein (1980), groups form for both functional and
psychological reasons. Among the functional reasons for the existence of
groups, he included:
82
. working on complex or large tasks that cannot easily be completed by

one person
. a means of stimulating creativity and generating new ideas
. a coordinating mechanism that integrates different parts of the
organisation
. drawing on multiple points of view for problem-solving purposes
. as a socialisation device to ensure a common understanding of the
organisation’s missions and values among members.
In addition, Schein argued that groups also played an essential
psychological role by:
. fulfilling social needs (e.g. for friendship, interaction)

. developing or confirming a person’s identity and self-esteem
. reducing feelings of insecurity, anxiety and powerlessness.
Figure 2 Working in a group
3 Understanding group behaviour

The behaviour and performance of a group are influenced by the ways in
which members relate to each other. There are many factors shaping these
relationships, but here we look at two important ones: role structure (how
members are differentiated) and group cohesiveness (the strength of their
relation).
3.1 Role structure

Belbin’s (2004) seminal work provides some useful bases for understanding
group structure. He spent several years observing groups to identify the
factors that determined their success or failure. He concluded it was the
balance between different types of people that led to successful
performance. The most successful groups tended to be those with a mix of
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different people, i.e. people with a range of different behaviours, interests

and personalities. He identified nine roles that are important for a group to
be successful. Each role is associated with particular strengths and
weaknesses that can be counterbalanced if combined with the other roles:
Plants – creative, good at generating ideas and solving complex
problems but may be careless of detail.
Resource investigators – extroverted, and good at developing contacts,
identifying opportunities and resources in the external environment, but
can lose enthusiasm towards the end of the project.
Coordinators – can see the big picture, clarify goals and allocate roles
and responsibilities; they often act as the chairperson for the team. They
are good at delegating tasks to the right person but can be perceived to
be manipulative.
Shapers – task-focused and provide the necessary drive to ensure that the
team is kept moving and does not lose focus. They challenge the team to
improve, make sure that all possibilities are considered, and that the
team does not become complacent. However shapers can become
aggressive and offend other team members.
Monitor evaluators – critically analyse ideas rather than generate them,
they act as neutral and logical observers and judges of the team’s ideas
and decisions. However, they can become very critical, damping team
enthusiasm, and they lack the ability to inspire others.
Team workers – good listeners and diplomats; they are supportive and
understanding of others, and good at smoothing over conflicts. Since the
role can be a low-profile one, the beneficial effect of team workers can
go unnoticed until they are absent, when the team begins to argue, and
small but important things cease to happen. Because of an unwillingness
to take sides, a team worker may not be able to take decisive action
when needed.
Implementers – convert ideas and objectives into practical actions. They
are practical, reliable and efficient, and can be relied on to deliver on
time. However, they may be seen as inflexible since they will often have
difficulty deviating from their well-thought-out plans.
Completer finishers – are perfectionist and make sure everything is ‘just
right’. They may frustrate their team mates by worrying excessively
about minor details and by refusing to delegate tasks that they do not
trust anyone else to perform.
Specialists – provide expert knowledge and skills. They are single-
minded and self-motivated, but may dwell on technicalities.
Belbin’s framework provides a way of identifying different roles required
for successful groups and suggests that a team works best when there is:
. a match between individuals’ roles in the team and their natural

predispositions
. a mix of different people with different personalities in a team.
In addition, Belbin suggests that different team roles are important at
different stages of a group’s life. For example, at the start, plants,
coordinators and shapers are crucial. When the group moves on to
84
implementation, completers and implementers play a more important role. It

could also be that people play more than one role.
3.2 Group cohesiveness

In order for a group to function well, members need to cooperate; this
degree of cooperation is what is referred to as group cohesiveness. Cohesive
groups tend to be associated with greater members’ satisfaction, lower
absenteeism and higher effectiveness (Argyle, 1994). There are several
factors that can affect the cohesiveness of a work group, for example:
The size of the group – the larger the group, the more difficult it
becomes to maintain effective communication and coordination. If the
group becomes too large, it may split into factions or small units, with
potential friction between them.
Compatibility – the more homogeneous the group in terms of shared
backgrounds, interests, and values, the more likely it is to be cohesive.
Whilst, as we saw with the work of Belbin, a mix of people is useful to
promote group effectiveness, this should be balanced against the need to
avoid too much conflict between individuals.
Communications – the more easily members can communicate with each
other (rather than through a central figure or leader), the more likely they
are to develop cohesiveness.
Leadership – cohesiveness will be affected by the extent to which
leaders provide opportunities for members’ participation in decisions.
Personnel policies – personnel policies concerning performance and
rewards management can have an important impact on group
cohesiveness. For example, individual systems of performance-related
pay may damage cooperation and trust between group members.
However, highly cohesive groups may also have some dysfunctions as they
can stifle individuals, and impair decision-making. One particular problem
that can arise in strongly cohesive groups is ‘groupthink’ (Janis, 1972), a
situation where group consensus is so strong that it stops members
questioning decisions. Typical examples of groupthink in the business world
would include companies believing in the superiority of their products or
services and becoming blind to changes in the environment (e.g. new
technologies, changing customers’ demands) and the threat of competition.
4 Teamwork in contemporary organisations

Whilst working in groups has always been essential to organisational life,
this collaborative element of work has acquired even more importance
recently. Teams have become central elements in the reorganisation of work
designed to increase flexibility and encourage cross-functional collaboration.
In particular, organisations moving away from centralised, hierarchical
structures towards more flexible and flatter structures have often used teams
to re-organise work in a way that encourages collaboration across traditional
boundaries (for example across departments or geographical units). So team
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working is often seen as providing for more flexible forms of work

organisation. It can be designed to build connections between functions or
specialisms and to encourage broader employee participation; this in turn
can lead to various benefits such as greater adaptability, performance, and
employee satisfaction, as well as more innovative problem-solving (Hoegl
and Gemuenden, 2001). Indeed team working has become so popular that it
is now one of the most fundamental skills employers seek from new recruits
(for example, the ability to encourage and inspire other team members, as
well as interpersonal skills such as listening to, or negotiating with others)
(Hall, 2013).
Two particular types of teams deserve special attention for their increasing
relevance in organisations: self-managed teams and virtual teams.
4.1 Self-managed teams

Self-managed teams, a contemporary development of autonomous working
groups, are groups of people doing a set of interdependent tasks to make a
complete product or deliver a service. Usually, self-managed teams are set
goals or objectives (these may be financial or production targets, for
example), but have discretion as a group as to how they organise
themselves to achieve these objectives. Team members manage most aspects
of their work including the allocation of tasks between themselves, choosing
a leader (or choosing not to have a leader), or assessing quality. Self-
managed teams may have a shorter or longer life span depending on the
nature of the project they work on. Examples could include a cross-
functional team made up of people from production, marketing, accounts
and HRM put together to design a new performance management system in
the organisation or a team forming around particular product ideas and
disbanding once the new product has been developed.
The rationale for self-managed teams draws on the job characteristics model
(Hackman and Oldham, 1980): self-managed teams provide employees with
the opportunity to develop and exercise more skills, responsibility,
autonomy and variety; as such, they can provide for more meaningful and
motivating work:
. Members may have to learn and use different skills as they rotate
between different jobs or tasks in the team.
. Team members are collectively responsible for achieving their targets or
completing their assignment.
. Team members have some degree of autonomy in terms of how they
organise work.
4.2 Virtual teams

Another relatively recent development is the growth of virtual teams.
Virtual teams take advantage of new communication technologies and meet
exclusively or primarily online to achieve their goals. Virtual teams are
particularly useful in large organisations that are dispersed geographically,
and especially in multinational companies operating across different
86
countries (Ahuja and Galvin, 2003). In these contexts, the ability to

transcend distance means that people from far away locations, and with
diverse backgrounds and perspectives can work together more easily, as
shown in the following example.
Example of virtual working: Capgemini

Capgemini is a global leader in consulting, technology, and outsourcing
services. Its headquarters are in Paris, but it operates in 40 countries,
employing 130,000 people across the globe. Capgemini’s consultants need
the ability to work effectively from any location. Therefore, all employees are
provided with powerful lightweight laptops with wireless connectivity, mobile
phones with email and internet capability, easy access to teleconferencing
facilities and the ability to access the intranet remotely for information and
processes. Business applications are hosted on the intranet to enable
consultants to remotely access time and expense recording, HR applications
(including performance management applications), company
communications, and to tap into the collective expertise and experience of
the business through an online knowledge-sharing system.
Although consultants are often based on-site with clients, Capgemini’s office
accommodation is designed to maximise collaboration. For example, in the
London office, there are no permanent desks; instead there are clusters of
hot desks and collaborative work areas. The coffee area features coffee
tables and entire walls made of markable white boards.
Capgemini provides its people with a great deal of autonomy in their daily
work. Consultants are often responsible for the planning and definition of
projects in line with customer requirements and operate in self-managed
teams; but each individual has a mentor; and pastoral care is provided by
the team leader. All these roles interact within a virtual environment, rarely
being together in the same physical environment. As a result of this context,
telephone, conference calls, email, other electronic communications and
frequent social gatherings are a key feature of the culture at Capgemini.
However, even organisations that do not work over widely dispersed

geographical areas are also increasingly harnessing information technologies
to enhance internal communication and knowledge sharing, as well as to
enable traditional teams to work more effectively (Arnison and
Miller, 2002).
Virtual teams are said to bring various benefits (Arnison and Miller, 2002):
. Employees do not have to be relocated in order to take part in a

particular project.
. Team members do not need to travel to see their counterparts in other
countries or regions, thus reducing the travel and accommodation costs
of doing international business.
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Readings 12–20
. It provides access to a broader pool of expertise and information by

allowing people from distant locations to interact and exchange
knowledge.
However, working in virtual teams can also raise challenges that need to be
addressed if it is to be successful. One of the main differences between
conventional and virtual teams is the system of communication used to
share information and interact with each other – email, intranet or
videoconferencing. Using these information technologies requires the
individual team members to acquire the necessary skills that will enable
them to collaborate effectively in a virtual environment.
In addition, virtual teams do not provide the same opportunity as
conventional or face-to-face teams for developing the relational and social
dimension of group interaction, yet such socialising is an important element
in bringing team members together as it helps members develop shared
norms and understanding. Indeed, in face-to-face groups, members acquire
much of their knowledge about group norms and procedures through
observation rather than verbal communication (Walther and Bunz, 2005). In
this respect, the electronic communication characteristic of the virtual team
takes away some of the richness of face-to-face interaction, and makes the
socialisation of members more difficult.
To help overcome these challenges, members of virtual teams should be
prepared to put more time and effort into building the relational dimensions
of their group; they could, for example (Ahuja and Galvin, 2003):
. Interact and contribute often, even if it is just to support someone else’s

contribution, because greater participation increases cohesiveness among
members of virtual groups.
. Make an effort to put relational content that might otherwise be
conveyed through non-verbal or contextual means into the verbal part of
a message.
. Be explicit about their reactions and thoughts since typical non-verbal
expressions will not be received as easily in virtual groups as they
would be in face-to-face groups.
Exercise 2
Consider the previous example, and make some notes on the following
questions:
1 What are the main benefits of virtual teams and working in Capgemini?
2 How does Capgemini facilitate relations between team members?
Comment
Virtual teams enable consultants based in different locations across the world
and on clients’ sites to work together. It also facilitates the exchange and
sharing of knowledge and contributes to the development of collective
expertise within the organisation.
88
Besides providing the technology for consultants to collaborate virtually

(wireless connection, teleconferencing facilities, intranet), Capgemini also
encourages face-to-face social relations through its office design (hot desks,
collaborative work areas).
Summary
In this reading, we have seen that groups, or teams, are central to
organisational life. We all usually belong to both formal and informal
groups, and both will affect how we behave at work. The performance and
behaviour of groups is affected by several factors such as the definition of
members’ respective roles (or group structure), and the degree of
cohesiveness. Whilst group cohesiveness is important for a group to
function effectively, it can also have damaging effects and impair decision-
making. Finally, for teamwork to be effective and satisfying, it needs to be
part of a coherent approach to managing employees that is designed to
increase motivation and satisfaction and that would include supportive HRM
policies (e.g. team-based performance assessment and pay).
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Readings 12–20
References
Adair, J. (1986) Effective Teambuilding, London: Pan Macmillan.
Ahuja, M. and Galvin, J. (2003) ‘Socialization in virtual groups’ Journal of
Management, vol. 29, no. 2, pp. 161–85.
Argyle, M. (1994) The Psychology of Interpersonal Behaviour, London:
Penguin.
Arnison, L. and Miller, P. (2002) ‘Virtual teams: a virtue for the
conventional team’ Journal of Workplace Learning, vol. 14, no. 4,
pp. 166–73.
Belbin, R. M. (2004) Management Teams: Why They Succeed or Fail, 3rd
edn., London: Heinemann.
CIPD (2008) Smart Working: The Impact of Work Organisation and Job
Design, London: Chartered Institute of Personnel and Development.
Hackman, J. and Oldham, G. (1980). Work Redesign. Reading: MA:
Addison-Wesley.
Hall, K. (2013) ‘Is teamwork the problem or the solution? Other forms of
co-operation may be more effective – and save precious management time’,
Human Resource Management International Digest, vol. 21, no. 6,
pp. 33–6.
Hoegl, M. and Gemuenden, H. (2001) ‘Teamwork quality and the success of
innovative projects: a theoretical concept and empirical evidence’,
Organization Science, vol. 12, no. 4, pp. 435–49.
Janis, I. (1972) Victims of Groupthink, Boston: Houghton Mifflin.
Procter, S. and Mueller, F. (2000) Teamworking, Macmillan: Basingstoke.
Schein, E. (1980) Organizational Psychology, London: Prentice Hall.
Trist, E. and Bamforth, K. (1951) ‘Some social and psychological
consequences of the longwall method of coal-getting’, Human Relations,
vol. 4, no. 1, pp. 3–38.
Walther, J. and Bunz, U. (2005) ‘The rules of virtual groups: trust, liking,
and performance in computer-mediated communication’ Journal of
Communication, vol. 55, no. 4, pp. 830–46.
90
Reading 20: Equality at work

Introduction
If people are an organisation’s main asset, as is often argued, then enrolling
people’s full capacity and potential, whatever their background, would seem
to be essential to organisational performance (Kamenou and Fearfull, 2006).
Therefore it would make sense for organisations to seek to eliminate
discrimination along lines of gender, race, disability, sexual orientation or
age since such discrimination makes for wasteful and inefficient use of
employees’ talents.
This sort of argument is central to making a ‘business case’ for equality, or
‘diversity’ as it has been referred to recently. The point here is that the
promotion of equality or diversity is in organisations’ interests, not only
because it makes for better use of employees’ potential, but also because a
diverse workforce can appeal to a wider customer base, can create a wider
pool of potential candidates for recruitment, can foster innovation and
creativity, and can improve an organisation’s reputation.
Beside this ‘business case’, there are also legal and ethical reasons for the
promotion of equality. In many countries, there is a legal requirement
imposed on organisations to promote equality in the management of their
employees. For example, European Union directives make it unlawful for
employers to discriminate on the basis of gender, race, religion, sexual
orientation, age or disability. The ethical argument rests on the notion of
social justice and the idea that all individuals have a right to be treated
fairly and equally; from this perspective, organisations have a moral
obligation to treat employees with fairness and dignity.
Figure 1 Demanding equality at work
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Readings 12–20
Exercise 1
Make brief notes in answer to the following questions:
1 Have you ever felt that you haven’t been treated equally at work or when
applying for a job, or do you know someone who you think has been
discriminated against?
2 What were the grounds on which you think you or the other person were
discriminated against?
3 Do you think this discrimination was in the interest of the organisation?
Give reasons for your opinion.
Comment
There are many grounds on which people could be discriminated against:
their gender, age, race, religion, sexual orientation or disability. Although in
the European Union, and many other countries, such discrimination is
unlawful, it has not totally disappeared as the next section shows. Whether
discrimination or the promotion of equality are in the interests of businesses
is a controversial issue. Some would argue that the best way to make
discrimination disappear from the workplace is to convince managers and
organisations that equality is good for business. However, critics of the
business case have questioned whether it is always in organisations’
interests to promote equality. From this perspective, simply relying on the
business case is not sufficient as it may sometimes pull away from equality;
so overcoming discrimination also requires moral and legal commitments.
We shall return to this debate towards the end of this reading.
Whilst there may be several reasons for organisations to promote equality in

the workplace, there is still evidence of discrimination in employment. In
the first section of this reading, we shall review the evidence concerning
trends of change in discriminatory practices in the UK. The following
section will look at what can be and has been done to promote equality in
employment, including legislation and organisational policies. In conclusion,
we shall return to debates concerning organisations’ motives for promoting
equality and ask whether the ‘business case’ provides solid ground for
equality in work organisations.
1 Equality at work: the evidence

Studies of equality in employment in Western economies consistently show
that legislation, as well as demographic, economic and cultural changes over
the past few decades, have done much to improve equality in the workplace,
but that there is still room for progress. Here we shall review evidence
related to gender and race equality.
92
For several decades, European countries have experienced an increase in

female labour force participation and employment. On average, the labour
force participation rate of women across the EU (i.e. the proportion of
women of working age either working or looking for employment) has
increased from around 55% in the early 1990s to more than 66% in 2012.
In the same period, women’s employment rate (i.e. the proportion of people
in the labour force actually working) has moved in the same direction,
increasing from 49% to 62%. However, in all EU member states, female
employment rates (62%) remain lower than those for males (76%). In the
UK, the employment rate of women was 68% and 80% for men (European
Commission, 2012).
Despite the increasing ‘feminisation’ of work, there is still ample evidence
of gender inequality. Globally, large parts of the paid work that women
engage in tend to be concentrated in occupations related to traditional roles
of women in the home (e.g. education, healthcare, elderly care, cleaning,
food processing, retail trade, clerical work) whilst men predominate in
technical fields, crafts and trades, transportation, plant and machine
operations, and managerial occupations (International Labor
Organization, 2012). These patterns of gendered concentration around
certain occupations are referred to as occupational segregation. Occupational
segregation has tended to be associated with the concentration of women in
jobs that are more insecure, have fewer career opportunities and lower pay.
In addition, whilst the wage gap has decreased, women still earn less than
men for equal work. A study conducted in the European Union suggests
that on average, women earn 16.2% less than men (after adjustment for job
characteristics and hours worked), with wide variation between countries,
ranging from less than 10% in Slovenia, Poland, Italy and Luxembourg, to
more than 20% in the United Kingdom, Czech Republic, Greece, Germany
and Austria (European Commission, 2012).
Similar trends can be observed for members of ethnic minorities. For
example, the 2011 UK census data revealed that with the exception of
Indian and Chinese groups, ethnic minorities are disadvantaged in the
labour market in terms of employment rate, earning levels, and occupational
segregation (Office of National Statistics, 2011). For example, Britain’s
ethnic minorities (other than Indian and Chinese groups) have consistently
experienced unemployment rates twice those of their white counterparts.
Average earnings were also lower, with some significant difference between
ethnic groups, Bangladeshi men being the most disadvantaged group with
average weekly net earnings being between 45% and 52% below those of
their white counterparts. Again, with the exception of the Chinese and
Indian groups, ethnic minority groups have lower proportions of
professional or managerial employment than their white peers and tend to
be concentrated in occupations with more limited career development
opportunities (Office of National Statistics, 2011).
Altogether the research evidence reviewed above suggests that traditionally
disadvantaged groups remain more highly concentrated in lower paid jobs,
with less prospect for promotion, training and career development.
93
Readings 12–20
2 Promoting equality
So what have organisations or public policy done to try to redress the
situation and address the problem of discrimination? Below, we review both
legal and organisational approaches to equality.
2.1 Equal opportunity (EO) legislation

In the UK, several pieces of legislation have come out since the 1970s to
promote equal opportunity, that is to enable all individuals to compete
freely and equally for employment opportunities. These various pieces of
legislation were consolidated and brought together in the Equality Act 2010,
which in line with EU Equal Treatment Directives, requires equal treatment
in access to employment regardless of age, disability, race, religion or
belief, sex, and sexual orientation (or what are referred to as ‘protected
characteristics’).
The legislative framework identifies two forms of discrimination, both of
which are deemed unlawful: direct and indirect discrimination. Direct
discrimination involves treating a person less favourably than another on the
ground of one of the so-called ‘protected characteristics’ identified by
legislation. This would involve for example refusing to hire a woman on the
ground of her gender. The following example provides some instances of
direct discrimination.
Examples of direct discrimination

. An employer refuses to consider a 54-year-old employee for promotion
because the employer believes that people over 50 do not have the
capacity to learn.
. A woman who is applying for a job as an adviser selling financial
products in a company that is dominated by men is rejected by the
selection panel because, although she has the same experience and
qualifications as male applicants, ‘she would not fit in with the
competitive, aggressive culture of the organisation’.
. A man answers a job advertisement for a hotel receptionist and is told
over the phone that because he is a man, he need not apply.
. A bar refuses to interview an applicant for a waitressing job because she
is Muslim.
Indirect discrimination involves using a requirement or condition that

applies equally to all groups, but is such that a smaller proportion of people
in some groups will comply, and the condition or requirement cannot be
shown to be justified. Indirect discrimination is more covert and often
involves forms of discrimination that have become institutionalised in the
criteria used for selection, or promotion in organisations. Examples of
indirect discrimination would be specifying minimum height when this is
actually not required to perform the job, or rules about clothing and
uniforms that may disadvantage certain ethnic groups and cannot be
94
justified on, for instance, safety grounds. Indirect discrimination is not

always easy to identify or demonstrate but you will find some additional
instances in the following example.
Examples of indirect discrimination

. The ad for a retail job in a clothing store says that only people who have
a driver’s licence should apply, even though driving is not part of the job.
An applicant who has good retail experience can’t get the job because
they have a disability and can’t get a driver’s licence.
. A woman who has the same qualifications as male applicants but has
taken a career break for childcare is rejected on the ground that she has
less work experience than men of similar age.
. An advertisement for a job as a cleaner requires applicants to speak and
read English fluently. This may disadvantage a person on the basis of
their race. The requirement may not be reasonable if speaking and
reading English fluently are not necessary to perform the job.
. A department store prohibits its employees from wearing hats or other
headgear when serving customers. This rule means that people whose
religious beliefs require them to cover their heads, such as Muslim
women, are prevented from working in the shop.
2.2 Organisational equal opportunity (EO) policies

So what can organisations do to overcome direct and indirect discrimination
and promote equal opportunity? Whilst many UK employers declare
themselves to be ‘EO employers’ or to ‘promote diversity’, there is
tremendous variation in the depth of policy and practices (Kirton and
Green, 2000). In some cases, it stops at a statement of intent; other
organisations may have an EO policy but do little to enforce or monitor its
operation, whilst in other cases more effort and resources may be deployed
in the implementation of policies and measures designed to tackle
discrimination.
Figure 2 Equality at work
95
Readings 12–20
In order to help organisations promote equality, the Equality and Human

Rights Commission in the UK provides guidelines for designing equal
opportunity policy. These guidelines include policies related to selection
practices based on fair criteria and evaluation; training programmes; or the
development of flexible working practices, and will now be discussed in
more detail.
Designing fair recruitment practices

. Encouraging job applications from groups that are under-represented in
the organisation. This, for example, would involve advertising job
vacancies openly rather than using word of mouth to attract applicants.
Relying on word of mouth is often deemed to be discriminatory as it
tends to reach, and attract, only people who are related to existing
employees and hence reproduce existing patterns of discrimination. In
order to attract applicants from diverse backgrounds, organisations
should therefore use more open forms of communication to advertise
vacancies.
. Drawing job and person specifications that rely on the demands of the
job or the organisation rather than images of who performed the job
previously. The way in which the job and the profile of the ideal
candidate are defined can lead to indirect discrimination by privileging
certain characteristics that represent people who are currently doing the
job, rather what is really necessary for the job. For example, Collinson
et al. (1990) illustrated the ways in which the articulation of the profile
of the ideal candidate could work along highly gendered lines. The male
managers in an insurance company considered that women did not make
suitable candidates for sales representatives simply by virtue of the way
they had defined the profile of the ideal candidate:
1 Sales representatives have to travel by themselves at night to visit
prospective clients.
2 The job is lonely and there are bad ‘patches’ where women will
be less resilient to the pressure.
3 There is an esprit de corps based on a shared male gender
identity, which women could disrupt.
4 Women would be too sympathetic to the client and be inclined to
settle for lower premiums.
. Formalising the recruitment and selection process to ensure equal
treatment of all candidates. In practice this means that the selection
process should focus on a set of skills, experiences, qualifications that
are important for the job and in terms of which all candidates are
assessed; all candidates should be asked similar questions, or at least
about similar areas related to the job.
Example of selection promoting equality: Centrica

Centrica, an integrated energy company, has included age as a core element
of its diversity policy. To this end, Centrica has removed age as a factor from
the selection process (including entrance to its apprenticeship scheme) and
has invested heavily in educating staff involved in recruitment in order to
96
attract candidates with the right skills and attitudes from across the labour
market. As such, they don’t look at ‘years of experience’, but rather at core
skills, attitudes and behaviours required in the organisation. Hiring managers
are trained on how to assess their business requirements and express them
in terms of skills and behaviours through job analysis. The HRM department
oversees all recruitment decisions to ensure best practice at every stage of
the recruitment process. In addition, Centrica developed an age-awareness
e-learning package for managers and employees to ensure that they
understood the legislation on age discrimination.
(based on Pollitt, 2009)
Training
. The provision of training and development to members of under-
represented groups to equip them with the skills, qualifications,
experiences, and support that will help them compete equally for work
opportunities and rewards. This could involve, for example, designing
mentoring and networking systems for women and members of ethnic
minorities in the organisation.
. Awareness training aimed at all staff in organisations to make them
understand the importance of equality and the measures they can take to
promote it. This may involve, for example, multicultural workshops
designed to improve understanding and communication between cultural
groups, as well as to confront stereotypes and personal biases. For
example, as we saw above, Centrica trains all its hiring managers to be
aware of, and overcome, potential age discrimination.
Flexible working practices

This may involve different forms of flexible working, and the provision of
career breaks or childcare facilities to help women and men meet domestic
responsibilities and pursue their career.
Example of flexible practices and training to promote equality:

B&Q
B&Q, a home improvement retailer that employs 38,000 people at 331 stores
across the UK, is committed to promote equality and employees’ work–life
balance by helping its staff pursue their careers and at the same time feel
fulfilled in their personal lives. More than 60% of B&Q employees work
flexible or part-time hours.
Flexible working arrangements at B&Q include:
. term-time contracts available not only for parents but also for
grandparents
. job share for employees who do not want, or are unable, to work full-time,
and an online job-share register to help people find a partner with whom
to job share
97
Readings 12–20
. guarantee that if a job-share partner leaves, the company will find an

alternative partner or accommodate existing working hours
. staggered starting and finishing times
. dual-store contracts, which allow employees to work at more than one
store, as long as their hours do not exceed full time, and so benefit from
full-time work when only part-time roles are available
. home and remote working for some employees on an occasional basis
. career breaks that enable an employee to take a break from work, for a
minimum of three months and up to a year
. the opportunity for fathers, in place of mothers, to extended maternity
leave, where both partners work for B&Q
. the option for mothers on maternity leave to work ‘keep in touch’ days
and take time off in lieu later.
In addition, the company has sought to make its fast-track development
programme more attractive to its female employees; this has led to an
increase of over 25% in the number of women joining the programme and
getting promotions. For example, one women who worked as a part-time
service manager three days a week went on the fast-track programme to
become a unit manager.
(based on Pollitt, 2008)
Exercise 2
Make some brief notes on the following question.
How do you think B&Q’s flexible working practices help promote equality?
Comment
The policies mentioned in the B&Q example mainly concern gender equality
and the provision of equal opportunities for mothers and fathers to combine
their careers with their family commitments. The provision of career breaks
and ‘keep in touch’ days for mothers on maternity leave allows women to
keep in tune with their jobs and the business whilst taking time off to look
after their newborns. Also, the flexible working patterns on offer, such as job-
sharing, staggered working hours, or term-time working, enable employees to
have a job and develop their career whilst looking after children.
98
Summary
We started this reading by suggesting there were several reasons for
organisations to promote equality in employment: legal, ethical and business
reasons. And if we take the case of the European Union, there is certainly
evidence that discrimination on the basis of gender, race, age, disability or
sexual orientation has been reduced over the past two or three decades.
Legislation has made direct and indirect discrimination unlawful, and some
organisations have designed comprehensive and far-reaching policies to
promote equality and diversity among all groups.
However, some discrimination remains and some argue that making equality
rely only on the business case is unlikely to tackle all forms of
discrimination because ‘the bottom line’ and equality may sometimes pull in
different directions (e.g. Cassell, 2009; Noon, 2007). For example, Noon
(2007) notes that organisations have for a long time obtained cost benefits
by undervaluing and exploiting women and ethnic minority workers as a
cheap, disposable and flexible workforce.
In addition, the business case and in particular the need to respond to
customers’ demands may play against equality. For example, Noon (2007)
argues that managers may fear that promoting a multi-ethnic workforce
could lead to a loss of customers and work against the interests of the
business.
So here the business case does little for equality. In other words, social
justice cannot be assumed to be served by economic rationality only;
economic rationality may at times, in some contexts promote equality but
not in others. For Noon (2007), the promotion of equality demands deeper
commitments from organisations than economic gains. And indeed,
organisations who have most successfully promoted equality have done so
as part of an ethical obligation rather than purely for economic reasons.
99
Readings 12–20
References
Cassell C. (2009) ‘Managing diversity’, in Redman T. and Wilkinson A.
(eds.) Contemporary Human Resource Management, 3rd edn., Harlow:
Pearson.
Collinson, D., Knights, D. and Collinson, M. (1990) Managing to
Discriminate, London: Routledge.
European Commission (2012) Female Labour Market Participation,
[online]. Available at http://ec.europa.eu/europe2020/pdf/themes/
31_labour_market_participation_of_women.pdf.
International Labor Organization (2012) Global Employment Trends for
Women 2012, [online]. Available at http://ilo.org/global/about-the-ilo/
newsroom/news/WCMS_195445/lang–en/index.htm.
Kamenou, N. and Fearfull, A. (2006) ‘Ethnic minority women: a lost voice
in HRM’, Human Resource Management Journal, vol. 16, no. 2,
pp. 154–72.
Kirton, G. and Greene, A. (2000) The Dynamics of Managing Diversity: A
Critical Approach, Oxford: Butterworth Heinemann.
Noon, M. (2007) ‘The fatal flaws of diversity and the business case for
ethnic minorities’, Work, Employment & Society, vol. 21, no. 4, pp. 773–84.
Office of National Statistics (2011) ‘2011 Census: Aggregate data’, [online].
Available at http://infuse.mimas.ac.uk.
Pollitt, D. (2008) ‘Employee engagement ‘does it’ for B&Q’, Human
Resource Management International Digest, vol. 16, no. 7, pp. 12–5.
Pollitt, D. (2009) ‘Diversity policies fuel business success at Centrica’,
pp. 21–4.
100
Acknowledgements
Acknowledgements
Figures
Reading 12
Figure 1: © iStockphoto.com/Babustudio
Reading 13
Figure 1: © Jake Curtis/Getty Images
Reading 14
Figure 1: © Pictorial Press Ltd/Alamy
Figure 2: © Bloomberg/Getty
Reading 15
Figure 1: © Ryan McVay/Getty Images
Reading 16
Page 53: © www.CartoonStock.com
Reading 17
Figure 1: Monkey Business Images/Shutterstock.com
Reading 18
Figure 1: © Gore-Tex Products. This file is licensed under the Creative
Commons Attribution-Noncommercial-NoDerivatives Licence http://
creativecommons.org/licenses/by-nc-nd/2.0/
Figure 2: © Centrica Plc
Reading 19
Figure 1: © iStockphoto.com/Chris-Mueller
Figure 2: © Monkey Business Images/Shutterstock.com
Reading 20
Figure 1: © Art Widak/Demotix/Corbis
Figure 2: © George Doyle/Getty Images
Illustrations
Reading 12
Figure 2: Maslow, A. (1970) Motivation and Personality, New York,
Harper and Row.
101
Readings 12–20
Text
Reading 13
Pages 17–18: Example of job description – Adapted from: Ochil Leisure
Enterprise (OLE), www.goodmoves.org.uk
Page 19: Example of assessing against competency – Adapted from http://
www.centrica.com
Pages 20–22: Freeman, H., (2001), 'Only the young and stylish need apply-
more and more companies are hiring new staff for their image rather than
their ability', The Guardian. Copyright (c) Guardian News & Media Ltd
2001
Reading 14
Pages 30–31: Adapted from Carter, B., Danford, A., Howcroft, D.,
Richardson, H., Smith, A. and Taylor, P. (2011) ‘All they lack is a chain’:
lean and the new performance management in the British Civil Service’,
New Technology, Work and Employment, vol. 26, no. 2, pp. 83–97,
Blackwell Publishing Ltd
Reading 16
Pages 53–54: Example of problems with PRP – Adapted from Beer, M. and
Cannon, M. (2004) ‘Promise and peril in implementing pay for
performance’, Human Resource Management, vol. 43, no. 1, pp. 3–48,
Wiley Periodicals, Inc
Reading 20
Pages 95–96: Pollitt, D. (2008) ‘Employee engagement ‘does it’ for B&Q’,
pp. 12–5, Emerald Group Publishing Ltd
102
Block 3
Readings 21–27
By Paul Ranford

First published 2015. Second edition 2017. Third edition 2018.
reproduction) may be obtained from the The Copyright Licensing Agency Ltd, Barnard's Inn, 86 Fetter Lane, London,
EC4A 1EN (website www.cla.co.uk).
Act 1988.
3WX
ISBN 978 1 4730 2379 6
3.1
Contents
Reading 21: Getting started with accounting and finance 5
Introduction 5
1 Importance of your studies of accounting and finance 6
2 Nature of accounting and finance 6
3 Structure and regulation of the accounting profession 8
4 Needs of financial stakeholders 9
5 Different types of accounting 11
Summary 12
References 12
Reading 22: Different legal forms of business 13
Introduction 13
1 Limited company 13
2 Ownership and management of limited companies 17
3 Other forms of business organisation 21
4 Financial reporting 25
Summary 28
References 29
Reading 23: Financial statements – the income
statement 31
Introduction 31
1 Pipes & Installations Ltd 32
2 The income statement 35
3 Your first analysis of an income statement 39
Summary 42
Reading 24: Financial statements – the balance sheet 43
Introduction 43
1 What is a balance sheet? 44
2 The relationship between the balance sheet and the income
statement 44
3 The balance sheet in more detail 45
4 Analysis of a balance sheet 50
Summary 55
Reading 25: Financial statements – the cash flow
statement 57
Introduction 57
1 What is the cash flow statement? 57
2 Cash inflows/(outflows) from operating activities 60
3 Cash inflows/(outflows) from investing activities 62
4 Cash inflows/(outflows) from financing activities 63
5 Bringing cash movements together 63
Summary 65
Reading 26: Analysing financial performance 67
Introduction 67
1 Financial performance – techniques and tools 67
2 Financial health of a business 80
Summary 92
Reading 27: Financial planning 93
Introduction 93
1 The importance of goals and business plans 93
2 The financial planning process 96
Summary 98
References 98
Acknowledgements 99
Reading 21: Getting started with accounting and finance
Reading 21: Getting started with

accounting and finance
Introduction
‘Accounting’ means the various processes involved in recording the flow of
economic resources into, out of and around a business (a process usually
called ‘bookkeeping’, more often simply regarded as the recording of
individual financial transactions in a timely and logical manner) and the
production of information for stakeholders (including management) based
on those records. The term ‘finance’, as you may know, often also involves
the processes involved in the generation and consumption of economic
resources – raising cash to fund a business venture, for example. For the
purposes of Block 3, however, a more specific definition will be useful:
The capture and summary of economic value and transactional data,

and interpretation of that data to facilitate business decisions.
Accounting has a very long history. The Rosetta Stone, the granite slab
discovered in Egypt in the late 18th century and now housed in the British
Museum, records in three languages a finance and tax decree issued
in 196BCE. Some of the earliest written records available to historians
comprise records of trade and taxes in the trading nations of the ancient
world (Mendlowitz, 2003). It can be understood why this should be the
case. For as long as organised trade has been in existence, people have
needed to keep a record of financial transactions so they could remember
who owed them money (and to whom they owed it), to report to their
employers or to various authorities, and to calculate whether their trading
was, over time, successful or not.
Figure 1 The Rosetta Stone
5
Readings 21–27
1 Importance of your studies of accounting

and finance
It is not difficult to see why an understanding of finance is generally
important to the owners and managers of a business. It would hardly be
possible to imagine a successful business being run by people who did not
have at least some understanding of its financial affairs and associated
financial reports. But the overall significance of the subject is important to a
much broader spectrum of society than just owners and managers. Many
people – employees or suppliers – depend on business for their livelihoods
and want to be reassured that the organisation to which they are offering
their services or products is stable and likely to continue for the foreseeable
future. Others – customers or clients – need to know that their dealings with
a business are dependable and that the business has the resources to respond
to their needs. Finally, governments and the public at large have an interest
in the activities of the more significant businesses. It is through its financial
reports that any business will inform its various stakeholders about the
economic impact of its activities (and, increasingly, the social impact too –
as you will find out later in this block).
Any survey of ‘why businesses fail’ (you may like to search for this or
similar phrases online) produces a list of reasons that, almost without
exception, include financial mismanagement amongst the top problems.
Most businesses that fail do not do so because they don’t have good
products or because they have too few customers, but because they don’t
manage their money well. ‘Running out of money’, ‘growing too fast’, ‘not
keeping control of expenses’, ‘not having enough capital’, ‘weak financial
skills’ are some examples of critical business problems that could be
avoided by sound financial management.
As you progress through this block, you will be reminded of the importance
of specific elements of financial reports to any specific business, but
remember the overall importance of financial management skills to other
businesses, to households and ultimately to society.
2 Nature of accounting and finance

Accounting is a process that involves a sequence of:
1 the systematic capture and recording of financial transactions and other
data
2 classifying, ordering and summarising the data
3 the production of useful and relevant information from that data and its
presentation to stakeholders.
It is possible that the language of accounting and finance – ‘receivables’,
‘inventory’, ‘equity’, etc. – may seem strange to you at first. But many
aspects of daily life can be expressed in terms that would be common in
accounting, and you will become familiar with the vocabulary as you work
through this block.
6
You will undoubtedly have been involved in some accounting process at

some stage in your life. You may have been asked to ‘account for’ your
time, or you may have prepared a shopping list, or sorted out and prioritised
a pile of bills that needed to be paid, or made notes of payments you have
made. Perhaps you have even kept a financial diary and made a personal
financial budget to help you achieve some savings target. Each of these
activities is an element involved in preparing an accounting statement
covering some period of time. Even a simple action such as checking your
personal bank statement and then preparing a schedule of expenses that
need to be paid when cash resources allow involves the identification of a
particular resource (in this case a bank balance) at a particular point in time.
Actions such as these – scaled up in number, size and significance, recorded
and summarised for easy comprehension, and then communicated to
business managers and other stakeholders – form the basis of all accounting
work.
Businesses use accounting information not only to see how the business is
performing – whether it is successful, the amount of profit it is making, if it
is able to pay its bills – but also to control business activities over time and
to forecast future performance that will arise from decisions made today.
For example, a business manager anticipating increased sales might wish to
understand how much will be added to the wages bill (and when it will be
added) by taking on new staff. Taking on too many staff in an uncontrolled
way might lead to a shortage of cash because higher wages might need to
be paid before the cash impact of the new sales has been achieved. An
understanding, from financial forecasts, of the rate at which wage expenses
will increase over time will allow managers to make decisions to address
the changes in sales expectations in a controlled way.
You will understand from this that any business manager who wishes to be
successful must have access to accurate and timely financial information
and be able to interpret that information in some sensible way. This block
will help you with aspects of interpretation – but providing that information
in the first place is the role of members of the accounting profession.
7
Readings 21–27
3 Structure and regulation of the

accounting profession
As a profession, accountancy is a relative newcomer compared to law and
medicine, which were both established as professions in medieval times. In
Great Britain it was not until the 19th century that increasing demand for
common bookkeeping and financial reporting practices, and for common
criteria in public accounting and taxation practice, led to the formation of
professional accounting institutes, societies and associations. These were
formed at local and national levels to serve the needs of industry and the
institutions of the British Empire. Their role – which they still fulfil today –
was to monitor and regulate the entry of people, appropriately qualified by
examination and experience, into the profession.
The accountants’ societies (as they were called in the early years) initially
represented particular types of accountancy that were considered different
from each other. Accountants specialising in the preparation of financial
reports for day-to-day management of an industrial business (then called
‘cost and works’ accountants) were considered different from accountants
involved in the preparation of financial reports for owners and other
stakeholders. As a result of this and other historical developments the UK
has several different accounting bodies (perhaps more than any other
country), some of which still specialise in different kinds of accounting –
although in modern times the overlap between them in terms of the work
they undertake is very significant. Several attempts made over the years by
the different UK institutes of accountants to merge into a smaller number of
bodies have been abandoned for one reason or another, and they remain
primarily organised by the type of accounting practised or by their location.
There are currently six accounting bodies with professional status in the
UK:
. The Association of Chartered Certified Accountants (ACCA)

. The Institute of Chartered Accountants of Scotland (ICAS)
. The Institute of Chartered Accountants in England and Wales (ICAEW)
. Chartered Accountants Ireland (formerly the Institute of Chartered
Accountants in Ireland (ICAI), considered to be both a British and Irish
professional body (it predates the Partition of Ireland in 1922)
. The Chartered Institute of Management Accountants (CIMA)
. The Chartered Institute of Public Finance and Accountancy (CIPFA) –
CIPFA operates mainly in the public sector, working in national and
local government.
The internal operations of these accounting institutes are self-regulating.
They have the power to subject members to their own disciplinary
procedures if they fail to observe the requirements of their body, for
example, by failing to follow accounting standards or by acting unethically.
Ethical standards of conduct are expected of accountants. The various
accountancy bodies require members to demonstrate high standards of
ethical behaviour which, according to the ICAEW, ‘plays a vital role in
8
ensuring public trust in financial reporting and business practices and

upholding the reputation of the accountancy profession’ (ICAEW, n.d.).
Most developed countries now have at least one (and usually only one)
main accounting body or institute. The UK is a distinctly unusual example
in having six different bodies.
In the UK (and increasingly across the globe), the regulation of financial
reporting has been separated from the regulation of the profession itself,
although there are elements of the auditing profession now regulated by
government bodies, specifically the Financial Reporting Council (‘the
FRC’). You will learn more about the responsibilities and aims of the FRC
in the section on ‘Financial reporting’ in Reading 22.
4 Needs of financial stakeholders

You learned above that accounting as a process involves the ‘production of
useful and relevant information …and its presentation to stakeholders’.
Stakeholders are defined as those who take an interest in financial
statements as the ‘users’ of financial information. Typical users are shown
in Figure 2.
Investors
Special
interest Customers
groups
Management Suppliers
Business
Organisation
Employees Lenders
The public Government
Competitors
Figure 2 Stakeholders in financial information
Some of these users have a direct interest in the business (as management
or employees) or have invested personal resources into it (as owners). Other
interests may be indirect – a desire to know if a business can meet its
financial obligations, or arising from concern about the impact of a
business’s activities on the environment or society at large. The financial
statements of companies listed on a recognised stock exchange (and,
increasingly, smaller companies) is heavily regulated with a view to
9
Readings 21–27
ensuring that a wide variety of users can find information relating to their
specific needs.
The information needs of specific financial stakeholders of a business can
be summarised as shown in Table 1.
Table 1
Financial stakeholder Financial information needed

Owner
Has a vested interest in the . How well the business is doing
business’s future and success; tends
compared with previous years and
to be financially conservative.
with competitors.
. Reassurance (from established
trends and comparisons with
previous years) that the source of
income is safe and secure.
Investor/shareholder
Invests money or has shares in a . Information on the business to
business; their analysis is often
allow comparisons with other
detailed and focused on short-term
businesses, with a view to
returns.
choosing between them.
. Indications that financial returns
will be maximised.
Lender
Gives loans; needs to know that the . Evidence that a business will be
interest is affordable and that the debt
able to pay the interest on any
can be repaid.
debts.
. The worth of a business should
the debt be unpaid and the
business forced to close.
Competitor
Has an interest in the relative financial . Growth in sales, market share, net
performance and business statistics of
profits, and overall business
rivals.
efficiency.
. Information about the cost
structure and operations of
competitors.
Manager/employee
Works for and is paid by the business . Reassurance (from comparisons
on a full-time or regular basis.
with competitors) that the business
will continue to operate
competitively.
. End-of-year figures that reflect
their competence.
10
Table 1 continued.
Financial stakeholder Financial information needed

Customer/supplier
Needs to know whether they are . Comparisons with previous years,
dealing with a financially sound and
assuring continuity of supply and
reputable business.
business without disruption to the
flow of goods or services.
. Ability of the business to pay for
goods and deliver on time.
Taxation official
Reviews financial statements for . Properly prepared and computed
accuracy and reasonableness, then
accounts and financial statements.
c9999hecks the amount of tax
payable. . Validity of accounts when
compared with similar businesses.
5 Different types of accounting

Not all stakeholders require the same financial information at the same time.
Accounting routines in any but the smallest business are usually organised
to meet different needs:
. Management accounting – for business managers who require rapid, up-

to-dateex and regular information on (for example) sales, costs, levels of
cash or debt, or short-term financial plans (‘budgets’)
. Financial accounting – reporting to other stakeholders, whose
information needs are usually satisfied by less timely reports, perhaps
quarterly, six-monthly or even annually.
It is important to note at this stage that the different routines of
‘management’ and ‘financial’ accounting do not mean that different
accounting records must be kept. The different routines involve differences
in reporting of the same underlying accounting data but organised,
summarised and communicated in rather different ways.
As a business manager you will need to understand that the timing, format
and contents of financial accounting reports are generally defined by law
and regulation and are usually made publicly available after being ‘audited’
(i.e. reviewed) by an independent firm of accountants. Management
accounting reports, however, are not publicly available – indeed they often
contain commercially valuable information that a business would not
generally allow to be seen by others. Their format and timing are a matter
for business management.
The published accounts of larger, privately owned businesses (such as
Tesco, BP or Barclays Bank) would be a type of formal report produced by
‘financial accounting’ routines (and indeed they are usually called ‘the
financial accounts’ as a consequence). You will look at an example of one
of those later in the block.
11
Readings 21–27
Summary
In this session you have learned something about the basics of the
profession of accounting, the different aspects of the role of an accountant
and of the importance of the broader discipline of finance within which
accountants operate. The profession seeks to meet the needs of financial
stakeholders, and (over many years) a regulatory apparatus has developed
that seeks to standardise and control the way in which those needs are met
for the benefit of stakeholders.
References
The Institute of Chartered Accountants in England and Wales (n.d.),
‘ICAEW Code of Ethics’ [online]. Available at www.icaew.com/en/
technical/ethics/icaew-code-of-ethics/icaew-code-of-ethics
(Accessed 20 October 2014).
Mendlowitz, E. (2003) ‘A history of accountancy’, The Trusted
Professional: The Monthly Newspaper of the New York State Society of
Certified Public Accountants, vol. 6, no. 11 [online]. Available at www.
nysscpa.org/trustedprof/archive/1103/tp24.htm (Accessed 20 October 2014).
12
Reading 22: Different legal forms of business
Reading 22: Different legal forms

of business
Introduction
You will know that businesses come in different shapes and sizes. Some are
very simple indeed. A business can be established by an individual as a
part-time, enjoyable hobby taking up a couple of hours per week, for
example, perhaps growing and selling potted plants. While this is a business
of sorts, it involves none of the expected formalities of business method and
structure and requires hardly any accounting records other than perhaps a
notebook to jot down costs and sales, and perhaps not even that.
As a business gains scale, however, more money is at stake and more
stakeholders become interested in its activities. Any business that is set up
for the purpose of profit should be declared to the relevant tax authorities.
The owner will (eventually) want to separate the business from his or her
personal finances, and the needs of customers, suppliers and employees will
all require it to be treated on a more formal – more businesslike – basis.
In the UK, different types of business must comply with different statutory
and regulatory requirements in their legal form and in their financial
reporting. Different countries and legal regimes will have their own ways of
running business corporations, and their own laws, rules and regulations.
In Europe with regards to Company Law, and globally with regards to
financial reporting requirements, many of the regulations and standards are,
however, being harmonised.
It is important that you understand something about all the forms of
business you are likely to meet in practice although, for the purposes of
Block 3, you will be focusing primarily on the ‘limited company’ as the
legal form with which you are likely to be most familiar. You will need to
be aware, however, of the other broad categories of business (and their
associated accounting and reporting requirements) that you may meet during
a business career.
1 Limited company
In the UK, a limited company (and similar forms of business entity in other
parts of the world) is recognised in law as incorporated; in other words
with the same ability to enter into legal agreements, to maintain its own
identity and finances distinct from its owners, to be sued and be responsible
(with very few exceptions) for all it does as if the company was itself a
person. (‘Incorporated’ comes from the Latin ‘corporare’ and means
‘formed into a body’.)
The word ‘limited’ is included in a company’s name because it indicates
that the financial responsibility of the owners of the company (the
‘shareholders’) is limited to the amount of their money (‘capital’) already
13
Readings 21–27
paid into the company’s resources and (again, with certain exceptions) that
the shareholders cannot be held financially responsible for any losses that
are incurred, or unlawful acts that are committed, by the company.
This concept of limited liability underpins what has become, by far, the
most common and important legal form of business worldwide. Its first use
can be traced back to Roman Law. In English Law communities with
property in common such as universities, monasteries and trade guilds
enjoyed the benefits of incorporated status from medieval times although the
award of such status was not common, requiring an Act of Parliament or
Royal Charter in each case. The first modern form of limited liability law
was enacted in the state of New York in 1811, with the dominant economic
power of the time (Great Britain) following in 1855. Limited liability lifted
the threat that an individual’s total wealth might be swallowed up in a failed
enterprise. This allowed money that was previously locked up in safe
government bonds to be pooled and risked in many large-scale business
ventures (including railways and the factories of the late industrial
revolution) that were demanding capital resources and rapidly reshaping the
19th century commercial world. Incorporated status also allowed a company
to endure even while its shares might be transferred from owner to owner, a
form of continuity not available to other legal forms of business (The
Economist, 1999).
In the UK, the legislation under which limited companies may be
established, organised and regulated has developed over many generations.
The first UK Act of Parliament that allowed the incorporation of companies
generally was the Joint Stock Companies Act 1844, with the option of
limited liability being added by the Limited Liability Act 1855. Company
law has developed under successive parliaments, and several acts have
consolidated legislation at irregular intervals ever since. The current framing
legislation is the Companies Act 2006 (UK Government, 2006).
In the UK, a limited company is given its legal substance by the depositing
of certain documents and information with the Registrar of Companies, the
government-appointed official based at Companies House. In the UK, there
are three such establishments: in Cardiff (registering companies in England
and Wales), in Edinburgh (companies in Scotland) and in Belfast
(companies in Northern Ireland). The required legal documents include:
. Memorandum of Association – setting out very limited information on

the desire of the first shareholders to form a company and to take at
least one share each (The Companies (Registration) Regulations 2008)
(UK Government, 2008).
. Articles of Association – a much more substantial document, setting out
the rules under which the company must be run (its ‘constitution’)
including, for example, how directors are appointed and removed, what
authority they and the shareholders hold, how often General Meetings
(meetings of all shareholders) should be held and how they will be
conducted, how decisions will be reached, what is to be done with
profits in terms of dividends or re-investment, etc. The government
helpfully provides a ‘model’ set of Articles that will generally be
adequate for most company uses (UK Government, n.d.(a)), although
14
many more substantial companies will have developed their own version
(within certain overall rules established by Parliament) over time.
A limited company that has ceased to trade and which is no longer involved
in economic transactions is regarded as a ‘dormant company’. Once
properly registered and given legal substance by the appropriate authorities,
a limited company endures, whether it is dormant or not, and no matter any
changes in its ownership. A limited company can only cease to exist in
prescribed ways; the process is usually called ‘winding up’ and involves the
assets of the company being collected and distributed amongst the
shareholders. A limited company may also be ‘struck off’ the Register of
Companies by the Registrar if certain conditions are met; this is a common
and convenient way of bringing to an end the reporting and administrative
burden associated with maintaining a dormant company on the Register of
Companies.
Most of the above relates to UK law and practice. Internationally, the legal
form of a limited liability company became commonly adopted in the legal
codes of most states of the USA and throughout Europe in the mid- to late-
19th century. In 1989 the Council of the European Union required all
member states to allow legal structures to enable individuals to trade with
the protection of limited liability (CEC, 1989). Businesses offering the
benefits of incorporation and limited liability for owners exist under various
names in all of the major economies, and specific examples of these will be
discussed below.
1.1 Types of limited company

The most common forms of limited company (and structures including
limited companies) are:
Private limited company (‘Ltd’)

A private limited company is often relatively small, either family-owned or
owned by a small number of business people who will often participate in
the management of the business. Its shares cannot be offered to the public
but can only be issued, or bought and sold, privately under the rules set out
in the company’s Articles of Association.
Our case study – ‘Pipes & Installations Ltd’, to which you will be
introduced later in the module – is a fictitious example of a private UK
limited company. You will find many more operating as traders or providers
of services in your local area. Look for any business name that ends with
‘Ltd’.
There are very similar legal forms of business in other countries. For
example, the German equivalent of the UK private limited company is the
Gesellschaft mit beschränkter Haftung, more commonly known as a GmbH
company. A large and well-known example is the multinational engineering,
tool and industrial components business Robert Bosch GmbH (usually
known as ‘Bosch’).
15
Readings 21–27
Public limited company (‘plc’)

A public limited company possesses all the attributes of its private
equivalent except that its shares may be offered generally to the public and
it can apply to have those shares traded on a recognised stock exchange
(such as the London Stock Exchange). It must include ‘public limited
company’ (usually abbreviated as ‘plc’) in its name.
Figure 1 The London Stock Exchange
This form of incorporation is likely to be preferred by major ‘brand’ names

in business (for example, Marks and Spencer plc, BP plc and many other
major businesses with which you may be familiar) and certainly by any
business that desires to raise finance from institutions (such as pension
funds) and public investors.
Again there are legal forms of business in other countries that are
equivalent to the UK ‘plc’.
. In the USA, the ‘business corporation’ signifies its corporate and limited
liability status by adding ‘Corporation’ or ‘Inc.’ to its name instead of
‘Ltd’. Examples of this are Microsoft Corporation and Apple Inc.
Legislation concerning corporate structure and activity in the USA is
different from state to state. In the late 19th century one of the states to
produce the earliest (and now regarded as the best-developed and most
‘corporate friendly’) set of company laws was the state of Delaware, and
today over 50% of all publicly traded companies in the USA have their
legal base in Delaware, even if their actual physical headquarters are
elsewhere (State of Delaware, n.d.). The corporate laws of the states of
New York and California are also important.
. In Germany (and German-speaking countries), the main equivalent is the
‘Joint-Stock’ Company (Aktiengesellschaft, or AG). Examples are
Daimler AG and Deutsche Telekom AG.
. In Japan the most common form of corporation is the Kabushiki kaisha
(‘KK’) (literally ‘stock company’, although the term ‘business
corporation’ is closer in terms of its meaning). It is the equivalent of the
UK limited company. Japanese law was changed in 2006 to bring the
regulations relating to the formation and operation of KKs closer to
corresponding organisations in the USA. Japanese companies have for
16
many years been features in the major technology and automotive

products worldwide; familiar names are Canon (Canon Kabushiki
Kaisha) and Honda (Honda Giken Kogyo Kabushiki Kaisha).
Other limited companies

There are some types of UK limited companies that gain their incorporated
status in other ways, although these are not common.
A company ‘limited by guarantee’ does not have a share capital but instead
has members who act as guarantors (usually for a very small sum) in the
case of the company being unable to pay its debts and being declared
insolvent. This form of incorporation is typically used by charities and some
larger membership organisations such as trade unions. Well-known
examples are the large charity Oxfam, and the trade union representing the
interests of performers, Equity.
A ‘chartered’ company is created by Royal Charter. These are rare, although
The Open University itself is an example of a chartered company, as are the
respective governing bodies of solicitors and accountants in the UK.
A ‘statutory’ company is created for public purposes by a specific UK Act
of Parliament. The Historic Buildings and Monuments Commission for
England (‘English Heritage’) is an example.
Groups of companies
One limited company may own all or part of another. This can result in
large and complex ‘groups’ of companies formed for administrative or
structural convenience, or simply because of acquisitive practices
(‘takeovers’) over time. Each individual company continues in existence
(unless wound up) as a separate legal entity within the group. There will be
an ‘ultimate holding company’ that under the Companies Act 2006 will be
required to prepare financial accounts (known as ‘consolidated financial
statements’) for the group as whole. It is enough at this stage to understand
that each individual company within such a group will still be required to
comply with the financial accounting and reporting arrangements
appropriate for its own legal form.
2 Ownership and management of limited

companies
2.1 The benefits and obligations of company ownership
A limited company is owned by its shareholders (also called members),
those who have paid money to the company in order to acquire a legal and
financial interest (‘a share’) in it. The shares can then be bought and sold by
the owners without any financial impact on the company other than its legal
obligation to record and maintain a register of the names and other details
of its shareholders at any time.
17
Readings 21–27
You may think that setting up a limited company seems very simple –
indeed the Companies House website provides a link to allow this to be
done online (Companies House, 2014). But beware – the benefits of limited
liability come at a price. There are registration and reporting obligations to
meet (financial accounts must be deposited with the Registrar at least
annually, for example), and the fines for failure to comply can be very
significant for a small business. In any event, providers of business finance
(for example, a bank) would generally ask the managers of a small limited
company to give a personal guarantee (i.e. a legally enforceable promise
that the managers will provide funds in order to ensure bank debts are
satisfied) for any finance provided, effectively removing the intended benefit
of limited liability.
Figure 2 Companies House headquarters
The owners of a limited company might also be employees of it. But any
salary or wage that they receive from their employment is not regarded as
part of the reward arising from their ownership. The financial benefit of
ownership of a limited company normally arises by the payment of a
dividend, a (usually) small amount per share declared on a regular basis by
the board of directors and approved by the shareholders in what is called a
general meeting. These meetings of shareholders are usually held at least
annually – an annual general meeting (AGM). As well as an annual
dividend shareholders can also, of course, sell their shares for a rather larger
cash sum. However, the ability to sell shares of a private limited company
will be restricted by law and by rules set out in the articles of association.
2.2 Management and governance of limited companies

While, in theory, the running of a company is a matter for its owners, in
practice (for all but relatively small or family-controlled companies), this is
delegated to a board of directors. The directors are bound by the articles of
association but otherwise they are responsible to the shareholders for day-
to-day management responsibility.
Under the Companies Act 2006, a director of a company is anybody who
holds the position of a director, whatever their title might be. A director
might be another company, but at least one director must be what the Act
calls a ‘natural person’ (i.e. a human being) aged 16 or over. The board of
18
directors will, however, generally comprise those people in charge of all

company affairs including the:
. Chief executive officer (or managing director) – the person who takes
the lead in management of the company, with powers delegated to him/
her by the remainder of the board
. Executive directors – people with active managerial roles, likely to be
fully employed within the business and often responsible for a
significant department – finance, sales, HRM, etc.
. Non-executive directors – companies of a medium size or larger will
often appoint to the board one or more such directors. They are
independent persons appointed from outside the company, not employed
by them but possessing either special expertise or broad business
experience to advise the board
. Chair of the board – often a non-executive director who chairs the
meetings of the board, and who ensures that board affairs are properly
run. On matters such as governance and other issues regarded as outside
the general operations of the business, the chair will often act as a
spokesperson in media interviews.
The relationship between the various members of the board, the board and
the company, and between the company and its various stakeholders
(including society at large) is complex. Most large companies have very
significant separation between ownership (shareholders) and management
(generally, directors, who act as agents for the owners) and this leads to a
situation in which the directors may potentially be conflicted between their
personal interests and those of the owners.
The set of mechanisms that seek to balance such interests and to ensure
transparency of reporting, accountability and proper stewardship of the
affairs of a company by the directors on behalf of shareholders and other
relevant stakeholders are together known as the rules of corporate
governance.
Corporate governance (after a series of headline-grabbing corporate
scandals) is a matter of significant government and public concern. The
financial crisis of 2008–09 triggered widespread re-appraisal of systems of
corporate governance, and these have been most recently codified in the UK
Corporate Governance Code issued by the Financial Reporting Council in
the UK (FRC, n.d.), and (for companies listed on the London Stock
Exchange) other relevant regulations imposed by the Exchange. Some
elements of the code involve:
. clear separation of the roles of chief executive and chair

. all directors standing for re-election on a regular basis, with a ‘formal,
rigorous and transparent procedure’ for the appointment of new directors
. an appropriate balance between executive and non-executive directors on
the board
. links between executive rewards and company performance
. formal communication procedures between the board and shareholders.
19
Readings 21–27
These are a few examples drawn from the code, and not all of these will be
applicable to all companies (especially smaller companies).
Corporate governance rules and practices differ in the major world
economies. In Germany, for example, large or publicly traded AGs have a
‘two-tiered board’ structure that consists of a supervisory board
(Aufsichtsrat) generally controlled by (and on behalf of) the shareholder
(roughly the equivalent of a UK or USA board of directors) plus a
management board (Vorstand) that is responsible for the day-to-day
operations of the business.
Spotlight on research
Chairs of governing bodies – What makes them effective?
By Chris Cornforth
The governance of third sector organisations, such as voluntary and

community organisations, is somewhat different to that of private sector
companies. Like companies they have a board or governing body with
overall responsibility for the organisation. But unlike companies, senior
executives are not usually formally members of the board, and the
board is elected by the organisation’s members rather than by
shareholders. So all the board members of third sector organisations
are non-executive or independent members, and they have
responsibility for making sure the organisation achieves its mission and
that its resources are used wisely for this purpose, rather than to act in
the interests of shareholders.
Although there has been a good deal of research on the governance of

third sector organisations, there has been relatively little research on
the important role of chairs of governing bodies, and in particular what
distinguishes effective from less-effective chairs. I was part of an
international study that addressed this question. The research involved
surveys of board members, chief executives, staff and chairs in the
USA, UK and Canada.
Interestingly it was the ‘softer’ personal qualities, interpersonal and

team leadership skills that were perceived to distinguish effective from
less-effective chairs. Effective chairs were seen to be good team
leaders and players. They did this by encouraging and acknowledging
the contributions of others, creating a safe environment where issues
can be discussed openly, and being fair and impartial. They were
perceived to have good inter-personal skills, such as influencing others,
mentoring and coaching, and managing conflicts constructively. Finally,
effective chairs were more likely to have the personal qualities of being
organised, confident, fair, open to new ideas, with an altruistic (rather
than self-serving) orientation.
(Source: Harrison et al., 2012; 2014; Cornforth et al. 2010)
20
3 Other forms of business organisation

Most of the products (computer, books, telephones, groceries) or services
(energy utilities, public transport) that you use or receive on a day-to-day
basis will be provided by a limited company of one form or another. In
terms of the volume of goods and services provided, it is overwhelmingly
the dominant form of business organisation. But in terms of numbers of
businesses, the sole trader dominates. The Office of National Statistics
estimates that ‘the majority (63%) of private sector businesses were sole
proprietorships, 28% were companies and 9% were partnerships’
(Department for Business Innovation and Skills, 2013). These (and other)
important legal forms of business will be described below.
3.1 Sole traders and general partnerships

A ‘sole trader’ (or ‘sole proprietor’) is a person undertaking a trade or
vocation, not necessarily working alone (he or she might employ other
people) but charging for the work or services they provide and solely
responsible for their business, which might be of any type. Examples are a
writer, a handyman (or handywoman), a childminder, a bookkeeper, and a
trader in small goods. This is the simplest form of business and it needs no
formalities to set up, although the tax authorities will still require annual
reports of profits earned. A sole trader will generally use personal funds to
operate his or her business, and thus will be personally liable for any debts
incurred. The big difference between this form of business and that run by a
limited company is therefore that the owner’s personal assets (including
property) may be claimed by creditors if the business’s bills are not paid.
One way to look at a ‘general partnership’ is to consider it as ‘several sole
traders working jointly to make a profit’. This perspective recognises the
similarities between partnerships and sole traders – the partnership does not
have an existence separate from the partners and the personal assets of all
the partners are at stake if business liabilities cannot be met. There are more
administrative and regulatory constraints however. Usually a formal
partnership agreement will be drawn up by a solicitor to set out the
proportions in which capital (money or other valuable assets) will be
injected into the business by the partners, and how profits will be split
amongst them. General partnerships are regulated by one of the older pieces
of business legislation still applicable – the Partnership Act 1890 (UK
Government, n.d.(b)) – which (in the absence of a formal partnership
agreement) sets out the default actions that must take place on a change in
partnership, or how profits should be shared. It is important to note that a
general partnership is a relationship of absolute trust – any partner can bind
all the others in legal contracts, and all partners are personally liable for the
debts of the whole partnership.
General partnerships remain available and are today used by rather specific
business ventures, such as investment clubs. They were the required form of
business organisation for professional firms such as accountants and
solicitors until 2000, when limited liability partnerships (LLPs) were
introduced.
21
Readings 21–27
3.2 Limited liability partnerships (LLPs)

As accounting and legal partnerships became more global in outlook and
scale and more complex in structure, and the business world more litigious,
the possibility loomed that an entire (and very large) accounting firm might
lose the whole of its capital base and the personal assets of all of its
partners due to the negligent or criminal activity of a single partner.
Extensive lobbying of government resulted in the Limited Liability
Partnerships Act 2000 (in England, Wales and Scotland) and the Limited
Liability Partnerships Act (Northern Ireland) 2002 (UK Government, 2000)
which introduced changes allowing the formation of Limited Liability
Partnerships (LLPs).
While maintaining the organisational flexibility and taxation arrangements
of a partnership, the Act provided some of the benefits of incorporated
entities – a recognition of separate legal personality and thus the separation
of the assets of the partnership from those of the partners – but also some
of their associated registration costs and reporting requirements. These costs
and complexities are far outweighed by the benefits of limited liability,
however, and an LLP is now the preferred legal form for professional firms
of accountants and solicitors. Some examples are the major firm of
accountants PriceWaterhouseCoopers LLP (http://www.pwc.co.uk/) and the
multinational law firm Clifford Chance LLP (http://www.cliffordchance.
com), both headquartered in London and very substantial businesses in their
own right.
Figure 3 PriceWaterhouseCoopers premises
In the USA the ‘limited liability company’ (with ‘LLC’ added to its name)
also combines some of the attributes of a corporation and partnership
structure, similar to the LLP in the UK. These are often smaller businesses
run by partners.
There are varied rules about different forms of partnership in different
countries. For example, in Germany, there is a form of limited partnership
called the Kommanditgesellschaft (KG) in which all but one of the partners
may have the benefit of limited liability – but the one remaining partner
(with liability that is theoretically unlimited) may itself be a form of limited
company. In this case, the name of the business must make the effectively
limited liability status of the entire partnership clear by adding ‘GmbH &
Co KG’ to its name. This legal form is, in fact, quite common in Germany.
22
3.3 Unincorporated associations

Unincorporated associations generally have no profit motive and exist in
order to provide facilities and services to people with a common interest.
They usually raise money by charging joining and membership fees; their
affairs would normally be run by a set of rules agreed by the membership
and administered by a relatively informal committee appointed by the
members. They are not subject to any regulation on the production of
financial statements. An annual ‘cash account’ (an analysed summary of
cash incomings and outgoings over a period), perhaps checked and signed
by an independent professional accountant, would generally be the
minimum expectation in a small unincorporated association such as a tennis
club or a local shop run by volunteers on a co-operative basis.
An unincorporated association has no legal substance. Any assets are held
jointly by the members, who would also be personally liable for any debts.
Because of this, larger unincorporated associations are rare. They might
include some trade unions or mutual societies, but once these reach any
significant size it is highly likely that they would seek some form of legally
incorporated status involving limited liability for the membership.
Exercise 1
What is the preferred legal form for these different types of business?
Consider the different forms of business venture or associations between

people listed below. What do you think would be the ideal business form for
each? Make some notes and give reasons for your choices.
Form of business venture
. a major high street retailer with thousands of shops

. a church choir of 30–40 people
. a professional partnership of 25 solicitors
. a local golf club (with, say, 200 members)
. a major golf club (such as St Andrews or Wentworth, with many
thousands of members and significant business activities)
. a small pharmaceutical company manufacturing specialist medicines
. a small plumbing business, ‘Bloggs and Daughter’, with a father and
daughter working together to provide plumbing services to the local
community.
Comment
On the understanding that there are no strictly ‘right’ answers, you may have
come up with something similar to the following:
23
Readings 21–27
Form of business venture Preferred legal form (with reasons)

A major high street retailer with Public limited company (plc) (and
thousands of shops possibly a group of companies), with
shares registered on a stock
exchange and available to the public
and with the liability of the
shareholders limited to capital already
paid in.
A church choir of 30–40 people An unincorporated association, not
intending to make a profit but with a
bank account to order and pay for
music, pay expenses and settle bills.
A professional partnership of 25 A limited liability partnership (LLP),
solicitors providing the organisational benefits
of trading as partners but with the
liability of partners limited to an
agreed sum, and with partners not
being financially responsible for the
misconduct or negligence of a
colleague.
A local golf club (with, say, 200 This could certainly be run as an
members) unincorporated association, but in
practice a club of such size (involving
business activities such as equipment
hire and sales, and bar/restaurant
facilities) would probably seek the
protection of limited liability (Ltd) for
its members.
A major golf club (such as St Andrews It seems very likely that the
or Wentworth, with many thousands of proprietors of a golf club of this size
members and significant business and stature would seek the protection
activities) of limited liability (Ltd or plc) status in
some form. It would be unsurprising to
find that a venture of such a scale
would involve a group of companies.
A small pharmaceutical company Pharmaceutical manufacturing is a
manufacturing specialist medicines specialised business that involves risk
to the public in the event of a
medicine having an undesired effect.
The protection of private limited
liability (Ltd) status would undoubtedly
be sought by the owners.
A small plumbing business, ‘Bloggs A ‘general partnership’ would be a
and Daughter’, with a father and common form of business
daughter working together to provide classification for a family business like
plumbing services to the local this, although a private limited liability
community company would not be uncommon
(e.g. ‘Bloggs & Daughter Ltd’).
While considering the preferred legal form for each of these enterprises you
may have realised that, in theory at least, most of the available forms of
classification can be applied to any business. That is not to say that it would
be appropriate or sensible to run a major high street retailer as (for example)
a general partnership. The choice will generally be made on the basis of
financial interests (the balance of risk and return for the members/owners/
shareholders, and perhaps on taxation considerations) and on the
appropriateness of the administrative burden for a venture of a certain scale
or with a particular profile of business risk. Some businesses, such as a
24
large firm of solicitors, will be required by their regulatory bodies to run their
affairs in a certain way, so some business forms will not be options for them.
4 Financial reporting
In this section you are going to focus on the financial statements that are
generally produced (and often published) by limited companies in order to
meet their reporting obligations under the Companies Act. Other forms of
business – sole traders, partners, plcs – will produce broadly similar (if not
necessarily as detailed) financial statements, and the principles that you
learn in this session are generally applicable to all, although levels of detail
and complexity will differ for different forms of business.
There are special sectors of the overall UK economy that have their own
additional financial reporting requirements:
1 The public sector (government organisations, local government, major
state organisations, such as the NHS) are required to comply with the
Government Financial Reporting Manual (UK Government, 2014) that
specifically provides for information to satisfy the principle of
Parliamentary accountability.
2 The ‘third sector’ (charities and not-for-profit organisations) which, if
registered with the Charity Commissioners, are required to comply with
the Commissioners ‘Statement of Recommended Practice’ (SORP) in the
preparation of their financial statements. The principle additional
information requirement in this case relates to the need to record and
report on the receipt and disbursement of specific significant charitable
donations and grants.
While these regulations are important in these economic sectors (and you
may meet them if you work with a government organisation or a charity),
they are strictly additional to the general accounting standards that will be
described below.
The financial statements of a substantial plc will be really quite lengthy and
detailed at first sight, but (as you will see later in Block 3) you should still
be able to identify and find your way around even such relatively complex
financial statements.
4.1 Regulation of financial reporting

In the early 1970s the various UK professional accounting institutes worked
together to establish the first body to develop agreed standards in
accounting, the Accounting Standards Committee (ASC). Increasingly since
the 1970s the standard-setting process has become, firstly, enshrined in
legislation and, secondly, extended internationally (ICAEW, n.d).
25
Readings 21–27
The ASC gradually extended its geographic reach, with the accounting
bodies of many other European and Asian countries becoming members
by 2001.
After several changes since the 1970s, the body that currently oversees the
formulation and distribution of accounting standards is a private sector
organisation called the International Financial Reporting Standards
Foundation, the principal objective of which is to:
develop a single set of high quality, understandable, enforceable and

globally accepted International Financial Reporting Standards...
(IFRS Foundation, n.d.)
Over 140 accounting bodies from 104 countries hold membership of this
standard-setting body. Its standards effectively apply to all major
international companies – those listed by the UK Stock Exchange and other
major international stock exchanges.
As regards business organisations that operate only in the UK and which are
not listed on the Stock Exchange, the aims involve harmonisation of UK
and other countries’ accounting standards towards those ultimately set out in
IFRSs.
This reading is concerned mainly with regulation of the financial reporting
of limited companies. The financial reporting of sole traders and general
partnerships is not currently regulated in the same way as that of limited
companies, although the scope of businesses to which accounting
regulations apply has broadened significantly. The trend continues towards
more inclusive regulation enforcing the application of accounting standards
on more and more businesses over time.
4.2 The need for regulation

Published financial statements of limited companies are something of a
compromise in terms of their information content. Not all stakeholders will
be interested in all of the information provided. Not all stakeholders will
have all of their information needs fully met. So financial statements
(usually published annually) must provide a basic minimum of information
on which all users can rely. In addition (if they are to be useful to all
stakeholders), those financial statements must be prepared so that choices of
the methods, concepts and treatments subjectively available to accountants
are reduced to a choice of standard accounting practices that can be applied
to similar circumstances in all businesses. (It is not necessary at this stage
to understand the technical details of particular accounting practices and
how, if applied subjectively, they may impact on reported results of a
business. It is enough simply to note that different choices of accounting
treatments in similar businesses that have performed similarly might lead to
very different published results.)
26
Exercise 2
Spend approximate 10 minutes on this exercise.
Why is it necessary for accountants to agree on standard accounting

practices when preparing or auditing published financial statements?
Take a few minutes to jot down some reasons why you think that financial
statements of different businesses need to be standardised. What are the
particular issues that standardisation of accounting practice might address?
Comment
The key issue is comparability – the ability to compare the published
financial accounts of different businesses in the same sector. There is also a
need for confidence that they have been prepared using the same
accounting treatments, methods and bases in each, and thus that similar
businesses performing similarly will publish broadly similar results.
As the business and investment world has become more international in

nature, so the issue of comparability has become more important to
international providers of business finance who may wish to compare
business results in different languages and from different nations. Standard
accounting practices have also addressed the need to standardise
accounting nomenclature, i.e. the particular vocabulary attributed to specific
items in financial accounts.
You might also have noted reliability as an issue. If financial statements are
prepared on bases that are familiar to users, then they will know what to
expect and will accordingly be able to make decisions more rapidly.
Possibly you also noted the need for objectivity in the preparation of financial
accounts. Professional accountants are trained to be objective, but a variety
of different accounting treatments may all be regarded as objective choices
whilst still not ensuring comparability. The formulation of standard
approaches to similar accounting issues adds to the objectivity of the task
while assisting in providing comparability of financial reporting between one
organisation and another.
4.3 Current standards

Unless your studies specialise to some extent in business accounting, you
will not need to be armed with the details of which particular standard-
setting bodies have defined standards for which particular classifications of
business. In any event, accounting standards are being refined and their
application in different jurisdictions is extending over time. You should
understand, however, that accounting standards are becoming more
internationalised as the value of harmonised accounting practices is
recognised by the investment and trade communities. International financial
reporting standards are, progressively, being adopted to replace national
standards in the UK, the remainder of the EU, and many other countries.
27
Readings 21–27
Summary
This reading has introduced you to the main forms of business that you are
likely to meet in your working life: private limited companies, public
limited companies, sole traders and partnerships. Depending on their legal
form, businesses require different types of financial information. They also
have different legal obligations to publish certain types of financial
information. When considering the financial information needs for a
particular business it is therefore generally necessary to bear in mind what
kind of business it is and what its legal form is. However, all businesses
need to produce and interpret financial information and the basic principles
of accounting and finance apply to any kind of business.
28
References
Companies House (2014), ‘Starting a new company’ [online]. Available at
www.companieshouse.gov.uk/infoAndGuide/companyRegistration.shtml
Cornforth, C., Harrison, Y. and Murray, V. (2010) What Makes Chairs of
Governing Bodies Effective?, a report prepared for the National Council for
Voluntary Organisations and the Charity Trustee Network, [online].
Available at http://oro.open.ac.uk/cgi/r/vitf8p (Accessed 13 December 2014).
Council of the European Communities (1989), Twelfth Council Company
Law Directive, Official Journal of the European Communities [online].
Available at http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?
uri=CELEX:31989L0667&from=en (Accessed 20 October 2014).
Department for Business Innovation and Skills (2013) ‘Business Population
Estimates for the UK and Regions’ [online]. Available at www.gov.uk/
government/collections/business-population-estimates
The Economist (1999), ‘The key to industrial capitalism: limited liability’
[online]. Available at www.economist.com/node/347323
Financial Reporting Council (n.d.), UK Corporate Governance Code
[online]. Available at www.frc.org.uk/.../The-UK-Corporate-Governance-
Code.aspx (Accessed 20 October 2014).
Harrison, Y., Murray, V. and Cornforth, C. (2012) ‘Perceptions of board
chair leadership effectiveness in nonprofit and voluntary sector
organizations’, Voluntas, vol. 24, no. 3, pp. 688–712.
Harrison, Y., Murray, V. and Cornforth, C. (2014) ‘The role and impact of
chairs and nonprofit boards’ in Cornforth, C. and Brown, W. (eds) Non-
profit Governance: Innovative Perspectives and Approaches, Abingdon,
Oxon: Routledge.
The Institute of Chartered Accountants in England and Wales (n.d.),
‘Knowledge guide to UK Accounting Standards’ [online]. Available at
www.icaew.com/en/library/subject-gateways/accounting-standards/
knowledge-guide-to-uk-accounting-standards (Accessed 20 October 2014).
IFRS Foundation (n.d.), ‘About the IFRS Foundation and the IASB’
[online]. Available at www.ifrs.org/About-us/Pages/IFRS-Foundation-and-
IASB.aspx (Accessed 20 October 2014).
State of Delaware (n.d.) Delaware Corporation and Business Entity Laws
[online]. Available at http://corp.delaware.gov/DElaw.shtml
UK Government (2000), Limited Liability Partnerships Act 2000 [online].
Available at www.legislation.gov.uk/ukpga/2000/12/contents
UK Government (2006), Companies Act 2006 [online]. Available at www.
legislation.gov.uk/ukpga/2006/46/contents (Accessed 20 October 2014).
29
Readings 21–27
UK Government (2008), The Companies (Registration) Regulations 2008

[online]. Available at http://webarchive.nationalarchives.gov.uk/
20110606083845/legislation.gov.uk/uksi/2008/3014/contents/made
UK Government (2013–14), Financial Reporting Manual 2013–14 [online].
Available at www.gov.uk/government/uploads/system/uploads/
attachment_data/file/283208/
government_financial_reporting_manual_201314.pdf
UK Government (n.d.(a)), ‘Set-up a private limited company’ [online].
Available at www.gov.uk/limited-company-formation/articles-of-association
UK Government (n.d.(b)), Partnership Act 1890 [online]. Available at www.
legislation.gov.uk/ukpga/Vict/53-54/39/contents
30
Reading 23: Financial statements – the income statement
Reading 23: Financial statements

– the income statement
Introduction
Most limited companies and larger professional partnerships will produce, at
least annually, three financial statements that summarise and present
financial information in a manner that has become fairly standardised in the
finance and accounting world.
The three financial statements generally produced are the:

1 Income statement – previously known in the UK as the ‘profit and loss
account’, and sometimes known elsewhere in the world as the ‘statement
of financial performance’ or ‘statement of profit and loss’.
2 Balance sheet – sometimes known as the ‘statement of financial
position’.
3 Cash flow statement.
This reading looks at the first of these three statements, the income
statement. Reading 24 looks at the balance sheet and Reading 25 covers the
cash flow statement.
A fourth statement exists: the statement of changes in equity (‘equity’ will
be defined in Reading 24), detailing movements in the worth of the business
that do not arise from its operating activities: movements such as the
declaration of dividends and the raising of new capital by issuing new
shares. This statement therefore deals with issues that are not relevant to
this module, which is concerned with introducing students to business
finance in terms of business operations rather than the raising of finance and
rewarding shareholders; it is nevertheless mentioned here as you will be
meeting a set of financial statements from a much more substantial business
before the end of this block and you will find such a statement there. For
the purposes of the examination of the financial statements of Pipes &
Installations Ltd, the statement of changes in equity will be disregarded.
31
Readings 21–27
1 Pipes & Installations Ltd

This section introduces a fictitious case study: Pipes & Installations Ltd. In
the remainder of these readings you will learn about interpreting financial
information using the equally fictitious financial statements of this company.
Pipes & Installations Ltd: a summary of the business and its

history
Pipes & Installations Ltd is a private limited company, 80% of which is owned
by Paula Newton, who is the managing director of the business.
Paula started the business as a sole trader (‘Paula’s Pipes’) providing

plumbing services in North Yorkshire about 15 years ago. The business grew
steadily and successfully until she was advised by her accountant that it had
reached a size that the costs of incorporation as a limited company would
not be substantial in relation to the benefit of protection of limited liability
over her personal funds. At about that time, Paula was also offered the
opportunity of expanding her business by buying the assets and continuing
work of another successful (and rather larger) competitor, ‘Peter’s Boiler
Installations and Maintenance’, the owner of which (Peter Arkwright) wanted
to retire.
With the help of her accountant and a local solicitor, Paula incorporated a
new limited company named ‘Pipes & Installations Ltd’ about seven years
ago and sold all of the assets and business of Paula’s Pipes to it for 80% of
the shares in the new company. Peter Arkwright also sold his business to the
new company, and received the other 20% of the shares plus a cash sum of
£6m that was financed by a bank loan secured over the assets of the
business and repayable in annual sums of £500,000. Interest of 8% per
annum is paid to the bank for this loan. An overdraft facility of a further £4m
(also bearing interest at a rate of 8% per annum) was negotiated with the
bank, and this was recently (at the bank’s request) also secured on the
general assets of the business.
On the date of incorporation Paula was appointed (and remains) managing

director in overall charge of day-to-day management. Peter was also
appointed a director of the business, although he no longer takes an active
role in its management as he retired immediately to Spain. He has agreed
that the company will not pay dividends until the bank loan is fully repaid, but
one day he hopes to pass on his shares to his grandchildren to give them
some income to help pay university fees.
Since then the business has continued to grow. It provides general plumbing
and heating services across most of the North of England, and Paula runs
the business from the company’s head office in Harrogate. Apart from Paula
and Peter, the board of directors (eight people in total) comprise the Sales
and Marketing Director, the Finance Director, the HRM Director and the
Technical Director (all full-time employees), and two non-executive directors
recommended by the bank. One of the non-executive directors acts as the
chair of the board. The board meets every three months (although Peter
usually attends using his tablet computer and electronic conferencing
software from his home in Spain).
32
The company’s head office is the base for 35 people, a mixture of full-time
and part-time administrative employees dealing with the business’s sales,
finance and HRM departments. About 200 service engineers (again a mix of
full- and part-time) are employed to deal with plumbing and boiler installation
and service requirements throughout the area served by the company.
Boilers and parts are usually purchased from the company’s suppliers in
Germany.
Paula is now a respected (and rather wealthy) member of the business

community in North Yorkshire. She is proud of the company’s profitable
growth, of its reputation as a supplier of reliable, cost-effective services to its
customers and of its commitment to the employment of a happy and diverse
workforce drawn mainly from the local population.
In the past year, Paula (with the agreement of her fellow directors) has
responded to the growth of the business in various ways. First, the company
invested £120,000 in a small property previously owned by a neighbouring
business. The property will be used to store surplus stocks of boilers and
their parts. In addition, she has significantly increased the size of the
company’s fleet of vehicles (an investment of £500,000) in anticipation of the
increase in the number of service engineers.
Paula has ambitions to improve the business’s ‘green’ credentials by

expanding into the business of supply and installation of solar panels and
other forms of sustainable energy supply that, she thinks, will in any event
replace standard boiler systems over time. She understands that this will
involve a fairly significant investment of time and finance, and she is
considering how best to put these plans to the other directors.
Figure 1 Plumbing installation parts and equipment
33
Readings 21–27
Exercise 1
Now make some notes on what Paula needs to be able to convince the
board and other stakeholders of before they will approve channelling
company resources to the new solar panel venture. The questions that Paula
will need to consider at this stage include:
. What will the directors need to know before approving Paula’s plans?
. What are the interests of other stakeholders that are likely to be relevant
to Paula’s plans?
. In particular, what will Peter’s reaction be, and what assurances will he
need before giving his own approval?
Comment
1 You (and the directors – certainly the finance director at least) may
immediately ask if Paula’s plans are affordable, if finance can be made
available, or if there are any constraints over finance that need to be
considered.
2 The board may also want to consider a full business plan examining the
market for the new venture. (You will be looking in more detail at the
likely content of a business plan later in this block.)
3 The directors will also want to know if the value of the continuing trade of
the company will be adversely affected in any way in the short term. It is
possible, of course, that the expansion of the business could lead to even
more opportunities for the current trade.
4 It is already established that the company’s bank has a continuing
financial interest in the business (actually a very significant interest, as
you will see later) and therefore they will need to be consulted if there is
any requirement for additional finance to be raised. The bank will first
want to be assured that current commitments to loan repayments can
continue to be met.
5 Employees in particular may see Paula’s ambitions as something of an
opportunity for more work, although they will also be concerned to ensure
that the work they are doing now is not risked in any way.
6 Other stakeholders, for example the German supplier of boilers and parts,
may be concerned about any long-term plans to reduce reliance on their
products although, providing Pipes & Installations Ltd conforms to any
legal agreements that have been established with the supplier, their
options for complaint may be limited. They have little control over the
strategic direction of Paula’s business.
34
You will soon be returning to Pipes & Installations Ltd to examine the
financial statements they have produced recently, and then applying your
learnings about them to the specific circumstances of the business, assessing
whether Paula’s plans for expansion are likely to be successful at this stage
of the business’s development or whether they should be postponed for
some time.
2 The income statement

The income statement shows how the business has made a profit (or a loss)
over a particular financial period – usually a financial year, but it could just
as readily refer to another period of time like a month (and this would be
common for management accounts).
The statement summarises transactions relating to:
. income – different businesses may use different words – ‘sales’, ‘gross

profit’, ‘revenue’, ‘fees’, ‘earnings’ or similar
. expenses – (often called ‘costs’ or ‘overheads’) – a summarised list of
the costs incurred in order to generate the income.
As may be obvious, a profit is generated if gross profit is higher than
expenses, and a loss if the reverse. You will find that accountants will
identify different levels of profit, the respective importance of which
depending on the specific sector in which they work and the particular
needs of the business. These might include:
. trading or operating profit – the profit or loss arising from the trade or
operations of the business, without any allowance for the cost of
financing the business (usually an interest charge) or the impact of any
taxation
. profit before taxation (or profit after interest) – operating profit minus
any interest charges, but before (as the title suggests) any taxation
charge
. profit after taxation – presumably self-explanatory, the profit remaining
after taxation has been deducted.
Table 1 shows the income statement that might be published by Pipes &
Installations Ltd.
(NB In business finance generally you will find the abbreviations 'k’ (from
‘kilo’) for ‘thousands’ and ‘m’ for ‘millions’; these abbreviations will be
used where appropriate throughout Block 3. Therefore, ‘£k’ below means
‘thousand of pounds’.)
35
Readings 21–27
Table 1 Pipes & Installations Ltd: income statement

Pipes & Installations Ltd
Income Statement (as published)
For the years ended 31 December 2015 and 2014
Year to Year to
31 Dec 2015 31 Dec 2014
£k £k £k £k
Sales revenue 12,547 12,152
Cost of goods sold (9,267) (8,706)
Gross profit 3,280 3,446
Other income
Profit on disposal of non-current assets 15 0
Less expenses
Distribution expenses (357) (400)
Administration expenses (1,336) (1,085)
Total expenses (1,693) (1,485)
Operating profit 1,602 1,961
Less finance costs

Interest paid (579) (594)
Profit before taxation 1,023 1,367
Less taxes
Corporation tax (275) (360)
Profit for the year retained in the 748 1,007

business
This income statement covers a period of two years which, for the sake of
comparison, are placed side-by-side. Traditionally, the most recent period
would be on the left (closest to the descriptive text).
You might observe that this is not a very detailed statement and it would be
difficult to dispute that point, although there is some useful information to
be gained by comparing what happened to income, expenses and profit from
one year to the next. However, this is the minimum income statement that a
private limited company (at least a company of the size of Pipes &
Installations Ltd) must deposit with the Registrar annually. Additional
information on certain detailed costs – amounts paid in wages and salaries,
the pay (‘remuneration’) given to directors and other specific items – must
also be provided, and these will normally be shown in notes to the financial
36
statements (not shown here, but you will look at an example later in
Block 3).
For the purposes of study in Block 3, a more detailed income statement is
provided in Table 2. This is much more like the summarised management
accounts that will be given to Paula and her other directors on a regular
basis, and even more detailed analyses will be available – for example a
similar income statement could be constructed for each region, or for the
different businesses of plumbing and boiler installations, etc.
Table 2 Pipes & Installations Ltd: detailed income statement

Income Statement (detailed)
Year to Year to
31 Dec 2015 31 Dec 2014
£k £k £k £k
Sales revenue 12,547 12,152
Less cost of goods sold
Opening inventory 1,103 993
Wages etc. (service engineers) 2,732 2,597
Purchases from wholesalers 6,889 6,219
10,724 9,809
Less closing inventory 1,457 1,103
Cost of goods sold 9,267 8,706
Gross profit 3,280 3,446
Less expenses:
Salaries etc. (management, office staff) 538 454
Rent and office services 132 114
Insurance 65 43
Distribution and postage costs 189 113
Marketing and advertising expenses 168 287
Office administration 56 54
Energy and other utilities 35 30
Depreciation 488 370
Profit on disposal of non-current assets (15) 0
Audit, accounting and legal costs 22 20
Interest on bank loan 200 240
Interest on bank overdraft 379 354
Total Expenses 2,257 2,079
Profit before taxation 1,023 1,367
Corporation tax 275 360
Profit after taxation 748 1,007
37
Readings 21–27
This is clearly a rather more detailed income statement. It begins and ends
with the same figures as those first provided, but the published statement
sets out a more summarised analysis of expenses. (You may be able to work
out which expenses have been allocated to ‘distribution’ and
‘administration’ expenses respectively, although it is not important to do
so.)
The important general elements of an income statement like this are:
. sales – as previously discussed, the gross amount earned by the

business; usually the total amount that has been invoiced to customers.
. gross profit – for example, an item bought for £15 and sold for £20 has
earned a ‘gross profit’ of £5. In Pipes & Installations Ltd this measure is
slightly more complex, although the principle is the same.
First, the business has bought materials (presumably new boilers and
parts) from manufacturers. A brief calculation adjusts this figure for the
value of the inventory of such items held by the business at the
beginning and end of the period – the technical aspects of this needn’t
concern you, although the calculation is set out above. The resulting
figure represents the cost to the business of the boilers and parts actually
sold to customers.
Second, you will see that Paula (or her finance director) has decided that
‘Wages and associated costs (service engineers)’ should also be included
in ‘Cost of Sales’, and this seems perfectly fair given that the business
involves the installation and/or servicing of plumbing and boiler systems
– that is, the service engineers are themselves a cost involved in earning
sales. (Note that this treatment is not standard; it is simply an internal
management accounting format that has been chosen by Paula or
(presumably) her finance director. The wages of the service engineers
could just as validly be included under ‘expenses’ below the gross profit
line.)
Together, these elements of cost (boilers, parts and the wages of service
engineers) are totalled to produce a figure called ‘cost of sales’ (or ‘cost
of goods sold’). It should be clear that ‘gross profit’ is simply ‘sales
minus cost of sales’.
. Expenses – the costs of getting goods to customers, of housing and
administering the business, and (in this case) the cost of financing the
business.
38
3 Your first analysis of an income

statement
Exercise 2
Examine the detailed income statement of Pipes & Installations Ltd (Table 2)
and pick out some important elements that you think might be of interest (or
indeed of concern) to Paula and other stakeholders of the business. You
might perhaps categorise the elements into broadly ‘good’ or ‘bad’ aspects
(from the perspective of Paula and the board). In particular, your analysis
might touch on the following questions:
. What has happened to Profit before taxation in the two years? How has it
changed, and by how much in percentage terms?
. What changes to other elements of the income statement have caused
this change in profit before taxation? (Be as specific as you can here.)
. Are there any matters of concern to which Paula and the board might
need to respond?
Comment
You might have picked out a number of points, including some or all of those
given in Table 3 and perhaps some others. Table 3 lists those which are
perhaps the most important that Paula (and the board) might consider:
39
Readings 21–27
Table 3
Issue Impact on business (from Commentary

perspective of the board)
Profit before taxation has Bad A downward change in
decreased from £1,367k to profitability is generally
£1,023k, a downward change of considered to be an issue that
£344k or a little under 25% requires urgent investigation and
explanation. Repeated over a
number of years, a trend would
be established that might result in
stakeholder interests being
damaged. Additional analysis
(such as that below) will help to
identify more specific issues.
However, that significant
downwards change in profitability
might (in some businesses) be
part of a planned change in
investment strategy that impacts
adversely on profit in one year
but which brings benefits to be
realised in future.
Sales have increased by £395k or Good Ordinarily, any upward movement
3.3% in sales is regarded as good
news. However further analysis
shows that this increase in sales
might have been achieved at
something of a price.
Gross profit has decreased by Bad It would be a matter of quite
£166k or 4.8% serious concern to Paula that
gross profit has decreased
despite the improvement in sales.
The issue might involve:
‘cost of sales’ (i.e. the prices
paid to the manufacturers for
boilers and parts, and the
wages of the service
engineers), or
selling prices – the increased
sales might have been
achieved by reducing selling
prices, for example.
Further analysis using information
that is not currently available in
the income statement would be
required to tease out the
(probably relatively complex)
reasons behind this decrease in
gross profit. It is likely that such
analysis would be conducted
quite urgently.
Total expenses have increased by Bad (in relation to sales and Total expenses have increased by
178k, or 8.6% gross profit) more than the proportionate
increase in sales and (as is the
case here) have increased when
gross profit has decreased.
40
Table 3 continued.

In addition, a comparison of some of the detailed expense lines are showing some quite significant
movements, including:
Distribution and postage costs Bad Perhaps significant increases in
have increased by £76k, or a postage costs are having an
startling 67% impact. But the issue may be as
simple as loss of control over the
extent to which external delivery
services are being used in
preference to delivery by service
engineers (which would generally
be the cheaper option).
Marketing and advertising Good (although possibly bad) Saving money on marketing and
expenses have reduced by advertising expenses may seem,
£119k, or 41% at first sight, a good thing.
However, one might then
consider the longer-term impact
on sales and prices. You might
note that an increase in sales
occurred despite the reduction in
marketing and advertising costs,
so the immediate question that
arises is, how has this been
achieved? This issue might be
linked to the reduction in gross
profit already discussed above. In
any event, it is very likely that the
sales and marketing director (who
is the person responsible for both
issues) will need to answer some
fairly serious questions from the
board on these points.
Depreciation costs have Bad (although possibly good in Depreciation is dealt with in more
increased by £118k, or nearly the longer term) detail under the ‘balance sheet’
32% discussion below. For the
purposes of this analysis of the
income statement, however, an
increase in depreciation might
arise from increased investment
in income-earning assets (which
might be good in the longer
term), or from increased
allowances for the use, wearing
out or obsolescence of such
assets (which would be bad if it
means that these assets will have
a shorter income-producing life
than expected).
41
Readings 21–27
Always, when comparing numbers or calculating percentages, use

appropriate levels of rounding and precision to allow a business
manager to form a view on the information given. The downward
change in profit before taxation, for example, can satisfactorily be given
as 25%, or even 25.2% if the decimal place is important to the
business. ‘25.164594%’ would definitely be excessive precision, and
would be more likely to distract rather than help the business manager.
Summary
So far you have only examined a single (and relatively simple) income
statement of Pipes & Installations Ltd. Even a very quick analysis of the
comparisons between the two years highlights a number of questions to be
answered and issues to be resolved. A financially minded member of the
board (for example, one of the non-executive directors appointed on the
bank’s recommendation) would be very likely to raise questions about these
matters and Paula will need satisfactory answers if she is to gain board
support for her plans for a strategic change in the business. The bank itself
will have a view, of course, but their position will be considered later in the
block. For the moment, you should recognise from the above commentary
that the income statement is only a summary of business performance over
a period. On its own it is unlikely to provide all the answers required –
every answer to a question is likely to provoke a demand for further, more
detailed analysis before specific business responses can be identified. And,
sometimes, a change that appears to be for the worse in the short term (for
example, a significant investment in marketing expenditure) may in fact
have been purposefully undertaken for good business reasons that are
intended to bring benefit in the longer term.
42
Reading 24: Financial statements – the balance sheet

– the balance sheet
Introduction
Having considered how a business has performed over a period, you will
now turn your attention to where a business stands at a particular moment
in time – information that is provided by the balance sheet. The balance
sheet is, you may think, rather an oddly named statement compared to the
‘income statement’, which provides exactly what its title implies. What is it,
exactly, that is ‘balanced’? (This question is addressed below.)
The balance sheet answers various questions about a business. What is it
worth? Can the business pay its bills? How will the owners benefit from
any profits earned?
Failing to understand a balance sheet may lead to failing to keep control of
cash resources – in other words, finding it difficult to pay bills as they arise,
or the wages of employees. In the worst cases, a business can become
insolvent – that is, incapable of paying bills that are now due – and in that
event the business is liable to be ‘wound up’ (i.e. its legal existence brought
to an end after an application to a court) and its assets sold off in favour of
its creditors.
Another title for the balance sheet (regularly used in the United States of
America) is ‘Statement of Financial Position’ which is more descriptive of
the information provided by the balance sheet and which is the title
recommended by the International Accounting Standards Board. But
alternative titles are allowed, so we’ll continue to use the traditional
‘balance sheet’ title here – wording which you will certainly find in
common use throughout English-speaking countries. Be prepared for either,
however.
43
Readings 21–27
1 What is a balance sheet?

A balance sheet is a list of the financial resources (usually called ‘assets’)
and the financial obligations (‘liabilities’) of a business at a particular
moment in time. It thus provides the ‘net worth’ of a business – the total
value of the assets less the total of any liabilities.
All of this sounds fairly mundane, but the balance sheet does much more
for the business manager than simply calculating the net worth of a
business. It provides information on the state of the business’s financial
health – its ability to pay its liabilities as they fall due, and its resilience in
the face of substantial economic challenges or unexpected adverse events.
The owners of a business (and those that lend it money) will use its balance
sheet to calculate the risk attached to their investment, and the likely reward
that will arise given any specific level of profit earned. (Technically, the
word ‘gearing’ is used to describe this relationship between reward and
profit. We’ll examine this in more detail below.)
The balance sheet can be described as a ‘snapshot’ of a business’s financial
affairs. Like a snapshot, a balance sheet gives some information about what
happened before the moment captured but nothing about what happened
subsequently, and that is a useful metaphor for the use of a balance sheet in
business.
2 The relationship between the balance

sheet and the income statement
It is now time to answer the question with which this reading commenced.
What is it that is ‘balanced’?
An accounting transaction – any transaction – must do one of two things:
. re-allocate assets and liabilities in some way – for example, the payment
of a bill will simply involve a reduction in cash resources (the ‘cash
account’) of the amount paid, and a corresponding reduction in liabilities
(‘payables’) to the extent a debt has been satisfied (thus leaving the net
worth of the business unchanged)
or
. change the net worth of a business – for example, selling a boiler bought
for £600 to a customer for £900 (paid in cash) decreases the ‘inventory
account’ by £600, increases the ‘cash account’ by £900 and increases the
net worth of the business (‘equity’) by the profit of £300.
It follows that there is a ‘balance’ between movements in net assets and
movements in the worth of the business (its ‘equity’). You may see the
implication of this – ‘profit’ (or ‘loss’) is defined as the ‘increase (or
decrease) in net worth of the business’ and that definition will be used
throughout Block 3. However, the net worth of a business might be
increased for reasons other than profit. In a limited company, extra worth
might be created by the issue of new share capital, or a reduction in the
44
business’s worth may be caused by payment of a dividend to shareholders.

As stated above, the technical accounting for these matters is beyond the
scope of this module and the definition of profit (or loss) used above is
therefore adequate for our purposes (and also for the general business
situations in which you are likely to be involved).
You may have come across the word ‘equity’ before in relation to the value
of a property that remains after any associated debt (a mortgage liability, for
example) has been deducted. In business, the concept is similar – the
‘equity’ of a business is the same as the value of the assets less all
liabilities (i.e. its ‘net worth’). If the liabilities outweigh the assets then the
business has ‘negative net worth’. This would be similar to a homeowner
being in ‘negative equity’ – and in business, as in property ownership, this
is a situation that is preferably avoided.
The essential job of the balance sheet is to provide a check that all
transactions have been properly entered in the accounting records. Each
‘account’ in the company’s financial records has produced a final ‘balance’,
and when added up the resulting totals of net assets and equity respectively
must be equal (otherwise there is an error that must be corrected). This is
the balancing process after which the balance sheet is named.
Figure 1 An historic accounting text
3 The balance sheet in more detail

You may now understand that an income statement (showing how much
profit or loss has been generated in a particular period) forms a bridge
between two balance sheets, as shown in Table 1.
45
Readings 21–27
Table 1
Balance sheets at 31st December 2015 and 2014
31 Dec 2015 31 Dec 2014
£k £k £k £k
Non-current assets
Property 6,835 6,786
Plant and equipment 215 269
Computers and office equipment 61 61
Vehicles 1,280 1,050
Total non-current assets 8,391 8,166
Current assets
Inventory 1,457 1,103
Receivables 3,054 2,752
Other current assets 18 16
Total current assets 4,529 3,871
Current liabilities
Payables 1,021 703
Corporation tax 275 360
Other tax liabilities 184 173
Bank overdraft 2,912 2,521
Total current liabilities 4,392 3,757
Net current assets/working capital 137 114
Total assets less current liabilities 8,528 8,280
Long-term liabilities
Bank loan 2,500 3,000
Net assets 6,028 5,280
Equity
Share capital 2,000 2,000
Reserve: retained earnings 4,028 3,280
Total equity 6,028 5,280
In the following sub-sections of this reading the individual elements of the

balance sheet (such as equity, current assets, current liabilities, etc.) will be
explained. You will then make a first attempt to interpret the balance sheet
of Pipes & Installations Ltd.
46
3.1 Equity
Focus first on the ‘equity’ section, traditionally placed at the bottom of the
balance sheet. You can see that equity in this business has two components
– share capital and a ‘reserve’ called ‘retained earnings’.
You can identify ‘share capital’ of £2m. Paula owns 80% of the shares
(i.e. she received shares valued at £1.6m when she sold the assets of Paula’s
Pipes to the new limited company) and Peter owns the remaining 20%
(originally valued at £0.4m, but of course Peter also received a cash sum of
£6m from the company to compensate him for the much larger business that
he also sold to the new company.
The share capital of a company does not change over time (subject to any
issue of new shares, which as discussed above will not be considered here).
It represents the original investment of the owners, and the shares can then
be sold to other individuals who will themselves become part-owners of the
business.
Rather more interestingly, the ‘retained earnings’ reserve has in fact
changed over the year. And by how much? The answer is by £748k – the
amount of net profit generated after all expenses and taxation have been
deducted, as you can see from the income statement in Reading 23. That
profit is ‘retained’ in the business by adding it to the ‘retained earnings’
reserve.
The link between the income statement and the balance sheet has now (at
last) been established. The balance sheet shows the net worth of a business,
analysed between various categories of assets and liabilities that will be
examined in more detail below. The income statement shows how that net
worth has changed (either by generating a profit or incurring a loss) by
specifying how that change occurred through sales, cost of sales, expenses,
etc. This is a key point. Remember this link as you move on.
3.2 Non-current assets

Looking now at the top of the balance sheet, usually the first thing listed is
‘non-current assets’. (These used to be called ‘fixed assets’ and you may
still hear that term used.) Non-current assets are the enduring things that a
business owns in order to generate sales – things such as property, motor
vehicles, desks, computers, etc. The key aspect of a non-current asset is that
it will continue to operate for more than one financial year, and thus the
cost of the asset needs to be spread over the period of its entire operating
life rather than at the moment it is first acquired.
Using the example of the purchase by a business of a computer for, say,
£1,000, it wouldn’t be appropriate to show this as an immediate expense of
the business because all that has happened is that one form of asset (cash)
has been exchanged for another form of asset (the computer). There has
been no change in the overall value of the business, and thus (using the
definition of profit or loss developed above) no loss.
But assets like computers wear out, or break down, suffer minor damage
over time. Their software becomes obsolete, and the computer will need to
47
Readings 21–27
be replaced with an upgraded version. In any event, an asset like a

computer (or a car, or even a building) has a limited lifetime – probably
measured in years. Accountants thus recognise the expense of using a non-
current asset (like a computer) over time – the cost of buying the computer
might be recognised over, say, 3 years.
There is a special term – ‘depreciation’ – that represents the proportion of
cost of the use of non-current assets recognised in each accounting period.
You should now understand that the value of non-current assets set out in
the balance sheet is stated after making some allowance for depreciation.
The original cost of the assets would have been higher than stated in the
balance sheet – but on the other hand, there are few accountants who would
guarantee that the value stated in the balance sheet is the value that could
be achieved if the asset were to be sold. Depreciation is a way of
accounting for the estimated reduction in value of a non-current asset over
time. It does not provide accurate valuations of those assets.
This concept of ‘spreading’ the cost of a non-current asset over several
financial years is well established in the accounting world. It arises from the
‘matching principle’ (sometimes called the ‘accruals concept’) which
dictates that expenses in the income statement should be matched to the
sales they have helped to generate. For example, a payment of rent made
three months in advance would not be recognised as an expense at the time
the payment was made, but in each of the three months to which it applies.
Additional extracts from the detailed non-current asset note that might
accompany the balance sheet of Pipes and Installations Ltd would include
the information shown in Table 2.
Table 2
31/12/2015 31/12/2014
£k £k £k £k £k £k
Original Depreciation Net Original Depreciation Net
cost book cost book
value value
Non-
current
assets
Property 7,120 285 6,835 7,000 214 6,786
Plant and 510 295 215 475 206 269
equipment
Computers 175 114 61 135 74 61
and office
equipment
Vehicles 2,760 1,480 1,280 2,340 1,290 1,050
Total non- 10,565 2,174 8,391 9,950 1,784 8,166
current
assets
This gives us interesting new information – the original cost of non-current

assets has increased from £9,950k to £10,565k – so it can be presumed that
an investment of at least £615k has been made in non-current assets during
48
the year. (We say ‘at least’ because some disposals of assets may have
occurred, thus increasing the amount that must have been invested in order
to reach £10,565k. This point will be discussed again when analysing the
cash flow statement.)
3.3 Current assets

Unlike non-current assets, current assets do not endure. They form part of
the movement of resources that cycle throughout business operations from
day to day. They include:
. Inventory – the stock of goods held for resale. In the case of Pipes &
Installations Ltd, inventory (approximately £1.5m) would comprise
boilers and parts bought from the German supplier but not yet sold on to
customers.
. Receivables – amounts billed to customers, but for which payment has
not yet been received (£3.1m in Pipes & Installations Ltd).
. Cash – money held in bank accounts. Pipes and Installations Ltd has
none. It has a bank overdraft, which appears in ‘current liabilities’
below.
Other current assets are common. A payment of rent in advance, for
example, would under the matching principle (as discussed above) be
regarded as a current asset to be ‘used up’ over the period that the rent
payment covers. Items similar to this would form ‘other current assets’ on
the Pipes & Installation Ltd balance sheet.
3.4 Current liabilities

Current liabilities are amounts that a business owes, or the value of
obligations that it must fulfil within 12 months of the balance sheet date
(and generally much more rapidly). Specific elements might include:
. Payables – amounts due to suppliers relating to bills/invoices that have

been received (£1.02m in Pipes & Installations Ltd).
. Taxation – rather self-explanatory, amounts that are owed to the tax
authorities including corporation tax (on profits) and other taxation
liabilities such as PAYE and National Insurance (taxation arising from
payment of wages and salaries) and VAT (Value Added Tax).
. Bank overdraft – the balance in the company’s bank account if it is in
overdraft, which is the case here (£2.9m for Pipes & Installations Ltd).
Pipes & Installations Ltd do not have any other current liabilities, although
additional liabilities might arise in the opposite circumstances as in
‘prepayments’ above. For example, if an energy bill was expected but had
not yet been received for a particular reporting period, an estimate of the
charge would be included under this heading. This process is called
‘accruing for’ the expected bill, and the resulting amount on the balance
sheet as an ‘accrual’.
49
Readings 21–27
(You will often find the term ‘working capital’ used to describe the net total
of the value of current assets and current liabilities together.)
3.5 Long-term liabilities

The final element to be considered in the balance sheet of Pipes &
Installations Ltd is long-term liabilities (also known as ‘non-current
liabilities’). A ‘long-term liability’ is defined as an amount owed that need
not be paid within 12 months of the balance sheet date. In other words, the
company has at least 12 months before it needs to find the cash resources to
repay the debt. Various sorts of liabilities might appear as ‘long-term’ – in
the case of Pipes & Installations Ltd, the remaining bank loan of £2.5m is
the only such item.
Figure 2 Small business loan application
4 Analysis of a balance sheet

To analyse the balance sheet of Pipes & Installations Ltd the following
exercises will focus on that together with the information on non-current
assets above, using the same approach as taken with the income statement.
Exercise 1
Pick out some important elements from the balance sheet shown above that
you think might be of interest (or indeed of concern) to Paula and other
stakeholders of the business. As before, do try to categorise the elements
you identify into broadly ‘good’ or ‘bad’ aspects from the perspective of Paula
and the board. (You may already understand that some elements may be
described as both ‘good’ and ‘bad’ depending on the perspective taken.)
Your analysis might touch on the following questions:
. How much cash is owed to the business by its customers? How has that
amount changed? Does this amount seem reasonable, given the level of
sales?
50
. What does Pipes & Installations Ltd owe to its suppliers? How has that
changed? Can these bills easily be paid? How?
. How much has the bank committed to Pipes & Installations Ltd in total?
How does this compare to the net worth of the business? What
consequences does this have for Paula’s (and, to a lesser extent,
Peter’s) ownership?
. Is the amount of profit made by the business a reasonable return on the
business’s total net worth?
. Are there any other matters of concern to which Paula and the board
might need to respond?
Comment
Possibly you may find answers to these questions rather more difficult to
identify than those you met when examining the income statement. The
issues are rather more complex than the fairly easily understood ‘impact on
profit’ questions that you considered there. There are, however, some very
important issues that need to be teased out using this analysis of the
balance sheet, and these issues will relate to two general questions that
most stakeholders will have in mind when considering balance sheet
information:
1 How financially healthy is Pipes & Installations Ltd? (‘Financial health’

means the business’s capability to maintain its day-to-day operations in
the long term. Reading 26 will examine this point in more detail.)
2 How is the business performing in terms of the profit generated by its
total net assets for the benefit of the shareholders?
These issues can be examined with some fairly broad analysis of the
balance sheet as shown in Table 3. Read through this table of commentary
carefully and ensure that you understand the points being made; a good
grasp of this example will help you to conduct a very useful analysis of any
balance sheet. Note that you are not expected to have identified all of the
issues below in your own analysis – or, at least, not in the detail that is
provided here.
51
Readings 21–27
Table 3

The business is owed nearly Bad You may at first think that an
£3.1m by its customers, an increase in the amount to be
increase of about £300k from 12 received from customers is a
months previously and good thing, reflecting increases in
representing a little under a the level of sales. But it is
quarter of sales during the year. important to consider what this
figure actually represents – cash
that is owed to the business but
which has not yet been collected.
It is likely that cash will be an
important and scarce resource in
most businesses. We’ll discuss
this in more detail in the section
on the Cash Flow Statement
below. For the moment, you
should recognise that any asset
representing cash withheld from
the business (however
temporarily) is likely to have an
adverse impact on its overall
financial health.
Pipes & Installations Ltd owes a Good (or possibly bad) The issue here again is cash.
little over £1m to its suppliers, up Mirroring receivables, the
from about £700k at the previous business is holding its suppliers’
year-end. cash resources and using them
itself, which is good for the
financial health of the business
(and helps also reduce the impact
of interest on its overdraft
balance). But (and this is very
significant) the reasons why
amounts owing to suppliers have
increased need to be carefully
examined. Is there perhaps
pressure on cash resources that
means that payments to suppliers
are being delayed? This would be
a serious and very difficult issue
for the business that we will
consider further below. For the
moment, you may have spotted
that Pipes & Installations Ltd has
obligations of over £1m to its
suppliers and, in addition, other
current liabilities (different forms
of taxation) of £459k. The total
amount owing, (other than to the
bank), is just under £1.5m.
52
Table 3 continued.

The bank’s total commitment to Bad (with elements of good) It is very encouraging to see that
Pipes & Installations Ltd is really the bank has such confidence in
very significant – a bank loan of the business of Pipes &
£2.5m plus the overdraft of Installations Ltd that it is prepared
£2.9m, a total of £5.4m. The net to offer it significant levels of
assets of the business excluding finance – to the extent that
the total amount owing to the almost half of the business is
bank is about £11.4m. So the ‘owned’ (effectively, if not legally)
amount owed to the bank by the bank. As explained in the
represents about 47% or nearly case study, the bank’s debts are
half of the business. secured over the assets of the
business – in other words, if the
business ceases to trade then the
bank’s debt will be paid back
before any residual amount is
distributed to the shareholders.
The board (and especially Paula
and Peter) might consider
whether it has concerns about
this, about the extent to which the
business is generally funded by
bank debt and whether this
implies a level of risk for the
shareholders about which they
feel less than comfortable. (See
the discussion on ‘gearing’ in
Reading 26, Section 2.4 below.)
The business retained a profit More comparative information Judging a profit of 12.5% as
after taxation of £748k needed ‘good’ or otherwise will depend
representing nearly 12.5% of its on the average returns made by
total net assets at 31/12/2015. the business sector in which
operates, and also on alternative
returns that can be generated
from other investments. You
might correctly consider that such
factors will also depend on the
external economic environment of
interest rates and investment
returns in the broader financial
market. Over time, however, this
measure will give Paula, Peter
and the other members of the
board a baseline against which
relevant comparisons may be
drawn.
53
Readings 21–27
Table 3 continued.

Investment in non-current assets – Good, provided these net Regular investment in non-
the analysis above allows us to investments can be afforded current assets – the things that
calculate that there has been net a business uses to generate
investment in non-current assets profit – would generally be
during the year as follows: expected in a business such as
Pipes & Installations Ltd. That
£k is how long-term stability of
profit generation needs to be
Property 120 assured – non-current assets
Plant and equipment 35 wear out or become obsolete –
and one would expect, over
Computers and 40
time, maintenance of operating
office equipment
capacity would imply an annual
Vehicles 420 net investment roughly equal to
Total 615 the annual depreciation charge
recognised in the income
‘Net’ investment means the total statement. In this case, the net
investment in non-current assets investment of £615k is
less the original cost of assets that somewhat higher than the
were sold or otherwise disposed of depreciation charge of £488k,
during the year. Information on perhaps indicating an increase
disposals of non-current assets in the scale of business
cannot be gained from the balance activities. This would be
sheet, but this point will be consistent with the increase in
discussed again when considering sales noted in the income
the cash flow statement below. statement.
The bank loan, originally created in Good – with some bad aspects in Faithfully observing the terms
order to pay Peter a cash sum that the particulars of a bank loan – especially a
allowed him to retire, has been loan secured on the assets of
reduced by £500k as required by the business – is always
the loan agreement. recommended in business. In
this case, the bank loan has
reduced by £500k as expected.
But then you might observe
that the bank overdraft has
increased by £391k (£2,912k –
£2,521k). In other words, the
cash made available to pay
bank loan obligations has come
(mainly) from the bank
overdraft. The business’s
overall obligation (its
‘exposure’) to the bank has
therefore changed very little,
despite the profit that has been
generated. The reasons for this
will be discussed on
examination of the cash flow
statement below. You should
acknowledge for the moment
that this may not be what either
the board or the bank expect or
desire.
54
Exercise 2
Consider now just how easy it would be for Pipes & Installations Ltd to
satisfy its obligations, given the overdraft facility that remains available. You
will need to calculate what remains of the overdraft facility at 31
December 2015 (this figure is sometimes called the ‘cash headroom’ or
similar) and compare it to the cash obligations that need to be satisfied at
the same date. What conclusions might you draw, and what actions might be
recommended to the board?
Comment
Obligations include payables of £1,021k, corporation tax liabilities of £275k
and other tax liabilities (very likely to be taxation on employee wages and
salaries) of £184k. This totals £1,480k.
You have already seen in the case study that the bank overdraft facility was
negotiated at £4m. But the overdraft stands at £2,912k on 31/12/2015,
leaving a ‘headroom’ of £1,088k (£4m – £2,912k), an amount insufficient to
pay total obligations. (And this is not to mention that the bank loan must be
reduced by a further £500k in the year to come.)
It seems likely that the board as a whole would be highly alarmed by this
state of affairs. (In practice, of course, it’s likely that the board would have
been regularly monitoring balance sheet and cash flow information – for the
sake of illustration the balance sheet is being presented here as though it
were ‘news’ to the board.)
You might have suggested various ways of dealing with the key issue, which
is that cash resources seem very stretched. The business already appears in
some difficulty, despite its profitable performance. As far as actions that will
impact on the balance sheet directly are concerned, you may have made
various suggestions – collect receivables, sell off surplus inventory rapidly,
perhaps sell surplus non-current assets, etc. All of these things could have
been suggested on the basis of your analysis above.
Summary
The balance sheet is a ‘snapshot’ of a business at a particular point in time,
summarising the resources it has available (‘assets’), calls upon those
resources (‘liabilities’) and the difference between the two (‘net worth’, or
‘equity’). It provides very different information from the income statement,
which shows how a business has generated a profit (or a loss) over a
particular period – a year, for example. In terms of the financial information
provided to Paula and the board by Pipes & Installations Ltd, you have
started to build a useful view of the business, the constraints within which it
55
Readings 21–27
is operating, some of the trends that may have been established, and some
of the concerns that the board might consider.
The bank is clearly a key stakeholder of Pipes & Installations Ltd. It has
funded (and continues to fund) a significant portion of the business’s net
assets, it holds security for the loan and overdraft it has provided, and two
members of the board were appointed on the bank’s recommendation. It
seems a reasonable assumption that these non-executive directors will bear
the interests of the bank in mind when considering Paula’s plans for the
future.
Finally, the amount owed by Pipes & Installations Ltd to the bank has
reduced only by a little (actually £109k) – not very much when compared to
the net profit earned after tax of £748k in the year to 31 December 2015,
and to the total exposure to the bank of £5.4m. In addition, the business
would have difficulty in meeting all of its financial obligations if called
upon to do so in the immediate future.
56
Reading 25: Financial statements – the cash flow statement

– the cash flow statement
Introduction
In most businesses, a cash flow statement does not generally provide very
much in the way of new information that a competent accountant cannot
piece together quite readily using two balance sheets, the bridging income
statement and some snippets of data on the disposal proceeds of non-current
assets.
So why, then, produce a cash flow statement at all?
The answer is that cash has a special status in business. It is the ultimate
‘liquid asset’ that has been likened to the ‘lifeblood’ of a business, without
a sustainable supply of which a business cannot survive. The cash flow
statement summarises the generation and utilisation of cash resources. It
allows a clear focus on this vital resource. And it highlights the likely
reasons for changes in cash balances that seem to be different from those
suggested by focusing simply on the income statement. It can also highlight
important trends in the use or absorption of cash that may not be clearly
perceived by routine examination of a balance sheet.
1 What is the cash flow statement?

Like the income statement, a cash flow statement covers a period of time. It
also, again like the income statement, acts as a bridge between two balance
sheets. While the income statement explains the increase (or decrease) in
the net worth of a business by showing how a profit (or loss) is generated
from sales and costs, the cash flow statement explains the change in cash
resources of a business by showing how cash has been generated and
consumed under various headings including those shown in Table 1.
57
Readings 21–27
Table 1
Cash generation/ Examples of cash Examples of cash

consumption heading inflows outflows
Operating activities . Operating profit . Operating loss
. Reductions in . Increases in
inventory, inventory,
receivables, other receivables, other
current assets current assets
. Increases in . Decreases in
payables, other payables, other
current liabilities. current liabilities.
Investment activities . Sale of non-current . Purchase of non-

assets current assets
. Short-term loans . Loans made with a
received. view to profitable
investment.
Financing activities . Long-term loans . Rewards to

received. shareholders,
e.g. dividends
. Repayment of long-
term loans
. Interest payments
made on loans.
Table 2 shows the cash flow statement of Pipes & Installations Ltd for the
two years ended 31 December 2015 and 2014. The balance sheet shows that
the business began the year with negative cash resources (i.e. an overdraft)
of £2,521k and completed the year with an overdraft of £2,912k, an overall
decrease in (or consumption of) cash resources of £391k. Given that the
business generated a profit of £748k in the year in question, how can cash
resources have worsened by £391k? The cash flow statement, provides the
answers.
Note: For the purposes of this cash flow statement, positive amounts
represent cash inflows. Negative amounts are in brackets and represent cash
outflows or an overdraft balance.
58
Table 2

Cash flow statements
Year to 31 Dec 2015 Year to 31 Dec 2014

£k £k
Operating activity:
Interest paid on overdraft (379) (354)
Corporation tax paid (360) (180)
Add back non-cash expenses:
Depreciation 488 370
Loss/(Profit) on disposal of non-current assets (15) 0
Changes in cash invested in working capital:

(Increase)/Decrease in Inventory (354) (110)
(Increase)/Decrease in Receivables (302) (85)
(Increase)/Decrease in Other current assets (2) 0
Increase/(Decrease) in Payables 318 120
Increase/(Decrease) in Other tax liabilities 11 0
Net cash inflow/(outflow) from operating activities 1,007 1,722
Investing activity:
Purchase of non-current assets (743) (150)
Proceeds on disposal of non-current assets 45 0
Net cash generated (consumed) by investing activity (698) (150)
Financing activity:
Repayment of bank loan (500) (500)
Interest paid on bank loan (200) (240)
Net cash generated (consumed) by financing activity (700) (740)
Change in cash balances (391) 832
Opening cash balance (overdraft) at 1st January (2,521) (3,353)
Closing cash balance (overdraft) at 31st December (2,912) (2,521)
59
Readings 21–27
2 Cash inflows/(outflows) from operating

activities
From one perspective, a significant purpose of the cash flow statement is to
answer the question ‘What has happened to profit, and why has it not turned
into cash?’ It seems reasonable, therefore, to start the cash flow statement
with the amount of profit (or loss) that has been generated through the
ordinary activities of the business – the ‘operating profit’.
Figure 1 Men using a cash counting machine
Operating profit excludes any costs relating to financing the business –

interest charges, for example. So operating profit can be calculated as
shown in Table 3.
Table 3
Operating profit calculation

Year to Year to
31 Dec 2015 31 Dec 2014
£k £k
Profit before taxation (per income 1,023 1,367
statement)
Add back costs relating to

interest charges:
Interest on bank loan 200 240
Interest on bank overdraft 379 354
Having isolated operating profit (i.e. excluding interest charges) at the

beginning of the cash flow statement, interest charges actually paid out as
cash outgoings are recognised next – but only to the extent that they are
‘operating’ interest charges which (for the purposes of this example) is
defined as interest on the overdraft (but not on the long-term loan account,
which will be inserted under ‘financing activities’ later).
60
Corporation tax actually paid to the tax authorities is recognised next. You
will see that Pipes & Installations Ltd paid its tax liability from the previous
year, £360k.
The next adjustment to cash from ‘operating activities’ relates to
depreciation. Operating profit is calculated after recognition of the cost of
depreciating non-current assets. Such depreciation does not involve any cash
outlay. Thus the calculation of cash inflows from operating activities needs
to be adjusted to exclude this charge.
There is another small adjustment to make arising from the additional
information that an accountant would need in order to construct this cash
flow statement. During the year to 31 December 2015, Pipes & Installations
Ltd sold some of its non-current assets (a mixture of plant, office equipment
and motor vehicles) for proceeds amounting to £45k in total. The written-
down value of those assets in the balance sheet of Pipes & Installations Ltd
was £30k. In other words, the assets had been over-depreciated by £15k
(shown as a ‘profit on disposal’ in the income statement) and this forms
another element of our calculation of cash inflows from operating activities.
As you work your way down the cash flow statement, you will see various
amounts shown as ‘Changes in cash invested in working capital’.
If the value of the stock of goods to be resold – the inventory – of a
business has increased, it can reasonably be inferred that there has been
some cash outflow in order to pay for those goods. You can see from the
balance sheet of Pipes & Installations Ltd that inventory went from £1,103k
to £1,457k – an increase of £354k, and this is accordingly recognised as a
cash outflow in the cash flow statement. If the value of inventory had gone
down, a corresponding cash inflow would have been recognised. Exactly the
same reasoning can be applied to the other elements of working capital – an
increase in receivables means that customers are holding more of the
business’s money than they did before – the equivalent of a cash outflow.
An increase in payables, however, works the other way around – an
increase in payables means that the business is holding more of its
suppliers’ cash, effectively a cash inflow.
The following exercise allows you to calculate the amount of cash absorbed
(or released) by Pipes & Installations Ltd’s working capital.
Exercise 1
From the cash flow statement of Pipes & Installations Ltd, calculate how
much cash has been invested in working capital in the year ended 31
December 2015. How does this compare with the same number for the
previous year?
Comment
Remember to be careful of numbers in brackets, which represent negative
cash movements, or cash outflows.
61
Readings 21–27
There are 5 lines in the cash flow statement that relate to changes in
working capital balances – inventory, receivables, other current assets,
payables, and other tax liabilities. You should have made the following
calculation:
–354 – 302 – 2 + 318 + 11 = –329
In other words, a total cash investment (outflow) of £329k in working capital.
In the previous year, the same calculation produces a cash outflow of just
£75k – so over the two-year period, 329k + 75k = £404k of cash has been
soaked up by increasing the business’s investment in working capital.
Whether this is advisable or otherwise will be examined below. An
understanding of how some of the business’s cash resources have been
consumed is, however, now becoming clear.
Our calculation of cash inflows arising from operating activities is now

complete. As you can see from the cash flow statement, they total £1,007k in
the year to 31 December 2015 (and £1,722k in the previous year).
What has happened to this cash? The remaining sections of the cash flow
statement are rather more brief and correspondingly easier to understand.
3 Cash inflows/(outflows) from investing

activities
The necessity for Pipes & Installations Ltd to invest regularly in non-current
assets in order to replace obsolete or worn out items (and therefore to
maintain operating capability and effectiveness) has already been discussed.
You worked out that a net investment of at least £615k had been made in
the year to 31 December 2015.
In fact, because some disposals of non-current assets (originally costing
£128k) had also been made in the year, the total amount invested in non-
current assets was higher, as shown in Table 4.
Table 4
Purchase of non-current assets £k

Property 120
Plant and equipment 68
Computers and office equipment 55
Vehicles 500
Total 743
This amount – £743k – is therefore recognised as a cash outflow in the year

under the heading ‘investment activities’. In the previous year it was a
much lower amount – only £150k – so the scale of increase in investment
in the later year (mainly the investment in property and the increase in the
62
numbers of service vehicles) is really very significant. What can be said is

that a net total of £698k (£743k less the proceeds gained from the disposal
of older non-current assets) has been spent from cash resources in order to
improve and extend the company’s capability to gain sales growth.
4 Cash inflows/(outflows) from financing

activities
The business of Pipes & Installations Ltd has been financed in two ways.
First, there were shares issued to Paula and Peter in exchange for some
assets and the respective businesses of the operations they ran as sole
traders previously. In addition, for the additional assets provided by Peter
and his larger business, the bank agreed to extend formal loan facilities of
£6m to the company, and that was used to pay Peter the remaining amount
that was due to him.
This part of the cash flow statement recognises:
1 changes in cash financing – arising from new sources of finance, or
repayments of existing sources (in this case, the annual £500k repayment
of the bank loan)
2 cash outflows involving payment to the providers of finance for the
funding they have offered. This could be dividend payments to
shareholders, although in this case it is interest payments (£200k) on the
outstanding balance of the bank loan.
Note that ‘cash balances’ in Pipes & Installations Ltd means the overdraft
balance, which has been provided by the bank within a facility that
technically the bank can reduce or remove at any time. The bank loan,
however, is a long-term arrangement that is likely to involve contractually
enforceable repayment terms agreed in advance. It is not an overdraft, and
therefore the bank cannot demand immediate repayment of the loan without
notice. The loan is therefore not regarded as part of the cash resources of
the business for the purposes of the cash flow statement.
5 Bringing cash movements together

The final few rows of the cash flow statement simply provide a total of the
cash movements in the year. The movement in the year (a £391k outflow
for the year to 31 December 2015) is added to the opening cash resources
(an overdraft of £2,521k) at the beginning of the year, and the resulting
total gives the available cash resources at the end of the year (in this case,
an overdraft of £2,912k).
Exercise 2
Imagine you are the finance director of Pipes & Installations Ltd and Paula
has asked you to explain in simple terms why cash balances have gone
63
Readings 21–27
down by £391k when she already knows that the business has generated an
operating profit of approximately £1.6m.
The cash flow statement and the case study (and some supplementary
information provided above) tells you what you need to know to answer this
question. Spend a few minutes studying the statement and write some notes
that will help you in your next discussion with Paula. You might consider the
following two ways of approaching the issue:
1 The cash flow statement of Pipes & Installations Ltd for the previous year
(to December 2014) shows a better picture than the one for the more
recent year, with cash balances actually improving by £832k. Why is this?
What changed (in terms of cash flows) since last year? A brief
comparison of the two years, line by line, will help you start to formulate
an answer to the question.
2 Looking only at the 2015 year, summarise in words the main categories
of cash movements that have impacted on cash balances but which have
not been recognised in operating profit.
Comment
One might understand Paula’s confusion. But the cash flow statement
provides (more or less) the specific answers that she requires. You may have
jotted down the following main points:
. First, the cost of servicing bank funding – the loan and the overdraft
together – is very significant. In total, it amounts to cash outflows of
£579k in the most recent year, and £594k in the previous year.
. Next, the investment in non-current assets. The combination of cash
spent on property (£120k) and the expansion of the vehicle fleet (£500k)
are items that (presumably) do not repeat from year to year, and thus the
whole amount must be found from the resources generated in the year to
December 2015 – which, as you now understand, are quite limited.
(There is an offsetting impact arising from the increase in payables –
effectively a cash inflow of £318k – although this might suggest other
issues, such as the lack of available cash resources putting pressure on
payments to suppliers.)
. The increase in cash invested in working capital – in inventory and
receivables in particular (a total of over £650k between the two). And that
is in addition to increases (smaller, but still increases) in the amount of
cash invested in these items in the previous year. So this raises
questions about whether these amounts are too high in relation to the
business generally. (We’ll look at this point again below.)
. Finally, of course, the level of operating profit has reduced by £359k since
the previous year. A reduction in profit means (eventually, once working
capital has worked through it cycles) reduction in cash resources.
64
You might have mentioned other items here – the increase in tax liabilities
that needed to be paid, for example. But remember that the managing
director’s time is limited. You should address the main and most significant
issues that answer the question.
Summary
The importance of the cash flow statement is difficult to overstate. It
categorises cash inflows and outflows into the various types of cash
generation and consumption (cash generated from or used by operating
activities, investment, financing activities) that can allow the user to rapidly
establish the important trends of cash generation and consumption over
time. Think of the cash flow statement as the bridge between two balance
sheets, showing how the cash resources of a business moved from the
opening position to the closing.
A cash flow statement is not the easiest financial statement to understand
for business managers who do not have a financial background, so don’t be
too concerned if you find these technical elements (and, in particular, the
construction of cash inflows from operating activities) quite difficult to
follow. This is not something you are likely to have to prepare yourself
unless you are intending to undertake higher levels of study in financial
accounting. It is, however, necessary for all business managers to
understand and be capable of interpreting the various standard financial
statements.
Before that, there is a further concluding point to make concerning the
usefulness of financial statements and accounting information generally.
This set of readings focuses on financial statements; much emphasis has
been placed on various measurements and ratios (that you will meet later)
that help managers and other users to interpret financial information and
measure (as far as is possible) the way a business has performed on behalf
of various stakeholders, and its financial health or resilience to unanticipated
events.
Financial statements say little, however, about the quality of the business’s
products, about the skills and diligence of its workforce, the creative talents
of its product design team, the experience and integrity of its board of
directors, the business’s reputation in the marketplace and many other
aspects of a business – all of those things that add value to what is often
called a business’s ‘brand’. In the actual financial statements (or ‘annual
reports’) of large businesses the basic financial statements as presented to
you here are supplemented by very considerable amounts of additional
information and explanatory notes. Even this level of detail – often running
to over 100 pages – would be insufficient for a business that was being
reviewed (for example) as a possible takeover target.
65
Readings 21–27
Do remember that the financial information you have studied here, while
providing information of basic importance to many stakeholders, only gives
a relatively limited picture of a business. But the financial statements and
the financial analysis tools about which you will learn more later are an
absolutely necessary part of a proper assessment of a business.
66
Reading 26: Analysing financial performance
Reading 26: Analysing financial

performance
Introduction
In whatever capacity you might be reviewing financial statements in the
future – as an investor, a business manager, an employee or supplier – you
will find this reading important. It will help you to answer some very
simple questions about a business, including:
. How is it performing? Is it successful, and likely to continue in business

for the foreseeable future?
. Can it afford to pay more in wages? Is it overcharging its customers? Is
it treating suppliers fairly?
. Can it pay its bills? Its wages? Its bank interest?
. Is the business resilient? In other words, will it be able to continue to
pay its bills in the event of an economic downturn?
This reading will take you through a number of techniques and simple
calculations that can be used to answer questions like this. These are
provided in the form of a series of exercises with solutions and
commentary. You will benefit most from this reading by attempting each
exercise first and then carefully reading through the solutions and
commentary, before moving on to the next exercise.
1 Financial performance – techniques and

tools
In earlier readings you were introduced to the three main financial
statements:
. income statement – showing how the net worth of a business has

changed over time by generating a profit (or loss) from trade or service
operations
67
Readings 21–27
. balance sheet (or statement of financial position) – a ‘snapshot’ of a

business, summarising: (1) the financial value of its assets and liabilities
(and thus its net worth) at a particular moment in time, and (2) the total
funds (capital plus reserves plus retained profits) used to finance those
assets and liabilities, generally described as the equity of the business
. cash flow statement – focuses on cash resources and shows how they
have changed over a period of time through: (1) operating activities
(generating a profit, changes in working capital), (2) investing activities
(for example the purchase or disposal of non-current assets) and (3)
financing activities (the raising of new funds or receipt/repayment of
loans, and the associated interest costs and dividend payments to
shareholders).
You have seen that these three financial statements already provide a lot of
information about a business. You are now going to examine this
information in more detail, employing some simple financial ratios that are
commonly used to help compare the performance and health of one business
with another, and with generally established ‘rules of thumb’.
1.1 Simple returns
1.1.1. Return on equity/return on capital employed

You may be familiar with the idea that a bank deposit account receives a
certain amount of interest calculated on the balance in the account. You will
probably have seen advertised rates of interest in the range of 1% pa to 3%
pa (‘pa’ is short for ‘per annum’, i.e. ‘per year’) which would be common
at the time this is being written, but these rates do change over time
depending on the external economic environment.
There is a very similar idea that can be applied to business. The owners of
a business would usually like to know the ‘return’ on their investment. They
might like, for example, to compare that return against more secure types of
investment – for example a bank deposit account – to assess whether the
risk associated with their investment in the business is adequately reflected
in the return being made.
Calculating the return on a business investment is not quite as simple as
assessing the return on a bank deposit account – but nor is it particularly
complicated. You have already seen in our discussion on the balance sheet
that the value of a business in the hands of its owners is the equivalent of
the ‘equity’ of the business. And, just as in a bank deposit account, the
return on that investment can be regarded as the increase in the value of
that investment over time. The income statement and the balance sheet
together provide all that is needed to assess the return on the owners’
investment.
68
Exercise 1
Table 1 sets out the return on a bank deposit account paying interest of 3%
pa. Complete the table giving the equivalent return made by Pipes &
Installations Ltd.
Table 1
Year to 31 December 2015 Bank deposit Pipes &

account Installations Ltd
Opening balance (or equity at the £1,000
beginning of the year)
Closing balance (or equity at the £1,030
end of the year)
Change in value of bank balance £30
or equity
Return on equity / capital (30 / 1,000) x
employed (calculated as the 100%
increase in value divided by the = 3%
opening balance or equity,
expressed as a percentage)
Comment
Your calculations of the return on equity for the owners of Pipes &
Installations Ltd should be as in Table 2.
Table 2
Year to 31 December 2015 Bank deposit Pipes &

account Installations Ltd
Opening balance (or equity at the £1,000 £5,280k
beginning of the year)
Closing balance (or equity at the £1,030 £6,028k
end of the year)
Change in value of bank balance £30 £748k
or equity
Return on equity / capital (30 / 1,000) (748 / 5,280)
employed (calculated as the x 100% x 100%
increase in value divided by the = 3% = 14.2%
opening balance or equity,
expressed as a percentage)
You may sometimes see So Pipes & Installations Ltd has made a ‘return on equity’ (the equivalent of
the same financial ratio the return on the bank deposit account) of 14.2% in the year to 31
described as ‘return on December 2015.
capital employed’
(‘ROCE’).
69
Readings 21–27
Exercise 2
Make some notes on this calculation and how you think this single figure (not
terribly meaningful on its own) could be made more useful to Paula. Why do
you think there is such a difference between the return on equity in a
business, and the return delivered by (for example) a bank deposit account?
Comment
This simple ratio is probably the most widely used in business. It provides
rather a lot of information for Paula, her fellow owner and directors and other
stakeholders to consider, so you shouldn’t be too concerned if the points you
have identified are not as comprehensive as those set out here.
1 The resulting figure needs to be placed in context in order to gain more

meaning from it. Some additional comparisons would need to be made. Is
this better or worse than the return delivered in earlier years? What return
was actually expected? (We’ll consider how to calculate ‘expected
returns’ in Business Planning in Reading 27.) What returns are earned by
other businesses providing the same sort of goods and services?
2 The return delivered by Pipes & Installations Ltd is substantially in excess
of the return that would have been provided if Paula and Peter had
simply invested their funds in a bank deposit account. Why is this? Surely
Paula and Peter would be very happy to invest all of their available funds
in the business, and none in bank deposit accounts, if the returns are this
different?
This is actually a fairly profound question, and the answer involves
some complex ideas:
(i) The key concept here is ‘risk’. A bank deposit account is, within
certain fairly generous limits, a ‘safe’ investment. It will provide
this sort of return repeatedly from year to year. The return from an
investment in Pipes & Installations Ltd is, however, likely to be
much more volatile – and it would not be at all surprising if, in
some years, the business made a loss and thus delivered a
negative return on equity. A better measure of return from the
business would perhaps be its average return over several years.
(ii) Not only is the return from an investment in Pipes & Installations
Ltd likely to be volatile and therefore risky, in fact the underlying
capital itself is also at risk. It is perfectly possible (as you will see
below) that Pipes & Installations Ltd might find itself unable to pay
its liabilities as they fall due, or be damaged by competitive
activity or by particularly expensive legal action. The directors of a
well-run company would take actions to mitigate (i.e. reduce)
some or all of these risks, but the fact remains that any of these
events might lead to the loss of the entire value of the business,
leaving Paula and Peter with no future returns and no value to
their investment. There thus remains room for a low-risk bank
deposit account as part of their personal investment strategy.
70
(iii) A bank deposit account is an example of what is called a ‘passive

investment’. The returns are generated whether the investor is
heavily involved (e.g. by seeking marginally better returns at other
banks) or not.
The same cannot be said for Paula and Peter, to whom an
investment in Pipes & Installations Ltd is ‘active’.
Paula’s full-time employment involves running the business. The risk
of her investment involves not only the return it generates but also
her continuing income.
Peter, on the other hand, remains involved as a director with all the
obligations and responsibilities that brings, but he received a
substantial sum to pay him for the business that was sold to Pipes &
Installations Ltd. It seems likely that his remaining investment in the
business represents only a part of his overall financial worth and he
may therefore regard the undertaking of high risk ventures by Pipes
& Installations Ltd as acceptable in terms of his overall financial
situation.
You have already seen that different stakeholders may have different
(and sometimes conflicting) interests to protect. Here is an example
of members of a particular group of stakeholders – the owners, in
this case – having potentially different interests, and therefore
different ambitions and different attitudes to risk. The owners may
thus take a different view on what is an acceptable rate of return
from year to year.
(iv) As far as other stakeholders are concerned, their responses will
be varied.
Employees (or perhaps their union representatives) might examine
the return on equity achieved over time and consider whether it is
overly favourable to the owners in terms of the balance of reward
between them and the employees. Discussions on this subject are
common in any business with a substantial number of employees.
The bank may be pleased with the level of return delivered, although
it’s likely that this ratio will to them be lower in importance than some
others on cash management and overall financial health, and we’ll
examine those below.
While domestic customers are unlikely to be considering the
implications of the business’s return on equity, the main German
supplier may well be interested in any return which they regard as
substantial. This interest may well impact on its pricing policy.
Competitors will be interested in this and other ratios for comparative
purposes.
You may have correctly noted that it wouldn’t be easy for Paula and Peter to
simply ‘put their funds in a bank deposit account’. The relationship between a
business as substantial as Pipes & Installations Ltd and its owners is quite
complex. The owner’s equity is represented by non-current assets and
working capital, and these funds cannot simply be extracted by the owner
(and the bank would have something to say about the matter if that were
attempted, as the balance sheet shows that no spare cash is available). The
simplest and most obvious way for Paula to turn the value of her business
71
Readings 21–27
ownership into cash available to deposit in a bank would be to sell her

shares. But then the valuation of her shares would be a very difficult
calculation, and probably not acceptable to Paula as that valuation is bound
up with the value she adds to the business as its managing director. If she
were to cease to be the main owner, the value of the business might be
calculated on a very different basis to that which she would prefer.
1.1.2 Gross margin

Gross margin (or ‘gross profit margin’), always expressed as a percentage,
is calculated from the detailed income statement as follows:
Gross profit / Sales x 100%
Gross margin represents that portion (expressed as a percentage) of the
average sales price of all goods sold that is in excess of the cost of those
same goods.
For example, if an item is sold for £100, and its total cost was £60, then
gross margin can be calculated as (100 – 60) / 100 x 100% or 40%. This
may seem a very obvious calculation when using simple numbers, but do
take care not to confuse ‘margin’ (as calculated above) with ‘mark-up’ – a
similar calculation, but using the cost as a base rather than the sales price of
an item. Using the example above, an item costing £60 and sold for £100
would have been ‘marked up’ by £40 / 60 x 100%, or 66.67%.
Simply remember that ‘gross margin’ is calculated as a proportion of sales,
not a proportion of cost.
There is now a series of exercises to help you understand the uses and
importance of this simple financial ratio ‘gross margin’.
Exercise 3
What is the gross margin earned by Pipes & Installations Ltd in each of the
two years ended 31 December 2014 and 2015? Complete Table 3 from the
income statement, then carry out the required calculation.
Table 3
Gross margin calculation Year to 31 Year to 31

December 2015 (£k) December 2014 (£k)
Sales
Gross profit
Gross margin (gross profit /
sales x 100%)
72
Comment
The following table shows how it should look.
Gross margin calculation Year to 31 Year to 31

December 2015 (£k) December 2014 (£k)
Sales £12,547 £12,152
Gross profit £3,280 £3,446
Gross margin (gross profit / 3,280 / 12,547 3,446 / 12,152
sales x 100%) x 100% x 100%
= 26.1% = 28.4%
Exercise 4
Consider the gross margins calculated above. Jot down some notes to
answer the following questions.
. Has the gross margin improved or got worse over the two years?
. Would that be a matter of concern for the directors and owners of the
business?
. What are the possible reasons for the change?
Comment
It may seem obvious that the gross margin earned by the business has
worsened from one year to the next, from 28.4% to 26.1%, a reduction of 2.3
To avoid confusion when percentage points.
comparing percentages
always use the wording There are various possible reasons (or combinations of reasons) that would
‘percentage points’ to explain why the gross margin may have worsened. The main reasons
describe the change. It’s include:
not appropriate to say
‘2.3%’ here because, as . selling prices may have reduced, in relation to the cost of goods sold
will be clear from the
numbers above, the gross . the cost prices of boilers and parts may have increased in relation to
margin figure has selling prices
changed by an amount . wages of the service engineers (which you will remember forms part of
that is significantly
higher than 2.3%. the cost of goods sold) may have increased in relation to the volume of
work they have done
. there may have been a change in what accountants call the ‘sales mix’ –
perhaps fewer high-margin products (possibly boilers) were installed in
comparison to the previous year, with an increase in lower-margin parts
and servicing.
73
Readings 21–27
Of course any combination of these reasons might be the cause of the

decrease. More elaborate information would need to be extracted from the
detailed management accounts in order to isolate the precise causes. You
can be sure that the sales and finance directors will want to know the
particular reasons for such a change in gross margin, as undoubtedly the
question will be asked by other members of the board and the explanations
(and any proposals for any appropriate action) will need to be delivered fairly
rapidly.
Whether the directors and owners should be concerned about this reduction
in gross margin will depend somewhat on the circumstances. Possibly there
was a planned reduction in selling prices with a view to increasing volume
sales for future benefit, and this would result in gross margins falling in a
controlled way in accordance with the plan. Possibly there was an unplanned
increase in the cost of boilers and parts, perhaps caused by an increase in
the value of the euro (the currency in which the German supplier bills Pipes
& Installations Ltd) in relation to the pound sterling. The first would not
necessarily be a matter of concern, although the board will want to continue
to monitor the impact of the change in selling prices. The second would
almost certainly be an issue to which the board would want to respond.
Exercise 5
How might the board respond to an increase in the cost of boilers and parts
from Germany if they desired to restore the gross profit margin to its
previous level? Jot down a few notes on this.
Comment
It may be that the board has few options – increasing selling prices would
seem an obvious response, but this may not be possible in the competitive
market in which Pipes & Installations Ltd operate. Perhaps the cost of boilers
and parts could be renegotiated with the supplier, asking them to share the
extra cost arising from the change in the respective values of the pound and
the euro.
(Students with experience in the financial markets may have noted that it
would be possible to limit the impact of a change in currency values by a
financial technique known as ‘buying forward’ or ‘hedging’, and this would be
correct although such knowledge is outside the scope of this module.)
74
Exercise 6
The element of cost of goods sold that has not been considered so far is the
wages of the service engineers. Give a reason why (one arising from the
figures in the income statement, and another from the relationship between
the business and its service engineers) why an immediate reduction in
service engineers’ wages would probably not be considered by the board
after reviewing the reasons for the change in gross margin.
Comment
You have already calculated that a reduction of 2.3 percentage points has
occurred in gross profit margins. Using a more detailed calculation (service
engineers wages as a proportion of sales), it can be seen that wages make
up only a relatively small fraction of the change.
You are not expected to have produced these calculations, but they are
provided here for reference:
The calculations are:
2014: 2,597k / 12,152k x 100% = 21.4%
2015: 2,732k / 12,547k x 100% = 21.8%
So, of the change in gross profit margins of 2.3 percentage points, only 0.4
percentage points (21.8% – 21.4%) arises from a change in the relationship
of service engineers’ wages to sales. The board must look elsewhere for the
main factor in the change.
You can see that a simple profit ratio – gross margin in this case – can
provide rather a lot to consider. The most basic questions to ask of any
accounting ratio are:
. Is there an identifiable trend established that should be either encouraged

or might be a cause for concern?
. Why has the particular ratio changed? What are the underlying causes?
1.1.3 Return on sales – operating profit margin (‘net margin’)

The operating profit margin is calculated in the same way as the gross
margin, except (as you may have already realised) the operating profit is
used rather than the gross profit.
Again always expressed as a percentage, it is calculated from the detailed
income statement as follows:
Operating profit / Sales x 100%
75
Readings 21–27
Do remember that ‘operating profit’ is the profit earned directly from the
trading operations of the business, and therefore generally excludes finance
costs such as interest. You will find the operating profit of Pipes &
Installations Ltd calculated in Reading 23.
Exercise 7
What is the operating profit margin earned by Pipes & Installations Ltd in
each of the two years ended 31 December 2014 and 2015? Complete the
first two rows of Table 4 from the income statement, then carry out the
required calculation.
Table 4
Operating profit margin Year to 31 Year to 31

calculation December 2015 (£k) December 2014 (£k)
Sales
Operating profit
Operating margin (operating
profit / sales x 100%)
Comment
The following table shows how it should look.
Operating profit margin Year to 31 Year to 31

calculation December 2015 (£k) December 2014 (£k)
Sales £12,547 £12,152
Operating profit £1,602 £1,961
Operating margin (operating 1,602 / 12,547 1,961 / 12,152
profit / sales x 100%) x 100% x 100%
= 12.8% = 16.1%
Exercise 8
Consider the operating profit margins calculated above. Make some notes to
answer the following questions.
. Has the operating profit margin improved or got worse over the two
years?
. Would that be a matter of concern for the directors and owners of the
business?
. What are the possible reasons for the change?
76
Comment
It will not take very long to conclude that the operating margin has also
worsened, from 16.1% to 12.8% or by 3.4 percentage points (the 0.1
difference is caused by rounding). Again, one would imagine that this would
be a matter of concern to the board. Most of the reduction in operating profit
(as a proportion of sales) arises because of the reduction of 2.2 percentage
points in gross margin, and this has been discussed above. There thus
remains an additional (3.4 – 2.2) = 1.2 percentage point that needs to be
explained. Exercise 9 allows you to consider how Paula might explain this
change.
Exercise 9
Spend approximately 20–30 minutes on this exercise.
You may already have realised that the additional 1.0 percentage point
reduction in operating margin must arise from changes in operating
expenses (i.e. total expenses excluding interest charges) from year to year
(as changes in the gross margin already fully account for any changes down
to the gross profit line in the income statement – and only expenses
therefore remain to explain the difference).
Examine the operating expenses set out in the detailed income statement
above. Which expenses have changed the most, and in which direction,
better or worse for the business?
Comment
A brief summary such as Table 5 sets out the changes.
Table 5
Operating expense (Increase)/decrease from (Increase)/decrease from Direction

2014 to 2015 (relative to 2014 to 2015 (£k) (B)etter or
sales, expressed in (W)orse?
percentage points)
Salaries and other costs (0.6) (84) W
(management and office
staff)
Distribution and postage (0.6) (76) W
costs
Marketing and advertising 1.0 119 B (or possibly
W)
Depreciation (0.8) (118) W
All other operating (0.2) (34) W
expenses
Change in total operating (1.2) (193) W
expenses
77
Readings 21–27
This is the sort of brief summary that a finance manager might prepare for
consideration by the board. Note how the report focuses on the significant
elements of the change in expenses. All relatively insignificant changes
(e.g. to insurance, energy costs, etc.) are grouped together under ‘All other
operating expenses’. This allows the board to consider only those issues that
are material to the operating results, and on which action can be taken to
produce a significant change.
Exercise 10
Considering the information in Table 5, comment on the four changes in

operating expenses from 2014 to 2015 that are the most significant in terms
of:
1 their impact on the income statement of Pipes & Installations Ltd

2 the extent to which the operating expense has changed from one year to
the next.
What might be the reasons for the specific changes, and what consequential
actions might the board therefore consider? Take into account the other
financial circumstances of Pipes & Installations Ltd in your answer.
Comment
You have probably mentioned:
. Marketing and advertising costs – this is the only change that is actually
a reduction in expenditure of £119k (or 41%), and one might imagine that
this would be regarded as good news. You have already considered how
a reduction in marketing and advertising expenditure might be linked to
the reduction in gross profit margin, so that won’t be considered further
here. Simply note that this reduction in expenses of 1 percentage point
relative to sales is thus offsetting (and therefore potentially camouflaging)
similar increases elsewhere.
The board will want to consider whether this reduction in marketing and
advertising expenditure is, overall, good for the future of the business.
. Depreciation costs have increased by, coincidentally, almost exactly the
same amount as marketing and advertising costs have decreased, and by
1.0 percentage points relative to sales. An increase in depreciation costs
by 32% since the previous year will have arisen from the investment in
non-current assets already discussed above.
The board has already approved this investment, but now they will
presumably wish to see the impact on sales that the investment was
probably intended to encourage and their attention will presumably turn
in that direction.
78
. Head office salaries have increased by 0.7 percentage points relative to

sales, and by 18.5% in comparison to the previous year. This sounds like
a lot, given that sales have increased by only 3.3%. It seems likely that
the board will want to review the number and cost of management and
office staff, and consider whether costs can be saved.
. Distribution and postage costs have increased by 67% – the largest
increase in percentage terms of all operating expenses – and also by 0.6
percentage points relative to sales. It may be that increases in costs have
been forced upon the business, with increases in fuel and postage costs
generally. The board might want to consider alternative distribution
arrangements in order to reduce the impact of this significant increase.
1.2 Conclusion on simple returns

These three simple financial ratios – return on equity, gross margin and net
margin – provide much of the information on business performance that will
be required by major stakeholders, particularly management and owners.
Monitored over the years, or compared with other businesses working in the
same sector, they will highlight trends and issues that require action by the
board or other managers. Most businesses will establish ‘rules of thumb’
based on these ratios, and this will provide a basis for planning the future of
the business.
There are many other simple calculations that might add more detail to
these three simple ratios. You worked out above how changes in service
engineer costs might be reasonably compared to changes in sales and it
would be possible to work one’s way down the list of expenses to perform
similar calculations on each.
There comes a point, of course, where this form of analysis can be taken to
excess – a comparison of some less significant cost (perhaps ‘energy and
utilities’ in our case study, for example) might show a large increase in
percentage terms (nearly 17%) but not be very material in terms of amount
of money involved (£5k). Focus on issues like this can become counter-
productive as they might take up management time for little benefit.
For the purposes of this module, the tools that you have now been given –
the income statement, balance sheet and three analytical tools called ‘ratios’
– will allow you to perform a very decent analysis of the performance of
any business. For the moment, however, the subject of business
performance gives way to that of business health.
79
Readings 21–27
2 Financial health of a business
2.1 The ‘quick ratio’ (or ‘acid test’)

Our attention turns back to cash. You may be familiar with some terms that
describe a shortage of cash resources to the extent that they are insufficient
to meet immediate obligations – ‘insolvency’ would be an example, perhaps
‘bankrupt’ would be a more extreme (and more formal) version.
The ‘quick ratio’ provides a way of assessing whether or not a business has
sufficient in liquid funds (i.e. cash, or assets that can rapidly be turned into
cash) to pay all its current liabilities.
It is calculated like this:
(Current assets – inventory)/current liabilities
The resulting calculation is usually expressed as a ratio (for example,
“2.1:1”). If you look at the balance sheet of Pipes & Installations Ltd, you
will see that ‘current assets – inventory’ simply leaves us with the
receivables figures (plus a small amount of ‘other current assets’). If there
were any cash resources, they would be included too. This represents the
amount of cash that the business has available (or will soon receive) to pay
immediate obligations – the current liabilities.
Exercise 11
What is the ‘quick ratio’ of Pipes & Installations Ltd in each of the two years
2014 and 2015? Would you consider the answer good news or not? Has the
ratio got better or worse over the two years? Complete Table 6.
80
Table 6
Quick ratio calculation At 31 At 31

December 2015 December 2014
Current assets minus inventory
Current liabilities
Quick ratio (current assets –
inventory/current liabilities)
Comment
Quick ratio calculation At 31 At 31
December 2015 December 2014
Current assets minus inventory £4,529k – £1,457k £3,871k – £1,103k
= £3,072k = £2,768k
Current liabilities £4,392k £3,757k
Quick ratio (current assets – 0.70:1 0.74:1
inventory/current liabilities)
Not all is rosy in the garden of Pipes & Installations Ltd. What does a quick
ratio of 0.70:1 (0.70 to 1) – a worsening from 0.74:1 at the previous year end
– actually mean?
Think for a moment about how the quick ratio is constructed. It was
calculated by dividing the total of cash resources (or resources that will soon
become cash) by the total amount that must be paid out to satisfy relatively
immediate financial obligations. If the answer is less than 1:1 (which is the
case here), then it can be concluded that those obligations are higher than
the available cash resources.
Does this sound like good news? To put this into a personal perspective,
imagine how you would feel if you didn’t have enough cash to pay your bills.
You can now see that a quick ratio of less than 1:1 is a fairly uncomfortable
place to be.
There is no generally accepted ‘safe’ level for the quick ratio in business.
Certainly, a quick ratio of 1:1 is probably (for fairly obvious reasons) the
absolute minimum, but you will find business textbooks (and websites)
suggesting anything between a ratio of 1.2:1 in industrial companies and of
2:1 – or even 2.5:1 – in high-turnover, low margin businesses.
81
Readings 21–27
Exercise 12
How is Pipes & Installations Ltd continuing to operate if it cannot

demonstrate that it has sufficient cash resources to meet the needs of its
creditors (payables and other liabilities)? Consider the most significant
liability in the balance sheet of the business, and what special circumstances
are involved that allow Pipes & Installations Ltd to tolerate (at least for a
while) a quick ratio where only 70% of its liabilities can be seen to be met
from immediately available cash resources.
Comment
As is the case in many businesses, it is the bank that has a special role
here. Pipes & Installations Ltd continues to operate happily, presumably,
thanks to the willingness of the bank to continue to allow a significant
overdraft. You read in the case study that the bank does hold security over
the business’s assets which in the balance sheet at December 2015 amounts
to over £11m (the total of the non-current assets, the inventory and the
receivables, less the payables and tax liabilities). The bank (again,
presumably) may feel comfortable with an overall debt owing to it of £5.4m
(£2,912k + £2,500k) given this level of security.
Having acknowledged this, you might also consider that an overdraft facility
can be cancelled at any time by the bank. And the state of comfort over its
security arrangements that the bank may enjoy is no reason for the board of
Pipes & Installations Ltd to feel equally comfortable. You could conclude that
a quick ratio of 0.7:1 (and trending in the wrong direction) is not easily
tolerable in any business for any significant length of time, and that the board
might wish urgently to consider ways in which this situation can be eased.
2.2 Receivables collection period

Look at the Balance Sheet of Pipes & Installations Ltd and check how
much is owing to the business from its customers – the amount held in
receivables. It is a fairly significant amount of money – a little under £3.1m
at 31 December 2015.
In a business like Pipes & Installations Ltd one might expect customers to
owe money. Boilers and parts are fitted, bills are raised and delivered to the
customer, and only when the customer is happy with the installation are
they likely to pay for the service received. All of this is as expected.
It may be that some customers are slow in paying their bills. Perhaps they
are poorly organised, or forgetful, or they have cash constraints of their
own. One occasionally finds a customer (in any business) who seeks to
avoid paying for as long as possible in order to maximise their own cash
resources.
82
You may be familiar with the concept of ‘credit control’, the function in any
business that seeks to ensure that customers pay their bills fully and on
time. It will be clear to you that money owing to Pipes & Installations Ltd
is money which will (eventually) be deposited in the business’s bank
account – although at the moment it is being held by somebody else.
How effective is the credit control function in Pipes & Installations Ltd?
There is a way to measure this – the ‘receivables collection period’, or the
average length of time (measured in days) that a customer takes to pay a
bill.
The receivable collection period is measured like this:
(Receivables / Sales) x 365
Exercise 13
Complete the first two rows of Table 7 and calculate the receivables
collection period for Pipes & Installations Ltd at each of the two year ends
2014 and 2015. Next answer the following questions:
. Does this seem a reasonable time for Pipes & Installations Ltd to be
waiting for its customers to pay their bills?
. In what way is the result trending – better or worse?
. What might the business do (in practical terms) to improve the situation?
Table 7
Receivables collection period At 31 At 31

calculation December 2015 December 2014
Receivables (£k)
Sales (£k)
Receivables collection period
((receivables / sales) x 365)1
1
Round to the nearest day.
83
Readings 21–27
Comment
Receivables collection period At 31 At 31
Receivables (£k) 3,054 2,752
Sales (£k) 12,547 12,152
Receivables collection period 89 days 83 days
((receivables / sales) x 365)
. It will seem difficult to say whether this is objectively a long period of time
for Pipes & Installations Ltd to wait for its customers to pay up. You might
say that 89 days (nearly three months) looks like rather a long time – you
probably wouldn’t expect to be allowed to wait so long to pay for
maintenance or installation work yourself – but a comparison to other
businesses in the same sector and perhaps some research on what is
expected in terms of credit terms by customers would be needed to be
certain of this.
Also, it might be that the business is seasonal – i.e. that the greater
proportion of the custom of Pipes & Installations Ltd falls in the early
part of the winter (perhaps when boilers are turned on for the colder
months) and it would therefore be unsurprising that the amount owed
by customers at the end of each December is particularly high. The
case study does not give us this information, however. More detailed
management accounts (perhaps prepared monthly) would allow Paula
to make this calculation and reach a more realistic average for the year
as a whole.
. What can be definitely concluded, however, is that the receivables
collection period has worsened from one year to the next – customers are
taking an extra 6 days to pay, on average. This represents a worsening of
the cash position by over £200k for this reason alone.
. Apart from carrying out the more detailed investigation based on monthly
management accounts suggested above, there is quite a lot of action that
Paula might consider. The effectiveness of the credit control function
might be examined, but so might the business’s policies on the terms
offered to customers. For example, there may be an opportunity to ask
customers to pay some part of the expected bill in advance, or as work
progresses. A policy of ‘payment on completion’ could be introduced.
In any event, it seems that Pipes & Installations Ltd has rather a lot of cash
resources locked up in its receivables balances at each year end, and finding
ways to reduce the amount owing (while maintaining sales) would clearly be
good for the business.
84
2.3 Inventory turnover period

You have already seen how the cash resources of Pipes & Installations Ltd
might be held by somebody else – the business’s customers. There is
another element of working capital in which cash has effectively been
invested – its stock of boilers and parts for resale, which is called its
inventory.
You will have read in the case study that Pipes & Installations Ltd has
invested £120k in a small property ‘used to store surplus stocks of boilers
and their parts’. This raises a couple of immediate questions:
. If stocks of boilers and parts are truly ‘surplus’, why are they being
stored and not used to service customer needs, returned to suppliers or
disposed of in some sensible way?
. What is the actual cost of this new storage facility once maintenance,
heating, depreciation, etc. have been taken into account?
While these questions cannot be answered using the information in the case
study, another objective measure can be used to help us. Just as with
receivables, there is a time-related measure of how much inventory is being
held by the company, and thus a way of monitoring the management of the
inventory and assessing whether cash might be released. The ‘inventory
turnover period’ calculates the average period of time (again measured in
days) that inventory is held in stock. Clearly (within certain limits as a
certain amount of inventory must be held if customer services are to be
maintained to the required standard) the lower this number the better.
Generally, the inventory turnover period is calculated as follows:
(inventory / cost of goods sold) x 365
In Pipes & Installations Ltd a technical adjustment to this formula is
required. You have already seen (in Reading 23) that ‘cost of goods sold’ in
this business includes the wages of the service engineers. As these are paid
directly (and as they are due) to the engineers themselves and not to the
suppliers of boilers and parts, they take no part in our calculation. The
revised formula (for Pipes & Installations Ltd’s purpose only) is therefore:
(inventory / (cost of goods sold – wages)) x 365
Exercise 14
Complete Table 8 and calculate the inventory turnover period for Pipes &
Installations Ltd at each of the two year ends 2014 and 2015 and answer the
. Does this seem a reasonable time for Pipes & Installations Ltd to hold its
inventory of boilers and parts, on average?
. In what way is the result trending – better or worse?
. What might the business do (in practical terms) to improve the situation?
85
Readings 21–27
Table 8
Inventory turnover period At 31 At 31

Inventory (£k)
Costs of goods sold (£k)
Wages (and other costs) of service
engineers (£k)
Inventory turnover period
((inventory / (cost of goods sold –
wages)) x 365)1
1
Round to the nearest day.
Comment
Inventory turnover period At 31 At 31
Inventory (£k) 1,457 1,103
Costs of goods sold (£k) 9,267 8,706
Wages (and other costs) of service 2,732 2,597
engineers (£k)
Inventory turnover period 81 days 66 days
((inventory / (cost of goods sold –
wages)) x 365)1
1
Rounded to the nearest day.
. As with the receivables, you won’t be able to conclude whether 81 days

is an appropriate time for a piece of stock (boiler, part or whatever) to
stay in inventory on average in Pipes & Installations Ltd. One would need
to carry out some research of businesses in the same sector, and again
seasonality might be a factor.
. Once again the situation has worsened from one year to the next –
inventory is being held for about 15 days longer at the end of 2015 than
at the end of 2014, and this equates (although you don’t have to do this
calculation) to an additional cash investment in inventory of over £250k –
not an insubstantial amount.
. Perhaps the first question that Paula might address is this: why does the
business carry any surplus inventory at all? It is clearly expensive, with
an entire small building acquired for storage purposes. This involves
substantial costs and cash outlay – and then there is the extra cash
involved in investing in the inventory itself.
. Paula might consider ways of disposing of this surplus inventory –
perhaps a promotional sale of boiler installations would do the job (and
help the sales figures at the same time), or perhaps some (if not all)
could be returned to the suppliers. The property acquired for £120k could
then be sold, helping reduce the amount of the overdraft and reducing
expenses too. More sophisticated answers might involve the
86
implementation of an inventory control system – a common and modern

form is often called a ‘just in time’ system – which involves the ordering
and receipt of inventory only at the moment it is required by the business.
These things should at least be considered by Paula and (probably) the
technical director.
2.4 Gearing (or ‘leverage’) and stakeholder risk/reward

The mechanically minded student may be familiar with the workings of gear
wheels or a lever, the practical effect of each being to produce significant
changes in output for limited changes in input.
The meaning of ‘gearing’ (this is the term used in UK-influenced financial
vocabulary) or ‘leverage’ (used in most of the rest of the English-speaking
world, but meaning much the same thing) in the business world is based on
the same idea, although in this case the ‘significant change in output’
generally refers to change in profit for a limited change in income or cost.
This is best illustrated with a simple example. Imagine a business that buys
properties, refurbishes them and then sells them for a profit. For the
purposes of this example, two such businesses will be used as examples,
each of which has bought an identical property for the same price –
£100,000. Each business has £100,000 available in cash resources, but the
funding of the property purchase is organised in very different ways.
Business 1 finances the purchase of the property mainly from its own cash
reserves, with a small additional long-term loan (£20,000) provided by its
bank.
Business 2 funds the purchase of the property with only a small amount of
its own cash resources (£10,000) and the remainder with a mortgage – a
form of long-term loan from its bank – of £90,000.
At the time of the purchase of each property, the (very simple) balance
sheets of each business are as shown in Table 9.
Table 9
Gearing
Balance sheet
Business 1 (£k) Business 2 (£k)

Property 100 100
Less long-term bank liability (20) (90)
Net worth 80 10
Equity 80 10
Gearing is calculated as follows: long-term liabilities / equity x 100
87
Readings 21–27
Exercise 15
What is the gearing of Business 1 and Business 2?
Comment
Using the formula above, you can quickly calculate the gearing of each
business:
Business 1: 20,000 / 80,000 x 100% = 25%
Business 2: 90,000 / 10,000 x 100% = 900%
You can clearly see that the gearing of Business 2 is much higher than that
of Business 1. Why is this important, or even of interest?
Imagine that, after refurbishment, each property can be sold for £110k – that
is a 10% profit on the original investment of £100k. What has happened to
the investment of equity in each business? The table below shows the result
of this, assuming the property is sold for cash.
Gearing
Balance sheet

Cash 110 110
Net worth 90 20
Equity 90 20
The equity investment in each business has increased by the profit on the
property disposal, £10,000. The impact on equity in each respective business
is, however, strikingly different:
Equity in Business 1 has increased by 10,000 / 80,000 x 100% = 12.5%
Equity in Business 2 has increased by 10,000 / 10,000 x 100% = 100%
In other words, the equity owners of Business 2 enjoy a return on equity that
is 8 times the return of the owners of Business 1. Identical properties
purchased, identical profit generated on its disposal – but a much higher
return for the equity stakeholders.
You may occasionally have heard in the business news of a ‘highly geared’
takeover of a well-known business. ‘Highly geared’ in this context means the
purchase of valuable assets using a high level of long-term debt to finance
the acquisition.
This is the magic of ‘high-gearing’ – a relatively low level of equity

investment produces an excellent return for a given level of profit.
What, then, is the downside? Surely everybody seeks to maximise the return
on their investment?
88
Now consider the position of Businesses 1 and 2 should they experience a

downturn in property values and their work produces an unwelcome result of
a £10k loss on each property rather than a profit.
Exercise 16
Complete the balance sheets in Table 11 for each example business,

assuming that a loss of £10k on disposal of each property – i.e. a disposal
price of £90k (the cash amount has been entered for you).
Table 11
Gearing
Balance sheet

Cash 90 90
Less long-term bank liability
Net worth
Equity
Comment
You should have produced the following table:
Gearing
Balance sheet

Cash 90 90
Net worth 70 0
Equity 70 0
The impact of high gearing should a loss be generated is now clear.

Business 1 has lost only 10 / 80 x 100% = 12.5% of its equity. This, you
might think, is bad enough – but not nearly as bad as for Business 2, which
has effectively been wiped out. It has lost the whole of its available equity
investment and the business owners have nothing left with which to start
again.
This demonstrates the usefulness of gearing as a measure of risk that the

owners of equity take when investing in the business. A relatively highly
geared business will improve the return on equity when a profit is generated.
89
Readings 21–27
But, conversely, the situation is made very much worse for the equity
stakeholders if a loss is produced.
The next exercise examines the extent to which gearing impacts on Pipes &
Installations Ltd.
Exercise 17
Using the balance sheet of Pipes & Installations Ltd, calculate the gearing of
the business in each of the two years given. Table 12 will help.
Table 12
Gearing
Balance sheet
Year to Year to
31 Dec 2015 31 Dec 2014
Long-term liabilities
Equity
Gearing (long-term liabilities / equity
x 100%)
Comment
Gearing
Balance sheet extracts
Year to Year to
31 Dec 2015 31 Dec 2014
Long-term liabilities 2,500k 3,000k
Equity 6,028k 5,280k
Gearing (long-term liabilities/equity x 41.5% 56.8%
100%)
What was the impact of gearing on the equity owners of the business (Paula
and Peter) when profits fell again in the year to December 2015? You have
already calculated (in Exercise 2 of Reading 23) that profits fell by a little
under 26%. The level of gearing in December 2015 means that the impact
on return on equity would be correspondingly greater.
In general terms, the gearing of Pipes & Installations Ltd is, perhaps, tending
to high levels – a relatively high proportion of the assets of the business is
financed by the bank rather than by the owners themselves. Whether the
equity owners of the business (Paula and Peter) are comfortable with this
90
level of gearing would be a matter of personal preference, but they would

undoubtedly have been advised that any reduction in profits (or, worse,
making losses) over time would have a higher impact on their investment
than if they funded the business wholly themselves.
2.5 Conclusion on financial health

The techniques for examining the financial health of a business are
summarised in Table 13.
Table 13
Financial ratio Specific element of How this relates to

business being ‘financial health’
measured
The ‘Quick Ratio’ (or How much cash is (or will The ability of the business
‘Acid Test’) soon be available) to meet to carry on its ordinary
immediate obligations operations without undue
pressure from creditors
Receivables How long it takes, on Cash held by others
collection period average, to collect debts impacts on the business’s
owed by customers ability to save interest
charges and meet its own
obligations
Inventory turnover How long, on average, Cash invested in inventory
period inventory is held before reduces the business’s
being sold ability to save interest
charges and to meet its
own obligations
Gearing (or The proportion of business Gearing can be seen from
‘leverage’) funding based on debt two different points of
rather than shareholder view. From one
equity perspective, high gearing
represents the opportunity
for the equity shareholders
to gain rewards out of
proportion to the scale of
any increase in profits.
From the other
perspective, low gearing is
a measure of the
resilience of a business,
its ability to survive in the
face of increased interest
rates, or significantly
increased costs.
91
Readings 21–27
Summary
Readings 23-25 above were concerned with providing you with an
understanding of the basic components and usefulness of the three main
financial statements - the income statement, the balance sheet and the cash
flow statement.
This reading (Reading 26) introduced you to some tools and calculations
that will allow you to undertake some rather deeper analysis of those
financial statements, analysis that will allow you to make some judgement
on the performance, the financial health, the resilience to economic
downturn and certain risk/rewards factors of any business.
Do note however that these judgements can only have any value if they are
set in an appropriate comparative context. Information concerning the
historical results of the same business, the current results of competitive
businesses, the various expectations or “rules of thumb” applicable to the
particular business sector or geographic area in which a business operates
will all help to provide measures against which such calculations can be
compared and conclusions drawn.
Conclusions on the health and resilience of a business may form elements
of plans to improve these measures – and you will be introduced to the
subject of financial planning in the next reading.
92
Reading 27: Financial planning

Introduction
In this reading, the perspective changes from the past (financial statements
prepared on the basis of transactions that have already occurred) to the
future, or how the business will grow and respond to new challenges.
You will be familiar with the idea of setting personal financial targets for
yourself – saving for a holiday or a car, or perhaps to satisfy a longer-term
need like saving enough to pay off a mortgage loan, or to supplement
pension income. These targets are called ‘goals’ and business owners and
managers, just like individuals, will have a series of goals that they (and
their business) will work towards.
Goals are not usually achieved without some careful planning, in business
as in personal life. Business planning is necessarily more complex however
– the numbers tend to be rather larger, usually more people are involved,
and the results of failing to meet a goal are often more consequential to
more people in the business world than in personal financial planning. So
this reading will focus on:
1 what particular goals might be the basis of a business plan
2 who might be interested in a business plan, and what they might want to
see it contain.
1 The importance of goals and business

plans
93
Readings 21–27
Exercise 1
What sort of goals might Pipes & Installations Ltd set itself?
Take a few minutes to jot down some goals that any business might hope to
achieve. To achieve them, what actions might be taken and what resources
might be needed?
Comment
There are many possible options, and you might mention a few like those in
Table 1.
Table 1
Goal/target Actions to be taken/resources that

might be required
Increase profit (usually some sort of . Increases in numbers of people
targets would be set – ‘by 50% within
dedicated to selling
3 years’ or ‘to £1m next year’ would
be examples) . Increase in the number of service
engineers
. Costs of closing an unprofitable
element of the business
(e.g. redundancy, lease
terminations)
. Costs of moving to new premises
with lower rents.
Reduce the amounts of cash invested . Invest in new software to improve

in Inventory by £500k and in
the management of purchase of
Receivables by £1m
boilers/parts, and to reduce the
amount of time inventory spends
in the warehouse before being
used
. Reduce prices to encourage the
replacement of older boilers with
new equivalents
. Employ a credit controller to focus
on reducing the amount owed by
customers.
Open in a new branch/store/factory in . Identify a property that must be

a new geographic area
either bought or rented, suitable
for the purpose
. Invest in machinery, technology
and office equipment
. Employ new staff, including
service engineers
. Invest in marketing initiatives that
will ensure the new operation has
customers from the
commencement of business.
94
Table 1 continued.
Goal/target Actions to be taken/resources that

might be required
Offer a new product or service (such . Identify a source of supply of the
as the solar panels installation service
new product, and agree prices that
planned by Paula)
allow profitable sales to be made
. Allocate management
responsibility to an individual
(possibly newly employed for the
purpose), whose job will be to
ensure that the new operation
opens in good time and provides a
reliable service from the outset
. Employ new salespeople and
installation operatives
. Invest in training to ensure the
installation operatives are able to
advise customers and install
equipment safely and effectively.
You might have added many other possibilities to this short list. Many goals
are non-financial in character – you might for example have mentioned
‘improve customer service’, or ‘reduce the number of staff leaving each year’
and these would be perfectly valid goals that would tend to improve the
overall efficiency of the business and its attractiveness to various
stakeholders, and this would lead to improved financial performance in the
longer term. Note that such goals do require the means of measuring the
change that the goal intends. For example, ‘improving customer service’
might be measured by undertaking some market research to establish just
how satisfied customers are with the service they receive now, followed up
by another market research exercise when changes intended to improve
customer service have been put into effect.
Having thought briefly about the sort of goals a business might set itself,
there is a related but very different question that must now be considered –
why is business planning regarded as an indispensable part of business
management?
Exercise 2
Why might any business need to produce a written business plan to help it
achieve its goals?
Take a few minutes to jot down some reasons why a business might want to
set out its goals, its methods of achieving those goals and the financial
consequences if the goals are achieved.
95
Readings 21–27
Comment
The reasons why a written and well-considered business plan should be
produced by any business include:
. A business plan provides a framework around which relevant

stakeholders can base their own activities. This framework remains in
place even if the actual individuals (employees and managers in
particular) in those roles change.
. To set objectives for managers to achieve (and possibly base bonuses on
their achievement).
. To decide what resources – people, plant and equipment, property – are
required to achieve the business goals, and to ensure that those
resources are: (1) affordable, and (2) in place at the appropriate time.
. To convince investors (or a bank) that the business is worth financial
support in terms of: (1) the achievability of its goals, and (2) the
plausibility and overall quality of the plan.
More general reasons might be mentioned – ‘to help grow the business’
would be a valid (if rather non-specific) response. The overall requirement is
to give relevant stakeholders – owners, managers, employees, (probably
most importantly) investors and lenders – confidence that the business has
set sensible targets, that resources have been appropriately deployed, that
future activities are likely to result in those targets being met and that there
are sufficient contingencies in place to give the plan resilience in the face of
unforeseen events.
2 The financial planning process

The process of business planning goes like this.
1 Assess resources – the net assets in the balance sheet, the available
people with their associated skill sets and management capabilities, and
(in particular) the level of cash available to fund any expected
investment requirement before the business can fund itself from its own
profits.
2 Set realistic, achievable goals – for all but sole traders this is likely to
be a relatively difficult process, especially if resources are constrained,
as is likely to be the case. It is also likely that more than one
stakeholder will be involved; at some stage trade-offs will need to be
made and compromises agreed.
3 Decide how the goals will be reached. This involves the allocation of
resources, decisions on investments to be made, timescales set for the
employment of people, etc. Contingency planning – in other words how
to react to the risk of unforeseen but plausible changes in circumstances
– is part of this element of the process.
96
4 Produce financial plans that demonstrate how all of these decisions will
impact on the business venture in terms of profit and (especially) cash
flow.
5 Produce a clear written document that incorporates all of this process.
This forms the final ‘Business Plan’ that is available for relevant
stakeholders.
The contents of a business plan will vary, depending on the purposes for
which it is being prepared. The UK Government provides a helpful (if
rather full, for our purposes) template for people who are self-employed or
starting a business, and many other examples are available online. For the
purposes of Pipes & Installations Ltd, a basic business plan might comprise:
. An ‘executive summary’ providing a description of the new venture,

brief details of the management team, the necessary funding
requirements and a review of the likely risks.
. A history of the business to date, its financial status and resources
(balance sheet) and current results (latest available income statement).
. A review of research relating to the market which the new product is
intended to serve – its scale (i.e. how much has been spent on similar
products), who the likely customers are, how they will be targeted,
estimates of likely market share and demand for the product, a
comparison with similar products offered by competitors.
. A description (in plain terms) of the new product, the state of its
development, the identified supplier and any pricing details.
. A marketing plan, setting out the target markets, pricing policy, selling
and distribution arrangements.
. A review of the management and organisation of the business – how it
is run, the career histories of key managers and employees, details of
location and required equipment.
. A set of financial forecasts and a statement of the assumptions on which
they are based. The forecasts will comprise at least a forecast income
statement, although (if the venture is of any significant size), a forecast
cash flow statement also. The financial forecasts may be for any
appropriate period – but 3-year or 5-year forecasts (by month) are
common.
97
Readings 21–27
Summary
Financial planning in business needs to be seen as a tool of business
management, a means of gaining the support of various stakeholders
(especially investors and lenders) rather than any solemn assurance that the
plan will turn out exactly as forecast. Business planning is undertaken
against a complex background of shifting economic change and other events
that are highly unlikely to turn out as expected. All of this is understood by
experienced bankers and investors. Their intention in reading a business
plan is to gain an impression of the quality of management thinking that it
demonstrates, of the thought processes that underpin the plan, of the
arrangements that have been made to manage the risk of unforeseen events
and, finally, of the potential rewards available for the risks undertaken.
References
HM Government (2014) ‘Write a business plan’, [online]. Available at
www.gov.uk/write-business-plan
98
Acknowledgements
Acknowledgements
Figures
Reading 21
Figure 1: Dea/G.Dagli Orti/Alamy
Page 7: © iStockphoto.com/Yarinca
Reading 22
Figure 1: © Claudiodivizia/Dreamstime.com
Figure 2: © Keith Morris/Alamy
Figure 3: © Alistair Laming/Alamy
Reading 23
Figure 1: © iStockphoto.com/Julie Harris
Reading 24
Page 42: © Randy Glasbergen
Figure 1: © University of Maryland
Figure 2: © Kirby Hamilton/iStockphoto.com
Reading 25
Page 56: © s-ts/Shutterstock.com
Figure 1: © SAAD SHALASH/Reuters/Corbis
Reading 26
Page 79: © Payaercan/iStockphoto.com
Page 82: © Jrcasas/iStockphoto.com
Reading 27
Page 92: © iStockphoto.com/millionhope
99
Block 4
Readings 28–36
By Fiona Harris and Anja Schaefer

Act 1988.
3WX
ISBN 978 1 47300 3491
2.1
Contents
Reading 28: What is marketing? 5
Introduction 5
1 Definitions of marketing 5
2 Marketing orientation 6
3 Some marketing terminology 9
4 Different types of marketing 9
Summary 11
References 12
Reading 29: The marketing plan 13
Introduction 13
1 The marketing planning process 13
2 Marketing information 15
3 Competitor analysis 17
4 Marketing strategy 20
Summary 25
References 26
Reading 30: Understanding customers 28
Introduction 28
1 Models of consumer behaviour 28
2 Social and cultural aspects of consumption 34
3 Business customers 38
4 Customer relationships and relationship marketing 40
Summary 42
References 43
Reading 31: The marketing mix – product 45
Introduction 45
1 What do we mean by product, good and service? 45
2 Differences between goods and services 47
3 Product benefits 48
4 New product development 49
5 The product life cycle 52
Summary 54
References 55
Reading 32: The marketing mix – place and pricing 56
Introduction 56
1 Distribution channels (place) 56
2 Pricing strategies 61
Summary 66
References 67
Reading 33: The marketing mix – promotion, people,
process and physical evidence 68
Introduction 68
1 Marketing communications as a two-way process 68
2 Planning marketing communications 69
3 The marketing communications mix 70
4 The extended marketing mix for services 75
Summary 78
References 79
Reading 34: Digital marketing 80
Introduction 80
1 e-commerce and m-commerce 80
2 Social media in marketing 82
3 Privacy 91
Summary 92
References 93
Reading 35: Marketing in social and political contexts 95
Introduction 95
1 What is social marketing? 96
2 What is political marketing? 99
Summary 104
References 105
Reading 36: Societal and environmental issues in
marketing 107
Introduction 107
1 The societal marketing concept 107
2 Environmental issues in marketing 112
Summary 117
References 118
Reading 28: What is marketing?

Introduction
Marketing is a word used so frequently in modern life that most people will
have their own idea of what marketing actually is. You probably have as
well. It is because the word seems to be used all the time that it is
important to consider what we mean by marketing in a business and
management studies context. There are more aspects to marketing than you
might first assume. Marketing is most certainly not just advertising, it is a
lot more.
‘I liked it better before the marketing people got a hold of it.’
In this reading we will first look at some definitions of marketing, and then
consider what is meant by a marketing orientation. The reading will
conclude by looking at different types of marketing, depending on context,
the nature of the customers, the nature of the product and so forth.
1 Definitions of marketing
Marketing is often thought of as a set of particular activities in which
marketers engage, such as market research, new product development,
selling or advertising. In a narrow sense this is what is commonly
understood by marketing management. Another, broader understanding is
that of marketing as a business philosophy; that is, as a general way of
doing business which starts with a focus on customer needs and
expectations. Many marketing scholars and practitioners believe that, in
order to be a truly successful marketing organisation, a whole business
needs to have a ‘marketing orientation’. By this they mean that everybody
in the organisation should have the customers’ needs in mind in all their
work activities, even if they never have any direct contact with customers.
This follows from an understanding that no business would exist without
customers and that marketing is a central aspect of the entire business.
5
Readings 28–36
The following two definitions of marketing are in line with this idea that
marketing is something that involves the entire organisation, not just a
single department or function. The UK Chartered Institute of Marketing
defines marketing in a way that focuses on addressing customer needs:
Marketing is the management process responsible for identifying,

anticipating, and satisfying customer requirements profitably.
(Chartered Institute of Marketing, 2009)
The following definition by the American Marketing Association (AMA) is

complementary but focuses more on the activities of marketers:
Marketing is the activity, set of institutions, and processes for creating,

communicating, delivering, and exchanging offerings that have value
for customers, clients, partners, and society at large.
(American Marketing Association, 2013)
There are other definitions of marketing that focus on different aspects. For
the moment it will suffice to think of marketing as a range of activities,
carried out by various people in the business, designed to understand and
satisfy customer needs in a way that allows the business to make a profit or
to fulfil other organisational objectives. It is also worth noting that other
organisations besides businesses can benefit from a marketing orientation.
For example, a voluntary organisation might think about how it can best
meet the needs of its clients/beneficiaries, or a local authority could think
about meeting the needs of its residents. This broader scope is reflected in
the AMA definition.
2 Marketing orientation
This section introduces the idea of a marketing orientation as an overall
way of doing business, not just a function within a business. A marketing
orientation is not the only perspective that a business can adopt. Three other
common perspectives (also sometimes called business philosophies or
concepts) have been identified: product orientation, production orientation
and selling orientation. We now look at each of these, and at marketing
orientation, in turn.
2.1 Product orientation

Some businesses assume that customers value product quality above all else
and that a business that succeeds in producing better products than any of
its competitors will have to do little else in order to attract customers and
make a profit. Low prices, convenient distribution or convincing selling or
advertising become secondary considerations, or even totally unimportant.
This ‘product orientation’ view seems quite convincing for some products.
We all know of certain brands that have such a high reputation for superior
quality and prestige that some people seem quite willing to pay a very high
price and travel quite a distance in order to be able to obtain them. Luxury
sports cars (such as Lamborghini) or watches (such as Rolex) spring to
6
mind as examples. Normally, however, people do not consider just the

quality of a product; they also want value for money and to be able to buy
the product in a convenient location. In addition, they may need to be told
about the performance of a product and be persuaded, through some form of
promotion, to buy it.
2.2 Production orientation

Businesses operating under the ‘production orientation’ assume that buyers
are very price conscious and are prepared to accept merely adequate quality.
These businesses focus on making their production and marketing processes
as efficient as possible so they can produce large quantities of products at
low cost. This usually means mass production of fairly standardised goods.
This is the business orientation that led Henry Ford to develop the first
mass-produced car in the USA in the 1920s: the Ford Model T. There are
numerous modern examples of businesses that have succeeded with mass
producing standardised goods and selling them cheaply. Fast-food
businesses, such as McDonalds, are a good example. However, we can also
think of many markets where mass-produced products, even if they are very
cheap, are not as successful. Many people, for instance, do not particularly
like eating at fast-food restaurants and would prefer to spend a little more
for a greater choice of higher quality food. People are often also more
concerned with quality than with price when it comes to buying goods they
will use for a long time or on special occasions.
‘OK, we’ve set up the manufacturing facilities, organised the distribution network,
hired the marketing expertise, and allocated the advertising budget. Any ideas for
a product?’
7
Readings 28–36
2.3 Selling orientation

Other businesses assume that, no matter how good or cheap a product is,
not enough people will buy it unless the business makes a significant selling
effort. This is called the ‘selling orientation’. Sometimes, businesses
operating under this perspective also assume that it is possible to sell almost
anything as long as the right sales approach is taken.
Traditionally selling was mostly done face to face by sales people and this
is still commonly done when businesses try to sell to other businesses.
When businesses try to sell directly to consumers they now more commonly
approach them via telephone or email. This may be appropriate for some
products, typically those for which people might have a need but which
they would not normally buy unless prompted. Examples include insurance
or, notoriously, double glazing. On the other hand, the majority of products
seem to be sold without such an intensive (and often intrusive) selling
effort, and many consumers are becoming annoyed by unsolicited sales
approaches.
The notion that a good salesperson can sell anything also needs to be
treated with some caution. A business that is trying to encourage customers
to return to make further purchases in the future will need to be very
careful not to oversell its products, thereby provoking irritation or
dissatisfaction. Many people find it increasingly irritating to be called by
organisations trying to sell double glazing, solicitors’ services, or various
other kinds of goods and services over the phone, particularly when
telephone sales organisations use automated calls. For example, according to
figures from Citizens Advice, two thirds of British adults had received
unwanted text messages and calls about claiming for mis-sold personal
finance products, such as payment protection insurance (PPI), some being
contacted more than ten times in the previous 12 months (Winch, 2013).
2.4 Marketing orientation

The three previous orientations on business and its customers take
essentially an ‘inside-out’ approach, starting with what the business is good
at doing (such as high-quality products, efficient production, convincing
selling) and what they think customers want. In contrast, the fourth
perspective, the ‘marketing orientation’, takes an ‘outside-in’ approach,
starting with a thorough assessment of the needs and expectations of buyers
and then trying to fulfil those needs and expectations in order to attract
customers. Although this assessment might lead the business to concentrate
on product quality or costs, the crucial difference between this perspective
and the product and production orientations is that, from the outset, the
business does not merely assume what its potential customers may want, but
makes every attempt to find out. In addition, where the selling orientation
attempts to change consumers so that they will buy what the business has to
sell, the marketing orientation attempts to change the business’s offerings in
line with what consumers want to buy.
8
3 Some marketing terminology

Before we move on, you will need to familiarise yourself with a few terms
that marketers frequently use. These terms are also part of common
language but marketers use them in slightly different ways from general
language users.
Need: a perceived lack of something; an individual not only does not have
something but is aware of not having it; a ‘need’ in marketing terms is not
the same as a ‘necessity’. People have far more complex and far-reaching
needs than mere survival.
Want: a specific satisfier for a need. If you are hungry you need food, and
therefore may want a pizza.
Product: a product is best thought of, not as a specific physical good, such
as a car, but as a bundle of benefits, such as the ability to get from A to B,
the pleasure of looking at a new, shiny machine, the prestige of owning a
desirable make of car, etc.
Customer: a person or business buying a product; also called a buyer. The
word ‘client’ is also often used to mean ‘customer’, particularly by
professional service providers, such as lawyers or accountants.
Consumer: a person who actually uses the product or could potentially do
so. Customers are frequently also consumers and thus the terms may be
used interchangeably in some circumstances.
Market: a market consists of all the actual and potential buyers of the
business’s products. Sometimes the terms ‘market’ and ‘customers’ are used
interchangeably, but in reality a business’s customers are unlikely to be
100% of the market.
Market offerings: Some combination of products, services, information, or
experiences offered to a market to satisfy a need or want.
Exchange: The act of obtaining a desired object from someone by offering
something in return.
(Source: adapted from Kotler et al., 2013)
4 Different types of marketing

In order to understand the nature of marketing it is helpful to consider
marketing in a number of different contexts. The basic principles of the
marketing concept, i.e. the importance of making customers central to the
business’s marketing efforts, apply to virtually all marketing contexts.
However, at a slightly more detailed level, there are differences between
marketing to consumers and marketing to other organisations. There are also
a number of special contexts of marketing that are worth considering. Some
of these will be discussed briefly in the subsections that follow, and social
marketing and political marketing will be discussed in more depth in
Reading 35.
9
Readings 28–36
The different contexts of marketing introduced below are not exhaustive.

One could consider many other contexts, such as sports marketing,
marketing of public services, marketing of charitable causes, etc. The point
is that marketing has an important role in many organisations and sectors of
society, not just in the private sector.
4.1 Consumer marketing

A ‘consumer market’ refers to individuals and families who buy products
and services for their own consumption. This is distinct from business
markets, which consist of businesses (and other organisations) who buy
goods and services in order to incorporate them into their own production
or other organisational processes. Consumer markets therefore exclude all
types of buying by organisations.
Consumer marketing is perhaps the kind of marketing that most people
think of first when they think of marketing.
4.2 Business-to-business marketing

This is where businesses sell to other organisations (not just other
businesses, even though that is what it is called). Purchases by organisations
account for over half of all economic activity in industrialised countries
(Ellis, 2011), even if business-to-consumer marketing is more visible to the
general public. Typically, several organisations are involved in producing
every product or service sold to a consumer or end-user.
Think of all the different organisations that are involved in the production
chain of even a fairly simple product, such as a ceramic plate. The pottery
that makes the plates will have to buy clay either directly from a clay pit or
from another company that buys the clay from the pit and then sells it on.
They will have to buy all kinds of machinery to make the plates (and these
machines will again have lots of different components that may have been
made by different suppliers). Then the ceramics company will have to buy
paints and glazes to finish the plates, packaging materials to pack them in,
energy to run its plant and offices, office supplies, and so on and so forth.
The pottery may then not actually sell the plates directly to consumers but
may sell them to department stores and other retailers, who then sell them
to consumers. Looked upon like this, it is easy to see that business-to-
business marketing is an important part of the economy.
4.3 Social marketing

Social marketing is the idea that the tools of marketing can be applied to
health and social behaviours. Marketing techniques have been used to shift
various behaviours such as exercise, smoking, drinking and drug use
(Hastings and Domegan, 2014). Social marketing is discussed in more detail
in Reading 35.
10
4.4 Political marketing

Political marketing is the application of marketing ideas to the field of
politics. If you think about it, politicians and political parties market
themselves all the time to citizens and voters, using a wide range of
marketing tools such as communications, packaging, and so forth.
Marketing techniques have been used in politics for a long time but political
marketing as a focus of research and teaching is a modern field (Lees-
Marshment, 2014). Political marketing is considered in more detail in
Reading 35.
4.5 Marketing of cultural industries

This could quite easily be seen as a particular instance of services
marketing. Cultural institutions, such as museums, art galleries, theatre,
concerts, film and so forth all rely on visitors / viewers / participants in
order to be able to do what they do. Museums with few visitors cannot be
confident of public funding to stay open or improve their collections.
Commercially produced films are, of course, marketed like any other kind
of entertainment, but public funding of the film industry also depends on the
industry attracting enough viewers so that the public funders consider their
money well spent. Thus, cultural industries that rely on funding other than
commercial income need to market themselves to funders as well as to
consumers.
4.6 Fundraising
Voluntary sector organisations that depend on donations to carry out their
work increasingly use marketing techniques for their fundraising activities.
For example, they may use segmentation, targeting and positioning
techniques (discussed in Reading 29) in order to identify different groups of
donors and then target those most likely to give to their particular cause.
They may conduct market research to find out what motivates those who
support particular causes and how best to reach them. And they increasingly
provide techniques similar to ‘after sales services’ to let donors know how
their funds are being used and what is being achieved with the money.
Summary
This reading has looked at what is meant by marketing within business and
management studies. The reading has included a definition of marketing, the
idea of a marketing orientation, some common terms used in marketing, and
marketing in different contexts. It is important to clarify some of these
basics early on because marketing and related terms are so commonly used
in everyday language. Marketers attach a more specific meaning to a lot of
these words and it is important to remember these specific meanings as you
go along in your studies.
11
Readings 28–36
References
American Marketing Association (2013) ‘Definition of Marketing’, [online].
Available at https://www.ama.org/AboutAMA/Pages/Definition-of-
Marketing.aspx (Accessed 24 March 2015).
Chartered Institute of Marketing (2009) Marketing and the 7Ps: a brief
summary of marketing and how it works, [online]. Available at http://www.
cim.org/files/7ps.pdf (Accessed 24 March 2015).
Ellis, N. (2011) Business to Business Marketing: Relationships, Networks
and Strategies, Oxford, Oxford University Press.
Hastings, G. and Domegan, C. (2014) Social Marketing: From Tunes to
Symphonies, Abingdon, Oxon: Routledge.
Kotler, P., Armstrong, G., Harris, L. and Piercy, N.F. (2013) Principles of
Marketing, European Edition, 6th edition, Harlow, Pearson.
Lees-Marshment, J. (2014) Political Marketing: Principles and
Applications, 2nd edition, Abingdon, Oxon, Routledge.
Winch, J. (2013) ‘Over 30m people receive PPI nuisance calls’, The Daily
Telegraph, 29 August 2013. [online]. Available at http://www.telegraph.co.
uk/finance/personalfinance/10272025/Over-30m-people-receive-PPI-
nuisance-calls.html (Accessed 24 March 2015).
12
Reading 29: The marketing plan

Introduction
Planning is an essential part of how organisations achieve their objectives
within their resource constraints. A marketing plan specifies the strategies
and actions to be pursued, who will undertake them, the timeframe and the
intended outcomes. It also enables any problems to be detected early so that
corrective action can be taken. This reading examines the marketing plan
and its related activities. You will first learn about the marketing planning
process, then discuss marketing information, competitors and suppliers, and
finally marketing strategy, including segmentation, targeting and positioning.
1 The marketing planning process

Planning has been defined as:
a process in business that provides a systematic structure and

framework for considering the future, appraising options and
opportunities, and then selecting and implementing the necessary
activities for achieving the stated objectives efficiently and effectively.
(Brassington and Pettitt, 2006, p. 995)
The marketing plan sets out how marketing activities will be used to pursue
an organisation’s goals or objectives. For example, the academic publishing
company Sage aims to be ‘the world’s leading independent academic and
professional publisher’ (Sage, 2015). A marketing plan starts with a
situation analysis to establish the organisation’s current position and uses
this as a basis to derive the marketing strategy – how its objectives will be
achieved – and to devise a marketing programme for implementation to
achieve these objectives. The key components of the marketing planning
process are shown in Figure 1.
Goals Situation analysis Marketing strategy Implementation
• (Organisational • Marketing audit • Marketing objectives • Marketing programme

objectives) • SWOT analysis • Segmentation • Budgets
• Marketing & • Targeting • Monitoring
environmental analysis • Positioning
• Competitor analysis
• Customer analysis
Figure 1 The marketing planning process
1.1 Situation analysis

A situation analysis involves various analyses to assess the current situation
and anticipate future considerations.
13
Readings 28–36
A marketing audit involves taking stock of an organisation’s marketing

activities in relation to the internal and external environment.
You will already be familiar with a SWOT analysis (an organisation’s
Strengths and Weaknesses in relation to the Opportunities and Threats in its
environment). You will also have encountered the market and environmental
analysis known as STEEPLE (Social, Technological, Economic,
Environmental, Political, Legal and Ethical factors).
The final two components of the situation analysis are a competitor analysis
and a customer analysis, which involve identifying current and potential
competitors and customers. Both involve looking beyond the most obvious
competitors and customers. Competitors can include not just similar
products or services offered by other organisations, but also other types of
solutions to customers’ needs. For example, while pubs have declined
dramatically in the UK in recent years, coffee shops have expanded.
Although they might not obviously be competitors, both provide a place for
people to stop, meet friends and experience a sense of community.
Similarly, customers can include people who do not themselves consume a
product or service. If you consider children’s toys, entertainment or snacks,
you will notice that these are marketed to appeal not only to children, but
also to their parents who purchase them on their children’s behalf, by
highlighting their educational or nutritional value. Customer analysis will be
dealt with in more detail in Reading 30.
1.2 Marketing strategy

The situation analysis helps to formulate the marketing objectives, which
contribute to achieving the organisation’s objectives and upon which the
marketing strategy is based. A marketing strategy specifies an organisation’s
focus in marketing terms by which it aims to achieve its objectives. For
example, to meet its goal of being ‘the world’s leading independent
academic and professional publisher’, Sage has to make sure its books are
bought by as many people as possible across the world.
1.3 Implementation
The marketing strategy is operationalised through a marketing programme:
. the mix of product that an organisation is offering to consumers, i.e. a

product or service or combination of both
. price – what an organisation charges in exchange for its product
. promotion – the ways in which the product is communicated to
consumers
. place – where the product is offered – the distribution channels.
14
These elements are termed collectively as the ‘marketing mix’ by Borden

(1957, 1964) and subsequently dubbed the ‘4 Ps’ by McCarthy (1960).
We will discuss the marketing mix in detail in later readings.
Implementation of a suitably formulated marketing programme will require
budgeting and monitoring. Budgets need to be agreed to cover the financial
costs of the marketing programme and other resources that will be needed
to undertake it. Monitoring helps to ensure that the marketing plan stays on
track and that timely corrective action can be taken if necessary, rather than
waiting until the end of a marketing programme to assess whether it met its
marketing objectives.
The remainder of this reading will deal with marketing information (which
forms part of the customer analysis); competitor analysis; and marketing
strategy, particularly segmentation, targeting and positioning.
2 Marketing information
A marketing plan needs to be underpinned by accurate and timely marketing
information. Marketing information is used to ensure that an organisation’s
offering meets customers’ needs and to forecast and anticipate trends in the
market and the wider environment, so that relevant strategies can be
developed that respond to these trends while still addressing an
organisation’s objectives.
Marketing information can take a variety of forms, including:
. internal organisational records (such as sales data, complaints records

and loyalty scheme information)
. marketing research (both primary research conducted specifically for the
organisation’s benefit and relevant secondary research conducted for
other purposes – the latter could include, for example, customer research
for a related product or a newspaper article about a competitor)
. marketing intelligence (information collected through publicly available
sources, such as websites, observation, news reports, trade publications).
Internal organisational records can yield large quantities of data and are
likely to need to be managed and analysed to convert them into useful
information. They are most likely to be quantitative data, that is, data that
are expressed numerically. For example, a coffee house chain may analyse
data of its past sales in terms of total sales of a particular product (e.g. a
regular-sized cappuccino) as well as the percentage of customers that chose
that particular product (perhaps 20% of a coffee house’s coffee sales might
be regular cappuccinos). Such sources may only provide limited insights
and incomplete understanding of, for example, customer motivations and
evaluations. As a result it is often supplemented by non-numerical data,
known as qualitative data, for example from interviews exploring
consumers’ attitudes and perceptions.
Marketing research can take the form of surveys that generate quantitative
data or interviews that produce qualitative data (Figure 2). The research
may involve primary or secondary data. Primary data are marketing research
15
Readings 28–36
data that are designed for a specific marketing purpose, for example to
explore consumers’ reactions to a planned advertising campaign. Secondary
data are data that were originally collected for some other purpose but can
subsequently be used to help answer a different question, for example
secondary data about consumers’ shopping patterns might help to inform
decision-making about the location of a new supermarket. A limitation is
that secondary data might not perfectly fit the question for which it is
subsequently used, not having been designed for this purpose.
Figure 2 Market research interview
A variety of research methods may be used:
. surveys – either self-completion or administered by an interviewer.

. interviews – asking open-ended questions of individuals with questions
being structured to varying extents, including in-depth, where
interviewers explore issues according to matters raised by interviewees,
and semi-structured, where interviews follow a list of questions, but
retain some flexibility to examine issues raised. Some closed questions,
which require a specific answer (for example, yes or no) may also be
used.
. focus groups – small groups of people usually of similar age or the same
gender take part in discussions led by a facilitator to explore particular
issues. For example, a group of young men might be asked to discuss
their needs for skin care products by a research facilitator who asks
questions and prompts exploration of issues raised and encourages
everyone to contribute their views.
. observation – people’s behaviour is observed without intervention, for
example to observe how they navigate around a store.
. experiments – these may be used where the effects of a product or
consumer preferences need to be independently established. For
example, cosmetics brands often use experiments conducted by
independent research companies to support claims about their products’
effectiveness.
. projective techniques – this involves asking people to respond indirectly
in creative ways, where direct questioning could be sensitive or
embarrassing, for example people might be asked what word or image
16
they associate with something, or asked to complete a sentence

spontaneously or asked what a cartoon character might be saying.
Such methods may be used on their own or in combination. Using different
methods to research the same issue is called ‘triangulation’. They may also
be conducted via a variety of channels, for example, face-to-face, by
telephone, by post or online.
Marketing research is most commonly conducted to inform an organisation’s
decision-making and to help develop its products to ensure they match
consumers’ needs. However, it can also be used for other purposes. For
example, the coffee house brand Costa Coffee commissioned research that
used blind taste tests to establish the superior taste of its coffee in relation
to the market leader at the time, Starbucks. Costa used the research to
underpin an effective advertising campaign that used the line: ‘Sorry
Starbucks – the people have voted. In head-to-head taste tests, 7 out of 10
coffee lovers preferred Costa cappuccino to Starbucks’. Although Starbucks
complained to the Advertising Standards Authority (ASA) about the
advertisement, the ASA upheld Costa’s claims, which were supported by the
research (BBC, 2012).
Competitive marketing intelligence ‘is the systematic collection and analysis
of publicly available information about consumers, competitors and
developments in the marketplace’ (Kotler et al., 2013, p. 122). It helps
marketers to:
. understand customers and the ways in which they respond to branding

. monitor competitors’ activities
. detect opportunities and threats.
While marketing intelligence can help with environmental analysis, it can
be subject to proprietary restrictions or confidentiality considerations.
Legitimate intelligence obtained through publicly available sources (such as
exhibitions, websites and press cuttings) can be used to identify a
competitor’s range of products or services, positioning, promotional
activities, and strengths and weaknesses in order to help with an
organisation’s own strategy and market planning.
Ethics is an increasingly important issue in handling marketing information.
Marketers need to be mindful of data protection regulations relating to the
personal information they hold about customers and potential customers and
not engage in deception to obtain access to information. They also need to
restrict intelligence gathering to legitimate sources and not engage in
unethical or unfair behaviour or industrial espionage.
3 Competitor analysis
To compete successfully in a market, businesses need a good understanding
of their competitors, which feeds into the situation analysis as part of the
marketing planning process (shown previously in Figure 1). Businesses need
first to recognise who their competitors are, identifying not just the obvious
competitors who offer similar products or services, but consider more
17
Readings 28–36
broadly offerings that meet similar consumer needs, but perhaps in different
ways. Taking the widest definition, all businesses compete with all other
businesses for a share of customers’ money. If people decide to buy a new
car in one year they may then not want to or be able to afford an expensive
holiday in the same year. More immediate competitors depend on the
market segment that the business is targeting (i.e. the subgroup of customers
whose needs an organisation is trying to meet). As segments have different
needs and expectations, businesses may face different sources of
competition in different segments. For example, a bookseller might segment
(i.e. divide into smaller groups) their customers into those seeking
entertainment and those seeking information. In the first case, competition
would include that from other entertainment industries, such as cinema,
whereas in the second case other sources of information, such as online
encyclopedias or television documentaries, would need to be considered.
One useful way of analysing the type and severity of competition in an
industry has been suggested by Michael Porter in an article first published
in 1979 and since then reprinted several times (Porter, 2008). In this article
Porter proposes a ‘five forces’ model of the immediate environment. The
five forces are:
1 industry rivalry
2 the threat of new entrants into the industry
3 the threat of substitutes
4 the bargaining power of customers
5 the bargaining power of suppliers.
Threat of
new entrants
Bargaining power Bargaining power

Industry rivalry
of customers of suppliers
Threat of
substitutes
Figure 3 A graphical representation of Porter’s Five Forces (source: based on

Porter, 2008, p.80)
Figure 3 gives a graphical representation of Porter’s five forces.

Porter developed this model as a means of analysing the attractiveness of an
industry – the stronger all of these forces are the less attractive it will
normally be for a business to be operating in that industry. The first force,
‘industry rivalry’, refers to the competition between those businesses that
are offering the same or similar products to similar customers. For example,
in the UK the large supermarket chains Tesco, Sainsbury’s, Asda and
Morrisons all offer very similar product ranges and services and are in
direct competition with each other.
18
The ‘threat of new entrants’ refers to the likelihood of a new competitor

entering the same market, for example, UK supermarkets are facing
increasing competition from the German supermarket chains Aldi and Lidl.
According to Porter, barriers to entry (which reduce the threat of new
entrants) can include:
. Government policy or legal requirements restricting access. For example,

in virtually all countries you need to have passed several stringent
examinations before being able to set yourself up as a lawyer or a
doctor.
. High capital requirements. It is obviously financially easier to set up a
market stall than to build a new steel works.
. Economies of scale. If you need a certain size of business in order to be
profitable, then it is more difficult for a small firm to enter the market.
. Expected retaliation from existing competitors in the industry.
. Access to distribution. If you are to build a new food brand you will
need to negotiate access to the main food retailers in order to sell it (at
least if you are aiming for large quantities).
. Customer loyalty to established brands.
The ‘threat of substitutes’ refers to the likelihood that a business’s products
or services could be replaced with other products or services that, although
dissimilar in some respects, are capable of fulfilling the same customer
need. In the music industry, vinyl records were replaced with CDs, and the
latter are increasingly being replaced by music downloads from online
sources. Sometimes these trends can also be reversed and sales of vinyl
records have recently seen a bit of a revival (Ellis-Petersen, 2017).
If suppliers and customers are in a strong bargaining position, this is likely
to put more competitive pressure on the business in the industry. For
example, if most customers are very powerful (perhaps because they are
very large or because they have a strong market position with few
competitors themselves) then businesses selling to these customers may
have to compete strongly between each other in order to secure sales. For
example, there have been repeated criticisms that the large UK supermarkets
are using their strong market position to push down the prices of key
products, such as milk, leaving dairy farmers in a difficult economic
situation (BBC, 2012).
Porter’s model is obviously a simplification and contains a number of
assumptions that may not necessarily hold true. Most notably perhaps, it
seems to assume that the competitive environment changes only slowly, so
that businesses can assess it with a fair amount of certainty and are able to
plan. These criticisms notwithstanding, the model is quite useful for
understanding some fundamental aspects of competition.
19
Readings 28–36
4 Marketing strategy
Marketing strategy is the way in which an organisation chooses to achieve
its objectives and ‘is the process of analysing the environment and
designing the fit between the organization, its resources and objectives and
the environment’ (Proctor, 2002, p.1). An organisation’s marketing
objectives will have been derived from the situation analysis and
conjunction with the organisation’s objectives. Before considering an
organisation’s strategic options, we will first look at ‘the three pillars of
modern marketing strategy’ (Proctor, 2002, p. 188): segmentation, targeting
and positioning. We will then consider the strategic options in relation to
the stage of the product in its life cycle.
4.1 Segmentation and targeting

The process of dividing customers into subgroups according to various
distinguishing characteristics (such as age), is referred to as ‘segmentation’,
a concept based on the work of Robinson (1933) and developed and
popularised by Smith (1956). Marketers recognise the truism in the saying
that ‘you can please some of the people all of the time, you can please all
of the people some of the time, but you can’t please all of the people all of
the time’. So marketers use the process of segmentation to break down a
market of consumers into smaller groups using different forms of
categorisation. They then identify which group to focus (or target) their
efforts on attracting to their product offering – a process known as
‘targeting’ and hence the term ‘target audience’. The UK coffee house
market is dominated by three big brands: Costa Coffee, Starbucks and Caffè
Nero. However, each has a different target audience: Costa Coffee is
especially popular with women aged 35-54, Starbucks appeals to young
people and Caffè Nero attracts a more male audience.
Figure 4 Coffee shop customers
People can be grouped into segments in a variety of ways using basic

customer characteristics or product-related behavioural characteristics (Dibb
et al., 2001, p. 211):
20
Basic characteristics:
. demographic characteristics (for example, age, gender, race, religion)

. socio-economic characteristics (for example, social class, education,
income and occupation)
. geographic location (for example, housing location, urban/rural setting,
region, country)
. personality, motives and lifestyle (for example, risk-averse consumers,
consumers concerned with status, young families).
Product-related behavioural characteristics:
. purchase behaviour (for example, convenience-based, price-orientated)

. purchase occasion (for example, emergency or special occasion
purchases)
. benefits sought (for example, performance, prestige)
. consumption status (for example, regular, light, potential or non-users)
. attitude towards the product (for example, concern for the environment).
Basic consumer characteristics data is relatively easy to obtain, but not
everyone who shares the same demographic characteristics will have the
same needs or preferences, and grouping people in this way risks making
erroneous assumptions or drawing on stereotypes. For example, not all men
enjoy football and not all older consumers are inexperienced with social
media. So grouping people using product-related behavioural characteristics
can be useful.
4.2 Positioning
Once an organisation has decided which market segments to target, it needs
to ensure that their product offering is perceived to meet the needs and
expectations of those segments. In other words, there is a need to ‘position’
products or services in line with these needs and expectations. What counts
here is how customers define important product attributes and perceive the
business and what it has to offer.
Positioning was described by Rossiter and Percy (1996) as: 1) To ... (target
audience) ... 2) is the brand of ... (category of product) ... 3) that offers ...
(benefit). For example, Cadbury’s Fuse was positioned as: 1) To people on
the go (target audience) 2) Fuse is the brand of chocolate snack bar
(category) that offers 3) a filling snack with high chocolate content and a
variety of ingredients inside (benefit).
Positioning involves identifying competitive advantages that differentiate an
offering and enable it to occupy a distinct place in consumers’ minds
relating to competing offerings. Caffè Nero differentiates itself from the
other two leading coffee house brands by promising to provide an authentic
Italian coffee experience. Its baristas wear T-shirts carrying the strapline
‘The best expresso this side of Milan’ and the company employs an Italian
food consultant to create authentic Italian food to offer its customers.
21
Readings 28–36
Exercise 1
Using Rossiter and Percy’s (1996) formula, identify the positioning of a

product and a service with which you are familiar. Make notes of your
answer in whatever note format you prefer to use.
To ................................ (target audience) .....................................(product)

is the brand of ....................................(category of product) that offers
....................................... (benefit).
To ................................ (target audience) .....................................(service)
is the brand of ....................................(category of product) that offers
....................................... (benefit).
4.3 The product life cycle and strategic options

A product is viewed as having a product life cycle (PLC), a concept
originated by Forrester (1959) that borrows as a metaphor the biological life
cycle. This uses various stages of growth, maturity, aging and decline to
represent the progression of a product over time. A graph is typically used
to represent the stages of a product’s life cycle with time along the
horizontal axis and a curve plotted against revenue on the vertical axis to
show how sales increase then fall as a product passes through the various
stages of the life cycle. A product’s life cycle starts with its introduction,
progressing over time to the stages of growth, maturity and finally a
decline. The level of sales follows an elongated ‘S’ shape across the four
stages: starting low, increasing rapidly during the growth stage, levelling off
at maturity and decreasing into the decline stage. Different strategies are
appropriate at different stages of a product’s life cycle (Shaw, 2012) as
illustrated in Figure 5.
22
Sales
Introduction Growth Maturity Decline
Time
Penetration
Niche
Segment expansion
Brand expansion
Differentiation
Maintenance
Harvesting
Divesting
Figure 5 Shaw’s framework for marketing strategy (source: adapted from

Shaw, 2012)
At the introduction stage, Shaw (2012) argues there is a choice of two

strategies:
. A ‘niche strategy’, also referred to as a single-market strategy, involves

focusing on one narrowly defined market segment. A niche segmentation
strategy often uses price skimming – introducing a product at a high
price to sell to customers who are not price sensitive (less concerned
about price) and then progressively reducing the price to appeal to
customers who are more price sensitive (less willing or less able to pay
a high price).
. A ‘penetration strategy’ attempts to meet the needs of a large market
segment or multiple segments, for example by introducing a product at a
low price but capturing enough market by doing so to deter competitors
from entering the market owing to the low profit margins. Low price
might be combined with product quality and a high level of promotion
and distribution to increase penetration further.
In the early growth stage, two further strategies may be used:
. ‘segment expansion’, whereby additional customer segments are targeted

. ‘brand expansion’, in which additional products or variations on a
product (for example, providing additional services) are introduced to
increase customer choice and value.
As growth accelerates, another ‘strategy’ becomes an option and may be
followed into the maturity stage:
. A ‘differentiation strategy’ involves enhancing a product’s customer

value by adjusting product quality, the price level, promotion and/or
distribution. For example, a product might be differentiated from its
competitors by increased product quality, better value through reduced
23
Readings 28–36
price, higher prestige through a marketing communication campaign or

more convenience through wider distribution channels.
In the maturity stage, organisations may follow a relatively passive strategy:
. A ‘maintenance strategy’ involves using a stable marketing mix. Shaw

(2012) notes this is common among organisations that have a large
market share and few competitors, such as in oligopoly industries
(industries that are dominated by just a few sellers). The aim of a
maintenance strategy is to use adequate investment to maintain product
quality and customer loyalty.
As a product reaches mid-late maturity and sales begin to decrease, an
organisation may adopt:
. a ‘harvesting strategy’, in which expenditure on the marketing mix is cut

back so that sales exceed marketing expenditure. The aim is to maximise
the organisation’s cash flow and prolong and slow the product’s rate of
decline.
Finally, as a product’s sales decline still further it may become necessary to
follow:
. a ‘divesting strategy’ may become necessary in which expenditure on

the product ceases and it is withdrawn from the market.
However, some organisations are able to avoid decline by initiating new
growth. For example, many models of car are rejuvenated through periodic
redesigns and improvements. The Ford Fiesta, introduced in 1976 and now
in its seventh generation, was the best-selling car in September 2014 (The
Telegraph, 2014).
Exercise 2
What types of strategy do you think the following companies use?
Apple
Lamborghini (the luxury super sport car brand)
Federal Express (FedEx – the global express distribution company)
Comment
You could argue that Apple uses a brand extension strategy based on the
fact it has introduced a range of new products over the years; the Apple
computer has been followed by the iPhone, iPad and the Apple watch.
Lamborghini could be categorised as using a niche marketing strategy. Its

2014 benchmark model, the Lamborghini Huracán was priced at 169,500
euros and special editions have been limited to, for example, three units for
the Veneno in Lamborghini’s 50th anniversary year (priced at 3 million
euros), 50 units for the Murciélago 40th anniversary edition in the Verde
Artemis (jade green) and 250 units for the Special Edition of the Gallardo SE
characterised by a two-tone body paint.
24
FedEx could be considered as using a penetration strategy because it

provides delivery to all states in the USA and more than 220 countries and
territories worldwide.
Summary
In this reading we have looked at the marketing plan and its components
and how it is important to understand not only customers, but also
competitors, and the wider marketplace, using information and analyses to
help with decision making and strategy formulation. Hopefully, you will
have begun to appreciate how all aspects of marketing are connected and
feed into each other and collectively affect an organisation’s success. In the
next reading, we look at customers and consumers in more depth.
25
Readings 28–36
References
BBC (2012) Business boomers: coffee shops and hot shots. [online].
Available at https://www.youtube.com/watch?v=a2LcpwexhiU (Accessed 23
March 2015).
Borden, N.H. (1957) ‘Note on concept of the marketing mix’. In: Kelley, E.
J. and Lazer, W. (Eds), Managerial Marketing, Homewood, IL, Richard D.
Irwin.
Borden, N.H. (1964) ‘The concept of the marketing mix’, Journal of
Advertising Research, June, pp. 2-7.
Brassington, F. and Pettitt, S. (2006) Principles of Marketing (4th Edition),
Harlow England, Prentice Hall, p. 995.
Dibb, S., Simkin, L., Pride, W.M. and Ferrell, O.C. (2001) Marketing.
Concepts and Strategies, Boston, USA, Houghton Mifflin.
Ellis-Petersen, H. (2017) ‘Record sales: vinyl hits 25-year high’, The
Guardian, 3 January 2017, [online]. Available at https://www.theguardian.
com/music/2017/jan/03/record-sales-vinyl-hits-25-year-high-and-outstrips-
streaming (Accessed 30 May 2017)
Forrester, J.W. (1959) ‘Advertising: a problem in industrial dynamics’,
Harvard Business Review, March-April, pp. 100-110.
Kotler, P., Armstrong, G., Harris, L.C. and Piercy, N. (2013) Principles of
Marketing (6th European Edition), Harlow, Essex, Pearson Education
Limited.
McCarthy, E.J. (1960) Basic Marketing: A Managerial Approach,
Homewood, IL., Richard D. Irwin.
Porter, M.E. (2008) ‘The Five competitive forces that shape strategy’,
Harvard Business Review, vol. 86 (January), pp. 78-93.
Proctor, T. (2002) Strategic Marketing. An Introduction, London, Taylor &
Francis.
Robinson, J. (1933) The Economics of Imperfect Competition, London,
Macmillan and Company.
Rossiter, J.R. and Percy, L. (1996) Advertising Communications and
Promotion Management, New York, McGraw Hill.
Sage (2015) ‘Company information’. [online]. Available at Sage http://www.
uk.sagepub.com/aboutus/ (Accessed 20 March 2015).
Shaw, E.H. (2012) ‘Marketing Strategy’, Journal of Historical Research in
Marketing, vol. 4 (issue 1), pp. 30-55.
Smith, W.R. (1956) ‘Product differentiation and market segmentation as
alternative marketing strategies’, Journal of Marketing, vol. 20 (July)
pp. 3-8.
26
The Telegraph (2014) ‘September 2014’s best selling cars’. [online].

Available at http://www.telegraph.co.uk/motoring/picturegalleries/11143284/
September-2014s-best-selling-cars.html (Accessed 20 January 2015).
27
Readings 28–36
Reading 30: Understanding

customers
Introduction
Marketing as a business practice is all about understanding actual and
potential customers and meeting their needs, tastes and expectations.
Without a good understanding of customers a business is unlikely to be
successful in the long run. In trying to understand customer behaviour it is
useful to distinguish between the buying behaviour of individual consumers
and that of organisational buyers. Individual consumers buy goods and
services for their own use (or that of their family) whereas organisational
buyers buy goods and services to be used in their organisation, for example
in the form of raw materials, parts, office supplies, etc.
This reading first introduces several models of consumer behaviour. It then
looks briefly at the cultural and social meanings of consumption, which can
help us understand why people consume certain products and how they
consume them. The reading then introduces organisational business
behaviour. It finishes with a discussion of the importance of customer
relationships and the concept of relationship marketing.
1 Models of consumer behaviour

Many well-known models of consumer behaviour assume that consumers
tend to make rational choices about the products and services they buy and
use. Such models are concerned with understanding how individual
consumers evaluate and choose products, so that marketers can tailor their
offerings more effectively to consumer needs and expectations.
1.1 A simple model of consumer behaviour

Figure 1 represents a simple model of consumer behaviour, depicting
influences on consumer buying behaviour, buyer decision processes and
buyer responses. The model does not go into detail about what goes on
inside the buyer’s mind – it treats this as a ‘black box’; that is, something
that is known to exist but of which the internal workings are unknown. In
fact, quite a lot is known about what goes on in this black box and other,
more complex models of consumer behaviour capture some of this.
The model shown in Figure 1 assumes there are two main types of external
influence on consumers: market stimuli (the marketing offerings of different
businesses – represented as the marketing mix covered in Readings 31, 32
and 33) and elements of the business environment, as depicted in the
STEEPLE model first introduced in Reading 5. The buyer’s decision process
is discussed in more detail below but this reading will not go into detail
about all the other elements of Figure 1.
28
Reading 30: Understanding customers
The environment Buyer’s black box Buyer’s response

Marketing stimuli Other • Buyer’s characteristics • Buying attitudes and preferences
• Product • Social • Buyer’s decision process • Purchase behaviour: what the buyer
• Price • Technological buys, when, where, how much
• Place (distribution) • Economic • Other behaviour with respect to the
• Promotion (marketing • Environmental brand and company
communications) • Political
• Legal
Figure 1 Model of consumer behaviour (source: adapted from Kotler and Armstrong, 2010)
1.2 Different types of consumer behaviour

Consumers do not all make buying decisions in the same way. Depending
on the type of product being bought, different consumers may search for
different amounts of information on the product beforehand and spend
varying amounts of time assessing this information. Assael (1995)
distinguishes between four types of consumer buying behaviour:
. complex buying behaviour

. dissonance-reducing buying behaviour
. habitual buying behaviour
. variety-seeking buying behaviour.
Which kind of behaviour consumers engage in depends on how involved
they are in a particular purchase. This partly depends on their personality
and partly on the kind of purchase being made. The type of buyer behaviour
also depends on whether or not consumers can see significant differences
between the brands on offer. For example, there may be quite considerable
differences between the specifications and performance of different types
and makes of laptop computer but for many people, particularly those who
are less interested in or knowledgeable about computer technology, such
differences are difficult to tell. However, in recent years online price and
product comparison sites have made such information much more easily
accessible and comparable for consumers. Figure 2 shows Assael’s four
types of buying behaviour.
High involvement Low involvement
Significant Complex buying Variety-seeking

differences behaviour buying behaviour
between brands
Few differences Dissonance-reducing Habitual buying

between brands buying behaviour behaviour
Figure 2 Types of buying behaviour (source: adapted from Kotler and

Armstrong, 2010)
29
Readings 28–36
Complex buying behaviour

According to Assael (1995) ‘complex buying behaviour’ is characterised by
high consumer involvement and significant differences between brands. It
tends to occur when a purchase is expensive, risky or purchased
infrequently, or when consumers use the product to express themselves. A
good example is the purchase of a house or flat. For most people this
happens only very rarely; it may even happen only once in their lifetimes.
They will normally be very involved in this purchase; after all they will
usually expect to live in this house or flat for quite some time. Buying a
property is expensive and risky; most people need a mortgage to make the
purchase and therefore will commit themselves to regular payments over a
long period of time. However, many other types of purchases can also fall
into the category of complex consumer behaviour, including cars, more
expensive items of IT or home entertainment equipment, the holiday of a
lifetime or similar.
Figure 3 House for sale
Complex buying behaviour can also apply to much smaller purchases,

depending on the personality or mood of the consumer. For example, people
might spend quite some time considering alternatives and making up their
minds when buying even a relatively small gift for someone who is
important to them, or when choosing an outfit to wear for an important
occasion, say a friend’s wedding or a job interview. In this kind of buying
behaviour consumers are most likely to go through all or most of the stages
of the buyer decision process discussed below.
Dissonance-reducing buying behaviour

Consumers tend to engage in ‘dissonance-reducing buying behaviour’ when
they are highly involved in the purchase, but have difficulties determining
the differences between brands. ‘Dissonance’ can result from such a
purchase if consumers worry afterwards that they may have made the wrong
choice. Financial services products, such as insurance or investment
products, are good examples. Often a consumer will choose such products
on the basis of price or convenience and then seek further confirmation,
after the purchase, that they made the right choice. For instance, they may
seek out favourable product reviews online or in newspapers or magazines.
30
Figure 4 Insurance policy
Habitual buying behaviour

‘Habitual buying behaviour’ is perhaps the most common type of buying
behaviour. This occurs when consumers are not very involved in the
purchase, perhaps because the item is bought very frequently and/or does
not cost much money, and when they perceive few significant differences
between brands. Consumers tend to buy the same brand again and again out
of habit, but if their particular brand is not available, or if there is a good
offer on a competing brand, they may switch quite easily. Marketers of
goods in this category – such as household detergents, soap or toothpaste,
many groceries and a large number of other frequently bought items – often
use sales and price promotions to entice consumers.
Figure 5 Toothpaste
Variety-seeking buying behaviour

‘Variety-seeking buying behaviour’ occurs when consumers perceive
significant differences between brands but are not particularly involved in
the purchase. Many groceries fall into this category – for example, different
types of biscuit, bread or ice-cream – where consumers often alternate
between different brands for variety.
31
Readings 28–36
Figure 6 ‘Well done, another winner, Haskins.’
1.3 The buyer decision process

Consumers typically go through a number of stages when making ‘complex
buying decisions’. These are shown in Figure 7.
Need Information Evaluation of Purchase Post-purchase

recognition search alternatives decision behaviour
Figure 7 Stages in the buying decision process (source: adapted from Kotler and Armstrong, 2010)
In the first stage the consumer notices a problem or need that may be solved
through purchasing something. A need for financial advice, for example,
may be triggered by internal stimuli, such as a large overdraft, or by
external stimuli, such as an advertisement by a financial services business or
a friend telling you about professional financial advice that helped them.
Once the need is felt consumers may search for more information about the
products that might satisfy this need. Information search is likely to be very
limited or non-existent for habitual and variety-seeking behaviour, but more
extensive for complex buying behaviour. Kotler and Armstrong (2010)
distinguish between the following information sources:
. personal sources: family, friends, neighbours, acquaintances

. commercial sources: advertising, salespeople, the internet, packaging,
displays
. public sources: mass media, consumer-rating organisations; customer
reviews, price comparison sites
. experiential sources: handling, examining, using the product.
While consumers tend to receive the largest quantity of information from
commercial sources, the most influential sources are often personal as these
are considered more trustworthy; for example, information received by word
of mouth from friends or colleagues. While gathering information about
products, consumers already tend to start comparing and evaluating the
different products on offer.
Next, the consumer will normally come to a purchase decision. This may be
to purchase one of the brands they have looked at. However, consumers
may also find that none of the brands fulfils their requirements and that they
32
need to look at an alternative type of product altogether. They may also

decide not to purchase a product at this stage. For example, someone may
have a firm intention of buying a new kitchen, but then have their hours at
work reduced or face another urgent expenditure. As a result, they may
decide to postpone their purchase of the new kitchen.
Consumer behaviour does not stop once a purchase has been made. While
using the product they may find that it performs as well or better than they
expected, in which case they will be happy with their purchase and may
recommend the product to other people or write a positive review. If the
product does not perform as well as expected or has faults, however,
consumers have a number of options:
. to complain to the seller and expect any faults to be remedied

. to decide not to buy this kind of product again
. to tell all their friends and family about the problems they have had with
the product
. to write a negative review of the product.
Businesses need to provide solutions to any post-purchase problems, such as
repair or replacement of faulty goods. At the end of their useful life,
products need to be disposed of. This can be a problem for consumers if,
for example, the product contains any harmful materials such as the
coolants in refrigerators. Businesses are also increasingly asked to take back
products at the end of their life span. For example, the European car
industry is being asked to make more car parts recyclable and may be
required to take back old cars in the future.
Exercise 1
The purpose of this exercise is to link the theory of buying behaviour to your
own experience. Think about a recent purchase where you have engaged in
complex buying behaviour.
1 Describe the stages in the buying decision process that you went
through.
2 How was this process and the final decision you made influenced by
elements of the marketing environment?
Comment
1 The stages you have identified may coincide with those depicted in
Figure 7, but you may also have skipped some or gone through them in a
different order. Your information sources, the brands you considered, the
attributes you found important, how the different brands matched your
needs and the final decision you made will, of course, depend on the
product you were buying, as well as your personal preferences. You
should also have thought about what you did with the product after you
purchased it, whether there were any problems with it and, if so, what
you did about them.
33
Readings 28–36
2 Any influences from the marketing environment will also depend on the
kind of product you bought and your own circumstances and preferences.
You may have identified some sociological and demographic influences,
such as your age group, family circumstances or ethnic background;
economic influences, such as your income or the general economic
outlook; environmental influences, such as a preference for ecologically
sound products; technological influences, such as the compatibility of a
product with other technological systems that you may use; and/or
political influences such as the legality of certain types of products.
2 Social and cultural aspects of

consumption
We will now look at the role of marketing and consumption in the wider
social environment. Marketing is not only an aspect of business
management; increasingly, it is also seen as an important feature of
contemporary, affluent societies (sometimes called consumer societies). We
will first look at the notion of ‘consumer society’ and what this entails.
After that we will discuss cultural and social aspects of modern
consumption, particularly the notions of consumption as hedonistic pleasure,
as part of building self-identity and as communication. Understanding the
wider context of contemporary consumption is crucial for businesses
operating in consumer markets, as consumer behaviour is more complex
than a series of marketing inputs and consumer behaviour responses.
2.1 Consumer society

Consumption and marketing are important aspects of contemporary affluent
societies. McCracken (1990) describes consumption as essentially a cultural
phenomenon and argues that:
… in Western developed societies culture is profoundly connected to

and dependent upon consumption. Without consumer goods, modern,
developed societies would lose key instruments for the reproduction,
representation, and manipulation of their culture … The meaning of
consumer goods … [is an] important [part] of the scaffolding of our
present realities. Without consumer goods, certain acts of self-
definition and collective definition in this culture would be impossible.
(McCracken, 1990, p. xi)
Consumer society is characterised by the fact that a large proportion of the

population has access to a wide variety of consumer goods. People
increasingly define their lifestyle and position in life at least partly through
the goods and services that they own and consume. Consumer society has
been made possible only by industrialisation, which facilitated the mass
production of large numbers of consumer goods and then found a way of
34
making these goods available to the majority of the population. According

to Miles (1998), a crucial development in the emergence of consumer
society was the growth of working-class purchasing power. What used to be
luxury goods (such as dishwashers) gradually became everyday items
affordable by the majority of people. This applies only to affluent,
industrialised societies, however. In many countries of the world even today
the vast majority of the population can only dream of possessing consumer
goods that people in the industrialised world take for granted. Consumption
thus came to play an increasingly important role in people’s lives and
gradually the style and image of consumer goods became as important, if
not more so, than their functional value. This was accompanied and
encouraged by marketing tools, most notably advertising, which announced
the availability of these items to everybody and painted images of
glamorous lifestyles using a variety of consumer goods.
Figure 8 Consumer society
As Gabriel and Lang (1995) observe, views on the merits of consumer

society are mixed. Some think that the rise of consumer society allows new
freedom for people and gives meaning to their lives in an age when religion
and political ideologies have lost their meaning for many people. Other
views are more critical and argue that consumer society promotes excessive
preoccupation with material goods and money. Other authors discuss the
impact of the materialism associated with consumer culture on societies
(Steinfield and Scott, 2013) and the damage done to the natural
environment. Kilbourne (1998) argues that contemporary consumer societies
value money and material wealth above all else. People constantly buy new
goods rather than continuing to use and perhaps repair old but still
serviceable ones. For Kilbourne, these trends are at the heart of the current
environmental crisis.
35
Readings 28–36
Exercise 2
In order to relate the concept of consumer society to your own experience try
to answer the two questions below:
1 Do you think we live in a consumer society?

2 Can you think of examples where your own lifestyle, status and image
might be – partly – defined through consumer goods?
Comment
1 If you live in an affluent society, such as Western Europe, you will
probably answer the first question with ‘yes’. You may have thought about
aspects of modern life that remain less touched by consumption, but will
probably have found that there are not that many.
2 Examples of consumer goods that influence our lifestyle, self-image or
status are numerous and different people will come up with different
instances of this. The music we like to listen to, the clothes we wear, the
mobile phones or tablet computers we use, the kind of holidays we take,
to give just a few examples, all contribute to an image of ourselves, our
lifestyles and the status we may have in our own and in other people’s
eyes.
2.2 Consumption as pleasure

Most of us are familiar with the idea that consumption can be an activity
that brings pleasure. Many people enjoy the act of shopping itself; for
instance, the anticipation, the browsing and the comparison of goods, the
atmosphere of smart shops or lively markets, or the myriad options
available at a mouse-click from internet shopping pages. Many goods and
services, such as holidays or cosmetics, are bought precisely because they
are pleasurable to use. Independent of the actual use, we may also gain
pleasure from merely owning certain things because they allow us to show
off our style and taste to others (Bourdieu, 1984) or to dream and fantasise
about enjoyable, even if often somewhat unrealistic, scenarios involving
these objects (Campbell, 1987). For example, the owner of a pair of high-
performance running shoes might dream about running a marathon one day.
This dream will give them pleasure even when it is quite unlikely that they
will ever actually run the marathon.
36
Figure 9 The dream of winning the race
2.3 Consumption and identity

A second aspect of consumption is the way in which it can become a means
to help people construct (and communicate) their personal identity. At one
time, the work you did, the kind of house you lived in, the kind of person
you might marry, how you dressed and even the religion to which you
adhered were generally more or less determined at birth. In modern
societies this has changed. People rarely remain in the place in which they
were born but move around. They have far more freedom to choose their
work, their partners and their lifestyle. This means that they often need to
think about their own identity, and that they can and need to decide on their
lifestyle from different options (Giddens, 1991).
Consumption can play a major role in these choices. Through the kind of
goods and services that we choose to buy – and those that we don’t choose
to buy – we say something about ourselves, our preferences, our tastes, our
lifestyle and our economic and social status. Not only very special things,
but any kind of object may be loaded with meaning and used to build an
identity and self-image (Featherstone, 1991; Baudrillard, 1997). In this way,
consumers can consciously or unconsciously use products to build an image
of who they are and what they believe (Gabriel and Lang, 1995). For
example, parents may choose prams in order to say something about
themselves and their babies (Thomsen and Sørensen, 2006); families might
use consumption choices to build up their identity as a family (Epp and
Price, 2008); or adolescents may use the consumptions of certain products,
such as alcohol, to construct their membership of a group (Laghi
et al., 2013).
2.4 Consumption as communication

Many consumption activities take place in social settings, most frequently
the family, but also within circles of friends, work groups, and others.
Consumption becomes a kind of language through which people show their
status and taste (Veblen, 1925 [1899]; Bourdieu, 1984), and through which
they express social relationships. For example, Douglas and Isherwood
(1978) found that the food people serve and the porcelain, glass and
silverware that they use when entertaining guests at home varies depending
on whether the guests are parents-in-law, the boss or friends. The chosen
37
Readings 28–36
type of meal and surroundings make subtle – and sometimes not so subtle –
statements about the relationship between host and guests. Can you think of
some consumer goods that you own and what (you think) they say about
you? What does your choice of music, smart phone, handbag or means of
transport say about you? What you buy for others as presents also carries
messages about your relationship with them – what you think of them or
how you want them to regard you.
Figure 10 Handbags
3 Business customers
When thinking about marketing, people often think first of consumer
marketing, but business-to-business marketing is actually equally or even
more important. The overall volume of business-to-business markets is
much larger than that of consumer markets. There are some differences
between consumer and business-to-business markets of which you should be
aware. According to Kotler and Armstrong (2010) the most important
differences relate to:
. market structure and demand

. the nature of the buying unit
. types of buying behaviour.
In business markets, there are typically fewer but bigger buyers. There are
fewer buying businesses than there are consumers, but each business is
likely to buy much larger quantities of a product than a single consumer
would. For this reason business-to-business marketers tend to rely much
38
more on personal selling directly to customers. Often business markets are

also more geographically concentrated than consumer markets. In the UK,
for example, many financial services businesses have traditionally been
based in London. Businesses buy things that enter the production process
which produces consumer goods and services. If demand for consumer
goods changes, then demand for raw materials, parts, energy and other
things bought by businesses also changes.
Business purchases normally involve more people in the decision making.
The more complex a purchase is, the more people are likely to be involved
in it. For example, the purchase of a piece of production machinery may
involve staff from research and development, the engineering department,
the production department, the purchasing department and even, if it is a
particularly important purchase, top management. It is important for
marketers that sales people can deal knowledgeably with all these staff in
the buying unit.
As with consumer behaviour, there are different types of business buying
behaviour. The most important of these are:
. new buy: something a business buys for the first time

. straight re-buys: a simple repeat order for something the business buys
regularly: for example, office stationery
. modified re-buy: the business buys something it has bought before but
wants some modifications to the new purchase: for example, replacement
for worn-out equipment.
A new buy is probably the most complex buying situation, particularly if
the item needed is highly important to the business process and is
expensive. Production machinery or a new IT system may fall into this
category. A large number of people tend to be involved in the buying
process and lengthy discussions with potential suppliers may be necessary
before any decision is made. In straight or modified re-buys the business is
more likely to stay with the existing supplier as long as there have been no
problems with previous purchases. Often, long-term buyer–supplier
relationships develop in these areas.
Exercise 3
To help you gain a better understanding of the types of buying decisions

made by businesses imagine you are setting up a small fashion boutique or
sportswear shop. (You can use another type of business with which you are
more familiar if you like.) Try to answer the following questions:
1 What kinds of products and services does this shop need to buy?
2 Which of these would fall into the ‘new buy’, ‘straight re-buy’ or ‘modified
re-buy’ categories?
Tip: If you have difficulty imagining the products bought by these kinds of
businesses, you could visit one in your area and observe the sorts of things
39
Readings 28–36
they have and use in the shop. (The timing given above obviously doesn’t
include any store visits.)
Comment
1 Initially the store will need to be fitted out with wallpaper, carpets,
furniture, cash tills, computer, and so on. One of the biggest recurring
purchases will be the stock: that is, fashion items, sportswear. A store like
this will also need many other items, such as carrier bags, shoe boxes,
hangers, office stationery, cleaning products, etc. Services, such as
accounting, marketing research or advertising, or cleaning services, may
also be needed.
2 The initial purchases to set up the store (including fitting out and first
purchase of everything) are, of course, all new tasks and will be
considered carefully. Fittings, furniture and furnishings are particularly
important as they will determine the ambience of the shop. Stock
purchases will probably always be considered as ‘new buys’ as getting
the right fashion or sports items, which will appeal to customers, is crucial
to success. After the initial purchase, other items, such as office
equipment or hangers, etc., will probably become straight re-buys, if the
manager is happy with them, or modified re-buys if small changes are
desired.
4 Customer relationships and relationship

marketing
Much of academic marketing theory in the past has focused on the final
point of attracting customers and achieving a transaction (i.e. an exchange
of the business’s product or service against the customer’s money). And in
many cases that is exactly what happens in practice, for example if you buy
a snack from a food vendor or a fast food outlet when on a journey, or
when buying a low involvement item from a shop you go to infrequently.
But in many other cases, businesses actually develop longer lasting
relationships with their customers. For example, if you regularly get your
hair cut at the same place you will have got to know your hairdresser a
little. They will have an idea of how you like your hair cut, so don’t need
to start discussing this from first principles every time you go in. In all
likelihood you will also have engaged in conversations with them while
having your hair styled, so you may well know a fair bit about each other’s
personal lives. You may well go back time and again to that same
hairdresser’s precisely because they know you and your preferences and you
have built up a pleasant relationship.
Personal and sometimes long lasting customer relationships like this are
very important for many businesses, especially those that have a relatively
small number of customers who they can get to know reasonably well over
the years. Businesses that sell to other businesses and businesses that
40
provide services are often those that place most emphasis on building long-
term relationships with customers. This is what is behind the idea of
‘relationship marketing’, which became popular in marketing academia from
the 1990s onwards. Another example of relationship marketing is charity
fundraising, where charities try to establish a relationship with donors to
attract repeat donations. For individual donors who are likely to make
significant donations a good deal of time may be spent cultivating the
relationship in the hope of a large donation.
In contrast to the definitions you read in Reading 28, Grönroos defines
marketing in terms of customer relationships:
Marketing is to establish, maintain and enhance … relationships with

customers and other partners, at a profit, so that objectives of the
parties involved are met.
(Grönroos, 1990, p. 138).
Francis Buttle (1996) argues that the increased attention to relationship

marketing since the 1990s has been driven by a number of factors:
. More intense, often global competition has meant that businesses have
needed new methods of differentiating themselves from their
competitors.
. Many markets have become fragmented into smaller and smaller
segments and thus traditional market segmentation has reached its limits.
. Product quality has become generally high and businesses have found it
increasingly difficult to compete on superior quality alone as most
competitors are able to offer similar quality. This is forcing businesses to
seek competitive advantage in other ways.
. Customers have become more demanding and are not as brand loyal.
That is, they are willing to change suppliers frequently in order to get
the best deal. To keep their customers, businesses therefore need to pay
extra attention to them.
In addition to services marketing and business-to-business marketing, where
some form of relationship marketing has always been practiced by many
businesses (even if it wasn’t always called that), attempts have also been
made to introduce relationship marketing into other consumer markets. One
form of relationship marketing to consumers with which you may be
familiar is the ‘loyalty card’ issued by many large retailers. It is unclear,
however, whether most consumers actually want a ‘relationship’ with, say,
their supermarket.
One of the most important aspects of building long-term customer
relationships is building trust between the business and its customers. Trust
can often be a vital element in business-to-business marketing where
businesses and their customers have to trust each other enough to share
critical information that allows the business to tailor its products and
services to a particular customer (for example by building bespoke
machinery). Similarly, people need to trust their lawyers or doctors and thus
tend to prefer to work with those who they have known for some time.
Trust takes on additional importance in e-commerce, where goods and
41
Readings 28–36
services are sold and payment is received online (McKnight and

Chervany, 2014). Customers need to trust the e-commerce business
sufficiently to pay for goods that they then expect to receive a few days
later, usually through the post. Having dealt with the same e-commerce
business repeatedly and received goods quickly and exactly as expected will
increase the confidence of customers to buy from the same business again.
Positive ratings by other consumers will also increase consumer trust in a
particular provider.
There are good economic reasons why marketers should pay attention to
their relationships with customers. First, it is more expensive to win new
customers than it is to retain old ones and, second, a relationship with a
customer tends to become more profitable for a business the longer it
continues as repeat customers often place larger orders than customers who
are buying from a business for the first time. A key aspect of relationship
marketing is therefore to try to avoid customers moving to other businesses.
Summary
This reading has looked in some detail at customer behaviour. Much of the
focus of the reading has been on consumer behaviour, introducing different
models of consumer behaviour and discussing what cultural and social
meaning consumption carries. You have also learned about organisational
buying behaviour. Many firms only sell to other organisations and for them
an understanding of how such organisations make purchasing decisions is
vital. The reading concluded with a consideration of relationship marketing,
the idea that many organisations will benefit from building up long-term
customer relationships rather than focusing on one-off sales.
42
References
Assael, H. (1995) Consumer Behaviour and Marketing Action, 5th edition,
Cincinnati, South-Western College.
Baudrillard, J. (1997) The Consumer Society, London, Sage.
Bourdieu, P. (1984) Distinction: A Social Critique of the Judgment of Taste,
London, Routledge.
Buttle, F. (1996) ‘Relationship marketing’ in Buttle, F. (ed.) Relationship
Marketing: Theory and Practice, London, Paul Chapman Publishing, pp. 1–
16.
Campbell, C. (1987) The Romantic Ethic and the Spirit of Modern
Consumerism, Oxford, Macmillan.
Douglas, M. and Isherwood, B. (1978) The World of Goods: Towards an
Anthropology of Consumption, London, Allen Lane.
Epp, A. and Price, L. (2008) 'Family identity: a framework of identity
interplay in consumption practices', Journal Of Consumer Research, vol. 35,
issue 1, pp. 50-70.
Featherstone, M. (1991) Consumer Culture and Postmodernism, London,
Sage.
Gabriel, Y. and Lang, T. (1995) The Unmanageable Consumer:
Contemporary Consumption and its Fragmentations, London, Sage.
Giddens, A. (1991) Modernity and Self-Identity, Cambridge, Polity.
Grönroos, C. (1990) Service Management and Marketing: Managing the
Moments of Truth in Service Competition, Lexington, MA, Free Press/
Lexington Books.
Kilbourne, W. (1998) ‘Green marketing: a theoretical perspective’, Journal
of Marketing Management, vol. 14, pp. 641–55.
Kotler, P. and Armstrong, G. (2010) Principles of Marketing, 13th edition,
Upper Saddle River, NJ, Pearson Prentice Hall.
Laghi, F., Baiocco, R., Lonigro, A. and Baumgartner, E. (2013) 'Exploring
the relationship between identity status development and alcohol
consumption among italian adolescents’, Journal Of Psychology, vol. 147,
issue 3, pp. 277-292
McCracken, G. (1990) Culture and Consumption, Bloomington, IN, Indiana
University Press.
McKnight, D.H. and Chervany, N.L. (2014) ‘What trust means in e-
commerce customer relationships: an interdisciplinary conceptual typology’,
International Journal of Electronic Commerce, vol. 6, issue 2, pp. 35–59.
Miles, S. (1998) Consumerism: As a Way of Life, London, Sage.
Steinfield, L. and Scott, L. (2013) 'Creating and resolving tensions:
exploring the different effects materialism has on consumers and society',
Advances in Consumer Research, vol. 41, pp. 126-131.
43
Readings 28–36
Thomsen, T. and Sørensen, E. (2006) 'The first four-wheeled status symbol:

pram consumption as a vehicle for the construction of motherhood identity',
Journal Of Marketing Management, vol. 22, issue 9/10, pp. 907-927.
Veblen, T. (1925 [1899]) The Theory of the Leisure Class: An Economic
Study of Institutions, London, George Allen and Unwin.
44
Reading 31: The marketing mix – product
Reading 31: The marketing mix –

product
Introduction
The marketing mix ‘constitutes the company’s tactical tool kit for
establishing strong positioning in target markets’ (Kotler and Armstrong,
2010, p. 77). We briefly mentioned the marketing mix and its ‘4Ps’ in
Reading 29. The term ‘marketing mix’ was first coined by Borden in 1957.
In 1960 McCarthy introduced the idea of the 4Ps to represent four elements
of the marketing mix: product, price, place (also often referred to as
distribution) and promotion (today more commonly referred to as marketing
communications). Later, three further elements were added to more
accurately reflect the marketing mix for services (people, processes, and
physical evidence). This and the next two readings cover each of these
elements of the marketing mix (or 7 Ps) in turn.
The marketing mix represents the marketer’s perspective and Kotler and
Armstrong (2010, p. 77) noted that, from the customer’s perspective, the
4Ps can be thought of as 4Cs:
Product Customer needs and wants

Price Cost to the customer
Place Convenience
Promotion Communication
In this reading and those that follow, we will discuss each ‘P’ in more
detail, starting in this reading with the ‘product’. We will first discuss what
we mean by product, good and service, then consider the differences
between them and the benefits they offer. The reading will then go on to
examine new product development and conclude by revisiting the product
life cycle.
1 What do we mean by product, good and

service?
Marketers often use the term ‘product’ in a very broad sense to mean an
offering by an organisation irrespective of whether it is a material good or a
service or somewhere between the two. You may have noticed that in
previous readings we have used the terms ‘product’ and ‘offering’
interchangeably. Both goods and services represent bundles of benefits to
consumers that meet their needs and wants. A mobile phone is really a way
of sharing experiences with family, friends and others at a distance, a source
of entertainment and a means of finding your way. A bus service is a means
of getting somewhere and possibly an opportunity for some personal time.
This is the reason why goods and services can be substituted by not only
similar goods and services but by a very different product if it offers similar
45
Readings 28–36
benefits. For example, you might decide to buy a bicycle instead of taking
the bus. The mobile phone has taken the bundling of benefits to an extreme,
but it is still possible to employ service substitutes such as using the post,
having a photographer take your photo, enjoying other forms of
entertainment, and asking people for directions.
Figure 1 Mobile phones
Of course, not all products are aimed at consumers. Industrial products may
be bought by other businesses, perhaps as ‘materials or parts’ for
incorporating into the business buyer’s offerings or as ‘capital items’ for use
in the business buyer’s production or operations (for example, premises or
equipment) or as ‘supplies and services’ that are used in operations or
maintenance (for example printer paper, electricity and cleaning) (Kotler
and Armstrong, 2010).
Furthermore, not all products are ‘things’. The concept of a product can
also be extended to ideas and even people. Think, for example, how
common it is nowadays to refer to bands in the music industry as having
been ‘manufactured’. Other examples of different forms of products include
cities, events (such as festivals, The Olympic Games), movements (for
example, ‘slow cooking’) and even languages (some of you may remember
the created language Esperanto).
Figure 2 London 2012 Olympic Games
46
2 Differences between goods and services

Goods and services are not as different as you might think and many
offerings include elements of each. Although physical goods are thought of
as tangible while services are considered to be intangible, nearly all
physical goods have some intangible elements, such as advice given before
purchase, delivery and instalment, and after-sales services, such as repairs.
Likewise, most services include some tangible goods, such as the food
served in a restaurant or the hair care products applied by a hair stylist. It is
therefore best to think of a continuum of products, ranging from nearly
entirely tangible at one extreme to nearly entirely intangible at the other
extreme, with various combinations of tangible and intangible between these
two poles. This is illustrated in Figure 3.
Tangible
dominant
Detergent
Cosmetics
Salt Soft Fast-food
drinks Car outlets
Fast-food Consulting
outlets Teaching
Ad
agency Airline Financial
services
Intangible
dominant
Figure 3 Tangible and intangible continuum for goods and services (source: adapted from Kotler et al., 2006)
Kotler and Armstrong (2010) proposed five categories of products, based on

combinations of goods and services:
1 Pure tangible good – products with no service (for example, sugar,
music CDs).
2 Tangible good with accompanying service – products with some service,
such as installation, servicing, planning, training or maintenance (for
example, cars).
3 Hybrid offer – an equal mix of physical product and intangible service
(for example, an art workshop that provides both teaching and materials,
so that the consumer takes away both the learning and the art created).
4 Service with accompanying minor goods – services that form the main
offering, but which involve some product(s) (for example, an airline
provides a flight service, but often also offers food and beverages).
5 Pure service – services that are completely intangible (for example, tour
guides).
Alternatively, Blythe (2006) argued that it might be better to talk about
‘service elements’ rather than services, with service elements distinguished
by being:
47
Readings 28–36
. Intangible – they have no physical presence.

. Simultaneous production and consumption – a taxi passenger
experiences the journey at the same time as taking the ride.
. Perishable – if cinema seats are left empty, staff still have to be paid and
if a ferry has only a few passengers it still has to run and incur costs.
The empty seats cannot be sold later.
. Not amenable to trying in advance – you cannot try, for example, a hair
cut in advance or sample an operation before having it.
. Variable – human performance is variable even if a service is provided
by the same person.
Customers, therefore, may be thought of as buying a promise. ‘Intangibility’
often makes it difficult for customers to evaluate the product, sometimes
even after it has been consumed (for example, insurance if no claim has
been made), increasing the risks of purchase. ‘Simultaneous production and
consumption’ involves greater contact between the consumer and the
producer, often enabling service elements to be tailored to a customer’s
needs. For example, a hair stylist might provide tips on hair care or styling
a particular hairstyle. The ‘perishability’ of service elements drives
businesses to try to even out peaks and troughs in demand by offering
discounts or incentives to encourage consumers to fill empty seats or unused
capacity because it is often easier than varying staffing levels to meet
fluctuating demand. For example, holiday companies often offer last minute
discounts on holidays if you book very shortly before going and are not too
concerned about where you want to go.
3 Product benefits
There are three levels of product benefits:
. The ‘core product’ benefit is the kind of main benefit described above;
for example, communicating with friends and family in the case of a
mobile phone.
. The ‘actual product’ has product features and characteristics in addition
to the core benefit. These distinguish one brand from another. All mobile
phones serve as a means of communication, but they also have various
other features, ranging from additional functions such as internet access,
games or picture messaging, a note-taking function and a whole range of
inbuilt or accessory applications.
. At the third level, ‘augmented product’ benefits may include after-sales
services, such as a voicemail service in the case of mobile phones, free
warranties if something goes wrong with the phone or the option to
upgrade to the latest version at a lower price.
The three levels of product benefits are illustrated in Figure 4.
48
Augmented product
Installation
Actual product
Packaging
Core product
Brand Features
name
Delivery After-sale
Core benefit
and credit service
of service
Quality Styling
Warranty
Figure 4 Three levels of product
4 New product development

The process of creating new products is more of an art than an exact
science and it is difficult to generalise about it. However, a frequently
quoted model of the new product development process was proposed by
Crawford (1991). Only a small number of new products are successful and
the model is meant to reduce the risk of new products failing. In this model,
a number of steps of new product development are shown in the following
sequence:
1 New product planning – A business looks at its current products, how
well they are performing, and where the marketing environment poses
threats to existing products and opportunities for new products.
2 Idea generation – Specific ideas for new products are generated and
collected, perhaps through group discussion techniques such as
brainstorming.
3 Idea screening and evaluation – The ideas generated in the previous step
are examined for their feasibility and marketability.
4 Technical development – The technical aspects of the product are
investigated and a prototype is developed.
5 Market appraisal – Market research is carried out to assess whether the
product would be successful in the market.
6 Launch – The product is produced and offered in the market.
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Readings 28–36
Although most businesses are likely to cover all these stages in some form,
they may not give the same priority to each stage and may not follow a
strict sequence. The businesses most successful at developing new products
often carry out several of these stages simultaneously. For example, during
the 1980s and 1990s it was thought that Japanese car makers were much
better at bringing out new models quickly because they were able to shorten
the new product development process by doing several steps at the same
time. Some businesses are much better at developing new products than
others and this may be because of their organisational culture, which values
innovativeness and does not kill off new ideas too quickly.
Although some form of new product development is highly important to
most businesses and many put considerable resources and expertise into
their new product development processes, new products often fail in the
market. Not all innovations that seem technically brilliant to the experts
really fulfil a need in the market. For example, picture messaging in mobile
phone technology initially got off to a slow start because many consumers
did not really see the need to send each other pictures via a phone. On the
other hand, heavy reliance on market research in the early product
development stages may also lead to less than successful innovation.
Consumers generally find it very difficult to envisage real technological
innovations and tend to think in terms of slight improvements to existing
products. If businesses rely heavily on consumer feedback to suggest new
products they may end up being rather timid in their innovation strategies.
One of the difficulties with new products is the time, resources and work it
takes to establish a successful brand. This is why incremental innovations
are often added to existing products that already have loyal customers and
established reputations, rather than being introduced as new products. Car
models are sometimes radically different from their previous incarnations
but retain their model names. For example, the Honda Civic was refreshed
in 2006 and its futuristic new look at that time bore little discernible
resemblance to the preceding model.
Figure 5 Honda Civic 2006
50
Figure 6 Honda Civic 2000
When new products are launched under the umbrella of an existing brand
(as brand extensions) they benefit from the heritage or track record of that
brand, inspiring trust and confidence in customers and increasing the
chances of the new product’s success. For example, when Apple has
launched new products such as the iPad and more recently the Apple watch,
these will have benefited from the reputation of the Apple brand gained
from its Apple computers and iPhones.
Consequently, there are ‘degrees of newness’ (Blythe, 2006, p. 421) as
represented in Figure 7. At the conservative end of newness are product
replacements, which account for about 45% of new products. Examples
include the Honda Civic model mentioned above and successive iPhone
models. At the newest end are new-to-the-world products, which are
products that did not exist before and so initiate a new market and alter
consumers’ behaviour. In between there are additions to existing lines that
complement existing products, making them easier to use or more effective,
and new product lines that move into new markets (for example, Dyson fans
represented a new market from Dyson vacuum cleaners). Some new
products are technologies that have been transferred from other applications.
For example, sensor and materials technology developed for military
applications have been applied in consumer contexts such as intelligent
cruise control and laminated glass in cars.
% of new products
45%
25%
20%
10%
Product Additions to New product New-to-the-world

replacement existing lines lines products
Degree of newness
Figure 7 Degrees of newness as approximate percentages of new products

(source: based on Booz, Allen and Hamilton, 1982, cited in Blythe, 2006)
51
Readings 28–36
Exercise 1
Try to think of some examples of new-to-the-world products and, if they were

launched a good many years ago, consider how they have developed since
that time. If you have difficulty thinking of a product, you might consider the
example of personal computers or mobile phones.
Comment
The world’s first semi-programmable electronic digital computer (the first to
combine these three features) was designed and constructed at Bletchley
Park in the UK during the Second World War. ‘Colossus’, as it was called,
was the size of an entire room. Although the secrecy in which it was
developed meant that modern computers were not directly derived from it, its
capability and the people involved in its development contributed to the
evolution of later computers. Over the years the size and cost of computers
has reduced so that today in developed countries school children are
expected to have access to a computer and printer, and computers are
increasingly integrated into teaching and learning approaches.
5 The product life cycle

We introduced the idea of a product life cycle in Reading 29 when we
discussed strategy, with its four stages of introduction, growth, maturity and
decline. After a new product has been developed and is first introduced to
the market, sales may grow quite slowly initially as not many people yet
know about it. As it becomes better known, sales may grow quite rapidly
until they tend to level off during the maturity phase, when many potential
target customers have already bought it and more competitors introduce
similar products. Thus, eventually the sales of many products decline as
most customers already have them (the market is saturated) and new
substitute products are introduced. Decline is, however, not inevitable
because there are many strategies by which businesses can extend the life of
their products. The life cycle concept is useful for describing what is
happening to a product at a particular moment but it is not much use for
predicting the product’s future.
A life cycle curve may be drawn up for a product category, such as hair
care products; for an actual product type, such as leave-in-conditioner; and
for individual brands within that product type. The life cycles of product
categories tend to be longer than those of actual product types and the life
cycles of brands are often the shortest, but this can vary considerably. The
life cycles of some brands can span many decades and even centuries. (For
example, Persil washing powder was launched in the nineteenth century.)
Some ‘fad’ products have very short life cycles where a new product
catches the attention of many consumers and sales rise very quickly but
52
there is no real maturity phase and sales decline just as quickly as they rose
(examples include the Hula Hoop, the Rubik’s Cube, and – more recently –
Ugg boots or pet rocks).
The phases of a product’s life cycle are mirrored by the product’s adoption
by consumers as illustrated in Figure 9.
Money
Sales
Profit
Innovators Early Early Late

adopters majority majority Laggards
Introduction Growth Maturity Decline

Time
Figure 9 The product life cycle and product adopters (source: adapted from
Blythe, 2006)
Consumers may be classified according to the stage at which they adopt a

product (Rogers, 1962):
. Innovators – consumers who like to be the first to have a new product as

soon as it is introduced.
. Early adopters – consumers who like new innovations but let a little
time elapse and buy during a product’s growth stage.
. Early majority – consumers who wait until a new product has been fully
tried and tested before buying it during the start of the maturity stage.
. Late majority – consumers who are cautious and wait until most people
have a product before buying it during the end of the maturity stage.
. Laggards – consumers who only adopt a product when they have little
alternative but to do so, by which time the product may be in decline.
Exercise 2
Reflect on your purchasing tendencies and consider into which consumer

adoption category you might fit. You could consider your purchasing
tendencies in particular product categories, such as electronic goods or
fashion. Does your adoption category vary depending on the type of product
being purchased?
53
Readings 28–36
Comment
The answer to this question will, of course, vary from person to person. The
kind of consumer adopter you are may have quite a lot to do with your
general personality. Perhaps in doing this exercise you have discovered
something about yourself. It may also be possible that you fall into different
adoption categories depending on the product or the purchasing occasion in
question. I might be a late majority adopter of entertainment technologies,
such as computer game consoles or the latest television series box sets, but
be an earlier adopter of new fashion styles.
Summary
This reading has looked at products, their meaning, differences, benefits,
development, life cycle and consumer adoption. There is a reason to start a
discussion of the marketing mix with a look at products: without products
the rest of the marketing mix would not really matter. After working
through this reading you will now understand that services and physical
goods are both products and that the differences between them are more
along the line of a continuum than total opposites.
You have also learned that products exist on different levels of benefit, with
the core benefit being the most fundamental one. New product development
has been introduced as a vital part of all business but one with different
gradations – most new product development does not, in fact, consist of
new-to-the-world products.
Finally, the reading has considered the idea of the product life cycle along
with the idea of different consumer adoption styles. This is important for
marketers in a number of ways, for example in terms of how to promote
products at different stages of their life cycle and to different types of
adopters.
54
References
Blythe, J. (2006) Principles & Practice of Marketing, London, Thomson
Learning.
Borden, N.H. (1957) ‘Note on concept of the marketing mix’. In Kelley, E.
J. and Lazer, W. (Eds), Managerial Marketing, Homewood, IL, Richard D.
Irwin.
Crawford, C.M. (1991) New Products Management, Homewood, IL, Irwin.
McCarthy, J.E. (1964) Basic Marketing. A Managerial Approach.
Homewood, IL, Irwin.
Rogers, E.M. (1962) Diffusion of Innovations, New York, Macmillan.
55
Readings 28–36

place and pricing
Introduction
This reading looks at two further components of the marketing mix: place
In McCarthy’s (1964) (or ‘distribution’) and pricing. The channels through which a product is sold
and many subsequent and the price charged for it both send messages to consumers about the
descriptions of the product and affect consumers’ perceptions of the overall offering.
marketing mix, this
Distribution and pricing also affect a product’s profitability and we will look
element is called ‘place’
(so that the 4Ps – or at the various strategies that can be used to manage a product’s distribution
later 7Ps – all actually and pricing.
start with ‘p’). However,
‘distribution’ is actually
a more accurate term
than ‘place’ and will 1 Distribution channels (place)
therefore be used mostly
in this reading. Distribution channels are the ways through which a product is made
available to consumers. This is a highly important aspect of marketing. Not
only does the existence of distribution channels make it possible for
consumers to obtain the products they need and want, organisations along
the distribution channel also have important functions in terms of promoting
products and services, putting together an assortment of goods, and making
pricing decisions.
1.1 Different distribution channels

Some products and services are provided directly by the producer to the
consumer. In other cases, the distribution of a product or service involves
one or more intermediaries, such as retailers (who buy products from
manufacturers or producers to sell on to consumers), and brokers or agents
(who facilitate the exchange process between producers and customers).
Some distribution channels are very short: that is, they have few or no
intermediaries, whereas others are long and have many intermediaries.
The shortest distribution channels are those in which producers sell directly
to final customers without any intermediaries. For example, farmers might
sell vegetables, meat and eggs directly to consumers through a farm shop on
their own premises. Many industrial products are sold directly from
manufacturer to customers without any intermediaries. In addition, many
businesses sell directly to consumers by online order, giving them greater
control and direct access to their customers.
Slightly longer are those channels that include retailers as well as producers
and final customers. Distribution channels involving large retail businesses
often take this shape. Large retail chains are able to buy directly from the
manufacturers most of the goods they sell because they have the financial
ability to buy large quantities and the logistical capability to store them and
distribute them around the country to their own stores.
56
Reading 32: The marketing mix – place and pricing
When we think of retailers we typically think of high street shops or out-of-

town superstores but there are other types of retailers. Retailing is also
common online. For example, many supermarket chains now have online
retailing arms where customers can choose the groceries they want, buy
them online, and then have them delivered to their home or pick them up at
their nearest store, usually on the same day. Retailers such as Tesco or
Sainsbury's also use the data they collect from their customers either online
or in store to recommend other products that they expect might be of
interest to customers, based on their purchasing or viewing behaviour.
Online retailing is particularly suitable for services that do not require
physical goods to be transported, for example electronic downloads of
music and ebooks or electronic booking of train and airline tickets or entire
holidays. Insurance and other financial products are also increasingly bought
online rather than in a bank or other physical retail outlet. But online
retailing is not limited to such services. It is possible and increasingly
common to buy groceries, most household items, fashion, craft and hobby
supplies, and many more products online. In fact, an entire physical
distribution industry, comprising warehouse and transportation services, has
grown around the requirements of online retailers.
Figure 1 Grocery delivery van
Smaller retailers are often not in a position to buy directly from

manufacturers. In this case the distribution channel contains a further level,
namely wholesalers. These are businesses that buy large quantities directly
from manufacturers and sell on smaller quantities to stores such as local
grocery shops. Wholesalers often carry out a number of functions in the
distribution channel, such as storage and transportation, information
gathering and dissemination, and certain promotional activities, which
otherwise would have to be carried out by individual manufacturers or
retailers. By carrying out these tasks on behalf of manufacturers and
retailers, wholesalers can achieve economies of scale and improve the
efficiency of the whole distribution channel.
Sometimes even wholesalers are not in direct contact with producers. In this
case, a broker or agent may act as an additional intermediary between
producers and wholesalers. This is often the case in international marketing
situations where neither the producer nor the wholesaler is large enough to
57
Readings 28–36
deal directly with a business in a different country, or where the amount

sold is too small to warrant wholesalers or producers going to the effort of
dealing directly with each other. Table 1 summarises the different lengths of
distribution channels.
Table 1 Distribution channels
Channel 1 Manufacturer Consumer

Channel 2 Manufacturer Retailer Consumer
Channel 3 Manufacturer Wholesaler Retailer Consumer
Channel 4 Manufacturer Other intermediary Wholesaler Retailer Consumer
Some distribution channels are extremely complex. For example, the

clothing industry is typified by multi-tier supply chains in which the retailer
often has no direct contact with many of the lower level suppliers such as
fibre producers (WRAP, 2012).
1.2 Choice and functions of distribution channels

Choosing a distribution channel depends on a number of considerations
(Blythe, 2006, p. 647):
. market factors (buyer behaviour; willingness of distributors)

. producer factors (resources available; product portfolio size)
. product factors (complexity; perishability; special handling needs)
. competitor factors (control by competitors; avoidance of competition).
Let’s look at these factors in the context of coffee shops. Coffee producers
do not have the resources to sell coffee directly to consumers around the
world, so have to supply their raw produce through a series of
intermediaries. In the 1980s the UK was the biggest market for instant
coffee in the world and consumers generally made their own coffee.
However, in the 1990s branded coffee shop chains started to open following
the Starbucks model of providing sweetened milky versions of Italian-
inspired coffee, and they have been flourishing ever since.
Coffee shop brands buy coffee from all over the world and blend their own
in-store coffee blend, carefully monitoring its quality across the variety of
producers’ harvest seasons (a producer factor). The average coffee shop
customer spends over £450 on coffee purchases but regular devotees can
spend up to £2000 annually in coffee shops. For coffee shops, location is
crucial, both because they need to be located where customers seek
refreshment and because of the perishable nature of take-away coffee (a
product factor). Consequently it is common now to find the big brand coffee
shops operating outlets within university buildings and with drive through
capability on retail parks in addition to traditional high street locations.
Coffee shops only make a profit if they can control their fixed costs, such as
rents (a producer factor). The UK coffee shop chain Coffee Republic, which
originally operated on prime sites in London, had to scale back its
operations owing to high charges for renting these key sites. However,
many coffee shops were able to take advantage of lower rents during the
58
recession, while for consumers coffee remained ‘an affordable luxury’

(BBC, 2014a). While the three big coffee shop brands in the UK survive
successfully alongside each other, they are perceived as a threat to
independent coffee shops and are not welcomed everywhere, as evidenced
by a successful campaign against the planned opening of a Costa Coffee
shop in the UK town of Totnes (Kelly, 2012).
From a consumer’s perspective, the following aspects of a product’s
distribution may affect purchase behaviour:
. the convenience of the distribution location

. the extent of choice available
. the level of service and advice available
. the image and reputation of the distribution outlet
. the atmosphere and ambience of the distribution outlet.
Continuing our look at the coffee shop context, a third of consumers choose
their coffee shop based on its convenience over any other factor. The big
brand coffee shops (and also independent ones) offer a dizzying array of
choice of coffee types, variations, extras and cup sizes. Seasonal drinks are
also offered, for example at Christmas and during the summer, adding
seasonal flavours and iced varieties to their already extensive menus. By
offering so much choice, coffee shops benefit from the large margins
provided by the extras added by those customers who are not price-
sensitive. Coffee shops make a big play of making customers’ coffee in
front of them, with baristas finishing by creating decorative designs and
interacting with customers while they do so. ‘Service is a competitive
advantage’ (BBC, 2014a). Although drink varieties are easy for competitors
to copy, customers tend to favour particular coffee shops, based on the
image, atmosphere and ambience as well as convenience. Howard Schultz,
Starbuck’s Chairman, introduced the idea of using soft furnishings to create
‘a third place ... that place in people’s lives that was somewhere between
work and home – giving people a place to come together, giving people a
reason to come together and facilitating community through something as
simple as a cup of coffee’ (BBC, 2014a). The author J.K. Rowling famously
wrote her first Harry Potter novel in a coffee shop.
Exercise 1
Spend approximately 20 minutes on this exercise (not including any shop visits).
Think of the last time you visited a business to make a purchase or consume
a service. For this business, consider the distribution factors discussed
above from the perspectives of both the business and as a customer and try
to answer the following questions:
Why do you think the business chose to distribute their offering in the way
they have?
Which factors affected your purchase decision?
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Readings 28–36
Comment
Your answer will obviously depend on the kind of purchase or consumption
experience you chose to focus on and on your personal preferences. Take
the example of an independent shoe retailer in a small town.
Market factors: The owner of the business might have decided to set up this
particular type of business because they believe there is a big enough
market for shoes in that town and that not all people like to go to bigger
cities to do their shopping.
Producer factors: The retailer is unlikely to produce shoes him- or herself, so

buying shoes from different manufacturers may be the best way forward.
From the perspective of large shoe producers or importers, it may not be
viable to open their own store in a small town, so distributing through an
independent retailer may be best.
Product factors: Shoes are not perishable and need to be tried on, therefore
they are suited to distribution through a traditional retail store.
Competitor factors: This being a small town there may be no other shoe
retailers to compete with this store. The extent of competition from larger
stores in bigger cities would depend on the proximity of these cities and how
convenient it is for customers to travel there.
From a consumer perspective, a store in the same place where I live seems
convenient to me. Being a small shop, however, the choice of shoes
available might be more limited than if I visited a larger store in a bigger city.
However, even for a small shop, I would expect a reasonable amount of
choice, otherwise I would probably choose to go to a larger store elsewhere.
I might like the more personal service that smaller stores are often able to
offer. For a small shop, image and reputation may well be based on the level
of service and the choice I can get. And I am also likely to be influenced by
the atmosphere and ambience of the shop. If it is a pleasant environment to
spend half an hour to try on some shoes I am more likely to go there than if
the shop is dark and crammed, for example.
1.3 Channel management

Channel management concerns the way in which an organisation manages
its relationships with members of its distribution channels. Cooperation and
negotiation between channel members are important for goods to be
distributed efficiently. However, conflict can arise when the interests of one
party conflict with those of another or where there is a power imbalance
that the more powerful party uses at the expense of the other party. Power
can take various forms and include economic (e.g. control of resources,
company size) and non-economic (e.g. rewards, expertise) sources of power
(Blythe, 2006). For example, in 2007 UK dairy farmers presented a petition
to the government over very low milk prices that major supermarket chains
were forcing on them (Figure 2). The farmers claimed that the supermarkets
60
were abusing their buying power to drive milk prices to unsustainably low
levels and were thus endangering the survival of farms (BBC, 2007). A
power imbalance does not preclude successful channel relationships, but
may affect the behaviour of parties towards each other.
Figure 2 Protesters wore their cow costumes to Downing Street
Ultimate control of distribution channels is achieved through vertical

integration, in which a company owns its distribution channels as in the
case of oil companies who extract oil and supply petrol stations.
2 Pricing strategies
Pricing is the third element of the marketing mix. There is more to price
than you might think. Customers take into account not just the actual price
of a product; they also use price to make inferences about a product’s
quality, value and prestige. This is why some luxury brands of perfume and
designer jeans brands have fought against being sold in supermarkets at
lower prices and why some consumers are willing to pay higher prices for
expensive brands with few functional differences from cheaper brands.
However, where there are few perceived differences between brands, for
example generic products known as ‘commodities’ (such as sugar and
petrol), consumers will usually opt for the lowest price, assuming a choice
of brands is readily available. However, some consumers may be willing to
pay a higher price for generic products which offer some other benefit. For
example, some consumers will pay more for bananas or sugar that carry the
Fair Trade accredited logo because they want to ensure that the growers in
developing countries are paid a fair price for their produce.
2.1 Considerations in pricing

Organisations may offer variations of a product at different prices to serve
different customer segments or provide a range of pricing options to create
a choice architecture that guides customers to select a middle price, with the
price framing providing reassurance that the customer is being neither too
extravagant nor too thrifty.
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Readings 28–36
Using our coffee example again, in 2014 the average price of a regular
cappuccino was £2.30, with the price being made up as illustrated in
Figure 3. However, for customers who are not price sensitive, extras can be
added, which allow much higher prices to be charged for relatively small
increases in the cost of raw ingredients and VAT.
profit £1.00
profit 35p
VAT 65p
VAT 45p
fixed costs (staffing,
fixed costs (staffing, electricity, the coffee
electricity, the coffee £1.20
£1.20 shop itself, wi-fi
shop itself, wi-fi and sofas)
and sofas)
cup and napkin 15p
cup and napkin 15p
raw materials (milk, 30p
raw materials (milk, 15p water and coffee)
water and coffee)
Average cappuccino, cost: £2.30 Cappuccino with extras added, cost: £3.30
Figure 3 Price composition of an average cappuccino on the left and with extras added on the right (Source:
BBC, 2014a)
Price setting also needs to take account of:
. costs (of production and marketing)

. corporate objectives
. competitors
. complementary products in the organisation’s portfolio (for example
games for a console or toner cartridges for a printer).
2.2 Approaches to pricing

There are three basic pricing approaches: (i) cost-based; (ii) competitor-
based; and (iii) customer-based (Figure 4).
Cost-based Competitor-based Customer-based

Demand pricing;
Cost-plus Skimming; psychological pricing;
(in manufacturing) penetration pricing second-market
Non-market-based Market-based pricing

pricing
Figure 4 Pricing methods (source: adapted from Blythe, 2006)
62
Cost-based pricing
There are two basic types of cost-based pricing: cost-plus and mark-up,
neither of which are based on market considerations.
Cost-plus pricing starts with the cost of manufacturing a product and adding
a percentage for profit. Although it is a simple way of determining a price,
it is also risky because it doesn’t take account of the market and whether
customers would be willing to pay the resulting price or whether they might
be willing to pay more.
Mark-up pricing uses the same method but is employed by retailers who
start with the price at which they buy a stock of a product and then add a
mark-up, or margin, for profit to calculate that product’s shelf price.
However, the riskiness of this pricing strategy is reduced for retailers by
being closer to customers and so having a better feel for what customers
would be willing to pay. Retailers may also reduce their risks further by
buying stock on a sale-or-return agreement whereby they can return unsold
stock to the manufacturer for credit.
Competitor-based pricing
As its name suggests, competitor-based pricing involves setting a product’s
price in relation to competitors in the market. The more similar the product
to its competitors, the more similar the price needs to be because of the lack
of distinguishing benefits to charge a higher price. Alternatively, if an
organisation’s product has a technical advantage, it may use a ‘skimming’
strategy, in which it starts by charging a high price and then progressively
reduces the price over time as sales decline as either customers who can
afford the product have purchased it or more competitors enter the market.
Large flat screen televisions are an example of this, having been initially
very expensive, they are now priced within reach of a growing number of
consumers and offered by a variety of manufacturers (Figure 5).
Figure 5 Flat screen television
Market leaders can often set prices without needing to undercut

competitors’ prices. However, where organisations compete solely on the
basis of price, there are two strategies that they may use: penetration pricing
and predatory pricing. Penetration pricing is often used to introduce a new
product and achieve large sales quickly by charging less than competitors.
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Readings 28–36
The danger is that this can lead to a price war and a ‘race to the bottom’.
Predatory pricing is where a price is set below the cost of production to
force competitors out of the market. Predatory pricing is illegal (as well as
unethical) in many countries because it is anti-competitive, but it can be
difficult to prove. ‘Dumping’ is a form of predatory pricing, in which an
organisation sells (or ‘dumps’) its products in an international market at a
price that is either lower than they are sold in the domestic market or than
its production cost; it is also illegal.
Customer-based pricing
As Figure 4 above shows, there are several types of customer-based pricing
that take account of customers’ perspectives. ‘Demand pricing’ is based on
balancing the price customers are willing to pay for a product with the
number of customers who are willing to pay it, in relation to the cost of
producing quantities of the product. However, basing price on demand can
raise ethical issues about its fairness, where consumers are ‘willing’ to pay
extortionate prices because they have a strong need and have no alternative
or where there is strong pressure on them, for example, parents may feel
under pressure to buy their teenage children designer trainers to avoid the
children being bullied. Holiday suppliers that inflate their prices during
school holidays have recently been criticised because the practice
encourages parents to take their children out of school during term-time to
benefit from lower prices. Another example where pricing can be quite
difficult is in pharmaceuticals. New pharmaceuticals are very expensive to
develop, therefore drug companies need to achieve high prices initially to
recover these costs. Pharmaceutical companies have frequently been accused
of neglecting the needs of people in developing countries for two reasons:
1 Drugs are priced so high that patients or health services in poorer
countries cannot afford them.
2 Pharmaceutical companies are far more likely to develop drugs for
illnesses that are prevalent in rich countries, where people can pay for
them, than for illnesses that are very common in developing countries
(e.g. malaria) but where people can only pay very little for them (BBC,
2014b).
Figure 6 Pharmaceuticals
64
‘Psychological pricing’ is based on customers’ emotional responses and uses

price to encourage customers to draw inferences about a product, for
example its quality or prestige. This can be particularly influential for
services and intangible products but also tangible products bought online for
example, which are difficult to evaluate before purchase and hence often
involve an element of risk. Although ‘everyone likes a bargain’, there is
also a widespread belief that ‘you get what you pay for’. So if you had to
choose between a range of unknown brands to buy a product online which
you knew nothing about, you might use price as a guide to the quality of
the product in the absence of reliable supplementary information.
Psychological pricing is particularly powerful for important purchases that
entail not only financial risk, but some other type of risk, for example,
psychosocial risk (if the purchase is a present and you don’t want to be
embarrassed by it) or physical risk (if a sub-standard product has safety
implications). The use of emotion in marketing can raise ethical issues and
if it is used deliberately to manipulate consumers against their best interests
it is likely to attract criticism.
‘Second-market discounting’ involves offering a price discount for
particular groups of customers (for example, students and senior citizens) or
on particular days or at certain times (for example, many restaurants offer a
discount for diners on days or at times when business is quiet). However,
when price discounting is seen as discrimination, for example, offering new
customers a discount while charging existing customers more, it raises
ethical issues and regularly attracts negative publicity.
‘Product-line pricing’ is used for linked or complementary products, where
the price for the main product is low but the price of the required related
product is set high to achieve an overall profit. Unfortunately, in some cases
this can have detrimental side-effects. As an example, the replacement
cartridges for a particular printer cost almost as much as the printer itself,
with the unfortunate result that it encouraged consumers to buy a new
printer with a fresh guarantee and discard the existing printer rather than
buy a replacement cartridge. Besides being bad for the environment by
essentially turning the printer into a disposable item, this was arguably not
in the manufacturer’s best interests either as consumers might choose a
different brand of printer instead.
Exercise 2
Think about the last time you bought a car or paid for some form of public
transport. How did the price affect your purchase selection?
If you bought a car, did you keep the price to a minimum by choosing a basic
model or were you prepared to pay for particular valued extras?
If you used public transport, did you choose the cheapest option or the
fastest? Which factors were important to you and did you try to balance any
particular considerations?
65
Readings 28–36
Comment
There are many different considerations that can enter a purchase decision
and the price of a good or service is often a very important one. How
important price is does, of course, partly depend on your financial
circumstances. Someone surviving on a student loan is likely to be far more
inclined to buy a basic or second-hand car at a low cost or to choose the
most economic travel option, say a flight involving several changes and
lengthy waits, than someone earning a good salary. For example, my very
first car was a 10-year old second-hand car with nearly 100,000 miles on the
clock and it was only when I bought the fourth car in my life, about 20 years
later, that I finally felt the benefits of a new car outweighed the
disadvantages of the higher cost.
Summary
This reading has looked at two of the ‘4Ps’ of the marketing mix: place
(distribution) and price. Both play important roles, not just in making an
organisation’s offering available to consumers for purchase, but in
communicating messages about the offering to the target audience. In the
next reading we will explore communication in more depth in relation to the
fourth ‘P’: promotion.
66
References
BBC (2007) ‘Milk farmers protest over prices’, [online] BBC: Business, 6
February 2007. [online]. Available at http://news.bbc.co.uk/1/hi/business/
6332499.stm, (Accessed 16 April 2015).
BBC (2014a) ‘Business Boomers Coffee Shop Hot Shots Documentary’,
[online]. Available at https://www.youtube.com/watch?v=a2LcpwexhiU
(Accessed 20 March 2015).
BBC (2014b) ‘Pharmaceuticals industry facing fundamental change’, BBC:
Business, 7 November 2014. [online]. Available at http://www.bbc.co.uk/
news/business-29659537, (Accessed 16 April 2015).
Learning.
Kelly, J. (2012) ‘The independent coffee republic of Totnes’, BBC News
Magazine, 7 August 2012. [online]. Available at http://www.bbc.co.uk/news/
science-environment-19146445 (Accessed 23 January 2015).
McCarthy, J.E. (1964) Basic Marketing. A Managerial Approach.
Homewood, IL, Irwin.
WRAP (2012) Valuing our clothes. The true cost of how we design, use and
dispose of clothing in the UK. [online]. Available at http://www.wrap.org.
uk/content/valuing-our-clothes (Accessed 23 March 2015).
67
Readings 28–36

promotion, people, process and
physical evidence
Introduction
This reading concludes the marketing mix. The largest part of the reading
covers the fourth element in the original 4Ps of the marketing mix:
promotions, which is perhaps more accurately called ‘marketing
communications’. The reading also introduces three further elements of the
marketing mix that were conceived specifically for marketing services:
people, process, and physical evidence.
1 Marketing communications as a two-way

process
Marketing communications is not a straight forward, one-way process from
marketers to potential customers. As in any communication process, both
sender and receiver of any communication (for instance, speaker and
listener) are actively involved. The message that someone, e.g. a speaker,
intends to convey may be quite different from what the receiver, e.g. a
listener, hears. The receivers of communication make sense of what is being
communicated in the light of their own intentions, experiences, moods, and
similar. Communication is always a process involving more than one party,
even if only one of those parties does any overt sending of messages. For
example, let’s assume I have agreed with my partner to go for a walk on
Sunday morning. On that morning the sky is cloudy and it looks as though
it might start to rain. I might say, ‘It looks like it’s about to rain,’ meaning
to say that we should take raincoats on our walk, but my partner might
interpret my sentence as meaning that I don’t want to go. We have not
communicated properly.
Similar problems arise in marketing communications. They are further
compounded by the fact that in many types of marketing communication
there is no direct contact between the sender and the receiver of a message.
Instead, the message is sent through a medium, as in the case of advertising
or publicity, or is built into a display or pricing information, as may be the
case in sales promotions. Additionally, marketing messages are now so
numerous that potential customers often pay very little or no attention to
any particular message. In fact, they may actively try to avoid or ignore
marketing communications, for example by changing television channels
during advertising breaks or by refusing to listen to salespeople either at the
door or on the telephone.
68
Reading 33: The marketing mix – promotion, people, process and physical evidence
‘We’re going to spend £5M to put over the message that our product is so good
it sells itself!’
2 Planning marketing communications

Marketing communications are often expensive for businesses. In order to
make sure that money is spent in the most effective and efficient way and
that the intended message has the greatest possible chance of being received
by its intended audience, businesses often make great efforts to plan their
communications carefully.
Marketers often follow the so-called AIDA approach, which was first
proposed as an approach to sales strategy by Strong in 1925 but has since
been widely used for marketing communications generally (Wijaya, 2012).
The model suggests that good marketing communication should go through
the sequence of stimulating ‘awareness’, ‘interest’, ‘desire’ and ‘action’ on
the part of consumers. Not every single communication action will be
directed at each of these stages, although when a business launches a new
product it must first make consumers aware of the product. If the product is
highly innovative this may be done through public relations, by securing a
write-up in a specialist magazine or even in a general magazine or
newspaper, as well as advertising. Awareness may lead to interest on the
part of the consumer, but further advertising, or perhaps promotions in the
form of free samples, may increase interest levels. Once a level of
awareness and interest has been stimulated, marketers may concentrate on
trying to raise consumers’ desire for the product; for example, through
advertising that focuses on the situations in which the product might be
used or on the social status it could confer. Action, in the form of a first
trial, can be stimulated by free samples, money-off vouchers or similar sales
promotion techniques.
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Readings 28–36
Exercise 1
Think about a recent advertisement you have seen. Do you think it was
trying to raise awareness, interest, desire or action? Or perhaps a
combination of several of these? How was the advert attempting to do this?
Comment
Your answer will depend on the advertisement you have looked at. Perhaps
the advertisement was for a new product, like the new Apple iPhone 6, which
was introduced approximately at the time this reading was written. As the
concept of the iPhone was familiar to consumers already, adverts were not
actually concerned with raising awareness of what the product was but were
concerned with making consumers aware of the launch date. Many
subsequent adverts were trying to raise interest and action by advertising the
availability of the iPhone 6 for a certain price on new phone contracts.
‘The marketing
communications mix’
should not be confused
with the marketing mix
as such. It is a little
unfortunate that there are
multiple terms relating to
marketing strategy and
3 The marketing communications mix
the marketing mix which
are quite similar and We will now look in turn at the different elements of marketing
liable to be confused communications, also sometimes called the marketing communications mix.
with each other. This mix consists of advertising, sales promotions, personal selling and
However, these are public relations. Depending on the kind of business, product and market, a
commonly used terms in
business may focus on different elements of the mix. However, few
marketing practice and
scholarship and therefore businesses will use one form of marketing communication exclusively; nor
need to be introduced are the different elements necessarily substitutes for each other. Each
here. element has different strengths and weaknesses and they are generally used
in some combination that best reflects the communications needs of the
‘Sales promotions’ is business at a particular time. It should also be noted that marketing
another unfortunate communications are not always directed at customers. They can also be
incidence of two
different concepts
aimed at employees, pressure groups and other stakeholders in the business.
bearing more or less the Figure 1 summarises the type of messages and the type of audience for
same name. Sales which the different elements of the promotional mix are suitable.
promotions is one
element of marketing
communications.
Marketing
communications is also
sometimes called
‘promotion’. To avoid
this confusion we have
generally opted to refer
to ‘marketing
communications’ here
when we mean the entire
element of the marketing
mix.
70
Messages Transmitters Receivers
Advertising Consumers
Information about
products and
brands
Sales promotions Employees
Personal selling Pressure groups
Information about
the company
Public relations Other stakeholders
Figure 1 The promotional mix (source: adapted from Blythe, 2006)
Marketing communications is perhaps the element of the marketing mix that

has changed the most over recent years. This is not to say that types of
marketing communication that were common 20 or even 50 years ago are
no longer used. Quite the contrary: print, television and radio advertising
continue to be a highly important and visible part of the communications
mix particularly for consumer products; personal selling remains highly
important, particularly in business-to-business marketing; sales promotions
in the form of money-off coupons or buy-one-get-one-free promotions are
as ubiquitous as ever; and all organisations love to have good public
relations. But new forms of marketing communication and new media have
become highly important for marketers, in addition to the more traditional
forms of communication listed above. A significant amount of advertising is
now placed online rather than in print, television or radio. Sales promotions
have become much more targeted through retailers’ loyalty schemes and
new discount schemes have sprung up in the form of buyers’ clubs, such as
Groupon. Public relations are no longer confined to the printed press but use
new forms of media such as online blogs. And word-of-mouth
communications have now taken on a new dimension because of social
media where everyone has an opportunity to communicate with far more
people at the same time. The remainder of this section looks at the different
elements of the communications mix in turn.
3.1 Advertising
Unlike some other elements in the promotional mix, advertising is
impersonal and communicates with a large number of people through a paid
media channel. These channels include television and radio, print media
such as newspapers or magazines, billboards, cinema advertising, the
internet in the form of advertising banners and pop-ups on websites,
sponsored links in search engines, company presence in social media or
targeted advertising through text messages to mobile phones.
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Readings 28–36
There are different types of advertising (Brassington and Pettitt, 2005).

Pioneering advertising is used in the early stages of the product life cycle,
when businesses want to achieve consumer awareness and interest.
Competitive advertising may be more appropriate at a later stage in the
product life cycle, when it is necessary for businesses to distinguish their
product from those offered by competitors. Comparative advertising, which
directly compares the benefits of a brand against those of its leading
competitors, is one form of competitive advertising. Reminder or
reinforcement advertising is designed to operate after consumers have
already purchased the product. It serves to reassure them of the product’s
benefits and to confirm that they made the right choice in selecting this
particular product and brand.
Another type of advertising attempts to improve the general reputation and
image of the organisation. It is often directed at a whole range of
stakeholders, including local government, community, and pressure groups.
Through this the organisation tries to build up general goodwill in the
community. The example below highlights the use of an online video-
sharing platform for this purpose.
Example of online advertising: YouTube

Traditional advertising media, such as print, billboards, television, radio and
cinema advertising, continue to be important to marketers. Over recent
years, however, online advertising has become an increasingly significant
part of the advertising landscape. Consider the popularity of the video-
sharing platform YouTube. Part of the YouTube business model is to raise
revenue through paid-for advertising. Companies can use different online
advertising formats. Display ads are placed next to the video the consumer is
trying to watch. In order to watch these videos the consumer has to click on
them. Overlay ads are semi-transparent ads, often in the form of banners,
that appear in the lower 20% of the video the consumer is trying to watch.
Skippable video ads run before the consumer can watch their chosen video
but can be skipped after 5 seconds. Non-skippable video ads also play
before the consumer’s chosen video but cannot be skipped (YouTube, n.d.).
By placing their advertisement next to or within particular video content,
advertisers can target specific consumer groups, e.g. those interested in
watching science fiction movies.
3.2 Sales promotions

‘Sales promotions’ refer to the specific element of the promotional mix that
tries to create a temporary increase in sales by offering customers an
incentive to buy the product. Within this general definition, sales
promotions come in many different forms. Brassington and Pettitt (2005)
distinguish between the following types of sales promotion techniques:
72
. Money-based promotions: these are easy to implement, are very common

(but therefore don’t generate much excitement), can give money back to
people who would have bought anyway, and are expensive:
◦ cash-back (collect tokens to get refund)
◦ immediate price reductions at point of sale
◦ coupons.
. Product-based promotions are less likely to ‘cheapen’ the product image:
◦ ‘X % extra free’
◦ ‘buy one, get one free’
◦ free samples
◦ piggy-backing with another product: for example, putting a free
pack of coffee whitener with a pack of instant coffee.
Figure 2 Price promotions
. Gift, prize or merchandise-based promotions:

◦ gifts in return for proof of purchase (toy received on presentation
of a certain number of labels from a product)
◦ loyalty schemes
◦ competitions or sweepstakes (buying a product entitles you
to enter a prize draw).
Sales promotions are often used for lower value items. (If they were used
for premium or luxury brands they might ‘cheapen’ the brand image in
consumers’ eyes.) They tend to work best as part of an integrated
communications campaign, where advertising or public relations build the
brand image and sales promotions encourage people to try the product or
otherwise boost short-term sales. The example below shows how ‘deal of
the day’ promotions work online.
Example of online promotions: Groupon

Groupon is a website that offers ‘deal of the day’ online coupons to its users.
These coupons can then be redeemed at local and national retailers. As
there is a minimum threshold of consumers who need to sign up to a deal on
Groupon before it becomes valid, participating retailers have a certain
guaranteed number of sales and can thus plan the income they are going to
73
Readings 28–36
make from the deal. Groupon provides all the up-front marketing and copy
writing for product features, thus reducing the initial cost for participating
retailers. Retailers are attracted to this model because they believe it helps
to grow their customer base. However, like many money-off promotions,
Groupon deals often only attract bargain hunters who will move on to other
businesses as soon as the deal ends.
3.3 Personal selling
Figure 3 Personal selling
Personal selling can be a very powerful means of marketing communication,

perhaps the most powerful a business has at its disposal. A salesperson who
talks personally to a potential customer, finds out about their needs and can
explain the benefits of the product, is more likely to be successful in
making a sale than any advertising, sales promotion or public relations that
the business could use instead. Customers also have the opportunity to ask
direct questions about the product. However, a sales force also tends to be
the most expensive marketing communications tool for a business. Personal
selling is therefore mostly used for expensive or highly technical products
that need a lengthy decision-making process.
3.4 Public relations (PR)

Public relations (PR) is about creating a favourable image for the business
in the minds of its stakeholders. It often involves creating and placing
favourable news stories. Unlike advertising it is not paid for, but
newspapers or other media print present the story if they think it is of
sufficient interest to their audience. This also means that the journalists
publicising the story have the freedom to present it in their own way and
put their own slant on it.
Public relations operate by a number of key routes, including word-of-
mouth, press and television news stories, and personal recommendation. It
aims to put a positive image of the business and its products into people’s
minds and conversations. Good PR can be more effective than advertising
as it is free and thus saves on the promotional budget (although
organisations often have PR departments, and the people working in them
74
obviously have to be paid); it is often more credible in the eyes of

consumers and it is more likely to be read or viewed as it is considered
news rather than advertising. The following example focuses on the role of
social media in PR.
Example of word-of-mouth: social media

We can assume that people have talked about products and businesses for
as long as there has been any form of commercial activity. Word-of-mouth is
therefore perhaps the oldest form of marketing communications there is and
marketers have long been aware that word-of-mouth can work greatly in their
favour as well as to their detriment. However, in the age of social media, the
ability of individuals to talk to others has been greatly magnified. We can
now communicate not just with dozens of people but with hundreds or even
thousands. One form of word-of-mouth through social media is the consumer
ratings facility on hotel booking websites, such as booking.com. Here,
consumers can give a particular hotel a rating between 1 and 5 stars and
can also leave a comment about their impressions of the hotel and the
service provided there. Increasingly, businesses are also attempting to steer
word-of-mouth marketing through social media, for example by creating their
own pages on Facebook or by encouraging consumers to become active in
discussing products and their uses or even helping to design new products
on a company’s own website.
4 The extended marketing mix for services

The idea of the marketing mix was originally developed for physical goods.
As you have already learned in Reading 31, services are different from
physical goods in a number of ways (Blythe, 2006): they are mostly
intangible, they are produced and consumed at the same time, their quality
varies depending on the person providing the service, and they cannot be
produced in advance and stored for later sale or use.
This makes it difficult for customers to assess service quality before buying;
for example, by handling or testing the product. It has, therefore, been
suggested that the marketing mix should be extended by further elements, to
take better account of the particular nature of services marketing. These
elements are the ‘people’ who deliver the service, the ‘processes’ by which
the service is delivered and any other ‘physical evidence’ for service quality
that the marketer may provide.
Not all services are delivered by people in a face-to-face transaction.
Automatic cash machines and vending machines are two examples of
services for which the providers are not in face-to-face contact with the
customer. In many other cases, however, service quality can vary
significantly depending on the person who performs the service and it is
often extremely important to customers that they can trust that person. This
is particularly true for services that rely on special expertise, such as the
services provided by doctors or lawyers. Consumers’ satisfaction with, for
example, a haircut or a restaurant meal also depends on the skills of the
75
Readings 28–36
hairdresser or the chef, respectively. Service providers therefore often place

great importance on the attitude and training of their staff.
Figure 4 Restaurant service
Consumers can also gain confidence from the processes by which a service
is delivered. Restaurant food tastes better and is more wholesome if there
are proper processes to make sure that food is fresh and expertly cooked.
Whether medical treatment will help a patient depends on the doctor using
the correct procedures of diagnosis and treatment. Customers tend to be
reassured if those parts of the process that they can see look correct and
efficient to them.
Finally, service providers can often provide some kind of physical evidence
to suggest that an otherwise intangible service is of good quality. These are
the tangible elements of the service. The premises where a service is
performed can be an important clue. A clean restaurant seating area gives
customers hope that attention is being paid to hygiene, and the quality of
the furniture, cutlery and crockery may give an idea of the standard of
cooking. Similarly, customers usually have a fairly clear idea of how they
expect the premises of a bank or a doctor’s surgery to look and if actual
premises do not conform to those expectations they may lose confidence.
Exercise 2
Spend approximately 20 minutes on this activity.
The purpose of this exercise is to relate the theory of the marketing mix for
services to an actual service situation that you have encountered. Think back
to a recent occasion when you used a service. This could be either online or
in a face-to-face situation. Now try to answer the following questions:
Would you describe the service as being people based? If so, why and how
is it people based?
If you think that it is people based, do the people providing the service give
an impression of quality service provision? If so, how do they do this? If not,
why not?
What are the (observable) processes by which the service is provided?
76
Do these processes give the impression of quality service provision? If so,

how do they do this? If not, why not?
Is there any physical evidence of the quality of the service?
If so, what is it and what impression of service quality does it give you?
Comment
As with many activities, your answers will obviously depend on the service
you have chosen.
Let’s look at the services provided by an online retailer of sports equipment.

The people element of this service may at first seem very limited if your only
contact with the retailer is through their website. However, if you have a
query you may be able to ring up a helpline or ‘chat’ online and get advice
from a person. The knowledgeability and helpfulness of this person can be
an important clue as to whether this is a reputable and reliable service.
Friendliness, promptness of service, knowledge displayed and a professional
manner are often taken as signs of a good service, be that in a face-to-face
situation or when communicating at a distance on the telephone or through,
say, an online chat option.
Next the process. For our example of the online sports equipment retailer,
the ease of using the website, of finding the item you want, and of ordering
and paying will all give you an idea of the quality of the service. If the
website is not user-friendly you may well decide to use a different service
provider rather than persevere. Ease and security of payment are also
crucial. When you place an order and payment for this online, you have to be
able to trust the provider with the security of your personal and payment
details. The use of encryption or the ability to use a secure service such as
PayPal will increase your confidence in the provider. Once you have placed
your order you will be reassured if you get a confirmation email and then
further communications about the state of your delivery. Many online retailers
provide you with the option of tracking the delivery of your item(s) online,
which will further reassure you.
Finally, physical evidence also varies significantly between different services.

For example, there will be more physical evidence in a restaurant (premises,
furnishings, cutlery and crockery, menu, the actual food, etc.) than in an
internet banking service. In the case of the online sports equipment retailer,
the ultimate physical evidence of the service happens when the item you
ordered is delivered to you. The quality of the item and the condition in which
it arrives will all contribute significantly to your satisfaction with the service.
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Readings 28–36
Summary
This reading has concluded the topic of the marketing mix. One of the
important things to note about the marketing mix is that its elements are
meant to work together. There is no point in producing a top quality product
and then selling it at too low a price or through a discount store, as either
of these would contradict the image of top quality. Likewise the marketing
communications should also reflect that high-quality image, through
appropriate advertising messages and probably only very limited sales
promotions if any. As you have seen throughout this reading and the two
previous ones, the advent of online commerce and marketing has had
significant repercussions on many aspects of the marketing mix. This is
picked up again in the next reading.
78
References
Learning.
Brassington, F. and Pettitt, S. (2005) Essentials of Marketing, Harlow,
Financial Times/Prentice Hall.
Strong, E.K. (1925) ‘Theories of selling’. Journal of Applied Psychology,
vol. 9, pp. 75-86.
YouTube (n.d.) ‘YouTube advertising formats’, [online]. Available at https://
support.google.com/youtube/answer/2467968?hl=en-GB (Accessed 8
April 2015).
Wijaya, B.S. (2012) ‘The development of hierarchy of effects model in
advertising’. International Research Journal of Business Studies vol.5, issue
1, pp. 73-85.
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Readings 28–36
Reading 34: Digital marketing

Introduction
Marketing is one area of business where the development of communication
technology has been most keenly felt. You have already come across
changes in marketing practices triggered by modern communication
technology in several earlier readings. This reading looks a little more
closely at digital marketing, that is, the conduct of marketing practices
through electronic means. Although not all organisations make extensive use
of new communication technologies in their marketing practices, this is
becoming increasingly important for many.
The way in which consumers and marketers use electronic media has
changed significantly in recent years. The internet has shifted from being
seen as a medium through which consumers hunt for bargains, to a means
of providing enhanced service and building consumer relationships (Wang
and Head, 2007). Consumers no longer just consume information; they now
create it too (Berthon et al., 2012). The reach and complexity of
communication has also been transformed from one-way broadcast to many-
to-many conversations. This has shifted the focus and power of online
communications to consumers, offering new opportunities and challenges
for marketers. We will examine some of the possibilities, implications and
potential pitfalls of online marketing for businesses. The reading starts with
a short examination of digital marketing and e-commerce and then looks in
a bit more detail at marketing using social media, a fast growing area of
marketing practice.
1 e-commerce and m-commerce

As you have already learned in earlier readings, electronic commerce (e-
commerce) and mobile commerce (m-commerce) – using the internet and
mobile devices or smartphones to do business - are increasingly features in
business today. Although e-commerce still only represents a relatively small
proportion of the world's entire business its importance is growing for many
organisations. In 2014 the number of people worldwide who owned a
mobile phone for the first time exceeded that number of people who had
access to a desktop computer (ComScore, 2014, cited in Smart
Insights, 2015). These channels have enabled the direct distribution of
goods and services as companies are able to contact consumers directly via
their computers, mobile devices or smartphones. For example, you may
have been contacted by a range of companies offering special deals or
seeking to extend their customer relationship after you have perhaps stayed
in a hotel, bought a car, sought insurance quotations or used a gift voucher
for a leisure activity. Although internet access varies across the globe,
access is growing and enabling companies increasingly to trade
internationally.
80
The ways in which companies conduct their business through e-commerce

or m-commerce reflects on their brands; internet-based interactions with
consumers are not simply functional transactions, but marketing
communications that influence consumers’ perceptions, trust and
relationship with companies and their brands. In many cases, internet-based
interactions between businesses and consumers replace or supplement the
in-store experience. Many companies therefore try to recreate the ambience
or service that consumers would experience face-to-face, for example
through the design of their websites and opportunities to tailor search
options or explore the available offerings with content reinforcing the
brand’s values and heritage.
As well as building long-term relationships with existing customers,
businesses need to ensure that potential customers can find them easily
online. When consumers use a search engine to seek particular goods or
services, where a company appears in the results listing may determine
whether or not its website is viewed. Search engine optimisation (SEO) ‘is
the process of improving the visibility of a website/web page via unpaid
“organic” or “algorithmic” search results’ (Dibb et al., 2012, p. 577). It
involves considering how search engines operate and which search engines
and search terms target consumers use.
Exercise 1
Consider the website of a business from which you have purchased

something or that of a business of your choice and think about the ways in
which the site’s design affected or might affect your experience as a
consumer and how the company’s brand is communicated through the
website.
Comment
As so often, your answer will depend on the website you have chosen to
look at. You might have noted whether the website was easy to find, whether
the products you were interested in were shown upfront or whether you had
to click through several linked pages to find them. You might also have
considered how good the product choice was and how easy it was to
compare the different products, and whether the price and the delivery
conditions were right for you. Your impression was perhaps also influenced
by how easy it was to use the site. Most consumers greatly prefer websites
that are intuitively easy to use.
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Businesses are most likely to adopt digital marketing practices if one or

several of the following conditions are met (Van Slyke and Belanger, 2003):
1 digital marketing increases business efficiency, for example by shifting
some of the work to consumers, e.g. the consumer does most of the
work when booking a flight online, as opposed to a travel agent
inputting all the information
2 adopting digital marketing does not increase channel conflict, i.e. other
marketing channel members, such as existing retailers, do not feel
threatened by their supplier going directly to customers via electronic
means
3 it allows organisations to reach new markets; for example digital
marketing may allow smaller organisations to reach customers
worldwide, something that would have been more difficult and expensive
through traditional channels
4 they can contain the financial investment required to set up digital
marketing channels
5 changing consumer tastes and preferences favour digital marketing; for
example, most consumers now prefer to book travel online.
The more of these conditions are met, the more likely it is that an
organisation will consider digital marketing.
The fact that so many consumers now own and regularly use mobile devices
has greatly increased the range and possibilities of digital marketing. Mobile
devices allow not only consumers to search for information about products
and services on the move, they also enable businesses to contact consumers
as they go about their lives. Geographic segmentation combined with Global
Positioning System (GPS) technology can enable marketers to target specific
consumers via their smartphone or other wi-fi enabled devices by, for
example, delivering advertisements to these devices according to their
location (Tuten and Solomon, 2015). Such developments raise ethical issues
regarding privacy, as we will discuss later in this reading. First, however,
we consider the opportunities and challenges for marketers posed by social
media.
2 Social media in marketing

You are likely to have at least some idea of what social media and social
networking websites are and what they do. Social media have been defined
as follows:
a group of Internet-based applications that build on the ideological and

technological foundations of Web 2.0, and that allow the creation and
exchange of User-Generated Content.
(Kaplan and Haenlein, 2010, p. 61)
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Social media enable active participation in the form of communicating,

creating, joining, collaborating, working, sharing, socializing, playing,
buying and selling, and learning with interactive and interdependent
networks.
(Tuten and Soloman, 2015, p. 7)
When trying to understand how social media can transform marketing

practices, it is useful to start by looking at how consumers use social media.
2.1 How consumers use social media

You have already learned that marketing can be a two-way process, where
consumers play an active part in using products, interpreting and passing on
marketing communications, and influencing marketers' actions through their
preferences gathered by marketers through marketing information systems.
Digital technology has given consumers an even more active role in certain
aspects of marketing.
Social media may be used by both organisations and consumers for
listening, gathering information and communicating, and play an
increasingly influential role in consumer decision-making and behaviour.
Discussion forums on social media have increased the range of opinions
available to consumers about products; rather than just taking account of
family and friends’ experiences, consumers are now able to take into
account product reviews from large numbers of other consumers online.
Such sources of information are particularly powerful when an offering is
high involvement, expensive or difficult to assess before purchase, for
example, in the case of a service or experience. Consumers vary in their
level of engagement with digital technology, according to their personality,
demographic characteristics, geographic location and economic status. Even
if you do not use social media, you may still have consulted online reviews
of books or hotels before purchasing or booking them to reduce the
perceived risk involved in buying in situations where it is difficult to
evaluate an offering before purchase.
Much of the content on social media is, of course, generated by their users.
From the point of view of marketing, social media provide consumers with
the opportunity to be creative participants in the marketing process, to
varying degrees.
Berthon et al. (2012) proposed a consumer-generated media (CGM)
spectrum of creativity, ranging from discussing products/services informally
to modifying proprietary products or services and distributing these
modifications. Berthon et al.’s creativity spectrum is represented in Figure 1.
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Informal discussions about

products/services
Consumer-generated
media (CGM) Spectrum
of creativity
Creating structured reviews &
evaluations in text or video
Self-created advertising videos
Modification & distribution of

proprietary products/services
Figure 1 Spectrum of creativity in consumer-generated media (source: based on

Berthon et al., 2012)
Marketers need to understand social media technology, the consumers who

use it and the nature of the communication, its social relevance and its
intended audience in order to engage successfully with consumers online
(Dahl, 2015).
At the lowest level of creativity, consumers use social media for informal
discussions about products and services. For example, a gardener might ask
a question about the best slug repellent on a gardening online forum, such
as that provided by the Royal Horticultural Society in the UK.
At the next level up, consumers may create structured product / service
reviews and evaluations, using text, audio, video or a combination of these.
Rating a restaurant experience on a consumer review or booking site is a
fairly simple example of this. A rather more complex example would be
composing a video review of a movie, perhaps including clips from the
movie and interviews with other viewers as well as one's own opinions, and
posting such a review on a video-sharing site such as YouTube.
At the third level, Berthon et al. (2012) propose self-created advertising
videos (or texts, audios, etc.). For example, an author might make a video
advertising her latest self-published book. At this level, the boundary where
we would distinguish between consumers and producers become quite fluid.
For example, the author of a piece of fan fiction or a fan video associated
with a popular book, movie or TV-show will be creating this content purely
for their own enjoyment and would probably be considered mostly a
consumer who uses online media to be creative in their engagement with
that particular book, movie or TV show. On the other hand, authors of self-
created online content may also have commercial motivations and may thus
be considered producers rather than consumers. For example, the makers of
a popular video series following their sailing adventure around the world
might be earning money from viewers’ clicks on advertising content placed
near their video or might be using the video to encourage viewers to
support them through a crowd-funding website.
Finally, according to Berthon et al. (2012), consumers may modify
proprietary products/services (i.e. products developed and trademarked by
someone else) and distribute them with the help of social media. Although
such innovations or activities may not take place online, awareness of them
is often spread (distributed) via the internet. An example Berthon et al. give
84
is the adaptation by students of the Massachusetts Institute of Technology

(MIT) of plastic drinks bottles for channelling limited daylight into cramped
city dwellings in developing countries. Such modifications to an
organisation’s products or communications are not always welcome to the
organisation marketing the original product. A well-known example is the
appropriation of McDonald’s ‘super size’ promotional offer to upsize menu
offerings by the independent film maker Morgan Spurlock in his
documentary film ‘Super Size Me’. In this documentary, Spurlock ate only
food from McDonald’s menu for 30 days and documented the impact on his
health.
Exercise 2
Many communications of well-known brands now carry the following social

media icons:
What do you think is the purpose of placing these symbols next to marketing
communications? What is this meant to tell consumers or encourage
consumers to do?
Comment
The symbols, as you probably realise, mean that the organisation or even
the brand itself has a presence on these social media. By looking up the
organisation or the brand on these social media websites, consumers can
access the latest information and can exchange views about the product with
other consumers via the comment function. For the organisations, this is a
means of increasing communications about themselves or their products and
getting people to talk about them. Informal communications among
consumers is considered to be one of the most effective ways of promoting
an organisation, a product or a brand.
Through various online media, consumers now have considerable power to

influence other consumers' opinions of products/services and the
organisations that provide them. This can be positive for marketers but if
consumers comment negatively on a product or an organisation this can also
be very damaging to that organisation. This is particularly the case when
something goes wrong, for example if an organisation provides a faulty
product or fails in delivering a service. Examples might include an online
booking service for a highly anticipated sporting event or music
performance being overloaded, thus making it impossible for eager
consumers to book tickets online; or an airline experiencing a significant
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technical problem and having to cancel numerous flights. Grégoire et al.

(2015) looked at the potential online fallout from such service failures and
suggested five categories of online responses by consumers or competitors.
This is illustrated in Figure 2.
In some cases, companies can benefit from positive word-of-mouth or
publicity when they respond to failures or crises well (category 2 –
boasting). For example, if bad weather closes several airports, customers
might be favourably impressed if an airline took proactive steps to inform
them about the status of their flight, if they were able to contact the airline
easily via telephone or email, if the airline provided up to date and easy to
follow information on the next available flights on which customers could
be rebooked and, if all else failed, offered compensation for cancelled
flights.
Initial Service Failure
DO NOTHING 1. DIRECTNESS 3. BADMOUTHING

(rarer and rarer) Voicing directly to firms Negative
through social media word-of-mouth without
(good) contacting firms (bad)
Successful Instagram, Pinterest,
recovery Twitter, Facebook Flickr, review sites
2. BOASTING
Positive publicity about
recovery (good)
Customers’ Twitter, 6. FEEDING THE

Facebook, blog VULTURES
Competitors amplify
the situation (ugly)
Double Deviation Competitors’ Twitter,

(service failure followed Facebook
by failed recoveries)
4. TATTLING 5. SPITE
Online third-party Negative publicity about
complaining (bad) recovery (ugly)
User content-generated
Third-party website, media (e.g. YouTube)
blog, or newsletter Competitors’ Responses
Figure 2 Online responses by consumers and competitors following a service failure

(source: adapted from Grégoire et al., 2015)
The most damaging responses to a service failure or grievance are

categories 4 (tattling), 5 (spite) and 6 (feeding the vultures) in Figure 2;
these can occur both after the initial service failure and after a recovery
attempt by the company involved, and in some cases the company may not
even get the opportunity to put things right first. The speed and ease of
social media mean that consumers are not only more likely to complain
when they are unhappy with a company’s offering, but that many more
people become aware of grievances broadcast online and companies need to
86
rectify the situation very quickly because a grievance can be spread very
rapidly beyond a company’s control (known as going ‘viral’) even when
they take action to redress it. Grégoire et al. (2015) cite two cases to
illustrate this danger (‘the ugly’ in their online response categorisation
shown in Figure 2). In one case a group of young French consumers posted
a three-minute video on YouTube of them singing a song they had written
about why they were switching their mobile phone provider, which they had
filmed inside the provider’s Paris branch. The video attracted over 1.5
million views nearly overnight. In the second case, a video was posted on
YouTube of a delivery driver caught on a home surveillance camera
throwing a fragile parcel containing a computer monitor. In spite of the
delivery company responding to the complaint within three days on its
company blog, the video had already clocked up half a million views by
then and continued to increase to nine million views in the subsequent three
years.
Competitors can join in on social media, taking the opportunity to
accentuate the damage to a company’s reputation and perhaps take
advantage by offering an alternative to the consumer who was airing the
grievance. Grégoire et al. (2015) cite an example of this in which an airline
highlighted a competitor’s poor service record and offered free travel
through social media to a popular chef and television presenter who had
used Twitter to complain about a delayed flight by a competing airline.
Having examined consumers’ commercial-related online behaviour, let’s
turn next to marketers’ response options to managing and responding to
online and social media.
2.2 Marketers’ use of social media

There is a variety of online media, but these can be broadly categorised into
three types (Corcoran, 2009):
1 owned media (for example, an organisation’s website)
2 paid media (for example, sponsorship and advertising)
3 earned media (for example, word-of-mouth (WOM) and viral).
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Table 1 Categories of online media
Media Definition Examples The role Benefits Challenges

type
Owned Channel a brand Build for long-term
. Website . Control . No guarantees
media controls relationships with
. Mobile site existing potential . Cost . Company
customers and efficiency communication
. Blog
earned media not trusted
. Longevity
. Twitter
. Takes time to
account . Versatility
scale
. Niche
audiences
Paid Brand pays to Shift from

. Display ads . In demand . Clutter
media leverage a foundation to a
channel . Paid search catalyst that feeds . Immediacy . Declining
. Sponsorships owned and . Scale . Poor credibility
creates earned
media . Control
Earned When customers Listen and

. Word of . Most . No control
media become the respond earned
mouth credible
channel media is often the . Can be
. Buzz result of well- . Key role in negative
coordinated most sales
. Viral . Scale
owned and paid . Transparent
media . Hard to
and lives on
measure
(Source: Forrester Research, Inc. in Corcoran, 2009)
Marketers have control over the first (owned media), a degree of control
over the second (paid media) and no control over the third (earned media).
However, each type has its advantages and disadvantages, as detailed in
Table 1. Earned media are the most credible and can be very effective,
provided that customers’ communications are positive. Owned media are
low on trust, but are efficient and versatile. Paid media have poor credibility
and must fight through marketing clutter from other businesses, but offer
immediacy and reach.
Another way of categorising social media was devised by Weinberg and
Pehlivan (2011) using two dimensions: half-life information (the longevity
of information in terms of availability and interest) and depth of information
(the richness of information and the diversity of perspectives), as illustrated
in Figure 3. Blogs and online communities have a relatively long-life but
the latter have a greater richness of information and represent a greater
number and diversity of perspectives. Blogs can help increase product
knowledge and brand building. Online communities facilitate conversations
between consumers and organisations and lend themselves to customer
relationship management. By contrast, micro-blogs (such as Twitter posts)
and social networks have a shorter life, but again vary in their depth of
information. Micro-blogs are short and shallow and are good for keeping
brands top-of-mind. Social networks can be used to influence and track
consumers’ brand beliefs and attitudes. Weinberg and Pehlivan (2011) argue
that, while traditional marketing's objective as being about purchases is still
valid, the objective of social media marketing is social with the ultimate
88
being ‘consumer evangelism’. It is not realistic to participate in all forms of

social media, so companies need to choose carefully, according to their
target segments and the messages they wish to communicate, ensuring they
are integrated with other marketing activities (Kaplan and Haenlein, 2010).
Half-life of information
long
Blogs Communities
• E.g. WordPress • E.g. HP communities,
• Brand building MacRumours
• Convey product knowledge • Establish and maintain
relationships
Information
shallow deep
Micro-blogs Social networks

• E.g. Twitter • E.g. Facebook
• Create awareness and recall • Influence and track beliefs
• Brief engagement, short and attitudes
conversation
short
Figure 3 Weinberg and Pehlivan’s classification of social media (source: adapted

from Weinberg and Pehlivan, 2011)
For organisations, social media offer both opportunities and threats. The
aftershave brand ‘Old Spice’ experienced a dramatic increase in sales when
its television advertisement (‘The man your man could smell like’) was
posted on YouTube (Pitt et al., 2011). Fans and online communities can
promote products with or without an organisation’s involvement, providing
independent endorsement of its offerings and even contributing to an
organisation’s product portfolio. An illustration of an interaction between
brands and online communities is the introduction of a Lego set based on
the TV programme ‘Dr Who’, which was suggested by a fan of the
programme via the Lego website and subsequently received over 10,000
votes from the online community and was announced after undergoing toy
testing by an expert panel (BBC, 2015). However, social media can also be
used to challenge an organisation and pose a threat to its brand
communications, as discussed earlier. Negative reviews can have a bigger
impact than positive reviews (Bronner and de Hoog, 2013) and social media
have given consumers a voice that can rival an organisation’s marketing
communications. For example, when an energy provider asked on Twitter
what people wanted to know at a time when the company had just
announced price increases for gas and electricity customers, the responses
posted by Twitter users were not presumably as they had hoped: ‘...which
items of furniture do you, in your humble opinion, think people should burn
first this winter?’ and ‘will you pass on the cost savings from firing your
social media team to customers?’ (Dahl, 2015, p. 2)
With consumers’ media-enabled power to reach a mass audience, brand
protection has become as important as brand building as social media have
given rise to the social collective, increased transparency, criticism and
parody (Fournier and Avery, 2011). Grégoire et al. (2015), who you will
remember classified responses to service failures as good, bad or ugly (in
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Figure 2 above), made a number of recommendations about how best to

handle online consumer complaints:
. Monitoring
Organisations need to monitor social media for mentions of their
offerings or brands, either by employing staff to monitor social media or
by using tools available to do this (examples include Google Alerts,
which alerts companies to mentions of their company on a social
medium, TweetDeck, which tracks activities and mentions on Twitter,
and Social Mention and Mention, which identifies comments as positive,
negative and neutral). Monitoring social media enables companies to
respond to potentially damaging posts as quickly as possible to try to
convert them to positive retrievals of the situation or to limit their
damage.
. Direct complaints
Complex or severe complaints are best resolved privately with the
complainer limiting responses in the medium to acknowledgement and
notice of resolution of the complaint. Protracted negotiation involved in
resolving such complaints is better handled privately with the
complainant, because it can annoy others or make it difficult for them to
follow online and it is also safer to diffuse tensions outside of a public
potentially gladiatorial-like arena. Following satisfactory resolution,
Grégoire et al. (2015) suggested informing the community back on social
media that the matter had been resolved.
Simple complaints made directly to the company online are best handled
by responding publicly on the medium where it was raised.
. Boasting or positive PR
Positive word-of-mouth resulting from satisfactory resolution of a
service failure should be left in the hands of consumers to prevent a
company appearing to have engineered it.
. Badmouthing
When customers complain online without contacting the company to
give them the opportunity to rectify the complaint, the company needs to
be proactive to pick up the complaint through monitoring of social
media and then respond quickly to contact the complainant and resolve
the matter privately, acknowledging online the matter and notice of its
resolution and if appropriate counter any erroneous assumptions of
awareness or intent by the company.
. Tattling
When a complainant has involved a third party in their grievance, the
company may consider whether the third party might help broker a
resolution with the complainant.
. Spite
Viral complaints are very difficult to contain, so prevention is better.
However, if consumers do choose to take revenge on a company when
they are unhappy with it, again private resolution is recommended,
followed by public notification that the problem was fixed and measures
taken to prevent it happening again.
90
. Competitor responses
When competitors have seized the opportunity to promote their company
as offering superior service, there is no fixed solution and creativity may
be needed to find a response to regain the company’s position.
Social media marketing requires not only engaging content and cultural
resonance, but also flexibility, opportunism and adaptation balanced by risk
analysis (Fournier and Avery, 2011). It must also be blended with traditional
media (Hanna et al., 2011). Some organisations employ people to monitor
social media activity about their brands so they can respond swiftly to
negative remarks in, for example, tweets and act immediately to head off
bad publicity and restore a brand’s good name. It is even possible to view
scores for the number of fans, response times and response rates of different
brands (see for example, www.socially-devoted.com). The dangers of this
trend for organisations is the escalating expectation that they should respond
instantaneously to consumer dissatisfaction and that they could be held to
ransom by consumers threatening to broadcast their grievances through
social media. For consumers, it can mean that those who do not use social
media or are unwilling to air their complaints publically get less preferential
treatment from organisations.
3 Privacy
The flip side of the opportunities offered by technology is the risk of cyber
attacks, which vary from selling customer data to stealing or leaking secret
or sensitive information. Privacy is a key concern among consumers and the
use of personal data and concerns about information privacy is one of the
key barriers to consumers’ engagement in e-commerce (Wang et al., 2007).
Marketing via mobile phone represents perhaps a particularly great threat to
consumer privacy owing to the potential to disclose personal information
regarding a user’s location, device serial number, international mobile
equipment identity (IMEI), integrated circuit card identifier (ICCID) or SIM
card identity, social networks, life style, preferences and behaviour patterns
(Zhang et al., 2013).
The technology exists to use video cameras to inform merchandising
strategies and to harness video analytics, such as facial recognition and eye-
tracking, to understand consumers’ buying tendencies, albeit reported use of
such technology in practice has been relatively rare and regulation of it is
being debated (Garry, 2012). Face recognition technology poses a particular
risk to privacy by converting an image into biometric data that identifies
individuals automatically and can be used beyond individuals’ control
particularly when linked to a wealth of personal data from social networks
(Welinder, 2012).
Consumer data can also be used to drive personalised commerce through the
use of ‘Big Data’ (the integration of multiple datasets) or social analytics
(the mining of social network data). For example, Wal-Mart’s ‘Shopycat’
service uses data from Facebook to make product recommendations to
customers and gift suggestions for their friends (Garry, 2012). The line
between personalisation and intrusion is one that both marketers and
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consumers are having to negotiate. It has even been claimed that metadata
can mean that individuals become the product rather than the customer
(Caulkin, 2013).
Summary
The widespread use of digital media has changed consumer behaviour and
marketing practice in many respects. In previous readings you have already
come across numerous examples of this. This reading has looked at the idea
of digital marketing and particularly some of the implications of social
media use for marketers in more depth. The use of social media for
marketing is a fast developing area. This is the reason why much of this
reading has looked at social media marketing. Mobile phone marketing may
well develop similarly in the future. It is worth stressing again that digital
marketing does not make more traditional forms of marketing obsolete or
that all organisations do or should embrace digital marketing. But
increasingly marketers need to have some understanding of what digital
media mean for their business and how they shape marketing practices.
92
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94
Reading 35: Marketing in social and political contexts
Reading 35: Marketing in social

and political contexts
Introduction
Marketing is not confined to business contexts and need not involve what
we typically consider products or services. For example, marketing
techniques can be used to encourage people to vote for particular political
parties or to engage in other political activities such as voicing their
opinions on particular issues. Marketing techniques can also be used to
encourage people to lead healthier lives (for example the European Union’s
‘HELP’ quit smoking campaign) or to help prevent damaging behaviours or
abuse of vulnerable groups (for example the ‘STOP’ child abuse prevention
campaign of the National Society for the Prevention of Cruelty to Children
(NSPCC) (Figure 1)). Rather than goods and services, what is being offered
here are improvements to society’s economic, social, health and
environmental welfare. However, not-for-profit marketing may also involve
monetary exchange, for example, when charities, causes or political parties
seek donations through fund-raising campaigns.
Figure 1 NSPCC advert
In this reading we will explore marketing in two non-commercial contexts:

social marketing and political marketing. We will explain what each is and
then explore the principles and some examples of each type in the sections
that follow.
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1 What is social marketing?

In their textbook on social marketing, Hastings and Domegan (2014)
explain social marketing as follows:
Social marketing takes insights from the commercial marketer’s efforts

to influence our consumption behaviour and applies them to health and
social behaviours; it also looks critically at business in order to reduce
potential harms being done at both an individual and systemic level.
(Hastings and Domegan, 2014, p. 14)
As with commercial marketing, social marketing is about more than

advertising campaigns to, for example, quit smoking. It should also not be
confused with social media marketing (which you read about in Reading 34
and which is about a class of communication channels) although like
commercial marketing it may use these. Integrated marketing campaigns
that tackle social issues through multiple points of contact with a range of
stakeholders and communication channels are used, just as they are in
commercial contexts.
Social marketing attempts to influence behaviour, either by encouraging
people to engage in safer or healthier behaviour or by critiquing harmful or
unhealthy behaviour brought about by commercial marketing practices. The
latter is used to build the evidence base that informs policy aimed at
preventing harmful or unhealthy effects on citizens.
1.1 Principles and examples

Although marketing terms are used in social marketing, their meanings are
translated for use in non-commercial contexts. Like commercial marketing,
social marketing starts with an analysis of the external environment, of
stakeholders (including customers or clients) and of competitors.
Competition can take the form of competing desires, competing solutions,
competing interventions and competing providers and even apathy (Peattie
and Peattie, 2003). Just as being customer-focused is important in
commercial marketing, so a client orientation is needed in social marketing.
Social marketers need to understand the needs of those whose behaviour
they seek to change. Social marketing also uses segmentation and target
marketing to identify those people whose behaviour they want to influence.
Likewise, social marketers have to create ways to engage the target segment
and recognise the influence of the social context and social determinants of
behaviour. The marketing mix is also still used.
However, in social marketing the ‘product’ is the behaviour change or
social proposition rather than a commercial product. Sometimes the
suggested behaviour change is a mutually acceptable compromise. For
example, rather than asking drinkers to abstain completely from alcohol,
they are asked to limit their alcohol consumption to particular thresholds.
The ‘price’ is the cost to members of the target group in terms of the effort
or sacrifice involved in the behaviour change. ‘Promotion’ is the form(s) of
the behaviour change message and ‘place’ is the accessibility or location of
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the focal behaviour or the behaviour change intervention. Social marketing

also uses segmentation and target marketing to identify who they want to do
some form of behaviour.
Table 1 shows a comparison of commercial and social marketing examples:
a new car (commercial marketing example) and a driver awareness course
sometimes offered to motorists for minor driving offences (social marketing
example).
Table 1 A comparison of commercial and social marketing examples
Commercial example: Social marketing example:

New car Driver awareness course
Product Brand and model of car Safer driving
Price / ‘Cost’ Monetary figure Time off to attend
Communications TV/radio/print Letter offering attendance
advertisements, website as an alternative to points
on licence
Distribution Show rooms, dealerships Course venue
(Place)
Competition Other manufacturers and Prioritisation of other
models competing demands on time
or attention, speeding
Target market Drivers with needs matching Drivers who have committed
those offered by the car minor driving offences
Exercise 1
Create a table based on the template of Table 1 above, looking at a social

marketing campaign you have seen and a related commercial product of
your choice. If you are having problems thinking of a social marketing
example, you might want to consider a stop-smoking campaign, or a
campaign to encourage people to become more physically active.
Comment
You were probably able to complete this exercise using the example of the
driver training above. For a 'stop-smoking' campaign, the product might be
considered to be the health benefits from not smoking. The cost would be
the effort that it takes to overcome a nicotine addiction. The communications
is probably the element of the campaign that you first noticed, e.g. posters
urging smokers to stop. Distribution might be a little tricky to determine here.
But if the campaign encouraged smokers to access nicotine replacement
products through the National Health Service (or similar), then perhaps
pharmacists or a doctor's practice could be considered places of distribution.
Competition could be any other health-related activities, assuming people
only have the energy to pursue one at a time, or it could, of course, be the
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Readings 28–36
attraction of smoking itself. The target market is easy to define: it would

include all smokers.
You might be surprised to learn that branding plays a role in social

marketing as well as commercial marketing. The equivalent of corporate
branding is the organisation behind a social marketing campaign or
intervention. How people perceive and react to a social marketing message
or intervention is influenced by the brand reputation and credibility of the
organisation responsible for it. For example, if you were advised to drink
alcohol in moderation, how you felt about this advice might differ
depending on whether it was issued by the British Medical Association or
the manufacturer of a brand of alcoholic drink. Compare the two messages
and placements of alcohol advice in Figure 2. Both contain advice about the
need to ‘know your limits’ by the UK Chief Medical Officers, but (a) is
attributed to the Home Office and (b) is a drink manufacturer’s own social
responsibility initiative.
Figure 2 Alcohol campaign and initiative: (left) alcohol manufacturer initiative,

(right) NHS campaign
As in commercial marketing, social marketing uses research to help

understand the needs and motivations of target groups and the influences
and barriers to behaviour change. Research can uncover some unexpected
insights into target groups. For example, research revealed that to engage
young drivers in reduced speeding, the desired behaviour of careful driving
needed to be reframed as ‘skilful driving’, rather than telling them to slow
down (Hastings, 2008).
Just like commercial marketing, social marketing seeks to cultivate repeat
‘purchases’ through building a relationship with ‘consumers’, that is to say
social marketing typically aims to encourage sustained behaviour change. It
can be thought of as engaging in relationship marketing, but this is probably
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better regarded as mutually beneficial relationships based on exchange with

‘win-win outcomes’. However, while increased consumer purchasing may
follow quickly in response to a commercial marketing campaign, changing
people’s behaviour in social marketing contexts can take considerably
longer. Indeed, Hastings and Domegan (2014) note the danger of short-term
transactional thinking in evaluating social marketing campaigns.
In terms of critiquing harmful commercial marketing practices, social
marketers contribute to the evidence base that informs policy. Examples
include an analysis of tobacco industry documents for the UK Government’s
Health Committee (Hastings and MacFadyen, 2000) and a review of the
evidence on the extent, nature and effects of food promotion to children
(Cairns et al., 2009).
2 What is political marketing?

Political marketing applies marketing concepts and approaches to the
political context. As a sub-discipline, it draws on commercial marketing and
political science, but informally political marketing stretches back through
history; many of the activities we label as ‘marketing’ were practiced
thousands of years ago by political leaders. Lees-Marshment (2014, p. 1)
asserts that political marketing is ‘a fundamental part of political life’ and
describes it as being about:
How political elites [candidates, politicians, leaders, parties,

governments, government departments and programmes, NGOs and
interest groups] use marketing tools and concepts to understand,
respond to, involve and communicate with their political market in
order to achieve their goals.
(Lees-Marshment, 2014, p. 2)
Political marketing therefore includes not only campaigning by political

parties but also by a wide variety of groups, such as Greenpeace’s ‘Save the
Arctic’ campaign (Greenpeace, n.d.) (Figure 3) or the Guardian newspaper’s
‘Keep it in the ground’ campaign, which – among other things – is
encouraging charitable foundations not to invest their funds in fossil fuel
companies (The Guardian, n.d.).
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Readings 28–36
Figure 3 Save the Arctic
Due to the limited scope of a module reading, the remainder of this section
concentrates largely on campaigning by political parties. However, when
reading through this you should bear in mind that much of this will also
apply to political marketing by other organisations.
While some goals, such as getting elected or recognition, can be considered
self-serving, public service by politicians may involve a broad spectrum of
goals, such as raising awareness and understanding of important issues,
stimulating debate, improving representation, developing policies and
passing legislation. Political marketing uses marketing approaches to gain
power or influence to enable desired social, economic and environmental
change.
2.1 Principles and examples

The political landscape involves a large number of stakeholder groups. For
a political party these would include not only politicians, candidates and
voters (and the wider society), but also members, volunteers, donors,
internal and external staff, public/civil service, regulatory bodies, think
tanks, lobbyists, the media, celebrity supporters, opposition parties and other
governments.
Ormrod et al. (2013) argue that exchange is triadic rather than dyadic in
political marketing and involves three interactions:
(i) between voters and candidates/parties
(ii) between elected representatives
(iii) between governments and citizens.
All three are required for successful exchange because casting a vote for a
candidate will not bring reciprocal value unless the candidate is elected and
gains power to enact their promised manifesto.
Political marketing, like commercial and social marketing, involves an
analysis of the market and the competition. Marketing research is used to
help understand voters and competitors and to inform strategy. The UK
Labour Party famously used focus groups to test out its ideas. Political
marketing is zealous in its use of competitive intelligence gathering.
Political opponents as well as the press are also quick to seize on any whiff
of scandal or impropriety and politicians can fall from grace swiftly with
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hard-won reputations lost in an instant. The term ‘political arena’ conveys

the combative environment in which political actors vie to gain an
advantage with televised interactions frequently descending into a point-
scoring sport, rather than constructive debate.
Relationship marketing is important in political marketing to build trust and
long-term support, which is needed to implement policies and achieve
results over the long term. Co-creation may also be used, whereby
politicians involve the public in the process of development, design and/or
implementation of solutions. For example, the UK Conservative Party's
2010 general election manifesto strove to empower communities in the ‘Big
Society’.
Lees-Marshment (2014, p. 11) makes the point that politics differs from
business in being about ‘principles, ideals and ideology’ rather than just
offering voters what they want. A key tension is that power is determined
by gaining the majority of parliamentary seats in an election, but a
government’s ethical responsibilities may be considered to transcend the
majority’s interests and to protect the powerless and prevent the
disadvantaging of minorities. Political marketing must bear responsibility
for the impact of political messages on society. Overpromising what cannot
be delivered can damage not just a political brand but increase distrust
among voters, and negative or fear campaigns that marginalise particular
groups, such as asylum seekers or unions, not only damages those groups’
reputations but normalise discrimination and negative campaigning (Hughes
and Dann, 2009).
Segmentation, targeting and positioning

Political marketing campaigns are often carefully targeted at a detailed
level. For example, political parties now segment the electorate into micro-
and even nano-target groups (Lees-Marshment, 2014). Different segments of
voters will be targeted in different ways, depending on factors such as their
mobility (in terms of location – within reach or not of city centres), and
their socioeconomic status (which influences their receptivity to receiving
information and participating in events related to economic policy) (Cwalina
et al., 2013). Primary segmentation may be based on the extent and strength
to which voters align themselves with particular parties, with secondary
segmentation based on voters’ profiles, according to their demographic,
psychological and behavioural characteristics (Cwalina et al., 2013).
While positioning is also used in political marketing to specify unique
benefits offered by a political party in relation to opposition parties, these
can become blurred in cases where there is a ‘flight to the middle ground’
whereby parties fail to differentiate themselves from opponents’ positions
(Smith and Saunders, 1990, p. 299). This was observed in the so-called
‘New Labour’ in the UK during Tony Blair’s leadership, when the Labour
position encroached on the Conservative Party’s traditional position by
offering a ‘Third Way’ – a middle ground between capitalism and socialism
to appeal to voters from across the political spectrum. Bannon (2004), cited
in Lees-Marshment (2014), argued that to be successful, political
positioning should be: (i) clear; (ii) consistent; (iii) credible; (iv)
competitive; and (v) communicable (easily communicated).
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Readings 28–36
Product
The product in political marketing is complex and encapsulates not just a
policy, but the political brand, the actors representing it, their behaviour, the
party’s values, ideology and reputation. Voters are buying into the whole
package and may not be comfortable with all of the elements. For example,
they may object to certain policies or distrust specific politicians or dislike
particular campaigns. Political brands also act as heuristic devices –
shortcuts that many voters may use to simplify their voting decisions to
save their having to engage a lot of time and effort understanding the
differences between the increasingly wide range of parties’ policies and
values (Smith and French, 2009).
Communications and media

Although traditional media, such as direct mail marketing, posters and
television advertisements are still much in evidence, political marketing has
embraced new channels for communicating with the electorate. For
example, the campaign to elect President Obama used a wide range of
social media to engage directly with the US public and to engage young
voters. While communication is important in political marketing, the
application of marketing to politics extends beyond communication to the
entire behaviour of a political organisation, just as everything a business
does needs to be consistent with its brand identity. Just as with social
marketing, political marketing involves more than advertising campaigns,
albeit these are often the most visible to their target audiences. Public
relations feature heavily in political marketing, helping to create a
favourable image of a political party or candidate.
Exercise 2
Reflect on a current or past high profile political campaign you can recall and
try to identify how marketing approaches are being or were used to promote
a particular candidate or political party.
Comment
Perhaps the most salient marketing aspect you remember might be
advertising campaigns (on posters, television or radio) by the various political
parties and their candidates. The message of these campaigns would have
been carefully tailored to particular segments of the voting public that are
deemed most likely to be interested in that political party. Parties also often
try to put out a variety of messages tailored to different audiences and their
interests. For example, they might make promises to pensioners, calculating
that older people may be particularly likely to vote. As another example,
political parties are generally very astute about using public relations. Trying
to influence news stories could be considered an important part of political
marketing. Public debates between party leaders in the period leading up to
an election are further political marketing opportunities, as each party leader
102
will aim to portray a carefully calculated image of themselves and their

parties in these debates (Figure 4).
Figure 4 Image of televised debate between party leaders
Price
Price in political marketing has been interpreted as a ‘psychological
purchase’, encompassing the electorate’s economic and psychological hopes
or insecurities (Wring, 1997, p. 658). These are often the focus of negative
marketing messages, for example, a party may use fear messages that focus
on opponents’ intentions to increase taxes or cut public spending. Personal
attacks may also be made on candidates as well as parties.
When looking at a political campaign by an advocacy group, we might say
that the price is the effort people must make to support the particular cause
advocated by the group. This can be greater or smaller, depending on one's
involvement. If I want to support Greenpeace’s Save the Arctic campaign, I
might ‘pay’ a relatively small price if I merely sign up to their online
petition to politicians. (This will only cost me the few minutes it takes me
to locate the petition online and to put a few bits of information in.)
However, I could also choose to engage more seriously by joining a
demonstration or trying to persuade my friends to also support the
campaign. (This would require me to spend more time and effort but it
could also make a bigger contribution to the cause.)
Place
The importance of place in political marketing is evident in the voting
campaign tours undertaken by political candidates in the run up to elections
and their targeting of key constituencies where they hope to swing the votes
in their favour. In spite of the technological options available, personal
visits by candidates still offer a powerful route to connecting with the
electorate. One might say that parties are distributing their messages across
the country in this manner.
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Readings 28–36
In other cases, place can be much more tightly circumscribed. For example,
many political campaigns are about local issues, such as the siting of a new
road or planning permission for a new out-of-town shopping centre
(Figure 5). Here, campaigners are likely to target the local population and
local politicians or town planners.
Figure 5 Local political campaign
Summary
In this reading we have looked at the application of commercial marketing
concepts and tools in two areas of non-commercial contexts: social
marketing and political marketing. From these discussions and the other
applications of marketing introduced in Reading 28, you should now
appreciate the wide applicability of marketing and the harnessing of
common concepts to different contexts. In the next reading we look at
sustainability in marketing.
104
References
Bannon, D. (2004) ‘Marketing segmentation and political marketing’, Paper
presented to the UK Political Studies Association, University of Lincoln, 4-
8 April, cited in Lees-Marshment, J. (2014) Political Marketing. Principles
and Applications, second edition, Abingdon, Oxon, Routledge.
Cairns, G., Angus, K. and Hastings, G. (2009) The Extent, Nature and
Effects of Food Promotion to Children: A Review of the Evidence to
December 2008, World Health Organization. [online]. Available at http://
www.who.int/dietphysicalactivity/Evidence_Update_2009.pdf (Accessed 31
May 2015).
Cwalina, W., Falkowski, A. and Newman, B.I. (2013) ‘The macro and
micro views of political marketing: the underpinnings of a theory of
political marketing’, Journal of Public Affairs, vol. 12, issue 4,
pp. 254–269.
The Guardian (n.d.) 'Keep it in the Ground', The Guardian. [online]
Available at: http://www.theguardian.com/environment/series/keep-it-in-the-
ground, online item, (Accessed 20 April 2015).
Greenpeace (n.d.) 'Save the Arctic'. [online] Available at: http://www.
greenpeace.org/international/en/campaigns/climate-change/arctic-impacts/,
(Accessed 20 April 2015).
Hastings, G. (2008) Social Marketing. Why should the Devil have all the
best tunes? Oxford, Butterworth-Heinemann.
Hastings, G. and Domegan, C. (2014) Social Marketing: From Tunes to
Symphonies, second edition. Abingdon, Oxon, Routledge.
Hastings, G. and MacFadyen, L. (2000) Keep smiling. No one’s going to
die. An analysis of internal documents from the tobacco industry’s main UK
advertising agencies. [online]. Available at http://www.tobaccopapers.com/
keepsmiling/KeepSmilingReport.pdf (Accessed 18 March 2015).
Hughes, A. and Dann, S. (2009) ‘Political marketing and stakeholder
engagement’, Marketing Theory, vol. 9, issue 2, pp. 243–256.
Lees-Marshment, J. (2014) Political Marketing. Principles and Applications,
second edition. Abingdon, Oxon, Routledge.
Ormrod, R.P., Henneberg, S.C.M. and O’Shaughnessy, N.J. (2013) Political
Marketing. Theory and Concepts, London, Sage.
Peattie, S. and Peattie, K. (2003) ‘Ready to fly solo? Reducing social
marketing’s dependence on commercial marketing theory’, Marketing
Theory, vol. 3, issue 3, pp. 365–385.
Smith, G. and French, A. (2009) ‘The political brand: A consumer
perspective’, Marketing Theory, vol. 9, issue 2, pp. 209-226.
Smith, G. and Saunders, J. (1990) ‘The application of marketing to British
politics’, Journal of Marketing Management, vol. 5, issue 3, pp. 295–306.
105
Readings 28–36
Wring, D. (1997) ‘Reconciling marketing with political science: theories of

political marketing’, Journal of Marketing Management, vol. 13, issue 7,
pp. 651–663.
106
Reading 36: Societal and environmental issues in marketing
Reading 36: Societal and

environmental issues in marketing
Introduction
Marketing is perhaps the most outward-facing function of an organisation
and many of the societal and environmental challenges of business and
management are easily noticeable in a marketing context. Marketers have
been criticised for encouraging excessive consumption and materialism and
thus contributing to a lack of environmental sustainability, social envy and a
loss of non-material values. While many marketers would argue that
marketing does not actually create these problems in society, it merely
reflects them, it is in the interest of organisations to consider how their
marketing practices impact on societal well-being and environmental
sustainability. While Reading 35 focused on the way in which marketing
techniques can be used by non-commercial organisations to foster social and
political goals, this reading focuses on the societal and sustainability
implications of commercial marketing activities.
1 The societal marketing concept

One way in which we can think about the social impacts of marketing
activity is through the societal marketing concept. This is in many ways an
extension of the marketing orientation, discussed in Reading 28. According
to Kotler and Armstrong (2010) the societal marketing concept holds that a
business should work out what the needs, wants and expectations of its
target customers and markets are. It should then satisfy these needs, wants
and expectations better and more efficiently than competing businesses, in a
way (and here lies the crucial difference with the marketing orientation) that
maintains or improves the consumer’s and society’s well-being.
Why do we need a societal marketing concept? Kotler and Armstrong
(2010) argue that a pure marketing orientation may overlook the fact that
what consumers want in the short term and what is good for them in the
long term is not necessarily the same. For example, many of us find fast
food, such as hamburgers, tasty and consume it frequently, but fast food is
often not good for us in the long run because it can be high in fat and low
in fibre and essential nutrients. There can also be conflict between what
individual consumers desire and what is good either for society at large or
for the environment. Transport is a good example. Most of us enjoy the
convenience of travelling by car and/or aeroplane, with the result that the
number of cars on our roads and the number of air miles travelled each year
have increased enormously over recent years. You will probably be aware of
the negative consequences of increased travel, such as air pollution and
global warming, congested roads and noise from airports.
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Readings 28–36
In 1972 well-known Professor of Marketing, Philip Kotler was among the

first to write about the idea of societal marketing. He argued that businesses
should think of the products they offered and were developing in terms of
two dimensions:
1 the immediate satisfaction they provided to consumers; and
2 the long-term consumer welfare they provided.
Figure 1 shows four different types of product, depending on whether the
score is high or low on these two dimensions.
Immediate satisfaction
Low High
High Salutary products Desirable products

Long-run
consumer
welfare
Low Deficient products Pleasing products
Figure 1 Classification of new product opportunities (source: adapted from

Kotler, 1972)
To some extent, these four categories are self-explanatory. Kotler suggests

that marketing deficient products will not be successful for businesses
because there will be no market for them. Salutary products pose no moral
problem but may be difficult to market if consumers derive no immediate
satisfaction from them. Many businesses market pleasing products, for
which there tends to be a ready market. However, these are precisely the
products that, under the societal marketing concept, businesses should not
market as they are to the long-term detriment of consumer and societal
welfare. Desirable products are just that: desirable for the individual
consumer, desirable from a long-term societal perspective and desirable for
the business, which should be able to sell these well, and with a good
conscience.
The societal and environmental implications of marketing began to be
discussed extensively in the late 1960s and 1970s. Many of the concerns
raised then are still valid today. Feldman (1971) set out what he saw as the
main societal challenges for marketing at the time. According to Feldman,
the marketing system is designed to provide choice to consumers. While
this was once a highly desirable aspect of marketing, it has become
problematic once consumer choice and material wealth had reached a
certain level. More choice beyond that level not only provides only limited
additional benefit, it also increases environmental degradation, for example
when more and more powerful air conditioning systems or larger and larger
cars are bought, which consume ever more energy.
Feldman argues that marketers have a responsibility to mitigate the negative
environmental and societal impacts of their actions but that they generally
didn’t seem to take that responsibility. For Feldman, part of the reason is
that marketing practice, as a whole, tends to follow a mainstream belief in
108
Western societies that progress means growth, and that a lack of growth
equates to regression. Selling more and more and making products
constantly bigger (and better?) is a manifestation of this belief in growth.
Furthermore, Feldman argues that marketing has traditionally stressed
individual and social satisfaction of consumption (which results from the
approval of immediate others, such as friends and family) but has neglected
societal satisfaction, which he argues results from the buyer’s knowledge
that their consumption choices benefit society as a whole. An example of
societal satisfaction would be if a buyer deliberately chooses a car that
minimises energy consumption and pollution.
Feldman suggests that marketers can respond to societal challenges through
one of four strategic choices:
. They can ignore the societal and environmental challenges to marketing

practice.
. They can resist pressures to respond to these challenges, for example by
lobbying against legislation that would restrict existing marketing
practice (for example the tobacco industry spent years lobbying against
all legislation to restrict tobacco advertising).
. They can acquiesce and passively adjust to new legislative requirements.
. The final (and in Feldman’s view preferable) strategy is to explicitly
recognise that marketers need to play their part in meeting societal and
environmental challenges and to accept and proactively anticipate
legislation and societal pressure for change.
Prothero (1990) linked the societal marketing concept with increasing
environmental concerns of consumers and argued that these concerns make
it necessary for marketers to take their environmental and societal
responsibilities seriously. She points out that many companies seemed to
jump on the green bandwagon in the 1980s following green consumer
pressure but that some had put in place green or societal marketing
strategies much earlier than that, seemingly resulting from the genuine
convictions of a company’s owners or top management. Environmental
concerns in marketing are considered in more detail in the second main
section of this reading, below.
Exercise 1
Having read about the societal marketing concept, make notes on the
. Do you think marketers should take into account societal questions when
deciding on their marketing strategies?
. Can you think of any examples of marketing strategies that might be
harmful to society?
. Can you think of any examples of good societal marketing practice?
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Readings 28–36
Comment
. Although over 40 years have elapsed since then, the concerns raised by
Feldman (1971) and Kotler (1972) remain pertinent today. Consumer
choice and material consumption have increased rather than decreased
in recent years and what was then primarily true for North America and,
to some extent, Western Europe, is now increasingly true for other
economies, such as China, India or Brazil. The problems of balancing
individual choice with societal and environmental well-being are perhaps
even more critical than they were then. From this perspective it is difficult
to argue that marketers should not concern themselves with the societal
and environmental impacts of their practices. Whether the societal and
environmental efforts of marketers are enough to address the problem is
a different matter.
. Sadly, it would seem that business as a whole has made little progress in
solving the problems outlined by Feldman (1971). Marketing practice in
general usually still seems to emphasise individual choice and material
consumption over societal benefits and non-material consumption. One
example is a radio advertising campaign run by the UK supermarket
chain Sainsbury’s at the time of writing this reading. Sainsbury’s
promoted the fact that it was giving extra loyalty points on all fuel
purchases for a limited period of time (Figure 2). The advertisement
started with consumers discussing various reasons why they might use
their cars more in rather pointless seeming trips, such as a day trip to
visit a museum in remote John O’Groats (at the northern tip of Scotland).
. It is true, however, that a growing number of businesses compete over
the environmentally and societally benign nature of their products.
Examples could be the growth in fair trade products or environmental
marketing, discussed below.
Figure 2 Sainsbury petrol station
110
The basic principle that businesses should not only consider the immediate
expectations of their customers, but should also take into account the long-
term welfare of customers and society at large, is difficult to argue with. In
essence, it still defines a business’s social responsibility from a marketing
perspective. But the societal marketing concept has also come under some
criticism itself. Most of the critics say that the main problem is that it has
not really made much difference in practice. For example, Abratt and Sacks
(1989) found at that time that managers in large tobacco and alcohol
processing businesses had never heard of the societal marketing concept.
The same managers were not really prepared to accept that their businesses
had a responsibility for the welfare of their customers and society. More
recently, Crane and Desmond (2002) argued that the societal marketing
concept was not a good basis on which one might make marketing practice
and theory more socially responsible. The reasons for this, they argued,
were that:
(a) there was not enough explicit moral responsibility in the societal
marketing concept
(b) it was difficult to establish who should define what the interests of the
consumer and of wider society were
(c) there was too much emphasis on ‘good’ or ‘bad’ products, with not
enough consideration of how and by whom these products were being
used.
Moreover, these authors argued, three decades after the development of the
societal marketing concept, social concerns over marketing had not only not
gone away but had actually increased. This suggested that the societal
marketing concept had not actually done the job it was expected to do.
Isn’t that the tobacco slogan we used in the sixties?
So far, we have mainly considered societal and environmental issues

together. Many people, however, believe that environmental issues are too
big to be considered as merely a subset of societal problems. Environmental
or ‘green’ marketing has become a topic in its own right and is discussed in
the next section.
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Readings 28–36
2 Environmental issues in marketing

Business and marketing practices have an impact on the natural
environment at every stage in the production and consumption process. This
is from the sourcing of raw materials, through the production of goods and
services and storing and transportation of finished goods, to the use of the
product by the final consumer and its eventual disposal. As a result, there
are a large number of well-known environmental problems that are largely
or partly the result of human economic activity. Throop et al. (1993) list the
following problems at local, regional and global level:
. Inadequate solid waste disposal capacity: Modern society produces ever

larger quantities of industrial and household waste, whereas suitable
places for landfill sites and other forms of waste disposal become ever
scarcer.
. Air pollution: Industrial processes and consumer use of more and more
machinery, including cars, leads to air pollution.
. Declining fish and crustacean populations: Modern fishing fleets use
high-tech methods to find and catch more and more fish, to a point
where major fisheries worldwide have collapsed and are no longer
commercially viable.
. Topsoil erosion: This is a common problem associated with modern
agriculture, particularly large-scale, industrial-style agriculture – heavy
machinery disturbs top soils that are then blown away by wind or
washed away by rain; logging of forests and increasing population
pressure in ecologically sensitive areas also often leads to this problem.
. Ozone depletion: CFC (chlorofluorocarbon), a chemical once common in
aerosols and refrigerators, is the main culprit of ozone depletion; the
phasing out of such chemicals from consumer products and industrial
processes may be able to reverse this process.
. Marine and fresh water pollution: This results from industry, agriculture,
households, shipping and other sources.
. Toxic waste accumulation: Many toxic wastes, such as many artificial
chemicals, accumulate in nature and can still be found – for example, in
marine mammals – years after their production and use ceased.
. Species extinction and reduction of biodiversity: Population pressure,
intensive agriculture and industrial development all encroach on the
habitats of plant and animal species and can lead to their extinction.
. Wetlands destruction: This is one example of valuable wildlife habitats
being destroyed by development; for example, for housing, agriculture or
industry.
. Climate modification: Accelerated use of fossil fuels in industrial
processes and consumption is thought to contribute to global climate
change with unpredictable but potentially very serious consequences.
Many of these problems are not directly or exclusively related to marketing
but to modern industrial societies in general. However, marketing plays an
important part in the development of them. Conventional marketing practice
112
has been criticised for its lack of ecological sustainability. In the context of
the rise of consumer society, marketing practice has been criticised for
promoting excessive consumption and materialism and thus the over-
exploitation of natural resources for the production and use of consumer
products. Another key criticism is that product design is often
environmentally wasteful as many consumer products have only short
durability, use excessive amounts of raw materials and are not being
designed for recycling. No part of the marketing chain is without criticism.
Excessive packaging, production of marketing materials and the
transportation of finished goods, often over long distances, are all criticised
as being wasteful (Velasquez, 2002).
‘Green’ marketing has been proposed as a solution, at least a partial one, to
the environmental issues connected with conventional marketing. The logic
behind it is that there is a rising consumer awareness of, and concern about,
environmental issues. Consumers demand more environmentally responsible
products and production processes. Marketers react flexibly to these
consumer demands, changing products and processes to achieve the same
consumer benefits with less environmental detriment. Those who do not
respond are perceived by consumers to be environmentally irresponsible and
are eventually pushed out of a competitive market.
Peattie and Charter (1994) identify a number of driving forces that
encourage marketers to aim for more sustainable marketing practices,
including:
. public opinion and changing societal values

. green consumer demand and the opportunities of a growing market for
environmentally friendly goods and technologies
. internal and competitive pressures
. legislation
. green investment funds
. interest from media and pressure groups
. the cost to business from environmental disasters.
They argue that, in order to ‘go green’ successfully, marketers need to adopt
a holistic view of the green marketing process, which includes an
appreciation of and influence over all aspects of a business, its products and
production system. Green marketing requires new types of information
regarding the environmental performance of products, supplies, production
processes and competitors. It also requires marketers to think in timescales
of years or even decades, rather than months.
Many businesses have responded to these drivers for more environmentally
friendly business and marketing practice. Environmentally concerned
consumers can now buy a whole range of less environmentally harmful
product alternatives, ranging from organic foodstuffs, more readily
biodegradable detergents, low-energy light bulbs, more fuel-efficient cars, to
paper products made from recycled paper, timber products from sustainable
forestry, and many more. The following example introduces certification by
the Forest Stewardship Council (FSC).
113
Readings 28–36
Example of certification: Forest Stewardship Council (FSC)

The Forest Stewardship Council (FSC) is an international non-governmental
organisation founded in 1994 in order to ‘promote environmentally
appropriate, socially beneficial, and economically viable management of the
world’s forests’ (FSC UK, n.d.). They have developed a system of forest
certification and product labelling that allows timber merchants and
consumers to identify wood from well-managed forests. Through this
measure, the FSC is trying to encourage environmentally responsible
customer behaviour.
According to the FSC website:
Forest managers or owners who want to achieve FSC Forest

Management Certification contract an FSC accredited certification body
to carry out an assessment. The certification body checks that the
operation complies with all relevant FSC requirements. If it does, they
issue a FSC forest management certificate, which is valid for five years
and monitored annually to make sure the company continues to meet
FSC standards. If the forest owner or manager wishes to sell FSC
certified products, they will also need chain of custody certification.
Chain of custody certification applies to manufacturers, processors and
traders of FSC certified forest products. It verifies FSC certified forest
products along the production chain. At each stage in the chain of
processing and transformation, chain of custody certification is needed
to confirm that FSC certified wood products are kept separate from
uncertified products, or mixed in approved ways.
(FSC International, n.d.)
There are numerous timber products that carry the FSC logo (Figure 3),
including paper products, furniture, timber, etc.
Figure 3 The FSC logo
Exercise 2
Consider your own shopping habits and make some notes on the following
questions:
. When you normally shop for paper products, do you ever look for
information that tells you whether the products you buy are certified by
the FSC? Why, or why not?
114
. Do you agree that consumers should take environmental responsibility

and buy products that are environmentally friendly? Why, or why not?
Comment
. There are several environmental labelling schemes for consumer
products available, and retailers sometimes offer additional environmental
information on their products. Many consumers look at some of this
information but few manage to look at and act on all of it. You might have
found yourself in a similar situation. A reason for not always taking in
environmental information about products is that it is time consuming to
attend to all this information; often too, it is not that easy to work out what
really is the most environmentally responsible purchasing option, as there
is so much information and it can be conflicting. Or you might have felt
that other considerations, such as product quality or price, were more
important to you.
. Reasons for agreeing that consumers should buy environmentally friendly
products are that this helps to preserve old-growth forests, particularly
tropical rainforests, which are vitally important for world climate and
therefore have an impact on all human life. Reasons for disagreeing are
that it may be inconvenient to try to find environmentally responsible
products, that they may cost more and that individual consumers have
little influence if others continue to behave in an environmentally
detrimental way.
While green marketing seems to have made some progress towards offering
consumers more environmentally responsible product alternatives, the notion
of ‘green’ marketing and ‘green’ consumption as a solution to environmental
problems has also been criticised. If over-consumption is at the heart of
many environmental problems, it may be difficult to see how more
consumption, even of less environmentally harmful products, can be the
solution. Kilbourne (1998) argues that green marketing and consumption
should be studied within a more general framework of the wider economic
and social system that sustains a belief in the promise of abundance and
ever greater levels of material accumulation.
According to Sagoff (1986, p. 229) individuals act differently as consumers

than they do as citizens, namely that ‘we act as consumers to get what we
want for ourselves. We act as citizens to achieve what we think is right or
best for the community’. The danger of approaching environmental problems
as marketing problems is the reliance on individual consumer preferences
that may reflect short-term ‘selfish’ desires and wants rather than a long-term
appreciation of the common good. If consumers are not willing to pay for
social and environmental ‘goods’ through their individual purchase behaviour,
then such goods will not be supplied. In Sagoff’s view the ‘public’ and
‘shared’ nature of environmental problems makes them more appropriate for
public policy than for market solutions.
It may be the case that concentrating on green consumer pressure and

marketing often merely serves the purpose of patching over fundamental rifts
between current Western lifestyles and the requirements of ecological
balance, thus suggesting easy solutions where there may be none (Smith,
115
Readings 28–36
1998; Iyer, 1999). Welford (1997) even argues that all the talk about greener
management and marketing only serves to mask business-as-usual behind
the scenes and that business has ‘hijacked’ environmentalism for its own
ends. You may have your own views on this argument; take a look at the
appropriate section of the Study Companion to help guide your thinking.
Sustainable consumption
The idea that current levels and modes of consumption are
environmentally unsustainable in the medium to long run is not new and
is at the heart of much thinking about environmental marketing. Since
the 1970s there have been voices criticising the materialism and excess
of modern consumption and calling for consumers to return to simpler
life styles and alternative modes of consumption. Calls to curb
consumption can seem rather dour and spoil-sport at a time when
consumption is seen as an important source of pleasure as well as a
means of expressing one’s identity and communication with others.
However, this need not necessarily be so. Sustainable consumption can

be hedonistic, serve to build or express identities, and be a means of
communication. For example, consumers who are interested in reducing
their ecological footprint might search for second hand furniture in street
markets, buy organic produce from farmers’ markets or trade their own
services for goods or services provided by friends and neighbours
through informal or formal bartering. Being a ‘green consumer’ can be a
matter of identity as much as anything else. Many people take great
pride in being green and their whole lifestyle is built around this.
Sustainable consumption choices are often a meaningful constituent of
such an identity. Finally, environmentally conscious consumption
choices are just as suitable for communicating something about oneself
as other consumption choices. Driving a small, less environmentally
harmful car makes a statement about one’s values to other people, as
do decisions not to consume or to buy something. For example, if I
have an allotment to grow some fruit and vegetables and if I
furthermore decide to grow this produce in as near an organic fashion
as I can, I say something about what I believe in to other people. And I
have the additional benefit of talking to like-minded people while I tend
to my allotment.
Sustainable consumption choices therefore do not necessarily mean

foregoing pleasure or a means of expressing oneself but can be
meaningful ways of seeking enjoyment, expression of identity and
communication in and of themselves.
(Schaefer and Crane, 2005)
116
Summary
This reading has looked at how businesses have tried to address the social
and environmental concerns that are often associated with marketing. We
looked at the societal marketing concept and its impact on marketing
practice, as well as cause-related marketing and advocacy advertising. We
then took a closer look at some of the environmental problems associated
with business activity and how green marketing tries to address these. We
hope that this study session and the book as a whole will have helped you
form some of your own opinions about the positive and negative aspects of
modern marketing practice.
117
Readings 28–36
References
Abratt, R. and Sacks, D. (1989) ‘Perceptions of the societal marketing
concept’, European Journal of Marketing, vol. 23, no. 6, pp. 25–33.
Crane, A. and Desmond, J. (2002) ‘Societal marketing and morality’,
European Journal of Marketing, vol. 36, no. 5/6, pp. 548–69.
Feldman, L.P. (1971) ‘Societal adaptation: a new challenge for marketing’,
Journal of Marketing, vol. 35, no. 3, pp. 54–60.
FSC International (n.d.), 'FSC Certification: Ensuring environmental, social
and economic benefits. [online]. Available at https://ic.fsc.org/certification.4.
htm (Accessed 20 April 2015).
FSC UK (n.d.) 'Who we are', [online]. Available at http://www.fsc-uk.org/
about-fsc.2.htm (Accessed 20 April 2015).
Iyer, G.R. (1999) ‘Business, consumers and sustainable living in an
interconnected world: a multilateral ecocentric approach’, Journal of
Business Ethics, vol. 20, pp. 273–88.
Kilbourne, W. (1998) ‘Green marketing: a theoretical perspective’, Journal
of Marketing Management, vol. 14, pp. 641–55.
Kotler, P. (1972) ‘What consumerism means for markets’, Harvard Business
Review, May–June, pp. 48–57.
Peattie, K. and Charter, M. (1994) ‘Green marketing’ in Baker, M.J. (ed.)
The Marketing Book, 3rd edition, Oxford and Boston, MA, Butterworth-
Heinemann, pp. 691–712.
Prothero, A. (1990) ‘Green consumerism and the societal marketing
concept: marketing strategies for the 1990's’, Journal of Marketing
Management, vol. 6, issue 2, pp. 87–103.
Sagoff, M. (1986) ‘At the shrine of Our Lady of Fatima, or why political
questions are not all economic’ in VanDeVeer, D. and Pierce, C. (eds)
People, Penguins and Plastic Trees: Basic Issues in Environmental Ethics,
Belmont, CA, Wadsworth.
Schaefer, A. and Crane, A. (2005), ‘Addressing sustainability and
consumption’, Journal of Macromarketing, vol. 25, issue 1, pp. 76-92.
Smith, T. (1998) The Green Marketing Myth: Tending our Goats at the
Edge of Apocalypse, Toronto, University of Toronto Press.
Throop, G.M., Starik, M. and Rands, G. (1993) ‘Sustainable strategy in a
greening world’, Advances in Strategic Management, vol. 9, pp. 63–92.
Velasquez, M. (2002) Business Ethics: Concepts and Cases, Upper Saddle
River, NJ, Prentice Hall.
Welford, R. (1997) Hijacking Environmentalism: Corporate Responses to
Sustainable Development, London, Earthscan.
118
Acknowledgements
Acknowledgements
Figures
Reading 28
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Reading 29
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Figure 4: © Albany Pictures/iStockphoto.com
Reading 30
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Attribution-Share Alike Licence http://creativecommons.org/licenses
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Figure 10: © Matthew Cole/Shutterstock
Reading 31
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Figure 5: © jez atkinson on flickr.com. Used under CC BY 2.0
Reading 32
Figure 1: © Ocado
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Reading 33
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119
Readings 28–36
Reading 35
Figure 1: Courtesy of the NSPCC
Figure 2: © Tegestology/Alamy and 79564 © Graham Oliver/Alamy Stock
Photo
Figure 3: © Jenny Matthews/Alamy
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Figure 5: © SteveStone/iStockphoto.com
Reading 36
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120
Block 5
Readings 37–45
By Alessandro Sancino

Act 1988.
3WX
ISBN 978 1 47300 3507
2.1
Contents
Reading 37: The economic system 5
Introduction 5
1 What is meant by economics and the economic context? 6
2 The economic system 7
3 Impact of the economic system on businesses and consumers14
Summary 17
References 18
Reading 38: Economic indicators 20
Introduction 20
1 Gross Domestic Product (GDP) 21
2 Consumer Price Index 26
3 Rate of unemployment 31
Summary 32
References 33
Reading 39: The financial system 34
Introduction 34
1 The role of financial institutions 34
2 Foreign exchange markets 37
3 The global financial crisis 39
Summary 43
References 44
Reading 40: Supply and demand 45
Introduction 45
1 Understanding demand 46
2 Understanding supply 55
3 The equilibrium price 59
Summary 62
References 63
Reading 41: Fiscal and monetary policies 64
Introduction 64
1 Fiscal policy 64
2 Monetary policy 71
Summary 76
References 77
Reading 42: Market structures 78
Introduction 78
1 Different market structures 78
2 Implications for consumers and businesses 84
Summary 88
References 89
Reading 43: Comparing economic systems 90
Introduction 90
1 Market economy 91
2 Planned economy 96
3 Mixed economy 99
Summary 104
References 106
Reading 44: The role of government 107
Introduction 107
1 Government as a system of public organisations 108
2 What does government do? 113
Summary 117
References 119
Reading 45: Business-government relations 121
Introduction 121
1 Types of business–government relations 121
2 Public–private partnerships 124
3 Lobbying 127
Summary 131
References 132
Reading 37: The economic system

Introduction
This reading introduces the concept of the economic system. Understanding
the economic system is vitally important for all types of organisations and
their managers. For example, business managers need to understand how
supply and demand shape prices in order to set prices for products and
services and to estimate whether new investments are likely to pay off in a
certain period of time. They also need to understand how interest rates,
rates of inflation or economic growth can impact on their own business so
they are properly prepared.
Understanding the economic system is also a vital skill for public and third
sector managers. Public organisations and the goals they pursue are deeply
affected by trends in the economy. For example, consider public
organisations that set and pay out social security payments to unemployed
people. Economic trends such as the level of unemployment are obviously
and directly important to such organisations. Governments and their
agencies design and implement some of the policies aimed at influencing
economic trends, for example creating the conditions for economic growth.
Finally, third sector managers also need an awareness of the economic
system and to scan the economic context in which their organisations
operate. For example, the financial crisis of 2007/8 had a significant impact
on funding for third sector organisations. You will learn more about all
these aspects of the economic context in this and the next few readings.
Summing up, a manager who does not understand the basic principles of
economics is no more likely to succeed in the medium to long term than
one who doesn’t understand money or the basic principles of accounting.
You may not have studied economics before, but if you read a newspaper or
turn on the television you will more than likely come across news relating
to the economy. And when you do some of your regular activities, such as
buying food in a supermarket, going to work, getting a loan from a bank,
etc., you engage in economic behaviour yourself. We are all part of the
economic system; economics touches on almost every aspect of everyday
life.
This first reading starts with an introduction to what is actually meant by
economics and the economic context. You will look at the different
economic actors and how they relate to each other within the economic
system. The economic system will be represented in this reading as a
circular model of flows of goods, services and money. This model will help
you to understand the impacts that the economic system can have on
businesses and consumers.
5
Readings 37–45
1 What is meant by economics and the

economic context?
Before learning more about economics and the economic context it is useful
to understand a bit more about what the term ‘economics’ actually means.
Over the years, different scholars have offered several different definitions
of economics. Adam Smith, a prominent Scottish economist of the
eighteenth century, who is generally regarded as the father of economics,
defined economics as a (social) science that enquires into the nature and
causes of the wealth of nations. This definition emphasises the production
and growth of wealth as the subject matter of economics and it comes from
his famous book, first published in 1776: An Inquiry into the Nature and
Causes of the Wealth of Nations (Figure 1).
Figure 1 Adam Smith’s Inquiry into the Nature and Causes of the Wealth of
Nations
Another well-known definition is that of Paul Samuelson, an American

economist and the first American to win the Nobel Prize in Economics. He
proposed a definition of economics emphasising the idea of production of
goods and services with scarce resources, and their distribution among
individuals and groups:
Economics is the study of how societies use scarce resources to

produce valuable commodities and distribute them among different
people and groups of society.
(Samuelson and Nordhaus, 1992, p. 3)
Lionel Robbins is a British economist and former head of the economics

department at the London School of Economics. In his Essay on the Nature
and Significance of Economic Science, he offers this widely used definition:
6
‘Economics is the social science which studies human behaviour as a

relationship between ends and scarce means which have alternative uses’
(Robbins, 1935, p.16). This is the definition that will be used in this block.
According to Parkin and Bade (2003) and Goldberg (2000), the main issues
in the study of economics relate to the following big questions:
. What to produce? In other words, what goods and services should be

produced using scarce resources such as raw materials, labour, and
capital.
. How to produce? For example, should goods be produced using mostly
labour or using mostly machines?
. For whom to produce? In other words, how should goods and services
be distributed among the population?
. Should everybody get access to a good or service or only certain people
(perhaps those that need it the most, or those that can pay the most)?
There are two branches of economics: microeconomics and
macroeconomics. Microeconomics is the branch of economics that studies
how individuals (for example citizens, consumers, employees, managers
and/or entrepreneurs) and/or organisations (public, private or third sector)
make decisions to maximise what they can achieve with their limited
resources. In doing so, individuals and organisations interact with each other
and create markets. The functioning of the markets is another fundamental
object of analysis studied by microeconomics.
By contrast macroeconomics studies the overall functioning of the economy
by analysing fluctuations of the main variables in the aggregated economic
activity. In other words, it deals with the big issues in the economy such as
the size and growth of Gross Domestic Product (GDP), inflation, and the
rate of employment (Murphy, 2009).
One way to understand the main differences between micro- and
macroeconomics is to think about physicists: they look at the big world of
planets, stars and galaxies, but they also study the minute world of atoms
and the tiny particles that comprise those atoms. Economists do the same:
there is macroeconomics, which is concerned with how the overall economy
works, and there is microeconomics, which is concerned with how supply
and demand interact in individual markets for goods and services
(Rodrigo, 2012). In macroeconomics, the unit of analysis is typically a
nation – how all different markets interact to generate phenomena such as
inflation, economic growth and unemployment. In microeconomics, the unit
of analysis is a single market – for example, whether price rises in the
chemical or energy industries are driven by changes in supply or demand.
2 The economic system

In any society, the way in which resources are allocated and distributed and
how an economy is organised and sustained is a central concern. The
economic activity includes all the behaviours and decisions that people and
organisations make in relation to their consumption, production, work, trade,
7
Readings 37–45
saving and investment choices. Buying an iPad is an example of a

consumption activity. The manufacture of automobiles or furniture are
examples of production activity. You may be an employee working for a
specific organisation. As a student, you might have in mind some
organisations you would like to work with. The exports and imports of a
country are an example of trade. Your decision not to spend all your salary
in a month is an example of a savings decision. If you decide to use your
savings to buy financial shares through the stock market this is an example
of an investment decision. All these activities are examples of economic
activities. In the real world there are millions of these kinds of decisions
that individuals and organisations take every day. In doing so, they establish
economic relationships with other individuals and organisations (for
example if there is a buyer it means that there is a supplier of that good or
service). Together, all these economic relationships form the economic
system.
The economic system is the system of interconnections and
interdependencies between actors that carry out activities of consumption,
production, work, trade, saving and investment in order to satisfy their
preferences. Every economic system has specific features depending on the
way it addresses the central questions mentioned above: what is produced;
how much is produced; how and for whom goods and services are
produced.
Economists tend to distinguish between four main types of economic
system:
. Planned or command economies: In planned economies, the

government decides how to use and distribute resources and it manages
all or most of the resources and industries; it might even define the kind
of work individuals do. Planned economies are typically associated with
the political systems of communism and socialism. Very briefly, in a
communist system, the government owns the factors of production
(i.e. all the inputs and resources that go into the production of goods and
services) and decides how to use the resources. In a socialist system, the
government controls critical industries, but individuals can run other
businesses.
. Market economies: In pure market economies, economic decisions are
made by private individuals or organisations and government is not
involved. The interactions of individuals and organisations in markets
determine how resources are allocated and goods are distributed.
. Mixed economies: Pure market or pure command economies are
conceptualisations rather than something that might be found in the real
world. All real-world economies are mixed economies; they combine
elements of market and of planned economies (Rohlf Jr., 1998, p. 48).
Many economic decisions are made through markets by individuals and
organisations but the government also plays a role in the allocation and
distribution of resources. However, if you think of planned and market
economies as opposite ends of the economic systems spectrum, some
countries are closer to the market economy type (for example the United
States of America) and others to the command economy type (for
example China).
8
. Traditional economies: A traditional economy is an economic system in

which traditions and customs shape the goods and the products the
society creates; this kind of economic system is often rural and farm-
based. Examples of traditional economies might include those of the
Kavango tribes of Namibia or the Saharias of central India
(O’Connor, 2004).
2.1 Sectors of the economy

The economic system is comprised of different sectors. You are, by now,
already familiar with the classification into public, private and third sector,
and into primary, secondary and tertiary sector. In an economic system, the
term ‘sector’ highlights an aggregation of different economic activities that
share some common characteristics. For example, the primary sector
comprises activities related to the production and/or extraction of natural
resources. Typical examples of primary sector activities are agriculture,
fishing and natural resource extraction. The secondary sector includes all
those economic activities that take the raw materials produced by the
primary sector and create from them tangible goods and products. Some
examples of industries of the secondary sector include construction and
automotive manufacture. The tertiary sector is called the service sector and
it encompasses the selling of services and skills. Examples could be health
and transportation industries. Some of the economic literature further
distinguishes between the tertiary and the quaternary sector. Tertiary and
quaternary are both service sectors, but this is a further classification for
distinguishing those activities among the tertiary sector that are based on
information and knowledge services, such as research and development,
financial services, business consulting (The Business Dictionary, n.d.).
Comparing how many people work in each of the sectors of the economy
(the so-called employment structure) can be very useful for understanding
the stage of the economic development of a country. If the majority of a
population works in the primary sector we talk about pre-industrial
economic systems. If the majority of a population works in the secondary
sector we talk of an industrial economic system. And if most people in an
economy work in the tertiary sector this is referred to as a post-industrial
economic system. Figure 2 shows the employment structures in three
different countries. You can immediately see that the proportion of people
working in the primary, secondary and tertiary sectors varies enormously
between these countries. For example, in the USA only 2% of the
population works in primary industries, whereas in Brazil it is 23%. In
Nepal, 81% of the population work in primary industries (probably mostly
in agriculture).
9
Readings 37–45
2%
16%
23%
23%
3%
Primary
Secondary
Tertiary
24%
75% 53% 81%
USA Brazil Nepal
Figure 2 Employment structures in the USA, Brazil and Nepal (Source: BBC, 2014a)
Two economists – Allen Fisher (1935) and Colin Clark (1940) –

independently of each other proposed the so-called three-sector hypothesis
according to which, in the course of economic progress, employment will
first shift from agriculture to manufacturing, and then to services. This
model – known as the Clark–Fisher model – highlights how the importance
of each sector changes over time and moves from pre-industrial to industrial
and then post-industrial. Each country has a particular path towards the
development of the three phases. Figure 3 shows the UK case.
70
60
Sector percentage of employment in UK
tertiary
50
40
30 secondary
20
10 primary
quaternary
0
1800 AD 2000 AD
pre-industrial industrial post-industrial
Figure 3 The Clark–Fisher model: the UK case (Source: BBC, 2014b)
In Figure 3 you can see that in approximately 1800 AD 70% of the UK

population worked in the primary sector. Most of this will have been
agriculture. The primary sector was then by far the most significant sector
of the economy by the number of people working in it. Sometime during
the 19th century, the secondary sector started to overtake the agricultural
sector, as people migrated from rural areas to the industrial cities. And in
the 20th century there came a time when the largest proportion of the UK
population no longer worked in the primary or the secondary sector but in
the tertiary sector, i.e. in service industries.
10
2.2 The circular flow of income

The economic system consists of the innumerable relationships that exist
between different individuals, groups of individuals and organisations
pursuing economic activities. In this section you will delve a little deeper
into these relationships in the economic system. To start off, Exercise 1
encourages you to think about your own experience of the economic
system.
Exercise 1
Spend no more than 15 minutes on this exercise.
This exercise will help you to start thinking about some of the flows of money
in the economic system, based on your own experience. Think of some of
the economic decisions you took in the past year and the economic
relationships of which you were part. The following questions may help:
. From where does your main household income come? An employer

perhaps? Another source?
. How much money did you save last year?
. Did you borrow any money last year?
. What was your most expensive purchase last year?
. Where do you keep your money and savings, e.g. in a bank, building
society or credit union?
. Did you buy any products from other countries, food perhaps? What were
these products?
. What other economic relationships do you have?
Comment
Your main household income may be the salary you get from the
organisation you work for. But it could also be a pension, a grant or some
other income. Savings vary considerably from person to person; they are
influenced by level of income, level of expenditure, personal values and
habits. Many people choose to save with banks because of habit or
convenience, others are influenced by the savings rates, conditions of
current accounts or loan facilities offered. The most expensive purchase that
people make is often something like a house or flat but it could be a car or
perhaps a smaller item, such as a household good like a new washing
machine or heater. But it could also be a service item, such as the holiday of
a lifetime or – in less happy circumstances – medical treatment paid for
privately. You may find that you buy quite a few goods made outside your
home country: food items, clothing, furniture, etc. In all these decisions you
were part of an economic relationship between yourself and someone else,
usually an organisation: your employer, your bank, the companies from
whom you buy various goods and services. And then there are many other
11
Readings 37–45
economic relationships and expenditures, such as the taxes you may pay
that put you in an economic relationship with the government.
You have now probably realised how many economic decisions you take on
a regular basis. These all contribute to the flow of money in the economic
system. The economic system comprises millions of individual economic
decision makers like you. The model presented in Figure 4 helps you to
place your decisions into a broader model called the circular flow of income
and to picture the role of different actors in the economic system. This
model describes the circulation of income between households and
organisations, considering also the role that banks, government and foreign
trade play.
The circular
flow of income INJECTIONS
Export
expenditure (X)
Government
expenditure (G)
Consumption Investment (I)

of domestically
Factor produced BANKS, etc GOV. ABROAD
payments goods and
services (C x1)
Net Net Import
savings taxes expenditure
(S) (T) (M)
WITHDRAWALS
Figure 4 The circular flow of income (Source: adapted from Sloman, 2008,
p. 278).
In Figure 4 the economic system is divided into two main categories:

organisations and households. A household is an example of an individual
economic unit. ‘Household’ refers to an economic unit made up of
individuals who live at the same address: it might be a family with children
or a single person living alone or another group of people living at the same
address. ‘Organisation’ in this case refers to organisations that are providing
goods and services for households, for example businesses. You have seen
that organisations can be categorised into different economic sectors,
depending on their field of activity.
The circular flow of income (shown as the blue inner flow in Figure 4)
highlights flows of goods and services and of payments between households
and organisations in a given country. Firms pay money to households in a
number of different forms: wages and salaries, dividends on shares, rent and
so on. These payments are in return for the factors of production that are
supplied by households. Factors of production are labour, capital, and land.
12
These payments are called factor payments in the model (as in payments for
the factors of production) and are shown as the left hand blue arrow in
Figure 4. (Note that this is a model of high abstraction: of course firms
often pay interest or rent to other firms; however, the model assumes that
this money will eventually find its way into households; the model is not
concerned with specific individual transactions but with an abstract,
generalised flow of money between firms and households.) Households also
pay money to firms when they consume goods and services. This is
represented by the right hand blue arrow in Figure 4. Note that the model
refers to the economic system of a country. The inner flow of income shown
in blue therefore only refers to the flows of money between firms in that
country (domestic firms) and households in that country. If households spent
all their money on buying domestically produced goods and services and if
firms paid out all the money they receive in the form of factor payments to
domestic households, this flow would continue at the same level for ever.
Money would just go round and round (Sloman and Wride, 2009).
However, not all the circular flow of income can be explained just by the
relationships shown by this inner flow. Members of households can save
some of the money they earn, they have to pay taxes to central and local
government and they can decide to consume imported goods and services:
these behaviours are called withdrawals (in the sense that money is
withdrawn from the core domestic income flow shown in blue in Figure 4).
These other types of economic transactions generate different relationships
from those highlighted in the core economic flow. Savings go from
households to banks and other financial institutions. Taxes are paid by
households to government. The purchase of goods and services produced by
organisations outside the domestic economy transfers some domestic money
out of the country. The total of withdrawals is the sum of net savings, net
taxes and the expenditures made by households for imported goods and
services.
Similarly, not all of the money that goes into organisations comes from
household spending. As well as withdrawals from the inner flow of income
shown in blue there are also injections into it. In particular, there are three
main kinds of injections:
. Investments are the sum of extra money that organisations and/or

households can obtain from financial institutions.
. Government expenditures are the money that government spends on
goods and services provided by other organisations.
. Export expenditures represent the money that comes into the circular
flow of income from the purchases of domestic goods and services from
abroad.
Therefore the role of banks, government and foreign trade is highly
important for the economic system. For example, higher interest rates can
result in more money for banks and for people with savings but also in
higher expenditure for households with mortgages. Thus, these latter
households have – given their limited resources – less money to spend on
buying goods and services provided by firms. If there are many households
with mortgages and interest rates go up, this can impact on the level of
13
Readings 37–45
profits of domestic firms and on their decisions on future investments. On

the other hand, if there is more government expenditure that may sustain the
production of some firms working with government, for example firms that
build public infrastructure. The functioning of the economic system is quite
complex and dynamic and the circular model presented above – like most
economic models – is an abstraction and simplification. Such abstractions
and simplifications are necessary to picture the complex reality that is an
economic system but you always need to bear in mind that reality will be
messier and more complex.
3 Impact of the economic system on

businesses and consumers
The model of the circular flow of income shows the main economic actors
and the main relationships between them. In addition to the core
relationship between households and organisations, banks, government and
international trade play a decisive role in withdrawing or injecting money
into the economic system. This section provides an example to illustrate
some of the relationships in the economic system.
Figure 5 A salmon farm
Consider a fictitious company that farms salmon in a Scottish loch. Let’s

assume that the company rears the salmon from small hatchlings, and then
sells fresh, frozen and smoked salmon fillets to restaurants and retailers as
well as directly to customers through its website. The business pays for the
following factors of production which it acquires from individuals
(households) or other businesses:
. Labour: employees who work directly to rear the salmon and fish it;
employees who fillet and process the salmon, pack the finished product,
transport it to customers, etc.; employees who help with the
administration and clerical work of the company, including sales staff,
accountants, office workers; cleaners and other employees who maintain
the plant and the equipment. Managers are also part of the labour factor
of production (even if they are the owners of the business). All these
people, including the managers, will require payment for their work,
which would be part of the factor payments shown in Figure 4. (Here
14
only those employees are listed who might be directly employed by the
business. The business will also buy in a lot of goods and services from
other businesses.)
. Capital: the business will have needed money to get started and may
continue to need investment to grow; capital may have come from the
owners of the business, or perhaps from a bank or some other source.
This capital also needs to be paid for, either in the form of dividends if
coming from the owners, or in the form of interest if coming from a
bank.
. Land: the use of an area of the loch (Scottish lake or sea inlet) to rear
the salmon in; also use of land to build its processing plant on. Again,
the use of the land will need to be paid for; either the business needs to
buy the land outright, or it needs to pay rent for it.
Ultimately, the payments that the business makes for all these factors of
production are assumed to end up in the hands (or rather bank accounts) of
households. Households are also consumers and some of them will use the
money they earn in return for providing labour, capital or land to buy fresh,
frozen or smoked salmon, either directly from the company through its
website or from a retailer who has bought it from the business.
So far in this example you have looked at the aspects of the core circular
flow of income as it relates to this salmon rearing and processing firm and
its customers and employees. In Figure 4 you have already seen there are
further flows of income (shown in green in the figure) outside this core
flow. One of these relates to exports, which lead to injections of income
into the domestic economy from abroad. Exports are the focus of
Exercise 2.
Exercise 2
This exercise will help you to understand how exports impact on the
economic system. Read the article below and answer the following
questions:
1 Where in the model of the economic system shown in Figure 4 would you
locate the salmon exports described in the article?
2 What effects does an increase of foods and drinks exports have on the
UK domestic economy?
Scottish salmon boosts UK food

exports
Rebecca Burn-Callander, The Telegraph, 24 Mar 2014
Scottish salmon has become one of the UK’s most prized exports,
contributing to a 5 per cent rise in UK food and soft drink exports
to £12.8 bn, according to new industry research
15
Readings 37–45
Scottish salmon exports helped to increase Britain's export sales by 5

per cent last year. Exports of the Scottish fish to the USA rose by £43
m to hit £199 m, while sales to China almost doubled from £23 m to
£50 m. ‘These impressive figures are the result of the fantastic
reputation our salmon enjoys around the world,’ said Scott
Landsburgh, chief executive of the Scottish Salmon Producers’
Organisation. ‘The latest export figures just scratch the surface with
the growth of people looking for premium and healthy foods, there
remains plenty of scope to share this rapidly expanding market’. Last
year, total export sales of food and non-alcoholic drinks reached £12.8
bn, the research found, up 5 per cent on the previous year.
The figures signal a return to export growth for the UK, following a
flat year in 2012.
Exports to the USA generated £525 m in total sales, up 7 per cent on
the previous year, while China has grown 82 per cent to become the
UK’s second-largest export market, representing £201 m in revenue.
According to new research from the Food and Drink Federation (FDF),
the total export revenue to non-EU markets increased by 11.5 per cent
last year. Sales to the EU rose just 3 per cent.
However, the bloc still accounts for 75 per cent of total UK exports.
Ireland remains the largest overall market for UK food exports, worth
£3.2 bn last year. Export sales to Ireland grew 7 per cent in 2013,
mostly driven by a £90 m increase in sales of milk, sauces, chocolate,
ice cream and cheese.
Pork products are also driving significant revenues, the research found.
In 2013, exports of British pork to China grew 100 per cent to £20 m.
This market is still in its infancy. The UK first gained access to the
Chinese pork market in 2011 after Defra and the industry associations
won an export license. Chocolate has become one of the UK’s fastest-
growing export markets. As well as the £16 m increase in chocolate
sales to Ireland, taking the total to £165 m, Australia has also
developed an appetite for British confectionary. Australian export sales
of chocolate grew by a £7 m to £21 m last year. Chocolate retailer
Thorntons commented: ‘Australia is becoming our biggest single
international market.’
According to the FDF, the UK made £6.6 bn in revenue on alcohol
exports last year. But growth in Scotch whisky sales, the UK’s largest
food and drink export overall, remained flat last year at £4.4 bn. Steve
Barnes, economic and commercial services director at the FDF, said,
‘In contrast to UK goods exports falling in 2013, food and drink
exports are back in growth, testament to the strong demand for quality
British food and drink and the growing importance of export to our
industry.’
‘The recovery of exports to key EU markets is particularly welcome
news for food and drinks manufacturers as exports to the EU account
for 75 per cent of total export sales.’
16
Comment
The article describes the rise in export expenditures for products like salmon
and pork, and more generally in the UK foods and drinks industry. This
results in an injection into the British economic system and it is represented
by one of the upper green arrows in the model of the circular flow of income
in Figure 4.
The injection of new money coming from abroad may have some beneficial
effects in the UK economy, such as more jobs in the food and drinks and
related industries in order to sustain the increased production, more
investments and presumably more profits in the sector. In terms of some
possible negative effects, due to the increased global demand, prices of
those products may increase. However, the rise of export expenditures is
generally considered as a positive thing for the domestic economy.
Summary
This reading has given you an introduction to what is meant by economics
and the economic system. Economics is a social science that studies at the
micro level how individuals and organisations behave in markets in order to
use their limited resources to satisfy their preferences; and at the macro
level how the overall economy is performing in terms of, for example,
economic growth, employment/unemployment, and inflation. You have also
learned that, when people carry out economic activities, they establish
relationships with each other, constituting the so-called economic system.
The main relationships that occur in the economic system have been
highlighted by the model of the circular flow of income. The model of the
circular flow of the income highlights the fact that organisations, as well as
individuals, are embedded in an economic system and that every economic
decision is taken within this system of relationships between different
economic actors. You have also started to look at the roles played by
financial organisations and governments in the economic system. Several of
these issues will be picked up again later in these readings.
17
Readings 37–45
References
BBC (2014a) ‘Characteristics of industry: comparing employment
structures’, BBC Bitesize, [online]. Available at http://www.bbc.co.uk/
schools/gcsebitesize/geography/economic_change/
characteristics_industry_rev2.shtml (Accessed 5 February 2015).
BBC (2014b) ‘Characteristics of industry: changing employment structures
over time,’ BBC Bitesize, [online]. Available at http://www.bbc.co.uk/
schools/gcsebitesize/geography/economic_change/
characteristics_industry_rev3.shtml (Accessed 5 February 2015).
Burn-Callander, R. (2014) ‘Scottish salmon boosts UK food exports’, The
Telegraph, 24 March 2014, [online]. Available at http://www.telegraph.co.
uk/finance/newsbysector/retailandconsumer/10717423/Scottish-salmon-
boosts-UK-food-exports.html (Accessed 24 September 2014).
Clark, C. (1940, revised and reprinted in 1951), The Conditions of
Economic Progress, London: Macmillan.
Fisher, A.G.B. (1935) The Clash of Progress and Security, London:
Macmillan.
Goldberg, K. (2000) An Introduction to the Market System, New York:
Sharpe.
Murphy, A. (2009) The Genesis of Macroeconomics: New Ideas from Sir
William Petty to Henry Thornton, Oxford University Press: Oxford.
O’Connor, D.E. (2004) The Basics of Economics, Westport, CT: Greenwood
Press.
Parkin, M. and Bade, R. (2003) Microeconomics: Canada in the Global
Environment, 5th edition, Toronto: Pearson.
Robbins, L. (1935) An Essay on the Nature and Significance of Economic
Science, 2nd edition, London: Macmillan.
Rodrigo, G.C. (2012) ‘Micro and macro: the economic divide’,
International Monetary Fund, [online]. Available at http://www.imf.org/
external/pubs/ft/fandd/basics/bigsmall.htm (Accessed 24 September 2014).
Rohlf Jr., W.D. (1998) Introduction to Economic Reasoning, 4th edition,
US: Addison–Wesley Publishing Company.
Samuelson, P.A. and Nordhaus, W.D. (1992) Economics, 14th edition) New
York: McGraw-Hill.
Sloman, J. (2008) Economics and the Business Environment, 2nd edition,
Pearson: Edinburgh.
Sloman, J. and Wride, A. (2009) Economics, 7th edition, Financial Times,
Prentice Hall: Harlow.
Smith, A. (1776) An Inquiry Into the Nature and Causes
of the Wealth of Nations. Raleigh, N.C.: Alex Catalogue. eBook.
18
The Business Dictionary (n.d.) ‘Definition of quaternary sector’, The

Business Directory, [online]. Available at http://www.businessdictionary.
com/definition/quaternary-sector.html#ixzz3EEe5yin7, (Accessed 22
September 2014).
19
Readings 37–45
Reading 38: Economic indicators

Introduction
This reading introduces you to an important idea in macroeconomics,
namely economic indicators. Economists have developed several indicators
that show how important aspects of an economy are developing. The three
key economic indicators covered in this reading are: Gross Domestic
Product (GDP), Consumer Price Index (CPI), and the rate of unemployment.
As citizens, a basic understanding of key economic indicators like these can
help us to better make sense of what is going on in the economy. It can
help us to interpret the news and some of the decisions made by politicians
and other important economic actors, such as central banks(central banks
are national banks that provide banking services for a country’s government
and commercial banks, as well as implementing monetary policy. This is
covered in more detail in Reading 41). Understanding key economic
indicators can help business managers to make a few first – necessarily
tentative and crude – assumptions about the development of their own
business. For example, the rate of inflation gives a first indication of the
prices that businesses may have to pay for the goods and services they buy
from other businesses, or how consumers may behave in the near future.
(For example, all other things being equal, people tend to spend more
during a period of high inflation because they want to buy things before
they become more expensive.) The rate of growth of GDP and the
unemployment rate give a broad indication of the health of a country’s
economy and can be an aid to making decisions about investment. None of
these indicators on their own can give strong indications of the decisions
that business managers – or individuals in their economic behaviour –
should make. However, taken together and with many other types of
information, they can help to form a picture of the economic context.
The economic system can be analysed in different contexts. For example,
you could analyse the economic system in Europe, in the UK and/or in
England, and also in a single city in a specific English county. Moreover,
you can look at trends in the economic system in a single year and/or over
a longer period, for example the past decade. An economic indicator is
a statistic about an economic activity. Economic indicators allow analysis of
various aspects of economic performance. They also provide measurements
of current economic performance and estimates of future performance.
However, economic indicators can themselves influence the economic
context. For example, if – based on the indicators – leading economists
predict an improvement in economic performance and an increase in
employment, this can raise the confidence of consumers or investors. This
can then become a self-fulfilling prophesy. If consumers buy more because
they have confidence that unemployment will be low, or if investors invest
more because they have confidence that the economy will grow, this rise in
demand and in investment can stimulate the economy so that it indeed
grows or unemployment falls.
There are plenty of economic indicators, such as indicators of the amount of
outputs produced within a country, of public expenditures, of consumer
20
spending, of international trade dynamics and of many other important

matters. You may already have come across Gross Domestic Product (GDP),
Consumer Price Index (CPI) and the rate of unemployment in the headlines
of television news or the newspapers. These concepts will then help you to
better understand the related concepts of economic growth, inflation and the
debate around unemployment.
Figure 1 Economic growth
1 Gross Domestic Product (GDP)

The first economic indicator you will look at is Gross Domestic Product
(GDP). This economic indicator is probably the most commonly used one
and it aims to synthetise the overall situation of an economy in a single
number. GDP can be measured in three ways: output measure; expenditure
measure; income measure. Here we focus on the most commonly used: the
output measure. By this measure, GDP represents the total value of goods
and services produced in an economy (for example a country), by all sectors
of the economy during a given period of time, usually a year.
In the UK, GDP is calculated every three months surveying tens of
thousands of organisations. The UK Office for National Statistics collects
information by doing surveys on sales from 6,000 companies in
manufacturing, 25,000 service sector firms, 5,000 retailers and 10,000
companies in the construction sector (BBC, 2011). Data is also collected
from government departments covering activities such as agriculture,
energy, health and education. Since the output of one business (for example,
steel) can be the input of another (for example, automobiles), double
counting is avoided by combining only ‘value added’, which for any one
activity is the total value of production less the cost of inputs, such as raw
materials and components valued elsewhere (Stutely, 2006, p. 28).
GDP can be used for different purposes: for example, the European Union
uses GDP as a basis for identifying the contribution that each country has to
make to the EU budget. It can also be used by international economic
bodies, for example the Organization for Economic Cooperation and
Development (OECD) or the International Monetary Fund (IMF), in order
to compare the economic performance of different countries. Moreover,
GDP figures can be very useful for central banks (like the Bank of England
21
Readings 37–45
in the UK or the Federal Reserve in the USA) for determining monetary

policy (which will be covered later).
GDP is also very important for understanding the concept of economic
growth. Economic growth tends to fluctuate. In some years there might be a
high rate of economic growth and a country can experience a boom. In
other years, economic growth might be low or even negative: in this
situation a country can experience a recession. This cycle of boom and
recession is known as the business cycle (Sloman, 2008). Economic growth
is represented by the trend of the GDP growth rate. The GDP growth rate is
calculated as follow:
Change in GDP over one period
GDP growth rate = × 100
GDP at the start of the period
For example, imagine that on 1 January 2020 the GDP of a country is US

$100 bn. If on 31 December 2020 it is US$110 bn, the GDP growth rate for
the year 2020 in the given country is 10%. If the value of the GDP is up on
the previous three months, the economy is growing. If the value of the GDP
is down on the previous three months, the economy is contracting. Two
consecutive three-month periods of contraction mean an economy is in
recession (e.g. Blanchard and Johnson, 2012). Recessions differ in length
and in depth. The length of a recession can be measured by the number of
consecutive 3-month periods (i.e. quarters) with GDP decline. The depth of
recession is evaluated by the size and length of negative growth rates. For
example, Figure 2 highlights the trend of World GDP from 1998 to 2013,
comparing rich countries, BRICS countries (the acronym BRICS denotes the
large emerging economies of Brazil, Russia, India, China and South Africa;
sometimes South Africa is omitted and the acronym BRIC is used), and
other emerging economies.
World GDP*
% change on a year earlier
Rich countries BRICS Other emerging countries Total
2
+
0
–
2
4
1998 99 2000 01 02 03 04 05 06 07 08 09 10 11 12 13
*Estimates based on 52 countries representing 90% of world GDP. Weighted by GDP at purchasing-power parity
† Brazil, Russia, India, China and South Africa
Figure 2 World GDP 1998–2013
22
Exercise 1
Table 1 GDP data for Country A and B in the years 2020, 2021 and 2022
GDP 2020 2021 2022

Country A 874 890 900
Country B 440 444 450
Note: All values are in US$ bn.
Now calculate the GDP percentage annual rate of growth for the year
2021 and 2022 for Country A and B. Which has had the highest annual rate
of growth? Which country has grown more?
Comment
The GDP percentage rate of growth for the years 2021 and 2022 is
calculated as follows:
Country A
Year 2021 Year 2022

(890 − 874) (900 − 890)
* 100 * 100
874 890
Country B
Year 2021 Year 2022

(444 − 440) (450 − 444)
* 100 * 100
440 444
The results of the GDP’s annual growth rate are reported in Table 2.
Table 2 GDP’s annual rate of growth for Country A and B in period

2021 and 2022
GDP annual rate of growth (%) 2021 2022

Country A 1.8 1.1
Country B 0.9 1.4
The highest growth rate has been 1.8% for Country A in 2021. Country A
has grown more in 2021, while Country B has grown more in 2022 even if
the absolute level of GDP of Country B is still lower than Country A.
So what do the value of GDP and its growth rate mean for businesses? If
the growth rate is high, it is generally a positive indicator for the economy.
23
Readings 37–45
A strong growth rate normally means that businesses will need to employ
more people and therefore reduces unemployment. In the opposite case,
slow or negative annual GDP growth indicates problems in the economy,
often coupled with greater unemployment. A forecast of strong GDP growth
over the next year normally means more demand for the products and
services offered by businesses. This, in turn, means businesses may have to
employ more people in order to satisfy this demand, which reduces the
unemployment rate. If people are employed this usually means they have
more money to spend, which in turn may lead to yet more demand for
goods and services. This information can give businesses some indications
of how to plan ahead. However, remember we are talking at a macro-level,
so differences may exist across sectors and between individual businesses.
For example, Italy experienced a recession in 2012 and almost all the
sectors had a negative level of production compared to the previous years,
but some sectors – like that of financial and insurance activities –
experienced some limited growth in the same period (ISTAT, 2013, p. 26).
Exercise 2
Table 3 shows the values of GDP in several countries in 2011, and

projections for 2030 and 2050. (Note that fluctuations in currency exchange
rates have been calculated out of these figures and GDP figures for each
country have been converted to international dollars using a measure called
purchasing power parity rates (World Bank, n.d.)). Now imagine you are the
managing director of a medium-sized company making kitchen appliances
(Figure 3).
Figure 3 Kitchen appliances
You have a high market share in your home market and are considering
entering one or two foreign markets. There are, obviously, a lot of different
things you need to consider when making a decision about which countries
to enter. However, as a first step you want to see which countries seem to
offer the most growth potential in the medium- to long-term future. On this
basis and considering the values reported in Table 3, which countries seem
to be most attractive as markets? You should look at both absolute size of
GDP and growth rate.
24
Table 3 GDP in selected countries
Position Country GDP Position Country GDP Position Country GDP

(2011 US (2030 US (2050 US
$bn) $bn) $bn)
1 USA 15094 1 China 30634 1 China 53856
2 China 11347 2 USA 23376 2 USA 37998
3 India 4531 3 India 13716 3 India 34704
4 Japan 4381 4 Japan 5842 4 Brazil 8825
5 Germany 3221 5 Russia 5308 5 Japan 8065
6 Russia 3031 6 Brazil 4685 6 Russia 8013
7 Brazil 2305 7 Germany 4118 7 Mexico 7409
8 France 2303 8 Mexico 3662 8 Indonesia 6346
9 UK 2287 9 UK 3499 9 Germany 5822
10 Italy 1979 10 France 3427 10 France 5714
11 Mexico 1761 11 Indonesia 2912 11 UK 5598
12 Spain 1512 12 Turkey 2760 12 Turkey 5032
13 South 1504 13 Italy 2629 13 Nigeria 3964
Korea
14 Canada 1398 14 South 2454 14 Italy 3867
Korea
15 Turkey 1243 15 Spain 2327 15 Spain 3612
16 Indonesia 1131 16 Canada 2148 16 Canada 3549
17 Australia 893 17 Saudi 1582 17 South 3545
Arabia Korea
18 Poland 813 18 Australia 1535 18 Saudi 3090
Arabia
19 Argentina 720 19 Poland 1415 19 Vietnam 2715
20 Saudi 686 20 Argentina 1407 20 Argentina 2620
Arabia
(Source: PricewaterhouseCoopers (PWC), 2013, p.2.)
Comment
There are no definitive right or wrong answers in this exercise. However, if
you assume that GDP is related to the overall consumer demand in a market
and that the markets with the biggest overall consumer demand are likely to
be the most attractive for your product, then China, the USA and India look
like interesting markets to explore. China and India, in particular, do not only
seem to offer a very sizeable overall market in the next 30 years but also
show high growth rates. But there are also impressive rates of growth of
GDP in countries like Brazil, Mexico and Indonesia (all three countries more
than double the absolute level of GDP from 2011 to 2030). On the other
hand, a country like Germany might first look less promising because its
growth rate is projected to be less than that of some other economies. Note,
however, that it is still expected to grow. As said above, GDP and growth
rate will not be your only criteria for deciding which markets to enter. There
25
Readings 37–45
are many other factors that you would need to take into account. And, of
course, you will be aware that these are projections and long-term economic
projections are not necessarily all that accurate. But high GDP rates of
growth are relevant for businesses because they indicate there might be
possibilities for opening up new promising markets. Firms that are thinking of
opening new branches and/or stores internationally and/or firms that want to
reach new customers globally through e-commerce need to be aware of the
expected GDP rates of growth across the world.
This exercise aims to make you aware of the projections for the growth of
GDP until 2050 in the 20 biggest economies in the world. The figures may
have suggested the increasing importance of countries in continents like
Africa and Asia. Perhaps you didn’t expect to find countries like Poland and
Turkey in this ranking, or countries such as Nigeria and Vietnam that enter
into the rankings only in the projections for 2050.
2 Consumer Price Index

Another important economic indicator is the Consumer Price Index (CPI).
This indicator is important for understanding the economic phenomenon of
inflation. Inflation indicates a general rise in the price level in a country, as
distinct from an increase in the price of any specific good or service: so,
inflation focuses on the overall level of prices in a country. Inflation should
be distinguished from the opposite phenomenon that is deflation: a general
decline in the price level.
The importance of inflation to businesses and consumers is easy to see. For
example, consider the impact of a rise in oil prices for a haulage company;
or the impact of a rise in food prices for people with low income. In the
case of high inflation, businesses and consumers may have less confidence
in their ability to spend and invest because their money loses purchasing
power. In other words, you need more money to buy the same things, so –
if your income stays the same – you will be able to buy fewer things. This
may impact the overall level of consumption as well as the level of
investment by firms. However, if wages and other incomes are also rising
with inflation, the impact of inflation may be more subtle as individuals
may, in fact, feel better off, because they have a larger sum of money in
their pockets or bank accounts (even if that money is now worth less). One
effect can be that individuals save less and spend more because they assume
things will become more expensive and they would prefer to buy them
immediately, before they do.
However, although the opposite trend of a general decline in prices might at
first seem a good thing – after all, things will be cheaper to buy – deflation
is also not desirable. As a matter of fact, deflation is generally even less
desirable than inflation as it tends to trigger a vicious cycle. With falling
prices, consumers tend to postpone their purchases with the expectation of a
further decline in prices; this can cause a significant drop in consumption
26
impacting on firms. It is important to note at this point that central banks

can put in place several tools for combating inflation and deflation and
ensuring price stability. This will be covered in the next reading.
How can we calculate inflation? As said above, inflation depends on the
price level. The price level is often measured using a weighted average
(i.e. an average obtained by multiplying each component by a factor
reflecting its importance) of the prices of a typical basket of consumer
goods and services. The weights reflect the relative importance of the goods
and services in the consumption expenditures of the ‘average’ consumer.
For example, in the USA, the Bureau of Labor Statistics calculates the
consumer price level by creating a basket of thousands of items purchased
by consumers, such as food, housing, clothing, transportation, medical care,
recreation, education, communication, and energy. To see how weighting
works, suppose there are only three items in the basket: bread, milk and
apples. And suppose that the typical consumer spends half their income on
bread, 30% on apples and 20% on milk. Then the general price level is the
weighted average of the prices of these goods, calculated as 0.5 × (price of
bread) + 0.2 × (price of milk) + 0.3 × (price of apples). You will see that
the weights applied come from the spending profile, i.e. what consumers
typically spend on each type of product. What goes into the basket and the
weights applied to each item are changed regularly over time because the
composition of the typical consumption basket changes over time.
The rate of inflation of a country is then measured by the rate of change in
its price level. The rate of inflation is calculated in the following way:
CP level in current period − CP level in previous period
Consumer price (CP) inflation rate = *100
CP level in previous period
The rate of consumer price inflation shows how the cost of living rises or
falls for the typical consumer. As you have already learned, inflation means
you can buy less with the same amount of your money; deflation means you
can buy more. Consumer price inflation data are published as an index, such
as the Consumer Price Index (CPI). To create an index, the consumer price
level for a particular year, such as 2020, is chosen as the base year. This
level is set to 100. Then the CPI for any subsequent year is expressed as a
percentage increase over that base year. So if, for example, consumer prices
are 6% higher in a later year than in the base year, the CPI for that later
year is 106. The CP Index (starting from the base year of 100) should be
calculated in the following way:
Consumer price level in new year
New consumer price index = *100
Consumer price index in base year
Exercise 3
Consider the data presented in Table 4.
27
Readings 37–45
Table 4 Consumer price level in a given country per years 2020,

2021 and 2022
Year 2020 2021 2022

Consumer price level 150 165 177
Now calculate the Consumer Price Index (CPI) for years 2021 and 2022
considering the year 2020 as the base year.
Comment
Consumer price level in new year
New consumer price index = * 100
Consumer price index in base year
CP Index calculations:
165
In 2021 : New CPI = * 100 = 110
150
177
In 2022 : New CPI = * 100 = 118
150
177 * 100
where X =
150
The results are shown in Table 5.
Table 5 Consumer Price Index in a given country in 2021 and 2022
Year 2020 2021 2022

Consumer Price Index 100 110 118
Having learned how the consumer price level, rate of inflation and the CPI
are calculated, Exercise 4 now takes you through a real case study on
inflation and its impacts on consumers and businesses.
Exercise 4
Read the article below and consider the effects of inflation on house prices in
London. What do you think are the impacts of the described house price
inflation on consumers, investors and the housing industry?
28
Figure 4 London houses
London houses now cost more than

£500,000
Peter Spence, The Telegraph, 16 Sep 2014
Getting your foot on the property ladder will require an average salary
of £51,500, according to new figures. Analysts expect UK house prices
to increase by 6–10 per cent over the whole of 2014.
The average price of a London home has exceeded £500,000 for the
first time, taking it into a new stamp duty bracket [the tax buyers need
to pay when buying a house or flat] and attracting a tax bill of more
than £20,000. The cost of a typical home in the capital was £514,000
in July, as the average value rose by 19.1 per cent on last year. Homes
bought for between £250,000 and £500,000 incur stamp duty at 3 per
cent, while those costing from £500,000 up to £1 million are charged
at 4 per cent. Richard Snook, a senior economist at PwC, said: ‘The
average London property is now eligible for a minimum £20,000 tax
bill.’ The data from the Office for National Statistics (ONS) showed
that, nationwide, average house prices rose by 11.7 per cent in the year
to July, as the national average price reached £272,000. However, there
are signs that the UK housing market has cooled in the past two
months, with a heavier stamp duty burden possibly contributing to
some of the slowdown.
‘We still expect UK house price growth for the year as a whole to
come in within our projected range, around 6 to 10 per cent, but it’s
currently on course to be towards the upper end of this,’ said Mr
Snook. Stretched house price to earnings ratios may also slow rises,
suggested Howard Archer, of IHS Global Insight. The statistics also
show that first-time buyers paid 13.5 per cent more — an average of
£209,000 — for homes in July than those who bought in the same
month a year earlier. Separate figures from the Council of Mortgage
Lenders show that on average first-time buyers took out loans worth
84 per cent of the value of their properties. The loans were 3.41 times
their income. The average first-time buyer has a salary of £51,500 — a
29
Readings 37–45
typical deposit is £33,400. While London has seen the strongest

growth in prices, other regions have seen values rise by more than 10
per cent in the year to July according to the ONS. The south-east and
east of England both saw double digit rises, with Northern Ireland the
only area in the UK to see gains of below 5 per cent. Martin Beck, a
senior adviser to the EY Item Club, an independent economic
forecasting group, suggested that the data could cause some headaches
at the Bank of England. ‘The housing market continues to present a
complication in what is otherwise a fairly benign environment for
monetary policy’, said Mr Beck. Fabio Fois of Barclays said the
‘strong’ increases ‘support our view that the Bank of England will
likely move sooner rather than later’ in raising rates. Matthew Pointon
of Capital Economics said there has been a ‘sharp easing back’ in
demand for new homes but that has been ‘driven primarily by a
shortage of homes up for sale’.
Comment
This article presents a real example of inflation. The effects can be analysed
from several perspectives. For example, people who want to buy their first
house in Central London will find this more difficult; they may have to save
longer for a deposit and will have to spend a higher proportion of their
incomes on the monthly repayments of a mortgage. This means they will feel
poorer because they then have less money available to spend on other
things, such as clothing, food, travel, leisure activities, etc. People who buy
houses not in order to live in them but as an investment, on the other hand,
will be affected differently. While they may have to spend more money on
any house or flat they can also expect higher returns on their investment if
they can then sell these properties at a higher price in the future. Those
selling houses (individuals or businesses) are affected differently again. They
may achieve higher profits as they can sell for higher prices. But this will only
be the case as long as buyers continue to buy at the high prices that are
being demanded.
This section has given you an insight into why inflation is such an
important economic indicator for businesses to consider. The main reason is
that it can say something about future consumer spending behaviour. If
prices are too high, people can modify their consumption behaviour by
buying less, buying alternative products if they are available at a cheaper
price or, in the case of London house price inflation, considering a move to
areas outside London. Moreover, if prices are expected to go up in the near
to medium future, consumers and organisations may decide to spend their
money now before things become more expensive. If prices are expected to
go down the opposite is likely to happen: consumers and organisations will
postpone their non-essential spending to wait for the cheaper prices ahead.
30
3 Rate of unemployment
The third main economic indicator is the rate of unemployment. The rate of
unemployment is a key variable in economic and social policy, for a
number of reasons. It indicates underutilisation of available resources in an
economy. Furthermore, a high unemployment rate imposes severe social
costs in terms of falling standards of living, and the emotional strain and
uncertainty that goes with being unemployed and having to look for a job,
or fearing unemployment. It normally also causes a rising bill for social
welfare payments, although the availability and extent of unemployment
benefits varies significantly between countries.
Figure 5 Protests about unemployment levels
‘Employment’ in economic data includes both work for a wage and self-
employment – running your own business. A person becomes unemployed
when they lose a job – voluntarily or involuntarily. You may resign
voluntarily or you may be involuntarily laid off. Examples of voluntary
unemployment include wanting to look for paid work elsewhere or wanting
to withdraw from the labour market. Examples of involuntary
unemployment include a temporary loss of a job, for example because of
cuts in production, or a permanent job loss through redundancy.
Total unemployment in a country refers to the number of people out of paid
work but actively seeking employment. A country’s labour force is the total
of those who are employed and those actively seeking work. The rate of
unemployment is then the proportion of the labour force that is unemployed.
The rate of unemployment (expressed as a percentage) is measured as:
unemployment
Unemployment rate = x 100
labour force
Definitions of unemployment vary significantly between countries, and over
time within a country, depending not only on the method used to collect the
data, but also on how stringently or leniently ‘actively seeking’ is defined.
If people ‘actively seeking employment’ are defined in a stricter way (for
example, only those count who regularly attend appointments at the job
centre and can prove they have applied for a certain number of jobs over
the past two weeks) then the official unemployment level and
31
Readings 37–45
unemployment rate will be less than if ‘actively seeking employment’ is

defined more loosely.
The level of unemployment has a huge importance in the functioning of the
economic system. Unemployment implies a waste of scarce economic
resources and reduces the long run growth potential of the economy.
Moreover, it impacts on businesses and on government in negative ways. In
the first case, unemployment means less income for people and less money
to be spent in consuming goods and/or services offered by businesses; in
the second case, unemployment impacts on government with higher benefit
payments and lower tax revenues as a consequence of the inactivity of
individuals.
Unemployment rates vary greatly over time and between countries. For
example, in 2000 the total unemployment rate across the 28 member states
of the European Union was 9.1%. It then fell to less than 7% in the period
between 2005 and 2008 and then rose sharply following the financial and
economic crisis starting in 2008 to reach 10.9% at the beginning of 2013.
But this unemployment was very unevenly distributed. In September 2014
the unemployment rate in EU member states was lowest in Germany (5.0%)
and Austria (5.1%) and highest in Greece (26.4% in July 2014) and Spain
(24.0%). The unemployment rate for the UK was 6.0% (Eurostat, 2014).
Furthermore, unemployment is generally unevenly distributed among
different groups of the population. Youth unemployment is often higher than
the general unemployment rate for a country, which is particularly
worrisome as it affects the future of a country’s population. In
September 2014, the youth unemployment rate was 21.6 % in the EU. The
lowest rates were observed in Germany (7.6%), Austria (9.1%) and the
Netherlands (9.8%), and the highest in Spain (53.7%), Greece (50.7% in
July 2014), Italy (42.9%) and Croatia (41.8% in the third quarter 2014)
(Eurostat, 2014).
Summary
In this reading you learned about the importance of three key economic
indicators:
. Gross Domestic Product (GDP), which indicates economic growth

. Consumer Price Index (CPI), which indicates inflation
. the rate of unemployment.
You learned that high rates of economic growth indicate the health of an
economy; countries with high GDP rates may be more attractive as markets
to invest in but can also indicate higher competition in the global economy
coming from firms of those countries. You have also learned about the
meaning of inflation and deflation and their effects on the economic system
and on consumers. Finally, this reading has looked at the rate of
unemployment and the economic and social costs of unemployment.
32
References
BBC News (2011) ‘Q&A: What is GDP?’, BBC News: Business, [online].
Available at http://www.bbc.com/news/business-13200758, (Accessed 20
September 2014).
Blanchard, O.J. and Johnson, D.R. (2012) Macroeconomics, 6th edition
(Global Edition), Upper Saddle River, New Jersey, USA: Pearson
Education.
Eurostat (2014) ‘Unemployment statistics’ [online]. Available at http://epp.
eurostat.ec.europa.eu/statistics_explained/index.php/
Unemployment_statistics#Recent_developments_in_unemployment_a-
t_a_European_and_Member_State_level (Accessed 18 November 2014).
ISTAT (2013) ‘Rapporto Annuale 2013. La situazione del Paese’, (‘Report
on Italian Economy for 2013’), Italian Institute for Statistics (ISTAT),
[online]. Available at http://www.istat.it/en/files/2013/05/
Rapporto_annuale_2013.pdf (Accessed 24 September 2014).
PricewaterhouseCoopers (PWC) (2013) ‘World in 2050. The BRICs and
beyond: prospects, challenges and opportunities’ PricewaterhouseCoopers
(PWC), [online]. Available at http://www.pwc.com/en_GX/gx/world-2050/
assets/pwc-world-in-2050-report-january-2013.pdf (Accessed 5
February 2015).
Pearson: Edinburgh.
Spence, P. (2014) ‘London houses now cost more than £500,000’, The Daily
Telegraph, 16 September 2014, [online]. Available at http://www.telegraph.
co.uk/finance/newsbysector/constructionandproperty/11099087/London-
houses-now-cost-more-than-500000.html (Accessed 25 September 2014).
Stutely, R. (2006) Guide To Economic Indicators: Making sense of
Economics, 7th edition, New York: Economist Books.
World Bank (n.d.) GDP per capita, PPP (current international $), [online].
Available at http://data.worldbank.org/indicator/NY.GDP.PCAP.PP.CD
(Accessed 22 September 2014).
33
Readings 37–45
Reading 39: The financial system

Introduction
This reading analyses the financial system, which is a sub-system of the
economic system. The financial system allows the transfer of money from
those who have it in surplus (typically families because they usually save
part of their earnings) to those who need more money (typically businesses
because they have to finance their investments). The financial system is a
hugely important part of modern economies and has an important enabling
function for the economic system as a whole.
A financial system can be defined as the system of relationships among
individuals and different kinds of organisations aimed at acquiring, spending
and managing money and other financial assets (Melicher and
Norton, 2008). In this reading you will learn about the role of financial
institutions and of foreign exchange markets in the economic system, and
about the global financial crisis that began in 2008, its key stages and its
impacts on businesses and more generally on society.
Figure 1 A bank
1 The role of financial institutions

Financial institutions are institutions that provide financial services to their
clients and members. They are also called financial intermediaries because
the main function they fulfil in an economic system is to act as
intermediaries between those individuals and organisations that have money
they want to invest and those who need money to invest. Some of the most
important financial institutions are the banks. Banking activity has ancient
origins: in Europe the need to get loans and to put money in secure places
was already recognised in ancient Greece. According to Hildreth (1837) the
first kind of institution that we now would call a bank was established in
the Republic of Venice 700 years ago.
34
Today modern banks offer several financial services that can impact on the
functioning of the economic system. According to Sloman and Wride (2009)
banks provide five important services in the economy:
. Expert advice: financial institutions advise their customers on financial

matters, such as how best to invest their money or alternative ways of
obtaining finance.
. Expertise in channelling funds: financial intermediaries have specialist
knowledge that helps them and their customers to channel money into
those ventures that may yield the highest returns and to assess the risk
in, say, investing in certain ventures or giving loans for particular
projects.
. Maturity transformation: most borrowers want or need to borrow
money for long periods of time whereas most investors, particularly
small savers, want to be able to access their deposits at short notice. If
borrowers had to go directly to investors there would be a mismatch
here that could severely restrict the number of loans agreed. Banks
borrow money from a large number of small savers who can then
withdraw their money at short notice. They then lend that money to, say,
house purchasers for a much longer period, typically 20 to 30 years.
Because the banks collect money from so many different savers, not all
of these will want to invest and withdraw at the same time. The bank
should therefore normally have a pool of money available that it can
lend to borrowers over a longer time period.
. Risk transformation: individual investors may be unwilling to lend
their money directly to a borrower in case the borrower does not pay
them back; they are unwilling to take that risk. Because financial
institutions lend to so many different borrowers they can risk the
occasional default on paying back. They can absorb that loss because of
the interest they earn on all the other loans they have made.
. Transmission of funds: many financial institutions (particularly banks)
also have the function of facilitating the transmission of payments from
one individual or organisation to another. This is done by the use of
credit or debit cards, internet and telephone banking, cheques, direct
debits, bank transfers, etc. Therefore people don’t have to rely on cash
for all their transactions, which is both more convenient and safer.
Figure 2 The Cooperative bank
35
Readings 37–45
The investment decisions of banks can have important impacts on the

economy and society as a whole. The example below is about a UK bank
that has decided to invest its money only in economic activities that respect
some level of ethical concerns.
Example of a bank with an ethical policy: The Co-operative

Bank, UK
The Co-operative Bank provides high street and internet banking, current
accounts, mortgages, savings accounts, credit cards and loans. It places
much importance on being an ethical financial institution and on its ethical
policy. Its Ethical Policy covers five key areas: human rights, international
development, ecological impact, animal welfare, and social enterprise. In line
with its customers’ ethical concerns, The Co-operative Bank restricts finance
to certain business sectors or activities, while at the same time committing to
provide finance to those organisations making a positive community, social
and environmental impact.
(The Co-operative Bank, n.d.)
Until now we have generally talked about banks; however, we need to

distinguish between commercial banks and investment banks. A commercial
bank receives money from businesses and individuals and lends money to
them. Commercial banks are open to the public and serve individuals,
institutions and businesses. A commercial bank is almost certainly the type
of bank you associate with ‘bank’ because it is the type most people
regularly use. The Co-operative Bank, together with other well-known
brands of banks, such as Deutsche Bank, HSBC and Barclays are examples
of commercial banks, although they may also have investment banking
arms.
An investment bank is a financial intermediary that performs a variety of
services for businesses and some governments. Investment banks do not
take deposits or give loans to individuals. Investment banks specialise in
large and complex financial transactions, such as acting as an intermediary
to help individuals and organisations make large investments, facilitating
mergers and other corporate reorganisations, and acting as a broker and/or
financial adviser for institutional clients (Sloman and Wride, 2009). Some
examples of investment banks are Goldman Sachs and Merrill Lynch; you
may have heard their names on the news. Building societies are financial
institutions that specialise in savings accounts and mortgages for house
buyers. These days, at least in the UK, they perform many services that are
similar to those of banks.
Banks are not the only financial institutions. Insurance companies, stock
brokers, and companies specialising in specific financial services (such as
leasing or credit rating) are also financial intermediaries.
36
2 Foreign exchange markets

The financial system facilitates the transfer of money between different
economic actors. This can happen at a national level but also at an
international level. In the latter case, it means that business transactions
may be in different currencies.
Foreign exchange markets are markets for the trading of currencies and they
have increased their relevance enormously with globalisation. Think about
any experience you may have had of exchanging currencies, for example
pounds into euros. The amount of money you exchanged was probably quite
small. However, consider a Swiss firm that wants to buy machinery from
Japan or all the foreign investments made each year by UK companies.
What happens in foreign exchange markets is very relevant to businesses
(especially those that trade a lot with countries with foreign currencies). For
a start, exchanging money into a different currency can be costly. Banks
charge up to 5% in commission for exchanging money. At that rate, if you
were to transfer £200,000 into another currency, your bank could charge
you £10,000 for just a single transfer (although, to be fair, you would
probably be able to negotiate a more competitive commission if you were to
transfer such a large sum of money).
More influential are the exchange rates, i.e. the rates at which one currency
trades for another on the foreign exchange market (Sloman, 2008, p. 367).
Exchange rates are determined by supply and demand in the foreign
exchange markets. International business transactions are strongly influenced
by the level of exchange rates. Businesses need to be aware of the exchange
rates and particularly fluctuations in them because even a previously
profitable transaction could become unprofitable through a change in
exchange rates. For example, if the value of the pound sterling rises in
comparison with the US dollar UK exporters can have problems because
either US customers will have to pay more if the UK business wants to
maintain the prices it gets in sterling, or the UK business will have to
accept lower income from its exports if it wants to maintain the dollar
prices that US customers pay. Moreover, exchange rates can be very
volatile, adding a lot of uncertainty to international business operations.
Exchange rates can also have other important implications in terms of their
effects on exports. If the value of the exporters’ currency has been rising,
consumers in countries with other currencies may look for less expensive
substitute products, which will reduce the demand for products from the
exporting country with the strong currency.
In order to reduce the economic uncertainty arising from fluctuating
exchange rates, countries sometimes take measures to fix the exchange rate
of their own currency to that of another, economically stable country. In
Europe, countries of the so-called Eurozone have gone one step further and
have introduced a common currency, called the euro. The example below
looks at some possible benefits derived from the adoption of the euro for
the countries in the Eurozone. The text is drawn from the official website of
the European Union, so it might emphasise the positive side of the euro.
Others would prefer to highlight the negative side of the euro, for example
euro member countries’ loss of sovereign powers in monetary policy
37
Readings 37–45
(policies to control the supply of money in an economy, often through

setting interest rates), or the loss of the ability to engage in competitive
devaluations (where a country devalues its currency to increase its
competitiveness in international markets). Over recent years the Eurozone
has experienced sustained economic recession and the stability of the euro
has been questioned. Critics have also questioned the wisdom of introducing
a single currency in a group of countries that do not have a unified
economic policy. It is not the purpose of this reading to take a position on
whether the introduction of the euro was a good idea or not. The example is
meant to help you think about some of the implications arising from the
adoption of the euro.
Example of a common currency: the euro
Figure 3 Bank notes from the Eurozone
The euro is the currency of 19 euro area countries: Austria, Belgium, Cyprus,
Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania,
Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, and Spain,
and the 333 million people who live in this so-called Eurozone. It has rapidly
become the second most important international currency after the dollar.
The euro is managed in a way to promote its stability, contribute to low
inflation and encourage sound public finances. The euro was introduced
partly because a single currency is seen as a logical complement to the
single market and it contributes to making this single market more efficient.
Using a common currency has the advantage of increasing price
transparency, eliminating currency exchange costs, facilitating international
trade and giving the EU a more powerful voice in the world. The size and
strength of the euro area were also expected to protect it better from external
economic shocks, such as unexpected oil price rises or turbulence in the
currency markets. Last but not least, the euro gives the EU’s citizens a
tangible symbol of their European identity.
(European Commission, n.d.)
38
Exercise 1
Imagine you are running a medium-sized business producing specialist

electronic equipment in France. Your business is going well and you have
been approached by potential customers in Spain and the Netherlands. If
you take on these new contracts you will have to source more component
parts, some of which you currently buy from suppliers in Germany and
Canada. What impact does the existence of the euro have for your
business?
Comment
For your export plans, the fact that your potential customers are in Eurozone
countries is beneficial. You will not have to worry about currency fluctuations
when selling to either Spain or the Netherlands, so can plan better the prices
you want to charge. The same applies for the supplies you are buying from
your German supplier. Again, prices agreed with the supplier are in the same
currency and will not be affected by currency fluctuations. The supplies you
buy from Canada are different. If the value of the euro goes down either you
will have to pay more in euros for the components you are buying from
Canada or your Canadian supplier will have to accept a lower price in
Canadian dollars.
So, let’s say the Canadian supplier charges $100 for a particular component.
If a Canadian dollar costs €0.60 to buy you will have to pay €60 for each
component. If the value of the euro goes down to a point where a Canadian
dollar costs €0.71 to buy (the rate on 18 November 2014, when this reading
was written) and your supplier still charges $100 per component, you will
have to pay €71 of each component. If, however, you had agreed that you
would pay in euros and you continue to pay your supplier €60 per
component, as you had done before, and they will now only receive $84.75
for each component. So either you have to pay more or they receive less. As
a medium-sized business you are unlikely to be a hugely important customer
for the Canadian supplier, so in all likelihood you will have to pay more for
your components.
3 The global financial crisis

The financial system is one of the key facilitators and even drivers of global
economic growth. However, it can experience periods of crisis. This is what
happened during the global financial crisis that occurred in 2008.
Understanding what happened in this crisis will help you appreciate the
interconnectedness of the financial system and the significance and influence
of financial actors within the whole economic system.
Here is the story in short (and somewhat simplified) (adapted from Singh, n.
d.). In 2000/1 the Federal Reserve (the central bank of the United States of
39
Readings 37–45
America – see Figure 4) lowered interest rates from 6.5% to 1.75% in order
to counter the effects of a short-lived recession. It kept the interest low as
there was fear of the recession recurring or deepening. By this it created a
flood of cheap money in the economy where individuals and organisations
could get loans for a very low interest rate (i.e. cheaply). In order to find a
profitable use for all this cheap money bankers started to give so-called sub-
prime mortgages to borrowers who had little regular income, low paying or
even no jobs and no significant assets, but who were keen to realise their
life's dream of buying a home.
Figure 4 The US Federal Reserve
In order to create further profitable financial products, banks also started to

repackage these mortgages into complex financial products called
collateralised debt obligations (CDOs), which they then sold to other banks.
CDOs are sophisticated financial tools that banks use to repackage
individual loans into a product that can be sold on to other investors
(AboutNews, n.d.; Investopedia, n.d.). A CDO is so-called because the
assets that are being packaged in it – such as mortgages, bonds and loans –
are essentially debt obligations that serve as collateral (i.e. security against
the loan) for the CDO. Through these complex financial products that were
being sold on to other banks and investors, a big secondary market for
subprime loans developed.
All this went well while interest rates stayed low and most borrowers were
able to make the monthly payments on their mortgages. From June 2004,
however, interest rates in the USA started rising and the demand for houses
decreased. During the last quarter of 2005, home prices started to fall. Many
subprime borrowers could not pay the higher interest rates and stopped
making their monthly payments on their mortgages. Up to March 2007 more
than 25 US subprime lenders filed for bankruptcy, starting a tide of bank
failures. Problems in the subprime market began hitting the news, and
horror stories started to leak out. According to 2007 news reports, financial
firms and hedge funds owned more than US$1 trillion in securities backed
by these now-failing subprime mortgages – enough to start a global
financial crisis if more subprime borrowers started defaulting.
40
Figure 5 The subprime mortgage crisis
By August 2007 it became clear that the financial market could not solve
the subprime crisis on its own and the problems spread beyond US borders.
The interbank market, where banks lend money to each other, froze
completely because banks no longer trusted each other’s securities. British
Bank Northern Rock had to approach the Bank of England for emergency
funding because it did not have sufficient liquid funds (i.e. cash, or assets
that can rapidly be turned into cash) to pay all its current liabilities. By that
time, central banks and governments around the world had started coming
together to prevent further financial catastrophe. Despite central banks
starting to reduce interest rates radically (considered a good thing in this
instance because it allowed banks to borrow money cheaply in order to
increase their liquidity) more banks ran into trouble. For example, in the
USA, Lehman Brothers filed for bankruptcy, Indymac bank collapsed, Bear
Stearns was acquired by JP Morgan Chase, Merrill Lynch was sold to the
Bank of America, and Fannie Mae (The Federal National Mortgage
Association, FNMA) and Freddie Mac (The Federal Home Loan Mortgage
Corporation, FHLMC) were put under the control of the US federal
government. Continued interest rate cuts and liquidity support by central
banks in several countries were not enough to stop such a widespread
financial meltdown. In 2008 the US, European and other governments came
out with various bailout packages, government guarantees and outright
nationalisation to stabilise the banking system and prevent a widespread
consumer panic.
The crisis that started in the financial sector soon had real consequence in
the economy as a whole. In the USA output of goods and services was 6%
lower in the fourth quarter of 2008 and first quarter of 2009 compared to
the same periods in the previous year. Unemployment in the USA increased
to 10.1% by October 2009, the highest rate since 1983 and roughly twice
the pre-crisis rate. A decline in GDP brought with it a decline in innovation,
as shown by a stagnation of patent applications; this stagnation correlates to
the similar drop in GDP during the same time period. The consequences in
European economies were similar or worse, with the effects of the crisis
lasting much longer there.
41
Readings 37–45
Figure 6 Lehman Brothers filed for bankruptcy
The effects of the crisis did not stop with the private sector. In an attempt to
stop European banks that had invested heavily in the US housing market
from failing, European governments came to the rescue in countries such as
Germany, France, the UK, Ireland, Denmark, the Netherlands and Belgium.
The cost of bailing out the banks led to deficits in the public finances of
many of these countries and financial markets started to worry about
whether the worst-affected countries would be able to pay back the money
they had borrowed. Investors became particularly concerned about Greece,
which was going through serious economic difficulties and had government
debts nearly twice the size of the economy. Governments found it
increasingly difficult to borrow large amounts of money and thus what
started as a banking crisis became a sovereign debt crisis, meaning the
countries affected were (perceived to be) unable to pay their public debt
(European Commission, 2014).
The links between central bank policy, marketing decisions made by
mortgage lenders, changes in house price levels and subsequent failing of
banks, government bail-outs and falling GDP demonstrates the
interconnected nature of the economic system and the importance of
financial institutions in it. One of the important negative effects of the
banking crisis on the rest of the economy is that banks became very
reluctant to lend to businesses, particularly small business. This meant that
many small businesses now faced liquidity problems of their own, often
sufficiently severe to put them out of business because they were no longer
able to pay their suppliers. It also demonstrates the global nature of the
modern financial system because what started in the USA affected large
parts of the world (although not all) in a kind of domino effect.
The global financial crisis had important effects on the social, cultural and
political dimensions of the economies. In social terms, an example was the
rise of unemployment due to the economic downturn that reached dramatic
levels in countries like Greece and Spain, where youth unemployment is
particularly dramatic, reaching levels of over 50% in 2014. In cultural
terms, the issue of subprime mortgages (irresponsible in many
commentators’ eyes) (The Economist, 2013) and the failure of Lehman
Brothers increased ethical concerns over business conduct in general, and
that of large financial institutions in particular. In political terms,
government and EU intervention increased during the crisis in order to bail
out not only failing banks but entire countries like Greece.
42
Figure 7 Protests during the Greek economic crisis
The regulatory oversight of the banking sector also increased, which was a
contributing factor in tighter lending criteria. These tighter lending criteria
further exacerbated the already existing difficulty of gaining credit faced
especially by small- and medium-sized enterprises. This is the so-called
credit crunch, an economic condition in which investment capital is difficult
to obtain because banks and investors become wary of lending funds to
enterprises (Investopedia, n.d. b). Many enterprises went into bankruptcy as
a consequence of reduced demand, unavailability of bank credit and
increased competition from other countries less affected by the global
financial crisis, for example China. After the bankruptcy of any bank the
turbulence in financial markets grew because financial actors feared the
possible bankruptcy of states. Third sector organisations were also hit by
the global financial crisis: donations went down due to the depression of the
economic activities and government transfers to third sector organisations
were generally reduced as a consequence of the austerity measures
implemented in the public sector in many Western countries.
Summary
Working through this reading you have learned about the financial system
and the role of financial institutions in the economy. You have learned about
the importance of exchange rates for businesses due to the increasing
international financial flows among businesses and countries. The financial
system has an important enabling and catalyst function in the economic
system; however, it can experience periods of crisis, with heavy
implications for businesses, consumers and on all kinds of public and third
sector organisations. Managers need to consider carefully the consequences
of the global financial crisis, probably not only as a period of crisis, but
also as a complex readjustment of economic power across the world: this
can be a threat, but it can also be an opportunity for the opening up of new
markets and business opportunities.
43
Readings 37–45
References
AboutNews (n.d.) ‘CDOs (Collateralized Debt Obligations)’, [online].
Available at http://useconomy.about.com/od/glossary/g/CDOs.htm (Accessed
18 November 2014).
The Co-operative Bank (n.d.) Ethical Policy, [online]. Available at http://
www.co-operativebank.co.uk/aboutus/ourbusiness/ethicalpolicy (Accessed 26
September 2014).
The Economist (2013) ‘The origins of the financial crisis’, The Economist, 7
September 2013, [online]. Available at http://www.economist.com/news/
schoolsbrief/21584534-effects-financial-crisis-are-still-being-felt-five-years-
article (Accessed 23 October 2014).
European Commission (n.d.) Euro, [online]. Available at http://ec.europa.eu/
economy_finance/euro/index_en.htm (Accessed 25 September 2014).
European Commission (2014) ‘Why did the crisis happen?’ Economic and
Financial Affairs, European Commission, [online]. Available at http://ec.
europa.eu/economy_finance/explained/the_financial_and_economic_crisis/
why_did_the_crisis_happen/index_en.htm (Accessed 22 October 2014).
Hildreth, R. [1837] (1968) The History of Banks: To which is Added, A
Demonstration of the Advantages and Necessity of Free Competition in the
Business of Banking, New York: Augustus M. Kelley Publishers.
Investopedia (n.d. a) ‘Collateralized Debt Obligation – CDO’ [online].
Available at http://www.investopedia.com/terms/c/cdo.asp (Accessed 23
October 2014).
Investopedia (n.d. b) ‘Credit Crunch’, [online]. Available at http://www.
investopedia.com/terms/c/creditcrunch.asp (Accessed 25 September 2014).
Melicher, R. and Norton, E.A. (2008) Introduction to Finance: Markets,
Investments, and Financial Management, 13th edition, New York: Wiley.
Singh, M. (n.d.) ‘The 2007-08 financial crisis in review’, Investopedia
[online]. Available at http://www.investopedia.com/articles/economics/09/
financial-crisis-review.asp (Accessed 22 October 2014).
Pearson: Edinburgh.
Sloman, J. and Wride, A. (2009) Economics, 7th edition, Harlow: Financial
Times-Prentice Hall.
44
Reading 40: Supply and demand

Introduction
This reading focuses on a key economic principle: the formation of prices
through the interplay of supply and demand. This will help you to
appreciate better, for example, why the prices of hotels go up during
holidays, why the prices of summer clothes go down at the end of the
summer, why the prices of flight tickets go up when the date of travel is
closer to the purchase of the tickets, and why the prices of mobile phone
tariffs have gone down in recent years after the increase of the numbers of
operators providing mobile phone services.
However, in order to understand supply and demand you need to understand
first the concept of market. A market can be defined as a place where
buyers and sellers come together in order to trade goods and/or services
(Sloman, 2008). There is a market for most goods and/or services sold:
thus, for example, we can have a market for oranges, for cars, for houses,
for mobile phones, for insurance or for shares in companies.
There are not only physical markets, but also virtual markets where
economic activity takes place. Examples of physical markets are a street
market, whereas websites like amazon.com, ebay.com or taobao.com are
examples of virtual markets.
Example of a virtual market: Taobao

China's Taobao is one of the world's largest e-commerce websites, like a
combination of eBay and Amazon, only bigger. Its 500 million registered
users trade almost 50,000 items of merchandise every minute on average.
Taobao has two major platforms: the TMall, where established brand owners
sell directly to customers, and the Taobao Market place, where smaller
companies and budding entrepreneurs set up shop. On 11 November 2013,
when Taobao held its annual big sales day, goods worth 1 bn. yuan were
traded in just over six minutes and the total sales for the day amounted to
more than 35 bn. yuan (the equivalent of US$5.6bn or £3.45 bn). With more
than 800 million items listed, you can find almost anything offered for sale on
the website.
(Xu, 2014)
All markets are underpinned by the forces of supply and demand. The basic
principle here is that if a good is sold by many suppliers, but few buyers
are interested in demanding (buying) it, the price of that good is going to
decrease. Conversely, if many buyers are interested in demanding a
particular good, and there are few suppliers, the price of that good will
increase. This reading will look in more detail at this phenomenon. An
important point to make right at the beginning is that demand and supply
only work exactly like in this model when markets are perfectly
competitive. For markets to be called perfectly competitive, they must meet
some precise conditions (Colander, 2006, p. 253):
45
Readings 37–45
. both buyers and sellers are price takers, i.e. they cannot independently
set prices but have to buy or sell at the going rate
. the number of firms is large and firms are all searching for profit
maximisation
. there are no barriers to entry or exit, i.e. new firms can easily enter the
market if there is a lot of demand, and existing firms can also easily exit
the market if there is not enough demand
. firms’ products are identical
. there is complete information, i.e. every buyer and seller knows
everything about all other buyers and sellers’ products and prices.
Don’t worry at this point if you don’t understand some concepts. You will
learn more about perfectly competitive (and other types of) markets later in
Reading 42.
As you will probably have realised when looking through the definition
above, perfectly competitive markets do not actually exist; it is an abstract
concept. There are some markets that are somewhat close to the conditions
of perfect competition, so that the general interplay of supply and demand
can be observed. However, the majority of markets are not even close to the
conditions of perfect competition. In most markets, buyers and sellers do
not have anything even close to complete information about each other and
about the nature of the products and services on offer. There are also many
markets where there are only a fairly small number of buyers and sellers,
and where there are indeed significant barriers to entry or exit. Many
markets are also strongly influenced by government intervention, which can
change the behaviour of buyers and sellers.
1 Understanding demand
In this section you will learn about three very important things: the
relationship between demand and prices (the so-called law of demand); the
concept of price elasticity of demand; and the factors beyond price that may
influence demand.
1.1 The law of demand

In economics, demand for a given good and/or service represents the
amount of that good and/or service that people are both willing and able to
pay for at a given time (e.g. Antonioni and Flynn, 2011; Colander, 2006;
Katz and Rosen, 1998; Sloman, 2008). For example, if you are a consumer
that likes luxury cars but you don’t have the money for buying them, then
you aren’t part of the demand for luxury cars. Moreover, we need to
distinguish between two slightly different concepts: quantity demanded and
demand. The quantity demanded refers to how much of a good and/or a
service consumers demand at a specific price given their income and
preferences; demand means the whole range of quantities that a consumer
with a given income and preferences demands at different prices (Antonioni
46
and Flynn, 2011, p. 173). You will see that it is fairly easy to distinguish
between these two concepts.
The relationship between demand and prices is known as the law of
demand. This law is based on the following principle: considering all other
things being equal or held constant (the so-called ceteris paribus clause), if
the price of a good rises, the quantity demanded of the same good will fall.
This will happen because consumers will be able to afford less of the now
more expensive good, so they will either reduce their consumption or they
will try to look for alternative or substitute goods. The first situation is
known as the income effect, whereas the second situation is known as the
Ceteris paribus, meaning substitution effect (Sloman, 2008, p. 35).
‘all other things being
equal or held constant’ is The relationship between demand and prices is shown by the demand curve.
a phrase often used in More specifically, the demand curve is the graphic representation of the
the language of relationship between price and quantity demanded (Colander, 2006, p. 91).
economics. Many rules We could have the demand curve of an individual consumer or the
or propositions in
aggregate demand of all the consumers: in the first case, it is called the
economics are true only
if the ceteris paribus
individual demand curve, whereas in the latter case it is called the market
clause is satisfied. demand curve. The term curve is used even if the graph has different forms.
Figure 1 highlights the market demand curve for an annual one-year course
on management (‘Certificate of Management’) offered by a single university
in distance learning. As you can see in this hypothetical example, if the
price is £5,000 the number of students (quantity demanded) that are willing
to attend the course is 100; if the price goes down to £2,000, the number of
students increases to 400. Of course, estimating the trend of demand is not
an easy exercise and it is usually based on the results of specific market
surveys.
5
Price (thousands of £)
0
0 100 200 300 400 500 600 700
Quantity demanded
Figure 1 The market demand curve for attending a management course
The market demand curve is intended to show the total demand in the
market for attending a management course offered by a single UK
university. In particular, the demand curve shows how the quantity
demanded changes in relation to different levels of price. There may, of
course, be other price points, for example you might be willing to pay
£10,000 for attending this management course because it can increase your
chances of promotion.
47
Readings 37–45
The slope of the demand curve is downward showing a negative

relationship exists between price and quantity demanded, i.e. if prices go
up, fewer consumers will demand the good or service and if prices go
down, more consumers will want the good or service. This applies in the
vast majority of cases, although there are exceptions, for example luxury
goods. Thorstein Veblen, an American economist, studied the cultural
influences on consumption and noted – among the other things – that some
kinds of goods may be in greater demand at higher prices: some examples
are luxury items, such as luxury cars, jewellery, designer clothes, high-end
wines, etc. (Veblen, 1899). Here, the higher the price of a good the more
luxurious it is thought to be and lowering the price would not, in all
likelihood, lead to much increased demand.
Exercise 1
Figure 2 Apples
Consider the market for apples and consider the different quantities
demanded at different levels of price as shown in Table 1.
Table 1 Prices of apples and corresponding quantities demanded
Price of apples Total market demand

(pence per kg) (tonnes)
30 5000
50 4000
70 3000
90 2000
110 1000
Now draw the demand curve in a two-dimensional line chart putting the
different levels of price from 0 to 110 pence on the vertical axis (which is
also called the y axis in graphs like this) and the different quantities
demanded from 0 to 5000 tonnes on the horizontal axis (also called the x
axis).
48
Comment
Figure 3 below shows the demand curve you will have plotted using the
figures above. The five points highlighted in the line represent the matching
between the price and the quantities demanded at the five different levels
given. The curve also allows us to estimate intermediate points. For
example, at 100 pence per kg we would estimate to sell 1500 tonnes of
apples.
120
110
100
90
Price in pence per kg
80
70
60
50
40
30
20
10
0
0 1000 2000 3000 4000 5000 6000
Demand in tonnes
Figure 3 A demand curve for apples
1.2 The price elasticity of demand

As said before, in the vast majority of cases (excluding for example the
Veblen goods) there is a negative relationship between price and demand. In
other words, if a firm raises the prices of its products, it will expect a
decline in the level of sales. However, the extent of this change in demand
is not the same for all goods and services. If the price of an essential good
doubled, such as say winter fuel, people would probably try to be more
energy efficient but they would not stop buying fuel to heat their houses.
On the other hand, if the price of, say, cinema tickets suddenly doubled the
drop in demand could be much greater as – unlike fuel - cinema is not an
essential good. Therefore, firms want to know the extent to which demand
changes after a change in prices. Price elasticity of demand (PED) measures
the responsiveness of the quantity demanded to a change in the level of the
price, and it indicates how much the quantity demanded of a good varies
when the price increases or decreases by a certain percentage.
The PED is calculated as follows:
Percentage of change in the quantity demanded
PED =
Percentage of change in the price
49
Readings 37–45
Note that the value of PED will nearly always be negative, as price and
demand stand in an opposing relationship to each other, i.e. if the price goes
up, demand goes down and vice versa. Economists tend to ignore the
negative sign before the value of PED and tend to talk of a value of PED of
greater or smaller than 1. This reading follows that convention here and
refers to values of PED equal to, greater or smaller than 1. When the value
of PED is 1 this means that the quantity demanded changes exactly in the
same proportion as the change in price. Demand in this case is neither
elastic nor inelastic.
When the value of PED is more than 1, the demand is said to be price
elastic – this means that the change in the quantity demanded is
proportionally greater than the change in price; the higher the value of price
elasticity, the more elastic the demand is said to be. When the value of PED
is less than 1 we have inelastic demand – this means that the change in
quantity demanded is proportionally smaller than the change in price.
Exercise 2
This exercise is designed to help you understand elasticity of demand better

and to calculate PED for a specific case.
Look back at the estimated demand for a Certificate in Management at

different prices given in Figure 1 above. Assume that the price for attending
the Certificate of Management course has been established at £4,000.
(a) Calculate the price elasticity of demand (PED), working out whether
demand is elastic or inelastic if the price were raised to £5,000.
(b) Consider the main implications of this value of PED for the pricing of the
course.
Comment
Raising the price to £5,000 means there will be a demand of 100 students
for the management course. Given that at £4,000 the demand was of 200
students, the change in the quantity demanded is 100. The change in the
price is from £4,000 to £5,000, so it is equal to £1,000. Summing up, the
formula for calculating the PED at the value of £5,000 is the following:
(100 / 200) * 100 50%

PED (5000)= = = 2
(1000 / 4000) * 100 25%
As you can see the PED is elastic because it is higher than 1. You can try to
calculate the PED at different levels of the price with the same procedure.
Remember: demand is elastic if the value is higher than 1; demand is
inelastic if it is lower than 1. Knowing the value of PED can help you to make
better decisions in terms of pricing and this can have a great impact on your
profitability. As a matter of fact, if you consider the value of PED and the
trend of your costs per student, you will be able to determine the impact on
profits of increasing prices to £5,000. Depending on the cost of teaching
each student, our fictional university may decide that the financial gain of
increasing fees to £5,000 would not be sufficient to outweigh the numbers of
50
students lost. However, be aware that costs may not be proportional to

quantities. For example, for book publishers, a large proportion of the cost is
in the initial development of the book (e.g. fees to the author, editing and
proofreading, etc.). Therefore, the cost of raising a print run from 1,000 to
1,100 books will be less costly than producing the first 100 books.
You have now seen that knowledge of the price elasticity of demand for its
products is very important for every company in making decisions about
pricing. This is further illustrated in the example below.
Example of price increases: Royal Mail stamps
Figure 4 Royal Mail stamps
Britons shun Christmas cards after stamp price rise

Millions fewer Christmas cards will be sent this year as consumers react
against Royal Mail’s steep increase in the price of stamps.Half of Britons
over the age of 50 plan to cut the number of cards they send because of the
cost of stamps, according to a poll of 10,000 people for this newspaper [The
Telegraph] by Saga.
The average number of cards sent per person will fall by a quarter from 38
last year to 28 this year.
Ros Altmann, Saga’s director general, said that December will be less festive
than usual as people take a red pen to their annual Christmas card list.
‘This is a reduction in Christmas cheer. We mustn’t forget how important a

lifeline the postal system is for people,’ said Ms Altmann.
She said that rising stamp prices will particularly affect the elderly, who are
less prone to communicate with friends and family via email.
‘It is easy to take instant communications for granted but many older people
are reliant upon the postal system – particularly at Christmas – and value it
highly,’ said Ms Altmann.
In April, Royal Mail increased the price of a first class stamp from 46 pence
to 60 pence while second class stamps rose from 36 pence to 50 pence.
Ian Murray, the shadow postal affairs minister, said that the expected fall in
card numbers is ‘significant’ given that people over 50 are more likely to use
traditional mail than younger age groups.
51
Readings 37–45
‘It is an obvious consequence of Royal Mail increasing its prices

disproportionately. They are walking a fine line between pricing people out of
the market and increasing their revenues,’ said Mr Murray.
According to Saga’s research, which was carried out by Populus, 51 per cent
of people over the age of 50 will send fewer Christmas cards than last year
because of the higher cost of stamps.
While 20 per cent of people over 50 said they will send ‘far fewer’ cards, a
further 31 per cent said they will send ‘slightly fewer’ cards. Three in five
people over the age of 75 will send fewer cards.
On average, all the people surveyed said they plan send 10 fewer cards
each this year compared to last year, the research found. Given that there
are 21 million people over the age of 50 in the UK, the total number of cards
sent this Christmas could slump by 210 million.
Royal Mail has sought to minimise the impact of the stamp price rise by
allowing people who get Pension Credit, Employment and Support Allowance
or Incapacity Benefit to buy 36 first or second class stamps at last year’s
prices.
The group has sent leaflets to homes in the UK detailing the scheme. To use
the scheme, people need to provide a letter from the Department for Work
and Pensions – or the Social Security Agency in Northern Ireland – when
they buy the stamps.
However Saga’s Ms Altmann said that millions of people who are not eligible
for the discount will still be affected.
‘Policy makers must not forget how dependent ordinary people are on the
postal system. For many, their lives are enriched by both sending and
receiving cards.’
‘Many people will be upset they cannot send as many cards as they have
done in previous years. This is an essential means of communication and at
this time of the year particularly, posting cards is a crucial part of spreading
festive greetings,’ she said.
Saga's research found that nine out of ten people have friends on their
Christmas card lists who they only correspond with once a year with annual
cards. This rises to 93 per cent of people aged between 70 and 74.
A Royal Mail spokesman said that Saga’s findings ‘run counter’ to similar
research that the postal group carried out.
The spokesman said: ‘We have done some detailed consumer research that
showed that people are still intending to send as many or more Christmas
cards than last year.’
He said that the group asked people how they felt about Christmas cards
compared to e-cards. While significant numbers of people said they find
electronic communication convenient, they still prefer physical cards, he said.
(Hall, 2012)
52
1.3 Other determinants of demand

As we have seen, the demand curve highlights the relationship between the
quantity demanded and the price, but quantity demanded can depend on
many other factors beyond the level of prices. Indeed, the demand curve is
associated with a particular time; at a different time the demand curve can
be different. For example, if Chelsea football team were to reach the final
match of the Champions League, it is likely that its supporters would be
willing to buy the tickets even if the prices are going up. This happens
because many other factors, such as tastes and preferences, impact on the
quantity demanded of goods and/or services, and tastes and preferences can
be influenced by several elements, like fashion, advertisement, culture, etc.
The quantity demanded is also influenced by other variables such as
income, the availability and price of substitute and complementary goods
and/or services, and the expectations of future price changes. Considering
the first variable mentioned (income): a wealthy person will normally pay
less attention to price and more attention to other factors in their buying
decisions, such as the quality, style, durability, fashionability, etc. of the
goods and services that they are buying (e.g. Fisher, 1987).
The quantity demanded is also determined by what happens in the markets
for substitute and complementary goods. Complementary goods are goods
that can (or even need to) be used simultaneously to meet a need, for
example petrol and automobiles or stamps and postcards. Two goods can be
defined as complementary if an increase in the price of one leads to a
decrease in the quantity demanded of the other. Considering the example
above, the increase in the price of stamps wasn’t only assumed to lead to a
decrease in the demand for stamps but also for greeting cards. Conversely,
two goods or services can be considered substitutes for each other if an
increase in the price for one leads to greater demand for the other. For
example, if the price of petrol and diesel goes up too much, people may
reduce the use of automobiles and use trains instead. In this example, trains
are a substitute for automobiles.
Figure 5 Fuel pumps
53
Readings 37–45
Finally, it is not only actual price changes but also expectations about price
trends that can influence the quantity demanded. For example, people may
buy flight tickets in advance with the expectation that prices will rise nearer
to their intended time of travel. Or they may postpone the purchase of the
latest computer game because they expect that the price will go down in the
near future.
So far, this section has looked at changes in the quantity demanded. This
refers to the quantity demanded by those people who are already in the
market for a particular good or service, for example all people who are
current customers of, say, petrol. As discussed above, the market for petrol
may exhibit greater or lesser elasticity of quantity demanded, depending on
how much individuals reduce or increase their consumption of petrol if the
price rises or falls. It is, however, also possible that the entire market for a
good or service becomes greater or smaller, i.e. there is a greater or smaller
overall number of people demanding the particular good. This is called a
‘change in demand’. It can be due to many different factors, such as new
uses that are being found for a product, new competitors entering the
market, substitute products being developed, etc. So, to stick with the
example of automobiles and petrol, if substitute technologies for the petrol
engine were developed that were widely available, cheaper and less
environmentally polluting than current automobile engines, most new cars
may be equipped with the new technology instead of traditional petrol
engines. This would reduce the total market for petrol, constituting a change
in demand. To use a well-known, real life example, when personal
computers (PCs) became widely available in the second half of the 20th
century, demand for mechanical typewriters disappeared almost completely.
On the other hand, total demand for a good or service can also increase.
This may be due to technological change, wide availability and falling
prices of goods, or the discovery of new uses for an existing product. When
mobile phones became ever smaller and cheaper around the beginning of
the 21st century, overall demand for them increased enormously. Or, to stick
with the example of management courses, if in a given year there was a
higher investment by all UK business schools into advertising campaigns to
promote management courses, it would probably result in a larger market
demand for this kind of course.
These kinds of changes in overall demand can be represented by a leftward
(for falling demand) or rightward (for increasing demand) shift in the
demand curve. Thus, if the hypothetical advertising campaign by all UK
business schools was successful in increasing overall demand for
management courses, the demand curve for management courses would shift
to the right. This means that, at a given price, more people would demand
these courses than before. In Figure 6 below, this is shown by the rightward
shift of the demand curve from D to D1, where D1 represents the demand
curve after the overall increase in demand following the advertising
campaign.
54
Price
D D1
Quantity demanded
Figure 6 Rightward shift in demand curve, representing an overall increase in

demand
If, on the other hand, there was a press campaign highlighting that
leadership courses generate greater increases in the salaries of people
attending them than management courses, this would probably result in
more people preferring to attend a leadership course rather than a
management course. The demand curve for management courses would then
shift to the left, meaning that at a given price fewer people would demand
these courses. In Figure 7 this is represented by the shift of the demand
curve from D1 to D2.
Price
D1
D2
Quantity demanded
Figure 7 Leftward shift in demand curve, representing an overall fall in demand
2 Understanding supply
While the demand curve looks at how much of a product consumers are
willing to buy at a given price, the supply curve models how much of a
product producers are willing to supply at a given price. Producers combine
various factors of production – land, labour and capital – to make products
or services that they wish to sell. Producers are incurring costs when
producing goods and services. They will want to reflect these costs in the
price they receive for the good or service and they will want to make a
certain amount of profit. The price they receive therefore can be split up
into four elements called factor incomes: wages, rent, interest and profit. If
you pay 35p for a chocolate bar, that 35p represents a contribution to all
55
Readings 37–45
these elements. For example, 10p may be the cost of the ingredients; 5p the
administration and promotion costs; 7p the cost of the labour that goes into
making it and in running the company; 9p may be the contribution to the
cost of all the machinery and buildings used by the company, leaving 4p as
the element of profit. If the price per unit sold goes up but the costs of
production remain more or less the same, profits increase. Therefore
producers will normally want to offer more items for sale at higher prices
than at lower prices (Biz/ed, n.d.).
Whereas the relationship between demand and price is normally negative
the relationship between supply and price is normally positive. In the vast
majority of cases, the higher the price of goods and/or services, the more
profitable it becomes to produce them, so existing suppliers will produce
more of it and new suppliers may enter the market, and thus supply will
increase.
As with the demand curve, it is also possible to represent the relationship
between supply and price by using a curve: the supply curve. Figure 8
shows a hypothetical supply curve for apples. Prices in pence are plotted on
the vertical axis and the quantity supplied on the horizontal axis.
120
110
100
90
80
70
60
50
40
30
20
10
0
0 1000 2000 3000 4000 5000 6000
Supply in tonnes
Figure 8 A supply curve for apples
The line plotted in Figure 8 shows five particular points where price meets
quantity supplied (although we can, of course, read many more off the
graph). These five points are summarised in Table 2 together with those
where price meets quantity demanded.
Table 2 Price of apples and the total supply and demand in the market of
apples
Price of apples Total market supply Total market demand

(pence per kg) (tonnes) (tonnes)
30 1000 5000
50 2000 4000
70 3000 3000
90 4000 2000
110 5000 1000
56
However, the shape of the supply curve will also vary, resulting in different
price elasticity of supply. This will be influenced by the ease with which
suppliers can react to changing circumstances and increase or decrease the
amount they can offer for sale. For example, each year at the Wimbledon
Tennis Championships, there is a limited amount of tickets available for the
Centre Court. The All England Club (which administers the Championships)
cannot easily increase the number of seats available. Over the longer term
they may be able to build new stands and so on, but in the short term they
cannot really increase supply of Centre Court seats at all. With other types
of products supply can be increased more easily. For example, during a hot
summer ice cream manufacturers may increase output in order to satisfy the
increased demand. This would be relatively easy to do (at least significantly
easier than increasing the seating capacity of Wimbledon’s Centre Court) if
they employ workers on overtime, increase production through using
existing machinery or adopting shift patterns of working (Biz/ed, n.d.).
Figure 9 Wimbledon’s Centre Court
Nevertheless, as we saw for demand, the quantities supplied and the size of
supply may depend on the impact of several other factors (Sloman, 2008,
p. 42):
. Technology, taxation, or changing input prices can impact significantly

on the costs of production. As a matter of fact, the development of new
technology or the reduction of input prices (e.g. for raw materials,
energy, etc.) often allow a firm to produce more quantity with the same
money invested.
. The profitability of alternative products can also influence supply. For
example, a farmer may consider growing more wheat and less cabbage if
the price of the first goes up more significantly than the latter.
. The profitability of goods in joint supply refers to the situation when the
production of one good also results in the production of another. For
example, the demand for petrol leads to more refining of crude oil which
therefore leads to the increased production of other oil products.
. External events, such as new legislation also influence supply. For
example, if there was a new law that makes the wearing of ski helmets
compulsory one would expect to see an increase in the supply (as well
as demand) of such helmets.
57
Readings 37–45
. And, just as with demand, expectations of future price changes can also
influence supply. This actually happens on a regular basis in order to
cope with anticipated seasonal demand for certain goods. For example,
clothes retailers bring in stocks of winter clothes before the winter
actually starts, in order to cope with the anticipated demand.
Increases in the size of supply are represented by a rightward shift of the
supply curve whereas decreases result in a leftward shift. One example is
the increased supply of low-cost flights, which is discussed in the example
below. While the price level influences the quantity supplied the opposite is
also true: the level of supply influences prices. So, an increase in supply
without growing demand may lead to lower prices. This will be discussed in
more detail in the next section of this reading. After reading the example
below you may come to the conclusion that the segment of transatlantic
low-cost flights will experience increased competition and reduced prices in
the near future.
Figure 10 WOW air
Example of increased supply: Low-cost airlines and transatlantic

flights
Low-cost airline to start flights from London Gatwick to Washington
DC and Boston, with fares from £99 promised
It may be the cheapest transatlantic flight ever – £99 one way to Boston and
Washington DC from London.
WOW air (www.wowair.co.uk), a budget Icelandic airline, is making an

introductory fare available to those booking a selected number of sale-price
seats online from today.
The carrier is launching new flights from London Gatwick to Boston Logan
International Airport on March 27 and to Baltimore Washington International
on June 4. They all fly via Reykjavik, the tiny Icelandic capital.
[…]
The availability of the £99 seat price, which includes taxes, will be based on
demand, a WOW air spokesman said, advising those wishing to take
advantage of the deal to book sooner rather than later. […]
The flights from Reykjavik to the USA will be operated using Airbus A321
Extended Range aircraft. WOW air’s existing Airbus A320 family aircraft will
58
carry passengers from London Gatwick to Reykjavik on the first leg of the
journey. The London to Boston flight will operate five days a week, the
Washington flight four.
‘This is just the beginning of our plans to transform low-cost transatlantic

flights,’ said Skúli Mogensen, CEO of WOW air. ‘We’re opening up the
market to a whole new market of travellers who might previously not have
been able to afford transatlantic travel.
The low-cost airline market is “scrambling to offer cheap flights to North

America”, Mogensen added.
WOW air’s transatlantic foray comes less than four months after another low-
cost airline, Norwegian, launched services from Gatwick to three US cities –
New York, Los Angeles and Fort Lauderdale – using Boeing 787
Dreamliners.
Fares for those routes start from £149 per person, but are typically more
expensive. The cheapest November flight to New York with Norwegian is
£209 one-way, for example, while the cheapest flight in January 2015 is
£179.
Telegraph Travel’s Soo Kim was among those on board the inaugural service
in July, and found that Norwegian’s on board ‘extras’ also raise the cost of
flying considerably, with a small, 330 ml bottle of water priced at US$4
(£2.50), sandwiches from US$11 (£6.85), headsets for in-flight entertainment
costing US$5 (£3.10) and blankets US$4.
Ryanair has previously suggested it hopes to launch low-cost flights to the

USA with selected fares starting at an ambitious £10. It does not currently
possess the medium- or long-range aircraft to offer the routes, however.
Other low-cost airlines to have made a decent fist at long-haul services

include Air Asia X, the Malaysia-based long-haul arm of Air Asia, and Jetstar,
which flies from Australia to destinations such as Japan and Hawaii.
Some attempts were less successful, however. Laker Airlines tried and failed
with a no-frills transatlantic model, as did Zoom Airlines, while Oasis Hong
Kong went bankrupt in 2008, three years after launching flights from the
Chinese city to Gatwick and Vancouver.
(Paris, 2014)
3 The equilibrium price

You have now learned a little about the basic properties of supply and
demand curves. The really interesting aspect of supply and demand,
however, is how they interact to produce prices.
The equilibrium of supply and demand is where the supply and the demand
curves cross. This point marks the equilibrium price and the equilibrium
quantity; this is known as the market equilibrium. This is the point where
supply in the market is equal to demand in the market. The equilibrium
price then is the price at which supply and demand in that market are equal.
59
Readings 37–45
Going back to our fictitious market for apples, Figure 11 shows both the
supply and the demand curve and where they intersect. The intersection lies
at 70p, which is therefore the equilibrium price. In this example, the
quantity of apples that people want to buy at this price is equal to the
quantity of apples that other people want to sell at this price. Therefore
there is neither unmet demand driving up prices, nor surplus supply leading
to a reduction in prices. Therefore, all other conditions being equal, prices
and quantities demanded and supplied will stay stable at this level.
120
110
Supply
100
90
80
70
60
50
40
30
Demand
20
10
0
0 1000 2000 3000 4000 5000 6000
Demand in tonnes
Figure 11 An equilibrium price for apples
The market equilibrium is considered stable because, even if the market

supply and demand are situated at a different point from the equilibrium
point, adjustments will take place in the market to finally end up at the
equilibrium point. For example, consider the case represented below in
Figure 12, where there is an excess of supply in the market of apples
because producers have (for some reason) been expecting to sell at a high
price P2. The quantity supplied in expectation of price P2 is shown as QS.
However, at P2 the demand for apples is actually quite low, shown as Qd.
So therefore, at P2, there is a surplus in the market of apples as represented
by the difference between Qs and Qd.
Excess supply
P2 Supply
P*
Demand
Q
Quantity Q* Quantity
demanded Qd supplied Qs
Figure 12 Excess supply
60
If apple producers see the huge amount of apples unsold, they certainly will
not want to waste them; so they will start to lower the price until supply no
longer exceeds demand. This situation is represented by the point where P*
and Q* meet. This is the new market price for that quantity of apples being
produced. However, apple producers may decide that it is no longer worth
their while to produce so many apples at this lower price. Therefore, some
of them may decide to harvest fewer apples next year. If supply exceeds
demand in the longer term, some producers may stop producing altogether.
This would lead to a reduction in supply, which would then push the price
up again.
Similarly, in the case of excess demand – that is more apples are demanded
at 70p per kilo than are being offered at that price (look at Figure 13 and
more specifically at point Qd), consumers start bidding the price (P1) up in
order to obtain apples. In this latter case, we are in a situation of a shortage
of apples in the market. This will create an adjustment where the price will
increase to the level P* in order to reach the market equilibrium, that again
is where P* and Q* meet. These increased prices may make apple
production more attractive and producers may decide to produce more
apples in future, or new producers may enter the market. This would have
the effect of increasing supply and the price of apples would fall again. In
other words, market forces tend to push the market price toward the
equilibrium price (P*).
Supply
P*
P1 Demand
Q
Quantity Q* Quantity
supplied Qs demanded Qd
Excess demand
Figure 13 Excess demand
Of course, as said before, all this will only hold true under the particular
circumstances of perfect competition (discussed in more detail later in these
readings) and all other things being equal. In the case of apples it is easy to
see that supply, in particular, may be influenced by factors other than the
level of demand and price. For example, if there is a bad harvest due to
frost in late spring then there may be a shortage of apples despite high
demand and the producers’ desire to produce more apples. Also, the market
adjustments towards the equilibrium price may take some time. In the case
of excess demand and insufficient supply, producers may respond by
planting more apple trees to increase supply. However, apple trees take a
few years to mature sufficiently to start producing apples and therefore the
increased supply would come with a few years’ delay.
61
Readings 37–45
Summary
Economic activity takes place in markets where individuals and
organisations trade goods and services with each other. This reading has
introduced the supply and demand model: understanding how supply and
demand works and the formation of the price equilibrium is probably one of
the most important things to know if you want to succeed in business.
More specifically, you have learned that demand decreases if prices go up
whereas the supply increases; and that changes in prices can impact in
different ways on the quantity demanded depending on the elasticity of
demand. You have also learned about the main factors that impact on supply
and demand and the distinction between changes in the quantities supplied
or demanded and changes in the overall supply or demand.
Finally, the reading has covered how markets adjust to deal with situations
of shortage and/or of surplus moving to a point of price equilibrium.
However, you will now realise there are also many other factors beyond
those highlighted above that can impact on the quantity supplied/demanded
and that can influence the position of the supply and demand curve. In
particular, different economic policies promoted by governments can impact
on the level of supply and demand.
62
References
Antonioni, P. and Flynn, S.M. (2011) Economics for Dummies, 2nd edition,
John Wiley & Sons: Chichester.
Biz/ed (n.d.) ‘Interactive supply and demand 2’, [online]. Available at http://
www.bized.co.uk/learn/economics/markets/mechanism/interactive/part2.htm
(Accessed 8 February 2015).
Colander, D.C. (2006), Microeconomics, 6th edition, McGraw-Hill/Irwin:
New York.
Fisher, J.E. (1987) ‘Social class and consumer behavior: the relevance of
class and status‘, in Wallendorf, M. and Anderson, P. (eds.), Advances in
Consumer Research, Volume 14, Provo, UT: Association for Consumer
Research, pp. 492–496.
Hall, J. (2012) ‘Britons shun Christmas cards after stamp price rise’, The
Daily Telegraph, 23 November 2012, [online]. Available at http://www.
telegraph.co.uk/finance/newsbysector/retailandconsumer/9697062/Britons-
shun-Christmas-cards-after-stamp-price-rise.html (Accessed 2
October 2014).
Katz, M.L. and Rosen, H.S. (1998), Microeconomics, 3rd edition, McGraw-
Hill/Irwin: New York.
Paris, N. (2014) ‘Iceland's WOW air launches £99 flights from London to
the US’, The Daily Telegraph, 23 October 2014, [online]. Available at
http://www.telegraph.co.uk/travel/travelnews/11180582/Icelands-WOW-air-
launches-99-flights-to-the-US.html (Accessed 23 October 2014).
Pearson: Edinburgh.
Veblen, T.B. (1899) The Theory of the Leisure Class. An Economic Study of
Institutions. Macmillan: London.
Xu, D. (2014) ‘Boyfriend for hire? 10 strange things on Taobao‘, BBC
News: Asia, 22 April 2014, [online]. Available at http://www.bbc.co.uk/
news/world-asia-26185600 (Accessed 2 October 2014).
63
Readings 37–45
Reading 41: Fiscal and monetary

policies
Introduction
This reading will examine two specific economic policies that can influence
the economic context: fiscal and monetary policy. These are two
fundamental tools that governments and monetary authorities (such as
central banks) use to influence aggregate supply and demand. The aggregate
demand (AD) is the total demand for all the goods and/or services in a
given economic context at a given time. Symmetrically, the aggregate
supply is the total supply of goods and services in a given economic context
at a given time (e.g. O’Sullivan and Sheffrin, 2007).
Fiscal policy deals with government decisions about the level of taxation (a
withdrawal from the circular flow of income) and public spending (an
injection into the circular flow of income). Monetary policy deals with
increasing or decreasing the supply of money and with the setting of
interest rates for obtaining money. Both fiscal and monetary policies are
tools with which governments and monetary authorities aim to influence
business cycles. Fiscal and monetary policies also impact on individual
businesses in several ways, for example:
. if interest rates go down, borrowing will become less expensive for

businesses
. if there is an increase in public spending, there will be more money in
circulation, positively affecting consumption and commercial purchasing.
This reading will introduce different fiscal and monetary policies, how they
can be implemented, and how this impacts on the economy.
1 Fiscal policy
Fiscal policy is concerned with the setting and management of public
expenditure and taxation. These are important tools in managing the
economy, aimed at limiting the extremes of economic growth and decline.
For example, during periods of recession, governments may increase
aggregate demand by lowering the level of taxes or by buying more goods
and services directly.
How does this happen? In the first case, having to pay less taxes, consumers
have more money to spend on buying goods and services; in the second
case, higher government expenditure increases demand for goods and
services bought by government. Increasing demand is likely to increase the
revenues and profits of producers, who then have more money to spend on
things such as employing more people, buying new machinery and doing
research and development (R&D). Both cases are examples of an ‘expansive
fiscal policy’. However, there is also ‘restrictive fiscal policy’. During
periods of economic boom, governments may want to reduce government
64
Reading 41: Fiscal and monetary policies
expenditures or raise taxes. The aims of a ‘restrictive fiscal policy’ can be,
for example, to reduce the amount of money in circulation in order to
contain inflation or to reduce the amount of public debt.
Of course, forecasting the effects of different fiscal (and monetary) policies
on the main economic indicators is a very difficult task, and policies may
also have negative or unintended consequences. In other words, there is no
single correct fiscal policy; this depends on different circumstances, not
only economic ones, but also social, historical and cultural. This is why it is
sometimes said that economic choices are political in themselves because
they are implicitly built on the preference for some objectives rather than
others. This reading introduces the types of fiscal policies governments
might pursue and their possible effects.
The expected benefits of an expansive fiscal policy through increased
government spending are often explained in terms of the multiplier effect.
The idea here is that any new injection of money into the circular flow of
income will generate a new demand for goods and services, which will lead
to more spending and in turn to more income, and so on. Therefore, the
multiplier effect refers to a situation where the increase in overall income
deriving from any new injection of spending is larger than the initial
spending. The size of the multiplier effect depends upon individuals and
organisations’ attitude to spending or saving the new money. For example,
consider a new worker hired after an increase in production by a firm that
has benefited from new orders by the government: if that worker spends all
the salary obtained, the multiplier effect will be higher than if that worker
saves half of his/her salary. The example below looks at the multiplier
effect of the London 2012 Olympic and Paralympic Games.
Example of the multiplier effect: the legacy from the London

2012 Olympic and Paralympic Games
Figure 1 The London Olympic stadium
The cost of hosting the London 2012 Olympic and Paralympic Games has
been justified as a good investment due to the multiplier effect that was
expected to lead to significant economic benefits as a legacy of the games.
The games required a high level of investment by the UK government, but
they resulted in several positive economic knock-on effects, according to a
joint UK government and Mayor of London report. The report states that £9.9
65
Readings 37–45
billion in international trade and inward investment has been won because of
the games and games-time promotional activity, and 70,000 jobs for
unemployed Londoners have been created. International visitors increased in
2012 and as a consequence tourist spending for that year increased
significantly from previous years. The games also allowed many UK
companies to gain relevant expertise in the organisation of big sport events:
this has resulted in £120 million of contracts already won by UK companies
from the Brazil 2014 World Cup and Rio 2016 Olympic and Paralympic
Games. The London 2012 Olympic and Paralympic Games contributed also
to the regeneration of East London: 11,000 homes are planned and more
than 10,000 jobs will be created on the Park conversion of the Athletes’
Village into homes.
(UK Government and Mayor of London, 2013)
The idea of expansive fiscal policies to stimulate the economy is generally

linked with the name of British economist John Maynard Keynes (Figure 2).
Keynes is considered the father of macroeconomics and one of the great
economists of the 20th century. One of his most important works is his
‘General Theory of Employment, Interest and Money’ (Keynes, 1936). News
and economic discussions often talk of a Keynesian approach to fiscal
policy to describe an expansive fiscal policy. The Keynesian approach
emphasises the importance of public spending in stimulating aggregate
demand (especially during periods of economic recession). This is in
contrast with neoclassical economic theory that puts more confidence in the
ability of the market to ‘self-correct’ and balance the right level of
aggregate supply and demand.
Figure 2 John Maynard Keynes
While expansive fiscal policy is generally concerned with stimulating

demand, restrictive fiscal policy is most commonly concerned with reducing
public debt. Public debt can be defined as the sum of the
total borrowings of a central government comprising of internal debt (owing
to national creditors) and external debt (owing to foreign creditors) incurred
in financing its expenditure (The Business Dictionary, n.d.). A country with
a public debt has to pay interest on this debt. Moreover, the country is
66
dependent on those lending the money. As a result, restrictive fiscal policies

might aim to reduce the amount of public debt by increasing taxes or by
reducing government expenditure in order to pay less interest and to ensure
more fiscal stability.
However, restrictive fiscal policies can negatively affect consumers and
businesses either due to the increased tax burden or because of reduced
benefits and reduced public sector purchasing resulting from reduced public
spending (Figure 3). Many businesses have the public sector as one of their
main clients and these businesses will be particularly hurt by a reduction of
public expenditures. This can include businesses and non-profit
organisations operating in sectors like social services, health or
infrastructure, where the public sector is usually an important and
sometimes even the only customer.
Figure 3 Protesting health service cuts in Spain
Fiscal policies depend on many complex and interrelated factors, such as

political ideology, social conditions or the global or regional (e.g. European)
economic situation. Three main factors need to be borne in mind:
. the trend of the business cycle

. the level of taxation
. the level of public debt.
The trend of the business cycle, i.e. whether an economy is growing or in
recession plays an important part in deciding which fiscal policies to pursue.
In a period of slow economic growth or recession, governments may wish
to pursue expansive fiscal policies in order to stimulate growth. Whether
they do this through increased public expenditure or reduced levels of
taxation will depend on the existing levels of public debt and the current
level of taxation and tax revenue. A country with an existing high public
debt is usually not in a position to increase government expenditure and a
country with an already low tax revenue will have difficulties in further
reducing the level of taxation. Therefore, if the government of a country
with high public debt but also reasonably high tax income wanted to
implement an expansive fiscal policy, it would probably do this by reducing
taxes and not by increasing public spending through further public debt.
67
Readings 37–45
Table 1 shows the amount of public debt as a percentage of GDP in several

countries of the European Union, whereas Table 2 shows a comparison of
tax revenue as a percentage of GDP in the same countries.
Table 1 Total central government debt as a percentage of GDP
Country/Year 2000 2005 2010

Austria 61.2 62.1 65.8
Belgium 99.5 91.8 96.8
Denmark 54.8 39.3 39.6
Finland 48.0 38.2 41.7
France 47.4 53.3 67.4
Germany 38.4 40.8 44.4
Greece 108.9 110.6 147.8
Ireland 34.8 23.5 60.7
Italy 103.6 97.7 109.0
Luxembourg 3.2 0.8 12.6
Netherlands 44.1 43.0 51.8
Portugal 52.1 66.2 88.0
Spain 49.9 36.4 51.7
Sweden 56.9 46.2 33.8
United Kingdom 42.2 43.5 85.5
Table 2 Tax revenue as percentage of GDP
Country/Year 1971 1981 1991 2001 2011

Austria 34.6 40.1 40.2 44.9 42.3
Belgium 35.0 41.5 42.1 44.6 44.1
Denmark 41.4 42.8 45.9 48.5 47.7
Finland 33.2 37.8 45.4 44.8 43.7
France 33.6 40.3 42.3 44.1 44.1
Germany 32.0 35.9 36.0 36.3 36.9
Greece 20.0 21.9 26.5 33.2 32.2
Ireland 29.1 31.7 33.3 28.8 27.9
Italy 26.3 30.9 38.1 41.7 43.0
Luxembourg 25.7 36.6 33.4 39.8 37.0
Netherlands 37.1 42.0 45.1 38.1 38.6
Portugal 17.6 23.5 27.9 30.7 33.0
Spain 16.2 23.8 32.8 33.9 32.2
Sweden 38.6 47.7 49.8 49.4 44.2
United Kingdom 34.8 36.2 34.0 36.2 35.7
(Source: OECD.Stat, data extracted on 6 August 2014)
68
Exercise 1
Look at the data in Tables 1 and 2 above, and then answer these questions:
1 Which countries had the highest central government debt as a

percentage of GDP in 2010? How had this changed over the ten-year
period shown in Table 1?
2 Which countries have seen the highest and lowest increase in tax
revenue over the period shown in Table 2?
3 Which counties do you think might be least likely to pursue an expansive
fiscal policy through increased government spending? Which ones might
be most likely to do so?
Comment
1 In 2010, the highest central government debt as a percentage of GDP
was that of Greece (147.8%, up 36% from an already high 108.9 %
in 2000), followed by Italy (109.0%, up by 5% since 2000). You may also
have noticed that in every country, with the exception of Belgium and the
Nordic countries of Sweden, Finland and Denmark, central government
debt rose between 2000 and 2010. However, in many of these countries,
government debt as a percentage of GDP fell between 2000 and 2005,
rising again between 2005 and 2010.
2 All the countries in Table 2, except Ireland, saw an increase in tax
revenue as a percentage of GDP in the period from 1971 to 2011. Some
of the greatest increases were seen in Greece (a 61% increase from
20.0 in 1971 to 32.2 in 2011) and Italy (63% increase from 26.3 in 1971
to 43.0 in 2011), whereas the tax income as a percentage of GDP hardly
increased over the same 40-year period in the United Kingdom or the
Netherlands. However, even in countries where tax revenue has risen
sharply over a 40-year period they did not continue to do so in the past
decade shown in Table 2. In fact, tax revenue as a percentage of GDP
fell in Greece between 2001 and 2011 and only rose very moderately in
Italy.
3 Given the data in Tables 1 and 2 you might expect that a country like
Greece would be least able to increase government spending in order to
pursue an expansive fiscal policy. It has very high debt levels and its tax
revenue as a percentage of GDP has hardly risen at all between
2001 and 2011, roughly the same period of time during which its central
government debt as a percentage of GDP rose by 36%. For example, a
country like Denmark might be better able to increase government
spending if it wanted to, as its central government debt as a percentage
of GDP stood at 39.6 % in 2010 (down from 54.8% in 2000 and roughly
the same as in 2005) whereas its tax revenue as a percentage of GDP is
one of the highest among the countries listed here at 47.7 %.
69
Readings 37–45
Fiscal policies have an important impact on business. For example, in the

global economy businesses increasingly consider the level of taxation when
making decisions about where to locate headquarters, new branches and
their tax domicile. The following example is about Fiat–Chrysler’s decision
to establish its tax domicile in the UK, shifting away from Italy, the
traditional home base of Fiat.
Example of fiscal strategy: Fiat-Chrysler
Figure 4 Fiat–Chrysler
Fiat–Chrysler creates Dutch holding, sets tax domicile in UK

Fiat said it would register the holding of its newly created Fiat Chrysler
Automobiles NV group in the Netherlands and set its tax domicile in Britain,
cementing a politically sensitive shift away from its home base in Italy.
The decision, announced today, comes after Fiat took full control last week
of Chrysler, creating the world's seventh largest carmaker.
Fiat said the combined group would have a primary stock market listing on
the more liquid New York Stock Exchange and a secondary one in Milan.
The U.K. tax base mirrors a structure that Fiat-Chrysler CEO Sergio
Marchionne created for CNH Industrial NV, Fiat's truck and tractor affiliate,
which is also based in the Netherlands.
“The choice of the Netherlands and the U.K. could allow the group to have
better taxation both on dividends and capital gains,” said Monica Bosio, an
analyst at Intesa Sanpaolo in Milan.
Marchionne said he would like to complete the listing of the newly merged
Fiat Chrysler Automobiles in the United States as of Oct. 1, but
acknowledged it may be tough to do so.
70
“It's a relatively large undertaking,” Marchionne said today in a conference

call with analysts.
“Today we can say that we have succeeded in creating solid foundations for
a global automaker,” Marchionne said in a statement. “An international
governance structure and listings will complete this vision.”
Fiat said the creation of the new group would have no impact on headcounts
in Italy or elsewhere.
Italian Prime Minister Enrico Letta dismissed concerns about Fiat's decision
to base Fiat-Chrysler group in the Netherlands.
He said the headquarters issue was less important than jobs and investment.
“The question of the legal headquarters is absolutely secondary. What counts
are jobs and the number of cars sold,” Letta told reporters today.
(Reprinted with permission, Automotive News [January 29, 2014]. © Crain
Communications, Inc.)
2 Monetary policy
As you have seen, aggregate supply and demand can be influenced by fiscal
policy. However, this is not the only economic policy that can be used to
influence the economy. Monetary policy deals with the supply of money and
it is primarily based on the setting of interest rates. It is not usually pursued
by governments directly, but by central banks, although this is not always
the case; for example, the Bank of England was not independent in respect
to monetary policy until the late 1990s.
Figure 5 European Central Bank headquarters in Frankfurt, Germany
A central bank can be thought of as a bank of central government. It is the

monetary authority responsible for overseeing the monetary system for a
nation (or group of nations). A very well-known example of a central bank
is the European Central Bank (Figure 5) (which is, of course, an example of
a central bank that is not actually a bank of central government).
71
Readings 37–45
Example of a central bank: The European Central Bank

Since 1 January 1999 the European Central Bank (ECB) has been
responsible for conducting monetary policy for the ‘Eurozone’. The ECB is
the central bank for Europe's single currency, the euro. The ECB’s main task
is to maintain the euro’s purchasing power and thus price stability in the euro
area through the making and implementation of monetary policy for the euro
area.
Beyond monetary policy, the ECB pursues additional tasks, for example
authorising the issuance of banknotes within the euro area, collecting
statistical information necessary in order to fulfil its tasks, supervising the
conduct of credit institutions in order to ensure the stability of the financial
system, etc. The ECB was established as the core of the Eurosystem and
the European System of Central Banks (ESCB). The ESCB comprises the
ECB and the national central banks (NCBs) of all EU Member States
whether they have adopted the euro or not.
(European Central Bank, n.d.)
A central bank is different from other banks because it has the unique
power of issuing banknotes and coins of a given currency. (You may have
heard about the popular concept of ‘printing money’ as a key role of central
banks.) The Swedish Riksbank (founded 1656) and the Bank of England
(founded 1694) were the first central banks to be established in Europe. A
central bank controls the overall amount of money available in the economy
and it has a wide range of responsibilities, such as regulating and
overseeing the banking system, implementing monetary policy, overseeing
currency stability, and promoting low inflation and full employment. Most
central banks are owned by their respective governments (e.g. Blanchard
and Johnson, 2012; Burda and Wyplosz, 1993).
Similarly to fiscal policy, there can also be an expansive or a restrictive
monetary policy. An ‘expansive monetary policy’ aims to increase the
amount of money supplied by reducing interest rates. Expansive monetary
policy is usually implemented during periods of economic recession. A
central bank sets an interest rate at which it lends to other financial
institutions. This interest rate is normally called the ‘base rate’ and it affects
the whole range of interest rates set by commercial banks and other
financial institutions for their own savers and borrowers (Bank of England,
n.d.). In the case of a reduction in interest rates, it should make saving less
attractive and borrowing more attractive for businesses and consumers,
which should stimulate spending and increase demand. A reduction in
interest rates also reduces the cost of loans to business and can therefore
stimulate firms to increase borrowing and make investments in order to
increase production and meet increased consumer demand.
Monetary policy is primarily based on influencing the demand and supply of
money by setting interest rates; however, central banks may also use other
policy tools. Quantitative easing is an example of such a policy tool. It
involves the printing of new money issued by the central bank for the
purchase of government bonds (a bond issued by a national government,
generally with a promise to pay periodic interest payments and to repay the
72
face value on the maturity date). This is a way of injecting new money
(liquidity) into the economic system with the aim of increasing the
circulation of money and lowering the cost of borrowing. Quantitative
easing was used by both the US and UK central banks to stimulate the
economy after the global financial crisis of 2008. Quantitative easing is
quite a complex subject and you don’t need to get to grips with its details at
this stage in your studies. However, it is worth being aware of it as a
monetary policy tool as it has been used extensively by governments in the
wake of the 2008 global financial and economic crisis (see more in the
article in Exercise 2 below) and the term was used a lot in the news in the
years to follow.
A ‘restrictive monetary policy’ is characterised by an increase in interest
rates. This will reduce the money supply and therefore make it less
profitable to invest and produce. Restrictive monetary policies aim to reduce
inflation. For example imagine that people are doing well and are in the
mood to spend. It may be, however, that the economy is not geared up to
meet this increased demand. As a result, prices and inflation start to rise. In
this situation a central bank may decide to make borrowing more costly by
raising interest rates. As a consequence, banks will normally charge higher
interest rates to their customers, reducing the amount they are able to spend
and thus consumer demand. An increase in interest rates may also
encourage inflows of money from abroad as international investors look for
the most profitable investments. Such an influx of foreign money will
appreciate the value of the domestic currency, but it will make exports of
domestic goods relatively less competitive.
Of course it is very difficult to predict precisely what the impact of changes
in monetary policies will be or how long it will be before they take effect.
The main effects of a rise or decrease in the interest rates can take up to
about two years to be felt (Bank of England, n.d.). Accordingly, central
banks set interest rates based on judgements about what inflation might be
over the next few years.
Summing up, for businesses lower interest rates mean reduced costs of
financing the business, thus stimulating demand for money. Individuals with
mortgages or other loans at variable rates also benefit from reduced interest
rates because they will pay less interest on these loans and mortgages. All
these effects should increase the circulation of money, boosting economic
growth. In contrast, higher interest rates are set in order to reduce inflation
and maintain price stability. They impact on businesses through increased
costs of borrowing, which lead to reduced investment. Consumers may also
spend less as they find it more expensive to borrow money and/or may be
more tempted to save rather than spend their money. This reduced demand
by businesses and consumers is likely to lead to lower prices, thus stopping
or reducing inflation.
Exercise 2
Read the article below and then answer the following three questions in no
more than 50 words.
73
Readings 37–45
1 What kind of monetary policy is described in the article?

2 Why did the central banks in question decide to implement this kind of
monetary policy?
3 What are likely to be the main economic effects of this kind of monetary
policy?
Note: It is not necessary for you to understand the detail of all the concepts
and terms used in the article. Focus on the gist of the article and what it tells
you with respect to the three questions asked above.
Rate expectations; Central banks are

keeping monetary policy loose to
stimulate recovery
The Times, 20 December 2013, p. 30.
Interest rates are going up. That is certain because, having been at
almost zero in the United States of America and Britain for the past
five years, they cannot go any other way. Policymakers are in no hurry,
though. Ben Bernanke, the departing chairman of the Federal Reserve,
America's central bank, restated this week that interest rates would be
kept low. The Fed's programme of monetary stimulus, known as
quantitative easing (QE), will be scaled back but only in a small
increment.
Monetary conditions in the advanced industrial economies, led by the
United States of America, will remain loose for some time yet. There
is a good reason. Recovery is still not well established and inflation is
subdued. Policymakers wish to signal to consumers, businesses and
investors that there will be no sudden withdrawal of stimulus. Even so,
there are risks to this policy. It may distort Western economies for a
long time to come and make it more difficult to achieve a return to
more normal conditions.
The very low level of interest rates in America, Britain and the
Eurozone stems from the collapse of the Western banking system
under a cascade of bad debts from 2007 to 2009. Mr Bernanke, who
made his academic reputation with studies of the Great Depression of
the 1930s, was convinced that avoiding a disaster on that scale
required central banks to flood the economy with cheap money.
That is what they have done. After the collapse of Lehman Brothers,
the US investment bank, in 2008, the Fed and the Bank of England cut
interest rates to only just above zero. Because rates cannot go lower
than zero, they also adopted QE. This entailed buying large quantities
of government bonds in order to put money into the economy. The
European Central Bank, covering the Eurozone, has not been so
prompt in easing policy but last month it too reduced its benchmark
interest rates to 0.25 per cent.
74
The Fed will start to scale back (or ‘taper’) its QE programme by US
$10 billion a month from its previous level of US$85 billion a month.
This remains a very loose stance of monetary policy, which Mr.
Bernanke emphasised by referring explicitly to the Fed’s commitment
to keep interest rates low. The Fed, like other central banks, is
concerned not to undermine economic recovery. Language is important
in giving the right signal. Similarly, Mark Carney, the Governor of the
Bank of England, has stated that it will not consider raising rates until
the unemployment rate (now at 7.4 per cent) falls below 7 per cent.
This is unorthodox but defensible policy. Central banks have taken the
view that while demand remains weak, inflationary pressures are in
check. That has turned out to be a good call. Consumer price inflation
in the UK has fallen back to only just over 2 per cent. In the Eurozone
there is a serious risk of deflation. That would do great damage to
economic recovery as consumers would put off their purchases. There
is no immediate risk in any advanced economy of losing control of
prices.
(The Times, 2013)
Figure 6 Quantitative easing explained
Comment
1 The article describes an expansive monetary policy adopted by several
central banks (the European Central Bank, the US Federal Reserve, and
the Bank of England) based on keeping interest rates low and on
quantitative easing.
75
Readings 37–45
2 They have decided to implement this kind of monetary policy in order to

promote economic recovery and because inflation was relatively quiet.
3 With this kind of monetary policy they expect businesses can easily
borrow money, make investments, stimulate demand and thus promote
economic growth.
Summary
Every government has an economic policy through which it tries to
influence the business cycle and the circular flow of income. Economic
policy is based mainly on two kinds of policy: fiscal and monetary policy.
In this reading we examined expansive and restrictive fiscal and monetary
policies.
Two of the main fiscal policies that governments can employ are changes in
the rate of taxation and changes in the level of government spending. The
main instrument of monetary policy is change in the base interest rate
charged by central banks to commercial banks, which influences the cost of
borrowing for business and consumers. An increase in interest rates may
discourage firms to invest and be politically unpopular because the general
public don’t like to pay higher interest on their loans and mortgages,
whereas a decrease in interest rates may be helpful during recessions, but
not sustainable in the long run.
Summing up, this reading should help you as a citizen to be better able to
analyse the economic situation and the behaviour of government in fiscal
policies; as a consumer to better judging whether you are likely to pay more
or less interest on any loans or mortgage in future; and as an employee,
manager and/or entrepreneur to better understand the likely impacts of
different fiscal and monetary policies on the economy and the implications
for your organisation.
76
References
Automotive News (2014) ‘Fiat-Chrysler creates Dutch holding, sets tax
domicile in UK’, Automotive News, 29 January 2014, [online]. Available at
http://www.autonews.com/article/20140129/COPY01/301299917/fiat-
chrysler-creates-dutch-holding-sets-tax-domicile-in-uk (Accessed 23
October 2014).
Bank of England (n.d.) ‘How monetary policy works’, [online]. Available at
http://www.bankofengland.co.uk/monetarypolicy/Pages/how.aspx (Accessed
24 October 2014).
Blanchard, O.J. and Johnson, D.R. (2012) Macroeconomics, 6th edition
(Global Edition) Upper Saddle River, New Jersey, USA: Pearson Education.
Burda, M. and Wyplosz, C. (1993) Macroeconomics. A European Text,
Oxford: Oxford University Press.
European Central Bank (n.d.) ‘The European Central Bank Tasks’, [online].
Available at https://www.ecb.europa.eu/ecb/tasks/html/index.en.html
Keynes, J.M. (1936) The General Theory of Employment, Interest and
Money, Macmillan: London.
OECD (n.d.) ‘Total central government debt as a percentage of GDP’,
[online]. Available at http://stats.oecd.org/index.aspx?queryid=8089, data
extracted on 06 Aug 2014 from OECD.Stat
OECD (n.d.) ‘Tax revenue as percentage of GDP’, [online]. Available at
http://stats.oecd.org/index.aspx?DatasetCode=REV, data extracted on
06 Aug 2014 from OECD.Stat
O’Sullivan, A. and Sheffrin, S.M. (2007) Economics: Principles in Action,
Pearson/Prentice Hall: Boston.
The Business Dictionary (n.d.) ‘National Debt’, [online]. Available at http://
www.businessdictionary.com/definition/national-debt.html#ixzz39cigt8B8
The Times (2013) ‘Rate Expectations; Central banks are keeping monetary
policy loose to stimulate recovery’, The Times, 20 December 2013, p. 30.
(accessed through NEXIS database, 23 October 2014).
UK Government and Mayor of London (2013) ‘Inspired by 2012: The
legacy from the London 2012 Olympic and Paralympic Games’, London:
Cabinet Office, [online]. Available at https://www.gov.uk/government/
uploads/system/uploads/attachment_data/file/224148/
2901179_OlympicLegacy_acc.pdf (Accessed 23 October 2014).
77
Readings 37–45
Reading 42: Market structures

Introduction
In this reading you will be looking at firms and market structures. Market
structure tells us about the characteristics of the market within which firms
interact: the number of suppliers and buyers in a given market, the nature of
interactions among them, and the existence or not of barriers to entry
(Colander, 2006; Katz and Rosen, 2008; Sloman, 2008). The concept of
market structure helps us to explore the dynamics in different forms of
market. There are four main types of market structure: perfect competition,
monopolistic competition, oligopoly, and monopoly. In this reading you will
look in more detail at the main features and dynamics in different market
structures, at how businesses tend to behave and interact in each of them
and at the impacts of different market structures on businesses and
consumers.
1 Different market structures

1.1 Perfect competition
As you have already learnt in Reading 40, perfect competition is a market
structure with the following characteristics:
. a large number of buyers and suppliers

. the goods and/or services traded are identical or homogenous
. organisations can enter and exit freely in the market
. complete information in the market exists among players.
In perfectly competitive markets the actions and behaviours of any single
buyer and/or seller have a negligible impact on market prices; in this sense,
it is said that buyers and sellers are both ‘price takers’. Moreover, in
perfectly competitive markets there are no advantages for established firms
because any firm can easily join or leave the market.
Perfect competition is an ‘ideal’ type that does not really exist in reality.
However, there are markets that can be seen to approximate the conditions
of perfect competition to some extent, as in the following example.
Example of perfect competition: Mercado Central de San Pedro

in Cusco, Peru
Agricultural products are often used as examples for discussing perfectly
competitive markets because there are usually numerous sellers and buyers
in the market, with comparatively low barriers to entry and a relatively
homogenous product (the variation in the quality of, for example, wheat, is
far less than the variation in the specification and quality of, say,
automobiles). Here we consider the case of agricultural markets in a specific
context, that of the ‘Mercado Central de San Pedro in Cusco’ (Peru)
78
(Figure 1). Cusco is a city in south-eastern Peru, in the Andes mountain

range. It was the site of the historic capital of the Inca Empire and its
elevation is around 3,400 m (11,200 ft). Even though it is a mountain city,
Cusco has a very high population (435,114 inhabitants). Moreover, it can
count also on a very high number of tourists because it is close to the
famous site of Machu Pichu (Wikipedia, n.d.).
Figure 1 The Mercado Central de San Pedro
In the Mercado Central de San Pedro a great quantity of small farmers come
from the surrounding mountains to sell their products (potatoes, onions,
carrots and different kinds of vegetables and fruits, etc.). All producers are
very small and a large part of the economy in Cusco is still based on
agriculture. Buyers are represented by all households of Cusco and by the
tourists, so there are no big buyers; suppliers are truly very numerous.
Therefore, in the Mercado Central de San Pedro there are no individual
suppliers or buyers that have the power to influence final prices. In that
context, prices are determined by the interactions among supply and demand
and the producers have to accept the prices set by the market. The high
numbers of suppliers and buyers, the homogenous products they sell, the
existence of no barriers to entry and of no interdependence among the
suppliers makes this market quite close to perfect competition.
In the vast majority of markets, however, perfect competition is more an

abstraction than a reality because in almost every industry – with very few
exceptions – there are differences both in the bargaining power of buyers
and suppliers. Moreover, pretty much all products have some distinctive
features, so product homogeneity is a condition that is very rarely satisfied.
In other words, perfect competition fails to describe the markets where firms
produce differentiated goods and/or services and where firms can influence
the price at which they sell their products through their own behaviour.
Accordingly, we need to analyse three other types of market structure:
monopolistic competition, oligopoly and monopoly.
79
Readings 37–45
1.2 Monopolistic competition

Monopolistic competition is a market structure with many independent firms
operating in a competitive market where each firm sells a slightly different
good or service. Monopolistic competition is similar to perfect competition
in the sense that there are a large number of suppliers, and there is freedom
for them to enter and exit freely from the market. However, it differs from
the model of perfect competition because of the non-homogeneity of the
goods traded. In this sense, you can think of monopolistic competition as a
market structure that shares some features with perfect competition and
some others with monopoly.
In monopolistic competition, products sold are slightly different, giving
suppliers some degree of control over the prices they can charge. This
creates market power because each firm knows that it can raise the price to
some extent without losing its customers, in contrast to what happens in
perfect competition. Of course, this is only true to a certain extent because
beyond a certain level consumers will consider changing to a different
product.
A situation of monopolistic competition can result, for example, from
advertising. Successful advertising can create a sense of uniqueness to a
brand, with the effect that the buyer does not consider other brands to be
suitable substitutes. Consider the cosmetics industry: products are often very
similar at a fundamental level but the brand can make a significant
difference.
Finally, in monopolistic competition, entry barriers exist, but they are
usually low. A lot of small businesses operate in market structures
characterised by monopolistic competition, for example high-street stores
(e.g. barbers, pubs, wellness centres) and restaurants. The example below
shows how Indian restaurants in Milton Keynes, UK (where the Open
University is located) operate in a market structure characterised by
monopolistic competition.
Example of monopolistic competition: Indian restaurants in

Milton Keynes, UK
Figure 2 An Indian restaurant
According to the website www.tastecard.co.uk, there are 13 Indian

restaurants in Milton Keynes. The competition of Indian restaurants can be
80
considered a form of monopolist competition: there is a relatively large

number of Indian restaurants (considering the size of Milton Keynes), they
sell slightly differentiated products (all food is Indian of course, but recipes
and tastes will be slightly different), there are few barriers to entry (if there
still continues to be demand for Indian food, other Indian restaurants may
open without too many difficulties), and each firm acts independently (for
example, prices can be very different from one restaurant to another one).
1.3 Oligopoly
Oligopoly is a market dominated by a few firms, each of whom knows that
its decisions will influence the nature of the competition in the industry.
Firms operating in a market structure characterised by oligopoly may have
considerable power in determining the level of prices and outputs. One of
the key features that differentiates oligopoly from monopolistic competition
is the interdependence existing among the firms: the actions of one firm in
an oligopolistic market affects the other firms. Oligopolists may collude or
compete with each other. Collusion means acting together for the mutual
benefit of all firms. Collusion can be open, covert (with agreements –
formal or not – reached in secret), or tacit – that is based on rules and
understandings without any agreement. Competition among oligopolists can
be based on price, even if it is more commonly through non-price
competition: this usually includes offering special promotions, competing
over the quality of the products sold, providing customer care services, etc.
There are many examples of industries operating in an oligopolistic market
structure, such as the automotive industry, the supermarket industry, the
banking industry. The example below is about the insurance industry in
Sweden.
Example of an oligopoly: the insurance sector in Sweden
Figure 3 A Swedish insurance company
In Sweden, the insurance sector is an oligopoly, where profits of the major

insurance companies are stable. The four main players (Länsförsäkringar, If,
Folksam and Trygg-Hansa) dominate the non-life insurance market
completely, with a 91% market share on motor vehicle insurance, 88% on
accident and healthcare insurance and 81% on home and house insurance.
(Svenska Dagbladet, 22 Oct 2013, Näringsliv, p. 13.)
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Readings 37–45
1.4 Monopoly
A monopoly is a market structure where the supply of a good and/or service
is concentrated in the hands of one single supplier and there are no easy
substitutes for the goods and/or service that it provides because they are
unique. Monopolies are characterised by the presence of high barriers to
entry, meaning is it impossible or nearly impossible for other suppliers to
enter the market and compete with the monopolist. There are different kinds
of entry barriers that generate different types of monopoly:
(i) a monopoly of resources when, for example, a single organisation has
the exclusive control over a natural resource (e.g. natural gas)
(ii) a state monopoly when the state reserves the exclusive right to sell a
particular good and/or service or gives this right exclusively to another
organisation
(iii) a natural monopoly when a single organisation can supply a good and/
or service to the entire market at a lower cost than any other
organisation.
An example of the first type of monopoly is represented by the Russian
company Gazprom. Gazprom is the largest extractor of natural gas in the
world and it has the pipeline monopoly in Russia (even if there is an
ongoing and growing argument for limiting this kind of monopoly of
resources (e.g. Weaver, 2014). Gazprom’s monopoly is partial because it
only applies to Russia. It is very hard to find cases of companies that have a
total, worldwide monopoly over a particular raw material. One example is
De Beers, which had a near total monopoly of the diamond market until the
late 1980s (see below).
The second type (State monopoly) applies when the state provides goods
and/or services to its citizens that the private sector would not provide or
would offer at a higher price. We also speak of a state monopoly when the
state gives the exclusive right to provide a particular product or service to a
private organisation. State monopolies are relatively common, particularly in
utilities and infrastructure. For example, in many countries railways and the
postal system are provided as a state monopoly.
The third type of monopoly happens when there are significant ‘economies
of scale’ in the supply of a good or service. Economies of scale refer to the
fact that the average costs of production tend to decrease when the scale of
production increases. You can have economies of scale for different kinds of
costs: for example, if you buy a machine and start to increase your scale of
production from that machine, this will cost you relatively less in terms of
costs for the machine per single output produced. In some industries and in
some contexts the economies of scale might be so developed that de facto
they may result in a situation of a monopoly.
82
Example of a monopoly: De Beers and the diamond market
Figure 4 De Beers
De Beers (Figure 4) is a cartel of companies that dominated the diamond

market for most of the 20th century. De Beers runs most of the diamond
mines in South Africa, Tanzania, Namibia and Botswana. It brings all of its
rough stones to a clearing house in London and sorts them into thousands of
grades, judged by colour, size, shape and value. For decades, if anyone else
had rough diamonds to sell, De Beers bought these too, adding them to the
mix. With its near monopoly as a trader of rough stones, De Beers has been
able to maintain and increase the price of diamonds by regulating their
supply. However, this stable, established and monopolistic system has since
fallen apart. Other big miners got hold of their own supplies of diamonds, far
away from southern Africa and from De Beers's control. In Canada, Australia
and Russia rival mining firms have found huge deposits of lucrative
stones: BHP Billiton, Rio Tinto and Alrosa have been chipping away at De
Beers's dominance. Rival mining firms do share one big interest with it: high
prices for the stones they dig from the ground. That is why, although it is
under pressure, the central clearing system that sustains high prices could
yet survive a bit longer. Rather than controlling a pure monopoly, De Beers
might be able to run a quasi-cartel that stops the market from opening fully.
(The Economist, 2004)
Now, before summarising and discussing the main differences among the
four main market structures presented, we have to specify that there are
other types of minor and less-known market structures: the monopsony and
the oligopsony. The first refers to a situation where there are many firms
selling products, but only one buyer (the monopsonist) that has full power
in negotiating prices. The oligopsony is similar to oligopolies, but in this
case there are only a few buyers. Thus, suppliers have to deal with the
negotiating power of the few buyers, the so-called oligopsonists.
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Readings 37–45
2 Implications for consumers and

businesses
Market structures have important implications for the level and type of
competition and likely firm behaviour. Understanding this is therefore
important for both firms operating in a market and customers (consumers or
other businesses) buying from these firms. Table 1 summarises the main
characteristics of the four different market structures discussed above.
Table 1 Market structures: a comparison
Main Perfect Monopolistic Oligopoly Monopoly

characteristics competition competition
Number of firms Almost infinite Many Few dominant firms One
Type of product Homogenous Slightly Differentiated Limited differentiation
differentiated
Barriers to entry None Few High High
Interdependence Each firm acts Each firm acts Interdependent One firm in the market,
independently independently strategic pricing no concerns about
competitors
Firm's pricing Price taker Limited price- Price maker Price maker, however
power (passive) making power government may regulate
prices
Businesses can be expected to behave very differently in different market

structures. This may seem obvious but it has important implications for
business practice. For example, if a firm is operating in a market
characterised by monopolistic competition, it will have to differentiate its
products or services more, i.e. make them more attractive, in order to attract
and retain customers. A firm operating in an oligopolistic market will have
to invest considerable energies and money into analysing the strategies
pursued by the other firms in that market in order not to lose market share.
Competitor analysis is obviously less important in a monopoly, where a
firm’s attention will be mainly focused on other issues, such as reducing
production costs. Firms will also be concerned with responding to
government regulation as governments frequently regulate the prices and
service levels offered by companies that hold a monopoly. In an oligopoly
there is the greatest incentive for different firms to work together, formally
or informally, to avoid destructive competitive situations such as price wars.
(Note that many forms of collusion between firms in an oligopolistic market
are illegal in many countries as they are deemed to unfairly disadvantage
consumers).
Market structures thus have significant impacts on the level and type of
competition in a market and on the likely behaviour of firms. It is also
important to note that market structures can change over time. For example,
monopolistic competition could turn into an oligopoly if the circumstances
are such that larger firms have a competitive advantage (say lower costs or
better ability to market their products to consumers). If this were the case,
larger firms could be expected to out-compete smaller ones, with the result
84
that small firms might go out of business or are bought up by their larger
competitors, leaving fewer but larger firms competing in that market.
Market structures also have implications for the prices paid by consumers.
Perfectly competitive markets should be good for consumers as no firm can
charge more than the equilibrium price and therefore prices can be expected
to be relatively low. Monopolistic markets can be expected to result in
higher prices for consumers and a monopoly supplier can, in theory, charge
as much as they like for an essential good. In practice, of course,
monopolistic markets for essential goods, such as utilities, are often
regulated by the state, which limits the amount that the monopolist supplier
can charge. Oligopolistic markets can be fiercely competitive, resulting in
low prices for consumers, or the few firms in it can start to actively
cooperate or passively follow each other’s prices, leading to less fierce
competition and thus usually higher prices. Normally, however, an increase
in the number of competitors leads to a decrease in prices. A good example
is the mobile phone industry where an increase in operators has led to a
decrease in prices paid for both handsets and the price of phone calls and
data downloads. Exercise 1 looks at the structure and features of the car
rental market, including how issues such as barriers to entry and the number
of operators impact on competition dynamics and prices.
Exercise 1
Read the article below and write a short informal report (approximately 150
words) answering the following three questions:
How would you define the market structure for car rentals in the USA?
In what ways is the structure of the car rentals market different from that of
the other two industries mentioned in the article (airline and railroads)?
What are the implications in terms of price level and the level of competition
in the three different industries?
Figure 5 Picture of car rentals firm
85
Readings 37–45
Whitney Tilson: Car rental prices

will continue to rise
Louis Bedigian, Benzinga, 15 May 2013
Expect big changes from Hertz […], Enterprise and the entire industry
over the next 10 years. Whitney Tilson, the founder and Managing
Partner of Kase Capital, believes that the US car rental segment will
begin to resemble the railroad industry’s transformation over the last
10 years.
‘Meaning very capital-intensive businesses characterised by cutthroat
competition, very low returns on capital, poor balance sheets, etc.,’
Tilson told Benzinga. ‘And then the railroad industry consolidated into
a few big players and they all got smart and started behaving like
an oligopoly and just started raising prices. They started operating a lot
smarter as an oligopoly and the railroads – just go look at the major
railroad stocks, including Burlington Northern, which is now obviously
owned by Berkshire (NYSE: BRK-A), and these stocks have just had
incredible runs over the last 10 years.’
Tilson, who recently invested in Hertz and Avis, said that the same
thing is already happening to the auto rental business.
‘More than 90 percent of the auto rental business [and] more than 98
percent of the airport auto rental business in this country is now
controlled by three companies: Hertz, Avis and Enterprise,’ he said.
‘They're already taking prices up. Last quarter Hertz and Avis took
pricing up about four to five percent year-over-year. When you're
talking about fairly low-margin businesses, when you can jack prices
up by that amount, it has very leveraged benefits to the bottom line.’
Tilson said that he does not expect the price increase to be a one-time
deal. ‘I don't expect them to raise their prices five per cent a year for
many years in a row,’ he added. ‘But I think there is a lot of room for
them to take pricing up over time. That's sort of the core of the
investment thesis for both of them. They're both trading at 12 to 13
times earnings, so they're not very expensive, so I think you sort of get
a free call option on them being able to raise prices for many years to
come.’
The threat of new competitors

While some price hikes can pave the way for new competition, Tilson
is not worried about that happening within the car rental space.
‘There's Zipcar, which came out with somewhat of a different model,’
he said. ‘Avis just bought Zipcar. Hertz is introducing the same kind of
Zipcar service where you can go and just rent one of their cars for a
couple of hours. But that doesn't really threaten the industry. That's an
opportunity for them to grow the industry, and Avis now owns Zipcar.
86
The real question would be to say: 'Well, everybody knows there's not
going to be any new, major railroads just because of the nature of the
land and building a track. It's not gonna happen. There's zero chance
of any major new entrants into the North American railroad industry.
But auto rental isn't railroads – it sort of looks more like airlines.’
That said, Tilson noted that every time the airline industry hits a good
patch, ‘A bunch of new startup airlines come in and ruin it for
everybody.’
‘So why isn't that gonna happen with the car rental industry?’ he
questioned. ‘First of all, I'll simply point to history: how many new
airlines have started in the last 20 years? The answer is dozens. How
many new auto rental companies have been started in the last 20 years
– you know, major ones? The answer is zero. I think that says
something right there.’
‘Why is that? Well, partly because billionaires can get very stupid
about starting airlines. There's something cool about starting up an
airline. There is absolutely nothing cool – investors and billionaires
don't get excited about starting a car rental company.’
Believe it or not, it may actually be cheaper and easier to start an
airline. ‘If someone gave us a few hundred million dollars, you and I
could start an airline,’ said Tilson. ‘We could go lease a couple gates
at JFK, San Francisco and Los Angeles, and we could get 100 percent
financing on a few airplanes and literally we could start an airline for a
few hundred million dollars just serving a few routes ‘cause there a
few high-volume routes that you can come in and start making money
on day one.’
Ambitious entrepreneurs could not do that with an auto rental business.
‘We can't just go buy a bunch of cars and lease some space in a car
rental garage at three airports and think we have a business,’ said
Tilson. ‘It would require the investment of billions of dollars and it
would take years to set up enough of a network to where we could
really have a business that could compete with Hertz, Avis and
Enterprise. So my view is that – I'm not claiming that the barriers to
entry are the same as they are in the railroad business, but I would
argue that they are closer to the railroad business than they are to the
airline business.’
Tilson also pointed out that, in addition to the dozens of airlines that
were started over the last 20 years, a significant portion are still
operating.
‘The airline business is still much more competitive with far more
players,’ he said. ‘Imagine if there were only three airlines in the
United States that controlled 90 percent of all traffic. The auto rental
business, I think, is structurally much better than the airline business.
So I'm pretty excited about it over the next few years.’
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Readings 37–45
Comment
According to the information contained in the article the US market for car
rentals can be considered a form of oligopoly.
The railroad industry and the airline industries are also oligopolies but with
some different features. The railroad industry is described as a form of
oligopoly with very high entry barriers, whereas the airline industry is
described as an oligopoly with lower entry barriers and higher
competitiveness due to the ‘dozens of airlines that were started over the last
20 years’ that makes this industry ‘much more competitive’.
In terms of competitiveness, the car rentals industry occupies a middle

position, with airlines being the most competitive and railroads the least. In
terms of prices, the article says that the market structure of car rentals in the
USA (characterised by three main dominant players) will probably cause a
continued rise in prices in the future. However, the entrance of new players –
as happened in the airline industry, but with relatively higher entry barriers –
could contribute to the reduction of prices. The important point here is that
the entrance or the exit of players into a market can have a considerable
effect on the level of competitiveness and prices.
Summary
In this reading you learned there are different market structures and that
every firm needs to understand the main features of its market and the main
competitive dynamics in that market. In perfectly competitive markets there
are numerous buyers and sellers of a good or service and the goods and/or
services traded are homogenous and replaceable. In monopolistic
competition there are also numerous buyers and sellers but the goods or
services on offer are differentiated. In oligopolies a small number of large
firms, offering differentiated goods or services, tend to compete fiercely
with each other. Finally, monopoly is a form of market where a single seller
offers a product or service for which there are no close substitutes. Each
market structure has consequences for the level of competition, business
behaviour, prices and consumer choice. This is why some industries are
regulated by the government in order to shape the market structure or the
prices that can be charged. This will be covered in more detail later in this
book of readings.
88
References
Bedigian, L. (2013) ‘Whitney Tilson: Car Rental Prices Will Continue to
Rise’, 15 May 2013, [online]. Available at http://www.benzinga.com/
trading-ideas/long-ideas/13/05/3593235/whitney-tilson-car-rental-prices-will-
continue-to-rise (accessed 13 March 2015).
Colander, D.C. (2006), Microeconomics, 6th edition, McGraw-Hill/Irwin:
New York.
Katz, M.L. and Rosen, H.S. (2008), Microeconomics, 3rd edition, McGraw-
Hill/Irwin: New York.
Sloman, J. (2008), Economics and the business environment, 2nd edition,
Pearson: Edinburgh.
Svenska Dagbladet (2013) ‘Sweden: 'The insurance sector – an oligopoly',
22 Oct 2013, (accessed through NEXIS database, 23 October 2014).
The Economist (2004) ‘The cartel isn’t for ever’, The Economist, 15
July 2004, [online]. Available at http://www.economist.com/node/2921462
Weaver, C. (2014) ‘Putin suggests ending Gazprom pipeline monopoly’, The
Financial Times, 22 July 2014, [online]. Available at http://www.ft.com/
cms/s/0/d87d224a-11af-11e4-b356-00144feabdc0.html#axzz3KeDJDAYV
(Accessed 1 December 2014).
Wikipedia (n.d.) ‘Cusco’, [online]. Available at http://en.wikipedia.org/wiki/
Cusco (Accessed 25 October 2014).
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Readings 37–45
Reading 43: Comparing economic

systems
Introduction
The idea of different economic systems was briefly introduced in Reading
37. In this reading you will compare different economic systems in greater
detail and learn more about the ways in which government, business and
other organisations interact in them.
It will be helpful to look at some definitions of ‘economic system’ again.
According to the Encyclopaedia Britannica ‘economic system’ refers to:
The way in which humankind has arranged for its material

provisioning.
(Encyclopaedia Britannica, n.d.)
Welch and Welch (2009) state that an economic system is a particular way
of organising the relationships between different economic actors
(businesses, households, and government) to make decisions about what
goods and services should be produced, how they should be produced, and
who will get the benefits of these goods and services.
At some level, most people will be aware that the production, distribution
and consumption of goods and services is not organised in the same way
across different societies or different periods in history. Imagine a tribal
society in, say, Papua New Guinea and how people there would produce
and distribute various goods and services, such as food, house construction
or the care for sick members of society. The images conjured up in your
mind are probably rather different to those that occur to you if you think
about how the production and distribution of goods and services is arranged
in a Western society, such as the United Kingdom. Now consider what you
know about a society like North Korea or Cuba and how people produce
and get access to goods and services there. Perhaps images of strictly state
directed production and very limited consumption choices come to your
mind. Again, very different to the way in which these matters are arranged
in Western economies where a multitude of businesses are vying for
customers’ attention and there are so many consumption choices that it can
at times feel overwhelming.
Perhaps a bit surprisingly there are not that many fundamental ways in
which an economic system can be organised. Economists distinguish
between only four different types of economic system:
1 traditional economies
2 market economies
3 planned (or command) economies
4 mixed economies.
In traditional economies (Figure 1) the main production and consumption
decisions are made according to custom. These customs can, of course, vary
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Reading 43: Comparing economic systems
quite a bit between different societies. Traditional economies were once the
main type of economy and they can still be found in, for example, tribal
societies today. However, they are no longer particularly common and will
therefore not be covered in any detail in this reading.
Figure 1 A traditional economy
At a very fundamental level one could say that an economic system is

concerned with allocating resources, or co-ordinating all those decisions that
are needed to provision humankind with the material goods and services
that it requires, and with providing the information needed to make these
decisions. There are two main mechanisms by which this information can
be provided and the decisions coordinated: markets and plans (Gregory and
Stuart, 2004). Therefore, the main distinguishing feature of different
economic systems is the extent to which this coordination is either left to
the interplay of the forces of supply and demand in a free market, or is
centrally planned – generally by government – in a top-down fashion.
Different economic systems therefore also tend to differ in the degree of
government involvement in detailed economic decisions.
How key business decisions are made and what role business managers play
in making these decisions varies significantly under different economic
systems. Managers operating in a market economy have very different roles
and responsibilities to those operating in a planned economy. In practice,
the majority of economies today are mixed economies, with varying degrees
of government influence on economic and business decisions. Business
managers need to understand which aspects of the economy are strongly
influenced by government intervention and which are left more to the
interplay of supply and demand.
1 Market economy
1.1 What is a market economy?
A market economy is one where the activities and decisions of different
economic actors are coordinated through the operation of a free market,
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i.e. the interplay of supply and demand, without (much) interference from
government or other central planning agencies. A market economy is
different from the mere existence of a market place. Market places have
existed and still exist in traditional economies. In pre-market economies,
markets were the means to bring together sellers and buyers of goods that
people couldn’t produce at home and of luxuries, but they were not the
means by which the provision of essential goods and services was assured.
Market economies work on the assumption that market forces, such as
supply and demand, are generally the best way of coordinating the millions
of decisions that are taken every day in a typical economy. A key argument
of the advocates of market economies is that even the best central planning
mechanisms are not up to coordinating so many different decisions on a
regular basis. Markets do not require any one person or group to have an
overview of all these different activities as markets facilitate decentralised
decision making. The market mechanism coordinates all these different
decisions without any need for anyone to have an overview. In other words,
markets are deemed by their advocates to be simply more efficient.
Friedrich Hayek (Figure 2), a well-known Austrian economist, found that
the system of supply and demand that determines prices in a free market did
a remarkably good job of coordinating people’s economic actions, even
though that coordination was not part of anybody’s intent. According to
Hayek, there is a good reason why markets are so much better at
coordinating economic activity than central planning. It is because each
individual economic actor has detailed knowledge about particular resources
and potential opportunities for using these resources. The virtue of a free
market is that it gives maximum freedom to people to make use of
information that only they have (Hayek, 1935).
Figure 2 Friedrich Hayek
A pure market economy would be one where all decisions on what is to be

produced and how labour and other factors of production, such as land, raw
materials or machinery, should be allocated are made through free markets,
without any government intervention or even any other non-market
arrangements (such as coordinated action by different businesses). Such an
economy is sometimes called a ‘free market economy’, and sometimes it is
also referred to as ‘laissez-faire market economy’. Entirely free market
economies without any government intervention or any non-market form of
coordination probably do not exist anywhere in the real world. In fact, the
economies of most developed nations today could be classified as mixed
economies. The reason why some countries are, nonetheless, often said to
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have free market economies is because market forces drive most of their
economic activities. The greater the proportion of goods and services that
are subject to the free interplay of market processes, the more meaningful it
is to refer to an economy as a market economy.
1.2 Market economy and ownership of the means of

production
Different economic systems are often associated with different types of
ownership of the means of production. A market economy requires certain
types of ownership rights, where individuals or groups are legally
recognised as the owners of certain resources and have the right not only to
use these resources but also to sell or exchange them with other individuals
or groups. Without such a concept of ‘alienable’ property (i.e. property that
can be freely bought or sold) there can be no market where goods and
services are sold and bought, and hence no supply and demand and no
market economy.
However, this does not mean that the means of production must be privately
owned for a market economy to exist. It is true that most people, when they
think about market economies, think about capitalist economies. Capitalism
refers to an economic system where the means of production (land,
infrastructure, factories, tools, natural resources and raw materials) are
largely or entirely owned by private individuals (or groups of individuals)
and are used to generate profit and allow capital accumulation (which can
be very broadly defined as the accumulation of money and other financial
assets in the hands of particular individuals or groups of individuals).
While market economies may be most closely associated with capitalist
ownership structures it is possible to think of market economies where the
means of production are collectively owned but operated according to the
rules of supply and demand. In other words, decisions in an economy could
be coordinated through a market, i.e. the interplay of supply and demand,
and yet the businesses that participate in these markets could be collectively
or publicly owned, for example by cooperative societies or even by the
state. This type of economy is called a ‘socialist market economy’. There
are no existing economies that could be characterised as socialist market
economies at present but in many countries there are enterprises that are
owned by co-operatives or collectives. The Co-op movement present in
many European countries is an example. Another well-known example in
the UK is the retailer John Lewis (Figure 3), which is owned by its
employees. Similarly there are State-owned enterprises (for example the UK
government at one point owned many of the car manufacturing companies
in the country) that operate in the market in a way similar to privately
owned enterprises.
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Figure 3 John Lewis
1.3 The role of government in a market economy

Proponents of free market economies normally think that governments
should only have a very limited role in economic affairs. However, they do
not normally advocate governments having no role at all, and there are no
countries in which governments deliberately take no role in economic
affairs. Rather, most free market economists do, at the very least, see an
important role for government in creating the conditions under which
markets can flourish. For example, Adam Smith, the father of economics
and one of the main theorists of market economy, believed that governments
had an important role in enforcing contracts and granting patents and
copyrights to encourage inventions and new ideas. He also thought that the
government should provide public infrastructure, such as roads and bridges,
which he thought would not be profitable for individuals to provide
(Smith, 1776). Friedrich Hayek was generally an advocate of very limited
government intervention, believing that government intervention in markets
would lead not only to inferior allocation of scarce resources and less
effective coordination of economic activities, but also to a general loss of
freedom. However, he also argued there would be no rationally defensible
economic and political system in which the state did nothing. Hayek (1944)
recognised a role for governments in performing tasks that could not be
performed by markets. In particular he felt governments should set the
conditions for safeguarding competition in the markets. He also thought that
governments should regulate to protect the natural environment; something
which he did not think could be left to markets. And he also thought
governments had a role in preventing fraud and in organising a system of
social insurance to provide a welfare safety net.
1.4 Criticisms of market economies

Critics point out that free markets do not always provide the fair and
efficient allocation of scarce resources that their advocates claim
(e.g. Stiglitz, 2002). Nearly all economists – even the most ardent free
market economists – recognise there can be a number of ‘market failures’.
Market failures are situations where markets do not operate according to the
94
free interplay of supply and demand and therefore fail to allocate resources
efficiently. There can be a number of reasons for such market failures:
. Excessive power of one or several participants in the market, for

example in the case of a monopoly. This means the market does not
approximate the conditions of perfect competition that are necessary for
the free interplay of supply and demand, and prices are distorted by the
excessive power of one economic actor (Figure 4).
Figure 4 The problem of a big fish in a free market
. The ‘non-excludability’ of certain products. This means that a product or

service, once provided, is available to everyone, whether or not they
have paid for it. A typical example would be the provision of a public
good, such as street cleaning. Everybody will benefit from clean streets,
whether or not they have paid for the cleaning to be carried out. It is
therefore not economic for a private provider to offer street cleaning
services in an open market. Rather, this is a public good that tends to be
paid for by the public, for example through local taxes that are used by
local government to pay for the service.
. ‘Externalities’ associated with the production, distribution or
consumption of a product. Externalities are unintended side effects of a
product or service that are not reflected in the market price because it is
not in the interest of anyone to pay for them. Environmental pollution is
a typical externality. Many production processes can be polluting for the
environment, for example through the emission of C02, which is now
generally agreed to be contributing to climate change. Nobody actually
wants the C02 emissions and thus nobody would voluntarily pay for the
damage they cause. This means that – in a free market – the cost of
these emissions will not be part of the price charged for the product. The
markets will under-price this product.
. One of the key criticisms of the concept of a pure market economy is
that this assumes perfect information. Modern economies are
characterised by information asymmetries. One party to a transaction
(such as the sale and purchase of a good or service) usually has more or
better information than the other. In particular, large corporates generally
have a lot more knowledge about their own products and processes than
a consumer (or a competitor) has and they can use this information to
get an unfair advantage (for example selling a good for far more than it
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Readings 37–45
cost to produce or even deliberately misleading consumers about the

properties of a product or any hazards associated with it).
2 Planned economy
A planned economy is also sometimes called a command economy. The
most important aspect of this type of economy is that all major decisions
related to the production, distribution, commodity and service prices, are
made by some central authority, usually the government. Thus, a planned
economy is government directed, and market forces have very little say in
such an economy. This type of economy typically lacks the kind of
flexibility that is present in a market economy, and because of this, the
planned economy reacts slower to changes in consumer needs and
fluctuating patterns of supply and demand.
On the other hand, a planned economy aims at using all available resources
for developing production instead of allotting the resources for advertising
or marketing. Moreover, a planned economy aims to achieve a more
homogenous degree of economic development and to avoid class differences
and regional imbalances. In this sense, the planned economy was thought of
as an alternative to the market economy. It was an attempt to reduce some
drawbacks of the latter, like social injustice and inequalities, especially
those between the owners of the factors of production (the entrepreneurs)
and the workers. Its ideological foundations can be traced back to the vision
of society of Karl Marx and Vladimir Lenin. Karl Marx (Figure 5) was one
of the most influential thinkers of the 19th century. His best known writings
are the Communist Manifesto, which he published together with Friedrich
Engels in 1848 (Marx and Engels, 1848/1972) and his major work, The
Capital (Marx, 1867/1887). Vladimir Lenin was a communist revolutionary
politician who took power in 1917 in the Soviet Union and acted as head of
the government until his death in 1924. He implemented a planned economy
in the Soviet Union.
Figure 5 Karl Marx
Planned economies have been established in the 20th century in several

countries, including Russia (previously the Soviet Union) and China.
However, these two countries in the late 20th century have progressively
moved towards a form of mixed economy and they are now among the key
players in terms of goods and services traded globally. The only remaining
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examples of a planned national economy are Cuba and North Korea, but
even in these countries some limited private ownership of means of
production can now be found.
2.1 Main features of a planned economy

In planned economies, government plans determine what gets produced,
how much of it gets produced, how it should be produced, and who gets
what is produced. In contrast to market economies, where markets are the
coordination mechanism, in planned economies government plans are used
for coordinating all the economic activities of production, distribution and
consumption of goods and services.
Planned economies reject the idea of the private ownership of means of
production. Rather, the national economy is thought of as a unified
production process, centrally managed in a top-down fashion by the
government. Government plans are used to establish production targets for
businesses and for the allocation of all resources (e.g. land, labour, money,
raw materials, etc.). As Ziegler writes:
A centrally planned economy is one in which a small group of officials

make major investment and production decisions for society. This
system is hierarchically organised … Information is channelled up
through the structure while directives flow downwards through a
pyramid of authority. The system is supposed to operate ‘rationally’,
meaning that organisational actions are directed towards attaining a set
of goals at minimal cost.
(Ziegler, 1982, p. 296)
If market economies are associated with capitalism, planned economies are

associated with two different but related models of society: communism and
socialism. In communism, the government owns all the factors of
production and fully decides how to use these resources. There is no form
of private entrepreneurship in communism, and all economic processes are
determined by government plans. In socialism, the government controls the
most critical industries, but individuals can run non-critical businesses; thus
some forms of private entrepreneurship are permitted.
The role of businesses in planned economies is very limited. They must
merely ‘implement’ commands and they become ‘executants’ of plans and
directives from above. Thus the command mechanism requires relative
centralisation and severe restriction on the autonomy of subordinate
operational units.
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2.2 Main criticisms of the planned economy
Figure 6 Poster advertising economic progress in the Soviet Union
Central planning and control may be very effective in achieving certain

goals: the industrialisation achieved in the Soviet Union is an example of
some positive effects of central planning (Ziegler, 1982, p. 299). However,
the planned economy suffers from a lot of criticisms and can be said to
have failed the test of history. In almost all countries where it has been
implemented it has now been abandoned and at least some elements of a
market economy have been introduced.
The main disadvantages of a planned economy relate to the difficulty in
organising all the economic activity. This kind of planning requires
collecting and using a lot of information that is often unavailable. Indeed, it
is practically impossible to gather all the necessary information to formulate
an effective plan for production because the economic system is dynamic
and it is characterised by continuous changes and adjustments. Government
plans also require an organised system of rules, procedures, and people in
charge for the elaboration and the implementation of those plans. This
usually leads to the development of an overwhelming and redundant
bureaucracy.
One of the main limits of the planned economy is also that central control
over resource allocation results in a significant reduction of individual
freedom. Consumers cannot choose what to buy, individuals are not free to
pursue their talents and choose where to work or to run their own business.
In this sense, we can say that the planned economy enters in the life of
individuals and imposes a sort of dictatorship of the state over individuals’
life, resulting in an infringement on individuals’ freedom. As a
consequence, entrepreneurship in planned economies is very limited and it
is subordinated to government approval and government control.
In planned economies, prices are determined by the government; this can
lead to an inefficient use of resources due to the complexity in connecting
the supply with the real demand. For example, during the communist era,
demand exceeded supply for almost all consumer goods in countries with a
planned economy (Figure 7). This was due to the fact that the government
98
promoted a forced industrialisation, pushing production to the maximum in

some sectors (for example those related to the army) and neglecting other
sectors (for example, clothing and appliances).
Figure 7 Long queues formed for basic goods in Poland in the 1980s
Another criticism of planned economies is that they are less able to promote
incentives for innovation compared to market economies. In the latter,
competition for higher profits pushes businesses to innovate and develop
new products or services. Finally, planned economies are more exposed to
political corruption because centralised decision-making can lead to abuses
of power. In addition, the inherent inefficiency of plans (due to the lack of
available information) can create the need for bypassing or destabilising the
official decision-making process.
3 Mixed economy
A mixed economy combines elements of both the planned and the market
economies in one system. This means that features of both market and
planned economic systems can be found in this type of economy. This
system prevails in many countries where neither the government nor the
business entities control all the economic activities; both sectors play an
important role in the economic decision-making of the country. In a mixed
economy there is flexibility in some areas and government control in others.
It means that some goods and services in the economy are allocated by
market mechanisms and other goods and services are allocated by
government through plans or direct public provision. You will learn more
about the different kinds of government intervention in mixed economies in
the next reading.
Mixed economies include both capitalist and socialist economic policies and
often arise in societies that seek to balance a wide range of political and
economic views (Economy Watch, 2010). The combination of private and
government intervention in a mixed economy can, in theory, allow the
economy to benefit from both the incentive to innovate provided by the
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Readings 37–45
competition existing in markets and the social and environmental protection

provided by the government through regulation and social intervention. If
Adam Smith and Friedrich Hayek (among others) can be considered as
advocates of free market economies (even if, as already pointed out above,
they recognised a limited role of government in the economy) and Karl
Marx and Vladimir Lenin (among others) as advocates of a planned
economy, John Maynard Keynes (among many others) can be considered
one of the most important advocates of a mixed economy. According to
Keynes (1936), the State has an important role not only in more traditional
fields such as ensuring protection of patents or providing security, but also
in promoting full occupation through government intervention and public
spending.
3.1 Main features of a mixed economy

Mixed economies are characterised both by private and public ownership of
factors of production. In other words, businesses and state intervention co-
exist in the same economic system. Businesses have the economic freedom
to pursue their entrepreneurial ideas, but in doing so they need to comply
with the regulation provided by the state. Mixed economies seek to combine
the advantages both of market and planned economies, trying to minimise
their disadvantages. For example, in mixed economies the State defines the
regulatory framework for the economy and provides direct intervention and
public services in some key industries, which can include energy, aerospace,
health etc., whereas other industries are left to private enterprise and market
coordination. In this way, in theory, competition among private businesses
and the supply and demand interactions can prompt optimal resource
allocation through markets where this is most appropriate, and the expanded
governmental role can address market failures, provide key goods and
services, and help less advantaged people through public welfare.
Figure 8 Air France is an example of a formerly government owned airline, partly

privatised in 1999
In mixed economies, economic choices of individuals and businesses are

free; prices are set through market mechanisms and through the interplay of
demand and supply, even if government may have an impact on the way
markets operate and on the operations of businesses through regulation.
Government intervention and free markets can come in different levels in
mixed economies. Hall and Soskice (2001) in their book on varieties of
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capitalism highlight two main types of mixed economies: liberal market

economies and coordinated market economies, which constitute ideal types
at the poles of a spectrum with different countries sitting at different
positions along this spectrum.
In liberal market economies, businesses coordinate their activities primarily
via competitive market arrangements and, in response to the price signals
generated by such markets, they adjust their willingness to supply and
demand goods or services. In coordinated market economies, businesses
depend more heavily on non-market relationships generated by government
intervention.
Thus, in contrast to liberal market economies (LMEs), which depend more
on competitive market forces for coordination of economic activity,
coordinated market economies (CMEs) rely more on strategic interaction
between businesses, business associations, and government as a coordinating
mechanism. The USA and the UK can be described as examples closer to a
liberal market economy, while Scandinavian countries (Denmark, Finland
and Sweden) can be considered examples of CMEs. Other countries such as
France, Italy and Germany can be located in a more intermediate position.
Notwithstanding their possible benefits, mixed economies have been often
criticised for drawbacks deriving from the costs of free riding in the
markets or for the costs of too much government intervention. For example,
the critique of information asymmetry, which applies to free market
economies, also applies to some extent to mixed economies.
Jeremy Rifkin, who authored many books about the impact of scientific and
technological changes on the economy (for example see Rifkin, 2014),
argues that the economic system of the future needs to be radically different
from today’s typical mixed economies. In the example below his vision of a
sharing collaborative economy is discussed. According to Rifkin, this model
could overcome both capitalism and socialism and lead towards a new kind
of economic system.
Example of a sharing collaborative economy: Jeremy Rifkin and

the collaborative commons
Radical new economic system will emerge from collapse of capitalism
At the very moment of its ultimate triumph, capitalism will experience the
most exquisite of deaths.
This is the belief of political adviser and author Jeremy Rifkin, who argues
the current economic system has become so successful at lowering the
costs of production that it has created the very conditions for the destruction
of the traditional vertically integrated corporation.
Rifkin, who has advised the European Commission, the European Parliament
and heads of state, including German chancellor Angela Merkel, says: ‘No
one in their wildest imagination, including economists and business people,
ever imagined the possibility of a technology revolution so extreme in its
productivity that it could actually reduce marginal costs to near zero, making
products nearly free, abundant and absolutely no longer subject to market
forces.’
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Readings 37–45
With many manufacturing companies surviving only on razor thin margins,

they will buckle under competition from small operators with virtually no fixed
costs.
‘We are seeing the final triumph of capitalism followed by its exit off the
world stage and the entrance of the collaborative commons,’ Rifkin predicts.
The creation of the collaborative commons

From the ashes of the current economic system, he believes, will emerge a
radical new model powered by the extraordinary pace of innovation in
energy, communication and transport.
‘This is the first new economic system since the advent of capitalism and
socialism in the early 19th century so it’s a remarkable historical event and
it’s going to transform our way of life fundamentally over the coming years,’
Rifkin says. ‘It already is; we just haven’t framed it.’
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Some sectors, such as music and media, have already been disrupted as a
result of the internet’s ability to let individuals and small groups compete with
the major established players. Meanwhile, the mainstreaming of 3D printing
and tech advances in logistics – such as the installation of billions of
intelligent sensors across supply chains – means this phenomenon is now
spreading from the virtual to the physical world, Rifkin says.
Climate change
The creation of a new economic system, Rifkin argues, will help alleviate key
sustainability challenges, such as climate change and resource scarcity, and
take pressure off the natural world. That’s because it will need only a
minimum amount of energy, materials, labour and capital.
He says few people are aware of the scale of danger the human race is
facing, particularly the growing levels of precipitation in the atmosphere,
which is leading to extreme weather.
‘Ecosystems can’t catch up with the shift in the planet’s water cycle and
we’re in the sixth extinction pattern,’ he warns. ‘We could lose 70% of our
species by the end of this century and may be imperilling our ability to
survive on this planet.’
Convergence of communication, energy and transport

Every economy in history has relied for its success on the three pillars of
communication, energy, and transportation, but what Rifkin says makes this
age unique is that we are seeing them converge to create a super internet.
While the radical changes in communication are already well known, he

claims a revolution in transport is just around the corner. ‘You’ll have near
zero marginal cost electricity with the probability of printed out cars within 10
or 15 years,’ he says. ‘Add to this GPS guidance and driverless vehicles and
you will see the marginal costs of transport on this automated logistics
internet falling pretty sharply.’
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Rifkin is particularly interested in the upheaval currently rippling through the

energy sector and points to the millions of small- and medium-sized
enterprises, homeowners and neighbourhoods already producing their own
green electricity.
The momentum will only gather pace as the price of renewable technology
plummets. Rifkin predicts the cost of harvesting energy will one day be as
cheap as buying a phone: ‘You can create your own green electricity and
then go up on the emerging energy internet and programme your apps to
share your surpluses across that energy internet. You can also use all the
big data across that value chain to see how the energy is flowing. That’s not
theoretical. It’s just starting.’
He says the German energy company E.ON has already recognised that the
traditional centralised energy company model is going to disappear and is
following his advice to move towards becoming a service provider, finding
value by helping others manage their energy flows.
He urges large companies across all sectors to follow suit and, rather than
resist change, use their impressive scale and organisational capabilities to
help aggregate emerging networks.
Network neutrality: key to success

While Rifkin believes the economic revolution is likely to be unstoppable, he
warns that it could be distorted if individual countries and corporations
succeed in their intensifying battle for control of the internet:
‘If the old industries can monopolise the pipes, the structure, and destroy
network neutrality, then you have global monopolies and Big Brother for
sure.’
‘But if we are able to maintain network neutrality, it would mean that any
consumer who turns prosumer, with their mobile and their apps, already can
begin to feed into this expanded internet of things that’s developing.’
‘People think this is off on the horizon but if I had said in 1989, before the
web came, that 25 years later we’d have democratised communication and
40% of the human race would be sending information goods of all kinds to
each other, they’d have said that couldn’t happen.’
The paradox of over-consumption

Isn’t Rifkin concerned that the ability to produce goods so cheaply will just
lead to more strain on the planet’s limited resources as a growing global
population go on a buying frenzy?
He believes there is a paradox operating here, which is that over

consumption results from our fear of scarcity, so will go away when we know
we can have what we want.
Millennials are already seeing through the false notion that the more we
accumulate, the more we are autonomous and free. It seems they are more
interested in developing networks and joining the sharing economy than in
consumption for consumption’s sake.
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Readings 37–45
Non-profit sector to become pre-eminent

What about the concern that the end of capitalism would lead to chaos?
Rifkin believes the gap left by the disappearance of major corporations will
be filled by the non-profit sector.
For anyone who doubts this, Rifkin points to the hundreds of millions of
people who are already involved in a vast network of co-operatives around
the world:
‘There’s an institution in our life that we all rely on every day that provides all
sorts of goods and services that have nothing to do with profit or government
entitlement and without it we couldn’t live and that’s the social commons.
There’s millions of organisations that provide healthcare, education,
ministering to the poor, culture, arts, sports, recreation, and it goes on and
on.’
‘This isn’t considered by economists because it creates social capital which

is essential to all three of the internets, but doesn’t create market capital. But
as a revenue producer, it’s huge and what’s interesting is it’s growing faster
than the GDP in the private market system.’
At the age of 69, Rifkin admits he may not live long enough to see his hope
for a better future materialise, but says the collaborative commons offers the
only viable way forward to deal with the sustainability challenges faced by
humanity.
‘We’ve got a new potential platform to get us to where we need to go’, he

says. ‘I don’t know if it’s in time, but if there’s an alternative plan I have no
idea what it could be. What I do know is that staying with a vertically
integrated system – based on large corporations with fossil fuels, nuclear
power and centralised telecommunications, alongside growing
unemployment, a narrowing of GDP and technologies that are moribund – is
not the answer.’
(Confino, 2014)
Summary
Economic systems are systems developed by humankind for organising the
relationship between different economic actors in order to define what, how
and for whom those goods and services should be produced. Markets and
government plans are the two main systems used for coordinating the
relationships between different economic actors.
We can have different types of economic systems even if actually almost all
the national economies can be considered mixed economies. Understanding
the main features of the economic systems where businesses operate and the
role played by each economic actor is a key skill for every manager.
However, you should bear in mind that economic systems may evolve
depending on the times, contexts and circumstances; for example, we are
currently experiencing an increasing blurring of the line between public and
104
private intervention, and the emerging of retrenchment of State in some

sectors accompanied by more intervention in other sectors of the economy.
In the next reading we will look more in detail at the role played by
government in mixed economies and at the kind of relationships that may
exist between businesses and government in those kinds of economic
systems.
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Readings 37–45
References
Confino, J. (2014) ‘Radical new economic system will emerge from collapse
of capitalism’, The Guardian, 7 November 2014, [online]. Available at
http://www.theguardian.com/sustainable-business/2014/nov/07/radical-new-
economic-system-will-emerge-from-collapse-of-capitalism (Accessed 30
November 2014).
Economy Watch (2010) ‘Types of economic system’, Economy Watch, 29
June 2010, [online]. Available at http://www.economywatch.com/
world_economy/world-economic-indicators/type-of-economic-system.html
(Accessed on 28 November 2014).
Encyclopaedia Brittanica (n.d.) ‘Economic system’, [online]. Available at
http://www.britannica.com/EBchecked/topic/178493/economic-systems
Gregory, P.R. and Stuart, R.C. (2004) Comparing Economic Systems in the
Twenty-first Century, New York: Houghton Mifflin.
Hall, P.A. and Soskice, D. (eds.) (2001) Varieties of Capitalism: The
Institutional Foundations of Comparative Advantage, Oxford: Oxford
University Press.
Hayek, F.A. (1935) Prices and Production, 2nd edition, New York:
Augustus M. Kelly Publishers.
Hayek, F.A. (1944) The Road to Serfdom, Chicago: University of Chicago
Press.
Keynes, J. M. (1936) The General Theory of Employment, Interest and
Money, Macmillan: London.
Marx, K. (1867) Capital, Vol.I, Hamburg, Otto Meisner Verlag, first English
edition 1887, Moscow: Progress Publishers.
Marx, K. and Engels, F. (1848) ‘The Communist Manifesto’, in Tucker, R.
C. (ed.), The Marx-Engels Reader, 2nd Edition (1972), New York: W.W.
Norton & Company.
Rifkin, J. (2014) ‘The Zero Marginal Cost Society: The Internet of Things,
the Collaborative Commons, and the Eclipse of Capitalism’, New York:
Palgrave MacMillan.
Smith, A. (1776) An Inquiry into the Nature and Causes of the Wealth of
Nations, edited by Cannan, E. (1976), Chicago: University of Chicago
Press.
Stiglitz, J.E. (2002) ‘Globalization and its Discontents’, New York: W. W.
Norton.
Welch, P.J. and Welch, G.F. (2009) Economics: Theory and Practice, 9th
edition, London: John Wiley and Sons.
Ziegler, C.E. (1982) ‘Centrally Planned Economies and Environmental
Information: A Rejoinder’, Soviet Studies, vol. 34, issue 2, pp. 296–299.
106
Reading 44: The role of government
Reading 44: The role of

government
Introduction
This reading focuses on the role that government plays in mixed economic
systems and on its impacts on businesses. In Reading 41 you saw that
governments and monetary authorities may influence the economic context
through fiscal and monetary policies. However, there are many other ways
in which governments can influence how some markets and industries work,
for example: enacting laws, buying services, allocating funds to businesses
etc. In this reading you will learn:
. how government is organised

. the main functions of government
. how government activities may affect the ways businesses operate and
the economic context.
Understanding the role of government is crucial for any business: as you
will see, there are many situations where businesses engage – directly or
indirectly – with government. Since every government is governed by
politicians and by political ideas and plans, political decisions such as the
kind of services and infrastructures provided by government and the quality
of its governance (for example in terms of political stability) are factors that
impact significantly on the context within which businesses operate.
Figure 1 Parliament in session
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Readings 37–45
1 Government as a system of public

organisations
Government can be defined as the system by which a state or a community
is governed (Oxford English Dictionary, 2010). Democratic government is
organised around three main branches: legislative, executive and judicial
(Figure 2). Each branch has its own powers and responsibilities. The
concept of separation of powers for the legislative, executive and judicial
function has roots that go back to ancient Greece, even if it is commonly
associated with the work of the French political philosopher Montesquieu
(1748/1989). Montesquieu formulated the idea of separation of powers,
pointing out that – in order to prevent abuses from one power and to ensure
effective governance – the legislative, executive and judiciary functions
should be entrusted to different institutional bodies.
Figure 2 The tripartite system of powers in government
Consider the example of the United States of America. The legislative

branch is made up of the House of Representatives and the Senate, known
collectively as the Congress. Their main responsibilities are making laws,
regulating relationships among the states that constitute the United States of
America, controlling tax and spending policies. The executive branch
consists of the President, his or her advisors, and various departments and
agencies. The US President is responsible, among other things, for
enforcing the laws of the land, for foreign affairs, and for the armed
forces. The judicial branch consists of the US Supreme Court and
the Federal Judicial Center. This branch has the responsibility to administer
justice and it has jurisdiction over cases relating to Federal Constitutional
Law (United States House of Representatives, n.d.).
So far, we talked about how government is organised at the central level –
this level is generally known as the national or, in some cases, the federal
level. However, this scheme may be reproduced across various other levels
of government (e.g. regional, provincial, local). The number of levels of
government depends on the way a state is organised. For example, in the
USA there are governments at federal state level. Similarly in Germany
each ‘land’ (or federal state) has a government. Spain and Italy have
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regional governments, and in the United Kingdom there are devolved

governments in Scotland, Wales and Northern Ireland, but not in England.
Each level of government is responsible for different policies and tasks. For
example, local governments (municipalities, provinces, counties, etc.) are
often responsible for issues like social services, land and environment
management, waste disposal, etc. whereas central governments are normally
in charge of issues related to foreign policies, national security, justice, etc.
However, there is not always a rigid division of tasks because more than
one level of government may be involved with the same policy area. For
example the central government may set regulation and high level policy for
social services but delegate the implementation of these services to the local
government level. In short, there are multiple interacting public
organisations at different levels: phenomenon referred to as multi-level
governance and/or inter-governmental management (e.g. Agranoff and
McGuire, 1998; Gage and Mandell, 1990; Hooghe and Marks, 2001).
During recent decades, many countries have seen a process of considerable
transfer of tasks from central governments, both upwards towards
supranational institutions like the European Union and downwards towards
local governments. In the first case, this process has been labelled the
‘Europeanization’ of public policies (e.g. Radaelli, 2008), whereas in the
latter case scholars have talked about devolution or federalism (e.g. Pollitt
and Bouckaert, 2004).
Governments across the world and at every level pursue their activities
through the public sector. The public sector can be defined as the part of the
economy concerned with providing various government services. People
working in the public sector are part of the so-called civil service. In
thinking about the public sector, it is important that you realise it is
composed of different kinds of public organisations, for example, public
schools, public hospitals, fire authorities, state owned enterprise, public
agencies, etc.
Below are two examples of public organisations (a state-owned enterprise
and a public agency) that have been created by government for pursuing
different aims; many other examples could have been provided.
Example of a state-owned enterprise: London & Continental

Railways
London & Continental Railways (LCR) is a UK government-owned company.
LCR is a limited liability company that is wholly owned by the Department for
Transport of UK Government. It has specific expertise in managing and
developing property assets within a railway context, and in particular property
assets associated with major infrastructure projects. For example, LCR
delivered the High Speed 1 (HS1) railway that is the railway between St
Pancras in London and the Channel Tunnel.
(LCR, n.d.)
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Readings 37–45
Figure 3 London & Continental Railways
Example of a public agency: The Environment Agency in the UK

A public agency is a public body in charge of some specific tasks. It is
autonomous from central government in the sense that it has executive
powers and delegated tasks, even if it is subjected to the scrutiny of
government (e.g. Pollitt et al., 2005; Verhoest et al., 2011). The Environment
Agency (EA) is a public agency that was established in 1996 by
the Department for Environment, Food and Rural Affairs (DEFRA) of the UK
government. It is responsible for the protection and enhancement of
the environment in England and one of its tasks is to inspect businesses and
assure their compliance with environmental regulation.
(UK government, n.d.)
Figure 4 An Environment Agency officer at a flood site in the North of England
In other words, ‘government’ is not a monolithic entity, but a system of

interrelated public organisations at different levels. As you learned in
Reading 43, the size and role of government is closely linked to the
110
economic system under which a country operates, which in turn depends on

factors such as historical development and political ideology. This can even
happen over a relatively short period of time of several decades. For
example, many Western countries saw the development and expansion of
the welfare state in the late 1960s and 1970s, resulting in an unprecedented
growth of the public sector in most developed countries. However, the
1980s and 1990s were marked by concerns and attempts to reduce the size
of the public sector, or, at least, to make it more efficient (Jackson, 2009).
At the time this reading was written, several contradictory trends could be
observed. There was more government involvement in tasks considered
unusual before, for example the bail out of banks such as the Royal Bank of
Scotland by the UK government during the global financial crisis. At the
same time, however, the UK government was also increasingly contracting
out public services to private and third sector organisations. Government
expenditures reflect historical and current political decisions, but are also
highly sensitive to economic developments. General government spending
as a share of GDP provides an indication of the size of the government
across countries. In Exercise 1 you will learn more about the large variation
of this ratio across the member countries of the G20.
Exercise 1
Table 1 shows government expenditures as part of GDP in the G20

countries. The G20 membership comprises a mix of the world’s largest
advanced and emerging economies, representing about two-thirds of the
world’s population, 85% of global GDP and over 75% of global trade (G20, n.
d.).
The members of the G20 are Argentina, Australia, Brazil, Canada, China,
France, Germany, India, Indonesia, Italy, Japan, Republic of Korea, Mexico,
Russia, Saudi Arabia, South Africa, Turkey, the United Kingdom, the United
States of America and the European Union. In order to ensure comparability
of the data we considered Spain in place of the European Union because it
was invited as the unique European guest country for the year 2014.
Look at Table 1. Then choose five countries and consider the following
questions:
. Which countries have relatively high government spending as a

percentage of GDP?
. Which have low government spending per GDP?
. In your view, what do these differences say about the relative role of the
government in those countries?
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Readings 37–45
Table 1 Comparison of government expenditures as a percentage of GDP in

the G20 countries (Year: 2014).
Country Gov't expenditure % of GDP

Argentina 40.9
Australia 35.3
Brazil 39.1
Canada 41.9
China 23.9
France 56.1
Germany 45.4
India 27.2
Indonesia 18.5
Italy 49.8
Japan 42.0
Korea, South 30.2
Mexico 26.6
Russia 35.8
Saudi Arabia 35.1
South Africa 32.1
Spain 45.2
Turkey 34.9
United Kingdom 48.5
United States 41.6
(Source: The Heritage Foundation, 2014)
Comment
We don’t know which countries you considered, but there are several
elements of interest in Table 1. For example, the European countries have
the highest level of government expenditure as a percentage of GDP (France
56.1%, Germany 45.4%, Italy 49.8%, Spain 45.2% and United Kingdom
48.5%). Thus, in comparative terms, you could argue that there is a greater
role for government in European countries compared to other countries such
as the USA and China. This could be explained, among other things, by the
larger extent of government expenditure on public welfare and public health
compared to that provided by other countries.
The variation of the level of government spending as a percentage of GDP

can be indicative of different approaches to the role of the state in the
economy. You will see how this can impact on businesses later in this
reading.
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2 What does government do?

Government exercises different functions in relation to the economy and
business. The main activities pursued by government in mixed economic
systems can be grouped into four categories:
1 establishing a legal framework
2 providing public services
3 directly supporting business through financing and advocating
4 public procurement.
2.1 Establishing a legal framework

The first group of government activities includes those related to the
establishing of the legal framework that regulates the rights and the duties
of individuals and the spaces of action of public, private and third sector
organisations. In order to establish the legal framework around business and
the economy, government can pass laws, set policies and provide regulation
in areas such as advertising, employee rights, safety and health, consumer
protection, environment, and many others. There are regulations for almost
every kind of industry or sector.
Consider environmental legislation and regulation that is now in existence
in most countries. These have far reaching impacts on the way in which
organisations conduct their activities, ranging from waste disposal and the
avoidance of air and water pollution, noise and dust reduction, to
safeguarding scarce natural resources and the protection of wildlife habitats
and biodiversity. Public sector organisations can play their own role in
setting standards and promoting environmentally responsible behaviours by
other organisations, perhaps most notably by setting environmental
standards in their purchasing policies, which private sector suppliers have to
follow in order to win public sector contracts. In this context it is
noteworthy that, in Europe, legal and regulatory frameworks are
increasingly being set by the European Union (national governments then
implement these frameworks by incorporating them into national law).
Other examples of government activities in this first category include:
. Bans on certain types of business behaviour for reasons of public safety

and/or of public health (for example a ban on tobacco advertising that is
now in force in most European countries).
. The formal processes that an entrepreneur has to follow if he/she wants
to start a new business. This is a very important issue, since in many
countries the bureaucratic obstacles may deter people with good business
ideas from embarking on the path of formal entrepreneurship: you can
learn more about this in the example provided below.
Example of starting a business and bureaucratic procedures:

some insights from the Doing Business report of the World Bank
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Readings 37–45
Figure 5 Red tape
Opening a new business always requires a series of procedures to be

carried out with the public sector in order to get all necessary licences and
permits and completing any required notifications, verifications or inscriptions
for the company. The ‘Doing Business’ report of the World Bank compares
the bureaucratic burden (i.e. the number of different processes, and the time
and cost involved in completing them) for a domestic small- or medium-size
limited liability company to start up and formally operate in 189 countries.
According to this report, if you want to start a business in Austria you need
to complete eight different processes with an average required time of 22
days. In China the processes are eleven and the days needed for finishing
them all are on average 31.4. These bureaucratic burdens are much higher
in China and Austria than in New Zealand where there is only one process
involved in starting a business and it takes half a day on average.
(World Bank, 2014)
2.2 Providing public services

The second main group of government activities deals with providing public
services. Public services are very much part of our life. Public services that
you may experience in your own daily life can include the provision of
drinking water (Figure 6), waste water disposal, waste disposal, gas
provision for domestic use, public transport, public infrastructure provision
such as roads, education, health care, and police and fire services. These
services can all be responsibilities of central government or local councils,
although the extent to which they are actually carried out by public bodies
varies between countries and also from service to service. For example, the
provision of drinking water and waste water disposal have been privatised
in some countries, including the United Kingdom. Other services may be
provided by private companies but are subsidised by local or central
governments. Public transport is often an example of this. Health care is
nearly entirely public in many countries, with the National Health Service
(NHS) of the United Kingdom being a good example. In other countries,
health care is nearly entirely private, for example in the United States of
America. In yet other countries there is a public health care provision to
cover the basics but there is also a fairly extensive private health sector.
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Spain is an example. Police and fire services, on the other hand, are public
services in virtually all countries.
Figure 6 Drinking water infrastructure
The quality of public services impacts significantly on all of us as citizens

and on all businesses. They provide an important frame for business activity
as firms are dependent on utilities, such as water, energy and
telecommunications, as well as infrastructure, such as road, rail and air
connections in order to run their business. Businesses also benefit from a
good education system that provides well educated employees and a good
health system that ensures their employees stay healthy. Therefore, the
quality of public services and public infrastructures are very often important
factors that businesses take into consideration when deciding where to
locate. The example below is about a public service provided by the
regional government of Navarra in Spain in order to support businesses and
spark innovation.
Example of public service: Centro Europeo de Empresas e

Innovación de Navarra
The Centro Europeo de Empresas e Innovación de Navarra (CEIN) was
established by the Government of Navarra (Spain) with the main mission to
diversify the industrial and economic area of Navarra and contribute to its
development by stimulating entrepreneurship, helping the creation and
consolidation of new businesses and promoting innovation in small and
medium companies. The centre has a structure with dedicated experts and
funds for helping entrepreneurs to turn their ideas into viable businesses; for
training entrepreneurs to be committed to innovation and ready to adopt
change; for identifying new business opportunities for the region, etc.
(European Union Regional Policy, 2007, p. 7)
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2.3 Directly supporting business through financing and

advocating
The third group of activities provided by government involves direct
support for business by providing capital and reducing the cost of capital by
offering loans or loan guarantees as well as advocating for business.
Governments at central, regional and local level as well as
intergovernmental organisations such as the European Union often provide
funds to support businesses in particular industries or sectors. Mazzucato
(2013) points out that some of the best known innovations of the past years
have been financed by public funds. For example, some of the applications
found on iPhones have been developed by Apple using public funds.
Mazzucato (2013) also cites the example of Elon Musk, a so-called ‘hero’
of Silicon Valley, which launched Tesla, a manufacturer of electric cars,
thanks to a government loan guarantee of US$500 million.
Figure 7 Picture of research lab activity
Governments also often play the role of advocate for businesses in their
country, region or municipality, for example in their relations with other
countries. The next example looks at this role of government.
Example of an advocating role: the UK and Chinese

governments
Bilateral (or multilateral) commercial trade agreements can be very important
for fostering businesses’ transactions among the signing countries. For
example, the UK and Chinese governments have signed a £14 billion trade
and investment deal after the meeting with the Chinese Premier Li Keqiang
and Prime Minister David Cameron during a visit of the Chinese Premier to
the UK. The annual UK–China summit took place just 6 months after the
Prime Minister’s visit to China and with bilateral trade at record levels – up
by 8% overall in 2013. According to the UK government, UK exports to China
have more than doubled since 2009; the UK is the most popular European
116
destination for Chinese investment, benefitting from over £8 billion in 2013/

14 alone, creating or safeguarding over 6,000 jobs in the UK.
(UK Government, 2014)
2.4 Public procurement

The last group of government activities is represented by those activities
related to the role that government plays in purchasing goods and services
from organisations of other sectors. Public organisations are amongst the
most prolific consumers in the European Union. Their annual purchasing
power represents over 16% of the EU’s GDP and, in the construction sector,
public organisations are even responsible for 40% of all purchases (Ecopol,
n.d.). This is a key way in which many businesses are involved in
transactions with public organisations. There are many possible examples
for this: from public organisations that commission the construction of
public infrastructures from private sector firms, to public organisations that
outsource the provision of social services to third sector organisations. The
example below is about the role of Green Public Procurement as a possible
driver for the promotion of sustainability in businesses.
Example of public organisations as a client: the potential of

Green Public Procurement
Green Public Procurement (GPP) is ‘a process whereby public authorities
seek to procure goods, services and works with a reduced environmental
impact throughout their life-cycle when compared to goods, services and
works with the same primary function that would otherwise be procured’
(European Commission, 2008). GPP is a powerful policy tool for influencing
the market by giving a competitive advantage to businesses that respect the
environment and promote sustainability as a strategy for achieving their
mission. An example of environmental criteria that can be used by public
organisations in their procurement activities is a municipality that decides
that only organic food should be served in municipality run activities (such as
schools and day care centres).
Summary
Business and management happens in a dynamic and complex environment
of government intervention and regulation. In this reading you learnt more
about the role that government plays in the economic context. Government
activities can be categorised around four main typologies:
. establishing the legal framework of business through laws and policies

. delivering public services
. providing capital and advocating for the interests of businesses
. buying goods and services.
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Readings 37–45
Government has an important role in the economic context and, as you have
learnt, government spending as a percentage of GDP may be around half of
the GDP in some countries. The economic system is shaped by the many
relationships that occur between government and the other actors of the
economic context. Understanding and managing effectively the relationships
with government is a critical skill for many businesses. You will learn more
about this in the next reading.
118
References
Agranoff, R. and McGuire, M. (1998) ‘A jurisdiction-based model of
intergovernmental management in U.S. cities, Publius, vol. 28, issue 4,
pp. 1–21.
Ecopol (n.d.), ‘Green Public Procurement’, [online]. Available at http://
www.ecopol-project.eu/en/green_public_procurement (Accessed 14
November 2014).
European Commission (2008) ‘Public procurement for a better
environment’, Communication from the Commission to the European
Parliament, the Council, the European Economic and Social Committee and
the Committee of the Regions Brussels’, COM(2008) 400/2, Brussels.
European Union Regional Policy (2007) The Smart Guide to Innovation
Based Incubators (IBI): 20 Case-Studies, European Union, [online].
Available at http://ec.europa.eu/regional_policy/sources/docoffic/2007/
working/innovation_incubator_case.pdf(Accessed 14 November 2014).
Gage, R.W. and Mandell, M. (eds.) (1990) Strategies for Managing
Intergovernmental Policies and Networks, New York: Praeger.
G20 (n.d.) ‘The G20 and the World’, [online]. Available at https://www.g20.
org/g20_priorities/g20_and_world, (Accessed 14 November 2014).
Hooghe, L. and Marks, G. (2001) Multi-Level Governance and European
Integration, Lanham: Rowman & Littlefield.
Jackson, P.M. (2009) ‘The size and scope of the public sector’, in Bovaird,
T. and Löffler, E. (eds.), Public Management & Governance, 2nd edition,
Routledge: London, pp. 25–39.
London Continental Railways, (n.d.) ‘About LCR’, [online]. Available at
http://www.lcrhq.co.uk/about-lcr/ (Accessed 14 November 2014).
Mazzucato, M. (2013) The Entrepreneurial State: Debunking Public vs.
Private Sector Myths, London: Anthem Press.
Montesquieu, C.S. (1748/1989) The Spirit of the Laws, New York:
Cambridge University Press.
Oxford English Dictionary (2010) ‘Government’, Oxford: Oxford University
Press.
Pollitt, C. and Bouckaert, G. (2004) Public Management Reform: A
Comparative Analysis, Oxford University Press: Oxford.
Pollitt, C., Talbot, C., Caulfield, J. and Smullen, A. (2005) Agencies: How
Governments do Things Through Semi-Autonomous Organizations, New
York: Palgrave Macmillan.
Radaelli, C. (2008) ‘Europeanization, policy learning, and new modes of
governance’, Journal of Comparative Policy Analysis: Research and
Practice, vol. 10, issue 3, pp. 239–54.
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The Heritage Foundation (2014) ‘Explore the Data’, [online]. Available at

http://www.heritage.org/index/explore?view=by-variables, (Accessed 11
November 2014).
UK Government (2014) ‘UK and China agree £14 billion of trade and
investment deals’, [online]. Available at https://www.gov.uk/government/
news/uk-and-china-agree-14-billion-of-trade-and-investment-deals (Accessed
14 November 2014).
UK Government (n.d.) ‘Environment Agency’, [online]. Available at https://
www.gov.uk/government/organisations/environment-agency (Accessed 14
November 2014).
United States House of Representatives, (n.d.) ‘Branches of Government’,
[online]. Available at http://www.house.gov/content/learn/
branches_of_government/ (Accessed 12 November 2014).
Verhoest, K., Van Thiel, S., Bouckaert, G. and Laegreid,
P. (2011) Government Agencies: Practices and Lessons from 30 Countries,
Basingstoke: Palgrave Macmillan.
World Bank Group (2014), ‘Starting a Business’, [online]. Available at
http://www.doingbusiness.org/data/exploretopics/starting-a-business,
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Reading 45: Business-government relations
Reading 45: Business-government

relations
Introduction
Business–government relations refer to the interactions between the public
and private sector. The relationships which link government and business
are inherently complex. Analysing these relationships is an essential element
in understanding the political context of business and management. As a
matter of fact, every business (and also third sector organisations) needs to
be able to monitor and understand the impact of legislation, and be able to
exploit the business opportunities coming out from public spending and
public funds. Some businesses may also have a higher level of engagement
with government, participating in the regulatory discourse in order to give
their contribution in the definition of the legal framework or partnering with
government for delivering public services. In this reading you will start to
look at the main typologies of business–government relations and then you
will focus on two main relations that may exist among businesses and
government: partnership and lobbying.
1 Types of business–government relations

Compared to recent years, the complexity of business–government relations
is today significantly increased. They are characterised by unpredictable
policy contexts and by increasingly complex issues, like for example
climate change, cyberterrorism, and financial regulation. An unpredictable
policy context has been defined by Lawton and Rajwani (2011, p. 271) as a
context where ‘the firm is unexpectedly confronted by policy decisions,
stakeholders, issues or actions within a political system and as a result of
that must proactively react to this unanticipated policy context’. An example
of unpredictable policy decisions that hugely impacted on businesses was
the regulation about security procedures in the airline industry after the
terrorist attack of nine eleven (11 September 2001) in the USA.
The way and the contexts where business–government relations are
exercised might be very different (e.g. Adly, 2009). For example, in the
western context some practices are more institutionalised and formalised,
whereas in other contexts such as Africa or Asia, weak or incomplete
institutionalisation might lead to the development of more informal
activities. In Figure 1 you can see the business–government relations
spectrum.
This scheme highlights five main typologies of relations that may occur
between businesses and government. These typologies are situated along a
continuum that spans from a lower degree of formal business involvement
in the relationship with the government towards a higher level of formal
involvement represented by a partnership between a business and the
government.
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Readings 37–45
BUSINESS-GOVERNMENT RELATIONS SPECTRUM

Degree of formal business involvement
– +
Lobbying Consultation Agreement Collaboration Partnership
Figure 1 Business–government relations spectrum
At the opposite ends of the arrow there are lobbying and partnership. In the
first case business and government interact on some issues, but there is a
low level of formal business involvement. In the latter case, business and
government work formally together through the creation of a new
organisation (the partnership). Those two main cases are discussed more
deeply in the following two sections, so here we focus on the three
intermediate typologies: consultation, agreement and collaboration.
Relations of consultation between business and government may exist when
the government asks businesses and – more in general – all the stakeholders
of the private and third-sector to be heard on some issues. Consultations
may also occur from the opposite side when businesses consult government
on some issues. There are many possible examples of this – from focus
groups between local government and third sector organisations on social
policy issues, to meetings between businesses and ministries in order to
discuss situations created by business crises. The example below is that of a
European consultation on regulatory and administrative burdens on tourism
businesses.
Example of EU consultation: tourism businesses
Figure 2 A restaurant
The European Commission has promoted a business consultation about

regulatory and administrative burdens on tourism businesses, which may
impede their capacity of growth and their competitiveness. The objective of
this public consultation is to identify all the EU, national, regional and local
policy initiatives (legislative or not) and administrative practices, where there
may still be scope for further reducing the burden for SMEs, and in particular
for micro businesses. With this consultation, the European Commission aims
to obtain tourism businesses’ views on possible good practices and initiatives
that may be taken in order to promote more bureaucratic simplification.
(European Commission, 2013)
122
The third type in the business–government relations spectrum concerns

agreements between government and businesses. This situation is
characterised by a higher level of formal business involvement compared to
consultation because it doesn’t simply imply that the voices of businesses or
government are heard, but it is based on an agreement that should be
respected between the parties. Through an agreement both the parties agree
on some common aims or behaviours to be taken, but they still continue to
work alone. There are many ways through which relations of agreement
may be implemented, like for example memorandum of understandings. The
next example looks at an agreement between the government and insurance
companies.
Example of an agreement between government and business:

flood insurance
Hundreds of thousands of households in flood-prone areas will be
guaranteed affordable flood insurance after the government and insurance
industry agreed a deal.
The new agreement will cap flood insurance premiums, linking them to
council tax bands so that people will know the maximum they will have to
pay.
To fund this, a new industry-backed levy will enable insurance companies to

cover those at most risk of flooding. All UK household insurers will have to
pay into this pool, creating a fund that can be used to pay claims for people
in high-risk homes.
(UK Government, 2013)
The fourth type in the business–government relations spectrum concerns

collaboration. The main difference between agreement and collaboration is
that in the first case government and business just agree on something,
whereas in situations of collaboration they agree on working together on
some issues, even if it doesn’t lead into the creation of a new organisation,
like in the partnership case. Examples of relations of collaboration may
occur when governments contract out the provision of public services:
public outcomes are established by government, but the delivery is
outsourced to private or third sector organisations; in this sense, they
collaborate to the final achievement of the relevant public outcomes.
Contracting-out, also referred to as outsourcing, is defined to take place
when a government purchases services from a private firm under contract
but retains accountability for the service (Savas, 2000).
In other words, government sets the field for collaboration, identifies the
public outcomes to be achieved and then opens the field for collaborating
with the other actors (beyond the public ones) that are present in the
economic context: contracting out may be one of the examples, but others
could be provided, such as sponsorships offered by businesses for creating
local parks or maintaining roundabouts. Unleashing the opportunities that
are coming out for businesses and third sector organisations from the
pursuit of the public value is one of the key debates that is emerging among
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scholars and professionals about the potentialities of new models of

business in society (e.g. Porter and Kramer, 2011).
Before going into more details about the relations of partnership and
lobbying between business and government, Table 1 summarises the key
features of the five typologies.
Table 1 Business–government relations’ typologies and their main features
Business–government relations spectrum

Lobbying Businesses influence government
Consultation Businesses share formally their voices, information
and resources with government
Agreement Businesses and government agree on some issues/
projects
Collaboration Businesses and government work together on some
issues/projects
Partnership Businesses and government establish a new
organisation (the partnership) for working together
2 Public–private partnerships
Government and businesses may engage in relations of partnership. The
partnership between government and business may come in different legal
forms (e.g. mixed enterprises, associations, foundations etc.) and fall into
different policy areas. Policy areas such as building and site development,
transportation, education and culture, sports, military logistics, health and
social policies, the prison system, and waste management have been
indicated as having a high partnership potential (Lienhard, 2006, p. 557).
This is not an exhaustive list and some other areas may have been
mentioned.
Figure 3 The Canal du Midi, France
Public–private partnerships (PPPs) are not a new concept. In the 17th

century, the Canal du Midi in Toulouse, France (Figure 3), was built and
124
managed by a private sector entity in partnership with King Louis XIV.

However, the literature identifies the 1990s as a starting point for the
modern public–private partnerships era, particularly in Britain, where John
Major’s Tory government enacted a Private Finance Initiative law that
represented the first systematic attempt to facilitate more public–private
partnerships (LaFaive, 2014).
PPPs have been described by several authors as a third route (Klijn and
Teisman, 2004), a grey area (Drewry, 2000) or a shadowy area
(Collin, 1998), in which the State and private businesses work together for
the delivery of public services, instead of using the traditional model based
on the internal production of services by either the private sector or the
public sector. This third route can be seen as an attempt to combine the
values of public sector with the operating logic and principles of the private
sector in order to deliver societal goals (e.g. Skelcher, 2005).
Klijn and Teisman (2004) defined PPPs as a collaboration between public
and private actors marked by the quality of durability, in which the actors
jointly develop products and services, and share the risks, costs and
benefits. PPPs have been used by public organisations for identifying new
methods for financing their investments, especially for building
infrastructures and for bringing new flexibility and entrepreneurship to the
design, execution and management of public investments.
PPPs can represent for the public sector the balance between the need for
strategic coordination and to retain control of investment processes and the
need to involve private actors (engineering and design firms, building firms,
service providers and banks, etc.) during the execution and financing
processes. For example, in 2012, the City of Seattle announced a public–
private partnership with Gigabit Squared to provide high-speed fibre
connections to residential and commercial customers. Table 2 highlights the
main advantages and risks in PPP projects from the perspective of both
government and business.
Table 2 Advantages and risks of PPP projects
PPPs: advantages and Government Business

risks from the government
and business perspective
Advantages Financial relief/gain Opening up of new
in efficiency markets
More rapid Attractiveness of public
realisation of projects business partner
Optimised task Improvement of the
fulfilment/relief chances for success
Image enhancement
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Risks Selection of partner Long-term commitment/

Long-term stability
commitment Long path to decision
Complexity Diverging interests
Conflict of interests Political risks
(e.g. changing parties in
power)
(Source: adapted from Lienhard, 2006, p. 552)
As we have just said, PPPs have been used for developing some important
public infrastructures; examples can be found in the realisation of a city
parking in Zurich (Parkhaus), of the last motorways realised in Italy (the so-
called BreBeMi that connects Brescia, Bergamo and Milan) and in the case
of the Channel Tunnel Rail Link with the participation of the UK and the
French governments.
In most of the cases, public–private partnerships may originate the creation
of a mixed enterprise with shareholders that can be mostly public or private
organisations depending on the case. An example of mixed enterprise that
came under the control of a main private shareholder is reported in the next
example.
Example of a public–private partnership: Luton Airport
Figure 4 Luton Airport
The Airport of Luton employs directly over 500 and indirectly 8,000 staff
respectively. Luton Airport was established by a pioneering public–private
partnership deal signed in August 1998. It is publicly owned by Luton
Borough Council, but is operated managed and developed by a private
consortium, London Luton Airport Operations Ltd, for a period of 30 years. A
specialist airport management company, TBI plc, became the majority
shareholder in London Luton Airport Operations Ltd in March 2001 when
they increased their shareholding by buying shares from Barclays Private
Equity and Barclays UK Infrastructure Fund. In January 2005 TBI plc was
taken over by Airport Concessions & Development Ltd., (ACDL) a company
126
owned by Abertis Infraestructuras (90%), and Aena Internacional (10%),

both of Spain.
(London Luton, n.d.)
3 Lobbying
Businesses and campaigning groups expend an enormous amount of money
trying to influence government to legislate in their favour. This activity is
known as lobbying: seeking to influence public organisations to take
account of private views and interests while deciding the public interest and
making regulations about it. Lobbying is as old an activity as governing
itself. It is done by a great variety of actors: by other governments (their
lobbying is called ‘diplomacy’), and by private and third sector
organisations. According to Schepers (2010, p. 478), lobbying belongs to
the fundamental civic right to be able not only to choose but also to
influence governments and parliaments in how to define the public interest,
what and how to regulate it. In some way, lobbying can be seen as a
natural, modern extension of the traditional right of petition.
The lobbying business is frequently referred to as an ‘industry’. The fact
that we now attach the word ‘industry’ to the practice of lobbying indicates
it is a big business in itself. For example, considering the case of the USA,
according to the Center for Responsive Politics (n.d.), in the USA in 2013
there were 12,359 lobbyists registered and in the same year the total
lobbying spending was equal to US$2.41 billion. The first ranked sector for
money spent on lobbying were the manufacturing, textiles, steel and
chemical industries, the insurance/real estate sector and the health sector.
It has long been common practice for big business to spend enormous sums
of money on lobbying government. After all, the stakes are high.
Legislation can sink businesses overnight, or at least inflict huge financial
damage, even with the best of intentions. The voluntary sector has also
become far more professional in its dealings with government. The larger
charities, for example, all finance large public affairs departments, employed
to both monitor and influence government and public opinion. Even many
smaller charities now employ in some cases specific public affairs officers.
In Exercise 1 you can learn more from the direct experience of a lobbyist.
Exercise 1
Read the information contained below about the experience of Cathy Owens,
a lobbyist. Then consider the following three questions:
. What is lobbying?
. According to Cathy, why is lobbying related to ethics?
. What, according to Cathy, is the potential benefit of lobbying?
Cathy Owens (Figure 5) has worked on all sides of the business–third-
sector–government triangle. She was a successful lobbyist before being
employed as a special adviser to the Welsh Assembly Government. After
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Readings 37–45
leaving government, Cathy took up the position of director of Amnesty

International in Wales. She now co-runs her own successful public affairs
company, Deryn, which represents a range of clients, from small charities to
bigger businesses. Cathy kindly agreed to share her experiences and
thoughts about lobbying with B100 students.
Figure 5 Cathy Owens
Cathy Owens: You may be wondering what a lobbyist actually does. I do

think it is important, as you are starting your business degrees, to develop a
richer understanding of the lobbying industry, the interface between business
and government. Our line of work almost deliberately operates under the
radar of most people because our work is to promote the interests of other
groups. I see the role of my company as coaching, educating and preparing
clients for a more professional and effective relationship with government. So
very often our role is to help our clients prepare well enough so that they can
continue a positive relationship with government independently of us. Other
times we are a little more involved. At Deryn, our main focus is on dealing
with the Welsh Assembly Government, and we very much hold a Welsh
identity, although we do work with local government and the government in
London as well. Government can be complex and difficult for people who
have not worked inside it to understand, to grasp how the different
departments are structured, which minister and which officials have
responsibility for what, and of course issues often fall between departments
and individuals. So the whole thing can become quite disorientating,
especially for companies not based in Wales but who want to operate in
Wales. I am lucky because I have worked across many divides. I was a
government special adviser for many years, before that worked in lobbying,
then after government in the NGO sector and now I run my own business.
My business partner is a former elected politician and so we both know our
way around the system, understand its intricacies. We know how responsive
some ministers, advisers and officials are to outside bodies and we also
have a good idea of their position on certain issues.
You might ask why this is important, why does the world need people in my
line of work? There are certainly lobbying organisations out there which are
not in my view very ethical at all. They take money from businesses I would
personally have a problem with. In our business we do hold quite strong
ethical standards about who we accept as clients. We would never take
128
money from the tobacco industry, for example. Recently we were asked to
get involved on behalf of the television and theatre industry because they
wanted the Welsh government to soften its stance on the ban on smoking in
public places. Their point was that a ban on smoking in public places was
unfair on the creative arts as it meant that they could not film actors
smoking, or have actors smoking on stage, even if the script called for it. Of
course we could have taken on the contract but we turned it down. We have
a similar stance on companies who lobby on behalf of fracking for gas
extraction. These are not really rules that we have written down, it is more
that we discuss issues as they come up and take a position on them. Being
an ethical lobbyist does involve some tough decisions – especially when
there is money on the table, but there is a certain way we want this business
run.
The other thing about lobbying that is often overlooked is the amount of work
we do on behalf of smaller charities. Often without our intervention they
would never get noticed. I would say that around 50% of our work is with the
charity sector. We are able to highlight some important causes that might
otherwise not get noticed. For example, we recently were able to get some
sponsorship to hold a big event for the National Ankylosing Spondylitis
Society. Yes, you did read that correctly. Ankylosing Spondylitis is a kind of
chronic arthritis which affects parts of the spine but of course barely anyone
has heard of it. What we discovered from talking to this small but very
important society is that so many people suffer from this condition and it was
important to raise awareness amongst politicians and opinion-formers. So we
found a bunch of well-known people who suffered from this condition and
had them speak at an event in the Assembly. One of them was actually quite
a well-known Westminster MP. We managed to get the majority of Welsh
Assembly Members along to the event and it created quite a big impact. We
know the media and were able to get some good coverage. We know how to
event manage for a government audience. That package just wouldn’t have
happened without a professional public affairs intervention.
Sometimes the work of a lobbyist is much more hands-on and involved in the
detail of legislation and governing. For example, I work pro bono on behalf of
the Wales Violence Against Women Action Group and have been doing so
now for over six years, simply because it is a cause I really believe in. We
have been phenomenally successful over the years in raising the profile of
this issue and getting it high up the Welsh Assembly Government’s agenda.
But of course, government being government, when it came time for new
legislation in this area, things started to slip and go wrong. So when the draft
legislation was presented it was obvious that the original intentions of the
government were getting lost. Why was this? Was it because government
ministers had changed their minds? No. It is because the detail of these
pieces of legislation is passed around government departments. Government
officials, who can be quite cautious, start to work on the legislation, and what
appears the other end can be quite different from the original intention. So I
have been meeting one of the government special advisers on this every
week to stay on top of it but if we weren’t doing this then the whole point of
the legislation could be lost, or at least heavily diluted. It is about knowledge
of the system and the patience and analytical skill to stay on top of
something like that.
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Of course I don’t want to leave the impression that all of our work involves
charities pretty much anyone would support. We do work on behalf of large,
blue-chip business as well. We have just been working with the mobile and
communications company EE, for example, on broadband roll-out policy,
making sure its voice is heard. We also do some quite large-scale projects,
such as working with large renewable energy projects and companies, which
can of course divide opinion amongst the public. But we believe in renewable
energy and we believe that tough choices and compromises need to be
made by everyone for a more sustainable energy balance, and so we do that
work. These are always easy choices but we talk them through. When I
worked in government I was surprised at how few approaches I would
receive from lobbying companies. In many ways that was a shame. My area
of policy responsibility was culture and sport and I made a big effort to go
out and meet as many organisations in this area as I could. That voice from
the outside, from people who actually do the work in communities, is so
important. Why? Because government work is busy, it is often all-consuming.
It may seem on the outside as if progress is very slow, but inside that
government bubble, there are always little dramas, twists and turns. On top
of that, officials have often been socialised into the ways of government.
They are often people who have developed a level of expertise, but also a
strong opinion, on their area of policy. That voice and level of expertise is
crucial for ministers to hear when they are making policy and drafting
legislation. But that can’t be the only voice they hear. So I saw it as an
absolutely critical part of my role as a special adviser to get out and look for
and surface those outside voices. It is the only way governments can make
good policy, good law, that is relevant and valuable to citizens.
Comment
There are several elements of interest in the experience of Cathy.
As far as the first question is concerned, in Cathy’s words lobbying is

essentially described as an activity about the promotion of interests of your
clients: this is done mainly dealing with government, but in some cases with
the overall society (think of the charities example provided). Cathy sees her
work as ‘coaching, educating and preparing clients for a more professional
and effective relationship with government’.
Lobbying – ‘the interface between business and government’, in her words -

is very much related to ethics (our second question), because campaigning
and promoting some interests implies a judgement about the interests and
values you are advocating. For example, in the experience of Cathy she has
told us that she refused to have among her clients a company in the tobacco
industry.
In terms of potentialities of lobbying (our third question), as Cathy said,

lobbying can be a powerful tool for any kind of businesses and/or third sector
organisations in order to highlight some important causes that might
otherwise not get noticed.
130
Summary
Business and government relations could be seen for businesses as a
strategic activity aimed at creating value for the company (Schepers, 2010).
In this reading you have learnt that understanding, analysing and eventually
managing effectively the relationships with government is critical for the
success of many businesses. Relations between businesses and government
may vary from lobbying to partnership, with some more intermediate forms
like consultation, agreement and collaboration. The importance of business–
government relations is tremendously increasing, because many societies are
in a period of profound change and the division of economic activity into
three sectors (private, public and third sector) is no longer adequate. This
means that much of the business is now happening in more hybrid areas
where different sectors engage in different kinds of cross-sector
relationships; in this perspective, adopting a systemic and holistic view for
looking at businesses and at their relationships with the other actors of the
economic system is one of the key skills that every manager needs to have.
131
Readings 37–45
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UK Government (2013) ‘Defra and Association of British Insurers reach an
agreement on flood insurance’, [online]. Available at https://www.gov.uk/
government/news/flood-insurance-agreement-reached, (Accessed 8
February 2015).
133
Readings 37–45
Acknowledgements
Figures
Reading 37
Figure 1: Picture of Adam Smith: © Old Paper Studios/Alamy
Figure 1: Adam Smith title page of book: © Lebrecht Music and Arts
Photo Library
Figure 2: Taken from www.bbc.co.uk GCSE Bitesize
Figure 4: Sloman, J. (2008) Economics and the Business Environment, 2nd
edn. Copyright © Pearson 2008
Figure 5: Eugene Sergeev/Shutterstock
Reading 38
Figure 1: Teal Adrian/Cartoonstock.com
Figure 2: Taken from: www.marctomarket.com. Source The Economist
Figure 3: Stoyan Haytov/123Royaltyfree.com
Figure 4: ©Jan Kranendonk/Dreamstime.com
Figure 5: © Geoffrey Robinson/Alamy
Reading 39
Figure 1: © KevinAlexanderGeorge/iStockphoto.com
Figure 2: © Furlong/Getty Images
Figure 3: ©iStockphoto.com/alexandrumagurean
Figure 4: © Daniel Thomberg/Dreamstime.com
Figure 5: © iStockphoto.com/Kirby Hamilton
Figure 6: © Rex/Glenn Copus/Evening Standard
Figure 7: © Rudy Cech/Barcroft Media/Getty Images
Reading 40
Figure 2: Taken from http://creepypasta.wikia.com. This file is licensed
under the Creative Commons Attribution-Share Alike Licence http://
creativecommons.org/licenses/by-sa/3.0/
Figure 4: Jeff Overs/Getty Images
Figure 5: © Myimagine/Shutterstock.com
Figure 9: © Neil Tingle/Alamy
Figure 10: © Johann68/Dreamstime.com
134
Acknowledgements
Reading 41
Figure 1: © Robert Harding World Imagery/Alamy
Figure 2: © Gordon Anthony/Getty Images
Figure 3: © Pedro Armestre/AFP/Getty Images
Figure 4: © Tony Gentile/Reuters/Corbis
Figure 5: © Robert Harding World Imagery/Alamy
Figure 6: © Kipper Williams
Reading 42
Figure 1: © Bob Masters/Alamy
Figure 2: © ImageBROKER/Alamy
Figure 3: © Vargklo This file is licensed under the Creative Commons
Attribution-Noncommercial-ShareAlike Licence http://creativecommons.org/
licenses/by-nc-sa/2.5/
Figure 4: © Scott Barbour/Getty Images
Figure 5: © Jeff Greenberg/Alamy
Reading 43
Figure 1: © iStockphoto.com/JDEstevao
Figure 2: © AFP/Getty Images
Figure 3: © Murdock2013 | Dreamstime.com
Figure 4: © Cartoonwork.com. Carol Simpson Productions
Figure 6: © The Advertising Archives
Figure 7: © Keystone Pictures USA/Alamy
Figure 8: © Richair/Dreamstime.com
Reading 44
Figure 1: © Mustafa Yalcin/Anadolu Agency/Getty Images
Figure 2: © Icefields/Dreamstime.com. Government Photo
Figure 3: © Jack Pease Photography. This file is licensed under the
Creative Commons Attribution Licence http://creativecommons.org/licenses/
by/3.0/
Figure 4: © ronfromyork/Shutterstock.com
Figure 5: © David Simonds
Figure 6: © Christopher Boswell/Shutterstock.com
Figure 7: © SOMKKU/Shutterstock.com
Reading 45
Figure 2: © iStockphoto.com/Arpad Benedek
Figure 3: © iStochphoto.com/Typhoonski
Figure 4: © Jeremy Selwyn/Evening Standa/REX
135
Readings 37–45
Figure 5: Courtesy of Cathy Owens
Text
Reading 37
Page 15: Burn-Callander, R., (2014), 'Scottish Salmon' Boosts UK food
exports' The Daily Telegraph 24 March 2014.© Telegraph Media Group
Limited 2014
Reading 38
Page 29: Spenc, P. (2014) London Houses Now cost more than £5000.000,
The Daily Telegraph 16 September 2014.©Telegraph Media Group Limited
2014
Reading 40
Page 51: Hall, J. (2012) ‘Britons shun Christmas cards after stamp price
rise’, The Daily Telegraph, 23 November 2012, © Telegraph Media Group
Limited 2012/2014
Page 58: Paris, N. (2014) ‘Iceland's WOW air launches £99 flights from
London to the US’, The Daily Telegraph, 23 October 2014,© Telegraph
Media Group Limited 2012/2014
Reading 41
Page 70: Automotive News (2014), 'Fiat-Chrysler creates Dutch holding,
sets tac domicile in UK', Automotive News 2014. Reproduced by
permission of Crain Communications Inc.
Page 74: The Times (2013) Rate Expectations: Central banks are keeping
monetary policy loose to stimulate recovery. 20 December 2013. Copyright
© The Times 2013
Reading 42
Page 86: Bedigian, L. (2013), ‘Whitney Tilson: Prices Will Continue to
Rise’, 15 May 2013, Copyright © Benzinga.com
136
Block 6
Readings 46–55
By Owain Smolović-Jones

Act 1988.
3WX
ISBN 978 1 4730 03514
2.1
Contents
Reading 46: Introduction to business ethics 5
Introduction 5
1 Defining business ethics 8
2 Ethics, the law and regulation 12
Summary 15
References 16
Reading 47: Corporate social responsibility 17
Introduction 17
1 Should corporations have a social responsibility? 19
2 The basics of corporate social responsibility 20
3 Dimensions and attitudes to CSR 23
4 Criticisms of CSR 31
Summary 32
References 33
Reading 48: The environment, sustainability and
business 35
Introduction 35
1 Key environmental issues and the implications for business 37
2 Sustainability and business 45
Summary 50
References 51
Reading 49: Immanuel Kant and deontological ethics 53
Introduction 53
1 Kant’s theory of moral duty 55
2 The usefulness of Kant to business ethics: a discussion 61
Summary 62
References 63
Reading 50: Consequentialist ethics 64
Introduction 64
1 Utilitarianism 65
2 Problems with utilitarianism 70
Summary 71
References 73
Reading 51: Justice in organisations and societies 74
Introduction 74
1 Distributive justice 75
2 Justice as fairness: John Rawls 78
Summary 81
References 83
Reading 52: Virtue ethics 84
Introduction 84
1 Virtue ethics: moral and intellectual virtues 88
2 Virtue ethics: problems and possibilities 90
Summary 91
References 93
Reading 53: Human rights and business ethics 94
Introduction 94
1 What are human rights? 95
2 Human rights and business 98
Summary 102
References 103
Reading 54: Stakeholder management 104
Introduction 104
1 Ways of thinking about stakeholder management 106
2 Informing stakeholder analysis and management from an
ethical basis 110
3 Influencing stakeholders 111
Summary 113
References 114
Reading 55: Codes of ethics 115
Introduction 115
1 The purpose of codes of ethics 117
2 Codes of ethics: problems and possibilities 121
Summary 123
References 125
Reading 46: Introduction to business ethics
Reading 46: Introduction to

business ethics
Introduction
Why study ethics as part of a business and management qualification? Let’s
start with a story of an industrial accident which, for many, represents one
of the most compelling cases of why business organisations have ethical and
social responsibilities above and beyond their economic purpose and beyond
the letter of the law.
Example of ethical and social responsibility: The Bhopal disaster

In 1969 the US chemicals manufacturer Union Carbide Corporation and its
Indian subsidiary, Union Carbide India Limited, agreed to build a pesticide
factory in Bhopal, India. The factory would produce a pesticide called Sevin,
which consisted of the two major chemical ingredients: alpha-naphthol and
the highly toxic methyl isocyanate (MIC). A second plant was built in the
late 1970s. This plant met with several problems during construction and had
to be modified before becoming operational in 1979. It never operated to full
capacity and was beset with numerous safety problems, shutdowns and
periods of partial operations from 1982 to 1984.
A settlement had sprung up in the immediate vicinity of the plant, mostly

housing Union Carbide workers and their families. Although a settlement this
close to the factory was illegal under local law, the authorities did not
intervene, partly because it provided cheap housing for factory workers on
low wages.
In 1984, the chair of the Union Carbide board of directors, Warren Anderson,
and the company’s top management endorsed a plan to sell the Bhopal plant
because it was underutilised and therefore not profitable. The company also
announced its plans to expand investment in areas other than pesticide
production.
On the evening of 3 December 1984 the disaster began to unfold. An

operator noticed that the pressure on one of the MIC storage tanks was four
times higher than normal but was unconcerned because he assumed this
was due to maintenance operations during the previous shift. Around
midnight several workers noticed their eyes had begun to water and sting, a
sign of a chemical leak. A small leak was soon discovered but caused the
workers no concern as they were frequent at this plant. The workers decided
to go to the canteen for their tea break and to address the leak afterwards.
Finally, the pressure in the MIC tank caused the relief valve to open and
poisonous gas escaped several hundred feet into the air. Because of the
weather conditions the gas drifted to the surrounding villages and
settlements. Gas leaked for 40 minutes and finally covered an area of 25
square miles.
As the gas spread, weak and elderly people died within moments, others
experienced watering and stinging eyes and breathing difficulties. The
5
Readings 46–55
authorities decided to divert incoming trains because of the gas leak, thereby
cutting off the best means of escape from the area for most people. Only the
wealthy were able to flee the area in their cars. Most of the 1 million
inhabitants of Bhopal tried to flee on foot. The plant was shut down but it
was only three days afterwards that the situation was considered stable
(Figure 1). Four years later, the number of dead was estimated at about
3,000, with 300,000 more having received injuries such as burned lungs,
charred eyes and damage to the nervous system.
Figure 1 The Bhopal plant after the disaster
The accident was later attributed to poor management and cost cutting at the
Bhopal plant, perhaps because of Union Carbide’s decision to sell the plant.
Plant and equipment were allowed to deteriorate and skilled employees were
replaced with less qualified ones, all in an effort to save money. Low
employee morale and possible sabotage have also been suggested as
causes for the accident.
The Indian government withdrew the operating licence for the Bhopal plant
immediately after the accident. The Attorney General of India (i.e. the head
public prosecutor) proposed sueing Union Carbide in the USA rather than the
Indian courts because US law provided for much tougher sentences in such
cases of business negligence but this was refused by the US courts. On
moving to the Indian courts, Union Carbide and the Indian government
reached an out-of-court settlement of US$470 m, much lower than the US
$3.3 bn hoped for by the government. Union Carbide also committed to
building a hospital with US$17 m in Bhopal to treat those affected by the
disaster. The authorities in Bhopal later placed a warrant out for the arrest of
Warren Anderson, the chair of Union Carbide, for manslaughter. He was
never brought to trial in India and died in a US nursing home in 2014. Seven
former employees of Union Carbide, all Indians, were charged and convicted
in 2010 of causing death through negligence (26 years after the event!) By
this time they were in their 70s. In 2014, the magazine Mother Jones
produced an article quoting local officials in Bhopal as stating that between
120,000 to 150,000 people are still suffering serious health consequences as
a result of the disaster.
6
(Trotter et al., 1989)
Exercise 1
Having read through the example above, make some notes on the following
questions:
1 Who do you think is to blame for the Bhopal disaster?

2 Were the authorities right to pursue the chair of Union Carbide through
the criminal courts?
3 What are the main lessons that you think business managers can learn
from this story?
Comment
The answers to the questions above are to some extent a matter of opinion.
However, based on the case information, here are some thoughts:
1 Most commentators agreed that Union Carbide India Limited and its
parent company Union Carbide Corporation had a responsibility to
maintain the plant in good and safe working order and had failed to do
so. Even if an act of sabotage by a worker had taken place (whether this
was the case remains a matter of debate to this day) it was still the
company’s responsibility to make sure such things could not happen. The
courts found Union Carbide neglected its duty to keep the plant in safe
working condition and was fined accordingly. It could also be argued that
the authorities that had allowed the settlement to spring up so close to
the plant carried some blame. In addition, perhaps the Indian authorities
should have exercised tighter regulatory control over the plant and are to
blame to some extent for not doing this.
2 It is interesting to consider whether the chairman of the board of Union
Carbide was personally responsible. It could be argued that, as the top
manager of the company, he was ultimately responsible for everything
that went on in the organisation. However, it could also be argued that no
single person can possibly know or control everything going on in a large
organisation and that someone can only be morally responsible for things
over which they have some control.
3 One of the most important lessons to be learned is the enormous
potential of companies to do harm to people and the environment if they
are not careful. If business organisations have this much potential to
cause harm then they surely also have a responsibility to do everything in
their power to minimise or eliminate this potential. Another related lesson
is that by not making sure harm is avoided or minimised, the company’s
reputation and ultimately its survival (at least as an independent
organisation) is at stake.
7
Readings 46–55
This example will probably make it obvious to you that ethics is not a ‘nice
to have’ extra for managers to think about but can become a vital question
of business survival. Arguably, responsible business behaviour is even more
important for the stakeholders of business organisations, whose livelihood,
health and even lives may be at stake.
Ethics is, of course, not only an issue for business organisations. On the
contrary, stakeholders have even more right to expect responsible and
ethical conduct from those running public sector organisations. After all,
such organisations exist to set the rules that govern society, provide public
services, and generally concern themselves with the public good. Voluntary
organisations are often set up with the explicit goal of achieving some
social purpose, such as help for disadvantaged groups. Therefore we may
reasonably expect those who work in them to take into account ethical
considerations in their decisions. If we talk about business ethics in these
readings it is partly as a matter of convenience (‘business, public and
voluntary sector ethics’ would be quite a cumbersome title) and also
because questions of ethics often seem particularly stark in the business
context. Business ethics has therefore developed into a field of academic
study in its own right. But the vast majority of the ideas and concepts
introduced in this set of readings are relevant to all sectors.
This reading will first define business ethics. It will then consider the
legislation and regulation covering the activities of business and how
following the law and rules differs from applying an ethical lens to activity.
1 Defining business ethics

Business ethics is a field of study concerned with judgements about what is
right and wrong within the area of business (and other organisational)
practice. However, this definition conceals in its simplicity a range of more
complicated issues.
In reality business ethics is mostly not about right and wrong but about
‘wrong and more wrong’ or ‘almost-right and a-bit-wrong’. In other words,
business ethics is often about dilemmas:
. dilemmas that have to take into account complex contexts

. dilemmas that acknowledge managers very often operate from a basis of
incomplete information
. dilemmas that acknowledge managers often operate from a basis of
insufficient time
. dilemmas that look very different depending on the theoretical and
practical position from which they are viewed (Lawton et al., 2013).
8
Much of the business studies material you encounter in your modules aims
to make the world of business more understandable and more manageable.
It provides theories and tools that enable you, if not to simplify the
demands and challenges you will face in real life, then at least to put more
order into an organisational life that is often full of complex and competing
demands.
Business ethics, in some ways, can also offer methods of tidying up your
thinking. However, in other ways it is an area of study that takes you
directly into uncertainty. It does not necessarily try to tame uncertainty but,
rather, offers you a range of ways to think about uncertainties in business.
Business ethics allows you to view uncertain and complex situations from a
range of perspectives. These perspectives can come in the form of particular
practitioner and social issues, theoretical frameworks or more applied
managerial practices. Each will provide a different perspective on business
ethics and, hopefully, when they are placed together (issue, theory and
practice), you may gain a richer and more comprehensive view of the
possibilities for working as an ethical manager.
Example of a business ethics perspective: National Grid and

housing development in London
The National Grid is the company that owns the electricity transmission
system in England and Wales. It has recently signed a deal to develop some
of its land in Greater London for new housing, in partnership with a large
property developer. If you were a manager with The National Grid and
already possessed your OU business degree, you would be able to apply a
range of strategy and marketing theory to build competitive homes that would
sell well. You would apply some operations theory to ensure the project was
completed on time. Some finance theory would be applied to ensure the
project finished within budget and that sales made a profit. Human resources
theory would be applied to ensure your employees were satisfied and worked
in an efficient manner.
But what about the rights and wrongs of building new homes? A business
ethics perspective would recognise the uncertainties and complexities of a
large new home building project. First, you would look at some of the ethical
issues. For example, what would the environmental impact be of building
new homes? You might also look at the social issues concerning housing;
there are currently too few homes available in London at affordable prices.
9
Readings 46–55
You would look at some ethical theories to explore different ways of

analysing the process of making decisions, the consequences of those
decisions and in fact the character of the managers and people working for
you. Finally, you would also want to look at some more practical ways of
enacting an ethical approach to building new homes – perhaps considering
how to enforce certain ethical standards. In isolation none of these issues,
theories or ways of working with ethics would provide one correct answer but
they might contribute to making sense of some of the uncertainties, risks and
interests at play.
When studying business ethics and when having to deal with ethical issues
in your work be careful not to seek definite answers. Business ethics is a
complex area of study that will help you to reflect on complex business
problems and expand the basis upon which you make your judgements. It is
not about easy answers.
Finally, business ethics looks quite different depending on where you stand
in relation to a business. In fact as a diverse group of students you will be
approaching the area of business ethics from a number of different identity
positions. Many of you will be employed in business and some of you will
be managers within a business. Both of these groups of people will think
about the rights and wrongs of business activities based on the fact they
deliver services or products for others. Simultaneously you are all
consumers of business products and so you will make judgements on the
rights and wrongs of a business from this perspective. If you value the
products or services of a business you will be concerned that it remains
financially healthy into the future so that you can continue to enjoy its
products or services but you may also be concerned that your custom is not
financing unethical practices. You may own shares in a business, in which
case you will be concerned with the return you may get for your
investment. You may also want to be sure your money is not invested in
activities you disagree with, for example because they harm the
environment, or because the company employs people at very low wages in
bad working conditions. You may perhaps also be a member of a particular
political, religious or advocacy group and so have a defined cause that is
important to you: for example, you might be concerned about human rights
or animal rights.
In other words, there are many valid ways in which one can read business
ethics – as a manager, worker, shareholder, consumer or advocate. Each of
these is an important perspective and increasingly business managers are
being asked to consider each one, as you have already discovered through
an introduction to stakeholder analysis.
Exercise 2
Imagine you are a manager leading the project outlined earlier to build new
homes in the London area on unused land owned by The National Grid. In
order to make sure you make the right decisions you want to consider what
the main concerns of the key stakeholders (i.e. individuals or groups of
10
people affected by this project) are. Make some notes on one main concern
you think each of the following people might have:
. an employee of the housing company that will build the new homes
. a shareholder of the housing company
. a potential homebuyer
. a member of an environmental advocacy group.
Comment
Here are some concerns that the groups mentioned above might have:
. An employee would, of course, want to be treated in a humane way, with

a decent wage and working conditions. An employee would be interested
in the project going ahead as this is likely to make their employment more
secure.
. A shareholder will want a good return on investment. If the project goes
ahead this is likely to lead to improved profits for the housing company
and therefore a better return on shareholders’ investment. On the other
hand, if anything went wrong with the project, for example a serious work
accident, environmental pollution in the course of the building work, or the
discovery of illegal working practices, such a scandal would affect the
reputation of the company and could have a negative effect on the share
price.
. A homebuyer would be concerned with the social issue of the affordability
of housing, an issue that is especially pronounced in the Greater London
area. The building of new homes could be good news in this respect
because it will increase the availability of houses and thus might reduce
prices. However, if the new homes were only aimed at rich people and
priced accordingly, this would not help ordinary house buyers.
. An environmental group will be concerned with the extra pollution and
environmental impact created by the development and would be seeking
reassurances that the development will be abiding by environmental
regulations and will be using the latest, eco-friendly technology.
Each of these perspectives may be valid and you can probably already see
that it could be difficult to make sure that all these different interests are
being met. You will be studying some of these issues in more detail later.
In conclusion, adopting an ethics perspective is concerned with refining

judgement and finding a way of balancing and evaluating competing claims.
This balancing act often involves a set of key questions:
. How do businesses balance their need to make a profit for their owners
with the need to contribute to the broader good of society?
. How far should businesses go in contributing to the wellbeing of
society?
11
Readings 46–55
. Where do the responsibilities of business begin and end?

Businesses might, more often than not, want to do the right thing but are
constrained by living with limited resources, time pressures and budgets.
These issues will be discussed throughout the readings that follow.
2 Ethics, the law and regulation

Laws and regulations are formally recorded rules, many of which apply to
businesses and other organisations. They can be regarded as a form of
guidance for the conduct of business and as a means for judging whether
businesses have complied with their societal duties. They are an official
record of a minimum set of standards a society expects businesses to adhere
to.
The sources of laws and regulation are manifold but can be summarised as
broadly emanating from government and from business itself. ‘Government’
is a broad term that stands for ‘a variety of institutions and actors at
different levels that share a common power to issue laws’ (Crane and
Matten, 2010, p. 493).
Exercise 3
Take a few minutes to list some government institutions that have the power
to issue laws affecting the work of a business in some way.
Comment
In thinking about this question, you will likely have identified a range of
national and local government institutions that issue a diversity of broad and
specific laws. You may have identified national, regional and local
governments, as well as arms-length organisations acting on behalf of
government. You may also have thought about international,
intergovernmental bodies, such as the United Nations or the World Trade
Association, that also make rules that affect businesses. Apparent from your
thinking should be the idea that ‘government’ is a catch-all word for all
bodies that issue laws. The multiplicity of government bodies that make laws
and regulations affecting businesses is further explored below.
In the UK, laws are only made by elected politicians, who are people voted
in by citizens to represent their beliefs and interests. Government bodies can
therefore operate at a national level – for example through the UK
Parliament and its MPs. The UK government writes and applies all kinds of
laws that regulate the behaviour of businesses. For example, the National
Minimum Wage in the UK states that all businesses must pay workers a
minimum amount of money per hour for their work. If a business violates
the law, it could face criminal prosecution.
12
Sitting above the UK Government (in the sense of having a wider reach of
influence, but not necessarily depth of influence) is the European
Commission and Parliament. Deriving from Europe is a broader set of legal
requirements, as agreed by member states. Much of the UK’s health and
safety legislation and its workers’ rights legislation (such as paternity leave
and so on) comes from the European Union. European Union legislation
also enables free trade and free movement of labour across the borders of
member states. The United Nations (UN) is another salient example of what
is referred to as a supranational governmental agency, meaning it transcends
the borders of nation states. One important purpose of the UN is to gain
international agreement for issues considered to be a high priority for the
world in general. Hence the UN has played a leading role in trying to gain
agreement on action to combat climate change. Moreover, as you will note
elsewhere in this block, the UN has been an important institution in
introducing the concept of human rights. The UN is also a powerful
development agency, meaning it leads initiatives to develop the economies,
health and wellbeing of developing countries, countries that are frequently
targeted by businesses as consumer markets or as alternative sites of
production.
Beneath the UK government sits a range of national and regional elected
bodies. In Wales, Scotland and Northern Ireland, devolved national
governments have the power to legislate in most areas of policy outside
defence, macro-economic matters and the provision of welfare, especially in
the delivery and design of public services. Legislation affecting transport
and the environment might very often vary in the UK’s devolved nations.
For example, the Scottish Climate Change Bill is widely regarded as
imposing more stringent targets than those set by either the UK Parliament
or the European Commission. Beneath devolved national governments, local
councils (district, county and unitary) can issue smaller scale bylaws and
make a broad range of decisions concerning the legality or otherwise of
business operations. One example of such powers lies in the ability of
councils to determine whether certain building work and trading practices
are legal.
Governments can also establish official bodies that conduct their activities
at arm’s length from elected politicians. In other words, these bodies are
supposed to deal with issues that are relatively non-political – they
formulate policy and deal with enforcement in a way that is not supposed to
be subject to party politics. While such agencies do not draft and pass
legislation, they do produce guidance, and some agencies possess powers to
impose punishments and sanctions on businesses that break the law. One
such influential agency in the UK would be the Environment Agency,
which, amongst a number of responsibilities, monitors and supports the
moving of hazardous waste.
When thinking about business operations and ethical conduct, businesses
need to therefore carefully consider whether they abide not only by national
laws but by those set and policed by other government agencies.
However, outside the scope of government, businesses often establish rules
to govern their own conduct. Such self-imposed rules may arrive from a
variety of trade or sector bodies. Businesses often prefer industry regulation
13
Readings 46–55
to legislation because they feel that such self-regulation will be more aware
of the particular conditions and needs of an industry and will impose less
bureaucracy on businesses. One example of a powerful professional
association is the UK Chartered Institute of Personnel and Development
(CIPD). While not holding any direct power over businesses, the CIPD
approves particular training and professional standards widely accepted in
the UK as good human resource practice.
Most legislation and regulation is derived from a basis of ethical
deliberation. This is certainly the case in most democratic states. In other
words, legislation and regulation are usually thought of as a representation
of what a society thinks is a fair representation of the ethical standards
expected of business in a society (Crane and Matten, 2010). This does not
mean that laws and regulation capture the entirety of a society’s
expectations for ethical conduct in business. Viewing ethics simply as a
matter of legislation and regulation is therefore problematic.
There are several problems with simply viewing business ethics as a matter
for legislation and regulation.
First, decisions about new laws may be coloured by special interests of
various groups with political power as well as by a neutral deliberation of
what is right. Most people know that political parties gather money and
support from particular bases (business, trade unions, and so on). It is
therefore always possible that this power base of the party in government
may have an unduly strong influence on legislation. Legislation favouring
workers or big business might not always be as favourable to small- and
medium-sized businesses or to the unemployed, for example. In other
words, it may be the case that not all legislation is strictly ethical or helpful
for business practitioners trying to do the right thing. Sometimes being an
ethical practitioner might involve going beyond, or even counter to, the
official law or regulation.
Second, the world we inhabit is one marked by continuous and rapid
change, due to an eroding natural environment, changing migration patterns,
development of technology and an increasingly connected global population.
Today’s rules and laws may be of no use tomorrow. It usually takes
legislation some time to catch up with the latest scientific knowledge or
developing societal consensus on certain issues. Ethical business practice
may therefore mean having to go beyond the law in certain respects. For
14
example, many businesses go beyond what the law requires of them in how
they treat their employees, how they relate to local communities, or the
technology they employ in order to protect the environment.
Finally there is the problem referred to as the democratic deficit problem.
The phrase ‘democratic deficit’ has entered common parlance as a way of
describing how citizens can live in a system officially described as a
democracy and treated as such internationally but where a considerable
number of its citizens have no real power to influence politics and
legislation (Norris, 2011). In this case, the law cannot really be regarded as
a manifestation of societal consensus on how individuals and organisations
(such as businesses) should behave.
In short, while following the law would normally be considered an
important element of business ethics (although there may be exceptions to
this, for example where laws themselves are discriminatory or seem
arbitrary), ethical business conduct cannot be equated with merely following
the law. Often businesses are asked to – and do – go beyond the law in
order to behave in a way that they and their stakeholders consider to be
right.
Summary
This reading started by introducing the idea of business ethics as an area of
study concerning the analysis of judgements about what is right and wrong
in business. It was stated that business ethics can be viewed from a range of
different perspectives, those of managers, employees, customers, citizens,
politicians, and pressure and community groups. Viewing ethics from each
point of view can open an ethical practitioner to a range of new and valid
perspectives.
The reading concluded by considering the role of legislation and regulation
in relation to business ethics. Societies seek to legislate and regulate in
order that their ethical expectations are formally captured, which can be
useful for businesses, as more clarity is provided governing what is
considered right and wrong. Nevertheless, laws and regulation cannot
capture every dimension of ethical business conduct and business managers
often need to go beyond the law and develop their own judgement on
societal, environmental and ethical issues concerning their business.
15
Readings 46–55
References
Crane, A. and Matten, D. (2010) Business Ethics: Managing Corporate
Citizenship and Sustainability in the Age of Globalization, Oxford, Oxford
University Press.
Lawton, A., Rayner, J. and Lasthuizen, K. (2013) Ethics and Management
in the Public Sector, London, Routledge.
Norris, P. (2011) Democratic Deficit: Critical Citizens Revisited, Cambridge,
Trotter, R.C., Day, S.G. and Love, A.E. (1989) ‘Bhopal, India and Union
Carbide: the second tragedy’, Journal of Business Ethics, vol. 8,
pp. 439–454.
16
Reading 47: Corporate social responsibility
Reading 47: Corporate social

responsibility
Introduction
In this reading the issue of corporate social responsibility (CSR) will be
discussed. CSR is a concept that deals with the ethical and social
responsibilities businesses have over and above the law. It seeks to provide
a framework to enable businesses to think about and prioritise their
responsibilities. The idea of CSR does have its critics, specifically those
people who argue it is not the place of business to engage in ethical duties
over and above legal responsibilities because it is a matter for citizens, via
their governments, to establish ethical expectations in society.
Nevertheless, given the imperfections of any legal and regulative
framework, as previously discussed, CSR has developed as a means by
which businesses have been able to proactively come to terms with their
ethical outlooks and responsibilities. In this reading you will be introduced
to a defining piece of CSR thinking: Carroll’s notion of there being different
dimensions of CSR engagement. Carroll argues that businesses can think of
themselves as operating in one of four types of CSR engagement – from the
very low to the very ambitious. As the reading proceeds you will be asked
to think about some of the main issues and debates arising in this field of
study.
To begin read through the example below. This is the CSR statement of
Tata Power, the energy subsidiary of the major Indian company, Tata. Tata
is best known in the UK as a steel producer but is a large and diverse
company.
Example of a corporate social responsibility statement: Tata

Power
Figure 1 Tata Power
17
Readings 46–55
"At Tata Power, our Sustainability Policy integrates economic progress, social
responsibility and environmental concerns with the objective of improving
quality of life. We believe in integrating our business values and operations
to meet the expectations of our customers, employees, partners, investors,
communities and public at large.
We will uphold the values of honesty, partnership and fairness in our

relationship with stakeholders.
We shall provide and maintain a clean, healthy and safe working

environment for employees, customers and the community.
We will strive to consistently enhance our value proposition to the customers

and adhere to our promised standards of service delivery.
We will respect the universal declaration of human rights, International

Labour Organization's fundamental conventions on core labour standards
and operate as an equal opportunities employer.
We shall encourage and support our partners to adopt responsible business

policies, Business Ethics and our Code of conduct Standards.
We will continue to serve out communities:
. By implementing sustainable Community Development Programmes

including through public/private partnerships in and around its area of
operations.
. By constantly protecting ecology, maintaining and renewing bio-diversity
and wherever necessary conserving and protecting wild life, particularly
endangered species.
. By encouraging our employees to serve communities by volunteering and
by sharing their skills and expertise.
. By striving to deploy sustainable technologies and processes in all our
operations and use scarce and natural resources efficiently in our
facilities.
. We will also help communities that are affected by natural calamities or
untoward incidence, or that are physically challenged in line with the Tata
Group's efforts.
. The management will commit all the necessary resources required to
meet the goals of Corporate Sustainability.”
(Tata Power, 2014a)
Exercise 1
Having read through the CSR statement of Tata Power above, make some
notes on the following questions:
. What issues of corporate social responsibility (e.g. environment, human

rights, etc.) does Tata Power identify in its CSR statement?
18
. What are the groups of stakeholders to whom Tata Power has a

responsibility, according to its CSR statement?
. What kind of values does Tata expect of its employees and in its overall
conduct?
Comment
. The main thing to note about this statement is its breadth. The issues of
CSR identified by Tata are broad indeed, possibly reflecting not only the
reality of the reach and impact of multinational corporations to affect
people’s lives but also this particular company’s strength of commitment.
We see in this statement that the company highlights human rights,
working conditions, the environment, local communities and the conduct
of employees as important issues to be addressed.
. Given the issues highlighted above, a number of stakeholders become
important for Tata: employees and their trade unions (the company is
committed to equal rights as certain working standards), citizens in the
local communities where Tata operates, even the local wildlife
surrounding Tata’s plants can be considered as stakeholders.
. The company states it is committed to ‘honesty, partnership and fairness’
in its relationship with stakeholders. The company speaks almost as if it
is, in itself, a person with certain beliefs and values. Of course we know
that any company is a collection of a number of people, not all of whom
will share the same commitments. So is it realistic or beneficial for a
company like Tata to describe itself as if it were a person with ethical
commitments? This issue will be picked up in the following section.
1 Should corporations have a social

responsibility?
Think a moment about the person you are closest to. This might be a
member of your family, or a close friend. Imagine that this person has
somehow disappointed your own personal ethical code. For example, this
person might have confided in you that he/she had been lying about
something in his/her personal life, or even breaking the rules at work. You
might feel angry with this person. You might urge them to somehow come
clean. You might even choose to hold that person accountable yourself. Or
you might feel great sympathy and offer some kindly advice. The point is
that there is a person you can hold responsible. You can point at this person
and know that if this behaviour becomes more widely known, then there
will – and probably should be – consequences.
Notions of responsibility become more difficult when dealing with a
business. A business is not a person in the strictest sense. You can’t have a
coffee or a chat with a business. A business is not, in and of itself, a living,
breathing, feeling human. Nevertheless, in the eyes of most laws, businesses
19
Readings 46–55
are thought of as a kind of person. They have responsibilities in law, in the

same way as people do.
This might strike you as somewhat harsh in many ways. Think about what
it must be like to be the chief executive of a large organisation, a large
manufacturing company, or even a government body, such as a large local
authority. This chief executive may employ thousands of people, and can’t
possibly be expected to know of everything that happens in the
organisation. And yet this chief executive – and others in the organisation –
will be held accountable, in law or by public opinion, if the organisation is
suspected of acting illegally or unethically.
Note here, though, the difference between violating the law and something
much less formal. A business might behave within the law but still commit
an ethical violation. Think back to what has already been discussed.
Legislation cannot possibly hope to capture the entirety of a society’s
ethical beliefs and expectations.
Hence there is the notion of corporate social responsibility (CSR). CSR can
be thought of as both the belief that a business has responsibilities to
society beyond its legal responsibilities and the manner in which it follows
through on such perceived obligations.
2 The basics of corporate social

responsibility
Tata is a large steel manufacturer founded in India, that employs (at the
time of writing) around 50,000 people in Europe. Look back to the CSR
statement of Tata in the example above. It contains a section that states why
the company believes social responsibility is important for its business.
Elsewhere on the group’s website it is stated that its belief in CSR can be
traced to the company founder, Jamsetji Tata, ‘who believed that businesses
must operate in a way that respects the rights of all its stakeholders and
creates an overall benefit for society’ (Tata, 2014b). The text continues by
stating that its commitment to CSR, as well as being embedded in this
20
rather general commitment to society, and to transparency and

accountability, is also expressed in a commitment to being a ‘fair and caring
employer’.
It is not the intention here to promote the virtues of a particular company
such as Tata but it is worth reflecting on what the consequences might be if
Tata did not buy into the principles of CSR. Imagine a large steel plant
opened in your neighbourhood. Or that a company, such as Tata, bought an
existing plant in your area as happened in parts of northern England and
South Wales. This company could invest an awful lot of time, resources and
energy in trying to work around regulations and laws, in the way it
employed people or in the way it treated its local environment. The
company might even spend a considerable amount of money employing
lobbyists to work towards softening workplace and environmental laws and
regulations.
A glimpse of a pre-CSR world in heavy industry can be found in the Big
Pit museum in Blaenavon, South Wales (Big Pit, 2014). Formerly a working
pit, tourists can now look around underground, exploring the lives and
conditions of miners and their families throughout history. The tour
(conducted by former working miners) and the displays are full of stories of
the exploitation of workers, as well as their local communities. There are
also many examples of industry trying to work with local communities,
contributing to local amenities and resources. The difference is stark,
bringing home the impact a big business makes on its surrounding area and
employees. The museum offers a fascinating glimpse into life before the
idea of CSR became widespread, when often employees, communities and
stakeholders relied on little more than the individual discretion and goodwill
of wealthy pit owners. Sometimes these owners engaged, listened and took
their responsibility as citizens seriously. More often than not, they did not.
One could argue that in this age of 24-hour media and the internet that it is
in the financial interests of companies to promote a sense of CSR. If a
business develops a reputation as exploitative or immoral, horror stories will
soon escape into the public domain. At the dawn of the industrial
revolution, there was no such thing as 24-hour news and the press was far
more respectful of people in positions of authority. Nowadays enormous
pressure and scrutiny is brought to bear on the conduct of business.
The catch is that it might be possible for businesses to operate legally but
unethically because either the law has not yet caught up with the progress
of business or because the legal system and system of government is
imperfect.
CSR can thus be thought of as an idea that deals with determining and
working with the ethical and social responsibilities of business beyond their
legal obligations. Offered below is a good definition of CSR:
Corporate social responsibility includes the economic, legal, ethical

and philanthropic expectations placed on organisations by society at a
given point in time.
(Carroll and Buchholtz, 2009, p. 44)
21
Readings 46–55
To supplement this definition, it is worth adding the notion that CSR also
includes the expectations and obligations placed on businesses by businesses
themselves. In other words, businesses can choose to go further than is
expected from them by society – they can lead expectations for social
responsibility.
Exercise 2
Which of the following definitions do you think best describes the concept of
CSR? Note down some short reasons for your answer.
(a) CSR is a concept that explores the obligations of businesses to their

owners.
(b) CSR is a concept that explores the appropriate degree of legislation and
regulation as they apply to businesses.
(c) CSR is a concept that describes the responsibilities of a business to
communities, stakeholders, and owners over and above what is required
by legislation and regulation.
Comment
CSR is an influential idea within business practice that has been written
about and debated extensively. The concept has settled and matured over
the past 40 years as a practical framework to enable businesses to reflect
and plan for the kinds of activities that will ensure it is held accountable as a
responsible corporate citizen in the eyes of stakeholders, managers and
owners. At the root of CSR is the notion that businesses are becoming ever
more powerful and influential, with greater global span, and that they are well
positioned to make a difference (for better or worse) within specific
communities.
The definition that best describes the concept is the third in the list above:
CSR is a concept that describes the responsibilities of a business to
communities, stakeholders, and owners over and above what is required by
legislation and regulation. Think about it this way: if you, as a private citizen,
broke no laws – e.g. you did not dump your household waste in unauthorised
public areas; you did not drive while under the influence of alcohol; you did
not steal from other people; you did not harm your neighbours by spilling
toxic fumes from your home into the air – would that be enough to qualify as
a socially responsible citizen and neighbour? Such behaviour would more
likely qualify you as a law-abiding citizen. In order to be socially responsible,
you would be required to contribute to the community and society in some
way over and above legal and regulative requirements.
There are various ways in which a business might seek to contribute to the
wellbeing of society. Businesses can conduct research to improve the
sustainability of operations over and above legal requirements. They can
seek to support the local community in which they work, for example,
22
through sponsoring certain community initiatives. Businesses can also raise

money for targeted charities, or even for schools. Furthermore, the owners
of a business can choose to donate money to causes not specifically related
to the core aims of a business, simply because they regard such use of their
money as a good in and of itself.
This means there is a lot of variety in terms of the CSR activities that
business can engage in. With all of this variety, how can one truly know
whether such a business’s CSR activity really makes a difference or that
such activity is a true representation of the ethicality or otherwise of a
business? The next section will prompt you to think about different
dimensions of CSR and to employ a way of differentiating between
businesses that commit much to CSR and others that do not.
3 Dimensions and attitudes to CSR

3.1 Dimensions of corporate social responsibility
It is often difficult to know where CSR begins and where legal
responsibility ends. In fact the lines do change frequently, according to
experience, political pressure and public mood. Nevertheless, it is helpful to
differentiate between what does and does not count as CSR, as well as to
make some sense of how seriously businesses take the idea of CSR. Some
CSR activity may be fairly superficial, even conducted more to improve the
public relations of a company than to genuinely use the power and
resources of a business to make a difference, but other CSR activity can be
said to involve a serious commitment of time, resources and energy. It is
helpful, therefore, to consider the range of responsibilities held by a
businesses and to reflect on whether these responsibilities can be thought of
as CSR activity or simply good basic business practice.
Archie Carroll developed a model to help people think about these
responsibilities. His four-part, pyramid-shaped model was first published in
1979, and was subsequently refined over the years in response to critique
and feedback from academic peers and practitioners (Figure 2).
Be a good Contribute resources to the

corporate citizen community; improve quality of life.
Philanthropic
Responsibilities
Obligation to do what is right,
Be ethical Ethical
just and fair. Avoid harm.
Responsibilities
Law is society’s codification
Obey the law Legal of right and wrong. Play by
Responsibilities the rules of the game.
The foundation upon

Be profitable Economic
which all others rest.
Responsibilities
Figure 2 Archie Carroll’s pyramid of corporate social responsibility (Source:

adapted from Carroll, 1991).
23
Readings 46–55
At the base of the pyramid, Carroll describes the economic responsibilities

of a business. A business is ethically obliged to make money: to generate
wealth, pay its employees and provide a return on investment for
shareholders. Providing economic stability, in Carroll's view, is the
equivalent of building solid foundations in a building. Without these
foundations, there is little chance a business will be able to conduct itself
ethically.
One step up from economic responsibilities in Carroll's model are legal
responsibilities. As already stated, societies expect businesses to abide by
the law, which, ideally, will be the product of decades, even centuries of
legislative and constitutional development via democratic elections and
debate. These are not particularly examples of CSR though, as companies
have to deliver according to the law anyway. Legal responsibilities should
not be viewed as discretionary activities. You may also be surprised to find
in the model that legal responsibilities are captured as a second-order
obligation of business after economic responsibilities. The unfortunate
impression made is that it is more important to turn some kind of profit than
abide by the law! Nevertheless, let’s not be too picky in the critique. Carroll
was clear that legal and economic responsibilities were fundamental to any
ethical business venture.
On the third rung up in Carroll’s pyramid is the notion of ethical
responsibility and here Carroll enters the realms of CSR proper. These are
the activities that fall outside the scope of legislation and regulation.
Discussing ethical responsibilities Carroll is somewhat of a realist. Ethical
responsibilities in this model can be thought of as social norms. Norms are
simply a series of expectations that groups (organisations, sectors, societies)
generate based on years of experience and social interaction. So, over time,
societies come to think of polluting rivers, for example, as a bad thing,
whereas during the industrial revolution acts such as tipping waste into the
river were regarded as quite normal. The waste had to go somewhere!
The line as to what constitutes an ethical responsibility and legal
responsibility is dynamic; it moves around a lot. Sometimes it takes the law
a while to catch up with the public’s expectations of what constitutes ethical
behaviour. So a business’s ethical conduct one day might simply be a legal
necessity the next. Polluting rivers can serve as an example here.
Nowadays, businesses could expect a stiff fine, or worse, if they were
discovered dumping hazardous substances into a nearby source of water.
They do not gain any credit in the eyes of the public for not polluting
rivers. It is just expected, as a baseline social norm, reinforced through legal
requirement, that businesses should not pollute rivers. Yet if the clock was
wound back some centuries, one can imagine that a business making a
proactive decision not to pollute rivers but to invest in alternative disposal
solutions would have seemed like a business making an ethical effort.
At the pinnacle of the pyramid lies the notion of philanthropic
responsibility. Adopting the word ‘responsibility’ is a little misleading.
Being responsible implies some kind of requirement – formal or informal –
an imperative to do something. But the very concept of philanthropy
24
suggests something quite different. The Oxford English Dictionary defines

philanthropy as:
Love of humankind; the disposition or active effort to promote the

happiness and well-being of others; practical benevolence, now
especially as expressed by the generous donation of money to good
causes.
(OED, 2015)
In other words, philanthropy exceeds social expectations. It need not even,

as Carroll holds, be desired by society. In fact philanthropy may even go
against the grain of what is popular or not in a society. Some charitable
causes can be controversial. Philanthropy is often pursued privately; we
may never even learn of someone's philanthropic generosity. It is something
that can be done for no other reason other than a desire to help others.
At other times, philanthropy can be very high profile. For example, the
Gates Foundation, established with the wealth generated from Bill Gates’
success with Microsoft, is high profile and closely associated with the
names of Bill Gates and his wife, Melinda. One could argue that the
visibility of the Gates family attracts more attention and money for its
causes, such as improving educational attainment and general development
work. Very few people would expect the Gates to have taken on such an
ambitious charitable foundation. They did so, presumably, because they
wanted their wealth to make a difference in the world. Of course being
associated with such high-profile philanthropic activity might well enhance
the reputation of Microsoft and indirectly result in greater profitability. But
if all the Gates were interested in was better publicity it would hardly have
been necessary to establish such an ambitious charitable foundation. There
are easier ways, such as employing more press officers!
Philanthropy should also be thought of more broadly than simply donating
to charity, or even establishing a charity. Philanthropy, as was suggested in
the definition, can also be about going further than is expected in the daily
operations of a business – using business resources to make a difference for
society over and above regular business interests. Philanthropy plays on
more controversial territory than other dimensions of CSR. Some would
regard philanthropy as inappropriate for a business. Every penny spent by a
business on philanthropy is a penny less spent on something else.
Nevertheless, what counts as philanthropic is also contested. What may
seem excessively ethical may in the future become expected, especially if
businesses are effective in shaping the norms people possess about what is
necessary from a business.
CSR beyond economic and legal responsibilities can often be good for
business. Businesses often try to stay ahead of social expectations, and may
even try to play a role in shaping social expectations. It can be argued this
is good business, leading innovation, as well as just doing good. Consider
the example of Toyota, which made a decision to radically expand its range
of vehicles with hybrid engines, as well as standard ones. This was not
something it had any legal responsibility to do, and was perhaps not even
something that society expected it to do.
25
Readings 46–55
Figure 3 Volunteers who are part of corporate philanthropy.
Example of going further than required: Toyota’s hybrid car

engines
At the time of writing, Toyota had five different hybrid vehicles on the market,
so anyone interested in purchasing a more fuel-efficient and environmentally
friendly car, has a choice of sizes and prices to choose from (Figure 4). The
days of hybrid or plug-in electric vehicles being restricted to one particular
model are, it seems, over. Car manufacturers are responding to a large
increase in demand from the public, at least in the UK, where The Guardian
(Nicholls, 2015) reported that in 2014, sales of hybrid and plug-in electric
cars increased by 58 per cent in 2014 – with 51,739 new registrations of
such cars reported. Despite falling oil prices at the time of writing leading to
something of a tail-off in sales of hybrid and electric cars in the USA, the
longer term trend seems to be upward. Further to electric and hybrid
vehicles, Toyota is now working on producing a hydrogen-powered car.
Figure 4 A Toyota hybrid car
If you visit the Toyota website you will note that environmental concerns are
dominant in the statement from its President, Akio Toyoda. Visiting the
company’s sustainability pages reveals a wide-ranging commitment to
improving the environmental performance of the company. The company
openly states that climate change is one of the major issues facing humanity
and lists carbon dioxide emissions as a major cause of climate change. One
might expect a company that contributes to the world’s carbon emissions to
adopt a more defensive stance but that is not the case with Toyota. Its
26
commitments are not merely captured in the production of more

environmentally friendly vehicles but also in making the entire production and
sales process more environmentally sustainable, captured in Toyota’s ‘360-
degree’ environment policy (Toyota, 2014).
Exercise 3
What might be the purely business advantages of exceeding social

expectations of CSR? After reading through the example above, make some
notes on what you think are the advantages that Toyota gains from
developing a range of hybrid cars.
Comment
Investing in CSR activity necessarily means that a business is not spending
its limited resources on other aspects of the organisation. In the case of
Toyota, spending money on more product variation, by making more hybrid
vehicles, will come at a cost. Nevertheless, the purely business case for
making such investments might be that Toyota expects to gain more
customers that way, given that more and more people want cars that are
considered less environmentally harmful. Also, in setting a higher-than-
expected ethical standard within an industry, a business is potentially
establishing a new baseline standard that one day competitors will have to
follow. If it becomes a law or a generally expected standard at some point in
the future that all cars should have hybrid engine technology, Toyota may
well be at a competitive advantage because it will have years of experience
in developing such engines. There might be a profit advantage for a
business to invest in high levels of CSR commitment at an earlier stage
because competitors will eventually have to commit resources in order to
catch up. Outside the immediate business benefits are the purely ethical
benefits – of feeling good about contributing to society and leveraging some
of a business’s social influence and reach to do more than simply make
money.
3.2 Attitudes to CSR

Businesses differ in the extent to which they take CSR seriously. To many
observers it is important to understand how committed a company is to its
social responsibilities. For example, the managers and clients of ethical
investment funds (investment funds that only invest clients’ money in
businesses that do not violate legal and ethical norms or that are considered
to take social responsibility seriously) need to understand how seriously the
businesses in which they invest take their social responsibilities. Carroll is
again of some help here. He enhanced his CSR pyramid by offering four
27
Readings 46–55
dominant attitudes towards CSR, helping readers make sense of the

motivations that might sit behind various approaches to CSR.
. Reactive–Reactionaries. Carroll states that this group of business

practitioners seek to dodge responsibility for CSR, actively investing in
ways of avoiding blame and responsibility for ethical lapses. Such a
position often involves either denying there is a problem in the first
place or seeking to blame others for the problem.
. Defensive. Such a posture means that businesses will seek to do the
minimum required to meet the ethical expectations of society, for
example, abiding by the law and investing in excellent public relations
but not backing up such public declarations with substantive activity.
. Accommodation. Accommodators will listen carefully to advocacy
groups and to what society is telling them, and then follow suit. They
allow others to lead on ethics and act as good, responsive followers.
. Pro-active. Businesses adopting a proactive stance to ethics will seek to
shape social expectations of right and wrong. Philanthropic activity often
falls into this category. In more recent years businesses have even
sought to develop partnerships with charitable organisations or pressure
groups to research particular issues of public concern and to try to co-
create solutions. For example, GlaxoSmithKline is currently working
with Save the Children to isolate a specific form of antiseptic used in its
mouthwash products to help fight pneumonia amongst new-born babies.
Internet retail giant Amazon is an increasingly important business and
employer for the UK. Many of you will be customers of the business and
some of you might have experience working for the business. In the
example below, we ask you to reflect on how you might characterise
Amazon’s attitude towards CSR, based on Carroll’s classification.
Example of corporate attitude to CSR: Amazon UK

Amazon employs around 7,000 people in the UK, most of whom work in its
warehousing operations. The days of Amazon specialising in books and
music are long gone. It is now a much bigger operation dealing in all kinds of
household goods, clothes, sports equipment, and also provides a large
marketplace for other companies and private individuals to sell their own new
and second-hand products.
In the autumn of 2014, the company announced that it would hire an

additional 1,000 workers. These workers start on a salary of £7.39 an hour,
rising to £8.90 an hour after two years. In 2015 the UK national minimum
wage was £6.50 an hour. Many of you reading this will be Amazon
customers, people who value the generally competitive prices, range of
goods and efficient service and delivery. It is also worth noting that Amazon
reports it works hard to improve its environmental performance, through less
and more recyclable materials and more efficient distribution (Amazon UK,
2014a). If you visit the Amazon website you will also note that Amazon
donates to a long list of charitable causes. For example, the company,
according to its website, has donated 25 Kindle e-readers to primary schools
located near its warehouse operations and £2,000 in gift vouchers for the
school to spend on stocking the machines with books (Amazon UK, 2014b).
28
Yet the company’s operations in the UK have also been the site of much
controversy. Criticisms of Amazon have focused on employee relations and
the amount of tax paid by the company in the UK (Garside, 2014).
Amazon’s UK business is a complex machine. Although the company runs a

number of warehousing, distribution and office operations from the UK,
Amazon’s European operation is officially based in Luxembourg, a country
that offers lower taxes for businesses. At the time of writing the European
Commission had announced it was launching an investigation into whether
Amazon’s agreements with Luxembourg violated its laws.
The level of Amazon’s UK tax contribution has become a hot issue. In the
2013 tax year the company paid £4.2m of corporation tax, having sold goods
worth £4.3bn, according to the mainstream British media. The previous year,
Amazon paid £3.2m in corporation tax.
Although Amazon in the UK employs around 7,000 permanent employees, at

times of seasonal demand (chiefly, at Christmas), the company employs
considerably more temporary agency staff (Amazon UK, 2014c). These
members of staff usually earn less than permanent staff. An undercover
investigative reporter for The Observer newspaper (Cadwalladr, 2013) stated
she was employed at £6.69 an hour, 19 pence above the minimum wage.
The undercover report lists a range of employment practices that many of
you will find strict, e.g. 15-minute staff breaks beginning at the point where
an employee stands in a giant warehouse (Figure 5). (The undercover
reporter stated that it took her six minutes to walk to an area where she
could sit and have a snack.)
Figure 5 An Amazon UK warehouse
Exercise 4
Make some notes on the following questions:
29
Readings 46–55
. What are the main CSR activities that Amazon seems to engage in?
. Reflecting back on Carroll’s dominant business attitudes to CSR, where
would you position Amazon and why?
Comment
This is a difficult task to complete because it is challenging to make a
judgement on a company’s activities based solely on a brief passage of text.
Undoubtedly there are nuances and complexities relating to Amazon’s
business practices and model that are not captured here. That said, based
on publicly available information, one can start to build a picture of a
contradictory company where many of the judgements about the ethicality or
not of the business depend on interpretation.
If you visit the Amazon website it will take a significant amount of time to
read through all the charitable causes to which the company donates.
Furthermore, it has a substantial section on its website related to the
environment.
Is Amazon in the UK an economically responsible operation, according to

Carroll’s criteria? The problem with the Carroll model is that it does not
reflect the complexities of a business like Amazon. According to the laws and
practices of Luxembourg (where Amazon is based), the company is
economically responsible. It pays its taxes there. Furthermore, when one
traces back how much of its income is attributable strictly to its UK
operations, it also pays its taxes in the UK. But is Amazon in Europe really a
Luxembourg business? It technically employs more people (including casual
staff) in the UK and certainly conducts more business in the UK than in
Luxembourg. Its UK warehouses are called ‘fulfilment centres’, meaning that
technically their function is only to ‘fulfil’ orders made to the business based
in Luxembourg. In other words, the company abides by the law as it is
presented to it and so according to Carroll’s model is economically
responsible.
When one views Amazon’s legal and ethical responsibilities, one notes a
range of benefits for permanent employees – such as stock options, 25 days
of paid annual leave and so on, over and above the legal limits.
Nevertheless, benefits and wages for temporary contract workers are inferior
and some would consider its employment practices, such as the rule of three
sick days in three months for temporary workers leading to employment
termination, as harsh. Nevertheless, the company operates within the law
and so, according to the Carroll model, should be considered as ethically
and legally responsible. One might go further and state that Amazon’s
packaging policies and donations to charitable causes means it can also be
regarded as active in a range of what Carroll refers to as discretionary
responsibilities.
But does all of this mean that Amazon is a paragon of CSR? Perhaps, when
you have time, you can enter the company name and ‘UK tax’ or ‘workers’
into an internet search engine. What you will find is a range of news stories
from the mainstream media in the UK, featuring statements from a number of
high-profile politicians and trade unionists questioning the ethicality of the
company. Returning to points made elsewhere in the readings, referencing
30
the Carroll model only gets you so far. It allows you to make a judgement
about the degree of CSR of a business against a context of a particular
context (in this case, against a context of current UK tax and employment
law) but does not provide a more ambitious ethical model.
CSR does have its critics and it is worth highlighting some of the criticisms
that have been levelled at this area of business ethics. The concluding
section of the reading will describe and discuss these criticisms.
4 Criticisms of CSR
Although the idea of CSR is gaining more and more followers among
businesses, it has been subjected to significant criticism. Most prominently,
Nobel Prize winning economist Milton Friedman (1970), writing in the New
York Times, asked whether businesses really had any responsibilities outside
maximising profit. Friedman asserted it was the role of democratically
elected governments to establish the ethical expectations of societies and
that business simply had the responsibility of abiding by the rules. Of
course if businesses violate the law, they should be held accountable but the
business of determining ethical standards was the responsibility of those
elected by the people.
Friedman did, however, believe governments should expect extremely high
ethical standards of business, so his argument should not be read as some
sort of free pass for business from ethical responsibilities.
Friedman continued by suggesting that one should not and cannot think of
businesses as human beings and that businesses cannot therefore be held
accountable in the same way as human beings. And yet businesses are a
collection of human beings. Employees are citizens in their own right. They
will often live in the communities affected by the decisions of their
employers. Furthermore, one can also argue that even if a chief executive
cannot be expected to know of everything that happens in her or his
organisation’s name, the chief executive and senior management can be
highly influential in creating a culture that either encourages people to
behave according to certain ethical standards or not.
Regardless of the continuing debate about the appropriate degree of
engagement of business with CSR, the idea of CSR has become a dominant
means of thinking about ethics within business. This is demonstrated by the
number of CSR initiatives and policies that now exist within business
organisations. Regardless of the criticisms levelled by Friedman, it appears
that businesses themselves have made the decision that CSR is a useful way
of thinking about and acting upon the ethical responsibilities of a firm.
31
Readings 46–55
Summary
This reading began by stating that CSR is one of the most important
concepts in the field of business ethics. It explores the social responsibilities
(imposed upon and self-imposed) of businesses outside what is required by
law and regulation. Adopting a CSR perspective in business asks managers
to consider not only what society might expect from business but also how
businesses might set a pro-active agenda and go beyond current social
expectations.
The reading introduced the work of Archie Carroll, who has attempted to
define different dimensions of CSR and different attitudes of businesses
towards CSR. The model is helpful in analysing the practices of businesses,
taking note of which kinds of activity could be classed as CSR and which
not. The model also helps students and analysts of business ethics in
making judgements about the activities of particular businesses.
The reading also introduced some criticisms of CSR, notably, that such
activity could be viewed as outside the appropriate remit of a business to
generate profit. Despite the criticisms of CSR, it has proven an enduring
and influential idea within business, both for those who study business
ethics and for business practitioners more widely.
32
References
Amazon UK (2014a) ‘Amazon and our planet’, [online]. Available at http://
www.amazon.co.uk/Amazon-and-our-Planet/b/ref=footer_planet?
ie=UTF8&node=299737031 (Accessed 6 March 2014).
Amazon UK (2014b) ‘Amazon in the community’, [online]. Available at
http://www.amazon.co.uk/b/ref=footer_community?
ie=UTF8&node=2492376031 (Accessed 6 March 2014).
Amazon UK (2014c) ‘Careers’, [online]. Available at http://www.amazon.
jobs/ (Accessed 6 March 2014).
Big Pit (2014) ‘Museum Highlights’, [online]. Available at http://www.
museumwales.ac.uk/bigpit/about/ (Accessed 6 March 2014).
Cadwalladr, C. (2013) ‘My week as an Amazon insider’, The Observer, 1
December, [online]. Available at http://www.theguardian.com/technology/
2013/dec/01/week-amazon-insider-feature-treatment-employees-work
(Accessed 6 March 2014).
Carroll, A. (1991) ‘The pyramid of corporate social responsibility: Toward
the moral management of organizational stakeholders’, Business Horizons,
vol. 34, issue 4, pp. 39–48.
Carroll, A. and Buchholtz, A. (2009) Business and Society: Ethics and
Stakeholder Management, Mason, Ohio, South-Western Cengage Learning.
Friedman, M. (1970) ‘The Social Responsibility of Business is to Increase
its Profits’, The New York Times Magazine, 13 September.
Garside, J. (2014) ‘Amazon UK boycott urged after retailer pays just £4.2m
in tax’ The Guardian, 9 May, [online]. Available at http://www.theguardian.
com/business/2014/may/09/margaret-hodge-urges-boycott-amazon-uk-tax-
starbucks (Accessed 6 March 2014).
Nicholls, L. (2015) ‘Green vehicle demand revs up as UK electric car sales
quadruple.’ The Guardian, 8 January, [online]. Available at http://www.
theguardian.com/environment/2015/jan/08/green-vehicle-demand-revs-up-uk-
electric-car-sales-quadruple (Accessed 13 October 2015).
Oxford University Press (2015) Oxford English Dictionary [Online].
Available at http://www.oed.com.libezproxy.open.ac.uk/view/Entry/142408?
redirectedFrom=philanthropy#eid (Accessed 13 April 2015).
Tata Power (2014a) ‘Sustainability Policy,’ [online]. Available at http://
www.tatapower.com/sustainability/sustainability-policy.aspx (Accessed 6
March 2015).
Tata Steel (2014b) ‘Ethical Behaviour’, [online]. Available at http://www.
tatasteeleurope.com/en/sustainability/ethical-behaviour (Accessed 6
March 2015).
Toyoda, A. (2014) ‘Aiming to Achieve Sustainable Growth and to Bring
Smiles’ Toyota, President’s Message, [online]. Available at http://www.
toyota-global.com/investors/ir_library/annual/pdf/2014/p3_4.pdf (Accessed 6
March 2014).
33
Readings 46–55
Toyota (2014) ‘Toyota 360-degree approach’, [online]. Available at http://

www.toyota.co.uk/environment/360-approach (Accessed 6 March 2014).
34
Reading 48: The environment, sustainability and business
Reading 48: The environment,

sustainability and business
Introduction
For many years business operated as if natural resources were unlimited and
any impact of business activity could be absorbed easily and indefinitely by
the natural environment. Increasingly, we know this is not the case and
natural environmental forces are becoming an important consideration for
businesses. On the one hand, business activities have a significant impact on
the natural environment. On the other hand, changes in the natural
environment can equally significantly affect businesses’ capacity to carry
out their activities. Business is influenced by and has an impact on the
natural environment at every stage in the production and consumption
process, from the sourcing of raw materials, through the production of
goods and services and storing and transportation of finished goods, to the
use of the product by the final consumer and its eventual disposal.
The Earth’s natural resources provide us with the air we breathe, the water
we drink and use for many other purposes, the plants and animals we eat,
the materials from which we build our houses, make our clothes and
construct our tools, and the energy we need for heating, transportation and
industrial production. If these resources are being used or made unusable at
a faster rate than natural processes can replenish them, human quality of life
must deteriorate in the longer term. If they are distributed unequally
between people, as they generally are, quality of life deteriorates faster for
some people than for others, but ultimately it deteriorates for everybody
(Diamond, 2005). Figure 1 gives a graphical representation of how
businesses use environmental resources and release wastes into the
environment at different stages of the business process.
Figure 1 Business and the natural environment
35
Readings 46–55
The degradation of the natural environment and the dominant role of human
beings in this process is now largely beyond dispute (see IPCC, 2014). In
many ways, people are the victims of their own success, to the extent that
as human beings have developed the capacity for mass production,
accessible and speedy travel and have largely grown wealthier
(Piketty, 2014), the side effect is that the environment has had to absorb
more strain.
You have already learned about several examples of significant
environmental impact of business activities, particularly if these activities
go wrong. In the case of the Bhopal disaster the environment also suffered
in addition to the terrible damage caused to human lives and health. The oil
spill at BP’s Deepwater Horizon drilling platform in the Gulf of Mexico in
2010 is an example of the inherent danger of an important economic
activity, namely the extraction of mineral oil, which is needed not only to
heat our homes and run our cars but to fuel most industrial processes. The
example below gives a more everyday example of how business activity
affects the natural environment.
Example of environmental impact: bakeries

Bakeries are an example of everyday businesses that can be found in most
towns (Figure 2). Bakery businesses come in very different sizes, ranging
from large businesses that bake mass-produced bread for sale in
supermarkets and other retail outlets, to very small businesses baking
artisanal breads for local customers that buy directly from the bakery.
Consider the example of a small, local bakery and its environmental impacts.
Figure 2 A bakery
Looking back at the flow diagram in Figure 1 above, the bakery would
require:
. Raw materials in the form of flour, water, yeast, and some other
ingredients for its breads. All these ingredients are derived from
renewable natural resources. Producing them also requires some raw
materials derived from non-renewable natural resources (most fertilizers,
for example). Changes in the natural environment could have an impact
on the business, for example if droughts or floods (e.g. caused by climate
change) affected a harvest.
36
. Energy and other resources required to run the production processes

(e.g. preparation of the dough, baking, etc.). Energy is likely to be an
important natural resource to consider here as baking is quite energy
intensive. All food businesses also require a good supply of clean water.
Energy and drinking water are both scarce natural resources. Burning
fuel also releases CO2, thus contributing to the release of so-called
greenhouse gases (implicated in climate change).
. Packaging materials to wrap the bread in. These could be made from
paper (made from renewable natural resources, i.e. wood pulp) or plastic
(made from non-renewable natural resources, i.e. mineral oil) and require
energy to produce. The wrapping also needs to be disposed of by the
consumer after consuming the bread, and will mostly go to landfill sites.
. Transport. Although we assume that the business sells directly to
consumers some transportation is still required. For example, customers
have to get to the bakery to buy their bread and we can assume they
won’t all walk there. Or perhaps the bakery is selling directly to customers
at local markets, in which case it will have to transport the bread there.
This reading will focus first on the general issue of environmental change. It
will subsequently address the role of business in contributing to
environmental problems, consider how damage to the environment may
affect the viability of businesses in the medium and longer term and also
explore how businesses can contribute to improvements in the health of the
environment. The second part of the reading will highlight the concept of
sustainability as important for guiding business activity in the context of
environmental challenges. The chapter closes with a brief reflection on the
notion of environmental management for business and, specifically, how the
idea of the triple bottom line may guide businesses in making sustainable
decisions and running operations in a sustainable manner.
1 Key environmental issues and the

implications for business
Reading the newspapers or watching the news on television for a few days
will normally bring to your attention a number of stories about
environmental problems that are caused by human activity. You will
therefore be familiar with the fact that environmental issues are numerous
and varied. This section introduces a selection of environmental issues that
have high significance for businesses: climate change, waste management,
population growth and the loss of biodiversity.
1.1 Climate change

Climate change is perhaps the greatest environmental issue facing humanity
and business.
37
Readings 46–55
A report from the US National Academy of Sciences and the UK Royal

Society (2014) states that the Earth’s temperature has increased by 0.8%
since 1900, but that the majority of the warming has occurred since 1970.
Further, the report states that emissions of CO2, the main so-called
greenhouse gas considered responsible for climate change, have increased
40% since 1800: this is known because scientists are able to measure
trapped gases in the atmosphere and in masses of ice. The presence of other
harmful gases in the environment, such as methane, has also increased.
Increases in temperature result in melting of the world’s ice-caps, causing
sea levels to rise. Currents are disturbed. Climate change causes damage to
eco-systems, which leads to stress on or even the extinction of animal
species. More immediately for humans, climate change makes weather
patterns less stable and is associated with an increased frequency of natural
disasters, such as flooding.
The major cause of climate change is pollution from human sources,
particularly the emission of CO2 from the burning of fossil fuels such as oil,
coal and natural gas. Businesses of various shapes and sizes are the major
source of global pollution (Helm and Hepburn, 2011). An astonishing study
by Heede (2014) has demonstrated that two thirds of the planet’s pollution
between 1854 and 2010 was caused by only 90 businesses. These vary from
household names such as energy giants BP, Exxon and Chevron, to large
state-owned companies. More worrying is the fact that collective efforts to
reduce pollution seem far from sufficient. The UN’s Intergovernmental
Panel on Climate Change report of 2013 (IPCC, 2013) stated that efforts to
reduce emissions of harmful substances into the environment were being
outstripped by industrial growth. The report warned that the planet was on
course to reach an overall warming of two degrees within 30 years – and it
is the two-degree landmark that scientists believe will act as the tipping
point beyond which the world will experience major environmental
disruption.
Big problems such as climate change will need the effort of various groups
in society to solve them, including businesses. Perhaps one way of thinking
about a strategy for combating climate change in the future might be to
place more emphasis on the importance of business solutions, for example
innovative ways of achieving economic aims with fewer natural resources
(Verweij and Thompson, 2011).
There is also evidence that businesses are turning their minds to innovations
to address the problems of climate change and environmental degradation
(e.g. Senge et al., 2010). This is not only true for large enterprises.
Research conducted by Williams and Schaefer (2013) demonstrates that
managers of small- and medium-sized businesses in the UK were well
informed of current evidence regarding the environment and were actively
engaged in exploring and implementing more environmentally friendly
modes of operation. The next example is about businesses that have won
awards for their efforts to move to low-carbon technologies in order to help
address the problem of climate change.
38
Example of low-carbon innovation: The Shell Springboard low-

carbon innovation awards
Energy company Shell has been giving awards to UK entrepreneurs that
have come up with good ideas to reduce carbon emissions in business. Here
are three examples of past winners of the award.
. Ventive has developed a passive heat recovery unit for domestic

buildings that mimics nature to ventilate homes without the need for
electrical connections or heaters – reducing heat loss by 97%.
. Shiply is a dynamic service that matches people needing to move goods
with transport companies going there anyway – an innovation that has
now gone global, saving around 25 million kilograms of CO2 since its
launch.
. Vantage Power’s young co-founders have created a hybrid bus engine
that can be easily retrofitted into existing fleets – saving operators
thousands of pounds on fuel costs, and generating significant carbon
reductions.
(Shell Springboard (n.d.))
It is unlikely that businesses will be able to ever solve the problem of

environmental decline alone. Moreover, simply by existing, a business, just
like any human being, marks the environment in some way. Nevertheless,
learning from innovation seems to be one way in which good environmental
practice in business can be spread and further adopted. Individual
businesses seem to be developing new ways of improving environmental
impact all the time. Such innovations may take the form of using more
recycled materials, creating new technologies to make businesses more
energy efficient or supporting suppliers that adopt sustainable business
models and favourable employment practices. Perhaps environmental
innovation will enjoy an increasingly close link to long-term profitability in
the future.
Increasingly, it is not only large firms that are starting to engage with the
problem of climate change, but small businesses, too. This is the topic of
research described in the Spotlight on Research below.
Spotlight on Research
Research conducted by Sarah Williams
This research is interesting because it challenges preconceptions
widely held about small business owners’ attitudes towards
environmental issues. The authors state that the usual attitude of
government towards small businesses is that they have to be educated
and regulated in order to improve their environmental performance.
Evidence from this study, however, indicates that small business owners
are very much motivated by personal values and beliefs that they can
make a difference to improving the environment.
39
Readings 46–55
In more detail, the authors conducted nine in-depth interviews with the
owners of small businesses in the east of England. Owners were asked
about the pro-environmental measures they had enacted within their
own businesses. They were then questioned about their motivations for
implementing such environmental changes. The picture developed by
the authors is of a group of owners who were very attuned to both
environmental and social issues and who understood their role in
contributing to environmental improvement. In one particularly evocative
quote, an owner defines their identity as a normal person seeking to
make a difference:
I haven’t got braids in my hair and smoke spliffs and go dancing

over an open fire at the weekend and all that, but I’m really
interested in our future, in how we’re going to get there, how it can
be delivered, what I can do at a micro level.
(Williams and Schaefer, 2013, p. 182)
The authors note that, of course, small business owners are concerned
about the financial cost of implementing pro-environmental measures
but that these concerns appear to be over-ridden by the social
conscience of owners. Noted in the article is the fact that government
efforts to engage business in environmental issues usually focus on the
business case for doing so, especially the prospect of businesses
saving money through environmental improvement. The findings of this
study indicate, however, that government might be better advised to
frame its policies and communication with small business in terms of
values rather than purely financial terms.
(Williams and Schaefer, 2013)
Considering these examples and the research described above it is worth

reflecting on the position of people in business. Ethics textbooks and
articles talk at length about the conduct of people in business but rarely are
readers exposed to the words and beliefs of business people themselves.
One could be left with the view that business people are these unruly,
immoral actors who only care about lining their own pockets. Yet business
people are human beings like anyone else – people who by and large do
care about ethical issues such as the environment.
1.2 Waste management

The production and disposal of waste is a major issue for society and for
business. The by-products of business and of consumers have to be disposed
somewhere and somehow. Waste, however, causes land, air and water
pollution. Landfill waste, for example, emits harmful methane gas into the
atmosphere or can leak heavy metals into ground water. Liquid waste, for
example in the form of waste water discharged by factories, can pollute
rivers, lakes, sources of ground water and the sea. And waste in the form of
gases, such as emitted from household or industrial chimneys or from
40
vehicles, pollutes the air, causing breathing difficulties among other

problems.
Tighter regulations and market innovations have meant that business has
become better at disposing of waste, at least in European nations. You need
only look as far as your local river to notice, if you are old enough, a
marked difference in its cleanliness over the past 20 to 30 years. The
Environment Agency in the UK carries up-to-date cleanliness data on its
website.
Recycling more and using more materials capable of being recycled is, of
course, one way in which business (and citizens) can help reduce the strain
on the environment. Recycling helps reduce pollution from landfill and
helps reduce the harm caused through the manufacture of new materials
from scratch. The good news is that Europe, certainly, is becoming better at
recycling. In 2001 recycling rates in the UK were only 12% for all solid
everyday waste but in 2010 they were 39%, the largest rise in Europe
(European Environment Agency, 2013). The target set by the European
Commission is that all of the EU member nations will recycle 50% of
everyday, solid waste by 2020. Overall, recycling rates have increased in
Europe and there seem to be two reasons for this. The first is that
information on the benefits of recycling is easier to come by. The second is
that it is easier to do now – with all local authorities in the UK, for
example, required to provide quite comprehensive recycling services.
Businesses also engage increasingly in recycling. This has environmental
benefits but also benefits the businesses themselves as they need to pay less
for waste removal if the waste is separated for recycling. The example
below is from the website of small business magazine Inc. in the USA and
gives advice to small businesses on how to start recycling office waste.
Example of recycling office waste
Figure 3 An office recycling station
As much as 90 percent of office waste in the average workplace can be

recycled. Here's how to get started.
By Peter Vanden Bos
Companies everywhere are ramping up efforts to go green, but sustainability

starts with your employees. They’re the ones printing the sheets of paper
41
Readings 46–55
and drinking the soda cans that often easily end up in the trash can, without
much thought.
In the average workplace, about 80 to 90 percent of solid waste is actually

recyclable, according to the US Environmental Protection Agency (EPA).
Establishing an office recycling initiative won't just reduce your carbon
footprint, but it could also save your business money. Here’s how to get
started.
[…]
Paper products are a typical place to start. In US workplaces, one to two

pounds of paper product waste is generated on average each day, according
to Kent Forester, an environmental protection specialist at the EPA.
Beverage containers, too, are a no-brainer; most workers go through as
many as three a day, Forester says.
A few months after you launch your program, as employee participation and
awareness increases, you can move onto other, larger recyclable objects,
such as ink cartridges, computers, and other electronics.
[…]
Recycling these products can also generate a small amount of revenue for
your company, in addition to trash pickup savings. Sites like Gazelle offer to
pay for electronics. Staples has a comprehensive electronics recycling
program that offers rebates for Staples products. In 2008, they recycled more
than 22 million ink and toner cartridges in the USA.
[…]
(Vanden Bos, n.d.)
1.3 Loss of biodiversity

The loss of biodiversity is a major issue for both humanity in general and
business in particular. Biodiversity simply means the variety of life on the
planet (United Nations, 1992). The importance of biodiversity can be
summarised by the fact that the planet needs a diversity of life in order to
function. The world needs trees in order to provide people and animals with
oxygen to breathe, bees in order to pollinate, animals and plants to provide
food, and so on. Degradation of one aspect of life results in a tipping in the
balance of eco-systems.
According to the European Commission (2011, p. 1), the situation, as far as
biodiversity is concerned, is perilous, as ‘current rates of species extinction
are unparalleled. Driven mainly by human activities, species are currently
being lost 100 to 1,000 times faster than the natural rate’. In more detail,
the UN’s Food and Agriculture Organisation estimates that 60% of our
ecosystems have been used in an unsustainable manner or degraded and that
75% of fish species are either depleted to a large extent or over-exploited.
So what does the loss of biodiversity have to do with business, specifically?
The argument of the Commission is that loss of biodiversity comes with a
heavy economic cost attached. In other words, even though damaging the
42
biodiversity of the planet might often serve short-term business interests –

e.g. clearing forests in order to graze cattle or grow crops demanded by the
market – the longer term economic consequences greatly outstrip the shorter
term benefits. For example, the European Commission (2011) estimates that
insect pollination alone benefits the European economy to the tune of
£11.82 bn per year (Figure 4). Losses in the bee population and harm to
insects can therefore cause huge damage to European wealth because people
rely on pollination for vital food production ingredients and so on.
Figure 4 Bees play an important part of the European economy
To adopt a more positive stance, it appears that business is becoming more

aware of the economic problems associated with biodiversity loss. The
accountancy and consultancy firm PriceWaterhouseCoopers (2010) found
that the number of business chief executives concerned with the impact of
biodiversity loss on business had grown to 27%, with CEOs in Latin
America and Africa more concerned than CEOs in other parts of the world.
Clearly, as of 2009, this still left 73% of business leaders who were not
particularly concerned with the impact of biodiversity loss on business. The
overall strategy from government and research institutes in this area seems
to be to accentuate the positive results business might accrue through doing
more to address biodiversity. For example, The Economics of Ecosystems
and Biodiversity (a government and business-funded research organisation),
estimates that business opportunities from fixing the loss of biodiversity
could be worth somewhere between £1.24 trillion to £3.73 trillion by 2050,
a growing market for any potential eco-entrepreneurs reading this text.
So what might some of the larger implications for business be of the
erosion of the natural environment? There are numerous effects an erosion
of the natural environment might hold for business. For one, employees
might be less healthy in the future, with more people suffering from
respiratory illnesses, such as asthma and bronchitis. Second, it might be
harder for employees to travel to work because of shortages in fuel. Cost
and shortage of fuel is also of course a major concern for any business that
deals with distribution of goods. There are less tangible but equally
damaging consequences for business if damage to biodiversity continues
apace. People rely on a diverse natural environment to sustain their health
and to keep the ecosystem moving. The decrease in the global bee
population is one recent and stark reminder of the interconnectedness of
43
Readings 46–55
nature, and how erosion in one aspect of nature can hold serious
consequences elsewhere. The major risks for business are, of course, risks
more prominently associated with humanity in general. Major natural
disasters brought about by climate change, decimate and kill, which is
hardly conducive to material prosperity. The side effects of global warming
might lead to more armed conflict and tension, particularly over resources
previously considered natural and freely available, such as fresh water.
Conflict is bad for business as it creates instability. These are just some of
the many negative consequences facing business if the damage to our
natural environment proceeds apace.
1.4 Consumer action to combat environmental

problems
Businesses, due to their big impact on the environment, have a particular
responsibility to address environmental issues, but they are not the only
ones with an environmental responsibility. Other groups in society are also
asked to contribute their efforts. One such group are consumers. The
following exercise asks you to consider what you, as a consumer, are
currently doing to minimise your impact on the environment and what else
you could perhaps be doing.
Exercise 1
Think about your lifestyle as a consumer and professional and how it affects
the environment. What are you currently doing to reduce the impact of your
lifestyle on the environment? How could you further modify your lifestyle and
daily routine to reduce your environmental impact? Make some notes on this.
Comment
There are many ways in which individuals can make changes to their
lifestyles in order to make a contribution to environmental improvement in
general. Sometimes it seems as though some of these efforts are somewhat
irrelevant in comparison to the relatively massive pollution on the part of
large industrialised and high-growth countries. Nevertheless, perhaps in
adopting certain good practices, individuals may offer models for best
practice elsewhere. Some common personal strategies for reducing carbon
footprints include:
. making more use of public transport or subscribing to workplace car pool

schemes
. saving for an electric or hybrid car instead of a petrol or diesel car
. living closer to work and either walking or cycling
. living in smaller, more energy-efficient housing
. recycling more materials – both at work and at home
. taking less foreign holidays, thus reducing pollution from aircraft
44
. holding less face-to-face meetings that involve asking people to travel

and instead using virtual technologies
. consuming less in general, e.g. making sure clothes and household
goods last longer.
2 Sustainability and business

Increasingly, businesses are talking about their relation to the natural
environment in terms of sustainability. When the idea of sustainability was
first developed it was thought of mostly in terms of environmental
sustainability (Crane and Matten, 2010). The idea here is that for the
environment to remain healthy and viable into the future, businesses should
not simply be thinking about the short-term impacts of their operations but
should be thinking about their impact for future generations. A concern for
sustainability is important for citizens but also for businesses. After all, a
business is unlikely to yield much profit if the environment is damaged to
an extent that people cannot live well and natural resources are no longer
available.
The idea of sustainability became popular in the 1980s, in line with a
general increase in awareness of environmental issues. The United Nations
established the Brundtland Commission (named after the former Norwegian
Prime Minister, Gro Harlem Brundtland, who led the commission) in 1983.
The task of the Commission was to come up with an agreed definition of
what a sustainable approach to economic growth and environmentalism
might mean and to develop some ideas of how economic practices could
become more sustainable (Gladwin and Kennelly, 1997).
The Commission reported in 1987, producing the seminal report Our
Common Future. The report has remained an influential document in the
area of sustainability, chiefly for two reasons.
1 The report provided a working definition of sustainability that is still
widely accepted and used. The Commission defined sustainable
development as ‘development that meets the needs of the present without
compromising the ability of future generations to meet their own needs’
(Brundtland, 1987, p. 37). Note this is a pragmatic as much as an
idealistic definition. There is a recognition from a sustainability
perspective that human beings have reached a certain level of
development, of scientific knowledge and production capability, such
that most people would find it uncomfortable to return to simpler days,
where they consumed less, lived shorter lives, knew less of the world
and so on.
So sustainability is not about returning us all to pre-modern lifestyles
without technological and industrial development. Sustainability is
pragmatic and recognises there is much in the modern lifestyle and
modern business that should be protected and celebrated.
45
Readings 46–55
Nevertheless, sustainability asks people to look forward and to consider

not only whether business practices are suitable for our present needs
but also about whether they will be suitable for future generations. Such
thinking may mean cutting back on some modern excesses of
consumption and movement. Sustainability certainly asks that people
pollute less and create less waste.
2 The other influential aspect of the Brundtland Report was an expansion
of thinking on sustainability from a largely environmental focus to
something encompassing social and economic sustainability as well. This
reading has already explored the environment, so the remainder of this
section will be dedicated to economic and social aspects of
sustainability.
Economic growth was highlighted by the report as important. Without
thriving businesses offering people work and useful products and services,
and spreading prosperity, it could be argued that there would be little of
worth for us to sustain. The Brundtland report was important in making an
explicit link between longer term environmental health and sustained
prosperity. The relative weight that people give to short-term economic and
longer term environmental concerns varies. You may perhaps have noticed
how prior to the 2008 global financial crisis, environmentalism seemed high
up the political agenda. Political leaders made a lot of effort to stress the
importance of environmental protection. For example, prior to the 2010
general election the soon-to-become UK Prime Minister David Cameron
promised that his government would be the most ‘green’ ever. National
newspapers were full of features on ‘staycations’ (the phenomenon of eco-
friendly holidays in one’s own country) and organically produced clothes
and food. But as the financial crisis unfolded, there suddenly seemed to be
much less talk about environmental sustainability. Perhaps this is perfectly
natural and understandable as people worry about much shorter term needs,
such as how to house and feed themselves and their families. But the
general question of how to link our need for material security and longer
term concern with the environment will remain a real issue for political and
business decisions in the future.
The Brundtland report also stressed the importance of sustainable social
development, alongside economic and environmental concerns. Social
development mainly refers to issues of values and fairness. The report
argues that economic growth is no good if its benefits are not felt by all
members of a society or if it is achieved through the exploitation of
particular individuals, groups or communities. It is therefore necessary to
think about how business activity impacts not just on economic
development and environmental processes but also on social issues,
particularly fairness in society. If you simply think about this in relation to
your own communities, it makes sense. Communities where there is a lot of
poverty and inequality tend to experience other problems, such as crime and
also tend to be less happy and fulfilling places to live. These are not
socially sustainable communities, in other words.
Many of you will be familiar with Boots, a retail chain that sells
pharmaceutical, health and cosmetic products. Below you will consider one
way in which it is seeking to make its business more sustainable.
46
Example of a move towards sustainability: Boots pharmacies
Figure 5 A Boots pharmacy
Boots is primarily a large pharmacy chain, founded in Nottingham in 1849

(Figure 5). In 2014 it experienced a drop in profits of 17%, primarily
attributed to more competition from supermarkets offering more
pharmaceutical products, and it stated that it would cut around 500 jobs to
help offset the losses. The company has also faced criticism for employing
staff on zero-hour contracts. Zero-hour contracts mean that workers do not
receive the same benefits as other staff (paid leave and so on) because they
are not employed even as temporary workers. They are usually told at short
notice whether and when they will be required to work. In general Boots has
been criticised for displaying more of an emphasis on profit-maximisation
since the company was bought by a private equity firm in 2007.
In more recent years Boots has extended its range of ‘naturally sourced’
products. Primarily witnessed in its Botanics brand, the selling point of such
products (such as moisturisers, shampoos and soaps) is that the number of
artificial chemicals used are minimised, with ingredients primarily sourced
from nature. Of course deriving products from nature is itself problematic.
For example, palm oil is a naturally derived oil that serves a range of
functions in production because of its versatility and it is widely used in
cosmetic products. Nevertheless, significant concerns have been raised
because over-consumption of palm oil has led to the erosion of wildlife and
animal species, particularly in parts of central and west Africa, south-east
Asia and Central America.
Boots recently won the Guardian newspaper award for sustainable use of
natural capital (Earley, 2014). The company was praised by the award
judges for moving from a system of measuring carbon footprint to a ‘holistic’
approach that encapsulates impact measurement of business activity on
biodiversity and sourcing of raw materials as well. The Botanics range
referenced above encompasses around 180 lines and Boots has taken it
upon itself to analyse the broader impact of its products at every step of the
production process. Products are judged sustainable or not according to 24
separate criteria. The company can also now trace the source of 100% of its
natural raw materials and believes it has cut the environmental impact of its
productions by 32%.
47
Readings 46–55
Perhaps the most interesting aspect of Boots’ sustainability drive is its

partnership with the Royal Botanic Gardens (Kew Gardens in the UK).
Working with the gardens has enabled Boots to identify more sustainable
producers of its natural materials. For example, it now uses a Fairtrade and
organic hibiscus extract from a cooperative in Burkina Faso. The company
also states that it now uses 100% ‘sustainable’ palm oil derivatives (although
the notion of sustainability in relation to palm oil remains a contested issue
(Fitzherbert et al., 2008)).
Exercise 2
Having read the example above, think about the three dimensions of
sustainability discussed earlier: environmental, economic and social. Make
some notes on the following questions:
. How well do you think Boots is doing according to these three criteria?
. Do you think there are any contradictions between the three criteria for
sustainability for Boots or can they be mutually supportive?
. Would you be happy to call Boots a good example of a sustainable
business?
Comment
. Clearly a top priority of Boots is to remain a commercially viable
business. Yet at present it is experiencing a period where its profits have
dropped. Note here the word ‘dropped’, meaning that it still makes a
significant profit, so perhaps Boots is doing fine on economic
sustainability. It also seems to have made some significant efforts in
terms of environmental sustainability, with its Botanics range, its co-
operation with Kew Gardens to identify more sustainable plant extracts
for its products, and its attempt to use sustainable palm oils. On the
social sustainability side, however, one might be concerned about the use
of zero-hour contracts, which is perhaps not a particularly fair way of
distributing the economic benefits from the business.
. An executive concerned with sustainability might be concerned about
some of the apparent contradictions between the economic dimension
and the environmental and social dimensions of sustainability. If one has
to cut the benefits and working conditions of workers, or pursue
environmentally harmful production methods in order to increase profits,
then perhaps such profits are not sustainable. Or perhaps a very sudden
dip in profits, even if the business still remains in profit overall, should be
read as an indication that the business will not remain financially
sustainable for very long.
. Boots has experienced many of the pressures experienced by other large
high street retail chains globally in recent years. Therefore, one might
argue that the fact it is investing in a more environmental means of
48
production and auditing of its production chain despite these pressures is

admirable.
Since the publication of the Brundtland report some thought and research
have gone into how its ideas could be made more explicitly relevant to
business. After all, it is often the case that people in business would like to
take their responsibilities towards the environment and society more
seriously but might perhaps lack the support and tools to act (Bansal and
Howard, 1997). Elkington (1997) developed the idea of the ‘triple bottom
line’ as a way of translating the three dimensions of sustainability in the
Brundtland report into business language. The phrase ‘triple bottom line’
plays on the notion of the bottom line in accounting, which denotes the
profit made. Elkington argued that businesses should not focus on profit as
the only bottom line because this is an unsustainable way of doing business
in the longer term. Rather, businesses should try to balance economic,
environmental and social concerns, and think of their environmental and
social impacts as two further bottom lines, i.e. something that defined the
success of a business in addition to its financial success. Environmental
sustainability for a business, as already explored, concerns minimising the
environmental damage caused through pollution, use of limited resources
and waste disposal. Social sustainability concerns how a business sees its
role in society – does it treat its employees fairly, contribute to the social
wellbeing of its community (and potential employees) through educational
initiatives and other interventions? Economic sustainability refers to the
core duty of a business to make a healthy profit but in a way that can be
sustained over many years without damaging the aforementioned social and
environmental dimensions of the triple bottom line.
Of course, defining sustainability in terms of economic and social criteria,
as well as environmental ones, risks diluting the environmental message.
Often businesses are accused of paying only lip service to the full
implications of sustainability and concentrating on the economic dimension
at the cost of ignoring the environmental and social dimensions.
Sustainability can thus become another term for doing business as usual.
However, sustainability has become a key way in which businesses talk
about their social, environmental and ethical responsibilities these days.
Sustainability has become an area of business in its own right, with
sustainability consultancies offering audits, tools, and other services (see the
following example).
Example of a sustainability consultancy: The Carbon Trust

The Carbon Trust is one of the better known consultancies in the area of
sustainability in the United Kingdom. It is a not-for-profit company funded by
the UK government. It employs around 160 people to help government
bodies, businesses and voluntary organisations reduce their carbon
emissions and develop low-carbon technologies.
49
Readings 46–55
Ultimately, whether or not sustainability is a useful concept for building a

more comfortable, prosperous world for future generations is a matter for
you – current and future business workforce and leaders. Perhaps the one
thought to leave you with in this reading is whether sustainability strikes
you as a useful concept and if so how you might work with it in your own
practice.
Summary
This reading began by considering contemporary environmental issues that
were broadly summarised as global warming and pollution, waste and
biodiversity. Each issue was demonstrated as important for humankind in
general but also as holding important implications for the future of business.
For example, it is unlikely that businesses will be able to sustain
profitability if the world is a more unstable place, marked by increasing
natural disasters. Moreover, you were asked to reflect in more depth on the
more immediately ethical matter of whether it was acceptable for businesses
to function in ways that damaged the world’s biodiversity and contributed
significantly to global warming.
The second part of this reading highlighted one of the dominant ways in
which businesses now think about their environmental responsibilities, that
of sustainability. We traced the beginnings of the idea and outlined how the
concept has grown to encapsulate economic and social concerns, as well as
environmental concerns. Finally, this idea of sustainability raising some
important ethical dilemmas for executives and managers was suggested.
Boots was presented as a case study of an organisation that is currently
trying to balance concerns of sustainability across dimensions of the social,
economic and environmental.
50
References
Bansal, P, and, Howard, E. (1997) Business and the Natural Environment,
Oxford, Butterworth-Heinemann.
Brundtland Commission (1987) Our Common Future: Report of the World
Commission on Environment and Development, New York, United Nations.
Crane, A, and Matten, D. (2010) Business Ethics: Managing Corporate
University Press.
Diamond, J. (2005) Collapse: How Societies Choose to Fail or Survive.
London, Penguin.
Earley, K. (2014) ‘Boots quietly getting on with improving impact of
Botanics range’, The Guardian, 15 May, [online]. Available at http://www.
theguardian.com/sustainable-business/sustainability-case-studies-boots-
botanics-range (Accessed 8 March 2015).
Elkington, J. (1997) Cannibals with Forks: The Triple Bottom Line of
Twenty-First Century Business, Oxford, Capstone.
European Commission (2011) Our Life Insurance, our Natural Capital: An
EU Biodiversity Strategy to 2020. Brussels, European Commission.
European Environment Agency (2013) Managing Municipal Solid Waste: A
Review of Achievements in 32 European Countries. Copenhagen, European
Environment Agency.
Fitzherbert, E., Struebig, M., Morel, A., Danielsen, F., Brühl, C., Donald, P.
and Phalan, B. (2008) ‘How will oil palm expansion affect biodiversity?’
Trends in Ecology and Evolution, vol. 23, issue 10, pp. 538–545.
Gladwin, T. and Kennelly, J. (1997) ‘Sustainable development: a new
paradigm for management theory and practice’, in Bansal, P. and Howard,
E. (eds) Business and the Natural Environment. Oxford, Butterworth
Heinemann.
Heede. R. (2014) ‘Tracing anthropogenic carbon dioxide and methane
emissions to fossil fuel and cement producers, 1854-2010’, Climactic
Change, vol. 122, issues 1–2, pp. 229–241.
Helm, D, and, Hepburn, C. (2011) The Economics and Politics of Climate
Change, Oxford, Oxford University Press.
Intergovernmental Panel on Climate Change (2013) Climate Change 2013:
The Physical Science Basis. New York, The United Nations.
Intergovernmental Panel on Climate Change (2014) Climate Change 2014:
Synthesis Report, Geneva, Switzerland, IPCC.
Piketty, T. (2014) Capital in the Twenty-First Century, Cambridge,
Massachusetts, Harvard University Press.
PriceWaterhouseCoopers (2010) Biodiversity and Business Risk: A Global
Risks Network Briefing. London, PwC.
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Readings 46–55
Senge, P., Smith, B., Kruschwitz, N., Laur, J. and Schley, S. (2010) The
Necessary Revolution: How Individuals and Organizations are Working
Together to Create a Sustainable World, Broadway Books, New York.
Shell Springboard (n.d.) ‘Previous winners’, [online]. Available at http://
www.shellspringboard.org/previous_winners/ (Accessed 8 January 2015).
United Nations (1992) Convention on Biological Diversity. New York,
United Nations.
US National Academy of Sciences and the UK Royal Society (2014)
Climate Change: Evidence and Causes, [online]. Available at https://
royalsociety.org/~/media/Royal_Society_Content/policy/projects/climate-
evidence-causes/climate-change-evidence-causes.pdf (Accessed 13
April 2015).
Vanden Bos, P. (n.d.) ‘How to start an office recycling program’, Inc.,
[online]. Available at http://www.inc.com/guides/2010/04/start-office-
recycling-program.html, (Accessed 8 January 2015).
Verweij, M. and Thompson, M. (eds). (2011) Clumsy Solutions for a
Complex World: Governance, Politics and Plural Perceptions. Basingstoke,
Hampshire, Palgrave Macmillan.
Williams, S. and Schaefer, A. (2013) ‘Small and medium sized enterprises
and sustainability: Managers’ values and engagement with environmental
and climate change issues.’ Business, Strategy and the Environment, vol. 22,
issue 3, pp. 173–186.
52
Reading 49: Immanuel Kant and deontological ethics
Reading 49: Immanuel Kant and

deontological ethics
Introduction
This reading introduces an important way of thinking about ethical
decisions. The idea here is that people should be following universally
applicable ethical rules in their decisions and actions in order to make
ethically correct choices. As you will see in the reading, this is not a
question of simply following rules set by others but requires a lot of serious
thinking from the individual. This type of thinking about ethics is called
Deontology is a way of deontology.
thinking about ethics that
judges the morality of an Immanuel Kant, a philosopher from the 18th century, is regarded as the
action based on whether main deontological thinker and his work is still discussed and his ideas
the action conforms to followed to this day (Figure 1). Kant believed that human beings are
one or several moral uniquely capable of generating sound moral laws and therefore have an
rules.
obligation to treat other human beings as equals, as free and deserving of
dignity and respect. Kant makes high demands of the ethical reasoning and
action of people, demands that are not always easy to fulfil in daily life, be
that in private life or at work. But his ideas are often very good at
explaining why we feel uncomfortable about certain types of behaviour,
why we think they might be morally wrong. They can give us a way of
firming up such vague notions of right and wrong and thus help decision
making.
Figure 1 Immanuel Kant
Although we may feel instinctively that certain business practices are

simply wrong, it is often difficult to make sense of these feelings in a
coherent way. The example below of the deaths of seafood harvesters in the
53
Readings 46–55
UK may help you apply Kant’s thinking to business ethics in order to

solidify what we might mean by right and wrong in a business setting.
Example of unethical working practices: The Morecambe Bay

disaster
On February 5, 2004, a story ran in the British press about 19 illegal Chinese
immigrants who were drowned because they had been caught by the
returning tide when harvesting seafood in Morecambe Bay in Lancashire
(Figure 2). It turned out that these people had been brought to the UK with
the promise of work and had been employed at very low wages, with no
safety equipment and without a guide. Such immigrant workers are
transported in dangerous conditions on the promise of a better life abroad by
predatory criminal gangs, referred to as ‘snakeheads’. The workers in
Morecambe Bay were understood to have been paid less than £1 an hour.
The Chinese workers in question, in order to make more money, worked into
the evening and were cut off by the incoming tide.
Figure 2 Actors recreating the disaster of Morecambe Bay
Exercise 1
Many political commentators used this tragic incident outlined in the example
above to call for tighter checks on illegal immigration but this is not the point
of repeating the story here. Instead, focus on the company employing these
people. Do you think the company acted ethically in employing them? Note
down some reasons for your answer.
Comment
Perhaps you had rather mixed feelings on reading this example. If so you
would not be alone. You might have thought that the company gave these
people a chance of employment and life in the UK that they desired. But then
you might also have wondered why the company was doing this: presumably
not because its managers really cared about the immigrants. If they cared
they would probably not have sent the workers out there without a local
54
guide who was knowledgeable about the tides or without safety equipment.
You might have the uncomfortable feeling that the company acted in order to
increase their profits and that they cared very little about the welfare of the
workers they employed. In other words, perhaps they treated these workers
as merely a means to increase the company’s profits, not as having rights
and deserving respect. As you read on you will realise that Kantian ethics
has a lot to say about the morality of treating other people as a means to an
end, rather than ends in their own right.
1 Kant’s theory of moral duty

This section cuts to the heart of Kant’s significance for moral and ethical
theory and asks you to consider what is known as Kant’s categorical
imperative. Kant’s fundamental position is that people hold a basic
responsibility to treat human beings as ends in themselves and not as a
means to an end. This simply means that Kantian moralists believe that the
overriding concern of business managers should be duty towards other
specific human beings and that compromising over this duty towards others
is unacceptable. People should be treated as ends in themselves and not as a
means to achieving some other personal or organisational objective. Such a
formulation holds important implications for how business managers make
decisions. It is not good enough for Kantians to think about the end-result
of a decision benefitting a large number of people if one of the side effects
is that they have to harm a few people to achieve their ends.
Kantian moral theory is relevant to business ethics because it allows us to
think of the basis for making decisions and asks whether such decisions can
be sustained in the form of general rules for doing business. Kantian ethics
is more interested, in summary, in the process of making a decision rather
than weighing up the consequences of a decision. So a Kantian in business
would ask how ways of working could demonstrate care and respect for
others, rather than how certain decisions might result in some desirable
outcome.
Kant (1785/2012) stated that it was possible to identify a certain universal
moral obligation that every human being had a duty to follow – both in
everyday conduct but also in the more specific domain of decision-making.
The philosophical underpinning for this statement was Kant’s belief that
human beings are unique to the animal kingdom in that we are capable of
engaging in abstract reasoning (Kant, 1781/2007).
Let’s think about that statement for a couple of minutes. A family dog is
incapable of making generalised moral rules – rather, it feels loyalty
towards its owners, empathy even. If it is a good natured animal this is
because of its experiences (and genes) more than anything else. Human
beings, on the other hand, can make up general moral rules irrespective of
the situation they find themselves in. We will tell ourselves that it is simply
wrong to steal and lie regardless of specific human experiences. This means
55
Readings 46–55
we are able to draw up general moral rules for ourselves that are bigger
than the demands of any one situation in isolation. One classic example of
this thinking might be that we know it is wrong to steal from customers or
from our employer. Most people know this despite the fact that the vast
majority of them have never stolen anything from their customers or
employers and so have not had to learn that stealing is wrong from (bitter)
experience. A family pet, on the other hand, will have to be taught in a
behavioural fashion, each time she/he steals food from a table, that doing so
is wrong (‘No, you can’t steal a stranger’s sandwiches on this walk!’). Over
time the pet will come to remember that this is regarded as bad behaviour.
Kant’s argument is that human beings do not need to learn from such
repeated experiences – people are capable of designing abstract moral rules
to cover many issues like this.
Kant was also a realist. He knew that people could be pulled too much into
the demands of particular experiences, dragged into making exceptions to
moral rules (Kant, 1788/2004). In other words, in order to be moral, people
often have to suppress certain urges to make an exception. If you were a
receptionist in a hospital, for example, and a parent with a sick child
marched to the front of the queue and demanded treatment, you might
experience an urge to protect the child and fast-track this patient. Many of
your instincts and paternal feelings would be urging you to do so. But your
moral code would tell you that there are good, morally sound methods
employed in the hospital for prioritising cases and that making individual
exceptions would throw that system into chaos.
Kant also recognised the basic pull within people to do good. Given the
daily doses of misery people see via the news nowadays, this may seem like
a less credible statement. Yet if you think about it, the vast majority of
one’s daily dealings with others are civil and even pleasant. The proof for
Kant’s assertion that ultimately we all feel the pull to do good lies in the
fact that we usually feel terribly guilty after we have done something
wrong. So that, for example, if we were to award a job to someone because
we knew them, not because they were the best person for the job, then we
would in all likelihood feel bad about it. Kant therefore identified something
akin to what we now think of as our conscience: that nagging sense that we
could always have done better, have worked harder and achieved more. The
conscience is a cruel thing – it gnaws away at people and means that a
human’s life is often marked by managing feelings of guilt. Nevertheless,
Kant would say this is one of the special and valuable aspects of being
human.
The picture you should be developing in your heads by now is of a human
being (a business practitioner in our case) being pulled in two different
directions at once. The first demand is to give in to experiences (which
should be avoided) and to simply follow our basic urges according to
whatever situation we are facing. The other demand (to be followed) is to
apply a universal rule so we are not continually nagged by our conscience
and might contribute to the general moral good of the community. If you
were late for a business meeting, your adrenalin, anxiety and even fear
would be telling you to speed up your car, take a few risks and make it on
time. But your conscience would be telling you that this is crazy behaviour
for a meeting – hardly worth your life or those of others. And besides, if
56
everyone drove like a maniac because they were late, the roads would be
even more dangerous. That pull in two directions is what Kant was trying to
make sense of.
Kant (1785/2012) called his demand to do good the categorical imperative.
This core duty was broken into three parts in Kant’s writing – three rules of
sound moral reasoning. Each of these three imperatives will be explained in
turn.
1.1 Kant’s first rule
You should only act a certain way, or make a particular decision, if

you are content that such an act can be adopted as a universal law.
Returning to material already covered, Kant here prefigures the notion of

sustainability. A decision is not worth taking if similar decisions elsewhere
could not be sustained. In relation to climate change, Kantian theory might
present a dilemma. On the one hand, one sustainable law for all would
mean everyone would have to abide by strict carbon emissions targets. On
the other hand, it might be regarded as an inconsistent moral position that
one group of nations in the industrialised West were allowed to base their
economic growth on extensive carbon pollution but that other countries
should now be denied that same right. This is a genuinely difficult ethical
question. In other situations the reasoning would be simpler. For example, it
would be hard to make a general rule that if you are late for a meeting you
should be allowed to drive over the speed limit. If everyone followed that
rule, there would be chaos.
Exercise 2
Requiring that the principles underlying decisions or actions should be

capable of being generalised into a universally applicable law is not solely a
matter for big issues, like climate change. Much behaviour within
organisations is quite inconsistent and would be considered morally
problematic by Kantians. Can you think of examples of common
inconsistencies within organisations? Make a list of some examples.
Comment
People who work in organisations are fallible human beings like anyone else,
and as prone to inconsistent moral standards as anyone else. Some
examples of inconsistencies within organisations that would be considered as
problematic by Kantians might include:
. Favouritism: treating one employee with more favour than another is

inconsistent. This is not to state that exemplary behaviour should not be
rewarded. Rather, it is to state that rewards and sanctions should be
applied in a consistent and uniform manner. Displaying inconsistency and
workplace favouritism would not be acceptable.
57
Readings 46–55
. Turning a blind eye to ethical lapses: Organisations have been known to

overlook unethical behaviour from certain individuals for a couple of
reasons. For example, some individuals may be considered too powerful
to challenge and some individuals may be considered too technically
gifted to challenge. Kantian moralists would regard it as unacceptable
that a person is allowed to get away with certain behaviours (being
unpleasant to others, or even harassment) due to status or technical
ability.
. Feeding narcissism: Narcissism is a technical term from psychoanalysis
that refers to people whose sense of importance (pride) needs to be
frequently reinforced by the words and actions of others. Narcissists often
do well (up to a point) within organisations because they can be good at
self-promotion, although there does come a time when employees can
put more effort into feeding narcissistic needs of individuals rather than
the needs of the organisation (Gabriel, 1999). Kantians would regard
narcissism as unacceptable because not everyone’s narcissistic needs
can be equally attended to – otherwise organisations would exist to
pamper the egos of employees rather than to achieve their overall
objectives.
1.2 Kant’s second rule
One should always treat human beings as ends in themselves, rather

than as a means to an end.
This rule stands in stark opposition to the consequentialist ethical position

to be explored in the next reading, which very broadly states that people
should think of the outcomes of their decisions over and above the process
through which they come to a decision.
How often are decisions made in business, politics and government without
proper regard to the position of the individual human? It is easy for people
in business to think of employees, customers and suppliers as numbers on a
spreadsheet. A lot of the practice of management seems to be based on
dealing with abstract numbers and depersonalised organisational objectives
rather than the actions of living human beings. This even applies to areas of
business and management that, in themselves, seem quite progressive and
benign. For example, much of the literature in business studies addressing
social inequality is hard to read. This is not because the language is
difficult, but because much of it is so amoral. It asks business leaders to do
more to promote more people from ethnic minorities, or women, for
example, not because it is simply the only morally acceptable thing to do,
but because it is ‘good business’ – you make more money if you have a
diverse workforce because you are not placing restrictions on the available
pool of talent. Kant would find such a position morally unacceptable
because it is treating people as a means to an end (making more money)
rather than as ends in themselves. Or to come back to a fairly simple earlier
example, speeding to work in your car because you are late is unacceptable
58
because you would be treating others – pedestrians, other drivers and so on

– as if they were merely there as a means to an end (to get out of your
way). By speeding, you are not treating other humans as ends in
themselves, people who each have their own valid reasons for being on the
road.
From a business perspective, this is perhaps the hardest of all of Kant’s
rules. The founding purpose of business is, after all, to make a sustainable
profit. One could argue that making a profit can be a moral act – spreading
prosperity and valued goods as widely as possible. Moreover, perhaps
employees expect their labour to be somewhat exploited. The question is, to
what limit is exploitation of people’s time and identity acceptable? Most
people accept there are times when they will have to work beyond
contractually specified minimums, to meet deadlines and to enable an
organisation to continue in the longer term. During lean economic times,
people often even accept pay cuts. Yet Kantian moral reasoning asks
business practitioners to place respect for other humans at the heart of
practice. Even if the economic environment is poor, a Kantian might
involve employees in discussions about how everyone in an organisation
might make collective sacrifices.
1.3 Kant’s third rule
One should be sure that one’s moral position is capable of being

universally acceptable to other rational human beings.
Here we get close to what is often referred to as the ‘golden rule’ of many
moral positions, both philosophical and religious (Crane and Matten, 2010,
p. 106). The rule holds that you should not do to others what one would not
be happy for others to do to you (or to those close to you). This kind of
moral reasoning might lead us to be critical of, for example, business
executives who make employees redundant while simultaneously claiming
personal pay rises or financial bonuses.
Another example of the reasoning expressed in Kant’s third maxim would
consider whether you would be happy for a decision you make to become
public knowledge. This is about whether a particular decision could be
regarded as valid when studied by another rational human being. Would you
be happy for your crazed driving to become public knowledge or for others
to take risks with your loved ones’ lives if they were late for work? Most
likely not!
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Readings 46–55
Figure 3 The second and third principles of Kant’s categorical imperative
Exercise 3
Think back to the private conversations you have held or the private
decisions you have made over the past week or so – or even meetings you
might have attended at work. Would you be happy for the detail of these
deliberations or conversations to be made public and read about by your
friends, customers and family?
Comment
National governments and political leaders have faced much criticism in the
wake of memos and conversations thought to be private being made
available in the public domain via Wikileaks. Before being too judgmental of
these people and agencies it might be worth reflecting on your own private
conduct and decide whether you would be content for your detailed
reasoning to be publicly available to others. It is quite common for
employees to grumble about customers or co-workers in private. This rule
suggests that relatively trivial (although also potentially harmful) phenomena
such as office gossip would not be morally acceptable behaviour. More
obvious behaviour, such as making private discriminatory (racist, sexist and
homophobic) remarks obviously fails this rule. It does not matter that other
people did not hear someone say these things – it is the fact that they were
said at all that matters.
For Kant, all three rules needed to be met before an action can be
considered moral. Taken together Kant’s three rules of moral action imply a
quite strict moral code, one very few people would be able to follow on a
60
regular basis. That is the point. These rules were designed to be

challenging, to stretch human beings beyond some of their cruder instincts
and towards the urge that Kant believed everyone feels to do good.
2 The usefulness of Kant to business

ethics: a discussion
Proposing an ambitious, universal theory speaks of Kant's optimism that
humans hold much potential for good, for sophisticated reasoning, for
learning, for innovation.
On the one hand, one implication of Kant’s thinking would be that the idea
of corporate social responsibility is a no-brainer. Of course businesses have
a duty – an imperative – to care for the environment, the communities in
which they operate, their staff, their customers. Similar arguments may be
offered for the concept of sustainability. A business may be tempted to take
the easy route for a short-term boost in profits, but such actions would
likely be immoral in the eyes of Kant. In fact, adopting a Kantian position
would likely entail a far stricter adherence to ideas of social responsibility
and sustainability than are currently envisaged by most businesses, implying
the need for businesses to operate from a different mindset, thinking of
themselves part of a moral community rather than existing in a competitive
game (Bowie, 1998; Moran, 2009).
On the other hand, how likely is it that business practitioners (or any
normal, fallible human being) can actually follow Kant’s moral
requirements? What if Kant simply overestimated people’s urge and ability
to do the morally right thing? Even a casual glance at the horrors in the
news might lead you to this conclusion. If human beings are good by
nature, then why is so much of human history marked by violence?
A related point is that making one’s own moral judgements in the way that
Kant seems to require is actually quite hard. Instead of working out the
rules for doing good for themselves, most people generally seem to prefer
to obey authority (Stavrakakis, 2008). In other words, perhaps we are more
naturally programmed to follow what the boss tells us to do rather than
engage our own moral reasoning.
Being told what to do in organisations and society is actually quite
comforting because it means people don’t have to think too much for
themselves (Grint, 2010). In fact if there was not such a thing as
organisational or social authority, life would be harder and would lack some
kind of basic structure. The problem is that if you rely too much on
authority you can stop seeing right from wrong.
Any number of business scandals or even human rights atrocities could
suggest that people do indeed prefer to follow orders than think for
themselves. In many cases of unethical conduct you might hear the guilty
try to excuse themselves by saying: ‘I had no idea. I was only following
orders.’
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Readings 46–55
But perhaps the point of deontological ethics according to Kant is that, no

matter how much it might be human nature to follow orders or the trends
rather than develop one’s own moral judgement, developing this moral
judgement is precisely what ethics is about. It may not be easy but that
doesn’t mean it isn’t the right thing to do.
Summary
Kantian moral reasoning is hugely influential and important for business
ethics. Kant asks that we focus on the process of decision-making, of our
everyday conduct, rather than analyse the consequences of decisions. You
were introduced in this reading to Kant’s categorical imperative, this notion
that we are each compelled (as rational people) to moral reasoning. You
learned that Kant thought of his categorical imperative in the shape of three
principles: one related to the sustainability of decisions, one that asks you to
think of people as ends in themselves, not as a means to an end and one
that asks practitioners to consider whether their conduct would be viewed
by others as morally valid.
Kantian ethics adopts an ambitious stance and asks that we think of
ourselves as being part of a moral community, rather than existing in the
kind of ruthless and competitive game often portrayed in the business press
and literature.
62
References
Bowie, N. (1998) Business Ethics: A Kantian Perspective, Oxford, Wiley-
Blackwell.
University Press.
Gabriel, Y. (1999) Organizations in Depth: The Psychoanalysis of
Organizations, London, Sage.
Grint, K. (2010) ‘The Sacred in Leadership: Separation, Sacrifice and
Silence.’ Organization Studies, vol. 31, no. 1, pp. 89-107.
Kant, I. (1781/2007) Critique of Pure Reason, London, Penguin.
Kant, I. (1785/2012) Groundwork of the Metaphysics of Morals, Cambridge,
Kant, I. (1788/2004) Critique of Practical Reason, New York, Dover.
Milgram, S. (2010) Obedience to Authority: An Experimental View, New
York, Pinter and Martin.
Moran, K. (2009) ‘Can Kant have an account of moral education?’ Journal
of Philosophy of Education, vol. 43, issue 4, pp. 471–484.
Stavrakakis, Y. (2008) ‘Subjectivity and the Organized Other: Between
Symbolic Authority and Fantasmatic Enjoyment.’ Organization Studies,
vol. 29, no. 7, pp. 1037-1059.
63
Readings 46–55
Reading 50: Consequentialist

ethics
Introduction
Consequentalism is a Consequentialist ethics requires us to move beyond the means of a decision
way of thinking about (the process of arriving at a certain action) outlined by Kant and to consider
ethics that judges the ends, results of particular decisions. What will create the most benefit for
rightness or wrongness
people in the end? In exploring consequentialism, this reading will outline
of an action on the basis
of the consequences of the most influential ethical theory in this area: utilitarianism. Please do not
that action. be put off by these two rather long words: consequentialism and
utilitarianism. What is being discussed here is actually quite a simple idea
at its core: utilitarianism and consequentialism ask that business
professionals think about and weigh up the benefits and drawbacks (the
consequences) of their actions and decisions. Consequences here override
the immediate moral duty in Kant to other human beings.
Utilitarianism has proven to be an important area of ethics for managers in
the private and public sector because it urges a somewhat dispassionate
analysis of the consequences of certain decisions. How many people will
benefit from a given decision, versus how many people (if any) will suffer?
Do the benefits outweigh the drawbacks? Some of the refinements and
subtleties within this theoretical area will be unpacked in the next section.
As you proceed through this reading on utilitarianism, you will do so in
relation to an example of a specific business and public sector dilemma: the
proposed building of a third runway at Heathrow Airport in west London.
Example of business dilemma: Heathrow Airport
Figure 1 Terminal 5 at Heathrow Airport
Heathrow Airport is a busy place, as anyone who has travelled to or from

there will testify (Figure 1). According to the airport’s own statistics
(Heathrow Airport, 2014), 72.3 m people arrived at or departed from the
airport in 2013. That works out at an average of 191,200 people travelling to
and from the airport every day. In 2013, there were 469,552 air movements
recorded at Heathrow, which means the number of planes landing or taking
off. If you have ever sat in the vicinity of the airport you will note that the sky
64
Reading 50: Consequentialist ethics
above it often resembles a busy road, with planes continuously taking off or
touching down. Indeed, the airport states that it operates at 98% of its
capacity, the highest level in the UK.
The airport claims a third runway is needed to better and more efficiently
manage the large numbers of passengers using its services. In general,
airports bring in tourists and business people, contributing to the UK
economy. Efficient airports also enable people to travel more freely, to visit
family and to enjoy their leisure time outside a demanding work schedule.
Advocates of expansion state, therefore, that a third runway would generate
significant economic benefits but also improve the less tangible experience of
being a Heathrow customer.
In opposition to the airport expansion are a number of resident,

environmental and conservation groups. Residents in the west of London feel
their quality of life will be adversely affected by increased noise and air
pollution. Environmentalists are concerned with the increase in the emission
of carbon dioxide from air travel in general. AirportWatch, an organisation
that brings together various resident and environmental campaigners
opposed to airport expansion in the UK, is often quoted in mainstream media
stories concerning airport expansion. Its stance is that the government ought
to use its powers to reduce the number of people travelling by plane.
Initially, when elected in 2010, the UK Conservative-led coalition government

was opposed to the building of a third runway at Heathrow, citing mainly
environmental concerns, as well as quality of life issues (such as noise
pollution). Subsequently, however, the government established the UK
Airports Commission, which is researching and taking evidence on the
various options for airport expansion in the south east of England.
After outlining the basic features of utilitarianism, you will be asked to

think about the key points made in relation to the example of Heathrow
expansion, hopefully drawing out some of the key business and public
interest ethical issues at play. The reading will conclude by considering
utilitarianism in contrast to the material already explored on Kantian moral
reasoning, with the aim of making clear the distinctions – but not
necessarily oppositions – between the two theoretical positions.
1 Utilitarianism
1.1 What is utilitarianism?
Pioneered by British philosopher Jeremy Bentham and later substantiated
and developed by John Stuart Mill over the course of the 18th and 19th
centuries, utilitarianism urges careful consideration of which course of
action will promote the greatest benefit (utility) for the greatest number of
people.
When you first hear a statement such as ‘the greatest benefit for the greatest
number’ you will probably be impressed by its simplicity and logic.
Utilitarianism has proven an influential theory over time, perhaps largely
65
Readings 46–55
because it seems to be good common sense. For example, the BBC was
established along utilitarian principles – providing the greatest cultural and
educational benefit for the greatest number, in terms of happiness generated
(through entertainment programmes) and in terms of the more sober
capacity of media broadcasting to educate the masses. Likewise, the UK’s
National Health Service, while enacted and driven by a strong socialist
sense of justice, also held strong utilitarian connotations: the idea that a
society with as many healthy people in it as possible is beneficial for
maximising utility in other areas (prosperity and happiness, for example).
Many academics have noted the similarities between utilitarianism and a
cost–benefit analysis, a familiar tool within business (e.g. Crane and
Matten, 2010). Such an analysis will seek to gather together as much data
as possible to substantiate the risks and potential benefits of a particular
decision. Whichever option comes out as the most beneficial with the least
risk attached will be the preferable option. As such, utilitarians often prefer
to operate on the basis of hard data, i.e. measurable data capable of being
expressed in numbers (Bykvist, 2009).
Exercise 1
Can you think of any other major public or private sector innovations that can
be said to be informed in a strong way by the basic principle of
utilitarianism? Take 15 minutes to list a few examples that spring to mind and
provide a justification as to why these innovations appear to be particularly
utilitarian in nature.
Comment
The public sector is strongly informed by utilitarianism. Perhaps this is
because public sector managers and leaders often represent and work on
behalf of large numbers of people and therefore need to think about the
welfare and best interests of a whole group (nation, region or city) rather
than a particular customer segment or individual. Most major areas of the
public sector are underpinned by a utilitarian ethos. For example, the idea of
a prison is utilitarian. Prisons are concentrated spaces that allow a large
number of units (prisoners) to be processed (punished and rehabilitated)
simultaneously and in the same physical space. Prisons also allow a certain
degree of consistency and quality – governments can apply certain
standards across the board, with the assumption being that this systematic
processing of prisoners will generate the greatest possible utility for
prisoners, measured by successful reintegration into society and reoffending
rates, and will create utility for the law-abiding majority, who are able to
function in their communities without the presence of those who have been
sentenced to prison.
The private sector, however, might also be said to be a ready source of

utilitarian values. Large-scale business operations are often very utilitarian.
Big supermarkets are designed to provide the greatest choice and
sometimes the greatest value for the largest number of people. The internet
is a great example of an innovation with strong utilitarian benefits. Its
66
success might be explained by its capacity to generate a significant amount

of entertainment and education for an enormous number of people, relatively
cheaply. Staying with the world of technology, you need only study the
reported motivations of entrepreneurs such as Steve Jobs (Isaacson, 2011)
and Bill Gates (Manes and Andrews, 1994) to discover that these individuals
were seemingly driven by more than the desire to make money. Both, in
different ways, seemed motivated by the idea that previously difficult and
inaccessible technology (computers) could be made usable, readily available
and affordable for large swathes of people. Maximising people’s capability to
learn and entertain themselves at home could therefore be viewed as a
strongly utilitarian mission.
1.2 Different forms of utilitarianism

There are different and sometimes competing views of utilitarianism in the
literature and in practice. Lawton (2000) distinguishes between ‘act
utilitarianism’ and ‘rule utilitarianism’. Act utilitarianism is a position that
takes each individual decision in turn, seeking to maximise utility in
individual cases. Rule utilitarianism attempts to draw more general rules as
to the kind of decisions that generally seem to maximise utility.
Analysing the Heathrow example, you might interpret the issue quite
differently drawing on either act or rule utilitarianism. Thinking of the
Heathrow example in terms of act utilitarianism, you would view the issue
as a one-off case, in isolation. You might think specifically about the cost–
benefits of building the extra runway in and of itself. Thinking about the
Heathrow example as a matter of rule utilitarianism, you would seek to
think about the issue within the context of the UK’s broader airport,
transport, economic and environmental policies. In other words, you would
consider the case for Heathrow expansion as either something broadly
complementary to, or contradictory to, longer term UK interests and policy.
Crudely put, if the emphasis in UK policymaking is more inclined towards
cutting carbon emissions (as a general rule) you might be minded not to
consider the expansion, whereas if the longer term priority is to generate
more business activity (through one-off acts), then you might be minded to
think favourably about the idea of airport expansion in general.
Figure 2 Cartoon depicting utilitarianism
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Readings 46–55
1.3 How to define utility?

A trickier notion in utilitarianism is how theorists and practitioners define
the utility they seek to maximise. In other words, what is the good that
utilitarianism seeks to maximise?
Goodin (1995) distinguishes between three forms of utility. The first he
describes as hedonic. Hedonic utility deals with pleasure and was the focus
of Bentham’s philosophy. A hedonic utilitarian will seek to explore the
psyches of people, measuring feelings of pleasure and satisfaction.
Preference utilitarians would seek to build on the hedonic position by
asking what maximises pleasure in the longer term. Such a view might
avoid rather silly situations, such as education administrators and
practitioners pandering to the comfort and enjoyment of students and
underinvesting in activities that will generate positive learning outcomes
that would benefit students more in the longer term. Goodin’s problem with
these forms of utilitarianism is that they do not sufficiently discriminate in
terms of quality and merit of pleasure. What matters is simply the outcome
of pleasure. Applying this kind of logic it would matter less that you have
learnt something in this module and more that you have enjoyed it a lot!
This was an issue that also concerned John Stuart Mill (see Mill, 1863/
2008), who tried to distinguish between the different types of utility on
merit.
Goodin’s conclusion is that a third dimension of utility is necessary: welfare
utility. In other words, decisions attempting to generate the greatest utility
for the greatest number of people would prioritise the welfare value of these
decisions. Welfare does not equate to pleasure – it is about what is good for
people. The problem is that often people either do not know what is good
for them or are willing to take certain risks with their welfare.
You might be very fond of excellent whiskey and cigars, for example, as an
occasional treat. It is not necessarily in the interest of your best welfare to
maintain this habit but it brings you pleasure. You might also be very fond
of food high in saturated fats. Sometimes people are unaware of how much
damage they are inflicting on their welfare. This is why welfare
utilitarianism usually involves someone in a position of authority with more
knowledge than everyday people, someone who can take decisions on their
behalf. In our case of bad health habits, such experts might seek to explore
what labels and taxation levels on products harmful to health are necessary
to discourage those habits – or even whether certain products should be
available for purchase in the first place. Such experts will seek to balance
hedonic utility (the benefits and rights of people to enjoy themselves) with
welfare utility (what is good for people, even though it may be unpopular).
Hence expertise is very important in a utilitarian view of ethics, i.e. you
need someone able to identify what, objectively, would generate the greatest
amount of welfare for citizens or customers.
Exercise 2
Think about the example of the Heathrow expansion in terms of hedonic,

preference and welfare utility. How might you view the issue of expansion
68
from each of these three different positions? What kinds of utility might
expanding the airport, or even rejecting the expansion, generate? Are they
necessarily contradictory positions or are there also some similarities
evident?
Comment
Thinking about different forms of utility in relation to a specific example
draws out the differences in each position.
Hedonic
In terms of more immediate pleasure-related benefits, we could imagine that
passengers might expect to undergo a more streamlined and efficient
experience at Heathrow after expansion. More capacity might lead to a more
relaxed passenger experience. We might legitimately question, however,
whether the passenger experience at present is unpleasant, at least in
comparison with other airports. To what extent is the Heathrow experience
more or less comfortable and enjoyable than experiences passengers face
elsewhere? Perhaps you have been a passenger at Heathrow and other
airports and can make your own judgement on this issue.
Perhaps there are measures other than expansion that might improve the
experience of passengers at Heathrow: improved seating, facilities, shops
and cafés.
Preference
This position asks you to think about pleasure in the longer term. The key
question here is whether any expansion might generate real, longer term,
pleasure-related benefits. From this perspective you might ask whether
expanding the airport might lead to a more comfortable experience for airport
and airline staff, people who are at the airport all the time and will be there
most days for the foreseeable future. Operating at near full capacity must
inevitably generate workplace stress and so building in more slack to the
system might create a more enjoyable and relaxed working environment.
Likewise, residents affected by an increase in air traffic might consider the
issue of expansion to be one of preference utility. For some people, viewing
aircraft landing and taking off is a pleasurable experience but for others, the
extra noise and sight of more planes in the sky is an unpleasant experience.
Welfare
Already discussed is the notion of caring for staff at Heathrow. In addition,
you might seek to explore whether adding more capacity might make the
airport a more secure place for passengers. What might the security
implications be for operating at a lower capacity?
The main argument made in favour of expansion is economic. It is argued

that the building work and extra business generated through a larger, more
efficient airport will be good for the welfare of the UK by generating more
prosperity and employment. The area around Heathrow might become busier
(affecting hedonic and preference utility) but the contribution to welfare utility
will make the project worthwhile, or so say the proponents of expansion.
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Readings 46–55
Finally, you might consider the environmental implications of airport

expansion as an important welfare issue. To what extent might an expanded
airport make a difference to the carbon emissions of the UK? Remember that
it is not simply the extra emissions from aircraft that need to be considered
here but also the increase in the number of vans, trucks, buses and cars
accompanying any airport expansion.
In the case of welfare utility, you would need to think about the proposed
expansion in the context of the UK’s longer term interests and wider policy
objectives. It might be, for example, that certain gains or losses in welfare or
more pleasure-related utility might be considered acceptable if balanced out
by gains elsewhere in the system. This is what it means to adopt a more
systemic and strategic approach to public policy.
2 Problems with utilitarianism

Different ethical positions stress different aspects of morality. They all offer
different ways of thinking through particular moral problems and can
therefore be useful. However, all positions also have shortcomings if looked
at from a different perspective. Three problems can be identified in relation
to utilitarianism.
The first relates to the prominence granted to expertise within the theory.
Who decides what represents utility and makes judgements about who
would benefit the most from certain decisions? Experts can (and usually do)
hold very different views about certain issues. For example, you can find
expert economists on the political right who will tell you that the fairest
way of ordering a society is through free markets and small government.
Yet you will also find an equally expert economist holding social
democratic views who will insist that government has an important role to
play in regulating markets and in being more proactive in generating
opportunities through education and welfare provision. Perhaps it is not
good enough to tell ourselves that these decisions are better off in the hands
of experts because in doing so we automatically give up power to a figure
of authority. Maybe we need to learn how to control and modify our own
habits and behaviour more (for example, by being sensible about the
amount of fine whiskey and cigars we consume). Perhaps sometimes an
expert will propose a solution, for example to Heathrow airport, because
that expert is more aligned with either environmentalism or business
expansion – experts are human beings too and as such carry the same biases
and preferences as everyone else.
Another problem with utilitarianism is that you can never be entirely certain
of the reliability of a measure of utility (Lawton, 2000). Try sitting in a
room with a selection of your work colleagues and ask them why they come
to work in the first place. Then try the same with family members. It is
unlikely that all of the people you ask will provide you with the same
answer. Some will tell you they come to work for money. Others will tell
70
you they come to work for the friendship of co-workers. Some people will
tell you they come to work because they believe in the purpose of the
organisation. Despite the large number of sophisticated models for
measuring utility, ultimately a question as complex as ‘What is utility?’
implies a lot of subjective judgement and a difficult balancing of competing
interests.
The final criticism of utilitarianism is that it can lead to minority people
being overlooked or even oppressed (Crane and Matten, 2010). One
example of such a problem can be identified in the area of national security
and torture. The years following the 9/11 attack on the World Trade Center
in New York amplified the debate concerning torture because certain
practices conducted by the US intelligence services came to the attention of
the public. First, it should be noted that the US government denied that
practices such as waterboarding did constitute torture. Second, a utilitarian
argument suggested that more extreme methods of interrogation generated
results in the form of the identification and capture of terrorists. The
evidence for this assertion is at best mixed and some of the biggest sceptics
as to the effectiveness of torture can be found within the ranks of the
military. Nevertheless, the broader argument offered was that it is in the
greater social interest that a minority of people are treated with some force
(tortured, if that is your view). The position of minorities, people who may
be innocent or who genuinely have no information to share, is considered of
secondary importance to the larger goal.
Summary
Consequentialist ethics is concerned with the assumed results of decisions,
whereas deontological ethics is more interested in the process of how a
decision is made. In this reading you were introduced to the philosophy of
utilitarianism, the ethical position that tells you to make decisions based
upon a requirement to generate the greatest possible benefit for the greatest
possible number of people. It was stated that there are broadly two forms of
utilitarianism – act utilitarianism and rule utilitarianism – although in
practice most utilitarian philosophers and practitioners would consider these
to be overlapping positions. You were asked to differentiate between
hedonic, preference and welfare forms of utility. Three problems were
identified in relation to utilitarianism: handing over power to experts and the
welfare of minorities.
This reading will now conclude with a brief discussion of some of the
similarities and differences between the deontological and consequentialist
ethical positions encountered so far, as a means, hopefully, of clarifying
some problems or confusion you might be experiencing.
Utilitarianism, of course, seeks to analyse and weigh up the pros and cons
of various outcomes, whereas Kantian ethics is much more interested in the
means of getting there in the first place. Both theoretical positions can,
however, be adopted in order to generate ethical rules. Furthermore,
contemporary utilitarians argue they are in fact sensitive to the needs of
minorities; that a utilitarian decision should not be taken if there is a danger
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Readings 46–55
of real harm being caused to a minority group or individual. In this sense,

Kant’s rule of respecting individuals as ends in themselves would be
respected.
However, Kantian moral reasoning does apply stricter and less flexible rules
on decision-makers. A decision should never be taken if it cannot be made
into a general rule or law! This is a firm commitment that can never be
broken. Utilitarianism, on the other hand, seems to demonstrate more faith
in the role of expertise in approaching each issue in turn. Modern science
and knowledge has reached such a point that perhaps certain decisions are
better left in the hands of experts, or at least it is fair to acknowledge the
dangers of operating without expertise. Nevertheless, there is also a danger
present in replacing sound moral reasoning with the views of experts – we
hand over power to think and act for ourselves. Finally, it would hardly be
fair to state that deontological ethicists do not think about consequences.
After all, it is likely impossible not to think about the consequences of a
decision when reflecting on whether you are treating human beings as ends
in themselves. In practice, therefore, it is unlikely that you will find a
business that only uses deontological or consequentialist ethics. It is more
likely that the two will be balanced in business practice.
72
References
Bykvist, K. (2009) Utilitarianism: a guide for the perplexed, London,
Continuum.
University Press.
Goodin, R. (1995) Utilitarianism as a Public Philosophy, Cambridge,
Heathrow Airport (2014) ‘About Heathrow Airport: Facts and figures’,
[online]. Available at http://www.heathrowairport.com/about-us/company-
news-and-information/company-information/facts-and-figures, (Accessed 8
March 2015).
Isaacson, W. (2011) Steve Jobs: The Exclusive Biography, London, Little,
Brown.
Lawton, A. (2000) Ethical Management for the Public Services,
Buckingham, Open University Press.
Manes, S. and Andrews, P. (1994) Gates: How Microsoft’s Mogul
Reinvented an Industry and Made Himself the Richest Man in America,
New York, Touchstone.
Mill, J.S. (1863/2008) On Liberty and Other Essays, Oxford, Oxford
World’s Classics.
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Readings 46–55
Reading 51: Justice in

organisations and societies
Introduction
Justice is an ethical perspective that takes account of how benefits and
resources are distributed in a society, or even within an organisation. It asks
one to think about how one might design just opportunities and the
distribution of wealth. Theories of justice are informed by how one views
issues such as suitable reward for work undertaken and how a society or
group views its responsibilities towards those less economically productive
(the elderly, disabled, sick, even children).
In one sense a discussion of justice could hover in quite high-level, abstract
thought. High-level thinking on justice informs how governments view their
responsibilities to citizens and informs the policies they design and
implement to encourage productivity and innovation but also to care and
nurture those who need more support. Does a government think in broadly
right wing or left wing terms about justice, for example? Justice, in this
more abstract sense, can also inform the strategic policies and cultures of
businesses. What is the correct balance for organisations to strike between
support for struggling employees and rewarding high performers? Do
businesses have a wider obligation to contribute to social justice? In this
section you will touch upon these bigger issues but will primarily focus on
justice as a practical theoretical stance for practicing managers. You will
therefore consider how perspectives on justice can inform day-to-day
decisions in business.
Before embarking further, you will now read an example of a basic human
resource management dilemma. You will return to this dilemma as you
proceed with the reading, re-interpreting it according to each lens of justice
presented.
Example of a human resource dilemma

You are a manager in a large firm. You have a staff vacancy for a junior
marketing officer and have been asked to sit in on the interview panel. This
is an entry-level position, although you have stated on the job description
that you would prefer to recruit a university graduate with some additional
vocational training in marketing. After a rigorous recruitment process, which
included psychometric and IQ testing, as well as some simulated business
activities and a face-to-face interview, you are left with a choice between two
candidates. There seems to be little separating them. Both have similar
grades from good universities and have pursued extra training in marketing.
However, Candidate 1 has undertaken six months of an unpaid internship at
a prestigious marketing firm in London and has offered positive references
from the firm. Candidate 2 has spent the eight months since graduating
working a mix of service and bar jobs. Candidate 1 seems more comfortable
and experienced with the language and daily practical challenges of an office
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Reading 51: Justice in organisations and societies
marketing job. But there is also something about the enterprise and energy
of Candidate 2 that appeals. Which candidate would you employ?
Figure 1 A job interview
In the reading that follows, various concepts of justice will be introduced as

a way of making sense of this example.
1 Distributive justice
The emphasis on distribution in the title is important here. Most
perspectives on justice make explicit reference to how goods, rewards and
benefits are distributed amongst employees, organisations and citizens. You
will now read about some different distributive perspectives
(Velasquez, 2002).
‘Egalitarian views’ on justice hold as a basic principle that all people should
be treated equally and that no individual differences (e.g. socio-economic
background, race, sexuality, etc.) can justify unequal treatment (Cohen,
2001 and 2011; Mason, 2006). It is a commitment to egalitarianism that lies
at the heart of much legislation at national and supranational level
prohibiting discrimination and enshrining rights for certain groups, such as
paid maternity and paternity leave for new parents. It is a relatively
straightforward notion that holds that none of us are inherently superior to
others and that it is unethical if some groups and individuals are structurally
more advantaged than others. Yet is it realistic or even helpful to think of
people as fundamentally equal? Perhaps it is right, for example, that
businesses should be able to reward employees they particularly value, and
who offer the greatest value for their organisations.
An egalitarian senior executive might consider ways in which their business
could level the playing field as much as possible, so that employees could
experience equal treatment and equal access to opportunities. Further, an
egalitarian executive might also consider ways in which the business could
pay special attention to certain groups and communities, for example,
through outreach programmes, targeted recruitment fairs and training
opportunities to marginalised groups and individuals.
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Readings 46–55
Exercise 1
Looking again at the human resource dilemma in the example above, place
yourself in the position of a manager who holds a strong egalitarian sense of
justice. Which candidate would you appoint? What would be your
justifications for doing so and what might some of your other, broader
organisational options be to correct any injustices you identify in the system?
Comment
An egalitarian would face a dilemma in this situation. At face value the
business has provided the same opportunities to both candidates: the same
amount of information and the same testing procedures. The question is
whether an egalitarian would be satisfied to go no further.
The issue of unpaid internships was chosen deliberately to illustrate a

growing ethical problem within business. As the jobs market becomes more
competitive, so the entry-level expectations for employees grows. Young
people entering the world of work could be forgiven for wondering how and
when they were supposed to have gained experience when they are fresh
out of school or university and are applying for a job, which seems like an
entry-level position. The answer is often that they were expected to dedicate
a significant amount of time prior to applying for a paid position in unpaid
labour. Such a phenomenon is particularly notable in the media and the
creative industries and has led to concerns that these sectors are
increasingly being occupied by the children of wealthy parents because they
can afford to subsidise their offspring while they work for free, gaining
industry experience. An egalitarian would be reluctant to discard the
internship experience, focusing instead on only paid experience because,
after all, the same opportunities, from the perspective of the employer, have
been afforded to both candidates. A broader egalitarian perspective might
seek to resolve this dilemma in future by establishing its own (paid)
internship scheme or sponsoring a certain number of students from targeted
universities, with the same opportunities provided to anyone willing to apply.
A ‘capitalist perspective’ on justice holds that benefits generated through

work should be distributed according to contribution (Friedman, 2002;
Fulcher, 2004). In other words, open markets determine how wealth is
distributed according to what, and who, people value. Markets also provide
a guide for the setting of salaries within organisations. If one’s work is
valued and people are willing to pay for it, then capitalist justice dictates
that one will be rewarded. The key concept in capitalist justice is the notion
that competition and free markets are healthy. Competition yields innovation
as businesses seek to outperform and out-innovate one another. The
capitalist sense of justice does not simply affect the private sector. In more
recent years a more competitive ethos has spread into the public sector as
well. More services viewed as non-essential have been outsourced to private
sector providers. The healthcare and education systems have been
76
redesigned (at least in England) to encourage more competition between

schools and hospitals for patients. The justification for the spread of more
competition into public services is usually that it offers more just outcomes
for citizens in the end because providers are forced into competing for
service users and are therefore also forced to offer better services in order
to attract these users (Le Grand, 2007).
Exercise 2
Place yourself in the position of a manager holding a strong sense of

capitalist justice. Which candidate would you appoint and what might some
of your justifications be for doing so?
Comment
The solution here for a capitalist would be relatively simple: appoint
Candidate 1. The market has dictated that a reasonable entry requirement
for this industry is the accruing of workplace experience on an unpaid basis.
The market dictates that Candidate 2 either finds a way of working for free or
seeks an alternative career path. A more enlightened capitalist might ask if
such a system of unpaid labour provides a basis for longer term profitability.
It might hurt the business in the longer term if it failed to recruit people who
did not come from wealthy families and so an enlightened capitalist might
draw similar conclusions to an egalitarian and seek to provide paid
internships through the business. It might hurt the competitiveness of a
business in the longer term if it failed to recruit smart people from poorer
backgrounds.
A ‘socialist perspective’ on justice is rooted in the belief that benefits and

wealth in a society should be redistributed to cover everyone’s basic needs,
with any surplus value redistributed to cover people’s non-basic needs
(Braverman, 1999; Eagleton, 2012; Marx, 1867/2008). The difference
between a socialist perspective and an egalitarian perspective lies in the
level of intervention by business or government. A socialist would believe
in a higher degree of intervention in order to more heavily influence an
equal outcome for citizens or employees. As Velasquez (2002) notes,
socialism has much in common with the notion of a family. When parents
bring up children, they accept their role as nurturers and support children
who they accept should not be forced to work for wages until they reach a
certain age. Variants of socialism have been responsible for establishing
some important institutions whose primary driver is the notion of a fair
distribution of justice. The National Health Service, comprehensive
education and the welfare state in the UK may all be said to be driven by a
broadly socialist view of justice.
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Readings 46–55
Exercise 3
Place yourself in the position of a manager operating from a strong sense of

socialist justice. Which candidate would you appoint and what might some of
the justifications be for doing so?
Comment
A socialist would likely argue that it is the responsibility of organisations to
redistribute benefits and opportunities, as well as equalising outcomes for
people. Such tasks should not simply be left to governments. So, the job
would go to Candidate 2. It is unfair that Candidate 1 has accrued more
experience: no one should provide their labour free of charge – a socialist
would view this as exploitation and a deepening of oppressive social
structures.
When reading the above descriptions of various perspectives on justice and

reflecting on them in relation to a specific human resource management
case, it is worth reflecting that each position is discussed in something of a
pure form. In reality you would likely experience organisations,
governments and individuals who operate from a basis of a mix of
perspectives on justice – a little bit socialist, capitalist and egalitarian.
Nevertheless, hopefully bringing out each of these perspectives in isolation
in this reading will help you identify and analyse the origins and influences
upon many of the policies and practices of organisations.
2 Justice as fairness: John Rawls

John Rawls (Figure 2) was a philosopher who tried to distil several ideas of
justice into one set of principles, bearing in mind the previous point made
that it is rare and perhaps often undesirable that practicing managers or
leaders in society restrict themselves to only one perspective on justice. In
general, people in the UK at least have tended to favour a mixture of
perspectives. The UK seems to value the personal freedoms, links between
hard work and wealth, and innovation of free-market capitalism but also
values the best of socialism – the building of institutions to care for all
citizens and a redistributive tax system to provide a good quality of life for
the less fortunate.
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Figure 2 John Rawls
Before getting underway with Rawls’ work, it is worth noting that you
should not read his theory as a kind of perfect compromise between
competing notions of justice. Rawls was committed to a liberal model of
capitalist democracy (the EU and US model, in other words), so if you are
reading this from a different national context, you may well not relate to the
logic of his arguments as much as a reader from the UK or some other
western European nations.
The key text for the purposes of this reading is Rawls’ (2001) A Theory of
Justice. It is a comprehensive and ambitious piece of work, which will now
be summarised briefly. Rawls’ theory of justice as fairness hinges on two
central principles.
The first principle states that ‘each person is to have an equal right to the
most extensive basic liberty compatible with a similar liberty for others’
(Rawls, 2001, p. 56). This principle refers to a right to certain liberties
Rawls holds as fundamental, such as: freedom to vote freely, freedom of
speech, the right to own property and freedom from persecution. These are
core principles of a standard liberal democratic model.
The second principle states that:
social and economic inequalities are to be arranged so they are both:

(a) reasonably expected to be to everyone’s advantage and
(b) attached to positions and offices open to all.
(Rawls, 2001, p.56)
The first part of this second principle acknowledges the importance of

wealth being redistributed to help those most in need. The reservation here
is that this must be done to ‘everyone’s advantage’. In other words, a
society can damage itself by placing too much emphasis on welfare and not
enough on generating wealth. Key here is the notion that the more
prosperous a society, the more everyone should benefit – but a society
cannot care for its less advantaged citizens if it is not sufficiently
prosperous. The second part seeks to enshrine a principle of equality of
opportunity: that jobs and positions of authority should be equally attainable
for everyone, providing they are prepared to take advantage of their
opportunities, in the form of education and training (as you have enrolled
on an OU degree, this includes you!)
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Readings 46–55
These principles are subtle and designed to address the complexities of

balancing economic interests with justice. There is a strong link to be found
with Kantian theory. The link lies in an assumption that these principles
would be those chosen by any rational person if they had no knowledge of
how their life would unfold. In other words, nobody chooses from birth to
be poor, a member of an oppressed group or to suffer illness or injury.
Bearing this in mind, Rawls asks his readers to imagine how they would
like to be treated by their society in the event that they somehow became
disadvantaged. He calls this way of thinking about principles and the future
the ‘veil of ignorance’, thinking and theorising on the basis of not knowing
what the future might hold for you.
Rawls’ critics state that it is impossible to ask someone to operate from a
position of ignorance, given that they will already have a lifetime of
experience to draw upon.
What Rawls is asking, however, is that legislators and even powerful
business people put in place policies, laws and regulations that make people
think about justice in such a disinterested way. He is asking that people
remove the temptation to exploit and persecute others by enshrining certain
over-arching principles of justice – in rules and laws.
So, how can Rawls’ theorising be applied to business? The protection of
liberties outlined in the first principle suggests it would, for example, be
unjust if workers were pressurised by trade unions to join. It would be
equally unjust for businesses to make threats in order to prevent workers
from joining a trade union or seeking to achieve, say, better wages or
working conditions through trade union action. It also suggests that a
business has an obligation to reward its employees at least to a certain
minimum standard to enable them to engage in the basic liberty of owning
property if this is how they choose to spend their money. Equally, this
principle does acknowledge a degree of in-built inequality in a society.
Some will achieve more than others because they are more intelligent, more
enterprising or simply work harder, and their liberty to earn more through
legal and ethical means should not be inhibited.
The emphasis on a productive society in the first part of the second
principle suggests that phenomena such as price fixing, monopolies and
even exorbitant bonuses for senior executives (especially those whose
businesses do not perform very well) are unjust. They are unjust because
they do not generate wealth or encourage hard work or enterprise, but
reward greed. The second part of the second principle suggests it would be
unjust if people experienced unequal access to opportunities such as
education and training. This would be problematic in societies where
children from poor backgrounds suffer poor learning opportunities in
comparison to children from better off families.
Exercise 4
Returning to the example outlined in the introduction and placing yourself in

the position of a manager operating from the basis of a Rawlsian sense of
80
justice, which candidate would you appoint and what might some of your
justifications be for doing so?
Comment
There is no easy answer provided by Rawls and perhaps this is an indication
that the theory is of value. After all, the notion of justice is complex – dealing
with often fragile and inter-dependent factors and social dynamics. You
would not want to deny Candidate 1 his/her liberties – she/he has simply
taken advantage of opportunities available. However, to start employing
people on the basis of free work undertaken, would perhaps establish an
unjust precedent for the future. It might also be hindering the potential
economic prosperity of society by playing a part in the normalising of
inequality. Inequality in this case means that the wealthy have an advantage
in the jobs market. This would inevitably disadvantage smart people from
poorer backgrounds from getting ahead. It would therefore hurt the prosperity
of everyone in the long run. Perhaps one solution might be to acknowledge
the rise of the internship phenomenon by offering a short-term paid
internship, which would allow young people the opportunity to gain
experience while earning some kind of basic wage. A Rawlsian might also
think about ways in which this issue of justice might be addressed on the
national level. Perhaps there is a role for government in supporting paid
internships in targeted sectors of economic benefit to society, or even of
legislating to limit unpaid internships.
Summary
This reading has introduced the idea of justice as a way of thinking both
about larger issues affecting business and smaller, more day-to-day decision
making. Justice was introduced as a means of thinking about how wealth
and benefits are distributed justly within a society, or even within an
organisation. The reading also asked you to think about the role of business
in building and sustaining a just society. How do smaller decisions made by
business affect the justness or otherwise of a broader society?
The first part of the reading was dedicated to presenting various
perspectives on justice: utilitarian, socialist and capitalist. It was noted that
although societies draw on each of these views, they are seldom used in
isolation. They were seen as somewhat blunt instruments in relation to our
two business situations. You were then presented with Rawls’ theory of
justice as fairness, a more complex attempt to balance demands of social
justice and economic prosperity. It was shown that Rawls’ theory can
indeed hold some serious business implications, implying responsibilities for
executives, employees and consumers.
Relating the discussion to other readings, Rawls’ theory of justice is
informed by Kantian moral reasoning in as much as it asks practitioners to
think about how actions aimed at generating more justice can be generalised
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Readings 46–55
into a rule for organisations and societies. Valuing all people as ends in
themselves can be identified as lying at the heart of the generation of such
rules. That being said, Rawls’ position on justice also encourages
practitioners to think about the consequences of their actions. This is
especially true in the Rawlsian interpretation of business management,
where practitioners are asked to think about the consequences of their
decisions in terms not only of organisational but also broader social justice.
82
References
Braverman, H. (1999) Labour and Monopoly Capitalism: The Degradation
of Work in the Twentieth Century, New York, Monthly Review Press.
Cohen, G. (2001) If You’re an Egalitarian, How Come You’re so Rich?
Cambridge, Massachusetts, Harvard University Press.
Cohen, G. (2011) On the Currency of Egalitarian Justice and Other Essays
in Political Philosophy, Princeton, New Jersey, Princeton University Press.
University Press.
Eagleton, T. (2012) Why Marx was Right, New Haven, Connecticut, Yale
University Press.
Friedman, M. (2002) Capitalism and Freedom, Chicago, University of
Chicago Press.
Fulcher, J. (2004) Capitalism: A Very Short Introduction, Oxford, Oxford
University Press.
Le Grand, J. (2007) The Other Invisible Hand: Delivering Public Services
through Choice and Competition, Princeton, New Jersey, Princeton
University Press.
Marx, K. (1867/2008) Capital: An Abridged Edition, Oxford, Oxford
World’s Classics.
Mason, A. (2006) Levelling the Playing Field: The Idea of Equal
Opportunity and its Place in Egalitarian Thought, Oxford, Oxford
University Press.
Rawls, J. (2001) A Theory of Justice, Oxford, Oxford Paperbacks.
River, New Jersey, Prentice Hall.
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Readings 46–55
Reading 52: Virtue ethics

Introduction
Virtue ethics is an area of ethical theory that focuses on the characteristics
and qualities of individuals and, occasionally, communities. This way of
thinking asks what it means to be a virtuous practitioner and how one may
develop and encourage virtuous characteristics within an organisation. Fix
the characteristics of individuals, fix the ethics. The basic premise is that
ethical practice will occur if individuals and communities nurture ethical
traits and practices. Fashioned by Aristotle in Ancient Greece (Figure 1),
virtue ethics was birthed at a time when significant concerns were being
raised about the nature of education. Ethicists of the day were concerned
that education was becoming too market-oriented; that it was being sold to
the children of the wealthy as a means of helping them become more
successful manipulators of public opinion (Grint, 2001).
Figure 1 A bust of Aristotle
One can read virtue ethics therefore as a serious attempt to engage students
in deliberation about ethical matters, to nurture future generations of ethical
practitioners who would lead their city-states in a just manner. Aristotle
wanted to educate future public leaders in a way that developed their human
virtues, rather than simply their skills (in public speaking or finance, for
example).
The purpose of virtue ethics is the creation of what Aristotle called the
‘good life’ (Aristotle, 350BC/2009). With this phrase, Aristotle was making
the claim that one experiences greater happiness when one pursues a
virtuous life – hence the notion of pleasure was inserted into the discussion
of ethics for the first time. Perhaps he had a point. When you think of (the
caricature of) businesspeople with great wealth but also a trail of broken
personal relationships, who care little about the world in which they inhabit,
you cannot but help wonder how truly satisfied such people would be. In
84
contrast, look at someone like the US entrepreneur and investor Warren

Buffett, who is well known for his philanthropic generosity and for urging
his children to earn their own money. In Buffett you see someone who
genuinely seems delighted with his lot in life (for considerable evidence of
this see Schroeder, 2009). That is not to say that riding aboard a luxury
yacht, staying in the best hotel suites or driving sports cars are not
pleasurable activities, but perhaps in comparison to feeling connected to
humankind, to making a contribution to one’s community, the more
hedonistic aspects of life can feel a little shallow. The remainder of this
reading will ask you to reflect upon the helpfulness of virtue ethics in
business.
As the reading proceeds you will be asked to reflect on the issues raised in
relation to a well-known case study from business, that of the former Apple
chief executive, Steve Jobs.
Exercise 1
What would you consider to be the defining characteristics of an ethically

virtuous business practitioner? Make a list of some of the behaviours and
traits that would define someone in business as virtuous. You can include
examples of people who seem to embody these virtues that you know from
your professional life or from public life.
Comment
Take a moment to look back over your list. You may have included virtues
such as honesty, courage, being hard working, perseverance, or willingness
to learn, among others. To what extent do you think these virtues would be
applicable in all situations and to what extent do you think they are context
specific? Traits such as honesty and courage might be regarded as important
in some situations but in others could be regarded as problematic. For
example, it is unlikely that you would want your chief executive to act in a
continuously honest way, telling each and every employee, for example,
exactly what she/he thinks of their performance at any particular time. The
truth can hurt sometimes and there are often ways of communicating
important, truthful messages without employing blunt honesty. Likewise,
courage may be appreciated in some contexts more than others – some
professions regard caution and conservatism as far more valuable than
courage (accountancy, for example). Even in the traditionally ‘courageous’
professions, such as firefighting, experienced professionals will tell you that
virtues such as patience, willingness to learn and perseverance (in relation to
analysis of situations and the research and science of fires) are just as
important as courage.
That said, perhaps adopting a general posture of, say, honesty, in sensible
doses, can be a universally valid virtue. Generosity and care might be other
virtues that in general and in proportion could be regarded as universally
welcome virtues.
Finally, did you include any virtues that could not easily be described as
strictly moral? It is possible to possess virtues that are more intellectual or
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Readings 46–55
practical. I could be a caring, honest and courageous teacher but unless I

had a grasp of the practical side of teaching (how to design a class, how to
write clear text), my moral virtues would probably not count for much. In
other words, perhaps it is unhelpful to view moral virtues in isolation. Nobody
listens to the morally rich but technically incompetent professional. These
issues will be expanded upon in the remainder of the reading, in relation to
Steve Jobs and Apple.
Now read this example, which raises the question of whether Steve Jobs
was a virtuous leader.
Example of a virtuous leader: Steve Jobs

Many of you will already be familiar with Steve Jobs’ life and career
(Figure 2). It is certainly compelling, as many readers of Isaacson’s (2011)
seminal biography will attest. Like many successful entrepreneurs, Jobs
started his company in a modest way, tinkering with machinery in his
bedroom and then in his parents’ garage in the early 1970s with his friend
and soon-to-be Apple co-founder Steve Wozniak. Apple launched its first
computer in 1976 and captured attention with what would become the
defining characteristic of all future Apple products: technical performance
combined with simple, sleek design.
Figure 2 Steve Jobs, co-founder of Apple
Jobs was clearly a driven and hardworking man, who also happened to have
an excellent technical mind. But were these virtues sufficient? Jobs
infamously lost his job, fired by the board of his own company in 1985 after
Apple lost considerable market share to IBM (Smolović Jones, 2012). Many
would have retreated into a life of bitterness and isolation following such a
setback but Jobs in fact formed a new computer company, NeXT, and the
animation revolutionaries, Pixar (makers of Toy Story and so on). Jobs later
sold NeXT to Apple and sold Pixar to Disney. In the latter deal, Jobs netted
himself around US$4bn of Disney shares.
Following another period of success, especially in educational software and

desktop publishing, Apple suffered a dip in performance, coming close to
86
bankruptcy in the mid-1990s. During this period, Apple realised that it would
need something a little unorthodox and dramatic to reverse its fortunes. It
turned to Jobs and asked him to come back as the chief executive. He
accepted and Apple’s rise in fortunes, with products such as the iPod, iPad,
iPhone and resurgence in the computer market are well known.
Many people would be reluctant to return to an organisation that had

previously sacked them; such places often hold bitter memories. They might
be especially reluctant to return if they had also accumulated a significant
independent fortune in the intervening years. But return to Apple is precisely
what Jobs did. Clearly, then, Jobs was someone who possessed much in the
way of intellectual and technical virtues, as well as more personal virtues of
resilience and determination. Jobs was not interested in the Apple job solely
for the money; there was a higher mission at play for him.
But what about Jobs’ moral virtues? To many, Jobs is thought of as an

inspirational figure. If you have time, it is strongly recommended that you
track down his graduation address at Stanford University, freely available in
streaming video form on the internet. In this address, he speaks to hundreds
of bright American graduates and urges them to be bold and adventurous in
their professional lives – to stand for something greater than their own
narrow and short-term interests.
Yet it is well known that Jobs was also an abrasive character

(Isaacson, 2012). Perhaps such abrasiveness is common in people who are
so professionally driven: they do not manage to be so successful, so driven
and focused, without upsetting people along the way. Steve Jobs was a
borderline obsessive character, however. His compulsion to control at Apple
is spoken of in reverential tones by authors in business studies. One of the
better known stories about Steve Jobs concerns his predilection for tight
security measures at Apple headquarters (Rothaermel and
Horbaczewski, 2012). These measures approached something one would
expect to see in an intelligence or military base. Employees were only
allowed access to certain parts of the building, depending on their level of
clearance. In fact, new employees were often given dummy work until they
proved their trustworthiness and so could be entrusted with ‘real’ work. Jobs
was well known for energetically pursuing competitors through the courts if
he felt that Apple’s intellectual property had been violated. He was also a
ruthless cost-cutter – slashing the cost of production of the iPhone
dramatically, for example.
Nevertheless, Jobs was someone who delegated a lot, at least to those

people he respected and who had earned his trust. Jonathan Ives, for
example, was handed significant discretion in the design process of the iPod,
iPhone and iPad. Much of the retail strategy was delegated to an expert in
this area, Ron Johnson.
Jobs was therefore a brave, intelligent, determined and energetic man who
dedicated himself to a project beyond his own self-interest. Does this make
him a virtuous leader? This issue will now be discussed in more depth
alongside a consideration of virtue ethics.
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Readings 46–55
1 Virtue ethics: moral and intellectual

virtues
Aristotle identified two broad types of virtues he thought people ought to
cultivate: moral virtues and intellectual virtues.
In the case of intellectual virtues, he distinguished between three types of
intelligence:
1 The kind of knowledge we might think of as craft knowledge: hands-on,
practical know-how.
2 The kind of knowledge we might think of as bookish intelligence.
Someone who is academically intelligent may be able to comprehend a
difficult theory, grapple with complex mathematical equations or bring
an analytical eye to a piece of literature. They might also be able to
think intellectually about the purpose and strategy of an organisation.
3 The third intellectual virtue is a combination of the first two categories,
but also the creation of something new – that of practical wisdom. Grint
(2007) holds that practical wisdom is essential for learning how to lead
in organisations because it involves the acknowledgement of the
importance of learning from experience (getting one’s hands on a
problem in a practical sense) but simultaneously of being able to glean
more general, meaningful intellectual lessons of use for the wider
organisational community because of the capability of being able to
connect experience to theoretical learning. Thinking over your studies at
the OU, what we are really aiming for is to enable you to become
technically and intellectually gifted learners who can make a real
difference in the workplace – people possessing practical wisdom, in
other words.
Exercise 2
88
Knowing what you do about Steve Jobs, would you say he demonstrated
aspects of the three types of knowledge identified above? List some
examples of how his intellectual virtues might fit certain categories more than
others.
Comment
Like many tech-entrepreneurs, Jobs initially experienced success because of
his technical prowess. He displayed technical knowledge in abundance, co-
inventing a new kind of personal computer that was technically superior and
also simple to use. Nevertheless, he was clearly also someone of some
abstract intellectual virtue. He noticed a gap in the market and as most
successful business people will attest, building a successful business from
nothing requires significant intellectual capabilities as well as pure practical
sense. What might be called practical wisdom is also visible in the way he
managed to continuously learn from his mistakes and setbacks to come back
as a stronger, more capable business leader. He might have held certain
consistent beliefs – in control, in his commitment to simple design – but
these were applied to a range of innovative new products. He was someone
who was not afraid to be proven wrong by experience, in other words. Jobs
was also someone who was prepared to pass on technical and intellectual
responsibilities to people he thought better equipped to handle them, thus
displaying practical wisdom via the principle of sensible delegation.
But what of Jobs’ moral virtues? Moral virtues can be thought of as

characteristics such as honesty, loyalty, friendship, courage, kindness, and so
on. These are the characteristics usually drawn upon to determine whether
someone is considered a good, bad or somewhere in between person.
Aristotle’s position was that neither moral virtues nor intellectual virtues
made a virtuous individual when taken in isolation. To be truly virtuous one
had to display both intellectual and moral virtue. Hence, it is perhaps
pleasant to encounter someone who is kind but that person will likely make
little impact on the world unless they are also able to combine this kindness
with a certain set of intellectual virtues, which will enable them to make a
real difference in the world. Hence when one thinks of particularly
successful moral leaders they are usually people able to make a difference
from a moral perspective but are also people with significant intellectual
virtues, or they surround themselves with people who possess these virtues.
Exercise 3
Based on what you know of Steve Jobs, would you describe him as a
morally virtuous business professional? Make a list of the ways in which he
could be described as a morally virtuous or unvirtuous person. Provide some
examples to justify your position.
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Readings 46–55
Comment
Steve Jobs was well known for not suffering the company of fools. He could
be a difficult, even short-tempered person. Furthermore, he was someone
who consistently displayed a lack of trust in others – unless they proved they
were worthy of his trust. Jobs’ zeal for cost-cutting and pursuit of production
efficiencies may also be questioned; particularly when one considers some of
the difficulties Apple has experienced in the past with unethical practices at
the production plants of its suppliers (Foxconn’s operations in China stands
as an example (Kiss, 2012)). Nevertheless, Jobs could certainly be described
as a courageous man. This is witnessed in his ability to learn from his
mistakes and bounce back. It could also be argued that perhaps the
characteristics that mark Jobs as ‘difficult’ – determination to the point of
belligerence, confidence and courage to the point of zeal – could also be
characterised as positive moral virtues. Jobs was committed to a project
bigger than his own success – revolutionising the way we access and
interact with information technology. Perhaps what can be noted is that Jobs
was successful at combining certain moral virtues with intellectual virtues.
The complete package may not have been to everyone’s liking but in the end
was suitable to the context. Perhaps Jobs would have been a terrible boss of
a small charity or local co-operative but was perfect for the hyper-competitive
and fickle world of technology.
2 Virtue ethics: problems and possibilities

The major criticism of virtue ethics is that it tends to focus on the
characteristics of an individual at the expense of bigger issues
(Žižek, 2011). For example, during the financial crisis of 2008 and onwards
many prominent commentators and writers were critical of the public’s
focus on the perceived dishonesty of individual bankers. They felt that this
risked overlooking more systemic and cultural problems with the finance
sector and indeed with society itself (people’s attitudes towards spending
and debt, for example).
The other criticism of virtue ethics is that particular virtues are hard to
generalise as universally valuable. This was identified in the example of
Steve Jobs, where it was noted that his virtues might have been effective in
the tech-business world but might not have been as welcomed in other
spheres of life. Nevertheless, there is no reason why organisations could not
develop context-relevant virtues suitable for their own particular
environments.
To end on a positive, it has been noted that virtue ethics can act as an
important basis for managers to think about their own personal ethical
development and that of their staff (Hartman, 2013). The argument of these
authors is that through focusing on the development of one’s own and
others’ virtues, businesses can work towards establishing organisations that
90
are broader communities of virtuous behaviour. In such communities, we

would all hold each other to account and there would be ample opportunity
for people to develop their virtues through experience and targeted training.
Colleagues support and challenge each other to be more virtuous at work.
Interestingly, Aristotlean theory has experienced somewhat of a renaissance
in recent times. Morrell (2009), for example, holds that an important duty of
organisations is to contribute to a public good. He argues that organisations
need to reflect on how their actions and policies either help or hinder
employees and citizens in pursuing the development of their virtues. In the
public sector, Lawton (2000) and Lawton et al. (2013) have argued that
virtue ethics bears a close resemblance to many of the desired practices and
characteristics expressed through what is often referred to as the public
sector ethos. The latter simply refers to an assumption that people who
choose to work in the public sector are driven by a desire to contribute to
their communities and to help citizens in a way less prominent, in general,
than people who choose to work in the private sector. The case made by
these authors is that virtue ethics can act as an important guiding principle
for the career progression of public sector professionals.
Summary
The reading began by introducing virtue ethics as being concerned with the
ethical characteristics of individuals. It was stated that identifying
universally valid virtues is quite challenging. Not every characteristic can be
seen as virtuous across all contexts. The reading was delivered in tandem
with an analysis of the virtues of Steve Jobs. You were introduced to the
idea of virtue as twofold, concerning intellectual and moral virtue. The case
was made that Aristotle viewed these virtues as interdependent: that to be
truly virtuous one ought to develop a combination of moral and intellectual
virtues. In relation to Steve Jobs, it was noted that he displayed
considerable virtues along both intellectual and moral dimensions, although
perhaps he might not be viewed as a virtuous practitioner in all contexts.
The reading concluded with a broader discussion of virtue ethics. That
discussion outlined the two major criticisms of this position: that virtues
seem to be context-dependent and that focusing only on individuals may
distract attention from larger, systemic ethical issues and practices.
Nevertheless, it was noted that virtue ethics is a valued theoretical
perspective because it enables organisations to plan and reflect upon what
might be considered valued virtues in a particular context, acting as a guide
for practical staff and even citizen development.
As with the previous theories discussed in this chapter, you should not view
virtue ethics in isolation. Of course it is a theoretical position that misses
certain important dimensions of ethics. For example, in focusing on
characteristics of individuals it perhaps skips over some important
dimensions concerning good practice in decision making and in working
with others – which were addressed via Kant’s moral imperative. It also
does not address the consequences of decisions. It asks only that we each
seek to develop our virtues – the assumption being therefore that possessing
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the best of virtues will result in a satisfactory conclusion. Yet perhaps we

all know of examples of good people who have made bad decisions, even
for the best of reasons. Nevertheless, when taken in their totality, each of
these theoretical positions offers something different. The strength of virtue
ethics is that it asks people to look within themselves, to take responsibility
for their own and others’ ethical development. It also holds the possibility
of providing a useful framework for an organisation-wide analysis of the
kinds of virtues managers believe are appropriate for a particular context.
92
References
Aristotle (350BC/2009) The Nicomachean Ethics, Oxford, Oxford World’s
Classics.
Grint, K. (2001) The Arts of Leadership, Oxford, Oxford University Press.
Grint, K. (2007) ‘Learning to lead: Can Aristotle help us find the road to
wisdom?’ Leadership, vol. 3, issue 2, pp. 231–246.
Hartman, E. (2013) Virtue in Business: Conversations with Aristotle,
Cambridge, Cambridge University Press.
Isaacson, W. (2011) Steve Jobs: The Exclusive Biography, London, Little,
Brown.
Kiss, J. (2012) ‘The Real Price of an iPhone 5: Life in the Foxconn
Factory.’ The Guardian, 13 September.
Lawton, A. (2000) Ethical Management for the Public Services,
Buckingham, Open University Press.
Morrell, K. (2009) ‘Governance and the Public Good’, Public
Administration, vol. 87, issue 3, pp. 538–556.
Rothaermel, F. and Horbaczewski, A. (2012) ‘Apple (in 2011) after Steve
Jobs’, Harvard Business School case study.
Schroeder, A. (2009) The Snowball: Warren Buffett and the Business of
Life, London, Bloomsbury.
Smolović Jones, O. (2012) ‘Apple: Life after Steve Jobs?’ University of
Auckland case study, Auckland, University of Auckland.
Žižek, S. (2011) Living in the End Times, London, Verso.
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Readings 46–55
Reading 53: Human rights and

business ethics
Introduction
When we think of human rights, our minds perhaps naturally drift to war
and politics, or a toxic mixture of both. Having access as we do to readily
available media, we are more aware than ever (if we choose to be) of some
of the horrors perpetuated upon human beings by other human beings in the
name of some cause or other, or simply to fuel the mania of a brutish
regime or leader. And it is true that the roots of human rights philosophy
can be traced to the social and political. However, how governments and
societies have responded to past atrocities and moments of social fracture
has also held important implications for business.
Human rights have, in fact, become increasingly important to business over
time. Perhaps this is because what we expect from an employment contract
has matured. We are more aware of the harm we can suffer at work –
exposure to pollution, debilitating injury and the effects of stress. Human
rights are also important for the reputation of a business. No business would
like to be branded as taking risks with the welfare of its employees. Finally,
human rights has become a more pronounced issue because businesses now
operate on a global scale not previously witnessed. Business executives
have to consider how workers are treated in countries with differing
standards of human rights.
This reading will first explain the background of the concept of human
rights. Following this you will explore the most influential body of work on
human rights, the UN Declaration of Human Rights, in relation to business.
Before proceeding any further, the following example introduces a business
scenario that we will return to as the reading proceeds.
Example of human rights in business: tyre production

You are a manager for a large tyre production company (Figure 1). Recently
you were part of a team that led a successful and highly lucrative bid to
secure a contract to make most of the tyres for a large Japanese car maker,
whose UK production facility is based in the north east of England. Part of
your winning strategy was to pledge to open a manufacturing plant in an
adjoining complex to the car manufacturer’s plant. Locating your plant here
will enable you to respond flexibly to the car maker’s just-in-time production
system. The extra work created by this contract means you will not have to
relocate any of your existing workers, unless they decide to apply for a new
job at the plant, but you will have to open and run a new base of operations
from scratch. You are an experienced manager but you have never taken on
a job on this scale before. As an ethical practitioner you have heard that
abiding by good human rights practice is an important consideration when
establishing a new organisation but that doing so is more complicated than it
seems. It’s time to hit the books and find out about some of the history, main
features and current debates concerning human rights and business.
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Reading 53: Human rights and business ethics
Figure 1 A tyre factory
1 What are human rights?

The idea that all of us are endowed with certain basic human rights is a
powerful and well-established principle. So well-established, in fact, few of
us give the concept much thought; we take it for granted. People believe,
rightly or wrongly, that as civilised individuals they are entitled to certain
rights. They feel entitled not to be enslaved, for their governments not to
cause harm and for access to a certain amount of basic protection, such as
access to clean water and decent healthcare. You can probably think of
many more instances of rights you think people deserve.
Exercise 1
Imagine you are playing a computer-simulated game that allows you to build
a civilisation from new. If you are starting a society from scratch, what would
you write into the constitution of your state as basic human rights. What
would you like the children and grandchildren of the people in your state to
be guaranteed into the future?
Comment
If you are looking for a detailed list of rights in this section and some
accompanying commentary, you will be disappointed. Elsewhere you will
have explored theories of justice in business ethics. Within that reading you
will have noted there are many different conceptions of justice, depending on
one’s ideological values. What one holds as important in justice terms does
feed through into how one conceptualises human rights. Some of you will
have drawn a quite expansive list, including rights to education, healthcare,
housing and welfare (more akin to egalitarian or socialist perspectives on
justice). Others will have drawn up quite minimalist lists covering more ‘basic’
rights, such as the right not to be oppressed, tortured or enslaved (more akin
to capitalist notions of justice). How far human rights should extend is a
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matter of some debate and contention and these are issues you will reflect
upon as this reading proceeds.
So where did human rights thinking come from? Human rights began to be
formalised and developed hand in hand with organised, institutionalised
religion. People developed the notion that people are created with a series
of ‘natural’ rights that override anything written in law. Primarily, the
notion of a right seems to express the belief that there is something unique
about being human that imposes an expectation that human life be respected
and protected in a way that we do not always believe extends to other
animals. Nevertheless, it would be wrong to claim that natural rights should
be regarded as only associated with religious belief, or at least the
relationship is more complicated than first sight suggests.
How we think about human rights changed significantly during the Age of
Enlightenment, a period in history (from around 1650 to the 1780s), when
concepts such as reason and rationality became driving forces in science
and philosophy. For the first time, the idea that human beings are unique
and rational thinking creatures became commonplace. If we think of
ourselves as uniquely rational then it stands to reason that human beings
should be endowed with certain rights that match this status. Kant, of
course, was the pre-eminent moral philosopher of the time and his notion of
duty, that we should treat people as ends in themselves and not as a means
to an end, has proven highly influential in how we think of this notion of a
human right. Before Kant and the Enlightenment, however, there was
Thomas Hobbes (Figure 2) and John Locke.
Figure 2 Thomas Hobbes
Hobbes’ Leviathan (1651/2008) proved a controversial piece of work on

publication because he questioned the notion that human beings are
somehow naturally civilised. Left to their own devices, without strict rules
and laws to govern them, Hobbes believed human beings would self-
destruct in a wash of chaos and violence. Such a vision is often drawn upon
96
in contemporary films dealing with a post-apocalyptic and savage world. A

consequence of this pessimistic view of human nature was that Hobbes
believed people needed the intervention of enlightened philosophers and
law-makers to enshrine something called a social contract. By social
contract Hobbes meant a collective understanding of what it meant to be a
human being and to respect other human beings that would inform all laws
and social practices. Is there any law that tells you to let other people off a
train before getting on, therefore avoiding that awful and uncivilised
pushing and shoving? No, it is a matter of collective, social understanding,
that we should aim to be polite and courteous to one another so that
everyone may experience a feeling of safety and comfort. Hobbes’ thinking
was truly ambitious during a time when people regarded social injustice,
violence and illness as normal facets of everyday life.
John Locke (Figure 3) disputed Hobbes’ reading of human nature but
nevertheless arrived at similar conclusions, namely the need for a set of
guiding principles to inform an underlying social contract of rights. Locke
was mainly concerned with securing rights of life, liberty and property.
These might seem very basic to a present-day reader but one should
remember that at the time, people had not experienced the great revolution
in science and philosophy of the Enlightenment and were still living in
largely feudal societies, of servitude and obedience to monarchs and the
landed gentry. Locke’s (1690/2014) exploration of people’s right to own
property, while almost common sense to many contemporary readers, must
have presented an enormous shift in mindset for societies accustomed to
land and wealth being possessed by a few, largely won through inheritance
and conquest. As you may have noted, Hobbes and Locke were very
influential in the thinking of Kant and his notion that humans should be
treated as ends in themselves, not as a means to an end.
Figure 3 John Locke
If you fast-forward 300 years to a post-World War II world, the UN

Declaration of Human Rights is the most important contemporary statement
on rights. It is a document that seeks to capture a global consensus on what
it means to hold human rights and what these rights might be in practice.
The backdrop against which the Declaration was drafted was, of course, the
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Holocaust. Preventing such mass slaughter and wholesale invasion of rights

was the guiding principle behind the work, which was drafted by the
world’s most pre-eminent scholars and experts on government of the time.
The Declaration continues to hold a great degree of importance for the
world of business, as well as global politics. The next section will explore
human rights more closely in relation to business, drawing on the example
of the tyre plant from the introduction.
2 Human rights and business

Thinking back to the first exercise in this reading and how one’s views on
justice may shape how one views appropriate human rights, Velasquez
(2002) distinguishes between a negative and a positive view of human
rights.
A negative human right essentially places restrictions on government in
order to protect the individual liberties of citizens. Read alongside
utilitarianism, you might assume therefore that an individual’s rights can act
as a counterbalance to perspectives that seek to override the rights of an
individual for some kind of greater social good. Individual rights may be
inconvenient on occasion but nevertheless need to be protected, even if that
means instilling some restrictions on the pursuit of a greater collective
good. Philosophers holding conservative views generally believe that human
rights should end at the negative. Nozick (2001), one of the most influential
philosophers of this tradition, for example, believes that human rights
should constitute little more than protecting people from government
coercion. He reads into this principle the basic right of people to be able to
trade and own goods freely in open markets but goes a stage further by
stating that this means that taxes and welfare provision should be stripped
back to a bare minimum.
A critic of this position might, of course, note that unrestrained markets,
where we have experienced them, do not always result in the kind of
freedoms Nozick celebrates. Price fixing and the chasing of short-term
profits are but two examples of how ‘freedom’ for business can, in fact,
interfere quite substantially with people’s rights to properly paid work and
good health, not to mention property ownership.
A positive perspective on human rights states that government (or even
business) needs to actively intervene to provide rights and ensure the
protection of rights. For example, as an officially bilingual nation, Welsh
people are entitled to receive government documentation and services
through the medium of the Welsh language. A negative approach to human
rights would dictate that it is up to the free market to determine which
languages survive and which die in a society – if you value the Welsh
language, use it or lose it! A positive approach to human rights
acknowledges that government has a proactive role to play in protecting
people’s cultural life and part of that duty might be to finance the right of
people to converse and manage their affairs through an official language of
their choosing.
98
A recent movement within the positive rights perspective is what has

become known as the capabilities approach. Chiefly derived as a theory of
international development, the capabilities approach takes the basic notion
of rights and seeks to build on this platform to develop people and groups
according to what they might be capable of achieving, given the right
support. It is therefore a more pro-active (and therefore very much a
positive) stance on rights. Nussbaum (2013) describes ten key capabilities
she believes ought to be developed – ranging from the more basic, such as
the capability to lead a long and healthy life, to more intellectual concerns
with developing oneself through learning. Sen (2001) was in equal terms
celebrated and attacked for suggesting that a capabilities approach was in
fact an idea that was designed to protect personal freedoms. His case is that
the present consensus view on liberty and rights has not led to an
enhancement of freedom in general because so many people in developing
countries experience significant deprivations, paying the price for the
enjoyment people in the global North derive from free market capitalism.
Exercise 2
Do you tend to lean more towards a positive or negative view of human

rights? Does your view of justice influence your position? What do you base
your personal beliefs upon – life experience, business experience or
education, for example? Take a few minutes to think about your position and
try to summarise it in some notes.
Comment
This discussion has hopefully drawn out the fact that as you approach a
more detailed discussion on human rights in a business context, how certain
rights are interpreted largely depends upon your political and philosophical
commitments. You may believe that certain rights should be pursued further,
some less. Or perhaps you simply have not thought much in the past about
whether or how your personal sense of justice influences your view of human
rights. Perhaps you have never reflected on your own political and value
positions with regards justice, which is perfectly understandable in the
pressured and time-poor contemporary workplace. Nevertheless, taking
some time to reflect on this is helpful for the ethical business practitioner and
perhaps can even serve as a basis for some valuable conversations at work.
Let’s now return to the example outlined in the introduction to this reading.
What are some of the human rights you would have to take into
consideration when opening a new manufacturing plant?
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Exercise 3
Spend approximately one hour on this exercise.
Take a good look at Figure 4, which provides a slightly shortened version of

the UN Declaration of Human Rights. Not all of these are particularly relevant
for business and management but many are. Which would you identify as
important when thinking about opening a new plant in the UK and why?
Make some brief notes on this question.
Figure 4 An abridged version of the Universal Declaration of Human Rights
Comment
What follows is a more detailed account of which articles might be of
relevance. You may have identified more, or less, articles as relevant. There
is no definitively correct answer here but hopefully the following discussion
will be helpful in developing your thinking. Please also bear in mind that you
are not being asked to memorise these articles, merely to reflect on the
concept of human rights and how the concept can manifest in a business
setting.
Article 1 of the Declaration states that we are all ‘born free and equal in
dignity and rights’. The Article is reinforced in Articles 6, 7 and 8, stating that
people should have equal access to legal remedy in the event of their rights
being infringed. So the Declaration states that all should be treated equally
under law. Hence, a benefit for one employee should be available to all.
There are various UK laws and EU Directives protecting people’s right to
equal treatment, such as the EU Directives on Race Equality and Equal
Treatment. Article 23 of the Declaration is specific in terms of equality, noting
that people should receive the same salary for performing the same work.
This might sound like an obvious provision when thinking about opening a
new plant but you would be surprised how many businesses and public
institutions have been caught paying certain groups less than others despite
the fact that individuals were undertaking work of equal importance. One
should also note here that the evidence demonstrates that women still often
get paid less than men for comparable work (Whitehouse, 2015).
100
Article 3 of the UN Declaration enshrines everyone’s right to life, liberty and

security of person. One might read further into this right and state that
everyone employed by a business should be guaranteed a safe working
environment, tolerable shift patterns and working hours. Hence the raft of UK
and EU health and safety regulations, as well as the EU Working Time
Directive to address these issues. Needless to say that in the example of
opening a new plant, if you wanted to stay within the law, you would be well
advised to employ some experts in the area of health and safety legislation.
Article 4 is a statement that no one should be held in slavery. There are

examples of modern-day slavery in the UK, in the black market, as people
are held captive and forced to work under intolerable conditions. You
encountered such an example elsewhere in the readings concerning Chinese
cockle pickers in Morecambe Bay. As a major tyre producer, you perhaps
ought to think in more detail about the source of your production materials.
Do your suppliers adopt the same standards regarding human rights as you
do? Article 5 provides protection against torture or degrading treatment. You
are certainly not in the torture trade but it would be worth your while thinking
about the kind of culture of management you wanted to encourage in the
plant. Some businesses have faced negative press exposure for treating staff
in a degrading way – for example in regulating the toilet breaks of staff and
so on.
Article 12 of the UN Declaration raises interesting issues regarding people’s

right to privacy. Human resource management can sometimes tip over into
an erosion of employee privacy and indeed many critical organisation
scholars have drawn attention to how tools such as coaching, 360-degree
feedback and even work-organised social events infringe people’s rights to
privacy, to a protected space outside work where they can freely pursue their
own interests (Townley, 1994).
Article 19 of the Declaration states that everyone should be entitled to

express their opinion freely. This is an interesting right for managers to
consider. When setting up a new production site, one might want to think of
how one could instil open and effective channels of communication so that
those making decisions on behalf of the business could be well-informed
(Tourish and Hargie, 2004). A major problem for senior managers is that they
often work in a state of ignorance. Hearing about the existence of problems
at all is often presented as quite a challenge for organisational leaders – the
assumption being from many workers that bosses only want to hear good
news and flattery (Gabriel, 1999).
Article 17 states that everyone should be able to purchase property in their

home country, a right envisaged as far back as John Locke. Should this
matter to business? Perhaps so, when read against Article 23, which states
that:
. Everyone has the right to work, to free choice of employment, to just and
favourable conditions of work and to protection against unemployment.
. Everyone who works has the right to just and favourable remuneration
ensuring for himself and his family an existence worthy of human dignity,
and supplemented, if necessary, by other means of social protection.
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In other words, as far as the UN is concerned, employers are expected to

remunerate their employees to such an extent that they should be able to
lead a fulfilling and healthy life. One might go a step further and suggest that
employees should be rewarded to such an extent that they can one day, in
some form or another, and provided they save sensibly, be able to own
property. In the UK, such rights are reinforced by the National Minimum
Wage and certain guarantees for paid holiday and sickness absence.
Employers with a positive rights outlook would view these rights as an
important basis for developing a long-serving, skilled, engaged and healthy
workforce. That is not always the case, of course. The rise of the short-term
contract worker does raise some human rights concerns. Some people do
indeed find themselves trapped in short-term contract work without the
benefits of paid leave and so on that other people enjoy. The phenomenon of
the zero-hour contract, where people are told on a weekly basis whether
they have work or not and do not receive the protections of other staff,
should be a worrying trend for those concerned with human rights.
To conclude, human rights offer significant challenges for managers to

consider, across overlapping fields, from pay to working conditions, to more
explicitly social and political concerns, such as gender and race equality.
There is no doubt that businesses need to pay close attention to human
rights, as the consequences for not doing so can be harmful. Yet the extent
to which a business pursues a human rights agenda largely depends on the
political and philosophical preferences of executives, whether they adopt a
broadly positive or negative approach to rights.
Summary
This reading began by introducing the idea of a human right, exploring its
meaning and genesis. The history and philosophical underpinning of human
rights is important to business because it provides an explanation for the
social understanding (the social contract) that underwrites so much goodwill
between people and organisations. If a business infringes the social contract
assumed by workers, it can expect problems of resistance and even full-
blown revolt. Nevertheless, it was also stated that there are two broad
perspectives on human rights: negative and positive. People in the negative
camp largely seek to protect individual liberties and believe that in order to
do so one must scale back government legislation, taxation and regulations.
Those in the positive camp see human rights as a springboard for more
ambitious social change. Finally, you explored the relevance of human
rights to a real business situation, the establishing of a new production
plant. You were taken through each of the Articles relevant to business
within the UN Declaration of Human Rights (which are reinforced through
European and UK law). In the end, although there are certain rights
business is compelled to abide by, it was also noted that many human rights
are discretionary in the sense of it being up to business leaders how far they
choose to interpret and follow through on these rights.
102
References
Gabriel, Y. (1999) Organizations in Depth: The Psychoanalysis of
Organizations, London, Sage.
Hobbes, T. (1651/2008) Leviathan, Oxford, Oxford World’s Classics.
Locke, J. (1690/2014) Two Treatises of Government, North Charleston,
North Carolina, Creative Space.
Nozick, R. (2001) Anarchy, State and Utopia, Oxford, Wiley-Blackwell.
Nussbaum, M. (2013) Creating Capabilities: The Human Development
Approach, Cambridge, Massachusetts, Harvard University Press.
Sen, A. (2001) Development as Freedom, Oxford, Oxford Paperbacks.
Tourish, D. and Hargie, O. (2004) Communication Skills for Effective
Management, Basingstoke, Hampshire, Palgrave Macmillan.
Townley, B. (1994) Reframing Human Resource Management: Power,
Ethics and the Subject at Work, London, Sage.
United Nations (2014) Universal Declaration of Human Rights, [online].
Available at http://www.un.org/en/documents/udhr/ (Accessed 8
March 2015).
River, New Jersey, Prentice Hall.
Whitehouse, G. (2015) Equal pay for Women: Trends and Prospects in
Cross-national Perspective, Abingdon, Oxfordshire, Routledge.
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Readings 46–55
Reading 54: Stakeholder

management
Introduction
Stakeholder analysis and management have become increasingly influential
areas of thought within organisation studies and in the world of practice.
Why? It is argued that we live in an increasingly connected world and the
problems we face as societies also affect businesses because previously held
national and organisational boundaries overlap more than ever before.
The public seems interested in business from an ethical perspective in a
way previously unimaginable. There is more pressure on business to take
account of causes and issues outside the immediate demand to make
money. Adopting a stakeholder analysis and management perspective is one
way for businesses to approach how they prioritise and analyse external
demands and influences. The intention in this reading is to consider in more
depth the practical utility of stakeholder management for the practitioner.
Specifically, you will be introduced to some models of stakeholder
identification and management, allowing you to reflect on some new ways
of planning stakeholder relationships.
In the following example you will look at stakeholder management in
relation to clothes retailer H&M.
Example of stakeholder management: H&M

H&M is a Swedish clothes retailer and manufacturer launched in 1947, and
which has recently become a dominant player in the global marketplace
(Figure 1). The business model of H&M is well known. As low-cost airline
companies such as Ryanair and Easyjet shook up the aviation market, so
H&M shook the clothes market. Emphasising both low-cost and up-to-date
fashion, the company was able to undercut high street competitors in terms
of price while also meeting or exceeding competitors in terms of commitment
to the latest fashions. If you walk into an H&M store, you will notice two
things. The first is that the store will likely be full of young people, a
demographic with less spending power than other age segments and with a
more fickle affinity to fashion. Yet this is also a demographic that tends to
place more value on fashionable appearances. The second is the sheer
quantity of products available to browse. It is easy to become overwhelmed
with the choice in H&M. The company produces a lot of clothes for a market
that tends to wear particular garments for a shorter period of time.
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Reading 54: Stakeholder management
Figure 1 An H&M store
If you own a garment from H&M, take a look inside at the label. Chances are
it was manufactured in a developing country where the cost of production is
considerably lower than in countries such as the UK. Fair enough, you might
say. You get more choice at a cheaper price and the quality is probably just
as good as the clothes you used to buy from UK manufacturers.
Nevertheless, there is no doubt that operating an expansive, global business
comes with ethical risks attached. How can H&M stay on top of the working
conditions in each of the production plants it uses to produce its clothes, for
example? H&M enjoys some freedom in terms of where it locates its
production facilities, but such freedoms might also create a range of
additional pressures and points of ethical vulnerability for the company.
Exercise 1
Make a list of who you think H&M’s stakeholders are and what their interests
in H&M might be.
Comment
The following stakeholders might be important for H&M:
Customers who buy the product and ultimately pay the wages and
shareholder dividends. Customers will be interested in value for money – that
is one of the main reasons people shop at H&M. Yet they may also be
concerned with the welfare of the people who produce the clothes and the
environmental impact of the company.
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Shareholders will want a financial return on their investment; that goes

without saying. Nevertheless, perhaps unethical business practice will harm
their investment in the longer-term. Scandal is not good for business.
Employees are important stakeholders. These are the people we encounter

in H&M stores when we browse and pay for our items. If they are miserable,
chances are we will not leave the store in a positive frame of mind. H&M will
also have employees making the clothes (indirectly, via contract, most likely),
whose rights need to be upheld. The company will also have a raft of back-
room staff (managers, warehouse workers, etc.), who have a stake in the
company.
Non-governmental organisations (NGOs) and charities. As has been

noted elsewhere, it is very common now for charities and advocacy groups
to take an active interest in the activities of big business. So how does a
business decide which cause to support and which to ignore? Sometimes the
decision will be concerned with profit: which cause will benefit them the most
financially, or, cause them the least financial harm? Other times the decision
might be more ethically driven: which cause most speaks to their values as a
business?
Government. H&M will likely deal with government at a number of different

levels. It will work with local government in terms of its network of stores
(planning permission, transport, local taxes, etc). H&M will undoubtedly have
to think about national government (corporation tax, abiding by national laws
regarding pay and worker rights). It will also have to work closely with
transnational government (bodies that extend over more than one nation
state, such as the European Commission), which will expect certain
international standards in pricing, worker rights, and so on.
This list is far from exhaustive and is meant more to draw out why
stakeholder analysis and management is important for businesses. Making
lists, however, does not help anyone. What we do with such lists is more
important. In other words, how do businesses go about differentiating and
prioritising the demands and needs of stakeholders? Introducing you to some
different ways of thinking about stakeholder management will therefore be
the focus of the remainder of the reading.
1 Ways of thinking about stakeholder

management
Simply listing a number of stakeholders may be a useful exercise for you.
In fact, you have already in this module thought of the stakeholders that
might be relevant to various organisations. Yet drawing up such lists alone
does not necessarily illuminate why certain stakeholders are considered to
be more important than others, let alone what a business might do as a
result of identifying these stakeholders. Academic research can be helpful in
both of these regards. Pick up most texts on stakeholder management and
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you will likely be presented with some form of grid, such as the one in
Figure 2 by Eden and Ackermann (2012).
High
SUBJECTS ACTORS
INTEREST
CROWD LEADERS
Low
Low High
POWER
Figure 2 Stakeholder interest power grid, adapted from Eden and Ackermann
(2012)
The purpose of such a grid is to get managers thinking about not only
which stakeholders have a particular interest in the company but also which
have the power to either cause problems or help the business achieve its
goals. In other words, some stakeholders may matter more than others. This
is partly common sense – for example, if a certain group of workers
possesses little power (they may not be unionised, have anywhere else to go
for work), then why should a business place its interests above other
interests, such as those of shareholders, or even the business press?
In the grid in Figure 2 above, Eden and Ackermann settled on ‘interest’ and
‘power’ as important variables in stakeholder identification and
management. The authors define interest as encapsulating stakeholders who,
for one reason or another, will hold some kind of investment in the work of
a business.
Power could be said in many instances to overlap with interest. This is best
illustrated by the fact that if a business has a strong interest in a
stakeholder, then clearly by default that stakeholder will be in a powerful
position. H&M’s shareholders will possess some power over senior
executives, as they can always replace executives, if they are organised and
motivated enough. Of course the senior executives of H&M possess power
in the sense that any change of senior management always brings with it
disruption, which often harms share value.
Exercise 2
Revisiting your list of potential H&M stakeholders, which ones seem to

qualify as stakeholders because of particularly high interest and which
because of particularly high power? Provide some justification for your
reasoning.
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Comment
In the case of H&M, it is clear that a customer will be interested in the
activities of a business because the customer will choose (or not) to spend
money in H&M stores. Alone, a single customer may have little power, but if
a customer organised a group and started to campaign against a particular
aspect of H&M’s business practices, such a customer might also possess
high power. This might especially be the case in the age of mass
communication and the internet.
A charity, pressure group or trade union will be interested in H&M to the

extent that it might either see the business as a potential future partner to
further its cause or as a target for a campaign of one sort or another. Interest
also works the other way around, of course. The business might be
particularly interested in the support of a stakeholder. Charities or trade
unions might therefore on occasion be said to possess some power over a
business.
Shareholders are obviously interested in a business because they have

some material investment in the future of the business. Yet not all
shareholders are powerful, especially if their ownership represents a very
small proportion of the business. As with customers, very often shareholders
need to form coalitions in order to gain more power within a business.
Politicians and government will hold a large amount of power over a

business like H&M to the extent that such actors can legislate in a way that
could make the business’ life more difficult – through higher taxes, stricter
employment and planning regulation, for example. Yet government actors are
not always particularly interested in a specific business or even a business
sector as a whole, at least until this business begins to harm citizens or
starts to receive negative media attention for an ethical lapse. Many
businesses will be perfectly satisfied with a low level of government interest,
unless the business itself is seeking a change in legislation.
What this discussion has hopefully illuminated is that some stakeholders

will matter more, or less, to businesses, and their level of importance will
vary according to circumstances. Eden and Ackermann provide a more
detailed account of how managers can analyse the position of a particular
stakeholder according to an assessment of that stakeholder’s perceived
power and interest.
First, a stakeholder might hold low interest and low power. These
stakeholders are referred to as being ‘the crowd’. They are described as
such because many businesses are overwhelmed with external noise – a
range of demands and people they could be paying attention to. Ultimately,
however, businesses must choose to overlook the majority of potential
stakeholders – to pass them by in the crowd.
Some stakeholders might hold a high level of interest in the business but
possess little power. These are referred to as subjects in the sense that they
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might be described as being subjected to the power of a business but can do

little to influence the business. An example will illustrate this stakeholder
positioning. The role of suppliers in big business is often described in
powerless terms. H&M can always shift production of certain garments to
other locations – such is the way with globalised business. It may cost
money to shift sites of production and a business will always weigh up the
cost–benefit of decisions like these but, ultimately, H&M has power over
garment suppliers, who, in turn, have an important interest in H&M because
the supplier might not be awash with alternative customers.
Those stakeholders deemed to hold low levels of interest but high levels of
power represent an interesting category, that of leaders. Leaders will be
powerful people or groups, who for one reason or another are not concerned
by the activities of the business. There are, of course, many reasons why
these stakeholders could be both powerful and disinterested. It might be that
the stakeholder is unhelpfully disinterested (apathetic), in the sense
that one would like this stakeholder to be more interested. In the case of
H&M, it might be that if the business was engaging in a major
public relations campaign, then it would hope that powerful media
stakeholders could be interested in the campaign. Yet convincing the
national media of the importance of a story is no easy matter: journalists
tend to be suspicious of free publicity for businesses posing as news
stories. In other cases, the business might be satisfied for powerful
stakeholders to remain disinterested, as has already been mentioned in
relation to business and government.
Actors are those stakeholders who are both powerful and interested. Clearly
this group represents the core focus of managers within a business. Usually,
shareholders and employees fall into this category, although not always of
course. These are stakeholders who invest a lot of human or financial
capital in the business and so stand to gain a lot by the company performing
well in material and ethical terms. This is not to say that other groups, such
as collections of customers and pressure groups, might not move into this
category of powerful and interested because of some high-profile publicity
or more collective and concerted action.
The strength of the Eden and Ackermann model is that it enables a
relatively simple way of distinguishing between stakeholders and
therefore offers managers a means of prioritising which stakeholders they
respond to and work with and which they may choose to either ignore or
have minimal engagement with.
Yet, although the model asks businesspeople to look beyond pure profit as a
means of analysing success, it is surprisingly ethics-free in the sense that it
does not provide readers with an ethical basis for choosing to prioritise one
stakeholder over another. Readers are asked to make judgements based on
the interests of a business, not on the ethical rights and wrongs of business
decisions.
Finally, the model does not tell managers about their options in terms of
how to engage with stakeholders. Some stakeholders may be satisfied with
merely receiving information. Others may insist on exercising a great deal
more influence than that. Stakeholders can be low maintenance, high
maintenance or somewhere in between (Mitchell et al., 1997).
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2 Informing stakeholder analysis and

management from an ethical basis
Stakeholder analysis models are useful in as much as they provide tools for
identifying and prioritising stakeholders in more depth (Figure 3). They are
less helpful in that they often do not provide as much detail on how
a business can apply an explicit ethical lens to the analysis. In many ways,
the models could be interpreted as still primarily driven by material interest
(profit) and damage minimisation, as no ethical system of prioritisation is
provided as a guide.
Figure 3 Stakeholder interests
Notably, Carroll (1991) is an exception. Drawing on Kantian theory, he

asks his readers to differentiate between broadly immoral, amoral and moral
stances that business managers can adopt towards stakeholders.
An immoral stance would probably result in the following sorts of
relationships with stakeholders. Employees would be viewed as a means to
an end, exploited and repressed as much as possible to maximise profits for
senior executives. Laws and regulations would be broken as long as the
financial risk of doing so was not too great. There would be minimal
contact with external charities, unless executives felt they could mislead and
even bribe outside organisations into support for public relations reasons.
Competitors would be seen as targets to be undermined (legally and
illegally), or as potential partners in crime (via price fixing and
normalisation of other dubious practices).
An amoral stance would abide by the law but not stretch any further. So
employees would be guaranteed minimum wages and conditions as
established by national or supranational (e.g. European) standards. How
suppliers are dealt with would simply be a matter of market forces – the
more competitive the market, the less stakeholders would receive. The
measure of involvement with external organisations, such as charities,
would simply be about profit – would a partnership enhance profitability or
not?
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A moral stance would involve the ethical and philanthropic dimensions

outlined by Carroll earlier in his writing, and referred to elsewhere in this
block, on types of corporate social responsibility (CSR). Regardless of what
the law states, a moral approach to stakeholder relationships would consider
a robust moral rule to apply to all stakeholders.
Thinking back to Kant and Rawls, a manager operating from a moral
perspective would not lose sight of the profitability of the business. To do
so would be immoral because it would not be a sustainable position; the
capacity for the business to act morally in the longer term would be
harmed if the business started to struggle financially. A utilitarian logic of
generating the maximum benefit for the largest number of people would
also be violated by a manager overly generous in terms of rewarding
stakeholders at the expense of profitability. Within the boundaries of
sustainable profitability, therefore, a moral manager might consider some of
the following questions, which you can reflect upon in relation to your own
employer or a business you take a particular interest in.
Adopting Rawls’ veil of ignorance, if you were a supplier in a competitive
market, how would you want to be treated by your customers? Would you
be satisfied with experiencing regular and intolerable pressures, writing
these off as impersonal market forces, or would you want more from your
customers – some trust, loyalty and so on?
Which stakeholder engagements would create the maximum benefit for the
largest number of people in society? Does the business also have a
responsibility to contribute to the wellbeing of minorities not covered by
this utilitarian logic?
Again adopting Rawls’ veil of ignorance and broader human rights
concerns, if you were a junior employee of the business, someone
committed to saving sensibly and perhaps starting a family one day, what
would you need from your employer to support you to do so? What would
this mean for everyday working conditions, pay and other workplace
entitlements?
How could the business work in partnership with government and charitable
organisations to set high standards? How could it use some of its own
expertise and resources to research areas of ethical value to society and
therefore be proactive in establishing and predicting future ethical standards
(a CSR perspective)?
Thus far you have been asked to reflect on the analysis of stakeholders and
how a business might, in practice, seek to inject some sound ethical theory
into an analysis of stakeholder relationships. In the next section, you will
explore how businesses might take this information and seek to influence
stakeholders in an ethical manner.
3 Influencing stakeholders
Rodgers (2006) has argued powerfully that most businesses approach
stakeholders on a proposal-by-proposal basis. For example, if H&M was
struggling financially, it might place a concrete proposal on the table to
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reduce the pay of its shop and warehouse staff. Employees might simply
accept the proposal as inevitable in leaner economic times. Or they might
enrol the assistance of the shop workers’ union (the Union of Shop,
Distributive and Allied Workers in the UK) and campaign against the
proposal. H&M would do what it could to persuade the trade union and
employees that the proposal was the only way of safeguarding jobs in the
longer term. The trade union and employees would seek to maximise
wages and job security without causing the business to go bust. One should
note here that concrete proposals are inevitable and important; these are
the kinds of decisions business managers make every day.
Rodgers’ argument, however, is that most businesses miss a trick by
overlooking their capacity for influencing bigger, broader and longer-term
issues. By putting in the work with stakeholders at the level of a
broader issue, some of the disagreement and pain experienced over
individual proposals can be minimised or avoided altogether. So a key task
of business is to influence issues before they become proposals, problems or
scandals.
Such a proactive approach means strategic thinking on behalf of
management to identify important issues of the future and to take a
proactive stance of working with groups and government to ensure a
business remains ahead of the game on particular issues. Adopting Rodgers’
thinking, H&M might identify, for example, an influential forestry charity
and conduct some jointly funded research into sustainable forestry methods
that will help with its sustainable sourcing of raw materials (for your
information, the business does do this in real life). This research could be
presented to government and disseminated via the press. Such a stance
would not only be ethically sound but might also establish new standards
for the industry in general, forcing competitors to invest simply to catch up
to the standard established by H&M.
Some businesses go further than others in relation to identifying and
seeking to influence big issues. Oil company Shell works with stakeholders
to influence and jointly design solutions to longer-term issues. It has, since
the 1970s, invested a considerable amount of time and money into scenario
planning. It employs some of the world’s leading economists, political
scientists and management thinkers to do what businesses rarely have the
time for – to think big thoughts about the future. What will the world’s
environment, security and political dynamics be like in 20 years’ time?
Most businesses cannot afford to fund such rigorous, big-picture thinking
but perhaps also underestimate their capacity to influence issues before they
become ethical problems.
Exercise 3
The discussion of influencing proposals or issues is quite broad. Can you

think of any other much more practical and specific ways in which a business
might seek to influence its stakeholders?
112
Comment
Rodgers (2006) provides a number of more specific ways in which
businesses may seek to influence stakeholders. Some examples are
provided below, although you might have thought of additional types of
influencing.
Influencing through lobbying: a business may employ a specialist lobbying

firm or directly hire full-time lobbyists on the company payroll if a major
aspect of the business involves influencing government.
Influencing through the media: a business might seek to highlight a

specific issue of concern or even an area where the business is innovating
via broadcast, internet or print media. Such methods of influencing are quite
indirect and do not establish personal relationships but may be effective in
terms of generating some momentum for a particular issue.
Direct personal relationships: business executives may decide that some

stakeholder relationships are so important they require the personal attention
of senior people within the organisation. Or executives might delegate such
duties, depending on the perceived importance of the stakeholder, to people
further down the organisational hierarchy.
Indirect personal relationships: Perhaps an executive might not know a

stakeholder very well or a stakeholder may be unwilling to listen to the
executive for some reason. However this executive might know someone
who the stakeholder will listen to. Executives very often, therefore find
alternative, yet still personal, ways of influencing stakeholders.
Summary
In this section you were introduced to stakeholder analysis as a means of
prioritising and working through the relative importance of the claims made
by stakeholders on the time and resources of business. These key
dimensions were suggested as the perceived power of a stakeholder over a
business and the interest (or legitimacy) a stakeholder has to a stake in the
business. This is a consideration of whether the stakeholder is worthy, as
well as powerful, in other words.
Following this discussion, it was noted that stakeholder models often
miss any notion of ethical deliberation in their analysis. With this in
mind you were introduced to the concept of moral, amoral and immoral
stances towards stakeholders as a means of guiding manager decisions.
Finally, you were introduced to various dimensions and ways of thinking
about influencing stakeholders. Influencing was differentiated as the
influencing of proposals and the influencing of issues. Some further
examples of more specific modes of influencing were also introduced.
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Readings 46–55
References
Carroll, A. (1991) ‘The pyramid of corporate social responsibility: Toward
the moral management of organizational stakeholders’, Business Horizons,
vol. 34, issue 4, pp. 39–48.
Eden, C. and Ackermann, F. (2012) Making Strategy: Mapping out Strategic
Success, London, Sage.
Mitchell, R., Agle, B. and Wood, D. (1997) ‘Toward a theory of stakeholder
identification and salience: defining the principle of who and what really
counts’, The Academy of Management Review, vol. 22, issue 4,
pp. 853–886.
Rodgers, C. (2006) Informal Coalitions: Mastering the Hidden Dynamics of
Organizational Change, Basingstoke, Hampshire, Palgrave Macmillan.
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Reading 55: Codes of ethics

Introduction
It is one thing for a business to establish in broad terms how it views its
ethical responsibilities, but it is another for such a big-picture position to
translate into specific action. Designing and then implementing a code of
ethics has become one important way of practicing ethics in business.
Codes are most often associated with individual businesses or other single
organisations. Yet codes are increasingly being adopted outside formal
organisational structures (Crane and Matten, 2010). For example, print
journalism or the legal profession will usually have a code of ethics
designed and adopted by its professional representative body. Professionals
will often even have these codes included in their employment contracts,
meaning they can face disciplinary measures – be struck off an official
professional register, or sacked from their organisations – if they violate
these ethical codes.
This reading will explore why organisations, associations and sectors adopt
codes of ethics in the first place. The second section examines some
problems and possibilities for codes of ethics highlighted by academic
research. In expanding upon some of the important issues related to codes
of ethics, you will focus on an example of a particularly well-known code:
the Police Service of Northern Ireland (PSNI) Code of Ethics. Although this
is a public sector case study, it might also prove useful as a point of
reflection for business. Businesses often have to engage in the practice of
policing in an informal sense – chasing customers for payment, taking civil
and even legal action, ensuring their products are not being abused by users,
working with other bodies to ensure their products are used in a socially
responsible way (for example, in the alcoholic drinks industry) and, of
course, some businesses are more explicitly involved in policing (debt
collectors being one obvious example).
Example of a code of ethics: the Police Service of Northern

Ireland
On 10 April 1998 (Good Friday) the various sides in the Northern Ireland
dispute signed an agreement that aspired to solidify peace. The agreement
was the culmination of many years of hard work and negotiations between
British governments (Labour and Conservative), the Irish government, the US
government and political and paramilitary groups in Northern Ireland. The
main achievement of the agreement was to introduce devolved government
for Northern Ireland, whereby the nation would remain part of the United
Kingdom but adopt more powers to govern itself. An important part of the
agreement was the reform of Northern Ireland policing. At the time, the Royal
Ulster Constabulary, which was the police force for Northern Ireland, was a
key point of tension between communities, with republicans feeling the force
was too closely aligned with the cause of unionism and police officers often
feeling under siege, unfairly singled out by politicians, and more like quasi-
soldiers than police officers.
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The Good Friday Agreement established a commitment to bring into being a

new police force: the Police Service of Northern Ireland (PSNI) (Figure 1).
This service would, more consciously from the outset, draw on officers from
both of the major communities in Northern Ireland. It would also have to
abide by a new code of ethics, committing the force to fair and impartial
treatment of all. An updated Code was introduced in 2008, replacing the
original (2003) Code. Policing codes of ethics are freely and publicly
available, and you can view this Code online. This is perhaps indicative of
the intention underlying the production of such codes in the first place: they
are in place as much to reassure and inform the public as they are guides for
serving professionals.
Figure 1 The Police Service of Northern Ireland
The Code is comprehensive, comprising ten Articles covering: professional

duty (the most substantial section); police investigations; privacy and
confidentiality; use of force; detained persons; equality; integrity; property;
fitness for duty; and the duty of supervisors. It also has a clear commitment
to three pillars of ethics philosophy: community, human rights and duty.
To take the last pillar first, the Code adopts the key principle of Kantian
ethics, of treating people as an end in themselves, with the then Chief
Constable, Sir Hugh Orde, stating in his introduction to the Code: ‘In our
daily work we should treat each person in the way in which we would want a
police officer to treat us or members of our family’ (PSNI, 2008 p. 4). One is
also reminded in this quote of Rawls’ ‘veil of ignorance’ referred to earlier in
the block, that police officers should try to place themselves in the shoes of
someone who is being questioned, detained, or even as a victim. How would
they like to be treated by police officers, bearing in mind that the core job of
being a police officer is bringing offenders to justice?
The language of human rights is visible throughout the Code, with particular
references to the UN Declaration, European Convention of Human Rights
and the UK Human Rights Act (1998). Human rights are covered with
particular reference to the treatment of people in detention, the use of force
deployed by a police officer during their duty and in treating people equally,
regardless of their political or cultural affiliations.
116
Finally, there is a sense in the document of a commitment to community, a

key pillar of CSR thinking, or at least the role PSNI has in building a healthy
and cohesive community in Northern Ireland. Police officers are expected to
conduct their duties ‘in co-operation with’ the community. A solved case is
welcome and the most important part of being a police officer, but better to
both solve crime and simultaneously strengthen the sense of community in
Northern Ireland – and certainly better not to damage trust in the course of
investigating a crime.
Overall, the language of the Code is one of command. Each Article is framed
with the language of either ‘you shall’ or ‘you shall not’. Such unambiguous
language is adopted because like many other Codes, the PSNI code is used
for two purposes. The first is to provide a model for what the organisation
thinks is an acceptable standard of ethical behaviour within the organisation.
The second carries the weight of prohibition – it is written to tell officers what
they must not do. Supporting the prohibitions laid out in the Code is a quite
detailed description of the disciplinary action a police officer might expect if
she/he breaches the Code. These sanctions range from an informal
conversation with a line manager in the event of a relatively trivial breach, to
dismissal and reporting to outside bodies, or even criminal prosecution, in
the event of a more serious breach.
You will be asked to periodically return to the PSNI Code as you proceed
through the reading.
1 The purpose of codes of ethics

Codes of ethics can be thought of as serving three practical purposes for
organisations and managers:
. They can provide a definitive sense of what an organisation stands for

and therefore a practical guide to day-to-day acceptable conduct.
. They can, as a result of their practical utility, act as a basis for education
and training interventions.
. They can be used as a basis for taking disciplinary measures against
employees who are accused of breaching the standards recorded in the
code.
You will approach each of these three dimensions in turn.
1.1 Offering a practical programme and guide for

ethical conduct
The obvious answer to what codes of ethics are for has already been
provided; codes offer an important way of solidifying what businesses mean
by ethical conduct. Codes establish broad principles and offer more specific
guidance for employees. Some codes can appear minimalist, merely
reiterating a company's commitment to abide by the laws of the countries in
which it operates.
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It is also common for organisations to provide explicit guidance defining

corruption and bribery. This is especially common for businesses that
operate in a number of different national contexts, where the notion of a
'gift' or 'favour' may be interpreted differently.
In a nutshell, therefore, codes of ethics are supposed to act as practical
guides for employees about how to conduct themselves. They should
provide general guidance about how an organisation regards what it means
to be an ethical employee and also provide more detailed guidance in the
event that an employee needs to refer to some specific guidance in
conducting their duties. With reference to the PSNI Code, there is an
emphasis placed in the language of the Code being ‘designed to assist’
officers (PSNI, 2008 p. 2). ‘No one underestimates the judgments police
officers have to make on a daily basis in providing an effective policing
service. The Board believes this Code will help police officers as they make
those difficult judgments’, says Professor Sir Desmond Rea, Chair of the
PSNI Board, in his introduction to the 2008 Code. The emphasis here is on
the helpful intent of the Code, in place to assist officers, not to target and
victimise police officers.
Applying a broader lens to the Code, you may be struck by the image
conjured of what the Code suggests is an ideal police officer. A police
officer is expected, on the one hand, to be a sensitive and well-read figure,
familiar with human rights legislation, someone who will use force, but
only sparingly and when justified, aware and responsive to the needs of the
various political and cultural sensitivities of Northern Ireland (so, politically
educated and informed, in other words), and supportive and protective of
the feelings and rights of victims and their families. On the other hand,
police officers are expected to be examples of clean and respectable conduct
– professional in their investigative techniques, untouchable in terms of
undue influence and corruption, and diligent in protecting privacy and
sensitive and confidential information.
Exercise 1
Does your employer have a code of ethics? Have you ever read it? Take
some time to do so. Does the code provide you with a clear sense of how to
conduct yourself while working for or representing your organisation? How
would you characterise the nature of the code? Is it minimalist or does it
offer more ambitious guidelines? What kind of professional does your Code
require you to be? Think in terms of an image.
If you are not currently employed, or in full-time education, you might want to
choose a code from a business whose products you consume, or even delve
into the code of the OU.
Comment
The PSNI code is ambitious and comprehensive, perhaps a signal of the
sensitivities surrounding that particular organisation. Likewise, in some
business areas that have experienced ethical issues in the past, detailed
codes would be expected. At other times, codes can be quite minimal. In
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such cases what is their purpose if all they do is re-iterate the legal
obligations of employees? Codes can, however, provide a useful guide for
practitioners in terms of how an organisation views a model professional.
1.2 Codes can act as an educational tool

Issues of business ethics can be confusing, complicated and context-
dependent. A person can violate a particular set of ethical expectations
without even realising it and do so perfectly innocently. Misunderstanding
because of the way a person was brought up, educated or socialised –
especially in an increasingly global world – is common. So codes can
provide one basic way of educating a workforce about what is expected of
them ethically. Codes of ethics can provide a blueprint for training
interventions, as well as practical and specific guidance for particular
situations people may encounter (Romani and Szkudlarek, 2014).
Returning to the PSNI Code, we could easily envision a series of
organisational interventions designed around each of the ten articles,
opportunities for employees to learn about best practice and specific
requirements in each of the areas. For example, how PSNI expects its
officers to behave when they are faced with a particularly unruly, even
violent person they must take into custody for further questioning or arrest
might form the basis of an entire training programme in and of itself.
Training sessions can, of course, be boring and sometimes generate hostility
if they are perceived to be irrelevant. Of course, you might say, you believe
in respecting your co-workers and behaving with honesty and integrity. The
fact that most people try to do the right thing in their professional, as well
as personal lives, perhaps merely emphasises the importance of ethics being
of practical relevance, rather than simply appearing as if an organisation is
covering itself legally, e.g. ‘We told them in Training Session 2.65b and
Rule 87, subsection 2f, that they couldn't do that!’
Exercise 2
Have you ever experienced ethics training (Figure 2) or experienced an

ethical dimension to other training initiatives? Take a moment to think about
what worked in that training intervention and what you would improve for the
future. How would you make ethics more relevant for an organisation, in
other words?
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Readings 46–55
Figure 2 Ethics training
Comment
Most people have been forced to undergo training that appears to go on far
too long and the experience can be frustrating. At other times, training can
prove highly relevant. There is little evidence concerning what appears to
make ethics training effective but the general rule with training interventions
is that they need to be relevant to practice in order to work. People
undergoing training need to feel that the material they are covering is either
professionally useful or aspirational. One trick with working in an effective
way with a code of ethics might therefore be translating it well into exercises
and discussion forums that hold specific and practical value.
1.3 Codes of ethics can be used as a basis for

disciplinary action
As stated by Lawton et al. (2013), there is an enforcement element to codes
of ethics, a hard edge that sits alongside the more positive guidance and
role modelling purposes offered. If an employee has agreed to be judged by
the standards established in the code of ethics of an organisation,
association or sector, then this code can be used as a basis for taking
disciplinary or even criminal action in the event of a breach. Lawton et al.
distinguish between three possible levels of offence that might be
highlighted through reference to a code of ethics.
An ‘inappropriate’ offence might be an action that is judged to be against
the spirit or intention of a code of ethics, even potentially taking the form
of an understandable but ultimately incorrect act. These sorts of slips are
usually dealt with through internal reprimand or minor disciplinary action.
120
In the case of PSNI, a written warning can be issued to an officer, which

remains on that officer’s record for 12 months. ‘Unethical’ breaches of
codes are more serious. In the case of PSNI an example might be making a
mess of an investigation or overlooking a certain suspect because of
community or political ties. Such breaches can be dealt with internally,
through an independent public figure such as an ombudsman or even via
criminal procedures. Finally, an ‘illegal’ act is one that goes not only
against the spirit and detail of a code of ethics but is also against the law.
Accepting bribes, covering up evidence or physically abusing or torturing
prisoners would fall into this category. Such breaches are matters for the
criminal justice system and there are plenty of examples of police officers
being prosecuted, like anyone else, through the courts.
This enforcement aspect of codes of ethics is undoubtedly important
because it provides the ‘sharp teeth’ without which it would be more
difficult to root out bad ethical practice. Nevertheless, linking codes of
ethics to enforcement does introduce an element of repressiveness.
Employees might begin to develop a sense of alienation and resentment
towards a code, as well as those responsible for administering a code, if
they think the code is being used mostly to punish, rather than as a way of
supporting and guiding good practice.
2 Codes of ethics: problems and

possibilities
There is little agreement within academic research about whether codes of
ethics are particularly useful in establishing more ethical conduct in
organisations. Perhaps if you are employed as a busy professional you are
in a better position to judge than academic researchers!
Research conducted by Thomas Farrell
This Spotlight on Research reports on one aspect of doctoral research
on advertising ethics conducted at the Open University Business School
by Thomas Farrell from 2007 to 2012.
The research investigated how advertising professionals in the United

Kingdom understood ethically controversial advertising and their own
responsibilities with respect to such advertising. Thirty-three
practitioners in marketing organisations, advertising agencies, and
regulatory organisations were interviewed. The type of advertising
campaigns studied included advertisements for pharmaceuticals and
cosmetics, video games, and good causes such as smoking cessation
and child protection.
Advertising in the UK is regulated through the Advertising Code, an

industry wide code of conduct, which all television, radio and print
advertising in the UK must abide by. Among other things, the code
121
Readings 46–55
requires that advertising must cause no harm or offence to members of

the public. Harm, for example, could be caused by: stereotyping
particular groups of viewers; messages or images that could cause
psychological distress; depicting dangerous behaviour that could be
copied by children; and many more. The codes are enforced through a
regulatory system consisting of clearance bodies (that clear television
and radio advertising before broadcasting) and the Advertising
Standards Authority (ASA) (that rules on advertisements if complaints
are received). Where adverts are found to be violating the advertising
code they must be amended and, in some cases, withdrawn completely.
The research found that, for many of the practitioners taking part in the
study, ethics was embodied in the advertising codes. The code acted as
some kind of ‘law’. If an advertisement was compliant with the code,
practitioners mostly felt this was ethical. Quite a lot of effort went into
making sure adverts (mostly) complied because negative ASA rulings
were very costly for advertisers who then had to develop new
campaigns. However, this reliance on the code also meant that many
practitioners (not all) then felt they didn’t have to think too hard about
the ethics of their actions beyond complying with the codes. If the
codes embodied ‘ethics’, then no independent moral thinking was
required.
(Farrell, 2012)
Two relatively straightforward reasons, and one more difficult reason, for
the patchy effectiveness of codes are offered (Grundstein-Amado, 2001).
The first straightforward reason is that codes, it is argued, can become
either bogged down in legalistic requirements and jargon or, equally,
become stuck in the clouds of impractical language. So codes can either
become complicated lists of laws and regulations or they can be expressions
of ideals held by some senior executives (often expressed in grand
language) that bear little connection to the daily experiences of staff.
The second relatively straightforward problem with codes of ethics is that
they can be developed outside any sound theoretical grounding. Thousands
of years of theorising on ethical conduct are either only tacitly referenced or
passed over entirely. This could be a case of academic thinkers not making
their own ideas relevant enough for a practitioner audience. But let's not let
practitioners off the hook so easily. One would hope that anyone charged
with designing a code of ethics would pay some attention to the millennia
of debate and writing in the area of ethics. Perhaps as students of ethics
theory, you can design the codes of ethics of the future.
The third and far trickier problem with codes of ethics concerns their
'internalisation' (Grundstein-Amado, 2001; Helin and Sandström, 2008).
Let's play with this word 'internal' for a while. If you think about it, any
piece of paper, or set of words written down somewhere, is obviously
outside of us – it is not part of us – of our brains and bodies. Codes of
ethics are a collection of statements in a written document. The content of
codes of ethics should, of course, aim to capture the things we collectively
stand for, as professionals, as productive members of society and so on. But
122
the very fact that someone else has written the code, drawing on theory and
practice that professionals might not have directly experienced, means that
these professionals are immediately one step removed from the code. There
can be a degree of alienation experienced in relation to codes of ethics in
other words: ‘What do human rights lawyers and Immanuel Kant know
about my job as a professional?’ These documents can never be written in
real-time by all of the people doing the job these codes are supposed to
regulate.
Statements written down are relatively static, whereas one’s personal
experiences, feelings and beliefs are actually pretty changeable, influenced
by a broad range of sources. They adapt with the situation and with the
times. So how can a text (code) hope to capture this richness of experience?
In order to feel ownership of anything in work life, or personal life, one has
to be able to feel a sense of ownership, of identification. Arriving as they
do from an outside source, it is easy for codes of ethics to feel imposed, or
even counter to the real professional demands made of practitioners.
This feeling of imposition is actually common in business and
organisational life. Codes are very often written or adapted as a result of
some pressure from outside an organisation or from high up in an
organisation. In the case of the PSNI Code, it was written as a result of
much larger political pressures and agreements, established between major
global political leaders.
Summary
This reading began by stating that codes of ethics are important sources for
both capturing the ethical principles and standards of an organisation and
for providing some explicit guidance for employees on how to behave and
relate to others while at work. Three ways in which codes of ethics are
commonly used were listed: as a guide for employees, as an educational
tool and as a resource for taking disciplinary action against employees.
The second part of the reading highlighted some problems and possibilities
for codes of ethics. The problems identified also signalled possibilities for
practicing managers. First, codes can become alienating because of heavy
legal language or management jargon. Second, codes can become detached
from solid ethics theory. Third and finally, codes can feel imposed from
outside and can therefore heighten employee alienation.
The challenge with codes of ethics appears to be to treat them as a first step
towards creating a more alive and fluid ethical culture. For example, a code
might state the basic principles of an organisation, but how these principles
cross over into specific detailed practice might require more detailed debate
and discussion with staff. The trick with codes of ethics, it seems, is to
somehow capture what already matters to professionals, but also to stretch
and challenge their thinking. The latter point, of course, means that codes of
ethics can, and perhaps should, be aspirational documents. Unless codes
seem to appeal to the identifications and experiences of professionals, they
123
Readings 46–55
can become at best meaningless and at worst, the source of alienation and
hostility.
124
References
University Press.
Farrell, T.A. (2012) Controversial advertising in the UK: its regulation and
practitioner ethical decision making, Thesis (PhD), The Open University.
Grundstein-Amado, R . (2001) ‘A strategy for formulation and
implementation of codes of ethics in public service organizations’,
International Journal of Administration, vol. 24, pp. 461–478.
Helin, S. and Sandström, J. (2008) ‘Codes, ethics and cross-cultural
differences: Stories from the implementation of a corporate code of ethics in
a MNC subsidiary’, Journal of Business Ethics, vol. 82, issue 2, pp. 281–
291.
Police Service of Northern Ireland (2008) Code of Ethics, Belfast, Northern
Ireland: PSNI, available online at: http://www.nipolicingboard.org.uk/
final_code_of_ethics-2.pdf (accessed 8 March 2015).
Romani, L. and Szkudlarek, B. (2014) ‘The struggles of the interculturalists:
Professional ethical identity and early stages of codes of ethics
development,’ Journal of Business Ethics, vol. 119, issue 2, pp. 173–191.
125
Readings 46–55
Acknowledgements
Figures
Reading 46
Figure 1: Taken from wikipedia.org. Used under CC-BY-SA. 2.0
Page 9: © Carol Simpson Productions
Page 14: © Mike Shapiro
Reading 47
Figure 1: © frans lemmens/Alamy
Page 20: Taken from www.brainstruck.com and used under Creative
Commons as at http://creativecommons.org/licenses/by-nc-nd/2.5/in/
Figure 2: Carroll, A. (1991) ‘The pyramid of corporate social
responsibility: Toward the moral management of organizational
stakeholders’, Business Horizons, vol. 34, no.4, Elsevier.
Figure 4: © Hero Images Inc./Alamy
Figure 5: © Jim West/Alamy
Figure 6: © Geoffrey Robinson/Alamy
Reading 48
Figure 1: © Anja Schaefer
Figure 2: © aerogondo2/Shutterstock.com
Figure 4: © Johnny Greig/Alamy
Figure 5: © Ale-ks/iStockphoto.com
Figure 6: © TMO Buildings/Alamy
Reading 49
Figure 1: Taken from wikipedia.org
Figure 2: © Phil Noble/PA Archive/Press Association Images
Figure 3: CALVIN AND HOBBES © 1989 Watterson. Reprinted with
permission of UNIVERSAL UCLICK. All rights reserved.
Reading 50
Figure 1: © Warren Rohner via flickr.com and wikipedia. Used under
Creative Commons BY-SA 2.0
Figure 2: CALVIN AND HOBBES © 1989 Watterson. Reprinted with
permission of UNIVERSAL UCLICK. All rights reserved.
126
Acknowledgements
Reading 51
Figure 1: © skynesher/iStockphoto.com
Figure 2: © Frederic Reglain/Gamma-Rapho/Getty Images
Reading 52
Figure 1: © Ancient Art & Architecture Collection Ltd /Alamy
Figure 2: Matthew Yohe / http://en.wikipedia.org/wiki/File:
Steve_Jobs_Headshot_2010-CROP.jpg. This file is licensed under the
Creative Commons Attribution-Share Alike Licence http://creativecommons.
org/licenses/by-sa/3.0/
Page 87: © Cathy Wilcox
Reading 53
Figure 1: © Lakruwan Wanniarachchi/AFP/Getty Images
Figure 2: © North Wind Picture Archives /Alamy
Figure 3: © Lebrecht Music and Arts Photo Library
Figure 4: © Everett Collection Historical/Alamy
Reading 54
Figure 1: © Ian Waldie/Getty Images
Figure 3: © Cartoonstock.com
Reading 54
Figure 1: © Radharc Images/Alamy
Page 118: © Cartoonstock.com
Text
Reading 46
Page 18: Taken from www.tatapower.com
127
Block 7
Readings 56–61
By Nik Winchester

Act 1988.
3WX
ISBN 978 1 4730 03521
2.1
Contents
Reading 56: Globalisation (1) – the basics 5
Introduction 5
1 What is globalisation? 7
2 International trade 10
3 Foreign direct investment (FDI) 12
Summary 15
References 16
Reading 57: Globalisation (2) – the impacts on business 18
Introduction 18
1 Cost drivers 18
2 Government drivers 21
3 Technological drivers 23
4 Market drivers 27
5 Conclusion on drivers 28
Summary 31
References 32
Reading 58: Transnational practices (1) – global value
chains, outsourcing and offshoring 34
Introduction 34
1 Global value chains 34
2 Outsourcing and offshoring 38
Summary 50
References 51
Reading 59: Transnational practices (2) – the nature and
practice of transnational corporations 53
Introduction 53
1 What is a transnational corporation? 53
2 Why do firms become TNCs? 54
3 How do firms become TNCs? 57
4 The size and scope of TNCs 60
Summary 67
References 69
Reading 60: International business ethics (1) – bribery
and corruption 71
Introduction 71
1 Bribery and corruption 71
2 Responding to bribery and corruption 77
3 Regulatory responses 83
Summary 85
References 86
Reading 61: International business ethics (2) – work,
sweatshops and responsible business 88
Introduction 88
1 Economic globalisation and labour 88
2 Ethics and sweatshops 91
3 More comprehensive theories 98
4 TNCs – a more positive view 100
Summary 102
References 103
Reading 56: Globalisation (1) – the basics
Reading 56: Globalisation (1) – the

basics
Introduction
Globalisation can be a difficult term to deal with. For some it represents the
final stage of economic integration where global citizens operate in a global
economy to the potential benefit of all (Wolf, 2004). To others it speaks of
the domination of aggressive and greedy transnational corporations
exploiting the world’s resources outside of state control (Dyer et al., 2014).
For some it is over-stated. For others it represents the inevitable completion
of world history (Ohmae, 1990). No wonder some authors have suggested
the term is highly problematic (Hirst et al., 2009; Scholte, 2005). Despite
these differing views, however, there is general agreement that ‘something’
has changed and that ‘something’ is to do with the claim that what happens
in one part of the globe appears to affect other parts outside of its location.
In simple terms we live, work and consume within a global context.
This reading, together with Reading 57, outlines the basics of the global
context and discusses how this affects business organisations of all sizes,
type and location. It focuses on how this dynamic context offers both
challenges and opportunities for business and, importantly, how this global
context is inescapable. This will involve establishing a few facts about the
global economic context and a brief dip into the history of globalisation. (In
order to understand the current business context it is important to have a
grasp of its history.)
Figure 1 Globalisation
Exercise 1
Before the facts about the global context are presented the following offers
an example of how the global context can affect business. Read the case
and write notes on the following questions:
5
Readings 56–61
Why does Paula find it more difficult to get credit for her business? (Think
about what has changed in the business environment.)
What does the case tell us about the global context of business?
Example of a business in the global context: Pipes &

Installations Limited
The year is 2009. Paula is the owner of a small business based in the UK
called Pipes & Installations Limited, a supplier and manufacturer of plumbing
goods. The past few years have been good for the business and she is
looking to expand – to rent larger premises, purchase new capital equipment
and hire new employees. This expansion requires funding so Paula
approaches her bank. She presents recent accounts showing the company’s
good standing and year-on-year growth in both revenue and profits together
with a detailed business plan. She has a good relationship with her bank.
The business has serviced its debts without trouble, having received
substantial loans on two separate occasions. She is feeling confident that
this is a well-thought through business plan underpinned by solid financials.
However, this time she receives a curt response of ‘no’; the proposal is
deemed too risky under the bank’s new rules following the financial crisis.
Unperturbed she goes to another bank and presents the same business
plan. This bank says ‘yes’, but offers her a loan at a significantly higher
interest rate than she has paid in this past. Given historically low interest
rates in the UK this is confusing. However, the loan officer says that under
current economic conditions, the bank has to offer a premium rate based on
the risk they are taking. The recession affects everyone and small business
expansion is a risk.
Paula then goes to another bank that takes a long look at the business plan
and the accompanying documents and offers a positive response. In this
case the interest rate is higher than she is used to but not exceptionally so.
However, the bank insists on another proviso. They want some collateral in
order to secure the debt. Because Pipes & Installations Ltd does not own its
premises, the bank asks for the debt to be secured on the equity in Paula’s
house. Once again the issue of risk is cited.
Paula is confused and concerned. It appears that her business is growing

and sustaining yet access to funds has changed fundamentally. How would
you explain this change?
Comment
In responding to the question of why Paula is finding it more difficult to get
credit the following points are relevant:
. The role of the financial crisis is a factor. In Block 5 you discussed the
financial crisis and how it sprung initially from the US sub-prime market.
One of the effects of the crisis was to plunge many economies into
recession. It could be that the banks reckon Pipes & Installations Ltd is
particularly vulnerable to the recession. (This could well be true if the
6
business supplies those that build new homes because the recession
affected this sector significantly.)
. Another factor concerns the response of banks to the financial crisis. Not
only are they subject to increased regulatory oversight but also they are
increasingly concerned with measuring and controlling risk. The financial
crisis was partially the result of somewhat reckless lending by banks. The
banks then become risk averse, seeing SMEs as a sector subject to high
risk. They seek to control risk by, for example, refusing loans to small
businesses or securing loans on collateral.
. It could be that the bank’s cost of credit has increased, i.e. the rates they
pay to access the financial markets have increased. They, therefore, pass
this onto their customers in the form of higher interest rates.
Whilst it is not possible to pin down exact reasons from the case, the fact is
that because of the financial crisis, the rejection rates for loans to small
businesses have increased, interest rates have risen and collateral is
increasingly being demanded (Cole, 2012; Fraser, 2012). The result is that
SMEs are finding it harder to access credit and do so on less favourable
terms. This is not to do with any fundamental change in the nature of SMEs
and how they conduct their business but has everything to do with the
impacts of the global context and the deep and extensive connections of
economic activity across the globe. In this respect, the global context is not
the sole concern of international business (i.e. those businesses who operate
internationally) but a dynamic context that affects all business.
1 What is globalisation?
It is this sense of activity being more connected across the globe, be it
economic, political or cultural, that captures an important element in any
account of globalisation. Globalisation has proven notoriously difficult to
define, and this section extracts the key features of this term. Authors have
described globalisation as ‘a set of processes through which the world is
becoming a single space’ (Chirico, 2014, p. 8) and as a trend toward
‘greater economic, cultural, political, and technological interdependence
among national institutions and economies’ (Wild and Wild, 2014, p. 31).
Ohmae (1990) encapsulated this when he talked of a ‘borderless world’.
This captures the sense in which, whilst we live in a world of discrete
nation states, these boundaries are becoming more permeable. These borders
no longer have the defining importance that they used to. Business,
consumers and citizens are no longer insulated from the rest of the world in
quite the same way as previously assumed.
It is also worth noting that globalisation is more than an economic
phenomenon. As Rassekh states: ‘The term globalisation refers to the
process of increasing interaction and integration of cultures, societies, and
economies’ (Rassekh, 2014, p. 390). Globalisation has a large impact on
many aspects of our lives, not simply the opening up of the world economy
7
Readings 56–61
and the increasing flow of goods and services across national boundaries.
Although this reading focuses on the economic dimension of globalisation,
both political and cultural dimensions in particular shape the functioning of
globalisation and business practice within the global context. For example,
some argue that globalisation leads to a certain convergence of culture in
general and consumer behaviour in particular (Sklair, 2002). (Perhaps this
may explain the rapid expansion and success of Starbucks around the
world.)
A second point worth emphasising is that globalisation is a process leading
towards interdependence between economies and polities. It does not
describe the existence of an end stage in which a ‘borderless world’ exists.
Globalisation is not a completed project nor is it inevitable, as Dicken
describes:
Globalization… is not an inevitable end-state, but, rather, a complex,

indeterminate set of processes operating very unevenly in both time
and space. As a result of these processes, the nature and the degree of
interconnection between different parts of the world is continuously in
flux.
(Dicken, 2011, p. 8)
So in talking about globalisation, it is necessary to keep in mind that whilst

the forces or drivers towards globalisation (discussed in the next reading)
are both significant and powerful it is not the case that all economies, all
businesses, all polities or all individuals are affected equally by
globalisation. Nor should it be assumed that the current state of
globalisation is stable and not subject to change. (This point can be
emphasised by looking at the recent history of the changing role of China in
the world economy.)
Figure 2 World map
The focus in this reading is on economic globalisation; in this sense

globalisation can be treated as ‘the shift towards a more integrated and
interdependent world economy’ (Hill, 2011, p. 6). Put simply, businesses in
any location of the world are a part of the global context; what happens in
one part of the world can have an effect on business elsewhere. This is not
to say that everything that happens across the world affects all businesses
8
but that the links and consequences are stronger and more numerous than
they previously were.
How this integration occurs is, of course, important, and that suggests
another feature of globalisation, that of ‘markets’. Economic interactions
are, in general, carried out through markets with limited interference from
states in the form of tariffs, trade embargoes and the unfavourable treatment
of foreign capital. In this way globalisation follows the logic of what is
called ‘neoliberalism’. This can be understood as the attempt to remove the
interference (in particular government interference) in market functioning:
also known as the ‘Washington consensus’ (Chirico, 2014, p. 91). However,
all businesses are still subject to degrees of regulation and state influence.
As in all these definitions it is necessary to take care not to over-state
claims and to think carefully about both what has changed and what has
stayed the same. Globalisation has been subject to some rather extreme
claims and from these one might think that the world is being controlled by
transnational corporations that are running the world for their own benefit!
This section ends with a final definition that helps in understanding the
nature and challenges of economic globalisation. This links together the
idea of economic integration with the increasing importance of the market
as a way to coordinate economic activity across the globe. Globalisation can
be defined:
... in three distinct but interrelated senses: first, to describe the

economic phenomenon of increasing integration of markets across
political boundaries (whether due to political or technological causes);
second, to describe the strictly political phenomenon of falling
government-imposed barriers to international flows of goods, services,
and capital; and finally, to describe the much broader political
phenomenon of the global spread of market-oriented policies in both
the domestic and international spheres.
(Lindsey, 2002, cited in Wolf, 2004, pp. 14–15)
So in brief:
. Globalisation concerns the increasing interdependence of economic,

cultural and political practices.
. Globalisation is multi-dimensional. It is not simply an economic
phenomenon.
. Globalisation is not an existing end state, but a dynamic process.
. Not all businesses are affected by globalisation equally but all are
affected in some manner.
. Economic globalisation refers to the interdependence and
interconnections of economic activity coordinated through markets.
. Globalisation is not only about the actions of large transnational
corporations (although they are important).
Having reached a definition of sorts (or at least narrowed down the key
facets of globalisation) the discussion now turns to selected facts and figures
that show its extent and dynamics.
9
Readings 56–61
2 International trade
Not only is globalisation difficult to define, it is also difficult to measure.
How might we measure the increasing connectedness of the world
economy? One way of looking at the dynamics and intensity of
globalisation is to consider the flow of goods and services across national
borders, i.e. to look at international trade. However, there are a number of
notes of caution worth remembering before taking a look at the figures:
. International trade is not the same thing as globalisation. Globalisation

refers to a shift towards global interdependencies. For sure international
trade is a part of this, however, it is not the whole of the story.
. An increasing amount of international trade is due to transfers within
transnational organisations within global production networks. The
United Nations Conference on Trade and Development (UNCTAD)
estimates that approximately 80% of global trades are within such
networks (in the form of intra-firm trade, offshored-outsourcing or
market transactions) (UNCTAD, 2013a, p. 135).
. International trade is nothing new. The benefits and practice of
international trade has long been recognised. (It may surprise you to
know that in 1874, over 86,000 tonnes of cheese were imported into the
UK, over half of which was from USA (Blundel and Tregear, 2006).)
Despite these comments the figures appear to speak for themselves. After
the end of World War 2, international trade was marked by rapid growth.
According to the World Trade Organization, in 1948 the value of
merchandise exports was US$59 billion and by 2012 this figure had jumped
to an astonishing US$17,930 billion (an increase of more than 300 times the
1948 figure) (WTO, 2013a). As Table 1 shows, exports are increasing in
value and with increasing year-on-year growth.
Table 1 Growth in international trade
1948 1953 1963 1973 1983 1993 2003 2012

World merchandise 59 84 57 579 1838 3677 7380 17930
exports (US$ billion)
(WTO, 2013a, p. 22)
The past three decades have shown the most substantial, almost exponential,
growth in international trade as the World Trade Organization notes:
International trade flows have increased dramatically over the last three
decades. According to WTO trade statistics, the value of world
merchandise exports rose from US$2.03 trillion in 1980 to US$18.26
trillion in 2011, which is equivalent to 7.3 per cent growth per year on
average in current dollar terms. Commercial services trade recorded
even faster growth over the same period advancing from US$367
billion in 1980 to US$4.17 trillion in 2011, or 8.2 per cent per year.
(WTO, 2013b, p. 55)
10
It is necessary to take some care in understanding these figures which report

global trends. The impression could be given that all nations across the
world are trading with greater frequency – both importing and exporting –
receiving the benefits of international trade. However, the picture is more
subtle. The distribution of international trade is uneven, trade flows are
geographically bounded and the global map of international trade is subject
to change.
Looking more closely at international trade figures it can be seen that not
only is the world share of exports (and imports) focused on a select few
countries, but that this concentration has been subject to a number of
fluctuations. At the current time the most notable change is the rise of
China as a major international economic power. The following details some
of these features (adapted from WTO, 2013b, pp. 60-61)):
. China is currently the world’s largest exporter of merchandise goods. In

2011 it produced 10.4% of the world’s goods by value. However, going
back to 1980 it was ranked 30th with a meagre 0.89% of manufactured
goods by value.
. In the period 1980–2001 South Korea has moved from 32nd in 1980
(0.86%) to 7th (3.04%) in the list of the world’s largest exporters.
. Three countries (China, USA and Germany) account for over a quarter
(26.6%) of world merchandise exports by value.
. USA is the second largest exporter. However, its share has decreased
from 11.09% (1980) to 8% (2011).
. The highest ranked country in Africa is Nigeria (35th), with 0.64% in
2011, down from 1.28% in 1980.
. USA retains it place as the world’s largest importer of manufactured
goods with 12.29% of value in 2011.
The second point is that although this form of trade is referred to in terms
of globalisation, international trade is still geographically bounded to a
significant degree.
. Europe: just under three quarters of all European trade occurs between
European countries, i.e. it is ‘intra-regional (Dicken, 2011, p. 20).
. Asia: just under 50% of all exported trade is conducted within Asia
(20% goes to North America, 18% to Europe) (Dicken, 2011, p. 20).
. North America: 50% of its trade is similarly intra-regional (a significant
proportion of this trade is to Mexico) (20% goes to Europe and another
20% to Asia) (Dicken, 2011, p. 20).
. Africa: only 12% of Africa’s trade takes place within the continent. (The
Economist, 2014).
This has led some commentators to suggest that the current economic
environment should not be characterised as globalisation but is instead a
form of regionalisation where cross-border flows are contained within
geographical blocs (Rugman, 2001; Scholte, 2005). Despite these issues,
there is still a large amount of international trade flowing across these
regions. The map below shows the geographical distribution of these flows,
11
Readings 56–61
emphasising both the regional nature and uneven distribution of

international trade.
Europe-CIS, 3.6%
North America-Europe 1.8%
CIS
To Asia CIS-Asia,
North South and Central Europe 1.3%
America America-Europe, Europe-Middle
1.4% Europe- East, 2.0% North
North Africa, America-Asia,
America-South 2.3% Europe-Asia,
7.8%
and Central Middle 8.8%
America, 2.1% North America-Middle East Asia
East, 1.0% Middle To South and
East-Asia, 5.1% Central America
South and
Central South Africa
America-Asia, North
and America-Africa, Africa-Asia, 1.7%
2.0% Central 0.8%
America
Source: WTO Secretariat estimates

Note: World trade includes intra-EU trade. Arrow weights based on shares in 2011. Trade within regions and with unspecified
destinations represented 54% of world trade in 2011
Figure 3 A map showing geographical distribution (source: WTO, 2013b)
In looking at these figures on international trade there is a mixed picture.

Whilst the trade in merchandise goods (as well as the trade in services) is
growing rapidly, the global economic map is hardly borderless and equal.
Certain economies continue to dominate the world export map and this trade
has a significant intra-regional element. By contrast others have more
recently become major world economies showing massive economic growth.
However, there is a vast number of countries who appear as minor players
in the international export trade and show limited signs of expansion.
Despite all these subtleties, and the fact that a significant proportion of this
trade is within transnational corporations, the sheer rate of growth of
international trade suggests that opportunities exist to trade across national
borders and that no economy is immune to the threat of competition from
the rest of the globe.
3 Foreign direct investment (FDI)

Whilst figures on international trade indicate the quantity of cross-border
transactions it says little of the sense of interconnectedness that
characterises economic globalisation. If businesses only produced goods and
services within their home country and sold them into the world economy
(or as noted above most likely to within their region), it could hardly be
said that the world has seen a significant change. This scenario describes
simply the expansion of international trade between discrete and bounded
12
nations. (As Scholte notes, this is hardly a new phenomenon and there is
already a word for it ‘internationalisation’ (Scholte, 2005)). However other
measures can offer further insight into the interdependencies characteristic
of economic globalisation; the one most offered is foreign direct investment
(FDI).
Foreign direct investment is defined as a ‘direct investment across national
boundaries to buy a controlling investment in a domestic firm or to set up
an affiliate’ (Dicken, 2011, p. 20). For example when Tata Steel (an Indian
company) bought Corus (an Anglo-Dutch steel company) in 2007 this
would also be classed as FDI. Similarly when Starbucks opens up one of
their coffee shops outside USA. (If a business chooses to outsource
production to another business (as Apple does in the manufacture of
iPhones and iPads) this is not FDI – this is an economic transaction across
borders.) Whilst the ‘foreign’ part of FDI is straightforward, the ‘direct’
component of this phrase may need some explanation. ‘Direct’ investment
concerns control, or as the World Bank puts it a ‘lasting management
interest’, which they define as a minimum of 10% of voting stock (World
Bank, n.d.). Therefore, if a business purchases shares in a foreign business
in order to make a short-term profit without any interest in influencing its
actions this would not be FDI.
FDI is important in understanding globalisation because it points towards a
greater economic integration across national boundaries. Businesses are
exerting lasting management interest outside of their home nation; they are
functioning across national boundaries. When you see the sign under the
Asda supermarkets logo that says ‘part of the Walmart chain’, or go on a
foreign holiday and find another Starbucks, or buy your clothes from
H&M, you are encountering the occurrence of FDI. It speaks of the global
reach of organisations as they spread themselves throughout the world.
In the period 1975–1985, FDI grew consistently, roughly tracking the
growth rate in exports (Dicken, 2011, p. 20). However, since 1985 FDI has
shown a spectacular rate of growth outpacing exports. In 2013 FDI was
measured at US$1.46 trillion (UNCTAD, 2014). FDI is therefore becoming
a powerful indicator of the increasing connections between national
economies and the distribution of ownership and control within them.
Once again care should be taken when interpreting these aggregate figures
to suggest that the world’s economies are equally interconnected. FDI is
distributed in an uneven manner and is subject to trends, shocks and
historical change. In a recent report UNCTAD (2014) noted that FDI was
significantly affected by the global financial crisis and has yet to recover to
pre-crisis levels (in 2007 the figure for FDI was US$2.00 trillion). The
report also notes that:
. USA remains the highest receiver of FDI inflows at US$168 billion,

however, this figure remains in decline. In terms of outflows it remains
by far the largest investor nation at US$329 billion.
. China is the second highest receiver of FDI with US$127 billion.
However its outflows are US$84 billion.
. In total FDI inflows fell by 32% in the period 2011–2012.
13
Readings 56–61
. FDI flows to developing countries represent 52% of all global FDI

inflows. (In terms of outflows, however, the figure is 30.6%.)
(UNCTAD, 2013a, pp. xii–xiv)
Another way of looking at the role and extent of FDI is to compare FDI
inflows with GDP at a national level. For example, if for a particular
country the level of FDI coming into a country is high relative to GDP it
can be said that this particular national economy is highly interconnected
with the global economy. Whilst this comparison could be considered a
little superficial it does offer some insight. Table 2 gives this figure for a
number of the countries and, interestingly, offers a comparison between
1990 and 2008.
Table 2 Inward foreign direct investment as a share of gross domestic

product 1990 and 2008 (% share of GDP)
1990 2008 1990 2008

Japan 0.3 4.1 China 5.8 8.7
Italy 5.4 14.9 Korea 2.1 9.8
Germany 6.6 19.2 India 0.5 9.9
US 6.9 16.0 Taiwan 6.1 11.6
Australia 23.7 27.4 Philippines 7.4 12.7
Canada 19.6 27.5 Indonesia 7.7 13.1
Poland 0.2 30.7 Brazil 8.0 18.3
France 7.1 34.7 Argentina 6.2 23.0
UK 20.6 36.9 Mexico 8.5 27.1
Spain 12.8 39.6 Malaysia 23.4 33.0
Hungary 1.7 41.4 Thailand 9.7 38.4
Denmark 6.9 44.1 Vietnam 25.5 53.6
Czech Republic 3.9 52.7 Chile 33.2 59.6
Sweden 5.3 52.9 Singapore 83.1 179.3
Ireland 88.9 63.7
Switzerland 15.0 76.1
Netherlands 23.3 74.0
Belgium ... 102.9
(Source: based on data in UNCTAD, 2001;2009, cited in Dicken, 2011, p. 22.)
Exercise 2
Using Table 2 above, how would you characterise the global interconnectivity
of national economies?
How has it changed from 1990–2008?
Feedback
Some of the features I noted were:
. There appears to be a large variance in the extent to which national

economies are integrated into the world economic system. The figures
run from a very low 0.3% in Japan in 1990 to the 179.3% of Singapore in
14
2008 (although it should be noted that Singapore does have a very small
domestic economy). Overall the pattern appears uneven.
. Most of the figures have increased in the period 1990–2008 (with the
notable exception of Ireland, which showed a significant decline). This
appears to suggest that inter-connection is increasing.
. Some countries show enormous increases. This appears to indicate the
increasing number of countries becoming globalised.
. If I was going to describe a general trend it would be that inter-
connectedness appears to be increasing, although the base levels are
highly variable (as are some of the individual growth rates).
. There appears to be good evidence of economic globalisation.
Summary
Economic globalisation describes an environment in which the world’s
economies are increasingly inter-connected. Political interference in markets
is lessening offering business broader global opportunities. In looking at
international trade and FDI there is evidence of increasing economic
interactions across national borders. Business, it appears, is becoming
increasingly global. However, excessive generalisations need to be avoided;
economic globalisation is unevenly distributed, and is subject to fluctuations
and dynamics. Certain national economies appear more ‘globalised’ than
others, whilst others appear rather tenuously linked to these dynamics.
Reading 57 will explore the next question: why is this happening and what
does this mean for business?
15
Readings 56–61
References
Blundel, R. and Tregear, A. (2006) ‘From artisans to “factories”: the
interpenetration of craft and industry in English cheese-making, c1650-
1950’, Enterprise & Society, vol. 7, no. 4, pp. 705–739. [online]. Available
at http://oro.open.ac.uk/29132/1/Blundel_and_Tregear_2006_-
_EandS_article.pdf (Accessed 19 September 2014).
Chirico, J.-A. (2014) Globalization: Prospects and Problems, Sage, London.
Cole, R.A. (2012) How Did the Financial Crisis Affect Small Business
Lending in the United States? SBA.gov. [online]. Available at http://www.
sba.gov/advocacy/how-did-financial-crisis-affect-small-business-lending-
united-states (Accessed 3 July 2014).
Dicken, P. (2011) Global Shift: Mapping the Changing Contours of the
World Economy, 6th edn., Sage, London.
Dyer, S., Humphries, M., Fitzgibbons, D. and Hurd, F. (2014)
Understanding Management Critically, Sage, London.
Fraser, S. (2012) The Impact of the Financial Crisis on Bank Lending to
SMEs, London: BIS (Department for Business Innovation and Skills).
[online]. Available at https://www.gov.uk/government/uploads/system/
uploads/attachment_data/file/34739/12-949-impact-financial-crisis-on-bank-
lending-to-smes.pdf (Accessed 3 July 2014).
Hill, C.W.L. (2011) International Business: Competing in the Global
Marketplace, 8th edn., New York, McGraw-Hill.
Hirst, P., Thompson, G. and Bromley, S. (2009) Globalization in Question,
3rd edn., Cambridge, Polity.
Ohmae, K. (1990) The Borderless World, London, Collins.
Rassekh, F. (2014) ‘Economic globalization: an empirical presentation and a
moral judgment’, in Boylan, M. (ed.) Business Ethics, 2nd edn., Chichester,
Wiley-Blackwell.
Rugman, A. (2001) The End of Globalization, London, Random House
Business Books.
Scholte, J.A. (2005) Globalization: A Critical Introduction, 2nd edn.,
Basingstoke, Palgrave Macmillan.
Sklair, L. (2002) Globalization: Capitalism and its Alternatives., 3rd edn.,
Oxford, Oxford University Press.
The Economist (2014) ‘Cabling Africa’s interior: Many rivers to cross’, The
Economist, 5 July 2014. [online]. Available at http://www.economist.com/
news/business/21606270-dogged-firm-roots-zimbabwe-has-brought-fast-
broadband-landlocked-parts-africa (Accessed 19 September 2014).
UNCTAD (2013a) World Investment Report 2013, United Nations
Conference on Trade and Development, New York and Geneva: United
Nations. [online]. Available at http://unctad.org/en/publicationslibrary/
wir2013_en.pdf (Accessed 3 July 2014).
16
UNCTAD (2013b) Trade and Development Report 2013, United Nations

Nations. [online]. Available at http://unctad.org/en/PublicationsLibrary/
tdr2013_en.pdf (Accessed 3 July 2014).
UNCTAD (2014) Global Investment Trends Monitor, United Nations
Conference on Trade and Development, Number 15, 28 January 2014, New
York and Geneva: United Nations. [online]. Available at http://unctad.org/
en/PublicationsLibrary/webdiaeia2014d1_en.pdf (Accessed 3 July 2014).
Wild, J.J. and Wild, K.L. (2014) International Business: The Challenges of
Globalization, 7th edn., Harlow, Pearson.
Wolf, M. (2004) Why Globalization Works: The Case for the Global Market
Economy, London, Yale Nota Bene.
World Bank (n.d.) Foreign direct investment, World Bank. [online].
Available at http://data.worldbank.org/indicator/BX.KLT.DINV.CD.WD
WTO (2013a) International Trade Statistics 2013, Geneva: World Trade
Organization. [online]. Available at http://www.wto.org/english/res_e/
statis_e/its2013_e/its2013_e.pdf (Accessed: 3 July 2014).
WTO (2013b) World Trade Report 2013, Geneva: World Trade
Organization. [online]. Available at http://www.wto.org/english/res_e/
booksp_e/world_trade_report13_e.pdf (Accessed: 3 July 2014).
17
Readings 56–61
Reading 57: Globalisation (2) – the

impacts on business
Introduction
The previous reading outlined the features of economic globalisation. It also
suggested this was an ongoing process that is both distributed unevenly and
subject to dynamics (such as the large shocks from the global financial
crisis of 2007-8). The reading cautioned against rather extreme claims that
the economic world is borderless; location still plays an important part in
business. (Arguably, however, its influence is less than it once was.)
However, the general point is that removing ourselves from the global
context is, to all intents and purposes, not an option. Even if you work in a
small local business, global economic processes still influence its practice.
Drivers of globalisation
The question that remains is what drives economic globalisation? Why does
it appear so powerful and so important for business? Indeed, how have
people become used to economic globalisation so that it becomes an
everyday part of life? This section discusses the forces that drive economic
globalisation, that both disrupt previous ways of doing business and drive
this process ever onward. Remember, this is not simply about more cross-
border trade (although this is important) this concerns increasing
interconnections throughout the global economy.
There is no definitive list of what drives economic globalisation. The
following, however, offers an overview of the key drivers of globalisation
drawn from a variety of sources (Crane et al., 2008; Hill, 2011; Sloman and
Sutcliffe, 2004; Steers et al., 2013; Wild and Wild, 2014; Yip, 1989).
1 Cost drivers
Businesses are designed to achieve goals. Those in the for-profit sector (as
the name suggests) are looking to make profit; in the not-for-profit sector
the emphasis may be on doing the most with their resources. The subject of
how businesses should go about doing this is, of course, complex and it is
an issue you will explore in further detail as you continue your studies in
business and management. However, one way that organisations can make
their bottom-line look better (or do more with the same level of resources)
is to reduce costs. Globalisation offers businesses extensive opportunities to
do this, as detailed below:
1 reducing the cost of inputs (such as raw materials or partially finished
goods) that the firm consumes
2 reducing the direct cost of wages, i.e. the cost of employing workers,
through offshoring
18
Reading 57: Globalisation (2) – the impacts on business
3 reducing spending on wages through outsourcing.

(It is important to remember that this is not a list of all of the cost drivers
that affect business. Here the focus is on those drivers that increase the
interaction with the global context.)
1 If an input into a business, such as raw materials or components, is
available cheaper (factoring in transport costs) and to an acceptable
quality outside its home nation, then the business may choose to
purchase from abroad. This is hardly a new practice and marks a basic
understanding of international trade. However, it does mark a first step
by a business into the global context. Indeed, even for small businesses,
suppliers of inputs may be distributed across the globe.
2 Depending on the nature of the task in the organisation, wages are often
a considerable cost to a business. (Indeed wages are a significant part of
many small businesses’ costs.) The wages for different occupations vary
significantly across the globe, therefore a business may choose to locate
a new plant (or close down an old plant and relocate) in a country where
wages are significantly lower. This practice is known as offshoring; this
is where a business chooses to locate or relocate part of its business
operations to another country. Note that its workers are still directly
employed by the business, for example when a South Korean electronics
manufacturer opens a new plant in Vietnam, they are engaged in
offshoring. Through offshoring a business shows a significant
engagement with the global context (and the challenges and
opportunities that it offers). Offshoring is a significant activity in
contemporary business, particularly in the context of global production
chains within Transnational Corporations (TNCs).
Figure 1 A call centre in the Philippines
3 A business can choose an alternate method of operating within the

global context, that of commissioning aspects of its business in another
country, known as outsourcing. (Technically this is called offshore-
outsourcing because a business can choose to outsource to another
business within its country.) For example the iPad is assembled for
Apple in China by the business Foxconn. (Wage rates in China are
significantly lower than in USA where Apple used to manufacture its
products.) When a business chooses to outsource aspects of its
19
Readings 56–61
operation to a business located in another country it can attract

controversy, particularly in respect of lost jobs in the home country. As
with offshoring, outsourcing is a similarly significant practice, with
certain countries specialising in particular sectors (for example software
development in India, call centres in India and the Philippines,
manufacturing in China).
In discussing the link between globalisation and cost reduction, the focus is
often on the move of relatively low-skilled manual tasks to cheaper wage
countries, for example China’s rise to becoming the world’s largest
manufacturer. The assumption is that more highly skilled tasks are retained
in the home country. There are several problems with this view: First this
represents a rather limited view of the skills existing in countries around the
world. Second is that such ‘high-skilled’ jobs are already being outsourced
and offshored. The following article from The Economist (2010) offers a
discussion of legal outsourcing (and offshoring).
The growth of legal outsourcing –

Passage to India
The Economist, 24 June 2010
Companies and law firms are turning to India for cut-price legal
services
Ritu Solanki, a 28-year-old lawyer with a degree from Nottingham
University, spends most of her time drafting contracts and legal memos
for a telecoms firm in Britain. She, however, is in Gurgaon, a high-rise
satellite city on Delhi's edge, where she works for CPA Global, a
legal-outsourcing company. A lawyer with similar experience at a
London law firm might charge up to US$400 an hour for the sort of
work Ms Solanki does; her labour costs around US$50 an hour. As law
firms and corporate legal departments face mounting pressure to cut
costs, an increasing number are choosing the Indian option.
Last year, Rio Tinto, an international mining group, moved a tranche
of legal work to Indian lawyers at CPA Global, which has its
headquarters in Jersey, to save a fifth of its legal costs. Others are
following. In May CMS Cameron McKenna, a British law firm, signed
the legal industry's biggest outsourcing deal with Integreon, an
American company with operations in India. Over the next ten years,
Integreon's Indian staff will provide the British firm with services from
human resources to legal research.
Though India's legal-process outsourcing (LPO) industry is still small,
it is growing fast. In a recent report, ValueNotes, an Indian
consultancy, estimated that India's LPO revenues will grow from US
$146m in 2006 to US$440m this year and US$1.1 billion in 2014. The
number of Indian firms offering LPO services has swelled from
50 in 2005 to more than 140 today. Investors have spotted the
potential. In February, Actis, a British private-equity outfit that
20
specialises in emerging markets, invested US$50m in Integreon.

Intermediate Capital Group, also based in Britain, has bought an
undisclosed chunk of CPA Global.
The growth in LPO has been boosted by the global economic
slowdown. ‘It's a very obvious way to cut costs and it is hard to refute
once you have seen the good work that is being produced,’ says Leah
Cooper, CPA Global’s strategy director. Until four months ago, Ms
Cooper was Rio Tinto’s managing attorney. Western lawyers have in
the past been slow to outsource even the most basic work to India,
because of worries about confidentiality and quality. But they are now
commissioning ever larger volumes.
Developments within India’s outsourcing industry have also
contributed to making the country a more compelling destination for
legal work. Although still dominated by low-value process outsourcing,
such as call-centres, the fastest growth is in companies offering highly
skilled work, from medicine to engineering and information technology
(IT). A growing number of newly qualified lawyers, trained in a legal
system based on Britain's and often educated at British or American
universities, are drawn to the higher salaries and international
experience now being offered. Such lawyers are capable of doing more
complex work than the document review and proofreading that
currently forms the bulk of legal outsourcing.
That said, many legal jobs, from court appearances to the handling of
witness depositions, will never be outsourced. And fears persist among
some senior lawyers about sending even the simplest chores offshore.
A profit-inflating scandal last year at Satyam, India’s fourth-largest IT
outsourcing company, reawakened old worries. There is also the
question of how young lawyers will cut their teeth if the jobs they
typically do are sent instead to Delhi. Ms Cooper says: ‘I hear that
every day and my response is, I didn’t learn a thing as a baby lawyer
digging through boxes in a storeroom. We may have to rethink how
our lawyers are trained.’
2 Government drivers
Government drivers refer to the actions of governments that shape the
global economic environment. This concerns the progressive opening up of
states to market forces (also called ‘neoliberalism’). It includes:
1 increasing the number of market-based economies and increasing market
orientation in planned economies
2 increasing commitment to reduce barriers to trade
3 rise of co-operative organisations of global governance.
1. At the time of writing it might be taken for granted that China is the
world’s largest manufacturer, that most countries’ economies are based on
market principles, and that Eastern Europe contains a variety of distinct
21
Readings 56–61
nations with market-based economies. Yet this opening up of the majority of

the world’s economies is a relatively recent phenomenon. Indeed the latter
half of the 20th century was marked by bitter oppositions often framed
around different economic systems: the capitalistic market on the one hand
and socialist planned economies on another with limited trade between these
two. Now these barriers are either absent or substantially reduced. The
ideology of the market as the best, most efficient way to organise business
practice means that the global market becomes a place of opportunity and
challenges, from selling McDonald’s to China, to migrant workers within
the EU. The world becomes a place in which to sell and compete.
2. Not only has the number of countries based on free-market principles
increased but the economic policies in respect of international trade have
also changed. Governments are becoming increasingly concerned with
creating policies in which trade flows freely, for example:
. Governments have reduced the number and extent of additional taxes or

duties (known as tariffs) that governments impose on import and export
of goods and services.
. There are less state-controlled monopolies with the advent of large-scale
privatisation.
. Governments are enabling foreign companies to invest in their country.
Foreign Direct Investment (FDI) is welcomed rather than being treated
with suspicion or subject to significant restrictions.
In summary, not only are there more countries in which to trade into and/or
operate within, but also the barriers to trade are being reduced.
3. In order to secure this openness to trade, states are increasingly forming
and committing to global and regional associations that enable and protect
trade. For example:
. The World Trade Organization seeks to promote the opening of trade

across its member nations.
. The World Bank frequently requires the opening of trade as a
requirement for financial aid.
. The EU is committed to producing a single common market with free
flow of workers and capital within its borders.
These government drivers increase globalisation in both a quantitative and
qualitative way, i.e. it changes both the level and type of cross-border trade
and investment. The global marketplace not only offers opportunities for
businesses of all kinds but can also expose them to competition without the
benefit of government protection in the form of tariffs, import quotas,
embargoes and/or subsidies (or other protectionist measures).
22
Figure 2 World Bank headquarters
3 Technological drivers
Technology has transformed businesses, created new ones and made others
redundant. Technology has shaped and enabled the global economic context,
not only through the rapid diffusion of internet-connected devices, but also,
as will be explained, the more commonplace ‘invention’ of the standard-size
metal box. The following outlines two key drivers:
1 Information and communication technologies (ICT)
2 Technologies of transportation.
1. ICT has had such a profound effect on the business environment there is
insufficient space to describe them all. The following lists a few:
. At a basic level if a business is to operate in a global context, it needs

to be able to communicate across national boundaries, to speak to
suppliers, to customers, and to managers in other locations. In 1930 the
cost of making a phone call between New York and London was US
$244.65 per minute and connections were unreliable, but by 1990 this
figure was US$3.32 (Hill, 2011, p. 14). It is now possible to make a
Skype call for free to anybody with a Skype account and an internet
connection.
. The increasing sophistication of communications technologies and the
software underpinning it means that businesses can create and effectively
operate complex global production chains and supply chains, often
coordinating them with real-time data.
. The internet also reduces the entry costs into the global market to, in
some places, close to zero. If I choose to sell my wares on the auction
site eBay, I can have access to a global marketplace of millions for a
small listing fee.
ICT has disrupted industries and sectors, opening up new opportunities, for
large and small businesses alike. A couple of examples are presented below.
23
Readings 56–61
Example of a technological driver: Mike Doughty

Mike Doughty is a musician. His career started in the early 1990s when he
was the singer, guitarist and songwriter in the band Soul Coughing. The
band produced three albums and achieved modest success until breaking up
in the late 90s. Since then Mike Doughty has performed as a solo artist
producing a number of albums of left-field singer–songwriter music. These
albums are published through a variety of record labels and made available
in both physical stores and latterly online music stores such as Apple’s
iTunes.
In 2013 he decided to produce a new album. Rather than signing with a

record label, going to a recording studio paid for by the label, and receiving a
percentage of the sales once costs had been recouped, he went in a
different direction. Doughty signed up with Pledgemusic, an online site that
enables musicians to gain support from their fans. Pledgemusic is a crowd-
funding site where fans of Doughty’s music can pledge amounts of money to
support the recording of the album. (For US$10 you get a digital download of
the album. For US$1,050 you can have the guitar used to record the songs.)
Doughty set a funding goal for the project. If it reached the goal the music
would be recorded and released; if not the project doesn’t proceed and the
backers are not billed. In order to get this moving, Doughty offered updates
to pledgers and advertised his project across social media sites (Facebook,
Instagram, etc.) Over 4,000 fans located across the globe pledged various
amounts, and the project reached three times its goal. The album was
recorded without record company involvement. Doughty secured sales for his
music, interacted with his fans and gained a cash flow for his business.
Figure 3 Mike Doughty
24
Exercise 1
The next example, Moon Studios, is a small independent creator of video

games; not only it is operating in the technology sector but ICT itself has led
to the structuring and operation in an interesting manner. Read the following
extract from a news report from the website Eurogamer about its first game,
called ‘Ori and the Blind Forest’. As you read think about and write some
notes (bullet points are fine) on how the technological driver of ICT affects
the operation of this business.
Ori and the Blind Forest looks great,

but plays even better
Jeffrey Matulef, Eurogamer, 7 July 2014
If you’re curious what specific part of the world conceived of Ori’s

breathtaking art, the answer isn’t as cut and dry as you may expect as
Moon doesn’t have a physical office. Instead, the indie studio is
comprised of people in Sweden, Vienna, Israel, Germany, Australia,
USA, and more. In fact, some of Moon’s team members had never met
in person until Ori’s recent reveal at E3.
‘This is probably the biggest example of an agile studio working and
making this actually happen in a very successful way,’ Smith [a
producer at project partner Microsoft] says. ‘There's always somebody
awake working on the game.’
Mahler [the founder of Moon studios] says he was initially worried
that the various time zones and lack of close proximity would hinder
production, but he actually found it resulted in better work – probably
because he made some smart hires. ‘The reason I wanted to do that
was because I've been working in the industry for 10 years now and I
always went through these heartbreaking moments where it’s like
‘There’s this one person who’d be awesome for this job,’ but then you
approach the person and they’re like ‘Sorry guys, I can’t do it. I can’t
relocate. I have my child in school’ and so on,’ the studio founder
laments.
‘That really sucks because then you need to get a person who might
not be the right person. So when I approached Microsoft, I told them
‘Hey guys, I have this really cool team, but we’re spread all across the
world.’ Then we got this surprising e-mail where they told us, ‘We
don't care. As long as you show us progress, that’s fine.’ That’s how
we basically founded Moon Studios.’
25
Readings 56–61
Comment
First of all, it is not surprising to hear of an organisation that employs
numerous nationalities. However, what is perhaps more surprising is that
these employees are not employed in the same location, or even the same
country – and that some of them have only met (i.e. in the same physical
space) for the first time late on in the project. In this case, ICT appears to
have disrupted the problem of location in respect of recruitment, i.e. how to
attract people who can’t move their physical location for whatever reason. It
seems then that a complex project, such as game development, can be
carried out across the globe with people who rarely, if ever, meet physically –
a position supported by their project partner Microsoft.
2. If a business is selling physical goods, it needs to be able to get them to

their customer. If all that is required is sending a single book sold through
Amazon Marketplace to a customer in a nearby town the matter is simple.
However, the issue is made substantially more complex if a product is being
manufactured in the thousands or even millions in China to be distributed
throughout Europe and USA. What if you are in charge of a complex
production chain, such as automobile production, where parts are sourced
across the globe, the engine being made in one country, the chassis in
another, and a third is assembling the product that then needs to be
distributed to dealers throughout the world. To solve this problem it is
necessary for there to be a reliable, low-cost and integrated way to send
goods around the world.
This issue is solved, in the main by the shipping companies of the world –
who carry approximately 90% of the world’s goods by weight. The key
innovation was not ICT systems to track cargo and streamline delivery but a
simple box: the container. Prior to the 1950s shipping goods around the
world required specialist skills. Vessels would be packed according to
weight, fragility and size, creating a complex puzzle, that took on average
10 days to unload (Wild and Wild, 2014, p. 38). Now goods are placed into
identical shaped containers and can be loaded and unloaded with ease (in a
matter of hours rather than days) at global hub ports with direct links to
onward transport. The container has produced a highly reliable, cheap (if
relatively slow) way to send goods around the world. It has also meant that
a small business that outsources its production can ship their goods without
prohibitive cost. Indeed, this technological innovation has been one of the
most significant drivers of globalisation (as a book about the shipping
container reflects in its title: ‘The box that changed the world’ (Donovan &
Bonney, 2006)). Whilst transporting goods by sea is cheap and efficient it is
hardly fast. For example, shipping a container from Shanghai to New York
takes 26 days (The Economist, 2014). Hence, air transportation has shown
increased importance. More suited to higher priced (and lower weight)
goods, air freight prices have substantially decreased – with costs no longer
prohibitive. By the early 2000s air transportation accounted for 28% of the
value of US trade (as compared with 7% in 1965) (Hill, 2011, p. 15).
26
4 Market drivers
The final driver relates to the generation of a global market for goods and
services, where a certain degree of standardisation and convergence takes
place and there is a changing structure of demand:
1 global products
2 global structuring of demand.
1. Economic globalisation can be understood in terms of global products, as
a result of the ‘convergence in buyer preferences in markets around the
world’ (Wild and Wild, 2014, p. 31). These are products that are aimed at a
global market. They are highly standardised and each consumer is offered
the same product. If I walked into an Apple store anywhere in the world I
would find the same range of products (iPhones, iPads, iMacs, MacBooks).
Indeed some have claimed that ‘customers increasingly prefer global brands
over local products; they want iPads or BMWs, not because they are
American or German, but because they are ‘branded’’ (Steers et al., 2013,
p. 16). This also relates to the claim that globalisation leads to cultural
convergence where cultures, tastes and preferences becomes similar as a
result of globalisation. The existence of such standardised products enables
firms to reduce marketing costs and production costs. There is no need to
alter the brand or produce a different range of products for other countries,
thereby offering opportunities for global expansion without these additional
costs. However, assuming the existence of a standardised global marketplace
is no replacement for understanding local preferences, and global businesses
may have to adapt products to local tastes. For example, Proctor and
Gamble produce a variety of flavours of its Crest brand of toothpaste for
Chinese consumers, such as, ‘lemon, tea, strawberry, salt and honey’ (The
Economist, 2009).
2. Globalisation can also be understood in terms of the structure of demand.
The opening up of markets offers a more globalised marketplace into which
businesses may sell. For some, globalisation refers to increased economic
growth across the globe, which thereby enable consumers to purchase both
more (or indeed more expensive) goods and services. (However this
assumption concerning the positive impact of economic globalisation on
GDP is still under debate (Dicken, 2011; Rassekh, 2014; Walby, 2009)).
This can also lead businesses to locate in (rather than simply sell into) these
nations in order to access those consumers in these growing markets. For
example the luxury goods retailer Gucci has stores in Lebanon, India,
China, Brazil and Azerbaijan (Gucci, n.d.). This driver may also refer to the
existence of global customers – those that scour the globe for suppliers, for
example, a computer manufacturer purchasing hard drives as an input for its
computers. A consequence of this driver is that businesses are likely to face
increased competition from across the globe.
27
Readings 56–61
5 Conclusion on drivers
Whilst these drivers are treated separately in the discussion above they are
in practice interrelated. For example:
. If a business wants to offshore production to a lower wage country and

the latter’s government doesn’t allow FDI, then the business cannot
make the investment.
. If punitive tariffs exist in the importation of certain goods (e.g. such as
selling foreign cars into India where (in 2013) they are subject to an
import tax of approximately 60% (Sidhartha, 2013)), then, despite a
well-integrated transport and an efficient ICT coordinated global
production chain, the goods will still be overpriced.
It is these drivers, operating together that enable the global context. As Hill
states ‘lowering trade barriers make globalisation of markets and position a
theoretical possibility. Technological change has made it a tangible reality’
(Hill, 2011, p. 14).
It can be tempting to describe only the positive side of these drivers: the
opportunities for Mike Doughty to fund his music, for Gucci to find new
customers, for business to cut their costs. However, these drivers present
challenges too. These could be operational, (such as how to manage
outsourcing and the time taken for goods to reach their destination) or more
general features of the competitive environment. The results of these drivers
can be a globalised market that is highly competitive, i.e. the small
independent music retailer that is now competing with Apple’s iTunes,
Spotify and Amazon alongside its ‘local’ competition. The UK manufacturer
may be competing with large companies who use complex global supply
chains to source and assemble products at the lowest price.
In opening up the market, businesses may seek global opportunities (such as
more potential customers, more ways to increase efficiency and control cost)
but they also face global competition. Not only are there more and more
players in the market, the global context is highly dynamic. Who could have
predicted the global rise of Facebook, eBay and Google? Yet these
businesses have disrupted the global context of business and it would be
unreasonable to expect that the context will not change in the coming years
and decades. It is also the case that economic globalisation has led to the
rise of enormous transnational corporations, some of which may appear to
have near monopoly powers.
Exercise 2
The following article offers a first person narrative of a small business taking
its first steps into the global trading environment – in this case by selling its
goods in Germany.
Read the following narrative of Jeremy Carson taking his business into the
export market (Carson, 2014).
28
Then identify the globalisation drivers and how they impact upon his
business:
Start-up diary: German export

opportunities abound
Jeremy Carson, The Telegraph, 19 May 2014
Jeremy Carson, founder of men’s toiletry brand 100 Bodycare, gets

his German wings after a large export order lands in his lap
I’m on a plane! Clearly this is not a remarkable occurrence in itself,
yet it’s pertinent because I’m on my way to sell my products outside
the UK.
This happened by accident. My goal was to focus on developing the
brand in the UK and I have been working on new advertising and
products. But out of the blue I’ve been given an opportunity to export
to a prominent retailer.
It’s ironic that I spent so much time trying to expand 100 Bodycare
into the largest retailers in the UK yet completely by luck I get this
opportunity given to me in another country. The opportunity came
about as I was demonstrating my products in a London Planet Organic
store and a German man started asking me about my products. He let
me know that his friend was head of buying at a German retailer and
he’d be in touch.
After that discussion the process was remarkably quick. Within a few
days I got an email request for samples. One week later I was invited
to Germany to present my brand.
Although it’s exciting to be selling abroad, I do have concerns.
Principally, I’m wary of this opportunity abroad distracting me and
leaving me without the time and finance to focus on my initial
objective of building the brand in the UK. I need to focus on this as
it’s here where I’ve implemented the most resources, have the most
contacts and therefore have the best chance of growth. If I spread
myself too thin I’ll lose the impact I can make in the UK.
Despite these questions, I decided to take this export opportunity. I did
this more due to the size of the retailer in question than my desire to
have export sales. My business needs the volumes that a large retailer
can generate to help finance growth. In addition I believe that once
your brand has presence in a recognisable retailer it’s more likely you
will be approached by others.
Nevertheless just being in a big retailer is no guarantee of success.
Therefore it’s key to choose the market you enter carefully to ensure
its right for your brand. Before I decided to crack Germany I evaluated
practical considerations such as cost of distribution. In addition, I
looked at specific consumer traits in that market such as sports
29
Readings 56–61
participation and openness to natural products. This evaluation made

me more confident that I was making the right decision.
In taking this opportunity though I’m now facing an issue impacting
all small businesses in the consumer goods market: the cash flow
management of stock. Working with this large retailer will significantly
increase my stockholding to four months, which puts a big financial
stress on the business. Therefore it’s key to get professional advice
about factoring and bank facility options to ensure that the business
will not fall over while taking on a large customer with high stock
requirements.
Another issue I’m faced with is whether to work with a distributor or
manage the customer on my own. The advantage of the distributor is
their country-specific knowledge and ability to advertise the brand. But
I’m only in one retailer, so I decided to work with them independently
and avoid spending 20pc of sales on distributor fees.
This decision was also made in part as I found the logistics of
exporting easier than I thought, particularly in dealing within the EU.
Tax is simplified as there are no trade tariffs, whilst my packaging and
formulation do not have to be amended to satisfy the rules of the
market.
After trading for a year the business is now in a very different phase
than it was when it started. The initial problem was whether or not the
idea had potential. Having proven this, the focus is now on growth. It's
tough deciding whether to focus on developing new products, direct to
consumer retailing, marketing communications investment,
collaborations with other businesses or exporting. For now, though, I'm
going to concentrate on replicating what I’ve done in the UK in the
German market. Wish me luck!
Comment
One of the first impressions I gained was that Carson appeared to be initially
focused on the UK market and hadn’t thought of the opportunity for
expansion by crossing national borders. The global economic context
discussed in this reading speaks of the interconnections of people, of things,
of economies, of polities. So the presence of this opportunity is really a
demonstration of the inter-relations of markets.
In operating within the EU, Carson notes that the single-market and its lack
of tariffs enables exporting without having to negotiate complex political and
legal obstacles (a government driver).
This expansion also raises the question of outsourcing and offshoring, not
here of production (indeed, on their website they emphasise UK based
production) but of distribution. Due to the nature of the expansion, he opts
for keeping distribution in-house. (Do you think this might raise issues of
future expansion?) (a cost driver).
30
The final point is that Carson appears to see his products as a global
product; selling a standardised product, not a distinct one for the German
market. Perhaps he sees the creation of the standardised global brand in the
future? (a market driver)
It is also worth noting that issues of finance are ever-present, and in

particular the issue of cash flow when entering a growth phase.
As is emphasised throughout this reading, the globalisation drivers are not

restricted only to large corporations, although they are significant players in
taking advantage of and driving economic globalisation. Nor are they limited
to those businesses that engage in international trade – the global economic
context creates interdependencies that reach into all aspects of business.
This produces a global economic environment that is dynamic and can be
(as the global financial crisis showed) potentially volatile.
Summary
One of the basic results of economic globalisation is the opening up of new
markets. There are more places in which goods and services can be sold,
and in that respect globalisation represents an opportunity for business, a
potential source of revenue. The converse is also true. In opening up more
markets, more businesses can enter this market. Thus economic
globalisation, in the form of increased competition, raises significant
challenges of opportunities to business of all sizes and types.
31
Readings 56–61
References
Carson, J. (2014) ‘Start-up diary: German export opportunities abound’, The
Telegraph. 19 May 2014. [online]. Available at http://www.telegraph.co.uk/
finance/businessclub/10840604/Start-up-diary-German-export-opportunities-
abound.html (Accessed 19 September 2014).
Crane, A., Matten, D. and Moon, J. (2008) Corporations and Citizenship,
Cambridge, Cambridge University Press.
Donovan, A. & Bonney, J. (2006) The Box That Changed the World: Fifty
Years of Container Shipping - An Illustrated History. East Windsor,
Commonwealth Business Media, 2006.
Gucci (n.d.) Stores [online]. Available at http://www.gucci.com/uk/stores
Matulef, J. (2014) ‘Ori and the Blind Forest looks great, but plays even
better’, Eurogamer, 7 July 2014. [online]. Available at http://www.
eurogamer.net/articles/2014-06-28-ori-and-the-blind-forest-looks-great-but-
plays-even-better (Accessed 19 September 2014).
Rassekh, F. (2014) ‘Economic globalization: an empirical presentation and a
moral judgment’, in Boylan, M. (ed.) Business Ethics, 2nd edn., Chichester,
Wiley-Blackwell.
Sidhartha (2013) ‘EU demands duty-free car imports into India; domestic
auto industry worried’, The Times of India, 12 April, 2013. [online].
Available at http://timesofindia.indiatimes.com/business/india-business/EU-
demands-duty-free-car-imports-into-India-domestic-auto-industry-worried/
articleshow/19504857.cms (Accessed 19 September 2014).
Sloman, J. and Sutcliffe, M. (2004) Economics for Business, 3rd edn.,
Harlow, FT-Prentice Hall.
Steers, R.M., Nardon, L. and Sanchez-Runde, C.J. (2013) Management
Across Cultures: Developing Global Competencies, 2nd edn., Cambridge,
The Economist (2009) ‘Selling foreign goods in China: Impenetrable’, The
Economist, 15 October 2009. [online]. Available at http://www.economist.
com/node/14660438 (Accessed 19 September 2014).
The Economist (2010) ‘The growth of legal outsourcing: Passage to India’
The Economist, 24 June 2010. [online]. Available at http://www.economist.
com/node/16439006 (Accessed 19 September 2014).
The Economist (2014) ‘The Panama Canal: Now for the next 100 years’,
The Economist, 16 August 2014. [online]. Available at http://www.
economist.com/news/americas/21612185-it-was-good-investment-america-
32
now-china-has-its-eye-canal-now-next-100#sthash.8XFoPgDk.dpbs
Walby, S. (2009) Globalization and Inequalities: Complexity and Contested
Modernities, Sage, London.
Globalization, 7th edn., Harlow, Pearson.
Yip, G.S. (1989) ‘Global Strategy…In a World of Nations? Sloan
Management Review, vol. 31, no. 1, pp. 29–41.
33
Readings 56–61
Reading 58: Transnational

practices (1) – global value chains,
outsourcing and offshoring
Introduction
As you have seen, economic globalisation is a defining feature of the
contemporary world. International trade and foreign direct investment (FDI)
are growing rapidly. Whilst there are regional trends within economic
globalisation and not all national economies are globalised to the same
degree, the reach and impacts of economic globalisation are extensive.
Globalisation sets the context against which businesses operate. However,
these broad indicators of economic globalisation do not explain the ‘how’,
‘why’ and ‘what’ of economic globalisation, for example:
. How are all these cross-border flows organised and managed?

. Why do particular businesses choose to operate across national borders
and what are the benefits and challenges they meet?
. What does this all mean for businesses, for employees, for consumers?
These questions will be posed in this and the following reading, offering
you an introduction to key transnational practices in the global context.
1 Global value chains

We will start with a basic point: goods that are consumed, inputs into
manufacturing processes, services that are purchased, all have to come from
somewhere. Without them business would grind to a halt. The question is,
how do they reach consumers? To put it another way, what processes occur
for these goods to reach their destination, for people to access services, for
businesses to get their inputs?
Transport is important here. Clearly there has to be some way for these
goods and services to reach the consumer; for example, oil has to be
delivered to a refinery to turn it into petrol and diesel. From the raw
material to the finished good there can be numerous processes. For example,
in order for a cricket bat to be put into the hands of a trained professional
sports person, the wood needs growing, harvesting, cutting, moulding,
gluing, and testing. (Each of these stages is a process that leads from the
tree to the cricket bat.) This ‘transformation’ of inputs into outputs is a
standard feature of businesses and the point at which they add value, and
thereby generate revenue and (hopefully) profits. The terms ‘production
chain’, or ‘value chain’ are used to describe these processes. The first term
emphasises that something goes on within a business that transforms an
input to an output (such as sewing cotton fabric into a T-shirt). The second
term emphasises that this ‘something’ is designed to add value (for example
the selling price of the T-shirt is more than the cost of the cotton plus its
34
Reading 58: Transnational practices (1) – global value chains, outsourcing and offshoring
costs of manufacture). (Note that certain authors use the term ‘network’
rather than ‘chain’. In this reading we treat these terms as identical.)
The basic proposition of economic globalisation is that these ‘chains’ are
increasingly global. In a recent report for the Organisation for Economic
Co-operation and Development (OECD), De Backer and Miroudot note that:
World trade and production are increasingly structured around ‘global

value chains’ (GVCs). A value chain identifies the full range of
activities that firms undertake to bring a product or a service from its
conception to its end use by final consumers. Technological progress,
cost, access to resources and markets and trade policy reforms have
facilitated the geographical fragmentation of production processes
across the globe according to the comparative advantage of the
locations. This international fragmentation of production is a powerful
source of increased efficiency and firm competitiveness.
(De Backer and Miroudot, 2013, p. 5)
It is necessary to take some care with the meaning of the term ‘global’ here.
‘Global’ does not mean that production chains are equally distributed
around the world, that all goods and services are produced in every nation.
(As with international trade and FDI there is a strong regional element.) The
term ‘global’ indicates that production processes are geographically
dispersed and integrated across nation states. These production chains can
be simple, however, they can sometimes be staggeringly complex, crossing
multiple national borders and involving many businesses. However, even
looking at a relatively simple product, such as a pair of jeans, can indicate
the presence of complex relations between businesses across nations. The
following example, taken from the website of a clothing manufacturer
‘Nudie Jeans’ (itself based in Sweden), describes the global production
network (GPN) associated with their jeans:
Example of a global production network: Nudie Jeans

The fabrics used for our jeans come from suppliers in Turkey, Italy and
Japan. We source from [the] following manufacturers; Bossa, Isko, Orta
Anadolu, Italdenim, Kaihara and TRC. The organic cotton used in the fabrics
is grown in Turkey for all fabric suppliers except TRC and Italdenim where
the cotton comes from India… The inner pocket fabric is made from organic
cotton fabric from Armstrong Knitting Mill in India.
Buttons, rivets and snap fasteners are made under environmentally safe and
transparent production conditions by Berning & Söhne in Germany. The
zippers come from YKK in Germany. All threads come from Coats and are
bought locally by our suppliers in Italy and Tunisia. Our suppliers in Italy
make the care-labels locally. The booklets are made in Denmark by A-Tex.
The woven Nudie Jeans tag and paper waist tag is made in Turkey by A-Tex
and the polybag and booklet for Backbone is made in India by A-Tex.
(Nudie Jeans, n.d.)
35
Readings 56–61
A pair of jeans is hardly the most complex product in the world, however
this description of a manufacturing process shows a complex and
geographically global production system. Every piece of the jeans, down to
pocket lining and labels, is split up into individual parts and sourced from
different organisations – the term for this is ‘fragmented’ (or ‘unbundled’)
production (as contrasted with ‘integrated’ where the production process is
wholly carried out within the business). Why this is the case is discussed
later, however, what is striking about the example is the extensiveness and
complexity of the production network within even a simple product. In the
garment sector, particularly in respect of standardised products, such value
chains are common. Indeed, many garment sellers do not make any of their
products in-house but instead focus on marketing and sales (De Backer and
Miroudot, 2013, p.8). For example, if you bought a pair of Gap jeans,
would it surprise you to know that at no point in the physical production of
the jean itself (as opposed to its design and retail) has the product been
touched by a direct employee of Gap?
To use another example, the iPhone is an iconic device. It was a game-
changer in respect of what phones look like, how they operate and what
they do. If you walked into an Apple shop and picked one up, on the back
of the device it states ‘Designed by Apple in California: Assembled in
China’. This a quite interesting language. Note that it does not say Made in
China, but that it is put together in China (or more specifically by a
business that is located in China). The first thing to note about Apple is that
in 2004 it closed its last factory in USA. For the period 2004–2012 it was
not possible to purchase an Apple product that had been physically made in
either USA or by Apple itself. (In 2013 Apple opened a new and relatively
small production plant in Arizona (Garside, 2013)). (Of course, the story is
different for the software on an Apple device.) The question is, what is
going on in-between, i.e. between the design and the assembly? Where do
all the components come from? In an article from The Economist in 2011,
the authors offer a ‘teardown’ of the value and components from the iPhone
(The Economist, 2011).
It reveals a number of interesting features:
. Assembled in China is a literal statement, none of the components listed

in the teardown come from Chinese companies (i.e. companies that are
owned and operated from China).
. The production network is global, encompassing a variety of nations,
each sending items to the assembly line in China.
. Although Apple does not manufacture anything for the iPhone in USA,
it still sources from US-based businesses. Indeed there are four US
companies listed. Note that although they are US companies they are
also global. Texas Instruments, for example, is a world-wide
manufacturer, including owning a plant in China (Texas
Instruments, 2013).
36
Apple iPhone 4 teardown - 16GB GSM version, cost breakdown, $
CONTRIBUTING COMPONENT MANUFACTURERS

Manufacturer/Origin *: Component/Cost:
Flash memory/26.00
/S. Korea
Infineon/Taiwan DRAM memory/11.60

Murata/Japan & Taiwan Applications processor/8.08
Skyworks; TriQuint/United States Baseband/10.25
Micron/United States Bluetooth & Wi-fi/8.00
Baseband/6.20
ST Microelectronics/Italy Flash memory/2.50
Dialog Semiconductor/Taiwan Accel. & gyroscope/2.25
Power management/1.51
Texas Instruments/United States Audio/0.98
Cirrus Logic/United States Touchscreen control/0.90
AKM Semiconductor/Japan E-compass/0.70
Unknown manufacturers Display & touchscreen/38.50
Mechanicals & electro-mechanicals/19.97
Camera/13.70
Battery/6.00
Accessories/5.67
Others Other parts/15.19
0.0
Total components:
178.00
TOTAL COSTS †
Sources: Apple; HIS iSuppli;
Average sale IDC Worldwide Mobile Phone
price: $560.00 ‡ Tracker, August 4th 2011
APPLE’S *Site of manufacture,

SLICE: location of company
368.00 headquarters may be
different
†IHS iSuppli estimates
‡Final retail price to public
can differ due to carrier
charges and sales tax
Manufacturing by Foxconn’s
Foxconn (Shenzhen, margin: 7.00
China): 7.00
Figure 2 Apple iPhone 4 breakdown
A point that struck me was the large role of Samsung as a supplier; its
products count for about 26% of the production cost of an iPhone. (This is
as distinct from the selling price of the product.) This might seem surprising
as Samsung is one of Apple’s competitors (with its Galaxy range of
smartphones) – indeed Samsung and Apple have been pursuing each other
through various courts in the world claiming patent infringements. So it
seems that these networks are not only global, but they also include
working with competitors.
As well as offering an insight into a global production network, the figures
offer detail of the ‘value’ part of the value chains. In this respect, the
figures offer a clear view of where the ‘value’ is going, namely:
For a US$560 iPhone:
. Components cost US$178.
37
Readings 56–61
. The cost of assembly is a tiny US$7.

. The margin to the assembler is also a small, US$7 per unit.
. The majority of the revenue accrues to Apple itself (assuming that it is
selling direct to the customer) US$368.
Therefore, it is a useful reminder that within a global production network
value does not necessarily flow to all businesses equally. Being a part of the
global production network of an extremely successful product, such as the
iPhone, does not mean that every business becomes wealthy.
Once again, it is important to remember that production networks are
nothing new. Businesses, after all, function by transforming one thing into
another and offering it to the market. The fact that trade occurs across
national borders is not the defining feature of economic globalisation, it is
the intensity of its use and the consequences that derive from this intensity.
To get a sense of the scale of global value chains in the contemporary world
economy, a report from the OECD notes that:
Today, more than half of world manufactured imports are intermediate

goods (primary goods, parts and components, and semi-finished
products).
(De Backer and Miroudot, 2013, p. 5)
International trade, therefore, is substantially made up of trade within value

chains. It is not finished goods being sold in another national marketplace.
The question is, why is this the case, and what form does this trade take?
2 Outsourcing and offshoring

Looking at the examples of Nudie Jeans and Apple, it is apparent that these
businesses do not manufacture much of its product (if at all):
. In the case of Nudie Jeans, they design, market and sell their products.
. In the case of Apple, they design the products and software, but leave
other businesses to provide the hardware and assembly operations. Apple
then market and retail their items.
This splitting up of different activities within the business and choosing to
get other organisations to carry out these activities is called ‘outsourcing’
and represents a major trend in contemporary business practice
(Dicken, 2011). It is important to remember, however, that outsourcing
refers strictly to an organisation choosing to do something outside of their
business. It does not necessarily have anything to do with globalisation.
Therefore if a company that manufactures football kits gets them designed
by another business in the same town this is outsourcing (again a further
reminder that outsourcing is not solely to do with production but also
concerns services), just as if the business gets the garments sewn in a
factory in Vietnam. On a further technical note, outsourcing is not identical
with buying inputs on the open market such as when a plumber purchases
38
pipes from a local store. Outsourcing refers to closer relationships between

buyers and suppliers and, indeed, these relationships can be very long term.
Outsourcing can become controversial when it is combined with another
practice, that of, ‘offshoring’. This is when a business chooses to carry out
part of its activities in a country in which it does not reside. Again, strictly
speaking, whether the business chooses to own this offshore plant or selects
an independent supplier is irrelevant here. The key thing is that the business
is crossing national boundaries within its value chain (i.e. it becomes a
global value chain). All this may seem like splitting hairs, however,
outsourcing and offshoring are distinct business practices that, although
related, are not identical.
Exercise 1
Before continuing, just to check your understanding, take a look at the
following examples and decide whether these are outsourcing, offshoring or
both:
1 A UK-based business closing its design department down and contracting

in designs from UK designers.
2 A Korean manufacturer opening up a wholly owned plant in Vietnam.
3 A French small business getting its products made by another business in
China.
4 A US company opening a call centre in the Philippines.
5 A Chinese company opening and operating a mine in Zambia.
Comment
1 is outsourcing but because the business has not gone outside its country
it is not offshoring.
2 is offshoring, however since the plant is owned by the company it is not
outsourcing.
3 is both outsourcing and offshoring.
4 is offshoring, but since it owns and runs the call centre it is not
outsourcing.
5 is offshoring, the Chinese company owns and operates the mine.
The question that remains is why is there all of this outsourcing and
offshoring? Why do firms decide to move production (either away from
their home state, outside of the firm, or both)? Presumably there has to be
some benefit for the business. There has to be some rationale to make
changes (or in the case of a new business to decide whether to outsource,
offshore or both). To answer this, it is necessary to look a little further into
these practices.
39
Readings 56–61
2.1 Outsourcing
In respect of outsourcing, the academic Peter Dicken says there are
essentially two major types of this practice. In the following quote he refers
to the business doing the outsourcing as ‘the principal’.
. ‘Commercial’ outsourcing: the manufacture of a finished product. The

supplier plays no part in marketing the product, which is generally sold
under the principal’s brand name and through its distribution channels.
The principal firm may be either a producer firm, that is, one that is also
involved in manufacturing, or a retailing or wholesaling firm whose sole
business is distribution.
. ‘Industrial’ outsourcing.
◦ Speciality outsourcing involves the carrying out, often on a long-
term basis, of specialised functions which the principal chooses
not to perform itself but for which the supplier has special skills
and equipment.
◦ Cost-saving outsourcing is based upon differentials in production
costs between principal and supplier for specific processes or
products.
◦ Complementary or intermittent outsourcing is a means adopted
by principal firms to cope with occasional surges in demand
without expanding their own production capacity. In effect, the
supplier is used as extra capacity often for a limited period of
time or for a single operation.
(Dicken, 2011, p. 145)
Outsourcing, then, creates a relationship between a principal and their
suppliers. The relationships can be short (as in the case of complementary
or intermittent outsourcing) or may involve lengthy relationships over many
years (e.g. where the supplier provides specialised services over the long
term). Principals may also provide finance, machinery, and technical
assistance in order to secure the quality of the product or service that is
delivered. Often the principal will provide detailed specification of the
products required and will be solely responsible for all marketing of the
product. Relationships between principals and suppliers may be long term
with suppliers providing critical products and/or services for the principal.
The question is why do firms enter into these arrangements (both the
principal and suppliers). From the principal’s perspective the first answer to
this question is ‘cost’. Outsourcing can enable significant cost reduction
(one of the drivers of globalisation). This is an important issue and is
discussed below in respect of offshoring. However, outsourcing raises a set
of broader issues for those involved in the relationship. Table 1 below
outlines some of the key benefits and downsides of outsourcing for both
principals and suppliers.
40
Table 1 Benefits and downsides of outsourcing
Type of Potential benefits of Potential downsides

firm outsourcing
Principal Focus: firm focuses on what it is Over-reliance on suppliers can
good at (sometime called its core leave the firm vulnerable
competencies) (e.g. over-reliant on supplier
Flexibility: firm can change or add skills and expertise, vulnerable
suppliers if supplier goes out of
business)
Access to specialist expertise
without having to develop it in- Limited control over how
house suppliers work (e.g. labour
issues/ quality control) – lack
Externalises risks to a degree of transparency in supply
Reduces costs of inputs chain
Risk to reputation from either
poor quality goods / services
or sweatshop-style working
conditions
May have to support suppliers
financially to retain supply
Sharing of technical / design
skills could lead to supplier
firm copying the product and
selling it direct (the supplier in
effect becomes a competitor
of the principal)
Supplier Continuity of orders – firms can If principal changes its focus

plan for the future or products, supplier can
Access to technical knowledge of become expendable
principal Potential over-reliance on a
Opening access to new markets small number of principals
(e.g. principal could go bust –
or exert power within
contracts)
Principal may impose policies
and practices on the supplier
(Adapted from Dicken, 2011; Hill, 2011; Oshri et al., 2009)
Note how the issue of cost reduction is only one amongst many issues that
have to be considered in respect of outsourcing; a lack of appreciation of
some of the downsides of outsourcing can be costly. If a manager is only
thinking about reducing costs and does not consider some of the downsides
then the decision to outsource might be a mistake. (For example, if a
supplier who delivers a critical product to the principal goes out of business
then the manager may have made a very bad decision indeed.) Similarly
from the perspective of suppliers, what may seem like a good opportunity to
secure the future of the business and increase revenue could have its
downsides. For example, if the principal pays late, goes out of business, or
changes supplier, the supplier may well experience severe financial
difficulties.
It is also worth noting that this discussion presents a rather simplified model
of outsourcing; it refers to a principal outsourcing production (or a service)
41
Readings 56–61
to a single supplier. However, the actual practice of outsourcing is more

complex:
. Outsourcing can involve multiple suppliers. Principals will often

outsource to a variety of suppliers each potentially providing a different
input.
. Outsourcing may lead to supplier competition. In order to manage some
of the risks (and keep costs down), principals may (and often do)
outsource the same input from multiple suppliers; therefore suppliers
may be in competition with each other.
. Outsourcing can be multi-tiered. Suppliers may themselves outsource
some of the production for the same reasons that principles outsource.
(It is possible that these suppliers may then outsource and there may be
a series of tiers involved in the outsourcing relationship.)
As noted above, with many of these global trends outsourcing is nothing
new; indeed outsourcing may be one way of extracting value from
specialisation. (It allows businesses to focus on what they are really good
at.) What, however, is different in the current global context is both the
extent of outsourcing – it has become ‘one of the most remarkable changes
that characterised firm behavior in the last decade’ (Merin and Rodriguez,
2007 cited in Dicken, 2011 p. 145) – and also its global reach and spread.
Therefore it is necessary to consider the related practice of ‘offshoring’.
2.2 Offshoring
In thinking of manufacturing it is common to see the products of Western
businesses made in other countries, such as China, Vietnam, South Korea,
India, etc. In terms of some services, such as call centres and technical
support lines, the same is also true. Why is this the case? In terms of
offshoring, cost is, perhaps, the most important reason. In a survey
conducted in 2006 93% of those who offshored cited cost as an important
driver in the decision to offshore (Oshri et al., 2009, p. 10). In particular
there is the issue of labour cost, i.e. wages.
Labour costs vary for different businesses. The costs of employing highly
skilled labour or those with scarce skills can be relatively high. For
example, a highly automated factory will spend less on wages than a more
traditional one such as garment sewing by hand. Businesses have strong
incentives to cut costs, and as a generalisation the higher the level of wages
on the balance sheet the more the incentive to find ways of controlling and/
or reducing these costs. One way to do this is to look for ways to substitute
people with machines (assuming that the cost of automation is not
prohibitive). After all machines can work for 24 hours a day, aren’t
members of trade unions, can’t go on strike and don’t need cost of living
allowances. Another approach is to find cheaper sources of labour. Both
have been used by businesses. However, in terms of economic globalisation
the focus is on the latter.
In order to get a sense of the differences in wages across countries Figure 3
shows the hourly direct pay for manufacturing in different selected countries
taken from the ILO’s Global Wage report (ILO, 2012, p. 11).
42
The first thing to note is the sheer scale of differences between wage rates,
from the highest of US$34.78 in Denmark to a low of US$1.41 in the
Philippines. Think about this for a moment. Imagine you are the owner of a
small manufacturing business in Denmark paying the average wage for the
country. You then look at the wages in India and assuming you could find
workers in India who can do the job then by offshoring to India you could
save US$33.36 per hour per person. Doing a quick calculation for a 50-
strong workforce based on a 40-hour week, reveals figures that are quite
stark. Assuming that the quality of manufacturing is sufficiently high and
transport costs are not excessive, the business can save a massive amount
on its labour costs. The business can then sell its products at a lower price
than its competitors, or work with higher margins, or both. The question is
why wouldn’t any business choose to take elements of its activities offshore
(either through outsourcing or by opening a plant elsewhere in the world)?
From an initial financial perspective, why wouldn’t offshoring be the
answer?
It is no surprise that many businesses have looked at these financial figures
and made the decision to use offshoring as part of their business strategy.
Manufacturing has long shifted offshore (particularly of mass market
goods). In contrast some jobs cannot be offshored – think of an offshored
painter and decorator for example. However, it is necessary to think beyond
manufacturing to other services that can be offshored, such as accounting,
finance, IT and human resources. A firm that specialises in advising
companies on offshoring and outsourcing suggests that 2.1 million business-
services jobs will have been offshored in the period 2002–2016 (The
Economist, 2013a).
Although the main reason cited by business in their decision to offshore is
cost, it is not the sole reason. Other cited reasons include:
. Competitive pressure. This could be as straightforward as a business

needing to offshore because their competitors are already doing it. That
is, they have to offshore in order to continue to be competitive.
. Improving service levels. Offshoring may enable access to higher
quality, better skilled, better trained and/or better motivated staff, which
will enhance its relationships with its customers. (This is more
frequently cited in respect of service offshoring.)
(adapted from Oshri et al., 2009)
43
Readings 56–61
Philippines 1.41
Hungary 4.74
Poland 4.86
Brazil 5.41
Slovakia 6.03
Estonia 6.10
Czech Republic 6.81
Portugal 7.16
Argentina 8.68
Singapore 12.68
Greece 13.01
Spain 14.53
Israel 15.28
New Zealand 17.29
Japan 18.32
Italy 18.96
France 21.06
United Kingdom 21.16
Austria 21.67
United States 23.32
Netherlands 23.49
Belgium 24.01
Canada 24.23
Sweden 24.78
Finland 25.05
Germany 25.80
Ireland 26.29
Australia 28.55
Switzerland 34.29
Denmark 34.78
0 10 20 30 40
US dollars, 2010
Note: Direct pay for time worked is wages and salaries for time actually worked.
Source: United States Department of Labor, Bureau of Labor Statistics (BLS), 2011.
Figure 3 A graph showing a comparison of hourly direct pay for time worked in manufacturing
When a business considers offshoring (whether it outsources or not) it is

faced with a question: outsource to where? Presumably the first answer
would to be where it is cheapest. After all, if cutting costs is the main
reason for offshoring then the rational view would be to go where the most
benefit could be obtained. However, is this always the best approach to take
for the business?
44
Figure 4 Since 1986 the Simpsons has been animated by AKOM Production Ltd,
based in South Korea
The manufacture of mass market clothing is an industry that has embraced

both outsourcing and offshoring. There is an extensive labour input into
garment manufacture, and wages in this sector vary enormously across
countries. If you look at the labels on your clothing it would not be
surprising to see labels that say ‘Made in China’, ‘Made in Vietnam’ ‘Made
in India’. With predictable and cheap transport links across the world
garment manufacturers are in a position to reap the benefits of cheap labour
costs. (Or to look at it another way, because most of their competitors have
gone offshore they would be unlikely to survive without doing the same). It
would be expected, therefore, that if we looked at the major garment sellers
in the world we would see the same pattern of offshoring to the cheapest
viable location. However, looking more closely the pattern is not quite so
clear.
Zara is a fashion chain owned by a transnational business based in Spain
(Inditex). As with many such retailers it is engaged in offshoring:
Zara’s factories in Spain and those it uses in Portugal, Morocco, and

Turkey produce its trendiest clothes, often riffs on the latest fashion
trends. They account for about half of Zara’s inventory, according to
the company. Its more basic T-shirts, sweaters, and the like are ordered
on a traditional schedule, about six months in advance, from factories
in Asia, where labor costs are often cheaper, then sent by ship to
Spain.
(Berfield and Baigorri, 2013)
Zara appears to have answered the question on where to offshore with a

somewhat complex answer. For half of its production it appears to be
seeking to reduce costs in general and labour costs in particular. However,
the other 50 per cent of its garments are produced in locations closer to its
retail outlets. These production sites are used to produce clothes that are
highly fashionable at great speed. Zara operates in the so-called ‘fast-
fashion’ market, regularly producing new designs in order to keep
customers returning and with greater frequency. Whilst production in Spain
45
Readings 56–61
and Portugal (for example) will cost more, the business is able to keep new
and fashionable products on its shelves, and respond to new fashion trends
rapidly (rather than with a six-month lead time) (The Economist, 2014).
Figure 5 A Zara store
This phenomenon of offshoring to those locations that are geographically

close to the home location is known as ‘nearshoring’ – whilst the cost
benefits may not be as high, there may be other consequences that are
desirable. Indeed, in its business Zara can produce fashionable clothes
quickly in response to changing trends. The hallmark of their success is
being able to deliver this speedy ‘service’ to their customers. It is important
to emphasise that whilst the labour costs reduction promised by offshoring
is appealing, the decision needs to be made in the context of the broader
business strategy.
2.3 The risks

When Zara chose to nearshore some of its garment production, its managers
recognised that reducing wage costs is not the sole reason behind the
decision to offshore and outsource. Simply put, outsourcing all of its
production would not enable Zara to carry out its business plan. Other
authors, however, have claimed that there are broader risks associated with
offshoring and outsourcing:
Table 2 gives a summary of some of the risks associated with offshore
outsourcing in reference to the principal. It splits it up into a series of risks:
Table 2 Offshore outsourcing risks
Risk category Sample risks

Business No overall cost saving
Poor quality
Late deliverables
Legal Inefficient or ineffective judicial system at offshore locale
Intellectual property rights infringement
Export restrictions
46
Inflexible labour laws

Difficulty obtaining visas
Changes in tax laws could significantly erode savings
Inflexible contracts
Breach in security or privacy
Political Perceived as unpatriotic
Politicians threaten to tax companies that source
offshore
Political instability within offshore country
Political instability between the principal and offshore
countries
Workforce Supplier employee turnover
Supplier employee burnout
Inexperienced supplier employees
Poor communication skills of supplier employees
Social Cultural differences
Holiday and religious calendar differences
Logistical Time zone challenges
Managing remote teams
Coordinating travel
(Source: Adapted from Oshri et al., 2009, p. 10)
The first category (‘Business’) is worthy of comment; simply because

labour costs are low does not mean that the overall costs to the business are
low. It could be that the production is inefficient (it takes longer to produce
the item) or that services are slower to resolve issues, e.g. an offshored call
centre might not resolve issues at the same pace or quality. Transport costs
could also rise, meaning that margins could be reduced elsewhere in the
business. What if the goods are poor quality, perhaps the rejection rate in
the factory is high, or that the goods delivered are late and do not meet the
standards required?
Where a business engages in offshore-outsourcing it lacks direct control of
how its suppliers work and the political and economic context in which they
operate. This raises a number of risks: for example how can the outsourcing
firm guarantee:
. A supply of skilled labour?

. That the political regime remains stable?
. That government regulations do not shift rapidly?
. That cultural differences do not hinder communication?
Even at a basic level if the principal and supplier are working in
significantly different time zones how will communication be managed?
These are all potential risks and none of them might occur in a particular
principal–supplier relationship. However, these broader risks are in need of
consideration when taking the decisions to outsource and/or offshore.
Exercise 2
A number of businesses have chosen to reverse their decision to offshore

(whether outsourced or not) and return production (or services) back to their
47
Readings 56–61
home country. This is known as ‘reshoring’. Table 3, drawn from a report in

The Economist, gives examples of US businesses that recently decided to
reshore production (The Economist, 2013b). As you look at this table think
about the reasons behind the decisions to reshore, and about how the risks
identified in this reading affected these decision. Write notes to explain your
thinking.
Table 3 Decisions, decisions
Company What and where Why

Chesapeake Bay Production was shifted from Rising labour costs in China;
Candle China to Maryland in 2011. wanting to respond more
The company will export to quickly to customers.
China from there.
Ford Motor Production of medium-duty Thanks to an agreement
Company trucks is moving from with the trade union, the firm
Mexico to Ohio, saving can now hire new workers at
2,000 jobs. Adding extra US$14 an hour.
capacity to a Michigan plant
will save another 1,200.
Otis Elevator A factory is being moved To keep R&D closer to
from Mexico to South manufacturing and reduce
Carolina. logistics costs.
General Electric Production of large Having manufacturing,
household appliances design and development
(e.g. water heaters, fridges) close together; being more
is being shifted from China responsive to customers.
and Mexico to Kentucky.
Sleek Audio Production of high-end Quality problems in China.
earphones has moved from
Dongguan in China back to
Florida.
(Sources: Boston Consulting Group; PricewaterhouseCoopers; press reports The

Economist, (2013b))
Comment
In the first instance, the appearance of reshoring appears slightly odd. The
wage differences between China and USA (and Mexico and USA) are large
and one would expect significant cost savings on this basis. Indeed this
probably forms one of the reasons why these businesses went offshore in
the first place.
However, looking at these examples of reshoring a number of the risks of

offshoring and outsourcing were realised, for example:
. In the case of Chesapeake, the promised cost savings were not

achieved. Wages have significantly risen in China over the past few
years, so the promised cost savings were not realised in the medium
term.
. Sleek Audio found that the quality was insufficient. As a provider of high-
end audio equipment, quality is central to their business.
. Both Otis and General Electric wanted to keep R&D (Research and
Development) closer to production sites. Perhaps cultural differences and
48
working in different time zones hindered effective communication and

responsiveness to customer demand.
. General Electric also noted the potential inflexibility of offshoring. This is
similar to the reason cited by Zara in its choice of offshoring locations.
. Ford is particularly interesting. It could be said that returning production
to USA is seen as patriotic, as a response to political risks. However Ford
are only returning production to USA as long as labour costs are
controlled.
It is not the case that a business that has offshored is faced with a single
decision, that of continuing in the country they are in or returning ‘home’ as
it were. Economic globalisation is dynamic – decisions can be revisited,
reversed and changed. What appears settled, such as China being the
world’s largest manufacturer of goods, is both a relatively recent
phenomenon and one that can be subject to change. As an example,
Samsung is a large corporation based in South Korea that makes a vast
range of products. It recently took the decision to shift some of its
production from China to Vietnam because of the rising cost of labour in
China:
Record economic growth that made China the second-biggest economy

has fuelled wage inflation, pricing many workers out of low-end jobs.
The base monthly salary for a factory worker in Beijing was US$466,
compared with US$145 in Hanoi, according to a 2012 survey of pay
by the Japan External Trade Organization.
(Lee and Folkmanis, 2013)
The increasing demand for labour in China and increasing demands by

Chinese workers has led to rising wage costs. (This is a simplification, but
the figures are clear.) This has led Samsung to reconsider its global
production network and move some of its production to Vietnam, where
wages are currently significantly lower than in China. Offshoring, in this
context, becomes a dynamic pattern, where businesses may change their
offshore location to take advantage of prevailing conditions within
countries. Indeed, Samsung is not the only business to take this decision;
LG Electronics, Nokia and Intel have shifted some of their production to
Vietnam since 2010. Businesses do not offshore in a once-and-for-all
manner. They keep a lookout for ways to minimise costs and respond to
changes in the structure and costs within a country. This is not to say that
China will no longer be a significant player in manufacturing – after all it
has specialised skills and well developed infrastructure both of which are
highly attractive to business – but it is not the only choice for those
offshoring.
49
Readings 56–61
Summary
This reading discussed the hows and whys of economic globalisation. Much
of international trade operates through global production networks / global
value chains. Many of these involve offshoring and outsourcing. All of
these practices have shown immense growth within the past 20–30 years,
meaning that many businesses are linked across the globe. As a point of
note it is necessary to remember that these transnational practices are not a
new phenomenon. (For example, by 1929 Coca-Cola was producing its
beverages in 64 bottling plants located in 28 countries (Sklair, 2002,
p. 193)). It is their rapid and continuing growth that marks economic
globalisation.
This system of production and service delivery is marked by significant
dynamics. The global economy never stays still for long, firms move from
one country to another in search of the most effective way to carry out their
business. Whilst cost has been a key driver in these developments, it is not
everything, geography may still play a part (as in the case of nearshoring)
or the benefits may not be realised or risks are too high (as in the case of
reshoring). All that can be said is that change is built into the system and
stability is unlikely over the medium term.
50
References
Berfield, S. and Baigorri, M. (2013) ‘Zara’s fast-fashion edge’, Bloomberg
Business Week, 14 November 2013. [online]. Available at http://www.
businessweek.com/articles/2013-11-14/2014-outlook-zaras-fashion-supply-
chain-edge (Accessed 25 July 2014).
De Backer, K.D. and Miroudot, S. (2013) ‘Mapping global value chains’,
OECD Trade Policy Papers, No. 159, OECD Publishing. [online]. Available
at http://dx.doi.org/10.1787/5k3v1trgnbr4-en (Accessed 25 July 2014).
Garside, J. (2013) Apple creates 2,000 jobs shifting production back to US.
The Guardian, 5 November 2013. [online]. Available at http://www.
theguardian.com/technology/2013/nov/05/apple-creates-us-jobs-renewable-
energy (Accessed 18 May 2015).
ILO (International Labor Organisation) (2012) Global Wage Report.
[online]. Available at http://www.ilo.org/wcmsp5/groups/public/—
dgreports/—dcomm/—publ/documents/publication/wcms_194843.pdf
(Accessed: 25 July 2014).
Lee, J. and Folkmanis, J. (2013) ‘Samsung shifts plants from China to
protect margins’ Bloomberg, 12 December 2013. [online]. Available at
http://www.bloomberg.com/news/2013-12-11/samsung-shifts-plants-from-
china-to-protect-margins.html (Accessed 4 August 2014).
Nudie Jeans (n.d.) Nudie Jeans Production Guide. [online]. Available at
http://www.nudiejeans.com/productionguide/ (Accessed 19 September 2014).
Oshri, I., Kotlarsky, J. and Willcocks, L.P. (2009) The Handbook of Global
Outsourcing and Offshoring, Palgrave Macmillan, Basingstoke.
Sklair, L. (2002) Globalization: Capitalism and its Alternatives, 3rd edn.,
Texas Instruments (2013) Texas Instruments acquires UTAC facility in
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Texas-Instruments-acquires-UTAC-facility-in-Chengdu-China?DCMP=tms-
make-clover-131210&HQS=tms-make-clover-ba-pr (Accessed 10
September 2014).
The Economist (2011) ‘Apple and Samsung's symbiotic relationship: Slicing
an Apple’, [online]. Available at http://www.economist.com/blogs/dailychart/
2011/08/apple-and-samsungs-symbiotic-relationship (Accessed 19
September 2014).
The Economist (2013a) ‘India’s outsourcing business: On the turn’, The
Economist, 19 January 2013. [online]. Available at http://www.economist.
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services-and-back-office-work-turn (Accessed 19 September 2014).
51
Readings 56–61
The Economist (2013b) ‘Home or abroad? Herd instinct’, The Economist,

19 January 2013. [online]. Available at http://www.economist.com/news/
special-report/21569575-companies-need-think-more-carefully-about-how-
they-offshore-and-outsource-herd-instinct (Accessed 19 September 2014).
The Economist (2014) ‘Clothes retailing: The dedicated followers of fast
fashion’, The Economist, 5 July 2014. [online]. Available at http://www.
economist.com/news/business/21606277-spains-most-successful-fashion-
retailer-inditex-has-two-ambitious-local-rivals-snapping-its (Accessed 19
September 2014).
52
Reading 59: Transnational practices (2) – the nature and practice of transnational corporations
Reading 59: Transnational

practices (2) – the nature and
practice of transnational
corporations
Introduction
The organisations most associated with economic globalisation are
transnational corporations (TNCs). (These are also called multi-national
corporations (MNCs) and in these readings these terms are treated as
identical.) In particular, focus has been on those enormous corporations
which operate across virtually all of the globe. The so-called anti-
globalisation movement often targets these firms, accusing them of
destroying local markets, putting small firms out of business, ruthlessly
exploiting their suppliers, being involved in abusive labour practices
(whether directly or indirectly) and forcing their global standardised
products on a diverse world. These seem like forceful objections to TNCs.
However, all this rhetoric might get in the way of understanding what TNCs
are, what drives them to become transnational, and how they organise their
global operations. The focus of this reading is to explore the TNC as a part
of economic globalisation rather than an apparent focus and symbol of
protest.
1 What is a transnational corporation?
Exercise 1
Before discussing what a TNC is, write down a few quick notes in response
to the following questions:
1 What are the key features of a TNC?

2 Can you name any TNCs? If so, write their names down.
Comment
I cannot anticipate your precise answer to these questions. However, often a
response will talk about very large companies that operate in many of the
countries of the world. In terms of the names, I suspect you offered some
familiar names of large companies, perhaps Apple, Starbucks or Ford – large
US companies. Did you think of any non-profit organisations that operate
across the globe such as Médecins Sans Frontières (Doctors Without
Borders) or Amnesty International?
53
Readings 56–61
It is tempting to start a definition of the TNC with the question of size.

However, the reality is somewhat more modest. Below are two definitions,
one from an academic writer and the other from the United Nations:
A transnational corporation is a firm that has the power to coordinate

and control operations in more than one country, even if it does not
own them.
(Dicken, 2011, p. 110)
Transnational corporations (TNCs) are incorporated or unincorporated

enterprises comprising parent enterprises and their foreign affiliates. A
parent enterprise is defined as an enterprise that controls assets of
other entities in countries other than its home country, usually by
owning a certain equity capital stake.
(UNCTAD, n.d.)
From these definitions a number of points are important:
. The definition makes no reference to size. Whilst there are some TNCs
that are enormous in both size and influence these properties are not
what defines a TNC. TNCs can be any size.
. A TNC does not have to be global in its operations. It does not have to
operate in all countries in the world to be a TNC. Having operations in
more than one country counts.
. TNCs are not defined by selling into other markets but concern control.
If a firm sells its goods bought from wholesalers around the globe via
the internet, it is not a TNC. To be a TNC the firm must exert control
over operations within more than one country. Hence a firm that simply
outsources its production to another country is not by definition a TNC.
. A firm that engages in foreign direct investment (FDI) (i.e. it is the one
doing the investing) is by definition a TNC.
Although it may sound surprising, an eBay seller of toys based in the UK
who has set up a small distribution centre in France is classed as a TNC.
This is despite it having a modest turnover and employing perhaps only five
people. (It may be unlikely that such a firm would think of itself as a TNC.)
Having defined what a TNC is the next question is why they exist?
2 Why do firms become TNCs?

There are various globalisation drivers that influence how businesses operate
and what challenges and opportunities they may face. In looking specifically
at the motivations behind businesses becoming TNCs (rather than simply
selling its products in the global marketplace) there are two main
explanations (Dicken, 2011), namely:
. market orientation
. asset orientation.
54
Market orientation
This orientation refers to the desire to expand the markets into which a firm
is selling by locating within them. This could be in terms of opening up the
geographical reach of a product or service, i.e. the customer receives the
same good irrespective of their location (for example the Sony PlayStation4
is virtually identical wherever you purchase it). Alternately a firm may
modify that product to meet the demands of that market (e.g. to respond to
specific preferences concerning product design, name and taste, etc.) For
example, McDonald’s creating a separate menu without pork and beef for
its stores in India. There are a number of elements that affect how attractive
or indeed unattractive a particular location may be to a business:
Figure 1 Sony Playstation 4
. Size of the market, in particular the level of income within the country
(perhaps measured by per capita income) – a figure that varies
extensively by country. There has to be enough consumers with
sufficient income to buy the goods and services offered by the business.
. Structure of the market. What is the nature of the demand for goods and
services in the economy? For example a firm selling luxury goods would
not be advised to move into a country where wages are at a subsistence
level and the structure of demand is based on the purchase of basic
necessities.
. Accessibility, in terms of how goods can get into and be distributed
within a country and political constraints in the form of tariffs, trade
embargoes, regulations concerning FDI and/or potential governmental
interference.
Businesses need to take such features into consideration in choosing a
location, otherwise their move into this place could fail.
Asset orientation
Assets (another term for this could be inputs) required by a firm are not
distributed evenly (think about where oil reserves are located across the
world), and the cost of these assets varies enormously across the globe. In
the case of businesses involved in the extractive industries this is
55
Readings 56–61
particularly important. Natural resources are located in particular

geographical locations and, therefore, a firm has to site its production where
these assets exist and seek to expand to these places. However, there are
two other classes of assets that may motivate a firm to invest across
borders:
. Access to labour. For some sectors this may mean access to cheap
unskilled labour, however, for others it may be a way to access high
level skills. Relevant issues in this factor are:
◦ the knowledge and skills present in the country
◦ the level of wages
◦ labour efficiency (i.e. how productive labour is within the
performance of the required tasks)
◦ the state of labour relations (e.g. Is the workforce highly
unionised? Is there a history of strikes?)
. Access to knowledge. It is particularly the case that technological
innovations appear within geographical clusters (most famously Silicon
Valley in California and the perhaps less well known Silicon Fen in
Cambridge (Naughton, 2013)). A business may wish to site in such areas
to be close to where the action is and (as noted above) have access to
the highly skilled labour within such clusters.
Not all of these factors may be relevant to a particular business and both
the asset and market orientation may be relevant for certain firms. However,
they represent strong pulls towards global operations. Which orientations
have the most pull and which of the factors within them are particularly
important will vary from firm to firm. However, for the prospect of opening
new markets, access to assets and reducing costs are relevant for all firms
seeking to flourish within a competitive market.
Exercise 2
To test your understanding of the difference between asset and market

orientation, the following offers short examples of businesses becoming
TNCs. (Assume that previously the businesses only operated in one country.)
For each example, write down whether asset orientation or market
orientation or both is important in explaining the choice of location and
explain why.
1 A Norwegian software firm opening a software development office in

Silicon Valley in USA.
2 A Chinese mining firm opening and operating a copper mine in Zambia.
3 A French luxury goods firm opening up retail outlets in Dubai.
4 A US based manufacturing business opening a factory in Mexico.
56
Comment
1 This is an example of asset orientation. Access to knowledge (the high-
tech cluster in Silicon Valley) and labour (highly skilled programmers) are
both important.
2 This is an example of asset orientation, in terms of the location of a
physical asset (copper) and access to labour with the required skills.
3 This is an example of market orientation. Issues of structure and
accessibility are important here.
4 This is an example of asset orientation, in particular access to labour
(that is no doubt cheaper and less unionised).
3 How do firms become TNCs?

Early accounts dating from the 1960s–1970s suggested a sequential process
of firms transnationalising (known as the ‘locational product life cycle’
theory (Dicken, 2011, p. 117)). Broadly this theory suggests that a firm
begins in its domestic market and grows within that market initially. The
firm develops specific assets and expertise within that market before it seeks
opportunities to operate elsewhere. It is then a matter of transferring its
assets and expertise into other sites. Essentially organisations undergo a
series of steps where they serve their home market first, overseas demand
would be served by exports. As these markets mature or become saturated,
firms expand into new markets in a more systematic manner, by opening
new production plants in other markets. (These production sites are located
in the new markets themselves.) As the sequence develops, production then
shifts to low-cost countries that then displace production in both home and
relatively high-cost countries – thus reaching the multi-site and complex
global production networks seen today (Dicken, 2011).
As a number of authors have argued there is evidence to suggest that firms
have followed this sequential path to becoming a TNC. However, it is not
the case that all firms either have to, or inevitably will, follow this path.
Changes in technology, the nature of the market, advances in logistics, the
falling price of international transport (to name a few factors) allow firms to
take different paths. Figure 2 offers some suggestions of both the
conventional path – the downward pointing arrow in the centre – and
alternative paths that firms may pursue.
57
Readings 56–61
The conventional path

Serve domestic
market only
Export to overseas market(s)

through independent channels
‘Short (e.g. sales agents) ‘Parallel paths’
circuits’ e.g. licensing,
franchising,
Establish sales outlet in collaboration in
overseas market(s) R&D, production,
marketing,
(a) by acquiring (b) by setting up sourcing,
local firm new facility strategic alliances
Establish production
facility overseas
(a) by acquiring (b) by setting up
local firm new facility
Figure 2 Diverse paths of TNC evolution (source: Dicken, 2011)
On this a number of points are relevant:
. The conventional path is not inevitable nor always the most desirable
path to take. Taking another path does not mean a firm is behaving
incorrectly. It is simply choosing a different route, based on perceptions
of its environment and how it wants to develop within it.
. Firms can bypass any of the intermediate steps and go for overseas
production facilities early on in their development. For example, after
only five months of operation Nestlé was manufacturing its products
outside of Switzerland (Dicken, 2011, p. 119)
. Companies can bypass a direct involvement in these stages by acquiring
or merging with a domestic company with global operations. For
example, the international development organisation Mercy Corps, used
a deliberate strategy of mergers to expand its global operations
(Balasubramaniam and Jayawickrama, 2010).
. Many TNCs have grown their TNC base through acquisition. For
example Lenovo (a Chinese company) purchased the PC business of
IBM (a US company). Tata (India) purchased the car manufacturer
Jaguar (UK).
. Organisations in the not-for-profit sector can also show a similar
sequence of international expansion. For example, the charity Oxfam
started in the UK in 1942 (although it did not adopt the title Oxfam
until 1965), opening its first shop in the UK in 1948. Oxfam remained a
UK-based organisation (although working across the world) until 1963
with the opening of Oxfam Canada. From the 1960s onwards other
national Oxfams came into being and in 1994 Oxfam International was
created as an international confederation; by 2014, this confederation
had 17 organisations as members (Oxfam, n.d.). In this way a UK-based
charity moves from a UK organisation to a large confederation with
global reach and presence.
58
An example of a firm expanding overseas is the Mexican baking firm

‘Grupo Bimbo’. (This is also a reminder that not all TNCs are from Western
Industrialised nations.)
Example of a firm expanding overseas: Grupo Bimbo

Grupo Bimbo is on the prowl in el Norte again. In 2009 the Mexican baking
giant bought part of Weston Foods for US$2.3 billion, becoming the biggest
baker in USA. Two years later it bought Sarah Lee’s American baking
operations for US$960 million. In the past month it has been in a battle over
the tastiest bits of Hostess Brands’ bread business, as that once-iconic and
now-bankrupt company winds up its affairs.
Bimbo brings more than a shopper’s eye to its expansion. It is a master at

bread-related breakthroughs. It helped introduce Spaniards to sliced loaves
and pioneered the packaging of bread in clear cellophane. It is also a master
of efficiency and logistics: Bimbo lorries with their teddy-bear logo are
familiar sights in Mexico and Central America. The combination of savvy deal
making and relentless cost-squeezing has made Bimbo a behemoth of baked
goods, with sales of US$10.8 billion in 2011.
Together the emerging-market countries now have more than 1,000 firms
with annual sales above US$1 billion. Many are content to stay at home –
after all, their markets are growing at least twice as fast as the rich world’s.
But some, like Bimbo, are determined to venture abroad, invading foreign
markets and buying foreign companies. They are sharpening old skills and
acquiring new ones. And in the process they are reconfiguring entire
industries.
Figure 3 Grupo Bimbo delivery van and company mascot
Grupo Bimbo offers an example of expansion through acquisition,

particularly into US markets, although the company operates throughout the
world. However, all of these approaches start with the ideas that a firm sees
itself as servicing its domestic market first. Its initial growth and operation
is within its home nation. By contrast authors have identified the rise of
companies that are ‘born global’ (Gabrielsson and Manek Kirpalani, 2004;
59
Readings 56–61
Kudina et al., 2008). From their initial outset they operate globally, as in the
example of the technology company EyeView:
Example of a ‘born global’ business: EyeView

Take EyeView, a quintessentially modern start-up that was a global citizen
from its very first day. The company uses ‘rich media’ – a combination of
videos and audios – to teach customers how to use websites. Most of the
company’s customers are international, so the videos are produced in many
different languages and watched the world over.
The company currently occupies an upper floor of a nondescript building in

Tel Aviv, but in its earliest years it lived on three continents. Two of the
company’s founders were based in Boston, the third in Sydney and the fourth
in Tel Aviv. The company made its first videos in Australia and its first
customers were on America’s West Coast.
In this case technology is disrupting the sequence of steps altogether. It is

also a reminder TNCs can start out small. This is another reminder that
economic globalisation is dynamic and disruptive, rarely staying still.
4 The size and scope of TNCs

Although the TNC is not defined by either size or a particular
developmental path, there are a significant number of large TNCs whose
size and geographical spread are extensive. It is all very well to talk about
large TNCs running vast business empires spanning the world, but who are
they and what, precisely do we mean by a large corporation? Lists are
regularly produced of the world’s largest companies and this reading uses a
report issued by the accountancy firm PwC, itself a TNC, that ranks the
global top 100 companies by market capitalisation. The top 20 in
March 2014 is reproduced in Table 1.
Before looking deeper into the meaning of the table, it is necessary to gain
an understanding of just how large these organisations are. Saying that
Apple has a ‘worth’ of US$469 billion sounds a lot (an awful lot) but just
how large is this? One way to get this into perspective is to compare these
figures with those of countries, measured in terms of their GDP, and see
where these organisations fit. Looking at the figures for GDP in 2013
(World Bank, n.d.) it can be seen that Apple would be ranked 27th (out of
the 191 countries on the World Bank’s list), Exxon, 28th, Google, 29th.
Each of these companies are ‘worth’ more than substantial countries such as
Greece, Portugal, South Africa, Malaysia; even the ‘smallest’ business on
this list (HSBC) would be 52nd on the list (just above the Czech Republic).
Even on this admittedly rather crude measure, the size of these corporations
is impressive. These are businesses that are ‘worth’ more than the majority
of countries in the world. It is no wonder, therefore, that such corporations
are of significant interest when understanding and potentially criticising
60
economic globalisation. When such large corporations decide to do

something, to put it rather bluntly, it matters. This could be in terms of:
. attracting or enforcing favourable terms from their suppliers

. influencing governments to gain favourable conditions for their business
and/or reducing regulations
. driving other firms out of business due to their economies of scale and/
or enormous marketing spends
. creating monopolies or oligopolies that distort the market and lead to
excess profit making and/or negative effects on consumer choice.
Table 1 Top 20 companies ranked by market capitalisation
Company name Nationality Industry Rank + / - 31 March 2014 31 March 2009
Rank Market cap Rank Market cap

($bn) ($bn)
Apple Inc USA Technology 32 1 469 33 94

ExxonMobil Corp USA Oil & gas (1) 2 416 1 337
Google Inc USA Technology 19 3 409 22 110
Microsoft Corp USA Technology 2 4 318 6 163
Berkshire Hathaway USA Financials 7 5 286 12 134
Inc
Roche Holding AG Switzerland Health care 12 6 266 18 119
Johnson & Johnson USA Health care 1 7 261 8 145
General Electric Co USA Industrials 16 8 256 24 107
Wells Fargo & Co USA Financials 46 9 244 55 60
Nestle SA Switzerland Consumer 5 10 244 15 129
goods
Walmart plc USA Consumer (8) 11 242 3 204
services
Royal Dutch Shell United Oil & gas (3) 12 238 9 139
PLC Kingdom
PetroChina Co Ltd China Oil & gas (11) 13 225 2 287
Novartis AG Switzerland Health care 15 14 224 29 100
Chevron Corp USA Oil & gas (4) 15 220 11 135
JP Morgan Chase & USA Financials 12 16 215 28 100
Co
Procter & Gamble Co USA Consumer (7) 17 213 10 138
goods
Samsung Electronics South Consumer 35 18 209 53 61
Co Ltd Korea goods
Pfizer Inc USA Health care 17 19 205 36 92
HSBC Holding PLC United Financials 23 20 199 43 79
Kingdom
(Source: PwC, 2014, p. 39)
61
Readings 56–61
As well as the sheer size of these economic entities, it is noticeable they are
not evenly located around the globe. Note that this does not mean these
firms do most of their business in their ‘home’ nation, but that they are
registered there.
. US companies appear with great frequency. All of the top 5 are listed as
US companies, and 13 out of the 20 businesses on this list are US
companies (indeed US businesses account for 47 of the largest 100
companies in the world).
. In the top 20 there are only five nationalities (US, UK, Switzerland,
China and South Korea).
This serves to reinforce the point that globalisation does not mean the equal
distribution of TNCs; globalisation has a regional element. What is also
noticeable is the volatility of economic globalisation, which can be seen by
comparing the figures for 2009 and 2014. In five years Apple climbed from
33rd to the top of the table, whilst the retailer Walmart slipped from 3rd
to 11th.
Whilst these figures tell of the absolute size of these companies, this offers
limited insight into the global reach of these firms. The following offers a
few examples, to begin with the retailer Walmart:
Each week, more than 245 million customers and members visit our
nearly 11,000 stores under 71 banners in 27 countries and e-commerce
websites in 10 countries. With fiscal year 2014 sales of approximately
US$473 billion, Walmart employs 2.2 million associates worldwide.
(Walmart, n.d. a)
Once again there is a regional basis to the story. Walmart has a strong
presence in North, South and Central America. However, with the exception
of the UK (gained through its acquisition of the supermarket chain Asda
in 1999) it has no retail presence in Europe (Walmart, n.d. b). Of course,
these figures refer only to its retail presence. If you looked at the global
value chains within Walmart its reach goes far beyond these 27 countries.
The motor car manufacturer Toyota (21st on the size list) offers similar
evidence of global operations:
As of the end of Dec. 2013, Toyota conducts its business worldwide

with 52 overseas manufacturing companies in 27 countries and regions.
Toyota's vehicles are sold in more than 160 countries and regions.
(Toyota, n.d.)
Once again if you looked further into the supply chain, the number of
countries would expand and the global reach would be further. However, it
would be a mistake to think of large TNCs as solely a product of high-
income Western economies. Indeed as Guillén and Ontiveros note: ‘As of
2010 emerging economies and developing countries were home to 25
percent of the largest 500 companies in the world [and] 29 percent of the
total number of multinational firms’ (Guillén and Ontiveros, 2012, p. 26).
Below are a couple of examples. The first is probably familiar to you as a
62
maker of mobile phones and televisions (amongst others). The second is

probably less familiar (although it does own the UK retailer ‘Superdrug’):
Examples of TNCs: LG Electronics and Hutchison Whampoa

LG Electronics, Inc. of the Republic of Korea was established in 1958 as a
pioneer in that country’s consumer electronics market under the name of
GoldStar. It set up its first European Union sales affiliate in Germany in 1980
and its first plant in the United States in 1982. The company changed its
name to LG Electronics in 1997. In 2004, total consolidated sales amounted
to US$38 billion, with more than 66,000 employees in 39 countries.
Hutchison Whampoa Ltd. (Hong Kong, China) … is a large diversified

company. It is the world’s leading port investor, developer and operator, with
39 ports across nine markets in Asia, South America, West Asia and Africa.
With the recent acquisition of Marionnaud from France, it is the largest
health and beauty retailer in the world, as well as an international corporation
in mobile telecommunications and a large hotels developer and management
company. The group also has interests in transportation, energy and water
plants. Hutchison dates to the 1800s and has always been a Hong Kong,
China-based TNC. In 2004, reported consolidated turnover was
approximately US$23 billion, with operations in 52 countries and about
200,000 employees worldwide.
(UNCTAD, 2007, p. 16)
The final example is a reminder that not all TNCs are for-profit
organisations focused on opening up markets and increasing sales and
revenues. This is a description of the humanitarian organisation The
International Committee of the Red Cross (ICRC):
Example of a not-for-profit TNC: the ICRC

Established in 1863, the ICRC operates worldwide, helping people affected
by conflict and armed violence and promoting the laws that protect victims of
war. An independent and neutral organisation, its mandate stems essentially
from the Geneva Conventions of 1949. We are based in Geneva,
Switzerland, and employ some 13,000 people in more than 80 countries. The
ICRC is funded mainly by voluntary donations from governments and from
national Red Cross and Red Crescent Societies.
(ICRC, n.d.)
Looking at all of these companies what is apparent is not only their

enormous size but also their global reach. There is also a substantial
diversity in the way in which these TNCs developed and are organised. The
work of Bartlett and Ghoshal (1989) was an early attempt to characterise
the forms that TNCs can take. They identified four forms, described below:
. They could take the form of a decentralised federation where

the corporate headquarters does not direct or plan the
development of their overseas operations. The latter are there
63
Readings 56–61
to find and exploit opportunities within a local market

(termed a ‘multinational’ form).
. Alternatively there could be a more focused planning role in
the corporate headquarters. Overseas operations (though
possessing some degree of autonomy) are very much seen as
parts of the centre (termed the ‘international’ form).
. Other forms give all control to the centre. Overseas
operations function as delivery units to the unified global
market. Overseas operations are places that do work for and
are controlled by the centre (the ‘global’ form).
. A final form loosens the control of the centre by seeing all
parts of the business as a coordinated whole. Each provides
essential elements to the business and shares their knowledge
amongst it. The firm generates a complex set of
interdependencies. (Confusingly Bartlett and Ghoshal call this
the ‘transnational’ form. A better term is given by Dicken
who describes this as an ‘integrated network’.)
(Bartlett and Ghoshal, 1989, pp. 35–71; Dicken, 2011, p. 129)
However they are organised, TNCs are significant players in the world of
international trade, and it is estimated that about 80% of world trade is
linked in some manner to the global production networks within TNCs,
either as trade within their networks or via market based transactions
between TNCs (UNCTAD, 2013, p. 135).
Exercise 3
This reading has focused on the form, size and development of the TNC; it is
very much focused on the perspective of the TNCs themselves, i.e. what
explains the move to operate across national boundaries, and what benefits
they may obtain. An alternative perspective is that of the local business, one
that is very much located in a particular geographical area serving a local
population and employing local workers. What happens when these large
global companies enter into competition with these small businesses?
Tesco is one of the world’s largest retailers, employing over half a million
people, with 6,784 stores based in 12 countries and sales of £70.9 billion per
year. It still has a focus in the UK; 310,000 of its employees and 3,378 of its
stores are within the UK (Tesco plc., n.d.). Tesco sources its goods from
around the world, through a complex series of global networks. What
happens, therefore, if Tesco opens one of its smaller convenience stores on
a local high street? The following news report looks at how the opening of
one of these stores in Bristol affected local businesses.
Read the article and note down the effect of this store opening on the local
businesses (both positive and negative). If you were a local councillor in
Bristol, would you allow Tesco to open another one of these stores?
64
Tesco's effect on the high street

Dickon Hooper, BBC News, 18 October 2005
Shopkeepers kept their sangfroid when a Tesco Express opened in

February on a busy high street in Bristol
The majority said their customer base could sustain the competition:
the new store would be right in the heart of the Gloucester Road,
known for its family-run shops and customer service.
Some traders – there are bakers, cafes, greengrocers, a butchers and a
Somerfield within 100 metres – even argued that Tesco's presence
could be positive by bringing in more trade.
But there were dissenters. Jayanty Patel, whose shop, Pats News, is
now a few doors down from the Express, said: ‘They affect everyone –
newspapers, fruit shops and bakeries. It will depend on whether people
support us.’
Eight months later and Phil Fordham, owner of the Bakers’ Basket,
also close to the store, is considering closing after more than 20 years.
He says that Tesco has had a negative effect.
Trade drop-off
‘Things have been quieter, with less people coming in. It’s more
passing trade [that’s gone] – our regular customer base hasn’t really
changed’, he said.
‘Closing up is something we are looking at for a combination of
reasons – trade is getting quieter across the country, we’ve lost a little
bit to Tescos and I’m looking at the hours I’m putting in.’
Mr Patel added that he had also noticed a ‘drop-off’ in trade since
February.
‘If people are buying groceries and a paper there, that is different. But
they are going and only buying papers there.’
‘You can't do anything. People go there. There has been a 25 to 30%
loss [in trade].’
Andrew Simms, from the New Economics Foundation, is not surprised.
He says that supermarkets reduce local diversity and take money out
of the local economy.
‘The trend is that trade is lost by the local independent retailers. The
marketing power [of the supermarkets] gives them an unfair
advantage.’
But Tesco says its Express stores complement other shops.
Prosperous community
65
Readings 56–61
‘If shops close down people simply move on to another shopping area.
It’s about keeping shoppers local. It’s about working together,’ a
spokeswoman said.
‘Like any good retailer our aim is to be part of a prosperous business
community where all retailers benefit by providing more choice to
attract more customers.’
Other Gloucester Road retailers told BBC News that Tesco had not
affected them.
Mike Russ, of Alex Fruits, said the main problem for traders in the
road was parking restrictions.
‘A lot of people go into Tesco who want to shop after we’re shut. It’s
not a problem. If it was a Tesco superstore next door, it probably
would make a big difference.’
Barry Graham, who runs the deli counter at the butchers, T & PA
Murray, added: ‘I don't think they have affected us. What has helped
has been TV programmes about the supermarkets.’
‘We've picked up a lot of business by people now understanding what
happens to their meat.’
Professor Ian Clarke, from the Lancaster University Management
School, says the consumer now ‘wants more choice and something
different’.
‘Retail provision has changed, as have our lifestyles. People are far
busier and are struggling to fit in shopping.’
‘Very local provision is still insufficient and there is an element of
being fed up with Tesco and the rest and wanting something different:
it is about being local to where you live and work.’
If it is about being local, then Mr Simms has a parting argument –
local shops, once gone, find it very hard to come back.
Figure 4 Tesco Express store
66
Comment
There are a lot of competing views in this article, for example:
. Those who see a significant drop off in trade from the competition that
the Tesco store brings (potentially leading to the closure of local
business).
. Those who see no effect, indeed by differentiating themselves from a
large supermarket they maintain market share.
. None of the local traders see a net positive effect. Although Tesco
suggests that its shops complement the local shopping area and may
indeed increase the numbers of people shopping in this area of Bristol.
As a local councillor, the decision to allow or otherwise is difficult. Tesco will
bring employment into the area and will offer food at relatively low prices.
However, this may be at a cost to local businesses. Should a councillor
protect local business even if they are uncompetitive? Many councils have
come up against just these issues as large retailers seek to expand their
number of retail outlets, often in the context of local objections. However, the
power of local councillors may be limited, given the scale and resources of
these retailers, it has been claimed that councils may be afraid to deny
permission, fearing long and costly legal battles (Howker, 2009).
Summary
As this reading has shown there are strong incentives for businesses to
operate beyond their national border and become TNCs; both in terms of
opening access to markets into which they might sell their products and/or
services, and gaining access to inputs and labour. Becoming a TNC offers
opportunities in terms of both revenue growth and cost reduction. It is no
wonder, therefore, that many businesses have taken this opportunity. In so
doing they have not taken a single path but developed ways of becoming
transnational that fit their plans (even to the extent of new businesses being
global from the start).
Although the TNC as a form is not defined by its size, it is important to
acknowledge the existence of vast organisations that span the globe whose
value exceeds that of many national economies. Through their size and
reach they have opportunities to influence economic and political practices
that other businesses do not. Whether they use this influence to the benefit
of others is, of course, an open question. Taking the perspective of a small
business faced with the prospect of direct competition from such large,
efficient and heavily marketed organisations, the power of some TNCs may
appear difficult to resist.
TNCs, even large ones, are a diverse group, choosing to operate, organise
and develop in different ways. To understand their impact it is necessary to
have a more fine-grained knowledge of the particular circumstances.
67
Readings 56–61
However, it is possible to say that TNCs and their enormous growth have
altered the business context, disrupting the idea of a local or even national
market by a global outlook and global competition.
68
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www.toyota-global.com/company/profile/facilities/worldwide_operations.
html (Accessed 19 September 2014).
UNCTAD (n.d.). Transnational corporations (TNC), United Nations
Conference on Trade and Development. [online]. Available at http://unctad.
org/en/Pages/DIAE/Transnational-corporations-(TNC).aspx (Accessed 19
September 2014).
UNCTAD (2013) World Investment Report 2013, United Nations
Nations. [online]. Available at http://unctad.org/en/publicationslibrary/
wir2013_en.pdf (Accessed 3 July 2014).
UNCTAD (2007) The Universe of the Largest Transnational Corporations,
United Nations Conference on Trade and Development. [online]. Available
at http://unctad.org/en/Docs/iteiia20072_en.pdf (Accessed 8 August 2014).
Walmart (n.d. a) Our Story, Walmart. [online]. Available at http://corporate.
walmart.com/our-story/ (Accessed 19 September 2014).
Walmart (n.d. b) Our Locations, Walmart. [online]. Available at http://
corporate.walmart.com/our-story/locations#/ (Accessed 19 September 2014).
World Bank (n.d.) GDP. [online]. Available at http://data.worldbank.org/
indicator/NY.GDP.MKTP.CD?order=wbapi_data_value_2013
+wbapi_data_value+wbapi_data_value-last&sort=desc (Accessed 19
September 2014).
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Reading 60: International business ethics (1) – bribery and corruption
Reading 60: International business

ethics (1) – bribery and corruption
Introduction
Economic globalisation involves the regular crossing of national borders,
which can take a number of forms, such as money, people, goods or
services. Crossing these borders involves certain challenges, for example the
risks of maintaining quality when offshoring, dealing with different rules
and regulations in different countries, and/or operating within a different
political context (Cavusgil et al., 2013; Steers et al., 2013). What these
challenges share is that they arise from encountering difference when
crossing national borders. The result is that doing business across borders is
not quite the same as doing it in our home country – wherever that is.
These differences may give rise to ethical problems that are distinctive and
require careful thought if they are to be resolved successfully. In this
reading you will extend your knowledge of business ethics by looking at
some of the distinctive business ethical challenges raised by globalisation –
these can be grouped under the name ‘international business ethics’. The
ethical elements within economic globalisation can be very controversial
and the so-called anti-globalisation protestors frequently deploy ethical
arguments to condemn aspects of economic globalisation. In what follows,
simple answers to these questions are not proposed (they remain subject to
debate and contestation). What is discussed are ways to consider these
questions in a nuanced manner.
1 Bribery and corruption

Corporate bribery concerns the use of monies in order to gain favourable
terms for a business (Philips, 2014). This could take the form of paying a
government official to win a contract, paying an individual within an
organisation to purchase products or services from a particular company, or
paying government inspectors not to report health and safety violations. It
could be claimed that bribery is problematic in businesses in that it both
distorts economic exchange (e.g. the buyer is not getting the best market
price for their goods) and also fails to preserve fairness (e.g. a business only
gets a large government contract because of its payment of a bribe, or rules
and regulations are not enforced in the same manner for every business). In
this way bribery can be said to undermine fair business practices and the
rule of law. It is unsurprising that anti-bribery legislation exists in most
jurisdictions across the world. It appears that bribery and corruption are
simply unacceptable (either because it introduces unfairness or has
undesirable consequences or both). However, these practices are not
unknown to the global business environment as you will see in the
following example.
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Readings 56–61
Example of bribery and corruption: Smith & Wesson

Smith & Wesson Holding Corp has agreed to pay US$2.03 million to settle
US Securities and Exchange Commission charges [that] its employees and
representatives bribed foreign officials to supply firearms to military and law
enforcement departments overseas.
The SEC said on Monday that sales staff at the Springfield, Massachusetts-
based company engaged in a ‘pervasive’ effort to win contracts from
2007 to 2010 by authorising or making illegal payments or providing gifts to
government officials in Pakistan, Indonesia, Turkey, Nepal and Bangladesh.
In one instance, Smith & Wesson approved a sale of 548 pistols to Pakistani
police after its agent, who was hired in 2008, notified the company he would
give cash and more than US$11,000 worth of guns to police officials to
complete the deal, the SEC said.
(Stempel, 2014)
It should be noted that Smith & Wesson are paying the fine to settle the
claim rather than go through the court process. However, the way that this
business operated appears deeply troubling. According to the article those
working for Smith & Wesson offered cash and weapons in exchange for
contracts, in essence to secure an economic deal for the company. Other
companies competing for these contracts, perhaps offering a better product,
or a better deal or both would not be able to compete because of corruption
within the government and bribes paid by Smith & Wesson. The fact that
this involves the weapons trade appears more distasteful. That this is
unethical behaviour appears beyond doubt; it is simply unacceptable. Indeed
it appears to run against prevailing values and norms concerning fairness
and right and proper business behaviour (issues you have discussed in
Block 6). There is a temptation to end the discussion here, however, there
are further questions to ask.
Figure 1 Bribery
The first question is the extent to which bribery and corruption exists within
the global economy. Is the example of Smith & Wesson particularly unusual
or rare? If so, we could treat Smith & Wesson and those that they bribed as
particularly unethical business people who would be rarely met. If this
argument were true, it could be claimed that this case raises issues that
72
global business would rarely encounter – this is not to say it is acceptable,

just very rare. In essence, it is necessary to know the extent of bribery and
corruption within the global economy. Measuring this is, of course, difficult.
Given that such activity is generally illegal in most nations, both those
paying and receiving bribes have a strong incentive to hide this behaviour
(in order to avoid fines and/or time in jail). Therefore other indicators of the
corruption across the globe can be made use of as proxies for direct
measurement.
Transparency International is a non-profit organisation focused on fighting
corruption. It has numerous chapters around the world. The organisation has
a broad remit covering corruption in public services as well as business
practices (although the two are linked). Since 1995 it has published the
Corruption Perceptions Index (CPI) that seeks to measure the perceived
extent of corruption in the public sector within 177 countries. (A short note
of caution here, the index does not directly measure the extent of corruption
but uses a method to assess the perceptions of corruption. You can find
more about how they go about getting the data on their website.) Public
sector corruption is important in understanding business practice for a
number of reasons:
. Businesses frequently have to interact with the public sector in order to

operate in another country (e.g. gaining permits, filing accounts, paying
taxes).
. Businesses frequently are bidding for contracts paid for by the public
sector (e.g. building roads, operating mines, providing uniforms,
providing weapons).
. In some countries the government will often be a partner in business
activities.
. It suggests the general incidence and toleration of corruption within a
country.
Exercise 1
The CPI produces a figure that rates the perceived level of corruption from 0
to 100. Zero indicates a highly corrupt public sector – one where corruption
occurs throughout the whole of the public sector, whilst 100 indicates highly
clean (i.e. one where bribery and corruption simply does not happen). A
score of less than 50 indicates a serious problem with corruption. Table 1
below gives the results for the year 2013.
Have a look at the figures and make some notes on its findings. For
example, does anything surprise you? Does corruption appear concentrated
in a particular geographical area? Where is your country located on the list?
Do you agree with the perception?
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Readings 56–61
RANK COUNTRY/TERRITORY SCORE RANK COUNTRY/TERRITORY SCORE RANK COUNTRY/TERRITORY SCORE

1 Denmark 91 57 Namibia 48 119 Mozambique 30
1 New Zealand 91 61 Oman 47 119 Sierra Leone 30
3 Finland 89 61 Slovakia 47 119 Timor-Leste 30
3 Sweden 89 63 Cuba 46 123 Belarus 29
5 Norway 86 63 Ghana 46 123 Dominican Republic 29
5 Singapore 86 63 Saudi Arabia 46 123 Guatemala 29
7 Switzerland 85 66 Jordan 45 123 Togo 29
8 Netherlands 83 67 Macedonia (FYR) 44 127 Azerbaijan 28
9 Australia 81 67 Montenegro 44 127 Comoros 28
9 Canada 81 69 Italy 43 127 Gambia 28
11 Luxembourg 80 69 Kuwait 43 127 Lebanon 28
12 Germany 78 69 Romania 43 127 Madagascar 28
12 Iceland 78 72 Bosnia and Herzegovina 42 127 Mali 28
14 United Kingdom 76 72 Brazil 42 127 Nicaragua 28
15 Barbados 75 72 Soa Tome and Principe 42 127 Pakistan 28
15 Belgium 75 72 Serbia 42 127 Russia 28
15 Hong Kong 75 72 South Africa 42 136 Bangladesh 27
18 Japan 74 77 Bulgaria 41 136 Côte d’Ivoire 27
19 United States 73 77 Senegal 41 136 Guyana 27
19 Uruguay 73 77 Tunisia 41 136 Kenya 27
21 Ireland 72 80 China 40 140 Honduras 26
22 Bahamas 71 80 Greece 40 140 Kazakhstan 26
22 Chile 71 82 Swaziland 39 140 Laos 26
22 France 71 83 Burkina Faso 38 140 Uganda 26
22 Saint Lucia 71 83 El Salvador 38 144 Cameroon 25
26 Austria 69 83 Jamaica 38 144 Central African Republic 25
26 United Arab Emirates 69 83 Liberia 38 144 Iran 25
28 Estonia 68 83 Mongolia 38 144 Nigeria 25
28 Qatar 68 83 Peru 38 144 Papua New Guinea 25
30 Botswana 64 83 Trinidad and Tobago 38 144 Ukraine 25
31 Bhutan 63 83 Zambia 38 150 Guinea 24
31 Cyprus 63 91 Malawi 37 150 Kyrgyzstan 24
33 Portugal 62 91 Morocco 37 150 Paraguay 24
33 Puerto Rico 62 91 Sri Lanka 37 153 Angola 23
33 Saint Vincent and the 94 Algeria 36 154 Congo Republic 22
Grenadines 62 94 Armenia 36 154 Democratic Republic of
36 Israel 61 94 Benin 36 the Congo 22
36 Taiwan 61 94 Columbia 36 154 Tajikistan 22
38 Brunei 60 94 Djibouti 36 157 Burundi 21
38 Poland 60 94 India 36 157 Myanmar 21
40 Spain 59 94 Philippines 36 157 Zimbabwe 21
41 Cape Verde 58 94 Suriname 36 160 Cambodia 20
41 Dominica 58 102 Ecuador 35 160 Eritrea 20
43 Lithuania 57 102 Moldova 35 160 Venezuela 20
43 Slovenia 57 102 Panama 35 163 Chad 19
45 Malta 56 102 Thailand 35 163 Equatorial Guinea 19
46 Korea (South) 55 106 Argentina 34 163 Guinea-Bissau 19
47 Hungary 54 106 Bolivia 34 163 Haiti 19
47 Seychelles 54 106 Gabon 34 167 Yemen 18
49 Costa Rica 53 106 Mexico 34 168 Syria 17
49 Latvia 53 106 Niger 34 168 Turkmenistan 17
49 Rwanda 53 111 Ethiopia 33 168 Uzbekistan 17
52 Mauritius 52 111 Kosovo 33 171 Iraq 16
53 Malaysia 50 111 Tanzania 33 172 Libya 15
53 Turkey 50 114 Egypt 32 172 South Sudan 14
55 Georgia 49 114 Indonesia 32 174 Sudan 11
55 Lesotho 49 116 Albania 31 175 Afghanistan 8
57 Bahrain 48 116 Nepal 31 175 Korea (North) 8
57 Croatia 48 116 Vietnam 31 175 Somalia 8
57 Czech Republic 48 119 Mauritania 30
Table 1 Corruptions Perceptions Index 2013 (source: Transparency International)
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Comment
Below are my reflections on these figures:
. No countries gain the perfect score of 100. Denmark and New Zealand
are the closest with scores of 91. This indicates that no country is
perceived as entirely immune from corruption. This is quite a surprising
result and suggests that public sector corruption is perceived to exist in
all countries irrespective of their level of economic development.
. Out of the 177 countries included in the table, 123 score less than 50.
This means that 69% of the countries analysed are perceived to have a
serious problem with public sector corruption. (Note that this is not to say
that those with a figure above 50 are free of corruption.)
. There seems to be some geographical concentrations in the figures. 95%
of countries in Eastern Europe and Central Asia have a score below 50,
the figure is 90% for those in Sub-Saharan Africa, 84% for the Middle
East and North Africa. This contrasts with a figure of 23% for the EU and
Western Europe. Although it should be noted that no area is immune
from corruption (for example, Greece, a member of the EU, scores 40).
. Some of the major sites of foreign direct investment are designated as
highly corrupt (for example China (score of 40), Philippines (36), Vietnam
(31)). Many TNCs are therefore operating in countries that the CPI
designates as having a serious problem with corruption.
It is necessary to be somewhat cautious when thinking about what these

figures mean for business. A first point is that just because a country has a
low score on the CPI does not mean that every business operating in that
country is engaged in some form of corrupt practice; businesses often
control their activities to prevent corruption occurring. The second,
however, is a matter of awareness. If a business chooses to operate in a
country with a low score, there is the potential for corruption to exist within
the public sector (and, perhaps, more broadly). There may be an expectation
that bribes will be paid to secure certain services, guarantee contracts, or
gain official approval for business activities. Therefore, managers in the
business need to think hard about how they will operate in that country if
they are to avoid corruption.
The CPI is a useful tool in exploring perceptions of corruption within
countries, however, it doesn’t tell the whole story. To put this in terms
familiar to economists, CPI tells of the demand-side of corruption,
i.e. where those that will accept bribes are most likely to exist in
comparative terms. It does not tell us about the supply-side, i.e. where these
bribes originate. To apply this to international business, if no companies are
prepared to pay bribes, there is no supply to satisfy those demands.
Exercise 2
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Readings 56–61
Since 1999 Transparency International has produced an index designed to

assess where bribery is coming from, this is called the Bribe Payers Index
(BPI). ‘The index ranks 28 of the world’s largest economies according to the
perceived likelihood of companies from these countries to pay bribes abroad’
(Transparency International, 2011, p. 2). In this measure countries are given
a score of between 0 and 10: a score of 10 indicates the view that
businesses in these countries never pay bribes abroad, a score of zero
indicates the view that they always do. The results from the 2011 report are
shown in Table 1.
As with the CPI, note any issues that occur to you, for example are any
major economies prone to bribe paying? Are there any countries from where
no bribes are paid? Is there any relation between those countries that pay
bribes and those that receive them?
Table 2 Bribe Payers Index 2011 (Source: Transparency International)
Rank Country/Territory Score
1 Netherlands 8.8
1 Switzerland 8.8
3 Belgium 8.7
4 Germany 8.6
4 Japan 8.6
6 Australia 8.5
6 Canada 8.5
8 Singapore 8.3
8 United Kingdom 8.3
10 United States 8.1
11 France 8.0
11 Spain 8.0
13 South Korea 7.9
14 Brazil 7.7
15 Hong Kong 7.6
15 Italy 7.6
15 Malaysia 7.6
15 South Africa 7.6
19 Taiwan 7.5
19 India 7.5
19 Turkey 7.5
22 Saudi Arabia 7.4
23 Argentina 7.3
23 United Arab Emirates 7.3
25 Indonesia 7.1
26 Mexico 7.0
27 China 6.5
28 Russia 6.1
Average 7.8
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Comment
Below are some of my reflections on these figures:
. As with the CPI, no country is shown as entirely clean. There is a

perception that every country in the list contains within it businesses that
pay bribes when they operate internationally. (Remember, the index does
not tell us where this bribery happens, it simply tells us where it comes
from.) The question is, then, the extent to which this occurs.
. The countries at the bottom, China and Russia, are both major
economies whose businesses are expanding across the globe. This gives
a strong cause for concern in respect of the honesty and decency of
some aspects of international business.
. There is a strong correlation between the CPI and BPI that suggests
perceived corruption within a country appears to be related with corrupt
practices by businesses within that country as they go abroad.
The BPI is a useful reminder that corruption is not simply a problem for
others. It is not simply a property of low income countries, or those recently
undergoing regime change. Businesses within large high-income economies
appear to offer some of the supply to meet that demand, thereby sustaining
corruption in parts of the world economy. The issue is, how should such
practices be treated from an ethical point of view?
2 Responding to bribery and corruption

A reasonable question to ask is whether bribery is ever acceptable. Is it ever
ethically permissible for a TNC to pay a bribe when they operate across
national borders? The answer requires some thought and alternative views
are available – each offering a different view of this practice. Before
discussing these views, a more nuanced account of what bribery actually is
would be helpful.
The previous discussion and the CPI and BPI talk simply about bribery. No
differentiation was made between different ways in which corruption and
bribery operate, both in who they are aimed at and their extent. However, in
some of their more detailed discussions Transparency International talk
about three distinct forms of bribery within international business:
(a) Petty. This is bribery that involves ‘low-level public officials – for
example to speed up administrative processes and/or facilitate the
granting of licenses’ (Transparency International, 2011, p. 18).
(b) Grand. This refers to the use of ‘improper contributions to high-ranking
politicians or political parties to achieve influence’ (Transparency
International, 2011, p. 18).
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Readings 56–61
(c) Private. This involves the payment or receipt of bribes between private
firms (Transparency International, 2011, p. 18).
In this definition, bribery can run from paying an official to speed up a
process (a process that the official is contracted to carry out – but will get
the job done more quickly if given a bribe – these are called ‘facilitation
payments’) to millions changing hands to a high-level official in order to
gain a lucrative public sector contract. Therefore in thinking about bribery it
is necessary to be sure that all parties are discussing the same thing. For
example, someone might accept ‘petty’ bribery as undesirable but a fact of
life, whereas they might reject ‘grand’ bribery as unacceptable under any
conditions.
The following offers five approaches to international business ethics, each
of which offers a different view on bribery drawn from a selection of the
literature (Bowie, 1999, 2009; Hill, 2011; Wild and Wild, 2014). Note that
these five views represent a deliberately simplified and partial account of a
vast range of philosophical positions designed to get you to think through
some of the key issues. Some, though not all, of these views are related to
the theories of business ethics you have previously discussed.
Cultural relativist
One view is that ethical standards are simply reflections of a culture. There
are no universal standards to which appeal can be made. When a TNC
begins to operate in a different country it should therefore follow the
standards existing in that country. When a business opens a plant in another
country or does a deal with its government the business should respect this
other culture and operate by its rules. It follows, therefore, that if bribery is
a part of the fabric of another country’s culture it is ethically acceptable
(even if it is hardly ethically desirable) for the TNC to pay bribes in that
country. An example of this view is provided by Chabal and Daloz
describing practices within Nigeria:
Provided the beneficiaries of graft do not hoard too much of what they
accumulate by means of the resources made available to them through
their position, and provided they redistribute along lines that are
judged to be socially desirable, their behavior is deemed acceptable.
Corruption is not, therefore, a matter of a few ‘rotten apples’ or of a
venal ‘class’, even less as an ‘evil’ to be eradicated by means of
vigorous ‘ethical’ campaigns. On the contrary, it is a habitual part of
everyday life, an expected element of every social transaction. This
ought not to surprise us. As we have already emphasised, there is in
Africa a marked reluctance to abide by the abstract and universalist
norms of the legal-bureaucratic order that are the foundations of
Western polities…. Expectations of probity, therefore, appear to be
limited to one’s kith and kin, the members of one’s community, but
they obviously cease to apply beyond. The usual response by Nigerians
to the charge that their country is deemed by some to be the most
corrupt on Earth is: ‘This is how we do things in Nigeria!’
(Chabal and Daloz, 1999, cited in Velasquez, 2010, p. 491)
78
In basic terms, this approach argues that if bribery is ethically acceptable in

one country then a TNC operating in that country is free to engage in
bribery (even if it would not do in its home country).
Righteous moralist
A related but radically different approach to that of the cultural relativist is
the righteous moralist. The righteous moralist accepts that moral standards
are simply reflections of a culture but then suggests that the standards of the
home country are better. Therefore, the ethical standards in the home
country of the TNC should apply irrespective of where the TNC is
operating. As the academic Charles Hill notes, this view is frequently
espoused by managers from developed nations (Hill, 2011). This view
suggests that the approach taken in the home country is the only one that
should apply irrespective of where the TNC is operating. If the home
country deems bribery ethically unacceptable then the operations of the
TNC anywhere in the world should not partake in bribery. As Turow says,
‘I cannot accept the idea that bribery, which is wrong here, is somehow
more tolerable abroad’ (Turow, 2014, p. 388). Once again there may be
some implications of this approach that might be problematic and these will
be discussed later.
Moral universalist
Another view is one that suggests there are certain moral universals. These
are ethical standards that should apply to everyone irrespective of their
location (indeed irrespective of the time they live in). This view rejects the
claim that ethical standards are simply reflections of a particular time and
place and argues that there are certain eternal moral truths that should be
applied at all times and in all places. This is a form of the deontological
approach you discussed in Block 6. Taking a Kantian view it could be
argued that bribery fails the categorical imperative (i.e. it could not become
a universal law) and is therefore always unacceptable. It simply does not
matter whether bribery is accepted in either the home country or the country
they chose to operate in (or anywhere else for that matter). Bribery is
simply ethically unacceptable and should never occur.
Moral consequentialist
The moral consequentialist view considers not whether bribery is acceptable
within another country but whether paying bribes has undesirable
consequences. This could be in terms of assessing the consequences of an
individual bribe (as in act-utilitarianism) or a consideration of the general
effect of bribe paying by business (as in rule-utilitarianism). You discussed
these views in Block 6. Transparency International offers this kind of
approach (and one based in rule-utilitarianism), as it argues:
Foreign bribery has significant adverse effects on public well-being

around the world. It distorts the fair awarding of contracts, reduces the
quality of basic public services, limits opportunities to develop a
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Readings 56–61
competitive private sector and undermines trust in public institutions.

Engaging in bribery also creates instability for companies themselves
and presents ever-growing reputational and financial risks.
(Transparency International, 2011, p. 2)
In effect Transparency International is arguing that bribery is unacceptable

because its consequences are far reaching and unappealing. Bribery has the
consequence of undermining fair business and robust political institutions. It
does not matter whether bribery is treated as acceptable in the culture in
which the TNC is operating; bribery is simply a practice that, because of
its extensive negative consequences, is ethically unacceptable and is,
therefore, prohibited.
Naïve immoralist
The final approach is perhaps the least sophisticated but is worth airing. The
naïve immoralist view simply states that if other businesses in that nation
are paying bribes then this business can do it (irrespective of any ethical
issues that may arise). This view could be characterised as ‘if everyone is
doing it, I might as well do it myself’. What is distinctive concerning this
approach is that it bypasses an ethical justification for practices. It simply
does not matter if bribery is ethically unacceptable, if others are doing it,
then in order to compete in this market I need to practice bribery. The view
is immoral, not in the sense that you or I might not like this view (even
though this may be the case) but in the sense that morality doesn’t really
matter. It is what others are doing that counts.
Exercise 3
You will find some of these views compelling, you may disagree with some of
them strongly – particularly some of the more extreme views. However, the
problem is that they can be somewhat abstract. For this activity these
abstractions are brought down to earth through a dilemma:
To bribe or not to bribe?

You are a manager in a TNC based in the UK. You are opening up an office
in another country and require a number of permits from the local
government in order to get the office up and running. Your boss is
pressurising you to get the office open as soon as possible (within the next
few weeks). You have an agent in the country to help things run smoothly.
The agent contacts you and says that the permits will take approximately
four months to be processed. The agent then says that the permits can be
fast-tracked for a reasonably small ‘facilitation payment’. This is to be paid in
cash, direct to the local government official. Your agent tells you that this is
how you do business in this country, and certainly this is how your
competitors behave. You know you can put this through the budget under
general expenses, you won’t get caught and you feel the pressure to get this
80
office up and running. However, you recognise this as a bribe and that it
would be illegal in your country.
First of all think about what you would do in this situation. Write down your
view and the reasons you hold it. Write down more than a ‘yes’ or ‘no’
answer. Try and explain the reasoning behind your decision.
Secondly, use the five approaches and note down what they would
recommend in this situation.
. Cultural relativist
. Righteous moralist
. Moral universalist
. Moral consequentialist (both rule- and act-utilitarianism)
. Naïve immoralist.
Comment
This is not a question of giving a right or wrong answer. These are the kinds
of things that international businesses are likely to face and decisions have
to be taken. This is an issue of unearthing your views and seeing how other
approaches respond.
◦ This is simple. Because it is acceptable business practice in this

country to pay these facilitation fees, you are ethically warranted
to pay the bribe.
◦ Because this practice is unacceptable in your country, it is

irrelevant whether or not the rules appear to be different in another
country – you should not pay the bribe.
◦ If paying a bribe is morally wrong, no matter how ‘petty’ the bribe

is, then you should not pay it. (If, of course, ‘facilitation payments’
are not morally wrong then it is acceptable to pay the bribe.)
. Moral consequentialist
◦ For a rule-utilitarianist, if bribe paying as a general rule has bad

consequences then it is ethically unacceptable. For an act-
utilitarianist, it depends how the individual weighs the
consequences of paying a bribe in this particular case. For
example if this payment will lead to a successful business, a good
appraisal from your boss and you are unlikely to be caught, this
bribe could be seen as acceptable.
. Naïve immoralist
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◦ Morals simply have nothing to do with it. If your competitors pay

these fees you should also do it. If you did not, it would put you at
a competitive disadvantage.
Did you use any of these approaches in reaching your decision, or did you
use a blend of them, weighing up their relative merits? Additionally elements
in the case may have persuaded you to a particular view. For example, what
if your boss used your inability to get this new office running as an excuse to
give you a bad appraisal or question your ability to get the job done (or even
threaten you with redundancy?) How might this affect your decision? What
would happen if this payment became public? It is important to remember
that ethics in the real world is surrounded by real pressures in real situations
each of which can affect decisions made.
Sometimes, however the line between what is and what isn’t bribery cannot
be so clearly defined, as the following example shows.
Example of an unclear distinction between hospitality and

bribery
You are a manager in a TNC based in France. You are planning to open an
office with a local partner in another country. You have been warned that the
country’s bureaucracy is frequently slow and can often hold up matters for
months on end. You have heard of facilitation payments being made by your
competitors, but your organisation has a strong policy outlawing such
payments (as does the law of your country). You personally believe that
bribery is unacceptable.
As a hands-on person you have decided to travel to this country to see what
can be done. As part of this you have decided to meet up with some local
business owners and potential partners. You have a hospitality budget and
decide to take this group out for a meal at a good restaurant. (This is how
the company normally behaves with its clients). The meal is fantastic and
somewhat costly (but well within your budget). At the end of the meal one of
the local business owners thanks you for a great meal and as they leave
they tells you that they know people in the local government and that they’ll
speed up bureaucracy for you – after all, it was a great meal and a favour is
owed. In a couple of weeks the permits come through. On your desk you see
a receipt for the meal and you realise it is probably for more than the
facilitation payments you know about, and begin to feel distinctly uneasy.
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Figure 3 A restaurant meal
Taking customers, clients and business partners out for a good meal appears
to be a perfectly acceptable business practice. It is hardly what one could
call bribery. Yet in this instance it has led to a practice, if not directly
corrupt, then at least unfair. The businessman who helped the permits
through felt they were returning a favour (a favour for a great meal) – a
favour that would be unacceptable in the home country. Paying for a meal
appears somewhat distinct from authorising a bribe, yet nonetheless the
individual’s actions have led to the same result. Has this person, in effect,
paid a bribe? Or are they not responsible for another’s actions?
3 Regulatory responses
Bribery and corruption are a feature of international business. This does not
mean that all, or even the majority, of international business transactions
involve bribery and corruption. However, there are sufficient high profile
examples that it would be naïve to not account for bribery and corruption in
the international (and national) environment. As the previous example
shows, views on bribery diverge and the line between bribery and
acceptable business practice can be blurred (and whose responsibility it is
when matters go wrong).
TNCs have frequently responded by developing their own codes of conduct
in respect of bribery and corruption. For example in 2002 BP created a
zero-tolerance policy for facilitation payments arguing that they are, in
essence, low level bribes. Their view is that because bribes corrupt both the
giver and receiver they are therefore unacceptable in any form, even if it
meant losing sales (Hill, 2011, p. 137). Their 2014 code of conduct
document underscores this by reference to a single code that covers all of
their employees. With reference to bribery BP’s code states:
We do not tolerate bribery and corruption in any of its forms in our

business.
We comply with anti-bribery and corruption laws and regulations and
support efforts to eliminate bribery and corruption worldwide. We
work to make sure that our business partners share our commitment.
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Readings 56–61
. Do not offer or accept bribes, kickbacks or any other kind of

improper payment including facilitation payments.
. Keep accurate books and records so that payments are
honestly described and company funds are not used for
unlawful purposes.
(BP, 2014, p. 20)
Figure 4 A BP facility
It is interesting, here, that there is reference to facilitation payments under

the same category as bribes. Whether they are acceptable in a particular
country is simply irrelevant (close to the ‘moral universalist’ or ‘righteous
moralist’ approach). Additionally the code also refers to appropriateness of
gifts and entertainment, which are not to be either sent or received ‘in
return for any business, services or confidential information, or if the intent
is to bias a decision’ or where they ‘could be seen as a bribe’ (BP, 2014,
p. 16). Of course it is necessary to remember that the existence of a code is
only one part of the story; its effective implementation is critical.
Bribery within business has long been the subject of legislation. The most
recent in the UK is the UK Bribery Act 2010. In giving advice on the Act,
the Ministry of Justice talks about the liability of companies for actions by
individuals and organisations acting on their behalf (e.g. employees or
agents) wherever they are located. Providing hospitality to clients and
giving gifts is acceptable as long as it is not carried out in order to
influence a business decision. With facilitation payments, the act is clear
‘Facilitation payments are bribes under the Act just as they are under the
old law’ (Ministry of Justice, 2010, p. 2).
It appears then that the question of facilitation payments is clear. They are
bribes and are, hence, illegal. Not all jurisdictions agree on this matter. The
US law covering bribes (the Foreign Corrupt Practices Act) contains a
specific exclusion on facilitation payments (or ‘grease payments’ as they are
sometimes called in the US) (Hill, 2011, p. 130). Such payments are
excluded on the basis when they simply affect the timing of an action. The
argument is that because a government official would normally carry out the
task, the payment merely affects the speed at which the activity is carried
out. As Hill notes, US businesses have complained that making these
payments illegal would mean that they are uncompetitive (Hill, 2011).
Therefore there is some degree of cultural relativism (and legal relativism)
even amongst the largest economies in the world. The OECD takes a middle
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ground in this area arguing that business should either ‘prohibit or

discourage’ these payments (OECD, 2011, p. 47) . This highlights one of
the key issues in economic globalisation that national laws and regulations
are still important for international business practice, yet these regulations
may differ across nations.
Summary
In this reading you discussed a critical issue facing international business,
that of bribery and corruption. As a matter of record the international
business environment has shown the presence of illegal and ethically
questionable practices. There is a market for corruption with both suppliers
and consumers making deals. Both CPI and BPI offer a somewhat shocking
view of the perceptions of the extent of corruption around the world.
In responding to this environment international business ethics offers a
series of approaches. Each offers a different argument on the acceptability
or otherwise of bribery (even if some of them reach the same conclusion).
Although some cases of bribery appear clear-cut, the line is sometimes
blurred, particularly in respect of facilitation payments and hospitality. Both
businesses and governments have responded by producing respectively
codes of conduct and legislation. However, even in the global economic
environment both the ethical arguments and legislation have not reached a
single agreed upon solution.
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Readings 56–61
References
Bowie, N.E. (1999) Business Ethics: A Kantian Perspective, Oxford,
Blackwell.
Bowie, N.E. (2009) ‘Relativism and the moral obligations of multinational
corporations’, in Beauchamp, T.L., Bowie, N.E. and Arnold, D.G. (eds.),
Ethical Theory and Business, 8th edn,. Upper Saddle River, NJ, Prentice
Hall.
BP (2014) Our Code Our Responsibility, BP. [online]. Available at http://
www.bp.com/content/dam/bp/pdf/code-of-conduct/
bp_code_of_conduct_english.pdf (Accessed 21 August 2014).
Cavusgil, S.T., Ghauri, P.N. and Akcal, A.A. (2013) Doing Business in
Emerging Markets, 2nd edn., London, Sage.
Ministry of Justice (2010) The Bribery Act 2010: Quick Start Guide.
[online]. Available at https://www.gov.uk/government/uploads/system/
uploads/attachment_data/file/181764/bribery-act-2010-quick-start-guide.pdf
(Accessed 21 August 2014).
OECD (2011) OECD Guideline for Multinational Enterprises, 2011 Edition.
[online]. Available at http://www.oecd.org/daf/inv/mne/48004323.pdf
Philips, M. (2014 [1984]) ‘Bribery’ in Boylan, M. (ed.) Business Ethics,
2nd edn., Chichester, Wiley-Blackwell.
Steers, R.M., Nardon, L. and Sanchez-Runde, C.J. (2013) Management
Across Cultures: Developing Global Competencies, 2nd edn., Cambridge,
Stempel, J. (2014) ‘Smith & Wesson settles SEC bribery case over firearms
sales’, Reuters, 28 July 2014. [online]. Available at http://www.reuters.com/
article/2014/07/28/us-sec-smithandwesson-idUSKBN0FX1G620140728
(Accessed 3 December 2014).
Transparency International (2011) Bribe Payers Index 2011. [online].
Available at http://files.transparency.org/content/download/98/395/
2011_BPI_EN.pdf (Accessed 27 February 2015).
Transparency International (2013) Corruption Perceptions Index 2013.
[online]. Available at http://files.transparency.org/content/download/700/
3007/file/2013_CPIBrochure_EN.pdf (Accessed 27 February 2015).
Turow, S. (2014 [1987]) ‘What’s wrong with bribery’ in Boylan, M. (ed.)
Business Ethics, 2nd edn, Chichester, Wiley-Blackwell.
Velasquez, M. (2010) ‘Corruption and bribery’, in Brenkert, G.G. and
Beauchamp, T.L. (eds.) The Oxford Handbook of Business Ethics, Oxford,
Oxford University Press.
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Globalization, 7th edn, Harlow, Pearson.
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Readings 56–61
Reading 61: International business

ethics (2) – work, sweatshops and
responsible business
Introduction
The relationship between globalisation and business ethics goes beyond
bribery and corruption. Ethical issues have the potential to rise at any point
in the global context. Global value chains produce relations between
multiple businesses and employees across the globe. What goes on in some
of these businesses is the subject of frequent criticism, particularly
regarding the unacceptable treatment of workers. This reading explores
some of the ethical issues associated with labour conditions in the
outsourced global value chain, exploring both the practices at the sharp end
of globalisation and how ethical theory helps make sense of these events.
The discussion then moves to the broader question of responses to the
ethical challenges raised by globalisation, in both comprehensive ethical
theories of international business and specific codes of conduct.
1 Economic globalisation and labour

Economic globalisation has fundamentally re-structured the world of work;
much of the manufacturing that occurred in the Western world has shifted to
low-cost countries, through a combination of offshoring, outsourcing and
the growth of emerging market multinationals (Dicken, 2011; Grint, 2005).
This has meant that production is now formed of complex webs of relations
that criss-cross the globe. TNCs source their products from a variety of
suppliers who themselves may outsource elements of their production and
so on. If it were possible to map the relations of the TNCs across the world
you would see lines criss-crossing the globe, offering a picture of
complexity and interdependencies, the very stuff of economic globalisation.
This picture, however, is partial. It doesn’t offer insight into what is going
on inside these organisations: How is work organised? How are labour
rights protected? Are workers treated fairly? Do workers receive a decent or
living wage? Hence it is necessary to peer inside these organisations in
order to find out what it is like to work as part of a global production
network.
One of the key driving forces for businesses to go offshore is to take
advantage of lower wage rates in different countries. It might be assumed,
therefore, that what a business is doing is simply transplanting its
manufacturing from one place to another (or in the case of outsourcing and
offshoring selecting a supplier from another country who can provide the
same goods and services at a reduced cost). This may involve making
people redundant in a particular country or location (and there may well be
ethical issues in this respect), but the point is that the accounts should show
that costs are down and, all things being equal, profits are up. Such
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Reading 61: International business ethics (2) – work, sweatshops and responsible business
reasoning is based upon the assumption that labour conditions are the same
across the world, the difference is simply cost. This, however, is a rather
dangerous assumption to make.
To coincide with the 2010 World Cup held in South Africa, the
International Labour Rights Forum (ILRF) produced a report that analysed
the labour conditions associated with the manufacture of footballs. The
report looked at the four largest football manufacturing countries: Pakistan,
India, China and Thailand. Here are some of its findings:
. ‘In some Indian stitching centers proper drinking water, medical care
facilities, and even toilets are often absent. In one Chinese factory,
workers worked up to 21 hours a day during the busy season and did not
have a single day off in an entire month.’ (ILRF, 2010, p. 3)
. ‘Workers are often paid below the legal minimum wage and their
incomes can barely cover basic needs. They are also vulnerable to
occupational health hazards and are frequently blocked from accessing
social protections including health care.’ (ILRF, 2010, p. 3)
. ‘Workers spoke of gender based discrimination. Female home-based
workers were paid the least and faced the possibility of losing their jobs
permanently due to pregnancy.’ (ILRF, 2010, p. 2)
. ‘Despite efforts undertaken by governments, advocacy groups, and
industry members alike, child labor still exists in the soccer ball industry
where stitching is outsourced to home-based work.’ (ILRF, 2010, p. 6)
. ‘Needle piercings, headaches, backaches, muscular pains, and loss of eye
sight are very common among all stitchers regardless of their working
locations….stitchers pull and bite the chemically treated thread with
their teeth. Most workers do not treat their health problems. This may be
due to the fact that they cannot afford health care costs.’ (ILRF, 2010,
p. 19)
Figure 1 Children stitching footballs in India
The rest of the report offers disturbing reading and gives cause for some
thought. The next time you kick a hand-stitched football think about the
labour that goes into it. It may have been stitched by a child, by someone
being paid beneath the minimum wage in this country, by someone who is
under threat of unemployment if she became pregnant. It seems that in the
football manufacturing business (it should be noted that these conditions are
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reported in those who are making balls for the largest and most well-known
football brands in the world) labour conditions are somewhat difficult to
accept (at least according to this report). It seems then that going offshore is
not simply a matter of going from one gleaming factory to another but it
involves working with countries where labour conditions are very different
from those in the Western world. It is how businesses respond to this
difference that forms an ethical dilemma.
The temptation may be to think that the football stitching industry is
somehow different from all of the other sectors in the world economy.
However, a continuing stream of reports, investigations and newspaper
articles would disagree with this view; for example:
. The International Labour Organisation (ILO) estimated that in 2012 168

million children are in work, 85 million of whom are in hazardous work
(although both figures have reduced since 2000) (ILO, n.d. a)
. The ILO also notes that 21 million people are in what they term forced
labour, which generates an estimated US$150 billion in illegal profits
(ILO n.d. b)
. In 2014 The Guardian reported that prawns sold in some of the UK's
large supermarkets were the product of slave labour – workers reported
being subject to regular beatings, torture and forced to work 20 hour
shifts for no pay (Hodal et al., 2014)
. An internal audit of Apple’s suppliers revealed that 106 children were
employed across a total of 11 factories (including some with forged
papers) (Garside, 2013).
It is important to remember that appalling labour conditions are very much
a part of the collective past of the West (indeed the writer Leo Huberman
gives an example of an official report showing workers as young as two
being employed in USA in 1934 (Huberman, 1936, p. 121)). So before
someone condemns a practice as something that other people do in other
countries, they should be aware that child labour and abusive labour
practices may be very much part of their history. Having said that, there is
general agreement that practices such as forced labour and slavery are
unacceptable; indeed as soon as the companies found out about slave labour
involved in the sourcing of prawns they ceased their relations with these
businesses. (It is clear that the companies did not know of these practices.)
It could be said that the issue is clear cut; from whatever perspective taken,
these are violations of generally accepted ethical values. Indeed it could be
said that any approach to international business ethics that condones these
practices, is itself ethically objectionable (or it might need severe revision if
it were to become acceptable).
However, one of the discussions that occupies both academics and business
in respect of work and globalisation is that of sweatshops. Indeed much of
the criticism of TNCs in the garment industry has been organised around
campaigns against sweatshops (as well as a broader criticism of working
conditions under which products are assembled and manufactured in
offshore-outsourced global value chains (Kline, 2010)). Sweatshops are
defined as businesses that have employment practices involving some or all
of the following: low wages, forced overtime, health and safety violations,
90
abusive management and/or union busting. The academic, Iris Marion

Young offers a vivid description of conditions in sweatshops:
Conditions in such manufacturing facilities vary, of course, but the

following conditions are typical. The vast majority of workers are
female, and often as young as thirteen or fourteen. They are often
treated in dominative and abusive ways by bosses, and sexual
harassment is common. Typically they work ten- to sixteen-hour days
in peak seasons. If the manufacturer is behind on an order, the workers
may be forced to work through the night. They have few bathroom
breaks or other opportunities for rest during their long working day.
Since leave and vacation time are generally unavailable, a worker too
ill to work is often fired. Violations of the most basic health and safety
standards are normal. Factories are often excessively hot, with no
ventilation, insufficient lighting, excessive noise, little fire-fighting
equipment, blocked exits, poor sanitation, unhygienic canteens and
bathrooms, and no access to clean drinking water. Typically, workers
in these facilities have no freedom to organize unions to bargain
collectively with their employers. Workers who complain and try to
organize are typically threatened, fired, blacklisted, beaten, and even
killed. Local governments often actively or passively support such
anti-union activity.
(Young, 2011, p. 127)
It is an understatement to say that working conditions in sweatshops are

unpleasant. In some the practices are extreme (particularly when it comes to
responses to union action). (However, Engels’ description of working
conditions in England in 1844 provides similar examples (Engels, 1952
[1845]). However, there are a number of ethical questions here:
. Are sweatshops ever ethically acceptable?

. What are the most unappealing practices and why?
. What would need to be changed to make sweatshops acceptable (if this
is indeed possible)?
2 Ethics and sweatshops

As with the discussion of bribery and corruption, the five approaches to
international business ethics outlined in the previous reading can be used to
explore the interface between ethics and sweatshops. It also offers an
opportunity to discuss some of the problems associated with these
approaches.
◦ In its strongest form the cultural relativist could say that if
sweatshops are ethically acceptable in a particular country, then it
is ethically acceptable for a TNC to make use of sweatshop
conditions. It could be that a number of these practices, such as
beating union organisers, are illegal and ethically unacceptable. In
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this context international business might be able to accept some

practices rather than others (the fact that a practice exists in one
country does not necessarily make it acceptable; the reference is
to ethically acceptable practices within that country). However,
the broad view is that if it is ethically acceptable in a country
then it is acceptable (whether or not it is acceptable in the home
country of the business is simply irrelevant).
◦ There are a number of problems with this view. Perhaps one of
the major features is the rather dismissive way that it treats a
home country view and condones the ethical norms of another
culture. It can lead into some rather unpleasant consequences –
for example if it was ethically acceptable in one culture to
employ slaves, to employ young children at starvation level
wages, or to ignore health and safety, then it becomes ethically
acceptable for a business to condone these practices. If an ethical
theory is going to help us make decisions then the fact that those
in the home country abhor certain practices, such as forced labour
should, it seems, be relevant. This is why extreme forms of
cultural relativism are somewhat unappealing. However, this
approach does point out that certain ethical norms are different in
different cultures and they may be relevant in helping treat
another culture with respect, whilst also retaining the home
country’s point of view.
◦ The righteous moralist view is in direct contrast to the previous
approach. It simply says that since sweatshop conditions are
unacceptable in their home country, then it is not ethically
acceptable in another. A TNC, indeed any business, should,
therefore, never get involved with sweatshop conditions, be it in
their own factories located elsewhere or in their suppliers.
◦ This view is certainly more appealing than the cultural relativist,
in that it offers direct guidance on practices and can condemn
unpleasant practices (although if such practices are acceptable in
the home country then they are acceptable elsewhere). The
question is does it go too far? Does this mean that all conditions
should be equalised? Should all employees of a TNC receive
equal wages and benefits? If so, can the organisation afford to
survive in a competitive market? The view is also culturally
intolerant; the home country’s view is deemed the only acceptable
view, others are simply dismissed.
◦ The moral universalist is closely related to the righteous moralist
view but is different in an important way. This view says that
when working conditions violate universal moral norms they are
morally unacceptable. The only matter is determining which
practices are unacceptable and which are not (e.g. long hours
might be deemed acceptable but unsafe working conditions are
not).
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◦ This view is more philosophically oriented, based in

deontological theories, and therefore depends on the
establishment of what universal moral norms are (if, indeed this
is possible). If not, it might be said that moral universalists are
just righteous moralists who are making exaggerated claims!
. Moral consequentialist
◦ The view of sweatshops from the moral consequentialist
perspective is less clear cut. If the consequences of the existence
of sweatshops in general (as in rule-utilitarianism) or in a
particular case (as in act-utilitarianism) are on balance positive,
then sweatshops either in general or in a particular case are
ethically acceptable. If the consequences are negative, then it is
unacceptable.
◦ Any consequentialist view has the problems of measuring
consequences. However, in respect of the issue of sweatshops a
key problem is that it could reach unpleasant conclusions. For
example if working in an unsafe factory for extremely long hours
with an abusive manager is deemed better than subsistence farm
labour, then the view might appear to condone rather unpleasant
ways of treating people. For an act-utilitarian the view may also
be inconsistent, sweatshops in different parts of a single country
may be acceptable depending on the consequences in each
particular case.
. Naïve immoralist
◦ The naïve immoralist view is the most extreme in that it denies
the relevance of morality to this discussion. If sweatshops are the
way things happens in one country and if this is how to reduce
costs and increase profit, then we do it.
◦ The key problem with this approach is that it is not really a moral
view at all. In essence businesses may use sweatshops because
this increases profits; the human cost is simply not part of the
calculation.
There are some subtleties in these approaches that are not captured in these
summaries, and there are many and varied philosophical approaches
available to the international business ethicist that cannot be covered in this
short discussion. However, it is worth considering a different perspective on
business ethics, that of the workers themselves and how they view their
situation. International business ethics tends to look at the problem from the
position of the business and thinks about its rights and obligations. It tends
not to see the world through those at the sharp end of globalisation, those
actually working in the ‘sweatshop’. When the perspective of the employee
and the context in which they live and work is taken into account, the
situation is made more complex by introducing ideas of the rights of
individuals and the justness of their treatment (issues you have discussed
previously). This is particularly relevant when thought turns to the
consequences of closing down a sweatshop or a business choosing not to
outsource to a particular country.
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In an article that is still proving controversial to this day, Ian Maitland

(2009 [1997]) argues that sweatshops are ethically acceptable and that
TNCs should have no concerns at all about using sweatshops in pursuit of
their business objectives. The first point to note in this argument is that the
definition of sweatshops excludes some of the practices described by Iris
Marion Young, i.e. beatings, abuse and forced labour are viewed as
unacceptable practices. So, when Maitland defends sweatshops it is not the
same as condoning slavery. His argument is less dependent upon abstract
moral principles, focusing instead on more practical issues, namely:
. Although sweatshops pay low wages (and even below minimum wages
in the country) they still pay more than alternative employment
opportunities for those employed (such as farm labour).
. Although sweatshop conditions appear harsh, they are no more harsh
than conditions in locally owned factories (indeed, they are probably
better).
. Sweatshops can offer employment for those who are often excluded
from the labour market (in particular women) – indeed they may allow
poorer families to escape from absolute poverty.
. Sweatshops have a net positive effect on the economic development of
the nation (certainly more than if TNCs did not generate economic
activity in that nation).
To Maitland, as long as an employee enters into an employment contract
freely with full information on working conditions (what Maitland terms the
‘classical liberal standard’ (Maitland, 2009, p 599)) then there is nothing
wrong with sweatshops. They may be tough and, from a Western view,
intolerable, but they are better than the alternatives (unemployment,
subsistence farming, even worse conditions in locally owned factories) and
in providing opportunities for income for poor families are potentially
praiseworthy. When the view of those working within the sweatshop is
taken, the consequences of removing this potential source of employment is
negative – they lose income and opportunity – after all these countries often
have limited social welfare systems. As can be expected this view has
attracted substantial debate and disagreement. However, it is a useful
reminder that in respect of international business ethics the context in which
work occurs and the perspective of workers are important in understanding
and responding to ethical dilemmas.
Exercise 1
International business ethics offers plenty of quandaries and different

approaches from which to consider them. Each approach offers different
advice and conclusions on how business should practice as it crosses
national borders encountering as it does different ways of doing business,
different cultures, different norms and different political and legal systems. To
end this discussion the activity below poses some ethical questions in the
form of scenarios.
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The following gives three scenarios and poses the question of what would
you do in each case. You will find that the five approaches to international
business ethics help make sense of the issues. You are tasked with
providing reasons for your answers. Imagine you are being interviewed on
television and need to back up your argument. Remember there are no right
and wrong answers here. You are looking to make a well-reasoned argument
drawing on your learning from this reading.
Scenario 1 Child labour

You are the manager of a business based in Germany. Your company has
outsourced much of its production to a variety of countries. You are
conducting an audit of your suppliers in Vietnam. On one visit to a factory
you notice that a number of workers look particularly young, certainly below
the minimum age. You question the shift manager who initially denies
employing children. After a bit of pushing he admits there are a few children
working in the factory. Before you have a chance to respond, he says they
are orphans and if they are made redundant, they will have no income and
be unable to afford a place to live – essentially they will end up living on the
streets.
Assuming this is true, what should you do? What is the ethical course of
action?
Scenario 2 The view from home

You are a manager in an electronics firm based in a medium-sized town in
USA. The business works in a highly competitive market where margins and
profits are slim. The company has been successful but shown little growth; it
has managed to maintain market share. However, each year sees profits
reducing. Unlike all of your competitors you manufacture all of your goods in
USA. Your boss tells you that costs need to be cut otherwise the company
will not survive in the medium term. Looking at the financial figures you see
the opportunity to make substantial savings by shifting production to Mexico.
Wages are significantly lower there and the factory there has a great
reputation for quality and good working conditions. The effect of shifting
production to Mexico will mean the loss of 1,000 well-paid manufacturing
jobs in USA. Your company is the only manufacturer in this town and these
workers will find themselves unemployed with limited options for alternative
employment in the town. (These are mostly low-skilled jobs paying minimum
wage.) However, this will mean that the company will become more profitable
and this will satisfy the shareholders (and your boss). The head office will
stay in USA and your job will be safe. However, you have lived in the town
for the past ten years and have many good friends who work in the factory
and who will lose their jobs if production is relocated.
What should you do? What are the ethics of this decision?
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Scenario 3 The ethical consumer

You are planning to purchase a new pair of trainers made by a well-known
brand. You think of yourself as an ethical consumer and want your purchases
to match your beliefs. You locate a pair on the internet. Before you make
your purchase you do some investigation about the company and how it
produces its goods. You find a report on the company that a lot of its
products are stitched by hand by women who are paid very low wages and
subject to long hours with no overtime; women are regularly sacked for
becoming pregnant with no recourse to the law. You see further that female
participation in the labour force is low and that most of these women were
previously very poor subsistence farmers. If they do not receive this income
then they will likely descend into poverty.
Should you buy the trainers or not? What are the ethical issues?
Feedback
These scenarios are deliberately designed to raise difficult ethical questions,
for example:
1 Is it acceptable to employ children if the alternative for them is

homelessness and poverty?
2 Is it acceptable to outsource if this means sacking your colleagues in
order to make more money for the company (and maybe ensure its long-
term future)?
3 Is it acceptable to buy products from sweatshops if this helps vulnerable
people – even if the conditions are unpleasant?
I will not give you any definitive answer to these questions; they are very
much live issues. The point is for you to draw on your learning to help situate
these issues, make sense of them and construct an argument. Below are a
number of examples of the kinds of arguments that could be made (including
reference to the five perspectives on international business ethics discussed
in this reading):
. If you believe that there are certain inherent and universal wrongs, you
may say that child labour is never acceptable under any conditions –
even if the consequences are unpleasant (a moral universalist view).
. You might say that if child labour is acceptable in another country then it
is not up to the business to interfere with this practice (a cultural relativist
view).
. You might say that poverty is an intolerable consequence, in which case
it overrides the wrong of child labour (a moral consequentialist view).
. You might say that the primary duty of business is to make money,
therefore it should move its factory to Mexico (a naïve immoralist view).
. You might think that it is the duty of a business to protect well-paid US
jobs and it should never move its factory to Mexico (a righteous moralist
view).
96
. You might think that the ethical consumer should never get involved with
sweatshops and therefore you should not purchase these goods (a moral
universalist view).
. You might think that the beneficial effects of sweatshops are so great that
they outweigh the negatives; you might want to buy more than one pair of
these trainers (a moral consequentialist view).
Each of these views draws on the different approaches you have been
considering, none of which appears to close the debate definitively. Indeed
international business ethics requires us to debate and reconsider our views.
Fairness in a global labour market
The maritime industry is arguably the most globalised sector of the
global economy; indeed making global trade possible. It is
characterised by complex structures of ownership and operation, and
the crews are made up of seafarers from across the globe brought
together in multinational crews.
In interviews with seafarers I often heard complaints about fairness in

respect of terms and conditions that vary by nationality. Seafarers of
different nationalities are paid very different rates of pay, for example
for the same job an American seafarer would receive approximately
four times the amount in wages than one from Bulgaria. Not only do
wages differ, but different nationalities work different lengths of
contracts with different leave periods.
This is not unusual in the global economy, workers in different countries

receive different wages and are subject to different conditions even
when employed by the same TNC. The difference, however, with the
maritime sector is that these different nationalities are working in the
same place, the ship. Seafarers were working side-by-side doing the
same job yet receiving different wages and conditions by virtue of their
nationality.
If this occurred in a UK-based factory, this would be considered

discrimination and the employer would be subject to legal action.
Employers cannot discriminate between workers on the basis of their
nationality. However, in the maritime sector such differences, again
based on nationality, are commonplace and accepted.
I and a colleague interviewed a number of senior ship-managers to

understand their response to this apparent unfairness. Some of the
arguments we heard were as follows.
. Some took a naïve immoralist approach arguing that fairness is not

relevant in this case. These differences are simply the result of the
functioning of the global labour market for seafarers.
97
Readings 56–61
. Some adopted a moral consequentialist approach, arguing that

equalising terms and conditions across nationalities would lead to
the unemployment of seafarers from low wage countries.
. Some agreed with the moral universalist approach that fairness is
important, but argued that since seafarers were well off in
comparison with their fellow nationals (where they spend their
wages), these low paid seafarers were, in fact, treated fairly.
Interestingly none of the managers thought that this situation should be
changed and all sought to defend the practice. However, this case
raises interesting questions for international business ethics, in
particular how fairness is, or should, be treated in a global context. Is
discrimination of this sort acceptable? Or should all seafarers on a
vessel receive the same wages and conditions for the same job
irrespective of where they come from?
Source: Winchester and Bailey, 2012
3 More comprehensive theories

Working in an international context raises difficult and complex issues for
business practice. This is particularly so where businesses are operating in a
country without well-developed regulations and/or the means to implement
them. This calls for a greater responsibility on business to operate within
clear and shared ethical guidelines. In 2000 The United Nations Global
Compact (UNGC) was launched in order to provide a comprehensive
framework for businesses in order to work towards ‘the vision of a
sustainable and inclusive global economy which delivers lasting benefits to
people, communities, and markets’ (UNGC, n.d. a). The basis of the UNGC
is the creation of a set of ten principles covering four areas: human rights,
labour, environment and anti-corruption. It is a voluntary initiative, where
companies agree to abide by these principles. As of 24 June 2014, there are
over 8,000 businesses participating in the scheme, distributed across 145
countries (UNGC, n.d. b). The following gives a summary of the ten
principles, but note that the UNGC provides substantially more detail on
each of these principles:
The UNGC asks companies to embrace, support and enact, within their
sphere of influence, a set of core values in the areas of human rights,
labour standards, the environment and anti-corruption:
The UN Global Compact

Human Rights
Principle 1: Businesses should support and respect the protection of
internationally proclaimed human rights; and
Principle 2: make sure that they are not complicit in human rights
abuses.
Labour
Principle 3: Businesses should uphold the freedom of association and
98
the effective recognition of the right to collective bargaining;

Principle 4: the elimination of all forms of forced and compulsory
labour;
Principle 5: the effective abolition of child labour; and
Principle 6: the elimination of discrimination in respect of
employment and occupation.
Environment
Principle 7: Businesses should support a precautionary approach to
environmental challenges;
Principle 8: undertake initiatives to promote greater environmental
responsibility; and
Principle 9: encourage the development and diffusion of
environmentally friendly technologies.
Anti-Corruption
Principle 10: Businesses should work against corruption in all its
forms, including extortion and bribery.
(UNGC, n.d. c)
The UNGC covers many of the issues discussed in this and the previous
reading and offers a clear statement of the responsibilities of business as
they operate across the globe (although it equally applies to businesses
operating in a single country). On this it is worth making a couple of
points:
. In avoiding being complicit (i.e. directly or indirectly involved) in

human rights abuses, the principle is very broad. It refers to direct
actions by businesses that cause human rights abuses as well as any
‘beneficial’ complicity where organisations it works with commit rights
abuses irrespective of whether the business knew about it or not. This
commits businesses to find out about what goes on in their supply chains
to the furthest extent. (UNGC, n.d. d)
. In discussing child labour the Global Compact recognises that simply
removing child workers from the business may be counter-productive
(and indeed may lead to other substantial problems). Therefore it tasks
business to provide an alternative for the individual and their family (for
example, by enrolling them in schools, or finding alternative
employment for their parents). (UNGC, n.d. e)
The UNGC represents an extensive attempt to codify the role of global
business in global society. However, the voluntary nature of the UNGC may
give cause for concern. Voluntary compliance to codes (especially one as
extensive as this) does not have a particularly good history – and, of course,
no business is forced to sign up to the compact.
From a more philosophical point of view Richard T. De George in his book
Competing with Integrity in International Business sought to define the
ethical responsibilities of multinational business. (He uses the term
‘multinational business’ rather than transnational corporations). He states
these in terms of seven guidelines that are reproduced here:
G1. Multinationals should do no intentional direct harm.

G2. Multinationals should produce more good than harm for
the host country.
99
Readings 56–61
G3. Multinationals should contribute by their activity to the

host country’s development.
G4. Multinationals should respect the human rights of their
employees.
G5. To the extent that local culture does not violate ethical
norms, multinationals should respect the local culture and
work with and not against it.
G6. Multinationals should pay their fair share of taxes.
G7. Multinationals should cooperate with the local
government in developing and enforcing just background
institutions.
(De George, 1993, pp. 46–55)
As with the UNGC, there are some subtleties to this view that cannot be
gone into here. However, there are a number of points worth noting:
. Some of the statements concerning harm are similar to elements of the

UNGC (although it predates it).
. The view does give some support to the cultural relativist view by
suggesting that TNCs should follow local norms. However, it does this
with a large caveat that if they violate the norms of the home country of
the TNC, home country norms should prevail.
. The guidelines present a positive obligation for the role of TNCs. It is
not that they should avoid harm (e.g. human rights abuses) but they
should have an active role in doing good, and developing a political and
social context in which these guidelines are protected.
In both of these views there is recognition that the TNC, by entering into
another country, develops a responsibility to that community in respect of
its development. It should be an active participant in that country in order
to ensure what might be termed ‘just business’ (Ruggie, 2013) for the whole
community, society or nation. In so doing this moves far away from the
TNC as an organisation dedicated to profit maximisation that moves across
the world chasing cheap labour. By contrast, in this view the TNC becomes
an ethical participant in a variety of national communities, and this is
potentially one of the profound contributions of an ethical approach to
economic globalisation.
4 TNCs – a more positive view

Some of fiercest critics of TNCs and their role in economic globalisation
tend to present a caricature of the way TNCs conduct their business. For
example, TNCs are only interested in profit, in increasing shareholder value
and they are prepared to do this whatever the human costs. The view is that
if sweatshops increase profits then TNCs will use sweatshops because it is
in their nature. At best TNCs don’t know about the exploitation inherent in
their global value chains; at worst they knowingly exploit the poor and
vulnerable in the world. As with most caricatures there is no doubt some
truth in the view that some TNCs have sourced their goods from sweatshops
without much investigation or concern. However, it is also true that some
TNCs have taken active responsibility in securing the conditions of work
within their suppliers, actively intervening to enhance and improve
100
conditions (although the highly cynical might see this as a way to manage
and protect their reputation thus securing increased profits). (There may be
little chance in convincing the cynic otherwise, so this view will be left to
one side.)
Similarly in discussing international business ethics examples often bring up
the unpleasant side of business, of forced labour, of oppressive working
conditions, of bribery, of corruption. Therefore this section ends the
discussion of international business ethics with a reminder of some of the
positive things that some TNCs do.
The garment industry is one sector of the global economy that is frequently
accused of using sweatshops. Next is a clothing retailer based in the UK
which (as with many businesses in the sector) sources its products from a
variety of suppliers from around the world. Since 1998 it operates with
what it calls a Supplier Code of Practice. (This has had a number of
revisions since this date.) It states the minimum standards required from all
of its suppliers, covering a broad range of issues, which are similar to the
UNGC but are not identical with it:
. no child labour
. no forced labour
. freedom of association
. healthy and safe working conditions
. lawful wages and benefits
. lawful working hours
. equal opportunities
. employment security
. respectful treatment of employees
. effective management systems.
(Next, 2011, pp. 2–3)
If suppliers wish to work with Next then they have to demonstrate their
compliance with this code, otherwise Next will not sign a contract. Existing
suppliers are audited by Next’s team of full-time code of practice auditors
to ensure compliance. If the suppliers do not meet all of these standards
Next offers help and support in order to raise standards to the required
level. If issues are not resolved (or steps not taken) then Next will, in the
end, terminate the relationship. Next also states that the code of practice
includes those suppliers used by their contracted party (i.e. where they
outsource themselves) and places a responsibility upon themselves and their
suppliers to maintain their code of practice throughout their entire supply
chain.
In 2002 Next became a member of the Ethical Trading Initiative (ETI), an
alliance of NGOs, businesses and trade unions that has a mission to
improve working standards worldwide, particularly when they involve
supply chains (ETI, n.d.). In an article on Next, ETI reports on Next
organising and participating in conferences for its suppliers and buyers in
respect of their code of practice, as well as training and practical support
for suppliers to meet their code of practice (ETI, 2009). This is not to say
that Next have not been accused of using sweatshops – a report in The
Guardian showed evidence of excessive working hours and a lack of
overtime pay in factories that supply Next (as well as Marks and Spencer
and Gap) (Chamberlain, 2010). However, what Next is doing is more than
101
Readings 56–61
simply avoiding sweatshop conditions – or relying on others to sort out the

problems – it appears to be a proactive participant in attempting to raise
standards.
The ETI provides examples of other companies operating in a more
proactive and positive manner with their suppliers (ETI, 2008). Such
examples offer a picture of TNCs that is beyond the crude caricature of
deeply exploitative capitalist enterprises abusing workers to provide cheaper
goods to Western consumers. Indeed, Next and the ETI offer a useful
reminder that when TNCs are accused as a group of being ethically
unacceptable it is important to look more closely into what these businesses
actually do and how they differ from each other.
Summary
This reading has looked at the link between globalisation, work and
international business ethics. Labour practices at the sharp end of the supply
chain can offer a rather unpleasant image (to put it mildly). News reports
regularly indicate deeply abusive practices – practices that appear
unacceptable to any reasonable ethical point of view (although there are
some extreme views that might differ). In a less extreme example the role
of sweatshops provokes some difficult dilemmas in international business
ethics. Far from being obviously unacceptable, the issue raised by
sweatshops (outside of illegal abuse) raise subtle dilemmas for working
across national boundaries – none of which appear solved in a once-and-for-
all manner by straightforward applications of business ethical principles.
Ethical theories when they hit the ground, when ethical decisions are made
in practice, rarely conform to the abstract world of academic business
ethics. Hence these approaches may be better treated as ways of looking at
the issue in the round rather than as simple solutions to be applied. The use
of more comprehensive frameworks and codes that recognise tensions
within these approaches may be more helpful in this regard. The issue of
TNCs and labour conditions can sometimes seem to be a trial of the ethical
desirability of the TNC; TNCs frequently appear in a bad light. However,
not all TNCs act the same, and there is some evidence of a more proactive
ethical stance and practice by some as they navigate the ethical dilemmas of
international business.
102
References
Chamberlain, G. (2010) ‘Gap, Next and M&S in new sweatshop scandal’,
The Guardian, 8 August 2010. [online]. Available at http://www.
theguardian.com/world/2010/aug/08/gap-next-marks-spencer-sweatshops
De George, R.T. (1993) Competing with Integrity in International Business,
World Economy, 6th edn, Sage, London.
Engels, F. (1952 [1845]) The Condition of the Working-Class in England in
1844, London, George Allen and Unwin.
ETI (n.d.) About ETI, Ethical Trading Initiative. [online]. Available at
http://www.ethicaltrade.org/about-eti (Accessed 19 September 2014).
ETI (2008) M&S: Getting supplier buy-in, Ethical Trading Initiative.
[online]. Available at http://www.ethicaltrade.org/in-action/member-
performance/marks-and-spencer-getting-buy-in (Accessed 19
September 2014).
ETI (2009) Next plc.: Building awareness, Ethical Trading Initiative.
[online]. Available at http://www.ethicaltrade.org/in-action/member-
performance/next-plc-winning-suppliers-hearts-and-minds (Accessed 19
September 2014).
Garside, J. (2013) ‘Child labour uncovered in Apple's supply chain’, The
Guardian, 25 January 2013. [online]. Available at http://www.theguardian.
com/technology/2013/jan/25/apple-child-labour-supply (Accessed 19
September 2014).
Grint, K. (2005) The Sociology of Work, 3rd edn., Cambridge, Polity.
Hodal, K., Kelly, C. and Lawrence, F. (2014) ‘Revealed: Asian slave labour
producing prawns for supermarkets in US, UK’, The Guardian, 10
June 2014. [online]. Available at http://www.theguardian.com/global-
development/2014/jun/10/supermarket-prawns-thailand-produced-slave-
labour (Accessed 19 September 2014).
Huberman, L. (1936) Man’s Worldly Goods: The Story of the Wealth of
Nations, New York, Monthly Review Press.
ILO (n.d. a) Child Labour. [online]. Available at http://www.ilo.org/global/
topics/child-labour/lang–en/index.htm#a1 (Accessed 19 September 2014).
ILO (n.d. b) Forced labour, human trafficking and slavery. [online].
Available at http://www.ilo.org/global/topics/forced-labour/lang–en/index.
htm (Accessed 19 September 2014).
ILRF (2010) Missed the Goal for Workers: The Reality of Soccer Ball
Stitchers in Pakistan, India, China and Thailand, (International Labour
Rights Forum). [online]. Available at https://archive.cleanclothes.org/
component/docman/doc_download/31-missed-the-goal-for-workers
103
Readings 56–61
Kline, J.M. (2010) Ethics for International Business, 2nd edn., London,
Routledge.
Maitland, I. (2009 [1997]) ‘The great non-debate over international
sweatshops’, in Beauchamp, T.L., Bowie, N.E. and Arnold, D.G. (eds.),
Ethical Theory and Business, 8th edn., Upper Saddle River, NJ, Prentice
Hall.
Next (2011) Code of Practice Policy Summary. [online]. Available at http://
www.nextplc.co.uk/~/media/Files/N/Next-PLC/pdfs/corporate-responsibility-
report/1%20COP%20Standards%202011%20-%20Code%20Policy%
20Summary%20Nov%2013.pdf (Accessed 19 September 2014).
Ruggie, J.G. (2013) Just Business: Multinational Corporations and Human
Rights, New York, W.W. Norton & Company.
UNGC (n.d. a) Overview of the UN Global Compact, United Nations
Global Compact. [online]. Available at https://www.unglobalcompact.org/
AboutTheGC/index.html (Accessed 19 September 2014).
UNGC (n.d. b) UN Global Compact Participants, United Nations Global
Compact. [online]. Available at https://www.unglobalcompact.org/
ParticipantsAndStakeholders/index.html (Accessed 19 September 2014).
UNGC (n.d. c) The Ten Principles, United Nations Global Compact.
[online]. Available at https://www.unglobalcompact.org/AboutTheGC/
TheTenPrinciples/index.html (Accessed 19 September 2014).
UNGC (n.d. d) Global Compact Principle Two, United Nations Global
AboutTheGC/TheTenPrinciples/Principle2.html (Accessed 19
September 2014).
UNGC (n.d. e) Global Compact Principle Five, United Nations Global
AboutTheGC/TheTenPrinciples/principle5.html (Accessed 19
September 2014).
Young, I.M. (2011) Responsibility for Justice, Oxford, Oxford University
Press.
Winchester, N. and Bailey, N. (2012) ‘Making sense of "global" social
justice: claims for justice in a global labour market’, Sociological Research
Online, vol. 17, no. 4. [online]. Available at http://www.socresonline.org.uk/
17/4/10.html (Accessed 27 November 2014).
104
Acknowledgements
Acknowledgements
Figures
Reading 56
Figure 1: © Ivcandy/iStockphoto.com
Figure 2: © bymandesigns/iStockphoto.com
Reading 57
Figure 1: © dpa picture alliance archive/Alamy Stock Photo
Figure 2: © qingwa/iStockphoto.com
Figure 3: Courtesy of Mike Doughty
Figure 4: © Microsoft
Reading 58
Figure 1: Taken from http://teacherweb.com © Pearson Prentice Hall Inc.
Figure 2: Taken from www.economist.com/blogs 2011
Figure 4: © AF Archive/Alamy
Figure 5: © Robert Herhold/iStockphoto.com
Reading 59
Figure 1: © Nick Moore/Alamy
Figure 2: Dicken, P. (2011) Global Shift: Mapping the changing contours of
the World Economy, Sage Publishing Ltd
Figure 3: © Susana Gonzalez/Bloomberg/Getty Images
Figure 4: © Michael Puche/Shutterstock.com
Reading 60
Figure 1: ©kruwt/iStockphoto.com
Figure 2: © Transparency International, 2015. All Rights Reserved
Figure 3: © Valenaphoto/iStockphoto.com
Figure 4: © Jeff Whyte/Shutterstock.com
Reading 61
Figure 1: © Joerg Boethling/Alamy
Tables
Reading 58
Table 3: Taken from The Economist Special Report, Jan 19th 2013:
Companies need think more carefully about the offshore and outsource herd
instinct. The Economist.
105
Readings 56–61
Reading 60
Table 1: Hardoon, D. and Heinrich, F. (2011) Bribe payers index ©
Transparency International
Text
Reading 57
Page 20: The Growth of Legal Outsourcing – Passage to India, The
Economist, 24th June 2010
Page 25: Matulef, J. (2014) Ori and the Blind Forest looks great, but plays
even better, from www.eurogamer.net
Page 28: Carson, J. (2014) German export opportunities abound, Daily
Telegraph, 19th May 2014 © Telegraph Media Group Limited
Reading 59
Page 64: Courtesy of BBC
106

B100 Introduction To Business Management (The Open University)

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B100 An introduction to business and management

The Open University, Walton Hall, Milton Keynes MK7 6AA.

Reading 1: What is a business?

1 Deﬁning the meaning of business

. a branch of a national bank

. They offer goods or services to customers.

Reading 2: Different types of

Size – this is a fairly obvious but important category. A local

1 Classifying businesses by size

Figure 1 Examples of small businesses

. Large enterprises employ 250 people or more and have an annual

2 Classifying businesses by industry

. The primary sector involves extracting and harvesting natural products

Some people also distinguish a fourth sector, which is made up of

It is useful to distinguish these broad economic sectors as we can see that

3 Ownership structures and legal forms

legal responsibilities, including the paperwork that the owners need to

Business partnerships – an arrangement where two or more individuals

4 Examples of different businesses

Example of small, family-owned, private limited company:

The business has approximately 25 employees and does all its

Example of large, shareholder-owned, public limited company:

Example of large, family-owned, private limited company:

Figure 3 Mercadona supermarket

Mercadona competes successfully against international supermarket chains

productivity through extensive employee training. It is now the largest

. Is this a large, medium-sized, small or microbusiness?

Reading 3: Businesses and other

1 The differences between organisations

. Who has ultimate control or ownership of the organisation?

Table 1 Characteristics of private, public and third sector organisations

Characteristics Private sector Public sector Third sector

(Source: adapted from Billis, 2010, p. 55)

In the private sector, businesses are ultimately controlled by their owners. In

Describe the characteristic features of an organisation that you are familiar

Public 1 4 Third 1 Public/third

Figure 1 Different sorts of hybrid organisation (source: based on Billis, 2010)

1 A charity that provides a counselling service to people in need but that

Reading 4: What is management?

Some of the things that managers do are:

As with ‘business’ there are quite a few deﬁnitions of ‘management’; here

The process of dealing with or controlling things or people [...] 1. The

Management in business and organizations is the function that

comprises planning, organizing, stafﬁng, leading or directing, and

From these deﬁnitions we can see that management has to do with

. forecasting and planning

2 What others think managers do

What do managers do at work?

Recently [...] my mind raced back 25 years to my ﬁrst encounter with

. 55%: Managers control people’s actions at work, making sure they

Do you have a formal managerial role? Do you consider yourself a manager?

Reading 5: The external

The variety of businesses in the country has also increased; many

The following extract, from a newspaper article, gives an example of a

Arena Flowers’ Valentine’s display

was started as an e-commerce ﬂower business in 1998 by entrepreneur

Answer the following questions based on the extract above:

1 How does Arena Flowers differ from a traditional ﬂorist’s shop?

Both businesses and individuals behave according to their expectations of

make borrowing more expensive and thus discourage consumers from

Box 1 The effect of changes in exchange rates

Month Exchange Cost of toys exported Cost of wood imported

Figure 1 Power station