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 Cambridge
International AS & A Level

Business
Second edition

Malcolm Surridge
Andrew Gillespie
Acknowledgements
p.118 © Charlie Box/Dyson; p.131 © Courtesy of L’Oreal; p.262 © Abel, G. J. (2018). Estimates of global
bilateral migration flows by gender between 1960 and 2015. International Migration Review, 52(3), 809-852;
p.282 © Berkeley Earth. Retrieved from http://berkeleyearth.org/wp-content/uploads/2020/01/2019_Time_
Series.png; p.283 © Toshiba Corporation (2019). Environmental Report. Retrieved from https://www.toshiba.
co.jp/env/en/communication/report/pdf/env_report19_all_e.pdf; p.290 © Acha Leke, Mutsa Chironga, and
Georges Desvaux, Africa’s overlooked business revolution. McKinsey & Company. November 15, 2018. Retrieved
from https://www.mckinsey.com/featured-insights/middle-east-and-africa/africas-overlooked-business-
revolution; p.292 © Colgate-Palmolive Company. Retrieved from https://investor.colgatepalmolive.com/static-
files/a65490ac-2442-41e3-8751-e18a1471bd92; p.472 © BP p.l.c. Energy with Purpose. BP Annual Report and
Form 20-F 2019. Retrieved from https://www.bp.com/content/dam/bp/business-sites/en/global/corporate/pdfs/
investors/bp-annual-report-and-form-20f-2019.pdf
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Contents
Introduction vii

AS LEVEL

1 Business and its environment

1.1 Enterprise 1
1.1.1 The nature of business activity 1
1.1.2 The role of entrepreneurs and intrapreneurs 8
1.1.3 Business plans 13
1.2 Business structure 16
1.2.1 Economic sectors 16
1.2.2 Business ownership 18
1.3 Size of business 27
1.3.1 Measurements of business size 27
1.3.2 Significance of small businesses 27
1.3.3 Business growth 30
1.4 Business objectives 33
1.4.1 Business objectives in the private sector and public sector 33
1.4.2 Objectives and business decisions 38
1.5 Stakeholders in a business 41
1.5.1 Business stakeholders 41
1.5.2 The relative importance and influence of stakeholders on
business activities 43

2 Human resource management

2.1 Human resource management 47
2.1.1 Purpose and roles of human resource management 47
2.1.2 Workforce planning 48
2.1.3 Recruitment and selection 50
2.1.4 Redundancy and dismissal 54
2.1.5 Morale and welfare 56
2.1.6 Training and development 59
2.1.7 Management and workforce relations 62
2.2 Motivation 66
2.2.1 Motivation as a tool for management and leadership 66
2.2.2 Human needs 66
2.2.3 Motivation theories 68
2.2.4 Motivation methods in practice 76
2.3 Management 83
2.3.1 Management and managers 83

3 Marketing
3.1 The nature of marketing 93
3.1.1 Role of marketing and its relationship with other
business activities 93
3.1.2 Demand and supply 95
3.1.3 Markets 98
 3.1.4 Consumer and industrial marketing 101
CONTENTS

3.1.5 Mass marketing and niche marketing 102

3.1.6 Market segmentation 103
3.1.7 Customer-relationship marketing 104
3.2 Market research 106
3.2.1 Purposes of market research 106
3.2.2 Primary research and secondary research 107
3.2.3 Sampling 110
3.2.4 Market research data 111
3.3 The marketing mix 115
3.3.1 Elements of the marketing mix 115
3.3.2 Products 116
3.3.3 Product portfolio analysis 117
3.3.4 Pricing methods 123
3.3.5 Promotion methods 127
3.3.6 Place (channels of distribution) 134

4 Operations management
4.1 The nature of operations 142
4.1.1 The transformational process 142
4.1.2 Efficiency, effectiveness, productivity and sustainability 144
4.1.3 Capital-intensive and labour-intensive operations 148
4.1.4 Operations methods: job, batch, flow, mass customisation 149
4.2 Inventory management 151
4.2.1 Managing inventory 151
4.2.2 Just in time 155
4.3 Capacity utilisation and outsourcing 157
4.3.1 Significance and measurement of capacity utilisation 157
4.3.2 Outsourcing 160

5 Finance and accounting

5.1 Business finance 162
5.1.1 The need for business finance 162
5.1.2 Working capital 166
5.2 Sources of finance 169
5.2.1 Business ownership and sources of finance 169
5.2.2 Internal and external sources of finance 170
5.2.3 Factors affecting sources of finance 176
5.2.4 Selecting the source of finance 178
5.3 Forecasting and managing cash flows 180
5.3.1 Cash-flow forecasts 180
5.4 Costs 187
5.4.1 Cost information 187
5.4.2 Approaches to costing 189
5.4.3 Uses of cost information 194
5.4.4 Break-even analysis 199
5.5 Budgets 205
5.5.1 The meaning and purpose of budgets 205
5.5.2 Variances 209

iv
A LEVEL

Contents
6 Business and its environment
6.1 External influences on business activity 214
6.1.1 External influences on business activity: Political and legal 214
6.1.2 External influences on business activity: Economic 227
6.1.3 External influences on business activity: Social and
demographic 255
6.1.4 External influences on business activity: Technological 266
6.1.5 External influences on business activity: Competitors and
suppliers 271
6.1.6 External influences on business activity: International 274
6.1.7 External influences on business activity: Environmental 281
6.2 Business strategy 287
6.2.1 Developing business strategy 287
6.2.2 Corporate planning and implementation 304

7 Human resource management

7.1 Organisational structure 313
7.1.1 Relationship between business objectives and structure 313
7.1.2 Types of structure 316
7.1.3 Delegation and accountability 321
7.1.4 Control, authority and trust 323
7.1.5 Centralisation and decentralisation 324
7.1.6 Line and staff 325
7.2 Business communication 328
7.2.1 Purposes of communication 328
7.2.2 Methods of communication 330
7.2.3 Channels of communication 334
7.2.4 Barriers to communication 335
7.2.5 Role of management in facilitating communication 336
7.3 Leadership 341
7.3.1 Leadership 341
7.3.2 Theories of leadership 343
7.3.3 Emotional intelligence/emotional quotient 346
7.4 Human resource management strategy 349
7.4.1 Approaches to human resource management 349
7.4.2 Flexible workforces 352
7.4.3 Measurement, causes and consequences of poor employee
performance 358
7.4.4 Strategies for improving employee performance 360
7.4.5 Roles of IT and AI in human resource management 363

8 Marketing
8.1 Marketing analysis 366
8.1.1 Elasticity 366
8.1.2 Product development 371
8.1.3 Sales forecasting 375

v
 8.2 Marketing strategy 383
CONTENTS

8.2.1 Planning the marketing strategy 383

8.2.2 Approaches to marketing strategy 384
8.2.3 Strategies for international marketing 387

9 Operations management
9.1 Location and scale 394
9.1.1 Location 394
9.1.2 Scale of operations 400
9.2 Quality management 406
9.2.1 Quality control and quality assurance 406
9.2.2 Benchmarking 410
9.3 Operations strategy 412
9.3.1 Operations decisions 412
9.3.2 Flexibility and innovation 414
9.3.3 Enterprise resource planning 416
9.3.4 Lean production 417
9.3.5 Operations planning 422

10 Finance and accounting

10.1 Financial statements 430
10.1.1 Statement of profit or loss 430
10.1.2 Statement of financial position 435
10.1.3 Inventory valuation 438
10.1.4 Depreciation 440
10.2 Analysis of published accounts 444
10.2.1 Liquidity ratios 445
10.2.2 Profitability ratios 448
10.2.3 Financial efficiency ratios 450
10.2.4 Gearing ratios 452
10.2.5 Investment ratios 453
10.3 Investment appraisal 457
10.3.1 The concept of investment appraisal 457
10.3.2 Basic methods 458
10.3.3 Discounted cash-flow methods 460
10.3.4 Investment appraisal decisions 462
10.4 Finance and accounting strategy 467
10.4.1 Using accounting data to enable strategic
decision-making 467
10.4.2 Using accounting data and ratio analysis in strategic
decision-making 471
Index 481
Photo credits 488

vi
Introduction
This book introduces you to Business. It has been written to
meet the requirements of the Cambridge International AS &
A Level Business syllabus (9609) for examination from 2023.
The syllabus (9609)
The Cambridge International AS & A Level Business syllabus
is based on five topics which are studied at both AS Level
and A Level. These are:
» Business and its environment
» Human resource management (HRM)
» Marketing
» Operations management
» Finance and accounting.
The AS section of the syllabus gives you the opportunity to
understand what happens inside businesses and introduces
you to key business terminology. It also looks at the four
internal functions of businesses providing an understanding
of how they operate and how businesses manage workforces,
research and satisfy customer needs, manage the process of
creating goods and services and manage their finances. You
are encouraged to consider the working of these internal
functions in different business contexts.
The A-Level material builds on AS content and is based around
the concept of strategy. It looks in detail at the external
influences on business activity and encourages you to take
account of what is happening in the real world. The syllabus
looks at ways in which businesses can develop, plan and
implement corporate strategies. It also covers the strategic
elements of the four business functions introduced at AS and
encourages you to think about these in business-wide contexts.
The features of the book
The book will guide you through the Cambridge International
AS & A Level Business programme of study, although you
should supplement it with research into businesses in your
own and other countries. You are fortunate that there is an
immense amount of information available about businesses,
their behaviour and the environments in which they operate.
The internet is an enormous and valuable resource and you
will also find that newspapers, magazines and television
contain a lot of relevant information. However, business
activity takes place around you all the time: when you
are shopping, travelling to and from school or college or
enjoying leisure activities such as visiting the cinema. There
are many opportunities for you to see the operation of some
of the models and theories you will study.
This textbook includes the following features:
Chapter overview
At the outset of each chapter there is guidance on the
material that is covered in the chapter. This shows the
knowledge that can be gained from studying this chapter.
The syllabus (9609)
Glossary terms
These boxes contain descriptions of highlighted glossary
terms used throughout the book to help explain additional
concepts.
Handling data
This feature is designed to help to develop relevant
numerical skills such as conducting calculations and
interpreting numerical data.
Case study
There is a diverse range of case studies to illustrate how
theories and concepts operate in the real world. These all
have questions to help you to develop the skills needed in
preparation for your examinations.
Study tip
These appear throughout the book and are designed to help
you to understand the material that you have studied and to
prepare for your examinations.
Test your learning
At the end of each chapter there is a range of questions
and activities to help you to reinforce your learning and to
develop the necessary skills.
The key concepts
The syllabus is based on the six key concepts set out
below which should underpin your study of the subject
matter. Familiarity with these key concepts can help you to
understand the material in this resource and the syllabus,
and help you think about how these can be applied to
diverse business scenarios and questions.
As these concepts are an essential aspect of the syllabus,
they have been signposted throughout the textbook using
the associated icons. The syllabus definitions of these
key concepts can be found within the syllabus on the
Cambridge International website, but we discuss these
further here:
Change
All businesses are subject to change and have to respond to
it regularly and frequently. Change may be internal, perhaps
following the appointment of a new leader which could,
for example, result in a new organisational culture, new
methods of production and the targeting of new markets.
Alternatively, it may be external, perhaps as a consequence
of a change in the business environment; the UK’s recent
decision to leave the European Union is a prime example.
Managing change effectively contributes to business success.
vii

INTRODUCTION
Context
Businesses operate in diverse contexts and these have a
major influence on decision-making. A decision that might be
appropriate and successful for a small family-owned business
facing a drop in sales may be entirely unsuitable for a large
multinational manufacturer facing the same problem. You
need to understand the importance and impact of context.
Decision-making
Change can create a need for decision-making. Decisions
can be taken by stakeholders within the business as well as
those outside of it. Decisions may be based on instinct or a
‘hunch’, or on the analysis of the available quantitative and
qualitative data. Decisions can be taken at different levels
within an organisation and may impact on part or all of it.
Enterprise
Enterprise is the ability to make new ideas work and thus
enables businesses to take advantages of opportunities that
may exist. Enterprise is not simply limited to start-ups; in a
changing world, enterprise is vital for competitiveness.
Innovation
Innovative businesses are more able to develop new products
or better ways of producing them. This helps to enhance
competitiveness and strengthen performance by leading
the field rather than being a more passive follower.
Strategy
A business’s strategy is its long-term plan to achieve its
objectives. Successful businesses are able to develop and
implement effective strategies through analysing the
business environment and the opportunities available and
making appropriate choices.
The structure of the AS- and
A-Level examinations
There are two examination papers for AS and two for A Level
Business. The subject content of AS Business is assumed
knowledge for the A-Level papers.
AS Level Paper 1: Business Concepts 1
• This paper carries a total of 40 marks and has a duration
of 1 hour 15 minutes.
• It tests the entire AS element of the syllabus.
• It comprises two sections:
• Section A contains four short answer questions. The
first three questions are split into two parts each.
• Section B contains two essay questions, one of
which must be answered. The essays are split into
two parts each.
• Section A and Section B each carry a maximum of
20 marks.
AS Level Paper 2: Business Concepts 2
• This paper carries a total of 60 marks and has a duration
of 1 hour 30 minutes.
• It tests the entire AS element of the syllabus.
viii
• It comprises two data response questions which may be
based on text and numerical data. Each question is split
into six parts.
• Each of the two data response questions will carry a
maximum of 30 marks.
A Level Paper 3: Business Decision-Making
• This paper carries a total of 60 marks and has a duration
of 1 hour 45 minutes.
• It tests the entire A Level syllabus and builds on AS
knowledge and understanding.
• It is based on a case study which includes prose, tables
of data and numerical or diagrammatic appendices.
• The case study will normally have five questions
attached to it.
A Level Paper 4: Business Strategy
• This paper carries a total of 40 marks and has a duration
of 1 hour 15 minutes.
• It tests the entire A Level syllabus, and builds on AS
knowledge and understanding.
• It comprises two questions, each worth 20 marks, based
on a series of numerical and non-numerical data relating
to a case study.
The information in this section is based on the 9609 syllabus
for examination from 2023. You should always refer to the
appropriate syllabus document for the year of your examination
to confirm the details and for more information. The syllabus
document is available on the Cambridge International website
at http://www.cambridgeinternational.org.
Preparing for Business examinations
The Business syllabus requires you to understand the
relevant theories and concepts set out in the syllabus
and covered in this book. However, you will also need
to know how to organise ideas, construct arguments,
make decisions, solve problems, conduct calculations
and interpret data. Finally, it is important for you to
ensure you know how to apply your knowledge to business
scenarios, such as those set out in questions that relate to
data response materials or case studies.
This textbook contains numerous questions throughout, and
at the end of, each chapter which have been designed to
help you to develop these essential skills.
Malcolm Surridge & Andrew Gillespie
A note on the exam-style questions
Exam-style questions (and sample answers) have been
written by the authors. In examinations, the way marks
are awarded may be different. References to assessment
and/or assessment preparation are the publisher’s
interpretation of the syllabus requirements and may
not fully reflect the approach of Cambridge Assessment
International Education. Cambridge International
recommends that teachers consider using a range of
teaching and learning resources in preparing learners for
assessment, based on their own professional judgement of
their students’ needs. Third-party websites and resources
referred to in this publication have not been endorsed by
Cambridge Assessment International Education.
1 Business and its environment
AS LEVEL

1.1 Enterprise

1.1.1 The nature of business activity

Chapter overview
In this chapter we examine:
★ the nature and purpose of business activity; for example, we look at factors of production, the business environment,
what businesses do and the concept of adding value
★ the differences between local, national, international and multinational businesses
★ the role of the entrepreneur and intrapreneur; for example, we consider why entrepreneurs are important to the
economy, and barriers to entrepreneurship
★ business risk and uncertainty
★ business plans; for example, we consider the purpose of business plans, their key elements and their limitations.

1.1.1 The nature of business activity and organising what they do in order to achieve targets,
such as helping people get better more quickly or improving
the quality of students’ education.
The purpose of business activity
What will you do this weekend? Have you got a part-time The transformation process
job to earn some money? Are you going to go out to a café
All businesses are involved in the transformation process.
or go shopping in the town centre? Whatever you do, you
They take inputs and transform them in some way to
will come into contact with many different businesses,
produce outputs that they hope consumers will want.
either as a consumer buying and using their products or
as an employee working to create them. Businesses are
INPUTS TRANSFORMATION OUTPUTS
everywhere! Just think of the last time you went shopping
• land PROCESS • goods
– the outlet where you shop is a business, it has bought
• labour • services
the products from a supplier, they were transported by
• capital • by-products
a delivery business and the firm probably uses another CREATES VALUE
business to help promote itself. In every transaction • enterprise
between a customer and a business, many other businesses
will have been involved to bring about that exchange.
There are many different definitions of a business, but what
they tend to have in common is the idea of someone (or a FEEDBACK
group of people) working in an organised way to achieve
a given target. Notice the key elements of this definition ▲ Figure 1.1 The transformation process
– firstly, the activities of those involved are organised in
some way and, secondly, the business is created with a Inputs
specific purpose in mind: often the business objective The inputs into a business are also called the factors of
is profit but, as we shall see later, there are many other production. These are:
reasons why people set up in business. Using a definition of » land
organised activities and a given target, many organisations » labour
such as hospitals and even schools could be classified as » capital
businesses. They may not have profit as a target, but they » enterprise.
do involve many different people working together, planning

GLOSSARY TERMS
Business objectives are measurable targets set by the The factors of production are the inputs into the
business, such as sales or profits that have to be achieved transformation process of a business; namely land, labour,
within a given time period. capital and enterprise.
The transformation process involves converting inputs into
outputs.

1
 Land
This involves choosing the location of the business. This is
1.1 critically important for businesses such as shops and cafés.
For other businesses such as farming, what will matter
is the quality of the land in terms of the ability to grow
different crops or rear livestock. The success of a farming
business will be directly affected by changes to the quality
of the land and the weather. For some businesses, what will
matter is access to resources; for example, oil drilling and
mining businesses need to be near the natural resources.
AS LEVEL 1.1 ENTERPRISE
The significance of land as an input will be particularly high
in the primary sector.
Under the heading of land we also include premises.
The amount of space available to a business can affect
how much can be produced or how many customers can
physically fit in the restaurant or store. The nature of the
premises can also affect the working environment and
people’s motivation. For example, working in a modern
office with a good canteen, parking spaces and a central
location might be appealing to employees.
GLOSSARY TERM
The primary sector is the first stage of production and
includes extracting or growing resources. Farming,
mining and fishing are all part of the primary sector.
Labour
Organisations will need staff. The quality of employees
in terms of their skills, their attitudes (for example, to
customers), their willingness to work and their natural
abilities will have an influence on the success of any
business. What makes a film a great success? The quality of
the writing, the acting and the production – people play
a key role in the success of any film. Many films therefore
promote themselves on the basis of who the actors are or
who the director is. Similarly, universities promote their
professors. Music labels promote their bands. Publishers
promote their author list. So people can be a crucial
element of the transformation process.
Capital
The word ‘capital’ has many meanings. In this instance,
we mean the equipment used by businesses. The coffee
machines in the coffee shop, the ovens in the fast-food
restaurants, and the scanning equipment in shops are all
examples of capital equipment. The amount and quality of
the capital equipment in a business can affect the service it
provides. For example, the online retailer Amazon is admired
for the efficiency with which it processes an order and is
able to make suggestions to customers of what else they
might like to buy. These rely on the quality of Amazon’s
warehousing facilities and computer programs.
Enterprise
Enterprise refers to a set of skills that develops new ways
of doing things or new things to do. Enterprise refers to the
ability to be creative and innovative, to come up with new
ideas, to combine resources in different ways and to be willing
to take risks. Enterprise brings together the other factors of
production to create and make a business idea competitive.
2
The choice of inputs
The choice of inputs into the business and who supplies
them can affect:
» the costs of a business
» the quality of the final product (and therefore sales).
In recent years, customers have become increasingly
interested in what resources are used in a production
process and where they have come from. Firms may
highlight the fact that they use recycled materials, that
their supplies come from local businesses or that their
ingredients are ‘natural’ or ‘organic’.
Firms will also face the choice of whether to buy in some
materials or produce them themselves. Tyrrells uses the fact
that it grows its own potatoes when it promotes its potato
crisp products. Most other crisp manufacturers buy in their
potatoes.
Outputs
The output of a business is a product. A product may be a
good or a service, or a combination of the two.
» A good (or a product) is a tangible physical item, such
as a car or a laptop computer. Businesses can produce
and stock them. This means that they can produce or
purchase the goods that they sell in advance of demand;
for example, a store may stockpile new electrical goods
before a busy selling period.
» A service is intangible. Examples of services
are education, creating music, hairdressing and
physiotherapy. Most businesses in more developed
economies are in the service sector. Services cannot be
stored; they have to be produced for customers as they
are needed. This can create problems, because if there is
a rush of customers, there are no products stockpiled and
so queues form or waiting lists have to be introduced.
In many cases, a business provides a combination of goods
and services. For example, you may choose a restaurant
because of the food you can eat there (the goods) but also
because of the waiters, the environment and the way you
are treated (the service).
Most outputs are intended for sale. A firm produces
goods and services to sell to customers. However, there
may also be by-products from the transformation process;
for example, a firm’s production may create waste and
pollution. Many customers pay attention to these issues
and, increasingly, firms are considering the effects
of their production on other groups, such as the local
community. Some by-products may also form the inputs
to other industries.
For most products there is a series of stages in the
transformation process which are involved in taking the
initial materials and ending up with the final product. The
author JK Rowling took her imagination and a computer
and turned her ideas into magical manuscripts for her Harry
Potter books. The publishing company worked with the
author, designers, editors, a marketing team, a printing
business and a distribution business and turned the
 CASE STUDY
Dabbawalla
▲ Figure 1.2 A busy dabbawalla delivery in Mumbai
Every day in Mumbai, India, around 250 000 people get
their lunches delivered by ‘dabbawallas’. A ‘walla’ means
manuscripts into a series of books. Bookstores take a range
of books and transform them into a retail experience for the
customer. A series of transformations has gone on to get
the idea from the author’s mind into a book and into the
hands of the reader.
Managing the
Managing the transformation Managing the
inputs process outputs
TRANSFORMATION
INPUTS OUTPUTS
PROCESS
FEEDBACK
▲ Figure 1.3 Chain of operations
Businesses need to identify exactly what they want to
provide in terms of the range and quality of products they
offer. For example, do they want to specialise in a few types
of items or provide a wide range of goods and services?
Businesses also need to decide on the resources they will
need in order to provide the product to the standard they
want for their customers. There are a number of questions
involved here: How many people are needed? What skills are
needed? Will they be trained? What materials will be used?
What equipment? And so on. Businesses need to find a way of
generating a product that customers value so much that they
will pay more for it than it costs the business to produce.
Adding value
Adding value occurs in a transformation process when
outputs are produced that are worth more than the inputs
brought in to provide them.
1.1
a ‘doer of something’ and a ‘dabba’ is a stainless steel
lunchbox. The lunchbox is picked up from the customer’s
home and taken to a sorting station. The lunchboxes are
then divided up according to destination and delivered
on bike, on foot or taken on the train. After lunch, the
box is collected and taken back to the customer’s home.
1.1.1 The nature of business activity
This is an incredibly efficient but very labour-intensive
and low-technology process, with almost no boxes going
missing or to the wrong address. The price is so low that it
is easier to pay for the delivery than to take your lunchbox
with you on your journey to and from work.
Questions
1 Explain one way in which the dabbawallas transform
inputs into outputs. [3]
2 Evaluate how you would measure the success of
this transformation process. [12]
For example, artists such as Andy Warhol, Vincent van Gogh,
David Hockney and Rembrandt took their imagination, paint
and canvas and produced amazing works of art that now
sell for millions of dollars: far more than the cost of the
items used up in their production. They added value via the
transformation process.
Jamie Oliver, a famous chef, takes standard ingredients
such as meat, herbs and vegetables, puts them together in
a unique way and comes up with a fantastic meal. He takes
ingredients that many others may use but transforms them
in a way that appeals to customers, sells books and attracts
viewers for his TV series. Clearly, he has added value by
using his talent, creativity and personality.
GLOSSARY TERM
Adding value occurs in a transformation process when
outputs are produced that are worth more than the inputs
brought in to provide them.
Adding value can be done in ways that may seem odd to
some. Here are some examples:
» Some companies buy new jeans and then stretch
them, batter them and fray them to make them look
distressed while, at the same time, more than doubling
their price.
» Bottled water that sells for $10 a bottle comes from
King Island, near Tasmania. It is called ‘Cloud Juice’ and
is claimed to be the purest in the world. It is rainwater
that has been collected from a plastic roof and then
bottled. It is supposed to be so pure because it comes
from rain clouds that travel 7000 miles from South
America without passing over any land, and therefore
not encountering pollution.
» One of the most expensive coffees in the world is
Luwak Coffee. This is made from coffee cherries that
3
 have been eaten and digested by common palm the brand or developing a unique selling proposition
civets (a type of animal). The civets use their keen (USP). A USP is a feature of the product that makes it
1.1 sense of smell to select the choicest and ripest beans.
The beans are supposed to be much sweeter as a
different from competitors’ products for the customer; for
example, a product may be perceived as better quality,
result of the digestion process and, having passed better designed, more reliable or more user-friendly than
through the animal, they are hand-collected from the competitors’ products.
jungle floor.
To increase the value it adds, a business might aim to:
STUDY TIP
» reduce the costs of producing the product. This means
cutting back on waste, ensuring the best price for the When answering questions, you may need to think about
AS LEVEL 1.1 ENTERPRISE

how different firms create value. What can businesses do

supplies and making sure that mistakes are not made. All
to add more value? Should they focus on the benefits they
activities that do not create value need to be examined
are providing, or try to control costs more effectively?
to see if they are truly necessary.
» increase the perceived benefit of the product in the
eyes of the customer. This could be through building

CASE STUDY
FedEx
FedEx connects people with goods, services, ideas FedEx has over 180 000 vehicles and nearly 680 planes. It
and technologies. By doing this, FedEx says it creates delivers over 15 million packages on an average day and
opportunities that drive innovation, energise businesses deals with over 250 requests linked to package tracking
and help communities improve their standard of living. each day.
FedEx says it does far more than deliver packages. It says
Source: www.fedex.com/en-us/about/company-structure.html
it delivers joy in the holidays, provides hope to survivors
of natural disasters and solves business problems. Its Question
network extends to over 220 countries and territories.
1 Explain one way in which FedEx can add value in its
Its 490 000 team members are united behind the FedEx
transformation process. [3]
promise to ‘make every FedEx experience outstanding’.

CASE STUDY
IKEA
IKEA is a furniture producer and retailer. The value chain
of a product describes all the stages of operations, from
Listen to
the initial raw materials through to the sale of the actual
customers
goods. In IKEA’s case, it owns and manages nearly all the
stages of its value chain. IKEA says that the starting point
for any value chain is the product itself, and the idea for
this starts with ‘listening to people’s needs and dreams, Design and
Sell create
so we understand how we can make a difference’. the product
Typically, IKEA turns this initial idea based on customers’
needs into a sketch of how the product might look. This
sketch is then discussed with its suppliers, who consider
how it might be made, transported and stored in-store.
IKEA will be looking for ways of producing a product with Package and
a high-quality design and finish while keeping costs low. Manufacture
distribute to
IKEA is always trying to improve the product at each stage the product
stores
of discussion and review. Improvements are welcomed
from the various people involved in production; for
example, designers and technicians. One such suggestion ▲ Figure 1.4 The value chain of a product
might be using a more sustainable material.

4
 Much of IKEA’s furniture is produced and packaged in the
form of a flat-pack, which lowers transport costs because
it is easy to put large quantities on lorries and on shelves
in-store. This helps keep prices low for IKEA’s customers,
who then take the products home and build the products
themselves. Collaboration between customers, partners
and co-workers aids IKEA’s pursuit ‘to add value to
people’s everyday lives’ by producing good-quality
furniture at low prices.
Source: https://about.ikea.com/en/about-us/the-ikea-value-chain
GLOSSARY TERMS
A brand is a name, design, logo, symbol or indeed anything
that makes a product recognisable and distinguishes it
from the competition in the eyes of the customer.
Market forces are the forces of supply and demand which
determine the price of a product and the quantity bought
and sold in a market.
Opportunity cost measures the sacrifice made by
choosing one option in terms of the next best alternative
foregone.
Businesses and economic activity
Businesses make up an important part of any economy.
They are important because they employ people, they pay
employees’ wages and salaries and they provide goods
and services. Businesses provide the products we buy and
give us the jobs and earnings we need to buy them. When
businesses are doing well and expanding they employ
more people and generate more income for the economy.
Businesses innovate to win more customers: they create
new goods and services and this can improve the quality
of our lives, by providing better food, better clothes
and better electronic goods. Businesses therefore drive
economies forward, and this is why governments are eager
to help new firms start up and compete, and why they often
try to help businesses grow.
Choice and opportunity cost
In any economy there is a fixed amount of resources at any
moment and therefore decisions have to be made about how
these resources are used. Given the scarcity of resources,
choices are inevitable in terms of what should be produced
in the economy, how these products should be produced and
who should receive them. Some of these decisions will be
made by market forces of supply and demand: it will be the
result of bargaining between consumers and businesses. If,
for example, demand for a particular product increases, this
will encourage businesses to use their resources to produce
this instead of something else. Imagine you were a farmer
and had limited land. You have to decide what to grow on
it. This will depend in part on demand: if the demand for a
particular crop increases, you may switch to this and away
from something less in demand.
Some decisions about what to produce and how to produce
may be made by the government. For example, the
Questions
1 Analyse one way in which IKEA adds value in its
transformation process. [4]
1.1
2 Evaluate the importance of the customer in IKEA’s
value chain. [12]
1.1.1 The nature of business activity
government may provide some or all of the health services,
the transport system, the police or the education system in
a country.
Governments tend to take control of goods and services
they think are vital to their economy and where they want
to ensure access for most people.
However, whenever decisions are made about what
to produce – whether it be the free market or the
government – it will involve an opportunity cost. Given
that resources are limited, if they are used to produce
more of one item, then this is at the expense of something
else. Opportunity cost measures the sacrifice you make if
you choose one course of action in terms of the next best
alternative. For example, if a business decides to use its
labour force to increase output of soft drinks, then the
opportunity cost is what could have been produced if the
labour force had been used to produce something different.
Whenever a business makes a decision it should consider the
opportunity cost. A project that earns a profit of $100 000
may seem attractive, but if the resources could have been
used to earn $250 000 it is not so appealing. When judging
the success of a business you should also consider the
opportunity cost. If Walmart, the huge US retailer, made
a profit of $10 million, this would not be that impressive
given the people, stores and equipment it has; these
resources could be used elsewhere to earn more than that.
Walmart’s profit before tax in 2020 was actually over $20
billion, so you can see why its investors wouldn’t be very
happy it if only made $10 million!
The dynamic business environment
Businesses do not operate in isolation. Whatever they do
is linked to what other businesses do; for example, their
suppliers, the firms that distribute and promote their
products, the banks that lend them money. They are also
affected by many other external factors such as:
» Political and legal issues For example, new laws by
a government can prevent the way some products are
promoted (such as cigarettes) and can affect the way
employees must be treated and the way a business
produces (perhaps to reduce its environmental impact).
» Economic issues For example, the amount of income
in an economy can change over a period of time,
affecting demand; the value of one currency in terms
of another can alter, affecting the cost of importing
supplies; and the cost of borrowing can go up,
increasing costs.
5
 » Social issues For example, an increase in the size of the
population or the average age of the population in a
1.1 country can affect the level of demand and the types of
products people buy.
» Technological issues For example, changes in the
availability and speed of the internet can make it easier
to find suppliers and sell across the world.
These external factors (known as PEST – political, economic,
social and technological) will continually be changing and
this will affect what businesses produce and the resources
AS LEVEL 1.1 ENTERPRISE
they use. These factors can all have an impact on a business,
as shown in Figure 1.5. External factors can affect:
» the demand for products
» the costs and availability of inputs
» the nature of the transformation process.
If labour costs in one country become more expensive, for
example, businesses might switch production to another
country or start to use more machinery instead. If a
government signs a treaty with another country to make
trade easier, its businesses might start to sell more to
customers in the new partner country. New laws may make
certain products or production techniques impossible.
Businesses therefore need to monitor their external
business environment because it is dynamic (ever-changing)
CASE STUDY
Lockdown
In 2020, the Coronavirus (COVID-19) pandemic affected
countries all over the world. Governments reacted in
different ways, but in many countries shops were forced
to close and people were ‘locked down’ at home for
several weeks. Many businesses such as restaurants
simply could not operate at all. Others such as food shops
were forced to change the way they operated to ensure
that people kept a suitable distance from each other. A
limited number of people would be allowed in shops and,
once inside, they could not get too close to each other.
Staff were often serving behind screens. In the first few
What does a business need to do
to succeed?
To succeed, a business needs to be more competitive than
its rivals. This means it needs to provide better value for
money. Its ability to achieve this depends on:
» the benefits it offers. For example, what does its
product do relative to those of its competitors? Is it
faster? Easier to use? Smaller? Bigger? Longer lasting?
» what price is being charged relative to the competition.
Businesses will aim to outperform their rivals by offering
the same benefits for less, or more benefits for the
same price. The difficult part is deciding what it is that
customers actually regard as a benefit, working out how
to provide them and somehow doing this more cheaply
than competitors, or finding additional benefits without
increasing the price. How businesses try to do this is
6
and, if necessary, managers will need to change some of
their decisions about inputs, the transformation process or
the outputs they produce accordingly.
Economic Social
Political Technological
Business
▲ Figure 1.5 External influences on a business
STUDY TIP
Remember that the key external factors in the
environment of a business will vary between industries.
In the health sector, demographics may be very
significant; in the computer sector, technological changes
may be critical. You need to assess the key issues for any
given industry.
weeks of lockdown, there was often panic-buying, with
products such as hand sanitiser, toilet rolls and some
food products in high demand. When lockdown was over
there were concerns over how well economies would
recover. Businesses had closed down and people had lost
their jobs.
Questions
1 Evaluate the possible effects of the COVID-19 pandemic
on the transformation process of retail stores. [12]
examined in the rest of this book. Even if a business does
manage to become competitive, it cannot afford to be
complacent because competitors will soon follow its lead;
this means it needs to keep improving and seeking ways of
becoming more competitive. Many once-famous businesses
have now disappeared and those that are still successful can
only stay that way by constantly improving.
STUDY TIP
Remember that businesses often compete in different
ways. Some may offer premium products and be able to
justify high prices. Others may offer more basic products
at low prices. An important thing to think about is how
sustainable this approach is in the long term – will others
be able to imitate the idea easily or can the business
protect its success?
Why do businesses fail?
Businesses fail when they stop being competitive. This
means that they stop providing good value for money
relative to their competitors. This can be due to external
reasons (perhaps they have a high level of borrowing and
so their costs are hit badly when the cost of borrowing
rises) or internal reasons (such as poor training of staff
leading to poor customer service). Businesses fail when
they end up providing relatively low benefits given the
price they charge. This can be because of their choice of
inputs, their choice of outputs or the way they manage the
transformation process. We hope that reading this book
will help you avoid some of these problems if you decide
to manage a business. Having said that, while many of
the problems of business are avoidable, some – such as an
earthquake – may be more difficult to plan for!
In fact, many businesses fail early on in their life. This is
because:
» the people managing them may not have had much
experience of business. Often people who start up a
business have an interest in a product but have not
necessarily run a business before. They may be good at
making things, for example, but not so good at dealing
with customers or managing money. It may also be
difficult to recruit experienced staff to join the business
because they may want the security of a bigger business
that has been around for longer and has a track record
of success. This means that those making the business
decisions may not be very good at it.
» new businesses do not have much market power, which
can make it difficult to survive. For example, suppliers
may be worried whether they will be paid and demand
payment in advance, which can cause cash-flow
problems. Meanwhile, buyers may have a lot of power.
Imagine being a new small supplier trying to sell to a big
supermarket. The buyer (the supermarket) may push the
price down and be slow to pay, causing further financial
problems for the new business. Given its lack of power,
it may have to pay more for supplies and advertising
than more established businesses, making it difficult to
compete on price.
HANDLING DATA
Imagine 60 per cent of new businesses in a country fail
in the first two years. Of those that survive, another 40
per cent fail in the next three years.
Imagine 400 000 businesses start up in one year; how
many would you expect to be left after five years?
Local, national, international and
multinational businesses 1.1
The scope of business activity can vary significantly. Some
businesses operate very much within a local market; for
example, a local hairdresser or local café. Their customers
will come from the local area. The success of these
businesses will be affected by the number of potential
customers in the local area and their spending power. A
shop in a rural area, for example, may struggle to attract
1.1.1 The nature of business activity
enough customers. Local laws introduced by the city or
town will affect what the business can do.
Other businesses may have more of a national market. There
may be a national bus company offering routes within the
country or a national energy business. In this case, the
business has a wider customer base that may be based
all over the country. These businesses will be affected by
national laws and by decisions of the national government.
For example, changes in national government spending may
affect demand for products.
In other instances, businesses may operate around the
world. These businesses are international – they export
products to other countries. These businesses will be
affected by changes in the value of their currency compared
to other currency (this is known as the exchange rate) and
by trading agreements between countries. For example,
national governments may sign a treaty making it easier
to sell products in each other’s countries. By becoming
an international business, an organisation may have more
places to find the best suppliers and resources; this can
allow it to access better quality supplies are a lower price.
Going international means a business may also have more
markets to sell to; this can lead to faster growth and reduce
the risk of being dependent on one market. In recent
years there has tended to be more co-operation between
countries, making it easier to be an international business.
This has also been helped by better communications and
better transport systems.
If businesses have bases abroad (for example, they have
shops or factories in other countries) they are known as a
multinational. Whereas international businesses trade with
or buy from other countries, multinationals actually have
production bases or offices in these other countries. This
means multinationals can benefit from incentives (such as
subsidies) provided by other governments to locate there.
It also means the business is closer to its market, which
may mean it understands it better. In some cases, there are
limits to the products coming from abroad into a country, or
a tax is placed on them which makes them more expensive;
by being based within a country these restrictions can be
overcome. Another benefit of being multinational is that it
spreads risk by having bases in different countries. If there
is a problem with production in one country – for example,
due to a natural disaster – production may be switched to
the other location.
7
 1.1.2 The role of entrepreneurs
1.1 and intrapreneurs
Entrepreneurs
An entrepreneur is someone who is willing to take a
risk to start a new project or a new business. Enterprise
refers to the skills needed to do this, such as creativity.
An entrepreneur has an idea and then tries to make it
work. Entrepreneurs see the resources that are available
AS LEVEL 1.1 ENTERPRISE
and the possibilities of combining them in a particular
way to provide a product or service. Entrepreneurs create
new businesses and in so doing provide new products and
services. Some entrepreneurs, such as Sir Richard Branson
of Virgin and Stelios Haji-Ioannou of easyGroup, continually
have ideas for new businesses and set up many different
ones during their careers. Such people are called ‘serial
entrepreneurs’.
GLOSSARY TERMS
Entrepreneurs are individuals who take the risk to create
or start a new business or project.
Enterprise is the skill needed to make a new idea work.
What qualities is an entrepreneur likely
to need for success?
There is no single set of qualities that has been identified
that will definitely make someone a successful entrepreneur.
Entrepreneurs can differ enormously in terms of their
backgrounds, skills, interests and personalities. However, it
is likely that a successful entrepreneur is someone who:
» is prepared to work very hard, especially in the initial
stages of setting up the business. This means you need
determination and the ability to cope with stress and
setbacks
» has a vision. Many entrepreneurs have stories about
the various problems they encountered when they first
started up. Problems with money, suppliers, equipment
and so on are all fairly common. It is also quite usual
for others around you to be more cautious and less
certain that your project will work than you are. To be
successful, you need faith in your idea and a belief in
your own vision, even when there are initial problems
» is willing to take a risk. It takes a lot of nerve to give up
your existing job and start out on your own and yet this
is what many people do. You may have to give up the
salary, the company car, the support from head office and
the pension just to pursue your dream. You may also have
to go through quite a long period of time with relatively
low rewards before you make it a success (if you ever do!).
8
According to the Royal Bank of Scotland (RBS) a successful
entrepreneur is usually:
» well-rounded Someone who can make the product,
promote it, sell it and count the money
» able to bounce back A person who can cope with
mistakes and have the confidence to try again
» innovative Not an ‘inventor’ in the traditional sense,
but a person who is able to carve out a new niche in the
market, often a niche that is invisible to others
» results-oriented To make a business successful requires
a drive that only comes from setting goals and targets
and getting pleasure from achieving them
» a professional risk-taker To succeed means taking
measured risks. Often, successful entrepreneurs use
a step-by-step approach to risk-taking, at each stage
exposing themselves to only a measured amount of
personal risk and moving from one stage to the next
only as each decision is proved
» totally committed Hard work, energy and single-
mindedness are essential elements in the entrepreneurial
profile.
CASE STUDY
Hirka
In 2017, an entrepreneur in Indonesia started a business
that turned scraps of skin from chicken feet into leather,
which is then made into shoes. These ‘chicken’ shoes
are marketed as alternatives to ones made from reptile
skin, such as snake and crocodile, as ‘reptile’ shoes
have been increasingly criticised by customers and
animal rights supporters. The ‘chicken’ shoes do not
rely on breeding animals for purpose, as they are made
from scraps and waste material that comes from dim-
sum and fast-food restaurants.
The transformation process that turns these inputs
into shoes begins by dyeing the chicken skins and then
sewing pieces together. It takes about 10 days and up to
45 chicken feet to make a single pair of shoes. The
business employs six people.
Hirka’s most popular style of shoes are sneakers, and
the company makes only 70 pairs per month to ensure
quality is kept high. These sell for Rp500 000 ($31) and
above.
Questions
1 Explain one reason why someone might set up in
business for themselves. [3]
2 Evaluate the factors that might determine the
success of this shoe business. [12]
Why become an entrepreneur?
There are many attractions to being an entrepreneur:
» You will experience a great feeling of satisfaction if your
idea is successful. Imagine being able to look at a large
business and know that you created it and helped it to
grow.
» You will be your own boss. Fed up with being told what
to do? Dislike orders? Then being an entrepreneur may
be the way forward. Setting up on your own means it
is your business, to do with as you wish. This can be
challenging and demanding but it does mean you are
more in control of your own destiny. Some people prefer
this to working for others: they like their independence.
CASE STUDY
Awfully Chocolate
▲ Figure 1.6 Lyn Lee
Living in Singapore – a very cosmopolitan city – Lyn
Lee was amazed that she could not find a simple dark
chocolate cake! Most chocolate cakes in the market were
either too sweet and creamy or not chocolatey enough.
So she decided to set up a business to make the perfect
everyday chocolate cake – soft, moist, very chocolatey
but not too sweet or creamy. With some friends, she tried
different recipes and techniques every weekend for a
» You keep the rewards. If you work in a business for
someone else then the rewards belong to them. You may
work very hard and very successfully and get a bonus,
but the major rewards will usually go to the owners. If
1.1
you are an entrepreneur, you are the owner and so any
rewards belong to you. The downside is that if anything
goes wrong, the losses are yours as well.
» You have more control of what you do and when you do
it compared to working for someone else. Many people
become self-employed because of a desire for more
1.1.2 The role of entrepreneurs and intrapreneurs
flexible working and an improved balance between work
and their social lives.
year. As people not from the baking industry, they tried
innovative methods to create a recipe they loved – and
Awfully Chocolate was born.
The first Awfully Chocolate store opened in 1998 in Katong
in Singapore, in an old side street. It offered only one type
of chocolate cake for sale. It was also unconventional
in that the cake was not displayed, so the store did not
look like a typical cake shop. This enhanced the quirky
character of how Awfully Chocolate made its mark.
Friends and family thought the business would not
last three months and even her supplier warned her
about over-ordering boxes. But Awfully Chocolate
gained a reputation for delicious handmade chocolate
cakes and quirky design, and demand proved high.
Cakes sold out every day and its reputation grew
beyond Singapore.
But Lyn wanted Awfully Chocolate to grow on its own
slowly, so she only opened her second store in 2004,
using the profits from her first shop. Awfully Chocolate’s
products now include more cakes, tarts, ice cream and
truffles. It also owns the brands Everything with Fries,
Sinpopo and Ninethirty by Awfully Chocolate, and now has
17 stores across Asia.
Lyn says that ‘every city has got its own bit of character,
bit of personality, its own quirks’, so you need to
understand these to make it work.
According to Lyn, although people say the success is due
to luck, it’s actually due mainly to hard work!
Source: www.bbc.co.uk/news/business-11701575
Questions
1 Analyse one reason why demand for Awfully
Chocolate’s products may have been high. [4]
2 Evaluate whether the success of a new product is
likely to be mainly due to luck. [12]
9

CASE STUDY
1.1
Government regulations
Governments regulate businesses to protect different
groups. For example, laws may be introduced to prevent
employees from being exploited, to protect customers
from unsafe products and to protect businesses
from other businesses using unfair tactics. However,
regulations can make it more difficult to set up and run
AS LEVEL 1.1 ENTERPRISE
a business, which can deter entrepreneurs or make it
difficult to do business. This can lead to entrepreneurs
not starting up a business or doing so in another
country. In Uruguay, for example, entrepreneurs have
to deposit a significant sum of money in the bank and a
new business has to pay many taxes.
Questions
1 Explain one reason why people want to set up in
business. [3]
2 Evaluate the problems that regulations can play
in determining the success of a new business. [12]
The role of intrapreneurs
An intrapreneur is an entrepreneur within an existing
business. As businesses get bigger, they often worry that
they lose some of the creativity and risk-taking that they
had when they first started. The danger is that to control
a larger business, the managers introduce many rules and
policies which potentially limit innovation.
Intrapreneurship occurs when the business encourages
people within the organisation to think and act like
entrepreneurs. The business wants existing staff to challenge
the way things are done, to question whether there are
better ways of doing what they do and to take business
risks; they want intrapreneurs. The aim is to keep established
businesses moving forwards, being flexible and keeping
CASE STUDY
Ease of starting up
The Doing Business Index produced by the World Bank
measures the number of procedures, such as the time
and cost, involved for a small to medium-sized company to
start up and formally operate in each economy’s largest
business city.
10
ahead of competitors. To help people be intrapreneurs, the
business needs to empower them to make decisions and give
them the resources they need to try things out. The business
needs to encourage an approach where it is perfectly
acceptable to try and fail in order to ensure that employees
are willing to take risks. Intrapreneurship can be critical to
the ongoing success of a business.
Entrepreneurs and intrapreneurs create change and
challenge the way things are done. They find and create new
markets, generate income and employment and bring about
innovation. They are extremely important to the growth
of an economy and to improving the quality and range of
goods and services on offer.
GLOSSARY TERM
Intrapreneurs are people within an established business
who think and act like entrepreneurs.
Barriers to entrepreneurship
Entrepreneurship may be limited in a country because of a
number of factors:
» The financial system may not be good at supporting
start-up businesses. Banks, for example, might think
starts-ups are too risky and avoid them, or make it
difficult and expensive for them to borrow.
» There may be many different regulations involved in
setting up a business, which discourage people from
doing this or make it complex and slow to do.
» The culture in the country may not favour entrepreneurs;
failure may not be accepted socially and those who do
fail may find it difficult to find financial backers when
they want to start a second venture.
» The government may prefer state provision and not
want to encourage entrepreneurs; there might be some
goods or services that have to be provided by the
government.
The table below shows the data for the top five and bottom
five countries identified in May 2019. The top five are
the countries where it is easiest to do business and the
bottom five are the countries where it is most difficult to
do business.
 ▼ Table 1.1 Ease of doing business by country
Location Starting a business rank
New Zealand
Georgia
Canada
Singapore
Hong Kong, China
Chad 186
Cambodia 187
Somalia 188
Haiti 189
Venezuela 190
Questions
1 Explain one factor that might influence the ease of
doing business in a country. [3]
Business risk and uncertainty
Uncertainty is a feature of business life. Businesses have to
make decisions based on what they know and, in many cases,
their best estimate of a situation. Decision-making is often
focused on preparing for the future and, obviously, we do
not know exactly what is going to happen then. Businesses
can look at what is happening now, what has happened in
the past and they can research what different scenarios
might look like in the future, but they will not know with
100 per cent certainty. This means decisions will involve a
risk. Risk occurs when there is a danger that the outcomes
will be unfavourable. Businesses will want to assess the risk
and, where they can, take actions to reduce the risk.
Entrepreneurs are people who are prepared to take risks
to start up and develop a business. They are investing
time, money and effort into a new project that may or may
not work. The danger is that it will not work and all their
investment will be lost. Many new businesses fail. Look at
the main shopping street in your nearest village or town.
How long have the shops been there? Have some opened
up recently? Have some closed down in the last year? The
landscape of the centre of most towns is changing all the
time as some business ideas fail and others rise to take
their place. The real risk to entrepreneurs is that they will
lose much or even everything they have put into a project
because the business idea eventually fails.
Some of the causes of risk are external. For example, there
could be a change in the economy, meaning people have
less money to spend than entrepreneurs had expected (and
so demand for their products is lower than they hoped), or
competitors may have changed their behaviour, making it
more difficult for similar businesses to survive.
Alternatively, the causes of risk could be internal. It may be
that an entrepreneur’s understanding of the market is not as
good as they had thought and they make some bad pricing
decisions. It may be that their judgement of people is poor
Starting a business score 1.1
1 100
2 99.6
3 98.2
4 98.2
5 98.2
1.1.2 The role of entrepreneurs and intrapreneurs
52.5
52.4
46.0
36.4
25.0
Source: www.doingbusiness.org/en/rankings
2 Evaluate the implications of the data above if you
were going to set up a business abroad. [12]
and they hire the wrong people, with the result that the
quality of service is not as good as hoped.
Entrepreneurs may sometimes undertake a project ‘because
it is there to be done’. They may be driven by a desire to
do something new. This in itself may be a reward in terms
of self-satisfaction or a sense of self-achievement: they
can hopefully look back on their career and be proud of
what they have achieved. However, entrepreneurs may also
be interested in other rewards from setting up, such as
the financial gain from owning their own business. These
rewards can be high! For example, YouTube was set up in
February 2005 by Chad Hurley, Steve Chen and Jawed Karim.
The website includes music videos, movie and TV clips, as
well as material posted by the general public. In 2006, the
founders of YouTube sold their business to Google for $1.65
billion! Not a bad return in less than two years.
To go ahead with any venture, the expected rewards must
justify the risk involved. In an ideal world, a project would
have a high reward and low risk, but typically new ventures
are very risky because there are so many things that can
go wrong. In fact, many ideas do not even get launched.
Entrepreneurs hit so many setbacks or face so many
difficulties that the project does not go ahead.
▼ Table 1.2 Risks and rewards matrix: analysing projects
Risk
Reward Low High
Low These are safe projects These projects are not of
but do not generate interest because of the
high returns. high risk relative to the
low rewards.
High These projects are These projects are of
ideal: low risk but high interest but risky. To go
rewards. However, it ahead, entrepreneurs
may not be easy to find must believe the rewards
projects like these! outweigh the risks.
11
 HANDLING DATA
1.1 If you estimate that a project has a 55 per cent
probability of succeeding, what is the probability of
failure?
CASE STUDY
AS LEVEL 1.1 ENTERPRISE
Banyan Tree
Historically, a banyan tree gave shelter to weary
travellers. Its name is now the brand of a chain of
luxury hotels and resorts around the world, founded by
multimillionaire Ho Kwon Ping.
Ho Kwon Ping attended Stanford University after he left
school, and later protested against the Vietnam War. In his
time as a journalist for the Far East Economic Review, he
wrote controversial articles that resulted in him spending
two months in a Singapore jail. He continued working as
a journalist after his release and settled with his wife
on an island off the shore of Hong Kong. He joined the
family business after his father became ill, deciding that
it needed to do more than manufacture products for other
companies. Producing for others, he realised, limited your
profits and eliminated your brand presence.
This fuelled his decision to move the company into the
hotel industry, but he struggled to generate customer
interest in their planned new hotel in Phuket, Thailand.
Ho Kwon Ping resolved that the Banyan Tree should offer
STUDY TIP
Remember that any decision has a risk attached to it, but
the key question is whether this risk is worth it. Managers
must try to assess the probability of any outcome and
decide whether the business should pursue any course of
action given the risk involved.
Why do governments like
entrepreneurs?
Governments like entrepreneurs because they set up new
businesses in an economy. This means that entrepreneurs:
» create jobs and help keep unemployment low in the economy
» earn money and pay taxes
» create competition for the existing providers in markets
and provide new products and services. This is good for
customers, who get more choice, and this is likely to lead
to better service.
Given the benefits of entrepreneurship, many governments
are willing to help entrepreneurs to start up and grow their
businesses.
12
a different type of hotel, designed to stand out from the
competition, with a luxury spa and villa format instead
of the typical hotel building with rooms. He insisted on
decisions others thought would not work because he was
sure they would. For example, the staff at the spa did not
wear shoes because being barefoot in Asia is a sign of
respect, and they wore Asian clothes rather than the white
uniforms that staff in Europe tended to wear.
Banyan Tree Hotels & Resorts has now grown into one of
the leading providers of resorts and spas, operating in 28
countries with 47 resorts and hotels around the world,
64 spas, 72 retail centres and three championship golf
courses.
Questions
1 Analyse one external factor that might have helped the
success of Banyan Tree. [4]
2 Evaluate the features you think make a successful
entrepreneur. [12]
The role of business enterprise in the
development of a country
Enterprise involves taking risks to develop new ideas. This is
important to businesses and the country as a whole because
a business enterprise finds solutions to problems, and new
and better ways of doing things. This can help the business
reduce costs and offer more benefits at a lower price than
competitors.
For the country as a whole, enterprise leads to innovation,
which creates new products and economic growth.
Enterprise challenges established ways of doing things and
provides competition to existing providers. This can lead to
more choice, better quality and lower prices for customers.
How can governments help
entrepreneurs?
There are many ways in which governments can help
entrepreneurs. They can provide:
» access to advice and useful information to help them get
started. For example, a new entrepreneur may have little
experience of financial matters and appreciate some
advice in this area
» funding such as grants to help with the initial start-up
costs
» legal protection for new ideas. For example, a patent
provides legal protection for an invention. This means
that inventors can make profits without their ideas
being ‘stolen’ by others.
CASE STUDY
EY World Entrepreneur of the Year
In 2020, Dr Kiran Mazumdar-Shaw of Biocon Limited, India,
won the award for the EY World Entrepreneur of the Year.
Kiran graduated from a brewing school in Australia in
1975 and returned to India to begin her career. However,
as a woman in a very male-dominated industry, she
struggled to get a job. Instead, she started her own
business and founded Biocon in 1978 with a mere $500
from investors. Today, Biocon is a leading biotech company
and one of the largest employers in Asia, with a workforce
of over 11 000. Kiran has been named on both the Forbes
100 Most Powerful Women list and Time magazine’s 100
Most Influential People in the World list. She is known for
her determination and proactive approach.
Led by Kiran, Biocon has gone from manufacturing
pharmaceuticals, such as immunosuppressants, to
1.1.3 Business plans
A business plan is a written document that sets out
key aspects of a business idea. A business plan is often
produced by entrepreneurs when setting up a business to try
and anticipate any potential problems and opportunities,
and to put in place appropriate actions. A business plan
is a useful document to have to show potential business
partners, investors or banks. This is because it shows the
business is thinking ahead, is researching the risks and has
suitable plans. A business plan should have information
and data to support the ideas and plans of the business and
reduce the risks to those lending money to it.
A business plan should be a working document: as
conditions change it should be updated to reflect this and
the plans changed accordingly. A business plan is not just
for when a business starts up; the business should keep it
relevant as the business grows.
Key elements of business plans
A business plan will typically have the following elements:
» an outline of the owners and their background and
experience
» an overview of the business idea and its products
» an analysis of market conditions and the positioning of
the business and its products within the market
» an outline of how the business is to be promoted
» an estimate of the sales of the business
HANDLING DATA
Imagine you need to raise $250 000 to start your
1.1
business. The government will provide 3 per cent, and
your savings equal 6 per cent. How much money do you
still need to raise?
1.1.3 Business plans
discovering, developing and producing medicines for
chronic diseases such as diabetes. Biocon has been
consistently ranked as one of the highest investors in
research and development in India. Kiran is very focused
on helping society. Through her business, she aims to
develop affordable medicines that can help save millions
of lives.
Questions
1 Analyse one factor that might have contributed to
the success of Kiran’s business. [4]
2 Evaluate the importance of spending on research
and development of new products to the success
of Kiran’s business. [12]
» a financial section which would include a cash-flow
forecast, a profit forecast and a statement of what the
business owns and owes
» details of the human resource requirements of the
business.
The benefits and limitations of
business plans
To produce a business plan, an entrepreneur will undertake
market research and make plans for the different functional
areas of the business. To produce a business plan, managers
must think carefully about what has to be done. This will
help the business to identify the degree of risk involved in
any aspect of the business and take appropriate actions to
manage this risk. The plan is a way of co-ordinating all the
different activities of the business so that everyone knows
what has to be done when, and how this fits with what is
happening elsewhere within the business. The plan sets
‘milestones’ of what is to be achieved by when. It can set
targets so everyone in the business knows how to measure
success and understands how what they do contributes
to the overall success of the business. At any moment,
the progress of the plan can be checked and, if necessary,
action can be taken. Even if things start to go wrong,
having a plan is valuable because managers can assess
where they are compared to where they should be and then
decide what to do. Without a plan, they may not recognise
that things have gone wrong until far too late.
13
 However, a plan is simply a statement of what the business
intends to do. How useful it is will depend on how accurate
1.1 its forecasts are, whether the right actions are planned in
the given circumstances and whether they are implemented
effectively. Simply having a plan does not guarantee
success – it depends how good it is and how well it is
carried out.
The nature of the plan will differ for a start-up business
compared to an established business (for example, because
the start-up will have limited experience compared to a
AS LEVEL 1.1 ENTERPRISE
business that has been going for some time). Similarly, it
will differ for a small business compared to a big business
in that the latter’s plan is likely to be more complex and
involve more money, more products and more markets.
CASE STUDY
TikTok
TikTok, the 15-second video app, is a technology start-up
that has grown incredibly fast. Within two years, TikTok
was rivalling Netflix, YouTube, Snapchat and Facebook
with more than 1 billion downloads in 150 markets
worldwide and operating in 75 languages. TikTok had a
value of nearly $80 billion within two years of starting
up. Through the app, users create and share homemade
videos on their phones. This content has proved incredibly
attractive to young audiences all over the world.
Virtually no translation is needed, as TikTok’s content is
primarily visual. This allows it to reach larger consumer
audiences more easily than other successful Chinese
apps, such as Tencent’s messaging app WeChat. WeChat
is used extensively within China but is mainly used by
Chinese communities outside of China. Within China,
TikTok is known as Douyin.
TEST YOUR LEARNING
Short answer questions
1 Define the term ‘factors of production’. [2]
2 a Explain one possible purpose of business apart
from profit. [3]
b Explain one reason a business might want to
make a profit. [3]
3 a Define the term ‘scarcity and choice’. [2]
b Define the term ‘opportunity cost’. [2]
4 a Define the term ‘business plan’. [2]
b Explain one reason why producing a business
plan is useful for a business. [3]
5 Explain one way in which growth in the economy
might affect the costs of a business. [3]
6 a Explain one reason why a business might fail. [2]
14
However, for all of these businesses, planning can
help prevent mistakes by identifying difficulties early,
co-ordinating actions across departments and helping to
take action quickly to get back on track. Even so, plans
must always be reviewed because external and internal
conditions will change, and therefore the plan may need to
be flexible to keep relevant and competitive.
STUDY TIP
Remember that producing a business plan is only part of
the challenge of managers. To make it work, it has to be
implemented effectively.
Founder Zhang Yiming, who is in his thirties, was inspired
by the early success of China’s technology pioneers of the
late 1990s, such as Robin Li of Baidu, Jack Ma of Alibaba,
and Pony Ma of Tencent.
TikTok makes money through adverts and from the sale
of virtual goods, such as emojis and stickers, to fans. It is
easy to use and is designed to exactly match what users
want to see, rather than recommending content based on
people’s viewing habits and ‘likes’.
Questions
1 Analyse one factor that might determine the
success of a new app. [4]
2 Evaluate the value of having a business plan to a
business such as TikTok. [12]
b Explain one effect of business failure on an
economy. [3]
7 a Define the term ‘intrapreneurship’. [2]
b Explain one reason intrapreneurship is
important to business. [3]
8 a Define the term ‘adding value’. [2]
b Explain one way a business might try to add
more value. [3]
9 a Define the term ‘multinational business’. [2]
b Explain one reason why a business might
become a national rather than a local business. [3]
10 a Explain one likely feature of a successful
entrepreneur. [3]
b Explain one reason why entrepreneurs are
important to an economy. [3]
Data response question
Me & the Bees Lemonade was set up by Mikaila Ulmer
when she was aged four!
Mikaila’s interest in bees started when she got stung
twice within a week. She started to research bees to find
out more about them and became fascinated. Around
that time, her family had encouraged her to enter some
children’s business competitions, and her grandmother
had sent her a cookbook which contained a special
recipe for flaxseed lemonade. Mikaila decided to adapt
the recipe and use honey from the honeybee rather than
sugar. That was the start of her business. It was originally
going to be known as Be Sweet Lemonade but Mikaila
had to change the name as it was already being used by
another business. She decided to call her business Me &
the Bees Lemonade because a percentage of sales are
donated to help save the bees. The company has now
been in ‘buzzness’ for more than 10 years! Its products
are sold in many different retailers, such as Whole Foods
Market across Texas and Kroger stores in Houston. The
product range now includes lip balm and different types
of lemonade.
Mikaila gives many talks about the importance of saving
the bee population. She has also written her first book,
Bee Fearless, Dream Like a Kid. The business has some
high-profile investors, including $800 000 from a group of
National Football League players. 1.1
From the very beginning, Mikaila invested some of the
profits from the sale of her lemonade to organisations
fighting hard to save bees. Me & the Bees encourages
everyone to ‘Buy a Bottle ... Save the Bees’.
Most recently, Mikaila launched her own non-profit,
Healthy Hive Foundation. Through research, education
1.1.3 Business plans
and preservation, the Healthy Hive Foundation is
dedicated to increasing bee awareness and the number of
safe environments for bees to survive and thrive.
Questions
1 Explain one reason why Mikaila set up in business. [3]
2 Explain one factor that influences demand for
Mikaila’s products. [3]
3 Analyse one skill that Mikaila would have needed
to be such a successful entrepreneur. [4]
4 Evaluate the challenges that Mikaila’s business
might face in the future. [12]
15
 1 Business and its environment
AS LEVEL
1.2 Business structure
AS LEVEL 1.2 BUSINESS STRUCTURE
Chapter overview
In this chapter we examine:
★ the different economic sectors in an economy, that is, the difference between primary, secondary, tertiary and
quaternary sectors and the private and public sectors, including the concepts of unlimited liability and limited liability
★ the advantages and disadvantages of different forms of legal structure, such as sole traders, partnerships,
companies, co-operatives, franchises, joint ventures and social enterprises.
1.2.1 Economic sectors
There are many types of businesses and it is useful to be
able to categorise them to analyse their performance and
the different issues they face. Typical ways of categorising
business include by sector and by legal status.
Primary, secondary, tertiary and
quaternary sector businesses
The many businesses that exist in an economy operate in
one of three sectors:
» Primary sector This is the first stage of production
and involves acquiring or extracting raw materials. For
example, oil has to be extracted from the under the
ground, coal has to be mined, fish have to be caught
and crops have to be grown. Oil, mining, fishing and
agriculture are all in the primary sector of the economy.
Raw materials can be renewable resources, such as fish
and wind power; this means they can be replenished.
Or raw materials may be non-renewable, such as oil and
coal; this means the total stock available is reduced as
they are consumed.
» Secondary sector This is the part of the economy
that manufactures and assembles products using
raw materials. For example, cars are manufactured
using many different parts and materials, and so car
manufacturing is part of the secondary sector. Similarly,
the construction industry uses many parts to produce
houses and office space.
» Tertiary sector This is made up of businesses that
provide services. These services are intangible – that
is, the service they provide cannot be physically
touched (unlike manufactured goods, for example).
Examples of businesses in the tertiary sector include
retailers, transportation businesses and providers of
financial services, such as insurance. This is often the
biggest sector in developed economies in terms of both
employment and the value of the output.
16
– Quaternary sector This is a subset of the tertiary
sector which represents organisations that are
based on knowledge and the skills of employees;
for example, information service businesses, such
as management consultancies, and research and
development businesses.
The more developed an economy is, the more resources are
diverted into the tertiary and quaternary sectors. Economies
begin by being very agriculturally based (primary sector).
Investment in capital equipment leads to more factories and
equipment and the development of the secondary sector. As
investment continues, resources tend to move away from
the mass-production processes towards higher value-adding
sectors based on services and knowledge. For example,
developed economies may focus on sectors such as design,
programming, creative work, and research and development
more than mass production.
The public and private sectors
We can also distinguish between businesses that are owned
by private individuals, which are in the private sector,
and those that are owned by governments, which are in
the public sector. Local supermarkets, clothes shops and
hairdressers are likely to be in the private sector (although
not always); the provision of electricity, water and health
services is often in the public sector (although, again, this
will vary from country to country). Some products may
be provided by both the public and private sectors; for
example, there may be government-run schools and private
schools.
If a government takes control of a private sector business,
this is called nationalisation. If a government sells one
of its organisations to the private sector, this is called
privatisation.
Typically the government is likely to run organisations:
» that have a strategic importance to the country, such as
defence, in order to protect the country
» that provide essential services, such as energy and
water, that the government wants to make sure everyone
has access to regardless of income
» whose benefits may not be fully appreciated by
individuals, such as education and health. These are
called merit goods.
Public sector organisations can have social objectives, not
just profit objectives. This means they may provide non-
profit-making services, such as transport to remote areas. A
private sector business would probably not be interested if
there were not enough passengers, but the government may
provide this service for the welfare of its citizens.
GLOSSARY TERMS
Nationalisation occurs when a government takes
ownership of a business from the private sector into the
public sector (see Chapter 6.1.1).
Privatisation occurs when a government transfers
ownership of a business from the public sector to the
private sector (see Chapter 6.1.1).
Merit goods are goods or services, such as education
and health, whose benefits individuals may not fully
appreciate. For example, when thinking about how much
to spend on healthcare, people will think of the benefits
to themselves rather than the benefits that being healthy
also bring to those around them.
Reasons for the changing relative
importance of private and public
sectors
The extent to which a government intervenes and the public
sector is involved in an economy will vary from country to
country and depends a great deal on political views about
the role of the state. In countries such as North Korea,
there has been a belief that the government should mostly
decide how resources are allocated and so there is a large
public sector and small private sector.
Cuba is one of the world’s most centrally planned
economies, meaning that the government still runs most of
the organisations that exist on the island. According to the
CIA World Factbook, the Cuban government employed nearly
73 per cent of all Cuban workers in 2017. Although there
have been some changes in recent years to encourage more
private sector businesses, the number remains very small
and the government still controls the majority of business
activities. By comparison, countries such as the USA allow
market forces to allocate resources to a greater extent, so
the public sector is smaller and the private sector is bigger.
However, the role of government may change over time; for
example, in China the government has been intervening less
in the economy and the private sector has been growing in
recent years, whereas in Venezuela government intervention
1.2
has increased in the last 20 years.
The reasons why there might be less government
intervention, and therefore a bigger private sector, include
a desire that people own their own businesses. This is
because it gives a great focus on running them well. If
individuals own all or part of an organisation, they will
1.2.1 Economic sectors
want it to make a profit because they will benefit from
this financially. This encourages people to identify and
meet customers’ needs – to provide them with the goods
and services and the quality they need and want. It also
encourages people to be efficient and not waste resources
because they want to generate more profits. By comparison,
if an organisation is owned by the government, those
working within it may not be concerned with whether their
products are in demand or not, and they may not be focused
on increasing revenue or reducing costs because they do not
benefit directly.
The reasons why there might be more government
intervention, and therefore a bigger public sector, is
because people do not trust the private sector. For example:
» They may want more provision of healthcare and
education for everyone. In the private sector, this will
only be provided for those who can pay.
» They may want to provide a full range of services,
including some that are not profitable; for example, rail
or bus links to remote areas or a postal delivery service
to distant locations within the country.
» They may want to use some businesses to help maintain
employment levels in a region or economy, even if it is
not as efficient as it could be.
» They may worry that the private sector is misleading
customers, or selling products which are cheap to make
but not safe, in order to make more profits.
▼ Table 1.3 Benefits of the private and public sectors
Benefits of private sector Benefits of public sector
Focus on profits means Focus on what is beneficial
businesses want to provide for society rather than what
what is demanded and ensure is profitable
quality is good
Focus on profits means Will not try to exploit or
businesses want to be mislead customers
efficient and not waste
resources
17
 CASE STUDY
1.2
Cuba
AS LEVEL 1.2 BUSINESS STRUCTURE
▲ Figure 1.7 A street in Havana, Cuba
Since 1965, Cuba has been governed by the Communist
Party. It has been one of the most centrally planned,
state-run economies in the world since then. However,
although the government in Cuba retains a high level of
political control, it is gradually opening up markets to
allow competition. For example, Cubans can now set up
private businesses to sell electronic devices and mobile
phones, run hotels, and buy and sell used cars. The
government has reduced the number of state sector jobs
as part of its reform process and has opened up some
1.2.2 Business ownership
When setting up in business, the founders must consider
the most appropriate legal form for their enterprise. There
are several different types of business organisation, each
of which has its own legal structure. These include sole
traders, partnerships, private limited companies and public
limited companies, co-operatives, franchises, joint ventures
and social enterprises.
Sole traders
▲ Figure 1.8 Sole traders run their own businesses
When individuals run a business on their own, they are known
as ‘sole traders’. Plumbers, decorators, window cleaners and
18
retail services to entrepreneurs. Over half a million Cuban
workers are now self-employed. Other changes include
the private ownership and sale of property, and private
farming and non-agricultural co-operatives.
Despite the increasing opportunities for UK companies in
Cuba, the market still offers challenges, which include:
● very slow decision-making, with most important
business decisions being referred to high-level
government
● all sales in Cuba are public sales, controlled by heavy
regulation
● commonality of payment delays
● the standard practice for the Cuban state to expect to
buy on credit terms of 1–2 years
● potentially increased market competition due to easing
of US sanctions, which will make it easier for Cubans
to trade in the USA.
Sources: CIA World Factbook; UK government, Department for
International Trade
Questions
1 Analyse one potential benefit of a centrally planned
economy. [4]
2 Evaluate the possible impact for businesses in
Cuba of having more privately owned businesses. [12]
hairdressers are often sole traders. The people running these
businesses work for themselves. In some cases, sole traders
hire other people to help them out, but they are the owners
and remain responsible for the overall business. Sole traders
are actively involved in the running of it on a daily basis.
What does it take to be a successful
sole trader?
As a sole trader you need to be someone who is willing
to work on your own, who has the confidence to make
your own decisions and who can turn your hand to almost
any aspect of your business. As a sole trader, you may
have to serve customers, decide what equipment to buy,
deal with suppliers and keep accurate and up-to-date
business records. This requires a wide range of skills and an
enormous degree of flexibility.
Sole traders have to be used to working hard: running your
own business is no easy task. You must also be good at
managing stress. All the decisions of the business are yours
alone, so if you get it wrong the responsibility is yours. On
the other hand, if it is successful, the sense of achievement
and the rewards are yours too!
Becoming a sole trader requires a high level of self-
discipline, because you are your own boss: there is no one
to tell you what to do. This can be very exciting, because
you decide what is going to happen. However, it also means
that you have to motivate yourself to get things done. For
example, you have to organise your day properly and use
your time effectively.
The advantages of being a sole trader
One of the main advantages of being a sole trader is that
it is so easy to start up in business. Unlike starting other
types of organisation, you do not need to register with
anyone or fill in any special forms: you can just start trading
(provided you declare your profits to the government tax
office at the end of each financial year!). If you suddenly
decide you want to be a gardener, a web designer, an artist,
an interior decorator or a cleaner, you could start up in
business tomorrow. It may be wise, however, to do some
planning and get some training first!
Many people also enjoy not having to take orders from other
people. They like the freedom to make their own decisions,
to decide when and where to work, what to do and how to
do it. You can also make decisions quickly as you don’t have
to check with anyone to get permission to do something. It
can be incredibly motivating to be your own boss. Another
important advantage of being a sole trader is that you keep
all the rewards of the business. You don’t have to share the
profits with anyone else.
Many entrepreneurs begin as sole traders for these reasons.
The challenges of being a sole trader
While being a sole trader can be very fulfilling, it also
brings with it many challenges. Making all the decisions can
be exciting, but you carry all the responsibility if anything
goes wrong. If you work for someone else and there is a
real problem, you have someone to work with to solve it.
Being a sole trader can be quite lonely: some people find it
difficult to cope with the pressure. The hours may be quite
demanding too. This is particularly likely to be an issue in
the early years, when you are trying hard to build up enough
business. Also, you may not be able to take much time off
for holidays because you may not be able to afford to close
the business and risk losing customers.
Another difficulty is raising finance to set up the business
and expand it. You generally have to rely on your own money
or money from friends and family (plus the money from
the business itself, once it is up and running). Of course,
it is possible to borrow from a bank or other financial
institution, but they often charge smaller businesses quite
high interest rates because they are worried about the risk
of failure and want to cover their losses.
Unlimited liability and its importance
Being a sole trader is also quite risky if anything goes
wrong. This is because sole traders have unlimited liability.
The sole trader keeps any rewards the business makes,
but is also personally responsible for any losses. If their
business has problems, a sole trader can lose their personal
possessions.
In many ways, working for other people in a large
organisation is much easier because you are likely to:
» have other people to share ideas with
» receive a more regular income
» be able to call on experts to help you solve problems.
On the other hand, there is not quite the same sense of 1.2
achievement and satisfaction of having created something
for yourself.
▼ Table 1.4 Advantages and disadvantages of being a sole
trader
Advantages Disadvantages
1.2.2 Business ownership
• Making your own • Sources of finance are
decisions can be limited.
motivating. • You rely heavily on your
• You can make decisions own ability to make
quickly and respond decisions.
rapidly to changes in the • You may work long hours
market. and have limited holidays,
• You have direct contact leading to stress.
with the market. • You are subject to
• Setting up is easy. unlimited liability.
GLOSSARY TERM
Unlimited liability occurs when an individual or groups of
individuals are personally responsible for all the actions
of their business. With sole traders, there is no distinction
in law between the individuals and the business, and so
they could lose their personal assets if the business has
financial problems.
Partnerships
If you join with other people and set up a business together,
this is known as a partnership. This is common in professions
such as accountancy, medicine and law. The benefits of
forming a partnership over being a sole trader include:
» You have other people to share ideas with.
» There are more people to invest in the business and help
finance it.
» You can benefit from each other’s specialist skills; for
example, if you have a legal practice, you could have one
partner specialising in tax law, another in marital law,
another in company law, and so on. This enables you to
offer a wide service to customers.
» You can cover for each other if someone is ill or on holiday.
However, a partnership can present challenges:
» You need to consult with others and there may be
disagreements between the partners over the policies
and direction of the business.
» You are dependent on the actions of others. If, for
example, one of the partners makes a mistake or brings
the partnership into disrepute, it will have an impact on
all the partners. Each partner is liable for the actions of
the other partners’ actions, which can be risky.
» In most partnerships, the partners have unlimited
liability, which means that there is no distinction
between the individuals and the business. If the
business is sued, for example, the individuals may lose
their personal possessions. This is a risk that some
people may not be prepared to take.
19
 To reduce some of the possible problems of a partnership,
the individuals involved are advised to write a ‘deed of
1.2 partnership’. This document sets out the ‘rules’ of the
partnership; for example, it sets out:
» how the partnership would be dissolved if someone wanted
to leave. It would set out how the partnership would be
valued and therefore what the person leaving would receive
» how to resolve disputes if the number voting for and
against is equal
» how profits will be divided up; if this is not specified,
the profits are divided up equally.
AS LEVEL 1.2 BUSINESS STRUCTURE
Limited liability and its importance
Limited liability means that a company is responsible for
the money it owes but that the personal possessions of its
owners are safe. This is different from a sole trader, who has
unlimited liability and could lose everything if the business
has financial problems.
Having limited liability is essential for companies to be able
to raise money by selling shares. Without it, investors would
be far less likely to buy shares because of the risk to their

personal possessions. If you invested in a business with

▼ Table 1.5 Advantages and disadvantages of setting up as
a partnership
Advantages
• Share resources, ideas and
workload
• More sources of finance
than a sole trader
• Cover if someone is ill or
on holiday
Disadvantages
• Share profits
• May disagree over decisions
• Unlimited liability
unlimited liability, it would mean giving money to others to
use and risking everything you owned. With limited liability,
you know what the maximum amount is that you could lose;
this means that the risk is limited.
Having company status means that:
» the business must pay to have its accounts checked
annually by independent accountants (called auditors)
» the company accounts must be made public, so that
outsiders can see the revenue and profits of the
business, as well as what it owns. This means that there
is less privacy of affairs than if you are a sole trader.

HANDLING DATA Private limited companies

You have four other partners in your business. You have
agreed to share profits. If your profits are $240 000, how
much does each partner receive?
Companies
To avoid some of the problems of being a sole trader or
a partnership, you may decide to establish a company
instead. To set up a company, the owners have to complete
various documents. In the UK these documents are kept at
Companies House. This process is known as incorporation.
A company is owned by shareholders. Each share in the
business represents a part of the company. The more shares
someone owns, the more of the company belongs to them.
A company has its own legal identity, separate from that of
its owners. The company can own property, equipment and
other goods in its own right and is responsible for its own
debts. If the company fails, the shareholders can lose the
money that they invested in the business when they bought
shares, but they cannot lose more than this. This is because
shareholders have limited liability.
GLOSSARY TERMS
A company is a business organisation which has its own
legal identity and which has limited liability.
Shareholders are persons or organisations that own a
part of a company.
Limited liability means that investors can lose the money
they have invested into the business but their personal
possessions are safe. There is a limit to their risk.
A franchise occurs when a franchisor sells the rights to
use or sell their products to a franchisee.
Private limited companies have ‘ltd’ after their names.
They are owned by shareholders and the owners can place
restrictions on who the shares are sold to in the future.
For example, many (but not all) private limited companies
are owned by families who limit the sale of shares to other
members of the family: this makes sure that outsiders do
not become involved. Owners of shares in private limited
companies cannot advertise their shares for sale; they have
to sell them privately.
Public limited companies
Public limited companies have ‘plc’ after their names.
Once again, they are owned by shareholders but, unlike
private companies, restrictions cannot be placed on the
sale of these shares. Shareholders in public companies
can sell their shares to whoever wants to buy them. This
can cause problems if another firm starts to buy up shares
in the business in an attempt to gain control of it. Some
of the shareholders may want to resist this takeover,
but they cannot stop fellow shareholders from selling
their shares.
Another difference between plcs and ltd companies is that
shares in plcs can be advertised in the media. This is why
you can see the share prices of public companies listed in
the newspapers, but not those of private companies. Most
companies become public because they want to advertise
their shares to the general public and raise relatively large
sums of money. Most public companies (but not all) are
bigger than most private companies.
If the owners of a private company do not need to raise
large sums via the sale of shares and want to maintain
control over their company then they probably would not
want to make it a public company.

20
 HANDLING DATA
There are 250 000 shares in a company. You have 400
shares. What percentage of the company do you own?
CASE STUDY
UK dividends
In 2020, there was a massive drop in the amount of
dividends paid by companies in the UK – and indeed
around the world – amid the Coronavirus (COVID-19)
pandemic. UK dividends were more than 60 per cent lower
in 2020 than in 2019. To give a context, dividend payments
globally fell by only 20 per cent during the financial crisis
in 2008.
Banks cancelled their dividend payments indefinitely to
hold on to their cash. Retailers, hotel groups, airlines,
travel groups and many manufacturers did the same.
The oil giants BP and Shell – which according to Citywire
accounted for nearly 30 per cent of UK dividends in
2020 between them – faced severe pressure to reduce
dividends because the oil price collapsed with less
demand for energy from businesses because they had
shut down. Shell announced it would stop dividends for
the first time since 1945.
The ability of many companies to pay dividends may be
affected for years to come. Even before the pandemic
CASE STUDY
Tesla and Toyota
In 2020, the share price of Tesla, the electric car maker,
went so high that the company became the world’s most
valuable car maker, overtaking Japan’s Toyota. Tesla’s
share price went to over $1100, which gave the company a
market capitalisation of $209.47 billion (£165 billion). This
meant that Tesla was worth approximately $4 billion more
than Toyota, even though the Japanese producer sold
around 30 times more cars in 2019 and its revenues were
more than ten times higher. The price of shares in Tesla
increased as investors began to feel more confident about
the future of electric vehicles. Many analysts believe
that Tesla is significantly ahead of its rivals in terms of
its product range, capacity and technology. The value of
Tesla in 2020 was approximately three times the combined
value of General Motors and Ford.
Franchises
If you do not have an idea for your own business or do
not want to risk setting up completely on your own, you
might want to buy a franchise. A franchise occurs when
one business (the franchisor) sells the right to use and
sell its products and/or services to another business (the
franchisee). Imagine you were interested in setting up a
1.2
1.2.2 Business ownership
began, businesses such as high street stores were
already under pressure from e-commerce. Oil companies
were trying to survive given the long-term decline in
hydrocarbon consumption. Car makers and airlines were
generally struggling in highly competitive industries for
decades, making little, if any, profit. Even the industries
which typically offered relatively high dividends, such as
utilities and telecommunications, now face increasing
regulation and weak long-term growth.
However, even amidst such difficult times there were
some business sectors that offered opportunities, such as
insurance businesses and delivery companies.
Questions
1 Explain one factor that might influence the amount of
dividends paid by a business. [3]
2 An investor wants to know what shares to buy. Advise
her on an industry you think is likely to do well in your
country in the next few years. [12]
▼ Table 1.6 A comparison of Tesla and Toyota
Sales volume 2019 Sales revenue 2019 ($bn)
Toyota 10.46 million 281.20
Tesla 367 000 24.6
Questions
1 Analyse one factor that may determine the demand
for electric cars. [4]
2 Evaluate the factors that affect the price of Tesla
shares. [12]
fast-food business. You could sit down and develop your
own idea from scratch. However, it could prove to be
difficult to come up with something that would capture
demand and then decide on a brand image, a way of
producing the food, a menu and decor for your stores. An
alternative would be to buy the rights to sell, for example,
McDonald’s products in a given area. In this case, you would
be buying a McDonald’s franchise.
21
 How do franchises work?
There are many different forms of franchise, but the basic
1.2 elements of a franchise agreement are:
» The franchisor sells the right to the product in return
for an initial fee and a percentage of the franchisee’s
turnover.
» The franchisee receives the right to the name and the
systems used by the franchisor. This may include access
to materials and training methods.
In the case of the McDonald’s example, the company will
AS LEVEL 1.2 BUSINESS STRUCTURE
want to keep close control over its brand name, products
and reputation. Therefore, if you buy a McDonald’s
franchise, you have to follow very close rules in terms of
what you sell, how you sell it, the pricing, the way the
food is cooked, where it is bought, how you use the logo,
and so on.
Well-known franchises include:
» Ben and Jerry’s ice cream
» Domino’s Pizza
» McDonald’s fast-food restaurants.
▲ Figure 1.9 An example of a well-known franchise
Buying a franchise
If you buy a franchise, you are buying a product that has
already been on sale and therefore has a track record. This
means you can see whether or not it works. You can also
learn from other franchisees who are already established
and benefit from their experience.
The advantages of buying a franchise
The advantages of buying a franchise include:
» Because you are joining other franchisees, as a group
you may have more bargaining power than you would
have on your own. This may mean you get better deals
with suppliers or when buying advertising space.
Franchisees will often pool money to promote the brand
on a regional or national scale. Any advertisement for
the brand helps all the franchisees.
» You have the support of the franchisor and this can
help you with decisions such as pricing, choosing
suppliers and planning ahead. This should reduce the
risk of something going wrong because there is more
experience, joint power and support than if you were
setting up alone.
» Buying a franchise may be less risky than setting up
completely on your own. This is because there is past
data for you to analyse before deciding whether or not
to go ahead with the idea. At the same time, it will be
your own business and so there is still the incentive to
make it successful, as you will benefit directly.
22
The problems of buying a franchise
The most obvious problem with buying a franchise is that
it costs you money! This reduces the profits you make.
However, you hope that by buying a franchise you will do
better than you would have done on your own. Whether
you are better off with a franchise therefore depends on its
success and the terms and conditions of the contract.
Although one of the main benefits of buying a franchise is
that you are linked to other franchisees, this can also be
a problem. If, for example, the quality of service in other
franchises falls, it may damage the overall brand and hit
your sales as well. You become dependent on others and
vulnerable if there are problems elsewhere.
How much should you pay for a franchise?
Usually, there are several different types of payments
involved in buying a franchise. For example, there may
be an initial purchase fee plus a percentage of turnover
each year. On top of this there may be money you have
to invest each year to cover marketing and management
expenses. The amount you pay for a franchise will
depend on:
» the likely turnover of the business
» the typical profits
» whether you have the exclusive rights to a particular
geographical area and, if so, how big and attractive
this area is
» the amount of training and support provided.
HANDLING DATA
A franchisor asks for a $12 000 fixed fee each year plus 2
per cent of profits after this fee and other costs are paid.
Your revenue this year is $650 000. Your costs (not
including any costs associated with the franchise) are
$420 000. What are the profits this year?
Selling a franchise
One advantage of being a franchisor is that you benefit
from the income generated from the franchisees. They will
pay a fee to buy the franchise and a percentage of turnover.
This generates earnings for the franchisor.
Franchising is also a way of growing fast. If you were trying
to grow a business on your own, you would have to fund it
all yourself; for example, you would have to find the funds
to buy more premises and refurbish more shops. If you sell
franchises then the costs of opening a particular outlet falls
to the franchisee. This may make fast growth much more
feasible because individual franchisees are all funding their
own enterprises. Domino’s Pizza, for example, was founded
in 1960 by Tom Monaghan. His ambition was to grow the
business to three stores – that’s why there are three dots
on the company logo. However, through franchising, the
business has grown to become the world leader in pizza
delivery.
Another benefit of being a franchisor is that it may lead to
more motivated managers because they are running their
‘own’ stores or businesses, rather than just being employees
of a bigger business. This may help the business as a whole
to be more successful.
CASE STUDY
Toni&Guy
▲ Figure 1.10 Toni&Guy hairdressers, UK
Toni&Guy started in 1963, when Toni Mascolo opened a
salon with his brother in Clapham, London. Today, the
company has over 475 salons in 48 different countries,
many of which are franchises.
Toni grew up in Italy. When he was a boy, he would walk
past his father’s hair salon every day on his way home
from school. ‘I had a stool where I would sit and would
wash hair, which made my father very proud. By the age of
12, 13, I was doing perms. It was a hobby. It’s always been
a hobby.’
Toni (whose real name was Giuseppe) had wanted to
become a lawyer, but that changed when the family
migrated to London when he was 14. Although he had
excelled at school in Italy, he couldn’t speak English, so
his only option was to work for his father.
STUDY TIP
When studying franchises, you need to compare this way
of starting up your own business with the alternatives.
1.2
What are its advantages and disadvantages compared
to other ways of starting up? What would determine
whether an individual did this, rather than ‘going it alone’?
1.2.2 Business ownership
Together, Toni and Guy (whose real name was Gaetano)
continued to open more salons, and established the TIGI
brand in 1979. Under this brand name they launched
gel, rollers, scissors and many more products and sold
franchises to grow the business. The TONI&GUY video
library supports teaching in their salons, emphasising the
dedication of Toni and Guy to the development and further
education of their employees.
Toni&Guy’s business interests, apart from the salons
themselves, include:
● the production and distribution of products used and
sold in the salons
● the Toni&Guy branded products, which have been
developed with Alliance Boots
● another hairdressing chain called essensuals
● hairdressing training academies
● a business that supplies the salons with fixtures and
fittings
● an IT business
● an in-house media agency.
The company has developed other brands which now
include TONI&GUY, label.m and essensuals.
Source: www.independent.co.uk/news/people/profiles/
toni-mascolo-wash-and-grow-6230921.html
Questions
1 Analyse one factor you think is important to make a
hairdressing business a success. [4]
2 A hairdresser has asked you whether they should
adopt the same model as Toni&Guy. Advise them
on whether to do this. [12]
23
 CASE STUDY
1.2
7-Eleven
7-Eleven is the world’s largest convenience retailer. Its
business model is that of franchising its name and way of
operating; it is one of the biggest franchises in the world.
The company has grown fast and says its success is based
around the saying of its founder Joe C Thompson Junior,
which was: ‘Give the customers what they want, when and
AS LEVEL 1.2 BUSINESS STRUCTURE
where they want it’.
7-Eleven says that it is ‘customer-obsessed. We always
poll customers to ensure we are bringing them solutions
they can’t even imagine.’
If you want to be a franchisee for 7-Eleven, the investment
required will include:
Co-operatives
Another form of business is known as a co-operative.
Co-operative businesses are owned and run by and for
their members, whether they are customers, employees or
residents. The members of a co-operative have one vote
each and so it is a democracy. Members, such as farmers or
freelancers, tenants or taxi drivers, can often do better by
working together. Sharing the profit is a way to keep it fair
and make it worthwhile.
Rather than rewarding outside investors, a co-operative
shares its profits among the members. When someone leaves
the co-operative they give up their shares. According to
the International Co-operative Alliance, nearly 300 million
people around the world are employed by co-operatives,
while over 1 billion are members.
There are different forms of co-operative, such as:
» Employee co-operatives These occur when the business
is owned equally by all the employees who work there.
Each employee has a vote in the business decisions
and shares in the profits. The advantage of this is
that employees may be more motivated to make the
business a success because they are part-owners. One
of the problems, however, is that decision-making
may be difficult if everyone has an equal vote but
disagrees. Also, you cannot sell shares to those outside
the business to raise finance, which might limit access
to funds.
» Community co-operatives These are owned by members
of a community to provide a local service, such as a
post office.
» Retail co-operatives These occur when independent
retailers join together. A group of independent stores
may come together and operate under one brand name.
This means they can get better deals from suppliers by
buying in bulk and can share marketing costs.
24
● the initial franchise fee
● the expenses to train staff according to the 7-Eleven way
● cost of inventory to open the store
● spending on business supplies
● purchases of business licences and permits
● insurance costs.
Source: https://corp.7-eleven.com/corp/about#corp_about_intro;
https://franchise.7-eleven.com/franchise/the-financials
Questions
1 Analyse one reason why 7-Eleven might franchise
its business. [4]
2 A friend has asked you whether they should buy a
franchise in 7-Eleven. Advise them on whether to
do this. [12]
CASE STUDY
Co-operative facts and figures
‘At least 12 per cent of people on Earth [belong to one]
of the 3 million co-operatives on Earth. Co-operatives
provide jobs or work opportunities to 10 per cent of the
employed population, and the 300 largest co-operatives
or mutuals generate $2034.98 billion in turnover ...’
Source: https://ica.coop/en/co-operatives/facts-and-figures
Questions
1 Explain one benefit of being part of a co-operative.
[3]
2 Evaluate the reasons why the co-operative
approach is so popular around the world. [12]
Joint ventures
A joint venture occurs when businesses collaborate on a
project but do not formally join together all their activities.
For example, in the car industry a number of manufacturers
might share the research costs of developing an electric
car but they would still compete with their other models.
In the pharmaceutical industry, two businesses may share
their research skills for a new medicine. When entering a
new market overseas, a company may set up a venture with
a local business to help make the contacts and develop the
networks it needs to distribute its products.
The benefits of a joint venture are that:
» businesses can share skills, resources, expertise and
experience; this can benefit both parties
» businesses can collaborate on projects that are
mutually beneficial without having to merge all their
operations. This makes the process easier, less difficult
to manage and less expensive than a full joining
together (called a merger).
However, there may still be difficulties, such as:
» agreeing on the division of the profits; there may be
disagreements over the relative contribution of each
business
» different views on how decisions should be made and
what the priorities are
» different views on whether and how to end the venture.
Social enterprises
Not all enterprises are set up to make a profit. Local sports
clubs, government organisations and charities, for example,
do not have profit as the main objective. They are set up for
other purposes.
Social enterprises are businesses that have social aims and
which trade in order to benefit the community or society
in general. Examples of social aims are job creation and
training, providing community services and ‘fair trade’ with
developing countries. Well-known social enterprises in the
UK include Cafédirect, The Big Issue, The Co-operative Group
and the Eden Project, but there are many others (more than
55 000) operating in a wide range of industries, from farmers’
markets and recycling companies to transport providers and
childcare. The number of social enterprises is increasing as
people become more concerned about issues such as the
environment and inequality.
CASE STUDY
The Big Issue
The Big Issue Group is a social enterprise in the UK aimed
at reducing poverty by creating opportunities for people.
The group has grown over the years and now includes:
● a magazine which offers employment opportunities to
people living in poverty
● a fund that invests millions of pounds to support
enterprises that bring about social change
● a charity shop that sells social enterprise products.
In 1991, The Big Issue magazine launched with the aim of
providing homeless people with an opportunity to earn
money by selling copies to the public. The magazine’s
sellers are from a wide range of backgrounds, but all
of them struggle with poverty. Sellers buy The Big Issue
magazine for £1.50 and then sell it on to their customers
for £3. This means the seller is earning money and is not
begging for it. Not only that, but the act of having to organise
Changing legal structure
It is relatively common for someone to set up in business as
a sole trader and then to change the business into a private
limited company (ltd) later on, when they want to raise funds
from selling shares or want the benefits of limited liability.
To operate as a ltd company, a business must:
» have its accounts checked by an independent accountant
(called an auditor) each year
CASE STUDY
1.2
Wikipedia
Wikipedia was created in 2001. It is a multilingual, web-
based, free-content encyclopedia project and is now
one of the largest online encyclopedias. It is written by
volunteers all over the world. Its articles can be edited
by anyone with internet access. Articles are continually
updated and improved by online contributors. The
1.2.2 Business ownership
website was created by the not-for-profit Wikimedia
Foundation, who says:
‘The Wikimedia Foundation provides the essential
infrastructure for free knowledge. We host Wikipedia,
the free online encyclopedia, created, edited, and
verified by volunteers around the world, as well as many
other vital community projects. All of which is made
possible thanks to donations from individuals.’
Source: https://wikimediafoundation.org
Questions
1 Explain one way in which Wikipedia transforms
inputs into outputs. [3]
2 Evaluate the ways in which the success of
Wikipedia might be measured. [12]
themselves and manage their money as well as interacting
with the public to sell the magazine all help individuals to
build up their self-confidence and self-reliance.
The magazine has won numerous awards and led to the
creation of over 120 similar magazines in 35 different
countries.
Key facts about The Big Issue include:
● over 200 million copies of the magazine have been sold
● 92 000 people have sold The Big Issue.
Source: www.bigissue.com/about
Questions
1 Analyse one way in which The Big Issue helps
society. [3]
2 Discuss the ways in which The Big Issue would
measure its success. [12]
» publish details of its accounts such as revenue and
profits each year
» publish administrative details, such the address of the
company and names of its directors.
This means the business affairs of a private company are
more open than those of a sole trader. If you want to keep
your earnings private, you would want to remain as a sole
trader.
25
 It may be that the owners of a private company want to
make it public, as did Facebook in 2012. This gives the
1.2 company access to more potential investors. To do this,
the business must make more information available to the
public and there is greater regulation of the way it operates
and the information it provides. Becoming a public company
opens a business to even greater scrutiny and even bigger
TEST YOUR LEARNING
AS LEVEL 1.2 BUSINESS STRUCTURE
Short answer questions
1 Define the terms ‘primary sector’, ‘secondary sector’,
‘tertiary sector’ and ‘quaternary sector’. [8]
2 Define the term ‘public sector’. [2]
3 Explain one advantage of a partnership compared
with a sole trader. [3]
4 a Define the term ‘limited liability’. [2]
b Explain one way that limited liability can benefit
a company. [3]
5 Explain one advantage of creating a company
rather than operating as a sole trader. [3]
6 a Define the term ‘franchise’. [2]
b Explain one reason for buying a franchise. [3]
7 Explain one benefit of being part of a co-operative
compared with a company. [3]
8 Explain one advantage of being a sole trader
compared with a partnership. [3]
9 Explain one way a company can raise finance. [3]
Data response question
In 2020, Warner Music Group decided to sell shares to
the general public. Warner Music included some of the
world’s biggest record labels including Warner, Atlantic,
Elektra and Parlophone. The company had many major
recording artists signed to it, including Ed Sheeran and
Katy Perry, representing over 80 000 songwriters and
composers, from Beethoven to Madonna. The company
also owns the music publisher Warner Chappell which,
26
legal and accountancy bills. However, it does enable its
shares to be sold more easily on the stock exchange and this
makes the shares more attractive to more investors, because
they know they should be able to sell them, if needs be, to
someone else (this means the shares of a plc are relatively
easy to sell).
with over 1.4 million copyrights, is one of the world’s
largest. Publishing is more secure and profitable than
recorded music, although the majority of Warner Music’s
income is generated by the latter.
Warner Music had previously been bought by billionaire Sir
Len Blavatnik for $3.3 billion (£2.5 billion) in 2011, when the
industry was not doing well. The value of music companies
rose after that, aided by the fast emergence and growth of
paid streaming services such as Spotify. In 2019, its profit
was $256 million and its revenue was $4.5 billion. By 2020,
Warner Music was worth around $6 billion. Warner had
initially intended to sell its shares in February 2020, but
when the Coronavirus (COVID-19) pandemic took hold, it
delayed the sale. It then intended to sell the shares on 3
June 2020, but delayed this for a few days because it did not
want to distract attention away from the Black Lives Matter
movement that was in the news.
Questions
1 Define the terms:
a ‘company’ [2]
b ‘private sector’. [2]
2 Calculate Warner Music’s profit as a percentage of
its revenue in 2019. [2]
3 Analyse one reason why investors would buy
shares in Warner Music. [4]
4 Evaluate the extent to which the price of a share in
Warner Music depends on when it is sold. [12]
1 Business and its environment
AS LEVEL

1.3 Size of business

1.3.2 Significance of small businesses

Chapter overview
In this chapter we examine:
★ how the size of a business can be measured
★ the significance of small and family businesses for the economy
★ business growth.

1.3.1 Measurements of HANDLING DATA

business size
The size of a business can be measured in many ways such as:
» the turnover (revenue) of the business
» the number of employees
» the value of the assets of the business shown on its
statement of financial position
» the market value of the business (for example, the value
of all of its shares)
» other indicators such as the number of stores or even
the number of vehicles (for example, for a bus company).
The best measure will depend on the sector you are
considering. For example, public sector organisations might
not generate revenue (for example, if the health service is
provided for free) so it may be more appropriate to measure
the number of employees.
It is also important when considering the size of a business
to think about its ownership. What seems like a ‘small’
business may actually be part of a much bigger ‘parent’
organisation and therefore have access to its funds and
expertise. When governments are considering policies,
such as subsidies and tax allowances, they will examine the
ownership of a business and whether it is part of a bigger
parent organisation.
Your company has 30 000 shares. The share price
increases from $2.50 to $2.80.
a Calculate the old and new market values.
b Calculate the percentage change in the market value
of the company.
1.3.2 Significance of small
businesses
Advantages and disadvantages of being
a small business
The advantages of small businesses are that:
» they are relatively easy to set up
» they are flexible because decisions can be made quickly
(without having to consult lots of other people)
» they are often run by very motivated individuals
because they probably set up and own the business, and
so they want it to succeed because they personally gain
the rewards
» they are often very creative because it is easy for those
involved to communicate with each other and share
ideas.

STUDY TIP
Note that profit measures the success of the activities
of a business. It is not in itself a measure of the size of a
business.

27
 CASE STUDY
1.3
Businesses in the EU
Shown below is the way in which the size of businesses annual turnover or the annual statement of financial
is categorised within the European Union (a grouping of position total.
27 European countries). This is important because it can
Micro, small and medium-sized businesses account for
affect the government support that is available and which
99 per cent of businesses in the European Union.
regulations apply to them.
Question
When determining a business’ size, the number of
AS LEVEL 1.3 SIZE OF BUSINESS

1 Analyse two benefits these businesses bring to the

employees is always taken into account and either the
EU economy. [8]
▼ Table 1.7 Measuring the size of businesses within the European Union

Enterprise category Number of employees Annual turnover (€m) OR Annual statement of financial
position total (€m)
Medium-sized < 250 ≤ 50 OR ≤ 43
Small < 50 ≤ 10 OR ≤ 10
Micro < 10 ≤2 OR ≤2

However, small businesses do have disadvantages:
» They lack power in the market (for example, with suppliers
and customers) and so can find it difficult to survive.
» They may lack much experience compared to more
established firms.
» They may find it difficult to raise finance because of the
high risk involved as so many small businesses fail.
This is why governments sometimes try to help small
businesses by providing advice, lower taxes and less
regulation to help them survive.
CASE STUDY
Small business finance
Small and medium-sized enterprises (SMEs) face
challenges getting finance, said the Vietnam Chamber
of Commerce and Industry (VCCI). It said that finance
was expensive because the banks themselves are
paying high interest rates of more than 13 per cent to
get savers to provide them with funds. The banks also
prefer to offer loans to large companies and state-run
enterprises as they are a safer investment.
The Vietnamese government has ordered the banks to
lend more to SMEs.
Questions
1 Analyse two ways that high interest rates might
make it difficult for SMEs to survive. [8]
2 Evaluate why the Vietnamese government might
beeager to lend more to SMEs. [12]
Family businesses have some strengths:
» The family members may share values, leading to fewer
disagreements.
» Those involved may work hard so that the family as
a whole prospers; their ties to the business will be
emotional as well as financial, which may make them
more committed to the survival and success of the
business. This may mean they will work harder and for
longer than outsiders.
» Individuals may be very supportive of each other
because they are family members.
» Family members may be willing to plan for the long term
because they will be looking for the benefits they can
bring for future generations.
» A number of family members may be involved in
providing finance and expertise.
» There may be decreased costs as family members may be
willing to work for less than outside employees, at least
in the short term.

Strengths and weaknesses of family

businesses ▲ Figure 1.11 Family businesses are common in some
A number of businesses in an economy will be run by families. countries, such as India.
This is especially true in countries such as India, where the
culture tends to encourage families to work together.
28
However, there may also be weaknesses:
» Sometimes in a family business, decisions may be made
for emotional reasons rather than rational ones. It may
be that the correct thing is to do ‘A’ but because we
don’t want to upset a family member we do ‘B’ instead.
» The family members may lack the right experience
but there may be reluctance to bring in outsiders.
Sometimes the wrong people may be doing jobs but
family ties keep them in that role.
CASE STUDY
A family business
Nelson Assemany and his four brothers opened a shop
together in Rio de Janeiro in 1967. Now employing their
sons, today they have two shops: one selling fabrics, the
other selling imported consumer goods.
While outsiders often think Brazilian business is dominated
by big companies such as the mining business Vale and
oil group Petrobras, in reality 85 per cent of the country’s
companies are much smaller, family-run operations.
These businesses can adapt easily in a crisis compared to a
company managed by a board of directors, where you have
to consult other people and get approval for everything.
The importance of small businesses
and their role in the economy
In most economies, the majority of businesses are quite
small, often one-person businesses. For example, plumbers,
hairdressers, restaurateurs, lawyers and photographers
are often sole traders. Although these small businesses
are the most significant in terms of number, the larger
businesses tend to dominate in terms of the total number
of people they employ and the value of the output they
produce. There may only be one Google or one Ford, for
example, but they each employ a lot of people and have a
very high turnover! Nevertheless, the small business sector
is very important to any economy. This is because small
businesses:
» create jobs, reducing unemployment
» provide competition for established businesses to ensure
they remain competitive
» provide new sources of ideas. Small businesses are often
very creative and many innovations start in smaller
organisations
» can go on to grow in the future.
Small businesses and the economy
Small businesses are important to economies because they
help create jobs and are often sources of innovation. Many
new products or new ideas come from small businesses,
so they are a source of entrepreneurial thinking. Small
businesses create competition and provide momentum to
an economy to promote economic growth. However, the
founders and owners often need support. Governments may
provide this support through:
» It may be difficult to manage your relationship with
others in the business easily because you will be
influenced by emotional issues as well as business
factors.
1.3
» The biggest difficulty for any family-run business is
handing over power to the next generation when the
current head of the family retires.
1.3.2 Significance of small businesses
Family businesses are also more likely to be focused on
long-term growth, because the aim is to pass them on to
the next generation, while large companies are often too
concerned with short-term results and shareholder profits.
Questions
1 Define what is meant by the term ‘company’. [2]
2 Evaluate the advantages and disadvantages of family
businesses. [12]
» better business and enterprise training at school and
university
» access to support and advice
» access to finance
» making it easier to start up and run a business; for
example, by removing regulations that add to costs and
make it difficult to operate.
The role of small businesses as part
of the industrial structure in some
industries
Small businesses are often very innovative. In industries
such as pharmaceuticals and computers, many of the
breakthroughs are made by small businesses; bigger
businesses then often take over or work with the smaller
organisations to develop the ideas further. Bigger, more
established businesses often provide the finance and
capacity to produce and sell the product on a large scale.
Small businesses can also provide specialist services
that bigger organisations might not be interested in
providing for themselves; for example, while the larger
firm concentrates on its core business, the small firm
might specialise in, say, digital marketing, specialist legal
advice or provide expertise on a new market overseas.
Small businesses can concentrate on small segments of
the market (called niches) and sell their services to bigger
organisations who buy in this expertise.
GLOSSARY TERM
A niche is a small segment of a market.
29
 CASE STUDY
1.3
Businesses in the UK private sector
The data below shows the composition of the UK economy in 2019 in terms of the size of businesses.
▼ Table 1.8 Estimated number and size of businesses in the UK, 2019

Business Employment (thousands) Turnover (£ millions)

All businesses 5 867 770 27 498 4 149 973
AS LEVEL 1.3 SIZE OF BUSINESS

SMEs (0–249 employees) 5 860 085 16 630 2 168 005

Small businesses (0–49 employees) 5 824 500 13 157 1 528 684
With no employees 4 457 820 4 835 304 508
All businesses with employees 1 409 950 22 663 3 845 465
of which:
1–9 employees 1 155 385 4 206 595 013
10–49 employees 211 295 4 116 629 163
50–249 employees 35 585 3 473 639 321
250+ employees 7 685 10 868 1 981 968
Source: UK government, Department for Business, Energy & Industrial Strategy
Question
1 Evaluate the contribution of small businesses to the UK economy in 2019. [12]

» develop new products for its customers

HANDLING DATA
The market as a whole is worth $960 000. Your niche is
worth $60 000. What percentage of the market is this?
1.3.3 Business growth
Business growth is a common objective of any business. By
growing:
» a business can get more power over suppliers and
customers, which might help it to make more profits
» a business can reach more customers and there is the
possibility of more profit through more sales
» the owners can eventually own something that is worth
more
» the owners can have a sense of achievement because
they can look back and be proud of having grown the
business
» a business can raise its profile.
Why and how a business might grow
internally (organic growth)
The size of a business is not fixed – it can change over time.
One way to grow is to expand your existing operations. This
is called internal or organic growth.
To do this a business may:
» try to grow sales of its existing products in its existing
markets
» find new markets where it can sell its existing
products.
External growth
External growth occurs when a business expands by buying
up another business or joining with another business. This
is known as integration. The process of integration is
sometimes called a merger and sometimes a takeover. In
a merger, two or more businesses mutually agree to join
together to form one new one. Alternatively, one business
may unilaterally decide to acquire another; this is known as
a takeover.
In the case of a takeover, one business buys control of
another one by gaining the majority of its shares. It can do
this by offering shares in its business (which is called a paper
offer) or by paying to buy the shares (which is a cash offer) or
a combination of the two. The directors of the company being
targeted may welcome the bid and advise their shareholders
to sell; this is a friendly takeover, which could be called a
merger. However, the directors of the target company may
resist the bid and advise their shareholders not to sell; this
then becomes a hostile takeover.
There are different forms of integration:
» Horizontal This occurs when one business joins with
another at the same stage of the same production
process; for example, a car manufacturer acquires
another car manufacturer.

30
» Vertical This occurs when a business acquires another
business at a different stage of the same production
process. Backward vertical integration occurs when
the business joins with a supplier; forward vertical
integration occurs when a business joins with a business
closer to the customer, such as a distributor or retailer.
» Conglomerate diversification This occurs when a
business joins with another business operating in a
different sector; for example, a car manufacturer joins
with a confectionery business.
The motives for these different types of integration may
vary; likely reasons for them are shown in Table 1.9.
▼ Table 1.9 Motives for different forms of integration
Type of integration Likely motives
Horizontal Greater market power; economies of
scale
Forward vertical Gaining access to the market, for
example, by joining with retailer
Backward vertical Gaining control over supplies – this
may improve co-ordination, improve
quality and reduce costs
Conglomerate Spreading risks by operating in
different markets; less vulnerable
to a change in conditions in one
market
Integration and stakeholders
The coming together of businesses will have an impact on
stakeholders. The precise effect will depend on the nature
of and success of the deal. However, some of the potential
implications are:
» Investors The deal is likely to cost money initially
but, if it works, bring higher returns in the long term.
If investors generally approve of the deal, the share
price of the bidder will rise and, if profits do increase,
dividends may as well. However, in reality many mergers
and takeovers do not do as well as expected, in which
case the shareholders of the bidding company may be
disappointed.
» Managers The effect on managers will depend on
the deal, but in some cases it will mean there is a
duplication of roles. Company A may have a marketing
manager and so might company B. With integration
there may be an opportunity to save money by only
having one marketing manager.
» Suppliers They may benefit if the combined business
does well and grows. However, the new, bigger business
may have more power to push down prices from suppliers.
Why a merger/takeover may or may not achieve
objectives
Many businesses like the idea of external growth. This is 1.3
because it is a way of growing rapidly. By joining with
an existing business, it is possible to quickly enter a new
market or to achieve a much bigger presence in a market.
However, often these deals are not as successful as
expected. Problems of mergers and takeovers include:
» the costs of doing the deal itself. Integration may involve
1.3.3 Business growth
legal costs, finance costs and reorganisation costs
» the clashes that may occur when the businesses start
to try and work together. There can often be significant
differences in the way that people work, what they
prioritise and how they make decisions, and this can
lead to friction, higher costs and mistakes being made
» inefficiency because the business is too big. This can
cause problems co-ordinating it, communicating to staff
and building a common sense of purpose.
Joint ventures and strategic alliances
Another form of external growth occurs when a business
forms a joint venture or establishes a strategic alliance
with another business. This means they agree to co-operate
in specific areas but do not fully join together in all aspects
of their operations. In the case of a joint venture, the
businesses create a new legal entity to collaborate together.
The joint venture agreement will specify all the details of
the contract, including the rights of the partner businesses,
the objective of the venture, how day-to-day operations
will be carried out and how profits will be distributed. In
the case of a strategic alliance, they remain completely
independent businesses but collaborate on a given project.
The advantage of joint ventures and strategic alliances is
that businesses share their expertise and assets in areas
where they feel this will bring benefits. However, they
can avoid some of the problems that come with trying to
integrate whole businesses together. Strategic alliances will
often be used when co-operating on a project allows the
businesses involved to benefit from each other’s resources
and expertise and to make more profits.
Joint ventures are often used when businesses enter
new markets. The ‘outside’ business can join with a local
business and use its expertise and contacts. In this
situation, a joint venture can reduce risks by making
use of the local business’ inside knowledge, contacts
and awareness of the country’s culture and business
environment. In some countries, foreign businesses can only
operate in conjunction with local ones and so joint ventures
are a common way of entering the market.
31
 TEST YOUR LEARNING
1.3
Short answer questions
1 a State two ways of measuring the size of a
business. [2]
b Explain one possible advantage of being a big
business compared with being a small business. [3]
2 Explain one problem of being a small business. [3]
3 Explain one reason why a government might want
AS LEVEL 1.3 SIZE OF BUSINESS
to support small businesses. [3]
8
4 Define the term ‘internal growth’. [2]
5 State two ways in which a business might try to
grow. [2]
6 Explain one advantage of being a family business. [3]
7 a Explain one reason why a business might want
to grow internally. [3]
b Explain one problem of internal growth. [3]
⑧
8 a Explain one reason why a business might want
to grow externally. [3]
b Explain one benefit of horizontal integration. [3]
9 Explain one reason why a merger or takeover may
not achieve its objective. [3]
10 Explain one benefit of a using a joint venture to
enter an overseas market. [3]
Data response question
Family businesses in Asia
From Samsung in South Korea, Reliance Industries in
India, to Hon Hai, the Taiwanese maker of the iPad, family
businesses dominate Asia’s (and increasingly the world’s)
business environment. They make up half of Asia’s public
limited companies and a third of the market capitalisation
value of all companies on the stock exchange, and they
employ millions of people. However, many of these
businesses are failing to plan for the transition to a public
limited company with external shareholders. This can
lead to uncertainty, at best, and potentially ruinous family
disputes. For example:
● Lee Kun-hee, the 70-year-old chairman of electronics
giant Samsung, was sued by both his brother and sister
over company shares left by their late father.
● India’s richest man, Mukesh Ambani, was involved
in a five-year dispute with his brother Anil over their
father’s vast Reliance empire.
32
● In Hong Kong, a row emerged over the future of
billionaire Stanley Ho’s Macau casino business, which
led to Mr Ho arguing against some of his own children.
● Winston Wong, eldest son of the late Taiwanese tycoon
Wang Yung-ching, sued to recover $4 billion worth
of disputed assets that he claimed were taken by
members of his father’s third family. Wang founded
Formosa Plastics, one of Taiwan’s biggest companies.
Given that many of Asia’s most successful businesspeople
are now in their eighties and nineties, the next decade
will probably see a number of contentious leadership
successions.
Asia’s biggest family businesses
● Samsung Electronics (South Korea)
● Reliance Industries (India)
● Hon Hai Precision Industries/Foxconn (Taiwan)
● Sun Hung Kai Properties (Hong Kong)
● Tata Consulting (India)
● Cheung Kong (Hong Kong)
● Hutchison Whampoa (Hong Kong)
● Wilmar International (Singapore)
● Bharti Airtel (India)
● Formosa Petrochemical (Taiwan)
A recent study tracked the market performance of
250 family companies that underwent a succession. It
found that, on average, these companies’ market values
declined by almost 60 per cent during the period starting
five years before the succession and up to three years
afterwards. The performance of a family firm is often
down to the skills, charisma and connections of the
founder, something that subsequent generations may find
hard to replicate.
Questions
1 Define the terms:
a ‘public limited company’ [2]
b ‘market capitalisation’. [2]
2 Explain two reasons why family businesses are so
important to the economy. [6]
3 Evaluate whether family businesses are ‘ultimately
doomed to fail; it is just a question of time’. [12]
1 Business and its environment
AS LEVEL
1.4 Business objectives
Chapter overview
In this chapter we examine:
★ business objectives in the private and public sectors
★ objectives and business decisions.
1.4.1 Business objectives in the
private sector and public sector
An objective is a target. A good objective will state what
is to be achieved (for example, an increase in profit), how
much the business wants it to be (for example, $25 000)
and when it wants this to be done by (for example, in three
years). This means a good objective should be:
» specific in terms of what the target is
» quantifiable (measurable)
» time-specific in terms of when it should be completed.
A business will have an overall objective, such as a target of
doubling its profits within five years. This will then give the
business’ managers the opportunity and information to set
departmental targets. For example:
» The marketing department may have to increase sales by
40 per cent over an agreed period.
» The operations management department may need to
reduce costs by 20 per cent over the next three years.
» The human resources department may have a target to
increase labour productivity by 8 per cent over the
same time period.
Within each department every individual should also have
their own objective. For example, to reduce costs by 20 per
cent, the person responsible for ordering supplies for the
business may be set a target of finding a supplier that is 5 per
cent cheaper. The manager in charge of sales for the south-
east of the country may be asked to increase sales in their
area by 30 per cent to help overall sales rise by 40 per cent.
Those objectives which relate to the entire business, such
as growth, are also termed corporate objectives.
The setting and pursuit of objectives of a business helps
it to co-ordinate its activities, whether it operates within
the private sector or the public sector. It provides goals for
employees at all levels within the organisation and helps
managers to co-ordinate the activities of all employees. The
Starbucks case study on page 34 emphasises the importance
of objectives within large and growing organisations.
Corporate Departmental Individual
objectives objectives objectives
▲ Figure 1.12 Business objectives
1.4.1 Business objectives in the private sector and public sector
GLOSSARY TERMS
An objective is a target that is measurable and has a given
timescale.
Labour productivity measures the output per time period
of an employee.
A corporate objective is a target set for the business as a
whole.
Business objectives in the private
sector
We saw in Chapter 1.2 that private sector businesses are
owned by individuals. Businesses in the private sector can
have a number of objectives, including the following.
Profits and profit maximisation
Profits are maximised when the difference between sales
revenue and total costs is at its greatest. Some firms set
objectives which involve achieving a minimum level of
profit, allowing the business and its managers to focus
on other objectives. This approach, known as satisficing,
may be pursued by smaller family-owned organisations.
Satisficing allows the owners of these businesses to achieve
other targets, such as entering new markets or increasing
the size of the business.
Other businesses may seek to earn the greatest possible
profits to satisfy their shareholders’ desire for high
dividends. This might be a shorter-term objective. Others
may pursue the longer-term objective of providing acceptable
levels of dividends, but they may also look for growth in the
value of the company and therefore in its share price. This
can provide shareholders with long-term financial benefits.
Growth
Many businesses have an objective of growth because their
managers believe that the organisation will not survive
otherwise. If a firm grows, it should be able to exploit
its market position and earn higher profits. This benefits
business owners (in the long term) by providing greater
dividends, as well as offering better salaries and more job
security to the employees and managers of the business.
33
 The case study on Starbucks shows that the company has
set itself the aim of growth. This will have been expressed
1.4
CASE STUDY
Starbucks’ objectives
Starbucks is an American multinational company. In 2019,
it operated 30 600 stores in 80 countries selling coffee,
other drinks and food.
AS LEVEL 1.4 BUSINESS OBJECTIVES
Starbucks sets out its objectives clearly on its website and
one of these is growth. Starbucks has put in place a range
of plans to achieve its growth objective. The company has
opened new restaurants, improved its use of technology
within its stores and developed new products for its
customers.
These decisions appear to have been successful, as
Starbucks has improved its financial performance. Sales
Survival
This objective is for the business to continue to trade over a
defined period of time, rather than to submit to some form
of commercial pressure and be forced to cease trading. This
is an important objective, even for the largest of businesses
at certain times. However, it is a more common one for
small and newly established businesses. Survival is likely to
become a key objective during:
» periods of recession or intense competition
» times of crisis, such as during the 2020 Coronavirus
(COVID-19) pandemic.
Cash flow
For most businesses, cash flow is a vital element of success
as it is essential to be able to pay debts on time. This is
especially true of businesses that have long cash cycles.
A cash cycle is the time that elapses between the outflow
of cash to pay for the resources needed to produce a
product and the receipt of cash following the sale of the
product. Businesses in industries such as pharmaceuticals
and construction may have long cash cycles.
Walt Disney, the global entertainment company, has an
objective to strengthen its cash-flow position. The failure
to set an objective relating to cash flow could have dire
consequences for a business if it is unable to pay its debts
as they fall due. In the worst case, a shortage of cash could
result in a business having to cease trading.
GLOSSARY TERMS
The market share of a business measures its sales as a
percentage of the total market sales.
Cash flow is the movement of cash into and out of a
business over a time period.
Ethics are moral principles that can shape the way a
business behaves.
Social responsibility is a philosophy under which
businesses consider the interests of all groups in society
as a central part of their decision-making.
34
in quantified objectives, possibly relating to sales figures or
market share in other countries.
at cafés open for at least a year have increased by 6 per
cent globally. In 2019, its sales reached a record figure of
$6.8 billion.
Questions
1 Explain one reason why making Starbucks’ employees
responsible for its marketing might help the company
to achieve its objective of growth. [3]
2 Evaluate the benefits that Starbucks might receive
from its clearly stated business objectives. [12]
Diversification
Diversification is an objective where a firm produces an
increased range of unrelated goods and services. Adopting
this objective allows a business to spread its risk by selling
a range of products (rather than one) or through trading in
different markets. Thus, if one product becomes obsolete
or a market becomes significantly more competitive, then
the alternative products or markets will provide a secure
source of revenue for the business while it seeks new
projects. Diversification allows a business to avoid relying
on one or two products and has been the principle behind
the creation of conglomerate businesses – those that sell
a range of products in different markets. PepsiCo Inc., the
multinational soft drink and snack producer, has pursued
the objective of diversification to extend its product range
beyond soft drinks. This is intended to help it to compete
with its powerful rival, The Coca-Cola Company.
Business objectives in the public sector
Providing a service to the community
Businesses in the public sector are owned by the government.
Usually a major objective of businesses in this sector is
to provide a service to all of the country’s population. For
example, if a transport system is owned by the government,
it may operate bus services to remote areas where few
people live. Private sector businesses may not be willing to
do this as it may not be profitable due to the low number of
passengers. In India, the government has set public sector
businesses the target of constructing 11 000 kilometres of
roads each year to improve transport services.
Similarly, it may be necessary for public sector businesses to
provide some products that otherwise may not be available.
Private sector businesses may not be willing to make the
huge investments necessary to develop systems needed
to supply utilities such as gas, water and electricity. In
many countries these services are supplied by the public
sector. For example, in Pakistan there are publicly owned
businesses supplying electricity in many localities including
Lahore, Faisalabad and Multan.
Financial objectives
Businesses in the public sector do not seek to maximise
profits, unlike many of those in the private sector. In many
countries, public sector organisations are expected to at
least cover their operating costs, to avoid needing financial
support from the government. Public sector businesses in
some countries have an objective to generate a financial
surplus which is reinvested to improve the service offered
by the business. In 2020, businesses in the public sector in
Indonesia were reviewed by the government, and some were
merged with others or closed due to very weak financial
performance.
Development of relatively poor regions
Many countries operate public sector businesses in regions
with low incomes. This can help to raise standards of living
in less affluent parts of the nation. In New Zealand, the
government is making changes to ensure that public sector
organisations meet the needs of the country’s indigenous
Maori population.
Private sector business
(e.g. Lenovo, Tata Group)
Profits and Growth Survival Cash flow Diversification
profit
maximisation
Public sector businesses
(e.g. electricity supply)
Providing a Financial Regional
service objectives development
Social enterprises
(e.g. Wikipedia)
Social objectives Ethical objectives
▲ Figure 1.13 Objectives for different business sectors
The objectives of social enterprises
Social enterprises are businesses which operate to benefit
the community or society in general. As a result, they
normally set themselves social and ethical objectives.
Social and ethical objectives have received much attention
recently. In part, this is the result of widespread access
to the internet, making it easier for the public to discover
information about the behaviour of businesses. Some
investors will only invest in companies that trade with
ethical or social objectives. Importantly, a significant
proportion of customers seek to purchase products from
businesses with social and ethical objectives. Pursuing such
objectives, and publicising the fact, can offer a business a
distinctive and attractive image.
Social objectives
Social objectives include targets that relate to matters
such as providing employment for people or improving 1.4
facilities for local people (for example, building a play park
for local children). Social enterprises frequently reinvest
their profits to help to meet their social objectives. A study
by the University of Pennsylvania showed that many social
enterprises have ambitious goals of having more clients and
expanding their operations but that few set quantifiable
targets.
1.4.1 Business objectives in the private sector and public sector
Ethical objectives
Ethical objectives are those that are based on moral
principles. Examples of ethical objectives include protecting
the environment through the use of sustainable production
techniques and ensuring that suppliers receive fair and
prompt payment.
The importance of business objectives
Business objectives set out what the business wants to
achieve. This provides a focus for all decisions. Employees
know what they are supposed to achieve and can then make
suitable decisions. Without objectives, employees do not
know the priorities and do not know how success will be
measured. This can lead to a loss of focus and a wasteful
use of resources. Objectives can:
» motivate employees by providing targets
» provide a measure of control, as progress can be
reviewed against these targets.
Corporate social responsibility as a
business objective
A business may have many objectives relating to different
areas. For example, it may want to boost profits but, at the
same time, may be aware of its impact on society as a whole
and the environment in particular. Any business will have
certain responsibilities to other groups by law. For example,
there are laws in many countries determining the minimum
an employee can be paid, the information businesses have
to provide about their products, and the procedures to be
taken to make the working environment safe. All businesses
should have an objective of acting legally. However, some
may accept obligations to society over and above the legal
minimum; this type of behaviour is known as corporate
social responsibility (CSR). For example, a business may
believe:
» it should ensure that work is interesting and that
employees have a good career path within the
organisation
» it has a responsibility to keep people in work as much as
possible and therefore be reluctant to force anyone to
leave the business
» it is important to pay suppliers quickly rather than
taking as long as possible and holding on to money
» it should invest in its local community to improve the
area and quality of life of the community where it is
based.
35
 CASE STUDY
1.4
The Good Hotel
The Good Hotel is part of the Good Group, set up by who really need it. According to its website, a one-night stay
Marten Dresen. The Good Group is a social enterprise, can finance one week’s education for a child in Guatemala.
offering customers luxury accommodation in wonderful
In its first year of trading, Good Group donated approximately
locations. In 2020, the business operated hotels in London
$80 000 to its causes in Guatemala, and is on target to
and Antigua de Guatemala. By 2021, it plans to open hotels
donate more than $500 000 per year. This has financed the
in five new locations.
building of three schools, providing quality education
AS LEVEL 1.4 BUSINESS OBJECTIVES

The Good Hotel operates in an environmentally conscious
way. It sources its food locally and treats suppliers fairly.
It offers vegetarian and vegan meals and does not use
plastic straws in any of its hotels. It does not put TVs in its
hotel rooms, opting to instead provide spaces that facilitate
connection and conversation. The Good Hotel believes that
‘conversation is the key to community’.
All the business’ profits are invested into educational
projects in Guatemala to provide skills and training to those
for over 500 students in impoverished Guatemalan
communities.
Source: www.good.community
Questions
1 Explain one way in which operating as a social
enterprise has shaped The Good Hotel’s objectives. [3]
2 Evaluate whether The Good Hotel can be expected to
compete successfully with other hotels operated by
businesses in the private sector. [12]

A business that acts responsibly believes it is a corporate of people and its impact on the planet. This is known
citizen with obligations to society. This type of business as the triple bottom line (profit, planet, people) and it
will set targets to do more for society than it is obliged to encourages sustainable production, allowing it to continue
by law. in the long term without damaging the environment.

CSR and the triple bottom line

While many organisations see profit as important, they
may also be concerned about how this profit is made and Profit
the impact of the business on others. This means that
businesses often have social and environmental objectives
relating to how they treat suppliers, how they treat staff
and the impact of their activities on the environment and
other groups, such as the local community. A business may
be willing to accept lower profits if it significantly reduces
pollution, if it ensures only recycled resources are used and
if it helps the local community, for example.
Sustainable
This increasing interest in social and environmental Planet production People
issues may be because there is more information available
about such things and so managers are making better-
informed decisions. It may also be a response to the fact
that consumers, employees and investors are increasingly
interested in such issues. Not only that, if competitors are
demonstrating their environmental and social awareness,
then other businesses may have to follow in order to retain
their competitiveness. John Elkington, a business author
and advisor, suggested a business’ performance should be ▲ Figure 1.14 Elkington’s triple bottom line
measured by examining three Ps: its profits, its treatment

36
 CASE STUDY
Social objectives at Intel
Intel is one of the world’s largest manufacturers of
semiconductors, a component used in many electrical
products including telephones and computers. In 2019,
it employed more than 110 200 people across the world.
The company’s mission statement is ‘to bring smart,
connected devices to every person on Earth.’ It believes
that technology can help to improve living standards.
▲ Figure 1.15 The Intel organisation believes in corporate
social responsibility
Mission statement, aims, objectives,
strategy and tactics
The mission of a business is the fundamental reason why
it exists. A mission statement sets out the purpose of
the business. For example, an airline may exist to be the
‘best airline in the world’; a computer manufacturer may
aim ‘to help people work more effectively’, and a cosmetics
business may intend ‘to bring beauty to everyone’. The
mission will be determined by the owners of the business.
A business’ aims are its long-term goals and are often
referred to as its corporate aims, meaning that they
relate to the whole business. Businesses do not normally
state aims as numerical targets but rather in qualitative
terms. For example, a housebuilder might set itself an
aim of building environmentally friendly homes. Both
corporate aims and mission statements are set by senior
managers within the business. They are designed to
provide guidance for setting objectives and to assist junior
managers in decision-making.
The mission and aims are rather general statements and,
unlike objectives, whether or not they have been achieved
cannot easily be measured. What exactly does a business
measure to decide if it is the best airline? It could be the
number of planes it operates, or the number of passengers,
or perhaps the level of customer satisfaction. This is why
corporate objectives exist, to turn the mission and aims
into measurable, specific and time-related targets.
1.4
Intel’s 2018 corporate social report states: ‘In celebration of
Intel’s 50th anniversary, we set a goal to engage 50 000 of our
employees to volunteer more than 1 million hours in 2018.
We exceeded that goal, with more than 68 000 employees
(or 64 per cent of our employees) volunteering approximately
1.5 million hours of service throughout the year. To support
1.4.1 Business objectives in the private sector and public sector
our goal, each business group achieved a participation rate
of over 50 per cent. Over the past 10 years, our employees
have generously donated their skills, technology expertise
and more than 10 million hours of service to tackle
environmental challenges, improve education and help
meet community needs around the world.’
Intel’s volunteer groups have worked in many countries
including Malaysia, Japan, Namibia and Puerto Rico.
Source: Corporate Social Responsibility at Intel, 2018–19 Report
Questions
1 Define the terms:
a ‘mission’ [2]
b ‘objectives’. [2]
2 Evaluate the extent to which Intel benefits from
having a widely publicised mission statement. [12]
Once these targets have been set, the business has to
decide how to achieve them most effectively. The long-
term plan to achieve an objective is known as a strategy.
For example, if a business wanted to increase profits by
30 per cent in three years, the strategy might be to target
overseas markets. However, this strategy has to be put
into action; in this example, a decision has to be taken on
which countries will be targeted. However, other decisions
have to be made too: In what order will the new markets
be entered? What products will be offered in each? The
shorter-term action plans that combine to make up the
strategy are known as tactics.
Mission Aims Objectives Target Strategy Tactics
statement
▲ Figure 1.16 From mission to tactics
GLOSSARY TERMS
A mission statement sets out the overall purpose of a
business.
An aim is a long-term goal that determines the objectives
that an organisation sets itself.
Strategy is the long-term plan to achieve the objective of a
business.
Tactics are the short-term actions needed to implement
the strategy.
37
 1.4.2 Objectives and business
1.4 decisions
The role of objectives in the stages of
business decision-making
Managing a business involves many different decisions;
for example, deciding on the objectives, deciding the best
way of achieving these (which is set out in the company’s
strategy), and deciding how to bring the strategy about on
AS LEVEL 1.4 BUSINESS OBJECTIVES
time and at an acceptable cost through use of appropriate
tactics. Making the right decisions is therefore an important
part of good management. Decision-making involves:
» Setting the objectives This is essential because
the success of a plan can only be judged against the
objectives that were set. Making a profit of $100 000
may be disappointing if the objective was $300 000,
but not if the target was $80 000! It is important to set
realistic and achievable targets.
» Gathering information Before you decide what to do,
you need information on where you are at the moment,
what else is happening and what your options are in
order to analyse the situation.
» Selecting a suitable strategy Having analysed the
information, you can decide on the best strategy; for
example, targeting domestic or overseas markets.
» Implementing the strategy This is where the tactics
come in to make sure the plan works well.
» Reviewing This is essential to see how you have got
on and what, if anything, needs to be changed. After
the review you can consider whether the objectives are
still appropriate or not; you may need to set higher or
different targets, for example.
Setting
objectives
Reviewing
Gathering
information
Implementing Selecting a
the suitable
strategy strategy
▲ Figure 1.17 The process of decision-making
How objectives might change over time
Over time, the objectives of a business may change. This
can be for many reasons, both internal (inside the business)
and external (outside the business):
» Internal A business may have new owners or managers
who want to achieve different things. Perhaps they
38
want the business to grow faster, for example, or are
more concerned about the environmental record of the
business than the previous owners.
» External Perhaps the economy has gone into decline and
so the organisation needs to reduce its growth target.
Perhaps competitors have entered the market, which
means the profit target was too ambitious and needs to
be amended downwards.
Decision-making is a continuous process in which decisions
are being taken and reviewed and new objectives are set.
Translating objectives into targets
and budgets
The overall objectives of a business need to be cascaded
down into departmental and then individual targets for
people. Using objectives throughout the organisation helps
to ensure everyone is working towards the same aim. With
each objective there should be a strategy of how it is to be
achieved and specific tactical targets showing the details of
the activities that need to be undertaken. A plan will show:
» who is in charge of what
» what they have to do
» when it must be done
» how much they have to spend; that is, what budget has
been agreed.
A budget is a financial target that might set out expected
revenues and also anticipated expenditure. This helps with
financial planning. The size of the budget will depend on
what the objective is and what has to be done to achieve it.
GLOSSARY TERMS
A target is a goal pursued by a business, such as achieving
a particular market share or rate of growth of sales.
Budgets are financial plans setting out a business’ future
revenues and expenditure.
Ethical behaviour is behaviour that is thought to be
morally correct and not necessarily the most profitable.
The communication of objectives and
their likely impact on the workforce
When setting objectives, this should be done in discussion
with the people who will be responsible for achieving them.
This should help make sure the objectives are realistic and
that the people involved are committed to achieving them.
If a target is forced on an employee, they may not try very
hard to achieve it because they may not think it is feasible
or even possible to hit.
Having an objective can be very motivating because it
provides a sense of direction, so that employees know
what they are doing and why, and how this fits in with
the overall strategy of the business. It can also motivate
because it sets workers a target, so they have something to
aim for and something that can be reviewed.
However, objectives may be demotivating if the person who
is set them does not believe in them and has no sense of
ownership. If an employee feels they have been set a target
that cannot be reached, or they do not have the budget to
make it possible, they will probably feel demotivated. This
means that how an objective is set and what resources are
allocated to it are very important.
STUDY TIP
Remember that some of the businesses you will
encounter in question papers may be large ones, and this
can pose a challenge for the business to communicate
corporate objectives clearly. This problem can be more
serious if the business operates in different countries
with different languages and time zones.
SMART objectives
To be effective, objectives should be SMART. SMART
objectives must be:
» Specific They must define exactly what the firm is
measuring, such as sales or profits.
» Measurable They must include a quantifiable target; for
example, a 10 per cent increase in sales revenues.
» Agreed If targets are simply imposed on people, they
are likely to resent them. If, however, the targets are
discussed and mutually agreed, people are more likely to
be committed to them.
» Realistic If the objectives are unrealistic (for example,
they are too ambitious), people may not even bother to
try and achieve them. To motivate people, the targets
must be seen as attainable.
» Time-specific Employees need to know how long they
have to achieve the target; for example, is it two or
three years?
CASE STUDY
Ethics at Texas Instruments
Texas Instruments (TI) is based in Dallas, Texas, and
makes a diverse range of electrical products including
military equipment and calculators. In 2020, it employed
30 000 people in 30 countries.
TI’s board of directors adopted ethical principles very
early. The company established an ethics office in 1987
and appointed the company’s first ethics director. Its
ethics director and staff have three primary functions:
● to ensure that business policies and practices are
continuously aligned with ethical principles
● to clearly communicate ethical expectations
● to provide multiple channels for feedback, through
which stakeholders may ask questions, voice concerns
and seek resolution of ethical issues.
Of course, unethical behaviour does not have to be the case,
but businesses must be clear on the behaviour they expect
from employees in terms of how they reach their targets.
An example of a good objective might be ‘to increase profits
by 25 per cent over the next four years’. By comparison, a
bad objective would be ‘to do much better’ – it is not clear
what ‘doing better’ actually means, how it will be measured
1.4
or how long you have to achieve it.
How ethics may influence business
objectives and activities
Business ethics refers to what is considered to be right
1.4.2 Objectives and business decisions
or wrong in terms of business behaviour. For example, is
it ethical behaviour to sell cigarettes if you know they
can damage people’s health? Is it ethical to produce a
good or service if the process of producing it damages
the environment? Is it ethical to show advertisements for
children’s toys between children’s television programmes to
get the children to pester their parents to buy them?
Managers face ethical issues all the time, in all areas
of business. Sometimes the objectives of the business
can encourage unethical behaviour. If employees are set
extremely high sales targets, they might decide to sell
products to people who don’t really need them or to avoid
telling people some of the problems that might occur with
the product if they don’t ask. The drive to boost sales can
lead a business’ employees to behave badly. In recent years
there have been many sales scandals; for example, insurance
companies have sold people policies that were unlikely to
ever pay out and banks have not told people they could be
earning higher returns if they changed to a different type
of bank account. This behaviour is usually driven by a desire
to hit high targets, in order either to keep a job or to earn
bonuses.
The company’s website makes its ethical position clear.
‘Our challenge ... is to provide the tools employees may
need to make tough but appropriate decisions quickly.
We work to ensure they have a clear understanding of the
global rules and regulations that govern our operations, as
well as our own values, principles and ethical expectations.’
Source: Adapted from www.ti.com
Questions
1 Explain two reasons why Texas Instruments sets out
its ethical objectives on its website. [6]
2 Evaluate the case for and against Texas Instruments
operating with ethical behaviour as a key objective at
all levels in the business. [12]
This is why some businesses have a ‘code of ethics’ or a
‘code of conduct’ to make it clear to employees what is and
what is not regarded as acceptable behaviour.
39
 TEST YOUR LEARNING
1.4
Short answer questions Data response question
1 a Define the term ‘business objective’. [2] A different bank
b Explain one feature of a good objective. [3] New Zealand has four major banks which dominate its
2 a Define the term ‘mission statement’. [2] banking market, holding a market share of around 80 per
b Explain one benefit to a multinational business of cent. Two years ago, Provident Bank opened its first
having a mission statement. [3] branches in Auckland and Wellington amid great publicity.
The new bank’s corporate objectives include achieving high
AS LEVEL 1.4 BUSINESS OBJECTIVES

3 a Define the term ‘corporate responsibility’. [2]

b Explain one reason why corporate responsibility rates of growth and establishing 20 branches through the
is important to an oil company such as BP. [3] country within its first three years of trading.
4 Explain two differences between strategy and The bank has a mission statement which sets out its
tactics. [6] commitment to a high standard of customer service. This
5 Explain one type of strategy a business that is figures prominently on its website and is used in much of
entering new markets overseas might adopt. [3] its publicity, including its recruitment materials.
6 a Explain one stage of decision-making. [3] Provident Bank has set out to differentiate itself from its
b Explain one reason why it is important to review rivals by adopting strongly ethical corporate objectives
decisions. [3] which influence its strategy and tactics. It does not invest
7 a Define the term ‘ethics’. [2] in businesses whose actions damage the environment
b Explain one reason why businesses try to take or those that supply armaments. It is a carbon-neutral
ethical decisions. [3] business. Its charges are higher than the large,
8 Explain one reason why a marketing manager might established banks, but its marketing is distinctive and
consider ethics when making a decision. [3] research suggests that it is appealing to wealthy New
9 a Define the term ‘budget’. [2] Zealanders.
b Explain one advantage to a business of setting a
Questions
budget. [3]
10 Explain two reasons why a growing business’ 1 Define the terms:
objectives might change over time. [6] a ‘corporate objectives’ [2]
b ‘tactics’. [2]
2 Analyse one reason why Provident Bank considers
its mission statement to be important. [4]
3 Evaluate the case for and against Provident Bank
adopting ethical corporate objectives. [12]

40
1 Business and its environment
AS LEVEL

1.5 Stakeholders in a business

1.5.1 Business stakeholders

Chapter overview
In this chapter we examine:
★ the different groups affected by business behaviour
★ the relative importance and influence of stakeholders on a business.

1.5.1 Business stakeholders

Individuals or groups with an interest in Internal and external stakeholders
the activities of a business The stakeholders of any business can be divided into two
categories: those who are part of the business and those
All businesses involve and affect many other people and who operate outside it.
groups by their activities. These individuals and groups are
called stakeholders. Stakeholders include: Internal stakeholders include:
» the owners of a business, such as the shareholders of a » the owners of the business – this covers sole traders,
company partners and shareholders
» the business’ employees » the business’ employees, such as managers and shop-
» the business’ managers, who take tactical and strategic floor workers.
decisions External stakeholders include:
» the suppliers of goods and services » suppliers. These are the individuals and other
» the banks and other organisations that provide finance organisations that provide businesses with the goods
» customers, who buy the products and services that are needed to carry out production
» the local community, which may be concerned about » customers who purchase the goods and services that are
issues such as employment and pollution sold by the business
» the government, which collects tax revenues and hopes » the government, both local and national
for high employment levels. » banks who provide businesses with a range of financial
Stakeholders may not have formal authority over a services, such as giving loans
business, but it may be in the business’ best interests to » the community, including people who live near to any of
take their needs into account when making decisions. It has the business’ facilities.
become more common for businesses to attempt to meet
the needs of as many of their stakeholders as possible in
order to generate a positive image.
External stakeholders
STUDY TIP Internal stakeholders
(e.g. owners, Stakeholders
(e.g. suppliers,
customers,
When responding to questions about stakeholders, do not managers, the government,
other employees) the bank,
be too ambitious and write about too many stakeholders. the community)
This will make it difficult to develop arguments fully and
to write analytically. Instead, you should select the two
or three stakeholder groups that are most relevant in the
circumstances and focus exclusively upon these.
▲ Figure 1.18 Internal and external stakeholders

GLOSSARY TERMS
Stakeholders are groups or individuals who have an interest Internal stakeholders are individuals and groups within a
in a business. business; for example, employees.
Authority is the power or ability to carry through a task or External stakeholders are groups outside a business; for
action. example, people who live near to the business’ premises.

41
 Roles, rights and responsibilities of
1.5 the stakeholders
Each of the stakeholder groups above will have their own
objectives. Some examples are:
» Employees may want good rewards for the work done,
job security, a safe working environment and some
opportunities for promotion.
» Shareholders will want financial rewards in return for the
risk of their investment.
» Suppliers will want to be paid on time and to be kept
AS LEVEL 1.5 STAKEHOLDERS IN A BUSINESS
Each stakeholder will have certain legal rights. Employees
may have an employment contract that the business must
adhere to, while the owners or shareholders are entitled
to be kept informed of the business’ activities. These
stakeholders may also have responsibilities to the business.
In return for their wages, employees are expected to
complete their tasks competently; in return for payment for
their products, suppliers should supply goods and services
of an appropriate quality and quantity. Businesses are
therefore in a two-way relationship with their stakeholders.

well-informed of any changes in orders.

» The government will want the business to act legally; for
example, to pay its taxes on time.
▼ Table 1.10 Summary of stakeholders’ roles, rights and responsibilities

Stakeholders Possible rights include Possible responsibilities include

Employees • To be treated fairly • To work effectively
• To be paid fairly • To turn up for work on time
• To be kept informed
Suppliers • To be paid on time • To provide good quality products meeting the set
• To be informed of any potential changes in orders specifications at the time set
in the future
Owners/ • To receive a share of profits • To treat management fairly
shareholders • To be kept informed by management
Customers • To be supplied the right quality products on time • To pay on time
Government • To be paid taxes • To protect businesses, customers, employees and
• To have businesses obey the law the environment
Managers • To be rewarded appropriately for responsibilities • To carry out duties to best of ability
• To have duties commensurate with seniority • To be discrete in handling sensitive business data
Banks and other • To be repaid promptly and on time • Not to charge excessive interest rates or to
lenders withdraw loans without a reasonable period of
notice
The local • To live in an area that is free from excessive noise • To co-operate with the business in its daily
community or other forms of pollution activities
• To have a say in decisions which impact the local
community
• To benefit from employment

CASE STUDY
Gold Fields Limited engages stakeholders
Gold Fields Limited operates eight mines in Australia,
Chile, South Africa, Peru and Ghana. The business’
mining operations in Ghana make it the country’s largest
producer of gold and the largest private sector employer
with approximately 5200 direct and 83 000 indirect
employees. It uses a forum to discuss issues and listen to
its stakeholders. The aim is to engage with and update key
stakeholders on its operations and activities.
Those invited include government ministers, members
of the community, financial institutions, investors and
the media. The company is committed to sustainable
development and has invested in socio-economic
development projects in the community where it operates.
Its investment focuses on education, health, water
and sanitation, and development. A world-class water
treatment plant has recently been constructed at Tarkwa
and this provides communities with access to clean water.
The company has also tried to employ locals wherever
it can – a high proportion of the company’s workforce in
Ghana are locals.
Questions
1 Explain one reason why employees and customers
might be Gold Fields’ major stakeholders in Ghana. [3]
2 Evaluate the extent to which Gold Fields Ghana
may have benefited from holding its ‘stakeholder
forum’. [12]

42
Why become a shareholder?
By investing in a company, shareholders become the
owners of the business. This means that, if the business
is successful, the value of their shares should increase.
Shareholders should also receive some of the profits that
the company makes each year. The part of the profits paid
out to shareholders is called the dividends. The more profit
a firm makes, the bigger the dividends are likely to be.
Each year the shareholders will decide on the amount of
dividends to be paid per share; the more shares a person
has, the more dividends they receive in total.
Shareholders can also influence the policy of the business.
Most types of shares grant their owners voting rights. Each
share is worth one vote. By buying more shares, people can
get more votes and have a greater influence over what the
firm actually does. If someone owns more than 51 per cent
of the shares, they control the business and, therefore, can
decide company policy.
All companies must have an annual general meeting (AGM)
to which the shareholders are invited and every shareholder
must receive a copy of the company’s annual report. The
annual report reviews the performance of the business over
the last year. At the AGM, the directors and managers give
an overview of the company’s position and respond to any
questions that shareholders might have.
In the UK, financial institutions such as banks, pension
funds and insurance companies own most company shares.
These organisations buy shares to make a profit through the
dividends they receive and by selling the shares at a higher
price later on. They can then pass their profits on to their
own investors.
GLOSSARY TERM
Dividends are money that is paid out of profits to
shareholders. It is a reward to the owners of the business.
1.5.2 The relative importance
and influence of stakeholders on
business activities
The interaction between a business’
decisions and its stakeholders’
responses
Any business decision can impact on stakeholders. Examples
include:
» Employees may be affected by a decision to reduce the
size of the business.
» Shareholders will be affected if the profits of the
business are low.
» Suppliers may be affected by an increase in orders and
be able to grow their businesses.
» The community may benefit from the expansion of the
business and greater income being earned and spent in
the area.
» The government may be affected by the creation of more
jobs and more taxes being paid.
The impact of business activity can be positive or negative. 1.5
Sometimes one group may benefit and another may suffer.
For example, a decision to cut wages would not be popular
with staff but may enable higher rewards for the investors.
A decision to shift production abroad would not benefit
the government of the original country but may benefit the
community where production now occurs.
1.5.2 The relative importance and influence of stakeholders on business activities
If stakeholders do not welcome changes, they can take
various actions to avoid the effects of them. The following
are examples of possible responses from stakeholders:
» Shareholders can sell their shares and invest elsewhere.
» Banks can refuse to lend more or charge more for
businesses to borrow.
» Employees can leave and work elsewhere or, as a group,
they may take strike action, which means they withdraw
their labour, hoping to get the business to change its
policy.
» Suppliers can refuse to supply the business or demand
better payment terms, such as payment on delivery.
The impact of stakeholder aims on
business decisions
Most stakeholder groups have aims in their relationship with
the business. We shall consider some examples.
1 Employees This stakeholder group is likely to have aims
such as improving working conditions, maximising pay
and other benefits, and seeking secure employment.
Businesses have to take these aims into account
when making decisions. For example, Google employs
many highly skilled people. When taking decisions on
investing in expansion, the company would ensure that
it budgets for attractive pay rates, provides working
conditions that encourage and promote creativity and
that it offers job security. If Google failed to take these
decisions, it would experience difficulties in recruiting
the most talented and productive employees.
2 Customers Arguably this stakeholder group has the
greatest impact on business decisions, particularly when
the customer has a wide choice of suppliers of a product.
If, for example, a supermarket takes a decision to raise
prices, it may find that many of its customers buy
their groceries elsewhere. The decisions taken by many
managers in businesses will be intended to provide the
best possible value and service to their customers. In
this way, customers are a major force shaping business
decisions.
3 Suppliers Businesses depend on suppliers to deliver
raw materials, components and other services.
Without receiving the correct supplies at the right
time, a business may not be able to continue trading.
Businesses would normally seek to take decisions which
do not impact adversely on suppliers, such as delaying
payments or changing orders at short notice. A supplier
is more likely to have a significant impact on business
decisions if it is a major supplier and if there are few or
no alternative sources of supply.
43
 4 Owners and shareholders Shareholders can be a
very influential group on business decisions taken by
1.5 companies. Shareholders in the UK can vote to remove
directors of a company if the directors take decisions of
which the shareholders disapprove. The owners of small
businesses (sole traders and partners) are more likely to
be the people who are taking the business decisions.
Thus, there is less chance of any disagreement occurring.
How and why a business needs to be
AS LEVEL 1.5 STAKEHOLDERS IN A BUSINESS
accountable to its stakeholders
The shareholder concept
Businesses have certain legal responsibilities to their
stakeholders. For example, there are laws controlling the
ways in which businesses can promote their products and,
for food manufacturers, the ingredients that can be used.
Some businesses simply do what they have to by law and no
more. They focus mainly on rewarding their owners. They
will pay employees what they need to get the job done
but do not think they have any more responsibilities other
than this. They will try to get the lowest price for supplies,
perhaps by threatening to use different suppliers. They will
pay governments the taxes they have to but will not think
CASE STUDY
Hitachi: contributing to a sustainable society as a good corporate citizen
Hitachi is a multinational company, based in Japan,
that produces a range of products including trains,
construction equipment and power tools.
Climate change is a priority for Hitachi, and we are
striving to reduce CO2 [carbon dioxide] emissions ... We
announced our long-term environmental targets, called
Hitachi Environmental Innovation 2050, which include a CO2
reduction target of 80 per cent ... by 2050 (compared to 2010).
To achieve a resource efficient society, we are responding to
the issue of water scarcity and promoting the efficient use
of water and other resources. We are also promoting the
effective use of plastic and other resources to minimise our
impact on [the] natural [environment] ...
Hitachi has faced a range of natural disasters, such as
an earthquake in Japan in 2011. Hitachi City in north
Tokyo, which is the headquarters of the company,
was particularly badly affected by the disaster. These
problems did disrupt the company’s supply chain but
the business continued to achieve good results. The
managers believe its ability to survive such disasters
A business is made up of people with different opinions
and, sometimes, very different views on what they want
to achieve and how they think it should be achieved. Any
major decision is likely to make some better off and others
worse off; it is therefore likely to meet with opposition from
some stakeholders.
Every decision will involve different stakeholders and
will consider their objectives and their relative power. Do
44
they have any obligation to invest more in their region or
country. This is known as the shareholder concept, where
rewarding owners is the key business objective.
The stakeholder concept
However, increasingly, organisations are trying to work with
their stakeholders and regard them much more as partners.
This co-operative approach is known as the stakeholder
concept. This view believes that it is better in the long
term to treat stakeholders well.
For example, working closely with suppliers and paying
them a fair reward for their work (even if this is more
than the business would have to pay) will lead to better
quality suppliers and much greater flexibility by suppliers
to help out when needed. Focusing on employees’ careers
and showing concern about their welfare could lead to
greater loyalty and commitment and, as a result, a better
quality of work. Being interested in the environment could
help save costs through initiatives such as recycling,
but it could also make the business more attractive to
employees, customers and investors. The stakeholder
concept fits in with corporate social responsibility in
that it stresses the benefits of accepting obligations to
stakeholders over and above what the law requires.
was due to its stakeholders. The company has a good
relationship with its different stakeholder groups such as
customers, suppliers and national governments.
Hitachi believes it is important to be a good corporate
citizen. For example, it says that environmental issues
such as climate change are becoming a priority, and there
is increasing awareness of the relationship between
businesses and human rights. The United Nations has
asked companies to make broad contributions to society,
mainly through corporate activities, with an eye on the
environment but also alleviating poverty and protecting
human rights. Hitachi is eager to do just this.
Source: Hitachi Sustainability Report 2019, www.hitachi.com/
sustainability/download/pdf/en_sustainability2019.pdf
Questions
1 Explain two ways in which Hitachi could claim to be a
good corporate citizen. [6]
2 ‘Working with stakeholders helps Hitachi.’ Evaluate
this statement. [12]
managers want to listen to them? Do managers need to
listen to them? What will happen if managers ignore them?
This means the managers of a business need to think about
their relative power. A well-organised workforce that is
unionised, for example, may be able to negotiate for more
consultation and participation in decision-making than
individual employees could on their own. Managers may
want to pay more attention to an investor who owns 65
per cent of the company compared with one who owns
1 per cent. A key supplier of a business’ major component
will have more influence than the supplier of a component
that can be bought in thousands of different stores. So,
the more well-organised a stakeholder group is, the more
managers need that particular stakeholder, and the more
that managers like or agree with the stakeholders and their
objectives, the more likely the stakeholders are to influence
a manager’s decision.
The role of different stakeholders can be shown using a
stakeholder map, as in Figure 1.19.
Level of interest
Low High
A B
Low Minimal Keep
effort informed
Power
C D
High Keep Key
satisfied players
▲ Figure 1.19 A stakeholder map and how a business may
view different stakeholders
Groups in quadrant D are likely to influence decisions a lot.
They are interested in what is going on in the business and
CASE STUDY
Foxconn and Amazon
The Foxconn Technology Group manufactures technology
products for well-known multinational companies such
as Apple and Amazon. The company has been criticised
for reducing wages and not operating according to local
labour laws. In response, Foxconn dismissed two senior
managers at one of its factories where work is carried out
to fulfil orders from Amazon.
Foxconn has received a lot of criticism in the past for its poor
working conditions. Amazon and Foxconn have previously
attracted attention for allegations of poor treatment of
Chinese workers. The pressure group China Labor Watch
(CLW) published allegations in 2018 that Foxconn had
forced employees to engage in long – and illegal – periods
of overtime working. In response the company announced
that it had taken disciplinary action against the managers
responsible for mistreating employees.
‘Amazon and Foxconn responded that they would make
improvements to the factory’s working conditions,’ CLW
stated. ‘However, CLW’s 2019 investigation found that
How changing business objectives
might affect stakeholders
As the objectives of a business change, this may well
affect the way it treats its stakeholders. For example,
are very powerful (for example, major investors); managers
will need to keep this group happy. By comparison,
stakeholders in quadrant A are not very interested and are
not powerful (for example, your milk delivery service or
1.5
local newsagent); you do not need to worry much about
this group.
How conflict might arise from
stakeholders having different aims
and objectives
1.5.2 The relative importance and influence of stakeholders on business activities
One of the issues when dealing with stakeholders is that
their aims might conflict; it might not be possible to please
all of the groups all of the time. For example:
» Investors may push for lower costs to increase their
profits and rewards and this may lead to fewer or lower
pay increases for employees.
» In order to meet customer demands for cheaper
products, the business may relocate to cheaper
production facilities overseas, thus upsetting the local
community.
» In order to meet government demands for more
environmentally friendly operations processes, the
business may change its production system, leading to
higher costs and higher prices for customers.
A business may have to juggle different demands and
compromise on occasion.
Foxconn’s working conditions did not improve, and instead
deteriorated.’
CLW also reported that Foxconn’s wages, which were
already very low, had been cut by a further 16 per cent.
This, the pressure group reported, had led to such low
rates of pay that the company experienced significant
labour shortages. These labour shortages resulted in the
company recruiting very young employees, a number of
whom had to work overtime.
Source: www.digitalcommerce360.com/2019/08/09/amazon-is-
under-fire-for-factory-hiring-practices-
and-treatment-of-workers
Questions
1 Explain two reasons why some of Foxconn’s
stakeholders might not have approved of the actions
that the company has taken. [6]
2 Evaluate whether Foxconn has done the right thing
by taking these actions. [12]
a greater emphasis on environmental issues may lead
to more concern for society as a whole and future
generations, in addition to a focus on recycling, reusing
and less waste and pollution. A focus on better quality
might lead to better treatment of suppliers. On the other
45
 hand, greater pressure for profits may mean managers
start to cut back on training, career development and wage
1.5 increases in order to reduce costs; they might also bargain
hard to push down suppliers’ prices.
TEST YOUR LEARNING
Short answer questions
AS LEVEL 1.5 STAKEHOLDERS IN A BUSINESS
1 a Define the term ‘stakeholder’. [2]
b Explain one reason why the Malaysian government
might be a stakeholder of a Malaysian retailer. [3]
2 Explain one way in which businesses and employees
have responsibilities to one another. [3]
3 Explain two possible responsibilities that a business
that manufactures chemicals might have to its local
community. [6]
4 a Explain one responsibility that a business may
have to its suppliers. [3]
b Explain one likely reaction of a retailer’s
stakeholders to a decision to close 10 per cent of
its shops to increase profitability. [3]
5 a Explain one responsibility of the Indian
government to its businesses. [3]
b Explain one way in which the adoption of an
objective of growth might affect an airline’s
customers. [3]
6 a Define the term ‘social responsibility’. [2]
b Explain one reason why a business might wish
to be accountable to its bank. [3]
7 Explain two reasons why a large manufacturer might
experience difficulty in meeting the objectives of its
shareholders and its customers simultaneously. [6]
8 a Explain one reason why a business might wish
to be accountable to its employees. [3]
b Explain one way in which a retailer could be
accountable to its employees. [3]
9 Define the term ‘internal stakeholder’. [2]
10 Explain the possible effect of a hotel’s decision
to increase its prices significantly on two of its
stakeholder groups. [6]
46
It is very difficult for managers to take decisions to satisfy
all stakeholders simultaneously, especially at a time of
change when major strategic decisions may be forced upon
them. It may be that the best they can do is to satisfy as
many stakeholders as possible.
Data response question
A change of approach
Multan Textiles Ltd has had a change of heart. Its new
management team has decided to implement a range
of policies intended to meet the needs of all of its
stakeholders, rather than solely its shareholders. The
adoption of policies based on the stakeholder concept
has significant implications for all of the company’s
stakeholders.
The company has agreed to raise its employees’ wages
over the next few years, at a rate in excess of the current
rate of inflation, and to improve working conditions. It
also has offered its suppliers more favourable credit
terms to encourage a long-term relationship. It is also
reviewing its manufacturing processes to minimise the
impact of the chemicals on its employees and the local
community.
The company has a long tradition of manufacturing textiles
in the region and a good reputation. It is profitable, although
its shareholders have expressed some dissatisfaction at
declining profit levels over the last few years.
Questions
1 Define the terms:
a ‘shareholder’ [2]
b ‘stakeholder concept’. [2]
2 Analyse one benefit to Multan Textiles Ltd of
implementing policies based on the stakeholder
concept. [4]
3 Evaluate the case for and against Multan Textiles
Ltd retaining its original approach based on the
shareholder concept. [12]
 2 Human resource management
AS LEVEL
2.1 Human resource management
Chapter overview
In this chapter we examine:
★ the purpose and roles of human resource management (HRM)
★ why and how businesses prepare workforce plans and the importance of labour turnover
★ how businesses recruit employees, including the process and key documents
★ how businesses select employees
★ the nature and use of employment contracts
★ the ways in which businesses make employees redundant and dismiss them
★ issues affecting staff morale and welfare
★ the purpose, methods and importance of training and developing employees
★ key elements of management and workforce relations.
What is human resource management?
Human resource management (HRM) comprises the
acquisition, training, motivation and reward of human
resources within the business.
Over recent years, the influence of Japanese management
techniques, and their evident success in managing
people, has encouraged the adoption of human resource
management by companies across the globe.
GLOSSARY TERM
Human resource management (HRM) is the process
of making the most efficient use of an organisation’s
employees.
2.1.1 Purpose and roles of human
resource management
Human resource management can help businesses to
generate a significant competitive advantage over rivals
and to achieve organisational objectives, such as growth
and increased profitability. Many companies use HRM to
enhance organisational performance.
If implemented fully and operated properly, HRM recognises
the individual rather than producing personnel policies for the
whole workforce. All the elements of HRM (such as recruitment
and selection, training and development, redundancy and
dismissal) are geared to fulfilling the needs of the individual
as well as those of the organisation. All aspects of the HRM
‘package’ should be co-ordinated to ensure coherence and to
assist the attainment of strategic targets.
If an organisation is successful in operating its HRM policy,
one outcome could be motivated and creative employees who
2.1.1 Purpose and roles of human resource management
are committed to the firm and who do not seek to leave. Such
employees should be aware of the goals of the organisation and
understand how they can contribute towards the attainment of
organisational targets, such as growth in market share.
Under this scenario, a business should incur lower
recruitment costs and enjoy higher levels of productivity
and a reduction in faulty products. It may attract top-class
applicants to vacancies because of its reputation as a caring
and enlightened employer. All of these factors should make
the organisation more competitive and better able to cope
with the rigours of operating in international markets.
However, in reality the case for HRM is not so clear-cut. Many
businesses in the UK differ in their interpretation of HRM.
Some see it as a confirmation of the value of employees who
have to be developed to meet the needs of the organisation.
Others take a ‘harder’ attitude, viewing employees as simply
another resource to be used as effectively as possible. The
latter approach has a much more short-term focus and may
help a business to meet objectives, such as becoming the
lowest-cost producer in the market.
The fact that different interpretations of the policy exist make it
more difficult to assess its contribution to achieving objectives
and overall competitiveness. We will look at these two
approaches to HRM more fully in Chapter 7.4 later in this book.
The role of HRM in meeting
organisational objectives
We saw in Chapter 1.4 that an organisational or business
objective is a target that is normally specific in terms of what
the target is, how it is measured and the time by which it must
be completed. A business might set itself targets such as:
» achieving a certain growth rate in terms of sales (for
example, 10 per cent per year)
47
 » becoming the lowest-cost producer in a market, enabling
it to charge low prices
2.1 » attaining social objectives, including protecting the
natural environment or maintaining employment levels
in low-income communities.
Two key arguments exist which mean that the use of HRM
within businesses is vital to meet organisational objectives.
1 The nature of the workforce has changed over recent
years. Greater use of part-time and peripheral workers,
for example, has encouraged human resource managers
AS LEVEL 2.1 HUMAN RESOURCE MANAGEMENT
to view people as a resource to be deployed as
effectively as possible. Simultaneously, the existence of
a better-educated workforce, along with the expectation
that workers should carry out more complex tasks and
duties, has led managers to view employees as valuable
assets to be developed to make the organisation more
competitive and able to outperform rivals.
2 Changes in organisational structure have led to many
managers taking on responsibility for managing people
within the organisation. Techniques such as delayering
and the development of empowered teams have been an
integral part of the implementation of human resource
management. Acquiring, developing, motivating and
CASE STUDY
The First State Bank
In 2020, the First State Bank announced that it was to
introduce a human resource management package to
improve the productivity of its 44 000 employees. This
programme is intended to develop employees’ skills and
to ensure suitable candidates are available for future
promotions.
The Bank will use technology to automate many of
the functions of its HR department, including paying
employees, booking holidays and repayment of some
expenses. Senior managers at the Bank estimate that this
will save approximately 5000 employee days of work each
month, resulting in a substantial cost reduction for the
publicly owned Bank.
2.1.2 Workforce planning
The reasons for and role of a
workforce plan
Before a business recruits, selects or trains employees, it
must establish future labour needs. This is not simply a
matter of recruiting sufficient employees. Those recruited
must have the right skills and experience to help the
organisation achieve its corporate objectives. Managers
will draw up a workforce plan or human resource plan
to detail the number and type of workers the business
needs to recruit, as well as the location where they will be
employed.
48
rewarding employees are, it is argued, best done by
managers and colleagues close to the employee in
question. Empowered teams can play a role in recruiting
employees and identifying training needs. This approach
to HRM embodies a philosophy entirely in harmony with
modern management techniques such as delayering and
teamworking. This approach to HRM can help a business
to meet challenges through possessing workforces which
are more efficient and responsive to customers’ needs
than those of competitors.
GLOSSARY TERMS
Delayering is a reduction in the number of levels of
hierarchy within an organisational structure.
Teamworking is the process of breaking down production
into large units and using groups of employees to
complete these tasks.
A workforce (or human resource) plan assesses the
current workforce and actions necessary to meet the
business’ future labour needs.
Labour turnover is the percentage of a business’
workforce that leaves a business over a given period of
time (usually one year).
The automation of the HR function offers other benefits
to senior managers. The new HR system gives managers
instant access to all employees’ qualifications,
experience, performance appraisals and positions held.
This will help the Bank’s managers to manage the talent
available more effectively and will ease the process of
planning its future workforces.
Questions
1 Explain two reasons why HRM might be an
important issue within the First State Bank. [6]
2 Evaluate whether the advantages of the
introduction of new technology into the Bank’s HR
department will outweigh the disadvantages. [12]
Workforce plans plays an important role in making
businesses competitive and enabling them to meet their
organisational objectives. For example:
» They help businesses to deal with changes (such as the
impact of new technology or changes in consumers’
tastes) by ensuring that they have the right employees
in terms of numbers, work locations and skills.
» Workforce plans help businesses to prepare for changes
in the workforce, such as the introduction of new
production-line machinery or a significant proportion of
employees leaving through retirement.
Workforce plans are designed to help businesses to prepare
for changes in their environments and not simply to respond
to them.
Businesses require a range of information when developing
human resource plans:
» They need to research to provide sales forecasts for the
next year or two. This will help identify the quantity and
type of labour required.
» Data will be needed to show the number of employees
likely to be leaving the labour force in general (labour
turnover). Information will also be required on potential
entrants to the labour force.
» If wages are expected to rise then businesses may
reduce their demand for labour and seek to make greater
use of technology.
» The plan will reflect any anticipated changes in the
output of the workforce due to changes in productivity
or the length of the working week.
» Technological developments will impact on planning the
workforce. Developments in this field may reduce the
need for unskilled employees while creating employment
for those with technical skills.
Labour turnover
number of staff leaving during the year
turnover = × 100
average number of staff
This ratio measures the proportion of a workforce leaving
their employment at a business over some period of time,
usually one year. Low wages and inadequate training leading
to poor morale among employees may cause high levels of
labour turnover. Another cause is ineffective recruitment
procedures, resulting in the appointment of inappropriate
staff. Other reasons include redundancy and retirement.
HANDLING DATA
Last year, 45 employees at Kenya Fuels Ltd left
the company. The company had an average of 900
employees during the year. The company’s HR manager
had forecast that the company’s labour turnover figure
would be 4 per cent.
1 Calculate the labour turnover figure for this company.
2 How many employees would have left if the HR
manager’s forecast had been accurate?
Some level of labour turnover is inevitable. Managers seek
some labour turnover to bring new ideas into a business,
but not so much as to impose excessive recruitment costs.
A survey in the UK in 2017 by the Chartered Institute of
Personnel and Development (CIPD) revealed that labour
turnover in the UK was 16.5 per cent and that it has risen
steadily for some years. Businesses attempt to manage
labour turnover to achieve a balance between the costs of
recruitment and the potential for disruption to production
on the one hand, and bringing new employees with
enthusiasm and ideas into the business on the other.
The implications of different rates of labour
turnover
Surveys in the UK have shown that labour turnover for most
businesses surveyed has a negative impact on performance
and their ability to achieve organisational objectives. This
suggests that most businesses face a higher labour turnover
than desired or that they face unexpected recruitment
costs. If the rate of labour turnover continues to rise in
2.1
the UK, this may result in businesses incurring significant
additional costs to recruit and train new employees. They
may also face additional wage costs if they have to increase
pay to reduce the level of labour turnover.
However, it may be that a business suffers a rate of labour
turnover that is too low. For example, in creative industries
2.1.2 Workforce planning
such as marketing, it is often helpful for a business to
have a stable and steady rate of turnover. This can help to
develop ideas for new products and more effective ways of
working.
The implications of different labour turnover rates depend
on the industry in which the business operates and the type
of labour in question. For example, a seasonal business that
hires a high proportion of unskilled employees may not be
concerned by high rates of labour turnover. It can recruit
during the off-season and its expenditure on training
is likely to be low. The same would not be true of an
organisation that employs highly skilled employees who are
difficult to replace. A hospital might be an example of this
type of organisation.
CASE STUDY
Labour turnover and restaurants in the
USA
Hotels and restaurants across the world face very
high rates of labour turnover. Restaurants in the USA
experienced rates of nearly 75 per cent in 2018, meaning
that around three-quarters of business employees are
leaving each year. The equivalent figure for 2010 was
57 per cent.
The restaurant industry is the US economy’s largest
employer of teenagers, as one-third of all working
teenagers in the USA are employed in a restaurant. The
industry also employs a high proportion of students,
who may only work part of the year and tend to leave
employment once they finish studying. This helps
to reduce costs and to allow restaurants to charge
competitive prices for meals.
Restaurant guests also develop a comfort level with an
employee with whom they regularly interact. Appointing
new employees can affect regular operations which are
vital to the smooth running of any restaurant, especially in
the kitchen. Having skilled and experienced staff is vital in
the American restaurant industry, where competitiveness
is based heavily upon employee performance.
Questions
1 Explain two reasons why labour turnover rates
of ‘nearly 75 per cent’ might cause problems for
managers in restaurants in the USA. [6]
2 Evaluate the possible actions the managers of
restaurants in the USA might take to reduce rates
of labour turnover. [12]
49
 2.1.3 Recruitment and selection
2.1 The process of recruitment
The process of workforce planning, in which a business
analyses its expected future labour needs and compares this
to its current workforce, may identify the need for recruiting
new employees. Alternatively, the need for recruitment
may arise because an existing employee opts to leave. The
recruitment process is summarised in Figure 2.1.
AS LEVEL 2.1 HUMAN RESOURCE MANAGEMENT
Use HR plan to decide
number and type of employees needed
Prepare:
1 Job adverts
2 Job descriptions
3 Person specifications
Advertise outside the Advertise inside the
business (external recruitment) business (internal recruitment)
Receive job applications
Prepare shortlist for selection,
matching applications and person
specifications
Select employees using interviews, etc.
▲ Figure 2.1 The process of recruitment and selection
Source: CIPD Resources and Talent Planning Survey
Recruitment is likely to be a more important activity in a
business that is expanding or one which is developing new
products or entering new markets. In such cases, the business
may require a substantial number of new employees and these
may come from inside the business (existing employees) but
are more likely to be recruited from outside it.
STUDY TIP
It is easy to get bogged down in the detail of recruitment
and selection procedures. While such knowledge is
fundamental, it is vital to think about how successful
different approaches to recruitment and selection might
be in helping the business to achieve its organisational
objectives.
In 2018, more than 70 per cent of businesses taking
part in a UK survey said that they were experiencing
50
recruitment difficulties. The key reason cited was a lack of
suitable candidates. Recruiting is expensive. The average
recruitment cost of filling a vacancy in the UK in 2020 was
£3000 and took nearly 28 days, during which output and
sales may have been lost. However, many managers would
argue that these figures are less costly than appointing the
wrong employee and perhaps having to repeat the process.
Two very important documents used in the process of
recruitment are job descriptions and person (or job)
specifications.
GLOSSARY TERMS
Recruitment and selection is the process of filling an
organisation’s job vacancies by appointing new staff.
Job descriptions list the duties and responsibilities
associated with a particular job.
Person (or job) specifications outline the skills,
knowledge and experience necessary to fill a given
position successfully.
An employment contract is a legal agreement between
an employer and an employee setting forth the terms and
conditions of the employment arrangement.
Job descriptions
Once managers know the type and number of employees
required, job descriptions can be prepared. These relate
to the position rather than the person. Typically, job
descriptions might contain the following information:
» the title of the post
» employment conditions
» some idea of tasks and duties
» the key aims and responsibilities of the job
» where the job fits into the organisation.
A job description is likely to form the basis of the
employment contract, which we consider below. It also
offers other important information to employers and
employees.
» It helps employers by allowing them to consider exactly
what should make up the job and how this job relates
to others within the organisation. It can also be used
to judge performance of an employee at some point
following their appointment. Employees can be set
targets based on the information included in the job
description. During an interview, the job description
might form the basis for the interviewer’s questions.
» It provides potential employees with essential
information to help them to decide whether or not to
apply for a job. For example, the descriptions of tasks
and duties will help them to decide whether they would
enjoy the role.
Person specifications
Person or job specifications set out the qualifications
and qualities required in an employee. They relate to the
employee, whereas job descriptions relate to the job. They
include:
» educational and professional qualifications required
» character and personality needed
» skills and experience wanted.
Candidates’ applications should be compared against the
person specification and those applicants with the ‘best fit’
should be invited to interview or other selection procedure.
This document, therefore, plays a vital role in helping an
organisation decide which of the applicants for a post
should progress to the next stage of selection.
Methods of recruitment
Once managers have prepared job descriptions and person
specifications, a decision has to be made as to how to recruit
the necessary employees. A number of options are available.
Job advertisements
The start of recruitment is often drawing up an advert
for the vacant position. This advert could be placed in
newspapers, magazines or on the internet. The advert
needs to be targeted so as to attract suitable applicants
while dissuading unsuitable candidates from applying.
For example, if an international airline such as Pakistan
International Airlines was recruiting a senior manager, it
may advertise the vacancy globally. In contrast, a retailer
seeking to advertise a vacancy for a shop assistant would
be more likely to advertise the job in a local newspaper.
In part, the choice of where to advertise a job will also be
determined by cost; generally, businesses are willing to
spend more heavily on recruiting senior employees.
An effective job advertisement should contain sufficient
information to attract and engage potential employees
but not too much so as to discourage them from applying.
Figure 2.2 contains a checklist of possible information to
include in a job advertisement.
Job title
Location of job
Brief description of business, its products and markets
Outline of job role
Any special features of the job such as part-time or
flexible hours
Some indication of qualifications and experience
required
Salary or salary guide
Other reward details such as a company car
Explanation of how to apply and the recruitment
process
Contact details for the business
▲ Figure 2.2 A checklist for writing job advertisements
Employment agencies
Employment agencies provide employers with details
of suitable applicants for posts they may have vacant.
Agencies usually charge considerable fees for bringing
together employers and potential candidates. Businesses
may use employment agencies to recruit highly specialist
employees or those with skills that are scarce. Although
this is a costly method of recruitment, agencies often have
2.1
skills and contacts that many businesses do not possess.
Online recruitment
Online recruitment allows businesses and other
organisations to use their websites to recruit potential
employees cheaply and from any part of the world.
2.1.3 Recruitment and selection
This method of recruitment can increase the number of
applicants and the quality of employees who are eventually
employed. Online advertising can reach much larger
audiences, increasing the number of applicants. Equally,
this form of advertising can be targeted, as relevant
groups help to improve the quality of applicants. Websites
operated by both businesses and governments bring
together those seeking work and businesses intending
to recruit. Examples include the privately owned Rozee
website (www.rozee.pk) in Pakistan and the New Zealand
government’s jobs website (www.jobs.govt.nz).
CASE STUDY
Job advertisement
BUILDING A BETTER WORLD
OSEEC provides a platform for social, economic and environmental
communication and collaboration, with the aim of creating and supporting
policies that increase development in these sectors, enriching quality of life for
people across the globe. Our platform enables global organisations, charities
and governments to share information, co-ordinate resources and collaborate
efforts to tackle shared social, economic and environmental problems.
Director – Environment Directorate
www.oseec.org/ed
A Berlin-based position with a competitive salary and benefits
The Environment Directorate (ED) oversees global communication on
environmental objectives, including design, collaboration and implementation
of multinational policies to combine economic efficiency with sustainable
environmental practice. The ED also provides information, analysis and
advice to support emerging and transition economies currently engaged in
development, promoting inclusivity and environmental sustainability.
This position provides intellectual and strategic leadership in the areas of
biodiversity and biosafety, natural resource management, climate change and
environmental indicators, resource efficiency and waste reduction, and
sustainable environmental practice. This position is responsible for ensuring
that current and future policies fully reflect the aims of OSEEC in this
Directorate and for providing effective support for OSEEC members.
The successful candidate will have significant knowledge and experience in
the aforementioned policy areas, with attestable powers of analysis,
communication, planning and organisation. They will be expected to
promote the intrinsic value of OSEEC in bringing together world partners
to multiple audiences, obtaining wide-reaching media coverage.
This position requires fluency in either English or German and a partial
knowledge of, or willingness to learn, the other. Full details of the position can
be found at www.oseec.org/careers/vacancies (ref. 93752). Applications
must be submitted online by 23 March 2020.
▲ Figure 2.3 An example job advertisement
Question
1 Evaluate whether or not this is an effective job
advert. [12]
51
 Other methods of recruitment
Firms headhunt employees who are currently working for
2.1 other organisations in order to offer them employment.
Those employees who are headhunted are usually either
senior managers or people with specialist skills, perhaps in
short supply. Specialist executive recruitment agencies exist
which can target precisely the right type of candidates, but
they normally charge high fees.
Governments operate a number of training schemes to
improve the skills and knowledge of the workforce. In the
AS LEVEL 2.1 HUMAN RESOURCE MANAGEMENT
Internal and external recruitment
Firms may recruit internally through promotion or
redeployment of existing employees. Internal recruitment
offers a number of benefits:
» Candidates will have experience of the business and its
culture and will be familiar with the firm’s procedures.
» Internal candidates may not require induction training.
» Internal recruitment provides employees with
opportunities for promotion.
» It avoids the need for expensive external advertising.

USA, the Department of Labor’s Employment and Training
Administration funds job-training programmes to improve
the employment prospects of adults, youths and workers
who have lost their jobs. Its training is designed to boost
workers’ employability and earnings. This provides a source
of employees for American businesses that are seeking to
recruit workers.
» Selection may be easier as more is known about the
candidates.
However, internal candidates are drawn from a limited pool
of employees and the skills and experience of this group of
people may be insufficient to meet the business’ needs. This
limitation is more likely in the case of smaller businesses and
with senior appointments or for rapidly growing businesses.

CASE STUDY
IHG uses online recruitment in Dubai
The InterContinental Hotels Group (IHG) is about to open
a new hotel in Dubai. Many of the guests at this new
hotel will be from countries other than the United Arab
Emirates (UAE), as Dubai is a major tourist destination
and its airport is a hub for flights from a large number
of countries. The Indigo Dubai Downtown has launched a
recruitment campaign to attract employees with a range
of skills and experience. The intention is to appoint people
in a range of roles within the hotel including finance,
reception, cleaning, as well as bar and restaurant staff.
The company has a reputation for providing
accommodation within a relaxed setting. It has designed
a number of eye-catching adverts intended to attract
candidates with the skills and personalities that match its
needs.
IHG has used online recruitment to enable it to recruit
employees from any part of the world. This could
provide the company’s managers with a large number
of applicants from which to choose. One requirement
from any selected applicants will be to record a video
describing the place in which they live.
Source: Adapted from www.hoteliermiddleeast.com/
business/115326-hotel-indigo-dubai-downtown-launches-
recruitment-campaign
Questions
1 Explain two reasons why some potential applicants
may not apply for jobs using the IHG’s website. [6]
2 Evaluate the case for and against companies based
in the UAE relying increasingly on their websites to
recruit new employees. [12]

Managers may be keen to have a wider choice of candidates investing more resources and time in the recruitment and
and may seek to recruit externally. This can result in selection process.
applications from higher-quality candidates, especially if
▼ Table 2.1 Methods of selection used by a sample of UK
recruitment is through national media or nationally based businesses in 2015 and 2017
recruitment agencies. External recruits may bring fresh
ideas and enthusiasm into the business. This can be a vital 2015 2017
factor in an organisation with a low level of labour turnover. Method of selection
survey (%) survey (%)
However, external recruitment is likely to be very expensive. Competency-based interviews 77 78
It also carries a greater risk as candidates are not known to Interview following contents 83 74
the business. of CV/application form
Online tests 24 23
GLOSSARY TERM
Personality/attitude 36 35
A business culture is the attitudes, values and beliefs that
questionnaires
normally exist within an organisation.
Assessment centres 38 39
Group exercises (e.g. role-
Selection playing)
27 24
A number of selection techniques exist. Because of the high
costs resulting from recruiting the wrong people, firms are Source: Resourcing and Talent Planning Survey, 2017 (CIPD)
52

Question
1 Evaluate whether the data in Table 2.1 suggests that
UK businesses are attempting to minimise costs of
selection. [12]
Methods of selection
Curriculum vitae, résumés and application
forms
Curriculum vitae (CVs) take various forms but are all designed
to record key information about potential employees, such as
their education, professional qualifications and experience in
previous employment. This is designed to help managers to
match employees to person specifications which detail the
requirements of the job. Thus, they can form an important
element of the early stages of the selection process.
Résumés are very similar. A résumé normally summarises
the applicant’s relevant job experience, education and
training. The résumé is usually sent to employers with a
covering letter which may contain additional information.
Some businesses supply application forms for prospective
employees to complete. These are normally used in place of
CVs and résumés. They offer the advantage that businesses
can ensure that all applicants have the chance to supply the
information that is required to make the selection decision.
Also, because the application forms are in a standard
format, it can be easier to compare candidates’ applications.
CVs, résumés and application forms all tend to be used
early in the selection process, and they can be a useful
means of screening candidates and deciding which to
invite to interview or other method of selection. They are
particularly valuable if a business receives a large number of
applications for a position.
Interviews
These remain a popular form of selection technique and
are the most common in the UK, as shown in Table 2.1.
Interviews can involve one or two interviewers or even
a panel. Candidates can be asked a series of questions
designed to test their knowledge of, and suitability for, the
job. Some interviews (sometimes called competency-based
interviews) may require candidates to undertake specific
job-related tasks to assess their skills.
They are relatively cheap and allow the two-way exchange
of information, but are unreliable as a method of selection.
Some people perform well at interview, but that does not
necessarily mean they will perform well at work.
References
Many employers ask candidates to supply references at some
stage in the recruitment and selection process. These are
written by former employers or by other people in a position
of authority who may know the candidate well. They will set
out the candidate’s strengths and possibly their weaknesses
and provide potential employers with a further indication
of the applicant’s suitability for the post. References are
not always accurate. For instance, an employer may give an
employee an undeservedly good reference if they want to
2.1
get rid of them.
Testing
Testing as part of the selection process can take a variety
of forms. Psychometric tests are very common; these can
take two forms. An aptitude test provides candidates with
2.1.3 Recruitment and selection
opportunities to demonstrate their skills and abilities
in relation to the job. For example, an aptitude test
for a sales role might involve the candidate making a
sales presentation. Personality tests examine the likely
behaviour of potential employees and how they might
respond to certain situations in the workplace. They
involve numerical and written questions and can help to
assess how well the applicant might fit in with existing
employees.
Assessment centres
Managers are aware of the high costs of poor selection
decisions and this has led to the heavy use of assessment
centres. Many managers believe that this is a more
reliable method of selection. In such centres, a number
of candidates are subjected to a variety of selection
techniques over a period of between two and four days.
These might include some or all of the following:
» simulations of circumstances that might occur within
the job
» a variety of interviews
» group exercises, such as role-plays involving a number of
the candidates and assessment centre staff
» tests of candidates’ personalities.
Employment contracts
An employment contract is a legal agreement between
an employer and an employee, setting forth the terms
and conditions of the employment arrangement. It is a
legally binding agreement designed to protect the rights
of employers and employees. In the UK, the Employment
Rights Act requires employers hiring workers for more
than a month to issue an employment contract. A contract
does not have to be issued immediately upon an employee
starting work, but its conditions are in force from the
time an employee commences employment. Employees’
contracts may be verbal, implied (for example, through
previous practice) or written, though the latter is more
common and preferable in many ways.
The laws relating to employment contracts vary between
countries. Here we refer to those that apply within the
UK. An employment contract in the UK should contain the
following information:
1 the employee’s and employer’s names
2 date when employment began
3 the scale (and rate) at which the employee will be paid
and the frequency of payment
4 the employee’s usual hours of work
53
 5 the employee’s entitlement to holidays – how many days
and whether they can only be taken at certain times of
2.1 the year
6 rules relating to absences due to sickness or injury,
including sick-pay conditions
7 the employee’s right to a pension (if any) and employer’s
and employee’s contributions
8 the notice from either side to terminate the employment
contract. This states the period of time that must elapse
between the employee stating their intention to leave
the job and doing so. Similarly, it may record the time
AS LEVEL 2.1 HUMAN RESOURCE MANAGEMENT
period to be given to employees before making them
redundant or dismissing them
9 the job title and a summary of duties
10 the location or locations of the work
11 details of any trade union agreements relating to the job
12 disciplinary procedures – this sets out the rules
establishing standards of conduct at work and how the
employer may respond to any breach of these rules
13 grievance procedures – this will state how an employee
can make a complaint against other staff or their
treatment at work.
An employment contract may include implied terms which are
not directly stated. Examples of implied terms include:
» employees not stealing from employers
» employers providing a safe and healthy working
environment
» employers meeting legal requirements, such as giving a
minimum of a certain number of days of paid holidays
» employees should have essential qualities and
qualifications to carry out the job; for example, lorry
drivers should have a relevant category of driving licence.
If either the employer or the employee suffers financial loss
because the other party has breached the contract, they
can claim compensation in a court of law. For example,
an employee who leaves before the end of a fixed-term
contract and thereby causes disruption to the employer may
be sued for damages. In many cases in the UK, an employee
may take an employer to an employment tribunal to settle a
certain range of disputes relating to employment.
Employment tribunals
Employment tribunals in the UK hear claims about matters
to do with employment. These may include unfair dismissal,
redundancy payments and discrimination. Employment
tribunals are similar to law courts, but they are less formal.
No one in an employment tribunal wears a wig or gown.
Almost all hearings are open to the public, and evidence is
given under oath or affirmation.
2.1.4 Redundancy and dismissal
It is only possible for an employer to legally terminate
the employment of a worker for specific reasons and
having followed certain procedures. It may be that the
employer takes disciplinary action against an employee;
this may result in the employee being dismissed. Similarly,
employment may be ended as a result of redundancy. We
54
shall examine each of these situations in turn and explain
the difference between the two.
GLOSSARY TERMS
A dismissal occurs when an employer terminates the
employee’s contract.
Redundancies take place when an employee is dismissed
because a job no longer exists.
Redundancy
Redundancy is a legal reason for an employer to dismiss an
employee, but it can only occur if a job no longer exists.
Redundancies can take place for a variety of reasons, including:
» A business closes down and all its employees are made
redundant.
» The jobs of some employees are replaced by new
technology.
» A business moves some of its operations overseas and
some jobs are lost as a consequence.
Voluntary and involuntary redundancies
Voluntary redundancy occurs when an employer, wishing
to make redundancies, invites employees to apply for
redundancy in return for a financial compensation
package. This is often the first choice for a business
wishing to make redundancies. This form of redundancy can
help to maintain the morale of a workforce at what can
be a very difficult time for a business. Offering voluntary
redundancies means that employees choose to leave. Some
employees, for example, those near to retirement or those
who might find it easy to obtain alternative employment,
might find the offer of financial compensation very
attractive.
By contrast, involuntary (or compulsory) redundancy is
where employees are selected for redundancy. They have
no choice in the matter. This is likely to occur when a
large number of employees are to be made redundant
and insufficient people are willing to take voluntary
redundancy. Involuntary redundancies often damage the
morale and performance of the workforce. We shall see in
the next chapter that job security is an important factor
affecting motivation at work. Customers may also be less
willing to purchase products from businesses that are using
involuntary redundancies.
The law requires that use of involuntary redundancy must
follow set procedures. These are explained below.
Procedures for redundancy
If a business in the UK intends to make 20 or more
employees redundant, it is obliged to consult with any
relevant trade union or other employee organisation at
least 30 days before any redundancies occur. The employer
must also consult with individual employees. If 100 or more
employees are to be made redundant, consultations must
take place at least 90 days before the process of making
people redundant can commence.
Part of this consultation may involve agreeing a procedure
by which those employees who are to be made redundant
are to be selected. It is likely to be beneficial to involve
employees and their representatives in making such
decisions. Businesses commonly seek to reduce the number
of employees who have to be made redundant by:
» asking for volunteers for redundancy
» banning any overtime to maximise the number of jobs
that are retained
» not replacing employees who leave for other reasons.
CASE STUDY
Airline makes redundancies
Philippine Airlines (PA) announced that it has cut 300
jobs as a result of continued financial losses. The
airline said that this will help the company to reduce its
costs, adding that it was offering voluntary redundancy
packages to long-serving employees. Those who accept
will receive benefits including flight pass privileges and
career counselling assistance. The company’s workforce
currently totals 6087 employees.
Other cost-reducing initiatives include:
● increasing revenues from flights and other products
● a vigorous cost-management approach
● investment in digital technology.
The announcement was made after Philippine Airlines
posted its biggest ever loss ($208 million) in 2019. The
company blamed these losses on high levels of interest
payments on debts and on unexpected global crises,
Redundancy pay
Employees in the UK who have been continuously employed
by the business for two years and who are made redundant
due to the closure of the business or reduced need for
employees are entitled to compensation in the form
of redundancy payments. The calculation for statutory
redundancy pay is:
» half a week’s pay for each full year of service where the
employee is aged under 22
» one week’s pay for each full year of service where the
employee is aged between 22 and 41
» one and a half week’s pay for each full year of service
where the employee is 41 or over.
The maximum number of years that can be taken into account
in calculating redundancy pay is 20 years. Some employers
may choose to pay higher levels of redundancy pay.
Many employers will have a set of redundancy guidelines with
which they will comply to ensure that they do not break any
employment laws relating to the process of redundancy.
Dismissal
Dismissal takes place when an employer terminates an
employee’s employment contract. We saw above that
redundancy is one reason for dismissal. Thus, dismissal is a
more general term than redundancy, which is a specific form
of dismissal.
If, despite these measures, employees have to be made
redundant, there must be clear and agreed criteria for
selecting them. The criteria for redundancy could be based
upon employees’ skills and experience (that is, the business
2.1
would retain the most skilled and experienced) or on
absence and disciplinary performance (those with the best
records keeping their jobs). Employees who are selected for
redundancy must be given between one and twelve weeks’
notice of their impending redundancy, depending on how
long they have been employed by the business.
2.1.4 Redundancy and dismissal
causing the cancellation of flights to mainland China,
Hong Kong and Macau.
As part of its statement on the redundancies, the airline
said that it would be acquiring new aircraft and launching
new routes between Cebu and Los Angeles, as well as
routes to Perth, Pagadian, Kota Kinabalu and Manado.
Source: Adapted from www.ch-aviation.com/portal/news/86974
Questions
1 Explain two reasons why Philippine Airlines might
prefer to use voluntary redundancies, rather than
involuntary redundancies, to achieve the desired
reduction in its workforce. [6]
2 Evaluate the case for and against Philippine Airlines
making 300 employees redundant. [12]
Apart from redundancy, there are a number of reasons why
employees may be dismissed legally in the UK. The reasons
for ‘fair’ dismissal include:
» when employees are unable to do their jobs properly,
perhaps because they do not have the necessary skills or
qualifications to be competent
» as a result of persistent or long-term illness (but not
because of a person’s disability)
» for ‘gross misconduct’ – theft or violence towards
colleagues or customers may be considered gross
misconduct
» a ‘substantial reason’ such as not agreeing to reasonable
changes in employment terms or if an employee is given
a prison sentence.
Employees should receive an explanation in writing of the
reason for their dismissal within 14 days of it happening.
Employees may also be entitled to receive up to 12 weeks’
notice of dismissal, depending upon how long they have
been employed by the business.
If employees in the UK are dismissed for other reasons,
this can be classed as ‘unfair dismissal’. Dismissals are
classed as ‘automatically unfair’ if the reason for dismissal
is connected with an employee exercising rights relating to
factors such as the following:
55
 » pregnancy: including all reasons relating to maternity
» family reasons: including parental leave, paternity leave
2.1 (birth and adoption), adoption leave or time off to care
for dependants, such as children who are ill
» trade union membership: including being a member of a
union and union recognition.
STUDY TIP
Do make sure that you distinguish between redundancy
and dismissal. Redundancy is just one of the reasons
AS LEVEL 2.1 HUMAN RESOURCE MANAGEMENT
Employee morale is the level of satisfaction, as well as the
overall sense of well-being, of a business’ employees. An
employee who is satisfied and content at work usually tends to
co-operate with colleagues and managers and to perform well.
GLOSSARY TERMS
Employee welfare is a broad term covering a wide range
of facilities that are essential for the well-being of a
business’ employees.
Employee morale is the satisfaction felt by employees

why a business can dismiss employees fairly and legally. within the workplace.
Dismissal is a more general term. Work–life balance refers to the obligations placed on
employees by employers that determine the amount of
time that employees spend on work-related activities.

2.1.5 Morale and welfare

At its most basic, every employer is required by law to
provide essential amenities such as toilets, sinks and clean
drinking water for employees. Most employees also hope to
find additional facilities, such as a cloakroom and a clean
and hygienic seating area for workers to use during meal
breaks. There should be facilities nearby for heating food or
water for hot drinks.
A ‘good’ employer who is concerned about employee
welfare may also consider other issues besides the physical
working environment. For example, such employers will seek
to develop their employees as fully as possible to improve
their performance at work.
HRM, welfare and employee morale
Human resource management can play a central role
in developing and improving the morale and welfare
of employees. Recruiting people with the intention of
developing their skills and improving their performance
throughout a long-term relationship is at the heart of
what is called ‘soft’ human resource management. Such
an approach to HRM may well seek to develop the skills of
employees and to encourage them to work with the business
for long periods of time. Using this ‘soft’ approach to HRM
also offers benefits to the business of providing good
facilities for employees.

CASE STUDY
Working at Google
Here’s a taste of what Google offer their employees:
● On-site physicians and nurses, convenient medical
services, and comprehensive health care coverage help
keep you healthy and happy. (Varies by location.)
● Googlers and their families have travel insurance and
emergency assistance, even on personal vacations.
● New parents get time off and some extra spending money
to help them welcome their new bundle of joy.
● We’ll reimburse you for classes or degree courses
that help you with what you do. Google is committed to
continuous learning among its employees.
● Googlers get legal advice at no cost and, in the USA, also ▲ Figure 2.4 More time with your baby (image for
get common legal services at a generous group discount. illustration purposes only)

Source: www.google.com

Questions
1 Explain two reasons why Google’s employees might
benefit from the company’s commitment to continuous
learning. [6]
2 Evaluate the benefits Google might receive from
treating its employees in this way. [12]

▲ Figure 2.5 Travel without worries (image for

illustration purposes only)

56
Work–life balance is a topic of increasing importance for
employers as well as employees. The term work–life balance
refers to the time an employee spends on work-related
duties compared with time spent on non-work activities.
Non-work activities include leisure interests and time spent
with family and friends.
CASE STUDY
International working hours
Despite concerns about the work–life balance of many
employees, average working hours in many countries
have declined since 2012, as shown in Table 2.2 (below).
Many countries have laws to restrict the number of hours
people may work, though these are not always enforced.
For example, China has legislation imposing a 44-hour
maximum normal working week with overtime payments
for hours beyond this. However, surveys suggest that this
limit is ignored by many employers.
Foxconn is a major company in China which manufactures
large numbers of mobile phones for Apple and other
businesses. A report released in September 2019, by
China Labor Watch, alleged that Foxconn did not always
follow Chinese labour laws. This investigation found that
its Apple 11 factory ‘routinely’ and ‘repeatedly’ ignored
laws that were put in place to regulate the employment of
temporary workers.
Research has shown that long working hours can damage
the health of employees, endanger their safety at work and
increase levels of stress. A few countries have long average
working weeks. In Columbia, the average working week is
47.7 hours, reportedly the longest in the world. However,
long working weeks do not always lead to high levels of
productivity.
▼ Table 2.2 Weekly working hours in a selection of OECD
countries, 2012 and 2019
Country 2012 2019
Australia 33.2 32.9
Chile 39.0 36.8
Mexico 42.8 41.1
Spain 32.4 32.4
Turkey 35.7 35.2*
Average of OECD members 33.9 33.2
* 2018 data
Source: OECD data,
https://data.oecd.org/emp/hours-worked.htm
Some governments have become concerned about the
possible adverse implications for the health of employees
and for rates of labour productivity of excessive working
hours. The European Union has implemented a working
2.1
time directive intended to limit working hours to a
maximum of 48 per week, although exceptions can be
made.
2.1.5 Morale and welfare
It also reported that Foxconn failed to follow laws
concerning its permanent staff, including claims that
employees were not permitted to resign during peak
season, needed to provide three days’ notice if they
wished to quit during their probationary period, and
needed permission to not work overtime.
Source: www.theregister.com/2019/09/09/
foxconns_apple_11_ factory_clw_report/
Questions
1 Explain two reasons why many governments have
passed laws to impose limits on the number of
hours employees may work each week. [6]
2 Evaluate the case for and against Foxconn
requiring its employees to work very long hours
each week. [12]
Many employers are concerned about long working
hours and their impact on the work–life balance of the
people who work for them. Long working hours can
harm the performance of employees, which may have a
significant impact on the performance of the business
itself.
Some major businesses have implemented policies designed
to relieve the pressure on employees and to help them to
achieve a sensible balance between work and non-work
activities. The Colgate-Palmolive company is an American
multinational manufacturer of consumer products such
as soaps and detergents. It has acquired a reputation
for employment practices that set realistic expectations
for employees, and it encourages the development of
time-management skills. Colgate-Palmolive also offers
its employees the chance to work flexible hours and to
telecommute. It provides nearby back-up childcare facilities
to assist parents who work at home. As a result, Colgate-
Palmolive has a low rate of labour turnover, which offers it a
range of benefits.
57
 The impact of diversity and equality in
2.1 the workplace
Although the terms ‘diversity’ and ‘equality’ are frequently
used together, and sometimes interchangeably, they have
different meanings.
Diversity, in a workplace context, refers to recognising the
differences between individual employees and also the
differences that may exist between different groups of
employees. Businesses that operate diversity policies will
AS LEVEL 2.1 HUMAN RESOURCE MANAGEMENT
treat people as individuals and will value the benefits that
diverse individuals and groups in a workplace may offer to a
business. Employee diversity could be based upon gender, race
and ethnicity, disability, religion, sexuality, class and age.
In contrast, policies related to equality are intended to
create a fairer society where all employees can contribute
and fulfil their potential. One key aspect of this is to operate
policies that allow all employees the opportunity to reach
senior positions in a business, irrespective of their age,
gender, ethnicity or sexual orientation. This is considered
necessary as many groups, such as women and minority
ethnic groups, are under-represented in senior positions
in businesses. This can mean that the skills and abilities
of such employees are wasted. By including such groups,
businesses can become more competitive and successful.
A number of governments have enacted employment
legislation to ensure that businesses design and implement
policies to encourage diversity and to promote equality.
For example, the UK government passed the Equalities
Act in 2010. This offered protection to employees on the
grounds of:
» direct and indirect discrimination
CASE STUDY
Equality and diversity at the University of Cambridge
The University of Cambridge, in the UK, is one of the best-
known universities in the world. It was founded in 1209.
In 2020, it had over 11 000 staff and 23 000 students from
countries throughout the world.
The University of Cambridge is committed in its pursuit
of academic excellence to equality of opportunity and to a
proactive and inclusive approach to equality, which supports
and encourages all under-represented groups, promotes an
inclusive culture, and values diversity.
The commitment applies to all protected groups and is
underpinned by the University’s Equal Opportunities Policy
and Combined Equality Scheme (CES). It is managed by the
University’s Equality & Diversity Committee.
The University’s Equality & Diversity essential online
training module:
Firms take positive decisions on welfare and training
because they have the potential to improve the morale and
motivation of employees. We shall see in Chapter 2.2 that
there are different views on what motivates employees.
Some writers on motivation argue that physical faculties
58
» harassment
» victimisation.
The Act identifies a number of ‘protected characteristics’.
These are:
» age
» disability
» gender reassignment
» marriage and civil partnership
» pregnancy and maternity
» race
» religion or belief
» gender
» sexual orientation.
Operating an effective policy for equality offers benefits
to businesses. Drawing on all people within the local
community when recruiting offers the best opportunity to
employ the most talented employees, which will enhance
the performance of the business. Similarly, promoting the
most able employee, regardless of personal characteristics,
secures the greatest level of talent for the business. Any
other approach is likely to harm the business.
The elements of a policy designed to promote diversity can
also bring benefit to the business. A diverse workforce may
allow the business to understand the needs of a market
which may comprise diverse consumers. This will assist
the organisation in meeting the needs of its consumers
more effectively. A business that acquires a reputation for
operating an effective diversity and equality policy may
become an attractive employer to potential employees.
This process is called employer branding and can
help businesses to attract highly talented and skilled
employees, whatever their personal characteristics.
aims to help staff understand the main principles of equality
and diversity, their impacts on the University and how members
of staff and students can access support and other resources.
The module, which can be accessed on a variety of platforms,
including tablets and laptops, is Cambridge-specific and
takes about 30 minutes to complete.
Source: www.equality.admin.cam.ac.uk
Questions
1 Explain two ways in which training might assist
Cambridge University to implement its equality and
diversity policy. [6]
2 Evaluate the extent to which the benefits of the
University of Cambridge’s equality and diversity
policy outweigh its costs. [12]
are important. Other writers on motivational theory would
argue that providing training and allowing employees to
develop themselves and to fulfil their potential are powerful
motivators.

GLOSSARY TERMS
Diversity, in an employment context, refers to recognising
the differences between individual employees and also the
differences that may exist between groups of employees.
Equality is the circumstance in which all people are equal,
particularly in relation to rights and opportunities in the
workplace.
Training is a process whereby an individual acquires job-
related skills and knowledge.
Development refers to activities designed to increase
employees’ skills, education, knowledge and abilities in
the workplace.
2.1.6 Training and development
Training and development can help employees to improve
their performance at work. Employees who are offered
opportunities for training and development are often more
motivated. In the next chapter we will look at some of
the motivational theories that explain this relationship.
Businesses that offer good-quality training and
development often have very loyal workforces, and it
can help to develop a reputation as a ‘good’ employer.
Improvements in the performance of a business’ labour
force can assist the organisation in achieving its
objectives. Training and other development activities
can result in higher levels of productivity or fewer faulty
CASE STUDY
Center Parcs
▲ Figure 2.6 Center Parcs is a business that offers its
employees regular opportunities for training.
Center Parcs opened its first UK village at Sherwood
Forest in July 1987, offering short-break holidays at any
time of year. Since then it has expanded its operations and
currently operates six villages across the UK and Ireland.
Each UK holiday village is set in a forest environment,
typically 400 acres (162 hectares) in size, and provides
high-quality accommodation in fully equipped villas,
products. Both factors can help businesses to reduce their
costs.
Development is a broader term than training and refers to 2.1
a wider range of activities intended to improve employee
performance at work. It includes attendance on courses
studied at colleges and universities, performance tracking
and improvement, coaching and mentoring, as well as
training.
Types of training
2.1.6 Training and development
Almost all employees receive training at some point during
their working lives and this training comes in different
forms.
Induction training
Employees may receive training when commencing a new
job. This is known as induction training and is intended to
introduce an employee to the business. Induction training
may provide employees with information on the following:
» important policies such as health and safety, and
disciplinary procedures
» the layout of the factory or office
» their new colleagues
» the basic duties of the job.
Induction training enables a new recruit to become more
productive quickly. It can prevent costly errors resulting
from employee ignorance and can make a new employee feel
welcome, thereby reducing labour turnover.
apartments and lodges. Each village offers an extensive
range of sports and leisure activities, plus numerous
restaurants, bars and retail outlets and an Aqua Sana
Spa facility. Woodland, water and a natural healthy
environment are the essential elements of a Center Parcs
break.
The company employs about 9500 people and values its
staff. It has the following statement on its UK website:
... we encourage our employees to develop their skills
and reward them when they are successful. Our training
and development programme offers our employees the
opportunity to develop their technical and professional skills
as well as their leadership potential, from entry level through
to managers.
Source: www.centerparcs.co.uk/company-information/our-
responsibilities/our-people.html
Questions
1 Explain two possible reasons why Center Parcs
might have such a clear and highly prominent
statement on its website. [6]
2 Evaluate the benefits of effective systems of
training to Center Parcs, which is expanding. [12]
59
 Off-the-job training
This involves training outside the workplace, at a college,
2.1 university or some other training agency. Off-the-job
training can take the form of a range of activities in
which job-related skills and knowledge are acquired. These
activities can include external courses such as lectures and
seminars, self-study or open learning.
On-the-job training
This form of training does not require the employee to leave
AS LEVEL 2.1 HUMAN RESOURCE MANAGEMENT
the workplace. They learn from experienced employees
through observation and work shadowing. The trainee may
work through instruction manuals or receive guidance from
senior employees.
▼ Table 2.3 The impact of training and development
Drawbacks
• Training and development activities use up valuable resources
that could be utilised elsewhere in the organisation.
• Attendance at training and development activities may mean
that employees are unavailable to the organisation for a period
of time. Production may suffer as a consequence.
• Employees, once trained, may leave for other, possibly better-
paid jobs.
• The beneficial effects of these activities may vary because
some managers might seek to avoid training and developing
their staff as it can lessen the degree of control they have over
their subordinates.
The impact of training and development of employees is
potentially greater if the market in which the firm operates
is subject to fierce competition. For example, firms may
operate extensive development activities in an attempt
to improve rates of creativity and/or productivity to gain
an advantage over competitors. Businesses manufacturing
motor vehicles have tended to invest more heavily in
such activities over recent years for these reasons. When
products are similar, price is often a very important
factor influencing consumers’ buying decisions. In such
circumstances, minimising costs (and prices) is vital. A key
part of this is making sure that labour is as productive as
possible.
An emphasis on training and development may have an
impact on the management style used in the business.
Managers who engage in large-scale development and
training activities will be more likely to value techniques
such as delegation and teamworking. Partly, this is a
question of philosophy: democratic and communicative
managers are more likely to value employees and therefore
will aim to develop them as much as possible. However,
there are practical reasons why training and development
will be needed in these circumstances. Businesses cannot
expect to benefit from granting employees greater
authority without preparing them for such roles.
60
The impact of training and development
Some businesses, for example, Center Parcs, invest heavily
in training and development, often regarding it as a core
element of their human resource management. Some
managers value it highly because they believe it improves
employee attitude, motivation and performance. Others
are less eager to spend money in this way, taking the view
that ‘if they cannot do the job already, why are we paying
them?’ Managers may be especially suspicious of off-the-job
training, which can be very expensive.
Training and development activities offer benefits and
drawbacks to businesses. These activities can be expensive
and disruptive but can improve employee performance. The
possible impact, in terms of benefits and drawbacks, is
summarised in Table 2.3.
Benefits
• It can improve employee performance, and hence the
competitive position of the business, by developing new
skills and knowledge.
• Training and development should improve employee
morale and productivity.
• Training and development are core components of HRM
and assist organisations in having the right workforce to
achieve strategic objectives.
• A reputation for training and developing employees
will assist businesses in attracting and retaining high-
quality, creative and productive employees.
GLOSSARY TERMS
Delegation means passing authority down the
organisational hierarchy. This is only genuine if the
manager relinquishes some control to the subordinate.
Intrapreneurship occurs when individuals within
organisations are being entrepreneurial – taking risks and
generating new ideas.
Employee development to encourage
intrapreneurship, multi-skilling and
flexibility
Intrapreneurship
We saw in Chapter 1.1 that entrepreneurs are individuals
who take risks to develop business ideas and start their own
businesses. Some larger organisations attempt to encourage
entrepreneurial approaches among their employees to
improve the organisation’s performance. This is termed
intrapreneurship. Such organisations encourage individuals
to develop ideas for new products or ways of producing
goods and services within their own departments or
sections of the business. In effect, employees are supported
to behave as entrepreneurs within a large business. One
well-known example of successful intrapreneurship is
Spencer Silver, who developed the Post-It note while
working at 3M, an American multinational company. He was
a chemist who developed the glue used in Post-It notes.
His innovative type of glue was strong enough to hold
papers together, but easily pulled apart without tearing the
documents. It could also be used repeatedly.
Employees cannot simply be expected to become
intrapreneurs overnight. A range of learning and
development activities are required to prepare employees to
fulfil the role of an intrapreneur successfully.
» Personal skills Intrapreneurs need many of the
strengths associated with entrepreneurs. They should
be creative, confident and pursue their ideas with
persistence. They should be good at solving problems
and willing to take calculated risks. Thus, they need
to be able to analyse risk to avoid making damaging
decisions. Ongoing training and development activities
can help to develop and improve such knowledge and
skills.
» Technical skills Successful intrapreneurs must be
able to analyse markets, organisations and consumer
behaviour to uncover problems. These may take
the form of unfulfilled or unrecognised needs or
production bottlenecks. Intrapreneurs then apply a
range of skills to solve these ‘problems’. Developing
the knowledge and skills to undertake this analysis and
CASE STUDY
Facebook
Facebook has over 2 billion users worldwide and nearly
45 000 employees. It is expanding and recently recruited
800 employees in the UK. It is an important company in
the global technology industry.
The company describes itself as constantly solving
problems. It hires people with different backgrounds and
viewpoints to help it make better products. The company
supports its employees to become bold and confident and
to seek to solve the problems they care most about. Its
employees work together in small teams to develop new
products quickly. The company offers high-quality training
and operates its own university.
Over time, Facebook has extended its product range,
sometimes by buying other businesses; for example,
Multi-skilling and flexibility
Multi-skilled workers have the skills to perform roles in more
than one area of a business’ activities. For example, in a
manufacturing business, multi-skilled workers may receive
training in all aspects of constructing the product, as well
as the ability to perform inspections to ensure products are
of suitable quality. Having multi-skilled employees allows a
business to switch workers to where they are needed over time.
subsequent problem-solving are central to success as an
intrapreneur. These skills may need to be supported by
relevant technical skills such as engineering or, as in the
case of Spencer Silver, those of a chemist.
2.1
» Senior employees The learning and development
activities are not limited just to employees engaged in
intrapreneurial activities. It is important that managers
and leaders also have the intrapreneurial spirit and
that this exists throughout the organisation. They
should encourage risk-taking, innovative activities and
ensure sufficient resources (human and non-human) are
2.1.6 Training and development
provided. They may require training and development to
fulfil such roles effectively.
The need for learning and development activities in an
intrapreneurial organisation will be continuous as markets,
products, technology and consumer needs change over time.
In addition, labour turnover will mean that new employees
are recruited who lack the necessary skills to operate
as effective intrapreneurs. Learning and development
activities will be needed throughout the careers of
intrapreneurs.
Simply recruiting some very talented individuals and
hoping this will be sufficient to promote intrapreneurship
within the organisation will not be enough. Businesses
need to develop a learning and development plan to build
innovation throughout the organisation.
WhatsApp in 2014. The company’s range now
includes:
● Instagram
● WhatsApp
● Messenger
● Augmented Reality
● Virtual Reality
● Facebook Connectivity.
Questions
1 Explain two reasons why Facebook encourages its
employees to be intrapreneurs. [6]
2 Evaluate the extent to which training and
development at Facebook is essential to encourage
intrapreneurship among its workforce. [12]
A company with multi-skilled employees has the potential
to have a flexible workforce. This enables managers to use
workers where needed to match the business’ needs. This
flexibility assists businesses in:
» meeting unexpected increases in demand for their
products
» covering for employees who are absent
» dealing with crises, such as delays in production.
61
 Labour flexibility arising from multi-skilling allows the business
owner to maintain production levels under circumstances that
2.1 would otherwise leave workers idle and reduce profits.
Training and development play critical roles in creating a
multi-skilled workforce and the flexibility that arises from
this. Without enhanced skills and knowledge, employees
will be unable to carry out a variety of roles. Training and
development activities will be required on a long-term basis
in industries where the skills required change and develop
over time.
AS LEVEL 2.1 HUMAN RESOURCE MANAGEMENT
2.1.7 Management and workforce
relations
Co-operation between management and the workforce can
reduce the number of disputes that may occur between the
two sides. Disputes can result in strikes (where workers
withdraw their labour) or other measures, such as banning
overtime working.
▼ Table 2.4 The costs of industrial disputes
Employers
• The business may lose revenue from selling its products if the dispute
results in industrial action, such as a strike, and production is halted.
• The business may lose future sales if its customers believe that it is
an unreliable supplier.
• The business’ relationship with its employees may be damaged in the
long term, with negative implications for morale and productivity.
• The business may be regarded as a more risky investment and may
encounter more difficulty in raising finance, or it may be expected
to pay higher interest rates for loans
• The business’ image may be damaged if it is involved in a dispute with
its employees and this may result in the loss of some of its customers.
The benefits to employers
Employers benefit in a range of ways from co-operation
with employees.
» Helping to develop a strong employer brand Employers
who avoid disputes with employees and who have effective
mechanisms to resolve any disputes quickly will be viewed
more favourably by potential employees. This will assist
them in attracting more able and productive employees.
» Enhancing employee morale Having a workforce with
high morale is a valuable asset for any business. Poor
employer relations are likely to lead to employees
believing they are not valued and will reduce their sense
of well-being and morale. Such factors can damage
employee performance severely.
» Improving the business’ corporate image Avoiding
disputes or settling them quickly helps a business to
develop or maintain a reputation as a fair and reasonable
employer. This can have positive effects on a range of
stakeholders, including customers and investors.
» Strengthening competitiveness Good employer–
employee relations can be a powerful competitive
weapon. They can reduce costs by eliminating lost
62
GLOSSARY TERMS
Multi-skilling exists when employees have the skills to
carry out several roles within an organisation.
A trade union is an organisation of workers established
to protect and improve the economic position and working
conditions of its members.
Collective bargaining is negotiation between employers
and representatives of employees, normally trade union
officials.
The benefits of co-operation between
management and the workforce
One way of considering how co-operation between
management and the workforce benefits both parties is to
consider the costs that may arise from any sort of dispute
(see Table 2.4).
Employees
• Employees may lose pay if the industrial dispute
takes the form of a strike.
• The dispute may weaken the employer’s finances,
putting employees’ job security at risk.
• A financially weakened employer may not be able
or willing to pay for training and development for
employees, denying them the chance to improve and
update their skills and knowledge.
• The employer may respond to the threat of, or actual,
industrial action by replacing people with technology
in the production process or by moving overseas.
production, adding to a business’ reliability as a supplier
as its production is not interrupted, and can enhance
labour productivity (thereby lowering labour costs), as
workers are motivated by what they regard as fair pay
and working conditions.
The benefits to employees
Equally there are a number of advantages to employees from
the maintenance of good relations with their employers.
» Financial benefits Employees avoid loss of pay during
periods of industrial disputes if good relations are
maintained. However, because the employer may also
be financially stronger as a result of avoiding wasteful
disputes, there is a greater possibility of future
improvements in pay and conditions.
» Job security An employer is less likely to consider
replacing employees with technology or moving overseas
to locations where industrial action rarely or never occurs.
» The possibility of greater participation in decision-
making Involving employees in decision-making is one
way of helping to maintain good relations, but it is also
a possible benefit to employees from doing their part
 in maintaining a positive relationship. Where amicable
relationships exist, employers may be more willing
to offer opportunities for employee involvement in
decision-making.
The value of co-operation between employers and
employees is probably greatest where the costs of industrial
disputes are most significant. This might be where the
business is in a weak competitive or financial position, and
it is vulnerable to losing its customers to rivals or at risk of
financial failure. Similarly, industrial disputes might be risky
by full-time union employees (called organisers or officers).
The region is made up of a number of branches (more
than 6000 in the case of Unite) and each branch has an
elected shop steward. The shop steward communicates with
2.1
employers on behalf of the union’s members and reports
back to members regarding management decisions. The
union head office has administrative, statistical and legal
staff, as well as the senior officials of the union. Other
trade unions operate similar structures.
Most trade unions across the world have similar objectives.

2.1.7 Management and workforce relations

for employees in areas of high unemployment and for those These focus on improving the economic position of their
who are relatively unskilled. If a prolonged dispute results members by fulfilling the following objectives.
in a loss of jobs, they may experience difficulty in finding » Maximising pay Trade unions engage in collective
alternative employment. bargaining to provide their members with the highest
possible rates of pay.
The impact on employers and » Achieving safe and secure working conditions Unions
often provide training for safety representatives who
employees of trade union involvement can advise employers on health and safety issues.
Creating a workplace in which there is a focus on health
in the workplace and well-being can be an important factor in creating
Trade unions employee engagement.
Trade union membership has declined in many countries » Attaining job security Arguably this is the most
around the world. Figure 2.10 shows that the percentage important objective of a modern trade union, and it is
of national workforces belonging to a trade union varies one that is difficult to fulfil in the light of pressures
significantly. OECD – the Organisation for Economic resulting from globalisation and the increasing use of
Co-operation and Development – has 32 member countries. technology in the workplace.
In 1985, average trade union membership in OECD » Participating in and influencing decisions in the
countries was 30 per cent. By 2019, that had fallen to just workplace Trade unions may achieve this through
16 per cent. collective bargaining or through having representatives
on any employer–employee committees. Trade unions
may play a role in decisions ranging from a change in
Iceland 90.4 fringe benefits, such as free lunches, to the closure of
Sweden 66.1
Belgium 54.2 one or more parts of the business.
Italy 34.3
Canada 25.9
Ireland 24.2
Collective bargaining
United Kingdom 23.2 Collective bargaining between employers and trade unions
Japan 17.1 usually covers issues such as wages and salaries, holidays,
Germany 16.7
Australia 13.7 the length of the working week and employee pensions.
Mexico 12.0 Because the negotiation is collective, any agreement
South Korea 10.5 that is reached applies to all those represented by the
United States 10.1
Turkey 8.6
trade union. The rules for collective bargaining are usually
France 7.9 agreed between the trade unions and each individual firm.
Trade unions are in a better position to negotiate than
Source: Forbes, https://bit.ly/3n5cncW individuals as they have better collective negotiating skills.
▲ Figure 2.7 Trade union membership as a percentage of Furthermore, the threat of taking industrial action (such as
the total workforce in a selection of countries strikes) gives them increased power in negotiations, helping
them to achieve higher rates of pay.
Most OECD countries have seen a decline in trade union
membership. The only ones that have seen increases since
1985 are Iceland, Belgium, Spain and Italy. Iceland remains STUDY TIP
the most unionised country in the OECD, with 90.4 per cent Do not assume that trade unions do not offer any benefits
of its workers being members of a trade union. to employers. The case study below outlines some of
Trade unions are normally organised on a regional basis. the benefits that they can offer and you should be able to
For example, in the UK, Unite operates in ten regions argue the positive and negative impact of trade unions on
throughout the UK and Eire and is the UK’s largest employers.
trade union. Each region has a regional office staffed

63
 CASE STUDY
2.1
Airbus and European works councils
European Union laws relating to European works councils
affect any organisation with at least 1000 employees, of
which least 150 employees are located in two or more
member states of the EU. European works councils (which
operate on behalf of employees) bring together employee
representatives in a multinational company from across
AS LEVEL 2.1 HUMAN RESOURCE MANAGEMENT
Europe. The works councils inform and consult employees
on the group’s activities and future prospects. European
works councils help trade union members to respond to
the decisions that employers take on a global basis.
A European works council is made up of at least one
elected employee from each country in which the
multinational operates, along with representatives from
senior management. They normally meet annually and
discuss issues affecting employees throughout the
organisation. These include health and safety, merger
proposals, the closure of plants and the implementation
of new working practices, such as teamworking.
Airbus, the multinational plane manufacturer, has its
headquarters in Toulouse in Southern France. The
Employees can receive significant benefits from being
represented by trade unions. In the UK in 2018, those
employees who were represented by trade unions earned
approximately 7.9 per cent more than people carrying out
similar work who were not members of a trade union.
Trade unions bring other benefits for employees. For
example, they can play a major part in monitoring health
and safety issues to protect the workforce. This can help to
provide a more secure working environment and reduce the
number of accidents.
It may appear that trade unions only offer disadvantages
to employers. They are able to use collective bargaining
to negotiate higher wages than would be paid in a
TEST YOUR LEARNING
Short answer questions
1 a Define the term ‘human resource management’. [2]
b Explain one activity that forms part of human
resource management.
2 Explain two possible benefits to a business of an
effective system of human resource management. [6]
3 a Define the term ‘workforce plan’.
b Explain one factor that might influence the
workforce plan of an international retailer.
4 a Explain one possible effect of a high level of
labour turnover in a business.
b A business has 9500 employees. During the year,
190 leave its employment. Calculate its rate of
labour turnover.
5 a Explain one difference between recruitment
and selection.
64
company operates factories in the UK, Germany, France
and Spain. In 2020, it announced plans to consult its
European works council over plans to cut 2362 jobs in
its factories. The jobs are under threat due to reduced
levels of demand for its aircraft. The company said it
wanted to manage the implications of the job losses for its
workforce ‘in a responsible manner’. The company said
it hoped to consult on opportunities for those employees
who are affected. The matters to be discussed include
transferring affected employees to work in other locations
within the company.
Questions
1 Explain two reasons why Airbus might prefer to
transfer employees in Europe rather than make them
redundant. [6]
2 Evaluate whether or not Airbus’ employees benefit
overall from the existence of the company’s European
works council. [12]
non-unionised workplace. This wage differential is known
as the trade union premium. This can increase the business’
costs of production. As a consequence, profits may be lower
or prices may have to be higher, reducing the business’
competitiveness. This can be a serious disadvantage in an
industry where competition is based on low prices, such as
the airline industry. Despite this, employers can also benefit
from the existence of trade unions for the following reasons:
» They act as a communications link between management
and employees and can reduce the chance of industrial
action occurring.
» Professional negotiation on behalf of a large number of
employees can save time and lessen the likelihood of
disputes occurring.
b Explain one method of selection. [3]
6 a Explain one difference between internal and
external recruitment. [3]
b Define the term ‘job description’. [2]
[3]
7 a State three items that might be included in an
employment contract. [3]
b Define the term ‘person specification’. [2]
[2]
8 Explain one benefit a business might receive from
preparing and using a person specification. [3]
[3]
9 a Explain one difference between redundancy and
dismissal. [3]
[3]
b Explain one reason why an employee may be
made redundant. [3]
10 Explain two reasons why businesses invest in
[3]
training and development despite the high costs. [6]
[3]
Data response question
The company behind the soaps and shampoos in
hotel bathrooms
Cannell Ltd manufactures soaps, shampoos and other
complimentary toiletries that are available in hotel
bathrooms. The company operates two factories with
acombined workforce of 380, and labour costs are
47 percent of its total costs. The company is relatively
small and, selling throughout Europe, faces intense
price competition from larger rivals. Recently the
company has had to reduce its prices to retain some
major customers. Profitability has declined in recent
years – last year it fell by 14.5 per cent. The company
has a highly skilled workforce, although its labour
turnover figure rose to 23.4 per cent last year from
14.9 per cent the previous year.
Cannell Ltd’s managing director believes strongly in
the importance of training and development, including
induction training. He has proposed doubling the 2.1
company’s expenditure on training. Employees work
in teams and the company updates its production-line
technology whenever it can afford to do so. The company
has never had to use redundancy to manage its workforce.
Questions
1 Define the terms:
2.1.7 Management and workforce relations
a ‘induction training’ [2]
b ‘redundancy’. [2]
2 Analyse one reason why Cannell Ltd should be
concerned about its rate of labour turnover. [4]
3 Evaluate whether or not the managing director is
correct to argue that the company should double its
spending on training and development. [12]
65
 2 Human resource management
2.2
AS LEVEL
Motivation
AS LEVEL 2.2 MOTIVATION
Chapter overview
In this chapter we examine:
★ the nature and importance of motivation as a management and leadership tool
★ the needs of employees while at work
★ some of the theories of motivation that can be applied in the workplace
★ the practical methods of motivation used by businesses, both financial and non-financial.
2.2.1 Motivation as a tool for
management and leadership
There are two ways we can think about motivation at work
and what causes it:
» Motivation can be the will to work due to enjoyment of
the work itself. This implies that motivation comes from
within an individual employee.
» An alternative view is that it is the will or desire to
achieve a given target or goal that is the result of
external factors, such as the promise of a reward, or to
avoid the threat of punishment.
The first of these views assumes that motivation lies within
the individual employee and the second assumes that it is
the result of some external factor. People in the workplace
have differing views on the sources of motivation. A survey
revealed that nearly 90 per cent of employers believe that
money is the main motivator, while employees rank pay
fourth, behind an interesting job, security and achievement.
This distinction is an important one, and you should
remember it when considering theories of motivation and
how, in practice, leaders and managers can motivate other
people.
Whatever causes it, motivation is an important factor
for all businesses. Having a well-motivated workforce is
vital to assist all businesses in achieving their objectives.
Organisations whose workforces possess high levels of
motivation tend to show the following characteristics:
» a low level of absenteeism by employees at all levels
within the business
» relatively few employees deciding to leave the
organisation, giving a low level of labour turnover
» good relations between managers and other employees
» high levels of labour productivity from the workforce.
A business that enjoys the benefits of a highly motivated
workforce is also likely to have a productive workforce. Low
production costs offer firms two opportunities:
» to sell their products more cheaply
» to maintain price levels and enjoy greater profits.
66
Thus, well-motivated workforces offer managers and
leaders the means to achieve a range of common business
objectives, including those below.
» Growth High levels of labour productivity and low
labour turnover will support businesses in increasing
the volume of sales by providing increased output
cost-effectively.
» Higher profits Having well-motivated and very
productive employees assists businesses in producing
products more cheaply per unit. This is an important
means of increasing profits.
GLOSSARY TERMS
Motivation describes the factors that arouse, maintain and
channel behaviour towards a goal.
Absenteeism describes a situation in which an employee
is absent from work without a good reason.
Human needs can be defined as the elements required for
survival and good mental and physical health.
2.2.2 Human needs
Fundamental human needs are relatively few and finite.
They are likely to be similar – or the same – for all countries
and cultures and to change little over time. A list of human
needs is likely to include the following:
» physical needs. For example, having enough income to
meet essential needs e.g. food, drink and shelter
» safety needs e.g. job security, contract of employment,
reduced uncertainty, health and safety policies, and
good working conditions
» social needs e.g. team or group working, good
communication and involvement
» esteem needs e.g. recognition, status, responsibility,
respect and feedback on performance
» self-actualisation needs e.g. fulfilment of potential,
challenging work, sense of achievement and
development of new skills.
 CASE STUDY
Al Rashed International Shipping Company
The Kuwait-based Al Rashed International Shipping
Company trades in international markets and has
benefited from high rates of recent sales growth and is
planning further growth. The company depends on highly
motivated staff to achieve its ambitious expansion plans.
The company was established in 1911 and is currently
a major player in shipping markets in the Persian
Gulf. It supplies a range of services including ocean
freight, international air freight and land transport both
domestically and internationally.
In its vision statement, the company says that it is
‘committed to consistently deliver extraordinary value to
our customers and stakeholders through the building of
passionate, empowered teams [of employees]’.
Ravi Varrier is Al Rashed’s chief executive officer (CEO).
He has worked for the company for more than 30 years
and believes that the company’s success has been based
How human needs may or may not be
satisfied at work
Employment does offer the possibility of satisfying some,
but possibly not all, of these human needs. The following
needs could be met through employment, but this may not
always be the case.
» Subsistence Employment can provide an income
sufficient to allow people to have shelter, food and
clothes so that their lives are not threatened by the lack
of these basic items. However, this need is only met
if employees have an employment contract that offers
them regular and sufficient hours of work to meet their
basic needs.
» Protection Work can satisfy this need in a number
of ways. A permanent employment contract may
provide the security of knowing that the income from
employment will be received for the foreseeable future.
Some forms of employment also provide health care
and pensions to give employees an income in old age.
However, many forms of employment do not offer much
in the way of protection. Some employees have no
guaranteed hours of work and no pensions.
» Participation This can be achieved through working
in teams, from teams of shop assistants through to
membership of the board of directors of a large public
company. Participation can also take the form of
responsibilities within an organisation.
2.2
on the quality of its staff. The company aims to have an
effective workforce and has carefully thought-through
systems of recruitment and selection, as well as
training. The company has strict policies to avoid any
discrimination and encourages teamworking.
Training is organised by each department within the
2.2.2 Human needs
business. Training focuses heavily on communication and
customer service. The company responds quickly and
positively to any customer complaints.
Source: https://al-rashedgroup.com/handbook/
Questions
1 Explain two ways in which having highly motivated
employees might offer advantages to the
shareholders of the Al Rashed International Shipping
Company. [6]
2 Evaluate the benefits that you think this company might
gain from having a well-motivated workforce. [12]
» Creation Many working environments offer opportunities
for creativity and some may require this as an integral
part of employment. Others may offer few opportunities.
Working in advertising or architecture requires creativity
but this can also be an important part of manual work,
such as constructing houses. Creativity can take other
forms, including developing teams and building brands.
» Freedom Working in an organisation does offer
surprising numbers of opportunities for freedom. In
a democratically managed business, managers may
empower employees. This gives them control over their
working lives and a high degree of freedom not only to
take decisions but to decide which decisions to take.
It is important to remember that the extent to which
this need may be met at work depends on the way that
the business is managed. Some managers may opt to
retain control and offer little freedom to more junior
employees.
Some other human needs may also be met through working.
For example, many businesses provide leisure facilities
for their employees, and it is not unusual for people to
engage in leisure activities with their colleagues from
work. However, this may not be the case for people such as
farmers or lorry drivers who often work alone.
67
 CASE STUDY
2.2
Working at Google
Though Google has grown a lot since it opened in 1998, we ● Googlers sharing cubes, yurts and huddle rooms – and
still maintain a small-company feel. very few single offices
● laptops everywhere – standard issue for mobile
At lunchtime, almost everyone eats in the office café, sitting
coding, emails on the go and note-taking
at whatever table has an opening and enjoying conversations
● foosball, pool tables, volleyball courts, assorted video
with Googlers from different teams. Our commitment to
games, pianos, ping-pong tables and gyms that offer
AS LEVEL 2.2 MOTIVATION

innovation depends on everyone being comfortable with

yoga and dance classes
sharing ideas and opinions. Every employee is a hands-on
● grassroots employee groups for all interests, such as
contributor and everyone wears several hats. Because we
meditation, film, wine-tasting and salsa-dancing
believe that each Googler is an equally important part of our
● healthy lunches and dinners for all staff at a variety of
success, no one hesitates to pose questions directly to Larry
cafés
or Sergey in our weekly all-hands (‘TGIF’) meetings – or
● staff-rooms packed with a variety of snacks and drinks
throw a volleyball across the net at a corporate officer.
to keep Googlers going.
Our corporate headquarters, fondly nicknamed the Source: Adapted from www.google.co.uk
Googleplex, are located in Mountain View, California, USA.
While our offices are not identical, they tend to share Questions
some essential elements. Here are a few things that you
1 Explain two ways in which the human needs of
might see in a Google workspace:
participation and creation may be met by working
● bicycles or scooters for efficient travel between
at Google. [6]
meetings, dogs, lava lamps, massage chairs, large
2 Evaluate the extent to which human needs are met
inflatable balls
by working at Google. [12]

2.2.3 Motivation theories
Many different views exist on motivation, and they differ
because it is not clear why people work. Is it to gain money,
to enjoy social interaction with other humans, or to fulfil
personal needs such as achievement and recognition? Or is
it a combination of some or all of these?
Motivation theories can be classified broadly into two
different perspectives: content theories and process
theories. Content theories consider ‘what’ motivates people
and are concerned with individual needs and goals. Taylor,
Mayo, Maslow, Herzberg and McClelland studied motivation
from a content perspective. In contrast, process theories
examine the process of motivation and are concerned with
‘how’ motivation occurs. Vroom studied motivation from a
process perspective.
GLOSSARY TERMS
Schools of thought are individuals and groups who hold
similar views on a particular matter – in this case on what
motivates employees.
Piece-rate is a system whereby employees are paid
according to the quantity of a product they produce.
Division of labour is the breaking down of production
into a series of small tasks, carried out repetitively by
relatively unskilled employees.

▼ Table 2.5 Schools of thought for content theories of motivation

School of thought Key writers Essential ideas

Scientific school Frederick Winslow Taylor
(1856–1917)
Human relations school Elton Mayo
(1880–1949)
The neo-human Abraham Maslow (1908–70),
relations school of Frederick Herzberg (1923–
management 2000) and David McClelland
(1917–1998)
Motivation is an external factor achieved through money. Employees
should be closely supervised and paid piece-rate. Time and motion
studies determine efficient means of production and workers are
trained and told how to operate.
This brought sociological theory into management and accepted
that employees could be motivated by meeting their social needs.
More attention was given to the social dimension of work (e.g.
communication, working as groups and consultation between
managers and employees).
This school highlighted the importance of fulfilling psychological
needs to improve employee performance. Motivation, according
to Maslow and Herzberg, depended upon designing jobs to fulfil
psychological needs.

68
Content theories of motivation
The content theories of motivation can be divided into
three schools of thought. These are set out in Table 2.5.
The school of scientific management
Motivating workers became an important issue as the size
of businesses increased in the late-nineteenth century.
Managers developed the division of labour to its fullest
extent in an attempt to increase efficiency and improve
competitiveness. The introduction of mass-production
methods, along with the use of division of labour, increased
the numbers of people working in factories. At the same
time, their tasks became monotonous.
Against this background, managers began to investigate
ways of increasing employee motivation to improve
competitiveness and employee satisfaction. Frederick
Winslow Taylor was the most notable of these early writers
on motivation and became known as ‘the father of scientific
management’.
Taylor’s theories were based on a simple interpretation
of human behaviour, that people were motivated solely
by money – his term was ‘rational man’. He combined this
principle with a simple interpretation of the role of the
manager: to operate the business with maximum
efficiency.
The key elements of Taylorism
» The starting point of Taylor’s approach was work study.
He measured and analysed the tasks necessary to
complete the production process. He used a stopwatch
to measure how long various activities took and sought
the most efficient methods of completing tasks. He
encouraged the use of the division of labour, breaking
down production into small tasks.
» From this he identified the most efficient employees and
the approaches they adopted. Using these as a basis, he
then detailed ‘normal’ times in which duties should be
completed and assessed individual performance against
these norms.
» Employees were provided with the equipment necessary
to carry out their tasks. This principle extended to
giving stokers (men shovelling coal) a shovel of a
size appropriate to their physique to maximise their
efficiency. They were also given elementary training and
clear instructions on their duties.
» Because, according to Taylor, employees were only
motivated by money, the final stage of the system was
to design and implement a piece-rate pay system. Under
a piece-rate system, employees are paid according to
the amount they produce. Taylor, however, developed
differential piece-rate systems to encourage efficiency
among employees.
» Taylor also believed in close supervision of the workforce
to ensure that they continued to make the maximum
effort possible, motivated by pay.
Taylor’s views were unpopular with shop-floor employees.
Shop-floor employees are those who work on production
lines in factories and do not have any management or
supervisory role. His systems forced them to work hard
and, by raising productivity levels, placed the jobs of the
less efficient workers under threat. Taylor’s approach raised
2.2
efficiency and productivity, so businesses did not need as
many employees. His ideas resulted in strikes and other
forms of industrial action by dissatisfied workers.
1 Study the work process to
determine the most efficient
production methods
2.2.3 Motivation theories
2 Observe and time the best
workers in these methods
3 Train the remaining workers
to the same standard
4 Implement differential pay
rates and close supervision
to increase productivity
▲ Figure 2.8 The essential features of Taylorism
Taylor’s legacy
It is easy to dismiss Taylor and his ideas. His entire
philosophy was based on the belief that employees were
motivated only by money. He ignored any social dimension
of employment and made employees work very hard for what
was a meagre wage. His ideas resulted in workers endlessly
completing monotonous tasks. There was considerable
hostility towards his ideas and opposition from politicians
and the business community.
However, Taylor made a significant and enduring
contribution to the management of business organisations.
He established management as a scientific subject worthy
of research and study. His approach was adopted by many
premier figures in the business community in the early
decades of the twentieth century, including Henry Ford.
His techniques encouraged the use of mass production and
the conveyor-belt system. Furthermore, his work provided a
starting point for a later and more people-centred approach
to management.
STUDY TIP
Avoid considering Taylor simply in negative terms.
Certainly, many of his ideas would not be acceptable in
modern businesses, but others (for example, simple
piece-rate pay and work study) have endured. A balanced
assessment of Taylor should take into account the lasting
elements of his approach, as well as the shortcomings.
69
 CASE STUDY
2.2
Salary packages important for Indian employees
A survey carried out by TJinsite, research division of
TimesJobs.com, revealed that 77 per cent of employees
in India judge salaries to be more important than the
location of the job. However, the respondents rated
salary and job status to be of equal importance, although
financial rewards are considered important by most
AS LEVEL 2.2 MOTIVATION
people taking part in the survey.
The importance of pay varies between older and younger
employees. Younger employees consider pay to be more
important, while older workers tend to rate job status
more highly.
The human relations school
A fundamental weakness of the scientific school was that
it ignored the social needs of employees. This, and the
obvious unpopularity of the ideas of Taylor, led to the
development of the human relations school. This school
of thought concentrated on the sociological aspects of
work, and its foremost member was an Australian-born
psychologist, Elton Mayo (1880–1949). Initially, Mayo was
one of Taylor’s disciples, believing in the importance of
scientific management to business efficiency.
The Hawthorne effect
Mayo’s views altered as a result of research he conducted
at the Western Electric Company in Chicago. The research
was to examine the effects of changes in lighting on the
productivity of workers at the company’s Hawthorne plant.
Previous experiments on lighting and productivity had
produced unexpected results. Researchers had anticipated
that improving lighting would increase productivity because
giving workers better working conditions would allow them
to work harder and earn more money. They were astonished
when productivity increased not only in the group who
were given improved lighting but also among a group whose
lighting had not changed.
It became apparent that the employees were responding
to the level of attention they were receiving as part of the
investigations and because they were working together as
a group. This became known as the ‘Hawthorne effect’. As
a result of this and similar experiments, Mayo stressed the
importance of ‘social man’ within the workplace.
From these experiments, Mayo concluded that motivation
was dependent upon:
» the type of job being carried out and the type of
supervision given to the employee
» group relationships, group morale and the sense of
worth experienced by individuals.
70
Employees in most industries in India rate salaries
as important – there was minimal variation between
different industries. Respondents said that factors such
as job titles, location and status are significant, but an
attractive salary is always a critical factor in persuading
employees to apply for jobs.
Questions
1 Explain two reasons why salaries are an important
element for younger people in choosing jobs. [6]
2 Evaluate other possible situations in which
salary might be considered very important by
employees. [12]
The implications of the ‘Hawthorne effect’
Following the publication of Mayo’s findings, managers
gradually became more aware of the importance of meeting
the social needs of individuals at work. Social environments
at work and informal working groups were recognised
as having positive influences upon productivity. The
acceptance of Mayo’s views led to a number of developments
in businesses during the 1940s and 1950s, many of which
remain today.
» Personnel departments were established to ensure that
employees’ social needs were met at work wherever
possible.
» Employees were provided with a range of sporting and
social facilities to foster the development of informal
groups among employees.
» Works outings and trips became a familiar part of an
employee’s year (for example, multinational retailer
Marks and Spencer organises short-break weekends for
its employees).
» Managers gave more attention to teams and
teamworking.
Mayo’s recognition of the importance of teamworking is
perhaps his most enduring testimony. Many firms have
organised their workforce into teams; for example, the
Japanese electronics manufacturer, Toshiba.
Mayo’s work took management forward in general and
motivation in particular. He moved the focus onto the needs of
employees, rather than just on the needs of the organisation.
STUDY TIP
Don’t just think of Mayo in terms of communicating
with bosses, and his emphasis on social and sporting
facilities. This is only part of his work. He advocated
the benefits to employers and employees of working
in teams: this aspect of his work is an important issue
within many businesses today.
The neo-human relations school
This could also be called the new human relations school.
Abraham Maslow, Frederick Herzberg and David McClelland
are key members of this particular school and began to put
forward their views in the 1950s. The neo-human relations
school considered the psychological aspects of employment
and argued that motivation lies within each individual
employee; managers merely need the key to unlock the
motivational force.
By focusing on the psychological needs of employees, 2.2
Maslow, Herzberg and McClelland encouraged managers to
treat their employees as individuals, with different needs
and aspirations. Their work emphasised that, because
people are different, the techniques required to motivate
individuals will also differ.

CASE STUDY

2.2.3 Motivation theories

Motivating accountancy graduates
Respondents to an internet survey have judged training
and development of skills to be more important than
salary, according to a survey by accountants Ernst and
Young. Most of the 1051 respondents were accountancy
graduates with additional experience in the industry. The
key elements of the survey were:
● Approximately 44 per cent rated training as the most
important factor attracting them to a job.
● A mere 18 per cent of respondents placed salary and
benefits as the most important factor.
● The reputation of the business was judged most
important by 12 per cent and 8 per cent identified the
business’ culture as the vital factor.
Questions
1 Explain two ways in which employees may be
motivated by pay. [6]
2 Evaluate whether the results of this survey show
that pay as a motivator is outdated and irrelevant for
today’s employees. [12]

Maslow’s hierarchy of needs

In 1954, Maslow published his ‘hierarchy of needs’,
setting out the various needs that, he argued, everyone
GLOSSARY TERM
attempted to meet through working. Maslow presented his The hierarchy of needs is a theory that employees have
hierarchy of needs as a triangle with basic needs shown at successive requirements that can be fulfilled through work.
the bottom and his so-called higher needs towards the top
(see Figure 2.9).

5 Self-
actualisation
e.g. fulfilling
potential
Higher
4 Esteem needs needs
e.g. recognition
and achievement

3 Social needs
e.g. relationships with fellow employees

2 Security needs
e.g. employment contract, safe working conditions
Basic
needs

1 Physiological needs
e.g. food, drink, shelter

▲ Figure 2.9 Maslow’s hierarchy of needs

71
 Abraham Maslow established five levels of human needs was satisfied (see Table 2.6). So once an employee’s basic
that can be satisfied through work. Maslow’s argument was needs had been met, perhaps through a system of fair pay,
2.2 a relatively simple one. Employees, he argued, have a series
of needs they seek to fulfil at work. These are in a hierarchy
they could be motivated further by the offer of secure
and continuing employment. Similarly, a worker whose
– once a lower level need is satisfied, individuals strive to social needs were met through employment could next
satisfy needs further up the hierarchy. be motivated by the opportunity to satisfy self-esteem
needs. This could be achieved by taking responsibility for
The key point of Maslow’s argument was that a business
a major project, offering the chance of achievement and
could motivate its employees by offering them the
recognition.
chance to fulfil a higher level of need once a lower one
▼ Table 2.6 An explanation of Maslow’s hierarchy of needs
AS LEVEL 2.2 MOTIVATION

Maslow’s level of need Examples Means of satisfying needs

Food, water, shelter, clothing Through pay and a warm and dry working
1 Physiological needs
environment
A safe and secure working environment for Implementing a proper health and safety
2 Security needs employees policy, providing employees with employment
contracts
Contact and friendships with other employees Social and sporting facilities, opportunities to
3 Social needs
work in groups
Achievement, recognition and self-respect Delegating authority to junior employees,
4 Esteem needs
offering promotion opportunities
To fulfil one’s potential completely Providing opportunities to take new
5 Self-actualisation
responsibilities and to develop new skills

Maslow’s theory was attractive to managers from the
outset. It offered a more individualistic approach to
motivating employees, recognising that not all people are
the same. Managers had long realised that what motivated
one person would not necessarily motivate another.
Maslow’s theory offered an explanation and an alternative
approach for managers.
Frederick Herzberg’s two-factor theory
Herzberg’s two-factor theory was the result of a study
designed to test the view that people face two major sets
of influences at work. Herzberg’s resulting theory was based
on the results to questions asked of 200 accountants and
engineers in the USA.

Herzberg’s motivators – these satisfiers relate to the job itself and can create positive motivation

Personal Potential
achievement Recognition to satisfy
Interest in
the work Responsibility
itself Growth and
MOST LEAST
advancement
IMPORTANT IMPORTANT

Relationship
with fellow
workers
Working Salary
Company conditions
Supervision Potential
policy and
to dissatisfy
administration

Herzberg’s hygiene factors – these relate to the job environment and have the potential to dissatisfy

▲ Figure 2.10 Herzberg’s hygiene and motivational factors

72
The first part of Herzberg’s motivation theory is related to
the environment of the job. He identified a range of factors
that shaped the environment in which people work; he
called these influences hygiene or maintenance factors.
These factors are all around the job but are not a part of
the job itself. Herzberg’s research identified a number of
hygiene factors, including the following:
» company policy and administration
» supervision of employees
» working conditions
» salary
» relationship with fellow workers (at the same level).
Herzberg’s crucial finding was that hygiene factors do
not lead to motivation, but without them employees may
become dissatisfied. So, according to Herzberg, an employee
cannot be motivated by pay, but they might be dissatisfied
by inadequate financial rewards. Hygiene factors were so
named because Herzberg believed attention to them would
prevent hygiene problems. It is important to note that
Herzberg’s research classified pay as a hygiene factor and,
therefore, as unable to motivate.
CASE STUDY
Frederick Herzberg
Frederick Herzberg was born in Massachusetts in the
USA in 1923. He attended City College, New York, before
enlisting in the army. During his military service, he
witnessed the survivors at Dachau concentration camp.
▲ Figure 2.11 Frederick Herzberg
The second finding of Herzberg’s research established those
factors with the ability to motivate – the motivators. These
factors relate to the job itself and can be used to positively
motivate employees. He identified the following factors as
2.2
motivators:
» personal achievement of goals and targets
» recognition for achievement
» interest in the work itself
» responsibility for greater and more complex duties
» personal growth and advancement.
2.2.3 Motivation theories
Herzberg believed that these approaches (hygiene and
motivation) must be used simultaneously. Employees
should be managed so they have a minimum of
dissatisfaction. They should get achievement, recognition
for achievement, take interest in their work and be given
responsibility to allow them to grow and develop within
their work.
GLOSSARY TERMS
Hygiene factors (also called maintenance factors)
are a group of influences that may result in employee
dissatisfaction at work.
Motivators are a series of factors, such as promotion, that
may have positive influences on employee performance at
work.
Herzberg gained a PhD in Psychology at the University
of Pittsburg and began to turn his attention to business
management. He became Professor of Management at
Case Western Reserve University, where he established
the Department of Mental Health. In 1972 he joined the
University of Utah’s College of Business.
Herzberg developed a reputation as one of the most
influential thinkers on people at work and employee
motivation. He combined his deep knowledge of employee
psychology with a series of practical experiments in
the workplace. His book Work and the Nature of Man
(1966) was voted one of the ten most important books on
management theory and practice in the twentieth century.
He died in January 2000.
Questions
1 Using examples, explain two differences between
Herzberg’s motivators and hygiene factors. [6]
2 Evaluate the possible reasons why a book on
employee motivation was voted one the twentieth
century’s most important management books. [12]
73
 ▼ Table 2.7 Herzberg and Maslow compared
2.2 Motivation factors (higher needs)
Maslow
• Self-actualisation needs
• Esteem needs (higher needs)
Maintenance factors (lower needs) • Social needs
• Security needs
AS LEVEL 2.2 MOTIVATION
• Physiological needs (mainly lower
needs)
Both Maslow’s and Herzberg’s theories have the major
advantage in that they were not simply theoretical
writings – practical implications for management were
within the theories. Both authors encouraged managers to
utilise their employees’ abilities by giving them challenging
tasks.
Weaknesses do exist within these theories, of course.
Herzberg’s assertion that pay cannot be used to motivate
might be true of many employees in wealthy, developed
economies. However, this may not be the case with workers
in poorer, developing countries. Equally, Maslow’s theory is
based upon a hierarchy and the assumption that individuals
move from one level to the next. His work has been
criticised on the grounds that people do not move through
these needs in the same order. It also assumes that, once
a need is fulfilled, it loses its power to motivate. This may
not be the case, especially with the higher needs.
STUDY TIP
Many answers to questions on motivation receive low
grades because students do not apply their knowledge
to the scenario in the question. Ensure that you do not
simply explain relevant theories – you must apply them to
the scenario.
David McClelland’s theory of needs
The American writer David McClelland was also a part of
the neo-human relations school of thought. He is perhaps
best known for his work on achievement motivation. In
his acquired needs theory, McClelland argued that an
individual’s motivation depends upon their needs and that
these needs are determined by the individual’s experience.
McClelland identified three types of motivational need:
» achievement motivation (n-ach)
» authority/power motivation (n-pow)
» affiliation motivation (n-affil).
McClelland believed that these three needs exist, to
differing extents, in all employees, irrespective of their role
or status within the business. McClelland’s work emphasised
that the combination of these three needs determines:
74
Herzberg
• Achievement
• Recognition
• Responsibility
• Interest in work
• Personal growth
• Company policy and administration
• Supervision
• Working conditions
• Relationship with fellow workers
» each employee’s behaviour in terms of what motivates
them
» how they manage and motivate other employees.
The need for achievement
People who have a high need for achievement (n-ach) aim
for excellence. This means that they are likely to avoid
low-risk situations as they derive little satisfaction from
meeting targets that are not challenging. Equally, they tend
to avoid high-risk situations as they fear not achieving.
Therefore, this type of person aims to attain realistic but
challenging goals – ideally those in which they have a 50
per cent chance of success. This type of employee has a
strong need for feedback on achievement and progress, and
they have a need for a sense of accomplishment.
The need for authority and power
A need for power (n-pow) can fall into one of two
categories:
» a need for personal power and to direct or control other
employees – this is a need which may be considered
undesirable
» a need for institutional power – this is a need to
organise other employees to attain the organisation’s
objectives.
Managers and leaders with a need for institutional power
are likely to contribute more to a business enterprise than
someone whose need for power is a personal one. The
employee with a need for authority and power wants to
have an effect on an organisation and to have some degree
of control. They may also want to have more status within
the organisation.
The need for affiliation
Employees who have a need for affiliation (n-aff) generally
seek harmonious relationships with other people in the
organisation. They need to feel accepted and are motivated
to work with other people. This type of employee works
well as a member of a team and enjoys social interaction.
Employees who are motivated by the need for affiliation
often work successfully and effectively in marketing, sales
and customer service.
 CASE STUDY
Motivating generation Y employees
The Moresby Bank Ltd is based in Papua New Guinea and
provides a range of banking services. It is relatively small
with only 2850 employees. Despite this it experiences
problems with its labour turnover rates, particularly
among junior employees. In 2020, the Bank suffered an
average labour turnover rate of 23 per cent, while the
figure for junior employees reached 34 per cent.
The Bank’s executive vice-president for HR management,
Latifa Pini, commented: ‘This bank is very serious about
management of our generation Y employees (those born
after about 1983) since they are certainly going to be our
future senior managers. If we don’t understand them then it
will be difficult to make the bank as successful as it might be.’
She continued to argue that generation Y employees dislike
being forced or ordered to do something, while employees
born between 1946 and 1964 (called baby boomers) prefer
to be in control and want others to follow them.
The implications of McClelland’s work
McClelland’s work has clear implications for leaders and
managers. The principle is that employees with different
needs require different roles and tasks if they are to be
motivated effectively.
» An employee with a high need for achievement Such
employees should be given tasks which are demanding
but which can be reasonably expected to be achieved.
Such employees require regular feedback, especially of a
positive nature.
» An employee with a high need for authority and
power This type of employee is most likely to flourish
and perform well when controlling others. For a junior
employee this could be a supervisory role, while more
senior employees may fulfil this need by managing large
teams of employees.
» An employee with a high need for affiliation Working
as part of a team, especially a co-operative one, is likely
to allow employees to meet their needs for affiliation.
Equally, this type of employee is likely to perform best
when interacting with other employees, and they should be
provided with opportunities to do this whenever possible.
Process theories of motivation
Process theories of motivation look at what people are
thinking about when they decide whether or not to put effort
into a particular activity. Examples of such theories include
expectancy and equity theories. They try to capture the
process that employees go through when making choices with
goals in mind. Unlike the other theories of motivation we
have considered, they see the individual as an active decision-
maker, rather than trying (in the case of the neo-human
relations school) to meet certain needs. Process theories
emphasise the actual process (or method) of motivation.
There are a number of process theories of motivation, but
we shall just consider the one developed by Victor Vroom.
2.2
Latifa Pini argued that generation Y employees perform
most effectively if given challenging work, rewards
related to performance and direct instructions. ‘Give them
challenging work, and if they achieve something, then
recognise them for that achievement. It does not have to
be a financial reward but something that will make them
2.2.3 Motivation theories
feel proud to be part of the team and organisation,’ Pini
concluded.
Questions
1 Explain two differences between the need for
power and the need for achievement in McClelland’s
theory. [6]
2 Evaluate the extent to which McClelland’s
explanation of the differing behaviour of the older
and younger employees at Moresby Bank Ltd is the
only valid one. [12]
Victor Vroom’s expectancy theory
This theory, developed by Vroom in the early 1960s, argues
that motivation depends on employees’ expectations of
the results of their efforts. If employees know what they
want from an outcome and believe they can achieve that
particular outcome, they will be motivated. In brief, Vroom’s
theory argues that the behaviour of individuals is such as to
maximise pleasure and to minimise pain in whatever form it
may occur. Vroom’s model consists of three major elements,
as illustrated in Figure 2.12.
Expectancy
Expectancy
leads to
Performance
Instrumentality
leads to
Outcome
(reward)
Valence
Personal
objectives
▲ Figure 2.12 Victor Vroom’s expectancy theory
» Expectancy This refers to the confidence that
employees may have in their ability to complete a
particular activity or task to an acceptable standard.
Demotivation will result if an employee believes that
they are not capable of completing the task in question
satisfactorily.
» Instrumentality This is the belief of employees that
the completion of a particular activity will lead to a
desired outcome. In a situation of high instrumentality,
the employee has confidence that specific activities
75
 will result in the achievement of a valued reward.
Instrumentality will be greater if employees recognise
2.2 a clear link between actions and rewards and have
confidence that they will receive the promised rewards
for achieving their targets.
» Valence This represents the strength of a person’s
desire to achieve a specific outcome. Valence is
positive if a person prefers the outcome to not
achieving it. If the person is indifferent to the
outcome then the valence will be zero. High values
of valence mean that an outcome is highly attractive
AS LEVEL 2.2 MOTIVATION
to employees and has great potential to motivate. In
such circumstances, managers can use the possibility
of attaining this outcome as a means of motivation.
For example, a salesperson may find the prospect of a
monetary bonus for achieving an agreed sales target
very desirable. The salesperson must have confidence
in their ability to achieve the number of sales
necessary to receive the bonus.
2.2.4 Motivation methods in
practice
The theories in practical situations
Reading the various theories of motivation, it can
appear that there are a number of straightforward
methods of motivating employees. However, in practice
this is not necessarily the case. Managers may lack
the resources or knowledge to be able to apply these
theories in the workplace. For example, a business
may not have sufficient financial resources to be
able to increase pay or offer promotions as a means
of motivating workers. Furthermore, workforces are
increasingly likely to contain diverse employees who may
be motivated by different factors. This can make the
task of improving levels of motivation more difficult for
a manager in a modern business.
Energage (a research and consulting firm based in
Philadelphia) has conducted research into employee
motivation in the USA. It surveyed more than 20 million
employees working for 60 000 businesses between 2004
and 2020. Across all sectors and populations within the
USA, appreciation of employees’ efforts is ranked among
the most important drivers of motivation, according to this
survey. Appreciation can take many forms, such as financial
rewards or praise, and is part of many of the theories we
have studied. This research suggests that in the workplace,
elements of many of the theories we have covered can be
very effective in increasing levels of motivation. It also
suggests that there are relatively simple ways to improve
employee motivation.
Financial motivators
Managers and organisations use a variety of pay systems in
an attempt to improve the performance of their workforce.
Despite attention given to the views of Herzberg, which
76
suggest that monetary methods of motivation are of limited
value, pay remains a major incentive.
▼ Table 2.8 Opinions on the motivational powers of pay
Writer Opinions on the motivational power of pay
Frederick Taylor Taylor saw pay as the primary motivating
factor for all workers. He referred to
workers as ‘economic animals’ and
supported the use of piece-rate.
Abraham He saw pay as a reward which permitted
Maslow employees to meet the lower needs on
their hierarchy.
Frederick Herzberg saw pay as a hygiene factor
Herzberg and a possible cause of dissatisfaction.
In a few circumstances pay might be a
motivator if, for example, it is used as a
recognition for merit.
Time-based pay
Some employees receive payments based on the number
of hours that they work each week or month. Their income
is based on an hourly rate of pay. Thus an employee may
be paid $11 an hour. If the employee works 36 hours in a
particular week, they will receive gross pay amounting to
$396 ($11 × 36 hours).
This payment system has the advantages of being simple
to understand and transparent. Many countries across
the world have minimum-wage laws based on specific
hourly rates of pay which can be increased over time to
compensate for inflation.
However, time-based pay can result in employees becoming
clock-watchers and not being prepared to carry out any
duties outside the hours for which they are paid.
Salaries and wages
Most employees receive their payment in the form of
salaries or wages. Salaries are expressed in annual terms
(for example, a production manager might be paid a salary
of $30 000 per year) and are normally paid monthly. Salaried
employees are not normally required to work a set number
of hours per week, though their employment contract may
state a minimum number of hours.
On the other hand, wages are usually paid weekly and
employees are required to be at work for a specified
number of hours. Employees on wages are normally paid a
higher rate (known as overtime) for any additional hours
worked.
Piece-rate
Under this pay system, employees are paid according to the
quantity they produce – a form of payment by results. Thus,
an employee on a production line might receive an agreed
amount for each unit of production they manufacture.
Piece-rate is common in a number of industries including
textiles, electronics and agriculture.
Piece-rate offers businesses a number of advantages
and disadvantages. The introduction of piece-rate pay
can increase the productivity levels achieved by many
employees within a business. This can effectively reduce
the business’ labour costs for each unit of output that is
produced. However, this rise in productivity may be at the
expense of quality and customer complaints may increase.
A business using piece-rate may lose customers as a
consequence of its introduction, especially if quality is an
important factor in customers’ buying decisions.
Bonuses and commission
Bonuses are additions to pay that are linked to individual
or team performance measured against targets or objective
criteria. Employers introduce bonus payments to reward
individuals for doing well. By definition, a bonus payment is
an extra and not part of basic pay. Bonuses can be paid to
employees in different industries and at different levels in
an organisation. Some examples are:
» profit-related bonus, for example, to a manager in a
retail organisation
» performance bonus payments to senior managers or
directors or investment bankers
» bonus payments for reaching production targets in
manufacturing.
Commission, like piece-rate, is the payment for the quantity
(or value) that is produced by an individual employee. In
some industries, such as telesales, an employee’s entire
income may be made up of commission, although it may
have to meet any conditions imposed by minimum-pay
laws. Employees can be paid a percentage of the value of
any products they sell as commission. This form of payment
has similar advantages and disadvantages to piece-rate.
However, in many countries it has become less common. One
explanation for this may be that its disadvantages outweigh
its advantages.
Profit sharing
Profit sharing is a reward system under which employees
receive some part of the business’ profits. This is a type
of performance-related pay (see opposite) but not one
which discriminates between the performances of individual
employees. Such payments, which may vary according to the
employee’s seniority within the organisation, are separate
from, and additional to, regular earnings.
Profits are paid to employees in the form of cash or
company shares. Profit-sharing schemes can improve an
employee’s loyalty to the business by breaking down the
‘us and them’ attitude. Under profit-sharing schemes, a
greater level of profit is regarded as being of benefit to all
employees, not just to senior managers. Employees may be
more willing to accept changes designed to improve the
business’ profitability.
The danger with profit-sharing schemes is that they can
provide rewards that are too small to represent a worthwhile
payment for employees. On the other hand, if they are too
generous, the business may lack sufficient funds for capital
investment.
GLOSSARY TERMS
Performance-related pay (PRP) exists where some
part of an employee’s pay is linked to the achievement of
2.2
targets at work. These targets might include sales figures
or achieving certain grades in an annual appraisal.
Variable pay is a reward for working that is based on
employee performance or results judged against some
targets.
2.2.4 Motivation methods in practice
Performance-related pay
Performance-related pay (or PRP) has become more
widely used over recent years and has developed
along with employee appraisal systems. PRP is only
paid to those employees who meet or exceed some
agreed targets. Under PRP, employees are paid for their
contribution to the organisation, rather than their
status within it.
Businesses of all sizes throughout the world have introduced
PRP. It is widely used in Hong Kong and Japan, with Nissan
as a prime example. Despite criticisms, PRP remains popular,
and many employees support linking some element of pay
to performance. However, there have been criticisms of the
huge rewards paid to some senior managers and directors of
moderately successful companies.
Criticisms of PRP
A number of other criticisms of performance-related pay
have been put forward:
» Many employees perceive PRP as fundamentally unfair.
This is particularly true of those working in the services
sector, where individual employee performance is
difficult to measure.
» Employees fear that they might be discriminated against
because they do not get on with the manager who makes
a decision on their performance. This can result in their
performance worsening, not improving.
» A majority of businesses operating PRP systems
do not put sufficient funds into the scheme.
Typically, the operation of a PRP scheme adds 3–4 per
cent to a business’ wage bill. This only allows employees
to enjoy relatively small performance awards, which may
be inadequate to change employee performance.
Developments in PRP
Increasing numbers of businesses are implementing a
system known as variable pay. Some managers argue
that a business’ performance often depends upon the
achievements of the few.
Variable pay is really a development of PRP. It is similar
in that it rewards employee performance, but there are
differences. PRP operates according to a formula used
throughout the company. Variable pay is far more flexible
and the potential rewards for star employees are greater.
If the business performs well, employees benefit under
variable pay, but they can suffer financial penalties in a less
successful period.
77
 Some managers remain unconvinced of the value of PRP, no
matter how sophisticated the scheme. The widespread use
2.2 of PRP may, in part, be an attempt by managers to keep pay
rates down for the majority of employees. PRP, or variable
pay, treats employees as individuals, limiting the ability of
trade unions to bargain collectively.
Targets set. These are
agreed between employee
and line manager. May take
the form of sales targets,
level of customer
AS LEVEL 2.2 MOTIVATION
satisfaction, etc.
Pay decision made. Those Evidence collected on
meeting all performance employee performance
targets fully might receive through, for example,
5% extra. Least effective observation of employee
performers may receive 0%. at work.
▲ Figure 2.13 The operation of a typical performance-
related pay system
CASE STUDY
Profit-sharing at Ford
Ford is one of the world’s best-known manufacturers of
cars and other vehicles. In 2019, the company’s profits were
just $47 million, a very heavy fall compared with 2018.
The company said that the decline was due to a range of
operational reasons including unexpected costs associated
with the launch of Explorer, a new model of car.
The fall in profits led to a reduction in the company’s
profit-sharing payments to its employees. The company
revealed that these would be 13 per cent lower: $6600
per employee, compared to $7600 in the previous year.
Ford does not pay profit shares to all of its hourly paid
employees.
Some other vehicle manufacturers will pay their
employees larger sums as profit-sharing bonuses.
GLOSSARY TERMS
Fringe benefits (or perks) are those extras an employee
receives as part of their reward package.
Job redesign means changing the group of tasks or duties
which make up a specific job.
Job enrichment occurs when employees’ jobs are
redesigned to provide them with more challenging and
complex tasks. Also called vertical loading.
78
Fringe benefits
Fringe benefits (sometimes referred to as perks) are those
extras that an employee receives as part of their reward
package. Examples include:
» a company car (or a mileage allowance for an employee’s
own car)
» private health insurance
» employers’ contributions to pension schemes
» discounts for company products.
Firms tend to use fringe benefits to encourage employee
loyalty and to reduce the number of employees leaving the
firm. A danger of the widespread use of fringe benefits is
that costs can increase quickly, reducing profitability.
STUDY TIP
Remember that PRP remains a highly topical and
controversial issue. While there are a number of
arguments in favour of it, a central weakness remains.
This can be explained in terms of the theory we covered
earlier. Writers such as Maslow and Herzberg argued that
money has limited power to motivate employees. PRP, no
matter how it is implemented, has more in common with
Frederick Taylor’s views of motivating employees.
Employees at GM will be paid $8000 and employees at the
lorry manufacturer FCA will receive $7280.
Tim Stone, Ford’s chief financial officer, expressed
optimism about the company’s prospects for 2020, while
acknowledging that ‘results were not OK in 2019’.
Source: https://eu.freep.com/story/money/cars/ford/2020/02/04/
ford-profit-sharing-2020-checks-bonus/4644019002/
Questions
1 Explain two reasons why Ford might expect its profit-
sharing scheme to improve the performance of its
workforce. [6]
2 Evaluate the possible problems Ford faces in
operating its profit-sharing scheme. [12]
Job enlargement is giving employees more duties of a
similar level of complexity. Also called horizontal loading.
Job rotation is the regular switching of employees between
tasks of a similar degree of complexity.
Empowerment is a series of actions designed to give
employees greater control over their working lives.
Non-financial motivators
Many non-monetary methods of motivation tend to focus
upon the design of employees’ jobs. Employees can be
motivated by asking them to do a job that is challenging
and interesting. A good job should have at least a number
of the features listed below.
» Employees carry out duties that result in a definite end
product.
» Clear and challenging goals give employees something to
aim at. Goals should be demanding but not unattainable.
» Employees should be able to identify easily their
contributions to the organisation.
» Jobs should be designed so that employees are involved
in planning their own schedules of work, choosing their
Complexity of tasks
work methods and coping with problems as they arise.
The main methods of non-monetary motivation attempt to
incorporate some of these features into the working lives of
employees.
Job redesign
Employers can change the design of employees’ jobs to
encompass more or different duties, or duties that are more
challenging. Job enrichment occurs when employees’ jobs
are redesigned to provide them with more challenging and
complex tasks. This process, also called vertical loading, is
designed to use all employees’ abilities. The intention is to
enrich the employee’s experience of work.
Frederick Herzberg was a strong supporter of job
enrichment. He believed that enrichment provided
employees with motivators that increased the satisfaction
they might get from working. Job enrichment normally
involves a number of elements:
» redesigning jobs so as to increase not just the range of
tasks but the complexity of them
» giving employees greater responsibility for managing
themselves
» offering employees the authority to identify and solve
problems relating to their work
» providing employees with the training and skills essential
to allow them to carry out their enriched jobs effectively.
Job enrichment involves a high degree of skill on the part
of the managers overseeing it. They must ensure that they
do not ask employees to carry out duties of which they are
not capable.
Job enlargement does not increase the complexity of tasks
carried out by an employee; instead it increases the number
of similar duties. It is also termed horizontal loading.
A number of firms operating a policy of job enlargement
simply require employees to carry out a number of similar
tasks. Thus, a receptionist might be asked to carry out a
number of duties in addition to dealing with telephone and
personal enquiries from customers. The receptionist may
also be asked to maintain records of petty cash and update
customer records, for example.
Job enlargement offers benefits to the employee in that
carrying out a range of duties, rather than a single one
repeatedly, may stimulate their interest. The business gains
an advantage from having an employee able to carry out a
wider range of duties, possibly reducing its labour costs.
Job rotation is a particular type of job enlargement. Under 2.2
this system employees switch regularly from one duty to
another. Thus, a supermarket may require employees to
spend one week on the checkout, one week stacking shelves
and one week dealing with customer enquiries. Job rotation
may reduce the level of monotony, but it does not increase
the challenge of the job.
2.2.4 Motivation methods in practice
Job enrichment
Increasing the
complexity of
tasks carried out
by an employee
or a group of
employees
Job enlargement
Increasing the number of tasks
of a similar level of complexity
Extent of tasks
▲ Figure 2.14 Job redesign: job enrichment and job
enlargement
Employee empowerment
Empowerment involves redesigning employees’ jobs
to allow them greater control over their working lives.
Empowerment gives employees the opportunity to decide
how to carry out their duties and how to organise their
work.
Empowerment can make work more interesting as it offers
opportunities to meet a number of individual needs.
Empowered workers can propose and implement new
methods of working as they bring a new perspective to
decision-making. They may spend a part of their working
lives considering the problems they face and proposing
solutions.
Empowerment would receive the approval of Maslow and
Herzberg. It provides motivators, as well as offering
employees the opportunity to fulfil higher needs.
Employees require training if they are to be empowered.
They are unlikely to have the skills necessary to schedule
tasks, solve problems, recruit new employees and introduce
new working practices. It takes time to implement
empowerment and teething problems are common.
Teamworking
Teamworking exists when an organisation breaks down its
production processes into large units instead of relying
upon the use of the division of labour. Teams are then given
responsibility for completing the large units of work. Team
members carry out a variety of duties including planning,
problem-solving and target-setting. A number of different
team types operate within businesses:
79
 » Production teams Many production lines have been
organised into distinct elements called ‘cells’. Each of
2.2 these cells is staffed by teams whose members are multi-
skilled. They monitor product quality and ensure that
production targets are met.
» Quality circle teams These are small teams designed to
propose solutions to existing problems and to suggest
improvements in production methods. The teams contain
members drawn from all levels within the organisation.
» Management teams Increasingly, managers see
AS LEVEL 2.2 MOTIVATION
themselves as complementary teams, establishing
the organisation’s objectives and overseeing their
achievement.
There has been a major trend in businesses towards
teamworking over recent years. Teamworking is a major part
of the so-called Japanese approach to production and its
benefits have been extolled by major companies, such as
Honda.
Teamworking offers employees the opportunity to meet
their social needs, as identified by Maslow; Herzberg
identified relationships with fellow workers as a hygiene
factor and McClelland noted that some employees have a
high need for affiliation. However, much of the motivational
force arising from teamworking comes with the change
in job design that usually accompanies it. Teamworking
requires jobs to be redesigned, offering employees the
chance to fulfil some of the higher needs identified by
Maslow, such as esteem needs. Similarly, teamworking offers
some of the motivators; for example, achievement.
Training and development
Some businesses invest heavily in training and development,
often regarding it as a core element of managing their
workforces successfully. Managers value training because
they believe it improves employee motivation and
performance. They believe that training helps to motivate
employees because they feel valued by the business and this
fulfils what Maslow would have called their esteem needs.
However, training has drawbacks as a technique of
motivation. It can be very expensive, especially if it takes
place away from the workplace, and it may not be the most
cost-effective method of motivating employees. A further
danger is that employees may leave once they have acquired
new skills and higher levels of motivation, attracted by
higher pay elsewhere.
Employees may receive induction training when starting
a new job. This type of training is intended to introduce
a new employee to their job and working environment.
Induction training can give employees confidence in their
ability to do a job from the outset and this confidence may
boost their motivation and performance in the workplace.
Employee participation
Employee participation is the involvement of employees
in the process of decision-making within a business,
possibly through the appointment of worker directors. Many
80
businesses recognise the motivational and other benefits
of involving employees in decision-making within an
organisation. We consider employee participation more fully
below.
GLOSSARY TERMS
Job design is the process of grouping together individual
tasks to form complete jobs.
Employee participation is the involvement of employees in
the process of decision-making within a business.
Promotion and status
Promoting an employee to a more senior position within
the business is likely to prove motivational. Organisations
that offer clear paths for promotion are likely to have more
motivated employees, as promotion brings a number of
benefits including financial rewards, more opportunities for
taking responsibility, and recognition. Employees in such
organisations will be more able to identify a career path and
would be expected to be more motivated and committed to
achieving advancement.
Herzberg recognised that many employees needed
opportunities for advancement. McClelland identified a
group of employees with high needs for authority and
power. Both writers acknowledged that having clearly
defined routes for progression up the organisational
structure can be an effective means of meeting these needs
and can motivate employees and improve their performance
at work.
If employees believe that their employer offers no prospects
for advancement, they may seek alternative employment.
This can reduce a business’ retention rates and increase its
costs, including those for recruitment and training.
Businesses can gain a competitive advantage by
establishing and publicising clear promotion paths for
employees. This approach can assist managers in attracting
the most talented employees and in developing a strong
employer brand.
Similarly, granting someone higher status within an
organisation, perhaps through giving them their own office
or parking space, may motivate them by fulfilling their need
for self-esteem. However, some businesses have opted for a
policy of single status in recent years. Single status means
that businesses end discrimination between different grades
of employees within the organisation, by providing the
same facilities and benefits for all.
Methods of employee participation
As we have seen, employee participation is the involvement
of employees in the process of decision-making within
a business. Trade unions can be opposed to the use of
employee participation because techniques such as quality
circles can replace unions in the workplace. Employee
participation can take numerous forms, including:
» Quality circles These are groups of workers who meet
regularly to identify methods of improving all aspects
of the quality of their work. Quality circles normally
involve four to ten employees, drawn from all levels
within the organisation, and focus on supplying
imaginative ideas.
» Works councils Managers and employees meet within
works councils to discuss issues such as working
conditions, pay and training. They are popular in many
countries, especially Germany. Employee representatives
» Employee shareholders Firms across the world operate
schemes whereby their employees can buy shares in the
company, often at discounted rates. Because employee
shareholders have a financial interest in the business’
2.2
performance, it may be that their motivation levels
and performance will improve as a consequence. If the
business performs well, its share prices should increase,
giving financial benefits to the employee.
» Autonomous work groups These are teams of employees
who are given a high level of control over their working

2.2.4 Motivation methods in practice

on works councils are normally elected by the workforce lives – in effect, another form of empowerment. Some
and works council representatives may also be appointed such groups elect their own leaders and can appoint new
to a company’s board of directors. staff, as well as having considerable authority over what
tasks to complete and in what sequence.

Elton MAYO Abraham MASLOW Frederick HERZBERG

emphasised the importance of argued that businesses should offer identified factors (which he called
social contact and human employees the opportunity to fulfil ‘motivators’) which are central in
interaction in motivation their ‘higher needs’ such as status improving employee performance
and recognition at work

encouraged use of Maslow’s theory the use of autonomous work

teamworking in business supports the use of groups generate ‘motivators’
quality circles for those involved

EMPLOYEE
PARTICIPATION

▲ Figure 2.15 Employee participation and motivational theory

CASE STUDY
Primark in Bangladesh
Primark is one of Europe’s largest retailers of clothes and led to a number of administrative changes, including
operates more than 230 shops. The company has a well- transparent pay rates and accurate and detailed pay slips.
publicised commitment to improve working conditions in
Primark has also supported the creation and publication
its suppliers’ factories in Bangladesh. It has established
of a range of posters setting out workers’ rights. The
committees to allow employees to participate in decision-
whole scheme is designed to ensure that workers are
making in a number of its factories, allowing employees to
empowered, educated and effective communicators
make proposals to improve their working conditions. The
dedicated to improving working conditions in one of the
programme covered factories in Dhaka, Savar Gazipur
world’s poorer economies.
and Narayanganj. In preparation, Primark provided
training to 500 managers in the factories and more than Questions
1000 employees to ensure they had the necessary skills
1 Explain two difficulties that Primark might face in
to implement decisions to enhance working conditions in
establishing its worker-participation committees. [6]
diverse environments.
2 Evaluate whether or not Herzberg’s theories of
Equipped with new skills, including those related to motivation offer the best explanation of the benefits
bargaining, the factory workers have reduced working that Primark might receive from setting up worker-
hours and increased holiday entitlements, while participation committees. [12]
increasing hourly pay rates. The negotiations have also

81
 TEST YOUR LEARNING
2.2
Short answer questions Data response question
1 a Define the term ‘motivation’. [2]
A traditional business
b Explain one characteristic of a highly
motivated workforce. [3] Gibble Ltd is a long-established manufacturer of luxury
2 Explain one way in which a business may benefit pens. It is a traditional business with a clear hierarchy and
from having a highly motivated workforce. [3] many long-serving managers. Its products are recognised
as being of the highest quality and it charges premium
3 a Identify two human needs.
AS LEVEL 2.2 MOTIVATION

[2]
prices for them. Its most expensive pen sells for $1250.
b Explain two key elements of FW Taylor’s
theory of motivation. [6] Despite the company’s profits reaching record levels, its
4 Explain one difference between Frederick managers are seeking ways to improve the performance
Herzberg’s motivators and his hygiene factors. [3] of its workforce. Some managers believe that pay
5 a Define the term ‘process theory of motivation’. [2] is the best way to improve motivation and employee
performance. Others would prefer more employee
b Explain one difference between the need for
participation allowing greater use of teams and
achievement and the need for affiliation. [3]
techniques, such as empowerment and job enrichment.
6 a Explain one difference between piece-rate
pay and hourly pay. [3] Questions
b Explain one possible benefit to a business of
1 Define the terms:
profit-sharing. [3]
a ‘empowerment’ [2]
7 Explain two features that an employer should include
b ‘job enrichment’. [2]
in the design of a job if it is to motivate employees. [6]
2 Analyse one way in which Gibble Ltd might use
8 a Explain one difference between job enrichment
monetary methods of motivation to improve the
and job enlargement. [3]
performance of its workforce. [4]
b Define the term ‘job design’. [2]
3 Evaluate whether it is inevitable that Gibble Ltd
9 Explain two different types of teams that may be
will use non-financial methods to motivate its
used within a business. [6]
workforce. [12]
10 a Define the term ‘employee participation’. [2]
b Explain two techniques that businesses may
use to encourage employee participation. [6]

82
2 Human resource management

2.3
AS LEVEL

Management

2.3.1 Management and managers

Chapter overview
In this chapter we examine:
★ the functions of management
★ the role of managers using the theories of Fayol and Mintzberg
★ the contribution of managers to business performance
★ a range of management styles
★ McGregor’s theory X and theory Y managers.

2.3.1 Management and managers STUDY TIP

What is management?
Describing management is a complex task, and there have
been a number of attempts by writers to classify what
managers do within an organisation. For example:
» Henri Fayol, writing in the early twentieth century, set
out the functions of management.
» In contrast, Henry Mintzberg identified ten roles carried
out by managers.
We will consider both of these classifications in more detail
in this chapter.
Many business writers draw a distinction between a leader
and a manager. A manager is someone who gets things
done. Managers tend to focus on the present and the short
term and are responsible for implementing the decisions
of others. They manage but they also follow. Their role, in
many ways, is to maintain things the way they are.
Leaders, by comparison, are people who are followed, who
have a vision of the future and a clear sense of where they
Do make sure that you distinguish between management
and leadership in your answers and avoid using these
two terms interchangeably. If the question is about
management, make sure that is what you write about!
The functions of management
The theorist Mary Parker Follett believed that management
was ‘the art of getting things done through other people’.
From Fayol onwards, various writers over the years have
argued that this involves different functions. However,
those set out in Figure 2.16 would be considered the key
functions that are carried out by most managers.
pany objectives
Com
Di
ng

are taking the business. A leader decides what needs to

re
ni

ct
an

be done and is prepared to shake things up to get it done.

in
Pl

According to a significant writer in this area, John Adair, The

‘leadership is the process of motivating others to act in Manager
particular ways’. We look at leadership in much more detail
g
O

in Chapter 7.3.
llin
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isi

Co
ng

GLOSSARY TERM
Leadership includes the functions of ruling, guiding and
inspiring other people within an organisation in pursuit of
agreed objectives. Com s
p a n y o bje cti v e
Management is planning, organising, directing and
controlling all or part of a business enterprise.
▲ Figure 2.16 The functions of management

83
 All businesses operate in different ways and may require » planning
managers to undertake varying tasks and duties. However, » organising
2.3 these various management duties and tasks can be
categorised into four basic functions – the functions of
»
»
directing
controlling.
management. The four principal functions of management are:

CASE STUDY
Saudi Arabian company wins airport car park contract
AS LEVEL 2.3 MANAGEMENT

Sharjah Airport is one of the busiest in the United Arab
Emirates. In the past, the managers at Sharjah Airport
Authority have managed parking by passengers and staff.
However, it was decided recently that another company
should be employed to take on this role. The contract was
won by Mawgif, a business based in Saudi Arabia.
Mawgif has promised to use technology to support its
management of parking at the airport in the hope of
improving the travel experience of passengers passing
through Sharjah Airport. It has significant experience in
this area as it already operates parking in more than ten
cities and has operations in Saudi Arabia and Jordan. It
also plans to offer drivers parking at Sharjah Airport new,
and more convenient, methods of paying parking charges.
Source: www.moodiedavittreport.com/national-parking-company-
mawgif-wins-15-year-sharjah-airport-parking-contract/
Questions
1 Explain two functions of the managers at Sharjah
Airport Authority. [6]
2 Evaluate which of the functions of management will
be most important if Mawgif’s managers are to
respond effectively to winning this contract. [12]

Planning Organising
Planning is the first of the functions of management and Management must assemble the resources that they need
involves looking to the future. It is the foundation upon to carry out the actions set out in the plan. Through the
which the other three functions of management should process of getting organised, management will determine
be based. Planning requires management to evaluate the internal organisational structure, establish and
where the company is currently and where it would like to maintain relationships, as well as allocate necessary
be in the future. This allows managers to take decisions resources.
so that the company moves forward in an organised and
Global demand for palm oil is rising quickly. Worldwide
coherent manner to give managers something against which
production of palm oil has been climbing steadily for
to judge their decisions. Planning may involve a variety of
five decades. Between 1995 and 2015, annual production
tasks, including:
quadrupled, from 15.2 million tonnes to 62.6 million tonnes.
» establishing objectives or targets for the business
By 2050, it is expected to quadruple again, reaching 240
» gathering together forecasts of key data, such as costs
million tonnes. Plantations have been established in Africa
and revenues
and South America. In order to organise this expansion, the
» drawing up plans for functional areas within the
managers will need a range of resources:
business such as finance, human resources or
» land for palm oil plantations and oil mills
marketing – these plans should fit together to help the
» labour to plant the trees, build the mills and, eventually,
business achieve its objectives
harvest the fruit of the trees and process it
» estimating the likely resource needs for any proposed
» capital to finance the plan.
plans.
The companies may also need to restructure their workforce
The planning process is continual because external factors
to operate plantations in Africa and South America to
(such as licences to operate telecommunications services
ensure that their planned operations run efficiently. A well-
in many countries, for example) change all the time. These
managed business will use minimal resources to achieve its
changes may cause a company to adjust its course of action
objectives. (The palm-oil industry has a high environmental
to ensure that it achieves its objectives.
impact which companies must also take into account – see
Planning helps managers to reduce the chance of projects pages 233 and 257.)
failing in the future. A plan can highlight problems and
encourage managers to develop solutions. It can help to Directing
make sure that managers have the resources they need. A
The third function of management is directing. Through
plan can also be extended to help managers to overcome
directing, management is able to influence and oversee the
emergencies or crises – these are called contingency plans.
behaviour of the staff in achieving the company’s goals, as
For example, a company might draw up a contingency plan
well as assisting them by providing the necessary resources.
to cover the consequences if a bid made to operate mobile
Directing employees effectively entails motivation and
phone services is unsuccessful.
communication.

84
» Motivation is the willingness to achieve a target or
goal. Employees that are highly motivated generally
perform better, which assists businesses in achieving
objectives. For this reason, managers tend to put a lot of
focus on motivating their employees. For example, they
provide financial-incentive programmes to encourage
employees and may also grant them authority to take
decisions to help improve motivation and performance.
» Communication is the exchange of information between
one or more people. Effective communication can take
a number of forms. It may simply be praise or clear
guidance; alternatively, it could be detailed instructions.
Whatever form it takes it can help to achieve high levels
of productivity and encourages employees to use their
initiative as well as to solve problems.
Controlling
Controlling involves setting standards using the company’s
objectives and then evaluating and reporting performance.
Once management has done both of these things, it should
compare the two to determine any necessary corrective
or preventive action. Managers can report on business
performance in a number of ways:
» Financial reports Many companies publish details
of their financial performance each year. This gives
interested parties information on their sales, revenues
and profits. In many countries there is a legal
requirement for companies to report on profits or losses
to assist governments in assessing whether the correct
amount of tax has been paid.
» Employee performance Such reports may provide
information on productivity (the quantity produced per
employee per week, for example), levels of absenteeism
or training costs. For many service businesses, these can
be vital measures of performance.
» Social performance Managers can measure a business’
performance in terms of behaving ethically, minimising
pollution and creating jobs.
Palm-oil producers may need information on each of the
above areas to assess whether their planned expansion
of palm-oil production in countries throughout the
world is progressing according to their plans. The
control process is a constant task for managers. Through
the process of control, a manager is able to identify
potential problems and take the necessary decisions to
overcome them.
▲ Figure 2.17 A newly established palm-oil plantation
Question
1 Evaluate why it might be necessary for palm-oil
producers to report on their social performance in
2.3
Africa to ensure that their activities are controlled
effectively. [12]
Henri Fayol’s theories of management
Henri Fayol (1841–1925) was a French mining engineer. He
2.3.1 Management and managers
developed a theory of business administration and published
his ideas in his book, Industrial and General Administration,
originally published in France in 1916. Fayol created his
theory at roughly the same time as Frederick Winslow Taylor
developed his ideas about scientific management.
As a director in a mining company, Henry Fayol established
what he thought were the fourteen key principles of
management. His work set out how managers should
organise and interact with employees. He also identified
five primary functions of management which supported his
fourteen principles.
Fayol was one of the earliest writers on management theory
and remains a very strong influence on management theory
and practice.
Fayol’s fourteen principles
1 Division of work Output can be increased if employees
are specialised in different areas of production. This
occurs because employees become increasingly skilled
and productive.
2 Authority Fayol believed that managers need authority
to give orders to subordinates. However, it is important
to remember that responsibility comes with authority.
3 Discipline This refers to obedience and is a core value in
an effective organisation.
4 Unity of command This means that an individual
employee should receive orders from one manager and
that the employee is answerable to that manager.
5 Unity of direction In a well-co-ordinated organisation,
teams with the same objective should be working under
the direction of one manager and following a single
plan.
6 Subordination of individual interests to the general
interest The interests of any one employee or group
of employees (including managers) should not be more
important than the interests of the organisation as a whole.
7 Remuneration Employee satisfaction occurs when all
employees are paid fairly. This covers financial and non-
financial rewards.
8 Centralisation This refers to how close employees are to
the decision-making process. It is important to achieve
a balance between senior managers (at the centre)
and more junior employees being involved in decision-
making.
9 Scalar chain Employees must know where they are in
the organisation’s structure. They should know who is
their manager and those people over whom they have
authority.
85
 10 Order Employees must have the right resources to carry Interpersonal management
out their jobs effectively. In addition, the workplace
This category entails managing through other people.
2.3 should be clean, tidy and safe.
11 Equity Fayol believed that managers should be kind and
» Figureheads represent their colleagues. They carry out
social, ceremonial and legal responsibilities and are
treat all employees fairly at all times.
expected to be a source of inspiration. Figureheads are
12 Stability of tenure of personnel Managers should aim
considered to have authority.
to have the right staff in the right place and to minimise
» Leaders create and maintain an effective working
the rate of labour turnover within the business.
environment and motivate and develop more junior
13 Initiative Employees should be given the necessary
employees. In this role, employees manage the
freedom to be creative and to develop new ideas. This
performance and responsibilities of everyone in their
helps to encourage employees to be engaged and
AS LEVEL 2.3 MANAGEMENT

team.
motivated.
» Liaisons must communicate with internal and external
14 Esprit de corps Organisations should strive to promote
contacts. They need to network effectively to gather
team spirit and unity and create good morale within the
information.
workplace.
Fayol’s fourteen principles may have been written more than Informational management
one hundred years ago, but many of these principles are The roles in this category involve processing information.
now adopted by almost all managers, although they were » Monitors search for internal and external information
considered revolutionary when first published. relevant to the business, looking for relevant changes in
the environment. Monitors also look after their teams in
Fayol’s functions of management terms of performance and welfare.
Fayol set out five functions of management. These are: » Disseminators pass on valuable information to others in
» planning » co-ordinating the organisation. This is a central communication role.
» organising » controlling. » A spokesperson represents and speaks for their
» commanding organisation. In this role, they are responsible for
transmitting information about their organisation and
You will see that Fayol’s functions of management are very
its goals to the people outside it.
similar to the generic managers’ roles described earlier (on pages
84–85). Analysing the functions and principles of management
gives some insight into what managers have to do to be Decisional management
effective and efficient. Some management writers have argued This category of management role uses information to take
that when Fayol’s writing on good management was accepted, decisions.
productivity and living standards in America increased. However, » Entrepreneurs plan and initiate change as a manager
this may have been the result of other factors too. within a business organisation.
» Disturbance handlers deal with the unexpected and
Mintzberg’s roles of management also with crises. Managers should take control in such
circumstances and attempt to solve disputes.
Henry Mintzberg is Professor of Management Studies at
» Resource allocators take decisions on the most
McGill University in Montreal, Canada, and a renowned
effective use of an organisation’s resources including
author on management. One of his most famous pieces
finance, staff and capital equipment.
of writing, in 1990, set out the ten roles performed by
» Negotiators engage in important negotiations within
managers within businesses. He argued that management is
and outside the business.
not about functions but about what managers do.
Mintzberg reached a number of conclusions from his studies.
Mintzberg argued that managers performed ten roles and
» Senior managers are very busy and have heavy
that these fall into three categories, as shown in Table 2.9.
workloads! There is little free time and trying to get
▼ Table 2.9 Mintzberg’s management roles and categories away from work is difficult.
» The work is fragmented; managers are moving from
Role Category one task to another. They need to focus on what really
1 Figurehead matters and what really makes a difference (80 per cent
2 Leader Interpersonal management of results usually come from 20 per cent of the effort, so
3 Liaison they try to work out what that 20 per cent is).
4 Monitor » Managers focus on short-term, immediate problems. They
5 Disseminator Informational management are often firefighting, dealing with the problem in front
6 Spokesperson of them; this pushes them away from long-term planning
and thinking.
7 Entrepreneur Decisional management
8 Disturbance handler
9 Resource allocator This category of management role
10 Negotiator uses information to take decisions.

86
 CASE STUDY
SF Airlines plans to enlarge fleet
SF Airlines is based in Shenzen, China, and was founded in
December 2009. It provides a service transporting cargo
and has transported around 2.5 million tonnes of cargo to
destinations in central and south-east Asia and Europe. It
only commenced flights between Frankfurt (Germany) and
Wuxi (China) in September 2019.
Each week, SF Airlines operates an average of 959
flights to 65 airports. The airline plans to double its
fleet to 118 aircraft and to expand its network of routes
to 70 destinations during 2020. SF Airlines has also
expanded its fleet of aircraft by 16 per cent during 2019
and now operates 58 planes. In December 2019, it was
given approval by the US Department for Transportation
» Verbal contact is preferred to written as, with the latter,
lots of information is received but it takes longer to get
a response. Managers seldom get out and about; walking
around is useful because it makes you visible and more
aware of the issues within the business.
» Managers actually control little of what they do day to
day – things happen to them!
Mintzberg’s work on management roles was based on
observing senior managers, and this is both a weakness
and a strength of his theory. He did analyse what managers
really do, but he did not consider the working lives of
middle or junior managers, so, in this respect, his analysis
may be considered incomplete.
The contribution of managers to
business performance
Managers play a critical role in business activities and can
have a significant influence on their performance. There are
many elements of the work of managers which can impact
on the performance of the business. We will consider some
of these below (these are also summarised in Figure 2.18).
» Setting suitable objectives Managers play an important
role in setting objectives and monitoring the actions
taken to achieve these. Setting objectives which are
appropriate and achievable is an important part of
business success. If they are too challenging, employees
may be demotivated by failure; if too easy to achieve,
the business may underperform. Effective managers
also monitor the progress of the business towards
its objectives, ensuring, for example, that sufficient
resources are available to employees. Managers at
Volkswagen, the German car manufacturer, plan to
switch production from cars powered by internal
combustion engines to those with electric motors. By
2028, Volkswagen will sell 70 different electric vehicles
and the company will be carbon-neutral by 2050. Its
future success will depend on how effective managers
are in guiding the business to achieve these objectives.
2.3
to operate flights from China to any point in the USA. In
response to this, the airline will introduce flights from
Hangzhou to New York three times each week.
Source: www.ch-aviation.com/portal/news/85299-chinas-
sf-airlines-fleet-to-top-60-aircraft-in-2020
2.3.1 Management and managers
Questions
1 Explain two reasons why planning will be an important
function for SF Airlines’ managers in the future. [6]
2 This expansion represents a major challenge for SF
Airlines’ managers. Evaluate which of Mintzberg’s
roles would be most important in the management
of the company’s growth. [12]
» Allowing subordinates to work to their full potential
Managers who can recognise and respond appropriately
to the needs and abilities of their workforce are more
likely to achieve success. Some employees will flourish
if managers relax control and empower employees
to make decisions and take greater control of their
working lives. In other situations, managers may need
to use more authority. If managers achieve the right
balance between the use of authority and freedom for
employees, the workforce, and hence the organisation, is
likely to perform better.
» Making good-quality decisions Managers tend to make
a lot of decisions. Some of these can have significant
implications for the performance of the business.
Effective managers will use their experience and skills,
as well as data, to make good-quality decisions. Modern
managers frequently have access to enormous amounts
of data on, for example, market trends and consumer
behaviour. This can be used to support and inform
decision-making and can help to reduce the risk in major
decisions, such as that taken by Volkswagen above.
Use workforce and other
resources as efficiently Increased sales
as possible and profits
Set
Achieve
objectives
challenging
on time,
but
enhancing
achievable
business’
objectives
performance
Protecting and/or
Take informed decisions
increasing market
using experience and data
share
▲ Figure 2.18 Some ways in which managers can contribute
to business performance
87
 Styles of management
2.3 There have been many studies looking at styles of
management and evaluating the extent to which they have
been successful. There is no simple answer to which style is
most effective, as it depends on the circumstances. Here,
we will consider a range of styles of management.
One classification of styles is to consider the extent
to which managers ‘tell’ or ‘listen to’ their staff. Using
this approach, managers have been classified as being
AS LEVEL 2.3 MANAGEMENT
autocratic, paternalistic, democratic or laissez-faire
(literally meaning ‘leave alone’). However, there are many
more different styles of management that can be identified
using this approach. The Tannenbaum and Schmidt
continuum, shown in Figure 2.19, emphasises that there is
Manager-centred management
Use of authority by the manager
Manager makes Manager sells Manager
decision and decision to presents
announces it subordinates i.e. ideas and invites tentative decision
convinces them questions subject to change
Range of behaviour
▲ Figure 2.19 The Tannenbaum and Schmidt continuum
GLOSSARY TERMS
Autocratic management exists when managers keep
control of information and make major decisions alone.
Sometimes known as authoritarian management.
Paternalistic management is a style in which managers
take decisions in what they believe are the best interests
of their subordinates.
Democratic management occurs when information is
shared and team members participate in decision-making.
Sometimes known as participative management.
Laissez-faire management takes place when managers
allow subordinates freedom to make their own decisions.
Autocratic management
This is also sometimes termed authoritarian management.
It refers to a management or leadership style which assumes
that information and decision-making are best kept at the
top of the organisation. It is also characterised by:
88
a range of management styles depending upon the extent
to which managers take decisions or whether subordinates
contribute significantly to decision-making.
A key factor in differentiating between these styles is
communication. At the autocratic end of the spectrum,
communication is likely to be downward only as the manager
‘instructs’ their subordinates as to their duties. Paternalistic
management is a ‘softer’ version of this, as we shall see.
Democratic management is more likely to result in two-way
communication, as consultation and ‘selling’ of the final
idea take place. Laissez-faire management may result in
relatively little communication, as the problem or task may
be outlined with subordinates having considerable freedom
thereafter.
Subordinate-centred management
Area of freedom for subordinates
Manager Manager presents Manager defines Manager pemits
presents problem, gets limits and asks group to function
suggestions and group to make independently
makes decision decision within defined
limits
» one-way communication (downward)
» minimal delegation or decentralisation
» close supervision of employees.
Martha Stewart, an American entrepreneur, built up a vast
global business venture including publishing, television
broadcasting and online commerce, despite (or perhaps
because of) her reputation as an autocratic manager.
Under this style, the manager determines objectives,
allocates tasks and expects obedience from subordinates.
In these circumstances, employees become very dependent
upon their managers, as they do not have the necessary
information (or confidence) to act on their own initiative.
Organisations managed in an authoritarian style can face
difficulties. People avoid making decisions, so that matters to
be decided are either passed up for the decisions to be made
at a higher level or decisions are made by committees – as it
is more difficult to dismiss all the members of a committee
for jointly making a wrong decision. Senior management
tends to be overworked and staff turnover tends to be high.
This style of management becomes more difficult to operate
successfully as an organisation grows.
As with all of these management classifications, the
term ‘autocratic manager’ covers a spectrum of actual
styles. Extreme autocratic management will result in
▼ Table 2.10 Autocratic management – circumstances in which it may be applicable
Appropriate
• When a rapid decision is needed – perhaps in an emergency
• When it is important that the same message is given out
by everyone in the organisation – maybe as part of crisis
management
• When managers are responsible for a large number of
(possibly unskilled) subordinates
Paternalistic management
Paternalistic management is broadly autocratic, but this
type of manager takes into account the interests of the
workforce when making decisions. Paternalistic managers
consult with junior employees over decisions and may
take some notice of the views expressed by subordinates.
However, paternalistic managers retain control over most
decision-making and only delegate minor decisions (and
little freedom) to subordinates.
A paternalistic manager regards their staff as an extended
family. Businesses using this style of management consider
it important to meet the social and leisure needs of their
staff. This approach was common in the UK in the past, and
Cadbury’s (a manufacturer of chocolate and similar products)
was a well-known example.
Paternalistic managers often develop very loyal subordinates
because subordinates feel protected and cared for. It is
not unusual for paternalistically managed businesses to
have a low rate of labour turnover. This can help to reduce
recruitment costs and improve competitiveness.
However, paternalistic managers do not encourage their
employees to use their creative and imaginative skills, nor
do they encourage the use of initiative. This can mean that
the business does not make the most effective use of the
human resources that it has available.
Democratic management
Democratic management (sometimes called participative
management) entails operating a business according to
decisions agreed by the majority. Decisions may be agreed
formally through a voting system, but they are more
likely to be the result of informal discussions. Typically,
democratic management encourages some or all of the
following:
» the manager delegates a great deal and encourages
decentralisation
» the manager and subordinates discuss issues and
employee participation is actively encouraged
subordinates having no freedom of action. More benevolent
autocratic leadership will allow for the possibility of some
discussion or persuasion. This implies that limited two-way
communication may occur.
2.3
Inappropriate
• When taking highly complex decisions requiring diverse
2.3.1 Management and managers
knowledge and skills
• When leading a talented, self-motivated and creative group
of employees
• In circumstances in which junior managers are expected to
develop a full range of managerial skills
» the manager acts upon advice and explains the reasons
for decisions
» subordinates have some control over their own working
lives.
The successful operation of this style requires excellent
communication skills on the part of the manager and the
ability to generate effective two-way communication. A
considerable amount of management time may be spent on
communicating in one form or another. This approach helps
to develop the skills of subordinates and generally results in
a more satisfied workforce.
Democratically led groups usually have low dependency on
their manager, offer constructive ideas and suggestions
and derive great satisfaction from their employment.
As a consequence, such groups have high levels of self-
motivation and may require relatively little supervision.
There is evidence of a trend towards more democratic styles
of management, though this depends on many factors,
including the size of a business and its culture. The trend
towards democratic management has a number of possible
causes:
» Management theory has developed and provided
substantial evidence that people are more likely to
be motivated (and productive) through the use of a
democratic management style.
» Management has become more complex. Globalisation
means that businesses are larger and more complicated
organisations, and the environment in which they
operate is dynamic and subject to rapid change.
Individuals are more likely to need the support that
democratic management provides to succeed in these
circumstances.
STUDY TIP
Do learn the glossary terms in this chapter (and the other
chapters as well!), as understanding the terms that may
be used in questions is essential and you may be asked to
provide definitions.
89
 CASE STUDY
2.3
Steve Jobs
Steve Jobs was an unconventional manager. His
management style was not the stuff of textbooks – he
wasn’t known for his democratic style or consensus-
building approach. Jobs founded the American technology
company Apple with school friend Steve Wozniak in 1976,
and was effectively fired from it in 1985. However, he
AS LEVEL 2.3 MANAGEMENT
Some analysts do not consider Jobs to have been the
best manager of people. There are times when clear
and decisive management is essential and a strength,
especially in times of crisis. However, it may be that
Jobs should have delegated more and listened more, as
subordinates often have great ideas.

returned to the company in 1997 and achieved greatness.

Under his control, the market value of Apple’s shares
increased from about $5 billion in 2000 to $351 billion in
2011, when ill-health forced his retirement. It remains one
of the most valuable companies globally; he also created
one of the world’s most valuable brands.
Sir Richard Branson, the founder of the Virgin Group of
companies, was a fan of Steve Jobs. He has described Jobs
as an autocratic manager with a ‘meticulous eye’ for detail.
Branson considered Jobs to be someone who wanted to
work with people who were like-minded and who would
follow his instructions. Jobs was not thought to be a good
delegator and tried to become involved in too many aspects
of the business. He was very demanding as a manager,
expecting a great deal from the people who worked for him.
Despite the criticisms of Jobs as a manager, he is
considered to have been an excellent communicator and
he was the public face of Apple for many years. He was
also passionate about his work. He loved finding gaps in
the market and developing products that people really
wanted. Jobs’ legacy lives on in Apple.
Questions
1 Explain two differences between autocratic and
democratic management styles. [6]
2 Evaluate whether being passionate about your
business and a good communicator is more important
than the management style that is used. [12]

Laissez-faire management
This approach is sometimes described as ‘mild anarchy’.
Under this approach, the manager has a minimal input into
the operation of the business. Employees take the majority
of the decisions with little reference to the manager. As a
consequence, the organisation can lack a sense of direction
as well as co-ordination and planning.
A laissez-faire style of management may occur because
of the personal shortcomings of the manager or a lack
of the essential skills needed to carry out the manager’s
role successfully. Alternatively, it may be a conscious and
brave policy decision to give staff the maximum scope for
showing their capabilities. It may be an appropriate style to
adopt in certain circumstances. For example, the manager
of a highly creative team may deliberately adopt this
▼ Table 2.11 The key features of a selection of management styles
style in the expectation of bringing out the best in their
subordinates.
Laissez-faire management may be successful in the
following circumstances:
» The manager is one among a number of equals in terms
of experience and qualifications.
» The workforce is self-motivated and understands the role
of the manager.
» The workforce understands and agrees with the
organisation’s objectives.
Laissez-faire management tends to result in highly
independent employees who are willing to voice their
opinions. Staff may be satisfied or dissatisfied with this
style of management, depending on their skills, the
complexity of the tasks to be completed and their own
personality.

Autocratic Paternalistic Democratic Laissez-faire

Description Keeps information and Dictatorial, but Entails managing a Manager has a
decision-making among decisions are intended business on the basis peripheral role, leaving
the senior managers to be in the best of decisions agreed by staff to manage the
interests of the the majority business
employees
Decision-making Sets objectives and Manager explains Encourages Manager evades duties
allocates tasks. decisions and ensures participation and unco-ordinated
Manager retains control social and leisure needs and makes use of delegation occurs
throughout are met delegation

90
 Autocratic Paternalistic Democratic Laissez-faire

Communication
One-way
communication
Mainly downwards,
though feedback will
Extensive, two-
way. Encourages
Communication is
mainly between people
2.3
downwards from take place contributions from at the same level in the
manager to subordinate subordinates organisation, though
little occurs
Uses Useful when quick Can appear democratic, When complex Can encourage
decisions are required but is really ‘soft’ decisions are made production of highly
autocracy requiring a range of creative work by

2.3.1 Management and managers

specialist skills subordinates
Advantages Decisions and direction Can engender loyalty, Commitment to May bring the best out
of business will be and frequently enjoys business, satisfaction of highly professional
consistent. May project low labour turnover due and quality of work may or creative groups
image of confident, to emphasis on social all improve
well-managed business needs
Disadvantages Lack of information, An autocratic style Slow decision-making Staff are likely to
so subordinates are can result in groups and need for consensus lack focus and sense
highly dependent on becoming highly may avoid taking ‘best’ of direction. Much
managers; supervision dependent. They may decisions dissatisfaction among
needed become dissatisfied subordinates is common
with manager

Thus, a poor performance by a group of workers may be

Style versatility
Building on the contention that there is not a single perfect
style of management, it is possible to argue that the best
managers are those who adopt a style suitable to the
circumstances. Thus, the most talented managers might
be the most versatile, able to call on one or more of the
styles we have discussed in order to assess the demands of
the situation. Therefore, a versatile manager might adopt
a democratic approach when reaching a decision on a
proposed marketing campaign with a small group of writers
and artists but they may demonstrate a more autocratic
style when dealing with a crisis.
Douglas McGregor’s Theory X and
Theory Y
Douglas McGregor was an American social psychologist
who researched into leadership and management in large
companies. His writing developed understanding of how
the attitude of a manager might shape their behaviour. His
book, The Human Side of Enterprise, was published in 1960
and has received much acclaim, particularly his celebrated
comparison of two types of manager as set out in Theory X
and Theory Y. McGregor’s theories were based on research he
had conducted into the attitudes of managers towards their
employees.
His research revealed that many managers assumed their
workers were motivated solely by money and had no real
desire to work. McGregor referred to this type of manager
as Theory X. He also discovered an alternative, and less
common, type of manager, which he termed a Theory Y
manager. Such managers, according to McGregor, believed
workers sought more than financial gain from employment.
the result of a work environment lacking stimulation and
challenge for employees. The behaviour of employees,
argued McGregor, is often the result of the way they are
treated.
McGregor did not believe in the views expressed by Theory
X managers. He set the theory only to disprove it as part of
his support for the views expressed by Theory Y managers.
A Theory Y manager is more likely to be one who believes
the following to be true:
» Workers seek satisfaction from employment and not just
a pay cheque.
» Workers possess knowledge, creativity and imagination.
» Workers willingly commit themselves to organisational
objectives.
» Poor performance by employees is due to repetitive and
monotonous work or poor management.
» Employees wish to contribute to decision-making.
Theory X is derived from the work of FW Taylor and the
scientific school of management, who contended that
workers were ‘economic animals’ motivated solely by
money. Theory X managers seek to get the best from their
employees by use of techniques such as piece-rate pay and
close supervision.
Alternatively, Theory Y stems clearly from Mayo’s human
relations approach and Maslow’s work on human needs
(see pages 70–72 on motivation). It focuses on meeting
the social and psychological needs of individuals within
the workplace. McGregor’s work is, however, a theory of
management and not one of motivation.
If managers adopt a Theory Y style, the implications can be
significant for a business. These might include:

91
 » greater delegation within the organisation, allowing those
further down the hierarchy to have greater authority
2.3 » training for managers to encourage delegation and to
improve two-way communication
» reviewing the business’ culture to discourage managers
from retaining what they might see as their ‘authority’
TEST YOUR LEARNING
AS LEVEL 2.3 MANAGEMENT
Short answer questions
1 a Define the term ‘authority’.
b Explain one function of management.
2 Explain two ways in which good communication
might help a manager to carry out the functions
involved in their job.
3 a Explain one reason why organising is an
important function of management.
b Explain one way in which managers can report
on business performance.
4 Explain one reason why most managers normally
focus on short-term problems.
5 a Explain one difference between autocratic and
laissez-faire styles of management.
b Explain one advantage of the use of democratic
management.
6 a Explain Henri Fayol’s fourth management
principle: unity of command.
b Explain one other management principle
identified by Fayol.
7 Explain one reason why managers who allow
employees to work to their full abilities may help to
improve a business’ performance.
8 a Explain one difference between McGregor’s
Theory X and Theory Y managers.
b Explain one way in which FW Taylor’s theory of
motivation might have influenced McGregor’s
Theory X management style.
92
» considering the organisation’s structure and approaches,
such as thinking about delayering.
Businesses moving towards a Theory Y approach to
management require planning, the support of managers and
shop-floor workers, and considerable training for all the
employees involved.
Data response question
[2] A growing business
[3] Gadfly is a small, private limited company that designs
and manufactures bicycles. It competes with a number of
large multinationals and its unusual designs have proved
[6] popular. The business is growing quickly (sales are rising
by an average of 19 per cent each year) and it now has two
[3] factories, each with its own manager who is responsible
for production at their site. A major extension to one of the
[3] factories is expected next year. The number of employees
is rising rapidly and last year reached 397, most of whom
[3] are relatively unskilled.
The business was established by Ali ten years ago and he
[3] hopes that it will continue to grow quickly. Ali is a natural
autocrat and likes to take all of the decisions using little
[3] delegation. He is a good communicator, has 30 years’
experience as an entrepreneur and also understands the
[3] bicycle manufacturing industry.
The business is changing as it grows. The company is
[3] having to produce a larger range of bicycles, and it needs
more skilled employees to design new products and to
sell the bicycles in new markets – the company made its
[3] first sales in Australia and Argentina earlier this year. Ali
is beginning to wonder whether his management style is
[3] suitable for this changing company.
Questions
[3] 1 Define the terms:
a ‘delegation’ [2]
b ‘management’. [2]
2 Analyse one reason why planning is an important
part of the managers’ role at Gadfly. [4]
3 Evaluate whether Ali’s use of an autocratic
management style is suitable in these
circumstances. [12]
3 Marketing
AS LEVEL
3.1 The nature of marketing
Chapter overview
In this chapter we examine:
★ the role of marketing and its relationship with other business activities
★ marketing objectives
★ the factors influencing supply and demand, and how supply and demand interact
★ the features of different markets
★ market share and market growth
★ the difference between consumer and industrial markets
★ the differences between B2C and B2B marketing
★ the difference between mass and niche markets
★ different methods of market segmentation
★ the costs and benefits of customer-relationship marketing.
3.1.1 Role of marketing and its
relationship with other business
activities
All organisations need customers. The purpose of all
businesses is to understand and provide the goods and
services that customers want. Indeed, according to Peter
Drucker, a very influential management writer, there is
only one valid purpose for a business, which is ‘to create a
customer’.
Marketing is the function of the business that is
responsible for understanding customer needs and
developing the right products, setting the right price and
promoting and distributing products in the right way.
Marketing provides the link between the customer and the
production function of the business. Marketing ensures that
what is being provided is actually wanted and needed (that
is, it is something of value), communicates this and makes
the product available to customers.
Operations
Human
Finance
resources
Marketing
▲ Figure 3.1 Integrated business functions; for the
business to succeed, the activities of the different
business functions must be integrated effectively
3.1.1 Role of marketing and its relationship with other business activities
GLOSSARY TERM
Marketing is the process of identifying, anticipating and
satisfying the needs of customers in a mutually beneficial
exchange process.
The importance of marketing
Effective marketing occurs when a firm fully understands
the requirements of its customers and is able to meet
these needs successfully. The marketing function helps the
organisation to provide a product that the customer wants,
is affordable, is perceived as good value and that leaves
the customer and the organisation itself satisfied with the
transaction. Marketing is an ongoing process because:
» customers’ needs change over time (for example, the
developing interest in health issues has increased
demand for health clubs and reduced demand for high-
fat foods)
» the business environment can change (for example, with
new laws, changes in technology, the economic climate
or the 2020 Coronavirus (COVID-19) pandemic)
» competitors enter the market with their own offerings,
and so businesses must respond to this
» a firm’s own strengths change and develop.
Effective marketing will, therefore, change over time to
ensure there remains a good match between customers’
needs and the business’ own strengths. Effective marketing
will lead to high levels of customer satisfaction, which
means that customers:
» are more likely to come back and buy more
» are more likely to tell their friends to try the products
» may be more willing to try new products by the business
» may become loyal to the product and less likely to
switch to competitors.
93
 CASE STUDY
3.1
Hugh Davidson
Offensive marketing can be defined as: ‘An openly
competitive marketing strategy involving one company
exposing and attacking the weaker points of another
company in order to take market share directly away from
the competition.’
AS LEVEL 3.1 THE NATURE OF MARKETING
Hugh Davidson is a marketing writer who has advised
many large companies around the world. One of his books
is called Offensive Marketing. According to Davidson,
‘Offensive marketing involves every employee in building
superior customer value very efficiently for above average
profits.’ This is an interesting definition of marketing in
that it highlights that:
● everyone is involved in marketing, because everyone
affects the quality of the service and the customer’s
impression of the product
Defining marketing
A formal definition of marketing should include the features
below.
» It is an exchange process – that is, it is two-way. The
business offers the customer a good or service and in
return receives something, usually payment.
» It is mutually beneficial because both sides should gain
from the exchange. Customers should be satisfied with
the product and firms should make a profit (assuming
that the firm is a profit-making organisation). Firms are
unlikely to give away products for nothing.
» It aims to identify and anticipate customer needs.
Entrepreneurs need to understand their customers to
know what to offer them. However, it is not always
enough just to identify customers’ needs: in fact,
sometimes the customers may not know themselves
what their needs and wants are. In some markets, such
as fashion and film, firms have to anticipate what
customers will want in the future. They have to predict
trends even before most customers know what these
trends will be.
» It aims to delight customers. Nowadays satisfying
customers may not be enough, as many other firms are
also doing this. It’s much better to delight the customer,
so that they are more than satisfied and more likely to
buy from you.
The purpose of marketing is to match the abilities and
strengths of the business to the needs of the market.
Marketing involves a whole range of activities, including
finding out what customers want, developing new products,
packaging and promoting the products, and setting
the price. All these activities are aimed at developing
and providing goods and services which will satisfy the
customer (so they will buy them), and make a profit for the
94
● it is important to develop value for money that is better
than your competitors’, not just the same
● it is important to use resources efficiently – that is, you
must think about how much you spend on marketing
and measure the returns from different types of
spending
● the aim is not just to do well but to achieve profits that
are above average – the mark of a truly successful
business.
Questions
1 Explain one feature of offensive marketing. [3]
2 Evaluate the possible benefits of an offensive-
marketing approach. [12]
firm. The more effective the marketing, the better the value
provided for customers and the greater the rewards the
business should be able to make.
Marketing and other business functions
The purpose of marketing is to ensure that the organisation
meets the customers’ needs in the present and in the
future. Marketing is therefore a dynamic process. To be
effective it must work with the other functions of the
business to influence:
» what is produced, that is, the precise nature of the
firm’s offerings (for example, in terms of design, features
and quality)
» how many are produced – marketing must estimate
likely sales, which in turn will influence the quantity of
goods and services the business must be able to provide
» the range of products offered (for example, how
extensive the menu should be in a restaurant; how many
different models should be displayed in a store)
» the price at which products are sold – this therefore
determines how much can be spent on materials and the
transformation process if a profit is to be made.
Marketing will discuss and negotiate with:
» operations over how much can be produced, what
benefits can be offered and what the costs will be
» finance over the amount that can be spent on
developing, launching and promoting the product or
service
» human resources over the number and skills of staff
required.
There may be, for example, occasions when the business
does not have the money, skills or capacity to develop a
product.
 CASE STUDY
Amazon
When Amazon.com was launched in 1995, it set out ‘to
be the Earth’s most customer-centric company, where
customers can find and discover anything they might want
to buy online … and this will be available at the lowest
price.’ Being customer-centric means the company
starts with what the consumer wants and then works
backwards. This goal still drives Amazon, although it
is now worldwide not just in the US and has millions of
sellers, consumers and content creators (for example,
selling their own books). Each of these groups has
different needs, and Amazon always works to meet these
needs by innovating new solutions to make things easier,
faster, better, and to be more cost-effective.
Marketing objectives and corporate
objectives
Marketing objectives are the targets set for the marketing
function. Typically, these include:
» Sales targets These might be set in terms of sales volume
or value. Specific targets may be set for the business as a
whole and also for specific products or particular regions.
» Market share Increasing sales may not in themselves be
particularly impressive if the market as a whole is growing
fast and competitors’ sales are increasing faster than
yours. This is why a business may set targets in terms of
the share of the market. Market share measures the sales
of one product or business as a percentage of the total
sales in the market. A business may set a target such as
its sales being 5 per cent of the market in the next year.
» Brand awareness A business may want to increase people’s
awareness of its brand relative to the competition.
The marketing objectives will be linked to the overall
objectives of the business – the corporate objective.
For example, if the business has a target of growth,
the marketing department may have to increase sales.
If the corporate target is to boost the profits of the
business, the marketing team might focus on sales of
the most profitable products and place less emphasis on
others that sell but are not necessarily as profitable.
Corporate Marketing
objective objective
(e.g. increase (e.g. increase
profits by 5% market share to
next year) 12% next year)
▲ Figure 3.2 Corporate and marketing objectives
STUDY TIP
An objective should be quantifiable and include a time
element. For example, ‘to increase market share to 3 per
cent by 2025’.
3.1
Amazon’s approach is supported by its highly developed
systems that collect and analyse data, enabling Amazon to
understand customer needs and behaviours. The founder
of Amazon, Jeff Bezos, says that the most important thing
is to ‘focus obsessively on the customer’.
Questions
3.1.2 Demand and supply
1 Analyse one benefit of being a customer-centric
company. [4]
2 Analyse one way that Amazon’s focus on providing
products at a low price might affect one of the other
business functions. [4]
3 Analyse one way that the needs of consumers and
sellers might differ. [4]
Marketing strategy Marketing objectives
= where are we
= how to get there
heading for?
▲ Figure 3.3 Marketing objectives and strategy
GLOSSARY TERMS
A marketing objective is a marketing target for the
business, setting out what it wants to achieve and when.
A corporate objective is a target set for the business as a
whole.
A marketing strategy is a marketing plan to achieve the
marketing objective.
STUDY TIP
Remember that marketing is not just about making
customers happy. The business also needs to meet its
objectives, so think about issues such as the costs of any
marketing action compared to its likely returns. Also,
bear in mind what the business can actually deliver given
its capacity, employees and other resources.
3.1.2 Demand and supply
A market is made up of buyers and sellers. The sellers
supply the product and the buyers demand it. If markets
are allowed to work without government intervention, and
if they are competitive with many different sellers, then
the quantity produced and the price in the market will be
determined by the forces of supply and demand. This can be
shown in a graph.
A supply curve shows how much producers are willing and
able to supply at each and every price, with all other factors
constant. It is usually upward-sloping because as the price
95
 increases, producers are more willing and able to supply Look at Figure 3.5a. If the price was originally at P1 then, at
more. They are more willing because of the higher price, and this price, the quantity supplied is greater than the quantity
3.1 they are more able because the higher price means they can
produce more even if their costs are slightly higher.
demanded – because the price is high, producers want to
sell more than customers want to buy. This leads to excess
supply, or a surplus. In a free market with no intervention,
The supply of a product will depend on:
the price will fall. As it does, the quantity demanded
» the number of firms producing. With more firms
increases, the quantity supplied falls until P0 is reached.
producing, the supply in the industry should increase
P0Q0 is the equilibrium price and quantity; at this price the
» the time period. Over time, more firms can move into
quantity demanded and supplied is equal and there is no
this market if it is attractive, which could increase supply
incentive to change.
» technology. Technological developments will increase
AS LEVEL 3.1 THE NATURE OF MARKETING

the quantity supplied If the price was P2 then at this low price the quantity
» costs. If a business can reduce its costs (for example, demanded is greater than the quantity supplied and
by using cheaper supplies or being more efficient in its there is excess demand. This is known as a shortage. In
operations) this means it can produce more at each price a free market, the price will increase; this increases the
and supply can increase. quantity supplied and reduces the quantity demanded until
equilibrium at P0Q0 is reached.
A demand curve shows how much customers are willing and
able to buy at each and every price with all other factors Price
unchanged. It is downward-sloping because as the price falls,
customers can afford to buy more with the same income. Supply
The demand for a product will depend on factors such as: P1
» the income of buyers, as this will affect how much they
can afford
» the price of rivals’ products. If these are cheaper, this is
likely to reduce demand for your product
P0
» the price of complementary products (for example, if
you buy a printer and print cartridges together, these
are complementary products). If a complement is
cheaper, customers might buy more of it and more of
the associated product as well P2
» marketing activities. Effective marketing by a business Demand
should help increase demand for the product.

Q0 Quantity

Promotional ▲ Figure 3.5a

activities
Changes in demand conditions
Competitors A demand curve shows the quantity of a product demanded
(substitutes) Population at each and every price, with all other things unchanged.
The demand curve can shift if, at each price, the quantity
demanded changes. This may be because of:
Influences » a change in consumer incomes
on » a change in the price of rivals’ products
demand
» a change in the price of complementary products
» a change in customers’ tastes and social values
Price Complements » a change in the marketing activities of the business.
A change in price leads to a movement along a demand
curve. A change in one of these other factors changes the
quantity demanded at each and every price and shifts the
Income demand curve.

Changes in supply conditions

▲ Figure 3.4 Influences on demand A supply curve shows the quantity that businesses are
willing and able to supply at each price, with all other

96
factors unchanged. The supply curve will shift if, at each Price Supply S2
price, there is a change in the quantity supplied. This may
be because of:
» an improvement in technology. This might increase the
Supply S1 3.1
quantity supplied at each price
» a reduction in costs. Again this would allow a business P4
to supply more at a given price
» government subsidies or taxes on producers. P0

A change in price leads to a movement along a supply curve.

A change in one of these other factors changes the quantity

3.1.2 Demand and supply

demanded at each and every price and shifts the supply curve.

The effect on equilibrium of a decrease Demand

in demand
Q4 Q0 Quantity
If demand conditions change and there is a decrease, the
quantity demanded at each price will shift demand inwards. ▲ Figure 3.5c
This is shown in Figure 3.5b as the demand curve moves to D2. ▼ Table 3.1 Effects of shifts in supply and demand
At the old price there is now excess supply and this leads to
a fall in the price. As the price decreases, this decreases the Change Equilibrium Equilibrium
quantity businesses will supply and increases the quantity price quantity
demanded until a new equilibrium is reached. The equilibrium
Increase in demand Increases Increases
is now P3Q3; less demand leads to lower prices and output.
Decrease in demand Decreases Decreases
Price
Increase in supply Decreases Increases
Supply Decrease in supply Increases Decreases

P0 HANDLING DATA
1 Draw a diagram of supply and demand for cars for
P3 a given year, showing the equilibrium price and
quantity.
2 Now show an increase in demand. What happens to
D1 the equilibrium price and quantity?

Demand D2
Q3 Q0 Quantity
▲ Figure 3.5b
The effect on equilibrium of a decrease
in supply
If there is less supply in a market, perhaps because of a bad
crop, the supply curve would move to S2 and equilibrium would
be at P4Q4 – as shown in Figure 3.5c. Less supply in the market
means that at the original price there is excess demand (that
is, a shortage) and this leads to higher prices. As the price
rises, there is a decrease in the quantity demanded and a rise
in the quantity supplied until the new equilibrium is reached.
This has a higher price and lower output.
The effects of shifts in supply and demand on the
equilibrium price and quantity are shown in Table 3.1.
CASE STUDY
Supply and demand
The Pacifica Super Penthouse apartment is located on
the top two floors of New Zealand’s tallest residential
building. It is for sale at a price of $40 million. This
makes it the most expensive single-family home in New
Zealand. The building is not yet completed, and so buyers
have the option to design the penthouse themselves or
leave the interior design to the tower’s developers. The
developer’s plans include a conservatory, an open-plan
area, a luxury kitchen and dining area, and a wine cellar.
The top floor (the 54th) includes a spa and sauna, five
guest bedrooms and a master bedroom.
Questions
1 Analyse one factor that might influence the supply of
apartments in the development. [4]
2 Evaluate how an increase in demand for apartments
might affect the equilibrium price and quantity in
the short and long term. [12]

97
 3.1.3 Markets
3.1 Consumer and industrial markets
There are different types of markets. In consumer markets,
the customer buys the product and it is consumed. For
example, you buy food, music and clothes and then use
(consume) these. If a business is selling products direct to the
consumers who will consume them, this will involve business-
to-consumer marketing, often abbreviated as B2C.
AS LEVEL 3.1 THE NATURE OF MARKETING
These consumer items will have had to be produced and that
will have involved machinery, transport and technology.
When you are selling products to be used in the production
process for other products (for example, a production line or
raw materials), this is known as a producer (or an industrial)
market. When one business is marketing its products to
another business to buy, this is known as business-to-
business marketing, or B2B.
▼ Table 3.2 Industrial and consumer markets
Industrial Consumer
markets markets
Number of buyers Relatively small Large
Nature of buyer Professional Individuals
Local, national and international markets
Some products, such as oil, are sold on worldwide markets.
There are international producers and the products are
demanded all over the world. Other products tend to
be more national; this means they are sold mainly or
exclusively in the domestic country, such as a chain of
clothes stores. Others may be traded only in the local area,
such as a local taxi business or hairdresser. The markets
in which a firm operates affect the likely sales, the nature
of the competition and the complexity of the marketing
challenge.
▼ Table 3.3 Examples of local, national and international
markets
Type of market Possible examples
Local Taxis, hairdressers, local food markets
National National energy, national rail, national
water
International Tobacco products, mobile phones,
pharmaceuticals
Customer (market) orientation versus
product orientation
A customer-oriented (or market-led) business is one that
bases its decisions on customers’ needs. It continually
monitors its environment to find out what customers
want, what competitors are offering and what changes
are occurring in the market. By being market-oriented, a
firm should be able to ensure that the product or service
it provides matches its customers’ needs. If there is a high
98
level of competition then firms need to be market-oriented
to survive; if they are not, rivals will meet customer needs
more effectively and reduce their sales. Any entrepreneur
wanting to succeed should make sure there is demand for
their product. This will usually be done via market research
to try to identify the likely level of sales.
By comparison, a product-oriented (or product-led) business
focuses more on what it can produce and hopes that this
will fit with customer requirements. This is a very risky
approach because the firm may produce something the
customer does not want. If an entrepreneur assumes that
because they like the idea, everyone else will also like
it, this is being product-oriented. Not everyone thinks or
behaves in the same way, so entrepreneurs must check that
there is demand before starting out.
Although being product-oriented is less likely to succeed
than being market-oriented, it can work if the customer has
limited choice; for example, in some countries, governments
only allow a few firms to produce particular products and
so customers have to buy what is available. If it is lucky,
the business may produce a product that people want, or in
some cases people invent products that customers did not
know they wanted until the product arrived. However, over
time, as customers find alternatives, product-oriented firms
are likely to suffer.
CASE STUDY
Amazon
Founded: Incorporated July 1994.
Mission: To be Earth’s most customer-centric company
where people can find and discover anything they want
to buy online.
Headquarters: Seattle, Washington, USA.
Websites: Amazon serves its consumers through its
retail websites. It operates websites in the USA, the UK,
Germany, Japan, France, Canada, China, Italy and Spain.
Selection: Amazon and more than 2 million third-party
sellers offer millions of unique, new, refurbished and
used items in categories such as:
● Books ● Kids & Baby
● Movies ● Grocery
● Music ● Health & Beauty
● Video Games ● Clothing, Shoes &
● Electronics & Jewellery
Computers ● Health & Beauty
● Home & Garden ● Sports & Outdoors
● Tools ● Automotive &
● Toys Industrial.
Questions
1 Define the term ‘customer-centric business’. [2]
2 Visit the Amazon website (www.amazon.com).
Evaluate the ways in which Amazon tries to be the
world’s most customer-centric business. [12]
Measuring market share and growth
Markets will differ in nature. For example, this could be in
terms of:
» Market size The size of a market can be measured in
terms of the volume of sales or the value of sales. For
example, there may be 20 000 products sold (volume) or
$100 000 sold (value). If the volume of sales increases, the
value will also usually increase, but this depends on what
is happening to the price. If the price falls, it is possible
that more units are sold but the value of sales declines.
» The number of competitors Some markets have many
thousands of competitors – just think of how many
hairdressers and cafés there are. In other markets there
are relatively few providers – how many electricity or
train companies are there, for example?
» Market growth Some markets do not change in size
very much, while others grow fast and some shrink.
The growth of a market is measured by the percentage
change in its size over a given period. Generally,
businesses will prefer fast-growing markets because they
can all sell more. If the market is static then one firm
can only sell more at the expense of another; this can
lead to aggressive, competitive behaviour.
GLOSSARY TERMS
Business-to-consumer marketing (B2C) occurs when one
business is marketing its products to the final consumers.
Business-to-business marketing (B2B) occurs when one
business is marketing its products to other businesses.
The market size is the total number of items sold (this is
measuring volume) or the total value of sales.
Market growth measures the rate at which the market as
a whole is growing over a given time period.
Market share is measured by the sales of a business (or a
particular product) relative to the total market sales. Its
equation is:
sales of a business (or product)
market share = × 100
total market sales
For example, if product A sells $40 000 and the total market
sales are $160 000, the market share of product A is:
$40 000
× 100 = 25%
$160 000
Measuring market share is not always easy. This is because
the data you have on the sales in general may not be easy
to collect; competitors, for example, may not want to
share information. It will certainly take time and, at best,
estimates of the market are likely to be a year or so out of
date. While you will know your sales this month, it may not
be easy to compare this with other firms’ sales accurately;
market share data is therefore most likely to be accurate
when looking backwards. 3.1
STUDY TIP
In some cases you may be asked to calculate the market
share as shown above. In other cases you may be asked
to calculate the size of the market given the market
share. For example:
Product A has sales of $20 000; this represents a market
3.1.3 Markets
share of 40 per cent.
We now calculate 1 per cent of the market. If $20 000 =
40 per cent of the market, we can divide by 40 to get
1 per cent.
$20 000
1 per cent market share = = $500
40
Total sales in the whole market (which is 100 per cent)
will equal $500 × 100 = $50 000.
Market growth measures the rate at which the market as a
whole is growing over a given time period. If, for example,
the growth rate is 2 per cent this year, it means that the
market is 2 per cent bigger than one year before. The
growth may be measured in terms of the growth in sales
volume or value. Its equation is:
this year’s market sales – last
year’s market sales
market growth = × 100
last year’s market sales
For example, if the market sales last year were $200 000 and
are now $220 000, then:
$220 000 – $200 000
market growth = × 100 = 10%
$200 000
If the growth rate is positive, it means the market is getting
bigger. If the growth rate is negative, it means the market
has become smaller.
Similarly, data on market growth is difficult to estimate at
any given moment because of the problems in gathering
data from all outlets and all producers. Again, it is most
likely to be accurate when looking backwards.
A further problem with calculating market share and market
growth is actually defining the market in which a business
operates. What is the market for your local bus company? Is
it bus transport in your area? But how large do you define
the area being considered? Or is it bus transport in the
whole country? Or is it all forms of transport in your area?
It is not always easy to clearly define the market a business
operates within.
99
 CASE STUDY
3.1
Ford
The data below was produced by Ford, the automobile manufacturer, in its 2019 annual report.
▼ Table 3.4 Ford retail sales, industry volume and market share, 2018

Retail sales Industry volume Market share

(in millions of units) (in millions of units) (%)
AS LEVEL 3.1 THE NATURE OF MARKETING

United States 2.5 17.7 14.1

Canada 0.3 2.0 14.7
Mexico 0.1 1.5 4.8
North America 2.9 21.5 13.4
Brazil 0.2 2.6 9.2
Argentina 0.1 0.8 12.1
South America 0.4 4.5 8.3
United Kingdom 0.4 2.8 13.7
Germany 0.3 3.8 7.9
EU21 1.4 19.6 7.2
Russia 0.1 1.8 2.9
Turkey 0.1 0.6 10.9
Europe 1.5 20.9 7.2
Middle East and Africa 0.1 3.8 3.0
China 0.8 26.2 2.9
Australia 0.1 1.2 6.0
India 0.1 4.4 2.2
ASEAN 0.1 1.7 6.6
Asia Pacific 1.1 43.5 2.5
Global N/A 94.2 6.3
Total company 6.0 N/A N/A

Source: https://annualreport.ford.com/Y2019/default.aspx

Questions
1 Calculate the proportion of Ford’s sales in 2018 that were made in North America compared to the total
company sales. [2]
2 Calculate the total size of the market for vehicles in North America in 2018. [3]

STUDY TIP
In some cases you may be asked to calculate growth. In 20
other cases you may be asked to calculate the sales given
× $500 000 = $100 000
100
a certain growth rate. For example:
This means the new sales are $500 000 + $100 000 =
A market had sales of $500 000. This grows by 20 per cent. $600 000.
What are the sales now?
To calculate this you must work out 20 per cent of
$500 000 and add it to the original sales. To calculate 20
per cent you use:

100
Implications of changes in market share
and growth
A change in market share means that a business’ sales
account for a greater proportion of the total sales in the
market in the given period. If the market remains the
same size or is growing then an increasing market share
means higher sales. However, if the market is declining,
the market share could be increasing even if sales are
falling.
When considering market share, it is important to bear in
mind the total market size. A small percentage of the global
confectionery market is still a lot of sales!
The growth of a market shows the rate at which sales are
increasing. In general, businesses might prefer faster
growth to slower growth because it creates more sales
opportunities. However, it is again important to bear in
mind the size of the sales involved. A 1 per cent growth
in the market for laptops is still a large number of sales
because the market is so big, whereas a 10 per cent growth
of a very small local market might only mean additional
sales of a few thousand. In well-established, bigger markets
growth may be slow but the numbers involved can still
be huge.
HANDLING DATA
1 A business sells $20 000 in a market worth $800 000.
Calculate its market share.
2 A business has a market share of 8 per cent in a
market worth $400 000. Calculate its sales.
3 A market was worth $300 000 and increases in size
to $360 000. Calculate the market growth rate.
4 If a market was worth $500 000 but grows by 2 per
cent, calculate the size of the market now.
3.1.4 Consumer and industrial
marketing
STUDY TIP
It is very important when answering marketing questions to
think about the specific market the business operates in. It
is important to adapt your understanding for the particular
market. Selling bars of chocolate may require heavy
advertising, while selling aeroplanes may require a very
experienced sales team. Attractive packaging may help sell
perfume, but it is less significant for selling tractors!
GLOSSARY TERM
A unique selling point (USP) is something about your
product which is perceived by your customers as unique.
Classification of products and how
marketing might differ for different 3.1
types of goods and services
There are many different types of products and these can be
classified as:
» Consumer products, which are items bought by the final
user. These can be subdivided into:
– Convenience items These are usually relatively
cheap items and distribution is the key to marketing
3.1.4 Consumer and industrial marketing
here; for example, newspapers and milk. Customers
will not spend much time searching for them in
different stores; they pick up what is convenient
in the nearest shop. This means producers have to
get them distributed in many different places and
displayed in a way that attracts attention. This
is important because some convenience items are
bought on impulse (for example, chewing gum) when
they are seen in the store.
– Shopping items These are products such as clothes
or electrical goods which are more expensive than
convenience items. When customers go to buy them,
they shop around, comparing prices and features;
they may go and look several times before actually
buying. Customers may go to a retail area where
they can quickly move from one store to another to
compare. The producer has to clearly demonstrate
value for money; for example, by stressing a unique
selling point (USP) to show why its product is
better than the competition’s.
– Specialist products are products that customers
have probably thought about for a long time and
for which they are willing to travel to find the right
item; for example, Rolex watches or Ferrari cars.
Specialist products may be distributed to relatively
few locations, but the nature of the outlet is very
important to the overall brand image. These products
are probably not very price-sensitive because people
want them for their status and their uniqueness.
» Industrial products These are products which are
bought by businesses to use in their production process
to produce the consumer goods. They include:
– Installations These are big items of expenditure,
such as production lines and new office space.
Buyers will take a lot of care over the precise
features of the item, especially any technical
features, because it is a major item of spending.
– Materials These are materials used in the production
process. There may be several possible suppliers, so
buyers will shop around. The quality, reliability and
flexibility of supply will be very important when
buying these products.
– Supplies These are basic items such as paper and
light bulbs; there will be many suppliers and the
buyer will look for good prices.
101
 Types of fewer mistakes? At a lower cost? To win sales, it will be
products important to convince the customer of the business case
3.1 for it. The person buying it will need to justify it to their
managers and investors.
Consumer Industrial
Industrial buyers are usually professionals, and therefore
will be very interested in the technical specifications of
what is being offered and a whole range of issues such as
Convenience Installations the payment terms, delivery times and your reliability as a
supplier.
Often business-to-business marketing will involve a sales
AS LEVEL 3.1 THE NATURE OF MARKETING

Shopping Materials
Specialist Supplies
▲ Figure 3.6 Types of product
Business-to-business marketing versus
business-to-consumer marketing
When one business is targeting other businesses, it
will tend to be dealing with relatively small numbers
of customers. These customers will want to understand
how buying this product will help them in what they
do – will it enable them to do their work faster? With
▼ Table 3.5 Classification of products
force approaching the business customers to explain
the benefits of what they have to offer. The sales team
will usually require specialist technical knowledge and
an understanding of how their product helps the other
business.
Business-to-consumer businesses are dealing with larger
numbers of potential buyers. These buyers will not be
professional buyers (it’s not their full-time job!) and they
may be more interested in the brand, the image of the
product and the emotional benefits they get from buying
it. In B2C marketing, more use is likely to be made of
advertising and other promotional techniques to reach a
wider audience.

Industrial products Consumer products

Buyers Professionals Amateurs!
Number of buyers • Relatively few May be millions if a mass-market product
• Selling to businesses
May focus on • Technical specifications and how it helps their business • Benefits in terms of consumption
do better • May be more influenced, for example, by
• When the product can be supplied and in what quantities look or design or packaging
• What the payment terms are
Promotion Often uses sales force to approach customers May be advertising for mass-market product

» By focusing on a small segment of the market, this may

3.1.5 Mass marketing and niche
marketing
Niche marketing occurs when a firm targets a specific
market segment – that is, a particular group of similar
customer needs and wants. For example, Aston Martin
targets the luxury sports car market and Umbro targets
the football market. By focusing on a niche, a firm can
understand the specific requirements of its customers and
ensure its offering meets these needs precisely. A business
can tailor its marketing approach and avoid wasting time
and money on activities that are not relevant.
Niche marketing is quite common for small businesses. This
is because:
» It focuses on just one segment of the market and therefore
the resources required may be relatively small. This makes
it affordable and feasible for a start-up business.
not be perceived as a threat by larger, established firms.
If a start-up is perceived as a real threat, the established
firms may cut prices or try to influence stores to get
them to stop distributing the product.
However, there are dangers associated with niche
marketing:
» The total number of customers is likely to be quite
low and therefore, if anyone changes their mind
and switches to a different product, this can have a
significant effect on the total demand.
» If the product does prove to be successful then larger
businesses may be attracted by this success and enter
the market. Small businesses may struggle to match the
power and resources of larger firms and so may lose their
share of the market.

102
By comparison, a mass marketing approach targets the needed to generate the necessary demand to make mass
majority of the market. This usually involves high volumes production viable. However, over time, a niche product may
of production and much higher capacity levels than niche
marketing. This may make it unrealistic for a start-up
become more mainstream and therefore niche products may
be moved into the mass market.
3.1
business, especially given the high levels of promotion
▼ Table 3.6 Advantages and disadvantages of niche and mass marketing

Niche marketing Mass marketing

Advantages Disadvantages Advantages Disadvantages

3.1.6 Market segmentation

• Small market segment so marketing
activities can be very targeted
• Small segment of market so larger
firms may not be interested
• Can often charge high price for a
specialised, targeted product which
helps cover cost of provision
Small market so • Large-scale production enables lower
overall returns unit costs; this enables lower prices,
not that high in making the product accessible for
absolute terms customers but at the same time still
profitable for the business
• Large target market means the total
sales and profit in absolute terms
may be high
Products not adjusted
for differences in
customer needs; specific
groups may be targeted
more effectively by niche
producers

There are various ways in which a market may be

GLOSSARY TERMS
Niche marketing occurs when a business focuses on a
particular (usually small) segment of the market.
A market segment exists when there is a group of clearly
identifiable customer needs and wants.
Mass marketing occurs when a business targets the
majority of the market.
STUDY TIP
When studying this topic, you should be aware of the
benefits and problems of a niche-marketing approach.
You should also appreciate the importance of
understanding and monitoring customers’ needs.
To make your business more effective, you have to
understand exactly what your customers want and
provide them with excellent value for money.
3.1.6 Market segmentation
Within any market, different segments may exist. For example,
within the market for newspapers there are some readers who
are most interested in sport, others who want financial news,
and others who want celebrity gossip. Different newspapers
have been developed to target these different groups.
Within the chocolate market, the demand can be segmented
into groups such as:
» snacking – you buy the chocolate and eat it there and
then (for example, a Mars bar)
» sharing – you buy the chocolate and take it home to
share with others (for example, Cadbury’s Heroes)
» gift – you buy the chocolate to give to others (for
example, Thornton’s chocolates).
segmented, including:
» Geographic segmentation This type of segmentation
focuses on aspects of consumers such as the location of
customers or the climate in different regions. Cars sold
to Africa, for example, will have to withstand high levels
of heat; cars sold to Scandinavia will need to cope with
the cold. Cars targeted at people living in cities may
be relatively small so it is easy to get around and park;
people living in the countryside may want more rugged
vehicles to cope with the terrain.
» Demographic segmentation This type of segmentation
focuses on aspects of consumers such as age, gender,
income, occupation, marital status and stage in the
family life cycle. In the toys market, for example, the
type of toys 3 year-olds will play with is very different
from those wanted by 13 year-olds. When you are single,
you may be looking for a city centre, 1-bedroom flat;
when you are married with children you may want a
3-bedroomed house with a garden, near a good school
and out of the city.
» Psychographic segmentation This type of segmentation
focuses on aspects of consumers such as personality,
lifestyle, values, social class and attitudes. Are you
someone who likes belonging to a group? Are you
someone who is very ambitious? Do you want material
things? Do you care how products have been made and
their impact on the environment? These factors might all
influence the way a product is promoted and the actual
design of the product. Some holidays may be designed
for adventurous, outgoing types. Others might target
customers wanting a package holiday in Spain. Your
job and earnings are likely to influence a whole host
of lifestyle factors: the newspaper you read, where you
shop, where you go on holiday, the interests you have
and what you wear.

103

3.1 Geographic
Types of
market
AS LEVEL 3.1 THE NATURE OF MARKETING
segmentation
Demographic Psychographic
▲ Figure 3.7 Types of market segmentation
For a market segment to appeal to a business, it must be:
» measurable, so you can identify it exists and measure
its size to decide on the likely earnings
» accessible, so you have the resources to offer what
would be required and be able to get your products to
the customers
» profitable, so you can meet customer needs and your
own needs at the same time.
Advantages and disadvantages of
market segmentation
By segmenting a market effectively, managers can identify
which segments they want to target. By understanding the
requirements of a particular segment, they can develop
the marketing activities to meet these needs more closely.
Hopefully, this should increase sales and boost brand loyalty.
Effective segmentation should lead to effective marketing,
with businesses providing exactly the right product in the
right place at the right time and price. However, the more
a market is segmented, the more variations there are to the
product and its marketing – imagine producing a different
cleaner for the sink, oven, shower, toilet, floor, door handles,
carpets, work surfaces, windows, walls, and so on. Each
one may meet a very specific need, but co-ordinating and
providing such a range of products may be expensive. If
possible, it would be easier and cheaper to produce an all-
in-one cleaner to cover at least some of these functions. The
firm may well get cheaper inputs if it buys in bulk and can
spread one set of marketing costs over more units.
Businesses may therefore have to trade off the appeal
of segmenting and meeting specific groups of needs
more precisely with the benefits and cost advantages of
producing a limited range of products on a larger scale.
GLOSSARY TERMS
Customer-relationship marketing (CRM) involves gathering
and analysing data about customers to understand their
behaviours and take appropriate actions to move them
towards a purchase.
104
STUDY TIP
Although targeting specific segments may seem
appealing from a marketing perspective, it may make
production more complex as it requires different models
to be produced. Managers must balance the desire to
meet the specific needs of customers with the costs and
challenges this may generate.
3.1.7 Customer-relationship
marketing
Aims of CRM
Customer-relationship marketing (CRM) involves gathering
and analysing data about customers. The aim of CRM is
to understand customers’ behaviour and take appropriate
actions to move them towards a purchase and repeat
purchases. A business will interrogate its data on customers
to understand where in the buying process they are and to
identify actions to make them buy and to retain them.
Customer retention is very important to businesses. It
is a measure of customer loyalty and can be measured by
the proportion of customers who continue to buy from the
business over a period of time. If a business sells a product
to a customer who does not return to buy again then, to keep
sales going, it has to keep finding new customers. This can
be expensive and time-consuming. Ideally, a business will
develop a relationship with a customer and generate ongoing
sales. For example, an online retailer might want to develop
a relationship so that it becomes the ‘go-to’ place for a
customer to buy from; they become loyal to the business. This
loyalty and repeat purchases of a range of products provided
by a business can be built up in various ways, such as:
» by analysing customers’ buying patterns and making
recommendations of what else they may want to buy
» analysing customer behaviour to understand what
incentives to offer customers to gain their loyalty and
repeat purchases.
Costs and benefits of CRM
By holding on to customers and generating repeat
purchases, the business hopes to generate more revenue
from its customers while keeping its marketing costs low.
The benefits of CRM are that it can lead to more sales from
the existing customer base at relatively low cost. The costs
of CRM are the investment required in data systems to
gather tools and staff skills in order to analyse information
on customer enquiries and buying patterns.
Customer retention measures the proportion of customers
who continue to buy from the business over a period of time.
 TEST YOUR LEARNING
Short answer questions
1 Define the term ‘marketing objectives’. [2]
2 a Define the term ‘market segmentation’. [2]
b Explain one benefit of segmenting a market. [3]
3 a Explain one factor that influences the supply of
goods or services in a market. [3]
b Explain one factor that might increase demand
for a product. [3]
4 a Define the term ‘niche market’. [2]
b Explain one possible benefit of operating in a
niche rather than a mass market. [3]
5 a Define the term ‘market share’. [2]
b Explain one possible benefit to a business of
having a high market share. [3]
6 a Define the term ‘market growth’. [2]
b Explain one possible benefit to a business of
selling in a fast-growing market. [3]
7 Explain one difference between a consumer
market and an industrial market. [3]
8 a Define the term ‘business-to-consumer
product’. [2]
b Explain one possible difference between
marketing a business-to-consumer product
and a business-to-business product. [3]
9 a Define the term ‘customer orientation’. [2]
b Explain one possible benefit of being customer-
oriented rather than product-oriented. [3]
10 a Define the term ‘customer-relationship
3.1
marketing (CRM)’. [2]
b Explain one possible benefit to a business of
customer-relationship marketing. [3]
Data response question
The fluctuating price of oil
3.1.7 Customer-relationship marketing
In 2020, US oil prices became negative for the first time in
history. This was due to the greatest fall in demand in
25 years. The result was a surplus of oil and a fall in the
price of oil to almost –$40. This meant producers were
paying buyers to take the oil off them, so they didn’t have
to pay for storage costs and because they had no more
storage capacity.
The fall in demand was due to the negative growth of most
economies during the ‘lockdown’ that was necessary amid
the Coronavirus (COVID-19) pandemic. Supply continued
to increase even as demand collapsed, and this is likely to
cause a fall in petrol prices.
Questions
1 Define the terms:
a ‘market’ [2]
b ‘surplus’. [2]
2 Analyse one way in which a fall in the price of oil
might affect businesses. [4]
3 Evaluate the factors that might affect the price of oil. [12]
105
 3 Marketing
AS LEVEL
3.2 Market research
AS LEVEL 3.2 MARKET RESEARCH
Chapter overview
In this chapter we examine:
★ the purposes of market research
★ the main features of a market: size, growth, competitors
★ aspects of customer and consumer characteristics, profiles, wants and needs
★ the difference between primary and secondary research
★ the reliability of data
★ the meaning and value of sampling
★ analysis of quantitative and qualitative data.
3.2.1 Purposes of market research
Market research involves the gathering and analysis of data
that is relevant to your marketing. The purpose of market
research is to understand more about the customers of a
business and the main features of the market as a whole to help
the business make better marketing decisions. For example, a
business might want to use marketing research to identify the
main features of a market, such as:
» the size of the market. This can be measured in terms
of the number of dollars spent in it (the value of the
market) or the number of items purchased (the volume of
the market)
» the growth of a market. This measures the rate at which
the market has increased (or potentially decreased) in
size. The growth in a market is measured by:
change in market size
market growth = × 100
original market size
For example, if the market size is $200 000 and it
changes to $220 000, the growth is:
($220 000 − $200 000)
market growth = × 100 = 10%
$200 000
Usually the growth of a market will be measured over
a year; for example, 10 per cent growth this year. If a
market is growing fast, this means that demand is there
and may create more opportunities for sales to increase
» competitors. Research will give the business an insight
into how many competitors there are in a market and
what their sales are. A business can identify its own
market share and the market share of its competitors.
The market share of a business is measured by its sales
as a percentage of total sales.
sales by the business
market share of a business = × 100
total market sales
106
For example, if the sales of a competitor are $40 000 and
the total market sales are $160 000, its market share is:
$40 000
market share of a business = × 100 = 25%
$160 000
A business will be interested in the relative size of these
competitors because this might reflect their strength
and the threat they might create. In some markets there
may be relatively few competitors – usually this is true in
the banking and telecommunications industry. In other
industries there may be many competitors; for example, this
is usually the case with hairdressers and cafés.
Market research will also allow a business to identify how it
is positioned relative to its competitors; for example, is it
regarded as better value for money? Is it seen as a premium
product or more basic than its rivals? This might affect
some of the marketing actions the business then takes.
As well as understanding the market as a whole, managers
can also use market research to identify different aspects
of customers and consumers, such as their characteristics,
profiles, wants and needs. A customer is someone who
purchases and pays for a product or service. A consumer
is the person who ultimately uses the product or service.
If you buy and drink a cup of coffee, you are the customer
and consumer. If your parents buy you a present for your
birthday, they are the customer and you are the consumer.
Businesses need to consider both their customers and
consumers when deciding on how best to market their
products.
Characteristics of consumers and customers might include
aspects such as their age, gender, income, where they are
located and their lifestyle. This might allow the business
to identify patterns within its customers and adjust its
marketing accordingly. A customer profile is an outline
of the customer base of the business – it outlines the
characteristics of the customers.
Customer and consumer needs refer to what people must
have to survive, such as water and food. Customer wants
refer to what people desire but are not essential, such as a
particular type or brand of food. Market research can identify
the fundamental need to buy the product (for example,
because customers are thirsty or hungry) and customer wants
(which shows which product they would like to buy). Having
identified customers’ need, a business will aim to make them
want its products as opposed to those of a competitor.
Market research provides a manager with information which
is important for effective decision-making. Imagine you
are wandering around a house at midnight and none of the
lights are working. You stumble, move slowly and make
mistakes getting around. Market research can provide the
lighting in the room that enables you to move quickly,
efficiently and effectively, to get to where you want. Market
research can provide the light you need in order to view the
whole situation.
By undertaking market research, managers should have
a better idea of what people want and how they behave.
This should mean that the firm can meet their needs more
effectively and avoid wasteful marketing activities. Imagine
that you are considering launching a new product. If you
can find out who your target market is, what they like,
what they read, where they shop, what they watch and
listen to, then your marketing can be much more effective.
For example, there is no point in spending money on a
big Saturday afternoon television campaign if your target
audience is out watching a sports match.
Market research may be undertaken before the business is
set up in order to decide whether or not it is viable. It can
also be undertaken once the business is up and running to
decide what to do next; for example, whether to change the
price of a product or launch a new brand.
Assesses the
Identifies effectiveness
market of different
opportunities marketing
actions
Market
research
Assesses the
alternative
options open to
the business to
meet customer
needs
▲ Figure 3.8 Uses of market research
Typically, market research is used to:
» identify features of a market such as its size,
the segments that exist, its growth and what
competitors exist
» identify features of the customers and consumers in
the market. This means identifying customer needs
and wants, and the profiles of different customer
segments.
3.2
Having undertaken this analysis, businesses can use their
market research findings to:
» assess the alternative options open to the business to
meet customer needs
» assess the effectiveness of different marketing actions.
3.2.2 Primary research and secondary research
GLOSSARY TERMS
Market research is the process of gathering, analysing
and producing data relevant to the marketing process.
Primary market research gathers data for the first time
for a specific purpose.
STUDY TIP
Simply gathering data for the sake of it does not make
much sense, so managers need to be clear about why it
is being gathered, how accurate it has to be, what time
there is to gather it in, what the best way of gathering it is
and what costs are involved.
3.2.2 Primary research and
secondary research
Primary market research
In some cases, you may have to gather new data for a
specific purpose. This is called primary market research.
For example, you may want to discover what people in your
local area think of your specific idea, whether they are
likely to use your particular service or what they think of
your business name. This sort of information will not exist
already, so you will need to undertake new research.
Primary research can be tailored precisely to your own
needs, but it can be quite expensive and time-consuming
compared with using information already collected. The
danger is that because of cost constraints, or because you
are inexperienced, you only ask a relatively small number of
people or a specific group that does not really represent the
population as a whole. This means that your results may be
biased and misleading. If you ask your friends, for example,
they may tell you it is a great idea even if it isn’t, because
they do not want to upset you!
If you are going to undertake primary research, you need to
make sure that you:
» don’t lead people into giving you the answer you want
(for example, ‘Why do you think my idea is so good?’ is a
leading question)
» ask a representative group of people (that is, that you
hope will represent your target group)
107
 » ask enough people for the findings to be significant (one
person’s opinion may not necessarily reflect the views of
3.2 the population as a whole).
Primary data can be gathered:
» by observation. For example, you may watch what is
happening in the stores of your possible competitors
or count how many people walk by a potential location
for your shop on a typical day to calculate the
‘footfall’. In high-street retailing, the footfall is an
important indicator of the likely number of customers.
AS LEVEL 3.2 MARKET RESEARCH
The more people that walk past, the more customers
you may get
» through surveys. You may have been stopped in the
street and asked your opinion about something. This is
a face-to-face survey and is one way of finding out what
people think. Firms also use telephone, mail or online
surveys to find out the views of potential customers.
CASE STUDY
Africa
Africa is one of the biggest emerging markets in the
world. This rapidly expanding, competitive environment
creates a growing need for market research. Consumers
are the lifeblood of companies, but do companies actually
possess sufficient knowledge about their consumers? Are
their customers (perfectly) satisfied with their products/
services? What are their opinions and wishes? How could
their loyalty be improved? These are important questions
for organisations and investors operating in Africa. Africa
represents a major market opportunity with a growing
population, a growing middle class and relatively fast
economic growth.
The potential
Africa will be the fastest-growing economy in the world in
the next five years. For example, Uganda has an economic
growth of 6.41 per cent per year, yet only 1 per cent of the
total global market research budget is invested in Africa.
The basic survivors (people living on or below one dollar
a day) is a huge group in African countries (in Uganda,
for example, this group is 65 per cent of the population).
Given the fact that Africa is the fastest-growing economy
in the world, the basic survivors move towards a regular
middle class, with comparable incomes and Western
consumer behaviour. This means there is a huge potential
for doing business, but there is still an unused investment
opportunity in African countries.
Companies that find new ways to overcome constraints
and tap opportunities can gain insights, market share
108
Surveys may give you an idea of what people think of your
idea and help you decide whether or not to go ahead
» by asking a small group of people what they think
(a focus group)
» by test marketing. Sometimes a business may try a
product in a test market, such as a particular region, for
a while to see how it sells. If this goes well it might be
rolled out to other areas; if sales are poor, changes could
be made to the product or the way it is promoted to see
what happens then.
GLOSSARY TERMS
A focus group is a small number of people gathered
together to talk about a particular issue in open
discussion.
Secondary market research uses data that already exists.
and customer or supplier loyalty, and will secure a strong
position in this growing market.
Effective market research methods in
developing countries
More than 500 million Africans use a mobile phone
and the market is growing fast each year. Mobiles
have penetrated to even those villages that have no
electricity and no landlines. The rapid and accelerating
penetration of mobile phones through all levels of
society in developing countries means that it is possible
to communicate with the basic survivors and emerging
middle classes. This underlines the massive potential
to use mobile phones in order to reach and interact with
huge groups of people across the continent. The explosive
growth of Africa’s mobile communications industry offers
a vast potential to interact with people on a personal level.
Market research is conducted by inviting people to
participate in surveys and rewarding them with incentives
such as mobile phone credits. The mobile phone is
particularly well-suited to market research as it is cost-
effective, reliable and enables clients to obtain results
virtually in real time. Furthermore, it allows consumers
to participate in surveys when and where it suits them.
These advantages have a positive impact on response
rates, data quality and validity of results.
Source: www.mckinsey.com
 3.2
1 2 3 4 5
Basic Survivors Working Families Rising Strivers Cosmopolitan The Affluent
Professionals

Basic Survivors are the Working Families are Rising Strivers are Cosmopolitan The Affluent of Africa
largest consumer the second largest emerging from the Professionals are have a disproportionately
group in Africa and are consumer group. They first two segments, typically located in high purchasing power,
characteristically low focus their spending having built their urban areas. They are and are considered
income consumers. on their children’s purchasing power busy with work but wealthy regardless of
They tend to live in needs and they value through access to often have active where they travel

3.2.2 Primary research and secondary research

urban slum areas or stability and routine credit or other social lives. As a result, across the globe. This
rural areas and make in their lives. resources. They value these consumers group is extremely
day-to-day decisions upward mobility and value pragmatic small and very fickle.
based on basic needs. buy based on products but are also
convenience, quality, brand conscious and
or even more influenced by the
‘expressive’ factors. media.

▲ Figure 3.9 Five key sub-Saharan African consumer segments

Questions
1 Analyse one benefit of using the mobile phone to 2 Evaluate the potential benefits of using market
undertake market research. [4] research for businesses targeting Africa. [12]

general information on the economy, the market and on

Secondary market research
Given that the amount of money you have available to
spend when starting up a business is likely to be limited,
you will probably have to carry out most of your market
research yourself rather than using specialist companies
to do it for you. The cheapest and quickest way of doing
this is to see what information about the market already
exists. What data has been collected and published? A
tremendous amount of information is available on the
internet, in libraries and in newspapers, as well as from
other sources. Using data that already exists is called
secondary market research. It is particularly useful for
competitors.
While secondary data is usually quite quick to get hold of,
it is not always in the right format for your needs, or up to
date. The research may have been done in the previous year,
when what you want is this year’s figure. It may organise
sales data according to the sales per country, when what
you need is data focusing on a particular city. Nevertheless,
secondary research is usually a good starting point. Once
you have looked at secondary sources, you can identify what
else you need to know and what information needs to be
gathered for the first time.

CASE STUDY
Coca-Cola
Sparkling soft drinks
NARTD 4.3%
Hot beverages

Packaged food 4.0%

$1.6 Juice, dairy

trillion and plant Household products 3.5%

0 1% 2% 3% 4% 5%
Note: NARTD = non-alcoholic ready to drink. Industry growth
RTD tea/coffee Hydration for NARTD excludes white milk and bulk water

Energy ▲ Figure 3.11 Industry retail-value growth

NRTD cold

Note: RTD = ready to drink; NRTD = not ready to drink

▲ Figure 3.10 Hot and cold beverages industry retail value

109
 According to Coca-Cola, there are significant long-term 3.2.3 Sampling
3.2 growth opportunities both for the soft-drinks industry
and for Coca-Cola. Coca-Cola has a 20 per cent market The need for and limitations of
share of cold non-alcoholic beverages, with a very small
market share in hot non-alcoholic beverages. sampling
If you decide to undertake a survey, the total number
In the developing and emerging world, only about 30 per
of people you are interested in is known as your ‘target
cent of beverage consumption is commercialised, and
population’. For example, if you have an idea for a website
Coca-Cola’s market share within these regions is about
half of what it is in the developed world. The developing
dedicated to your favourite football team, your target
and emerging world represents 80 per cent of the population would be all the fans of the club around the
AS LEVEL 3.2 MARKET RESEARCH

world’s population; over 6 billion people. world. In most cases it will not be possible to interview all of
the people in your target group. It may be too expensive or
Therefore, Coca-Cola believes there is compelling would simply take too long to talk to everyone. Imagine your
long-term growth potential across the world through website was aimed at the fans of a big club like Manchester
growing the overall industry and continuing to gain United FC or FC Barcelona. There are hundreds of thousands
share. of fans all over the world. Even if you managed to identify
▼ Table 3.7 Hot and cold beverages: developed and them somehow, the cost and time involved in trying to talk
developing/emerging markets to them would make it unrealistic, especially if you are a new
business and therefore likely to have limited funds.
Developed Developing and
markets emerging Instead of interviewing everyone in the target population,
(% sales markets (% sales the business might decide to take a sample. A sample is a
volume) volume) group of people that is intended to represent the overall
population. By interviewing, say, 500 fans you would hope
Non-commercial 30 69 to get an impression of what all the others think.
Alcohol 11 3
Obviously, the results will not be 100 per cent reliable,
Hot beverages 12 11 because you have not asked everyone in the population –
Cold beverages 47 17 you have only asked some of them. This means that you
cannot be totally confident of the results. So it is important
Population 1.5 billion 6.1 billion to choose a sample that is big enough to be representative
of the whole market. The findings from a sample that is too
Source: https://coca-cola.com
small may not be very reliable.
Question
1 Evaluate the significance of the data in the case STUDY TIP
study, in Figures 3.10 and 3.11, and in Table 3.7, for
When deciding on the size and type of sample, you need
Coca-Cola’s marketing. [12]
to think about issues such as the time available, the costs
and how accurate the data needs to be.

HANDLING DATA
Sampling methods
1 Following market research, Nick estimates the There are three main ways of selecting a sample:
market as a whole is worth $1 500 000. He believes » Random sample With a random sample, all the
his company can achieve a market share of 50 per members of the target population have an equal chance
cent. What would his sales value be? of selection. If you wanted a random sample of 30
2 Nick also thinks the market will grow by 5 per cent students at your school, you could take a list of names
next year, but he can retain the same market share. of all the students and then pick 30 names at random.
What would his sales value be then? You would then have to find them to interview. This
approach has the advantage that anyone could be
▼ Table 3.8 Primary and secondary research asked. However, it can be quite time-consuming,
because once the names have been selected you then
Primary Secondary have to go and find those people. If they were not in
• New data • Existing data school on that day, you would have to wait until they
• Specific to your needs • Gathered for another were, slowing up the whole process.
• May take longer to gather purpose » Stratified sample A stratified sample is based on
• May be expensive • May be relatively quick
particular proportions (such as 60 per cent males, 40
• May be relatively cheap
per cent females; or 20 per cent aged 16–35 and 80 per
cent aged over 35). This type of sample is used when

110
 the target population has particular characteristics that
you want reflected in your sample. You reproduce the
characteristics of the target population and randomly
sample within each category.
» Quota sample With a quota sample, the research sets
proportions (for example, male/female or different
age groups) which may or may not reflect the target
population. People who meet these characteristics are
found as quickly and easily as possible, which means
that a quota is not a random sample. For example,
if you want to interview 12 students (5 male and 7
female) you simply approach people and see if they
match these criteria and work with the first five male
students and first seven female students who agree to
take part.
A quota sample is easier and quicker to complete than
a random sample (as you do not need to know all the
members of the population), but it is not random
because members of the population do not have an equal
chance of selection. To find 30 students, for example,
you might simply find one class and ask them. This could
lead to very biased results because they would all be a
similar age and/or may all study the same subject. With
a random sample you would expect a range of ages and
interests, which might provide a better insight into the
school as a whole.
Types of sample
Random Stratified Quota
▲ Figure 3.12 Types of sample
Choosing a sampling method
The choice of sampling method will depend on factors such as:
» the time available. If time is limited, a quota is likely to
be used because it is relatively quick to do
» your knowledge of the target population. To select
people randomly you must have details of the target
population. If you were selecting from a list of
cardholders or club members this would be feasible.
However, if you were interested in potential buyers of
your product, you would not necessarily know who they
were and so could not select from this group randomly
» the extent to which the target population has clearly
differentiated groups of buyers. If the buyers can be
differentiated clearly (for example, 70 per cent male,
30 per cent female) then you would want to use a
stratified sample.
3.2.4 Market research data
Quantitative and qualitative market
research
Quantitative and qualitative market research are two
different approaches to market research.
Qualitative research is based on the opinions, values and
beliefs of people. It is usually undertaken using a small
focus group or in-depth one-to-one interviews. This type
of market research aims to understand why customers
3.2
behave in certain ways, or to find out what people think of
a product or what they would do in a particular situation.
Qualitative research examines why customers do what they
do. For example, a focus group might be used to discuss
consumers’ views of a brand to understand their shopping
habits. This often helps marketing managers understand
what customers think of their product compared to another,
3.2.4 Market research data
and can be a starting point in the research process. Focus
groups may highlight particular issues or give a reaction
to a business idea that can be examined in more detail.
Given that qualitative research involves small groups, it
means that the findings are not statistically reliable; this
is why more extensive research is often used as a follow
up. Qualitative research can be quite expensive and slow to
organise because it is so important to get the right group of
people to talk to.
Quantitative market research is based on relatively large
samples and is therefore more statistically valid. This sort
of research is often used to show what has happened in
a market, and its findings can be expressed in numerical
terms (for example, sales of brand X have increased by 45
per cent; 12 million people watched a particular television
programme last week; the market for soft drinks is worth
more than $4 billion). Quantitative market research is used
to answer questions such as: how many units might be
sold? When are items most likely to sell? Where? What has
happened? Quantitative research is usually gathered via
surveys such as telephone, face-to-face or email.
Analysing market research results
When analysing the market research results a business needs
to consider:
» Can the results be trusted to be relatively accurate? In
other words, is the research valid?
» Would the research give the same results if it were
repeated? In other words, is the research reliable?
GLOSSARY TERMS
A sample is a group of people selected to represent the
population as a whole.
The validity of market research refers to how accurate
the findings of market research are.
The reliability of market research refers to the extent to
which the same results would be received if the research
was conducted again.
The accuracy may depend on factors such as how the
information was gathered, what the sample size was and
how accurate you want the findings to be. Researchers often
express their findings in terms of confidence levels based
on a statistical analysis of the data. For example, they
might say they were 95 per cent confident that sales would
111
 be between $20 million and $26 million in two years’ time
but only 68 per cent confident they would be between $23
3.2 and $25 million. The more precise you want the estimate to
be, the less confident the researchers are likely to be. The
confidence level of market research findings relates to how
reliable the data is.
Interpreting marketing data
Marketing data may be presented in many forms, often
tables, charts and graphs. For example, a pie chart may be
AS LEVEL 3.2 MARKET RESEARCH
When examining line graphs, you may want to consider the
trend and how much sales fluctuate around this trend, as this
will affect how much capacity is required and is being used.
Do check the axes when looking at data. Figure 3.15 and
Figure 3.16 show the same sales figures but, by changing the
y-axis, the sales look as if they are rising more sharply in the
second figure.
Sales ($)
120

used to illustrate market share:

100
Sales (%)
80
Product E: 1, 4% 60
Product D: 2, 8%
40

20

0
Product C: 4, 2017 2018 2019 2020 2021 2022 2023 2024
16%
Product A: ▲ Figure 3.15 Line graph – shallow y-axis
13, 52%
Product B: 5,
20% Sales ($m)
110

100

90
Product A Product B Product C Product D Product E
80
▲ Figure 3.13 Example of a pie chart
70
In this pie chart we can see the sales of each product and
what proportion of the total market sales this represents 60
(that is, its market share). 50
2017 2018 2019 2020 2021 2022 2023 2024
Sales data over time is often shown using a line graph:
▲ Figure 3.16 Line graph – steep y-axis
Sales ($m)
60 Data may also be presented using a bar chart; for example,
the sales of a business in different regions or the sales of
50 competitors.
40
Sales ($’000s)
30 45
40
20
35
10 30
25
0 20
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
15
▲ Figure 3.14 Example of a line graph 10
In Figure 3.14, we can see there is an upward trend in sales. 5
Sometimes marketing managers want to plot the underlying 0
Competitor A Competitor B Competitor C Competitor D
trend to ‘smooth out’ the data. They do this using moving
averages (this is explained in Chapter 8.1). We have assumed ▲ Figure 3.17 Example of a bar chart
this data was produced in 2022. The sales from 2023
onwards are, therefore, forecasts; this is often shown with a Some data may also be in the form of tables. For example,
dotted line. Table 3.9 shows forecasted sales volume and sales value
data for a product.

112
▼ Table 3.9 Example of a table showing index values » The sales value in 2022 is 5 per cent more than 2021.
» The sales value in 2023 is 10 per cent more than 2021.
Year
Index of sales
volume (units)
Index of sales
value ($)
»
»
The sales value in 2025 is 15 per cent less than 2021.
The sales value in 2026 is 10 per cent more than 2021.
3.2
2021 100 100
Notice that in this example the sales volume by 2026 is 10
2022 102 105 per cent less than in 2021 and yet the sales value is 10 per
2023 105 110 cent more; this must be because the price of the product
has increased.
2024 110 120
2025 95 115 Using marketing data

3.2.4 Market research data

2026 90
Tables often show data as index numbers. An index number
shows percentage changes relative to a starting or base point.
In the table above, the base is 2021 and changes in sales
volumes and values are shown compared to that. For example:
» The sales volume in 2022 is 2 per cent more than 2021.
» The sales volume in 2023 is 5 per cent more than 2021.
» The sales volume in 2025 is 5 per cent less than 2021.
» The sales volume in 2026 is 10 per cent less than 2021.
Notice we can easily see the change in the sales volume;
we do not know what the actual level of sales is, only the
percentage change. Similarly with sales value:
110 When examining any marketing research data, in whatever
form it is produced:
» check the source. Has this been produced internally or
by a specialist market research agency, for example? You
will want to take a view on the reliability of the data
» check the dates. How recent is the data? Markets can
change quickly so be wary of old data. At the same time,
if you are considering forecasts, you need to find out
how it is gathered and how reliable it is likely to be
» check the units. Be sure to check whether you are
measuring in thousands or millions of dollars, for
example. Also check the labelling of the axes – are you
measuring sales or profits, for example?

CASE STUDY
Esports
2000
1790
1750

1500
Revenue in US$ millions

1250
1096
1000
865
750 655
493
500
325
250 194
130
0
2012 2014 2015 2016 2017 2018 2019 2022
▲ Figure 3.18 Esports market revenue worldwide, 2012–2022

Esports, or competitive video gaming, has existed for Source: www.mckinsey.com/industries/technology-

over 20 years. Sponsors like Intel and Red Bull have been media-and-telecommunications/our-insights/the-keys-
hosting events for more than 10 years. However, in the to-esports-marketing-dont-get-ganked
last couple of years there has been a significant increase
Questions
in interest in esports by major brands. Companies such as
Coca-Cola and Mercedes have brought spending on their 1 Calculate the percentage growth in esports market
esports sponsorship into their main marketing budget. revenue between 2012 and 2018. [3]
2 Explain one factor that might determine the demand
One of the appeals of esports is the reach it has with for esports. [3]
young men and the high levels of engagement. In the USA, 3 Evaluate the appeal of sponsoring an esports event
in 2020, it is estimated that there were 21 million esports to a business. [12]
fans; 83 per cent were male and 84 per cent under the
age of 35. It is now the third most-popular spectator sport
for young men.

113
 TEST YOUR LEARNING
3.2
Short answer questions
1 a Define the term ‘market research’. [2]
b Explain one reason for undertaking market
research. [3]
2 a Define the term ‘secondary market research’. [2]
b Explain one advantage of secondary research
compared to primary research. [3]
AS LEVEL 3.2 MARKET RESEARCH
3 a Define the term ‘primary market research’. [2]
b Explain one advantage of primary research
compared to secondary research. [3]
4 Define the term ‘sample’. [2]
5 Explain one reason why a business may use
sampling when undertaking market research. [3]
6 Explain one feature of effective market research. [3]
7 Explain one source of information for secondary
market research. [3]
8 Explain one limitation of sampling. [3]
9 Explain one factor that might influence how much is
spent on market research. [3]
10 Explain one reason why spending more on market
research may not lead to higher sales. [3]
Data response question
Burberry and luxury brands
Consumers around the globe have high expectations of
luxury brands. They widely research products before
purchasing and expect exceptional service in-store. The
strong interest in forward-looking fashions and innovative
products is partly driven by the younger customers now
entering the luxury market.
Consumers are increasingly using luxury products
to say something about themselves, to express their
individuality, their own style or point of view. This means
luxury products increasingly have to be fashionable and
are often sold in limited-edition ranges. The fastest-
growing segments of the luxury market are young
consumers and Chinese consumers, and they expect to
buy an increasing number of products they would describe
as ‘fashionable’.
The market for clothing and accessories is increasingly
polarising between the mass market and luxury products.
Consumers are increasingly preferring products that are
positioned either at the highest or the lowest end of the
market rather than mid-market. A huge amount of the
114
growth in the luxury market is driven by generation Z and
millennial consumers*. Generation Z consumers are more
willing to shop in a physical store – although they also
expect an online presence. They prefer heavily logoed
products and are not especially brand loyal. Younger
consumers are highly socially and environmentally aware.
Concern about sustainability and a brand’s social or
political stance is a key factor in their purchasing decision
process.
Findings from market research about the luxury market
include:
● market growth has varied by region. China has
continued to have very fast growth and is attractive
to businesses due to its market size. There are more
buyers in China due to fewer restrictions on importing
products, more restrictions on buying abroad and
more tax-free shops. Spending across the rest of Asia
has been strong in recent years, with Hong Kong,
Macau and Japan benefiting from travelling Chinese
consumers due to the relative strengthening of the
Chinese yuan and strong local consumption in Korea.
Sales in the Middle East have remained relatively flat
due to low oil prices and lower government spending
in the economy
● online sales of luxury brands have been rising fast,
especially in Asia
● in luxury accessories, the handbag category has done
especially well recently
● growth in shoes has been highest in the trainers
segment
● growth estimates for the luxury market over the next
five years remain in line with 2019 estimates, ranging
from 3 per cent to 5 per cent per year.
* Generation Z refers to people born between 1997 and
the early 2010s. Millennials are people born between
1981 and 1996.
Questions
1 Define the terms:
a ‘market size’ [2]
b ‘market growth’. [2]
2 Analyse one way in which Burberry might research
the market for its new products. [4]
3 Evaluate how market research can help the
success of Burberry’s new products. [12]
3 Marketing
AS LEVEL
3.3 The marketing mix
Chapter overview
In this chapter we examine:
★ the elements of the marketing mix (the four Ps)
★ the importance of the product in the marketing mix
★ product portfolio analysis
★ pricing methods
★ promotion methods
★ place (channels of distribution).
A customer is influenced by many factors when deciding
whether or not to purchase a product. The combination of
these factors is known as the marketing mix. By developing
an effective marketing mix, a business can meet the needs
of its customers successfully. In this chapter we examine
the different elements of the marketing mix.
GLOSSARY TERM
The marketing mix is the combination of elements that
influence a customer’s decision on whether or not to buy
a product.
3.3.1 Elements of the marketing
mix
The marketing mix comprises all the elements associated
with a product that affect whether or not the customer
decides to buy it. A broad range of factors may affect
customers’ purchasing decisions.
Consider why a customer might choose to shop in one
supermarket rather than another. The list below contains a
number of factors affecting this decision.
» How far away is it?
» How easy is it to park?
» What is the range of products like?
» Are the prices competitive?
» What facilities are there (for example, a coffee shop)?
» Are the staff friendly and helpful?
» What services are provided (such as carrying shopping to
customers’ cars)?
» Does the supermarket offer a loyalty card?
There are clearly many factors that influence a consumer’s
decision to choose one business rather than another,
and these are all part of the marketing mix. An effective
marketing mix offers the customer the right mix of benefits
at the right price. Improving the mix will involve changing
3.3.1 Elements of the marketing mix
or enhancing the combination of elements that affect the
customer’s buying decision.
Place
Price
(distribution)
The marketing
mix
Product Promotion
▲ Figure 3.19 The marketing mix is commonly described as
the four Ps
The marketing mix is often simplified and is commonly
described as ‘the four Ps’. This approach identifies four
elements in the mix (all beginning with the letter ‘P’):
» Price How much are customers charged for the product
and what are the terms of payment? For example, can
you put a deposit down and pay in instalments? How
does this price compare with that of rivals?
» Product This includes the many different aspects of a
product such as its design, quality, reliability, features
and functions. For example, you may buy something
principally because of its style (for example, Bang &
Olufsen, Apple), its features, its reliability and durability
(for example, JCB, Caterpillar) or the brand (for example,
DKNY, Gucci).
» Place This refers to the way the product is distributed.
Is the product sold direct to the customer or through
retail outlets? Can you buy online, or do you have to
travel some distance to get to a shop where it is sold?
115
 » Promotion This is the way the firm communicates
information about the product to the customer. For
3.3 example, it may use advertising or a sales force to highlight
its strengths. The promotion of a product will affect the
image that customers have of it and their awareness and
understanding of the benefits of the product.
However, the marketing mix can be extended to also feature
other factors, such as a further three Ps:
» People A well-trained, well-informed, polite staff can
influence people to buy from one shop rather than another.
AS LEVEL 3.3 THE MARKETING MIX
Customer service is an important marketing weapon.
» Physical environment This includes factors such as the
layout, decor and parking, and can be an important influence
on which restaurant, pub or store a person chooses.
» Process The ease of ordering and paying can influence
a purchase. Many supermarkets have introduced self-
scanning to reduce queues and attract customers.
3.3.2 Products
The difference between goods and
services
Products refer to goods which are tangible products;
services are intangible. Businesses will keep reviewing
their products to ensure they are relevant and continue
to meet customer needs. When reviewing their products,
businesses will consider the core benefit that the product
provides. For example, a soft drink satisfies thirst, a washing
machine provides clean clothes and an aircraft moves people
and cargo from A to B. Businesses have to be aware of new
substitutes coming along – with more social communication
systems such as Zoom, Skype and FaceTime, people may not
need to travel as much. With more emailing there may be
reduced need for letter-writing paper. The ways of providing a
core benefit can change and businesses must be aware of this
and prepare accordingly.
Tangible and intangible attributes of
products
The tangible attributes of products refer to the physical
aspects of a product. In the case of a washing machine, for
example, the business would consider what size, features,
capacity and types of wash were needed and what energy
usage it had. The features customers require would vary – in
the case of a washing machine, some people live in tower
blocks and use industrial-size washing machines in the
basement areas. In other cities people have apartments
with smaller washing machines inside. In some countries
people have a utility room with lots of space, and the
washing machine is a ‘top loader’ where people put the
washing in from the top. In other regions the workspace
on the top is needed and so washing machines are ‘front
loaders’. Products must be developed according to how
people are likely to use them. These attributes of a product
include the specifications, features and design of the
product.
116
Intangible aspects of the product refer to aspects that
cannot be touched but can still be important to customers,
such as the brand and its key values. It also includes
aspects of the product such as a guarantee, after-sales
servicing or additional technical support which come with
the purchase. Some people stick with their phone service
or energy company because they trust them to fix things
quickly if ever there is a problem. Some businesses buy
their photocopiers or computers from companies that can
maintain them effectively.
GLOSSARY TERMS
The products of a business refer to what it offers to sell
to its customers. These may be goods, which are tangible
items, or services, which are intangible.
The tangible attributes of a product refer to its physical
aspects, such as how it looks and feels.
The intangible aspects of a product refer to aspects that
cannot be touched but can still be important to customers,
such as the brand and its key values.
Product differentiation occurs when the benefits of
your product are perceived as clearly different from
competitors’ products.
The importance of product development
Developing new products is essential to most businesses.
This is because:
» customers’ tastes change and so a business must change
what it offers as well; for example, customers generally
want less sugar in their food products than in the past
» competitors will constantly be developing their
offerings, so a business needs to innovate to keep up
and remain competitive
» developments in technology will create new
opportunities for products (and indeed can create whole
new markets) which businesses will want to make use of
» new laws and regulations change what can be produced;
for example, diesel cars may be banned in the future.
Of course, some products seem to have been around for
many years – such as Kellogg’s Cornflakes – but even
here there will be some developments relating to the
ingredients, recipe, packaging, size of the boxes and
communications about the benefits of the product. At the
same time Kellogg’s will be developing other products to
meet emerging customer needs.
Product differentiation and unique
selling point
One possible approach of marketing is to differentiate the
products that the business sells relative to its competitors.
Product differentiation occurs when the benefits of your
product are perceived as clearly different from competitors’
products. Your product may be perceived as easier, safer,
better designed or trendier, for example. This differentiation
can be achieved by having a unique selling point (USP); this
is something about your product which is perceived by your
customers as unique. For example, you might be selling the
only water from Lake X or the best performing car according
to a recent survey. By promoting its USP, a business can
differentiate its offering and may be able to charge more or
offer better value for money.
3.3.3 Product portfolio analysis
Product life cycle
The product life cycle traces the stages of a product over
its life. The typical path for a product can be divided into
five stages, as in Figure 3.20.
Sales
Launch
Time
Research
and Introduction Growth Maturity Decline
development
▲ Figure 3.20 The product life cycle
GLOSSARY TERMS
Product portfolio analysis occurs when a business
examines the position of all of its products in terms of
their relative market share and market growth.
The product life cycle shows the stages of a product over
its lifetime.
1 The research and development stage
During this stage, the basic idea for the product is
developed and tested. Mock-ups of a design may be made,
models of a product may be produced or a new recipe may
be taste-tested. This stage can be expensive for a firm
and no revenue is being generated during this period. This
is a time of high risk because the product may never be
developed successfully and the investment at this stage
may not be recovered. For example, it took James Dyson 15
years and more than 5000 prototypes of the Dyson vacuum
cleaner before he got it right, highlighting the time and
money that can be used up in the development phase.
The length of the research and development process
will vary from product to product. In the case of new
pharmaceuticals, it can take 12–15 years to develop and test
products before they can be launched, whereas developing
a new design for a greetings card is likely to take months
rather than years. Some products, such as newspapers, are
modified on a daily basis (although significant changes,
such as the size of the paper or whether to switch to colour,
are far less frequent).
2 The introduction (launch) stage
3.3
This is the stage at which the product or service is launched
and put on sale. Many product ideas will never actually
reach this stage. They are abandoned after prototypes have
been produced and tested. In the launch phase, promotion
costs will be relatively high to make potential customers
aware of the product, therefore a loss is still likely to be
3.3.3 Product portfolio analysis
made. Producers may also struggle to get firms to stock
their products or customers to try their service at this
stage if the business is new, with no proven track record.
Buyers may be reluctant to risk switching to or trialling a
new product, particularly if there are heavy costs involved
in doing so. For example, if there is a penalty payment
for switching from one credit card, mortgage company,
electricity company or gas company to another, customers
are more likely to remain with their existing providers.
3 The growth stage
If the product becomes known and accepted by customers,
sales should grow. At this stage, it should be slightly easier
to get distributors to stock the products, as they will be
more confident of sales and therefore willing to stock
them. The firm should begin to make profits at this stage,
as revenues begin to outweigh costs. For example, sales
of teeth-whitening formulas, smoothies, men’s cosmetics
and laser eye-surgery are at their growth stage in several
countries. At this stage, you need to make sure you can meet
the demand and manage the growth process. You may be
taking on more staff, buying more equipment and expanding
your premises; if this is happening rapidly it can be difficult
to keep control. Making sure you can meet deadlines and
maintaining quality can be major problems at this time.
Of course, some products never reach the growth stage:
they are launched but are never successful and sales fail to
take off.
4 The maturity and saturation stage
At this point in a product’s life, the growth of sales slows
down. The product may have been in the market for some
time and competitors may have launched similar products.
Products such as washing machines and televisions are
currently in their maturity stage. The maturity stage can
last for years in some cases. There is no rapid expansion and
managers must consider what to do next with the product;
for example, should funds be invested to try to boost sales
or should the product be scrapped?
5 Decline
Eventually, the sales of any product are likely to fall. The
business may find it more difficult to get the product
distributed at this stage and may be forced to cut the price
to maintain sales. For example, you will have seen reduced-
price CDs or books in the bargain areas of shops: the price has
been reduced to try to increase sales. Products such as board
games, road atlases and bow ties are in their decline stages.
117

STUDY TIP
3.3 Remember that the shape of the product life cycle will
vary from one product to the next. In some cases, a
product may sell well for relatively few weeks or months
and then fade; for example, a successful film. Other
products may sell well for years, such as a popular book.
Products may be at different stages in different regions.
Using the product life cycle
AS LEVEL 3.3 THE MARKETING MIX
Managers may use the product life cycle model to identify
which stage a product is in at any given moment and
CASE STUDY
Dyson
Dyson is a technology company that is well-known for
its product innovations, such as its vacuum cleaners and
hairdryers. In 2016, it started to develop prototypes of
electric cars but, in 2019, Dyson announced it was going
to end this project. The company said it had developed
a fantastic car but it was not commercially viable to
produce it.
Dyson had intended to invest more than £2 billion
in developing a radical and different type of electric
vehicle. It was never intended for the mass market but,
even given the premium price Dyson expected to charge,
▲ Figure 3.21 Dyson patent diagram from 2019
Questions
1 Analyse one factor that influences the design of a
vacuum cleaner.
118
then adjust the marketing mix accordingly. For example,
promotion may be used to announce the launch of a product
in the introduction phase but to stress the differences
with competitors in the maturity phase. The price may
be high initially if the product has some unique features
but may have to be reduced in later stages as competitors
enter the market. Distribution may be difficult to get at
first when a product is new, but it may be easier over time
when it has begun to prove itself. The business should
be able to improve the firm’s performance by recognising
or anticipating where the product is in its life cycle and
adapting the marketing mix accordingly.
the company did not think it could sell enough to be
profitable.
The intention had been to produce the car in Singapore,
although £200 million was invested in research and
development and test-track facilities within the UK.
The project employed 523 people, 500 of whom were in
UK, and Sir James Dyson said they had achieved a great
deal, even if the car was not going to go into production.
The company said that work on developing the
battery technology could be transferred to its other
projects.
Source: Charlie Box/Dyson
2 Evaluate whether Dyson was right to invest in
[4] developing an electric car. [12]
Extending sales in the product by consumers as a product to use when dandruff was
already present. The company tried to change this
life cycle
Effect of
perception to get people to use it all year round to
prevent dandruff, as well as cure it
3.3
extension strategy » reducing the price. As products approach the maturity
stage, firms often cut the price to maintain sales. The
success of this depends on how sensitive demand is to
changes in price
» adapting the product. Look around a supermarket
Sales

and you will see endless examples of ‘new, improved’

products or products with added X, extra Y or less Z!

3.3.3 Product portfolio analysis

These are all ways of trying to keep the consumer
interested in the product
» introducing promotional offers. Another technique often
Time used by firms to try to prevent sales from falling is to
▲ Figure 3.22 Extension strategies have competitions or offers to boost their sales
» changing the image of the product. Products may be
A firm may try to prevent the sales of a product going into repackaged to make them appear more modern and
decline by using extension strategies. Methods to do this attractive to consumers.
might include:
» increasing the usage of the product on any given GLOSSARY TERM
occasion. For example, shampoo products often advise
An extension strategy occurs when marketing activities
you to wash once, then rinse your hair and wash again,
are changed to prevent sales from falling.
thereby doubling the usage rate
» encouraging the use of the product on more occasions.
For example, Head & Shoulders shampoo was seen

CASE STUDY
Command and conquer
Command and conquer is a computer game in which there
is a war between the Global Defence Initiative and a
terrorist group called the Brotherhood of Nod. Command
and conquer was originally a video game in 1995, when
it was first released on compact discs. Players could
compete against others using what was then an emerging
technology – the internet. It sold around 3 million copies.
In 2020, a new, improved version came out. This was
similar to the original in many ways but had better graphics.
Revamping products is common in the music industry where
music will be remixed, remastered or brought out as a
special edition or part of a compilation. Film studies produce
the director’s cut or an edition with ‘extras’ or ‘outtakes’.
More than 30 updated computer games were launched in
2020. Final Fantasy vii Remake is a remake of a PlayStation
game from 1997. It sold 3.5 million copies in three
days when it was released in April 2020. Re-releasing
games appeals to those who remember them from their
childhood. It is also cheaper than developing a new game
from scratch, which can cost $100 million.
Questions
1 Analyse one factor that affects the promotional mix of
a new computer game. [4]
2 Evaluate whether computer games companies are
right to relaunch past games. [12]

▼ Table 3.10 Examples of how marketing decisions may change at different stages of the product life cycle

Introduction Growth Maturity Decline

Price May be low to introduce May be able to increase May hold May cut to boost sales
with demand

Distribution May be limited as stores May increase to gain May hold May focus on best-
unsure whether to stock access to the market performing outlets

Promotion May focus on awareness May try to increase May highlight differences May try to reinforce
awareness with competitors who may existence and benefits
have entered of the product

Product May be limited number May widen range with May stop developing new May focus on best
of models/varieties demand models/varieties performers

119
 CASE STUDY
3.3
Segway
AS LEVEL 3.3 THE MARKETING MIX

▲ Figure 3.23 Segway products

The Segway Personal Transporter (PT) was a self-
balancing electric scooter that was launched in 2001
by Dean Kamen, its American inventor. ‘Our inspiration
for the name “Segway” came from the word segue,
which is defined as “to transition smoothly from one
state to another”. Segway transforms a person into an
empowered pedestrian, allowing him/her to go farther,
move more quickly and carry more.’ The Segway had a
self-righting technology. If you leant forward, a collection
of microprocessors and a set of sophisticated tilt sensors
and gyroscopic sensors adjusted so you maintained your
balance. The Segway could travel up to 12 miles an hour
(19 km/h).
In 2015, Segway joined with Ninebot, a privately held
Chinese company. The combined company focuses on
the research and development, design, manufacturing,
distribution and sales of short-distance transportation
products. According to Segway, more and more people
are using Segway-Ninebot products as an eco-friendly
alternative for many of the short journeys that are
typically made by car.’
Unfortunately, the transportation revolution that inventor
Dean Kamen had envisioned when he launched the
Segway PT never really took off. The Segway’s original
price tag of around $5000 was too high for many
customers. The initial difficulties customers often had
balancing also caused problems. The number of high-
profile accidents – including the death of the company’s
owner in 2010 when he drove a Segway off a cliff by
mistake – did not help the Segway’s image. Furthermore,
some governments declared that the Segway could not be
used in any public place. It was too fast to be used on the
pavement but not safe enough to be used on the road.
In June 2020, the company announced that it would stop
production of the Segway PT. The company continues to
produce other products and the Segway only accounted
for about 1.5 per cent of the company’s revenue by this
stage.
Source: https://uk-en.segway.com/about-the-brand
Questions
1 Analyse one reason why the company may have
stopped production of the Segway PT. [4]
2 Evaluate the ways in which the marketing of a
Segway product might change as it moves from
the introduction to the growth phase of the product
life cycle. [12]

120

HANDLING DATA
Over five years the sales of a product are as shown in
Table 3.11.
▼ Table 3.11 Sales of a product over five years
Year Sales
1 $100 000
2 $150 000
3 $200 000
4 $220 000
5 $225 000
1 What stage of the product life cycle do you think the
sales are in? Explain your answer.
The value of the product life cycle model
The product life cycle model is valuable because it highlights
the fact that marketing activities have to be adjusted at
different stages in the development of a product.
However, it is important to remember that the product life
cycle is just a model and its shape will vary considerably
between products. In the case of a new single release by
a band, for example, the life span may be just a matter of
weeks, whereas Marmite was launched in the early twentieth
century and is still in its maturity phase. Toys often have
short life cycles but some of them, such as Barbie dolls,
have been around for many years. So marketing decisions
in relation to the product life cycle are not clear-cut; some
products in decline have had to be taken off the market
because they cannot be made viable while others, such as
the drink Tango, have been rebranded and brought back to
great success.
Often, it will only be clear in retrospect what stage a
product was in; what appears to be a slight dip may turn
out to be the decline of a product, or what appears to be a
decline may only be a slight dip: it only becomes clear later
on. Unfortunately, businesses have to make decisions as
they go. They do not have the luxury of waiting to see what
would have happened if they had not acted.
Another limitation of the product life cycle model is that it
traces the sales of one product over time. Most businesses
have several products and therefore it is important to look
at their overall position.
Product portfolio analysis
Most firms have more than one product; some have
hundreds. For example, at the time of writing, Unilever
owns a huge number of brands, including Ben & Jerry’s, Cif,
Domestos, Lipton, Magnum, Marmite, Omo, Surf, Timotei
and Walls, to name but a few. The range of products and
services a firm has is known as its product portfolio. As part
of its planning process, a business will examine the position
of these products in their markets. This is known as product
portfolio analysis (PPA). One of the most famous models
of portfolio analysis was developed by the management
consultancy Boston Consulting Group and is known as the
Boston Matrix. This model analyses the position of a firm’s
products in terms of their market share and the growth of
3.3
the markets they operate in.
GLOSSARY TERMS
Product portfolio analysis (PPA) examines the market
position of a firm’s products.
3.3.3 Product portfolio analysis
The Boston Matrix is a method of product portfolio
analysis that examines the products of a business in terms
of their market share and the market growth.
Types of product in the Boston Matrix
Each circle in the Boston Matrix represents one particular
product or service. The size of the circle illustrates the
turnover of the product; the bigger the circle, the higher
the turnover. The firm’s products can be classified according
to their market share and the growth of the market in which
they operate.
Stars Question marks
High
Market growth (%)
Cash cows Dogs
Low
High Market share Low
▲ Figure 3.24 The Boston Matrix
» Cash cows are products that have a high market share
but are selling in a slow-growing market. In some cases,
this type of product will be the market leader in a mature
market. Although the market may not be growing very
fast, this may be because it has grown in the past,
leaving little room for further expansion. For example,
the market for washing machines in the UK is quite big
but is not actually growing very fast; given the size of the
market, a brand with a high market share will have sales
worth millions of pounds. By comparison, the market for
electric cars and organic food is still relatively small but
has potential for fast growth. A cash cow already has a
large market share, so much of the promotional work will
have been done already. The product is likely to have a
good distribution system and people will be aware that
the product exists. The firm is used to producing the
product in relatively large volumes and so the cost per
unit should be fairly low. As a result, this type of product
is likely to bring in high levels of cash for the firm. This
can be used to finance other products.
121
 » Question marks (or ‘problem children’). These are » If a business has too many dogs, it may have insufficient
products that have a small market share of a fast-growing new products to keep it going in the future. As a result,
3.3 market. These products may go on to be very successful
but, equally, they may fail. They are quite vulnerable
it may want to invest in new products.
» If a business has lots of cash cows, it is generating
and their future is uncertain (hence the name). There relatively high levels of cash but, again, needs to
is a high degree of risk associated with these products, think about the future: cash cows tend to be dominant
because you cannot be sure they will succeed. They products in markets that have already grown. A business
need protecting by the firm and they require extensive may want and need to be involved in newer markets as
marketing. Most new products are question marks well, and it should therefore look to develop some star
because their future is so uncertain, although there are products.
» If a firm has too many question marks, it may be quite
AS LEVEL 3.3 THE MARKETING MIX

exceptions when a product takes off quickly.

» Stars These products enjoy a large share of a market that vulnerable, as question marks need protective marketing
is growing rapidly. They are highly successful products to maintain and grow their position in the market, and
for the business; however, they are usually expensive in this may drain a firm’s resources.
terms of marketing. Money must be spent to ensure they
With an appropriate mix of products, the cash cows can be
retain their position in a growing market. For example,
used to finance the development of question marks and
they may need to be promoted heavily to maintain
turn them into stars. This way the firm uses money from
customer awareness and to increase distribution in the
established markets to enter new markets and so protects
market.
its future. Portfolio analysis, therefore, provides a good
» Dogs These products have a low market share and are
basis for effective marketing planning:
selling in a slow-growing market. A firm may want to
» Dog products may be sold off or production and sales
get rid of these products unless it thinks it can improve
halted.
its sales. However, dogs can sometimes be revived.
» Star products may be invested in to maintain their
Lucozade used to be seen as a drink to help sick people
position.
get better, until it was very successfully repositioned as
» Cash cows may be ‘milked’ to provide funds.
a sports and energy drink.
» Question marks may be protected.
The impact of product portfolio analysis on Stars Question marks
marketing decisions
High
Market growth

The Boston Matrix provides a snapshot of the position of

all of a firm’s products at a particular moment in time,
whereas the product life cycle focuses on just one product. Cash cows Dogs
This enables managers to see whether or not they have a
Low

balanced portfolio – that is, an appropriate mix of products.

It can help a business to be more effective by providing an
overview so that the manager can take appropriate actions. High Low
Relative market share
For example:
▲ Figure 3.25 The Boston Matrix (2)

CASE STUDY
Coca-Cola
The Coca-Cola Company is a beverage company. It underperforming (which it calls ‘zombies’), it eliminates
has over 500 brands which are sold in more than 200 them to make room for newer products.
countries and territories. Its portfolio of products come
Just over half of Coca-Cola’s revenue is now from sparkling
in the following categories: soft drinks; water, enhanced
soft drinks, with tea and coffee and juice, dairy and plant
water, and sports drinks; juice, dairy, and plant-based
drinks making up about another 20 per cent each, and the
beverages; tea and coffee; and energy drinks. In addition,
remaining sales being from hydration drinks.
the company owns four of the world’s top five non-
alcoholic sparkling soft drink brands: Coca-Cola, Diet Source: https://investors.coca-colacompany.com/strategy/
Coke, Fanta and Sprite. growth-strategy

The company believes its success arises from its ability Questions
to connect with consumers by providing them with a 1 Analyse one reason why Coca-Cola sells products in
wide variety of beverage choices to meet their desires, different product categories. [4]
needs and lifestyle choices. The company constantly 2 Evaluate how product portfolio analysis is useful to
reviews its portfolio and when it has products that are Coca-Cola. [12]

122
 CASE STUDY
Crocs
Crocs, Inc. is a world-famous shoes manufacturer. The
company was established in Colorado, USA, producing
simple, comfortable boat shoes. Nowadays, Crocs
footwear can be found all over the world and there are
over 120 different styles. Crocs are distinctive for their
bright colours and their comfort. The company describes
its products as the ‘most delightfully comfortable shoes in
the world’. It claims that comfort leads to happiness and
this makes the world a better place! The footwear is made
of very soft, light and flexible material which makes them
easy to wear. The shoes are made using the company’s
own resin, called Croslite.
Since the business started in 2002, over 600 million
pairs of Croc shoes have been sold in over 90 countries.
The company has over 4000 employees worldwide. Croc
says that it designs everything for the people who wear
STUDY TIP
You need to be able to discuss the value of the product
life cycle model and product portfolio analysis. How
can these models be used in marketing? What are their
limitations? You also need to make sure you can apply
them. Can you tell from sales which stage of the life
cycle a product is in? Can you identify a cash cow or dog
product?
To make their businesses more effective, business
managers need to monitor and develop suitable product
portfolios. They must also adapt their marketing at
different stages of the product life cycle. You need to be
able to make recommendations, such as how to extend
the life cycle of a product or how to improve the portfolio
of a business’ products.
3.3.4 Pricing methods
The price of a product can have a major influence on its
appeal and whether or not customers think it is good
value for money. In this section, we examine the factors
influencing the price of a product and different pricing
strategies. Getting the price right is an important element
of effective marketing, because it will determine whether
customers believe they are receiving value for money.
How price affects purchasing decisions
The price of a product plays an important part in our
decision about whether or not to buy it. If the price is too
high, we simply cannot afford the product even if we want
it! Even if we can afford it, we may decide it is not value for
money if the price seems too high compared to the benefits
the product offers.
3.3
its footwear. It aims to keep its designs simple and
light.
The original Crocs products sold very well, but then
entered the maturity stage of the product life cycle. At this
stage the managers used the original Crocs as cash cows
3.3.4 Pricing methods
to finance the development of new styles for different
types of occasion.
Source: https://careers.crocs.com/about-us
Questions
1 Analyse one feature of Crocs’ products that you
would use when promoting the product. [4]
2 Evaluate whether the Crocs brand can last for
another 30 years. [12]
The price will, therefore, often play a significant role in
the purchasing decision. However, the relative importance
of price is likely to vary according to the product and
the particular circumstances. For example, if two petrol
garages opposite each other are charging different prices
for petrol, we are likely to choose the cheaper one. We are
unlikely to be loyal to a particular brand of petrol. When
buying a wedding ring, however, we do not always go for
the cheapest! Similarly, when buying clothes and shoes we
may be willing to pay more for an item if we think the brand
justifies this.
Even if you wanted to choose the cheapest price, it can
be difficult to compare prices directly – look at how
complicated the price structure is for mobile phones or
electricity. The structure of special rates, different tariffs
and different options can make it difficult for customers to
know which is actually the best deal.
Cost of
Type of product producing a
unit
Factors
influencing
price
Demand for
Competitors
a product
▲ Figure 3.26 Factors influencing price
Factors determining the price of a product
The price of a product will depend on the following range of
factors.
123
 » The type of product Demand for some products is more
sensitive to price than others. When you are looking
3.3 to buy a new microwave, for example, you are likely to
look online or go to a shop that stocks several models.
You may even go to a couple of different outlets to
compare what they offer. This type of product is called
a ‘shopping good’ because you shop around to find a
good deal. These products are very sensitive to price
differences so prices need to be competitive.
Other products are known as speciality items. These
AS LEVEL 3.3 THE MARKETING MIX
include high-performance cars and luxury watches.
Customers are likely to be willing to travel some distance
to find these items and are heavily influenced by their
design and branding factors. These products are less
sensitive to price changes because they are unique. This
may lead to higher prices.
» The cost of producing a unit Although in the short term
a firm may sell an item at a loss to get it established in
a market, in the long term a product will nearly always
have to generate a profit. This means the price has to be
greater than the cost per unit. Some organisations (such
as museums and hospitals) are non-profit making and so
do not necessarily have to cover their costs. However,
most firms in the private sector have to make a long-
term profit to survive. The price therefore cannot fall
below the unit cost for too long.
» The ability of customers to pay If the economy is doing
well and customers have high income levels, a firm may
be able to increase prices. If, however, incomes are
falling, customers may be more sensitive to the price
and look for a better deal (or wait before purchasing);
this may delay any price increases by firms.
» The demand for a product The level of interest in and
demand for a product will also affect the price that
firms can charge. Holiday companies will often increase
their prices in the school holidays, when they know lots
of families will want to go away. The holiday companies
lower prices when demand is lower during term time.
» The sensitivity of demand to price changes The
sensitivity of demand to price is measured by the
price elasticity of demand (which we will examine in
Chapter 8.1). Demand for some products is very sensitive
to the price, as people shop around for the best deal.
Other items may not be so sensitive; for example,
if it is an exclusive item.
» Competitors The price that a business sets for its
product must take account of competitors’ prices. If
competitors are offering a similar product or service
and it is easy to switch from one to the other, firms
are likely to set similar prices to each other. This is why
businesses will often stress the particular benefits of
what they are offering, so they can justify a higher
price. If customers believe a product provides better
value for money, they may still buy it even if it is more
expensive. Stella Artois beer, for example, ran a very
124
successful ‘reassuringly expensive’ campaign in the UK,
stressing that you pay more for high-quality lager. The
price was said to reflect the quality. There are now many
websites offering price comparisons; this makes demand
more sensitive to price as customers are looking around
more.
» Pricing points Some businesses aim to have a given
range of products at particular pricing points in the
market (for example, the top or bottom end of the
market) depending on the brand image and other
elements of the marketing mix. Some businesses produce
several different brands, priced at different levels.
For example, a business may produce several different
watches (often under different brand names); some in
an exclusive range, some for the mass market and some
discounted items.
» The objectives of the business The price charged by a
firm will be influenced by its objectives. If a firm has a
particular profit target, this will influence the price that
is set per unit. If it wants to achieve $10 000 profit and
expects to sell 20 000 units, it must make $0.50 profit
per unit, if this is possible. If, however, it is aiming for a
high market share (at least in the short term) it may be
willing to sell at a lower price if this will help to boost
sales.
» The stage in the product life cycle The price of a
product is likely to be changed at different stages in the
product life cycle. For example, when the product is in
the maturity stage, the price may need to be reduced to
avoid losing sales to competitors.
» The rest of the marketing mix The price a firm charges
also depends on the other elements of the marketing
mix. A heavily branded consumer product (such as Nike
trainers or Coca-Cola) will be expensive compared to a
product which does not have a well-known brand, for
example. An exclusive four-star restaurant will charge
more than a fast-food store. A designer boutique will
charge more than Primark. Typically, the price will be
higher if the product:
– has a unique selling point
– is perceived as being exclusive
– is in high demand
– is sold through exclusive outlets.
There are therefore many factors that can influence the
price of a product, and setting the price is a complex
decision. If managers understand these influences, they can
market their products more effectively by setting the right
price for the market conditions. Managers can judge, for
example, whether a price cut makes sense, given the market
conditions.
Of course, a price is not fixed forever and there are a
number of times when a firm might reconsider the price
it is charging for a product. In the following sections, we
consider different pricing strategies and approaches.
 CASE STUDY
Vertu
Vertu‘s aim was simple: to create something
extraordinary. Its main products were luxury mobile
phones. These began at a price of around $10 000. The
company said that its products brought together great
craftsmanship, outstanding performance and exceptional
customer services.
Every Vertu phone was handmade by a single craftsman
at the company’s small factory at Church Crookham,
England. This is not like any other phone – Vertu used
materials such as ruby, sapphire and titanium. Each
material used was selected not just for the fact that
it looks good, but also for its exceptional strength.
Customers could have phones made to order so that the
design reflects their personal choices.
GLOSSARY TERMS
Competitive pricing is when companies set their prices at
the same level as, or slightly below, their rivals.
Penetration pricing is a pricing strategy aimed at gaining
market share via a low entry price.
Price skimming occurs when a high initial price is set for a
product and this is reduced over time.
Price discrimination occurs when different prices are
charged for the same product.
Pricing methods for new products
When a product is first launched into a market, a firm has
to decide what price to charge. It has a number of options:
» Competitive pricing Some firms set their price at the
same level as their competitors or deliberately undercut
their rivals. Richer Sounds, a hi-fi, home cinema and TV
specialist, guarantees to charge lower prices than rivals.
Esso operates a ‘pricewatch’ to monitor competitors’
prices. Several retailers offer to refund the difference if
you can find the same product cheaper in another local
store. Competitive pricing is common when consumers
can easily make a direct comparison between different
products. The rise in internet usage has made it easier
for customers to compare prices between firms; this puts
more pressure on firms to be competitive.
» Penetration pricing This strategy uses a low price to
enter the market and gain market share. This makes
sense if there are cost advantages from producing on a
large scale. For example, in some markets a high level of
investment is required to set up, such as when investing
in premises and equipment. Once this investment has
3.3
When you owned a Vertu you could also get access
to a concierge service. This means you had your own
private butler online. This service was available for
customers 24 hours a day, every day of the year,
and helped customers organise their lives and gain
access to the most exclusive events and places. For
3.3.4 Pricing methods
example, the concierge service could help customers
get tickets to watch large-scale sports events around
the world, meet globally famous chefs at Michelin-star
restaurants or travel to private islands.
Questions
1 State one group that would be a target market for
Vertu. Explain your answer. [3]
2 Evaluate the factors that would have influenced the
price set for the Vertu phone. [12]
been carried out, a firm may want to generate high
levels of demand to spread the costs over many units.
A low entry price might help do this. Price penetration
is also beneficial if the market is price sensitive (price
elastic), in that a lower price will generate significantly
higher sales and increase revenue.
» Price skimming This strategy uses a high price to enter
a market. Even though the price is high, some people
may still be eager to try a new product. Once sales from
this group of people have been exhausted, the price can
be dropped to attract a new group of customers. When
this group is exhausted, the price can be cut again. A
price skimming strategy is appropriate if the firm can
protect its idea or invention so that competitors cannot
enter with a cheaper version in the early stages. Price
skimming makes sense if the market is not particularly
price sensitive (that is, it is price inelastic), so that a
price cut would generate a relatively smaller increase in
sales. This strategy is often used with new technology;
for example, the latest computer or computer accessory
enters the market with a high price, which then falls
quite rapidly a year or so later.
» Price discrimination This occurs when different prices
are charged for the same product. You will sometimes
find that demand conditions for the same product can
vary and the price changes as a result. For example,
demand for public transport around 8 a.m. is very heavy,
as people want to get to work for 9 a.m. Similarly,
demand is busy between 5 p.m. and 6 p.m., as people
want to get home. Demand is less heavy at other times
of day. If a business can identify different demand
conditions, it may want to change the price in the
different markets. The demand for transport before
9 a.m. and between 5 p.m and 6 p.m. is likely to be price
125
 inelastic: it is not sensitive to price because people have
to get to and from work. At these times, a transport
3.3 business may increase price to increase revenue. At
other times of day, demand may be more price elastic
(that is, sensitive to price) because there is not the
same pressure on people to travel; they can always delay
their journey or not go at all. To raise revenue at these
times, the business may decrease price. The result is
that customers pay different prices for the same journey
at different times of day.
Price discrimination may occur when firms charge
AS LEVEL 3.3 THE MARKETING MIX
different prices:
– at different times of day; for example, taxi fares may
be higher after midnight
– to different age groups; for example, lower fares on
the bus for children and pensioners
– to different customer groups; for example, discounts
for members.
» Dynamic pricing occurs when prices are changed at
different times to reflect demand conditions. Airlines
may change prices according to when you book, utility
companies may change rates according to demand
for their services during a day, theatres, cinemas and
sports stadia may change the ticket prices depending on
when you are looking. Dynamic pricing is much easier
with online ordering, where the business can track
in real time the availability of places or products and
measure levels of demand by the number of searches and
enquiries, and then adjust the price accordingly. For the
business, it means it does not have to estimate demand
in advance and set what it hopes is the right price – it
can adjust continually, increasing it if demand looks
high and reducing it if demand is low. This should allow
the business to control demand more effectively and
ensure, for example, that its planes, hotels and sports
arenas are full. The business should be able to maximise
revenue (increasing prices if demand is high to ration
the products available rather than turning people away)
and make full use of the capacity available. From a
customer’s perspective, it means be prepared to discover
you paid a very different price from the person in the
seat next to you!
» Cost-based pricing occurs when a business considers
the costs of an item and adds on an amount or a
percentage to ensure it makes a profit. A shop may
buy in a product at $10 and add on $2 to sell at $12.
The advantage of this approach is its simplicity and
it means the business is certain it makes a profit,
assuming the item sells. However, the disadvantage is
that it is ignoring demand. It may be that there is such
demand that this product could sell for $20 at that
moment.
» Psychological pricing takes account of the
psychological effect of a price on customers. For
example, a high price for consultancy work might
suggest that the person is an expert; if the price is
126
too low customers may worry about the consultant’s
competency. Other examples of psychological
pricing are:
– charging, say, $49.99 rather than $50. In the
customer’s mind, this makes the price ‘$40
something’ rather than ‘$50 something’ and therefore
more attractive.
– putting ‘was’ and ‘now’ or ‘sale’ to suggest this is
a bargain. For example, ‘was $20, now $15’ may be
more appealing than just stating ‘$15’.
Penetration
pricing
Psychological Price
pricing skimming
Pricing
Cost-based strategies Price
pricing discrimination
Dynamic Competitive
pricing pricing
▲ Figure 3.27 Pricing strategies
GLOSSARY TERMS
Dynamic pricing occurs when different prices are changed
at different times to reflect demand conditions.
Cost-based pricing occurs when a business considers the
costs of an item and adds on an amount or a percentage to
ensure it makes a profit.
Psychological pricing takes account of the psychological
effect of a price on customers.
The promotional mix refers to the combination of
ways in which the business communicates about its
products.
STUDY TIP
You need to understand the many different factors that
can influence the price of a product and the different
pricing strategies and tactics used by businesses. You
need to be able to discuss the factors that determine the
right price in any situation.
By understanding these pricing methods, managers can
decide on the best price to set when launching a new
product. To make a business more effective, it needs
to select a price that makes customers feel they are
receiving excellent value for money. The price must be
reviewed and changed as market conditions and external
factors change.
 CASE STUDY
IKEA
IKEA is a furniture and home-furnishings business. It
seeks ‘to create a better everyday life for people ... by
offering a wide range of well-designed, functional home-
furnishing products at prices so low that as many people
as possible will be able to afford them.’
3.3
space. It also avoids the assembly costs as consumers
do this for themselves
● stocks many of its products in a warehouse space.
Customers find their products and take them to the
tills themselves; this saves on staff costs.
Source: www.ikea.com/ms/en_JP/about_ikea/the_ikea_way/

3.3.5 Promotion methods

IKEA is, therefore, committed to high-quality design at
low prices. To achieve this it: our_business_idea/index.html
● designs and manufactures the products itself
● manages its supply chain to be as efficient as possible Questions
● locates its stores away from town centres to benefit 1 Analyse one reason why IKEA is able to keep its
from low rents prices low. [4]
● stores many of the products ‘flat-packed’ (that is, not 2 Evaluate the importance of price as a factor in the
assembled) which enables it to store more in any given success of IKEA. [12]

3.3.5 Promotion methods

In marketing, promotion refers to the ways in which
businesses communicate about their products. Advertising

A business will want to communicate the benefits of its

products to its customers. It has to let them know the
Sales promotion Personal selling
product exists, what it does and why they should buy it. In
this section, we examine the importance of the promotional
mix in marketing. This is the combination of activities used
to communicate about and promote the business and its
products. Managing the way that a business communicates
with its customers about its products is vital to its success. Public relations Merchandising

What is promotion and what are its

objectives?
The promotion of a product involves communicating about
it to existing or potential customers. The purposes of
promotion include:
» informing customers (for example, telling them about
modifications to the product, promotional offers or new
releases)
» persuading them (for example, highlighting your
product’s benefits compared with competitors’ products)
» reassuring buyers they did the right thing by buying the
product in the first place.
The objectives of promotion are likely to be:
» to increase sales of a business
» to increase the market share of a product
» to position the product relative to competitors in the
minds of customers.
The promotional mix
The promotional mix refers to the combination of ways in
which a business can communicate with its customers. The
choice of promotional mix influences the effectiveness of
the way in which the business is communicating; this, in
turn, influences the effectiveness of the firm’s marketing.
Direct mail Branding
▲ Figure 3.28 The promotional mix
The elements of the promotional mix include the
following.
Advertising promotion
Advertising is a paid-for means of communication which
is part of the promotional mix. Advertising is often used
as a long-term strategy to build brand loyalty. There
are, of course, many different media available in terms
of advertising, such as newspapers, radio, television and
billboards. Increasingly, nowadays, there are also online
advertising media available.
Managers must determine the most appropriate media
to use. This depends on the resources available, the
target group and their lifestyles, the likely sales (which
influences how much can be spent) and the nature of the
product. Mass-market products such as cars may be able
to justify television advertising, for example, whereas a

127
 local decorator may advertise in shop windows or a local
magazine. The difficulty with advertising is that many
3.3 consumers are bombarded by different adverts, and so
getting a message through to your target group that they
actually pay attention to can be difficult. With the growth
of digital television and radio, as well as the internet, the
volume of messages aimed at consumers is increasing all
the time and this can reduce the effectiveness of some
advertising. Advertisers therefore have to think carefully
about what messages to deliver, what media to use and
when to advertise.
AS LEVEL 3.3 THE MARKETING MIX
Effective advertising will be measured by considering the
outcomes achieved (for example, more sales or greater
awareness of the product) in relation to the costs of the
campaign.
Sales promotions
Sales promotions are attempts to boost sales using
techniques such as promotional offers, competitions and
price cuts. Offers can include 10 per cent extra free and
‘buy one, get one free’ (called ‘BOGOF’). Sales promotions
may be used as a means of boosting sales in the short
term. When undertaking a promotional campaign, a firm
must consider:
» What will it cost?
» What will it do to the brand image?
» To what extent will the offer be effective? For example,
the type of offer you would give as a sportswear
company is different from a wine or perfume business
» What is the likely impact on sales?
Personal selling
Personal selling is based on face-to-face contact with
customers. This may be used by manufacturers to get
distributors to take their products, or in industrial markets
and the service sector, where the producer often deals
directly with the customer. Financial services such as
pensions, insurance and mortgages are often sold in this
way. Similarly, the sale of products such as photocopiers
CASE STUDY
South Africa
According to the market research company Nielsen, South
African shoppers are obsessed with sales promotions.
According to a report by Nielsen, called The Price of
Promoting, 75 per cent of South African shoppers know
the prices of their regular grocery items and notice when
those prices change. This makes South Africa one of the
most price-sensitive countries in the world.
In South Africa, consumers face significant financial
constraints, especially with the rising price of petrol,
taxes and energy bills. This means that customers are
searching for special offers. The use of promotions
can attract customers in the short term but it can also
damage the value of a brand. In 2018, around 30 per cent
128
often takes place through a sales force. If a product is
sold in low volumes, is technical and complex and needs
to be explained to customers, then a sales force is likely
to be an effective promotional method. The sales team
can be absolutely essential in some markets. For example,
manufacturers must work to achieve sales through the
retailers; the manufacturing companies’ sales teams compete
very aggressively to get their products displayed in the best
way to get their promotions highlighted in the stores.
Direct promotion
This promotion involves communications delivered directly
to the consumer without any intervening media. Examples
of direct promotion are house-to-house selling, such as
Avon or Tupperware sales, direct mailings and emailings,
and telemarketing (which is where a sales team telephone
customers). With increasingly sophisticated database
information, these can be carefully targeted – although this
is not always the case. Some direct promotion is associated
with ‘junk mail’, which means it is not very well targeted.
Businesses do need to be careful where they get their
mailing lists from and ensure they are not breaking any data
protection laws by accessing a list. Databases have to meet
data protection requirements (for example, customers must
have access to the information held on them) and be kept
up to date to be useful.
Direct promotion can be relatively cost-effective and
the response rate can be measured relatively easily. For
example, what proportion of visits or telephone calls lead
to action by the customer? What proportion of people who
receive an email respond to it?
STUDY TIP
Don’t confuse the promotional mix with the marketing
mix. Read the question carefully and make sure you are
focused on the right ‘mix’!
of the total sales of consumer goods that are bought
frequently were sold at a discounted price. There were
also more sales promotions. The danger for producers
is that consumers are becoming used to looking for
deals. This will reduce the profit margins of producers
and retailers, as 22 per cent of shoppers say that they
regularly switch stores according to where the best
promotions are (an increase from 16 per cent in 2017).
Question
1 Evaluate the importance of sales promotions as
part of the promotional mix in South Africa. [12]

CASE STUDY
Swatch
Swatch Group is an international group active in the
design, manufacture and sale of finished watches,
jewellery, watch movements and components. The
Swatch Group owns a number of watch brands. These
brands target different groups and have different price
points.
Questions
1 Define the term ‘segmentation’. [2]
2 Evaluate the possible reasons why a firm such as
Swatch operates with different brand names. [12]
The role of branding
In some markets, branding is very important. By building
a brand, businesses hope to make customers more loyal.
This may allow them to charge more for items, by making
the demand price inelastic. It may also make it easier to
introduce new products under the same brand name, as
customers may feel reassured and be more willing to try
them. If customers recognise a brand, they can associate
with all of its values and this in itself can provide a
benefit – people may feel more secure driving a Volvo than
other brands of car, more fashionable using an Apple Mac
than other computers, and smarter wearing Prada than other
fashion labels. Increasingly, some people want to identify
with a brand and the lifestyle that is associated with it.
Brand loyalty is very important because it is easier and
cheaper for a business to sell more to an existing customer
than it is to generate a new customer. However, a brand has
to be protected and managers have to be careful that it does
not become associated with the wrong things. For example,
in 2010, Toyota had to recall millions of cars due to a brake
problem which damaged the company’s reputation for quality.
CASE STUDY
Sir Richard Branson and the Virgin brand
▲ Figure 3.29 Sir Richard Branson
Sir Richard Branson was born in 1950 and educated at
Stowe School, in the UK. He went into business aged 16,
publishing Student magazine. As a young entrepreneur,
Brands may form an important part of a promotional
campaign. Businesses may promote the brand because it
brings with it all the associated values. When a new Apple
iPhone is promoted, we expect a super design, a fantastic
3.3
look to the product and some new technology, because
that’s what we associate with Apple. A well-established
brand brings with it immediately a collection of messages
that feed into any communication. A Tesla product will
be innovative, a Gucci product will be luxurious, and a
Volvo product will be safe. Promotional campaigns can use
the brand as a selling point in itself (think about strong
3.3.5 Promotion methods
brands such as the University of Cambridge or Harvard
University) that immediately conveys something about the
product.
At the same time, promotional campaigns will help build the
brand. The promotions will convey key messages about the
personality of the brand – is it fun? Quirky? Global? Young?
The design and messaging of advertisements, of digital
campaigns and all other forms of promotion can shape the
brand and customers’ attitudes towards it. Imagine you are
about to buy a laptop or tablet – will you look at Apple?
Microsoft? Lenovo? HP? Google Chrome? Without even
thinking about price or technical specifications, you will
have a reaction to each of those brand names; this reaction
could be due to past experience, but it will also be shaped
by the promotional campaigns of the business. At times,
promotional campaigns will specifically aim to change your
perception of a brand. Burberry, for example, was originally
positioned as quite an exclusive brand, but it then became
one very wide range of products, which some say damaged
its appeal; in recent years it has been trying to re-establish
this link with premium fashion design. Amazon has been
criticised for the terms and conditions of employees in its
warehouses, and it has responded to this by promoting
the work of those people working in the warehouses and
inviting people to visit. Promotion may, therefore, be used
to build, reposition or protect a brand.
it was clear he had a real flair for publicity. He originally
set up the Virgin brand as a mail-order record company,
then subsequently opened a physical store in Oxford
Street, London. In 1972, he founded the Virgin Records
music label and recorded what came to be a best-selling
record, Tubular Bells by Mike Oldfield, in 1973. In the
punk rock era, Virgin Records signed the Sex Pistols,
even though other record labels wouldn’t go near them.
This proved to be a marketing success. Over the years,
Virgin accumulated many other stars, including Genesis,
Peter Gabriel, Simple Minds and The Rolling Stones. This
gave Virgin a major international presence in the music
industry. Virgin has also diversified into air and rail travel,
mobile phones, finance, weddings, wines, retail, drinks,
hotels and gymnasiums. It now has around 200 companies
in over 30 countries, employing more than 25 000 people.
129
 One of Sir Richard’s strengths has been his ability to get vehicles that are designed to give private individuals the

3.3 free publicity for the business. He has had his picture
taken in a wedding dress, as well as with Pamela
Anderson, Diana, Princess of Wales, and Nelson Mandela.
In 1985, Sir Richard attempted to beat the record for the
fastest crossing of the Atlantic by boat, but his vessel hit
driftwood and sank only 100 miles (160 km) from home.
In 2004, he achieved the fastest crossing of the English
Channel by amphibious vehicle, marking the twentieth
anniversary of the Virgin Atlantic brand.
AS LEVEL 3.3 THE MARKETING MIX
opportunity to see the Earth from space. It will operate
a regular schedule of space flights from the company’s
base at New Mexico’s Spaceport America, the world’s first
purpose-built commercial spaceport.
Questions
1 Explain one key feature of the Virgin brand. [3]
2 Evaluate other products that you think the Virgin
brand could extend to. [12]

Sir Richard’s latest venture is space travel. Virgin Galactic

is a commercial spaceline. It operates modern space

CASE STUDY
Biggest global brands
▼ Table 3.12 Biggest ten global brands

Ranking Company Change in brand value (%) Brand value ($m) 2019
1 Apple +9 234 241
2 Google +8 167 713
3 Amazon +242 125 263
4 Microsoft +17 108 847
5 Coca-Cola –4 63 365
6 Samsung +2 61 098
7 Toyota +5 56 246
8 Mercedes +5 50 832
9 McDonald’s +4 45 362
10 Disney +11 44 352
Source: www.interbrand.com/best-brands/best-global-brands/2019/ranking/
Questions
1 Choose one of the brands in Table 3.12 and explain one element of its brand values (that is, what does
the brand stand for?). [3]
2 Evaluate the benefits to a business of having a strong brand. [12]

The role of packaging
Packaging may be needed to:
» protect the product; for example, while being
transported (think of an egg box!)
» preserve the product; for example, tinned food
» keep the product secure; for example, razor blades
are high-value items and are vulnerable to being
stolen from stores. The packaging of these products
is sometimes bigger than it needs to be to make them
visible in-store
» provide information to customers; for example,
information on the ingredients.
However, packaging can also play a role in the promotion
of the product. Packaging helps communicate about the
product. The packaging can:
» reinforce the positioning and branding. Think about
perfumes; the bottle itself and the box it is in often reflect
a premium product. The shape, the design and the colours
of the packaging will send messages about the product
» reinforce a promotional campaign; for example, if a
promotional offer is on where there is 10 per cent extra
free, this can be shown on the packaging.
At the same time, the promotional campaign can focus
on features such as new sizes, resealable containers, new
shapes of containers or new recyclable materials.

130
 CASE STUDY
L’Oréal
According to L’Oréal, the cosmetic business, packaging
is a ‘make or break’ factor in the beauty experience. It
has a huge influence on the commercial success of a
product, affecting the reviews of beauty bloggers and the
responses of their millions of followers.
Source: L’Oréal (UK) Limited
▲ Figure 3.30 L’Oréal packaging
Digital promotion
The fastest growing element of the promotional mix
in recent years has been digital promotion. Digital
promotion involves promoting a brand, product or
service on digital channels such as search engines, social
media, email and mobile apps. Many businesses in recent
years have reduced their spend on printed materials and
increased their digital spend.
Businesses use social media such as Facebook, Twitter and
Instagram to develop their brand image and to communicate
with their target market. They also use paid-for online
advertising such as Google AdWords to target potential
customers, or they might pay social influencers such as
Kim Kardashian West to endorse their products – this will
enable a business to bring its product to the attention of all
the followers of the influencer. Businesses also encourage
customers to leave reviews online, as this can help to gain
customers’ confidence in the product.
Digital promotion can be very cost-effective. You can
target customers very carefully based on factors such as
their location, age and interests. A business can also track
exactly what actions customers take – for example, they can
measure the click-through rate (CTR) from an advert to a
website; they can also track exactly the movements of the
consumer coming to the firm’s website to measure whether
it leads to a sale. Adverts can be shown to users depending
A recent packaging development at L’Oréal is Lip Magnet.
3.3
L’Oréal’s packaging innovation team designed an
applicator capable of applying the right amount of product
on the lips with comfort, precision and creating the
sensation of a weightless film. The transparent bottle with
thick walls highlights the product shade.
Questions
3.3.5 Promotion methods
1 Analyse one factor that might influence the packaging
of a cosmetic product. [4]
2 Evaluate the importance of packaging in the marketing
mix of cosmetic products. [12]
on what they are searching for or what they have been
looking at. Adverts can adjust depending on whether this
is a person’s first visit to a website or whether they have
been there before. If a business understands its customer
profile well and targets them effectively, and if it monitors
the actions taken by customers and adapts what it does
accordingly, then digital promotion can be very effective
and low-cost.
However, businesses do need to monitor their spending
and make sure it is targeted. Paying for millions of click-
throughs by customers who like the online advert but have
no intention of buying the product can waste money. The
effectiveness of digital promotion is also limited to those
who are online; it will not reach those who are offline.
GLOSSARY TERMS
Digital promotion involves promoting a brand, product or
service on digital channels such as search engines, social
media, email and mobile apps.
The click-through rate (CTR) measures the number
of visits to a website as a percentage of the number
of impressions of a digital advert. For example, a
CTR of 20 per cent means 20 per cent of the times an
advert is viewed, someone clicks on it to find out more
information.
131
 CASE STUDY
3.3
Dwayne ‘The Rock’ Johnson
In 2020, Dwayne ‘The Rock’ Johnson was listed as the before tax. His films include Fast and Furious and
highest-paid sponsor for an Instagram post. It was Jumanji. Johnson also has a partnership with the US
claimed that Johnson charged over $1 million per post sports brand Under Armour and holds a stake in the
last year. Previously, Kylie Jenner was listed as the Norwegian bottled-water brand Voss.
highest-paid. She has 182 million Instagram followers;
Source: www.bbc.co.uk/news/business-53261043
Johnson has 187 million. It was estimated that footballer
AS LEVEL 3.3 THE MARKETING MIX

Cristiano Ronaldo was worth $889 000 per post, and Kim Questions
Kardashian West could charge $858 000. The rankings of
1 Analyse one factor that influences the amount
social-media sponsors were produced by Hopper HQ and
someone can charge to sponsor a social-media post.
were estimates, as the precise amounts paid are highly
[4]
protected.
2 Evaluate the importance of social media in affecting
According to Forbes, Johnson was the highest-paid consumers’ buying decisions. [12]
actor in the world, earning nearly $90 million in 2019

CASE STUDY
Facebook versus Twitter
▼ Table 3.13 Facebook versus Twitter – selected metrics

Facebook Twitter
Market capitalisation ($bn) 655.7 27.4
3 June 2020
Revenues ($bn) 70.7 3.5
2019
Net profit ($bn) 18.5 1.5
2019
Employees (’000) 48.3 4.9*
Q1 2020
Daily active users (bn) 1.7 0.2
Q1 2020

* Q4 2019
Source: The Economist

Questions
1 Analyse one factor that might determine how much a social-media business can charge other businesses to
advertise on it. [4]
2 Evaluate the importance of social media in the marketing mix of businesses. [12]

132
 CASE STUDY
Digital marketing
Recent market research shows:
● Only 17 per cent of consumers have been influenced
to buy a product or service following an endorsement
from an influencer or celebrity.
● On the other hand, 32 per cent of consumers are
influenced to buy a product or service following a
positive review on social media.
● 8 in 10 consumers have undertaken at least one or
more financial activities via a digital channel in the
past year.
Each of the different methods of promotion has its own
advantages and disadvantages, as shown in Table 3.14.
For example, personal selling is obviously quite
labour-intensive, and therefore expensive, but the firm gets
immediate feedback from its customers.
▼ Table 3.14 A comparison of promotional methods
Method of promotion Advantages
Advertising • Wide coverage
• Control of the message
• Can be used to build brand loyalty
Direct promotion • Relatively cheap
Sales promotions • Can entertain and interest the consumer
Personal selling • Two-way communication
• Can answer customer enquiries
Digital promotion • Can be very targeted
• Can track actions taken online
• Can use influencers to attract new customers
CASE STUDY
Red Bull
Red Bull is an ‘energy drink’ that originated in Thailand
and is sold to combat mental and physical fatigue. The
marketing of the product has been highly successful and
includes a number of unusual promotional methods.
For example:
● Selected students (students are a key market) are
given free cases of Red Bull if they throw a party;
others are given a car with a model Red Bull on the
top to drive around and be noticed by others. This
is known as ‘viral marketing’. It relies on a few key
trendsetters spreading the word about a product
and leading to others wanting to be associated
with it.
● Sales teams identify key bars and clubs and promote
heavily via merchandise, such as branded coolers
and point-of-purchase (or POP) displays.
3.3
● 54 per cent of consumers say fashion is the top category
where social media has influenced their purchases, while
45 per cent of consumers say the same for technology.
Questions
1 Analyse one possible objective of a social-media
3.3.5 Promotion methods
campaign. [4]
2 Evaluate the importance of social media for
businesses wanting to promote their products. [12]
Disadvantages
• Can be expensive; for example, TV advertising
• May not get read
• Often short-term effects
• Can encourage brand switching
• Can be expensive
• Can only reach a limited number of customers
• Need to target effectively
• Will not reach those who are not online
● The company heavily invests in brand-building, including
promoting the slogan ‘Red Bull gives you wings’.
● Red Bull sponsors many extreme sports events
including cliff diving, BMX and skiing. Red Bull also
sponsors the Red Bull Flugtag (‘flight day’ in German),
a competition where entrants launch themselves off a
30-foot (9-metre) ramp in homemade ‘flying machines’
into a body of water.
● In recent years, mainstream advertising such as
television has also been used.
Questions
1 Analyse one reason why a business might choose
to sponsor an event. [4]
2 Evaluate other types of events you think it would
make sense for Red Bull to sponsor. Explain your
selection. [12]
133
 Choosing the right promotional mix
3.3 Businesses use a combination of promotional methods to
communicate to potential customers about their products.
The composition of the promotional mix depends on
numerous factors:
» Nature of the product Consumer-durable products,
such as televisions and washing machines, are likely to
be advertised to the final customer. Firms usually use a
sales team to deal with wholesalers and retailers but use
advertising to get customers to demand the product in
AS LEVEL 3.3 THE MARKETING MIX
the stores. By raising awareness of the brand, customers
will recognise it when they go to buy a product.
Similarly, companies producing shampoos and household
cleaners often advertise on television. By comparison,
sales of heavy construction equipment are usually made
direct to the customer and rely on the sales force. There
are relatively few customers in this case, the product is
expensive and sold in low volumes, and there are many
technical details that need to be explained. A sales force
is likely to be much more effective than, say, an advert
in a brochure.
» Marketing expenditure budget Inevitably, the budget
acts as a constraint on all firms’ promotional activities
because it limits the amount of money available to
spend in this area. Faced with a small marketing budget,
for example, a firm cannot even consider television
advertising and may have to rely on local newspaper
advertising instead.
» Available options Technological developments are
creating new possibilities, such as internet advertising
and text advertising. Legal changes also influence
what is possible; for instance, what products can be
advertised and how they can promote themselves. For
example, there are strong restrictions on the promotion
of alcohol and tobacco.
Improvements in the promotional mix may:
» reduce costs, as cheaper ways of communicating are
adopted
» boost sales, as better ways of communicating are used
to communicate more effectively and to more people.
STUDY TIP
You need to be able to understand the different
messages a business might be trying to communicate
to different groups, such as investors and consumers.
You also need to understand the different elements of
the promotional mix and how these will be changed for
different products and different situations. Think about
whether some methods are more appropriate than
others for specific products. Do not assume advertising
is always the answer – there are many other ways of
communicating that may be more effective for some
products.
134
GLOSSARY TERMS
The marketing expenditure budget is the amount of
money a business allocates to spend on marketing
activities such as promotion.
The distribution channel describes how the ownership of
a product moves from the producer to the customer.
To make its promotion more effective, a business might
alter the total amount spent on it or review the promotional
mix. As customers’ habits change, the mix might need to
be altered as well (for example, switching to more internet
advertising).
3.3.6 Place (channels of
distribution)
The distribution of a good or service refers to the way
in which the ownership of it passes from the producer to
the consumer. In some cases, the product goes directly
to the end customer from the producer (business-to-
consumer marketing, see page 102). For example, Dell
Computers supplies some of its customers direct, without
intermediaries, as does Avon Products. Services such as
insurance, health care and education tend to be provided
directly to the end customers.
In other cases, producers use intermediaries. Most producers
of electrical goods, such as Sony and Phillips, have
intermediaries between the producer and the final seller.
These intermediaries include:
» retailers (such as Walmart), which are the final stage
in the distribution chain. Many goods are sold through
retailers rather than direct to the customer
» wholesalers. These buy products in bulk from producers
and sell them on to retailers, who then sell direct to
the final consumer. Retailers use wholesalers because
they offer a range of products and it is easier dealing
directly with them than with many different individual
manufacturers.
The different distribution channels can be described in
terms of the number of levels involved in the process (see
Figure 3.31).
Zero-level channel: no intermediaries
Producer Consumer
One-level channel: one intermediary
Manufacturer Retailer Consumer
Two-level channel: two intermediaries
Manufacturer Wholesaler Retailer Consumer
▲ Figure 3.31 Distribution channels
» In a zero-level channel, the good or service passes
directly from producer to consumer without any
intermediaries. For example, dentists, accountants and
plumbers have zero-level channels.
» A one-level channel has one intermediary. For example,
a retailer buys the product from the manufacturer and
sells it to the consumer.
» A two-level channel has two intermediaries. For
example, a wholesaler buys the product from the
manufacturer and sells it on to retailers, who sell to the
final customers.
The distribution strategy will vary considerably from
product to product. In the case of milk, newspapers and
chewing gum, for example, the aim is usually to generate
as wide a distribution as possible. These types of goods are
called convenience items because consumers are not willing
to travel far to buy them – they need them to be easily
accessible. In order to get to as broad a market as possible,
several intermediaries may be used.
With products such as personal computers, vacuum cleaners,
microwaves, and so on, consumers usually want to compare
the features and prices of different brands. Manufacturers
of these products need to get them distributed to certain
stores where customers expect to go to find them. These
shopping goods do not need to be distributed to as many
outlets as convenience items, but the firm may have to
fight hard to get intermediaries to stock them. Although
with the growth of online shopping manufacturers do sell
directly to customers, many sales are still through retailers,
including online retailers such as Amazon.
More exclusive (or speciality) products such as Rolex,
Porsche, Bang & Olufsen and Bose have even fewer outlets,
but the nature of these outlets is very important. They
must reinforce the nature of the brand, and so a great deal
of time is spent ensuring they are well maintained and
suitably exclusive. In some cases, the manufacturer owns
the outlet to ensure it presents its products in a way that is
appropriate to the brand.
Products that are sold to other businesses (business-to-
business marketing, see page 102) rather than the final
consumer are called industrial goods (rather than consumer
goods). These tend to be distributed directly. This might
include machinery, office equipment and specialised
computer software.
One growing trend in business is for products to be bought
directly from the producer. Distribution is increasingly
zero-level. Customers can access their products online and
buy direct from retailers or even direct from the producer.
Distribution at this point is then either direct to the
customer or via a pick-up point; if customers are using ‘click
and collect’, for example, they order the product online and
collect it later in-store.
The objectives of distribution
The management of distribution will focus on ensuring the
right products reach the right customers at the right time 3.3
and at the right cost. It will aim to ensure the distribution
process:
» gets the products where customers need them; for
example, in the right shops and outlets
» makes sure the products reach where they need to be in
good time and are undamaged
» provides good value for money.
3.3.6 Place (channels of distribution)
Choosing a distribution channel
The choice of distribution channel will depend on factors
such as:
» Access to markets If the target number of customers
is relatively small (for example, you are targeting
a few large companies), then it may be possible to
distribute directly. If, however, you have a mass-market
consumer product, it is not realistic to try to distribute
individually to all your customers – you will want to
use intermediaries to help get your products to the
market. Heinz could not distribute its baked beans to
every individual household in the UK; it has to sell via
wholesalers and retailers.
» The desired degree of control If a producer sells its
products to other intermediaries then it hands over
control of the way they are marketed. The new owner
can change the price, the way it is described relative to
its competitors and where it is displayed in the market.
Concern over the impact of such decisions on the brand
may mean that a producer decides to sell directly or only
via its own outlets.
» Costs It may be cheaper to sell a product direct to
the customer. If the product goes through various
intermediaries, all of whom add on their own profit
margin, the final price will probably be higher than if
the business sold direct to a customer.
Companies such as Amazon.com, Direct Line and
lastminute.com have turned the distribution of their
services into a major competitive weapon. By distributing
directly to the customer, they have cut their own costs
(enabling them to offer better value) and provide a more
convenient service for customers. You can now order your
weekly shopping, buy your books, check your bank account
and book your holiday from home. The internet allows many
firms (even very small firms) to deal directly with their
customers on a global basis.
Choosing the right distribution channel is an important (and
often under-estimated) part of the marketing mix. It can
have a big impact on the success of the business in terms of
factors such as:
» market coverage
» costs
» control over the way the product is promoted and
marketed in-store.
135
 Digital distribution
3.3 One of the growth areas of business is digital distribution,
when customers access products directly online. When Netflix
began, it physically distributed films on CD to customers’
homes. The films were posted out and posted back. It now
produces content which is digitally distributed online. This
has transformed the entertainment industry.
Music is another example of an industry which has been
revolutionised by digital distribution. Many years ago, music
AS LEVEL 3.3 THE MARKETING MIX
Other examples of digital distribution are e-books and
computer games. The Coronavirus (COVID-19) pandemic
in 2020 forced many businesses to increase their online
provision; this is speeding up digital distribution in sectors
such as education and health care.
Digital distribution is cheap and enables products to be
available to customers whenever they wish, wherever
they wish, through a variety of devices. However, digital
distribution will not be appropriate for markets where
customers want a physical product such as clothing.

companies produced physical records and distributed these

physically to stores. Now, via providers such as Spotify,
customers can consume music digitally.

CASE STUDY
E-commerce sales in Asia
In billion USD 90%
1462 83%
1286 77%
1188 74% 74%
1077
957
832
707

2017 2018 2019f 2020f 2021f 2022f 2023f

Note: f = forecast data

Bangkok Central North North-east South

▲ Figure 3.33 Percentage of adults owning mobile

17%
phones in Thailand

35% E-commerce is a very fast-growing industry in Thailand.

According to the Ministry of Digital Economy and Society,
16% Thai e-commerce has grown the fastest of all economies
that are part of the Association of Southeast Asian Nations
(which is a group of countries that trade together) at 14–18
per cent a year.
11%
21% With a national income of $602 billion, Thailand is
the second-largest economy and the second-largest
business-to-consumer e-commerce market in Southeast
Asia (Indonesia is the largest).
The e-commerce market in Thailand is worth $3.5
By segment (2018)
billion. This is expected to reach $13 billion by 2025,
given the higher level of demand for Thai products.
Fashion Food and beverage, and Demand is especially high for electronics, but behind
Home and personal care this there are high levels of interest in fashion, jewellery,
Electronic and media Furniture and appliances watches, health and beauty products, and car parts.

Toys, hobbies and DIY

▲ Figure 3.32 E-commerce sales in Asia

136
 One reason for the growth of e-commerce is the
high number of internet users. Nearly 60 per cent of
households have the internet in Thailand; this is one of the
highest rates in Southeast Asia.
In 2008 there were 16.1 million internet users; by 2018
this had increased to approximately 45 million. There are
also currently 124.8 million mobile subscribers, 44 million
LINE messenger users and 52 million Facebook users.
In Thailand, 52 per cent of online transactions are made
on mobile devices, making the country a regional leader
in mobile commerce. (Thailand is second only to South
Korea, at 58 per cent.) The Thailand Marketing Research
Society reported that 71 per cent of smartphone users
Getting the right distribution outlet
Of course, the nature of the distribution outlet itself can
have an impact on the buying experience. The layout of
the stores, the decor, the availability of staff and changing
rooms, and the in-store displays all leave an impression
and influence the customer’s view of a product. This is
particularly important for speciality items such as luxury
cars, jewellery or sophisticated technology. Visit a Mercedes
dealership, a Gucci outlet or an Apple store and you
immediately get a sense of the brand values.
If producers of such products are selling through stores
(theirs or anyone else’s), the store design and the way their
products are displayed is very important. IKEA, the Swedish
furniture retailer, is renowned for its highly effective store
design. Its stores are very large and are placed out of town.
This makes it cheaper for the company to offer a large
number of parking spaces. The stores are relatively easy
to get to for car drivers, which is important because the
items bought are often big and bulky. Once customers get
there, the stores are designed in such a way that customers
have to walk through all the displays to get to the tills –
you cannot ‘nip in’ and buy one thing. This may mean that
customers buy more than they had planned.
In supermarkets, all kinds of techniques are used to make
you buy more:
» The width of the aisles and the music being played
affects the speed that you walk around the store.
» You will usually be greeted by the fresh-fruit displays
when you walk in; this creates an impression in your
mind that all their products are fresh.
engage in online shopping twice a month, and 90 per cent
plan to shop online in the future.
Unsurprisingly, Thailand is an appealing target for
3.3
foreign investment, due to its market size and growing
e-commerce potential. Already Chinese internet giants
like Alibaba and JD.com have invested there.
Source: www.thailand-business-news.com/tech/ecommerce/75276-
thailand-ecommerce-market-shooting-for-success.html
Questions
3.3.6 Place (channels of distribution)
1 Analyse one reason why e-commerce is growing
fast in Thailand. [4]
2 Evaluate the benefits of e-commerce to
producers. [12]
» The aroma in the store is likely to be fresh bread (many
now have bakeries on-site, but even if they do not, they
can create the smell of fresh bread); this tends to create
positive, warm feelings within us.
» You will usually enter on the left-hand side of a store
because we tend to like walking in and turning right.
» The basic items such as bread and milk will usually be
at the back of the store, so that you have to pass many
other items to find them and hopefully buy other things
along the way.
» Key items on promotion will be placed in display bins at
the end of aisles so you see them when you turn, or by
the tills; these are to prompt impulse-buying.
» Complementary items such as soft drinks and crisps will
usually be placed near each other, as buying one may
prompt buying the other.
Store designers have become very aware of the effects that
the decor and layout can have on customers, and they have
therefore become much more sophisticated in their designs.
The physical environment is an element of the marketing
mix, because it can have an important effect on where we
choose to shop and how we behave as shoppers while we are
there.
GLOSSARY TERM
The distribution outlet is where the product is actually
sold; for example, the shop.
137
 CASE STUDY
3.3
Hotel Chocolat
When Angus Thirlwell and Peter Harris opened the very
first Hotel Chocolat shop in north London in 2004, ‘it
was the start of a revolution in British chocolate’. The
two entrepreneurs were determined ‘to make chocolate
exciting again’. Hotel Chocolat now has 103 shops
along with cafés and restaurants, three boutiques in
AS LEVEL 3.3 THE MARKETING MIX

Copenhagen and a hotel on its cocoa plantation in the

Caribbean.
Thirlwell and Harris started an online chocolate business,
investing £5000 each, but found greater success with
a conventional high-street presence. The stores were
carefully designed to reflect the premium chocolate sold
there. The company chose dark-walnut wood interiors and
porcelain tiles. It used long counters like a hotel reception
desk, and made the stores spacious so that people could
wander around, like in a hotel lobby. Whereas fast delivery
was the sales pitch of the internet website, quality was the
selling point of the stores.
The company prides itself on doing things differently.
It says that right from the beginning it ignored what it
was told. When it began and was told to make the shells of
its Easter eggs as thin as possible, it did the opposite and
made them incredibly thick! When it was told it must make
chocolate bars with bite-sized pieces, it decided on giant
slabs! ▲ Figure 3.34
The company is unusual in that it grows its own cocoa. Questions
This is grown on its Rabot Estate plantation in Saint
1 Analyse one factor that Hotel Chocolat might take
Lucia. Unlike most chocolate, Hotel Chocolat focuses on
into account when deciding a location for a
more cocoa and less sugar. Often, 40–50 per cent of its
new store. [4]
ingredients are cocoa; much more than is typical in the
2 Evaluate the possible reasons why Hotel Chocolat
industry.
was more successful when it opened stores than
Source: https://us.hotelchocolat.com/our-story when it was just operating online. [12]

CASE STUDY
L’Oréal and distribution
L’Oréal produces beauty products, hair products and fragrances. It uses seven distribution channels, shown in
Figure 3.35.

7 distribution
channels

Department
Pharmacies and Hair salons Branded retail Mass retail Travel retail E-commerce
stores and
medispas
perfumeries

▲ Figure 3.35 L’Oréal distribution channels

Questions
1 Analyse one factor L’Oréal will consider when choosing a distribution channel. [4]
2 Evaluate the advantages and disadvantages of the different channels of distribution used by L’Oréal. [12]

138

STUDY TIP
You need to think about the factors that influence a
company’s choice of distribution channel and its outlets,
and the effect this has on its costs and the quality of
service it provides.
A business may improve its effectiveness by reviewing its
distribution, as this may influence its market coverage, the
level of service provided and its costs. Many people under-
estimate the importance of distribution, but it is often
vital to the success of a product. You will only sell chewing
gum or newspapers if they are widely distributed and well
displayed, for example.
The internet and marketing
The growth of the internet is an important external change
which has, of course, had a big impact on marketing
activities. For example, businesses can now:
» trade globally 24 hours a day, seven days a week,
relatively easily
» use very targeted marketing; for example, using Google
AdWords so that your advert only shows when some key
words are used
» monitor consumer behaviour very accurately; for
example, tracking how visitors to the website move
around the site
» charge different prices depending on where people are
searching from and when they search. This is known
as dynamic pricing (see page 126) and is used a lot by
airlines and hotels. The price you are offered depends on
when you enquire and what the demand is at that stage;
if there are still lots of vacancies, the prices tend to be
lower
» use direct distribution from the producer to the consumer
without the need for wholesalers and retailers. It also
enables electronic distribution (for example, of music
and books) without a physical product being distributed
(for example, to e-readers and MP3 players).
The impact of the internet on market research and the
marketing mix includes:
» Data The internet allows businesses to gather and
analyse data on consumers far more than was ever
possible in the past. For example, if you go on the
website of a business, it can track what you look
at, for how long and what action you then take. It
can monitor whether this is the first time you have
visited and how you reached the site – for example,
was it through a direct search or via an online advert?
Was it through your laptop or your mobile phone?
This all provides extraordinary amounts of data on
consumers that, with advances in technology, can be
processed quickly and cheaply, allowing very targeted
marketing actions. When developing a promotional
campaign online, a business can set criteria which
3.3
again allow very focused marketing. Google adverts,
for example, can run in a given region for selected
search terms. Facebook ads can target people in a
particular age range with particular interests, hobbies
or lifestyles. Collecting the right data, analysing and
using it effectively can enable very focused marketing.
» Price The internet allows prices to be changed according
3.3.6 Place (channels of distribution)
to when people order (for example, how far in advance
of an event), what time of day they order, whether they
have visited the site before, whether they have bought
from you before. The ability to adjust the price based
on many factors so that there is no ‘one’ price is known
as dynamic pricing. Businesses such as airlines and
online retailers such as Amazon use dynamic pricing very
effectively.
» Promotion Businesses can promote their products online
and target who their adverts reach depending on, for
example, where you are searching from and which terms
you are using to search. Businesses can get others to
help promote their products through viral marketing,
where their own campaign is forwarded via social media
(such as Twitter and Facebook) by individuals to their
friends. Methods of promotion such as blogs and Twitter
are cheap ways of communicating.
» Distribution Businesses can now sell direct to
the customer online rather than selling through
intermediaries. By selling directly through e-commerce,
a business may need fewer physical stores. This is known
as ‘clicks rather than bricks’.
» Product Some products can now be downloaded rather
than having to be physically produced; for example,
music and e-books.
» People Interestingly, people are not necessarily removed
from marketing due to the internet. In fact, many
businesses now promote in their websites the ability to
talk to a customer service representative at any time.
The internet can interest you in an item and the sales
representative can help you with enquiries or to make
your choice.
» Process The internet can make the buying process more
convenient in that you can search more widely than in a
main shopping street.
» Physical evidence The design of a store may be less
significant with the internet, but the design of the
website becomes the key. The appearance, the ease of
finding information and navigating the site affect the
customer experience.
139
 CASE STUDY
3.3
E-books
Book publishers generated almost $26 billion in revenue Questions
in 2019 in the USA. Of this, total print sales were $22.6
1 Analyse one factor that might affect sales of
billion and e-books took $2.04 billion, according to the
e-books. [4]
Association of American Publishers’ annual report (2019).
2 Evaluate the threat that e-books pose for printed
Those figures include fiction, trade and educational books.
books. [12]
AS LEVEL 3.3 THE MARKETING MIX

Despite the disruption of digital media in other industries

(such as news publishing and music distribution), it seems
that people still favour printed books. In part, it is the
physical object. Cover designs, for example, can make a
book appealing and something people want to own and
have in their homes. Physical books act as a reminder of
what you have read, they show others what you have read
and they decorate your home.
Popular print genres include nature, cookery and
children’s books while crime, romantic and thriller
readers prefer to engage with novels via e-readers, says
Nielsen Book International.
In the UK, 63 per cent of physical book purchases are
made by people aged under 44, while 52 per cent of
e-books are purchased by those over 45, according to
Nielsen. ▲ Figure 3.36

TEST YOUR LEARNING

6 a Define the term ‘price discrimination’. [2]
Short answer questions
b Explain one benefit of price discrimination to a
1 Define the term ‘marketing mix’. [2] business. [3]
2 a Define the term ‘product life cycle’. [2] 7 a Define the term ‘brand’. [2]
b Explain one way in which the marketing mix b Explain one way in which developments in digital
might change at different stages of the product promotion help businesses. [3]
life cycle. [3]
8 a Explain one possible objective of promotions. [3]
3 a Define the term ‘extension strategy’. [2]
b Explain one way sales promotions can benefit a
b Explain one extension strategy with an example. [3] business. [3]
4 a Define the term ‘price penetration’. [2] 9 a Define the term ‘distribution outlet’. [2]
b Explain one condition necessary for price b Explain one benefit to a producer of a short
penetration to be effective. [3] channel of distribution. [3]
5 a Define the term ‘price skimming’. [2] 10 a Define the term ‘USP’. [2]
b Explain one condition in the market for price b Explain one benefit to a business of having
skimming to be effective. [3] a USP. [3]

140
Data response question
Harry Potter
Harry Potter is a character who features in a series of
seven children’s books by JK Rowling. The story is mostly
set at Hogwarts School of Witchcraft and Wizardry, and
focuses on Harry Potter’s fight against the evil wizard
Lord Voldemort, who killed Harry’s parents as part of his
plan to take over the wizarding world.
The first novel, Harry Potter and the Philosopher’s Stone, was
published in 1997. Since its launch, the books have gained
immense popularity and commercial success worldwide,
also leading to films, video games and various merchandise –
from ‘Quidditch’ chess sets to ‘HufflePuff’ wall hangings,
‘Goblet of Fire’ candle holders to ‘Hedwig’ pillowcases.
Altogether, the books have sold well over 500 million
copies, have been translated into more than 63 languages
and reach readers via a variety of distribution channels.
The success of the novels has made the author the
highest-earning novelist in literary history.
Although the author did not have any age group in mind
when she wrote the books, the publisher initially focused
on the market segment of young children, aged 9–11.
Rowling, whose first name is Joanne, was asked to use
her initials rather than her first name because it was
thought that young boys would not be interested in reading
a book written by a woman.
Word-of-mouth reviews, especially among young males,
have been an important part of the books’ success.
Rowling’s publishers were able to build on this buzz by the
rapid, successive releases of the first four books, which
maintained interest in the brand.
The launch of a new Harry Potter book was a great event, with
long queues forming outside bookshops and some stores
opening at midnight to sell the first copies. Fan-generated
content, helped by the growth of the internet, has been an
important part of the Harry Potter success story. 3.3
Fan sites such as www.the-leaky-cauldron.org and
www.mugglenet.com help promote products and
merchandise.
One of the most remarkable aspects of Harry Potter’s
success is its appeal to adults, apparently reminded of
classics of their own childhoods. Bloomsbury quickly
acknowledged the purchasing power of these ‘kidults’ by
3.3.6 Place (channels of distribution)
issuing the Potter series as ‘adult hardbacks’, with covers
redesigned using photographs rather than drawings.
Following the original seven books and eight film
adaptations, there are now four Wizarding World of Harry
Potter theme parks (two in Florida, one in Hollywood and
one in Osaka in Japan). The Warner Bros Studio Tour, The
Making of Harry Potter, has had more than 8 million visitors
since it opened outside London in March 2012. Rowling,
who began writing the books as a single mother living on
government benefits, has become hugely wealthy. In 2020,
her fortune was valued at £650 million.
Harry Potter even has its own spin-off prequel series, the
five-star film Fantastic Beasts and Where to Find Them.
Questions
1 Define the meaning of the following terms:
a ‘market segment’ [2]
b ‘distribution channel’. [2]
2 Analyse one way in which the marketing mix has been
used to maintain sales of Harry Potter products. [4]
3 If no more Harry Potter books are written, evaluate
the extent to which this means that sales of Harry
Potter must inevitably decline. [12]
141
 4 Operations management
AS LEVEL
4.1 The nature of operations
AS LEVEL 4.1 THE NATURE OF OPERATIONS
Chapter overview
In this chapter we examine:
★ the factors of production: land, labour, capital and enterprise
★ inputs, outputs and the transformational process
★ how operations adds value
★ the meaning of effectiveness, efficiency, productivity and sustainability
★ capital-intensive and labour-intensive operations
★ the advantages and disadvantages of different operations methods: job, batch, flow and mass customisation.
4.1.1 The transformational
process
The process of transforming inputs into outputs is the
responsibility of operations managers. They are there to
make sure that the process occurs in the way that the
business wants and that particular operations targets are
met. For example, operations managers may be concerned
with achieving a particular level of quality and ensuring
that costs are not too high.
The effectiveness of a business depends a great deal on the
quality and cost of the operations process. If managers can
improve the operations of the business, they can make it
more efficient, increase the volume of output and improve
quality. The marketing function identifies the opportunities
within a market; the operations function then delivers
this as effectively and efficiently as possible. Effective
operations means the business is doing the right thing –
that is, it is meeting its operational targets. The business
produces these products in the right quantities and with
the right specifications. Efficient operations means the
business is doing what it does at a low cost – that is, it is
producing and delivering its products in a cost-efficient
manner. Effective operations should lead to more sales
and profits. Poor operations leads to mistakes being made,
which can result in having to replace items, recall products
or even pay damages.
Operations involves producing physical goods such as cars,
but also providing services, such as schools and hospitals,
which are intangible. These create particular issues: with
physical products, managers will consider how much
inventory (or stock) to hold whereas with services, it is not
possible to hold inventory and so managers have to deal
with queues if demand is high.
The precise nature of operations will, therefore, vary
from business to business. If you are running a hotel,
for example, operations management involves making
142
sure the rooms are ready, the kitchens meet health and
safety requirements, the televisions, kettles and trouser
presses in the rooms work, the towels are washed and dried
and there is enough food to feed the guests. If you are
running a tyre and exhaust centre, operations management
involves making sure you have enough spare parts (held as
inventory) so that you can fix a customer’s car quickly and
safely, the equipment you have is suitable and working,
and you can generate the bill accurately. If you are running
a clothes shop, it involves making sure you have the right
number and mix of clothes on display, the store layout is
appropriate, the queues are not too long and there is a
security system to prevent theft.
GLOSSARY TERMS
The output of a business is the total amount produced in a
given time period.
Inventory refers to the stocks held in a business, such as
materials and semi-finished goods.
Operations management oversees the planning, co-
ordination and control of the transformation process,
turning resources (inputs) into outputs.
There are many different forms of transformation. These
include:
» changing the characteristics of materials, information or
customers. For example, manufacturers take components
and build something new with them. Beauty salons,
hairdressers and cosmetic surgeons take people and
improve their appearance (we hope!). Doctors, dentists,
physiotherapists, psychiatrists and teachers all help us
to improve some aspect of ourselves. Accountants take
our receipts and turn them into a set of accounts to
show investors or government tax inspectors.
» changing the location of materials and information.
Federal Express and Cathay Pacific simply move items
or people around. Google helps you find something that
is already there – it helps you to access information.
 An estate agent gives you information on houses that
you might be interested in. This service saves time
and money for the seller and helps the buyer sell the
property more quickly.
» changing the ownership of materials. Wholesalers buy
in bulk from a number of producers. Retailers then buy
from wholesalers because it is easier to deal with them
than with every single producer: it reduces the number
of transactions and makes the process simpler.
When designing its transformation process, a business must
consider questions such as:
» What level of output will be provided? Is the business
aiming to produce hundreds, thousands or millions of
units? How many customers does the business expect
to have?
» What quality of service will be provided? How many
people will be served in the shop? Will the business
deliver its products to people’s homes? What will its
policy be if people want to return items?
» How will the business provide the service? Will it provide
it online or via shops? Will it use high staffing levels or
invest in more equipment?
» What aspects of the process will the business undertake
for itself and what elements will be outsourced to
or bought in from other providers? The business may
decide to manage the shop itself but get cleaners in
to tidy up, employ accountants to do the finances and
use specialists to design the decor. It may produce a
range of clothes but simply do the design work itself
and get someone else to produce them, like Benetton;
alternatively, it may design and manufacture the
products itself, like Zara and IKEA. All these decisions
will have an impact on the costs, flexibility and the
complexity of running the business.
The transformation process of a business is ongoing and
dynamic. If the output produced is not acceptable or needs
to be improved, the business will have to change the inputs
and/or the way it produces. It will then monitor the results
and, if necessary, change again. Change may also be due to
external factors; for example, increasing concern about the
environment has influenced what is produced and how.
Using factors of production
Operations will involve the management of its factors of
production, such as:
» Land This will include location decisions and finding
the right base for a business, while considering issues
such as the cost and ease of access to supplies. In
some operations processes, such as farming, managing
the land is a key part of the transformation process.
On the other hand, choosing the right site is essential
to a retail operation. Being close to transport links is
essential to exporters.
» Labour This refers to the number and the skills of people
you employ; for example, in sectors such as sport, music
and computer programming, the skills of employees are
absolutely critical.
» Capital This refers to capital goods such as equipment
and machinery. These are vitally important in sectors
such as online businesses, where the technology is at
the centre of the business, or car production, where
4.1
production-line technology determines output, quality
and flexibility.
» Enterprise This refers to the ability of employees to
come up with new ideas, to find solutions to problems
and be creative. This determines what other resources
are used and what the business offers. Enterprise is
4.1.1 The transformational process
very important in sectors such as advertising and
consultancy.
Operations managers must decide on the right combination
of resources for the transformation process given the
desired targets and constraints, such as budgets. This will
depend on factors such as the nature of the process, as well
as the cost and availability of different resources.
The stages of the transformation
process
The operations process involves all the different stages,
including:
» producing the initial idea (for example, in a research
laboratory) to developing prototypes and testing these
to check the product works and is safe to launch
» designing the best method of production to be efficient
and to hit volume and quality targets
» deciding on the levels of inventory which should be held
to keep production going and just in case anything goes
wrong
» ensuring production goes according to plan
» delivering to the next stage in the process, such as a
retailer
» if necessary, handling the recall of products if there are
faults.
STUDY TIP
Remember that operations management can affect the
volume of production, the costs and the quality of the
product. Operational decisions will be linked to the other
functions; for example, to sales, the overall finances of
the business, and the skills and number of employees
required.
Operations management involves all the stages of the
transformation process and therefore is directly involved
in the process of adding value. The more efficient the
operations process, for example, the fewer resources are
used up for the output produced and so more value can be
added. Similarly, the better quality the product and the
more effectively that it meets customer needs, the more
likely sales are to increase and the more the customer
may be willing to pay for the product, which increases the
value added.
143
 Marketing is responsible for identifying the needs of
customers; this department must work with operations to
4.1 find the best way of fulfilling these needs while at the
same time meeting the business objectives. For example,
marketing will identify the key benefits customers want
and the prices they are willing to pay; operations must then
see if it can meet these targets at an appropriate cost. If
operations can deliver the right combination of products at
the right time and quality, and do this efficiently, it will be
adding value to the business. Effective operations provides
something customers want and are able to pay for at a cost
AS LEVEL 4.1 THE NATURE OF OPERATIONS
that is profitable for the business.
CASE STUDY
Mondelēz International
Mondelēz International is a snacks business that sells its
products all over the world. Its product portfolio includes
chocolate, biscuits, gum and candy. These include world-
famous brands worth billions of dollars such as Cadbury,
Oreo, belVita, Milka and Trident.
Part of the success of the business is due to the
effectiveness and efficiency of its operations. According
to the company, the manufacturing process at Mondelēz
International includes:
● safety and environmental measures. These measures
are to ensure that the business meets global, national
and local safety, security and environmental standards
and regulations
● planning and scheduling production, and ensuring that
the correct supplies of raw materials and packaging
4.1.2 Efficiency, effectiveness,
productivity and sustainability
The importance of efficiency and
effectiveness in operations
The operations manager will want the operations process
to be both effective and efficient. An operations process is
effective if it achieves its set target; for example, it
produces the target of 200 units a day. The process is
efficient if it does not waste resources and if it minimises
costs given the quantity and quality required.
A production process may be effective but inefficient if it
is producing the target but at a high cost. Equally, it may
be efficient at what it does but ineffective if it is producing
the wrong thing or the wrong quantity.
STUDY TIP
Effectiveness focuses on what you do.
Efficiency focuses on how you do it.
144
The operations of a business will, therefore, affect the value
added because it will affect factors such as:
» the amount of resources used and how they are used,
affecting cost of production. The more efficient the
operations are, the less waste there is and the lower the
cost per unit should be.
» the quality of production and factors such as speed of
delivery, which will affect how much customers will pay
and how many sales are made.
materials, labour and finished goods to meet
production and meet customer demands are in place
● developing new production methods and processes
● ensuring the quality of products
● acquiring, installing and maintaining capital
equipment and ensuring this remains functional.
Operations jobs include production operators, who are
in charge of the production lines, and plant managers,
who have overall responsibility for their area and who are
constantly seeking to improve the production process.
Questions
1 Explain one way that operations management
can add value for Mondelēz International. [3]
2 Evaluate the importance of effective operations
management to Mondelēz International. [12]
The importance of productivity in
operations
One measure of efficiency is productivity. This measures
the output produced given the inputs used up. Productivity
is very important to businesses because managers will want
to get the most from the resources that they have. Greater
productivity increases efficiency because:
» the more output produced from a given input, the lower
the unit cost
» the less input needed for a given level of output, the
lower the unit cost.
That is, greater productivity leads to higher efficiency.
Labour productivity specifically measures the output per
worker. The equation to calculate this is:
total output
labour productivity =
number of employees
Labour productivity measures the output of a business in
relation to the number of employees. For example, if 10
people produce 50 units in total each week, their productivity
is 5 units each. The higher the labour productivity, the more
is produced per person per time period.
Productivity is a crucial concept in operations management
because it can have a significant effect on the cost of
producing a unit. The higher the productivity, the more
units each worker is making and, if wages are unchanged,
the labour cost per unit will be cheaper. As a result,
managers are constantly seeking ways of improving labour
productivity because this means the firm can either make
more profit per unit, can reduce the price to become
more competitive or can produce more. Improving the
effectiveness of the business may therefore be directly
related to improving the productivity of its resources.
Imagine a juice drinks business where employees are
squeezing the fruit by hand; if they bought a juicer,
productivity would increase so that more customers could
4.1
be served or fewer staff might be required.
GLOSSARY TERM
Productivity measures the output per hour, per person or
per machine.

4.1.2 Efficiency, effectiveness, productivity and sustainability

HANDLING DATA
Copy and complete Table 4.1. Assume that employees are paid $200 each per week.
▼ Table 4.1 Calculating labour productivity

Number of Weekly wage Output Productivity Labour cost per unit

employees bill ($) (number of units) (output/number (weekly wage
of workers) bill/number of units)
100 $20 000 1 000 10 $20
100 ? 2 000 ? ?
50 ? 1 000 ? ?
? ? 2 000 40 ?

be able to make more output than colleagues who are

How can productivity be increased? using outdated equipment. As the UK’s Department
Increasing of Business and Skills says when commenting on the
Investment in the number low productivity in the UK compared with many other
equipment of hours countries: ‘A worker can be 100 per cent efficient with a
and worked
Training shovel but it won’t count if his international counterpart
technology
is equipped with a JCB!’
Changing the
» Changing the way that work is done If the way in
Ways to Motivating which a product is made is changed, this can affect
way the
increase employees
work is done
productivity
the speed and the effectiveness of the production
process. Many firms have implemented teamworking
▲ Figure 4.1 Ways to increase labour productivity
in recent years, resulting in improved productivity
levels. If activities in the process can be combined and
Labour productivity may be increased by using a variety of undertaken simultaneously rather than in sequence,
techniques. this speeds up production and enables higher
» Increasing the number of hours worked If employees productivity.
work more hours or more days each week, this could » Motivating employees If employees can be motivated
increase their output. However, this is not necessarily a (perhaps by offering more rewards or by giving people
long-term means of increasing employees’ productivity more responsibility – see Chapter 2.2) effort and
because they are likely to get tired and stressed, and may productivity may increase.
therefore become less productive in the long term. Also, At any moment, managers will have to consider which of
there is a limit to how many extra hours can be worked. the above options are available given the firm’s resources,
» Training This is a very important way of increasing and which will work best when it comes to boosting
productivity. Training can increase employees’ output by productivity. In one business the issue might be motivation;
helping them to gain more skills and to learn new and in another it might be a lack of modern equipment. If
better ways of doing things. managers can boost productivity, they will be improving the
» Investment in equipment and technology If employees performance of the business.
have modern and more efficient machinery, they should

145
 CASE STUDY
4.1
Finance Against Warehouse Receipts
AS LEVEL 4.1 THE NATURE OF OPERATIONS
▲ Figure 4.2 Nyiombo Investments Ltd is now able to
meet more than 60 per cent of Zambia’s fertiliser
demand.
It is often very difficult for farmers in Africa to get loans in
order to buy essential materials such as seeds, fertilisers
and pesticides. This is because they lack assets to act as
collateral and so many banks are not willing to take the
risk. Without these resources, farming is inefficient and
CASE STUDY
Assembly lines
▲ Figure 4.3 One of the first assembly lines was for the
Model T.
Employee resistance to higher
productivity
While managers might be eager to increase productivity,
employees may resist such efforts, because:
146
so the returns the farmers gain are low. To help improve
the situation, the Standard Chartered Bank has helped
develop various financing schemes to enable farmers to
get the finance they need. One of these is called Finance
Against Warehouse Receipts. Under this scheme, farmers
use their crops as collateral; the corn, soya or wheat act
as the security for the loan.
For example, through this scheme, Standard Chartered
has been able to finance farmers’ borrowing to buy
fertilisers. The use of these fertilisers has boosted
average crop yields to over a tonne per hectare – a
significant increase in productivity. The programme has
been so effective that it has helped the country move
from importing maize to producing bumper harvests and
becoming an exporter.
Questions
1 Explain one way you could measure the productivity
of a farm. [3]
2 Evaluate the ways in which farmers might improve
the productivity of their farms. [12]
The Model T Ford was produced between 1908 and 1927.
During that time, Henry Ford introduced assembly line
techniques which dramatically increased productivity.
Each car moved along a line with parts being added to it;
individual workers specialised in a particular aspect of
production. As a result, producing a car took 93 minutes
instead of 12 hours and this brought down unit costs so
much that the price could fall from $890 to $240. The
ability to produce a reliable car at a relatively low price
made this a tremendous success; so much so that, at its
peak, the Model T accounted for 50 per cent of all cars in
the USA and 10 per cent of all the cars in the world.
Questions
1 Analyse one reason why unit costs usually decrease
when productivity increases. [4]
2 Evaluate the possible implications of introducing
assembly line techniques. [12]
» they do not want to work longer or harder
» they do not want to learn new skills
» they fear that higher productivity levels may lead to job
losses
» they feel it is unfair that they are producing more unless
they receive higher rewards.

STUDY TIP
Remember that employees may not welcome efforts to
increase productivity. Also, increasing productivity may
lead to a fall in quality if production is rushed.
The importance of sustainability in
operations
Customers are increasingly interested not only in what a
business produces but also how it produces it. For example,
customers may want to know where supplies come from and
how employees are treated. They may also want to know
how sustainable the operations process is.
Sustainable operations are operations that meet the
present needs of the business and, indeed, society without
compromising on the ability to meet future needs – they do
not use up resources that could be used in the future. For
example, if energy is sourced from non-renewable sources, such
as coal-fired generators, this is a non-sustainable source – the
coal is being used up. If, however, the energy a business uses
comes from wind power, the wind cannot be used up (it is
renewable). Sustainability also involves considering the impact
of the operations of a business on the environment – does it
pollute? Does it create emissions? Does it generate waste?
Customers and society as a whole are much more aware
of climate change issues and of the relationship between
businesses and the environment. This awareness is because
we have more information on the damage that has been
done to the environment and there is a greater appreciation
that the need for change is becoming urgent. Becoming
more sustainable therefore involves:
» using more resources that are not used up by consuming
them, such as recycled materials
» using fewer resources generally
» recycling and reusing resources more
» reducing the negative impact of a business’ activities on
the environment.
CASE STUDY
Coca-Cola
Coca-Cola, the world-famous drinks company, says that
its purpose is clear: to ‘refresh the world’ and ‘make a
difference’. It says it does this by creating loved brands
and ensuring these are produced sustainably. The
company says it aims to make a difference in people’s
lives, communities and the planet as a whole by doing
business in the right way.
In 2018, Coca-Cola launched its approach to sustainability,
called World Without Waste, with what it said was a
simple, focused purpose: to make the world’s packaging
waste problem a thing of the past. World Without Waste
has three fundamental goals:
● to make 100 per cent of its packaging recyclable,
globally, by 2025
The implications for a business of the greater interest in
sustainability are:
» the need to reconsider what is produced. For example, in
the car industry there has been a very significant increase
4.1
in the demand for electric vehicles in recent years rather
than diesel or petrol; this is because electric vehicles
are less harmful to the environment. National and local
governments in many countries are introducing legislation
to force the switch to electric vehicles
» the need to reconsider how products are produced. For
example, can renewable sources of energy be used? Can
4.1.2 Efficiency, effectiveness, productivity and sustainability
waste be reduced and can fewer resources be used in the
process?
» the need to reconsider the packaging used. A great
deal of packaging in the past has been non-recyclable.
Plastic packaging has come under particular attack
because of the levels of plastic found in the sea and the
impact of this on sealife.
Being sustainable will:
» involve change. This will need planning and will involve
training and getting employees to understand the need
for change
» involve costs for new equipment.
However, the benefits are:
» These actions are good for the environment and
therefore good for society as a whole.
» These actions may attract customers, employees and
investors who are looking for businesses who behave in
this way.
» These actions may avoid negative comment in the media.
» These actions may be necessary by law or may be in
advance of future mandatory changes so the firm does
not have to be reactive.
GLOSSARY TERM
Sustainable activities are those that meet the needs of the
business or of society without compromising on the ability
to meet future needs.
● to use at least 50 per cent recycled material in its
packaging by 2030
● to collect and recycle a bottle or can for each one that
it sells by 2030.
Coca-Cola is aiming to make packaging part of a circular
economy, with a focus on the collection of 100 per cent of
its products and an increase in the recycling it does. Its
goal is to create what is called a ‘closed-loop system’ in
which old bottles and cans can become new bottles and
cans.
Questions
1 Define the term ‘sustainable operations’. [2]
2 Evaluate the importance of sustainability to the
success of Coca-Cola. [12]
147
 In the case of labour-intensive processes, many of the costs
CASE STUDY are variable, whereas in capital-intensive processes, costs
4.1 How often do you include sustainable
How often do you include sustainable packaging in your
are mainly fixed.
purchasing decision? Global top 10 countries in 2019 (%) ▼ Table 4.2 Advantages and disadvantages of labour- and
packaging in your purchasing decision? capital-intensive processes

Always 10 10 7 9 Advantages Disadvantages

Labour- Production may be May take time to train
20 23 24 intensive flexible to customer staff with necessary
Usually 25
processes needs skills
AS LEVEL 4.1 THE NATURE OF OPERATIONS

Less expensive to Product may vary in

set up than buying consistency and quality
45 43 equipment
46
Sometimes 47 Employees can use Volumes produced may
skills and initiative be low
to be creative
Capital- Can produce high Can be expensive to
25 27
Never 17 21 intensive volumes set up
processes Output can be High fixed costs
Millennials Gen Xers Baby Average standardised and increasing break-even
boomers consistent output
Source: McKinsey & Company May be able to Can be difficult to
▲ Figure 4.4 Sustainable packaging – influence on produce continuously customise products to
purchasing decisions (%) individual customer
needs
Question
1 Evaluate the significance of the above data for ▼ Table 4.3 Capital-intensive versus labour-intensive
businesses. [12] processes

Capital-intensive processes Labour-intensive processes

4.1.3 Capital-intensive and Expensive to set up Lower set-up costs

labour-intensive operations Can produce high volumes May involve lower output
levels
A capital-intensive process is one that involves a relatively
Can achieve lower average May be relatively expensive
high proportion of machinery and equipment relative
costs if volume is high for high volumes as high
to other resources. Imagine a bottling process using a
amounts of labour are needed
production line and producing millions of bottles a day.
Other examples of capital-intensive processes are car May be relatively inflexible Can be quite flexible
manufacturing, oil refining and airlines. A capital-intensive
process can produce high quantities of a standardised
product at a relatively low unit cost (as the costs are spread GLOSSARY TERMS
over so many units). However, a capital intensive process: Capital-intensive production means there is a high
» can be expensive to set up with investment in proportion of capital (for example, machinery) used
technology relative to other factors of production.
» can be relatively inflexible in terms of producing Labour-intensive production means there is a relatively
different versions of the product (although technology high proportion of labour (employees) used relative to
means that flexibility is now improving) other factors of production.
» is expensive per unit if only a few items are produced.
A labour-intensive process uses a relatively high proportion
of people (such as full-time, part-time and temporary STUDY TIP
staff) compared to other resources; for example, a design Whether a process should be capital or labour intensive
business, hotels, or a fruit-picking business. will depend on factors such as the importance of a
Using a high proportion of labour can enable the business personal service, the finance available for investment and
to be very flexible and produce a wide range of personalised the volume of output required.
services. However, it may limit the volume of products that
can be produced.

148
4.1.4 Operations methods: job,
batch, flow, mass customisation
Job
process
Different
Mass
types Batch
customisation
process
of operation process
processes
Flow
process
▲ Figure 4.5 Different types of operation processes
There are different types of operation methods. Some of
these are:
» Job production This involves one-off production.
Imagine the work of a portrait artist, wedding
CASE STUDY
Coca-Cola and COVID-19
In 2020, Coca-Cola opened the world’s fastest bottling
production line in Chengdu, Sichuan province. This was
part of the United States-based Coca-Cola’s efforts to
increase its manufacturing capacity and investment in
China.
The new plant is able to produce 120 000 cans every hour,
while the current industry average ranges between 66 000
cans and 90 000 cans every hour. This equates to 260 000
metric tons of products every year, worth around 1.3
billion yuan ($183 million). This is also Coca-Cola’s only
automatic production line that is able to produce a variety
of different packaging specifications simultaneously.
Coca-Cola’s first production plant in China was built
in 1999 in Chengdu. This more recent investment was
part of the company’s attempts to increase work and
resume production after the 2020 Coronavirus (COVID-19)
pandemic. This involved investing in equipment renewal
and technical transformation, and upgrading facilities.
photographer or architect. Each item is unique for each
customer, which means that production is very flexible.
It tends to require a wide range of skills because of the 4.1
range of jobs that may be done. It also requires good
project management skills because each order is unique
and will have different planning requirements. As a
result, job production tends to be quite expensive.
» Batch production This occurs when items move together
from one stage of a process to another. For example,
when producing bread you bake one batch at a time.
This approach is cheaper per unit than job production
4.1.4 Operations methods: job, batch, flow, mass customisation
because you are producing products in groups. At the
same time, you have some flexibility to change the
recipe or approach from one batch to another.
» Flow production This involves large-scale production
using production-line technology. It is capable of huge
volumes (for example, of cans of beans or bottles of
water) but produces relatively standardised products.
Products ‘flow’ from one stage to another. It is relatively
expensive to set up to buy the production equipment
and is not especially flexible in terms of producing
a variety of products. However, if the volume of
production is high, the set-up costs can be spread over
many units, meaning the unit costs will be relatively
low. Mass production suits mass markets where demand
is stable and high.
» Mass customisation This is a relatively new
development made possible by technological advances.
This type of process is on a large scale but, whereas
mass production usually lacks flexibility, this
technology enables a variety of models to be produced
Globally, Coca-Cola experienced significant changes in
consumer buying patterns in 2020, with significant falls in
the buying of drinks through distribution channels known
as ‘away-from-home channels’, such as shops.
To expand its range of products, Coca-Cola has recently
combined forces with the Chinese dairy business China
Mengniu Dairy Co. This joint venture will produce
and sell chilled milk, which is expected to have a real
potential for growth in China. Coca-Cola is also offering
a new range of ready-to-drink coffee products in China
under the Costa brand, to further benefit from the
country’s rising ready-to-drink market. Costa Coffee
entered the Chinese market in 2006 and now has over
500 stores there.
Questions
1 Explain one way in which the Coronavirus
(COVID-19) pandemic affected Coca-Cola’s sales. [3]
2 Evaluate the benefits of this new production line
for Coca-Cola. [12]
149
 on the same production line. VW, for example, uses
the same basic car platform for many of its cars. Mass
4.1 customisation generally involves heavy investment in
technology.
▼ Table 4.4 Operations processes
Type of production Features
Job One-off, unique, tailor-made items
Batch Items move as a group from one
AS LEVEL 4.1 THE NATURE OF OPERATIONS
stage of the process to another
Flow Items move continuously from one
stage of the production process to
another
Mass customisation Large-scale production with the
flexibility to produce a number of
different models
TEST YOUR LEARNING
Short answer questions
1 aDefine the term ‘operations management’.
bExplain one way in which effective operations
management can increase the profits of a
business.
2 Define the terms ‘effectiveness’ and ‘efficiency’.
3 a Define the term ‘labour productivity’.
b Explain one way of increasing productivity.
4 a If output is 300 units and the number of
employees is 20, calculate the labour
productivity.
b Explain one reason why a business might
want higher productivity.
5 Explain one reason why employees may resist
attempts to increase labour productivity.
6 a Define the term ‘sustainable operations
process’.
b Explain one reason why sustainability is
important to a business.
7 a Define the term ‘labour-intensive’.
b Explain one benefit of a labour-intensive
production process compared to a
capital-intensive production process.
8 Explain one reason why a business may adopt a
capital-intensive production process rather than
a labour-intensive production process.
9 a Define the term ‘job production’.
b Explain one benefit of batch production
compared with job production.
10 a Define the term ‘flow production’.
b Explain one benefit of mass customisation to a
business.
150
Problems of changing from one method
of production to another
Changing from job to batch to mass production will depend
on the nature of demand. Mass production requires high
volumes and therefore is not appropriate for job production,
where each item is unique. Batch production enables
relatively high outputs and some flexibility (for example,
printing batches of different magazine titles) but is not
appropriate if a customer wants something unique.
Moving from job to batch to mass production will require
investment in capital equipment. It will enable higher
volumes (assuming the demand is there) but there will be
less flexibility in terms of tailoring the product to customer
needs.
Data response question
[2] The Singaporean economy
Singapore has a highly developed and successful free-
market economy. The economy depends heavily on exports,
[3] particularly of electronics, petroleum products, chemicals,
[4] medical and optical devices, pharmaceuticals, and on
[2] Singapore’s vibrant transportation, business, and financial
[3] services sectors.
In the last ten years, the economy of Singapore has grown
by an average of 5 per cent a year. The country’s productivity
[2] has also grown over the same period by about 1 per cent a
year, which matches that of other developed economies. The
[3] majority of the population in Singapore has benefited from
a growth in earnings and a rise in their standard of living.
[3]
Even so, productivity gains have been slower than in
the past due to more reliance on people for growth;
[2] for example, in the service sector. The government of
Singapore is eager to improve productivity and sees
[3] this as a key driver of economic growth. It is focusing
[2] on ways of improving productivity through a number of
programmes and schemes. Singapore has attracted
major investments in advanced manufacturing,
[3] pharmaceuticals, and medical technology production.
Source: www.forbes.com/places/singapore/?sh=5268e7dcc959
[3] Questions
[2] 1 Define the terms:
a ‘productivity’ [2]
[3]
b ‘economic growth’. [2]
[2]
2 Analyse one reason why an increase in productivity
can help businesses and the economy to grow. [4]
[3]
3 Evaluate the ways in which the Singaporean
government could help businesses to improve
their productivity. [12]
4 Operations management
AS LEVEL

4.2 Inventory management

4.2.1 Managing inventory

Chapter overview
In this chapter we examine:
★ how to manage inventory
★ how to interpret inventory charts
★ the importance of supply chain management
★ just in time (JIT) versus just in case (JIC) inventory management.

4.2.1 Managing inventory The costs and benefits of holding

Purpose of inventory
The term ‘inventory’ refers to products that the business
owns but will use up during the operations process.
Inventory was previously also called stock.
Types of
inventory
Work in Finished General
Raw materials
progress goods supplies
▲ Figure 4.6 Different types of inventory
Types of inventory include:
» raw materials – these are items used in the production
process
» work in progress (semi-finished goods) – these are items
where some work has been done on them but they are
not complete
» finished products – these are goods that are ready to be
sent to the customer
» general supplies – these are items that are used to keep
the business going, such as supplies of cleaning materials.
These inventories are held:
» to enable production to take place and so that orders
can be met
» just in case anything goes wrong. For example, you
may want to hold excess materials in case there is a
problem with deliveries from the supplier; you may want
to hold inventories of semi-finished items in case there
is a breakdown in part of the system; you may want to
hold finished goods in case there is a rush order from a
customer.
inventory
The benefits of holding inventory are that you have
products ready if you need them, and if there are any delays
or breakdowns in the process you can continue to operate.
This means sales can continue and the business generates
revenue. However, holding inventory can lead to:
» costs of storage – for example, the costs of a warehouse
facility
» opportunity cost – because the money invested in
inventories could be used elsewhere to earn money.
Money in inventory is therefore ‘tied up’ and not
generating more returns
» security costs – to protect the materials from damage
or theft
» the risk of the inventory depreciating, that is, becoming
out of date – this may be because the inventory goes off
(in the case of food) or becomes unpopular (in the case
of fashion items) and so is wasted.
Buffer inventory, reorder level and
lead time
» Buffer inventory is the minimum amount of inventory a
business wants to hold just in case of problems.
» The lead time is how long it takes from ordering the
supplies from a supplier to them arriving at the business.
» The reorder level is the amount of inventory left at
which a business needs to place an order so that the
new inventories arrive before the business goes below
its buffer level.
» The reorder quantity is the amount ordered each time.
Inventory (stock) control charts
Inventory control charts can highlight how much inventory
is being used up, how much to reorder and when.

151
 In Figure 4.7, the business uses up 200 units a week at a
constant rate. It wants to always hold 100 units as a buffer Inventory 900

4.2
(units)
inventory just in case. The lead time is one week. This 800
means the business needs to reorder at 300 units. As the
supplies are being made and delivered (which takes one 700
week) another 200 units will be used up, which means that
600
when the order arrives, the business is down to its buffer of
100. The reorder quantity in this case is 800 units a month 500
(given that the business expects to use up 200 units for
400
each of the four weeks). Figure 4.7 assumes that the usage
rate of the inventory is constant each week.
AS LEVEL 4.2 INVENTORY MANAGEMENT

300 Reorder level

Inventory 900 200

(units)
800 100 Buffer inventory
700
0
600 1 2 3 4 5 6 7 8 9 10 11 12 Time
(weeks)
500
Run out of inventory
400
▲ Figure 4.9 Effects of failing to reorder
300 Reorder level
200
Inventory (stock) control
100 Buffer inventory
The decision on how much inventory to hold is a trade-
0 off between the costs of holding the inventory and the
1 2 3 4 5 6 7 8 9 10111213141516 problems that might occur if inventory is not held.
Time
(weeks)
The minimum amount of inventory that a firm wants to hold
▲ Figure 4.7 Inventory control chart at any time is known as the buffer inventory (or the safety
inventory). If the level of inventory falls below the buffer
In Figure 4.8, we see a situation where the inventory starts level, there may be a risk of running out; this could either
to be used up at a faster rate after week 8 and the business halt production or mean that customers have to be turned
therefore runs out of inventory before new supplies arrive. away because no finished goods are available. Several factors
This is known as an ‘inventory out’. influence the level of buffer inventory a business holds:
» the rate at which inventory is generally used up. The
Inventory 900 faster inventory is used up, the more the firm will have
(units)
800 to hold at any moment
» the warehousing space available. The smaller the space
700
the firm has for storage, the lower the level of inventory
600 » the nature of the product. If the product is fragile or
500 likely to depreciate, the firm will not want too much
inventory in case it breaks or loses value rapidly
400
» the reliability of suppliers. The more reliable suppliers
300 Reorder level are, the fewer buffer inventories the firm needs to hold,
200 because it knows it can get more as and when required
» the suppliers’ lead time. The lead time is the time it
100 Buffer inventory
takes for products to arrive from when they are ordered.
0 If the lead time is two days, for example, this means
1 2 3 4 5 6 7 8 9 10111213141516
Time
that it takes two days for supplies to arrive once you
(weeks) have ordered them. The shorter the lead time, the
Run out of inventory
smaller the amount of inventories a firm needs to hold.
▲ Figure 4.8 Example of a business running out of If, however, the lead time is long, the firm will need to
inventory hold more inventory to last while it waits for a delivery.
In Figure 4.9, the supplies do not arrive – perhaps due Effective inventory management involves making sure that
to a problem at the supplier because inventory was not the business does not have too much or too little inventory.
re-ordered – leading again to an inventory out.

152

HANDLING DATA
800
700
600
Inventory (units)
500
400
300
200
100
0
1 2 3 4 5 6 7 8
Time (weeks)
▲ Figure 4.10 Inventory control chart
1 What is the reorder quantity in the inventory chart
above?
2 What is the lead time?
3 How many units are used up each week?
CASE STUDY
COVID-19 and retailers
The Coronavirus (COVID-19) pandemic of 2020 created
major problems for retailers. In many countries,
retailers of non-essential products were forced to shut
down for extended periods. For clothes retailers, this
meant that they had inventory that would be seen as out
of fashion. Inditex, the world’s biggest fashion retailer,
announced that it was writing off over $300 million
worth of inventory. This means the company reduced its
valuation of what the inventory was worth.
Some retailers responded to the virus by cutting prices
to try and sell their existing inventory. H&M of Sweden
cut prices by up to 70 per cent. Other retailers cancelled
orders of inventory as they did not think the customer
demand would be there.
Once lockdown was over and people came out to start
shopping, retailers then faced the problem of not having
enough inventory that customers wanted to buy.
Questions
1 Explain one reason why clothes retailers hold
inventory.
2 Evaluate the factors that influence how much
inventory clothes retailers should hold.
Supply chain management
Businesses will have suppliers. These suppliers will often
have suppliers, and these businesses may also have their 4.2
own suppliers. There is therefore a chain of suppliers from
the raw materials through to the finished product. The
supply chain refers to all the different stages involved
in making, distributing and selling a good or service,
beginning with the material through to the production of
parts, through to the distribution and sale of the product.
4.2.1 Managing inventory
Think of the food in a McDonald’s restaurant. Farmers will
Reorder level have raised animals that are sent to abbatoirs, and the
meat is then sent to processing facilities before being
distributed to the restaurants. Farmers will also grow
other foodstuffs, such as lettuce, which will be sent to the
9
McDonald’s outlets. Wheat will have been grown and this
will be sent to grain mills and then to a factory to produce
buns. The range of ingredients used in McDonald’s foods
will be created through a complex set of relationships with
suppliers. Supply chain management involves managing
the flow of goods and services, and includes all the
different processes that transform raw materials into final
products. Effective supply chain management means that
these interrelationships between suppliers are managed
well. This can lead to:
» lower costs, because the process is more efficient
» fewer mistakes being made
» greater co-ordination of what is delivered, when and in
what order
» better-quality supplies
» less time between orders and delivery.
Effective supply chain management can therefore help
provide a business with a competitive advantage. Equally,
poor supply chain management can cause delays, increase
costs and lead to poor quality.
Businesses will want to consider their responsibilities in
relation to their suppliers. For example, to what extent do
they want to know how their suppliers produce? Businesses
are increasingly being questioned about all aspects of their
supply chain, such as the ingredients in their products,
the source of their supplies, the working conditions and
treatment of their employees. Businesses must consider
the processes they want to have in place to manage these
aspects of their supply chain. Many businesses now have
a code of conduct of their suppliers to ensure that these
organisations meet the standards of the business selling the
final product. Greater media coverage has made businesses
think more, not just about how they behave but also about
how their suppliers behave.
[3]
GLOSSARY TERMS
[12] The supply chain refers to all the different stages involved
in making, distributing and selling a good or service,
beginning with the material through to the production of
parts, through to the distribution and sale of the product.
Supply chain management involves managing the flow of
goods and services, and includes the different processes
that transform raw materials into final products.
153
 CASE STUDY
4.2
COVID-19 and supply chains
In recent years, there have been major worldwide shocks pharmaceuticals. The closure of factories, ports and
which have threatened the global supply chains of many airports affected companies across the world and has
businesses. For example, there have been the September also contributed to contracting trade.
11 terrorist attacks in 2001; the SARS virus of 2002; the
One reason that many businesses were affected so badly
financial crisis of 2008 and the trade wars between the
is because they had no plan if their supply chain was
USA and China in 2019 and 2020. All of these changes have
seriously disrupted. They had built a chain of efficient,
AS LEVEL 4.2 INVENTORY MANAGEMENT

damaged global trade, and the use of global supply chains

after the global financial crisis has grown more slowly
relative to world income than in the decade before.
It is possible that the consequences of the Coronavirus
(COVID-19) pandemic in 2020 will deal an even bigger
blow to supply chains than these other events. The
World Trade Organization estimated that global trade
would fall by up to 32 per cent in 2020. China’s Hubei
province, where the Coronavirus outbreak began, is
a manufacturing hub which produces components
for many industries such as cars, electronics and
low-cost suppliers but their plans did not allow for
unexpected interruptions. Since the pandemic began,
many businesses have started to look at bringing supply
closer to home. However, this often involves higher costs
and does not make use of the specialisms which certain
regions around the world have developed.
Questions
1 Explain two factors that influence whether a
business chooses local suppliers. [6]
2 Evaluate how supply chain management can
affect the competitiveness of a business. [12]

CASE STUDY
The clothing supply chain
A recent UK parliamentary report, Fixing fashion: clothing supplement their basic earnings towards a level where
consumption and sustainability, stated the following: they can support themselves and their families. Precarious
employment conditions are rife, with temporary contracts,
Garment production is one of the world’s biggest and most
agency work and subcontracting the norm. Violations of
labour-intensive manufacturing industries, with estimates
the right to freedom of association are commonplace,
of those directly employed ranging from 25 million to 60
unionisation rates are extremely low and collective
million people. Since the 1980s, many leading Western fashion
bargaining is rare.’
retailers have been sourcing their clothes from countries
with low labour costs and poor environmental governance. A 2016 report into Corporate Leadership on Modern Slavery
This shift in production has been facilitated by a 90 per cent found that of 71 leading retailers in the UK, 77 per cent
fall in shipping costs between the late 1950s and 2015, as believed there was a likelihood of modern slavery occurring
shipping containers revolutionised trade in goods. Most of the at some stage in their supply chains.
garments sold in the UK are produced in Asian countries. This
Poor working conditions in fashion supply chains hit the
fashion model means that consumers in the UK ‘are getting
headlines on 24 April 2013, when the Rana Plaza building
pleasure and enjoyment from fashion, and that is coming
in Bangladesh collapsed. The building housed five garment
at a cost to workers and the environment in exterritorial,
factories where 1138 people died and another 2500 were
overseas production routes, as well as agriculture.’ Poor pay
injured, making it one the largest industrial disasters in
and conditions are standard in global garment supply chains
history. The victims were mostly young women.
according to evidence submitted by the global trade union,
IndustriALL. It stated that: Source: https://publications.parliament.uk/pa/cm201719/
cmselect/cmenvaud/1952/report-files/195205.htm ©
‘Workers work long hours, often far beyond legal limits, for Parliamentary Copyright
poverty wages and in conditions that breach Occupational
Health and Safety (OHS) standards. The wages of most Questions
garment workers are no higher than the level of the minimum 1 Analyse one reason why most garments sold in the
wage in their country, which in many cases is well below West are produced by suppliers in Asia. [4]
the level of subsistence. Excessive working hours are a 2 Evaluate the ethics involved in the management of
continuing and entrenched problem. Production peaks the clothing supply chain. [12]
are managed by relying on excessive overtime. Workers
are compelled to work extremely long hours in order to

154
4.2.2 Just in time
One approach to inventory control is known as ‘just in
case’ (JIC). This is the traditional approach in which
businesses hold inventory just in case there are problems
with suppliers or just in case there is an increase in
demand. By holding excess inventory, businesses can
keep producing and selling even if suppliers cannot
deliver and even if demand suddenly spikes. However, the
disadvantage of JIC is that inventory has to be stored,
maintained and protected, and this costs money.
A different approach to inventory control is known as ‘just
in time’ (JIT). Just-in-time production occurs when firms
produce products to order. Instead of producing as much
as they can and building up inventories, firms only produce
when they know they can actually sell the items. Similarly,
components and supplies are only bought in by a firm as
and when they are needed.
The aim of just-in-time production is to reduce a firm’s
inventory levels by as much as possible. In an ideal world
there would be no inventories at all; supplies would arrive
and be used to produce items that are sold immediately to
the final customer. The advantages of this system are:
» A just-in-time approach should provide a firm with
tremendous flexibility; firms produce what is required,
when it is required. In the past, firms have tended to
try to estimate what demand would be and produce this
amount in advance of actual sales. This system works as
long as demand has been estimated correctly.
» JIT production should reduce costs. With no inventories,
the firm does not have to pay for warehousing or
security. The firm also avoids the opportunity cost of
having money tied up in inventories.
» JIT production should help minimise wastage. If goods
are produced and left to accumulate as inventories,
they are likely to get damaged, to depreciate, to go out
of fashion or to be stolen. JIT avoids these issues. This
means that JIT is part of a lean approach to business.
Lean production seeks to minimise the waste of
any resource, such as time and materials, to make a
business more efficient.
Although the just-in-time process has many advantages,
there are several potential problems or disadvantages:
» The system relies on suppliers providing parts and
components at exactly the time they are needed. If this
type of flexible and reliable supplier cannot be found,
the system breaks down.
» JIT can cause problems if the suppliers fail to deliver on
time. The manufacturer has no buffer inventory and so
cannot produce. For example, the earthquake in Japan in
2011 was a disaster for those directly affected by it. It
also caused enormous problems for businesses operating
a JIT process and reliant on supplies from Japan. With a
delay in supplies, they struggled to produce. The closure
of suppliers due to the Coronavirus (COVID-19) pandemic
in 2020 had similar disastrous effects for those reliant on
their products.
» The JIT system also means that the firm is vulnerable
to action taken by employees. Any stoppage can be
extremely expensive because production is halted
completely.
» Switching to JIT can lead to an increase in costs because
of the extra reordering. Because parts are ordered much
4.2
more frequently, the firm may lose bulk discounts and
will also have more administration costs.
GLOSSARY TERM
Lean production is an approach that continually
seeks to reduce any form of wastage in the production
4.2.2 Just in time
process.
STUDY TIP
The right level of inventory to hold will depend on factors
such as how well it can be stored, the costs to store it,
the reorder time, the expected level of demand and the
business’ operations strategy.
Using just in time
Running a just-in-time system is complex and places many
demands on a business. It requires:
» Excellent relationships with suppliers Businesses
need to be able to rely on suppliers to deliver goods
at precisely the right time. They cannot afford delays
as this halts production. Also, the goods must be of
perfect quality as the manufacturer has no inventories
to replace faulty supplies. A firm must be able to trust
its suppliers completely.
» Reliable employees Because the business does not have
many (if any) inventories at any stage of the process,
the firm cannot cope with stoppages. If strikes occur, for
example, the whole production process stops. A business
cannot supply customers using inventories as none exist.
JIT relies upon maintaining a good relationship between
employers and employees.
» A flexible workforce To ensure that production can
respond to demand, a firm needs a flexible labour
force. This means that if someone is ill, another
employee must be able to cover for them, or that if
demand is high in one area of the business, people
can be moved to that area to help out. Firms using
JIT expect employees to be ready to work anywhere,
anytime. People must change to meet the demand for
different products because JIT is focused entirely on
matching supply to customer orders.
Introducing just-in-time production involves:
» investment in machinery which is flexible and can be
changed from producing one type of item to another
without much delay
» training employees so that they have several skills and
can do a variety of jobs (multi-skilling)
» negotiation with employees so that their contracts are
flexible and allow them to move from one job to another
» building relationships with suppliers who can produce
just in time as well.
155
 CASE STUDY
4.2
Toyota
AS LEVEL 4.2 INVENTORY MANAGEMENT
▲ Figure 4.11 The earthquake and tsunami in Japan
(2011) caused problems for companies using JIT
systems.
In April 2011, the Japanese car maker, Toyota, had
to temporarily halt production at its UK engine-
manufacturing plant on Deeside, Flintshire, and five other
of its factories across Europe. The stoppage came after
Japan was hit by an earthquake and tsunami. A director
TEST YOUR LEARNING
Short answer questions
1 Define the term ‘opportunity cost’.
2 Explain one reason why a business might hold
inventory.
3 Explain one cost of holding inventory.
4 Explain one factor that influences the amount of
buffer inventory held by a business.
5 a Define the term ‘lead time’.
b Explain one factor that might influence the lead
time of a supplier.
6 Explain one reason why supply chain management
is important to a business.
7 Define the term ‘just-in-time production’.
8 Explain one reason why a business might use
just-in-time production rather than just-in-case
production.
9 Explain one possible problem of adopting just-in-
time production.
10 Explain one factor that influences the right level of
inventory for a business to hold.
156
of the Centre for Automotive Industry Research at Cardiff
Business School, Cardiff University, explained that the
problem arose because they relied on parts coming in
from Japan.
Toyota uses a just-in-time supply system, which allows
very little slack in the system. Once supply is interrupted,
it does not take long for other factories to be affected.
Experts have been recommending for years that
manufacturers diversify their supply base. After
all, recent history is full of examples of widespread
supply chain disruptions and their consequences for
manufacturers who were reliant on too few sources
– from the terrorist attacks on 11 September 2001 to
Hurricane Katrina in 2005 and the cloud of volcanic ash
from Iceland that shut down Europe’s skies in 2010.
Questions
1 Analyse one way in which lean-production techniques
might benefit Toyota. [4]
2 Evaluate whether Toyota should stop using lean-
production techniques given the risks of disruption
to supply. [12]
Data response question
[2] Zara
The international retailer, Zara, is famous for its ‘fast
[3] fashion’. It produces relatively small quantities of any one
[3] design and quickly changes the designs to ensure it stays
up to date with fashion. Store managers monitor designs
[3] in other stores and sales patterns, and send orders each
[2] week directly to the company’s own factories. Unlike many
other retailers, Zara has not subcontracted production,
[3] and produces in Europe rather than Asia to ensure it
keeps control of quality and can respond quickly. It has its
[3] own team of 200 designers able to imitate any new best-
selling designs that hit the fashion world. It designs more
[2]
than 12 000 items a year. It can design and get an item in
its stores in weeks, whereas its competitors take months.
Its approach is very much just in time; it produces in
[3] response to demand rather than ahead of it.
[3] Questions
1 Define the term ‘inventory’. [2]
[3]
2 Analyse one possible advantage to Zara of holding
relatively little inventory. [4]
3 Evaluate the issues involved if a retailer wishes to
adopt a fast-fashion approach. [12]
4 Operations management
AS LEVEL
4.3 Capacity utilisation and
outsourcing
Chapter overview
In this chapter we examine:
★ the meaning and measurement of capacity
★ the significance and measurement of capacity utilisation
★ the impact on a business of operating under or over maximum capacity
★ the impact on a business of outsourcing.
In this chapter, we examine issues relating to the maximum
output a firm can a produce, which is known as capacity.
A business will not want to have capacity sitting idle but
at the same time won’t want to have too little capacity,
so getting the capacity right is an important aspect of
operations planning.
4.3.1 Significance and
measurement of capacity
utilisation
The capacity of a business is the maximum amount it can
produce given its existing resources, and it depends on the
number and quality of its factors of production. What is the
amount and what is the standard of equipment available?
How many staff does the business have and how well trained
are they? How efficient is its transformation process?
Over time, the capacity can be increased with more
investment, but at any one moment there will be a
maximum number of orders that a business can cope with.
The capacity of a bus company can be measured by how
many passengers it can carry. The capacity of a restaurant
is how many meals it can serve. The capacity of a school is
how many students it can accept. The capacity of a plane is
how many passengers it can take.
Capacity utilisation measures the existing output relative
to the maximum. It can be calculated using the following
equation:
per cent capacity = existing output over a
given time period
× 100
maximum possible output
over a given time period
4.3.1 Significance and measurement of capacity utilisation
For example:
a Existing output is 300 units a week, maximum output is
500 units a week.
Capacity utilisation = (300 ÷ 500) × 100 = 60 per cent
b Existing output is 400 units a week, maximum output is
500 units a week.
Capacity utilisation = (400 ÷ 500) × 100 = 80 per cent
Imagine a concert where the stadium is completely
sold out, with 30 000 in the audience; this means that
capacity utilisation is 100 per cent, which is good for the
promoter of the event. But what if you have a theatre that
is half-full? This means that its capacity utilisation is only
50 per cent.
GLOSSARY TERMS
Capacity measures the maximum amount of output a
firm can produce at a given moment with its existing
resources.
Factors of production are inputs into the transformational
process of business, such as land, labour, capital and
enterprise.
Capacity utilisation measures the existing output relative
to the maximum possible output.
HANDLING DATA
1 If capacity is 800 units and present output is 200
units, calculate the level of capacity utilisation.
2 If capacity utilisation is 20 per cent and capacity is
3000 units, calculate the present level of output.
3 If capacity utilisation is 20 per cent and present
output is 4000 units, calculate the capacity.
157
 CASE STUDY
4.3
Suzuki
In 2020, Suzuki, the motor vehicle producer, announced that
it intended to increase its capacity in Myanmar. The company
invested in a new production line for four-wheeled vehicles
at its plant in south-eastern Yangon to handle tasks such
as the painting of car bodies. Suzuki has two factories in
the country.
AS LEVEL 4.3 CAPACITY UTILISATION AND OUTSOURCING
The investment is estimated to be roughly 12 billion yen
($108.91 million) and it will increase the factory’s floor
space tenfold to 42 000 square metres, from the current
4000.
The factory had previously been importing painted
car bodies from other countries, including India, and
assembling the vehicles in Myanmar. With growth
expected in Myanmar’s new car market, Suzuki has
decided to set up a production system that could supply
demand quickly. As a result, the factory’s production
capacity should increase to 40 000 vehicles per year from
a previous 10 000.
STUDY TIP
Remember that the capacity of a business will affect the
sales it is trying to achieve and, therefore, its human
resource planning and financial position. There is little
point generating more demand if there is not the capacity,
unless the business is willing to let others produce for it
and/or have queues and waiting lists.
The impact of operating under capacity
If capacity utilisation is low, it means that the existing
output is relatively low compared to what could be
produced. This is inefficient because resources are not being
fully utilised. The business could be producing more and,
assuming the demand was there, earning more revenue and
profit. The train could have more passengers, the health
club could have more members, the sandwich business could
be making more sandwiches. A business will, therefore,
usually want a high level of capacity utilisation.
Higher levels of capacity utilisation are desirable because
they spread the fixed costs of a business over more units.
The fixed costs of a business are those costs that do not
change with output; for example, the rent on a building or
the interest payments on a loan. As output expands, these
fixed costs can be divided by more units. For example, if
fixed costs are $10 million and 1 unit is produced, the fixed
cost per unit is $10 million; if 10 million units are produced,
the fixed cost per unit is $1. Higher capacity utilisation
therefore helps reduce unit costs and, therefore, increase
profit margins. Imagine you were renting a market stall for
$500 and you sold 250 items. Each item would have to earn
$2 simply to cover the rental costs. If you sold 1000 items,
each one would only have to earn 50 cents to cover the fixed
costs – this is because as your output increases, the fixed
cost per unit falls. This is very significant because it means
158
According to the Automotive Association of Myanmar,
sales of new cars in 2019 were 21 916, an increase
of 25 per cent from 2018. Suzuki holds 60 per cent of
Myanmar’s market.
Toyota plans to begin operating its first factory in the
country in the near future. Chinese manufacturers are
also due to enter Myanmar to benefit from growing
demand. The opportunity for Chinese manufacturers has
increased with improved quality and less concern from
younger buyers about the brand.
Questions
1 Explain one factor that determines the capacity of
Suzuki. [3]
2 Evaluate the reasons why Suzuki expanded capacity
at its Myanmar factory. [12]
there are major cost advantages of having higher capacity
utilisation. A business with low capacity utilisation not only
wastes resources but has high unit costs. This will reduce
profit margins if the price stays the same. If the firm tries to
increase the price to cover the higher unit costs, it may find
that sales fall and the situation becomes even worse.
Improving the position of the business may therefore
involve increasing the capacity utilisation, either by
boosting demand (which may be through marketing
activities) or reducing the capacity of the business if some
of it is no longer needed.
Methods of improving capacity
utilisation
Your capacity is under-utilised (that is, capacity utilisation
is low) if demand is not matching the level of output you
are able to provide. For example, you have a cinema that
can take 400 people but there are only 80 watching the
film (this is 20 per cent capacity utilisation); you have a
café with 40 tables but only 4 are occupied at the moment
(this is 10 per cent capacity utilisation). Capacity under-
utilisation therefore occurs when demand is too low. In this
situation the business may:
» do nothing If this is seen as a temporary issue, the
business may accept under-utilisation for a short time
(for example, when a World Cup football match is on
television, the number of high-street shoppers falls;
capacity utilisation in restaurants is usually lower during
the week compared to the weekend)
» renew its marketing activities to boost demand For
example, changes in the promotional strategy may be
made: new offers, increased efforts by the sales team or
more advertising may help increase sales
» reduce the level of capacity If, over time, demand
is lower than capacity, the business may rationalise.
Rationalisation means the business may reduce its
capacity levels. For example, you may reduce the
number of staff you have, you may sell off some of your
production equipment if it is not needed, or you may sell
off some land if this is not required. Of course, changing
capacity levels may be easier in some businesses than
others. If you run a taxi or delivery business, you could
reduce the number of vehicles you operate fairly easily.
However, if you run a cinema, it is not easy to split the
cinema in half to reduce the capacity. If you have a café,
you cannot easily sell off a quarter of it. In general, it
is easier to reduce the labour input by making people
redundant or asking them to go part-time. Reducing the
land and capital inputs can be more difficult
» subcontract for other firms If you do have excess
capacity, you may offer your resources to other firms
and produce on their behalf. This is subcontracting.
Some shops may rent out part of their space to other
businesses, for example. A food business may offer to
produce for someone else and put the other firm’s brand
name on the products.
GLOSSARY TERMS
Capacity under-utilisation occurs when a business is
producing less than the maximum amount it can produce,
given its existing resources.
Rationalisation occurs when a business reduces the scale
of its operations and reduces its capacity level.
Subcontracting occurs when one business employs
another business to undertake some of the work.
High levels of demand relative to
capacity
If demand is high, a business may be operating close to
100 per cent capacity utilisation. This may be possible in
the short run, but it may put pressure on resources if the
business is operating at full capacity for a sustained period
of time. Employees may feel under pressure and become
tired. There may not be time for day-to-day maintenance
and repair of equipment, increasing the risk of breakdown
or failure. A business may, therefore, wish to operate below
100 per cent capacity utilisation over a period.
If demand is above the normal capacity of a business,
managers may respond in various ways. In the short term,
they may try to increase the capacity by opening longer
and asking employees to work more hours than usual.
Another response might be to subcontract output to other
producers. This brings risks because the original business
is no longer directly responsible for the quality. It is also
expensive because the subcontractor will want to make a
profit. However, using a subcontractor can allow a business
to continue to meet its customers’ orders and may maintain
goodwill. Other responses to high demand include:
» starting a waiting list This can increase the sense
of exclusivity, which may suit premium brands, but
customers may switch to another business where they
can buy the products they want.
» increasing prices Higher prices can be used to reduce
demand. This can increase profit margins, but the
4.3
business will need to set the price at the right level to
avoid ending up with demand becoming too low.
If demand looks as if it is going to remain high, a business
may look to invest to increase its capacity over time. For
example, a business may build new production facilities if it
thinks the demand will justify this investment financially.
4.3.1 Significance and measurement of capacity utilisation
Capacity shortage
If demand is too high for the firm’s capacity, there is a
capacity shortage; for example, there are more people
wanting tickets for a gig than there are places, there are
queues outside the nightclub, or there is a waiting list for a
product. In this situation a business may:
» do nothing You may think that the fact that the
product is in short supply relative to demand adds to its
appeal. Some clubs might want to build on the image
that they are difficult to get into. Morgan sports cars
used a waiting list of several years but simply saw this
as evidence of the appeal of their cars – they did not
want to increase their output. You may also think that
the excess demand is temporary and so not want to
make any major changes, given that it may not last (for
example, it may be the latest fashion trend to wear a
certain brand of sunglasses or t-shirt, or it may just be a
particularly busy day or night). In this situation people
will simply have to wait. A business may start a waiting
list or limit the number any one person can buy
» expand capacity If you believe demand is likely to
remain high then you may increase capacity. This will
require investment (for example, you may need more
people, more equipment and bigger premises) but
may well be worthwhile due to the extra sales you
can generate
» outsource If you cannot meet all the demand yourself,
you may use other producers to produce for you. This
increases the amount you can supply but you need to
be careful that quality does not suffer and, because
the outsourcing suppliers will want to make a profit,
your own profits may be less on the units they make
compared to you making them yourself. Alternatively, a
business may outsource some of its non-core activities
so that it can focus on the essential elements of the
business. For example, in a school the governors may
decide to outsource activities such as the catering, the
maintenance and the security so that they can focus
on teaching and learning. This may enable managers
to concentrate on what they do best and make use of
the skills and experience of specialists in other areas.
Caterers that supply to many schools, for example, may
have economies of scale that make it cheaper to use
them than to try to do it yourself
» increase the price If demand is too high relative to
supply, a business may increase the price to bring
demand down to the ‘right’ level. This is what happens
in many markets. If demand for a particular company’s
shares increases, there is only a certain number available
159
 and so the holders of these can increase the price. If you
have a house in an area that becomes very desirable then,
4.3 given the higher levels of demand compared to supply,
you can increase the price. The price can therefore act as
a rationing mechanism to reduce the demand, and at the
same time it can increase the profit margin per item.
4.3.2 Outsourcing
Outsourcing occurs when the business uses other producers
AS LEVEL 4.3 CAPACITY UTILISATION AND OUTSOURCING
to undertake some of its operations. A business may
outsource some aspects of its operations which it does
not regard as critical to what it does and/or where it may
benefit from the expertise and scale of others. A business
might outsource its catering and security, for example.
Similarly, it may outsource its customer enquiry helplines to
specialist call centres. There may be times when a business
does outsource key parts of its process to help expand its
capacity and ability to deal with customer orders.
Outsourcing may enable a business:
» to use the specialist services of another business An
outsourcing supplier may be using specialist equipment
which it is not cost-effective for the business to invest in
for itself, given the scale of this particular operation. A
school is likely to outsource the printing of its prospectus,
because it prints relatively low volumes and it would not
be cost-effective to have its own printing presses
» to benefit from lower costs by using a business that
specialises in an activity (such as customer credit
checks) rather than trying to learn how to do it itself
TEST YOUR LEARNING
Short answer questions
1 Explain one factor that might influence the capacity
of a business.
2 Define the term ‘capacity utilisation’.
3 a If present output of a business is 400 units and
capacity is 1200 units, calculate its capacity
utilisation.
b If capacity utilisation is 80 per cent and output is
400 units, calculate the capacity of the business.
4 a Define the term ‘undercapacity’.
b Explain one problem for a business of operating
under capacity.
160
» to increase its capacity.
However, when outsourcing, a business should consider:
» the impact on costs The provider will want to take a
profit and therefore the business needs to make sure
that outsourcing is better value than doing it itself.
Sometimes a business may outsource initially but, as the
scale of the activity grows, it may be worth taking the
activity back in-house
» the impact on quality The quality of work from a
specialist provider may be better than the business
could produce itself, but the business needs to be
sure. The business is not directly in control of what is
happening and therefore must ensure that specifications
and expectations are clear and that there are systems in
place to monitor quality
» reliability of delivery The outsourcing supplier must be
able to deliver reliably, on time, so that the rest of the
business’ operations are not held up
» the response of the existing workforce By
outsourcing, a business is moving production away
from the business itself. This may lead to a loss of
jobs. For example, if a business decided to outsource
its design and marketing activities, this would reduce
the need for these jobs internally. This may meet with
resistance.
GLOSSARY TERM
Outsourcing occurs when the business uses other
producers to undertake some of its operations.
5 Explain one way in which a business might improve
its capacity utilisation. [3]
6 Explain one way in which a business might respond
[3] to a capacity shortage. [3]
[2] 7 Define the term ‘outsourcing’. [2]
8 a Explain one benefit to a business of outsourcing. [3]
b Explain one disadvantage to a business of
[2]
outsourcing. [3]
9 If a business produces 200 units and its capacity
[2]
utilisation is 70 per cent, calculate its capacity. [3]
[2]
10 Explain one reason why higher capacity utilisation
is likely to lead to lower unit costs. [3]
[3]
Data response question
Air travel in Indonesia
Indonesia has seen a rapid rise in its number of air
passengers, from 30 million in 2009 to over 115 million
in 2018. This growth has been due to the growth of the
middle classes and the appeal of low-price airlines.
Indonesia has also increased in popularity as a holiday
destination for international tourists; there were over 10
million international arrivals in 2018. As a result of this
expansion, there are a number of plans to expand the
capacity of the airports. Although airports and airlines
were massively under capacity in early 2020, demand
grew fast once travel started up again.
Given the rise in air travel in recent years, many domestic
and international airports have been operating over
capacity. The government has highlighted the need for
more infrastructure as a priority. Major improvement
works are planned for existing airports with further plans
for new ones to be built. Soekarno-Hatta International
Airport, near Jakarta, received 112 million passengers
in 2018 – far above its intended capacity of 70 million.
In December 2019, a third runway was opened to ease 4.3
congestion; there are plans to build a new airport to
serve Jakarta in the near future. Other improvements
are planned around the country, including Kualanamu
International Airport which serves Medan. A new airport
is planned in Bali to help reduce congestion in the existing
Ngurah Rai Airport in Denpasar. Although a site has been
proposed on the island, Bali’s popularity as a tourist
4.3.2 Outsourcing
destination has put it under significant environmental
pressure, with issues around water availability and safe
sewage disposal.
Questions
1 Define the term ‘capacity’. [2]
2 Analyse one reason why the Indonesian government
wants to increase airport capacity. [4]
3 Evaluate the factors the Indonesian government
should consider before deciding whether to
expand airport capacity. [12]
161
 5 Finance and accounting
AS LEVEL

5.1 Business finance

AS LEVEL 5.1 BUSINESS FINANCE

Chapter overview
In this chapter we examine:
★ the reasons why businesses need capital – for example, for survival or growth
★ why businesses need short-term and long-term finance
★ the distinction between cash and profits
★ shortages of finance and business failure
★ working capital, trade receivables and trade payables, capital and revenue expenditure.

5.1.1 The need for business
finance
Businesses need finance for a variety of reasons;
for example, to purchase assets such as supplies of
raw materials and machinery. There are three major
circumstances in which a business needs to raise finance.
1 When it is first started
This is referred to as ‘start up’ finance or capital, for
obvious reasons. The amount of finance raised by a
business that is starting up is likely to be relatively
small. An entrepreneur establishing a new business is
unlikely to have access to large amounts of finance, and
banks and investors may be unwilling to invest in an
untried enterprise.
Start-up finance or capital may be used to purchase the
assets that a business needs to begin trading. In the case
of a manufacturing business, this may be to buy a lease,
allowing the business to use a factory for an agreed
period of time. Start-up finance may also be required
to buy machinery and vehicles. Start-up businesses
supplying services may purchase slightly different
non-current assets such as leases on shops or offices.
Any start-up business is likely to require finance to fund
its market research and also for promotion to establish
its brand and identity among potential customers. It
can prove difficult for some start-up businesses to raise
sufficient finance and this is an important reason why
some business ideas never become reality.
Businesses also need cash to allow them to start
trading. Cash is required to pay the bills that arrive
regularly, such as for supplies of raw materials or
for services such as telephone and water. A newly-
established business may not receive any payment from
its customers for a period of time and it is important
that the new business has sufficient funds to settle its
debts. We will cover cash in more detail in Chapter 5.3.
GLOSSARY TERMS
An asset is any item owned by a business that can
generate an income for the enterprise.
Capital is the money invested into a business either by its
owners or by organisations such as banks.
Non-current assets are assets that a business expects to
hold for one year or more. Examples include property and
vehicles.

CASE STUDY
Creating a STORM of interest
The STORM Creative Events Agency was established
by Keyis Ng. It is a fashion, lifestyle, events and public
relations firm. Keyis Ng has had a huge impact on the
Singaporean and regional fashion scene.
The 24-year-old entrepreneur founded his company with
a start-up capital of just $15 000. The company organises
product launches, private parties, fashion shows and
awards ceremonies to promote brands and business
ideas. It is good at gaining press coverage for its events
and uses its contacts in the media throughout Asia to
gain extensive coverage of its innovative events.
Questions
1 Explain two reasons why an entrepreneur starting
a new business would need to raise finance. [6]
2 Evaluate the reasons why Keyis Ng was able to start
the STORM Creative Events Agency with so little
start-up finance. [12]

162
2 When it grows materials can also create a need for short-term finance.
Many businesses seek to grow, and for some it is an Short-term finance of this kind is usually repayable within
important objective, as we saw in Chapter 1.4. When it
is growing, a business will need finance for a number of
a one-year period. 5.1
Sometimes businesses need to purchase major non-current
reasons:
assets, such as land and buildings, or they may decide to
– To buy additional non-current assets For example,
expand or to take over other businesses. To do this they
in 2019, Amazon (an online retailer) announced that
will require long-term finance which will be repaid over
it was expanding its online grocery service, Amazon
a period of time longer than one year and, often, much
Fresh, in India and promised delivery within a few
longer.
hours of an order being placed. This new service will
be available to customers in some parts of Bengaluru Table 5.1 classifies a range of sources of finance according to

5.1.1 The need for business finance

and it will be extended to other cities later. In order whether they are short- or long-term.
to provide this service, the company would have
needed to finance the purchase of a range of non-
current assets, such as additional chilled cabinets
GLOSSARY TERMS
to store perishable food and vehicles to deliver the Short-term sources of finance are needed for a limited
groceries. period of time, normally less than one year.
– To hire and pay for new staff In Amazon’s case, Long-term sources of finance are those that are needed
this means hiring and training delivery drivers for its over a longer period of time, usually over a year.
grocery service. As Amazon Fresh is to be extended
throughout India, this could require a large amount
of finance. ▼ Table 5.1 Classifying sources of finance
– To buy additional supplies of groceries Amazon
Internal sources of External sources of
hopes to sell its groceries to a large number of
finance finance
customers and to provide rapid delivery. This will
require it to hold at least some inventories (stocks) of Short-term • Working capital • Overdrafts
groceries. Finance will be required to purchase these. sources of • Retained profits
3 To survive finance
Sometimes businesses need finance to survive. The Long-term • Retained profits • Bank loans
ability of businesses to survive is often under threat in sources of • Sale of assets • Venture capital
two situations: finance • Sale and • Mortgages
– When first established One-third of new businesses leaseback • Debentures
in the USA did not survive their first two years of • Share capital
trading. A new business may not survive for a variety • New partners
of reasons, including a lack of customers or higher • Government grants
costs than forecast. If the new business can raise and loans
finance during this critical early period, it is much • Crowdfunding
more likely to survive. • Microfinance
– When facing a crisis Crises can take many forms,
but they normally involve a loss of income from sales
or higher than expected costs, or both. If a business The difference between cash
can raise finance during a crisis, it is more likely and profits
to be able to pay its debts on time and to survive.
It was for this reason that governments across the Profit is the surplus of sales revenue over total costs, if
world took steps to increase the finance available to any exists, over a trading period. Just because a business
businesses during the Coronavirus (COVID-19) crisis is profitable, it does not mean that it will hold large sums
in 2020. of cash or even have enough cash. There are a number of
reasons why this situation might arise:
» Firstly, the business might sell large amounts of goods
Short- and long-term sources or services at profitable prices by offering customers
of finance 60 or 90 days to pay for their purchases. This will mean
that the business has to find cash to buy supplies
A business may need short-term finance to pay its bills
and pay employees several months before the cash
and to keep its suppliers happy. This is an important part
from the sale of the product flows into the business.
of the management of cash flow. Managing cash flow
This problem can be worsened if the business pays its
can be difficult if a firm’s customers are late in making
suppliers promptly.
payments for goods and services they have purchased or if
» Alternatively, a business such as a jeweller might hold
sales are unexpectedly low. In either case the firm is likely
large amounts of (expensive) inventory for customers
to be short of funds needed to purchase raw materials,
to view before making a choice. This will result in large
pay wages and salaries, and it will need short-term finance
amounts of cash being tied up in the form of inventories
to continue trading. Sudden increases in the costs of raw
and not available to the business for other purposes.

163
 » A business may have paid for non-current assets and
used large sums of cash to do so. These assets may
5.1 support the business over many years, and they will lead
to future inflows of cash. However, the outflow of cash
would be at the start and may place pressure on a firm’s
finances.
Thus, a profitable business may find itself short of cash
and possibly unable to settle its bills as they fall due. This
could lead to the firm becoming insolvent and having to
cease trading. A cash crisis is a major reason why many
businesses fail.

Periods of cash shortage

Cash
AS LEVEL 5.1 BUSINESS FINANCE

flows Cash inflows

Cash outflows

0
At end of the
Time
Income trading period
and costs income exceeds Income
costs = profit
Income
Costs

Income
Costs Costs

0
Time

End of trading
periods

▲ Figure 5.1 Profit and cash

STUDY TIP Business failure

Do spend time mastering the distinction between cash
and profits, as it is very important for the managers of
businesses. If you are asked about cash flow, try to avoid
drifting into arguments about profit and vice versa.
In the long term, however, a business has to make a profit
to satisfy its owners. They have invested funds into the
business, quite possibly by purchasing shares, and expect to
see a return on their investment. This is only possible if the
business makes a profit in the longer term. A business may
survive for some time without making profits if its owners
are prepared to be patient, but cash has to be managed
carefully in the short term to ensure that bills can be paid
on time and that the business survives.
A lack of finance is a common cause of business failure.
A business fails when it is unable to pay its debts and
is unable to continue trading. This is called insolvency.
A business is judged to be insolvent when its debts (or
liabilities) exceed its ability to pay them. In the UK, and
many other countries, it is illegal for an insolvent business
to continue trading. The process followed by businesses
declared insolvent differs between companies and other
types of business as illustrated in Figure 5.2.
GLOSSARY TERMS
Insolvency exists when a business’ debts (or liabilities)
exceed the assets available to pay them.
Liabilities refers to the money owed by a business to
individuals, suppliers, banks and others.

164
Unincorporated
businesses (e.g. sole
traders, partnerships)
Bankruptcy
A Creditors
business is
judged
insolvent
Liquidation
Incorporated
businesses
(e.g. companies) Unsuccessful
Administration
Successful
▲ Figure 5.2 Insolvency, bankruptcy, administration
and liquidation
1 Bankruptcy
A business whose owners are not legally separate from
the business itself is known as an unincorporated
business. The owners of these businesses do not have
the protection of limited liability as discussed in
Chapter 1.2. If an unincorporated business in the UK is
unable to settle its debts, it will be declared bankrupt
by a court of law. The assets owned by the bankrupt
business will be sold; this can include the private
possessions of the business’ owners, such as property
and savings. The money raised from this sale will be
shared between the individuals and organisations who
are owed money (known as the creditors). It is unlikely
that the creditors will receive all the money that
they are owed as the business will not have assets of
sufficient value to cover all its liabilities.
2 Administration and liquidation
A company (that is, an incorporated business) that is
judged to be insolvent will often have its assets sold to
settle its liabilities. These assets will not include the
private possessions of the business’ owners (normally
shareholders). The process of selling assets for cash is
called liquidation. The process of liquidation takes two
forms:
– Compulsory liquidation. This occurs when a
creditor seeks an order from a court of law to have
the business’ assets sold as it has not received
payment of a debt. In such circumstances the court
will appoint a receiver. A receiver is a business that
specialises in taking control of an insolvent company
and making arrangements for creditors to be paid.
A receiver may be able to keep the business going
if its finances are not too weak. However, it is very
common for receivers to close the business down and
to sell all its assets.
– Voluntary liquidation. This is when the owners of
the company decide to enter liquidation. This might
be because they recognise the weakness of the
business’ financial position. It can also occur when
the owners of a company want to retire and are
unable to sell the business as a growing concern.
Some companies may decide to enter administration.
By entering administration, a company receives legal
protection from the threat of immediate liquidation.
It is usual for an administrator to be appointed with
the responsibility of protecting shareholders’ interests.
Administrators attempt to keep the business trading,
though they may have to sell some assets to do so.
5.1
If the administrator is not able to keep the business
receive trading by renegotiating and settling its debts, the
some company will face liquidation.
payments
Working capital
Essential, to pay for day-to-day expenses and
keep the business operating
5.1.1 The need for business finance
Continues
=
trading
Current assets
• Cash in the bank
• Trade and other receivables due to settle
their accounts soon
• Inventories – raw materials and components
less
Current liabilities
(Debts payable in the short term)
• Debts repayable to the bank, e.g. overdraft
• Trade and other payables who expect to be
paid in the near future
• Tax due to authorities
▲ Figure 5.3 Working capital
GLOSSARY TERMS
Bankruptcy occurs when an individual, a sole trader or a
partnership is judged unable to pay its debts by a court of
law.
Liquidation is the dissolution of a company by selling its
assets to settle its liabilities.
Administration is a process available to a company to
protect itself while it attempts to pay its debts and to
escape insolvency.
STUDY TIP
In some circumstances, current liabilities might be
greater than current assets. In this case, working capital
will be negative (and may be called net current liabilities).
As a negative figure it is often shown in brackets.
HANDLING DATA
Last year Darwin Hotels Limited had current assets
amounting to the value of $25.0 million and current
liabilities totalling $19.9 million.
1 Calculate its working capital for last year.
2 This year its current assets fell by 5 per cent while
its current liabilities rose by $1.1 million. Calculate
its working capital for this year.
165
 5.1.2 Working capital
5.1 Working capital measures the amount of money available
to a business to pay its day-to-day expenses, such as bills
for fuel and raw materials, wages and business rates. Much
attention is given to the capital firms choose to invest in
non-current assets, but of equal importance to the success
of a business is the capital set aside to finance regular
transactions.
Working capital is what remains of a business’ liquid assets
AS LEVEL 5.1 BUSINESS FINANCE
once it has settled all its immediate debts (see Figure 5.3).
It is possible to calculate the working capital of a business
from its statement of financial position by using the
following formula:
working capital = current assets – current liabilities
A statement of financial position records a business’
assets and liabilities. We look at statements of financial
position (also known as balance sheets) in detail in
Chapter 10.1.
Working capital is important to all businesses. It has been
described as the ‘lifeblood’ of a successful enterprise.
If any business is unable to pay its bills promptly, then
it may be forced to close down as a consequence of
insolvency.
However, working capital can also be a source of finance
for a business. If a business manages its working capital
effectively it may have a strong working capital position. To
do this, it may need to:
» make sure that its trade receivables (the money that it is
owed from customers and any other groups) are received
on time
» ensure that it does not hold too high inventory (or
stock) levels as this can tie up large amounts of cash for
a business
» pay its own debts (trade payables) as late as possible
so that as much cash as possible is held in the business
at any given time.
If a business’ current assets exceed its current liabilities
on a regular basis, this provides the business with a
potential source of finance. However, this source of finance
is only available on a short-term basis.
GLOSSARY TERMS
Working capital is the cash a business has for its
day-to-day spending.
Current assets are items owned by a business that can be
readily turned into cash. Examples include cash, money
owed by customers (trade receivables) and inventories
(stocks).
Trade payables is the amount of money owed by a
business to its suppliers for goods and services that have
been received but which have not been paid for.
Trade receivables is the amount owed by a business’
customers for products that have been supplied but for
which payment has not yet been made.
166
CASE STUDY
Melaka Limited raises $9.3 million
for working capital
Melaka Limited has sold $9.3 million of its shares to
raise finance to ensure that it has sufficient working
capital to fund its future plans. It sold 46.5 million
new shares to raise the finance it required and the
company’s directors said they were ‘delighted’ with the
support of the shareholders in buying the shares.
Melaka Limited operates in the oil and gas industry
and is seeking to expand quickly and provide energy to
the rapidly growing Asian economies. This involves the
discovery and extraction of oil and gas from different
locations including the Timor Sea and the Gulf of
Thailand.
In June 2020, the company announced losses of $5.7
million for the financial year compared to profits of
$14.2 million for the previous financial year.
Question
1 Explain two reasons why Melaka Limited might
have needed large amounts of working capital. [6]
Managing trade receivables and
trade payables
By managing trade payables and trade receivables carefully,
businesses can reduce the chances of running out of cash and
improve their working capital position. As we saw earlier, a
shortage of cash is a major cause of insolvency.
Most businesses are granted time to pay for products by
their suppliers. For example, an airline might buy a large
quantity of aviation fuel for $5 million from an oil company.
This fuel might be delivered in March, but payment may not
be expected until June. This means that the oil company is
giving the airline credit (called trade credit) for three months.
The $5 million will be a trade payable for the airline as it is
money that it owes for goods it already has but for which
payment is outstanding. This is a financial advantage for the
airline as it is, in effect, a $5 million loan for three months
on which no interest is charged. It is also an example of a
trade payable – a short-term debt which has yet to be paid.
In contrast, many businesses also give their customers
time to pay for the goods and services that they buy.
A coffee producer may sell large quantities of coffee to
customers such as shops and cafés. The coffee producer
may, for example, allow a large supermarket trade credit for
two months when it places an order for coffee worth $2.5
million. This is a valuable order and the coffee producer will
want to keep the supermarket as a customer. This means
that the supermarket does not have to pay the $2.5 million
for the coffee it has bought until two months after it
arrives in its warehouses. From the coffee producer’s point
of view this is a trade receivable, as it is a debt for goods
supplied which has not yet been received.
Businesses can improve their working capital position by
managing trade receivables and trade payables carefully.
There are several actions a business can take:
» It can delay its trade payables (or negotiate more trade
payables) if possible. This will mean that it will hold
cash within the business for longer, giving it a higher
sum of cash within the business.
» It can require that its trade receivables are paid by its
customers within a shorter time period. This will bring
quicker inflows of cash, again helping its trade balance.
» Many businesses will seek to carry out both of the
part of its trading activities. Spending on employees’ wages
is an example of revenue expenditure. Revenue expenditure
is shown on a business’ income statement as it is part of a
business’ trading costs or expenses. The differences between
5.1
revenue expenditure and capital expenditure are summarised
in Table 5.2.
▼ Table 5.2 Revenue and capital expenditure
Revenue expenditure Capital expenditure
Explanation This is spending on This is spending on

5.1.2 Working capital

actions above, as each has a positive effect on their assets that are used non-current assets
holdings of cash. up in a relatively that will be used by
short period of time. the business for a long
We will look at trade payables and trade receivables in more
period of time.
detail in Chapter 10.2.
Examples Spending on fuel, Expenditure to purchase
Revenue expenditure and capital components and raw property, vehicles and
materials. production equipment.
expenditure
Possible Revenue expenditure This type of spending
We have seen that businesses need to raise capital to start effects on is essential to has no immediate
up and to expand. Once a business has raised funds to profits production but, if not effect on profits.
finance its start-up costs, the business can start trading. controlled, can have However, capital
If it takes a decision to expand, the business will require an immediate and expenditure is essential
additional finance, in excess of that received from sales, to damaging effect on a if a firm is to generate
finance the purchase of additional non-current assets and business’ profits. long-term profits.
other items.
If the start-up or the expansion is successful, the new or
newly expanded business will earn revenue from its sales.
GLOSSARY TERMS
This will be used to buy more labour services and raw Revenue expenditure refers to the purchase of items such
materials to enable it to continue trading. as fuel and raw materials that will be used up within a
short space of time.
The expenditure carried out by a business can be divided
Capital expenditure is the spending by a business on non-
into two categories: revenue expenditure and capital current assets such as premises, production equipment
expenditure. Capital expenditure is on items that may and vehicles.
be used many times, mainly non-current assets. A new
A statement of financial position is a financial statement
computer system is an example of capital expenditure.
that records the assets (possessions) and liabilities
Expenditure on items required to start up or to expand a
(debts) of a business on a particular day at the end of an
business can be classified as capital expenditure. These will
accounting period. It was previously called a balance sheet.
be shown on a business’ statement of financial position as
they include the purchase of non-current assets. An income statement is a financial statement showing a
business’ sales revenue over a trading period and all the
Revenue expenditure is on the goods and services needed by relevant costs incurred to generate that revenue.
a business that will be used up in the short term as a normal

CASE STUDY
Vardhman Textiles
Vardhman Textiles, one of India’s largest textile
manufacturers, plans to increase its capital expenditure by
142 per cent in 2021–22 to finance the purchase of the new
property and machinery needed for its planned expansion.
The company expects to spend Rs. 7.5 billion compared to
Rs. 3.5 billion in 2018–19.
The company manufactures fibre, yarn, sewing thread and
fabrics, and forecasts significant rises in its revenue from
sales and consequently rises in its profits.
Vardhman’s recently released Annual Report judged
that yarn exports would be affected due to a slowdown
▲ Figure 5.4 A selection of textiles in demand owing to the Coronavirus (COVID-19) crisis

167
 in 2020. However, it expects a revival in global demand
5.1 and significant growth in yarn sales in 2021. The Report
expects cotton prices to be relatively unchanged in 2021–
22 following a 6.1 per cent fall in cotton prices in 2019–20.
At the same time, the prices paid by buyers of yarn have
risen by 32 per cent to Rs. 210 per kilogram.
AS LEVEL 5.1 BUSINESS FINANCE
TEST YOUR LEARNING
Short answer questions
1 Explain one circumstance in which a business may
need to raise finance. [3]
2 Explain one difference between short-term and
long-term sources of finance. [3]
3 Explain one difference between cash and profits. [3]
4 a Define the term ‘bankruptcy’. [2]
b Explain one circumstance in which a business
would be judged to be insolvent. [3]
5 Explain one difference between compulsory
liquidation and voluntary liquidation. [3]
6 Analyse one circumstance in which administration
might enable a company to avoid liquidation. [4]
7 a Define the term ‘working capital’. [2]
b Explain one reason why working capital
is important to all businesses. [3]
8 Explain one difference between trade payables
and trade receivables. [3]
9 Explain two ways in which a business might manage
its trade receivables and trade payables effectively. [6]
10 Explain one difference between revenue expenditure
and capital expenditure. [3]
Data response question
HW Limited is growing very quickly
HW is a private company that manufactures machinery for
export to businesses across the world. The company has
grown quickly recently and has been keen to attract new
customers. It expects to continue its fast growth in sales
and needs to place a very large order with its suppliers for
parts and components.
168
Questions
1 Define the terms:
a ‘revenue expenditure’ [2]
b ‘capital expenditure’. [2]
2 Evaluate the view that this capital expenditure will
increase the profits earned by Vardhman Textiles. [12]
HW has:
● ordered increasing amounts of supplies needed to
manufacture its machinery and has some overdue
bills
● offered trade credit to its customers allowing them 90
days to pay for deliveries
● not been able to persuade its own suppliers to offer it
more than 30 days’ trade credit for its purchases.
HW has recently supplied a major customer with
machinery valued at $14.6 million – easily its largest-ever
order. The company is waiting for payment, which is due in
45 days.
The company’s financial position is mixed: it is profitable
but short of cash. Its products are well-designed, reliable
and it is able to charge high prices. The company’s
managers are very successful at keeping costs low.
However, it has an urgent need for short-term finance and
this is worsening.
Last month HW faced a financial crisis and was unable to pay
its suppliers. It feared that it might be forced into liquidation.
However, it was advised to go into administration. The
administrator was able to renegotiate the later repayment of
some of its debts and the company survived.
Questions
1 a Define the term ‘liquidation’. [2]
b Explain one reason why HW had ‘an urgent need
for short-term finance’. [3]
2 Analyse one reason why HW is profitable but suffers
from cash-flow problems. [4]
3 Evaluate whether or not it was a good decision for
HW to enter administration. [12]
5 Finance and accounting
AS LEVEL

5.2 Sources of finance

5.2.1 Business ownership and sources of finance

Chapter overview
In this chapter we examine:
★ business ownership and sources of finance
★ internal and external sources of finance
★ the factors that affect the choice of sources of finance
★ how businesses select their sources of finance.

5.2.1 Business ownership and
sources of finance
The form of ownership (or legal structure) is a major
influence on the sources of finance that are available to
a business. We looked at the different types of business
ownership in Chapter 1.2.
Start-up businesses, many of which may be sole traders or
partnerships, normally have a relatively limited range of
sources of finance to draw upon as they represent a greater
risk to potential investors and have few, if any, internal
▼ Table 5.3 The legal structure of a business, possible sources of finance and key issues
sources of finance for use. In contrast, a limited company
has a greater range of sources of finance that it can use,
including the sale of shares. In the UK, only public limited
companies can benefit from being able to raise capital
by selling shares on the London Stock Exchange, but all
companies can sell their shares to individuals, with certain
limitations.
Table 5.3 sets out the major sources of finance available
to each of the major legal structures and offers some
consideration of factors that decision-makers in each case
may take into account. We shall consider these sources of
finance in more detail in the following section.

Legal form of business
Sole trader or proprietor
Partnership
Private limited company (ltd)
Public limited company (plc)
Possible sources of finance
Owner’s savings, banks, suppliers,
government grants and loans
Partners’ savings, banks, suppliers,
government grants and loans
Dependent upon the size of the private
limited company: suppliers, banks,
government grants and loans, venture
capital institutions, private share issues
Suppliers, banks, government grants and
loans, venture capital institutions, public
share issues via the stock exchange
Key issues for consideration
• Difficulty in providing security for those
lending funds to ensure repayment (known as
collateral)
• Loss of control by owner
• Businesses must provide evidence that they
have potential to develop
• Financial history of business/owner
• Problems of introducing new partner
• Lack of collateral
• Potential expense of raising large sums of
money
• Should it form a limited company?
• Disagreement among existing shareholders
• Difficulty finding suitable shareholders
• Loss of control by existing shareholders
• Lack of collateral for those lending funds
• Element of risk in a loan
• State of economy and stock market
• Ability to move to an area receiving
government aid
• Recent financial performance
• Reputation of company and senior managers

169
 5.2.2 Internal and external
5.2 sources of finance
We saw in the previous chapter that businesses need finance
for a range of reasons. There are a number of sources from
which they can raise finance. These can be split into two
categories:
» internal sources of finance from within the business
» external sources of finance from outside the business.
AS LEVEL 5.2 SOURCES OF FINANCE
GLOSSARY TERMS
An internal source of finance is one that exists within the
business.
An external source of finance is an injection of funds
into the business from individuals, other businesses or
financial institutions.
Trade credit is a period of time offered by suppliers of
goods and services before payment is to be made.
Internal sources of finance
The major internal sources of finance are owners’
investments, retained earnings, sale of unwanted assets, sale
and leaseback of non-current assets and working capital.
Owners’ investments
One source of finance is for the owners of the business to
provide the funds from their own resources. This may involve
the use of savings. Alternatively, the owners of a business
may take out a personal loan using their house (or other
assets) as security and invest this money into their business.
They may also persuade friends and family to invest in their
business, perhaps in return for part-ownership.
Owners investing in their own business can be helpful in
persuading others to invest. Banks and other financial
institutions will often want to see evidence that business
owners are willing to risk some of their personal capital
in the enterprise before agreeing to make a loan or other
investment. If the owners are not willing to risk investment
in their own business, it will be more difficult to raise
finance from other sources.
Retained earnings
Earnings from previous years are a major source of finance,
particularly for smaller businesses. A company’s retained
earnings are those profits from previous years that have not
been paid to shareholders as dividends. For other types of
business, they are the profits that remain in the business
CASE STUDY
Ted Baker Plc in a sale and leaseback deal
The British fashion clothing retailer, Ted Baker Plc, has
sold its headquarters in King’s Cross, London, in a sale and
leaseback deal. The company, which sells clothing in stores
in ten countries, has received a reported £78.75 million for
170
and are not paid to owners. It is common for businesses to
use these retained earnings as sources of finance. By using
retained earnings for reinvesting, a business avoids paying
interest on a loan and this can avoid heavy interest charges
if a large loan is required. Furthermore, using this source of
finance may avoid the need for a company to sell further
shares, enabling existing shareholders to retain control if
they continue to hold a majority of the shares.
But using retained earnings can have substantial
opportunity costs – that is, the business may lose out from
not using these funds in another way. Reinvesting retained
earnings may not be popular with shareholders who could
receive higher dividends if retained earnings were reduced.
Alternatively, the business may lose out on interest it may
have received if it had held the money in an interest-paying
bank account.
This method of finance is only available to firms making a
profit over a period of time. Even then, the profits may not
be sufficient to purchase expensive non-current assets.
Sale of unwanted assets
Firms can raise cash by selling assets that they no longer
require – normally these are non-current assets. The sale
of some assets can raise large amounts of finance for
businesses. Thus, a business might have land, buildings
or other assets that are not required and they may decide
to sell to raise capital. In 2019, Murphy Oil Company, an
American multinational, sold some assets it owned in
Malaysia, including oilfields, for $2.13 billion. Murphy Oil
Company was raising money to invest in shale oilfields in
America which were expected to be highly profitable.
Raising finance in this way offers a key benefit in that the
business is not committed to a stream of future interest
payments, nor might its shareholders suffer dilution of
control. However, the business would normally lose access
to the assets it has sold.
Sale and leaseback of non-current assets
But what if the non-current assets will continue to be
required by the business? A popular technique of raising
funds in recent years has been sale and leaseback. Under
this arrangement firms sell valuable assets and lease them
back again. This means that they have the capital from the
sale of the assets as well as the continuing use of these
assets, so that their business is not disrupted. The major
drawback is that the business now has to pay for the use of
assets which previously were freely available. This may have
a negative impact on long-term profits.
the property known as the ‘ugly brown’ building. This will
allow the company to reduce the amount of debt that it has
and the interest payments due on it.
 In 2020, Ted Baker Plc also announced that it was cutting 102 many of its shops due to the 2020 Coronavirus (COVID-19)
jobs and removing 58 vacant posts as part of a strategy to
cut its costs. The retailer expects to save £12 million over the
pandemic. Although it continues to sell its products
online, its managers estimate that sales have fallen by 68 5.2
next two financial years as a result of these staff reductions. per cent as a result of the store closures.
Ted Baker’s financial performance has been poor in Questions
recent months. Ted Baker recorded a loss from trading of
1 Explain two reasons why Ted Baker might have
£23 million over the six months to August 2019, compared
wanted to reduce its amount of debt. [6]
to a profit of £24.5 million in the same period in 2018. The
2 Evaluate whether or not a sale and leaseback deal
company’s share price has fallen from around 500 pence
was a good method for Ted Baker to raise finance
in October 2019 to just over 100 pence in April 2020.

5.2.2 Internal and external sources of finance

at this time. [12]
Along with many other retailers, the company has
suffered a heavy fall in sales when it was forced to close

levels, chasing customers for payment (other organisations

STUDY TIP
Do take care to distinguish between the sale of unwanted
assets and sale and leaseback arrangements. The latter
may be appropriate as a source of the finance if the
assets are important to a business’ continued trading.
If the assets are surplus to requirements, a simple sale
may be the best option.
Working capital
As we saw in the previous chapter, working capital is
the cash required by a business to pay for its day-to-day
operations. Working capital is needed to pay for items
such as fuel, raw materials and wages. Reducing inventory
that owe the business money) more urgently and delaying
payment to suppliers can raise cash generated from a firm’s
working capital.
Firms might seek to improve terms they are offered for
trade credit. Many suppliers grant their customers an
interest-free period of grace in which to pay for goods
and services they have received. From the customers’
point of view, this is a useful form of finance that helps
fund working capital at the expense of the seller’s cash
flow. The typical credit period offered to customers is 30
days. If a business can extend this period to, say, 60 days,
it is equivalent to an interest-free loan lasting for two
months. It may be, however, that suppliers are less willing

Sale of
Owners’ Retained Sale and Working
unwanted
investment earnings leaseback capital
assets

Internal

Government Sources
grants of
finance Share capital
Crowdfunding

Debentures
Microfinance
External

Trade credit New partners

Debt factoring
Venture capital

Mortgages
Bank overdrafts
Bank loans

Leasing and
hire purchase

▲ Figure 5.5 Internal and external sources of finance

171
 to offer discounts on selling prices if they grant generous
trade credit terms. Although the receipt of trade credit is
5.2 a means of improving a company’s working capital, it is
technically an external source of finance.
External sources of finance
When individuals, other businesses or organisations such
as banks or governments provide capital to a business, this
is termed external sources of finance. Businesses are more
likely to use external sources of finance when:
AS LEVEL 5.2 SOURCES OF FINANCE
» a large sum of finance is required (as they will find it
more difficult to raise such sums internally)
» the level of risk associated with the business is low,
making it easier to persuade outsiders to invest or lend
money
» the company’s profit levels are relatively low, reducing
the possibility of the use of retained profits.
The following are some of the main external sources of
finance.
Share capital
This is a very common form of finance for both start-up
capital and also for additional capital in a later stage of the
business’ life. Firms raise capital by selling, quite literally,
a share in their business to investors. A share is simply a
certificate giving the holder ownership of part (or a share)
of a company. Owning shares is sometimes called having
equity in a company. By selling large numbers of shares,
companies can raise significant sums of capital. Issuing
shares can be very expensive as it normally involves hiring
the services of specialist financial experts, which means it
is only appropriate for raising very large sums of capital.
Share capital is available to both private limited companies and
public limited companies. However, in the UK, it is much easier
for public limited companies to sell shares for two reasons:
» They can sell shares on the stock exchange. This is an
efficient international market which brings together
buyers and sellers of shares and sets share prices.
» Unlike private limited companies, public companies do not
need the permission of other shareholders to sell shares.
Equally, existing shareholders can sell their shares freely.
Both these factors make it easier to buy and sell shares in
public limited companies and encourage shareholders to buy
shares in the first place.
There are a number of benefits from selling of shares or
equity as a source of finance. Although a company will
be expected to pay an annual return to shareholders
(dividends), the level of this payment is not fixed and in
an unprofitable year it may be possible for the company to
avoid making any payment.
Bank overdrafts
A bank overdraft is perhaps the best-known method of
short-term finance. It is a service offered by banks allowing
a business to borrow up to an agreed limit for as long as it
wishes. Overdrafts are a very flexible form of finance as the
amounts borrowed can vary as long as they are within an
172
agreed figure. They are also simple to arrange – established
business customers can often arrange or increase the limit
of an overdraft without completing any forms.
However, overdrafts can be quite expensive, with interest
being charged at between 4 and 6 per cent over the bank’s
normal lending rate on a daily basis. This is not a problem
unless a business seeks to borrow on overdraft over a long
period of time. In these circumstances, it might be better
for a business to convert its overdraft to a longer-term
method of finance. A further drawback of using overdrafts
as a source of finance is that banks can demand immediate
repayment, although this is rare.
Trade credit
This is another form of short-term finance which is
normally available for periods of 1–3 months. Trade credit
is the period of time given by suppliers before payment
for goods and services is due. Trade credit is really an
interest-free loan offered by suppliers, usually for periods
of 30–90 days. This can be invaluable for any business that
is short of cash, and the absence of interest charges makes
it more attractive than an overdraft.
Leasing and hire purchase
These are similar forms of finance in many ways, but they
have one important distinction. Hire purchase is a means
of buying goods whereby a buyer pays through a series of
instalments, often paid monthly. In most cases, the goods do
not belong to the purchasing business until the final payment
is made. This operates similarly to a loan in that the business
effectively has the finance to buy the goods and pays the
cost back over time. Goods purchased on hire purchase may
be more expensive than if the business was able to pay cash.
Leasing also involves paying for non-current assets, such
as vehicles and machinery, over a period of time. However,
in this case the business never owns the assets; it is really
renting them for a specific time period. It does, however,
avoid the need for businesses to find large sums of capital
to finance the purchase of expensive non-current assets.
Bank loans
Bank loans are relatively straightforward to arrange if the
business that is seeking the credit has a satisfactory financial
history. The bank gives the business an agreed amount of
money and the business makes repayments over an agreed
period of time. The amount repaid includes the amount
of capital borrowed, plus interest. If the bank lending the
capital considers the loan in any way risky then it is likely
to charge a higher rate of interest. Small businesses, in
particular, suffer from this effect. Normally banks charge
about 2 per cent over their base rate of interest for bank
loans. Interest rates can be fixed or variable. A fixed rate
means that the interest rate charged will not change over the
period of the loan; however, a variable rate may change.
Banks will often require security for their loans and this will
usually be in the form of property. Such security is often
termed ‘collateral’. If the business defaults on the loan by
not making repayments, the bank can sell the property or
other assets held as collateral in order to recoup the money
that was lent. In this way, the bank lowers the degree of
risk it incurs in making loans to businesses.
GLOSSARY TERMS
A bank loan is an amount of money provided to a business
for a stated purpose in return for a payment in the form of
interest charges.
Venture capital is funds (in the form of a mix of share and
loan capital) that is advanced to businesses which are
thought to be relatively high-risk.
Debt factoring takes place when banks provide up to 80
per cent of the value of a business’ debts immediately to
provide an instant inflow of cash.
Mortgages
Mortgages are long-term loans granted by financial
institutions solely for the purchase of land and buildings.
The land or building in question is used as security or
CASE STUDY
Even banks need to raise capital
India’s third-largest private-sector bank raised Rs 125 000
million ($1.76 billion) by selling shares in September 2019.
Axis Bank said that its share issue was oversubscribed
(meaning that the demand for shares was greater than the
number for sale). The share price was Rs 629 each.
Shares of Axis Bank were trading 1.3 per cent higher at
Rs 703.70 on the Indian Stock Exchange following the share
sale. The shares were sold to several large-scale foreign
investors as well as to insurance companies.
Amitabh Chaudhry, Axis Bank’s chief executive officer
said ‘We will strive to ensure that we continue our
growth journey and keep delivering the best value to our
Venture capital
Venture capital is an important source of finance for
small to medium-sized businesses which are considered to
be risky and therefore in some danger of failing. Venture
capital is normally a mix of loan and share capital. Financial
institutions (for example, merchant banks) provide venture
capital, and wealthy individuals (who are known as ‘business
angels’) are another source.
Organisations and individuals providing venture capital
frequently wish to have some control over the organisation
to which they are providing finance. The business’ owners
may need to sell some shares in their company (generally
a minority stake) to the person or organisation providing
the venture capital. Providers of venture capital may seek
a non-executive director role in the business in which they
are investing. Venture capital investors not only provide
capital but also experience, contacts and advice when
required, which distinguishes venture capital from other
collateral for the loan. These loans can be for long periods
of time – often up to 50 years. Mortgages can have fixed or
variable rates of interest and are particularly suitable when
a business wishes to raise large sums of money.
5.2
Some businesses may choose to remortgage their premises
to raise capital. A remortgage either increases the existing
mortgage or establishes a mortgage where one did not exist
before. This source of finance is particularly popular with
small businesses.
5.2.2 Internal and external sources of finance
Debentures
Debentures are a special type of long-term loan to be repaid
at some future date, normally within 15 years of the loan
being agreed. The rate of interest paid on debentures is
fixed. In some circumstances, debentures may not have
a repayment date, representing a permanent loan to the
business; this is an irredeemable debenture. Debentures are
normally secured by using the business’ non-current assets
as collateral. They are another form of loan capital. Holders
of debentures do not have voting rights in the business.
customers, shareholders and investors consistently and
on a sustainable basis’.
Raising this capital from an external source of finance will
help Axis Bank to achieve its growth strategy.
Source: www.vccircle.com/axis-bank-raises-1-76-bn-via-
share-sale-to-gic-others-bain-capital-sits-out
Questions
1 Explain one difference between external and
internal sources of finance. [3]
2 Evaluate the case for and against Axis Bank
raising finance by selling shares. [12]
sources of finance. However, a significant drawback is that
providers of venture capital will not advance huge amounts
to businesses. It is unusual for venture capitalists to lend in
excess of $850 000 in a single deal.
Debt factoring
Debt factoring is a service offered by banks and other
financial institutions. If businesses have sent out bills (also
termed invoices) that have not yet been paid, they can ‘sell’
these bills to gain cash immediately. Selling or factoring
debts in this way provides up to 80 per cent of the value of
an invoice as an immediate cash advance. A further payment
is made once the financial institution receives the payment
of the invoice. It is usual for the financial institution to
retain approximately 5 per cent of the value of the invoice
to cover its costs of collecting the debts. However, in some
circumstances, no payment may be required and, in others
cases, a flat fee may be charged rather than a percentage
payment. The process is summarised in Figure 5.6.
173
 Business

5.2 5. Factor pays

business remainder 3. Factor initially
of debt when pays business 2. Business ‘sells’
collected from approximately debts to factor.
customer; charges 80% of value
1. Business fees of of debts.
supplies customer approximately 5%.
with goods
and services. Organisation providing
factoring services
AS LEVEL 5.2 SOURCES OF FINANCE

Financial
4. Customer pays organisations
factor full value of such as banks
debts when due. provide debt
factoring
services
Customer

▲ Figure 5.6 The process of debt factoring

Many small firms believe that to lose up to 5 per cent of Microfinance

their earnings makes factoring uneconomic – this can
Microfinance is a term that describes the provision of
eliminate much of their profit on the sale of their products.
financial services for poor and low-income clients. Although
Their customers are also likely to be aware that the debts
much publicity has been given to the granting of small
have been factored, which may cause them to worry about
loans, microfinance includes other basic financial services
the business’ ability to manage its short-term finance. They
such as savings, the transfer of money and insurance for
may seek other suppliers if they believe the business is
those on low and very low incomes. An important element
financially unstable. However, debt factoring does offer a
of microfinance is that it supports the transfer of money
number of benefits:
from people earning reasonable incomes to poorer relatives
» The immediate cash provided by the factor means that and friends in different countries. Without the services
the firm is likely to have lower overdraft requirements
provided through microfinance, this might not be possible.
and will pay less interest.
» Factoring means businesses receive the cash from their Improving access to such services allows those on low
sales more quickly. incomes to fund activities which will create incomes, build
assets and protect against risks. Microfinance is regarded
Debt factoring has become more popular for businesses
by many as a way of reducing poverty among low-income
in some countries. This is particularly true for small and
citizens across the globe. Microfinance can entail a transfer
medium-sized businesses, as overdrafts have become more
of money from high-income to lower-income countries. The
difficult to arrange.
case study below illustrates its workings and benefits.

CASE STUDY
Lendwithcare
Lendwithcare ‘fights poverty and injustice in 87 countries
around the world to help the world’s poorest people find
routes out of poverty’. As part of its poverty-fighting
work, Lendwithcare provides microfinance services.
Large numbers of relatively wealthy individuals in
high-income countries provide small amounts of
funds to Lendwithcare. These are subsequently lent to
entrepreneurs in low-income countries and repaid over a
period of time. The loans normally help the entrepreneurs
to establish or expand their businesses.
Lendwithcare is seeking to organise microfinance for
María del Carmen Jimenez’s business plan. María
is 28 and a single mother with one child, and lives in
Cariamanga in Ecuador. María is a primary school
teacher. She has had the position for the last six years.
Additionally, she runs a beauty parlour with her sister. Her
sister works at the parlour full-time while María joins her
each day after finishing teaching at school.
María requested a loan in order to purchase new furniture
and accessories for the parlour. Hopefully, this will make their
business more attractive and bring in more customers. María
would also like to purchase extra inventories, specifically
creams, soaps and lotions, as many of their customers are
women who ask for facials and make-up. María is seeking a
loan of about $2000 and plans to repay it over one year.
Source: https://platform.buildily.com/lend-with-care;
www.lendwithcare.org
Questions
1 Explain two reasons why banks in Ecuador might
be unwilling to lend María $2000. [6]
2 Evaluate the arguments for and against lending
María a small sum of money. [12]

174
Crowdfunding
Crowdfunding is a source of finance that entails collecting
relatively small amounts of money from a large number of
supporters (the ‘crowd’). Crowdfunding in a business context
usually involves members of the ‘crowd’ each lending a small
sum of money to the business. Occasionally, these small
sums may be given as donations or represent early payment
for the business’ goods or services. Online businesses (such
as Kickstarter) exist to bring together entrepreneurs and
large numbers of investors offering small sums of capital.
The activities of businesses such as Kickstarter have helped
to make crowdfunding a viable and popular source of
finance for businesses, especially small ones.
Crowdfunding has become popular in recent years, especially
with small and medium-sized businesses, because banks in
many countries have been unwilling to lend following the
financial crisis of 2009–10. Equally, savers with spare cash
have received very low interest rates and these have often
been lower than the rate of inflation, meaning that savings
are losing value over time. Consequently, savers have sought
other ways to generate income from their savings.
CASE STUDY
Crowdfunding: a different source of finance
George Christakos owns and manages a restaurant
in Nova Scotia, Canada. Facing the normal difficulties
in raising capital, he decided to use his business’
customers as a source of finance. He wanted to enlarge
the restaurant that he co-owned with his father, Leo, in
the town of Halifax. George’s first choice as a source of
finance, the bank, decided not to lend him any money.
Not dismayed, George and his father decided to use
crowdfunding to raise the finance they needed.
Mr Christakos’ crowdfunding effort was unique, but
entirely suitable for his business, and comprised three
options for his customers. For investing $50, a customer
was rewarded with lunch for two and two t-shirts. The
option of a four-course dinner for two for investing $100
proved to be the most popular. For customers with larger
sums to invest, George offered two dinners a year for the
rest of the restaurant’s life.
Government grants
There are various grants and subsidised loans available to
businesses from the UK government and other agencies
within the UK. The government offers grants and loans
to support business expansion, to provide funding for
researching and developing new products, and to assist
A number of entrepreneurs have set up internet-based
businesses to meet the needs of savers and small and medium-
sized businesses. They have acted as a link between the two
groups, providing information on businesses seeking finance
5.2
and administering loans provided by the ‘crowds’ of savers.
Each saver may lend a relatively small amount to any business;
this limits the effect if the business fails to repay the loan.
Crowdfunding is attractive for businesses as it avoids the
need to deal with local banks, which can be bureaucratic
and slow to make decisions. Furthermore, even if the banks
5.2.2 Internal and external sources of finance
agree to grant a loan to a business, they may charge higher
interest rates than crowdfunders.
GLOSSARY TERMS
Microfinance is the provision of financial services for poor
and low-income clients.
Crowdfunding is a source of finance that entails collecting
relatively small amounts of money from a large number of
supporters (the ‘crowd’).
Using crowdfunding as a source of revenue, the
restaurant raised $23 000 from 115 contributors, 80 per
cent of whom lived close to the restaurant. Crowdfunding
campaigns can take many different forms. Some involve
donations while others, such as Mr Christakos’ effort,
involve the pre-purchase of goods or services. In any
event, the goal is to raise capital.
Questions
1 Analyse two reasons why a loan from the bank
might have been George Christakos’ first choice
of a source of finance. [8]
2 Evaluate the major advantages and disadvantages
to a small business of using crowdfunding as a
source of finance. [12]
businesses in buying new premises or improving existing
properties. An estimated 4500 grants and financial
programmes are available to UK organisations, amounting to
a potential total value of £50 billion. Many other countries
offer similar schemes.
175
 Government grants will usually only cover a proportion
of the total costs of a start-up or an expansion. There is
5.2 also likely to be a great deal of competition from other
businesses for government grants and there is usually a
fixed amount of money available under most grant schemes.
However, the major advantage of government grants is that
entrepreneurs and businesses do not have to repay them as
long as they meet any conditions under which the grant was
given.
GLOSSARY TERM
AS LEVEL 5.2 SOURCES OF FINANCE
A government grant is a sum of money given to
entrepreneurs or businesses for a specific purpose.
HANDLING DATA
A government provided a grant of 15 per cent of the
start-up cost of a new business under one of its
schemes. The amount of the grant was $375 000. How
much was the start-up cost of the new business?
New partners
This is an option for small and medium-sized enterprises.
A partnership (whether it has limited liability or not) can
take on a new partner who will invest into the enterprise
in return for becoming a partner and owning a share of the
business. Similarly, a private limited company can decide
to sell more shares, as long as the existing shareholders
support the decision. In return for the ownership of a share
of the business, the new partner(s) or shareholder(s) will
provide an injection of capital.
Table 5.1 on page 163 classifies the sources of finance we
have discussed according to whether they are short- or
long-term, internal or external sources. You will note that
retained profits can be classified as short- or long-term
finance, as a business can opt to use this type of finance
over any timescale.
5.2.3 Factors affecting sources of
finance
The managers of a business that is deciding on a source
(or sources) of finance will be influenced by a number of
factors, including the following.
Cost of the source of finance
For most businesses that are raising capital, the cost of
alternative sources might be an important factor in making
a decision as to the best source of finance. The costs
incurred by firms raising capital can take a number of forms.
176
The rate of interest
The rate of interest charged by organisations granting loans
can be a significant influence, especially if the loan is a
large one. The interest rate charged will depend on the level
of risk that the loan represents to the lender and the time
period of the loan. A short-term loan to a high-risk business
might be charged at a high rate of interest.
CASE STUDY
Pakistan’s cement industry faces high
borrowing costs
Paying interest on loans has become a major cost for
Pakistan’s cement industry, given that interest rates
have steadily risen to around 13 per cent at the start
of 2020. Companies in the cement industry are paying
high interest rates on long-term borrowing. This has
led to calls for a reduction in interest rates amid fears
that the high costs of financing loans might hit the level
of profits made by firms in Pakistan’s cement industry.
Some of the firms are considering issuing shares as an
alternative means of raising the finance that they need.
The industry’s financial position has been weakened
further by poor levels of demand in Pakistan for
concrete products and by a sharp decline in the level of
exports to India. Sales of cement products have been
flat in most countries, with the exception of China.
Questions
1 Explain one benefit that Pakistani cement
producers might receive from selling shares to
raise finance. [3]
2 Evaluate the reasons why high interest rates
have been such a burden for businesses in the
cement industry in Pakistan. [12]
The costs of selling shares
For a public limited company, a share issue can be an
attractive option. However, this can be an expensive
method of raising capital, as it entails considerable
administration and promotion and, on occasions, a form of
insurance to provide the funds if the sale is not successful.
When shares are first sold by a company, it has to use the
services of other expert organisations to organise the sale.
It is common for companies to use merchant banks for this
purpose.
Public limited companies sometimes use rights issues to
sell new shares. A rights issue involves selling additional
shares to existing shareholders in proportion to the number
of shares already owned. For example, existing shareholders
may be offered the opportunity to buy one new share for
each eight already held. Because of the relatively low cost
of issuing shares in this way, it is usual for them to be sold
at a slight discount to encourage sales.

STUDY TIP
Do not confuse the sale of new shares and second-hand
ones. Firms sell newly issued shares directly to the
shareholders. In contrast, second-hand shares are sold
mainly through the stock exchange. When second-hand
shares are sold on the stock exchange, it is not a source
of finance for the company whose shares are sold – it
is merely a means of the shareholder recovering the
investment by selling the shares to another person or
organisation.
Opportunity cost
A decision to use a particular source of finance may have a
cost in terms of what has to be given up as a consequence
of the decision. For example, a decision to use sale and
leaseback as a source of finance may appear to be a low-
cost option. However, this source of finance will commit
the company to paying each month or year for the asset
that has been sold. Similarly, using retained profits for
reinvestment into the company involves an opportunity
cost which can be measured in terms of the reduction
in the amount of profits available to pay dividends to
shareholders. Finally, receiving trade credit from a supplier
may be an attractive short-term source of finance, but it
carries a possible opportunity cost in that the supplier
may charge a higher selling price because it is, in effect,
providing an interest-free, short-term loan.
For many businesses, accessing sources of finance at the
lowest possible cost is the most important factor.
Flexibility
Some sources of finance are highly flexible and can be
adapted to meet a business’ precise needs. The most
obvious example is an overdraft. This source of finance
allows a business to overspend its current account or not
according to its needs (but subject to an overall limit).
Thus, a business can use its overdraft only when necessary
and can avoid any interest charges at times when its
finances are stronger. This flexibility has a cost, however:
overdrafts are an expensive source of finance.
Although government grants are appealing to many
businesses because they do not normally have to be repaid,
they can be an inflexible form of finance. Many grants are
only available with strict conditions attached. Many UK
government grants are only made if the business creates
new jobs or at least maintains employment levels. Because
of this, grants may not be a suitable source of finance in
circumstances where labour is relatively expensive and the
newly acquired finance could be used to introduce labour-
saving technology.
The need to retain control
Some sources of finance may result in the original owners
of the business losing some, or even complete control of it.
Certain forms of finance are only available if the person or
organisation investing gains a say in how the business is
managed. This is perhaps most obvious in the sale of shares.
If a private or public company makes a succession of share
5.2
issues, it may be that the number of new shares issued is
greater than the number of ‘original’ shares. In this case,
the new shareholders may gain control of the company.
However, it may be possible for the company to issue shares
that do not carry full voting rights. This can allow the
original shareholders to retain control though, of course,
it makes the issue of new shares much less attractive to
5.2.3 Factors affecting sources of finance
potential shareholders.
Smaller businesses that do not trade as companies can
also lose some degree of control if they opt to use certain
sources of finance. For example, venture capitalists may only
agree to provide finance to what may be a risky business if
a part of their investment is in the form of shares and they
have a say in the management of the business.
The uses to which finance is put
Some sources of finance are particularly suitable in certain
situations. For example, a business that is seeking to raise
finance to purchase property and has to rely on loan finance
will probably consider taking out a mortgage. As we saw
earlier, a mortgage is a long-term loan (and can be available
at relatively low rates of interest) and the combination of
these two factors makes it an ideal source of finance to
purchase property, which can be very expensive.
If the finance is being raised to fund a risky start-up, then
an entrepreneur may experience difficulties in finding
investors willing to put capital into the business. In this
situation, a venture capitalist may be the best choice as this
source of finance specialises in investing in relatively high-
risk enterprises and may also provide support and guidance
to novice entrepreneurs.
Finally, if the finance is needed to fund additional working
capital, perhaps because a business is expanding, then an
overdraft or perhaps trade credit may be selected as the
funding will only be required for a short period of time
until the business achieves a higher level of sales and an
increased inflow of revenue. This additional revenue can
repay the overdraft or settle the outstanding trade credit.
The level of existing debt
If a business has substantial amounts of existing loans,
banks may be unwilling to agree to increasing the amount
of debt. Banks may judge that further loans will represent a
risk to them as the interest payments may be considerable,
especially if interest rates rise. In such circumstances,
a business may be forced to seek alternative sources of
finance, such as selling an asset (and possibly leasing it
back) or selling shares if the business is a company. As a
rule of thumb, if a business has borrowed more than half
the total capital that it has raised, banks may judge further
loans to be too risky.
177
 5.2.4 Selecting the source of
5.2 finance
The preceding section has highlighted that a business will
choose its sources of finance based on a number of factors,
including cost, flexibility and the need to retain control.
When making judgements on the most appropriate source of
finance, managers must take into account a range of factors
relating to the business’ internal position and the business
environment in which it is trading.
AS LEVEL 5.2 SOURCES OF FINANCE
» The business’ financial situation Is it profitable? If
so, it may be able to use retained profits as a source of
finance or at least be able to provide evidence to banks
and other trade payables (creditors) that it can repay
loans. Alternatively, it may have assets that it can sell
and lease back, or simply sell.
» The business’ reputation A reputation as a reliable
and popular business may also enable its managers to
CASE STUDY
Venture capital in China very scarce in 2020
At the time of writing, China is facing a lack of venture
capital for its start-up businesses. The situation is not
simply affecting start-ups, as established businesses that
are seeking to grow are also starved of venture capital.
There was a fall of over 65 per cent in investment in start-
ups by venture capitalists in China and Hong Kong (called
Greater China) in the first three months of 2020 compared
to the same period in 2019. This increased the difficulties
in raising capital experienced by many businesses through
Greater China in a period which has become known as the
‘capital winter’. Figure 5.8 shows the dramatic decline in
venture capital as a source of finance in 2020 as compared
to previous years.
Questions
1 Analyse two circumstances in which a business
might choose to use venture capital as its primary
source of finance. [8]
2 Evaluate the other sources of finance that an
entrepreneur starting a business in China in 2020
might choose to use. [12]
STUDY TIP
If a question asks you to suggest and justify a source
of finance for a given situation, do not always select a
single source. It is very common for businesses to use
several sources of finance to fund a project, especially
if a large sum of capital has to be raised. It may also be
easier to justify the use of a mix of sources, as it reduces
the impact of the disadvantages of any single source of
finance.
178
persuade suppliers to offer increased trade credit, which
can fund short-term needs for finance. Equally, such a
reputation will assist a business in negotiating loans,
possibly at favourable rates of interest, or in persuading
shareholders to purchase the company’s shares.
» The business’ legal structure This will play a role in
making the decision on the appropriateness of sources of
finance. Thus, only companies will be able to elect to use
share capital as a source to fund start-ups or expansions.
» The business environment The environment in which
the business is trading will also shape the decision.
If sales in a market are growing, the business may be
better able to finance the repayments on a loan as its
revenues should increase in the future. On the other
hand, if interest rates are high (making loan capital a
relatively expensive source of finance), businesses may
seek alternative sources.
50
45
40
35
30
US$ billion
25
20
15
10
5
0
2018 2018 2018 2018 2019 2019 2019 2019 2020
(1) (2) (3) (4) (1) (2) (3) (4) (1)
Year (quarter)
▲ Figure 5.7 Venture capital provided in Greater China,
quarterly 2018–20
Source: https://edition.cnn.com/2020/03/26/tech/china-startup-
funding-coronavirus/index.html
As you can see, a business will take a range of factors into
account when selecting the best source (or sources) of
finance to use. There is no single best source – it always
depends on the circumstances.
 TEST YOUR LEARNING
Short answer questions
1 a Explain one source of finance that is available
to a sole trader. [3]
b Define the terms ‘leasing’ and ‘hire purchase’. [4]
2 a Define the terms ‘loan capital’ and ‘share capital’. [4]
b Define the term ‘sale and leaseback’. [2]
3 Explain one advantage and one disadvantage of
using debt factoring as a source of finance. [6]
4 Define the term ‘microfinance’. [2]
5 Using an example, explain one difference between
short-term and long-term sources of finance. [3]
6 a Define the term ‘venture capital’. [2]
b Explain one advantage to a business of using
venture capital as a source of finance. [3]
7 a Define the term ‘government grant’. [2]
b Explain one reason why it is easier for a public
limited company to raise finance by selling
shares than it is for a private limited company. [3]
8 Explain one reason why a partnership may
experience difficulties in raising large sums of
finance. [3]
9 a Define the terms ‘overdraft’ and ‘bank loan’. [4]
b Explain one disadvantage to a business of using
an overdraft as a source of finance. [3]
10 Explain one advantage and one disadvantage to
companies of raising capital by selling shares. [6]
5.2
Data response question
Sunshine Tours looks to expand
Sunshine Tours Plc is a London-based company that sells
its shares on the London Stock Exchange. It sells holidays
to European and American tourists. All of its holidays
are based on the island of Mauritius. The company
has suffered a decline in sales due to falling incomes
5.2.4 Selecting the source of finance
in Europe and America, and its profits have steadily
declined, reaching just £48 million in 2019. However,
sales are forecast to rise over the next three years at an
accelerating rate.
The company’s directors wish to expand the business. The
company already has large long-term debts, although it
has repaid 30 per cent of these since 2017. Its business
plan for 2021–24 sets out details of capital expenditure
totalling £150 million, although the sources of finance to
be used have yet to be decided.
The company’s shares have been performing well, despite
its recent dip in profits, and it has maintained impressive
dividend payments to its shareholders. One of the
directors believes that the company should raise all the
capital it needs by selling shares. Another argues for the
use of debentures as interest rates are low in the UK.
Questions
1 Define the terms:
a ‘capital expenditure’ [2]
b ‘debenture’. [2]
2 Analyse two factors that the directors of Sunshine
Tours Plc may take into account when deciding which
sources of finance to use to raise the £150 million it
needs. [8]
3 Evaluate whether or not Sunshine Tours Plc
should sell shares as the only means of raising
the capital it needs. [12]
179
 5 Finance and accounting
AS LEVEL

5.3 Forecasting and managing

cash flows
AS LEVEL 5.3 FORECASTING AND MANAGING CASH FLOWS

Chapter overview
In this chapter we examine:
★ the meaning and purpose of cash-flow forecasts
★ the interpretation and amendment of simple cash-flow forecasts
★ the methods that businesses can use to improve their cash flow.

5.3.1 Cash-flow forecasts should be included in the plan at the time they take
place. A simplified cash-flow forecast is illustrated in
Figure 5.8, which introduces opening and closing cash
The meaning and purpose of cash-flow balances. These are the sums of cash held by a business
forecasts at the start and end of a trading period.
Businesses need to manage their cash carefully to ensure
they have sufficient to pay their bills as they become due NOVEMBER
for payment. This means that businesses need to manage Closing cash
balance:
cash flows to ensure that cash can flow into the business in + $35 000
time to be available to make payments – that is, in time to
meet cash outflows.
Cash flow is the movement of cash into and out of a
DECEMBER
business over a period of time. A potentially profitable Opening cash
enterprise can fail because of poor management of cash balance:
flow. Businesses are especially vulnerable to cash-flow + $35 000
difficulties in their first months and years of trading
and during periods of major expansion. It is for this
reason that many financial institutions demand evidence DECEMBER
that entrepreneurs and managers have planned the DECEMBER
DECEMBER Take away
Add total cash
management of cash for a new or expanding enterprise inflow of:
Net cash flow total cash
before granting a loan. of ($20 000) outflow of:
$120 000
$140 000

GLOSSARY TERMS
Cash is a business’ most liquid asset – it is notes and coins
DECEMBER
as well as funds held in the business’ bank accounts. Closing cash
A cash-flow forecast is a document that records a balance:
business’ anticipated inflows and outflows of cash over + $15 000
some future period, frequently one year.

The structure of a cash-flow forecast JANUARY

Opening cash
Most businesses construct cash-flow forecasts. These balance:
are predictions of a business’ inflows and outflows of + $15 000
cash. Although cash-flow forecasts differ from one
another, they usually have three sections and are
normally calculated monthly. An essential part of cash-
flow forecasting is that inflows and outflows of cash ▲ Figure 5.8 Opening and closing cash balances

180
 January February March
Cash sales
1 Cash in Credit sales
Total inflow
Raw materials
Wages
2 Cash out
Other costs
Total outflow
3 Net
Net monthly
monthly
cash flow
cash flow
4 Opening Opening balance
and closing
Closing balance
balances
▲ Figure 5.9 A typical layout for a cash-flow forecast
Figure 5.9 shows a typical layout for a cash-flow forecast.
Although the exact structure can vary, all cash-flow
forecasts should contain the following elements.
1 Cash in The first section forecasts the cash inflows
into the business, usually on a monthly basis. This
section includes receipts from cash sales and credit
sales. Credit sales occur when the customer is given
time to pay (normally 30, 60 or 90 days) and are
recorded in the forecast in the month in which the
income is received.
2 Cash out The cash out (or expenditure) section will
state the expected expenditure on the goods and
services. Thus, a typical section might include forecasts
of expenditure on rent, rates, insurance, wages and
salaries, fuel, and so on. These are shown for the
month in which the payment is made. At the end of this
section, the total expected outflow of cash over the
time period in question would be stated.
3 Net monthly cash flow The net monthly cash flow is
calculated by subtracting the total outflow of cash from
the total inflow.
4 Opening and closing balances The final section of
the forecast has the opening balance and the closing
balance. The opening balance is the business’ cash
position at the start of each month. This will, of course,
be the same figure as at the end of the previous month.
The net monthly cash flow is added to the opening
balance figure. The resulting figure is the closing cash
balance for the month. It is also the opening balance for
the following month.
Cash-flow forecasts – a case study
Steve Marshall is buying a bookshop. He knows that he needs
to forecast his cash flow to help him to identify times when
he might experience cash-flow problems. Knowing when he is
likely to be short of cash gives him the chance to arrange an
overdraft or short-term loan. His bank is unlikely to advance
him a loan unless he constructs a cash-flow forecast.
Steve has made the following forecasts about his business for
the first four months of trading from June until September:
» Steve has raised $75 000 from a bank loan and his
savings to buy the lease on a property and to purchase
books. He also intends that this money will be used to
pay his start-up marketing costs.
» Steve expects his business to have an opening cash
balance of $2000 at the start of June.
» Steve anticipates his cash sales to rise steadily for
each of the four months (from $5750 to $9215) as his
5.3
business becomes better known. However, he has already
received an order to supply books to a local college. The
order was for $10 000. He expects payment in September,
but will buy the books in June, at the same time as he
purchases his initial inventories.
» Each month, Steve orders books from his suppliers to
5.3.1 Cash-flow forecasts
replace those he has sold.
» He has to pay his own wages and those of a part-time
assistant. These normally amount to $1500 each month.
» Other costs including his rent, rates, heating and
lighting amount to $1500 each month in June and July,
but are higher in August and September.
Steve’s cash-flow forecast (shown in Table 5.4 on page 182)
illustrates many of the key principles. An important figure
for each month is shown in the row entitled ‘Net monthly
cash flow’. This simply records the balance between the
inflow and outflow for the month. June is a good example
of how this operates: in June, Steve had cash inflows from
savings and borrowings of $75 000 and he expected to
receive $5750 from book sales. At the same time, he planned
to spend $94 500 on his initial purchase of books, as well
as supplying the college’s order, and also on marketing,
wages and rent. Thus, in June he expected his net cash flow
(cash inflows less cash outflows) to be –$13 750 ($80 750 –
$94 500). In cash-flow forecasts, negative figures can be
shown in brackets or with a minus figure in front. Hence, the
figure entered for net monthly cash flow in June is ($13 750).
There are two main reasons why businesses might forecast
their cash flows:
1 To support applications for loans Almost all new
enterprises require loans to enable them to become
established, and established businesses may need them
during periods of expansion. Banks and other financial
institutions are far more likely to lend money to a
business that has evidence of financial planning. It is
reassuring for the bank that the business’ managers
understand the importance of cash and have planned
carefully to avoid cash-flow crises. Cash-flow planning
gives the bank more confidence that the entrepreneur
or managers will be able to make the repayments of the
loan as and when they are due.
2 To help avoid unexpected cash-flow crises One-
fifth of newly established businesses fail within two
years of starting trading. A high proportion of these
fail because of cash-flow difficulties. Similarly, many
large and established businesses encounter cash-
flow problems which can result in the closure of the
business, as in the case of De La Rue, the British
printer discussed in the case study on the following
page. Planning can help avoid such difficulties. Cash-
flow planning can help to ensure that businesses do
not suffer from periods when they are short of cash
and unable to pay their debts. By forecasting cash
flows, a business can identify times at which it may
not have enough cash available. This allows it to make
the necessary arrangements to overcome this problem.
181
 ▼ Table 5.4 Steve Marshall’s cash-flow forecast

5.3 June July August September

Cash in
Savings and borrowings 75 000 0 0
Cash sales 5 750 7 500 8 475 9 215
Credit sales 0 0 0 10 000
Total cash inflow 80 750 7 500 8 475 19 215
AS LEVEL 5.3 FORECASTING AND MANAGING CASH FLOWS

Cash out
Purchase of lease on shop 30 000 0 0 0
Purchase of books 59 000 4 500 5 000 6 100
Wages 1 500 1 500 1 500 1 500
Marketing costs 2 500 1 500 975 400
Other costs, e.g. rent 1 500 1 500 1 605 1 630
Total cash outflow 94 500 9 000 9 080 9 630
Net monthly cash flow –13 750 –1500 –605 9 585
Opening balance 2 000 –11 750 –13 250 –13 855
Closing balance –11 750 –13 250 –13 855 –4270

CASE STUDY
Banknote printer runs short of cash
In the United States of America, printing money and cash inflows. In 2018, the UK government decided to use
minting coins is the job of the Bureau of Engraving and another supplier for its new blue passports following the
Printing, part of a government department. But in the country’s decision to leave the European Union. In the
United Kingdom, banknotes and passports are printed by following year, the Venezuelan central bank defaulted on
a private company, De La Rue. It is an irony that De La Rue a payment, resulting in De La Rue losing £18 million in
is running low on cash. income.
De La Rue is one of the world’s major suppliers of Questions
passports and banknotes. It is thought to be the largest
1 Analyse two reasons why cash-flow forecasting is
commercial printer in the world. The company’s cash-
an important activity for De La Rue. [8]
flow problems have occurred despite the company earing
2 Evaluate the reasons why a company that earns
£564.8 million in revenues and recording an annual profit
profits of £31.5 million in a year might run out
of £31.5 million in 2019.
of cash. [12]
De La Rue’s survival has been put in doubt by two pieces
of bad news in two years which will reduce its expected

HANDLING DATA
Use the information in the De La Rue case study to
calculate the percentage of De La Rue’s revenue that
was profit in 2019.

182
Interpreting and amending cash-flow
forecasts
Interpreting cash flows
Interpreting a cash-flow forecast simply means reading
the forecast and taking note of what it reveals. Managers
will look at cash-flow forecasts in detail and will look
for periods when the business is expected to be short
of cash. This will be shown when closing balance figures
are negative. A negative figure for a closing balance tells
managers that, in that period, the business’ cash outflows
have been sufficiently high to use up more than the cash
that is available. It also tells managers that cash outflows
are taking place before sufficient inflows have occurred.
If managers can identify cash-flow problems before they
occur, through the use of cash-flow forecasts, they are able to
take remedial actions to prevent the problem occurring. They
might, for example, arrange an overdraft with the bank to
ensure they have enough cash available to pay bills on time.
The case study of Steve’s bookshop also illustrates how the
construction and interpretation of a cash-flow forecast can
be of value to managers. Steve’s business will be short of cash
during June, July, August and, to a lesser extent, September.
The closing balances for these months indicate that he will
require a maximum of $13 855 of additional cash in a month
to enable him to pay his rent, wages, and so on. Knowing this
in advance means that Steve can take steps to avoid a cash
crisis, possibly by agreeing an overdraft with his bank.
Although the use of cash-flow forecasts can help businesses
to plan and manage their finances, the process does involve
a degree of uncertainty. Managers cannot be certain about
the accuracy of their forecasts of inflows, especially if they
are engaging in a new venture, such as launching a new
product or entering a new market. Most businesses will
base their forecasts of cash inflows on the results of market
research. However, this may not be accurate if the managers
carry out insufficient primary research or rely on out-of-
date or inappropriate secondary research data. This is more
of a risk for companies entering markets where less current
data is available.
Forecasting cash outflows accurately can also be difficult.
Unexpected changes in the price of resources can result in
forecasts proving to be very inaccurate. For example, between
the start of January and the middle of March 2020, the price
of a barrel of West Texas oil fell from over $63 to around
$27, a decrease of 57.1 per cent. Forecasting cash outflows
accurately can be challenging for businesses that use large
quantities of products which have volatile prices, such as oil.
Amending cash-flow forecasts
Changes in a business’ circumstances can have a substantial
effect on a business’ cash-flow forecast and it may have to
be amended as a consequence. A cash-flow forecast may
need amending for two broad reasons:
1 Inflows differ from the forecast This will be a concern
if they are lower than forecast, perhaps because sales
are lower than was expected or because payments are
received later than anticipated.
2 Outflows differ from the forecast It is common for a
business to experience higher outflows than forecast or
for outflows to take place earlier than expected. 5.3
For example, Steve Marshall’s cash-flow forecast (Table 5.4)
may have under-estimated the bookshop’s cash sales in June.
The actual figure may have been $6750. This would result in a
number of changes to Steve’s cash-flow forecast for June:
» the business’ total cash inflow being $81 750 in June
» the business’ net monthly cash flow becoming –$12 750
» the business’ closing balance becoming –$10 750.
5.3.1 Cash-flow forecasts
The key figure here for Steve Marshall is the closing balance
figure. This is still a negative figure, but a small one. As a
result, Steve may need a smaller overdraft from his bank to
ensure that he has sufficient cash to pay the bookshop’s
costs in July.
Cash outflow figures may also be different from the
forecast, requiring amendments to be made. The handling
data feature below gives an example of this.
HANDLING DATA
Use the information from Table 5.4 to answer the
following questions.
1 What would the closing balance have been in
September if marketing costs in September were
$2150?
2 What would have been the opening balance for
October?
Methods of improving cash flow
Trying to prepare accurate cash-flow forecasts is only part
of the solution. Businesses have to decide how they are
going to improve their cash position – if they identify
a future problem with their cash position. A number of
techniques can be used to improve a cash flow:
» Reducing costs If a business is able to reduce its
costs of production, this will lead to a reduction in the
amount of cash flowing out of the enterprise and will
strengthen its cash-flow position. This reduction in costs
can be achieved in a number of ways. A manufacturing
business may seek lower-cost resources to reduce its cash
outflows. For example, a furniture manufacturer may opt
to use timber from non-sustainable sources because it is
cheaper. A business supplying services may seek to reduce
wages by cutting hourly rates or reducing the number of
employees. Such actions may result in undesirable side
effects even if the business’ cash-flow position improves.
Using lower quality resources may reduce the quality of a
product and lead to a business having to reduce its prices,
which may damage cash inflows. Moving away from the
use of environmentally friendly (and more expensive)
resources or cutting wages and/or employment levels
may attract adverse publicity. The outcome may be a
fall in sales, which could reduce cash inflows. However,
it is possible that a business may opt to use techniques
such as recycling to reduce the costs of acquiring raw
materials. This can have a positive effect on the business’
image if it is perceived to be environmentally friendly and
may result in rising sales.
183
 » Improving the management of trade receivables and
trade payables Most firms receive some trade credit
5.3 from their suppliers; this is known as trade payables. This
means they may be given 30, 60 or 90 days to pay for
supplies. If a business can persuade suppliers who have
previously been reluctant to offer trade credit to do so,
it will increase its trade payables figure and improve its
cash-flow position. Remember that cash-flow management
is a matter of timing; delaying payments always helps.
Another important move might be to extend existing
AS LEVEL 5.3 FORECASTING AND MANAGING CASH FLOWS
trade credit agreements from, say, 30 to 60 days. It may
not, however, be possible for a small or newly established
business to negotiate favourable credit terms if it does
not have a suitable financial history. A business may also
offer customers less favourable terms for trade credit.
This means it reduces its trade receivables. This may
require all customers to pay for products within 30 days,
whereas in the past trade credit was for 60 days. Good
control of trade receivables and trade payables can mean
earlier inflows of cash and fewer bad debts. If a business
is not actively chasing up customers to ensure that they
pay, and pay on time, cash-flow problems may be the
result. Firms can improve their cash-flow position by
managing these inflows and outflows more effectively.
Using sources of finance to strengthen
a cash position
We saw in the previous chapter that a business may raise
finance through a number of sources of finance. Some
of these sources can be particularly useful in helping to
overcome a period of cash shortage.
Debt factoring
We saw in the previous chapter that a business can receive
cash earlier by ‘selling’ its debts to a debt factor. Figure
CASE STUDY
Otago Communications suffers cash problems
Otago Communications (OC) is one of New Zealand’s
leading manufacturers of telecommunications equipment.
It supplies large quantities of equipment to multinational
companies throughout the world, offering generous trade
credit terms. Its profits have been steady in recent years,
though disappointingly low. Last month it announced its
intention to sell one of its best-known factories to raise
NZ$75 million of urgently needed cash. The company’s
factory is located in a stylish glass and steel building in
Dunedin, on New Zealand’s southern island. OC moved into
the building in 2001 and enlarged it in 2007; it is currently
the workplace for 1880 of the company’s employees.
The company intends to sell and lease back the building
as it is vital to its operations. Analysts estimate that it will
raise NZ$200–300 million, which would provide a crucial
cash inflow for the business.
184
5.6 on page 174 illustrates the stages involved in debt
factoring. This technique offers the advantage of providing
a significant and immediate inflow of cash, but it can
damage the business’ profitability. It is likely that a debt
factor will charge a fee equivalent to approximately 5 per
cent of the total value of the debts and this will reduce the
business’ profits on the transaction by the same percentage.
HANDLING DATA
Inara Industries has invoices to the value of $770 000
which it wishes to use for debt factoring. The factoring
company has offered 80 per cent of the value of the
invoices immediately and a further 15 per cent when
they are paid by the customer in three months’ time.
1 How much will Inara Industries receive from the
factoring company immediately?
2 How much will Inara Industries receive from the
factoring company in total?
Arranged short-term borrowing
The majority of businesses have agreed an overdraft
with their bankers. Overdrafts can be expensive but
reasonably economical because a business only borrows
when necessary. A short-term bank loan will also provide
an inflow of cash, but it may be more costly in terms of
interest charges.
Sale and leaseback
This method of improving cash flow entails a business
selling a major asset – for example, a building – and then
leasing it from the new owner. This provides a significant
inflow of cash into the business, improving the immediate
cash position, but commits the firm to regular payments to
lease the asset, which may weaken its future cash position
and its profitability.
OC has suffered from well-publicised cash-flow
problems, particularly in recent months – its cash
position weakened by NZ$680 million over three
consecutive months alone. A spokesperson for OC said:
‘We have enough cash resources to do what we need. But
to cut costs and save cash we are looking at all possible
options with no stones being left unturned. One of those is
the possibility of selling one of our factories.’
Questions
1 Analyse two other ways in which OC could have
improved its cash-flow position. [8]
2 Evaluate whether the advantages of OC’s
planned sale and leaseback deal outweigh its
disadvantages. [12]
Leasing outflow of cash from the business and helps it to retain
a larger holding of cash. As with leasing, this technique
Using leasing, a business simply leases (or rents) non-
current assets (such as vehicles and computers) rather than
can strengthen a business’ short-term cash position
substantially due to the high cost of non-current assets.
5.3
buying them. This conserves precious reserves of cash and
The purchaser only becomes the owner of the asset once
can have quite a significant impact on a business’ short-
the final payment is made. Hire purchase may be used to
term cash position, as non-current assets can be very costly.
finance the acquisition of relatively expensive assets such
However, as with several of these techniques, it does require
as vehicles and can therefore have a considerable impact on
businesses to make a steady outflow of cash over time.
the business’ cash-flow position.
Hire purchase
Choosing a method of improving

5.3.1 Cash-flow forecasts

We saw in the previous chapter that hire purchase is a
means of obtaining credit for the purchase of a non-current cash flow
asset. The business purchasing the asset pays a percentage There is no single best method of improving a business’
of the purchase price as a deposit and the remainder in cash flow. All the methods we discussed have their
instalments over a lengthy period of time. This slows the advantages and disadvantages, as summarised in Table 5.5.
▼ Table 5.5 The advantages and disadvantages of selected methods of improving a business’ cash flow

Method Advantages Disadvantages

Improved management • Can be a ‘free’ method of improvement
of trade receivables and • Can be implemented relatively quickly
payables • Available to most businesses
Debt factoring • Can generate large and immediate inflows of
cash
• Available to businesses with little power to
negotiate favourable trade credit terms
Short-term borrowing • Can be available to the business immediately
• May be highly flexible (as in the case of an
overdraft)
Sale and leaseback • Avoids the need for any interest payments
• Retains the use of the asset for the business
and can raise large sums of finance
Leasing • Avoids the need for large cash purchases on
assets that may decline in value
• Can allow businesses to use the most up-to-
date assets
Reduction in costs • Can boost the business’ profitability as well
as strengthening its cash-flow position
• May improve the business’ image if it involves
techniques such as recycling
Hire purchase • Can delay cash outflows by a considerable
time period
• May be used to finance the purchase of
relatively expensive non-current assets,
having a significant impact on a business’
cash-flow position
• Reducing trade credit offered may result in a
loss of customers
• May not be available to new businesses or
those without a reputation as reliable payers
• Can reduce the amount of profit on each sale
(by up to 5 per cent)
• May not be viable for businesses making very
small profits (such as start-ups)
• Businesses with weak cash positions may be
unable to negotiate short-term loans
• Can be a relatively expensive option as
interest rates may be high
• Only a business with saleable assets can
engage in this method
• This may reduce the business’ long-term
profits by increasing expenditure
• The business is committed to regular, smaller
outflows
• The company does not own the assets that
are used
• May compromise quality of products if
cheaper resources are used
• Businesses may have to lower prices if quality
is reduced
• This is an expensive method of buying non-
current assets and may reduce profitability
• The business does not own the asset until the
final payment is made

185
 TEST YOUR LEARNING
5.3 8 a Define the term ‘trade payables’. [2]
Short answer questions
b Explain one method a business might employ to
1 a Define the term ‘cash flow’. [2] improve its cash-flow position. [3]
b Explain one reason why a business might 9 Explain one advantage and one disadvantage of the
forecast its cash flow. [3] use of debt factoring as a method of improving a
2 Explain one reason why a profitable business may business’ cash-flow position. [6]
be short of cash. [3] 10 Explain two reasons why a small business suffering
3 Explain one reason why newly established
AS LEVEL 5.3 FORECASTING AND MANAGING CASH FLOWS

from cash-flow problems might prefer to arrange a

businesses are vulnerable to cash-flow problems. [3]
4 a Explain one difference between net monthly
cash flow and an opening balance.
b A business has a closing balance of $10 000 at
the end of October and has experienced a net
monthly cash flow of $44 500. Calculate its
opening balance in November.
5 a Define the term ‘cash-flow forecast’.
b Explain one benefit to managers of preparing a
cash-flow forecast.
6 A business has the following cash-flow data for July:
– an opening balance of $130 250
– cash inflows of $675 750
– cash outflows of $754 500.
a Calculate its net cash flow for July.
b Calculate its opening balance for August.
7 A business has forecast the following cash-flow
data for February:
– cash inflows of $115 000
– cash outflows of $140 115.
a Calculate the business’ net cash flow for the month. [2]
b Its actual cash inflows were 10 per cent higher
than expected. Recalculate its net cash flow.
▼ Table 5.6 A cash-flow forecast for MM’s copper mine for Year 2
short-term loan rather than rely on an overdraft. [6]
[3] Data response question
Mugunga Mines Ltd
The rising price of copper in world markets has resulted
[2] in the opening of new copper mines in Uganda. In the past,
these might not have been considered profitable, however,
[2]
the price of copper might continue to fluctuate in the future.
[3] Mugunga Mines Ltd (MM) is one company that reopened
a small mine last year. It is a well-established company
with valuable non-current assets and a good record for
being profitable. Opening the new mine necessitated a
large investment ($3.5 million) in mining equipment and
preparatory work before mining could commence.
[2]
[2] The company’s customers have been given at least 60
days’ trade credit before paying for the copper they
purchase and the size of their orders has risen quickly.
The company had some cash-flow difficulties in the first
year of operating the new copper mine. It has prepared
a quarterly cash-flow forecast for the second year of
trading for the copper mine, as shown in Table 5.6 below.
One manager commented that the cash-flow forecast
[3] showed an improving cash position.

Quarter 1 Quarter 2 Quarter 3 Quarter 4

$000s $000s $000s $000s
Cash in
Credit sales 875.5 923.0 998.7 1,075.4
Total cash inflow 875.5 923.0 998.7 1,075.4

Cash out
Transport and distribution costs 313.6 322.6 366.3 387.7
Wages and salaries 500.5 501.2 502.5 503.1
Other costs 100.8 102.1 107.8 108.7
Total cash outflow 914.9 925.9 976.6 999.5
Net monthly cash flow (39.4) (2.9) 22.1 75.9
Opening balance (125.5) (164.9) (167.8) (145.7)
Closing balance (164.9) (167.8) (145.7)

Questions 2 Analyse one reason why Mugunga Mines Ltd’s cash

position is described by one manager as ‘improving’
1 a Define the term ‘trade credit’. [2] over the year. [4]
b Calculate the company’s closing balance for 3 Evaluate whether debt factoring is the best way for
quarter 4. [3] the company to deal with any future cash-flow
difficulties. [12]

186
5 Finance and accounting
AS LEVEL

5.4 Costs

5.4.1 Cost information

Chapter overview
In this chapter we examine:
★ why businesses need accurate information on costs
★ the types of costs businesses have to pay
★ the full and contribution approaches to costing, including their uses and limitations
★ how cost information can be used for decision-making, including setting prices, to monitor and improve business
performance, to calculate profits and for special order decisions
★ the calculation and interpretation of break-even output
★ the uses and limitations of break-even analysis.

5.4.1 Cost information GLOSSARY TERMS

What is a cost? It is simply an expense paid by a business Costs are expenses that a business has to pay to engage in
as part of its trading. Some of the expenses or costs firms its trading activities.
have to pay include payments for raw materials, fuel and Revenue is the income a business receives from selling its
components, as well as wages and salaries. goods or services.

In contrast, revenues are a business’ income or earnings

over a period of time. Total revenues are the sum of a
business’ earnings from the sale of all its products. Total The need for accurate cost information
revenue is calculated by multiplying the selling price of a Calculating costs accurately can help managers to make
product by the number of products sold. a number of important decisions. By combining cost
information with expected revenues, managers can calculate
revenue = quantity sold × average selling price whether or not a business (or an element within it) is likely
Costs and revenues are vital data for most businesses. to make a profit or a loss. From this information, a range of
By comparing the total costs for a business over a period other decisions may follow, including:
of time with the revenue that it earns, it is possible to » whether or not to start up a new business
calculate whether the business has made a profit or a loss. » whether to go ahead with a planned expansion
An important formula for almost every business is: » whether to take on a particular order from a customer,
which may be unusual in some way
profit (or loss) = total revenue − total costs » whether there is a need to reduce waste
» whether to engage in some activity, such as increasing
Average Number
Variable Fixed
security to prevent loss or wastage.
selling × of units +
price per costs costs
sold Without precise information on costs, managers cannot
unit
make decisions that are likely to prove beneficial to a
gives gives
business. For example, a business may be considering a
TOTAL REVENUE minus TOTAL COSTS decision to enter a new market and its market research
may indicate the likely returns from this expansion.
A critical element of the decision, though, will be to
gives
calculate the costs of doing so, enabling the business’
1 Profit if TR > TC
2 Loss if TR < TC managers to forecast the likely profitability of this
3 Break-even if TR = TC decision. Calculating the costs of this decision with a
high degree of accuracy is not always easy, as we shall
▲ Figure 5.10 Costs, revenues and profits/losses
see later in this section.

187
 Types of costs
5.4 Fixed costs
Fixed costs do not change when a business alters its level of
output. For example, a business’ rent will not vary if there
is an increase or decrease in the level of production. Other
examples of fixed costs include management salaries and
interest payments made by the business.
Figure 5.11 relates to XYZ Computers Ltd, a business that
produces computers. You can see that whether the factory
AS LEVEL 5.4 COSTS
produces 10 000 or 60 000 computers each year, the fixed
costs faced by the business will remain the same at
$5 million.
Fixed costs ($m)
Variable costs ($m)
7
6
Fixed
5 40
costs
4 costs
3 25
2 20
1
0 10 20 30 40 50 60 70
Output of computers per annum (000s)
▲ Figure 5.11 Fixed costs
The reason that these costs do not alter is that the business
simply uses its existing facilities fully at times when it
is receiving more orders. For example, in the run-up to
warm summer weather, a manufacturer of sunglasses might
increase its output, thereby using its existing production
facilities more fully. The firm’s rent, rates and other fixed
costs will be unchanged. Similarly, as winter approaches,
sales and production of sunglasses are likely to fall,
meaning some production facilities might be unused, but
fixed costs will remain the same.
CASE STUDY
High fixed costs in Mauritius
Manufacturers of cement in Mauritius sold around 700 000
metric tonnes of the product in 2019. The island has a
large number of construction projects, including the
sports centre in Côte d’Or and the Metro Express, all of
which lead to a large demand for cement.
188
Variable costs
In contrast to fixed costs, variable costs alter directly
with the level of a firm’s output. This means that a firm
increasing its output is likely to have to pay higher variable
costs, whereas one reducing its output could expect
variable costs to fall. Expenditure on fuel, raw materials
and components are all examples of variable costs.
XYZ Computers Ltd in Figure 5.12 faces variable costs of
$500 for each computer it manufactures; this is necessary
to pay for various items including the electronics, case
and monitor. Thus, to produce 20 000 computers means the
company faces variable costs of $10 million (20 000 × $500);
to manufacture 50 000 results in variable costs of $25
million (50 000 × $500).
50
Variable
30
10
0 10 20 30 40 50 60 70
Output of computers per annum (000s)
▲ Figure 5.12 Variable costs
It is usual to illustrate variable costs as a straight line,
as in Figure 5.12. This suggests that expenditure on items
such as fuel, labour, raw materials and components rises
steadily along with output. Variable costs are drawn this
way for simplicity. In the real world, the line may gradually
flatten out as businesses frequently negotiate lower prices
per unit when placing large orders. This means that XYZ
Computers Ltd may be able to purchase components more
cheaply, meaning that the variable costs associated with a
production level of 50 000 computers might be $22.5 million.
This means that the variable cost of each computer has
fallen from $500 to $450.
Until 2011, the government of Mauritius controlled the
price of cement as it was concerned that prices might be
too high and prevent development. A major cause of this
was a lack of competitiveness in the industry. High fixed
costs of production meant that it was difficult for new
businesses to raise enough capital to enter the industry
 and compete effectively with established producers.
As a consequence, the industry comprised two major
suppliers.
The degree of competition in the Mauritian cement
industry has been reduced rather than increased. The two
firms that existed in 2011 – Lafarge and Holcim – merged
in 2015 to form a single company: LafargeHolcim Ltd.
Total costs
The calculation of total costs assumes that all the costs faced
by a business are either fixed or variable. This means total
costs can be calculated simply using the following formula:
total costs = total fixed costs + total variable costs
Total costs of production are an important piece of
information for a business. Managers can use this
information in taking decisions on levels of output and
prices to be charged. For example, firms that have very high
levels of fixed costs, perhaps due to needing expensive
equipment, will seek to produce large quantities of output.
This reduces the effect of fixed costs on the selling price by
spreading them over a large quantity of sales.
One point to note is that a business’ total costs when
output is zero are only fixed costs, as without any
production there cannot be any variable costs.
Direct and indirect costs
An alternative way of classifying the costs encountered by
a business is to divide them into direct and indirect costs.
Direct costs can be related to the production of a particular
product and vary directly with the level of output. Examples
include the costs of raw materials and fuel.
Indirect costs are overheads that cannot be allocated easily
to the production of a particular product and relate to the
business as a whole. Indirect costs include the costs of
marketing and administration. Indirect costs are generally
recognised as difficult to control. Unless managers are
vigilant, these costs can increase rapidly and reduce a
business’ profits.
Indirect costs are also called ‘overheads’ and are
always fixed costs. Direct costs tend to vary with the
level of production and are normally (but not always)
variable costs.
GLOSSARY TERMS
Direct costs can be related to the production of a
particular product and vary directly with the level of
output.
Indirect costs are overheads that cannot be allocated to
the production of a particular product and relate to the
business as a whole.
Full costing allocates all the costs of production for the
whole business. Therefore, these costs are absorbed
into each output unit. This is also known as absorption
costing.
Questions
1 Analyse two reaons why a business entering an
industry may want to keep its variable costs as low
5.4
as possible. [8]
2 Evaluate the reasons why high fixed costs may have
led to the cement industry in Mauritius having just
one supplier after 2015. [12]
The Honshu Motor Company
5.4.2 Approaches to costing
This manufacturer of motor cars may incur direct and indirect
costs as set out below.
Direct costs Indirect costs
• direct materials such as sheet • indirect labour costs, for
steel and engine parts example management salaries
• direct labour, for example and wages paid to security staff
• other indirect costs such as
wages paid to employees on
production line administration and distribution
direct costs + indirect costs = total costs of production
▲ Figure 5.13 Direct and indirect costs of production
5.4.2 Approaches to costing
The differences between full and
contribution costing
A problem faced by businesses when attempting to calculate
costs accurately is allocating or dividing up indirect costs
between different elements of the business. This can be a
particular problem for large businesses that produce a range
of products.
One reason why it is difficult to calculate the total costs
of producing a single unit of output is that indirect costs
can be allocated in different ways and this can result in
different cost figures. As a consequence, managers may take
decisions that are incorrect.
When a business produces a number of products using
a single office or factory, it is difficult to calculate the
total cost of producing a single unit of output of any of its
products accurately. The problem it faces is how to allocate
indirect costs such as marketing and administration. There
are two approaches that can be taken.
Full costing
One method of deciding upon costs is full costing, which is
used by many businesses. This is also known as ‘absorption
costing’ and normally categorises costs as direct and
indirect. This approach to costing involves charging all the
costs of a particular enterprise to a unit of output. Thus,
all the costs associated with the production of a particular
product are ‘absorbed’ by it. This approach may require
managers to allocate indirect costs to all the business’
different products.
Full costing can allocate (or divide up) indirect costs
between different products produced by a business using
a range of criteria, such as the percentage of total indirect
costs used in the production of each product.
189
 Total cost of Total direct Allocated share
operating a division within a business. We explore this in
producing a = + the case study on Palm Foods.
costs of indirect costs
5.4 particular
product The allocation of indirect costs in this way is unlikely to be
entirely accurate. This has significant implications because,
by changing the way that these costs are allocated, the
Divided by Total cost of
number of units = a single unit profitability of different areas of a business can be affected.
of output of output For example, in the Palm Foods case study, if the company’s
accountants had decided to allocate indirect costs on the
▲ Figure 5.14 Key relationships for full (absorption) basis of the number of employees in each division, then the
costing indirect costs allocated to the division producing meat
AS LEVEL 5.4 COSTS

Contribution costing
The concept of contribution is an important one and is
used in calculating break-even output, as we shall see later
in this section. The use of contribution is based on clearly
classifying costs as fixed or variable. Contribution can be
calculated by use of the formula below:
contribution = sales revenue – variable costs
Contribution has two potential uses. Firstly, it is used to
pay the fixed costs incurred by a business. Any contribution
remaining after this transaction is profit for the business.
profit = contribution – fixed costs
It is possible to consider contribution in two broad ways:
either in relation to a single unit of output or in relation to
the entire output of a particular product or business.
When contribution is calculated for the sale of a single
product, we refer to it as contribution per unit. It is
calculated by using the formula:
variable costs of
contribution selling price of one –
per unit = unit of output producing that
unit
GLOSSARY TERMS
Contribution can be defined as the difference between
sales revenue and variable costs of production.
Break-even is the level of production or output at which a
business’ sales or total revenue is exactly equal to its total
costs of production.
Profits are the amount by which revenue exceeds total
costs, although there are several different measures of
profit.
The full-costing method
The full-costing approach normally divides costs into
direct costs and indirect costs. To calculate the total cost
of producing a single unit it is necessary to include all
costs, both direct and indirect. This can be a tricky process
if it is to provide accurate costing figures. The problem
centres on allocating indirect costs or overheads in a way
that represents the true costs of producing a product or
30
meals would have been: × $6 000 000 = $2 250 000. This
80
is $150 000 below the method actually used and would have
boosted the profits of this division by a similar amount,
assuming nothing else changes.
HANDLING DATA
The accountants in the Palm Foods case study might
have decided to use the number of employees working
in each of the company’s divisions as the basis for
allocating its indirect costs.
Calculate how the total indirect costs would have
been allocated between the fish and vegetarian meals
divisions if this method had been used.
So, as we have seen, if a business makes two or more
products, or operates multiple divisions or brands, full
costing entails allocating (or absorbing) indirect costs as
accurately as possible to the different parts of the business’
operations. If, for example, a business just produced two
products, it could allocate its indirect costs taking into
account the type of overhead:
» Indirect costs such as rent or property taxes could be
allocated or apportioned according to relative floor
space taken up by the production of the two products.
So, if product A takes up 60 per cent of the floor
space, then 60 per cent of these fixed costs should be
apportioned to product A.
» Indirect costs such as wage costs associated with
management and administrative staff could be allocated
according to the number of people employed in the
production of each product.
As many businesses produce more than a single product,
especially large-scale businesses, this approach to costing
is widely used. It is also recognised by many governments
as the accepted method to use in preparing financial
statements. This trend is also increasing as markets become
more global in nature and businesses have to extend their
product ranges to meet the diverse needs of customers
across the world. Nevertheless, when a business produces
a range of products (as we can see in the Rajasthan
Electronics Ltd case study) it requires managers to make
difficult decisions to allocate indirect costs.

190
 CASE STUDY
Palm Foods allocates its indirect costs
Palm Foods manufactures a range of ready-to-eat
meals aimed at high-income consumers. The company’s
products can be divided into three divisions:
● Meat meals: these contain a range of foods based
mainly on chicken and lamb.
● Fish meals: this is a smaller part of the company’s
5.4
The company’s managers want to know the cost of
production for its three divisions to help with their
decision-making. They use the full-costing approach to do
this. The company’s total indirect costs for 2019–20 were
$6 million.
The company’s accounts department has calculated some

5.4.2 Approaches to costing

production and is becoming less popular.
key statistics relating to the three divisions within the
● Vegetarian meals: these are increasingly popular as
company.
meals on their own or as accompaniments to some of
the company’s other products.
▼ Table 5.7 Palm Foods’ key statistics

Accounting item Meat meals Fish meals Vegetarian meals

Sales revenue (%) 50 20 30
Number of employees on each production line 30 25 25
Area of the factory floor used by each division (square metres) 2 000 1 300 1 700
Total direct costs incurred in production (%) 40 30 30

Palm Foods’ accountants have decided to allocate the ● Vegetarian meals: 1 700 × $6 000 000 = $2 040 000
company’s indirect costs for 2019–20 according to the 5 000
area of the factory’s floor space used by each of its three Questions
divisions. As a consequence, the indirect costs were 1 Calculate the allocation of indirect costs that would
allocated as shown below: have resulted if the company’s accountants had used
sales revenue as a guide. [6]
● Meat meals: 2 000 × $6 000 000 = $2 400 000
5 000 2 Evaluate the ways in which the company should have
allocated its indirect costs. [12]
● Fish meals: 1 300 × $6 000 000 = $1 560 000
5 000

CASE STUDY
Full costing at Rajasthan Electronics
Rajasthan Electronics Ltd manufactures consumer
electronics which are sold in Pakistan and other
countries in Asia. The company’s production is divided
into three product groups: televisions, microwave
cookers and digital radios. The costs associated with the
company’s production over the last financial year are
shown in Table 5.8.
▼ Table 5.8 Production costs at Rajasthan Electronics Ltd
The company’s managers use a policy of full costing
to calculate its costs and profits on its three products,
which are made in the same factory in Faisalabad. The
company’s indirect costs were $120 million for the year.
Rajasthan Electronics’ managers decided to allocate the
company’s indirect costs on the basis of the percentage

Televisions ($m) Microwave cookers ($m) Digital radios ($m) Total ($m)
Revenue from sales 286 145 225 656
Direct materials costs 107 77 78 262
Direct labour costs 97 45 87 229
Total direct costs 204 122 165 491
Allocated indirect costs 52 27 41 120
Total costs 256 149 206 611
Profit 30 (4) 19 45

191
 of revenue earned by each division. The calculations (with The managers’ decision to allocate indirect costs in this

5.4 some rounding) carried out by the finance department are

shown below:
way resulted in two of its divisions earning profits while
the third, the microwave division, recorded a small loss.
● Allocated indirect costs to televisions: Not all of the company’s managers agreed with this
286 approach to allocating indirect costs, and the managers
$120 million × = $52 million
656 of the microwave division were angry at suggestions that
● Allocated indirect costs to microwaves: production of microwaves should be stopped as they were
145 apparently making a loss rather than a profit.
$120 million × = $27 million
656
Questions
● Allocated indirect costs to digital radios:
AS LEVEL 5.4 COSTS

225 1 Analyse two other possible ways that Rajasthan

$120 million × = $41 million Electronics Ltd might have allocated its indirect
656
● Total indirect costs = $120 million costs. [8]
2 Evaluate whether or not Rajasthan Electronics Ltd
should stop producing microwave cookers. [12]

In the case of Rajasthan Electronics Ltd, the use of full
costing makes it very difficult to judge with any certainty
the precise financial position of the company’s three
product ranges. There is a danger that the company’s
senior managers may judge that the microwave division is
unprofitable and decide to discontinue production of this
product. This could prove to be a poor decision for two
reasons, as we shall see in the following continuation of the
case study.

CASE STUDY
Further events at Rajasthan Electronics
The managers of the microwave division are concerned ● Allocated indirect costs to televisions:
about proposals to end production of their cookers. In $120 million × 0.46 = $55 million
response, they have recalculated the company’s profits
for the past financial year using full costing but using a ● Allocated indirect costs to microwaves:
different basis for allocating indirect costs. $120 million × 0.15 = $18 million
The company’s operations managers have recently ● Allocated indirect costs to digital radios:
reported that the production of televisions uses 46 per $120 million × 0.39 = $47 million
cent of the factory’s floor space, that digital radios uses
● Total indirect costs = $120 million
39 per cent and microwave cooker production takes place
in 15 per cent of the available factory space. This was This allowed the managers to present a revised set of
used as a basis to recalculate the profits from the three profit figures, as shown in Table 5.9.
product ranges. Their revised calculations (again with
some rounding) are shown on the right:
▼ Table 5.9

Televisions ($m) Microwave cookers ($m) Digital radios ($m) Total ($m)
Revenue from sales 286 145 225 656
Direct materials costs 107 77 78 262
Direct labour costs 97 45 87 229
Total direct costs 204 122 165 491
Allocated indirect costs 55 18 47 120
Total costs 259 140 212 611
Profit 27 5 13 45

This data shows that: Questions

1 The microwave division may be profitable.
1 Analyse two reasons why a large business might use
2 If production of microwaves is discontinued,
full costing. [8]
the business’ fixed costs are unlikely to change
2 Evaluate whether this is a more accurate way of
and will have to be paid by the remaining two
calculating the company’s profits for its three
divisions, which will damage the profitability of the
product ranges than the approach based on the
company.
percentages of revenues earned by the divisions. [12]

192
 HANDLING DATA
Use the data in the Rajasthan Electronics case studies to 2 Calculate the change in the company’s profits if it
5.4
answer the following questions. managed to reduce its direct materials costs by
1 Calculate the percentage of total costs that are 10 per cent.
represented by direct labour costs.

Uses and limitations of the full-costing method

Full costing has a number of uses as well as limitations.

5.4.2 Approaches to costing

Some of these are summarised in Table 5.10 below.
▼ Table 5.10 The uses and limitations of full costing

Uses
• This approach to costing allows a business to take all of
its costs into account before making pricing decisions.
• Using the full costing is very common as this approach is
recommended by the International Financial Reporting
Standards (IFRS).
• Managers have to give thought as to the most effective
method of allocating indirect costs, which may result in
an accurate approach.
Limitations
• It is difficult to allocate indirect costs accurately – the
allocation is often based on proportions of direct costs.
• It can result in bad decisions. Businesses may discontinue
production of apparently unprofitable divisions,
departments or brands.
• If sales are below what is expected, allocated indirect costs
per unit of production could be higher than forecast, meaning
that a price that was expected to be profitable may not be.

▼ Table 5.11 Sales revenue, variable costs and contribution

GLOSSARY TERM for a business producing three products
Contribution costing calculates the cost of a product
solely on the basis of variable costs, thus avoiding the Product A ($) Product B ($) Product C ($)
need to allocate fixed costs. Revenue from 175 000 342 750 55 250
sales
Variable 87 150 169 700 14 525
The contribution-costing method labour costs
Contribution costing is sometimes referred to as ‘marginal
Variable 32 000 88 560 12 770
costing’. Contribution costing excludes fixed costs as a
materials costs
central part of the calculation and only allocates variable
costs. This is valuable in a business that has a number of Other variable 25 450 67 425 13 050
products, or several factories or divisions. A product or costs
division that earns sufficient revenue to cover its fixed Total variable 144 600 325 685 40 345
costs is likely to be viewed favourably by the managers costs
of the business. If this is the case then the product will
Contribution 30 400 17 065 14 905
generate a positive contribution and assist in paying fixed
costs or providing profit.
The example in Table 5.11 shows that product A contributes
The contribution-costing approach can be applied to the $30 400 towards paying fixed costs, product B $17 065 and
production and sale of a single unit of output or to the product C $14 905. In total this is $62 370. If we assume that
entire output of a product or products over a given time the fixed costs of the company for this period of time are
period. If a business would incur an additional cost of $39 500, we can calculate the profits that the company has
$100 in producing a single extra unit of output (this is its made.
marginal cost) but would expect to sell that product for
Total contribution: $62 370
$125, then it would make a positive contribution of $25 on
that unit of output. Fixed costs: $39 500
Alternatively, we can consider contribution costing for the Profit: $22 870
entire production of a particular product or products as
If a product makes a positive contribution, as is the case in
shown in Table 5.11.
Table 5.11, then it is worth the business continuing to produce
it. There may even be an argument for continuing to produce
it if it makes a negative contribution, as we shall see later.

193
 The difference between contribution and profit GLOSSARY TERMS
It is essential to understand that contribution and profit
5.4 are not the same thing. Contribution is the surplus left over
Average costs are the total cost of production divided by
the number of units produced.
from sales revenue (or total revenue) once variable costs
have been paid. Profit is any surplus from sales revenue over Marginal cost is the extra cost resulting from producing
one additional unit of output. In most situations the
a trading period once all costs have been paid.
marginal cost of an additional unit of a product is the
variable cost of its production.
The limitations of contribution costing and when
it might be used
As with full costing, contribution costing has a number of ▼ Table 5.12 Fixed, variable and total costs of producing
AS LEVEL 5.4 COSTS

limitations. The main limitations include the following. televisions

» It can be difficult to distinguish between fixed and
Level of production Fixed Variable Total
variable costs accurately. For example, some costs
(million televisions) costs costs costs
have elements of both and are known as semi-variable
per year ($m) ($m) ($m)
costs. One example of a semi-variable cost is landline
telephone costs. The monthly line rental would be a 0 200 0 200
fixed cost, because it remains the same irrespective of 1 200 180 380
the level of business activity. However, the call charges
2 200 360 560
are variable as they are likely to alter directly with a
business’ level of activity. 3 200 481 681
» Fixed costs do not always remain constant when the 4 200 624 824
level of output alters. Some fixed costs tend to be
5 200 760 960
higher as a result of a business increasing its level
of output. For example, promotional costs or website 6 200 880 1 080
maintenance costs may increase in line with production 7 200 990 1 190
levels. This makes the division of costs into fixed and
8 200 1 240 1 440
variable elements less accurate.
» The tax authorities in some countries do not accept the
use of contribution costing. For this reason, its use is Average costs
less common than that of full costing. Average costs are simply total costs at any level of output
Contribution costing is likely to be used in a number of divided by that level of output. They are also called unit
circumstances. It can help managers to decide whether to costs. In Table 5.12, it is possible to calculate average costs
accept an order as it shows the variable costs of producing at each level of output. For example:
products. If a business receives a number of non-standard » At an output of 3 million televisions, the average cost is
orders, it may use contribution costing to determine $681 million ÷ 3 million = $227 per television.
whether or not to accept such orders. We will explore this » At an output of 5 million televisions, the average cost is
more fully in the next section. $960 million ÷ 5 million = $192 per television.
» At an output of 7 million televisions, the average is
Businesses that produce many different products may be more $1190 million ÷ 7 million = $170 per television.
likely to use contribution costing because the difficulties
involved in allocating fixed (or indirect) costs between Average costs tend to fall as a business increases its
many different products can be too great. Any resulting cost production levels because its fixed costs are spread over a
figures may be judged inaccurate and any decisions taken on larger output, and so the amount allocated to each product
the basis of these figures may be incorrect. is smaller as the level of production rises.

5.4.3 Uses of cost information HANDLING DATA

Calculating average, marginal and Use the information in Table 5.12 to answer the
total costs following question.

Managers can calculate a number of costs to assist with At what levels of output would the average cost of
decision-making. Three vital ones are: televisions be:
» average costs a highest b lowest?
» marginal costs
» total costs.

194
Marginal costs
Marginal costs are the extra costs resulting from producing
one additional unit of output. Marginal costs do not
really take into account fixed costs, as they have to be
paid whatever the level of production of the business.
Thus, marginal costs are concerned with variable costs
(the direct costs of materials and labour, for example). In
most situations, the marginal cost of an additional unit
of a product is the variable cost of its production. In the
example of our television manufacturer in Table 5.12, we
know that to produce 4 million televisions would result in
a total cost of production of $824 million. If we assume
that fixed costs are unchanged and that the variable cost
of producing one more television is $200, the total cost will
rise to $824 000 200 for 4 000 001 televisions. This means
that the marginal cost of producing this one additional
television is $200.
Costs and pricing decisions
The costs of production can have a significant influence on
a firm’s pricing decisions.
Average costs and prices (cost-plus pricing)
Cost-plus pricing is the most commonly used method of
setting prices. It involves deciding the price of a product
based on the average cost of a single unit of the product.
The average cost is calculated by dividing total production
costs by the number of units that are produced. To this
value is added an amount which is called a mark-up. The
mark-up is, in effect, profit. Average cost plus mark-up is
the price charged.
For example, if a furniture manufacturer is aware that a
single table costs $125 to produce and decides to price the
table at $150, the pricing method is cost-plus. In these
circumstances the manufacturer can be certain the product
will sell at a profit, but may be less sure about the level of
sales. Cost-plus pricing does not take into account the state
of the market or actions of competitors.
Scenario A Scenario B
The company produces 1000 The company produces 5000
bicycles during the year. Total bicycles during the year. Total
production costs are $100 000 + production costs are $100 000 +
($50 × 1000) = $150 000 ($50 × 5000) = $350 000
Average cost of producing one Average cost of producing one
bicycle = $150 bicycle = $70
▲ Figure 5.15 Average costs and production levels
A firm can help to keep costs of production for each
individual unit to a minimum by producing on the largest
possible scale. Consider the two scenarios shown in
Figure 5.15 for the London Bicycle Company. This company
has fixed costs of $100 000 and each bicycle has variable
costs of $50 for materials and labour.
Manufacturing in the circumstances of scenario B would
allow the company to set lower prices for its bicycles or to
enjoy higher profits – or both. For example, in scenario B it
could reduce its price from more than $150 per bicycle to,
5.4
say, $100. This would allow it to make a profit of $30 per
bicycle and it is likely that sales would rise significantly due
to the price fall, possibly boosting profits further.
GLOSSARY TERMS
Cost-plus pricing is the process of establishing the price
5.4.3 Uses of cost information
of a product by calculating its cost of production and then
adding an amount which is profit.
Contribution pricing is based on the notion that any price
set that is higher than the variable cost of producing a
product is making a payment towards fixed costs.
Marginal costs and prices (contribution pricing)
By knowing how much it costs to produce an additional
unit of output, a business can be guided in setting
prices or deciding whether to accept orders at specific
prices. Marginal costs are based on the variable costs of
production. Fixed costs will not be affected by the decision
to supply additional units and so it is the contribution from
any sale that is critical. Contribution can be calculated
using the formula below:
contribution = revenue – variable costs of production
The concept of contribution is useful when taking pricing
decisions. If the manager or owner of a business sets a price
in excess of the variable cost of producing the product,
then each sale will make a positive contribution to fixed
costs. If sufficient sales are made, the enterprise will earn a
profit. This approach to pricing is also called contribution
pricing.
For example, the manager of a restaurant may calculate that
the typical variable cost of serving a meal to a customer is
$12. If the restaurant charges customers an average price
of $25 for each meal, then it will make a profit as long as
it attracts enough diners. It is certain that the revenue
received from each customer will contribute $13 ($25 − $12)
towards fixed costs.
Contribution pricing offers firms flexibility when deciding
upon the amount to charge for their products. Businesses
that have well-established products in high demand may
be able to price significantly in excess of the variable cost
of production. In these circumstances, each sale makes
a major contribution to fixed costs and profits. Fashion
clothing is an example of a product where prices are set
considerably above variable costs. Thus, a business might
charge the equivalent of $75 for a t-shirt that costs $10
to manufacture. The contribution of $65 from each sale
is necessary because the business faces high fixed costs,
spending heavily, for example, on marketing. Furthermore,
products in the fashion industry have very short lives.
195
 However, contribution pricing has its weaknesses. While
setting a price that generates a positive contribution
5.4 may result in the firm earning a profit, this depends upon
the business in question achieving sufficient sales. This
is far from certain as this approach to pricing places
relatively little emphasis on the state of the market. Using
contribution as a guide for pricing may result in low levels
of sales because competitors’ prices are lower or their
responses may be unpredictable.
STUDY TIP
AS LEVEL 5.4 COSTS
Many students confuse contribution and profit, yet this
distinction is vital and understanding it is important to
gain top-level grades. Profit is revenue less all costs,
while contribution is revenue less only variable costs.
Using costs to monitor and improve
business performance
Managers of all businesses constantly monitor costs to
ensure that:
CASE STUDY
Starbucks expands in the Indian market
The American coffee retail chain, Starbucks, opened its
first coffee shop in India in 2012. Understandably, the
market of 1200 million people was very attractive to the
company, as incomes and a taste for coffee among Indians
increased. However, selling in India required the company
to change its approach in some ways. Starbucks, famous
for its caramel macchiato and espresso, offered smaller
and cheaper beverages to attract coffee drinkers in India.
In 2019, Starbucks opened more than 30 outlets in India, the
largest number of new store openings since 2012. However,
Café Coffee Day is still India’s largest coffee shop chain.
In 2018, Starbucks also announced its plan to open outlets
in the western state of Gujarat, where it opened five
stores in the cities of Surat and Ahmedabad. Starbucks
However, for a large-scale global business, such as
Starbucks in the case study, it may be difficult to compare
performance in different countries in this way because of
huge differences in costs. Thus, monitoring and comparison
of costs in this way is likely to be more effective if it takes
place in a single country or within countries with similar
costs for resources such as labour.
Equally a trend of falling costs may provide an indication
that profitable opportunities exist. For example, in 2019,
the rental costs of retail properties in Hong Kong fell by
over 10 per cent compared with the previous year. This
cost information might assist a retail business to make a
profitable decision on expansion.
Thus, budgets can be used to monitor how well costs are
controlled, but also to assist the business’ managers in
improving the business’ performance. By using the cost
196
» the costs incurred by separate areas of the business
(divisions or branches, for example) do not differ
significantly without good reason
» costs are not increasing unexpectedly and are similar to
the forecasts set out in the company’s budgets
» the business continues to hit its profits targets.
We look at budgets in much more detail in Chapter 5.5.
A business that operates many similar branches or outlets
may compare the costs of its branches and seek to reduce
costs to those achieved by the most efficient performer.
In this way, the company uses cost data as indicators of
best practice and seeks to duplicate this approach in other
areas of its business to improve performance and profits.
It may be possible for senior managers to set cost targets
for areas of the business controlled by junior managers and
to reward achievement of these targets. In this way, large
organisations are more able to control costs and improve
profits.
now has 157 outlets in ten Indian cities including Mumbai,
Hyderabad, Chennai and Bengaluru.
Starbucks will continue to need to set its prices lower
than in the United States if it is to increase its sales
further in India. Starbucks’ expansion plan in India
includes offering customers more vegetarian food options
and adding new food items.
Questions
1 Analyse one reason why selling its products at
lower prices in India might not necessarily reduce
Starbucks’ revenue. [4]
2 Evaluate the reasons why the costs of operating a
coffee shop in Gujarat might be different from those
in a state in the USA. [12]
information, managers can take decisions to improve the
business’ performance and, especially, its profitability. For
example:
» It may be able to reduce its costs following such an
analysis. If it is placing increasingly large orders with its
suppliers, it may be able to negotiate larger discounts
for bulk orders. Alternatively, if it is not using all of
its supplies, it may reduce the size of its orders and its
costs. This is vital if the supplies are perishable.
» Labour is a major cost for many businesses and
especially those operating in the service sector.
Monitoring labour costs is important to maximise
profits. For example, if a business hires too much labour
and that labour is not fully employed then the business
is incurring costs that are not matched by revenue.
Profitability will be damaged as a consequence.
A business’ managers may look at cost data over a period of ▼ Table 5.13 Sales revenue, total costs and profits from
time. Changes in the figures may reveal underlying problems producing televisions
that can be corrected to improve the business’ profits. We
can consider a few examples of using cost data in this way. Level of production Sales Total Profits 5.4
» Rising labour costs within a business when output is not (million televisions) revenue costs or losses
increasing could show that employees are working less per year ($m) ($m) ($m)
efficiently. This could be caused by a range of factors, 0 0 200 (200)
including a lack of training or poorly motivated employees.
1 300 380 (80)
Once the cause of the rising labour costs has been
identified, managers can take appropriate remedial action. 2 600 560 40
» Rising costs of raw materials over time could indicate

5.4.3 Uses of cost information

3 900 681 219
that there are high levels of waste or that suppliers have
4 1 080 824 256
increased costs significantly. In either case, the cost
information could alert managers to a problem which 5 1 250 960 290
needs attention to improve profits. In 2020, Hasbro, the 6 1 320 1 080 240
American toy manufacturer, said it would be seeking to
7 1 420 1 190 230
manufacture more of its toys outside China due to the
rising costs of producing in China. 8 1 600 1 440 160
» A business’ fixed costs may increase more rapidly than
might be expected over time. Managers responsible for
controlling these costs may take action in response. HANDLING DATA
Use the information in Table 5.13 to answer the
Using cost information to calculate following questions.
profits 1 Assume the television manufacturer could always
sell its televisions at $300 per television, no matter
Profits are the amount by which revenue exceeds total
what its level of output. At what level of output would
costs, although there are several different measures of
it make the highest profit?
profit. Figure 5.10 on page 187 illustrated that comparing 2 Why is profit highest at this level of output?
the total costs for a business with the revenue that it earns
over a period of time shows whether a business has made a
profit or a loss. The key formula for profit is: Contribution costing and special-order
profit (or loss) = total revenue − total costs decisions
At the end of a trading period, the managers of a business One of the key advantages of using contribution costing is
can calculate the business’ profits using its cost and that it can help managers to make what are called special-
revenue information. So, if a business generated sales order decisions.
revenue totalling $256.4 million during the financial year
and incurred total costs amounting to $208.9 million, it GLOSSARY TERM
could calculate its profits as follows:
Special-order decisions occur when a business’
profit = $256.4 million – $208.9 million = $47.5 million managers have to decide whether or not to accept unusual
customer orders.
In Table 5.12 on page 194 we considered the fixed, variable
and total costs of producing televisions. Table 5.13 shows
how this cost data can be used to calculate whether or Special-order decisions
not the business producing televisions makes a profit. Businesses sometimes have to make decisions on whether
Furthermore, it can be used to calculate the expected profit to accept orders that are not on their normal terms. For
at different levels of output and to decide which might be example, a firm might receive a large order for its products
most profitable. However, this is only possible when the at a price significantly lower than it usually receives.
company has the relevant revenue information as well. In this Alternatively, a business might receive an order which offers
case, we assume that to sell higher quantities of televisions, a price above the usual but which requires special features
the company has to sell its products at lower prices. This is or a very early delivery date, meaning the supplier is likely
why its revenue does not rise steadily with output. This cost to incur additional costs in fulfilling the order.
information, when added to information about sales revenue
(or total revenue), allows managers to calculate profits. Firms faced with the dilemma of whether to accept this
type of order are facing special-order decisions. In these
The information in Table 5.13 suggests that the television circumstances, the concept of contribution can be applied
manufacturer would make the highest profits if it produced to assist the business in reaching a decision on whether or
(and sold) 5 million televisions per year. Of course, it not to accept the order.
is important to understand that this is forecast data
and might not be completely accurate. However, it is an
important aid to a business’ decision-making.

197
 CASE STUDY
5.4
Margaret Roberts Woollens
AS LEVEL 5.4 COSTS
▲ Figure 5.16 One unit on which contribution costing
could be applied
Margaret Roberts Ltd manufactures woollen sweaters
for local shops at a standard price of $40. The sweaters
Prices lower than normal
It is not unusual for a firm to receive an order for a large
quantity of its products at a price below that normally
charged. Consider the case study above.
A number of factors need to be taken into account when
taking special-order decisions such as this.
» Will additional fixed costs result from accepting the
order? In the circumstances above, Margaret Roberts Ltd
may have to hire additional factory space, increasing
its overheads, meaning that additional contribution is
required to meet these costs before extra profits are
earned. Thus, if the firm has to pay an extra $10 000
in rent, then profits will be unchanged as a result of
accepting the order. Therefore, having sufficient spare
capacity is an important prerequisite of accepting such
an order.
» Might the order lead to higher variable costs? Accepting
a large order might mean that workers are paid overtime,
pushing up variable costs. Workers at Margaret Roberts
Ltd might be paid higher hourly rates, meaning that the
variable cost of producing a single item rises to $35.
In these circumstances the order would not be worth
accepting.
» Before making a special-order decision (at a price below
the norm), a business needs to ensure that the customer
198
are very popular with tourists and sell for high prices,
particularly during the summer season. The cost of wool
and the wages paid to knitters means that the average
variable cost of producing a single woollen garment is
$30. To the surprise of the managing director of the firm,
a large order is received from a national clothes retailer.
The retailer requires 5000 sweaters and other garments,
but is only willing to pay Margaret Roberts Ltd $32 per
item. Should Margaret Roberts Ltd accept the order?
Contribution is the key to making this decision. The firm
would earn a positive contribution on each sale. Each
woollen item sold would incur variables costs of $30, but
would earn revenue of $32. Thus each sale would create
$2 of contribution. Therefore, meeting the order would
earn the business an additional $10 000 in contribution.
This might mean profits would rise (or losses would fall)
by $10 000.
Questions
1 Analyse two reasons why accepting this order may
not increase the level of profits earned by Margaret
Roberts Ltd. [8]
2 Evaluate the non-financial factors the managers at
Margaret Roberts Ltd might consider before deciding
whether or not to accept this order. [12]
will not simply resell the product to other firms at the
usual selling price, thereby making a quick profit at the
expense of the manufacturer.
» A business may accept a lower price than normal, even if
it doesn’t produce a positive contribution, if it believes
that it will result in more sales at higher prices in the
future.
STUDY TIP
When responding to questions on special-order decisions
(or costing decisions generally) it is important to consider
non-financial factors as well as financial ones. Read the
case study or stimulus material carefully to ensure you
pick up on any non-financial factors that may have been
included as clues.
Prices higher than normal
It may appear a stroke of good fortune for a business
to receive an order at a price above that usually levied.
However, if the order requires products to have a
specification higher than normal or to be delivered at short
notice, it is likely that the supplier will face higher costs.
This may make the order unprofitable.
Once again, contribution is the key to the decision. If the
selling price exceeds the variable costs and no additional
fixed costs are incurred, the order would be worthwhile
and would result in increased profits. Therefore, if
Margaret Roberts Ltd had an order for a new style of
sweater which needed more expensive wool than normal
and had to be completed within six weeks, the firm would
need to:
» calculate the extra variable costs associated with the
order – overtime pay for workers and more expensive
materials, for example
Contribution and break-even
Contribution is an important part of break-even analysis. We
saw earlier that contribution can be defined as the difference 5.4
between sales revenue and variable costs of production.
Contribution is calculated using the following formula:
contribution = revenue − variable costs
Contribution can be used to pay the fixed costs incurred
by a firm. Once these have been met fully, contribution
provides a business with its profits.

5.4.4 Break-even analysis

» consider whether it had sufficient spare capacity to
Revenue from sales
meet the order – avoiding additional fixed costs
» decide whether accepting the order would generate
less
extra contribution and profits.
Variable costs
Qualitative factors
Qualitative factors are often important in such decisions. gives
Accepting an order such as that received by Margaret
Roberts Ltd may offer long-term benefits. The customer Contribution
may return with further orders and it may help to increase
brand awareness in new markets. It may help the business contribution is
used to pay
concerned to achieve its corporate aims, especially if these
are growth or increasing market share. Fixed costs

On the other hand, the consideration of qualitative factors once fixed costs are
may result in a decision not to supply a special order. paid, contribution
provides
It may be regarded as too risky. For example, managers
may believe that allowing their products to be sold in
large quantities at lower prices could damage its brand Profits
image. It may, for example, make the product appear less
exclusive and make it difficult to charge higher prices
in other markets. Sales and profit margins may fall as a ▲ Figure 5.17 Contribution is the difference between sales
consequence. revenue and variable costs of production. Profit is the
surplus of sales revenue over all costs

5.4.4 Break-even analysis Calculating break-even output

The manager of a business wishing to calculate the break-
What is break-even analysis and why is even point or level of output will require the following
information:
it important? » the selling price of the product
Break-even output is that level of output or production at » the variable cost of producing a single unit of the product
which a business’ sales generate just enough revenue to » the fixed costs associated with the product (remember,
cover all its costs of production. At the break-even level fixed costs do not change as the level of production
of output, a business makes neither a loss nor a profit. alters).
A business’ managers may use break-even analysis for a
This information is used within the following formula:
number of reasons:
» to help decide whether a business idea will be profitable
and whether it is viable break-even fixed costs
=
» to help decide the level of output and sales necessary to output selling price per unit − variable
generate a profit cost per unit
» to support an application by a business for a loan from a
bank or other financial institution This formula can be rewritten given that contribution is the
» to assess the impact of changes in the level of result of taking away variable cost per unit from the selling
production on the profitability of the business price of a product:
» to assess the effects of different prices and levels break-even fixed costs
of costs on the potential profitability of the business =
output contribution per unit
» to judge whether launching a new product or entering
a new market will be profitable given expected sales We will use the scenario set out in the following case study
forecasts. to illustrate the construction and interpretation of break-
even charts.
199
 CASE STUDY
5.4 Using break-even analysis
Sarah Feng is planning to expand her restaurant chain
and to open a new restaurant in New York, specialising
in Cantonese food. She has a lot of experience in the
industry, as she already operates 12 restaurants in Sydney
and Kuala Lumpur. Her new restaurant will maintain her
reputation for serving high-quality food in beautifully
AS LEVEL 5.4 COSTS
▼ Table 5.14 Sarah’s analysis for The River Palace
Type of cost or revenue
Average selling price per meal at The River Palace
Variable costs per meal – ingredients, fuel, wages
Monthly fixed costs of the new restaurant – lease for the property, rent and rates
Using this information, Sarah was able to calculate how
many meals she will need to sell (or how many diners she
has to attract) in her restaurant if the project is to break
even.
break-even fixed costs
=
output contribution per unit
Sarah knows her fixed costs will be $10 000 each month
and this figure is entered into the top of the formula. To fill
in the bottom, Sarah has to take away the variable cost of
producing a meal from the price the customer pays for a
meal. The contribution earned from each meal in Sarah’s
new restaurant is $25 ($60 − $35). Thus:
$10 000
monthly break-even output = = 400 diners
$25
While this calculation gives Sarah a quick guide to the
number of customers her restaurant will need to break even,
it tells her little more about the level of profit or loss The
River Palace might make. A break-even chart is one way to
work out the level of profits the business will generate if
her forecast is proved to be correct.
Break-even charts
Sarah knows that The River Palace can seat a maximum of
30 customers per night and that she normally opens for 25
evenings each month. This means that her maximum number
of customers each month is 750 (30 customers × 25 nights).
When Sarah constructs her break-even chart, her horizontal
axis will run from zero to 750 customers.
The vertical scale on a break-even chart records costs and
revenues. Normally revenues are the highest figure. At most,
Sarah could attract 750 customers paying an average of $60
200
furnished buildings. Sarah plans to call her restaurant
‘The River Palace’.
Sarah needs a loan to open The River Palace. She has
already looked at a building which would accommodate
up to 30 diners. She produced the figures set out in
Table 5.14.
Amount
$60
$35
$10 000
So, Sarah knows that, if her plan for The River Palace
is to break even, she will need to attract at least 400
customers each month. If she attracts more than 400
customers, the project will make a profit. Sarah plans to
open The River Palace on 25 evenings each month and
would, therefore, break even if she had an average of 16
customers each night in the new restaurant.
Questions
1 If Sarah increases her prices to an average of $70
per meal, calculate the level of her new break-even
output. [6]
2 Evaluate whether or not Sarah’s planned price
increase would be a good idea. [12]
each. So, the highest revenue she could possibly receive
is $45 000 ($60 × 750). Her vertical scale should have a
maximum value of $45 000.
Sarah’s break-even chart shows the monthly fixed costs she
will have to pay: $10 000. This is illustrated in Figure 5.19.
Variable costs are also illustrated. As variable costs
are expenditure on items such as components and raw
materials, these costs will rise along with output. If Sarah
has an increasing number of people dining at The River
Palace, she will need to buy more food and her wage bill
will also rise.
Variable costs always start at zero. The highest variable
cost Sarah could encounter is to provide 750 meals, each
having a variable cost of $35. The highest variable cost
would therefore be $26 250 ($35 × 750). This maximum
figure is connected by a straight line to the origin as
shown in Figure 5.18.
 The maximum value on this axis is worked out Finally, the break-even chart shows the revenue The River
by multiplying the maximum output by the Palace will earn. Sarah has already calculated that an
45
5.4
average selling price (i.e. $60 x 750 = $45 000).
average customer spends $60 on a meal in her restaurant.
40 Once again, there are two extreme situations.
» If The River Palace does not have any customers, it will
35 not have any revenue. Thus the revenue line begins at
Costs and revenues ($000)

30 Variable
the origin.
costs » If the restaurant is full, Sarah expects each of the
25 750 customers to pay $60 on average. If The River
Palace attracts this level of custom, it will earn
$45 000 ($60 × 750).

5.4.4 Break-even analysis

20

15 Figure 5.20 shows the break-even chart with the revenue

Fixed costs = $10 000 line included. To make the chart easier to read, the variable
10 costs line has been left out in this case.
The
origin The maximum figure on this axis is simply
5 the maximum level of output. The new Revenue
restaurant can seat 750 diners each month 45
0 100 200 300 400 500 600 700 750
40
Monthly output (customers)
Break-even occurs Total costs =
▲ Figure 5.18 Fixed and variable costs on a break-even chart 35

Costs and revenues ($000)

where total costs and fixed costs +
revenue are equal variable costs
30
Total costs are simply the sum of fixed and variable costs.
» If The River Palace has no customers in a month, it will 25
not incur any variable costs. At zero output, total costs
are the same as fixed costs. In Sarah’s case, this will 20
mean a total costs figure of $10 000 per month. 15 Fixed costs
» At the other extreme, The River Palace might be full, = $10 000
with 750 customers each month. Sarah will add together 10
fixed costs (still $10 000, of course) and variable costs at Break-even output
full capacity (750 customers’ meals each having variable 5 confirming the earlier
costs of $35), equal to $26 250. Thus, total costs for calculation
0
the restaurant in these circumstances will be $36 250 100 200 300 400 500 600 700 750
($10 000 + $26 250). Monthly output (customers)

The line connecting these two points represents total costs.
This line should be parallel to the variable costs line and is
shown in Figure 5.19.
45
40
This total costs line will be
parallel to variable costs –
35 the difference between the
Costs and revenues ($000)
▲ Figure 5.20 The complete break-even chart
The break-even chart tells Sarah that she needs 400
customers each month if The River Palace is to break
even. This confirms the calculation we carried out
earlier. However, a break-even chart provides much more
Total costs = fixed information. Sarah can use it to read off the level of profit
costs + variable costs or loss her new restaurant will make according to the
number of customers it attracts.

two lines is fixed costs If the River Palace attracts fewer than 400 customers
30 Variable each month, it will record a loss. The amount of the loss is
costs
shown on the graph by the vertical distance between the
25
total cost line and the revenue line at the relevant level of
20 output. Similarly, if the restaurant attracts more than 400
customers in a month, it will generate a profit that month.
15
Fixed costs
Here the profit is shown by the vertical distance between
= $10 000 the revenue line and the total cost line.
10
Figure 5.21 shows the level of loss and profit made by The
5 The origin – all variable River Palace if it attracts 200 customers and 600 customers
cost curves begin here per month.
0
100 200 300 400 500 600 700 750
Monthly output (customers)
▲ Figure 5.19 Including total costs on a break-even chart

201
 Revenue
45

5.4 Revenue earned from

600 customers = $36 000

40

Total costs
35
Profit = $5 000
AS LEVEL 5.4 COSTS

30 Total cost of supplying

600 customers = $31 000
Costs and reveunes ($000)

25
Total cost of supplying
200 customers = $17 000 Break-even
point
20
Loss = $5 000

The margin
15 of safety

10
Revenue earned
from 200 customers
= $12 000

5
Break-even
output

0 100 200 300 400 500 600 700 750

Loss-making Profit-making Monthly output

range of output range of output (Number of customers)

▲ Figure 5.21 Showing profits and losses on a break-even chart

CASE STUDY
Nigerian films fail to break even
The film industry in Nigeria is experiencing some good
times. Much of this is due to the efforts of Kunle Afolayan,
a 46-year-old director. Kunle has produced a series of
films since 2005 which have impressed knowledgeable
film critics and have received highly favourable reviews in
the New York Times.
Despite this international acclaim, it remains difficult to
generate profits from making films in Nigeria. His new
film, Citation, about a scandal at Nigerian and Ghanian
universities which came to light in 2018, began filming in
2020. Kunle predicts that it will ‘beat records’. The film
is still showing and earning revenues, but some analysts
believe it is unlikely to break even.
Yet box-office receipts are not Kunle’s main concern.
‘Nigerian films that are driven by commercial interests alone
make a lot of one-off noise, but people don’t remember them
in six months’ time,’ he says. ‘That isn’t the kind of legacy I
want to leave.’ Most of his films have been financed through
a combination of his own earnings, bank loans and individual
investors, though he has now attracted funding from further
afield, receiving a Ford Foundation grant to make Citation.
The Ford Foundation was established by the Ford motor car
manufacturing company.
Source: https://econ.st/32pt6A6
Questions
1 Explain two actions that Kunle Afolayan might take
to help make his latest film profitable. [6]
2 Evaluate why investors might choose to invest in a
film which is not expected to make a profit. [12]

202
 HANDLING DATA
Mike plans to open a business providing people with
help to learn how to use computers and the internet.
Mike thinks his fixed costs will be $21 000 per year
and the variable costs of serving each customer will
be $100. His average price per customer will be $240.
He expects to have 200 customers in his first year of
trading.
1 If his figures are correct, will he break even in his
first year of trading?
2 Calculate his expected profit or loss during his first
year of trading.
The margin of safety
A break-even chart can be used to show the margin of
safety, although this can also be calculated. The margin
of safety measures the quantity by which a firm’s current
level of sales exceeds the level of output necessary to
break even.
The following formula expresses the margin of safety as a
number of units of output.
margin of safety = current level of sales − break-even output
In our previous example of The River Palace restaurant, if
it is successful and attracts 600 customers each month, the
margin of safety will be 200 customers (600 customers –
400 customers). This means that, in these circumstances,
the restaurant could lose 200 customers each month before
it reached break-even output and began to make a loss.
This is shown in Figure 5.21 (page 202) for an output of 600
customers per month.
There is an alternative method of calculation which
expresses the margin of safety as a percentage of current
sales. The formula to use for this is:
margin of current level of sales − break-even output
safety = × 100
current level of sales
Using this formula for our example we would get:
600 − 400
margin of safety = × 100 = 33.3%
600
This tells us that the restaurant could lose just over 33
per cent of its sales before it found itself in a break-even
position.
GLOSSARY TERM
The margin of safety measures the quantity by which a
firm’s current level of sales exceeds the level of output
necessary to break even.
The uses and limitations of break-even
analysis
Most financial techniques have uses and limitations, and
5.4
break-even analysis is no exception. The uses of break-even
analysis include the following:
» It is a simple technique, allowing most entrepreneurs to
use it without the need for expensive training. Because
of this, it is particularly suitable for newly established
and small businesses.
» It is a technique that can be completed quickly,
5.4.4 Break-even analysis
providing immediate results.
» It can be of value in supporting a business’ application
to a bank for a loan.
» By using break-even charts, a business can forecast the
effect of varying numbers of customers on its costs,
revenues and profits.
» Break-even analysis can be used to analyse the
implications of changing prices and costs on the
enterprise’s likely profitability.
However, break-even analysis has a number of limitations:
» It assumes that all products are sold. For example,
Sarah might assume that she will attract 600 customers
each month. She will order the necessary food and hire
sufficient staff. However, if only 500 turn up, she will
not make the profit indicated for 600 customers on the
break-even chart.
» It is a simplification of the real world. Businesses do not
sell all their products at a single price and calculating
an average is unlikely to provide accurate data. The
technique is also difficult to use when a business sells a
number of different products.
» Costs do not rise steadily as the technique suggests. As
we have seen, variable costs can rise less quickly than
output because of the benefits of buying in bulk.
» Any break-even analysis will only be as accurate as the
data on which it is based. If costs or selling prices are
incorrect, then the forecasts will be wrong.
Break-even analysis offers some support to businesses,
and especially to start-up enterprises or those seeking to
expand by launching new products and/or entering new
markets. However, it is only a guideline and its value should
not be overstated. Perhaps, most importantly, entrepreneurs
and managers should bear in mind that the value of the
technique depends on the use of reliable data for costs,
prices and expected sales.
203
 TEST YOUR LEARNING
5.4 10 a Define the term ‘margin of safety’. [2]
Short answer questions
b Calculate the margin of safety if a business has
1 Define the terms: sales of 10 000 units per year and its break-even
a ‘costs’ [2] output is 6500 units. [2]
b ‘revenues’. [2]
2 a Explain one difference between average costs Data response question
and marginal costs. [3] The new hotel
AS LEVEL 5.4 COSTS

b Explain one reason why average costs might

fall as a business increases its level of output. [3]
3 a Define the term ‘full costing’. [2]
b Explain one way in which a large manufacturing
business might allocate its overheads between the
different products that it supplies. [3]
4 Explain one reason why it might be difficult for the
manufacturer in question 3b to allocate its overheads
accurately. [3]
5 Explain one reason why a business might refuse an
order for its products at a price that is higher than
normal. [3]
6 Explain one reason why a business might decide to
accept an order for its products at a price of $300 per
unit when its normal selling price is $400 per unit. [3]
7 Explain one way in which a business might calculate
the marginal cost of a single unit of output. [3]
8 Explain one reason why contribution costing avoids
the need to allocate overheads. [3]
9 a Define the term ‘break-even output’. [2]
b A business sells its products for an average price
of $40, has fixed costs of $100 000 and contribution
per unit of $15. Calculate the level of output
required to break even. [2]
Santa Rosa Hotels has just opened its latest hotel in
Huaraz, close to the Parque Nacional Huascarán in Peru.
The area is a popular tourist destination and the numbers
visiting are rising quickly. There are many other hotels in
the area and the new hotel is not expected to be full at any
time during its first year of operation.
The hotel’s manager is keen to make the new business
profitable and plans that every guest at the hotel will
make a contribution to fixed costs. They are concerned
about their pricing decisions, as labour and other costs
are expected to rise significantly over the next year or two.
Santa Rosa Hotels has not been a very profitable company
since 2019 and its shareholders are keen to see an
improvement in this area over the next year or two.
Questions
1 Define the terms:
a ‘contribution’ [2]
b ‘fixed costs’. [2]
2 Analyse one reason why it is important for the
company to calculate its costs accurately. [4]
3 Evaluate the case for and against the decision to use
cost-plus pricing. [12]

204
5 Finance and accounting
AS LEVEL

5.5 Budgets

5.5.1 The meaning and purpose of budgets

Chapter overview
In this chapter we examine:
★ the meaning and purpose of budgets and the benefits and drawbacks of their use
★ the meaning, calculation and interpretation of variances.

5.5.1 The meaning and purpose of
budgets
What are budgets?
Budgets are financial plans. Firms plan their earnings and
expenditures using budgets. Budgets are usually drawn
up on a monthly basis, over the period of a financial year.
There are a number of types of budgets:
» Sales revenue or income budgets These set out
the business’ expected sales revenue from selling its
products. Important information here includes the
expected level of sales and the likely selling price of
the product. A start-up business may have relatively low
revenue budgets during its first few months of trading. It
is likely that the sales revenue budgets will be increased
as the business becomes better known. In contrast, an
established business may have a large and loyal customer
base and substantial inflows of revenue from a range of
different products or brands, for different regions, or
from a number of subsidiary companies.
» Production or expenditure budgets Businesses need
to plan their expenditure on labour, raw materials, fuel
and other items which are essential for the process of
production. Research is necessary to prepare accurate
expenditure budgets. For example, an independent
forecast in 2019 revealed that wages in countries in
Asia are expected to rise by between 2.3 per cent and
12 per cent during the next financial year – this would
be important data for Asian firms with large workforces.
The production budget will also contain forecasts for
expenditure on overheads and a cash budget as well.
» Profit budgets This type of budget forecasts a
business’ total revenue and total costs and shows
whether it is expected to make a profit or loss over
a future trading period. The Coronavirus (COVID-19)
pandemic of 2020 led to numerous businesses revising
their profit budgets following forecasts of substantial
falls in revenue from sales.
STUDY TIP
Remember that budgets are forecast data and may
be incorrect. You should read any case study material
carefully to see if there is any evidence about its likely
accuracy and use this to help to develop your answers.

CASE STUDY
Hotels in Singapore
Hotels in Singapore enjoy one of the highest rates of
occupancy in the world. Data from the Singapore Tourism
Board shows that 93.8 per cent of its hotel rooms were
occupied in July 2019. This represents a small increase
from the summer of 2018, when the rate was 92.5 per cent.
Forecasters are expecting Singapore’s hotel occupancy
rate to decline in the future. They have identified three
reasons for this forecast:
● Hotels in Singapore are projected to lose customers to
competitors located in Hong Kong, which is expected
to become a more popular location for business
conferences, boosting demand for hotels.
● A number of new hotels are due to open in Singapore
during 2020, including the Singapore New Edition. This
will increase the number of hotel rooms available.
● Many businesses have decided to reduce their
travel and accommodation budgets. Fewer business
travellers are forecast to stay in hotels in Singapore.
These changes have already affected the financial
performance of hotels in Singapore. In the autumn of 2019,
Singapore Hotels Ltd reported that the average earnings
from its rooms was $240. Since the summer of 2019, the
average earning figure had fallen from just over $249.
Questions
1 Analyse two reaons why the changes forecast in the case
study might have a significant impact on the sales revenue
budgets of the hotel division of Singapore Hotels Ltd. [8]
2 Evaluate why it might be difficult for hotel companies
in Singapore to forecast future sales revenues
accurately at this time. [12]

205
 There is the risk, of course, that the information in budgets
may not prove to be accurate. For example, sales revenue
5.5 budgets may be incorrect if there is an unexpected slump in
sales due to, say, a change in consumers’ tastes and fashions,
» Budgets can be used to motivate employees. Employees
or the entry of a new competitor into a specific market.
The benefits and drawbacks of budgets
As with most techniques of financial control, there are
benefits and drawbacks to the use of budgets.
AS LEVEL 5.5 BUDGETS
concerned that its product range is not selling well, it
may increase its budgets in the areas of market research,
research and development or advertising.
can gain satisfaction from being given responsibility
for a budget. Often large businesses use what is known
as ‘delegated budgets’ whereby control of budgets
is given to individuals and teams at all levels within
the organisation. They may also gain satisfaction
from keeping within a budget. As a result, their level
of motivation and their performance may improve,

The benefits of budgets benefiting the firm as a whole. In Chapter 2.2 we

» Production or expenditure budgets allow managers
to ensure that a business does not overspend. Senior
managers receive their own budgets and can allocate
these between the various parts of the department
or area for which they are responsible. Figure 5.22
illustrates this process. As long as each individual
budget holder makes sure that they do not spend
more than the agreed figure, the business’ overall
expenditure should remain under control. Modern
technology makes the control and monitoring of such
budgets easier.
» Budgets allow senior managers to direct extra funds into
important areas of the business. Thus, if a business is
considered motivation in more detail.
» Sales revenue budgets can also be used as targets
for employees, possibly as part of the appraisal
process. Employees may be motivated to improve their
performance by the existence of targets in the forms of
sales revenue budgets.
» Information on expenditure budgets allows senior
managers to examine those areas of a business that
manage costs effectively. The most successful areas
or divisions can become models for other parts of the
business.

Board of Directors
(advised by Director
of Finance) plans
revenue and spending
for financial year

Production Human Resources

Decides budget of $3m

for marketing – Director
of Marketing controls
budget

Public relations – Advertising – Staff salaries and

$¾m for $½m to pay for a expenses – $1¾m for sales
sponsorship and series of advertising and marketing salaries,
events campaigns commission and expenses

These budgets will be controlled by relevant managers. They may be

further divided into, for example, a budget for expenses for the sales force.
▲ Figure 5.22 An example of using budgets within a company

The drawbacks of budgets in their ability to control finances. The cost of the
training could be substantial, depending on the skills
» If a business intends that a significant proportion of its
of the workforce. Furthermore, there could be teething
employees should manage budgets (known as delegating
problems as employees adjust to the new roles and
budgets) then training will be required. Some people will
responsibilities.
not welcome the extra responsibility or feel confident
206
» Allocating budgets fairly and in the best interests of the
business is difficult. Some managers may be skilled at
negotiating large budgets for the areas for which they
are responsible. This might be at the expense of more
worthy areas. Thus, for example, a manager responsible
for the sales force in existing markets may receive a
large budget allocation, while insufficient funds are
given to developing new markets.
CASE STUDY
Alibaba
The Alibaba Group was founded in 1999 by 18 people led
by Jack Ma, a former English teacher from Hangzhou,
China. Its founders started the company to support small
businesses, to help small enterprises to compete more
effectively in China and globally. Initially the company
created online marketplaces enabling buyers and sellers
to meet and buy and sell products. By 2019, the company
had grown very rapidly and employed 102 000 people,
earned revenues totalling $56.15 billion and profits
amounting to just under $12 billion.
By 2020, Alibaba provided a wide range of services. Its
websites provide:
● sales services for businesses and consumers
● services for electronic payments
● search engines for shopping
● cloud computing services.
Different approaches to budgeting
Incremental budgets
Incremental budgets are a very simple approach to
budgeting. In an incremental budget, figures from the
previous budget are used as a basis for the new budget.
According to circumstances, a small percentage change may
be made to the previous figures to allow for alterations in
costs or expected revenues.
Incremental budgets work well in a stable business
environment, where changes are relatively small and
normally predictable. This approach to budgets is more
common in less competitive or less changeable markets
where profits are relatively stable. However, the use of
incremental budgets can have a number of shortcomings.
» It can encourage overspending by managers Managers
may be encouraged to add a percentage to costs each
year rather then looking at ways to reduce costs when
using incremental budgeting.
» Managers may ‘massage’ the data Some managers may
forecast little growth in sales revenue but substantial
increases in costs when drawing up incremental budgets.
This would lead to them having favourable variances
which could suggest the area has been managed
efficiently.
» It does not encourage risk-taking One of the main
criticisms of incremental budgeting is that it tends to
» Budgets normally relate to the current financial year
only and are short-term in nature. Therefore, managers
might take decisions in order to keep within the current
budget which is not in the longer-term interest of the
5.5
business. For example, a decision to reduce the size
of a workforce for budgetary reasons might result in
competitors gaining more of the market over the next
few years.
5.5.1 The meaning and purpose of budgets
Alibaba owns and operates a wide variety of different
businesses throughout the world. For example, in 2018,
Daraz, a Pakistani online store, was bought by the Alibaba
Group, making the South Asian e-commerce platform an
important part of Alibaba’s global operations.
The Alibaba Group aims to grow quickly. It has set itself
some important targets to ensure its continued growth.
Three important targets are:
● to have 2 billion global customers by 2036
● to create a further 100 million jobs
● to support over 100 million profitable businesses on
its websites.
Questions
1 Analyse two reasons why budgeting would be
important to Alibaba while it is growing quickly. [8]
2 ‘It is impossible for Alibaba to draw up accurate
budgets.’ Evaluate this view. [12]
allocate funds to the same use each year. Managers may
find it difficult to acquire large sums for new and more
risky activities. This may result in lower profits in the
long term.
GLOSSARY TERMS
Incremental budgeting is a process where budget figures
are minor changes from the preceding period’s budgeted
or actual data.
A flexible budget is a budget that is designed to change
along with the sales volume or production levels.
Flexible budgeting
Flexible budgets (or flex budgets) avoid some of the
problems that are associated with the use of variances
within normal budgets. A common problem with the use
of variances is that some of the variances may be due to
external factors, such as a significant fall in sales due to
an economy moving unexpectedly into a period of falling
incomes. In such circumstances, it can be difficult to
identify how much of a difference between a forecast
and an actual budget is due to external factors and how
much to poor management within the business. The use
of flexible budgeting removes at least some of the effects
of the external factors, allowing managers to analyse
underlying issues.
207
 In the example in Table 5.15, the managers would be
able to see that sales were much lower than expected, at
5.5 $600 000 rather than $750 000. The flexed budget adjusts
other budget figures in the light of this change. This
means that, in this case, direct costs will be divided by
750 000 and multiplied by 600 000 to reflect the change in
sales revenue.

▼ Table 5.15 An example of a flexible budget

Normal budgets ($000s) Flexible budgets ($000s)

Budget Actual Budget Flexed budget Actual
Sales revenue 750 600 750 600 600
AS LEVEL 5.5 BUDGETS

Overheads 200 204 200 200 204

Labour 180 162 180 144 162
Materials 220 201 220 176 201
Other costs 60 53 60 48 53
Total costs 660 620 660 568 620
PROFIT 90 (20) 90 32 (20)

Therefore, although costs fell as a result of the large drop in
sales, they didn’t fall as much as may have been expected
given the substantial reduction in output. Once the budget
has been flexed, it is simple to see that all categories of
costs recorded adverse variances and that they overspent
in the context of the falling level of production. Contrast
this with the original budget – the favourable variances
for direct costs such as labour and materials may have
suggested that the budget holders managed these costs
effectively.
HANDLING DATA
1 Look at the information in Table 5.15. If the flexed
budget for sales revenue was $700 000, calculate the
flexed budgets for labour and materials.
However, the process has a number of drawbacks too:
» Zero budgeting is effective for setting production (or
expenditure) budgets, but it has little relevance to sales
budgets. To set a zero budget for sales revenue would be
ridiculous.
» Budgets might be allocated according to the negotiating
skills of managers rather than the genuine needs of their
areas or departments.
GLOSSARY TERMS
A budget holder is responsible for the use and
management of a particular budget.
Zero budgets exist when budgets are automatically set
at zero and budget holders have to argue their case to
receive any funds.

The uses of budgets

Zero budgeting Measuring performance
Gathering information can be time-consuming even if
For many businesses, the figures in the profit budget will
budgets are based heavily on the previous year’s figures.
have an important influence on decision-making within
An alternative approach used by a number of firms is zero
the business. Comparing the actual profit figure with the
budgeting. Using this system, each expenditure budget
budgeted figure for the trading period can be a useful
is set at zero at the start of the budget setting process.
measure of a business’ performance.
Managers responsible for the areas covered by the budget
(HR managers, for example) have to bid for budget and to A business’ managers will also use budgeted and actual
justify the money they request. data to assess the performance of elements of the business
as well as its performance overall. We saw earlier (in
Using zero budgets can help firms in a number of ways:
Table 5.15) that the use of flexible budgets can strip out
» It avoids budgets creeping up each year as one year’s
the effects of changes in the market and overall sales.
budget is based on the figures from the previous year,
The resulting budgetary data can be used to judge the
plus a little to allow for inflation. In this way, it can
effectiveness of, for example, the control of costs in
assist a firm to control costs.
different areas of the business. Those managers who return
» It helps firms adjust their spending as the relative
favourable variances on expenditure budgets may be judged
importance of areas within the firm changes. For example,
more effective.
the purchase of an automated switchboard might mean
that the budget for this area can be reduced. This money A business’ budgets may also highlight the relative
can be used effectively elsewhere in the business. performance of a business’ divisions or sectors. Many
multinational businesses operate in different regions of

208
the world. Coca-Cola, the American multinational soft
drinks company, produces and sells its products throughout
the world. It separates its activities into five geographic
divisions: North America, Africa, Asia, Latin America,
Europe and other. The performance of these areas against
the budgets that have been drawn up will assist the
company’s managers in judging the performance of these
five divisions.
Budgeted data alone can be used as a measure of
performance. It may be that a business’ budgeted profits
are low or declining when compared to previous financial
years. This may lead the business’ managers to take
decisions to improve the financial performance of the
business in advance of the year’s trading. This may entail
changing prices and reducing costs in the short term. In
the longer term, management teams may consider entering
new markets and developing new products as a means of
improving financial performance.
Allocating resources
The provision of detailed budgets on expected sales can
reveal much about the forecast performance of individual
areas or divisions within a large business. This information
can help managers to make decisions on which areas of the
business are likely to perform well and those that may not.
Using this information, managers can make decisions on
how to allocate financial, human and other resources most
effectively. We saw in the previous section that Coca-Cola
operates five divisions in different regions of the world.
The company’s managers may allocate more resources to
those divisions that perform most successfully when actual
performance is judged against budgeted data.
It is not unusual for businesses to have budgets of many
millions, or even billions, of dollars – this would certainly
be the case for Coca-Cola. In such circumstances, it is
impossible for a single person, or even a group of people,
to effectively monitor these budgets to ensure costs are
controlled and planned revenues are earned. A system
of budgets allows a large number of people within the
organisation to take a share of responsibility for managing
finances. This process was illustrated in Figure 5.22
(page 206). In this way, budgets provide an effective means
of allocating resources.
Controlling and monitoring a business
Budgets are an effective way of ensuring that a business
does not spend more than it should. As long as every
employee ensures that they do not spend in excess of their
budget, costs should not get out of control. Equally, if
those involved in sales meet their targets then the business
should earn its planned level of profit. This should help the
business to achieve its objectives.
Managers may also take decisions based on the actual data
in budgets through the calculation of variances. If, for
example, sales budgets show substantial adverse variances,
managers may question the quality of their products or their
approach to pricing, as well as the accuracy of the market
research they undertook. Similarly, managers will respond
to expenditure budgets that show significant variances –
adverse or favourable. 5.5
Businesses use budgets to assess the viability of new
projects, such as launching a new product or relocating to
a new region or country. In this case, the research process
involved in preparing the necessary budgets is helpful and
the final budget figures are likely to have a major influence
on a final decision by senior managers.
5.5.2 Variances
5.5.2 Variances
Once a business has planned its sales revenue and
expenditure, it is essential to monitor the accuracy of
these financial plans by comparing the budget figures
with the actual figures resulting from the business’
trading. Budgets can also provide a wealth of information
to help managers take decisions on how to improve the
performance of the business.
» Analysing budgeted and actual expenditure This
provides information on how successful the business
is at controlling its costs. As a business grows, it is
possible to judge the ability of different parts to manage
its expenditure against given targets. If one area of a
business is regularly overspending its budgets, managers
may take action to reduce expenditure and, by so doing,
increase profitability. Relevant actions might include
addressing issues such as poor motivation, quality
problems or not using capacity fully. Of course, if a
business or part of a business fails to meet expenditure
budgets regularly, it may be because the budgets are too
low to be achievable.
» Analysing sales revenue A business that fails to
meet its sales revenue budgets for one or more of its
products may need to consider why this is occurring.
Prices may be too high when compared with those
of competitors, the business may not be advertising
sufficiently or not targeting the correct market
segments, or the quality and/or design of the product
may be inadequate. Good managers will use the
information from analysing budgets to make decisions
to improve the business’ sales performance.
» Analysing profits budgets Profits below budget are
likely to be a cause of concern for most businesses.
These can be caused by excess expenditure or by revenue
falling short of expectations or a combination of these
factors. This scenario may prompt managers to examine
means of cutting expenditure as well as boosting sales
revenue.
Adverse and favourable variances
A variance occurs when an actual figure for sales revenue,
expenditure or profits differs from the budgeted figure.
Actual sales revenue or expenditure figures may be higher
or lower than budgets. Variances are categorised as adverse
or favourable. These two categories of variance are shown in
Table 5.16 on page 210.
209
 ▼ Table 5.16 The two categories of variance
5.5 Favourable variances
A favourable variance
exists when the difference
between the actual and
budgeted figures will result
in the business enjoying
higher profits than shown in
the budget.
AS LEVEL 5.5 BUDGETS
Adverse variances
An adverse variance occurs
when the difference between
the figures in the budget and
the actual figures will lead to
the firm’s profits being lower
than planned.
$840 000. However, the actual figure was $790 000. In this
case the variance (or difference) is $50 000. It is an adverse
variance because it will result in the business’ profits being
lower than forecast or its loss larger than forecast. In
contrast, the business’ fuel costs are only $70 000, which is
$5000 less than the budgeted figure. In this case, this is a
favourable variance because this will result in the business’
profits being larger than forecast (or a smaller loss than
budgeted).
▼ Table 5.17 Calculating variances

Examples of favourable Examples of adverse

variances include: variances include: Revenue/ Budget Actual Variance
• actual wages less than • sales revenue below the cost figure ($) figure ($)
budgeted wages budgeted figure Sales 840 000 790 000 $50 000 (adverse)
• budgeted sales revenue • actual raw material costs revenue
lower than actual sales exceed the figure planned
Fuel costs 75 000 70 000 $5000 (favourable)
revenue in the budget
• expenditure on fuel is less • overheads turn out to be Raw 245 000 265 000 $20 000 (adverse)
than the budgeted figure. higher than in the budget. material
costs
Possible causes of favourable Possible causes of adverse
variances: variances: Labour 115 000 112 000 $3000 (favourable)
• wage rises lower than • competitors introduce new costs
expected products, winning extra
• economic boom leads to sales
higher than expected sales • government increases HANDLING DATA
• rising value of currency business taxes by
1 Look at the information in Table 5.15 (page 208).
makes imported raw unexpected amount
Calculate the actual sales revenue required under
materials cheaper. • fuel prices increase as
the ‘normal budget’ to result in a favourable
price of oil rises.
variance of $79 000.

The process of calculating a variance is simple, as shown

by Table 5.17. It simply involves a comparison between Calculating variances can give a business advance notice
the budgeted figure and the actual figure. In Table 5.17, that its financial plans are inaccurate. This can be carried
the business had forecast that its sales revenue would be out each month and will show before the end of the financial

Seek new markets

Cut prices at home or overseas Product range
if consumer demand
update or extend as
is sensitive to price
appropriate
changes (price elastic)

Improve company Adverse sales

image revenue Increase advertising
PR donations to sales revenue less than and/or promotions
charities planned

Cut wages or increase

Adverse production Reduce waste
labour productivity
(cost) variances use fewer raw materials
increase amount
expenditure higher and produce fewer
produced per worker
than planned faulty goods
per hour

Seek cheaper raw

materials
purchase from
overseas or in bulk

▲ Figure 5.23 Responding to adverse variances

210
year that the firm’s finances are not as planned. This
allows the business to take action to reduce expenditure or
increase revenue at an early stage. Figure 5.23 summarises
the range of actions that businesses may take in response
to adverse variances.
Firms may also need to respond to favourable variances.
Production costs which are lower than planned may be
regarded as beneficial. But sales revenue that is greater
than anticipated might be caused by the firm selling
more products than planned. In these circumstances, the
Other factors leading to adverse and
favourable variances
It may be that variances are not the result of unexpected
5.5
developments and changes in the markets in which
businesses operate. Poor forecasting techniques can also
result in unexpected revenues and expenditures, and
therefore variances.
Managers may make insufficient use of market research to
forecast sales revenue. This can lead to adverse or favourable

business might not have sufficient supplies to meet future
customer requirements. This could result in the loss of long-
established customers and should be avoided.
There are internal connections in budgets which are
important to understand. For example, if a business
experiences a rise in output and sales revenue above
expectations, it will affect expenditure. If a product
becomes unexpectedly popular and sales rise, the
business may have to purchase more raw materials and
hire additional labour. This is likely to result in adverse
expenditure variances. Similarly, sales below those set out
in the budget may lead to favourable variances for costs, as
expenditure falls since less is produced. We considered this
in the section on flexible budgets on page 207.
5.5.2 Variances
revenue variances. It may also result in inaccurate budgets
for expenditure, as the managers will not have forecast
correctly the amount of labour and other resources that
the business needs to satisfy customers’ needs. Inaccurate
budgets are also the result of inexperience on the part
of managers, and variances will be more common when a
business is new to a market and has no financial records on
which to base forecasts.
STUDY TIP
Questions asking you to analyse variances are common in
Business exams. It is important for you to identify those
areas in which major differences between planned and
actual expenditure or revenue have occurred. This will
help to give a focus to your answer. It is also very likely
that you will be asked to suggest possible causes (or
cures) for the variances.

CASE STUDY
BMW’s new factory in Mexico
In 2019, the German car manufacturer, BMW, opened a
new car factory in Mexico, approximately 400 km north
of the capital city, at San Luis Potosí. The new factory
uses ports on both the west and east coasts of Mexico for
transporting components and to export finished vehicles.
The company has invested more than US$1 billion in
the new production location. The plant, which already
employs 2500 people, has a high proportion of Mexican
employees who have been trained in BMW’s approach to
production.
The factory at San Luis Potosí will build BMW’s most
successful model series: the BMW 3 Series Sedan.
This popular car has set the standard for performance,
efficiency and design, and the company expects high sales
of the new model. The new model does, however, face ▲ Figure 5.24 Use of robots on BMW’s production line
intense competition from the Audi 4 and Mercedes C class means that fewer workers are used.
and others.
In its new factory, robots and employees work directly Questions
alongside one another, making effective use of the 1 Analyse one possible factor that might result in the
strengths of each. Production began in April 2019, with the new factory recording adverse variances. [4]
plant producing 240 cars per day by October. In 2020, the 2 ‘The “intense competition” that the BMW 3 series
factory‘s production had risen to 580 cars per day, moving will face is the most important reason for BMW
towards its annual production capacity of 175 000 units. drawing up budgets for the new factory.’ Evaluate
this view. [12]

211
 CASE STUDY
5.5
ADL acts on budgets
ADL is a television company in Argentina which produces The company’s managers have just been reviewing
and broadcasts a range of programmes and operates its financial performance, including analysing its
three satellite channels. It is particularly noted for performance against budgets. Some of the data they
producing documentaries and popular drama series. considered is shown in Table 5.18 below.
The market for making and broadcasting television
One of ADL’s managers said she believed that this
programmes is growing rapidly in Argentina and other
budgetary data provided the best possible measure of
AS LEVEL 5.5 BUDGETS

Spanish-speaking countries, although rates of growth

ADL’s performance.
vary widely over time. Last year’s growth in sales was 11.5
per cent, while the year before it was just 2.9 per cent.
▼ Table 5.18 ADL’s budget data

Budget ($m) Actual ($m) Variance

Sales revenue 3 347.8 3 999.4

Labour costs 1 552.2 1 840.3 288.1 A

Materials costs 205.7 201.6 4.1 F
Other costs 630.1 916.6 286.5 A
Overheads 597.0 602.4 5.4 A
Total costs 2 985.0 3 560.9
Profit/(loss) 362.8 438.5

Questions
1 Calculate the variances for the company’s total sales 2 One manager believed that ‘this budgetary data
revenue, total costs and profits, stating whether each provided the best possible measure of ADL’s
is adverse or favourable. [6] performance’. Evaluate this view. [12]

TEST YOUR LEARNING

6 a Define the term ‘variance analysis’. [2]
Short answer questions
b Explain one reason why it is important for
1 Define the terms: managers to monitor budgets once they have
a ‘sales revenue budget’ [2] been set. [3]
b ‘expenditure budget’. [2] 7 A business has the following budgetary data:
2 a Explain one reason why setting budgets may
▼ Table 5.19
lead to an improvement in the motivation of
employees. [3]
Budget ($m) Actual ($m)
b Budgets are short-term in nature. Explain one
reason why this might be a problem for a Sales revenue 254.75 295.10
business. [3] Total costs 222.86 256.84
3 a Explain one reason why it might be difficult for
a business to forecast its sales accurately. [3] Calculate its profit variance and identify whether it is
b Explain one way in which a change in the economy adverse or favourable. [4]
may make a business’ budgets inaccurate. [3] 8 Explain one difference between adverse and
4 a Define the term ‘flexible budget’. [2] favourable variances. [3]
b Explain one reason why a business might decide 9 a Explain one factor that may lead to a business
to use a flexible-budgeting system. [3] having adverse variances on its profits. [3]
5 a Define the term ‘zero budgets’. [2] b Define the term ‘incremental budgeting’. [2]
b Explain one reason why a business might decide 10 Explain one way in which budgets might help a
to use a zero-budgeting system. [3] large multinational company to manage its finances
efficiently. [3]

212
Data response question ▼ Table 5.20 Nadal Ltd, Ronda Café – budget figures for

Nadal Ltd
first three months of trading
5.5
Nadal Ltd’s cafés sell budget-priced drinks such as coffee Budget ($) Actual ($)
and tea, as well as tapas and light meals. The company Sales revenue 11 500 10 990
has succeeded despite, or maybe because of, the weak
economic position in Spain. The company’s brand name Indirect costs 4 250 4 300
is associated with low prices and value for money. The Direct costs 6 890 6 900
company plans to expand using finance raised mainly
Profits 360 (210)
through loans.

5.5.2 Variances
Last year, Nadal Ltd opened its 59th café in Ronda, Questions
southern Spain. This is its first café in this part of Spain
and the company has only conducted secondary market 1 Analyse two problems that Nadal Ltd faced in
research. The new manager in Ronda has no experience setting its budgets for the new café. [8]
of cafés or financial planning, but they are experienced 2 a Calculate the profit variance for the first three
in retail and in managing people. Despite this, sales have months of trading for the Ronda café. [3]
risen steadily, if slowly, and customer feedback is positive. b Evaluate whether the benefits of drawing
up budgets outweigh the drawbacks to
Nadal Ltd. [12]
3 ‘The managers at Nadal Ltd should be pleased with
the performance of its café in Ronda.’ Evaluate this
view. [12]

213
 6 Business and its environment
A LEVEL

6.1.1 External influences on business

activity: Political and legal
A LEVEL 6.1.1 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: POLITICAL AND LEGAL

Chapter overview
In this chapter we examine:
★ the cases for and against nationalisation and privatisation
★ how the government might use the law to control a range of business behaviour
★ the effects of changes in political and legal factors on businesses and their decisions.

Businesses cannot ignore changes in their environment and

The business environment any single business is not sufficiently large or powerful to
Businesses do not operate in isolation and are subject to have any significant influence on this external environment.
a range of external influences. This external environment This means that all businesses have to make appropriate
is subject to constant change and these changes can mean responses to changes in their external environment
different things to different businesses. For example, a to ensure that they remain competitive and, for many
change in the economic environment might lead to a fall enterprises, as profitable as possible.
in consumers’ incomes. This could cause a large reduction
in sales for a business selling luxury products such as The factors which make up the external environment for
jewellery but have little impact on a retailer selling businesses differ. A small business that grows vegetables
basic foods. and fruit for sale in a local market is likely to be subject
to different external forces compared to a multinational
company that sells consumer electronics globally. Despite
Politi this, the elements making up the external environment for
ntal cal
me and
iron leg businesses can be classified as shown in Figure 6.1.
v al
En
We shall consider each of these elements of the business
FORCES
environment over the next three chapters. In particular,
we will consider the impact of changes in these elements
and how such changes might affect decisions taken by
l
ona

Econ

businesses.
Internati

omic

Responses to forces for

change by entrepreneurs,
directors, managers and
The political environment
other stakeholders A range of political decisions can help to determine
the business environment. For example, governments
Co m

throughout the world take decisions on the extent to

h ic
ra p

which they will become involved directly in the production

pe
ti t o

og

of goods and services. In some European countries,

m
rs

FOR CHANGE
government-owned businesses supply a range of products
de

d
an

su nd
pp
lie ia la including water and electricity. The government in the USA
rs S oc
tends to rely on privately owned organisations to supply
Technological most products to consumers.

▲ Figure 6.1 The external environment within which

businesses operate

214
6.1.1.1 The advantages and
disadvantages of privatisation
The issue of privatisation is a central part of the debate
about the extent to which the government should intervene
in the economy. Over time, governments in diverse
economies such as Argentina, Malaysia, New Zealand and
the UK have implemented policies to reduce the state’s role
in the economy, to allow markets and businesses to operate
with the maximum degree of freedom. In part, this has been
achieved through the policy of privatisation whereby state-
owned enterprises are sold to the private sector.
In some countries, privatisation has been accompanied
by the reduction in government subsidies and grants to
industry and by legislation limiting the state’s role in
business matters. This approach to managing the business
environment is described as laissez-faire (where the
government intervenes as little as possible) and puts faith
in a greater degree of self-regulation by businesses.
Nationalisation is a policy which has the opposite effect
to that of privatisation, as shown in Figure 6.2. There are
recent signs that some governments are pursuing policies,
including nationalisation, which involve a greater degree
of state control over business. This has been driven
by a number of factors, including the perceived weak
performances of privatised businesses in some economic
sectors. The Coronavirus (COVID-19) crisis of 2020 has also
resulted in some governments being forced to take a greater
degree of control over economic activity. At the time of
writing, it remains to be seen to what extent this will be a
permanent state of affairs.
Can be achieved through Can be achieved through
a policy of privatisation a policy of nationalisation
A more laissez-faire
approach to managing the
business environment
Lesser Extent of the state’s role in the economy
▲ Figure 6.2 Nationalisation and privatisation
We shall consider privatisation first. There are, not
surprisingly, advantages and disadvantages to privatising
businesses. The main advantages and disadvantages of
privatisation are set out below.
GLOSSARY TERMS
Privatisation is the process of transferring organisations
from state ownership to being owned and controlled by
individuals and other businesses in the private sector.
Nationalisation is the transfer of a privately owned
organisation to the control of the state.
Innovation is the development of new ideas into new
products or new methods of producing products.
The advantages of privatisation
» Increased efficiency This is a key argument for
governments implementing a policy of privatisation and 6.1.1
was used to justify its use in the UK from 1980 onwards.
Managers in government-owned businesses do not
normally share in profits and may be set targets other
than making profits. In a privatised business, managers
are responsible to shareholders who expect to receive a
share of profits. Managers also often receive a share of
profits. These factors encourage managers to cut costs
6.1.1.1 The advantages and disadvantages of privatisation
and increase efficiency. There is some evidence that
businesses do operate more efficiently once privatised.
» Operational independence Managers in state-
owned businesses often have to meet targets set by
governments. Such targets might include maintaining
employment levels, rather than producing as efficiently
as possible with whatever size workforce is optimal.
Being free of any government targets, privatised
businesses can become more competitive and may, in
the longer term, be more profitable.
» Higher levels of investment and innovation
Governments are often unable to afford to invest
enough to ensure a business remains competitive.
They may have other priorities, such as investing in
health care services, which are important if they want
to be re-elected. Privatising a business may mean that
its new owners are more willing and able to invest in
establishing production methods and in developing new
products which make the business more competitive.
This can secure its long-term future.
The disadvantages of privatisation
» Some industries are not suited to competition The
nature of some industries means that it can be most
efficient to have just a single producer – this is termed
a ‘natural monopoly’. For example, it makes sense to
have a single firm supplying tap-water to households
in a particular area. If this single business is privately
owned, it would lack competition and may charge high
prices and offer poor services, as customers would have
no choice. Privatising such businesses would be unlikely
Greater
to offer benefits to consumers or to promote efficiency.
» The need to protect consumers Some industries, such
as health care and education, are not well-suited to
private ownership. The risk in privatising businesses
in these types of industries is that private businesses
might prioritise profits over, for example, patient care
in a hospital. Many countries in the world operate public
health services for these reasons.
» Short-termism There is a risk that the managers of some
privatised businesses may focus on short-term profits to
satisfy shareholders through rising share prices and high
dividend payments. However, this might be achieved at
the expense of investing in projects which would provide
long-term profits, ensuring the viability of the business
over many years and its ability to provide employment
and pay taxes to the government.
215

6.1.1
A LEVEL 6.1.1 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: POLITICAL AND LEGAL
An assessment of privatisation
Privatisation will not always be successful. Firstly, it depends
on the industry. Some industries such as airlines and
telecommunications have enjoyed much increased levels of
efficiency and profits following privatisation. It has proved
less effective in industries such as public transport and
health care, where the profit motive is not so important.
Privatisation has generally been more successful in creating
efficient and fair industries when regulators have been
» Levels of long-term investment There is some
controversy over whether state or private ownership
results in higher long-term levels of investment.
However, there is a school of thought that governments
are more likely to provide the long-term investment
needed to create important services for the public, such
as railways and electricity supply networks. Governments
across the world have provided the investment necessary
to create high-speed railways.

established. Regulators can ensure that competition is fair
and that dominant firms do not exploit their market power
at the expense of competitors and customers. In particular,
it is important that governments avoid privatisation where
it would create a private monopoly (a single supplier of a
particular product) as the lack of competition may result in
high prices and poor products.
6.1.1.2 The advantages and
disadvantages of nationalisation
Nationalisation occurs when the state takes control of
privately owned enterprises. It is not surprising that there
are also advantages and disadvantages associated with a
policy of nationalisation.
The advantages of nationalisation
» Businesses can operate in the public interest Privately
owned businesses normally operate with a profit
motive – though there are exceptions. Nationalising
a business means that the government can set its
objectives. These objectives can be in the interests of
society as a whole and not just based on making the
maximum possible profits for the owners of the private
business. The East Coast Main Line is a major railway
route between London and Edinburgh in the UK. This
route was privatised in 1997 but returned to state
control in 2008, when the private company operating
it suffered financial difficulties. It was managed
successfully by the state until 2015, when it was once
again privatised before being taken into state control
once more, as the second private company operating
it faced financial problems. This shows that there are
circumstances in which it is challenging for a private
company to make sufficient profits while operating a
business in the public interest.
» The treatment of employees There is some evidence
to suggest that employees are more likely to be
exploited within a privatised business. Governments
often privatise businesses to cut the costs of
operating them. So, for example, many government
buildings in the UK are cleaned by employees
belonging to private companies. Private cleaning
companies win contracts for cleaning by offering
to provide such services at very low costs. The pay,
conditions and job security for cleaners and other
employees in state-run businesses tend to be better
than in their privatised equivalents.
216
The disadvantages of nationalisation
» Political interference Opponents of nationalisation
argue that governments are subject to political pressures
and take decisions that please voters rather than making
sound business sense. Some governments have pursued
policies which have led to nationalised businesses hiring
too many workers. This has boosted employment (often
in poor regions) but has resulted in high costs and
uncompetitive enterprises. Subsequently, governments
are often unwilling to make redundancies for fear of the
bad publicity that will result.
» Inefficiency This is perhaps the major criticism
of nationalised businesses. The managers of some
nationalised businesses are not expected to meet
targets that would be common in privately owned
enterprises. Nationalised businesses are also sometimes
shielded from the full force of competition from overseas
businesses. These factors can remove the incentive
for managers to produce up-to-date and desirable
products at the lowest possible cost, thereby offering
the greatest value to consumers. It is this perceived
weakness that has prompted many calls for privatisation.
» Reduced competition Nationalisation can discourage
competition. Governments that privatise industries
frequently reduce the regulations governing that
industry at the same time. This encourages more
businesses to enter that industry. The outcome is often
more choice and lower prices than would be the case
with a nationalised business.
GLOSSARY TERM
Regulation is the enforcement of principles or rules that
result from the passing of a law or series of laws.
An assessment of nationalisation
As with privatisation, it is not possible to say that
nationalised businesses will perform better (or worse) than
their privately owned equivalents. Inevitably, it depends
on the circumstances. However, it is possible to say that
the advantages of a nationalised business are more likely to
outweigh its disadvantages in the following circumstances:
» where high-quality managers are appointed and clear
targets are set
» where the central government does not try to manage
the business
» where sufficient investment is available for short- and
long-term investment needs
» where the interests of all stakeholders are considered
and not simply the need to generate profits.
▼ Table 6.1 A comparison of privatisation and nationalisation

Management
Privatisation
Transferred by the state to be managed by
Nationalisation
Owned and managed by the state instead of
6.1.1
the private sector the private sector
Examples In 2015, the Australian government sold NSW Ferguson Marine Engineering, a shipbuilding
Electricity to the private sector for more company, was nationalised by the Scottish
than $16 billion. Government in 2019.
Key benefits • Increased efficiency • Better treatment of employees
• Operational independence • Operate in public interest

Key drawbacks
Circumstances in which more
likely to be successful
• Higher levels of investment and
innovation
• Some industries not suited to competition
• The need to protect consumers
• Short-termism
• Industries open to global competition,
such as airlines or telecommunications
• Industries requiring a high degree of
innovation
6.1.1.3 How a government might use the law to control business activity
• The state can provide a reliable source of
long-term investment
• Political interference
• Inefficiency
• Reduced competition
• Natural monopolies such as water supply
• Non-profit services such as health care

STUDY TIP
Do think about the cases for nationalisation and
privatisation in different situations. You should appreciate
that there is not a simple answer to the question of which
is best. Thinking about the circumstances in which each
is best will deepen your understanding and improve your
ability to develop arguments and make judgements on
this issue.
6.1.1.3 How a government might
use the law to control business
Laws relating to employment practices,
working conditions and pay
These laws govern the relations between workers, employers
and trade unions. The UK government has a range of laws
which it uses to control the ways in which people are
employed in the UK. Governments can use laws to control a
range of issues related to employment, including:
» employment practices
» conditions of work
» wage levels.
Some examples of the employment laws in the UK are shown
in Figure 6.3.

activity Working
The Minimum
time
The law is a framework of rules governing the way in which regulations
Wage Act
societies operate. Laws are sometimes called legislation.
Working
These rules apply to businesses as well as individuals. The conditions
Pay
legal framework influences businesses in a number of ways, Laws relating to
affecting almost all areas of business activity. Marketing, Health and employment practices, The National
production, employment, relationships with customers and Safety at working conditions Living Wage
competitors, and even decisions on location are examples of Work Act and pay
areas of business activity that can be influenced by laws.
Collective Employment Individual
STUDY TIP labour law practices labour law
You do not need to know about specific laws, but you
would benefit from some knowledge of the major laws Employment The Equality
Relations Act
in your country relating to the aspects of business
Act
behaviour covered below. You should also consider the
effects they have on local businesses. This chapter will ▲ Figure 6.3 Employment legislation
use examples of laws in operation in the UK to illustrate
the explanations.

217

6.1.1
A LEVEL 6.1.1 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: POLITICAL AND LEGAL
Employment practices
Employment practices refers to the way in which businesses
treat their employees from hiring until the end of their
relationship with the business. Most countries have a range
of laws covering issues relating to individual employees and
groups of employees within the workplace.
Laws relating to individual employees are frequently
designed to ensure that all employees are treated fairly and
equally. In recent years, there has been a focus in many
countries on avoiding discrimination against particular
Employers and employees are likely to negotiate on a
variety of matters. These negotiations may include items
such as working conditions and other workplace rules, pay,
hours of work, holidays, sick leave, retirement benefits
and health care benefits. Some examples of these laws
in the UK, as well as a later one granting more powers to
trade unions, are described below.
» Employment Act 1980 Under this Act employers were
no longer obliged to negotiate with unions – many
unions were derecognised as a consequence.
» Trade Union Act 1984 This legislation made a secret

groups of employees. The UK passed a key piece of anti-
discrimination legislation in 2010, as outlined below.
» The Equalities Act 2010 This Act replaced a number
of earlier anti-discrimination laws in the UK (such
as the Disability Discrimination Act) to simplify
legislation in this area. The Act relates to nine protected
characteristics which cannot be used as a reason to treat
people differently or unlawfully. Each person in the UK is
protected by this Act, as everybody has one or more of
these characteristics. The protected characteristics are:
– age
– disability
– gender reassignment
– marriage and civil partnership
– pregnancy and maternity
– race
– religion or belief
– sex
– sexual orientation.
This Act makes unfair treatment unlawful in the
workplace, in education and when supplying goods and
services.
Employees in many countries are protected against unfair
dismissal. Unfair dismissal is the termination of a worker’s
employment contract without a legal reason. In the UK,
legislation relating to unfair dismissal only relates to
workers once they have been in a particular job for one
year or more. There are a limited number of reasons why an
employee might be dismissed:
» where a job no longer exists – this is redundancy
» gross misconduct – examples of this include theft from
the employer or behaving violently at work
» failing to carry out duties in a ‘satisfactory manner’
» another substantial reason – for example, the ending of
a temporary contract.
All other reasons for dismissal are considered unfair.
Employees who think they have been unfairly dismissed can
claim compensation by taking their case to an industrial
tribunal.
There are also laws that govern relationships between
employers and groups of employees. This is often referred
to as collective labour law. This group of laws applies
to the operation of industrial relations and collective
bargaining as well as the activities of trade unions.
ballot of employees a legal requirement before unions
could take any industrial action against employers, such
as strikes.
» Trade Union Reform and Employment Rights Act 1993
Unions were required to give employers a minimum
of seven days’ notice before taking official industrial
action. It also abolished minimum pay rates, although
laws establishing minimum wage rates were introduced
by a different government in 1999.
» Employment Relations Act 1999 Under this Act, a
trade union with a membership exceeding 50 per cent
of the employees in any particular business can demand
union recognition and the right to introduce collective
bargaining.
Laws relating to employment practices can quickly become
outdated, as business practices and operations change.
Governments in countries throughout the world are under
pressure to ensure that laws relating to all aspects of
employment are up-to-date and fit for purpose.
One matter which is receiving a lot of attention in
many countries across the globe is that of the insecure
employment of workers in the so-called gig economy. A
‘gig’ is a term used to describe a single piece of work, such
as delivering a meal or transporting a passenger in a taxi.
At the core of the gig economy are app-based platforms
that allocate work in small quantities – making deliveries,
driving passengers or cleaning homes. People working
in the gig economy are not classified as employees,
but contractors. As a consequence, they do not receive
guaranteed hours of work or amounts of pay. However,
from the point of view of companies operating in the gig
economy, using workers in this way can be an effective
means of controlling labour costs. The case study below
looks at the response of law-makers in the American state
of California to the gig economy.
GLOSSARY TERM
The gig economy is a labour market in which short-term
contracts or freelance work are common, as opposed to
permanent jobs.

218
 CASE STUDY
New laws affect the USA’s gig economy
The government in California (one of the USA’s most
prosperous states) has passed a new law that makes it
mandatory for contract (or gig) workers to be treated by
companies as employees. The intention is to improve job
security and working conditions of employees in the state’s
gig economy. Uber’s use of contractors has enabled the
6.1.1
Examples of occupations in the gig economy include taxi
drivers, food-delivery workers, construction workers
and those employed in nail salons. It was predicted that
the new law would affect at least 1 million workers in
California.
But the new law threatens the business models (and

company to operate taxi services in cities across the world.
The legislation came into effect at the start of 2020 and
states that, if a company directs a worker in the way they
perform their tasks or includes their work as part of
their regular business, they must class that worker as an
employee instead of a contractor.
The new law may have an effect on other states. Trade
unions and other employee groups are calling for similar
legislation in New York, Washington State and Oregon.
Many people working in the gig economy have been
classified as contractors without access to benefits
including minimum wage rates, sick pay and holiday pay.
6.1.1.3 How a government might use the law to control business activity
possibly the futures) of gig economy companies like
Uber and Lyft, which employ large numbers of people as
contractors to reduce costs and increase profitability. The
law has received a lot of criticism from some businesses
for potentially reducing employment levels and the growth
of businesses.
Questions
1 Analyse one possible way in which the managers
of a Californian business in the gig economy might
respond to this new law. [4]
2 Evaluate the case for and against the passing of
this new law in California. [12]

We will explore the gig economy and other new employment ▼ Table 6.2 The legal requirements for paid holidays in a
practices further in Chapter 7.4. selection of countries

Country Legal entitlement Notes

Working conditions
to paid holiday
The term ‘working conditions’ refers to a range of factors per year
affecting an employee’s experiences at work, including
hours of work and paid holidays, as well as their safety and China 16–26 days Precise figure depends
security in the workplace. on length of employment
with the enterprise
Many countries have laws relating to working hours. The
USA – No federal or state laws
European Union (EU) operates its Working Time Regulations,
on paid holidays
which were introduced in 1998. This European Union
legislation set a limit of 48 hours on the number of hours Singapore 18–25 days Precise figure depends
that employees could be required to work each week. on length of employment
Employees can opt to work longer hours if they wish, but with the enterprise
employers cannot insist that they do so without inserting Iran 53 days This includes 27 days of
an appropriate clause in their employment contract. The paid public holidays
regulations also gave employees an entitlement to four
weeks’ paid annual leave. Although the UK has left the Laws relating to health and safety in the workplace
European Union, these laws will remain in place until and are an important element of the conditions of work for
unless new ones are passed. all employees, especially those working in potentially
It is increasingly common for employees to have an dangerous industries, such as mining. The International
entitlement to a period of paid holiday each year. These Labour Organisation (ILO) reports that there are more than
legal rights are also part of the Working Time Regulations 2.78 million deaths per year in workplaces throughout the
mentioned above. This law applies to most employees who world. Additionally, there are some 374 million non-fatal
are paid at their normal rate. The amount of paid holiday set work-related injuries each year resulting in more than 4 days
out in employment legislation varies considerably between of absences from work. The human cost of this is vast and
non-EU countries. Table 6.2 offers some examples. the economic burden of poor health and safety practices is
estimated at 3.94 per cent of global gross domestic product
(GDP) each year. In this case, GDP measures the total value
of output produced by the world’s economy over a year.

219
 Health and safety legislation has been enacted to
discourage dangerous practices by businesses and to
6.1.1 protect the workforce. The legislation in the UK is designed
to prevent accidents in the workplace and has developed
steadily over the last 30 years. The main Act in the UK
is the Health and Safety Act of 1974. This is an example
of delegated legislation, whereby parliament gives
responsibility to government departments to update the
scope of the legislation as necessary. This process avoids
any particular aspect of legislation taking up too much of
parliament’s time.
A LEVEL 6.1.1 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: POLITICAL AND LEGAL
The Health and Safety at Work Act gives employers a
legal obligation ‘to ensure that they safeguard all their
employees’ health, safety and welfare at work’. The Act
covers a range of business activities, including:
» the installation and maintenance of safety equipment
and clothing
» the maintenance of workplace temperatures
» giving employees sufficient breaks during the
working day
100%
73%
97%
89%
Note: The ILO has 187 members, meaning few countries are not members.
Source: International Labour Organisation; Minimum wage setting in Europe and beyond –
▲ Figure 6.4 The proportion of ILO members in different regions of the world that operate minimum wage legislation
Minimum wage rates can vary within countries. Some are
not the same throughout the different regions of a country.
In the USA, some states (for example, Alabama and South
Carolina) do not have any minimum wage laws and the rates
can vary significantly in other states. In 2020, the minimum
hourly wage rate in Wyoming was $5.15 compared to $13 per
hour in California. Other countries have passed minimum
wage laws which impose different minimum rates for different
occupations. For example, India has a large number of
different minimum wage rates for some selected occupations.
The UK’s National Minimum Wage Act came into force on
1 April 1999. The key features of this legislation are:
» a general hourly minimum wage rate for workers aged
over 24
220
» providing protection against dangerous substances.
Businesses are required to protect the health and safety of
their employees ‘as far as it is reasonably practicable’. This
means that the business concerned must have provided
protection appropriate to the risks. Thus, a chemical
manufacturer would be expected to provide considerable
protection for its employees. The Act also requires employees
to follow all health and safety procedures and to take care of
their own and others’ safety. In the UK, the Health and Safety
Executive (HSE) oversees the operation of the Act and carries
out inspections of businesses’ premises. The HSE also carries
out investigations following any serious workplace accident.
Wage levels
Pay rates are another area relating to employment in which
a high proportion of countries have passed laws. Many
countries have minimum wage laws, which set out wage
rates below which businesses must not pay. The use of
minimum wage laws is illustrated in Figure 6.4 below.
91%
the ILO perspective, 18 September 2019, David Mosler
» separate minimum wage rates for those aged 16–17,
18–20 and 21–24
» all part-time and temporary workers must be paid the
minimum wage.
In April 2016, this legislation was supplemented by
the introduction of the national living wage in the UK.
This applies to employees aged 25 and over and pays a
significantly higher rate than the minimum wage. In 2020,
the rate was set at £8.72 per hour. UK minimum and national
living wage rates are raised each year to ensure that these
wages at least keep up with the current rate of inflation.
In November 2020, the University of Massachusetts
Amherst, the National Bureau of Economic Research and
the IZA Institute of Labor Economics carried out research
into the effects of minimum wages. Their conclusions were
that even the UK’s relatively high minimum wage rates
had little negative impact on employment rates, while
substantially increasing the pay and living standards of
low-paid employees.
Laws relating to marketing
behaviour
The law covers the marketing activities of businesses in
most countries. Approximately 80 per cent of countries
have passed laws to protect consumers from the marketing
activities of businesses. The scope of these laws varies
and there is a general criticism that they are not updated
sufficiently to reflect changes in marketing behaviour,
such as the use of the internet. The UK has a series of laws
designed to safeguard consumers against:
» businesses charging excessively high prices or rates of
interest
» unfair trading practices; for example, selling quantities
less than those advertised
» unsafe products, such as children’s toys with sharp
objects or toxic paint
» having insufficient information on which to take
purchasing decisions.
Since 2014, the Competition and Markets Authority (CMA)
has overseen legislation relating to marketing activities
in the UK. It seeks to improve the position of consumers
by giving them information to allow them to make better
choices when purchasing goods and services. It also
protects consumers by prosecuting businesses that offend
against marketing legislation and by negotiating voluntary
codes of practice with producers of goods and services.
CASE STUDY
Queensland to ban ‘junk food’ adverts
The government of the Australian state of Queensland
has banned junk food advertising at government-owned
locations in a bid to eliminate poor diets and obesity
among children. The state’s Health Minister, Steven Miles,
said the unhealthy marketing activities would be stopped
throughout the state. The advertising sites affected will
include bus stops and train stations.
‘Junk food advertisers target kids, we know that, and
obesity in childhood is a leading indicator of obesity in
adulthood,’ Mr Miles said. ‘This is about doing what we can
to protect our kids from the kind of marketing that leads
them to make unhealthy choices.’
‘Obesity is a real challenge for our community, for our
hospitals and the health services, but also for the
individuals who are suffering – this is really just a decision
about the government leading by example and saying that
we will use our spaces to advertise healthier options,’
he said.
There is a considerable quantity of marketing legislation in
the UK. The Acts listed below represent a few highlights.
» The Consumer Rights Act 2015 replaced three major
pieces of marketing legislation in the UK. This Act was
6.1.1
introduced to modernise the law in this area, making it
simpler and stronger. The Consumer Rights Act states
that all products (including, for the first time, digital
products as well as physical products) must be of
satisfactory quality, fit for purpose and as described.
All products must meet the following standards:
– Products must be of satisfactory quality. Goods
6.1.1.3 How a government might use the law to control business activity
shouldn’t be faulty or damaged when purchased.
– Products should be fit for the purpose they are
supplied for and offer the consumer the benefits
promised.
– The goods supplied must match any description
given to consumers, or any models or samples shown
to consumers.
» The Consumer Credit Act 1974 This Act lays down
that consumer credit can only be given by licensed
organisations. It also sets out the terms under which
credit may be given.
It is also necessary to protect the public from improper use
of the power of advertising. It involves a combination of
legal controls and self-regulation.
» The Trade Descriptions Act 1968 This Act makes
misleading descriptions of goods and services an offence.
» The Advertising Standards Authority This body
supervises the operation of this code of practice. It
is an independent body; its members are not in the
advertising industry. The ASA protects the public and
deals with their complaints.
Jane Martin is the executive manager of the Obesity Policy
Coalition, a group pressing the Australian government
to take action against obesity. Ms Martin approved this
decision by the government of Queensland, noting that
young people are particularly susceptible to junk food
advertising.
The governments of other Australian states are
considering passing similar laws to control marketing
activities.
Source: www.abc.net.au/news/2019-04-21/junk-food-ads-
binned-queensland-government-crackdown/11034284
Questions
1 Analyse two ways in which laws can constrain the
activities of fast-food businesses. [8]
2 Evaluate the extent to which laws of this type
benefit the stakeholders of fast-food restaurants
in Queensland. [12]
221
 Laws relating to competition
6.1.1 Competition law is intended to protect businesses and
consumers from the effects of anti-competitive practices.
Most governments believe that free and fair competition in
markets brings many benefits. The UK government set out
the importance of competition to its economy in 2001:
Vigorous competition between firms is the lifeblood of strong
and effective markets. Competition helps consumers get a
good deal. It encourages firms to innovate by reducing slack,
A LEVEL 6.1.1 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: POLITICAL AND LEGAL
putting downward pressure on costs and providing incentives
for the efficient organisation of production. As such,
competition is a central driver for productivity growth in the
economy, and hence the UK’s international competitiveness.
Source: UK Department of Trade and Industry
Businesses operating in the UK are subject to UK and, at the
time of writing, to EU competition law, although this may
change after 31 December 2020. The major competition laws
in the UK are:
» the Competition Act 1998
» the Enterprise Act 2002
» the Enterprise and Regulatory Reform Act 2013.
Competition law in the UK operates in three main areas:
1 Cartel activity Cartels involve two or more businesses
working together to limit the extent of competition
that exists in a market; they are considered to be a
serious form of anti-competitive practice. Cartels are
agreements between businesses not to compete with
each other, for example, on price, discount levels,
credit terms or in respect of particular customers or in
particular areas. The outcome is that consumers will
be disadvantaged, primarily because they will have to
pay a higher price (agreed by the cartel) than would
otherwise be the case. In addition, the economy will
be damaged by a lack of competitiveness among its
businesses.
2 Abuse of a dominant market position The law defines
a dominant market position as ‘a position of economic
strength enjoyed by an undertaking which enables it to
prevent effective competition being maintained in the
relevant market by affording it the power to behave to
an appreciable extent independently of its competitors,
customers and ultimately of its consumers.’ Such markets
can be national or local, as well as the whole of the EU.
Abuse of such a position can take a number of forms,
including:
– imposing unfair purchase or selling prices or other
unfair trading conditions
– limiting production, markets or technical
development to the prejudice of consumers
– imposing unfair and inconsistent terms on different
trading partners.
3 Other anti-competitive practices These could include
agreements with suppliers not to sell below certain
prices, limiting production to drive up prices, agreeing
not to sell to a competitor’s customers, etc. This also
includes mergers and takeovers which may be harmful
to the competitive process in markets.
222
The scope of
UK and EU
competition law
Abuse of a Other
Cartel activity dominant anti-competitive
market position practices
▲ Figure 6.5 The extent of competition law
GLOSSARY TERMS
A cartel exists when two or more businesses collude to
control prices and/or output, thereby limiting competition
and increasing profits.
A merger is the combining of two or more firms into a
single business, following an agreement by the firms’
management teams and shareholders.
A takeover occurs when one company acquires complete
control of another by purchasing more than 50 per cent of
its share capital.
Mergers and takeovers
Takeovers and mergers have the potential to provide
businesses with a high degree of market power, as they
create larger enterprises. They can also lead to a reduction
in the degree of competition within a market. The
competition authorities in the UK are required to assess
whether a merger or takeover should be prohibited on the
basis of whether it can be expected to lead to ‘a substantial
lessening of competition’. In the UK, the primary
responsibility for the regulation of mergers and takeovers
lies with the Competition and Markets Authority (CMA).
Mergers will be assessed by the CMA if:
» the business being taken over exceeds a given size (a
sales revenue exceeding £70 million), or
» the newly merged business would control 25 per cent or
more of its market.
Key UK competition laws
The legal framework for the UK’s competition policy
is provided by the Competition Act 1998, the Enterprise Act
2002 and the Enterprise and Regulatory Reform Act 2013.
» The Competition Act 1998 prohibits cartels and
abuses of dominant market position. It also outlaws
concerted practice; for example, when businesses
agree to divide up a market and not to compete in each
other’s ‘part’ of the market. The penalties for breaching
this Act can be severe. Businesses may be fined up to
10 per cent of their worldwide sales revenue if they
enter into an anti-competitive agreement or abuse a
dominant market position.
» The Enterprise Act 2002 amended earlier laws and
strengthened the power of the UK authorities to deal
with anti-competitive practices and market dominance.
This Act has a number of important provisions:
– It places a clear focus on the impact of the business’
activities on the degree of competition. Practices
 are judged as to whether they create a ‘substantial
lessening of competition’ rather than whether they
are ‘in the public interest’.
– It imposes tougher penalties on those involved in
cartels by criminalising their activities. Directors or
other people involved may be fined or sent to prison
for up to five years if involved in cartel activity.
Company directors may also be disqualified from
being a director for up to 15 years.
– It empowers consumer organisations to make
complaints (known as ‘supercomplaints’) to the
CMA about markets that are not working well for
consumers. For example, in 2018, this legislation was
used to make a complaint about businesses charging
loyal customers higher prices than new customers for
the same products.
– There are greater opportunities for victims of
anti-competitive behaviour to gain compensation.
Consumer bodies will be able to make claims on
behalf of individuals who have suffered. This
CASE STUDY
US authorities approve T-Mobile and Sprint merger
The competition authorities in the United States have
approved a merger between two of the country’s biggest
mobile telephone service providers: T-Mobile and Sprint.
The new business will be valued at $26.5 billion. On
the face of it, this deal reduces the number of mobile
telephone providers in the USA from four to three.
The deal was finally approved after the two companies
agreed to sell some of their assets to another company. The
deal includes agreement that Dish, a satellite dish supplier,
will buy Boost Mobile, Virgin Mobile, Sprint’s prepaid
business, and ‘certain’ other assets currently owned by the
two companies. This will position Dish as the fourth major
US mobile telephone provider, replacing the one that will be
lost once T-Mobile and Sprint merge. The two companies
will be required to provide at least 20 000 cell sites and
hundreds of retail locations to Dish, and it will also get
unrestricted access to T-Mobile’s network for seven years
as it works to build a mobile network of its own.
The law and business location decisions
Many countries have legal systems which control where
businesses can locate. It is not unusual for businesses
to be located in particular areas – often alongside other
businesses. So, many towns and cities create industrial
estates where business can locate. Retailers may be limited
to certain streets – often where other shops already
operate. Many countries, including the United States, make
it illegal to locate businesses outside designated zones.
Businesses that want to build new premises may need to
apply for permission from the authorities. Applications for
new premises are decided in line with national and local
policies. Points for consideration include:
means that businesses may be sued for damages by
third parties that have been harmed by their anti-
competitive actions.
– The assessment of mergers is influenced less by
6.1.1
politicians and is more independent.
» The Enterprise and Regulatory Reform Act 2013 The
main provisions of this Act, relating to competition, are
as follows:
– It created the CMA, bringing together the
Competition Commission and the competition work of
the Office of Fair Trading. Thus, a single organisation
6.1.1.3 How a government might use the law to control business activity
is responsible for competition policy.
– It makes it quicker and simpler for businesses,
especially small and medium-sized enterprises,
to make legal challenges to anti-competitive
behaviour.
– It also makes it easier for consumers and small
businesses who have suffered loss due to anti-
competitive behaviour to obtain redress.
When T-Mobile and Sprint announced their merger plan,
they claimed that their combined assets would make them
a stronger competitor to the other two companies in the
market: AT&T and Verizon. T-Mobile and Sprint said they
would be able to reduce prices for consumers and more
quickly offer the new 5G service across America. These
claims have faced harsh criticism from consumer groups
and some experts.
Questions
1 Analyse one reason why reducing the number of
companies selling products in a particular market
might be harmful to consumers. [4]
2 The American competition authorities ruled in favour
of the merger. Evaluate whether or not this is a good
outcome. [12]
» the size, layout and external appearance of buildings
» proposed means of access and impact on the
neighbourhood
» availability of infrastructure, such as roads and
electricity supply
» how the proposed use of the development relates to the
rest of the neighbourhood.
Another factor influencing business location which
has a legal dimension is the use of special economic
zones. These are areas within individual countries where
business and trade laws are different from the rest of
the country. They are designed to attract businesses to
locate there. Governments pass laws to allow businesses
locating in these areas a range of benefits such as tax
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6.1.1
A LEVEL 6.1.1 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: POLITICAL AND LEGAL
holidays, financial support, and fewer laws and regulations
relating to employment and international trade. Often
these special economic zones are sited in poor regions
of the country. By 2018, 147 economies operated special
economic zones including China, India, Bangladesh, Saudi
Arabia, the Philippines, South Korea and the UAE.
Laws and particular goods and services
Governments use laws to control the production, sale
and consumption of a range of goods and services. Legal
6.1.1.4 The impact of changes
in political and legal factors
on businesses and business
decisions
Changes in political and legal factors frequently lead to
more intervention in business matters. For many businesses,
this can be a disadvantage as such interventions can result
in increased costs of production, as businesses in most

controls may be applied to particular products for a number
of reasons:
» The production and consumption of these products may
result in damage to the natural environment.
» The goods and services may be harmful to consumers
and they may also be addictive.
» Their consumption may have adverse effects on others or
on society generally.
Globally there are many products that are subject to legal
constraints; we shall consider a small selection. Some of the
more common ones include:
» tobacco
» alcohol
» medicines
» gambling
» vehicles with diesel and petrol engines.
Governments tend to take a range of steps to control
businesses that produce and sell these products, as well as
consumers who use them.
» Taxation Governments may impose heavy taxes on the
sale of products, such as tobacco and alcohol. This is
intended to discourage consumption, though it also acts
as an important source of revenue for many governments.
Tobacco taxes in many countries form more than 50 per
cent of the selling price of the products.
» Limiting sales Governments may control the sale of
products directly to a lesser or greater degree. The use
of vehicles with petrol and diesel engines is restricted
in many cities including Singapore, London, Milan and
Stockholm. Equally, there are commonly age limits
on those who can buy and consume certain products,
such as gambling and tobacco. It is thought that such
products can be particularly harmful to younger people.
In some countries (for example, Canada), strong alcohol
can only be purchased from a relatively small number of
licensed shops.
» Outright bans on production and consumption
The sale of alcohol is banned in a number of Muslim
countries and some states in India. All forms of
gambling are illegal in Cambodia and Qatar.
» Restricting sale to ensure safe consumption
Many countries control the sale of products, such as
medicines, to ensure that consumers use them safely.
The intention is for consumers to receive the health
benefits with minimal risks. In most countries, only
specified shops and other outlets with suitably qualified
staff are allowed to sell certain medicines.
nations are legally obliged to employ a number of non-
productive employees. For example, health and safety laws
may require the appointment of safety officers. In addition,
other costs of production may increase as businesses
have to pay minimum wage rates and locate in what may
be costly places. Similarly, the requirement (under the
Equalities Act in the UK) to make ‘reasonable’ alterations
to the working environment to enable the employment of
people with disabilities adds to production costs.
Changes in laws relating to employment practices,
marketing behaviour or competition, or decisions to raise
minimum wage rates, may all have negative effects on
businesses. Such changes can be critical if they increase
costs of production and the business concerned operates in
a globalised market with very price-conscious customers.
If rival businesses operating in other countries do not face
similar increases in costs of production, they will operate
with a competitive advantage. Such changes may result in
some businesses losing sales, market share and profits.
However, there can be positive consequences for businesses
from political and legal changes. Changes in employment and
other laws can help to motivate the workforce and improve
the performance of the workforce. For example, employees
who work in a safe and secure physical environment will be
more contented and probably more productive. Employers
will also avoid the costs, delays and bad publicity caused
by accidents at work or employee complaints about poor
conditions. Furthermore, freedom from arbitrary dismissal
may encourage a more co-operative and productive
workforce, enhancing the performance of the business.
The effects of legal and political changes may be greater
for small firms that have fewer resources and are less able
to keep up with changes in employment and other laws,
and may not be able to afford to respond in the appropriate
manner. Larger firms are more likely to employ specialists
and are more likely to be prepared for, and able to finance,
change. They may also be able to afford employment
lawyers to advise them on avoiding some of the effects of a
new piece of legislation.
STUDY TIP
Do think about political and legal changes in a balanced
way. The effects on businesses do not always have to be
negative, as we have seen. Also think in a structured way
about how businesses might respond to such changes.
Considering the likely effects on, and responses of, each
functional area of a business may be helpful.

224
 CASE STUDY
Vietnam increases its minimum wage rates
The Vietnamese government increases its minimum
wage rates each January in line with the cost of living. A
new minimum wage rate for workers, which will result in
an increase in monthly pay of up to 300 000 Vietnamese
dong, equivalent to approximately US$14, was introduced
in January 2020. This represented an increase of
approximately 5.7 per cent in the country’s minimum
wage rates.
The country has different minimum wage rates in four
regions, determined by the level of economic development
in each region. Zone 1 covers urban Hanoi and Ho Chi
Minh City. Zone 2 covers rural Hanoi and Ho Chi Minh
City, as well as Can Tho, Da Nang and Hai Phong. Zone
3 includes provincial cities and the districts of Bac Ninh,
Bac Giang, Hai Duong and Vinh Phuc. Zone 4 comprises
the rest of the country.
Business responses to the effects
of changes in the political and legal
environment
Most businesses will take decisions necessary to offset the
effects of the change in their political or legal environment
as far as possible. If the changes are judged favourable,
businesses will consider how to take advantage of the new
circumstances. Business decisions could take a number of
forms, which include the following.
» Changes in production methods Legal and political
changes may lead to decisions whereby businesses
use fewer employees in the production process and
replace them with capital equipment. Some businesses,
particularly footloose multinationals that can move
location easily, may decide to close production facilities
and produce elsewhere.
» Selling or buying assets Businesses may take the
decision to sell part of their operations if they need to
meet the requirements of competition authorities when
TEST YOUR LEARNING
Short answer questions
1 Define the terms:
a ‘privatisation’ [2]
b ‘nationalisation’. [2]
2 a Explain one advantage of privatisation. [3]
b Explain one reason why some industries may not
be suited to privatisation. [3]
3 a Explain one advantage of nationalisation. [3]
b Explain one reason why nationalised industries
may be less efficient than those in the private
sector. [3]
4 a Define the term ‘trade union’. [2]
6.1.1
According to a survey released by an employment
website, salaries in Vietnam are rising faster than other
Asian countries but still remain low – and lower than
in countries such as China. Vietnam’s minimum wage
increase of 5.7 per cent is higher than last year’s figure of
5.3 per cent, but lower than that in 2018 and 2017.
6.1.1.4 The impact of changes in political and legal factors on businesses and business decisions
Vietnam has been considered a low-cost location for
multinational businesses and is a popular location for many
well-known multinationals. Samsung, Bosch, Panasonic
and General Electric all have operations in the country.
Questions
1 Analyse two possible effects of this change in minimum
wage rates on businesses located in Vietnam. [8]
2 Evaluate the best way for businesses in Vietnam to
respond to this change in minimum wage rates. [12]
contemplating a merger or takeover. Conversely, changes
in laws relating to conditions of work, including health
and safety, might result in the purchase of new assets to
meet changed legal requirements.
» Changes in prices and target markets Rising costs
may force some businesses to pass these onto
consumers in the form of higher prices, if market
conditions allow. Other businesses may decide to
target other market segments which may be willing to
pay higher prices.
» Decisions to cut production and/or develop new
products Political and legal changes can lead to
businesses deciding to stop producing certain
products and to supply other products. Legal changes
in many countries have led to tobacco sales falling
significantly. Some tobacco manufacturers have
responded by closing factories, while others have
switched production to vaping products.
b Explain one reason why laws relating to
employment practice need to be updated
regularly. [3]
5 Explain one way in which minimum wage rates
might vary within a single country. [3]
6 a Explain one way in which laws relating to
marketing behaviour might affect businesses. [3]
b Explain one type of business activity that
competition law is designed to prevent. [3]
7 Explain one action that a government might take
to control the production, sale and consumption of
particular goods and services. [3]
225
 8 Explain one reason why political and legal changes
6.1.1 might reduce the competitiveness of a business.
9 Explain one reason why the existence of laws to
[3]
control employment practices may be beneficial to
businesses. [3]
10 Explain one way in which a business might respond
to a change in the law which increases its costs of
production significantly. [3]
Data response question
A LEVEL 6.1.1 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: POLITICAL AND LEGAL
MD vehicles
MD is a multinational company that manufactures vehicles
and has factories in several countries. The company’s
workforce is becoming less productive over time and
profit margins are falling as a result. The market for cars
is increasingly price competitive, although MD is a brand
that is highly valued by customers and demand for its cars
is not strongly sensitive to price.
A new government has been elected in one of the
countries where MD produces over 30 per cent of its cars
in a very large factory. This government has announced
changes to laws governing working conditions which will
come into force in one year’s time. These include:
● an increase in the number of days of paid holiday from
15 to 20
● an extension of health and safety laws.
226
One director of MD said that the effects of the changes to
laws on working conditions would damage the company’s
future performance.
The new government has also taken a decision to
nationalise one of MD’s most important suppliers of
components which is sited close to its factory. This was
an unexpected change and MD’s directors are concerned
about the impact it may have on its operations.
Questions
1 Analyse one possible effect on MD of the government’s
decision to nationalise one of its major local suppliers. [4]
2 Evaluate the decisions that the company might take
in response to the changes in the laws relating to
working conditions. [12]
3 One director said that ‘the effects of the changes to
laws on working conditions would damage the
company’s future performance.’ Evaluate this view. [12]
Essay question
1 Evaluate whether or not new laws designed to
promote competition are in the interest of all the
stakeholders of a business. [20]
6 Business and its environment
A LEVEL

6.1.2 External influences on business

activity: Economic

6.1.2 External influences on business activity: Economic

Chapter overview
In this chapter we examine:
★ how governments assist businesses and promote enterprise
★ the ways in which governments constrain business activity
★ government macroeconomic objectives
★ the effects of macroeconomic objectives and economic performance on business activity
★ the government’s economic policies – fiscal, monetary and supply side policies – and their impact on businesses.

Every business is affected to some degree by the national
(or global) economy in which it operates. An economy is an
immensely complex thing. It comprises millions of buyers
(or consumers) and hundreds of thousands of businesses
all making decisions to spend, hire labour, use certain
machinery, produce more or less, lend money or borrow it to
produce goods and services.
This is then complicated further by the actions of
governments that intervene in the working of the
economy in order to achieve their social and economic
objectives. Most governments aim to manage economies
so as to maximise the standard of living of the country’s
inhabitants, while pursuing other goals such as protecting
the environment. The UK government aims to achieve
economic stability in its management of the economy by
avoiding, whenever possible, sudden and dramatic changes
in the performance of the economy.
A country’s economic environment is made up of two main
elements:
» The factors which reflect the performance of that
economy as well as other economies; for example, how
fast prices are rising (inflation) and the number of
people who do not have a job (unemployment).
» The actions taken by governments to achieve the desired
economic performance.
The factors which make up the economic environment are
summarised in Figure 6.6.

Government policies affecting

the economy

Policies to support Exchange- Policies to

Fiscal Monetary Supply-side
businesses and rate avoid market
policies policies policies
promote enterprise policies failure

Businesses
in the
economy

The exchange Economic

Inflation Unemployment
rate growth

Elements of economic
performance affecting
the economy

▲ Figure 6.6 Influences on the economic environment

227
 6.1.2.1 How governments might
6.1.2 help businesses and encourage
enterprise
Governments benefit from having a strong economy. It
provides employment for the country’s inhabitants and a
source of taxation for the government. The government
is able to use the tax revenues it receives to pursue
its objectives, such as providing education and health
A LEVEL 6.1.2 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: ECONOMIC
How governments help businesses
There are a number of ways in which governments may
provide help to businesses throughout the economy.
Developing an effective infrastructure
An economy’s infrastructure is essential for its businesses
to be able to operate. Without effective systems of
transport, communications and energy supply, businesses
would not be able to engage in production and supply goods

services. For these reasons, all governments intervene
in the economy to help businesses and to encourage
enterprise.
GLOSSARY TERMS
Enterprise is the skill needed to make new ideas work.
Infrastructure refers to the physical and organisational
factors necessary to allow both society and an economy
to operate effectively; for example, transport and
communication networks.
A joint venture occurs when businesses collaborate on a
project (or projects) but do not formally join together all of
their activities.
2.0
and services. Infrastructure can also help to determine
the competitiveness of a country’s businesses. If energy,
transport and communications are provided efficiently and
relatively cheaply, it can help to reduce the operating costs
of businesses and sharpen their price competitiveness.
Some governments recognise the importance of up-to-date
infrastructure to economic success and invest relatively
heavily. Figure 6.7 shows the relative amounts invested in
infrastructure in a selection of countries between 2008 and
2017. Governments may invest directly or use a mixture of
state and private investment to develop their infrastructures.
In recent years, there have been more projects, of greater
scale and complexity than ever before, being proposed and
progressed. High-profile examples include a new bridge
linking Hong Kong to Macau and Zhuhai, Thailand’s Eastern
Economic Corridor, Australia’s Inland Rail project and the
Dubai Solar Park (this is the world’s largest single-site solar
installation, to which more than US$4.3 billion of private
investment has been committed).

1.8
Infrastructure investment (% GDP)

1.6
Australia
1.4

1.2
India Turkey
1.0
Japan UK
0.8

0.6 Germany

0.4 USA

0.2

0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Year

Note: This data relates to transport infrastructure investment only. GDP is a measure of the value of a nation’s output.
Source: OECD; https://data.oecd.org/transport/infrastructure-investment.htm
▲ Figure 6.7 Infrastructure investment in a selection of countries, 2008–17, as a percentage of GDP

HANDLING DATA
Look at the data presented in Figure 6.7 and answer the 2 In 2016, Germany’s investment in its infrastructure,
following questions. measured in billions of euros, was higher than in 2015.
1 The graph shows infrastructure investment as a Explain how this happened, given that the graph in
percentage of GDP. Why might the USA’s investment in Figure 6.7 shows a decline between 2015 and 2016.
transport infrastructure have been higher in 2017 than
that of Turkey?

228
The UK has taken some important decisions on its
infrastructure. It has not invested as heavily as some
other countries in its infrastructure over the past 30 years,
although investment has risen since 2009. Partly as a
response to this, the government prepared its infrastructure
spending plan for the period to 2033.
The National Infrastructure Plan details about £375 billion of
investment in energy, transport, communications and water
projects by 2033. The insurance industry also plans to spend
£25 billion by 2020 using customers’ payments in pension
and other funds to finance this investment. Examples of the
UK’s programme of investment in infrastructure include the
Crossrail Project in London, the development of a new nuclear
power station at Wylfa, North Wales, and, controversially, the
building of a high-speed rail line, known as HS2, to connect
London to Birmingham and, later, Manchester and Leeds.
How businesses benefit from investment in
infrastructure
Infrastructure projects create significant opportunities for
businesses as well as providing better facilities (such as
road and rail transport for them to use). There are obvious
opportunities for firms in the construction industry to
benefit from expenditure on building new roads, bridges
and power stations. These can result in strategic decisions
to expand production or to engage in joint ventures with
competitors to deliver on large infrastructure projects such
as the Crossrail Project in London.
Other businesses in a wide range of industries are also likely
to benefit from orders associated with improving the UK’s
infrastructure. For example, the Crossrail Project has resulted
in Bombardier (a Canadian multinational engineering company)
supplying an order for 65 new trains for the Crossrail railway.
This order created 760 new jobs to build the trains and 80 jobs
to maintain them once they are operational. Bombardier has
a contract to build 60 per cent of the new trains that will be
needed in the UK as it improves its infrastructure.
Providing advice to businesses
The provision of advice to companies can be a relatively
inexpensive means of supporting businesses and helping
them to become more competitive. Governments can offer
advice in a number of areas, including:
» raising capital and managing finance
» managing employees effectively; for example, offering
guidance on recruiting, training and keeping employees
» trading overseas – governments may offer advice on how
to sell products in specific overseas markets
» developing new products and processes of production.
Many governments operate websites which offer a range
of advice and contacts for those starting new businesses
and managing existing ones. For example, the USA federal
government operates a small business hub which provides a
wide range of advice for the country’s small businesses.
Providing services for businesses
Governments can support business activities in other ways
apart from offering advice.
» Recruitment and training It is common for governments
to operate systems designed to match unemployed
workers to potential jobs. In this way, they can help
to reduce the costs to businesses of finding suitable
6.1.2
new employees. In the UK, the government operates
Job Centre Plus to bring employers with vacancies
and unemployed workers together. A new government
website named Universal Jobmatch has been introduced,
allowing unemployed workers to search for employment;
employers can upload and manage their own vacancies
6.1.2.1 How governments might help businesses and encourage enterprise
while searching for prospective employees. Similarly,
governments can support businesses by providing training
or helping businesses to provide their own training. The
Indian government funds programmes providing training
and has also established the National Skill Development
Corporation (NSDC) as a public–private sector partnership
to stimulate investment in training.
» Helping businesses to raise finance Governments may
provide loans and grants directly to businesses, usually
to invest in new equipment, buildings or other facilities.
They may also guarantee loans provided by banks. This
makes banks more willing to lend to what might be
high-risk businesses, as the government guarantees
the repayment of the loan should the business default
on payment. We look at how the UK government helps
businesses financially in more detail below.
» Supporting businesses trading overseas It is common
for governments to support businesses that are
exporting goods and services overseas. In the UK, the
government supports businesses that are exporting, or
planning to do so, through the work of the Department
for International Trade. This department helps
businesses to acquire the skills and contacts necessary
for exporting and provides advice about exporting
to particular countries. It also offers help in winning
contracts overseas, on using technology to facilitate
exporting and by organising trade shows and exhibitions
to showcase UK businesses and exports.
Government policies to encourage
enterprise
Governments generally seek to establish an enterprise-
friendly business environment, which will encourage people
and organisations to develop their ideas as well as to
establish and expand their businesses. Governments pursue
policies to promote enterprise for many reasons: enterprise
creates jobs, increases the taxes paid to the government
and, of course, today’s new enterprises can become
tomorrow’s multinational businesses.
Establishing or expanding a business can be a risky process
for those involved: entrepreneurs may give up safe, well-
paid jobs and owner-managers may mortgage homes to
borrow money to expand businesses. It can go wrong,
but the aim of much government support is to promote
enterprise and to reduce the degree of risk.
Decisions and actions by governments and their agencies
encourage and promote the development of enterprise and
innovation. The UK encourages enterprise in a number of
229

6.1.2
A LEVEL 6.1.2 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: ECONOMIC
ways, both financial and non-financial. These have changed
significantly in recent years as the importance of enterprise
to the government has increased.
Financial support for enterprise
The British Business Bank is a government-owned
business development bank. It manages all UK government
programmes that help smaller businesses to gain access
to finance. It was established in 2012 to help make sure
finance markets for small and medium-sized businesses work
» The New Enterprise Allowance This is available to the
long-term unemployed who want to start their own
business. It is in two parts: a weekly allowance totalling
£1274 over 26 weeks and access to a loan of up to £2500.
» Start-up loans This scheme provides loans to businesses
of up to £25 000, with the average being £7200. There is
a fixed interest rate of 6 per cent and repayment can be
made over any period between 1 and 5 years.
» Enterprise Finance Guarantee (EFG) EFG is a loan
guarantee scheme. It allows banks and other lenders to

effectively. It does not lend directly to businesses, but it
will work alongside private-sector partners. It will pull in
more private-sector funding to maximise its impact. At the
end of the 2018–19 financial year, the bank had lent £6.6
billion to 89 000 businesses. Its lending activities increased
by 27 per cent in that year.
Some of the national schemes of financial support for
enterprise (specifically smaller businesses) overseen by
the British Business Bank are shown below, but these are
supplemented by a variety of regional and local policies.
offer small businesses which lack security or a proven
track record a normal commercial loan. Lenders can use
EFG to help businesses arrange loans and overdrafts.
Loans can be guaranteed from £1000 to £1.2 million.
Small and medium-sized businesses with annual sales
revenue below £41 million can get EFG-backed loans.
Between its launch in 2009 and 2018, EFG has supported
the provision of over 29 000 business loans to a value of
over £3.2 billion.

CASE STUDY
Malaysia urged to make social enterprise scheme simpler
Social enterprises are businesses which have clear social
objectives, such as helping those on very low incomes
or protecting the environment. A scheme in Malaysia
designed to help this type of business will increase growth
rates in this sector. However, Malaysian entrepreneurs
have argued that the government must offer greater
incentives and fewer regulations.
Twenty-two diverse social enterprises have received
accreditation recently for this scheme. The scheme
gives social enterprises tax deductions as well as the
opportunity to apply for grants.
However, some entrepreneurs state that registration
is not easy to manage. ‘The documentation process is
very data-intensive. Aspiring or new social enterprises
will find it difficult so there must be an easier process,’
said Kuhan Pathy, co-founder of Masala Wheels, a
social enterprise that supports disadvantaged young
people.
In many Asian countries, such as Malaysia, incomes
have risen but governments have continued to struggle
with poverty in towns and cities, unequal educational
opportunities and environmental issues. This has led a
number of countries (Thailand and Vietnam, for example)
to pass laws intended to encourage and support social
enterprises. Some critics of these laws think that too
many regulations will limit the growth in numbers of
social enterprises.
Source: www.reuters.com/article/us-malaysia-socialenterprise-
scheme/cut-the-paperwork-malaysia-urged-to-make-
social-enterprise-scheme-simpler-idUSKBN1ZT19A
Questions
1 Analyse two ways in which the Malaysian government
might encourage the creation of more social
enterprises. [8]
2 Evaluate the view that any government intervention
into a market will lead to significant long-term
constraints on some businesses. [12]

Non-financial support for enterprise
The UK government provides a range of support, advice
and inspiration for entrepreneurs establishing and growing
their businesses. A focal point of government support for
enterprise is its website ‘Business is Great’.
The Department for Business, Innovation and Skills (BIS)
is the key UK government department concerned with
developing and providing enterprise support. It works with
businesses, financial institutions and other government
departments to help UK businesses start up, grow and
succeed.
One element of the BIS’ work has been to develop ‘growth
hubs’ across the UK. Since May 2016, the UK has 39
growth hubs across the country. They are communication
networks bringing together local and national, public- and
private-sector partners – such as Chambers of Commerce,
universities and banks – co-ordinating local business
support and connecting businesses to the right help for
their needs. Businesses that have been in contact with a
growth hub are growing faster than other businesses in
terms of sales revenue (9 per cent compared to 2.5 per
cent on average) and employment (8 per cent compared to
0.1 per cent).

230
Other aspects of BIS’ work to provide a more ‘enterprise-
friendly’ environment in the UK include:
» Reducing the number of regulations which constrain
business activity. The government operates a policy of
removing two regulations for each new one created.
» BIS works with the tax authorities in the UK (HM
Revenue and Customs) to offer support to new and small
businesses by reducing the tax they pay on any profits
and also the cost of employing people.
» Supporting innovation through helping researchers,
developers, innovators and businesses, together with
necessary to develop new products and processes. The
government established UK Research and Innovation
in 2018. This new organisation operates across the
whole of the UK with a combined budget of more than
6.1.2
£6 billion.
» The government offers a range of schemes to help
entrepreneurs and businesses to develop new products
and processes. These include help to develop the ideas
(in terms of expertise, advice and funding) as well as
support on how to protect ideas (known as intellectual
property or IP).

6.1.2.1 How governments might help businesses and encourage enterprise

universities, to bring together the skills and technology

CASE STUDY
The Four Anjels bakery
In 2010, four entrepreneurs established Four Anjels It is possible to judge that the support the Four Anjels
bakery in Gloucestershire, England. It operates with received was effective: by 2020 the bakery was operating
the vision of employing ‘passionate bakers to make 24 hours a day, five days each week.
hand-made products’. Initially the bakery had just five
employees but has since grown to have 40 staff and major
customers including Caffè Nero.
After six years of successful operation, the business’
owners realised that changes would be required in order
to continue their planned development and growth. Project
manager Phil Stevens said: ‘We knew that we needed
to relocate to new premises, but we also saw that we
were entering a period of significant change. We needed
guidance to manage the change efficiently and further
business support around the issues that would naturally
come from a period of change and rapid growth.’
The team consulted a range of different business advisors
and consultancy services, but could not find the kind of
support they needed. Phil was sceptical of the advice they
received, feeling it was not considering fully the needs of ▲ Figure 6.8
their specific business. Source: www.thegrowthhub.biz/the-buzz/
‘When we made contact with the growth hub and were news/case-study-four-anjels
introduced to our business guide, Sarah Gregg, we knew
Questions
from the very first meeting that we had found the right
partner. She took the time to really get to grips with our 1 Analyse two reasons why the support provided by
business and requirements, and then showed us how the Gloucestershire growth hub was an important
growth hub could provide us with effective support.’ element in expanding Four Anjels. [8]
2 ‘Non-financial help is more important than financial
The four entrepreneurs attended a number of growth hub support to establish an enterprise-friendly business
events. Meeting a financial advice panel ‘provided a valuable environment.’ Evaluate this view. [12]
focus and delivered real results’ according to Sarah Gregg.

The UK government also seeks to encourage enterprise and
to develop the relevant skills in young people. It:
» recruits young business owners to volunteer as
enterprise champions to talk to young people about
establishing and running their own enterprises
» works directly with schools and colleges to encourage
the use of schemes. For example, it promotes
the ‘Enterprise Village’ to help schools to set up
businesses.
The effects of enterprise policies
The impact of these policies to encourage enterprise and
innovation is greatest among smaller organisations. It has
a substantial impact on strategic decisions made by the
owners of such businesses by influencing decisions on
whether to start an enterprise or to expand it. However,
these policies also stimulate innovation in organisations
of all sizes. In many ways, this could affect functional
decision-making significantly as managers seek to expand
operations, hire additional employees to produce innovative
products and plan marketing campaigns to promote them.

231

6.1.2
A LEVEL 6.1.2 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: ECONOMIC
6.1.2.2 How governments might
constrain business activity
» Regulation of privatised monopolies to protect
In the previous chapter, we considered a range of laws
which might constrain the activities of businesses. For
example, many governments have passed laws constraining
the production, sale and consumption of certain products
such as alcohol, tobacco and gambling. Laws that affect
businesses are supplemented by regulations in many
countries. Regulations are used to set out how businesses
the United Arab Emirates investigated the behaviour
of a Pakistani bank to determine whether or not it had
breached the country’s financial laws.
consumers and other businesses We saw in
Chapter 6.1.1 that privatisation brings advantages
and disadvantages. Regulations are used to protect
consumers, especially when state-owned monopolies
have been privatised. In the late-twentieth century,
the UK privatised many state-owned monopolies that
supplied products including water, electricity and

should respond to laws.
The most common forms of regulation are government
regulation and self-regulation. Government regulation is
a natural extension of legislation, in that it defines and
controls some of the ways that a business or individual can
operate in order to follow the law. A very straightforward
example is food packaging in Canada, which must, at the
very least, be packaged with both English and French
wording.
The use of regulation
Regulation can relate to a variety of business activities,
including pricing and their impact on the environment.
There are a number of aspects of regulation that affect
business activity in the UK and shape the economic
environment in which all firms operate. These include:
» Regulation with the aim of creating free and fair
competition between businesses Regulation can
relate to any industry or business in the UK that is
not operating in the best interests of consumers. The
focus of most regulation is to protect the consumer
by ensuring that there is sufficient competition
within specific industries and to eliminate any trading
activities that are not in the interests of consumers.
Such activities may include businesses limiting the
range and variety of products available to consumers.
Regulators can take a number of actions to protect the
interest of consumers, such as controlling prices, taxing
profits that are judged to be ‘excessive’, and allowing
new entrants to an industry to have access to the
facilities of existing producers.
Regulations constraining business activity operate in
every country. In 2020, Chinese regulators investigated
Luckin Coffee Inc for uncompetitive activities; at the
same time, regulators in America were investigating
whether Apple’s credit card infringed some of the
country’s rules.
» Regulation of certain high-profile industries such as
banking Some industries in the UK and elsewhere are
regulated particularly closely because of their potential
to act against the interests of consumers or their ability
to damage the economy. Banking and financial services
are examples of such industries.
Governments in a number of countries have passed
new laws constraining the activities of banks and
other businesses supplying financial services such as
insurance. These new laws have led to regulations which
are imposed and monitored by relevant authorities,
often central banks. In 2020, the banking regulator in
232
gas during the 1980s and 1990s. This meant that
these monopolies became private companies and the
government established regulators (Ofwat, Ofgem and
Ofcom, for example) to ensure that the companies did
not abuse their market positions. The role of these
regulators is to act to ensure that consumers’ interests
and those of other businesses are protected and that
these natural monopolies do not charge excessive prices
and make excessive profits.
» Self-regulation In some industries, governments have
permitted self-regulation to operate, usually through
a code of conduct which all businesses within the
industry agree to abide by. The government reserves
the right to impose legal controls if a code of conduct
is judged to be ineffective. Such self-regulation can
be overseen to ensure that firms in industries subject
to legal controls operate properly and as intended. For
example, the Indian government has proposed using
self-regulation to control the content that is available
on the internet throughout the country. India already
uses self-regulation to limit the activities of the print
and broadcast media.
Other ways in which governments
might constrain business activity
Governments can intervene in markets to constrain the
activities of businesses in other ways apart from imposing
regulations.
» By subsidising production of good and services When
a government offers a business or an industry a subsidy,
it effectively pays a part of the costs of production. This
encourages a greater increase in output of that product
as it becomes more profitable to produce it. However,
this can have negative effects on those businesses
that supply goods and services which compete with
the subsidised products. In a number of countries,
governments offer subsidies to kerosene producers.
These affect the competitiveness of businesses
supplying gas or solar power and may result in some
failing or not growing as they might have done without
the subsidies to their competitors.
» Providing information on products Many consumers
are unable to make informed and good-quality
buying decisions on health and education products.
Governments intervene in a range of markets through
the use of advertising to give consumers relevant
information to help them make better buying decisions.
Such advertising may impact negatively on industries
such as those supplying alcohol, tobacco and gambling.
» Implementing a range of economic policies We shall
see later in this chapter that governments can intervene
in markets by implementing a range of policies, such
as altering interest rates or changing the level of
expenditure on goods and services supplied by privately
owned businesses.
6.1.2.3 How governments deal
with market failure
One reason for governments to intervene in the operation of
a market is market failure.
When a market operates correctly, it responds to the signals
given by prices and increases or reduces the resources
used by businesses in the market to supply more or less of
the product. Over time, global oil prices have risen from
$30 per barrel in 2016 to more than $60 per barrel at the
start of 2020. The price has risen because consumers of
oil (individuals and businesses) have demanded more of
the product. In response to the signal of rising prices,
oil companies have sourced new supplies of oil and have
increased production.
The failure of markets to work properly can come about for
a number of reasons. Most governments have taken steps to
attempt to limit the extent of each type of market failure.
1 Monopolies and cartels The existence of monopolies
and cartels might mean producers have too much power,
resulting in insufficient output and high prices. As a
consequence, consumers may receive too little of certain
products, resulting in a lower standard of living.
Governments frequently pass laws to encourage
competition and to restrict a wide range of anti-
competitive activities. Such laws prohibit the abuse
of monopoly power (for example, by raising prices
excessively to boost profit margins) and the operation of
cartels. Such laws protect consumers from the adverse
effects of monopoly power. Offending firms are normally
fined, sometimes very heavily.
2 Damage to the environment Producers that pollute the
environment are not paying the full costs of production.
For example, they might discharge toxic waste into a
river rather than paying for it to be taken away and
treated. These costs are imposed on someone else. It is
often governments (and therefore taxpayers) that have
to pay to clean up the pollution. This means that part of
the costs of production are paid by a third party. Costs
passed on in this way are called external costs, and they
can result in severe environmental damage and problems
for future generations. This type of market failure
creates oversupply of certain products as producers
(and ultimately consumers) do not pay the full cost
of production. Some industries (for example, palm oil
producers) have received criticism for the environmental
damage arising from the deforestation that has
accompanied huge increases in the supply of this type
of oil.
Governments tend to control external costs in three
main ways. They can impose indirect taxes (that is, a
tax that adds to the selling price of a product) with the
aim of raising the costs of production to account for
6.1.2
the external costs paid by other groups in society. This
should lead to higher prices and lower profit margins,
discouraging production and consumption of the
products. Alternatively, governments can levy fines on
businesses that damage the environment and thereby
impose costs on others. Finally, a government may pass
laws to ban processes and products that cause external
6.1.2.3 How governments deal with market failure
costs.
3 Consumers and producers possess insufficient
information about products Some consumers may have
too little information about the benefits of buying
products, such as health and education services. As a
result, they may buy too little of them and there will be
an inadequate supply of these products – this is a form
of market failure. Governments frequently intervene
in these markets to encourage consumers to buy these
types of products, either by subsidising them or by
supplying the products themselves and providing them
without charges. This form of market failure is likely to
result in undersupply, as too few resources are allocated
to producing goods and services in these markets.
However, it can also result in the over-consumption of
some products (drugs, for example) if consumers are
unaware of the dangers they pose.
To overcome this type of market failure, governments
frequently provide information about the benefits or
drawbacks of products. For example, in many countries
there have been health information programmes to
advise smokers of the danger to health of consuming
tobacco. Many such programmes have been successful
and there has been a sharp decline in tobacco
consumption in many countries.
4 Poaching of skilled labour If a business invests
heavily in training its workforce to provide job-
related skills, it can expect a consequent increase
in productivity as a reward for devoting resources
to training. However, one possible outcome is that
highly skilled employees become attractive to rival
businesses, who are able to offer them higher wages as
they have not paid the training costs. Such poaching of
labour can result in too few resources being allocated
to training for fear of poaching. Thus, the market fails.
Overcoming the poaching of labour is difficult for
any government. If it has sufficient funds available,
it may provide some training itself and can offer tax
benefits to businesses that engage in staff training.
However, such approaches can be very costly to have any
significant effect.
GLOSSARY TERM
Market failure occurs when a market does not work
properly and resources are not allocated correctly.
233

STUDY TIP
6.1.2 Market failure is a strong argument for government
intervention in the economy and can provide a powerful
line of analysis when responding to questions on the
merits (or otherwise) of state involvement in the business
environment.
6.1.2.4 Macroeconomic objectives
A LEVEL 6.1.2 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: ECONOMIC
of governments and their impact
on business activity
Every government in the world operates with a number
of macroeconomic objectives. The key macroeconomic
objectives for the UK are as follows.
» Sustainable economic growth This means that the
value of the economy’s entire production of goods and
services should increase over time. However, this should
be at a rate which is sustainable – this means that it can
be maintained over time while minimising the damage to
the environment.
» A steady and low rate of inflation The UK
government’s inflation target at the time of writing
is 2.0 per cent, meaning that it aims to have prices
rising in the UK at this rate annually. This is a major
economic objective which the Bank of England pursues
on behalf of the government.
» Low levels of unemployment It is not possible to
eliminate all unemployment in an economy. The UK
government (along with many others) wants to achieve
a level of employment whereby those who are able and
willing to work have a job.
These macroeconomic objectives have implications for
businesses, as they influence the economic environment
in which all businesses operate. In the following sections,
we will look at each of the government’s main economic
objectives in more detail, along with the impact they can
have on business activity.
Economic growth
Economic growth is an increase in the value of goods and
services produced by a nation’s economy. Fluctuations in
GLOSSARY TERMS
Macroeconomics is the study of the behaviour of a whole
economy and the factors that can influence it.
Microeconomics is the study of smaller parts of an
economy, such as the behaviour and decision-making of
businesses and individual consumers.
Economic growth is an increase in the value of goods and
services produced by a nation’s economy over a period of
time.
Inflation is a sustained rise in the general price level and a
corresponding fall in the value of money.
234
the rate of economic growth result in the business cycle,
which we consider later in this section. If the rate of
economic growth is negative (that is, if the economy is
getting smaller) for six consecutive months, then it is said
to be in recession.
Economic growth is normally judged through the changes in
the level of gross domestic product (GDP), which measures
the value of a nation’s output of goods and services. In
February 2020, the GDP of the UK was £2 264 855 million.
The population of the UK is approximately 66 million,
giving a GDP per head (or per capita) equal to £34 316.
Governments seek to increase this figure over time, as it
represents a rise in the country’s standard of living.
Most countries’ economies experience economic growth over
a period of time, though, in the short term, economies may
stagnate or even decline in size. Figure 6.9 illustrates the
quarterly economic growth rates for the UK from 2010
until 2020.
Governments usually aim to maintain steady and sustained
economic growth over a period of time. However, this is a
difficult target to achieve, as the operation of the business
cycle tends to create the fluctuations apparent in Figure
6.9. Governments use counter-cyclical policies (including
control via interest rates and taxation levels) to attempt
to eliminate the more extreme fluctuations. High rates of
economic growth are not desirable, as they tend to result in
slumps whereby economic growth may become negative.
Governments can stimulate growth as a consequence
of their economic policies. Short-term growth can be
encouraged by cuts in interest rates and taxation which
fuel borrowing and spending, leading to greater output
and, hence, economic growth. The danger is, however,
that firms and individuals purchase products from
overseas, promoting growth in foreign economies. Supply-
side policies may be put in place to achieve sustained
economic growth. This type of policy involves increasing
the productive capability of the economy by improving
the skills of the workforce, encouraging more people into
employment and promoting competition within markets to
increase output and GDP.
Unemployment is the number of people who are seeking a
job but are unable to secure one.
A recession is characterised by falling levels of demand and
declining levels of output and employment over at least a
six-month period.
A slump takes place when production is at its lowest,
unemployment is high and there are many business
failures.
Supply-side policies are a range of measures designed to
improve the free operation of markets and, therefore, the
total amount that is produced (or supplied) by an economy.
 3
2.5
GDP
1.5
1
2010 2012 2014
Year
▲ Figure 6.9 Economic growth rates in the UK, 2010–20
CASE STUDY
UK’s economic growth slows
The UK’s Office for National Statistics (ONS) has stated
that growth in gross domestic product (GDP) was flat
overall in the last quarter of 2019, as consumer spending
was low over the Christmas shopping period and
manufacturing output fell sharply.
The growth rate slowed in the third quarter of 2019,
although annual growth did increase slightly to 1.4 per
cent in 2019, just above the 2018 economic growth rate of
1.3 per cent.
However, the ONS reported that the economy grew by
0.3 per cent in December from the previous month,
faster than expected, and suggesting that the decline in
economic growth might be short-lived. Surveys show
that the service sector – which accounts for about 80
per cent of the economy and includes hotels, shops and
restaurants – also recovered to show the strongest
growth since mid-2018.
The case for economic growth is not clear-cut. Growth brings disadvantages as well as advantages for businesses. These
arguments are summarised in Table 6.3.
▼ Table 6.3 The benefits and drawbacks of economic growth for businesses
The benefits
• High rates of economic growth provide the government
with increased tax revenues permitting greater
expenditure on health, education and transport,
benefiting all businesses and encouraging further growth.
• Growth provides opportunities for all in society.
Individuals benefit from greater chances of promotion;
high levels of consumer spending encourage enterprise.
Businesses small and large may thrive in a growing
environment.
• Businesses generally enjoy higher sales and increased
profits. Expansion is likely for firms selling income
elastic products such as cars and foreign holidays.
Growth creates new markets for products.
6.1.2
6.1.2.4 Macroeconomic objectives of governments and their impact on business activity
2016 2018 2020
Source: Trading Economics (Office for National Statistics)
However, economists said the underlying momentum
of the economy slowed over the year as a whole.
Manufacturing output fell sharply in the fourth quarter,
owing to weaker levels of production in the car industry,
effectively finishing 2019 in recession after three
consecutive quarters in contraction.
The ONS said quarterly GDP growth had been declining
during 2019, continuing the slowing that has been
experienced over the previous five years.
Questions
1 Analyse one reason why economic growth is an
important macroeconomic objective for most
governments. [4]
2 ‘The economic data provided in the case study
represents bad news for all UK businesses.’ Evaluate
this view. [12]
The drawbacks
• Not all regions within an economy benefit equally during
periods of economic growth. For example, firms selling in
prosperous regions of a country are likely to enjoy increased
sales, while those in less prosperous regions may only see a
marginal increase in revenues.
• Growth may result in shortages of labour and other materials.
This may result in higher wages and prices, fuelling inflation
and creating uncertainty among the business community.
• Growth places individuals and businesses under pressure.
Workloads increase and decisions may be rushed. In these
circumstances, it may prove impossible to maintain the quality
of management and businesses may lose co-ordination and a
clear sense of direction.
235
 Economic growth and the business cycle
All countries suffer fluctuations in the level of GDP and
6.1.2 business activity within their economies. At times spending,
output and employment all rise; during other periods, the
opposite is true. The value of a country’s output over a
period of time is measured by a nation’s gross domestic
product – this figure is dependent upon the level of
economic activity. A rising level of economic activity will
be reflected in a higher level of GDP.
A LEVEL 6.1.2 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: ECONOMIC
GLOSSARY TERM
The level of economic activity refers to the amount of
spending and production in an economy. Governments
generally aim to have smooth increases in the level of
economic activity over time.
The business cycle describes the regular fluctuations
in economic activity (and GDP) occurring over time in
economies. Figure 6.10 illustrates a typical business cycle.
Trade cycles generally have four stages:
» Recovery or upswing as the economy recovers from
a slump; production and employment both begin to
increase. Consumers will generally spend more in these
circumstances as they are more confident in the security
of their employment. Initially, businesses may respond
cautiously to signs of increasing consumer confidence.
No major decisions are required to meet rising demand
while spare capacity exists – firms simply begin to utilise
idle factories, offices and other assets. As business
confidence increases, firms may take the decision to
invest in further non-current assets (factories, machinery
and vehicles, for example). Employees experience less
difficulty in finding jobs and wages may begin to rise.
» A boom follows with high levels of production and
expenditure by firms, consumers and the government.
Booms are normally characterised by prosperity and
confidence in the business community. Investment in
non-current assets is likely to increase at such times.
However, many sectors of the economy will experience
Gross domestic product
Boom
Trend of
Recession
or downswing
Slump
0
Time
▲ Figure 6.10 The stages of the business cycle
236
pressure during booms. Skilled workers may become
scarce and firms competing for workers may offer higher
wages. Simultaneously, as the economy approaches
maximum production, shortages and bottlenecks will
occur as insufficient raw materials and components
exist to meet demand. Inevitably this will result in their
prices rising. The combination of rising wages and rising
prices of raw materials and components will create
inflation. It is the existence of inflation that usually
leads to the end of a boom.
» A recession occurs when incomes and output start to
fall. Technically a recession exists once GDP has fallen
for two successive three-month periods – that is, for six
months. Falling sales will begin to eat into businesses’
profits. In circumstances such as this, governments in
the UK and elsewhere have tended to lower interest rates
in an attempt to stimulate demand and sales. Despite
the falling interest rates, falling profits are likely to
result in plans to invest in new factories and offices
being delayed or abandoned. The level of production in
the economy as a whole may stagnate or even fall. The
amount of spare capacity within the economy will rise.
Some businesses will fail and the level of bankruptcies is
likely to rise.
» A slump often, but not always, follows a recession.
In some circumstances, an economy may enter the
upswing stage of the business cycle without moving
through a slump period. Governments may take action
to encourage this by, for example, increasing their
own spending or lowering interest rates. A slump sees
production at its lowest, with high unemployment, and
increasing numbers of firms will fail.
Figure 6.10 illustrates a smooth and regular trade cycle in
operation. In reality, the change in gross domestic product
is likely to be irregular, as economic cycles of different
duration and intensity operate simultaneously. The business
cycle is a major influence on the performance of businesses.
As the economy moves from one stage of the cycle to
another, businesses can expect to see substantial changes
in their trading conditions.
r time
GDP ove
Recovery or
upswing
The impact of economic growth and the
business cycle
Table 6.4 identifies some actions that different businesses 6.1.2
might take in response to the business cycle. However, not
all businesses are equally affected by the changing trading
conditions, as summarised in Table 6.5.
▼ Table 6.4 The trade cycle and business actions

Stage of business cycle Key features Likely reactions by business

6.1.2.4 Macroeconomic objectives of governments and their impact on business activity

Recovery or upswing • Increasing consumer expenditure
• Existing spare capacity used
• Production rises
• Business confidence strengthens
• Investment increases
Boom • Rate of inflation increases
• Bottlenecks in supply of materials and
components
• Some firms unable to satisfy demand
• Profits probably high – but hit by rising
costs
Recession • Government reduces interest rates
• Firms reduce production as demand falls
• Spare capacity rises
• Business confidence declines and
investment is cut
• Profits fall
Slump • Increasing number of bankruptcies and
insolvencies
• Government lowers interest rates further
• High levels of unemployment
• Low levels of business confidence and
consumer spending
• Opportunity to charge higher prices
• Rising numbers of business start-ups
• Businesses take decisions to invest in non-current
assets
• Businesses operate nearer to (or at) full capacity
• Firms face increasing pressure to increase prices
• Businesses seek alternative methods to increase
output
• Wage rises offered to retain or attract skilled
labour
• Managers plan for falling levels of demand
• Firms seek new markets for products – possibly
overseas
• Some products may be stockpiled
• Workers laid off – or asked to work short-time
• Financially insecure firms may become bankrupt
or insolvent
• Firms offer basic products at low prices
• Businesses may close factories to reduce capacity
• Large-scale redundancies may occur
• Marketing concentrates on low prices and easy
payment deals

▼ Table 6.5 Products affected and unaffected by the business cycle

Firms supplying these products may be significantly Firms supplying these products are unlikely to be affected
affected by the business cycle to a great extent by the business cycle – in fact demand
may rise for some of these products in a recession/slump
• Leisure air travel • Fuel, including petrol, gas and electricity
• Sports and leisure goods • Cigarettes and tobacco
• Jewellery • Water and sewage services
• Household furniture • Unbranded basic foods
• Cars

A number of businesses may find that demand for their products such as televisions and laptops, and construction
products is relatively unaffected as the business cycle materials such as bricks and windows.
moves through its stages and the rate of economic growth
Businesses selling basic foodstuffs might have to take little
alters. Producers and retailers of basic foodstuffs, public
or no action to survive a recession; in fact, demand for their
transport and water services may notice little change
products might increase as consumers switch from more
in demand for their products. This is because these are
expensive alternatives. At the other extreme, businesses
essential items consumers continue to purchase even when
supplying materials to the construction industry could
their incomes are falling – demand for them is not sensitive
be hard hit, as firms delay or abandon plans to extend
to changes in income.
factories and build new offices. Their position might be
Demand for other categories of products is more sensitive made worse by a fall in demand for new houses, as hard-up
to changes in income levels and therefore the stages of the consumers abandon schemes to move home.
business cycle. Examples include foreign holidays, electrical

237
 CASE STUDY
6.1.2
Pakistan misses economic growth target
A LEVEL 6.1.2 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: ECONOMIC
▲ Figure 6.11 The State Bank of Pakistan
Pakistan’s central bank has estimated that the rate of
economic growth in the country for the financial year
2019–20 will not reach the 4 per cent target that was set.
The State Bank of Pakistan (SBP) has analysed Pakistan’s
economic performance and recommended that the
HANDLING DATA
Assume that Pakistan’s average annual population
growth is 1.75 per cent. Given that the country had 219
million inhabitants in 2019, what will be the revised
forecast for 2025?
Economic growth and the business cycle are permanent
features of the economic environment for firms. The effects
of changes in the business cycle vary from industry to
industry. Firms selling goods whose demand is sensitive to
changes in income (known as income elastic goods), such
as designer clothes and foreign holidays, may find that
sales rise in a boom and fall during recession. Conversely,
businesses selling staple products, such as foodstuffs,
where demand is not income elastic may be relatively
unaffected by the business cycle.
It is possible to argue that the business cycle will only
provoke short-term responses in many firms, because its
effects are relatively short-lived. Booms and slumps do not
last forever and businesses can take actions to see them
through difficult trading periods. During boom periods,
managers may increase prices to restrict demand and
increase profitability; they may subcontract work to other
firms or seek supplies from overseas. Equally, in conditions
of recession or slump, lay-offs may occur or short-time
working may take place while overseas markets are targeted
to increase sales. Well-managed firms will predict the onset
of a boom or slump and take appropriate action in advance.
238
government should take action to support the country’s
economy to achieve sustained economic growth. In its
report, the SBP pointed out that the output of Pakistan’s
larger manufacturing businesses fell by nearly 6 per
cent in comparison with the previous year. The industries
affected by this decline included construction and vehicle
manufacturing. In view of this, the report suggested that
Pakistan could not be expected to achieve its GDP growth
target of 4 per cent. The central bank has previously
predicted a growth rate of around 3.5 per cent for
Pakistan’s economy; other economists fear it might be as
low as 2.4 per cent. The country’s growth rate would need
to be around 7 per cent to maintain living standards for its
rapidly-growing population.
Questions
1 Analyse two effects on businesses in Pakistan of the
country’s rapid growth in population. [8]
2 ‘The expected fall in the economic growth rate will
have differing impacts on the country’s businesses.’
Evaluate this view. [12]
Short-term responses may be all that are required if
governments are successful in eradicating the more extreme
effects of the business cycle.
Inflation
Inflation can be defined as a persistent rise in the price
level and the associated fall in the value of money. For
many businesses, a low rate of inflation is not a problem.
As long as wages are rising at about the same rate or
higher, a low constant rate of price increase simply serves
to help maintain demand. Inflation only becomes a major
problem for businesses when it is high, rising rapidly or
(worst of all) is doing both together.
Inflation in the UK, and in many industrialised nations
throughout the world, has been at historically low rates
over the last 15 years or so. The UK’s rate of inflation
was 0.7 per cent (as measured by the CPI – see below) in
September 2020, and is forecast to remain around 2 per cent
until 2023.
How is inflation measured?
The UK government measures the rate of inflation by use of
the Consumer Price Index (CPI). The CPI was introduced in
December 2003 and measures the average monthly change
in the prices of goods and services purchased by households
in the UK. The government will use this to set targets for
inflation in the future. The CPI is calculated using more
than 700 separate goods and services for which price
changes are measured throughout the country.
The causes of inflation
There are a number of factors that may cause inflation.
Economists tend to classify the causes of inflation as
demand-pull or cost-push factors. The cause of inflation
can be an important factor for businesses as it provides
some indication of likely future government policies to
control inflation.
Demand-pull inflation
Demand-pull inflation occurs when the demand for the
country’s goods and services exceeds its ability to supply
these products. As a consequence, prices rise generally as
a means of restricting demand to the available supply. The
underlying cause of this might be the government allowing
firms and businesses to have too much money to spend,
perhaps as a consequence of cutting taxes or lowering
interest rates.
Cost-push inflation
Cost-push inflation occurs when firms face increasing costs
due to factors such as rising wages or increasing costs of
raw materials and components. This type of inflation can
arise from a number of sources.
GLOSSARY TERMS
The Consumer Price Index (CPI) measures the rate of
inflation based on the changes in prices of a basket of goods
and services.
Demand-pull inflation occurs when the demand for the
country’s goods and services exceeds its ability to supply
these products.
4
CPI
–2
2010 2012 2014
Year
Source: https://tradingeconomics.com/united-kingdom/inflation-cpi
▲ Figure 6.12 Inflation in the UK 2010–20
» Wage rises If trade unions and employees are successful
in negotiating pay increases significantly above the
rate of inflation, then further price rises might be the
result. This becomes more likely if productivity is not
6.1.2
increasing, allowing businesses to offset some of the
increased wage costs against additional production.
However, labour market conditions can influence the
rate of wage increases and, therefore, inflation. For
example, wages in Spain fell by about 20 per cent
between July 2011 and January 2014 as jobs were scarce
6.1.2.4 Macroeconomic objectives of governments and their impact on business activity
and the rate of unemployment rose above 20 per cent.
This contributed to the country’s very low inflation rate.
» Imported inflation One of the hidden causes of
inflation is rises in import prices. The UK and Belgium
are susceptible to this type of inflation as they are
‘open’ economies, importing large quantities of raw
materials, components and finished goods. Import
prices rise when the exchange rate is falling and more
of the domestic currency is required to purchase a given
amount of a foreign currency. Although exporters might
complain about rising exchange rates, they do help to
control inflation.
Cost-push inflation happens when firms face increasing
costs due to rising wages or increasing costs of raw
materials and components.
2016 2018 2020
239
 CASE STUDY
6.1.2
Comparing the rates of inflation in Uruguay and Indonesia
The annual inflation rate in Uruguay increased to 10.86 per
cent in April 2020 from 8.32 per cent in the previous
month. It was the highest inflation rate since June 2016, as
prices rose further for food and non-alcoholic products,
and housing. Uruguay’s exports declined by 40 per cent
between April 2019 and March 2020.
A LEVEL 6.1.2 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: ECONOMIC
Indonesia’s annual inflation rate declined to 2.67 per cent
in April 2020, the lowest since March 2019 and below
market expectations of 2.77 per cent. Prices rose more
slowly for housing and utilities, food, drinks, and food and
restaurant services. On a monthly basis, consumer prices
rose 0.08 per cent in April, the least since October 2019.

10

8
CPI

2
2010 2012 2014 2016 2018 2020
Year
Source: https://tradingeconomics.com/uruguay/inflation-cpi
▲ Figure 6.13 Inflation in Uruguay 2010–20

10

8
CPI

2
2010 2012 2014 2016 2018 2020
Year
Source: https://tradingeconomics.com/indonesia/inflation-cpi
▲ Figure 6.14 Inflation in Indonesia 2010–20
Questions
1 Analyse one likely effect of Uruguay’s high rate of 2 ‘Indonesian businesses have operated in a better
inflation on its businesses. [4] macroeconomic environment than those in
Uruguay.’ Evaluate this view. [12]

240
The impact of inflation on business
Inflation can have a number of effects on businesses.
» Many businesses may suffer falling sales in a period
of inflation. Consumers might be expected to spend
more during inflationary periods, as they would not
wish to hold an asset that is falling in value. However,
research shows that people save more (perhaps due to
uncertainty) and sales for many businesses fall.
» It can be difficult to maintain competitiveness (and
especially international competitiveness) during bouts
of inflation. Rising wages and raw material costs may
force firms to raise prices or accept lower profit margins.
Firms operating in countries with lower rates of inflation
may gain the edge in terms of price competitiveness
under such circumstances.
Inflation can offer some benefits to businesses, however.
Some analysts suggest that low and stable rates of
inflation may be beneficial. A steady rise in profits can
create favourable expectations and encourage investment
by businesses. Inflation can also encourage long-term
borrowing and investment by businesses, as the value of
their repayments (in real terms) declines over time.
Unemployment
Unemployment remains an important issue in most
countries. It is important because it represents a waste of
resources if labour is unused: if all available workers were
used, the country concerned would be able to produce more
and its citizens would enjoy a higher standard of living. The
social effects of high and prolonged rates of unemployment
can be devastating – poor health and crime are just two
factors associated with unemployment and poverty.
GLOSSARY TERM
Structural unemployment occurs due to fundamental
changes in the economy whereby some industries reach
the end of their lives.
8
Unemployment rate
3
2010 2012 2014
Year
Note: The unemployment rate is the percentage of the workforce who do not have a job but are looking for one.
Source: https://tradingeconomics.com/united-kingdom/unemployment-rate
▲ Figure 6.15 UK unemployment
Types of unemployment
People can be unemployed for a number of reasons.
Governments find it useful to distinguish between the 6.1.2
various types of unemployment, as each type requires
a different remedy. Although many different types of
unemployment exist, we shall focus on three main types.
1 Structural unemployment
Economies continually change: some industries die and
others emerge to replace them. Structural unemployment
6.1.2.4 Macroeconomic objectives of governments and their impact on business activity
occurs due to fundamental changes in the economy whereby
some industries reach the end of their lives. Structural
unemployment occurs for a number of reasons:
– the adoption of new methods of production
– significant and permanent changes in demand
– increasing competition from overseas
– rising income levels, meaning demand for some
products declines.
But structural change in the economy also offers
opportunities to businesses. Rising incomes and
technological developments have led to the development
of the mobile phone industry. This industry employs a large
number of people in manufacturing the product, supplying
networks and in retail outlets.
Structural unemployment is a difficult problem for
governments to solve. Because large numbers of employees
may no longer have the skills that employers require,
training is an important part of any solution. Other
approaches include encouraging foreign producers to
establish themselves in the country to provide employment
for those with skills not needed by domestic businesses.
The UK has been particularly successful in attracting motor-
vehicle producers from across the world.
2016 2018 2020
241
 Competition
from overseas
6.1.2 New methods
of production
Changing patterns
of demand
Causes
Structural
unemployment
Effects
A LEVEL 6.1.2 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: ECONOMIC
Certain skills no New opportunities
longer needed
Localised
unemployment
▲ Figure 6.16 Causes and effects of structural
unemployment
2 Cyclical unemployment
Cyclical unemployment arises from the operation of the
business cycle – a topic we considered in detail earlier in
this chapter. The boom stage of a business cycle will see
this type of unemployment minimised as firms increase
their production levels. At this stage of the business cycle,
those who have been unemployed for some time (and with
relatively few skills) may find work.
At the other extreme, much of the unemployment
experienced during a slump will be cyclical. The effects
of cyclical unemployment can be considerable as
unemployment increases substantially in the move into
recession. Some businesses seek to protect themselves
against cyclical unemployment by the introduction of
profit-related pay. Such schemes allow pay to fall during
a recession along with profits, reducing the need to make
workers redundant.
3 Frictional unemployment
People moving between jobs cause frictional
unemployment. If a person leaves one job, they may not
be able to move into a new position immediately. While
they are searching for new employment, they are classified
as frictionally unemployed. The government providing
improved information on job vacancies available may reduce
the level of frictional unemployment. A healthy economy
will have some amount of frictional unemployment as
people move between jobs.
GLOSSARY TERMS
Cyclical unemployment is caused by the operation of the
business cycle, rising in slumps and falling in booms.
Frictional unemployment exists because people may
be temporarily out of work between leaving one job and
starting another.
Inventories are the raw materials and other items
necessary for production to take place. They also include
finished products that have not yet been sold.
Migration is the movement of people between countries or
regions with the intention of settling in the new location.
242
STUDY TIP
It is important to relate the impact of unemployment (or
changes in other economic factors) to the precise type
of business under consideration. Some businesses rely
heavily on labour as a key element of production – this is
more likely to be true of businesses that supply services.
Hence, a change in the level of unemployment will have a
greater impact on this type of business.
The impact on businesses of changing
unemployment levels
Rises in unemployment can have serious implications for
businesses, though the precise impact and likely responses
of firms will depend upon their circumstances and the type
of unemployment.
Cyclical unemployment might result in businesses suffering
from falling sales. In the short term, firms may be able to
add any surplus production to inventories. Alternatively,
businesses may seek new markets, perhaps by selling
overseas. Not all businesses will be equally affected
by changes in unemployment levels. Businesses selling
essential products may be relatively unaffected by cyclical
unemployment, while suppliers of luxury products could
suffer substantial reductions in sales.
Structural unemployment can have a significant effect
on businesses because it is frequently highly localised
and often very persistent. For example, high levels of
unemployment suffered by former coal-mining communities
would have considerable implications for most businesses
in the locality. Unemployment brought about by the
decline of an industry also has an impact upon associated
industries. For example, falling production in the UK’s
shipbuilding industry contributed to the decline in the
country’s steel industry.
If there is a need to reduce output then rationalisation
and redundancy might follow and factories and offices
may be closed. Research and development plans may be
abandoned or postponed as firms seek to reduce their
costs to match their (reduced) revenues. A predicted fall in
the level of demand may encourage the firm to diversify,
possibly into foreign markets. Businesses may consider
mergers with other firms to help reduce costs or to
broaden product ranges.
Periods of low unemployment cause different problems
for businesses and provoke different responses. Falling
unemployment and accompanying skill shortages create
problems that take time to solve. Businesses look to the
government to assist through the provision of state training
schemes and the development of relevant vocational courses
in schools and colleges. In the UK, governments have
attempted to support industry in these ways.
However, businesses can take action.
» Skill shortages encourage the development of capital-
intensive methods of production in manufacturing and
service industries. Using technology to replace labour
can boost productivity, thereby enhancing international
competitiveness.
» Businesses may relocate to take advantage of more
plentiful and cheaper sources of skilled labour. However,
in the case of the UK, this may require location outside
Europe as most of the EU is experiencing similar skill
shortages.
CASE STUDY
Global migration
20% and over
10–19%
5–9%
1–4%
<1%
No data
Source: United Nations Report on International Migration, 2019 (page 13)
▲ Figure 6.17 International migrants as a percentage of the total population, 2019
Migration is the movement of people between different
countries. Over the last 20 years, many European and
North American countries have experienced significant
inflows of migrants from parts of the Middle East, Africa
and Asia. According to the UN, ‘in 2019, more than half
of all international migrants worldwide lived in Europe
and Northern America, with roughly 82 million residing
in Europe and nearly 59 million in Northern America’.
Although some people have left countries in Europe and
America, the inflows have generally been much larger,
creating a positive net inflow of migrants. Figure 6.17
shows the percentage of the population that are migrants
in most countries.
The impact of migration depends upon a number of
factors and not just the size of the net migration flow.
If migrants possess suitable skills and are primarily of
working age, they offer substantial benefits to businesses
» Businesses may invest in training schemes to develop
the required skills in their employees. This may entail
giving relatively junior or unskilled employees additional
skills to enable them to carry out a wider range of
6.1.2
activities. This can be a risky approach, however, as
unscrupulous competitors may poach skilled employees
once training is completed.
The skills shortage creates difficulties for many businesses
and opportunities for others. Recruitment agencies and
firms providing training for other businesses may enjoy
6.1.2.4 Macroeconomic objectives of governments and their impact on business activity
increasing demands for their services during a period of
skill shortages.
in countries such as the UK and Australia. They can
assist in overcoming skill shortages and reduce the
expenditure that firms must make on training. In addition,
the increased supply of people into the labour market may
help to prevent wages from rising. This is especially likely
if migrants are willing to work for lower wage rates.
Source: United Nations Report on International Migration 2019
(page 6), www.un.org/en/development/desa/
population/migration/publications/migrationreport/
docs/InternationalMigration2019_Report.pdf
Questions
1 Analyse two benefits that Australian businesses
might receive from a net inflow of migrants. [8]
2 Evaluate whether a net inflow of migrants affects
the competitiveness of businesses in the receiving
nation. [12]
243

6.1.2
A LEVEL 6.1.2 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: ECONOMIC
The economic environment and
business strategy
A business’ strategy is simply the long-term plans through
which it seeks to attain its corporate objectives – that
is, the objectives of the whole business. For example, a
business may have growth as a major corporate objective
and will develop plans to achieve the desired rate of
growth. These plans may include increasing innovation as
part of the development of new products, entering new
markets or pursuing a policy of takeovers and mergers.
Figure 6.18 summarises some of the major economic
variables that might impact upon businesses’ strategic
planning and decision-making. The diagram also emphasises
the interrelationships that exist between the elements that
make up the economic environment for businesses.

Unemployment State of labour market

Business cycle
• Type (e.g. frictional) • Skill surpluses
• Boom
Unemployment • Location • Skill shortages
• Slump
varies according • Skills in surplus • Migration flows
to stage of the
business cycle

Business strategy
e.g.
• Growth
Inflationary pressures • Rationalisation
more likely in a boom • Market dominance
• Diversification
• Technological
leadership

Inflation and Close links

Inflation interest rates between
Exchange rates
tend to rise and Interest rates interest and
• Rate of price increase exchange rates • Level and trend
fall together • Levels, relative to
• Trend in price change other nations • Affect all firms
• Rate relative to that but especially those
• Trend: rising/falling
in other countries trading overseas

▲ Figure 6.18 Business strategy and the economic environment

6.1.2.5–7 Government
macroeconomic policies and their
impact on businesses
Governments operate a number of different policies with the
aim of providing the best possible economic environment
for businesses. This entails adjusting the level of activity
in the economy to avoid the excesses of booms and slumps.
The government’s economic policies can be divided into the
following categories:
1 Monetary policy Using this policy, the government (or
the central bank, such as the Bank of England, acting
on its behalf) manipulates the amount of money and/
or interest rates within the economy in order to achieve
the desired level of economic activity.
2 Exchange rate policy This is often regarded as a part
of monetary policy and involves the manipulation of
the value of a country’s currency. This can affect the
economy by changing the prices of exports and imports
and, thereby, the price competitiveness of the country’s
businesses.

244
3 Fiscal policy This refers to the government’s use
of taxation and public expenditure to manage the
economy. By adjusting the levels of taxation and
government expenditure, the government can alter the
level of activity within the economy.
4 Supply-side policies These are designed to improve
the free operation of markets and, therefore, the total
amount that is produced (or supplied) by the economy.
Privatisation is one type of supply-side policy, along
with limiting trade union power and providing training
for unemployed workers.
GLOSSARY TERMS
Monetary policy is controlling the amount of money and/
or interest rates within the economy in order to achieve
the desired level of economic activity.
Exchange rate policy is the deliberate adjustment of the
value of a country’s currency to achieve desired changes in
the prices of imports and exports.
Fiscal policy is the use of taxation and public expenditure
to manage the level of activity in an economy.
▼ Table 6.6 Changes in interest rates – objectives, impact and business decisions
Rising interest rates
The likely objectives of increasing interest rates include:
• reducing the level of consumer spending
• limiting inflationary pressure in the economy
• slowing the level of economic growth (as measured by GDP)
• avoiding increasing imports creating a deficit on the
balance of payments.
(In general, higher interest rates will assist in dampening
down an economic boom.)
The likely impact on businesses of increasing interest rates
include:
• Many businesses may experience falling sales as consumers
increase savings.
• Demand for products purchased on credit may decline
significantly.
• The cost of borrowing, whether short- or long-term, is likely
to increase for businesses, possibly cutting profit margins.
• Increased value of the currency increases the prices of
exports while reducing import prices.
Examples of how businesses’ decisions may be affected by
increasing interest rates include:
• Businesses may cancel or defer investment plans as they
may be too costly with higher interest rates.
• Firms reduce levels of inventories as they seek to cut
borrowing costs.
• New marketing campaigns might be introduced, possibly
based on low prices, to attract consumers.
• Some businesses may seek to borrow money from overseas if
interest rates are significantly lower in foreign countries.
Monetary policy
This type of economic policy involves adjusting the amount
of money in circulation and, hence, the level of spending 6.1.2
and economic activity. Monetary policy can make use of one
or more of the following:
» adjusting interest rates
» controlling the money supply
» manipulating the exchange rate (which we will consider
separately).
6.1.2.5–7 Government macroeconomic policies and their impact on businesses
Although at times all three techniques have been used, more
recently governments have tended to rely upon altering
interest rates to manage the economy. Since 1997, in the
UK, the Monetary Policy Committee of the Bank of England
has had responsibility for setting interest rates. Giving this
power to central banks is common in other countries, too.
For example, the Reserve Bank of India performs a similar
role. In the UK, the Monetary Policy Committee sets interest
rates monthly with the aim of achieving the government’s
target for inflation while attaining long-term growth in the
economy. Table 6.6 highlights the aims that may lie behind
authorities altering interest rates and, importantly, the
implications for individuals and businesses.
Falling interest rates
Reductions in interest rates may be introduced with the
following objectives in mind:
• reducing levels of unemployment
• stimulating the level of production in the economy
• promoting exports sales by reducing the exchange value of
the currency
• increasing rates of economic growth in the economy.
(Reducing interest rates can assist an economy in recovering
from a slump.)
The impact on businesses of falling interest rates include:
• Demand and sales are likely to increase, especially for
products bought on credit.
• Production is likely to be stimulated, increasing
employment.
• Export sales of price-sensitive products may increase while
imports become less competitive.
• Businesses may undertake increased investment, promoting
growth in industries such as construction.
Examples of how businesses’ decisions may be affected by
falling interest rates include:
• Businesses may decide to increase investment in new
factories and new products as borrowing is cheap and
consumer spending may be forecast to rise.
• Firms may invest in advertising campaigns to attract new
customers at a time of cheap borrowing.
• Businesses may offer attractive ‘buy now, pay later’ deals to
attract customers as they can afford to increase borrowing
to finance this.
• Some businesses may seek to use cheap finance to finance
takeovers of rivals or suppliers.
245
 Broadly speaking, rises in interest rates depress the level of
economic activity and reductions promote an expansion of
6.1.2 economic activity.
Interest rates are the price of borrowed money. Although
the Bank of England sets the base rate, many other interest
rates operate in the UK. The precise rate of interest charged
on a loan depends on several factors, including the time
period of the loan and the degree of risk attached to it.
In the UK, expenditure is particularly sensitive to changes
in interest rates. One prime reason for this is mortgage
A LEVEL 6.1.2 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: ECONOMIC
interest payments. Millions of UK consumers have mortgages,
which are large loans taken out to purchase houses. A rise in
interest rates increases the payments made on mortgages,
leaving less money available for other types of expenditure.
Similarly, a cut in rates reduces mortgage payments, freeing
money for other forms of expenditure.
The impact on businesses and their
decisions of changes in interest rates
The impact of rising interest rates will depend upon the
size of the change as well as the initial rate. A small
increase at a relatively high level of rates will have little
impact, while a larger increase from a low base rate will
have a significant impact, prompting businesses to take
significant decisions.
CASE STUDY
Consumer debt worries in Russia
The monetary authorities in Russia have been concerned
by a sharp increase in unsecured borrowing by the
country’s consumers. Any borrowing that is unsecured
is not guaranteed by collateral such as property or other
saleable assets. Credit cards and some bank loans
are examples of unsecured borrowing. In 2019, around
5 million Russians were using more than 50 per cent of
their incomes to repay unsecured loans. Any financial
institution offering new loans of more than 10 000 roubles
($154) will be subject to the new rules.
Before being able to offer unsecured loans, banks
in Russia will be required to assess the extent of a
consumer’s previous borrowing and the proportion of
However, it is not only the direct effects of altering interest
rates that affect businesses. The use of interest rate
policy by the authorities can have a profound impact upon
the general economic environment in which businesses
operate. The Reserve Bank of India changes interest rates
to assist the Indian government in achieving its economic
objectives. This means that altering rates affects the level
246
Not all businesses are affected equally. We can identify
several categories of businesses that are particularly
susceptible to changes in interest rates:
» Small firms are often affected greatly by changes in
interest rates, as they have smaller financial reserves
and a relatively greater need for borrowing. The Bank of
England estimates that every 1 per cent rise in interest
rates costs the UK’s 1.5 million small firms an extra
£200 million in interest rate payments. Significant rises
in interest rates can lead to substantial increases in
bankruptcies or insolvencies among small firms.
» Even larger firms with high levels of borrowing can be
affected by alterations in interest rates. For example,
a rise in rates can lead to a hefty increase in interest
payments, forcing firms to reduce costs elsewhere or to
pass on the extra expenses in the form of higher prices
– if this is possible. Alternatively, a cut in interest rates
offers a substantial reduction in expenses to such firms,
improving their competitiveness.
» Firms trading overseas are affected by alterations in
interest rates. Rising interest rates tend to lead to an
increase in the country’s exchange rate. This occurs
because individuals and businesses overseas purchase,
say, rupees to invest in Indian financial institutions to
benefit from higher interest rates. Rising demand for a
currency tends to increase its price – or its exchange
rate. A fall in interest rates would have the opposite
effect.
income already used to repay existing debts. If banks do
make any ‘risky’ unsecured loans, they will be required to
hold increased reserves to cope with any consumers who
do not repay their debts.
Forecasts by the Russian Central Bank suggest that growth
rate of consumer borrowing will decline in the last three
months of 2019 to about 10 per cent, from 22 per cent in 2018.
Questions
1 Evaluate whether or not the effects of a continued
rise in unsecured borrowing will be entirely bad for
businesses in Russia. [12]
of unemployment, inflation and growth existing in the
economy. Changes in interest rates also change business
managers’ expectations of these key economic variables,
affecting their day-to-day and strategic decisions.
Table 6.7 illustrates the relationship that exists between
the level of interest rates and key economic variables such
as economic growth and unemployment.
▼ Table 6.7 Interest rates and other economic variables
Other economic variables
Unemployment
Rising interest rates
Unemployment increases as levels of
production decline
Inflation Falling demand and output reduces
inflationary pressure
Economic growth Will slow as businesses cut output and
investment
Exchange rates Exchange value of currency is likely to rise
Quantitative easing (QE)
Since March 2009, interest rates in the UK have been held at
very low levels by the Bank of England. In March 2020, the
rate was cut to 0.1 per cent, the lowest figure ever, as part
of the government’s response to the Coronavirus (COVID-19)
crisis. Many other countries have very low rates of interest
at the time of writing. Rates in Hungary, Hong Kong, South
Korea, the USA and New Zealand are all below 1 per cent.
Such low interest rates limit the flexibility of authorities
responsible for monetary policy. There is no real possibility
to lower rates further to expand production and to help
the economy achieve higher rates of economic growth.
When interest rates can go no lower, a central bank’s only
monetary policy option is to pump money into the economy
directly. That is quantitative easing (QE).
The way the central bank does this is by buying assets –
usually financial assets, such as government and corporate
bonds – using money it has simply created. The institutions
selling those assets (either commercial banks or other
financial businesses such as insurance companies) will then
have ‘new’ money in their accounts, which then boosts the
money supply. The hope is that this money is subsequently
used to purchase goods and services and to boost output
and growth. In 2020, the UK government announced a new
programme of quantitative easing with a total value of
£200 billion to help to stimulate the economy as part of its
response to the Coronavirus crisis. Quantitative easing has
also been used by central banks in Japan, Sweden, the USA
and Brazil.
Business decisions and changes in
monetary policy
Businesses can be affected significantly by changes in
monetary policy, both the use of quantitative easing and
changes in interest rates. Such changes may prompt a range
of decisions by businesses, depending on the scale and
expected duration of any changes in monetary policy. We
consider a small sample below.
» Borrowing Changes in interest rates directly affect the
cost of borrowing; quantitative easing can affect them
indirectly. Businesses will be likely to adjust the amount
they borrow and invest in the light of changes in
Falling interest rates
Unemployment decreases as the level of
6.1.2
economic activity rises
Increasing output and spending causes
prices to rise, fuelling inflation
Is stimulated by cheaper loans and rising
business investment
6.1.2.5–7 Government macroeconomic policies and their impact on businesses
Exchange value of currency generally falls
interest rates. For example, a period of very low interest
rates (as is the case in North America and much of
Europe at the time of writing) may encourage decisions
on investment as any funds needed will be relatively
cheap, making it likely the profits on a project will
be higher.
» Prices Reductions in interest rates may give a business
more flexibility to raise prices as consumers will be more
able to afford loans to buy products. A rise in rates
might put pressure on businesses to reduce prices for
some products – especially those (such as cars) normally
bought using loans.
» Product development Falling interest rates might
encourage businesses to invest in developing new
products as the cost of doing so may be reduced.
Alternatively, rising rates may persuade businesses to
adapt existing products to reduce production costs and
boost price competitiveness.
» Cutting costs Rising rates may provoke bouts of cost-
cutting as businesses seek to reduce the debts on which
they have to pay interest. This can lead to decisions
affecting many parts of a business including the sale
of assets, reductions in the size of the workforce and
ceasing production of less successful products.
GLOSSARY TERMS
Debt is an amount of money that has been borrowed by a
business but not yet repaid.
An exchange rate is the price of one currency expressed
in terms of another. For example, the US dollar might be
worth 0.78 euros.
Exchange rates
An exchange rate is simply the price of one currency
expressed in terms of another. Thus, at a particular time,
the Chinese yuan may be worth 3500 Vietnamese dong or
4.9 Thai baht.
London is one of the premier international centres
for buying and selling foreign currencies – each day
transactions total billions of pounds. Exchange rates
between most currencies vary regularly according to the
balance of supply and demand for each individual currency.
247

6.1.2
A LEVEL 6.1.2 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: ECONOMIC
The effects of exchange rate changes
Exchange rates can change significantly over time. A rise in HANDLING DATA
the value of a currency is an appreciation; a decline in its
In May 2020, an American company exported cars
value is termed a depreciation.
to Uruguay at an average price of $32 000 per car.
In October 2018, the American dollar exchanged for 32.49 Assuming no other changes, how much would an
Uruguayan pesos ($U). By May 2020, the exchange rate was average car sell for in Uruguay?
$1 = $U44.21. This meant that the value of the Uruguayan
peso had depreciated by just over 36 per cent over the Changes in the value of currencies affect the prices of
period. Alternatively, the value of the American dollar had exports and imports, as shown in Table 6.8.
increased (or appreciated) by the same amount.

▼ Table 6.8 The effects of changes in the value of the Uruguayan peso

The exchange rate of Uruguayan Prices of Uruguayan exports overseas Prices of imported goods in Uruguay
pesos (in foreign currencies) (in pesos)
Appreciates (rises) Increase Fall
Depreciates (falls) Fall Increase

Using the information in Table 6.8, we can see that the fall
in the value of the Uruguayan peso against the American
dollar between October 2018 and May 2020 would have had
the following effects (assuming no other changes):
» Prices of Uruguayan exports to the United States of
America (for example, wool from its Corriedale sheep)
would have fallen by approximately 36 per cent. Sales
would be likely to rise as a consequence, and Uruguayan
exporters would receive the same amount in pesos per
kilogram of wool.
» American products (for example, software for computers)
imported by Uruguay would have been up to 36 per cent
more expensive. However, the price the Americans received
in dollars would not have changed. It is likely, however,
that because prices were higher in Uruguay, American
companies would sell smaller quantities of their products.
Small changes in the exchange rates of most countries occur
all the time as demand for the currency and supplies of it
alter. A series of slight rises and falls over a period of time
is not necessarily a major problem for industry. Of more
concern is a sustained rise or fall in the exchange rate,
or a sudden and substantial change in the exchange rate.
Governments often seek to control fluctuations in exchange
rates (as we shall see later this chapter), as exchange rate
changes can create uncertainty for a number of reasons.
▼ Table 6.9 Changes in exchange rates
» If firms agree deals priced in foreign currencies, they
may receive more or less revenue from a particular
transaction than expected if the exchange rate alters in
the intervening period. Thus, a deal to sell clothes to
France may give Bangladeshi manufacturers less revenue
than anticipated if the contract is agreed in terms of
euros and the Bangladeshi taka then rises in value
against the euro. In these circumstances, the quantity of
euros stated in the contract will convert into a smaller
number of taka, causing a shortfall for the exporter.
» Changing exchange rates can affect prices and sales
in overseas markets, even if the exporter avoids direct
exchange risk by insisting on payment in domestic
currency. For example, a London-based clothes
designer may sell clothes overseas but stipulate that
they are paid in pounds sterling. A rise in the value of
the pound may mean that foreign retailers are forced
to increase the prices of the clothes to maintain profit
margins. As a consequence, sales may be lower than
expected, giving the London-based design company
less revenue than forecast.
» Competitors may respond in unexpected ways to exchange
rate changes. Foreign firms may reduce prices to offset
the effects of an exchange rate change, putting rivals
under pressure to do the same or lose market share.

How might Zimbabwean firms respond to a
rising value of the Zimbabwean dollar?
Exporters • Allow prices to rise in foreign markets reducing
probable sales. Remember, exporters receive
the same price in dollars for each overseas sale
but will sell less in this situation.
• Leave prices unchanged in overseas markets.
Sales should be unchanged but the exporter
will receive fewer dollars from each sale.
Neither of these options is attractive to
exporters – a rising exchange rate is bad news.
How might Zimbabwean firms respond to a
falling value of the Zimbabwean dollar?
• Exporters could allow prices to fall in overseas
markets as a result of the exchange rate change.
They will receive the same amount in dollars from
each sale but should achieve higher sales.
• Increase their prices to maintain price levels
in terms of the foreign currency. Sales should
remain constant (depending on competitors’
actions) and revenue should rise in dollars as
a result.

248
 How might Zimbabwean firms respond to a
rising value of the Zimbabwean dollar?
Domestic producers • Reduce prices to compete with cheaper
imports.
• Enjoy the benefits of cheaper imports of
materials and components.
• Emphasise other elements in the marketing
mix; for example, the quality of the product.
STUDY TIP
Remember that products are not sold on the basis of
price alone. When considering the likely consequences
of a change in exchange rates, it is important to note that
factors such as quality, reputation, after-sales service
and meeting delivery dates are important influences on
buyers’ decisions.
GLOSSARY TERMS
A currency appreciates when its value rises against
another currency or currencies.
A currency depreciates when its value declines against
another currency or currencies.
The impact of changes in exchange rates on
businesses
Fluctuations in exchange rates create a great deal of
uncertainty for businesses trading internationally. When
exchange rates are volatile, businesses become uncertain
about earnings from overseas trade. This adds to the risk
businesses incur as part of their trading activities.
Firms like to operate in a relatively risk-free environment
and to reduce uncertainty. The undesirable consequences of
exchange rate changes can be reduced through the use of
techniques such as forward foreign currency markets. This
sets a guaranteed exchange rate at some future date (when
transactions are completed), meaning that the amount
received from overseas trading is more certain. However,
fixing an exchange rate in this way does not guarantee a
particular level of sales. Furthermore, the bank arranging
this service may require a fee.
Exchange rate changes are more of a problem in
markets where fierce price competition occurs. In these
circumstances, demand is more likely to be price elastic
and businesses are under pressure to respond quickly to any
change in exchange rates.
Businesses may respond to the pressures of exchange
rate changes by seeking to create productive capacity in
overseas markets to avoid the effects of changing currency
values. A number of foreign motor manufacturers located in
the UK have revealed that they are considering relocating in
the euro zone in Europe to avoid the difficulties imposed by
fluctuations in the value of the pound against the euro. In
How might Zimbabwean firms respond to a
falling value of the Zimbabwean dollar?
• Enjoy increased sales as a result of rising prices 6.1.2
of competitors’ imported products, assuming
foreign businesses do not hold prices down.
• Increase prices (to some extent) to enjoy
increased revenues from each sale.
• Beware the increased cost of imported raw
materials and components.
6.1.2.5–7 Government macroeconomic policies and their impact on businesses
particular, Toyota has argued strongly for the UK to adopt
the euro to eliminate exchange rate risk.
An alternative approach is to require suppliers to price
their products in a different currency – this is usually
the currency in which it sells its products. As a result,
fluctuations in the exchange rate will have less impact on
a business as it pays suppliers in the same currency that it
receives from its customers.
Exchange rate policy
Exchange rate policy is normally implemented by the
authorities responsible for a country’s monetary policy.
Many economists believe that exchange rate policy is a
part of monetary policy. Exchange rate policy involves the
country’s authorities affecting the value of its currency
against those of other countries. This can be done in
several ways:
» changing the country’s interest rates, as we saw earlier
» buying or selling large quantities of a currency on the
foreign exchange market to alter its value
» not allowing the currency to have a ‘free’ value
determined by the forces of supply and demand but
imposing a fixed exchange rate. The government can
decide at any time to change its fixed exchange rate,
though this approach does bring other problems.
The impact of exchange rate policy
Exchange rate policies have an effect on businesses because
changes affect the prices of imports and exports. We saw
earlier that a fall in the exchange rate makes a country’s
exports cheaper overseas, while making imports from
foreign countries more expensive. In effect, a fall in the
exchange rate can increase the price competitiveness of a
business. Its products can be sold more cheaply overseas
and products sold in its ‘home’ market by foreign producers
will become more expensive. The opposite is true, of course,
for a rise in the exchange rate, which will increase the price
of exports from the country concerned while simultaneously
making imports cheaper.
The impact of exchange rate policies on businesses may
vary according to a number of factors, including:
» how important price is in consumers’ buying decisions.
Demand for some products is highly sensitive to price
changes; for example, some foods and fuels. Businesses
operating in price-sensitive markets will be strongly
affected by exchange rate policy
» the extent to which the business is engaged in overseas
trade. Some businesses buy raw materials, components
249
 or finished goods from overseas, others sell products
overseas, and some do both. Businesses that engage
6.1.2 heavily in importing and exporting will be more exposed
to changes in exchange rate policy.
Business decisions and changes
in exchange rate policy
Businesses may not respond to changes in exchange rates,
especially if they are relatively minor or not expected to be
long-term. However, businesses do have a number of ways
A LEVEL 6.1.2 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: ECONOMIC
expenditure and the amount raised in taxation in any given
year. In the UK, the fiscal year runs from 6 April to 5 April
the following year; in many other countries it runs from
1 January to 31 December.
The balance between taxation and government expenditure
in the UK is determined annually when the Chancellor of the
Exchequer announces the annual budget. The government
can operate two broad types of fiscal policy:
1 Expansionary fiscal policy This entails cutting taxation
and/or increasing government expenditure on items

such as health, education, social services, defence and

in which they can respond to exchange rate changes when
necessary.
» Lower prices This can be effective in offsetting the
price advantages that overseas competitors might have
following a change in exchange rates due to policy
changes. However, one consequence is likely to be a fall
in profit margins, unless the business can reduce its
costs of production.
» Adjust quality or the product itself The business may
reduce the quality of its products, possibly by using
cheaper raw materials, or its size if it is a food product,
for example.
» Produce overseas Some multinational businesses can
switch production to factories overseas to avoid the
effects of adverse changes in exchange rate policy. This
is not an option for most businesses.
Fiscal policy
Fiscal policy is the use of government expenditure and
taxation as a means of controlling the level of activity
within the economy. In particular, a government’s fiscal
policy is the relationship between the level of government
transport. The effect will be to increase the amount the
government borrows to fund its expenditure (known as
the public sector net cash requirement or PSNCR) or to
reduce the surplus held in the government’s coffers at
the end of the fiscal year.
2 Contractionary fiscal policy This is brought about by
reducing government expenditure or increasing taxation,
or by both policies simultaneously. The effect is to cut
the government’s borrowing or to reduce the deficit on
its budget for the fiscal year.
Figure 6.19 summarises the operation of fiscal policy. Fiscal
policy can help to stabilise the economy (avoiding the worst
effects of the business cycle) through the operation of the
‘automatic stabilisers’. For example, lower unemployment
when the level of economic activity is high means temporarily
lower social security spending and higher income tax
receipts. Higher company profits generate higher tax receipts,
and higher spending by consumers yields higher receipts
from indirect taxes. These factors together will have a
contractionary effect, dampening an economic boom.

Results in:
Achieved by:
Expansionary fiscal policy: Increased output and spending,
Cutting rates of taxation
To increase the level less unemployment but
and/or increasing
of economic activity possible increase in inflationary
government expenditure
pressure and more imports

Fiscal policy

Results in:
Achieved by:
Contractionary fiscal policy: Lowered output, spending and
Increasing rates of taxation
To reduce the level of employment; may curb
and/or cutting government
economic activity inflationary pressure and
expenditure
spending on imports

▲ Figure 6.19 The operation of fiscal policy

The impact of fiscal policy on businesses Although the overall effect may be predicted, the
implications for individual businesses will vary according
Tax and expenditure policies can have immediate effects on
to the type of product supplied. Firms supplying luxury
the level of economic activity, although the precise effects
goods (long-haul foreign holidays, for example) might be
will depend upon the types of tax altered and the nature of
significantly affected by a change in income tax rates,
government expenditure.
especially for those earning higher incomes, while those
» Direct taxes These are taxes on income and profits
selling basic foodstuffs may be relatively unaffected.
and, in the UK, include income tax and corporation
tax (levied on company profits). Direct taxes take a
» Indirect taxes VAT (value added tax) is the major tax on
spending in the UK and other EU countries. It and other
larger amount from individuals earning high salaries
taxes on spending are classified as indirect. Changes in
and companies announcing handsome profits. The
this type of taxation can have a rapid effect on the level
government can forecast with some accuracy the effects
of economic activity, although its effects are difficult
arising from an increase (or reduction) in income tax.
to predict. An increase in VAT or other indirect taxes
250
 will lower consumer spending, reducing demand for
goods and services and, eventually, lowering the level
of economic activity. For example, Japan increased its
main indirect tax rate from 8 to 10 per cent in October
2019 and this has had a significant impact on consumer
spending. However, the extent of the fall in demand
will depend upon the price elasticity of demand for the
goods in question. Consumers will continue to purchase
essentials such as fuel and food, although demand
for products associated with home improvements, for
example, may decline. An important side effect of
increasing indirect taxes is that it is inflationary.
Government expenditure is the other half of fiscal policy.
Governments may alter expenditure in two broad categories:
1 Transfer payments This is expenditure on
unemployment benefit, pensions and other social
security payments. Changes in expenditure on these
Economic activity declines as
Level of economic
economy moves into recession,
activity rising rapidly
production rises less quickly
threatening inflation and
or declines. Unemployment increasing
increased imports
GDP
Govt. policies head off worst
excess of a boom. Slackening
of growth in GDP achieved by
increasing interest rates or increasing
taxation, cutting govt. expenditure
0
Time
▲ Figure 6.20 Government economic policies at work
GLOSSARY TERMS
Direct taxes are taxes on income and wealth; for example,
income tax, corporation tax and inheritance tax.
Indirect taxes are taxes on spending; for example, value
added tax (VAT).
Business decisions and changes in fiscal
policy
Fiscal policy changes can have considerable effects on
business decisions because they can remain in place for long
periods of time. A decision by a government to increase
indirect taxes or to increase investment in infrastructure
is likely to continue to have an impact on businesses for
some time.
Changes in fiscal policy may affect a number of decisions
taken by businesses, many of them strategic. We consider
some examples below.
» Location decisions Changes in rates of taxation and
government spending (for example, on infrastructure)
can influence decisions on where some businesses
locate. If a government reduces its taxes on businesses
items will have a rapid impact, as they are received by
relatively poor members of society who will most likely
spend any increase or cut back, if necessary, almost
immediately. An increase in transfer payments often
6.1.2
results in substantial increases in demand for basic
goods such as food, public transport and gas.
2 The infrastructure Governments improve the
infrastructure through their spending on housing, roads
and flood protection. Investment in these areas can
increase the level of economic activity by boosting
demand for the services of construction firms while
6.1.2.5–7 Government macroeconomic policies and their impact on businesses
reducing costs for other firms. A new road, for example,
might cut a business’ transport costs. This, however, is
a much slower method of altering the level of economic
activity. In 2020, the Chinese government announced that
it was planning a number of new infrastructure projects
to help to increase the economy’s economic growth rates.
Path of GDP without
govt. policies
GDP following
implementation of
govt. counter-
cyclical policies
Deep slump avoided by policies
such as cutting interest rates,
reducing rates of taxation or
increasing govt. expenditure
to below those in other countries, it may lead to some
businesses relocating to that country, particularly those
businesses that do not incur huge costs in moving
location. One reason why Google has established a
significant part of its operations in Ireland is the low
rate of Irish business taxes. Equally, improvements to a
country’s infrastructure may reduce costs of production,
making it a more attractive location.
» Production decisions Businesses may adjust their
production levels according to the level of taxation and
government spending. Reductions in taxes and increases
in government spending can lead to increased demand
for products. Businesses will need to adjust output
accordingly and this may require decisions to increase
productive capacity. The UK government is committed
to spending heavily on infrastructure over the next few
years and construction businesses will increase their
capacity accordingly.
» Human resource decisions Governments levy a range
of taxes on employment. In the UK, businesses have
to pay a tax called national insurance for each person
employed. Changes in these taxes can affect the cost of
using labour and may lead to decisions to use more or
less labour in the production process.
251
 Supply-side policies
6.1.2 Supply-side policies are a range of measures intended to
improve the operation of free markets and the amount that
is produced by the economy. They can take a number of
forms.
» Labour market measures In recent years, many
governments have implemented policies intended to
allow labour markets to operate more effectively. The
UK government has been a strong advocate of allowing
labour markets to operate more freely and flexibly.
A LEVEL 6.1.2 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: ECONOMIC
For example, by reducing the power of trade unions,
businesses were enabled to implement policies to
allow them to use labour more flexibly and efficiently.
Employees were able to carry out a range of duties,
rather than limited roles, to avoid demarcation disputes.
Disputes and confrontations became less common as a
consequence of a series of laws.
Other policies have been implemented to encourage
the effective operation of labour markets. Unemployed
people have been encouraged back into the labour force
through the provision of training programmes designed
to equip them with employable skills, by limiting
the availability of unemployment benefit to those in
genuine need, and by cutting income tax rates on low
earners to encourage people into the labour force.
» Privatisation As we saw in Chapter 6.1.1, this is the
process of transferring organisations from the state
to the ownership and control of individuals and other
businesses. Privatisation can offer opportunities for
privately owned businesses to trade in markets which
were previously government controlled. There may also
be opportunities to purchase state-owned businesses.
CASE STUDY
China’s economy showing signs of recovery
After initially concentrating on responding to the
domestic Coronavirus (COVID-19) epidemic, the Chinese
government has switched its attention to boosting the
performance of its economy, which was badly affected by
the virus.
In 2020, China’s National Bureau of Statistics (NBS)
released some positive data showing that the country’s
economy is beginning to recover from the worst effects of
Coronavirus. All but 4 per cent of the country’s medium-
and large-scale businesses have resumed production and
orders for components and other supplies have increased.
Approximately 80 per cent of employees have returned
to work as the country has ended much of its lockdown.
Simultaneously, demand for goods and services has risen
as consumer spending has increased.
A report on labour in China by Caixin Global said that
‘Many companies in labour-intensive industries had
252
» Other supply-side measures Governments have tried to
make other resources more freely available by removing
controls on the operation of markets that provide
capital and land. The negotiating of the free movement
of capital throughout the EU has been a major factor in
increasing the funds available to EU enterprises.
The impact of supply-side measures on
businesses and their decisions
The effects of supply-side measures on businesses are
varied and depend on the precise nature of the policy.
Labour market measures have the potential to increase the
number of potential employees and to allow businesses
to use them more flexibly. Privatisation gives businesses
the opportunity to enter markets that were previously
controlled by the state, or to buy shares in or attempt
takeovers and mergers with businesses that were previously
state-owned. Other changes allow businesses greater
freedom in moving capital and other resources across
national frontiers to where they are needed.
These effects have significant implications for business
managers and owners. They may opt to make decisions, such
as expansion, if more labour is available and it is possible
to use it more flexibly to suit the precise needs of the
business. Expansion overseas may become more possible
if controls on capital and other resources are eased.
For example, many businesses located in the European
Union have expanded into other countries within the EU.
Privatisation has given opportunities to businesses to take
decisions to enter new markets. For example, in the UK,
most water is supplied by private companies. Previously
they would not have been able to operate in this market.
trouble filling factory floors until early March as workers
in (severely) virus-hit
regions such as Hubei and Henan were barred from
travelling.’
The Chinese government has provided extensive financial
support to small businesses. The Global Times of China
said that this support amounted to billions of dollars.
Source: www.thestar.com.my/business/business-news/2020/
04/04/china-showing-signs-of-economic-recovery
Questions
1 Analyse two likely effects of rising consumer
confidence and spending on businesses in China. [8]
2 Evaluate how the Chinese authorities might use
economic policies to ensure that the economy
continues to grow steadily over the next few years. [12]
▼ Table 6.10 A summary of methods of government intervention
How governments’ economic policies help businesses
Method of intervention
Reductions in the rate of interest
Cuts in direct and indirect taxes
Increases in government spending (e.g. on
infrastructure or welfare benefits)
Helping unemployed back into work through
policies such as training and improving information by increasing the number of people who are in employment and have the
on job vacancies
How governments’ economic policies constrain business activity
Method of intervention
Increases in the rate of interest
Increases in direct and indirect taxes
Reductions in government expenditure
Implementing health advice policies
(e.g. on the dangers of tobacco or alcohol)
Expected effects
6.1.2
Businesses may invest more in new production facilities as the cost of
borrowing is reduced, and consumers may increase spending as loans are
cheaper and saving is less worthwhile due to lower interest rates. The
level of economic activity should rise.
May encourage higher levels of production as it becomes more profitable,
and consumers may also increase spending as their net pay (after tax)
6.1.2.5–7 Government macroeconomic policies and their impact on businesses
rises or as the price of goods falls. Once again, the level of economic
activity should increase.
Lower-income consumers in receipt of rising benefits are likely to increase
spending on a range of basic products (as saving of such rises in benefits
occurs rarely). Businesses in construction and engineering sectors may
receive orders from government for infrastructure projects, directly
increasing output. Government’s expenditure on infrastructure is also
likely to increase pay of many associated workers, increasing spending and
therefore production. These effects will increase the level of economic
activity.
These supply-side actions should increase the level of economic activity
right skills to carry out a job efficiently. This can enable businesses to
increase production and to do so in a cost-effective manner because they
employ suitably skilled workers.
Expected effects
By making borrowing more expensive, this is likely to dissuade businesses
and consumers from borrowing for investment or to buy expensive
products such as homes, cars and electrical products. It may also
encourage saving, reducing consumption and investment further.
This reduces the take-home pay of employees and/or increases the prices
of products. Either of these effects will reduce consumers’ spending
on goods and services and reduce the level of economic activity.
Simultaneously, businesses may have reduced profits available to invest
(and to encourage future investment).
Reductions in transfer payments, such as pensions, directly affect the
ability of less well-off consumers to purchase goods and services. At the
same time, the government may reduce orders placed with a range of
domestic businesses. The effects of both types of cuts will be to reduce
economic activity.
Economists call products such as tobacco and alcohol ‘demerit’ goods
because they can be harmful and many consumers are unaware of this. As
a consequence, consumers are discouraged from consuming them through
advertising and other policies. This can (and does) result in reduced sales,
leading to lower levels of production and decreased levels of economic
activity.
253
 TEST YOUR LEARNING
6.1.2 6 Explain two ways in which a government’s anti-
Short answer questions
inflationary policy may affect small businesses. [6]
1 a Define the term ‘enterprise’. [2] 7 a Explain one difference between cyclical and
b Explain one way in which a government might structural unemployment. [3]
intervene to help businesses. [3] b Define the term ‘exchange rate’. [2]
2 a Explain one economic objective for a government. 8 a Explain one reason why exchange rate changes
[3] can create uncertainty for businesses. [3]
b Explain one reason why businesses may benefit
A LEVEL 6.1.2 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: ECONOMIC

b Define the term ‘unemployment’. [2]

from a steady rate of economic growth. [3]
9 Using examples, explain one difference between
3 a Define the term ‘market failure’. [2] fiscal and supply-side policies. [3]
b Explain one way in which market failure may 10 Explain two ways in which a rise in interest rates
affect businesses. [3] might affect an exporter located in India. [6]
4 a Define the term ‘recession’. [2]
b Explain one consequence for a car manufacturer Data response question
of the economy experiencing a period during
The UK’s economic performance
which it doesn’t grow. [3]
5 a Define the term ‘inflation’. [2] Since 2014, the performance of the UK’s economy has
been relatively weak, and there have been signs of
b Explain one effect of inflation on a major
further weakness as its rate of economic growth has
retailer. [3]
fallen steadily. Some key data for the economy is shown
in Table 6.11.
▼ Table 6.11 Selected macroeconomic data for the UK, 2014–19

Year 2014 2015 2016 2017 2018 2019

GDP growth (%) 2.6 2.4 1.9 1.9 1.4 1.4
Inflation rate (CPI, %) 0.5 0.2 1.6 3.0 2.1 1.3
Unemployment rate (%) 5.7 5.1 4.7 4.4 4.0 3.8
Exchange rate ($ per £) 1.54 1.47 1.23 1.35 1.27 1.31

The performance of the UK’s economy over this period
has varied between regions. London and the south-east
of England have been less affected by slowing growth
rates. Some businesses have performed well despite
the difficult economic conditions. For example, Jaguar
Land Rover Automotive performed strongly over most of
this period, principally due to its buoyant export sales.
In contrast, some of the UK’s retailers have struggled
despite high levels of employment in the UK.
Questions
1 Analyse one possible consequence of the falling
rate of unemployment for the UK’s businesses.
2 Evaluate the effects of the changes in the exchange
rate over the period 2014–19 on UK exporting
businesses. [12]
3 ‘The data in Table 6.11 suggests that UK businesses
would have been uncompetitive between 2014 and
2019.’ Evaluate this view. [12]
Essay questions
1 Evaluate the extent to which government policies
aimed at reducing inflation cause rapidly expanding
businesses more difficulties than inflation itself. [20]
2 ‘All businesses in a country benefit from a sustained
[4] fall in a country’s exchange rate.’ Evaluate the
extent to which this statement is true for a country
of your choice. [20]

254
 6 Business and its environment
A LEVEL
6.1.3–7 External influences on
business activity: Other
Chapter overview
In this chapter we examine:
★ social and demographic factors affecting businesses
★ technological change and businesses
★ how competitors and suppliers impact on businesses
★ international and environmental factors affecting businesses.
In the previous chapter we saw how the economic
environment can affect business behaviour. However,
economic influences are not the only force shaping the
external environment in which businesses trade. We can
identify at least six other factors that contribute to the
business environment:
1 Social factors Businesses are subject to pressures
from groups in society and social change. Pressure
groups in several countries are currently calling on a
number of large businesses, mainly multinationals, to
pay a ‘fair’ amount of tax on their profits. This may
lead to businesses altering their practices to record
more profits in the countries in which they operate
and therefore to pay a greater amount of tax on
profits. Simultaneously, social changes are occurring.
One example is the increasing number of one-person
households as more people opt to live alone. The
number of one-person households worldwide is forecast
to rise by 30 per cent between 2016 and 2030. This
change has implications for housebuilders and suppliers
of foodstuffs, both of whom may need to supply larger
volumes of smaller-sized products.
2 Demographic changes This refers to changes in the
population structure and size. Such changes can have
profound implications for businesses. For example,
the population of China is ageing quickly. By 2050,
approximately 26 per cent of China’s population will
be aged over 65, compared with 11 per cent in 2018.
This change will reduce the quantity of labour available
to China’s enormous manufacturing sector, as well as
creating a significant change in the types of products
that are purchased. The movement of people, for
example, from the countryside to cities is also a notable
change in many countries.
3 Technological factors Changes in technology are taking
place at an increasing rate and can have an enormous
impact on businesses. For example, the development
of the internet and online retailing has forced many
retailers to make significant alterations to their business
models.
6.1.3 Social and demographic
4 Competitors and suppliers The actions of competitors
can act as a major constraint on business activities.
For example, businesses can be under pressure to
deliver new products or to sell at highly competitive
prices. In contrast, many businesses, and especially
manufacturers, rely upon suppliers to deliver raw
materials and components promptly and reliably.
5 International factors Trading links with other nations
are important for many businesses. Countries across
the world have reached trade agreements and advances
in technology have facilitated trade across national
frontiers. Multinational companies have played a greater
role in economies, although their relationships with
national governments have not always been entirely
harmonious.
6 Environmental factors Managing businesses to minimise
the adverse impact on the environment attracts an
enormous amount of attention from the media and
the general public. At the same time, consumers and
businesses have become more aware of the impact
of their activities on the environment. Businesses
have responded to these concerns by using audits to
monitor the effects of their activities and seeking more
sustainable approaches to production.
GLOSSARY TERM
Demography is the study of human populations, including
their size, growth rates and movements.
6.1.3 Social and demographic
Businesses are a part of society and are affected by social
changes; equally, businesses’ actions impact upon society.
Social factors that affect businesses include migration and
new patterns of demand created by changes such as ageing
populations. At the same time, the actions of businesses,
such as their activities damaging the environment, also
affect society.
255
 6.1.3.1 Corporate social responsibility ▼ Table 6.12 Stakeholders’ interests

6.1.3–7
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER
Corporate social responsibility is a business philosophy Stakeholder Possible nature of stakeholder’s interest
that emphasises that firms should behave as good group
citizens. They should not merely operate within the law Shareholders • Expectation of regular dividends
but should consider the effects of their activities on • Rising share prices
society as a whole. Thus, a socially responsible business • Preferential treatment as customers; for
attempts to fulfil the duties that it has towards its example, lower prices
employees, customers and other interested parties.
Collectively, these individuals and groups are termed a Employees • Steady and regular income
business’ stakeholders. • Healthy and safe working conditions

• Job security
Stakeholders include shareholders, employees, customers, • Promotion and higher incomes
suppliers, pressure groups and the local community. The
Customers • Certain and reliable supply of goods
interest that stakeholders have in a business will vary
• Stable prices
according to the nature of the group.
• Safe products
• After-sales service and technical support
Local Suppliers • Frequent and regular orders
communities • A sole-supplier agreement
Residents, other • Fair prices
businesses,
Customers
local councils Suppliers Government • Prompt payment of correct taxes to
Providing raw agencies HRMC (the organisation responsible for
Final consumers, materials,
wholesalers, components, collecting some taxes in the UK)
pressure groups services, etc. • Ensuring the businesses operate according
to local laws
The
business Local • Steady employment
communities • Minimal pollution and noise
Employees Government • Provision of facilities (for example,
Individuals, trade agencies scholarships, arts centres or reclaimed
unions, works tax authorities, areas) for the local community
councils local councils
Shareholders
Individuals, Some businesses willingly accept these responsibilities,
institutional partly because their managers want to do so and partly
investors because they fear a negative public image. It can be
argued that socially responsible behaviour can pay off for
businesses in the long term, but it may entail additional
▲ Figure 6.21 Examples of a business’ stakeholders short-term expenditure.

STUDY TIP GLOSSARY TERMS

Figure 6.21 shows the primary stakeholders for
businesses, although others exist. When writing about
stakeholders, it is important to develop answers fully.
This is impossible if you attempt to cover too many
stakeholder groups – just concentrate on the two or three
that are most relevant.
Meeting social responsibilities has many implications for
businesses:
» taking into account the impact of their activities on the
local community – protecting employment and avoiding
noise pollution, for instance
» producing in a way that avoids pollution or the reckless
use of finite resources
» treating employees fairly and not simply meeting the
demands of employment legislation
» considering the likely sources of supplies (and whether
they are sustainable) and the ways in which suppliers
meet their social responsibilities.
256
Corporate social responsibilities are the duties a
business has towards employees, customers, society and
the environment.
A pressure group is a group of people with common
interests who organise to influence public opinion and the
decisions of businesses and governments.
Dividends are money that is paid out of profits to the
company’s shareholders. It is a reward to the owners of
the business.
The impact of corporate social responsibility
The nature of a business’ social responsibility will vary
according to the nature of the business. A petrochemicals
company is more likely to be concerned with polluting the
environment than a bank. On the other hand, in an age
of rapid developments in information technology, banks
may see their corporate social responsibility to be the
maintenance of employment. We can identify a number of
key elements of corporate social responsibility beyond the
responsibilities a business has to its shareholders.
» Responsibilities to consumers The consumer has
become a force to be reckoned with over recent decades
and this has been reflected in the development of
consumerism. Increasingly, consumers have been better
informed about products and services and prepared
to complain when businesses let them down. The rise
of consumerism has meant that businesses have been
required to behave more responsibly by looking after
the interests of the consumer. Offering high-quality
customer service, supplying high-quality products that
are well-designed and durable at fair and reasonable
prices should create satisfaction and, quite possibly,
generate repeat business.
» Responsibilities to employees Businesses have a
variety of responsibilities to their employees that are
not a legal requirement. For example, firms should
provide their employees with training to develop
their skills as fully as possible and make sure that the
rights of employees in developing countries (where
employment legislation may not exist) are protected
fully. This may mean paying higher wages and incurring
additional employment costs.
» Responsibilities to the local community Firms can
benefit from the goodwill of the local community. They
can encourage this by meeting their responsibilities
to this particular stakeholder group. This may entail
providing secure employment, using local suppliers
whenever possible and ensuring that the business’
operation and possible expansion does not damage the
local environment.
» Responsibilities to suppliers Businesses can promote
good relations with suppliers by paying promptly, placing
regular orders and offering long-term contracts for
supply. These are not legal requirements and might result
in higher prices for materials and components but may
also assist suppliers to meet their own responsibilities –
for example, in the maintenance of employment.
Over recent years, businesses have become much more
aware of the expectations of stakeholder groups. In the
past, managers were expected to operate businesses largely
in the interest of the shareholders. A growing awareness
of business activities by consumers and other stakeholder
groups has complicated the task of the management
team. Businesses are also subject to the attentions of
pressure groups pursuing a particular interest. For instance,
Greenpeace campaigns to protect the environment and its
activities have significant implications for businesses. For
example, it is acting against uncontrolled deforestation
in Indonesia and Malaysia which is creating palm-oil
plantations. Today’s managers have to attempt to meet the
conflicting demands of a number of stakeholder groups.
GLOSSARY TERMS
Sustainable production occurs when the supply of a
product does not impose costs on future generations by,
for example, depleting non-renewable resources.
Social auditing is carrying out independent investigations
into the impact of a business’ activities upon society in
general.
Issues associated with corporate social
responsibility
There are a range of issues relating to corporate social 6.1.3–7
responsibility that modern managers have to take into
account. We can consider a variety of actions and decisions
that managers might – or might not – take if their business
is to be judged as socially responsible. Taking the positive
approaches outlined below would assist most businesses in
meeting their social responsibilities.
» Engaging in sustainable production Many
6.1.3 Social and demographic
manufacturers have considerable potential to cause
damage to the environment. Using sustainable
production processes (sometimes at considerable
cost) can reduce or eliminate many forms of pollution.
Malaysia, the world’s second largest producer of palm
oil, has pledged to conserve a minimum of 50 per cent
of its total land area as preserved forests. In 2010, 58
per cent of Malaysian land remained as forest. For many
businesses, the impact of their sources of supply can be
considerable. Using sustainable sources for resources
means that future generations will have access to the
same materials. Body Shop International’s refusal to use
any materials that are unsustainable or any components
that have been tested on animals reflects a sense of
responsibility to many relatively poor communities in
developing countries and to animals.
» Putting employees before profits Maintaining
employment, even when the level of sales is not
sufficient to justify this, is an important means of
fulfilling corporate social responsibilities, as is the
continuation of unprofitable factories to avoid creating
high levels of localised unemployment. These types of
policies are only really possible in the short term, unless
the business in question is earning handsome profits
elsewhere.
» Supporting local communities This is an important
way of fulfilling social responsibilities which can
provide the public with a clear perception of the ‘caring’
side of modern businesses. The US Bankcorp is one of
the largest banks in the USA and provides banking,
investment, mortgage and payment services to millions
of individuals and businesses. In 2019, it gave $13
million to workforce development programmes across the
country that provided education critical to long-term
economic success. This is part of the bank’s commitment
to supporting the communities in which it trades.
» Social auditing Carrying out social audits is not a new
idea – businesses in the Netherlands used this idea as
long ago as 1966. Social auditing assesses the impact
of a business’ activities on society as a whole. It is
not simply a measure of financial performance. Many
successful businesses recognise that they will only
prosper in the long term if they satisfy the needs of all
their stakeholders – and are seen to be doing so.
In 2019, over 90 per cent of the world’s largest
companies engaged in some form of social auditing.
High-profile examples include Bosch, Walt Disney, BMW,
IKEA and Lenovo. Social audits normally have several
elements. Businesses start the process by designing and
implementing policies, setting out how they will manage
257
 the impact of their businesses on society as a whole.
This may include issues such as:
6.1.3–7 – using sustainable sources of raw materials
– ensuring that suppliers trade ethically, avoiding, for
example, the use of child labour
– operating a thorough health and safety policy above
legal requirements, thereby protecting the well-being
of employees
– engaging in a continuous process of environmental
management, monitoring the effects of production
on the natural environment
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER
– trading ethically and attempting to take account of
the moral dimension in decision-making.
The next stage of social auditing is that an independent
body monitors the effectiveness of these policies and the
impact on society generally. Finally, once the social audit
is complete, businesses review their policies in the light
of the information from auditors. In most cases the social
audit is published in a process known as social reporting.
Suporting Putting
Social
local employees
Sustainable
auditing production
communities before profits
Actions having a positive
effect on society
Corporate social
responsibility
Actions having a negative
effect on society
Paying incentives Using certain Presenting the
to win contracts accounting practices business or its
products inaccurately
▲ Figure 6.22 CSR and positive and negative actions
CASE STUDY
Airbus fined for paying bribes to win contracts
Airbus is a European company that manufactures aircraft.
In 2020, it was fined £3 billion for paying large bribes in
20 countries to ensure it received contracts to supply
aircraft. The investigation into Airbus’ corruption took four
years and involved enquiries in a number of countries,
including the UK and France. This fine was the largest
ever imposed on a company for corruption.
The judge at the court in London said that the company’s
offences were ‘grave’ and that the use of bribes was
clearly a major problem within Airbus. The court was told
that in the four years after 2011, Airbus had paid bribes
in Malaysia, Sri Lanka, Indonesia, Taiwan and Ghana.
258
Social audits can be a valuable exercise for firms to
conduct. They may identify antisocial (or potentially
antisocial) behaviour before problems arise. This
helps to promote the corporate image of the business
as a caring and responsible organisation. However,
conducting an audit of this kind is not a guarantee that
a firm is socially responsible. Managers must ensure
that social policies are carried out effectively at all
levels within the organisation and that employees
are committed to them. Sufficient resources must be
devoted to ensuring that the business remains socially
responsible, and problems identified in social audits
should be resolved speedily. The danger of a less active
approach is that social audits publicise weaknesses
and firms are seen not to respond, with damaging
consequences for their corporate image.
Businesses can engage in activities which are generally
regarded as being harmful to society in general. We consider
three examples of ways in which businesses might behave
that are not considered socially responsible.
1 Paying incentives for the award of contracts Some
businesses have been accused of paying bribes to other
organisations to win contracts to supply products. This
is unethical and means that markets do not operate
efficiently. Without the payment of bribes, it would
be expected that the supplier offering the best value
for money would be awarded a contract. In a fair
competition, businesses would consider the cost and
the quality of the product to make a decision on which
supplier to use. Payments by suppliers to win contracts
means that this no longer applies. Such actions can
result in companies keeping inaccurate records of their
financial affairs, governments receiving lower tax
receipts and consumers buying products which are not
the best that might be available to them under truly
free competition. Unfortunately, there have been a
number of examples of large businesses engaging in
paying bribes to win contracts. We look at one high-
profile example in the case study below.
Airbus admitted that it had used agents to pay bribes
to win contracts for supplying aircraft. Prosecutors in
France had investigated possible cases of bribery in other
countries including China and Japan.
Questions
1 Analyse one reason why paying bribes in this way
is not in the interest of society in general. [4]
2 Evaluate whether paying the £3 billion fine or the
loss to Airbus’ reputation will have the biggest
impact on the company. [12]
2 Accounting practices A business’ accounts are a
financial record of its trading activities over a period
of time. They are supposed to be a ‘true and fair’ record
of what has happened and give an accurate picture of
the business’ financial position. This has not always
been the case, and businesses have engaged in a range
of accounting practices to present their financial
performance in a more favourable light. Some are illegal,
while others are not illegal but are not ethical.
Some practices, such as hiding the level of the business’
debts, are illegal. In 2001, the managers at Enron, an
American commodities and energy company, hid huge
debts that the company owed. When this was revealed,
the company collapsed. Shareholders and investors lost
over $74 billion and thousands of employees lost their
jobs. In 2008, Lehman Brothers (a bank) also hid the
extent of its debts, prompting the business to collapse
when this became public.
Other accounting practices may be legal and are
often called window dressing as businesses attempt
to make their financial performance look as positive
as possible. These include borrowing short-term at a
vital point to make the business’ cash position look
favourable or valuing certain assets (such as brands) at
what might be considered excessive levels to increase
the company’s value. Finally, some businesses may
bring forward sales to an earlier trading period to
increase profitability during that period.
3 Presenting the business or its products inaccurately
It is natural that a business will present itself and its
products in the best way possible. After all, it wants to
achieve the highest levels of sales possible. Businesses
may use terms in their advertising which may not be
entirely clear. For example, following concerns about
the impact of plastic on the global environment, many
businesses claim to sell products with packaging that
is biodegradable. However, this can be meaningless
as most materials do biodegrade over time, although
some plastics can take hundreds of years to do so. In
September 2015, the authorities in the USA discovered
that many Volkswagen cars being sold in America had
a ‘defeat device’ – or software – in diesel engines that
could detect when they were being tested, changing
the performance accordingly to improve results. A
number of stakeholder groups can be affected by these
actions. For example, in the case of Volkswagen’s ‘cheat’
technology, consumers buying the company’s products
did not receive the product they believed they were
buying. People throughout the USA and other countries
could also be subject to higher levels of air pollution as
a consequence as well.
A growing proportion of businesses are engaging in
corporate social responsibility reporting or social
accounting. As a result, a ‘successful’ business might not
be the most profitable but the one of most value to all
sections of the society within which it operates.
GLOSSARY TERMS
Window dressing is the preparation of financial
documents in order to present a company’s performance
6.1.3–7
in the best possible light.
Social accounting (also known as corporate social
responsibility reporting) is the process of communicating
the social and environmental effects of a business’
operations to its stakeholders.
6.1.3 Social and demographic
6.1.3.2 Why businesses need to consider
the needs of the community
It is easy to argue that by meeting the needs of the
communities in which they operate, businesses are likely
to reduce profitability. Providing workers with ongoing
training, investing in facilities for the local community,
trading with suppliers who do not use cheap child labour
and only engaging in non-polluting production techniques
to protect communities will all increase costs. The outcome
for the business will be lower profits and reduced levels of
competitiveness. However, this is a relatively simple view
and there are more subtle arguments in favour of businesses
fulfilling their obligations to the community.
» To project a positive public image Some businesses
have a high profile with regard to issues of social
responsibility. For example, many people see oil
companies such as Shell and ExxonMobil as having
enormous potential to pollute. The directors of these
companies have recognised this and regard socially
responsible behaviour as an important competitive
weapon. As an example, Shell supports education and
produces much valuable material for use in schools and
colleges. In particular, the company gives information
on environmental matters. Clearly, both Shell and
ExxonMobil hope that being seen to be socially
responsible will improve their sales.
The actions of all businesses are more open to scrutiny
nowadays than in the past, making it increasingly
important to manage their public image. At the same
time, consumers have become more concerned about
the impact of businesses on their communities. Recent
research in the USA has revealed that over 65 per cent
of consumers will be less likely to buy products from
businesses that damage the environment or do not care
for their employees and local communities. Businesses
are also subject to the attentions of pressure groups
pursuing a particular interest. For example, Greenpeace
campaigns to protect the environment and Amnesty
International seeks to protect human rights. Both
pressure groups operate globally, and the actions
of pressure groups such as these can highlight any
behaviour by businesses which harms the communities
in which they operate. Pressure groups can generate
adverse publicity with the potential to damage sales. As
companies become larger, they often operate globally
259
 and managing these huge enterprises becomes more
difficult. Many multinational companies operate global
6.1.3–7 supply chains in which it is very difficult to monitor the
activities of all suppliers. Pressure groups will publicise
any actions by suppliers which are harmful, such as the
use of unsafe factories, and the impact can be quite
damaging for any businesses linked to these suppliers.
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER
▲ Figure 6.23 Pressure groups seeking to protect human
rights have publicised the terrible effects of a factory
fire in India in 2020. The fire killed seven people in a
factory which supplies denim to major clothing suppliers
throughout the world.
» To reduce costs of production Sometimes, behaving
in a socially responsible manner by considering the
needs of the community may reduce production
costs. Treating employees with respect, providing
good training and paying above the going rate may
improve motivation and performance and reduce labour
turnover. For businesses where labour represents a high
proportion of total costs (banking and insurance, for
example), this could represent an important saving.
Furthermore, building a reputation as a ‘good’ employer
may help the business to attract the most talented
employees, which can assist in improving levels of
creativity and productivity. A survey of companies in
the USA ranked Microsoft as the country’s top employer.
The company scored highly for paying employees well,
investing to provide facilities in local communities and
in protecting the environment. This can give businesses
in technology industries an important competitive
advantage.
» To create product differentiation In markets
where little product differentiation occurs, adopting
a position where the business is seen to care for the
community may improve sales and profits. This can
be important in making a business stand out from its
rivals. It can help to maintain customer loyalty and to
attract new customers. It can also enable a business
to charge higher prices than some competitors who
may not possess the same public image. In the UK, the
Co-operative Bank is notable in the banking sector in
promoting its ethical and socially responsible views.
260
It may be that looking after the interests of everyone in the
community by engaging in socially responsible behaviour
might reduce profits in the short term, but over a longer
timescale the marketing advantages may dominate and
profits could increase.
6.1.3.3 Demographic changes
Demographic change covers any change in the population,
including average (or median) age, life expectancy, family
structures and migration between countries. Demographic
change can be analysed at global, national or local levels.
Global demographic changes
Population growth and size
One notable change in the global population is that it
is growing quickly, particularly since 1950. In 2019, it
was 7.7 billion and is forecast to reach nearly 11 billion
people by 2100. However, the rate of growth of the world’s
population is forecast to slow significantly by the end of
the current century, when the rate of change is expected
to be around zero. The actual and forecast changes are
shown in Figure 6.24.
HANDLING DATA
1 Use the information in Figure 6.24 to calculate the
percentage change in global population between:
a 1950 and 1987
b 1987 and 2019
c 2019 and 2050 (forecast).
2 The increase in the size of the population is similar
in each of these periods. Explain why the percentage
figure falls over time.
The growth in the global population will not be evenly
spread throughout the world. Some continents, such as
Africa, are forecast to have very rapid population growth,
whereas the population of Europe is forecast to decline.
More than half of global population growth between now
and 2050 is expected to occur in Africa. Africa has the
highest rate of population growth among major areas.
The population of sub-Saharan Africa is projected to double
by 2050.
On the other hand, the populations of 55 countries or areas
in the world are expected to decrease by 2050, of which
26 may see a reduction of at least 10 per cent. Several
countries are expected to see their populations decline
by more than 15 per cent by 2050, including Bosnia and
Herzegovina, Bulgaria, Croatia, Hungary, Japan, Latvia,
Lithuania, Republic of Moldova, Romania, Serbia, and
Ukraine. Figure 6.25 summarises the differences in forecast
population growth for the world’s continents.
 2.1% 10.9 billion
Annual growth rate of the world population in 1968 in 2100

World population 6.1.3–7

9.7 billion
in 2050

7.7 billion
in 2019

6.1.3 Social and demographic

1.08%
in 2019

5 billion
in 1987

2.5 billion
0.04% was the average in 1950
2 billion
population growth rate
in 1928
between 10 000BCE
1 billion
and 1700
in 1803
600 million
in 1700
0.1%

1700 1750 1800 1850 1900 1950 2000 2019 2050 2100
Projection

Source: Our World in Data (author Max Roser); https://ourworldindata.org/future-population-growth

▲ Figure 6.24 World population growth 1700–2100

+26% 37–41
North –4% North 40–46
America Europe +20% Europe 29–40
Asia America
Asia

+115% 19–25
+27% Africa 27–41 Africa
Latin and Latin and
South South
America
+48%
America
32–37
Oceania Oceania

Source: UN Source: UN
▲ Figure 6.25 Changes in population 2013–50 ▲ Figure 6.26 Rises in median population age, 2013–50

The average age of the global population
The global population is ageing, which is reflected in
higher average age for the populations of most countries.
Nearly every nation in the world is experiencing growth in
both the number and proportion of older persons in their
populations. By 2050, about 16 per cent of the global
population will be aged over 65, compared to 9 per cent
in 2019. In 2050, one in four persons living in Europe and
North America could be aged 65 or over. In 2018, for the
first time in history, persons aged 65 or older outnumbered
children under five years of age globally. The number of
persons aged 80 years or over is projected to increase by
198 per cent, from 143 million in 2019 to 426 million in 2050.
There are two major causes of the ageing global population.
Fewer people are being born and people are living longer.
The result is fewer younger people and more older people
driving up the average age of the population in almost all
countries. Figure 6.26 summarises how the average age of
the population will rise in different parts of the world.
Migration
Research into migration by the International Organisation
for Migration has produced some startling statistics:
» In 2017, approximately 272 million people were
international migrants, or 3.6 per cent of the world
population, and approximately 750 million were internal
migrants.
» About 51 per cent of international migrants reside in
10 countries. The most popular destination country
is the United States (where 49.8 million foreign-born
people officially resided in 2017), followed by Germany
(12.2 million), Saudi Arabia (12.2 million), the Russian
Federation (11.7 million), the United Kingdom (8.8
million), the United Arab Emirates (8.3 million), Canada
and France (7.9 million each), Australia (7.0 million) and
Spain (5.9 million).

261
 » The top five countries by size of their diasporas (number
of international migrants living abroad) in 2019 were
6.1.3–7 India (17.5 million), Mexico (11.8 million), China (10.7
million), the Russian Federation (10.5 million), Syria (8.2
million) and Bangladesh (7.8 million).
» Europe has a relatively high proportion of international
migrants in its population – over 10 per cent on
average. Countries in northern and western Europe have
the highest shares, with some cities having very high
proportions. For example, in 2018, 36 per cent of the
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER
population of London were born overseas.
Figure 6.27 gives some indication of the size, sources
and destinations of flows of international migrants. Many
migrants move from countries with relatively low incomes
to those with higher average incomes.
National demographic changes
We saw above that there are two changes in population
which are common to most nations. These are:
▲ Figure 6.27 Flow of migrants between the world’s countries and regions, 2010–15
262
» rising average ages
» large migrant flows.
However, other factors vary between different countries. In
terms of population growth, many countries in Africa have
forecast much higher rates of population growth, while some
European countries are anticipating falling populations.
Population flows within nations
There are large-scale population movements taking place in
many countries. One of the most prominent of these is the
movement of people from rural areas to towns and cities.
This is a process called urbanisation. It has taken place on
a large scale in developing countries, where workers move
from the countryside to seek better-paid employment in the
increasing number of factories that are operating in urban
areas. China’s urban population rose from 45 to 60 per cent
of its total population between 2007 and 2019. The Economist
forecasts that the country’s cities will eventually be home
to approximately 1 billion people – about 70 per cent of the
country’s population.
Source: SAGE Publications
But urbanisation is not limited to emerging economies
such as that of China. Most countries in the world have
experienced this phenomenon. In 2019, for example, 83 per
cent of people in the USA lived in urban areas. Table 6.13
shows the rates of urbanisation for a selection of countries
in 2000 and 2018.
GLOSSARY TERM
Urbanisation is the movement of people from the
countryside to live in cities.
» The global trend towards urbanisation means that many
cities and large towns have experienced increasing
populations.
» The attractiveness of a particular locality within a
6.1.3–7
country depends on a range of factors including wage
levels, availability of jobs and the cost of housing.
» Some rural areas (for example, prosperous seaside towns)
can attract people who have retired.
In the UK, places with coastlines such as Dorset, Devon and
Cornwall attract people of retirement age from elsewhere

6.1.3 Social and demographic

in the UK. London’s population is growing, like many other
▼ Table 6.13 Urbanisation rates for a selection of countries, cities. It is a very popular home for people aged 20–29, but
2000 and 2018 every other age group in London declined in number between
2014 and 2017. The places in the north of England that saw
Country Population living in urban areas (%) the largest increases in population were rural areas.
2000 2018
Japan 79 92 STUDY TIP
Argentina 89 92 The information about local changes relates mainly to
Netherlands 77 91 the UK. You should investigate the population changes in
your country and consider how businesses may respond
UK 79 83 to this.
Portugal 54 65
Nepal 13 20
6.1.3.4 The impact of social and
Indonesia 42 55
demographic change
Source: World Bank data, https://data.worldbank.org/
indicator/SP.URB.TOTL?locations=US
The impact of corporate social responsibility
We have already seen that consumers throughout the world
are better informed about the activities of businesses
HANDLING DATA with respect to the environment and their stakeholders.
Developments in technology, and notably the rising use of
In 2000, the population of Japan was 127 million and, by social media to report behaviour by firms that is deemed
2018, it had fallen slightly to 126 million. Use the data in unacceptable, have had a significant impact on corporate
Table 6.13 to calculate how many additional Japanese decision-making. Bad news about a company can be shared
people were living in urban areas in 2018 compared to and re-shared thousands of times, reaching many potential
2000. consumers. Companies have to be aware of this and aim to
avoid being the subject of bad news.
The other important factor in national population changes Businesses have to care about being socially responsible
is the impact of global migration flows on national because their customers do. A number of studies have
populations. Figure 6.27 shows that there have been shown that a business’ CSR policies increasingly influence
significant flows from lower-income countries to those with consumers’ spending decisions. For example, a survey by
higher average incomes. This has resulted, for example, in Landor Associates, the branding company, found that 77 per
substantial flows from countries in Africa and south Asia cent of consumers say it is important for businesses to be
to countries in North America and Europe. Many of these socially responsible.
migrants are young males. Between 1990 and 2019, most
of the increase in the number of international migrants Being judged to be a socially responsible business can
occurred in high-income countries (98 million), whereas the help organisations to attract the best employees and
middle-income and low-income countries only added about to build a strong employer brand. In a global workforce
20 million to their migrant population (17 million and 3 study by Towers Perrin, the professional services firm, CSR
million, respectively). was identified as the third most important influence on
employee engagement. And it is likely to become more
important: a survey by the accountancy firm, Deloitte,
Local demographic changes
revealed that among employees aged 18–26, a business’
These can vary from country to country but a few trends degree of social responsibility is an important influence on
may be observed: their decision to work there.

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6.1.3–7
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER
Acting in a socially responsible manner can also help
businesses to access new markets, and this can be very
attractive at a time when globalisation is increasing
competitive pressures. CK Prahalad (who was a well-known
business author and Professor of Corporate Strategy at
the University of Michigan) made a case for the fastest
growing new markets and entrepreneurial opportunities
being found among the billions of poor people ‘at the
bottom of the [financial] pyramid’. Thus, companies that
can incorporate socially responsible behaviour within their
strategic decision-making may be able to gain access to
» Choosing suppliers is an increasingly important issue for
firms which are keen to confirm that their raw materials
and components come from socially responsible firms.
Many firms operate a code of conduct for suppliers,
including the American restaurant chain McDonald’s.
This fast-food company operates a code of conduct
prohibiting suppliers from using child labour and
insisting upon basic health and safety standards. The
company has a contractual right to inspect suppliers’
premises to ensure their code of conduct is implemented.
» Supporting the local community is an important way

these markets and benefit over time from their growth.
Business decisions and social responsibility
Businesses can take a variety of decisions and actions,
allowing them to meet their responsibilities to their
stakeholders in general.
» For manufacturing businesses, the impact of their
sources of supply can be considerable. Using sustainable
sources for resources means that future generations
will have access to the same materials. The French
multinational company, Danone, manufactures a range of
food products. It has made sustainability a priority and
is pursuing a range of policies to achieve this priority;
for example, reducing its CO2 emissions.
» Many manufacturers have considerable potential to
damage the environment. Taking decisions to alter
production processes (sometimes at considerable cost)
can reduce or eliminate many forms of pollution. In
2020, Avantium, a Dutch biotechnology company,
announced a pioneering project that hopes to make
plastics from plant sugars rather than fossil fuels. The
project has the backing of Coca-Cola, which hopes to
secure the future of its bottled products by tackling the
environmental damage caused by plastic pollution and
dependence on fossil fuels.
of fulfilling social responsibilities. It can provide the
public with a clear perception of the ‘caring’ side of
modern businesses. During the Coronavirus (COVID-19)
crisis in 2020, Adobe, the American software company,
supported education at home by allowing students,
schools, colleges and universities free access to its
desktop apps online. Visa, the American multinational
financial services company known for its credit
and debit cards, has built partnerships with local
governments and non-profit enterprises around
the world with the aim of increasing the degree of
financial inclusion of the world’s poorest people. Visa’s
integration of CSR into its strategic decision-making
is offering poorer people in developing countries new
means to pay and receive money, as well as to save. It
also helped to increase the company’s revenues, which
rose by over 17 per cent in 2019 compared with 2018.
» More than half of the best-known companies in the
UK (those making up the FTSE 100) are members
of Business in the Community. This organisation
exists to assist member companies in ‘continually
improving, measuring and reporting the impact that
their business has on their environment, workplace,
marketplace and community’.

CASE STUDY
Global Reporting Initiative
Global Reporting Initiative (GRI) has pioneered and
developed a comprehensive Sustainability Reporting
Framework that is widely used around the world. The
Framework enables all businesses to measure and report
their economic, environmental, social and governance
performance, thus enabling businesses to be more
transparent. This transparency and accountability builds
stakeholders’ trust in organisations and can lead to many
other benefits. Thousands of businesses of all sizes and in
many different industries use GRI’s Framework in order
to understand and communicate their performances to
stakeholders.
GRI has its headquarters in Amsterdam in the Netherlands.
This acts as a hub, co-ordinating the activity of GRI’s many
network partners. GRI has regional offices in Australia,
Brazil, China, India and the USA. Its global network
includes more than 600 supporters as well as 30 000 people
representing different businesses and industries.
Questions
1 Analyse two differences between an oil company’s
economic performance and its social performance. [8]
2 Evaluate the benefits businesses might receive
from using GRI’s standard format to report their
performance to stakeholders. [12]

264

GLOSSARY TERMS
Strategic decision-making relates to choices made by
senior managers over the long-term plans of the business.
Accountability is the extent to which an individual or group
is held responsible for a decision or policy.
The impact of demographic change and
business decisions
population over the long term, even if the more modest
demographic forecasts are correct.
However, if income per head remains low, or even declines, 6.1.3–7
the impact on demand may diminish considerably. The
population of Nigeria is expected to increase from 200
million currently to 900 million by 2100. If incomes rise,
this would be a highly attractive market for many businesses
as it will have a larger population than the USA. It would
also comprise many younger consumers who might buy the
products of fashion clothing and technology companies at

6.1.3 Social and demographic

The implications of demographic change and population
movements are potentially immense but also difficult to
predict as population forecasts can vary widely. The picture
is further complicated by a lack of certainty about likely
income levels in some countries which experience rapid
population growth. Demand for a wide range of goods and
services could increase rapidly along with the size of the
a time when demand in some countries with declining and
ageing populations may be stalling. Businesses may need
to make strategic decisions about entering new markets
to take advantage of these opportunities. These may be
profitable in the longer term but could involve a high
degree of risk. Other firms will find these opportunities
attractive and they could prove highly competitive.

CASE STUDY
Demographic change and the UK leisure industry
In 2013, Visit England commissioned Trajectory, a leading
insight and futures consultancy, to report on forecast
changes in the external environment for businesses in the
leisure and tourism industry over the period 2013–23.
The information below is part of its report.

▼ Table 6.14 A summary of population and social change trends

Type of demographic change Possible implications

Ageing society
Vertical family (where several
generations of the same
family live in one household)
Baby boom
Untraditional families
Changing ethnic profile
Squeezed middle generation
Multi-speed demography
As life expectancy increases, there will be increasing numbers of older people in society.
Driven by both rising life expectancy and lower fertility rates, the shape of the family is
changing.
Over the past 15 years, a sustained rise in the birth rate has caused a mini baby boom.
New types of family are emerging, including step families, same-sex parents and older
parents.
There is a rising number of both BAME and foreign-born people, whose tourism habits need
to be understood.
Amid rises in the number of younger and older people, the number aged 35–49 is falling.
For different regions and local authorities, the speed and nature of these changes will vary.

Key implications for the leisure industry
● Families are changing in size, shape and composition, and
are far removed from the traditional ‘nuclear’ family –
tourism businesses need to be flexible and responsive.
● A baby boom and an ageing population will see an
emphasis on the intergenerational family holiday.
● Grandparents will be younger than ever before, and
retiring baby boomers will prioritise their leisure time.
● A sharp rise in the number of over-80s will see a
generation keen to go on holiday but potentially reluctant
(or unable) to travel far.
● The ‘squeezed middle generation’ (those aged 35–49
in 2020) will be lacking free time and willing to treat
themselves.
● Black and minority ethnic (BAME) and immigrant
populations’ tourism habits are currently poorly
understood, but are an increasingly large part of the
market.
Source: www.visitengland.com/sites/default/files/
visit_england_report_print_tcm30-39493.pdf
Questions
1 Analyse two possible decisions that a UK hotel chain
might take in response to the opportunities provided
by the forecast demographic changes for the UK. [8]
2 ‘Forecast global demographic changes offer more
opportunities than threats for UK businesses.’
Evaluate this view. [12]

265
 The ageing populations of Europe and Japan will provide
increasing opportunities for a range of businesses supplying
6.1.3–7 products, such as health care and leisure products. However,
the scale of these opportunities can be difficult to predict
migrants to the cities which may not be well catered for
by existing businesses. It is, of course, easier to gain a
customer base in a market that is growing.

over the longer term. The Office for Budget Responsibility

(OBR) has predicted that health care spending in the UK
could range from 7.8 to 16.6 per cent of GDP in 2061,
compared with 7.1 per cent in 2018–19. At the same time,
the UK will have a larger number of young people due to a
rise in its birth rate since the 1990s.
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER

Businesses will have opportunities in the form of the

development of new markets (for some ethnic groups), as
well as the expansion of existing ones, such as those for
the young and very elderly. The latter may prove attractive
as it may involve functional and less risky decisions as
businesses seek to increase sales in growing markets in
which they already operate.
HR managers will also be able to use the innovative
▲ Figure 6.28 Masdar City in Abu Dhabi in the United
potential of diverse workforces towards achieving business
Arab Emirates will incorporate the latest technology in
goals. Recent research has identified a strong correlation
construction, energy supply and transportation. It will be
between those businesses that employ diverse workforces completed by 2025 and will be home to 50 000 people and
and the level of the businesses’ performance. Drawing on 1500 clean technology businesses
the changing composition of populations, as is occurring in
the UK, can enhance a business’ competitiveness. The most The threats to businesses of demographic change and
innovative companies are already using increasingly diverse population movements can take the form of increased
workforces in terms of gender, ethnicity, age and values. competition, possibly from overseas businesses, attracted
For many other businesses, opportunities and threats by the growing market. Competition may force up the
will coexist. Changes in the structure and location of price of resources such as land and property, pushing up
population, caused by age changes, urbanisation and the operating costs of businesses in urban areas. Rents for
migration, will create new or expand existing market offices in major cities are rising quickly; rents for office
segments or niches. Enterprises which can respond quickly space in New York are approximately four times those in
or which are proactive may be able to exploit new markets, rural areas of the USA. Businesses in urban areas may face
especially with the use of appropriate technology. The squeezed profit margins as a consequence, unless they can
threats of competitors growing at their expense will be take decisions to locate in less costly areas.
greater for businesses that do not recognise that this
element of their external environment is changing rapidly.
6.1.4 Technological
Urbanisation throws up a range of issues for businesses.
In the twenty-first century, the rate of technological
Opportunities exist in providing many different goods and
progress is increasingly rapid. The last few years have seen
services to markets that are growing quickly. The consumers
a number of technological advances that have significant
of these goods may be individuals, other businesses and
implications for businesses. The internet has probably been
governments. This high level of investment is likely to be
the biggest single technological factor leading to change
replicated in urban areas across the world, as governments
in business behaviour, but other sources of technological
seek to provide transport and communication facilities
change, such as biotechnology, are also having and will
to allow cities to flourish. Companies that can provide
continue to have substantial effects on businesses and
technological solutions to problems (such as providing
their decisions. Technological change impacts on many
large amounts of cost-efficient, renewable-energy, high-
areas of a business and requires managers to make decisions
technology, low-carbon transport) will benefit from the
in response. Some possible impacts and responses are
process of urbanisation. Urbanisation can also provide
summarised in Table 6.15.
opportunities for new businesses to supply the needs of

266
▼ Table 6.15 Examples of the impact of technological change on business functions and some possible responses
Area of business Examples of impacts
Creation of new markets
Marketing New means of communicating with
customers
New methods of internal
communication
Operations management Different ways to design and
produce products
Different methods of
communication
Human resources
New methods of production
6.1.4.1 The impact of technological
change
Marketing decisions
Technological advances have created new markets for new
products and new ways to sell them.
New markets and new products
New technology can open up new markets for businesses. In
1990, mobile telephones were unheard of by most people.
In 2019 alone, 1.37 billion smartphones were sold globally
by manufacturers. Companies such as Samsung, Apple,
Huawei and Xiaomi have grown as a consequence of the
developments in this field of communications technology.
Markets for voice-controlled devices, such as Amazon’s
Alexa speaker, have been created as a consequence of
technological advances. A forecast by Juniper Research
estimates that there will be 8 billion voice-controlled
devices globally by 2023. Today, there are multibillion-dollar
markets selling products such as smart televisions and
tablets to billions of consumers globally.
Businesses can use new technology to help them to
develop new products. This is particularly the case for
manufacturing businesses. The increasing use of technology
across every aspect of manufacturing – from R&D (research
and development) and design, through manufacturing to
distribution – has seen the volume of data rise extremely
rapidly. Advances in software are helping manufacturers to
gain insights into important aspects of their businesses,
including market trends, consumer behaviour and causes
of inefficient production. Businesses are able to analyse
big data to learn more about their customers and use
this in designing new products which meet customers’
needs as fully as possible. Big data is a large, diverse set
of information that grows at an ever-increasing rate. It
often comes from multiple sources, such as social media,
questionnaires and from monitoring consumer buying
patterns. It is often presented in different formats. New
software enables businesses to analyse big data to identify
Some possible responses
Development of new products to meet demand in new markets
6.1.3–7
Businesses adopt new methods of marketing communications
and distributing products
Location decisions may change. New technology may be
used to create more efficient communication with other
stakeholders, such as suppliers
6.1.4 Technological
Using new technology to seek competitive edge when
developing new products or processes. Some smaller
businesses may seek to operate in niche markets or engage in
merger or takeover activity
May result in more homeworking or closer supervision of
employees to improve productivity
Adjustments to workforce to reflect changing methods and
maintain competitiveness
patterns in, and influences on, buyer behaviour. This can
then inform the development of new goods and services.
The beauty industry was one of the first industries to
use the power of large-scale data gathering and analytics
in order to better understand and respond to customers’
needs. Companies like Alibaba’s Tmall Innovation Group in
China have access to data gathered from more than 4 billion
customers to draw from when developing new, innovative
products that appeal to their customer bases.
Using technology in the products themselves, rather than
in the production process, also offers great advantages to
businesses. Firms possessing a technological lead over rival
producers are frequently able to charge a high price for
their products – at least until the competition catches up.
This technique of price skimming is likely to boost profits.
Possessing a technological edge may attract new customers
to a business. Apple sets very high prices for the latest
models of its smartphones, while older models are sold at
lower prices once they are no longer considered to be the
very latest technology. The high profits generated from
this approach to pricing helps the company to finance the
development of further new products.
GLOSSARY TERM
Big data refers to large and complex sets of data.
These have been difficult to analyse in the past, but
improvements in technology are making the use of big
data more feasible.
New ways of promoting and selling products
One of the world’s largest businesses, the Microsoft
Corporation, has played a central role in developing
new technological products, particularly computers and
software. Microsoft has benefited from technology in
terms of being able to develop new products but also from
using technology to promote and market its products.
Technological advances have allowed the company to
produce new products, such as its software and gaming
267

6.1.3–7
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER
equipment (for example, the Xbox), as well as providing a
means to promote and sell its products online as consumers
can download the company’s software at any time.
It also has used technology as a basis for product
development and to encourage consumer loyalty. Microsoft’s
Office product (a package containing Word, Excel, etc.) is
designed to be used with its Windows operating system
but is also highly compatible with the company’s internet
browser (Edge). Technology has offered the company the
opportunity to develop and sell a suite of products, rather
Decisions by businesses to use technology to distribute
products offers substantial cost advantages. Thus, Apple
does not have to pay to distribute its products, nor does
it have to pay retailers commission on each sale. This
increases the company’s profit margin and increases its
flexibility in pricing decisions. The company also receives
marketing benefits in that it can easily collect large
amounts of data about its customers and their preferences,
enabling it to target its future marketing effectively.
Technological change has enabled businesses to promote

than a single one. products in new ways and to target particular audiences
more effectively. For example, social media provides a
Businesses increasingly rely entirely on technology to
major opportunity for businesses when it comes to product
distribute their products. Apple is famous for producing
marketing. It can be a quick and easy way to communicate
innovative technological products, but the company also
information on new products to a large group and that
uses technology to distribute its products. Its iTunes
group can be targeted carefully. Social media is flexible:
store allows purchasers to download music, music videos,
it can be used for a product launch, public statement or
television shows, applications, iPod games, audio books,
a networking event to engage customers. It also allows
various podcasts, feature-length films and movie rentals.
businesses to use influencers (often celebrities with a
It is also used to download applications for the iPhone.
large online following) to persuade potential customers
Technological change has changed the way that many
to buy particular products. Finally, increasing numbers
companies market their products and this has disrupted
of businesses are using chatbots powered by artificial
the activities of many established businesses. One example
intelligence (AI). These are attempts to recreate humans
is television broadcasting. In China, Tencent streams
using technology, and they can be used to engage with
videos, allowing its customers to watch a wide range of
potential customers to promote brands and particular
programmes at any time. By 2019, the company had over
products.
90 million customers and, along with other video-streaming
companies, posed a major threat to traditional television
broadcasters. These developments have put pressure on GLOSSARY TERM
existing broadcasters to change their business models Artificial intelligence and machine learning are similar
and many have developed their own video-streaming concepts and refer to technology that can think and act
(or on-demand) services. like humans.

CASE STUDY
Google’s AI-powered chatbot
Chatbots have been used by businesses for several years, commercial uses. It is expected to be used to replace
but until now their use has been limited to a few simple some humans in engaging in conversations with
functions, such as voicing certain sections of a business’ customers and to improve the learning of foreign
website. languages.
Google believes that it has made a significant Questions
development with a chatbot called Meena, which has
1 Analyse two ways in which a business might use
the ability to engage in conversations which nearly
Google’s Meena to increase its competitiveness. [8]
match those provided by employees. Meena is a very
2 ‘The most important way in which technological
complex piece of software which is ‘trained’ using
change will influence marketing is through enabling
social-media conversations. Google says that Meena
businesses to base decisions on a better understanding
has the ability to engage in sensible and specific
of their customers.’ Evaluate this view. [12]
conversations and, therefore, has many potential

Operations management decisions
New methods of communication
Technological advances also affect the ways in which
businesses operate. Communications within businesses
have been transformed by technology. Businesses can
communicate simply, cheaply and (most importantly) quickly
across the globe. Developments such as video conferencing
have allowed employees in a business to see and talk with
one another while at different locations. Software products
such as Zoom and Microsoft Teams allow up to 500 people
to participate in meetings simultaneously. This offers

268
considerable benefits in terms of use of time and reduction
of costs to multinational businesses or even those operating
more than a single site one country.
Extranets and virtual private networks (VPNs) are methods
by which businesses can enable specified employees and
other stakeholders to communicate through secure computer
links. These have created better communications between
businesses, helping to improve efficiency. Companies
like Walmart, the giant American retailer, share sales
data through private links with suppliers such as Procter
previously carried out by people. The most dramatic aspect
of this has been use of computer-controlled technology
on the production line. This is now an integral part of
lean production. Its use allows businesses to control the
6.1.3–7
production line to supply variants on a standard product
to meet the precise demands of consumers. For example,
Vauxhall’s car factory at Ellesmere Port in the UK uses
computer-aided manufacturing systems to produce different
colours and styles of cars in succession in response to
customers’ orders. This is part of the company’s just-in-time
(JIT) or ‘pull’ manufacturing system.

6.1.4 Technological
& Gamble, to enable production and deliveries to match
demand in the stores. Walmart estimates that this improved
its inventory control enormously when introduced and saves
$2 billion in costs each year.
Advances in communication technology also offer
businesses opportunities to reduce costs of production.
Following the lockdowns in many countries due to the
Coronavirus (COVID-19) crisis in 2020, a range of businesses
recognised that large numbers of employees could work
from home for at least part of the working week. Advances
in communication, such as the business communication
platform provided by Slack Technologies, a multinational
software company, allow companies to maintain efficiency
with a high proportion of employees working from home.
Unsurprisingly, technology companies such as Twitter and
LinkedIn are leading this trend, though managers in many
businesses will see this as a way to cut costs in providing ▲ Figure 6.29 Computer-aided manufacturing (CAM)
systems being used to spray-paint car bodies
office space for employees.
The use of computer-aided design and computer-aided
New methods of production manufacture (CAD and CAM respectively) has assisted
New technology offers a range of benefits to businesses and in improving productivity levels in many manufacturing
consumers. This can be vital in an increasingly competitive industries, helping to keep costs down and enhance
global market in which businesses seek to take decisions productivity. Because of this, their use has spread to many
to improve their market position by offering high-quality industries, including food processing and the manufacture
products at the lowest prices possible. A significant of pottery. Technology on the production line often involves
advantage of technological change to businesses is that the use of robots, as shown in Figure 6.29. But the latest
it allows the development of new methods of production, wave of robots adds to what a human employee can achieve.
resulting in lower costs. This permits the firm to enjoy Cobots (collaborative robots) are programmable through
higher profits on each sale. Using ever-more sophisticated assisted movement. They ‘learn’ by first being moved
technology in developing, planning and producing products manually and then copying the movement moving forward.
is one way of achieving lower costs. These robots are considered collaborative because they can
The process of manufacturing in many industries has been work alongside humans.
transformed by automation, whereby machines do jobs

CAPP
Computer-aided process planning
– identifies the most efficient ways in which
to manufacture products.
CAD
Computer-aided design
– this allows designers to produce
new products and components
using 3D models displayed on CAM
computer screens. CAD makes it Computer-aided manufacture
easy to develop and redraw designs. – computers are used to operate robots and
other machines on the production line.
Linking CAD and CAM allows new designs
to be accommodated quickly into the
production process. CAM can also be used
to order raw materials and components

▲ Figure 6.30 Computer-aided design, computer-aided manufacture and computer-aided process planning

269

6.1.3–7
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER
Other businesses have virtually removed humans from the
production process. In June 2018, the Chinese e-commerce
giant JD.com unveiled a fully automated storage and
shipping facility in Shanghai. Its factory has 20 industrial
robots that can pick, pack and transfer packages with no
human presence or oversight. Without robots, it would take
as many as 500 workers to fully staff this 40 000-square-
foot warehouse – instead, the factory requires only five
technicians to service the machines and keep them working.
This approach to production is termed a ‘lights-out factory’
as the robots can operate in the dark.
Technology can also allow managers to track employees
at work using employee ‘wearables’. This can help to train
workers but can also be used to monitor performance,
although some employees may consider it too intrusive.
As an example, employees working in some warehouses
are required to wear a wristband that not only tracks their
locations as they ‘pick’ items to be dispatched but can also
‘read’ their hand movements, buzzing or emitting a pulse to
alert them if they are selecting the wrong item.
Employees’ reactions to decisions based around

technological change can be diverse. The reaction will

Technology is not only used in production processes in the
manufacturing sector but is also widely used by businesses
that supply services. For example, companies such as Aviva
supply insurance policies using the internet. Policyholders
enter their requirements onto the company’s website
and complete their personal details. Aviva’s technology
computes the price and deducts the appropriate sum from
the customer’s credit card before downloading the policy to
the customer’s computer. The whole production process is
based on technology.
Human relations
Humans within businesses are always affected by
technological change. This is particularly true when new
technology is introduced into the production process.
Such change may simply lead to some minor changes in
the duties of employees. On the other hand, technological
developments can result in enormous changes for a
business’ workforce. For some it may be redundancy, as
humans are replaced by technology as part of the process
of automation. Many banks have made workers redundant
owing to advances in technology with, for example, online
banking replacing high-street branches. Other employees
may be required to undertake duties dramatically different
from those with which they are familiar as a result of the
increasing use of technology in the banking sector.
Technological change can also impact in other ways; for
example, by giving companies access to highly skilled
employees for specific tasks. Some workers with very
specialised skills (for example, in science) may be located
across the globe. Developments in computer software
enable businesses to gain access to such staff. Computer
platforms such as Kaggle and Science Exchange allow
businesses access to employees with specialised skills
on a short-term basis for a particular project. This allows
managers to make decisions not to employ such people
permanently, offering advantages such as a wider pool of
labour and lower labour costs.
depend partly on the likely effect of the technological
change on the workforce and partly on the understanding
and attitudes of the workforce about the change, along with
the way it is communicated to them and implemented. For
some employees, it may represent an opportunity. They may
have a chance to acquire new skills, to make their jobs more
secure and enjoy higher wages or salaries. The new working
practices may offer great benefits. Technology can allow
employees greater control over their working lives, leading
to increased responsibility and possibility of achievement.
This can result in greater motivation. Others may fear
technological change as it increases job insecurity. This
is likely to be true of those with few skills who carry out
tasks that may be easily automated. Fear of unemployment
may lead to industrial action as workers seek to protect
their jobs. In such circumstances, the introduction of new
technology may be awkward and expensive. Redundancy
payments may be expensive and corporate images may
suffer.
New, technology-based products can create jobs and
unemployment at the same time. For example, the AI-
powered chatbots we discussed earlier will inevitably cause
a loss of jobs for employees, such as those working in call
centres. Simultaneously, employment has been created in
industries developing, manufacturing and maintaining the
chatbots.
The reaction of employees to technological change may
depend upon the culture of the business. Businesses
operating with a traditional culture, placing great emphasis
on bureaucracy and convention, may experience difficulties
in adapting to technological change. The existence of a
task culture may make the process less difficult. It may be
most appropriate where the managers of businesses that are
affected by technological change develop a culture that is
responsive to change and where employees’ attitudes are to
embrace change rather than to resist it.

CASE STUDY
Google’s culture
For its employees, Google feels like a small business,
even though this is not the case. Despite its recent growth,
the company encourages this impression by providing
facilities such as its café, where most employees eat and
take advantage of opportunities to talk with colleagues
from different departments. Conversations may be about
work and highly technical or about someone’s pet – which
can be brought to work.

270
 As its website states:
Google’s emphasis on innovation and commitment to cost
containment means each employee is a hands-on contributor.
There’s little in the way of corporate hierarchy and everyone
wears several hats. The international webmaster who creates
Google’s holiday logos spent a week translating the entire site
into Korean. The chief operations engineer is also a licensed
neurosurgeon. Because everyone realises they are an equally
important part of Google’s success, no one hesitates to skate
over a corporate officer during roller hockey.
Google’s hiring policy is aggressively non-discriminatory
and favours ability over experience. The result is a staff
that reflects the global audience the search engine serves.
Google has offices around the globe and Google engineering
centres are recruiting local talent in locations from Zurich
Threats and technological change
Technological change can be threatening as well as
providing opportunities for businesses. The impact of
technological change has been profound on one of the UK’s
most familiar organisations: Royal Mail. In recent years, the
company has seen its volume of business fall by between 5
and 7 per cent per annum as the average number of letters
posted has declined each year. The major reason for this
change is increasing competition from digital delivery of
information. Royal Mail expects the volume of items it
handles to continue to decline, but at slower rates, over
the next few years. The company has estimated that the
decline in its volume of business will continue to reduce its
operating profit and share price.
The threats of rapid changes from technology are
considerable. Firms in high-technology markets will face
demands to research new products and to implement
more efficient methods of production. However, as we
have seen, pressures exist in most industries to improve
technology used in products and processes to maintain
competitiveness. New technology, in whatever form,
can be a major drain on an organisation’s financial
resources. Installing new technology on the production
line or developing new products with more sophisticated
technology will involve a heavy capital outlay and possibly
disrupted production. Thus, a business may lose sales
revenue at the time its expenditure rises significantly.
Some firms may experience difficulty in raising the funds
necessary to purchase new technology.
Businesses operating in markets experiencing rapidly
changing technology can be left behind or find it too
expensive to keep up with other producers. Small firms can
be particularly vulnerable even if they are well-managed.
This is one factor leading to mergers and takeovers in
markets supplying high-technology products or where there
are rapid changes in technology.
New production methods do not always work effectively
from the start. Some teething problems are inevitable
to Bangalore. Dozens of languages are spoken by Google
staffers, from Turkish to Telugu. When not at work, Googlers
pursue interests from cross-country cycling to wine-tasting, 6.1.3–7
from flying to frisbee. As Google expands its development
team, it continues to look for those who share an obsessive
commitment to creating search perfection and having a great
time doing it.
Source: http://mooglemb.com/threads/googlecache/
64.233.187.104/corporate/culture.html
Questions
6.1.5 Competitors and suppliers
1 Analyse two reasons why some employees in
manufacturing businesses may fear technological
change. [8]
2 ‘Google’s culture assists the business in embracing
technological change.’ Evaluate this view. [12]
following the introduction of state-of-the-art technology
onto production lines. Workers will take time to adapt
to what is required of them and the technology may not
behave as expected. This may result in lower levels of
productivity and lead to higher production costs.
6.1.5 Competitors and suppliers
Competitors and suppliers are important stakeholders for
businesses. In Chapter 6.1.2, we looked at how market
structures and the power of buyers and suppliers can affect
businesses. Here we will consider how competitors and
suppliers can affect businesses and their decisions.
Competitors frequently play a significant role in determining
the success of a business. Competitors may influence
businesses in many ways. The entry of a new competitor
into a market can pose problems for existing businesses,
who may lose market share and profits as a consequence.
Equally, they can provide a stimulus for product or market
development and may enhance the business’ efficiency.
They can influence a business’ marketing mix; for example,
the prices at which it sells its products. This is illustrated
by some businesses engaging in competitive pricing, as we
discussed on page 125.
As we shall see, managing suppliers effectively can help
businesses to face the challenges posed by competitors.
However, the process of managing suppliers has become
more difficult as supply chains have become more complex.
Many businesses operate global supply chains, developing
relationships with other firms from numerous countries.
Businesses are also increasingly associated with the actions
of their suppliers, and their reputations can be damaged by
suppliers being judged to have behaved unethically. Several
multinational clothing manufacturers have been criticised
for using suppliers who have been accused of paying very
low wages and using child labour on production lines. Such
allegations can be very damaging to sales figures.
271

6.1.3–7
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER
6.1.5.1 The impact of competitors and
suppliers
Businesses will want to try to make the competitive
environment more favourable. This means they may take
decisions such as those outlined below.
Imposing and avoiding barriers to entry
Barriers to entry make it more costly for other businesses
to enter the market and help to remove or avoid competitive
However, businesses seeking to enter a market will seek
to avoid these barriers to entry. One way in which this
can be achieved is through disruptive innovation. This
form of innovation creates a new market by disrupting
an existing one and often avoiding barriers to entry in
consequence. Technological change has enabled much
disruptive innovation to take place. Airbnb is a classic
example of disruptive innovation that combines business-
model innovation and technology to avoid potential
barriers to entry in the hotel industry. It provides an
online marketplace that brings together people with

threats. For example, a business may spend very heavily on
promoting its products so that any entrant would face high
costs in raising customer awareness of its products. Equally,
an established business may introduce substantial price
cuts on its products to make it more difficult for a rival to
compete. Most businesses protect new ideas and products
that they have developed to prevent competitors using
them. Protecting intellectual property (IP) though the use
of patent, registered design and copyright laws is important
in many industries, such as computing and software.
accommodation and travellers seeking somewhere to stay.
At the outset, Airbnb focused on matching travellers who
were looking for a cheap alternative to staying in a hotel
but, as the business grew, it expanded into providing
higher-priced accommodation as well. It now lists over
5 million places for people to stay and offers more
accommodation than any hotel chain. It has avoided the
fixed costs (such as buying or renting suitable properties)
that form a barrier to entry into the hotel industry.

CASE STUDY
Netflix
Netflix started out as a DVD-by-mail rental business. By but it was too late. Netflix was growing very rapidly and,
launching an online subscription-based movie-streaming despite Blockbuster’s brand and resources, Blockbuster
service, it utilised new technology and a new business unable to dislodge Netflix from its now firmly established
model to disrupt the existing market. Today, its online market position.
platforms are used by over 180 million people in more
10
than 190 countries.
9 2004: Blockbuster
launches online $8 billion
In the 1990s, Blockbuster dominated the video rental 8
industry and was expanding rapidly, with over 9000 on-demand, drops
7
late fees 2007: Blockbuster
stores worldwide and nearly 85 000 employees. After the
US$ billion

6
launches total access
turn of the century, however, Blockbuster began to lose 5 DVD by mail
significant revenue to Netflix, which targeted market 4
segments that had been left unexplored by Blockbuster. 3
Initially, Netflix’s movie-subscription service via mail 2007: Netflix
2 launches
didn’t appeal to Blockbuster’s mainstream customers, 1 streaming
but was very attractive to new customers who had 0
Bankrupt
adapted well to online shopping. 2002 2004 2006 2008 2010 2012 2014 2016
However, Netflix did not reach the mainstream until after it Blockbuster revenue Netflix revenue
separated from its DVD mail service and changed to online
streaming. Instead of having to visit a store to rent (and ▲ Figure 6.31 Revenues for Netflix and Blockbuster,
then return) a movie, customers could access a huge range 2002–16
of entertainment without having to get off their sofas, for a
fixed monthly subscription fee. When Netflix switched to its
Questions
subscription-based business model, Blockbuster was still 1 Analyse one barrier to entry that made it difficult for
the market leader, earning billions of dollars. Netflix to compete with Blockbuster at first. [4]
2 Evaluate how Blockbuster might have responded
As Netflix gradually began to win customers with its more successfully to the entry of Netflix into its
flexible and accessible online-streaming service, market. [12]
Blockbuster launched rival online services in response –

272
 GLOSSARY TERMS
A barrier to entry is something that makes entering a
market more difficult for businesses, such as the need for
specialist skills.
A patent provides legal protection for a new invention.
Disruptive innovation is innovation that establishes a
new market by disrupting an existing market or creates a
new market segment, sometimes replacing established
market-leading businesses and products.
Responding to competitors or the impact of
substitute products
If a business has few competitors, customers will face more
difficulty in finding alternatives to those products sold by
that business. The management team of a business may seek
to lessen the impact of an emerging competitor by either
merging with the business or by taking it over. The latter
option is favoured by large businesses that are threatened by
smaller innovative enterprises. However, this is an approach
that may need to be taken before the new business poses too
much of a threat, as in the case of Blockbuster and Netflix.
Bigbasket is India’s largest online grocery store. In 2020, it
bought a smaller rival, Daily Ninja, that sells groceries to
those buying basics daily – a different market segment. This
action effectively neutralised the threat posed by the new
arrival and provided a boost to Bigbasket.
It is common for businesses to face established competitors.
As we saw in Chapter 6.1.1, most countries have laws to
encourage free and fair competition and to avoid any
collusion between businesses in the same industry. Many
businesses respond to competitors by taking actions
such as:
» seeking to move themselves into a different market
position by, for example, selling to a different market
segment or differentiating their products from those
sold by rivals. Some airlines compete with rivals by
operating low-cost models, enabling them to offer very
low fares to customers
» targeting new markets, possibly overseas. In the UK, a
number of the major supermarkets, such as Tesco, faced
strong competition and little growth in UK markets.
Some targeted overseas markets in response. Tesco
operated a chain of stores in California. Others decided
to enter different markets within the UK; for example,
Sainsbury’s established a bank.
Often competitors will produce products which are very
good substitutes for those sold by an established business.
Dealing with substitute products may involve short-term
decisions such as price reductions. This is more likely to be
successful if price is an important element of the buying
decision. An alternative approach is to produce a new
product to compete with the new substitute. If these are
very similar, they may be called ‘me too’ products, though
these are rarely as successful as the product they emulate.
Other management teams may take a longer-term approach
and invest in researching and developing new products with
which to provide competition.
Managing suppliers
Businesses seek to manage their suppliers so as to enhance
their competitive position. Some businesses seek to have 6.1.3–7
power over their suppliers. This can strengthen the business’
own financial and competitive position. Businesses tend
to have power over suppliers if they are larger and if
alternative sources of supply exist.
Having power over a supplier offers a number of benefits to
a business:
» The business has more control over price, meaning it can
6.1.5 Competitors and suppliers
demand a low price, helping it to increase sales.
» It may not have to pay quickly for the items (so it can
hold the money and have a stronger cash-flow position).
» Suppliers may be more willing to supply slightly different
products or meet earlier deadlines without making
additional charges.
It may be that a business seeks a different relationship with
a supplier. This might be one in which they work closely
together, seeking a long-term relationship. Suppliers can
offer businesses specialist advice and can be sources of
innovation, helping to develop new competitive products.
For example, at the time of writing, many customers in
the UK are complaining about the use of plastic packing
by retailers. Packaging suppliers may be able to work with
customers to develop effective and environmentally-friendly
forms of packaging.
Developing a long-term relationship with suppliers can offer
a range of potential benefits to a business:
» Lower costs Selecting the most efficient suppliers helps
to minimise the costs of components, raw materials and
services. Using a small number of suppliers may also
assist in maintaining consistent quality and avoiding
costs associated with faulty items. This can give
businesses greater freedom in pricing decisions, as they
can reduce prices while maintaining acceptable profit
margins.
» Collaboration Good relationships with suppliers can
promote effective two-way communication, as both
parties can offer ideas on how to improve production
systems to their mutual benefit. Suppliers might, for
example, offer suggestions on how technology could
be used to make a supply system more responsive and
efficient.
» Innovation Suppliers can stimulate innovation in
products and production processes by offering the
benefits of their expertise in specific areas. In 2020, the
American car manufacturer, General Motors, recognised
the contribution of many of its suppliers to the success
of its business by presenting them with awards. Its
suppliers had been strongly innovative, helping it to
develop improved seating and safety technology in its
vehicles. Research in the vehicle manufacturing industry
in the USA suggests that businesses which develop
long-term relationships with suppliers have the fastest
product development processes and improve product
quality consistently.
273

6.1.3–7
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER
6.1.6 International
All businesses operate in an international environment to
some extent. Even small businesses that only sell in local
markets may buy supplies from overseas or face foreign
competition. Therefore, international trade and trading
links form an important part of the external environment
for businesses.
6.1.6.1 The importance and impact of
» Engaging in international trade can increase and
stabilise a business’ sales over time. Trading overseas
assists businesses to extend the life cycles of their
products. For example, many London-based fashion
houses are selling products in the southern hemisphere,
targeting Australia, New Zealand and South Africa
in particular. Many items of fashion clothing have
notoriously short life cycles and this is one way of
extending a summer season for fashion clothes, boosting
sales and profits. Equally, in a period of low economic

growth, such as that experienced by most European

international trading links
International trading links are important for businesses in
economies throughout the world for a number of reasons:
» They provide supplies of raw materials and components
for businesses at highly competitive prices. This enables
importers to be price competitive in turn, as costs are
lowered below what they would have been without
international trade.
» They open up markets for the goods and services that
they produce. This can assist businesses in increasing
sales and profitability. The case study below shows
how the Australian mining industry (and the Australian
economy generally) has benefited from its export links
with China. Trading links also allow businesses to enter
new markets, benefiting from economies of scale.
countries at the time of writing, overseas markets such
as those in Asia can be highly lucrative and rescue
flagging sales.
» Exposure to international competition can encourage
domestic businesses to improve their efficiency to
increase the chances of survival. It may also result
in businesses adopting modern and more productive
methods of production to enhance competitiveness.
The importance of international trading links does vary
between countries and can be judged through trade
openness – that is, an economy’s exports and imports
expressed as a percentage of its GDP. Figure 6.32 shows the
trade openness data for most of the world.

No data 0% 20% 40% 75% 100% 150% >350%

Source: Feenstra, Robert C., Robert Inklaar and Marcel P. Timmer (2015), ‘The Next Generation of the Penn World Table’
American Economic Review, 105(10), 3150–3182, available for download at www.ggdc.net/pwt
▲ Figure 6.32 Trade openness

274
 CASE STUDY
Australia’s continuing mining boom
▲ Figure 6.33 An open mine in Australia
The extraordinary economic growth rates achieved by
China since the early 1990s have been a major influence
on the Australian economy, and especially on its mining
industry, much of which is located in Western Australia
and the Northern Territory. As China’s rate of economic
growth has regularly been around 7–8 per cent per year
since 2011, its demand for Australian resources soared
to supply the roads, infrastructure and the products it
exports throughout the world. Australian exports to China
rose in value from $5 billion in 2002–03 to approximately
$117 billion in 2018–19.
There were a number of other significant changes
resulting from increased exports of primary resources to
China between 2002 and 2019:
● Weekly household incomes in Western Australia and
the Northern Territory, where mining is an important
industry, have risen more quickly than in the rest of
Australia.
GLOSSARY TERM
Trade openness is a measure of the extent to which an
economy engages in trade. It is usually calculated using
the value of the economy’s exports and imports expressed
as a percentage of its GDP.
International trading links are therefore important to
businesses for a variety of reasons. They have a significant
impact on businesses, both positive and negative. Benefits
include:
» They provide new markets and potential for growth in
sales.
» They provide sources of supply for raw materials,
components, labour and capital.
However, international links can pose risks for businesses
as well:
6.1.3–7
● In 2018–19, 242 000 people were employed in mining
compared to 90 000 in 2002 – that is about 2 per cent of
the Australian workforce.
● Iron ore prices doubled between 2009 and 2019.
● Investment in mine projects or infrastructure in
Western Australia was higher than in any other region
6.1.6 International
in the world in 2019.
% %
30 30
China
20 20
Japan
USA EU
10 10
South Korea India
0 0
01/02 05/06 09/10 13/14 17/18
▲ Figure 6.34 Australian exports by destination
(percentage share), 2001–18
Source: www.rba.gov.au/publications/bulletin/2019/jun/
spillovers-to-australia-from-the-chinese-economy.html
Questions
1 Analyse one possible problem that businesses
in China may face as a result of the high rates of
economic growth in the country. [4]
2 ‘All the stakeholders of Chinese manufacturing
businesses have benefited from the increasing
levels of trade with Australia.’ Evaluate this view. [12]
» They allow overseas competition access to a business’
domestic market. This competition can be very fierce.
» The market price for products may fall as a result of
global trade.
Businesses may take a variety of decisions in response to
the existence of international trading links. We will consider
a sample of these below.
» Decisions on suppliers and products The existence of
international trading links may offer businesses a wider
choice of suppliers, particularly if the raw materials,
components or products supplied are not perishable or
bulky. Many clothing retailers, for example, choose to
buy their clothing from producers located in countries
with low wage costs, such as Bangladesh and Vietnam.
This type of trade is made significantly easier due to
the use of technology in international trade, as we shall
275
 see later. Using low-cost suppliers overseas can boost a
business’ profit margins.
6.1.3–7 Some resources may only be available from overseas
and unless there are effective trading links with the
appropriate countries, it may not be possible to produce
certain products. For example, rare earths are 17 elements
such as cerium and yttrium that have magnetic and
conductive properties. They are used in manufacturing a
wide range of consumer products, from iPhones to electric
car motors, rechargeable batteries, satellites and lasers.
However, there are few viable sources of supply in the
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER
world for these products. China has substantial supplies
of rare earths, but a dispute between it and the USA
may mean that American manufacturers struggle to buy
supplies of rare earths. This may force manufacturers to
seek alternative supplies or to design these elements out
of their products, if possible.
» Market-positioning decisions International trading links
may allow a business to reposition itself in the market.
Access to cheaper sources of supply could, for example,
enable the business to seek to increase its market share
by positioning itself as a low-cost producer. Alternatively,
it may achieve this through relocating part or all of its
operations overseas to reduce its production costs.
» Expansion and location decisions Businesses may
consider the state of existing trading links between
countries as part of a plan to expand into overseas
markets. Deteriorating international trading links can
also fuel major decisions. Research by Velocity Global in
2019 showed that 90 per cent of senior decision-makers
at UK technology firms were seeking to expand overseas.
Almost half of those businesses (43 per cent) said that the
uncertainty caused by Brexit (the UK’s decision to leave
42
11–31
6–10
1–5
Not applicable/
no trade agreements
▲ Figure 6.35 The countries with the most trade agreements in 2019
» Bilateral and multilateral trade agreements A bilateral
trade agreement is simply one that exists between two
countries. It may cover all industries or just a number of
specified ones. The USA and Australia have a bilateral
trade agreement which was signed in 2004. This trade
agreement removed tariffs on a range of agricultural
276
the European Union) was a key driver behind their plans
for overseas growth, according to the findings. Equally,
many Asian companies have taken decisions to move
a part of their operations within the European Union,
because this offers the chance to trade freely within
27 countries without barriers. So Toyota, for example,
the Japanese car manufacturer, has factories in various
countries within the EU, including France and Portugal.
» Decisions on mergers, takeovers and joint ventures
Close trading links between countries can also encourage
businesses to work together. This might be formally as
the consequence of a merger or a takeover. Alternatively,
businesses may simply agree to work together on one or
more projects as part of a joint venture. International
trading links are normally an important element of such
deals to allow components, supplies and other resources
to move freely and efficiently between the countries
involved in the project.
6.1.6.2 The impact of international trade
agreements on businesses
When two or more countries enter into a trade agreement,
they agree to lower or remove any trade barriers that may
exist between them. These may be in the form of tariffs
(taxes on imports) or quotas (limits on the volume of
imports). They may also agree to some degree of integration
between their rules on international trade.
International trade agreements are common and many
countries have multiple agreements, as shown in Figure 6.35.
Trade agreements can be classified according to the number
of partners or by level of integration of trade policies.
Source: The World Trade Organization/Statista
and textile exports and imports between the USA and
Australia. A multilateral trade agreement exists between
more than two countries. The Asia-Pacific Economic Co-
operation Group is an agreement between 21 countries
bordering the Pacific Ocean to implement policies to
encourage free trade.
» The level of integration on international trade
policies An international trade agreement might just
create free trade between the nations concerned. Free
trade agreements simply remove barriers to trade, such
as tariffs and quotas. However, some international trade
agreements may go further and involve some level of
integration on tariffs to be imposed. A customs union
not only creates a free trade area but also member
countries agree to impose common tariffs on imports
from external countries. The European Union (EU) is an
example of a customs union.
Such agreements can have a number of effects on
businesses. They can facilitate trade between businesses
that are located within the countries that reach the
agreement. For example, agricultural businesses in both
Australia and the USA have benefited from the removal
of tariffs on their exports to each other. As a result,
agricultural business in both countries have the opportunity
to sell within larger markets. This may enable them to
take decisions to increase production and to benefit from
economies of scale, increasing their competitiveness.
However, the downside is that agricultural and textile firms
in both countries have been subject to tougher competition.
Some businesses may fail as a consequence or be forced to
merge or seek other markets as a result.
International trade agreements can create new markets for
businesses. Many multinational businesses consider the
European Union a very attractive market. This is because it
comprises over 500 million relatively high-income consumers
across 27 countries. This can affect the location decisions
of businesses. Many firms have created productive capacity
within the EU to avoid its common external tariff. In 2017,
there were nearly 3000 large multinational companies (such
as Ford or Sony) with some operations within the EU. Many
of these companies have taken decisions to make major
investments into the EU. In 2018, investment into the EU
totalled €301 billion.
6.1.6.3 The role of technology in
international trade
Technological advances are transforming international
trade by making processes more efficient. The newest
wave of technologies has been driven by innovations in
telecommunications, computing and the development of global
information networks. The twenty-first century will most likely
be noted for the falling cost of trading information. Thanks to
fibre-optic cables, satellites and digital technology, the cost
of overseas telecommunications is approaching zero.
In this section, we will look at four technological
innovations:
» artificial intelligence and machine learning
» the internet of things (IoT)
» 3-D printing
» blockchain technology.
GLOSSARY TERMS
The internet of things (IoT) refers to the billions of
physical devices throughout the world that are connected
6.1.3–7
to the internet and collecting and sharing data.
A blockchain is a digital database containing information
(such as records of financial transactions) that is tamper-
proof.
Artificial intelligence and machine learning
6.1.6 International
Artificial intelligence (AI) and machine learning can
be used to optimise trade shipping routes and manage
vessel and truck traffic at ports. This can reduce the time
taken to transport goods from one country to another,
thereby reducing costs and encouraging greater volumes
of international trade. One company in India is using AI
to reduce the costs of transporting products in lorries
across long distances to ports. The company’s system uses
algorithms to predict precisely when lorries will arrive and
leave particular locations, allowing teams of drivers to be
constantly employed. AI is thus helping to cut down travel
time by more than half, by eliminating the need for rest
breaks which a single driver would require.
Additional cost savings can be made by automating
warehousing and container loading and unloading. AI
algorithms combined with advanced robotics cut storage
costs and allow products to be received by the customer
more quickly.
Machine learning can stimulate international trade in
a number of ways, including the provision of instant
translations. E-commerce search queries from potential
buyers overseas can be instantly translated from one
language to another and immediate responses offered.
The internet of things
The internet of things (IoT) relates to the fact that many
billions of devices are connected to the internet nowadays,
and they are capable of collecting information and sharing
it. Due to the rapidly falling price of computer microchips
and the widespread availability of wireless networks, it has
become possible to link nearly anything (from a tiny pill to
a lorry) to the IoT.
IoT technology can reduce the number of items lost in
transit, as they can be tracked continuously. It can also
optimise the transporting of products, reducing transport
costs. An average shipping container has only 20 per cent
of its capacity used. Research has shown that tracking each
container using IoT technologies could improve container
utilisation by 10 to 25 per cent and reduce annual spending
on containers by nearly $13 billion by 2025. Lowering the
costs by using technology in these ways is likely to create
larger volumes of international trade.
277
 3-D printing
Three-dimensional (3-D) printing is a manufacturing process
6.1.3–7 that creates a physical object from a digital design. The
process works by using a printer to lay down thin layers of
material in the form of liquid or powdered plastic, metal
or cement, and then fusing the layers together. Boeing,
the American aircraft manufacturer, is using 3-D-printed
titanium parts in the construction of its 787 Dreamliner
airliners.
It is possible that 3-D printing has the potential to have
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER
the greatest impact on international trade of any current
technological development. It might make improvements
in the cost and efficiency of transporting goods irrelevant.
Instead of producing products in one country and
transporting them to many others, it may become possible
to set up ‘printing centres’ in various countries near to
large numbers of customers. Only local transport would
be required, cutting costs significantly. 3-D printing also
allows some complex products to be produced in one
piece, thus lowering the number of production steps and
production costs.
There are differing views on the impact of 3-D printing on
global trade, as it is too slow to support mass production
currently. However, the more optimistic studies forecast
that once high-speed 3-D printing is mass-adopted and
cheap enough, global trade may decrease by as much as 25
per cent, since 3-D printing reduces the need for imports.
Blockchain technology
A blockchain is a digital database containing information
(such as records of financial transactions) that is tamper-
proof. It can be simultaneously used and shared within a
CASE STUDY
Maersk’s ‘reefers’
Back in 2012, in response to increasing competition, the
Danish shipping company Maersk formed a joint venture
with Ericsson, a Swedish multinational telecommunications
company, to develop a real-time remote container
management (RCM) system across its fleet of ‘reefers’, or
refrigerated containers.
Close to 300 000 reefers have been equipped with RCMs that
transmit reefer performance data 24 hours a day, seven days
a week, on key issues such as temperature, power supply and
location to Maersk’s private data cloud, where they can be
analysed in real time at the company’s headquarters.
The system, which has been operational since mid-2015,
allows Maersk to track and monitor container performance
at any point. According to Maersk, prior to the introduction
of the RCM system, close to 60 per cent of cargo losses
stemmed from malfunctioning reefer units, poor supplier
278
large network of users. Blockchains create a continuously
growing list of records, which are combined in ‘blocks’
that are then ‘chained’ to each other – hence the term
‘blockchain’. Once added to a blockchain, information is
time-stamped and cannot be modified, so that attempted
changes can easily be detected, and transactions are
recorded and shared.
In addition to making movement of goods across
national frontiers more efficient, reliable and secure,
blockchains are changing the ways in which international
trade is financed. For example, blockchain is being used
to simplify the time-consuming and costly process of
obtaining a Letter of Credit, a payment mechanism used in
international trade.
AI and
The internet Blockchain
machine 3-D printing
of things (IoT) technology
learning
Lowering costs Making international
of international trade simpler and
trade more secure
Potential to
increase volume of
international trade
▲ Figure 6.36 Technology and international trade
For these technologies to have the maximum possible
impact on international trade, it will be important for
governments to reach agreements on a range of issues,
including taxation and licensing the use of the technology.
handling of off-power periods and wrong temperature set
points. The system can also be used to detect faults, allowing
for quicker repair and cutting down on the need for manual
equipment inspections. Maersk’s end goal now is to use big
data for predictive maintenance to prevent faults.
Source: The World Trade Organization – ‘The Future of World
Trade: How Digital Technologies are Transforming
Global Commerce; www.wto.org/english/
res_e/publications_e/wtr18_3_e.pdf
Questions
1 Analyse two ways in which the use of this technology
might affect Maersk’s profits from transporting
products internationally. [8]
2 ‘Advances in technology will inevitably lead to
greater volumes of international trade.’ Evaluate
this view. [12]
6.1.6.4 Multinational businesses
A multinational corporation (MNC) is a business
organisation which has its headquarters in one country but
has operations in a range of different countries. There are
numerous examples of such organisations: car manufacturers
like Ford, Toyota, Honda and Volkswagen, oil companies like
Shell, BP and ExxonMobil, and technology companies like
Huawei, Google, Microsoft and Ericsson.
Multinational companies operate a global strategy,
making strategic decisions in terms of resources,
facilities and markets available throughout the world.
Many businesses trade as multinationals to exploit the
cheap labour and other resources available in developing
countries. Furthermore, by selling in global markets,
multinationals can reap the advantage of economies of
scale. The trend in many markets is towards fewer, larger
producers. The global car manufacturing industry is an
example of this, with many mergers and takeovers in
recent years.
Multinational businesses, by their very nature, tend to be
large or very large organisations. Research has revealed
that approximately 82 000 businesses in the world can
be classified as multinationals. The largest 100 of these
companies account for about 40 per cent of international
trade. Their size means they often have considerable
power and influence and, as a result, have come in for
some criticism of their actions. Events such as the tax
avoidance scandal in the UK and other European countries
(covered in the case study below) have attracted much
criticism and, sometimes, an assumption that MNCs are
always a ‘bad’ thing.
Why do companies want to become
multinationals?
For many companies, the following might be some or all of
the reasons to expand into different countries:
» Reduce transport and distribution costs by producing
nearer to markets Some multinationals seek to expand
to Asian countries, as sales are growing relatively rapidly
for many products in that part of the world.
» To be able to sell in new markets by locating in them
This can help a business such as Lenovo or Walmart to
develop a recognised brand.
» Secure supplies of raw materials or markets There may
be controls on exporting certain raw materials so, by
locating in the country concerned, businesses can avoid
such regulations.
» There may be cost advantages, most often in terms
of low labour costs Many companies have created
production facilities in countries with low labour costs.
For example, Coca-Cola established production facilities
in Vietnam as early as 1993 to take advantage of low
production costs.
The case for and against multinationals
The activities of multinational companies have attracted
a lot of attention in the media over recent years and have
provoked strong reactions among stakeholder groups.
The advantages of multinationals to host
countries
» Economic growth and employment Multinationals bring
foreign investment to countries that are not their home
6.1.3–7
base. If they choose to expand by building production
facilities, they will be bringing investment into the
country or cutting unemployment as well as helping the
sales figures of local businesses which supply them with
goods and services. The effects of the investment might
be seen as essential for helping a country escape from
6.1.6 International
poverty or vital in promoting economic development
within the country.
» Skills, production techniques and improvements in
the quality of the workforce It can be argued that
multinationals bring with them new ideas and new
techniques that can help to improve the quality of
production and help boost the quality of human capital
in the host country. Many will not only look to employ
local labour but also provide them with training and new
skills to help them improve productivity and efficiency.
» Availability of quality goods and services in the host
country In some cases, a multinational’s production
in a particular country may be primarily aimed at the
export market. However, in other cases, much of the
multinational’s production may be aimed at consumers
in the country in which the products are produced.
In the case of many Japanese car manufacturers, the
investment made into UK production has enabled them
to get a foothold in the European Union and to avoid
tariff barriers; Brexit may lead to them reconsidering this
decision. Consumers in the UK have had access to high-
quality vehicles at cheaper prices, and the competition
this has created has also led to improvements in working
practices, prices and quality in other related industries.
» Improvements in infrastructure In addition to the
investment in a country in production or distribution
facilities, a company might also invest in additional
infrastructure facilities like road, rail, port and
communications networks. This can provide benefits for
the whole country in that it creates employment as well
as providing improved facilities for local businesses.
The disadvantages of multinationals
If a country plays host to a multinational company, it may
pay one or more of the costs below.
» The effect on employment may be minor If the
multinational uses skilled employees, many jobs might
go to skilled workers from other countries rather than
to domestic workers. Alternatively, a multinational
company may operate capital-intensive systems of
production, using little labour from the domestic
country. This would mean that the effect on employment
may be minimal and the wages paid to these workers
may not stay in the host country.
» Some MNCs may be footloose This means that they
might locate in a country to gain advantages in
terms of lower rates of taxation or lax regulations on
environmental protection. However, the multinational
may relocate elsewhere if regulations are tightened or
tax rates are increased. As a result, there might not be a
long-term benefit to the country.
279
 » Pollution and environmental damage Some countries
may have less rigorous regulatory authorities that fail
6.1.3–7 to monitor the environmental impact of multinationals’
activities effectively. This can cause long-term
problems. In 2020, there was a leakage of styrene gas
at the LG Chem factory in Andhra Pradesh in India. At
least 13 people were killed and over 1000 hospitalised.
This led to people being evacuated from the area and
complaints of lack of government regulation.
» Profits leaving the host country Profits might go back
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER
to the headquarters of the multinational rather than
being reinvested within the host country. This may
lead to lower rates of employment and GDP in the host
country than might have been expected.
6.1.6.5 Relationships between
multinationals and governments
Multinationals are very powerful. The revenue of Walmart,
the American multinational retailer, gives it a bigger budget
than most governments have. With financial power comes
influence. As multinationals have become larger and more
powerful, a number of aspects of their relationships with
governments have become more critical and complex.
Multinationals are no longer just a source of taxation for
governments.
Tax issues
Many governments have problems in ensuring that hugely
profitable multinational companies, such as Amazon and
Google, pay appropriate levels of taxation on these profits.
Many such companies are very successful in minimising
CASE STUDY
Multinationals under spotlight for tax avoidance
One of the UK government’s most important committees
has called for multinational companies that make a large
proportion of their sales in the UK, but pay little tax there,
to pay a fair and reasonable amount of tax on profits. This
follows demands from politicians in other European and
Asian countries for measures to tackle corporate tax
avoidance. A number of multinational businesses, including
Coca-Cola, Google, Amazon and IKEA, have been strongly
criticised for operating policies to reduce declared profits
to avoid paying taxes on these profits. Coca-Cola has
been criticised by the authorities in Vietnam and has been
investigated by tax authorities. In 2020, it was prosecuted
and forced to pay $35.4 million in tax arrears and fines.
The UK government’s Public Accounts Committee
(PAC) believes the government create rules limiting
activities that reduce companies’ tax bills, and should
also collaborate with other countries to minimise profit-
shifting globally.
However, the relationship between governments and
multinationals over tax is complex. Some countries are
encouraging multinationals to locate there for tax purposes
by offering low rates of tax on profits. Some countries offer
‘sweetheart’ deals to particular multinationals. In 2019,
280
their overall tax bill by setting up offices in countries with
low tax rates and claiming their profits are earned there.
For example, each dollar of profits reported in the USA
or Germany will be taxed at a rate of around 30 per cent,
whereas profits reported in Bermuda will be taxed at 0 per
cent. New research by the University of California suggests
that 40 per cent of multinational profits are shifted to
tax havens and that 10 per cent of the world’s largest
multinational firms are responsible for 98 per cent of this
activity. The result is that governments throughout the
world lose $200 billion in tax revenue. At the same time,
multinationals rely on public services such as transport and
energy links, which are often paid for by the taxes of other
organisations and individuals.
A pressure group, Tax Watch UK, has estimated that five
major multinational companies – Apple, Cisco, Facebook,
Google and Microsoft – made profits estimated at $30
billion from trading in the UK between 2012 and 2017. Most
of these profits were transferred to other low-tax countries,
resulting in taxes of just $933 million or a tax rate of about
3 per cent.
Governments have struggled to reach agreements on how
to tax multinational companies fairly. There has been
tension between governments over a key question: if a
multinational from one country invests or sells its products
in another, in which nation should it pay taxes on its
profits? This matter is not yet resolved. In the meantime,
countries such as France and the UK are threatening to
impose their own taxes on the profits of multinational
companies unless an international agreement is reached.
‘Global companies with huge operations in the UK
generating significant amounts of income are getting
away with paying little or no corporation (profits) tax
here,’ said a member of the PAC. ‘This is outrageous, and
an insult to British businesses and individuals who pay
their fair share.’
Source: www.reuters.com/article/britain-tax-bigbusiness-
idUSL5E8MU9DT20121203?edition-redirect=uk
Questions
1 Analyse two reasons why multinational companies
such as Coca-Cola are often able to make higher
profit margins than those which operate in a single
country. [8]
2 Evaluate the possible consequences for the UK or
Vietnam if multinationals such as Google and Coca-
Cola are forced to pay higher rates of taxation. [12]
the EU authorities concluded that Nike (a multinational
sportswear manufacturer) had paid too little tax in
the Netherlands. This was a result of a deal between
the government and the company, which benefited the
Netherlands but not the rest of the EU.
Governments taking part-ownership of some
multinationals
Some governments have recognised that multinationals
have the ability to generate enormous revenues and have
taken significant shareholdings in those companies in
recent years. Governments across the world owned almost
25 per cent of the Fortune Global 500 (the world’s largest
500 companies measured by revenue earned) in 2019. By
investing in state-owned enterprises beyond their borders,
governments earn a share of profits and gain some influence
over the economies of other countries. This can be an
important way of generating funds to replace the ‘lost’ tax
revenues.
As an example, Russia is able to wield influence in countries
in eastern Europe as its giant energy company, Gazprom, has
built a gas pipeline to supply these states. China controls
over 1000 multinational companies, including Sinopec and
ICBC China. Countries like France and Germany are also
prominent owners of multinational companies.
Governments as customers of multinationals
Most governments are becoming more dependent on the
goods and services that are supplied by multinationals.
Governments are seeking to supply services digitally
wherever possible and have become more reliant on
multinational companies to enable them to do this. For
example, Huawei, a Chinese technology company, supplies
technology for the telecommunication systems used in many
countries.
India is a good example of a country where products
provided by multinational companies will be increasingly
demanded by the government. Government spending in
India on IT services reached $7.7 billion in 2020 and is
forecast to grow by 7–8 per cent per year for several years.
Multinational companies can expect to win a number
of contracts to help the Indian government to provide
healthcare and education and collect taxes using digital
platforms.
6.1.7 Environmental
The media take a great interest in business activities in
relation to the environment. When firms are found to be
guilty of some act of pollution, adverse publicity is likely to
follow. Society expects higher standards of environmental
performance than in the past and, thus, environmental
factors are an increasingly important influence on business
behaviour.
6.1.7.1 The influence of physical
environmental issues
There are many potential causes of damage to the
environment. The major environmental concern identified
by most governments is global warming. This is the rise in
global temperatures which, although it occurs naturally over
the course of millennia, is accelerated by the release of a
mixture of gases (called greenhouse gases) into the Earth’s
atmosphere. These emissions are produced predominantly
by the consumption of fossil fuels (for example, the
burning of petrol or diesel in engines, and by the plastic-
manufacturing process), much of which is the result of
6.1.3–7
business activity. As greenhouse gas (principally carbon
dioxide) emissions increase, the so-called greenhouse effect
increases, which causes global temperatures to rise and
climate conditions to alter drastically.
Other environmental problems include the pollution of
rivers and land and the dumping of waste, some of which is
6.1.7 Environmental
toxic and harmful to wildlife and humans alike.
Businesses contribute in many ways to the creation of
environmental damage, such as:
» the emission of gases through production processes
» pollution caused by transporting raw materials and
products, particularly using road vehicles which
emit noxious gases and create congestion and noise. Air
pollution is a major cause of death and is estimated to
be responsible for 5 million deaths globally each year
» pollution of the sea by businesses using it as a ‘free’
dumping ground. The North Sea between the UK and
Europe is one of the most polluted stretches of water in
the world
» destruction of natural environments as a result of
activities such as logging (cutting down trees for
commercial purposes, as in the Indonesian forests) and
the building of homes on greenfield sites (that is, land
that has not been previously built on).
Figure 6.37 illustrates that emissions of carbon dioxide
by all countries have continued to rise in recent years.
Emissions of carbon dioxide from some countries are
growing more slowly. However, emissions in some regions
with large numbers of developing economies (for example,
Asia) have risen more sharply since 1999. Despite engaging
in activities that damage the environment, there is evidence
that some businesses and some regions are improving some
aspects of their environmental performance.
40
Lighter band shows
30
margin of error
CO2 (gigatonnes)
20
10
0
1959 1979 1999 2019
Source: Global Carbon Project/CICERO
▲ Figure 6.37 Global emissions of carbon dioxide 1959–2019
There is a considerable body of evidence, as shown in Figure
6.38, to show that world temperatures are rising. Although
global warming is a controversial topic, many scientists
argue that businesses throughout the world are a major
contributor to this trend. This development is linked to the
rise in emissions of carbon dioxide shown in Figure 6.37.
281
 1 that firms pay all the costs associated with the production

Global temperature anomaly (°C)

0.8 of a product, governments can avoid market failure, which
6.1.3–7 0.6 we discussed in Chapter 6.1.2. Market failure could occur as
a result of pollution because suppliers may not be charged
0.4
the full costs of production and oversupply might result, as
0.2
profits are high. Most governments take actions to avoid
0 businesses causing environmental damage and imposing
−0.2 costs on others.
−0.4
−0.6 How environmental issues might influence
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER

−0.8 business behaviour

1860 1880 1900 1920 1940 1960 1980 2000 2020
The need to alter business practice to take account of
Source: Berkely Earth environmental issues has implications for most aspects of
▲ Figure 6.38 Evidence of rising average global business activity.
temperatures 1850–2019 » Production Firms face pressure to redesign products
to use less packaging and materials and to make
How businesses contribute to environmental these materials biodegradable or recyclable. These
requirements affect all types of businesses. For
issues example, housebuilders are under great pressure to
Businesses are acutely aware of their private costs (the costs build on brownfield sites (land previously used for
of production they have to pay themselves), such as expenses building, often in cities and towns) and to protect the
for raw materials and wages. These are easy to calculate countryside by minimising the use of greenfield sites.
and form part of the assessment of profitability. However, Strict controls on production techniques are intended
environmental pressure groups and others have pressed for to minimise pollution.
businesses to acknowledge the costs they create for other » Purchasing Businesses are encouraged to seek sources
groups in society – the external costs of production. of supply that are sustainable and do not damage the
Noise, congestion, air and water pollution all impose costs environment, or to use recycled materials. For example,
on other individuals and groups in society. A firm extracting the paper industry uses a great deal of recycled
gravel from a quarry may create a number of external costs. materials, and it includes this as part of its promotion.
These could include congestion and deterioration of local » Marketing Businesses use their ‘green credentials’
roads caused by its lorries. This would impose costs in as an important component of their marketing
terms of delay and noise pollution on local residents. The strategy. Adverts will make reference to environmental
destruction of land caused by the quarrying could create an protection and even projects to improve the
eyesore for people living nearby and may reduce the value of environment. Packaging will confirm the company’s
their properties. Dust may be discharged into the atmosphere. concern to avoid pollution, especially that caused by
However, the quarrying firm will not automatically pay for single-use plastic. This is particularly important to
these costs. It requires government action to ensure that it firms that are seen to have great potential to pollute,
pays these external costs as well as its internal ones. including oil companies such as BP and Sinopec. It is
also important to those businesses who use this aspect
of their operations as a USP – Body Shop International
Total cost is an example of the latter. The case study on Unilever
of production on page 285 shows the importance some managers
place on an environmentally-friendly (or sustainable)
business model.
» Human resources New processes and procedures in
Private or External manufacturing make some jobs and skills obsolete,
internal costs costs creating a need for redundancies or retraining.
Environmental management has resulted in many
e.g. Fuel costs, e.g. Air pollution, businesses needing employees with new skills, requiring
wages and rising sea levels, a retraining programme or recruitment. Environmental
salaries Governments acidified water managers seek to minimise the effects of the business’
attempt to activities on the environment and to ensure that the
ensure businesses
firm meets new legislative requirements as they emerge.
pay all costs
of production Businesses may also seek to hire employees skilled in
resource management and with the ability to influence
▲ Figure 6.39 Internal and external costs of production corporate decisions to ensure the development of
Thus, the total costs of production equal internal or private management strategies designed for the most efficient
costs plus external costs borne by third parties. By ensuring use of scarce natural resources.

282
The implications of environmental protection are profound,
especially for the so-called polluting sector (for example,
chemicals, oil extraction and refining). They require a
corporate response from senior managers within a business.
But, as with many external influences, the environment
provides opportunities for businesses as well as constraints.
New markets have been created for businesses supplying
training in environmental management. Firms also offer
to supply environmental control equipment to adapt
production processes so that they minimise the possibility
of environmental harm. Equally, a market exists for testing
equipment to monitor emissions or the toxicity of waste
products. Finally, businesses can use environmental policies
as a means of obtaining a competitive advantage. The
Atmosphere (chemicals
and GHGs such as CO2)
Emissions reduction
Energy, Business operations
resources
Resource
Streamlining of
recycling, reuse
energy and
material
procurement
Hydrosphere
(chemical substances)
Emissions reduction
▲ Figure 6.40 The factors influencing the standards used in Toshiba Group’s environmental audit, 2019
» its emissions of gases such as carbon dioxide
» the business’ use of energy, water and other resources,
and their environmental impact – generally businesses
set themselves targets of using fewer resources
» how much waste the business creates and how it
disposes of it
» the impact of its use of transport on the environment
» how the business’ operations impact on biodiversity –
this could be vital, for example, for businesses
producing or using herbicides to control weeds in crops
» the supply chain used. If a business’ suppliers do not
operate in an environmentally friendly manner, it can
have a substantial effect on the business’ environmental
performance. The supply chain can determine over half
of the organisation’s impact on the environment.
German car manufacturer, BMW, for example, promotes
itself as a manufacturer of cars that are almost entirely
recyclable. This could prove attractive to environmentally
aware consumers.
6.1.3–7
6.1.7.2 The use of environmental audits
Many businesses conduct environmental audits to assess
the impact that their operations may have on the physical
environment. This type of auditing began in the USA
in the 1970s and has spread globally. It is particularly
6.1.7 Environmental
common in businesses that operate in industries with the
potential for environmental damage, such as airlines and car
manufacturing. An environmental audit may cover a range
of a business’ activities:
Environmental impacts
Recycling
Products
Users
Waste,
end-of-life products
Promoting the
three Rs
(reduce, reuse
Final disposal and recycle)
(waste)
Emissions reduction
Source: Toshiba Group’s Environmental Report, 2019
The performance of the business in each of the areas of
its activity will normally be judged against targets set by
the business itself and any relevant regulatory standards
imposed by environmental legislation. Figure 6.40 shows
the aspects of its operations that would be used to develop
standards for Toshiba Group’s environmental audit. The
Toshiba Group is a Japanese multinational company that
manufactures a range of electronic products.
GLOSSARY TERM
An environmental audit is an independent assessment
of a business’ activities to judge the extent to which it is
complying with relevant laws and its own policies.
283
 A business might take an environmental audit for a number
of reasons:
6.1.3–7 » to ensure it meets any necessary legal requirements
» to protect or improve its corporate image
» in response to concerns about the environmental impact
of its operations, including previous accidents that have
damaged the environment
» to help with a decision on whether or not to invest in new
assets, such as a new factory or production equipment.
Environmental audits are normally conducted by
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER
independent organisations that specialise in this type of
work. Prior to the audit, the standards against which the
audit is to be conducted will be discussed and agreed.
Once the audit is complete, the auditing organisation will
submit a report detailing its findings against the relevant
standards. If the audit reveals weaknesses, the business
will take any necessary steps to improve its environmental
performance. Table 6.16 shows part of the results of the
Toshiba Group’s audit in 2019, identifying good and non-
conforming aspects within different areas of its operations.
▼ Table 6.16 Adapted from part of the outcome of Toshiba
Group’s environmental audit, 2019
Items to be Number of non- Number of
confirmed conforming items good examples
Environmental 15 9
policies and systems
Legal compliance and 9 4
risk management
Business processes 9 2
Products and services 4 8
Information 1 13
disclosure and
communication
Supply chain 4 0
management
Source: www.toshiba.co.jp/env/en/management/audit.htm
The information in an environmental audit can be used
by the business itself as well as by a number of its
stakeholders.
» The business The managers within the business will
use audits for a variety of purposes. A primary use is to
identify aspects of the business’ operations which may
not meet the company’s own standards or any relevant
regulations. Once any non-conforming aspects have
been identified, suitable corrective action can be taken.
In Toshiba’s case in 2019, in Table 6.16, the company
may need to address a number of issues within its supply
chain. The business may also use this to help to present
an environmentally friendly image to help it increase
sales and market share. The Toshiba Group publishes a
huge amount of information about its environmental
performance. The company uses this as a competitive
weapon to enhance its status in consumers’ eyes.
284
» Customers Some customers, and especially those that
are businesses, will look closely at the environmental
audits of businesses from which they buy products.
Some will seek to deal only with businesses that protect
the environment; others will not wish to be associated
with a business that might receive bad publicity as a
result of damaging the environment. Most customers
will be interested in product safety and disposal of the
products once they are no longer useful.
» Employees Employees of a business, or their trade
unions, may monitor the business’ audit to check on their
safety in the workplace. Much of the information in an
environmental audit is of relevance to this stakeholder
group, including emissions of gases, the effects of
reported chemical spills and training on health hazards.
» Suppliers The information in an environmental audit is
important to suppliers. It sets out the environmental
standards to which the business expects to operate
within its supply chain. It also shows the recent
performance of suppliers, enabling them to judge and, if
necessary, improve their own performance.
6.1.7.3 The impact of sustainability on
business and business decisions
Sustainability can be considered to have three elements:
economic, social, and environmental (also known as
the three Ps: profit, people, and planet). The aim of a
sustainable business approach is to meet the current needs
without destroying the chances of future generations
meeting their needs. Sustainability may involve using
minimal resources in production, possibly by recycling,
allowing employees to work from home to reduce time spent
commuting, and not using resources that cause pollution,
such as oil or gas.
For a business to be sustainable, it must focus on long-term
strategies for making a positive impact on the environment
and on society. Sustainability is about considering business
decisions in terms of years, or even decades, and considering
many more factors than just short-term financial benefits.
Consumer awareness of the importance of sustainability
has increased as high-profile campaigns (such as the
one about plastic waste) highlight the issues. According
to a report in 2018, 81 per cent of respondents of a
global survey felt strongly that companies should help to
improve the environment. Approximately 85 per cent of
respondents born between 1981 and 1996 stressed the
importance of businesses protecting the environment.
These consumers are projected to be spending $150
billion on sustainable goods by 2021, which sends a clear
message. Further research, however, shows that many
businesses have been slow to respond to consumers’ desire
for sustainable business models. In 2018, only 27 per cent
of businesses surveyed included sustainability in their
business strategy.
 CASE STUDY
Unilever says sustainability is key to business model
Unilever is a multinational manufacturer of consumer
products. It makes a number of well-known and popular
brands such as Persil, Dove and PG Tips. The company
puts corporate social responsibility at the heart of its
operations through its Unilever Sustainable Living Plan
or USLP. It has moved to using sustainable resources to
reduce its environmental footprint.
‘We want to help create a world where everyone can live
well within the natural limits of the planet. By using our
resources as a business to address issues such as health
and hygiene, gender equality, climate change and plastic
packaging waste, we are delivering short-term and long-
term benefits for our shareholders and society.’
Rebecca Marmot, Chief Sustainability Officer, believes that
the USLP has brought many benefits. ‘Unilever’s Sustainable
Living Brands – which include brands like Dove and
Hellmann’s – have consistently outperformed the average
growth rate of other products since 2014. We have avoided
over €1 billion in costs, by improving water and energy
efficiency in our factories, and using less material and
producing less waste. The USLP has also become a decisive
factor in helping Unilever to attract the best talent, and
has been instrumental in forging strong partnerships with
NGOs, government organisations and other businesses.’
Businesses can take a range of decisions to make their
operations more sustainable. We shall consider a few of
these below.
» Reduce waste Some businesses produce large amounts
of waste directly or indirectly. Reusing resources such as
water can cut waste during production, as can making
products and packaging recyclable. Some analysts argue
that selling products that are not recyclable will become
increasingly difficult in the future. Equally, compostable
packaging is becoming an essential for many consumers.
» Energy usage This is another high-profile element
of sustainable production. Using fossil fuels creates
carbon emissions, which contributes to the rise in
global warming. Many businesses are switching to
using renewable forms of energy for all aspects of
their operations, including the use of electric cars.
Consumers increasingly expect and respond positively
to such initiatives. Businesses in the energy industry
are also under pressure to adapt their products to make
them sustainable. For example, BP, one of the world’s
largest oil companies, is committed to developing clean
and renewable sources of energy over time.
» Change business cultures Senior managers must
take strategic, long-term decisions to make the
business more sustainable. However, this is unlikely
to be successful unless people at all levels within the
6.1.3–7
Unilever annually reports progress against its targets
in its Sustainable Living Report – an audit of its social
responsibility activities. Some of its successes include:
● more efficient use of energy and water in its factories
● offering health and hygiene programmes to 1.3 billion
people
6.1.7 Environmental
● no longer sending any waste to landfill sites and reducing
waste resulting from consumption of its products
● using only renewable electricity throughout the company
and halving gas emissions from manufacturing
● lowering the quantities of sugar in beverages and
meeting high nutrition standards for foods that are
manufactured
● employing a workforce in which women have more
opportunities and are in 51 per cent of management
roles.
Source: www.unilever.com/news/press-releases/2020/unilever-
celebrates-10-years-of-the-sustainable-living-plan.html
Questions
1 Unilever’s USLP has reduced the business’ costs of
production by €1 billion. Analyse two ways in which
this might have occurred. [8]
2 Evaluate how Unilever’s shareholders might react
to the company’s USLP. [12]
organisation support the move. This may require training
and a shift in the business’ culture. For example, it
may require managers to develop a more innovative
culture to encourage employees to develop new ideas
and approaches to making the business’ operations
sustainable.
» Marketing decisions As we saw earlier, changes in
consumers’ opinions are driving businesses to make the
changes necessary to make the organisation sustainable.
It is therefore vital for businesses to promote their
‘green credentials’ once they are in place. This can be
an important element of maintaining competitiveness.
This is a major reason for the Toshiba Group incurring
considerable costs in environmental audits and reporting
its findings. Many companies use their sustainable
policies in their promotional activities.
» Investment decisions Businesses are increasingly
recognising the advantages of investing in ‘clean’
technology to allow their operations to become more
sustainable. Others are making enormous strategic
decisions to supply products which do not damage the
environment. Volkswagen, the German car manufacturer,
has decided to stop producing cars with petrol or diesel
engines and has switched production to electric cars. It
believes this investment will generate good returns in
the long term.
285
 TEST YOUR LEARNING
6.1.3–7
Short answer questions
1 Explain one implication of an environmental change
for businesses.
2 a Define the term ‘corporate social responsibility’. [2]
b Explain one implication for businesses of meeting
their corporate social responsibilities.
3 Explain two reasons why a small retailer competing
A LEVEL 6.1.3–7 EXTERNAL INFLUENCES ON BUSINESS ACTIVITY: OTHER
with much larger rivals might decide to meet its
corporate social responsibilities as fully as possible.[6]
4 a Define the term ‘pressure group’.
b Explain one way in which a manufacturer might
meet its responsibilities to the local community. [3]
5 a Explain one important trend over recent years
in the population of a country with which you are
familiar.
b Explain one impact this trend in population may
have had on local businesses.
6 a Explain one marketing decision that a business
may take in response to technological change. [3]
b Explain one reason why employees may welcome
technological change.
7 a Explain one barrier to entry that an entrant to an
industry may face.
b Explain one way in which a business’ decisions
may be influenced by the structure of the market
in which it operates.
8 a Define the term ‘trade openness’.
b Explain one way in which international trading
links might pose a threat to a business.
9 Explain one difference between a bilateral and a
multilateral trade agreement.
10 a Explain how one area of business activity might
be affected by environmental factors.
b Explain one difference between internal and
external costs of production.
Data response question
Muirvale Housebuilders
The structure of the UK’s population is changing quickly,
especially flows of migration and age patterns. At the
same time, the number of single-person households
286
is rising. By responding quickly and efficiently to such
changes, Muirvale Housebuilders, one of the UK’s smaller
housebuilding companies, has increased its profits
[3] steadily, although its profits declined last year. It trades
in a market that is dominated by large companies such
as Taylor Wimpey. Muirvale’s prices are 5 per cent higher
[3] than the market average.
Muirvale’s corporate plan sets out:
– its intention to build a greater variety of properties
than most of its competitors, including large, small
[2] and retirement properties
– its commitment to meet its customers’ needs as fully
as possible, including after-sales service
– its aim to enhance its reputation for quality products.
[3] Part of the company’s strategy is its use of corporate
social reporting, of which it was an early adopter. It uses
[3] sustainable materials and builds on more expensive
brownfield (previously developed) sites whenever it can. It
wishes to present itself as a socially aware business and,
in particular, aims to be environmentally friendly as far as
possible. It uses the results of its corporate social report
[3]
extensively in its marketing.
[3] Muirvale’s market research has shown that, possibly
owing to tougher economic conditions in the UK, demand
for most types of housing in the UK has become more
[3] price elastic. The research has also revealed a high level
of awareness of Muirvale’s socially responsible behaviour.
[2]
Questions
[3]
1 Analyse two demographic changes that may have
influenced Muirvale Housebuilders’ corporate
[3] plans. [8]
2 Evaluate how the existence of larger competitors
[3] might influence Muirvale Housebuilders’ decisions. [12]
3 ‘Muirvale Housebuilders should continue to produce
[3] its corporate social report.’ Evaluate this view. [12]
Essay question
1 ‘Concern about possible damage to the environment
is the most important factor affecting the external
environment, particularly for large businesses.’
Evaluate the extent to which this statement is true. [20]
 6 Business and its environment
A LEVEL
6.2.1 Developing business strategy
Chapter overview
In this chapter we examine:
★ business strategy
★ strategic management
★ approaches to developing business strategy.
6.2.1.1 Business strategy
A business strategy is the long-term plan of a business
that is developed to help it achieve its objectives. For
example, to achieve growth, a business may decide to
target emerging economies, such as Brazil and China, as its
strategy. A strategic decision:
» is long-term – often strategies are planned to last for
several years
» involves high levels of resources, such as finance
» is high risk, due to the resources involved. There is also
a risk that the overall plan could be wrong (no matter
how well-implemented)
» is difficult to reverse. If resources have been committed,
it will not be easy to reallocate them.
Strategic decisions will be made by senior managers within
the organisation. They are difficult decisions to make, not
just because so much is at stake but also because they are
not decisions that are taken very often. A new strategy is
likely to be unique to the business and the situation it is in,
and therefore these are challenging decisions to make.
The purpose of the strategy is to identity clearly how the
business is going to achieve its objectives. The strategy may
set out which markets it is going to compete in, what its
product range will be and where the product will fit in the
market relative to competitors. Having a clear plan makes it
easier for everyone in the business to operate: it will help
managers to decide on priorities and where to allocate time
and funds. The strategy will help co-ordinate the actions of
everyone in the organisation, as they can consider how their
actions contribute to the overall plan.
The strategy is put into effect through a series of shorter-
term actions, known as tactics. For example, if the strategy
was to expand overseas, the business would need to decide
which foreign market to enter first, which products to offer
and whether to enter an alliance with a local business.
GLOSSARY TERM
Strategic management is the process of developing and
implementing a strategy.
6.2.1.2 Strategic management
6.2.1.2 Strategic management
Strategic management is the process of developing and
implementing a strategy.
It has three stages: analysis, choice and implementation.
» Strategic analysis involves an assessment of the current
position of the business and its environment, plus a
forecast of the opportunities and threats which might
emerge in the future. A business will want to assess how
good or bad its own internal activities are; for example,
how efficient is it? How much capacity does it have?
How strong is its brand? How well trained are its staff?
What is its financial position? It will also want to assess
the business environment; for example, how intense is
the level of competition? What is the economic climate
like? What technological changes are occurring in the
industry? By analysing the internal and external aspects
of the business, managers can identify the strengths
and weaknesses of the business and the opportunities
and dangers it faces. Some of the tools managers use
to analyse their business, such as SWOT analysis, are
examined below.
» Strategic choice occurs when managers decide on the
strategy they want to pursue based on their analysis.
These decisions may focus on what customers the
business wants to cater for; for example, should it
concentrate on its existing customers or aim at a
new group? Which products should it offer – should it
focus on existing products or develop new ones? Some
businesses choose to concentrate on gaining more
market share with their existing products in existing
markets; others may choose a different strategy, such
as developing new products for new customers. The
different strategic choices open to a business are
analysed later using models such as the Ansoff Matrix.
» Strategic implementation. Choosing a strategy may
be quite a complex decision but, to make sure it is
successful, it has to be implemented effectively. This is
often a challenge. Successful implementation involves
planning what has to be done when, by whom, to
what standard and using what resources. Successful
implementation involves making sure the right things
287
 happen at the right time in the right way. It involves
co-ordinating and managing resources and trying
6.2.1 to prevent things from overrunning, costing more
Strategic analysis Strategic choice
▲ Figure 6.41 Strategic-management process
A LEVEL 6.2.1 DEVELOPING BUSINESS STRATEGY
The need for strategic management
To develop a strategy a business will want to:
» set out its objectives
» analyse the business environment to determine the best
way of meeting these objectives
» analyse the internal functions of the business.
The ‘right’ plan will depend on what needs to be achieved,
the current situation of the business and the world around
it. As circumstances change, so should the strategy. A
business needs to be constantly reviewing what it is doing
because of changes inside and outside of the business.
New products, new staff, new competitors, new laws, for
example, mean a business has to review whether its existing
CASE STUDY
Disney
In February 2020, Bob Iger gave up his role as the Chief
Executive of Disney. At that time, Disney was extremely
successful. Its film division was highly profitable, with
seven of the ten biggest hits of 2019. It had just launched
its streaming service, Disney+, to challenge Netflix. It had
also completed a $69 billion acquisition of 21st Century
Fox. During Bob Iger’s 14 years in charge, Disney’s share
price had increased in value fivefold. However, by May
2020, profits were 91 per cent lower than the year before,
due to the impact of the Coronavirus (COVID-19) global
pandemic.
Coronavirus has had a major impact on Disney and
other entertainment businesses. Cinemas are shut,
advertising is down, filming is disrupted and there are
no live sports to show on television. However, Disney has
been hit especially hard given the nature of its portfolio.
Business strategy and competitive
advantage
The strategy of a business will determine the markets in
which it competes, what goods and services it offers and
how it wants to position itself relative to competitors. Will
it focus just on Europe? Will it concentrate just on hair care
products? Will it aim to be a premium brand or a discount
business?
The success of a strategy depends on whether it fits with the
strengths of the business (that is, can it do what it sets out to
288
than expected or not working. This requires effective
leadership and includes plans for how the business will
respond if something goes wrong.
Strategic implementation
plan is still appropriate. With the growth of online business,
does it need to have high-street stores any more? With the
opening up of more markets overseas, should it set up in
Russia? With more skilled staff, should it broaden the range
of services it offers? Strategic management therefore means
the business needs to review and analyse its position before
planning what to do next. It should ensure the business
strategy is appropriate for the conditions of the moment
and prepare itself effectively for the future.
Once a strategy is agreed, it then has to be put into practice.
The implementation of the strategy is as important as the
strategy itself – there is no point having a good plan and then
carrying it out badly. Equally, there is no point implementing a
strategy effectively if it is actually the wrong plan!
It relies heavily on its film studios, even more now that it
has acquired Lucasfilm (which owns Star Wars) and Fox.
This increased its consumer product sales (for example,
of light sabres and Iron Man toys) until the virus hit and
cinemas and shops closed.
Disney has also diversified into theme parks and leisure
facilities. In 2020, it owned six theme parks and four
cruise ships as well as an island in the Bahamas. These
have all been closed because of the outbreak of the virus.
Questions
1 Analyse two reasons why Disney’s share price had
increased under Bob Iger. [8]
2 Evaluate the reasons why Disney’s strategy
appears to have gone wrong. [12]
do effectively and efficiently?) and whether it fits the external
environment (a major push for growth at a time of recession
may be difficult, for example, whereas a move into products
for older people may work if the population is ageing).
Effective strategic management understands the internal
and external environment and, from this, develops a
strategy that is possible for the business to achieve and
that provides it with an advantage over rivals. Every
business will be seeking to find a strategy (such as cost-
cutting or differentiating) that will provide it with a
competitive advantage over its rivals.
The first stage in strategic management is to analyse
the existing situation to identify the strategic choices
available.
STUDY TIP
Never underestimate the importance of getting the right
strategy. If you are trying to develop your print publishing
business while everyone else goes online, you may be
doomed. If you invest in heavy, petrol-consuming cars
while the world becomes more concerned about the
environment, you will struggle. Getting the strategy
right is the key to success, which means you need to
understand the strengths of a business and the external
environment when analysing a case study.
6.2.1.3 Approaches to developing
business strategy
Blue ocean planning
This occurs when a business combines a strategy of
differentiation and low costs to create a new space in the
market and new demand. This approach seeks to create and
capture uncontested market space, which thereby makes the
competition irrelevant. The blue ocean view is that you can
redefine industries and markets.
In their book, Blue Ocean Strategy, Chan Kim and Renée
Mauborgne introduced the terms ‘red ocean’ and ‘blue
ocean’. Red oceans are all the industries in existence
today – this represents the known market space. In red
oceans, the industry boundaries are defined and accepted,
and the competitive rules of the game are known. In this
situation, companies try to outperform their rivals to grab a
greater share of existing demand. As the market space gets
more crowded, profits and growth are reduced. Products
become commodities, leading to aggressive, ‘bloody’
competition. This where the term ‘red’ comes from. By
comparison, blue oceans represent all the industries not in
existence today – the unknown market space, where there is
no competition. In blue oceans, demand is created instead
of being fought for. This creates opportunities for growth
that are both profitable and rapid.
▼ Table 6.17 Red and blue ocean strategies
Red ocean strategy involves: Blue ocean strategy
involves:
• Competing in the existing • Creating an uncontested
market space market space
• Attempting to fight and • Aiming to make the
beat the competition competition irrelevant
• Fighting for existing demand • Creating new demand
• Focusing on differentiation
or low cost
An example of blue ocean thinking led to the change made
by the French Groupe SEB. SEB moved out of the highly
competitive market for conventional French-fry makers
by creating a fry maker that operated without needing
large quantities of oil to be heated. The Acti-Fry made
healthier French fries with only one tablespoon of oil. This
transformed the market for French-fry makers. 6.2.1
Another example of a blue ocean strategy is Cirque du Soleil.
This is a Canadian entertainment business which began in
the 1980s, set up by a group of people who had a vision
of what they wanted a modern circus to be. They didn’t
want light-hearted entertainment for children. They wanted
a much more sophisticated experience with some of the
world’s best performers. Children were still in the audience,
6.2.1.3 Approaches to developing business strategy
but the high prices meant that what was offered had to
amaze adults. Cirque du Soleil did not attempt to be another
circus with clowns and performing animals – its blue ocean
strategy reinvented the market.
Scenario planning
This is another technique to help managers plan ahead.
In this approach, managers try to imagine three or four
possible scenarios that might develop in the future in their
industry. Scenario planning does not assume the future
will be like the past; it asks managers and experts to think
of what the world might look like in the future. This could
be very different from the past (as we saw with the rapid
collapse of financial markets in 2007 and 2008 across the
world). This technique has been used widely by Shell, where
managers work with experts to create possible visions of
what the world might look like in the future. For example,
one scenario might include a stable political position in
the Middle East, high levels of oil production and a low oil
price. Another might focus on high levels of intervention by
the government to reduce car usage, leading to high taxes
and low levels of demand. Managers then work on how these
scenarios might affect their business and the implications
for their strategy. Peter Schwartz, who was head of Shell’s
scenario planning team in the 1980s, describes scenarios as
‘stories that can help us recognise and adapt to changing
aspects of our present environment. They form a method for
articulating the different pathways that might exist for you
tomorrow, and finding your appropriate movements down
each of those possible paths.’
GLOSSARY TERMS
PEST analysis is a way of analysing the external
macroenvironment of business.
The macroenvironment refers to factors largely outside
the control of the business, such as the economy and
legal changes. A business cannot easily influence these on
its own.
PEST analysis
PEST analysis is a way of analysing the external
macroenvironment of business. The macroenvironment
refers to external factors that are beyond the control
of the business itself. PEST analysis examines Political,
Economic, Social and Technological factors. It can also be
known as PESTEL analysis, referring to Political, Economic,
Social, Technological, Environmental and Legal factors.
289

6.2.1
A LEVEL 6.2.1 DEVELOPING BUSINESS STRATEGY
Managers attempt to identify the relevant factors in their
environment and, again, rank them according to their
relative importance for the business.
» Political factors include legal issues, trade agreements
and changes in government policy.
» Economic factors include the interest rates, inflation,
economic growth and exchange rates.
» Social factors include demographic factors and social
trends.
» Technological factors involve changes in technology.
The results of a PEST analysis will vary from business to
business. For some, the economic growth of a country will
be vitally important; for others, what the government is
doing may be more significant. Furthermore, if a business
operates in many different countries or has different
business divisions, it may need to undertake a number of
PEST analyses. These need to be reviewed regularly as the
external environment changes.

CASE STUDY
Africa’s expanding market

Source: McKinsey & Company

▲ Figure 6.42 The size of Africa

290
 The physical size of the African continent is often
underestimated. Figure 6.42 helps put it in perspective.
Africa covers 11 million square miles. According to the
management consultant, McKinsey, many managers
underestimate the size of African markets and
overestimate the challenges they will face. This leaves
Africa as a real opportunity for many businesses.
There are, of course, challenges such as economic and
political volatility and some infrastructure limitations
in a number of countries. However, Africa has 1.2 billion
potential customers and this number is expected to
double by 2050 (at a time when world population growth
is generally slowing). Africa will soon be the fastest-
urbanising region in the world. Africa already has as many
cities with over 1 million inhabitants as North America
does, and more than 80 per cent of its population growth
over the next two decades will occur in cities. The income
per capita of Africa’s cities is more than double the
continental average, making them attractive markets for
many businesses. Consumer spending in Africa was over
$1.4 trillion more than India’s in 2019.
SWOT analysis
A SWOT analysis considers the internal and external
environments of a business.
‘S’ and ‘W’ stand for strengths and weaknesses. These
are internal features of a business at the present time.
Strengths may include:
» a high level of cash funds
» a strong brand name
» a good distribution network
» highly skilled staff.
Weaknesses might include:
» high borrowing
» a lack of new products being developed.
‘O’ and ‘T’ stand for opportunities and threats. They refer to
external events that might happen in the future. Threats are
events that might damage the business and opportunities
might benefit the business. Opportunities might include:
» entering new markets overseas
» an alliance with a competitor to develop new technology
» going online.
Threats might include:
» legislation that would increase wage costs
» new competitors entering the market
» takeover by a competitor.
Managers will try to identify the relevant strengths,
weaknesses, opportunities and threats. They will then rank
Africa already has many big companies (over 400
with a revenue of over $1 billion) and a tremendous
entrepreneurial spirit. Many entrepreneurs have 6.2.1
set up specifically to meet unmet demand in Africa.
For example, Jumia is one of the continent’s leading
e-commerce businesses. M-Kopa sells solar power kits
to over 600 000 rural households. Roha is an investment
company which supports manufacturing businesses; a
recent investment by Roha is an $80 million glass-bottle
plant near Addis Ababa. The plant has the capacity to
6.2.1.3 Approaches to developing business strategy
produce 200 million bottles a year.
Africa is not a continent to ignore.
Questions
1 Analyse two reasons why Africa might be a good
region of the world for businesses to target. [8]
2 Evaluate the usefulness of PEST analysis when
assessing Africa as a potential market. [20]
them in order of their significance – what is the biggest and
most damaging threat, for example?
The process of undertaking a SWOT analysis involves
discussion and, in itself, is useful to get managers sharing
ideas and perspectives. SWOT analysis is the basis for
strategic planning.
Developing the outcome of a SWOT analysis into
strategic objectives
Once a SWOT analysis has been undertaken, managers should
have a clearer view of what the business is good at, what
its weaknesses are, what it could be doing and what it
must protect itself against. From this, they can develop a
strategy (or series of strategies) which may seek to:
» build on their strengths to exploit their opportunities;
for example, use the brand to launch more products
» reduce or remove their weaknesses; for example, reduce
borrowing
» protect themselves against threats; for example, taking
over a competitor who is threatening to take more
market share.
A SWOT analysis is not a one-off exercise. Given that the
internal and external environment is constantly changing,
it should be continually reviewed and strategies adjusted
accordingly. For example, a strategy of growth may be
appropriate in a booming economy, but in a recession it may
be necessary to focus on survival.
291
 CASE STUDY
6.2.1
Colgate
Colgate describes itself as a caring, innovative growth ● number 2 position worldwide in liquid fabric
company that is reimagining the future for people, their conditioners, and hand dishwashing
pets and our planet. The company says it keeps a tight ● number 1 market share in vet clinics in the USA.
focus on four product categories: oral care, pet nutrition,
Colgate is the brand most recommended by the
home care and personal care. Its brands include Colgate,
dental profession worldwide, and it also has a strong
Palmolive, Ajax, Sanex and Hills Pet Food. These
recommendation by vets worldwide.
A LEVEL 6.2.1 DEVELOPING BUSINESS STRATEGY

brands have strong market positions. For example, the

company has: The company’s strategy is to drive organic sales growth.
● number 1 position worldwide in the liquid hand soap This, it says, will be achieved by:
market ● accelerating growth through product innovation and
● number 2 position worldwide in bar soaps and liquid building on existing brands
body cleansing market ● innovating to gain share in high-growth market
● number 1 position worldwide in manual segments
toothbrushes ● expanding in new distribution channels
● number 2 position worldwide in mouthwash ● maximising growth online
● number 1 position in worldwide market share in ● investing to gain greater market penetration in
markets where it competes growing populations.
50

40.6
40 Colgate 41.1

30

20
13.7 Competitor 1 15.5
Competitor 2 12.6
10 13.2
12.9 Competitor 3 7.5

0
‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 ‘13 ‘14 ‘15 ‘16 ‘17 ‘18 ‘19
Year to date
Source: Colgate-Palmolive Company
▲ Figure 6.43 Colgate’s market share of the worldwide toothpaste market

61.6%
Questions
41.3%
1 Analyse two reasons why Colgate keeps focused
37.1%
on just four product categories. [8]
2 Evaluate the ways in which Colgate’s strengths
might influence its strategy. [12]
Dove Coca-Cola Colgate
▲ Figure 6.44 Proportion of households buying Colgate
products

CASE STUDY
Increasing environmental awareness
Greater environmental awareness among citizens and
governments led to the signing of the Paris Agreement
in December 2015. This was an agreement among many
governments to take action on climate change and which
naturally has implications for business. The desire to
achieve a low-carbon economy expressed by the Paris
Agreement means that businesses will need to change
what they produce and how they produce it. For example,
we are starting to see a significant move away from diesel
vehicles and towards electric ones.

292
Increasing environmental awareness also means there
is pressure from investors for more information on how
businesses are producing. For example, the Climate
Action 100+ is an initiative by 256 investors. These
investors have trillions of dollars in their funds and
will only invest in businesses which have high levels of
disclosure about their impact on climate change.
CASE STUDY
Lego
Lego’s mission is to bring LEGO® play to more children
around the world. Lego says that:
When children play, they learn. They learn lifelong skills like
problem-solving, communication and collaboration, which
are more critical than ever. A study by the World Economic
Forum estimates that, given the pace of change, 65 per cent
of kindergarten children will hold jobs that have not yet been
invented. The only way that children can be prepared is to
give them skills that can be applied whatever their job turns
out to be.
Play is an effective way to develop these skills from a young
age, and LEGO® play is especially powerful as it offers
children endless possibilities. Just six two-by-four LEGO®
bricks can make 915 million different combinations. Our
strategic priorities are designed to deliver long-term,
sustainable growth and, importantly, bring the power of
LEGO® play to even more children around the world in order
to inspire and develop builders of tomorrow for generations
to come.
Sustainable growth
The company’s designers strive for creativity and
innovation. Each year, around 60 per cent of the
company’s products are new. The company is also
creating completely new approaches to play, such as
LEGO® Hidden Side, which combines augmented reality
and building. It has also built LEGO® play into a range of
digital experiences such as digital games, apps and voice-
based intelligent home assistants. Developing ‘fluid play’
– the combination of digital and physical play – will be a
priority for Lego now and in the future.
STUDY TIP
The key to PEST and SWOT analysis is to prioritise the
key issues in the external and internal environments.
Managers can list their business’ strengths and
weaknesses and the opportunities and threats in the
environment, but the key is identifying which are the most
important ones and, therefore, being able to know where to
concentrate their thinking.
Questions
1 Analyse two actions governments might take to
achieve a low-carbon economy. [8]
6.2.1
2 Evaluate the impact of climate change on business
strategy. [20]
6.2.1.3 Approaches to developing business strategy
Innovating retail
Digitalisation and the rise of e-commerce are reshaping
the toy retail market, as shoppers look for new
experiences from different sources – powerful brand
experiences in physical stores and ease and value for
money online. To adapt to these changes, Lego is investing
its retail ecosystem, for example, by upgrading its
LEGO.com e-commerce site and opening nearly 150
branded stores, including flagship stores in Amsterdam
and Beijing.
Expanding into new markets
Lego’s annual report points out that, ‘by 2032, 90 per cent
of the world’s 2 billion children will live outside Europe and
North America, with more than three-quarters living in
eastern Asia’. Perhaps not surprisingly, Lego is increasing
investment in these growth markets. For example,
Lego plans to have over 200 stores in around 40 cities in
China in the near future. It has also continued to build its
e-commerce presence on popular platforms, such as Tmall
and JD, and extend its partnership with Tencent to provide
unique digital content and games. The company was also
pleased with the success of its new product range, which
was designed to celebrate Chinese New Year. This showed
Lego that there is strong consumer demand for culturally
relevant products.
Source: Lego Annual Report 2020, https://issuu.com/
arturocreative/docs/lego_memoria_ final
Questions
1 Analyse two factors influencing Lego’s strategy. [8]
2 Evaluate the opportunity that digital technology
creates for Lego. [12]
293
 The role of business vision/mission
6.2.1 statements and objectives in strategic
analysis
Whatever strategies are developed, these must fit with the
overall mission statement or vision of the business. If the
mission is to be ‘the world’s greatest airline’ then a strategy
that takes the business into soft drinks would not fit; if the
A LEVEL 6.2.1 DEVELOPING BUSINESS STRATEGY
CASE STUDY
Environmental profit and loss statements
The way customers have been buying clothes is, in many
cases, extremely environmentally unfriendly. On average,
people are buying 60 per cent more items of clothing today
than they did 15 years ago but they only keep them for half
as long. So we are buying more new clothes and using
them less than we used to. This is bad for the environment
because production of textiles has a greater effect on
climate change than international aviation and shipping
combined, as a recent UK parliamentary report highlights.
However, consumers may change their habits and
are expected to ask more questions about how their
clothes are made in the future. Generation Z (those born
between 1995 and 2010) are especially interested in the
environmental impact of the clothes they buy so, to target
these customers, producers need to look at what they do.
One way in which brands may respond is to calculate the
environmental costs of producing goods and express
these in monetary terms so the business, its customers
The role of Boston Matrix analysis
A business may use the Boston Matrix, which we covered
on pages 122–123, as part of the data gathered for a SWOT
analysis. The Boston Matrix highlights the position of
different products in their market and the growth of the
market as a whole. Undertaking this analysis enables a
business to take a view of what its strategy should be next.
Stars Question marks
High
Market growth (%)
Cash cows Dogs
Low
High Market share Low
▲ Figure 6.45 The Boston Matrix
294
mission is to be ‘the leading global pharmaceutical company’
then a strategy that involves retrenchment to focus on just
the domestic market would not be acceptable. The mission
sets out the overall guidelines within which strategies
must fit. It sets the scope of the business’ activities, for
example, in terms of where it wants to compete, which
product markets it wants to be involved in and the relative
focus on different stakeholder groups.
and investors can assess the impact of its activities.
The ‘Environmental Profit and Loss Account’ (or EP&L)
developed by Kering (the owner of brands such as Gucci
and Balenciaga) is one way of doing this. This approach
provides a methodology to measure a company’s
environmental impact in a way that can be compared
between businesses. It takes into account carbon
emissions, air pollution, water use, water pollution, waste
generation and any land adaptation needed to produce
the product. All of these are costed and included in the
company’s environmental profit and loss.
Questions
1 Analyse two benefits to businesses of producing
environmental profit and loss statements. [8]
2 Evaluate the importance to a business of taking
account of environmental issues when developing
its strategy. [12]
For example:
» Dogs (low growth, low market share). Should the
business sell off these products or stop producing them?
Or, if it invests heavily, is there a chance of reviving
them successfully?
» Cash cows (high market share, low market growth). Can
the business milk these (that is, take as much cash as it
can from them) to finance investments elsewhere?
» Question marks (or problem children; low market share,
fast market growth). Should the business invest in these
to build them up?
» Stars (high market share and growth). Should the
business invest to protect and grow these?
The business will also take an overview of its portfolio. If it is
too reliant on cash cows, for example, it may need investment
into new products for the future. If it has too many question
marks, for example, this is quite high risk in the short term.
For very large firms the Boston Matrix is used not just for
products but for the whole business. If a company owns
many other companies then it may analyse the relative
strength of these using the matrix and decide which ones to
sell, invest in and milk.
Porter’s Five Forces analysis
Businesses will also want to analyse the markets in which
they operate. A common tool used for this is Porter’s Five
Forces analysis. This examines five different forces which
determine the likely profitability of an industry. The
immediate business environment that contains these forces
is known as the microenvironment (or the competitive
environment). It includes groups that the business is likely
to interact with regularly. These groups exert forces on the
business, namely:
» rivalry
» entry threat
» buyer/supplier power
» substitute threat.
An understanding of the existing forces will determine the
profits that can be generated, but it will also highlight how
a business might want to change its strategy to make the
forces more favourable. These forces are examined in more
detail below.
GLOSSARY TERM
The microenvironment (or the competitive environment)
refers to groups or individuals that businesses regularly
interact with, such as suppliers, distributors and
competitors.
Rivalry
This refers to the number of firms in the market and their
relative size. If there are many firms of a similar size then
the potential profits of the market have to be shared
between them, reducing the likely profits of any one
business. However, if the market is dominated by, say, two
firms then their profits are likely to be relatively high.
Entry threat
The way a business behaves will not only be affected by the
existing number of competitors in the market but will also
depend on how likely it is that other firms will enter the
market in the future. This in turn depends on the existence
of barriers to entry, which are factors that make it difficult
to enter a market, such as:
» Entry costs Heavy investment may be required to set up
the business because of specialist equipment or facilities
needed. You can imagine that setting up a chemical
plant or car manufacturing premises could require quite
large sums of money. This will automatically make it
difficult for some entrepreneurs to enter the market.
By comparison, setting up an online business might be
relatively cheap.
» Brand loyalty If the established firms have a high level
of brand loyalty then it will be more difficult for others
to enter the market, because of the problems in gaining
sufficient market share to break even. Loyalty to Nike
sportswear and Twinings tea, for example, make entry
into these markets quite tough.
» Legal restrictions If the existing provider has a patent,
this means you cannot imitate the invention without
permission (and usually paying a licensing fee). 6.2.1
High barriers to entry mean that the firms already in the
market are ‘safe’ from competition, at least for a while.
This means that the competitive pressure is reduced and
this may affect the quality of the service. On the other
hand, if entering a market is very simple then it is highly
competitive, forcing better service. For example, setting
up a sandwich shop is not particularly expensive or
6.2.1.3 Approaches to developing business strategy
difficult, and so there is enormous pressure in terms of the
prices charged and quality of food and service provided.
There are always shops closing and opening and new
forms of food emerging because of the very high level of
competition. This is good for customers but not so good for
the entrepreneurs, who have to remain very responsive to
market requirements to survive.
If there are very few barriers to entry, this is likely
to reduce the profits being earned by the established
businesses in an industry. If high profits are being
made by existing firms, more businesses will enter
and the profits will have to be shared out among more
organisations. If, however, there are high barriers to entry
then existing firms can make high profits without others
entering to take them away.
Buyer/supplier power
The competitive environment in a market also depends on
the power of buyers and suppliers. All businesses are part
of a supply chain and are reliant on other businesses or
individuals that they buy from or sell to. If you are reliant
on a few key suppliers then they are likely to be able to
charge you more, and the level of service they have to
provide may not be that high because you need them so
much. They are likely to be able to increase their profits at
your expense – you pay them more so your profits fall and
theirs increase.
Raw materials
Supplier
Manufacturing
Distribution
Customer
Consumer
▲ Figure 6.46 A supply chain
The power of suppliers depends on:
» their number and how similar their products are. If it
is easy for you to switch suppliers then their power is
lessened
295
 » their size and the extent to which they depend on
you. If the suppliers are small and rely on you then you
6.2.1 have power over them. If you represent only a small
percentage of their business then they have more power,
because they are more likely to reject your requests if
they choose.
Similarly, buyer power affects what happens in a market. If
buyers have a lot of power, they may be able to push the
price down and insist that the product is amended to meet
their requirements. If buyers are powerful, you are likely
A LEVEL 6.2.1 DEVELOPING BUSINESS STRATEGY
Substitute threat
This refers to the ease with which a buyer can switch to
an alternative type of product that performs the same
function. If you are charging high prices for aluminium
cans, could buyers switch easily to plastic bottles? If
the price of air flights is high, can buyers switch to sea
ferry and trains to get to their destinations? The greater
the substitute threat, the more buyers can move away;
therefore, the prices that existing firms will be able to
charge will be lower, as will their profits.

to receive a lower price, reducing your profits. A buyer will ▼ Table 6.18 Porter’s five forces summary
have power if:
» there are relatively few buyers, so that the business Five forces
relies on them heavily. For example, if a company makes Rivalry
very specialised technical equipment, there will be a
limited set of customers, so the business will need to
retain those customers. On the other hand, the loss of Barriers to
one customer at a nightclub may not be that significant entry
» they have many potential alternative suppliers, so they Buyer power
can switch away from a business relatively easily if they
need to. This puts the business in a weaker bargaining
Supplier
position. If you are the only firm that can produce a
power
particularly complex piece of equipment then you have a
lot of bargaining power; if you are one of many possible
suppliers of paperclips, you are not in such a strong Substitute
position. threat
Effect
Low rivalry means there is little competition
and this enables higher profits.
High barriers protect existing firms and
enable higher profits.
Low buyer power means established firms can
charge more and earn higher profits.
Low supplier power enables established
firms to push down the price of supplies,
increasing profits.
Low substitute threat means customers cannot
easily switch away, enabling higher profits.

CASE STUDY
Aerospace and defence
The global aerospace and defence industry, perhaps
more than any other industry, involves huge numbers
of parts to produce the finished product. A fighter jet
engine, for example, has thousands of complex individual
parts, which means there are thousands and thousands
of specialist parts suppliers. Each and every one of them
is contributing to the manufacture of planes, missiles or
engines that are sold for billions of dollars.
The aeroplane makers like Airbus and Boeing, the engine
makers such as GE and Rolls-Royce, and the defence
firms including Raytheon and Northrop Grumman, are
huge and powerful organisations. Each of them has
trading relationships with a vast number of suppliers, who
in turn rely both on the big players and on each other.
The industry often experiences mergers and takeovers.
For example, in the commercial aviation market, most
deals tend to involve a supplier (such as a company
making the landing gear for an aeroplane) buying one
of its suppliers (for example, one that makes smaller
components such as nuts and bolts, or springs and
levers). The deals tend to be larger than $200 million, but
smaller than $500 million. They are often paid for in cash.
In addition to having the right skills, suppliers must also
be sufficiently large and capable to respond to the big
players’ requirements. Having suffered delays to major
programmes, such as the Airbus A380 and the Boeing 737,
as a result of difficulties in dealing with suppliers, both
are eager to deal with fewer suppliers of everything, from
seats and curtains to in-flight entertainment equipment
and avionics.
Questions
1 Analyse the effect of two of Porter’s five forces
on the likely profits of aeroplane manufacturers. [8]
2 Evaluate the effect of the power balance between
defence manufacturers and governments on the
profits being earned in the industry. [12]

» few competitors and substitutes, so that customers

Actions to change the competitive
environment
Businesses try to make the competitive environment more
favourable. This means that to increase their own chances of
success they would want:
» a high barrier to entry, so that other businesses will not
enter the market – this would remove a competitive threat
could not easily find alternatives
» low supplier power, so that they have power over
suppliers. This might mean that they can demand a low
price and do not have to pay quickly for the items (and
so can hold on to the money and earn interest in the
bank for longer)

296
» low buyer power, so that buyers are dependent on their
products. This should make demand more price inelastic,
and so they may be able to charge more for their
products.
Businesses will want to change the five forces to make the
industry more favourable. For example, they might:
» join together in an industry association to have more
buying power over suppliers
» buy competitors’ companies to reduce the degree of
competition in the market
» develop USPs to reduce the ability of customers to find
substitutes.
STUDY TIP
You need to be able to decide on the relative strength of
the five forces in a given industry and the impact of this on
the profitability of businesses. You should also consider
how businesses might react to influence the forces and
make them more favourable. Make sure you are clear
about the difference between substitute threat and
rivalry, as these are often confused. A business producing
the same type of product is a rival. A business producing
something that consumers might switch to is a substitute.
Core competencies framework
Working with CK Prahalad, Gary Hamel, an American
management consultant, developed the concept of core
competencies in relation to strategic management in
1990. ‘Core competencies are the collective learning in
the organisation, especially how to co-ordinate diverse
production skills and integrate multiple streams of
technologies.’ In summary, core competencies are the
things that an organisation does extremely well, and an
organisation’s strategy should be based on these things.
Prahalad and Hamel identified three factors in their
framework to identify the core competences of a business.
Core competences should:
1 provide access to a wide variety of markets A business
may be particularly good at new product development
and could extend into many different product
categories. Or it may be good at developing technology
to link people who want to offer a service to those
who want to use that service, such as house rental, car
rental, bike rental or food delivery
2 deliver a significant customer benefit Businesses need
to consider what it is that makes customers choose one
business over another – is it the ability of the producer
to produce the same product more consistently than
other? Or more quickly? Or better designed?
3 be difficult for competitors to copy There is little
point having a competence that others can provide
as well. This is because it means the business won’t
stand out. A core competence should be something
that requires a particular technology, location, culture
or system that others struggle to imitate. For example,
a business may have patented technology that others
cannot use without permission.
Hamel and Prahalad argued that if an organisation is not
good at something, it should consider outsourcing it to
others that have competencies in these areas. Businesses
should concentrate on what they are good at and build on
6.2.1
this. For example, a business might make smartphones but
its actual competence is in its assembly skills, which could
be adapted to other products.
Hamel saw strategic planning not as a series of logical
steps but as moments of dramatic change. He said that
‘Strategic innovation will be the main source of competitive
6.2.1.3 Approaches to developing business strategy
advantage in the future.’ He believed great strategies come
from challenging the existing situation.
Businesses need to think about their purpose, seek out
ideas from the fringes and, in particular, embrace the
democratising power of the internet. They need to think of
their competencies and build their strategies based on this.
The Ansoff Matrix
The Ansoff Matrix was developed by Igor Ansoff (1918–2002).
It examines strategies in terms of the products offered
and the markets a business competes in. It highlights four
possible strategies open to businesses, as in Figure 6.47.
Products
Existing New
New product
Existing Market penetration
development
Markets
New Market development Diversification
▲ Figure 6.47 The Ansoff Matrix
» Market penetration This strategy occurs when a firm
tries to sell more of its existing products to its existing
customers. To achieve more sales, the firm may adjust
elements of its marketing mix. For example, it may
increase its spending on advertising or cut its prices.
This is a relatively low-risk strategy because managers
are familiar with the products and markets. It may be
possible to implement actions to boost sales in existing
markets in the short term.
» New product development This strategy focuses on
developing new products and offering these to existing
clients. Firms operating in the soap, shampoo and
laundry detergent markets, for example, are continually
developing new brands for their customers. This strategy
is risky in the sense that many new products often fail.
Only one in ten new products launched survives the
first two years, so all the investment in developing the
product can be lost. On the other hand, managers should
have a relatively good understanding of the market and
their customers’ buying processes, and so they may feel
297

6.2.1
A LEVEL 6.2.1 DEVELOPING BUSINESS STRATEGY
confident (often wrongly) that their offering will be
successful despite the high failure rate of others.
» Market development This strategy occurs when a
firm offers its existing products to a new market. For
example, it may try to sell its products overseas or it
may try to target new segments of its existing market.
Many sportswear companies have successfully marketed
their products as fashion items, for example. Chewing-
gum companies have offered their product as an aid to
giving up smoking, as something which helps prevent
tooth decay and as a breath freshener; the product,
because it is now operating in two different markets. If
sales decline in one market, demand may be sustained or
even increase in another one.
Diversification is risky in the sense that managers
are operating in an unfamiliar zone. Imagine that
your senior managers at school decided to move the
organisation into clothes retailing as well. Of course,
it is possible they could run a business like this very
well, but it would be completely different from running
a school, and they are likely to have real problems
adjusting to the different circumstances. On the other

therefore, has been offered to many new segments.
This strategy involves quite a high level of risk, because
managers will not know the market well and will have to
work hard to understand the segments within the market
and the buying process.
» Diversification This strategy involves offering new
products to new markets. For example, a chocolate
company may decide to diversify into the soft drinks
market. This is a high-risk strategy because the firm may
have only a very limited understanding of the production
and marketing requirements of the new sector. If it is
successful, however, it actually reduces the firm’s risk
hand, by operating in different markets, managers
are spreading the risks of demand falling; if demand
falls in one market, sales in the other market may
continue to sustain the business. Market penetration,
by comparison, is safe in that managers are operating
within their comfort zones; your school managers are
still running the school but trying to make it bigger.
The managers know about education, they know the
suppliers they want to work with, the competitor schools
and market conditions. The danger is that the business
is dependent on one market alone, which can make it
vulnerable.

CASE STUDY
Primark
In June 2020, as the number of cases of Coronavirus
(COVID-19) fell in most countries, Primark, the low-price
clothes retailer, announced it was going ahead with
plans to open five new stores in the USA, France and
Poland. This market development strategy was despite
(or possibly because of) economic uncertainty over
Coronavirus. Many other retailers announced closures
and redundancies, and Primark revealed it had had a
75 per cent fall in sales in the three months before this
announcement.
Once Primark started to reopen its stores in June, it
experienced high sales of childrenswear, leisure clothes
and nightwear. Summer clothes such as shorts and
t-shirts were also in high demand. Sales of travel-related
clothes were down.
Primark’s new US stores will be in New Jersey and Florida,
increasing its total number of US stores to 11. In France,
Primark will open stores in the Belle Epine and Plaisir
shopping centres in Paris. The company will also open its
first new store in Warsaw, Poland. Primark has announced
further stores will be opened in Malaga and Lisbon.
Primark suffered particularly badly in the lockdown due to
the virus because it had no online shopping site.
Questions
1 Analyse two factors Primark might consider when
choosing a country in which to expand. [8]
2 Evaluate the advantages and disadvantages of a
market-development strategy for Primark. [20]

STUDY TIP
Choosing where to compete (markets), what to compete
with (products) and how to compete (positioning) are the
key strategic decisions. Once these decisions are made,
the tactical decisions (that is, the marketing mix) are
more straightforward – if you know what to offer, whom
to offer it to and what you are trying to achieve, the mix
should follow logically. You start with the strategy and
the mix follows from this.
Remember that when answering a question on strategy, you
don’t usually have to go through all the different options. For
example, you may need to select which strategy works best
for the business and possibly compare it with another.

298
 CASE STUDY
Mars corporate fact sheet
▲ Figure 6.48 A selection of Mars chocolate
Mars, Incorporated, is a family-owned company, with six
industry-leading business units: chocolate, petcare, food,
drinks, symbioscience and, most recently, Wrigley gum
and sugar (after it joined with Wrigley). Headquartered
in McLean, Virginia, Mars operates in more than 79
countries. It is a recognised leader in confections with
a wide range of product offerings including gum, mints,
hard and chewy sweets, lollipops and chocolate. Mars has
approximately 65 000 associates worldwide and $28 billion
in annual revenue.
The combination of Mars and Wrigley in 2008 brought
together two strong, international businesses and created
one of the world’s leading confectionery companies.
The portfolio spans a variety of categories such as
confectionery items, main meals, side dishes, beverages,
snack foods, frozen snacks, organic foods, pet foods, and
now also includes Wrigley’s vast portfolio of gum brands
and sugar items.
Fast facts
● It is one of the world’s largest family-owned
companies.
● It has more than 317 sites worldwide, including 150
manufacturing facilities.
● Its products are sold in more than 180 countries.
STUDY TIP
Remember that while choosing the right strategy is
critical, the business must also be able to deliver it. If
you choose a low-cost strategy, can the business actually
get its costs down? Does it have a more efficient way of
providing the service than others? Does it have better
relations with suppliers? Is it avoiding some costs by
missing out some stages (for example, direct selling)?
You cannot sustain low prices unless you somehow
have lower costs, so make sure this is feasible for the
business. Similarly, if you offer a differentiated product,
how is it differentiated? What value have you actually
created? Is this sustainable or can it be imitated easily?
6.2.1
● Mars was founded in 1911, when Frank C Mars started
making and selling buttercream sweets in Tacoma,
Washington, USA.
● Wrigley was founded in 1891, when William Wrigley
Jr arrived in Chicago with $32 in his pocket and the
ambition to start a business of his own.
6.2.1.3 Approaches to developing business strategy
● Mars’ first blockbuster product was Milky Way,
invented by Frank and his son Forrest in 1923.
● In 1893, the Wrigley Company introduced Juicy Fruit
and Wrigley’s Spearmint gums, with Doublemint
making its debut in 1914.
● Mars established the Waltham Centre for Pet Nutrition
in 1965 in the UK.
Mars brands
● Chocolate: M&M’s, 3 Musketeers, Combos, Dove,
Galaxy, Twix, Snickers, Mars, Milky Way, Kudos,
Maltesers, Celebrations
● Petcare: Pedigree, Whiskas, Cesar, My Dog, Sheba,
Royal Canin, Kitekat, Frolic, Chappi, Winergy, Trill,
Waltham, Aquarian, Banfield
● Food: Uncle Ben’s, Dolmio, Suzi Wan, Masterfoods,
Seeds of Change, Ebly
● Drinks: Flavia, Klix
● Mars: Symbioscience focuses on innovative solutions
that change the way we care for ourselves and the
natural world, for example, Mars Plantcare-Seramis,
Mars Sustainable Solutions
● Wrigley gum and sugar: Starburst, Skittles, Lucas,
Tunes, Lockets, Kenman, Skwinkles, Rondo, Juicy
Fruit, Orbit, Altoids, Life Savers, Eclipse, Extra, Hubba
Bubba, Doublemint, Spearmint, Pim Pom, Sugus.
Questions
1 Analyse two possible benefits of Mars being a family
company. [8]
2 Evaluate whether Mars’ strategy of operating in
several different regional and product markets is a
good one. [20]
Force Field Analysis
When making a strategic choice there will be forces
pushing for change. These could be falling profits, a new
management team or a falling share price. At the same time,
there will be resistance to change such as unwillingness
by employees or financial constraints. This idea of forces
for change and restraining forces was put forward by Kurt
Lewin, a social psychologist, in his Force Field Analysis
model.
299
 Driving forces
(positive forces for change)
Restraining forces
(obstacles to change)
6.2.1
Present
State
or
Desired
State
A LEVEL 6.2.1 DEVELOPING BUSINESS STRATEGY
▲ Figure 6.49 Lewin’s Force Field Analysis model
At any moment, the forces for and against strategic change
will be balanced, which is why the business is pursuing its
existing strategy. For strategic change to occur, there must
be an increase in the forces pushing for change (perhaps
if there is a takeover and the new owners insist on it) or
a decrease in the forces preventing change (for example,
a training programme gives staff the necessary skills).
Managers must identify the forces for and against change
and try to increase the forces for and decrease the forces
against if they want change to occur.
Imagine a situation in which managers want to introduce
new technology. To bring about change, managers must
try to increase the pressure for it. For example, they might
stress to employees:
» the dangers of holding on to old technology (for example,
loss of competitiveness and the possible loss of jobs)
» the benefits of new technology (in terms of boosting
competitiveness)
» the threats from competitors who are already using this
technology.
Alternatively, managers might focus on reducing the
resistance to change and perhaps:
» educate employees on the benefits of the change
» offer incentives to those willing to change
» threaten or intimidate those who resist
» guarantee jobs to reduce this insecurity
» offer training to those who need to re-skill.
Decision trees
In order to make the right decisions, managers may
use different approaches to help them organise their
information and think through the various problems. These
include decision-tree analysis. Decision-tree analysis tries
to estimate the possible outcomes of different courses of
action and work out the likelihood of these occurring. A
decision tree is a mathematical model which can be used
by managers to help them make the right decision. By
combining possible outcomes with the probability of them
happening, managers can compare the likely financial
consequences of different decisions.
The value of the technique will, of course, depend on
managers’ ability to accurately estimate the options and
their likelihood, but it does stress the key issues of risk
and rewards.
300
Using the decision-tree model
A decision tree sets out the options to managers. Given the
problem facing them, managers will identify possible courses
of action.
In Figure 6.50, the square highlights that a decision has to
be made. The lines coming out from this are the different
options; in this case there are three, including doing
nothing. Managers have to estimate the different outcomes
from each course of action; this is shown on the lines
coming from the circle.
Expected
outcome
success
$1m
Modify existing product 0.8
($0.2m) failure
0.2
($0.3m)
success
$4m
Enter new market 0.6
($1m) failure
($2m)
0.4
Do nothing
($0.5m)
▲ Figure 6.50 A decision tree
For each of these possible outcomes:
» The result is measured in financial terms so the
outcomes can be compared.
» The probability of each outcome is estimated. The
probabilities of all the outcomes must add up to 1
(or 100 per cent) – this means there is a 100 per cent
chance that something will happen.
In Figure 6.50, three options are identified:
a Modify the existing product This is expected to cost
$0.2 million. The likelihood of success is 0.8, so the
managers are 80 per cent confident of success perhaps
because it is modifying a product they know well. The
result of success would be $1 million. The probability of
failure is 0.2 (20 per cent). (Note: Only two outcomes
are given and one of these must happen, so the
probability of success or failure must add up to 1.)
b Enter a new market This is more expensive. The
cost is estimated to be $1 million. The probability
of success is estimated at 0.6 and is expected to
generate returns of $4 million. The probability of
failure is estimated at 0.4 and this is expected to lead
to losses of $2 million.
c Do nothing This is expected to lead to losses of
$0.5 million.
Faced with a choice between these options, a manager
will consider the likely outcomes, the probability of these
outcomes and the initial investment.
Using the data on the outcome, the manager can calculate
what is known as the expected monetary value (EMV) of
each decision. This is the average return expected from a
decision, taking account of the different financial outcomes
and their probability. It shows what you would expect to
gain (or lose) on average if you made this decision many outcomes might be more complicated, but the same
times. The EMV is calculated by multiplying the probability principles apply.
of each outcome by its financial value and adding these
together; it is a weighted average of the outcomes.
Expected
outcome
6.2.1
very successful
$0.5m
For example: 0.4
a Modify the existing product There is a 0.8 chance of Training successful $0.3m
$1 million (that is, this is fairly likely) but there is a 0.2 ($0.1m) 0.4
chance of losing $0.3 million. If this decision was taken fails ($0.1m)
many times, the EMV would be: 0.2

6.2.1.3 Approaches to developing business strategy

EMV = (0.8 × $1m) + (0.2 × –$0.3m) very successful
$3m
= $0.8m –$0.06m = $0.74m Introduce 0.5
new technology successful
If this decision were repeated many times then 80 per ($0.5m) 0.2
$1m
cent of the time you would gain $1 million and 20 per
fails ($1m)
cent of the time you would lose $0.3 million; on average, 0.3
the reward would be $0.794 million.
b Enter a new market There is a 0.6 chance of gaining
$4 million and a 0.4 chance of losing $2 million, so:
Do nothing
EMV = (0.6 × $4m) + (0.4 × $2m) ($0.2m)
= $2.4m –$0.8m = $1.6m ▲ Figure 6.51 A decision tree
If this decision were repeated many times then 60 per
cent of the time you would gain $4 million and 40 per Calculations
cent of the time you would lose $2 million; on average a Training
the reward would be $1.6 million.
EMV = (0.4 × $0.5m) + (0.4 × $0.3m) + (0.2 × –$0.1m)
Using the EMV, the managers can compare this with the = $0.2m + $0.12m – $0.02m = $0.3m
initial costs and estimate the likely overall return.
a Modify the existing product The expected gain is Net gain = EMV – initial cost = $0.3m – $0.1m = $0.2m
$0.794 million. Given an initial cost of $0.2 million, b New technology
this leads to an expected net gain of $0.594 million.
b Enter the new market The expected gain is $1.6 million. EMV = (0.5 × $3m) + (0.2 × $1m) + (0.3 × –$1m)
Given an initial cost of $1 million, this leads to a new = $1.5m + $0.2m – $0.3m = $1.4m
gain of $0.6 million. Net gain = $1.4m – $0.5m = $0.9m
c Do nothing This is expected to lead to a loss of
$0.5 million. c Do nothing Expected loss = $0.2 million.
Based on this analysis, the manager would select the Based on this, the managers would choose new technology
option of entering a new market because it has the highest because it has the highest net gain of $0.9 million.
expected net gains. In reality, the number of possible

CASE STUDY
EMV
Expected
outcome
Questions
success $2m 1 Calculate the missing values in the decision tree in
New advertising 0.8 Figure 6.52. [2]
($1m) failure 2 Calculate the EMVs for the following options on the
($0.1m)
? decision tree:
success a new advertising [3]
$6m b new product [3]
New product 0.5
($2m) c do nothing. [1]
failure
($4m) 3 Decide which option should be chosen. [6]
?

Do nothing
($0.2m)
▲ Figure 6.52 A decision tree

301

HANDLING DATA
6.2.1 If the probability of winning $10 000 is 40 per cent and
the probability of winning $20 000 is 60 per cent, what
is the EMV of this decision? What if the probability of
winning $10 000 was 25 per cent and the probability of
winning $20 000 was 75 per cent?
STUDY TIP
A LEVEL 6.2.1 DEVELOPING BUSINESS STRATEGY
Remember that managers can take action to try to
increase the probability of success and reduce the
probability of failure. In the case of a new product launch,
greater investment in market research or greater
expenditure on promotion may help, for example.
The usefulness of decision trees
Decision trees are very useful because:
» They make managers think about the different options.
This discussion can create new solutions which may not
have been thought of if they had not gone through this
process.
» It makes them consider the possible outcomes, both
good and bad. This may make them realise some of the
difficulties or attractions they might not have realised
without thinking it through in this structured way.
» It makes them quantify the possible outcomes. They
have to discuss and research to find out how likely an
outcome is and what it would lead to financially. This,
again, can be very revealing.
» It means that they make a decision based on logic rather
than emotions. If needs be, this can be demonstrated to
others to explain why a decision was made and help to
gain support.
However, businesses need to treat decision trees with some
caution because:
» The value of a decision tree will depend on the options
included. If managers fail to think of a good solution,
the decision made will be relatively poor.
» The values for the probabilities are estimates and
therefore may not be accurate – particularly if the
decision has not been made before. Also, managers may
suffer bias and over-estimate the possibility of success if
they like the idea of a project.
TEST YOUR LEARNING
Short answer questions
1 Define the term ‘business strategy’. [2]
2 a Define the term ‘strategic management’. [2]
b Explain one possible benefit of strategic
management. [3]
3 a What is meant by ‘S’ and ‘W’ in ‘SWOT analysis’? [2]
b Give an example of each. [2]
4 a What is meant by ‘O’ and ‘T’ in ‘SWOT analysis’? [2]
b Give an example of each. [2]
302
» The outcomes are assessed in financial terms, but some
outcomes may not be easy to value; for example, the
potential impact on a brand image of a poor product or
the social impact of a decision.
» The trees do not take account of what might or might
not fit with the ethics of the business. A decision may
be profitable but unacceptable to the business; for
example, it may be profitable to launch a new brand of
cigarette in a country, but a company may not want to
associate with this type of product.
» The EMV is calculated as a weighted average – it shows
what would happen on average if the decision was
made many times. However, decision trees are most
likely to be used for big strategic decisions that will
only happen once; in this case the EMV is of limited
value because you will actually receive only one of the
outcomes, not an average of them. The implications of
this are shown below.
STUDY TIP
Remember to check where the data has come from and
how likely it is the decision-makers will have been able
to estimate the probability and the financial value of
outcomes effectively. Some outcomes will be difficult to
estimate in financial terms.
Implementing a strategy
Developing a strategy is not enough to be successful. A
business must implement the strategy effectively. This
involves:
» clear communication of what needs to be done when, by
whom and why
» effective leadership to inspire and motivate employees
towards making sure the strategy is successful
» effective management to monitor what is happening
and to take actions if anything is delayed or not on
target. The business needs clear, measurable targets and
effective systems to measure and control activities
» sufficient resources for all the tasks that need
implementing.
Even if a strategy is implemented effectively, managers
must keep reviewing their business environment to ensure it
is the right strategy. As circumstances change, it may well
be that the strategy needs to change too.
5 Define the term ‘blue ocean strategy’. [2]
6 Define the term ‘PEST analysis’. [2]
7 Explain two of the five forces in Porter’s model. [6]
8 Define the term ‘core competencies’. [2]
9 Explain two types of strategy in the Ansoff Matrix. [6]
10 Explain one reason why decision trees can help
lead to better decisions. [3]
Data response question
Ford
Ford, the vehicle producer, has a plan which it calls
Creating Tomorrow Together. It says that to move this
plan forward requires tough decisions. For example,
the company has had to reduce the size of its workforce,
reduce the number of layers of management to flatten the
structure and generally try to reduce bureaucracy.
Other actions taken by Ford have included investment
in Europe and South America to build on the company’s
strengths in these regions, while trying to support regions
that perform less well. In China, for example, Ford has
been developing a local leadership team and has localised
the first of five products – its Lincoln Corsair.
Ford says it needs to develop a targeted vehicle product
portfolio for its different markets. This includes a new
F-150 and electric Mustang Mach-E, as well as relatively
new vehicles such as the Ranger, Explorer, Police
Interceptor, Escape, Super Duty and the Lincoln Aviator
and Corsair in North America; the Ford Puma and two-ton
Transit in Europe; and the Territory, the first-ever fully
Ford electric vehicle in China.
Ford appreciates that the vehicle industry is in the middle
of profound change, unlike anything it has seen in the
115-year history of its business. It says that the forces
driving this disruption are rapidly advancing technology
that is leading to increasingly intelligent vehicles and a
deep need for a smarter transportation system – one that
is cleaner, safer and less congested. It is the pairing of
the two that will revolutionise the industry, and Ford says
it wants to be there leading the change. This will include
offering a range of compelling propulsion choices for its
customers that are high-performing and good for the
planet by reducing CO2 emissions.
Ford also wants to bring new levels of intelligence and
much greater computing power to help make navigation,
music and connecting its vehicles to smartphones, and
also to the smarter world, faster and easier. Its cars will
be connected to the cloud, to combine conversational
voice recognition with the power of internet search, so
drivers and passengers always have access to the latest
information, from the closest restaurant to the nearest
electric-vehicle charging station.
Ford is also working with Argo AI to develop self-driving
vehicles. The company has made strategic agreements
and partnerships – with VW, Rivian and Mahindra –
that are increasing Ford’s leadership in electric and
autonomous vehicles, and creating new business models 6.2.1
for profitable growth in emerging and emerged markets.
In the fast-changing world of vehicles, Ford says that
its founding mission of ‘advancing human progress by
providing freedom of movement’ is as vital, if not more
so, than it has ever been. According to Ford, it has always
built great vehicles that allow people to move freely and
now, with a more intelligent world, it can do more to
6.2.1.3 Approaches to developing business strategy
support human progress than ever before.
Ford’s aim is to design smart vehicles for a smart
world. In doing so, it says it has the opportunity to
create significant value for all of its stakeholders, while
designing and building a better transportation system that
will improve life for everyone.
Source: Ford Annual Report 2019, https://annualreport.
ford.com/Y2019/default.aspx
Questions
1 Explain two factors in Ford’s external environment
which might determine its strategy. [6]
2 Analyse two factors in Ford’s internal environment
which might determine its strategy. [8]
3 With reference to Porter’s five forces, analyse the
effect of two of the five forces on the profits of the car
industry. [8]
4 Using the Ansoff Matrix, evaluate the possible
strategies that Ford could adopt in the future. [12]
5 Evaluate the benefits of strategic management to
Ford. [20]
Essay questions
1 Evaluate the extent to which buyer power determines
the profits made by businesses in the food-retailing
industry. [20]
2 Evaluate the importance of strategic management
for the success of a multinational business. [20]
3 Evaluate the usefulness of decision trees to
managers when making strategic decisions. [20]
4 ‘Diversification is the best strategy for a business
with an objective of rapid growth.’ Evaluate the
extent to which you agree with this view. [20]
303
 6 Business and its environment
A LEVEL
6.2.2 Corporate planning
and implementation
A LEVEL 6.2.2 CORPORATE PLANNING AND IMPLEMENTATION
Chapter overview
In this chapter we examine:
★ corporate planning
★ corporate culture
★ transformational leadership
★ strategic change
★ contingency planning and crisis management.
6.2.2.1 Corporate planning
A corporate plan sets out where the business wants to
go and how it intends to get there. It sets out what its
objectives are. The plan shows the detail of what needs
to be done to get where the business wants to be. Each
department will produce its own plan linked to the overall
plan for the business.
Having a plan clarifies for everyone what they are supposed
to be doing and what success looks like, and it enables them
to prioritise resources and measure success.
6.2.2.2 Corporate culture
The strategy of a business will be influenced by its culture.
This will affect whether it is a risk-taker, whether it seeks
short-term rewards or is willing to plan long term, whether
it cares about its stakeholders and even whether it seeks to
go beyond its existing borders. In this section we discuss
the meaning and importance of culture.
What is corporate culture?
The culture of a business (corporate culture), can be
described as the values, attitudes and beliefs of the
people working for it. It describes ‘the way we do things
around here’ (Ouchi 1981). Hoftstede (1991) describes it as
‘the collective programming of the mind’, which perhaps
highlights how individuals’ own values may change as they
become accustomed to the established ways of doing things
when they join a business.
In reality, there is no one culture in a business – different
departments, different levels within the business, different
groups of employees may all have their own way of doing
things. Nevertheless, there may be some key areas where
people generally agree and this can therefore help to define
the ‘overall culture’ of a business.
304
In the same way that people can differ and their attitudes
can vary enormously, so the culture of businesses can be
tremendously different. For example, organisations may be:
» Entrepreneurial In these organisations you are
highly valued if you try something, even if it does
not necessarily work. The fact you had an idea and
tried to make it work is regarded as worthwhile and
commendable. This type of organisation may value
people who ‘think outside the box’, try new approaches
and show initiative.
» Bureaucratic This type of business may want people
who stick to the rules and who do not make decisions
for themselves. In some organisations, you may not
want people to start making up their own rules. At
the tax office, for example, you would want all the
tax forms processed in the same way. The risks of
letting people use their initiative could be too high in
some organisations or some parts of organisations; for
example, you may want nursing staff to concentrate on
administering the treatment doctors have prescribed
and not diagnosing people or making decisions on the
medication for themselves.
» Customer-focused Some organisations clearly value
their customers (most would, we hope, but in reality not
all do!). This means getting it right for the customer,
who is regarded as important – staff are expected
to put themselves out to make sure the customer’s
expectations are met. Employees are not expected
to find reasons why things cannot be done. While a
customer-focused approach seems sensible and certainly
advisable in competitive markets, some businesses have
been much more inward-looking and have focused on
what they could do and what they wanted to do rather
than what customers wanted. British Airways had a
terrible reputation in the 1970s, because it placed too
much emphasis on flying planes and not enough on
the customer experience. Money was being invested in
engines, landing gear and pilots’ uniforms but not in
improving the in-flight entertainment or the cleanliness
of the planes. A big push to refocus on customer needs
 led to a change in approach (which culminated in the
rebranding of the business as the ‘world’s favourite
airline’), training all staff to place the customer first.
More recently, McDonald’s has been accused of being
too inward-looking and not appreciating the change
in the market demand towards wanting healthier food.
Similarly, the major American car manufacturers, such as
General Motors and Ford, spent too long producing big,
oil-guzzling cars and did not appreciate that customers
wanted more fuel-efficient, smaller vehicles that were
being provided by producers such as Toyota.
» Conservative (or not!) In these businesses there is a
tendency to avoid risks. Relatively safe decisions are
taken and before any new ideas are accepted there
is extensive (possibly overly extensive) research. At
CASE STUDY
Johnson & Johnson
The mission statement of Johnson & Johnson highlights
the importance of the customer to the business. This
set of beliefs has been proved on many occasions when
employees have worked hard to make sure that customer
service is outstanding and that customers are treated
properly.
Our credo
We believe our first responsibility is to the doctors, nurses
and patients, to mothers and fathers and all others who use
our products and services. In meeting their needs everything
we do must be of high quality. We must constantly strive to
reduce our costs in order to maintain reasonable prices.
Customers’ orders must be serviced promptly and accurately.
Our suppliers and distributors must have an opportunity to
make a fair profit.
We are responsible to our employees, the men and women
who work with us throughout the world. Everyone must
be considered as an individual. We must respect their
dignity and recognise their merit. They must have a sense
of security in their jobs. Compensation must be fair and
adequate, and working conditions clean, orderly and safe.
We must be mindful of ways to help our employees fulfil
their family responsibilities. Employees must feel free to
make suggestions and complaints. There must be equal
opportunity for employment, development and advancement
GLOSSARY TERMS
A corporate plan sets out where the business wants to go
and how it intends to get there.
Corporate culture refers to the values, attitudes and
beliefs of a business’ employees; it refers to ‘how we do
things around here’.
the other extreme are high-risk organisations, where
decisions are made without enough thought about the
resources and the dangers involved. In 2008, the global
banking system underwent major shocks due in part to
6.2.2
high-risk lending – bank managers had taken undue risks
in their attempts to increase their lending and this had
damaged them in the long term when borrowers could
not repay.
» Short term, long term Some businesses are very
focused on the short term (perhaps because of pressure
from investors for dividends); this means they may
6.2.2.2 Corporate culture
be reluctant to invest in new product development or
training. Others look more towards the long term (for
example, they might plan 15 years ahead for the next
revolution in the internet).
for those qualified. We must provide competent management,
and their actions must be just and ethical.
We are responsible to the communities in which we live and
work, and to the world community as well. We must be good
citizens – support good works and charities and bear our
fair share of taxes. We must encourage civic improvements
and better health and education. We must maintain in good
order the property we are privileged to use, protecting the
environment and natural resources.
Our final responsibility is to our stockholders. Business
must make a sound profit. We must experiment with new
ideas. Research must be carried on, innovative programmes
developed and mistakes paid for. New equipment must
be purchased, new facilities provided and new products
launched. Reserves must be created to provide for adverse
times. When we operate according to these principles, the
stockholders should realise a fair return.
Source: www.jnj.com/credo
Questions
1 Analyse two benefits of outstanding customer service
to Johnson & Johnson. [8]
2 Evaluate the impact ‘Our credo’ might have on the
performance of Johnson & Johnson. [12]
Types of culture
There are many ways of analysing the culture of a business,
although, given that every business will be unique, all these
can do is describe in broad strokes some of the key features
of an approach. One model is that of Charles Handy (1993),
which outlines four types of culture:
» Power culture This type of culture is most common in
relatively small, owner-run businesses. There is one
305
 dominant person (or a few key people) who makes all the overlap (for example, university lecturers designing their
major decisions and all employees refer to them if they own courses independent of each other and the students
6.2.2 want to know what to do. The ‘boss’ is in charge of all
the operations of the business and its success depends
finding that elements of these courses overlap).
Unfortunately, sometimes the individuals will resist if a
very much on them. This can be very positive because it more centralised approach is needed, because they are
can lead to decisive leadership, quick decision-making used to their independence.
and a consistent approach. However, if the business
starts to grow, the person or people at the centre The importance of corporate culture
may become overloaded and unable to cope with the
The culture of a business or a part of a business matters
number of decisions that need to be made. This can
because it determines how employees will behave in any
bring decision-making to a halt as employees wait to
A LEVEL 6.2.2 CORPORATE PLANNING AND IMPLEMENTATION

given situation. This can work in an organisation’s favour.

get a response. It also encourages employees to become
reliant on the boss and not learn how to make decisions
for themselves.
» Role culture This is very common in businesses as
they grow and tend to adopt a more formal structure
and culture. The importance of someone begins to be
defined by their position in the hierarchy and their
job title. This type of culture relies quite heavily on
rules and procedures. To do well you need to follow the
systems that are in place and do what is expected of
you, rather than using your initiative to define your
own job boundaries. Communication is via established
channels of communication rather than through, say,
informal conversation. This leads to very predictable
outcomes in terms of performance. Senior managers
know what is going to happen because employees do
what they have been told to do. This has the value of
certainty. However, the danger is that the organisation
is inflexible to change and is not prepared for
unexpected challenges.
» Task culture This is relatively common in businesses
such as design agencies or management consultancies,
where the value of an individual to a project depends
on their expertise rather than any formal title. In this
approach, teams are formed for particular projects and
individuals brought into these as and when they can
contribute. Your value depends on what you can add
to the team rather than your age or how long you have
been working there. This approach can bring together
expert teams to help solve different problems; however,
co-ordinating this approach can be difficult.
» Person culture This is not very common, but it occurs in
an organisation or part of an organisation where there
are groups of well-qualified individuals who respect
each other’s skills and knowledge. This may occur in
a university or a doctors’ practice, for example. Each
individual is fairly self-reliant and can make decisions
for themselves. They collaborate with each other and
share their expertise and skills when needed, but they
operate independently. This works well if the business
can function with relatively independent units, but the
danger is that the approach lacks consistency and may
Companies such as Google have a culture that recognises
and rewards creative talent and technological skills. Bright
computer programmers will go far in this organisation
regardless of their age and, to some extent, regardless of
their formal qualifications; if they can do it and prove they
can do it, they will probably be promoted. This encourages
ideas and new thinking which helps keep Google ahead of
its rivals. A culture of accuracy and attention to detail, by
comparison, may ensure your firm of accountants does not
make any mistakes.
On the other hand, a culture can limit a firm’s success.
In some retail organisations, the customer seems an
unwelcome visitor! Customers are not truly valued and
employees do not make the effort to provide good customer
service. This will lose the business money over time. In
other organisations, the unwillingness to take risks may
mean market opportunities are missed. For example,
imagine that a retailer’s culture was one of unquestioning
agreement with the chief executive’s decisions; this would
mean that when the wrong products were ordered and the
wrong approach to displays was chosen, no one would dare
to speak up. The culture did not encourage a questioning
approach, which meant that even though staff may have
seen the iceberg ahead, they would not shout out the
dangers because they simply followed the course the
captain set for them.
The importance of culture in terms of the success (or failure)
of a strategy should not be underestimated. Is the business
full of ideas, encouraging initiative, stressing the value of
working hard and working effectively? Are new projects met
with open arms? Do individuals take care to get it right and
show commitment to a project? All these issues depend on
the culture of a business. It determines what people do,
how they work together, how much effort they make, what
they strive for and, basically, determines how the business
‘ticks’. Whatever strategies you bring in, whatever ideas you
have, the culture of the business will influence whether
they are implemented, how they are implemented and the
level of commitment to them by employees.

306
 CASE STUDY
The five principles of Mars
Quality
The consumer is our boss, quality is our work and value for
money is our goal.
Our company is dedicated to the highest quality in all the
work we do. Quality is the uncompromising standard for our
actions, and it flows from our passion and our pride in being
part of the Mars community. Quality work, which results from
our personal efforts, is the first ingredient of quality brands
and the source of our reputation for high standards.
Responsibility
As individuals, we demand total responsibility from ourselves;
as associates, we support the responsibilities of others.
Mutuality
A mutual benefit is a shared benefit; a shared benefit will
endure.
We believe that the standard by which our business
relationships should be measured is the degree to which
mutual benefits are created. These benefits can take many
different forms, and need not be strictly financial in nature.
Likewise, while we must try to achieve the most competitive
terms, the actions of Mars should never be at the expense,
economic or otherwise, of others with whom we work.
Efficiency
We use resources to the full, waste nothing and do only what
we can do best.
GLOSSARY TERM
Transformational leadership exists when leaders identify
what changes are needed, create a vision and inspire
employees to carry through the changes.
6.2.2.3 Transformational
leadership
Transformational leadership is a style of leadership that
was described by James Burns in his book Leadership and
later developed by Bernard Bass. It is an approach in which
leaders work with others to agree what needs to be changed
and develop the appropriate steps to be taken. However,
it sets out to transform the rest of the team so that they
become leaders themselves. This can be a powerful way
of bringing about change because those involved are the
leaders of it.
Bass identified four elements that make up a
transformational leader, known as the ‘four Is’. These are:
6.2.2
How is it possible to maintain our principles, offering
superior value for money and sharing our success? Our
strength lies in our efficiency, the ability to organise all
our assets – physical, financial and human – for maximum
productivity. In this way, our products and services are made
and delivered with the highest quality, at the least possible
6.2.2.3 Transformational leadership
cost, with the lowest consumption of resources; similarly, we
seek to manage all our business operations with the most
efficient processes for decision-making.
Freedom
We need freedom to shape our future; we need profit to
remain free.
Mars is one of the world’s largest privately owned
corporations. This private ownership is a deliberate choice.
Many other companies began as Mars did, but as they
grew larger and required new sources of funds, they sold
stocks or incurred restrictive debt to fuel their business.
To extend their growth, they exchanged a portion of their
freedom. We believe growth and prosperity can be achieved
another way.
Source: www.mars.com/about/five-principles
Questions
1 Analyse two factors that might influence the culture of
Mars. [8]
2 Evaluate the ways in which the culture of Mars might
affect the behaviour of employees and its business
performance. [12]
» Idealised influence (II) This means that the leader
acts as a role model and wins the respect of their team.
They encourage a shared vision so the team sets out to
achieve the overall objectives of the business.
» Intellectual stimulation (IS) These leaders encourage
others to innovate and to form new ideas for the
organisation and themselves. They push others to
challenge their own beliefs and values, as well as
those of the company, in the belief that this leads to
innovation.
» Inspirational motivation (IM) Transformational leaders
work to increase team morale through motivational
techniques and acting as inspiration for their followers.
They set high expectations to individual followers and
motivate them to gain their commitment to a shared
organisational or team belief.
» Individualised consideration (IC) Transformational
leaders create a diverse and supportive environment,
where individual differences are respected and
celebrated. They will know each of their followers
individually, and listen to any concerns or needs that
their team members may have.
307
 These four elements create an open, communicative and
diverse culture; this is intended to empower the team.
6.2.2 Transformational leaders are often described as mentors
and role models. They lead by example and create an
environment where innovative thinking is aligned with
the values, beliefs and objectives of the organisation.
This gives ownership of the change to the people who are
closely involved in it.
Idealised
A LEVEL 6.2.2 CORPORATE PLANNING AND IMPLEMENTATION
influence (II)
Inspirational Transformational Intellectual
motivation (IM) leadership stimulation (IS)
Individualised
consideration (IC)
▲ Figure 6.53 Bass’ model of Transformational leadership
6.2.2.4 Leading and managing
strategic change
Given that change is going to occur both internally and
externally, managers must consider the best way(s) of
managing it. Resistance to change may come in many forms,
such as:
» a lack of effort to learn the necessary new skills or a
general lack of co-operation
» a demand for more pay
» a refusal to use the new systems
» a demand for extended discussion to slow down the
process of change.
Figure 6.54 highlights the different states that employees
might be in when managers are introducing change. This model
by Zeira and Avedisian highlights that openness and readiness
for change will depend on how dissatisfied employees are with
the present situation and the extent to which they think they
will suffer from the change. The more dissatisfied they are and
the less they think they will personally suffer as a result of it,
the more open they will be to change.
308
Perceived personal risk
Low from change High
High
Moderate to
High readiness indeterminate
for change readiness for
Level of satisfaction with
change
existing situation
Moderate to
indeterminate Low readiness
readiness for for change
change
Low
▲ Figure 6.54 Employee readiness for change
Change may not happen because there is resistance to it.
Also, it may be that the business lacks the resources to
bring it about. We may know that we need to update our
database systems, improve our websites or refurbish our
stores, but we may lack the resources to do so. Often, the
very time when change is needed (when a business is doing
badly) is when a business is short of resources to bring it
about. The lack of resources may involve a lack of:
» money; for example, a business may not have the cash or
access to credit to invest
» skills; for example, a business may not have the talents,
experience and abilities within its organisation to
manage a change or bring about change effectively. This
may be due to the recruitment policy, a lack of training
and/or a new situation arising which requires new skills
it does not have
» time; you should never underestimate time as a resource.
There may be many changes managers want to bring about,
but they may be so busy firefighting (see Mintzberg’s
analysis of what managers do on pages 86–87) that they
cannot implement all the changes they would like to.
Another problem that can occur is that managers simply
do not recognise that change is needed. They may be too
inward-looking and not appreciate that their market has
changed. A manager like this is a reactive rather than a
proactive manager.
STUDY TIP
Remember that the best way to bring about change will
depend on what the change is, how much those involved
understand the need for it, the degree of resistance to it
and the time and resources available.

CASE STUDY
Huawei
Huawei was founded in 1987. It is one of the world’s
largest providers of information and communications
technology (ICT) infrastructure and smart devices,
such as smartphones. Huawei says it is ‘committed to
bringing digital to every person, home and organisation
for a fully connected world’. Huawei has over 194 000
employees operating in more than 170 countries and
regions. It has more than 3 billion customers around the
world.
Huawei is a private company which is completely
owned by its employees. Through the Union of Huawei
Investment & Holding Co., Ltd, the company has
a shareholding scheme which is only available to
Huawei employees. No government agency or outside
organisation holds shares in Huawei.
Huawei says that it exists to serve its customers. It says
the company’s common values are ‘staying customer-
centric and creating value for customers’.
Source: www.huawei.com/uk/corporate-information
Questions
1 Analyse one reason why being customer-centric
might face resistance from employees. [4]
2 Evaluate the ways Huawei might develop a
strategy to avoid resistance from employees. [12]
Developing a strategy to manage
change
Managers will need to consider the right strategy to manage
change in any given situation. This will depend on factors
such as:
» the potential level of resistance
» the extent to which the reason for change is understood
» the resources and time available.
In some cases, the focus may be on informing staff. In
other cases, persuading employees of the need for change
or the benefits of change is more significant. On some
occasions, the strategy may need to concentrate on forcing
it through.
Techniques to implement and manage
change successfully
Change is most likely to be successful if:
» those affected by the change are involved in bringing it
about (rather than having it imposed on them)
» those involved in the change feel they have an
opportunity to air their views
» the benefits of the change are made clear to those
involved
» individuals feel able to cope with the change; they feel
they have the resources and skills to deal with it
» the people involved agree with the reasons for the change.
Developing a change culture
Changing culture can be important but difficult. Businesses
will want to have a culture that is open to change and 6.2.2
be willing to embrace a new strategy and implement it
fully. According to Kotter and Schlesinger (1979), the main
reasons why people resist change are:
» self-interest – they do not want the effort of change or
are better off as they are (for example, their status or
importance might be lower after the change)
» misunderstanding and lack of trust – they do not
6.2.2.4 Leading and managing strategic change
understand why change is necessary and/or are
suspicious about why the change is happening
» they prefer the status quo – they would rather keep
things as they are because they feel comfortable with it
» they do not think the new idea will work – they think
there are flaws in it and therefore it would be wrong to
pursue it.
To change the culture of an organisation, you need
to change what people value and what they believe is
important. This can happen, but it often takes time.
Imagine you were someone who does not like sport, who
sees no point in taking part in it if you do not like it,
and who likes the freedom your sixth form gives you to
choose whether to participate. If the school headteacher
suddenly decides that your views on the importance of
sports at school are wrong and that from now on it will
be compulsory, you would probably argue about this. It
is possible that over time you could be convinced that
compulsory sport at school would help your academic
performance or help you feel better in yourself, but simply
being told that this is true would not necessarily work. You
would want to see some evidence or try it out for a while
to see for yourself, or be talked through the arguments for
and against until you were convinced and agreed with the
arguments being made. Unfortunately, businesses do not
always have time to go through this process with every
member of staff. Sometimes culture needs to be changed
faster than a process of education and discussion allows;
sometimes leaders may think it is better to push on and let
people see the benefits rather than spend the time trying
to convince them in advance.
To achieve change quickly, managers may:
» offer incentives for those who agree to the changes
and start adopting them (higher marks for those who
participate in sport); this is a ‘carrot’ approach
» punish those who do not adopt the changes (lower marks
for those who do not participate in sport); this is the
‘stick’ approach.
Neither the carrot nor the stick approach will in itself
change people’s attitudes. They are simply changing
behaviour. They do not change what you believe, simply
what you do. This means people will not be very committed
to the changes. However, in the long term, if the changes
are proved to be beneficial, people may change their
attitudes as well.
Other approaches include:
» educating people about the benefits of change
» reassuring people about the change, to reduce fears
309

6.2.2
A LEVEL 6.2.2 CORPORATE PLANNING AND IMPLEMENTATION
» providing resources to enable people to prepare and
train for change
» focusing on key people to get their support; once they
are won over, others will follow.
Why can change go wrong?
Kotter (1990) studied more than 100 companies going
through change and identified the following most common
errors made by managers who were trying to bring about
change:
1 Too much complacency It is common to think problems
» a major computer virus attacking the database
» an epidemic causing illness among staff.
Contingency plans might include:
» using two suppliers for the same part or component
in case there are problems with one of them; this can
safeguard supply
» paying a fee to be able to use computer facilities or
office space elsewhere in case of flooding, earthquake or
a terrorist attack
» training employees in several tasks so they can take

can be dealt with later. Managers need to create a sense
of urgency when introducing change.
2 Failing to build a substantial coalition This means that
forces opposing change often undermine the changes
that managers are trying to bring in. Managers need
to build a coalition to gain support and help push the
change through.
3 Underestimating the need for a clear vision Without
a clear vision of where you are headed, you may end up
with a series of initiatives that are rather disconnected.
4 Permitting roadblocks against the vision This means
allowing things to get in the way and delay change.
Managers need to empower people to clear such obstacles.
5 Not planning or achieving short-term wins It is
important to sustain momentum. Managers need to
secure short-term wins to show they can succeed.
6 Declaring victory too soon Managers need to keep
moving.
7 Not anchoring changes in corporate culture Managers
need to anchor change and make sure it is part of the
culture; for example, by rewarding those who have
helped bring it about.
Change may not come
about because of:
Resistance A lack of Ignorance that
to change resources change is needed
▲ Figure 6.55 Unsuccessful change
6.2.2.5 Contingency planning and
crisis management
Businesses operate in uncertain and risky environments.
Managers are always making decisions about the future and,
inevitably, are not sure of exactly what the future will be
like. This makes planning even more important – planning
for a situation that is expected but also reviewing the plan
regularly to assess where the business is compared with
where it is expected to be. Managers must then decide what
to do next to get back on track, if necessary. One type of
planning is known as contingency planning. This occurs
when a firm prepares for unlikely events, such as:
» a fire
» the bankruptcy or insolvency of a major customer
» the closure of an important supplier
310
over from others if there are major absences, illnesses or
strikes
» ensuring new products are in development so that if
there is a problem with existing products, they can be
replaced.
However, you cannot afford to have a contingency plan
for every event (such as alien invasion or being hit by a
meteorite). Managers must therefore decide exactly which
events are worth preparing for and how many resources
to put into contingency planning. Should the firm have
back-up plans in case there are problems with suppliers?
Should it have a plan for what to do if there is a safety
problem with one of its products? What about planning
for a situation where a competitor makes a takeover bid?
Decisions must be based on the likely risk and damage of
any event.
A contingency plan should provide a sense of direction and
enable each element of the business to see how it should
contribute. It should help managers set their priorities and
allocate their resources.
CASE STUDY
Honda
In 2020, Honda, which produces motorcycles, cars,
generators and lawn mowers, had to deal with a
cyber-attack that affected its worldwide operations.
The attack impacted on the company’s ability to access
its computer servers, use email and internal systems.
Honda said that one of its internal servers was attacked
externally.
Work at Honda’s UK factory was stopped, and other
operations in North America, Turkey, Italy and Japan
were suspended.
Cyber-security experts said it was probably a
ransomware attack, whereby hackers could have
encrypted data or prevented Honda from accessing some
of its IT systems.
Honda employs nearly 220 000 people globally across
over 400 group affiliate companies.
Questions
1 Analyse two ways in which a cyber-attack might
affect Honda. [8]
2 Evaluate the possible benefits of contingency
planning to Honda. [12]
The greater the likelihood of an event and the greater the
potential damage if it does occur, the more likely a firm is
to plan for it. Food manufacturers, for example, are likely to
plan for a situation where their products are contaminated
and they have to recall them. An airline will plan for the
event of a crash. An oil transportation business will prepare
for a spillage.
The need for contingency planning highlights the dynamic
nature of business and the need to be prepared for the
unexpected. Obviously, a firm cannot prepare for every
emergency, but it is worth highlighting the biggest risks
and preparing for these. Firms must continually examine
their own operations and their environment to check that
they are prepared for possible changes in the future; in this
way managers will be proactive (anticipating and preparing
for change) rather than reactive (having to react to crises
as they develop).
Of course, this does not mean that companies that have
contingency plans are safe from disaster. Unfortunately,
managers often do not or cannot foresee what events
will occur. In 2008, for example, there was a major global
financial crisis that few had predicted. This led to a problem
gaining credit and lower customer spending, which damaged
many businesses, very few of which would have had any
form of plan for this scenario. In 2020, the Coronavirus
(COVID-19) pandemic adversely affected national and global
economies, as countries were forced to close their borders
and go into full lockdown to prevent spreading the virus.
TEST YOUR LEARNING
Short answer questions
1 a Define the term ‘corporate plan’. [2]
b Explain two benefits to a business of having a
corporate plan. [6]
2 Define the term ‘corporate culture’. [2]
3 Explain one way in which culture affects decision-
making. [3]
4 Define the term ‘task culture’. [2]
5 Define the term ‘innovative culture’. [2]
6 Explain one link between corporate culture and
strategic management. [3]
7 Define the term ‘transformational leadership’. [2]
8 Explain two elements of effective strategic change. [6]
9 a Define the term ‘contingency planning’. [2]
b Explain one benefit of contingency planning. [3]
10 Define the term ‘crisis management’. [2]
Data response question
Lenovo
At Lenovo, innovation isn’t just what we do, it’s part of our
DNA. It doesn’t just make us who we are, it flows through
everything we do – from the smartphone in your pocket and
light bulbs in your smart home to the servers in your data
centre. And beyond.
GLOSSARY TERM
Contingency planning involves preparing for unexpected
events.
6.2.2
The impact of a crisis
When a disaster does occur, such as a fault in a product or
a fire at a factory, this can cause panic. It is hoped that
the firm will have a contingency plan which it can put into
6.2.2.5 Contingency planning and crisis management
action but, even so, this is likely to be a stressful time. It
is easy to rush into a decision at times like these because
of the pressure to do something and be seen to be doing
something – this can lead to rushed and inappropriate
decision-making. On the other hand, if you delay too
long, the crisis may get worse. As well as sorting out the
crisis itself, the firm may have to handle the press. When
managing a crisis, it is important to:
» identify the ‘facts’ as soon as possible. What is the
scale of the problem? How many people are likely to be
affected?
» establish good communication systems. Managers must
make sure that everyone is ‘online’ and reacting in the
same way. If, for example, different managers are giving
the press different information following a scare about
the safety of the product, this will create the impression
they are not in control and the public may lose faith
» have the authority and resources to make decisions
quickly, rather than having to consult endless committees.
Lenovo began with a small team of 11 engineers over 30
years ago, in China. Now it is made up of a diverse team
of innovators in more than 180 markets. Lenovo says that
these innovators are ‘constantly reimagining technology to
make the world more interesting’ and to solve some of the
global challenges we face. Lenovo says it is ‘dedicated to
transforming its customers’ experience with technology’.
Lenovo’s strategy has been described by analysts as one
of ‘protect and attack’; it is both defensive and offensive
at the same time. Defensively, Lenovo is aiming to build
on its success in China, where it is the top seller of PCs.
To do this, it aims to build its links with distributors and
retailers as well as increasing its direct, online sales.
Lenovo also aims to build relationships with large-scale
buyers, such as governments and educational institutions.
This involves Lenovo sales representatives working
closely with these partners.
Lenovo has a strong position within China thanks to
an extensive distribution network, many of whom are
exclusive distributors, meaning they cannot sell other
firms’ products. Lenovo is also a Chinese business;
this may mean it has closer links with the culture of
the country than some others and this may give it an
advantage in that market. An example of this was the
‘wedding computer’ that Lenovo produced. This was a
low-price computer in the colour red (which denotes
311
 luck in China) and which had the Chinese symbol for
6.2.2 ‘happiness’ on it. This was extremely popular in rural
China as a gift at weddings.
The ‘attack’ part of Lenovo’s strategy is to become much
bigger overseas. This international expansion can provide
long-term profits but often involves initial losses as the
business tries to establish itself. Operating overseas
is also difficult because consumers around the world
can have very different consumer preferences, and
the competition and regulatory framework can differ
A LEVEL 6.2.2 CORPORATE PLANNING AND IMPLEMENTATION
significantly. To maximise its impact overseas, Lenovo
has made various acquisitions to use local expertise. For
example, in 2014 it bought Motorola Mobility because of
this company’s strength in North and Latin America. In
2017, Lenovo purchased 51 per cent of Fujitsu’s PC division
because of its strength in Japan.
Lenovo is not only expanding geographically, it is also
investing heavily in innovation to develop new products.
312
Historically, Lenovo has focused on PCs but is now looking
to what it calls the ‘PC+ world’, in which the PC links
a network of interconnected devices such as tablets,
smartphones and smart TVs.
Source: www.lenovo.com/gb/en/about/whoweare
Questions
1 Analyse two benefits to Lenovo of investing in
innovation. [8]
2 Evaluate the extent to which Lenovo’s ‘protect and
attack’ strategy seems to be a good one. [20]
Essay questions
1 Evaluate the extent to which it is easy to change the
culture of a struggling business. [20]
2 Evaluate the importance of culture in determining
the success of a multi-site business. [20]
7 Human resource management
A LEVEL

7.1 Organisational structure

7.1.1 Relationship between business objectives and structure

Chapter overview
In this chapter we examine:
★ how organisational structure can support business objectives
★ different organisational structures
★ delegation and accountability
★ control, authority and trust
★ centralisation and decentralisation
★ line and staff employees.

7.1.1 Relationship between CHIEF EXECUTIVE,

MANAGING DIRECTOR
BOARD OF DIRECTORS –

business objectives and structure

AND OTHER DIRECTORS
e.g. Director of Finance,
Director of Marketing
What is an organisational structure? MANAGERS
The organisational structure, which may be shown in an Take responsibility for
organisation chart, sets out: achieving short- and
long-term targets,
» the routes by which communication passes through the
responsibility for
establishing strategy
and the business’s
overall direction
MIDDLE MANAGERS –
traditionally have
responsibility for a function,

Authority may be delegated

e.g. sales managers, e.g. market research
business production managers,
» who has authority (and power) and responsibility training managers
Accountability

within the organisation SUPERVISORS/TEAM

» the roles and titles of individuals within the LEADERS
organisation Given authority for
overseeing operations
» the people to whom individual employees are (market research,
accountable and those for whom they are responsible. production quality, for
example) on a
Figure 7.1 illustrates a simplified organisational chart for a day-to-day basis
large business.
SHOP-FLOOR WORKERS
The organisation’s structure plays a vital part in shaping the These could be
production teams,
success of the business. This determines the ways in which sales representatives,
its work activities are organised and how responsibility and clerks involved in finance,
authority are allocated. The structure of an organisation training, quality control
and advertising
affects how employees (from the most junior to the
very senior) carry out their responsibilities and use their Communication can pass up and
authority, how they co-ordinate and work alongside others, down the organisation, as well as
horizontally, e.g communication
and the extent to which the business achieves its goals and between managers
objectives.
▲ Figure 7.1 A simplified organisational chart
GLOSSARY TERMS
An organisational structure is the way in which a business
The case for flexible organisational
is arranged to carry out its activities. structures
Authority is the power to control situations or the A flexible organisational structure is one in which workers can
decisions and actions of others. easily adapt to their customers’ needs, efficiently complete
Responsibility is the duty to complete a task and to be their work and make decisions as and when necessary.
accountable for one’s actions.

313

7.1
A LEVEL 7.1 ORGANISATIONAL STRUCTURE
Management writer, Peter Drucker, was a strong advocate
of flexible organisational structures. A common mistake
by managers, Drucker argued, is that they tend to become
obsessed by organising the business’ structure just one
way. At various times, decentralisation has been the key
element of a successful structure; later, close control and
command of employees was considered essential. ‘There is
no such thing as the one right organisation,’ Drucker wrote.
‘There are only organisations, each of which has distinct
strengths, distinct limitations, and specific applications. It
has become clear that organisation is not an absolute. It is
A flexible organisational structure is likely to possess a
number of important characteristics:
» It will be continually changing and evolving to meet
changing needs. Employees at all levels will be used to
change and will be likely to respond positively to it.
» It will focus strongly on the needs of its customers. This
may mean that, for example, employees may work in
teams which can be disbanded and new ones formed to
meet customers’ changing demands.
» The organisation may make use of consultants and
temporary and part-time employees to supply specialist

a tool for making people productive in working together. As skills or to manage peaks and troughs in demand for its
such, a given organisational structure fits certain tasks in products.
certain conditions and at certain times.’

CASE STUDY
The structure of HSBC
HSBC is one of the world’s largest banking and financial
services organisations. Its global businesses serve more
than 40 million customers in 64 countries and territories.
In 2019, it had over 235 000 employees. However, HSBC
has announced that it plans to cut its global workforce by
up to 35 000 people by 2023, as part of a move to restore
profitability.
HSBC operates within four business groups as part
of a matrix organisational structure: Commercial
Banking, Global Banking and Markets, Retail Banking
and Wealth Management, and Global Private Banking.
However, it has also created a ‘global network of locally
incorporated subsidiary companies’ that oversee of the
bank’s operations at a country and regional level. Its
simplified organisational structure is shown in Figure 7.2,
while Table 7.1 shows some of HSBC’s largest and
best-known subsidiaries and their primary areas of
operation.

HSBC
Holdings Plc
UK
Holding company
HSBC Latin HSBC
American 99% HSBC Overseas HSBC Bank HSBC 99% HSBC HSBC Bank 94% HSBC Intermediate holding
Holdings (UK) Mexico SA Holdings (UK) Canada Bank Plc France Egypt SAE Holdings BV company
Limited Limited Operating company
UK
HSBC North HSBC
HSBC Bank 80% The Saudi 40%
America Trinkaus &
Brazil SA British Bank
Holdings Inc Burkhardt AG
Germany
HSBC The Hongkong
HSBC HSBC Bank HSBC Asia HSBC Bank
HSBC Bank Investments 70% HSBC Bank and Shanghai
Finance Middle East Holdings (China) Co
Chile (North Malta Plc Banking
Corporation Limited (UK) Limited Ltd
America) Inc Corporation Ltd
USA HK
HSBC Bank HSBC HSBC Bank HSBC Bank
HSBC
(Panama) Securities (Vietnam) (Taiwan)
Bank AS
SA (USA) Inc Limited Ltd
Turkey
HSBC HSBC Bank HSBC Private HSBC HSBC HSBC Bank
99% HSBC HSBC Bank Banking
Latin America Argentina Private Bank Australia Malaysia
USA Inc USA, NA# Holdings
BV SA (Suisse) Limited Berhad
(Suisse) SA
HSBC Bank PT Bank
98%
Bermuda Ekonomi
Limited Raharja Tbk
62% Indonesia
Hang Seng
Hang Seng
Bank (China)
Bank Limited
Ltd
HK
Middle
Latin America North America Europe East Asia-Pacific

Source: HSBC
▲ Figure 7.2 The simplified organisational structure for HSBC

314
 ▼ Table 7.1 Some of HSBC’s major subsidiaries
Subsidiary Primary area of operation
Hong Kong, with an
The Hongkong and Shanghai
extensive network
Banking Corporation Limited
throughout Asia-Pacific
Hang Seng Bank Limited Hong Kong
HSBC Bank Plc United Kingdom
HSBC France France
HSBC Bank USA N.A. United States of America
Grupo Financiero HSBC, S.A.
Mexico
de C.V.
GLOSSARY TERM
A matrix organisational structure uses teams of
employees with suitable skills drawn from across the
normal departments to respond to the business’ needs.
Organisational structures should
reflect businesses’ needs
The organisational structure adopted by a business will
depend upon the type and size of the business, and it will
be designed to meet the needs of the business as fully as
possible. A number of key factors will be taken into account
by the business’ managers when designing (or redesigning)
an organisation’s structure:
» The business’ size As the business grows, it is more
difficult for managers to control growing numbers of
employees. Thus, in order to manage their workloads
efficiently, they will devise a structure that gives
more authority to those lower in the organisational
structure.
» The type of product supplied by the business A
business that supplies a range of diverse products
may organise itself traditionally into divisions. For
example, Hard Rock Café operates in this way. It
originally started as a restaurant business, established
by Peter Morton and Isaac Tigrett, but later expanded
into hotels and casinos. Key areas of the business,
such as casinos, have some degree of independence,
while still operating within the overall structure of the
organisation.
» The business’ objectives Businesses that are seeking
growth may organise themselves so as to minimise costs
and, hence, selling prices. This may encourage the use
of organisational structures which pass considerable
authority to relatively junior employees to minimise
management costs. This may also motivate junior
employees and improve productivity.
The HSBC brand is recognised worldwide. HSBC operates
under a single brand name and logo all over the world.
The bank’s latest advertising campaign is underpinned by 7.1
the phrase ‘Together we thrive’, reflecting its long-term
commitment to helping customers succeed throughout
the world.
Source: www.hsbc.com/investors/investing-in-hsbc/
group-structure
Questions
7.1.1 Relationship between business objectives and structure
1 Analyse one key issue in designing an effective
organisational structure for a multinational business
employing 235 000 people. [4]
2 Evaluate whether the advantages to HSBC of
organising itself in this way are greater than the
disadvantages. [12]
Organisational structures should
facilitate growth and development
An organisational structure should allow and assist a
business to increase its scale and to change in other ways
to enable it to meet its corporate objectives. The structure
used when a business seeks to grow and develop should
allow the organisation to adapt, to produce new products or
to operate in different markets.
As a business grows, its chain of command from those at
the top of the organisation to those at the bottom is likely
to lengthen. This may require a structure that is flatter,
with fewer layers of authority between senior and junior
employees. This will make communication easier and more
reliable, ensuring that decisions are more likely to be
understood and acted upon and that senior managers can
readily gather information from below. If a structure has too
many layers of authority, decisions may be slower and the
organisation may become less competitive as it becomes
slower to respond to changes in the market and other
external changes.
Organisational structures are subject to factors that require
them to adapt if the business is to remain successful. Changes
in technology, changes in competitors’ behaviour, changes
in government policies and changes in tastes and fashions
can all act as a catalyst for a change in an organisation’s
structure. For example, a new competitor entering a market
might result in an increase in price competitiveness,
necessitating existing firms to cut costs. Reducing the size
of the workforce and adapting its structure to contain fewer
layers of authority may be one way to achieve this. However,
if a structure is too rigid, this may not be possible.
STUDY TIP
You should assess the strengths and weaknesses of any
organisational structure by using all the information
available to you and considering the extent to which
the structure assists the business in achieving its
organisational objectives.
315
 Organisational structures should
7.1 encourage intrapreneurship
We saw earlier in this book that entrepreneurs are people
who have business ideas and a willingness to take the
risk necessary to start their own businesses to develop
them. The managers of some large organisations seek to
capture and use the spirit of entrepreneurship, and the
design of the organisation’s structure is one way to do
this. Intrapreneurs are expected to take responsibility for
A LEVEL 7.1 ORGANISATIONAL STRUCTURE
turning an idea into a profitable product through taking
necessary risks and innovating. Shutterstock, a business
that supplies photos for commercial purposes, holds a
hackathon lasting 24 hours once a year to let employees
pursue their own ideas. A hackathon is an event during
which employees develop new technologically-based ideas
at an accelerated pace.
To foster intrapreneurship within a large organisation, it
is important to use empowerment to help employees to
be creative and innovative. In terms of the organisational
structure, this means that it must be designed to allow
employees freedom to take their own decisions. This
may require limited control and supervision by managers
to encourage employees to have the confidence and
opportunity to develop ideas. This may exist in a structure in
which managers are responsible for relatively large numbers
of self-motivated employees. Furthermore, employees will be
given (or delegated) authority to take a range of decisions
and have authority over the resources that are necessary
for intrapreneurs to operate successfully. An organisational
structure which allows managers to have trust in their
employees’ ability and motivation to develop successful new
products is essential to promote intrapreneurship.
7.1.2 Types of structure
Key features of formal organisational
structures
Levels of hierarchy
A fundamental element of any organisational structure is the
number of levels or layers of hierarchy. Organisations with
a large number of layers or levels are referred to as ‘narrow’
or sometimes ‘tall’. That is, there is a substantial number of
people between the person at the top of the organisation
and those at the bottom. In contrast, ‘flat’ organisational
structures have fewer layers of authority. Figures 7.3 and 7.4
illustrate both flat and tall types of structure.
Managing
Director (1)
Total = 111
employees Managers or
team leaders (10)
100 shop-floor
workers
▲ Figure 7.3 A ‘flat’ organisational structure
316
Managing
Director (1)
Directors (3)
Total = 121 Managers (9)
employees
27 supervisors
81 shop-floor
workers
▲ Figure 7.4 A ‘narrow’ or ‘tall’ organisational structure
Traditionally, UK businesses have tended to use ‘narrow’ or
‘tall’ organisational structures as they have grown. However,
attracted by the prospect of faster and more effective
communication, and influenced by the structures used by
the some of the world’s most efficient companies, many
businesses have either adopted or moved towards flatter
organisational structures. Drawbacks exist in making such
a move. The process of flattening structures (which is
called delayering) has led to businesses operating with
significantly wider spans of control.
Chains of command
The organisational structure shows the business’ chain of
command. This is the way that authority is organised within
the business and shows who has control over which other
people in the enterprise. It also reveals how communication
flows through the organisation and how many layers that
messages must pass through to move from the top to the
bottom of the organisation – or vice versa.
GLOSSARY TERMS
Intrapreneurship takes place when individuals come up
with new ideas within their division, department, team or
business unit and follow them through.
Empowerment is a series of actions designed to give
employees greater control over their working lives.
Levels (or layers) of hierarchy refer to the number of
layers of authority within an organisation. That is, the
number of layers that exist between the chief executive
and a shop-floor employee.
Delayering is a reduction in the levels of hierarchy within
an organisational structure.
The chain of command is the line of communication and
authority existing within a business. Thus, a shop-floor
worker reports to a supervisor, who is responsible to a
departmental manager, and so on.
Once businesses have adopted a narrow organisational
structure, they have long chains of command from those
at the top of the organisation to those at the bottom.
Businesses with many layers of hierarchy frequently
experience communication problems, as messages moving
up and down the organisation pass through many people
and may be distorted or not passed on. Some business
writers have estimated that each extra level of hierarchy in
the structure reduces the effectiveness of communication
within the organisation by approximately 25 per cent.
Spans of control
A span of control is the number of people who report
directly to a manager. Spans of control and levels of
hierarchy have a relationship. An organisation with a wide
span of control will have relatively few levels of hierarchy –
the ‘flat’ organisation in Figure 7.3 (page 316). Conversely,
‘narrow’ organisations have many layers of hierarchy but a
narrow span of control. Figures 7.3 and 7.4 illustrate a broad
and a narrow span of control for two organisations that have
a similar number of employees.
A narrow span of control allows team leaders, supervisors
and managers to keep close control over the activities of
Manager A
Supervisor B
Worker Worker Worker Worker Worker
D E F G H I
▲ Figure 7.5 Spans of control
Responsibility and authority
Responsibility means that someone is expected to complete
a task or series of actions, and that they are answerable
for the results of their actions and any decisions they have
taken. In business, a manager is still responsible even when
they ask someone else to carry out some tasks. Authority
gives managers and other employees within a business the
power or right to exercise control and to make judgements.
Delegation and accountability
One key strategy an entrepreneur might adopt is to delegate
authority as the organisation increases in scale. Giving
people more authority is likely to lead to wider spans of
control. Wider spans of control can operate effectively if
junior employees have been delegated authority to take
decisions. This reduces the workload on their manager
or team leader; this person does not have to monitor all
subordinates so closely, freeing time for other duties.
The extent to which an organisation adopts delegation as
a key element in its organisational structure depends upon
the managers’ views of control. Some managers like to
retain as much control of decision-making as possible, and
only delegate when the pressure of their workload makes
this essential.
However, it is important that an employee understands how
much authority has been given to them through delegation
and therefore understands what they are responsible for.
Frederick Herzberg, when developing his two-factor theory
of motivation, argued that clear accountability is the basis
for providing achievement as a motivator.
the employees for whom they are responsible. As the span
of control widens, the subordinate is likely to be able to
operate with a greater degree of independence. This is
because it is impossible for an individual to monitor closely
7.1
the work of a large number of subordinates. A traditional
view is that the span of control should not exceed six if
close supervision is to be maintained. However, where
subordinates are carrying out similar duties, a span of
control of 10 or even 12 is not unusual. It is normal for a
span of control to be narrower at the top of an organisation.
This is because senior employees have more complex
7.1.2 Types of structure
and diverse duties and are, therefore, more difficult to
supervise. Figure 7.5 shows that Manager A has a span of
control of two, while Supervisors B and C have spans of
control of 5 and 4 respectively.
Supervisor C
Worker Worker Worker Worker
J K L
Centralisation and decentralisation
Centralisation and decentralisation are opposites. A
centralised organisation is one where the majority of
decisions are taken by senior managers at the top (or
centre) of the business. Centralisation can provide rapid
decision-making, as few people are likely to be consulted. It
should also ensure that the business pursues the objectives
set by senior managers.
Decentralisation gives greater authority to empower
employees lower down the organisational structure.
This may mean granting greater authority to employees
in branches, departments or divisions of the business.
Decentralisation may also entail relocating jobs and
functions (such as managing budgets) to other parts of the
organisation. Decentralisation may result in quicker and
more effective decisions taken by employees with a good
understanding of the customers’ needs. It may also result
in more motivated employees who relish greater authority.
However, it does rely upon good communication and a clear
focus on organisational objectives.
GLOSSARY TERMS
A span of control is the number of subordinates directly
responsible to a manager.
Centralised organisations are ones in which managers
hold the greatest decision-making power.
Decentralised organisations give greater decision-making
power to employees further down the organisational
structure.
317
 Informal organisational structures
7.1 This type of structure exists where the organisation does
not have an obvious structure. This is common in the case
of professionals (doctors and lawyers, for example) where
they operate as a team. The professionals normally receive
administrative support from others within the organisation.
This form of organisational structure allows highly trained
and motivated employees to organise their working lives
and to take decisions with a high degree of independence.
A LEVEL 7.1 ORGANISATIONAL STRUCTURE
However, it is less appropriate for many businesses as it
lacks co-ordination and control by senior managers.
Three types of organisational
structures
Businesses can adopt different organisational structures
according to a number of factors, including the size of the
organisation, the environment in which it operates and the
personal preferences of the owners and senior managers.
We will discuss the factors influencing the choice of
organisational structure in detail in the next section of this
chapter.
Hierarchical structures
Hierarchical organisational structures share decision-
making throughout the business and give all employees
a clearly defined role, as well as establishing their
relationship with other employees in the business. In
a hierarchical organisational structure, all employees
(apart from the most senior director or manager) are
subordinate to someone else. It is common for this type
of organisational structure to be based upon departments
and, because of the dependence upon agreed procedures,
it can be bureaucratic.
Chief Executive
Directors
Managers
Junior Managers
Supervisors
Shop-floor Staff
▲ Figure 7.6 A hierarchical structure
If this type of structure is ‘narrow’, it normally has a number
of features:
» The organisation will be centralised, with the most
important decisions taken by senior managers.
» Hierarchy is important and senior managers expect to be
treated with respect.
» Tradition is important and change is often implemented
slowly.
Alternatively, as we saw earlier, it may be a ‘flat’ organisational
structure which may result in a more decentralised
318
organisation. A flat hierarchical structure may also make
greater use of delegation, as managers at all levels have to
deal with wider spans of control. Close management may prove
impossible if a manager has a large number of subordinates
reporting to them and delegation can become a necessity.
Communication in formal organisations is principally
downwards and uses established routes, moving down from
senior to junior employees. Employees are aware of lines
of command and communication and the position of their
department or unit within the organisation. All employees
appreciate the possibilities for promotion that exist in the
business. Furthermore, as the business becomes larger,
decision-making can become slower as communication
has to pass through many layers within the organisation.
Simultaneously, co-ordinating the business’ attempts to
achieve its objectives becomes difficult. Senior managers
become more remote and may take decisions that are not
appropriate to local situations or to the needs of particular
groups of customers.
▼ Table 7.2 The advantages and disadvantages of
traditional hierarchical structures
Advantages Disadvantages
• Authority and • Organisation can be slow to
responsibility are clearly respond to customer needs.
established. • Communication, and
• The promotion path is especially horizontal
clearly signposted. communication, may be poor.
• Flat structures may • Senior managers may
offer junior employees become remote from junior
interesting jobs with employees and customers.
delegated authority. • Managers can become
overworked if the span of
control is too wide.
Functional structures
Many hierarchical structures (such as that shown in
Figure 7.6) are based around functions within the
business. This means that the hierarchy is based upon
departments such as marketing, human resources and
the other internal functions that are a part of most
businesses. Figure 7.7 illustrates this.
This type of functional structure allows specialists to
operate (for example, in marketing and finance) within
their area of expertise. They can generate new and very
innovative ideas, but other areas of the business may be
unaware of such developments.
The disadvantages of this structure can become more
apparent as the organisation grows in size. Departments
may bid for resources in an attempt to increase their size
and prestige within the business, rather than because this
will benefit the organisation.
Organisational structures based on geography
and products
This type of organisational structure can be seen operating
in businesses throughout the world in slightly different
ways. Some businesses organise their structures around
 Chief
Executive

7.1
Finance Human Resource Production Sales and Marketing Senior
Director Director Director Director Management

7.1.2 Types of structure

Finance Human Resource Production Sales and Marketing Middle
Managers Managers Managers Managers Managers

Trainee Accountants, Personnel and Supervisors and Marketing Officers Junior Managers and
Accounts Clerks, etc. Training Staff Production Workforce and Sales Force Shop-floor Employees

▲ Figure 7.7 A functional organisational structure

geographical regions, possibly based on countries or
even continents. Figure 7.2 on page 314 shows how the
multinational bank HSBC structures its organisation based
on geographical regions – at least to some extent.
An alternative approach is to structure the organisation
according to the products or brands that it produces. This
allows the employees to focus on the needs of customers
for a specific product, rather than what might be a diverse
range of products.

CASE STUDY
The BBC
The British Broadcasting Corporation (BBC) is the ● news and current affairs
largest television and radio broadcaster in the world. It ● design and engineering, including new technologies
is a public sector organisation owned by the state and ● finance, human resources, strategy, security and
operates under a Royal Charter. Its main task is to provide property
impartial television, radio and online services to the UK. ● BBC nations and regions.
It also operates an international broadcasting service,
In addition, the BBC also operates BBC Studios and BBC
BBC World Service, which broadcasts in more than 40
World News. BBC Studios is a wholly owned subsidiary
languages and reaches over 200 million people each
which sells BBC and other UK television programmes
week. In 2019, the BBC had 22 401 employees.
overseas.
The work of the BBC is overseen by a Trust which sets the
The BBC’s headquarters was previously at Broadcasting
corporation’s objectives and makes sure that the BBC’s
House in London. In 2011, it started the process of moving
senior managers meet high standards of performance. It
some of its operations to Salford, near Manchester, in the
also monitors the output of the BBC against the expectations
north of England, and by 2020 it had 3200 staff working
of its audiences by holding a detailed review every five years.
there.
The Executive is responsible for the operational
management of the BBC and for fulfilling the objectives Questions
set by the Trust. The Executive comprises the Director- 1 The BBC Trust sets its objectives and the Executive is
General of the BBC and other senior figures, including responsible for its operational management to achieve
those responsible for television, radio, news and current these objectives. Analyse one possible implication of
affairs, and digital services. this division of roles. [4]
2 Analyse two problems the BBC may have faced in
Alongside the Executive, the BBC has the following
moving a significant proportion of its operations to
operational areas:
Salford, more than 200 miles (320 km) away from
● television
London. [8]
● radio and education

319
 Functional organisational structures have similar advantages
and disadvantages to hierarchical structures. In addition,
7.1 they can generate high levels of motivation and loyalty
to departments or divisions. However, this focus on
departments or divisions can become harmful if decisions
are taken without reference to other elements of the
business or its overall objectives.
Some businesses, such as HSBC, opt to base their
organisational structures on geographical regions because
the products that consumers demand vary considerably in
A LEVEL 7.1 ORGANISATIONAL STRUCTURE
different countries. By organising itself in this way, the
Bank is able to meet the needs of its 60 million customers
more fully. Indeed, it promotes its services by emphasising
that it operates in many different markets with customers
who have different needs.
Other businesses produce highly differentiated products
that require different production methods. As a
consequence, they base their organisational structures
Production Marketing
Project A Manager Production Staff Marketing Staff
Project B Manager Production Staff Marketing Staff
Project C Manager Production Staff Marketing Staff
Project D Manager Production Staff Marketing Staff
▲ Figure 7.8 A typical matrix structure
Businesses using matrix structures put together teams of
individuals with the specialist skills necessary to complete
a particular project. Each individual within the project
team brings a particular skill and carries appropriate
responsibilities. The aim is to allow all individuals to use
their talents effectively, irrespective of their position within
the organisation. So, a project manager looking to develop a
new product may be able to call on IT and design skills from
relatively junior employees elsewhere in the organisation.
Matrix structures focus on the task in hand – launching
a new product, opening new retail outlets, closing down
factories or entering overseas markets for the first time.
Project groups often have strong senses of identity in spite
▼ Table 7.3 The advantages and disadvantages of a matrix structure
Advantages
• Focuses on tasks necessary for business success
• Encourages organisations to be flexible and responsive to
customers’ needs
• Motivates and develops employees by providing varied and
challenging tasks
320
around the supply of these products. This is the case with
the BBC, where its different divisions look after music, news
and future media, including its online services. Employees
may need different skills to operate in these separate
divisions to meet customers’ needs effectively. Organising
the business into smaller specialist divisions can improve
the quality and speed of decision-making as well as the
quality of the product itself.
Matrix structures
This type of organisational structure is task-orientated
and based on the use of teams. It is intended to overcome
many of the problems associated with the traditional or
hierarchical structure. It is a combination of a vertical
chain of command, operated through departments or units,
and horizontal projects of product teams. A typical matrix
structure is illustrated in Figure 7.8.
Chief Executive
Human Resources Finance
HR Staff Finance Staff
HR Staff Finance Staff
HR Staff Finance Staff
HR Staff Finance Staff
of being drawn from various areas in the business. This
is because they are pursuing a clearly defined objective,
providing team members with a sense of purpose and
responsibility.
Matrix structures bring problems with them. Employees can
find it difficult having two managers (project managers
and departmental managers) because of divided loyalties.
They can be uncertain about which parts of their work to
prioritise and conflict can result. Matrix structures have a
reputation for being expensive to operate: administrative
and secretarial staff can be costly when used in support of a
number of projects.
Disadvantages
• Employees can have divided responsibilities
• Conflict can occur between project and departmental
managers, reducing performance of organisation
• Heavy expenditure on support staff may be required
How and why organisational structures change
with growth
In a very small organisation, an entrepreneur or manager
may be able to make all the necessary decisions and carry
out many managerial tasks. They may not necessarily have
the experience or knowledge to do this as effectively as
possible, but lack of finance may preclude the employment
of specialists.
However, as an organisation grows this may become more
difficult – it becomes impossible for the entrepreneur to
take all decisions. Because of this, the structure adopted by
the organisation might need to be adjusted as it develops.
Increasing levels of hierarchy
The most obvious change is that the organisation will
introduce more levels of hierarchy to avoid managers
having too heavy workloads. A small business may initially
be owned and managed by a single person, but growth
may mean that the owner has to recruit two managers
to take control of some of the business’ functions. These
managers may report to the owner, creating an additional
level of hierarchy. Further growth and consequent
CASE STUDY
China’s banks need to review organisational structures
The Chinese economy is entering a period of change. This
has significant implications for the country’s banks, many
of which operate throughout the entire country, with some
also operating branches overseas. The banks have been
left facing three major challenges:
● Business analysts believe that China’s banks should seek
to increase their dealings with small- and medium-sized
enterprises, as well as with retailers. This is important
as large enterprises use more non-bank finance.
● Secondly, the banks must develop more new and
innovative products to win new customers and to meet
their changing demands.
Organisational structure and delayering
As an organisation reduces the number of levels of hierarchy
through the process of delayering, it becomes a flatter
organisational structure. This may be necessary because the
business is becoming less responsive to its customers, or
because it needs to reduce the number of managers to lower
costs and enhance its competitiveness.
A flatter organisational structure will entail fewer levels of
hierarchy and wider spans of control. It does not necessarily
mean that the organisation will adopt a different structure.
A business with a functional structure may not change its
type of structure as it removes layers, it may simply operate
with fewer levels.
recruitment of shop-floor employees may mean that the
new managers’ spans of control become too wide to be
operated effectively. This, in turn, might require the
appointment of more managers, which may ultimately
7.1
require the introduction of an additional level of hierarchy
if the original owner’s span of control and workload become
unmanageable.
New divisions or departments
Another structural consequence of growth may be that,
as a business moves into new markets or starts to supply
7.1.3 Delegation and accountability
new products, it establishes separate areas within the
organisation to manage this. This can be necessary for two
reasons:
1 The development means that the organisation is too
large to manage as a single entity. Better-quality
decisions and a tighter focus on meeting customer
needs may be achieved with a separate division.
2 The new development may require the provision of very
distinct products, requiring employees with different
skills and distinctive operational procedures. This may
be carried out most effectively within a separate part of
the organisation.
● Finally, the banks should adapt their organisational
structures. Changes in types of customers and
the need for new and innovative products will call
for different organisational structures. The new
organisational structures will require close co-
operation and co-ordination among different divisions
and groups of employees.
Questions
1 Analyse two issues that China’s banks may face if
they implement a change in organisational structure. [8]
2 Evaluate the best type of organisational structure
for China’s banks. [12]
7.1.3 Delegation and accountability
We saw earlier in this chapter that delegation is the passing
down of authority through the organisation. In contrast,
accountability refers to the fact that responsibility remains
with the manager or other person who has delegated
authority. For example, a junior employee who is delegated
responsibility to carry out specific tasks or to make certain
decisions will be held accountable by the relevant manager
if they perform poorly. This accountability can take several
forms within a business:
» The poorly performing employee may not receive a bonus
or other financial reward that is associated with the
delegated task.
321
 » If the employee is considered not to have the necessary
skills to perform delegated tasks that are a central part
7.1 of their employment, this may lead to the business
offering further training.
» Alternatively, if the employee is deemed to be
incompetent in carrying out delegated tasks, this may
form the basis of a case for dismissal.
The key point here is that delegation passes down the
organisational structure, while accountability flows upwards
from subordinates to managers.
A LEVEL 7.1 ORGANISATIONAL STRUCTURE
The process of accountability
Delegation is likely to be an effective element of the way
an organisation structures itself and operates if a number
of conditions are met. There are a number of stages in the
process of delegation:
» The process of delegation should commence with
planning and preparation. Thus, both the junior and
senior employees need to understand the objectives of
delegating authority. In 2019, Starbucks continued its
programme of expansion in India by opening five new
coffee shops in Surat and Ahmedabad. The company
will have delegated authority to its senior managers in
the country and, in turn, the senior managers will have
granted authority to branch managers to operate the
branches successfully. This will have entailed careful
preparation and the recruitment and selection of
suitable employees.
» Both parties to delegation may require training to
provide them with the necessary skills to be a successful
part of an organisation that makes effective use of
delegation. Managers may require training to help them
select the best people to delegate to and to support
employees through the process. Employees may require
▼ Table 7.4 The advantages and disadvantages of delegation
Advantages
• Delegation can improve the motivation levels of junior
employees. This can improve labour productivity and
reduce rates of labour turnover.
• Delegation can speed up and improve the quality of decision- • It may be inappropriate in some organisations where
making. Decisions may be taken by employees who are close
to customers and have a better understanding of their needs,
and they do not have to refer decisions to managers.
• Delegation can reduce the workloads of senior and middle
managers, allowing them to focus on key tasks and to
improve their performance.
• Delegation improves the skills of junior employees and
prepares them for more senior roles in the organisation.
322
training to acquire the essential skills to carry out
their new tasks. Trust must exist between manager and
subordinate. The manager must trust the employee to
carry out the delegated tasks effectively and be willing
to give up control of the tasks that are delegated.
On the other hand, the subordinate must trust that
the manager will not interfere in the delegated tasks
without good reason, and that they will support the
subordinate’s decisions and actions.
» The manager may need to implement means to support
subordinates carrying out delegated tasks. This is
essential if the tasks are very complex or if the employee
is new to having greater authority and a different
role within the business. The support may be regular
meetings or an ongoing programme of training.
The impact of delegation on a business
Delegation affects all aspects of a business and not just its
workforce. Through the use of delegation, a business may
change its operational methods, using employees in teams
and allowing them greater authority to take decisions.
Delegation can impact on a business’ marketing function.
It can be used to provoke increased levels of innovation
and greater responsiveness to the needs of a business’
customers. Implementing delegation may be costly initially
but, over time, it can improve employee motivation and
productivity, helping to reduce unit costs of production.
If delegation is used effectively, it may increase the
competitiveness of a business through the creation of
more innovative products, a more settled and productive
workforce and, in the longer term, an improved financial
performance.
The use of delegation can bring benefits and drawbacks to a
business, as summarised in Table 7.4.
Disadvantages
• The costs of training. Delegation may require a business to
spend heavily upon training employees to ensure they have
the necessary skills.
leadership styles are authoritarian and managers may
be unwilling (or lack the skills) to pass control to junior
employees.
• Delegation is not a suitable strategy to adopt to manage
a crisis. Such situations would require rapid decisions by
experienced senior managers.
Delegation and motivation
We saw in Table 7.4 that delegation can have very positive
effects on the motivation levels of junior employees. If
subordinates are delegated authority to manage interesting
and challenging duties, it can enhance motivation.
» Maslow would argue that delegation allows employees to
fulfil self-esteem needs by being involved in decision-
making and having the trust of managers, which is a
form of recognition.
» Similarly, Frederick Herzberg believed that delegation
7.1.4 Control, authority and trust
The relationship between spans of 7.1
control and levels of hierarchy
Two fundamental features of an organisation’s structure are
span of control and levels of hierarchy. These two factors
are interrelated: an organisation that reduces its levels of
hierarchy is likely to widen the spans of control of many
of its employees. Increasing the number of levels with

7.1.4 Control, authority and trust

acts as a motivator. His research revealed that personal approximately the same number of employees will narrow
achievement, recognition and interest in the work itself spans of control.
are three of the most important means of motivation. If Earlier in this chapter we looked at the distinction between
subordinates are delegated challenging and interesting tall and flat organisational structures. Table 7.5 explores
tasks, Herzberg’s theory suggests that this could have a this relationship and its implications further.
highly positive effect on motivation.
▼ Table 7.5 Spans of control, levels of hierarchy and narrow and flat organisational structures

Balance between spans Associated leadership Other comments Examples

and levels style
• Managers can retain control of
This is more likely to
Tall organisational decision-making.
be authoritarian, with
structures with many • Employees may be relatively unskilled More likely to be used in
managers having a Theory
levels of hierarchy and and less prepared to take decisions. relatively small businesses
X view (see page 91) of
narrow spans of control • Motivation may depend upon financial
employees.
incentives.
• Employees are more likely to be skilled,
Flat organisational Leaders may use democratic possibly multi-skilled. This structure may be used
structures with few methods based upon a • Motivation will be linked to job design. by large businesses and
levels of hierarchy and Theory Y view (see pages • The business may engage in delayering especially those operating
wide spans of control 91–92) of employees. and/or may make use of self-managed multinationally.
teams.

Delayering has been a common feature of changes in
organisational structures of many businesses in recent
years. Delayering reduces the number of levels of hierarchy
but widens spans of control. It is common for businesses to
remove whole layers of management (and especially middle
managers). The process of delayering offers a number of
advantages to businesses:
» It can result in substantial reductions in wage costs,
which may be important for a business that operates in a
price-competitive market or one that aims to increase its
profitability. Middle managers are frequently highly paid
and so removing them results in a substantial saving on
wage costs.
» By removing layers of hierarchy, delayering can
shorten the chain of command, improving the flow of
communication within the business and making it more
responsive to the changing needs of its customers.
» Delayering (rather like delegation) results in junior
employees having greater authority. This may enhance
motivation as jobs will have to be redesigned and may
become more diverse, challenging and interesting.
Despite these advantages, the process of widening spans
of control by removing layers of hierarchy can lead to
disadvantages. Job losses are an integral part of delayering
and this can threaten the security needs of all employees
within the business, damaging motivation levels and
employees’ performance. Further issues are knowledge
management and succession planning. A danger in
delayering is the loss of knowledge that is essential to the
organisation from the dismissal of the next generation of
senior managers. An organisation that is delayering needs
to handle these issues openly and sensitively.
GLOSSARY TERMS
Labour productivity measures the relationship between
the amount of labour used in production and the quantity
of outputs of goods or services.
Knowledge management is the process of identifying,
maintaining and effectively using an organisation’s
resources of knowledge.

323
 CASE STUDY
7.1
Google
Google has been reported to have nearly 60 staff for every
manager, and it makes extensive use of small project
teams. It also releases staff for about 20 per cent of
their time for their own self-directed innovation projects.
The company continues to produce innovative online
services and functions, including services which have
A LEVEL 7.1 ORGANISATIONAL STRUCTURE
revolutionised online commerce.
We strive to maintain the open culture often associated with
start-ups, in which everyone is a hands-on contributor and
feels comfortable sharing ideas and opinions. In our weekly
all-hands (‘TGIF’) meetings – not to mention over email or in
the cafe – Googlers ask questions directly to Larry, Sergey
and other execs about any number of company issues. Our
The difference between authority
and responsibility
Managers frequently delegate authority to more junior
employees. This gives them power in relation to an agreed
set of circumstances. For example, Pakistan International
Airlines may delegate authority to one of its pilots to take
decisions on a particular flight. However, despite this
decision, overall responsibility for this flight remains with
the senior managers at the Airline. Thus, if problems arise,
the senior managers are responsible for the well-being of
the plane and all its passengers. Even if the pilot makes an
error, responsibility will still lie with the senior managers,
possibly because they gave authority to someone without
all the necessary skills. Therefore, while it is possible to
delegate authority, the responsibility remains with the
delegator (or senior employee).
STUDY TIP
Do not say in your answers that managers delegate
responsibility – this would reveal incomplete
understanding. Managers can only delegate authority –
responsibility remains with them.
Possible conflicts between control
and trust
To be effective, delegation has to be based upon
trust. The manager has to be willing to cede control to
employees and to trust them to take the right decisions on
the business’ behalf. Giving trust has to be accompanied
by a reduction in control. Delegation is ineffective if
managers are continually looking over subordinates’
shoulders. Such close supervision will not allow the junior
employees to use their authority independently and is not
an efficient use of the manager’s time.
For some managers, it can be difficult to give up control
and to trust subordinates, especially if they have a
324
offices and cafes are designed to encourage interactions
between Googlers within and across teams, and to spark
conversation about work as well as play.
Google’s approach to organising its employees is
successful and it is a highly profitable business.
Source: www.google.com
Questions
1 Analyse two problems that Google might encounter
from allowing its employees to work unsupervised
for 20 per cent of their time. [8]
2 Evaluate the possible reasons why Google operates
a flat organisational structure. [12]
Theory X view (see page 91) of employees. Managers are
more likely to be willing to trust employees if:
» the business’ culture and leadership style encourage
trust and delegation
» employees are skilled and prepared to exercise greater
authority
» they have received training on effective delegation.
If these factors are present, trust is more likely. If managers
are unable or unwilling to trust subordinates, they will
retain control.
7.1.5 Centralisation and
decentralisation
We looked at centralisation and decentralisation on
page 317. In recent years, many businesses have
decentralised because it brings benefits to many
stakeholders.
» Decentralisation provides junior employees with the
opportunity to fulfil needs such as achievement and
recognition through working. This should improve
motivation and reduce the business’ costs by, for
example, reducing the rate of labour turnover.
» Decentralisation is doubly beneficial to managers. It
reduces the workload on senior managers, allowing
them to focus on strategic (rather than operational)
issues. At the same time, it offers junior managers an
opportunity to develop their skills in preparation for a
more senior position.
» Customers may benefit by having more decisions
made locally which can encourage the business to
meet their needs more fully. Many junior employees
in the organisation may have better understanding
of customers’ needs and operational matters, and
delegation may allow them to use their skills and
understanding to good effect.
However, some businesses remain centralised. This might
be because the senior managers like to remain in control of
the business and to take the major decisions. The decision
to centralise may reflect the preferred style of management
of the business’ senior managers and their desire to retain aken by junior
ions t emp
ecis
authority. This may occur when employees are relatively
low-skilled and its managers are experienced decision- M
an
y d
lops j
Deve unior
loy
ee
s 7.1
makers. In addition, if a business makes all its buying employees

decisions centrally, it is likely to benefit from purchasing H

elp loca
economies of scale, allowing the possibility of shareholders

s t l cu
o m sto
CENTRALISATION
receiving increased benefits. In such circumstances, an

eet mers
organisation is likely to perform more effectively if power Senior

need
managers are
remains at the centre of the organisation. Senior

s of
managers experienced
Most decisions

7.1.6 Line and staff

want to decision-
taken by senior makers
retain managers
STUDY TIP control Purchasing
economies

n
i m t iv a ti o
Do not assume that decentralisation is preferable. of scale

ve s
pro
Whether a business should decentralise or not will

Mo
Many employees
are low skilled
always depend upon its circumstances.

Red
u c es w o rk lo a d of
s enio r
m anager
GLOSSARY TERMS
Line managers have authority over specified people within DE C E N N
T R A LIS A TIO
the organisation.
Staff managers have responsibility for support functions
within the business, such as information technology ▲ Figure 7.9 Centralisation and decentralisation
systems.

CASE STUDY
IOHK
Many millions of people in the world do not have access
to financial services such as bank accounts. IOHK has
disrupted markets, for example, by creating software
which makes financial services more widely available. Its
customers include governments and other businesses.
The company is decentralised and uses small teams to
carry out individual projects.
The company is not unusual in that it uses blockchain
technology in its software development. More unique is its
use of the concepts underpinning blockchain technology
to organise and manage its business. IOHK’s business
model is based around decentralisation. It has 250
employees living and working in 20 different countries and
no headquarters. Employees work from locations and to
schedules that suit their individual needs. The company’s
business model depends on technology. Its ‘distributed
business operating system’ enables employees to be
highly productive. The company says that this technology
enables it to equal, and even exceed, productivity levels
achieved by most businesses.
Tamara Haasan, chief of staff at IOHK, believes the way
the company works offers many benefits. ‘A remote,
distributed business operating system encourages people
to share information, communicate daily, find information,
track goals, deliverables and still have fun and form
personal connections in a seamless and sustainable way.’
However, IOHK also depends on more conventional
approaches to managing its employees, including
manuals for induction and other training. It is determined
to have a collaborative workforce and not one that
comprises many isolated employees.
Sources: www.verdict.co.uk/decentralised
-working-blockchain-iohk/
Questions
1 Analyse one reason why IOHK is dependent on
technology to allow its decentralised structure to
operate efficiently. [4]
2 Evaluate the case for IOHK using decentralisation
in this way. [12]

7.1.6 Line and staff
Line managers normally hold departmental responsibilities
(including managing people and other resources) and derive
their title from fulfilling a role in the line of command from
the top to the bottom of the hierarchy. They have the power
and authority to direct the actions of subordinates who are
accountable for carrying out certain duties. Line managers
operate with the aim of assisting the business in meeting
its corporate objectives.
Staff managers are often appointed as the organisation
grows in size and are used to relieve senior managers of
some time-consuming duties. Examples of staff managers
include IT and HR managers. Staff managers only indirectly
325
 contribute towards achieving corporate objectives.
Instead, a staff manager is responsible for making sure all
7.1 the supports are in place so that the line staff are hired,
trained, equipped and supported while they carry out the
actual operations.
Causes of conflict between line and
staff managers
The authority of staff managers is different from that of line
A LEVEL 7.1 ORGANISATIONAL STRUCTURE
managers. While the line manager focuses on generating
revenue, the staff manager often has to engage in expenditure
to support further operations. This can lead to tensions in the
workplace, especially when there is no clear understanding of
the difference in the authority of the positions.
Line managers do not always welcome the appointment of
specialist staff managers. Line managers might feel that
their position and status is threatened and may believe
staff managers only understand a part of the complexities
of their jobs. When staff managers take decisions relating
to their specialist areas (for example, developing and
implementing recruitment policies), line managers may
not consider that they meet the needs of their particular
division or department and may oppose their use.
Staff managers may sometimes feel that their opinions are
not taken into account in corporate decisions. For example,
when appointing a new member of staff, the relevant line
manager may have the final say, but a specialist HR staff
manager may have a valuable contribution to make to the
selection process, and they may be unhappy if they are not
allowed to play a part in the decision.
Conflict is more likely in organisations where there is not a
clear and well-understood division between the authority
of line managers with responsibility for operations and that
of staff managers. If these authorities overlap, it is the
TEST YOUR LEARNING
Short answer questions
1 Define the term ‘organisational structure’. [2]
2 Explain two factors that might influence a
business’ managers when designing its
organisational structure. [6]
3 a Define the term ‘level of hierarchy’. [2]
b Explain one reason why communication may be
more difficult in a narrow hierarchy. [3]
4 Explain one advantage and one disadvantage to a
business of operating a functional organisational
structure. [6]
5 a Define the term ‘matrix organisational
structure’. [2]
b Explain one disadvantage to a business
of operating a matrix organisational structure. [3]
6 a Define the terms ‘delegation’ and
‘accountability’. [4]
326
responsibility of senior managers within the business to
make decisions to clarify and publicise responsibilities.
Is there a ‘best’ structure for
organisations?
It is easy to criticise traditional hierarchical structures as
being old-fashioned, costly and having little relevance to
modern businesses. This is not always the case. We can list
scenarios and circumstances in which such a structure would
be appropriate and effective. Similar arguments can be put
forward for matrix or functional structures.
We do, however, tend to think of an organisation as
operating a single structure. It may be that large businesses,
in fact, operate more than a single structure, reflecting
the different needs of various areas of the organisation.
Therefore, a large firm may organise itself as follows.
» Its research and development division may operate
on an informal basis to make the most effective use
of talented and highly skilled scientists. This division
would simply make sure that the scientific team received
sufficient administrative support from clerical staff.
» Its administration may be based on a traditional
structure in the expectation of achieving a continually
high standard of work and benefiting from a consistent
approach to this aspect of business.
» Its sales and marketing teams may be organised on
a matrix structure and have clear targets and tasks
to achieve. These could be in the form of developing
existing markets, breaking into new markets or
conducting market research.
It may be that these differing structures could be found
within a single organisation. Dangers exist in this approach,
as the organisation could become difficult to co-ordinate,
and some divisions may begin to pursue objectives different
from those of the overall business.
b Explain one advantage to a large multinational
business of engaging in delegation. [3]
7 a Define the term ‘authority’. [2]
b Explain one reason why authority may be
delegated but responsibility may not. [3]
8 a Explain one reason why trust is an important
element of delegation. [3]
b Explain one reason why a policy of delegation
might be difficult to implement within a business
that operates an authoritarian leadership style. [3]
9 a Explain one reason why a business may choose
to operate a decentralised organisational
structure. [3]
b Explain one benefit to a large multi-site business
of implementing a policy of decentralisation. [3]
10 a Define the terms ‘line managers’ and ‘staff
managers’. [4]
b Explain one reason why conflict may occur
between line and staff managers. [3]
Data response question
Nayudu Software Ltd
Janardan Nayudu’s software company is growing quickly.
It designs, installs and maintains software for a range of
companies throughout India and Asia. All of its software
solutions are individually designed to meet its customers’
precise needs. It has excellent relationships with its
customers (most of which are large businesses) due
to the consistent quality of its work. It has a reputation
for improving on and developing the work of some of its
competitors and for having highly skilled employees.
Growth has led to a need to change the company’s
organisational structure: it increased its workforce by
24 per cent in 2020 (to 496) compared with 2019. Many
employees were attracted by pay rates that were 9 per
cent above the industry average. Despite this, labour
turnover remained at 12 per cent.
In 2020, the company employed 31 managers and these
changes together led to a significant increase in its
typical span of control. As a consequence, authority has
been delegated to all employees, including those newly
appointed. Some managers are unhappy with this change.
Janardan Nayudu wishes the business to move to a matrix
organisational structure. This will allow the employees to
become more empowered. He is considering increasing
the training budget (which was overspent in 2020) but
considers maintaining profit margins a priority. 7.1
Questions
1 Analyse two possible implications for Nayudu
Software Ltd of a ‘significant increase in its typical
span of control’. [8]
2 a Calculate the increase in the number of
employees between 2019 and 2020. [2]
7.1.6 Line and staff
b Calculate Nayudu Software Ltd’s average span
of control in 2020. [2]
c Evaluate whether training is the most important
factor for the company in preparing to empower
its workforce. [12]
3 ‘The company should move to a matrix structure
as Janardan Nayudu proposes.’ Evaluate this view. [12]
Essay questions
1 Evaluate the extent to which delayering will assist
a business in achieving its corporate objectives. [20]
2 ‘A matrix organisational structure is always likely
to be more efficient than a functional organisational
structure.’ Evaluate the extent to which this
statement is true. [20]
327
 7 Human resource management
A LEVEL

7.2 Business communication

A LEVEL 7.2 BUSINESS COMMUNICATION

Chapter overview
In this chapter we examine:
★ the purposes and methods of communication
★ the channels of communication used by businesses
★ barriers to communication
★ the role of management in facilitating communication.

7.2.1 Purposes of communication THE SENDER

(initiates the
MESSAGE
(the information
communication) that is transmitted)
STUDY TIP
Before reading this chapter, it is worthwhile revisiting
AS Level Section 2 on leadership, organisational
structures and motivation. This will provide you with MEDIUM
a good foundation for studying communications. (how the message
is passed on,
FEEDBACK e.g. email)
(was the message
What is communication? received and
understood?)
Communication involves the transfer of information. This
transfer can take place between people, or between people
and organisations, or between different organisations. A
transmission mechanism is simply the method by which one RECEIVER
(the audience at
person communicates with another. Letters and email are whom the message
examples of methods of communication. Communication is targeted)
involves a number of elements, as shown in Figure 7.10.
▲ Figure 7.10 The process of communication

CASE STUDY
Cathay Pacific
International Airport and operates 155 aircraft. The airline
employs nearly 34 000 people (including its subsidiaries)
and has a well-designed website. Along with its
subsidiaries, it carried more than 35 million passengers
during 2019.
The company engages in communication for many
different reasons, including marketing purposes. Over
recent years, it has made greater use of electronic
communication, both internally and externally.

Questions
▲ Figure 7.11 A Cathay Pacific aeroplane 1 Analyse two reasons why electronic communication
Cathay Pacific is the international airline of Hong Kong. may be important to Cathay Pacific. [8]
It operates scheduled passenger and cargo services to 2 ‘Marketing is the most important reason for Cathay
79 destinations in 46 countries. It has four wholly owned Pacific to engage in communication.’ Evaluate
subsidiary airlines. Cathay Pacific is based at Hong Kong this view. [12]

328
Advertising provides an example of business communication.
» The sender is the company that commences the process
of communication.
» The message is the information that the business wishes
to send to its audience. In the case of Cathay Pacific,
an advertisement may be transferring information about
the quality of the airline’s services.
» The medium is the way in which the message is
communicated. Cathay Pacific might use newspapers and
magazines to transmit its advertising message.
» The audience is the target group at whom Cathay
Pacific might aim its message. This group would be
fairly broad, including any potential airline passengers
on any of its routes.
» Feedback, in Cathay Pacific’s case, could take the
form of the company asking customers where they
heard about the airline when making a booking. Cathay
Pacific could also ask about the effectiveness of its
advert to assess whether to use similar approaches in
the future.
GLOSSARY TERMS
Communication is the exchange of information between
people.
Feedback is a response to communication that may
confirm receipt and comprehension.
Effective communication occurs when information is
passed on to other people or groups and feedback is
received, confirming that the communication has been
understood.
An annual report is a comprehensive account of a
company’s activities during the trading year that has just
finished.
When is business communication
essential?
Businesses communicate with their stakeholders in a variety
of ways and for a variety of purposes. There are numerous
circumstances in which is it essential for businesses to engage
in communication, and we consider some of these below.
Marketing purposes
Businesses need to communicate with potential and actual
customers to research their needs through primary market
research. In many industries, this creates an ongoing
need for two-way communication. Businesses also inform
their customers of the products that they are selling
through a variety of promotional activities, and they may
use public relations events to present the business in a
positive light to its stakeholders, including local residents
and government. This category of communication will
also include routine items, such as arranging delivery of
products to customers and negotiating prices.
Operational reasons
This forms a significant reason for communication within
and outside the business. Internal communication will take 7.2
place continually to ensure that operations are organised
efficiently. For example, meetings may be held to discuss
how to respond to a large order or complaints from
customers. Alternatively, communication will be necessary
with suppliers to order raw materials or components and to
arrange delivery.
Communications may also be essential if the business faces
7.2.1 Purposes of communication
a crisis. It may be necessary to communicate urgently with
affected stakeholders, such as employees and customers,
and to make public statements intended to reassure all
stakeholders. In 2019, Boeing, the American multinational
aircraft manufacturer, faced such a crisis when two of its
737 Max planes crashed, killing 346 passengers and crew.
The BBC reported that the company was criticised by an
international panel, including representatives from the
Federal Aviation Administration (FAA), as well as officials
from NASA and nine other countries, for ‘confusing’
communications following the crashes. This was very
damaging for the company and emphasises the importance
of effective communication in such circumstances.
Managing the workforce
Effective communication is essential to create and
maintain a productive workforce. This category of
communication would include that essential to the process
of recruitment and selection, which we considered at length
in Chapter 2.1. Negotiation with trade unions or other
employee representatives over pay and working conditions,
as well as appraisal interviews, are further examples of this
category of communication.
Financial communication
Information on a business’ financial performance is vital
to effective decision-making at all levels within the
organisation. Junior managers will require budgets to
enable them to control expenditure and to act as targets for
revenue. More senior managers might look at data relating
to cash flow and profitability produced by the business’
finance department. This type of communication will also
take place externally when businesses send invoices to
customers or pay those sent by suppliers.
Legally required communication
Most businesses are obliged to communicate with external
parties to provide key information. In the UK, businesses
have to engage in two-way communications with Her
Majesty’s Revenue and Customs (HMRC) to establish any
liability to pay taxes and then to pay those taxes. Public
companies have to publish an annual report and accounts
containing specified information on financial and other
aspects of the business’ performance over the previous
financial year.
329
 This communication can be internal, that is with other
individuals or groups within the business. Thus, an email
7.2 sent from the director of human resources to team leaders
concerning overtime rates would be an example of internal
communication. External communication takes place
between a business and other organisations or individuals.
For example, a business providing details of job vacancies
on its website as part of the process of external recruitment
would be communicating externally.
Figure 7.12 summarises the key internal and external reasons
for communication and emphasises that it is a two-way
process.

COMMUNICATIONS
A LEVEL 7.2 BUSINESS COMMUNICATION

INTERNAL EXTERNAL
exchange of information with
external individuals and firms
exchange of information
within an organisation

FORMAL INFORMAL information generated information needed

emails verbal communication

letters non-verbal communication
job specifications gossip/grapevine

Customers Local residents Government bodies Government bodies Customers Suppliers

cost and availability pollution, profit and laws and orders, prices and
of goods and employment loss data, regulations, statistics market delivery
services opportunities tax returns on industry research data dates

▲ Figure 7.12 A summary of communication

» Interviews These are a formal method of communication

7.2.2 Methods of communication
There are a number of standard methods of communication
that are used by businesses.
Spoken communication
» Telephone communication This is widely used in
business to transmit simple messages quickly and
effectively. It allows contact with individuals and offers
immediate feedback, but it does not offer a written
record of discussions or allow callers to view each other’s
body language.
» Meetings These occur in a variety of forms, including board
and shareholder meetings or meetings with customers
and suppliers. Less formal meetings such as quality circles
and social events are also forums in which information
is exchanged. Meetings can allow in-depth discussion
and testing of ideas, as well as providing a record of
communication. However, they are time-consuming and
expensive, especially for multinational businesses.
» Presentations These are frequently used in businesses;
for example, internally to transmit information on
new projects and ideas, and externally to attract new
customers. Detailed information (especially relating to
sales and products) can be exchanged using this method
and the record of a presentation can be sent to any
interested parties.
that may be used to appoint new staff or to deal with
disciplinary or grievance issues. This method encourages
detailed discussions, though they can only involve a
relatively small number of people.
Written communication
This is more appropriate when detailed information needs
to be exchanged. It can be slow, though modern technology
(for example, texts and emails) can speed up the process.
» Reports are widely used to transmit information by
businesses. They can relate to important issues, such as
an investigation into the establishment of a new nuclear
power station, or smaller topics, such as reasons for low
sales of a new product. They are also used to inform on
the financial performance of companies.
» Business letters are an external form of communication
used, for example, to make contact with politicians
about factors affecting the business or to arrange other
forms of communication, such as meetings. The use of
letters is declining, however, as they are replaced by
electronic forms of communication.
» Memoranda are extensively used internally to exchange
information concisely and rapidly on a wide range of
topics, though in many businesses they have been
replaced by emails.

330
Electronic communication
Developments in technology have transformed the way in
which businesses communicate and are continuing to do so.
» Electronic mail (email) This method of communication
allows computers to speak to one another throughout
the world at very low cost. Messages are stored on
servers and can be accessed by the recipient through
the use of a password. This is particularly useful for
quick international communication across different time
zones, as messages can be stored until the recipient is
available.
» Websites These play a central role in communication for
most businesses, even relatively small ones. They offer
a chance to communicate with stakeholder groups to
publicise products, collect research data, achieve sales
CASE STUDY
Golden Screen Cinemas’ Facebook page
Golden Screen Cinemas is Malaysia’s largest cinema
chain. The company operates 34 cinemas with 366
screens. Its largest cinema is in Mid Valley Megamall and
has 21 screens and 2763 seats. Golden Screen faces tough
competition from TGV Cinemas, which has 32 cinemas
throughout Malaysia.
Golden Screen Cinemas makes effective use of its
Facebook pages to communicate with its customers. This
can be seen at https://www.facebook.com/GSCinemas.
At the time of writing, the company has 1.89 million
» Text messages These are used by businesses to
communicate with customers, mainly for marketing
purposes. Research shows that 99 per cent of texts are
opened, making them an effective medium.
» Web chats and chatbots Live web chat is operated
by a human. Customers type their queries, and a
customer support agent responds by manually typing
their answers. Live web chat is a popular way to deliver
customer support; in fact, you can argue that some
demographics prefer website chat to other channels,
such as voice or email. Web chat has its challenges
though, particularly as its scope is limited by the
number of employees a business can use in this way.
Chatbots provide a similar service to customers but are
operated by computers using artificial intelligence. This
offers businesses the possibility of dealing with many
customers simultaneously.
» Intranets These are electronic, computer-based
communication networks, similar in nature to the
internet but used internally by individual businesses.
They are ideally suited to large businesses, especially
those with a number of locations. They can provide an
email service as well as access to information of interest
to large numbers of employees.
» Video conferencing This allows people to communicate
face-to-face while in different locations, nationally
or internationally. Software such as Zoom and Alibaba
DingTalk are popular as they can facilitate meetings
of up to 100 people. It saves time and avoids the
and provide after-sales service. A rapidly increasing
volume of business is conducted via the internet in most
countries throughout the world.
» Social networking media These include well-known
7.2
websites such as Facebook, Instagram, WeChat, Sina
Weibo and Twitter. Many businesses operate Facebook
pages to communicate with customers and other
stakeholders, to respond to enquiries and to project a
positive corporate image, and the capability and uses of
social networking media continue to evolve. Businesses
can also promote events, offer discounts and draw
7.2.2 Methods of communication
attention to sales using social media. Recruiters and
salespeople often seek key contacts through social-
media websites.
followers and the pages have trailers for movies that it is
showing or will show soon.
Questions
1 Analyse one possible reason for Golden Screen
Cinemas having a Facebook page. [4]
2 Evaluate whether or not Golden Screen Cinemas
should rely solely on electronic communication
for its marketing in the future. [12]
need for employees to travel to meetings. This form
of communication was used widely during the 2020
Coronavirus (COVID-19) pandemic, and many businesses
are expected to continue to make extensive use of this
technology to replace face-to-face meetings in the
future.
» Instant messaging tools Software such as Slack has
become important for business communication. This
software is ideal for letting workers share quick thoughts
or even hold digital meetings in and out of the office.
Most such tools also include facilities for sharing files.
Visual communication
Visual communication uses images to transmit information
to audiences. Methods of visual communication that are
used by businesses include posters, displays, webpages and
photographic communication. Some businesses use symbols
to represent their products and image: Nike’s tick is one
example.
Visual communication can be used as an effective method
of communicating a simple message or as a reminder of
information previously communicated. It may be effective
and is more likely to be used in certain industries, such
as fashion clothing. Recent research suggests that people
retain and recall information that is presented visually more
fully than that which is presented orally. However, it does
have a significant drawback in that it is often one-way and
may not offer the opportunity for feedback.
331
 % taken into account by managers when assessing the strengths
100 and weaknesses of any method of communication.
7.2 80
» Costs of communication Businesses will take into
account the cost of any method of communication when
60 deciding whether or not to use it. Most businesses
40 attempt to control costs tightly to maximise profits
and returns to owners such as shareholders. Costs of
20
communication can include the purchase of relevant
0 technology and associated training costs. Attendance
Oral Visual Visual + Oral at meetings involves opportunity costs for employees
involved as they are not carrying out other duties.
A LEVEL 7.2 BUSINESS COMMUNICATION

Source: Jerome Bruner, as cited by Paul Martin Lester in

‘Syntactic Theory of Visual Communication’
▲ Figure 7.13 Percentage of oral and visual information
retained
Strengths and weaknesses of different
methods of communication
Owners and managers of businesses will select which
method of communication to use on the basis of the relative
strengths and weaknesses of the various methods. A number
of factors will determine any choice made, such as cost and
speed of communication. The factors which are of greatest
importance will depend on the circumstances. A business
that is experiencing cash-flow difficulties may consider costs
closely, while for a news media organisation speed may be
most important. We will consider three factors which will be
STUDY TIP
When weighing up the strengths and weaknesses of
methods of communication, do not just analyse costs
incurred. Do consider the potential costs to businesses of
poor or incomplete communication.
» Speed of communication In many situations, businesses
require communication to be rapid as well as accurate.
Electronic communication has made this objective easier
to achieve through use of telephones (landlines or
mobiles), email, live chat and video conferencing. Speed
may be vital to meet the urgent needs of a customer, to
advise of problems with a product or to communicate
decisions to employees. Figure 7.14 assesses a selection
of methods of communication in terms of speed and cost.

MORE
EXPENSIVE video conferencing
television
live chat
chatbots

interviews
phone calls

cost of
communication

gossip
email

the cost/speed
trade-off

letters
memos

CHEAPER

SLOWER speed of FASTER

communication

▲ Figure 7.14 The speed and cost of a selection of methods of communication

332
» Target audience Some communication within businesses
may simply involve an exchange of information between
two people at the same location. In such circumstances,
a number of methods may be used including email,
telephone or a face-to-face discussion. The problem of
selecting the best method becomes more complex when
CASE STUDY
Khosa Law Chambers
Khosa Law Chambers has operated in Lahore for more
than 40 years. The law firm has represented clients in
a wide variety of cases, some of which have attracted
attention from national and international media.
A number of the company’s cases have been important in
legal terms, with long-term implications. The legal practice
is broad-ranging and handles cases in human rights,
banking, immigration, corporate, real estate and crime.
The Chambers has represented some of the most
important people in Pakistan, including the former Prime
▼ Table 7.6 Summary of the strengths and weaknesses of a selection of methods of communication.
Method Advantages
Email • Fast and cheap
• Can be used for mass communications
• Can be personalised
Telephone • Very cheap
• Allows instantaneous feedback
Meetings • Can include visual elements
• Encourage interactions and immediate feedback
• Remote meetings can involve people from
different locations cheaply
Business letters • Provides a physical record of communication
• Suitable for formal circumstances, such as job
appointments
Social media • Can be targeted at particular audiences
• Offers visual elements and opportunities for
feedback
Text messages • Cheap to deliver
• Can be used for mass communications
Live chat • Can deal with customers’ individual issues
• Feedback can be provided
Chatbots • Provide consistent message
• Can be used by businesses on a large scale
The strengths and weaknesses of using
technology in communication
We saw earlier that technology is increasingly offering
businesses new ways in which to communicate. Just a few
larger numbers of people are used, especially if they are
in different locations. For example, if the chief executive
of a multinational business wishes to communicate with
several thousand employees in many countries about the
7.2
implications of the company’s new strategy, email may
be the chosen method as it is low-cost and quick.
7.2.2 Methods of communication
Minister Benazir Bhutto and numerous other senior
politicians and business leaders.
The company has a network of affiliates in major cities
around the world – for example, London and Toronto.
Questions
1 Analyse one reason why effective communication is
particularly important to Khosa Law Chambers. [4]
2 Evaluate the most important influences on
Khosa Law Chambers’ choice of methods of
communication. [12]
Disadvantages
• Can result in too much communication
• Can contain viruses
• No visual elements
• No physical record of the communication
• Can be very expensive
• Time-consuming if travel is involved
• Remote meetings can have technical problems
• Can be costly, especially when written in bulk
• Slow, as dependent on speed of mail delivery
• May be expensive in terms of staff time
• Mistakes in this form of communication are made
public
• Only suitable for simple short messages
• More difficult to include visual elements
• Can be costly in terms of staff needed
• May give inconsistent messages
• May not be suitable to respond to unusual queries
• Quality of communication may vary if
programming is poor
years ago, for example, few businesses would have used
chatbots to communicate with customers. Technology
has significant strengths and weaknesses when used by
businesses as the basis of a method of communication, as
shown in Table 7.7 (page 334).
333
 ▼ Table 7.7 Strengths and weaknesses of using technology in communication

7.2 Strengths
• It provides cheap and quick methods of communication
and can transfer complex and highly technical information
effectively. It is of particular value to companies that operate • New technology can be expensive to install and may require
internationally or those that sell to target groups which use
electronic media as the major means of communication.
• It avoids the need for endless pieces of paper, as businesses
strive towards paperless administrative systems.
A LEVEL 7.2 BUSINESS COMMUNICATION
Weaknesses
• Some employees may be resistant to the new technology
and make ineffective use of it.
substantial training of employees, incurring further costs.
• High-technology communication systems can generate
enormous amounts of communication that may not improve
the efficiency of the organisation. Technology does not

• It allows automatic generation of communications; for necessarily encourage selective communication.

example, reordering of inventories and invoicing of customers.

7.2.3 Channels of communication Communication may be one-way, either moving up,

Communication channels refer to the way information flows
within an organisation and with other organisations.
How communication works within a
business
Communication can take place in many different ways
within a business. Some communication is interpersonal
(just between two people); for example, an appraisal
interview. Individuals may also communicate with groups –
a manager may brief a sales team prior to the launch of a
new product, for example. Communication also takes place
between groups within businesses; for example, between a
management team and trade union representatives.
Chief Executive
down or across the organisational structure with no
feedback. Communication can be two-way, moving up and
down the organisational structure, perhaps as a part of
discussion between managers and team leaders over the
development of a new product. This entails those at higher
and lower levels in the organisational structure initiating
communication. In contrast, vertical communication
takes place either up or down the organisational structure.
Figure 7.15 shows an example of a company’s chief executive
communicating with those lower down the organisational
structure; for example, over relocation plans. Finally,
horizontal communication may occur between employees
at the same level in the organisation, possibly a planning
meeting between the company’s managers.

Board of Directors
Two-way Vertical
communication communication
between Managers from Chief
managers Horizontal communications Executive
and team between managers to shop-
leaders at a floor
meeting Team leaders employees

Shop-floor employees

▲ Figure 7.15 Communication flows through an organisational structure

GLOSSARY TERMS Problems with different channels of

One-way communication takes place when information is
passed within a single direction in the organisation with no
feedback taking place.
Two-way communication exists when information is
passed up the organisational structure as well as down it,
or outside the organisation and back in again.
Vertical communication is the exchange of information
between individuals or groups who are at different levels
within the organisation; for example, between managers
and shop-floor employees.
Horizontal communication involves individuals or
groups at the same level of hierarchy within the business
exchanging information; for example, a meeting of a
company’s board of directors.
communication
Each of the channels of communication we discussed in the
previous section has associated problems.
» One-way communication One-way communication
means that no feedback will be received. Feedback can
be important when communicating within or outside
the business. If a manager simply issues instructions to
subordinates without offering opportunities for them to
respond, then the quality of decision-making may suffer.
Subordinates may have valuable insights into decisions,
taken from a different perspective, which may help
managers avoid making costly errors. Having a different
perspective on decisions can improve a business’
performance. It is for this reason that many businesses

334
 operate quality circles which provide employees from
all levels of the organisation opportunities to offer
suggestions and ideas.
» Two-way communication Two-way communication can
contribute to a manager being subject to too much
information. The use of electronic information brings
some disadvantages in this respect and some managers
can receive hundreds of emails every day. This makes
it very difficult for managers to respond and to select
those messages which are most important. Two-
way communication can also delay decision-making,
especially if a large number of people are involved in the
decisions. This may not, for example, assist a business in
providing a speedy response to an emergency.
» Vertical communication This channel of communication
may prove ineffective if employees do not pass on
information to their subordinates or superiors. Equally,
they may provide information which is incomplete,
inaccurate or both. This type of problem is more likely
to arise in organisations which have a tall organisational
structure with many levels of hierarchy and relatively
narrow spans of control.
» Horizontal communication Some horizontal
communication may be informal and may not
support decisions that have been made through
vertical communication channels. This can result
in a less clear focus on organisational objectives
and may require further vertical communication to
correct it. For example, managers at a particular
level in the organisation may be critical of a major
decision. They may discuss it among themselves
rather than responding up the hierarchy to the
decision-makers. This could slow decision-making
and damage organisational efficiency. It can also be
time-consuming if decisions made through horizontal
communication have to be approved subsequently by
senior managers – and through vertical communication.
This may slow decision-making and harm a business’
competitiveness.
7.2.4 Barriers to communication
There are a number of factors which can prevent
information flowing through an organisation and to relevant
stakeholders outside it.
Changes in business practices
The increasing need for information (and thus
communication) has been further increased by
developments such as empowerment, decentralisation and
the widespread use of just-in-time techniques. Extending
the roles and authority of employees creates a greater need
for new channels and methods of communication. In view
of this, it is perhaps not surprising that many businesses
have been unable to keep up! The use of consultants and
contract workers and the rise in teleworking have increased
the diversity of communication required. Through the
involvement of so many groups, communication has become
more difficult to carry out efficiently.
Many large businesses operate in several locations around
the world. This means they have employees from different
cultures using diverse languages and working in different
time zones. All three of these factors can inhibit effective
7.2
communication.
GLOSSARY TERM
Teleworking is working from home, or remotely, while
using technology to communicate with employers and
colleagues.
7.2.4 Barriers to communication
Too much reliance on IT systems
Some businesses have recognised the imperfections in their
communications systems. However, many have relied upon
IT to overcome these problems and have created further
problems. If IT is to be effective, it requires that employees
be trained and that systems suit their precise needs. Simply
throwing IT at the problem creates more, rather than better,
communications.
Digital Platypus is a UK-based marketing agency business
which organises fundraising campaigns for charities.
It attempts to prevent technology being a barrier to
communication by banning internal emails. Any employees
who flout this ban have to make a £5 donation to charity!
Inappropriate management and
leadership styles
Some managers use leadership styles that discourage
effective two-way communication within the business.
Some individuals prefer to operate an autocratic leadership
style (which we discuss in the next chapter) and a
traditional organisational structure. This only encourages
downward communication, resulting in a lack of information
at different levels in the organisational structure.
Equally, some managers may encourage working practices
that keep managers and shop-floor employees apart (such as
having separate facilities) and this may discourage effective
communication, some of which may be informal.
STUDY TIP
The importance of communication to a business cannot
be underestimated. When dealing with case studies, it
is often an important argument to say that a business’
performance can be improved in many ways through
improvements in communication.
Merger and takeover activity
Mergers and takeovers usually create larger and more
complex businesses. Mergers and takeovers are popular
methods of achieving high rates of growth, but when they
fail, it is often due partly to poor communication. This
might be due to a lack of information in the pre-merger or
takeover stage, as well as during the co-ordination that
is essential afterwards. This can create communication
335
 problems and the process itself can pose similar difficulties.
The merger in 2012 between the Ghana Water Company
7.2 Ltd and Ghana Urban Water Ltd was eased because it
was relatively small-scale and because of the similarities
between the two businesses. The chief executive of the
newly merged business was able to lead meetings of
employees discussing the implications of the change.
Two multinational car manufacturers, Nissan and Renault,
have worked together in an alliance for some time,
producing engines and other components that could be used
A LEVEL 7.2 BUSINESS COMMUNICATION
in cars sold by both companies. However, the two companies
decided not to go ahead with a full merger in 2020 due, in
part, to poor communication between the two businesses.
Potential barriers to communication included different
languages, business and social cultures, and working in
different time zones.
CASE STUDY
The email problem
Manuel Gomes is the chief executive of Rapid Games Ltd,
a software company. The company operates nine offices
in cities across Europe, having just merged with a rival
business. It has ambitious plans to open offices in Asia
next year as part of its continued expansion. The company
has experienced a significant level of labour turnover
recently and has appointed a large number of new
managers since Manuel’s appointment.
Manuel has only been in his job since the merger five
months ago and is already experiencing communication
problems. He currently has 7000 emails in his inbox – and
the number has grown steadily. He says that he receives
about 150 emails each day. ‘I fear my inbox is getting out
Overcoming barriers to communication
The first stage in overcoming barriers to communication is
for managers to identify the particular barrier or barriers
that exist. This analysis allows them to apply appropriate
solutions to overcome the difficulties. Table 7.8 lists
some major barriers to communication and suggests some
approaches to overcome each of these.
7.2.5 Role of management in
facilitating communication
In most organisations, formal and informal communications
take place.
» Formal communication uses official channels to
transmit information on behalf of an organisation,
such as its goals or policies. This information often
follows a chain of command, flowing from managers to
subordinates throughout the organisation. It may also
flow from the organisation to stakeholders outside the
336
Lack of understanding by managers
A principal cause of poor communication is that managers
do not recognise that there is a problem. Symptoms of
poor communication (such as poor industrial relations and
low levels of motivation) may be thought to have other
causes. Because senior managers have access to all the
information they require and can communicate easily with
all in the organisation, they may be unaware that others in
the business do not receive information that is essential to
their jobs.
The use of jargon or technical terms
These are specialist terms used by people in particular
industries which may be used when communicating
with non-specialists. This is possible in a wide range of
industries and not just in technology companies.
of control,’ he says. ‘I have to pick the emails that are
relevant to me very carefully as I get copied in to so many
messages sent by employees within the company. My
major worry is that I might miss a vital email message –
one that contains the most important information that I
will need to know all year.’
Questions
1 Analyse one barrier to communication, other than
the use of technology, that may exist at Rapid
Games Ltd. [4]
2 Evaluate the actions that Rapid Games Ltd might
take to prevent its use of technology becoming a
barrier to the company’s communications. [12]
business. Information exchanged in a company meeting
is a formal communication channel, as is the company’s
annual report.
» Informal communication takes place outside the formal
structures within a business. Gossip between groups
of employees during a break from work is an obvious
example. Informal communication can be rapid but
inaccurate, and it is important for businesses to ensure
that important matters are communicated promptly
using formal methods, such as meetings, to avoid wildly
inaccurate information being transmitted.
GLOSSARY TERMS
Formal communication is the exchange of information
and ideas within and outside a business using official
channels, such as annual general meetings.
Informal communication is the exchange of information
and ideas using unofficial channels, such as at social
events.
▼ Table 7.8 Possible methods to overcome a selection of barriers to communication

Barrier to communication
Changes in business practice
Too much reliance on IT systems
Possible means of overcoming it
Planning and training are important here. Planning will help to identify any communication
7.2
issues that may arise as, for example, the result of delegating authority to a significant
proportion of the workforce. Once identified, training can provide the knowledge and skills
that the employees will require.
In some senses, this is another change in business practice and therefore planning and
training can dovetail to provide an analysis of the problem and solutions to it. However,
it may also require an understanding on the part of managers at all levels that more

7.2.5 Role of management in facilitating communication

Inappropriate management and
leadership styles
Merger and takeover activity
Lack of understanding by
managers
Use of jargon or technical terms
communication is not necessarily better communication. Using technology selectively and
with a clear focus is most likely to improve communication.
Managers and leaders may use autocratic styles leading to, for example, much one-
way communication. In some circumstances, this might result in poor communication,
for example, as in a situation where subordinates are skilled and experienced and have
important information to communicate. Adopting a leadership style more suited to the
circumstances may be an appropriate measure here.
Frequent and regular communication can help all employees and the business’ stakeholders
to understand the changes that are taking place and their implications. Encouraging
employees to be proactive in raising issues and providing a consistent message can help to
limit lack of knowledge and misunderstandings.
Managers should receive training in communication as it is a central part of their work.
This should focus on the barriers that are most likely to exist in their internal and external
communications and how to avoid these.
Communications training to ensure employees consider the audience for communication
and select language appropriately will help. Some larger businesses may have employees
monitoring the use of language in formal communications.

» Gaining immediate feedback It may be difficult to obtain

The role of informal communication
within a business
Informal communication moves freely within the
organisation and is not bound by pre-defined channels
and communication routes. Informal communication in
the workplace is often called the ‘grapevine’ and generally
begins with employees through social relations. Informal
communication tends to increase during times of change
within businesses, such as during a takeover or merger.
Informal communication can also be fuelled by a lack of
formal communication. This occurs because employees
speculate about what might happen in the absence of hard
information. Research suggests that between 75 per cent
and 90 per cent of information transmitted through informal
communication is accurate. It also shows that informal
communication has little long-term effect on organisations.
the views of employees to a significant decision using
formal channels of communication. This may take time
and employees may be guarded in what they say. Managers
could use informal communication to gain a reaction to
a major decision from different perspectives within the
organisation, possibly even before it is announced using
formal channels. This might help to improve the quality of
decision-making within the business.
» Job satisfaction The use of informal communication can
help to increase the level of job satisfaction enjoyed by
a business’ employees. Expressing ideas and frustrations
to colleagues without any concerns about their reactions
can help employees to manage the stresses and strains
of working life. For this reason, many businesses provide
facilities (such as social areas) which facilitate informal
communication.

The advantages of informal communication The disadvantages of informal communication

» Improving working relationships Informal
communication plays a vital role in developing
relationships throughout an organisation. It might
create better understanding between the members of a
team, improving productivity as a result. A harmonious
relationship between management and labour also
benefits businesses. Management can use informal
communication channels to know the attitudes and
opinions of the workforce. This can help to reduce
misunderstanding between workers and management,
and will improve their relationships.
» Inaccurate information Employees may transmit
inaccurate information through informal channels.
This can occur because there are no controls on this
channel of communication and no penalty for passing
on false or distorted information. Managers may have
to devote time and other resources to correcting any
misunderstandings or issues arising from the use of
informal channels of communication.
» Contradicting formal communication A business
may experience a situation in which information sent
through formal channels is contradicted by that passed
337
 through informal ones. This can create difficulties for Good communication can have a positive impact upon
the business, as decision-making may slow and levels employee motivation and performance. Praise and
7.2 of motivation and productivity may be damaged if
employees believe that they are not being given the full
recognition are widely seen as motivators, but they rely on
communication. Communication can also give employees
story through formal channels. important feedback about their performance and help to
improve it in the future. In this respect, appraisal systems
Informal communication is more likely to be widespread
(and especially developmental appraisal systems) have been
within organisations that have ineffective formal channels
of considerable value.
of communications. Although some degree of informal
communication is welcome and advantageous for most
businesses, it should supplement and enhance formal Suppliers
A LEVEL 7.2 BUSINESS COMMUNICATION

channels and not replace them. Efficient and profitable

production requires supplies
to arrive promptly,
Communication and business efficiency especially under
JIT systems.
Effective communication is an essential element of business
success. A survey by the Institute of Management and
UMIST in the UK stressed the importance of good-quality
communications within businesses. The survey reported that Business
good communication could assist employees of all types Employees
Customers managers
within a business and enhance its efficiency. Good
Effective Effective
communications
» Good communication makes it easier to implement communication communication
with employees
change – an important issue in a business environment, allows businesses allows managers
(praise, listening
to discover and to take good
which is subject to rapid and continual change. fulfil customers’ quality decisions
to ideas) can
improve the
Businesses that manage change successfully tend to be needs – increasing on the basis of the
performance
more efficient and competitive. sales and profits. best information
of the workforce.
available.
» It encourages and develops commitment to the business
from employees at all levels within the organisation,
increasing levels of motivation and rates of labour
productivity. General public
» Effective communication helps to ensure that the Being aware of social change
business is co-ordinated and that all employees and presenting the business
favourably assists in recruiting
pursue the same corporate objectives. As a result, the quality staff and
business is more likely to be successful in achieving its achieving profitable
objectives. sales.

The role of a manager in a modern organisation is ▲ Figure 7.16 The benefits of effective communication with
to communicate with everyone – shareholders, the stakeholders
media, customers and suppliers. The measure of today’s
manager is how well they communicate, and good-quality
communication by managers with the business’ stakeholders
STUDY TIP
offers many benefits. When answering questions on the importance of effective
communication, avoid the temptation to try to develop
Successful decision-making requires that managers have too many arguments. Select the best two or three and
access to as much relevant information as possible. The key develop these as fully as possible.
management roles of planning, prioritising, co-ordinating
and controlling depend upon access to information. This
indicates the importance of good communication to Communication is the cornerstone of co-ordination. In large
businesses. businesses, it is easy for different departments or parts of
the organisation to pursue differing objectives. Regular
For example, modern techniques such as just-in-
and effective communication can help to ensure that all
time production place great emphasis on effective
employees remain closely focused on agreed corporate
communication systems. If supplies of components or
objectives and that the business operates efficiently.
raw materials are not available when required, businesses
are likely to incur substantial (and unnecessary) costs,
as well as being unable to provide high-quality customer
service. Similarly, techniques such as Kaizen (which
aims at continuous improvement and is discussed in
Chapter 9.3) rely heavily upon effective, two-way internal
communication.

338
 CASE STUDY
Black Fern Media Limited
Black Fern Media Limited (BFM Ltd) is a media company
located in New Zealand and Australia. The company is
partly owned by an Italian company. BFM has interests
in several different markets including publishing
newspapers, online publishing, radio broadcasting and
advertising in New Zealand and Australia. It uses teams
throughout its organisation to collect and publish news
and other information for broadcasting and publishing.
The teams work together to provide the highest quality
service possible. The company relies heavily on
communications technology (such as video conferencing)
to keep its costs low.
In New Zealand, BFM operates seven radio networks
broadcasting news, popular music and classical music.
In Australia, BFM’s major radio networks bring together
audiences in Sydney, Melbourne, Brisbane and Adelaide. It
also operates a nightclub in Sydney.
Methods to improve communication
Good-quality communication is essential for successful
management. Globalisation is resulting in businesses
becoming larger and more diverse, meaning that, to operate
successfully, good communication is even more important
than ever. To adapt to the changing demands of the global
marketplace, a business can take a number of actions to
improve its communication.
» Train employees in communication skills Modern
business communication is a complicated activity, often
requiring competence in a range of activities: listening,
speaking, writing and reading skills, to say nothing of
technological skills. To carry out all these activities
satisfactorily, employees will require training at regular
intervals – it is not a one-off action. In spite of this,
training in communication skills is a priority with a
relatively small number of businesses and is often cut
during less prosperous periods.
» Avoid the danger of generating too much information
Modern technology has substantially increased the
risk of this occurring, and many firms simply invest
TEST YOUR LEARNING
Short answer questions
1 a Define the term ‘communication’. [2]
b Explain one difference between the message and
the medium in the process of communication. [3]
2 a Explain one reason why businesses
communicate. [3]
b Explain one reason why feedback is an important
element of successful communication. [3]
7.2
BFM publishes 15 daily and more than 75 non-daily
newspapers across Australia and New Zealand. It is a
leading publisher in New Zealand, with The New Zealand
Journal shaping public opinion in the country. In Australia,
it offers popular and entertaining publications in some of
Australia’s most wealthy regions.
7.2.5 Role of management in facilitating communication
The company has market-leading online sites, such as
BFM News Online, and a strong audience connection with
its radio and news-branded web and mobile sites. BFM
continues to expand its digital businesses.
Questions
1 Analyse two reasons why effective communication
might improve the efficiency of BFM Ltd. [8]
2 Evaluate the most important reasons why effective
communication is essential to BFM Ltd. [12]
in technology when facing communication problems.
By evaluating communication needs before taking
any action, a business increases the probability of
implementing an effective solution. A survey in the
UK revealed that nearly 50 per cent of voicemail
systems were switched off within a year of installation,
indicating that many managers do not spend time
evaluating the position before taking decisions to invest
in new technology.
» Recognise that cultural and linguistic differences
exist These are common within a large multinational
and can inhibit effective communication. Honeywell,
the computer manufacturer, operates in 11 countries,
employs 114 000 people and encourages its employees to
be sensitive to cultural differences when communicating.
The company stresses that it is important to respect
and value cultural differences, to be aware of prejudice,
and to ensure that employees have the full picture when
communicating before making judgements. Multicultural
communication is set to become a common feature
in the lives of more employees as business becomes
increasingly global.
3 a Define the term ‘communication channel’. [2]
b Using examples, explain one difference between
vertical and horizontal communication. [3]
4 Explain one advantage and one disadvantage of using
written communication within a large multinational
company. [6]
5 Explain two factors that the owner of a newly
established business might consider when deciding
on the best way to communicate with actual and
potential customers. [6]
339
 6 Explain one reason why a small business may decide
7.2 not to make extensive use of technological methods of
communication.
7 a Explain one reason why agreeing to a merger
may result in communication difficulties for both
businesses involved.
b Explain one other barrier to communication.
8 a Explain one reason why it is important for
businesses to communicate effectively with
suppliers.
A LEVEL 7.2 BUSINESS COMMUNICATION
b Explain one reason why good communication
can help to improve the motivation of a business’
workforce.
9 Explain one difference between formal and informal
communication.
10 a Define the term ‘effective communication’.
b Explain one action that the managers of a
business with six restaurants may use to improve
communication.
Data response question
Casa Rosa
Chile has a long history of producing fruit juice. In recent
years, the industry has grown rapidly and much of its
output is exported to countries throughout the world.
Casa Rosa has an 80-hectare site in Atacama, a popular
fruit-growing region.
The farm’s owner uses an autocratic leadership style,
insisting that all 24 current employees assemble for an
unpopular 30-minute briefing each morning, where the
instructions for the day are issued. The large numbers
340
of temporary and seasonal employees attend too. Little
[3]
use is made of electronic methods of communication,
such as computers or mobile phones; the company has
not made a decision on whether to create a website. The
wider management team has developed a good personal
[3] relationship with the buyers of their fruit, but sales and
[3] profits have fallen slowly in recent years. Competitors
are promoting themselves and selling directly overseas,
responding to a changing market and increased overseas
[3] sales.
The farm’s workforce is dissatisfied with the leadership
style and the use of spoken instructions. This year its
[3] productivity declined by 5 per cent to 8550 litres of fruit
juice per employee. At the same time, the rate of labour
[3] turnover of full-time employees rose to 25 per cent. Most
[2] employees believe internal and external communication
is poor.
Questions
[3]
1 Analyse one strength and one weakness of
Casa Rosa’s reliance on spoken communication. [8]
2 a Calculate the labour productivity for Casa
Rosa’s employees for last year. [4]
b Evaluate whether or not Casa Rosa should
invest in technology to improve communication. [12]
3 Evaluate the extent to which the leadership
style is the major factor determining the
quality of communication at Casa Rosa. [12]
Essay question
1 Evaluate the extent to which technology can help
large businesses improve their communication. [20]
7 Human resource management
A LEVEL
7.3 Leadership
Chapter overview
In this chapter we examine:
★ the purpose of leadership and what roles a leader might have
★ the qualities of a good leader and the different leadership styles that exist
★ the nature of emotional intelligence and Goleman’s four competencies.
7.3.1 Leadership
We saw in Chapter 2.3 that a manager is someone who
gets things done. Leaders, by comparison, are people who
are followed, who have a vision of the future and a clear
sense of where they are taking the business. According to a
significant writer in this area, John Adair, ‘Leadership is the
process of motivating others to act in particular ways.’
The purpose of leadership
Leaders provide the vision that takes a business forward.
They take the difficult decisions and can inspire or push
through difficult changes. Leadership may not always be in
the hands of one person – the leaders may be a team – but
the direction needs to come from somewhere. Particularly
in a crisis, people look to a leader for guidance and to show
them what to do; this is often why, when an organisation is
in trouble, a new leader is brought in.
The ability of great leaders in sport, in business, in politics
and in all aspects of life to achieve great things is inspiring.
Just think of someone like Nelson Mandela, who helped
bring about the end of the division between black and white
people in South Africa and made this a peaceful process by
leading through example.
It can be argued that leaders have a range of duties relating
to all aspects of the business’ operations. The tasks of
leaders may include:
» Deciding objectives for the organisation Leaders have
to establish a sense of direction for the organisation
and establish objectives to move the organisation
towards its overall aims. In 2020, Amir Paracha was
appointed as chief executive officer (CEO) of Unilever
Pakistan Limited. He has experience of improving
the performance of a business’ sales and marketing
functions, and he is likely to set objectives in this area
as well as others for the company.
» Providing expertise and setting standards for the
organisation The leader is likely to be required to show
enthusiasm in difficult times and to take a major role in
solving problems as they arise.
7.3.1 Leadership
» The leader will play a key role in determining the
structure of the organisation (hierarchies and spans of
control). They will determine lines of communication and
control, and they will be instrumental in shaping the
culture of the business.
» Leaders may become role models for individuals within
the organisation and may choose to build alliances of
senior individuals to protect their position.
The nature of leadership has changed over recent years
for a number of reasons. Rapid advances in information
technology have meant that leaders have far more
information available to them to make decisions. This
can help them make better-informed decisions, but it can
also mean that they have too much data and experience
difficulty in selecting the key elements.
Leaders may have been specifically recruited to change
the way a business operates and may face resistance from
employees who fear they will be worse off following the
changes. Employees may try to block or disrupt the change.
A leader’s ability to implement change may depend upon
the amount of support received from others within the
organisation. It will also depend upon factors such as:
» the resources available to implement change. In some
cases, the leader may lack resources, making change
difficult if, for example, funds are not available for
training or recruitment
» the extent to which employees understand the need for
change
» the support from other senior managers.
The challenge faced by leaders has been increased by
developments such as the trend for many markets to
become global. This has meant that many firms now operate
in a larger and far more competitive environment. Decisions
in such circumstances have become more complex and
managers are now often required to attempt to organise
production in a number of countries, facing a variety of
languages, customs and cultures. Production difficulties are
compounded by differing demands from customers across
the globe.
341

STUDY TIP
7.3 If asked to discuss the importance of leadership in a case
study, do look for evidence in the case study itself that
you can use to support your arguments. For example, the
business may trade in a very changeable market, which a
leader can do little about.
Leadership roles in business
A LEVEL 7.3 LEADERSHIP
An entrepreneur who is designing a structure for a new
organisation, or amending an existing one, is likely to
consider a number of roles for employees as part of the
process.
Directors
Directors are found as part of the workforce of a company –
either private or public. Directors are proposed by the
chief executive officer of a company and take up the role
CASE STUDY
Trina Solar appoints non-executive director
Trina Solar Ltd is a manufacturer of solar photovoltaic
(PV) products and one of the leaders in this particular
market. The company has announced the appointment of
Henry Chow as a non-executive or independent director.
Henry has held a number of posts as a director in the Asia
Pacific region. He worked for IBM, serving as general
manager and subsequently as chairman of the IBM
Greater China Group. Henry was also a member of IBM’s
Worldwide Management Council and IBM’s Strategy Team.
These groups advise IBM on its strategy and help it to
respond to a changing world environment.
Henry already holds a number of senior roles. He is a
non-executive director on the board of AMD, an American
Managers
Managers carry out a range of duties. These are often
categorised as planning, organising, motivating and
controlling. Managers normally have authority over a
number of junior employees and plan and monitor short- and
medium-term strategies for the business. We looked at the
role of managers in more detail in Chapter 2.3.
In a small business, the owner may carry out the duties of
manager and director, looking after all the planning for the
business as well as organising and controlling day-to-day
activities. This is one reason why many entrepreneurs are
very busy people!
Supervisors
Supervisors represent a link between managers and the
business’ shop-floor workers. They are the first rung of
management and are in regular contact with shop-floor
workers. Supervisors are delegated some authority by
342
if they are subsequently elected by shareholders. The role
of directors is largely strategic; they set and oversee the
achievement of long-term goals for the business.
Directors can be executive, non-executive or independent.
Executive directors are employed by the company in a senior
capacity, possibly with responsibility for a part or function
of the business, such as marketing. Non-executive and
independent directors perform similar roles, although the
latter may not own shares in the company. These types of
directors are not employed by the company and are usually
appointed because they have a particular knowledge or
skill. They also may protect the interests of the company’s
shareholders, employees, customers and other stakeholders
if decisions are not taken with their interests in mind.
Directors exist within relatively small, privately owned
companies but are likely to fulfil broader roles than in larger
companies because smaller companies employ fewer people.
company, and acts as an adviser to Bridgepoint, a British
private equity company. Henry is a graduate of the
University of Hong Kong, holding a degree in electrical
engineering.
Questions
1 Henry Chow has been a manager and a director at
IBM. Analyse one significant difference between
these two roles. [4]
2 Evaluate the key benefits that you think Trina
Solar Ltd will gain as a result of Henry Chow’s
appointment. [12]
managers to take decisions on day-to-day issues, such as
staffing or tactics to meet deadlines. Supervisors also act
as a line of communication between managers and shop-
floor workers.
Worker representatives
Employee representatives may be chosen by their fellow
employees or appointed by management. Their roles can
vary but most:
» receive information from and give information to
management teams; for example, about pay and
conditions or major decisions to be taken by the
company, such as an expansion
» pass on information to all employees within the
workforce, often through meetings
» are consulted by management teams over certain
workplace matters that are likely to have a significant
impact on employees, such as the introduction of new
technology into a business.
Worker representatives are frequently involved in issues
concerning pay. They may take part in negotiations over
future pay rates for the workforce of a business and,
recently, in some countries, have played a role in limiting
the pay received by senior managers within businesses.
The qualities of a good leader
The business environment in which leaders operate has
changed over recent years. Many subordinates will not
just accept being given instructions; junior and middle
managers are often well-trained and expect to be able to
CASE STUDY
What to look for in a top CEO
Four leading Ghanaian managers have offered advice on
what makes a good leader and how to lead a successful
business. Prince Kofi Amoabeng, chief executive
officer (CEO) of UT Bank, Jude Bucknor of Bucknor and
Associates, Dr Kofi Amoah of Progeny Ventures and
Michael Ikpoki, CEO of MTN, each spoke to an audience of
Ghana’s business leaders and received acclaim for their
presentations.
The four speakers made up the panel at the fifth MTN
Business World Executive Breakfast addressing the
question ‘Being an effective leader in business’. The
speakers emphasised the importance of having vision and
being passionate about business matters.
Jude Bucknor said, ‘It is essential for a good leader to
have a vision that spells out clearly where you want to go
and how you will get there.’ He argued that innovation is
also important and that leaders have to be able to think
creatively.
So, has the general view of a good leader changed over recent years?
▼ Table 7.9 Traditional and modern views of good leaders
The traditional view of a ‘good’ leader
• A strong, decisive character
• An ‘expert’ in the relevant field of business
• An autocrat (to a significant degree)
• Focus on profits and financial success
• Good communicator, but most comfortable with downward
communication
7.3.2 Theories of leadership
Over the years, many theories have been presented
concerning leadership. Views have altered, and this has been
reflected in the changing approaches to leadership adopted
by businesses. We shall consider five different groups of
leadership theories:
» Trait theory What characteristics should a good leader
possess?
» Behavioural theory What does an effective leader do?
» Contingency theory How do the circumstances affect
the success of a leader?
contribute to decision-making. The modern leader has to
take into account their views and to broaden the ownership
of decision-making. Indeed, given the complexity of many
modern organisations, the leader relies upon support from
7.3
others in the management team.
Furthermore, the increasing pace of change means that
today’s leaders have to be dynamic and flexible and able to
respond effectively to changing environments. In particular,
leaders of businesses providing technical products or services
might experience and have to respond to rapid change.
7.3.2 Theories of leadership
Michael Ikpoki stressed the importance of a sense
of responsibility and that generating high returns for
shareholders was an essential element of success. He
added that successful leaders make the most effective
use of their workforces and develop talent in others.
Dr Kofi Amoah concluded that having a sense of humour
and control over the workplace are central qualities in a
successful leader in business.
Source: www.ghanamma.com/2012/06/29/
top-ceos-inspire-others/
Questions
1 Analyse one way in which the leader of a large
multinational company can help to make the business
successful. [4]
2 Evaluate the possible reasons why these experienced
and successful CEOs have different views on the
qualities needed for a successful leader. [12]
The modern view of a ‘good’ leader
• Charismatic, with a flair for public relations
• Possessing principles; for example, taking ethical decisions
• Excellent communicator, and a good listener
• Welcoming advice and support from specialists
• Flexible and able to flourish in a changing environment
» Power and influence theory Where do leaders get their
power?
» Transformational theory How do the most successful
leaders carry out their roles?
Trait theory
Many writers have argued that all leaders should have
a number of traits or characteristics, though there is
some disagreement as to the precise nature of these
traits. However, the consensus is that certain personality
traits differentiate a good leader from other people.
Trait theories have developed from the concept of the
343
 charismatic leader – Nelson Mandela or Barack Obama, for
example. Examples such as these have led to trait theory
7.3 being termed ‘great person theory’. Supporters of the idea
of the charismatic leader contend that such individuals
have identifiable characteristics that set them apart from
ordinary mortals. Some traits commonly mentioned by
writers include:
» being informed and knowledgeable
» having the ability to think creatively and innovatively
» possessing inner motivation and the desire to achieve
» having the ability to act quickly and decisively
A LEVEL 7.3 LEADERSHIP
» projecting an air of authority.
One of the reasons for the decline in popularity of trait
theories is that successful leaders have been found to
exhibit different characteristics from each other.
Behavioural theories
These theories focus on how a leader behaves, trying
to identify the right way of leading rather than what a
leader is like as a person. There have been many studies
looking at styles of leadership and considering which are
successful.
One classification of styles considers the extent to which
leaders ‘tell’ or ‘listen to’ their staff. Kurt Lewin developed
a framework for categorising the behaviour of leaders. He
identified three types of leaders:
» autocratic leaders take decisions without consulting
their subordinates
» democratic leaders invite opinions from subordinates
before taking any decisions
» laissez-faire leaders allow subordinates to take
decisions without interfering.
However, there are many more different styles of leadership
that can be identified using this approach. The Tannenbaum
and Schmidt continuum (shown in Figure 2.19 on page 88)
emphasises that there is a range of leadership behaviour
depending upon the extent to which leaders take decisions
or whether subordinates contribute significantly to
decision-making.
A key factor in differentiating between behavioural
leadership styles is communication. At the autocratic end of
the spectrum, communication is likely to be downward only
as the leader or manager ‘instructs’ their subordinates as to
their duties. Democratic leadership is more likely to result in
two-way communication, as consultation and ‘selling’ of the
final idea take place. Laissez-faire leadership may result in
relatively little communication, as the problem or task may
be outlined with subordinates having considerable freedom
thereafter.
The behaviour of leaders affects their performance in the
role. However, research has shown that different types of
leadership behaviour may be optimal at different times.
Therefore, the most talented leaders may be those that
adjust their style to match the situation. For example,
a leader might adopt a ‘tell’ style if subordinates lacked
job-related skills and experience and were less able to
contribute effectively to decision-making.
344
Contingency theory
The contingency theory of leadership states that a leader’s
effectiveness depends (or is contingent) on whether or not
their leadership style matches the situation. This means
that a leader may be effective in one set of circumstances,
but not in another. Contingency theories identify several
factors that can determine the circumstances faced by a
leader, including:
» the nature of the subordinates who are being led
» the tasks facing the employees
» the business’ objectives.
Fred Fielder (who was a business and management
psychologist at the University of Washington) developed
one of the best-known contingency theories of leadership
in 1967. Fielder argued that a leader’s style cannot easily be
adapted and, therefore, that the effectiveness of a leader
depends on there being a match between the style and
circumstances. Fielder believed that there is no best style
of leadership because its effectiveness depends on the
situation in which the leader is working. He argued that, to
identify an effective leader for a specific situation, it was
important to consider both the leader’s personality and the
demands of the situation. Fielder categorised a person’s
leadership style by examining the traits of employees which
that leader would and would not want to work with. This
revealed which of the two following factors most strongly
described their leadership style:
» Task-orientated Such leaders perform well in situations
where it is vital to complete a particular job, and they
can build teams to achieve this.
» People-orientated These leaders are good at building
relationships with people and in maintaining harmonious
working relationships.
The demands of the situation can be judged to be
favourable or unfavourable by considering three factors:
1 Relationships between the leader and subordinate
members This is the extent to which the other
members trust and have confidence in the leader and
shows their willingness to be guided by the leader.
Higher levels of trust and confidence give a more
favourable situation.
2 Task structure The extent to which the tasks facing the
group are structured, with clear goals and instructions
on completion. More structured tasks represent more
favourable situations.
3 The leader’s position power The power the leader has
to direct the subordinate group is based on their place
in the organisation and ability to reward and punish.
The more power the leader has, the more favourable the
position.
Fielder’s research found that a task-orientated leader
will be more effective when the situation is favourable.
In this situation the task is structured, the leader has
good relationships with subordinates and has power.
All subordinates need here is a leader that can offer
direction. Equally, task-orientated leaders will be more
effective than relationship-orientated leaders when the
situation is unfavourable. In this case, subordinates need
a leader that can provide task structure and direction. As
relationships between leaders and other members are poor,
a relationship-orientated leader will have little impact.
Fielder argued that a relationship-orientated leader will
perform more effectively in a moderately favourable
situation. As the leader will be liked to some extent by
the group, have some power and the task will have some
structure, the ability to develop good relationships will be
important in completing the task successfully.
Fielder’s conclusion was that the most effective way to
manage a given situation is to change the leader to match
the situational factors (leader–member relations, task
structure and the leader’s power) or to change the situation
to suit the leader.
Other writers have developed contingency theories of
leadership. However, Fielder and other contingency
theorists all argue that, no matter how skilled and
experienced the leader is, there will always be situations
that they will find challenging to handle. Therefore,
contingency leadership theorists believe that a leader’s
success depends on the leader’s skills matching the
situation and not adapting to it.
GLOSSARY TERM
The contingency theory of leadership considers the
context of leadership and the impact of the situation on the
leader’s success.
Power and influence theories
Power and influence theories of leadership examine the
different ways that leaders use power and influence to
achieve results, and the leadership styles that are developed
as a consequence. Leadership and power are closely related:
a person who is a leader is also likely to have the most
power to make decisions. However, power does not just
depend on the leader; it depends also on how the leader is
perceived by others.
A well-known theory of power and influence is French and
Raven’s five forms of power.
French and Raven’s five forms of power
In a study in 1958, two social psychologists, John French
and Bertram Raven divided power into five distinct and
separate forms. The five types of power they identified
were coercive, reward, legitimate, referent and expert. In
1965, Raven identified informational power as a sixth form
of power. Table 7.10 summarises the forms of power and
divides them into two categories.
▼ Table 7.10 French and Raven’s forms of power
Positional power Personal power
• Reward power • Expert power
• Coercive power • Referent power
• Legitimate power
• Informational power
» Reward power Some leaders derive power from being
able to offer rewards to their employees. These rewards
can take a variety of forms, though many are financial
in nature. They include pay rises and promotions,
7.3
participating in interesting projects or receiving
training. Although this is one of the more common forms
of power used by leaders, it has limitations. Leaders may
run out of rewards – there are only so many promotions
they can offer and the company’s budget is unlikely to
extend to endless pay rises. In some circumstances, the
7.3.2 Theories of leadership
rewards on offer may not be attractive to all employees.
For this form of power to be effective, the rewards must
be available and desirable.
» Coercive power Coercive power uses the threat of force
to gain compliance from others. Using this form of
power, a leader controls subordinates by threatening, or
implementing, some form of sanction. This might, for
example, be a refusal to grant a promotion or a bonus.
Coercive power is often not an effective source of power
for a leader. Coercive leaders frequently get low levels of
performance from their subordinates, who simply seek to
do enough to stay out of trouble.
» Legitimate power Legitimate power comes from a
person being appointed to, or selected for, a position
of authority. In some senses, this is the power that is
associated with a job title; the CEO of a company has
power partly because of the role that they hold. The
higher the position in the hierarchy, the greater the
potential the employee has to use legitimate power.
However, legitimate power can be unpredictable and
temporary. If a leader loses their job title and position,
legitimate power can instantly disappear, because
people were influenced by the position held rather than
by the person.
» Informational power Possessing and controlling
information that is needed by others can be a source
of power for leaders. The types of information that
can generate power include knowledge of a business’
financial performance, who is to lose their jobs during an
economic downturn or details of a takeover bid for the
business. This form of power is becoming more widely
used in many businesses. Leaders have access to much
more information nowadays as a result of the availability
to collect and analyse big data. This form of power arises
not only from having access to the information but also
from being able to manipulate or withhold it.
» Expert power This form of power derives from a person’s
knowledge and/or experience. Employees will frequently
respond positively to someone that they respect for
their capacity to carry out a role effectively. James
Dyson, the founder and owner of Dyson Ltd (a British
electronics company) might use this form of power
because of his scientific experience and expertise – as
well as legitimate power from his role as the owner. This
form of power is more durable than many other forms. It
will remain so long as a leader is perceived to retain this
expertise. For some leaders, such as James Dyson, it may
be used throughout their careers.
» Referent power This form of power arises from a leader’s
personality, image, charisma or presence. Leaders with
345
 referent power have the ability to influence followers,
but this is dependent entirely on the followers’
7.3 perceptions of their leader. Within many businesses,
this form of power has become increasingly important
as the organisation has adopted more collaborative
styles of working, with greater use of delegation and
empowerment. As with expert power, this form of power
is likely to last so long as the leader is judged to retain
those personal characteristics that enable them to
influence others.
A LEVEL 7.3 LEADERSHIP
In the past, many leaders in many organisations relied
mainly upon positional power to give them influence over
subordinates. However, this has changed in recent years.
The move of many businesses towards flatter organisational
structures and greater questioning of authority has resulted
in personal power becoming more important and more
widely used.
Transformational theory
Transformational leadership occurs when leaders perform
their roles so effectively that they gain the trust, respect,
appreciation and loyalty of the people who follow them.
We have also explored transformational leadership in the
context of corporate planning and strategic implementation
in Chapter 6.2.2.
The transformational style of leadership changes (that
is, transforms) people’s behaviour. It was originally
devised by sociologist James Downton Jr, and developed
further by political scientist James MacGregor Burns, who
popularised it in his 1978 book, Leadership. He defined
transformational leadership as a process where ‘leaders and
their followers raise one another to higher levels of morality
and motivation’. The work by Burns was then further
developed by Bernard M Bass, who studied the underlying
psychological attributes that make a transformational leader
and identified a number of key features. Transformational
leaders:
» set clear and consistent goals
» encourage others
» lead through influence and charisma
» are models of integrity and fairness
» inspire others to rise to challenges
» encourage people to look beyond their self-interest
towards the greater good of the organisation.
Bass described transformational leadership in terms
of what he termed the ‘four Is’. These described how a
transformational leader can provide idealised influence,
intellectual stimulation, inspirational motivation and
individualised consideration. These were explained in
more detail on page 307.
Transformational leadership can be viewed as a process with
a number of stages:
» Work with employees to create an attractive vision.
» Combine the vision and a strategy to achieve it.
» Develop the vision into smaller elements and actions to
be completed.
346
» Show confidence and optimism about the vision and how
it will be achieved.
» Achieve the vision through implementing a series of
small, achievable steps.
7.3.3 Emotional intelligence/
emotional quotient
Daniel Goleman defined emotional intelligence as the
‘capacity for recognising our own feelings and those of
others, for motivating ourselves, and for managing emotions
well in ourselves and in our relationships’. Emotional
intelligence (or emotional quotient, EQ) is a relatively new
managerial model, which received much attention following
the publication of Goleman’s book, Emotional Intelligence, in
1995. The EQ concept argues that IQ (intelligence quotient,
a conventional measure of a person’s intelligence) is too
narrow as a measure of potential performance of employees,
including managers and leaders.
The EQ model emphasises that there are areas of emotional
intelligence that determine how well employees will
perform. A high-performing employee needs more than
a high IQ (the normal measure of intelligence) because
this ignores vital elements of a person’s character and
behavioural patterns. Some employees may be brilliant and
have a very high IQ, but they may lack personal skills and
not get on well with other people. Research indicates that
people with a high IQ are not automatically good performers
in the workplace.
When researchers measured employee performance against
IQ, they discovered that:
» low IQ predicts low performance
» high IQ produces varying levels of performance, from
very low to very high.
The same results were found when the research included the
professional skills that employees possessed. That means
that an employee with a high IQ (and professional skills)
can be a very high performer, but they may equally be a
very low one. Thus IQ and professional skills in themselves
do not predict high performance. They are necessary for
employees to perform well, but they are not enough on
their own.
An important step in this area was to test for employee
competencies and not just intelligence and professional
skills. Research compared groups of high and average
performers to find the competencies that made the
difference.
GLOSSARY TERM
Emotional intelligence is the capacity for recognising our
own feelings and those of others, for motivating ourselves,
and for managing emotions well in ourselves and in our
relationships.
Goleman’s emotional intelligence
competencies
Goleman’s work evolved to produce a model of 18 personal
competencies grouped into four clusters as summarised in
Table 7.11. His research tested these competencies against
employee performance and this showed that possession
of these competencies did coincide with high levels of
employee performance in the workplace. Although there
have been a number of studies on the importance and
Emotional intelligence and business
Emotional competencies have particular relevance for
leaders and managers. Leaders have to be able to motivate 7.3
and inspire others, establish good relationships and manage
conflicts between subordinate employees. They also have
to influence the ways other employees behave and be good
communicators (including listening!). A leader’s role is to
motivate others to do their jobs effectively. Managers have
to work within a team, be able to develop others (as part
of delegation), be able to initiate change and also be able

7.3.3 Emotional intelligence/emotional quotient

impact of emotional intelligence competencies, Goleman’s to manage conflict. To carry out these roles successfully,
work was carried out specifically within businesses. leaders and managers have to possess emotional
▼ Table 7.11 Goleman’s four competencies of emotional competencies.
intelligence
Research shows that exceptional leaders and managers
Self-awareness Social awareness possess a range of emotional competencies – both personal
and social. Such competencies, it is argued, are the
1 Emotional self-awareness 10 Empathy
major factor determining the performance of leaders and
2 Accurate self-assessment 11 Organisational awareness
managers. Emotional competencies can be learnt and may
3 Self-confidence 12 Service orientation
develop over time. Therefore, training in this area can play
Self-management Relationship management an important part in developing all of an organisation’s
(social skills) human resources.
4 Emotional self-control 13 Developing others Thus, emotional intelligence is increasingly relevant to
5 Transparency 14 Inspirational leadership the development of organisations and employees, because
6 Adaptability 15 Being a catalyst for change the EQ principles provide a new way to understand and
7 Achievement orientation 16 Having influence assess people’s behaviour, leadership styles, attitudes,
8 Initiative 17 Conflict management interpersonal skills and, most importantly, their potential
9 Optimism 18 Teamwork and performance.
collaboration

Source: Adapted from Transgrowth at www.transgrowth.com

EQ is responsible for
58% of your job
performance

$29 000
People with high EQ
make $29 000 more
annually than their
low EQ counterparts
90% of top
performers have high EQ

Source: Talent Smart

▲ Figure 7.17 The importance and benefits of emotional intelligence

347
 TEST YOUR LEARNING
7.3 Laporte Ltd was founded by Rahim in 2004 and he retains
Short answer questions control of the business. He has a clear vision for the
1 a Explain one difference between a leader and a business and is an effective communicator – including
manager. [3] being a good listener. Rahim dominates the senior
b Explain one purpose of leadership. [3] management team that takes strategic decisions and likes
2 Explain two factors that determine the ability of a to control important decisions, but he is known to care
leader to implement change. [6] deeply for the well-being of the company’s employees. He
3 a Explain one leadership role in business. also has a reputation for becoming involved in some day-
A LEVEL 7.3 LEADERSHIP

[3]
b Explain two qualities of a good leader. [6]
4 Explain one difference between trait and behavioural
theories of leadership. [3]
5 Explain one difference between autocratic and
laissez-faire styles of leadership. [3]
6 Explain one advantage of the use of democratic
leadership. [3]
7 Define the term ‘contingency theory of leadership’. [2]
8 a Define the term ‘transformational leadership’. [2]
b Explain one feature of a transformational leader. [3]
9 Define the term ‘emotional intelligence’. [2]
10 Explain one reason why emotional competency can
help a leader to be effective. [3]
Data response question
Changing times
Laporte Ltd is a small sports clothing manufacturer that
competes in markets with much larger, multinational
manufacturers such as Nike. Laporte Ltd’s clothes are
popular as they are unusual designs and much more
long-lasting than other clothing that is available. This has
enabled Laporte Ltd to achieve rapid growth over the last
five years and an increase in its market share, though this
remains small.
to-day decisions, usually to the irritation of more junior
managers.
Laporte Ltd is experiencing change. It is entering new
markets in China and Japan and launching several new
clothing ranges to attract new customers. The firm will
need a new factory to meet the expected increase in
demand. This will be built close to its existing facilities
and will more than double its productive capacity.
Rahim is under pressure from shareholders to increase
the company’s profits and dividends, and he is beginning
to wonder whether his leadership style is suitable in these
circumstances.
Questions
1 Analyse two reasons why Rahim’s leadership might
be important to Laporte Ltd’s stakeholders over
the next few years. [8]
2 Evaluate the extent to which Rahim’s leadership
style is suitable in these circumstances. [12]
Essay question
1 Evaluate the importance of emotional intelligence
in determining whether or not a person is likely to
be a successful leader. [20]

348
7 Human resource management
A LEVEL
7.4 Human resource management
strategy
Chapter overview
In this chapter we examine:
★ different approaches to human resource management
★ flexible-working contracts
★ the ways in which employee performance is measured
★ the causes and consequences of poor employee performance
★ how to improve employee performance
★ management by objectives
★ technology and human resource management.
7.4.1 Approaches to human
resource management
A human resource strategy is the medium- to long-term
plan that is implemented to achieve the business’ human
resource (HR) objectives. It is a central element of a
business’ approach to human resource management (HRM).
A number of factors have persuaded UK businesses to
implement HR strategies.
» A principal argument is that Japanese businesses have
had apparent success in managing people using this
approach, and they have been seen to gain significant
competitive advantage from managing a human resource
that produces high-quality products at minimum cost.
It is HRM that is credited with achieving this match
between employee behaviour and organisational
objectives.
» Changes in organisational structure have led to many
managers taking on responsibility for managing people
within the organisation. Techniques such as delayering
and the development of empowered teams have been an
integral part of the implementation of HR strategies.
Acquiring, developing, motivating and rewarding
employees are, it is argued, best done by managers and
colleagues close to the employees in question.
» The increasing popularity of psychological approaches
to motivation has encouraged the adoption of HR
strategies which demand styles of working that meet
the social and psychological needs of employees.
The adoption of flatter organisational structures and
7.4.1 Approaches to human resource management
psychological techniques of motivation are essential
elements of HR strategies. Organisations that adopt
these techniques and structures would naturally move
towards adopting some type of HR strategy.
However, the adoption of HR strategies by businesses in
many developed countries is not as sweeping and as clear-
cut as some might suggest. Surveys have indicated that
many companies have opted to select only the elements
of the HRM package that fit in with their philosophies,
management style and corporate objectives. For example,
a firm might choose to implement rigorous selection and
appraisal methods but ignore other aspects, particularly
developing employees through training. This means that
there is not a single HR strategy or approach to HRM.
Different firms have interpreted HRM in different ways.
» Hard HR strategies Some firms operate ‘hard’ HR
policies, treating employees as a resource to be used
optimally. Such firms regard employees as yet another
resource to be deployed as efficiently as possible in
pursuit of strategic targets. Employees are obtained as
cheaply as possible, controlled and then disposed of
when necessary.
» Soft HR strategies Other firms use HR systems that
can be regarded as ‘soft’. This approach is based on the
notion that employees are perhaps the most valuable
asset a business has and they should be developed to
maximise their value to the organisation. This makes a
long-term approach essential. Employees are seen as a
resource to be valued and developed over time and in
response to changing market conditions.
349
 ▼ Table 7.12 Hard and soft approaches to HRM

7.4 ‘Hard’ HRM ‘Soft’ HRM

Philosophy Regards employees as a resource like any other
available to the business
Timescale Sees HRM as a short-term policy; employees
hired and fired as necessary
A LEVEL 7.4 HUMAN RESOURCE MANAGEMENT STRATEGY
Sees employees as different from, and more
important than, any other resource available to
managers
Takes a long-term view of using the workforce
as efficiently as possible to achieve long-term
corporate objectives

Key features • Employees paid as little as possible
• Employees only have limited control over
working life
• Communication mainly downward in direction
• Leaders tend towards Theory X view of
workforce
• Employees recruited externally to fulfil the
business’ needs, giving short-term solutions
• Judgemental appraisal
Associated leadership Leaders operating this style of HRM are more
style likely to be at the autocratic end of the
leadership spectrum.
Motivational Probably the main motivator is pay, with limited
techniques used use of techniques such as delegation and
teamwork.
• Managers consult with employees
• Managers give control over working lives
to employees through delayering and
empowerment
• Leaders tend towards Theory Y view of workforce
• Emphasis on training and developing employees
• Employees promoted from within, reflecting
long-term desire to develop workforce
• Developmental appraisal
Leaders implementing this style of HRM are more
likely to be democratic in nature.
Motivation through delegation and empowerment.
Heavy use of techniques designed to give
employees more authority.

CASE STUDY
Appointing an HR manager
HR Manager – global manufacturer, Guangdong
province
Location: Shenzen, China
Salary: Over $125 000 per annum
A global manufacturer is seeking to appoint an HR
manager with responsibility for a workforce of 900
employees.
The organisation
The company manufactures a range of products for
use in the automotive industry. Its sales have increased
rapidly since 2015 and further growth is forecast. The
company’s mission is to be innovative and to support its
customers in developing new products and maintaining
competitiveness.
Candidate profile
Candidates will be expected to bring significant
knowledge of HR management within a multi-site
manufacturing environment.
● Ability to communicate effectively in Chinese and
English
● Evidence of implementing major changes to working
practices across organisations
● Experience of developing effective relationships with
core stakeholders
● Education to tertiary level, supported by relevant
professional qualifications
● A track record of successful management in a
manufacturing context
● Varied experience of management, including the use of
full range of hard and soft HR strategies.

The role Questions

The person appointed will be located in Shenzen but will 1 Analyse two differences between hard and soft HR
have responsibilities at other factories in Guangdong strategies. [8]
province. They will be expected to provide strong 2 ‘It is impossible to use hard and soft HR strategies
leadership to improve workforce performance to help to within a single business with any success.’ Evaluate
the meet the company’s HR and corporate objectives. this view. [12]

The role involves managing staff within a manufacturing

context and also introducing significant organisational
change.

350
Hard HR strategies » It can help a business to build a reputation for being
a ‘good’ employer. Good employers seek to offer
A hard HR strategy offers a number of advantages to a
business:
their employees diverse and interesting jobs and
the opportunity to develop their skills. The pay and
7.4
» It makes it easier for businesses to adapt the size and
conditions on offer are attractive and the employer
composition of their workforces to match the needs
ensures that employees receive regular training to
of their customers. Thus, a business using this type of
improve their skills and enhance promotion prospects.
strategy will be prepared to hire and dismiss workers
Being regarded as a good employer allows businesses
as necessary, without the need to maintain the size of
to attract higher-quality candidates, which in turn
its workforce during a downturn in sales. This allows
improves the quality of the workforce and the overall
a business to cope more effectively when trading in

7.4.1 Approaches to human resource management

performance of the business. A recent survey showed
markets that suffer from regular fluctuations in levels of
that working for a respected employer was one of the
demand.
most important factors to jobseekers when applying for
» It can result in lower costs, especially in the short term.
employment. This can make a soft HR strategy attractive
Adopting a hard approach to employees may mean that
to employers in Asia, as the region is suffering from
a business only uses employees with minimal skill levels
a severe shortage of employees with technical and
and relies on the use of technology and a small number
professional skills. Attracting and retaining highly
of highly skilled core employees to meet the needs of
skilled employees is vital for the future of many
its customers. This means that the business may be
businesses in the region.
able to reduce expenditure on its workforce by paying
low wage rates (perhaps minimum wage) and to avoid
» It can improve knowledge management within a
business. This means that the business is more likely
heavy and regular expenditure on employee training.
to possess a workforce with the knowledge and
Such a strategy, if successful, may boost profits to the
skills essential for the business to continue trading
satisfaction of shareholders.
effectively. This comes about because this approach
» It allows managers to retain control over the workforce
usually results in a lower level of labour turnover
and to direct operations as they wish. Under such an
and therefore employees develop long-term working
approach, employees will be told what their duties
relationships with businesses, allowing them to bring
are, with relatively little opportunity for discussion on
experience to bear in decision-making.
how to complete a job and limited input in terms of
suggestions on how to improve the production process.
» It may also develop a more creative workforce.
Employees will be given more opportunities to
This approach can assist a business in maintaining its
contribute to decision-making and to provide
focus on its corporate objectives.
suggestions and ideas on improving the operation of the
However, the hard approach to HR can also bring about a business. This can motivate the employees (by meeting
number of disadvantages: what Maslow identified as an individual’s higher needs)
» The level of labour turnover might be very high. This and also provide an organisation with some excellent
can impose a number of costs on the business. First, it ideas, without incurring the costs of hiring consultants.
has to recruit replacement employees. This can be costly Because these ideas are generated by people with
in terms of advertising and using managers to select various perspectives on the organisation, they can be
the new staff from the applicants. Secondly, even if different and creative.
the jobs are relatively unskilled, some training is likely
Of course, this type of human resource strategy does have
to be required, which may involve further expenditure.
its drawbacks:
Finally, new employees are likely to be less productive
during the initial period of their employment, which will
» It can be very expensive, especially in the short term.
The costs of training employees can be significant,
detract from the overall levels of productivity achieved
particularly if they are given off-the-job training. These
within the business.
costs could be wasted to some degree if the employee
» Employees may be demotivated by this approach to
leaves soon after completing the training, possibly as
employment. The failure of managers to develop a long-
a consequence of being ‘poached’ by an unscrupulous
term relationship with employees will mean that it is
rival – this is an example of market failure. Higher rates
unlikely that what Herzberg identified as motivators will
of pay and good working conditions can also add to an
be present in the job to any great extent. For example,
employer’s costs.
the chance to take responsibility for projects and
opportunities for promotion will be limited. This approach
» It can be difficult and expensive to alter the workforce
in response to a change in market conditions. The soft
relies heavily on pay as a motivator and ignores the
HR strategy is likely to rely heavily on full-time and
potential of social and psychological factors to motivate
permanent employees, and thus the business might have
employees and improve their performance at work.
surplus capacity if demand falls and little potential to
increase output if demand rises.
Soft HR strategies
The approach to HR strategy used will obviously depend
A soft HR strategy offers a number of advantages to a
upon the type of business concerned. It may be that
business, although in many cases these are the opposite of
businesses employing less-skilled employees may opt to use
those discussed above.
351
 a harder approach, as the costs of losing employees may be
less and the potential for increasing responsibility within
7.4 the organisation is less obvious. On the other hand, a more
skilled workforce might be more suited to a softer approach
to make the most effective use of their talents and to
minimise the risk of highly trained, skilled and productive
employees leaving the organisation.
CASE STUDY
A LEVEL 7.4 HUMAN RESOURCE MANAGEMENT STRATEGY
Skill shortages in Singapore
Active Global Caregivers (AGC) looks after mainly
elderly patients in their own homes in a number of Asian
countries. Its charges are relatively low.
Singapore is experiencing an ageing population. Nearly
1 million of its citizens are forecast to be over 65 by
2030 and about a third are expected to need eldercare.
Its current population is just under 6 million. While
the demand for care in Singapore is rising, the country
is suffering from a shortage of skilled health-care
employees.
AGC is aware of the difficulty of recruiting skilled health-
care workers given increased demand from other
nearby countries. It has had to devise ways to attract the
employees that it requires. AGC has created a recruitment
7.4.2 Flexible workforces
Businesses across the world use fewer full-time employees than
was the case in the early 2000s. Such employees are relatively
expensive as the firm incurs all the costs of employment, such
as making pension contributions and providing training. Those
full-time employees who are hired tend to be highly skilled and
perform central roles within an organisation.
Businesses have opted for workforces containing increasing
numbers of part-time and temporary employees, as well as
those who work at home or for hours which can vary each
week. Labour forces with high proportions of these types of
employees are called flexible workforces.
Having a flexible workforce can provide a business with a
competitive advantage. If a workforce is flexible, it can be
adjusted to meet the business’ needs. When the business
faces high levels of demand and sales, it can call on more
workers to enable it to increase production. When times
are quiet and sales are low, it does not incur unnecessary
costs by employing idle workers. A simple example exists in
retailing. Many shops have more customers at the weekends.
To ensure they can serve all these customers promptly, they
employ part-time employees to supplement full-time workers
at the weekends.
Types of flexible workforces
There are a number of ways in which businesses can create
flexible workforces. Some of the main ones are discussed in
this section.
352
STUDY TIP
When dealing with questions on the advantages and
disadvantages of the two types of HR strategy, it is
essential to consider the nature of the business and its
workforce. This may enable you to justify the use of a
particular approach, either hard or soft.
network in the southern Asian region and has presented
the prospect of working in Singapore as favourably as
possible. Despite these initiatives, it can still take a
considerable period of time to recruit new employees and
the company is under pressure to provide training to its
existing workers.
Questions
1 Analyse two problems that AGC may have faced
as a result of encountering significant skill
shortages in Singapore not long after the business
was established. [8]
2 ‘The skill shortages will encourage companies
providing care for the elderly in Asia to adopt
soft HR strategies.’ Evaluate this view. [12]
Using temporary workers
Temporary workers are employed for a limited period
of time – often to meet a business’ need for additional
staff during busy periods or to provide specialist skills
which are only needed rarely. The need to maintain
competitiveness by matching the size of the workforce
to expected sales is one factor causing an increase in
the proportion of temporary workers in the workforce in
the UK and other countries. Temporary workers are often
employed in businesses that normally trade for only part of
the year. Examples include staff employed at theme parks
and many people in the tourist industry, including skiing
instructors.
GLOSSARY TERMS
Flexible workforces exist when businesses place less
reliance upon permanent full-time employees and make
greater use of other forms of employment such as part-
time, temporary and zero-hours contracts.
Temporary workers have employment contracts that only
exist for a specific period of time – perhaps six months.
Part-time staff work less than a full-time week; for
example, 20 hours each week.
Job-sharing is a flexible form of working, in which two
people work part-time to complete the work of one full-
time employee.
The number (and proportion) of workers on temporary and 2018, though this hid significant changes in levels of
contracts varies significantly within the 37 countries of the temporary workers and changes in their importance within
Organisation for Economic Co-operation and Development
(OECD). This is shown in Table 7.13, which compares the
the workforce. There have been significant rises in Turkey
and Sweden and falls in Colombia and South Korea. In most
7.4
data in a selection of countries for 2008 and 2018. The countries, a much higher proportion of young people (aged
average proportion of employees on temporary contracts 18–24) tend to be on temporary contracts.
across the OECD countries remained stable between 2008
▼ Table 7.13 Comparative data on percentages of employees working part-time and on temporary contracts in 2008 and
2018, in selected countries

7.4.2 Flexible workforces

Percentage of workforce on temporary contracts Percentage of workforce on part-time contracts
Country
2008 2018 2008 2018
Canada 11.9 12.6 18.6 18.7
Chile 31.2* 28.6 9.1 20.7
Colombia 28.5 27.0 15.1 15.5
Japan 8.4 N/A 19.6 24.0
Korea (South) 22.4 19.4 N/A N/A
Portugal 21.1 22.0 11.9 10.5
Sweden 13.4 14.8 23.6 21.9
Turkey 11.1 13.1 8.5 9.9
UK 4.8 4.2 25.3 26.0
OECD average 11.3 11.3 18.7 21.3

* 2010 data
Source: Organisation for Economic Co-operation and Development (OECD); http://stats.oecd.org

Part-time working
Part-time staff only work for a portion of the standard Per
lw
iphera orkers
working week. Many employees work for two or three emp
orary or sel
f-e
e,t m
days each week. Sometimes two people share a full- im

pl
-t

time job, each working for a part of the normal working

oy
art

Core workers

ed
•p

week. This is called job-sharing. In contrast, a full- • full-time employees

time employee works for the entire working week. In • highly skilled and
trained
many countries, a full working week is between 35 and • important roles
45 hours. • job security
on ry
•

The percentage of employees who work part-time has ly

risen steadily across most OECD countries, with Chile,
Japan and Turkey recording notable increases. Developing
countries such as Argentina exhibit the same trend.
In 2008, 32.4 per cent of those employed in Argentina
worked part-time; by 2018 the equivalent figure was 37.8
per cent.
Core and peripheral workers
One way in which a flexible workforce can be organised
is as part of a ‘flexible firm’. This idea was developed by
John Atkinson and The Institute of Manpower Studies.
They explained that flexible workforces comprise a core
workforce and a peripheral workforce, as illustrated in
Figure 7.18.
h ir e ssa
d w hen nece
▲ Figure 7.18 The organisation of a firm with a flexible
workforce
The business’ core workers would be highly qualified and
trained, would be motivated and would be in permanent
full-time employment with security of employment. In
contrast, the peripheral workers would only be hired when
necessary. They may be low-skilled or have highly specialised
skills that are not required all the time. An example of the
latter category could be experts on environmental pollution.
This would allow the business to respond to fluctuations in
demand without incurring the ongoing costs of employing
all its workers on a permanent basis. The peripheral workers
could be employed part-time or by using temporary contracts.

353
 Annualised hours contracts
Employees working in this way are expected to work, say, an
7.4 average of 38 hours each week, but they can be employed
to work longer hours during busy weeks, with an equivalent
reduction in working hours during quieter periods. It is
common for this type of contract to be used for employees
working in agriculture and horticulture.
Zero-hours contracts
A LEVEL 7.4 HUMAN RESOURCE MANAGEMENT STRATEGY
childcare reasons. From 2014, this right was extended to
all employees in the UK with at least 26 weeks’ continuous
service.
Homeworking avoids the need for employees to spend
time and money travelling to and from work. It can also
save costs for an employer, who doesn’t have to provide
an office or other workplace for the employee. Advances
in information technology have made homeworking
more practical for many people. Employees are able to
communicate effectively using software packages such as

These are given to people who are employed by the business Zoom, Microsoft Teams and Slack. We considered this fully in
but only work and receive pay when both the business and Chapter 7.2.
employee agree to do so. Some types of work that might use
zero-hours contracts include: Shift-working
» providing catering services at events
Shift-working is an employment practice that is designed
» cleaning in offices, factories and other commercial
to allow businesses to carry on their core activities for 24
premises
hours a day. It is very common in industries such as health
» caring for elderly or unwell people
care, where patients can require services at all times of the
» delivery driving.
day. In the USA, it is estimated that approximately 15 per
Under UK law, an employee on a zero-hours contract has cent of employees are involved in working shifts.
the same rights as a standard employee, including minimum
wage and holiday pay. But the supply of work is very much
in the hands of the employer. Employees do not have a
guarantee of receiving any hours in a given week or month
and shifts can be cancelled with very little notice, leading
to financial insecurity for employees working on these
contracts.
Zero-hours contracts are widely used in the UK and are
increasing in popularity among employers. In 2019, 896 000
people were employed on this type of contract in the UK,
compared to just 190 000 in 2011. The use of zero-hours
contracts in the UK has caused a lot of controversy, in part
because the lack of guaranteed hours increases employees’
financial insecurity. This may be why they are less widely
used in many other countries.
▲ Figure 7.19 Shift-working is essential in some industries
Flexitime such as health care. It does, however, impose strains
Flexitime exists when a business allows its employees on employees who regularly switch between different
to work flexible hours. A flexitime system is designed to shifts.
offer employees more freedom to start and finish work Working shifts can mean that businesses are able to use
at times that suit their family responsibilities and travel expensive assets such as factories and machinery as fully
arrangements. Most businesses using this system agree core as possible. The fixed costs of these assets can be spread
working hours during which all employees must be at work. over a greater volume of production, helping to reduce
An employee has to work the agreed core hours but has the unit costs. Providers of services may also be able to gain a
flexibility to fit in the remainder of their hours to suit their competitive advantage by offering services 24 hours a day.
circumstances. Most businesses allowing employees to work Some supermarkets are open all day and night nowadays.
flexitime also permit them to vary the number of hours each
week, so long as, over time, they have worked the total
Job-sharing
number of agreed hours.
We saw earlier that two people can share a full-time job,
each working for a part of the normal working week.
Homeworking This can offer businesses benefits if the people have
Homeworking avoids the need for employees to travel complementary skills, and they may be able to work more
to work. Instead, they carry out their duties where they effectively than a single person. However, communication
live. Different countries have different approaches to problems can exist as the people job-sharing do not
homeworking. In some, the right to work from home is normally work together.
provided by law; in others it is entirely up to an employer–
employee agreement. Since 2003, working parents in the
UK have been entitled to request flexible working for

354

GLOSSARY TERMS
Annualised hours operate when an employer states the
number of hours employees must work over a whole year.
Weekly working hours can be varied to suit the employer’s
circumstances.
A zero-hours contract exists when an employer does not
have to offer the employee any fixed hours of work and the
employee does not have to accept the hours offered.
Flexitime is a way of working which allows employees
to fit their working hours around their individual
circumstances.
Shift-working is an employment practice in which
different groups of workers are employed at the same
place of work but at different times of the day to ensure
continuous production.
Compressed working hours is an employment practice in
which an employee normally works full-time but in fewer
than the normal number of days per week.
Compressed working hours
Compressed working hours is a flexible-working
arrangement under which employees are allowed to
compress their regular normal working week into fewer
days. For example, someone working a five-day working
week could ask to work only Monday–Thursday but start
their day earlier and finish later in order to make up their
total number of hours. Under this system, employees can
take time off for personal reasons and make up the time by
working longer hours at other times of the week.
Compressed hours can be very attractive for employees,
although employers may not always have key employees
available at critical times, unless the system is very well-
managed.
The gig economy
One matter which is receiving a lot of attention in
many countries across the globe is that of the insecure
employment of workers in the ‘gig economy’. The gig
economy is based on flexible, temporary or freelance jobs,
often involving connecting with clients or customers
through an online platform. People working in the gig
economy are not classified as employees but as contractors.
As a consequence, they do not receive guaranteed hours of
work or amounts of pay.
Many well-known businesses operate in the gig economy
and employ people on flexible contracts as a means of
providing price-competitive products. Uber, FedEx and
Deliveroo are all part of the gig economy. The Chartered
Institute for Professional Development estimates that
1.3 million people in the UK are employed within the gig
economy. America has a more developed gig economy, with
estimates showing that around 30 per cent of the working
population is already working in some form of gig role.
From the point of view of a business, operating in the gig
economy and using workers in this way can be an effective
means of controlling labour costs. Employing gig workers
reduces labour costs, as they are only employed when
required and the employer does not have to pay some
associated costs, such as holiday pay and pension costs, as
the worker is not classified as an employee. However, the
7.4
idea that gig workers are independent freelancers and not
employees is being challenged in some countries.
Workers do not always benefit under the gig system of
employment. Their income is insecure as they are not
guaranteed specific hours of work or levels of income.
Working in a gig role can also disrupt the individual’s
7.4.2 Flexible workforces
work–life balance and patterns of sleep. This form of
flexible employment can mean that workers have to make
themselves available for any gigs irrespective of the time
and other necessities such as family commitments.
The advantages and disadvantages of
flexible-working contracts
The advantages and disadvantages of flexible-working
contracts can be considered from the point of view of both
the business and its employees. There are diverse flexible-
working practices and all of the benefits do not apply to
each.
The advantages of flexible-working contracts
Businesses can benefit from the use of flexible-working
contracts in a number of ways. It can assist in recruitment,
as being able to work flexibly is attractive to many
employees. Acquiring a reputation for providing flexible-
working possibilities, whether in terms of hours or location,
can help to make a business an attractive employer and to
build an employer brand. This also helps a business to retain
its most experienced and skilled employees.
The International Workplace Group (IWG) reported in
2019 that UK, USA, Australian and Indian businesses are
particularly likely to use flexibility to attract and retain top
workers in an increasingly competitive talent market. In
Poland, a staggering 92 per cent report they are using this
strategy.
Some forms of flexible working can assist businesses
in becoming and remaining competitive. Some forms of
flexible contracts, such as zero-hours contracts and the
use of gig workers, help to keep labour costs to a minimum
as many non-wage payments, such as holiday pay, may be
avoided. This helps to enhance price competitiveness and to
enable the business to provide goods and services flexibly
to meet the demands of their customers. Both factors can
boost sales and market shares.
A further benefit to businesses from the use of some forms
of flexible employment contract is that it assists them in
matching supply to demand. Businesses that commonly
experience expected fluctuations in demand (such as
tourism) or in the need for labour (agriculture) can use
temporary contracts or annualised hours to overcome the
problems associated with a fluctuating need for labour
over time. This avoids labour shortages and a potential
loss of customers or idle labour and higher costs of
production.
355
 Flexible contracts can also allow businesses to hire
specialised labour without incurring training costs. They can
7.4 hire the people they need as contractors or on temporary
contracts and receive as many benefits as possible with
minimal expenditure. Keeping labour costs low in this way
helps businesses to control overall costs and to be price-
competitive.
Finally, there are significant advantages in terms of
motivation and labour productivity from the use of some
forms of flexible-employment contracts. Allowing employees
A LEVEL 7.4 HUMAN RESOURCE MANAGEMENT STRATEGY
to work flexitime, compressed annual hours or homeworking
can improve motivation and levels of productivity. A
survey conducted by the IWG in 2019 revealed the extent
of employee support for at least some forms of flexible
contracts. Figure 7.20 shows a summary of some key findings.
Employees can also benefit from working on flexible
contracts. It can make the job more attractive if they can
benefit from arrangements such as compressed hours to,
for example, pursue further education or qualifications to
enhance career prospects. Forms of flexible working, such
as part-time contracts, homeworking and flexitime, enable
employees to fit their other commitments (for example,
childcare) around their working lives. These approaches to
working support employees in managing their work–life
balance and can increase their loyalty to businesses.
The use of gig working and zero-hours contracts also
supports employees who may only wish to work for limited
and irregular hours. Using this form of contract, employees
are able to work for just the times that suit them. This form
of contract could be popular with students, for example.
▼ Table 7.14 A summary of the advantages and disadvantages of flexible-working contracts for businesses and employees
For businesses
Advantages • Manage fluctuations in demand effectively
• Lower cost of employing people with specialist
skills
• Reduction in training and other non-wage labour
costs
• Increased competitiveness
Disadvantages • Communication may be less effective
• Some types of contract may lead to higher levels
of labour turnover
• Some flexible contracts can damage employee
motivation and performance
CASE STUDY
Uber and flexible contracts
Uber is an American multinational company that provides
ride-sharing (taxi) services as well as food-delivery
services. It has grown rapidly over recent years but is
not yet profitable, despite receiving revenues of over $14
billion in 2019. Some of Uber’s drivers in the USA withdrew
their labour for 12 hours in protest against poor working
conditions and low wages. At the same time, the company
356
85% of respondents confirm that productivity has increased
in their business as a result of greater flexibility.
OVER 4/5 of respondents confirm that, when faced with
two similar employment offers, they would turn down
the one that didn’t offer flexible working.
OVER HALF of employees globally are working outside of
their main office headquarters for at least 2.5 days a week.
65% of businesses say flexible working helps to reduce
investment in property and to manage risk.
65% of respondents believe that businesses that tailor the
work environment to the work function of staff are more
productive.
Source: IWG Global Workspace Survey, 2019
▲ Figure 7.20 Some benefits of flexible working
Homeworking offers savings in time and money to
employees by enabling them to work from home for at
least part of the working week. This avoids the need to
commute to work, which can be very costly. It can also give
employees more freedom in terms of choosing where to
live. Being located close to the place of work is no longer
so important. Cheaper housing may be available in other
locations.
For employees
• Can help to manage work–life balance
• Supports employees in meeting other
commitments, such as child care
• Reductions in expenditure on travel to work
• Suitable for those only available to work at
certain times
• Insecure employment and uncertain earnings
• Communication can be an issue
• Some forms of flexible contract may result in
social isolation
• May damage career progression
began to sell its shares to the general public as it ‘went
public’ in its initial public offering (IPO).
Uber drivers from seven American cities stopped work to
take part in the protest, while there was a demonstration
by drivers in front of the company’s headquarters in
San Francisco. The protests became international
when the company’s drivers in several cities in the UK
 also expressed their dissatisfaction with their working
conditions.
Shona Clarkson, an organiser with the Gig Workers
Rising, felt drivers were not being treated fairly. ‘Uber’s
much-anticipated IPO will put millions into the pockets
of executives, but the drivers who are the core of the
service of the company will get nothing. Uber is paying
drivers poverty wages and continues to slash wages while
executives make millions.’
● more transparency in Uber’s decision-making
● the opportunity for employees to participate in
company decisions. 7.4
Uber argues that its drivers are not employees and, thus,
are not entitled to typical employee benefits such as
holiday pay. Instead, the company contends that they are
contractors.
Source: www.theguardian.com/technology/
2019/apr/24/uber-drivers-strike-ipo

7.4.2 Flexible workforces

In the USA, drivers working for Uber may only earn an
average of $8.55 per hour before tax is deducted. In
comparison, the minimum wage in California is $11 per
hour. The drivers in San Francisco have called for four
major changes:
● higher pay rates
● better working benefits, such as holiday pay and
greater job security
Questions
1 Analyse one advantage and one disadvantage to
Uber’s employees of working for the company. [8]
2 Evaluate the extent to which Uber looks after the
interests of all of its stakeholders. [12]

The disadvantages of flexible-working contracts pay for essential items, such as accommodation. In turn,
this brings disadvantages to businesses. Employees on these
Flexible working can result in relatively poor
contracts may be poorly motivated as their employment is
communication between employees and the business
insecure and productivity may suffer as a result. Businesses
and this can be a disadvantage for both groups.
can suffer from very high rates of labour turnover in these
Businesses may find that employees job-sharing on
circumstances. Research shows that fast-food chains in
temporary contracts or working from home are less
the USA have labour turnover rates of 130–150 per cent,
able to communicate effectively, as there is little or no
meaning that the average employee stays with the business
opportunity for face-to-face communication. Technology,
for less than one year. Businesses with high rates of labour
in the form of video conferencing and messaging, can
turnover can have high recruitment and training costs.
help with this. However, some businesses are concerned
This can be less of an issue in industries such as fast-food
that electronic communications may not be entirely secure
retailing, where many employees are relatively low-skilled
and this may pose a risk when exchanging confidential
and limited training is required.
information.
A minority of employees may feel that the use of flexible
Some forms of flexible contracts are less popular among
employment contracts can damage their chances of career
certain groups of employees. In particular, zero-hours
progression. Homeworking and part-time contracts may
contracts and gig working have received much criticism for
mean that an employee is not regularly in the workplace and
failing to provide a regular and certain income. A lack of a
may be less visible when opportunities for promotion arise.
guaranteed income can make it difficult for employees to

CASE STUDY
Zero-hours contracts
Industrial action became more common in the UK in 2019, the use of zero-hours contracts. In the same month,
as employees became less willing to accept existing employees from several branches of the fast-food retailer,
pay and working conditions. Data collected by EMW, a McDonald’s, did the same in several locations in the UK.
commercial law firm, showed that UK workers engaged in McDonald’s had previously offered employees working
96 strikes over the year compared with 66 in the previous on zero-hours contracts the opportunity to transfer
year. to contracts under which hours of work were fixed. It
reported that 80 per cent of its employees declined the
EMW identified that one cause of the 45 per cent rise in
offer.
the number of strikes in the UK was dissatisfaction with
zero-hours contracts. The UK’s official statistics agency, Questions
the Office of National Statistics (ONS), has produced
1 Analyse one possible implication of being on a zero-
data showing that between 2012 and 2018, just over a
hours contract for an employee at McDonald’s. [4]
quarter of new jobs in the UK were offered on zero-hours
2 ‘McDonald’s should expand its use of zero-hours
contracts. These contracts are unpopular as they do not
contracts to its restaurants in other countries.’
guarantee employees a set number of working hours.
Evaluate this view. [12]
In November 2019, cleaners and security staff at
University College, London, took industrial action against

357
 7.4.3 Measurement, causes and
7.4 consequences of poor employee
performance
Methods of measuring employee
performance
Before managers decide on changes to the workforce
as a result of recruitment or training, it is important
A LEVEL 7.4 HUMAN RESOURCE MANAGEMENT STRATEGY
to assess the performance of the existing workforce. A
number of measures are available to businesses to assess
the performance of their employees. Armed with this
knowledge, managers are then in a better position to
implement appropriate changes to improve the performance
of the workforce and the business overall.
Labour productivity
output per period
labour productivity =
number of employees at work
This is perhaps the most fundamental indicator of the
performance of a group of employees and has implications
for a business’ costs and, hence, the prices that it can
charge. Productive workers produce larger quantities of
output per worker per time period and this is a measure that
is relatively easy to calculate.
Labour productivity depends upon factors such as the
extent and quality of capital equipment available to the
workforce, as well as its skills and degree of motivation.
Thus, it is possible for managers to take a range of actions
with the intention of improving labour productivity figures.
Research indicates that, overall, labour productivity in the UK
increases by about 2 per cent per annum. This improvement
in efficiency reduces the labour costs involved in producing
a typical unit of output. Improvements in labour productivity
allow businesses to enjoy increased profit margins or to
reduce prices (while maintaining profit margins), hopefully
leading to increased sales. Businesses can increase their
competitiveness in terms of costs and prices if they can
increase productivity at a higher rate than that of rival
businesses.
Labour turnover
number of staff leaving during the year
turnover = × 100
average number of satff
This ratio measures the proportion of a workforce leaving
their employment at a business over some period of time,
usually one year. Low wages and inadequate training,
leading to poor morale among employees, may cause high
levels of labour turnover. Another cause is ineffective
recruitment procedures, resulting in the appointment of
inappropriate staff. Other reasons include redundancy and
retirement.
Some level of labour turnover is inevitable. Managers seek
some level of labour turnover to bring new ideas into a
358
business but not so high as to impose excessive recruitment
costs. Estimates suggest that the average rate of labour
turnover in the USA in 2019 was 19 per cent. In contrast, in
the UK, the average labour turnover rate is approximately
15 per cent, with varying rates for different sectors. For
example, privately owned businesses tend to have a slightly
higher rate, while organisations in the public sector (schools
and colleges, for example) have marginally lower rates.
Managers attempt to manage labour turnover to achieve
a balance between bringing new employees with
enthusiasm and ideas into the business against the costs
of recruitment. Research by the Chartered Institute for
Professional Development (CIPD) in the UK suggests that
most businesses face a higher labour turnover than desired
and that this results in unexpected recruitment costs.
HANDLING DATA
Serendipity Ltd manufactures electrical components.
Its managers recorded the following data over the most
recent financial year:
● Average number of employees = 750
● Output of components (000s) = 2250
● Number of employees leaving the business = 50.
The company’s managers also calculated that its
productivity figure has fallen by 15 per cent since the
year before.
1 Calculate Serendipity Ltd’s productivity and labour
turnover figures for the most recent financial year.
2 Calculate Serendipity Ltd’s productivity figure for
the year before this.
Absenteeism
number of staff absent (on one day)
absenteeism = × 100
total number of staff
Absenteeism occurs for a variety of reasons, including
industrial accidents and illness. The term is frequently used
to describe a situation where an employee is absent from
work frequently and without good reason. Thus, it is used
as a measure of the morale and motivation of a workforce.
High levels of absenteeism can dramatically increase a
business’ costs.
STUDY TIP
Being able to interpret and comment on the results of
measures of employee performance in relation to the
business in question is important. For example, rates
of labour turnover could be critical in industries where
employees are highly skilled and expensive to train.
GLOSSARY TERM
Absenteeism occurs when an employee is not present at
their place of work.
Health and safety
health and
number of working days lost per
annum for H & S reasons
safety = × 100
total number of possible working days
This measures the safety of the working environment. A
dangerous working environment not only lowers employee
morale but may also damage the performance of the
CASE STUDY
Labour productivity in Pakistan
Pakistan has a long-standing problem with its low rates
of labour productivity. Labour productivity per worker in
the country grew 1.4 per cent annually between 2000 and
2017, as opposed to 3.9 per cent in Bangladesh, 5.8 per
cent in India and 8.5 per cent in China.
The Nobel Prize winning economist Paul Krugman had
little doubt about the importance of labour productivity.
He noted that ‘productivity isn’t everything, but in the long
run it is almost everything.’
In the 1980s, labour productivity in Pakistan grew at
4.2 per cent per annum. By the 1990s, this had sharply
declined to 1.8 per cent, falling further to 1.4 per cent
during 2000–17. Since 2007, it has been growing at
The causes and consequences of poor
employee performance
There are a number of factors which can result in poor
employee performance at work.
Poorly designed jobs
Employees may perform poorly because the job they
are required to do has been designed poorly. It may be
monotonous, involving a limited range of duties which are
repeated regularly. It may be too stressful, too demanding
or too time-consuming, meaning that employees have
insufficient leisure time. All of these factors can result in
employees performing their work poorly.
The CIPD researched the working lives of over 5000
employees in the UK in 2019. A summary of its key findings
is given below.
The UK Working Lives Survey is an annual assessment of job
quality across seven different categories including pay and
benefits, contracts and employment terms, and voice and
representation.
Poor work–life balance was identified as a particular problem,
with many people admitting their job caused disruption to
family life and made it hard for them to switch off in their
downtime. Three in five (60 per cent) say they work longer
hours than they want and one in four (24 per cent) say they
overwork by ten or more hours a week. A quarter (24 per cent)
admit it’s difficult to relax in their own time because they are
workforce. Absence due to accidents and injuries in the
workplace increases the labour costs incurred by a firm and
can lead to adverse publicity. 7.4
Managers need to measure employee performance to assess
the efficiency (and competitiveness) of the workforce. In
service firms (where labour costs are a high proportion of
total costs), this can be a particularly important factor.
Measures of employee performance also help to assess
whether a workforce is fully motivated.
7.4.3 Measurement, causes and consequences of poor employee performance
around 1 per cent. In many other Asian countries, labour
productivity has been growing at over 5 per cent per
annum in recent years.
Rates of labour productivity are dependent on the use of
capital equipment and technology as well as the skills and
motivation of the workforce.
Questions
1 Analyse one possible implication for a business’
competitiveness if its workforce has negative labour
productivity rates over a period of several years. [4]
2 ‘The use of more technology in the workplace is the
best way for Pakistani businesses to improve their
labour productivity figures.’ Evaluate this view. [12]
thinking about work and that their job affects their personal
commitments (26 per cent).
The report also uncovers evidence of high levels of work
intensity which, like a poor work–life balance, is known to be
a cause of stress. Nearly a quarter of people say they often
or always feel exhausted in their jobs (22 per cent), or under
excessive pressure (22 per cent).
Source: CIPD, UK Working Lives Survey 2019; www.cipd.co.uk/
about/media/press/poor-work-life-balance
Leadership and management styles
Employees may perform poorly at work because they are
managed badly. Managers and leaders may opt to use styles
which are inappropriate to the skills and experience of
the workforce and the circumstances. Some managers, for
example, may exercise a high degree of control over highly
qualified and skilled employees, while expecting them to
be creative and productive. In these circumstances, the
workforce would respond more positively to a management
style which was more democratic in approach. Similarly,
some employees may require guidance and support and
might not respond effectively to a management style which
allows them considerable freedom at work. This might lead
to poor employee performance at work.
A leader or manager may be a poor communicator and this
can impact adversely on employee performance. Employees
may not be set clear targets or given helpful feedback on
performance which would help them to improve.
359
 Demotivation (such as the ability to lead) or the experience required.
Because of this, they may not be able to carry out the
Frederick Herzberg identified a number of factors which had
7.4 the potential to demotivate employees. If employees believe
duties and tasks of the job effectively.
that their wages or salaries are too low, if they have a poor
relationship with fellow workers, or if working conditions are The consequences of poor employee
unsafe or unpleasant, they are likely to be demotivated. A
demotivated worker will be likely to perform poorly and may
performance
leave the business when the opportunity arises. A business with poorly performing employees is likely to be
at a competitive disadvantage. Its unit costs of production
may be higher than those of its rivals, meaning that it
Insufficient resources
A LEVEL 7.4 HUMAN RESOURCE MANAGEMENT STRATEGY

may not be able to compete in terms of price. This can be

Employees may perform poorly because they do not have
the necessary skills to carry out their duties efficiently. The
business may not invest in providing employees with the
training necessary to allow them to work efficiently. This
is likely to be a more important factor in industries such
as medicine and technology, which are subject to ongoing
changes.
Employees may also perform poorly because they have
insufficient or unreliable physical resources to be
productive. For example, an employee may have low levels
of productivity if their production-line equipment is
outdated or unreliable.
Ineffective systems of recruitment and
selection
Businesses might simply appoint the wrong employee to a
position. This employee might be the wrong person as they
do not possess the necessary skills, personal characteristics
a significant disadvantage if the business’ customers base
their buying decisions on price or if competitors sell very
similar products.
In some sectors, poor employee performance may result in
a business becoming less innovative. This could reduce its
ability to develop new products to meet changing consumer
needs or to reflect advances in technology. This could be
highly damaging for businesses such as Apple or Lenovo,
which rely on maintaining customer loyalty by continuously
producing market-leading products.
If a business has ineffective recruitment and training
systems, it may acquire a reputation as a poor employer.
Many employees and ex-employees make comments about
their employers online, and it is easy for people considering
applying for a job with a business to conduct some simple
research. This may make it more difficult for the business to
attract the most skilled and productive employees. In turn,
this could damage its long-term performance.

Causes of poor Measures of employee Consequences of poor

employee performance performance employee performance

Poorly designed jobs

Competitive
disadvantage
Inappropriate leadership Labour productivity
and management styles
Lower levels of
Labour turnover innovation

Demotivation
Reputation as a
Absenteeism poor employer

Insufficient resources
Health and safety Higher recruitment
and training costs
Ineffective recruitment
and selection

▲ Figure 7.21 The causes, measurement and consequences of poor employee performance

7.4.4 Strategies for improving Training

employee performance
There are a number of approaches a business can take
to improve the performance of its employees. A logical
approach to improving poor employee performance is to
consider the causes and to implement policies intended to
address this.
360
Businesses can invest in training to provide job-related
skills the employees require to carry out their work
more effectively. Training can also improve a workforce’s
performance in terms of health and safety by alerting
employees to dangers in the workplace and encouraging the
use of safe working practices.
 pay. Team pay is a method of linking the pay of employees
to the level of performance that they have achieved in a
team. Team pay means that all members of a team receive
some sort of financial incentive when a goal or target
7.4
is reached. The goals might be financial, sales-related
or expressed in terms of quality. Team pay might be a
supplement to basic pay or it might represent the entirety
of an employee’s pay.
Team pay is a very attractive technique, as more businesses
adopt flatter organisational structures and make more use

7.4.4 Strategies for improving employee performance

of delegation. Modern businesses using these approaches
to organising their employees require a workforce that can
be flexible in its ability to deliver improvements in quality,
profitability and customer service.
▲ Figure 7.22 On-the-job training Team pay aims to reinforce behaviour that leads to effective
Training can also improve employee performance if teamwork. Being a part of a successful team can be very
managers and leaders receive training to help them to satisfying and may discourage absenteeism, as individuals
handle subordinates more sensitively and effectively. may be unofficially accountable to other team members and
not want to let them down.
However, training can be costly and there is always
the risk that employees may leave the business for ▼ Table 7.15 Team pay versus individual pay
alternative, higher-paid employment once they possess
these employable skills. Training to improve employee Team pay Individual merit pay
performance is more likely to be effective when employees • Rewards teamwork and • Creates internal competition
are highly skilled or when improved employee performance co-operation • Encourages withholding of
can provide a distinct USP. • Encourages information- information
sharing and • Individuals try to improve
Motivation communication work systems – with less
A highly motivated workforce is likely to be highly • Encourages group to chance of changes being
productive with low levels of labour turnover and improve work systems implemented, as may not be
absenteeism. In Chapter 2.2, we considered a number of • Increases flexibility and widely supported
ways in which businesses may improve the motivation of ability to respond to • Decreases flexibility
their workforces. This may require businesses to redesign changing needs • Incorporated into base
jobs to make them more attractive and fulfilling, perhaps • May be incorporated into salary
by empowering employees and/or offering the opportunity base pay • No focus on wider
to work in teams. Well-designed jobs can help to reduce • Focus on wider organisation
labour turnover and absenteeism by allowing employees to organisation
fulfil Maslow’s higher needs (such as self-esteem) at work. Source: M Thompson, Team-working and Pay (1995) Institute
Herzberg argued that personal achievement, recognition and of Employment Studies
responsibility were key motivators. By creating jobs that
allow employees to have responsibility, to achieve goals
and to receive recognition, it is possible for businesses to Employer branding
satisfy larger numbers of employees and discourage them Employer branding can be defined as creating a perception
from leaving the business. of the business as a really good place in which to work
in the minds of current employees, as well as other
STUDY TIP stakeholders such as customers and shareholders. A survey
of 895 businesses in the UK by the CIPD revealed that 69
Don’t forget the materials that you studied at AS Level.
per cent of businesses consider that they have an employer
Your studies of motivation will help you to understand
much of the material we cover in this chapter.
brand, and that this is particularly important to smaller
businesses with fewer than 250 employees. Having a good
employer brand helps to persuade employees to stay with
Pay systems a business and can be an important factor in retaining the
services of skilled and potentially footloose employees.
Businesses can use pay systems, such as piece-rate or
performance-related pay, which reward employees according
to the amount produced or for the attainment of specified Flexible-employment contracts
targets. This approach can be effective in improving We saw earlier in this chapter that there are a variety of
productivity, especially in manufacturing organisations. ways in which businesses can employ people more flexibly.
This can bring together some of the other benefits, such as
A newer approach to pay, which is intended to improve
improving motivation and enhancing a business’ reputation
the performance of teams within the organisation, is team
361
 as an employer. In particular, the use of flexitime,
homeworking and job-sharing can offer real benefits
7.4 to employees. The use of such contracts can improve
motivation and reduce labour turnover. Both factors can
be expected to improve employee performance in the
workplace.
Management by objectives
Peter Drucker spent many years researching major
companies, such as General Electric and DuPont in
A LEVEL 7.4 HUMAN RESOURCE MANAGEMENT STRATEGY
Thus, in our example in Figure 7.23, a business has a
mission statement that sets the organisation the overall
target of becoming the ‘premier supplier of bottled water
in Europe’. The business’ corporate objectives contribute
to this mission – one might be to increase sales in Europe
by a certain percentage each year. A business comprises
functions such as marketing, finance and production.
These functions should contribute to the achievement of
corporate objectives by doing their bit. Thus, marketing
should increase sales, raise production output and so on.
Finally, the departments, teams and individuals at the

the United States. In 1954, he published The Practice

bottom of the hierarchy should all make their co-ordinated
of Management, one part of which was his theory of
contribution to the attainment of the objectives of the
‘management by objectives’ (MBO). This theory stated the
functional area of the business in which they work.
central role of objectives in business management.
An important element of the operation of MBO is the review
Implementing MBO of the extent to which targets have been met and the
development of new goals, targets and objectives in light of
According to Drucker’s theory of management by objectives,
this experience.
to implement MBO managers should:
» identify and agree targets for achievement with subordinates
» negotiate the support that will be required to achieve The usefulness of MBO
these targets The usefulness of MBO in any given situation depends on
» evaluate over time the extent to which these objectives the balance of its advantages and disadvantages. MBO
are met. offers a number of advantages to businesses:
» MBO can improve communication within the organisation
The objectives set at each level should be co-ordinated to
as the target-setting and evaluation process takes place.
ensure that the business achieves its corporate objectives.
It can give managers a fuller appreciation of the duties
Each member of staff should make a contribution, no matter
and problems faced by their subordinates.
how small, towards the whole business achieving its overall
» Employees may be motivated by having a clear
objectives.
understanding of what they are trying to achieve and
e.g. 'To become
how it helps the business achieve its overall goals. MBO
the premier Mission has the potential to improve employee performance.
supplier of bottled statement » MBO can highlight training needs for managers and
water in Europe'
subordinates, improving their performance and
productivity.
e.g. to increase Corporate objectives,
sales in Europe by once achieved, allow » The attainments of goals can help all employees to fulfil
5% in each of the the business to fulfil some of the higher needs identified by Maslow.
next 5 years its mission statement
Drucker recognised at the outset that MBO had a number of
potential drawbacks:
Objectives stated in greater detail

e.g. (marketing Business functions

function) to achieve pursue objectives » Some employees may find the setting of targets
a 10 per cent share to assist the
business in threatening. Employees at different levels within
of the bottled water
markets in Italy and achieving its the organisation have varying perceptions of issues,
Spain within 5 years corporate objectives problems and their solutions. The manager might set
targets that the subordinate considers unachievable.
e.g. (market Attaining » All employees within the organisation must be
research) to develop departmental committed to the technique if it is to succeed and
a plan to research objectives
customers' views on contributes to the benefit the business.
bottled water in Italy business achieving its » Setting targets for highly specialised employees can
and Spain corporate objectives be difficult and tends to remove the focus from the
mainstream corporate objectives.
e.g. to design Individuals and » Modern businesses operate in a business environment
questionnaires teams negotiate that is changing rapidly; for example, as a result of the
as part of targets which assist
market research departments in globalisation of markets. Objectives can quickly become
campaign achieving their goals out of date if, for example, a technological development
by a multinational competitor means that products are
▲ Figure 7.23 Management by objectives obsolete.

362
7.4.5 Roles of IT and AI in human
resource management
Types of technology and HRM
There are five main trends in technology that are influencing
the ways in which HR operates within a business:
» Data analytics The use of artificial-intelligence (AI)
technology to interrogate data stored on cloud-based
databases has transformed the amount of information
a business many thousands of dollars, and technology has
the potential to reduce the costs and time taken when
appointing new employees. Social media has been used as 7.4
an integral part of recruitment for many years, with websites
such as LinkedIn playing a key role in bringing together
those looking for work and employers with job vacancies.
However, more recent technological advances have helped
to make the recruitment process faster and more cost-
effective. Technology can be used to scan and analyse
applicants’ CVs and application forms and select the most

7.4.5 Roles of IT and AI in human resource management

available to HR specialists.
» Cloud computing This is the core of most technological
HR systems. It stores vast amounts of data and
its accessibility can encourage employees to work
collaboratively.
» Mobile technology The use of mobile technology through
smartphones and other devices increases and improves
communication between HR and other employees.
» Social media This technology is still widely used for
recruitment and selection, and it is used increasingly as an
inexpensive means for communication and team-building.
» The internet of things (IoT) This works with AI and
the cloud to gather data from employee wearables and
other devices.
Social The internet Cloud Big data
media of things computing and analytics technology
desirable candidates. AI enables HR teams to evaluate
large numbers of job applications quickly and efficiently.
Some businesses are now also using AI in the form of
chatbots to conduct interviews with candidates. There is
some evidence that AI can outperform humans in judging
the hard skills that are essential to complete a job, such
as relevant job-related knowledge. This allows human HR
specialists to focus on assessing candidates’ soft skills,
such as their ability to fit in with the existing team and
business culture. It is likely that this combination of AI and
HR specialists will improve the recruitment and selection
process.
Phenom People is a business that provides AI software in
the USA to help businesses make good-quality recruitment
Mobile and selection decisions. The company operates a ‘talent
experience management’ platform as an all-in-one solution
to recruitment issues. Phenom People claims to have over
300 companies as clients, including Microsoft.

Managing the performance of employees

Traditionally, the performance of employees was managed
through regular appraisal meetings, during which
Technologically past achievements were evaluated and targets set for
based HR the future. Technological developments have created
performance-management software which tracks the
performance of employees continuously and can update
▲ Figure 7.24 Developments in technology and HRM targets and provide employees with feedback on their
performance at any time. The software also allows other
employees to contribute to the assessment of an individual
How technological advances affect HRM employee’s performance as a central part of the process.
Recruitment and selection Figure 7.25 summarises the operation of performance-
management software.
The process of recruitment and selection is a costly exercise
for most businesses. Recruiting a senior manager can cost

Colleagues and
Personal goals, Employee records Manager and
managers give Software accumulates
projects and tasks when tasks and employee have
constructive criticism and summarises
which work towards goals are regular catch-up
to employee, employee performance,
the organisation’s completed so that discussions, either
recognising strengths which can be used
objectives are put manager can track in person or
and areas for in a formal appraisal
into the system progress electronically
improvement

▲ Figure 7.25 The operation of performance-management software

One feature of managing employee performance is the use
of wearables by the business’ workforce. Employee wearables
are clothing that incorporate some computing and software
technologies. Wearable technology in the workplace can
be used to monitor an employee’s productivity by checking
on their location and the activities in which the person
is engaged at any time. Some businesses use wearable
technologies to provide augmented instruction; for
example, to check that employees are selecting the correct
items from the shelves in a warehouse. This technology
can also identify if an employee is engaged in a hazardous
activity and intervene, if necessary.
363
 Communication between HR and other
employees
7.4 Advances in communication technology have made it easier
for those responsible for HRM to communicate and work
with employees across the organisation. Many organisations
have moved away from using emails, as inboxes become too
crowded and the level of engagement of employees with
this form of communication is often poor.
New forms of technology have helped to improve
A LEVEL 7.4 HUMAN RESOURCE MANAGEMENT STRATEGY
communication and stimulate employee engagement with
HR initiatives. Nowadays, many companies use different
online methods to exchange files and messages such as
Skype, Slack and Basecamp. Some HR managers use social
intranets and computer-based newsfeeds to transmit
CASE STUDY
FTD Ltd
FTD Ltd is a clothing retailer with 112 shops located
throughout the UK. It also sells online. It has enjoyed rising
profitability, employing nearly 2000 people in its stores
and in three very large warehouses, from which clothing is
distributed to its shops and its customers. Many employees
are on zero-hours contracts and those who turn down
work are rarely offered any further employment. Its pay
rates are below average for the industry.
The company’s workforce is not well-motivated and
labour turnover is high. Employees complain of poor
working conditions, limited training and many only stay
a few months. They say they have little communication
with managers – apart from receiving instructions – and
are frequently disciplined for minor errors or lateness.
Last year, the company’s labour turnover rate was 105 per
cent, the highest ever. Productivity has also declined and
last year was estimated to have fallen by 3.5 per cent.
The company’s managers have investigated increasing the
use of technology in its operations in the belief that this
Technology is changing the role of HR
within a business
Developments in technology have allowed HR managers to
spend less time on basic administrative tasks. Technology
has allowed databases to replace physical files and enabled
much more time-effective searches and analyses to take
place. Storing information in cloud systems means that
much more data (including big data) is available for
analysis. This can be conducted rapidly and efficiently. It
also allows HR specialists to produce reports speedily and
364
information without interrupting work patterns. This can
assist in engaging and enthusing employees and improving
performance at work.
Creating a more diverse workforce
Research throughout the world indicates that more diverse
workforces (in terms of both gender and ethnicity) generate
higher levels of productivity and profitability. In part,
this may be because consumers in many countries value
businesses that employ diverse workforces. HR managers
can use technology to monitor recruitment practices for
diversity. They can also use technology to analyse HR data
to identify any salary gaps between employees of different
gender or ethnicity, and they therefore help to promote a
positive culture within the business.
will improve the performance of its workforce. They are
considering the following proposal:
● replacing many online customer advisors with chatbots
● using employee wearables to monitor the performance
of employees, especially in its warehouses
● recruiting and selecting employees using only
information technology and artificial intelligence to
analyse applications and conduct interviews.
The company’s directors have very different views on the
likely success of this proposal.
Questions
1 Analyse two ways in which FTD Ltd might improve
the productivity rates of its employees. [8]
2 Evaluate the case for and against the company’s
proposal to make greater use of information
technology and artificial intelligence in managing
its workforce. [12]
with a precise focus. It allows payrolls and other HR records
to be updated quickly and to be accessible to all authorised
people within the business.
This simplification of the many administrative tasks
through the use of technology has given more time for HR
managers to devote to strategic matters. This means that
HR managers can focus on long-term people issues, such
as ensuring the business matches human resources to the
business’ needs, and that it develops values and cultures
in the workforce that support the achievement of the
organisation’s corporate objectives.
 TEST YOUR LEARNING
Short answer questions
1 Explain two differences between a ‘hard’ and a
‘soft’ human resource strategy. [6]
2 a Define the term ‘flexible workforce’. [2]
b Explain one advantage to a business of using
temporary employment contracts. [3]
3 Explain one difference between annualised-hours,
7.4
Data response question
Punjab Sugar Mills Ltd
Punjab Sugar Mills has enjoyed a substantial rise in sales
over the last four years, although sales have fluctuated
at times. It trades in a highly competitive global market
in which profit margins have declined steadily. The
level of production at the factory tends to fluctuate in a

7.4.5 Roles of IT and AI in human resource management

compressed-hours and zero-hours employment
contracts.
4 a Define the term ‘flexitime’.
b Define the term ‘job-sharing’.
5 Explain one reason why some businesses benefit
from operating within the gig economy.
6 a Explain one advantage of the use of flexible-
employment contracts.
b Explain one disadvantage of the use of flexible-
employment contracts.
7 a Define the term ‘labour productivity’.
b Woodland Mines Ltd recruited 250 people last
year and 200 employees left. Its average
number of employees during the year was 6000.
Calculate its rate of labour turnover.
8 a Explain one reason why absenteeism may be a
problem for a business.
b Explain one method a business might use to
improve the performance of its employees.
9 a Define the term ‘management by objectives’.
b Explain one advantage to a business of the
use of management by objectives.
10 Explain one way in which technological advances
might affect the way a business recruits and selects
employees.
▼ Table 7.16
predictable way throughout the year as sugar harvests
[3] are completed in different parts of the world.
[2] The company’s workforce has grown rapidly too, although
[2] some HR managers support the introduction of more
technology to replace people. The process of producing
[3] sugar is suited to the use of technology, and this could
help the company to achieve its overall aim of increasing
[3] its profitability. However, Punjab Sugar Mills Ltd has
decided to invest heavily in training its employees at
[3] all levels during the last 18 months rather than buying
[2] technology, preferring to use labour-intensive production
methods. The factory operates for 18 hours a day, 5 days
each week.
The company’s chief executive values his workforce and
[3] considers good employer–employee relations essential
if the business is to succeed in the future. However, some
[3] employees believe that communication is poor within the
business, despite the company’s democratic management
[3] style. Employees complain that they do not always get a
[2] chance to voice their opinions.
The management team have been studying some key data
[3] for the company, shown in Table 7.16.
The price of sugar cane has fluctuated on world markets,
leading to significant fluctuations in the company’s costs.
[3]
However, growing demand in Indian markets and in other
Asian countries, with rising incomes, has boosted sales
revenue.

Last year One year ago Two years ago Three years ago
Sales ($’000s) 4 785.6 4 387.4 4 401.9 4 011.2
Sugar production (metric tonnes) 9 570 8 335 8 282 8 337
Profit margin (%) 9.22 10.43 9.14 7.95
Employee numbers 2 512 2 401 2 456 2 339
Labour turnover (%) 7.3 7.1 11.2 7.4

Questions
1 Analyse one way in which the use of flexible
workforces might enable Punjab Sugar Mills Ltd’s
managers to reduce the company’s labour costs.
2 a Calculate the company’s productivity figures for
last year and two years ago.
b Evaluate the strengths and weaknesses of the
performance of Punjab Sugar Mills Ltd’s
workforce over the last four years.
3 Evaluate the possible actions that Punjab Sugar Mills
Ltd’s managers might take to improve further the
[4] performance of the company’s workforce. [12]
[4] Essay question
1 ‘Labour productivity is always the most important
measure of employee performance.’ Evaluate the
[12] extent to which this statement is true. [20]

365
 8 Marketing
A LEVEL

8.1 Marketing analysis

A LEVEL 8.1 MARKETING ANALYSIS

Chapter overview
In this chapter we examine:
★ the elasticity of demand: price, income and promotional
★ new product development
★ research and development (R&D)
★ sales forecasting.

8.1.1 Elasticity Price elasticity of demand

Market analysis
Market analysis examines the conditions of a market. This
includes the size of a market and the factors that influence
demand. A key aspect of market analysis is to consider how
sensitive demand is to changes in different factors.
Every business is interested in what affects demand for its
products and services. What is it that makes its sales go up,
or down? Will sales alter if the business changes the price
or if consumers’ incomes change? What is the strength of
the relationship between, for example, price and sales? If
the price is cut by 10 per cent, will sales go up by 5 per
cent, or will they go up by 50 per cent? Similarly, if average
consumer income levels rise by 5 per cent, what impact will
this have on demand for the firm’s products?
The relationship between changes in demand and changes
in factors, such as price and income, is measured by
the elasticity of demand. Effective marketing involves
an understanding of what influences demand and how
sensitive demand is to different factors. This requires an
understanding of the concept of elasticity. If the change
in quantity demanded is greater than the change in the
variable, with all other factors unchanged, this is known as
elastic. If the change in quantity demanded is less than the
change in the variable, with all other factors unchanged,
this is known as inelastic.
We now consider some of the key variables that can
affect demand – namely, price, income and promotional
expenditure – and consider the elasticity of demand in
relation to these.
There are several types of elasticity, but one of the most
important to businesses is the price elasticity of demand.
This measures the sensitivity of demand to a change in
price, with all other factors unchanged. A business can
change its price but, before it does so, it will want to know
the possible impact on the demand for its products.
Why does the price elasticity of demand matter?
By calculating the price elasticity of demand, a business
can identify how changes in price may affect the quantity
of its sales and, therefore, revenue. This is important for its
marketing planning. If, for example, a business is planning
a price cut, it will want to estimate how much sales are
likely to increase. This allows the business to ensure it has
sufficient inventory or capacity to meet demand. It may
also have implications in terms of employing people. For
example, the firm may need to hire extra people or get
staff to work overtime to meet orders. The business will
also want to calculate whether the price cut is worthwhile
financially. Will the price cut lead to higher profits or not?
An understanding of price elasticity should, therefore, lead
to better pricing decisions.
Calculating the price elasticity of demand
The price elasticity of demand measures the percentage
change in quantity demanded following a price change,
when all other factors remain the same.
price elasticity percentage change in quantity demanded
=
of demand percentage change in price

GLOSSARY TERMS
Market analysis examines the conditions of a market.
The price elasticity of demand measures the sensitivity
of demand to a change in price, with all other factors
unchanged.

366
Demand is said to be price elastic if the value of the
price elasticity of demand (that is, the size of the number,
ignoring whether it is a positive or negative number) is
greater than 1 – that is, a given percentage change in price
brings about a greater change in quantity demanded. For
example, if demand rises by 20 per cent when the price is
cut by 10 per cent, the price elasticity of demand will equal
+20
= −2
−10
Demand is said to be price inelastic if the value of the
price elasticity (that is, the size of the number, ignoring
whether it is positive or negative) is less than 1 – if
a change in price leads to smaller change in quantity
8.1
demanded. For example, a price cut of 10 per cent, leading
to an increase in demand of only 5 per cent, will have a
price elasticity of demand of
+5
= −0.5
−10

The value of 2 shows that for every 1 per cent change in
price, the quantity demanded changes by 2 per cent –
that is, by twice as much. The negative sign simply shows
that the price and quantity demanded move in different
directions. If price goes down, quantity demanded rises,
and if price rises, quantity demanded falls.
8.1.1 Elasticity
The negative sign shows that as price goes down, quantity
demanded rises – that is, they move in opposite directions.
The 0.5 (which is less than 1) shows that every 1 per cent
change in price leads to a 0.5 per cent change in quantity
demanded. This means that demand is not very sensitive to
price changes – that is, demand is price inelastic.

Demand is price elastic. Quantity demanded Demand is price inelastic.

The quantity demanded increases The quantity demanded
changes more than changes less than
the price. the price.

+10%

Quantity demanded
increases
+0.5%
–1% Price cut –1% Price cut

▲ Figure 8.1 Price elastic and price inelastic demand

What determines the value of the price

HANDLING DATA elasticity of demand?
1 The price elasticity of demand is –0.8. Is this price
elastic or inelastic? What happens to sales if the Availability of
price increases by 20 per cent? similar products
2 The price elasticity of demand is –3. Is this price
elastic or inelastic? What happens to sales if the Type of product Time
price increases by 20 per cent?

Factors influencing price

elasticity of demand
GLOSSARY TERMS
A price elastic demand means that the impact of a change
in price leads to a larger change in the quantity demanded
(in percentages), with all other factors unchanged. Demand for a brand
Proportion of income
versus demand for a
spent on a product
A price inelastic demand means that the impact of a product
change in price leads to a smaller change in the quantity
demanded (in percentages), with all other factors ▲ Figure 8.2 Factors influencing the price elasticity of
unchanged. demand

367
 The price elasticity of demand will be affected by a number
of factors, such as:
8.1 » The availability of similar products If a consumer can
switch easily from one product to another, its demand
is likely to be quite sensitive to price changes (that is,
demand will be price elastic). When buying an energy-
saving light bulb, for example, most customers do
not care what brand they buy – faced with two types,
they are likely to buy the cheaper one. Demand would
therefore be price elastic. Many businesses attempt to
differentiate their products so that consumers do not
A LEVEL 8.1 MARKETING ANALYSIS
switch to competitors’ offerings (that is, the firms try to
make demand for their products price inelastic). Coca-
Cola, for example, has worked hard to distinguish its
products from other cola drinks. Coca-Cola hopes that
relatively few consumers will switch brands, even if its
price is higher. Successful branding should, therefore,
reduce the price elasticity of demand and make demand
price inelastic.
» Time In the short term, customers are often loyal to
their existing provider (for example, their credit card
company, their bank or their insurance company).
This may be because they can’t be bothered to look
for alternatives or because they think that changing
isn’t worth it in the short term as conditions might
change again and so any advantage a competitor has
may be temporary. However, over time, if customers
feel they are getting a bad deal, this will act as
an incentive to switch. They also have more time
to explore their options. This means demand will
become more price sensitive (that is, more price
elastic) over time.
» The type of product When buying convenience
products, such as milk, purchasers tend to go to the
nearest shop. Consumers do not spend much money
on each item and are not too concerned about price.
Demand for this type of product is likely to be price
inelastic. In comparison, shopping for goods such as
clothes is likely to be much more sensitive to price
(that is, more price elastic). This is because customers
spend time comparing their options.
» The proportion of income spent on the product
If you spend only a small proportion of your income
on a product, you may not be very sensitive to price
changes, because they will have a limited impact
on your spending. However, if you spend a high
proportion of your income on something (such as
housing) then a given percentage change will have a
more noticeable effect and demand is likely to be more
price sensitive.
» Demand for the brand versus demand for the product
Demand for petrol is likely to be very price inelastic –
most consumers would find it difficult or inconvenient
to do without their cars. However, demand for one
company’s petrol is likely to be more price elastic
368
than demand for petrol in general, as it is fairly easy
to switch to another petrol company. Demand for a
particular brand is therefore likely to be more price
elastic than demand for the whole product category.
Price elasticity of demand, total
revenue and profits
A price cut and price elastic demand
If demand for a product is price elastic, a business can
increase its revenue by lowering the price. Although it earns
less for each item, its overall revenue increases because it is
selling so many more products.
Imagine that a firm sells 10 000 units at $5; its total
revenue is 5 × 10 000 = $50 000. If the price is cut to $4
and sales jump to 15 000, the new total revenue will be $4 ×
15 000 = $60 000. A 20 per cent price cut increases sales by
50 per cent and revenue increases.
Whether this increase in revenue also means an increase
in profit depends on what happens to the costs when the
firm produces and sells more. If, for example, a business
has to increase capacity, it may incur significant additional
expenses and so, although it is earning more, profits may
fall. On the other hand, if revenue increases more than
costs, profits will rise.
GLOSSARY TERM
The total revenue is the income generated from sales. It is
also known as turnover or sales.
A price cut and price inelastic demand
If demand for a product is price inelastic, the revenue will
fall when the price is cut. This is because the increase in
sales is not big enough to compensate for the fact that each
item is selling for less.
Imagine that a firm sells 10 000 units at $5; its total
revenue is 5 × 10 000 = $50 000. If the price is cut to $4 and
sales increase to 11 000, the new total revenue will be $4 ×
11 000 = $44 000. A 20 per cent price cut increases sales by
only 10 per cent and revenue falls.
In this situation, when demand is price inelastic, the
business could earn more by putting the price up.
Although it would lose some customers, the fact that it
is charging more per unit means its overall income will
increase.
Imagine that a firm sells 10 000 units at $5; its total
revenue is 5 × 10 000 = $50 000. If the price is increased
to $6 and sales fall to 9000, the new total revenue will be
$6 × 9000 = $54 000. A 20 per cent price increase cuts sales
by only 10 per cent and revenue increases.
▼ Table 8.1 Summary of price elasticity and revenue

Price elastic demand

Price inelastic demand
Price decrease
Revenue increases
Price increase
Revenue decreases
8.1
Revenue decreases Revenue increases

CASE STUDY
Price elasticity of demand

8.1.1 Elasticity
▼ Table 8.2 Price elasticity of demand

Goods Estimated price elasticity of demand

Inelastic Salt –0.10
Matches –0.10
Toothpicks –0.10
Coffee –0.25
Tobacco products, short-run –0.45
Legal services, short-run –0.40
Taxi, short-run –0.60
Cars, long-run –0.20
Approximately a value of 1 Films –0.90
(that is, % change in quantity Housing, owner-occupied, long-run –1.20
demanded = % change in price)
Private education –1.10
Elastic Restaurant meals –2.30
Foreign travel, long-run –4.00
Airline travel, long-run –2.40
Fresh green peas –2.80
Cars, short-run –1.20 to –1.50

Sources: Bohi (1981); Cheng, and Capps Jr (1988); Gwartney, and Stroup (1997); Houthakker, and Taylor (1970);
US Department of Agriculture

Questions
1 Define the terms:
a ‘price elastic demand’ [2]
b ‘price inelastic demand’. [2]
2 Evaluate the significance of the findings in Table 8.2 for marketing managers. [12]

STUDY TIP
Students’ understanding of elasticity is often imprecise and so when someone has actually grasped the concept accurately,
it stands out from the other scripts! It is worth learning elasticity carefully.
Think about your wording – a price inelastic demand means that the relative change in the quantity demanded is less than
the change in price. It does not mean that there is no change at all. Remember that elasticity measures change in the
quantity demanded relative to changes in other variables.

369
 CASE STUDY
8.1
Elasticity of air-travel demand
The price elasticity of air-travel demand varies according
to the coverage and location of the market in which prices
are changed, as well as the importance of the air-travel
price within the overall cost of travel.
The estimate for the price elasticity of demand for a
A LEVEL 8.1 MARKETING ANALYSIS
particular route was found to be −1.4 on average, whereas
the price elasticity of demand for flights from any airport
in one country to another was −0.8.
Air-travel price elasticities on short-haul routes were
higher than on long-haul routes. This largely reflects
HANDLING DATA
1 The price elasticity of demand is −0.2. The price is
$200 and sales are 500 units. The price increases by
10 per cent.
a What is the effect on sales?
b What was the original total revenue?
c What is the new total revenue?
2 The price elasticity of demand is −2.5. The price is
$200 and sales are 500 units. The price increases by
10 per cent.
a What is the effect on sales?
b What was the original total revenue?
c What is the new total revenue?
Another common measure of elasticity is the income
elasticity of demand; this is analysed below.
Income elasticity of demand
The amount that demand changes in relation to changes in
income, all other factors unchanged, can be measured by
the income elasticity of demand.
income elasticity percentage change in quantity demanded
= Value greater
of demand percentage change in income
For example, if demand increases by 20 per cent when
income rises by 10 per cent, then:
+20
income elasticity = = +2
+10
This product is income elastic because the demand has
changed by more than the percentage change in income.
These are ‘luxury’ products, such as health clubs.
Alternatively, if demand increases by 5 per cent when
income rises by 10 per cent, then:
+5
income elasticity = = +0.5
+10
This product is income inelastic because the demand has
changed by less than the percentage change in income.
370
the greater opportunity for substitution on short-haul
routes (for example, travellers can switch to rail or car in
response to air-travel price increases).
Questions
1 Analyse two reasons why demand for short-haul
flights was more price elastic than demand for long-
haul flights. [8]
2 Evaluate the significance of the findings above for
the pricing of flights on a particular route. [12]
In both the above cases, demand increased when income
increased. These are called ‘normal products’ and have a
positive income elasticity of demand. If demand falls as
income rises, the product is known as an ‘inferior’ product.
This leads to a negative income elasticity of demand.
For example, if the quantity demanded falls by 2 per cent
when income rises by 6 per cent, then:
–2%
income elasticity of demand = = –0.33
+6%
Products such as basic own-brand items may be perceived as
inferior products; with higher levels of income, customers
switch to other items that are perceived as better.
▼ Table 8.3 Summary of income elasticity of demand
Income elasticity Meaning
of demand
Positive Normal product. Demand increases with
an increase in income. Demand falls
when income falls.
Negative Inferior product. Demand decreases
with an increase in income. Demand
increases when income falls.
Elastic. The percentage change in
than 1 quantity demanded is greater than the
percentage change in income.
Value less than 1 Inelastic. The percentage change in
quantity demanded is smaller than the
percentage change in income.
Luxury product Has positive income elasticity with a
value greater than 1.
Necessity product Has positive income elasticity with a
value less than 1.
Managers will monitor income elasticity because it will
influence what they produce, sell and where they target.
For example, if an economy is booming, retailers may decide
to hold more luxury products. If an economy is declining,
managers might decide to focus on producing inferior
products, or if their products are luxury, they might target
other markets where incomes are growing fast.

HANDLING DATA
1 If demand rises by 5 per cent when income rises by
20 per cent, what is the income elasticity of demand?
2 If demand rises by 15 per cent when income rises by
5 per cent, what is the income elasticity of demand?
3 If demand falls by 4 per cent when income rises by
8 per cent, what is the income elasticity of demand?
4 If the income elasticity of demand is +1.8, what is the
impact on demand of an increase in income from
$20 000 to $22 000?
5 If the income elasticity of demand is –0.2 and sales
are 5000 units, what is the effect of a 4 per cent
increase in income?
Promotional elasticity of demand
The promotional elasticity of demand shows the sensitivity
of demand in relation to changes in promotional
expenditure, all other factors unchanged:
percentage change in quantity
demanded
promotional elasticity
=
of demand percentage change in promotional
expenditure
A positive result would show a positive correlation between
promotional expenditure and the quantity demanded.
The bigger the figure, the stronger the relationship. For
example, a result of +0.1 means a 1 per cent increase in
promotional spending increases sales by 0.1 per cent; a
value of +3 means a 1 per cent increase in promotional
spending increases quantity demanded by 3 per cent.
Managers will be interested in the promotional elasticity
of demand because it will influence their spending in this
area. If, for example, the promotional elasticity of demand
for a product is +4, this means demand is very sensitive to
changes in promotional spending and managers may want to
allocate more resources to promotion. If, on the other hand,
the promotional elasticity of demand is +0.001, this means
that demand is not very sensitive to changes in spending.
In this case, managers may focus on other areas, such as
developing the design of the product, rather than investing
in promotional spending.
Of course, within the overall heading of promotion there are
different ways of promoting a product (such as advertising)
compared to sales promotions (such as competitions).
Managers may want to measure the sensitivity of demand
to different forms of promotion in order to identify which
forms are the most effective.
STUDY TIP
Remember to be precise when using the concept of
elasticity of demand in your answers. Is it the price
elasticity or the income elasticity you are referring to,
for example? Remember that when demand is income
inelastic, this does not mean that demand never changes
at all; it simply means that the change in demand is
smaller than the change in income.
Limitations of the concept of the
elasticity of demand
It is important to remember that the value of price elasticity
8.1
of demand at any moment is an estimate – you will never
know exactly how sensitive demand is to any given variable
until you actually change that variable and see what happens.
Therefore, a specific value of elasticity of demand needs to
be treated with some caution. This is especially true because
markets keep changing and this will affect the value of any
8.1.2 Product development
elasticity of demand. New products, changes in consumer
tastes, developments in distribution and competitors’
marketing campaigns will all affect the demand for a product.
This can make it difficult to know exactly what caused a
change in sales following the change in one variable. Was
it the change in the variable? Or was it government policies
or consumer confidence? For example, while it may appear
that a price cut of 1 per cent increased sales by 2 per cent,
suggesting a price elasticity of −2, in reality the sales may
have gone up for completely different reasons.
Having said this, with experience, by asking experts or by
analysing the results from a test-market, managers are likely
to have some idea of approximately how sensitive demand
is to a variable and may feel confident to base decisions
on this. Even if they do not know the exact value, an
understanding of whether demand is elastic or inelastic is
useful when it comes to making decisions.
GLOSSARY TERM
Research and development (R&D) is the generation and
application of scientific knowledge to create a product or
develop a new production process which can increase the
firm’s productive efficiency.
8.1.2 Product development
A common strategy in marketing is to focus on new product
development. New products may be the result of a need to
adapt to changing customer tastes or may be due to new
technology. Some businesses focus developing their product
range on their market-research findings. Others are led more
by their own research and development (R&D) and the
innovations that come from this. In some cases, the basic
product is developed without the business knowing what
to do with it. Dr Spencer Silver developed the technology
for an adhesive that could stick paper to things but would
also enable the paper to be removed easily. However, it took
several years before he realised the potential of this product
in the form of Post-It notes.
New product development will be critical for some
businesses. In the pharmaceutical industry, businesses are
very dependent on a relatively small number of patented
medicines. Developing new products to take over when the
patents on existing ones end is a vital part of business
planning. Some companies base their strategies on new
product development. 3M aims for over 25 per cent of its
revenue to come from products that have been launched in
the last 5 years. 3M invests over 5 per cent of revenue into
research development.
371
 The importance of new product development can be seen
in the Ansoff Matrix (as discussed in Section 6 – see pages
8.1 297–298). Developing new products involves investment
in research and development to produce new products, as
The new product development process
The stages of new product development are shown in Figure 8.3 below.
Product and
Idea Concept Business
process
generation testing analysis
development
A LEVEL 8.1 MARKETING ANALYSIS
▲ Figure 8.3 Stages in the development of a new product
» Stage 1 involves generating the initial idea and
considering whether it is feasible for the business.
For example, can the business produce it? Is there a
sense that there is demand? At this stage, ideas may
be rejected because the business does not have the
necessary resources.
» Stage 2 involves testing the concept further; this is
likely to involve market research to identify what is
actually required by the market – for example, in terms
of features. At this stage, ideas may be rejected because
the demand does not actually exist.
» Stage 3 involves analysing the business case for the
product and assessing its possible returns. At this stage,
an idea may be rejected because it is not financially
viable.
» Stage 4 involves development of the product idea and
also the process involved in producing it. At this stage,
the actual production may prove more difficult or more
expensive than initially imagined and the project may be
dropped.
» Stage 5 involves test marketing. This occurs when the
product is sold in a limited region or in limited numbers
to assess customers’ reaction to it. If demand proves
disappointing, a project may be dropped.
» Stage 6 involves the launch of the product. Even at this
stage, problems can occur in getting the product to
market or positioning it effectively. Many new products
are withdrawn not long after being introduced.
In some cases, such as new medicines, the process of new
product development can cost billions of dollars and take
many years because of all the testing required and the many
regulations the products have to meet.
Ideas for new products
Firms may generate the ideas for new products internally
or externally. Internally, ideas may simply come through
discussion, employees’ suggestion schemes, brainstorming
activities or the firm’s own research department, if it has
one. However, generating good ideas for new products
regularly requires a culture in which innovation is valued.
This means people will be encouraged to question, to
challenge and to improve the existing way of doing things
(rather than adopting an attitude of ‘it’s always been done
372
well as spending on testing and launching new products.
The failure rate of new products is relatively high and,
therefore, new product development involves a high
degree of risk.
Test Launch of the
marketing product
like that’). This means the business will want to build an
innovative culture. Amazon, for example, stresses that it
is important to try out new things, even if some fail. 3M
encourages innovation by ensuring that money is set aside
in budgets for people to try out new ideas.
Externally, many new ideas are registered at the Intellectual
Property Office; firms may search the patent office records
and, if they find a product or process they would like to use,
they can pay a fee to the owner of the patent for the right
to use their technology. Alternatively, a firm might buy a
franchise to produce under another firm’s name; in return
for this right the firm pays a fee and/or a percentage of its
turnover.
A firm’s customers can also be a valuable external source
of new ideas. You will notice that many companies have a
customer phone line or a comments book to gain feedback
from their consumers on their service and to discover more
about what customers really want. Innocent Drinks, for
example, has a ‘banana phone’ which customers can ring
with their ideas.
The importance of research and
development
Research and development (R&D) is part of the innovation
process. It refers to the generation and application of
scientific knowledge to create a product or develop a new
production process. For example, it may involve a team
of employees at a confectionery company researching a
new flavour or a new variety of sweet and then trying
out different versions until they have one they (and the
customers) are happy with. Or it may involve another team
in the business focusing on new ways of producing the
confectionery.
Research and development may be focused on an idea that
employees have or it may be the result of market research
which has identified a market need. The effects of the
Coronavirus (COVID-19) pandemic in 2020 highlighted the
urgent need for a vaccine, which led to massive investment
by many pharmaceutical companies.
Investing in research and development can be risky because
many research projects do not lead to successful products.
There are many stages in developing a new product and
there is no guarantee that an idea will go through to
the next stage. Even if a product is launched, it may not
succeed. For example, the marketing activities may be
ineffective, customers’ needs and wants may have changed,
CASE STUDY
The leading investors in research and development
the external environment may be different from what was
expected or competitors may respond aggressively.
8.1

8.1.2 Product development

In US$ billion

Amazon 22.6

Alphabet 16.2

Volkswagen 15.8

Samsung 15.3

Intel Co. 13.1

Microsoft 12.3

Apple 11.6

Roche 10.8

Johnson & Johnson 10.6

Merck 10.2

Toyota 10

Novartis 8.5

Ford 8
Source: Statista.com
▲ Figure 8.4 R&D spending

Questions
1 Analyse one way in which expenditure on research and development can benefit a business. [4]
2 Evaluate the possible factors that determine the amount that a business invests in research and development. [12]

CASE STUDY
Kellogg’s
Kellogg’s, the US breakfast cereal and snack-maker, has
said it will not change its marketing strategy to children
despite concerns about obesity. Its managers said that the
obesity issue centred around calorie intake and exercise,
not ‘bad food’. Kellogg’s plans to launch its Kashi brand
of wholegrain cereals in the UK and will soon introduce a
new version of All Bran to Japan.
The development illustrates how US food companies are
responding to increased concern about the contribution
of some processed foods to obesity and the marketing of
these products to children by highlighting efforts to develop
healthier products.
The company’s chief financial officer said, ‘The whole
issue with obesity is really calories in, calories out. There
aren’t any bad foods, it’s all about balance.’
Concern about the role of food companies in contributing
to obesity increased with a landmark lawsuit against
McDonald’s by New York teenagers, who claimed the
fast-food company played down the health effects of eating
Chicken McNuggets. Kraft Foods has focused attention on
the issue by voluntarily pledging to stop marketing in schools,
stop advertising to children under six and shifting food
promotions to the 6–11 year-old towards healthier items.
Asked whether Kellogg’s would be changing its promotional
strategy in the wake of Kraft’s move, the company’s
chief executive said, ‘We don’t move based on what the
competition does.’
Both Kellogg’s and its main rival in the breakfast cereals
market, General Mills, have in the past year stepped up the

373
 introduction of cereals containing whole grains, including those kinds of problems are really much more significant

8.1 those aimed at children. The chief executive said, ‘Kids have
been eating our products for decades. Offering options
and if we can put a dent in that, that would be very positive.’
Source: www.warc.com/newsandopinion/news/cadbury-kelloggs-
for what kids may want and what their mothers may want on-defensive-over-child-obesity/17177
them to eat is certainly a thing we’re interested in doing.’
The vice-president in charge of marketing said, ‘We think Questions
advertising cereal to kids is a very good thing to do and we’d 1 Analyse two reasons why product development may
like to do it more. Twenty-five per cent of kids walk out of be important to Kellogg’s. [8]
the door in the morning having eaten nothing. We think that 2 Evaluate the usefulness of the concept of elasticity
of demand to Kellogg’s. [20]
A LEVEL 8.1 MARKETING ANALYSIS

CASE STUDY
Akio Morita
Akio Morita was the founder of Sony. After serving in the
Japanese navy, he set up a small electronics company,
Tokyo Telecommunications Engineering, with his friend
Masaru Ibuka. Ibuka was an engineering genius who
invented many of the technical advances behind the brand
Morita created.
The company became very successful in the 1950s when
it produced a small transistor radio. The transistor was
invented in America, but Morita bought a licence from Bell
Laboratories to produce it in Japan. By the end of the decade,
Morita was exporting from Japan to the USA and Europe.
In 1958, he changed the company’s name. After weeks of
searching he found the name sonus, which is Latin for ‘sound’.
He changed this to Sony because ‘sony boys’ is Japanese
for ‘whizz kids’. In 1961, Sony became the first Japanese
company to be listed on the New York stock exchange. ▲ Figure 8.5 An original Sony transistor radio

With significant investment in R&D, Sony had further
successes with televisions and videotape recorders.
Morita developed the Sony Walkman which, at the time,
was a groundbreaking product. This product (which
changed the way we listened to music) was launched with
almost no market research and against the views of many
within the business.
‘The public does not know what is possible. We do,’ said
Morita. Interestingly, Apple’s Steve Jobs had the same
message many years later. ‘The visionaries have the
ability to look beyond where we are now to develop what
customers want, whether or not they know it.’ Morita’s
focus was on R&D, not market research.
In 1998, the Sony Walkman was declared the number
one consumer brand in America. Morita’s famous view of
globalisation was ‘think globally, act locally’. This means
that Sony used R&D to develop products that could be
used globally but could also be adapted to local tastes. By
adapting what it did, Sony managed to be regarded as an
American brand within America and a Japanese brand in
Japan.
Source: www.economist.com/news/2008/11/07/akio-morita
Questions
1 Analyse two benefits of R&D to Sony. [8]
2 Evaluate the risks to Sony of developing products
without market research. Justify your answer. [12]

source of income to some organisations. If one firm suspects

Protecting ideas for new products
If a firm manages to develop new products and new processes
successfully, it will naturally want to protect these from
being copied or imitated by competitors. If an innovation is
genuinely new, a firm may protect it by taking out a patent.
In the UK, under the 1988 Copyright, Designs and Patents Act,
the holder of a patent has the right to be the sole user of a
process or manufacturer of a product for 20 years after it is
registered.
The owner of a patent may sell the right to produce the
product or use a process to others. This can be a valuable
374
another of illegally producing a patented product or using its
patented technology, it can sue the offender. However, this
can be costly and time-consuming. To protect a product or
process worldwide, a firm must register the patent in different
countries; this can also be an expensive and slow process.
By comparison, the work of artists, writers and musicians
is automatically protected by copyright. Copyrights do not
have to be registered, although, once again, it is up to the
copyright holder to sue offenders. Designs and logos can be
protected by registering a trademark.
 CASE STUDY
8.1
L’Oréal
With the opening up of the emerging markets, L’Oréal’s
mission is broadening in response to the vast diversity of
populations. The whole company is focused on this new
horizon: teams enriched by their cultural diversity, a portfolio
of international brands present in the different distribution

8.1.3 Sales forecasting

▲ Figure 8.6 A selection of L’Oréal products
For more than a century L’Oréal has been pushing back
the boundaries of science to invent beauty and meet the
aspirations of millions of women and men. Its vocation is
universal: to offer everyone, all over the world, the best of
cosmetics in terms of quality, efficacy and safety, to give
everyone access to beauty by offering products in harmony
with their needs, culture and expectations.
channels, and research that is capable of grasping the
world’s complexity. The exploration of new scientific and
technological territories is being enriched by this global
dimension. Knowledge of different cultures and rituals
worldwide enables the laboratories to anticipate and invent
the products of the future.
L’Oréal:
● has 36 global brands
● operates in 150 countries
● has more than 88 000 employees
● registered 497 patents in 2019.
Source: L’Oréal Annual Report 2010, www.loreal-finance.com/
system/files/2019-09/LOREAL-2010-AR-volume1DEF.pdf
Questions
1 Analyse two reasons why L’Oréal might want to
target emerging markets. [8]
2 Evaluate the importance of innovation to the
success of L’Oréal. Justify your answer. [12]

CASE STUDY
Research and development spending
▼ Table 8.4 Top five countries in terms of number of Questions
patents
1 Analyse two benefits to a business of having a patent. [8]
Rank Country Total number of patents (2019) 2 Evaluate the possible reasons why the number of
patents varies so much from country to country. [12]
1 USA 198 766
2 Japan 57 465
3 South Korea 24 743
4 China 22 294
5 Germany 18 701

Source: https://statnano.com/report/s135

» the staffing required

8.1.3 Sales forecasting » the likely cash flow
Sales forecasts are estimates of the level of sales of » the return on investment.
a business in the future. The sales forecast is a very
important part of the planning of a business. The sales GLOSSARY TERM
forecast will affect:
A sales forecast is an estimate of the volume or value of a
» the expected level of revenue firm’s sales in the future.
» the capacity and production levels required

375
 All the different functions of the business will, therefore, ▼ Table 8.5 Monthly sales
be interested in what the sales forecast is because it will
8.1 affect their decisions. At the same time, the sales forecast
must be made in conjunction with the other functions; for
Month
January
Sales $m
5
example, the level of sales that is possible will depend on
capacity and the levels of staffing available. February 12
March 30
Methods of forecasting sales April 15
Managers are naturally interested in how markets will May 10
develop in the future, as well as their present situation.
A LEVEL 8.1 MARKETING ANALYSIS

It is important, therefore, for firms to look ahead when June 35

undertaking marketing. Marketing managers will be eager July 30
to forecast what sales in the market are going to be in the
August 16
future. From this they can estimate the likely sales of their
own products and produce their sales forecasts. September 50

A firm’s sales forecast sets out targets for overall sales and October 70
for particular products and services. It is a key element of November 30
a marketing plan and influences decisions throughout the December 22
organisation. To understand market trends, managers might
use one or more of the following methods of analysing
trends. Monthly sales ($m)
80

Calculating moving averages 70

If you look at the sales data in Table 8.5 and plot the figures 60
on a chart, you will see that the sales are quite erratic from 50
one month to the next, as shown in Figure 8.7. In October,
for example, sales are relatively high, whereas in August they 40
are lower. However, although the sales change from month to 30
month, the overall trend is clearly upwards. 20
One way of plotting the underlying trend is to calculate 10
the moving average. This looks at several periods at a
0
time and averages out the data. By doing this, the effect
y

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of particularly high or low figures is reduced because an Ju

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average has been taken.

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A type of common moving average is known as a four-period ▲ Figure 8.7 Monthly sales
moving average. This could be four days, weeks, months or
years. To calculate this, the first step is to find the average Again, the set of four months can keep moving down and
for each ‘set’ of four periods; in this case, each set of four the average sales per month calculated. This is shown in
months. Table 8.6.

For example: However, you can see there is a problem in terms of plotting
these figures. The average figure lies between a month. To
For January to April, total sales are: overcome this problem, the average of these averages is
$5m + $12m + $30m + $15m = $62 million calculated, allowing a figure to be plotted lining up with
a month (or in other cases it might line up with a year or
So the average sales for those four months is: quarter). This is called ‘centring’.
$62m
= $15.5 million
4
Now move down a month and consider February to May.
Total sales are:
$12m + $30m + $15m + $10m = $67 million
This means the average sales per month are:
$67m
= $16.75 million
4

376
▼ Table 8.6 Four-month moving average sales ▼ Table 8.7 Four-month centred moving average

Month Sales ($m) 4-month average

Month Sales ($m)
4-month
average
4-month centred
moving average
8.1
January 5
January 5
15.5
February 12
February 12
16.75
March 30

8.1.3 Sales forecasting

March 30
22.5
15.5
April 15
April 15 16.125
22.5
16.75
May 10
May 10 19.625
22.75
22.5
June 35
June 35 22.5
32.75
22.5
July 30
July 30 22.625
41.5
22.75
August 16
August 16 27.75
41.5
32.75
September 50
September 50 37.125
41.5
41.5
October 70
October 70 41.5
41.5
41.5
November 30
November 30 42.25
43
43
December 22
December 22
In this case, we take the first two moving averages and
average them. So, the average of moving averages = ($15.5 m This can now be plotted on a graph, as Figure 8.8 shows.
+ $16.75m) ÷ 2 = £16.125 million, and this can be plotted
between these results; for example, February is $16.125 Monthly sales ($m)
80
million. Then we take the next two results, $16.75m and
$22.5m, and average these. ($16.75m + $22.5m) ÷ 2 = 70
£19.625 million. The midpoint of these two results lies in 60
March. This process is continued for all the moving averages
50
to produce the four-month centred moving average, as in
Table 8.7. 40

We can see that the four-month centred moving average 30

shows the underlying trend of the data. It ‘smooths out’ 20
some of the particularly high or low figures because it takes 10
an average of four months. It shows the upward underlying
trend of the sales figures. 0
ry

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De ber

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be

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To recap the method:

Ju
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» Find the total for the given set – that is, four months.
Fe

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No
Se

» Find the moving average for this set – that is, four- Sales ($m) 4-month centred moving average
month moving average. ▲ Figure 8.8 Four-month centred moving average
» Centre your findings by adding two results and averaging
them.

377
 Extrapolation
To estimate the future sales in a market, managers may
8.1 look back to identify trends that have occurred (using,
for example, moving averages) and then, based on these,
predict forwards. This is known as extrapolation. A holiday
company experiencing a fall in the number of enquiries in
a particular month compared with past years may change
its sales forecast downwards. This technique is useful,
provided the trends identified in the past continue into the
future. If, in fact, there has been a major shift in buying
A LEVEL 8.1 MARKETING ANALYSIS
patterns (for example, the timing of buying has changed
or the economy has unexpectedly entered a recession),
extrapolation could be misleading.
Sales
Extrapolated trend
Trend
Present Future
Time
▲ Figure 8.9 An extrapolated trend
Extrapolation is thus only likely to be effective if market
conditions continue to develop in the future as they have
in the past – that is, extrapolation only works if past trends
actually continue. The problem is that many markets are very
dynamic and change rapidly. The market for cameras, for
example, has seen rapid change in the last 20 years with the
arrival of digital cameras. In this situation, extrapolation
may be very misleading – examining the past may provide
little indication of what is going to happen in the future.
Sales can drop suddenly, regardless of what has happened in
the past, perhaps due to a recession, competitors launching
a new product or a problem with production. The impact
of the Coronavirus (COVID-19) pandemic on the sales of
businesses all over the world is an example of how suddenly
and dramatically change can happen.
Sales
Advertising
▲ Figure 8.10 Positive correlation between advertising and
sales
378
Extrapolated figures must therefore be treated with caution
– their reliability depends entirely on the extent to which
the future will imitate the past. Obviously, firms can learn
from past trends – in the UK, for example, retail sales are
likely to increase in the run-up to Christmas, holidays in
Spain are more likely to be popular in the summer, central
heating is likely to be used more when the weather is
colder, and so on – but they must also look out for future
changes in the market conditions. Rapid developments in
technology, for example, can lead to major changes in terms
of what we produce and how business is conducted, and
this may make extrapolation more risky. Sales of netbook
computers looked to be soaring upwards until tablets such
as the iPad were launched.
GLOSSARY TERMS
Extrapolation involves identifying the underlying trend
in past data and projecting this trend forwards. In Figure
8.8, for example, the underlying trend in sales figures is
clearly upwards. If we assume this trend will continue, we
can project it forward and estimate future sales.
Correlation occurs when there are apparent links between
variables; for example, promotional spending and sales.
Correlation
Rather than using extrapolation, future market sales
may be estimated using correlation. Correlation occurs
when there appears to be a link between two factors. This
process attempts to identify whether there is any link (or
correlation) between different variables and the level of
sales. For example, a firm might discover a correlation
between its sales and the level of income in an economy –
with higher income, consumer sales might increase.
Correlation analysis examines data to see if any relationship
appears to exist between different variables. This is
important for marketing managers because, if they can
identify the key factors that determine demand for their
goods, and they can estimate what is happening to these
factors (for example, estimate income growth), they can
estimate total market sales and then their likely sales.
Examples of different types of correlation are shown in
Figures 8.10 and 8.11.
Price
Sales
▲ Figure 8.11 Negative correlation between price and sales
» In Figure 8.10, a ‘positive correlation’ means that there
is a direct link between the variables. An increase in
advertising, for example, might lead to an increase in
sales and vice versa. The sales of a product might be
positively correlated with income levels and the number
of customers in the market.
» In Figure 8.11, a ‘negative correlation’ means that the
two factors are inversely related. An increase in price,
for example, is likely to lead to a fall in sales, so price
and demand have a negative correlation.
It is important to note that correlation analysis simply
identifies an apparent link between the two factors; it
does not show cause and effect. For example, there is
often a strong link between coffee drinkers and smokers;
people who smoke often drink a lot of coffee as well. There
CASE STUDY
NHS bed crises
Health-service managers in the UK try to avoid bed crises
by using weather reports to forecast when people will fall
ill. The Meteorological Office has set up a unit using new
technology to give doctors up to two weeks’ notice of how
many patients are likely to develop bronchitis, heart attacks
and strokes. The service, which claims to be the world’s
first, allows hospitals and surgeries to prepare for increases
in demand using warnings generated by a supercomputer.
In the past, the UK’s National Health Service (NHS)
has been caught out by sudden changes in the number
of patients suffering respiratory and cardiovascular
diseases. Meteorological Office experts say the timing
was due almost entirely to changes in temperature and
climatic conditions. According to a spokesperson, ‘there is
a very close link between weather conditions and illness.
STUDY TIP
In many of the cases you are likely to face, a business will
be making a major decision. In this type of situation, large
sums of money may be at stake and the future of the
business may be at risk. It is possible but very unlikely
that in this situation a decision will be made without some
market analysis. You may question the way the analysis
has been undertaken, but some information is likely to be
better than none.
Other ways of estimating future sales
Using market research
Market research can be used to try to identify likely future
trends, rather than assuming they will be similar to the
past. The value of this research depends on whether it is
primary or secondary and the quality of the information.
If a small sample is used, for example, the forecast is less
likely to be accurate than if a larger sample had been used.
is a link between the two but this does not mean that
drinking coffee actually makes you smoke or vice versa. It
is important, therefore, to treat correlation figures with
some caution. Just because sales figures and the amount of
8.1
money spent on advertising expenditure are both increasing
does not necessarily mean that the advertising is boosting
sales. In many cases, firms feel that the high sales mean
they can spend more on advertising; that is, sales may
determine advertising spending rather than vice versa.
Alternatively, the increase in sales could be coincidental – it
could be caused by factors other than advertising.
8.1.3 Sales forecasting
However, the more times the correlation appears to exist
(for example, if the firm has regularly advertised and at the
same time sales have regularly increased), the more likely it
is that managers will believe that a link does occur.
We can predict almost the day when large numbers of
patients will seek treatment.’
More patients die in Britain from weather-related illnesses
than almost any other country in Western Europe. For every
one degree fall in temperature, 1.37 per cent more people
die. This is much higher than in other countries because
the British are often less well-prepared – they do not dress
warmly against the cold, their houses are less well-heated
or insulated, and they take less exercise.
Questions
1 Analyse two reasons why the NHS analyses weather
patterns. [8]
2 Evaluate other factors that are likely to influence
demand for health-care services. [12]
Types of research might include test-marketing (trying out
the product in a given area) or surveys. A test-market is a
representative selection of consumers which the firm uses
to try out a new product. Having seen the results in the
test-market, the firm can estimate how the product might
sell elsewhere and produce a sales forecast. By using a
test-market, the firm can see customers’ reactions before
committing to a full-scale launch. If necessary, changes
can still be made before the product is widely available.
Many film companies, for example, show their films to a test
audience before they go on general release, to assess the
public’s reaction.
The disadvantage of using test-marketing is that
competitors have an opportunity to see what you are
planning to launch. This gives them time to develop a
similar product and race you to launch first on a wide
scale. A test-market may also give misleading results.
This might be because the test-market chosen is not
representative or because competitors’ actions lead to
misleading results. For example, rivals might increase their
379
 promotional activities in the test-market to reduce a firm’s
sales and lead it to believe that the new product will not
8.1 do well.
Qualitative sales forecasting
Managers could use their own experience or hire industry
experts for their opinion of what is most likely to happen.
This approach to forecasting is known as qualitative sales
forecasting. It is not based on statistically valid data, but
it is linked more to personal judgements and feelings. This
A LEVEL 8.1 MARKETING ANALYSIS
market is great or if the firm is facing a new scenario and
does not have past data to build on.
A qualitative approach to sales forecasting may be based
on a ‘hunch’. Managers may make an educated guess of
what sales will be given their experience. Alternatively
qualitative sales forecasts may use the Delphi technique. In
the Delphi technique, managers assemble a group of experts
who are all asked individually for their views. These views
are analysed and key areas extracted. These findings are
circulated again to the experts for feedback and may be

qualitative approach is common if the rate of change in the circulated several times, incorporating the feedback each
time until a consensus is reached.

CASE STUDY
The flawed market research of new Coke
In 1985, the chairman of Coca-Cola announced, ‘the best
has been made even better’. After 99 years, the Coca-Cola
Company decided to abandon its original formula and
replace it with a sweeter version, named ‘New Coke’. Just
three months later, the company admitted it had made a
mistake and brought back the old version under the name
‘Coca-Cola Classic’!
Despite $4 million of research, the company had clearly
made a huge mistake. The background to Coca-Cola’s
decision to launch a new product was much slower
growth in its sales in the 1970s, especially compared
with Pepsi. Pepsi was also outperforming Coca-Cola in
taste-tests. The relatively poor performance was even
more disappointing, given that Coca-Cola was spending
an estimated $100 million more than Pepsi on advertising. ▲ Figure 8.12 A poster from the 1985 Coca-Cola relaunch
The taste-testing of the new recipe for Coca-Cola involved
that is, that if they chose a new flavour, the old one would
191 000 people in more than 13 cities. In all, 55 per cent of
be withdrawn. Also, the symbolic value of Coca-Cola may
people favoured New Coke over the old formula.
have been overlooked.
However, once the launch was announced, the company
was amazed by the negative response; at one point calls Questions
were coming in at a rate of 5000 a day. People were most 1 Analyse two ways in which Coca-Cola may have
annoyed by the fact that Coca-Cola dared to change the researched the market. [8]
formula of one of the USA’s greatest assets. 2 Coca-Cola did extensive (and expensive) market
research and yet still made a mistake. Evaluate whether
What went wrong? Possibly one problem was that when
this means that market research is a waste of time. [20]
undertaking the testing, customers did not know that
choosing one cola would mean the other was removed –

The method of forecasting used by a firm will depend on and consider the timing of the cash outflows to provide
the nature of the product and the market situation. these products. The cash-flow forecast will be produced
as a result of these considerations.
Sales forecasts and business decisions » Operations planning The expected level of sales will
influence the production schedule and, therefore, all
Sales forecasts will influence:
aspects of operations, such as the ordering of supplies,
» The expected profit figures for the business This will
inventory levels and distribution scheduling. The sales
be important to investors and if the business is putting
forecast must be produced in conjunction with the
together a business plan to raise funds. Managers will
operations team. If the expected level of sales is higher
usually present to investors or would-be investors their
than the firm’s capacity, for example, the business must
profit expectations for the coming years, and these will
decide whether to reduce the sales it makes, expand its
be based on their sales forecasts. This is why forecasts
capacity or subcontract.
and the assumptions on which they are based are looked
at very closely. The sales forecast will also affect the
» Human-resource decisions The level of sales for
different products potentially in different markets and
cash-flow forecast. Finance managers will consider the
parts of the world will affect HR requirements. High
level and timing of sales, look at the likely credit period
380
 levels of demand for one particular product may require
staff to be retrained or moved from one part of the
business to another to meet this level of sales. If the
forecasts are disappointing, the HR team may need to
stop recruiting or even make redundancies. The impact
of the Coronavirus (COVID-19) pandemic in 2020 meant
that many businesses had to review their sales forecasts
downwards and, as a result, make staff redundant.
CASE STUDY
BP
$150
$125
$100
$75
$50
$38.41
$25
$0
2000 2004 2008 2012 2016 2020
▲ Figure 8.13 Brent crude oil prices
STUDY TIP
Remember how important a sales forecast is. If you do
not have any sense of the scale of the possible sales, how
can you plan how much to spend, how much to produce,
and how many people to employ?
The reliability of sales forecasts
Forecasts are most likely to be correct when:
» a trend has been extrapolated and the market conditions
have continued as before
» a test-market is used and is truly representative of the
target population
» the forecast is made by experts (such as your own sales
forces) and they have good insight into the market and
future trends
» the firm is forecasting for the near future (it is usually
easier to estimate what sales will be next week rather
than estimating sales in five years’ time).
The benefits of sales forecasting
Inevitably, a firm’s external and internal conditions are
likely to change and this can make it extremely difficult
to estimate future sales. It depends, in part, how much
good-quality data you have gathered and the rate of change
in the environment. However, the fact that there are
difficulties in forecasting does not necessarily make this a
useless management tool. The simple process of forecasting
makes managers think ahead and plan for different
» Marketing decisions If the sales forecasts are
disappointing, it may be that the marketing team need
to review their activities to see if there is anything they
can do to improve them. The business will continue to
8.1
review the actual sales figures against the forecast and
take action where needed.
8.1.3 Sales forecasting
In 2020, BP announced that it was forecasting lower oil
prices for decades to come. Prices had fallen as demand
for energy reduced with the Coronavirus (COVID-19)
pandemic, but BP believed that the pressure from
government to cut carbon emissions would mean that
oil prices would stay low. Given the impact of its sales
revenue forecasts, BP said it would have to become
a leaner, more agile and lower-cost organisation.
The company has announced it will cut 10 000 jobs.
Questions
1 Analyse two reasons why oil prices might be low. [8]
2 Evaluate the value of sales forecasting to BP. [20]
scenarios. This may help to ensure they are much better
prepared for change than if they did not forecast at all.
Also, even though a forecast may not be exactly accurate,
it may give an indication of the direction in which sales are
moving and some sense of the magnitude of future sales,
which can help a firm’s planning. Ultimately, it may not
matter much whether sales are 2 000 002 units or 2 000 020
units, but it makes a big difference whether they are 2 million
or 4 million in terms of staffing, finance and production
levels – that is, provided the forecast is approximately right,
it can still be very useful, even if it is not exactly correct.
It is also important to remember that sales forecasts can be
updated. A firm does not have to make a forecast and leave
it there. As conditions change and new information feeds in,
the managers can update the forecast and adjust accordingly.
STUDY TIP
There are many sources of information that may help
with market analysis, such as internal, external, primary
and secondary. Although the temptation may be to gather
as much data as possible, this can lead to too much data
and actually delay action. A challenge to all businesses is
getting good-quality information – the right amount at the
right time, telling you the right things. Also, look at how
the data is gathered; the value of market analysis depends
on the quality of the information used. If information was
gathered using a small sample or if leading questions were
asked then it may be very misleading.
381
 TEST YOUR LEARNING
8.1
Short answer questions
1 a Define the term ‘price elasticity of demand’.
b Explain one implication for a business if the price
elasticity of demand for its product is −3.
2 a Define the term ‘income elasticity of demand’. [2]
b Explain one implication for a business if the income
elasticity of demand for its product is +2.
A LEVEL 8.1 MARKETING ANALYSIS
3 a Explain one implication for a business if its
promotional expenditure elasticity is +0.5.
b If the promotional elasticity is +0.8, calculate the
effect on demand of an increase in promotional
spending from $4 million to $5 million.
4 Explain one problem of using the concept of elasticity
when making decisions.
5 Explain one benefit to a business of investing in new
product development.
6 Explain one source of ideas for new products.
7 a Define the term ‘research and development’.
b Explain one way in which research and
development helps a business.
8 a Explain one way of forecasting sales.
b Explain one reason why it is important for a
business to produce sales forecasts.
9 Define the term ‘moving average’.
10 Define the term ‘qualitative sales forecasting’.
Data response question
L’Oréal
Our goal is to offer each and every person around the
world the best of beauty in terms of quality, efficacy, safety,
sincerity and responsibility to satisfy all beauty needs and
desires in their infinite diversity.
L’Oréal has five divisions: fragrances, skin care, make-up,
hair care and hair colour. L’Oréal’s brands include Garnier,
Maybelline, NYX, Stylenanda, Essie, Niely, Lancome, Yves
Saint Laurent, Armani, Biotherm, Urban Decay, Diesel and
Cacharel.
The company understands the importance of analysing
trends in its markets, such as an ageing population in
most markets, a growth in men’s consumption in its
product areas, and a growth of the middle classes in
many markets as incomes rise. It is very focused on
382
e-commerce and digital marketing, with 50 per cent of its
promotional spend involving online activity.
[2]
Previously, in forecasting its sales, L’Oréal used the past
to project the future. However, it argues that nowadays
[3]
this approach is not relevant. Technology, it claims, makes
forecasting a science. L’Oréal has what it calls a ‘Beauty
Tech’ programme, which uses data, consumer insights
[3]
and machine learning to forecast demand. Its analysis
of data enables L’Oréal to ensure the right inventory is
[3] in the right place at the right time, automatically. The
Beauty Tech Data Platform has been built with Google. It
compiles all the relevant data and then uses algorithms
[3] and artificial intelligence to automatically create more
detailed and more reliable sales forecasts.
[3]
The data are linked to marketing, sales, digital,
finance and supply chain departments, driving closer
[3] collaboration between these functions. All inputs are
[3] integrated in real time so that the algorithms can forecast
[2] demand in real time. The results are huge: improved
sales forecast accuracy, improved ability to ensure the
[3] rights products are there at the right time, maintenance of
[3] correct inventory levels and quicker identification of any
changes in trends.
[3] Source: www.loreal.com/en/group/about-loreal/our-purpose
[2]
[2] Questions
1 Is demand for L’Oréal products likely to be price
elastic or price inelastic? Explain one reason for your
choice. [3]
2 Is demand for L’Oréal products likely to be income
elastic or income inelastic? Explain one reason for
your choice. [3]
3 Is demand for L’Oréal products likely to be sensitive
to promotional expenditure? Explain one reason for
your choice. [3]
4 Analyse two ways in which technology is helping
L’Oréal with its sales forecasting. [8]
5 Evaluate the usefulness of sales forecasting to
L’Oréal. [20]
Essay questions
1 Evaluate the extent to which the concept of elasticity
is useful in marketing planning. [20]
2 Evaluate the possible benefits of market analysis
to a business. [20]
8 Marketing

8.2
A LEVEL

Marketing strategy

8.2.1 Planning the marketing strategy

Chapter overview
In this chapter we examine:
★ planning the marketing strategy
★ the contents of a marketing plan
★ the benefits and limitations of marketing planning
★ approaches to marketing strategy
★ strategies for international marketing.

8.2.1 Planning the marketing

strategy Objectives

A marketing plan sets out what a business intends to do

in relation to its marketing activities. The plan is likely
to be based on market research. This research will inform
the marketing decisions to ensure they are logical and
supported by the data. Market research is likely to provide
Marketing Marketing
information on issues such as: mix plan
Resources
» the market size (which may be measured in terms of
sales volume or sales value)
» the likely market growth
» the segments in the market and their size and growth
» the positioning of competitors according to
customers Research
» customers’ views of the brand
» information on the level of sales, through different
distribution channels and trends in distribution (for
example, whether there is a move towards online sales). ▲ Figure 8.14 Elements of a marketing plan

Based on this type of information, the business can develop
its marketing plan. It will then use market research to
assess how the plan is progressing and whether changes
need to be made to the plan.
It includes:
» the marketing objectives such as increasing market
share, increasing sales of particular products in
particular regions, smoothing out sales across the year,
achieving certain distribution targets (for example, to
be available in 1000 outlets by next year) or improving
brand awareness.
» the marketing strategy; that is, how the objectives will
be achieved (for example, by new product development
or targeting new segments)
» the resources required, such as staff time
» the marketing budget; that is, how much can be spent
on marketing activities
» details of marketing activities, showing what will be
done, by when, who is responsible and how much money
will be spent on each activity.
The marketing plan will set out what has to be done and
what resources are needed to do it. Each activity should
have a timeline so that progress can be measured. These
activities will include the marketing mix; for example,
details of any promotional campaigns running, including
details of when they run, how much they cost and who is
monitoring the response.
A marketing plan should be detailed and specific. It
should have clear targets to be achieved by named people
in a given time. This allows progress to be measured and
assessed throughout. If the outcomes are not as intended,
the marketing plan can be amended.
GLOSSARY TERM
The marketing plan sets out the marketing objectives,
strategy, budget and the activities necessary to achieve its
objectives.
383
 The benefits of marketing planning
8.2 By producing a plan, the marketing department is forced to
think carefully about what it has to do. It has to make choices
between what to spend its money on. It has to debate when
is the best time to undertake different activities and how
long they are likely to be. This is an important process that
can uncover potential problems and possibly highlight new
ways of doing things. The marketing plan is vital because:
» it shows which products need to be available to sell in
what quantities and at what times; this is crucial for the
A LEVEL 8.2 MARKETING STRATEGY
operations department
» it will influence HR planning in terms of the numbers
and skills of staff needed at particular times
» it will influence the financial forecasts, showing
expected profits and cash flow.
Having a marketing plan:
» helps to co-ordinate action between the different
business functions
» can motivate employees by setting clear targets for
different people so that they can assess their progress
and be measured on what they deliver
» can enable a proper review to see whether the targets
have been achieved and, if not, why not.
The limitations of marketing planning
While marketing planning can bring benefits, it can be
difficult to do and does have limitations. Conditions
may be changing fast, information you want may not be
available and you may not have the resources you would
like. There will be constraints and there will be uncertainty.
Sticking rigidly to a marketing plan can be dangerous if
circumstances have changed significantly. Events such as
the Coronavirus (COVID-19) pandemic, for example, will have
required massive changes in the marketing plans of many
businesses. Also it must be recognised that some plans
may turn out to be wrong. This could be because they were
based on incorrect or incomplete information, because of a
lack of skill and experience of the planner or because they
proved more difficult to implement than imagined.
However, this does not mean that planning should be
abandoned; simply that businesses and marketing managers
may need to be flexible and adapt the plan if conditions
or objectives change. By having a marketing plan, it is
possible to assess progress and, if it is different from what
is expected, changes can be made. With no plan at all,
people do not know what they are supposed to be doing
and therefore may either not make decisions (because they
don’t know what is the right thing to do) or will make their
own decisions (which may not be in line with what the
business as a whole wants to achieve).
HANDLING DATA
1 If your sales are $200 000 and your market share is
3 per cent, what is the size of the market overall?
2 If you set a target market share of 5 per cent of the
above market, what level of sales would you need
to achieve?
384
8.2.2 Approaches to marketing
strategy
The marketing strategy is the long-term marketing plan
aimed at achieving the marketing objectives. Imagine we
want to increase sales by 50 per cent over the next five
years. How can we do this?
1 We may decide to boost sales of our existing products. If
we do this, we could try to:
– increase the amount that existing customers buy
when they purchase (for example, buy more items
every time they visit our shops)
– increase the number of customers (for example,
encourage people to switch to our shop)
– increase the number of times they buy (for example,
more visits to the shop)
– increase the amount they spend (for example, get
them to trade up to premium items).
2 Or we may decide to develop new products.
There are different ways of achieving an objective. Each
strategy selected will have different implications in terms
of the precise marketing activities being carried out.
The strategy adopted will need to fit with the specific
marketing objectives. For example, an increase in market
share may be achieved through lower prices to penetrate
the market, whereas a repositioning of the brand to become
more of a premium item might include new branding and
packaging but not price cuts. A strategy of entering a new
market may require heavy investment in promotion to raise
awareness, whereas a strategy trying to get customers to
switch from a competitor may focus on sales promotions.
The marketing team will have limited resources and must
allocate these to support a strategy that meets the specific
objectives.
Deciding on a marketing strategy
Marketing strategies can vary significantly. For example:
» Lobbs is an exclusive shoemaker producing expensive
made-to-measure shoes – this is a niche, differentiation
strategy. Clarks competes much more in the mass market.
» Primark aims at the mass market via low prices. Karen
Millen aims more for the expensive fashion market.
» The Ford Ka was aimed at the younger driver (perhaps
their first car). The Aston Martin DB7 is aimed at the
highly successful executive.
When deciding on a marketing strategy, there are many
issues to consider as well as the marketing objectives. These
include being consistent with:
» the values of the business For example, the business
may be committed to sustainability and this might
affect what is offered. The business may have outlined
a clear ethical policy which might prevent certain
promotional strategies, such as targeting children to get
them to pester their parents to buy them a present.
» the resources of the business There is no point
developing a marketing strategy based around high-
volume sales if the business does not have the capacity
 CASE STUDY
8.2
Barbie
Barbie has been experiencing major competition from ● those who do not buy dolls at all, to try to win new
Bratz dolls in recent years. To boost sales of Barbie, customers.
managers could target different segments:
Each of these would be a different strategy to achieve the
● those who buy Barbie already, to try to get them to buy
same objective of increasing sales.
more
● those who used to buy Barbies but are older now, to Questions

8.2.2 Approaches to marketing strategy

try and get them to return to the dolls (for example,
1 Analyse two benefits to the producer of Barbie of
adult collectors)
identifying different segments in the market. [8]
● those who do not buy Barbies but buy Bratz dolls, to
2 Advise which of the strategies above you would
try to win over these customers
recommend. Justify your answer. [12]

for this. Similarly, there is no merit in a strategy focused A firm’s marketing strategy should aim to exploit its market
on a premium positioning if the business cannot provide opportunities and defend the firm against threats. It should
the level of customer service to support this. naturally build on the firm’s strengths and avoid entering
» the product itself For example, clothes retailing works market segments or offering products where its weaknesses
well online and a more digital distribution might be a will be exposed.
logical strategy. By comparison, hairdressers may promote
more online but won’t be able to distribute digitally.
» market conditions The nature of the market and the Set corporate objectives
markets in which the business competes will determine
what is feasible and what are achievable targets. For Set marketing objectives
example, the sales targets for Coca-Cola will be set in
billions of dollars, whereas a market stall in your village
may be happy with sales in the hundreds of dollars. Analyse your strengths and weaknesses
Market conditions will determine where the business
should compete and which segments it should target.
For example, should the firm compete in a niche market Analyse the external environment
or try to compete head-on with the major players in a
mass market? Should it compete in particular regions, in Produce marketing strategy
the country as a whole or globally?

Implement marketing strategy

The
business Review

▲ Figure 8.16 Forming a marketing strategy

When assessing a marketing strategy, managers should make
sure they are clear about:
Marketing » the characteristics of the target market
The market
strategy
Objectives » the positioning of the business relative to competitors
» the nature of the strategy (is it aiming to justify a
premium price or is it offering a low price?)
» the marketing objectives (how will success be
judged?)
» the risk involved in any strategy relative to the likely
The
product returns
» whether it fits with the business strengths. Could
Primark suddenly move into the premium market, for
▲ Figure 8.15 Factors to consider when developing a example? What about Gucci chewing gum? 7-Eleven
marketing strategy luxury hotels? Virgin old people’s homes?

385
 A co-ordinated marketing strategy
8.2 The marketing strategy must be linked to planning with the
other functions. It must be co-ordinated with all the other Marketing
areas of the business. For example:
» The expected level of sales must fit with what can be
delivered operationally.
» The positioning in the market must fit with what can
be delivered in terms of the product quality and level of
Finance Operations
service.
» The staff will need the required skills and training to
A LEVEL 8.2 MARKETING STRATEGY

deliver what is promised.

» The budget must be in line with financial plans to
achieve the desired overall profit targets. The marketing
activities must be affordable. For example, a business
Human resources
with limited funds may not be able to afford a major
promotional campaign.
A lack of co-ordination between the marketing strategy and
the other business functions could mean the resources are ▲ Figure 8.17 Marketing decisions must be co-ordinated
not in place in the right quantities and qualities required to with the other functions of a business
deliver on the strategy.

CASE STUDY

Unilever
Unilever is a large multinational business. Its mission
is ‘to add vitality to life. We meet everyday needs for
nutrition, hygiene, and personal care with brands that
help people feel good, look good and get more out of
life.’
Its marketing strategy is now focused on what it calls
‘power brands’; that is, key brands such as Dove and
OMO that it wants to develop globally. These brand
names will be extended to a wider range of products,
but lesser-known brands have been or are being
sold off. To achieve growth in the future, Unilever is
targeting emerging markets. In these markets, it has
▲ Figure 8.18 Some of Unilever’s power brands
two strategies:
● to get customers to buy products for the first time Questions
● to get customers to trade up.
1 Analyse two possible benefits of a strong brand. [8]
Source: www.unilever.com/news/press-releases/2004/04-02-12- 2 Evaluate the possible reasons why Unilever has decided
Unilever-puts-vitality-at-core-of-new-mission.html to focus its marketing strategy on power brands. [12]

STUDY TIP GLOSSARY TERMS

Remember how important the marketing strategy is.
The price and the promotional mix are only likely to work
if you are actually competing in the right market in the
first place and in the right way. If your strategy is clear
(for example, you decide you want to be a low-price
competitor) then much of the marketing mix becomes
straightforward – you are likely to offer basic products at
a low price with a message of value for money.
Protectionism occurs when a government protects
domestic producers against foreign competitors.
Tariffs are taxes placed on foreign goods and services
being imported into a country.
Quotas are limits on the number of foreign goods and
services that can be imported into a country.

386
Why change a marketing strategy?
It may be necessary for a firm to change its marketing
strategy for a number of reasons, such as:
» It may have changed its marketing objectives Rather
than wanting more sales from a given product range,
managers may now seek to diversify (for example,
to spread risk) or there may be more pressure from
investors to boost profits.
» Market conditions may have changed The slowing down
of the rate of growth in the PC market has led firms like
Microsoft to look for new markets to enter, such as cloud
computing. Government regulations to reduce smoking
is forcing tobacco companies to look for new markets
and, particularly, new products. The decline of the
traditional film camera market led the UK-based camera
shop Jessops to reconsider what it offers. Concerns over
diet have made McDonald’s think about how to make its
offerings seem healthier.
» Competitors’ actions A head-on attack from other firms
may force an organisation to move into a new segment,
or to focus on particular areas of its business where
it has a competitive advantage. In the UK, the threat
of supermarkets such as Walmart attacking its core
business led to Boots, which sold mainly health-care and
beauty products, moving more into segments such as
photography, optical and dental care.
» The firm’s own strengths As a firm develops its staff,
technology and product range, it may find that its
strengths create new opportunities and this brings about
a change in strategy.
» Poor performance If your strategy is working well, you
are likely to keep on with it. If your strategy is failing,
you need to rethink. A change in marketing strategy
may be prompted by the possibility of exploiting an
opportunity and/or protecting a business against threats
or poor performance.
Changing your marketing strategy can be a difficult process.
For example:
» If you keep the same brand name and try to move
upmarket, it can be difficult to win customers over. For
many years, Skoda was trying to reposition itself as a
relatively low-priced but reliable, well-designed brand.
For older buyers who remember quality problems in the
past and its very basic design, this was quite a shift in
its positioning and buyers took time to be convinced.
Equally, changes to the strategy can damage the brand
and hurt the long-term success of the business. At one
point, Burberry was growing so fast and using its brand
on so many products that it started to devalue its image
and the company had to be more selective to maintain a
premium image.
» It will involve changes in the other functions. For
example, the operations process may need to change,
perhaps to achieve higher volumes, fewer defects or
faster service. Equally, responsibilities and duties of
staff will change, which can be disruptive and resisted.
» More funds may be needed to enable the strategic
change. This may be to research the options, develop
new products or launch them in the market. This can be
difficult if, for example, the reason for the change was
8.2
that the business had financial difficulties.
IT and AI, and marketing activities
Developments in information technology (IT) are enabling
marketing teams to gather and analyse data in much bigger
quantities and at much faster speeds. Companies such
8.2.3 Strategies for international marketing
as Amazon can track in real time, not just what people
are buying but what they are looking at, how they are
moving around the website and when they are coming
back to look again. This can give businesses a much deeper
understanding of who their customers are, what influences
their purchases and what drives behaviour. Businesses
can identify trends, build algorithms to anticipate
behaviours and adjust their strategies accordingly.
Information technology can also link marketing to the
other functions more effectively, providing better
co-ordinated decisions.
Artificial intelligence (AI) is also helping marketing by
enabling marketing decisions to be taken automatically.
AI can interpret data and identify patterns that allow it
to drive dynamic pricing, adjusting the price according to
criteria such as time of day, location of the search and the
previous behaviour of the customer. Examples of the use of
AI in marketing include:
» making recommendations to customers on other
products they might like, based on previous buying and
search patterns.
» generating content on social media to match the
interests of the potential customer
» generating website content according to who is looking
at it (for example, is this the first visit to the site or a
return visit?)
» using chatbots on a website to provide computer-
generated responses to customer enquiries
» generating customer-specific content in online advertising
so that the advert you see depends on who you are.
8.2.3 Strategies for international
marketing
Businesses may not just be undertaking marketing activities
in one area or even one country. Companies such as Google,
Mercedes and Netflix will be operating in countries all over
the world. This is made possible due to globalisation.
Globalisation
In recent years, the amount of international trade involving
businesses buying and selling across borders has increased.
This is because:
» Political agreements have opened up markets by
removing or reducing protectionist measures such as
tariffs (taxes on foreign imports), quotas (limits on
387
 the numbers of imported goods) and administrative
restrictions that might make it difficult for foreign GLOSSARY TERMS
8.2 businesses to sell or operate in a country. Barriers to
trade still exist – for example, it is difficult for the big
The World Trade Organization is an organisation of
countries aimed at reducing protectionism across the
Western retailers to get permission to open in India – but world.
they have been falling in recent years due to the work of Economic collaboration occurs when countries make
governments and organisations such as the World Trade trade easier between each other.
Organization. Governments realise that trade enables
their businesses and citizens to access new markets
and, thus, stimulates economic growth. The increase in The implications for marketing of increased
trading agreements around the world, which makes trade
A LEVEL 8.2 MARKETING STRATEGY

easier, is because of economic collaboration. Of course,

there are still trade disputes and countries will block
trade with some other countries, but generally there has
been a move towards greater collaboration.
» Better transport and communications technology has
made it easier and cheaper to find markets, to move
products around the world and to manage businesses in
other countries.
Look at the labels on your clothes to see where they
were made, find out where the different components of
your laptop or mobile phone were made, and look at the
source of items on the shelves at your local shop and you
will appreciate how global the world has become. Many
businesses buy in products and services from abroad and
sell their products abroad.
Not only that, but money also flows around the world,
being invested in overseas banks and used to buy foreign
companies. Many famous ‘British’ brands, for example, are
now owned by overseas companies: Jaguar and Tetley Tea
are owned by Tata from India, and Manchester United FC is
owned by the Glazer family from the USA.
globalisation
Globalisation from a marketing perspective opens up
enormous opportunities and threats. It creates the
possibility of new markets and, literally, billions of
new customers if you can successfully target them. For
example, there are enormous numbers of people moving
out of poverty and eager to buy consumer products
in the emerging BRIC economies (Brazil, Russia, India
and China). Other economies to watch because of their
potential for fast growth have been identified as CIVETS
by some commentators (Cambodia, Indonesia, Vietnam,
Egypt, Turkey and South Africa) or the MINT economies
by others (Malaysia, Indonesia, Nigeria and Turkey).
However, globalisation also creates the possibility of
new competitors from abroad entering your markets. This
means you have to be even better at what you do in your
own market.

CASE STUDY
The NFL
The National Football League (NFL) has experienced
numerous problems in its marketing efforts to globalise
American football. Its attempts began in the 1970s with
some exhibition games played worldwide. In the 1980s,
the NFL created a European League, but this closed
down in 2006 as fans were disappointed by the quality of
the European game compared to the US game. The NFL
then focused on playing more games around the world
in countries such as Mexico and Canada, where they
felt there would be a market. These countries are of a
reasonable size, have a strong interest in sports and a
media interested in sports content. However, while local
events and partnerships had some impact, the biggest
change has been due to technology. Social media and
online opportunities have created new ways for the NFL ▲ Figure 8.19 American football has struggled to become
to distribute its products to a growing market worldwide. popular internationally
Technology has enabled globalised messaging and
communication. Questions
1 Analyse two problems the NFL might have in bringing
its sport to new markets around the globe. [8]
2 Evaluate the ways in which technology has made it
easier for a business to succeed globally. [12]

388
 CASE STUDY
Chinese export markets
Table 8.8 shows the top main export markets for Chinese producers in 2019.
▼ Table 8.8 Top main export markets for Chinese producers, 2019
Rank Country Market value ($bn)
1 United States
2 Hong Kong
3 Japan
4 South Korea
5 Vietnam
Question
1 Analyse two factors that might make markets attractive for Chinese exporters.
International markets
Overseas expansion may be appealing for several reasons:
» The domestic market is saturated Many markets are
mature (for example, the demand for microwaves, fridges
and televisions in the UK). Companies can only generate
replacement sales rather than many first-time buyers.
In emerging economies such as Brazil, Russia, India and
China, the economies are growing much faster, creating
opportunities for a rapid growth in sales. If investors
are pushing for fast growth, it may be that this is more
likely to come from abroad.
» The domestic market is subject to increasing
competition or regulation Further expansion within
a country may be blocked by a government that wants
to prevent monopoly power, for example. Expanding
overseas may overcome this problem.
» The benefits of particular market opportunities
overseas For example, China and India have populations
of more than 1 billion that could be targeted.
CASE STUDY
JD Sports
In 2020, JD Sports, the sports retailer which also owns
Blacks and GO Outdoors, announced high profits despite
difficult trading conditions. It said that this success was
due to its growth internationally. The sports retailer
reported total sales growth of 15 per cent in the 48 weeks
to 5 January 2020.
JD Sports had opened two stores in Thailand in the second
half of 2019, as well as its first five branches in the USA.
JD Sports said its policy not to enter into short-term
discounting had helped maintain its profit margins.
8.2
Percentage of China’s total exports
418.6 16.8
8.2.3 Strategies for international marketing
279.6 11.2
143.2 5.7
111 4.4
98 3.9
[8]
Entering a foreign market does, of course, bring various
problems. Perhaps most importantly, the firm is unlikely
to know the market as well as its domestic market. It will
need to ensure it fully understands market conditions,
including consumer buying behaviour, legal and economic
factors and the possible response of the competition.
Given that the market is not known as well, entering an
overseas market can be seen as risky. This is why many firms
entering overseas markets find a local partner to help them
understand the market.
STUDY TIP
International marketing offers many opportunities in
terms of new sales; for example, in China alone there
are more than 1 billion potential customers. However,
understanding the needs of customers, the competition
and the nature of the market can be very complex when
going overseas.
The company said that it was confident that, domestically
and internationally, in stores and online, its unique brand
provided a solid foundation for future development.
JD also operates in France, Portugal, Spain, Austria,
Malaysia, Australia and Singapore, and the company is
eager to continue growing.
Questions
1 Analyse two factors which determine whether JD Sports
is likely to open a store in a particular country. [8]
2 Evaluate the importance of international expansion to
JD Sports. [12]
389
 CASE STUDY
8.2
Tesco withdraws from overseas markets
In 2020, Tesco left Poland, selling 300 loss-making stores
to Netto (a Danish discount supermarket) for £181 million
on the grounds of ‘market challenges’. It continued to
operate in the Czech Republic, Hungary and Slovakia,
where it believes there continue to be growth prospects.
However, it has struggled in Poland, where consumers
A LEVEL 8.2 MARKETING STRATEGY
have continued to shop at convenience-led corner shops,
many of which are owned by larger companies and so are
able to compete on price with supermarkets.
In February 2020, Tesco also sold its joint venture in China
for £275 million to its state-run partner, China Resources
CASE STUDY
Food and drink in Asia
When Coca-Cola launched the Minute Maid Pulpy in
Malaysia, the focus of its marketing campaign was on the
content of orange pulp in the drink. Coca-Cola believe
that Malaysian customers enjoy chewing the pulp, so they
developed this new beverage to suit local tastes.
▲ Figure 8.20 Minute Maid Pulpy
As with entering any market, the marketing department
needs to carefully analyse marketing opportunities when
thinking of expanding overseas. This means looking at
factors such as the market size and the potential for
growth. The analysis will use techniques such as correlation
and extrapolation, but the firm may need to use local
expertise to try to understand the market better.
The market analysis should help identify possible markets
for the firm’s products, looking at the market conditions and
the strengths of the brand and the products themselves.
390
Holdings. That was followed in March by the sale of
its south-east Asian operations to Thai conglomerate,
Charoen Pokphand, for $10.6 billion. The deal, which
included more than 2000 stores, was the biggest in
Thailand’s history.
Questions
1 Analyse two reasons why Tesco expanded outside of
the UK. [8]
2 Evaluate the possible reasons for the recent sale of
Tesco stores in some countries. [12]
According to Coca-Cola, Minute Maid Pulpy is the best-
selling drink in China, Taiwan and Hong Kong. However,
Pepsi Co has also entered the Asian market in recent years
and currently has several products, including Tropicana
Guo Bin Fen juices and Cao Ben Le drinks, which are
inspired by Chinese medicine.
There is a history of Western food and beverage
businesses adapting their products in an effort to tailor
to local tastes. Some examples are McDonald’s and
Starbucks: McDonald’s offers Corn Cups on their menus
in Asia, and Starbucks offers green tea Frappuccinos to
their customers in China.
Questions
1 Analyse two benefits to Coca-Cola of having many
different brands around the world. [8]
2 Evaluate the advantages and disadvantages of
changing the recipes of products for different
regions. [20]
Once options have been identified, the firm must choose
which ones to target and then develop an entry plan,
thinking about when and how it will enter the markets.
For example, will it simply sell to the market or set up and
produce locally as well?
Understanding overseas markets can be difficult because
of differences in language, climate, culture and buying
patterns. There is therefore potentially a high amount of
risk involved, so managers must consider the likely rewards
and how much time and effort to spend on market research.
 CASE STUDY
8.2
Exports
The top five export products from Malaysia are: 3 other base-metal goods
1 electrical machinery and equipment 4 cocoa
2 mineral fuels, including oil 5 oil seeds.
3 machinery, including computers
Source: www.worldstopexports.com/malaysias-top-10-exports
4 animal/vegetable fats, oils, waxes
5 optical, technical and medical apparatus. Question

8.2.3 Strategies for international marketing

The top five export products from Nigeria are: 1 Analyse two factors that determine which are the top
1 mineral fuels, including oil exported products from a country. [8]
2 ships and boats

The method of entry into international markets If the market overseas looks as if it will prosper long-term, a
firm might take over a foreign partner or invest itself to set
When considering entering international markets,
up its own operations there. These show real commitment
businesses will want to:
and are major strategic decisions involving a high degree of
1 identify which markets they might want to enter This
risk and expenditure. Several UK businesses have found it
will depend on factors such as the potential market size
difficult to succeed abroad because of the real differences
and degree of competition
in approach between regions.
2 select how to enter This will depend on factors such as
the amount of investment and the degree of risk
3 enter the market This focuses on the implementation GLOSSARY TERMS
of the decision of how to enter. It involves bringing A pan-global marketing strategy markets a product the
together the necessary resources and managing the same way in all markets.
entry strategy effectively. A localised strategy adapts the marketing mix for local
conditions.
Identify Select how Enter
markets to enter markets

▲ Figure 8.21 Entering international markets

Pan-global strategy or localisation?
Typically, firms will start trading internationally by
Once the decision has been made to enter an overseas
exporting abroad. This means they will continue to focus
market, a business must consider the extent to which it
on the domestic market but accept orders from abroad.
will adapt its offerings to local conditions. Is it possible
This is a low-risk strategy – it simply involves a firm
to market the product in almost the same way in every
sending its products to other countries. It may at this
country (as Gillette does with its razors), which is known as a
stage do some marketing abroad; for example, advertising
pan-global marketing strategy, or will the marketing
its products or attending promotional events. If sales from
have to be adjusted for each market and be localised? If
abroad continue to grow, the firm might look for an agent
a business pursues a pan-global strategy, this means it is
or representative overseas. This means it has someone
adopting essentially the same marketing mix wherever it
based abroad who knows its firm well and understands
competes. A pan-global marketing strategy has been adopted
local conditions. They will try to generate business for the
by businesses in several markets, such as jeans, soft drinks
firm and may be paid on commission. Again, the risk of
and luxury goods. A Rolex watch, for example, is positioned
this approach is relatively low.
and marketed in a very similar way across the world.
A bigger commitment would be made when the firm finds a
One advantage of a pan-global approach is that it offers
partner and forms a joint venture or alliance. For example,
marketing economies of scale; for example, the business
it might collaborate on projects and share the profits. At
can develop one advertising campaign and one approach to
this stage it is not just someone representing the firm but
packaging worldwide. However, this type of strategy does not
someone who the firm is working with locally to generate more
respond to the requirements of different national markets
sales. For example, a drinks company might have an alliance
and so the business may lose sales to competitors who focus
with a local drinks company to share distribution costs or to
more on local needs. In markets such as food and drink and
gain access to some outlets. It might also franchise, if that
the media, a business may need to adapt significantly to
was appropriate. This would mean it was working with local
local requirements. On the other hand, a more local approach
partners who would understand the political, legal, economic,
may meet customer needs more precisely but may be more
social and technological issues better.
expensive and more complex to manage.

391
 In reality, most companies will choose a balance between
the pan-global and localised approach. Unilever, for
8.2 example, has built several superbrands, such as Dove. These
are global brands that sell in many different markets. They
have the same name and logo everywhere. However, some
adjustments are made in the way the product is promoted
to reflect local conditions. Unilever calls itself a ‘multi-
local multinational’. This is reflected in its structure: it
has brand managers who look after a brand globally and
local country managers who look after all related issues in
their areas. This approach is also called a ‘think global, act
A LEVEL 8.2 MARKETING STRATEGY
local’ strategy. Companies try to find economies of scale
where they can by doing things in the same way but, where
necessary, adjusting to the local market. McDonald’s has
the same basic brand image and approach everywhere, but
it adjusts the menu in different countries. Coca-Cola sells
its main brands globally but has more than 200 local brands
that only sell in limited areas.
CASE STUDY
Lego
The Danish company, Lego, is one of the world’s biggest
toymakers by sales and has almost tripled its sales
since 2007, despite the financial crisis and the popularity
of digital games. Lego’s sales overtook those of Hasbro
(which makes Transformers, My Little Pony and Play-
Doh), which was previously number two behind Mattel.
Lego’s new line of Friends building sets – developed for
girls – sold well alongside their established City, Star
Wars and Ninjago ranges.
▲ Figure 8.22 A Lego model of the Star Wars Death Star
392
Factors to consider when entering overseas
markets
When considering entering an overseas market, marketing
managers think about:
» the likely costs to establish the product in the market
and continue promoting
» the likely risk (given that they may not be familiar
with factors such as the culture, the legal system or
competitive environment, the risk could be relatively
high)
» the likely competition
» the understanding of the market
» the time frame
» the link with the business’ strengths and experience
» how to enter
» the likely returns (these could be huge in some markets
but must be balanced against the risk).
CEO Jorgen Vig Knudstorp believes that, while physical
play is still important, Lego’s popular video games and
website are allowing the company to connect with children
in the digital age.
The company, which was founded in 1932, used to have
only a small presence in toy markets in North America
and the UK but has significantly increased sales in the
USA, which is now its largest market. Lego also aims to
expand into Russia, Latin America and Asia to meet the
needs of their emerging middle classes.
Lego is 25-per-cent owned by the Lego Foundation, and
75-per-cent owned by the founder’s family. Jorgen Vig
Knudstorp noted that the company only keeps the cash it
needs in order to operate – the rest goes to the family to
be invested elsewhere. ‘If Lego needs [the cash], it flows
back.’
Lego is currently building a new factory in Hungary
and expanding the capacity of its factory in the Czech
Republic in a bid to move the bulk of its production to
low-cost countries. It plans to shut its packaging plant
at its headquarters in Billund but will be investing in its
moulding and engineering facilities there instead.
Source: www.ft.com/content/adefc266-7c15-11e2-bf52-
00144feabdc0
Questions
1 Analyse two factors that might determine demand for
Lego. [8]
2 Evaluate the factors Lego might consider before
choosing a new market to target. [12]
 TEST YOUR LEARNING
Short answer questions
1 a Define the term ‘marketing plan’. [2]
b Explain one benefit to a business of having a
marketing plan. [3]
2 Explain the importance of one element of a
marketing plan. [3]
3 Explain one reason why market research is useful
in developing a marketing plan. [3]
4 Explain two factors that should influence a
marketing strategy. [6]
5 Explain one way in which artificial intelligence can
affect marketing activities. [3]
6 Define the term ‘globalisation’. [2]
7 Explain one reason for increased globalisation. [3]
8 Analyse one way in which globalisation provides an
opportunity for businesses. [4]
9 Explain two ways a business might enter a foreign
market. [6]
10 Explain one factor that might influence a business
on how to enter a foreign market. [3]
Data response question
Uniqlo
Uniqlo focuses on what it calls ‘classic’ designs. Its vision
is to become the world’s number one casual clothing
brand. Uniqlo believes that everyone can benefit from
simple, well-designed clothes.
Whereas Inditex (which owns Zara and Hennes & Mauritz
of Sweden) aims to follow fashion trends, Uniqlo (which
is the main brand of Fast Retailing) wants to sell designs
that are ‘timeless’.
Uniqlo’s main growth markets are in Asia with networks of
shops in countries such as Vietnam, Singapore, Indonesia
and Thailand, but the company has also expanded into
Europe and America. This international expansion has
been important for the growth of the company and its
success has been reflected in a rising share price. In
Japan, its home country, Uniqlo has actually been closing
stores as the population is ageing and shrinking. In 2017,
Uniqlo’s international revenue overtook its domestic sales
for the first time. By 2019, Uniqlo had 817 stores in Japan
and 1370 stores abroad. including 807 in Greater China
(Mainland China, Hong Kong and Taiwan), 188 in South
Korea, 231 in Southeast Asia and Oceania, 91 in Europe,
and 62 in North America.
China is a particularly important market for Uniqlo.
China contributes over 70 per cent of the company’s
total international revenues. Although many Chinese
8.2
customers value more premium brands, Uniqlo products
are used as plain items to go with fashion items. Uniqlo’s
cold weather Heattech range has done particularly well in
China. In other warmer Asian markets the Heattech range
has been in less demand so Uniqlo has focused on other
products.
8.2.3 Strategies for international marketing
The chief executive of Uniqlo is a big fan of globalisation
although he is worried that barriers to trade could limit
international expansion. Uniqlo buys high volumes of ‘top-
quality materials at low cost by negotiating directly with
materials manufacturers worldwide and placing large-
volume orders to achieve the most favourable terms’. It
does not buy in quantities lower than 1 million. Uniqlo
does not own any factories. It outsources all production
to partner factories in China, Vietnam, Bangladesh,
Indonesia and India.
Uniqlo is keen to develop its market share in the US.
However it recognises that the North American market
remains highly competitive with many competitor brands.
In the United States, the company says that ‘the climate,
culture and type of products that consumers desire
differ on the east and west coasts. Even on the west
coast, climatic differences exist. Los Angeles enjoys
warm winters, while San Francisco winters are cold, and
Seattle’s are even colder. We adjust our product ranges
accordingly by offering shorts in Los Angeles even in
winter, by increasing our fleece displays in San Francisco,
and by focusing on down outerwear in Seattle.’
In Europe, Uniqlo has found that customers are very
conscious of sustainability issues. Therefore, they say,
‘it is up to us to conduct brand marketing that helps
consumers understand its corporate aim to create a
sustainable society’.
Source: www.fastretailing.com/eng/group/strategy
Questions
1 Analyse two ways in which Uniqlo benefits from
globalisation. [8]
2 Evaluate the challenges Uniqlo faces when expanding
overseas. [12]
Essay questions
1 Evaluate whether the advantages of targeting
overseas markets outweigh the disadvantages. [20]
2 Evaluate the extent to which greater globalisation
is good for business. [20]
393
 9 Operations management
A LEVEL

9.1 Location and scale

A LEVEL 9.1 LOCATION AND SCALE

Chapter overview
In this chapter we examine:
★ local, national and international location and relocation decisions
★ the scale of a business
★ offshoring and reshoring
★ globalisation and location
★ internal and external economies and diseconomies of scale.

9.1.1 Location Benefits of the optimal location

The location of a business can affect its costs, its demand,
its image and its ability to attract employees to work for
it. The location decision is therefore an important decision
that can affect the ability of the business to compete. The
decision of where to locate can also reflect the values of
the business; for example, if it wants to help employment in
a particular area. So, location choices should not be taken
lightly and will involve decisions at the most senior level.
A location decision can involve high levels of investment
and have a major impact on competitiveness. The right
location(s) for a business may affect:
» the costs of production
» the tax rates paid
» the availability of employees and the skills available
» demand for the products
» the ease of accessing markets
» the ease of accessing supplies
» access to natural resources.
Given the impact on costs and revenues, a location decision
will involve an assessment of the break-even output and likely
financial returns. Location decisions may involve several
different layers of decision-making: first which country, then
which region and, finally, which specific plot of land.
It may not always be possible to get the best (or optimal)
location. You may find that a particular site is already taken
or is too expensive. However, getting the best or nearly the
best location can have several advantages:
» Lower costs may make the break-even output lower and
reduce the risk of losses if sales are lower than expected.
Lower costs may increase the return on investment and
make a project worthwhile.
» Being closer to the customer (and therefore possibly
getting more customers as a result) may boost sales and
profits. Stores based in the city centre have a higher
footfall than those a few streets away.
» Overcoming trade barriers may increase sales (for
example, it is difficult to export to some countries
because of barriers to trade). By basing itself inside a
customs union, such as the European Union, a firm may
be able to sell in a particular country.
» It may add to the brand image For example, having
your flagship store on Fifth Avenue in New York or
Covent Garden in London may be important for the
status of your business.

CASE STUDY
Where products come from
If you have ever wondered where products are produced, 4 avocados: Mexico, California, New Zealand, Peru and
here are some examples of the biggest producing South Africa
countries for different products: 5 kiwi fruit: New Zealand
1 pineapple: Costa Rica 6 broccoli: China, India, Spain and Mexico.
2 pistachios: Iran and USA
3 nutmeg: Indonesia, India, the Netherlands and the Question
United Arab Emirates 1 Analyse two factors that influence whether a region
has an advantage in producing a certain product. [8]

394
Deciding where to locate
The decision on where to locate a business will be based
on a combination of quantitative and qualitative factors.
This means that it is a combination of factors that can be
CASE STUDY
Bangladesh
An increasing quantity of clothes are now being made
in Bangladesh and exported to China thanks to the
low labour costs. This helps businesses based there
to continue to generate sales despite a slow-down in
demand from Europe.
In Bangladesh, the average monthly salary for garment
workers is around $70 to $100, whereas China is
experiencing increasing demands for higher wages from
its employees. In some Chinese factories, for example,
wages are now around $400–500 a month per worker.
Chinese manufacturers say that if they source clothes
from Bangladesh, prices can come down by 10–15 per
cent. Bangladeshi garment exporters say the other
advantage they enjoy is that more than 90 per cent of
their products, such as t-shirts, jeans, sweaters and
casual trousers, enjoy duty free access to the Chinese
market.
CASE STUDY
American Apparel
▲ Figure 9.1 Dov Charney, founder of American Apparel
Dov Charney is the founder and chief executive of American
Apparel, the largest t-shirt manufacturer in America.
He is widely ‘admired for single-handedly creating one of
America’s most successful fashion retailers’, for devising
his company’s provocative approach to advertising, and for
treating employees well.
Mr Charney opened his first shop in 2003. By 2015, he
had more than 140 stores in 11 countries selling casual
clothes for men, women and children. His unbranded,
brightly coloured and moderately priced t-shirts,
measured, such as the expected impact on costs and revenues
(these are quantitative), as well as other factors that are less
easy to quantify, such as the attraction of the surroundings
and the quality of life in the area (these are qualitative).
9.1
China’s largest online clothing retailer has already
9.1.1 Location
shifted a portion of its shirts and casual trousers orders
to Bangladeshi factories. Meanwhile, Western fashion
brands such as Ocean and H&M are also making clothes
for Chinese customers in Bangladeshi factories.
However, Bangladesh’s poor infrastructure and political
instability have been a major concern for the clothing
manufacturers. In addition, there have been violent labour
protests (during 2019 and 2020) with workers demanding
better wages and conditions.
Questions
1 Analyse two factors a business might consider when
deciding whether to produce for itself or subcontract
to other businesses. [8]
2 Evaluate the advantages and disadvantages of
Bangladesh as a place to produce garments. [20]
sweatshirts, underwear and jeans became extremely
popular among the young, cosmopolitan group that
Mr Charney says represents the ‘world-metropolitan
culture’.
From the beginning, Mr Charney put great emphasis on
making his employees happy. Pay is performance-related,
and was far above California’s minimum wage. American
Apparel staff could buy subsidised health insurance for
$8 a week. They were entitled to free English lessons,
subsidised meals and free parking. Their workspace was
properly lit and ventilated.
Anti-sweatshop activists praise Mr Charney as a pioneer
of the fair treatment of garment workers. The benefits he
provided were expensive: subsidising health insurance
cost his firm $4–5 million a year; subsidising meals
cost another $500 000. Mr Charney said ‘I believe in
capitalism and self-interest. Self-interest can involve
being generous with others.’ While Gap, another
American fashion chain, outsources 83 per cent of its
production to factories in Asia, all of the 4000 or so
workers involved in American Apparel’s manufacturing
process worked in the same factory in downtown Los
Angeles. Mr Charney argued that it gave him control over
every stage of production, and enabled him to monitor
the fashion market and respond quickly to new trends.
395
 However, in 2015, American Apparel became bankrupt. The
9.1 company was bought by new investors and relaunched. A
decision was taken to outsource production overseas. The
company’s slogan is now ‘Ethically Made—Sweatshop Free’,
with the majority of its products being made internationally.
Most of its apparel is outsourced to factories in Central
America, primarily Honduras and Nicaragua.
Source: www.economist.com/business/2007/01/04/the-hustler
A LEVEL 9.1 LOCATION AND SCALE
Factors affecting location
Factors affecting a firm’s location include:
» Geographic factors; for example, the location of the
market. In some cases, such as retailing, it will often
be important to be close to the market. A central
high-street location is more likely to attract business
than a site located some distance away from the main
shopping areas. In other industries, such as telephone
banking, it is not so important to be close to the
customer.
» The infrastructure of the region The availability of
energy sources and transport facilities will affect the
ease, speed and cost of production. The importance
of such factors will vary between industries;
for example, transport facilities are crucial to a
wholesaler but less significant for an online insurance
business.
» Political factors; for example, political stability. The
political climate can have an impact on the appeal of
a certain area. For example, in 2016, the UK decided
to leave the European Union. For some businesses, this
may make the UK less attractive as a location as it is no
longer within the Union and, therefore, exports from the
UK may face protectionist measures. Increased rivalry
between the USA and China in recent years has led to
trade wars that may deter some producers who want to
export to one of these countries from locating in the
other.
» The costs of a particular location relative to other
options; for example, the cost of land itself will
vary from area to area, as will the cost of labour and
services such as electricity. Taxation rates can also vary
significantly from country to country. The decision to
locate can therefore have a significant impact on a firm’s
profits.
» The availability of lower-cost locations abroad has
been a major factor for UK firms considering relocating
to Asia or eastern Europe. Low-wage employees and a
much lower cost of living often make it very financially
attractive for UK firms to be based overseas.
» The availability of government grants and
incentives If, for example, a government offers
low rents or lower taxes to attract firms, this can
obviously act as an incentive to locate there. In the
last 20 years, for example, development agencies in
regions of the UK, such as Wales and Scotland, were
396
Questions
1 Analyse one reason why American Apparel wanted
to produce in Los Angeles. [4]
2 Evaluate the view that American Apparel is wrong
to outsource. [12]
very effective at attracting overseas investment, not
just because of financial aid, but also because of
the general level of local and national government
co-operation in areas such as planning permission.
Governments often use a combination of push and
pull techniques to encourage firms to locate in
particular regions. Incentives such as grants can help
to pull firms into an area; refusing permission to build
in other areas helps to push firms to locate where the
government wants them to be.
» The nature of the business itself The extent to which a
firm has freedom over the location decision depends in
part on what it actually does. A self-employed website
designer, for example, may be able to work from home.
A fast-food restaurant, by comparison, must be located
somewhere near its customers, while a mining company
must base its production facilities where the actual
minerals are.
» Marketing factors; for example, market access. The
location of a firm may affect its ability to trade in
particular markets. Firms based outside the European
Union, for example, must pay a tax (a tariff) to sell their
goods within the EU. Firms located within the EU do not
have to pay this tax. This may make the EU an attractive
location for businesses that want to export to these
markets.
» Exchange rates If the pound is strong, it is expensive
for UK-based producers to export. On the other hand,
it means UK firms have strong purchasing power
overseas, which may lead some firms to relocate
overseas when the pound is strong in value in terms
of other currencies.
» Demographic factors; for example, it may depend on the
availability of labour with the right skills in the area.
» Legal factors; for example, businesses may not
be allowed to build in some areas where wildlife is
protected or, if the process is dangerous (such as
nuclear energy), a firm may not be allowed to set up
near towns.
» Resources A firm may locate in a particular area
because of the resources it offers. Microsoft located near
Cambridge in the UK because it wanted easy access to
top graduates and research facilities.
» Image A perfume company, for example, may benefit
from being based in Paris or Milan, but it may not gain
the same prestige from being located in Scunthorpe in
the north of England.

Closer to
the market
Overcome
Government
trade
subsidies
barriers
Reasons for
locating
abroad
Lower Less
costs regulation
▲ Figure 9.2 Reasons for locating abroad
CASE STUDY
Tesla
In 2019, Elon Musk, the chief executive of Tesla,
announced that the electric-vehicle company would
set up its first European production plant near Berlin
in Germany. Tesla wanted to create an engineering and
design centre there. The site would produce the Model
3 and Model Y vehicles initially. It is located near the
city’s proposed new airport. Tesla had already expanded
production abroad with a plant near Shanghai.
Musk said that German engineering is outstanding and
that some of the best cars in the world were built in
Germany. In 2016, Tesla acquired the German company,
Grohmann Engineering, a specialist group for automated
manufacturing.
CASE STUDY
Apple
Around 12–16 million units of Apple classic Airpods
(approximately 30 per cent of the total global annual
production) are now being mass produced in Vietnam.
This is part of a shift of production out of China by Apple,
especially as trade relations between the USA and China
worsen. Many other US producers are also seeking to
diversify their production to locations other than China.
Typically, producers are looking at Vietnam, Thailand,
India and other south-east Asian countries.
Apple is said to have asked suppliers to plan to move
around 15–30 per cent of its hardware production out of
China. Inventec, another AirPods assembler, is currently
building a production plant in Vietnam.
» Quality of life For example, how attractive is the area in
itself? What are the facilities like? What is the standard
of living like?
» Ethical issues Some British firms have avoided
9.1
locating in low-wage areas for fear of being criticised
for ‘exploiting’ local staff or taking jobs away from
the UK. In many cases, firms expand in areas where
they already have established links (and therefore feel
some responsibility to the community) rather than
take jobs elsewhere. The Body Shop set up one of its
9.1.1 Location
manufacturing operations at Easterhouse in Glasgow,
Scotland, specifically to bring jobs to a deprived area.
Car production in Germany has mainly been based outside
of Berlin. Daimler and Porsche, for example, produce near
Stuttgart. However, some of the newer mobility ventures,
such as VW’s ride-hailing business, Moia, are based in Berlin.
Tesla is a California-based company. It will now face
increasing competition from Volkswagen, a German
business, which has made the biggest commitment to
electrification of any major car maker, as the industry
prepares for increasingly strict EU emissions regulations.
Questions
1 Analyse two possible reasons why Tesla chose Berlin
for its first European production facility. [8]
2 Evaluate the importance of location to Tesla. [12]
Many Apple suppliers, such as the two major iPhone
builders, Foxconn and Pegatron, and iPad maker Compal
Electronics, are all expanding production in north
Vietnam. Many are helping other tech companies, such as
Google and Amazon, to diversify production.
Part of the motivation to become less reliant on suppliers
in one country is to reduce risk if anything happens there.
Questions
1 Analyse two reasons why Vietnam might be becoming
a more attractive location for manufacturing. [8]
2 Evaluate the effect of location on the profits of Apple. [20]
397
 CASE STUDY
9.1
Disney
In the early 1980s, the heads of Disney were looking for a
location in Europe to open a new theme park. The first one
outside the USA was Japan, and now Disney was looking
for another base.
Disney initially came up with more than 1000 possible
A LEVEL 9.1 LOCATION AND SCALE
locations in Europe. By March 1985, the number of
possible locations for the park had been reduced to four;
two in France and two in Spain. Both of these countries
saw the potential economic advantages of a Disney theme
park and were offering financial deals to Disney. A strong
possibility was a site near Toulon in southern France,
not far from Marseille. The pleasing landscape of that
region, as well as its climate, made the location a likely
winner for the European Disney. However, thick layers of
Qualitative factors affecting location
Although firms are likely to examine the potential impact
on revenues and costs of selecting a particular site, the
decision may also be affected by less measurable factors,
such as whether the location itself appeals to the managers
or the quality of life in the area. For example, many
Japanese firms have been attracted to the UK because of
the importance of the English language in business. It is
also because English is learnt in Japanese schools – this
makes it easier for these firms to set up in the UK than in
France, for example.
The culture of the country and the extent to which you
think you understand its traditions, its ways of working and
its customers are all very important. According to Rugman
(2000), the probability of an American multinational
opening its first operations outside the USA in Canada
or the UK is 70 per cent; these are similar countries and
therefore appear to be familiar territories. The probability of
an American multinational opening its second operation in
Germany or Japan is 2 per cent; these seem less appealing
as the cultures are less familiar.
Once a few firms have set up in a location, this can also act
as an incentive for others to locate there, as they may think
this proves it is safe and that networking (that is, using
the expertise and experience of others) will be easier. The
growth of Hollywood as a film centre and Silicon Valley as
a centre for computing are in part because the success of
some firms has drawn in others.
Other possible qualitative factors which could attract
managers to particular areas include the fact that they like
the region, or they have particular attachments to the place.
Managers might also choose a location because the name of
the place enhances the product’s image – a fashion house
in New York sounds more exclusive than a fashion house in
Grimsby; an advertising agency in London may have more
appeal than one in Dundee. The reasons a particular location
is chosen are, of course, varied. In the case of call centres,
some firms have located in the north-east or north-west of
398
bedrock were discovered beneath the site, which meant
construction would be too difficult. Finally, a site in the
rural town of Marne La Vallée was chosen because it was
close to Paris, and its location was estimated to be no
more than a four-hour drive for 68 million people and no
more than a two-hour flight for a further 300 million. The
agreement to build was signed in 1986.
Questions
1 Analyse two operational issues involved in running
a theme park. [8]
2 Evaluate the factors that might influence where
Disney locates a theme park. [20]
the UK because callers like the accent of people from these
areas more than the accents of people from the south-east.
Although this factor may well impact on a firm’s profits, it is
difficult to place an absolute value on an accent and so this
also counts as a qualitative factor. Other firms have located
their call centres to India to cut costs despite understanding
issues due to the language differences.
Types of location decision
There are, in fact, many types of location decision that
managers may have to consider. There is the initial decision
of where to set up the business. In many ways, this is the
easiest decision in that the managers have no commitments
to existing facilities. On the other hand, it usually occurs
at a time when money is tight and the firm will be heavily
constrained by what it can afford. A key decision at this
time is the desired capacity level – how big must the
factory be? Or how much office space is needed? Managers
may want to be optimistic about the possible growth of the
business; at the same time, they do not want to commit to
large facilities and then find these are under-utilised.
Once a firm is established, it may have to consider
relocating at some point in its development. This occurs
when a firm wants to move its facilities. This may be
necessary because the initial reasons for choosing a place
have now gone (for example, government grants have been
withdrawn or tax rates have been increased), or perhaps
because the firm has outgrown its premises.
When relocating, a firm may have more experience of the
type of facilities it needs than it did when it first chose its
location; it may also have greater financial resources than
when it started up. However, relocation brings with it all
sorts of new problems, including:
» staff who do not want to move (or the firm does not
want to pay to relocate) – these people may need
compensation
» there could be a period of lost production time during
the move
» the costs of notifying customers and suppliers, as well
as administrative costs such as changing the firm’s
literature to include the new addresses.
A new location may also be part of an expansion process
– a firm could be building new production facilities or
opening up a new outlet, for example. The acquisition
of new premises inevitably brings with it issues of
management structure and control. A new facility will
need to be controlled and the senior managers will need
to decide on the best way of structuring the business,
such as deciding what new jobs are created, what the
reporting relationships will be and how to ensure effective
communication.
Some location or relocation decisions may be within the
local area; some may be within the local region; some may
be overseas.
» The further afield you go, the more complex and more
difficult the decision becomes because you have more
possible options.
» You may not know the region as well, so it may take
longer and you may need expert help.
» There may be more factors to consider; for example,
when going international, you need to consider different
laws, cultures, political systems and exchange rate
changes.
Offshoring
One type of location decision is known as ‘offshoring’. This
occurs when a business moves production out of its own
country to another. For example, a US business might move
production to Vietnam. Typically, a business will offshore to
make use of the resources elsewhere and, in many cases, to
benefit from lower costs. Differences in wage levels around
the world mean that businesses that are labour-intensive,
such as clothes producers, look to locate production in low-
wage economies. Producers may also want to benefit from:
» less strict regulation on issues such as health and
safety, environmental protection and employee rights.
Managers may want to take advantage of a country
where it is easier to hire and fire staff and where
employment costs are lower
» government incentives that are used to attract foreign
investment. This might include tax advantages or
subsidies
» avoiding protectionist measures if the products are to be
sold within the region
» being closer to the markets where the products are
sold. For example, Jaguar Land Rover Automotive Plc set
up production in China to be closer to this important
market
» a more skilled workforce.
A business may offshore all of its operations or just
some of them. For example, Dyson, the home appliance
manufacturer, keeps its research and development
department in the UK, where the business started, but has
moved production abroad to Malaysia.
Offshoring may be used to benefit from the advantages
that overseas operations can offer. This can increase the
competitiveness and profitability of a business. However,
moving production overseas can raise ethical issues. The
business may be criticised for taking jobs away from the
home country and there may be accusations of exploiting
9.1
employees abroad. Offshoring may also bring problems
associated with managing a business based overseas; for
example:
» With products having further to travel, there may be a
great risk of delays which could delay production.
» It may be more difficult to manage operations overseas,
for example, due to communication issues if the
9.1.1 Location
businesses operate in different time zones.
» There may be an exchange rate risk if there is a different
currency in the overseas location. Changes in the
exchange rate may reduce the cost advantage of being
based overseas, and this could introduce an element of
financial risk in the operations of the business.
» There may be a risk of political change in the overseas
country, which could remove the advantages of going
there in the first place. In some cases, overseas
governments, for example, have seized assets of foreign-
owned businesses.
These problems with offshoring sometimes cause businesses
to bring back production from overseas to their home
country; this is known as ‘reshoring’. This has been a
growing trend in recent years. Reshoring will be considered,
for example, if government policies change (making
domestic production more attractive again) or if costs
abroad rise (making production abroad less attractive).
Globalisation
Globalisation occurs when countries become more open
to trade and the movement of money, people, goods and
services across borders. With more globalisation, businesses
will look to locate in different places around the world
and it will be easier for them to do this. Globalisation has
increased due to factors such as:
» better communications, enabling businesses to operate
more easily around the world
» lower transport costs, making it financially viable to
move products all over the globe
» fewer trade barriers, making it possible to export and
import products more easily.
Of course, many social, economic and cultural differences
still exist between countries and the difficulties of locating
overseas should not be under-estimated, but globalisation
has brought about more openness. This means, for example,
that it may be easier and more appealing to locate
production overseas than it was in the past. Countries
often have trading agreements in which standards and
regulations are brought together so that, for example,
operating anywhere within the European Union is relatively
straightforward as the same policies apply. Globalisation,
therefore, opens up more markets to trade in, to locate in
and to buy from.
Having said this, we certainly are not operating in a world
which is one open market, and there will be instances where
trade flows are made more difficult. Under President Trump,
for example, the USA pursued a ‘Make America Great Again’
399
 campaign which introduced many trade barriers with China.
China responded with its own trade barriers. These policies,
9.1 combined with lower taxes and fewer business regulations,
CASE STUDY
Reshoring
In 2018, foreign direct investment and the number of US
companies reshoring was at its highest ever level. The
A LEVEL 9.1 LOCATION AND SCALE
appeal of relocating production back to the USA was due
to a combination of factors, such as:
● a reduction in regulations, making it easier to do
business in the USA
● tax cuts, making it cheaper to do business and
enabling businesses to keep more of their profits
● higher wages and prices in China, meaning it was
no longer so attractive on cost grounds
9.1.2 Scale of operations
Factors influencing the scale of a
business
When we talk about the scale of production, we are referring
to a firm’s output level; this will depend on its capacity. The
capacity is the maximum output that an organisation can
produce at any moment, given its resources. The capacity of
a firm at any moment will depend on:
» its capital, such as office space, store space, level of
machinery and equipment
» the existing level of technology
» the number and skills of its employees.
If a business increases its capacity, it is increasing the
scale of its production. Deciding on the correct scale for
an organisation is a critical decision for its managers. If
the capacity is too low compared with demand, they will
have to turn away orders, possibly losing customers. If the
level is too high compared with demand, they will have idle
resources such as equipment and machinery.
The ‘right’ scale for a business will depend on:
» The expected levels of sales The higher the level of
demand, the greater the desired scale, assuming the
demand can be sustained.
» The costs involved in growing Can the business afford
to expand? Expansion often involves investing in the
short term and may take months or even years to gain a
return. The organisation may not be able to produce on
the scale it wants because it does not have the money
to buy all the resources it needs.
» The resources available For example, firms may not be
able to recruit sufficient numbers of staff if the skills
they want are in short supply.
A firm can increase its scale by:
» investing in new capital, such as IT systems, equipment
and technology
400
made the USA more attractive for some companies that
had shifted production abroad; a number of US businesses
reshored their production back to the USA as a result.
● US government policy, making it more expensive to
import many products from China
● a desire to have supplies closer to home, because of
growing concerns that global supply chains could be
disrupted by events around the world.
Questions
1 Analyse two factors leading to greater globalisation in
the world economy. [8]
2 Evaluate the impact of greater globalisation on the
location decisions of a business. [20]
» investing in its labour; for example, training the
workforce to increase its productivity or hiring more
employees to provide more ‘people input’
» taking over another business or merging with another
organisation (for more on mergers and takeovers, see
page 222).
As a business grows and changes its scale, it tends to
experience efficiency gains (called economies of scale)
up to a certain scale and then inefficiencies (called
diseconomies of scale) after that (see Figure 9.3).
Cost per unit
0
Economies of scale Diseconomies
Output of scale
▲ Figure 9.3 Economies and diseconomies of scale
GLOSSARY TERMS
Capital is the money invested into a business and is used
to purchase a range of assets, including machinery and
inventories.
Economies of scale occur when the unit costs fall as the
scale of production increases.
Diseconomies of scale occur when unit costs increase as
the scale of production increases.
Causes of internal economies of scale
Internal economies of scale occur when the cost of
producing a unit (the unit cost) falls as the firm increases
its scale of production (its capacity level). There are several
types of economy of scale, as Figure 9.4 shows.
Technical
Marketing Financial
Types of
internal
economy
of scale
Purchasing Managerial
▲ Figure 9.4 Internal economies of scale
» Technical economies of scale As a firm expands, it
may be able to adopt different production techniques
to reduce the unit cost of production. For example, a
business may be able to introduce a production line. This
is expensive in itself, but if it can be used to produce
on a large scale, the costs can be spread over many
units, reducing the unit cost. At Mars’ factory in Slough,
3 million Mars bars are produced each day.
Another technical economy of scale is known as
specialisation. As firms grow bigger, they are able to
employ people to specialise in different areas of the
organisation. Instead of having managers trying to do
several jobs at once or having to pay specialist companies
to do the work, they can employ their own staff to
concentrate on particular areas of the business. For
example, they might employ their own accountants or
market researchers. By using specialists rather than buying
in these services from outside firms, the business can make
better decisions and save money. For example, a specialist
finance director may be able to find ways of reducing
the tax burden or organising cheaper sources of finance.
Specialisation also occurs when, as a business grows, it
splits the process into a series of separate routine tasks.
Each individual then completes their task and, because
they are focusing on a relatively small task and repeating
it, they become faster at it and more efficient.
» Purchasing economies As firms get bigger, they need to
buy more resources. As a result, they should be able to
negotiate better deals with suppliers and reduce the price
of their components and raw materials. Large firms are
also more likely to get discounts when buying advertising
space or dealing with distributors. If a firm can become a
big customer, the supplier will be eager to keep that deal
and so is likely to offer better terms and conditions. The
bargaining power of firms may mean lower unit costs and
also better cash flow. This approach is what enables a
business such as Walmart to compete so effectively.
9.1
» Marketing economies As the business expands, the cost
of a media campaign can be divided over more units of
sales, making bigger campaigns more feasible.
» Managerial economies As businesses grow, they can
afford to employ managers in specialist areas, such as
human resources and a legal department. This is because
the costs can be spread over more output. The use of
9.1.2 Scale of operations
specialists can lead to more effective and more efficient
decision-making.
» Financial economies As a business gets bigger and has
more assets, it may be able to borrow money at lower
interest rates. Banks may be more confident that they
can take assets if need be and so there is less risk of
not recovering the money; this means they are likely to
charge less.
Businesses that grow also tend to benefit from ‘learning
by doing’. More experience of what to do, how to do it,
what not to do and who to use to do it can make the whole
process more efficient. This efficiency gain should not
be underestimated. If you are trying to start a business,
for example, there is a tremendous amount you simply
do not know how to do. However, a more experienced
businessperson will have made the errors in the past and
will now be getting it right and operating more efficiently.
Economies of scale can be important because the costs of
producing a unit can have a significant impact on a firm’s
competitiveness. If an organisation can reduce its unit
costs, it can either keep its price the same and benefit from
higher profit margins, or it can pass the cost saving on to the
customer by cutting the price. If it chooses the first option,
this may mean higher rewards for the owners or more funds
for investment. If, on the other hand, it cuts the price, it may
be able to offer better value for money than its competitors.
The ability to lower price and still make a profit may be very
important in a market with falling demand; this means such
firms may be in a better position to survive a recession.
Firms with economies of scale may be able to price
competitors out of the market if they wish. This can act as
a threat to potential entrants who know they would be less
efficient than the established business at first, because
they would be operating on a smaller scale and therefore
may not want to take the risk of a price war. This means
that economies of scale can act as a barrier to entry.
The extent to which economies of scale exist will vary
between industries. In industries such as energy or
telecommunications, very heavy investment is required to
start operations and these costs can be spread over large
outputs, meaning economies of scale are important. It is
difficult for small businesses to survive in these industries
because they are very inefficient relative to the bigger
firms. In other industries such as hairdressing, the costs are
mainly labour, and growth requires more people. This means
economies of scale do not exist to the same extent and
many small businesses exist in this industry as a result.
401
 CASE STUDY
9.1
Vertical farms in Japan
In Japan there are now ‘farm factories’ producing high
volumes of lettuces. Within the factory, robots move lettuce
seedlings onto massive racks where they are grown under
LED lights. At full capacity, some of these factories produce
30 000 lettuces a day. These factories are known as vertical
farms. Plants are grown indoors in stacked layers, often
A LEVEL 9.1 LOCATION AND SCALE
without any soil. These vertical farms can be built anywhere
and produce whatever the weather. The scale of production
can reduce unit costs, making the business profitable.
To generate the returns investors require, a viable
vertical farm needs big facilities to gain economies of
scale, low levels of waste, and high levels of automation
of processes such as seeding and harvesting, that have
traditionally been labour-intensive.
CASE STUDY
WarnerMedia
WarnerMedia’s aim is to become the world’s leading
video-content company. To do this, it says it wants to be
the preferred choice for the best talent and the best ideas
in the industry; this will enable it to provide engaging
and valuable content. WarnerMedia shares this content
with consumers around the world through a range of
technologies.
It says that in all its decisions it will be financially
disciplined so that it can deliver high financial returns to
its shareholders.
WarnerMedia’s strategy has four main elements. The
company sets out to:
● use its large scale and its brands to invest in the best
storytelling in the industry
Causes of internal diseconomies
of scale
Diseconomies of scale occur when a firm expands its
capacity and the cost per unit increases. Diseconomies of
scale are often linked to the problems of managing more
businesses. As organisations grow, they have more products,
operate in more regions and have more staff, and simply
keeping everyone focused and working together can be
difficult.
Diseconomies of scale can therefore occur for several
reasons:
» Communication problems With more people involved
in the business, it can be difficult to ensure that
messages get to the right people at the right time.
Although developments in information technology such
as emails and intranets have helped, it can still be
402
The vertical farms can offer a stable supply of crops
(because they are growing indoors) and because conditions
are so hygienic that the plants have fewer blemishes. The
producers can also automate the slicing of lettuces, enabling
them to supply fast-food outlets with salad-ready lettuce.
Japanese vertical farmers are now looking to expand
overseas where this process could appeal – particularly in
countries where water supplies are an issue, such as the
United Arab Emirates. The main environmental concern
about these farms is the source of energy for the LED
lights but, wherever possible, this is solar power.
Question
1 Evaluate the importance of scale to vertical
farmers. [12]
● use technology and develop new business models
to increase the value of its content to consumers and
distributors and to drive the growth of the business
● increase its presence in the most attractive
international markets to take advantage of the growing
demand for its content worldwide
● ensure it is efficient, to help provide attractive returns
to its shareholders.
Questions
1 Analyse two possible factors which influence the
strategy adopted by WarnerMedia. [8]
2 Evaluate the benefits to businesses such as
WarnerMedia of operating on a large scale. [20]
Communication
Types
of internal
diseconomies
of scale
Motivation
Co-ordination
and control
▲ Figure 9.5 Internal diseconomies of scale
 quite difficult to make sure everyone in a large business
knows exactly what they are supposed to know, when
they are supposed to know it. When businesses are in
different parts of the world, there can be differences
in time zones; however, even if people are in the
same buildings, where there are hundreds of them it
can be difficult meeting up. With increased numbers,
there is great reliance on email rather than face-to-
face discussions and this reduces the quality of the
communications. There may be more messages in your
inbox, but this does not mean that communication is
actually effective.
» Co-ordination and control problems Just as
communicating properly gets more difficult in a large
organisation, so does controlling all the different
activities and making sure everyone is working towards
the same overall goals. As the firm expands and sets
up new parts of the business, it is easy for different
people to be working in different ways and setting
different objectives. It becomes increasingly difficult
to monitor what is going on and to make sure everyone
is working together. Culture differences are likely to
emerge as differences in the values of different parts
of the business become apparent. The UK division
will do things differently from the French division,
the operations team see themselves as different from
the marketing team. These differences in approach,
management styles and values can lead to difficulties
in terms of how the different parts of the business work
together, causing inefficiency. These differences can get
worse and lead to resentment due to the communication
problems outlined above.
» Motivation As a firm gets bigger, it can become much
harder to make sure everyone feels like a part of the
organisation (again highlighting the importance of
communication). Senior managers are less likely to
be able to stay in day-to-day contact with all the
employees, and so some people may feel less involved.
In a small business, there is often a good team
environment; everyone tends to see everyone else every
day and it is easier to feel they are working towards
the same goal. Any problems can be sorted out quickly,
face-to-face. As the organisation grows, its employees
can feel isolated and have less sense of belonging.
As a result, they can become demotivated. Think of
Maslow’s hierarchy of needs (see Section 2.2) and you
can appreciate that social needs and ego needs may be
neglected due to less personal contact.
Diseconomies of scale often occur when mergers
and takeovers take place. Managers often anticipate
economies of scale from sharing resources, synergy and
the power of a large scale. In reality, the difficulties
of agreeing on standard policies, cultural clashes,
different priorities and strategies can lead to significant
diseconomies which lead to cost disadvantages overall.
In practice, most takeovers and mergers lead to worse
financial performance for the combined companies than
they achieved individually. To avoid diseconomies of scale,
managers use practices such as:
» having a mission statement to unify the business and
outline the central purpose
» managing by objectives – an approach in which all
employees are set targets tying them to the overall
9.1
corporate objective
» using appraisals to review individuals’ progress and
ensure that they feel involved and as if they are acting
in line with the overall aims of the business
» communicating regularly in a variety of ways to ensure
people feel informed. This could be via newsletters,
9.1.2 Scale of operations
corporate videos, emails or staff meetings.
Getting the ‘right’ size of firm is a crucial issue for managers.
Firms want to be big enough to have market power and
benefit from economies of scale but not so big that they
suffer from diseconomies of scale. In industries such as
brewing and pharmaceuticals, many firms have joined
together to benefit from economies of scale. At the same
time, other firms have split up into smaller units because of
the problems of large size. There is, it seems, no ideal size.
It depends on the particular nature of the business, its own
culture and communication, and the nature of the industry.
Unit costs
($)
Output
Internal economies of scale: Internal diseconomies of scale:
as output increases, unit as output increases, unit
costs fall costs rise
▲ Figure 9.6 Internal economies and diseconomies of scale
STUDY TIP
Remember to look at the case studies to get an idea of how
big the owners or managers want the business to be. Also:
● check if the demand is actually there to justify
expansion – there is no point producing more if you
cannot sell
● check if it is possible to staff the expansion
● check to see if the business has mechanisms in place
(such as budgeting and appraisals) to try to ensure
that diseconomies of scale do not occur if it grows.
Causes of external economies and
diseconomies of scale
Internal economies and diseconomies of scale occur when
a business expands the size of its operations. External
economies and diseconomies occur when at each and every
level of output the unit cost falls (for external economies)
or rises (for external diseconomies). This happens due to
403

9.1
A LEVEL 9.1 LOCATION AND SCALE
factors outside of the business. External economies of scale Unit costs
($)
may occur because:
» suppliers have expanded and benefited from internal
economies of scale; as a result their unit costs fall
and this might be passed on to the business they are
supplying
» investment in infrastructure – for example, by the
government – reduces costs such as communication or
transports costs
» the business locates in a particular area which
specialises in this industry. Examples include Hollywood,

which specialises in film production and Silicon valley, Output

Output 1 Output 2
which specialises in technology businesses. It is likely
External economies of scale: at each output, unit costs fall
that a network of suppliers will develop in these areas due to factors external to the business
and many other similar businesses will be drawn to it
▲ Figure 9.7 External economies of scale
because they may be able share resources and facilities.
It is also likely to attract other businesses linked to the Unit costs
industry; for example, businesses linked to research and ($)

development or staff training. By locating in this area, a

business will have access to specialist suppliers and also
employees at a lower cost than if it had to buy them in
from elsewhere. The benefits that occur when businesses
within an industry cluster together are called economies
of agglomeration.
External diseconomies of scale may occur if suppliers have
become too big and experienced internal diseconomies,
which increases their unit costs. They might then increase
prices and so businesses buying from them experience Output 1 Output 2
Output
external diseconomies of scale. External diseconomies of scale: at each output, unit costs rise
due to factors external to the business

▲ Figure 9.8 External diseconomies of scale

TEST YOUR LEARNING

Short answer questions
1 Explain one possible ethical issue that might affect
a business’ location decision.
2 Explain two factors that influence the location of a
business.
3 Explain one reason why a business might offshore
its operations.
4 Explain one reason why a business might reshore
its operations.
5 Explain one reason why a business might relocate. [3]
6 Define the term ‘unit costs’.
7 a Define the term ‘internal economy of scale’.
b Explain one internal economy of scale.
8 Define the term ‘internal diseconomy of scale’.
9 Explain one reason why internal economies of scale
may help a business succeed.
10 Explain one reason why diseconomies of scale affect
unit costs.
Data response question
Pantaloon Retail India Ltd
[3] ‘With more than 1000 stores and 16 million square feet
(1.5 million square metres) of operational space,
[6] Pantaloon Retail India Ltd is now close to a point where it
reaps the benefits of economies of scale,’ its founder and
[3] managing director Kishore Biyani says.
The company’s aim is to expand its operational retail
[3]
space to 25–30 million square feet (2.3–2.8 million square
metres) in the next four years. Its annual revenues are
[2] expected to grow by 30–35 per cent between now and then.
[2]
Biyani recently said the company was very well-placed in
[3]
terms of its cost structures. ‘We are eliminating all the
[2] excess costs that are there in the system and becoming
very, very competitive.’
[3]
The global retailing business is one of low profit margins,
[3] with profitability dependent on the efficiency of a company
and its supply chain management, and its operational
scale.

404
Retailing in India Questions
India’s large-scale retailing sector is still in its early
growth stage, with the majority of the population relying
1 Define the terms:
a ‘revenue’ [2]
9.1
on millions of small, independent shops for their daily b ‘supply chain’. [2]
groceries.
2 Analyse two possible consequences of limiting
Government restrictions on direct investment by other the extent to which foreign retailers can compete
countries have thus far protected the local industry but in India. [8]
also meant there has been a lack of investment in areas 3 Evaluate the importance of economies of scale in
such as warehousing and cold-storage facilities. helping a retail business to compete. [20]

9.1.2 Scale of operations

In the past, foreign retailers have been allowed to own up Essay question
to 51 per cent of businesses which sell products from a
single brand, such as Nike sportswear. Those businesses 1 Evaluate the possible advantages and disadvantages
who sell multiple brands, such as Walmart Stores, have to a business of expanding the scale of its
been prevented from selling directly to consumers in production. [20]
India. However, they are permitted to run cash-and-
carry businesses which supply wholesalers and smaller
businesses and shops.
Source: www.marketwatch.com/story/indias-pantaloon-retail-
taps-economies-of-scale-2011-07-24

405
 9 Operations management
A LEVEL

9.2 Quality management

A LEVEL 9.2 QUALITY MANAGEMENT

Chapter overview
In this chapter we examine:
★ the meaning of quality in terms of meeting customer expectations
★ the difference between quality control and quality assurance
★ the impact of quality control and quality assurance
★ the impact of total quality management (TQM) on a business
★ the meaning of benchmarking
★ the importance of benchmarking in quality management.

9.2.1 Quality control and quality
assurance
An important aspect of operations management is
making sure that the goods and services produced are of
a suitable quality. A quality product is one that meets
the specifications that the firm has set out and, in turn,
meets the customers’ needs and expectations. As famous
management writer Peter Drucker says, ‘Quality in a product
or service is not what the supplier puts in. It is what the
customer gets out and is willing to pay for. A product is not
quality because it is hard to make and costs a lot of money,
as manufacturers typically believe. This is incompetence.
Customers pay only for what is of use to them and gives them
value. Nothing else constitutes quality.’ What is and what is
not quality therefore depends on the customers’ views.
Quality has been defined as ‘fitness for use’ by Juran (1981)
and ‘conformance to requirement’ by Crosby (1979). A pad
of paper priced at $1 or a light bulb priced at 75 cents can
both be quality products, provided they do what consumers
expect them to do. By comparison, a million-dollar house
or a $400 suit may be poor quality if they do not meet
consumers’ expectations. The fact that these products
are expensive does not mean they are necessarily of good
quality. To improve the effectiveness of the business,
managers must make sure that what they are producing
consistently meets customers’ requirements. This in turn
means that to produce good products, a firm must identify
exactly what customers are looking for. The firm must then
specify exactly what the product has to do and make sure
that these specifications are achieved every time.
To achieve quality, managers must therefore set targets
based on customer needs and expectations and then make
sure that the targets are being achieved. By improving the
quality of their products, managers should improve customer
satisfaction which should lead to repeat business.
GLOSSARY TERM
A quality product is one that meets customer
expectations.
Quality targets
The nature of the quality targets that are set will depend on
the type of business.
A hotel might set quality targets involving:
» customer satisfaction levels
» accurate billing
» speed of response, such as in reception and the
restaurant.
A manufacturing business might consider the following
aspects of quality:
» the proportion of products with defects
» the amount of waste produced in the process
» the proportion of returned goods.
A hospital might consider these aspects of quality:
» the time taken to see patients
» the average length of time spent by patients in hospital
» the recovery rates for different types of operation
» patient satisfaction rates.
These quality targets will not be fixed forever. Once a target
is achieved, managers should look to make it even more
challenging or find another area that needs focusing on, in
order to improve the business further.

Business Set quality target Identify needs Customer

▲ Figure 9.9 Identify needs – set quality target

406
Why does quality matter?
Poor quality leads to mistakes that have to be put right or
fixed. Goods may have to be thrown away. Items may be
returned and have to be replaced. In a worst-case situation,
you may even be sued for failing to deliver the products
promised. You may also lose customer goodwill and loyalty.
CASE STUDY
L’Oréal
At L’Oréal, the cosmetics business, quality is regarded as
essential for success. The company says that its mission is
to guarantee that the raw materials it uses and the products
it manufactures ‘are of identical quality to what was agreed
when they were approved, anywhere and at any time’.
L’Oréal says that ‘the performance, safety and regulatory
compliance of our formulas are based on the quality of our
raw materials’, so it does not allow any variation in quality.
First, the raw materials are checked as soon as they
enter the supply chain using industrial specifications.
The supplier details the criteria, standards and checking
methods that must be adhered to. Once the raw materials
arrive at the production plant, the labels are checked
on each package, and the raw materials are identified to
ensure that the item received matches the item ordered.
Further checks may ensure that what is in the delivery
STUDY TIP
Remember that we are referring to quality from the
perspective of the operations team. This, therefore, focuses
on whether the item is fit for purpose and does what it is
CASE STUDY
Jaguar Land Rover Automotive
In 2019, the automobile manufacturer, Jaguar Land Rover
(JLR), experienced disappointing financial results in China.
Partly this was due to the very competitive market conditions.
However, it was also due to poor quality production which
led to a loss of brand reputation and sales. JLR had several
problems in China with the reliability and dependability of its
production. At the same time, the overall car market in China
was getting smaller – in 2019 the number of new cars sold
fell for the first time in 28 years.
JLR’s quality problems go back to when the UK luxury
automaker was still owned by Ford. The problems
continued after Tata Motors acquired JLR in 2008. In
2014, JLR started production at a joint venture with Chery
Automobile in the east China city of Changshu. Five models
that were assembled locally – the Land Rover Evoque and
Discovery, and the Jaguar XFL, XEL and E-Pace – were all
launched between 2015 and 2017. Producing within China
meant customers could circumvent the 25 per cent tariff
that Chinese customs placed on imported vehicles. Not
only did JLR produce locally, it also changed its vehicle
interiors and exteriors to meet local tastes.
The effects of poor quality are therefore expensive. Philip
Crosby, a management writer in this area, believes that
between 20 and 35 per cent of firms’ revenues can be spent
putting right all the consequences of poor quality. He argues
9.2
that investing to prevent mistakes occurring is far cheaper
than putting things right later on. Improving quality can
improve customer satisfaction and save money.
9.2.1 Quality control and quality assurance
is the material described and that it will perform as
necessary. To allow these further checks, each production
plant has a quality department with its own laboratory
for performing the necessary tests. No raw materials are
used until all these checks have been undertaken.
Source: https://beautytmr.com/the-incredible-way-we-guarantee-
the-quality-of-our-products-b7c28270ac22
Questions
1 Explain one way in which L’Oréal ensures the quality
of its supplies. [3]
2 Analyse two reasons why quality is important to
L’Oréal. [8]
3 Evaluate the importance of quality supplies to
L’Oréal. [12]
intended to; it does not necessarily mean it is the most
expensive item in the store. Expensive items can be poor
quality if they are produced badly.
As example of the quality problems, in 2017 JLR had
to make 13 recalls in China for component defects
including engines, instrument panels, airbags and
batteries. The recalls affected 106 000 vehicles; this was
more than 70 per cent of JLR’s sales in China that year.
In recent years, local dealers have had to offer major
discounts to sell their inventory. The quality problems
have damaged the brand image of Jaguar and Land Rover
in China, making their products even less attractive to
local buyers. However, JLR has other challenges ahead.
For example, it needs to produce more electric vehicles to
meet local regulatory requirements. This requires major
investment and changes in production.
Source: https://europe.autonews.com/automakers/jaguar-land-
rover-hurt-quality-control-issues-china
Questions
1 Analyse two possible costs of poor quality for JLR. [8]
2 Evaluate the likely impact of poor quality on JLR’s
financial performance. [20]
407
 Quality control
9.2 The traditional approach to improving the quality of a firm’s
products is to put resources into inspecting the finished
products to find any faults that exist and remove them.
The logic behind this approach is that, if all the goods
and services with defects can be found, the customer will
only receive perfect products. As a result, quality will be
improved. This is known as a quality control system and it
relies on the inspection of products.
A LEVEL 9.2 QUALITY MANAGEMENT
In recent years, many managers have questioned whether
quality control is the best approach. One problem is that
quality control assumes that defects are inevitable. The
task is to make sure that they are discovered before the
customer receives the product. In effect, this is saying to
some elements of the production team that it is acceptable
for them to make mistakes because the quality control
department will find them later. This may mean that
employees do not take sufficient care in their work.
GLOSSARY TERMS
A quality control process relies on checking products for
faults at the end of the production process.
A quality assurance process aims to prevent mistakes
throughout the production process, rather than using
resources (such as time and money) to correct them at
the end.
Total quality management (TQM) is an approach to quality
involving all the employees in the organisation, whereby
employees consider not only the expectations of their
external customers but also those of their colleagues (or
‘internal customers’), to ensure that all aspects of the
work they produce are high quality.
Quality assurance
The quality assurance approach puts more emphasis
on preventing mistakes rather than finding them. If the
process can be designed in a way that ensures defects do
not happen (and in which employees produce correct work
every time), inspection at the end of the production process
is less important. This approach to quality focuses more
on prevention, not just inspection. It stresses the need for
employees to get it right first time.
An important part of this approach is that employees check
their own work rather than relying on someone else to
check it for them at the end of the process. This is known
as self-checking. Under this approach, employees also have
the right to reject any work of an unacceptable standard,
whoever produced it. Previously, employees often accepted
poor-quality items as they did not feel responsible for the
finished product. Faulty products were simply passed along
the production line until the quality control department
found the mistakes at the end. Under a quality assurance
system, employees are held responsible for their own work;
if they find faulty work from other employees, they need to
communicate with colleagues to sort it out or report it.
Ensuring that they produce quality work is now seen as
a part of everyone’s job. At General Motors, for example,
408
employees are told, ‘don’t accept errors, don’t build errors
and don’t pass them on’. This is a very different view from
the past, when quality was seen as something undertaken
only by the quality control department.
Quality assurance requires training so that individuals can
carry out their tasks effectively. It also involves choosing
the right suppliers so that they deliver products without
any defects – you will not check their products because
you assume that they are correct. Thus, the responsibility
for any problems caused later will be with the suppliers,
which therefore puts pressure on them to get it right
(see Figure 9.10).
Choosing the right suppliers Self-checking by employees
Quality assurance
Employees reject faulty work Training
▲ Figure 9.10 Quality assurance
Total quality management (TQM)
Total quality management (TQM) is an approach to
quality involving all the employees in the organisation.
This quality assurance system appreciates that everyone
within the firm contributes to the overall quality of the
product or service.
TQM recognises that all employees are of equal importance,
including those on the factory floor, the office staff, the
cleaners, the maintenance staff and the delivery drivers.
The way in which customers are dealt with when they
make enquiries, the accuracy of invoices sent out and the
reliability of the vans all have an impact on how customers
view the firm. It is not just the people who directly make
or provide the product who matter.
It is very important that all employees think about the
work they do and whether it is of a suitable quality. This
means that they need to think of who their customers
are. These customers may be the people who actually buy
the product, but they also include anyone for whom work
is produced.
Customers are not just external (the people from outside
the business who buy the product); they are also internal.
Employees need to think of the requirements of all the
people they produce work for and ensure they are providing
exactly what is required. For example, the warehouse staff
have to load materials onto the van for delivery, so the
delivery drivers are the internal customers of the warehouse
staff. Under the TQM approach, everyone has to think about
their customers’ needs: what they want, what standard they
want it to and when they need it by.
The TQM approach considers that employees should always
aim to improve the quality of what they do. It is tempting
to assume that what you are doing is ‘good enough’ and,
if profits are reasonable, it is easy to become complacent.
Such complacency is dangerous because markets and
conditions can change incredibly rapidly. To succeed, firms
must be continually trying to improve what they do to
ensure that they actively delight customers. Under TQM,
quality is seen as a dynamic process – it is a journey,
not a destination. If managers are able to improve the
quality of the firm’s operations, this should improve its
competitiveness.
Why might employees resist a TQM approach?
Some employees may resist the introduction of a TQM
approach. This could be because they see quality as the
job of a separate quality control department and do not
see why they should check their own work. They may think
it will lead to the redundancies of colleagues in quality
control if they actually manage to prevent all mistakes
and so do not want to do this. They may also be reluctant
to take on additional tasks. If they adopt TQM, they must
first be willing to reject any work that is passed to them
that is not satisfactory; that may involve telling colleagues
and friends to do something again, which can be difficult
to do on a personal level. Also, they must check their own
work before passing it on and may not see why they should
do this. Some employees may also resist a TQM approach
because they:
» don’t see why it is necessary
» don’t want to have to undertake additional training
» prefer to carry on doing things in the same old way.
Given that TQM involves a change in responsibilities and
duties, managers must make sure they:
» explain why it is necessary
» provide the necessary training and support so that
employees feel capable and reassured
» provide appropriate rewards so that employees
feel they are treated fairly for taking on extra
responsibilities.
Designing the product
The process of improving quality begins with a good
understanding of what internal and external customers
want. This involves effective market research and use of
information. The better the understanding of customers’
needs (including your own staff, your operations
department), the more likely it is that a firm will produce
something that meets their needs precisely.
The aim is to design a product to meet customers’
requirements and a means of producing the product that
enables the business to make an appropriate amount of
profit. The design stage is absolutely critical to the success
of a product and to achieving good quality. Effective
planning before production begins means that the firm
will produce something that customers want and that it is
produced in an efficient way. The way the process is laid
out, the equipment used, the level of technology involved
and the way in which it is organised all have a major impact
on the final quality of the goods or services.
Most companies would benefit from investing more at
the design stage. If the initial design of the product and
process is wrong, it is very expensive to put things right
later. Unfortunately, in the rush to put products on the
market, firms are willing to accept products and processes
that are only adequate, rather than excellent. This is all part
of a very common approach that is often more expensive in
9.2
the long term. According to the UK Department of Trade and
Industry, ‘Many senior managers [in the UK] still consider
the design function a necessary evil, a costly and non-
productive unit which often delays the introduction of a
new product.’
9.2.1 Quality control and quality assurance
STUDY TIP
You need to be aware of the importance of quality and the
difference between quality control and quality assurance.
You should be able to discuss the benefits of better
quality, the ways this can be achieved and difficulties
achieving it.
To increase its effectiveness, a business may try to
improve its quality and prevent mistakes occurring. You
need to think of the consequences of improving quality
for the other functions of the business, such as human
resources, marketing and finance.
Improving quality
Quality is an important element of a firm’s success. Not
surprisingly then, managers should always be looking to
improve the quality of their goods and services. If managers
want the business to improve its quality, they must make it
clear that this is a priority and develop appropriate systems
to make sure that employees are always trying to improve
quality. Bringing about better quality involves:
» defining clearly the needs of your internal and external
customers in order to set appropriate quality targets
» introducing a TQM approach and ensuring that aiming for
zero defects and getting it right first time is seen as an
important element of everyone’s job
» ensuring that the resources are available to enable
quality targets to be achieved (for example, sufficient
training so staff can check their own work) – this may
cost money at first but will save money in the long term
» working closely with suppliers to ensure they can meet
your needs quickly and reliably
» ensuring that there is an ongoing programme of target-
setting and measuring – once targets are consistently
achieved, more demanding targets can then be set
» ensuring that your reward systems recognise those who
achieve better quality.
Philip Crosby’s four absolutes
Philip Crosby’s name is best known for his writings on the
concepts of ‘Do It Right First Time’. He considers traditional
quality control, the idea of acceptable quality limits (that
is, treating a certain level of defects as acceptable), to
represent failure rather than an assurance of success. In
his view, firms must aim for ‘zero defects’ rather than ‘an
acceptable level of defects’. Of course, having a zero defects
approach will not prevent people from making mistakes,
but it will encourage everyone to improve continuously.
409
 The ultimate goal is to train all the staff and give them the
tools for quality improvement and to help them to prevent
9.2 mistakes occurring.
Crosby’s four absolutes of quality management are:
1 Quality is defined as conformance to requirements, not
as ‘goodness’ or ‘elegance’ – that is, quality is defined by
the customers, not by you!
2 The system for causing quality is prevention, not
appraisal – that is, don’t fix it later, get it right first
time.
A LEVEL 9.2 QUALITY MANAGEMENT
3 The performance standard must be zero defects, not
‘that’s close enough’ – that is, don’t accept mistakes.
4 The measurement of quality is the price of non-
conformance – that is, quality saves you money because
it saves you all the costs of fixing the mistakes and
having to rework items.
STUDY TIP
Students often assume that improving quality increases
costs. Crosby suggests that it can actually save money.
9.2.2 Benchmarking
As part of the drive to improve quality and to meet customer
requirements more effectively, some business will use a
process called benchmarking. This aims to develop better
processes and systems and this should lead to better quality.
Benchmarking occurs when one business measures its
performance against other organisations. Firms benchmark
against other organisations that are strong in particular
areas. The aim of benchmarking is to learn from the
best firms in the world and discover ways of improving
operations. If you want to know how to manage large
numbers of visitors, talk to Disney; if you want to know
how to come up with great design, ask Apple; if you want to
move things around reliably, talk to UPS.
Looking for ways to improve corporate performance
internally assumes that a business’ staff knows the best
way of doing something, or they know how to improve it.
Analysing the actions of other organisations, especially
experts in the relevant business area, means a business is
more likely to find the best solution. This is particularly
true if firms benchmark against the best in the world.
Benchmarking may be against other firms in the same
industry or even against organisations in a completely
different sector. It highlights the importance of being a
learning organisation and not being complacent. Firms may
use benchmarking to help them improve in areas such as:
» the reliability of their products
» their ability to send out the correct bills (also called
invoices)
» their ability to deliver items on time
» the time it takes to produce a product.
Organisations undertaking benchmarking are those most
eager to learn and improve and those that are unafraid to
seek outside help. They are focused on quality and meeting
customer expectations.
410
GLOSSARY TERM
Benchmarking occurs when one business decides to
measure its performance against the leaders in the field,
learning and, therefore, improving the quality of what it does.
The benchmarking process
1 The firm must plan what it wants to benchmark, which
firms it wants to benchmark with, how it is going to
collect the data, which resources to allocate to the
project and who is responsible for the project.
2 The firm must collect data from the other firm (or firms).
This may be through visits to their factories or offices.
3 The firm must analyse its findings to identify how it
could improve its own process.
4 The firm must adapt its findings so it can implement
the new methods in its own firm, given its own
circumstances.
5 The firm must measure the outcomes to ensure that
benchmarking has led to the desired improvement.
Plan what
to
benchmark
Collect
Measure data from
outcomes other
business
Adapt and Analyse
implement findings
▲ Figure 9.11 Benchmarking
The benefits of benchmarking
By undertaking benchmarking a firm should be able to:
» develop a better understanding of customers and
competitors
» have fewer complaints and more satisfied customers
» reduce waste and improve quality.
Benchmarking can be difficult because some firms will
naturally be unwilling to share their information. They
may want to keep their methods and processes secret and
might be reluctant to provide rival businesses with ideas
on how to improve. One way of avoiding this problem is to
benchmark against firms in different industries.
Firms must also be careful about trying to copy another
organisation’s methods exactly. Every organisation has
its own way of doing things, its own skills and its own
circumstances. They may have to adapt the other firm’s
methods for their own use.
 TEST YOUR LEARNING
Short answer questions
1 a Define the term ‘quality’. [2]
b Explain one cost of improving quality. [3]
2 a Define the term ‘quality control’. [2]
b Explain one method of quality control. [3]
3 a Define the term ‘quality assurance’. [2]
b Explain one benefit of quality assurance. [3]
4 a Define the term ‘total quality management’. [2]
b Explain one reason why staff may resist total
quality management. [3]
5 Explain one link between training and quality. [3]
6 Explain one reason why spending more to improve
quality might save costs in the long term. [3]
7 Define the term ‘benchmarking’. [2]
8 Explain one benefit to a business of benchmarking. [3]
9 Explain two reasons why better quality is becoming
more important to businesses. [6]
10 Explain one reason why a product could be expensive
to buy but be of poor quality. [3]
Data response question
Tesla
Tesla has been a highly innovative car producer from
the very beginning. Its founder, Elon Musk, had a vision
of an electric car that would transform the car industry.
However, from its early days, the company had quality
problems. This is perhaps not surprising considering the
fact that its technology was leading the world.
While the early Tesla models were criticised for their
quality, experts say that its 2020 Model Y marked a shift in
the quality of the build of the car. The 2018 Model 3 Tesla
was said by many to be poor quality even though it looked
good. The Model Y had a much better finish.
Quality has been a problem because Tesla has been
9.2
developing the technology at the same time as trying
to meet ever growing levels of demand. The company
has aimed to continue being innovative and develop new
technologies, but it has also had to scale up production
very rapidly. Perhaps not surprisingly, this has led to
production problems. Car reviews have highlighted
problems such as gaps between the car door panels, the
9.2.2 Benchmarking
computer screens going blank and doors not opening
being common with its earlier models. However, the
Model Y was rated fourth in its class in consumer reports
in 2020. The Lexus IS was first with a reliability rating
of 84 per cent, Tesla took fourth at 59 per cent while the
BMW 3-Series and the Alfa Romeo Giulia had only 20 per
cent and 13 per cent respectively.
Interestingly, despite its quality issues, Tesla remained the
fourth best-selling luxury maker in the USA with 9.8 per cent
market share. The Model Y was expected to be its top seller.
Questions
1 Explain one reason why Tesla might have had quality
issues. [3]
2 Analyse two ways in which poor quality might reduce
Tesla’s profits. [8]
3 Evaluate the importance of quality to Tesla. [20]
Essay questions
1 Evaluate the extent to which you think the
success of total quality management depends on
employees. [20]
2 Evaluate the extent to which improving quality is
expensive. [20]
411
 9 Operations management
A LEVEL
9.3 Operations strategy
A LEVEL 9.3 OPERATIONS STRATEGY
Chapter overview
In this chapter we examine:
★ operational decisions and links to other business functions
★ the changing role of information technology (IT) and artificial intelligence (AI) in operations management
★ flexibility of operations
★ innovation in processes and products
★ enterprise resource planning (ERP)
★ lean production including Kaizen, quality circles, simultaneous engineering, cell production, just in time (JIT)
★ operations planning.
9.3.1 Operations decisions
Operations management controls the transformation process
of the business. It lies at the very heart of a business
because it produces the goods or services it offers to its
customers. However, operations decisions cannot be made
in isolation; they must be integrated with the decisions
of the other functions. This is a two-way relationship; for
example, the nature of operations might influence the
human resource requirements but, equally, the skills and
talents of employees might influence what the business can
produce.
Marketing
Finance Operations
Human resources
▲ Figure 9.12 The interrelated functions of business
One of the functions that operations must liaise closely
with is marketing. The starting point for new products will
usually (but not always) come from marketing. Marketing
412
will have identified a market opportunity and then must
liaise with operations to see what is possible:
» Can the business produce enough to meet the expected
sales? Or will it need to increase its capacity?
» Can the business provide the right level of quality? What
benefits can it provide effectively and efficiently? What
level of service can be provided?
» Can the business sell at the price recommended by
marketing and still make a profit?
Many decisions will need to be reviewed to find the best
solution. For example, is it better to find cheaper supplies
so you can keep costs down, or could you actually push the
selling price up if the quality is better? Could you produce
the item with fewer features without damaging demand
significantly?
Operations managers will also want to work closely with the
human resource function. The operations of the business
will influence:
» the number of staff required
» the skills of employees and any training requirements.
If there are labour shortages, this might have an impact on
how much can be produced; if there is a shortage of certain
skills, it might influence exactly what can be produced.
The finance function will also liaise with operations.
For example, it will be important to assess the costs of
different operational options to see if the business can earn
a sufficient return. Any proposed investment in technology,
capacity, new equipment or new facilities will need
analysing in terms of the financial implications. Finance
may need to be raised internally or externally to pay for
any change in operations. Some operational possibilities
may not be affordable or generate sufficient returns to go
ahead.
The key to a successful business, therefore, lies in
integrating the various functions so that the limitations
and opportunities are clear. If functions operate
independently, they might find out too late that what they
want and have planned for is not possible.
Role of IT and AI in operations
management
Developments in information technology (IT) are
occurring at an increasing rate and they are making major
improvements to the operations process. Such developments
include:
» Better communications such as email, information
stored in the cloud and video conferencing. This can
enable better and faster decisions to be made and can
increase productivity. One trend that has really taken off
following the Coronavirus (COVID-19) pandemic in 2020
is remote working. IT enables people to work from home
much more easily than in the past. This can save the
business money on rent and travel costs. The impact on
productivity can vary.
» Faster transfers of information and better sharing of
information with suppliers. This enables the business
to order supplies when needed and to ensure the right
quantity and quality are ordered.
» Better links with retailers and better inventory control
systems reduce the amount of inventory that needs to
be held at any moment.
» Better data analysis; for example, calculating the costs
of any operations.
» The use of radio-frequency identification (RFID)
These are tags that can be used to identify and track
items within the operations process. An RFID tag
consists of a tiny radio transponder, a radio receiver
and transmitter. This enables the business to track
exactly where items are at any moment and to transmit
information to the next stage of the process.
CASE STUDY
Amazon
In 2018, Amazon opened a supermarket in Seattle with
no checkout operators or self-service tills. The store
uses hundreds of cameras mounted on the ceiling and
electronic sensors to identify each customer and track the
items that they select.
When customers enter the store, they swipe their
smartphones with the Amazon Go app. Then they are free
to put any of the products on the shelves straight into their
shopping bags. AI sensors track exactly what goes into a
customer’s basket and add this to their bill. Purchases are
billed automatically to customers’ credit cards when they
leave the store.
» Computer-aided design (CAD) This enables a business
to develop models and prototypes on computers rather
than having to actually build them. This can save
time and money. It also provides more flexibility and
9.3
accuracy when it comes to adjusting the design. By
saving and editing ideas, it is easier to update them.
» Computer-aided manufacturing (CAM) This can enable
higher levels of accuracy, quality and speed, and it can
therefore reduce costs.
Businesses are also able now to benefit from greater use
9.3.1 Operations decisions
of artificial intelligence (AI). AI occurs when computer
systems are developed to undertake cognitive problems
that normally require human intelligence such as learning,
problem-solving and pattern recognition. This means that
computers make decisions and undertake tasks that were
previously done by humans.
AI can affect all aspects of operations. For example, AI can
be used to monitor systems and predict whether there are
any likely problems emerging. It can be used to forecast
sales and therefore determine production scheduling. It can
make decisions to solve operational problems. All of this can
free up people to focus on other tasks.
IT and AI systems can help a business to integrate all the
aspects of operations more efficiently. They enable data
to be collected and analysed faster and more efficiently,
and they can improve the use of resources, reduce wastage,
increase flexibility and enable better decisions to be made.
However, there are investment costs, as well as the costs of
development and training, which need to be considered.
GLOSSARY TERMS
Computer-aided design (CAD) involves the use of
computers to develop, explain and modify a design.
Computer-aided manufacturing (CAM) is the use
of computer software to control machines in the
manufacturing process.
The AI system needs to identify exactly who people are
to make sure the right people are charged for the right
items. It needs to identify what has been put in the basket
and kept and not count anything that has been put back.
It needs to be able to identify each product accurately
for billing. This is very sophisticated technology which
Amazon has had to develop.
Questions
1 Analyse two benefits to customers of Amazon using
its AI technology in its stores. [8]
2 Evaluate the benefits to Amazon of using its AI
technology in its stores. [12]
413
 CASE STUDY
9.3
Microsoft
Microsoft, like some other technology companies, pays
news organisations to use their content on its MSN
website. From July 2020, the MSN homepage stopped
featuring news stories produced by journalists. Nearly
30 researchers lost their jobs when Microsoft replaced
them with AI software. Responsibility was handed over to
A LEVEL 9.3 OPERATIONS STRATEGY
computers to select and edit news articles from content
that appeared on other sites to put on its homepages.
CASE STUDY
L’Oréal
L’Oréal sells to a billion consumers and makes a total of
approximately 7 billion products every single year. That
is nearly 20 million products a day. These include hair
care and cosmetics. The company has huge amounts of
data available and it says it aims to use this to create even
better products. To do this, it collaborates with IBM, which
it describes as one of the world’s finest IT companies.
Working with IBM, L’Oréal has created a platform called
Operations 4.0. This analyses the data it collects from
9.3.2 Flexibility and innovation
The importance of flexibility in
operations
Targets in operations management include:
» the quantity of goods and services that have to be
produced and when the output is required, given the
expected sales pattern. Operations will have to consider
whether it can deliver the right quantity at the desired
time
» the level of quality expected by customers – that is,
what benefits are they expecting?
» the expected costs to enable a profit to be made at the
desired selling price.
Operations targets also include the flexibility of operations
required. For example, should a restaurant provide a set
menu or should customers be able to choose from a range
of items? Does a university provide a range of modules that
can be studied in any combination or does it offer a limited
number of degrees? Does an airline offer a range of flights
at different times from different locations? Businesses need
to decide how flexible they want to be. Flexibility can occur
in terms of:
» the quantities that customers can buy Think of Coca-
Cola and the number of different sized cans and bottles
it offers
» delivery time How much flexibility is there for the
customer to determine the day and time that the
414
Microsoft said it was part of an evaluation of its business
and was nothing to do with the Coronavirus (COVID-19)
pandemic.
Question
1 Analyse two factors Microsoft would have considered
before adopting AI to choose content for its MSN
website. [8]
a variety of sources to rethink its production plants, make
them more flexible and design them to be producing in
anticipation of what is happening in the market so that
stores have the right products they need at any time.
Question
1 Analyse two benefits to L’Oréal of working with IBM to
develop Operations 4.0. [8]
product or service will be delivered? Imagine a new
phone line is being fitted to your house. What is the
lead time before it can be fitted? Is it days or weeks or
months? Can you determine the day and time it will be
fitted, for example, or do you have to stay in all day to
allow them access to the house because the company
cannot give you a set time?
» specification How much can the customer influence the
actual design of the product? Imagine you are buying a
new phone – how much choice do you have in terms of
specifications? Could you personalise it?
Complete flexibility would involve the customer having a
personalised product that only they have, that is prepared
when they want and how they want it. By comparison, there
is a lack of flexibility if the business produces one version
of a product and the customer has to ‘take it or leave it’.
Examples of flexibility include:
» made-to-measure shirts and suits
» design-your-own shoes
» choosing the colour, tyres, interior design and other
specifications of a model of car.
The more flexible operations can be, the better it is in
terms of meeting customers’ needs. Flexible production
allows a business to target customers’ requirements more
precisely. However, in reality, there may be constraints
limiting this flexibility:
» The business may not be able to offer all the desired
features, because it lacks either the necessary skills or
technology. The costs of being flexible may be too high;
 switching from producing one product to another can be
expensive. Economies of scale will be more difficult to
achieve for short production runs of different products.
» The business may not have the capacity to produce in
the quantities required and therefore may need to look
to others to produce some of it (called subcontracting).
The business may be busy with another order and so
cannot start a new one for some time.
The flexibility offered by a business will depend on how
the business wants to position itself in the market and the
impact it will have on revenue compared to costs.
The pressure from customers is for more flexibility. With
greater access online to information about their options,
customers are generally in a stronger bargaining position
CASE STUDY
Awl & Sundry
Awl & Sundry’s company mission is ‘to democratise the
luxury of bespoke footwear’.
The company’s founder, Nikunj, discovered he could not
find a smart pair of shoes for a reasonable price. After six
weeks of searching, he could find nothing that combined
comfort, style and affordability – the only options forced him
to choose between them. The Awl & Sundry business was
therefore created because of Nikunj’s ‘frustration of not
being able to find the perfect pair of shoes at a fair price’.
Nikunj then set out to find a shoemaker able to create
custom-made shoes for a reasonable price – and he was
Process innovation
Innovation involves developing new ideas. This may be
developing new products (called product innovation)
or developing new ways of doing things (called process
innovation). For example, enabling people to order and pay
online is a process innovation – it is making the old way of
doing things seem slow and cumbersome.
Businesses will be looking for ways of being more efficient
and this means looking to save costs. Process innovation can
enable a business to improve what it does and save money in
doing so; for example, using technology such as CAD and CAM
to produce can enable better results, faster and at a lower
cost. Just think about how the internet has transformed the
way we find information – think of the quantity and quality
of information we now find quickly, and think about the time
saved compared with going to the library and trying to find
a book that someone else may already have borrowed! Think
also of how much easier it is to check in for a flight these
days thanks to online check-in; it makes it easier and more
convenient for the consumer and can enable the business
to reduce staffing levels and speed up the process at the
airport.
than they were previously, and they want products that
are more niche- and less mass-market. In the holiday
industry, for example, more people want to choose their
own destination, where they stay and what they do on
9.3
holiday, so they put together a unique holiday just for
them.
Technology is also enabling more flexibility in production.
Mass customisations, for example, occur when products
are produced on a large scale but customers have choice
over certain features, which ‘customises the product’. When
9.3.2 Flexibility and innovation
buying a computer, for example, you may choose the screen
size, the programmes that are pre-installed, the hard drive
and so on. For each of these choices, a customer chooses
from a limited list but the result is a product that feels
relatively customised.
successful. He found a group of craftsmen who made
‘beautiful, stylish, comfortable and durable’ shoes at
a significantly reduced production cost compared with
producers in the USA.
Source: https://shopconsortium.com/awlandsundry
Questions
1 Analyse two factors that might influence the price of
Awl & Sundry’s shoes. [8]
2 Evaluate the importance to Awl & Sundry of the shoes
being custom-made. [12]
Process innovation involves thinking about how you do
something, whereas product innovation focuses on what you
do. Process innovation can occur:
» when businesses change current processes involving the
way they produce or deliver a product; for example, to
enable ordering online
» when businesses adopt new ways of producing. For
example, they may automate a process by replacing
people with machines. Several aspects of building cars
are now undertaken by robots rather than people.
STUDY TIP
Remember that innovation can lead to new products but
also new ways of doing things – think of the way we listen
to music, read books and book tickets these days.
GLOSSARY TERMS
Product innovation focuses on developing new products.
Process innovation involves developing new ways of doing
something.
415
 9.3.3 Enterprise resource
9.3 planning
Enterprise resource planning (ERP) involves the use of
software to integrate the collection and use of information
for managers throughout a business.
ERP is a type of software that is used by businesses to
manage their day-to-day business activities, such as their
accounts, their supplies, their projects and their compliance
A LEVEL 9.3 OPERATIONS STRATEGY
ERP and business efficiency
By linking together the different functions and different
parts of the supply chain using ERP, the business should be
more efficient and more flexible. It should also have less
need to hold inventory because items can be ordered and
delivered just in time. A customer may place an order and this
information is immediately transferred to all the departments
that need to know about it, such as finance and production.
Production is now triggered to begin, and this sends out
orders to all the different suppliers for the right quantities of

with regulations and policies. ERP is based on data being

parts to arrive at the right time. This means inventory levels
held centrally and in a common format. ERP brings together
can be low, reducing inventory holding costs.
information that was previously held in different databases,
and helps to collect, store and analyse data across the With better information, managers should know instantly
business. what is available and what it is possible to produce in
the coming weeks; this should make the business more
For example, a car manufacturer buys in many different
responsive to changes and enable better use of the
parts from many different suppliers. Any given part, such as
resources available, including the workforce, thus increasing
brake pads, from a supplier will be uniquely identified in the
capacity utilisation. This can help a business to be more
central database. Information will be stored on how many
efficient and to be more flexible to customer needs. It can
brake pads were ordered and on what date, the product’s
also enable it to provide more accurate information for
specifications, when pads were due to arrive and when they
customers; for example, when estimating delivery times.
actually arrived, what they cost and when they were used.
This data would be essential to many departments within ERP therefore enables real-time data to be available, and
the business. this provides greater visibility and awareness of what
is happening at each stage of the process. It provides
The aim of ERP is to enable decision-makers within the
managers with insight into exactly what is happening ‘live’
business to have the information they need, when they
within the business. With lower costs, prices can also be
need it. It also links the business to outside stakeholders,
more competitive.
such as suppliers. It should provide information in a form
that is reliable, relevant and cost-effective, and it should
enable managers to know what resources are available at STUDY TIP
any moment, thus helping them with planning. Remember that inventory holding costs can include
security, depreciation if inventories go out of date,
GLOSSARY TERM warehousing costs and the opportunity cost of money tied
up in inventory.
Enterprise resource planning (ERP) involves the use of
software to integrate the collection and use of information
for managers throughout a business.

▼ Table 9.1 The impact of ERP

Factor Impact of ERP

Inventory control With better knowledge of demand patterns and existing inventory levels, managers should know
what to reorder and when, thus avoiding having too much inventory or running out.
Costs Better information should avoid over- or under-ordering and improve efficiency, thus reducing costs.
Pricing Lower costs may enable lower prices. Greater awareness of demand patterns may enable more
dynamic pricing.
Capacity utilisation Greater awareness of how resources are being used throughout the business may enable better planning,
ensuring higher capacity utilisation. For example, the business will be better placed to know whether it is
able to accept an order or how it can reorganise production to make it possible to accept an order.
Response to change Better information enables a quicker and more informed response to changes; the business will know
more about what is feasible given the constraints.
Management information ERP provides management with real-time information, which helps with staffing, inventory control
and cash flow.
Workforce flexibility ERP enables managers to track and plan production more accurately. This means employees can be
deployed exactly as and when required to particular tasks. There should be less wasted time for
labour. However, it does require workforce flexibility to enable the number of people to be increased
or decreased easily and for people to move from one task to another as required. This flexibility will
affect employment contracts and require employee training.
416
9.3.4 Lean production
Lean production aims to reduce wastage and, thereby,
make a business more efficient. This may be crucial in
an age of growing competition where there is a need to
provide excellent value for money. By being more efficient,
a business can reduce its prices and maintain its profit
margins, but it might hope to increase sales or keep the
price constant and benefit from higher profit margins.
With greater globalisation and competition from all over
the world, the pressure is on organisations to become more
efficient. They are often facing demands for increased
pay and higher input costs, but they cannot easily pass
these on to their customers so, to maintain profits, there
is a pressing need for greater efficiency. Managers are
constantly looking for ways of reducing the cost per unit.
This does not necessarily mean producing more cheaply – a
Ferrari car, a Chanel dress and Jimmy Choo shoes are always
likely to be expensive to make. However, many managers
will want to find the cheapest way of producing at a given
quality level. As we saw earlier, this may be achieved by
innovation. It can also be helped by trying to become
leaner in the way that a product is produced.
Lean production aims to reduce all forms of waste in the
production process. It is an approach that was developed
most fully in Japan. Waste is called ‘muda’ in Japan and
lean production aims to drive out all forms of muda. This
includes the waste of materials, time, energy and human
effort. Lean production streamlines operations so that
costs are reduced and efficiency increased. To achieve this,
a number of techniques have been developed (mainly in
Japan) aimed at getting things right first time and reducing
wastage levels. According to Taiichi Ohno (from Toyota), the
seven types of waste include:
1 Defects These only have to be put right later on
and cost money or they have to be thrown away or
reworked.
2 Overproduction of goods not demanded by actual
customers If they are not needed, why produce them?
They only have to be reworked or thrown away.
3 Inventories awaiting further processing or
consumption This represents idle money.
4 Unnecessary processing Why add features or extra work
if it is not needed?
5 Unnecessary motion of employees This wastes time
and energy.
6 Unnecessary transport and handling of goods Again,
a waste of resources.
7 Waiting for an earlier stage of the process to deliver
Waiting time is idle time!
Lean production therefore aims for:
» zero delays
» zero inventories
» zero mistakes
» zero waiting
» zero accidents.
The techniques involved in lean production include:
»
»
Kaizen
quality circles
»
»
simultaneous engineering
cell production
9.3
» just-in-time (JIT) manufacturing
» waste management.
Lean production involves focusing on problem areas and
finding the most efficient ways of addressing these. Once the
‘right’ method has been found, staff then need to be trained
and shown how to do this and then follow this approach. The
9.3.4 Lean production
aim is to develop clear and reliable ways of doing things. At
Toyota, for example, every activity is completely specified,
then applied routinely and repetitively. This is because all
variation from best practice leads to poorer quality, lower
productivity and higher costs.
The lean approach includes the ‘five Ss’:
» Sieketsu The aim is to standardise the approach in every
area so there is a right way of doing things and this is
applied consistently.
» Seiso Employees are expected to keep their work area clean.
» Seiton Employees are expected to organise their tools,
materials and documents so they can find them easily
and quickly.
» Seiri Employees need to have key equipment only and
remove unnecessary tools from their work area.
» Shitsuke Employees are expected to follow the ways set
out to complete a task.
The lean approach can be applied to any business operation.
Some benefits include:
» Banking Think of the processing of cheques and credit card
payments. The more efficient this process is and the less
time that is wasted along the way, the faster the bank can
collect its money and the better the return on investment.
» Hospitals Think of the ‘processing’ of patients – how
much time this can take and how many resources could
be wasted. A lean approach can lead to lower costs and
faster treatment time, leading to better patient care.
» Airlines Think how much money is wasted as aircraft sit
on a runway waiting to take off again. If ways could be
found to reduce the turnaround time, this could save the
airlines millions of dollars and allow the airports to earn
millions more in landing fees. Think of when you land
on a flight – are there ways of getting you off the plane
more quickly? Are the landing crews ready to get on the
aircraft quickly? Is the plane designed in a way that
makes cleaning easier and faster?
STUDY TIP
Remember that bringing in lean production may not
be quick. It may involve new suppliers and new ways of
working and training which might be resisted by those
within the business and existing partners.
GLOSSARY TERM
Lean production aims to reduce wastage and, thereby,
make a business more efficient.
417
 CASE STUDY
9.3
The Egyptian textiles industry
Egypt has a fully vertically integrated textiles industry.
The entire production process – from the growing
of the cotton to the production of yarns, fabrics
and ready-made garments – is carried out within
the country. The sector is an important part of the
Egyptian economy and accounts for around 30 per cent
A LEVEL 9.3 OPERATIONS STRATEGY
of employment and 15 per cent of exports. However,
analysts argue that the industry faces several problems.
These include:
● high inventory levels, including work-in-progress
(WIP) inventory, incoming and finished goods
inventory
Kaizen
The belief that firms can always do better is known as
‘Kaizen’. Kaizen is a Japanese word meaning continuous
improvement. The Kaizen approach tries to get employees
to improve what they do in some small way, every day of
every week of every year. If workers improve the quality of
their work by 1 per cent every single day, the effect over
just one year would be enormous. Too often, businesses
seek dramatic changes instead of small, regular changes. If
you want to improve your grades in your exams, it is unlikely
that there is any one thing you can do that will lead to a
sudden improvement in your marks. However, if you begin
to change many things over time, your grade is likely to
improve gradually.
Thus, the Kaizen approach focuses on the idea that
improvement comes through a series of small changes –
it is gradual rather than radical. The Chief Executive of
Toyota said that ‘when 70 years of very small improvements
accumulate, they become a revolution’. The profit margins
of many businesses are relatively small – they rely on
selling large volumes of products. What may seem like a tiny
Plan Do
Act Check
▲ Figure 9.13 The Deming cycle
418
● breakdowns of machinery and equipment owned by the
majority of firms, as a result of non-existent suitable
investments to carry out replacement and renewal
operations
● defective products and customer returns
● decreased profit margins
● marketplace competition
● no more space for inventory
● delays in delivery time.
Question
1 Evaluate the potential benefits of lean production to
the Egyptian textiles industry. [12]
reduction in costs for one unit, resulting from Kaizen, can
lead to significant increases in profit overall because of the
scale of the sales involved. And if the improvements keep
coming, the profits keep rising!
The Kaizen approach stresses that changes must be
monitored and evaluated to determine the extent of
the improvement made. At each stage, there should be
assessment of what actions have been taken and how
effective they have been.
The idea of continuously improving can be seen in the
work of Edward Deming (see Figure 9.13). Deming was
an American who achieved great fame in Japan for his
work on quality. Deming advised managers to focus on a
specific area and find the best way of performing, setting
appropriate quality targets. Managers would plan what
needed to be done, then do it, check to see the results and
then take action – the plan-do-check-act (PDCA) cycle. If
the targets were consistently being met, managers could
then increase the level of quality they were trying to
achieve and focus on how to do this. If the existing targets
were not being met, managers should find out why and fix
this before raising the bar.
nt
roveme
ous imp
Continu
Quality circles
Quality circles occur when employees involved in a
particular part of the operations process meet to identify
ways of improving quality. Managers invite employees to
become involved in improving the process. The benefit of
this approach is that those directly involved in the task are
helping to develop it; they will have the direct experience
to make improvements. Employees in a quality circle usually
meet without senior staff present. They develop their ideas
and then present them to the management team.
However, for quality circles to work effectively, the business
must have a culture where employees feel valued and want
to contribute. They must feel listened to and think their
ideas will be taken into account so that they will volunteer
to be involved. Quality circles rely on employees wanting
to improve the business; the ideas build on employees’
expertise.
STUDY TIP
Remember that a quality circle focuses on a specific part
of the operations process. It does not focus on issues
that cover the whole organisation. However, there may be
many quality circles within a business.
Simultaneous engineering
With the levels of competition in most markets increasing
rapidly, businesses are always looking for new ways of
out-competing their rivals. Many firms have tried to use
time as a competitive weapon. If an organisation is able
to produce an item in a shorter period of time than its
competitors, or deliver it more rapidly to customers, more
sales may result. Huawei keeps producing new models of its
products, for example, so that by the time the competition
has copied the features of the last one, it has already
moved on to a new version. Domino’s Pizza has competed
aggressively in the fast-food market by trying to achieve
pizza delivery within 30 minutes. Similarly, Dell can
produce a computer to a customer’s specifications within
weeks. Opticians can produce a pair of glasses in hours.
CASE STUDY
Thyssen Krupp
Thyssen Krupp is an engineering business that provides
products to companies in the vehicle industry, such as
car manufacturers. The company is a great believer in
the benefits of simultaneous engineering. It argues that
the goal of simultaneous engineering is significantly
shorter development times and faster market entry, given
ever-shorter product life cycles. It says that during the
simultaneous engineering phases, the company works
Amazon can deliver within 24 hours. At Yo Sushi, you can
help yourself rather than wait for a server to come to you.
As customers become eager for ‘instant’ service, the ability 9.3
to supply items as and when they are wanted may be crucial
to a business’ success. The growth of internet shopping, 24-
hour telephone banking and home delivery by supermarkets
all reflect a desire for quick, easy access to products. Firms
must try to react by reducing the time it takes to develop
products. Also, with new products being launched more
frequently and with rapidly changing customer tastes,
9.3.4 Lean production
products do not tend to survive for as long as they did in
the past. More than 80 per cent of new products are likely
to fail in the first few years. It may be important, therefore,
to develop products very quickly to keep competitive in the
market.
To speed up the development of products, businesses have
adopted simultaneous engineering methods. These involve
getting all the engineers and designers who are concerned
with a project to work on it at the same time. Instead of
having one person look at a product idea, develop it and
then pass it on to the next person or department, time can
be saved if everyone is looking at and discussing the work
simultaneously. This process has become easier due to the
increasing use of information technology, which enables
employees to communicate and share information more
easily.
An important element of simultaneous engineering is
scheduling activities effectively so that they are undertaken
as efficiently as possible. There are various ways to do this,
including using critical-path (or network) analysis, which we
will discuss below. This is particularly important in project-
based industries, such as construction, where every project
may be slightly different and needs very careful co-ordination.
GLOSSARY TERM
Simultaneous engineering occurs when as many activities
as possible involved in developing new products are
undertaken at the same time (as opposed to in sequence)
to save time.
together with its customers to develop optimal and
integrated production concepts. It develops customer
concepts and provides technical solutions using its
technical know-how and planning expertise.
Question
1 Analyse two benefits of simultaneous engineering to
Thyssen Krupp’s customers. [8]
419
 Cell production
9.3 Cell production is a method of organising production
around teams rather than a traditional production line, and
it can lead to less wastage. Instead of producing items on
a production line, the process is divided into a series of
different stages undertaken by teams or cells. Each team is
given the responsibility for a stage in the process.
An advantage of this approach is that teams are responsible
for a complete unit of work. Instead of each individual
A LEVEL 9.3 OPERATIONS STRATEGY
working on one simple task and having no real involvement
with the final product, working in cells can give employees
a sense of team spirit. It can also improve quality because
teams have work for which they have overall responsibility,
and they can clearly see the results of their efforts. Cell
production can, thereby, be very motivating for employees,
who feel they have more control over their own work, and
the team’s members can organise among themselves when
and how items are produced. They can also share their
skills and expertise, and they are also likely to feel much
greater responsibility for their work, because the next cell
has the right to refuse their work if it is poor quality. Cell
production thus involves self-checking by team members.
Hackman and Oldham (1976) developed a model of job
design which highlighted the key elements of a motivating
job (see Figure 9.14).
Core job dimensions Psychological states Outcomes
Skill variety
Meaningfulness High intrinsic
Task identity motivation
Task significance of work
High job
performance
Responsibility High job
Autonomy for outcomes satisfaction
Low
absenteeism
Feedback Knowledge of and labour
results turnover
▲ Figure 9.14 The key elements of a motivating job
This model stressed the importance of designing jobs in
which individuals had:
» skill variety – that is, they use a range of skills
» task significance – that is, they are working on something
that has some significance in terms of the overall
business, rather than just working on a small section and
thereby not appreciating why what they do matters
» task identity – that is, the work they do has a sense of
completion (for example, handing over a complete unit
of work to the next stage of the process)
» autonomy – that is, individuals have some independence
to make decisions on how they do the work
» feedback – that is, employees receive information on the
quality of their work.
Cell production helps in most of the areas above and should
therefore create more motivating work. Teams have control
over what they do; together they produce a complete unit
of work and they hand it over to the next cell, which will
give them feedback, and each member of the cell may
undertake a range of tasks. This should be more motivating
420
than simply undertaking the same task again and again on a
production line – in that system, you probably have no idea
why your part of the process matters, and there is almost no
skill variety or sense of task significance.
GLOSSARY TERM
Cell production occurs when the production process is
divided into stages undertaken by teams.
Just-in-time production
Inventories are goods that have been produced or are in
the process of being produced but which have not yet been
sold. As we saw at AS Level (page 155), just-in-time (JIT)
production occurs when firms produce products to order.
Instead of producing as much as they can and building up
inventories, firms only produce when they know they can
actually sell the items. Similarly, components and supplies
are only bought in by a firm as and when they are needed.
The aim of JIT production is to reduce a firm’s inventory
levels by as much as possible; in an ideal world there would
be no inventories at all. Supplies would arrive and be used
to produce items that are sold immediately to the final
customer.
Running a just-in-time system is complex and places many
demands on a business, as explained below.
» Excellent relationships with suppliers Businesses need
to be able to rely on suppliers to deliver goods at precisely
the right time. They cannot afford delays as this halts
production. Also, the goods must be perfect quality; the
manufacturer has no inventories to replace faulty supplies.
A firm must be able to trust its suppliers completely.
» Reliable employees Because the business does not have
many (if any) inventories at any stage of the process,
the firm cannot cope with stoppages. If strikes occur, for
example, the whole production process stops. A business
cannot supply customers using inventories as none exist.
JIT relies upon maintaining a good relationship between
employers and employees.
» A flexible workforce To ensure that production can
respond to demand, a firm needs to have a flexible
labour force. This means that if someone is ill, another
employee must be able to cover for them, or if demand
is high in one area of the business, people can be
moved to that area to help out. Firms using JIT expect
employees to be ready to work anywhere, anytime.
People must change to meet the demand for different
products because JIT is focused entirely on matching
supply to customer orders.
Introducing JIT production involves:
» investment in machinery which is flexible and can be
changed from producing one type of item to another
without much delay
» training employees so that they have several skills and
can do a variety of jobs (multi-skilling)
» negotiation with employees so that their contracts are
flexible and allow them to move from one job to another
» building relationships with suppliers who can produce
just in time as well.
Waste management
Central to lean production is the aim of reducing all forms
of waste. According to the European Union Waste Framework
Directive, waste is ‘anything for which we have no use;
which we want to or are required to throw away’.
By reducing wasted time and wasted materials, the
operations process becomes faster and more efficient.
However, there may still be waste products that are generated
by the processes of the business and waste management will
seek to manage all aspects of this. It will aim:
» to reduce the usage of materials and use the minimum
possible
» to recycle any materials it can
» to reuse any waste wherever possible
» to minimise any impact of the operations activities on
the environment; for example, preventing land
pollution.
CASE STUDY
EU regulations to reduce waste
New regulations are about to be introduced in the
European Union (EU) to ensure products are designed
so that they last and can be repaired if they go wrong.
These regulations will apply to a range of everyday items
such as mobile phones, textiles, electronics, batteries,
construction and packaging. The rules will also try
to prevent ‘premature obsolescence’; this occurs
when manufacturers deliberately make goods with
a short life cycle so that customers have to buy
a newer model.
The EU also wants to set a food waste reduction target,
stop over-packaging and end microplastic pollution. Other
recommendations are to introduce regulations that:
CASE STUDY
Waste and the clothing industry
In a recent UK parliamentary enquiry it was stated that:
… fashion consumption is causing a waste problem in the
UK and other countries. The sector ... still operates on a
linear model of ‘make, use, dispose’. ... around 300 000
tonnes of clothing ends up in household bins every year,
with around 20 per cent of this going to landfill and 80 per
cent incinerated.
Increasing garment lifetimes is one of the most effective
means of reducing their environmental footprint. Extending
the life of clothing by an extra nine months could reduce
carbon, waste and water footprints by around 20–30 per
cent each.
The waste is not just of finished products.
Hundreds of thousands of tonnes of fabric are wasted at the
design and production stage before the clothing reaches
Reduce 9.3
Recycle Reuse
9.3.4 Lean production
▲ Figure 9.15 Principles of waste management
How businesses manage their waste and the impact of their
waste in the environment is increasingly becoming a focus
for consumers and governments. There is a growing number
of regulations affecting how businesses use their resources,
how they produce their products and what happens once
their products have been used to limit the waste being
generated by business.
● increase the recycled content in products
● reduce the impact of products on the climate and
environment
● provide incentives when producers keep the ownership
of the product or the responsibility for its performance
throughout its life cycle – similar to car leasing.
Questions
1 Analyse two reasons why the EU would want to
introduce the regulations outlined in the case study. [8]
2 Evaluate the potential impact on producers if the
regulations outlined in the case study are
introduced. [20]
the customer. When garments are cut out as patterns, for
instance, as much as 15 per cent of the fabric can end up on
the cutting room floor. [...] In 2016, this supply chain waste
for clothing in the UK was estimated at over 800 000 tonnes
compared to just under 700 000 tonnes in 2012. This increase
is driven primarily by the increase in clothing consumption.
Around 440 000 tonnes of supply chain waste arises during
preparation of fibres to make yarn and during garment
production, most notably in China and India. [...] Some
designers, such as Mark Liu and Phoebe English, are now
experimenting with zero-waste pattern-cutting techniques in
which the garment pieces are designed to fit together like a
jigsaw so that nothing is wasted when they are cut. Businesses
[in New York State] are required by law to separate and
recycle or repurpose all textile waste including fabric scraps,
clothing, belts, bags and shoes if textiles make up more than
10 per cent of their waste during any month.
421
 Waste also comes in the form of clothes that are France introduced a scheme for clothing in 2007 making

9.3 destroyed without being sold.

In 2018, the British luxury brand Burberry faced a storm of
clothing, linen and footwear companies responsible for the
management of their end-of-life products. The scheme has
nearly trebled clothing collection points ... and collection
criticism when it revealed in its Annual Report for 2017–18
rates have increased by more than 50 per cent.
that ‘the cost of finished goods physically destroyed in the
year was £28.6 million’ ... [The company] had incinerated Source: https://publications.parliament.uk/pa/cm201719/
unsold clothes, accessories and perfume to protect its brand cmselect/cmenvaud/1952/report-files/195207.htm
and prevent unwanted stock from being sold cheaply. ... in © Parliamentary Copyright
September 2018, Burberry pledged to end the practice and
Questions
said it will reuse, repair, donate or recycle all excess stock.
A LEVEL 9.3 OPERATIONS STRATEGY

1 Analyse two ways in which clothing producers could

In some countries, producers are being made responsible reduce waste in their industry. [8]
for what happens to the clothing once customers have 2 Evaluate the need for better waste management
finished with it. in the clothing industry. [20]

Summary of the impact of lean production

▼ Table 9.2 Summary of the impact of lean production

Issue Impact of lean production

Inventory levels Reduced
Quality Improved. Lean production requires products to be right first time. It does not build in the idea
that there is buffer inventory in case something goes wrong. This focuses everyone on getting it
right first time and not having errors.
Efficiency • Increased, as savings are made on inventory costs
• Less time wasted
• Less waste of materials
• Less throwing away of out-of-date inventory
Reliance on suppliers Increased. Links with suppliers need to be excellent.
Capacity management Production occurs when demand is there; it does not produce in the hope that demand will occur.
This means production needs to be flexible according to demand and capacity utilisation will
vary. When there is ‘downtime’ (i.e. there is no production) maintenance activities will take place.
Capacity utilisation may be lower under lean production, but what is produced is sold.
Employees’ role Need to be flexible so they are ready to work when needed and in terms of what they do and when.

» The business is also very dependent on employees. If

Limitations of lean production
An operational strategy of introducing lean production is
not necessarily easy, cheap or quick. It requires:
» a workforce that is willing to take on extra
responsibilities, such as getting involved in a Kaizen
approach and quality circles. This means employees need
to feel trusted and respected. If this is not the case
initially, this trust needs to be won
» investment in the training of staff
» the right suppliers. These must be able to produce to
order and to produce high-quality items that can be used
in the process without having to be checked
» investment in technology; for example, to introduce an
ERP system and to link the business more closely with
retailers and suppliers.
The lean approach can also bring problems:
» For example, if there is a delay or disruption to supplies,
this will halt production at the business because it
has no buffer inventory. The business becomes very
reliant on suppliers and this is why a strong working
relationship and high levels of trust are needed.
422
staff strike, for example, the business has no supplies
to keep producing. This puts employees in a strong
bargaining position, which means again that trust is
vital. Employees must feel involved and well-looked-
after.
Businesses that develop an operational strategy around lean
production must therefore have excellent relationships with
both suppliers and employees.
9.3.5 Operations planning
The business environment is continually changing. This
creates new opportunities and threats. To anticipate change
or to react to it, managers need to undertake operations
planning. Operations planning will consider how the
business will meet its operations targets; for example, how
it will produce, what production will be scheduled and how
it will achieve its set quality targets. Planning will set out:
» what needs to be done
» how it will be done
» how progress will be monitored
» what action will be taken if the plan is not on target
»
»
the resources required for an activity
who is responsible for a given activity.
Part of operations planning may involve setting up project
teams. These teams may be established to:
» develop a new product
» research a new market opportunity
» work on a new process.
Once the task is complete, the project team will be
disbanded and another one created as and when required.
The membership of a project team will usually depend on
employees’ ability to contribute to the task. People may
be brought from different areas of the business to work on
specific projects.
Alternatively, a business may have permanent teams set
up specifically to manage projects, such as developing
new software or computer games. These teams will
usually have members from different functions across the
business so they can examine a project from different
perspectives. These teams will be given different projects
and be expected to develop, test and implement them
effectively.
A project usually involves individuals collaborating to
achieve a particular aim. They are temporary and work
within a given time and other resource constraints.
Managing a project therefore involves managing a team of
people to complete a task on time, to a given standard and
within given budget constraints. It involves:
» good communication skills to communicate to people
what is being done and what has to be done by when
» good people skills to pick the right team and to keep the
team working well together
» good planning skills to establish what can be done by
when and by whom
» good management skills to review progress and keep the
project moving forward.
These skills are especially important given that the project
may be in unfamiliar areas and/or where there is a great
deal of pressure to get the task completed because it can
be vital to the future of the business (for example, a new
product). They are important to ensure an innovative idea
becomes a reality.
Why do projects fail?
Projects may fail because:
» not enough time is spent on the planning, because of
pressure or a desire to get on with the work
» the difficulties and the time and cost involved are
underestimated, because often these projects have not
been done before so there is a lack of experience
» sometimes people want projects to succeed so almost
ignore the potential problems or are too confident they
can overcome them, or there are factors outside their
control, such as changes in the economy or problems
with suppliers.
Critical-path or network analysis
To achieve productive efficiency, managers will want to
plan projects as effectively as possible to ensure that time 9.3
and resources are not wasted. They do not want to have
people and machines sitting idle unnecessarily or materials
delivered well before they are required. To help them in the
planning process, managers may use network analysis, also
called critical path analysis (CPA).
Network analysis is a method of organising the different
9.3.5 Operations planning
activities involved in a particular process in order to find
the most efficient means of completing the task. The aim
is to complete the project in as short a time as possible.
To do this, a firm will determine the exact order in which
activities have to be undertaken and identify those which
can be undertaken simultaneously to save time. Network
analysis can be used in any type of project that involves
several activities – anything from opening a new store, to
planning a new advertising campaign, to organising the
relocation of the firm. The technique was developed for
DuPont in 1957 to speed up the building of a new plant. In
order to undertake network analysis managers must:
» identify all the different tasks involved in the process
» estimate the expected length of time each task will take
» determine the order in which the tasks must be
completed. For example, in some cases, particular tasks
cannot be completed until another one has taken place
first (these are known as ‘dependent’ activities). In
other cases, activities can be undertaken simultaneously
(these are known as ‘parallel’ activities, because they
can be undertaken at the same time as each other – ‘in
parallel’).
GLOSSARY TERM
Network analysis or critical path analysis (CPA) is a
method of organising the different activities involved in
a particular process in order to find the most efficient
means of completing the task.
Network charts
The next step is to construct a network chart. This is a
diagrammatic representation of all the activities involved
in the project, the order in which they must be undertaken
and the time each one will take. When drawing a network
diagram, the following features are used:
» a circle (called a ‘node’) represents the start and end of
an activity
» a straight line represents the activity itself.
A line showing an activity is labelled in the following way:
» above the line, the name of the activity is given
» below the line, the length of time the activity is
expected to take is shown – this is known as the
expected duration of the activity.
In Figure 9.16, activity B is expected to last ten days and
activity A is expected to last four days, but activity B can
only be started when activity A is completed (that is why it
only begins once A is complete).
423
 A B Adding earliest start times and latest
finish times
9.3 4 days 10 days
The next stage in producing a network chart is to show
▲ Figure 9.16 various information that can be calculated from the
In Figure 9.17, activities C and D can only be started after duration of each activity. This information is shown
activity B has been completed. Activity E can only start inside the node and, to do this, we now draw nodes in the
when C and D are finished. following way:
» The left-hand side shows the number of the node; this is
C used simply for reference and is done by numbering the
nodes left to right.
A LEVEL 9.3 OPERATIONS STRATEGY

A B 3 E
days » The right-hand side of the node is used to show two
4 10 D 5
days days days other pieces of information, known as the ‘earliest start
1 time’ of the next activity and the ‘latest finish time’ of
day
the activity before.
▲ Figure 9.17
Earliest start time
In Figure 9.18, we have added in some more activities. You The earliest start time (EST) is exactly what it says: it is the
can see that: earliest time a particular activity can begin. This piece of
» activity F can start immediately information is shown in the top-right space of the node at
» activity G can start once activity F is completed the beginning of an activity.
» activity H can start once activities E and G are
As you can see in Figure 9.19, the earliest times have now
completed.
been added. To calculate these figures, you take the EST of
C the activity before and add on the duration of that activity.
A B 3 E H C
4 10 days 5 3 A B 3
days days D days days 0 4 14 17
1 E
0 4 14 17
day 4 10 D 5
1 H
22 25
F G
22 25
6 9 3
days days
F 6 G
▲ Figure 9.18 6 13 9

All this information can be shown in Table 9.3. ▲ Figure 9.19

▼ Table 9.3 Network chart summary
Activity Preceded by Duration (days)
A –
B A
C B
D B
E C and D
F –
G F
H E and G
We now have a whole network diagram. Remember the
following rules when constructing a chart:
» The lines showing different activities must never
cross.
» The lines showing activities should always begin and
end at the midpoint of the nodes.
» The diagram must begin and end with one node.
» When drawing the activities and nodes, do not put the
end node on any activity until you are sure what comes
next and whether anything else must also be completed
before the following activity takes place.
The earliest time A can start is day 0 (this is the first
activity in the project); this activity takes 4 days so the
earliest time that B can start is day 4. Activity B takes 10
4 days so the earliest that C and D can start is day 14. E can
10 only start when C and D are both finished. C takes longer
than D, so the project must wait for this activity to be
3 completed before moving on; the earliest that E can start is
1 therefore day 17.
5 If you have a choice of numbers to add on to calculate
6 the EST, choose the bigger number. The projects cannot
9 continue until all previous dependent activities are
finished, so you must wait for the longest one to be
3 completed. Before H can start, for example, it must wait for
both E and G to be completed, which means it cannot start
until day 22.
By identifying the ESTs, a firm can see when materials
are likely to be needed. This means that components and
supplies can be ordered to arrive just in time to be used,
rather than arriving too early and sitting around, taking up
space and costing money, or arriving late and delaying the
whole project. Materials and resources for activity E, for
example, do not need to be ready until day 17.
Calculating the EST is therefore an important part of
developing a lean approach to a project and ensuring

424
people and materials are co-ordinated and ready at exactly delayed at all, the whole project will be late and will not be
the right moment. finished in 25 days.
Latest finish time ▼ Table 9.4 Example of a critical path 9.3
The bottom-right space of a node is used to show the latest
finish time (LFT) of an activity. Again, this shows exactly Activity Preceded by Duration (days)
what it says – the latest an activity can be finished without A – 4
holding up the whole project. B A 10
Activity H must finish on day 25 – the day the whole C B 3
project can be completed. Since activity H takes 3 days, D B 1

9.3.5 Operations planning

it means the activities before must be finished by day 22
if the project is to be completed on time. Activity E must E C and D 5
therefore be completed at the latest by day 22. Since E F – 6
takes 5 days, this means the activities before (C and D) G F 9
must be finished by day 17. Given that C takes 3 days (which
H E and G 3
is the longer activity out of C and D), if this stage is to be
completed by day 17, the stage before must be finished by
By identifying the activities on the critical path, managers
day 14.
can see exactly which activities are the priority in terms of
Rules when calculating ESTs and LFTs making sure they stay on time. The critical path also shows
To calculate the EST of an activity, work left to right and minimum project duration – that is, the shortest time in
add on the duration of the next activity to the previous which a project can be completed.
EST; if there is a choice, choose the biggest number to
add on. GLOSSARY TERMS
To calculate the LFT of an activity, work right to left and Free float time is the length of time an activity can overrun
deduct the duration from the previous LFT; if there is a without delaying the start of the next activity.
choice, choose the largest number to deduct. Total float time is the length of time an activity can
overrun without delaying the completion of the whole
Float time project.
Using the ESTs and the LFTs, it is possible to calculate The critical path refers to activities that have no float time;
the float time of an activity. There are two types of float if they overrun at all, the whole project is delayed.
time: The minimum project duration is the shortest period of
» Free float measures how much an activity can overrun time necessary to complete the project.
without delaying the next activity. To calculate free
float, use the equation:
Dummy activities
free float = earliest start time of the next activity
Sometimes, when constructing network diagrams, the
– the earliest start time of this activity
relationships get so complex that to help you draw them,
– the duration
you need a dummy activity. This is an activity that has no
» Total float measures how much an activity can overrun
time or costs involved, and you include it in the diagram to
without delaying the whole project. To calculate total
help show the relationships between ‘real’ activities – it is
float, use the equation:
simply a device to help you draw the diagram. See Table 9.5
total float time = latest finish time – duration for an example.
– earliest start time
▼ Table 9.5
For example, if activity D has to be finished by day 17,
can start on day 14 and lasts 1 day then the total float is Activity Preceded by Duration (normal time)
17 – 1 – 14 = 2 days. This activity has 2 days’ slack – it could A (None) 3 weeks
overrun by 2 days and the project would still finish on time. B (None) 4
By comparison, if activity B has to be finished by day 14, can
start on day 4 and lasts 10 days, its float is 14 – 10 – 4 = 0. C (None) 5
Here, there is no float – it must be completed on time or D A 8
the whole project will be delayed. B is therefore known E A, B 3
as a ‘critical’ activity because it has no total float. By
F C 5
identifying all of the critical activities, the firm can see
which activities must be finished on time; this is known as
A, B and C have no predecessor. They all start from the first
the critical path.
node (node 1). A can go from node 1 to node 2. B can go
The critical path for the project in Table 9.4 is ABCEH, from node 1 to node 3. C also starts at node 1. D can only
because these activities have no total float time. If they are occur after activity A, so D starts at node 2.

425
 Now for activity E; the difficulty here is where E should start.
E can only begin after A and B. A ends at node 2 and B ends
9.3 at node 3. But E poses a problem. If we joined A and B up,
going into node 2, so that E could start from here, this would
work for E but would be wrong for D. This is because it would
suggest D needed both A and B to finish before it could start,
which is not correct – it only needs A. The solution is to add
a dummy activity that runs from node 2 to node 3, as shown
in Figure 9.20, then start E at node 3. This shows that E needs
A and B whereas D only needs A, which is what we want.
A LEVEL 9.3 OPERATIONS STRATEGY
the firm can order materials and supplies to arrive
exactly when they are needed and not before. This saves
on storage costs and also the opportunity cost of having
money tied up in inventories. This can improve the firm’s
liquidity and free up cash which can be used elsewhere
in the organisation.
» Managers can use network analysis as a control
mechanism to review progress and assess whether the
project is on target. If there have been delays, the
effects of the ESTs and LFTs can be reworked to see the
effect on the completion of the project.

2
Although some of the estimates of the likely durations may
A D prove to be wrong, and although external factors may cause
Dummy delays, this does not mean that CPA is unnecessary. On the
contrary, by having a network diagram, the effects of any
B E
1 3 5 delays can be calculated relatively easily in terms of the
impact on the final completion date. CPA enables managers
to understand the significance and likely dangers of any
C F delay. Projects may still overrun, but managers should
4 be able to predict if this is going to happen as soon as a
problem emerges (rather than being taken by surprise) and,
▲ Figure 9.20 Network chart with dummy activity if possible, take action to get the project back on track.

CPA as a management tool HANDLING DATA

Network diagrams and CPA are useful management tools in
project management. ▼ Table 9.6
» When undertaking a CPA, managers must consider
exactly what activities are involved in a project. This Activity Preceded by Duration
is a useful exercise because it helps to make sure that A – 3
nothing is forgotten. It also means that managers B A 5
are likely to consult all the different departments
C – 2
and functions involved, and this can help to improve
everyone’s understanding of the issues and get them D B 10
involved in getting the project completed. E C, D 4
» Managers can calculate the earliest time by which the F – 1
project should be completed. This can be important
information for customers (for example, the firm can G F 12
announce a release date) and is important to help plan H E 3
launch arrangements. It can also help the managers I E, G 5
decide whether or not a deadline can be met.
J H, I 3
» Managers can identify the critical activities that must
be completed in time to get the whole project finished 1 Construct a network diagram from the data in
as quickly as possible. This means that they can focus Table 9.6.
on these specific activities and make sure they do not 2 What is the critical path?
overrun. At the same time, the amount of float time on 3 Calculate the total float and free float for each of the
non-critical activities can be calculated. While managers activities in the network.
cannot ignore these activities entirely, it may not matter
so much if they overrun (provided they do not use up
all their float time). It may even be possible to transfer GLOSSARY TERM
labour and other resources from non-critical activities to
Liquidity measures the ability of a business to meet its
critical ones to ensure the latter are completed promptly. short-term debts.
» Managers may be able to produce items or develop
products more quickly than the competition, providing
the business with a possible competitive advantage.
By seeking to reduce the time taken for a project, Limitations of CPA as a management
network analysis is an important element of time-based
management. tool
» Managers can implement JIT ordering. Network analysis Although CPA can help business decision-making, it can
shows the ESTs for each activity. Using this information, have a number of drawbacks and limitations.

426
» It relies on the estimates for the expected duration.
If these prove to be inaccurate, the calculations for
ESTs and LFTs, and so the critical path analysis, may
be wrongly identified. The estimates may be incorrect
because some managers may exaggerate how long an
activity takes to make it easier for them to complete
within the agreed time. On the other hand, some
managers may be too optimistic, particularly if these
activities have not been carried out before. A more
complex version of CPA, called programme evaluation
and review technique (PERT), includes a range of
estimates for the durations of different activities.
PERT produces a number of network diagrams based
on optimistic, pessimistic and most likely durations of
activities to take account of the fact that estimates
cannot be completely relied on.
» If JIT is used for the delivery of materials, the ability
to complete the project on time will depend on the
reliability of suppliers. If they are late, this will prevent
the next activity starting on time.
» CPA simply shows the quickest way to complete a
project; it does not guarantee that this is the right
project to be undertaking in the first place. It may be
that the firm’s resources could be used more effectively
elsewhere.
CASE STUDY
National Programme for IT
An ambitious multibillion pound programme to create a
computerised patient record system across the entire
UK National Health Service (NHS) was scrapped in 2010.
The £12.7 billion ($21.8 billion) National Programme for
IT was ended after years of delays, technical difficulties,
contractual disputes and rising costs. The UK government
decided it was better to discontinue the programme rather
than put even more money into it. An announcement was
expected for months after the National Audit Office cast
serious doubt on the wisdom of ploughing further money
into the scheme.
Other issues in CPA
Before a project is started, managers must agree on a
definition of success. They must set out exactly what
they want to achieve, otherwise subordinates may cut
corners to get the project done on time. The result may be
that the project is completed quickly but the quality is poor.
Managers must also agree on what resources and spending
they are willing to commit to the project. Obviously, the
quickest way of completing a project will depend on what
facilities and resources are available and how much the
firm is willing to invest into getting it completed. With
more people, more money and more machines, the project
could probably be speeded up. Whether particular activities
can be conducted simultaneously will often depend on
» All projects must be managed properly if they are to be
completed on time. Drawing up a network diagram is
only the starting point. Managers must agree on who is
responsible for each stage of the project. They must be
9.3
given the resources and budget to complete in the time
agreed. There must be an effective review system to
make sure the project is on schedule and to agree what
action to take if it is not. A network diagram can provide
a valuable focal point for the management system, but
it is up to the managers to make sure that everything
9.3.5 Operations planning
is implemented correctly and that each activity is
completed on schedule.
STUDY TIP
Some students argue that because the estimates of the
durations of activities can be wrong, or because changes
can happen to delay activities, this means that network
diagrams are useless. In fact, it is because things can go
wrong that these diagrams are so important – because
you have planned out what is expected to happen, this
means that if something does go wrong it is possible to
quickly calculate the effect of this on the project and take
appropriate action.
The problem, say analysts, is that the project was too
ambitious and the technology kept changing. The result
was that a lot of money was wasted that could have been
spent on nurses and improving patient care. The project
has not delivered as targets on dates, functionality,
usage and levels of benefit have been delayed and
reduced. Providers of NHS care, such as hospitals and GP
surgeries, will now be told to strike IT deals locally and
regionally to get the best programmes they can afford.
Questions
1 Analyse two reasons why this project was scrapped. [8]
2 Evaluate the possible reasons why this project
went wrong. [12]
whether the firm has or is willing to invest in the necessary
resources.
Managers will also be interested in the utilisation of
resources throughout the project. It may be that certain
activities could be undertaken simultaneously but that,
as a result, some weeks would require very high levels of
personnel, whereas in other weeks very few people would be
needed. If it adopted such an approach, a firm may have to
bring in extra staff for the busy weeks and pay its existing
staff to do little in the other weeks. Rather than have such
fluctuations in staffing levels, managers may want to shift
activities around; this may mean that the project takes a
bit longer, but it may nevertheless be more desirable if it
means that its full-time staff are fully employed each week.
427
 CASE STUDY
9.3
China’s Belt and Road Initiative
China’s Belt and Road Initiative is a huge investment Moscow New Silk Road
Rotterdam Maritime Silk Road
project to promote trade. It aims to connect six main
economic corridors, creating transport links in China,
Trieste Samarkand
Mongolia and Russia, Eurasian countries, central
and west Asia, Pakistan, other countries of the Indian Xian
subcontinent and Indochina. China has provided billions
A LEVEL 9.3 OPERATIONS STRATEGY

Fuzhou
of dollars for this massive construction project. The Kolkata
investment will significantly improve the infrastructure
in these regions and help markets to develop, with better
Nairobi
transport for supplies and exports. The programme
includes investment in trains, roads and ports. It has been
called China’s New Silk Road (the original, ‘Maritime Silk ▲ Figure 9.21 China’s Belt and Road initiative
Road’ was an ancient trading route across the world).
For example:
Question
● In Uganda, China has built a 50 km (30 mile) road to the 1 Evaluate the benefits of operations planning to the
international airport. businesses involved in China’s Belt and Road
● In Tanzania, China is investing in creating the biggest Initiative. [12]
port on the continent.
● In Europe, Chinese firms have bought 51 per cent of
the port authority of Piraeus, near Athens.

TEST YOUR LEARNING

Short answer questions
1 Explain one way in which operations decisions are
affected by another business function.
2 Explain one reason why operations flexibility can help
a business compete.
3 Define the term ‘process innovation’.
4 a Define the term ‘enterprise resource planning’. [2]
b Explain one benefit of enterprise resource
planning to a business.
5 Explain two ways in which lean production can
increase the profits of a business.
6 Explain one way that adopting just-in-time production
might affect inventory control.
7 a Define the term ‘network diagram’.
b Explain one benefit of constructing a network
diagram.
8 Define the term ‘dummy activity’.
9 Define the term ‘free float’.
10 a Explain one benefit of using critical path analysis
as a management tool.
b Explain one limitation of using critical path analysis
as a management tool.
Data response question
Toyota
Toyota is widely recognised as the founder of lean-
production techniques. These form the essence of what is
known as the Toyota Production System (TPS). The aim of
this production system is to completely eliminate waste.
Toyota sets out to make vehicles ordered by customers in
the quickest and most efficient way, as swiftly as possible.
[3]
The TPS was established based on two concepts:
[3] ● ‘jidoka’ (which translates as ‘automation with a human
touch’). This means that when there is a problem, the
[2]
equipment halts immediately, preventing any further
errors
● just in time, whereby exactly what is needed (and no
[3]
more) is produced in a continuous flow.
[6] Toyota says that ‘TPS and its approach to cost reduction
are the wellsprings of competitive strength and unique
[3] advantages for Toyota’. The company believes in making
only ‘what is needed, when it is needed and in the amount
[2]
needed’. To be able to fulfil a customer order as quickly as
possible, the vehicle must be quickly and efficiently built by
[3]
following these principles:
[2]
1 When a vehicle order is received, production instructions
[2] are issued to the beginning of the vehicle production line
as soon as possible.
[3] 2 The assembly line is stocked with the required number of
all necessary parts so that any kind of ordered vehicle can
[3] be assembled.
3 The assembly line must replace the parts used by
retrieving the same number of parts from the parts-
producing process.
4 The preceding process must be stocked with small
numbers of all types of parts and produce only the
numbers of parts that were retrieved by an operator from
the next process.

428
According to Toyota, ‘waste can manifest as excess 2 Explain two factors necessary for just in time to
inventory, extraneous processing steps and defective
products, among other instances. All these waste 3
succeed at Toyota.
Analyse two reasons why quality circles would be
[6]
9.3
elements intertwine with each other to create more useful to Toyota. [8]
waste, eventually impacting the management of the 4 Analyse two ways that enterprise resource planning
corporation itself.’ would benefit Toyota. [8]
Toyota says that, through the philosophies of ‘Daily 5 Toyota produces new models of car every few years.
Improvements’ and ‘Good Thinking, Good Products’, Evaluate the benefits of critical path analysis for
TPS has developed into a world-famous production Toyota when developing a new car. [12]
system. All Toyota production divisions continue to 6 Evaluate the importance of lean production to

9.3.5 Operations planning

make improvements to TPS, day and night, ‘to ensure its Toyota’s success. [20]
continued evolution’.
Essay questions
Source: https://global.toyota/en/company/vision-and-philosophy/
production-system 1 Evaluate the benefits of using critical path
analysis when undertaking a new project to
Questions build a factory. [20]
1 Explain two benefits of just in time for Toyota. [6] 2 Evaluate whether effective project management
is the key to business success nowadays. [20]

429
 10 Finance and accounting
A LEVEL
10.1 Financial statements
A LEVEL 10.1 FINANCIAL STATEMENTS
Chapter overview
In this chapter we examine:
★ the meaning, purpose and contents of a statement of profit or loss
★ changes in financial statements and their effects
★ the meaning, purpose and contents of a statement of financial position
★ changes in financial position and the links between the two types of financial statement
★ inventory valuation
★ depreciation.
Public companies in the UK and many other countries are
required to prepare financial statements complying with
the International Financial Reporting Standards (IFRS).
This encourages a more global approach to the presentation
of financial data, making comparisons and analysis more
straightforward. Despite this, there are some differences in
the ways that companies choose to present data in financial
statements, and you may notice some minor variations in
the examples we look at in this chapter.
Businesses produce a range of financial statements that
record their financial performance over a given trading
period. For many companies around the world, this is a legal
requirement. We shall look at two financial statements in
this chapter:
» statements of profit or loss (also called income
statements)
» statements of financial position (previously called
balance sheets).
STUDY TIP
When considering statements of profit or loss and
statements of financial position, do think about them
from the perspective of a variety of stakeholders. It
may be natural to consider them from the standpoint of
shareholders and suppliers, but think of the conclusions
that employees and customers may draw from the same
financial information.
GLOSSARY TERMS
A statement of profit or loss is a financial statement
showing a firm’s sales revenue over a trading period and all
the relevant costs generated to earn that revenue.
A statement of financial position is a financial statement
recording the assets (possessions) and liabilities (debts) of
a business on a particular day at the end of an accounting
period.
430
10.1.1 Statement of profit or loss
What is profit?
At its simplest, profit is what remains from revenue once
costs have been deducted. However, in the construction of
the statement of profit or loss, three main types of profit
are identified:
1 Gross profit This form of profit is calculated by
deducting cost of sales, such as materials and shop-floor
labour (also termed direct costs), from a business’ sales
revenue. This gives a broad indication of the financial
performance of the business without taking into account
other costs, such as expenses.
2 Operating profit This is a further refinement of the
concept of profit and is revenue less cost of sales
and expenses, such as rent and rates. This is a better
indication of the performance of a business over a
period of time as it takes into account most costs
incurred by a firm over a trading period.
3 Profit for the year This measure of profit takes into
account a business’ income from all of its sources,
trading and non-trading, and the full range of costs
incurred including taxes on profits and interest
charges. A business’ managers can decide how to
utilise profit for the year, and they may decide to pay
dividends to shareholders or to retain profits within
the business.
Profit can be defined in a number of ways, but it is
essentially the surplus of revenues over costs.
A loss is a situation where a business’ expenditure exceeds
its revenue over a specific trading period.
The contents of a statement of
profit or loss
Figure 10.1 provides an initial guide to the contents of a
statement of profit or loss as presented by most companies.
Negative figures are normally shown in brackets on financial
statements. However, this is not always the case, as is
shown in the extract from Marks & Spencer Plc’s statement
of financial position on page 437.
The statement of profit or loss comprises three main
There is no single format for a limited company’s
statement of profit or loss. In the UK, the Companies Act
of 2006 sets out the minimum amount of information
that must be included, though some modification can
10.1
be made to ensure a ‘true and fair view’ of the business’
performance.
The accounts of public limited companies also contain
notes giving further details of the figures included in
the statement of profit or loss. This depth of information
is important to allow shareholders and other interested

10.1.1 Statement of profit or loss

sections: parties to make an accurate assessment of the financial
1 Firstly, gross profit is calculated. This is the difference performance of the business.
between the revenue figure (sometimes called sales
revenue or turnover) and the cost of the goods that BUSINESS’ REVENUE
have been sold. The latter is normally expressed from sales
simply as ‘cost of sales’. This element of the statement minus
of profit or loss is sometimes called the trading
COST OF SALES (such as Cost of sales is often referred to
account.
fuel and raw materials) as ‘direct costs’.
2 Secondly, operating profit is calculated. This is
calculated by deducting the main types of expenses, gives
such as administration and selling costs. Gross profit is a broad measure of
3 The final stage of the statement of profit or loss is to GROSS PROFIT
profit that ignores some costs.
calculate profit for the year. This is arrived at by deducting
minus
the amount of tax payable for the year and any interest
Other examples include expenditure
paid while adding interest received. The profit for the EXPENSES (such as
on security and wages for
year figure shows the net amount that has been earned rent and managers’ salaries)
administrative staff.
for the shareholders. If the figure is negative (that is, gives
all costs and expenses exceed revenues for the year, Operating profit is a fair measure of
as in the case of Rolls-Royce below), this is termed loss OPERATING PROFIT performance as it excludes
for the year. non-trading activities.
making
Public limited companies are required by law to publish allowance for
their accounts. This means that they are available for INTEREST paid and received Companies pay corporation tax
scrutiny not only by the owners (shareholders), potential by the firm, profits on taxation on their profits.
investors and bankers but also by competitors. When
a company draws up its statement of profit or loss for
external publication, it will include as little information as PROFIT FOR THE YEAR
possible. Public limited companies usually supply no more
detail than is required by law. ▲ Figure 10.1 The contents of a statement of profit or loss

CASE STUDY
Rolls-Royce
Rolls-Royce Holdings is one of the UK’s best-known It sells its products throughout the world for commercial
companies and employed 50 000 mainly highly skilled and military use. Rolls-Royce operates joint ventures with
people in 2020. It manufactures engines for aircraft, companies in Germany.
ships and more general business use. It spends heavily
Rolls-Royce Holdings Plc’s statement of profit or loss is
on researching and developing new products and is the
shown in a summarised form in Table 10.1.
world’s second-largest manufacturer of aircraft engines.

431
 ▼ Table 10.1 Rolls-Royce’s summarised statement of profit or loss

10.1 Summarised statement of profit or loss for Rolls-Royce Holdings Plc (years ended 31 December 2018 and
31 December 2019)
2019 (£m) 2018 (£m)
Revenue 16 587 15 729
Cost of sales (15 645) (14 531)
Gross profit 942 1 198
A LEVEL 10.1 FINANCIAL STATEMENTS

Research & development expenses (770) (768)

Other expenses (1 024) (1 591)
Operating loss (852) (1 161)
Profit from other sources 139 358
Finance income (interest received) 252 271
Finance costs (interest paid) (430) (2 415)
Taxation (420) 554*
Loss for the year (1 311) (2 393)

* Rolls-Royce Holdings Plc received a substantial tax credit in 2018.

Source: Rolls-Royce Holdings Plc Annual Report, 2019; www.rolls-royce.com/~/media/Files/R/Rolls-Royce/
documents/annual-report/2019/2019-full-annual-report.pdf

Questions
1 Analyse one reason why Rolls-Royce’s employees may 2 Evaluate whether or not Rolls-Royce’s shareholders
be extremely concerned about the company’s financial would have been pleased with the company’s financial
performance over these two years. [4] performance in 2019. [20]

investment. Some owners want to see the company grow

HANDLING DATA
Suppose that Rolls-Royce Holdings Plc’s cost of sales
had been £15 324 million in 2019. Calculate its gross
profit, operating profit and loss for the year, assuming
no other changes.
How might a business use its profits?
One of the most important decisions taken by a business is
how to use its profits, assuming that it makes any. The uses
of profits can be divided into two categories:
» Distributed profits These profits are paid to the owners
of the business and this will be in the form of dividends
if the business is a company.
» Retained profits (or earnings) This portion of a
business’ profits is kept for investment in the business.
Such profits may be used to purchase assets to help
the business trade in the future. Examples include
machinery, vehicles or properties.
A key issue in distributing profits is the balance between
the short term and the long term. Distributing a high
proportion of profits may keep the business’ owners (most
likely shareholders) happy in the short term, but it might
not be in the interests of those wanting a long term
over a number of years and to benefit from owning a share
of a more valuable business.
As Rolls-Royce Holdings Plc made significant losses in both
2018 and 2019, the company’s management team had to
make a difficult decision about whether to pay dividends
to shareholders using profits from previous years or by
borrowing. The team decided to pay dividends of 11.7 pence
per share in both years.
GLOSSARY TERM
Assets are items owned by a business, such as cash in the
bank, vehicles and property.
Factors that can cause amendments in
statement of profit or loss
1 Changes in selling prices If a business raises or reduces
its prices, it is almost certain that its sales revenue
will alter as a consequence. A key determinant of the
effect on sales revenue following a price change is price
elasticity of demand. A business may be more inclined
to raise its prices if it believes demand is price inelastic.
In this situation, sales of a product are not particularly
sensitive to price and thus a price rise may increase
revenue.

432
2 Changes in the volume of products sold If a product
becomes more or less popular, the amount that is sold
is likely to alter and so will the business’ sales revenue.
This may well be as a response to a price change,
although other factors such as changing fashions or
the entry of new products onto a market may also
change the quantity of products that a business sells.
Alternatively, the business may increase sales as a
consequence of entering a new market or launching a
new product.
3 Changes in costs A rise in cost of sales or expenses
An example of amending a statement of profit
or loss
West Kericho Estate is a well-established tea plantation 10.1
in Kenya. It has recently prepared a draft of its statement
of profit or loss for the year, which is shown in Table 10.2
as the original figures. However, the original figures were
found to contain a number of errors:
» The company actually sold 12 500 kg of tea.
» The selling price of its tea averaged at $280 per kg over
the year.

10.1.1 Statement of profit or loss

is likely to reduce the profit recorded on a business’ » Its administrative and other expenses were actually
statement of profit or loss, or it is likely to increase $901 500.
its losses. » The interest rates charged on the company’s loans rose,
increasing its interest charges by 20 per cent.
» The company’s directors decided to increase the
STUDY TIP dividends it paid to $175 475.
If the quantity of products sold by a business is adjusted,
These changes are shown in the right-hand column of
then it is likely to have a knock-on effect on the business’
Table 10.2.
costs. It is highly likely that the business’ cost of sales
will alter and some expenses may also change, such as
distribution costs. You must ensure that, when answering
questions on this topic, you alter costs when necessary.

▼ Table 10.2 West Kericho Estate’s original and amended statement of profit or loss

Original figures ($) Amended figures ($)

Revenue (12 400 kg @ $275 per kg) 3 410 000 3 500 000
Cost of sales (12 400 kg @ $160 per kg) (1 984 000) (2 000 000)
Gross profit 1 426 000 1 500 000
Administrative and other expenses (878 000) (901 500)
Operating profit 548 000 598 500
Finance income (interest received) 12 000 12 000
Finance costs (interest paid) (36 000) (43 200)
Profit before tax 524 000 567 300
Taxation (@ 25%) (131 000) (141 825)
Profit for the year 393 000 425 475
Dividends paid (136 000) (175 475)
Retained profits 257 000 250 000

There are a number of key points to note about these
amendments:
» The new revenue figure is calculated by multiplying
the company’s output of tea (in kg) by the average price
per kg.
» If output changes, then the cost of sales will alter too
because the quantity produced changes. Here, output
rose from 12 400 kg of tea to 12 500 kg. Even though the
unit cost of production was unchanged at $160 per kg,
the overall cost of sales rises as output has increased.
» Gross profit changes if either revenue or cost of sales
alters.
» Finance costs increased by 20 per cent, which has an
effect on the profit before tax figure.
» Finally, dividends were increased, leaving a slightly
smaller figure for retained profits.

433
 CASE STUDY
10.1
Malé Traders Ltd
Malé Traders Ltd is based in Mauritius and grows sugar. Its estimated statement of profit or loss is shown in Table 10.3.
▼ Table 10.3 Malé Traders Ltd estimated statement of profit or loss

Original figures ($)

Revenue (10 425 tonnes @ $470 per tonne) 4 899 750
A LEVEL 10.1 FINANCIAL STATEMENTS

Cost of sales (10 425 tonnes @ $290 per tonne) (3 023 250)
Gross profit 1 876 500
Administrative and other expenses (975 450)
Operating profit 901 050
Finance income (interest received) 45 675
Finance costs (interest paid) (102 300)
Profit before tax 844 425
Taxation (corporation tax @ 20%) (168 885)
Profit for the year 675 540
Dividends paid (380 000)
Retained profits 295 540

Malé Traders Ltd has updated the information used for Question
its statement of profit or loss. The cost of its goods sold
1 Analyse whether or not the company retained more
has been changed to $300 per tonne; its administrative
or less profit than shown in its original forecast. Use
expenses were $956 425 and it received $51 200 as
calculations to support your answer. [8]
interest on its bank accounts. The tax rate for profits was
altered to 22 per cent. Finally, its dividends paid were
unchanged.

The impact on a business’ profit or loss The factors which can cause a business’ profits to fall – or
its losses to increase – are the opposite of those listed
of changes in costs and prices above. All these factors are summarised in Figure 10.2.
It is very rare for a business to earn the same profit (or
make the same loss) in two successive years. This is because
the environment in which the business operates is always
changing. New competitors arrive, existing ones cease Rising
trading, governments change taxes on profits, and sales Increases in revenues profits – Reductions in costs
and consumers’ tastes change. All these factors, and many • higher prices or falling • lower cost of sales and/or
others, combine to impact on a business’ statement of profit • increased sales volumes losses expenses
• reduced rates of taxation
or loss.
Falling
Profits generally rise (or losses fall) if: profits –
» selling prices increase and not too many customers buy or rising
elsewhere Reductions in revenues losses Increases in costs
» sales volumes (the quantity sold) increase and prices • lower prices • higher cost of sales
remain stable or even rise • lower sales volumes and/or expenses
» cost of sales and/or expenses decline, or they increase at • increased rates of
a lower percentage rate than revenue taxation
» governments make favourable tax changes, normally ▲ Figure 10.2 A summary of factors affecting a statement
through reducing rates of taxation. of profit or loss

434
10.1.2 Statement of financial
position
A statement of financial position is a financial statement
recording the assets (possessions) and liabilities (debts) of
a business on a particular day at the end of an accounting
period. It was previously called a balance sheet and many
companies, for example Rolls-Royce, still use this term. The
statement of financial position only represents a picture
of a business’ assets and liabilities at a moment in time –
it is commonly described as a ‘snapshot’ of the financial
position of an organisation. Because of this, statements
of financial position always carry a date on which the
valuation of assets and assessment of liabilities took
place. A consolidated statement of financial position is a
statement of financial position for a business that includes
information from all its divisions.
Key statement of financial position relationships
1 Assets = Liabilities
This is the fundamental relationship which helps to explain
why the statement of financial position ‘always balances’
2 Total assets = Current assets + Non-current assets
Businesses need to invest in a range of assets if they
are to operate efficiently
3 Liabilities = Share capital + Borrowings + Reserves
▲ Figure 10.3 Key statement of financial position
relationships
By recording assets and liabilities, the statement of
financial position sets out the ways in which the business
has raised its capital and the uses to which this capital
has been put. The statement of financial position provides
a great deal of information for those with an interest in a
business, and it is the primary financial document published
by businesses.
Statements of financial position are an essential source
of information for a variety of business decisions and for
a number of stakeholders. The precise information drawn
from the statement of financial position will depend upon
the stakeholder and the nature of their enquiry. We shall
consider the users of financial information later in this
chapter.
Assets
An asset is simply something that a business owns. Assets
are what a business purchases with its capital. There are
two main categories of assets that appear on the statement
of financial position. The distinction between the two
categories is based upon the time the assets are held within
the business.
1 Non-current assets These are assets owned by a
business that it expects to retain for one year or more.
Such assets are used regularly by a business and are 10.1
not bought for the purpose of resale. Examples of
non-current assets include land, property, production
equipment and vehicles.
2 Current assets This category of asset is likely to be
converted into cash before the next statement of
financial position is drawn up. Therefore, cash and
inventories (previously called stock) are examples of
current assets, as they are only retained by the business
10.1.2 Statement of financial position
for a short period of time.
Liabilities
A liability is a debt owed by the business to organisations
or individuals. Another way of thinking about a liability is
that it shows the sources of capital the business has raised
in order to purchase its assets. As with assets, there are a
number of categories of liabilities:
» Current liabilities In many senses, these are the
equivalent of current assets. They represent debts owed
by the business due for payment within one year or less.
Examples of such short-term debt are overdrafts and
taxes due for payment. Trade and other payables are
organisations such as suppliers to whom the business
owes money. These are normally classified as a current
liability because payment is usually due within a short
period of time.
» Non-current liabilities These are debts that a business
does not expect to repay within the period of one year.
Mortgages and bank loans repayable over the course
of several years are common examples of this type of
liability.
» Equity It may seem strange that the money invested
into the business by its owners (shareholders in the
case of a company) is a liability. However, if the
company ceased trading, shareholders would hope for
the repayment of their investment. Thus, these funds
(called ‘total equity’ or ‘total shareholders’ equity’) are
liabilities. This element of the statement of financial
position also includes reserves. These are the company’s
accumulated, retained profit.
GLOSSARY TERM
Equity is the shareholders’ stake in a company. It is the
balance that shareholders would receive if a company sold
its assets and repaid all liabilities.
Net current assets and net assets
Net current assets are calculated using the following
formula:
net current assets = current assets – current liabilities
435
 The figure that is calculated is also known as ‘working Some profits paid to owners (Dividends to
capital’. Many firms aim to have current assets which are shareholders if a company)

10.1 twice the level of current liabilities, though businesses

in some industries operate efficiently with lower ratios.
However, if current liabilities are greater than current
assets, then the figure will be in brackets.
Successful trading period
A business’ net assets can be calculated by totalling
the business’ assets and subtracting the business’ total
liabilities. Thus:
Some profits
A LEVEL 10.1 FINANCIAL STATEMENTS

net assets = (non-current assets + current assets) retained in business

– (non-current liabilities + current liabilities)
This is one way of calculating the value of a business.
Net assets represent what would be left to the owners of Reserves
a business if all its assets were sold and all its liabilities Retained profits
accumulated over time
paid. Net assets are sometimes called ‘net assets employed’.
Figure 10.5 shows how they can be calculated.

Reserves Figure for reserves rises

representing a liability and balancing
Retained profits invested
in assets and hence the
the rise in the value of assets value of assets rises
An important feature of a statement of financial position
is reserves. Reserves are simply profit accumulated during ▲ Figure 10.4 Assets, liabilities and reserves
previous years’ trading and not paid out to the owners of the
business. This accumulated profit is not held in the form of
cash, but it is invested into a range of assets that are useful The format of a statement of financial
to the business and will hopefully generate further profits. position
If a business is successful, purchases more assets and Presenting the data for a statement of financial position
grows, then its value will increase and so will the value of in a vertical format (as in Figure 10.5) is the most common
the assets. It may borrow money to achieve this growth; if format used, and all public companies in the UK are legally
it does, liabilities will grow at the same rate. However, if it obliged to present their statement of financial position
funds its growth out of profits, then the matching liability this way.
will be recorded as reserves, indicating that the owners’
stake in the business has risen in value. Remember that
the owners’ funds in the business are a liability, as they
represent money lent to the organisation.

£m

Assets are listed in order of liquidity – illiquid (difficult to turn into cash) first. Non-current assets 320

Comparing short-term (current) assets and liabilities gives information on the Current assets 165
business’ cash position. If net current assets is positive, the business should be
able to pay its way. Current liabilities (85)

Net current assets are also known as Net current assets 80

working capital.
Non-current liabilities records money borrowed long term by the business. Non-current liabilities (130)

Net assets shows the worth of the business. Net assets 270

Total equity is the money invested by the business’ shareholders. Total equity 270

▲ Figure 10.5 The format of a statement of financial position

436
 CASE STUDY
10.1
Marks & Spencer Plc
Marks & Spencer Plc is a well-known retailer in the UK. It sells clothing, food and household goods (such as furniture)
through 1463 stores and its website.
▼ Table 10.4 A summarised consolidated statement of financial position for Marks & Spencer Plc

Summarised statement of financial position for Marks & Spencer Plc, 28 March 2020 and 30 March 2019

10.1.2 Statement of financial position

2020 (£m) 2019 (£m)
Non-current assets 8 968.9 7 415.9
Inventories 564.1 700.4
Trade receivables and cash 546.4 552.6
Other current assets 104.5 182.1
Total current assets 1 215.0 1 435.1
Total assets 10 183.9 8 851.0
Trade and other payables 1 426.4 1 424.4
Other current liabilities 423.0 900.5
Total current liabilities 1 849.4 2 324.9
Non-current liabilities 4 626.0 4 056.9
Total liabilities 6 475.4 6 381.8
Net assets 3 708.5 2 469.2
Share capital 1 398.0 823.2
Reserves and retained earnings 2 310.5 1 646.0
Total equity 3 708.5 2 469.2

Note: Unlike many companies, Marks & Spencer does not Questions
use brackets for liabilities figures on its balance sheet.
1 Calculate Marks & Spencer Plc’s net current assets
Source: Marks & Spencer Annual Report 2020; https://corporate. figures for 2019 and 2020. [4]
marksandspencer.com/documents/msar2020/m-and-s_ar20_ 2 Evaluate the value of the information in this statement
financial-statements.pdf of financial position to a bank considering offering
Marks & Spencer a £250 million loan. [12]

value of its non-current assets on the statement of

Amending statements of financial
position
When amendments are made to a statement of financial
position, there are often knock-on effects because of the
system of double-entry that is used to draw up a statement
of financial position. This double-entry system is used
because, as we saw in earlier, a statement of financial
position must always balance between assets and liabilities.
Therefore, if a change is made to either assets or liabilities,
there has to be a compensating change to ensure that the
balance is maintained.
There is a range of actions a business might take which
would affect its statement of financial position. For
example:
» The purchase of non-current assets If a business
purchases non-current assets, such as property or
vehicles, then the initial effect will be to increase the
financial position. The compensating amendment could
take a number of forms:
• The business’ cash balance may fall by the same
figure, leaving the figure for total assets unchanged.
• The business may arrange a long-term loan to pay for
the new assets, causing a rise in liabilities to match
the increased value of assets.
• Similarly, additional shares may be sold, causing an
increase in total equity which represents a liability
to the company.
» The business repays a long-term loan This action will
initially reduce the company’s liabilities on its statement
of financial position. The compensating amendment
could be one of the following:
• The business sells additional shares to raise the
funds to repay the loan. Thus, the two changes to
the company’s liabilities will cancel one another out
on the statement of financial position.

437
 • The business sells an asset to generate the finance retained earnings (and therefore total equity) of the
to repay the loan. This would lower the company’s same amount.
10.1 assets by the same amount, as its liabilities are
reduced.
A wide range of other transactions will affect the statement
of financial position, such as the sale of inventories or
» The business reduces the value of some non-current
the use of an overdraft. The compensating amendments
assets on its statement of financial position This
here may be a rise in the amount of cash held in the
is a common action taken by a business and is termed
company’s bank account and a rise in current assets, such
depreciation (we will look at this in more detail later
as inventories, which may have been purchased using the
in this chapter). In this case, the balancing amendment
overdraft facility.
is likely to be a reduction in the figure for reserves and
A LEVEL 10.1 FINANCIAL STATEMENTS

CASE STUDY
Belem Manufacturing Ltd
▼ Table 10.5 The company’s managers need to incorporate a number of
changes into the figures shown in Table 10.5. These are:
Belem Manufacturing Ltd statement of financial ● The company has taken out an additional loan of $10
position as at 30 November million and has purchased vehicles with this capital.
$m ● Some of the company’s customers (receivables) paid
early – this amounted to $100 million.
Non-current assets 6 977 ● The company’s property has increased in value by
Inventories 1 500 $150 million due to general rises in property prices.

Receivables 1 075 The managers recognise that each of these changes will
need a compensating change to ensure that the statement
Cash 1 000
of financial position still balances.
Total current assets 3 575
Questions
Total assets 10 552
1 Calculate a revised statement of financial position
Current liabilities (4 720) based on these changes and ensure that it still
Net current assets (1 145) balances. [8]
2 Evaluate the extent to which these changes have
Non-current liabilities (1 041)
strengthened the company’s financial position. [12]
Net assets 4 791
Share capital 1 860
Reserves and retained earnings 2 931
Total equity 4 791

The relationship between items in
the statement of profit or loss and
the statement of financial position
There are a number of ways in which the information in
a business’ statement of profit or loss is related to that
included in its statement of financial position. These are
explored later in this chapter on page 442.
10.1.3 Inventory valuation
Inventories used to be called stock. In recent years,
businesses across the globe have tried to minimise
inventories, recognising that they can be costly to store
and manage and that they have the potential to tie up large
amounts of cash.
It is important that a business values its inventories
accurately on its statement of financial position to provide
stakeholders with a figure which allows them to judge the
value of the business with some degree of certainty.
The difficulties of valuing inventories
It can be difficult to value inventories accurately for a
number of reasons:
» Some inventory may lose value because it is perishable.
For example, foods may lose value as they approach the
end of their saleable life. This may make the valuation of
inventory a more complex task, as inventory of different
ages may have different values.
» Inventory may be a fashion product and therefore of less
(or more) value as tastes and fashions change.
» When valuing certain inventories, it can be difficult to
define a market price as part of the use of the
net realisable value (NRV) method, which we will
discuss below. For example, a business selling antique
furniture may experience problems in determining an

438
 accurate figure for some items of furniture, especially
those that are unusual. With other products, such as
works of art, it may be that valuations differ between
different people.
» Valuations can be affected by a range of external
factors. For example, a business’ valuation of its
inventories of oil could vary considerably as the global
oil price alters. In the first six months of 2020 alone,
global oil prices varied between a maximum of $63.27
per barrel and a minimum of $11.57 per barrel.
STUDY TIP
Although there are a number of methods of valuing
inventory, you only need to know the net realisable value
(NRV) method.
GLOSSARY TERMS
Depreciation is the reduction in the value of a non-current
asset over a period of time
The net realisable value (NRV) method is a means of
valuing inventories (or other assets) at the amount that
would be raised by selling them, less any costs involved in
the sale of the inventories.
The NRV method of valuing
inventories
There are a number of methods of valuing inventories, but
we shall concentrate on a single one – the net realisable
value (NRV) method. This approach values inventories at
their likely selling price after allowing a reasonable amount
for the costs associated with either the eventual sale or
the disposal of the asset. It is a commonly used method
of valuing inventories so as to ensure that they are not
overvalued or undervalued on a business’ statement of
financial position.
There are a number of stages in calculating the value of
inventories using the NRV method:
CASE STUDY
Goch Minerals Company
Goch Minerals Company is a mining company which
operates a number of mines in South America. Its mines
include the Crib Gold Mine in Honduras, the Sao Cisco and
Sao Porto gold mines in Brazil, a copper mine in Mexico
and recently-opened copper and iron ore mines in Brazil.
Its products are used by a wide range of manufacturing
businesses.
The company announced its trading figures for the third
quarter of 2020, stating that its revenue fell by 9 per cent
compared with the same trading period during 2019. The
company mined 50 101 ounces (1420 kg) of gold during
the first half of 2020. The price per ounce (28.3 grams)
1 Firstly, calculate the total value of all inventories held
by the business. This is simply the amount the company
could sell its assets for on the open market. As an
example, take a business that manufactures cans and
10.1
bottles for use in the food industry. On the day its
statement of financial position is drawn up, it might
have the following inventories:
– 2 000 000 cans as inventory that are sold for $0.30
each to other businesses
– 500 000 small bottles each with a selling price of
$0.40
10.1.3 Inventory valuation
– 600 000 large bottles which can be sold for $0.60 per
bottle.
The total value of the inventory is (2 000 000 × $0.30)
+ (500 000 × $0.40) + (600 000 × $0.60) = $600 000 +
$200 000 + $360 000 = $1 160 000.
HANDLING DATA
What would be the total value of the inventory above
if all bottles were valued at $0.50, assuming no other
changes occur?
2 Next, the costs incurred in selling each asset the
company possesses must be deducted. This would
include the cost of advertising the goods for sale and
the expenses involved in distributing these products.
Continuing our example, we could assume the cost of
advertising and distributing the cans and bottles is
$85 000.
3 The final stage entails deducting the costs associated
with selling the products from the revenue raised from
their sale. Thus NRV = $1 160 000 – $85 000 = $1 075 000.
The NRV method is widely used to value inventories
in businesses throughout the world. The International
Financial Reporting Standards’ (IFRS) accounting rules
require businesses to value inventory using the NRV method
unless the cost of buying the inventories is lower. In other
words, IFRS rules state that inventories should be valued
at cost or NRV, whichever gives the lower figure. Hence,
inventory that is difficult to sell may have a very low value
in the statement of financial position.
realised by the company for gold rose from $1529 to
$1730 over the same time period. The company valued its
inventories using the NRV method.
Questions
1 Analyse one reason why inventory valuation is a
particularly important issue for manufacturing
businesses. [4]
2 Evaluate why the use of the NRV method of inventory
valuation might be a good choice for the Goch Minerals
Company. [12]
439
 10.1.4 Depreciation
10.1 A business may engage in revenue or capital expenditure
as we saw in Chapter 5.1. However, only capital expenditure
has any relevance to the process of depreciation.
Depreciation is the reduction in the value of a non-current
asset over a period of time. Thus, a manufacturer may
purchase production-line equipment and reduce its value
as shown in Table 10.6.
▼ Table 10.6 The principle of depreciation
A LEVEL 10.1 FINANCIAL STATEMENTS
Singapore Components Ltd
Year Value of asset on Amount
statement of financial depreciated
position at end of year ($) annually ($)
2017 60 000 20 000
2018 40 000 20 000
2019 20 000 20 000
2020 0 20 000
Table 10.6 illustrates the effects of depreciation on the
statement of financial position and the statement of profit
or loss of Singapore Components Ltd. The initial cost of
the production-line equipment in 2017 was $80 000. The
company expects that this equipment will last for four years
and have no resale value. The effect on the accounts is
shown in the table. The value of the asset falls by $20 000
each year, reflecting its decline in value. The amount of
the decline in value (that is, depreciation) is shown as
an expense on Singapore Components Ltd’s statement
of profit or loss.
HANDLING DATA
Recalculate the asset value and amount of annual
depreciation in Table 10.6, assuming that annual
depreciation is 20 per cent of the initial cost of the
equipment.
Firms have to depreciate their non-current assets for a
number of reasons:
» To ensure the business is valued accurately. In the
case of Singapore Components Ltd, it would have been
incorrect to show the value of the production-line
equipment as $80 000 throughout its life. Its resale
value would decline for a number of reasons:
– The equipment would lose value as a result of wear
and tear.
– The production of more modern equipment would
mean that the value of this ‘older’ style of equipment
declines.
– Poor or inadequate maintenance of the equipment
may mean expensive repairs are necessary, further
reducing the equipment’s value.
» Thus, reducing the value of a non-current asset in line
with the factors above ensures that the value of the
440
business recorded on the statement of financial position
is a relatively accurate indication of the true worth of
the business.
» Depreciation also allows firms to calculate the true
cost of production during any financial year. Singapore
Components Ltd would have overstated its costs in 2017
if it had allocated the entire cost of its new equipment
to that particular financial year. By depreciating the
equipment by $20 000 each year for four years, one
quarter of the cost of the equipment is recorded each
year on Singapore Components Ltd’s of profit or loss.
This helps to gain an accurate view of the profitability
(or otherwise) of the business over the lifetime of the
equipment.
GLOSSARY TERM
Capital expenditure (CAPEX) is the money spent by
businesses on physical assets such as property or
machinery.
Depreciation: a non-cash expense
Depreciation is an expense or a cost to a firm that is
recorded on the statement of profit or loss. However,
depreciation is unusual in that it is a non-cash expense.
Depreciation does not require a business to make any
payment. It is recognition of the cost of providing a
particular expense normally made at the time the asset was
purchased. Depreciation is not a method of providing the
cash necessary to replace the asset at the end of its useful
life.
Calculating depreciation: the straight-
line method
This is a simple method of depreciation that reduces the
value of a non-current asset by the same amount each year,
until the asset is of no further use and is sold or scrapped.
This method of depreciation can be calculated by using the
following formula:
annual straight-line cost of machine – residual value
=
depreciation working life in years
The residual value of a non-current asset is the amount
received when the asset is no longer required and is sold.
Assessing straight-line depreciation
Straight-line depreciation offers a number of advantages to
the managers and other stakeholders of a business:
» It is very simple to calculate and equally easy to
understand. The value of a non-current asset can be
seen to steadily decline in the business’ statement of
financial position.
» It spreads the cost of an asset over its working life,
which is important if a business is to have an accurate
view of its financial performance.
However, this approach to depreciation has a fundamental
shortcoming. Its simplicity is its principal weakness. Few
assets lose their value steadily over a period of time. It is
much more common for an asset to lose value more heavily
in the early years of its life. Thus, the straight-line method
may overvalue a non-current asset in the early years of
its life. This is particularly true of vehicles and other
technology products.
» Depreciation provides an accurate value of a business’
assets throughout their lives. This allows for a ‘true and
fair’ assessment of the overall worth of the business at
any time. Having an accurate figure for the overall value
10.1
of the business is important for stakeholders, such as
investors and creditors.
» The amount of annual depreciation affects the overall
value and profits of a business, as shown in Table 10.7.

Why is depreciation important?

10.1.4 Depreciation
Depreciation is an important matter to businesses for a
number of reasons:
▼ Table 10.7 The effects of depreciation

Too much depreciation Too little depreciation

Effects on statement of financial Non-current assets valued at less than their Non-current assets on the statement of
position true worth, meaning that the true value of financial position will be overvalued,
business is understated giving a false impression of the
company’s worth
Effects on statement of profit or Depreciation expenses overestimated on Low rates of depreciation will reduce the
loss statement of profit or loss, reducing level of expenses incurred by a business. This will
profits result in a business’ profits being higher
than they would otherwise be
Wider effects Business may look unattractive to prospective This may make the company more
investors. Tax liability on profits may attractive to investors, but it will also
be reduced, but tax authorities might increase its tax liability
investigate! Business may record surplus
when asset is finally sold

CASE STUDY
Depreciation at the nightclub
Alan Cork, managing director of Frenzy, a nightclub in depreciation entered as a cost on the statement of profit
Otago, New Zealand, has just authorised the purchase of or loss would also be $5000. This method of depreciation
a new sound system. The new system cost $18 000 and spreads the $15 000 cost of the sound system evenly over
Alan estimates that, in a rapidly changing world, he will the three years of its working life.
need to replace it at the end of three years. The company
supplying the sound system has advised Alan that the Questions
resale value after three years would be $3000. 1 Analyse one reason why this company should
depreciate its assets. [4]
As a result, the value of the new sound system on the
2 Evaluate whether or not the use of depreciation
statement of financial position of South Island Leisure Ltd
would strengthen South Island Leisure Ltd’s financial
(the company that owns the nightclub) would be reduced
position. [12]
by $5000 annually. At the same time, the amount of

The relationship between statements
of financial position and statements of
profit or loss
We have seen that the statement of profit and loss
summarises a business’ revenues and costs over a certain
period of time, and it shows the resulting profit or loss
for that trading period. On the other hand, the statement
of financial position gives a snapshot of the business’
financial position on a given day. It doesn’t show day-to-
day transactions or the current profitability of the business.
However, many of its figures are affected by transactions
recorded on the statement of profit or loss.
» Profit, dividends and retained earnings Any part of
the profit for the year which is not paid to shareholders
as dividends is recorded as retained earnings or profits
on the statement of financial position.
» Short-term borrowing If a business arranges a short-
term loan, this will appear on the statement of financial
position as a current liability. Although the loan itself
will not be shown on the statement of profit and loss,
the interest payments on the loan will be recorded
there and will affect the profit for the year figure.
441
 » Depreciation We saw above that, as part of the process of Depreciation
depreciation, the value of non-current assets is reduced
10.1 on the statement of financial position and an expense
is recorded on the statement of profit or loss. This link Statement Statement
between the two statements is summarised in Figure 10.6. of of profit
» Inventories The method used to value inventory helps financial or loss
position The amount
to determine a business’ costs of sales and therefore its The value of
profit. The formula used in the statement of profit or by which the
many value
loss is: non-current
of non-current
assets
is reduced assets is
cost of sales = opening inventory
A LEVEL 10.1 FINANCIAL STATEMENTS

over time reduced

+ inventory purchases and their annually is
– closing inventory current shown as an
values are expense on
The value of closing inventory (that is, at the end of the recorded the income
each year statement.
trading period) depends on how inventory is valued on on the
the statement of financial position. The lower the value of statement
closing inventory, the higher the cost of sales, which results of financial
in lower profit. Conversely, a higher closing inventory position.
valuation results in lower cost of sales and higher profits. ▲ Figure 10.6 Depreciation – a link between the statement
The closing inventory figure will be included in the business’ of financial position and the statement of profit or loss
statement of financial position under current assets.

TEST YOUR LEARNING

6 a Define the term ‘depreciation’. [2]
Short answer questions
b A non-current asset that was purchased for
1 a Define the term ‘statement of profit or loss’. [2] $880 000 is expected to have a residual value of
b Explain one effect on a statement of profit or $120 000 after 8 years, when it will be sold. Using
loss of a rise in the average selling price of a the straight-line method of depreciation, calculate
business’ products. [3] the annual depreciation figure for this asset. [3]
2 Explain one likely consequence for a business’ 7 Explain one reason why the straight-line method
gross profits of: of depreciation may result in a non-current asset
a a rise in its cost of sales. [3] having an incorrect value on a business’ statement
b a rise in its expenses. [3] of financial position. [3]
3 a Explain one reason why cost of sales is 8 A business sells a product for which demand is price-
likely to alter along with the level of output of a elastic. Explain one likely effect of a reduction in
business. [3] prices on its operating profits. [3]
b Define the term ‘non-current asset’. [2] 9 a Explain one way in which depreciation links the
4 Explain two reasons why the statement of financial statement of financial position and the statement
position is an important document for a business’ of profit or loss. [3]
stakeholders. [6] b Define the term ‘inventory’. [2]
5 a Explain one way in which a business might use 10 a Define the term ‘net realisable value method of
its profits. [3] valuing inventories’. [2]
b Explain one effect of a rise in the selling prices b Explain one effect that reducing the value of
of a business’ products on its gross profit. [3] inventory on a statement of financial position
might have on a business’ profits. [3]

442
Data response question whether to supply the business, invest in its shares, lend

Saddlers – a growing supermarket business

it money or work for the business.
10.1
Saddlers is a large supermarket business, established Questions
more than 100 years ago. The public company has 1750 1 Analyse two reasons why it is important for Saddlers
stores and a fleet of 124 lorries which it uses to deliver to depreciate its assets. [8]
products from its warehouses to its stores. It has started 2 a Calculate the annual straight-line depreciation for
to deliver to individual customers and is purchasing vans the company’s vans, assuming they have a residual
to carry this out. The company pays $27 500 for each van value of $9500. [4]
and depreciates them over six years.
b Evaluate the extent to which Saddlers might face

Saddlers is respected for its extensive range of very fresh
fruit and vegetables. Saddlers purchases and stores huge
amounts of oil products to heat its buildings and fuel its
lorries. The company also sells non-perishable foods
and has recently expanded into clothing and electrical
products.
The company’s stakeholders have to take a range of
decisions in relation to the business. They make use of
its statement of financial position and statement of profit
and loss to allow informed judgements on issues such as
10.1.4 Depreciation
problems in valuing its inventory. [12]
3 Evaluate whether Saddlers’ statement of financial
position is more important to its stakeholders than
its statement of profit or loss. [20]
Essay question
1 Evaluate the extent to which the use of the straight-
line method of depreciation guarantees that a rapidly
growing company includes accurate figures in its
statement of profit or loss. [20]

443
 10 Finance and accounting
A LEVEL

10.2 Analysis of published accounts

A LEVEL 10.2 ANALYSIS OF PUBLISHED ACCOUNTS

Chapter overview
In this chapter we examine:
★ the calculation and interpretation of liquidity ratios, profitability ratios, financial efficiency ratios, the gearing ratio
and shareholder ratios
★ methods that businesses may use to improve ratio results.

We introduced statements of financial position and
statements of profit or loss in the previous chapter.
This chapter examines the use of a range of ratios to
analyse published accounts and to help to make informed
judgements of the financial performance of businesses.
There are a number of groups that are interested in the
financial information provided by businesses, especially
by public limited companies. Collectively, these groups
can be referred to as stakeholders and they may take an
interest in the published accounts of a business for a
variety of reasons. For example, suppliers may want to judge
the financial position of a business to evaluate whether
they should offer the firm credit. Similarly, individuals
contemplating buying shares in the business may try
to assess the business’ potential to make profits in the
future. Figure 10.7 summarises stakeholder groups and their
interest in a company’s financial performance.

Accounting information
• statement of
financial position annual report and accounts
• statement of profit
or loss

Internal users External users

• Managers – Is this business achieving organisational objectives?
– Is it using resources efficiently?
• Employees – Is the business stable and jobs secure?
– Are they receiving fair pay in the light of the
business’ performance?
• Shareholders – What is the return on their investment?
– How does this compare with alternative investments?
• Suppliers – How much cash does the business have?
– Will it be able to pay its bills?
• Government – What is the tax liability of the business?
• Competitors – How is the business performing in relation
to other businesses?

▲ Figure 10.7 Stakeholders and financial information

What is a financial ratio? GLOSSARY TERMS

Ratio analysis allows stakeholders to evaluate a business’
Ratio analysis is a technique for analysing a business’
performance through the investigation of key financial financial performance by comparing one piece of
statements, such as the statement of financial position accounting information with another.
and the statement of profit or loss. The major feature of
Liquidity refers to how easy it is to convert assets into
ratio analysis is that it compares two pieces of financial
cash without these assets losing value.
information. By comparing two pieces of data in this way,
it is possible to make more informed judgements about a
business’ performance.

444
Types of ratio 3 Financial efficiency ratios measure the effectiveness
with which an enterprise uses the resources available to
There are a number of ways of classifying financial ratios
(see Table 10.8). One approach is to identify five main
it. These are also termed ‘internal control ratios’.
4 Gearing examines the relationship between internal and
10.2
categories of ratio:
external sources of finance. It is therefore concerned
1 Liquidity ratios, also known as solvency ratios, measure
with the long-term financial position of the company.
the ability of the business to settle its debts in the
5 Investment ratios measure the returns received by
short term.
the owners of the company, allowing comparisons with
2 Profitability ratios assess the amount of gross or
alternative investments. They are sometimes called
other profit made by the business in relation to the
‘shareholders’ ratios’.
business’ turnover or in relation to the assets or capital

10.2.1 Liquidity ratios

available to it.
▼ Table 10.8 Types of financial ratios

Type of ratio Liquidity Profitability Efficiency Gearing Investment

Ratios used • Current ratio • Operating profit • Inventory • Long-term • Dividend per
• Acid test (or margin turnover ratio loans: capital share
quick) ratio • Gross profit • Payable days employed • Dividend yield
margin • Receivable days • Price–earnings
• Return on capital
employed (ROCE)
Purpose of ratios To assess the To provide a To provide evidence To assess the To give investors
ability of the fundamental on how well the extent to which information on the
business to pay its measure of the managers have the business returns on their
immediate debts success of the controlled the is based on investment
business business borrowed money
Interested • Suppliers • Shareholders • Shareholders • Shareholders • Shareholders
stakeholders • Managers • Managers • Managers • Managers • Managers
• Competitors • Employees • Suppliers • Competitors
• Employees • Competitors

Sources of information for ratio analysis

The most obvious sources are the published accounts of
the business or businesses concerned. In particular, ratio
analysis requires access to a business’ statement of financial
position and statement of profit or loss. However, although
this might be essential information, it is not all that is
required to conduct an in-depth ratio analysis of a business.
Other possible sources of information include:
» the financial performance of the business over
recent years Having an understanding of the trends
of ratios over time can assist in making judgements.
A profitability ratio might appear fairly low, but
if it represents a continuation of a steadily rising
trend then the figure may be more acceptable to
stakeholders
» norms or benchmarks for the industry The results
of ratio calculations should be judged against what
is normal for the industry. For example, an investor
might calculate that a company’s debtor day ratio is 35
days (the number of days, on average, that customers
take to settle their bills). This might be acceptable
for a manufacturing business but not for a fast-food
business
» data on the economic environment A decline
in profitability ratios might appear to reflect an
unsuccessful business. However, this might be more
acceptable in the context of a severe economic
recession, whereby sales and prices have declined.
STUDY TIP
Do take care to express the results of your ratio
calculations in the appropriate format. The section below
offers you guidance on this.
Expressing ratios
Ratios are normally expressed in one of four forms, as we
shall see in the following sections:
1 as days; for example, a business’ trade receivables may
be 43 days
2 as a percentage; for example, ROCE expresses operating
profit as a percentage of capital employed by the
business
3 as a multiple; for example, inventories (stocks) may be
turned over (or sold) five times a year
4 as a ratio; for example, the acid test ratio might have a
result of 0.9:1.
10.2.1 Liquidity ratios
These ratios allow managers and other interested parties
to monitor a business’ cash position, and they can be
calculated from data that is on the statement of financial
position. These ratios are important because even profitable
businesses can experience problems with liquidity and may
be unable to pay their bills as they fall due. This can, in
severe cases, threaten the business’ survival.
445
 Liquidity ratios measure the liquid assets held by a firm
(cash and other assets, such as receivables that are easily
10.2 convertible into cash). The value of these assets is then
compared with the short-term debts or liabilities the
business will have to pay. In this way, stakeholders may
evaluate whether the business’ performance may be harmed
as a result of liquidity problems. Suppliers, as well as
managers, are likely to be interested in a business’ liquidity
ratios, as they indicate its ability to pay money that
is owed.
A LEVEL 10.2 ANALYSIS OF PUBLISHED ACCOUNTS
GLOSSARY TERM
Liquid assets are items owned by a business which can
be easily and quickly converted into cash. Examples
include shares and government bonds, which can
normally be sold quickly.
Current ratio
This ratio measures the ability of a business to meet its
liabilities or debts over the next year or so. The formula to
calculate this ratio is:
current ratio = current assets
current liabilities
The current ratio is expressed in the form of a ratio, for
example 2:1. This would mean that the firm in question
possessed $2 of current assets (cash, trade receivables and
inventories) for each $1 of current liability (trade payables,
taxation and proposed dividends, for example). In these
circumstances, it is probable that the business would be
able to meet its current liabilities without needing to sell
non-current assets or raise long-term finance.
CASE STUDY
Chinese steel manufacturers face liquidity problems
With the Coronavirus (COVID-19) outbreak in 2020 severely
slowing demand and deliveries, China’s steel producers
are running short of storage space and are facing liquidity
problems as they lack money to pay their workers.
Steel mills have tried to maintain output, targeting sales
to the construction industry from early March. Steel
inventories peak annually in late winter, but in 2020 they
rose significantly higher than normal levels.
Just one week saw a rise of 13 per cent in China’s
total steel inventories, according to industry data.
Some Shanghai warehouses are at full capacity, while
inventories in Lecong city are sitting at over 700 000
tonnes, which is beyond its warehouse capacity.
The growth in inventory is largely due to the reluctance of
the steel mills to reduce their output. However, a survey
by Argus has shown that some mills have already cut their
output by 10–50 per cent. ‘We think demand for steel will
446
Using this ratio
For many years, holding current assets twice the value
of current liabilities was recommended. This is no longer
accepted, partly due to the use of computers in inventory
control and the widespread use of just-in-time systems of
production. A more typical figure might now be 1.6:1.
In spite of this, the ‘normal’ figure for this ratio varies
according to the type of business and the state of the
market. Fast-food outlets, such as McDonald’s, and
banks typically operate with lower ratios, whereas some
manufacturing firms may have higher ratios.
Firms with high current ratio values (say, 3:1) are not
necessarily managing their finances effectively. It may be
that they are holding too much cash and not investing in
non-current assets to generate income. Alternatively, they
may have large holdings of inventories, some of which
might be obsolete.
Acid test (or quick) ratio
This ratio measures the very short-term liquidity of a
business. The acid test ratio compares a business’ current
liabilities with its liquid assets (that is, current assets
minus inventories). This can provide a more accurate
indicator of liquidity than the current ratio, as inventories
can take time to sell. The acid test ratio measures the
ability of a firm to pay its bills over a period of two or
three months without requiring the sale of inventory. Its
formula is:
liquid assets
acid test ratio =
current liabilities
The acid test ratio is also expressed in the form of a ratio;
for example, 2:1.
largely improve from early March,’ said a manager at a
Hebei mill that has reduced its output by 30 per cent.
Mills also face a liquidity crisis from the sudden fall in
steel sales. China produces vast quantities of steel and
the steel manufacturers are losing at least $4.25 billion in
sales revenue each day. The companies are turning to any
financial means to acquire cash, including selling their
cargoes of seaborne iron ore before they arrive in China.
Source: www.argusmedia.com/en/news/2074167-chinese-
steel-producers-face-space-money-shortages
Questions
1 Analyse one reason why manufacturers may be
especially vulnerable to liquidity problems. [4]
2 Evaluate the extent to which it is important whether
or not a steel manufacturer holds a high level of
inventory. [12]
Using this ratio
Conventionally a ‘normal’ figure for the acid test ratio was
thought to be 1:1, giving a balance of liquid assets and
current liabilities. However, in recent years many businesses
have operated successfully with acid test figures nearer
to 0.7:1.
The value of the acid test ratio considered acceptable will
vary according to the type of business. Retailers might
operate with a figure of 0.4:1, because they trade mainly
in cash and have close relationships with suppliers. A
manufacturing business might operate with a ratio nearer to
the standard 1:1.
Firms should not operate over long periods with high
acid test ratios, as holding assets in the form of cash is
not profitable and does not represent an effective use of
resources. As with the current ratio, the acid test ratio can
be improved by selling non-current assets or agreeing long-
term borrowing.
Interpreting the results of liquidity
ratios
Liquidity ratios are based on figures drawn from the
statement of financial position relating to a particular
moment in time. Because of this, some caution should be
exercised when drawing conclusions from this type of ratio.
The actual figures on the statement of financial position
may be unrepresentative of the firm’s normal position,
due to factors such as window dressing or a sudden and
unexpected change in trading conditions.
▼ Table 10.9 The liquidity ratios for three multinational companies
Company Tiffany & Co.
Type of business Retailer of jewellery and other The company designs, develops
luxury goods
Date of statement of
31 January 2020
financial position
Current assets $3 880 million
Inventories $2 460 million
Current liabilities ($970 million)
Current ratio 4.0:1
Acid test ratio 1.46:1
Methods of improving liquidity
Firms can improve their current ratio in several ways:
» raising more cash through the sale of non-current assets
or the negotiation of long-term loans (Note: Raising
more cash through short-term borrowing will increase
current liabilities, having little effect on the current
ratio.)
» delaying any capital payments that would require cash
payments
» paying off some current liabilities. For example, if a
business has current assets totalling $100 000, with
The results of the calculations in Table 10.9 show that
Tiffany & Co. has a very positive liquidity position. Its
current ratio is 4.0:1, indicating that it has $4 of current
assets for every $1 of current liabilities it has to pay. This
10.2
should enable it to pay these short-term debts as they fall
due, and it has significant current assets in reserve in case it
encounters unexpected debts. Its current ratio is very high
because it holds a large volume of expensive inventory –
mainly jewellery – to allow it to meet its customers’ needs
as quickly as possible. Its acid test ratio also looks very
reassuring to stakeholders. It has $1.46 of liquid assets for
10.2.1 Liquidity ratios
every $1 of current liabilities.
Apple is well known for its consumer electronics and
especially the iPad. Its liquidity position is also very strong,
which is perhaps not surprising for a highly successful
multinational. One notable feature of its liquidity ratios is
that the result of its acid test ratio is little different from
that of its current ratio. These results show that Apple
holds very low volumes of inventory. Partly, this is because
it subcontracts its manufacturing operations to other
companies, such as Foxconn.
Finally, Carrefour is a French-owned retailer with stores
in many countries. Its liquidity ratios may appear less
comforting at first. However, it is not uncommon for
retailers to operate with low liquidity ratios. Businesses
such as Carrefour can rely on customers paying promptly
and mainly in cash. Thus, the company can be confident
that it will receive a regular inflow of cash into the
business.
Apple Inc. Carrefour SA
A French supermarket chain
and sells consumer electronics with stores in 18 countries
30 September 2019 31 December 2019
$162 820 million €18 875 million
$4 110 million €5 867 million
($105 720 million) (€23 061 million)
1.54:1 0.82:1
1.50:1 0.56:1
$50 000 in cash and $70 000 in current liabilities, the
current ratio is 1.43:1. This could be improved by using
some cash to pay the short-term debts. If $40 000 of
the short-term debts are repaid, the ratio changes
to $60 000 of current assets and $30 000 of current
liabilities, giving a current ratio of 2:1
» negotiating improvements in trade credit terms with
suppliers and customers. If trade receivables pay more
quickly and trade payables can be delayed, the business’
cash position can be strengthened.
447
 10.2.2 Profitability ratios
10.2 These ratios compare the profits earned by a business with
other key variables such as the level of sales achieved
or the capital available to the managers of the business.
Profitability ratios are important because they can measure
the effectiveness of managers in using the business’ assets
to generate profits. They are also important to company
shareholders as they influence the company’s share price, as
well as its ability to pay dividends. These ratios are also a
key way of comparing the performance of businesses in the
A LEVEL 10.2 ANALYSIS OF PUBLISHED ACCOUNTS
same industry.
The return on capital employed (ROCE)
ratio
This is an important ratio, comparing the operating profit
earned with the amount of capital employed by the
business. The capital employed by the business is measured
by its issued shares, plus its reserves, plus its non-current
liabilities.
The importance of this ratio is reflected in the fact that it
is also termed ‘the primary efficiency ratio’. The result of
this ratio, which is expressed as a percentage, allows an
assessment to be made of the overall financial performance
of the business. A fundamental comparison can be made
between the prevailing rate of interest and the return on
capital employed (ROCE) generated by a business.
ROCE = operating profit × 100
capital employed
STUDY TIP
ROCE is one of three key ratios used to assess the financial
performance of businesses. The other two are the acid
test ratio and gearing. Using these three ratios enables a
company’s short- and long-term liquidity positions to be
examined, as well as being a fundamental measure of its
profitability. Do think about the ways in which a business
may increase its ROCE figure if it is considered to be too
low. This may have implications for all the functional areas
of the business to increase profits and/or to reduce the
amount of capital employed in the business.
GLOSSARY TERMS
Capital employed is the total long-term funding used by a
business. It is calculated by adding together the business’
non-current liabilities, its share capital and its reserves.
Return on capital employed (ROCE) is an important
measure of business efficiency, which expresses
operating profits as a percentage of the capital employed
by a business.
448
Using this ratio
A typical ROCE may be expected to be in the range of
20–30 per cent, though it varies between industries and
businesses. It is particularly important to compare the
results from calculating this ratio with the business’ ROCE in
previous years and also those achieved by competitors.
A business may improve its ROCE by increasing its operating
profit without raising further capital or by reducing the
amount of capital employed, perhaps by repaying some non-
current liabilities.
The returns here vary enormously. The most eye-catching
figure is that of Rolls-Royce Holdings Plc (see Table 10.10
on page 449). The company’s financial position has been
severely affected by higher than expected costs associated
with its Trent 1000 turbofan engine. It had to pay costs
totalling nearly £2 billion over problems related to this
engine, but it announced that most of the difficulties were
resolved and that it expected to return to profitability.
Gross profit margin
This ratio compares the gross profit achieved by a business
with its revenue. Gross profit is earned before expenses
such as administration and marketing costs are deducted.
The ratio calculates the percentage of the selling price
of a product that constitutes gross profit. The answer is
expressed as a percentage.
gross profit margin = gross profit × 100
revenue
For example, in 2019 Rolls-Royce’s gross profit was £942
million. This was achieved from a revenue of £16 587
million. The company’s gross profit margin is therefore:
£942 million
gross profit margin = × 100 = 5.68%
£16 587 million
This confirms the result shown in Table 10.10. This gross
profit margin is low, especially if we take into account
that the company has not paid its expenses for selling the
products and also its administrative costs. We saw in the
previous chapter that the company recorded a substantial
loss in 2019 (£1311 million).
Using this ratio
The figure for gross profit margin varies depending upon the
type of industry. Firms that turn over their inventory rapidly
and then can trade with relatively few assets may operate
with low gross profit margins. Greengrocers (retailers who
sell fruit and vegetables) and bakers may fall into this
category. Firms with slower turnover of inventory and
requiring substantial fixed assets may have a higher figure.
Housebuilders may fall into this category.
The sales mix can have a major influence on this ratio. A
farmer selling eggs at a 10 per cent gross profit margin and
renting out holiday cottages at a 40 per cent margin could
improve the business’ overall profit margin (but reduce its same period was $4772 million. The company’s operating
turnover) by discontinuing egg production. profit margin is therefore:

operating profit margin = $4772 million ×100 = 12.20%

Operating profit margin
(Note that the terms ‘operating profit margin’ and ‘profit
margin’ are synonymous and that either is acceptable to use
when discussing this ratio.)
This ratio calculates the percentage of a product’s selling
price that is profit from operations, or operating profit
10.2
$39 117 million
Using this ratio
Results of this ratio can vary according to the type of
business, though a higher profit margin is preferable. A
comparison of gross profit and operating profit margins can
be informative. A business enjoying a stable gross profit

10.2.2 Profitability ratios

after most costs have been deducted, but before tax is paid
and before any allowance has been made for interest paid
and received by the business. Because this ratio includes
the majority of a business’ costs and expenses, it may be
regarded as a better indication of performance than gross
profit margin. Once again, the answer to this ratio is written
as a percentage.
operating profit margin = operating profit × 100
revenue
As an example of the calculation of this ratio, we can use
Nike, the American manufacturer of sporting equipment and
clothing. The company’s revenue for the trading year ending
in May 2019 was $39 117 million; its operating profit for the
margin and a declining operating profit margin may be
failing to control expenses effectively. This may be due to
the purchase of costly new premises, for example.
Interpreting the results of profitability
ratios
One key issue here is the comparison between gross and
operating profit margins. A comparison of the two margins
can inform stakeholders of the management of a business’
costs. The other important figure is that for ROCE, which is
a fundamental measure of a business’ efficiency.

▼ Table 10.10 The profitability ratios of three multinational companies

Company Apple Inc. Lenovo Rolls-Royce Holdings Plc

An American company which A Chinese multinational A UK multinational
Type of business designs, develops and sells technology company engineering company
consumer electronics
Date of statement of profit 30 September 2019 31 March 2020 31 December 2019
or loss/currency US$ million US$ million Pound sterling
Revenue $260 174 million $50 716.3 million £16 587 million
Gross profit $98 392 million $8 357.3 million £942 million
Operating profit/(loss) $63 930 million $1 438.6 million (£852 million)
Capital employed $182 300 million $8 870.0 million £1 534 million
ROCE (%) 35.07 16.22 –55.54
Gross profit margin (%) 37.82 16.48 5.68
Operating profit margin (%) 24.57 2.84 –5.14

It may not be a surprise that Apple Inc, the American
consumer electronics company, is highly profitable. The
most noteworthy figure here is Apple’s operating profit
margin. This is over 24 per cent, meaning that 24 cents
from each dollar of revenue received by the company
represents profit. This is a measure of the company’s global
success, but it is also necessary if it is to continue to be
a market leader in global consumer electronics. Continued
success will require the company to invest consistently in
developing new products, and this high level of profit gives
it the funds it needs.
Lenovo, the Chinese multinational technology company,
produced a steady figure for its ROCE, though far below
that achieved by Apple. The company may seek to
control its costs more tightly in the future to improve its
profitability. The most eye-catching figures come from
Rolls-Royce Holdings Plc. We saw earlier that the company
is experiencing costly problems with one of its engines. The
outcome is some very poor figures for profitability, notably
ROCE. Its financial performance is expected to improve in
the future.
HANDLING DATA
Use the information in Table 10.10 to answer the
following questions.
1 Assuming no other changes, what level of operating
profit would Lenovo have needed to make in 2020 to
record a ROCE figure of 20 per cent?
2 Given Apple’s 2019 profit figure, what amount of
capital employed would be necessary to result in a
ROCE figure of 40 per cent?

449
 CASE STUDY
10.2
Profits at McDonald’s
The McDonald’s Corporation is one of the world’s largest
restaurant chains, with a menu based mainly on burgers.
McDonald’s restaurants offer a substantially uniform
menu, although there are geographic variations to suit
local consumer preferences and tastes. At the start of
2020 it had 38 695 restaurants in 119 countries, of which
A LEVEL 10.2 ANALYSIS OF PUBLISHED ACCOUNTS
36 059 were operated by franchisees and 2636 were
operated by the company. The company has raised its
dividend for 43 consecutive years since paying its first
dividend in 1976. It has a globally recognised and valuable
brand name, as well as a clear focus on consumer needs.
The company’s financial performance for 2019 was above
expectations with sales volumes rising by 5.9 per cent,
although revenue was relatively unchanged from 2018.
Table 10.11 below shows some key figures from the
company’s statement of profit or loss for 2019.
Improving profitability
It is important to understand the difference between profits
and profitability. A business can improve its profits if it
reduces its costs or increases its revenues without any
other changes occurring. However, increasing profitability
requires managers to increase the amount of profit
compared to some other measure, such as revenue or capital
employed. Thus, a business might measure its profitability
by calculating its operating profit margin.
Not all actions intended to increase profits will increase
profitability and vice-versa. For example, a decision to
increase prices is likely to increase a business’ profitability,
as it will probably result in a higher percentage of the
selling price of the product being profit. However, if
demand is price elastic, it may result in a fall in profits.
We can identify a number of key ways in which businesses
can increase profitability:
» Increase prices If a business increases its prices and
costs do not rise, or they rise by a smaller percentage
than price, profit margins are likely to increase.
» Reduce costs Another way to increase profitability is to
reduce costs of sales and/or expenses. This can increase
the proportion of profits in the selling price of the
product and thereby improve profit margins.
» Reduce capital employed If a business is able to use
fewer resources in production, perhaps by selling any
spare capacity (factories, offices or equipment), it can
reduce the capital employed by the business. If this
action does not damage its ability to generate profits
then a higher ROCE figure is likely to result.
STUDY TIP
It is important to respond to the precise wording of
questions relating to profits and profitability. If a question
asks about profitability, do address this and not profits.
Similarly, if a question asks about profits, avoid straying
into discussing profitability.
450
▼ Table 10.11
$m
Revenue 21 076.5
Cost of sales 9 961.2
Operating profit 8 885.9
Questions
1 Calculate the following for McDonald’s in 2019:
a its gross profit margin [4]
b its operating profit margin. [3]
2 Evaluate the possible reasons why the McDonald’s
Corporation generates such a high operating profit
margin. [12]
10.2.3 Financial efficiency ratios
This group of ratios measures the effectiveness with
which management controls the internal operation of
the business. They consider the following aspects of the
management of an enterprise:
» how well inventories are managed
» the time that the business takes to settle its own debts
» the efficiency of its control of trade receivables; that is,
how long before customers pay their accounts.
Financial efficiency ratios are important because they
measure how effectively a business is managing its assets.
They show the ability of managers to use its assets and
manage its liabilities effectively over the current or latest
trading period. There are a large number of ratios that fall
under this heading, but we shall concentrate on just three.
The rate of inventory turnover ratio
This ratio measures a company’s success in converting
inventories into sales. The ratio compares the value of
inventories with the sales achieved, valued at cost. This
permits an effective comparison with inventories, which
can also be valued at cost. If the company makes a profit
on each sale, then the faster it sells its inventories, the
greater the profits it earns. This ratio is only of relevance
to manufacturing businesses, as firms providing services do
not hold significant quantities of inventories.
cost of sales
inventory turnover ratio =
average inventories held
In this form, the results of calculating this ratio are
expressed as a number of times per year. Century and Paper
Board Mills Ltd is a Pakistani company based in Karachi
and Lahore which manufactures a range of paper products.
On 30 June 2019, the company held inventories valued at
3484 million Pakistani rupees (PKR). During the company’s
financial year, which ended on that day, the company had
achieved sales (at cost) of PKR19 578 million. The company’s
inventories turnover ratio was therefore 5.62 times.
The inventory turnover formula can be reorganised to
express the number of days taken on average to sell the
business’ inventories.
inventory turnover ratio = inventories × 365
cost of sales
Our Century and Paper Board Mills Ltd calculation would
then become:
inventory turnover ratio = 3484 million × 365 = 64.95 days
19 578 million
Thus, if Century and Paper Board Mills Ltd sells its complete
inventories every 65 days, it will sell its inventories just
over 5.6 times during a year.
Using this ratio
The standard figure for this ratio varies hugely according
to the type of business. A market trader selling fruit and
vegetables might expect to sell his entire inventories every
two or three days – about 100 times a year. At the other
extreme, a shop selling antique furniture might only sell its
inventories every six months – or twice a year.
A low figure for inventory turnover could be due to
obsolete inventories. A high figure can indicate an efficient
business, although selling out of inventories regularly
results in customer dissatisfaction.
STUDY TIP
Other aspects of a business’ activities can have significant
impacts on the results of ratio calculations. For example,
if a business uses a JIT system of inventory control, it is
likely to have a much higher level of inventory turnover.
CASE STUDY
Late payment legislation
The Late Payment of Commercial Debts (Interest) Act
1998 and Late Payment of Commercial Debts Regulations
2002 give businesses in the UK the statutory right to claim
interest on late payments from other businesses. The
law was originally introduced in November 1998 but was
amended by European Union directive in 2002.
The law allows all businesses, including public sector
organisations, to claim interest from any other business or
organisation if payment is late. A late payment is defined
as where the agreed credit period given by the supplier
to the purchaser has expired. If no credit period has been
specified by the supplier, the Act specifies a default period
of 30 days, after which interest will accumulate.
Trade payables turnover days
This ratio is also referred to as trade payables (or creditors’)
collection period. It calculates the time typically taken by
Trade receivables turnover days
This ratio is also referred to as trade receivables (or
debtors’) collection period. It calculates the time typically 10.2
taken by a business to collect the money that it is owed by
customers. This is an important ratio, as granting customers
lengthy periods of credit (that is, periods of time to pay)
may result in a business experiencing liquidity problems.
The formula uses credit sales, rather than revenue, to
exclude any cash sales the business might make. If a
10.2.3 Financial efficiency ratios
company has cash sales, these should be excluded from the
calculation.
trade receivables turnover = trade receivables × 365
credit sales
GLOSSARY TERMS
Credit sales are purchases made by a business’
customers for which payment is delayed, normally by
30–60 days.
Cash sales are purchases where payment is made at the
time of the sale.
Using this ratio
There is no standard figure for this ratio. In general, a
shorter figure is preferred as the business in question
receives the inflow of cash more quickly. However, it can be
an important part of a business’ marketing strategy to offer
customers a period of trade credit, of perhaps 30 or 60 days.
A rise in this ratio may be due to a number of causes. A
period of expansion may mean that a business has to offer
improved credit terms to attract new customers, or a ‘buy
now, pay later’ offer may have been introduced.
Late payments are an important issue for many small
businesses in the UK. About one-quarter of all insolvencies
in the UK are caused by late payments. In a report in 2016,
the Federation of Self-Employed and Small Businesses
(FSB) estimated that if all payments were made on time, this
would have kept 50 000 UK businesses operating. In 2020,
there were further efforts in the UK to strengthen laws
protecting businesses from the effects of late payments.
Questions
1 Analyse two reasons why customers making late
payments can cause problems for a small business. [8]
2 Evaluate whether a small business might be
reluctant to claim interest from a customer which
regularly delays payment. [12]
a business to pay the money it owes to its suppliers and
other trade payables. This is an important ratio, as delaying
payment for as long as possible can help a business to avoid
liquidity problems.
451

trade payables turnover = trade payables × 365
credit purchases
10.2 The calculation of this ratio only requires the inclusion of
purchases of goods and services on credit. Therefore, the
formula uses credit purchases rather than cost of goods
sold, as some supplies may be purchased and payment made
immediately. These cash payments should be excluded from
the calculation of the trade payables turnover ratio.
Using this ratio
A LEVEL 10.2 ANALYSIS OF PUBLISHED ACCOUNTS
It is best to consider this ratio alongside the equivalent
trade receivables days ratio result. By comparing trade
payables days and trade receivables days, a business can
CASE STUDY
More on Century and Paper Board Mills Ltd
Some key data from the 2019 Annual Report for Century and Paper Board Mills Ltd is shown in Table 10.12. We have
assumed that all payments and sales are made under credit terms.
▼ Table 10.12 Some financial data for Century and Paper Board Mills Ltd, 2018 and 2019
2019 (PKR million)
Credit sales 22 241
Credit purchases (19 578)
Receivables 3 149
Payables (2 528)
Source: Century and Paper Board Mills Ltd Annual Report 2019; http://centurypaper.com.pk/admin/
Questions
1 Calculate the company’s trade receivables turnover days and trade payables turnover days in 2018 and in 2019.
2 Evaluate whether Century and Paper Board Mills Ltd managed its payables and receivables more efficiently
in 2018 or in 2019.
Improving financial efficiency
Improving the inventory turnover ratio requires a business
to hold lower levels of inventories or to achieve higher
sales without increasing levels of inventories. However, it
can be too simple just to argue that a lower figure is an
improvement. As we saw earlier, this is not the case in all
circumstances. Efficient inventory management requires
a business to hold the minimum necessary to ensure that
it can meet its customers’ requirements. An efficient
inventory turnover ratio will vary according to the nature of
the business.
The trade receivables ratio may be improved by reducing
the credit period on offer to customers or by insisting on
cash payment. A more focused approach is to conduct an
aged receivables’ analysis. This technique ranks a business’
receivables according to the period of credit taken. This
allows managers to concentrate on persuading the slowest
payers to settle their accounts. Trade payables’ turnover
days figures can be improved by delaying payment. If this
452
assess its liquidity position. If the figure for trade payables
days is lower than the trade receivables days, it is more
likely that the business will experience liquidity problems.
This is because, on average, it is paying suppliers and other
trade payables more quickly than it is receiving payment
from its customers.
STUDY TIP
Trade payables days is not a ratio that you would normally
be asked to calculate alone, but it is important to use
it alongside trade receivables days as a comparison
between the two, as it gives a useful insight into the extent
to which the business is managing its finances efficiently.
2018 (PKR million)
18 965
(16 459)
2 465
(2 216)
annual_report/Century-Paper-Low-24-Aug-2019-min.pdf
[8]
[20]
is negotiated, this can be a good method of improving
financial efficiency. However, a unilateral decision to delay
payment can create a poor relationship with suppliers,
who may suffer their own liquidity problems as a result
of the delay in payment. Businesses may also be charged
interest on delayed payments. If a business’ managers
could engineer a situation where a business’ trade payables
turnover days figure was higher than its trade receivables
turnover figure, then this would represent an improvement,
so long as relationships with customers and suppliers were
not harmed.
10.2.4 Gearing ratios
Gearing measures the long-term liquidity of a business.
Under some classifications of financial ratios, gearing is
included as a liquidity ratio. There are a number of methods
of measuring gearing; we shall consider the simplest form
of the ratio. This ratio analyses how businesses have raised
their long-term capital. It measures the proportion of
the long-term capital used within the business (capital
employed, in other words) that has been raised through
long-term loans. So, it compares its non-current liabilities
to its capital employed. The result of this calculation is
expressed as a percentage.
gearing = non-current liabilities × 100
capital employed
This measure of a business’ performance is important,
because by raising too high a proportion of capital through
long-term borrowing, businesses can become vulnerable to
increases in interest rates. Shareholders are also unlikely to
be attracted to a company with a high gearing ratio, as their
returns might be lower because of the high level of interest
payments to which the enterprise is already committed.
» As a general guide, a business with a high gearing ratio
has more than 50 per cent of its capital in the form of
non-current liabilities.
» A business with a low gearing ratio has less long-term
borrowing and a gearing figure that is below 50 per cent.
Much attention tends to be given to businesses that have
high gearing and are vulnerable to increases in interest
▼ Table 10.13 Gearing ratios of some leading international companies
Company Next Plc
Country and industry UK, clothing retailer
Date of statement of 25 January 2020
financial position/currency £ millions
Non-current liabilities £2 282
Capital employed £2 723
Gearing (%) 83.80
HANDLING DATA
Use the information in Table 10.13 to calculate the
following.
1 Assume that BP’s non-current liabilities in 2019
were US$99 720 million. What would have been the
effect on the company’s gearing ratio?
2 What figure for non-current liabilities would have
been necessary in 2020 for Next Plc to have a
gearing ratio of 50 per cent?
10.2.5 Investment ratios
These are also called shareholders’ ratios or investors’
ratios. The results of this group of ratios are of particular
interest to the shareholders of a company or to anyone
considering purchasing shares in a particular company.
Shareholders can receive a return on their purchase of
shares in two ways:
1 through dividends paid from the company’s profits over
the financial year
2 as a result of a rise in the price of the shares, called a
‘capital gain’.
rates. However, this may be considered acceptable in
a business that is growing quickly and generating high
profits. Furthermore, a business with a low gearing ratio
may be considered too cautious and not expanding as
10.2
quickly as possible.
Using this ratio
The key yardstick is whether a business’ long-term
borrowing is more than 50 per cent of capital employed.
Companies with secure cash flows may raise more loan
10.2.5 Investment ratios
capital because they are confident of being able to meet
interest payments. Equally, a business with well-known
brands may be able to borrow heavily against the value of
these brands to increase long-term borrowing. Firms can
improve their gearing by repaying long-term loans or by
issuing more ordinary shares.
Next Plc, in Table 10.13, is very heavily geared as it is
significantly in excess of the 50 per cent standard maximum
figure. The other two companies are less highly geared,
although BP has a figure just above the 50 per cent
benchmark.
BP Toyota
UK, oil and gas extraction Japan, vehicle manufacture
31 December 2019 31 March 2020
US$ millions US$ millions
$120 891 $129 171.5
$221 599 $319 958.2
54.55 40.37
These ratios are important because investors consider the
potential returns on their investments before deciding
whether or not to buy a company’s shares. Dividends
offer a short-term return on an investment and may be of
interest to shareholders seeking a quick return. However,
other shareholders may seek a long term return on their
investment. They may be prepared to forgo high levels of
dividends in the short term to allow profits to be invested.
They hope that the business will grow, increasing the price
of shares and providing a capital gain for shareholders.
There are a number of ratios that may be used by
shareholders. However, we shall concentrate on ratios
that compare the dividends received against the capital
investment made by shareholders when purchasing shares.
Dividend per share
This is an important investment ratio and is necessary
to calculate the dividend yield, which we shall consider
later. It is simply the total dividend declared by a company
divided by the number of shares the business has issued.
dividend per share = total annual dividends
number of issued shares
Results of this ratio are expressed as a number of cents or
pence per share, depending on the currency used.
453
 Assume that a company has issued 1725.69 million shares Dividend yield
and announces dividends totalling £293.77 million.
10.2 The dividend per share (DPS) for the company would be
calculated as follows:
This ratio is really a development of the previous ratio and
provides shareholders with more information. The dividend
yield compares the dividend received on a single share
£293.77 million with the current market price of that share. This provides
DPS = = 17.0 pence per share
1725.69 million shares shareholders with a better guide to a business’ performance,
as it compares the return with the amount that would need
It is normal for dividends to be paid in two parts: an interim to be invested to purchase a share. The result of calculating
dividend halfway through the financial year and a final this ratio is given as a percentage.
dividend at the end of the year.
A LEVEL 10.2 ANALYSIS OF PUBLISHED ACCOUNTS

dividend yield = dividend per share × 100

Using this ratio
A higher figure is generally preferable to a lower one, as
this provides the shareholder with a larger return on their
investment. However, some shareholders are looking for
long-term investments and may prefer to have a lower DPS
now in the hope of greater returns in the future and a rising
share price.
It is wise to compare the DPS with that offered by
alternative companies. However, it is also important to bear
in mind how much has to be invested to buy each share. A
low DPS may be perfectly acceptable if the company has a
low share price.
A business can improve this figure by announcing higher
dividends (and therefore reducing the amount of profit
retained within the business). This may prove attractive
to some shareholders, but it may not be in the long-term
interests of the business, particularly if profits are not
rising.
market price of share
Imagine a shareholder was considering investing in the
company mentioned above, and they noted that the share
price on one particular day was 475 pence (or £4.75), and
that the DPS for the company was 17.0 pence. The potential
shareholder could calculate the dividend yield as follows:
dividend yield = 17.0 × 100 = 3.58%
475
Using this ratio
A higher return will be regarded as preferable by
shareholders seeking a quick return. Longer-term investors
might settle for a lower figure, allowing the firm to reinvest
profits and offering the possibility of higher profits and
dividends in the future.
Results for this ratio can vary dramatically according to
fluctuations in the company’s share price.

CASE STUDY
Hewing International Plc announces dividends
Hewing International Plc is a mining company that
specialises in precious metals with its headquarters in
Belarus, although its shares are sold on the London Stock
Exchange. The company owns gold and silver mines in
Belarus, Moldova and Kazakhstan. Production output in
2020 consisted of 50 per cent gold, 39 per cent silver and
11 per cent copper.
In June 2020, Hewing International Plc announced a
dividend per share of £0.31 or 31 pence per share. At
the time, the company had 382 million issued shares
and the total dividend payment was £118.42 million; the
company’s share price on the London Stock Exchange
was quoted at 1155 pence. Last year’s dividend yield was
1.95 per cent.
The company has introduced a new dividend policy, paying ▲ Figure 10.8 Hewing International Plc trades in precious
regular dividends, which will represent 30 per cent of the metals
company’s profits for the year.
Questions
Commenting on the board’s decision, Klaudia Darbonova,
CEO of Hewing International, said, ‘Our new dividend 1 Analyse one way in which you think that Hewing
policy demonstrates how important we think it is to give International Plc’s shareholders will respond to this
our shareholders good and sustainable levels of investor announcement. [4]
return.’ 2 Evaluate the factors that might shape the
shareholders’ reactions. [12]

454
Dividend cover ratio
The dividend cover ratio shows how easily a business
can pay its dividend from its profits for the year. A high
dividend cover means that the business can easily afford to
pay the dividend, and a low value means that the business
might have difficulty paying a dividend.
dividend cover = profit for the year
annual dividend
This ratio should be considered in the context of the
stability of a company’s profits for the year. A low level
of dividend cover might be acceptable in a company with
steady profits, but the same level of dividend cover in a
company with volatile profits would indicate that future
dividend payments may be at risk.
Using this ratio
Generally speaking, a ratio of 2 or higher is considered
safe (in the sense that the company can well afford the
dividend) but anything below 1.5 is risky. If the ratio is
under 1, the company is using its retained earnings from
a previous year to pay this year’s dividend. This is not a
situation that can continue for a long-term period.
Price–earnings ratio
This ratio compares the current market price of a company’s
shares to its earnings per share. The price–earnings (or P/E)
ratio is also called the ‘price multiple’, and it is sometimes
referred to as a ‘multiple’ ratio because it shows how
much investors are willing to pay per dollar of earnings.
If a company’s P/E ratio was 16, this would show that an
investor was willing to pay $16 for $1 of earnings per share.
An average P/E ratio is approximately 14–15.
To calculate the P/E ratio, it is first necessary to calculate a
company’s earnings per share (EPS). The EPS is the amount
of the company’s profits that belong to a single share. The
EPS is calculated using the formula below:
earnings per share = profit for the year
total number of issued shares
Once the EPS has been calculated, it is then possible to use
this information to complete the calculation of the P/E ratio.
price–earnings ratio = current share price
earnings per share
Using this ratio
In most circumstances, a higher P/E indicates that investors
are anticipating higher growth in earnings in the future
than in companies with a lower P/E ratio.
Comparing the P/E ratio of a chosen company to other
companies in the same industry is a valuable exercise.
It can also be beneficial to analyse it against companies
from other industries or against the company’s previous
P/E ratios. However, different industries can have very
different growth prospects, making valid comparisons
more difficult. 10.2
CASE STUDY
La Araucania Fruit Producers
This company is located near Temuco in Chile. La
Araucania Fruit Producers reported the figures shown
in Table 10.14 in its annual reports in 2018 and 2019.
10.2.5 Investment ratios
▼ Table 10.14
2019 2018
Total annual dividends $450 000 $425 000
Number of issued shares 1 875 000 1 850 000
Market price of share $4.86 $5.24
(31 December)
Profit for the year $787 000 $680 000
Questions
1 Use relevant investment ratios to compare La
Araucania Fruit Producers’ financial performance
in 2018 and 2019. [8]
2 Evaluate whether La Araucania Fruit Producers
was more attractive to potential shareholders
in 2018 or in 2019. [20]
Methods of improving investor return
Investor return can take two forms:
» rising share prices giving a capital gain
» increased dividends providing shareholders with a higher
income.
A management team can possibly increase the company’s
share price by improving its relative performance against
other businesses in the same industry, although external
factors, such as the general performance of the economy,
will also influence share prices. However, if a company’s
financial performance is strong over a period of time, it is
likely to have a rising share price.
A number of companies, including Apple and American
Airlines, have engaged in share buy-back schemes. This
simply involves the company buying some of its own shares
back from shareholders. Sometimes companies do this to
return excess cash (which is not needed for operations)
to shareholders. This tends to increase the value of the
company’s remaining shares. It also helps to increase the
dividend per share for shareholders. Overall, it is likely to
improve the return for the company’s investors.
Management teams can also take a series of actions to
improve dividends, most obviously by increasing the
proportion of profits for the year distributed to shareholders
in the form of dividends.
455
 TEST YOUR LEARNING
10.2
Short answer questions
1 a Define the term ‘ratio analysis’.
b Explain one distinction between financial
efficiency ratios and profitability ratios.
2 a Define the term ‘gearing ratio’.
b Explain two sources of information that might be
important when conducting ratio analysis.
A LEVEL 10.2 ANALYSIS OF PUBLISHED ACCOUNTS
slowed and interest rates are expected to rise in the near
future. However, the government is confident of attracting
[2] foreign investment into the industry.
The company’s most recent accounts produced some
[3]
interesting ratios, as shown in Table 10.15.
[2]
▼ Table 10.15 Ratios for Lahore Construction Ltd
[6]

The year
3 Explain one reason why a company may have a low Ratio Last year
figure for the rate of inventory turnover. [3] before last
4 Explain two reasons why return on capital employed Profit for the year ($m) 50.24 71.76
is such an important ratio for stakeholders. [6] Acid test ratio 0.82:1 1.12:1
5 Explain one reason why it is useful to use the trade
Gearing 51% 64%
payables turnover and trade receivables turnover
ratios together when assessing a company’s ROCE 15.2% 14.1%
financial performance. [3] Total annual dividend ($m) 15.7 18.4
6 Pelennor Products is a rapidly growing business Number of issued shares (m) 180.39 176.82
providing IT services. The company’s trade receivables
turnover ratio has increased from 33.2 days to Average share price ($) 2.42 2.20
41.7 days over the past year. Explain one possible Earnings per share (EPS) ($) 0.17 0.14
implication of this for the business. [3]
7 a A company has non-current liabilities totalling The company has faced some criticisms from its
$456 000 and its figure for capital employed is shareholders. It has repaid some of its loans, reducing
$780 500. Calculate its gearing ratio. [2] its non-current liabilities. It is negotiating a $12 million
b Explain one reason why a business might be contract with the Pakistan government to build new roads
concerned if its gearing figure was 75.6 per cent. [3] near to Jacobabad.
8 Explain one reason why the dividend yield ratio might
Questions
provide a good measure of a company’s performance
for a potential shareholder. [3] 1 Analyse two benefits to LC Ltd’s stakeholders of the
9 Explain one reason why a dividend cover ratio of company reducing its gearing ratio. [8]
1.2 might be regarded as worrying by a company’s 2 a Calculate LC Ltd’s dividend cover for the two
shareholders. [3] years. [4]
10 Explain one aspect of a business’ performance that is b Evaluate the extent to which LC Ltd’s
not covered by ratio analysis. [3] shareholders would be satisfied with its
recent performance. [20]
Data response question 3 Evaluate whether or not it is possible to judge
LC Ltd’s future performance from its published
Lahore Construction Ltd (LC Ltd)
accounts. Justify your decision. [20]
Over the last ten years, it is estimated that the
construction industry in Pakistan has contributed Essay question
approximately 2.5 per cent of the country’s GDP. However,
1 Evaluate the extent to which return on capital employed
there are now fears that the industry is stagnating. LC Ltd
is a more valuable ratio for shareholders looking for
builds houses, roads and bridges. It has suffered from
long-term returns than investment ratios such as the
declining sales recently, as its housebuilding activity has
price–earnings ratio. [20]

456
10 Finance and accounting
A LEVEL
10.3 Investment appraisal
Chapter overview
In this chapter we examine:
★ the concept of, and need for, investment appraisal
★ the basic methods of investment appraisal: payback and accounting rate of return
★ discounted cash-flow methods of calculating investment appraisal: net present value and internal rate of return
★ quantitative and qualitative factors in investment appraisal
★ comparing methods of investment appraisal.
10.3.1 The concept of investment
appraisal
This chapter looks at the techniques that businesses can
use to make major investment decisions. It considers
the reasons why businesses undertake programmes of
investment, and it will look at financial and non-financial
methods of assessing the worth of alternative investment
projects.
Investment is an important term within business studies
and often entails managers taking major decisions.
Investment can mean a decision to purchase part or all of
another business, perhaps as a result of a takeover bid.
However, it is perhaps more common to use the term in
relation to the purchase of a non-current asset or some
other major expenditure. What is common is that all such
actions involve a degree of risk. This must be judged
against the likely return. The final decision will depend
upon managers’ assessment of these two factors.
Businesses take decisions regarding investment in a variety
of circumstances.
» When contemplating introducing new products A
business may assess the likely costs and returns from
investing in one or more new products.
» Expansion This may entail evaluating whether or not to
invest in new non-current assets as part of a planned
programme of growth. Tottenham Hotspur Football
Club in London invested $1 billion in developing a new
stadium, built in part on its existing ground at White
Hart Lane. The Club hoped to increase its sales revenue
by attracting larger crowds into the new stadium, which
has a capacity of 62 000 spectators.
» Spending Businesses may also use techniques of
investment appraisal before spending on promotional
campaigns, developing new brands or products or
retraining the workforce.
» Investing in new technology This may be undertaken to
reduce costs and improve productivity or to meet with
10.3.1 The concept of investment appraisal
legal requirements or the expectations of consumers. For
example, one of the world’s largest mining companies,
Rio Tinto, has started using driverless trucks in its iron
ore mines in Western Australia. These are expensive
vehicles which improve the productivity of the mines.
Investment appraisal is needed because, in each
circumstance, the business’ managers must use an
appropriate financial technique to decide whether the
returns received from an investment are sufficient to justify
the initial capital expenditure.
GLOSSARY TERMS
Risk is the chance of a misfortune occurring, possibly
resulting in financial loss.
Investment appraisal is a series of techniques designed to
assist businesses in judging the desirability of investing in
particular schemes.
Risk and investment appraisal
Risk is an important factor within investment decision-
making. Risk can be defined as uncertainty that is
quantifiable or that can be measured. There are two major
types of risk:
» Systematic risk relates to the environment in which
a project will operate. This type of risk could include
a loss of sales and cash inflow due to, say, an adverse
movement in the exchange rate.
» Specific risk is associated with a particular project; for
example, launching a product that is entirely new and of
which the firm has little experience.
Techniques of investment appraisal can incorporate an
allowance for risk, perhaps by reducing cash inflows or
increasing costs. More sophisticated techniques use the
theory of probability to attempt to arrive at more accurate
predictions. In these ways, techniques of investment
appraisal can assist managers in making more informed and
less risky investment decisions.
457
 Risk should be distinguished from uncertainty. Uncertainty
is not measurable and cannot be included in numerical
10.3 techniques of investment appraisal. An investment project
that appears to have a high degree of uncertainty attached
to it may not be undertaken, because the firm in question
may be unable to assess its likely costs and benefits.
10.3.2 Basic methods
Financial techniques for making
A LEVEL 10.3 INVESTMENT APPRAISAL
investment decisions
A number of techniques are available to managers to assist
them in taking decisions on whether to go ahead with
investments or to help in making a judgement between two
or more possible investment opportunities. This section will
look at three of the most important of these techniques:
payback, the accounting rate of return and discounted
cash flow. These financial techniques are valuable, but they
do depend upon a number of assumptions:
» that all costs and revenues can be forecast easily and
accurately for some years into the future
» that key variables (for example, interest rates) will not
change unexpectedly
» that the business in question is seeking maximum profits.
There are two major considerations for managers when
deciding whether or not to invest in a non-current asset or
another business:
1 the total profits earned by the investment over the
foreseeable future
2 how quickly the investment will recover its cost. This
occurs when the earnings from the investment exceed
the cost of the investment.
The process of assessing these factors is called investment
appraisal and refers to the process of assessing one or more
potential investments.
Payback
Payback is a simple technique that measures the time period
required for the earnings from an investment to recoup
its original cost. Quite simply, it finds out the number
of years it takes to recover the cost of an investment
from its earnings. In spite of (or perhaps because of) the
obvious simplicity of the payback technique, it remains
the most common method of investment appraisal used by
businesses, especially small ones.
▼ Table 10.16 A simple example of payback
Year Cash outflow ($) Cash inflow ($)
1 500 000 100 000
2 200 000
3 200 000
4 150 000
458
In Table 10.16, the calculation is simple: payback is
achieved at the end of year 3, when the initial investment
of $500 000 is recovered from earnings ($100 000 in year 1
plus $200 000 in each of years 2 and 3).
Calculations can be a little more complex, however, as
shown in Table 10.17.
▼ Table 10.17 A more complex example of payback
Year Cash outflow $ Cash inflow $
1 500 000 100 000
2 100 000
3 200 000
4 300 000
In this case payback is achieved during the fourth year. The
formula used to calculate the point during the year at which
payback is achieved is as follows:
number of amount of investment not recovered
payback =
full years(+
revenue generated in next year )
In Table 10.17, the investment has recovered $400 000 after
three years. Therefore $100 000 remains to be recovered in
year 4 before payback point is reached. During year 4, the
investment will generate $300 000. Thus:
payback = 3 years + 100 000 = 3.3 years, or 3 years 4 months
300 000
An alternative method of calculating the time required
to reach payback in the final year is to divide that year’s
inflow of cash by 12 to find out the monthly inflow. From
this figure it should be relatively easy to calculate the
number of months’ inflows that will be needed to cover
the outstanding balance of the cost of the investment.
In our example, the business required a further $100 000
to achieve payback in year 4 and the total inflow for that
year was $300 000. So, dividing the inflow of $300 000 by
12 months gives $25 000 per month. As there is $100 000


left to pay, this will take 4 months $100 000 .
$25 000
Figure 10.9 illustrates the concept of payback in the form of
a graph.
 700
Cumulative STUDY TIP
cash inflow
Do not spend too long on investment appraisal
calculations and do not carry out the same calculation
10.3
600
repeatedly. Make sure you show your workings when
Cash answering questions.
500 outflow
($500 000)

Accounting rate of return

Cash flows $000

400
The accounting rate of return (ARR) is a more complex and

10.3.2 Basic methods

meaningful method of investment appraisal. It is also called
300
the ‘average rate of return’. This technique calculates the
percentage rate of return on each possible investment.
200 The resulting percentage figure allows a simple comparison
Payback with other investment opportunities, including investing in
3 years
100 4 months
banks and building societies. It is important to remember,
however, that a commercial investment (such as purchasing
CAD/CAM equipment for a production line) involves a degree
0 of risk. The returns may not be as forecast. Therefore, it is
1 2 3 4 important that such an investment earns significantly more
Years than the rate of interest available in the local bank. If the
▲ Figure 10.9 Payback on a graph percentage return on purchasing the CAD/CAM equipment
was identical to that on a high-interest account in a bank,
Payback has the advantage of being quick and simple and
the latter would represent the better investment, as it
this probably explains its popularity, especially with small
carries little risk.
businesses. However, it does have disadvantages. It ignores
the level of profits that may be ultimately generated by There are two formulae that are used to calculate ARR.
the investment. For profit-maximising businesses, this may It can be calculated as:
represent an important omission. Furthermore, payback
ignores the timing of any receipts before payback is ARR = average profit × 100
achieved. The following example highlights this weakness. average investment

Two investment projects, A and B, each require an An alternative approach is to use the formula below:
investment of $1 million. Their expected earnings are shown
in Table 10.18. ARR = average profit × 100
asset’s initial cost
▼ Table 10.18 Comparing investment returns
Where:
Year Project A cash inflow ($) Project B cash inflow ($) total profit before taxation over the
1 500 000 100 000 asset’s lifetime
average profit =
2 300 000 100 000 useful life of the asset (in years)
3 100 000 300 000
In both cases, average profit is calculated in the same
4 100 000 500 000 way. The difference is in the investment figure used on the
bottom of the formula. It is either:
Both investment projects achieve payback at the end of » the initial investment, or
year 4. However, A is obviously more attractive because it » the average investment, where this is calculated by:
yields greater returns in the early years. Payback does not
take into account the timing of any income received. (initial investment – any residual value at the end of
the investment)
2
HANDLING DATA
Calculate the percentages of total revenue for projects
A and B (in Table 10.18) that are received in the first two
years. What is the significance of this difference?

459
 CASE STUDY
10.3
Miller Reprographics
Purchasing new IT equipment for Miller Reprographics Questions
is estimated to cost $120 000 and a return of $220 000
1 a Calculate the payback of this investment. [3]
over five years is anticipated. The cash inflows for this
b Calculate the ARR of this investment over the
investment for each of the five years is as follows:
first five years. [4]
● Year 1 – $30 000
2 Analyse two reasons why Miller Reprographics
● Year 2 – $40 000
might prefer to use ARR rather than payback to
A LEVEL 10.3 INVESTMENT APPRAISAL

● Year 3 – $40 000

judge this investment. [8]
● Year 4 – $50 000
3 Evaluate the factors that Miller Reprographics
● Year 5 – $60 000
might consider when deciding whether or not this
Miller Reprographics may consider this to be an attractive really is an attractive investment. [12]
investment. The company’s profits have declined in recent
years and the management team is keen to ensure that its
profitability improves in the future.

ARR is considered to be more useful than payback because

HANDLING DATA
Use the data in the Miller Reprographics case study to
calculate the total profit the company would have had to
earn to generate an ARR of 35 per cent.
it considers the level of profits earned from an investment,
rather than simply the time taken to recover costs. It also
offers easier comparison with returns on other investments,
notably financial investments in banks and building
societies. However, this technique also fails to differentiate
between investments that generate high returns in the early
years and those that offer greater rewards later on.

Income from Cost of Total profit

minus =
investment investment from investment

Total profit from Expected lifespan Average

divided by =
investment of asset in years annual profit

Average Cost of Accounting

divided by × 100% =
annual profit investment rate
of return (ARR)

▲ Figure 10.10 How to calculate accounting rate of return

10.3.3 Discounted cash-flow
methods
The technique of discounted cash flow takes into account
what is termed the ‘time value’ of money. The time value of
money is based on the principle that money at the present
time is worth more than money at some point in the future.
Thus, according to this principle, $1000 today is of greater
value than $1000 in one or two years’ time. There are two
major reasons why this time value principle exists.
1 Risk Having $1000 now is a certainty; receiving the
same amount at some point in the future may not
occur. The full $1000 payment may not be made; in
fact, no payment at all may be made. An investment
project may fail to provide the expected returns
because of a competitor’s actions, because of a
change in tastes and fashions, or as a consequence of
technological change.
2 Opportunity cost is the best forgone alternative. Even
if no risk existed, the time value of money would still

460
 exist. This is because the money could be placed into
an interest-bearing account generating a return. Thus,
if we assume that a rate of 5 per cent is available on an
interest-bearing account, $1000 in one year’s time is
worth the same as $953 today. The reason for this is that
by investing $953 at an interest rate of 5 per cent, we
would have $1000 after one year.
This time–value principle means that the longer the
delay before money is received, the lower its value in
present-day terms. This is called present value. Table
10.19 shows two investments requiring identical outlays.
Both projects also receive the same cash inflow over a
four-year period and would generate the same accounting
rate of return (10 per cent). However, the majority of the
cash inflow for project A occurs in year 1, while in project
B this is delayed until year 4. The time–value principle
would suggest that project A is preferable to project B. To
show the effect of the time–value principle, we need to
calculate the present value of cash inflows and outflows
through the use of discounting.
▼ Table 10.19 Two similar investment projects with
different time patterns for cash inflows
Year Investment project Investment project
A ($’000s) B ($’000s)
0 (now) (500) (500)
1 400 100
2 100 100
3 100 100
4 100 400
▼ Table 10.20 The process of discounting
Year Discounting factor used to Present value of $1000
convert to present value at a discount rate of
assuming 10% of interest 10% ($)
0 (now) 1 1 000
1 0.909 909
2 0.826 826
3 0.751 751
4 0.683 683
From this example, we can see that the rate of interest has
a significant effect on the present value of future earnings.
With a higher rate of interest, there is a greater rate of
discount. Thus, the present value of $1000 in three years’
time is $751, if the rate of interest is assumed to be 10 per
cent. However, if the rate of interest is estimated to be 5
per cent, the present value is greater, at $864.
The choice of interest rate to be used as the basis for
discounting is an important decision by a business
undertaking investment appraisal. The discounting rate
selected normally reflects the interest rates that are
expected for the duration of the project.
Discounting
Discounting is the process of adjusting the value of money
received at some future date to its present value – that 10.3
is, its worth today. Discounting is, in effect, the reverse
of adding interest. Discounting tables are available to
illustrate the effect of converting future streams of income
to their present values. The rate of interest plays a central
role in discounting, in the same way as it does in predicting
the future value of savings. Table 10.20 shows the
discounting figures and value in present-day terms of $1000
10.3.3 Discounted cash-flow methods
over a period of five years into the future. If the business
anticipates relatively high interest rates over the period of
the investment then future earnings are discounted heavily
to provide present values for the investment. Lower rates
result in discounting having a lesser effect in converting
future earnings into present values.
GLOSSARY TERMS
Discounting is reducing the value of future earnings to
reflect the opportunity cost of an investment.
Present value is the value of a future stream of income
from an investment, converted into its current worth.
The basic calculation is that the appropriate discounting
factor is multiplied by the amount of money to be received
in the future to convert it to its present value. Thus, at a
rate of interest of 10 per cent, the present value of $1000 in
two years’ time is $826 ($1000 × 0.826). The present value
of $1000 received in four years’ time is $683. This figure is
lower because the time interval is greater and the effect of
the time–value principle is more pronounced.
Discounting factor used to Present value of
convert to present value $1000 at a discount
assuming 5% rate of interest rate of 5% ($)
1 1 000
0.952 952
0.907 907
0.864 864
0.822 822
Net present value
Discounting expected future cash flows is the basis of
calculating net present value (NPV). This method of
investment appraisal forecasts expected outflows and
inflows of cash and discounts the inflows and outflows. To
calculate NPV, we need to know:
» the initial cost of the investment
» the chosen rate of discount
» any expected inflows and outflows of cash
» the duration of the investment project
» any remaining or residual value of the project at the
end of the investment (if the investment is to purchase
production equipment, this may have scrap value once it
is obsolete, for example).
461
 The outflows of cash are subtracted from the discounted
inflows to provide a net figure: the NPV. This figure is
10.3 important for two reasons:
1 If the NPV figure is negative, the investment is not
worth undertaking. This is because the present value
of the stream of earnings is less than the cost of the
investment. A more profitable approach would be
to invest the capital in an interest-bearing account,
earning at least the rate of interest that was used for
discounting.
2 When an enterprise is considering a number of possible
A LEVEL 10.3 INVESTMENT APPRAISAL
investment projects, it can use the NPV figures to rank
them. The project generating the highest NPV figure
is the most worthwhile in financial terms. In these
circumstances, a business may select the project (or
projects) with the highest NPVs.
An example of calculating net present value
Sailing Monthly is one of New Zealand’s most popular sailing
magazines. The owners of the magazine, Bure Publishing,
are investigating the production of an online edition
especially designed for tablet computers. The company has
conducted negotiations with two software houses regarding
the development of a website for its new product, e-sailing.
The two software houses offered very different ideas:
one (proposal A) suggested a basic product allowing Bure
Publishing to offer access to the magazine at a bargain
price; the other (proposal B) proposed a more sophisticated
product, to a higher technical standard, offering the
opportunity for premium pricing.
The cash flows associated with these proposals over a
five-year period are set out in Table 10.21 (page 463). These
show the cost of developing the website and the expected
revenues, less operating costs for the site each year. Bure
Publishing estimates that a 10 per cent discount rate would
reflect likely market rates of interest.
Bure Publishing would opt for proposal A on the basis
of this financial information, as the NPV for proposal A
(the cheaper option) is higher than that for proposal B.
The net cash flow for proposal A is also positive, as cash
inflows exceed outflows. Therefore, the investment is
viable. However, non-financial information may affect this
investment decision.
10.3.4 Investment appraisal
decisions
Quantitative results and their impact on
investment decisions
Once the investment appraisal process has produced an
answer, this needs to be compared with something in order
462
to make a decision. There are a number of criteria that a
business may use to make an investment decision:
1 The rate of interest The accounting rate of return (ARR)
and net present value (NPV) methods produce figures
that can be compared with the rate of interest. Any
interest rate chosen for this process will be based on the
interest rate set by the Bank of England (in the UK) or
other relevant central bank. In essence, the managers of
the business will seek a return that will be greater than
the current and forecast interest rates if the accounting
rate of return is used or, if they are using NPV, the
interest rate that is current should produce a positive
NPV.
However, using the interest rate as a criterion is not
straightforward. Many investment projects are long-
term, and expenditure and returns may take place over
many years. It is highly unlikely that interest rates will
remain unchanged for this period of time. Therefore,
managers have to decide on a rate or range of rates to
use in their calculations.
2 The level of profit We saw in Chapter 10.2 that a series
of ratios can be used to assess the profitability of a
business. One of these, return on capital employed (or
ROCE), provides a figure that measures operating profits
generated against the value of resources available to the
business. It is not unusual for a business to set itself
targets in terms of ROCE. Managers may insist that any
new investment project should generate returns that
will at least match (and hopefully exceed) the business’
overall target for ROCE.
3 Alternative investments It would be unusual for a
business to consider only a single investment project.
Most managers contemplating a major investment
will have other options. These could be very different
investments or simple variants on the first proposal.
The business may simply select the project or projects
that perform the best, subject to some minimum criteria
in terms of profits or percentage returns. In such
circumstances, opportunity cost is an important concept
for managers to bear in mind.
STUDY TIP
Investment criteria can be useful to you when responding
to questions on investment appraisal. When judging
whether or not a business should go ahead with a
particular investment, it is important to think about what
criteria the business would expect the investment to
meet. The case study may directly state these or they
may be implied. In either case, by relating your answer
to the criterion or criteria, you have a basis for making a
judgement that you are able to justify.
▼ Table 10.21 Comparing Bure Publishing’s investment projects using discounted cash flow

Proposal A Proposal B
10.3
Year Annual cash Discounting Present value ($) Annual cash Discounting Present value ($)
flows ($) factors at 10% flows ($) factors at 10%
0 (212 000) 1 (212 000) (451 000) 1 (451 000)
1 46 000 0.909 41 814 89 400 0.909 81 265
2 57 500 0.826 47 495 115 000 0.826 94 990
3 63 250 0.751 47 501 122 500 0.751 91 998

10.3.4 Investment appraisal decisions

4 69 000 0.683 47 127 144 275 0.683 98 540
5 71 000 0.621 44 091 140 000 0.621 86 940
Net present value 16 028 Net present value 2 733

CASE STUDY
Entrepreneur makes a takeover bid for Newcastle United Football Club
Henry Mauriss, an Los Angeles-based television agreement with Newcastle, thus ending Ashley’s
executive, has made a late, £350 million bid to buy 13-year ownership of the club. It is understood that
Newcastle United Football Club (which plays in the UK’s Mauriss believes he could take control of the club as early
Premier League) from the current owner, Mike Ashley. as September. However, there are other uncertainties.
Mauriss is the 56-year-old chief executive of Clear TV who The UK’s Premier League has a £500 million contract for
has made a fortune in the broadcasting industry. This bid overseas broadcast rights with Qatar’s beIN Sport. This
is worth £50 million more than the bid a Saudi Arabian- may be lost if the Saudi deal fails.
led consortium had previously agreed with Newcastle’s
owner. It is Mauriss’ first venture into the ownership of a Questions
sports club. 1 Analyse two benefits of using the NPV approach to
help to decide the financial case for major decisions
In order for Mauriss’ bid to succeed, the Premier League
such as this takeover. [8]
would have to veto the Saudi-led group’s offer (which has
2 Evaluate the difficulties that Henry Mauriss may
been on the table for three months). If this happened, the
have faced in forecasting the financial costs and
bid would also depend on whether the group chose to
returns of the proposed takeover investment. [20]
pursue the issue.
Should the Saudi consortium’s attempted buy-out
fall through, Mauriss would be at liberty to reach an

and no financial records to use as a guide in forecasting

The risks and uncertainties of
investment decisions
It is not a simple matter to assess the degree of risk
involved in an investment decision from quantitative data.
Risk is the chance of something adverse or bad happening.
In the context of investment decisions, there are two broad
possibilities: costs may be higher than forecast or sales may
be lower than expected.
Forecasting future sales can be a very difficult, and often
expensive, exercise. Market research can be used, but it is
costly and not always reliable. The difficulties in forecasting
sales arise from a number of factors:
» Timescales It is much harder to forecast sales accurately
many years into the future. Over a longer timescale, it is
more likely that tastes and fashions may change or that
new competitors or new products may enter the market.
» New markets If an investment project is based on a
business entering a new market (either in geographical
or product terms) then the business has less experience
sales. In December 2012, the global retailer Tesco
announced that it was pulling out of the USA, having
failed to break into one of the world’s toughest retail
markets. Operating costs proved to be high and sales
figures did not reach expectations. Apparently even one
of the UK’s largest companies did not find it easy to
forecast its sales accurately.
» Competitors’ reactions Deciding on a particular
programme of investment may bring a business into
competition with rivals in new ways. Entering a new
market (as in the case of Tesco above), producing new
products or developing new methods of production may
all provoke a response from competitors. This may take
the form of increasing advertising, cutting prices or
bringing out new products. Each of these actions will
impact on the sales associated with the investment
project. However, not knowing the type or extent of
reaction in advance makes it very difficult to estimate
its effect on future sales.
463
 » Equally, costs may rise above the forecast level,
reducing the returns from the investment, as we saw
10.3 with Tesco’s unsuccessful expansion into the USA. In
October 2018, the price of oil rose to nearly $75 per
barrel, reducing the profit margins of many companies,
including airlines such as Virgin Atlantic. By May 2020,
oil was priced at $17 a barrel. The volatility of prices for
such a fundamentally important product highlights the
difficulties that firms face when attempting to forecast
future costs of production.
A LEVEL 10.3 INVESTMENT APPRAISAL
Qualitative factors and their impact on
investment decisions
The financial aspects of any proposed investment will
clearly have an important influence upon whether a
business goes ahead with the plan. However, a number of
other issues may affect the decision:
» Corporate image A firm may reject a potentially
profitable investment project, or choose a less
profitable alternative, because to do otherwise might
reflect badly on the business. Having a positive
corporate image is important in terms of long-term
sales and profits, and it may be considered more
important than gaining short-term advantage from
profitable investments. Boeing, the American aircraft
manufacturer, invested in developing a new aircraft:
the 737 Max. The new plane was involved in two
crashes, one in 2018 and one in 2019, killing a total of
346 people. In response, many countries grounded
the plane, and the company began working on the
flight-control software that is believed to be the cause
of the problem. Many months later – at the time of
writing – the problem remains unresolved. Boeing’s
investment in the 737 Max and other aircraft may prove
less profitable as a consequence.
CASE STUDY
Cargill plans $113-million expansion in the Ivory Coast and Ghana
Global food and agriculture company, Cargill, has budgeted
$113 million to expand its cocoa-processing operations at
its sites in Yopougon, Ivory Coast, and Tema, Ghana. The
company’s plans for the two sites are as follows:
● Yopougon Production capacity will be increased by 50
per cent as a result of investing $100 million. Cargill will
employ an additional 85 local people and many jobs will
be created in other local businesses. More facilities will
be devoted to the production of Gerkens cocoa powders.
● Tema An investment of £13 million will be used to
increase production capacity at this site by 20 per cent.
Along with these investments, Cargill intends to invest just
over $12 million in improving its sustainability and supply
chain traceability programmes in Africa. The company
anticipates that this investment will provide a safer
environment for those living in the areas surrounding its
cocoa farms. It should also improve consumer confidence
by making the supplies it uses more traceable.
464
» Corporate objectives Most businesses will only
undertake an investment if they consider that it will
assist in the achievement of corporate objectives. For
example, Rolls-Royce, a company that publicly states its
aim to produce high-quality products, may invest heavily
in training for its staff and in research and development.
This will assist in the manufacture of world-class
aeroplane engines and vehicles.
» Environmental and ethical issues These can be
important influences on investment decisions. Some
firms have a genuine commitment to trading ethically
and to inflicting minimal damage on the environment.
This is a core part of their business philosophy. As a
consequence, they would not exploit cheap foreign
labour or use non-sustainable resources. Other firms may
have a weaker commitment to ethical and environmental
trading but may still avoid some investments for fear of
damaging publicity.
» Industrial relations Some potentially profitable
investments may be turned down because they would
result in a substantial loss of jobs. Taking decisions that
lead to large-scale redundancies can be costly in terms
of decreased morale, redundancy payments and harm to
the business’ corporate image.
STUDY TIP
It is essential to think about quantitative and qualitative
factors when making decisions on investment projects.
Most case studies will include some qualitative issues
for you to weigh up, and a good-quality answer will
take these into account in addition to any quantitative
information.
Lionel Soulard, managing director for Cargill West-Africa,
said, ‘Working directly with both governments and other
key stakeholders, we are committed to economic growth,
building sustainable local businesses and diversifying
sources of income for cocoa farming communities.’
Source: www.cargill.com/2019/cargill-invests-$113-
million-in-ivory-coast-and-ghana
Questions
1 Analyse one reason why Cargill would have used
investment appraisal techniques as part of its
decision to invest in the Ivory Coast and Ghana. [4]
2 ‘Qualitative factors would have influenced
Cargill more strongly than quantitative factors in
reaching this decision to invest $113 million.’
Evaluate this view. [20]
A comparison of investment appraisal
methods
The method of investment appraisal chosen will depend
upon the type of firm, the market in which it is trading and
its corporate objectives. A small firm may be more likely to
use payback because managers may be unfamiliar with more
complex methods of investment appraisal. Small businesses
also often focus on survival, and an important aspect of any
▼ Table 10.22 A comparison of techniques of investment appraisal
investment will be how long it takes to cover the cost of the
investment from additional revenues. Payback is therefore
valuable for firms who wish to minimise risk. 10.3
Larger firms that have access to more sophisticated
financial techniques may use the accounting rate of return
or discounted cash-flow methods. These methods highlight
the overall profitability of investment projects and may be
more appropriate for businesses where profit-maximisation
is important.

10.3.4 Investment appraisal decisions

Method of investment appraisal
Payback
Accounting rate of return
Discounted cash flow
Benefits
• Easy to calculate
• Simple to understand
• Relevant to firms with limited funds who
want a quick return
• Measures the profit achieved on projects
• Allows easy comparison with returns on
financial investments (e.g. bank accounts)
• Makes an allowance for the opportunity
cost of investing
• Takes into account cash inflows and
outflows for the investment’s duration
Limitations
• Ignores timing of payments before
payback
• Excludes income received after payback
• Does not calculate profit
• Ignores the timing of the payments
• Calculates average profits – they may
fluctuate wildly during the project
• Choosing the discount rate is difficult,
especially for long-term projects
• A complex method to calculate and
easily misunderstood

Is it worth using techniques of In assessing the value of numerical techniques of

investment appraisal?
The results of investment appraisal calculations are only as
good as the data on which they are based. Firms experience
difficulty in accurately forecasting the cost of many major
projects. It is even more difficult to estimate the likely
revenues from investment projects, particularly long-
term ones. It is perhaps possible to make an allowance to
represent risk; for example, the possibility of a competitor
taking actions that result in sales being lower than forecast.
However, uncertainty (which cannot be measured) may make
any investment appraisal worthless.
investment appraisal, some thought has to be given to
the alternative. Without the use of payback and the like,
managers would operate on the basis of hunches and
guesswork. Some managers may have a good instinct for
these matters, whereas others may not. As markets become
more complex and global, the need for some technique to
appraise investments becomes greater. It is more difficult
for an individual or a group to have an accurate overview of
a large international market comprising many competitors
and millions of diverse individuals. Detailed market research
to forecast possible revenues and the use of appropriate
techniques of investment appraisal may become even more
important in the future.

TEST YOUR LEARNING

4 a Explain one disadvantage of using payback in the
Short answer questions circumstances in question 3. [3]
1 a Define the term ‘investment’. [2] b Explain how the accounting rate of return is
b Explain one reason why a business might need to calculated. [3]
engage in investment appraisal. [3] 5 Bangar Leisure is considering the purchase of a
2 a Define the term ‘risk’. [2] new boat for cruises in Brunei Bay. The Royal Queen
b Explain one reason why a major retailer may make is available at a cost of $900 000 and would cost
a major investment. [3] $100 000 each year to operate. Over its ten-year life,
3 Thames Radio is contemplating investing in new the cruiser would generate $280 000 in revenue each
broadcasting equipment. The cost of the investment year. Calculate the accounting rate of return on this
is forecast to be £150 000. The expected additional investment. [4]
revenue from being able to broadcast to a larger area 6 a Define the term ‘present value’. [2]
is £40 000 per annum. Calculate the payback period of b Define the term ‘discounting’. [2]
this investment. [4]

465
 7 Harare Printers is appraising the costs and benefits Although holidaymakers are visiting Sri Lanka in

10.3 of a new piece of machinery. The equipment costs

$300 000 and has a working life of four years. The
company expects to generate revenue of $120 000
each year if it purchases the machine. Calculate the
net present value of this project, assuming an interest
rate of 10 per cent.
8 a Explain one criterion that a company may use to
make a decision on whether or not to go ahead with
an investment programme.
A LEVEL 10.3 INVESTMENT APPRAISAL
increasing numbers, its uncertain political situation has,
at times, deterred some international travellers from
visiting Tangalle. Leisure Group Ltd plans to build its
large, modern building in an unspoilt bay; this will result
in the destruction of many trees and other plants.
[5]
Leisure Group Ltd’s costs are shown in Table 10.23 and
are based on the use of a construction company based in
the United Arab Emirates.
[3]

b Explain one reason why it can be difficult to ▼ Table 10.23 Leisure Group Ltd’s costs
forecast sales. [3]
Year Investment cost ($) Profit ($)
9 Explain two actions a business may take to manage
the degree of risk involved in an investment decision. [6] Now (year 0) 2 500 000 0
10 Explain two qualitative factors a business may take 1 – 52 000
into account when making an investment decision. [6]
2 – 110 000
Data response question 3 – 150 000
A risky investment? 4 – 200 000
Tangalle is one of Sri Lanka’s most-visited tourist
destinations – its beaches are especially popular. Questions
Leisure Group Ltd operates a number of hotels in 1 Analyse two reasons why Leisure Group Ltd’s
other parts of Asia and is an ethical business which is proposed investment could be considered risky. [8]
committed to good employment conditions and good 2 a Calculate the accounting rate of return on the
wages for all its employees. High potential sales is one proposed hotel for its first four years of trading. [6]
factor influencing Leisure Group Ltd’s investigation into b Evaluate the major qualitative issues relating
building a new hotel in the town – its first one in the to the proposed hotel. [12]
country. This will help to achieve its corporate objective
3 Advise Leisure Group Ltd on whether or not it should
of growth. Leisure Group Ltd is profitable – its most
build the hotel. Justify your decision. [20]
recent ROCE figure was 17 per cent. The popularity of
Tangalle with tourists may also explain a rumour that Essay question
the Intercontinental Hotel Group (the world’s largest
hotel business) is to open a large hotel just outside 1 Many businesses operate in global markets.
the town. Evaluate whether this means that qualitative
factors should play the most important role in all
investment decisions. [20]

466
10 Finance and accounting
A LEVEL
10.4 Finance and accounting strategy
Chapter overview
In this chapter we examine:
★ how financial statements are used to develop strategies
★ what is in an annual report and its value to businesses and their stakeholders
★ how businesses judge performance over time and against competitors
★ the impact of accounting data on business strategy
★ the impact of debt and equity decisions, changes in dividend strategy, business growth and other business strategies
on ratio results
★ the limitations of ratio results and published accounts.
10.4.1 Using accounting data
to enable strategic decision-
making
Businesses produce a number of financial statements, but
we are only concerned with two: the statement of profit or
loss and the statement of financial position. We covered
these two statements in detail in Chapter 10.1.
Senior managers develop corporate strategies for businesses
to enable them to achieve their corporate objectives. They
use multiple sources of information to help them to make
good-quality decisions and these sources include financial
statements. The contribution of a company’s chief financial
officer (or CFO, who is responsible for managing the
business’ finances) has changed in recent years. Advances
in technology designed to record, manipulate and present
financial data have meant that finance specialists have
been able to contribute more to other aspects of the
management of a business. The CFO’s role has become
less about analysing historical financial data and more
about contributing to the development of new corporate
strategies. The information in key financial statements is
very important in developing these strategies.
GLOSSARY TERM
A chief financial officer (CFO) is the senior manager who
has overall responsibility for the financial affairs of an
organisation.
The statement of financial position
This statement can provide a considerable amount of
information to help directors and managers to develop
corporate strategies.
10.4.1 Using accounting data to enable strategic decision-making
The business’ ability to raise finance
If the business is pursuing an expansionary corporate
strategy, it is likely to need to raise funds to finance
its plans. In Chapter 6.2.1 we considered the possible
approaches managers might take to developing strategies.
A blue ocean strategy or a diversification option under
Ansoff’s classification may require expenditure on, for
example, recruiting and training employees to make the
workforce more innovative, or it may require the purchase
of new non-current assets to facilitate expansion into new
markets.
The statement of financial position can provide important
information to help assess the business’ ability to raise
funds. This statement paints a picture of the sources of
finance used by a business and allows stakeholders to assess
whether the business has borrowed an excessive amount
of finance. This would make it vulnerable to rising interest
rates and increase the degree of risk in an expansionary
strategy. If the business’ gearing ratio is significantly below
the crucial 50 per cent figure, it may be more possible to
finance a corporate strategy using loan capital.
The statement of financial position also shows the value or
worth of a business. A single statement may only provide a
limited amount of information – the value of the business at
a single point in time. However, a series of statements over
time can indicate the success of a business in achieving
and sustaining growth. This, of course, may make it more
possible for the business to raise finance through share
capital, as a business that has enjoyed steady growth may
be more attractive to potential shareholders. This could be
the case as the business’ previous strategy may be judged
successful, and a growing business may benefit from a
rising share price.
467
 The business’ liquidity position
We saw earlier that liquidity measures the ability of a
10.4 business to meet its short-term debts. The statement of
financial position contains details of the business’ current
assets and liabilities, and the acid test and current ratios
can be calculated to assess the business’ liquidity position.
Liquidity is important in determining a business’ future
strategy. This can be valuable to managers developing
strategies in a number of ways:
» It can provide evidence of the business’ ability to
A LEVEL 10.4 FINANCE AND ACCOUNTING STRATEGY
finance future capital expenditure. For example, a
strategy based on developing new products may require
CASE STUDY
Apple’s strategy
Apple is a multinational technology company which uses
product differentiation as its core business strategy. It
utilises sleek, simple designs and advanced functionality
to differentiate its products and services. The main
objective of implementing a differentiation strategy is to
increase competitive advantage.
Apple seeks to exploit its core competencies (such as a
talented and innovative workforce) to achieve long-term
competitive advantage. Its strategic targets focus on
business development in areas where its rivals are less
formidable.
Apple has created its competitive advantage by adapting
and developing the features of its products and services.
This strategy also allows Apple to benefit from first-
mover advantage, in that its innovations are usually
in advance of those developed by rivals. Apple is very
innovative in pursuit of its strategy.
Apple has simultaneously developed expertise in
software, hardware and services. Apple devices and
software work together and sync with ease. Apple’s
strategy creates discouraging switching costs for its
existing customers if they wish to change to a competitor’s
products, and also provides opportunities to offer loyal
customers new products and services.
The statement of profit or loss and
financial strategies
A management team can draw on some key information
in the statement of profit or loss to help it to devise a
corporate strategy.
The business’ revenue is an important factor. Alone, this
figure may be of limited value, but when judged over
time – or compared to that of other businesses in the same
industry – it can provide an insight into the business’
current position within its market. This may provide senior
468
substantial borrowing. The company’s liquidity position
will be an important factor in shaping such a decision
as, for example, it shows its ability to make loan
repayments on time.
» A business’ liquidity position will also be a factor
influencing the willingness of banks and other
organisations to make long-term loans to the business.
If the business’ liquidity position is weak, it may be
difficult to raise the necessary loan capital. Equally,
shareholders may be reluctant to purchase shares and
this can limit the business’ options for devising new
strategies.
▼ Table 10.24 Extracts from Apple’s statement of
financial position, 28 March 2020
Items $m
Non-current assets 176 647
Cash and short-term investments 94 051
Inventories 3 355
Other current assets 46 347
Total current assets 143 753
Total current liabilities 96 094
Non-current liabilities 145 881
Equity 45 243
Reserves 33 182
In 2019, Apple’s revenue was $260 174 million and its profit
for the year totalled $55 256 million. These figures were
very similar to those achieved in 2018.
Questions
1 Analyse one reason why Apple’s liquidity position
might be said to be ‘strong’. [4]
2 ‘Apple’s financial position is the primary reason for its
corporate strategy of product differentiation.’ Use the
information in the case study to evaluate this view. [20]
managers with vital information in devising new strategies;
for example, whether to be more or less aggressive, whether
to seek to change strategy or whether to continue with an
existing strategy.
Figures for profits hold more value in devising strategies.
They may provide some insights into the success of existing
strategies – at least in financial terms. Figures for gross and
operating profits provide some evidence of the business’
ability to control costs. A business that is highly successful
in this area (for example, the Irish low-cost airline, Ryanair)
may seek to establish strategies based on cost leadership.
Profit for year data indicate the resources that are available
to a business’ management team to implement new
strategies. A company with a rising profit for the year figure
may be able to sustain dividend payments to shareholders
while reinvesting profits into supporting a new (and
possibly) expansionary corporate strategy. Lego, the Danish
toymaker and retailer, enjoyed a 3 per cent rise in profits
in 2019 to 8.3 billion Danish Kroner ($1.25 billion). The
company also announced plans to open a further 150 new
stores in 2020, 80 of which will be in China.
Statement of financial
position
Liquidity Gearing
Growth?
Corporate
Innovation?
strategy
Diversification?
Revenues Cost controls Profits
Statement of profit
or loss
▲ Figure 10.11 Financial statements and strategy
GLOSSARY TERM
Key performance indicators (KPIs) are measures of how
well a business is meeting its targets, such as revenue or
profit per customer.
Annual reports and strategic
decision-making
Companies publish their annual report a few months after
the conclusion of the financial year to which it relates.
Experienced business analysts often joke that annual
reports should be read back-to-front. They point out that
the financial data is normally included at the back, while
the early sections are frequently a marketing exercise
intended to present the company in a very favourable light.
The contents of an annual report can vary according to the
country in which the company is based. The main function
of an annual report is to explain the company’s performance
over the most recent financial year to shareholders and
other investors. It should show how the company generates
value for its owners in the long term. The organisation
of the annual report varies between companies, as each
seeks to present its performance as positively as possible.
However, the structure and contents of the annual report
should enable shareholders to judge the company’s position
and performance, as well as its corporate strategy. 10.4
There are a number of elements which are commonly
included in an annual report. The contents list below relates
to companies in the UK. However, these contents will be
similar in most countries as many companies have (or seek
to have) shareholders from around the world.
» Highlights This is a summary of the company’s year. It
normally contains information such as the company’s
10.4.1 Using accounting data to enable strategic decision-making
corporate objectives, its strategy and business model
and some key performance indicators (KPIs), often for
a five-year period.
» Strategic report This is an important element which
summarises the success of the directors in implementing
the company’s strategy. It should evaluate the company’s
position at the end of the financial year and include
financial and non-financial KPIs in support of this analysis.
It should report on the risks that the company has faced
during the year and how the directors have managed and
responded to such risks. There should be an explanation
of any other factors that have affected the strategic
performance of the business; for example, environmental
or ethical issues. The strategic report should also offer
some analysis of those factors which might be expected to
impact on the company’s future performance.
» Statements or reviews These are written by those
holding key positions in the organisation (chairman,
chief executive, chief financial officer, for example).
The chairman’s report will normally refer to dividend
payments, the governance of the company and corporate
responsibility. The chief executive will comment on the
business’ performance, its KPIs and the market and wider
business environment in which the company is trading.
» Directors’ report This contains information about
individual directors, their individual responsibilities,
recommendation on the dividends to be paid to
shareholders and their interests. It also includes
information on voting rights of shareholders and the
company’s share capital.
» A report on ethics, sustainability and corporate social
responsibility This will contain information about
company policy and actions in the country or countries
in which the business operates, as well as (possibly) the
policy or actions of its suppliers.
» A report of corporate governance This explains who
the company is managed by, the management structures
in place and how its management complies with relevant
laws.
» Directors’ remuneration This records the remuneration
(pay) of all the company’s directors, as well as
a statement of the policy relating to directors’
remuneration.
» Independent auditor’s report Auditors are specialist
accountants who inspect company accounts to ensure that
they are accurate and fair. Their report will confirm this.
469
 » Financial statements These cover a range of financial
statements including the statement of financial
10.4 position and the statement of profit or loss, as well
as a five-year financial report and the company’s
accounting policies. The statements also include notes
which can be extremely detailed but often contain very
important information.
» Other information This section can provide information
about shareholders, the financial calendar for the
forthcoming year and links to further information that is
A LEVEL 10.4 FINANCE AND ACCOUNTING STRATEGY
available online.
The usefulness of annual reports
Annual reports are a legal requirement for public companies
in many countries because they offer benefits to the
business’ stakeholders as well as to the business itself.
The company that produces an annual report can benefit
in that it offers a marketing opportunity. The company’s
management team can use it to publicise some of their
most successful products as well as the company’s plans for
the future. This can help it to attract customers, especially
if it is a B2B company – that is, one that sells to other
businesses. In such cases, the customers are more likely
to read the annual report as they are likely to place large
orders with the company and have a significant stake in its
future.
The annual report can play an important role within
the business too. It can be an important means of
communicating targets and plans to important decision-
makers within the company. The annual report is likely to
set out the company’s future strategy in its early sections,
and this can be particularly valuable at a time of change.
The report can support other means of communicating a
change in strategy.
However, an annual report will be of greater value to
a business if it is read by key target groups, such as
shareholders and employees. Making it engaging and
available in different formats (PDFs online as well as
traditional paper copies) can increase its usefulness.
The annual report has value to other stakeholders as well:
» Shareholders and other investors It is possible to
argue that shareholders and other investors (potential
as well as existing) are a prime target for the messages
contained within an annual report. It is a means of
keeping shareholders up-to-date with developments
within the business and its markets, as well as in its
financial performance. A well-designed and informative
annual report can help to engage investors and
may assist in attracting investment in the future.
The most obvious limitation of annual reports is
that they contain a lot of historical information. To
overcome this potential weakness, an effective annual
report should include sections on market conditions,
470
product plans, and research and development to give
shareholders an insight into the company’s prospects.
Shareholders may use the information within annual
reports to compare a number of companies as potential
investments.
» Customers An annual report can be a means of
sustaining the confidence of customers that the
company is a suitable supplier for the long term. The
financial information can reassure customers that the
company’s future is secure by showing, for example,
that it has sufficient cash and has not borrowed too
heavily. Customers will also be concerned about the
quality of products, research into new products and
that production will not be interrupted. A report by the
director of operations might be of particular value in
meeting the needs of customers for this type of
information.
» Suppliers Most companies use a range of suppliers to
provide the goods and services required for production.
Suppliers will be interested in the company’s liquidity
position, as this will give useful information on their
ability to pay as well as the expected payment periods.
They may also be interested in new products in planning
and expected market growth rates, as these have
implications for the orders that the company is likely to
place with its suppliers.
» Employees Many companies seek to build an employer
brand whereby they are seen as an attractive place to
work by existing and potential employees. Employees
will want to know whether the company is financially
secure and whether it is a good employer, offering
competitive pay rates and opportunities for promotion.
Reports by key directors, such as the company’s chief
executive, can help to present the company as an
exciting and rewarding place to work.
» The media Newspapers, radio and television all report
on business matters. The annual reports of companies
are an important source of information. Although the
trend in revenues and profits may attract the initial
headlines, other elements of the report can be used
to help to build a strong public image of the company.
National and international media can help to shape
the views of many key stakeholders worldwide – an
increasingly important factor for many companies in
a globalised world. In particular, it may influence the
company’s ability to attract investment.
The above makes clear that annual reports have considerable
potential to influence a company’s stakeholders. However,
the most obvious criticism is that annual reports are often
historical documents. They are likely to offer greater value
if they have a clear focus on the company’s future and
are designed to meet the need for information among
the company’s major stakeholders. Figure 10.12 shows the
benefits that a good-quality annual report may offer.
 Shareholders
The media
Financial and
and other
investors
10.4
market
information on
Gives positive data future prospects
on performance and
prospects as key
influencers
Annual reports
Maintain confidence
• well-designed

10.4.2 Using accounting data and ratio analysis in strategic decision-making

by presenting data on
• informative
liquidity, quality, etc.
• available
• targeted

Employees Employer Customers

branding – it’s
a good place Positive information
to work on likely future orders
Security of payment

Suppliers

▲ Figure 10.12 Annual reports and company stakeholders

10.4.2 Using accounting data
and ratio analysis in strategic
decision-making
Assessing business performance over
time and against competitors
Management teams increasingly use financial data to
support strategic decisions. W Edwards Deming, an
American professor and management consultant, recognised
the importance of data in decision-making: ‘In God we
trust. All others must bring data’ is one of his most famous
quotes. Financial data can be enriched if it is provided for a
period of time and also if competitors’ data is available for
comparison.
its management team may implement strategic operational
decisions to improve this aspect of the business’ financial
performance.
However, the use of time-series financial data can be
unreliable. A business may show consistent improvements
in financial performance over a period of time, but this
cannot guarantee that this trend will continue in the future.
Businesses are subject to constant change, both internally
and in the environment in which they operate. The
retirement of a particularly talented and experienced leader,
the emergence of a new competitor or a sudden crisis, such
as that caused by the Coronavirus (COVID-19) pandemic
in 2020, may result in a sudden deterioration in financial
performance. Trend analysis can provide some important
data in assessing financial performance, but the future may
differ markedly from the past.

Using time-series financial data Using data from competitors

We saw earlier that annual reports frequently contain a
five-year summary of financial data. In the UK, this is a
legal requirement for public companies. It is important to
judge the performance of a company by considering data
over time to establish whether or not a particular trend is
emerging. For example, a small fall in revenue or operating
profits might not appear particularly significant. However,
stakeholders may consider it more significant if it is a
pattern that has been consistent over a number of years.
Similarly, senior managers may use trend analysis to inform
decisions on operations. Therefore, for example, if a
business’ cash position has steadily weakened over time,
It is usually insufficient to assess a business’ financial
performance using just financial data relating to that
company – even if it is available for a period of time.
Some managers benchmark data from those businesses that
are industry leaders and use this as targets. For example,
some retailers operate with very low levels of liquidity.
This can help to reduce borrowing costs as lower levels of
short-term debt might be required. Benchmarking other
businesses and using these as targets can help to improve
a business’ financial efficiency. In the UK, the Centre for
Interfirm Comparisons helps businesses of every kind to
improve their financial performance by providing financial
data as a basis for comparison.

471
 CASE STUDY
10.4
BP’s performance over five years
BP is a multinational oil and gas company, with refining and retailing. In 2019, it had 73 000 employees
headquarters in London. It operates in all areas of the working in locations across the world.
oil and gas industry including exploration, extraction,

Diversity and inclusion

(relates to BP employees) 25 2019 performance
2019
A LEVEL 10.4 FINANCE AND ACCOUNTING STRATEGY

Each year we report on the 25 Both measures increased slightly. As a

percentage of women and 24 global business we are committed to
2018
individuals from countries 24 increasing the diversity of our
other than the UK and the 21 workforce and leadership.
2017
USA among BP’s group leaders. 24
22
2016
23
19
2015
21
Women in group leadership
People from beyond the UK
and USA in group leadership

Greenhouse gas emissions (MtCO2B)

We provide data on greenhouse 2019 46.0 2019 performance
gas (GHG) emissions material to 2018 46.5 Our Scope 1 (direct) equity share
our business on a carbon emissions decreased by 0.5MtCO2B
dioxide-equivalent basis. This 2017 49.4 to 46.0MtCO2B in 2019
particular KPI comprises Scope 2016 50.1 (46.5MtCO2B in 2018).
1 (direct) emissions of CO2 and 2015 49.0
methane.

Return on average capital employed (%)

Return on average capital 2019 8.9 2019 performance
employed gives an indication of The decrease reflects lower profit
2018 11.2
a company’s capital efficiency. due to the impact of lower oil and
2017 5.8 gas prices and weaker refining
2016 2.8 environment.
2015 5.5

Total shareholder return (%)

Total shareholder return (TSR) 5.8 2019 performance
2019 Improvement in TSR reflects increased
represents the change in value of 1.1
a BP shareholding over a calendar dividends in 2019.
(4.6)
2018 0.5
year. It assumes that dividends are
reinvested to purchase additional 20.0
shares at the closing price on the 2017
9.5
ex-dividend date. 29.0
2016
55.5
We are committed to maintaining a (12.8)
progressive and sustainable dividend 2015
(8.3)
policy.
ADS basis (Note: The ADS basis for measuring total shareholder return includes shares available for purchase by American investors.)
Ordinary share basis

▲ Figure 10.13 A selection of BP’s performance data, 2015–2019

Source: BP Annual Report 2019 (pages 34–5), www.bp.com/content/dam/bp/business-sites/
en/global/corporate/pdfs/investors/bp-annual-report-and-form-20f-2019.pdf

Questions
1 Analyse two reasons why BP might have decided to
include non-financial data, such as that shown in
Figure 10.13, in its annual report.
472
2 ‘The financial information included in this case study
would allow a shareholder to make an accurate
[8] assessment of BP’s future financial performance.’
Evaluate this view. [20]
If suitable data is available, it can be a useful help for
stakeholders seeking to judge performance. Managers,
shareholders and other stakeholders can see if the
company’s revenue has grown as quickly as that of
competitors or whether the performance of the company’s
operating profit differs significantly.
It can be particularly useful to make comparisons with data
from competitors over a period of time. Figure 10.13 shows
BP’s ROCE data for a five-year period. The company’s ROCE
figures vary from 2.8 to 11.2 per cent. A shareholder might
consider these to be low figures. However, a comparison
with the ROCE data for Shell, one of BP’s major rivals, shows
that BP’s ROCE performance holds up well. Shell’s ROCE
figures fluctuated between 2 and 9 per cent over the same
period of time. This information enables the stakeholder to
make a more informed judgement.
However, there are times when the use of data from
competitors might not be so helpful. Some ratios do
a poor job at comparing one company with another. A
company’s choice of accounting policies used in its financial
statements will have an effect on its ratio results. For
example, companies may use different methods of inventory
valuation (and not just the net realisable method) and
any ratios that include inventory will differ from those
companies that use a different approach to inventory
valuation. Such ratios include inventory turnover and the
acid test ratio.
The impact of accounting data on
business strategy
In the 1980s, relatively little use was made of accounting
data in devising corporate strategies. Many large businesses
have subsequently employed strategic management
accountants to provide and analyse accounting data about
the business and its competitors to help develop and
implement corporate strategy.
Accounting data can help a business’ management team to
develop strategy in three principal ways.
Improving business performance
Strategic decisions such as whether or not to enter a
particular market or to produce a specific new product can
be based on an analysis of potential profitability. Financial
data used to compile the statement of profit or loss may
be interrogated to identify existing markets which offer
the highest levels of profitability. Financial forecasts
would normally be developed as part of a proposed new
strategy and profitability in terms of profit margins or
ROCE estimated. Strategic choices can be influenced by
having a view of which strategies generate profitability
ratios reaching a sufficient level. This might be a stronger
factor for those businesses which have suffered low and/
or declining profitability in recent years. For example,
profitability might inform strategic decisions on entering
new markets where higher prices may be charged.
A management team that is devising a new strategy will be
influenced by the business’ existing financial efficiency.
Poor results on financial efficiency ratios, such as a low
rate of inventory turnover, might encourage new strategies
10.4
that in part minimise holdings of inventory. This might,
for example, be a factor encouraging the development of a
strategy of market penetration.
Assessing the business’ ability to finance
a new strategy
10.4.2 Using accounting data and ratio analysis in strategic decision-making
Many new corporate strategies require major investments.
Management teams taking decisions on adopting a blue
ocean strategy or strategy of growth may need to invest
in recruiting new employees or training existing ones, or
they may need to purchase expensive non-current assets
to increase productive capacity. A large investment may
be a central element of implementing the new strategy. A
range of financial data may be helpful in determining the
strategy.
» ROCE data for the business may be used to set
investment criteria by which the investment element of
the strategy is determined. It may simply be that any
investment should generate a return at least equal to
the business’ average ROCE figure over recent years.
» Liquidity will shape some investment decisions. Poor
levels of liquidity (as measured by the current ratio or
the acid test ratio) may restrict the business’ ability
to raise finance, as well as its willingness to engage in
long-term borrowing. The business’ financial resources
may force the adoption of a less ambitious (and less
costly) strategy. Alternatively, it may be decided to
implement the chosen strategy over a longer period of
time.
» Gearing, recent figures for profit for the year and
dividend decisions will influence the business’ ability
to raise capital to fund a new strategy. Gearing figures
which are rising over time and are close to the 50 per
cent figure may mean the business has limited potential
to raise further loan capital. On the other hand, a
business that has generated strong and rising profit for
the year figures without paying too high dividends may
be able to finance more costly strategies.
Managing risk
Risk is the chance of something going wrong. Many new
corporate strategies carry a degree of risk. A business
may develop a strategy of diversification entailing selling
new products in new markets. The potential rewards of
this strategy may be considerable, but the level of risk
may also be high. Accounting data can help a business to
decide whether this risk is worth taking. It may be that
the forecast profitability figures are very much higher than
existing ones, making it an attractive strategy. A range of
accounting information, such as that relating to existing
liquidity, may help the management team to judge whether
the risk involved in the new strategy is too high.
Accounting data may also enable managers to judge whether
the business could survive the failure of the new strategy,
as well as shaping the decision itself. In November 2007,
473
 Tesco, one of the UK’s largest supermarkets, entered the
American retailing market. It invested $500 million to open
10.4 182 stores in California and Nevada, aiming for increased
rates of sales growth at a time when revenue growth in
the UK was relatively slow. As we saw earlier, the project
failed and Tesco withdrew from the US market in 2012,
having incurred losses totalling an estimated $1.5 billion.
The company would have used its accounting data to help
it to judge whether it could afford a loss of this size before
implementing this strategy.
A LEVEL 10.4 FINANCE AND ACCOUNTING STRATEGY
The impact of debt or equity decisions
on ratio results
Decisions made by managers in relation to the business’
capital structure can be important in both the short and
long term. Managers have to take ‘debt or equity decisions’.
They may opt to borrow funds, normally long-term, to
finance capital expenditure. This is funding by debt and it
means that the business is committed to paying interest
until the loans are repaid. Alternatively, a company
may sell shares to raise finance. In this context, this is
termed equity. The business does not have to pay interest
on equity, but it would be normally expected to pay a
proportion of profits as dividends.
All companies have to take a decision on the capital
structure that they will employ. These decisions may change
over time. In Chapter 10.2 we saw that Next Plc (a UK clothes
retailer) had raised £2723 million in capital by 2020. Of this
sum, £2282 million was debt. In contrast, Toyota (a Japanese
car manufacturer) had raised $319 958.2 million in capital by
March 2020, of which ‘only’ $129 171.5 million was debt.
The most obvious impact of debt and equity decisions is on
the business’ gearing ratio. Businesses that borrow larger
proportions of their capital will have a higher gearing ratio.
Unsurprisingly, in the cases of Next and Toyota above, the
former had a much higher gearing ratio:
» Next = 80.80 per cent
» Toyota = 40.37 per cent.
To summarise, the more a business chooses debt over equity
as a source of capital, the higher its gearing ratio.
Debt or equity decisions can also affect the results of
investment ratios, though the outcomes here are less
predictable. The decision to raise more capital through
equity results in the issue of a larger number of shares. For
example, this decision might reduce a company’s earnings
per share (particularly in the short term) and therefore
affect its price/earnings ratio, depending on the effect on
the market price of the company’s shares.
STUDY TIP
Don’t forget that, when calculating the gearing ratio
following an increase in long-term borrowing, the
figures on the top and the bottom of the formula need
to be altered. Students often forget to add the increased
borrowing onto the capital employed figure, which forms
the bottom half of the formula!
474
The impact of changes in dividend
strategy on ratio results
A dividend strategy can be an important factor
in persuading investors to buy a company’s shares.
Shareholders are attracted to companies that can be relied
upon to pay dividends, particularly if these payments
increase steadily over time.
Companies can operate a number of strategies when
deciding what proportion of their profit for the year to
distribute to shareholders in the form of dividends. Three
possible strategies are explained below.
» A strategy of increasing payments steadily over time.
This strategy, so long as it can be sustained, will help the
company to attract shareholders and will make it easier
(but potentially more costly) to raise capital by issuing
shares. Despite the potential cost, a number of high-profile
companies have adopted this approach. For example, in
2020, Coca-Cola announced increased dividends – the 57th
consecutive year in which it had done so!
» Some companies operate a refinement of the above.
They operate a stable growth trajectory in dividend
payments, seeking to increase it by a set percentage
each year. Over the last few years, Apple has increased
its dividends by around 5 per cent per year. This can be
reassuring to shareholders, but it may be difficult to
sustain during less prosperous periods.
» Other businesses follow a dividend strategy which is
based around short-term financial performance. So,
dividend payments rise at times when profits are high
and decline when they are low. Many companies will pay
dividends from retained earnings if they incur a loss
during a financial year.
In the short term, a change in a dividend strategy by
a company will have an impact on the results of its
investment ratios. A change in strategy which results in the
business paying higher dividends might have the effects
outlined below. A decision to reduce dividend payments
would be expected to have the opposite effects.
» The dividend yield ratio may increase if dividends rise
We saw in Chapter 10.2 that this is calculated by dividing
the dividend per share by the current market price of the
share. A rise in dividends is likely to increase the dividend
per share and the dividend yield as a consequence.
However, the announcement of increased dividends might
increase the company’s share price and this could dampen
the increase in the dividend yield figure.
» The dividend cover figure can fall if dividends increase
Dividend cover is calculated by dividing profit for the year
by the annual dividend payment. If this payment rises,
and profits are unchanged, the dividend cover figure may
fall, perhaps prompting fears among shareholders that
it is unsustainable. However, it may be that the reason
for the rise in the dividend payment is that profits for
the year have risen. The two rising figures may cancel
one another out, leaving the dividend cover figure
unchanged.
» Liquidity ratios may decline if companies increase
dividend payments When a company makes a decision
to pay dividends to its shareholders, this results in a
cash outflow. The company’s holdings of cash (which are
a current asset) may be lowered as a consequence. This
means that a decision to increase dividends may reduce
the company’s liquidity position as measured by the
current ratio or the acid test ratio.
Of course, the reason that the company has made the
decision to change its dividend strategy may also be
reflected in its ratio results. For example, a company such
as Coco-Cola, which consistently increases its dividend
payments, has managers that are confident in its ability
to generate profits. It may be that such decisions are
accompanied by rising profitability and this will be reflected
in rising profit margin and ROCE figures.
The impact of business growth on ratio
results
A growing business is one that is expanding in one of
several ways. It may be enjoying higher sales values and/or
sales volumes, there might have been an increase in the
productive capacity of the business as shown in increased
numbers of employees, or there might have been an increase
in the value of the business as measured by its total assets
employed.
Growth can affect the financial ratios of a business. The
precise effects will depend on the rate of growth and
whether it entails increasing productive capacity or using
existing capacity more fully. However, we can identify a
number of likely effects on a range of financial ratios.
The impact on profitability ratios
It might be expected that a period of growth would improve
a business’ profitability ratios. In many cases this might be
true, especially if the business is using existing capacity
more fully and has not incurred heavy costs in creating the
growth. In such circumstances, it would be likely for the
business’ ROCE to increase as its revenues and profits rise
and its capital employed is left relatively unchanged.
However, it is important to take into account how the
business’ growth has been achieved as well as its nature.
A business may achieve growth through cutting prices to
increase sales volumes and this is likely to be effective if
demand is price elastic. However, in these circumstances,
profit margins will be likely to fall as a smaller proportion of
the selling price will be profit. In 2019, Tesla, the American
electric vehicle manufacturer, cut its prices by up to $2000
per vehicle in an attempt to increase its sales volumes. As
a consequence, its operating profit margin fell even though
its revenue increased.
Alternatively, a business may decide to invest in increasing
its productive capacity to achieve a growth objective.
This may entail investing in non-current assets, such as
machinery or property, or taking over a smaller competitor.
10.4
In such a situation, the business’ capital employed is likely
to increase. The impact on the business’ ROCE figure would
normally be negative in the short term, as sales and profits
may take time to increase. If operating profit increases
less quickly than the business’ capital employed, then the
business’ ROCE figure will decline. However, in the longer-
term, if the growth strategy is successful, ROCE should
10.4.2 Using accounting data and ratio analysis in strategic decision-making
increase as operating profits rise. In 2019, AstraZeneca, a
pharmaceutical company, enjoyed rapid rises in sales of its
drugs designed to treat cancer. The firm had invested in
developing these products over many years and the impact
on its ROCE figure was seen in 2020, when it rose to 31.58
per cent from 24.15 per cent in the previous year.
The effects on liquidity ratios
Growth can weaken a business’ liquidity position, especially
if it is a rapid rate of growth. If the business does not
have access to the long-term finance that it needs, it will
be overtrading. Increased demand can lead to difficulties
in financing increased purchases of raw materials and
components. For example, a rapidly-growing business
may seek increased periods of trade credit from suppliers,
increasing its trade payables and thus its current liabilities.
Rising current liabilities are likely to result in weaker
liquidity ratios, as both the current and acid test ratios
have current liabilities as the denominator in their formulae.
Therefore, a higher figure for current liabilities indicates a
lower acid test or current ratio figure and a weaker liquidity
figure.
However, the effect of growth on liquidity ratios does
depend on the circumstances. If a business’ management
team have planned access to sufficient finance or draw on
cash reserves then the impact may be limited and of little
consequence to investors. In some industries, growth is
more easily financed. Some retailers may sell products for
cash and growth may increase holdings of cash as well as
current liabilities, resulting in little impact on liquidity
ratios.
GLOSSARY TERMS
Capital structure refers to the way in which a business
has raised the capital it requires to purchase its assets.
A dividend strategy refers to a company’s long-term
approach to allocating a proportion of its profits to
shareholders as dividend payments.
Overtrading occurs when a business expands quickly
without organising the long-term finance that is necessary
to fund the expansion.
475
 Financial efficiency ratios
May weaken; depends on:
10.4
• nature of the business
• actions of the management
team
Liquidity ratios
May weaken; depends on:
• timescale
• initial cash position
A LEVEL 10.4 FINANCE AND ACCOUNTING STRATEGY
• quality of financial
planning
Business
growth – rising
revenues, sales
volumes,
productive
capacity
▲ Figure 10.14 The impact of business growth on all of these ratios will depend on a range of factors, including the degree
of success of the strategy of business growth and the skills and experience of the management team
The effects on financial efficiency ratios
There is a potential for business growth to weaken financial
efficiency ratios, though the impact will depend on
the nature of the business and how well it is managed.
Businesses may hold greater volumes of inventory in
anticipation of rising sales and, if sales do not rise as
quickly as expected, the rate of inventory turnover can
decrease. There may also be an adverse movement in the
balance between trade receivables and trade payables. To
increase sales, a business may offer its customers more
favourable trade credit terms. This may, for example, be an
increase of 30 days in the period allowed for payment, or it
may involve offering trade credit where none was offered
before. This might be essential to win new customers and
create growth in sales. Such decisions will increase the
trade receivables turnover figure and may mean that it
exceeds the trade payables figure. This represents a lower
level of financial efficiency.
The effects on other ratios
Business growth has the potential to increase a business’
gearing ratio but only if any capital expenditure associated
with growth is mainly financed through long-term
borrowing. For those businesses that finance growth
from retained earnings, the effect could be to lower the
company’s gearing ratio, as its capital employed will
increase without any rise in non-current liabilities.
The effects on investment ratios are difficult to predict.
It is possible, during the early stages of a period of growth,
that a company’s annual dividend might be reduced as
retained earnings are increased. This could reduce its
dividend yield, depending on what is happening to the
company’s share price, and simultaneously increase its
dividend cover if profits for the year are maintained.
However, possible changes in profits and market share
prices make it difficult to forecast what might happen.
476
Other ratios
Impact may vary; depends on:
• extent of any long-term borrowing
• changes in profits and share price
Profitability ratios
May improve; depends on:
• pricing decisions
• costs of financing
• timescale
The impact of other business strategies
on ratio results
There is a wide range of strategies available to managers
other than business growth. We will consider two diverse
strategies and the impact they may have on a business’
financial ratios.
Cost leadership
A business might seek to increase its market share through
a strategy of cost leadership. This strategy could be used
to achieve market penetration. A central element of this
strategy is to minimise costs to allow the business to set
prices as low as possible, if desired. A cost-leadership
strategy is more likely to be used in markets where demand
is price elastic. A number of airlines across the world
operate cost-minimisation strategies.
Cost leadership has the potential to increase a business’
profitability ratios if it chooses not to set prices as low as
possible. If costs are a lower proportion of revenue, then
profit margin ratios are likely to be higher than they would
be otherwise. However, on occasions businesses use a
strategy of cost leadership to reduce prices to allow them to
be the lowest-price supplier in the market. This might result
in low profit margins. However, if the strategy is successful,
high sales volumes can boost the level of profit over time.
Cost leadership encourages financial efficiency, as
businesses pursuing this strategy seek to avoid any
unnecessary costs. This would include minimising holdings
of inventory and managing liquidity carefully to avoid the
costs associated with short-term borrowing. This should
lead to a situation where the rate of inventory turnover is
as high as possible, with inventory sold quickly. The trade
receivables turnover figure would be expected to be below
that of trade payables to protect cash holdings as far as
possible.
Diversification
Igor Ansoff categorised diversification as the riskiest of his
four strategies, as it involves selling new products in new
markets. It is risky because the product and the market that
is targeted are unfamiliar to the business.
A strategy of diversification may well weaken the business’
profitability ratios, as it is a costly approach. The business
will need to invest in developing new products at the same
time as establishing itself in a new market. A strategy
of diversification is likely to lead to significant levels of
investment by the business. This may increase costs of
CASE STUDY
Reach4entertainment
Reach4entertainment Enterprises Plc (R4E) supplies
branding, design and advertising services to businesses
in the theatrical, film and live-entertainment sectors. In
2018, following a period of poor financial performance,
the company developed and implemented a strategy of
diversification. The information below is taken from the
company’s annual reports in 2019 and 2020.
▼ Table 10.25
Revenue (£’000s)
Operating profit/(loss) (£’000s)
Non-current liabilities (£’000s)
Capital employed (£’000s)
Earnings/(loss) per share (pence)
Share price @ 30 June (pence)
On 27 June 2020, the company’s share price was 33 pence.
R4E does not currently pay a dividend.
Questions
1 Calculate the changes in the following ratios for R4E
in 2017 and 2019:
a ROCE [4]
b gearing. [4]
The impact of a diversification strategy on investment
ratios is difficult to predict and will depend on the success
of the strategy, along with the timescale involved. It may
be that profits and dividends are under pressure in the short
term, but dividends could increase over the longer term,
especially if profits rise significantly.
The limitations of using published
accounts and ratio analyses
We have spent some time considering the uses of financial
statements and of financial ratios in strategic decision-
servicing debts as well as rising expenditure in areas such
as promotion. The outcome, in the short term at least, could
be lower percentage figures for profit margins and ROCE.
The impact on these ratios in the longer term will depend
10.4
on how successful the new strategy proves.
A diversification strategy might entail the business in heavy
capital expenditure requiring an increase in long-term
borrowing. In the short term, at least, this might result in
an increase in the company’s gearing ratio. In some cases,
this could take the gearing figure beyond the 50 per cent
10.4.2 Using accounting data and ratio analysis in strategic decision-making
benchmark.
Against the tough backdrop of 2017, a new senior
management team has set up a strong base for 2019 by
reducing expenses and winning new business.
2019 was a year of great advancement, reflecting the continued
success of the turnaround strategy and the diversification of
the company into new areas of live entertainment.
With the shutdown of live venues and events in March 2020,
Covid-19 has had a significant impact on the entire industry.
2019 2018 2017
135 397 76 718 80 211
1 934 579 (2 394)
11 225 1 838 2 035
25 901 11 259 11 260
0.06 0.03 (0.30)
102 150 152
Source: Adapted from R4E Annual Reports 2019 and 2020,
www.r4e.com/investor-relations
2 ‘R4E’s diversification strategy has been completely
successful.’ Use the information in the case study
and the results of your ratio calculations to
evaluate this statement. [20]
making. Both sources of information, however, have
significant limitations.
The information presented in financial statements (and
used for ratio analysis) may not always represent the
business’ financial position as accurately as possible. Most
businesses, especially public limited companies, are under
pressure to present their financial performance in the most
favourable terms possible. There are a number of methods
by which a company can improve the look of its balance
sheet – these processes are called window dressing. The use
of window-dressing techniques can improve the business’
financial performance, at least in the short term, and
477
 provide more favourable financial data for analysis. This can place which might mean that conclusions made on the
mean that data in financial statements (and financial ratios basis of this data are out-of-date. New products may
10.4 based upon them) have to be treated with caution. have been launched onto the market or there may have
been a dramatic shift in consumers’ tastes. It is risky to
Financial statements can be window-dressed using a number
assume that the future will look like the past. Financial
of techniques, including:
statements also show what has happened and do not
» Some companies borrow money for a short period of
explain why. Further information may be needed here.
time to improve their cash position just before the date
» Inter-firm comparisons may be unhelpful Most
on which the balance sheet is drawn up. This action may
competitors will be different in one or more ways. They
enhance the company’s apparent ability to pay its short-
may differ in scale, in the segment of the market that
term debts.
is targeted or the objectives of the business. Many
A LEVEL 10.4 FINANCE AND ACCOUNTING STRATEGY

» An alternative method of improving a company’s cash

businesses operate globally nowadays and the market
or liquidity position is through the use of sale and
conditions can vary hugely between different markets.
leaseback. This entails the sale of major non-current
Therefore, differences in performances may be due to
assets and then leasing them back. Many retailers have
variations in market conditions rather than efficiency.
negotiated sale and leaseback deals on their high-street
» The data used to compile financial statements may
properties.
not be entirely reliable In addition to the issue of
» On statements of profit or loss, businesses may bring
window dressing, some information included in these
forward sales to an earlier period and thereby boost
statements may differ due to different accounting
revenue for a particular financial year. This does result,
methods. Differences in approaches to depreciation
however, in a lower figure in the next financial year. This
and inventory valuation can impact on financial
was part of the issue involved in the financial scandal
information.
faced by Tesco in the UK in 2014.
» The corporate objectives of the business Businesses
There is a fine line between presenting accounts as operate with different corporate objectives and this
favourably as possible and misrepresenting the performance may make comparisons invalid. Managers developing a
of the firm, which is illegal. The authorities in many strategy could find it difficult to judge the financial
countries have made several adjustments to accountancy performance of a competitor. It is too simplistic to
procedures in order to restrict the extent of window assume that all businesses pursue profit maximisation.
dressing. However, window dressing offers only short-term Businesses may not do so for a number of reasons. They
advantages to businesses. Any benefit will be offset by a may be more concerned about maintaining a reputation
decline in apparent financial performance in future years. for high-quality products or meeting the needs of
employees as fully as possible. Equally, they may take
There are a number of other limitations to using published
a long-term view of profits and be prepared to sacrifice
accounts and the results of ratio analyses:
short-term gains. A business might, for example, spend
» The information presented in financial statements
heavily on research and development to achieve greater
and used in ratios is historical It relates to a trading
financial rewards in the future.
period that concluded, at best, some months before.
In many fast-moving markets, changes may have taken

CASE STUDY
Intel
Intel is an American multinational company that
manufactures semiconductor chips. It is the world’s
largest chipmaker and has been the market leader since
1992. In 2019, the company earned revenue amounting to
$71.9 billion and profits of $22.0 billion. It has more than
110 000 employees worldwide.
Intel holds a 16.5 per cent share of the global semiconductor
market and increased its sales in 2019 while the market
size declined by nearly 12 per cent. While personal
computer sales are slowing, they remain important, and
Intel is expected to maintain its market position.
Analysts studying Intel have mixed opinions on how it will
perform in the future. They anticipate average earnings
per share growth at around 14 per cent up to 2022, below
the company’s figure of 16 per cent from 2015–19. Intel’s
price–earnings ratio is approximately 11.5, below the US
average of 15.8. The company’s shares are now priced at
a level that should make the company attractive to many
potential shareholders.
The company’s latest dividend yield figure is 2.16 per
cent. The dividend represents about 28 per cent of the
company’s earnings.
Questions
1 Using the data given, analyse two reasons why an
investor might decide to buy shares in Intel. [8]
2 Evaluate any other information that would be useful
to an investor who is considering investing in Intel. [20]

478
Another significant set of limitations of financial
statements and ratio analyses arise from their consideration
of solely financial data. While this is undeniably important,
other elements of a business should be taken into account
when evaluating performance, such as:
» the market in which the business is trading A business
that is operating in a highly competitive market might
experience relatively low profits, reducing the results of
ratios such as ROCE
» the position of the firm within the market A market
leader might be expected to provide better returns than
» the quality of the workforce and management team
These are important factors in assessing a business, but
they are not ones that will be revealed directly through
ratio analysis. Indeed, a business that invests heavily
10.4
in its human resources may appear to be performing
relatively poorly through the use of ratio analysis
» the economic environment In general, businesses
might be expected to perform more poorly during
periods of economic recession and to produce weaker
results from ratio analysis. During the period of poor

10.4.2 Using accounting data and ratio analysis in strategic decision-making

a small firm struggling to establish itself. However,
the small, struggling firm may be investing heavily
in developing new products and establishing a brand
identity. The struggling firm may generate large profits
in the future
economic performance for many major economies
which started in 2020, it is reasonable to expect the
financial performance of many (but not all) businesses
to decline.

TEST YOUR LEARNING

Short answer questions
1 a Define the term ‘strategic decision-making’.
b Explain one reason why information about a
business’ liquidity position might help managers
to develop corporate strategies.
2 Explain one way in which the information in a
business’ statement of financial position might enable
its managers to assess its ability to raise finance. [3]
3 a Define the term ‘annual report’.
b Explain one factor that is normally included in
the strategic report within a company’s annual
report.
4 Explain two reasons why shareholders and other
investors might be considered the primary target
for information included within a company’s annual
report.
5 a Define another stakeholder group (apart from
shareholders and investors) who will have an
interest in the information in a company’s
annual report and explain one reason why.
b Define the term ‘benchmarking’.
6 Explain one reason why using financial data for one
year only might be of limited value when making
strategic decisions.
7 a Explain one way in which accounting data may
help a company’s managers to manage the risk
of a new strategy.
b Define the term ‘debt’.
8 a Define the term ‘dividend strategy’.
b Explain one implication for the dividend cover
figure if dividends fall. [3]
[2] 9 Explain two reasons why a strategy of business
growth might not improve a business’ profitability
ratios. [6]
[3] 10 a Define the term ‘window dressing’. [2]
b Explain one other limitation of using published
accounts and the results of ratio analyses to
assess business performance. [3]
[2]
Data response question
Pandang Ltd
[3]
Pandang Ltd manufactures industrial vehicles (for
example, diggers and trucks) which are exported to many
countries. The company sells in very competitive markets.
[6] These markets are changing quickly as new technology
(allowing the development of self-driving vehicles, for
example) is having a significant impact.
The company has recently appointed a new CEO, who
[3] intends to develop new corporate strategies to expand
[2] its sales by at least 10 per cent each year for five years.
She also wants to extend its product range and enter new
markets.
[3] Pandang Ltd has faced difficulties over the last 12 months.
It is attempting to cut the cost of its pension scheme and
has introduced a less generous scheme which resulted
[3] in a bitter dispute with its employees. The new scheme is
[2] expected to save the business $600 million annually and
[2] will have pleased the company’s shareholders.

479
 ▼ Table 10.26

10.4 Last year ($m) The year before last ($m)

Statement of profit or loss
Revenue 10 172 9 776
Operating profit 166 219
Profit for the year 99 151
Statement of financial position
A LEVEL 10.4 FINANCE AND ACCOUNTING STRATEGY

Non-current assets 5 404 6 843

Current assets 1 803 1 454
Current liabilities 2 082 2 016
Non-current liabilities 739 1 320
Reserves and equity 4 386 4 961

Questions
1 Analyse two ways in which Pandang Ltd’s managers
might use the information in its statement of financial
position to develop its future corporate strategies. [8]
2 a Calculate the percentage change in the
company’s revenue between last year and
the year before last. [3]
b Evaluate the strengths and weaknesses of Pandang
Ltd’s financial performance last year and the year
before last using relevant financial ratios. [12]
3 ‘It is possible to assess Pandang Ltd’s future
performance on the basis of the results of its
financial ratio analysis.’ Evaluate this statement. [20]
Essay question
1 ‘Profitability ratios are far more important than any
other ratios for managers when developing a new
corporate strategy.’ Evaluate the extent to which
you agree with this statement. [20]

480
Index

INDEX
Page numbers in bold indicate case studies. see also economy; external influences barriers 335–6, 335, 337
absenteeism 66, 358 enterprise 1–15 channels 334–5
accountability 264, 313, 317, 321, 322 and finance 178 effectiveness 338–9, 339
accounting rate of return (ARR) 459–60, 460, objectives 33–40 in management 90–1, 313, 318, 328–40,
465 size of business 27–32 345, 359, 362, 403
achievement needs 74, 75, 75 stakeholders 41–6 methods 330–4, 331, 333, 336–8, 357
acid test ratio 446–7 strategy 287–312 purposes 328–30, 328
adding value 2–3, 143, 144 structure of business 16–26 use of technology 268–9, 331, 332,
administration 165 business objectives see objectives 333–4, 363, 364, 413
adverse variances 209–11, 211–12 business performance 196–7 communities
advertising 51, 128, 134, 221, 232–3, 329, see also financial statements/reports; relationship with business 42, 42, 43,
378, 379 ratio analysis 147, 256, 259–60, 264
advertising standards 221 business plans 13–14, 14 responsibilities to 257, 282
aims of business 288–9, 294 business strategy community co-operatives 24
annual leave 219 choice 287, 297–302 companies 20, 21
annual reports 100, 329, 469–71, 472 competitive advantage 288–9, 296–7 competition
annualised hours contracts 354 economy 244 see also globalisation
Ansoff Matrix 297–8, 371, 477 implementation 287, 302 effect on business 271–3, 272
appraisals 77, 403 marketing 383–92 competitive advantage 153, 260, 283,
appreciation (currency) 248–9 strategic analysis 287, 289–93, 292, 293, 288–9, 352, 401, 426, 468
artificial intelligence (AI) 268, 277, 331, 333, 294–6, 296 and costs 188–9
363, 387, 413, 413, 414 business values see corporate culture; ethical and external factors 241, 249, 266
assessment centres 53 issues gauging extent 106
assets 170, 432, 435–41, 437 business-to-business 102, 135 international 274
authority 313, 317, 323, 324 business-to-consumer 98, 102 and investment 463
autocratic management 88–9, 90–1, 90, 335, legislation and regulation 222–3, 223,
344 CAD/CAM/CAPP 269, 413 232
autonomous work groups 81 capacity 157 effect on marketing 385, 389
average costs 194, 195 capacity shortage 159–60 and pricing 124, 125, 126, 271, 273
average rate of return 459–60, 460, 465 capacity utilisation 157–60, 158, 416, 422 and privatisation 215, 216
capital 2, 143, 162 simultaneous engineering 419
B2B 102, 135 capital employed 448 and strategy 288–9, 295–7
B2C 98, 102 capital expenditure (CAPEX) 167, 167–8, 477 and success 7
backward vertical integration 31 capital structure 474 use of technology 136, 267–8
balance sheets see statements of financial capital-intensive operation 148 and workforce 61, 63, 65, 80, 352, 355,
position cartels 222, 223, 233 360
bank loans 19, 170, 172–3, 177 cash balances 180, 181 Competition Act 1998 222
bank overdrafts 172, 177 cash cows 121, 122, 123 competitive advantage 153, 260, 283, 288–9,
bankruptcy 165 cash crises 164, 183 352, 401, 426, 468
banks 174, 174, 232, 305 cash cycle 34 competitive environment 295–7
Bass model 307–8, 346 cash-flow forecasts 180–3, 182, 380 competitive pricing 124, 125, 126, 271, 273
batch production 149, 150 cash flows 34, 163–4, 183–5, 184 compressed working hours 355, 356
behavioural theories of leadership 344 cash sales 181, 182, 451 compulsory liquidation 165
benchmarking 410, 445, 471 cell production 420 compulsory redundancy 54
big data 267, 364 centralisation 85, 317, 324–5 computer-aided design and manufacture 269,
blockchain technology 277, 278 chains of command 315, 316–17, 323, 336 413
blue ocean planning 289 change conflict, stakeholders 45, 45
bonuses 77 see also demographic change; economy; conglomerate diversification 31
borrowing 246, 247, 401, 436, 453, 474 social change; technology consumer legislation 221
see also loans of objectives 38 consumer markets 98
Boston Matrix 121–2, 294 and organisational structure 315, 321 consumer price index (CPI) 239
brand awareness 95 effect of politics and legislation 225 consumer products 101, 102
brand development 3 product response to 116 consumer protection 223, 232, 233
brand image 396, 398 effect on stakeholders 43 consumers 103–4, 106–7, 257, 296–7
brand loyalty 104–5, 295, 368 transformation process 142–3 contingency planning 310–11, 310
brands and branding 22, 23, 123, 129–30, workforce management 146, 270, 308, contingency theory 344
129, 130, 131–2, 135, 386, 387 309–10 contribution 199
break-even analysis 190, 199–203, 200, 202 change culture 309–10 contribution costing 190, 193–4, 199
break-even charts 200–2 click through rate (CTR) 132 contribution pricing 195, 196
break-even output 190, 199, 200, 201, 202, climate change 281–2, 293 control, in organisations 322–3, 324
203 cloud computing 363, 364 convenience items 135
British Business Bank 230 cobots 269 co-operation 62–3
budgets 38, 205–11, 205, 207, 211–12 codes of conduct 39 co-operatives 24, 24
buffer inventories 151, 152 coercive power 345 copyright 375
bureaucratic organisations 304 collateral 172–3 core competencies frameworks 297
business culture see corporate culture collective bargaining 64 core workers 353
business cycle 236–8, 242 commission 77 Coronavirus pandemic 6, 6, 21, 136, 149, 153,
business development see expansion; growth communication 154, 167–8, 215, 264, 288, 372, 381
business environment annual report role 470

481
 corporate culture 52, 270, 270–1, 285, 304–7,
INDEX
305, 307, 309–10, 309, 418
corporate image 63, 464
corporate objectives 33, 95, 464, 478
corporate planning 304
corporate social responsibility 256–8, 258,
264
correlation analysis 378–9, 379
cost-based pricing 126
cost information 187, 194–9, 196, 198
cost leadership 476
cost-push inflation 239
costs
see also labour costs; production costs
break-even analysis 199–203, 200, 202
cost information 187, 194–9, 196, 198
cost leadership 476
costing methods 189–94, 191–2
distribution 136, 279
and economies of scale 401
of finance 176
of integration 31
inventories 151
and investment 463–4
effect of legislation 224
and location 396
and operations 148, 412
opportunity costs 177
outsourcing 160
production 65, 195, 224, 233, 260, 269,
282
and productivity 145, 146
and profits 124, 433, 450
reduction 3, 183, 185, 247, 277, 284–5,
416
sale of assets 439
and suppliers 273
types 187–9, 188, 189, 401
zero budgets 208
costs-plus pricing 195
Covid-19 see coronavirus pandemic
CPI 239
credit sales 451
creditors see trade payables
crises 163, 164–5, 181–2, 183, 310–11, 329
critical path analysis 423–7
Crosby, P. 406, 407, 409–10
crowdfunding 175, 175
cultural differences 339, 398
current assets 166, 435, 446
current liabilities 435, 436, 446
current ratio 446, 447
curriculum vitae/résumés 53
customer loyalty 268, 368
customer-focused organisations 304–5, 387,
415
customer-oriented businesses 95, 98, 99
customer-relationship marketing (CRM) 104–5
customer retention 104–5
customers
characteristics 106–7
focus on 95, 98, 99, 304–5, 387, 415
loyalty 268, 368
and pricing 123
as stakeholders 42, 43, 256, 284, 470
customs unions 277, 394
data analysis 363, 379
see also break-even analysis; financial
statements/reports; marketing
analysis; ratio analysis
debentures 173
debt factoring 173, 174, 184, 185
482
debts 177
see also trade payables
decentralisation 317, 324, 325, 325
decision trees 300
decisional management 86
decision-making
and communication 334–5
for/in crises 310–11
decision trees 300–2, 300
external factors 265
use of financial statements 467–71, 468,
478
investments 462–4, 463, 464
impact of legislation 225
locations 394, 395, 398–9
in management 63, 89, 90–1, 297–302,
322, 412–13
and objectives 33–9
and operations 143, 412–13
and production 118, 119, 120, 122, 341
ratio analysis 471–8, 472
and risks 8, 11–12, 473–4
and sales forecasts 380–1
and social responsibilities 264, 265
impact on stakeholders 43–4
decision trees 300–2
deed of partnership 19–20
delayering 48, 316, 321, 323
delegation 61, 317, 321–2, 322–3, 324
Delphi technique 380
demand
see also supply and demand
capacity utilisation 159
and flexible workforce 355
and pricing 124, 366–71, 369, 370, 432,
450, 476
demand-pull inflation 239
Deming, Edward 418, 471
democratic management 89, 90–1, 344
demographic change 238, 255, 260–6, 265,
471–8
demographic segmentation 104
depreciation 151, 248–9, 438, 440–1, 441,
442
development of businesses see enterprise;
expansion; growth; start-ups
digital distribution methods 136, 139, 140
digital promotion 132, 132, 133, 134, 387
direct costs 189
direct distribution 135
direct promotion 128, 134
direct taxes 250
directors, roles 342
discounted cash-flow 460–2, 465
diseconomies of scale 400, 402–3, 404
dismissal 55–6
see also redundancy
disruptive innovation 272, 273
distributed profits 432
distribution channels 135–40, 137, 138, 139,
140, 268, 279
diversification 34, 298, 299, 477, 477
diversity 58–9, 59, 266
dividend cover ratio 455, 474–5
dividend per share ratio 453–4
dividend strategy 474–5
dividend yield ratio 454, 474
dividends 21, 43, 172, 453–5, 454,
474–5
division of labour 85
divisions 320, 321
dominant market position 222
double-entry accounting 437
Drucker, P. 93, 313–14, 362, 406
dummy activities (CPA) 425–6
dynamic pricing 126, 139
earliest start time 424–5, 427
e-commerce 137, 139–40, 140
economic development 35
economic environment 6, 227, 445, 479
economic growth 12, 234–8, 235, 238, 247,
279
economic sectors 16–17, 18
economies of scale 400–1, 402, 403–4
economy 445
effect on business 6, 227, 244, 370, 445,
479
business role 5, 12, 29
economic growth 234–8, 235, 238, 247
exchange rates 247–50
fiscal policy 250–1
government intervention 228–33, 230,
231, 244–52, 252, 253
inflation 238–41, 240
monetary policy 244, 245–7, 246
effect on pricing 124
unemployment 241–3, 247, 253, 270, 279,
280
effective communication 329
effectiveness 144
efficiency 144–6, 144, 146, 215, 338, 416,
422, 448–52
see also lean production
elasticity of demand 124, 366–71, 370, 373–4
electronic communication 328, 331, 331, 333,
335
email 331, 335, 335
emerging markets 109–10, 375, 386, 389
emotional intelligence 346–7
employee co-operatives 24
employee morale 56–9, 63, 70
employee participation 80–1, 81
employee welfare 55–6, 70
employees
see also labour productivity; motivation of
staff; salaries and wages; workforce
intrapreneurs 10, 61–2, 62, 316
role in lean production 422
performance 85, 357–64
reliability 420
representatives 342–3
responsibilities to 257, 284
as stakeholders 42, 43, 44, 80–1, 256, 470
employer branding 59, 63, 361, 470
employment agencies 51
employment conditions 45
employment contracts 50, 53–4
flexible working 352–7, 361–2
employment legislation 217–21, 219, 224,
225
Employment Relations Act 1999 218
employment tribunals 54
empowerment 48, 79, 81, 316
enterprise
business activities 1–8
business plans 13–14
definition 2, 143
entrepreneurs and intrapreneurs 8–13, 9,
62, 86, 130, 162
government support 228–31, 231
legislation (laws) 222–3
Enterprise Finance Guarantee (EFG) 230
enterprise resource planning (ERP) 416
entrepreneurial organisations 304
entrepreneurs 8–9, 8, 9, 12, 13, 86, 130, 162
environmental audits 283
environmental issues 147, 233, 264, 280,
281–4, 282–4, 293, 464
environmental profit and loss statements 294
EPS (earnings per share) 455
Equalities Act 2010 58, 218, 224
equality 58–9, 59, 218, 224, 364
equations
capacity utilisation 157
costs 189, 190, 195, 199, 200, 203
EMV 301
financial statements 435, 436, 440–1
float time 425
human resource management 358, 359
investment appraisal 458
market share/growth 99, 100
marketing 366, 370, 371, 376
productivity 144, 358
profits 187, 197
ratio analysis 446, 448–55
working capital 166
equity 86, 435, 474
esprit de corps 86
ethical issues 35, 39, 85, 271, 394, 397, 399,
464
European Union (EU)
business size 28
customs union 277, 394, 399
regulations 57, 64, 219, 220, 421, 421,
451
exchange rates 247–50, 396
exclusive products 124, 125, 135, 415
expansion 167, 252, 276, 389, 400, 457
expectancy theory 75–6
expected monetary value (EMV) 300, 301, 302
expenditure budgets 205, 206, 209
expert power 345–6
exploitation of workers 216
exports 229, 248, 389, 391, 391, 392
extension strategies 119
external economies/diseconomies of scale
403–4
external growth 30–1
external influences 6, 214
see also competition; economy; technology
demographic change 238, 255, 260–6,
265
legislation (laws) 217–24, 219, 221, 223,
225, 225
on objectives 38
political environment 214–17, 224, 225
and risks 8, 11–12, 457, 459, 460, 463–4,
473–4
social change 255–60, 264–5
external production costs 282
external recruitment 52
external sources of finance 170, 171, 172–6,
173–6
external stakeholders 41
extrapolation 378
factors of production (inputs) 1–2, 143, 157
failed businesses 7
fair dismissal 55
family businesses 28–9, 29, 299
favourable variances 210, 212
Fayol, Henri 85–6
feedback 329, 334, 337
Fielder, Fred 344
finance and accounting
blockchain technology 278
budgets 38, 205–12, 205, 207, 211–12
cash flow 34, 180–6
role of communication 329
costs 187–204
failure of businesses 164–5
financial statements 430–43, 431–2,
434, 437, 438, 439, 468
investment appraisals 457–66
need for finance 162–4, 162
objectives 33–4, 35
planning 205–11
ratio analysis 444–56, 450, 451, 452
sources of finance 163, 169–79, 170–1,
173–6, 178, 184, 230
strategic decision-making 467–79, 468,
472, 477, 478
for types of business 19, 20, 22, 23
working capital 165–7, 166, 167
financial efficiency ratios 476
financial motivators 76–7
financial objectives 33, 34, 35
financial ratios see ratio analysis
financial regulation 232
financial statements/reports 85
annual reports 100, 329, 469–71, 472
financial position 435–8, 438–9, 442
limitations 477–9
profit or loss 430–4, 442
fiscal policy 250–1
fixed costs 188, 188–9, 189, 195, 198, 199,
200, 201
flat organisational structures 321, 323, 324
flexibility
budgets 207–8
employees 42, 62, 155, 252, 352–7, 361,
416, 420
in marketing planning 384
in operations management 149–50, 155,
414–15
in organisations 313–14
of pricing 195, 247, 268, 276
sources of finance 177
flexible budgets 207–8
flexible workforces 62, 155, 252, 352–7, 361,
416, 420
flexitime 354, 356
float time 425
flow production 149
focus groups 109
Force Field Analysis 299–300
forecasting
cash flows 180–3, 182
sales 375–81, 379, 380, 381
formal communication 336
formulas see equations
forward vertical integration 31
franchises 21–3, 23, 24, 372, 390
free float time 425
free trade agreements 276–7
French and Raven’s 5 forms of power 345–6
fringe benefits 77, 78
full costing 189, 190–3, 191–2
functional structures 318–20, 319
GDP 234, 235, 235, 236
gearing ratios 474, 476, 477
geographic segmentation 103–4
gig economy 218, 219, 355, 356, 356–7, 357
global crises 311
global population 260–1
globalisation 224, 339, 341, 362, 375, 385,
387–92, 388, 399–400
see also multinational businesses
Goleman, Daniel 347
goods and services legislation 224
government 280–1
INDEX
see also public service sector; regulation
economic growth 234–8, 235, 247
exchange rates 247–50
fiscal policy 250–1
interventions 228–33, 230, 231, 241,
242, 244–52, 252, 253
monetary policy 244, 245–7, 246
objectives 234, 235
relationship with business 12–13, 16, 29,
256
rights and responsibilities 42
supply-side policies 252
government expenditure 253
government finance 229, 230
government grants 175–6, 177, 396
governments, objectives 293
gross domestic product 234, 235, 235, 236
gross profit margin 448–9, 450
gross profits 430, 431, 468
growth
business 23, 30–1, 33–4, 34, 315, 320
economic growth 234–8, 235, 238, 247
expansion 167, 252, 276, 389, 400, 457
finance for 163, 467
and financial ratios 475–6
markets 99–101, 100, 106, 121, 178, 273,
276, 277, 298, 298, 299
in product life cycle 117, 120
Handy culture model 305–6
hard HR strategies 349, 350, 351
Hawthorne effect 70
health and safety 220, 224, 284, 359
Health and Safety at Work Act 1974 220
Herzberg, Frederick 72–3, 73, 74, 76, 79, 80,
81, 323, 361
hierarchical structures 318, 326
see also levels of hierarchy
hire purchase 172, 185
homeworking 354, 356, 357
horizontal communication 334, 335
horizontal integration 30
horizontal loading 79
human needs 66–7, 68, 70, 71–2, 71, 74–5, 75
human relations school 70–1
human resource management
see also leadership; motivation of staff;
training; workforce
communication 90–1, 313, 318, 328–40,
345, 359, 362, 403
employee performance 85, 357–64
flexibility of workforce 62, 155, 252,
352–7, 361, 416, 420
investment in 479
management of workforce 50, 62–5, 67,
155, 329
planning 48–9, 380–1
processes and strategies 83–90, 349–52
purpose and role 47–8
recruitment and selection 50–4, 352, 360
redundancy 54–5, 55, 56–7, 160, 464
strategies 349–51, 350
structure of organisation 313–27
impact of technology 48, 266, 270,
363–4, 364
hygiene factors 73
imports 239, 249, 276, 277
incentives 396, 398, 399
income budgets see sales revenue
income elasticity of demand 370
483
 income statements see statements of profit
INDEX
or loss
incremental budgets 207
indirect costs 189, 190, 191–2
indirect taxes 250–1
induction training 60, 80
industrial disputes 63, 69
industrial markets 98
industrial products 102, 135
inelasticity of demand 367, 368, 369, 370
inflation 238–41, 240, 247
informal communication 336
informational management 86
informational power 345
infrastructure 228–9, 251, 279, 396
innovation
see also products, development;
technology
in business environment 8, 29, 215, 230,
231, 273, 375
and employees 324, 360, 372
marketing 374, 375
in operations 415
R & D 372–3, 373
inputs see factors of production
insolvency 164–5
instrumentality theory 75–6
intangible aspects of products 116
integration (growth) 30–1
interest rates 28, 176, 176, 178, 245, 246,
247, 253, 462
intermediary distributors 135
internal finance sources 170–1
internal growth 30
internal recruitment 52
internal stakeholders 41
international businesses 7–8
international environment 274–7, 275,
279–81, 280
international markets 98, 387–92, 389, 390,
392
international trade 274–8, 275, 278, 387–92
internet 139–40, 175, 277, 363, 387
see also digital promotion; online sales
internet of things 277, 363
interpersonal management 86
interviews 53, 330
intranets 331, 333
intrapreneurship 10, 61–2, 62, 316
inventories 142, 151–6, 153, 156, 413, 416,
452
valuation 438–9, 439, 442
inventory control charts 151–2
inventory turnover ratio 450–1, 452, 476
investment appraisal
decisions 462–4, 463, 464
methods 458–62, 460, 463
risk 457–8, 463–4
investment ratios 474–5, 476, 477
investments 31, 170, 216, 453–5, 454, 455
see also shares
investors 31, 470
involuntary redundancy 54
jargon 336
JIC 155
JIT 155, 156, 269, 338, 420, 426, 427
job adverts 51, 51, 56–7
job descriptions 50
job design 359
job enlargement 79
job enrichment 78, 79
job performance see employees, performance
484
job production 149, 150 locations for businesses
job redesign 78–9, 80 decision-making 394–9, 394, 395–6,
job rotation 79 397–8
job satisfaction 56, 79, 89, 206, 337, 361, 420 expansion 276, 279
see also motivation of staff globalisation 399–400, 400
job security 63 and legislation 223–4
job-sharing 353, 355, 357 relocation 251
job specifications 50–1 long-term finance 163, 453, 468, 477
job training 60 long-term investment 216
joint venture businesses 24–5, 31, 229, 276 long-term planning 305
just in case inventory control 155 losses 187, 202, 432–3, 434
just in time processes 155, 156, 269, 338,
420, 426, 427 macroeconomic policies 244–52, 252
maintenance factors 73
Kaizen approach 418 management
key performance indicators (KPIs) 469 see also decision-making; human resource
knowledge management 323, 351 management; leadership
Kotter’s errors in change 310 business performance 87–8, 473–4
conflict 326
labour 2, 143, 196–7, 233, 251 functions 83–5, 84, 86
see also employees; motivation of staff; roles 86–7, 313, 336–9, 342–3
workforce styles 88–91, 90, 335, 359
labour costs 6, 77, 196, 197, 279, 351, 355, theories 85–7, 91–2
357 management by objectives 362, 403
see also labour productivity management teams 80
labour markets 252 managers 31, 44–5, 207, 208, 347
labour productivity see also management
and business objectives 33 manufacturing see production
and costs 196, 197 margin of safety 203
improving 48, 77, 269, 322, 359, 364 marginal costs 194, 195
measurement 144–6, 146, 358 see also contribution costing
labour turnover 48, 49, 49, 351, 357, 358, 364 market conditions 385, 387
labour-intensive production 148 market development 298, 298, 299
laissez-faire management 90–1, 344 market failure 233
land 2, 143, 173 market forces 5, 6
latest finish time 424, 425, 427 market growth 99–101, 100, 106, 121, 178,
lead time 151 273, 276, 277, 298, 298, 299
leadership market-led businesses 95, 98, 99
and communication 335 market penetration 297, 298, 473, 476
emotional intelligence 346–7 market research
flexibility 344 see also marketing analysis
purpose and roles 83, 86, 341–3, 342, data 108, 111–13, 113–14, 139, 183
343 purpose 106–7
theories and styles 307–10, 323, 343–6, for sales forecasting 379–80
350, 359 sampling methods 110–11
lean production 155, 156, 417–22, 418, 419 types 106–7, 109–10, 111–12
leasing 172, 185 market segments 103–4, 128–9, 136, 385
legal issues 6, 10, 18–26 market share 34, 95, 99–101, 100, 121–2,
legislation (laws) 58, 217–24, 451 276, 476
see also regulation market size 99, 101, 106, 383
annual reports 471 marketing 132
business locations 223–4 see also market research; marketing
competition 222–3, 223 analysis; marketing mix; markets
employment conditions 217–21, 219, 224, communication 329
225 customer relationship marketing 95, 99,
goods and services 224 104–5, 144, 470
marketing 221, 221 definition 94
patents 272 demand and supply 95–7, 95, 99, 158
level of economic activity 236, 244, 246, objectives 93–5, 383, 384, 387
250–1, 253 and operations management 412
levels of hierarchy 316, 317, 321, 323, 335 segmentation 103–4, 128–9, 136, 385
liabilities 164–5, 166, 435, 436, 446 strategy 381, 383–92, 385, 389, 390,
limited companies 20, 25, 169 392
limited liability 20 and sustainable businesses 282, 283, 285
line managers 325, 326 impact of technology 266–7, 387
liquid assets 166, 446 marketing analysis
liquidation 165 artificial intelligence in 387
liquidity 368, 445–7, 446, 468, 475 data analysis 108, 111–13, 139, 267
loans 173, 174, 175, 176, 181, 246, 246, elasticity of demand 366–71, 370
437–8 product development 371–5, 373–4, 375
see also borrowing sales forecasting 375–81, 379, 380, 381
local businesses 7 marketing expenditure budget 134, 135
local markets 98 marketing mix
 components 115–16
distribution 135–40, 137, 138, 139, 140,
268, 269
pricing see pricing main entry
products 115, 116–23, 118, 119, 120,
122, 123, 125, 384
promotion see promotion main entry
marketing plans 383–4
marketing strategy
development 384–7, 385
for international markets 387–92, 389,
390, 392
planning 383–4
markets
barriers to entry 272, 273, 295, 394, 396,
463
failure 233
growth 99–101, 100, 106, 121, 178, 273,
276, 277, 298, 298, 299
international 274, 275, 277, 389
position in 479
types 98, 101–3, 104–5
Maslow’s hierarchy of needs 71–2, 74, 76, 81,
323, 361
mass customisation 149–50
mass marketing 103
matrix organisational structure 314–15, 315,
320, 321
Mayo, Elton 70–1, 81
McClelland, David 74–5, 75
McGregor, Douglas 91–2
mergers 30, 31, 222, 270, 273, 276, 335–6
merit goods 17
microfinance 174, 174
migration 243, 244, 261–2, 263
minimum project duration 425
minimum wage 220, 224, 225
Mintzberg, Henry 86–7
mission statements 294, 403
Modern Slavery 154
monetary policy 244, 245–7, 246
monitoring performance 196–7, 208–9
monopolies 215, 232, 233
mortgages 173
motivating jobs 420
motivation of staff
role of communication 338
delegation and delayering 322, 323
demotivation 360
and flexible working 356, 357
in Herzberg theory 73
human needs 66–8, 68, 70, 71, 75
job satisfaction 56, 79, 89, 206, 337, 361,
420
in large organisations 403
and legislation 224
methods 70, 71, 75, 76–81, 78, 81, 350,
351
and objectives 38–9, 66, 362
and productivity 145, 146, 384
theories 68–76, 73, 75
motivators 59, 72, 73, 351, 361
moving averages 376–7
multinational businesses 8, 209, 277, 278–81,
314–15, 339, 391–2, 447
multi-skilled workers 62
narrow organisational structures 316, 321
narrow spans of control 335
National Infrastructure Plan 229
national living wage 220
national markets 98
National Minimum Wage Act 1999 220
nationalisation 16, 17, 215, 215–16, 217
natural monopolies 215
negotiators 86
neo-human relations school 71–5
net assets 436
net current assets 435–6
net monthly cash flow 181, 182
net present value 461–2, 463
net present value (NPV) 461–2
net realisable value (NRV) 439
network analysis 423–7
network charts 423–6
New Enterprise Allowance 230
niche marketing 29, 103
non-current assets 172, 185, 435, 437, 438
non-current liabilities 435, 436, 453
non-financial motivators 78–80
NPV 461–2, 463
NRV 439
objectives
and decision-making 33–9
ethical 39
government 216, 234, 235
growth 34
management 288–9, 294, 315, 341, 362,
403
and marketing 93–5, 124, 136, 383, 384,
387
organisations 313–16
social 35, 36, 37
and stakeholders 42, 45–6
trade unions 64
offensive marketing 94
offshoring 399
off-the-job training 60
on-the-job training 60
one-level channels 135
one-way communication 334–5
online recruitment 51, 52
online sales 136
on-the-job training 59
operating profit margin 449, 450
operating profits 430, 431, 468
operations management 33–40
capacity and outsourcing 157–61
capital-intensive/ labour-intensive 148
communication 329
critical path analysis 423–7
decision-making 412–13
effectiveness and sustainability 144–6,
144, 146, 147, 148
flexibility and innovation 149–50, 155,
324, 414–15
inventories 151–6, 153, 156
lean production 417–22
location and scale 394–405
methods 149–50, 149
planning 380–1, 422–7, 428
quality management 406–11
impact of technology 266, 267–70, 413,
413–14, 416
transformation process 1–3, 8, 142–4
opportunity costs 5, 6, 151, 177, 426, 460–1
organic growth 30
organisational structure
see also management
accountability 322
authority 323, 324
communication in 334–5
control 322–3, 324
delegation 321–2, 322–3
divisions 326
role of leaders 342–3
INDEX
and objectives 313–16
types 314–15, 316–21, 319, 321
outputs
see also products
break-even output 190, 199, 200, 201,
202
capacity utilisation 157–60
and fixed vs variable costs 188
outsourcing 159, 160, 395–6
overheads 189, 190, 191–2
overseas production 250
overseas trade 236, 237, 246, 249, 274–7,
279–81
see also international markets
overtrading 475
owner investment 170
ownership of businesses 18–26, 27, 44, 169,
171
packaging 131, 131–2, 147, 147, 148
paid holidays 219
pan-global strategies 391–2
partnerships 19–20, 169, 176
part-time workers 353, 357
patents 272, 273, 295, 372, 374, 375
paternalistic management 89, 90–1
pay systems 361
see also salaries and wages
payback technique 458–9, 465
P/E ratio 455, 474
penetration pricing 125, 126
people-orientated leaders 345
performance related pay (PRP) 77–8, 361
peripheral workers 353
person culture 306
person specifications 50–1
personal selling 128, 134
PERT 427
PEST analysis 289–90, 291
see also external influences
piece-rate 69, 76–7, 361
placement of product 115
see also distribution channels
planning
business plans 13–14
business strategy 287–302
corporate planning 304–11
financial 205–11
human resource management 48–9, 380–1
marketing strategy 383–4
operations management 380–1, 422–7,
428
workforce 48–9, 84, 87
plcs see public limited companies
political environment 214–17, 224, 225, 396
pollution 233, 264, 280, 282
population see demographic change
Porter’s Five Forces analysis 295–6, 296
power culture 306
power needs 74, 75
power theories of leadership 345–6
present value 461–2
pressure groups 256
price cuts 119, 153, 272, 273, 366, 368
price discrimination 125–6
price elasticity of demand 366–70, 369, 370,
432, 450, 476
price inelasticity of demand 367, 368, 369
price skimming 125, 126, 267
price-earnings (P/E) ratio 455, 474
pricing
see also marketing mix
485
 and costs of production 195
INDEX
cuts in price 119, 153, 272, 273, 366, 368
and demand 96, 124, 159, 366–70, 369,
370, 432, 450, 476
dynamic 126, 139
impact of ERP 416
and financial rates 247, 248, 249, 250
impact of legislation 225
in marketing mix 123–6, 124, 127
methods and factors 123–6
pricing points 115
and profits 124, 195, 368, 434, 449, 450
and sales 196, 378, 379
pricing points 124
primary market research 107–109
primary sector businesses 2, 16
private limited companies (ltd) 20, 25, 169
private sector 16, 17, 18, 33–4
privatisation 16, 17, 215–16, 217, 252
process innovation 415
producer markets 98
product design 408
product development 371–5, 373–4, 375, 419
product differentiation 116, 260, 320
product innovation 415, 415
product life cycle 117–21, 120, 124
product-oriented businesses 98
product portfolio analysis 117–22, 122, 123
production 79, 225, 251, 257, 269, 341, 400,
415, 418, 419
see also production costs; products
production budgets 205, 206, 209
production costs 65, 195, 224, 233, 260, 269,
282
see also fixed costs; labour costs
production teams 79
productivity see labour productivity
products
see also production; production costs
characteristics 116
development 116, 267, 268, 297–8, 409,
477
environmentally friendly 282
and exchange rates 249
effect of interest rates 247
effect of legislation 225
life cycle 117–21
in marketing mix 115, 116–23, 118, 119,
120, 122, 123, 384
use of network analysis 426
organisational structure 315
types 101–2, 116
profit budgets 205, 208
profit for the year 430, 431, 442, 469
profit sharing 77
profitability ratios 475, 477
profits
budgets 205, 209
and contribution 199
and costs 167–8, 193, 195, 196–7, 202,
434
difference from cash 163, 164
gross profits 430, 431, 448–9
maximisation 33
and pricing 124, 195, 368, 434, 449, 450
and privatisation 215
profitability ratios 475, 477
and revenue 187
and sales forecasts 380
as source of finance 170, 172
programme evaluation and review technique
427
project management 423–7, 427
486
promotion (marketing) risk averse cultures 306
advertising 116, 128, 134 risks/risk-taking 8, 11–12, 473–4
branding 129–30, 129, 130 investments 457, 459, 460, 463–4
digital promotion 132, 133, 134 robots 269, 270
direct promotion 128, 134 ROCE 448, 449, 462, 473, 477, 478
and elasticity of demand 371 role culture 306
packaging 131, 131–2
personal selling 128, 134 salaries and wages 70, 71, 76, 220–1, 225,
promotional mix 118, 119, 134–5 239, 361
sales promotions 128, 128–9, 134, 134 see also labour costs
promotional elasticity of demand 371 sale and leaseback 170, 170–1, 177, 184
promotional mix 119, 127, 134 sales
promotional offers 119 cash sales 181, 182, 451
PRP 77–8, 361 decline 117
psychographic segmentation 104 and exchange rates 248
psychological pricing 126 extending in product life-cycle 119
psychometric tests 53 forecasting 375–81, 379, 380, 381
public limited companies (plcs) 20, 26, 169, effect of inflation 241
172, 176, 430, 431 international trade 274
public service sector 1, 5, 16–17, 34–5, 215 and market share 100, 101
sales forecasting 375–81, 379, 380, 381
qualitative research 111 sales promotions 128, 128–9, 134, 134
qualitative sales forecasting 380 sales revenue 182, 205, 205, 206, 209, 432
quality 421–2 sales targets 95
quality assurance 406, 408 sales teams 128
quality circle teams 79, 80, 81, 418 sales techniques 138, 138
quality control 404, 406 sampling methods 110–11
quality management 404–11, 407, 422 scale of business 401–4
quality of products 160, 250 scenario planning 289
quality targets 406 scientific school 68, 69–70
quantitative easing 247 seasonal businesses 49
quantitative research 111 secondary market research 109–10
quaternary sector businesses 16 secondary sector businesses 16
quota sampling 111 security costs 151
R & D 117, 118, 371, 372–3, 373, 374, 375 selection for jobs 52–3
random sampling 110 self-regulation 232
ratio analysis 444–56 share buy-back schemes 455
for decision-making 471–8, 472 share capital 172, 173, 176, 176
financial efficiency ratios 450–2, 451, shareholder concept 44
452 shareholders 478
gearing ratios 452–3 annual reports 470
investment ratios 453–5, 455 company control 20, 43, 177
liquidity ratios 445–7, 446 employees 80–1
profitability ratios 445, 448–50, 450 investment ratios 453–5
rationalisation 159 as stakeholders 42, 256
recessions 234, 236 shares 20, 21, 176, 455, 474
recruitment 48, 50–2, 52, 52, 56–7, 229, 355, see also investments
360, 363 shift-work 354
redundancy 54–5, 55, 160, 464 shopping goods 124
references for jobs 53 short-term finance 163
regulation (EU) 57, 64, 219, 220, 421, 451 short-termism 215, 305
regulation (UK) 10, 216, 231, 232, 389 simultaneous engineering 419, 419
relationship-orientated leaders 344, 345 size of businesses 27–32, 28, 30, 315
reliability of research 112 slumps 234, 236
relocation 398–9, 400 small businesses 27–9, 28, 29, 103, 224, 246,
renewable energy 147 270, 401
reorder levels 151, 152 see also limited companies; partnerships;
reports see annual reports; financial sole traders
statements/reports SMART objectives 39
research and development 117, 118, 371, social accounting 259
372–3, 373, 374, 375 social auditing 257–8
reserves 435 social change, effect on business 6, 255–60,
reshoring 399–400, 400 264–5
responsibility 313, 317, 324 social enterprises 25, 25, 35, 36, 230
résumés 53 social influences on business
retail co-operatives 24 competitors and suppliers 271–3, 272
retailers 135 demographic change 255, 260–6, 265
retained earnings 170, 177, 432, 442 environmental issues 281–4
return on capital employed (ROCE) 448, 449, international environment 274–7, 275,
462, 473, 477, 478 279–81, 280
revenue expenditure 167 social change 6, 255–60, 264–5
revenues 167–8, 187, 468 sustainability 284–5, 284–5
rights issues (shares) 176 technology 266–71, 268, 277–8, 278
social media 132, 133, 331, 331, 333, 363 tariffs 276, 277 unity of command/direction 85

INDEX
social objectives 35, 37 task culture 306 unlimited liability 19, 20
social responsibilities 35–6, 256–60 task-orientated leaders 344–5 urbanisation 263, 266
soft HR strategies 349, 350, 351, 352 taxation 231, 233, 250–1, 253, 280, 280, 329 see also demographic change
sole traders 18–19, 169 Taylor, Frederick and Taylorism 69–70, 76 USP 102
sources of finance 163, 169–79, 170–1, team pay 361 utilities 34
173–6, 178, 184, 230 teamworking 70, 79–80, 145, 320, 361, 420,
spans of control 316, 321, 323, 335 423 valence 76
special economic zones 223–4 technology validity of research 112
speciality products 52, 124, 125, 135, 415 effect on business 6, 266–71, 268, value chain 4, 5
special-order decisions 197–9, 198 270–1, 272 variable costs 188–9, 193–4, 198, 199, 200,
specific risk 457 effect on competition 272 201
staff development 59–62 investment in 145, 285, 457 variable pay 77
staff managers 325–6 effect on leaders 341 variances 209–12, 211–12
staffing see employees; labour; motivation of in management 331, 332, 333–4, 363–4, venture capital 173, 177, 178
staff; workforce 413, 413–14, 416 vertical communication 334, 335
stakeholders 31, 41–6, 42, 44, 45, 256, 445 in marketing 387, 388 vertical integration 31
start-ups 7, 10–11, 11, 19, 162, 177, 203, 230 effect on trade 277–8, 278 vertical loading 78–9
statements of financial position 167, 435–8, temporary workers 352–3 visual communication 331–2
437, 438–9, 438, 441, 442, 467–8, 468 tertiary sector businesses 16 voluntary liquidation 165
statements of profit or loss 430–4, 431–2, test marketing 109, 379–80, 380 voluntary redundancy 54, 55
434, 441, 442, 468–9 Theory X and Theory Y 91–2, 323, 324 Vroom, Victor 75–6
stock control 152 time-based pay 76
see also inventories time-series data 471, 472 wages see salaries and wages
straight-line depreciation 440–1 time value of money 460–1 waste management 421, 421–2
strategic alliances 31 total float time 425 wholesalers 135
strategic decision-making 264, 464, 467–79 total quality management (TQM) 408 window dressing 477–8
strategic management total revenue 368 work–life balance 57
aims and objectives 288–9, 288, 294 trade agreements 276–7, 399 worker representatives 342–3
analysis 289–93, 292, 293, 294–6, 296 trade barriers 272, 273, 295, 394, 399–400 workforce
of change 307–10 trade credit 166, 171, 172, 177, 184, 185, 447 see also employees; labour productivity;
choice of strategy 287, 297–302 trade cycle 236, 237 motivation of staff; salaries and
competitive environment 296–7 Trade Descriptions Act 1968 221 wages
implementation 302 trade openness 274, 275 benefits of multinationals 279
planning 289 trade payables 166–7, 184, 185, 447, 452, 476 communication 337
strategy 287, 297–302 trade payables turnover days 451–2, 452 contracts 53–4, 352–7, 361–2
stratified sampling 111 trade receivables 166–7, 184, 185, 447, 452, diversity 364
structure of businesses 16–17, 18–26 476 flexibility 62, 155, 252, 352–7, 361, 416,
subcontracting 159 trade receivables turnover days 451, 452, 452 420
subsidies 232 trade unions 63–4 health and safety 220, 224, 284, 359
success in business 7, 8 legislation 218 investment in 479
suppliers trademarks 375 legislation 217–21, 219, 224, 225
and economies of scale 401, 402, 403, training 59–62 management 50, 62–5, 67, 155, 329
404 communication skills 339 morale and welfare 56–9, 155, 351, 358
and integration 31 for delegation 322 planning 48–9, 84, 87
and lean production 155, 420, 422 government services 229 in project management 423, 427
management of 257, 273 to improve performance 60, 145, 360–1 recruitment selection and redundancy
outsourcing to 160 job training 52, 59, 60 50–6, 55, 56–7, 160, 282, 360, 464
as stakeholders 42, 43, 44, 256, 470 and motivation 79, 80 response to change 146, 270, 270–1, 308,
trade credit 166, 171, 172, 177, 452 trait theory 343–4 309–10
supply and demand 95–7, 97, 159, 355 transfer payments 251 training see training main entry
see also demand transformation process 1–3, 3, 6, 8, 142–4 turnover 48, 49, 49, 351, 357, 358
supply chains 153, 154, 271, 275, 279, 282, transformational leadership 307–8, 346 workforce relations 62–5, 67
284, 295–6 trend analysis 471 working capital 166–7, 166, 171, 436
supply-side policies 234, 252 trends, and extrapolation 378 working conditions 81, 219–20
survival 34 triple bottom line 36 working from home 354, 356, 357
sustainability 147, 147, 148, 257, 264, 284–5, turnover working hours 57–8, 145, 154
284–5 inventory 450–2, 452 work-life balance 57–8
SWOT analysis 291 labour 48, 49, 49, 351, 357, 358 works councils 80
systematic risk 457 two-factor theory 72–3, 73, 74, 76, 323 written communication 330
two-level channels 135
tactics 37, 287 two-way communication 334, 335 zero budgeting 208
takeovers 30, 31, 222, 270, 273, 276, 335–6 zero defects approach 409, 410
tall organisational structures 316, 323, 335 unemployment 241–3, 247, 253, 270, 279, 280 zero-hours contracts 354, 356, 357, 357, 364
tangible attributes 116 unfair dismissal 55–6, 218 zero-level channels 135, 136
Tannenbaum and Schmidt continuum 88 unique selling point (USP) 102
targets 33, 38 unit costs of production 401

487
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Cambridge International AS & A Level Business Boost eBook

Boost eBooks are interactive, accessible and flexible. They use the latest
research and technology to provide the very best experience for students
and teachers.
● Personalise. Easily navigate the eBook with search, zoom and an image
gallery. Make it your own with notes, bookmarks and highlights.
● Revise. Select key facts and definitions in the text and save them as flash
cards for revision.
● Listen. Use text-to-speech to make the content more accessible to students
and to improve comprehension and pronunciation.
● Switch. Seamlessly move between the printed view for front-of-class
teaching and the interactive view for independent study.

To subscribe or register for a free trial, visit

www.hoddereducation.com/cambridge-alevel-Business