CHAPTER 2:  Production
 Procurement of supplies
PART 1: THE FIRM AND ITS
ENVIRONMENT
Environmental Scanning
- is a process of gathering, analyzing, and
dispensing information for tactical or strategic
purposes. The environmental scanning process
entails obtaining both factual and subjective
information on the business environments in
which a company is operating or considering
entering.
Business Environment
- According to Stephen P. Robbins & Mary
Coulter, “Environment refers to institutions and
forces that affect organizational performance.
External Business Environment
- may be defined as all those conditions and forces
which are external to the business and are beyond
the individual business unit, but it operates within
it.
External environment refers to the environment
that has an indirect influence on the business. The
factors are uncontrollable by the business.
The business environment may be classified into
two types:
EXTERNAL BUSINESS ENVIRONMENT
 refers to the forces/factors outside the
organization which may affect, either
positively or negatively, the performance
of the organization.
INTERNALBUSINESS ENVIRONMENT
 refers to the forces/factors within the
organization which may affect, either
positively or negatively, the performance
of the organization.
The SPECIFIC EXTERNAL BUSINESS
ENVIRONMENT includes:
 Stakeholders
 Customers
 Pressure groups
 Investors
 Employees
The INTERNAL BUSINESS ENVIRONMENT
includes:
 The organizations’ resources
 Research and development
 Products and services offered
MICRO EXTERNAL BUSINESS
ENVIRONMENT
Customers – The major task of a business is to
create and sustain customers. A business exists
only because of its customers.
Employees – Employing staff with relevant skills
and experience is essential. This process begins at
recruitment stage and continues throughout an
employee's employment via ongoing training and
promotion opportunities.
Suppliers – An important force in the micro
environment of a company is the suppliers, i.e.,
those who supply the inputs like raw materials and
components to the company.
Stockholders – As organizations require
investment to grow, they may decide to raise
money by floating on the stock market i.e., move
from private to public ownership.
Media – Positive media attention can “make” an
organization (or its products) and negative media
attention can “break” an organization.
Organizations need to manage the media so that
the media help promote the positive things about
the organization and reduce the impact of a
negative event on their reputation.
Competitors – Competition is a basic feature of
an open market economy. No business
organization can ignore its competitors and their
business strategy.
The GENERAL EXTERNAL BUSINESS
ENVIRONMENT includes:
 Economic
 Socio-cultural
 Politico-legal
 Demographic
 Technological
 World and ecological situations
MACRO EXTERNAL BUSINESS
ENVIRONMENT
Political – How changes in government policy
might affect the business e.g., a decision to
subsidies building new houses in an area could be
good for a local brick works.
Economic – How the economy affects a business
in terms of taxation, government spending, general
demand, interest rates, exchange rates and global
economic factors.
Social – How consumers, households and
communities behave and their beliefs. For
instance, changes in attitude towards health, or a
greater number of pensioners in a population.
Technological – How the rapid pace of change in
production processes and product innovation
affect a business.
Legal – The way in which legislation in society
affects the business. e.g., changes in employment
laws on working hours.
Environmental – Growing awareness of the
potential impacts of climate change is affecting
how companies operate and the products they
offer, both creating new markets and diminishing
or destroying existing ones.
INTERNAL BUSINESS ENVIRONMENT
- An organization's internal environment is
composed of the elements within the organization,
including current employees, management, and
especially corporate culture, which defines
employee behavior.
Mission Statement – An organization's mission
statement describes what the organization stands
for and why it exists. It explains the overall
purpose of the organization and includes the
attributes that distinguish it from other
organizations of its type. “What do we stand for?”
Products – A product is the item offered for sale.
A product can be a service or an goods.
Machinery – Machinery refers to specific
machines or machines in general that business
uses to produce products or in making business
operations.
Organization’s Structure – The formal structure
of an organization is the hierarchical arrangement
of tasks and people. This structure determines how
information flows within the organization, which
departments are responsible for which activities,
and where the decision-making power rests.
Organizational Culture – The organizational
culture is an organization's personality. Just as
each person has a distinct personality, so does
each organization. The culture of an organization
distinguishes it from others and shapes the actions
of its members.
The INTERNAL BUSINESS ENVIRONMENT
includes:
 The organizations’ resources
 Research and development
 Production
 Procurement of supplies
 Products and services offered
COMPONENTS OF ENVIRONMENTAL
SCANNING
 The development of a competitive
mindset
 Considering of future business scenarios
 Business prediction/forecasting
 Benchmarking
o The process of measuring or
comparing one’s own products
services and practices with those
of the recognized industry
leaders in order to identify areas
for improvement
CULTURAL INTELLIGENCE
 Is an individual's om to favorably receive
and adjust to an unfamiliar way of doing
things.
MONOCHRONIC CULTURE
 Is a culture where people tend to do one
thing at a time.
POLYCHRONIC CULTURE
 Is a culture that is more flexible on time
and it is used to accomplish many
different things at one time
ECONOMIC DEVELOPMENT
 Is a total process which includes not only
economic growth or the increase in the
amount of goods and services produced
by the country’s economy but also
consider the social, political, cultural and
spiritual aspects of the country’s growth.
ECONOMIC DEVELOPMENT
PHASES/STAGES
 Economic growth
 Improvement of human development
index
 Availability of benefits provided by
science and technology
  Societal improvement of the and help in the production of goods and
opportunities and services that they offer.
 General welfare of its members.

BUSINESS ORGANIZATION
 Is a collection of people working together
to achieve a common purpose related to
their organization's mission, vision, goals
and objectives and sharing a common
organizational culture.

ORGANIZATIONAL CULTURE
 Is the set of beliefs and values shared by
organization members and which guide
them as they work together to achieve
their common purpose.

COMPETITIVE ENVIRONMENT
 Refers to specific groups of people with
which the company/firm interacts
 The company’s customers, rival firms,
new entrants, substitutes, suppliers make PART 2: THE GOAL OF THE FIRM
up the firm's competitive environment
forces. The Firm
 The abovementioned competitive  A firm is a collection of resources that is
environment forces have the power to transformed into products demanded by
influence the nature of the competition consumers.
among rival companies so the firm must
learn to adapt to or influence also, the Why does a firm exist?
said competition.  transactions costs
 The less power each of these competitive  contracting and enforcement costs
environment forces have, the more  uncertainty
profitable the industry will be.  frequency of transaction
 The firm’s managers must be able to  asset-specificity
identify the varying needs of its  opportunistic behavior
customers and focus on creating
customer value. Limits to Firm Size
 The firm must also know the answers to  tradeoff between external transactions
the questions ‘Who are our rival and the cost of internal operations
companies?” ‘Who are the new entrants
to the industry?" ‘What are their different
or new and better ways of providing
value to customers?"
 The firm must realize that the substitutes
are the biggest opportunity or threat in an
industry and this implies that they may
have to think of new strategies in order to
compete with them. (Landline phones
have cellphones as substitute)
 The firm must also realize the importance
of their suppliers that provide them with
major inputs: raw materials for
manufacturing goods, money from
investors, and financial institutions, and
people who supply them with new ideas

The Goal of the Firm
 Throughout the text we will assume that
the goal of the firm is to maximize
profits.
o profit-maximization
hypothesis
 What is profit?
o revenue minus cost
Other goals that the firm might pursue:
 Economic Objectives
o market share
o profit margin
o return on investment
o technological advancement
o customer satisfaction
o shareholder value
 Noneconomic Objectives
o workplace environment
o product quality
o service to community
 Knowing the firm’s goals allows the
manager to make effective decisions
 How might different goals lead to
different decisions by the firm?
Do Companies Maximize Profit?
 Criticism: Companies do not maximize
profits but instead their aim is to
“satisfice.”
 Two components to criticism:
o Position and power of
stockholders
o Position and power of
professional
o Management
Position and Power of Stockholders
 Medium-sized or large corporations are
owned by thousands of shareholders who
may own only minute interests in the
firm, and, in addition, own interests in an
entire portfolio of firms.
 Shareholders are concerned with
performance of entire portfolio and not
individual stocks.
 Most stockholders are not well informed
on how well a corporation can do and
thus are not capable of determining the
effectiveness of management.
 Not likely to take any action as long as
they are earning a “satisfactory” return on
their investment.
Position and Power of Professional
Management
 High-level managers who are responsible
for major decision making may own very
little of the company’s stock.
Managers follow their own objectives rather than
those of the stockholders.
 Concern over job security may lead them
to be too conservative and instead pursue
a steady performance.
 Management compensation may be based
on some measure other than profits
Counter-arguments which support the profit
maximization hypothesis.
 Stock prices are a reflection of a
company’s profitability. If managers do
not seek to maximize profits, stock prices
fall and firms are subject to takeover bids
and proxy fights.
 The compensation of many executives is
tied to stock price.
Maximizing the Wealth of Stockholders
 Views the firm from the perspective of a
stream of earnings over time, i.e., a cash
flow.
 Must include the concept of the "time
value of money.”
o Dollars earned in the future are
worth less than dollars earned
today.
 Future cash flows must be “discounted”
to the present.
 The discount rate is affected by risk.
 Two major types of risk:
o Business risk
o Financial risk
 Business risk involves variation in
returns due to the ups and downs of the
economy, the industry, and the firm.
 All firms face business risk to varying
degrees
 Financial Risk concerns the variation in
returns that is induced by leverage.
 Leverage is the proportion of a company
financed by debt.
  The higher the leverage, the greater the
potential fluctuations in stockholder
earnings.
 Financial risk is directly related to the
degree of leverage.
If EVA is negative, then shareholder wealth is
being destroyed.
Another measure used to rank companies is Future
Growth Value (FGV).

Under this framework, maximizing the wealth of FGV measures how much of the company’s value
the shareholder means that a company tries to is due to expected growth.
manage its business in such a way that the Economic Profits
dividends over time paid from its earnings and the  Economic profits equal revenue minus
risk incurred to bring about the stream of economic cost.
dividends always create the highest price for the  Economic costs and accounting costs
company’s stock. differ.

How is the stock price affected by: Economic Profits

 changes in the size of the dividend?
 changes in the growth of dividends?
 changes in the risk faced by the firm?
Dividends are a portion of a company's
earnings which it returns to investors, usually as
a cash payment. The company has a choice of
returning some portion of its earnings to investors
as dividends, or of retaining the cash to fund
internal development projects or acquisitions.
The total value of the company’s common equity
is determined by multiplying the firm’s stock price
by the number of shares outstanding.
 Accounting costs are based on historical
costs.
 Economic costs are based on replacement
costs and also include opportunity costs.
 Normal Profit is the amount of profit
that is equal to the profit that could be
earned in the firm’s next best alternative
activity.
 It is the minimum profit necessary to
keep resources engaged in a particular
activity.

Another measure of the wealth of stockholders is

called Market Value Added (MVA)®

MVA represents the difference between the market

value of the company and the capital that the
investors have paid into the company.

MVA includes adjustments for accumulated R&D

and goodwill.

While the market value of the company will

always be positive, MVA may be positive or
negative.

Another measure of the wealth of stockholders is

called Economic Value Added (EVA)®

EVA is calculated as
EVA = (Return on Total Capital – Cost of Capital)
TOTAL CAPITAL - is all interest-bearing debt
plus shareholders' equity, which may include
items such as common stock, preferred
stock, and minority interest.

If EVA is positive, then shareholder wealth is

increasing.