Every effort has been made to trace all copyright holders, but if any have been inadvertently

overlooked, the Publishers will be pleased to make the necessary arrangements at the first
opportunity.
Although every effort has been made to ensure that website addresses are correct at time of going
to press, Hodder Education cannot be held responsible for the content of any website mentioned
in this book. It is sometimes possible to find a relocated web page by typing in the address of the
home page for a website in the URL window of your browser.
Hachette UK’s policy is to use papers that are natural, renewable and recyclable products and
made from wood grown in well-managed forests and other controlled sources. The logging and
manufacturing processes are expected to conform to the environmental regulations of the country
of origin.
Orders: please contact Bookpoint Ltd, 130 Park Drive, Milton Park, Abingdon, Oxon OX14 4SE.
Telephone: +44 (0)1235 827827. Fax: +44 (0)1235 400401. Email: [email protected]
Lines are open from 9 a.m. to 5 p.m., Monday to Saturday, with a 24-hour message answering
service. You can also order through our website: www.hoddereducation.co.uk
ISBN 978 1 5104 5334 0
eISBN 978 1 5104 5287 9
© Malcolm Surridge and Andrew Gillespie 2019
First published in 2019 by
Hodder Education,
An Hachette UK Company
Carmelite House
50 Victoria Embankment
London EC4Y 0DZ
www.hoddereducation.co.uk
Impression number 10 9 8 7 6 5 4 3 2 1
Year 2022 2021 2020 2019
All rights reserved. Apart from any use permitted under UK copyright law, no part of this
publication may be reproduced or transmitted in any form or by any means, electronic or
mechanical, including photocopying and recording, or held within any information storage and
retrieval system, without permission in writing from the publisher or under licence from the
Copyright Licensing Agency Limited. Further details of such licences (for reprographic
reproduction) may be obtained from the Copyright Licensing Agency Limited, www.cla.co.uk
Cover photo © chones – stock.adobe.com
Typeset in Integra Software Services Pvt. Ltd., Pondicherry, India
Printed in Italy
A catalogue record for this title is available from the British Library.
Contents
Introduction

Unit 1 What is business?

1 Understanding the nature and purpose of business
2 Understanding different business forms
3 Understanding that businesses operate within an external environment
Revision Section Unit 1 What is business?

Unit 2 Managers, leadership and decision making

4 Understanding management, leadership and decision making
5 Understanding management decision making
6 Understanding the role and importance of stakeholders
Revision Section Unit 2 Managers, leadership and decision making

Unit 3 Decision making to improve marketing performance

7 Setting marketing objectives
8 Understanding markets and customers
9 Segmentation, targeting and positioning (STP)
10 Using the marketing mix
Revision Section Unit 3 Decision making to improve marketing performance

Unit 4 Decision making to improve operational performance

11 Setting operational objectives
12 Analysing operational performance
13 Increasing efficiency and productivity
14 Improving quality
15 Managing inventory and supply chains
Revision Section Unit 4 Decision making to improve operational performance

Unit 5 Decision making to improve financial performance

 16 Setting financial objectives
17 Analysing financial performance
18 Sources of finance
19 Improving cash flow and profits
Revision Section Unit 5 Decision making to improve financial performance

Unit 6 Decision making to improve human resource performance

20 Setting human resource objectives
21 Analysing human resource performance
22 Improving organisational design and human resource flow
23 Improving motivation and engagement
24 Improving employer–employee relations
Revision Section Unit 6 Decision making to improve human resource performance

Unit 7a Analysing the strategic position of a business: internal factors

25 Mission, corporate objectives and strategy
26 Analysing internal position: financial ratio analysis
27 Analysing internal position: overall position
Revision Section Unit 7a Analysing the strategic position of a business: internal factors

Unit 7b Analysing the strategic position of a business: external factors and

strategic options
28 Analysing the external environment: political and legal change
29 Analysing the external environment: economic change
30 Analysing the external environment: social and technological change
31 Analysing the external environment: the competitive environment
32 Analysing strategic options: investment appraisal
Revision Section Unit 7b Analysing the strategic position of a business: external
factors and strategic options

Unit 8 Choosing strategic direction

33 Strategic direction: choosing which markets to compete in and what products to
offer
34 Strategic positioning: choosing how to compete
Revision Section Unit 8 Choosing strategic direction

Unit 9 Strategic methods: how to pursue strategies

35 Assessing a change in scale
36 Assessing innovation
37 Assessing internationalisation
38 Assessing greater use of digital technology
Revision Section Unit 9 Strategic methods: how to pursue strategies

Unit 10 Managing strategic change

39 Managing change
40 Managing organisational culture
41 Managing strategic implementation
42 Problems with strategy and why strategies fail
Revision Section Unit 10 Managing strategic change

Acknowledgements

Full glossary of key terms available online at

www.hoddereducation.co.uk/aqabusiness
Introduction
Welcome to your A-level course in Business. This book has been written to meet the precise
requirements of AQA’s A-level Business specification.
Book structure
This book is divided into chapters that match the content and structure of the AQA specification
which will help you to understand where you are in terms of covering the relevant material. The
A-level course in this book is divided into ten units of study, each comprising between two and
five chapters. The book assumes that you have no prior knowledge of Business and this is
reflected in the title of Unit 1: ‘What is business?’ At the start of each chapter we give an
overview of issues that will be covered and a list of the topics that you should aim to have
understood by the end.
Decision making is a key theme for the specification and therefore for this book. Unit 2 focuses
on the people who have to make decisions within business and the techniques they may use to
make these decisions. The next four units (3 to 6) reflect the importance of decision making and
are structured accordingly. Each of these units covers an aspect of the operation of a business
such as managing finance, marketing or human resources. The units have three distinct elements:
• identifying and explaining the objectives that may be set for this aspect or function of the
business
• looking at the information that may be available to help decision makers
• considering the types of decisions that may be made in this function of the business.
Units 7 onwards, which you may study in year 2 of your A-level course, centre on strategic
decision making. Thus, the seventh and eighth units of study entail analysing the current strategic
position of a business (where are we now?), while later units look at strategic direction (where do
we want to go?), strategic methods and managing change (how do we get there?). Understanding
this from the outset will help you to see the wider picture and how the topics that you study are
interrelated.
Mastering the models and theories you will study in this book will help you to understand
situations which businesses and managers encounter. They also give you a framework to analyse
the issues involved in a specific situation and can guide you in making relevant judgements and
in justifying them.
Book features
Within each chapter, we have included the following features to support you in studying the
material:

Key terms
This feature defines key terms from the specification. It is important to understand the
meaning of the terms set out in the specification to be able to relate these concepts to
a range of scenarios and to develop focussed responses to questions.

Business in focus

This feature should help to bring each topic to life by showing it in a real context. It
shows you how theories and models can be applied to real businesses and can be
used to help understand and analyse the decisions that managers, and others
associated with businesses, have to make. Each Business in focus feature will have
two or three practice questions at the end to encourage you to think further about the
topic.

What do you think?

This feature is designed to encourage you to reflect on what you have just covered in
a particular part of the book. It may ask you to relate an idea or concept to other
topics in the book or to your own experience, or to consider what you might decide to
do in a specific situation.

Handling data
This feature offers you an opportunity to apply your numerical skills to a topic and to
interpret a range of business-related data, including graphs and tables.

Key models and theories

This feature summarises key models and theories included in the specification and how
they may be used to answer questions set in a range of different business contexts.
ASSESSMENT ACTIVITIES

At the end of each chapter we provide a series of features which are relevant for you
whether you are studying A-level or AS Business. The features we have included are:

Knowledge check questions

These are questions intended to test your knowledge and understanding of the
material set out in the chapter.

Short answer questions

These require you to develop relatively brief responses to a variety of questions, some
of which will be calculations.

Data response questions

These provide a business scenario and ask you to answer a number of questions by
using your knowledge and understanding of the material in the chapter and relating it
to the scenario given.

Essay questions
Essays are included at the end of each chapter. This type of question is intended for
Alevel students only. There are no essays in the AS exams, although AS students
may benefit from tackling some of these questions.
Revision Sections
These are included at the end of each unit. They provide an opportunity for you to look back
over the material that has been covered in the unit and assess how well you have understood it.
These sections contain a number of features to help you to do this.
• Advice on the unit, particularly things you should do and things you should avoid when
studying these topics.
• A unit checklist (that follows the specification closely) to monitor your coverage of the topics
in the unit and your degree of understanding of each topic.
• A selection of short-answer questions that test your knowledge of the range of topics covered
in the unit.
• A case study which provides a contemporary business context on which a range of questions
have been set.
• Two essay questions.
AQA’s AS examinations in Business
If you are taking AS Business, you will take two examinations at the end of the year. Both exams
test all of the AS material covered in units 1 to 6 of this book.

Paper One
This paper is worth 50 per cent of the total AS marks and its duration is 1½ hours. It comprises
three sections:
• Section A – 10 multiple-choice questions
• Section B – four short-answer questions
• Section C – two data-response questions.

Paper Two
This paper is worth 50 per cent of the total AS marks and also lasts for 1½ hours. It is based
around a case study which is likely to include some numerical data. There will be approximately
seven questions relating to the case study.
AQA’s A-level examination in Business
If you are studying A-level Business, you may still take the AS examinations set out above, but
these will not contribute to your A-level qualification as the two are entirely separate. (Your
teachers will be able to advise you on whether you will take these AS examinations as practice.)
It is important to remember that the AQA A-level Business examination will assess the entire
content of the A-level specification, all of which is covered in this book. These examinations are
made up of three papers, each of which is worth 33.3 per cent of the total A-level marks. Each
paper has a duration of 2 hours and carries 100 marks.

Paper One
This paper has four compulsory sections:
• Section A – 15 multiple-choice questions each worth one mark
• Section B – short-answer questions totalling 35 marks
• Sections C and D – each comprising two essays from which you must choose one (that is one
essay from Section C and one from Section D).

Paper Two
This paper comprises three compulsory data-response questions each carrying approximately 33
marks and made up of three or four individual questions. One of these data-response questions
will have mainly numerical or graphic data.

Paper Three
This paper consists of a case study and approximately six compulsory questions.
Other sources of information
You may find it helpful to read the marking schemes that have been produced alongside past
examination papers as part of your revision. These marking schemes provide you with:
• answers to calculation questions
• examples of the knowledge and key arguments that might be used to answer non-numerical
questions
• the demands of the question – that is what you have to do to answer it fully
Understanding the significance of these last two bullet points is very important in writing
responses which answer the question as fully as possible. For example, in June 2018, AQA’s A-
level Paper One included the following question: ‘Analyse how delayering might affect the level
of profit of a business.’ To meet the demands of the question, students were expected to write an
argument which linked the consequences of delayering to the effect on the level of the profit
earned by a business. Such a response would reach the top level of the marking scheme. By just
discussing the consequences of delayering without a link to profit levels, for example, students
would only reach a lower level in the marking scheme. Therefore, understanding and responding
to the demands of questions is a vital element of writing good quality responses.
AQA publishes Examiners’ Reports for each of its AS and A-level Examinations after they have
been marked and the results issued. These reports set out aspects of the performance of students
on each paper which has been good, and those areas where performance can be improved.
Reading these reports can help you to prepare thoroughly for future examinations and to avoid
some possible pitfalls.
Wider study
This book will guide you through the AQA AS and A-level Business programmes of study,
although you should supplement this with research and wider reading. There is an immense
amount of information available about businesses, their behaviour, their decision making and the
environments in which they operate.
The internet is an enormous and valuable resource and there are numerous websites that are
worth visiting. Company websites contain vast amounts of information. For example, public
companies produce annual reports including information on their financial and social
performance. Newspapers and other media operate valuable websites. Those of the Guardian, the
Independent and the BBC are freely available and all have business sections. There are a number
of very useful government websites. A topical example is the Business is Great website
(www.greatbusiness.gov.uk). You will also find relevant information in magazines, newspapers
and on television programmes.
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. There are many
opportunities for you to see the operation of some of the theories and models that you will study.
Business is a subject that will have great relevance to your future life, whatever you choose to
do. We hope that you enjoy studying it and wish you good fortune in your examinations.
Malcolm Surridge and Andrew Gillespie
Chapter 1 Understanding the nature and
purpose of business
Introduction
The purpose of this chapter is to introduce you to Business as a subject and to encourage you to
think about the range of organisations that exist in a modern economy. The UK has businesses of
all sizes, from those employing just one person to those who employ many thousands. They
supply diverse products, from high technology products, such as military equipment, to relatively
simple services such as painting and decorating. This chapter also invites you to consider the
targets that businesses attempt to achieve and how they might measure their achievements.
What it is important to know by the end of this chapter:
• why businesses exist
• the relationship between a business’s mission and its objectives
• the objectives that businesses commonly set themselves
• the reasons why businesses set objectives
• how businesses measure profit and why it is important.
Why businesses exist
1. What are businesses?
The word ‘business’ is derived from the idea of ‘busy-ness’. This notion of ‘busy-ness’ is a good
description of many business organisations. They are busy finding and buying resources,
organising and using these resources in production, selling their products and making sure they
supply what their customers want. This tells us that businesses are organisations that transform
inputs or resources into outputs or products that are purchased by their customers.

Key terms
A good is a physical product such as a house or designer suit.
A service is an intangible item such as insurance or decorating.
A product is a more general term which includes goods and services.

Businesses are very diverse as well as being present in many aspects of our lives. They supply an
enormous range of goods and services that are demanded by individual consumers and other
businesses. They supply essential products such as electricity, health care and education as well
as luxury products including jewellery, gourmet meals and designer clothes. Businesses supply
goods and services. Goods have a physical existence and can be seen or held. Examples include
televisions and furniture. Services are products that are intangible, such as cleaning, dental care
or the provision of hotel accommodation.
Businesses are very important for the UK. They bring a number of benefits to the country, its
economy and its inhabitants.
• Businesses create employment. Businesses create jobs for individuals. In many cases the
business only has one person in it; in some cases, businesses employ hundreds of thousands of
people.
• Businesses create income. Business earn profits from their activities which are paid to their
owners who therefore earn income. Employees are paid for their work.
• Businesses create new products. Businesses can improve the lives of people by creating new
goods and services. Pharmaceutical businesses such as GlaxoSmithKline (GSK) research and
develop medicines that can cure illnesses, extend life expectancy and improve the quality of
people’s lives.
• Businesses can enhance a country’s reputation. Successful businesses can help to establish
and maintain a country’s reputation for being innovative and forward looking. The UK has a
strong global reputation for producing top quality music and television programmes.

Handling data
 Businesses Employment Turnover1
Thousands Millions
All businesses 5,694,515 26,723 3,739,171
SMEs (0–249 employees) 5,687,230 16,146 1,904,912
Small businesses (0–49 5,653,375 12,849 1,363,996
employees)
With no employees2 4,327,680 4,697 271,574
All employers, of which: 1,366,835 22,026 3,467,597
1–9 employees 1,117,810 4,093 552,637
10–49 employees 207,885 4,059 539,786
50–249 employees 33,855 3,297 540,915
250 or more employees 7,285 10,577 1,834,259
1 Total turnover figure exclude Section K (financial and insurance activities) where turnover is not
available on a comparable basis.
2 ‘With no employees’ includes sole proprietorships and partnerships with only the self-employed
owner-manager(s), and companies with a single employee, who are assumed to be directors.
Table 1.1 Estimated number of businesses in the UK private sector and their associated employment
and turnover, by size of business (2017)
Source: Department for Business, Energy & Industrial Strategy, ‘Business population esti-mates for
the UK and regions 2017’
1 What percentage of businesses in the UK at the start of 2017 had
a no employees
b over 250 employees?
2 What percentage of employment in the UK at the start of 2017 was in businesses
with
a no employees
b over 250 employees?
3 What percentage of turnover in the UK at the start of 2017 was in businesses with
a no employees
b over 250 employees?
Figures 1.1 Businesses come in many types and sizes.

Handling data

Figure 1.2 UK private sector business population, 2000–2017

Source: Department for Business, Energy & Industrial Strategy, ‘Business population estimates for
the UK and regions 2017’
1 Calculate the percentage increase between 2000 and 2017.
2 Analyse why this change might have occurred.
 2. What do businesses do?
Businesses exist to transform inputs or resources into goods and services that are in demand from
individuals and other businesses. This transformation process is illustrated in Figure 1.3.
The transformation or production process undertaken by businesses adds value to the inputs that
are used as illustrated in Figure 1.3. This increase in value occurs because they are demanded by
certain groups of consumers who will receive benefits from having that product. Because of this
the buyers are willing to pay a price that exceeds that paid for the inputs or resources used in
production. For example, Apple’s new versions of its iPhone sell for prices far in excess of the
cost of the resources used in it. Buyers pay these prices because the phone offers a range of
benefits, including the latest technology and status from owning a high- fashion product.
Businesses interact with us throughout our daily lives. It is not necessary to visit a high street or
a trading estate to see a business in operation. Modern methods of communication have brought
businesses into our homes, our relationships and our leisure activities. We encounter them when
buying goods and services, but also when engaging in everyday activities such as using the
internet to research something or communicate with friends. A business will have supplied the
tablet, phone, laptop or other device you use to connect to the internet, a business will also
provide the internet service and the webpages that you view. Finally, a business will have
provided the energy and the telephone or satellite connection necessary to use the internet.
Businesses exist to satisfy our needs for a range of goods and services which we would be unable
to provide for ourselves because we do not have the skills or time to source them, or because the
costs of supplying them ourselves would be prohibitive. For example, without specialist
businesses it is unlikely that we would be able to fly to other countries because we do not have
the resources or skills to source this service. Privately owned businesses are an efficient means of
supplying the wide variety of goods and services needed by modern economies. Other businesses
that are owned and operated by the government may supply goods and services that would not
otherwise be available. For example, it is common for governments to provide services such as
street lighting and national defence.
Businesses also exist to satisfy other needs. They provide a means of satisfying people’s desire to
be creative or to make money. Some entrepreneurs establish businesses to allow them to express
their creative talents. In 1993, Cath Kidston established a business selling distinctive fabrics,
wallpapers, china and clothing. Her design talents have created a successful business that
operates internationally. Others have made vast fortunes from creating and expanding
businesses. James Dyson, an inventor and founder of the Dyson business, has amassed net
wealth estimated in 2013 to be £3 billion.

Figure 1.3 Adding value by transforming inputs or resources into goods and services
The people who are employed by businesses have to make many decisions. The people who
create new businesses, called entrepreneurs, have to make vital decisions concerning how to turn
their ideas into a business, such as, where to locate the business, how many products should be
produced and at what price should they be sold. The decision-makers in larger businesses,
normally their managers, make decisions such as whether or not to produce a new product, to try
and sell in a foreign market or to buy another business.
3. Types of businesses
It is possible to categorise businesses and the products they supply in different ways. Some
businesses supply products directly to the final consumers and these are called business to
consumers (or B2C) firms. Well-known businesses such as McDonald’s and Sony are examples
of B2C businesses. In contrast, some other businesses supply their products to other business
organisations. These are business to business, or B2B, businesses, for example, Tata Steel
manufactures large amounts of steel in locations throughout the world. It sells its steel to other
businesses, such as car manufacturers, to help them to supply their own products.

Sectors
A business can be categorised according to the sector of the economy in which it is based.
Businesses are classified into one of three sectors according to the types of goods and services
they supply. The three sectors are:
• Primary – agriculture, forestry, fishing, mining and quarrying, oil and gas extraction
• Secondary – manufacturing, construction and the supply of electricity, gas and water
• Tertiary – the supply of services, for example, hotels, catering, transport, education and
health.

Business in focus: JCB

J.C. Bamford Excavators Limited, normally known as JCB, is a British multinational

manufacturer of equipment used in the construction, agriculture, power generation,
waste management and demolition industries. JCB produces a range of over 300
machines and maintains a reputation for excellent customer service. JCB is one of the
world’s top three manufacturers of equipment such as excavators, forklift trucks,
power generators, dump trucks and lighting equipment. It employs around 11,000
people on four continents and sells products in 150 countries.

Figure 1.4 JCB’s products are bought principally by businesses for use in their own production
processes. Some of JCB’s customers are large businesses themselves and can place substantial
orders with the company.
 Practice questions
1 Analyse why JCB is able to sell its products for more value than the inputs used by
the business to create them.
(9 marks)
2 JCB is a B2B firm and sells its products to a relatively small number of businesses.
Do you think that it is easier for a B2B business to sell its products?
(9 marks)

Some businesses may operate in more than one sector. For example, BP is one of the world’s
largest oil businesses. Its gas extraction activities place it in the primary sector and processing
the mineral oil into petrol and other products is a manufacturing process (secondary sector).
Finally, the business sells its products via retail outlets, which are part of the tertiary sector.
Over time, the tertiary sector has supplied an increasing proportion of production (measured by
gross domestic product or GDP) in the UK while manufacturing businesses have become
relatively less important. One reason for this trend is that businesses overseas are able to supply
manufactured products more cheaply. However, rising incomes in the UK have led to increased
demand for services such as hotels, travel and catering.

Key term
Gross domestic product (GDP) measures the value of a country’s total output of
goods and services over a period of time, normally one year.
 The relationship between mission and
objectives
Mission statements
A mission statement sets out what a firm is trying to achieve, that is, the reason it exists. For
example, a business may set out to be ‘the lowest-cost producer in the industry’ or to ‘maximise
the returns for our owners’. The mission may include a statement of what the firm believes it is,
what it values, which markets it wants to compete in and how it intends to compete. Mission
statements commonly focus on:
• the organisation’s values
• non-financial goals it may pursue
• the benefits of the business to the community
• how consumers are to be satisfied.

Key terms
what &
why
使命
.

A mission statement sets out a business’s overall purpose to direct and stimulate
the entire organisation.
⽬标1 ⽬的 Aims are long-term plans of the business from which its corporate objectives are
derived. Aims 是由多 4
objrvs 完成 ,

⼩⽬标 Objectives are medium- to long-term targets established to coordinate the business.
By setting the mission of the business, everyone within the business knows what they should
ultimately be trying to do. All of their actions should be directed towards the same thing. This
should make decision making easier: when faced with a series of options managers can compare
them in relation to the overall purpose of the business. Having a clear mission can also motivate
people – they know exactly why they are there and what the business is trying to achieve, and
this can give them a sense of belonging and direction.
However, some mission statements are unrealistic, or clearly just public relations exercises, and
so employees may pay little attention to them. A mission statement will only have value,
therefore, if the behaviour of everyone within the firm supports it. In these circumstances, it can
be a powerful way of uniting people and developing a corporate spirit.
The list below sets out some mission statements used by well-known organisations:
• to provide the finest, most technologically advanced power systems. Whether our products are
for use on land, at sea or in the air (Rolls Royce)
• to bring inspiration and innovation to every athlete in the world (Nike)
• to ensure the ability of Earth to nurture life in all its diversity (Greenpeace)
• to give people the power to share and make the world more open and connected (Facebook).
Aims and objectives
1. Aims
Aims are long-term plans from which a business’s objectives are derived; these are often referred
to as 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, the house-builder
Taylor Woodrow states that its corporate aim is ‘to make our homes environmentally sustainable
to build and to live in.’ Tesco’s aim is to broaden the scope of the business to enable it to deliver
strong, sustainable long-term growth.
Corporate aims (and mission statements) are set by the senior employees within the business and
are intended to provide guidance for setting other objectives and also to guide and assist more
junior managers in their decision making. So, for example, managers throughout Tesco’s stores
will take decisions intended to achieve the organisation’s aims of broadening the business’s
scope and delivering strong, sustainable growth. In this context, opting to open supermarkets in
China and to sell electrical products and clothing are all important long-term decisions that the
business has taken with the intention of meeting its corporate aims.
From its corporate aims (and from its mission statement) a business can set quantifiable
objectives, such as gaining a 35 per cent share of a particular market in Europe within three
years.

内部⽬标 ,

Figure 1.5 The hierarchy of objectives

Business in focus: Starbucks’ mission statement

Figure 1.6 Starbucks

Starbucks is clear about what makes it a great company. According to its mission
statement, the company’s success is because it is focused on the product as well as
the people.
Starbucks is always focused on the quality of its coffee. The company is passionate
about sourcing its coffee beans ethically and improving the lives of those who grow
them.
Its staff are called partners to reflect the belief that they work together and they
respect each other. Starbucks want its partners to be themselves and to be
passionate about their work.
It wants to engage with customers. It wants to provide customers with perfect drinks
but also to laugh with and help improve their lives even if it is only for a few minutes of
their day.
It wants its stores to be part of the communities where they are based. It wants its
stores and its partners to take their responsibilities to these communities seriously
and to make themselves welcome. It wants its partners to take positive action to
improve the communities they are in.
It focuses on delivering shareholder value by being successful in all these other
areas, If it gets things right with its coffee, its farmers, its partners and its
communities, it can achieve better shareholder value and the company will thrive.

Practice questions
1 Analyse how senior managers at Starbucks could use the information in the
business statement to set objectives for the business.
(9 marks)
2 To what extent is producing a mission statement likely to improve the performance
of a business?
(16 marks)

2. Objectives
 Once a firm has established its mission it can set its objectives. The objectives turn the mission
statement into something that is more quantifiable. Rather than simply being a statement of
intent, an objective sets out clearly what has to be achieved. It is a target.
Objectives are medium- to long-term targets established to coordinate the business. Objectives
should be quantified and have a stated timescale, such as ‘to earn a 20 per cent return on capital
next year’.
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.

可泮做的⼀可
g
「• Measurable – they must include a quantifiable target, for example, a 10 per cent increase.
的 • 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 – is it two
or three years?
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 or how long you have to achieve it.
 Common business objectives
Businesses may set themselves a number of objectives, including those below.

objertv
① profit maximization ,

rmoral
② CSR L corprrate Social
Respousibility ) .

③ Sales maximization ,

④ Revenne maximization .

⑤ Satisif avnor ,

满意度
⑥ Growth ,

Osurvival

0 Cash flow
 1. Profits and profit maximisation
Profits are maximised when the difference between sales revenue and total costs is at its
greatest. Some firms set objectives that involve achieving a minimum level of profit, allowing
the business and its managers to focus on other objectives.

Key terms
噔
Profit is the surplus of total revenue over total costs for a business over a trading
period.
Cash flow is the movement of cash into and out of a business over a period of time.

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 also growth in the value of the
business and therefore in the share price. This can provide shareholders with long-term financial
benefits.

profit Maximizaton 利润最⼤化 ,

「
Markee Struvthre 市场结构 ,

① perfeot competitim market ,

完全竞争市场
定
< . 农业
eg
价格由 Markee
,
,

② Imperfeot compertitionmarkec不完全竞争市场
eg 餐饮 .
.

价格由 firms 定 ,

7
monopolisie 有对断性竞争市场
price
maker
produes
varied
Hign
7
Oligoploy 寡头垄断 . Ln 家独⼤ )
barries .

any ho
substinte goods
家独 ⼤
monopoy
-
. ,

very high barries ,

2. Growth
Many businesses pursue 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 shareholders (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. We
saw earlier that Tesco has set itself the aim of strong, sustainable growth and this will have been
transferred into quantified objectives, possibly relating to sales figures or grocery market share in
other countries.
3. 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. Times when survival can become a
key objective include:
• periods of recession or intense competition
• times of crisis, such as during a hostile takeover bid.
During these times the business may have to take actions such as lowering prices that reduce
profits but enable it to continue to survive.
4. 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 face long cash cycles because there are large outflows for
long periods before the product is made and sold. 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.
5. Social and ethical objectives
Social objectives include targets that relate to matters such as providing employment for people
or improving facilities for local people (for example, building a play park for local children).
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. Such objectives have received much
attention over recent years. In part, this is the result of increasing awareness on the part of many
individuals and groups who have an interest in a business. Some investors will only invest in
businesses 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.

Business in focus: Marks & Spencer and its Plan A 2025

Ten years ago, we launched Plan A. We made 100 commitments to tackle five big
issues – climate change, waste, resources, fair partnerships, and health. These
issues are still as relevant as ever. They’re the beating heart of Plan A. Plan A 2025
strengthens our commitment to address these issues with 100 bold new targets.
Crucially, it forces us to address questions to which we do not yet have answers, but
must address if we are to become a truly sustainable retailer.
We have achieved a lot with Plan A over the last ten years but we need to accelerate
our work in our own operations, supply chains and with our customers too. Even for a
plan as ambitious as Plan A it’s clear that ‘steady as she goes’ is not enough given
the scale of wellbeing, community and planetary challenges we face. Nor is it enough
to race ahead alone, we’ll fail if the rest of the business community and the policy
ecosystem within which it operates does not change too, so we have to continue to
build bigger and bolder partnerships to affect collective change. So, more ambition,
more pace and more scale all define Plan A 2025. What does not change is our
determination to be the retail leader globally in sustainable business.
Source: Marks & Spencer’s Plan A

Practice questions
1 Analyse the benefits that Marks & Spencer would expect to receive from having
social and ethical objectives set out in its Plan A.
(9 marks)
2 Do you think that any retailer can expect to succeed in the future without setting
and publicising social and ethical objectives?
(16 marks)
Figure 1.7 These campaigns emphasise M&S’s ethical behaviour.
 and
⼀多样 h produols
inestriey
a 的

6. Diversification 差杀⼼ ,

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 source of revenue for the business while it seeks new projects.
Diversification avoids a business having ‘all its eggs in one basket’ and has been the principle
behind the creation of conglomerate businesses. Pepsico Inc, the multinational soft drink and
snack producer, pursued the objective of diversification to extend its product range beyond soft
drinks to help it to compete with its powerful rival Coca-Cola.

Short-run and long-run objectives

When deciding what they want to achieve, businesses can set both short-run and long-run
objectives. If a business has a long-run growth objective it may want to invest in training
employees to improve skills and performance, expanding into new markets and investing in
developing new products. All these activities may help to achieve the long-run growth objective.
However, they will prove expensive and short-run profits may fall.
By comparison, a business that wanted to maximise its profits in the short run and was not
concerned about the long term might cut back on all these activities. It would reduce expenditure
on training and developing new products. In the short run, profits may jump up but in the long
run this business may be in a much weaker position.
UK firms are often criticised for setting objectives that are too short-term and do not involve
long-term planning. Critics say that UK businesses fail to invest enough in ensuring they are
strong enough over the long term and that investment by UK businesses is very low. Instead,
they often go for short-term rewards. In their defence, UK managers often blame their investors
for insisting on short-term rewards. Many shareholders in the UK are businesses such as pension
funds and banks. These businesses need to make money for their own investors and often want
these earnings quickly; if a business cannot deliver, pension funds and banks will simply move
their investment elsewhere.

Business in focus: Me & the Bees Lemonade

Some entrepreneurs start very young. At age 14, Mikaila Ulmer is the boss of Me and
The Bees Lemonade.
Figure 1.8 Me & the Bees Lemonade products

Mikaila’s business started when she was even younger. In 2009, she started selling
home-made lemonade from a table at the front of her house. The drink was made
using a recipe that had been in her family for over 50 years. It includes honey. Ten
per cent of the company’s profits is used to help protect bees. Mikaila’s business grew
from her family home to supplying local businesses and then in 2015 she won a
contract to sell to the food and drinks chain Whole Foods Market. Her product is now
sold in over 500 stores across the US.
Source: BBC News, 2018 ‘The 13-year-old who built a best-selling lemonade brand’

Practice questions
1 Analyse the possible objectives Mikaila might now set for her business.
(9 marks)
2 To what extent do you think the objectives of Mikaila’s business are likely to
change over time?
(16 marks)
Why businesses set objectives
By setting objectives, a business and the people who have an interest in it (known as its
stakeholders) can gain a number of benefits. By agreeing on objectives with other people within
the business:
• managers can ensure that everyone is working towards the same overall target. Without any
clear objectives people are much more likely to do their own thing. Coordinating the efforts of
all employees can improve organisational performance, especially in large businesses that may
have people employed in different locations. For example, one of Tesco’s objectives is to
expand its retail services in all areas. This helps to encourage all the retailer’s employees to
seek ways to increase the business’s sales and can be supplemented with individual sales
targets for specific stores.
• employees may be motivated because they know exactly what the business wants them to
achieve. If an employee is set a target, they know precisely what they have to do. Without a
target, they may not be sure whether or not they are doing the right thing. Having a target also
enables employees to measure progress: they can see how they are doing and whether or not
they (or the relevant part of the business) are going to reach its target.
• the success of a business’s plans can be reviewed. Managers can measure how much has been
achieved compared to the target that was set. For example, the management team at Tesco can
see if it has achieved the sales or growth targets that it set for various parts of the business. If
the objective has not been hit, managers and employees can discuss why this has happened and
what they can do differently to achieve the target next time.

Key terms
Stakeholders are individuals or groups (such as employees, customers and local
residents) who have an interest in a business.
Revenues are the earnings or income generated by a business as a result of its
trading activities.
 r money
Cost ⼀
time
\ 情绪价值
The measurement and importance of profit
,

Costs and revenues

The relationship between profit, cost and revenue
Profit is a very important objective for many, but not all businesses. Making a certain level of
profit, or the maximum possible, will be an important objective for many of the UK’s largest and
best-known businesses such as Vodafone or Centrica, but not for others such as charities, which
pursue other objectives.
One of the most important relationships for a business is:
Profit = total revenue – total costs
This formula allows businesses to calculate whether they might make a profit and, if so, how
much it might be.

Business costs
What is a cost? It is simply the expenditure a firm makes as part of its trading. Some of the
expenses or costs firms face include payments for raw materials, fuel and components, as well as
for labour (paid as wages and salaries).
These costs can be classified in a number of ways, though the most common is to divide them
into fixed and variable costs.

Fixed costs
Fixed costs do not change when a business alters its level of output. As an example, a business’s
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 maintenance costs paid by the business.

Key terms
cost sunk 沉没成本 , 为了得到 ta 必须花的 l

Fixed costs are costs that do not alter when the business alters its level of output.
⼀

Examples include rent and rates.

钱)
Variable costs alter directly with the business’s level of output, for example, fuel
costs. 劳动⼒由 owtpt 变化⽽变化的成本 Costprive × Q
Total costs are fixed and variable costs added together.
Average costs are total costs of production divided by the level of production or
)output to give the cost of producing a single unit of output.
plcost voTo ⼀
TO
Λ Handling data owepre

> Q
 The managers at NTV plc have calculated that if the business manufactures 2 million
televisions in a year, the average fixed cost of producing one (that is the part of the
business’s fixed costs that has to be paid by a single television) will be £250 million
divided by 2 million, which equals £125.
Calculate NTV Plc’s average fixed cost of production if it produces:
1 1 million televisions a year
2 5 million televisions a year.

Variable costs
In contrast to fixed costs, variable costs alter directly with the level of a firm’s output. This
means that, a business that is increasing its output is likely to have to pay higher variable costs,
whereas one that is reducing output could expect variable costs to fall. Expenditure on fuel, raw
materials and components are all examples of variable costs.
Imagine NTV faces variable costs of £350 for each television it manufactures; this is necessary
to pay for the components, fuel, packaging and labour. So, to produce 2 million televisions, the
business faces variable costs of £700 million (2,000,000 x £350); to manufacture 5 million
televisions results in variable costs of £1,750 million (5,000,000 x £350). This level of
production and the variable costs are illustrated in Figure 1.9.
Figure 1.9 shows that expenditure on items such as fuel, labour, raw materials and other
materials rises directly along with output. Variable costs are drawn as a straight line for
simplicity. However, in the real world, the line may gradually flatten out as businesses frequently
negotiate lower prices when placing large orders. For example, NTV is obviously a large
business and would have a lot of power when negotiating with its suppliers. NTV plc may be
able to purchase materials more cheaply per unit if it places exceptionally large orders. This
would reduce the variable costs for each unit of production (or average variable costs) as output
increased, causing the variable cost line to flatten slightly at higher levels of output. The variable
costs associated with the production of 5 million televisions might, for example, be £1,600
million. If so, this would mean that the variable cost of one television is actually £320, not £350.
Variable costs are usually shown as a straight line.
Figure 1.9 Variable costs for NTV plc

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 = fixed costs + variable costs
Total costs can be used to calculate the average cost of producing a single unit of production. In
Table 1.2 we can see that the average cost of production is £600 per television if NTV plc
manufactures 1 million televisions. However, this falls to £400 per television if it increases its
production to 5 million televisions per year. This reduction takes place because the business’s
fixed costs are being spread over a higher level of production or output and therefore have a
diminishing impact on average costs of production.
Level of production Fixed costs (£ Variable costs (£ Total costs (£
(televisions, millions) million) million) million)
0 250 0 250
1 250 350 600
2 250 700 950
3 250 1,050 1,300
4 250 1,400 1,650
 5 250 1,750 2,000
6 250 2,100 2,350
7 250 2,450 2,700
Table 1.2 Cost information for NTV plc

What do you think?

Why are televisions normally manufactured by large businesses, rather than small
ones?

Costs and decision-making

Total costs of production are an important piece of information for a business. Managers of a
business can use this information when 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 expensive
equipment, will seek to produce large quantities of output. This reduces the effect of fixed costs
on selling price by spreading them over a large quantity of sales.
Information relating to costs can be extremely helpful to managers when deciding on prices. It is
unlikely that a business will want to set prices below the costs of production for any length of
time. If a business knows the average cost of producing a product, then it can set a price that is
higher, which will ensure it makes a profit, so long as it is able to sell all that it produces. This is
known as ‘cost-plus pricing’.
Sometimes businesses are not able to control the price at which they sell their products – they
might be a small firm in a very competitive market. In these circumstances it is important to
know costs of production to decide whether it is possible to sell products at a profit. This will
help the business’s managers to make a decision on whether to enter, or to remain in, a market.
In reality, it can be difficult for many businesses to calculate the average costs of production.
Many businesses produce a range of products using the same production facilities. This means
that the business’s fixed costs may relate to a number of different products and it can be difficult
to divide these fixed costs accurately between different products.

Handling data
Complete the table below.
Output Fixed Variable costs £ (assume VC Total Costs = Fixed Costs +
costs £ per unit is £2) Variable Costs £
0 200 0 200
10
20
30
40
50
60
Business revenues
A business’s revenue is its income over a period of time. You may also encounter the terms
sales revenue, sales income or turnover, which have the same meaning. Businesses calculate the
revenue from the sale of a single product as well as from their entire product range. In either
case, the calculation is the same:
Revenue = quantity sold × average selling price
In most circumstances, a firm can exercise some control over the quantity it sells and hence over
the revenue it receives.
If a business reduces its selling price, it can normally expect to sell more. Whether or not this
increases its revenue depends on the number of additional sales it makes as a result of reducing
its price. If competitors also reduce their prices, then few extra sales will result and revenue is
likely to be relatively unchanged or may even fall. However, if the price reduction makes the
product cheap compared to those of competitors, and it offers similar benefits, then a price
reduction might increase sales significantly increasing the revenue received by the business.
Similarly, a rise in price can be expected to reduce sales. The size of the fall in sales will depend
on many factors, including the loyalty of customers and the relative quality of the products. The
amount by which sales fall will determine whether the firm receives more or less revenue
following its price rise. Some businesses sell products that are unique or regarded as highly
desirable, perhaps because they are fashionable. For example, some producers of fashion
clothing, such as Gucci, can charge high prices and still enjoy relatively high sales.

What do you think?

Why are some businesses able to set high prices for its products and not suffer a
large fall in sales and in sales revenue?

The relationship between price and sales revenue is explained by the concept of the price
elasticity of demand (see pages 99–100).

Handling data
Complete the table below.
Output Total revenue £ Variable costs £ Total Costs = Fixed costs
(assume price = £5 a (assume VC per unit is £ and variable costs £
unit) £2)
0 0 0 200
10
20
30
40
50
60
Profits
A business makes a profit when, over a period of time, its revenue exceeds its total costs of
production. The formula necessary to calculate profit is:
Profit = total revenue – total costs
A business’s profits depend upon two main factors: profit margins and the quantity (or volume)
of sales.
• A profit margin is the amount or percentage of the final selling price that is profit. If a business
sells products where a large percentage (or margin) of the price is profit, then it is likely to
make large profits.
• However, the quantity a firm sells will also affect the amount of profits it earns. In general, if a
business sells a greater quantity of its products it will make more profit, so long as it does not
have to reduce price (and therefore its profit margin) to achieve higher sales.
If a business’s costs are greater than its revenues over an accounting period the enterprise will
make a loss rather than a profit.
Why are profits important?
For many businesses, profits are very important and are often used as a measure of success.
Many people who invest in enterprises do so in the hope and expectation of making a handsome
return on their money. For such investors it is not simply profits that are important, but rather the
size of the profit. A larger profit means a greater return for the investor.
Making a profit brings a range of benefits to a business and its owners and can influence a
number of decisions.
• A profitable business may be attractive to customers. The financial performance of many of
the UK’s better-known businesses is reported in the media. Customers may believe that
profitable businesses are selling desirable products and may be willing to make long-term
arrangements with a business that they consider to be financially secure.
• A business that makes a profit, especially one which exceeds expectations, is likely to be able
to persuade individuals and institutions such as banks to invest in it. This can make it cheaper
to raise finance and may encourage and support expansion decisions.
• A profitable business may be bought by a larger rival. A profitable business is attractive in
itself and may own valuable brands or be popular in a market which the larger business would
like to enter. This can earn the original owners large sums of money.
• A profitable business is more likely to have the confidence of its suppliers and they may be
more willing to allow the business time between the delivery of suppliers and payment. This is
effectively an interest-free loan.

Handling data
Complete the table below.
Output Fixed Variable costs £ Total Total revenue £ (assume Profit
costs £ (assume VC per unit is Costs price of £10 per unit) £
£2) £
0 240 0 240 0 (240)
10
20
30
40
50
60

For some businesses, earning a profit may not be at all important. A number of businesses are
not established and operated with the aim of making profits. Charities, for example, do not seek
to make profits. This type of business seeks to raise the maximum amount of income possible, or
to provide a high-class product, while earning enough to cover costs.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 What is the difference between a service and a product?
2 State two reasons why businesses exist.
3 List two inputs used by a business to make goods or services.
4 State two features of a business’s operations that may be reflected in its mission
statement.
5 Is the following statement true or false: ‘When drawn on a graph, variable costs
always start at the origin (where the two axes intersect)’.
6 State two features of a good objective.
7 Complete the following formula: Revenue = ………. × average selling price
8 A business has total costs of £12.5 million for producing 500,000 items. The
variable cost per unit of producing an item is constant at £20. What are the
business’s fixed costs?
i £12 million
ii £2.5 million
iii £1.5 million
iv £3.5 million
9 A business sold 37,000 garden sheds last year at an average price of £250. This
year it plans to reduce its price to £225 and expects its sales to rise by 15 per
cent. How much revenue can it expect to receive this year?
i £9,573,750
ii £8,325,000
iii £10,637,500
iv £9,775,750
10 A business has gathered the following information in relation to its most recent
year of trading:
• It produced and sold 75,000 items.
• The average selling price was £150.
• Its fixed costs were £4.5 million.
• Its average cost per unit of production was £85.
How much profit or loss did the business make during the year?
i £375,000 profit
ii £6,750,000 profit
 iii £375,000 loss
iv £4,875,000 loss

(b) Short answer questions

1 Explain one benefit to a rapidly expanding business of setting clear business
objectives.
(4 marks)
2 The following data applies to a recently established business:
• selling price = £500
• fixed costs = £255,000 R : 500000
000 .
• variable costs per unit of output = £120
180 U : ,
255 000
F ;
,

• sales = 1,000 units.

Calculate the business’s profits. Show your workings.
(5 marks)
3 Merlin plc constructs bridges and tunnels. Explain why the business might
consider setting cash flow objectives to be important.
(5 marks)
4 Explain one reason why it is important for a business that is expanding into new
markets to record a profit.
(6 marks)

(c) Data response questions

Burberry
Burberry, the premium British fashion label, was found to have destroyed nearly £30
million of unsold clothes, accessories and perfume. In total, it has destroyed over £90
million worth of goods in the last five years. These products were destroyed to prevent
them being resold at a low price because of the impact of this on the brand image.
The energy generated from burning its products was captured, making it
environmentally friendly. The company says that it aims to minimise the amount of
excess inventory it ends up with. It tries to deal with these excess products in a
responsible manner. In the past, Burberry has had problems with counterfeiters
damaging the brand. However, environmental campaigners are angry about the
waste.
In Burberry’s most recent financial year, the company reported a five per cent rise in
profit to £413m, with sales little changed at £2.7bn.
Source: Adapted from BBC News, ‘Burberry burns bags, clothes and perfume worth millions’ 19 July
2018
1 Explain why Burberry has excess inventory some years.
(5 marks)
2 Analyse the consequences for Burberry of increasing its profits.
(9 marks)
3 To what extent do you think Burberry is right to destroy its excess inventory?
 (16 marks)

(d) Essays
1 To what extent do you think maximising profit is always the most important
objective for large well-known businesses?
(25 marks)
2 Do you think mission statements are only of value to large businesses? Justify
your answer.
(25 marks)
Chapter 2 Understanding different
business forms
Introduction
This chapter builds on Chapter 1: Understanding the nature and purpose of business. It considers
the forms that may be adopted by the UK’s diverse businesses and the issues that relate to these.
It will explore the implications of different forms of ownership for important aspects of a
business’s operations, such as its decisions and performance. It will examine the role of
shareholders as owners of companies and why company share prices alter and what this means
for the organisation and its stakeholders.
What it is important to know by the end of this chapter:
• why businesses choose to operate in a particular form or to change the form that they use
• the issues that businesses face arising from decisions about which business forms to use
• the role played by shareholders and the reasons they decide to invest in companies
• the factors that influence share prices and the significance of changes in the prices of
companies’ shares
• the effects of different types of ownership on a business’s mission, its objectives, decisions and
ownership.
Private sector businesses
If a business operates in the private sector of the economy, it is owned by shareholders (in the
case of companies) or by private individuals. Large businesses such as GlaxoSmithKline and
small ones such as a local corner shop are part of the private sector. Private sector businesses are
not owned by government, local authorities or other state organisations. Most businesses in the
UK are part of the private sector and this is the case in most developed economies.
 1. Sole traders 个⼈柿⼀
When individuals establish and operate a business on their own, they are known as ‘sole
traders’, or sometimes as ‘sole proprietors’. This is a very popular form of business.
Sole traders are normally relatively small businesses such as plumbers, decorators, window
cleaners and hairdressers. The people running these sole trader businesses work for themselves.
It is not uncommon for sole traders to hire other people to help them out, but they remain
responsible for the overall business and are actively involved in the running of it on a daily
business.
Sole traders may work on their own, and must have the confidence to take decisions and the
range of skills necessary to run the business, including managerial skills. Sole traders may have
to serve customers, decide what equipment to buy, deal with suppliers and keep accurate and up-
to-date business records. This can require a wide range of skills and an enormous degree of
flexibility.
Operating as a sole trader requires a high level of self-discipline because there is no one checking
up or offering guidance. This can be exciting. It does, however, place a considerable emphasis on
self-motivation. Sole traders have to make things happen and ensure they manage their time
flexible effectively.
restriceions
⼀
the income gues to one man .

rless
The advantages of operating as a sole trader
⼀没有 easy decision making
-

One of the main advantages of being a sole trader is that it is so easy to start up and manage this
,

form of business. Unlike starting other types of organisation, such as companies, it is not
necessary to register the business with a government agency or fill in any forms. Sole traders can
沟通 simply start trading, provided any profits are declared to HMRC (Her Majesty’s Revenue and
Customs), which is responsible for collecting taxes on profits in the UK. Thus, it is possible for
问题 someone to start up and operate as a web designer, an artist, an interior decorator or cleaner at
short notice and with little administration required.

Figure 2.1 The rising popularity of businesses without employees

Source: Business population estimates for the UK and regions 2018 (Department for Business, Energy
 & Industrial Strategy)

Many sole traders also enjoy not having to take orders from others. They like the freedom to
make their own decisions, to decide when and where to work, what to do and how to do it.
Working as a sole trader allows people to make decisions quickly as they do not have to consult
or request permission from their boss. It can be incredibly motivating to be your own boss.
Another important advantage of being a sole trader is that any profits made by the business do
not have to be shared. Many entrepreneurs begin and continue to trade as sole traders for these
reasons. pressure .

Difficule 、 wnety
s
higher
-

rinky
-
.

raise
The challenges of being a sole trader r - lack of compeercion
.

to
While working as a sole trader can be very fulfilling, it also brings with it many challenges.
Making all the decisions can be exciting, but there is the pressure of holding all the responsibility
finame if anything goes wrong. When working with, or for someone else and there is a real problem,
there is someone else to work with to solve it. Being a sole trader can be quite lonely – some
people find it difficult to cope with this aspect of the pressure. The hours may be quite
demanding, too. This is particularly likely to be an issue in the early years when an entrepreneur
is trying hard to build up the business. Also, sole traders may not be able to take much time off
for holidays because they may not be able to afford to close the business and risk losing
customers.
Sole traders often face difficulties in raising finance to set up and expand their businesses. Major
sources of finance are their own money (perhaps from savings or redundancy pay) or money
from friends and family. Using these sources of finance means that the amount that can be raised
is often quite limited. 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.
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 businesses have problems, sole traders can lose their personal
possessions such as houses and savings.

Key terms
A sole trader is a business that is owned and managed by one person, but it may
employ other people.
Unlimited liability occurs when an individual or group of individuals is personally
responsible for all the actions of their business. With sole traders, there is no
distinction in law between the individual and the business so they could lose their
personal assets if the business has financial problems.

Business in focus: Jane’s social media

 Jane Binnion is a sole trader in Lancashire. Her business provides training to local
businesses and other organisations on the use of social media such as Facebook and
Twitter. Jane spent 25 years employed in a range of businesses. However, an injury
led to her becoming unemployed and she retrained for her new role. In her own
words: ‘I’m a great networker so I trained in social media, got a business adviser, a
website, joined a start-up course and on March 10th 2011, aged 48 1/3, I launched
Jane’s Social Media!’
Jane believes that the freedom to make decisions about working life, particularly
working patterns, brings benefits to sole traders and their families. One of her reasons
for starting Jane’s Social Media was that she needed more flexible working hours. ‘I
work from home and ensure that 90 per cent of the time I am here when my daughter
gets home from school. I have never been happier.’ Operating as a sole trader means
such decisions will not be challenged.
Jane’s business can respond quickly to the needs of its customers and provide an
individual service, helping it to achieve high levels of customer satisfaction. Jane’s
Social Media promotes itself as providing: ‘a personal and very individual service that
helps your company grow by getting you better connected via the appropriate social
media platforms.’

Practice questions
1 Analyse the reasons why Jane wanted to be a sole trader.
(9 marks)
2 Do you think that operating as a sole trader means that a business will always be
able to make good decisions?
(16 marks)

⑦ Advantages Disadvantages
Making key decisions can be motivating. Sources of finance are limited.
Decisions can be made quickly and sole Sole traders rely heavily on their own
traders can respond rapidly to changes in the ability to make decisions.
market.
Sole traders often have direct contact with It can entail working long hours, with
the market. limited holidays, leading to stress.
Setting up is straightforward. The personal possessions of sole
traders are vulnerable due to unlimited
liability.
Table 2.1 The advantages and disadvantages of being a sole trader
 2. Companies
Operating a business as a company can overcome many of the difficulties associated with being
a sole trader. To set up a company, the owners have to complete various documents, including a
Memorandum of Association and Articles of Association and register the business at Companies
House. This process is known as incorporation.

Key terms
A company is a business organisation that has its own legal identity and that has
limited liability.
股份有限公司 给并型 ,
)
Incorporation is the process of establishing a business as a separate legal identity
that allows it to benefit from limited liability.
股东 E A shareholder is an investor in and one of the owners of a company.
Limited liability means that in the event of financial difficulties, the personal
belongings of shareholders are safe.
股息 E Dividends are that part of a company’s profits that are paid to shareholders in
proportion to the number of shares that they own.
(
股份
A company is owned by shareholders. Each share represents a part of the company. The more
的分 )shares someone owns, the more of the company that 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 a company has limited
liability. This means that a company is responsible for the money it owes but that the personal
possessions of its owners (shareholders) are safe. This is different from a sole trader, who has
unlimited liability and could lose everything if the business had severe 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 a shareholder invested in a business with unlimited liability it would mean giving
money to others and risking everything. With limited liability, the maximum amount that could
be lost is fixed.
The shareholders can potentially benefit in two ways from owning shares.
• The value of the company and hence the value of the shareholders’ part ownership of the
company may increase. In effect this increases the price at which the shares may be sold at a
later date. However, company values and share prices can also fall – if, for example, investors
become worried about the future of the business they may sell their shares and to find buyers
the price might have to fall.
• Shareholders may receive a share of the company’s profits, if they are sufficiently large.
Profitable companies will distribute some of their profits to shareholders in proportion to the
 number of shares they hold. Profits paid to shareholders in this way are called dividends.
Trading as a company means that the business must pay to have its accounts checked annually by
independent accountants (called auditors). Furthermore, the company accounts must be made
public, so that outsiders can see the revenue and profits of the business, as well as what it owes.
This means that a company’s affairs are less private than for a sole trader.
Companies in the UK are divided into two legal categories: private limited and public limited
companies.

(a) Private limited companies

Private limited companies have ‘Ltd’ after their names. They are generally smaller than public
limited companies, and are relatively cheap to set up. It can cost only a few pounds to register a
private limited company with the Registrar of Companies in the UK.
Private limited companies also benefit from limited liability. Normally this means that the
liability of the shareholders is limited to the amount they invested in buying shares. However, for
some private limited companies, limited liability takes the form of a guarantee that the owners of
the company agree to pay if it fails. They cannot be required to pay more than they have
guaranteed thereby limiting their liability.
As with all companies, 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.

Business in focus: Cargill

Cargill is an American-owned multinational that describes itself as providing: ‘food,

agriculture, financial and industrial products and services to the world.’ This statement
reflects the diversity of Cargill’s business interests. It is heavily involved in global
agriculture. It purchases and trades agricultural commodities, such as palm oil; the
company breeds livestock and produces food ingredients such as starch and glucose
syrup, vegetable oils and fats for processed foods and industrial use. It is also
involved in the energy, steel and transport industries. Cargill also has significant
interests in financial services industry.
Cargill was founded in 1865 and by 2014 it had 145,000 employees working in 67
countries. Cargill is a family-owned private company. The descendants of the
founders own approximately 85 per cent of the company. Most of the company’s
spectacular growth has been due to reinvestment of the company’s own profits. By
refusing to become a public limited company, Cargill’s owners have denied
themselves the opportunity to sell shares to the general public through markets such
as the London Stock Exchange.
Source: Adapted from Cargill’s website
 Practice questions
1 Analyse the benefits to Cargill resulting from trading as a private limited company.
(9 marks)
2 To what extent do you think it is possible for a business to become a major
multinational organisation while remaining a private limited company?
(16 marks)

There is a range of reasons why the owners of private limited companies might decide to retain
this legal status, rather than becoming a public limited company.
保留⼯资 • The desire to retain control over the company. Becoming a public company is likely to be
accompanied by the sale of large volumes of shares through stock exchanges. If a sufficient
的控制 number are sold, it may be that the original owners only hold a minority of the company’s
shares and that control of the business has passed to those who own the majority of the shares.
权 It is possible for companies to raise capital by issuing shares which do not give their owners’
voting rights. However, companies and other organisations who purchase large quantities of
the shares issued by public companies are likely to want to have a say in decision-making.
有决测权 • Taking decisions in the company’s long-term interests. If a private company converts to
become a public company (through a process known as “going public”) many of the people
and organisations who buy its shares will be seeking short-term profits in the form of
dividends. This may put the senior managers of the company under pressure to make decisions
which might generate attractive levels of profits over the next year or two, but may not be in
the company’s best long-term interests. For example, pressure to improve profits may lead the
senior managers of a company to use less environmentally-friendly production methods which
享受利洞 could damage the company’s reputation in the long-term.
• Enjoying the profits generated by the company. Going public and selling more shares
means that there are more shareholders between whom dividends have to be shared. This
results in a dilution of profits and potentially lower returns for the original owners of the
business.

(b) Public limited companies 市场资本主⽂化 ,

「
Public limited companies have the term ‘plc’ after their names and include many well-known
businesses. Marks & Spencer, BSkyB and Vodafone are all examples of public companies based
in the UK. Public companies tend to be much larger than private companies. One way to measure
the size of a public limited company is through its market capitalisation. Market capitalisation
is the total value of the issued shares of a public limited company. The value of a company’s
market capitalisation is calculated by multiplying the company’s current share price by the
number of shares outstanding (that is, the number of shares issued and held by shareholders).
As with private companies, public companies are owned by shareholders, but restrictions cannot
be placed on the sale of these shares. Shareholders in public companies can sell their shares to
whoever they like. 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.
 Handling data
Company name Rank Market Capitalisation ($ bn) 31 March 2018
Apple 1 851
Alphabet 2 719
Microsoft 3 703
Amazon.com 4 701
Tencent 5 496
Berkshire Hathaway 6 492
Alibaba 7 470
Facebook 8 464
JPMorgan Chase 9 375
Johnson & Johnson 10 344
Table 2.3 Market capitalisation and the world’s largest companies, March 2018.
Source: ‘Global Top 100 companies by market capitalisation’ 31 March 2018 © PwC
What was the market capitalisation of the world’s largest three companies on 31
March 2018?

Another difference between private and public limited companies is that shares in public
companies can be advertised in the media. This is why the share prices of public companies are
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.
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.
There are benefits to businesses from trading as a public limited company.
• Access to capital. Public limited companies are able to sell shares freely using stock
exchanges, which are efficient markets for buying and selling shares. This enables them to
raise large sums of capital to fund a range of activities without having to take out expensive
loans. Raising capital through share issues means that public companies are not committed to
fixed interest payments as is the case when taking out a loan. The amount public companies
pay shareholders in the form of dividends will reflect the profitability of the business and will
not be more than it can afford.
宣传 • Publicity. Public limited companies are often in the media because of their size and
importance. This has the possibility of generating a lot of free, or at least low-cost publicity,
 which can enhance the company’s public image.
接管别 • The ability to take over other companies. Public limited companies are more able to buy
other companies as they have access to capital through selling shares. They can also purchase
的公司 other companies by offering the target company’s shareholders their own shares in part or full
payment. This can make it easier for public companies to grow relatively quickly.
的能⼒ ,
Reasons for changing business forms
Growth is a key factor encouraging businesses to change their forms. As a sole trader business
becomes larger, the owner may decide that it requires more access to capital and that the
protection of limited liability is vital and the business’s potential to incur debts increases. This
may result in a business becoming a private limited company. The desire to access more capital
and attain a higher profile may result in companies opting to ‘go public’ and convert from private
limited to public limited status.
私有化 ,

「
The UK has seen numerous businesses transfer from the public sector to the private sector in a
process known as privatisation. The popularity of privatisation in the UK and elsewhere can be
explained by its ability to raise large sums of capital for governments and by the belief among
many decision-makers that businesses tend to be more efficient when run privately rather than by
the state.

Key terms
A takeover occurs when one company acquires control of another by buying more
than 50 per cent of its share capital.
Privatisation is the process under which the state sells businesses that it has
previously owned and managed to private individuals and businesses.

x -

Tneffictency ×
0
低效率 ,

⑪
未知 。

publio sevtor ,

c
ifficiency
seveor
private -
7 costd
Public sector businesses 公共部⻔
The public sector comprises the organisations that are owned by (and sometimes funded by)
national or local government. There are three major elements of the public sector:
企业 ,

• Public corporations. These are enterprises owned by the state but offering products for sale to
the public and private sector businesses. These may be managed by central government (such
as Channel 4 television) or by local governments, for example, Manchester Airport.
Dorgmaitarian
• Public services. This category of the public sector includes organisations that provide services
,

to the whole nation. The National Health Service (NHS) is an example.

部到, gvern merrt.

• Municipal services. These are services offered by local governments and councils. Examples
→

include libraries and leisure centres.

Handling data

Figure 2.2 Number of business in the UK private sector with and without employees, by legal status,
start of 2017

Source: PwC
1 What is the number of businesses in the UK at the start of 2017 that were sole
proprietors (sole traders)?
2 What is the number of companies in the UK at the start of 2017 that had no
employees?

The size of the public sector in the UK has declined due to a series of privatisations in the 1980s
and 1990s. This resulted in the sale of a large number of government-owned industries to the
private sector. British Rail, the water and electricity supply industries were privatised along with
British Telecommunications (BT). The aim was to increase the efficiency of these industries and
to reduce the need for government subsidies. This resulted in many job losses, for example, in
the coal industry, as the new owners sought to create competitive businesses.
Not-for-profit businesses ⾮盈利性 ag. 红字会 ,

Not all enterprises are set up to make a profit. For example, local sports clubs, government
organisations and charities do not have profit as their main objective. They are set up for some
other purpose and can be part of the public sector or part of the private sector.
Social enterprises, for example, are businesses that have social aims and 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 include Cafédirect, The Big Issue, The Co-operative Group, the Eden Project and
Jamie Oliver’s apprentice programme Fifteen. Many others (over 55,000) exist, operating in a
wide range of industries from farmers’ markets and recycling companies to transport providers
and childcare.
The owners of not-for-profit businesses operate them for a variety of reasons. They may have a
strong belief in a particular issue, such as protecting the environment or caring for animals and
therefore establish a charitable business to raise funds for their particular cause.
Others may be established to provide a hobby or to replace employment. Jamie Oliver has
invested heavily in his restaurant chain Fifteen in part because he believes in offering a chance to
unemployed young people to acquire cooking skills. His website summarises the reasons he
established the chain to offer young, unemployed people the chance to gain employment skills in
a restaurant.

Business in focus: Wikipedia

Wikipedia is a multilingual, web-based, free-content encyclopedia project supported

by the Wikimedia Foundation and based on a model of openly editable content. The
name “Wikipedia” is derived from the words wiki (a technology for creating
collaborative websites, from the Hawaiian word wiki, meaning “quick”) and
encyclopedia. Wikipedia’s articles provide links designed to guide the user to related
pages with additional information. Wikipedia is written collaboratively by largely
anonymous volunteers who write without pay. Anyone with internet access can write
and make changes to Wikipedia articles, except in limited cases where editing is
restricted to prevent disruption or vandalism. Users can contribute anonymously,
under a pseudonym, or, if they choose to, with their real identity. The fundamental
principles by which Wikipedia operates are the five pillars. The Wikipedia community
has developed many policies and guidelines to improve the encyclopedia; however, it
is not a formal requirement to be familiar with them before contributing.
Since its creation in 2001, Wikipedia has grown rapidly into one of the largest
reference websites, attracting 374 million unique visitors monthly as of September
2015. There are about 72,000 active contributors working on more than 48,000,000
articles in 302 languages. As of today, there are 5,721,028 articles in English. Every
day, hundreds of thousands of visitors from around the world collectively make tens of
 thousands of edits and create thousands of new articles to augment the knowledge
held by the Wikipedia encyclopedia.
Source: Wikipedia

Practice questions
1 Analyse why so many people work for Wikipedia without pay.
(9 marks)
2 ‘The only businesses that are good for society are not-for-profit businesses.’ Do
you agree with this view?
(16 marks)

‘Fifteen represents the way I would have loved to have been taught myself; it embraces many of
the things I love and feel passionate about, not only in the catering industry but also in friendship
and family life.’ Jamie Oliver (www.jamieoliver.com)
 共同的 ; 双难的 ,
》 共同合作 ,

都要出⼑ 没有股东 ,

Mutual businesses
不能盈利为主 ,

Mutual businesses are characterised by the fact that they are run for the benefit of their members,
whether they are employees, customers, suppliers or the local community. In contrast, most
public companies are owned and controlled by outside investors.
Mutuals can be based on a variety of different legal structures. However, there is a legal structure
developed solely for mutual businesses that offers the benefit of limited liability. This is the
Industrial and Provident Society (IPS). Some mutual businesses use this legal structure whereas
others, including many co-operatives, are limited companies.
Co-operatives are a well-known example of mutual businesses and are run by groups of people
(called members) each of whom has a say in the management of the business. Co-operatives
must reflect four ethical values: honesty, openness, social responsibility and caring for others.
They should also operate according to the following principles: voluntary and open membership,
democratic member control, provision of education, provision of training and information and
concern for the community.
Different types of co-operatives exist: 顾客也参与
• consumer co-operatives, in which customers are the members of the business
• worker co-operatives, owned and operated by employees
• producer co-operatives, where a group of businesses work together to benefit from factors
such as increased bargaining power.
Co-operatives can be popular but some have faced criticism for not employing sufficient or
suitably skilled professional managers, instead relying on elected members who may be well
intentioned, but not suited to their roles.
Shareholders and share prices
We saw earlier that companies sell shares to raise capital for a variety of reasons and that public
companies can sell shares freely.
Who buys shares?
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.

Business in focus: Top holders of shares in UK plcs

FTSE 100
Rest of world 56.0
Individuals 9.5
Unit trusts 9.1
Other financial institutions 8.1
Insurance companies 5.0
Pension funds 3.0
Public sector 1.5
Private non-financial companies 2.6
Investment trusts 2.0
Banks 2.0
Charities, churches etc. 1.1
Total 100.0
Table 2.2 Share ownership in the UK 2016
Source: Office for National Statistic

Practice questions
1 A significant proportion of shares of UK plcs are owned by financial institutions.
Analyse the possible impact of this on the decisions of managers.
(9 marks)
2 To what extent do you think who owns a plc affects its success?
16 marks)
 The reasons for and risks of buying shares
Shareholders invest in business primarily for financial reasons. They may benefit (hopefully)
from an increase in the share price and from receiving a share of the profits in the form of
股息
E dividends. The more profit a firm makes, the bigger the dividends are likely to be. Some
shareholders invest to make a quick return and may seek out risky companies that may offer high
returns. Other groups of investors, such as pension funds and insurance companies, who have
large sums of other people’s money to invest, may seek longer-term, more secure returns.
However, there is a substantial risk in buying shares in most circumstances. The price of shares
can easily fall and this can be true of a well-managed and profitable business if the economy is
not performing well.
Companies can also make lower profits than expected which means dividend payments for all
types of shareholder may be lower than expected and also can have the side-effect of reducing
share prices, at least in the short-term.

What do you think?

You are thinking of buying shares in a company. What would you want to know before
deciding which ones to buy?

The degree of risk involved in buying shares also depends on the type of shares that are
purchased. Many shareholders purchase ordinary shares. These are the most risky type of share
because the holders only receive a dividend after many other stakeholders in the company have
received payments. Ordinary shareholders will only be paid after those who have lent the
company money in the form of long-term loans or debentures. They also receive payment after
those who have bought preference shares who receive a fixed payment. So, in a poor trading
year, shareholders may receive little or no dividend. However, in a good year they may be well
rewarded, as their payments are not fixed. The situation of ordinary shareholders illustrates how
risk and reward go hand-in-hand.
The role of shareholders
Shareholders can influence the decision-making of companies. Most types of shares grant their
owners voting rights. Each share is worth one vote. So, by buying more shares, people can get
more votes and have a greater influence over what the company actually does. If someone, or
more likely an organisation, owns more than 51 per cent of the shares in a company, 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 practice, it is relatively rare for shareholders in UK companies to have a strong influence on
the policies and decisions of public companies. However, over recent years, shareholders have
become increasingly critical about what they regard as unacceptably high levels of pay for senior
managers and have on occasions voted against it at AGMs.
Influences on share prices
Share prices can be affected by a wide variety of issues but the two major factors are the
company’s performance and the business environment in which it trades.
Public limited companies publish their financial results and provide trading updates twice a year.
These communications provide the company’s stakeholders with a lot of information about the
company’s performance. Companies are also obliged to give information about any event that
could influence their share prices, such as a takeover bid. These are known as regulatory
announcements.
If a company is performing well, and is expected to continue to do well, its share price should
benefit. Share prices tend to anticipate the future, so they can rise if a company has good
prospects and fall if the outlook is not promising.
Share prices are also affected by the business environment. If economic conditions are good and
expected to continue that way, investors tend to feel confident. So good news about a country’s
employment levels or positive data on manufacturing production, for example, will encourage
investors and may help to push share prices up. Companies are more likely to perform well and
deliver strong profits when the business environment is favourable as sales and product prices
are likely to rise. As a consequence, they are likely to generate higher profits and pay rising
dividends. Under such circumstances, demand for shares tends to rise and prices increase.
If the economic climate is troubled, as happens regularly in the UK and elsewhere, investors may
feel nervous. They may worry that a company’s profitability will suffer if economic conditions
are difficult. Fears about future profits tend to reduce demand for shares so prices may fall. This
means that, in a challenging business environment, companies can see their share price fall, even
if they are performing well. Equally, companies can benefit from a positive business
environment and their share price may go up, even if the business is not performing well.
The significance of share prices
The effects of changes in the share price of an individual
company
If a company’s share price alters it does not have a direct impact on the company’s immediate
financial position. Remember the company that sold these shares at the time they were first made
available to the public and received the capital inflow in return. Most, if not all, of this capital
will have been invested into the company to provide assets such as property, vehicles and
machinery as well as to finance the purchase of raw materials and to provide cash. Thus, if the
share price rises or falls, it does not affect the amount of finance that the business has available at
that time.
However, changes in share prices can have significant effects on a business over a slightly longer
timescale.
• Rising share prices. A rising share price tends to reflect well on the company’s management
team – they are more likely to be considered to be doing a good job and may receive bonuses
as a result. In many circumstances, a business may find it easier to raise capital when share
prices are rising. Potential shareholders will be more willing to buy an asset that is rising in
price; similarly banks may be more willing to offer loans to such companies, especially if they
believe that the rising share price is the result of the business performing well. These
arguments are particularly relevant if a company’s share price is performing better than share
prices generally.
• Falling share prices. This may be judged to be the result of a poor performance by the
management team and may make it difficult for it to raise capital. It may also make the
company vulnerable to a takeover as the cost of buying a controlling interest in the company is
reduced. This is more likely to be the case if the company’s share price is considered to be too
low, making it undervalued. However, this might be a response to a short-term factor, such as
profits being below expectations and not be an indication of the company’s likely long-term
performance.
Obviously the longer the trend in share prices lasts, the greater the impact. Thus a prolonged
decline in share prices might affect a company’s ability to recruit top-quality employees or to
raise finance for major investments.

The effects of a general change in share prices

If there is a substantial fall in share prices for most companies the effects on businesses generally
can be significant. At a time of falling share prices, many consumers and organisations that have
invested in shares may feel that their wealth is declining and cut their spending accordingly. This
reduces the sales made by a wide range of businesses, which in turn reduce their own spending,
‘multiplying’ the negative effect. This can provoke an economic recession, where the level of
national production declines over a period of at least six months.
A period of rising share prices can have the opposite effect, causing a positive wealth effect and
making it easier for companies to raise capital by issuing new shares.
Handling data

Figure 2.3 UK’s FTSE, 1997–2016

Source: Office for National Statistics

The FTSE 100 measures the value of the 100 largest companies in the UK in terms of
market capitalisation. Figure 2.3 shows there was a very sharp fall in share prices
during 2008 and early 2009. During this time the share prices of many well-managed,
profitable companies fell sharply as their sales dipped and nervous shareholders sold
their shares, depressing share prices further.
1 What is the percentage change in the FTSE 100 between July 1997 and July
2017?
2 Who do you think this change will have affected?
3 Why do you think the FTSE 100 changes so much over time?
 所有权 ,

The effects of ownership on businesses

1. The effects of ownership on mission
We saw in Chapter 1 that a business’s mission sets out what it is trying to achieve, that is, the
reason it exists. The type of ownership may have a considerable impact on the organisation’s
overall direction. Thus, for example, a public limited company is likely to have a mission that
will allow it to provide sufficient financial rewards to its shareholders.o
Nike’s Mission: ‘Bring
inspiration and innovation to every athlete in the world (if you have a body, you are an athlete).’
Succeeding in this mission will allow the American sportswear company to produce popular and
valued products that will generate high profits with which to reward its shareholders. In contrast,
the Midcounties Co-operative, based in the English Midlands, strives to ‘be a successful
consumer co-operative working towards creating a better, fairer world and to enhance the lives of
our colleagues, members, customers, and the communities we serve’. This mission is unlikely to
result in the business seeking to maximise its profits but in operating in a way that benefits
communities and many of its stakeholders.

上 profi
 2. The effects of ownership on objectives
A business’s mission naturally gives rise to the objectives that it follows. Thus Nike may seek to
achieve its mission by setting objectives relating to achieving a certain level of sales, producing
innovative products regularly or being the leading company in its market. The Midcounties Co-
operative may operate with objectives relating to the impact its business has on its stakeholders
and the communities it serves.
⑦ Type of The effects on:
business
Mission Objectives Decisions Performance
Sole May be May centre Potentially rapid and Ownership allows
trader unlikely to around responsive, but lacking business to be
have a meeting support and possibly responsive to
mission, but personal information. customers’ needs,
sole owner goals such as but may not be
provides generating too price
sense of sufficient competitive.
direction. income.
Private Mission may Could relate More complex as more Scale of this type
limited centre on to a people likely to be of business varies
company maintaining satisfactory involved. May have hugely.
family-run level of profits more information Performance
business or or financial available and some could be based
m
on reputation. stability to specialist input. meeting personal
ensure needs or on
continued benefits of being
survival. large scale.
Public Mission can Likely to relate Can be very complex Access to capital
limited play an to costs, and have long-term and pressure from
Company important role prices, implications. Some shareholders
to project the business decisions require likely to place
company’s image and specialist input and emphasis on
image and to market share need to be based on being competitive
provide a and link to extensive information. in terms of price,
focus for financial
…
Many routine decisions customer service
consistent performance also need to be made. or desirable
decision- in the longer products.
making. term.
Not-for- Mission can Likely to be May lack specialists. Probably
profit be important non-financial
wom
Desire to meet social measured in non-
in and can be or other objectives financial terms,
establishing less easy to may cloud but need to
the ethos of
m
measure such judgements. perform well
⺠族
 the business as benefiting enough financially
and 基础 ,
the to meet other
underpinning community or goals.
all decision- protecting the
making. environment.
Table 2.3 The effects of ownership

Business in focus: The Co-operative Group

We’re one of the world’s largest consumer cooperatives, owned by millions of

members. We’re the UK’s fifth biggest food retailer with more than 2,500 local,
convenience and medium-sized stores.
We’re also:
• the UK’s number one funeral services provider
• a major general insurer
• a growing legal services business.
As well as having clear financial and operational objectives and employing nearly
70,000 people, we’re a recognised leader for our social goals and community-led
programmes. We exist to meet members’ needs and stand up for the things they
believe in.
So, the more successful we are, the more we can give back to you and your local
community.
That’s why we’re different.
Source: The Co-Operative’s website Our co-op, Why we’re different © Co-operative Group Limited

Practice questions
1 Analyse how the Co-operative Group might measure its performance.
(9 marks)
2 Analyse how the co-operative model might affect the decisions managers make.
(16 marks)
3. The effects of ownership on decisions
The type of business is likely to have an impact on the complexity of the decisions that have to
be made as well as the speed of decision making. At times, public companies have to make
major decisions with enormous implications for the business. Major decisions such as the
takeover of another business would have been researched thoroughly beforehand to determine
the effect of the decision on key stakeholders such as customers, employees and shareholders
and may have taken time to complete because of this and the extent of communication involved.
To an extent, it is the scale of the business and its operations that determine the complexity and
need for information and expertise in taking this type of decision, but most larger businesses are
public companies.
At the other end of the scale, decision making can be a strength for small, sole trader businesses.
Decisions are likely to be less complex and involve fewer participants, speeding and simplifying
the process. This enables sole traders to be responsive to changes in their markets.
4. The effects on performance
The performance of a business can be measured in many ways, not just on its profits. It is
influenced by a wide range of factors such as the state of the economy and technological
changes, as well as the form of business that is adopted.
However, it is true to say that larger organisations, which are mainly public companies, may be
able to produce at lower costs due to the use of specialist employees and up-to-date technology.
This offers the potential to increase profits. Similarly, public companies may be more innovative
(as they can spend large sums on researching new products) and this may enhance their
performance, as in the case of Apple. Not-for-profit businesses may judge their performance in
other ways, and not simply financially. Thus they may measure performance in terms of raising
public awareness for an issue or on alleviating poverty.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 State two reasons why an entrepreneur may choose to operate a business as a
sole trader.
2 What is meant by the term ‘unlimited liability’?
3 Is the following statement true or false? ‘A company is owned by its stakeholders.’
4 State two differences between a private limited company and a public limited
company.
5 What is meant by the term ‘privatisation’?
6 Finn plc has a current share price of 75 pence and has issued 725 million shares.
It currently has £275 million in outstanding bank loans. What is its market
capitalisation?
i £543,750,000
ii £54,375,000,000
iii £286,750,000
iv £54,100,000,000
7 What is the difference between a public company and a public corporation?
8 What are mutual businesses?
9 State two factors that might influence the share price of a public company.
10 Is the following statement true or false? ‘If a public company’s share price falls this
immediately reduces the amount of capital available to the business.’

(b) Short answer questions

1 Explain one effect of a significant fall in a share price on the company concerned.
(3 marks)
 2 Explain why the owners of a private limited company might want to convert it to a
public limited company.
(6 marks)
3 Explain why sole traders are the most popular form of business in the UK.
(6 marks)
4 Benacre plc manufactures a range of components for high technology products
such as mobile phones. It is very profitable and has a rising share price. Explain
two risks in buying shares in Benacre plc.
(6 marks)

(c) Data response questions

Spotify
Spotify is a music streaming business. It was started in 2008 and is now available in
65 countries. Many of its listeners use the free service (paid for by ads). The company
has around 71 million users who pay a subscription but is yet to make a profit. In
2018, the company went public with its shares trading on the Stock Exchange for the
first time. The shares initially sold for around $165 but closed on the first day at nearer
$149. This meant the market capitalisation of the business was over $26 billion.
Source: Adapted from BBC News, April 2018, ‘Spotify shares dip on first day of trading’
1 Explain how Spotify can be earning a revenue but makes a loss.
(5 marks)
2 Analyse the factors that would have influenced Spotify’s share price when it went
public.
(9 marks)
3 To what extent does it matter whether Spotify makes a profit?
(16 marks)

(d) Essays
1 Do you think it is inevitable that a mutual busicness will perform less well than a
public limited company when trading in a competitive market? Justify your view.
(25 marks)
2 Thousands of UK businesses fail every year. To what extent does this make it
essential for all entrepreneurs to establish their businesses as private limited
companies and not sole traders?
(25 marks)
Chapter 3 Understanding that
businesses operate within an external
environment
Introduction
This chapter takes you outside the business itself to consider the external forces that can impact
upon businesses large and small. The scope of this chapter is very precise as the external
environment is an extensive topic and one that could not be covered effectively in a single,
relatively short chapter. Thus we will consider a limited range of external factors and we will
further limit the scope of this chapter by examining how these chosen external factors impact
upon a business’s costs and the level of demand (or sales) it experiences for its products. We will
look at other elements of the external environment and consider how businesses respond to
change in this environment in later chapters.
What it is important to know by the end of this chapter:
• The ways in which the following elements of a business’s external environment may affect its
costs and demand:
• market conditions and competition
• incomes
• interest rates
• demographic factors
• environmental issues and fair trade.
What is the external environment?
All businesses, whether large or small or whether supplying services or goods, operate within an
external environment. The external environment comprises those external forces that can
influence a business’s activities. These forces might arise from a number of possible sources, as
summarised in Figure 3.1. We will look at each of them in detail in the following section.
These forces are unpredictable and can change suddenly without warning. We saw in the UK in
2008–09 that, as a result of the financial crisis, incomes and spending by UK consumers fell
significantly and unexpectedly, resulting in many businesses suffering large falls in demand for
their products. More recently, concern about the UK’s trading relationship with other European
countries and how the UK might exit the European Union has caused uncertainty for business
and delayed investment decisions.

Figure 3.1 Some factors that shape the external environment for businesses

A further example of the effects of a change in the external environment is the relationship
between interest rates and incomes. A rise in interest rates may mean that consumers have to pay
more on any loans they have arranged (and especially on mortgages) leaving less income
available to spend on other goods and services.
The effects of changes in the external
environment
External forces have the power to affect a business’s activities in a number of ways. In this
chapter we will focus on the effects of changes in the external environment on the level of
demand for a business’s goods and services and on the costs that it incurs in producing those
goods and services.
It is important to understand that these external forces can have both positive and negative effects
on a business’s costs and its sales. For example, an increase in competition might result in a fall
in sales for a company, as in the case of Tesco. In contrast, an increase in competition in a
market from which a business buys raw materials or components might result in prices falling,
thereby reducing the business’s costs of production. Increased levels of competition in the food
manufacturing industry may result in lower prices for tinned or frozen foods. This may result in
lower prices for grocery retailers such as Tesco. This would enable the company to reduce its
prices or to maintain them and enjoy higher profits on the sale of each product.
Positive factors Negative factors

• A product becomes popular or • Consumers demand environmentally

fashionable, raising demand friendly products, increasing businesses’
• A major competitor leaves a market costs
• The number of consumers in a • New businesses enter a market,
country increases increasing the degree of competition
• Interest rates fall, making it cheaper • A market is over-supplied with products,
to borrow money to buy products depressing prices
• Consumers enjoy steadily rising • More people become unemployed,
incomes, increasing demand for reducing consumers’ incomes and
products spending

Table 3.1 A selection of positive and negative factors arising from changes in the external environment
The components of the external
environment
The factors considered represent some of the elements that make up the external environment for
all types of business.
1. Market conditions and competition
This part of the external environment contains two interrelated elements.
• Market conditions is a broad term that encompasses a number of factors which can affect a
market. Good market conditions would include rising sales figures and possibly rising prices.
This would be particularly attractive if sales were rising at a similar rate. Further elements of
good market conditions would include competition that is not too threatening and perhaps a
shortage of supply of products, which would encourage prices to continue to rise.
• Competition is a part of the conditions of a market but is worthy of a separate mention. The
competitive element of a business’s external environment includes the number, size and power
of rivals and potential rivals that a business faces in its battle to win customers.

Key terms
Market conditions refers to number of features of a market such as the level of
sales, the rate at which they are changing and the number and strength of
competitors.
Demand is a term used by economists to indicate the amount of a particular good or
service that consumers or organisations want, and can afford, to buy at given prices.
It shows the level of sales that businesses can expect.

Changes in the conditions of a market and/or the degree of competition can impact negatively on
both the level of demand or sales achieved by a business and also the costs that it incurs. For
example, the entry of a rival into a market can have a series of consequences for the businesses
already operating in that market, especially if the entrant is a large and competitive business. For
example, a new entrant may reduce the demand of existing businesses; it may also invest heavily
in marketing initiatives to gain sales, forcing established firms to also increase their spending to
try and protect sales.
A range of other factors can have adverse effects on the conditions faced by businesses in a
specific market.
• Some markets are vulnerable to large and dramatic changes in demand – this is more common
in markets such as those for fashion or technological products where new products are
launched more frequently.
• Existing suppliers may join together to form larger and more competitive businesses.
• Consumers may become more price-conscious, putting suppliers under pressure to match these
expectations.
• One business may launch a new, innovative product that makes existing products appear
relatively obsolete. This is likely to result in other businesses losing sales and having to invest
in developing their own updated products in response.
Of course market conditions can move in favour of businesses as well. For example, demand for
a particular product may increase in popularity, which may also result in higher prices being
received by producers in that market. A major business may leave a specific market, leaving its
customers available to those businesses that remain.
2. Incomes
A major influence on the demand for a business’s products is the level of income earned by its
customers. In many cases, rises in the level of income earned will result in increased sales.
Consumers’ incomes are determined by the level of a nation’s gross domestic product (GDP) in
that a rise in GDP will increase the incomes received by many consumers. A rise in GDP is
likely to result in a rise in demand for many products as consumers and businesses increase
spending on a range of goods and services.

Incomes and the level of demand for goods and services

It can be seen in Figure 3.2 that the rate of change of GDP in the UK, measured quarterly or over
a period of three months, has varied significantly even over a relatively short three-year period.
In 2012 and early 2013, there were quarters in which the UK’s growth in GDP was negative.
This means that the value of production in the UK fell during these quarters and, since
production fell in value, the incomes paid to people and business organisations to produce these
goods and services would also have declined. Fewer people would have been employed,
resulting in increasing numbers receiving benefits rather than wages. The incomes of those
remaining in employment would fall, for example, as opportunities to work extra hours became
less common. As a consequence, it is likely that many businesses experienced a fall in demand
for their products during these times in which consumers’ incomes declined.
In contrast, since late 2013 the UK has enjoyed a period of steady increases in GDP. This means
that consumers and businesses in the UK have seen their real incomes rise which, assuming they
choose not to increase their savings, could lead to a similar increase in demand for goods and
services.

Key term
Real incomes are incomes that are adjusted for the rate of inflation (or increase in
prices) to show changes in purchasing power.

Handling data
 Figure 3.2 UK’s GDP growth rate 2008–18

Source: ONS
1 What does the above diagram show about UK economic growth 2008–2009?
2 What has economic growth been like in the last few years?
3 What is the significance of this data for businesses?

There is a positive relationship between incomes and the level of demand for products that are
considered luxury items rather than necessities. Thus companies selling holidays in exotic
destinations may experience a substantial rise in demand if the level of earnings in a country
generally rises. This positive relationship may be less evident for products considered to be
essential such as basic foodstuffs. Table 3.2 illustrates the businesses that might see a rise in
demand following an increase in incomes and those that may be expected to benefit little, if at
all, from rising incomes. Even within these two categories the sensitivity of demand or sales to
income can vary. For example, jewellery sales may be highly sensitive to income levels as they
are considered to be a luxury good, while consumers may be less willing to reduce demand for
restaurant meals even when their incomes are falling.
We explore the relationship between the income received by consumers and organisations and
their levels of demand for goods and services as part of a theory called income elasticity of
demand. This is covered on pages 100–102.
Products for which demand is strongly Products for which income has little
influenced by income levels influence on demand

• jewellery • bread, milk and other basic foods

• luxury electrical items (e.g. widescreen HD • cigarettes and tobacco
televisions) • petrol
• restaurant meals • water
• long-haul holidays • lottery tickets
• household furniture
Table 3.2 Products for which demand is dependent upon incomes and those with little or no
relationship

Incomes and the costs of production

Changes in the level of income do not only affect the level of demand for a business’s products,
it can also impact on costs of production. If income levels are rising rapidly in an economy, as
has been the case in China where GDP has increased at an annual rate of around 10 per cent, then
wages will be rising too. This can result in businesses facing sharp increases in costs, especially
if they rely heavily on labour in their production processes. This may result in difficulties in
maintaining competitiveness in terms of prices.
The opposite can apply during periods in which GDP is falling, especially if this occurs for a
prolonged period.
3. Interest rates
Interest rates are normally expressed as a percentage. A bank may allow a business to borrow
money at an interest rate of 10 per cent. This means the business will have to pay a charge of 10
per cent of the amount borrowed for each year that the loan lasts. Most textbooks and media refer
to the interest rate as if there is only a single rate. In fact, a range of interest rates operates in the
UK at any time. Interest rates operating in the UK economy depend on the length of the loan and
the amount of risk associated with it. However, the authorities in the UK set the base rate and all
other interest rates relate to this.

Key term
Interest rates are the price of borrowed money.

In May 1997, the government gave the Bank of England responsibility for setting interest rates.
The Bank of England’s Monetary Policy Committee (MPC) meets each month and takes
decisions on whether to alter the base rate of interest.
Changes in interest rates have significant effects on businesses and the environment in which
they operate. Recent UK governments have relied heavily upon interest rates to control the level
of economic activity in the economy and to avoid the worst effects of the fluctuations in the level
of business activity. Since 2009, interest rates in the UK have been relatively low to encourage
borrowing and discourage saving. This helps to increase demand for many products and so can
boost production and employment levels.

Interest rates and the level of demand

Interest rates affect the level of spending by UK citizens and thus the level of demand for
businesses’ products. The level of their spending is dependent upon interest rates for a number of
reasons.
• Consumers are more likely to take a decision to save during a period in which interest rates are
rising. The return on their saving is greater and will persuade some consumers to postpone
spending decisions, reducing demand. Conversely, when rates are falling consumers might
save less and spend more.
• Changes in interest rates alter the cost of borrowing. Many goods are purchased on credit, for
example, cars and satellite TV systems. If rates fall then the cost of purchasing these goods on
credit will decline, persuading more people to buy the product. Demand for consumer durables
is sensitive to interest rate rises and sales of these products decline significantly following an
upward movement in the base rate.
• An increasing number of UK consumers have mortgages. A rise in interest rates will increase
the amount paid each month by householders. This reduces the income available for
expenditure on other products. Demand for a range of products will fall in these circumstances.
A fall in rates will have the opposite effect.
• Britain’s population is steadily ageing, meaning that more people are dependent upon pensions
and savings. This means that their income (which is often based on earnings from savings and
 investments) is highly dependent upon the rate of interest and this makes consumer
expenditure highly sensitive to rate changes.

Businesses, interest rates and costs

Interest rates affect businesses in a number of ways. It is not simply a case of whether they rise
or fall: businesses also take into account the overall level of rates. A small increase in interest
rates may have little impact if rates are low. This is unlikely to be the case when rates are high
before the change is introduced.

Figure 3.3 The effects on businesses of changes in interest rates

A rise in interest rates will increase the costs of production for many businesses. This occurs
because most businesses borrow money and are therefore subject to interest charges. A rise in
interest rates will therefore increase their costs. Businesses may borrow in the short term to fund
their day-to-day operations or long-term for investment purposes.
There is also a relationship between interest rates and the exchange rate of a currency. Thus if the
Bank of England increases the base rate of interest in the UK, it is likely that the exchange rate of
the pound will rise. This will result in imports of goods and services from overseas becoming
cheaper, which may benefit businesses that import raw materials, components or services from
other countries. However, this will also make UK exporters’ products more expensive overseas.
Not all businesses will be affected equally by changes in interest rates. Those that have high
levels of borrowing could benefit from a fall or be penalised by an increase in interest rates if the
rates charged on their loans are variable. Some businesses can protect themselves by arranging
fixed-rate loans, meaning that the interest charged will remain constant throughout the duration
of the loan.

Handling data

Figure 3.4 UK interest rates rise to 0.75%.

Source: Bank of England

1 Why do you think the Bank of England has kept interest rates at the levels shown
above?
2 What do you think the changes in the interest rate shown above might mean for
business?
4. Demographic factors
Demography is the study of human populations. Demographic factors are factors relating to the
population. The size and make-up of a population in terms of age can have important
implications for businesses. The human population of a country represents two stakeholder
groups for businesses: it provides the workforce and represents consumers. Thus, changes in
population can impact upon a business’s costs of production as well as the level of demand for
its products.

Key terms
Demography is the study of human populations.
Demographic factors are factors related to the population.

According to the Office of National Statistics, the population of the UK has changed relatively
rapidly in recent years. It has shown several notable trends, including the following:
• The UK population is projected to increase by 3.6 million (5.5%) over the next 10 years, from
an estimated 65.6 million in mid-2016 to 69.2 million in mid-2026.
• England is projected to grow more quickly than the other UK nations: 5.9% between mid-2016
and mid-2026, compared with 4.2% for Northern Ireland, 3.2% for Scotland and 3.1% for
Wales.
• Over the next 10 years, 46% of UK population growth is projected to result from more births
than deaths, with 54% resulting from net international migration.
• The UK population is projected to pass 70 million by mid-2029 and be 72.9 million in mid-
2041.
• There will be an increasing number of older people; the proportion aged 85 and over is
projected to double over the next 25 years.
• The UK population growth rate is slower than in the 2014-based projections; the projected
population is 0.6 million less in mid-2026 and 2.0 million less in mid-2041.
Source: Office for National Statistics
www.ons.gov.uk/peoplepopulationandcommunity/populationandmigration/populationprojections/bulletins/nationalpopulat

The implications of the UK’s changing population

These changes in the UK’s population size and structure will have considerable implications for
businesses. At the most simple level the increase in the size of the population can be expected to
increase demand for most goods and services. Many migrants have relatively low incomes so the
increase in demand may be more pronounced in businesses operating in certain markets, for
example, those supplying public transport, rather than in markets for luxury products. The effect
of migration has been regional within the UK. London and other cities as well as rural areas such
as parts of East Anglia have received large numbers of migrants, prompting substantial rises in
demand for local services such as health care.
The pattern of demand for goods and services will also be affected by the ageing of the UK’s
population. Businesses supplying products associated with older age groups may experience a
rise in demand simply because there are more people in these age groups.
Changes in population size and structure also affect the workforce that is available to businesses.
The UK received large numbers of migrants from Eastern Europe after 2005. Many of these
migrants were of working age and entered the UK to join the labour force. The high recent level
of migration has increased the size of the UK’s workforce and will have helped to control wage
costs as shortages of labour are less likely to occur.

What do you think?

Would all businesses in the UK benefit if migration to the UK was not controlled in any
way?

Handling data
Number of people
Immigration into UK 578,000
Emigration from UK 334,000
Table 3.3 Migration in the UK, 2018
Source: Office for National Statistics, 2018
What are the possible implications of the above data for UK business?
5. Environmental issues and fair trade
How the environment affects businesses
The media take a great interest in business activities in relation to the environment. When firms
are found to be guilty of an act of pollution, adverse publicity is likely to follow. Society
increasingly expects higher standards of environmental performance from businesses than in the
past. Being seen to be environmentally friendly can represent an opportunity for businesses to
differentiate themselves from competitors.
There are many potential causes of damage to the environment. A major environmental concern
identified by the government is global warming. This is caused by the release of a mix of
industrial gases (principally carbon dioxide) that has formed a layer around the earth. This layer
allows the sun’s rays in but prevents heat escaping causing the so-called ‘greenhouse effect’.
Other environmental problems include the pollution of rivers and land and the dumping of waste,
some of which is toxic and harmful to wildlife and humans alike.
Businesses contribute in many ways to the creation of environmental damage.
• The emission of gas through production processes.
• Pollution caused by transporting raw materials and products, particularly using road vehicles
that emit noxious gases and create congestion and noise. A report by the EU suggested that
pollution from vehicles in the UK could be responsible for up to 40,000 deaths among elderly
people each year.
• The pollution of the sea by businesses using it as a ‘free’ dumping ground. The North Sea is
one of the most polluted stretches of water in the world.
• Destruction of natural environments as a result of activities such as logging (for example,
cutting down trees for commercial purposes as in the Amazon rainforest) and the building of
homes on greenfield sites.

Costs of polluting the environment

Businesses are acutely aware of their private costs, that is the costs of production they have to
pay themselves, such as wages and expenses for raw materials. These are easy to calculate and
form part of the assessment of profitability. However, environmental pressure groups and others
have pressed for businesses to acknowledge the costs they create for other groups in society – the
external costs of production.
Noise, congestion, air and water pollution all impose costs on other individuals and groups in
society. A firm extracting gravel from a quarry may create a number of external costs. These
could include congestion on local roads caused by their lorries. This would impose costs in terms
of delay and noise pollution on local residents. The destruction of land caused by the quarrying
could create an eyesore for people living nearby and may reduce the value of their properties.
Dust may be discharged into the atmosphere. The quarrying firm will not automatically pay for
these costs. It requires government action to ensure that they pay these external costs as well as
their internal ones.
Thus, the total (or social) costs of production equal internal or private costs plus external costs
borne by third parties. By ensuring that firms pay all the costs associated with the production of a
product, governments can avoid what is termed market failure. Oversupply is one consequence
of market failure because producers are not paying the full social costs of production and making
the activity profitable and attractive to businesses.

Government legislation and the environment

The government has passed a series of Acts of Parliament designed to protect the environment.
Two acts are of particular importance.
1. The Environmental Protection Act, 1991 introduced the notion of integrated pollution control,
recognising that to control only a single source of pollution is worthless as damage to one part
of the environment means damage to it all. This Act requires businesses to minimise pollution
as a whole.
2. The Environment Act, 1995 established the Environment Agency with a brief of co-
ordinating and overseeing environmental protection. The Act also covered the control of
pollution, the conservation of the environment and made provision for restoring contaminated
land and abandoned mines.
The UK Government imposes fines on firms who breach legislation relating to the protection of
the environment. These are intended to force firms to bear the full social costs of their production
(including external costs) although environmental pressure groups and other critics believe that
the sums are not sufficient to deter major businesses with budgets of billions of pounds annually.
The Government also attempts to encourage ‘greener’ methods of production through the
provision of grants. It has also created the Carbon Trust, which gives capital grants to firms who
invest in energy-saving technologies.
The EU has also passed hundreds of directives relating to environmental protection. The UK is
also a signatory to a number of international agreements intended to provide environmental
protection on a global scale. For example, the UK Government has attended a number of Earth
Summits at which targets for reducing the production of carbon dioxide have been agreed.

The environment, costs and demand

Being environmentally friendly (or at least being believed to be so) by consumers offers
businesses a number of advantages. It can form the basis for highly effective and distinctive
promotion and can lead to increased recognition of the brand and possibly the opportunity to
charge higher prices. This can enable relatively small businesses to compete with larger ones.
Many large businesses have recognised the benefits of projecting an environmentally friendly
image. Unilever, the Anglo-Dutch multinational consumer products company, which is
responsible for well-known brands such as Ben & Jerry’s, Knorr and Dove, has publicised its
environmentally friendly approach widely. It intends to reduce the effects of its operations on the
environment by 50 per cent by 2020. Such an approach may be particularly productive when
rival products are not differentiated in other ways.
Opting to become more environmentally friendly can increase costs for many businesses. It may
involve investing in new production processes that produce fewer emissions or waste and
therefore lower pollution. Alternatively it may entail using resources from sustainable sources,
which are frequently more expensive. Both factors may push up the costs of production, making
it more difficult for the businesses concerned to compete with rivals. However, this is not
inevitably the case. Many businesses have sought to cut energy usage to reduce their adverse
impact on the environment. Du Pont, the American chemical company, committed itself to a 65
per cent reduction in greenhouse gas emissions in the 10 years prior to 2010. By 2007, DuPont
was saving £1.3 billion annually as a result of reduced energy use, equal to its total profits that
year.

What do you think?

Do the benefits of operating in an environmentally friendly manner always outweigh
the drawbacks?

Fair trade
Fair trade is a social movement that operates with the goal of assisting businesses in less-
developed countries to achieve improved trading terms. The movement hopes to improve living
standards in the less-developed countries and to promote sustainable methods of production.
This movement supports the paying of higher prices to producers, who are often exporters to
consumers in developed countries. There is a wide range of fair trade products available to
consumers in the UK and other developed countries, most notably coffee, sugar, tea, bananas,
wine and cotton.

Key terms
Fair trade is a social movement that exists to promote improved trading terms and
living conditions for producers of products in less-developed countries.
Sustainable production occurs when the supply of a product does not impose costs
on future generations by, for example, depleting non-renewable resources.

The impacts of fair trade for businesses are similar to those of environmentally friendly
production. Selling fair trade products has the potential to allow businesses to charge higher
prices without an unacceptable loss of sales. It may however, limit businesses to selling to a
smaller group of consumers for whom supporting producers in less developed countries through
free trade is an important issue. It is also likely to increase costs as paying a ‘fair’ price is a
cornerstone of the movement.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 Identify two factors that make up the external environment for a business.
2 What is meant by the term market conditions?
3 Is the following statement true or false? ‘Real wages are an employee’s wages
adjusted to allow for the rate of price increase or inflation.’
 4 State two products for which income has little influence on the level of demand.
5 What is meant by the term interest rates?
6 Is the following statement true or false? ‘The level of savings tends to rise when
interest rates fall.’
7 State two factors that may lead to a change in the size of a country’s population.
8 Is the following statement true or false? ‘Changes in the size of a country’s
population will only affect local businesses by altering the level of demand for the
products they produce.’
9 State one benefit to a business arising from it adopting policies to become
environmentally friendly.
10 What is meant by the term fair trade?

(b) Short answer questions

1 Explain the difference between incomes and real incomes.
(4 marks)
2 Explain why a decision by a manufacturer to produce environmentally friendly
products might increase its production costs.
(5 marks)
3 Explain one reason why a grocery retailer might decide to sell fair trade products.
(5 marks)
4 Explain why a fall in interest rates might have a significant impact on demand for
new houses.
(6 marks)

(c) Data response questions

Handel Ltd is based in Lincolnshire and produces frozen foods from products supplied
mainly by local farmers. It has a strong reputation for supplying basic foodstuffs at
very competitive prices. The company is long established, has good facilities and very
low levels of borrowing. The company employs large numbers of unskilled workers in
its factories as it aims to keep its costs as low as possible. Its business is seasonal
and it requires larger numbers of employees during peak seasons.
The company’s external environment is undergoing a period of rapid change. The
Bank of England has just announced an increase in interest rates, and net migration
also increased recently. Approximately 12,500 migrants entered Lincolnshire in the
last twelve months.
Most notably, a new German food-processing company has recently established a
new high-technology factory in Lincolnshire, investing £35 million, and is targeting the
UK food market. It sells a range of foods, mainly focusing on the higher price end of
the market, although its efficient use of technology allows it to be very price
competitive.
1 Explain why the rise in interest rates will only have a limited effect on Handel Ltd.
(5 marks)
2 Analyse how the increase in net migration to the UK might affect Handel Ltd’s
 costs.
(9 marks)
3 Do you think that the entry of the new German company to the market is certain to
reduce demand substantially for Handel Ltd’s products? Justify your decision.
(16 marks)

d) Essays
1 To what extent is competition always the most important element of the external
environment for fast-food chains?
(25 marks)
2 ‘Consumers becoming more aware of environmental issues inevitably has a
negative impact on businesses’ costs and revenues.’ Do you agree with this
statement? Justify your viewpoint.
(25 marks)
Revision Section: Unit 1 What is
business?
Advice for Unit 1
Top tips … Things to avoid …
It could be helpful to think about the Do not assume that laws always
advantages and disadvantages of the different constrain business activity. For
forms of business. What determines the right example, the passing of various
structure for a business? What issues are laws to limit damage to the
involved in choosing a business format? This environment have created
involves issues such as: How much does opportunities for many
someone need to work with others? Is outside businesses, including those
investment required? How critical is limited that manufacture equipment to
liability? Do not assume one approach is reduce harmful emissions or
always right – for example, it depends on the those that provide advice on
people, their objectives, the nature of the how to adjust operations to
business and the risk. meet newly created laws.
Remember that the impact of external change Do not assume external change
can affect costs and demand. The impact is always good or bad; it
varies according to the type of business – for depends on what the change is
example, high costs of borrowing will affect (e.g. higher incomes or higher
demand for new houses more than socks. borrowing costs).
Remember that external change affects what Do not become stuck
needs to happen within the business. For presenting data in the same
example, if demand increases a business may way. Remember that are many
consider expanding capacity, recruiting staff different ways in which data
and price increases. can be presented. Try to
understand what it tells you
(and what it doesn’t) and
consider how it might affect a
range of businesses and the
decisions they make.
UNIT 1 CHECKLIST
Having completed studying this unit you should be able to do all that is listed below.
You should read this list and confirm that this is the case.
Learning objective
Understanding the nature and purpose of business
Know and understand:
• why businesses exist
• the relationship between mission and objectives
• common business objectives
• why businesses set objectives and what these objectives might be
• how to measure and explain the importance of profit.
Understanding different business forms
Know and understand:
• the reasons for choosing different forms of business and for changing business
form such as sole traders, private limited companies and public limited companies,
private sector and public sector organisations and non-profit organisations such as
charities and mutuals
• unlimited and limited liability
• share capital
• market capitalisation
• dividends
• role of shareholders and why they invest
• influences on share price and the significance of share price changes
• the effects of ownership on mission, objectives, decisions and performance.
Understanding that businesses operate within an external environment
Know and understand:
• how the external environment can affect costs and demand
• the factors influencing costs and demand such as competition market conditions,
incomes, interest rates, demographic factors and environmental issues and fair
trade.
Practice questions
1 Mandy has run her cleaning business for three years as a sole trader. Explain one
reason why she might now want to set up a private limited company.
(5 marks)
2 Explain one way an external factor might affect the profit of a café.
(5 marks)
3 This year’s profits of a public limited company were significantly lower than
predicted months ago. Explain one possible consequence of this.
(5 marks)
4 The share price of restaurant company Pret a Manger fell recently. Explain two
reasons why this might have happened.
(6 marks)
5 Mars is a private limited company. Analyse how becoming a public limited company
might affect the managers’ decisions.
(9 marks)
Case study: Aston Martin Lagonda
In 2018, the luxury carmaker, Aston Martin announced that it might float on the
London stock market and become a public limited company. Analysts say the
business would probably have a market capitalisation of around £5bn. Its main
shareholders are an Italian investment fund and Kuwaiti investors. At the same time
as announcing it was going public, Aston also announced its first-half results,
reporting an eight per cent year-on-year sales increase to £445m for the six months
ended 30 June.
Aston Martin’s Chief Executive, Mr Andrew Palmer, said that the plan to float was a
‘key milestone’ in the history of the company. Although some worried about conditions
in the external environment, Mr Palmer felt that a luxury brand was not vulnerable to
external changes such as the UK’s decision to leave the European Union.
For the year ended 31 For the six months ended 30
December June
£m 2015 2016 2017 2017 (unaudited) 2018
Revenue 510.2 593.5 876.0 410.3 444.9
Profit/(loss) for the (107.0) (147.6) 76.8 16.1 11.5
period
Table U1.1 Overview of the Business: Consolidated Income Statement.
Source: Investigate.
Aston Martin has struggled for many years to make a profit. However, under the
leadership of Mr Palmer, the company has been widening its product range to turn
things around. Aston Martin Lagonda is focusing on what it calls a three-pillar product
strategy offering sports and GT cars, SUVs and sedans. This strategy, which includes
the opening of a new production plant in Wales, has seen Aston Martin Lagonda
launch new models such as the DBS Superleggera and the Aston Martin Valkyrie
hypercar.
In addition, the company is targeting a rapidly growing segment of High Net Worth
Individual (HNWI) consumers who are seeking more environmentally-friendly luxury
cars, re-introducing the historic Lagonda marque, as the first all-electric luxury
automotive brand. The Lagonda product range will target the SUV and sedan markets,
focusing on the ultra-luxury segment. Aston Martin Lagonda has a global presence
with approximately 30 per cent of unit sales from the UK, 26 per cent from Europe,
Middle East and Africa, 25 per cent from the Americas and 16 per cent from Asia
Pacific.
The company announced that it expected car sales in 2018 to rise to between 6,200
and 6,400 units, and in the medium-term it aims to build nearly 10,000 in the 2020
calendar year. As part of its strategy, Aston Martin has targeted female buyers – the
company has sold less than 4,000 cars to women in its 105-year history.
The company is also now involved in projects to build an electric flying car, luxury
homes in the US, and even a personal submarine. Mr Andrew Palmer says the
company is a luxury brand not just a manufacturer of cars, and is continuing to deliver
sustainable growth, margins and value for their shareholders whilst launching three
new models and variants in the first half of the year.
The Directors believe Aston Martin Lagonda is well positioned within the luxury
segment of the automotive market; the growth in number and wealth of HNWIs,
together with an increasing proportion of women and younger individuals in the HNWI
population, provides a greater potential customer base for Aston Martin Lagonda’s
cars.
Source: Adapted from BBC August 2018, ‘Aston Martin to sell shares on the London stock market’
Practice questions
1 Analyse the reasons why Aston Martin wanted to become a public limited company.
(12 marks)
2 Analyse the factors that might determine the share price of Aston Martin when it
first becomes a public limited company.
(12 marks)
3 To what extent do you think demand for Aston Martin cars depends on external
factors?
(16 marks)
4 To what extent do you think shareholders are the key stakeholder group for Aston
Martin?
(16 marks)
5 To what extent do you think profit is a good way to judge the success of Aston
Martin?
(20 marks)
6 Aston Martin is moving into new product areas. To what extent do you think that all
businesses need to change the products that they offer over time?
(24 marks)
Essay questions
1 To what extent do you think changes in interest rates are more important than
changes in demographic factors in terms of the impact on the profits of a business?
(25 marks)
2 Different forms of business include sole trader, companies and public sector
organisations. To what extent do you think the form of business determines how
much profit it can make?
(25 marks)
Chapter 4 Understanding management,
leadership and decision making
Introduction
This chapter introduces you to some important ideas. Decision making is an important theme for
the entire AS and A-level specification and this chapter will consider what managers and leaders
do within businesses, including the crucial task of taking decisions. The chapter will also look at
theories of management and leadership and use these to help you to analyse the effectiveness
of different approaches to management and leadership. (There may be a distinction between a
leader and a manager in large businesses. The leader may provide vision and overall direction,
while the manager(s) focus on ‘getting things done’. This is not the case in many smaller
organisations where the leaders are also likely to be managers. We will not focus on this
distinction in this chapter.)

Key terms
Leadership includes the functions of ruling, guiding and inspiring other people within
an organisation in pursuit of agreed objectives.
Management is planning, organising, directing and controlling all or part of a
business enterprise.

What it is important to know by the end of this chapter:

• what managers do
• the types of management and leadership styles
• the influences on the choice of management and leadership styles
• the effectiveness of different styles of management and leadership.
What managers do
Over a hundred years ago, the management theorist Mary Parker Follet wrote that management
was ‘the art of getting things done through other people’. Since then, various writers over the
years have argued that this involves different functions. However, those set out in Figure 4.1
would be considered the key functions that are carried out by most managers.

Figure 4.1 The functions of management

The functions of management
Businesses operate in different ways and may require managers to undertake varying tasks and
duties. However, these various management duties and tasks can be categorised into four basic
functions – the functions of management. The four principal functions are:
• planning
• organising
• directing
• controlling.
Each of these functions involves managers in making decisions, which is a constant and central
element of any manager’s work.

(a) Planning
Planning is the first of the functions of management and involves looking to the future. It is the
foundation upon which the other three functions of management should be based. Planning
requires management to evaluate where the company is currently, and where it would like to be
in the future. This allows managers to take decisions so that the company moves forward in an
organised and coherent manner. It gives managers something against which to judge their
decisions.
Planning may involve a variety of tasks, including the following:
• setting objectives or targets for the business or for the area of the business for which the
manager is responsible
• conducting analysis to gather together forecasts of key data such as the business’s costs and
revenues, consumers’ incomes, competitors’ prices and products
• drawing up plans for functional areas within the business such as finance, human resources or
marketing – these plans should fit together to help the business achieve its agreed objectives
• estimating the likely resource needs for any proposed plans.
The planning process is continual, as external factors (such as the amount and cost of available
labour, for example) change all the time. These changes may cause a company to adjust its
course of action to ensure that it achieves its objectives.
Planning helps managers to reduce the chance of projects failing in the future. A plan can
highlight problems and encourage managers to develop solutions. It helps to make sure that
managers have the resources they need. A plan can also be extended to help managers to
overcome emergencies or crises – these are called contingency plans.

(b) Organising
Management must assemble the resources that they need to carry out the actions set out as part of
the planning process. Through the process of getting organised, management will determine the
internal organisational structure and establish and maintain relationships, as well as allocating
necessary resources.
The American aeroplane manufacturer, Boeing, has announced it is to build a new factory in
Sheffield. The new factory will be in production by 2019 and will manufacture components for
use in Boeing’s next-generation aircraft, including the 737, 737 MAX and 777 planes. In order to
organise this expansion into a new factory, the company’s managers will need to assemble the
following resources:
• land on which the new factory will be built
• 30 highly skilled employees to staff the factory
• approximately £40 million to fund the building of the new factory.
Acquiring resources is an essential element of the effective management of establishing the new
factory. A well-managed business will plan carefully and may seek to use a minimum of
resources to achieve its objectives.

What do you think?

Should managers always seek to minimise the amount of resources that a business
uses to produce its goods and services?

(c) Directing
The third function of management is directing. Through directing, management is able to
influence and oversee the behaviour of the staff in achieving the company’s goals, as well as
assisting them by providing the necessary resources. Directing employees entails leading
employees through motivation and communication.
• Motivation is the willingness to achieve a target or goal. Employees that are highly motivated
generally perform better. This 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 incentives programmes to encourage employees and also may 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.
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.

(d) Controlling
Controlling involves setting standards using the company’s objectives, and reviewing and
reporting performance. Once management has done both of these things, it should compare the
objectives and performance to determine any necessary corrective or preventive action.
Reviewing is a very important part of a manager’s role as it allows reflection and judgement on
what has been achieved and encourages further decisions to ensure the business meets its
objectives.
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 that 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), absenteeism or training costs. For many
businesses supplying services these can be vital measures of performance.
• Social performance. Managers can measure a business’s performance in terms of behaving
ethically, minimising pollution and creating jobs.
When Boeing opens its new factory in Sheffield it may need information on each of the above
areas to assess whether its factory is progressing according to its 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.
Managers and decision making
Each of the functions that managers have to undertake entails decision making.
• Planning. In this stage managers will need to decide what objectives should be set for the
organisation, or their element of it. These objectives may relate to profits or, for some
businesses, they could be about achieving social or ethical targets. They may be influenced by
analysis of competitors or of consumers’ expectations. The analysis may reveal a gap in the
market (for, say, ethical products) that are not being met by competitors’ products. This
analysis will inform decision making.
• Organising. Managers have to decide what resources will be needed to allow the business to
fulfil its objectives as efficiently as possible. This could entail making decisions about where
to locate, whether to use technology or labour as the cornerstone of production and whether or
not to use sustainable resources.
• Directing. A central task for managers here is leading. This will require managers to decide
the best way to motivate the employees that they are managing. They may decide to use
money as the main method of encouraging their employees to work effectively or opt to design
interesting jobs that will stimulate their colleagues.
• Controlling. This final function entails further decision making. The process of reviewing will
compare actual performance against objectives and create two types of decision. What aspects
of the business’s performance require corrective action and what action should be taken?

Business in focus: Cuadrilla explores for shale gas in

Lancashire

Cuadrilla Resources Ltd is an oil and gas exploration and production company. In July
2018, it received permission from the UK government to frack for shale gas at a site in
Lancashire near to Preston. Fracking, or hydraulic fracturing, is a controversial
technique used to exploit reserves of gas held in shale rock layers deep within the
earth. The process requires the injection of highly pressurised fluids into the layers of
rock.
The company was pleased with the government’s decision. The company’s Chief
Executive, Francis Egan, said:
‘We now look forward to submitting a fracture consent application to (the government)
for our second exploration well and moving on to fracture the shale rock and flow the
natural gas which we believe will make a major contribution to reducing the UK’s gas
imports and improving our environment and economy.’
Cuadrilla plans to test the gas produced for about six months, and to seek permission
for a second well at the Preston site.
Cuadrilla argues that commercial extraction of natural gas from shale would see it,
along with its suppliers, become one of the biggest employers in Lancashire, with
specialist companies also moving to the region. Cuadrilla has already invested more
than £10 million into its activities in Lancashire. Cuadrilla expects that its activities will
create several hundred jobs in Lancashire and be operational for up to 10 years. It
also hopes to explore for shale gas at other sites in the future.
Fracking has received a lot of adverse publicity as many believe the process is
harmful to the environment. Cuadrilla expects to face continued opposition from
groups seeking to protect the environment, such as Friends of the Earth, as well as
from local residents.

Practice questions
1 Analyse why decision making will be an important part of managing this project if it
goes ahead.
(9 marks)
2 Do you think that planning will be the most important function for the managers at
Cuadrilla’s proposed sites in Lancashire? Justify your view.
(16 marks)

What do you think?

Advances in information technology mean that much more information is available to
managers to help them to take decisions. Do you think that this makes their roles
easier?
Types of management and leadership styles
Over the years, many theories have been presented concerning management and leadership.
Views have altered with time, and this has been reflected in the changing approaches adopted by
businesses.
Trait theory
Many writers have argued that all leaders or managers should have a set 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 or manager
from other people. Trait theories have developed from the concept of the charismatic individual –
Nelson Mandela or Barack Obama, for example. Examples such as these have led to trait theory
being termed ‘great person theory’. Supporters of the idea of the charismatic leader or manager
contend that such individuals have identifiable characteristics that set them apart from ordinary
mortals.
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 an individual behaves in a management or leadership role. The
theories try to identify the right way of leading or managing rather than the characteristics of the
person. There have been many studies looking at styles of leadership and management and
considering which are successful.
Researchers at Ohio State University used questionnaires to ask employees to describe the
behaviour of their managers. They identified two dimensions: ‘consideration’ and ‘initiating
structure’.
• A considerate style focuses on the wellbeing of subordinates. Are they comfortable at work?
Do they feel at ease and well treated? Managers with this style focus on listening to employees
and encouraging them. This type of manager is approachable and rewards good performance.
Staff may feel looked after. However, they may not necessarily complete the task effectively.
• An initiating structure focuses on defining and planning work. The leader concentrates on
getting the work done. They allocate tasks, inform subordinates of their tasks and monitor
progress. The work gets done, but staff may feel that they are being treated unfairly.

Key models and theories: The Blake Mouton grid

The Blake Mouton grid is a management and leadership style model. The model is
used to categorise management styles according to the manager’s concern for
production and concern for people. This approach allows managers to be placed into
five broad categories.

Another study by researchers at Michigan University called the relevant dimensions ‘task
orientation’ and ‘relationship orientation’. These different styles can be analysed using the Blake
Mouton grid, as shown in Figure 4.2. The vertical scale on this grid reflects a leader’s concern
for people. The horizontal scale reflects concern for task or production done.
If a leader or manager focuses on getting the job no matter what, they are ‘task focused’. The risk
here is that the goodwill and support of the team will be lost which may cause problems over
time. However, a leader who is concerned about keeping people happy may create a pleasant
working environment in which tasks are not always completed efficiently. This is called ‘country
club management’.

Key models and theories: Tannenbaum and Schmidt’s

continuum
The Tannenbaum and Schmidt continuum is another model that can be used to assess
a leadership or management style. This model categorises styles according to the use
of control and freedom. These are presented on a continuum where a manager or
leader’s authority is steadily replaced by freedom for subordinates.
Another classification of styles is to consider the extent to which managers or leaders ‘tell’ or
‘listen to’ their staff. Using this approach, individuals have been classified as being autocratic,
democratic or laissez-faire (literally ‘leave alone’). However, there are many more different
styles of managing and leading that can be identified using this approach. The Tannenbaum and
Schmidt continuum shown in Figure 4.3 emphasises that there is a range of leadership behaviour
depending upon the extent to which managers take decisions or whether subordinates contribute
significantly to decision making.

Figure 4.2 The Blake Mouton grid

Figure 4.3 The Tannenbaum–Schmidt continuum

A key factor in differentiating between leadership styles is communication. At the autocratic end
of the spectrum communication is likely to be downward only as the leader or manager
‘instructs’ his or her 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 then having considerable freedom to work as they see fit.
Who takes the decisions also has a very important effect. Autocratic managers are likely to retain
control of decision making, while democratic managers will seek to involve a wider group in
contributing to joint decisions. Laissez-faire managers tend to leave decision making to
subordinates.

(a) Autocratic leadership

This is also sometimes termed authoritarian leadership. It refers to a leadership or management
style that assumes that information and decision making are best kept at the top of the
organisation. It is also characterised by:
• primarily one-way communication (downward)
• minimal delegation or decentralisation (one person with authority)
• close supervision of employees.

Key terms
Authority is the power or ability to carry through an action.
Delegation is the passing of authority down the organisational structure.
Empowerment is a series of actions designed to give employees greater control over
their working lives.
Decentralisation entails passing authority from the centre of an organisation to those
working elsewhere in the business.

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 leader. With this style, the leader determines objectives, allocates
tasks and expects obedience from subordinates. In these circumstances, employees become very
dependent upon their leaders, 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 large numbers of staff may leave. This style of leadership becomes more
difficult to operate successfully as an organisation grows.
As with all the behavioural leadership classifications, the term autocratic manager covers a
spectrum of actual styles. Extreme autocratic management will result in 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.
Appropriate Inappropriate

When a rapid decision is needed – perhaps in When taking highly complex

an emergency. decisions requiring diverse
When it is important that the same message is knowledge and skills.
 given out by everyone in the organisation – When leading a talented, self-
maybe as part of crisis management. motivated and creative group of
When managers are responsible for a large employees.
number of (possibly unskilled) subordinates. In circumstances in which junior
managers are expected to develop a
full range of managerial skills.
Table 4.2 Autocratic management: circumstances in which it may or not be applicable

(b) Democratic leadership

Democratic leadership (sometimes called participative leadership) entails operating a business
according to decisions agreed by the majority. Decisions may be agreed formally through a
voting system, but it is more likely to be the result of informal discussions. Typically, democratic
leadership encourages some or all of the following:
• the leader delegates a great deal and encourages decentralisation
• the leader and subordinates discuss issues and employee participation is actively encouraged
• the leader acts upon advice, and explains the reasons for decisions
• subordinates are empowered and have greater control over their working lives.
The successful operation of this style requires excellent communication skills on the part of the
leader and the ability to generate effective two-way communications. 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 leader, 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 leadership, though this depends
on many factors including the size of a business and its culture. The trend towards democratic
leadership 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 leadership style.
• Leadership has become more complex. Globalisation means that businesses are larger and
more complicated and the environment in which they operate is dynamic and subject to rapid
change. Individuals are more likely to need the support that democratic leadership provides to
succeed in these circumstances.

Business in focus: Richard Branson assesses Steve Jobs’

leadership style
Figure 4.4 Richard Branson

Figure 4.5 Steve Jobs

Richard Branson admires Apple Inc.’s co-founder, chairman and CEO, Steve Jobs.
Jobs’ leadership was based on authority and the use of a ‘tell’ style in which the
manager makes a decision and announces it. Branson assesses Jobs’ leadership
style in the following way:

Leadership doesn’t have a secret formula; all true leaders go about things in their
own way. It’s this ability to think differently that sets them apart – and that
enabled the late Steve Jobs to create perhaps the most respected brand in the
world.
Steve Jobs’ leadership style was autocratic; he had a meticulous eye for detail,
and surrounded himself with like-minded people to follow his lead. While he was
incredibly demanding of his people, he wasn’t the best delegator – he wanted to
involve himself in every detail, which is the opposite of my own approach.
Personally, I have always believed in the art of delegation – finding the best
possible people for Virgin and giving them the freedom and encouragement to
flourish.
Steve Jobs was always at the centre of everything Apple did. Over his
extraordinary career, he learnt that it is vital that you don’t solely lead your
 company from a distance. Walk the floor, get to know your people. Even though I
don’t run Virgin’s companies on a day-to-day basis any more, I still find it crucial
to get out and about among our staff. No one has a monopoly on good ideas or
good advice, so as a leader you should always be listening.
Of course, there will be times when strong and decisive leadership is necessary;
to make sure the right moves are made. If you place the emphasis on getting the
little things right, and address the everyday problems that come up, you can
encourage a culture of attention to detail. Jobs may not always have been the
best leader of people – which may, in part, have been due to his health problems
– but he was innovative, determined and, above all, passionate. Finding gaps in
the market, and creating products that make a real difference to people’s lives,
can only be accomplished if you have passion for what you are doing. If you
make something you are proud of, that filters down to your staff, as well as your
customers. Today, more than ever, you’ve got to do something radically different
to make a mark.
Source: Adapted from ‘Virgin’s Richard Branson: Apple boss Steve Jobs was the entrepreneur I
most admired’, 6 Oct 2011 © Telegraph Media Group Limited 2019

Practice questions
1 Analyse how the leadership style used by Steve Jobs might have affected the
motivation levels of Apple’s workforce.
(9 marks)
2 To what extent is being a good communicator, or being decisive, more important
than the leadership style adopted by the leader?
(16 marks)

(c) Laissez-faire leadership

This approach is sometimes described as mild anarchy. Under this approach the leader has a
minimal input into the operation of the business. Employees are empowered to take the majority
of the decisions with little reference to the leader. As a consequence, the organisation can lack a
sense of direction as well as coordination and planning.
The laissez-faire style of leadership may occur because of the shortcomings of the leader, who
may lack the essential skills needed to carry out the 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
leader of a highly creative team may deliberately adopt this style in the expectation of bringing
out the best in his or her subordinates.
Laissez-faire leadership may be successful in the following circumstances:
• The manager or leader is one among a number of equals in terms of experience and
qualifications.
• The workforce is self-motivated and understands the role of managers.
• The workforce understands and agrees with the organisation’s objectives.
Laissez-faire leadership tends to result in highly independent employees who are willing to voice
their opinions. Staff may be satisfied or dissatisfied with this style of leadership, depending on
their skills and the complexity of the tasks to be completed.

Style versatility
Building on the contention that there is not a single perfect style of leadership, it is possible to
argue that the best managers are those who adopt a style suitable to the circumstances. The most
talented managers might be the most versatile, able to call on one or more of the styles we have
discussed having assessed the demands of the situation. 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 demonstrate a more autocratic style when dealing with a crisis.
Influences on the styles of management and
leadership
A number of factors may influence the style adopted by managers and leaders. Some of these are
considered below.
• The tradition and history of the business. Some businesses have a history of particular
management styles. For example, the John Lewis Partnership has a tradition of involving staff
in decisions and a ‘considerate approach’.
• The type of labour force. Highly trained, skilled and confident employees may be more suited
to democratic leadership as they have the ability to contribute to decision making and can
bring perspectives of which managers may be unaware.
• The nature of the task and the timescale. A manager does not always have to deploy the
same leadership style – good managers can use style versatility. An urgent short-term task may
require a more task-focused, autocratic approach. In contrast, a scenario that calls for a highly
creative, longer-term approach may be better managed by a laissez-faire style.
• The personality of the manager or leader. Confident individuals who are good
communicators may be suited to a democratic style of leadership. Decisive individuals with a
strong vision of where the business should be going may be more task-focused or autocratic.
Mark Zuckerberg, the CEO of Facebook, has been criticised for establishing a corporate model
in which autocratic management is encouraged.

Business in focus: The John Lewis Partnership

The John Lewis Partnership (JLP) has 50 department stores and 353 Waitrose
supermarkets located across the UK. Annual sales revenue exceeds £10 billion. The
business operates in a very different way to public limited companies. The company’s
employees own the business and profits are not paid to shareholders in the form of
dividends; instead they are distributed to the business’s employees as an annual
bonus. The company’s ownership structure was established by the company’s
founder, John Spedan Lewis, in 1864.
JLP has over 85,000 well-trained permanent staff and all of them are partners. The
company’s organisational structure allows managers the freedom to be
entrepreneurial and competitive in the way they run the business for long-term
success. It also allows the company’s owners, the partners, to share in the benefits
and profits of a business that puts them first. JLP’s structure is democratic. The
Partnership Board, the Divisional Management Boards and the Chairman’s
Committee form the management of the company. Partners have an official voice and
can hold management to account as well as make suggestions. Five partners are
elected as directors to the Partnership Board.
JLP is proud of its structure. Its website states: ‘As a Partnership we are a democracy
– open, fair and transparent. Our profits are shared, our partners have a voice and
there is a true sense of pride in belonging to something so unique and highly
regarded.’
Source: John Lewis Partnership website

Practice questions
1 Analyse the benefits that the John Lewis Partnership may receive from operating a
democratic management style.
(9 marks)
2 Do you think that the ownership structure at John Lewis is the major influence on
its management style? Justify your view.
(16 marks)
The effectiveness of different leadership
and management styles
What is effective management or leadership? At its simplest it is that which allows an
organisation to meet its objectives within the agreed timescale. It may also result in a workforce
performing more efficiently than those of similar competitors, perhaps measured by products
being produced at a lower cost per unit, though this is only a partial measure. Low-cost
production may be achieved at the expense of dissatisfied employees and large numbers of
employees leaving each year. Efficient employees who are satisfied by their work may provide a
good measure of managerial effectiveness.
Businesses operate with a wide range of approaches to management and leadership. This
suggests that different leadership styles are effective in different situations. We saw in the
previous section that there are a number of reasons why this takes place and effective managers
will take these factors into account. However, decisions about leadership and management styles
should not be taken in isolation.
For a subordinate-centred leadership style to be effective, a business will need to ensure that it
provides sufficient resources. It may need to spend heavily on training its employees to ensure
they have the necessary skills to carry out the roles that are expected. Equally, a business may
need to recruit its employees carefully to ensure that it has workers of sufficient calibre to carry
out the desired roles effectively. This may require the payment of wages that might be higher
than those paid by competitors.
Managers should recognise that they are unlikely to be effective in isolation. For any style to be
effective it requires support from others in the organisation. This support should come from
those higher in the organisation as well as from those below. Any style of leadership will require
support for its objectives and approach from more senior employees. They may provide the
necessary resources but also backing when difficult decisions have to be made. Similarly, those
lower in the organisation may obstruct a manager’s decisions, especially if they result in
unpopular changes. This can prevent decisions being taken which are necessary to reach the
organisation’s objectives.
Effective management may entail making a judgement about the skills and abilities of
subordinates. If they have relevant skills and abilities then it would be effective to involve them
in decision making to make use of these talents. To retain control and to operate in an autocratic
style in these circumstances would be to avoid making full use of the resources that are available.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 What is meant by the term ‘management’?
2 State two tasks that a manager may undertake while carrying out the role of
 planning.
3 Is the following statement true or false? ‘Directing is a management function which
includes leading employees by communicating with and motivating them.’
4 State two areas of business performance on which managers may report as part
of the reviewing process.
5 State two examples of decisions that managers may have to take when carrying
out the role of organising.
6 According to the Blake Mouton grid, which style of leadership combines a high
concern for people with a low concern for production?
7 What are the key characteristics of Blake Mouton’s ‘impoverished style of
leadership’?
8 State two circumstances in which autocratic leadership may be needed.
9 Is the following statement true or false? ‘Under the democratic style of leadership
a leader has a minimal input into the operation of the business.’
10 List two factors that might influence the leadership or management style that is
adopted.

(b) Short answer questions

1 Explain why controlling is an important role for managers.
(4 marks)
2 Explain why processing information is a vital task for managers.
(5 marks)
3 Explain why a democratic manager is likely to make use of delegation.
(5 marks)
4 Explain why style versatility might be considered the most effective management
style.
(5 marks)

(c) Data response questions

Patti and Ravi Shastri own and manage P&R Components Ltd, a small manufacturing
business in Birmingham. The business’s workforce of 125 people is diverse: it
includes a large number of unskilled workers as well as creative designers and
professional managers including accountants and engineers. The company
experiences a high proportion of its employees leaving each year – last year 25 left
and had to be replaced.
Patti is responsible for managing one of the company’s divisions with 45 unskilled
production line workers and uses an autocratic style of management allowing
employees little freedom in making decisions. This division has to respond quickly to
changes in orders from some major customers.
Ravi’s approach to leadership has changed over time. He has always been very
concerned about people. He has received criticism from Patti for his division being late
in supplying orders to some important customers. In response he has shown an
increased concern for production and has sent a number of employees on training
courses.
1 Explain why Patti chose a management approach that told employees what to do.
(5 marks)
2 Analyse why managing P&R Components Ltd’s workforce may be challenging.
(9 marks)
3 Evaluate the possible implications of Ravi’s change in leadership style using the
Blake Mouton grid.
(16 marks)

(d) Essays
1 Decision making is always the most important element of a manager’s job in a large
public limited company. To what extent do you agree with this statement?
(25 marks)
2 To what extent do you think that an autocratic leadership style is most suitable for a
newly established business?
(25 marks)
Chapter 5 Understanding management
decision making
Introduction
Chapter 4 looked at management and leadership styles and emphasised the central part decision
making plays in these roles. This chapter will consider the process of decision making in more
detail, including decision trees. It will also cover the factors that influence managers’ decision
making.
What it is important to know by the end of this chapter:
• the value of decision making based on data and on intuition
• the use and value of decision trees in decision making
• the influences on decision making.
Management and decision making
Making a decision entails selecting a logical choice from the options that are available. A central
part of a manager’s role is making decisions. Managers are in charge of various resources (such
as people, money, machines and materials) and must decide how to use them most effectively to
achieve the business’s objectives. This involves hundreds of decisions every week. Other
decisions may relate to whether or not to launch new products or to buy another business.
The decision-making process
It is possible to identify a number of stages in the decision-making process, as illustrated in
Figure 5.1.
• Setting objectives. This is an essential starting point because the success of a decision can
only be judged against the objectives or targets that were set. For example, a manager may be
considering how to increase a business’s weekly sales to 10,000 units. The effectiveness of the
resulting decision can be measured against this objective.
• Gathering and interpreting information. Before making a decision, a manager may decide
to gather information on the options that are available, including the costs and benefits.
Advances in information technology have made this stage easier for managers to complete and
more cost effective.
• Selecting the chosen option. Having weighed up the options available managers have to make
a choice based on the data and also on their experience.
• Implementing the decision. The manager will take actions such as using resources in the
chosen way and communicating their intentions to interested parties.
• Reviewing. This is an essential stage to judge whether the decision is having the desired effect
and meeting the objectives that were set. This offers an opportunity to consider whether or not
the objectives are still relevant and to assess whether or not the actions arising from the
decision need to be amended.

Figure 5.1 The process of decision making. Decision making is a dynamic and on-going process in
which managers are continually engaged.
Types of decisions
1. Programmed and non-programmed decisions
Different types of decision have to be made. In 1960, Herbert Simon analysed types of decision
in terms of programmed and non-programmed elements. Programmed decisions deal with
problems that are familiar and where the information required to make them is easy to define and
obtain. The situation is well structured and there are often established procedures, rules and
policies. For example, reordering components is often a programmed decision. Employees know
what has to be ordered, who to order from and how to order it. They simply decide on matters
such as when and how much to order.

Key terms
Programmed decisions are familiar and routine decisions.
Non-programmed decisions are less structured and require unique solutions.

In contrast, non-programmed decisions deal with situations that are unstructured and require a
unique solution. These are unusual decisions that may be risky, such as a major investment or
entering a new market.

2. Tactical and strategic decisions

Some decisions are strategic, meaning that they are long term, involve a major commitment of
resources and are difficult to reverse. We will consider strategy later in this book.
Other decisions are tactical, which is the focus of this chapter. Tactical decisions are short term,
taken more regularly and involve fewer resources. For example, the reordering of stock is a
tactical decision. The investment in purchasing new premises is a strategic decision.
Strategic decisions Tactical decisions
long term short term
involves large commitment of resources fewer resources involved
difficult to reverse easier to reverse
usually taken by senior management usually taken by more junior management
Table 5.1 One way of looking at types of decisions
Decision making, risks, rewards and uncertainty
Most decisions taken by managers involve some degree of risk. There is a chance, for example,
that a decision to reduce the price of a product will not result in a significant increase in sales.
There is a risk that customers will not respond to the stimulus of lower prices and that the
business will suffer a fall in revenue. Risk is normally measurable. When considering a price cut,
it may be possible to research the buying habits of the targeted consumer group to assess the
possibility of this happening. This situation illustrates how gathering more data relating to a
decision can help to reduce the risk. In this case, if the data collected suggested that consumers
would not respond in sufficient numbers, then the manager would not take the decision.

Key terms
Risk is the chance of incurring misfortune or loss.
Uncertainty is a situation in which there is a lack of knowledge and events, outcomes
or consequences are unpredictable.
Opportunity cost is the next best alternative foregone.

Business in focus: A big decision

Maersk Oil and three other project partners have taken a decision to invest £2.5
billion to ensure continued production from the Tyra gas field in the North Sea.
Maersk will invest £0.78 billion of the total sum. As a result, the Tyra field will continue
producing gas until at least 2047 with the potential to supply 1.5 million Danish
homes.
The Tyra gas field will be closed in November 2019 to allow the redevelopment to
take place. Gas production is expected to recommence during 2022.
Maersk Oil chief executive Gretchen Watkins said: ‘Tyra has been a key asset in the
history of Maersk Oil, and an important source of energy security for Denmark. The
redevelopment of Tyra is the largest investment carried out in the Danish North Sea,
and when completed in 2022, production from the Tyra field itself has the potential to
cover Danish gas consumption for a decade.’
Source: Adapted from Energy Voice, 1 December 2017

Practice questions
1 Analyse why it would have been important for the companies concerned to collect
and interpret information before reaching their final decision on this project.
(9 marks)
2 Do you think this investment was a risky decision for the companies? Justify your
view.
 (16 marks)

Rewards result if managers make good decisions. If the manager considering the price cut had
decided to reduce the price of the products and sales had risen substantially as a result, then the
reward could have been in the form of increasing revenues and possibly profits. It is often the
case that the riskier a decision, the greater the potential rewards. In 1995, Bill Gates, Founder
and former CEO of Microsoft, took the decision to focus his business on the internet and
received spectacular rewards. This would have been risky as there was little data available at the
time on projected internet use. Since then, Bill Gates has become one of the wealthiest people in
the world, with his fortune estimated at $91.3 billion in 2018. In 2018, Microsoft’s profits were
$16.6 billion.
However, risky decisions can go badly wrong. In 1985, Coca-Cola had a 100-year history and
sold the world’s most popular soft drink. To celebrate its centenary, the company decided to
introduce the ‘New Coke’, a reformulation of the original soft drink. The decision led to sales
slumping by 20 per cent and Pepsi-Cola became more popular. The decision was reversed but the
costs to the company were considerable.
Some types of decisions are unique and involve situations that managers have not experienced
before. Accordingly, it’s difficult to identify every possible outcome and even harder to establish
the probability of each of these outcomes. This makes it very difficult to assess the degree of risk
and the likelihood of incurring some loss or misfortune. This creates uncertainty. In the first six
months of 2018, investment made by car manufacturers in the UK was £347.3 million compared
to £647.4 million over the same period in 2017. Business analysts believe this 50 per cent fall
was due to uncertainty over the future of the economy created by the UK’s decision in 2016 to
leave the European Union in a process that had been named ‘Brexit’. Car manufacturers are
concerned that it may be more difficult to import components to the UK and export finished cars
to Europe in the future.
If a business takes a decision it normally involves a cost. In 2018, despite the uncertainty caused
by Brexit, the American pharmaceutical company, MSD, decided to invest in a new research
facility in the UK. This facility will require an investment of ‘hundreds of millions of pounds’
and will create 950 jobs. Decisions also have an opportunity cost. By deciding to invest millions
in this way, MSD would have been unable to choose a second best option, for example, to
expand an existing research centre. Opportunity cost is the best option that a manager gives up
in making a decision. Considering and evaluating different options is an important element of
decision making. Managers at MSD would have carefully evaluated their options before deciding
on the UK investment.
Decision making based on data and on
intuition
There are many different ways of making a decision. In some cases managers will research the
decision thoroughly; this means that they will gather data and analyse it before deciding what to
do. In other cases they may rely on their own experience from the past or on their instinct or
intuition. As we shall see, the approach taken will depend on a range of factors.
1. Decision making based on data
When a manager gathers data and analyses it before making a decision this is known as a
scientific approach to decision making. It is scientific because it is rational, logical and based on
data. Many of the mathematical topics you will study as part of this AS or A-level course are
used to help managers analyse the data as part of scientific decision making. In later chapters
you will read about break-even analysis, ratio analysis, investment appraisal and correlation
analysis. All of these management tools, and others, help managers to analyse relevant data to try
and make the right decisions.

Key term
Scientific decision making is based on data and uses a logical, rational approach to
decision making.

Figure 5.2 Factors that can shape decision making

The scientific decision-making process involves:

• recognising that there is a problem or opportunity, that is, recognising that a decision has to be
made
• setting objectives for what you want to achieve
• setting decision criteria and deciding how important each one is
• developing and identifying alternatives
• comparing the alternatives by analysing the available data
• choosing and implementing a course of action
• reviewing the effectiveness of the decision.
A scientific approach to decision making is rational and logical. Decisions are made based on
information, not intuition. This approach is likely if there is high degree of risk that managers are
seeking to reduce or if a major decision is to be taken.
If a scientific approach is adopted then managers need to understand the environment in which
they operate. This means they need to consider the external environment in which the business
operates and which factors within this environment are most significant for the decision they
plan to make. These will vary according to the type of business and the industry of which it is a
part. In the computer software industry, competition is a major influence and businesses must be
aware of possible actions and reactions by rivals to any decisions taken. In the healthcare market,
demographic changes may be a key factor. Managers must identify which factors are most
significant for them.
Managers have a range of ways of collecting data to shape their decision making. Data for
scientific decision making may be gathered, for example, through the internet, customer surveys
or the business’s records. Technology has made it simpler to collect and analyse data, as
illustrated in the example of Tesco plc and its Clubcard on the next page. The use of technology
means that businesses are frequently handling enormous amounts of data to arrive at conclusions
that are likely to be more reliable. Technology makes it easier and more cost effective to collect
and analyse data. Despite these advances, scientific decision making is not foolproof.

The limitations of scientific decision making

We have seen that scientific decision making is logical and rational. If the data is available and is
not too expensive to collect and analyse then its use in decision making makes sense. Managers
have to judge the benefits of a scientific approach to decision making against its expected costs.
For some decisions, such as a small business expanding into a new geographical markets, data
may simply be too expensive to collect.
The data that is available to support decision making may not always be reliable. When
considering launching innovative products it may be difficult to discover customers’ views on a
product that is unfamiliar to them. Steve Jobs, founder of Apple, said that customers did not
always know what they wanted and this could invalidate data gathered from them!
2. Decision making based on intuition, or ‘hunch’
An alternative approach to making decisions is to rely on intuition or ‘hunch’. This means that
managers have to rely on their instinct as to whether to make a particular decision. Intuition or
hunch may be appropriate when data is less likely to be available or managers fear that it may
not be reliable. Other circumstances in which this may be appropriate may include:
• when an important part of a decision is making an assessment of a potential business partner’s
personality or character
• assessing whether an advertising campaign for a new product may catch the attention of
consumers
• where sufficient quantitative data is not available or when the data that is available tells a
contradictory story
• when a quick decision is necessary, leaving insufficient time to gather and analyse the data.
Some very successful entrepreneurs and managers use intuition and hunches to make decisions.
Richard Branson is one manager who believes in the use of intuition, frequently quoting his
maxim: ‘I never get the accountants in before I start up a business. It’s done on gut feeling.’

What do you think?

Should all entrepreneurs rely on intuition rather than advice from professionals when
deciding whether or not to start a business?

Business in focus: Tesco Clubcard

Tesco plc is the UK’s largest retailer and operates in an increasingly competitive
market. In 2018, it reported sales revenue amounting to £57.5 billion and profits of
£1.3 billion despite intense competition from rivals such as Aldi and Lidl. Over 17
million people in the UK have a Tesco Clubcard – the company’s loyalty card. Over
20 million Clubcards are held by overseas customers. Clubcard holders provide
Tesco with details of age, gender and address and may also give information about
their families. Details of the store shopped in, products purchased and price paid are
stored against the holder’s Clubcard account for every transaction. Clubcard provides
Tesco with around 260 billion items of data each year to help its managers to make
scientific decisions.
Clubcard costs Tesco a reported £500 million each year to operate. In return, the data
generated assists Tesco in classifying its customers into different groups or
segments. The information provided by Clubcard helps Tesco to stock the right
products, charge the right prices, promote its existing and new products successfully
and communicate personalised offers to its customers. This information helps the
company to meet its customers’ needs at a time when UK consumers’ shopping
habits are changing rapidly. Tesco is also reported to sell the information it collects to
other businesses for more than £50 million a year.

Practice questions
1 Analyse the reasons why Tesco operates its Clubcard despite incurring costs each
year of £500 million to do so.
(9 marks)
2 Do you think that managers at Tesco no longer need to make any decisions using
intuition or hunches? Justify your view.
(16 marks)
Decision trees
A decision tree is a mathematical model which can be used by managers to help them make the
right decision. Imagine that a manager is trying to decide whether to cut the price of a product or
increase the amount of money spent on advertising or to do nothing. These options are illustrated
in Figure 5.3.

Key term
A decision tree is a model that represents the likely outcomes for a business of a
number of courses of action on a diagram showing the financial consequences of
each.

The square shows that a decision has to be made and the lines coming from it show the possible
choices facing the manager. Note that there is a third line saying ‘do nothing’. This is because
managers always have the option of doing nothing at all so you should always include this as an
option when drawing a decision tree.

Figure 5.3 The first stage of constructing a decision tree

Figure 5.4 Adding possible outcomes to the decision tree

Whenever managers choose a particular course of action such as advertising or cutting the price
there will be a range of possible outcomes. For example, if the firm advertises its products there
may be a big increase in sales or a small increase in sales; similarly if the price is cut this may
have a big or a small impact on sales. These possible outcomes are illustrated on the decision tree
as using circles to denote the existence of chance outcomes, as shown in Figure 5.4. Circles show
that different outcomes are possible; these are then illustrated by the lines coming out of the
circle. These circles are often numbered for ease of identification.
At this stage (Figure 5.4) the decision tree simply illustrates the options and the possible
outcomes. To make it more useful and to help managers make the decision, some numerical data
is needed.
First, in this case, managers need to know how likely it is that the predicted increase in sales will
be ‘high’ or ‘low’ for each option. This is known as the probability of a particular outcome. The
value of the probability can range from 0 to 1. The bigger the number the more likely it is that an
event will happen. If the number is 1 this means the event is certain to happen.

Key terms
Probability is the chance of a particular event occurring.
Expected values are the financial outcomes from a specific course of action adjusted
to allow for the probability of it occurring.
Net gains are the expected values of a course of action minus the costs associated
with it.

Figure 5.5 Probability

If all the outcomes of an event are considered their probabilities must add up to 1. If the
probability of it raining tomorrow is estimated to be 0.4 then the probability of it not raining
must be 0.6. Combined, the probabilities will equal 1 because it must either rain or not rain.

Handling data:
1 An event is said to have a 0.65 chance of occurring. What is the probability of this
event not occurring expressed as a percentage?
2 A business thinks that a new product has a 0.4 chance of being successful. What
is the percentage chance of it being judged unsuccessful?

In Figure 5.6 we have now added the probabilities of each outcome (shown by the number after
the letter ‘P’ in each case). For example, the manager has estimated that if the firm increases
spending on advertising there is a 0.5 chance of a high increase in sales and a 0.5 chance of a low
increase in sales. In other words, there is a 50 per cent chance of a high increase in sales and 50
per cent chance of a low increase. However, in the case of a price cut the manager estimates that
there is 0.8 chance of a high increase in sales (that is an 80 per cent chance) and a 0.2 (or 20 per
cent chance) of a low increase.
We have also added in the estimated benefits of each outcome. For example, if the firm
advertises and there is a high increase in sales the benefit will be an increase in revenue of £10
million. A low increase in sales would increase revenue by £2 million.
The diagram now shows:
• the three possible decisions the firm could take (cutting price, increasing advertising or doing
nothing)
• the outcomes of each one (high sales or low sales)
• the probability of each outcome (for example, 0.8 or 0.2)
• the financial benefits of each outcome – in this case, the effect in terms of extra revenue.
Doing nothing would, of course result in no additional revenue and incur no additional costs.
Calculating expected values for decision tress
The next step is to work out ‘the expected value’ of each decision. This is basically a weighted
average of the outcomes, taking account of the probability of each one occurring. Although the
firm may gain additional revenues of £10 million by advertising, this is only 50 per cent likely,
there is also a 50 per cent chance that it will gain only £2 million extra revenue.

Figure 5.6 Adding probabilities and estimated benefits to the decision tree

So what, on average will it gain? Imagine if this decision was made over and over again. In this
case, 50 per cent of the time the firm would gain £10 million and 50 per cent of the time it would
gain £2 million. This means on average it would gain £6 million.
This can be calculated using the equation:

(where ‘1’ represents the first outcome and ‘2’ represents the second outcome and so on.)
To calculate the expected value we multiply the probability of each outcome with the financial
consequences of the outcome and add them all up. This shows how much the firm would earn on
average if the decision was taken repeatedly.
For the option of cutting price we can see there is an 80 per cent chance of increased revenue of
£8 million and a 20 per cent chance of £3 million rise in revenue. This means on most occasions
the firm would earn £8 million additional revenue but there is a 20 per cent probability of
earning £3 million. Once again we calculate the expected value using the equation:

A price cut has a higher expected value than advertising, so on this basis the manager would
choose this option. The expected values are shown on the decision tree diagram above the
outcome circles; the options that are not chosen are shown using a double crossed line.
Figure 5.7 The decision tree with expected values added

Figure 5.8 The decision tree showing net gains

However, this is not necessarily the final element of calculating and interpreting a decision tree.
It is common for the various options of decision trees to have costs associated with them. Figure
5.8 has added the costs associated with cutting price (changing packaging and price lists, for
example) and for advertising (paying websites and radio stations for their services could be
examples). Figure 5.8 confirms that cutting prices is the preferred decision as it offers a higher
net gain. Net gains are calculated by subtracting any costs associated with a decision from its
expected value.
Once the costs of the two options are included in the calculation the net gain from the two project
is as follows:
Decision Expected value Associated costs Net gains
Cut prices £7 million £1.5 million £5.5 million
Increased advertising £6 million £4 million £2 million
Table 5.2 The financial outcomes of the two options

Handling data
Imagine that the probabilities for two options were different. Suppose that these were
as follows:
• Cut prices: high sales P = 0.6, low sales P = 0.4
• Increased spending on advertising: high sales P = 0.7, low sales P = 0.3.
Recalculate expected values and net gains for the two options using these
probabilities.

Business in focus: Calum’s decision

Lothian Watches Ltd is based in Edinburgh. It was founded by Calum McPhail, who
still owns a majority of the company’s shares. The company manufactures luxury
watches which sell throughout the world at prices in excess of £3,000.
Over the last 18 months there has been a sustained rise in demand for the company’s
watches. This has led to a situation in which the company is unable to meet demand
for its products. Calum has to decide whether to increase production or increase
prices to limit demand to a level that can be fulfilled – he thinks a 20 per cent price
rise will be necessary. Calum could increase production by asking his existing
workers to work longer hours. Many have indicated that they are willing to do so and
this is something that he has done several times before. He strongly prefers this
option as it is familiar.
However, he has conducted research among his customers in the past and thinks he
knows the effect on sales of increasing prices by 20 per cent. Calum’s assistant has
suggested that he uses a decision tree to help him to reach a decision, but Calum can
see problems with this.

Practice questions
1 Analyse whether Calum’s decision is programmable or non-programmable.
(9 marks)
2 To what extent do you think that the use of decision trees will help Calum to make
the correct decision?
(16 marks)
Assessing the value of decision trees
Using decision trees can be very useful for managers when taking decisions for a number of
reasons.
• It makes managers think about the different options they have and consider the possible
consequences of each one. This process may uncover other possibilities that had not been
considered before.
• Using decision trees may result in a more logical, less rushed process based on evidence rather
than gut feeling.
• It forces managers to quantify the impact of each decision considering the forecast costs,
benefits and probabilities of events happening.
• Decision trees provide a logical comparison of the options available to managers at a given
time.
However, decision trees do have various limitations and drawbacks.
• Decision trees only include financial and quantifiable data; they do not include qualitative
issues such as the workforce’s reaction to different options or the impact on the firm’s image.
• Decision trees use estimates of the probability of different outcomes and the financial
consequences of each outcome. The value of decision tree analysis depends heavily on how
accurate these estimates are. Probabilities are often estimates and this makes decision trees
open to manipulation by managers determined to achieve a desired outcome.
• It is difficult to use decision trees effectively when the range of possible outcomes is not clear
and those that can be anticipated can’t easily be quantified. Thus they would be less valuable
in making what Herbert Simon called ‘unprogrammed’ decisions. Equally, they are not well
suited to strategic decisions.
• Some managers may use decision trees, not because they believe in their value, but because
they can be used to justify a decision. In the event of a decision proving incorrect, the
managers may argue that the decision tree supported their judgement.
Influences on decision making
Decisions are not made in isolation. They are subject to a range of influences from outside and
inside the business. Tactical or programmed decisions may be subject to fewer decisions but all
will be influenced by the following factors to some extent.
1. The business’s mission and objectives
Whether a particular decision is right will depend on whether it helps a business to do what it is
there to do. A business’s mission sets out its broad purpose and it may be appropriate to consider
major, possibly non-programmable, decisions against this. Thus buying a rival business may
make sense if the business is aiming to be the dominant business in a market.
Objectives are quantifiable and time-related targets and may be an important influence on
different types of business decisions. For example, it may be appropriate to invest in training the
workforce if a hotel chain has an objective to improve its ratings for customer service by 50 per
cent over the next three years. What is the ‘right’ decision for one business may be the wrong
decision for another because their circumstances and mission and objectives are different.

Figure 5.9 Some influences on decision making

2. Ethics
Ethics can provide moral guidelines for decision making by managers. An ethical decision
means doing what is morally right; it is not merely a matter of calculating the financial costs and
benefits associated with a decision. Some businesses are noted for their ethical behaviour.

Key terms
Ethics are moral principles, which should underpin business decisions and actions.
The external environment comprises those external forces (such as changes in
competition or consumers’ incomes) that can influence a business’s activities.

However, a number of businesses have been accused of taking unethical decisions. These
decisions are not illegal but some would consider them to be morally wrong. For example,
several businesses including Amazon and Starbucks have been criticised for taking decisions that
allow the company to avoid paying some taxes in the UK. In many people’s view, such decisions
are immoral or unethical and this has resulted in some consumers boycotting these businesses.
Ethical factors can therefore have a strong influence on businesses’ decisions especially when a
business’s misdemeanours, whether real or imagined, feature on social media. Information
spreads quickly, having the potential to damage sales and profits. Many businesses consider the
ethical dimension of decisions carefully because they have a genuine desire to operate ethically
and this may form part of their mission. Other companies seek to be seen to be taking ethical
decisions because they wish to avoid the possibility of any adverse publicity.
Xerox, a global producer of printing equipment and software, is a company noted for its ethical
behaviour. In 2018, it was voted one of the world’s most ethical companies for the twelfth
consecutive year. This is an important accolade and helps the company to differentiate itself from
its rivals. Xerox received the award for a range of ethical behaviour including developing
products that combine user-friendliness with low energy usage, reducing carbon emissions. Its
status as an ethical company means that ethics will be a significant influence on decisions at all
levels within Xerox. Being judged to be ethical can also enable even a relatively small businesses
to compete against more powerful rivals.
3. The risk involved
If a manager is taking a high-risk decision (possibly a non-programmable one), they may want to
take steps to reduce the risk by gathering data on which they can base their decisions. A high
level of risk will make managers more cautious and they are likely to gather more data and to
seek advice as necessary.
In contrast, a low-risk programmable decision is more likely to be made relatively swiftly using
intuition or hunch. Such decisions are likely to be more familiar and more able to be quantified
and therefore techniques such as decision trees may be employed.

What do you think?

Should managers try to avoid taking high risk decisions whenever possible?
4. The external environment
We saw in Chapter 3 that a business’s external environment comprises a number of forces
including competition, consumers’ incomes, interest rates, demographic factors and
environmental issues. Changes in any of these forces can have considerable impacts on
businesses, depending on their circumstances.
If a business’s external environment is undergoing substantial change it may lead businesses to
delay or cancel decisions. This may take place because businesses are less able to forecast future
events and the degree of uncertainty surrounding a decision will increase. The response by
businesses to delay or abandon decisions is more likely if the external environment is changing
in unpredictable ways, increasing the degree of uncertainty. Following the financial crisis in the
UK in 2008–09, many house builders delayed decisions to build new homes on land they owned
as consumers’ incomes were falling and demand for houses was falling as a consequence.
In contrast, the sales of fair trade products in the UK rose by 7 per cent in 2017. These are
products for which suppliers are paid a price that enables them to have a reasonable standard of
living, even if it results in higher prices for consumers. This aspect of a changing external
environment may have led the South African wine producer Namaqua to convert some of its
best-known wine brands to become fair trade products.
5. Resource constraints
All managers want to make the best decisions. To do so, managers need the necessary resources,
such as information, time, labour and materials, to be available. However, most managers do not
have all these resources available all the time. For example, they may have insufficient finance or
time, or may not have the most accurate information. As a result, they have to satisfice. This
means to make the best decision possible with the available resources.
The amount of resources to be invested in the decision will also have an effect on its outcome. If,
for example, the decision concerns the purchase of new production equipment and involves
hundreds and thousands of pounds, a manager will probably research the decision very carefully.
With an unfamiliar decision involving high levels of resources, managers would not want to risk
getting it wrong. If, however, the decision simply involves ordering some supplies for the
business the manager might be more inclined to rely on their experience and to order quickly.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 Which stage is missing from the decision-making process shown here: setting
objectives, selecting the chosen option, implementing the decision, reviewing.
2 What is meant by the reviewing stage of the decision-making process?
3 What is the difference between risk and uncertainty?
4 What is meant by the term opportunity cost?
5 What is meant by the term scientific decision making?
6 State one circumstance in which making a decision based on intuition or hunch
might be appropriate.
7 What is meant by the term decision tree?
8 What is the expected value from the following situation?
A decision has two outcomes:
• Outcome 1 has a probability of 0.35 and an estimated benefit of £100,000.
• Outcome 2 has a probability of 0.65 and an estimated benefit of £70,000.
• The costs associated with the decision are £25,000.
9 Is the following true or false: estimated benefit × probability = net gain?
10 State one factor that might influence a manager when taking a decision.

(b) Short answer questions

1 Explain why unique decisions may be risky.
(4 marks)
2 Explain two limitations of scientific decision making.
(5 marks)
3 Explain why a manager might decide to use a decision tree to assist in making a
decision.
(5 marks)
4 Explain why managers taking decisions might be influenced by ethical factors.
(5 marks)

(c) Data response questions

Helen Earthy owns and manages an art gallery, which she operates in the hope of
encouraging and supporting local artists. She opened this business after many years
in management roles with public limited companies where she acquired a reputation
as a calm, logical and rational manager. She sells works of art that she has produced
as well as those of other local artists. Recently her sales and profits have declined.
She is considering how to improve the financial performance of her business – this is
essential to maintain her living standards.
After much thought and research into the costs and benefits of various actions, Helen
has been able to collect a lot of quantitative information. Based on this she has
narrowed her possible options down to two: to open her gallery for longer hours, or to
sell in shops locally as well as the gallery. Both will incur extra costs – but selling
elsewhere will be expensive. Helen believes that this is a suitable situation in which to
use a decision tree and has constructed the one shown in Figure 5.10.
Helen has taken her time over this decision but knows she has to decide what to do
soon; her accountant is pressing her to make a decision. Her decision is affected by
the resource constraints she faces but also by other factors such as the rapid growth
in population and income levels in nearby towns.
1 Calculate the net gains for:
a opening longer hours (3 marks)
b selling in local shops (3 marks).
(6 marks)
2 Analyse the possible reasons why Helen chose to use decision trees to assist with
this decision.
(9 marks)
3 To what extent would resource constraints be the major influence on this decision?
(16 marks)
Figure 5.10 Helen’s decision tree

(d) Essays
1 Do you think developments in information technology mean that scientific
approaches to decision making will become increasingly important in the future?
Justify your view.
(25 marks)
2 Do you think that the external environment will always be the most important
influence on decision making in businesses where the main objective is growth?
Justify your opinion.
(25 marks)
Chapter 6 Understanding the role and
importance of stakeholders
Introduction
This chapter builds upon the theme of decision making covered in Chapters 4 and 5.
Stakeholders are an increasingly influential element in decision making at all levels within
businesses. This chapter identifies the stakeholder groups that commonly exist, their power and
interests, their needs and objectives and how businesses manage their relationships with
stakeholders.
What it is important to know by the end of this chapter:
• why businesses consider stakeholders’ needs when making decisions
• stakeholder objectives and possible overlap and conflict of these objectives
• influences on the relationship with stakeholders
• how to manage the relationship with different stakeholders.
Stakeholders
Stakeholders are individuals or groups within society who have an interest in an organisation’s
operation and performance. Stakeholders include shareholders, employees, customers, suppliers,
creditors, the government, competitors and the local community. The interest that stakeholders
have in a business will vary according to the nature of the group.
Stakeholders can be classified as shown below.
• Primary stakeholders. These are individuals or groups that are affected by a particular
business activity, such as a decision to increase production. This category of stakeholders
includes customers, employees, creditors or anyone else with a functional or financial interest
in the business.
• Secondary stakeholders. These groups and individuals do not have direct functional or
financial relationships with the business although they are affected by, or can influence, its
actions. Examples are the general public, local communities, activist groups and the media.

Figure 6.1 Examples of a business’s stakeholders

It is also possible to categorise stakeholders as internal and external. Internal stakeholders are
those that are considered to be a part of the organisation, such as employees, shareholders and
managers. In contrast, external stakeholders exist outside the business. Examples are
governments and suppliers.
Stakeholders needs
Any business has a number of stakeholder groups with interest in its affairs. Table 6.1 identifies
some of the major groups and some of the needs that they might be expected to have.
Stakeholder group Possible nature of stakeholders’ needs
1. Shareholders • Steady return on investment in form of dividends
• Investment that does not lose value
• Preferential treatment as customers – for example, lower
prices
2. Employees • Steady and regular income
• Safe working conditions
• Job security
3. Customers • Reliable supply of goods
• Clear pricing policies
• Safe products
• After-sales service and technical support
4. Suppliers • Frequent and regular orders
• A sole-supplier agreement
• Fair prices
5. Creditors • Repayment of money owed at agreed date
• Profitable returns on investments
• Minimal risk of failure to repay money owed
6. The local • Steady employment
community • Avoidance of pollution and noise
• Provision of facilities (e.g. parks or arts centres) for local
community
Table 6.1 Stakeholders and some of their needs
Over recent years, businesses have become much more aware of the differing expectations and
objectives of their stakeholder groups. Previously, managers operated businesses largely in the
interests of the shareholders. A growing awareness of business activities among the general
public has complicated the task of the management team of a business. Today’s managers must
attempt to meet the conflicting demands of a number of stakeholder groups.

What do you think?

Some managers in companies consider shareholders to be the most important
 stakeholder group. Do you think that they are right to believe this?

The terms stakeholders and social responsibility are interrelated. Social responsibility is a
business philosophy proposing that firms should behave as good citizens. Socially responsible
businesses should not only operate within the law, but should avoid pollution, the reckless use of
limited resources or the mistreatment of employees or consumers. Some businesses willingly
accept these responsibilities, partly because their managers want to do so and partly because they
fear a negative public image. We consider social responsibility more fully later in this book.

Key term
Social responsibility is a term describing the duties a business has towards
stakeholder groups such as employees, customers and the government.
Stakeholder mapping
Managing stakeholders effectively is an important part of taking successful decisions. Analysing
the position of stakeholders as part of the decision-making process is important and mapping on
the basis of stakeholders’ power and interest can help managers to consider decisions in relation
to stakeholders’ needs and their ability to influence it.
Analysing stakeholders in this way enables managers to consider important questions such as
whether they should involve the stakeholder group in a decision, consult on their views or simply
advise them of what is to happen?
When taking decisions managers need to think about the relative power of stakeholder groups
that may be affected by the outcomes. A well-organised, highly unionised workforce operating
on a single site may, for example, be able to negotiate for more participation and influence on
decision making than could individual employees working alone in scattered locations.
Similarly, managers in a business may listen carefully to a shareholder that owns 60 per cent of
the company’s shares and is keen to see a good return on this investment.
Figure 6.2 shows how categorising stakeholders on a power-interest grid can guide managers on
how to treat different groups. We will consider each quadrant of Figure 6.2 in turn.
1. Quadrant A. This is not a powerful group of stakeholders. They could be businesses that
supply small quantities of low-value materials or a customer group that purchases small and
declining amounts of the business’s products. Managers do not need to worry too much about
this group and may only update them using general communications such as newsletters and
the business’s website. Minimal effort is required.
2. Quadrant B. This group of stakeholders does not have a huge amount of power either but is
interested in the business’s activities. It could be a group of residents close to a manufacturing
business, who are concerned about the impact of the business’s operations. Managers should
keep this group informed on its interest area and may choose to consult on specific low-risk
matters with this group. Careful management here may enhance the business’s reputation and
generate goodwill.
3. Quadrant C. This area of the map represents powerful groups who do not have a great
interest in the company’s activities. This group could include investors who are only
interested in high financial returns. It is important for managers to engage and consult with
this group and possibly aim to increase their level of interest. Businesses that involve
stakeholder groups in their activities can benefit from different perspectives and expertise as
well as receiving favourable publicity for encouraging their involvement.
4. Quadrant D. These are the most powerful and interested stakeholder groups and are likely to
have a major influence on management decisions. This group could include a customer who
purchases a high proportion of the business’s products and only wants to deal with reliable
and ethical suppliers. Managers need to keep this group happy, possibly by involving this
group in decision-making processes.
Figure 6.2 A stakeholder map

Stakeholder maps do not illustrate a static situation. Levels of interest and degrees of power may
change over time. For example, the power of a strongly unionised workforce could be reduced
by laws that limit the activities of trade unions. Equally, a relatively uninterested local residents’
group may become very interested if a local business opts to install a large number of wind
turbines nearby to generate electricity. Alternatively, rapid increases in demand for products may
increase the power of suppliers if their materials and components are judged to be increasingly
scarce and difficult to acquire.
Overlapping and conflicting stakeholder
needs
Stakeholder groups have different objectives, which will at times conflict. Equally, on other
occasions the objectives of stakeholders may coincide. Table 6.2 summarises the possible effects
on a selection of stakeholders arising from decisions commonly made by managers. You can see
that some of these decisions generally favour certain stakeholder groups and create
disadvantages for others. For example, a decision to raise prices is unlikely to offer many
benefits to customers, although the rise could be necessary in the light of improvements to the
good or service. However, a price rise does offer shareholders the very appealing possibility of
rising profits, dividends and share prices.
On the other hand, shareholders may be concerned about the launch of new products, especially
if the decision is risky as it may damage the business’s financial performance. Customers will
generally approve, however, as they receive a greater choice of products and the new launch may
be very innovative and appealing. This decision may also have positive effects for employees if
it increases the security of their jobs, or offers increased working hours or the prospects of
promotion and/or higher pay rates.
In Table 6.2, the green text shows broadly favourable impacts while the red text illustrates when
stakeholders may be disadvantaged. This figure illustrates that some decisions can benefit more
than one stakeholder group, while disadvantaging others. However, the precise impact will
depend upon the circumstances.
It is important to note however, that these effects depend on circumstances and the actions and
reaction of certain stakeholders. For example, a small increase in price may have relatively little
impact on a business’s stakeholders, especially if competitors are also increasing prices. The
impact of a price increase on stakeholders may be reduced to some extent if the product is a
necessity and competitors are taking similar actions. The well-publicised decisions of many
energy companies in the UK to raise prices substantially for gas and electricity have created an
outcry. However, due to the nature of the products, the impact on the employees, shareholders,
suppliers and creditors has been limited as demand has remained fairly constant, despite
customers’ attempts to reduce usage. In these circumstances, the conflict in stakeholder
objectives is between those of customers and many other stakeholder groups. Energy customers
want lower prices, whereas other stakeholders benefit from higher prices.

Business in focus: Hearst Magazines UK

In response to unprecedented growth in mobile readership, some UK magazines are

responding by creating innovative new services that enhance the experience of
reading their content through mobile devices. Hearst Magazines UK has developed
new mobile products for its magazines Elle and Company. It’s also hoped that the
publisher will be able to capitalise on this area of growth, following a 70 per cent
increase in online traffic seen across Hearst Magazines UK’s portfolio of titles.
 Consumers are increasingly choosing to access magazine content digitally, with 30
per cent of Elle’s readership and 45 per cent of Company’s now reading on a mobile
or tablet. In-house teams at Hearst developed the new products. For Elle they
produced the Elle Fashion Cupboard, which is designed to be played with and the
content is updated every 45 minutes. The Company Weekly Edit app delivers the
content readers want directly to their phones.
As well as being great products for readers, Hearst also hope that their new apps will
provide new avenues for advertisers and brand partners to engage with readers
through targeted campaigns. By 2019, the company’s apps were downloaded over 52
000 times each month. The most popular were Elle and Cosmopolitan.
Chief operating officer at Hearst Magazines UK Anna Jones said: ‘We are dedicated
to pursuing all of the amazing opportunities presented by mobile. Hearst’s work with
brand partners and advertisers in this area is already achieving impressive results,
and we anticipate strong revenue growth in this area.’ The approach appears to have
been successful. By early 2019, the company had become the UK’s largest digital
publisher with its products reaching one in every four adults in the UK.

Practice questions
1 Analyse the reasons why the interests of customers and employees may overlap in
these circumstances.
(9 marks)
2 Was the decision to launch new mobile products taken mainly in the interest of the
company’s shareholders? Justify your view.
(16 marks)

Similarly, the launch of some new products in industries such as computer games or software
may have a limited impact on stakeholders as this occurs regularly in such industries and can be
essential as existing products become obsolete. This may result in the objectives of stakeholders
overlapping as the decision fulfils those of a number of groups.
In contrast, the decision of some other consumer product businesses to launch a new product
could have a notable impact on many of the company’s stakeholders and may have the potential
for conflict. A new product may offer consumers increased benefits but the associated price rise
could be prohibitive for many. Shareholders may be content at the rise in share price and profits
that may accompany a successful launch, while competitors may bemoan a large decline in sales.
Employees and suppliers could benefit from increased workloads but large rises in sales and
revenue may reduce the company’s need for creditors. For example, Apple has been subject to
complaints by consumers that its computers, tablets and other products are overpriced.
Table 6.2 shows that certain decisions appear to benefit particular stakeholder groups and not
others. However, this may depend on the objective on which the managers’ decision was based.
For many years, the so-called budget airlines such as EasyJet have cut their operating costs
whenever possible with the objective of increasing sales and revenue. This has been enormously
successful. When the airline was launched in 1995 it carried 30,000 passengers during the year;
the equivalent figure for 2017 was over 81 million. The objective of the decision to operate with
low costs per passenger or flight, and to subsequently reduce them, was to achieve a growth in
sales rather than simply higher profits for the business. With this objective many of the
company’s stakeholders have benefited from more jobs, cheaper flights, increased orders for
supplies, higher levels of tax paid on profits and rising share prices. A decision to simply cut
costs to increase profits might be expected to create conflict in terms of stakeholders’ objectives.
If successful, it could be expected to benefit shareholders, while other stakeholders such as
customers and employees could be disadvantaged. This is less pronounced when cost reduction
is associated with a policy of growth.
Area of Employees Customers Shareholders Suppliers Creditors
decision
More jobs New Investment Possibility Borrowing
available. products needed may of larger or increases,
Possibility available. cut short-term more making
of Increased profits. regular repayment
Expand orders. more
production promotion production Share price
difficult.
and higher may reduce and long- Expectation
pay. prices. term profits of reduced Increased
could prices. profitability.
increase.
Pressure to Lower May increase Expectation Reduced
reduce prices profits, of reduced need for
wages. possible. dividends prices. borrowing
Longer Quality of and share May seek from
working goods or price. alternative creditors.
hours and services may Customers low cost Need to
less be reduced. may dislike job supplier. borrow
favourable losses and short term
Cut costs conditions. reduced to finance
Jobs may quality, cost-cutting
become less reducing programme.
secure. sales, revenue
More jobs & profits.
may result
if
successful.
Possibility Less value Profits, Possibility Increased
of received. dividends of receiving profits may
increased Products no and share higher support
wages or longer prices may prices. prompt
improved affordable. increase. Orders may repayment
working Competitors Sales may fall if price of debts.
Raise conditions. raise prices decline. rises reduce Falling sales
prices Sales too. Adverse demand may threaten
decline, publicity if this significantly. repayments.
 resulting in is an essential
job losses. product,
reducing share
price.
More jobs Greater Initial costs of Increased Increased
may result. choice of launch may orders if need to
Higher pay products. reduce profits. product borrow
and better Improved Risk of successful. funds to
working products unsuccessful New product finance
conditions, bringing product may may require launch.
if launch greater damage profits different Rising long-
successful. benefits. and share supplies term profits
Launch Prices may price. resulting in enhances
new increase to Increased loss of ability to
products cover sales, prices contract. repay loans.
development and profits May lead to
costs. could boost further
medium-term product
profits and launches,
dividends. creating
further need
for
borrowing.
Jobs lost as Lower Initial Orders Increased
technology prices as investment received need for
plays larger technology may reduce for new borrowing
role. more profits and supplies or to finance
New efficient. dividends. for the purchase of
higher-paid Services May lead to technology. technology.
jobs available for higher long- Increased If
created to longer term profits sales may successful,
Use more
manage hours. and rising result in enhanced
technology
technology. Standardised share prices. larger ability to
in
products Business’s orders. repay
production
may be less image may Lower borrowing.
likely to meet suffer due to production
individual job losses costs may
needs. damaging reduce
share price. pressure to
find
cheaper
supplies.
Table 6.2 Some possible positive and negative impacts of a range of decisions on selected
stakeholders
Influences in the relationships with
stakeholders
Businesses take a variety of different approaches to their relationships with stakeholders. Some
give meeting the needs of all stakeholders as fully as possible priority, while others focus on
meeting the objectives of key stakeholder groups such as shareholders.

Key terms
Market conditions refers to number of features of a market, such as the level of
sales, the rate at which they are changing and the number and strength of
competitors.

Business in focus: High Court supports controversial

chicken farm plans

The High Court has approved plans for an intensive chicken farm near Bridgnorth in
Shropshire in spite of local residents’ worries about the impact of the business on
their lives.
Matthew Bower plans to rear over 1.5 million chickens each year in buildings on his
farm. This level of production will generate over 2,250 tonnes of chicken manure each
year which will be spread on the farm’s fields as well as that of neighbouring farms.
Many local residents opposed the plans which were controversial. It was estimated
that hundreds of people lived in close proximity to the farm. One local resident, Nicola
Squire, said that Shropshire County Council had approved the plans for the scheme
to raise the chickens because it only considered the smell from the buildings housing
the poultry. She claimed that local residents would be badly affected by the smell
resulting from spreading chicken manure on local fields.
However, Judge Rhodri Price Lewis QC ruled in July 2018 that there was nothing
unlawful about Shropshire Council’s decision to allow the scheme to go ahead.

Practice questions
1 a Identify one stakeholder group in this scenario that has a high level of interest
and a high level of power and one stakeholder group that has a high level of
interest and a low level of power.
(2 marks)
b Explain the reasons for your choice.
(4 marks)
 2 Do you think that the use of stakeholder mapping would have helped Matthew
Bower to have gained planning permission for the chicken rearing scheme by
reducing opposition? Justify your decision.
(16 marks)

What do you think?

Is it always easier for managers to handle relationships with stakeholders if the
business is profitable?

A number of internal and external factors that influence these relationships.

1. Internal factors
(a) Business objectives
A business’s objectives may, arguably, have the strongest influence on its relationship with its
stakeholders. A business committed to pursuing ethical or social objectives would naturally give
a high priority to meeting the objectives of as many stakeholders as possible. This would have
significant implications for its decision making. The Co-operative Group is one of the UK’s
largest retailers and operates other businesses, including funeral services and an insurance
company, with strongly ethical principles. The Co-operative Group gives its customers and
employees a say in how the business is managed, seeks to protect suppliers by selling a wide
range of fair trade products and funds projects in many of the communities in which it operates.

Figure 6.3 Factors influencing a business’s relationships with its stakeholders

In contrast, a business that is focused on maximising its profits or achieving rapid rates of growth
may have a very different relationship with its stakeholders. Such businesses may seek to
minimise costs to enable it to make the maximum profit or to allow it to offer lower prices to
facilitate higher sales. This may entail making decisions that do not meet the objectives of many
stakeholders. These could include paying minimal wages, ignoring the needs of local
communities whenever possible and charging prices that some consumers might consider
excessive. Trading with objectives to maximise short-term profits may also limit the willingness
of the business to engage in communication and consultation with certain stakeholder groups.
However, communication could be an uncomfortable activity if stakeholders feel their needs are
not even being considered, let alone met.

(b) Management and leadership styles

In Chapter 4 we looked at the range of different management and leadership styles that may be
used within a business. Managers who take an autocratic approach are likely to focus less on the
objectives and needs of employees, especially in terms of non-pay issues such as the amount of
delegation they allow or the extent to which employees are permitted to play a part in making
decisions. Other stakeholders, including shareholders and local residents, may find that they have
little or no opportunities to shape management decisions and may feel that their interests are not
considered or met by the business’s management team. This lack of involvement or
communication can result in resentment and unnecessary opposition to decisions.

Business in focus: The Freedom Bakery

The Freedom Bakery has been trading since 2014. It was initially located in a prison
near to Glasgow. In 2016, it took the decision to expand and moved into a purpose-
built bakery on the edge of Glasgow city centre. The Bakery operates with the
objective of selling luxury bread and cakes in what is a very competitive market. The
business offers, in the words of its founder, Matt Fountain, ‘a range of fully organic
artisan “real” bread, plus a few delicious surprises…’

Figure 6.4 The Freedom Bakery products

The business is distinctive for a number of reasons. Firstly, it is a social enterprise.

The bakery provides jobs and training to those who were recently in prison. However,
unlike many social enterprises, the bakery puts 65 per cent of its profits back into the
business and its social aim is to assist offenders. The remainder of the company’s
profits will be paid to its investors and shareholders who will inevitably view it as a
commercial enterprise rather than a social activity. The Freedom Bakery is also
unique in that instead of using its social mission as a basis for promoting the
business, it emphasises the quality of its product range. This is a strategy rarely
followed in social enterprise and responds to the growing consciousness of retail
businesses for personal and social agendas in marketing objectives.
Despite this, Matt Fountain is steadfast in his commitment to paying his employees a
living wage, accepting his responsibilities to protecting the environment, as well as
meeting the needs of his stakeholders. He sees his business as a new type of social
enterprise that focuses on its products and the profits it can make by selling these to
protect its ability to achieve social targets.
Source: Adapted from the Guardian, 12 February 2014 and The Freedom Bakery website 2018
 Practice questions
1 Analyse how the objectives of the Freedom Bakery could affect its relationships
with its stakeholders.
(9 marks)
2 Do you think that it is possible for Matt Fountain to meet the objectives of all of the
bakery’s stakeholders? Justify your decision.
(16 marks)

In contrast, other management styles may be based on greater democracy or involvement and a
concern for the wellbeing of employees. This is likely to foster a better long-term relationship
with employees but the openness and belief in two-way communication may also have
significant implications for other stakeholder groups. Most stakeholders would benefit from
efficient communication and consultation as well as opportunities to play a part in decision
making. Many businesses profess to engage stakeholders in this way, though a smaller number
do so effectively.
David Solomon was appointed as the new CEO of the global investment bank Goldman Sachs in
2018. He is described as ‘a tough manager’. He is expected to centralise authority within the
bank which had previously been dispersed across a large management committee. His leadership
style could have a profound effect on the bank’s relationship with its stakeholders.

(c) The size and ownership of the business

For some small businesses it can be simpler to communicate with and involve stakeholders in
decision making simply because there are fewer of them. A sole trader may have a harmonious
relationship with its stakeholders because the owner knows many of them personally and
communicates with them regularly. They are able to shape this relationship as they wish without
being influenced by other owners in the business.
At the other extreme, a large public limited company may develop different relationships with its
stakeholders because of its legal structure. Some boards of directors may be under intense
pressure from powerful shareholder groups to maximise short-term profits. This could result in a
series of decisions that alienate other stakeholders. For example, the company may press
suppliers to reduce prices by threatening to move to competitors, refuse to negotiate with trade
unions to avoid paying higher wages and acquire a poor reputation for customer service by
failing to employ and train sufficient numbers of staff.
2. External factors
(a) Market conditions
A number of factors determine the market conditions faced by a business. These factors include
the level of sales, the rate at which they are changing and the number and strength of
competitors. In turn, the conditions a business encounters in the markets in which it trades may
influence its relations with stakeholder groups. A business facing particularly intense
competition from rivals may deliberately opt to engage more closely with stakeholders such as
customers, employees and suppliers to establish a distinctive reputation for meeting the needs of
stakeholders as fully as possible. This may help it to compete with other businesses that may be
more established or financially stronger, or simply to be distinctive.
Ernst & Young (known as EY) is a large global company supplying professional services such as
accountancy, auditing and advice on taxation issues. It promotes itself as focusing strongly on
the needs of its stakeholders by supporting the communities in which it works as well as
protecting the environment. This helps it to differentiate itself from powerful rivals such as
Deloitte and KPMG.
In some markets one or two businesses may be dominant, which can have implications for
stakeholder groups such as suppliers. In the UK, a number of large supermarkets have received
criticism for imposing tough conditions on suppliers under the threat of withdrawing their
custom if these are not complied with. This can lead to suppliers receiving low prices or facing
overly stringent quality checks. A business that dominates a market may also be able to exploit
consumers by failing to offer value for money if realistic competition does not exist. This can
also occur if a few large firms dominate a market and appear to collude on pricing, for example.
The six major suppliers of gas and electricity in the UK have faced claims of charging excessive
prices recently.

(b) The power of stakeholder groups

Some stakeholder groups have considerable power to impact on the activities and success of a
business. For example, large pension funds and insurance companies invest people’s savings in a
range of ways, including buying shares in public limited companies. Because of the size of their
shareholding they can become very influential and managers are conscious of their likely
reactions when making decisions. Over 70 per cent of shareholders, including influential pension
funds, voted against a pay deal for the senior managers at Royal Mail, the UK postal company, in
2018. They considered the proposed pay settlement excessive and this vote may impact
significantly on future decisions on management pay.
Similarly, businesses have to manage relationships with major suppliers and customers
effectively. Some management teams may seek to avoid becoming too reliant on a single
supplier for fear of the business gaining too much influence over decisions. In this circumstance
a threat to delay supplies or to stop supplying could be worrying, especially if the supplier deals
with many other businesses. Equally, a major customer could have considerable influence over a
business’s decisions on pricing and product range and may wish to be the sole seller of some
products.
(c) Government policies
The UK Government has a substantial influence on the way in which a range of businesses
manage relationships with their stakeholders. It uses laws and less formal codes of conduct to
guide businesses in their relationships with suppliers, customers, employees and local
communities. For businesses operating in industries that were previously owned and operated by
the Government, such as rail services, energy supply and water services, these controls can be
extensive, including restricting their ability to raise prices.
We will consider the impact of the law and government policy in later chapters.
Managing relationships with stakeholders
Managers can reduce the likelihood of opposition by stakeholders to a business’s actions and
decisions through communication and by involving them in the decision-making process to
some extent. This approach to managing interested parties is called stakeholder engagement.

Key terms
Communication is the exchange of information or ideas between two or more
parties.
Stakeholder engagement is a process by which managers involve individuals and
groups who may be affected by their decisions in those decisions.
Consultation is a process by which one groups discovers the views of another one.
Stakeholder mapping and stakeholder
management
Managers can use a variety of techniques to engage stakeholders in the activities and decisions of
the business. These can range from communicating about the business and its activities with
stakeholders to forming a partnership to share decision making and responsibility for a particular
project. Deciding the appropriate level of engagement will depend on an assessment of the power
of the stakeholder group, its level of interest in the decision or project and the resources
available.

Figure 6.5 Using the outcome of stakeholder mapping to select the stakeholder engagement approach

Source: www.stakeholdermap.com/stakeholder-engagement.html
Although the various methods of engaging stakeholders set out below are all valid, engaging
stakeholders will be more efficient and cost effective if it is used alongside stakeholder mapping,
which was discussed earlier in this chapter. Mapping allows managers to select and use means of
engagement that are appropriate for the degree of power and level of interest held by the relevant
stakeholder. The greater the power and level of interest a stakeholder exhibits, the more closely
managers may choose to engage them in the decision-making process. Figure 6.5 summarises the
approaches that are possible and relates them to stakeholder power and interest.
Possible approaches to stakeholder management
1. Partnership
This is the method that will involve the stakeholder group most closely in the decision or project.
A partnership may mean that decisions are taken jointly by the management team and the
relevant stakeholders and that the subsequent actions will also be implemented together.
Responsibility will be shared and this approach will inevitably involve a great deal of two-way
communication.

Figure 6.6 The Crossrail project in London will provide a new East-West railway line across the capital
from 2020, at a forecast cost of £17.6 billion. Many of the large construction companies responsible for
the project are working in partnership with smaller specialist suppliers.

It is therefore most suitable for stakeholders that have considerable power and interest in the
project or decision in hand. It may be worth the business concerned investing substantial
resources in the partnership. A business that is undertaking a major construction project might
involve its main suppliers in a joint planning and construction process to utilise their expertise
and to share responsibility for the project.

2. Participation
This is really a lesser form of partnership. Stakeholders will still be a part of the relevant team
and involved in decision making. They may have responsibility for a part of the activity and may
implement that part of the decision. They are likely to be engaged in extensive two-way
communication for that element of the decision or activity for which they have some
responsibility.
This is possibly more suited to stakeholder groups that have high power but a relatively low level
of interest. It may be used with powerful stakeholders who have a higher level of interest. For
example, major customers might be invited to carry out roles in the design stage of the
development of a new product. This might be a relevant engagement approach for an aircraft
manufacturer redesigning the interior of its aircraft.
3. Consultation
Consultation in this context means finding out the views of the relevant stakeholder groups. It is
not unusual for such consultation to be carried out within guidelines set by the business, and with
the business shaping the consultation process. Stakeholders will be expected to respond to
questions and, although there will be two-way communication, stakeholders will have limited
power to influence decisions and subsequent actions.
Consultation might be used when stakeholders have high interest but relatively low power. A
house construction company might consult with local residents on certain aspects of a plan to
build new homes in a locality, but only permit this to take place in relation to certain (perhaps
less controversial) elements of the proposal.

4. ‘Push’ communications
This form of engagement entails one-way communication from the business to relevant
stakeholder groups. Communication methods such as emails, podcasts, mailshots or letters may
be used. This approach is suited to stakeholders with low levels of power and mainly low levels
of interest in the project or decision in question. A business, possibly a licensed restaurant, may
opt to use this approach to inform local residents of its intention to open for longer hours each
evening.

5. ‘Pull’ communications
The final category of engagement communicates with stakeholder groups but only if they choose
to engage with the business and access the communication. This would be most appropriate for
stakeholder groups with little power or interest in a decision. Managers might choose this
approach to advise a minor supplier of its intention to adopt a new brand image for some of its
products. This is unlikely to have much impact on this particular stakeholder, provoking little
interest on their part.
Summary
A business’s relationship with its stakeholders can be handled efficiently and cost-effectively
using an approach that starts with stakeholder mapping to analyse the stakeholders’ degree of
power and level of interest. The results of this analysis can then be used to determine the most
suitable and cost-effective approach to stakeholder engagement.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 What is meant by the term stakeholders?
2 State two examples of primary stakeholders and two examples of secondary
stakeholders.
3 State two needs that customers may have as stakeholders.
4 Is the following statement true or false? ‘In the past, managers in companies
tended to operate largely in the interests of their stakeholders.’
5 State the two factors relating to stakeholders that are commonly measured on a
stakeholder map.
6 Using the stakeholder map (Figure 6.2), indicate which quadrant of the grid the
following stakeholder would be classified; a shareholder of a company with only a
few shares but who monitors the company’s activities closely.
7 State two objectives that suppliers may have in their relationship with a business.
8 State two possible positive impacts on stakeholders following a decision by a
business to reduce its costs.
9 State two internal factors that might influence a business’s relationships with its
stakeholders.
10 Is the following statement true or false? ‘Consultation is the most appropriate way
to engage high power, high interest stakeholders.’

(b) Short answer questions

1 Explain why the objectives of employees and customers might overlap if a business
decides to expand production.
(4 marks)
2 Explain one reason why the situation revealed by a stakeholder map may change
over time.
(5 marks)
3 Explain one way in which a business’s management or leadership style might
influence its relationship with its stakeholders.
(5 marks)
4 Explain why managers may want to involve stakeholders who are key players in
making a particular decision.
 (5 marks)

(c) Data response questions

Sinai Ltd is a construction company that has been awarded a contract to repair, renew
and extend the sewer system in a large town in Lincolnshire over a two-year period.
This is a large contract, worth £21.2 million, and will require the company to raise £2
million initially to fund it. Sinai Ltd will need to use the specialist services of other
companies, for example, for tunnelling and for managing health and safety risks.
These are likely to be very costly, though some suppliers provide important and
scarce services that are essential to the project.
The company has to decide how much of the work it should undertake itself and the
extent to which it should employ other businesses to carry out some activities. Making
good quality decisions is important because there is the possibility of winning further
contracts for similar projects.
The management team is uncertain of the extent to which it should involve the
company’s stakeholders in this decision and, if so, which ones. The chief executive
favours inviting employees, suppliers and the customer to participate in the decision-
making process, while others believe that all stakeholders are not the same and they
should form a partnership with suppliers for this project.
1 Explain why Sinai Ltd should consider the needs of its employees when making this
decision.
(5 marks)
2 Analyse the possible benefits and drawbacks to Sinai Ltd of inviting its stakeholders
to participate in decision making in these circumstances.
(9 marks)
3 Do you think that the company should form a partnership with all of its suppliers for
this project? Justify your decision.
(16 marks)

(d) Essays
1 To what extent is it more difficult for managers in a public limited company to meet
the needs of stakeholders than managers in a sole trader business?
(25 marks)
2 The business’s objectives are the most important influence on the relationship
between a multinational company and its stakeholders. Do you agree? Justify your
decision.
(25 marks)
Revision Section: Unit 2 Managers,
leadership and decision making
Advice for Unit 2
Top tips … Things to avoid …
Investigate the styles of leadership Do not simply assume that some leadership
and management used by senior styles are always good while others are
figures in businesses and consider always bad. Remember, that it depends on
why they might have adopted their circumstances such as the skills,
particular styles. Why have they experience and motivational levels of the
been successful – or workforce.
unsuccessful?
Decision making is a fundamental When writing on stakeholders it is important
element of this unit – the decision- to focus on the most important groups and
making structure underpins the not to write about too many different
units on the internal functions of stakeholders. You should be selective in
business (marketing, finance, choosing the most important and influential
human resources and operations). stakeholders. Stakeholder mapping may
Each of these units looks at help you to do this.
objectives, gathering and
analysing information and options
on which decisions can be made.
Understanding this should help
you in studying these four internal
functions.
Although you need to know how to It is not uncommon for students to confuse
calculate expected values and net the terms ‘stakeholders’ and ‘shareholders’.
gains it is also important for you to Try not to do this!
understand the situations in which
decision trees are of value and the
strengths and weaknesses of the
technique
If a case study includes a decision
tree, do consider the reliability of
the data source used to prepare it.
This may help you to judge the
value of the decision tree in given
circumstances.
UNIT 2 CHECKLIST
Having completed studying this unit you should be able to do all that is listed below.
You should read this list and confirm that this is the case.
Think about the topics in this unit in relation to different types of businesses and
industries. For example, when is the use of decision trees particularly valuable to
businesses? This will help you to prepare for analytical and evaluative questions.
Learning objective
Understanding management, leadership and decision making
Know and understand:
• the roles of managers within a business
• the types of management and leadership styles that may be used within a business
• the Tannenbaum and Schmidt continuum of leadership styles and the Blake
Mouton grid
• the effectiveness of different styles of management and leadership.
Understanding management decision making
Know and understand:
• how data (scientific decision making) and intuition can be used to take decisions
and the value of using these approaches in different circumstances
• risks, rewards, uncertainty and opportunity cost in relation to decision making
• decision trees
• how to calculate expected value and net gains on a decision tree
• how decision trees are used in decision making and their value in making decisions
• the factors that influence decision making by leaders and managers
• the stakeholders who have an interest in a business and their needs in relation to
the business.
Understanding the role and importance of stakeholders
Know and understand:
• how stakeholders’ needs may conflict or overlap
• how managers and leaders may consider stakeholders’ needs when making
decisions. Understand the model of stakeholder mapping and how this may be
used
• factors which may influence the relationships between businesses and
stakeholders
• how managers and leaders should manage relationships with stakeholders,
including the use of communication and consultation
• how to develop relevant arguments and make and support judgements, as
analytical and evaluative questions can be asked on the topics covered in this unit.
Practice questions
1 Explain one reason why an autocratic style of management may become less
effective as a business grows.
(4 marks)
2 Explain one reason why a business with a ‘country club style leader’ (Blake Mouton
grid) might have a low level of labour productivity.
(5 marks)
3 A decision tree has two options. Option A has an expected value of £4 million and
associated costs of £1.75 million. Option B has a 0.8 probability of generating
profits of £3 million and a 0.2 probability of profits of £5 million. Its associated costs
are £0.5 million.
a Calculate the net gain for Option A.
(2 marks)
b Calculate the net gain for Option B.
(3 marks)
c State which option has the highest net gain.
(1 mark)
4 A café is extending its opening hours. To advise its minor suppliers of this change it
has used ‘pull’ communications rather than consultation. Explain why it may have
done this.
(6 marks)
5 A manufacturing company has decided to automate its production line. Select two
stakeholder groups and analyse why this decision may have both good and bad
effects on the groups.
(9 marks)
Case study: Hitachi takes decision to move
rail business to Europe
Hitachi is a Japanese multinational engineering and electronics company with
headquarters in Tokyo. Hitachi is a highly diversified company that manufactures a
wide range of products and sells them throughout the world. Hitachi operates eleven
business divisions, and is a public company, listed on the Tokyo Stock Exchange.
Hitachi faces intense competition, often from companies that specialise in particular
markets such as the manufacture of trains. The company spends heavily on
researching and developing new products and employs around 2,700 people in its
research activities.
Hitachi Rail Europe
In 2014, Hitachi took the decision to move its profitable rail subsidiary Hitachi Rail
Europe to the UK. This company manufactures high technology trains, which are sold
in the UK and across Europe as well as Japan. The headquarters of the business
moved from Tokyo to London. A UK citizen, Alistair Dormer, was appointed as CEO of
HRE with control over its global operations. Relocation to the UK brought senior
managers closer to its factory, which is sited at Newton Aycliffe in the North East of
England. In 2018, Hitachi completed further construction at Newton Aycliffe. Hitachi’s
total investment in the site now exceeds £100 million and employs nearly 1,000
people.
Number of employees (2018) 303,887
Revenue for the financial year ending March 2018 £65,517
million*
Profit for the year (2017–2018) £1,617 million
Hitachi’s profits as a percentage of revenue, 2018 2.47%
Number of companies with which Hitachi has joint ventures, March 388
2018
Investment in researching and developing new products, 2017–18 £2,621 million
* ¥ yen converted to £ sterling using exchange rate during September 2018.
Table U2.1 Selected key data for Hitachi
Plans are in hand to open a University Technical College to help to provide local
people with the necessary skills to work for HRE and its suppliers.
One business analyst commented that it was an unprecedented move for a Japanese
company to relocate to the UK and it must reflect a high level of faith by Hitachi’s
senior managers in Japan in the skills and commitment of its UK workforce. However,
the decision affects relatively few jobs in Japan.
In 2012, HRE won a £1.2 billion order from the UK’s Department for Transport to build
intercity trains for the UK rail network on top of a £5.8 billion order that was already
agreed. This resulted in much criticism in the media and among the general public that
a company that was not British was allowed to win such a large contract from the UK
Government. A spokesperson for Hitachi said that this relocation of the company
would end any criticism that HRE is not sufficiently British.
HRE employs over 2,500 people and this is forecast to increase. Its revenue in 2017–
18 was £1,350 million. The company has set itself an objective of growth and its
relocation to the UK is expected to help with this. It has bid for a very large £7 billion
contract to build trains for the proposed High Speed 2 (HS2) line from London to
Manchester and the North. The UK government expects trains using HS2 to be
environmentally friendly. The company has a heavy manufacturing workload and is
delivering major orders for new trains, with 281 ordered by customers due to be in
service by 2021.
This decision to relocate HRE to the UK is a major long-term one and some thought it
was highly risky. However, the company carefully researched the possible outcomes
of this decision and judged risks against likely benefits. Hitachi has not said whether
any decision-making techniques were used as part of the decision-making process.
Hitachi Rail Europe and Bombardier agree joint project
In 2018, HRE and Bombardier a confirmed they intended to submit a joint bid to
design, build, deliver and maintain a fleet of high-speed trains for the HS2 route. HRE
and Bombardier are a tried and tested high speed train team, having already
successfully delivered one of Europe’s fastest trains in Italy. The proposed partnership
provides a world class team that has established manufacturing and servicing centres
throughout the UK. The collaboration brings together the necessary expertise in
building and maintaining high-speed trains.
The two companies agree on ethical principles. They will focus on creating long-term
employment in the UK and reducing environmental impact of their activities. A
previous train built by the two companies used 85 per cent recycled materials and the
joint bid for HS2 will include the latest noise reduction technology.
Practice questions
1 Analyse the possible reasons why profit is important to Hitachi.
(12 marks)
2 Analyse the benefits to Hitachi of using a democratic style of management
throughout its entire business.
(12 marks)
3 Do you think Hitachi Rail Europe’s decision to enter the joint project with
Bombardier in 2018, rather than on its own, was taken solely due to resource
factors. Justify your view.
(16 marks)
4 Some analysts thought that Hitachi’s decision to move its rail division to the UK was
highly risky. To what extent do you agree?
(20 marks)
5 Assess the value to Hitachi’s managers of the use of decision trees in making the
decision to move its HRE business to the UK.
(20 marks)
6 Do you think it is impossible for a business to satisfy all of its stakeholders when
making a major location decision? Justify your view.
(20 marks)
Essay questions
1 ‘Democratic leadership is essential if a business is to maximise its profits.’ To what
extent do you agree with this statement?
(25 marks)
2 ‘Attempting to meet the needs of stakeholders as fully as possible is certain to
reduce the competitiveness of a business.’ To what extent do you agree? Justify
your view.
(25 marks)
Chapter 7 Setting marketing objectives
Introduction
In this chapter we will consider what is meant by the marketing function and what activities are
involved in marketing. We will consider typical marketing objectives and the factors that might
influence what objectives are set.
What it is important to know by the end of this chapter:
• what is meant by marketing and marketing decision making
• typical marketing objectives such as sales volume, sales value, sales growth, market share and
brand loyalty
• how to analyse internal and external influences on marketing objectives and decisions.

Figure 7.1 The functions of business

Marketing
The marketing function of a business provides the link between the customer and the business.
This means that marketing managers need to understand the nature of the market they are
operating in and feed back this information to the other functions of the business such as
operations.

Figure 7.2 Marketing: the link between the business and the consumer

Marketing involves a mutually beneficial exchange process. The business provides a good or
service in exchange for something else – usually money. Note that the process should be
beneficial for both sides. The business itself gains from the transaction – for example, it may
gain profit – and the customer gains satisfaction, for example, from buying something that they
regard as good value for money. Ideally the marketing exchange is a win-win situation, where
both sides gain and therefore want to trade again.

Figure 7.3 A mutually beneficial exchange process

What do you think?

‘Make something people want. When you look at why companies fail it’s normally
because they don’t have enough customers.’ Drew Houston, founder of Dropbox. Do
you think having ‘enough customers’ will guarantee that a business succeeds?

Marketing aims to satisfy or ideally delight customers so they want to come back for more.
Marketing is not about one off transactions but about building a relationship with customers so
they are loyal to your organisation, will return for more and will be more willing to try other
products you offer. A bank, for example, wants to build a relationship with you so it helps
finance the various stages of your life such as university study, getting married and buying a
home. A bank will want you to buy a range of financial products from it over time, such as:
• a savings account
• a loan
• insurance for your house and possessions
• shares
• currency exchange.
Relationship marketing attempts to build long-term partnerships with customers; it aims to
retain customers and build the connections with the business – for example, getting the customer
to use the business for a wider range of services.

Key term
Relationship marketing is an approach to marketing in which a company seeks to
build long-term relationships with its customers by providing consistent satisfaction. It
focuses on customer retention rather than one off sales.

What do you think?

Why do you think marketing managers are more focused on relationship marketing
these days than they were in the past?

One of the great writers about marketing is Philip Kotler. Kotler defines marketing as ‘the art and
science of choosing target markets and getting, keeping and growing customers through creating,
delivering and communicating superior customer value.’
• It is a science because it is data driven; marketing managers will try and make decisions based
on evidence.
• It is an art because it has a creative element to it, for example, in determining how to
communicate the benefits of the product.
• It involves choosing the right target markets.
• It is about building relationships so that customers are retained and end up buying more over
time.
• It involves developing a product offering that is better value for money than rivals and being
able to communicate and deliver this.

What do you think?

Do you think marketing should be more of a science than an art? Why do you think
marketing is different from just ‘selling’ a product?
What is a market?
A market occurs when there are buyers and sellers. At any moment in the UK there are people
who want to sell their houses and there are people who want to buy them – this creates the
housing market. Similarly, there is a market for currency, shares, clothes, holidays, in fact for
almost anything you can imagine. The nature of these markets inevitably varies. A taxi company
provides a service for local customers, a coach company may operate nationally whereas oil is
traded globally. Some businesses sell via intermediaries – for example, newspapers are sold via
retail outlets whereas other business, such as restaurants, sell direct to customers. Many products
are sold online but you cannot buy a haircut online. It is important therefore for managers to
understand the nature of their market. Examining the particular characteristics of the market is
known as ‘market analysis’.

Key term
Market analysis involves examining the particular characteristics of a market such as
market size and growth.

Figure 7.4 The housing market

Decision making to improve performance in
marketing
The process of marketing decision making involves:
• setting marketing objectives
• understanding what customers want and can afford
• understanding the conditions in the market
• understanding what the capabilities and strengths of the business are relative to competitors
• understanding how best to deliver the benefits that customers are willing to pay for and in
ways where the business earns suitable returns
• implementing marketing decisions
• reviewing.
This process is iterative, meaning that managers will regularly be going backwards and forwards
from one stage to another. For example, the market analysis may provide information that leads
managers to change their objectives. As marketing decisions are made, more information may be
required leading to more marketing analysis. The process is also ongoing. The review stage
means that having seen what happened after certain decisions were made, managers may take
different actions next time.

Figure 7.5 The marketing process

This model suggests that marketing decisions are driven by data. Marketing managers collect and
analyse the data to make decisions. It is certainly true that if marketing managers are asking for
funds to invest in promoting products or to develop new products the senior managers are very
likely to want data to justify the investment. However, it is possible that hunch sometimes
influences decisions. Steve Jobs, the founder of Apple, is said to have been sceptical of data
gathered from customers, believing that his designers had a better idea of what people would
want in the future than the customers would!
Marketing decisions will help improve performance by ensuring that the business continues to
meet customer needs and wants and therefore the benefits it offers remains competitive.
Marketing will help identify the opportunities, develop the right offering, ensure the benefits are
communicated and that customers can access it. It should ensure the ‘right product, at the right
place, at the right price and the right time’.

What do you think?

Do you think there is any point in Apple asking customers what they want?
Some people wrongly say that marketing is just advertising. Explain why this is wrong.
Ethics and marketing
Like all decisions, making marketing decisions will involve ethical issues. For example:
• Should a business promote its products at children to get them to pester their parents to buy
them toys?
• Should a business produce and promote a harmful product such as alcohol or cigarettes?
• Should a business that produces a new drug for a serious illness charge high prices because it
can, or should it make it more widely available at a lower price?
• Should a business distribute chocolate near schools, given the levels of obesity in the UK?
The activities above are all legal; the question is whether owners and managers feel it is right to
undertake them.

What do you think?

Can you think of three other examples of ethical issues that might arise in marketing?

Key term
Business ethics refer to whether the actions of a business decision are perceived as
morally right or wrong.

Business in focus: The Earth’s most customer-centric

company

When Amazon.com launched in 1995, it was with the objective ‘to be Earth’s
most customer-centric company, where customers can find and discover
anything they might want to buy online, and endeavours to offer its customers the
lowest possible prices.’
This objective continues today, but Amazon’s customers are worldwide now, and
have grown to include millions of Consumers, Sellers, Content Creators, and
Developers & Enterprises. Each of these groups has different needs, and we
always work to meet those needs, innovating new solutions to make things
easier, faster, better, and more cost-effective.
In the 2017 Annual Report, Jeff Bezos, the founder of Amazon, said:

Congratulations and thank you to the now over 560,000 Amazonians who come
to work every day with unrelenting customer obsession, ingenuity, and
commitment to operational excellence. And on behalf of Amazonians
everywhere, I want to extend a huge thank you to customers. It’s incredibly
 energizing for us to see your responses to these surveys.
One thing I love about customers is that they are divinely discontent. Their
expectations are never static – they go up. It’s human nature. We didn’t ascend
from our hunter-gatherer days by being satisfied. People have a voracious
appetite for a better way, and yesterday’s ‘wow’ quickly becomes today’s
‘ordinary’. I see that cycle of improvement happening at a faster rate than ever
before. It may be because customers have such easy access to more information
than ever before – in only a few seconds and with a couple taps on their phones,
customers can read reviews, compare prices from multiple retailers, see whether
something’s in stock, find out how fast it will ship or be available for pick-up, and
more. These examples are from retail, but I sense that the same customer
empowerment phenomenon is happening broadly across everything we do at
Amazon and most other industries as well. You cannot rest on your laurels in this
world. Customers won’t have it.
How do you stay ahead of ever-rising customer expectations? There’s no single
way to do it – it’s a combination of many things. But high standards (widely
deployed and at all levels of detail) are certainly a big part of it. We’ve had some
successes over the years in our quest to meet the high expectations of
customers. We’ve also had billions of dollars’ worth of failures along the way.
Source: Amazon Jobs website

Practice questions
1 Analyse the benefits to Amazon if it meets the needs of its customers effectively.
(9 marks)
2 ‘A business should always aim to produce what customers want.’ To what extent
do you agree with this view?
(16 marks)
Marketing objectives
Marketing objectives are the targets set for the marketing activities of a business. Like any
objective, these should be specific in terms of what the objective relates to, measurable in terms
of there being a numerical target and time specific in terms of there being a date by which the
target needs to be achieved.

Key terms
A marketing objective is a measurable and time specific target set for the marketing
function; for example, to increase sales by 10 per cent within 3 years.
Sales value measures the level of sales in a given period in terms of the amount
spent.
Sales volume measures the level of sales in a given period in terms of units sold.
Market share measures the sales of one brand or business as a percentage of total
market sales in a given period.
Sales growth is the percentage change in sales volume or value over a given period.
Market growth is the percentage change in the total sales in the market over a given
period.

Figure 7.6 Possible marketing objectives

Marketing objectives might include:

1. Sales volume and sales value targets
Sales can be measured in terms of:
• Sales value – the value of sales is measured in terms of how much is spent on a product, for
example, sales of £30,000.
• Sales volume – the volume of sales is measured in terms of the number of units sold, for
example, sales of 200,000 kg or 5 million cans.
2. Sales growth targets
Managers will not just set targets for a given level of sales volume or value, they will also want
to measure how much they are increasing. For example, a target may be to increase sales volume
by 5 per cent over the next three years. The rate of growth expected will depend on many factors
including the growth rate of overall sales in the market. If the market is growing fast, at 10 per
cent for example, it is more likely that a manager will set a relatively high sales target for her
business. If the market is growing slowly it may be more difficult for a manager to increase the
growth of her own sales. Of course, the growth rate will depend on the actual level of sales.
When a business starts out it can be relatively easy to grow quickly because the numbers
involved are so small. If sales are £10,000 it is possible to achieve 50 per cent growth by
increasing sales to £15,000. However, if sales are high to start with it is more difficult to grow
quickly. If sales are £20 million then to achieve 50 per cent growth requires another £10 million
sales.

Handling data
To calculate the percentage growth in sales, use the following formula:

For example, if sales increase from £40,000 to £50,000 this is a growth rate of

Note: if the growth rate is negative this means that sales are falling.
If you are given the percentage market growth and the original market size, it is
possible to calculate the new market size.
To calculate what x per cent of a number is, use the following formula:

For example, if a market is worth £40,000 but is expected to grow at 5% then we

need to calculate 5 per cent of £40,000 and add it on to find the new market size.
So 5% of £40,000 is:

The new market size is therefore £40,000 + £2000 = £42,000.

1 If the market size increases from £50,000 to £60,000 what is the growth rate?
2 If a market is worth £400,000 and grows by 5 per cent, what is the new market
size?

Handling data
Figure 7.7 Volume of the UK video game software market, 2013–2018

Source: Mintel Video Games and Consoles - August 2018

1 What was the market growth in the sales video game software volume of UK
software between 2013 and 2017?
2 Why would marketing managers be interested in the growth rate of a market?

Handling data
Sales growth
Three years ago = 3%
Two years ago = 10%
Last year = 0%
This year = −4%
With reference to the data above, explain what is happening to the absolute level of
sales over the four years.
3. Market share
The market share of a product measures the amount it sells as a percentage of the total sales of
the market. It is given by the equation:

For example, if your product has sales of £400,000 and the total market sales are £4,000,000 then
the market share is

Market share is often given as a target rather than the absolute level of sales because it reflects
what is happening in the market overall. For example, increasing your sales by 5 per cent might
initially seem good. However, if sales for the market as a whole increase by 30 per cent, your
business is actually losing market share because your sales are not growing as fast as others. If an
objective had been set in terms of maintaining market share this would mean the marketing
manager needs to increase sales at the same rate as competitors.
Managers might want a high market share because this suggests:
• relatively high sales and therefore possibly profit (depending on costs)
• relatively high outputs; this may give the business power over suppliers and other partners –
this may enable it to negotiate better deals in terms of lower prices or better quality
• relatively high prominence in the market; this may raise the profile of the business, strengthen
the brand and make launching new products easier.

Figure 7.8 Market share

Handling data
If the market share of a product is given it is possible to calculate the size of the whole
market. For example:
Brand A has sales of £120,000, which represents a 20 per cent market share.
To calculate the size of the whole market we can:
• calculate 1 per cent of the market
• multiply by 100 to calculate 100 per cent (that is the whole market).
So if 20 per cent of the market is £120,000 we divide by 20 to calculate 1 per cent:

Then we calculate 100 per cent by multiplying by 100:

1 If the sales of brand X are £40,000 and this represents a market share of 8 per
cent, what is the size of the market as a whole?
2 If a business sells £80,000 and has 2 per cent of the market, what is the size of the
market as a whole?
4. Brand loyalty
Retaining customers is often an important aspect of marketing. Managers will want to measure
how many customers return to use the business again, that is how brand loyal customers are.
Keeping customers is easier and cheaper than having to attract new ones and so brand loyalty is
an important measure for managers especially if they are trying to build a relationship with
customers. Brands are also valuable and may be sold later – the stronger the loyalty the more it
may be possible to gain from the sale.

What do you think?

Can you think of the marketing objectives that the marketing manager of a hotel chain
might set?
How might the marketing objectives affect the other functions of the business?
The value of setting marketing objectives
The value of setting marketing objectives is that it helps to coordinate activities within the
business. In a large organisation, for example, the marketing divisions may have many
employees working in different areas, such as researching the market for new product ideas,
promoting products, managing communications about the product and selling the product to
intermediaries such as retailers. If the objectives are clear it helps to clarify what the priorities are
(where time and money should be spent) and how everyone is contributing to the overall target.
Marketing objectives will also be valuable to the other functions, as they will determine other
decisions such as staffing levels, production capacity and levels of investment. For example, an
ambitious market share objective may involve expansion and require more production capacity
and more employees.
Influences on marketing objectives
Marketing objectives will be influenced by both internal and external factors.

Figure 7.9 Internal and external influences on marketing objectives

Business in focus: The UK soft drinks market

The UK carbonated drinks market refers to fizzy soft drinks such as Coca-Cola and
Pepsi. The data below shows the size of the market and sales of companies within
the market.
Total
£m
2013 7,171
2014 7,343
2015 7,618
2016 7,877
2017 8,116
2018 (est) 8,499
2019 (fore) 8,795
2020 (fore) 8,991
2021 (fore) 9,271
2022 (fore) 9,533
2023 (fore) 9,782
Table 7.1 UK value sales of carbonated soft drinks, by retail and on-premise 2013–23
Source: Mintel

2017/18
Value £m
Coca-Cola (CCE) 656
Diet Coke (CCE) 470
Pepsi Max (PepsiCo) 344
Pepsi (PepsiCo) 222
Coca-Cola Zero Sugar (CCE) 162
Fanta (CCE) 157
Irn-Bru (AG Barr) 136
Schweppes (CCE) 126
Dr Pepper (CCE) 95
Other 620
Own-label 497
Total 3,485
Table 7.2 The UK carbonated soft drinks market
Source: based on IRI/Mintel

Practice questions
1 Calculate the percentage change in the UK value of sales of carbonated soft drinks
2013–2018.
(2 marks)
2 Calculate the estimated change in the UK value of sales of carbonated soft drinks
between 2018 and 2023.
(2 marks)
3 Calculate the market share of Coca Cola Enterprises (CCE).
(2 marks)
4 If you were a new business launching a brand in this market, what do you think
would be a realistic objective for market share by the end of the first five years?
Explain your reasoning.
(16 marks)

Handling data
Index numbers
Data, such as marketing research information, is often provided in the form of index
numbers. Index numbers show relative changes – they show the percentage changes
in data and this saves the reader having to work this out for herself.
Index numbers have a base point and then shows how data has changed relative to
this point.
For example, in the table below the index data shows the sales of a product:
Year Sales
2015 100
2016 105
2017 120
2018 90
Table 7.3
We can see that relative to 2015 (which is our base i.e. our starting level of sales):
• sales have increased by 5% in 2016. There is an increase of 5 out of 100, i.e. 5%
• sales have increased by 20% in 2017. There is an increase of 20 out of 100, i.e.
20%
• sales have decreased by 10% in 2018. There is a fall of 10 out of 100, i.e. 10%.
Notice that we do not know what the value of the sales is, what we do know is the
percentage change.
Look at the data in Table 7.4 which relates to the UK footwear market.
Total Index
£m
2013 8,255 67
2014 9,257 75
2015 9,980 81
2016 10,928 88
2017 11,802 95
2018 (est) 12,380 100
2019 (fore) 13,013 105
2020 (fore) 13,642 110
2021 (fore) 14,280 115
 2022 (fore) 14,928 121
2023 (fore) 15,584 126
Table 7.4 UK footwear sales, at current and 2018 prices, 2013-23
Source: Mintel Footwear Retailing data
The base year is 2018.
This data shows:
• the value of sales was 5% less in 2017 than in 2018
• the value of sales is forecast to be 5% higher in 2019 than 2018
• the value of sales is forecast to be 26% higher in 2023 than 2018.
Index numbers therefore save the reader time because the percentage change in the
data, relative to the base (starting) point, is shown.

Internal influences on marketing objectives and decisions

The internal influences on the marketing objectives and decisions set by managers include:
• the overall strategy of the business. If this is focused on growth, for example, the target level of
sales might be higher than if the strategy was to maintain the size of the business.
• the ambitions of managers. Ambitious and optimistic managers may set high and demanding
marketing objectives because they want to push the business forward.
• the existing position of the business. For example, if sales are £2 million then an increase to
£2.2 million within a year may be a more realistic objective than if sales at the moment are
£2,000. If the brand reputation is strong then a customer satisfaction target of 97 per cent may
be realistic but if the brand reputation is weak then it may be unrealistic. The objectives may
be less demanding.
• the amount the business can produce. If the capacity of a business is 200,000 units a year it
cannot set a sales target of more then this unless it outsources some of its production.
• finance. For example, the amount of promotional activity to make customers aware of the
product’s benefits that can be undertaken may be limited by finance.
• the employees of the business. This may affect the quality of design or customer service or the
range of services that can be provided and therefore the target level of sales.

Key terms
Internal influences on marketing objectives and decisions refer to factors within the
business such as employees and operational resources.
External influences on marketing objectives and decisions refer to factors outside of
the business such as the state of the economy.
Figure 7.10 Internal influences

External influences on marketing objectives and decisions

The external influences on marketing objectives and decisions include changes in the world in
which marketing operates will affect all of its activities, from who to target and how to
communicate with them to what it actually offers. For example, a business such as eBay was
only founded in 1995 and could not have existed much earlier than that because the technology
did not exist. It now has over 175 million active buyers globally. Snapchat, Instagram and
Netflix are only possible due to technological change; the same is true of Google Adwords and
online payments.
As technology has spread, with more online buyers, this has enabled these businesses to set ever
higher sales targets.
Changes in the external business environment can be analysed using the PEST-C framework.
These letters refer to Political (including legal), Economic, Social, Technological and
Competitive factors.

Figure 7.11 External influences on marketing objectives and decisions

• The political and legal environment determines what is allowed by law. For example, in
recent years there have been increasing restrictions on the packaging, promotion and
distribution of cigarettes. Meanwhile, Brexit (the UK’s decision to leave the European Union
(EU)) may well result in trade being more difficult with EU countries. This can affect
marketing targets that relate to what is sold where.
• Economic change. For example, changes in the economy affect how much customers can
 afford to pay for items. In 2008, the UK economy went into a recession, which meant that
incomes fell; many customers switched to lower priced supermarkets such as Aldi and Lidl
and away from Waitrose and Tesco. Globalisation and the growth of emerging economies
such as Indonesia, Nigeria, Turkey and Vietnam create new growth markets to target. Again
this will influence marketing objectives such as the expected sales in different markets.
• Social change is affecting customers’ views of what is acceptable and what they expect from
product and a producer. For example, there has been growing interest in the ethics of
businesses; there is greater concern over issues such as how employees are treated in the
business, suppliers and how the product is produced – for example, is it produced in an
environmentally friendly manner? In the fishing industry, for example, there is concern over
the way fish are caught, given some endangered species are also caught in the net as ‘bycatch’;
customers are often interested in the fishing method that has been used. John West has a code
on its cans that allow customers to track exactly how it was caught. There has also been many
population changes around the world such as growth, increased movement to the cities in
many countries, and an ageing population in some regions. This prompts changes in demand
and the marketing decisions made. For example, with bigger populations, overall demand may
be higher for food products and housing. With an aging population, there may be less demand
for nightclubs and more demand for healthcare products. All of these affect the likely targets
set by marketing managers for different products in different markets.

Key term
Globalisation refers to the increasing trade between countries and the growing
internationalisation of businesses.

Figure 7.12 Cigarettes with plain packaging

What do you think?

What changes do you think there might be in demand patterns if there is an ageing
population in a country?

• Technological change is affecting how businesses communicate with customers and track
 their behaviour, what they are offering them, how customers order products, how products are
reviewed and even where ideas for new products come from as customers are invited to submit
their own designs and ideas.
• The competitive environment. The degree of competition in a market affects the range of
options open to customers and what a business might have to offer to match its rivals. For
example, the internet is making it easier for customers to find alternatives which might force
some businesses to be more price competitive and improve the benefits they offer. The travel
and insurance industries have been transformed by the competition created by the internet.
Going online reduces costs for many businesses and enables them to reach wider audiences
globally.

What do you think?

Can you think of any more external factors that might influence the marketing
activities of businesses in the housing market? Which of the PEST-C headings do
they fit under?

The PEST-C framework is useful when analysing an industry and will highlight the specific
issues within that industry. If we take the housing market, which we introduced earlier, factors in
the external environment that might affect marketing objectives and decision making include:
• Political/legal:
• laws on how contracts are enforced
• regulations on the information sellers must provide to potential buyers
• regulations on where houses can be built and how they can be designed.
• Economic:
• the cost of borrowing money for a mortgage (which is a loan to buy a house); this will affect
the number of people able to buy a house
• incomes in the economy and the number of people in work; this will affect demand.
• Social patterns. These changes affect the typical size of house required (for example, a family
house or a retirement home) and the number of people looking for houses. Urbanisation occurs
when people move to the cities from the countryside, which affects the demand for housing in
different areas.
• Technological. Technological change will make it easier to promote your house for sale online
and for buyers to find information on the houses that are available and on what the area is like.
• Competitive. If more building businesses enter this market this will put pressure on existing
firms to offer better value housing.

Handling data
Figure 7.13 Proportion of the UK population in different age bands (2017)

Source: Mintel

Figure 7.14 Household size for the over 55s, by age, May 2017

Source: Mintel

Figure 7.15 Technology product ownership, by age, December 2016

Source: Mintel
Figure 7.16 Trends in how respondents would describe their financial situation, June 2017

Source: Mintel
1 Calculate the proportion of people aged 15 to 44 in the UK.
(2 marks)
2 Calculate the proportion of people ages over 44 in the UK.
(2 marks)
3 Which proportion of 55- to 64-year-olds have:
a a laptop
b a smartphone?
(2 marks)

What do you think?

Choose a product you know such as cars, football teams or mobile phones. What do
you think are the key factors in the external business environment that might affect
the marketing of this product? What factors might change for a business to set an
objective of increasing sales by 30 per cent in the next year? What factors might
make a business set an objective of reducing sales?

Key models and theories: PEST-C

The PEST-C model helps managers analyse the external environment of their
business. PEST analysis considers the Political, Economic, Social and Technological
factors. The ‘C’ considers the competitive environment. This structure helps managers
to categorise the different factors and help to analyse the external environment.
Managers must then assess the relative importance of each factor and consider
whether they create opportunities or threats.
Handling data
Figure 7.17 shows how some retailers have maintained their position in the UK
grocery markets, while others gain market share and some lose.

Figure 7.17 Market shares: The Big Four grocery multiples vs the discounter, 2010–17

Source: Mintel
1 What happened to the market share of the big four grocery retailers from 2011 to
2017?
2 What happened to the market share of the discount grocery retailers from 2011 to
2017?
3 Why do you think these changes occurred?

Handling data
Figure 7.18 The UK grocery retail market 2016

Source: Mintel
1 Which business has the biggest market share of the grocery retail market?
2 What is the market share of the largest four retailers?

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 Explain two ways of measuring the size of a market.
2 State two possible marketing objectives.
3 State two external factors that might influence the marketing activities of a
business.
4 State two internal factors that might influence the marketing activities of a
business.
5 Sales last year were £60,000; sales this year are £80,000. Calculate the sales
growth.
6 Give the equation to calculate market share.
7 If the growth rate of a market is –2 per cent what would this mean?
8 If sales rise from £250,000 to £300,000 what is the sales growth rate?
9 Sales growth last year was 3 per cent. This year it is 1 per cent. Sales have fallen.
True or false? Explain your answer.
10 If the market share of a business increases, its sales must be increasing. True or
false? Explain your answer.

(b) Short answer questions

1 Explain one way in which brand loyalty might benefit a clothes retailer.
 (5 marks)
2 Explain one external factor that might influence the marketing objectives set by a
tobacco business.
(5 marks)
3 Explain one internal factor that might influence the target number of visitors at an
entertainment park.
(5 marks)
4 Explain one factor that might affect the target market share of a business entering
the car insurance market in the UK.
(5 marks)
5 Explain how effective relationship marketing might benefit a bank.
(5 marks)

(c) Data response questions

Figure 7.19 Consumer expenditure through sports goods retailers, by retailer share, 2015

Source: Mintel, Sports Goods Retailing, July 2016

The data in Figure 7.19 refers to the sports goods market. Businesses competing in
this market include Sports Direct and JD Sports in 2016. This market has been highly
competitive in recent years.
1 Explain one possible advantage to Sports Direct of having a relatively large market
share.
(6 marks)
2 Analyse the external factors in the business environment that might affect the
marketing of sports good retailers.
(9 marks)
3 To what extent do you think it would be easy to enter this market and gain a 5 per
cent market share within three years? Justify your answer.
(16 marks)

(d) Essays
1 To what extent do you think the main influence on the marketing objective of a
business is likely to be competitors’ actions? Justify your answer.
(25 marks)
2 To what extent do you think that marketing managers should worry about the ethics
of their decisions?
(25 marks)
Chapter 8 Understanding markets and
customers
Introduction
In this chapter we will consider how businesses gather information to inform their marketing
decision making. Making better decisions enables a business to be more competitive. We will
examine the difference between primary and secondary marketing research and the use of
techniques such as correlation and extrapolation.
What it is important to know by the end of the chapter:
• explain what is meant by marketing research
• compare and contrast the value of primary and secondary marketing research
• explain the difference between qualitative and quantitative data
• use market mapping
• evaluate the value of sampling
• analyse the significance of positive and negative correlation
• be able to explain the significance of confidence intervals and extrapolation
• analyse the value of technology in gathering and analysing data for marketing decision making
• interpret price and income elasticity data and assess the value of these concepts
• evaluate how data is used in decision making and planning.
Marketing research
To decide what are realistic marketing objectives and how best to achieve them a business needs
to understand its market. Managers will want information to reduce the risk of making decisions.
To gather this information they will use marketing research. Marketing research involves
gathering and analysing data relevant to the marketing process.
Marketing research may be used for different purposes such as:
• analysing the existing position of the business; for example, the size of the market, trends in
the market and the sales and strengths of competitors
• deciding on possible marketing objectives
• identifying possible actions that could be taken
• deciding on the actions to take and how best to implement them
• assessing how effective marketing decisions have been.
Marketing research and decision making

Figure 8.1 The uses of market research in decision making

The marketing research process
The process of marketing research is to:
• identify and define what it is the business wants to find out
• decide on how to gather the data (this might depend on factors such as the amount of money
the business is willing to spend on gathering data, how long it has to gather the information
and how accurate the findings have to be)
• gather the data
• analyse the data
• interpret the findings and present them to inform decision making.

Key term
Marketing research involves gathering and analysing data relevant to the marketing
process. According to the American Marketing Association ‘Marketing research
specifies the information required to address marketing issues, designs the method
for collecting information, manages and implements the data collection process,
analyses the results, and communicates the findings and their implications.’

Figure 8.2 The marketing research process

Marketing research and the customer
One of the purposes of marketing research is to understand customers in detail.
Marketing research should provide an insight on the following:
• Who buys? The person who buys the product may not be the same as the person who
consumes. For example, parents may buy food, clothes, shoes and toys for their children.
Marketing managers need to understand who is involved in the buying process.
• What they are buying? Sometimes this may not be as obvious as it may seem at first. Bicycles
and perfume may be bought mainly as presents, newspapers to find out about sport, chewing
gum to help give up smoking.
• When are they buying? For example, some products may be seasonal and bought at certain
times of year (such as suncream in the summer and pop up tents during the festival season);
some products may be bought on specific occasions (such as flowers on Mother’s Day and
Valentine’s Day and laptops before the university year starts). Market researchers will also be
interested in when you first start thinking about a purchase – for example, you may look at
universities in the first year of sixth form – as this means they know when to target you in
terms of communications.
• Why are they buying? There are many reasons why people buy products. Some people buy
chocolate to reward themselves; others buy chocolates because they are feeling unhappy and
want to cheer themselves up.
• Who do they ask for information before buying? If you were buying a holiday, for example,
who would you ask for information? Where would you search for reviews? When choosing a
university, where would you look for information and whose opinion would you value?
• Where are they buying? This relates to how to distribute products. Do customers prefer to buy
online or in store – are there some things you prefer to by in an outlet? Where do they expect
to find the products? How far would they travel to buy them?
• What factors influence the decision to buy? The buying process for some products can be quite
complex and many different factors are involved. Think about buying a new car. You might
consider the price, the fuel consumption, the way it looks, the brand reputation, the colour, the
boot space, the number of people it fits in and many other factors. As shown in Table 8.1,
some of the different factors are organised under different categories:
• Personal: Is it a brand you want to be associated with?
• Economical: What will it cost to buy and run? What can it be sold for later (residual value)?
• Social: How will the car be viewed by others? Is it fashionable? Is it a well-known brand?
• Technical: What are the features and specifications of the car? Will it last?
Figure 8.3 The 6 Ws of market research

Figure 8.4 Understanding the consumer

Personal Economic Social Technical

Self image Price Status Reliability
Ethics Value for money Social norms How long it lasts
 Emotional links Running costs Fashion Features and specifications
How it performs
Table 8.1 Factors that influence customer decisions on whether to buy
Marketing research and competitiveness
Marketing research can provide managers with the information they need to make good
marketing decisions. If they understand their customers well, for example, they know what
products to develop, what benefits to offer and how to communicate them. This should enable a
business to provide better value for money than competitors.

Key term
Competitiveness measures the extent to which a business offers good value for
money relative to competitors. A business is competitive if it offers better value for
money than rivals.

Business in focus: Attitudes towards bottled water

Figure 8.5 Attitudes towards bottled water, December 2017

Source: Lightspeed/Mintel

Figure 8.6 Important factors influencing the choice of unflavoured bottled water, December 2017

Source: Lightspeed/Mintel

Practice questions
1 Analyse how the marketing research above might be used by a marketing
manager.
(9 marks)
2 To what extent do you think the actual bottle that the water in stored in is likely to
affect sales?
(16 marks)
Primary and secondary marketing research

Figure 8.7 Forms of marketing research

To gather data, marketing research may be:

• Secondary. This type of research uses existing data. For example, managers may learn about a
market by reading newspapers, looking at the annual reports produced by companies or
studying information produced by the government. Secondary marketing research, is a good
place to start because it is already available and therefore usually cheap. However, it may not
be in the exact format you require – it may be out of date or in a different format from the one
you want, for example, you are interested in the sales of houses in Oxford but can only find
secondary data for the South East as a whole.
• Primary. If secondary research is not fully appropriate then a manager may choose to
undertake primary marketing research. Primary research is first hand – it has been collected
for the first time. For example, managers may decide to observe shoppers’ behaviour though
CCTV, interview customers face to face, send out a questionnaire or have an online survey.
Many film companies show their films to sample audiences and this can affect the final cut of
the film; sometimes whole scenes are re-shot following the feedback from this primary
research.

Key terms
Primary marketing research collects and analyses data for the first time to use for
marketing purposes.
Secondary marketing research collects and analyses data that already exists for
marketing purposes.
Sampling
All of the people that a manager might want to interview are known collectively as the ‘target
population’. However, in most cases it will not be possible to interview or survey all of the
target population. This is because it is likely to take too long and be too expensive. As a result
managers may choose a sample; this involves selecting a representative group of people or items
from the target population.

The value of the sampling

Sampling provides an insight into a market. It saves money because the whole of the target
population does not have to be considered. It is also quicker than trying to test or talk to all the
target population. You will often see on the news on Election Day that a sample of people have
been interviewed about their voting intentions and based on this sample forecasts are made about
all the voting population.
However, there is a risk because you are relying on a sample and if this research is undertaken
badly the sample may not in fact be representative. In some cases political forecasters have made
incorrect predictions about who was going to win an election because of who they surveyed or
the way the research was carried out.
The value of sampling therefore depends on how it is conducted. For example, it will depend on:
• how the people or items are selected. For example, if you only ask your friends what they think
of your new business idea you may get biased answers; if you only ask men when most of your
customers are women this might also be misleading. The sample must be chosen carefully to
represent the target population
• how the sampling is conducted. For example, questions may be asked in a way which
encourages people to give a certain type of answer (‘Do you think this product is a) great? b)
fantastic? will lead to unreliable results).
• the sample size: the smaller the sample size the less you will be able to be sure that the results
reflect the target population as a whole. If you only asked three men in the UK what British
males in general think about gonig to a fitness club, your findings are unlikely to be
representative. The bigger the sample size the more reliable the findings might be.

Key terms
Target population is all the items or people that are relevant to the market research
being undertaken. For example, a business might be interested in all 16-to- 18-year-
olds in the UK.
A sample is a group of people or items selected to represent the target population.
Types of data: quantitative and qualitative data

Figure 8.8 Market research can produce quantitative and qualitative data.

• Quantitative data. This provides data in a numerical form, for example, ‘70 per cent of people
would recommend this product’, or ‘96 per cent of people use this product at least once a
year’. It is often gathered through surveys and its value is that it can show what is happening in
a market in a measurable format, for example, ‘sales have increased 30 per cent this year’.
However, it may not necessarily explain why changes have happened.
• Qualitative data. This is data that is not in a numerical form and is often descriptive – it can
describe why things have happened. This type of data is often used to provide information on
peoples’ emotions and feelings. It is data that provides an insight into why people do things or
what they think about a product. However, it is usually gathered through open questions in in-
depth interviews with a few people; it is therefore is often not statistically reliable. The
findings are often rather open ended and not easily measurable – for example, you might have
a whole series of different views about a brand. Qualitative data is often a good starting point
with primary research because it shows what people are thinking and why they do things; the
key issues raised by in-depth interviews can then be examined in more detail with quantitative
analysis.
Market mapping
Part of marketing research should involve understanding how a product or brand is perceived
relative to a competitors’ brand – is it seen as more of a youth brand? More upmarket? More
ethical? More reliable? Understanding these perceptions is important, either to reinforce them or
to challenge them. People may perceive your products to be expensive and you want to challenge
this and communicate that they are not. People may see you as the ‘original’ and managers want
to reinforce this to highlight the differences between their products and others. One technique to
identify what customers think of a brand is known as market mapping. Customers are asked to
rate a group of products in a market in terms of different characteristics. Typically these are rated
on the basis of two scales, such as low price to high price and traditional to modern, as shown in
Figure 8.8. The criteria used will depend on the particular market being examined and the issues
that matter to customers in these markets.

Figure 8.9 Market mapping

Key term
Market mapping analyses market conditions to identify the position of one product or
brand relative to others in the market in terms of given criteria.

Market mapping may also be used by businesses thinking of setting up in a market as it might
help them decide where they want to fit in the market relative to existing producers.
Interpreting marketing data
To interpret marketing data managers will use various tools such as:
• correlation
• extrapolation
• confidence intervals.
Correlation
Marketing data may help identify the correlation between different factors and the demand for a
product. Correlation occurs when there is an apparent relationship between one factor and
another.

Figure 8.10 A negative correlation

For example, it may be that marketing research suggests that increases in the price leads to fewer
sales; this would suggest there is a negative correlation between price and demand. It is a
negative correlation because when one factor goes up the other goes down; higher prices reduce
demand. Equally, if price goes down and sales go up this would also be a negative correlation.
By comparison, the correlation between income and demand may be positive. A positive
correlation occurs when the two factors move in the same direction. For example, if an increase
in customer income leads to increase in demand or a fall in temperature leads to a fall in sales of
sunglasses.

Figure 8.11 A positive correlation

If the correlation is zero then there is no apparent relationship between a factor and demand. For
example, a change in the weather may have no apparent effect on the sales of mobile phones.
Figure 8.12 No correlation

If a manager can identify the key influences on demand then this could help forecast sales in the
future. For example, if the population size seems to be a big influence on the demand for shoes,
and if the population size is expected to grow, this suggests that sales of shoes should increase. If
the age profile of the population affects the demand for medicines, then forecasts of an ageing
population can help estimate medical sales.
Correlation is given as a value between –1 and +1, as shown in Figure 8.13:

Figure 8.13 Strength of correlation

The higher figure (regardless of the sign) the stronger the correlation. For example,
• −0.8 is a strong negative correlation; +0.8 is a strong positive correlation.
• −0.2 is a weak negative correlation and +0.2 is a weak positive correlation.
It is important when analysing correlation to be aware that it simply shows an apparent
relationship between two factors – it does not prove that one leads to the other or indeed show
the direction of the relationship. For example, whenever ice cream sales increase so do shark
attacks – they are positively correlated. However, this does not mean ice cream sales lead to
shark attacks – the cause is obviously likely to be the hot weather leading to more ice cream
being sold and more people going swimming which then is likely to lead to more shark attacks.

What do you think?

What do you think is the likely sign and size of the correlation between:
• income and tobacco
• consumer age and sales of suncream
• sunshine and sales of precooked meals
• sales of wine and sales of cheese
• consumer income and vegetable sales?

What do you think?

Can you think of two variables that are positively or negatively correlated but where it
is unlikely that a change in one causes a change in the other?
Extrapolation
Market research will enable a business to track what has happened to sales in the past and to
estimate what sales might be in the future. One method of forecasting sales is to look at what has
been happening in the past and to continue this trend into the future. This is called
‘extrapolation’. If, on average, sales have grown by about 2 per cent a year for the past five
years, a business may work on the assumption this will continue and project or ‘extrapolate’
sales forward on this basis.
Extrapolation may be a valid way of forecasting sales, assuming that conditions do not change. If
the government is predicting demand for healthcare and education in the future it can extrapolate
from the numbers of people in different age groups at the moment. For example, the numbers
starting secondary school aged 11 in five years’ time can be extrapolated from the number of
children aged 6 now. However, in many markets there is sometimes disruptive change that alters
market conditions significantly and makes extrapolation of limited value.

What do you think?

How useful do you think extrapolation might be in:
• the construction industry
• healthcare
• the computing industry
• education
• the music industry?
Confidence levels and intervals
Sampling can help provide an insight into the target population as a whole but if you have not
asked the whole of the target population it will not be 100 per cent accurate. Market research
findings therefore have a confidence level that gives an indication of how certain they are of the
results. For example, a 95 per cent confidence level means that the researchers are 95 per cent
certain that their results are reliable and represent the population as a whole. A 68 per cent
confidence level means that researchers are 68 per cent sure that their findings represent the
population as a whole.

Key terms
A confidence level is the probability that the research findings are correct.
A confidence interval is the possible range of outcomes for a given confidence level.
For example, you might have a 95 per cent confidence level that sales will be
between £500,000 and £700,000 (interval).

The degree of confidence will depend on factors such as:

• the size of the sample; the bigger the sample the more likely it is that the findings will reflect
the population
• how the sample was constructed; for example, were the people involved selected randomly?
The degree of confidence in the findings will also depend on the margin of error that the
researchers provide (known as the confidence interval). For example, the researchers may be 95
per cent confident that sales will be somewhere between £200,000 and £300,000 as this is quite a
big margin of error. If you asked them to be more specific they may only be 68 per cent
confident that sales would be between say £250,000 and £280,000 because there is a much
smaller range. The range of possible outcomes is called the confidence interval.
The confidence level and confidence interval are linked. To be more confident of the forecasts
(to have a higher confidence level) the wider the confidence interval will be.
The concepts of confidence levels and confidence intervals can be shown in Figure 8.14, the
dotted line is the best estimate of future sales. However, Mintel provides an interval for different
degrees of confidence. For example, Mintel estimates that there is a 95 per cent probability that
in 2023 sales will be between £10,396 m and £9,169 m. This means there is a 95 per cent chance
sales will be within this range. Obviously, this is quite a wide range; if you asked Mintel to
narrow the range it is less confident that sales will be within it. You can see that the narrower the
range of possible outcomes (the confidence interval) the lower the confidence level (the
probability sales will lie within it).
Figure 8.14 Mintel estimates

Source: Based on IR/Mintel

Handling data

Figure 8.15 Value of mobile phone sales in the UK, 2012–22

Source: Based on IR/Mintel

1 What is the confidence interval at a 95 per cent confidence level for the value of
mobile phone sales in the UK in 2022?
 Figure 8.16 Forecast for the value of the UK games console market, 2013–23

Source: Based on IR/Mintel

2 Explain the difference between the expected value of sales for games consoles in
2023 for a 50 per cent confidence level and a 95 per cent confidence interval.

Business in focus: Airport research

Many of the world’s famous brands now believe that airports are an important part of
their distribution and for the airports themselves the brands are an important source of
revenue. In Qatar’s new airport travellers have 25,000 square metres of shops and
restaurants. Pernod Ricard, the French drinks company, and L’Oréal, the French
maker of cosmetics and perfume, call airports their ‘sixth continent’. Once passengers
have passed through the security checks they have what is known as the ‘golden
hour’ when they are wandering around with little to do but go shopping. Most are
relatively prosperous, given that they are travelling by air. Airport retailers know the
shopping habits of passengers because they can track data from their boarding cards.
They also know the schedules of flights and when customer land and take off. They
can change their products according to who is landing.
The World Duty Free Group (WDFG), one of the main retailers at Heathrow, tracks
arrivals into its database so that it has speakers of the right languages and who are
aware of cultural differences ready to serve customers. Brazilian women are happy to
allow a sales assistant to spray a perfume on them, whereas Chinese customers tend
to use a tester. Shop displays are also changed to meet national tastes. For morning
flights to Barbados, the cognac stand has expensive bottles of Courvoisier and
Hennessy, whereas for flights to America they put cheaper brands on display.
Airports are also used for marketing research laboratories. Sales of Cath Kidston’s
products at airports are an early indicator of where the company might want to open
stores overseas. Luxottica opened three Sunglass Hut boutiques in Italian airports to
see how they might do in the country as a whole.

Practice questions
1 Analyse the ways in which the use of data might influence the marketing decision
makers at airports.
(9 marks)
2 To what extent do you think it useful for businesses to use airports to test new
markets and new products?
(16 marks)
Interpreting the price elasticity of demand
The correlation between price and the quantity demanded is measured by the price elasticity of
demand. The price elasticity of demand examines the effect of a price change on the quantity
demanded, all other factors unchanged.
It is measured by the equation:

In order to estimate the price elasticity of demand for a product, managers may examine the
changes they have made in the past to the prices of products and can look at sales data to
estimate the effect future changes in price have on sales.
The answer to the price elasticity of demand equation is usually negative because a price increase
(+) leads to fall in quantity demanded (−) and vice versa; this gives a negative answer overall.
The size of the price elasticity (i.e. the size of the number ignoring whether it is negative or
positive) shows how responsive demand is to price changes; it shows how much the quantity
demanded changes in response to a 1 per cent change in price. The bigger the number the more
quantity demanded changes following a price change. If the size of the answer (regardless of
whether it is positive or negative) is 2, for example, this means that a 1 per cent change in price
leads to a change of 2 × 1 per cent = 2 per cent in quantity demanded.
If the answer is 0.5 it means a 1 per cent change in price leads to a change of 0.5 × 1 per cent=
0.5 per cent change in quantity demanded.
If the value of the price elasticity of demand (that is, the size of the number ignoring the sign) is
less than one this is described as price inelastic. This means that a given percentage change in
price leads to a smaller change in the quantity demanded. Note that this does not mean that the
change in quantity demanded is small, just that it is smaller than the change in price. A 50 per
cent change in quantity demanded is quite big but if the price change is 75 per cent then demand
is price inelastic because demand changed less than price. Price elasticity therefore measures
how much demand changes relative to price.
If the value of the price elasticity of demand (that is, the size of the number ignoring the sign) is
greater than one this is described as price elastic. This is because the change in quantity
demanded is bigger than the change in price.
Why does the price elasticity of demand matter?
If demand is price inelastic this means that a change in price leads to a smaller change in the
quantity demanded. The effect of this is to lead to an increase in revenue if prices are raised.
By comparison, if demand is price elastic then a price increase leads to a bigger percentage fall
in the quantity demanded and a fall in revenue. The fall in sales is so great that this outweighs the
effect of the higher price being charged. However, if demand is price elastic a lower price will
increase revenue. Although the price is lower on each unit this is outweighed by the increase in
sales.
Clearly understanding the price elasticity of demand is important when setting the price because
managers will want to estimate the impact on sales and revenue of any potential price change.

Figure 8.17 Price elasticity

Price elasticity is summarised in Table 8.2.

Price elastic Price inelastic
Price The increase in price leads to a The increase in price leads to a
increase bigger percentage decrease in the smaller percentage decrease in the
quantity demanded. quantity demanded.
Revenue falls. Revenue rises.
Price The decrease in price leads to a The decrease in price leads to a
decrease bigger percentage increase in the smaller percentage increase in the
quantity demanded. quantity demanded.
Revenue rises. Revenue falls.
Table 8.2 Price elasticity
What influences the price elasticity of demand for
a product?
A major influence on the price elasticity of demand of a product is how easy it is for customers
to change to an alternative product if the price of this one increases. If it is easy to switch away to
something similar then demand will be price elastic – with a price increase there will be a
relatively large fall in demand as customers choose cheaper alternatives. So if there are many
similar products on the market, and switching to them is easy, demand will be price elastic. By
comparison, if a product has a unique brand, has some special features or is protected in some
way – perhaps through a patent or trademark – demand will not be sensitive to price; demand
will be price inelastic. Many Dyson products have advanced patented technology as well as
stylish designs that distinguish them from competitors.

Key terms
A brand is a ‘promise of an experience’ and conveys to consumers a certain
assurance as to the nature of the product or service they will receive.
A patent protects new inventions and covers how things work, what they do, how
they do it, what they are made of and how they are made.
A trademark is a sign which can distinguish the goods and services of a business
from those of its competitors (a business may refer to its trade mark as its ‘brand’).

Other influences on the price elasticity of demand include:

• the time period. Over time, customers will be able to search for more alternatives and so
demand becomes more price elastic.
• how expensive the product is. If it is cheap to begin with then customers may not be very
sensitive to price as customers will still be able to afford the product.
• who is paying for the product. For example, if your flights are paid for by your company, your
demand for flights may be less sensitive to price than if you had to pay for it yourself.
Factor Effect on the price
elasticity of demand
Heavily branded product More price inelastic
Unique Selling Proposition (a quality that differentiates More price inelastic
the product from others)
Patent (legal protection of an invention) More price inelastic
Or
Trademark (legal protection of a sign)
Expensive or difficult to switch to another supplier More price inelastic
More substitutes available More price elastic
 Over time More price elastic
Table 8.3 Factors affecting price elasticity of demand

What do you think?

Do you think the price elasticity of demand for coffee and food at motorway service
stations is likely to be price elastic or inelastic? Justify your view.
On a Greek beach there is often a long row of beach bars selling drinks. Do you think
demand for drinks in one of these bars is price elastic or inelastic? Justify your
answer.

Key terms
The price elasticity of demand measures how responsive demand is to changes in
the price, all other factors constant.
The income elasticity of demand measures the sensitivity or responsiveness of the
quantity demanded of a product to a change in its price.
Interpreting the income elasticity of demand
The income elasticity of demand shows the correlation between quantity demanded and
customers’ incomes.
It is measured by the equation:

If the answer is positive this means an increase in income increases demand. Equally, a fall in
income reduces the quantity demanded. This is what happens for most ‘normal’ products.

Figure 8.18 Normal product

If the answer is negative this means that as income increases the quantity demanded falls; if
income falls quantity demanded increases. These products are known as ‘inferior’ because as
incomes rise customers switch to other products (for example switching from bicycles to cars); if
income falls, customers switch back to these products as they are on a lower budget.
The size of the income elasticity (regardless of the sign) shows how sensitive demand is to
income changes; it measures how much quantity demanded changes in relation to a 1 per cent
change in income. The bigger the answer the more responsive demand is.

Figure 8.19 Inferior product

For example:
• If the income elasticity is 2, this means that the change in quantity demanded is 2 times the
change in income. A 1 per cent change in income leads to a 2 per cent (2 × 1) change in
quantity demanded.
• If the income elasticity is 0.5, this means that the change in quantity demanded is 0.5 times the
change in income. A 1 per cent change in income leads to a 0.5 per cent (0.5 × 1) change in
quantity demanded.

What do you think?

Do you think the demand for following products is likely to be income elastic or
inelastic? Explain your answer.
• Cruise ship holidays
• Newspapers
• Luxury cars
• Milk
• Paint
Why does income elasticity matter?
An understanding of income elasticity is useful to managers because it helps them plan for
changes in the incomes of their customers. For example, if the economy is doing well and
incomes are rising, this will lead to relatively fast growth in the demand for products that have a
high, positive income elastic demand. By comparison, in a boom, demand for inferior goods
would fall.
An understanding of an impact of income on demand will affect planning for production, staffing
and finance.

Figure 8.20 Income elasticity

Income Result
elasticity
Positive ‘Normal’ products; an increase in income increases the quantity
demanded.
Negative ‘Inferior’ products; an increase in income decreases the quantity
demanded.
Less than Inelastic; the percentage change in quantity demanded is less than the
one percentage change in income.
More than Elastic; the percentage change in quantity demanded is less than the
one percentage change in income.
Table 8.4 Summary of income elasticity
The value of technology in gathering and
analysing data for marketing decision
making
Developments in technology are enabling businesses to gather more data on customers and to
analyse this data more effectively and more quickly. For example, if you use a supermarket
reward card the company can track what you are buying and link this to your address and all the
other information they hold about you. This can help the business to understand more about the
type of person buying products and what might influence their spending patterns. In the music
industry, for example, companies monitor the popularity of musicians promoting their own
music on social media channels such as YouTube or Soundcloud to try and spot the next big act.
The increasing ability to combine data from a variety of sources is known as ‘big data’. Think of
when you visit an online business such as Netflix – it will track your viewing and buying habits
and get to understand you so well that it can even recommend what else you might want to buy.
It can link what you are doing with what others are doing, and what else is happening in the
world – the weather, any major events and the major stories in the news. Its data can provide a
very detailed insight into buying patterns and how they are affected by changes to (say) the
product and price. It can enable businesses to link data far more effectively than in the past – for
example, to find correlations it had not appreciated existed. This can help the business forecast
sales more effectively and to build a relationship with you by being able to anticipate what you
want.

Key term
Big data refers to large and complex data sets. These have been difficult to analyse
in the past but improvements in technology is making the use of big data more
feasible.

Simply having more data does not guarantee success, however. The right data still has to be
collected, the right questions have to be asked and the right decisions made and implemented.
However, technology is providing better, faster and cheaper information that should improve
decision making. Just think about how valuable spreadsheets are to you if you are ever doing
mathematical work. Technology has given you a tool to speed up calculations, to enable you to
manipulate data faster and more effectively and to present your findings in useful and visually
attractive way. Technological change is enabling you to manipulate data in a way that your
grandparents could not have imagined. Does that mean you inevitably get everything right? Not
necessarily – it depends on whether you have the right numbers in the first place and set up the
system correctly.
The use of data in marketing decision making
and planning
Marketing research provides the information to help make decisions regarding marketing issues
such as what to produce, the price to charge and where to distribute. This is essential for
planning marketing effectively and for keeping up with changes in market conditions.
However, marketing research also provides information that will feed into the plans and
decisions throughout the business, as shown in Figure 8.21.

Figure 8.21 How market research affects other areas of the business

One common use of marketing research is to forecast the sales of the business. A sales forecast is
essential to planning throughout the business. It is required by all of the other business functions.
For example:
• Human resources need to know what staffing requirements are likely to be.
• The finance function needs to be able to estimate future cash inflows and profits.
• Operations need to know the expected level of sales to ensure this can be produced.
The sales forecast therefore influences many other plans within the organisation. Marketing
research provides the information needed on what is happening outside of the business and this is
essential to decide and plan what to do within the business.

What do you think?

Marketing research has shown that a rival is about to launch a new computer game
three weeks before you scheduled to launch yours. What might the impact be of this
information on the decisions and planning within the different functions of your
business?
Why can marketing research go wrong?
Marketing research can provide invaluable information to help marketing managers make
decisions. However, this does not guarantee success. Research may help reduce the risk of a
decision but does not remove it completely. This is because of:
• changes in markets. This means that the information that managers have gathered in a
particular situation may be out of date or even irrelevant fairly soon if conditions are changing
very rapidly – for example, with new technology and new business entering the market.
• the way the information is gathered. The business may use secondary data which may not be in
the format required or may use samples that do not necessarily reflect the target population
accurately.
• lack of information. In some cases, managers will be keen to make the decision and not want
to spend money on undertaking research. Perhaps they assume they understand the market,
assume they are right or simply lack enough finance for detailed research.

Business in focus: The launch of New Coke

Figure 8.22 New Coke and Classic Coke

In 1985, the drinks company Coca-Cola launched a new version of its cola product.
This was called New Coke. Coca-Cola had developed this product because it had
been losing market share with its existing cola. It undertook a great deal of marketing
research including taste tests with around 200,000 consumers. The taste tests
suggested that the new formula for the recipe of Coca-Cola would be more popular
with customers and help sales.
However, when the new formula was launched, it led to major complaints about the
changes. What Coca-Cola had not anticipated was the strong reaction against
changing anything to do with what became known as “Classic Coke”. Coca-Cola had
become a national icon in America. It was regarded as part of American culture and
the idea of changing it in any way was strongly criticised even if it did taste better. In
June 1985, the company was getting over 1,500 complaint calls a day about the
change that had been made!
Protest groups were created such as the Society for the Preservation of the Real
Thing and Old Cola Drinkers of America. In response to the negative media coverage,
Coca-Cola decided to bring back the original recipe and sell this as Classic Coke
alongside New Coke. Each product had its own promotional campaign.
The name of the new product was later changed to Coke II and eventually the
company stopped selling it in America.
The company’s product portfolio nowadays includes Classic Coke, Zero Coke and
Diet Coke. It also has many other brands such as Dr Pepper, Sprite, Minute Maid and
Fanta.

Practice questions
1 Analyse the possible reasons why the marketing research for Coca-Cola did not
predict the outcry over the removal of the old product.
(9 marks)
2 To what extent do you think the success of Coca-Cola is likely to be due the
strength of its brand?
(16 marks)
Marketing research and ethics
When gathering data, managers may need to consider the ethical implications of their marketing
research. For example, to what extent should they be asking consumers’ permission before
collecting information on their purchasing habits? Is it acceptable, for example, to film
consumers shopping without their permission? Is it acceptable to track their purchases online in
order to recommend other products they may like without asking for permission?

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1Explain what is meant by marketing research.
2State two possible uses of marketing research in decision making.
3Distinguish between primary and secondary marketing decision making.
4State two ways in which a business might gather primary data.
5State two possible sources of secondary data.
6Distinguish between quantitative and qualitative data.
7State two ways in which a sales forecast can affect the decisions of other
functions within the business.
8 If sales rise as promotional expenditure rises this is a positive correlation. True or
false? Explain your answer.
9 If future sales are predicted on the basis of past sales this is known as ………….
10 If the price elasticity of demand is – 2.6, demand is price elastic. True or false?
Explain your answer.

(b) Short answer questions

1 Explain one possible benefit of marketing research to a business about to launch a
new social networking app.
(5 marks)
2 Explain the advantages of primary market research compared to secondary
research when a business is considering launching a new product.
(5 marks)
3 Explain one way a mobile phone business might make demand for its business
more price inelastic.
(5 marks)
4 Explain one way a chain of leisure clubs might forecast sales.
(5 marks)
5 Explain how an understanding of elasticity of demand might help the marketing
manager of a hotel chain make decisions.
(6 marks)
(c) Data response questions
Technology and marketing decision making
Big data enables a business to bring together huge quantities of information from a
variety of sources; it can then process this to find links that will aid its marketing
efforts. Big data is used by the police, for example, to identify links between crime
patterns and factors such as the weather, special events that are happening nearby,
income levels, the time of day and year, and so on. If links can be found the police can
anticipate possible problems that might occur and allocate resources accordingly. In
business big data can be used to identify customer spending patterns and to develop
products to more closely match customer requirements. Close interrogation of data
regarding shoppers’ spending linked to other pieces of information, such as who is
shopping, when and where, and what else is happening in the environment, can allow
a business to adjust its future marketing activities to promote more sales.
Companies can use big data to draw on several sources to understand our lives – by
looking at data on our searches, our purchases, our social media purchases and our
location, companies can gain a very good insight into what we do and what we are
thinking about. Imagine then if in the future this was linked to in-store technology so
that businesses could identify you as you walk into each shop – the sales assistants
might well be able to predict what you are looking for or what you need to buy before
you know yourself and direct you to the products of interest to you in the store!
Specific adverts and promotions that are directly relevant to you may appear on your
smartphone as you walk into a particular outlet.
One of the most famous users of big data is Amazon, the online retailer. Amazon has
well over 200 million customers and a revenue of around $75 billion. A great deal of its
success is due to its ability to collect, analyse and use data on its customers. By
tracking your buying patterns it is able to personalise your experience of its website,
for example, making recommendations of other products you might enjoy and showing
adverts of products linked to other things you have bought. Other companies such as
M&S, Next, Boots and Dixons are also investing heavily in their information
technology systems in order to do similar things. The ability to analyse ever bigger
amounts of data from more sources means that, for example, when the weather turns
colder a fashion retailer could recommend winter clothes by the same designer you
have already bought from via an advert sent to your smartphone or when you log on
to their website to browse the rails. All of this enables retailers to provide very
personalised, tailor-made and focused communications to existing customers.
However, some people worry that their lives are too open to outsiders and feel that
this data analysis is an unwelcome loss of privacy.
1 With reference to the text above, explain possible ethical issues that might arise in
using technology to gather data.
(5 marks)
2 With reference to the text above, analyse the ways in which technology is enabling
more effective marketing decision making.
(9 marks)
3 To what extent do you think the success of more personalised marketing by
companies such as Amazon depends on the other business functions?
(16 marks)

(d) Essays
1 To what extent is marketing research an essential investment when developing and
launching a new product?
(25 marks)
2 To what extent do you think that primary marketing research is a better way than
secondary for the marketing manager to gather information for a price change?
(25 marks)
Chapter 9 Segmentation, targeting and
positioning (STP)
Introduction
In the last chapter we examined the value of marketing research in gathering and analysing
marketing information. This will help managers to make decisions. In this chapter we will
consider how businesses use marketing research information to identify segments in a market
and decide which segments to target. We will analyse how a business positions itself within a
market and then how this influences its marketing activities.
What it is important to know by the end of this chapter:
• the process and value of market segmentation, targeting and positioning (STP)
• the different methods of segmentation
• the influences on choosing a target market and positioning
• the value of niche and mass marketing.
The process of segmentation
By undertaking marketing research, managers aim to identify groups of similar needs and wants
within a market. The process of identifying different groups of similar needs is called
segmentation. The different groups of needs and wants are known as market segments. For
example, in the market for toys there may be a difference between the type of toys demanded by
different age groups or by boys and girls. In the hotel market, there may be a difference between
the requirements of businesspeople and families on holiday.

Key terms
Segmentation occurs when similar customer needs and wants are grouped within a
market.
Market segments are the groups of similar needs and wants within a market.
Targeting occurs when a business decides which segments it wants to operate in.

There are many different ways to group needs and wants. Common ways of categorising by
segmentation include:
Demographic segmentation
The term demographics refers to characteristics of the people in the target population. For
example, there may be similar needs and wants based on aspects such as age or gender: the
clothes women want to buy are typically different from those men want to buy, the clothes 18-
year-olds want to wear are typically different from those that their parents wear. Demographic
factors may also include what stage in their lives people are at (for example, are they in full-time
study, have they just got a job, are they looking after children, have their children left home). All
of these things affect buying behaviour.

What do you think?

Think ahead to the next 60 years of your life and what will happen to you in terms of
your lifestyle. What will change in terms of the types of products you buy or interests
you have, for example? At what stage of your life might you start thinking about
renting or buying a flat or house? Going on family holidays? Joining a gym?
Geographic segmentation
This method of segmentation groups needs and wants based on the geographical area in which
customers are based. The types of houses required in Iceland and in Nigeria may be very
different to each other due to climate conditions, for example. The types of food and drink sold
in McDonald’s outlets around the world may need to vary to meet the tastes of different
customers.
Income segmentation
High-income users of a bank, a holiday company or a hotel may have different demands than
low-income users. High-income earners are more likely to be interested in products to do with
saving and investing; lower-income groups are more likely to be interested in borrowing. High-
income earners generally may be more interested in overseas holidays, business-class airline
seats, private healthcare insurance and advice on buying shares and new cars.
A common way of segmenting people based on income and their professions is known as
socioeconomic grouping. The most common categories of socioeconomic groupings are:
A Higher managerial, administrative or professionals
B Intermediate managerial, administrative or professional
C1 Supervisors, clerical and junior managerial, administrative or professional
C2 Skilled manual workers
D Semi and unskilled manual workers
E Casual labour.
It is very common for the media to categorise their audiences on this basis. For example, ABs are
more likely to read The Financial Times and The Economist than C2s and Ds.
Behavioural segmentation
Demographic and income segmentation methods concentrate on the characteristics of consumers,
for example, how old they are. Behavioural segmentation focuses on what customers actually do.
For example, it analyses customers in terms of:
• when they buy (the purchase occasion). For example, many people start a health kick or buy
products to give up smoking in January as they start a New Year and want to change
themselves.
• how much they buy. For example, are they heavy users or light users of the product? Do they
buy just for themselves or for family members? This could obviously affect issues such as the
sizes in which products are offered; for example, family size packets of cereals versus smaller
packs.
• brand loyalty? Do they stay with the same brand or switch? If they are switchers you might be
able to attract them with special offers. If they are brand loyal you might want to reward them
to encourage others to become loyal. For example, Boots loyalty points.
• the benefit they want from the product. Are they buying a Harley Davidson as a means of
transport or to reward themselves for their achievement in life? Or because they are getting
worried about getting older and want to relive their youth? Or because it reminds them of the
freedom they once had when they were young? Understanding this will influence decisions
such as the way a product is promoted.
Having identified the segments in a market, managers are able to identify groups of similar needs
and wants. They must then decide which of these segments they want to focus on and how best
to approach them. Trying to sell more Barbie dolls to customers who already love the brand is
clearly different from trying to sell them to people who prefer Bratz, or to people who don’t like
dolls at all. It is important therefore to understand the needs, wants and features of the different
behavioural segments because this will affect the marketing decisions that are taken.
The value of segmentation
By segmenting a market, managers can understand what different groups want rather than treat
all customers as the same. When we want to buy a car, is it to use in the city, or to use to
transport the family around? Do we want a sports car, or an all-terrain vehicle? Different groups
have different requirements and priorities and marketing managers strive to understand them to
decide if they can meet them, and if so, how best to satisfy these needs.
Identifying a segment therefore enables more focused and efficient marketing – you do not waste
money promoting a product in the wrong place or investing in features that are not needed.
However, the more segments a business decides to focus on the more complex an operation can
be and the more expensive it can be to meet all the different needs. For example, it may be
relatively easy to produce one cleaning product to be used around the house. This type of product
can be produced on a large scale, which may be relatively efficient. However, customers may
want different products: oven-cleaners, glass cleaners, bathroom cleaners, floor cleaners and so
on. Adapting the product to these different needs may mean that customers are more satisfied.
However, every time the market is segmented again (for example, into shower cleaners, tile
cleaners, leather cleaners, computer screen cleaners) the potential market may be getting smaller
and the production runs may be reducing; this may make the segment unprofitable.
Managers will want to balance a desire to meet customer needs with what is practical, efficient
and profitable. For example, sixth forms want to offer a wide range of subjects to give students
choice but the more subjects that are offered the more complex it becomes to timetable, with
smaller class sizes, making delivery more expensive because there are more teachers with fewer
students in a class. Most schools therefore have some forms of option blocks, which provides
some choice but limits it.

What do you think?

How might you segment the housing market? What about the market for sportswear?
Targeting
Segmentation uses market research to identify which segments exist in a market. However a
business may not want to focus on all of them. Choosing which segments to focus on is known
as targeting.
Influences on choosing the target market
A business will target segments where it thinks:
• there is sufficient demand and potential profit to justify the investment. Some segments may be
too small to make sufficient profits (for example, many universities have dropped languages as
a degree course because the segment is too small).
• it has the ability to be competitive and gain sales. For example, do the requirements of the
target segment match the skills and competences of the business? Does the brand of the
business fit with the target segment? Can the business develop a competitive advantage in this
segment? So, rather than trying to offer all courses to all students, a university may target
certain courses (and therefore certain students) where it feels it has expertise and can excel.
By selecting target segments the business will be able to focus on the needs and wants of the
customers in these segments and hopefully meet their needs more precisely and effectively. This
should increase competitiveness and – provided the revenue is sufficient and the costs not too
high – profits.

Figure 9.1 The STP process

Key models and theories: The STP model

Some people think of marketing as a creative environment and there are certainly
some creative aspects to it, such as developing a promotional campaign. However, a
great deal of marketing involves using data and following a process. The STP model
shows a logical marketing process: identify the segments in the market, decide which
to target, decide where to position your products and then develop the marketing mix.
This highlights that the mix decisions about price, produce, promotion and distribution
should be linked to the earlier decisions about targeting and positioning.

What do you think?

Poundland has a clear target market. How do you think this affects its marketing
decisions? How might it affect its decisions in other functional areas, such as
operations and human resources?
Topshop seems to be targeting younger buyers relative to, Marks & Spencer. How do
you think this affects the marketing decisions it makes?
Niche marketing and mass marketing
If a business decides to focus on a specific segment of the market this is known as niche
marketing. For example, a clothes retailer may focus on tall or petite people. These groups of
customers are smaller than the market as a whole but have clearly identifiable needs and wants.
Saga Holidays, for example, targets the older holidaymaker and Classic FM radio targets lovers
of classical music. This allows the business to focus its marketing activities more precisely.

Key terms
Niche marketing focuses on a particular segment of the market.
A mass market approach aims to provide products that meet some of the needs of a
large proportion of the market.
Positioning identifies the benefit and price combination of a product relative to
competitors.

The value of niche marketing is that by focusing on a niche it may be possible to compete within
a bigger market such as fashion or the media, without directly challenging the bigger businesses
and therefore not being seen as a threat by them. The danger of challenging bigger, more
established players directly is that they may respond aggressively. For example, if a new
manufacturer of bicycles threatened the established brands they might cut prices or put pressure
on stores not to stock the new product. It might be better therefore to focus on a niche, such as
bicycles that fold up for those who commute on the train and want a bike to get to and from the
station, as this may not be perceived as a great threat to the big, powerful brands.

Business in focus: Acorn

Acorn, built by CACI, is a powerful consumer classification that segments the UK

population. By analysing demographic data, social factors, population and consumer
behaviour, it provides precise information and an understanding of different types of
people. Acorn provides valuable consumer insight, helping you target, acquire and
develop profitable customer relationships and improve service delivery.

Practice questions
1 Analyse how segmenting the market in the ways described above might be useful
for businesses.
(9 marks)
2 To what extent do you think the appeal of a market segment depends on how
many customers there are within it?
(16 marks).
 Figure 9.2 Acorn’s consumer classifications

Source: CACI website

Figure 9.3 A folding bike: a product for a niche market

A retailer focusing only on pink products may not take many sales from stores such as Next or
Marks & Spencer, a publisher that only produces books in Latin will not worry the big publishers
too much and an Algerian fast-food takeaway may not challenge McDonald’s head on. By
concentrating on a niche, a business is identifying a clear segment that is usually relatively small
and where they are not likely to be challenged by the bigger businesses that could undercut them.
On the other hand:
• A niche market may not be particularly big and therefore a business may be vulnerable to
losing a few customers. Total profits may be relatively low although this will vary from niche
to niche.
• If the niche does grow and become more popular (such as organic food) then this will actually
attract the bigger businesses in because they can see the profits are becoming worthwhile.
Over time the niche may want to move more into the mainstream.
An alternative approach to niche marketing may be to ignore some of the differences between the
segments and aim at the market as a whole. A mass market approach does not try to match the
needs of a specific segment precisely. Instead it aims to provide products that will meet some of
the needs of most of the people. A mass market newspaper such as The Daily Mirror, for
example, appeals to many people; nevertheless, some people will focus on the sport and be less
interested in the politics; some will be interested in the politics and less interested in the gossip.
Mass marketing aims for volume by trying to develop products that will meet some of the needs
of large numbers in the market. This will involve more customers and therefore potentially more
revenue and returns. However, being successful in the mass market requires:
• larger volumes (and therefore the investment and capacity) to fulfil orders
• promotional techniques to reach more customers
• potentially more competition as businesses fight in the relatively large market. Businesses will
therefore want to consider where they position themselves within the mass market.
The risks of targeting mass markets are the levels of investment required and the potential
difficulties competing against other businesses already in this market. Setting up to compete
against established high street banks, petrol stations or soft drinks producers could be difficult as
they will fight hard to retain their existing customers, with potentially high levels of resources to
fight with. Also the danger is that increasing numbers of niche providers gradually reduce the
demand as customers look for something that meets their needs more precisely.
In the 1970s, many British families went abroad for the first time as it was the first time it was
affordable thanks to cheaper transport and higher incomes. This was a mass market with large
numbers of people going to resorts in Spain. These holidays were not necessarily exactly what
customers wanted but it provided a holiday overseas and sun and so was attractive. Nowadays
customers in the holiday market are increasingly demanding personalised holidays. They do not
want a standard mass-market holiday but one that meets their own needs, which are different
from those of their neighbours. This creates opportunities for niche providers, for example,
offering tailor-made holidays or holidays to unusual destinations.

What do you think?

What are the possible implications for the different functional areas of a business of
moving from a niche to a mass market? For example, having set up a small organic
takeaway shop with recipes from Asia and having been successful, you decide to now
expand your business across the UK and make this a mass market offering. What are
the possible implications for marketing, finance, operations, human resources and
management?
Business in focus: Islamic banking

Banks act as an intermediary between people who want to save money and people
who want to borrow money. A bank typically attracts money into it from savers by
offering an attractive interest rate and makes a profit by charging lenders a higher
interest rate to borrow money. However, whilst this is the model of banking in the
West, this type of business activity is not regarded as acceptable in all societies or
religions. For example, under sharia law, Islamic banks are not allowed to make
profits by charging interest to lenders. Even so, a recent report by Ernst and Young
has shown that the assets of Islamic banks have been growing extremely fast, at
around 17 per cent a year, for the last few years; this is much faster than the growth
rate of more mainstream banks.
Obviously Islamic banks need to make a profit to finance their growth, so how do they
do this given the religious principles under which they operate? The answer is to find
other ways of making profits apart from charging interest. For example, when an
Islamic bank lends to a business, the deal might involve the company paying a
proportion of its profits to the bank in return. When lending money to someone to buy
a property, the bank might buy the property and then sell it to the client for more than
the buying price; it can then be paid back in instalments.
The growth in Islamic banking is partly due to the growth of emerging economies,
such as Indonesia and Malaysian, where there are large Muslim populations. Even
where Islamic banking is already quite strong, such as the Gulf States, these banks
have a relatively small market share and so there are plenty of growth opportunities.
However, the returns made by Islamic banks are typically much lower than
mainstream banks and the industry is quite complex because there are different ways
in which the banks organise their lending and repayments due to different
interpretations of what is acceptable under sharia law.

Practice questions
1 Analyse the possible reasons for the growth in Islamic banking.
(9 marks)
2 To what extent do you think Islamic banking is a good niche to target?
(16 marks)
Positioning
Having targeted a segment, for example, buyers over the age of 50 or families, managers must
now consider the positioning of their business in the market. This means how their products are
perceived relative to their competitors. The Daily Mail and The Daily Telegraph are both
newspapers but are perceived very differently by readers in terms of what they offer. What about
Xbox, PlayStation and Wii? All are computer consoles but users think there are significant
differences between them.
The positioning of a business can be shown using the market mapping technique outlined in the
last chapter. Managers identify two key aspects of the product that customers use to judge the
offerings of different businesses. For example, you might describe a clothing business as modern
or classic, or as expensive or great value for money. Managers can then plot where their business
or product sits relative to others in the market.

Figure 9.4 Positioning a clothing business

What do you think?

How do you think the positioning of the following brands differs?
• H&M and Next
• Puma and Nike
• Coca-Cola and Pepsi
• Barclays and Santander
• Facebook and Instagram
• Chelsea FC and Liverpool FC
• Samsung and Huawei
Figure 9.5 The factors influencing a company’s positioning

The positioning of a product relative to competitors depends on the following factors (as
compared to that of its rivals):
• its price
• the benefits it offers
• its brand image
• the level of service it provides.
Positioning and competitiveness
As we have seen, the positioning of a business can be described in terms of the benefits it
provides (in terms of the product, the level of service and its image) relative to competitors, and
the price charged relative to competitors.
The combination of benefits and price relative to other businesses will determine the
competitiveness of a firm’s offering. For example, a business may charge more than rivals and
still be competitive, provided it offers more benefits. A business can offer fewer benefits than
rivals and still be competitive, provided its prices are lower.
However, if a business offers less or the same benefits as rivals and charges a higher price it will
be uncompetitive. Ideally a business might want to offer high benefits and a low price but this
can be difficult to do as providing more benefits usually incurs additional costs.

Figure 9.6 Benefits–price matrix

The competitive and uncompetitive combinations are shown in Figure 9.6.

Managers will want to choose what combinations of benefits to provide and prices to charge and
where they want to position the business in the market relative to who is already there. For
example, should the business be a premium provider (Hilton Hotels) or a more basic provider
(Travelodge)?
Influences on the positioning of a product
Influences on the positioning of a product include:
• The strengths of the business. If, for example, a business is particularly efficient in its
processes it may aim to be a low-price provider. For example, the business may be large and
have bargaining power over suppliers, it may be particularly good at negotiating or it may have
good links with suppliers (or perhaps controls several stages of the supply chain). Businesses
such as Walmart and Amazon manage information very effectively, have developed very
efficient processes and have huge buying power. This enables them to position themselves as a
low-price provider.
• On the other hand, a business may be good at innovation, may have highly skilled employees
and resources and systems that encourage the development of ideas. In this case, a business
may focus on providing greater benefits than rivals. Apple, Bang and Olufsen and Mercedes
are not cheap but are innovative, well designed and have distinctive features.

Figure 9.7 A Bang and Olufsen product: well designed and innovative

• Competitors. Where a business positions itself in a market may depend on what the established
firms are already offering. Managers may produce a market map to identify what exists
already in the market and what gaps exist. If it chooses to target a gap it must have the
necessary strengths to do this well.
• Market conditions. External influences on positioning can be analysed using the PEST-C
model we looked at in Chapter 7. For example, as the economy recovers, low-cost airlines
such as easyJet have reconsidered their proposition and started to offer more benefits to meet
customer needs.

Business in focus: Tesco

Once regarded as the one of the most successful British companies of the century,
Tesco has faced a number of problems in recent years. Its entry into the US market
with the brand Fresh ‘n Go was extremely unsuccessful and led to the company
withdrawing in 2013. It also pulled out of Japan. Meanwhile, it seemed to have lost its
way in the UK market too, which was still by far the biggest part of its operations.
Tesco has let discounters, such as Aldi and Lidl, gain market share; it has misread
market trends and invested too heavily in big hypermarket locations when customers
are moving to do more online shopping. It also seemed to have lost its positioning in
the market; it has tried to be all things to all people resulting in confusion about where
it fits in the market. It is neither a clearly premium retailer like Waitrose nor a
discounter like Lidl. One of the challenges the company seems to face now is defining
how it wants to be perceived in the market relative to its competitors. It then has to
ensure it has the right products, promotions, prices, and physical environments and
locations to reinforce this positioning. Tesco has brought in a new chief executive to
lead the way forward.

Practice questions
1 Analyse the possible value to Tesco of having a clear positioning in the market.
(9 marks)
2 To what extent do you think the difficulties at Tesco were likely to be due to internal
issues rather than external?
(12 marks)

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 Explain what is meant by segmentation.
2 Grouping customers by their age is an example of ………. segmentation.
3 Deciding which segments to focus on and operate in is called ………
4 State one benefit of segmenting a market.
5 What is the difference between segmenting and targeting?
6 What is meant by positioning?
7 State two factors that might influence the positioning of a business.
8 Explain one reason why a business might want to change its positioning.
9 Explain the difference between niche and mass marketing.
10 Identify which of the combinations of benefits and price in the chart below would
be uncompetitive.
Price relative to rivals Benefits relative to rivals
High Low
High
Low

(b) Short answer questions

1 Explain one way the holiday market may be segmented.
 (5 marks)
2 Explain one way targeting business customers rather than holidaymakers might
affect the marketing of an airline.
(5 marks)
3 Ford is trying to develop cars that can be sold in the mass market across the world
rather than adapting cars for each market. Explain one benefit of this mass market
approach.
(5 marks)
4 Explain one reason a new breakfast cereal might be able to compete even if it has
a relatively high price.
(5 marks)
5 Explain one benefit to a drinks business of focusing on a specific segment of the
market.
(5 marks)

(c) Data response questions

Morrisons
In 2014, the supermarket business Morrisons announced that it was going to be
permanently cheaper, with price reductions on over 1,200 everyday essentials.
The price cuts, which on average are 17 per cent, are on their own brand and on well-
known branded products that together make up a typical weekly shopping basket. The
latest price drops follow earlier ones on milk, fresh meat, fruit and vegetables.
The Chief Executive of Morrisons said that although the company’s products were
now cheaper this does not mean that quality was reduced: the aim is to make food
more affordable to keep and gain customers.
The company is also being very transparent about its pricing. It launched a new
website, powered by mysupermarket.co.uk, which gives customers the ability to view
the pricing history of an item. The aim is to reassure them that prices are indeed
lower.
The cheaper prices are being promoted via a campaign which has the title, ‘I’m Your
New Cheaper Morrisons’. This was launched on 1 May 2014 with heavy advertising in
the commercial breaks during Emmerdale and Coronation Street on television.
Morrisons is the UK’s second largest fresh food manufacturer and unlike its
competitors it makes more than half of the fresh food it sells. It uses this vertically
integrated structure to maintain quality of products while keeping prices down. At the
same time, the retailer has extended its improved ‘Fresh Look’ programme to half its
500 stores, with more products and better customer service. It has also developed its
offers for online, wholesale, local and in-store services.
Following these changes, Morrisons has made good progress. Its Chief Executive
said Morrisons continued to become broader, stronger and more popular. Sales have
now risen for the past 11 consecutive quarters and its online delivery service is
available to more than three quarters of UK homes, including more parts of southern
England and Scotland for the first time. The company has achieved significant
improvement in its fresh produce, its own label products, its homeware and clothing
lines.
Source: Adapted from BBC article, September 2018: ‘Morrisons sales soar as revival continues’
1 Explain two benefits to a supermarket of segmenting the market.
(5 marks)
2 Analyse the factors that might influence a customer’s decision to choose one
supermarket rather than another.
(9 marks)
3 To what extent do you think changing its positioning is likely to be a good strategy
for Morrisons?
(16 marks)

(d) Essay questions

1 To what extent is the process of segmentation and targeting and positioning useful
to a business entering the retail clothing market?
(25 marks)
2 To what extent should your decision on which segment to target depend on how
many other businesses operate within it?
(25 marks)
Chapter 10 Using the marketing mix
Introduction
In this chapter we will introduce the marketing mix, examine the influences on the different
elements of the marketing mix and consider how it is used in marketing decision making.
What it is important to know by the end of this chapter:
• the elements of the marketing mix (7Ps)
• how to analyse the influences on and effects of changes in elements of the marketing mix
• the difference between industrial and consumer products
• the difference between convenience, shopping and specialty products
• the implications of the product life cycle and the Boston matrix for marketing decision making
• the influences on new product development decisions
• the influences on pricing decisions
• how to analyse the promotional mix, including branding
• how to analyse distribution decisions
• how to analyse decisions relating to people, process and physical environment
• the importance of an integrated marketing mix
• the value of digital marketing and e-commerce.
The elements of the marketing mix (7Ps)
The positioning of a business is a key part of the marketing planning of a business: it determines
how managers want the product to be perceived relative to rivals. For example, if a business is
deciding on launching a product it can analyse the market to identify the segments it wants to
target and then decide on its desired positioning. Does a new sports retailer want to be regarded
as a discounter (like Sports Direct) or more of a fashion business (like JD Sports)? In the case of
an established product a manager may decide to change the positioning of its product relative to
competitors; for example, Waitrose supermarket has been trying to reposition itself so it is not
seen as so expensive and Morrisons wants to reposition itself to compete more directly with the
discounters such as Aldi.

Figure 10.1 The marketing mix

Once a manager has decided on the positioning of the product or business in the market they can
then organise the marketing activities to reinforce this position. For example, in a premium hotel
you expect room service, a pool and excellent customer service, for which you would expect to
pay a relatively high price. In a budget hotel you expect a basic room and a low price.
The combination of marketing decisions that influence a customer’s decision to buy is known as
the marketing mix. The nature of the mix will depend on the positioning.

Key term
The marketing mix is the combination of marketing choices that can be used by a
business to influence consumers to buy products.

The marketing mix can be analysed using the 7Ps framework. The 7Ps are:
• The price of the product. This includes the prices charged for different versions of the product
 (for example, for different-sized bottles) and payment terms – for example, whether a
customer can pay in instalments.
• The product itself. This includes the physical features and specifications of the product (what
does it do), what it looks like (its design), how reliable it is, how long it lasts, what guarantees
are provided, what after sales service is provided.
• The distribution of the product (this is known as place). This refers to the distribution channel,
that is how the ownership of a product moves from the producer of the product to the final
customer. In some cases, a customer buys direct from the producer and the distribution channel
is known as ‘0 level’ as there are no intermediaries. In other cases, a product is sold to
intermediaries such as retailers who then sell it on to the final customer.

Key models and theories

The 7Ps of the marketing mix highlight the different factors that managers can
influence to affect customers’ decision to buy. The model provides a structure to
analyse the different decisions that have to be made. The decisions made for each
product will vary and the relative importance of a factor may vary at different times; for
example, if incomes are low the price may become more significant.

• The promotion of the product. This refers to the ways in which a business communicates
about the product. This can be through a variety of ways such as:
• advertising: this involves paid for communications, for example, in newspapers or on
billboards
• public relations: this is when businesses try to get free coverage of their activities, for
example, if their chief executive gives an interview to the press
• sponsorship deals, for example, promoting the Premier League
• sales promotions: these are special offers such as ‘buy one get one free’ (BOGOF)
• sales teams: many businesses have salesforces to contact potential customers or distributors.
This is especially important with industrial goods where a business is selling to other
businesses and uses its salesforce to make the contacts.
• the people involved in the transaction, For example, the people who take your enquiry if you
ring up about a product, the people who serve you in a shop, the people who change your tyre
in the garage and who cut your hair at the hairdresser. Their skills and their attitudes affect
your perception of the product.
• the process. This refers to how you actually buy the product. A customer’s satisfaction with a
good or service can be affected by the process that is involved in buying it or paying for it.
Paying for car parking has got a lot easier with mobile phone payment and ordering your
shopping has got easier by using your phone or your tablet; these sorts of changes have
improved the customer experience. Equally you can have a bad customer experience if the
website crashes when you want to make a booking, if the shop does not accept credit cards or
you have to wait a long time because of the queuing system. Improving the buying process can
therefore improve customer satisfaction.
• the physical environment. This refers to the physical premises of a business, (for example, if
 you go and buy a car, look around the car showroom) and how carefully it has been designed;
the decor, the cleanliness, the design, the pictures, the state of the cars themselves and the
reception desk all influence your perception of the business. The same is true when you go to
the hairdressers: the signage, the layout of the salon, the music playing and so on all affect the
positioning of the business.

Figure 10.2 The promotional mix

Figure 10.3 A car showroom

Business in focus: Music promotion

In 2014 Dolly Parton, American country and western singer, played a set at
Glastonbury, Britain’s largest music festival. She was seen by 100,000 people at the
festival and by a further 2 million television viewers. After this her album ‘Blue Smoke’
was near the top of the album chart for eight weeks. Her resurgence shows how
festivals are reshaping Britain’s music business.
The live music market is flourishing even as sales of recorded music have fallen.
Between 2012 and 2013, the live market grew by a quarter, according to the
Performing Rights Society for Music. Gig-goers now spend more than £1 billion a year
on tickets and almost half that again on food, drink and the like while at the gig.
Festivals make up a large part of this market. In the early 1990s, Britain had few
festivals but around 450 now take place each year. The festival season, once limited
to July and August, now stretches until early autumn.
One boost was a change to the licensing laws in 2005 which made it easier to put on
a show outdoors. The recession helped too: Britons who could no longer afford
foreign holidays found a weekend of camping in a muddy field more attractive. Ageing
crowds are another bonus. A survey in 2013 found that the average age of a reveller
at Glastonbury, excluding those under 18, was 36 years old. This older group tend to
have more cash to spend, and their demands have helped make festivals safer and
more pleasant. Security at bigger festivals has grown much tighter. Toilets are slightly
less gruesome. Better food and drinks have replaced cheap hot dogs and watered-
down beer.
All this is changing the way the music industry works. Festivals are increasingly seen
as a way to test whether big-name artists have enough fans to warrant arena tours.
Newer names find them essential: Clean Bandit, a British band who brought out their
first album in 2014, performed at over 20 festivals over that summer. And music
executives are increasingly taking into account how successfully they think artists will
perform at big outdoor gigs before deciding to sign them.
Source: The Economist, 23 August 2014

Practice questions
1 Analyse the ways in which you would promote the next album of the band Arctic
Monkeys.
(9 marks)
2 To what extent do you think a festival is a good way to promote a new band?
Justify your view.
(16 marks)

Business in focus: Waitrose

In 2018, Waitrose announced that it was going to test a delivery service which would
allow drivers to go into a customer’s house while they are out, and then put their
groceries in their fridges. This trial by Waitrose involves smart lock technology; this
allows customers to put an access code on their door lock which is then deleted when
the delivery is finished. The trial will involve around 100 homes in south London.
Although profit margins will be very low, the aim is to build customer loyalty. The
Head of Business Development at Waitrose said that there was a growing demand
from customers to make shopping even more convenient given their very busy
lifestyles. In-home delivery has been popular in other countries and so Waitrose is
interested to see whether it will have similar appeal in the UK.
The driver who makes the delivery will wear a body camera and customers will be
able to view the video the next working day.
In recent years, the arrival of discounter stores Aldi and Lidl and the increasing
popularity of online delivery has increased competition in the supermarket sector.
Source: Adapted from BBC, October 2018
 Practice questions
1 Analyse how improving the process of delivery may help Waitrose.
(9 marks)
2 To what extent do you think process is a better way for retailers to compete than
price?
(16 marks)

What do you think?

You have decided to open an upmarket hairdressing salon in the West End of
London. How might this positioning affect the 7Ps?

The decisions made about the 7Ps and the way the different elements of the marketing mix
interrelate will affect the customer’s overall perception of the product, whether they think it
represents good value for money and how they think it is positioned relative to other products in
the market.
The relationship between the positioning of a business and the marketing mix can be seen by
analysing Ryanair. Ryanair has been clearly positioned as a low-cost airline.
This means:
• The product is basic. The company focuses on short-haul flights to airports where it is cheap to
land. It uses a standardised fleet of planes so that parts are standardised and staff only have to
be trained to maintain and repair one type of aircraft, which keeps costs low.
• The price is low because it is positioned as a budget airline.
• The promotion focuses on the low-cost message and is via inexpensive methods. For example,
boss Michael O’Leary has tended to get a lot of publicity for some of the things he says (such
as threatening to charge customers to use the toilet on the plane!) – this gets the company’s
name mentioned without paying anything for advertising.
• The process focuses on online bookings to keep the costs down. If a customer makes a mistake
in the booking it is their fault and they must pay for any necessary changes. This may be
annoying but it keeps the price down and this is what the business is focusing on.
• The staff are expected to undertake many different tasks, which also helps keeps costs down.
Compare this with MontBlanc, which is positioned as a luxury brand that offers products such as
watches and pens, or ‘writing instruments’. To match this luxury positioning the marketing mix
includes:
• a product that is focused on craftsmanship
• high prices to reflect the brand’s exclusivity
• limited distribution; the products are sold in premium outlets
Figure 10.4 The stages of the marketing process

Figure 10.5 A Montblanc pen

• promotion that highlights quality; for example, advertising in upmarket publications

• the staff will place a high level of importance on customer service.

What do you think?

The InterContintental Group of hotels is one of the largest in the world. It comprises
several brands aimed at different customer segments as shown below. Explain why
Intercontinental might have a range of hotel brands. Discuss how the marketing mix
might vary for Holiday Inn and Crown Plaza.
Figure 10.6 The Intercontinental group owns several hotel businesses aimed at different market
segments. The Holiday Inn aims at families and social travellers, whereas the Crowne Plaza attracts
business guests.
Changes in the marketing mix
The positioning of a product is not fixed. It may need to change as internal or market conditions
change. For example, following a disappointing financial performance in 2014, Ryanair’s boss
announced the company would place more emphasis on customer service, for example, allowing
a second cabin bag on board, reducing the number of clicks to book online and having allocated
seats. These efforts to improve customer service and enhance the benefits offered were an
attempt to catch up with EasyJet, which had moved very successfully in this direction ahead of
Ryanair.
Changes in the mix occur due to internal or external influences. Internal influences might be:
• changes to the financial position. This might affect investment in new product development or
promotion.
• changes to staff bringing about new marketing opportunities. New signings at Arsenal might
improve the team and lead to greater promotions or higher priced tickets.
• changes to operations. For example, greater efficiencies might enable lower prices. More
innovation might lead to a wider range of products being offered.
• changes to objectives. New managers or owners may set new targets for the business. For
example, there may be a target of faster growth. These new objectives for the business as a
whole will have implications for each of the functions including marketing. New marketing
objectives might include higher sales and this might influence the marketing mix.
External influences can be analysed using the PEST-C: framework:
• Political and legal factors. For example, new European legislation might affect how products
have to be labelled.
• Economic factors. For example, if the economy is growing, higher prices might be possible.
• Social factors. For example, greater environmental concerns might affect how the product is
produced.
• Technological factors. For example, more people using the internet might make online
promotion more effective.
• Competition. For example, greater competition might mean the benefits of the product have to
be enhanced to match what they are offering.
Influences on the marketing mix
Types of product

Figure 10.7 Types of products

There are, of course, many different types of products and the relative importance of different
marketing activities and the nature of the marketing mix will vary for these. A common
distinction when analysing products is to distinguish between consumer and industrial
products.

Key terms
Consumer products are goods bought for consumption by the general public.
Industrial products are goods bought for use in business processes.

Consumer products are bought by individuals like you and me: we either consume them
ourselves or give them to others to consume. This means that there may be many thousands or
even millions of customers being targeted. As a result promotional activities may have to reach
large numbers of people and may justify national advertising.
When targeting customers of consumer products marketing managers will bear in mind that
consumers are not professional buyers. Although on occasion they may be rational and very
logical in their decision making there will also be occasions where they are emotional and
affected by all kinds of factors such as the brand image.
By comparison, industrial products are sold to businesses, which use them in their own
processes. In this case a business may be dealing with professional buyers (that is, buying is their
job) who:
• are probably less interested in packaging and branding in itself and more interested in having
evidence of the technical performance of the product
• will want to understand exactly how the product represents value for money and how it helps
their business improve their competitiveness.
Business in focus: Navigator photocopier paper

Navigator photocopier paper is sold mainly to businesses. The promotional

information below is aimed at business buyers.
INCREASED PRODUCTIVITY
99.99 per cent paper jam free. A reduction in jams which leads to a lower cost per
printed document.
IMPROVED SURFACE
Provides excellent printing quality while reducing toner consumption.
SILKY TOUCH
Extra smooth surface. Lower abrasiveness improves the lifetime of office equipment.
MULTIFUNCTIONAL
100 per cent guaranteed for all printers and copiers and any type of document.

Figure 10.8 Increased productivity per day (8 hours)

Source: Navigator website, www.navigator-paper.com

Practice questions
1 Analyse the potential benefits to a business of buying Navigator photocopier paper.
(9 marks)
2 To what extent do you think the product is the most important element of the
marketing mix in the case of industrial products?
(16 marks)
Types of consumer products
With the overall category of consumer products it is possible to analyse sub-categories:
• Convenience items: these are products such as milk and newspapers, which are very widely
distributed. Customers will not usually travel very far to buy these products and if they are not
available at one store customers will probably buy another brand. Ensuring the products are
widely available is an important part of the success of these products.
• Shopping goods: these are products where customers compare features and price between
different options and may take some time before deciding which one to buy. Shopping goods
are the sort of products you might visit several stores before deciding which brand to buy (i.e.
when out shopping or online). If you want to buy a washing machine or microwave you might
want to shop around and compare before deciding which model to buy. For this type of
product it is important to show the relative benefits of your product compared to rivals.
• Specialty products: these are products such as a sports cars or a Rolex watch. Customers may
have been thinking about buying these for months or even years. Customers will be willing to
travel far to buy this product and the brand may be very important, as will the physical
environment where it is sold.

Figure 10.9 Categories of consumer products

Convenience Shopping Speciality

Example Chewing gum TV Sports car
Distribution Very wide Wide Limited
(Place)
Price Not necessarily that important as Important as Not so
usually relatively low customers shop significant
around and compare as this is a
special
purchase
Product Some brand loyalty Some brand loyalty Strong
but comparison brand
between brands awareness
Promotion Aiming at large numbers of Will raise brand Very
 customers; aims to draw them awareness targeted
into the store and in-store will use
promotions to attract impulse
buys
Process Often impulse buy May have payment May want
and credit terms payment
terms
Physical Not very significant Relatively significant Very
environment significant
People Limited importance Important: want staff Very
in store to know the important –
strengths of the brand staff in store
and particular model reflect on
the brand
Table 10.1 The marketing mix and different types of product

Figure 10.10 Influences on the marketing mix

Analysis of product decisions
The product lies at the heart of the marketing mix. After all it is the product that defines the
benefits that the business provides. A product consists of:
• the core benefit it provides, for example, a washing machine provides clean clothes.
• the tangible product: this refers to features such as its specifications, its reliability and its
design. In the case of a washing machine, this would refer to the size, shape and look of the
machine as well as features such as spin speed and energy usage. (Samsung have recently
introduced a washing machine that will store a month’s worth of washing powder and
gradually release it as required; the washing machine decides how dirty the clothes are and
how much powder is needed!)
• the augmented product: this refers to the ‘extras’ such as the brand name, the delivery and
any guarantee and after-sales service provided. For example, a retailer may offer to take away
your old washing machine and install your new one, to encourage you to buy from it.

What do you think?

What do you think are the core, tangible and augmented aspects of a Toyota Prius (a
hybrid electric car)?

Figure 10.11 Features of a product

Features of a product
Managers will want to decide not only the features of a given product but also what products to
offer (which markets to compete in) and how many versions to offer (for example, what sizes,
with what forms of packaging).

Figure 10.12 Different offerings for different market segments

Figure 10.13 Aspects of managing products

Managers will want to:

• monitor the progress of individual products over time to decide whether to change the
marketing mix – this can be analysed using the product life cycle model
• take an overview of how all the products fit together to decide whether some need more
investment or whether some are no longer viable – this is analysed using product portfolio
analysis
• decide whether to develop new products as markets change (new product development)
• how to develop the brand of a product.
 Key terms
A product life cycle model shows the sales of a product over its life. Usually involves
stages such as introduction, growth, maturity and decline.
Product portfolio analysis examines the market position of all of the products of a
business, for example, in terms of market share or market growth.

These aspects of managing products are examined below.

Product life cycle
As part of their decisions about the marketing mix, managers will review how products are doing
over time and whether the mix needs to change. The different stages of a product’s progress in
terms of sales are shown on the product life cycle model in Figure 10.14; this model plots sales
over time.
The stages of a typical product life cycle are:
• Development: this is the stage when a product is being developed. At this stage there is
investment into research and development, products will be tested and assessed to see if they
are worth launching. This means money is being invested into product development but given
that there are no sales, cashflow is negative. Developing a new film, a new car or new TV
series takes time and money. Products such as driverless cars are still at this stage.
• Introduction: this is when a product is launched on to the market. Sales may be relatively
slow as awareness can take time to build. High levels of investment may be required to
promote the new product. Cashflow may still be negative. Products such as Google glasses are
at this stage.
• Growth: this when the sales begin to increase at a relatively fast rate. Customers are
increasingly aware of the product and sales are building. Managers will still be investing to
keep sales growing but by this stage cashflow should be becoming positive. Products such as
the latest iPhone are at this stage.
• Maturity: this is when the rate of growth of sales begins to slow; this could be because
competitors are entering the market taking away potential sales. Products such as BIC biros are
at this stage. Note that sales may be high, it is just that they are not increasing rapidly, possibly
because they are so high already.
• Decline: this is when sales are falling (the growth rate is negative), perhaps because new and
better products are now on the market. For example, sales of DVDs are now in decline.

What do you think?

What stage of the product life cycle do you think the following products are at? Why?
Product Annual sales growth
A −5 %
B 15 %
C 0%
Table 10.2

The marketing mix will need to be adapted at different stages of the product life cycle. For
example, when demand is growing the business may be able to maintain a relatively high price
whereas if the product is entering the decline phase managers may have to reduce the price.
When a product is introduced promotion may focus on making customers aware of the product;
when competitors enter the market the promotion may focus more on why this product is
different from others.

Figure 10.14 The product life cycle

What do you think?

What do you think the product life cycle for a new Harry Potter book by JK Rowling
would look like? Explain your reasoning.
What about the product life cycle for:
• Facebook
• Manchester United
• the next James Bond film
• Heinz Tomato Ketchup
• record players?

The value of the product life cycle model

The product life cycle model shows different stages a product may go through, from its
conception to its withdrawal from the market. The actual duration and precise nature of each
stage will vary from product to product. For example, a new restaurant may take months to
establish itself; a new film may be popular as soon as it is released. A successful medicine may
be on the market for over 15 years, whereas a new song may only be successful for weeks. From
this we can see how decisions may vary over time as the sales of a product move into different
stages. Just when these stages occur differs, but there are important lessons for marketing
managers about what to expect at some point in the progress of a product over time. The problem
is knowing exactly where you are at any particular moment; a slight fall in sales could be the
beginning of the decline stage of the life cycle or a temporary drop. Managers need to be careful
how they interpret the data before acting.
Elements of Introduction Growth Maturity Decline
the
marketing
mix
Price May enter May be able to Likely to May cut price to boost
with low price maintain a consider sales
to gain sales relatively high cutting price
or high price if price to sustain
demand is sales
high
Product Likely to be May develop May start to Focus on the most
limited other focus on profitable models
number of varieties/models best sellers
versions of as demand
the product is not
as it is just growing fast
launched any longer
Distribution May be Will become May focus May find it more
limited as the wider as more on best- difficult to maintain
product is not businesses will selling distribution as stores
yet want to sell the distribution may drop your product
established product channels for more popular
brands (this is called
delisting)
Promotion May focus on Continuing to Focus on Reduced to focus on
raising raise benefits of the most cost effective
awareness of awareness this product methods
the product compared to
rivals
Table 10.3 The marketing mix through the product life cycle

Handling data
Figure 10.15 Unit sales of Nintendo’s home consoles from 1997 to 2018 (millions)

Source: © Statista 2019

How might the data above in Figure 10.15 be useful to Nintendo’s marketing
managers?

Business in focus: Rainbow Loom

Figure 10.16 A Rainbow Loom

Rainbow Looms are one of the biggest crazes in recent years that have caught on
with children around the world. The product was originally developed by Cheong
Choon Ng in 2011 when he built a loom out of pins and wood. Mr Ng had noticed his
daughters weaving with elastic bands just using their fingers and decided there must
be a better way of doing it. (His background is in engineering.) The plastic loom he
developed enabled more complex patterns and more intricate designs to be created.
The success of Rainbow Looms has been extraordinary and incredibly rapid. This
 success is due mainly to word of mouth and children seeing others making bracelets,
and even clothes, with the looms and bands, and wanting to copy what everyone else
seems to be doing!
However, the Rainbow Loom and loom bands are not without critics. Some people
complain that they are bad for the environment because they are made of plastic and,
when thrown away, the bands do not biodegrade but instead enter the food chain
when they are eaten by fish. Others believe the bands are dangerous because
animals can choke on them and children can cut off the blood supply to their fingers if
they weave without the loom.
Typically, products such as the Rainbow Loom have a relatively short product life
cycle as children move on to the next craze.

Practice questions
1 Analyse the possible reasons for the growth in sales in loom bands.
(9 marks)
2 To what extent was the decline in sales of loom bands inevitable?
(12 marks)

Figure 10.17 Different product life cycles: a fad product, a product that makes a return to the market
and a product with a short life cycle

Extension strategies
An extension strategy occurs when a business attempts to prevent sales of a product from falling
and avoid or delay the decline stage of the product life cycle. For example, a business might:
• increase promotional expenditure to renewed interest in the product or to increase usage of the
product
• revamp the product in some way, for example, new packaging, new flavours
• find new target market segments for the product, for example, new countries to sell it in or
target a new age group with the product
• find new usage occasions for the product. For example, cereal companies are keen to try and
increase consumption at other times in the day apart from breakfast.
Figure 10.18 An extension strategy

What do you think?

How could Mattel, the producers of Barbie, extend its product life cycle?
The Boston Matrix
The product life cycle shows the progress of one product over time but most business have
several products. This means they will want to analyse the overall position of the collection (or
‘portfolio’) of products before deciding what to do next; this is known as ‘portfolio analysis’.
One well-known method of portfolio analysis is known as the Boston Matrix. It plots the
position of each product in terms of its market share and the relative growth of the market. The
size of the circle drawn to illustrate each product highlights the size of its turnover.

Key terms
The Boston matrix analyses all of a firm’s products in terms of their market share
and the growth of the market.
A balanced portfolio is an appropriate mix of products in terms of their market
shares and market growth.

Figure 10.19 Extension strategies

Business in focus: Candy Crush

 Figure 10.20 Candy Crush

King Digital Entertainment is the producer of the world famous, and slightly addictive,
Candy Crush games. The company’s sales have shot up in recent years with the
increased popularity of this game but, late in 2014, the business announced a fall in
its expected profits. This worried some analysts who thought this might be the
beginning of the end for the company as it was so reliant on one product, even though
its expected profits were still well over $2 billion. Some investors sold their shares and
the share price of the company fell significantly. However, King Digital
Entertainment’s managers are confident that this is not the case and the company is
here for the long term; new products that are in the pipeline will keep sales and profits
rising for years to come.

Practice questions
1 Imagine you are the managers of King Digital Entertainment in 2014. Analyse the
possible extension strategies you could use to prolong the life cycle of the Candy
Crush brand.
(9 marks)
2 To what extent should investors avoid mobile games businesses because of their
short product life cycles?
(16 marks)

In the Boston Matrix, products are given names according to which quadrant they are in.
• Dogs: these products with a relatively low share of a slow-growth market. Marketing managers
must either invest to revitalise these products or let them decline and eventually remove them.
 Figure 10.21 The Boston Matrix

• Cash cows: these products are well established and so have a relatively high market share;
however the market they are in is growing slowly, perhaps because it is mature and therefore
not growing fast any more. These products do not need promoting as heavily as some others
because they are well known and given their relatively high sales they generate a high level of
funds for the business. Think of Heinz baked beans: the total sales of baked beans is probably
quite large but not growing fast. Heinz baked beans is well established and should generate
high profits that can help fund other projects for the business.
• Problem children/question marks: these are products that are in fast-growth (and therefore
appealing) markets; however they are not yet established and only have a relatively small
market share. They are problem children because they may turn out to do well but equally may
not! Managers may want to invest to protect and grow these products.
• Stars: these are products that are in fast-growth markets and are doing well in terms of market
share. It could be the leading brand in a new type of app, for example. Managers will probably
need to keep investing in, promoting and gaining more distribution for these products to ensure
they remain stars.

What do you think?

Unilever has a vast product portfolio.
Why do you think companies like Unilever have built up their portfolios of products?
 Figure 10.22 The extensive product portfolio of Unilever

The value of the Boston Matrix

The value of the Boston Matrix model is it helps managers categorise their products and take a
view on what they should do next. For example:
• If all of the products of a business are cash cows managers might worry about the future
success of the organisation because sales growth is slow. In this case managers may decide to
invest to build some question marks and stars to help ensure future sales
• If all of the products of a business were dogs managers would definitely worry because they all
have low market shares in slow growth markets. Drastic action may be needed.

Handling data
Identify whether the following products are a cash cow, question mark, dog or star.
Explain your reasoning.
Product Market share (%) Market growth (%)
A 0.05 20.00
B 34.00 25.00
C 0.10 0.01
D 25.00 2.00
Table 10.4
Figure 10.23 Boston Box with funding

In theory, a manager will aim for some well-established products (cash cows) to help fund the
development and success of new products (question marks and stars). They will want a balanced
portfolio in which the mature, established products help prepare the business for the future.

Key models and theories

The Boston Matrix

The Boston Matrix helps managers analyse the position of their products in terms of
market growth and market share. This can help them decide on suitable marketing
plans; for example, managers may want to stop producing dog products and invest
more in question mark products. The Boston Matrix is a useful analytical and planning
tool. However, it is still up to managers to analyse the situation effectively, make the
right decisions and implement them successfully.

What do you think?

Why do you think a business might sell off some products in its portfolio?
What might a business look for in a product when deciding whether to add it to its
portfolio?

Business in focus: Coca-Cola

Figure 10.24 Coca-Cola owns multiple carbonated drinks brands

Coca-Cola is one of the world’s best known brands in its own right, but the company
also owns over 200 other brands of carbonated drink such as Sprite and Dr Pepper.
This means it competes in many different segments in markets all over the world.
However, the company faces a problem; people are becoming increasingly concerned
about their diet and there is some concern over the possible negative health
implications of drinking fizzy drinks with a high sugar content. Some governments are
also introducing taxes on drinks that have high levels of sugar in them. This is a
change in the social environment and to respond to this Coca-Cola has developed a
range of new products such as Coca-Cola Life. This drink has one-third less sugar
and one-third less calories than classic Coca-Cola.
Coca-Cola has also looked for new growth markets to move into. For example, in
2014, it bought a 16.7 per cent share in Monster, the energy drinks business. This
gave Coca-Cola a quick entry into the rapidly growing energy drinks sector as well as
gaining access to brands such as Monster’s Peace Tea and Hansen’s Natural Sodas.
These are potential growth areas for Coca-Cola and it has judged it more profitable to
buy established brands than try to build its own competing brand from scratch. For
Monster it has given the business access to Coca-Cola’s huge distribution system.

Practice questions
1 Analyse factors which might affect sales of Coca-Cola.
(9 marks)
2 To what extent do you think the Boston Matrix would be useful to marketing
managers for businesses such as Coca-Cola that have large product portfolios?
(16 marks)
Analysis of new product development decisions
New product development involves investment to modify an existing product or replace it with a
new one. It may take several months (for example, for a new computer game) or several years
(for example, for a new model of car).
New product development may be required because:
• the existing products are coming to the end of their life cycle
• new opportunities are opening up due to changes in the market
• there is a desire to build on the strengths of the brand
• it is a way of achieving growth
• to match what competitors are doing.
However, new product development involves risk because:
• Many product ideas do not make it to actual production. This is because the idea proves not to
be viable in terms of producing it and making a profit or because of technical problems along
the way.

Figure 10.25 The process of new product development

• Many products do not sell well and are withdrawn. This may be because the market has not
been understood properly, promotional problems or competitor actions.
When considering whether to invest in a new product, managers will consider the likely time it
will take to recover the initial spending (this is called payback) and the rate of return on the
investment.

What do you think?

What do you think managers could do to increase the likelihood of success of a new
film?

What do you think?

Apple has had several highly successful innovative products. What do you think
determines the success of Apple’s new product development?
Analysing pricing decisions
In addition to the features outlined in Figure 10.10 such as positioning, the stage of a product in
the product life cycle and the competitive environment which influence all aspects of the
marketing mix, when considering pricing decisions it is important to examine factors such as:
• The price elasticity of demand. If demand is price inelastic then it is possible to increase
revenue by increasing price; this is because the price increase leads to a smaller percentage fall
in quantity demanded. If demand is price elastic it is possible to increase revenue by reducing
the price; this is because the percentage increase in quantity demanded is greater than the cut
in price in percentage.
Businesses will consider the price elasticity of demand before making price changes.
• Costs. For a business pursuing profit a manager will need to ensure that over time the price
more than covers the cost per unit. In fact, some businesses adopt an approach to pricing called
cost plus: a plumber or road builder might estimate the cost of doing the work and add on a
percentage.
However, this method is not always appropriate. For example, the cost per unit may vary
according to how much is being produced and so managers may estimate expected sales at
different prices and compare this with the expected costs. If a business installs a high-speed
broadband network in an area for example, this will involve high fixed costs to set up the
system. The more users the business signs up the more it can spread these fixed costs and bring
the unit cost down. This will enable the same profit margin to be achieved with a low price. By
comparison, lower levels of sales may have higher unit costs and require a higher price to
make a profit.
The effect of price changes on revenue, sales and profit can be analysed using break-even
charts (see pages 216–219).

Business in focus: Dropbox

If at first you don’t succeed … try again; that seems to be the lesson learned from the
story of Drew Houston who along with Arash Ferdowsi founded Dropbox, the online
storage system, in 2007.
Mr Houston was studying at the world famous Massachusetts Institute of Technology
(MIT) when he had a business idea to develop a programme to play online betting
games. As a computer science graduate he seemed ideally placed to do this – except
that his programme kept losing to the human players and had to be scrapped.
However, like all great entrepreneurs, Mr Houston refused to be beaten and went on
to his next idea, which was to develop online courses for students. Unfortunately,
despite three years’ work, this also failed to take off. A lesser man might have walked
away from entrepreneurship but not Mr Houston.
Like so many fantastic business products, the idea for Dropbox came from frustration
with what was available already. Mr Houston did not like having to remember to take
USBs everywhere to carry his documents around. Storing files online seemed to be
the solution and although some other businesses were starting to offer this solution,
few people were actually using the services because they were not very user friendly.
The key to Dropbox’s success was to make the service very simple to set up and use.
Within 7 years the company had over 300 million users and growth remains rapid.
The ease of the experience and the value of the service provided means that
Dropbox’s customer base grows largely from customers telling their friends about it
and getting them to install it so they can share files easily.
So, what is it that makes a business successful? According to Mr Houston it is fairly
simple – you just have to make something that people want. When companies fail, he
argues, it is because they don’t have enough customers; so to succeed, just make
sure you provide something that lots of people want!

Practice questions
1 Analyse the possible reasons why new products often fail.
(9 marks)
2 What do you think is the key reason why Dropbox has succeeded? Justify your
answer.
(16 marks)

Handling data

Figure 10.26 New product launches in the UK carbonated soft drinks market, by the low/no/reduced
sugar claim, 2014–8

Source: Mintel
1 Explain what the data in Figure 10.26 shows.
2 Analyse the possible causes for the changes over time shown.
Influences on pricing
There are many different approaches to pricing that a business might adopt. These include:
• penetration pricing. This occurs when a business charges a low price to gain market share.
This is most suitable when demand is sensitive to price (price elastic). A low price can gain
high sales and enable the business to benefit from producing on a large scale (for example, it
may be able to gain lower prices from suppliers if it is buying materials on a large scale).

Figure 10.27 Factors that influence pricing

• price skimming. This occurs if a relatively high price is charged when a product is launched.
For example, when a new iPhone is launched there are often queues outside the stores as some
customers are so eager to buy it. Price skimming is most appropriate when demand is price
inelastic; for example, if the product is heavily branded.

Business in focus: Uber

Uber is still a relatively new business in the taxi market. Customers can identify the
nearest Uber car and use an app to order it and it should turn up in minutes. The
company’s mission is, ‘We ignite opportunity by setting the world in motion.’ In 2018
the company had three million drivers and 75 million riders (passengers). Although
the convenience of this service is appealing to customers they have been less
pleased with Uber’s dynamic pricing model. When demand is high, such as at the
weekends, Uber pushes up prices to many times more than its normal fares.
Uber was launched in San Francisco in 2010 and it lets passengers call drivers from
their smartphones. Uber has a number of carefully checked cars and drivers;
customers can even see who is picking them up and what their rating has been in the
past from their customers. Generally, Uber’s prices are slightly cheaper than a taxi
you stop in the street but when demand is high ‘surge prices’ kick in. On New Year’s
Eve, for example, prices can be seven times normal levels, and minimum fares of up
to $175 can apply.
Like many technology companies, Uber is an intermediary. It links independent cab
 drivers with customers wanting a ride, in the same way that Google links searchers
and advertisers or eBay links sellers and bidders. In recent years, complaints about
this dynamic pricing have led Uber to introduce UberPool; this allows riders to find
others going in the same direction and share a ride.
Source: Adapted from The Economist, 29 March 2014

Practice questions
1 Analyse the influences on the price of an Uber taxi ride.
(9 marks)
2 To what extent is Uber’s pricing policy ethical, in your opinion? Justify your answer.
(16 marks)

Figure 10.28 Customers queuing for a new iPhone

• dynamic pricing. This occurs when prices are changing rapidly in response to changing
demand conditions. For example, airlines and hotels can track the number of enquiries at any
moment and the number of seats or rooms left and change the price accordingly. This means
there is no ‘one’ price for a ticket or a room – it depends when you enquire and make the
booking.

What do you think?

Why do you think the price should only be set having considered the other elements
of the marketing mix?
Analysing promotional decisions
In addition to the features outlined in Figure 10.10 which affect all aspects of the marketing mix,
when considering the appropriate mix of promotions a manager will examine factors such as:
• the target audience. Who is the business trying to communicate with? It is vital to understand
the target group to understand how best to reach them. For example, day time television would
not be useful if you are trying to target people who are out at work during the day. Google
advertising would not be effective if your target group does not use the internet much.
• the promotional budget (how much money there is to spend). Some methods of promotion
are relatively expensive (for example, television advertising) and therefore would not be
possible on a small budget.

Figure 10.29 Red Bull sponsors sports

• the message. For example, Red Bull has been keen to associate itself with sports and high
energy activities and has done this through sponsorship of extreme sport type events.
• technology. The growth of online businesses has created many new forms of promotional
opportunities which are transforming the promotional strategies of many businesses. Whereas
you can never be sure who sees an advertisement on a billboard or in the newspaper, you can
target online advertising much more effectively. With Google adwords, for example, a
business can ensure its advert only appears if people enter certain search terms; they can also
define in which regions it will appear, at what times and on what types of devices. They can
assess the effectiveness of such advertising by measures such as CTRs (click-through rates)
which measure how many people click through an advert to a company’s website once it
appears on their screens. This is much more targeted promotional activity with much more
measurable results than in the past. Businesses are also making much use of social media; for
example, by creating their own blogs, contributing to other blogs linked to their products and
using viral marketing to generate a buzz about their products.

Key terms
Social media refers to the social interaction among people where they create, share
or exchange information and ideas in virtual communities.
Viral marketing is a marketing technique that uses social media and networks to
raise brand awareness and boost sales by getting users to recommend the
promotional campaign (such as a blog or advert) to others.
Influences on the promotional mix

Figure 10.30 Influences on the promotional mix

What do you think?

It is estimated that by 2020 there will be 50 billion ‘connected devices’ in the world –
that is seven times more than there will be people. How do you think this will affect
the promotional activities of business?
Analysing branding decisions
A brand represents a promise made by a business to provide a specific set of benefits. As
customers we recognise brands and believe that they each represent certain values and so buying
a branded product will deliver a certain set of features and/or services to us. We take a view of
different brands and whether or not we want to be associated with them and want what they
provide. We recognise a brand by its name, symbol/logo, slogan or anything else that is used to
identify and distinguish it from the competition.
A brand is recognised by customers and has various associations for them. A brand has a
promise of an experience. For example, if someone asked what you thought of Nike, Apple,
McDonalds, Primark, Marks & Spencer and Beats you would have various thoughts about all of
them: what the brand stands for, what it represents and what it means to you. These values can
make you loyal to the brand because you want to be associated with it and because the brand acts
as an assurance of the nature of the product and the service you will receive. A brand conveys
something to the customer: it may be exclusivity, excellence of customer service or ethics. A
brand is, therefore, a reputational asset, that is the reputation of the brand is something that has
value to the business.
The values of a brand are not created immediately; the associations and trust tend to build over
time. And a brand is not safe forever: brands are also vulnerable and can be severely damaged if
something happens that conflicts with its values.

Business in focus: Monster

Monster Energy drinks has a very different approach to promotion than most other
drinks companies. It does not spend money on adverts in any form, preferring instead
to focus on sponsoring people and events. It sponsors athletes, bands, sports events
and concerts, for example. This way, it helps people fulfil their ambitions and dreams
and enables the public to enjoy more great sport and music.
According to Monster, its staff and customers don’t really want 9 to 5 jobs – they
dream of being great sports stars or playing in a band. Monster helps people fulfil that
dream or allows them to experience the skills of those that do. The company throws
parties where people can come along and enjoy a great sporting or music event. It
offers great rewards to its customers, such as VIP access at events, trips with
musicians and athletes and equipment such as dirt bikes, snowboards and BMX
bikes.
Monster aims to represent a way of life that reflects living on the edge, punk rock and
partying. As the company expresses it, Monster is a lifestyle in a can.

Practice questions
1 Analyse why Monster has chosen not to invest in advertising.
(9 marks)
2 To what extent do you think the Monster approach to promotion would work for all
 businesses?
(16 marks)

Business in focus: Thomas Cook

In 2018, Thomas Cook decided to shut down its Club 18–30 brands. In the 1960s, this
was a leading holiday brand for people aged 18 to 30. It targeted young singles and
couples who wanted to travel without families or children. Thomas Cook bought the
brand in 1998. These holidays had a reputation of involving excessive behaviour.
Thomas Cook tried, unsuccessfully, over the summer to find a buyer for Club 18–30.
The company said it wanted to focus on its core brand and that Cub 18–30 no longer
fitted with its portfolio. The last holiday was a trip from Manchester to Magaluf,
Majorca.
Source: Adapted from BBC, October 2018

Practice questions
1 Analyse why Thomas Cook might shut down a brand.
(9 marks)
2 To what extent can the reputation of a brand influence a customer’s decision
whether to buy a product?
(16 marks)

What do you think?

According to brand specialists Interbrand, the biggest European brands of 2017 were
as follows.
Rank Company Revenue in 2017 ($m) Change in revenue
1 Apple 184,154 +3%
2 Google 141,703 +6%
3 Microsoft 79,999 +10%
4 Coca-Cola 69,733 +5%
5 Amazon 64,796 +29%
6 Samsung 56,249 +9%
7 Toyota 50,291 -6%
8 Facebook 48,188 +48%
 9 Mercedes-Benz 47,829 +10%
10 IBM 46,829 -11%
Table 10.5 The biggest European brands of 2017 by revenue
Source: Interbrand website
1 What do you associate with the brands above?
2 In what way do you think a brand has a value?
3 How would you estimate this value?

If a brand is strong this may mean that:

• demand is likely to be more price inelastic
• customers may become brand ambassadors, telling others about the brand and convincing them
to try it
• customers may be more open to other products launched under the same brand name
• it may be difficult for other brands to enter the market or gain market share.

What do you think?

What is your favourite brand of clothing? Why? What do you think wearing it says
about you?
According to Warren Buffett, one of the richest men and most successful investors in
the world, it takes 20 years to build a reputation. Do you agree with this?
Can you think of a brand whose reputation has been damaged in recent years?
Analysing distribution decisions
In addition to the features outlined in Figure 10.10 that affect all aspects of the marketing mix
when considering distribution decisions, a manager will also examine factors such as:
• the degree of coverage. Does the business intend to target customers globally? Nationally? Or
locally? The broader the spread of customers the more a business may have to use
intermediaries to reach them rather than try to distribute directly to them.
• the costs of different distribution strategies. Setting up your own distribution network (for
example, your own chain of retail outlets across the country) may be expensive and take time.
However, online sales opportunities mean businesses can now be global easily rather than
having to open stores around the world.
• the nature of the product. For example, if you have a high value product that sells in
relatively low quantities it may be realistic to distribute these products direct to the customer.
However, if the product is relatively low-value and sells in high quantities (such as chewing
gum) a business is likely to use intermediaries such as wholesalers and retailers. Convenience
items need to be widely distributed whereas specialty items can be focused on fewer outlets
that reinforce the brand.
• the degree of control a business wants over the way its products are priced and
promoted. If an intermediary is used, for example, this business may gain ownership and
therefore control how the product is displayed, promoted and priced. Companies such as Aston
Martin, Rolex, Gucci and Chanel keep very close control of the outlets that sell their products
because they want to protect the brand.
• how customers expect to access the product and what technology allows a business to
deliver. Increasingly, shoppers are expecting multichannel distribution. This means they
want to access a product in many ways. For example, businesses such as Tesco offers its
products:
• in out of town hypermarkets and supermarkets
• in more local city stores
• online.
Many businesses are having to respond to the demands from customers for greater flexibility by
developing more distribution routes. Technology is revolutionising distribution in many
industries and changing the value and nature of physical stores.

Key term
Multichannel distribution means that customers can buy the product in several
ways, for example, in store, online or ‘click and collect’.
People, process and the physical
environment decisions
In the past the marketing mix was often studied as the four Ps: price, place (distribution),
promotion and product. However, as the service economy has grown other marketing activities
have become important such as:
• the people. Those providing the service, advising and carrying out the task. The expertise and
skills of your hairdresser, accountant, doctor and dentist are all important influences on your
decision to use their services. Training, education and awareness of customer requirements are
all important parts of marketing. Have you ever praised the helpfulness of a store? Ever
criticised one for having staff who do not seem interested in you as a customer? If so you can
see the importance of people. What influenced your first impression of your school? Inevitably
it was the people you met, such as the teachers, the Head and the administrative staff.
Managers will have to decide on staffing levels, investment in training and how to reward
staff. These decisions will depend on factors such as how the business is positioned (we expect
more personal attention and interaction at a four-star restaurant than at a Subway outlet, for
example) and the nature of the product (for example, we may want more advice and
information for shopping goods compared to convenience items).
• the process. Part of the customer experience in the whole process of buying. Do you have to
wait for a long time in a queue? Are there seemingly endless forms to fill in? Can you order
easily online? All these features will affect the buyer. Stores may compete by making the
process easier: buy online and collect in store, 24-hour home delivery, online check-in and
swiping your credit card rather than having to enter your code are all examples of how the
process can make a business more competitive. Companies such as Disney appreciate that the
process is a very important part of the mix: they manage queues at their theme parks carefully
by flagging how long you have to wait, making sure you can always see the end of the queue
so it does not seem far away, having entertainers distract you and allowing you to have a set
time to go on a ride so you don’t need to queue. Technological changes in particular have
enabled businesses to improve their process.
• the physical environment. When you first walk into a leisure centre or the beauty salon you
get an impression. The way it is designed, what is on the walls, what facilities there are all give
signs that tell us something about the service. Marketing managers will want to consider how
this fits in with the brand. Just think of any new buildings around your school – what messages
do they convey in terms of design – are they modern in feel? Practical? Safe? What does the
physical environment tell you about what the school values. The same is true for businesses –
their head office, their offices generally and their stores all convey something. Managers will
consider factors such as where to locate them, how to design them and how much to invest in
them. This will again depend on factors such as the brand, the nature of the product and
positioning.

Business in focus: Hay fever

 Many of us choose to buy a brand we know because we find it reassuring and
because it reduces the risk of the purchase. We feel we understand the values of
particular brands and we know we can rely on their quality. This can make buying
quicker and less worrying. As a result of this, well-known, trusted brands may be
priced more highly because we, as customers, are willing to pay for reassurance. A
good example of this can be found in the pharmaceutical industry. When a company
develops a new drug it can protect it with a patent. This prevents it being copied by
others for a certain period of time and so allows the pharmaceutical company time to
recover its investment costs. This also gives the brand time to become established in
the market without competition. If successful this product becomes the brand we
associate with curing a particular condition and so turn to it when we want treatment.
Once the patent expires the drug can be copied and produced by other businesses
and these can be sold under their own labels. Whilst competitors do create new
cheaper options which customers buy, the branded products often continue to sell
well too. For example, Clarityn is a product to relieve the symptoms of hayfever. It
contains the active antihistamine ingredient Loratadine which prevents the body
creating the histamine that causes inflammation in the nose and throat. In 2018,
Clarityn sells a pack of 30 for £10.49 in high street chemists such as Boots. However,
Boots also sells its own label product of anti-hayfever tablets called Allergy Relief;
these also contain Loratadine and a pack of 30 is sold for £5.89. Products such as
Nurofen and Lemsip also have own-label equivalents but still command higher prices
and sell well as some customers prefer to buy a brand name.

Practice questions
1 Analyse the possible reasons why people are willing to pay more for a branded
product.
(9 marks)
2 To what extent do you think the brand is more important than the actual product?
(16 marks)

Figure 10.31 Foxton’s estate agents place great importance on making the physical environment in
their branches appealing to customers.
Business in focus: Travelodge

The upgraded Travelodge room

Our brand new room design has been created based on feedback from our customers
about what they value most in a hotel.
The Travelodge Dreamer® Bed – an upgraded new luxury king size bed provides the
correct amount of support and comfort to ensure they receive a good quality night’s
sleep. All topped with a quilted mattress topper with comfy, bounce back duvet and
four plump pillows.
For families travelling with children, and for those adults sharing for a quick overnight
trip, we have introduced separate pull-out family beds.
Soothing Design – to help create a warm and cosy ambiance in the new room,
Travelodge worked with a chromotherapy expert and has introduced a sleep inducing
colour palette to the room’s decor. The new Travelodge room feature wall has been
painted a tranquil blue, as research shows our body clock is programmed to relate the
colour blue to the hours of darkness.
Other additions to the new room include a stylish white contemporary ensuite
bathroom with shower, a larger desk area, new reading lights and a phone charging
socket built into the bed frame.
We’ve worked hard to understand what you truly need from a nights stay, which is
why we’ve fine-tuned our offer to provide you with our new SuperRoom option
alongside our amazing value standard room.
People
More than 11,000 Travelodge colleagues work together to look after our customers
each day. We offer a wide range of roles, including front-line guest service positions,
construction and maintenance teams and a range of positions in our support centre.
Source: Our company, Travelodge © Travelodge 2019

Practice questions
1 Analyse how market research might affect the marketing activities of Travelodge
hotels.
(9 marks)
2 To what extent do you think the product is a more important element of the
marketing mix than people for Travelodge?
(16 marks)
The importance of an integrated marketing mix
The marketing mix refers to all the activities that might affect a customer’s decision to purchase
and indeed their experience of the product and whether they return to buy again. To be effective,
the different aspects of the mix must work together and reinforce each other, that is they must be
integrated. For example, if you walk into a shabby cafe on the outskirts of town you might be
reluctant to pay high prices; the price and physical environment do not match. If you book a five-
star hotel for your honeymoon you expect the service and the staff to be outstanding; the people
have to match the product.
The different elements of the marketing mix must therefore complement each other to reinforce
the brand values. The mix must also be developed to be appropriate for the given context. For
example, the marketing mix must take account of:
• the position in the product life cycle; for example, in the decline stage the price may need to be
lowered
• the Boston Matrix; there may need to be investment in more distribution for the star products,
for example, to build on their success
• the type of product; the price must be competitive with rivals for shopping goods, for example,
but it is possible to charge higher prices than rivals for specialty products provided the brand is
strong enough
• the marketing objectives; for example, a desire to increase sales significantly may require more
investment in promotion
• the target market; for example, the promotional mix may need to be digitally based for a youth
market and use social media but these methods are unlikely to be as effective for buyers aged
over 80
• competition; for example, a business may want to differentiate itself from rivals and so
developments in their products may require more investment in new product development to
keep pace
• positioning: for example, a business such as IKEA wants to provide well designed furniture at
low prices. This affects aspects of the marketing mix such as:
• the product, which has to be designed and produced in a way that is cheap. Customers
assembling their own furniture and enabling it to be stored flat packed in a warehouse
environment (which has only basic features) keeps costs down.
Figure 10.32 IKEA store

• the physical environment. IKEA stores are located outside of town in low cost locations.
They are designed so that once you enter them it is difficult to leave without seeing
everything. It has the products kept in a warehouse environment which is cheap to build and
maintain.
• the process. Customers identify what they want and then find it in the warehouse. They take
it to their car themselves and assemble themselves.
• the people; staffing levels are kept low.
The positioning of the business influences all aspects of its integrated marketing mix.
The value of digital marketing and e-commerce
In recent years, developments in technology have significantly affected most aspects of business
not least marketing. For example, digital marketing has enabled businesses to:
• gather more information about customers and process it more quickly and more effectively.
This has provided much more insight into markets and customers
• build relationships with customers more effectively by being able to track their buying habits
and recommend other products they might like
• target very specific segments. A business can now set up online quite cheaply and focus on
quite a small segment of the market. It does not have to sell stock that may not sell: it can
produce to order.
• involve customers more in the marketing process; customers can provide reviews of products
to help other potential buyers; customers can also contribute designs and ideas online and the
business can produce these if there is enough interest
• target global markets 24 hours a day.

Key term
E-commerce is the buying and selling of products through an electronic medium such
as the internet.

Of course the value of digital marketing and e-commerce depends on how fast and how well a
business adopts it. Morrison’s was slow to go online and therefore lost market share: to
Morrison’s e-commerce proved a threat. HMV struggled as customers opted to download music
rather than buy in-store; although the company tried to respond by changing its product mix it
could not generate enough sales. By comparison, businesses such as eBay, Alibaba and Amazon
have flourished through digital marketing and e-commerce.
It should not be assumed that these technological developments benefit every business.
Traditional print newspapers have struggled as customers read online. Traditional television
producers have struggled as customers want to watch online as and when they want. The key for
marketing managers is to watch the trends in the market and make sure the business is adapting
accordingly.
Element of Technology
the
marketing
mix
Pricing Businesses can adjust price according to the time when people are
searching, where they are searching from and their previous
behaviour; regular changes in price as demand conditions change is
known as ‘dynamic pricing’. It is not appropriate these days to ask for
‘the price’ of a plane ticket – it depends on when you ask.
Promotion Online advertising can be much more targeted than, say, print
 advertising. If you place an advert in a newspaper or magazine you
cannot easily be sure who sees it or what they do as a consequence. If
you advertise online you can target the advert to show up in response
to particular search terms at specific times from specific locations; you
can also measure how many people then request more information or
visit your website.
Distribution By offering products online it Is possible to reach people around the
world 24 hours day.
Process An online presence designed for e.g. PC, tablet and phone allows
customers to find information and order whenever and wherever they
want.
Physical Some businesses are adopting an online presence to complement their
environment physical stores. For others the business is their online presence and so
the web design reflects the brand rather than a store.
Table 10.6 The marketing mix and technology

Business in focus: Location targeting

Walk along the street and look at all the places where advertising is placed – on bus
stops, on billboards, on posters on the wall, on the backs of buses and the sides of
cars. Advertisers are trying to communicate messages about their products in many
different ways. The problem for the companies trying to promote their products is that
these adverts are not very targeted – they may be seen by large numbers of people
but the products or messages may not be relevant to most of them so a great deal of
money spent on advertising is wasted. But what if the advertisers knew who was
walking past at any moment and could change their adverts and messages
accordingly? This means they could target their messages very precisely.
Developments in technology are making this possible – companies are able to track
where you are via your phone and then change their adverts accordingly. For
example, Esri is a company that specialises in location data mapping. It brings
location data gained from a range of sources such as Wi-fi, phone masts, GPS and
card transactions, and combines this with other data such as social media to enable
companies (Esri’s customers) to identify where their potential customers are at any
moment and advertise accordingly. This kind of targeted marketing is much more
efficient but acquiring the data obviously comes at a cost.

Practice questions
1 Analyse the benefits of location targeting for businesses.
(9 marks)
2 To what extent do you think location targeting is ethical?
(16 marks)
Business in focus: Xiaomi

In 2018, the phone producer Xiaomi announced that it was going to product a new
smartphone. It decided to release a low-price smartphone targeting the Indian market
under a new brand name. The phone is called the Poco F1. It has many premium
features despite the price, such as a long battery life and around eight gigabytes of
RAM – similar to Samsung’s Galaxy Note 9.
The price of the Poco F1 will be substantially less than its rivals. The basic model of
the Poco F1 – with 6GB of RAM and 64GB of internal storage – will sell for around
£230. The top-end version is £332.
If the Poco F1 is successful in India, Xiaomi will roll it out in up to 50 countries. Xiaomi
has managed to keep costs down by reusing parts wherever it can. For example, it is
not using the very latest optical technology.
According to reviewers, the phone is excellent value for money.
Manufacturer Smartphone shipments July Year-on-year Market share in
2017-June 2018 change Q2 2018
Samsung 307.5 million -1.9% 21.0%
Huawei 174.7 million +14.9% 15.9%
Apple 217.5 million +0.9% 12.1%
Xiaomi 116.2 million +81.2% 9.4%
Oppo 111.8 million +0.6% 8.6%
Vivo 93.4 million +8.5% 7.9%
LG 48.7 million -13.0% 2.9%
Others 376.6 million -22.5% 22.3%
Table 10.7 Global smartphone shipments July 2017 to June 2018
Source of data: International data corporation

Practice questions
1 Analyse the factors that influenced the marketing mix of the Poco F1.
(9 marks)
2 To what extent do you think the price is a more important element of the marketing
mix than the product for the Poco F1?
(16 marks)
Business in focus: Funerals

Some industries, like construction, are cyclical – they do well in times of booms and
badly during recessions. Other sectors such as financial administrators that help
recover money and close businesses down are contra cyclical – they do better when
the economy is doing badly. Other businesses are not as vulnerable to the economic
climate because they provide the essentials. The funeral industry is one of these.
Whatever else is happening in the world people die, so the funeral industry has a
steady demand. However, that does not mean that the market never changes.
Changes in society can affect whether people want to be cremated, while availability
of land can affect where and how people are buried. Also, technology is now having
an impact on the funeral industry: people can record messages to be played when
they are gone and readable QR codes can be placed on headstones so visitors can
play a message from the deceased; and it is even possible to set up a messaging
service to text everyone you know when you are dead. Further technological
innovations include having personalised coffins and a company called Celestis, for
example, charges around £3,000 to send your remains into outer space. No market, it
seems, can ignore changes in the macro-environment.

Practice questions
1 Analyse the ways in which technology is benefiting customers of funeral
businesses.
(9 marks)
2 To what extent do you think price is an important element of the marketing mix for
a funeral?
(16 marks)

Business in focus: Poundland

The discount retailer Poundland launched its online store in 2015. After failing to
make a profit, Poundland ceased online operations in early 2017 to focus on its
physical shops. B&M Bargains, one of Poundland’s major competitors, has always
maintained that e-commerce is not suitable for its business model.
The logistics involved in delivering items direct to customers’ homes are expensive
and complex. As discount stores rely on tight margins to be competitive, the sales
volumes would have to be enormous in order for online retail to be financially viable
for these businesses.
The problem is compounded by the low-value nature of the items being sold. The
average basket size of Poundland customers is likely to be significantly less than at
other retailers. The amount spent is so low that the cost of transporting the goods will
lead to a loss.
Another problem is that many customers call into discount stores as they are walking
past, rather than travelling specifically to shop in these stores – they are not
‘destination’ shops. As such, people are unlikely to shop online at these stores
specifically. Even if they do find the website, the cost of postage on top of the
purchase price makes online shopping unattractive to these price-sensitive buyers.

Practice questions
1 Analyse why Poundland has not been successful online.
(9 marks)
2 To what extent should all retailers avoid e-commerce?
(16 marks)

Handling data

Figure 10.33 Online grocery usage, December 2017

Source: Mintel

Figure 10.34 Why users shop online from for groceries, December 2017

Source: Mintel
1 What might the significance of the data above be for retailers?
2 How might it affect their marketing decisions?

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 Distinguish between price penetration and price skimming.
2 State what is on the axes of the Boston Matrix.
3 State what is on the two axes of the product life cycle.
4 Identify the four stages of the product life cycle.
5 What are the three categories of consumer products?
6 An attempt to prolong the decline of sales is known as an ………. strategy.
7 State one benefit to a confectionery business of having a well-known brand.
8 State two ways a business might try to prevent sales from falling in the decline
stage of the product life cycle.
9 If a product has a high market share of a low-growth market the product is known
as a cash cow. True or false? Explain your answer.
10 Price skimming is more likely when demand is price elastic. True or false? Explain
your answer.

(b) Short answer questions

1 Explain one influence on the price of a new game console.
(5 marks)
2 Explain one way in which a balanced portfolio might benefit a soft drinks business.
(5 marks)
3 Explain one way in which a social networking site might respond to falling numbers
of users.
(5 marks)
4 Explain how digital marketing is affecting the marketing mix of banks.
(5 marks)
5 Explain one way in which the marketing mix of a tyre manufacturer differs from that
of a hairdressing salon.
(5 marks)

(c) Data response questions

Google Glass
Figure 10.35 Google Glass

Google Glass was launched in the UK in June 2014. Interestingly the product was
priced relatively high at the time (at over £1,000) because it was, in essence, still in its
development phase and was aimed at those who were real technology fans and were
willing to pay premium prices to get the latest product early and experiment with it.
Google wanted these early adopters to feedback to the company so it could continue
to develop the glasses before targeting the mass market.
Google Glass had a small transparent display that was worn in front of the eye and
could display information to the wearer. It was powered by Android and the wearer
could access information such as websites, emails and numerous apps. Google Glass
also had a camera and microphone built in so the wearer could take or play back film.
Sound was communicated by vibrations, using a bone conduction transducer, through
the wearer’s head.
Once launched, there was resistance to the product from businesses that are reluctant
to have people wandering around possibly filming others. For example, some cinemas
banned cinema goers from wearing Google Glass in case they filmed the latest
releases. Some coffee chains banned the Glass as well because they didn’t want an
invasion of other customers’ and staff’s privacy. The Glass ended up a failure for
Google and it stopped being sold in 2016.
However, in 2018, Google Glass made a return, although it was a different version
and targeted a different audience. Google is now aiming its improved smart glasses at
businesses. The new version – called the Glass Enterprise Edition – has improved
battery life and is more comfortable to wear.
It faces competition from Microsoft’s HoloLens among others.
1 Explain one factor that might influence the price of Google glasses.
(5 marks)
2 Analyse the ways in which the marketing mix may change over the life cycle of
Google glasses.
(9 marks)
3 To what extent do you think the price of Google glasses will ultimately determine its
success? Justify your answer.
(16 marks)
(d) Essays
1 To what extent is price the most important element of the marketing mix these
days?
(25 marks)
2 To what extent is the product life cycle a useful model for managers of decision
making by the marketing managers of a perfume business?
(25 marks)
Revision Section: Unit 3 Decision
making to improve marketing
performance
Advice for Unit 3
Top tips … Things to avoid …
Remember that the price elasticity of Do not forget to show your workings
demand shows how much quantity when doing calculations. Even if the
demanded changes relative to the answer is wrong you may get marks
change in price: is it a smaller or larger for your earlier calculations. Do not
change? Price inelastic means the cross out any workings, as then they
change in quantity is smaller than the cannot be marked. It is better to
change in price, not that it does not leave them in even if they are wrong
change at all. in case there is something there that
is creditworthy.
Be very clear about the differences Do not forget to show your calculation
between the stages in the STP process as a percentage when calculating
so you can answer a specific question market share or market growth.
accurately.
Remember that the marketing mix Do not forget to question the income
includes all the activities that influence elasticity of demand – it shows how
the decision of customers to buy the much quantity changes relative to the
product. These factors overlap and are change in income – is it smaller or
interrelated. For example, you cannot bigger? If demand in income is
analyse the price of a product without inelastic this means the change in
considering the benefits it offers, the way demand is less than the change in
it is promoted and distributed, where and income; it does not mean that
how it is sold and who sells it. quantity does not change at all.
When discussing the elements of the Do not forget that to develop its
marketing mix, you must consider the marketing mix a business needs a
requirements of the specific product clear understanding of its target
being considered. There are not set market segment. It can then adapt its
answers to the best price to set, the best mix accordingly.
way to promote or the best way to
distribute: it depends on the product and
the particular objectives and environment
in which it operates.
UNIT 3 CHECKLIST
Having completed studying this unit you should be able to do all that is listed below.
You should read this list and confirm that this is the case.
Learning objective
Setting marketing objectives
Know and understand:
• the value of setting marketing objectives
• the external and internal influences on marketing objectives and decisions
• marketing objectives such as sales volume and sales value, market size, market
and sales growth, market share, brand loyalty.
Understanding markets and customers
Know and understand:
• the value of primary and secondary marketing research
• the interpretation of marketing data
• the value of sampling
• the value of technology in gathering and analysing data for marketing decision
making
• the interpretation of price and income elasticity of demand data
• the value of the concepts of price and income elasticity of demand to marketing
decision makers
• the use of data in marketing decision making and planning
• marketing research can include qualitative and quantitative data and market
mapping
• how to calculate market and sales growth, market share and size
• interpreting marketing data should including positive and negative correlation and
an understanding of the strength of the relationship, confidence intervals,
extrapolation
• how to interpret price and income elasticity of demand data and be able to analyse
the impact of changes in price and income on revenue (you do not need to be able
to calculate these).
Making marketing decisions: segmentation, targeting, positioning
Know and understand:
• the process and value of segmentation, targeting and positioning
• the influences on choosing a target market and positioning
• that segmentation methods include demographic, geographic, income and
behavioural segmentation
• that targeting may include niche and mass marketing
• the importance of and influences on an integrated marketing mix.
Making marketing decisions: using the marketing mix
Know and understand:
• the elements of the marketing mix (7Ps)
• product decisions
• pricing decisions
• decisions about the promotional mix
• distribution (place) decisions
• decisions relating to other elements of the marketing mix: people, process and
physical environment
• the importance of and influences on an integrated marketing mix
• the value of digital marketing and e-commerce.
Practice questions
1 Explain one way in which marketing research can benefit a start up.
(4 marks)
2 Explain one way the marketing mix may change if a business moves from targeting
a niche to targeting the mass market.
(5 marks)
3 Explain two factors that might influence the price of a new perfume.
(6 marks)
4 Explain the benefits of e-commerce to a retailer.
(5 marks)
5 Analyse how the choice of distribution channels might affect the profits of a furniture
manufacturer.
(9 marks)
Case study: The Cambridge Satchel
Company

Figure U3.1 A Cambridge Satchel Company satchel

The Cambridge Satchel Company is one of the great British business success stories
of recent years. The company was set up in 2008 by Julie Deane and her mother,
Freda Thomas. It started with £600 invested to get the idea launched. The company is
now known all over the world. It has even moved out of Deanne’s kitchen to prime
locations in London!
The Cambridge Satchel Company (CSC) bags are all hand made in the UK and the
Made in Britain feature is key part of the brand. The company’s product range has
grown from classic satchels to backpacks, handbags and small leather goods. Its
awareness has increased by being featured on influential fashion blogs to being
chosen as gifts for the cast members of the hit US TV show Mad Men as an end of
series party gift; this high-profile status has helped to make the product be seen as a
celebrity brand. The handmade bags have been bought by fashion celebrities such as
Alexa Chung, Taylor Swift and Rita Ora, and actress Emma Stone and have been
seen on hit US TV shows such as Girls and the Good Wife. The company also
featured as a case study in a Google advert campaign which generated a huge
amount of interest in the business.
In the early days, the company gathered most of its market research data through
bloggers. It would run a competition and for the price of giving away a handbag it
would learn a lot from people interested in fashion and the company’s products. This
was a lot cheaper than commissioning research and at that time was all they could
afford.
In 2014, Cambridge Satchel Company targeted more overseas markets after it
announced that Index Ventures (a global venture capital firm) had invested £13 million
into the group. The company also recruited a number of senior employees who were
experienced in the retail industry; for example, it recruited staff from Net-a-Porter and
Marks & Spencer. Julie and Freda felt the need to strengthen the management team
as the business has grown. As well as overseas expansion through retail stores the
company built its digital presence. Its aim was to build the profile of The Cambridge
Satchel Company as an internationally recognised online brand. It now sells in over
100 countries around the world.
The company’s first factory opened in Wigston in 2011, but later the company moved
to larger premises. Apprentices were taken on and taught traditional skills, easing
youth unemployment and reinforcing the company’s commitment to British enterprise.
The Cambridge Satchel Company has created a multi-million pound international
brand, with its customers acting as ambassadors – as they carry the company’s
products around they are seen by others and this leads to more sales.
However, the company has had to face the challenge of counterfeits. There are
hundreds of fake websites claiming to sell Cambridge satchels. Some sites take the
money and disappear, others send out poor imitations of the product, which damages
the brand. The company is fighting hard to find and prosecute counterfeiters and
protect its brand.
The business has also had to cope with the challenges of growth. Bringing in other
managers actually created problems for the company as they had different views of
what was required.
The company invested in too much capacity ahead of demand increasing. The
pressure to grow led to mistakes being made. In recent years, Deane has reduced the
size of her management team and brought the business back under her control,
focusing again on its core strengths. Cambridge Satchel has become a must-have
brand in China after Deane accompanied the Prime Minister on a trade mission there
in 2013. Last year, Deane visited China four times to win a deal to sell her products
through Alibaba’s Tmall (which is similar to Amazon but in Asia).
China is now the company’s second-largest sales area, second only to the UK, which
still represents 60 per cent of sales. The focus on China, and the launch of new
product lines, such as wallets, iPhone covers, and unusual new bags, such as the
Poppy (a cross between a doctor’s bag and a handbag), will hopefully improve the
finances of the company.
However, profit margins are unlikely ever to be big because the brand makes all of its
products by hand in the UK, employing 120 people. Deane still maintains that she
does not want to produce more cheaply abroad.
30/06/2017 30/06/2016 30/06/2015 30/06/2014 30/06/2013
£ £ £ £ £
Turnover 11,712,859 11,079,085 7,451,697 10,096,294 12,852,938
National Turnover 7,010,238 6,359,323 4,711,894 6,172,244 7,203,158
Overseas Turnover 4,702,621 4,719,762 2,739,803 3,924,050 5,649,780
Gross Profit 6,257,328 4,207,837 2,997,530 5,442,244 7,403,686
Operating Profit −484,272 −3,394,858 −3,507,431 1,792,960 4,692,172
Profit (Loss) for period −804,592 −1,332,624 −5,352,892 1,381,577 3,581,456
[=Net income]
Number of employees 129 132 118 103 96
Table U3.1 Cambridge Satchel Company: Finances/Turnover
Source: FAME database
Practice questions
1 Analyse why the Cambridge Satchel Company is eager to protect its brand.
(12 marks)
2 Analyse the reasons why China is a good market for the Cambridge Satchel
Company.
(12 marks)
3 To what extent do you think it is a good idea for the Cambridge Satchel Company
to make its products in Britain?
(16 marks)
4 The Cambridge Satchel Company has conducted market research through blogs.
To what extent do you think this is a good form of marketing research for the
company?
(20 marks)
5 The Cambridge Satchel Company has widened its product range over time. To
what extent is it essential for the business to have a portfolio of products?
(20 marks)
6 Do you think the brand is the most important element of the marketing mix of any
product?
(20 marks)
Essay questions
1 To what extent is price more important than any other element of the marketing mix
for industrial products?
(25 marks)
2 To what extent is it essential to invest heavily in marketing research when starting
up a business?
(25 marks)
Chapter 11 Setting operational
objectives
Introduction
Operations is one of the functions of a business: this group of activities is responsible for the
actual production of the good or service. In this chapter we will explain the meaning of
operations management and outline the activities it involves.
What it is important to know by the end of this chapter:
• what is meant by operations management
• the activities involved in operations management
• the factors in the environment that influence operations management
• how operations objectives are set
• the relationship between operations and other functions
• the operations decision-making process.

Figure 11.1 Functions of a business

Operations management
Operations management involves managing the process of converting inputs into outputs. It
transforms resources into goods and services. Goods are tangible items such as cars, tablets, or
mobile phones. Services are intangible, for example, mortgages, transport, or education. Take the
example of an airline: this transforms people by moving them from one location to another. To
do this an airline needs a plane, an airport and an air crew. The process as a whole is made up of
a series of smaller operations, such as checking in passengers and their baggage, getting them on
and off the aircraft, feeding them, ensuring they are safe, flying the plane and ensuring
passengers get the right bags at the other end. The overall operations process is therefore made
up of a series of smaller operations processes. The same would be true at your school or college.
Within the overall process of education there is a whole series of other operations that contribute
to the whole, such as catering, maintenance, IT and sports and activities.

Key terms
Operations management describes the activities, decisions and responsibilities of
the managing production and delivery of products and services.
A labour intensive operations process means a relatively high proportion of labour in
the production is used compared to capital equipment, for example, hairdressing.
A capital intensive process uses a relatively high proportion of capital equipment
relative to labour, for example, a bottling process.
The supply chain is the series of activities involved in taking the initial resources to
providing the final product.

What do you think?

Can you think of operations processes that occur within a school or college?

As with all aspects of business, operations management involves choices and decisions. For
example, an airline must decide where to fly to, what sort of aircraft to use, what systems to use
for booking in and for security, what sort of seats, entertainment and food to provide and how
best to provide it.
Operations management is at the very heart of the organisation: it is what it actually does.
Operations management affects all aspects of our lives: everything you read, use, consume,
watch, listen to or wear has been produced as a result of operations management. It involves a
transformation process which turns inputs into outputs.

What do you think?

 What operations activities do you think will be involved at the online retailer Amazon?

Figure 11.2 The operations process

The operations process is ongoing, as shown by the feedback loop. If the products do not sell
then operations managers will review their activities. Similarly, if there are quality issues,
environmental issues or changes in technology the operations process will be considered and
changed. Just think about how over the years agriculture has changed, with investment in new
equipment, new chemicals, new growing methods and new crops, and you can see how
operations management evolves over time. How many people, even thirty years ago, would have
imagined you would listen to music by streaming it as opposed to going to a shop to buy a
record, or that we would buy our holidays online instead of through a high-street travel agent.
Operations management involves taking decisions, such as:
• the level of output a business needs to be able to produce. For example, if a small food
producer wins a contract with a major national supermarket it will have to be able to produce
on a much larger scale. This will involve investment in equipment and people, managing a
more complex operation and coping with managing growth. Managers will want to assess
whether this is possible and whether it was what they want. They will also want to consider the
risk – what if the business expands and then the supermarket cancels the order? The operations
team will have to consider what would be involved to produce this higher level of output.
• the range of products the business wants to offer, the level of customer service to provide and
how flexible a business wants to be in relation to customer demands. For example, how many
versions of the product and how many different product categories does a business want to
provide? How much choice should the customer have?
• how best to produce the good or service. For example, is it better to use mainly labour – which
is known as a labour intensive process – or to invest more in equipment and have a capital
intensive process?
• how best to provide the good or service to the customer. For example, is it better to sell clothes
online or via high street stores? Or both?
• how much of a process managers want a business to provide itself and how much they want to
use suppliers. For example, Zara produces its own clothes, whereas most clothes retailers buy
them from other suppliers. The decision about how much of the process to undertake has
implications in terms of resourcing, quality and costs. Producers may move ‘upstream’ which
means going towards the raw materials and taking on more of these activities, or ‘downstream’
which means undertaking more activities that are moving towards the customer. All the
activities involved in taking the initial resources to providing the final product are collectively
called the supply chain. Managers will decide how much of the supply chain to directly
control and how much they will manage through other providers.
What do you think?
Can you think of any labour intensive operations processes?
Stages of the operations process
When you buy a product in a shop there may well have been hundreds of businesses involved in
the process of making this transaction happen: suppliers of components, manufacturers,
transportation businesses, retailers, advertising businesses and packaging businesses.

Figure 11.3 The stages of operations

This highlights that every operations process has a series of stages and that there are several
stages and businesses involved in a supply chain. Note how the operations process can continue
until after consumption, when a product may need disposing of or recycling. For example, in the
UK, retailers of household electrical goods and electronic equipment must provide free written
information to their customers on how they can return goods if they are faulty or not what they
wanted; and on how they can reuse and recycle electrical and electronic equipment, why this
waste needs to be separated from other waste and the damaging effects of not recycling electrical
and electronic equipment. Throughout any operations process, business activity impacts on
society and on stakeholder groups. Operations managers have to consider how they want to deal
with the impact on stakeholders, for example, whether they just want to act to meet the minimum
requirements of the law, or whether they want to do more than they have to save the environment
and act ethically.

What do you think?

Consider the possible impact on society throughout the operations process involved
in extracting, refining, transporting and selling petrol.
How might these operations activities affect different stakeholders?
Adding value
Operations management is based on transforming resources. It turns inputs into outputs. With a
recipe, a chef, cooking utensils and basic food ingredients can become a wonderful meal. A
group of musicians with a conductor, a rehearsal space and musical instruments become an
orchestra. An idea, a script, a director, a producer, actors and a film crew becomes a TV series.
Whatever type of operations process is undertaken the aim is to add value (that is, for the outputs
to be worth more than the inputs used up to produce them). The value of a process may be
measured in many ways depending on what it is and who is measuring – for example, is it
financially worth it? Is it worth it in terms of its impact on society? What about in terms of how
enjoyable it is? While many businesses make profit one of their key targets, a prison might be
interested in preventing reoffending, a charity may be focused on saving lives, a football club
may be interested in winning matches and a school in improving academic achievement. The
important thing is to make sure the process does add enough value to be worth undertaking (after
all, the resources could be used elsewhere) and to look for ways of increasing the value being
added. For example, your school will often review examination results and look for ways of
improving the teaching and learning even more. Like any operations processes, managers are
eager to measure what is being achieved and how to improve it further. If no value is being
added, the business would be better reallocating resources and providing something else.

What do you think?

Why might the concept of opportunity cost be important when managers are
considering whether they are adding enough value?

Business in focus: Ryanair

On time
Ryanair operates over 600,000 flights a year and 88% of those flights arrived on time
in the last 21 months.

Ryanair 88%
EasyJet 77%
Lufthansa 84%
Air France Did not publish
BA 78%
Aer Lingus 82%
Iberia 88%
Table 11.1 Airline punctuality (Ryanair facts and figures)
Source: www.ryanair.com

Practice questions
1 Analyse how the operational decisions that managers make at Ryanair might affect
the company’s profits.
(9 marks)
2 To what extent do you think that operations is the most important function of an
airline?
(16 marks)
The nature of operations management
The nature of operations management will vary enormously from business to business.
For example, operations can involve:
• gathering, analysing and distributing information (for example, search engines such as Google)
• storing and transporting products (for example, delivery businesses such as FedEx)
• transforming people (for example, plastic surgeons and psychotherapists)
• producing goods (for example, car manufacturers)
• bringing products and customers together (for example, retailers such as IKEA).

Figure 11.4 A Dell computer

Figure 11.5 An Akubra hat

Some operations processes will be very labour intensive, for example, architecture, advertising
or financial advice, whereas other processes will be capital intensive such as a bottling process.
Dell used to be proud of the fact that almost no human hands touched the computer in its
assembly whereas the production of an Akubra hat, which takes almost one month to make,
involves two hundred pairs of hands.
What do you think?
The UK is increasingly producing services rather than goods. What do you think might
be different in managing the operations of services compared to manufacturing?
The operations decision-making process

Figure 11.6 The operations decision-making process

The operations decision-making process involves:

• identifying the operations objectives
• analysing the existing position of the business in relation to operations
• choosing what actions need to be taken to achieve the objectives.
• implementing these decisions
• reviewing to see if they are on target and taking actions if not.
This process will be iterative, meaning that managers may move backwards and forwards
between different stages. For example, when they gather operations data they may go back and
revisit their objectives. If they have problems putting decisions into effect, they may revisit the
decisions.

What do you think?

Can you think how the internet and information technology might be affecting
operations decision making?
Ethics, the environment and operations
decisions
Like all decisions in business, operations decisions will include an ethical element. Managers
will have to decide what they think is right or wrong in any given circumstances. For example,
there will be ethical issues involved in:
• how to reward and treat employees. Increasing employees’ workloads may improve the
amount produced but place high levels of stress on employees.
• where to locate the business. Should the business locate in a low-wage location? This will be
good in terms of costs and profits but is it exploiting the workforce?
• safety features. Should the business avoid adding some safety features to the product (that they
do not have to have by law) because they would add significantly to costs?
• the environment. Should the business worry about the environmental costs of their suppliers’
operations or of the way in which supplies are transported to them?
This last example highlights an area of particular concern in operations, which is impact of the
activities of a business on the environment. Managers will want to assess this impact (for
example, in terms of noise, pollution and emissions) and may want to take this into account
when making decisions.

What do you think?

Can you think of three ethical issues or environmental issues involved in the
operations management of running a football club?
Operations, competitiveness and the competitive
environment
As we have seen, the competitiveness of a business depends on the benefits it can offer relative
to the price it charges compared to its rivals. If it can offer excellent value for money, it is
competitive. Much of this ability to be competitive depends on the operations activities of the
business. Operations activities deliver the actual goods and services, and the extent to which they
provide benefits for the customers relates to how well managed they are. The operations of the
business also account for the majority of the costs in a business and so again, operations
management is vital to competitiveness. Visit the website of almost any company and you will
see how strongly they cite ‘operational excellence’ as the key to success.
To maintain this excellence usually involves on-going improvements. The competitive
environment is such that if you are not launching a new or modified product, your competitors
are doing so, and therefore you will probably need to do the same fairly soon to keep up. Take a
product such as paint and you might imagine the market does not change much. However, visit
your local DIY store and you will find matt paint, gloss paint, quick-drying paint, non-drip paint,
odourless paint, in all sizes and types of containers alongside paint brushes, rollers and paint
sprayers: there is regular innovation as technology improves. The value offered by competitors is
likely to be improving constantly, putting pressure on all businesses to review and develop their
operations, in the same way as your school is constantly trying to develop its teaching and
learning to keep moving forward.
Setting operational objectives
The operations objectives that a business sets must fit with the overall competitive strategy of
the business. The operations objectives it sets must be linked to where it wants to achieve its
competitive advantage. For example, a business such as Poundland or the 99p store is competing
by offering products at a low price and this means it will have a low costs objective. Its
operations processes must then be able to deliver this and still enable the business to be
profitable. Some breakdown recovery companies compete by stressing how quickly they can be
with you if you break down: they will set targets relating to their response time and again the
operations process must be developed to enable the business to do this. An investment fund
business that offers expert advice or a hairdressing salon that promotes its ‘expert stylists’ will
set service objectives and will then have to make sure these are delivered. Operations objectives
therefore support the competitive strategy of the business.

Key term
An operations objective is a target set for the operations function such as to improve
the proportion of deliveries on time by five per cent within two years. Like all
objectives these should be SMARTER: specific, measurable, agreed, realistic, time
related, evaluated and reviewed.

Figure 11.7 Typical operational objectives

Typical operations objectives include:

• Quality. Operations managers have to decide what they think customers want and expect – in
liaison with marketing – and then set appropriate targets. For example, a quality target for an
 insurance company might aim to process a given number of claims accurately per day. A
quality operation is one that has the resources and systems in place so it can meet these key
targets consistently. The better the quality of an operation the more competitive a business
might be as customers will recommend it and use it again. McDonald’s is a very high-quality
operation. For example, it has set targets for how long food should be cooked, how it should be
laid out on a tray and what staff should say to customers: it hits these targets consistently,
meaning that on an operations measure the quality is high.
• Speed of response. Businesses may compete by providing their goods or services faster than
their competitors. For example, if the managers of a restaurant decide no customer should wait
more than five minutes to have a seat and must be served within one minute of sitting down
this may be appealing to customers and win business. The operations targets relate to the speed
of response. However, setting such a target will have resource implications in terms of the
number of seats, the level of staffing, the nature of the menu, training and equipment.
Similarly, if an optician decides to provide glasses within one hour, or a pizza company
decides to deliver within 30 minutes, this will require resourcing and have cost implications
but is a potential source of competitive advantage. Direct Line home insurance recently
advertised that it could replace stolen items within eight hours of a claim being made: a clear
use of a time target to provide additional benefits to consumers.

What do you think?

Can you think of any other businesses that compete on speed of response?

• Dependability: this refers to the ability of a business to deliver reliably on time. A delivery
business may set an objective that 95 per cent of its deliveries are picked up and arrive at the
set time. Provided it can deliver, this it is likely to be popular, assuming this level is better than
that of rivals. Similarly, if a bus company ensures its buses leave and arrive on time, this
should meet customer requirements, as will repair businesses or telecommunications
companies that arrive at the time agreed, or businesses that complete their projects on
schedule.
• Costs. If a business can produce at lower costs than rivals it can make profits with the same
price or it may allow a business to reduce its price and be competitive on that basis. A business
may therefore set cost objectives to enable it to control prices.
• Flexibility. If a business can meet customer needs more precisely than others this may give it
an advantage. A tailor may make a suit to fit your figure precisely; Marks & Spencer sells suits
‘off the rack’. A business may therefore have targets relating to the range of products it
provides and how flexible it wants to be to customer needs.
Other operational objectives include:
• Environmental objectives. Greater awareness of the environmental impact of operations
decisions and greater interest in the impact of decisions by stakeholders has raised the profile
of such objectives in recent years. These objectives might focus on recycling materials,
reducing waste or reducing emissions.
• Defect rates. Operations managers may measure the proportion of products that are thrown
away, have to be reworked or are sent back by customers for being faulty.
• Safety targets. Operations managers may set targets to limit the health risk to employees. For
example, they may aim to eliminate accidents or injuries.
Airline Car manufacturer Retailer
Proportion of planes leaving and Number of cars produced Speed of processing
landing on time per day transactions
Proportion of bags lost in transit Number of defects identified Customer satisfaction
in production
Time taken to get passengers Delivery time to car Not having unsold
on to the plane dealerships stock
Environmental targets Environmental targets Environmental targets
Turnaround time at airports Flexibility to customer Reducing queues
orders
Table 11.2 Examples of operations objectives
Setting operational objectives will have resource implications. For example, to be more flexible
may require more investment in technology and training.
The relative importance of these operational objectives will vary from product to product and
will depend on the target market and customer requirements. For example, with airlines, business
fliers want speed to get to and from meetings as fast as they can; the time taken may be more
important than cost. Holidaymakers may not be so bothered if the journey takes one hour longer
if it brings the price down. In the delivery business sometimes what matters most is that a parcel
is delivered on time; at other times it is more important that it is delivered safely; sometimes
there is no time or security pressure and you want a low price.
The relative importance of the different operational objectives will depend on how managers
want the business to compete. For example, McDonald’s focuses more on the speed of service
and less on flexibility (try asking for your burger to be cooked differently!) whereas a premium
restaurant may be slower but have more flexibility.

Figure 11.8 The importance of different operational objectives

A change in how the business wants to compete will require different operational objectives.
The Emma Maersk is one of the world’s biggest container ships that moves millions of products
around the world; for example, importing products from China to the UK. Given the huge
volumes it carries the unit cost per item is relatively low. However, the transportation is
relatively slow. If you want the Emma Maersk to travel faster, this will increase energy
consumption and increase costs. So there is a trade-off in this case between cost and speed. It
may not be possible to be the cheapest, fastest, most flexible and most dependable provider:
managers will need to make choices.

Figure 11.9 The Emma Maersk

Key term
A competitive advantage is a superiority that a business possesses over its rivals
that may allow it to achieve objectives, such as increased market share or profitability.
Using polar diagrams to illustrate operations
objectives

Figure 11.10 Polar diagram comparing bus and taxi services

The polar diagram in Figure 11.10 shows how important different aspects of operations might be
in the taxi industry and the bus industry. The relative importance of the five operations criteria
are shown by how far away from the centre the point is. The further away the line is from the
centre the more significant customers think this factor is in this industry.
For buses:
• It is essential the bus sticks to its set times (dependability is important).
• Relatively low costs are expected.
• Buses are not expected to leave their set route, that is flexibility is not expected to be high.
• Buses are not expected to be especially fast.
For taxis:
• Flexibility is essential to take you from one location to another.
• Taxis are expected to be relatively expensive.
• You understand a taxi may be a little later than promised due to traffic so dependability is less
signficant.

What do you think?

Can you plot a polar diagram for trains, airlines, coaches?
Business in focus: Inditex

Most fashion retailers change their clothes collections two to four times a year.
However, Inditex, which owns Zara, constantly brings out new designs, to encourage
consumers to return to its shops frequently and to ensure that it does not get stuck
with an inventory that is out of fashion.
Inditex has about half of its clothes produced in Spain or nearby countries, so it is
able to react quickly to changing trends. This costs more but helps to ensure it stays
in touch with changes in fashion. Most of Zara’s rivals buy their clothes from Asia to
keep costs lower. However, this slows down the response time to changes in
customer tastes because of the distances involved.
Amancio Ortega, the founder of Inditex, says that selling fashion is like selling fish.
Fresh fish sells quickly and at a high price. Yesterday’s catch must be discounted and
may not sell at all. The same is true with fashion: as soon as it becomes out of date
you have to discount it. This is why Zara holds little inventory and changes it regularly.
However, other businesses do it differently. Uniqlo, for example, produces large
quantities of relatively few product lines and changes these product lines relatively
rarely. The aim is to reduce costs through bulk buying.
Source: Adapted from The Economist, 24 March 2012

Practice questions
1 Analyse how the speed of response and flexibility helps Zara to compete.
(9 marks)
2 To what extent do you think Uniqlo’s operational approach is better than Zara’s?
(16 marks)
Internal influences on operational objectives and
decisions
The operations function does not operate in isolation. All operational decisions will have
implications for other areas of the business such as human resources, marketing and finance.
These other functions will also provide internal influences on operations decisions.
For example:
• Marketing activities may determine what actually has to be produced, how it is produced (for
example, customers may want free-range eggs or organic food) and what quantities are
needed.
• Human resources may determine what is possible. The number and skills of staff may
influence what can be provided. The skills and experience of the members of your football
team may determine how you play, for example.
• Finance. The finance available may affect the level of investment in technology which may
affect what can be produced.

Figure 11.11 All the other functional areas influence operational objectives

What do you think?

How can the operations process affect the other functions of a business?

What do you think?

What do you think makes a business customer-focused?
External influences on operational objectives and
decisions

Figure 11.12 External influences on operational objectives and decisions

Like all aspects of business, the environment in which operation decisions are made is changing
all the time. The external influences on operational decisions can be examined using the PEST-C
framework:
• Political and legal factors. For example, greater legal regulation and concerns over health and
safety. This may place restrictions on what can be produced, how it can be produced, where it
can be produced and who it can be produced for. For example, some countries ban gambling,
which means that online gambling businesses cannot offer their services to people based there.
• Economic factors. Changes in economic factors will affect the demand for products and the
costs of producing them. In a fast growing economy demand for many products is likely to
increase requiring more production. Meanwhile, increases in wages or input prices will
increase costs and may require operations to focus on ways of offsetting this by becoming
more lean.
• Social factors. There is now greater demand from customers for choice and variety. Social
trends will also affect what customers expect from operations; for example, where a product is
produced, how it is produced, what materials are used and how easy it is to recycle.
• Technological factors. With technological advances it becomes quicker to develop, test and
launch new products. To keep pace managers will want to consider how much they invest in
new product development and how to develop a business that encourages successful
innovation. Technology is also enabling new operations to exist (believe it or not computer
games, apps, online university courses and music streaming are not very old!) and enabling
new processes to develop (such as paying for parking with your mobile phone, ordering
products online or using new lightweight materials for aircraft). Technological change can
completely disrupt an industry: just think of the impact on operations for publishers of e-
books, for newspapers of online news services, for the music industry of streaming, for the
computer industry of cloud computing, for watchmakers, mapmakers, producers of
smartphones and for banks of online banking. Some of the biggest businesses in the world,
such as Google, Apple and Facebook are undertaking operations that did not even exist twenty
years ago. Radical changes are affecting what it is that businesses actually do and how they
 provide their services. This is affecting the skills required, the way businesses are competing
and what operations management involves.
• Competition. There is greater demand for better customer service as customers realise their
power to demand more and can find alternatives more easily online. This means business are
trying to offer more while also keeping costs down – this can be a difficult balance

Figure 11.13 Self-service check outs

Business in focus: Tesla

Figure 11.14 A Tesla car

Tesla Motors produces electric cars. The company was established in 2003 by
engineers from Silicon Valley, one of the world’s great computing hubs. Its founder
was Elon Musk. Tesla has created a new form of competition for the established car
companies such as Ford and General Motors. It has disrupted the car industry by
presenting an electric vehicle in which the software that controls much of the car is an
integral part of the design.
In 2008, the company launched the Tesla Roadster which is a sports car that is able
to accelerate from 0 to 60 mph in under 4 seconds. It is able to travel for around 245
 miles on one electric charge.
In 2012, Tesla launched the Model S which was positioned as a ‘premium sedan’. It
was followed with an SUV (Sports Utility Vehicle) in 2015.
In 2019, the company launched the Model 3 which is more of a mass market vehicle.
This new vehicle is part of a strategy by Tesla to make its electric cars available on a
large scale. The aim is to move the world’s drivers away from their dependence on
petrol cars and drive down the cost of electric cars. Tesla wants to promote its
sustainable energy solution by developing cars that can at least match if not beat
competitors in terms of design and performance.
Initially, with a technology as new as Tesla’s, unit costs are likely to be high and
therefore Tesla entered in the niche premium price market. As volumes build,
experience grows and there are further developments in technology, unit costs
usually fall and businesses can sell at a lower price. Like many technology
businesses, Tesla has invested any money it has into research and development to
keep enhancing its technology and enable new products to be developed and
launched as soon as possible.
Tesla’s long-term plan is to promote the switch to zero emission vehicles by using the
money from customers buying the expensive Tesla sports car to finance the
development of new lower priced family cars. It will then use the funds from the lower
price family cars to develop an even cheaper car.

Practice questions
1 Analyse the ways in which operations management at Tesla affects its sales.
(9 marks)
2 Do you think Tesla’s long-term plan is a good one? Justify your answer.
(16 marks)

What do you think?

What factors make a business innovative? Can you think of examples of how legal
regulations may affect operations activities?

These external pressures influence operations managers who have to produce better products,
with more flexibility at lower costs. To maintain competitiveness, operations managers have to
work ever harder and ever smarter. To do this they must review all aspects of the operations
process such as how they produce, what technology they are using, who they work with, where
they source materials and what controls and systems they have in place to check and improve
standards.

What do you think?

How do you think the operations activities of supermarkets have changed in recent
years?
Changing operational objectives
The operational objectives set by a business will depend on what the managers believe is
important and what they think is the best positioning of the business and the best way of
competing against rivals. This will be influenced by what rivals are doing and the resources of
the business, for example, its capacity and the skills of employees.

Business in focus: LEGO

Figure 11.15 Lego

The toy company LEGO® is one of the most successful and innovative companies in
the world with an estimated brand value of $7.6 billion in 2018.
Lego – from the Danish phrase leg godt, meaning ‘play well’ – began in the 1930s in
the small Danish town of Billund with some simple wooden toys hand-made in a
workshop by founder Ole Kirk Kristiansen. The iconic plastic bricks were first
manufactured in 1958. Today, Lego produces more than 4,200 unique elements in a
variety of different colours and finishes, at an astonishing rate of 68,000 elements per
minute.
Lego products are currently manufactured in the Czech Republic and Mexico, close to
its main markets of Europe and the USA.
Quality, precision and originality have been the cornerstones of the business. Lego
bricks must fit together perfectly and break apart easily. The moulds are accurate to
within 0.005 mm, ensuring that any Lego product you buy is compatible with any
other. New products must undergo a number of assessments including content
analysis, hazard classification, substance migration and compression, impact and bite
tests.
The development of new products is extremely important as they account for 60 per
cent of Lego’s annual sales. The company has a large team of designers based at
their headquarters in Denmark, while their Lego Ideas Portal allows enthusiasts to
 submit and vote on ideas for new models. Lego was also an early adopter of rapid
prototyping, enabling it to bring products to market faster.
Lego’s operations objectives are as follows:
• no product recalls ever – Lego does not want any substandard products released to
the market (there have been no recalls since 2009)
• to use 100 per cent renewable energy and stop using fossil fuels by 2020
• zero waste – Lego wants to reduce or recycle any waste it produces.

Practice questions
1 Analyse the reasons why Lego has set the operations objectives shown above.
(9 marks)
2 To what extent do you think the success of Lego depends on its operations
management?
(16 marks)

Operational objectives may change as the values and strategy of the business change. For
example:
• After a terrible oil spill in 2010, referred to as ‘Deepwater Horizon’, BP’s managers made
safety a higher priority to prevent it happening again.
• After much criticism for the way they took huge risks to try and boost profits, banks such as
Barclays have stated that they want to be much more ethical in their operations and try to
benefit the community.
• After a disappointing financial performance, Ryanair decided to put more emphasis on
customer service.

Figure 11.16 The Deepwater Horizon oil spill

ASSESSMENT ACTIVITIES
(a) Knowledge check questions
1 State two resources that might be used in an operations process.
2 State two possible operational objectives.
3 Outline three operations decisions that would need to be made to manage a
retailer such as H&M.
4 Outline three operations decisions that would need to be made to manage an
apps business such as Snapchat or Instagram.
5 State two internal influences on operational objectives.
6 State two external influences on operational objectives.
7 State two ethical or environmental considerations when making operations
decisions.
8 Which of the following do you think are directly linked to operations management?
Explain your answer.
• choosing suppliers
• installing new technology
• advertising the product
• selling shares
• reducing waste
9 When a high proportion of labour is used relative to machinery the operations
process is known as labour ……….
10 When transforming inputs into outputs operations management aims to ………
value.

(b) Short answer questions

1 Explain one external factor that might influence the operational objectives set by a
catering business.
(5 marks)
2 Explain one way the operations activities of an online retailer can affect its
competitiveness.
(5 marks)
3 Explain one way that operations management can add value for a coffee shop
chain.
(5 marks)
4 Explain one internal influence on the operational objectives of a train company.
(5 marks)
5 Explain one ethical issue that may be involved in the operations of a clothing
manufacturer.
(5 marks)

(c) Data response questions

German supermarket chains Aldi and Lidl again came first and second respectively in
YouGov’s Brandindex Buzz brand perception survey in 2017. Netflix and BBC iPlayer
took the third and fourth spots.
Aldi and Lidl are often called discounters and as family incomes have been squeezed
over the last few years more and more people have been visiting them. They offer a
no-frills shopping experience – for example, they only stock approximately 2,000 lines
compared to up to 20,000 in the Big Four supermarkets (Tesco, Asda, Sainburys and
Waitrose). Many of their products are also own brand and they only stock branded
items where they can use their purchasing power to obtain big discounts from their
suppliers.
However, their success isn’t just about price. They have made it their mission to
attract an increasingly middle-class customer base by combining affordability with
quality. They want people who would never previously have considered shopping
there. Although they only stock a limited range of items, they have increased this
since their first entry into the UK market and they’ve introduced premium ranges. The
two supermarkets have received various accolades for the quality of their products.
For example, in 2018 Lidl won Christmas Retailer of the Year.
1 Explain one way that food retailers add value for customers.
(5 marks)
2 Analyse the factors that might influence the operations activities of retailers such as
Tesco, Sainsbury, Aldi and Lidl.
(9 marks)
3 To what extent do you think the success of Aldi and Lidl is due to their operations?
(16 marks)

(d) Essays
1 To what extent do you think operations management is the most important factor in
the success of social networking sites? Justify your answer.
(25 marks)
2 To what extent does the competitiveness of a chocolate producer depend on its
operations? Justify your answer.
(25 marks)
Chapter 12 Analysing operational
performance
Introduction
In this chapter we examine how to analyse the operations performance of a business in order to
decide how to improve it.
What it is important to know by the end of this chapter:
• how to calculate operations data
• how to interpret operations data
• how operations data is used in decision making.
Calculation of operations data
Analysing the operational performance of a business involves measuring how an organisation is
performing in relation to its operations objectives. A business will review progress against these
targets in the same way as you might measure your academic progress against target grades: if
you are far away from targets you will hopefully take action to improve your performance.
Quite what a business sets as its operational objectives will depend on its operations and how it
wants to compete, but typical measures of operational performance include the following.
• Labour productivity. This measures the output per employee in a given period. It can be
calculated using:

For example, if output is 3,000 units in a given period and the number of employees is 300 then:
3,000 / 300 = 10
So, labour productivity is 10 units per employee.
Operations managers may influence labour productivity in many ways such as the way they train
and organise employees and how they reward staff.
• Unit (average) costs. This measures the cost per unit (and is sometimes called the ‘average
costs’). It can be calculated using the equation:

This is measured in pounds. For example, if a business produces 2,000 units and the cost is
£50,000 then:
£50,000 / 2,000 = £25
So unit cost is £25 per unit.
Operations managers may influence the unit costs in many ways. For example, they can consider
what suppliers to use, what resources to use, how to make the operations process more effective
and how to reduce waste. However, when trying to control costs managers must consider the
possible knock-on effects for the business: cheaper resources or less flexibility, for example, may
affect the customer’s experience of the product.
Controlling unit costs is important because it influences the price a business can charge and still
make a profit.

Handling data
To calculate the unit cost you need the total costs and the number of units produced.
 If unit costs are given, then total costs are worked out by multiplying the unit cost by
the number of units. For example, if the unit cost is £5 and 30 units are produced then
the total cost is £5 × 30 = £150.
1 Fixed costs are £20,000, variable costs are £2 per unit and output is 6,000 units.
What is the total cost? What is the unit cost?
2 If the unit cost is £4 and output is 4,000 units what are total costs?
3 If the unit cost is £30 and output is 5,000 units what are total costs? If fixed costs
are £12,000 what are the variable costs per unit?

Handling data
Units Fixed costs Variable costs £20 per unit Total Costs Unit (average) costs.
£ £ £ Total costs / output £
10 100 200 300 30
20 100 400 500 25
30 100 600 700 23
40 100 800 900 23
50 100 1,000 1,100 22
Table 12.1 Unit cost falls as output increases
In the table above, the unit cost falls as output increases. Why do you think this is?
What are the implications for pricing?

• Capacity. The capacity of a business measures the maximum it can produce given its existing
resources. For example, the capacity of a restaurant may depend on staffing, kitchen space and
number of tables. The capacity of accountancy business may be limited by the number of staff
and computers it has. The capacity of an airline may be determined by the number of pilots
and cabin crew, the number and type of planes and the number of landing slots. The capacity
of a call centre may depend on the number of operatives and the number of phone lines they
have. At any moment the capacity of a business is fixed, as there are a given level of resources.

Key terms
Capacity is the maximum output of a business at a moment in time given its
resources.
Capacity utilisation measures the existing output over a given period as a
percentage of the maximum output.
Over time, the capacity of a business can change as more resources become available. More staff
can be employed, more land can be acquired and more equipment bought. However this may
take time, for example, increasing the scale of your chemical processing plant or building more
nuclear power plants will take years. Increasing capacity is an investment and managers will
want to consider the cost, the likely returns and the risk.

Figure 12.1 A call centre

The desired level of capacity will depend on the expected level of sales.
• Capacity utilisation. Capacity utilisation measures existing output as a percentage of the
maximum possible output.
It is calculated by the equation:

For example, if an hotel has 50 rooms occupied out of a total of 150 rooms its capacity
utilisation is:
(50 / 150) × 100 = 33.3%
The higher the capacity utilisation the more resources are being fully utilised.
A low-capacity utilisation may be a concern to a manager because:
• it suggests that demand is relatively low
• the cost per unit is likely to be high. This is because the fixed costs of the business are not
spread over many units. This means there is a high fixed cost per unit, which may result in low
profit margins or even a loss on each unit. This is why businesses are often eager to achieve a
high capacity utilisation. This is because it allows them to spread their fixed costs over more
units and bring down the unit cost, enabling them to be profitable.
Output Fixed costs Variable costs £10 Total Unit costs Capacity
£1000 per unit costs utilisation %
100 1,000 1,000 2,000 2,000/100 = 25
£20
200 1,000 2,000 3,000 3,000/200 = 50
£15
 300 1,000 3,000 4,000 4,000/300 = 75
£13.30
400 1,000 4,000 5,000 5,000/400 = 100
capacity £12.50
Table 12.2 Unit (average) cost falls as capacity utilization increases

Figure 12.2 Graph showing how unit costs fall as capacity utilisation increases

Handling data
Output Fixed Variable Total costs = Fixed Unit costs £ Capacity
costs costs (£10 costs + variable utilisation %
£ per unit) £ costs £
100 £500 £1000 £1500 £1500/100= (100/400)*100
£15 =25%
200
300
400
(capacity)
*Variable costs = £10 a unit
Table 12.3
1 Complete Table 12.3.
2 What is happening to unit costs as capacity utilisation increases? Why do you think
this is?
3 What is the significance of this for businesses?
Figure 12.3 The potential benefits of high-capacity utilization

What do you think?

How might a business respond to low-capacity utilisation?
Most businesses only use 30 per cent of their server capacity. Why do you think this
is?
The use of data in operational decision
making
By analysing the operational data, managers may be able to identify problems or opportunities.
This enables them to analyse different courses of action and decide what to do next. Operations
data therefore informs operations decision making and planning. For example:
• If labour productivity is low managers can analyse this further to identify the cause. They may
then consider whether it is necessary to invest in training, review reward systems or change the
way work is undertaken.
• If unit costs (average costs) are higher than expected managers will analyse the cause. Is this
due to supplier costs? Low labour productivity? High levels of defects? Again this will lead to
actions being taken to improve the situation, such as negotiating with suppliers.
• If capacity is too low, managers may want to consider whether it is worth investing to expand.
This would depend on factors such as the costs, the likely returns and the risks involved.
• If capacity is too high, managers would consider whether they can increase demand (perhaps
by improving the promotions or the product) or whether the business should ‘downsize’, that is
reduce capacity by closing part of the facilities.
When making operations decisions, managers will consider the costs, the profits, the risks, the
impact on competitiveness and the effect on other functions and stakeholders. Some decisions
may be relatively quick to implement, for example, discussing lower prices with suppliers.
Others may take a significant period of time, for example, changing suppliers or changing
capacity.
Developments in technology have enabled operations managers to track data more effectively
and hopefully make better decisions.

Business in focus: BP

2015 2016 2017

Air emissions – nitrogen oxides (thousand tonnes) 123 125 122
Air emissions – sulphur oxides (thousand tonnes) 36 36 35
Environmental and safety fines ($ million) 0.6 15.0 3.6
Table 12.4 BP operations data
Source: BP

Practice questions
1 Table 12.4 shows some operations data for BP. Analyse the possible significance
of the changes in the operational data over the period shown.
 (9 marks)
2 To what extent is publishing such data a good idea?
(16 marks)

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 What is meant by labour productivity?
2 If labour productivity is eight units and there are six employees, what is the total
output?
3 If output is 48,000 units and the number of employees is 70, what is the labour
productivity?
4 Total costs are £44,000 and output is 11,000 units. What is the unit cost?
5 Capacity utilisation is 40 per cent and present output is 600 units. What is the
capacity?
6 If output increases total costs and unit costs will inevitably rise. True or false?
Explain your answer.
7 State two factors that might influence operational objectives.
8 Which of the following is most likely to be true?
• Increasing capacity utilisation will leave total costs unchanged.
• Increasing capacity utilisation will reduce total costs.
• Increasing capacity utilisation will increase total costs.
• Increasing capacity utilisation will increase unit costs.
9 Which of the following is the equation for unit cost:
• Total cost/output
• Total cost/labour
• Total costs/total revenue
• Fixed cost/variable cost?
10 Which of the following statements is true?
• Capacity can never be changed.
• High-quality products must be expensive.
• A business with 80 per cent capacity utilisation must be producing more than a
business with 20 per cent capacity utilisation.
• A fall in capacity utilisation often increases unit costs.

(b) Short answer questions

1 Explain one reason why a farmer might want to increase productivity.
 (5 marks)
2 Explain one factor that might influence the labour productivity of a checkout
assistant.
(5 marks)
3 Explain one factor that determines the capacity of a bank.
(5 marks)
4 Explain one way a football club may react if it consistently has low capacity
utilisation at its stadium.
(5 marks)
5 Explain one reason why greater capacity utilisation might decrease the unit costs of
a cinema.
(5 marks)

(c) Data response questions

Center Parcs
Center Parcs is a holiday business which opened its first village in the UK at
Sherwood Forest in July 1987. It provides short break holidays in the forest on a year-
round basis. Center Parcs has five villages across the UK: Whinfell Forest in Cumbria,
Sherwood Forest in Nottinghamshire, Elveden Forest in Suffolk, Woburn Forest in
Bedfordshire and Longleat Forest in Wiltshire. A sixth village, Longford Forest, will
open in Ireland in 2019.
The data in Table 12.5 shows the performance of Center Parcs in a number of areas
of the business:
2016/17 2015/16
Occupancy (%) 97.3 97.7
Sleeper nights (m) 7.2 7.2
Number of guests (m) 2.2 2.1
Capital investment (£m) 94.5 63.2
Revenue (£m) 440.3 420.2
Profit before tax (£m) 75.7 57.3
Average daily rate (£) (net of VAT) 178.60 167.31
Accommodation bookings via web (% of total) 85 84
Guest satisfaction (% of guests ranking their break as 96 96
excellent or good)
Employee turnover (%) 31 30
Table 12.5 Center Parcs performance data
Source: Center Parcs
1 Explain the significance of a 97.3 per cent occupancy rate.
(5 marks)
2 Analyse how the operations performance of the business has changed between
2015/16 and 2016/17.
(9 marks)
3 To what extent do you think measuring operational data is likely to be useful for
Center Parcs?
(16 marks)

(d) Essays
1 What do you think is the best way for a business to respond to low-capacity
utilisation? Justify your answer.
(25 marks)
2 To what extent should reducing unit cost be the key operational objective these
days?
(25 marks)
Chapter 13 Increasing efficiency and
productivity
Introduction
In Chapter 12 we analysed operational data including labour productivity and unit costs. In this
chapter we will examine the ways in which managers might improve the productivity and
efficiency of the business.

Key terms
Labour productivity measures the output per employee in a given time period.
Efficiency measures how well inputs are used to generate output. If a process
becomes more efficient it uses fewer inputs to produce a given output and the unit
cost should fall.

What it is important to know by the end of this chapter:

• the meaning and significance of efficiency
• the importance of capacity
• how to utilise capacity efficiently
• the meaning and significance of productivity
• how to improve productivity and efficiency
• the benefits and difficulties of lean production
• the meaning and significance of ‘Just in Time’
• the meaning and significance of labour and capital intensive production
• how to analyse difficulties increasing efficiency and productivity
• what is meant by the optimal mix of resources
• how to use technology to improve efficiency.
Efficiency
Operations managers may want to make their operations process more efficient. Increasing
efficiency involves getting more output from a given level of inputs. Alternatively, it can be seen
as using less resources to achieve a given level of output and quality. A more efficient process
will have lower unit costs because it is using its resources more effectively.
The importance of efficiency
Businesses are constantly trying to improve their efficiency because if they can drive down unit
costs they can bring the price down or make higher profits with the same price. In a highly
competitive business world, greater efficiency is important to be able to at least match what
others are doing. Ways of improving efficiency include:
• increasing capacity utilisation to spread fixed costs
• choosing the optimal mix of resources
• increasing labour productivity
• introducing lean production
• using technology.
Each of these methods will be examined in this chapter, along with the difficulties involved in
using them.
Improving efficiency: using capacity efficiently
The capacity of a business is determined by the resources it has at any given moment, that is the
amount and quality of its employees, capital and land. This determines the maximum that can be
produced at the time by the business itself. This is important because if this capacity is not used
fully it means that resources are being wasted. This is likely to increase the unit cost because the
fixed costs are not being spread over as many units as they would be if the business was at 100
per cent capacity. It is the role of marketing to generate more sales and achieve higher levels of
capacity utilisation. It is inefficient if resources are not utilised fully. On the other hand, if the
capacity is being fully utilised the business is unable to accept new orders and produce them
itself. This might lead to customers finding alternative providers and moving to them.
It is important, therefore, for a business to have the right level of capacity to meet demand and to
be looking ahead to what demand might be in the future; it can then prepare accordingly by
increasing or decreasing its scale over time, or making alternative arrangements.

What do you think?

If capacity utilisation is 10 per cent, what does this mean? What might be the cause?

If capacity utilisation is low this is inefficient and so a business might:

• try to improve its marketing to boost sales. For example, it might reduce price of the product,
spend more on the promotional mix, widen distribution or change the product.
• reduce its capacity. This is known as rationalising or downsizing. This may take time to do (for
example, to close and sell off stores) and may not be possible (for example, it may not be
possible to close part of a production line or part of a chemical factory without shutting the
production down). This may be a major strategic decision that is difficult to reverse and
therefore will be taken with care.
If demand is too high for the existing capacity a business might:
• outsource to other producers. This may take time to negotiate and is likely to be more
expensive than doing the task in house. Also the business that is outsourcing may be concerned
about the quality of the work: if it is poor this will reflect on the business that has overall
responsibility for the order. Businesses that have a strong brand or way of doing things (for
example, a management consultancy or firm of architects) may be wary of outsourcing a
service task to an alternative provider that may do things differently.
• find a way to reduce demand in the short term. This might be through pushing the price up.
Dynamic pricing occurs when businesses such as airlines change the prices regularly in
response to demand conditions. When demand is getting higher they can raise prices to match
supply more closely. Alternatively, a business might start a waiting list and provide the service
or good when it does have capacity.
Increasing efficiency: increasing labour
productivity
Another way of increasing efficiency is to improve the output per employee. The output per
employee is called labour productivity.
Labour productivity is measured by:

If a business can achieve more output from a given number of employees, then assuming the
wages and salaries stay the same, the cost per unit falls. For example:
100 employees produce 200 units with a labour cost of £2,000:
• Labour productivity = 200 / 100 = 2 units per employee.
• Unit cost of labour = £2,000 / 200 = £10 per unit.
If 100 employees produce 400 units with a labour cost of £2,000:
• Labour productivity = 400 / 100 = 4 units per employee; productivity has increased
• Unit cost of labour = £2,000/400 = £5 per unit; the labour cost per unit has fallen as
productivity has increased.

Figure 13.1 Higher labour productivity results in lower unit costs.

Handling data
Employees Wage Units Labour productivity (number of Wage cost per
costs £ units) unit £
1 100 10
2 200 30
3 300 60
4 400 100
5 500 200
 Table 13.1
1 Complete the Table 13.1
2 Explain the relationship between labour productivity and wages cost per unit.

Figure 13.2 Ways of increasing labour productivity

To increase labour productivity a manager may:

• invest in technology so employees have access to more equipment to help them complete their
tasks more effectively
• improve training of employees so staff have more skills to do their jobs
• change the way the work is organised and the design of jobs to improve the flow of work and
reduce time waiting to complete tasks
• change the way employees are rewarded to provide more incentive.

What do you think?

Why do you think simply measuring the quantity an employee produces may have
undesirable effects on quality?
Why do you think measuring productivity might be difficult in some businesses such
as healthcare, teaching and financial advice? What do you think should be measured
in these cases to assess employee performance?
Difficulties in increasing labour productivity
Although increasing productivity is in itself a desirable target for managers this must be achieved
without a negative impact elsewhere. Imagine you are rushing to get coursework done more
quickly: this might increase your productivity on a given day but the quality may suffer. Imagine
setting productivity targets in the health service: this might mean more patients are treated but
the quality of treatment may suffer. Higher productivity targets for a call centre may mean more
calls are taken but less time is taken with each customer, so sales and customer satisfaction may
fall. Managers need to be aware of ‘unintended consequences’ whereby setting one target leads
to undesirable behaviour and effects in other areas.
Also, while introducing ways of achieving higher levels of labour productivity is desirable for
the business (because output per employee is higher), this may be resisted by employees. This is
because if the demand for a product does not increase but productivity does, fewer employees
will be required to produce the output required. If demand is 100 units and output per employee
is 5 units this means 20 employees are required. If productivity is 25 units only 4 employees are
required to produce the same total output. This means higher levels of productivity may be
associated with staff being moved to jobs elsewhere in the organisation or being made redundant.
As a result employees may resist attempts to increase productivity because they want to retain
jobs.
Alternatively, employees may demand higher pay in return for higher productivity on the basis
that they deserve more. This is because higher productivity means more output can be produced
with the same number of employees, which can lead to more sales and revenue. It is not unusual
therefore for employees and managers to negotiate pay deals linked to increases in productivity.
However if the pay increase is too high it may offset any efficiency gains from the higher
productivity and therefore the business will not have benefited.
Increasing efficiency: choosing the optimal mix
of resources
The resources available to a business include land, labour and capital. The combination of
resources used by a business will depend very much on the nature of the operations process.
Running a logistics business like UPS that delivers parcels across the world is different from
running an online retailer, which is different from running a bottling plant. Each process brings
with it its own challenges and different combinations of resources.
Some processes are quite capital intensive: this means they involve a relatively high level of
capital equipment (such as machinery). Airlines and oil refineries and chemical plants are capital
intensive. By comparison, website design, nail parlours and hairdressers are relatively labour
intensive. The best (or optimal) combination of resources will depend on:
• the process itself, for example, what kinds of processes are involved. High-volume repetitive
tasks may be able to be undertaken by machinery, whereas very creative, ideas-type work may
not.
• what is affordable and achievable. It may be that the funds or space are not available to justify
investment in new equipment. It may be that the scale of operations does not merit it. A small
farm may not be able to afford some of the farming equipment because it would use it
relatively little, as its scale is small. It therefore may have to rent the equipment for short
periods of time, which is relatively expensive (although cheaper than buying it and having it sit
idle for most of the time). A large farm may have the scale required to justify such equipment
as the initial costs can be spread over high volumes and therefore be more efficient.
Getting the optimal mix of resources will affect the quality of the work done but also the
efficiency. A business that is operating without the latest technology because it cannot afford it
may be inefficient, for example. A business that meets extra demand by simply bringing in staff
because there is not time to invest in capital equipment may also be inefficient.

Business in focus: BMW Mini

Figure 13.3 The Mini assembly line

The same standards for quality, safety and careful use of resources apply at all
production sites within the BMW Group’s international production network. Innovative
production technologies and employees’ high level of expertise guarantee that more
than 20,000 individual parts can be turned into premium vehicles ‘made by BMW’.
The flexible and innovative production at BMW Group plants is geared towards
customer benefit, making it possible to meet individual customer wishes on schedule,
swiftly and flexibly. The required processes are very complex and can only be run
within highly flexible structures – both issues the BMW Group masters well.
At BMW in Oxford more than 4,700 associates work three shifts, seven days a week,
to produce as many as 700 Minis per day. The production process involves:
1 Bodyshell production: this is where metal is mainly welded together to form the
body of the MINI. This is a very capital intensive process using 230 robots and with
a quality standard of 0.05 mm standard.
2 Paintshop: The body shell is painted with several coats, including the optional
contrast roof (black or white). This is very capital intensive.
3 Assembly: All 2,415 different inner and outer parts of the Mini that come from 200
suppliers are mounted to the painted bodyshell. This involves relatively high levels
of labour as it is quite skilled.
About half of the £100 million investment at Plant Oxford has gone into modernising
and increasing the capacity of the paint shop. The paintshop took one million man-
hours to build, and is held together by over 250,000 bolts. Its construction in 1996/97
was the second-largest building project in Great Britain in that year (after the
Millennium Dome).
There are 372 different interior trim and 319 different exterior options for the new Mini.

Practice questions
1 Analyse how BMW might measure the success of its operations at BMW Mini.
(9 marks)
2 To what extent do you think effective operations management is important to the
sales of Minis?
(16 marks)
Increasing efficiency: adopting lean production
With greater pressure to keep prices low due to greater competition, lean production has been
adopted by more businesses seeking to remain competitive in recent years. Lean production aims
to reduce waste throughout the organisation. It seeks to reduce time wasted, material wastage and
final products that are wasted due to defects.

Key term
Lean production occurs when managers reduce waste and therefore operations
become more efficient.

Being lean aims to reduce waste by:

• improving quality and so reducing the number of items that need to be reworked, thrown away
or fixed.
• reducing the amount of inventory held as this reduces costs of protecting and storing it; it also
reduces the risk of the inventory going out of date or not being sold. Some businesses aim to
order in supplies only when they are needed. This is known as ‘Just in Time’ production and
involves holding as close to zero stock as possible. Lean production requires good
communication with suppliers and the ability of suppliers to produce and deliver quickly. It
also assumes good relations with employees and a reliable operations process because if
anything goes wrong (for example, a dispute with employees) there are no inventories as a
back-up.
• reducing the time items are waiting for something to happen to them; this is because if items
are idle they are not being sold and generating profits. This may be done by changing the
layout or the way a process is carried out.
• reducing the time when items are moving from one stage of process to another; again this
represents a waste of resources.

What do you think?

Why do you think suppliers and employees are crucial to the success of lean
production?

To become leaner a business may adopt a number of processes such as:

• Kaizen: this is an approach which emphasises the value of continuous improvement. Major
changes over time can occur as a result of relatively small changes made regularly. Employees
are encouraged to work in kaizen groups to focus on their area of work and come up with ideas
on how processes can be improved and made leaner. The idea is that those doing the work are
more likely to know how to do the work more efficiently.
• Andon: On a production line an andon cord is present above the process. If there is a problem
the andon cord is pulled and production stops. Flashing lights highlight where the problem has
 occurred and everyone goes to this point to understand what happened. The andon approach
involves transparency and ensuring that when a problem happens everyone in the organisation
learns from it and becomes more efficient as a result.
• Changes to the layout of a store or factory and changes to the process used to make it more
efficiently.
Figure 13.4 shows how changes to a system in a fast-food business can make a process leaner
and more efficient. It shows in number order the stages and movements in fulfilling an order,
both before and after changes that were made to improve efficiency.

Figure 13.4 Developing a leaner approach to making sandwiches in a shop

Business in focus: Amazon

Kaizen is a powerful tool for improvement that is used at Amazon. The founder Jeff
Bezos requires all senior managers to work in customer service at least one day a
year. This allows managers to experience what it is like on the front line, to
understand the problems that occur and to find solutions.
Each improvement from kaizen may be small but they add up to major change
overall. For example, on one day when Bezos was on the front line he discovered that
some suppliers were sending boxes that were incorrectly labelled or badly packed. In
one instance bottles were broken, which was dangerous for employees and if they
ever got to the customer would obviously be returned. Bezos introduced a ‘three
strikes’ policy.
The first time there is a problem, suppliers are reminded of the packing rules, the
second time anything happens they get a warning, and the third time they are
dropped as suppliers.
The ideal kaizen teams for Amazon include frontline workers, engineers, and a few
managers who are going to question and look for ways of improvement.
Source: Adapted from McKinsey & Company website

Practice questions
1 Analyse how kaizen might help Amazon be more competitive.
(9 marks)
2 To what extent do you think introducing kaizen at a business would be welcomed
 by employees?
(16 marks)

Business in focus: Lean operations at Airbus

Figure 13.5 Minutes and seconds per step for Airbus A320 single-aisle, medium-range airliner

Source: Ewan Duncan and Ron Ritter, ‘Next frontiers for lean’, McKinsey Quarterly 2014 © 1996–
2019 McKinsey & Company
Figure 13.5 shows how an airline reduced the turn-around time, i.e. how long it takes
to get the plane ready for take-off again once it has landed, for an Airbus through a
series of small improvements.

Practice questions
1 Analyse how the improvements shown above would benefit an airline.
(9 marks)
2 To what extent do you think introducing lean production would improve the
competitiveness of a business?
(16 marks)
Lean organisational structure
Being lean can affect every aspect of the business including its structure. Peter Drucker, a
management writer, once wrote that ‘much of what we call management consists of making it
difficult for people to work!’ What he means is that management can create so many forms, so
many rules, have so many meetings and have so many procedures that making decisions, getting
things done and actually getting on with work can be difficult. Lean organisations, therefore, try
to ensure that the systems and rules in place are the essential ones, that meetings are productive
and do not take up too much time and that there is not so much communication that people spend
most of their time responding to emails.

What do you think?

How would you ensure that management meetings are productive?
The difficulties of adopting lean production
Although lean production can provide greater efficiency it can also mean a business is more
vulnerable because there is no inventory if there is ever a disruption to production. If employees
strike, for example, or if suppliers fail to deliver, the business will have to halt operations. This
means that working closely in partnership with stakeholders is essential to keep operations going.
Even then the business is vulnerable to unpredictable events. For example, a major earthquake
and tsunami in Japan in 2011 disrupted the production of many lean producers that relied on the
production from there; they simply did not have the inventory they needed. This made
companies such as Honda review their ‘one supplier’ policy because although it helped build up
a strong partnership with that supplier it left the business very vulnerable to any disruption in
supply.
Introducing lean production can also be difficult. Employees are expected to take a more active
role in checking their own work to ensure that any problems are discovered early and that
mistakes are not repeated. Employees need to be engaged, have the skills and training to improve
the quality of their own work and be willing to send work back to others in the organisation if it
is not good enough. Some employees will resist these changes, preferring to keep their jobs as
they are and not want to train or take on extra responsibility.
Lean production also requires excellent links with suppliers so they know exactly what is needed
and when. This may require investment in communications and technology.

What do you think?

What do you think are the advantages and disadvantages of using one supplier rather
than many for any given input?
Using technology to improve operational
efficiency
Technological developments improve not just what is produced but how it is produced. Think of
how you do your coursework and compare it to how your grandparents did theirs: not only are
the nature of the tasks likely to be different but there will be radical differences in how you do
your work. You research online, word process, produce presentations on a computer and share
ideas online with friends. Your grandparents didn’t do any of these. And what about the way you
are taught: with interactive whiteboards, video clips, websites, virtual learning environments,
email, blogs and social media. Your parents are emailed reports and updates from the school and
may be able to log in to see what you are doing, how you are doing, what your attendance is like
and so on. This is a very different world from when your grandparents were at school! Many of
the products and processes we take for granted: booking cinema tickets or ordering food
deliveries via an app, downloading music, using sites that recommend other products we might
like or enable us to compare prices from different businesses and click and collect, simply did
not exist 20 years ago because the technology was not there.
Technology continues to move forward businesses and their operations, improving the quality
and improving their efficiency. Whether it is information technology, robots, computer-aided
manufacturing or transportation developments, technology is reducing unit costs as well as
helping organisations become more flexible and more competitive. Technological developments
enable businesses to:
• be more flexible to customer needs: with technology they can track customer behaviour more
effectively, target specific groups more easily and provide more personalised products.
• reduce costs by having more efficient processes with less errors; for example, online booking
and ordering means you enter your own details, saving the business time and money and
meaning there is less to change if the wrong details are put in. Technology enables processes
such as computer-aided design, which enables prototypes and models to be developed and
tested on screen rather than actually built.
• be innovative; for example, enabling you to stream films as and when you like: this should
increase customer satisfaction.
However, managers have to:
• have the finance to invest; new technology may be needed just at the moment when the
business is struggling and lacking finance to buy new equipment.
• have the training to use it effectively.
• understand and manage the impact on other functions; for example, technology may change
people’s jobs and managers have to ensure staff understand why this is happening, have the
necessary skills to adapt and do not resist this change if it is needed.
• be able to judge which technology will be useful in the long term rather than trying to adopt
every new development that comes along.
Business in focus: Technology and airlines

One of the key considerations when designing an aircraft is the weight. The heavier
the plane the more fuel it will use, thereby increasing fuel costs. Attempts to increase
fuel efficiency and improve the aerodynamic design of new aircraft have led designers
to stop using aluminium. The most modern planes, for example, Airbus’s A350, use
lightweight carbon fibre; this is a very strong and very light composite material. The
use of composite materials can reduce the weight of an aircraft by 20 per cent. Each
kilogram reduction in the weight of an aircraft can save the airline flying it around $1m
(£603,000) in costs over the lifetime of the aircraft.
Using these composite materials is also creating other possible savings. For example,
an A380 super-jumbo has about six million parts – but in future this could be reduced
considerably as some of the parts can be moulded together to form one part and be
manufactured at the same time. With fewer components, manufacturing time will be
reduced, therefore saving more money.
Designers are also looking at improving the shape of the aircraft to improve its
aerodynamics. One recent development has been the trailing edges of the wing of
Airbus’s latest plane, the A350 shown in Figure 13.6.

Figure 13.6 The Airbus A350

Practice questions
1 Analyse the benefits to airlines of this new technology of carbon fibre.
(9 marks)
2 To what extent do you think high levels of investment in technology are essential
for airline manufacturers?
(16 marks)
ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 An operations process that has little waste is known as ………. production.
2 What is the difference between total output and productivity?
3 You employ 20 employees who produce a total of 700 units per week. What is the
labour productivity?
4 Explain one reason why managers may be eager to increase labour productivity.
5 Explain what is meant by kaizen.
6 In ‘Just in Time’ production, businesses hold high levels of inventory. True or
false? Explain your answer.
7 State two ways a business might try to improve labour productivity.
8 State one reason why employees may resist attempts to increase productivity.
9 State two possible benefits of higher efficiency.
10 State one reason why labour productivity might fall.

(b) Short answers

1 Explain two benefits a food retailer might get from a leaner approach to operations
might benefit a food retailer.
(6 marks)
2 Explain one way in which a car manufacturer might improve productivity.
(5 marks)
3 Explain one possible way in which increasing efficiency might help the growth of a
restaurant business.
(5 marks)
4 A business employs 20 people with a productivity of 500 units per person. The
wage rate is £2,000 per person. Calculate the labour cost per unit.
(3 marks)
5 If productivity rises by 20 per cent at the business in Question 4, calculate the
labour cost per unit.
(3 marks)
6 Explain one reason why managers in a car factory may face resistance from
employees when trying to increase productivity.
(5 marks)

(c) Data response questions

Working hours and productivity
Research increasingly seems to suggest that working fewer hours a week can actually
increase labour productivity. Although managers often assume that working more
hours leads to more output there seems to be little correlation between hours worked
and productivity. A recent study showed that employees in Germany work almost 45
per cent fewer annual hours than Greece, but are 70 per cent more productive, while
annual German salaries are higher. It may be that improving the work–life balance
actually improves performance at work and output. This may be particularly true these
days in a service-based economy where new ideas and innovation are critical for
success.
Environmentalists are also in favour of a shorter working week because of its impact
on traffic congestion and pollution. Less time is wasted on commuting and less time in
spent sitting at your desk, which is bad for your health.
And of course, it is better for morale, which is good for both employees and
employers, who will have to deal with less labour turnover and a more motivated
workforce. This is important for businesses that are seeking to maintain their
competitiveness. Companies such as Google and Facebook are always looking to
ensure they keep their staff engaged to keep productivity high. However, companies
generally seem reluctant to take the decision to move to a four-day working week.
They are worried about not having staff there when others do.
Richard Branson at Virgin Group recently announced that staff at the Head Office
could decide how long to take on holidays and when to take them, without permission
from their bosses. Some think this may actually lead to higher productivity.
Of course, productivity is not just down to working patterns and whatever managers
do with working hours: they need to ensure that other factors such as training and
investment are not neglected.
1 Explain one way that online businesses such as Google and Facebook might
measure productivity.
(5 marks)
2 Analyse how working fewer hours might increase productivity.
(9 marks)
3 To what extent do you think a shorter working week is a good idea in all
businesses?
(16 marks)

(d) Essays
1 To what extent do you think that adopting lean production is guaranteed to lead to
higher profits? Justify your answer.
(25 marks)
2 Some of the most successful businesses these days are online, for example,
Amazon and Google. To what extent do you think productivity is a useful operations
measure for online businesses? Justify your answer.
(25 marks)
Chapter 14 Improving quality
Introduction
In this chapter we examine the concept of quality in operations. We analyse what is meant by
quality, how it can be achieved and the dangers of poor quality.
What it is important to know by the end of this chapter:
• the importance of quality
• how to analyse methods of improving quality
• how to analyse the benefits of improving quality
• how to analyse the difficulties of improving quality
• how to analyse the costs of poor quality.
Quality
Operations managers will set targets that determine what they are trying to achieve for their
customers. For example:
• A bottling plant may set a target for how many of the bottles produced should contain between
4.99 ml and 50.01 ml.
• An insurance company may set a target for how many claims are processed accurately.
• A call centre may set targets for how many calls are answered per hour.
• A supermarket may set a target on how many items are scanned per minute on average.
• A restaurant may set a target for how long it takes to prepare a meal.
• An airline might set a target for the proportion of passengers’ bags that are lost (hopefully a
low target!).
The business will have determined how it wants to compete and what it wants to provide.
Managers will then have set targets, such as those listed above, to ensure the business is
competitive. The quality of an operation is measured by the extent to which a business meets
these targets consistently. A good-quality operations process delivers exactly what it is intended
to produce and meets the targets that have been determined by the customer requirements; a
poor-quality operations process fails to achieve these targets or does so inconsistently. Imagine
you have set yourself the target of getting an A in A-level Business Studies and your teacher says
to do this you need at least 75 per cent on each piece of work. You listen in class, you study, you
research, you plan, you take care with your work and you read over your work. You consistently
achieve 80 per cent and you clearly have a quality process. Compare this to a student who
sometimes gets 90 per cent and sometimes 30 per cent and who has no system in place to do the
work: sometimes they spend the appropriate amount of time on it, sometimes they don’t,
sometimes they research, sometimes they don’t. This is not a quality process.

Key term
Quality is measured by the extent to which an operation meets its customer
requirements. A quality good or service is ‘fit for purpose’.

To achieve its targets and develop a quality process a business must develop appropriate
systems. It must also monitor what is happening to ensure the targets continue to be achieved. If
the targets are met then this is a quality process.
A quality operations process
For a business to have a quality operations process requires:
• a clear definition of what its targets are; these should be set to meet customer requirements
• systems to achieve these targets
• training of employees so that they have the necessary skills
• ongoing measurement of what is achieved relative to the targets
• action to be taken if performance does not meet the targets.
Quality is therefore very much linked to data: it involves specific targets that define what is
trying to be achieved and the efforts focused on achieving them. It is also an ongoing process. If
you are consistently getting 80 per cent in work then it is time to up the standard and aim for 81
per cent. it is important to review how you could do this, introduce change, measure what
happens and see if you can consistently achieve 81 per cent. When you can do this the standard
should move up again. Quality is a journey not a destination: you should always be trying to
improve.

What do you think?

What targets would you set for the operations of:
• a school
• a hospital
• a hotel
• a retailer?
The importance of quality
Achieving quality is important to remain competitive. Why would customers choose a business
that is unreliable, does not deliver what it promises or does not meet the agreed requirements? It
is easier for customers to choose alternative businesses with more organisations being online and
with developments in technology making it easier to source materials. As competitors keep
improving the quality of what they do, businesses need to improve and offer better quality to
their customers to retain them and gain their loyalty.
To improve quality, managers will want to develop processes to ensure that their targets are hit.
For example, this might involve:
• using market research to ensure the requirements of customers are clearly met and that what
the business is trying to achieve is appropriate relative to what competitors are doing
• the careful selection of suppliers
• training employees to check the work they receive and make sure it is acceptable, to do their
job properly and check their own work
• investment in technology to help ensure the process does what it is supposed to
• reviewing the way the work is done to see if the systems can be improved. This should be done
with the employees who undertake the work as they are in the best position to improve it. This
is where kaizen groups (see Chapter 13) may be used.

Figure 14.1 Ways to achieve quality

What do you think?

Can you name a business that you think has a quality operations process? Explain
your choice.
Quality assurance
One approach that is designed to prevent mistakes occurring and to ensure targets are hit is called
a quality assurance process. A quality assurance system refers to the activities involved to
ensure an operations process meets the requirements of its customers. The aim is to make sure
mistakes do not occur and to achieve zero defects. Think of all the measures and systems that are
in place to make sure a plane takes off and lands safely. Staff have been trained, technology is
used, processes are in place to make sure everything works before the plane takes off. It is no
good a plane being ‘nearly safe’ – it has to be absolutely right. This is the same approach many
other business are now trying to adopt: they want employees to think of what steps can be taken
to get it right and avoid errors.

Key terms
Quality assurance is the maintenance of target quality by attention to detail at every
stage of the process.
Quality control is a system of maintaining standards by testing or inspecting the
output against standards.

Consider a car production line. Traditionally, employees on the production line simply wanted to
produce as many cars as possible. Once the car was produced it was up to the sales and
marketing team to find someone to buy it. If an employee found a problem on the production line
they would simply do their work and move the faulty car on to the next stage. It was not their job
or responsibility to fix it and they did not have the training to do so. The car would move along
the line without anyone doing anything about the faults until it got to the end. At that point a
‘quality team’ would inspect and try and find the faults that had been built in. This is known as
quality control. Products are inspected to find faults. If anything, staff on the production line did
not want to solve any mistakes because it would remove the need for quality control and
therefore some employees would be made redundant.
Nowadays, car companies train staff to identify faults and expect employees to highlight them
and stop the production line rather than pass them on to the next stage. Every employee is held
responsible for any errors they pass on to the next stage. The aim therefore is to make everyone
feel responsible for quality and able to improve it in their part of the process. It is also intended
to reduce waste and lead to fewer items being returned as faulty. The intention is to make sure
that targets are hit at each stage and the final car does not even need checking: it must meet
quality standards as it has reached the end of the process.
The benefits of improving quality
The main benefit of improving quality is that it means a process is under control. It is doing what
it should be doing and consistently delivering what it should be delivering. This means
operations managers can feel comfortable that they can meet the set targets. Assuming these
targets have been set at an appropriate level the business will be competitive. It will be providing
its service fast enough and reliably enough in a manner it has promised. It says it will deliver the
gift within three days and does. It says the hair dye will last 20 washes and it does. It promises to
deliver the flowers between 9 a.m. and 11 a.m. and it does. It says that 90 per cent of its produce
is sourced locally and it is. This helps the brand image, leads to customer satisfaction and
generates goodwill through word of mouth.
Difficulties in improving quality
While improving quality seems an obvious target that everyone would agree with, that is not
always the case. For example, employees might:
• believe the business is doing well enough as it is and not see the need to set higher targets over
time. They may resent this and even perceive it as a criticism of what they currently do
• see improving quality as extra work and not understand why they should bother unless they are
paid more
• be unwilling to suggest improvements, believing this is management’s job not theirs
• be unwilling to undertake all the administration required to measure and check progress.
From the business perspective improving quality will require:
• discussing the issues with employees and getting them to agree to the process
• investing in training
• possibly changing suppliers
• developing a culture (that is, a state of mind) where getting it right first time and continually
measuring performance is the norm. This may be difficult to achieve due to employee
resistance and difficult to sustain and ensure this remains the way people think, rather than just
a short-term initiative
• incentives to encourage employees to value better quality as a target.
The consequences of poor quality
Philip Crosby, a famous writer on quality, argues that getting quality right is cheaper than paying
to fix things when they go wrong. He stated that the four absolutes of quality are:
1. Quality is conformance to requirements (quality is about meeting targets).
2. Preventing defects is preferable to inspection and correcting mistakes (quality assurance is
better than quality control).
3. Zero defects should be the target (don’t accept failure of any kind and keep aiming for better).
4. The cost of quality should be measured in terms of the costs of not conforming.
This last point is important: managers should not just focus on the cost of achieving quality
but on the costs incurred if they do not achieve quality.

Key models and theories: Philip Crosby

Philip Crosby is a famous writer on quality. His message, that improving quality can
actually save money rather than lead to more costs, was a very important one that
changed the way many managers thought about quality. By getting it right there is less
to fix later or replace and the overall costs can be lower.

Poor quality is expensive because:

• It costs money to recall faulty products and recall them. In recent years companies such as
Toyota and General Motors have had to recall significant numbers of cars due to production
problems.
• It can damage a brand’s reputation.
• It costs money to rework faulty items
• There may be legal costs if customers sue the company.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 What is meant by quality?
2 State one reason why improving quality is important.
3 State one difficulty of improving quality.
4 What is meant by quality assurance?
5 State two ways in which a business might try to improve the quality of its
operations.
6 State two costs of poor quality.
7 ‘Quality is a journey not a destination’; what does this mean?
8 ‘A quality product’ is the most expensive one in the market. True or false? Explain
 your answer.
9 State one benefit of high quality.
10 What is quality control?

(b) Short answers

1 Explain one way in which improving quality might help the competitiveness of a
hotel.
(5 marks)
2 Explain one way an airline might invest in marketing research as part of its efforts to
improve quality.
(5 marks)
3 Explain one way a hospital might measure its quality.
(5 marks)
4 Explain one cost of poor quality in an online bank.
(5 marks)
5 The Chancellor of a world-famous university has told staff that it is important the
organisation improves the quality of its service, given how much students now pay.
Explain one reason why staff might resist attempts to improve quality at this
university.
(5 marks)

(c) Data response questions

The car company, Toyota, was once recognised for its focus on quality. However in
recent years there have been a number of problems with Toyota cars, leading to
product recalls. The reason for this seems to have been a focus on rapid growth. Mr
Toyoda, the company’s President, has acknowledged that the company’s decision to
focus on growth meant that Toyota placed real pressures on its operations systems
and lost its focus on quality. What had made it great was making sure it met customer
requirements but in recent years it concentrated more on generating sales and
producing high volumes of cars.
Arguably the problems began in 2002, when Toyota set itself the goal of increasing its
global market share from 11 per cent to 15 per cent. To achieve this volume of sales
the company had to work with unfamiliar suppliers.
The majority of Toyota’s problems have almost certainly been due to its suppliers. The
automotive industry has a complex supply chain. The carmakers (who are known as
original equipment manufacturers, or OEMs) are right at the centre. Next come tier-
one suppliers, such as Bosch, Delphi, Denso, and Continental, who supply integrated
systems directly to the OEMs. After them are the tier-two suppliers, who provide
individual parts or assembled components either directly to the OEM or to tier-one
suppliers.
The tier-three suppliers often make just a single component for tier-two suppliers.
There are thousands of tier-two and tier-three suppliers globally, although their
numbers have fallen in the last decade as the OEMs and the tier-one firms have
focused on fewer key suppliers.
Toyota went as far as making some suppliers the sole provider of some products. Its
aim was to build long-term, trusting relationships. By comparison, Western car
companies tended to use many suppliers on short-term contracts to make them
compete against each other.
Most large car firms now follow Toyota’s approach and collaborate with key suppliers
on new product developments. Rather than just looking at the initial costs of a
component from a supplier, car companies now consider the possible costs if
suppliers were delayed or faulty.
Toyota’s rapid expansion meant that it had to use suppliers who did not necessarily
have the same focus on quality. Given its single sourcing approach it was highly
vulnerable to mistakes being made.

Figure 14.2 Tiers of suppliers to equipment manufacturers

1 Explain how Toyota can try to maintain good quality.

(5 marks)
2 Analyse the possible consequences of poor quality for Toyota.
(9 marks)
3 Do you think using one supplier is good for quality? Justify your answer.
(16 marks)

(d) Essays
1 To what extent do you think better quality should be the priority for all businesses in
the increasingly competitive markets in which they operate?
(25 marks)
2 Is improving quality within a car manufacturer inevitably going to be expensive?
Justify your answer.
(25 marks)
Chapter 15 Managing inventory and
supply chains
Introduction
Inventory (or stock) refers to the materials held by a business; for example, there may be
inventory of supplies or finished goods. In this chapter we examine the types of decisions
managers might make in relation to inventory such as when and how much to order. We also
consider how managers may respond to having too much or too little demand and how managers
manage the supply chain.
What it is important to know by the end of this chapter:
• ways of improving flexibility, speed of response and dependability
• the importance of inventory
• how to analyse the factors influencing how much inventory to hold and order
• how to examine the factors that might influence which suppliers are used
• how best to match supply to demand
• how to manage the supply chain effectively and the value of doing so
• how to evaluate the benefits and disadvantages of outsourcing.
Improving operational performance
In the last few chapters we have analysed how a business might achieve some of its operational
targets such as greater efficiency and better quality. However, there are other objectives that
managers may also be trying to achieve. These include:
• speed of response. In some industries, speed of response has been used as a competitive
weapon – the speed with which a recovery vehicle will get back to you if you break down, the
speed with which any exam script will be re-marked if you appeal the grade, the speed with
which a product can be delivered to you. Imagine you order a takeaway online – you may
select a company that can deliver quickly. For some businesses, improving the speed of
response is a way of being more competitive. To improve the speed may involve reviewing the
process to find time savings – for example, can some activities be carried out simultaneously
rather than one after another. Have you ever eaten your breakfast while getting dressed, doing
your teeth and finishing your homework? If so, you have been undertaking activities
simultaneously and saving time! Increasing the speed of response may also involve investment
in new technology. However, speed does not always need to be the key operational objectives.
You may be more concerned that your plane leaves at the time stated rather than whether it is
10 minutes faster than a rival company’s. You might be more concerned that the items ordered
online arrive in perfect working order rather than whether they arrive one day earlier, but
broken.
• dependability. This refers to a process starting and finishing at the stated time. This may be
very important in the travel sector or in project work where you may need to be sure that it
starts and ends on time. When exams are being marked it is vital the marking finishes in time
for the results to be published on the set date. Greater dependability may therefore be more
important in some industries than others. To achieve it may involve new processes, investment
and training.
• becoming more flexible. Some businesses might want to offer greater flexibility to their
customers. Made-to-order sandwiches at a cafe, any combination of A-level subjects in a sixth
form and your own personalised design of footware are all examples of greater flexibility.
Technological developments are making this flexibility easier. If you buy a BMW Mini, for
example, you choose the colour, the wheels, the radio, the type of roof, the upholstery, the
interior trim and various other features from different lists. Your car is then produced for you
and BMW claim no two Minis are exactly the same. The use of technology to produce on a
large scale while adapting the individual items to meet individual customer needs is called
mass customisation. Greater flexibility may lead to more customer satisfaction but there is a
trade-off – it may be more expensive to produce many different versions of a product and it
may be a more difficult and longer process to manage. Your school may not want to offer all
A-level subjects in any combination because it would be very difficult and expensive to
provide this. Most fast-food restaurants have a relatively limited menu so that staff do not need
much training, the restaurant does not need to hold lots of different inventory and they can buy
ingredients for these items in bulk. Being more flexible would not fit with this low-cost, fast
approach.
 Key terms
Mass customisation is the term for producing on a large scale while still enabling
individual customer preferences to be met.
An inventory refers to the stock a business holds. These include the raw materials
and other items necessary for production to take place. They also include finished
products that have not yet been sold.

Operations managers will, therefore have to decide what the key operational objectives are in
their business. In some industries, speed may be the key; in others dependability may be more
important. If flexibility is the priority it may involve holding more inventory to enable a business
to provide more choice.

Figure 15.1 Personalised Nike products

Inventory
The inventory of a business refers to the goods that it holds; it is also called stock. Inventory
may take several different forms:
(a) Inventory of materials and supplies may be held by the business. For example, a car
producer may hold vehicle parts ready to use in production.
(b) During a production process, semi-finished items may be held ready for the next stage of the
process.
(c) Finished products may be held ready for distribution or sale. Think of how much inventory
many retail outlets hold on their shelves.

Figure 15.2 The different forms of stock inventory

Business in focus: Waitrose distribution centre

Waitrose recently opened a new national distribution centre (NDC) in Milton Keynes.
The NDC is the size of about twelve Premiership football pitches and will be able to
deal with the distribution of around 25,000 nationally available grocery and home
department product lines that are sold in Waitrose branches and online at
Waitrose.com.
The NDC will deliver these products via Waitrose’s four regional distribution centres
(RDCs). It will also simplify the supply chain and improve the efficiency of handling
national product lines that in the past have been sent between RDCs. This should
enable more manageable growth. The company has plans to open 38 shops next
year and expand its online sales.

Practice questions
1 Analyse how a distribution centre could affect the performance of Waitrose.
(9 marks)
2 To what extent is the management of the supply chain the key to Waitrose’s
success?
(12 marks)
Figure 15.3 Inside a distribution centre

Why hold inventory?

Inventory is held to ensure that production can take place immediately (as opposed to having to
wait for supplies to arrive) and to ensure that customer orders can be fulfilled quickly (without
having to wait for items to be produced).
Influences on the amount of inventory held
Managing the amount of inventory held is important for these reasons:
• Holding inventory uses up resources. For example, managers may need to invest in
warehousing space or security measures to protect the items and prevent damage and theft.
• Holding inventory has an opportunity cost; that is, the money invested in producing products
could have been used for something else. Just think of how much money is invested in
inventory when you visit a car showroom – hundreds of thousands of pounds worth of cars
may be sitting on the forecourt. This is why managers are often eager for the inventory to ‘turn
over’ relatively fast as this frees up funds and generates a profit to expand the business.
• Inventory may go out of date and become worthless if held for too long.

Figure 15.4 Holding seasonal inventory like Christmas decorations uses up resources

Figure 15.5 The costs of holding inventory

To manage inventory, managers will want to measure how much of an item is held at any time,
what the likely usage rate is going to be and how quickly it can be replaced. Technology is
enabling much more efficient inventory control.
When managing inventory, therefore, a manager will want to make sure that enough inventory is
held to ensure that production and sales can continue and meet customers’ requirements quickly.
However, managers will not want to hold too much inventory because of the costs involved.
What do you think?
What do you think will determine how much inventory a retailer holds?
Inventory control charts
The management of inventory can be analysed using inventory control charts.
The key elements of this type of chart are:
• The buffer inventory. This is the minimum amount of inventory a business wants to hold.
Buffer or safety inventory is held to ensure production can continue in an emergency and/or
customers can continue to be supplied. The amount of buffer inventory may depend on how
difficult and expensive it is to store and how likely it is that there will be problems with
inventory arriving on time.
• The lead time. This is how long it takes from an order being placed with suppliers and the
items arriving. It is measured in days, weeks or months. The lead time determines when an
order has to be placed in order to arrive in time to prevent the inventory falling below the
buffer (safety) stock level.
• The re-order level. This is the level at which a new order must be placed for supplies. This
will depend on the buffer inventory, the rate at which materials are used up and the lead-time.
• Re-order quantities. This is the amount a manager orders of a particular item. It might depend
on factors such the cost and the ease of storage and the usage rate. The more often a manager
re-orders, the less the quantity that needs to be re-ordered, if other factors are unchanged. The
less often a manager orders, the bigger the re-order quantity will be, if others factors are
unchanged.
Problems with inventory control might arise if:
• supplies are delayed and do not arrive on time; in this case the business will use up its buffer
inventory for as long as it can
• the usage rate is faster than usual; perhaps because of an increase in demand

Figure 15.6 Inventory chart

Figure 15.7 Stock out

• there is a failure to reorder inventory. Increasingly, orders are done automatically but in some
areas this is still done manually and can be forgotten.
If a business does run out of inventory it may have to halt production and let customers know
there will be a delay. This may cause customer dissatisfaction and lead to lost orders. As a result,
a business may hold inventory ‘just in case’. In 2018, there was a great deal of uncertainty about
the terms under which the UK would leave the European Union. This led to fears that, when the
UK left the EU, there would be additional import checks on goods coming into the country,
threatening availability of products. Some businesses and customers began to increase inventory
and stockpile products as a result.

What do you think?

How do you think a business might react if it runs out of stocks due to problems at the
suppliers?
Technology and inventory control
Developments in technology are enabling managers to keep a better track of what inventory they
have. The use of Electronic Point-of-Sale scanners in stores, for example, enables the business to
know what it has available and when an item needs reordering. Better marketing databases also
mean the business can forecast likely sales more easily and therefore be able to have items in
place, avoiding the danger of running out.
Communications links with suppliers have also improved making ‘Just in Time’ more possible.
As items are running out, orders can be placed directly with suppliers, reordering them as and
when needed. This helps improve efficiency as businesses are not left with unwanted products
that they then have to discount or discard.
Managing supply to match demand
An important aspect of operations management is to ensure that the supply of a product can
match the demand. In some industries demand may be relatively stable and therefore the required
output is also fairly predictable. For example, assuming demand is constant, managing a soft
drinks factory will involve keeping the existing process running continuously.
However, in some businesses demand will vary enormously on different days of the week (for
example, retailers may be busier on a Saturday), at different times of the year (for example, a ski
resort) or even at different times of the day (for example, an accident and emergency unit at a
hospital or a car breakdown service).
To match supply to demand there are various methods an operations manager may adopt:
• employing a flexible workforce: by ensuring employees are multi-skilled and have flexible
contracts, managers may be able to move staff to where they are needed and increase hours to
meet any sudden peaks in demand. Managers may also make use of part-time or temporary
staff to enable them to increase or decrease the workforce as required.
• using queuing systems or introducing waiting lists to manage high levels of demand
• outsourcing production to other businesses to meet high levels of orders
• increasing prices to reduce demand
• accepting orders to produce for others if demand is low
• producing to order. This occurs when a business only produces when the actual order is placed
rather than producing items and hoping they will sell. This reduces any risk of being left with
unsold stock but requires a flexible production process.

Key terms
Part-time staff work less than a full working week, for example, 20 hours a week.
Temporary staff work for a limited period of time, for example, for the summer only.

Business in focus: Made.com

The furniture company Made.com collects customer orders and only produces the
furniture when it has enough orders. One of the reasons the company can keep
prices down is there are no warehouse costs to pass on to the customer.

Practice questions
1 Analyse the benefits for Made.com of only producing once an order is placed.
(9 marks)
2 To what extent do you think all retailers will end up online and not have physical
outlets in the future?
 (16 marks)

Business in focus: RAC Breakdown

The RAC’s roadside assistance service has 2.2 million individual members and 5.4
million corporate customers, and its 1,800 patrols attend around 2.5 million vehicle
breakdowns each year. The patrols fix four out of five breakdowns at the roadside,
and any that can’t be repaired easily are towed to the nearest garage. The RAC’s call
centres are open 24 hours a day, year-round, and handle about four million calls a
year – two calls per second at peak times.
The RAC also offers flexible roadside assistance to its members when they’re abroad
through its network of contractors and partners in 49 different European countries.

Figure 15.8 RAC breakdown vehicles

Practice questions
1 Analyse the factors that affect the demand for RAC breakdown services.
(9 marks)
2 To what extent do you think the RAC can predict demand for its breakdown
services?
(12 marks)
The supply chain
Take a look at your phone and think of all the producers who will have been involved in
producing and delivering this final product to you. One business may have designed it and then
used suppliers to produce parts such as the screen, the handset, the memory card, the camera and
so on. Then there will have been businesses involved in assembling all the parts, distributing the
phones to retailers and promoting the products. A large number of businesses will have been
involved in the overall process of developing and producing this final product. Managing
relations with all the other partners involved in the supply process is therefore an important
aspect of a business.
Managing the supply chain
Managing a supply chain involves taking decisions about:
• what to produce yourself and what to buy from others
• which other businesses to work with
• a supplier strategy, in terms of how many suppliers to work with; is the aim to build a long-
standing relationship with one supplier or get different suppliers to compete for business
regularly
• setting out the terms and conditions of the supplier relationship, for example, penalty clauses
for any delays
• deciding on the assurances from the supplier on their operations e.g. in terms of treatment of
employees, where they source their resources. A business that wants to protect its brand and its
image needs to be careful who it is buying from and will want to ensure it is not likely to be
affected by a scandal at its suppliers. Businesses such as Marks and Spencer and The Co-
operative promote an image of behaving very responsibly, so would not want to be associated
with suppliers who did not
• how much direct involvement to have with suppliers – will the business insist on a Code of
Conduct with suppliers? How rigorously will this be enforced and how? This has become an
important issue in many industries where there are important ethical and environmental issues
• how centralised purchasing should be; for example, do all offices around the world have to buy
their supplies from a company list, or are they able to choose who they want to work with?

Figure 15.9 The supply chain

Effective management of the supply chain will ensure:

• the right supplies arrive on time
• a fair price is paid for the items
• the products are produced in a way which is acceptable to the business.

What do you think?

How do you think better supply chain management can improve business?
The value of managing the supply chain
effectively
The way in which the supply chain is managed will affect:
• the extent to which suppliers meet the requirements of the business reliably
• the costs of the business
• the ability of the business to be flexible to customer requirements.
Managing the supply chain also involves ethical issues. For example, a business may buy
supplies from a supplier that is paying low wages or that has working conditions that do not meet
the standards in the home country. This may keep costs down but leave a business open to
criticism for working with that supplier.
The dangers of not managing your supply chain properly can be seen in the horsemeat scandal in
2013. Some meat labelled as beef burgers in UK supermarkets was found to be horsemeat, so
consumers had been misled. The pressure to keep costs down led to some business in the supply
chain switching cheaper meat for beef.
A more recent example of supply chain management issues occurred in 2018, when an
investigation alleged that companies such as ASOS and Marks and Spencer were using suppliers
who employed child labour in Syria which is in breach of the Modern Slavery Act.
In some cases, businesses will take control of their supply chain by owning more of the stages
within it. Vertical integration occurs when businesses start producing at different stages in the
production process, for example, they buy their suppliers or set up their own business to supply
themselves. This gives them greater control over their supply chain. IKEA and Zara, for
example, control the whole process from design to production to sale. This means the designers
understand how the products have to be moved, stored and used by consumers.

Key term
Vertical integration occurs when one business joins together with another business
at a different stage of the same production process.

What do you think?

What do you think might be the problems of vertically integrating and controlling much
of your supply chain?
Influences on the choices of suppliers
When choosing a supplier, many factors may be considered by a manager. For example:
• the cost of materials and quality. All managers will be conscious of costs although at the same
time they must consider whether the supplies meet their requirements, that is they must be
aware of the quality of the supplies. Managers will want value for money
• dependability. Managers will generally want supplies to arrive as and when they are ordered to
arrive. However, this may increase costs and so, as ever, there will be a trade-off. In the case
of a major project working to tight deadlines with a Just-in-Time approach for example,
dependability will be absolutely key. It may be less important in other situations.
• ethical considerations. Organisations are increasingly being held responsible for the behaviour
of their suppliers. Businesses need to decide on how much responsibility they need to accept,
what their standards are and how they will ensure they are achieved.

Business in focus: Fairtrade

When you buy products with the FAIRTRADE Mark, you support farmers and
workers as they work to improve their lives and their communities. The Mark
means that the Fairtrade ingredients in the product have been produced by
small-scale farmer organisations or plantations that meet Fairtrade social,
economic and environmental Standards. The Standards include protection of
workers’ rights and the environment, payment of the Fairtrade Minimum Price
and an additional Fairtrade Premium to invest in business or community projects.
These Standards are independently audited by FLOCERT.
Fairtrade works to benefit small-scale farmers and workers, who are among the
most marginalised groups globally, through trade rather than aid to enable them
to maintain their livelihoods and reach their potential.
For certain products, such as coffee, cocoa, cotton and rice, Fairtrade only
certifies small-scale farmer organisations. Working through democratic
organisations of small-scale farmers, Fairtrade offers rural families the stability of
income which enables them to plan for the future.
For some products such as bananas, tea and flowers, Fairtrade also certifies
plantations – companies that employ large numbers of workers on estates. Our
Standards for such large-scale production units differ and protect workers’ basic
rights; from keeping them safe and healthy, allowing them freedom of association
and collective bargaining, to preventing discrimination and ensuring no bonded or
illegal child labour. They also require employers to pay wages that progress
towards living wage benchmarks. Ensuring decent working conditions and strong
worker rights is central to Fairtrade’s work.
The producers themselves decide how the Fairtrade Premium should be
invested. The Premium is the additional sum of money paid on top of the
 Fairtrade Minimum Price that farmers and workers receive which can be invested
in social, environmental and economic developmental projects to improve their
businesses and their communities. In real terms, it means investment in schools,
transport, health care, sanitation, an improved environment and better business
equipment and practices.
Source: Fairtrade website

Practice questions
1 Analyse why a business might want to use Fairtrade products.
(9 marks)
2 Do you think all food businesses should only use Fairtrade supplies?
(16 marks)

Key term
Corporate social responsibility refers to the extent to which a business takes into
account its stakeholder views and accepts its obligations to society over and above
the legal requirements.
The changing supply chain
Managing the supply chain effectively has become more important and more complex in recent
years because many customers increasingly want to know more about how and where a product
is produced. Managers need to be able to track back more of their supplies to know the answers
to these questions. This may mean investigating not just their immediate suppliers but their
suppliers and their suppliers and so on. If you buy a tin of John West fish, for example, you can
now research where and when the fish was caught using the code on the tin. Managers are being
held accountable for more and more of the supply chain and there are greater demands for
transparency at all stages. An ethical business should ask questions not only about what it does
but what its partners are doing as well.

Figure 15.10 John West fish

However, greater globalisation means that it is easier to find suppliers around the world and to
move materials. Managers searching for the best value for money may be using suppliers
thousands of miles away and their suppliers will also be global. The supply chain can therefore
be very complex in terms of tracking who is involved and coordinating activities around the
world. Improvements in technology are enabling better tracking systems but equally supply
chains are often involving more organisations and may be stretched around the world.

Business in focus: Nike

In the early 1990s, news hit the headlines, as the conditions in the factories of some
of Nike’s suppliers to whom they outsourced their manufacturing were criticised. Low
wages and poor working practices revealed by the media resulted in many people
boycotting Nike’s products.
However, since the 1990s, Nike has changed the way it works with suppliers. In 1996,
working with other organisations and the US government it established the Apparel
Industry Partnership, and drew up a code of conduct for factories. In 1999, the
Apparel Industry Partnership established the Fair Labor Association, which aimed to
 improve working conditions in factories around the world. In 2005, Nike was the first
firm in the apparel industry to publish a full list of the suppliers it worked with. Nike
now has a large corporate responsibility team that works with suppliers to ensure
codes of conduct are enforced.
Although it is now common for businesses to have a code of conduct governing
working practices in supplier factories, it can be difficult to ensure these are enforced.
Corruption and bribery mean it is not always easy to get a clear picture of what is
going on in a factory. Auditors can be bribed and records can be faked. It may even
be that workers are complicit in poor working practices, wanting to maximise their pay
by working long hours or feeling that if they were to reveal the true situation they may
lose their jobs.
However, Nike feel that improving relationships with suppliers is worth it. They say
that productivity and profit have risen since new rules and procedures have been
enforced and that labour turnover has also fallen.

Practice questions
1 Analyse the effects of better supply chain management on the profits of a
business.
(9 marks)
2 Do you think that a business should take responsibility for the behaviour of its
suppliers? Justify your answer.
(16 marks)

Developments in technology are also changing the nature of the supply chain in some industries.
Customers can now access more products directly from the provider without as many
intermediaries. For example, only two years after the release of the Kindle, Amazon.com was
selling half of its books electronically for the titles it offers customers in both bound and digital
formats. The Kindle is removing the entire physical supply chain of going to a bookshop to buy a
book that has been produced by a publisher, printed by printer and physically sent to a store.
Outsourcing
Outsourcing occurs when a business uses another provider for some of its goods or services. For
example, a school may outsource the provision of food at lunchtime and the security of the
premises out of school hours.

Key term
Outsourcing occurs when an organisation uses a separate business or businesses
to complete part of its work – for example, a business may outsource cleaning its
premises.

The value of outsourcing

The benefits of outsourcing are that:
• It enables the business to make use of specialist skills and services; this may mean they get a
better quality of work provided more efficiently.
• It can increase the capacity of the business by getting some aspects of its provision provided by
others.
However, outsourcing can bring disadvantages and difficulties. For example:
• A business will be affected by the work undertaken by other businesses in terms of the costs
and quality of their suppliers. If the supplier’s quality is poor this may adversely affect the
reputation of the business itself.
• A business may also be held accountable for the actions of its suppliers; for example, if the
supplier behaves unethically the business buying its services may be criticised for using its
services.
• A business will have to pay enough for the products for the supplier to make a profit. This may
be more expensive than doing the work in-house.

What do you think?

Do you think businesses are more or less likely to outsource in the future? Why?

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 Explain the difference between flexibility and dependability as operational
objectives.
2 What is meant by mass customisation?
 3 State two problems of holding inventory.
4 State two factors that might influence the buffer level of inventory.
5 What is the difference between the re-order quantity and the re-order level?
6 The time taken for supplies to arrive from the time of them being ordered is known
as ………. time.
7 State one possible benefit of outsourcing.
8 State one possible problem of outsourcing.
9 State two factors that might influence the choice of a supplier.
10 State two benefits of effective supply chain management.

(b) Short answer questions

1 Explain one factor that might influence the level of inventory held by an upmarket
restaurant.
(5 marks)
2 Explain one factor Starbucks might consider when choosing which coffee farmers
to work with.
(5 marks)
3 Explain one factor a furniture store might consider before deciding whether to buy
in materials or produce them itself.
(5 marks)
4 Increasingly, customers want to be reassured about the way in which a product is
made and how it is sourcing its supplies. Explain one possible impact of changes in
these areas on a business.
(5 marks)
5 Explain one way in which a theme park might respond to having consistently high
queues for its rides.
(5 marks)

(c) Data response questions

Figure 15.11 Ben & Jerry’s ice cream

Ben & Jerry’s
Using our ingredients and the power of our purchasing decisions to support positive
change not only makes sense – it makes our ice cream taste sensational!
Caring Dairy
When you think about it, Ben & Jerry’s wouldn’t be Ben & Jerry’s if it weren’t for the
family farms supplying the high quality dairy ingredients we depend on. Caring Dairy™
is a unique program that’s helping farmers move toward more sustainable practices
on the farm.
Cage Free Eggs
The eggs we buy for Ben & Jerry’s ice cream in the United States come from hens on
Certified Humane cage-free farms. Certified Humane cage-free standards ensure that
laying hens have wholesome, nutritious food, access to clean water, and adequate
space to engage in normal behaviors, among other criteria crafted by veterinary
professionals.
Brownies
If you’ve ever had our Half-Baked™ or Chocolate Fudge Brownie ice cream flavors,
then you’ve already had a taste of the greatness that comes from Greyston Bakery.
Greyston Bakery is as committed to providing jobs and job training for individuals who
face barriers to employment.
Fairtrade
Fair trade is about making sure people get their fair share of the pie. The whole
concept of fair trade goes to the heart of our values and the sense of right and wrong.
Nobody wants to buy something that was made by exploiting somebody else.’ (Jerry
Greenfield, Ben & Jerry’s Co-founder)
Non-GMO
Ben & Jerry’s is proud to stand with the growing consumer movement for
transparency and the right to know what’s in our food supply by supporting mandatory
GMO labeling legislation.
Climate Change
All businesses have greenhouse gas emissions associated with their operations – at
Ben & Jerry’s, we have ours. We know our footprint, are working throughout our
operations to reduce it, and we report on progress annually.
Productive Waste
With an eye towards closing loops in our supply chain, we even send the dairy waste
from our Vermont plants back to two of the farms that supply us with fresh dairy
ingredients. Our waste is put into methane digesters with other farm waste – where it
generates energy to power the farms.
Cleaner Greener Freezer
We make ice cream in the nicest way possible, and now the freezers we put it in are,
too! Our ‘Lean & Green’ freezers are more climate-friendly and energy efficient!
Responsibly Sourced Packaging
Our paperboard packaging is Forest Stewardship Council certified, which means
forest wildlife, biodiversity and sustainability is protected from the start.
Source: How We Do Business © Ben & Jerry’s, 2019.
1 Explain the factors Ben & Jerry’s might consider when choosing a supplier.
(5 marks)
2 Analyse why Ben & Jerry’s is so concerned about the suppliers it uses and the way
it produces.
(9 marks)
3 To what extent is producing reports on its environmental impact useful for Ben &
Jerry’s?
(16 marks)

(d) Essays
1 To what extent is effective supply chain management essential to gain market
share these days?
(25 marks)
2 To what extent is outsourcing a good idea for a business wanting to be more
competitive?
(25 marks)
Revision Section: Unit 4 Decision
making to improve operational
performance
Advice for Unit 4
Top tips … Things to avoid …
Remember that to be successful any operations Do not assume that the
decision will depend on having the necessary output of an employee is
resources. It will also have an effect on all the other solely due to motivation. It
functions. is often determined by the
equipment available. In
addition, being motivated
may be of limited value if
the employee has not been
trained in the task and
does not yet have the
necessary skills.
Remember that quality has a specific meaning in Do not assume quality
operations relating to whether or not the business products are expensive; a
meets its operations targets (for example, is the quality process means
product the right weight, colour, dimensions)? A operational targets are met
low-price product that meets its operations targets not that the product is
can have a quality operation, whereas an necessarily expensive e.g.
expensive product that has variability in its McDonald’s may have a
processes would not meet quality operations quality process.
criteria.
Try to think about the most appropriate units to use Do not assume there is one
when measuring capacity. Managers of an airline best way of doing
may refer to the maximum number of passengers. operations – there are
It is important to apply your understanding to the many different but
context. successful approaches to
inventory levels, production
processes and the range of
products produced.
Measuring output per worker may be relatively Avoid making assumptions
straightforward in some businesses – e.g. number about the ‘right level’ of
of cars produced and divide this by the number of inventory until you
employees to calculate the cars per employee. understand the context of
However, in other businesses there may be other the case and its
indicators of performance – e.g. in an estate operational objectives.
agency or retailer the sales per employee may be In some cases, a business
measured. It is important to think of the context and can operate with almost no
refer to an appropriate measure of labour inventory; in other
productivity when analysing a given situation. situations, managers may
want to hold inventory, for
example, to show
customers.
Do not assume the
operational objectives will
always be equally
important. Sometimes
businesses may compete
on speed of delivery,
sometimes on quality,
sometimes on flexibility.
UNIT 4 CHECKLIST
Having completed studying this unit you should be able to do all that is listed below.
You should read this list and confirm that this is the case.
Learning objective
Setting operational objectives
Know and understand:
• the value of setting operational objectives
• the external and internal influences on operational objectives and decisions
• that operational objectives include costs, quality, speed of response and flexibility,
dependability, environmental objectives and added value.
Analysing operational performance
Know and understand:
• how to calculate operations data (e.g. labour productivity, unit costs (average
costs), capacity, capacity utilisation)
• the use of data in operational decision making and planning.
Making operational decisions to improve performance: increasing efficiency
and productivity
Know and understand:
• the importance of capacity
• the importance of efficiency and labour productivity
• how to increase efficiency and labour productivity
• the benefits and difficulties of lean production
• the difficulties of increasing efficiency and labour productivity
• how to choose the optimal mix of resources
• how to utilise capacity efficiently
• how to use technology to improve operational efficiency
• lean production including ‘Just in Time’ operations
• that the mix of resources should include an understanding of labour and capital
intensive processes.
Making operational decisions to improve performance: improving quality
Know and understand:
• the importance of quality
• methods of improving quality
• the benefits and difficulties of improving quality
• the consequences of poor quality
• the methods of improving quality should include quality assurance.
Making operational decisions to improve performance: managing inventory
and supply chains
Know and understand:
• the ways and the value of improving flexibility, speed of response and dependability
• how to manage supply to match demand and the value of doing so
• influences on the amount of inventory held
• influences on the choice of suppliers
• how to manage the supply chain effectively and efficiently and the value of this
• the value of outsourcing
• that ways of matching supply to demand include outsourcing, use of temporary and
part time employees, producing to order
• that inventory control should include: interpreting inventory control charts, lead
time, re-order levels, buffer level of inventory.
Practice questions
1 The capacity utilisation of a major sports stadium has been falling for the last few
years. Explain one action the business might take.
(5 marks)
2 Explain one factor that might influence the inventory levels of a fireworks business.
(5 marks)
3 Labour productivity at a car manufacturer is falling. Explain one way managers
could increase it again.
(5 marks)
4 Explain two ways that investing in achieving better quality may lead to higher profits
for a delivery company.
(6 marks)
5 Analyse how effective management of the supply chain could increase a retailer’s
profit margin.
(9 marks)
Case study: IKEA

Figure U4.1 An IKEA store

IKEA home furnishing products are designed, sourced, produced and supplied by two
Inter IKEA Group companies called IKEA of Sweden AB (IoS) and IKEA Supply AG
which form part of the ‘Range and Supply’ arm of Inter IKEA Group. Products are
distributed to franchisees globally and sold in IKEA stores, including in the UK. IKEA
sells products through 354 large out-of-town stores in 29 countries around the world
and promotes itself online, through apps as well as print and other media advertising.
The company offers around 9,500 products in its home furnishing range. There are
approximately 600,000 people across more than 50 countries involved in production at
its direct suppliers of home furnishings, and millions more people work in its extended
supply chains.
The mission of IKEA is to provide a range of well-designed home furnishings that are
affordable to large numbers of people. IKEA says it wants to help people lead a better
life by providing them with well-designed, low-price furniture. Its vision is to create a
better everyday life for the many people. It says that ensuring the well-being of the
IKEA community – from its co-workers, to its customers and the communities that it
operates in – is at the heart of everything it does. As a values driven company, it is
proud to support the Modern Slavery Act of 2015 and take steps to ensure modern
slavery is eradicated from every part of its business. The IKEA Way of Purchasing
Products and Services (IWAY) was introduced 17 years ago and operates as the
company’s code of conduct for its many suppliers. Guided by the Ten Principles of the
UN Global Compact, IWAY addresses a range of issues including forced or bonded
labour and unlawful wages. Compliance with IWAY is non-negotiable, and IKEA
carries out regular audits to ensure its continued implementation across its supply
chain. IKEA says that ‘it is important that IKEA customers feel confident that the
products they buy have been sourced and made in safe and responsible
environments. Our ultimate aim is to eradicate the risk of slavery in our supply chain,
while helping to lift people out of poverty by providing a safe and inspiring place to
work. Our products should not only improve the lives of our customers, but also
contribute positively to the lives of those who make and deliver them.’
‘At IKEA we understand that having a global supply chain means that we have a
responsibility to the people and communities on whom our operations have an impact.
We accept this responsibility and have outlined our ambitions, goals and actions in our
Sustainability Strategy; People and Planet Positive’. By addressing the challenges
posed by modern slavery practices, and working proactively to prevent them, we not
only take responsibility as a company, but see an opportunity to have a positive
impact on people and communities.’
In the past, the company has faced controversy. Twenty-five to thirty years ago IKEA
used political prisoners in communist East Germany to produce its products. The
company has said that it deeply regrets this. It says that better processes are now in
place to monitor working conditions at suppliers. IKEA has around 1,000 suppliers in
53 countries.
When designing furniture, IKEA works closely with its suppliers from the very start of
the process. This is to ensure that costs are minimised and that the products are
designed to be flat packed in stores. Customers wander around the store – which is
carefully designed so once inside you have to tour the whole store before leaving, to
make sure you see everything – and select their items. They then pick their items from
the warehouse and take them to the tills. At home, customers assemble their
products. By involving the customer in selecting and taking their products to the till
and in home-assembly the business keeps costs low. It aims to work with suppliers to
develop the most cost-efficient and creative ways of turning their ideas into products
for the home.
All of the materials used in IKEA’s products are tested rigorously during the product
development phase. The company studies closely how customer use their furniture to
influence future designs and products are tested and assessed at the two IKEA Test
Labs in Sweden and China; these are also used as training centres for co-workers
and suppliers.
IKEA’s approach to people and business can be seen its company values:
• togetherness (tillsammans)
• caring for people and planet
• cost-consciousness
• simplicity
• renew and improve
• different with a meaning
• give and take responsibility
• lead by example.
Source: IKEA website
Practice questions
1 Analyse the operational objectives the managers of IKEA might set for its business.
(12 marks)
2 Analyse the operational factors IKEA might consider when designing a new
product.
(12 marks)
3 To what extent do you think involving the customer in its operations is a key part of
IKEA’s success?
(16 marks)
4 To what extent do you think suppliers are a critical element of the success of IKEA?
(16 marks)
5 To what extent do you think IKEA is safe from other competitors taking its market
share in the future?
(20 marks)
6 IKEA monitors the behaviour of its suppliers to ensure they are legal and ethical. To
what extent do you think all businesses need to be concerned about the behaviour
of their suppliers?
(24 marks)
Essay questions
1 To what extent do you think that the speed of response is a more important
operational objective than costs for retailers these days?
(25 marks)
2 To what extent is price the most important factor for a manufacturer when choosing
suppliers?
(25 marks)
Chapter 16 Setting financial objectives
Introduction
This chapter is the first of four which consider how managers can take decisions to improve a
business’s financial performance. Setting financial objectives is the first element of the
decision-making process in relation to financial issues: deciding what financial objectives a
business should pursue. Later chapters in this unit will look at the subsequent stages in the
financial decision-making process, such as financial analysis and taking financial decisions.

Key term
A financial objective is a goal or target pursued by the finance department (or
function) within an organisation.

What it is important to know by the end of this chapter:

• the value of setting financial objectives
• the distinction between cash flow and profit
• the distinction between gross profit, operating profit and profit for the year
• the meaning of revenue, costs and profit objectives
• how cash flow objectives are set
• how objectives for investment levels are set
• how capital structure objectives are set
• the external and internal influences on financial objectives and decisions.

Figure 16.1 Functions of a business

The value of setting financial objectives
Financial objectives can be described as goals or targets that relate to the business’s financial
performance. It is common for financial objectives to contain a specific numerical element and
also a timescale within which they are to be achieved. The financial objective will be set by the
managers responsible for finance in the business, but will be consistent with other functional
objectives and also contribute to the achievement of the business’s corporate objectives.
Businesses can derive great benefits from setting financial objectives. It enables managers and
owners to judge the performance of the enterprise from when it is first established. Newly
established businesses may be vulnerable to running out of cash. Thus setting objectives for cash
flow can assist managers to avoid this particular pitfall. Similarly, many established businesses
(especially public limited companies) are judged by the level of profits that they make over a
financial year. The level of profits achieved by a business impacts upon other aspects of the
business’s financial performance, such as its share price and its ability to negotiate loans with
banks and other financial organisations.
Financial objectives are also valuable to managers as a measure of performance because most
businesses are judged on their financial attainments by other stakeholders. We saw in earlier
chapters that managers will take decisions designed to maximise profits or to control costs.
Because businesses are judged in this way by many of their stakeholders it makes perfect sense
for managers to set themselves objectives in these areas to try to maximise the business’s
financial performance.

What do you think?

Which of a public limited company’s stakeholders would be interested in the profits
earned by the business over a financial year? Why would they be interested?

The use of financial objectives enables managers to identify aspects of the performance of the
business that are causing problems at the earliest possible stage. For example, managers may
receive early warning that costs are higher than expected, or profits lower, if they have set
objectives for these aspects of financial performance. As an example, a comparison between
actual costs and the figures set out in the objective encourages corrective action, such as seeking
cheaper supplies or eliminating waste, to bring costs under control before they cause too much
damage to the business.
Finally, setting financial objectives, or any other objectives for that matter, can be very
motivating for employees at all levels within the business. Having a financial goal may
encourage employees to work conscientiously or creatively to achieve this goal, thereby
enhancing their performance and that of the business as a whole.
The distinction between cash flow and
profit
Cash flow and profits are two very different concepts:
• Profit. As we saw in Chapter 1, a business makes a profit if, over a given period of time, its
revenue is greater than its expenditure. A business can survive without making a profit for a
short period of time, but it is essential that it earns profits in the long run to provide a return for
the business’s owners.
• Cash flow. This relates to the timing of payments and receipts. Cash flow is important in the
short term, as a business must pay creditors (people and organisations to whom it owes
money).
Just because a business is profitable, it does not mean that it will hold large sums of cash, or even
have enough cash. There are several reasons why this situation might arise.
First, the business might sell large numbers of goods or services at profitable prices by offering
customers 60 or 90 days’ grace before they have to pay. This will mean that the business has to
find cash to buy supplies and pay employees several months before the cash from the sale of the
product flows into the business. This problem can be made more serious if the business pays its
suppliers promptly.
Alternatively, a business such as a jeweller might hold large amounts of expensive inventories
(or stock) for customers to view before making a choice. This will entail large amounts of cash
being tied up in the form of stocks, and not available to the business for other purposes.
A business may have paid for assets such as property or vehicles and used large sums of cash to
do so. These assets may support the business over many years, and will lead to future inflows of
cash. However, the outflow of cash may place pressure on a firm’s finances initially.
So, 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.
In the long term, however, a business has to make a profit to satisfy its owners. The owners will
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.
Different measurements of profit
It may seem surprising that there is more than one way of measuring profit. However, this is the
case and having different ways of measuring profit assists managers in assessing a business’s
financial performance and in making good decisions.
At its simplest, profit is what remains from revenue once costs have been deducted. However,
the managers of a business may calculate several different types of profit relating to a business’s
performance over a financial year. These are recorded on the business’s income statement.

Key terms
Income statements record a business’s sales revenue over a trading period and all
relevant costs incurred as well as the business’s profit or loss.
Gross profit is income received from sales minus the cost of goods and services
sold.
Direct costs are expenditure that can clearly be allocated to a particular product or
area of the business. Examples include raw materials and components.
Indirect costs are expenditure that relates to all aspects of a business’s activities,
such as maintenance costs for buildings or senior managers’ salaries.
Operating profit is the financial surplus arising from a business’s normal trading
activities and before taxation.
Profit for the year is a measure of a business’s profits that takes into account a wider
range of expenditures and incomes including taxation.

1 Gross profit. This form of profit is calculated by deducting direct costs (such as materials
and shop-floor labour – also known as cost of sales) from a business’s sales revenue. This
gives a broad indication of the financial performance of the business without taking into
account other costs such as indirect costs or overheads.
2 Operating profit. This type of profit takes into account all earnings from regular trading
activities and all the costs associated with those activities. However, operating profit excludes
any income received from, or costs incurred by, activities that are unlikely to be repeated in
future financial years. It also excludes profit from any joint ventures or non-trading activities
such as investments. Finally, it does not include some expenditure a business may undertake
such as paying interest on loans or taxation on its profits.
3 Profit for the year. This measure of profit takes into account a business’s 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’s managers can decide how to utilise its profit for the
year. They may decide to pay some to the owners of the business (dividends to shareholders in
the case of companies) or retain it within the business to invest in assets, provide a source of
cash or as savings.
Figure 16.2 Types of profit

Figure 16.2 summarises the relationship between the three types of profit we have explored.
However, not all businesses measure and record all three types of profit. Companies are more
strictly controlled by laws in the UK on how they have to present financial information for
stakeholders. However, companies do publish their financial information in slightly different
ways despite the strict legal rules.
Financial objectives
The managers responsible for a business’s finance department or function may set a range of
objectives, including those discussed below. These objectives will contribute towards the
business achieving its overall or corporate objectives.

Business in focus: Johnson Matthey’s profits

Johnson Matthey plc manufactures chemicals and related products including catalytic
converters, ingredients for the pharmaceutical industry and fuel cells. It also refines
and distributes precious metals such as gold, platinum and palladium. The company’s
operating profit and profit for the year fell between 2017 and 2018, as shown in Table
16.1.
Item 2018 (£m) 2017 (£m)
Revenue 14,122 12,031
Cost of sales 13,214 11,169
Gross profit 908 862
Indirect costs 549 400
Operating profit 359 462
Profit for the year 298 386
Table 16.1 Key financial data for Johnson Matthey, 2017–2018
Source: Johnson Matthey plc website
Johnson Matthey plc’s existing and potential shareholders consider the company’s
financial performance when making judgements about buying and selling its shares.
They may be particularly interested in the level of and change in its operating profit.

Practice questions
1 Analyse the reasons why Johnson Matthey plc’s profit for the year may have fallen
in 2018, compared with 2017.
(9 marks)
2 Do you think that Johnson Matthey plc’s shareholders will be particularly interested
in the level of change in the company’s operating profits between 2017 and 2018?
Justify your view.
(16 marks)
1. Revenue, cost and profit objectives
(a) Revenue objectives
Businesses commonly set themselves objectives in terms of earning a certain amount of revenue
over a financial period. Many new businesses set such an objective to assist them in building a
customer base and establishing themselves within their chosen market. A revenue objective may
be used more widely by businesses that aim to grow: setting a challenging objective in terms of
revenue can help to achieve growth. Businesses that sell products with short product life cycles
who wish to maximise the short-term selling opportunities that are available may also opt for
revenue objectives. They may also be particularly relevant for charities who aim to maximise the
revenues they can generate to support their chosen cause.

Key terms
Revenues are the earnings or income generated by a firm as a result of its trading
activities.
Objectives are medium- to long-term goals established to coordinate the business.

Revenue objectives can relate to an aspect of the business rather than the entire business. For
example, Amazon, the online retailer, has sacrificed profits for many years in pursuit of growth
in sales. Its low prices, designed to attract customers, have meant that the company’s profit
margins have been only about 1 per cent. However, the company is expecting to increase its
revenue from advertising on its website. In 2017, Amazon generated $1.7 billion in advertising
revenue. In future years, its revenue objectives from advertising are likely to be considerably
higher.

What do you think?

What actions might the managers at Amazon take to increase the website’s revenue
from advertising?

A more aggressive type of revenue objective can also be set. This is one which requires a
business’s revenue to grow at increasing rates over time. Thus, a business may aim to generate
revenue amounting to £4 million next year, £4.5 million the following year and £5.3 million in
the year after. This means that the rate at which revenue is increasing is rising from £0.5 million
per year to £0.8 million. The revenue objective could also be expressed as percentage increases.

Handling data
In the example above, calculate the percentage rate of increase in sales revenue:
1 from next year to the year after
 2 from the second to the third year.
3 Assume the company’s revenue is initially £3.5 million. If the company achieves a
75% increase in sales revenue in each of the three years, what will its total sales
revenue be by the end of the third year?

Revenue objectives can be based on a business reducing its prices in the expectation of making a
large number of additional sales and therefore increasing its revenue. This may be appropriate for
businesses such as supermarkets where demand for products can be sensitive to prices (or price
elastic, as discussed in Chapter 10). In these circumstances, a price reduction could boost
revenue from sales. In contrast, other businesses face inelastic demand, where customers make
buying decisions on a range of factors and price may be relatively unimportant. In this case, a
revenue objective may be based on increasing prices and relying on a relatively small proportion
of customers stopping buying the products.
Of course revenue objectives do have disadvantages. They do not necessarily increase a
business’s profits. Indeed a challenging revenue objective might only be achieved by increasing
costs for advertising, for example, which may result in lower profits. Revenue objectives that
entail reducing prices to increase revenue can also be risky as competitors may respond by
reducing prices too, resulting in a loss of revenue for all businesses involved but a pleasing
situation for customers.

Figure 16.3 Price changes with a revenue objective

Business in focus: Sainsbury’s and Asda merger

Two of the UK’s largest supermarkets announced in 2018 that they had agreed a
merger. Sainsbury’s and Asda announced that the two companies would merge
creating the UK’s largest supermarket with annual sales of around £51 billion. The
deal was subject to approval from the UK authorities who blocked the merger in April
of 2019.
The new business, which would have traded under the Sainsbury’s name, looked set
to compete more effectively with successful discounter supermarkets such as Aldi
and Lidl. The discounters have increased market share through selling groceries at
very competitive prices and, thus far, despite attempts to control costs, Sainsbury’s
and Asda have struggled to compete. Sainsbury’s has many stores in the south of the
UK, whereas Asda is located more in the north. The two companies would have
complemented one another when joined with stores throughout the UK.
The two supermarkets had hoped that their merger would have allowed them to
control costs more tightly by being able to negotiate better terms with suppliers for
large-scale orders. Sainsbury’s estimated that this could reduce its costs by £500
million annually.
Sales over 12 Market Sales over 12 Market Percentage
weeks to share weeks to share change in
February 2017, February 2018, sales 2017 to
£m £m 2018
Total 27,087 100 27,950 100 3.2
market
Tesco 7,581 28.0 7,785 27.9 2.7
Sainsbury’s 4,467 16.5 4,516 16.2 1.1
Asda 4,262 15.7 4,359 15.6 2.3
Aldi 1,724 6.4 1,963 7.0 13.9
Lidl 1,247 4.6 1,413 5.1 13.3
Table 16.2 UK Supermarket sales 2017–2018.
Source: Retail Gazette, March 2018, ‘UK grocery market “remains in good health” as Big 4 enjoy
growth’

Practice questions
1 Analyse the possible reasons why Sainsbury’s share price rose by 15 per cent
following the announcement of the merger.
(9 marks)
2 Would this merger have resulted in the new company making higher profits than
the two separate companies did previously? Justify your answer.
(16 marks)
 Handling data
Calculate the change in market share and the percentage change in sales for the new
company formed by the merger between Asda and Sainsbury’s between February
2017 and February 2018.

(b) Cost objectives

Businesses can pursue two different types of cost objective. Some businesses may set themselves
an objective of reducing costs by a given percentage or amount within a stated time period. The
intention may be to maintain the business’s profits if it is operating in a market in which prices
are falling. In recent years, the growth of Aldi, Lidl and other low-price grocery retailers have
placed great pressure on established supermarkets such as Morrisons, Tesco and Asda to reduce
prices to compete. To do so the supermarket either has to reduce costs or accept lower profits.
We look at this scenario more fully in the Business in Focus feature about the merger between
Sainsbury’s and Asda which was agreed in 2018.
Some businesses pursue objectives of cost minimisation. By minimising costs managers are able
to offer the lowest possible prices, which can represent good value to consumers. This financial
objective has become well known over recent years due to the publicity given to low-cost or
budget airlines, for example, EasyJet, and their policies of minimising costs. A financial strategy
of cost minimisation entails seeking to reduce to the lowest possible level all the costs of
production that a business incurs as part of its trading activities. In the case of the budget airlines
this has extended to minimising labour costs (some require employees to pay for their own
uniforms), reducing administrative costs by, for example, using the internet for booking and
using ‘out of town and city’ airports to reduce landing and take-off fees charged by airport
authorities.
The financial objective of cost minimisation has clear implications for the management of other
functional areas within the business. Clearly, the managers responsible for the other functions
should aim to operate with minimal expenditure in order to support the fulfilment of this
financial objective. Such a financial objective is likely to support corporate objectives such as
profit maximisation or growth.

Figure 16.4 Adidas’s products are increasingly popular with consumers throughout the world
(c) Profit objectives
It is very common for a business to have a profit objective. As with cost minimisation, this is
frequently an objective for the entire business and not just its finance function or department.
Profit objectives can be expressed in several different forms.
• As a simple figure. This figure will be based on profits generated in previous years and take
into account any expected changes in business activity over the foreseeable future. The
clothing retailer Superdry had a profit target of £100.6 million for the 2017–18 financial year.
Disappointing sales meant that its profits only reached £96.5 million, just over 4 per cent short
of its target.
• As a percentage increase in profits. This is usually a yearly target representing a certain
percentage rise on the previous year. In 2018, Adidas, the German multinational manufacturer
of clothing, footwear and accessories, announced that its revenues had risen by 15 per cent
over the last financial year. As a result, the company set itself an objective of increasing profits
by 22–24 per cent each year until 2020.

What do you think?

Why might the management team at Adidas have set a financial objective of rising
profits?

• As a percentage compared to sales. This is called a profit margin, which we will consider in
detail in the next chapter. Tesco, the UK’s leading retailer has pursued a profit objective
whereby profits are 5.2 per cent of its revenue from sales. This approach to a profit objective
allows the company’s revenue to change, but its profits must alter in line with it.
Profit objectives have the advantage of being simple to understand and measure and can help to
motivate employees across an organisation. However, they can be risky as well. If a business
suffers an unexpected change this can result in it recording profits lower than forecast which can
be damaging because it provides very clear, and possibly public, evidence of under-performance.
This may result in falling share prices and nervousness among banks and other financial
institutions that have lent the business money. In July 2018, Wizz Air, a low-cost airline,
revealed that its profits for the preceding three months were only £46.3 million against an
expected figure of £53.7 million. The company’s share price fell by five per cent in response to
this news.
Cash flow objectives
For many businesses cash flow is vital and an essential element of success. Without cash any
business is unable to meet its financial commitments as they fall due. If a business is unable to
meet its financial commitments it cannot continue trading. This is especially true of businesses
that face long cash cycles. A cash cycle is the time that elapses between the outflow of cash to
pay for labour and raw materials for a products or service and the receipt of cash from the sale of
the product. House builders, oil companies and pharmaceutical firms can face long cash cycles.
The Anglo-Dutch oil company Shell has set itself a positive cash flow objective of between $25
and $30 billion each year until 2020, assuming the oil price per barrel is around $60. Discovering
and retrieving oil and gas reserves can take many years and exposes companies such as Shell to
very long cash cycles. Thus, it is important for Shell to manage its cash carefully and setting
objectives for cash flow is an important part of this.
Banks require a steady inflow of cash from depositors to enable them to engage in lending
activities. The difficulties experienced over recent years by banks in the UK and other countries
has, in part, been due to a lack of cash being available to these organisations. Without cash,
banks do not have the necessary funds to avail themselves of profitable lending opportunities.
Other businesses that may establish financial objectives in terms of cash flow may include those
that are growing and need regular inflows of cash to finance the purchase of increasing quantities
of inputs such as labour and raw materials. Failure to set such objectives may result in a business
facing financial problems because it runs short of cash as its expenditure or outflow of cash ‘runs
ahead’ of inflows of cash. Such a situation is described as overtrading.
Objectives for investment levels and returns
Setting objectives for the level of investment (or
capital expenditure)
Many businesses set goals for the level of investment they wish to undertake over specific future
periods. Investment entails the purchase of assets that will remain with the business over the long
term and for at least a period of one year. This type of asset is called a non-current asset.
Investment objectives are also called capital expenditure (or capex) objectives. They are most
commonly set by businesses which purchase and use large quantities of non-current assets.

Key terms
Investment is the purchase of assets such as property, vehicles and machinery that
will be used for a considerable time by the business.
Non-current assets are items that a business owns and which it expects to retain for
one year or longer. Examples include property and vehicles.
Capital expenditure is spending undertaken by businesses to purchase non-current
assets such as vehicles and property. It is another term for investment.

A business may seek to achieve a certain level of capital expenditure over a financial year,
possibly to support a wider objective of growth. By undertaking a given level of capital
expenditure the business will increase its size, its value and its ability to supply products to its
customers. A retailer might, for example, set itself a capital expenditure objective of £25 million
each year for the next three years to fund the purchase of new stores across the UK. This
financial objective would support objectives set for the whole business such as achieving
specified rates of growth in sales or a targeted market share.

Figure 16.5 Retailers such as Debenhams invest in non-current assets such as property. The company
has recently set a lower financial objective in this area.
A business may set itself an objective of lowering its capital expenditure to reduce the amount it
has borrowed if it considers that its debts are too high. In this situation the management team
may divert funds that would have been invested into buying non-current assets to repaying loans.
This can reduce the interest payments that the company is liable to pay and increase profits in the
long term. In 2018, the high street retailer Debenhams announced that it was suffering a range of
financial problems associated with falling sales. The company is struggling to compete with
online retailers. It plans to cut capital expenditure from about £140 million in 2018 to £75–90
million pounds in 2019. This is part of a broader cost-cutting strategy designed to make the
company more competitive.
Capital expenditure objectives can be difficult to achieve principally because the business may
encounter problems in raising sufficient capital to fund its planned investment programme. It
may be easier to raise capital for investment if:
• the business has not borrowed excessive amounts already, reassuring lenders that it will be
able to repay any borrowings
• the business is purchasing non-current assets (such as property) that will retain value and could
be sold if necessary to repay a loan
• the business is a company and can sell additional shares to raise funds.
Setting objectives for returns on investment
An alternative way of setting financial objectives for investment or capital expenditure is to set a
target for the return on an investment. This objective expresses the annual return in the form of
operating profit as a percentage of the amount that was invested. The calculation is fairly simple,
using the formula set out below:

Suppose an entrepreneur purchases a corner shop for £100,000 and in the first year of trading
earns a profit of £6,000. The return on capital for this first year of trading would be 6 per cent.
A higher figure is preferable in this case and in most circumstances. However, it might be that
the corner shop will earn higher profits (and a higher return on the investment) in future years.
Many investments are long-term projects and it may be too simplistic to make a judgement
against an objective over a single year. Some investments (for example, in property) are designed
to produce returns over many years and may not meet the percentage return that is the objective
for some considerable time.
In setting objectives for returns on investment, managers may want to consider the alternative
uses for the capital concerned. A financial objective should, in the long-term at least, seek to
exceed alternatives, taking into account differences in the degree of risk. Thus managers may set
a lower objective if the choice is relatively safe. They may make the judgement that the project
with the higher returns represents too great a risk and opt for the safer alternative.
Capital structure objectives
Decisions made by managers in relation to the business’s capital structure can be important in
both the short and long term. Basically there are two types of capital that a business may use for
its operations and growth. Managers may opt to borrow funds, normally over a long-term period,
to finance capital expenditure. This commits them to paying interest on these loans until they are
repaid. However, managers in companies have another option. They can choose to sell shares to
fund their capital expenditure. The company may have to pay dividends to the new shareholders,
but only if the company makes sufficient profits. However, if a company sells too many
additional shares the existing owners may lose control of the business. We will look at sources of
finance for all businesses more fully in Chapter 18.

Key term
Capital structure refers to the way in which a business has raised the capital it
requires to purchase its assets.

A business’s capital structure is the balance between these two types of capital which are termed
loan capital and share capital. Figure 16.6 illustrates two companies with contrasting capital
structures.
Businesses that have capital structures with high levels of borrowing (normally more than 50 per
cent) as in the case of Company A in Figure 16.6, are referred to as ‘highly geared’. Such
companies may be at risk of rising costs if interest rates rise and, in any event, are committed to
interest payments, even if their revenues decline.

Figure 16.6 Contrasting capital structures

Handling data
1 A company has a total capital of £1,200,000. It has raised 42 per cent of its capital
 from the sale of shares. What is the value of its loans?
2 If it doubled its capital and 38 per cent of the increase in its capital came from
loans, what would be the total value of capital raised from shares?

There are a number of influences on the capital structure objectives set by businesses. The cost
of borrowing is one. At the time of writing, interest rates in the UK, and much of Europe, are at
low levels, so borrowing is very cheap and repayments on loans will be relatively low. This will
encourage companies to pursue capital structures with higher proportions of loan capital than at
times when interest rates are higher. Some companies set capital structure optimisation
objectives. This objective aims to minimise the cost of raising capital for the company without
affecting its overall value. In December 2017, Domino’s Pizza Group plc announced that it was
to buy back £20 million of shares that it had issued to achieve a ‘more balanced approach to
equity (share) and debt funding’.
In a time of inflation companies may opt for capital structure objectives that contain a higher
proportion of borrowing. In a situation in which prices are rising at, say 5 per cent a year, the
value of money (and a business’s debts) will be falling by the same percentage. Borrowing
relatively heavily in this situation may be sensible as the value of what is owed and repayments
will be falling.

Business in focus: Aryzta ‘improves’ its capital structure

Aryzta is a bakery business that is based in Switzerland. The company has

experienced financial difficulties in recent years as its revenue has been lower than
expected. In May 2018, Aryzta revealed that it was attempting to reduce its costs by
€200 million over three years. In August 2018, the company said it was seeking to
achieve a further annual saving of €90 million by 2021.
The company also revealed plans to raise €800 million through the sale of shares to
allow it to improve its capital structure and to reduce the amount of the company’s
debt. Chief Executive Kevin Toland expects this move to improve the company’s cash
flow. He said: ‘A significantly improved capital structure will provide Aryzta with the
means to continue to take the necessary steps to reposition the business and deliver
on our strategy. Over the medium term, we expect to generate significant cash flow
which will be applied towards continued net debt reduction and to resource selective
growth opportunities.’
Source: Adapted from an article in Just-Food, August 18th, 2018

Practice questions
1 Analyse the possible reasons why Kevin Toland believes replacing borrowing with
capital raised through the sale of shares might improve Aryzta’s cash flow.
(9 marks)
2 Do you think that decision to replace borrowed capital by that raised by selling
shares is a good one? Justify your view.
 (16 marks)

During prosperous times, when incomes are rising, share prices may be buoyant. This means a
company opting for a capital structure with a higher proportion of share capital may be able to
raise a greater amount of capital by selling a specific number of shares. At such times capital
structure objectives may be more reliant on share capital.
The internal and external influences on
financial objectives and decisions
A management team will be subject to a range of factors when setting its financial objectives.
Some of these influences arise from within the business, while others are external.
Internal factors
• The overall objectives of the business. This might be the most important internal influence
on a business’s financial objectives. A financial objective must assist the business in achieving
its overall or corporate objectives such as growth. The corporate objectives are set first,
followed by functional objectives such as financial objectives that are designed to complement
them. A business that has profit maximisation as its primary corporate objective may operate a
financial objective of cost minimisation. Reducing costs as a financial objective should assist
the business in maximising its profits.
• The nature of the product that is sold. The type of product can be a major influence on
financial objectives. Businesses with long cash cycles (such as the Anglo-Dutch oil company
Shell Corporation, mentioned earlier) are much more likely to set cash flow objectives as this
should be a major focus of their management of finance. Alternatively, if a product’s demand
is sensitive to price (if its demand is price elastic) it may be more likely to persuade managers
to implement and pursue a financial objective related to costs. This financial objective may
allow price reduction with a positive impact on future sales and the business’s sales revenue.
• The objectives of the business’s senior managers. If the managers of the business hold large
numbers of shares, perhaps as a result of founding the business, then pursuing a profit
objective may be appropriate as this may increase share prices and the value of their holdings.
On the other hand, managers may seek the recognition that accompanies the successful
achievement of a corporate objective of growth. In such circumstances a financial objective of
achieving substantial increases in revenue may be more appropriate.

Figure 16.7 Influences on financial objectives

Figure 16.8 Internal influences on financial objectives
External factors

Figure 16.9 External influences on financial objectives

• The competitive environment. A business will be unlikely to ignore the actions of its
competitors when establishing its financial objectives. For example, a retailer operating in a
highly competitive market might consider establishing an objective of increased levels of
investment to provide it with new and improved locations for its stores to attract greater
numbers of customers. In contrast, a business wanting to achieve a profit objective may seek to
form alliances with its rivals or to develop a USP for its products to allow it to charge premium
prices.
• The economic environment. Even though the UK economy has performed relatively well
recently, many businesses continue to experience difficulty in arranging loans. If a business is
experiencing difficulty in raising capital then financial objectives are more likely to centre on
profits. Achieving specific returns in terms of profit will assist in reassuring potential
shareholders or investors as to the safety of their investments and the level of expected returns.
It will also provide a source of capital for future investments.
The state of the economy has implications for consumer spending and the growth rates of the
markets in which businesses trade. If the market for the business’s products is expanding it
may lead a business’s managers to set more expansive financial objectives, such as higher
figures for profits or cash flow. In contrast, in a market in which sales figures are stable or
declining, financial objectives may be more cautious. Financial objectives such as cash flow
targets may be deemed more appropriate in these circumstances.
• The technological environment. Many businesses operate in environments in which
technology is changing rapidly and these can influence financial objectives. For example, an
increasing number of supermarket checkouts in the UK are no longer operated by an assistant,
similarly many transactions in banks no longer require a cashier. Such developments may
encourage managers to set challenging objectives for costs and increase long-term profit
objectives.
• The political and legal environment. Political and legal changes can have considerable
implications for the financial performance of businesses and the objectives they set
themselves. The UK’s planned departure from the EU – Brexit, as it is commonly called – may
have a significant impact on immigration into the country. In 2017, the level of migration from
other EU countries to the UK was the lowest it had been for a period of four years. There was
also a record number of EU citizens leaving the UK. Immigration from other EU countries to
the UK has created a supply of relatively cheap labour, enabling businesses to control costs
and cash flow more effectively and influencing these and other financial objectives. Research
by the London School of Economics has suggested that the impact of immigration on wage
costs is greatest for those businesses that employ large numbers of semi-skilled and unskilled
workers, and especially those that operate in the services sector.

Business in focus: Starbucks’ financial objectives

Starbucks is a multinational business that operates cafes selling tea, coffee, cakes,
sandwiches and light meals. It has 28,209 branches in countries throughout the world.
In 2018, its profits exceeded $6 billion, an increase of 11 per cent on 2017.
Since 2010, Starbucks has opened more than 10,000 new outlets, doubled its
revenues and tripled its profits.
In 2018, Starbucks set itself a number of financial targets including the following:
• opening 2,100 new stores in markets across the globe
• achieving sales growth of 3–4 per cent in existing stores
• revenue growth of approximately 5–7 per cent for the whole business.
Starbucks faces tough competition from other food and beverage retailers such as
McDonald’s and Costa Coffee. Rising incomes, especially in some countries in Asia,
could boost sales for food and beverages.
Starbucks shares have risen in price by more than three per cent this year.
Source: Starbucks Corporation

Practice questions
1 Analyse the possible implications of the company’s ambitious financial objectives
for its marketing and operations functions.
(9 marks)
2 Do you think that the actions of other businesses were the main influence on the
financial objectives set by Starbucks? Justify your view.
(16 marks)

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 What is meant by the term ‘financial objective’?
2 Distinguish between profit and cash flow.
 3 Is the following statement true or false? ‘Revenue minus cost of sales gives gross
profit.’
4 The following financial information relates to a company:
• revenue = £ 750,000
• operating profit = £125,500
• gross profit = £140,000
• profit for the year = £40,000.
Which of the following figures is the company’s direct costs?
i £625,000
ii £610,000
iii £710,000
iv £165,000.
5 Is the following statement true or false? ‘Reducing price when demand is price
inelastic may help a business to achieve a revenue objective.’
6 A business has set itself a financial objective of cost minimisation. State two
implications of this objective for other functions within the business.
7 Identify two categories of business that may set themselves cash flow objectives.
8 What is meant by the term capital expenditure?
9 Name the two types of capital that a business may use to purchase its non-current
assets.
10 State two factors that might influence a business’s choice of capital structure.

(b) Short answer questions

1 Explain why a profitable business may run out of cash.
(4 marks)
2 Explain the disadvantages of a business in a highly competitive market setting itself
revenue objectives.
(5 marks)
3 Explain why a public limited company might decide to reduce its capital
expenditure.
(5 marks)
4 Explain why a business that is growing quickly should set itself financial objectives.
(6 marks)

(c) Data response questions

Mark Ford established a farm growing chilli peppers in Suffolk last year. His business
has had a relatively successful first year although it didn’t make a profit, but Mark can
afford to be patient. The business has just won a contract with a major food
manufacturer to supply chilli peppers for a range of chilled meals. It is a large order
but the price is lower than Mark normally receives. There is the possibility of further,
even larger orders. The manufacturer will pay Mark 60 days after the peppers are
delivered. Mark will have to borrow money to invest in expanding production to fulfil
the contract.
Mark is keen to set financial objectives for the next three years as part of his plan to
expand his business to enable it to supply the food manufacturer. He plans to set
objectives for cash flow and revenue for the next three years. His accountant has
advised against setting objectives for revenue and suggests profit objectives for each
of the years.
Mark faces increasing competition from established chilli producers. One local rival
has reduced her prices and has arranged to supply a chain of organic shops.
However, he is determined to pursue his objective of growth for the new business and
to accept low profits or even losses in the short term.
1 Explain the possible reasons why the accountant advised against setting revenue
objectives for the next three years.
(6 marks)
2 Analyse why Mark thought setting objectives for cash flow were more important
than profit objectives.
(5 marks)
3 To what extent are external influences likely to have a greater impact on the
company’s financial objectives than internal influences?
(16 marks)

(d) Essays
1 Do you think that setting financial objectives is of greatest value for a business that
is growing quickly? Justify your decision.
(25 marks)
2 Do you think that financial objectives have any relevance for social enterprises and
other not-for-profit businesses? Justify your view.
(25 marks)
Chapter 17 Analysing financial
performance
Introduction
This chapter continues our consideration of how managers can take decisions to improve a
business’s financial performance. It looks at techniques of financial analysis, such as budgeting
and break-even analysis, which might provide managers with crucial information to support the
decision-making process. Subsequent chapters will consider the nature of financial decisions that
are taken by the managers of a business.
What it is important to know by the end of this chapter:
• how to construct and analyse budgets and cash flow forecasts
• the value of budgeting
• how to construct and interpret break-even charts
• how to calculate and illustrate changes in key variables on break-even charts
• the value of break-even analysis
• how to analyse profitability data
• how to analyse timings of cash inflows and outflows
• the use of data for financial decision making and planning.
Budgets
Budgets are financial plans for a future period of time. Businesses forecast their revenue and
expenditure (or costs) using budgets. Budgets are usually drawn up on a monthly basis, over the
period of a financial year.

Key term
Budgets are financial plans that forecast revenue from sales and expected costs over
a time period.

Later in this chapter we will consider cash flow forecasts, which are also financial plans and a
different type of budget. Sometimes they are called ‘cash budgets’. However, for the moment we
shall concentrate on budgets relating to earnings, expenditure and profits.
Types of budgets
1 Revenue or earnings budgets. These set out the business’s expected revenue from selling its
products. Important information here includes the expected level of sales and the likely selling
price of the product. It may be relatively straightforward for an established business to
forecast its revenues based on past performance. In contrast a start-up business may have more
difficulty and cautiously predict relatively low revenue budgets during its first few months of
trading.
2 Expenditure budgets. These are also called cost or production budgets. Businesses need to
plan their expenditure on labour, raw materials, fuel and other items that are essential for the
process of production. These set out the expected expenditure on a monthly basis for these
items.
3 Profit budgets. By combining sales revenue and expenditure budgets it is possible to
calculate expected profits. The profit budget is an important piece of information for managers
and would be of interest to many of the business’s stakeholders.
Setting budgets helps the business achieve its financial and wider objectives. If, for example, a
business has growth in sales as a major objective, the budgets will reflect this, with higher
revenues being forecast but also higher costs of production planned.
The construction of budgets
Before businesses can start to construct budgets for the coming year, they need to carry out some
research. This may involve:
• analysing the market to predict likely trends in sales and prices to help forecast revenue
• researching costs for labour, fuel and raw materials by contacting suppliers and seeing if they
can negotiate price reductions for prompt payment or ordering in bulk
• considering government estimates for wage rises and inflation and incorporating them into
future sales revenue and expenditure budgets.
Once a business has collected the necessary data, it is normal to draw up expected revenues from
selling products – the revenue or sales revenue budget – first. This is the first budget because,
once a firm knows its expected sales, it can plan production and therefore forecast expenditure.
This enables the business to forecast the costs associated with producing enough to match
planned sales. It is vital when constructing budgets that expenditure is sufficient to allow
production to match expected demand or sales. It is impossible for a business to increase its sales
without producing more of its goods or services to supply customers.
Once production budgets and sales budgets are completed, it is possible to compare revenues and
expenditure. This allows managers and entrepreneurs to forecast profits (or losses) for the future
trading period.
Figure 17.1 Constructing budgets
Sources of information for budgets
A major source of information for budgets is previous trading records on which to base revenue
and expenditure figures. Clearly, if a business has traded for several years, much of the
budgeting process can be based on the outcomes of previous financial years adjusted for
expected future events. Among other things, this enables managers to predict trends in sales and
seasonal effects with a greater chance of accuracy. This source is not, of course, available to
entrepreneurs who are starting a new business.
So, what other sources of information are available to managers who are constructing budgets?
Managers are likely to rely heavily on the results of market research to predict likely sales,
especially in markets that are subject to change. In fashion or technology markets, where
products’ life cycles can be short and where tastes and fashions may change quickly, market
research may play a vital role. Similarly, managers are likely to research the costs of supplies
that they require as part of the production process. Developments in technology, most obviously
the internet, have made it easier for managers to collect and analyse large amounts of data
relating to consumers’ needs and spending behaviour.
Government agencies can also provide managers with helpful information when constructing
budgets. The UK Government operates a website (www.gov.uk) designed to provide the owners
and managers of businesses with a great deal of information as well as links to other potential
sources of advice.
Difficulties in constructing budgets
Constructing a budget is not always an easy exercise. Here are some of the reasons why this may
be the case.
• It may be difficult to forecast sales accurately. Managers may find it difficult to estimate
their sales when setting the revenue budget. Most businesses are highly dependent on market
research to forecast sales and revenue. If this research is inaccurate, sales forecasts will
probably prove incorrect. Changes in tastes and fashions can occur rapidly, and consumers’
incomes may rise or fall, making accurate forecasts more difficult to achieve. Similarly, the
pace of change in high technology industries, such as personal computers, makes the process
of planning sales very tricky.

Business in focus: Vixen Soap Ltd

Vixen Soap Ltd is due to start trading in two months’ time. The company’s owners are
planning to manufacture a range of hand-made soaps. It intends to produce a range
of soaps including those made from olive oil, lavender and camomile, as well as
organic soaps. The intention is to sell these products using the internet and an
effective website has been developed to promote the new company and its products
as well as to provide a method of selling the soaps.
A detailed business plan has been prepared including sales, expenditure and profit
budgets for the first year of trading. They conducted primary and secondary market
research, which suggested that the company’s unique range of high-quality products
will prove popular and sales are expected to rise steadily. However, initial costs are
expected to be high as the company builds up a stock of products ready for sale and
it will have to negotiate a large loan from its bank.
The starting point of constructing budgets was estimating the company’s sales using
the market research data. By combining the likely volume of sales with the expected
prices, the sales revenue budget was developed. For example, the company’s
managers have forecast that in January the company would sell 5,000 bars of
scented soap at £1.49 each, giving a sales revenue of £7,450.
Once the level of forecast sales was decided, it was possible for the company to
calculate its expected costs of production. As with many start-up businesses,
production costs are initially high. The company has to build up a stock of its full
range of soaps to enable it to supply customers promptly. At the same time,
production costs have to reflect likely sales. So, variable costs of production are
forecast to rise in February and March as sales increase.
The company’s sales revenue, expenditure and profit budgets for its first three
months of trading are shown in Table 17.1.
January £ February £ March £
Sales of scented/flavoured soaps 7,450 12,560 17,500
 Sales of organic soaps 2,765 3,400 4,125
Total sales 10,215 15,960 21,625
Purchases of raw materials 19,500 14,010 15,550
Packaging 1,215 1,105 1,350
Wages & salaries 3,000 2,850 2,995
Marketing & administration 2,450 2,400 2,450
Other costs 975 1,100 1,075
Total costs 27,140 21 465 23,420
Profit/Loss −16,925 −5,505 −1,795
Table 17.1 Vixen Soap Ltd’s budgets

Practice questions
1 Analyse the reasons why it may be difficult for the managers of a start-up business
to construct its first budgets.
(9 marks)
2 Do you think that the managers of Vixen Soaps should be worried by the figures
shown in the budget in Table 17.1? Justify your view.
(16 marks)

• The risk of unexpected changes. Forecasting events for the next year is fraught with
difficulty. A business may face an unforeseen rise in costs – for example, oil prices rose from
$30 to $80 a barrel between 2016 and 2018. The price of oil affects nearly all businesses and
would alter the costs of many components and services as well as transportation. This can
increase expenditure above the budgeted figure, reducing their accuracy and effectiveness in
planning finances.
• Decisions by governments and other public bodies. These can make it difficult to set
accurate budgets. The Bank of England has increased interest rates twice since 2017, raising
them from 0.25 per cent to 0.75 per cent. Further increases are forecast, though far from
certain. Rises in interest rates can affect expenditure budgets as well as revenue budgets for
businesses that sell products that are often bought using borrowed money – house builders and
car manufacturers are obvious examples.
Analysing budgets
Constructing budgets is the first stage in the budgetary process. Once a business has planned its
sales revenue and expenditure, it is essential to analyse the data by comparing the budget figures
with the actual figures resulting from the business’s trading.

What do you think?

The owners and managers of many small businesses do not use budgets. Why might
this be the case?

Budgets can provide a wealth of information to help managers take decisions on how to improve
the financial performance of the business:

Business in focus: The Walking Boot Company

Phil Walton established the Walking Boot Company in 2010. A keen walker and
former shoe repairer, he felt that customers wanting to buy traditional leather walking
boots had little choice as large manufacturers had chosen to sell boots made of
modern synthetic materials.
Phil started the business with a very small budget of £5,000 and production initially
took place at his home. Sales were very low at first as Phil was only able to make
seven pairs of boots each week. At first, he sold his boots locally, mainly through
recommendations. Phil has set prices for his boots from £99 to £299.
An unexpected turning point occurred when the Walking Boot Company was featured
on a popular website and interest in its boots as a fashion item grew. The Walking
Boot Company has been featured in television programmes and fashion magazines.
As a result, sales have soared and Phil was able to open a factory in 2015.
Production levels at the factory exceeded 9,500 pairs of boots in May 2019.
The company’s sales have continued to grow quickly and it has begun to export its
products, selling rising numbers of boots in China and the EU. Its rapid growth has
required Phil to raise capital to finance the move into the factory and marketing
campaigns to support the company’s entry into export markets. The company
received an investment of £40 million from a venture capitalist in 2014.

Practice questions
1 Analyse why setting a budget is important for a business such as the Walking Boot
Company when it is first established.
(9 marks)
2 The Walking Boot Company is growing very quickly. Is this the most important
reason for it to set budgets? Justify your view.
 (16 marks)

1 Analysing budgeted and actual expenditure. This provides information on how successful
the businesses is at controlling its costs. The analysis of budgets makes it possible for
managers to judge the ability of different parts of a business to manage 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 of employees, problems with quality
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.
2 Analysing revenue data. A business that fails to meet its 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. Effective managers will use the information from analysing budgets to make
decisions to improve the business’s sales performance.
3 Analysing profits budgets. Profits below the budgeted figure are likely to be a cause of
concern for most businesses. These can be caused by excess expenditure, by revenue falling
short of expectations, or by a combination of these factors. This scenario may prompt
managers to examine means of cutting expenditure as well as boosting revenue from sales.

Variance analysis
The process used for analysing budgets is known as variance analysis. A variance occurs when
an actual figure for sales or expenditure differs from the budgeted figure. Actual revenue and
cost figures can either be higher or lower than planned and these differences fall into two
categories. The two categories of variance are shown in Table 17.2.

Key term
Variance analysis is the process of investigating any differences between forecast
data and actual figures.

Favourable variances Adverse variances

A favourable variance exists when the An adverse variance occurs when the
difference between the actual and difference between the figures in the
budgeted figures will result in the business budget and the actual figures will lead to
enjoying higher profits than shown in the the firm’s profits being lower than
budget. planned.
Examples of favourable variances include: Examples of adverse variances include:
• actual wages less than budgeted wages • sales revenue below the budgeted
• budgeted sales revenue lower than figure
actual sales revenue • actual raw material costs exceeding the
• expenditure on fuel less than the figure planned in the budget
 budgeted figure. • overheads turn out to be higher than in
the budget.

Possible causes of favourable variances: Possible causes of adverse variances:

• wage rises lower than expected • competitors introduce new products
• economic boom leads to higher than winning extra sales
expected sales • government increases business rates
• rising value of pound makes imported by an unexpectedly large amount
raw materials cheaper. • fuel prices increase as price of oil rises.

Table 17.2 The two categories of variance

Revenue/cost Budget figure (£) Actual figure (£) Variance

Sales revenue 840,000 790,000 £50,000 – adverse
Fuel costs 75,000 70,000 £5,000 – favourable
Raw material costs 245,000 265,000 £20,000 – adverse
Labour costs 115,000 112,000 £3,000 – favourable
Table 17.3 Calculating variances
The process of calculating a variance is simple, as shown in Table 17.3. It simply involves a
comparison between the budgeted figure and the actual figure. The business had forecast that its
sales revenue would be £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’s profits being lower than forecast, or its loss larger than forecast. In contrast, the
business’s fuel costs are only £70,000 – £5,000 less than the budgeted figure. In this case, this is
a favourable variance because this will result in the business’s profits being larger than forecast
(or a smaller loss than budgeted).
Carrying out regular variance analysis can give a business advance notice that its financial
forecasts are inaccurate and allow managers to take timely decisions to improve financial
performance. Variance analysis can be carried out each month and will show before the end of
the financial 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 17.2 summarises the
range of actions that businesses may take in response to adverse and favourable variances.
Managers may also need to respond to favourable variances. Production costs that are lower than
planned may be regarded as beneficial. But revenue that is greater than anticipated might be
caused by the firm selling more products than planned. In these circumstances, the 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 that 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 as less is produced.

Other factors leading to adverse and favourable variances

It may be that variances are not the result of unexpected 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 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 significant variances will be more common
when a business is new to a market and has no financial records on which to base forecasts.

Figure 17.2 Responding to adverse variances

The value of budgeting
The advantages of budgeting
Budgets are used to control finances effectively and enable managers to make informed and
focused decisions to improve financial performance. Production or expenditure budgets allow
managers to ensure that a business does not overspend. Senior managers receive their own
budgets and can allocate them between the various parts of the department or area for which they
are responsible. As long as each individual budget holder makes sure that they do not spend
more than the agreed figure, the business’s overall expenditure should remain under control.
Budgets allow senior managers to direct extra funds into important areas of the business. So, if a
business is concerned that its product range is not selling well, it may increase its budgets in the
areas of market research, promotion and product research and development.
Budgets can be used to motivate staff. Employees can gain satisfaction from being given
responsibility for a budget, and from keeping within it. As a result, their level of motivation and
their performance may improve, benefiting the firm as a whole. (We look at motivation in more
detail in Chapter 23.)
Revenue budgets can also be used as targets for employees. Employees may be motivated to
improve their performance by the existence of targets in the form of sales revenue budgets. If
successful this can increase the business’s revenue and possibly its profitability.
The disadvantages of budgeting
If a business intends that some of its employees should manage budgets (known as delegating
budgets), then training will be required. The cost of the training could be substantial, depending
on the skills of the workforce. Furthermore, there could be teething problems in the form of
errors or delays as employees adjust to the new roles and responsibilities.
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. So, for example, a manager responsible for the
sales force may receive a large budget allocation, while insufficient funds are given to the
manager responsible for production.
Budgets normally relate to the current financial year only. So, managers might take a decision to
keep within the current budget, which is not actually in the longer-term interest of the 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 because the business is unable to
supply sufficient quantities of the good or service.
Effective budgeting
The process of budgeting is more likely to be effective if the budgets are constructed to assist the
business in achieving its financial and wider objectives. Thus, a business with a growth objective
may require expenditure budgets that facilitate expansion. Effective budgeting may also require
that managers set demanding targets for employees to encourage them to work as efficiently as
possible which should assist the business in achieving ambitious targets.
Finally, effective budgeting requires that managers review budgets as frequently as possible to
assess their effectiveness. The budgets should be challenging but achievable. Reviewing budgets
allows managers to adjust them as necessary in the light of their experience.
Cash flow forecasts
There are two main reasons why a manager might forecast the cash flow for a business.
1 To support applications for loans. Almost all businesses require loans to enable them to
trade successfully. Short-term loans may be required to purchase supplies and businesses
negotiate longer-term loans to finance major projects such as purchasing property. 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 management team understands the
importance of cash and has planned carefully to avoid cash flow crises. Cash flow planning
gives the bank more confidence that the business will be able to make the repayments of the
loan as and when they are due.
2 To help avoid unexpected cash flow crises. A high proportion of business failures occur
because of cash flow difficulties. Constructing cash flow forecasts can help avoid such
difficulties. Cash flow planning helps to ensure that businesses do not suffer from periods
when they are short of cash and are 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
managers to make the necessary arrangements to overcome this problem.

Key term
Cash flow forecasts state the inflows and outflows of cash that the managers of a
business expect over some future period.
Constructing cash flow forecasts
The structure of a typical cash flow forecast is illustrated in Figure 17.3.
Although cash flow forecasts differ from one another, they usually have three sections, as shown
in Figure 17.3, and are normally calculated monthly. An essential part of cash flow forecasting is
that inflows and outflows of cash should be included in the plan at the time they take place.
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.
2 Cash out. The cash out (or expenditure) section will state the expected expenditure on goods
and services. Thus, a typical section might include forecasts of expenditure on rent, rates,
insurance, wages and salaries, fuel, and so on. At the end of this section the total expected
outflow of cash over the time period in question would be stated. The net monthly cash flow is
calculated by subtracting the total outflow of cash from the total inflow.

Figure 17.3 A typical format for a cash flow forecast

3 Net monthly cash flow. The final section of the forecast has the opening balance and the
closing balance. The opening balance is the business’s 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. Figure 17.4
shows an example of the calculation of opening and closing balances.

Handling data
1 Suppose, in the example given in Figure 17.4, that the cash outflow forecast for
December is £160,000. What would be the closing balance for December in these
circumstances?
2 Recalculate the figures in Figure 17.4, assuming that the closing balance for
November was (£52,500).
Figure 17.4 Opening and closing balances
Analysing cash flow forecasts
Timing is the key issue underpinning the management of cash flow and should guide managers
when making decisions in this area. Essentially a business should seek to ensure that it has
sufficient cash inflows prior to cash outflows taking place.
The cash flow forecast drawn up by the managers of Marshall Books Ltd and shown in Table
17.4 illustrates many of the key principles.

Net monthly cash flow and closing balances

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. In Table 17.4, the
month of June provides a good example of how this operates. In June, Marshall Books Ltd
expected to receive £5,750 from book sales, in addition to the £75,000 loan. At the same time, it
planned to spend £94,500 on an initial stock of books as well as supplying the local college’s
order, but also to spend on marketing, wages and rent. So, in June, the managers expected the net
cash flow (cash inflows less cash outflows) to be minus £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 could be (£13,750).
A negative figure for net monthly cash flow for a month can cause problems for a business if it
does not have sufficient cash to cover it. The new branch of Marshall Books Ltd only had £2,000
available in the form of cash and so the managers will have to make other arrangements to cover
the deficit of £11,750 (which is shown as the closing balance for the month). If the company is
unable to do this it may face severe problems.

Payables and receivables

Payables is a term that relates to the amount of time taken by a business to pay its suppliers and
other creditors. It is normally expressed in terms of days. Thus, a business might take an average
of 42 days to settle its bills. Receivables is a matching term that relates to the time taken by a
business’s customers (or debtors) to pay a business for the products that is has supplied. Once
again this is normally stated in days, for example, 45 days. Managers take decisions on how long
to allow customers before payment is due. The notion of allowing customers time for payment is
referred to as trade credit and offering trade credit can help a business to win customers as it
reduces the pressure on customers’ cash flow if they have additional time to pay.

Key term
Trade credit is offered when purchasers are allowed a period of time (frequently 30,
60 or 90 days) to pay for products they have bought.

Business in focus: The new bookshop

The managers at Marshall Books Ltd are planning to open an additional bookshop in
a growing town near to the company’s four existing bookshops. The company will
require a loan from its bank to finance the purchase of its new branch and
understands that the bank is unlikely to advance a loan unless it constructs a cash
flow forecast for the new enterprise.
The managers at Marshall Books Ltd have made the following forecasts about the
new branch for the first four months of trading from June until September:
• The company has raised £75,000 from a bank loan to buy the lease on a property
and to purchase a stock of books. This money will be used to pay the new branch’s
marketing costs.
• The new branch is forecast to have a cash balance of £2,000 at the start of June.
• Cash sales will rise steadily for each of the four months (from £5,750 to £9,215) as
the new branch becomes better known. The branch has already received an order
to supply books to a local college. The order is for £10,000. Payment is expected in
September, but the branch will buy the books in June at the same time as the initial
stock is bought.
• Each month the company orders books for this new branch to replace stock that
has been sold.
• The new bookshop will be staffed by one full-time and one part-time employee.
Wages normally amount to £1,500 each month.
• Other costs, including rent, rates, heating and lighting amount to £1,500 each
month in June and July, but are higher in August and September.
The cash flow forecast for the new bookshop is shown in Table 17.4.
June July August September
Cash in:
Savings & 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
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 −1,500 −605 9,585
Opening balance 2,000 −11,750 −13,250 −13,855
Closing balance −11,750 −13,250 −13,855
Table 17.4 The cash flow forecast for the first four months of trading for the new bookshop

Practice questions
1 Calculate the following figures for the cash flow forecast for the new bookshop:
• the net monthly cash flow for June
(2 marks)
• the closing balance for September.
(2 marks)
2 Do you think that this cash flow forecast will be valuable to the managers at
Marshall Books Ltd? Justify your view.
(16 marks)

One useful way of analysing a business’s cash position is to compare the number of days for
payables and receivables. If the figure for receivables is higher, this could cause the business to
incur cash flow problems. This tells managers that, on average the business pays its suppliers
earlier than it receives payment from its customers. The business is generally incurring an
outflow of cash before it receives inflows and a cash shortage may result.
In the example shown in Table 17.4 above, Marshall Books Ltd has, in effect given three months
trade credit to the local college. It is buying £10,000 worth of books in June (when the cash
outflow will occur) and payment will not be received until September, 90 days later. In effect the
company’s figure for receivables here is 90 days, while that for payables is 0 days. This does not
represent good management of the company’s precious cash.

Identifying potential crises

One important aspect of analysing cash flow forecasts is to highlight when the business may be
short of cash. This allows managers to take appropriate decisions to avoid the problem and may
prevent some vulnerable businesses from failing.
The cash flow forecast set out in Table 17.4, illustrates this. The new bookshop will be short of
cash during June, July, August and, to a lesser extent, September. The closing balances for these
months indicate that the new branch will require a maximum of £13,855 of additional cash (in
August) to enable it to pay rent, wages, and so on. Knowing this in advance means that managers
can take steps to avoid a cash crisis, possibly by agreeing an overdraft with its bank.
Break-even analysis
At break-even output a business’s sales of its products generate just enough revenue to cover
all its costs of production. Therefore, at the break-even level of output, a business makes neither
a loss nor a profit.

Key terms
Break-even output is that level of output or production at which total costs exactly
equal revenue from sales.
Contribution is the difference between revenue and variable costs.

Managers may use break-even analysis for a number of reasons:

• to help to decide whether the business idea will be profitable and whether it is viable
• to help to decide the level of output and sales necessary to generate a profit
• the results of break-even analysis can be used to support an application by a business for a loan
from a bank or other financial institution
• to assess the impact of changes in the level of production on the profitability of the business
• to assess the effects of different prices and levels of costs on the potential profitability of the
business.
Calculating break-even output
Contribution is an important part of calculation break-even output. Contribution is the
difference between sales revenue and variable costs of production. This is illustrated in Figure
17.5.

Key models and theories: Break-even analysis

The use of break-even analysis enables managers to calculate the level of output at
which revenue from sales and total costs are equal. ‘Break-even’ describes the point at
which business makes neither a profit nor a loss. This technique is valuable to
managers as they can compare sales forecasts with the level of sales required to
break-even to judge whether a project (or a business) is likely to be successful. The
technique can also be used to see the impact of changes in prices and costs on the
level of output needed to break even.

Business in focus: Sunderland Football Club faces cash flow

problems

Stewart Donald, the new owner of Sunderland Football Club, has had a tough
introduction to the difficulties involved in owning a large English football club. At the
start of the 2018–19 football season, the club had only signed one new player – a free
transfer from a Turkish club. At the same time, the club has sold a number of players
and had not renewed the contracts of others.
After owning the club for just one month and taking actions to reduce cash outflows, it
was reported in The Times newspaper that Stewart Donald had admitted the club was
facing cash flow problems. The club is seeking to borrow £8 million to help them
manage their finances over the short to medium term. No agreement has been
reached yet.
The previous owner of Sunderland Football Club, Ellis Short, allowed the new owners
to buy the club in instalments because they couldn’t afford to pay the £40m
immediately. The Times has revealed that the new owners paid only £15m up front
and now have to pay the rest in two further instalments, with one of those in summer
2019; however, the first was due in September 2018.
Source: Adapted from The Mag, 22 June 2018

Practice questions
1 Analyse how the actions taken by the new owners might have helped to strengthen
the cash flow position of Sunderland Football Club.
(9 marks)
 2 Do you think that the example of Sunderland Football Club shows that there is little
point in constructing cash flow forecasts? Justify your opinion.
(16 marks)

Figure 17.5 Contribution, revenues, costs and profits

Contribution is calculated through the use of the following formula:

Contribution = revenue - variable costs
Contribution can be used to pay the fixed costs incurred by a firm. Once these costs have been
met fully, contribution provides a business with its profits.
Contribution can be calculated in two different ways:
• If a manager decides to produce more than one product, they may calculate the contribution
made by each product to paying fixed costs and providing profits. Using contribution avoids
the need to divide up fixed costs between the firm’s various products. This assists managers in
assessing the financial performance of each of their products.
• Contribution can be calculated for the sale of a single unit of a product. This is known as
contribution per unit. It is calculated by using the formula:
Contribution per unit = selling price of one unit of output – variable cost of producing that
unit.
It is this second method of calculating contribution that is useful when calculating break-even
output.

Handling data
 Mike Parker is a tree surgeon. An average customer needing work on their trees pays
£950. Mike had 200 customers in his last year of trading. His total variable costs for
the year were £110,000.
Calculate:
1 Mike’s contribution per unit (single customer)
2 Mike’s total contribution for the year.

A manager wishing to calculate break-even point will require the following information:
• the selling price of the product
• the variable cost of producing a single unit of the product
• the fixed costs associated with the product – remember, fixed costs do not change as the level
of production alters.
This information is used within the formula set out below:

This formula can be rewritten, given that contribution is the result of taking away variable cost
from the selling price of a product:

Handling data
Mike wishes to calculate his break-even output for his tree surgery business. If his
fixed costs per year are £48,000, what number of customers will he need to break-
even?
Using break-even analysis: a case study
Hazel Foods plc owns and operates 112 restaurants throughout the UK. One of its restaurants is
in Soho, West London – it is called The Holly. This restaurant needs refurbishing and there is
potential to expand it as it is currently very small. The company can provide much of the finance
for the project to upgrade, although it would need to borrow some money.
Sarah Patel is the manager responsible for the company’s restaurants in London and is providing
the financial analysis for the decision on whether or not to refurbish The Holly. She has analysed
the likely effects of the refurbishment and has produced the figures set out in Table 17.5. Break-
even analysis is just one of the financial methods Sarah plans to use to help her to make a
decision on whether to refurbish the restaurant.
Type of cost or revenue Amount
Average selling price per meal at The Holly £60
Variable costs per meal – ingredients, fuel, wages £35
Monthly fixed costs of the restaurant, for example, interest charges & £10,000
business rates
Table 17.5 Sarah’s analysis for The Holly
Using this information, Sarah is able to calculate how many meals the company would need to
sell (or how many diners it has to attract) in the restaurant if the refurbished restaurant is to break
even.

Sarah knows that the refurbished restaurant 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 at The Holly is £25 (£60 – £35), so the calculation looks like this:

So, Sarah knows that, if the plan for The Holly is to break even, it will need to attract at least 400
customers each month. If it attracts more than 400 customers, the project will make a profit.
Hazel Foods plc operates all its restaurants for 25 evenings each month and The Holly would,
therefore, break even if attracted an average of 16 customers each night.
While this calculation gives Sarah a quick guide to the number of customers The Holly will need
to break even, it says little more about the level of profit or loss the restaurant 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.
We can use a break-even chart to analyse the financial position relating to The Holly once it is
refurbished.
Constructing a break-even chart
The first stage in constructing a break-even chart is to mark scales on the two axes. Sarah knows
that The Holly can seat a maximum of 30 customers per night and that it normally opens for 25
evenings each month. So the maximum number of customers each month is 750 (30 customers x
25 nights). So the scale on the horizontal axis runs from zero to 750.
The vertical scale on a break-even chart records costs and revenues. Normally, revenues are the
highest figure. So Sarah has to calculate the highest possible revenue the restaurant could earn.
At most The Holly could attract 750 customers paying an average of £60 each. So the highest
revenue it could possibly receive is (£60 × 750) = £45,000. If she marks the vertical scale from
zero to £45,000, Sarah will have an appropriate range of values.
Having marked the scales, the first line to be drawn onto the chart is fixed costs. This is
relatively simple as fixed costs do not change whatever the number of customers. So Sarah
marks a horizontal line on the chart to show the monthly fixed costs the company will have to
pay – £10,000. This is illustrated in Figure 17.6.
The next stage is to include variable costs. As variable costs are expenditure on items such as
components and raw materials, these costs will rise along with output. If there are an increasing
number of people dining at The Holly it will need to buy more food and the wage bill will also
rise.
Variable costs always start at zero – the origin. It is not necessary to plot variable costs at each
level of production. Sarah can simply calculate variable costs for the highest possible level of
output. This would occur if The Holly was full every night and the restaurant had 750 customers
each month. So, the highest variable costs Sarah could encounter are to provide 750 meals each
having a variable cost of £35. The highest variable cost would therefore be £26,250 (£35 × 750).
Sarah marks this point onto her break-even chart as shown in Figure 17.7 and draws a straight
line from this point to the origin.
Figure 17.6 Fixed costs on Sarah’s break-even chart

Figure 17.7 Adding variable costs to Sarah’s break-even chart

The next task for Sarah in drawing the break-even chart is to add together fixed and variable
costs. The results can be entered onto the chart as total costs. Sarah will calculate total costs at
zero output and maximum output (750 customers per month). She can mark these two points
onto the break-even chart and join them with a straight line.
• If The Holly has no customers in a month, it will not incur any variable costs. At zero output,
total costs are the same as fixed costs. In Sarah’s case, this will mean a total costs figure of
£10,000 per month.
• At the other extreme The Holly might be full, with 750 customers each month. Sarah will add
together fixed costs (still £10,000, of course) and variable costs at full capacity (750
customers’ meals each having variable costs of £35) equal to £26,250. So, total costs for the
restaurant in these circumstances will be £36,250 (£10,000 + £26,250).

Figure 17.8 Adding the total costs line to Sarah’s break-even chart

The line connecting these two points is equal to total costs. If it is drawn correctly, it should be
parallel to the variable costs line.
The last stage in constructing the break-even chart is to add on a line showing the revenue The
Holly will earn. Sarah has already calculated that an average customer spends £60 on a meal in
her restaurant. Following the approach we used for costs, Sarah works out the revenue if the
restaurant has no customers and if it is full every evening during a month.
• If The Holly does not have any customers, it will not have any revenue. So the revenue line
begins at the origin.
• If the restaurant is full, Sarah expects each of the 750 customers to pay £60 on average. If The
Holly attracts this level of custom, it will earn £45,000 (£60 × 750).
• The revenue line can be constructed by drawing a straight line to link the origin and the point
where a vertical line drawn up from 750 customers cross a horizontal line drawn across from
£45,000.
Figure 17.10 shows the break-even chart with the revenue line included. To make the chart easier
to read, the variable costs line has been left out in this case.
The break-even chart tells Sarah that she needs 400 customers each month if The Holly is to
break even when it is refurbished. This confirms the calculation we carried out earlier. However,
a break-even chart provides much more information. Sarah can use it to read off the level of
profit or loss her new restaurant will make according to the number of customers it attracts.
Figure 17.9 summarises how to construct a break-even chart.

Figure 17.9 In summary: constructing break-even charts

Figure 17.10 The full break-even chart
Interpreting break-even charts
Figure 17.11 shows the break-even chart for The Holly. We have indicated on the chart the
following scenarios:
1 Attracting 200 customers each month
If The Holly attracts 200 customers each month, the restaurant will make a loss when it is
refurbished as this figure is less than break-even output. The financial position of the business
will be:
Revenue (200 customers paying £60 each)
= £12,000
Total costs [costs of £10,000 + (200 x £35)]
= £17,000
With 200 customers The Holly will make a loss
= £5,000
This loss is illustrated on the vertical axis.
2 Attracting 600 customers each month
If The Holly attracts 600 customers each month when the refurbishment is complete, the
restaurant will make a profit, as this figure is greater than break-even output. The financial
position of the business will be:
Revenue (600 customers paying £60 each)
= £36,000
Total costs [costs of £10,000 + (600 x £35)]
= £31,000
With 600 customers The Holly will make a profit
= £ 5,000
The amount of profit at this level of output is shown on the vertical axis.
Figure 17.11 Interpreting break-even charts

It is, of course, possible to read off the level of profit that Sarah’s restaurant will make, whatever
the number of customers it attracts each month.
This is one way in which a break-even chart is of value to managers. It can be used to read off
the expected profit or loss at various levels of output. If the manager believes that they can
achieve a certain level of sales, this technique will provide guidance on whether this is likely to
be profitable or not.

The margin of safety

A break-even chart can be used to show the margin of safety. The margin of safety is the
amount by which a firm’s current level of output exceeds the level of output necessary to break
even.

Key term
The margin of safety measures the amount by which a business’s current level of
output exceeds break-even output.

If The Holly is successful and attracts 600 customers each month, the margin of safety will be
200 customers. This means that, in these circumstances, The Holly could lose 200 customers
monthly before it began to make a loss.
Changing variables and break-even analysis
Break-even analysis can assist managers in taking a range of decisions relating to their
businesses. Break-even analysis can identify the number of sales a business needs to make to
generate a profit at certain levels of costs and prices. However, break-even can also deal with
more complex circumstances including:
• analysing the impact of changing costs and/or prices on the profitability of the business
• deciding whether to accept an order for products at prices different from those normally
charged.
In spite of its relative simplicity, break-even provides managers with an effective and clear
method of analysis and can assist in making decisions, such as setting prices or accepting one-off
orders.
Break-even analysis can show the consequences for a business in terms of changing profits (or
losses) that may result from changes in fixed and variable costs or alterations in the firm’s selling
price. This is important for the planning of new businesses or projects for existing firms and also
for businesses that operate in environments which change frequently. It is too simplistic for
managers to assume that costs will remain constant or that prices in their markets will not alter
over a period of time. Using break-even analysis for a number of ‘what if?’ scenarios can
increase the value of the technique in financial planning and decision-making.
Table 17.6 illustrates the general effects of changing costs and prices on the break-even point of
a business. To calculate the precise effect of changes at a particular level of production, it is
necessary to conduct calculations or to construct a break-even chart.
Case study: the continuing story of the
refurbishment of The Holly
Sarah is conscious that the cost of construction work on older properties in London is rising
rapidly. She is concerned that the planned alterations to The Holly will cost significantly more
than she originally forecast and that this will increase the fixed costs as the company will have to
pay more interest on the loan it will need. If this happens this will reduce the profitability of the
restaurant. Sarah is concerned that a substantial rise in fixed costs (to say £12,500 each month)
might make the business unattractive in financial terms.
Figure 17.12 illustrates the effect of a rise in fixed costs on The Holly. The chart highlights that
the rise in fixed costs results in The Holly requiring a greater number of diners (500 rather than
400) to break even. This occurs because given the increase in costs faced by The Holly, the
restaurant will need to earn higher revenue to cover its costs. Originally, with fixed costs at
£10,000 a month, a revenue of £24,000 was sufficient to break even. With the increased level of
fixed costs, Sarah needs to attract sufficient diners to give the restaurant a monthly income of
£30,000 and a contribution of £12,500 to ensure that break-even is achieved.
Change in Effect on break- Impact on Other effects
business even chart break-even
environment output
Rise in Total cost line Greater Due to rise in costs greater revenue
variable pivots upwards. output (and so more customers and sales)
costs necessary are necessary to break even.
to break
even.
Fall in Total cost line Smaller Each sale incurs lower costs so that a
variable pivots output smaller number of customers is
costs downwards. required to needed to cover costs.
break even.
Rise in fixed Fixed cost line Greater Business incurs greater costs before
costs and total cost output earning any revenue, so more sales
line move required to will be required to cover costs and
upwards in a break even. break even.
parallel shift.
Fall in fixed Fixed cost and Smaller The business’s overall costs are lower
costs total cost lines output is and hence fewer sales will be required
make parallel necessary to break even.
shift downwards. to break
even.
Rise in Revenue line Break-even Each sale will provide the business
selling price pivots upwards. is achieved with greater revenue while costs are
at a lower unaltered. Hence fewer sales will be
 level of necessary to break even.
output.
Fall in Revenue line Break-even Every sale will earn the business less
selling price pivots is reached revenue so, as costs are unchanged,
downwards. at a higher more sales will be required to earn
level of sufficient revenue to break even.
output.
Table 17.6 The effects of changing costs and prices on a business’s level of break-even output

Figure 17.12 Break-even output and rising fixed costs

Sarah’s other fear is that The Holly may be forced to reduce its prices because of increasing
competition from other restaurants in west London. She believes that it may be necessary to cut
the average price of a meal at The Holly from £60 to £55 as part of her analysis. Sarah
recognises that if the restaurant has lower prices it will need to attract more customers to break
even. At the same time, the level of profit earned from a given number of customers will fall.
The effects of reducing prices by £5 per meal are shown in Figure 17.13. This assumes that all
costs are unchanged.
Managers can take actions to reduce the level of production or output necessary to break even.
So, if a business is able to increase its price, fewer units of output will need to be sold to break
even. A reduction in fixed or variable costs will have a similar effect.
Figure 17.13 Break-even output and reduced prices

What do you think?

Would an increase in price always increase the chance of a business actually
breaking even?
Break-even and non-standard prices
A similar analysis would have resulted if Hazel Foods plc had been approached by a customer
and offered the chance to provide a large number of meals at a price below the normal average of
£60 in The Holly if it is refurbished. Suppose a local theatre offered a contract to fill the
restaurant one night each week as part of its ‘View & Dine’ package. The theatre may only offer
a fixed price of £50 per diner, but guarantee a minimum of 25 diners on that evening. Sarah
could take this into account in her business planning and decide whether it is an attractive offer
using break-even analysis.
In this case, she may be tempted. Assuming her fixed costs for one night are £334 (£10,000/30)
and that her contribution per unit is now £15 (£50 – £35), The Holly would break even on this
offer with (just over!) 22 diners and the contract is for 25 as a minimum. Sarah might also think
that this is a good way of publicising The Holly. If they enjoy the experience, diners might return
and pay full price, or tell friends about it.
The value of break-even analysis
Most techniques of financial analysis have advantages and disadvantages, and break-even
analysis is no exception. Assessing its value entails considering the advantages and
disadvantages offered by break-even analysis in specific circumstances.
The advantages of break-even include the following:
• 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 also be used to analyse the
implications of changing prices and costs on the enterprise’s likely profitability. These ‘what
if’ analyses are arguably the greatest potential benefit to a business from using break-even
analysis.
• It is a simple technique allowing most managers to use it without the need for expensive
training. Because of this it is particularly suitable for newly established and small businesses
and those that produce a single product.
• It is a technique that can be completed quickly, providing immediate results. This means that it
can be used by managers at all levels within a business.
• Its use can be of value in supporting a business’s application to a bank for a loan. It provides
evidence of financial planning as well as evidence of whether the business is likely to make a
profit.
However, break-even analysis has a number of shortcomings:
• It says nothing about the level of sales a business might achieve. In our case study earlier Sarah
might have assumed 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. This
would require managers to divide up the business’s fixed costs and allocate them between its
products. This would be difficult to do accurately.

Business in focus: Revolut breaks even

Revolut is a digital bank offering its financial services online only. It was launched in
2015 and currently has two million customers worldwide. It became the first of a new
group of digital banks in the UK to break even after a growth in customer numbers
and a number of new products helped boost its revenues.
The firm is one of a number of digital banks that have sprung up in Britain in the past
few years, offering slick apps, cut-price fees and a ‘marketplace’ where users can
shop around for products from a variety of providers. Some have seen significant user
growth since, but all are loss-making.
Revolut founder Nikolay Storonsky told Reuters that that the company’s move to a
 break-even position was driven by growth in customer numbers and uptake of its
products. Unlike its rivals, Revolut offers paid-for premium and business accounts,
that have proven profitable for the start-up bank. It is also the only digital bank from
the UK to operate across Europe so far. Strong growth customer numbers in
countries like France, Germany and Switzerland helped drive its customer numbers
up by 50 per cent in just two months.
The firm’s closest competitors, including Monzo, Starling Bank and Tandem, which all
have British banking licenses, told Reuters they had not yet seen a month without
losses.
Source: Adapted from an article in The Independent, 26 February 2018

Practice questions
1 Analyse how the sale of its ‘paid-for premium and business accounts’ might have
helped Revolut to break even.
(9 marks)
2 To what extent is break-even a useful concept for the management team at
Revolut?
(16 marks)

• Costs do not rise as 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.
• A 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.
So break-even analysis offers some support to a manager when making a decision and to
entrepreneurs looking to start a business. However, it is only a guideline and its value should not
be overstated. Perhaps most importantly, managers should bear in mind that the value of the
technique depends on the use of reliable data for costs, prices and expected sales.
How to analyse profitability
We saw in Chapter 1 that profit is calculated by deducting total costs from the total revenue
received by a business over a given time period. Profit is a very important objective for many
businesses and it is one way of measuring the success of a business. Managers will analyse the
performance of a business in terms of profits and use this information to guide decisions. A
simple analysis of profit data would consider whether a business’s profits have risen or fallen
and the rate of change. Such an analysis would also examine the trend in the business’s profits
over a period of some years. Many public limited companies produce financial data to cover a
five-year period.
Table 17.7 shows the operating profit for Unilever, a multinational company that supplies a
range of consumer goods. Although the company’s operating profit has grown over the five-year
period, the rates of growth have varied considerably; the company’s managers may regard 2014
and (especially) 2017 as relatively successful years, while operating profits fell in 2015 and grew
slowly in 2016.
2017 2016 2015 2014 2013
Operating profit (£m) 8,857 7,801 7,515 7,980 7,517
Table 17.7 Unilever plc’s annual operating profit, 2013-2017
Source: Unilever website
However, a simple profit figure is not as revealing as it might appear. It is simple to assume that
if one firm makes a larger profit than another, it must be more successful. This might not be the
case. It is important to consider two factors when making a judgement on a business’s profits:
• What level of sales was necessary to generate the profits? If a firm achieves a high level of
profits from a relatively small number of sales, it may be considered very successful.
• How much money was invested into the project to produce the profits? Obviously, a larger
investment would be expected to result in a higher level of profits. We looked at the concept of
a return on an investment in the previous chapter but will focus on comparing profits and
revenues here.
We can make a more meaningful judgement about a business’s performance if we compare its
profits with something else in a simple calculation. Calculating ratios that compare profits to
revenue allows us to make more informed assessments of a business’s performance.
Profit margins
A profit margin compares a business’s profit to its sales revenue and expresses the outcome as a
percentage. Thus, profit margin = profit x 100/revenue. The calculation of this simple ratio can
provide a more informed analysis of a business’s financial performance and it can take several
forms depending on the type of profit that is used in the calculation.

Key terms
Profitability is a measure of financial performance that compares a business’s profits
to some other factors such as revenue.
A profit margin is a ratio that expresses a business’s profit as a percentage of its
revenue over some trading period.

It is possible to calculate a profit margin for a single product, or for the business’s entire output.
For a business that sells a single product at a standard price, these two figures should be the
same. However, in reality the majority of businesses sell a range of products at a variety of
prices.
Analysing the relative performance of the two businesses set out in Table 17.8 appears
straightforward.
Company Profits
Company X £12.42 million
Company Y £49.85 million
Table 17.8 A comparison of the profits of two companies
Company Y’s profits were approximately four times higher than those of Company X during the
most recent financial year. Thus, it would appear that Company Y recorded a better financial
performance. However, this comparison may not be between two similar-sized businesses with
equal access to resources.
By introducing more information into a financial analysis of a company’s performance, it is
possible to gain greater insight. Table 17.9 shows information on the revenue earned by the two
companies and enables us to calculate two profit margins for comparison.
Business Profits for last financial Revenue for last financial Profit margin
year year
Company £12.42 million £101.96 million 12.18 per
X cent
Company £49.85 million £603.16 million 8.26 per cent
Y
Table 17.9 A comparison of the profit margins of the same two companies
By including information on the revenues generated by the two companies we are able to
improve the quality of our analysis and to make a better quality judgement. The use of profit
margin reveals that, even though Company Y achieves a higher profit it is from a much higher
level of sales. Company Y’s profits were about four times as high as those of company X, but its
sales were about six times greater. As a consequence the percentage of Company Y’s revenue
that is profit is only 8.26 per cent, whereas the equivalent figure for Company X is 12.18 per
cent. So, although Company X is smaller, it can be argued that its financial performance is
superior.

Handling data
1 Assume that Company X in Table 17.9 generated a revenue of £98.5 million in the
last financial year. Calculate its profit margin.
2 Assume Company Y’s profit was unchanged, but that its profit margin was 9 per
cent. What was its revenue for the year?
Types of profit margins
It is possible for a business to calculate several different profit margins. There are three profit
margins that are commonly calculated.

1. Gross profit margin

Gross profit is a business’s revenue minus its direct costs or cost of sales. The gross profit
margin can be calculated using the formula below:

The gross profit margin does allow comparisons to be made between different businesses or over
different time periods. However, it has limited value as a measure of financial performance as the
calculation of gross profit does not include all of a business’s costs – for example, it excludes
indirect costs, interest payments and taxation. A negative figure for gross profit (that is, a gross
loss) will lead to a negative profit margin.
We can calculate the gross profit margin for Burberry plc for the financial years ending in 2017
and 2018, which are shown in Table 17.10. Burberry plc is based in the UK and is a global
retailer of luxury fashion products including clothing, cosmetics and perfumes.
Item 2018 £m 2017 £m
Revenue 2,732.8 2,766.0
Cost of sales (direct costs) 835.4 832.9
Gross profit 1,897.4 1,933.1
Operating profit 410.3 394.3
Profit for the year 293.6 287.7
Table 17.10 Selected profit data for Burberry, 2017 and 2018
Source: Burberry plc’s Annual Report, 2018
Between the two years, Burberry plc’s gross profits fell by £35.7 million or 1.85 per cent to
£1,897.4 million which looks to be a disappointing performance by the company. We can
calculate the company’s gross profit margin for the two years, as shown below.
2017: £1,933.1 m × 100 /£2,766.0 m = 69.89%
2018: £1,897.4 m × 100/£2,732.8 m = 69.43%
The company’s gross profit margin has declined slightly alongside a relatively small fall in
revenue. It may be that Burberry has been slightly less effective in controlling its direct costs.
Burberry plc’s direct costs would include the wages of its employees and the cost of purchasing
its distinctly branded clothing and other products.

2. Operating profit margin

A business calculates its operating profit by deducting direct and indirect costs of production
from its revenue. The operating profit figure is useful to managers and others interested in the
performance of a business, but more so when compared to the sales revenue the firm received in
the sale trading period.
The formula for calculating the operating profit margin is shown below.

If the firm makes an operating loss, then its operating profit margin will be negative.
In general, higher profit margins are preferable to lower ones, as a higher profit margin is likely
to lead to greater overall profits. This should meet with the approval of the business’s owners,
assuming that their objective is to make the largest profits possible.
However, the pursuit of increased overall profits can lead to a fall in a business’s profit margin.
Managers may decide to reduce prices to attract additional sales in the hope of gaining higher
profits. This may be effective, but only because the business earns a lower profit on each of a
larger number of sales to generate the increased level of profits. Such a situation is illustrated in
Table 17.11.
Units Sales Total Operating Operating profit
sold revenue £ costs £ profit £ margin %
Scenario 100,000 2,400,000 2,000,000 400,000 16.67
1
Scenario 110,000 2,585,000 2,170,000 415,000 16.05
2
Table 17.11 A rise in profits, but a fall in the operating profit margin
Operating profit margins do reflect a business’s financial performance more fully as operating
profit takes into account both direct and indirect costs and therefore the resulting profit figure is a
better measure of performance.
We can use the data in Table 17.10 to calculate the operating profit margin for Burberry plc for
2017 and 2018.
2017: £394.3 m × 100/£2,766.0 m = 14.26%
2018: £410.3 m × 100/£2,732.8 m = 15.01%
This piece of analysis is more revealing. The company’s operating profit margin has risen by
about three-quarters of one per cent over the two years, despite a fall in revenue. As operating
profit is normally regarded as a better measure of a business’s financial performance than gross
profit, this rise may be a satisfying result for the company’s management team. It suggests that
the company has managed to control its indirect costs (or expenses) well and perhaps more so
than its direct costs. The management team may seek to control direct costs such as inventories
and employee wages more tightly over future financial years.

3. Profit for the year

Profit for the year is a measure of a business’s profits that takes into account a wider range of
expenditures and incomes including taxation. It is possible to calculate a margin based on profit
for the year by using the formula below:

Finally, the data in Table 17.10 can be used to calculate profit for the year margins.
2017: £287.7 m x 100/£2,766.0 m = 10.40%
2018: £293.6 m x 100/£2,732.8 m = 10.74%
This final ratio shows an improvement over the two years, possibly because the company paid
less interest on its loans or because it generated more profit from non-trading activities. It does
mean that the company’s management team is in a position to pay shareholders an increased
dividend if this is judged to be in the company’s best interests.
The use of data for financial decision making and
planning
We saw in Chapter 4 that data is the basis of scientific decision making and that many managers
avoid taking decisions without relevant data to analyse. Using data to support decisions has also
become more straightforward and cost-effective due to developments in technology. It is
becoming increasingly possible for many businesses to analyse enormous quantities of
information (the so-called big data) to support decision making.
Managers use a range of financial information to plan their enterprise’s future activities and to
take decisions about these activities. Budgets, including cash flow forecasts, are a central part of
financial planning. Managers and other stakeholders (such as investors) use this information to
make judgements about the future viability of a business or a specific project. If managers
require loan capital to support the activity, financial planning of this type will be essential. Banks
and other investors will regard a loan as very high risk if they have not been able to view such
financial plans. Break-even analysis is also used, particularly by managers, to model ‘what if?’
scenarios. This can play a vital part in planning and also in decision making. Break-even analysis
could provide important evidence to assist managers in deciding whether to increase prices or to
continue production following a substantial rise in fixed or variable costs.
A well-known quotation says that a manager should not take a decision without considering
relevant numerical data, but should not take one on the basis of quantitative data only. Financial
data has an important role to play in decision making throughout a business. It will influence
decisions taken in all departments or functions of a business.
For example, managers would be unlikely to consider launching a new product without
considering a number of financial aspects such as the following:
• Does the business have sufficient capital (possibly from past profits) to fund this new product?
• What will be the effect of launching this new product on the business’s cash flow?
• Will the new product generate a profit and, if so, over what timescale?
• How might the return from investing in this new product compare with other possible
investments the business could make?

Key term
Primary market research collects and analyses data for the first time to use for
marketing purposes.

Business in focus: Next plc’s profits fall

Next plc is a clothing and home furnishings retailer. Next has approximately 500
stores in the UK and Eire and a further 200 stores in other countries overseas. It has
nearly 44,000 employees. Next sells a high proportion of its products online and is
famous for its Directory – a mail order catalogue.
In 2018, Next reported a small fall in its profits and revenue from sales in what it
described as ‘difficult trading conditions’. Next’s primary objective is to deliver long-
term returns to shareholders through growth in share price and the payment of
dividends. It attempts to achieve this objective through developing and improving its
product range and selling its products in the most profitable places.
Item 2018 £m 2017 £m
Revenue 4,055.5 4,097.3
Cost of sales (direct costs) 2,699.3 2,710.7
Gross profit 1,356.2 1,386.6
Operating profit 759.9 827.7
Profit for the year 591.8 635.3
Table 17.12 Selected profit data for Next plc, 2017 and 2018
Source: Adapted from Next plc’s website

Practice questions
1 Calculate Next plc’s gross and operating profit margins for 2017 and 2018.
(6 marks)
2 To what extent do you think that Next plc’s shareholders will be satisfied with the
company’s financial performance during 2017 and 2018?
(16 marks)
Is the data reliable?
Making decisions on the basis of financial data can improve the quality of such decisions, but it
does depend on the reliability of the data. Financial data is often underpinned by assumptions
about future customer buying behaviour, which determines revenue forecasts. It is not easy to
forecast revenue accurately. The reliability of the data may depend on the quality of research
used to provide it. Recent, relevant and well-focused primary market research is more likely to
result in reliable revenue data and therefore good quality decisions by managers.
For example, historical data on a company’s recent profits is likely to be accurate, but that does
not necessarily make it reliable. Historical data is not always a good indicator of future
performance, especially for businesses that operate in changing environments. In 2018, Marks &
Spencer plc, one of the UK’s foremost retailers, revealed that its profits before tax had fallen by
nearly two-thirds to just under £67 million. This represented a huge decline from previous years.
Managers have to make a number of judgements about data. They should consider whether it is
accurate, whether it is reliable and whether it is relevant to the decision they are to take. If the
answer to all these questions is yes, then they can consider how it should influence their decision.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 Is the following statement true or false? ‘Sales volume and average selling price
are key pieces of information needed to construct a budget.’
2 Drawing up budgets involves a series of activities. Place the four activities below
in the correct order.
a Construct expenditure budgets.
b Construct revenue budgets.
c Establish the business’s objectives.
d Analyse markets and previous years’ budgets to gather information.
3 State two reasons why a manager might analyse an expenditure budget.
4 Polly Ltd’s recent budget contained the following information:
• Budgeted expenditure on fuel: £37,500
• Actual expenditure on fuel: £42,000
• Previous month’s budget: £39,000.
Which of the following is the correct variance for this budget?
i £3,000 adverse
ii £4,500 favourable
iii £4,500 adverse
iv £3,000 favourable.
 5 For which two of the following reasons might businesses construct cash flow
forecasts?
i to increase the profit made per unit of production
ii to support applications for loans
iii as a means of forecasting future profit margins
iv to avoid financial problems during periods when they may be unable to pay
suppliers.
6 If Pip Ltd has an opening cash balance in April of £24,750 and a net cash flow for
the month of (£14,250) which one of the following will be its opening balance for
May?
i £39,000
ii £24,750
iii £38,500
iv £10,500
7 If a business has a net cash flow for October of £35,000 and an opening balance
of (£12,500), what is its opening balance for November?
8 Complete the following formula by filling in the missing word. ‘Cash inflow per
month minus cash outflow per month equals ……….’.
9 Is the following statement true or false? ‘Sales revenue minus contribution equals
fixed costs.’
10 The selling price of Marley’s hand-knitted sweaters is £90. The variable cost of
each one is £40. His monthly fixed costs are £1,000. His market research
suggests he will sell 16 sweaters per month. Should he start producing sweaters
on the basis of this information?
11 Does the total revenue line pivot or shift when there is a fall in prices?
12 Is the following statement true or false? ‘A fall in variable costs per unit will always
reduce break-even output.’
13 Saxon Pharmaceuticals plc’s revenue for the last trading year was £375.4 million;
its cost of sales were £225.2 million and its interest payments were £19.8 million.
Calculate its gross profit margin.
14 Is the following statement true or false? ‘A reduction in prices can, in some
circumstances, increase a business’s revenue.’
15 A company made an operating profit margin last year of 12.5 per cent. Its revenue
for the year was £1,500 million. What was the level of its operating profit?

(b) Short answer questions

1 Explain why a large, established company selling a range of well-known brands
may have access to a large quantity of good quality information when constructing
its budgets.
(4 marks)
2 Explain why a multinational business selling price and income elastic products may
suffer adverse variances on its revenue budgets
 (4 marks)
3 Explain the possible benefits to a business with a low profit margin of constructing
budgets for all its activities.
(5 marks)
4 Explain why managing payables and receivables carefully is important for a start-up
business.
(5 marks)
5 Explain why break-even analysis may be of limited value to a multi-product
business selling in an intensely competitive market.
(5 marks)
6 Explain why the managers of a small house building company may be less
confident that data on which they may base decisions is reliable.
(5 marks)

(c) Data response questions

Healthy Meals Ltd provides a range of low-calorie, organic ready-meals in Bristol; it is
the only supplier, although a competitor (part of a large food company) is about to
enter the market. Demand for healthy meals has a price elasticity of –0.45 in the city
and the company has received much coverage in the local media. The company has
been trading since 2011 and last year it enjoyed a very successful year, with its
operating profit margin rising to 20.07 per cent.
The company’s managers have started to look forward to next year’s trading and
primary market research has revealed the following:
• monthly fixed costs will be £15,000
• the average price of a meal is forecast to be £6.50
• continuing the company’s policy of slowly increasing prices may be less successful
• the ingredients of an average meal will cost £2.50
• other variable costs will amount to £2.00 per meal.
The company is considering launching a new range of meals based on seafood. One
manager believes that break-even analysis will be of great value in reaching a
decision on whether or not to go ahead with this project. Despite its rising profits the
‘Seafood Project’ will require a large loan from the company’s bank.
1 Calculate the company’s break-even level of production for the next year.
(4 marks)
2 Analyse why the company’s operating profit margin might have increased over the
last year.
(9 marks)
3 To what extent do you think that the company will benefit from the use of break-
even analysis in taking a decision on the ‘Seafood Project’?
(16 marks)

(d) Essays
1 Budgets offer the greatest benefits to decision-makers in large businesses. To what
extent do you agree?
(25 marks)
2 To what extent should managers rely less on financial data and more on data from
other functions of the business (such as marketing) when taking decisions on
whether or not to launch a new product?
(25 marks)
3 Decisions relating to cash flow are more important than other aspects of financial
planning and analysis for start-up businesses. To what extent do you agree?
(25 marks)
Chapter 18 Sources of finance
Introduction
This chapter builds on earlier ones and looks at a key decision that a business’s managers have to
make – that of deciding upon the most appropriate source of finance. It considers the various
sources that are available to managers from inside and outside the business. The next chapter will
look at other important decisions on how to improve profits or strengthen cash flow.
What it is important to know by the end of this chapter:
• the internal and external sources of finance that are available to managers
• the advantages and disadvantages of different sources of finance for short- and long-term uses.
A number of sources of finance are available from which managers can select, but the one
chosen will depend upon several factors:
• the amount of money required by the business
• the purpose for which the finance is required
• the time period over which the loan is required
• the legal structure of the business
• the financial position of the business.
We will look at a range of sources of finance in this section and consider how factors such as
those listed above may influence a business’s choice of sources of finance.
Internal and external sources of finance
A source of finance refers to the way in which a business raises the finance that it needs for some
activity. Sources of finance can be classified in a number of ways. Internal sources of finance
already exist within a business and it only requires a decision about how to use it. Profits held
over from previous years (known as retained profits) are an example of an internal source.
External sources of finance are funds that are injected from outside the business. A bank loan is
a prime example of this category of source of finance.

Key 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.
Short-term finance is finance needed for a limited period of time, normally less than
one year.
Long-term finance are those sources of finance that are needed over a longer period
of time, usually over a year.

Figure 18.1 Why businesses need short- and long-term capital and how they might meet those needs

It is also possible to classify sources of finance as short and long-term. A business may need
short-term finance to pay its bills and to keep its suppliers happy, possibly covering a
temporary shortage of cash. Sudden increases in the costs of raw materials can also create a need
for short-term finance. Short-term finance of this kind is usually repayable within a one-year
period.
However, businesses also need to purchase major capital assets such as land and buildings or to
expand or to take over other businesses. To do this they will require long-term finance, which
will be repaid over a period of time in excess of one year and on many occasions, much more
than one year.
Table 18.1 classifies a range of sources of finance according to whether they are short- or long-
term and internal or external.
Internal sources of External sources of finance
finance
Short-term sources of • Overdrafts
finance • Retained profits
• Debt factoring
Long-term sources of • Retained profits • Bank loans, mortgages &
finance debentures
• Sale of assets
• Venture capital
• Share capital
Table 18.1 Classifying sources of finance in terms of time scale and source
Internal sources of finance
An internal source of finance is one that exists within the business. The major internal sources of
finance are retained profits and sale of assets.

1. Retained profits
This remains a major source of finance, particularly for smaller businesses. Businesses can use
profits from the current trading year or profits from previous trading years as sources of finance
(technically these are called retained profits). By using profits for reinvesting, a business avoids
paying interest on a loan and this can avoid heavy interest charges if the loan required is a large
one. 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 profits can have substantial opportunity costs – that is the business may lose
out from not using these profits in another way. Reinvesting retained profits may not be popular
with shareholders, who are likely to receive a lower dividend as a result. Alternatively, the
business may lose out on interest it may have received if it held the money in an interest-paying
bank account.
This method of finance is only available to firms making a profit. Even then the profits may not
be sufficient to purchase expensive capital assets. Alphabet, the American parent company of
Google is highly profitable – its profits were over $12 billion in 2017. At the same time, the
company has long-term borrowing amounting to nearly $4 billion.

2. Sale of assets
Firms can raise finance 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 not required and they may decide to sell
to raise capital. Shell, the multinational oil company, has confirmed that it is on target to sell $30
billion of its assets during 2018 to repay some of its loans.
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.
But what if the 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. In 2018, Goldman Sachs, the American investment
bank, sought buyers for its London headquarters in a sale and leaseback deal. The Bank expects
to raise £1.3 billion from the deal. Businesses engaging in sale and leaseback deals 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 that previously were freely available. This may have a negative impact on its long-term
profits as well as its cash flow position.
External sources of finance
When individuals, other businesses or organisations such as banks or governments provide
capital to a business, this is an external source of finance. Businesses are more likely to use
external sources of finance when:
• 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 source of finance is low encouraging outsiders to invest or
lend money
• the company’s profit levels are relatively low reducing the possibility of the use of retained
profits.
The first three external sources of finance we consider are all types of loan capital – finance that
is borrowed. The major difference between them is the timescale of the borrowing. An overdraft
may be taken out for just a few weeks whereas a business mortgage could last for up to fifty
years. Loan capital can be attractive to a business as a source of finance because it does not lead
to any loss of control by the owners of the business.

1. Overdrafts
An overdraft is perhaps the best-known method of short-term finance. An overdraft is a facility
offered by banks allowing businesses 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 so long as they
are within an agreed figure. They are also simple to arrange – established business customers can
often arrange, or increase the limit, without completing any forms.

Key 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.
An overdraft exists when a business is allowed to spend more than it holds in its
current bank account up to an agreed limit.
Venture capital is funds advanced to businesses thought to be relatively high risk in
the form of share and loan capital.
Share capital is finance invested into a company as a result of the sale of shares in
the business.

Business in focus: Mango raises €100 million in sale and

leaseback deal

Mango is a Spanish fashion company that designs, manufactures and retails clothing
for men, women and children. The business trades as a private company and
 operates over 2,200 stores in 110 countries. In 2017, the company’s sales were over
€2 billion.
In 2017, Mango sold its main logistics centre in Lliçà d’Amunt in Northern Spain for
more than €100 million. The fashion group in Spain will remain as a tenant thanks to a
sale and leaseback agreement. The agreement says that Mango will stay as a tenant
of the complex for 30 years, while the new owner, Invesco Real Estate, anticipates a
return of around 5 per cent annually on its investment.
This is not the first time that Mango, which is based in Catalonia in Northern Spain,
has reached a sale and leaseback deal for some of its non-current assets. In 2016,
the company sold another logistics centre, located in Barcelona for €150 million in a
similar deal. Mango’s debts rose by 29 per cent during 2016 to more than €682
million.
In the 2017 financial year, Mango incurred losses of €33 million despite a 15 per cent
rise in its online sales. Business analysts have commented that the company is
sacrificing profits for growth in sales. In recent years Mango has invested heavily in
replacing some of its smaller stores with larger ones.
Source: Adapted from the Fashion United website, December 2017

Practice questions
1 Analyse the benefits that Mango may receive from using the proceeds from selling
its distribution centre to reduce its long-term debts.
(9 marks)
2 Do you think that sale and leaseback is the best choice as a source of finance for
Mango in these circumstances? Justify your view.
(16 marks)

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 their 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.

2. 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. Factoring debts in this way provides up to 80 per cent of the value of an
invoice as an immediate cash advance. The financial institution then organises the payment of
the invoice and makes a further payment to the business concerned. It is usual for the financial
institution to retain about 5 per cent of the value of the invoice to cover its costs in debt
collection. The process is summarised in Figure 18.2.
Many small firms believe that to lose up to 5 per cent of their earnings makes factoring
uneconomic – this can eliminate much of their profit margin. Their customers are also likely to
be aware that the debts have been factored, which may cause them to worry about the business’s
ability to manage its short-term finance. They may seek other suppliers if they believe the
business is financially unstable.
However, debt factoring does offer a number of benefits.
• The immediate cash provided by the factor means that the firm is likely to have lower
overdraft requirements and will pay less interest.
• Factoring means businesses receive the cash from their sales more quickly.
Debt factoring has become more popular for businesses, especially small and medium-sized ones
(SMEs) as overdrafts have become more difficult to arrange. We consider this development
further in the following Business in focus feature about UK banks.

3. Bank loans, mortgages and debentures

Bank loans can usually be arranged if the business that is seeking the credit is financially sound
and has a satisfactory financial history. The financial institution advances the business a set
figure and the business makes repayments over an agreed period of time. 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 loans such as these. Interest rates can be fixed or variable.
Banks will often require security for their loans and this will often be in the form of property.
Such security is often termed ‘collateral’. If the business defaults on the loan the bank sells the
property or other collateral and recoups the money that was lent. In this way the bank lowers the
degree of risk it incurs in making loans to businesses.

Figure 18.2 The process of debt factoring

Business in focus: SMEs in the UK banks face difficulties

with short-term finance

Small and mid-sized enterprises (SMEs) in the UK have traditionally relied heavily on
 overdrafts, which account for half of the financial products traditional banks have
offered to SMEs. They have been popular due to them being able to be arranged
easily, being cost effective and being a flexible way of borrowing money. There
remains a clear preference for the conventional sources of finance such as overdrafts
(18 per cent) and short-term business loans (16 per cent). Fewer than four per cent of
SMEs used crowdfunding or finance provided by business angels.
According to the results of a 2018 survey, of over 1,100 firms from across the UK,
over half (56 per cent) of businesses did not attempt to access short-term finance
over the last year. Smaller firms were less likely to access finance than larger
businesses. Almost two-thirds (63 per cent) of small firms (1–9 employees) did not
seek finance, compared with just over a third (39 per cent) of larger firms (50 or more
employees).
Nearly half (49 per cent) of those SMEs that sought short-term finance did so
because of cash flow issues, suggesting firms faced problems in balancing cash
outflows with cash inflows. Two-fifths of respondents describe their cash flow over the
last 12 months as ‘weak’.

Practice questions
1 Analyse why having short-term sources of finance available is important for small
and medium-sized businesses.
(9 marks)
2 Do you think that overdrafts are the best short-term source of finance available to
businesses? Justify your opinion.
(16 marks)

There are different types of loans available to businesses.

• Mortgages. Mortgages are simply 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 for the
loan – they act as collateral and will be sold to recover the money lent, if the borrower stops
repayments. These loans can be for long periods of time – often up to fifty years. Mortgages
can have fixed or variable rates of interest and are particularly suitable when a business wishes
to raise large sums of money.
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
is a source of finance particularly popular with small businesses.
• Debentures. Debentures are a special type of long-term loan to be repaid at some future date,
normally within fifteen 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’s non-current assets as collateral. Debentures are a form of loan
capital and holders of debentures do not have voting rights in the business.
The All England Lawn Tennis Club has issued debentures to help it to fund improvements to
centre court and its other facilities at Wimbledon. These are particularly popular with tennis
 fans as tickets for the Wimbledon tennis tournament are included in the deal.

4. Venture capital
Venture capital is an important source of finance for small enterprises and for businesses that
are considered to be risky and therefore in some danger of failing. It is normally a mix of loan
and share capital. Financial institutions, for example, merchant banks, provide venture capital as
well as individuals (who are known as business angels).
Organisations and individuals providing venture capital frequently wish to have some control
over the organisation for which they are providing finance. The business’s owners may need to
sell some shares in their companies (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 experience, contacts and advice when required, which distinguishes venture capital from
other sources of finance.
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 £500,000 in a single deal.
Despite this, Pinterest, an image-sharing social website, has raised $425 million from a number
of venture capital companies to finance its expansion online. The size of this deal reflects the
potential that venture capitalists believe lies in Pinterest.

5. Share or equity capital

This is a very common form of finance for both start-up companies and for established ones.
Companies 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. The
shareholders purchases shares and by selling large numbers companies can raise significant sums
of capital. Issuing shares can be very expensive, which means it is only appropriate for raising
large sums of capital.
Share capital is a source of finance for 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:
1 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.
2 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 several benefits from the selling of shares or equity as a source of finance. Although
the companies 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. It can be used to raise large sums of capital, as in the case of UK services
company Capita. In May 2018, Capita raised £681 million by selling new shares to existing
shareholders in a process known as a rights issue. Parts of the capital raised from selling the
shares will be used to reduce the company’s debts.
Business in focus: Crowdfunding – a different source of
finance

Figure 18.3 Crowdfunding can finance expansion

George Christakos owns and manages a restaurant in Nova Scotia in Canada and,
facing the normal difficulties in raising capital, decided to use his business’s
customers as a source of finance. He wanted to enlarge the restaurant in the town of
Halifax, a restaurant that he co-owns with his father, Leo. 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. This is a source of finance that invites small contributions from a
large number of people.
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 $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.
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.

Practice questions
1 Analyse why a loan from the Bank might have been George Christakos’ first source
of finance.
(9 marks)
2 Do you think that crowdfunding is the best source of finance for George? Justify
 your opinion.
(16 marks)

However, there are disadvantages of using share capital as a source of finance. Clearly it is only
available to companies. Private limited companies have to seek approval from existing
shareholders before issuing further shares. The most significant disadvantage is the potential for
loss of control. If a business issues too many shares it may dilute the control of the existing
owners to the point where new shareholders have a majority, and controlling, interest in the
business.

6. Other sources of finance

The increasing role and importance of the internet has acted as a catalyst for the development of
new sources of finance. It has allowed the owners of businesses to communicate with a large
number of people and to appeal directly for finance for their enterprises. The Business in focus
feature about crowdfunding illustrates an example of a restaurant raising a relatively small sum
of capital.

Key term
Crowdfunding is practice of funding a project or venture by raising many small
amounts of money from a large number of people, typically via the internet.

There are also more established businesses operating online with the intention of providing a
source of finance for businesses. These are termed peer-to-peer lenders and raise money from
large numbers of private investors to lend to businesses for specific projects. The peer-to-peer
lenders undertake some assessment of the risks entailed with the loan and administrate the
process in return for fees. Funding Circle and Zopa are among the UK’s best-known examples of
peer-to-peer lenders. By January 2019 Funding Circle had lent £4.6 billion to over 46,000
businesses in the UK.
Choosing a source of finance
In the previous sections we have seen that all sources of finance, whether internal or external,
short or long term, have advantages and disadvantages. These are summarised in Table 18.2.

Figure 18.4 The factors that influence managers’ decisions on sources of finance

Managers can select the most appropriate source of finance by considering the advantages and
disadvantages of each available source and making a decision on which is most appropriate for
their circumstances. There are a number of factors that managers will need to take into account,
as summarised in Figure 18.4.
The influences on decisions on sources of
finance
1. The business’s legal structure
The legal structure of a business is a major influence of the sources of finance that are available
to a business.
Start-up businesses, many of which may be sole traders or partnerships, normally have a more
limited range of sources of finance to draw upon as they represent a greater risk to potential
investors and have few, if any, internal sources of finance for use.
In contrast, a public limited company has a greater range of sources of finance that it can use
and, in particular in the UK, they benefit from being able to raise capital by selling shares on the
London Stock Exchange.

2. The cost of the source of finance

The costs incurred by firms raising capital can take a number of forms.
Source of Advantages Disadvantages
finance
• A flexible way of funding • Interest rates are high.
day-to-day financial • Bank may ask for repayment at any
requirements. time.
Overdrafts
• Interest is only payable • May not be available to some SMEs.
on the actual amount
borrowed.

• It allows businesses to • It can reduce or even eliminate a

receive cash almost business’s profit margin, if it is small.
immediately a sale is • Customers may be aware if debts are
Debt factoring made. factored and could lose faith in the
• It may reduce a supplier.
business’s overdraft and
interest charges.

• Can be negotiated to • They are inflexible and businesses

meet a business’s precise may pay interest on funds they are
requirements. not using.
Bank loans
• Managers can plan for • Businesses may be required to offer
repayments within collateral.
budgets.

• These are ideal sources • Managers will have to offer property

of finance for very long- as collateral for mortgages.
Mortgages
 and term projects. • Businesses can pay large amounts of
debentures • They avoid the owners interest on very long-term loans.
losing any control over
the business.

• They are a ‘free’ source • The owners of the business (e.g.

of finance as they do not shareholders) may wish to receive
Retained incur interest charges. the profits.
profits • They do not involve any • The business may lose out on
potential loss of control valuable alternative investments.
by a business’s owners.

• It can be used to raise • This source of finance is only

very large amounts of available to companies.
capital. • Private limited companies can only
Share capital • The company is not sell additional shares with
committed to fixed shareholder approval.
interest payments. • Existing owners may lose control of
the company.

• Can bring expertise into • Some entrepreneurs and owners

the business as part of may not wish to have venture
Venture the deal. capitalists involved in decision-
capital • Avoids having to pay making.
interest on the entire • Usually only able to raise small
amount of finance. amounts of finance.

• Can be a relatively cheap • Unfamiliar source of finance for many

source of finance. managers.
Crowdfunding • Increasingly relevant as • May not be suitable to raise very
UK banks reduce short- large amounts of capital.
term lending.

• May provide a source of • Loans are only available for relatively

finance when banks are small sums – may be insufficient for
Peer-to-peer
unwilling to lend. some businesses.
lending
• Loan can be arranged
relatively quickly.
Table 18.2 Some advantages and disadvantages of selected sources of finance
(a) 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. This 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.
(b) The costs of selling shares. For a public limited company a share issue can be an attractive
option, although this can be an expensive method of raising capital as it entails considerable
 administration and promotion and, on occasions, a form of insurance 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 entails
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 purchases.
(c) 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, using retained
profits for reinvestment into the company entails an opportunity cost which can be measured
in terms of the reduction in the amount of profits that can be paid to shareholders (these are
known as dividends).
For many businesses, accessing sources of finance at the lowest possible cost is the most
important factor.
Legal form Possible sources of finance Key issues for
of consideration
business
Sole Owner’s savings, banks, suppliers, Government • Security for
trader grants and loans. those lending
funds
• Loss of control
by owner
• Evidence that
business has
potential to
develop
• Financial history
of
business/owner
Private Dependent upon the size of the private limited • Disagreement
Limited company, suppliers, banks, Government grants and among existing
Company loans, venture capital institutions, private share shareholders
(Ltd) issues. • Difficulty finding
suitable
shareholders
• Loss of control
by existing
shareholders
• Lack of
collateral and
 security for
those lending
funds
• Element of risk
in the loan
Public Suppliers, banks, Government grants and loans, • State of
Limited venture capital institutions, public share issues via economy and
Company the Stock Exchange. stock market
(plc) • Ability to move
to area receiving
government aid
• Recent financial
performance
• Reputation of
company and
senior
managers
Table 18.3 The legal structure of a business, possible sources of finance and key issues

3. Flexibility
Some sources of finance are highly flexible and can be adapted to meet a business’s precise
needs. The most obvious example is an overdraft. This source of finance allows a business to
overspend on its current account (or not) according to its needs (but subject to an overall limit).
Thus, a business can use its overdraft only when it is necessary and can avoid any interest
charges at times when its finances are stronger. This flexibility has a price however: overdrafts
are an expensive source of finance.

4. 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 limited company makes a succession of share 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 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 considered 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.

5. The purposes for which the finance is needed

Some sources of finance are suitable in certain situations. Thus, 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. 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.
In contrast, 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.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 State the difference between a short-term and a long-term source of finance.
2 Is the following statement true or false? ‘A major consideration when deciding
whether or not to use retained profits as a source of finance is opportunity cost.’
3 What is meant by the term overdraft?
4 State two reasons why a manager might be reluctant to use debt factoring as a
source of finance.
5 State two features of a bank loan.
6 Is the following statement true or false? ‘Venture capital is not suitable as a source
of finance for start-up or small businesses.’
7 State two types of businesses that can use share capital as a source of finance.
8 State two possible advantages of using retained profits as a source of finance.
9 State two disadvantages of using overdrafts as a source of finance.
10 State two factors that might influence a manager’s decision on which source of
finance to use.

(b) Short answer questions

1 Explain the circumstances in which a business may decide to use an overdraft as a
source of finance.
(4 marks)
2 Explain one reason a company in a very competitive market with low profit margins
may decide not to use debt factoring as a source of finance.
(5 marks)
3 Explain one reason the management team of a successful public limited company
might decide not to use retained capital as its source of finance.
(5 marks)
4 Explain one reason a first-time entrepreneur might choose to use venture capital as
a source of finance.
 (5 marks)

(c) Data response questions

Bowles Foods plc is one of the UK’s largest food-processing and manufacturing
companies and is highly successful – its profits for the year have averaged £360
million over the last two years. It is well managed and has a reputation for paying
shareholders high and increasing dividends.
It owns factories across the UK and is planning to expand its operations into eastern
Europe. This requires the company to raise £750 million. Initially, the company
planned to use its profits over the next three years as the major source of finance, but
has opted to use share capital to finance the entire sum. The CEO has stated that it
will sell the new shares at an attractive price. The company owns a number of assets
including a derelict factory site in east London.
Some the of the company’s directors have opposed this decision and have
recommended that the company uses a mix of sources of finance, particularly aiming
to use share capital, profits and loan capital. They see significant advantages in this
approach, even though interest rates in the UK are forecast to rise steadily over the
next few years.
1 Explain the disadvantages of using profits to finance the proposed expansion.
(5 marks)
2 Analyse the possible implications for the company’s shareholders of using share
capital to finance the expansion.
(9 marks)
3 Do you agree with the decision to raise the £75 million solely by using share
capital? Justify your opinion.
(16 marks)

(d) Essays
1 To what extent do you think that it is true to say that it is always easier for a
profitable business to raise capital?
(25 marks)
2 ‘A well-managed business should not need to use any external sources of short-
term capital.’ To what extent do you agree with this statement?
(25 marks)
Chapter 19 Improving cash flow and
profits
Introduction
In previous chapters in this unit we have looked at the financial objectives that managers might
set for their businesses, the techniques they might employ to analyse the financial position of the
enterprise and some of the decisions they may take to achieve their objectives. This chapter
concludes this unit by considering two other key aspects of financial decision making: selecting
the most appropriate methods of improving a business’s cash flow position and its profitability.
What it is important to know by the end of this chapter:
• the methods used to improve a business’s cash flow position
• the methods used to improve a business’s profits and profitability
• the difficulties managers face in improving a business’s cash flow and profit.
Improving cash flow
The first stage in improving a business’s cash flow is to identify why the business is
encountering difficulties in this area. Having identified the cause of the problem it is possible to
apply the most appropriate remedy.
Causes of cash flow problems
Arguably, the major cause of cash flow problems is lack of planning by managers. Many
businesses, once established, do not forecast in this way and are thus at risk of unforeseen
problems.
A number of other factors can contribute to cash flow difficulties:
1 Overtrading. This occurs when a business expands quickly without organising funds to
finance the expansion. Rapid growth normally involves paying for labour and raw materials
several months before receiving payment for the final product. If this occurs over a prolonged
period, a business can face severe cash flow shortages.
2 Allowing too much trade credit. Most businesses offer trade credit, allowing customers
between 30 and 90 days to pay. This helps to win and retain customers. However, if a firm’s
trade credit policy is too generous, it may lead to cash flow difficulties as cash inflows are
delayed. In such a situation a business may find itself unable to pay its bills when they are due
as it has not received payment from its customers.
3 Poor credit control. A business’s credit control department ensures that customers keep to
agreed borrowing limits and pay on time. If this aspect of a business’s operation becomes
inefficient, cash inflows into the firm may be delayed. In some cases, a customer may not pay
at all (this is known as a ‘bad debt’). In such circumstances, it is highly likely that a firm will
encounter problems with its cash flow.
4 Inaccurate cash flow forecasting. It is unlikely that managers will always forecast cash flow
accurately. Inaccurate forecasting can lead to a business not believing that it will face cash
flow problems and possibly not monitoring its forecasts to confirm that they are correct.
Inaccurate forecasting may occur because of inexperience on the part of managers, unexpected
costs, perhaps due to an unforeseen rise in the price of fuel or raw materials or simply over-
optimistic assumptions about the level of future revenue from sales.
The importance of monitoring cash flow
Monitoring cash flow is an essential and ongoing element of managing cash flow effectively and
on improving a poor position. The process of comparing actual and forecast cash flows is called
variance analysis. (We considered variance analysis in Chapter 17.) If a manager can spot a
looming cash flow problem at an early stage by comparing forecast and actual cash flow on a
monthly basis then it is possible to take prompt and decisive action. These actions, which we
consider below, may rectify the problem before it becomes too severe.
Steve Marshall’s cash flow forecast – June
Budget Actual
Cash in
Savings & borrowings 75,000 75,000
Cash sales 5,750 5,230
Credit sales 0 0
Total cash inflow 80,750 80,230
Cash out
Purchase of lease on shop 30,000 29,500
Purchase of books 59,000 60,000
Wages 1,500 1,450
Marketing costs 2,500 2,400
Other costs, e.g. rent 1,500 1,500
Total cash outflow 94,500 94,850
Net monthly cash flow (13,750) (14,620)
Opening balance 2,000 2,000
Closing balance (11,750) (12,620)
Table 19.1 Monitoring Steve Marshall’s cash flow
In Chapter 17, we saw that the managers at Marshall Books ltd had drawn up a cash flow
forecast as part of their financial planning for the opening of the company’s newest bookshop.
Table 19.1 shows the actual cash movements that took place during his first month of trading in
comparison with the forecast. It is apparent that the bookshop’s cash position is slightly worse
than forecast. The managers expected to have a closing balance of (£11,750) whereas it is
(£12,620). This may mean that they need to increase the overdraft above the amount they
originally thought that would be needed.
 Handling data
An entrepreneur had forecast that her business would have a cash balance of
(£250,500) at the end of last month. Her opening balance for the month was
(£130,795) and her net cash flow for the month was (£111,425).
1 What was her cash balance at the end of the month?
2 Was it worse or better than she expected?

Managers need to assess the significance of any unexpected figures when analysing forecast and
actual cash figures. There are a number of possible causes when considering cash variances:
• It might be a one-off occurrence that will not happen again – such as a cancelled order (or an
unexpectedly large one).
• It could be due to seasonal variations such as high levels of sales at Christmas or over the
summer period – this can be important for certain types of businesses such as toy shops or
garden centres.

Business in focus: Carillion collapses

Until its collapse in 2018, Carillion provided a range of services to other companies
and to governments. It began as a construction company, building everything from the
company headquarters to football stadia. It later diversified into both the public and
private sectors, providing meals in schools and maintaining bases for the Ministry of
Defence. Carillion achieved sales revenues of over £5 billion in 2016; it employed
43,000 people.
Construction is an industry that has very low profit margins. To expand the business
and to maintain cash inflows Carillion’s managers won contracts to build hospitals and
roads by offering ever-lower prices. Unfortunately for Carillion, most of these projects
faced problems which increased costs. Carillion’s management made serious errors
and poor decisions. For example, it paid £306m for Eaga, a supplier of green-energy
products. A few months later, the UK government cut subsidies to the industry
resulting in a substantial fall in demand for Eaga’s products.
Carillion had plenty of debt – about £850m at the time of its last annual report –
although this had grown much larger by the time of its demise. Any high-margin work
is good, as long as you actually receive payment. Industry insiders say Carillion was
owed about £400m from Middle East contracts when it went under – for example, it
was owed £200 million for work in Qatar in preparation for the 2022 football World
Cup. The company had been trying to help itself by extending its payment times to
contractors from 80 days to 120 days.
The company issued warnings about its profits three times in the months leading to its
collapse. The company made a loss of £1.15 billion in the first six months of its final
year of trading. It finally collapsed in January 2018 having debts of over £1 billion and
 just £29 million in cash.

Practice questions
1 Analyse the reasons why Carillion faced cash flow problems.
(9 marks)
2 Do you think Carillion would have survived had it been more profitable? Justify
your view.
(16 marks)

• More critically, it may be part of a continuing trend – whether sales are rising or falling
steadily, there will be cash implications.
• It could be self-correcting – a surge in demand followed by a slump, and in this case no action
will be required.
Methods of improving cash flow
Identifying potential cash flow problems is only part of the solution. Managers have to decide
what actions to take to improve the cash position of their business. A number of techniques can
be used to improve cash flow.

1. Improved control of working capital

Working capital is the finance available to the business for its day-to-day trading activities.
Working capital is available to a business when its customers pay for the goods or services they
have received. Working capital is used to pay wages, and for fuel and raw materials. There are a
number of techniques set out below that a business may use to improve its working capital.

2. Negotiate improved terms for trade credit

Most firms receive some trade credit from their suppliers. This means they are given 30 or 60
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 improve its cash position. Remember, cash flow management
is a matter of timing – delaying payments always helps. Another important move might be to
extend existing trade credit agreements from, say, 30 to 60 days, or from 60 to 90 days.

3. Offer less trade credit

Similarly, a business can help its cash flow position by offering its customers less favourable
terms for trade credit. This may require all customers to pay for products within 30 days,
whereas in the past trade credit was for 60 days. However, this decision may result in a loss of
customers as they move to competitors who offer more favourable credit terms.

4. 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. Factoring debts in this way provides up to 80 per cent of the value of an
invoice as an immediate cash advance. The financial institution then organises the payment of
the invoice and makes a further payment to the business concerned. It is usual for the financial
institution to retain about 5 per cent of the value of the invoice to cover their costs.
Many firms believe that to lose up to 5 per cent of their earnings means that factoring is
uneconomic – it can eliminate much of their profit margin. However, factoring does offer the
benefit that the immediate cash provided by the factor means that the firm is likely to have lower
overdraft requirements and will pay less interest.
Debt factoring is generally used by small businesses. Businesses with a turnover above £1
million normally use an alternative technique (called invoice discounting) where the company
retains the administration of the deal within the business. This way, its customers need not know
that the company is using a debt factoring service. This can help a business to retain the
confidence of its customers.

5. Arrange short-term borrowing

The majority of businesses have an agreed overdraft with their bankers, although small and
medium-sized enterprises (SMEs) in the UK have faced problems in negotiating overdrafts over
the last few years. An overdraft allows a business to borrow flexibly according to its needs, up to
an agreed limit. Overdrafts can be expensive, but are reasonably economical and flexible when a
business only borrows a set amount for a short period. As an alternative, a business may decide
on a short-term loan to provide an injection of cash into the business. A short-term loan is likely
to have a lower rate of interest and the option to pay the loan back over two years or so may be
attractive to a business that is short of cash.

6. Sale and leaseback

This method of improving cash flow has been widely used by businesses over recent years. It
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 cash
position, but commits the firm to regular payments to lease the asset. In 2018, Dorian LPG, the
owner of huge tankers that transport natural gas around the world, agreed a $70 million deal for
its vessel, Concorde. Over half of the sum received by Dorian LPG was used to repay some of
the company’s existing debts.

Business in focus: Sale and leaseback of business vans

‘Cash flow poses problems for many businesses. But your vans could provide a
much-needed cash using sale and leaseback. It’s worth considering because
access to cash is limited and expensive. Small and medium-sized businesses are
being hit hard by late payers. Research in 2012 reported that average
outstanding debt for a small or medium-sized enterprise (SME) was £36,000.
But sale and leaseback can help. How? You sell your van, or vans, to a leasing
or fleet management company and they lease them straight back to you on a
contract hire deal.
How a sale and leaseback works
You sell your vans to a leasing company.
The money is transferred to your business.
The leasing company then leases your vans back to you.
The vans remain in your hands at all times, so there’s no disruption to your
operations. You get an agreed price for the vans and you pay a set monthly
rental to keep using them for an agreed period. You can pay for the lease
company to handle all the maintenance too, if you want.
A big advantage is the cash sum, which you can use to improve cash flow. But
there are other benefits. It can be cheaper than a bank loan. You don’t have the
hassle of disposing of the vans when it’s time for them to leave your fleet. You
also remove the risk of falling second-hand values. The leasing company handles
 disposal – subject to fair wear and tear conditions – and they take the hit if used
van prices plummet.
Little wonder that sale and leaseback deals have been on the up since the
financial crisis first occurred in 2008. But sale and leaseback is not suitable for
every business.’
Source: Glynn William, Sale and leaseback: a cash injection for your business vans © Copyright
Business Vans 2019

Practice questions
1 Analyse the reasons why sale and leaseback of vans might be attractive to a
business with cash flow problems.
(9 marks)
2 Do you think that sale and leaseback is always suitable to improve a business’s
cash flow position? Justify your view.
(16 marks)

Cash flow and business performance

A business can benefit in a number of ways from effective and careful management of cash flow.
1 Reduced borrowing costs. If managers can predict periods of cash flow difficulty and take
appropriate actions then it is likely that a business will not need to use its overdraft facility as
fully as might have been the case. This can reduce interest charges significantly. If a business
exceeds its overdraft limit then its bank is likely to impose penalty charges. Reducing interest
charges means that a business will incur lower costs and enjoy higher profits or reduced
losses.
2 Good relations with suppliers. Careful management of cash makes it more likely that a
business will be able to pay suppliers promptly and in full. Many suppliers offer discounts for
prompt payment and this can help a business to reduce its costs. Receiving a discount on
supplies is also an effective way of reducing the business’s costs.
3 Public relations. Businesses experiencing cash problems may lose the confidence of their
customers, who doubt their ability to continue to supply goods and services. In such
circumstances customers may no longer place orders; this is almost certain to exacerbate the
problem and may result in the company being unable to continue trading.
Improving 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. We looked at the topic of
profitability and profit margins in detail in Chapter 17.
Improving profits
A survey by The Royal Bank of Scotland revealed that over 25 per cent of small businesses said
that increasing profits was their ‘main objective’. There are a number of methods that a business
can use to achieve this aim.

1. Reduce costs of production

This is perhaps the first consideration of many managers when considering how to increase
profits. If a business can maintain its prices while reducing its costs of production then profit
margins will increase. So long as sales do not decline, its profits will rise. However, there are a
number of risks in taking this action. First, the reduction in costs may result in lower quality
goods or services being supplied. This could result in a loss of customers, which could prove
counterproductive and ultimately reduce profits.
In 2018, Jaguar Land Rover, one of the largest car manufacturers in the UK said that it was
moving production of its Discovery Sports Utility vehicle from Solihull in Birmingham to
Slovakia. The company will be able to take advantage of lower production costs in Slovakia.
Jaguar Land Rover already has factories in Brazil and China.

2. Increase prices
The other obvious option is to increase the price at which the business sells its products. An
increase in revenue per unit with costs stable will boost profit margins. However, this is a risky
option as an increase in price may lead to existing customers seeking alternative suppliers and
potential new customers looking elsewhere. The success of this decision depends on the
importance of price in the decision to purchase and thus on price elasticity of demand. The
manager of a luxury hotel may be able to increase prices for accommodation and food with little
effect on sales. In contrast, a small city-centre cafe may find a high proportion of its customers
move elsewhere if prices are raised.

Business in focus: Wearable technology improves

productivity
 Figure 19.1 The Neurosky MindWave tracks brain activity

Businesses worldwide are investigating the benefits of asking employees to wear

technology such as motion monitors and fitness bands in the workplace. Employees
at approximately 29 per cent of UK businesses and 63 per cent of American
businesses are already wearing some form of technology in the workplace.
Major companies such as BP have stressed the benefits of employees using
wearable technology. A technology director at BP has argued that wearable
technologies offer a number of benefits to businesses in the energy industry. He
explained that the technology could reveal heat stress allowing prompt intervention to
avoid any harm to employees. Employees could wear ‘smart glasses’ which would
allow them to receive guidance from expert colleagues who may be working
elsewhere. This could improve their effectiveness at work while simultaneously
helping to avoid accidents and injuries.
Moves to use wearable technology has been supported by research into the Human
Cloud at Work (HCAW) conducted by the University of London. The research was
carried out over one month. The participants in this research wore one or more of the
following technologies:
• Neurosky MindWave brain activity sensors
• GENEActiv motion monitors
• Lumo Back posture coach.
The HCAW study provided a number of important findings. It showed that the use of
wearable technologies increased labour productivity by 8.5 per cent. It also revealed
that employees did not appear to resent using this type of technology as only 5 per
cent of employees were concerned about their use and job satisfaction rose by 3.5
per cent amongst participants in the study.
In the future wearable technology could be used to generate a wide range of data on
factors that might affect employees’ performance at work such as an employee’s
location or the temperature of the workplace. This data could help managers to
improve employee productivity and the business’s competitiveness.

Practice questions
1 Analyse the possible financial benefits a business might receive from the
productivity of its employees increasing by 8.5 per cent.
(9 marks)
2 Do you think a multinational company should require its employees to use
wearable technology in all aspects of its operations? Justify your opinion.
(16 marks)

British Gas announced a 5.5 per cent rise in its electricity prices in April 2018, following a 12.5
per cent price increase in September 2017. Consumers protested against the increase and even
the UK government said that the price rise was unjustified. The company has received adverse
publicity and the impact of the change on customer numbers remains to be seen.
 What do you think?
How much of a risk is it for an energy company to increase its prices by a substantial
amount?

3. Improve the business’s efficiency

An efficient business uses a minimal amount of resources to produce its goods or services.
Managers can take a number of decisions to increase the efficiency of their businesses and
thereby reduce costs, with positive implications for profits.

4. Use capacity more fully

A business’s capacity is the maximum amount that it can produce. If this capacity is used fully
then the business’s fixed costs are spread across more units of output, helping to reduce average
cost. If prices are unchanged profits should rise as the business’s profit margin per unit will rise.
At the same time, more of the business’s products are sold without incurring too many additional
costs. This should increase revenue and profits.
Many small UK airlines operate Jetstream 41 aircraft, which can hold a maximum of 29
passengers. Profits from operating these aircraft can be increased if the aircraft is full, or nearly
full, on flights. In this context a full aircraft means that the airline is using its capacity as fully as
possible. The costs of operating a full aircraft are only a little higher (some additional fuel and
meals) and more passenger fares will increase revenue.

Figure 19.2 A Jetstream 41 aircraft

5. Reduce the number of substandard products

If a business produces products that are not of the right quality, then it incurs additional costs.
This is because it has paid to produce goods that it cannot sell. These must either be scrapped or
reworked to make them saleable. In either case, costs rise. Any management decisions (for
example, training employees to monitor quality) that help to reduce the number of poor-quality
products will help to reduce costs of production and enhance profitability.

6. Improve methods of production

Decisions to improve the efficiency of the production process can help to reduce costs and to
improve profitability. On the island of Jersey, businesses were encouraged by the island’s
government to recycle cooking oil for use to fuel vehicles, to reduce disposal costs of the oil, as
well as reducing expenditure on petrol or diesel.

7. Eliminating unprofitable aspects of production

A business can take decisions to close down certain aspects of its operations that are making a
loss. This can lead to increased profits for the remaining parts of the enterprise as the business
uses its resources in the most efficient manner. Homebase, a retailer that sells DIY products,
closed 42 of its 241 UK stores in an attempt to reduce its costs and return the business to
profitability. The decision put 1,500 jobs at risk.

Figure 19.3 Methods of improving profits

Taking actions to improve profitability
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’s profitability as it will
probably result in a higher percentage of the selling price of a product being profit. However, if
demand is price elastic it may result in a fall in overall profits. We saw earlier that British Gas
has increased its prices twice within twelve months. This action is likely to increase its
profitability. The company will probably enjoy increased profits as well as profitability from this
price rise as UK customers are reluctant to change energy suppliers and therefore demand for its
services is likely to be price inelastic.
Most actions intended to cut costs have the potential to increase profits and profitability so long
as the action does not reduce the value the consumer receives from the product. So, actions to
reduce a company’s waste should increase profits and profitability as they are unlikely to have
adverse consequences for consumers.
Difficulties in improving cash flow and
profit
Managers can face a number of difficulties when attempting to improve a business’s
performance in terms of cash flow and profits:
• identifying that there is a problem. This is not always simple to do in a timely fashion. It may
take a business several months to uncover a cash flow problem, for example, especially if cash
budgets are not carefully monitored.
• researching the cause of the problem. Identifying that there is a problem is the first difficulty.
In many cases the management team will have to research the cause before being able to take
appropriate action. If a company suffers a large and sudden fall in sales and thus profits it may
have to invest in primary market research to discover the reasons for the decline in consumer
interest. This may be a rival offering similar products more cheaply or may be because its
products are considered unfashionable. Once the cause is known suitable remedial action can
be taken.
• coping with any adverse consequences in terms of the image of the business. Some decisions
to improve cash flow or profits can have undesirable consequences. Jaguar Land Rover’s
decision to move production of its Discovery model to Slovakia will result in job losses in
Solihull. This is likely to have harmed the company’s image, especially in the West Midlands.
• some decisions may have adverse consequences in the short term. A business may decide to
invest more heavily in advertising to boost sales and improve profits. However, in the short
term the increased cost of promotion may damage its profits until sales begin to rise.
In addition each method we have discussed to improve a business’s cash flow or profits and
profitability has particular difficulties associated with it. These are summarised in Tables 19.2
and 19.3.
Method of Associated difficulties
improving cash
flow
Improved control • The employment of additional staff to oversee the control will
of working capital increase costs.
• Customers may object to being pressured to pay and buy
elsewhere.
Negotiate • This may be difficult for a firm with a poor payment record to
improved terms for achieve.
trade credit • Discounts for prompt payment may be lost reducing profit
margins.
Offer less trade • Customers may move to other businesses offering more
credit favourable trade credit terms.
• Prices may have to be lowered in compensation.
 Debt factoring • Use of this technique can reduce profit margins by up to 5 per
cent.
• Customers may be unsettled by the realisation that a supplier is
having cash flow difficulties.
Arrange short-term • This can be expensive, especially if an overdraft is used.
borrowing • The lender may gain some control over the business, either
through holding collateral or by being able to withdraw credit at
short notice.
Sale and • The business may not receive a good price for the asset,
leaseback especially if it is under pressure to sell it.
• The business is committed to paying a rental on the asset
permanently, which may reduce profits and impact on long-
term cash flow.
Table 19.2 Difficulties associated with techniques to improve cash flow

Method of improving Associated difficulties

profits
Reduce costs of • This may result in lower-quality products if cheaper
production materials or less skilled employees are used.
• It may entail redundancies upsetting customers and making
it difficult to attract high-quality candidates in the future.
Increase prices • May reduce sales and revenue substantially if demand is
price elastic.
• May result in criticism, particularly if the product is
essential.
Improve efficiency • May involve replacing labour with technology leading to
redundancies.
• May lose personal touch and lead to more standardised
products.
Use capacity more • May require a price cut, reducing revenue to some extent.
fully • May be difficult to manage supply effectively to match
demand, especially if it fluctuates.
Reduce the number of • May require additional expenditure on employees or
substandard products technology to identify faulty products.
• May require more expensive inputs, increasing costs.
Improve methods of • This approach might require an investment in technology
production increasing the business’s capital expenditure.
• Staff training costs may increase in the short and long term.
 Eliminate unprofitable • Possibility of redundancies resulting, with adverse publicity.
aspects of production • It may be difficult in some businesses to identify
unprofitable aspects of production.
Table 19.3 Difficulties associated with techniques to improve profits and profitability

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 Is the following statement true or false? ‘Drawing up detailed cash flow forecasts
eliminates all risks of cash flow problems.’
2 State two factors that may cause a business to encounter cash flow problems.
3 What is meant by the term ‘sale and leaseback’?
4 State one consequence of a business offering its customers less favourable terms
for trade credit.
5 State two possible implications for a business of using debt factoring to improve its
cash flow position.
6 Is the following statement true or false? ‘An increase in price will always increase a
business’s profits.’
7 What is the difference between profits and profitability?
8 State two reasons why using capacity more fully should increase a business’s
profits.
9 State two difficulties a manager may face as a consequence of reducing costs of
production to increase a business’s profits.
10 State two general difficulties managers might encounter when implementing
actions intended to improve cash flow or profits.

(b) Short answer questions

1 Explain how monitoring cash flow might help a rapidly expanding business to avoid
cash flow crises.
(6 marks)
2 Explain how decisions on terms for trade credit may affect the cash position of a
large and very competitive furniture retailer.
(6 marks)
3 Explain how effective management of cash flow might improve a business’s profit
margin.
(6 marks)
4 Explain how a hotel chain might improve its profitability by using its capacity more
fully.
(6 marks)
(c) Data response questions
Helix plc manufactures a range of components for high-technology products such as
tablets and smartphones and is one of the largest firms in the industry. The company
has its headquarters in London (which are valued at £95 million), but much of its
manufacturing is carried out in Vietnam and Thailand.
The company wishes to raise £125 million to finance expansion in Cambodia and to
allow it to close its UK factories. This is forecast to lower its costs by 20 per cent and
is judged essential to improve the company’s very low overall profit margin of 1.9 per
cent: some of its products have negative profit margins. It is considering taking
advantage of the property boom in London by selling its offices and leasing them back
again. Much of its capital has been raised through the sale of shares and it has low
levels of borrowing.
The company supplies many major technology companies including Samsung and is
noted for its price competitiveness in return for prompt payment. Helix plc’s customers
appreciate the quality of its products as well as its reliability. Demand for its products
is surprisingly price inelastic. It places very large orders with its own suppliers and
benefits from its scale.
1 Explain why a sale and leaseback deal might improve Helix plc’s cash flow position
but weaken its profitability.
(6 marks)
2 Analyse the possible reasons why Helix plc has a relatively strong cash flow
position.
(9 marks)
3 Do you think that Helix PLC should improve its profitability by moving production
from the UK to Cambodia? Justify your opinion.
(16 marks)

(d) Essays
1 Do you think that any actions taken by an SME (small or medium-sized enterprise)
to improve its cash position will inevitably damage its profitability. Justify your view.
(25 marks)
2 To what extent is price elasticity of demand likely to be the major factor determining
whether a fashion clothing retailer’s price cuts will improve its profitability?
(25 marks)
Revision Section: Unit 5 Decision
making to improve financial
performance
Advice for Unit 5
Top tips … Things to avoid …
Think about the topics in Do not express the answers to calculations in the
this unit in relation to wrong units. For example, a break-even calculation
different types of should be expressed in terms of units of output and
businesses and industries. a profit margin as a percentage.
For example, when is the
use of break-even analysis
particularly valuable to
businesses? This will help
you to prepare for
analytical and evaluative
questions.
Consider the effects of Do not confuse the sale of new shares and second-
financial objectives on hand shares. Firms sell newly issued shares
other functions such as directly to the shareholders. In contrast, second-
marketing. This can help hand shares are sold mainly through the Stock
you to develop powerful Exchange. When second-hand shares are sold on
lines of argument. 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.
Remember that financial Do not confuse contribution and profit: they are
objectives are not set in different concepts.
isolation from the rest of
the business. They will be
a part of the creation of
objectives for the entire
business and should help
to achieve these.
When writing about Using terms like costs and prices carelessly. They
budgets remember the have different meanings and should be used
links that exist with other precisely.
functions within a
business. One link is
between revenue budgets
and marketing. Market
research may play an
important part in
forecasting sales and
therefore also in revenue.
It is important that you Do not muddle profit and cash flow. Remember that
understand how cash flow they have quite different meanings. Avoid using the
forecasts are constructed terms interchangeably and if a question asks about
to help you to more easily cash flow, do not drift into discussing profit.
identify potential problems
and consider possible
solutions.
Practise both drawing When answering questions it is not necessary to
break-even charts and define the terms in the question at the start.
using them to illustrate the However, your answer should demonstrate that you
impact of a change in do understand the business terms on which the
price or change in costs question is based.
on both the break-even
point and profit.
When managers take Do not forget both the advantages and
decisions intended to disadvantages of the various sources of finance will
increase profits they help you suggest and justify suitable sources in
consider the effects on specific circumstances.
other functional areas
within a business. You
should look to consider all
aspects of a business
when tackling questions
on this topic.
UNIT 5 CHECKLIST
Having completed studying this unit you should be able to do all that is listed below.
You should read this list and confirm that this is the case.

Setting financial objectives

Know and understand:
• why businesses set financial objectives and the value to them of doing so
• a range of financial objectives including revenue cast, profit and cash flow
objectives, as well as objectives relating to investment and a business’s capital
structure
• the difference between cash flow and profit
• the difference between gross profit, operating profit and profit for the year
• the external and internal influences on financial objectives and decisions.
Analysing financial performance
Know and understand:
• how to analyse a business’s financial performance using a range of methods
• how to construct and analyse budgets and cash flow forecasts and the value of
budgeting
• how to analyse a business’s profitability including the use of profit margins
• how to construct and interpret break-even charts and the value of break-even
analysis
• how to analyse the timings of cash inflows and cash outflows
• the use of data for financial decision making and planning.
Making financial decisions: sources of finance
Know and understand:
• the internal and external sources of finance used by a business
• the advantages and disadvantages of different sources of finance for short- and
long-terms purposes.
Making financial decisions: improving cash flow and profits
Know and understand:
• the methods that businesses can use to improve their cash flow
• the methods that businesses can use to improve their profits and profitability
• the difficulties that businesses may face when attempting to improve their cash flow
position and profits
• how to develop relevant arguments and make and support judgements as
analytical and evaluative questions can be asked on the topics covered in this unit.
Practice questions
1 The data below shows the costs and revenues for a business that produces only
one product.
• Selling price = £120
• Current profits + £275,000
• Variable cost per unit = £70
• Annual fixed costs = £125,000
a Calculate the business’s level of break-even output.
(2 marks)
b Calculate the business’s current margin of safety.
(2 marks)
2 The data below relates to a business’s budgeted and actual financial performance
over the last financial year.
Revenue/cost Budget figure £ Actual figure £
Sales revenue 805,125 820,190
Labour costs 347,500 359,675
Material costs 202,350 231,250
Other costs 272,000 268,345

Calculate the business’s profit variance for the year and state whether it is adverse
or favourable.
(4 marks)
3 A business’s accounts show that over the last year its revenue increased steadily
along with its gross profit margin. However, its operating profit margin fell.
Explain the reasons why these changes in the business’s profit margin may have
taken place.
(5 marks)
4 Analyse one way in which a sole trader business that is short of cash may raise
short-term finance.
(5 marks)
5 Analyse the ways in which cutting prices might affect the profits of a business.
(9 marks)
Case study: Voltaic plc announces new
factory in Vietnam

The market
The market for manufacturing solar panels in the UK is subject to a number of
influences. Demand is generally rising as an increasing number of solar panel farms
are established and households and businesses are investing in their own source of
renewable energy. Retailers such as IKEA, sell solar panels in all its UK stores.
Panels are sold on the internet on websites such as eBay. The UK Government offers
a subsidy to those installing solar panels to encourage the expansion of renewable
energy generation. Homeowners with solar panels typically sell 60 per cent of the
electricity they generate.
The solar panel manufacturing industry is increasingly competitive with suppliers in
Asia proving very efficient. There has been a series of takeovers in the industry with
companies buying smaller rivals to gain market share. Prices for solar panels in
Europe fell by more than 30 per cent between 2015 and 2018. Prices are expected to
continue to decline slowly. This decline in price may be accelerated if the latest
research is converted into saleable products.
Researchers at Liverpool University have replaced cadmium chloride, a toxic
substance, in the production of panels with the much cheaper magnesium chloride.
This development could make solar panels less expensive, more flexible and easier to
use.
The performance of the world economy is patchy and demand in markets in the UK
and Europe for products such as solar panels has not risen as strongly as was
forecast. Furthermore, interest rates in the UK are forecast to rise over the next few
years, which may have a negative impact on consumers’ spending power. However,
economists have argued that, despite the expected rises, interest rates will remain
very low by historical standards for the foreseeable future and inflation rates are also
forecast to be low and stable.
The company
Voltaic plc manufactures a range of electronic products but its division that makes
solar panels is its largest. It has grown quickly since 2014 and has financed much of
its growth through loan capital; currently about 40 per cent of its capital has been
raised through loans agreed with its bank and other organisations. Investors have
been nervous about the company’s financial performance at times, however, fearing it
was at risk of overtrading.
Other aspects of the company’s financial performance have caused concern for some
of its stakeholders. In particular, its operating profit margin at 6.4 per cent has been
low in comparison to some other companies in the same market. One consequence of
this has been that Voltaic plc’s dividend payments have been low, leading to
complaints from a vocal group of shareholders seeking short-term returns.
Its solar panels are forecast to sell for an average price of £5,500 next year, though
this could alter as the market is changing, complex and difficult to predict.
The expansion plan
The company’s management team believes that there is considerable long-term
potential in the market for solar panels in Europe as well as the UK. It wishes to
increase its production capacity. Voltaic plc’s management team has developed a plan
to open a new factory in Tuy Hoa, a coastal town in Vietnam, which will initially only
manufacture solar panels. Typical monthly wage costs in Vietnam are about £100 a
month, one-third of those in China and approximately 10 per cent of the company’s
UK pay rates. The new factory will operate alongside the company’s existing solar
panel factory in North Wales, although trade unions believe the jobs should be created
in the UK and not overseas.
Annual fixed costs £4,500,000
Labour cost per solar panel £875
Materials costs per solar panel £2,900
Other variable costs per solar panel £1,625
Production capacity 120,000 panels
Table U5.1 Financial data for the Vietnamese factory for its first year of production
The company needs £74 million to finance the plan for the factory in Tuy Hoa and the
director of finance has recommended that £58 million of this is raised by the sale of
shares in the company. This will increase the total share capital of the company by 11
per cent.
Practice questions
1 Analyse the possible influences on Voltaic plc’s capital structure targets following its
expansion.
(12 marks)
2 Analyse the importance to Voltaic of setting financial objectives.
(12 marks)
3 To what extent do you agree with the company’s decision to finance its expansion
primarily through the sale of shares?
(16 marks)
4 The Finance Director believes that break-even analysis is of little value in judging
the financial performance of the new factory in Vietnam. To what extent do you
agree? Justify your opinion.
(20 marks)
5 To what extent do you think that a decision to open a factory in Tuy Hoa will
improve the financial performance of Voltaic plc?
(20 marks)
6 Do you think reducing costs is always the best way for a business to improve its
profits? Justify your view.
(20 marks)
Essays
1 To what extent is it inevitable that any decision by a business to improve its profits
will be unethical?
(25 marks)
2 ‘A profitable business should not experience any difficulties in maintaining a
positive cash flow position.’ To what extent do you agree? Justify your opinion.
(25 marks)
Chapter 20 Setting human resource
objectives
Introduction
This chapter is the first of five that consider how managers can take decisions to improve a
business’s human resource (HR) performance. It also is the first element of the decision-making
process in relation to human resource issues: deciding what HR objectives a business should
pursue. Later chapters in this unit will look at the subsequent stages in the HR decision-making
process such as analysing HR performance and taking HR decisions.
What it is important to know by the end of this chapter:
• the value of setting human resource objectives
• internal and external influences on human resource objectives and decisions.
A business’s human resource (HR) function or department is responsible for the use of labour
within the organisation. Human resource management (or HRM) views activities relating to the
workforce as integrated and vital in helping the organisation to achieve its overall or corporate
objectives. People are viewed as an important resource to be developed through training. Thus,
policies relating to recruitment, pay and appraisal, for example, should be part of a co-ordinated
approach to human resources. HRM is an all-embracing integrated approach that aims to make
the best use of human resources in relation to the business’s overall objectives.

Figure 20.1 The functions of business

The value of human resource objectives
Human resource objectives are the goals or targets that a business’s HR function or department
seeks to achieve. The achievement of these targets should assist the business in attaining its
overall corporate objectives. In its 2018 Annual Report, Tesco plc, one of the UK’s largest
retailers, has stated its core purpose: ‘Serving Britain’s shoppers a little better every day’. The
company’s human resource function has set itself a number of objectives to enable the business
to achieve this core purpose. For example, investing in training its 440,000 employees so they
are supported to develop their careers and to build skills for their future. This will assist them in
meeting the needs of Tesco’s customers as fully as possible.
It is normal for HR objectives to contain a specific numerical element and also a timescale within
which they are to be achieved. The HR target will be set by the managers responsible for human
resources in the business, but will be consistent with other functional objectives and also
contribute to the achievement of the business’s overall or corporate objectives. Thus the
management team at Tesco believes that having a well-trained workforce will aid it in fulfilling
its vision of growth.
Businesses can derive great benefits from setting human resource objectives. It is one way in
which managers and owners are able to judge the performance of an enterprise. It may be that
managers set objectives relating to the amount employees produce each week, the quality of their
work or to the feedback ratings received from customers. Such objectives can provide a target for
managers and employees and can help to improve performance, especially if monetary or other
rewards are offered for achieving the goals. It is possible to set HR objectives in relation to any
measurable aspect of employee performance and to use these as a means of motivation.
Further, by comparing the actual performance of the business’s workforce against these
objectives it is possible for managers to assess the achievements of the workforce and to provide
guidance on further actions that may need to be taken. In later chapters in this unit we will look
further at how to analyse performance and the actions that can be taken subsequently to improve
the performance of an organisation’s employees.
Human resource objectives are also valuable to managers because many businesses are judged
by customers on the basis of employee performance. By setting challenging but fair HR
objectives, managers can set a standard for employee performance which will meet the needs and
expectations of customers, who are a vital stakeholder group. It also helps the business’s image if
it is seen to have high and clear expectations of its employees and this can result in favourable
publicity. One reason for the success of the John Lewis Partnership (which operates 51
department stores and 349 Waitrose supermarkets) is that customers value the knowledge and
skills of the retailer’s employees. Setting demanding objectives in terms of employee
performance, involvement and training helped the business to achieve sales in excess of £11.5
billion for the first time in 2017.
Finally, the use of human resource objectives enables managers to identify those aspects of the
performance of the business at the earliest possible stage that are causing problems. If particular
divisions or parts of a business are failing to meet objectives for productivity, training or for
developing the most talented employees it is possible to take suitable corrective action. Without
objectives the diagnosis of the problem may be delayed until sales declined or customers decided
to purchase products elsewhere. Such a delay in identifying the problem could result in the
business suffering greater harm.
Employee performance is an important competitive weapon for many UK businesses that sell
services. In hotels, restaurants, railways, airlines and shops, customers interact regularly with
employees and the value they receive from buying the service will be determined to a great
extent by employee performance. Thus, those businesses whose employees provide better service
to customers will offer greater value and may be able to charge higher prices and to use the
quality of their service as a unique selling point (USP). A key element of achieving high
standards of employee performance is to set clear HR objectives that ensure the business has the
right number of suitably skilled and engaged employees in the right places and having values
that accord with those of the business.
Types of human resource objectives
There are a number of HR objectives, the importance of which will vary according to the type of
business, its products and the market in which it is trading.
1. Labour productivity
Managers may set human resource objectives relating to the quantity of products that employees
should produce, on average, over a specific time period. Such objectives may be more common
in manufacturing and construction industries where it is more straightforward to measure the
output of an individual employee, although they can be used widely. A report by the Guardian in
2018 into working practices at the online retailer Amazon revealed that some workers were
expected to wear electronic devices to measure the speed at which they work. The attraction of
setting labour productivity objectives is that it can assist businesses in controlling costs. If
employees are efficient and produce a large number of units of output in a working day, the costs
of producing an average unit will be controlled, enhancing the business’s price competitiveness.
We look at labour productivity more fully in Chapter 21.
2. The number and location of the business’s
workforce
It is normal for the labour needs of a business to change over time. A business might grow, move
overseas, replace employees with technology or take decisions to produce new products. Each of
these actions may mean that the business will require a different workforce. Technology-based
businesses in London and the south east of England are expanding quickly as demand for their
services rises. This growth is forecast to lead to the companies requiring an additional 46,000
employees by 2024. A number of high-profile technology companies have moved their
operations to London, or have expanded existing workforces, as shown in the Business in focus
feature about Facebook.
Meeting this objective is essential because the business needs to have sufficient employees to
ensure that it can meet the needs of its customers and to provide the best-quality goods or
services possible. Having a workforce of the correct size and in the right place also assists the
business in providing high-quality customer service. Ensuring that the business has the right
number of employees to meet its customers’ needs can be challenging for businesses that face
seasonal demand and can be an important HR objective.
For example, the Royal Mail requires additional employees at certain times of the year such as
Christmas, when demand for postal services is much higher. As a consequence one of the
company’s HR objectives will be to have a flexible workforce that can meet the changing
demands of its customers. Fulfilling this objective requires ongoing action on the part of the
company’s HR function.
Developments in technology have had an impact on HR objectives in terms of location. Some
businesses have opted to have a proportion of their employees teleworking. According to the UK
Government, teleworking is an arrangement that allows an employee to conduct work during any
part of regular, paid hours at an approved alternative worksite. This is feasible for many
industries because electronic communications makes it possible for employees to communicate
effectively with customers, colleagues and other stakeholders. Statistics from the Office for
National Statistics (ONS) show that 4.2 million people in the UK regularly worked from home in
2016. Research suggests that around half the UK’s workforce will work remotely (for example,
at home) by 2020. Some businesses have HR objectives relating to the location of employees that
support them in reducing labour costs. Others may make location decisions to make it easier to
manage the business. Dyson, the UK technology company, announced in 2019 that it was
moving its head office to Singapore. The company’s chief executive said this move was taking
place because its sales in Asia have risen very quickly and it manufactures large quantities of its
products in the region.

Business in focus: Facebook continues its expansion

Facebook announced it is doubling the size of its office space in London as big
technology firms continue to expand in the UK. The company is moving across
London from Fitzrovia to three buildings in King’s Cross. This move will enable the
company to meet its HR objective of increasing the size of its workforce. Facebook’s
new office is 600,000 square feet, around the size of nine football pitches.
The social networking company will have space for 6,000 workers at its new site in
King’s Cross, almost three times its current UK workforce, which is set to reach 2,300
by the end of 2018. ‘The UK is one of the best places in the world to be a technology
company and we’re investing here for the long term,’ Steve Hatch, Facebook’s
managing director for northern Europe, said in a statement. Average pay at Facebook
is reported to be in excess of £100,000 with software engineers being particularly well
rewarded.
Facebook is by far the most popular social media website with over 30 million users.
Approximately 45 per cent of these users visit the company’s website several times
each day.
London has been the primary technology hub in Europe for a number of years but
centres such as Paris, Berlin and Amsterdam have been preparing to attract start-ups
given uncertainty around the UKs plan to exit the EU. However, large technology
firms have continued to back London as a location with US technology giants
including Apple, Amazon and Google all expanding in London.
Source: Adapted from an article in The Independent, 23 July 2018, ‘Facebook doubles office space
in London despite Brexit uncertainty for tech firms’

Practice questions
1 Analyse the reasons why setting an HR objective of increased employment to meet
demand might affect decisions by the finance function at Facebook.
(9 marks)
2 To what extent is it particularly important for technology companies such as
Facebook to set HR objectives?
16 marks)

Handling data:
Year Home workers 000s Total in employment 000s
2008 3,641 29,285
2009 3,679 28,955
2010 3,670 28,562
2011 3,698 28,983
2012 3,800 28,999
2013 3,988 29,383
2014 4,202 31,153
 2015 4,219 30,859
2016 4,313 31,340
2017 4,325 31,717
Table 20.1 Home workers and the total in employment in the UK, 2008–2017
Source: Office for National Statistics
1 In what year was there the greatest increase in:
a the number of home workers
b the total number of people in employment?
2 Was the proportion of home workers greatest in 2008, 2012 or 2017?

What do you think?

Only about 14 per cent of employees in the UK work at home. Why don’t all business
try to benefit from technological developments and set an HR objective of having 33
per cent of employees working at home?
3. Employee engagement and involvement
There are numerous definitions of employee engagement. The Chartered Institute of Personnel
and Development (CIPD) has defined employee engagement as ‘being positively present during
the performance of work by willingly contributing intellectual effort, experiencing positive
emotions and meaningful connections to others.’

Key terms
Employee engagement describes the connection between a business’s employees
and its mission, goals and objectives.
Employee involvement exists in a business in which people are able to have an
impact on decisions and actions that affect their working lives.

The CIPD believes that this definition gives three dimensions to employee engagement:
• intellectual engagement – thinking hard about the job and how to do it better
• affective engagement – feeling positively about doing a good job
• social engagement – actively taking opportunities to discuss work-related improvements with
others at work.
Research by the CIPD and other organisations globally has shown that businesses benefit from
having engaged employees in terms of improved performance. There is a positive relationship
between how people are managed, employee attitudes and the business’s performance. You can
visit the CIPD website for more information.
Employee involvement as an objective seeks to enable employees to contribute to the
continuous improvement and performance of the business in which they are employed.
Employee involvement is sometimes referred to as ‘employee voice’ and is normally
management initiated. It can take a variety of forms.
• Considering employees’ ideas and opinions. This can be achieved by using two-way
communication channels or by establishing systems for employees to express their voice. The
communication is directly between managers and employees. This may simply be the use of
suggestions schemes or regular meetings between managers and employees to gather
employees’ opinions. Technological developments, especially in electronic media, have made
this a simpler process and communication often takes place through email.
• Employee representatives. This type of employee involvement can occur through the
appointment of employee directors or managers to provide the ‘employee voice’ on decision-
making bodies or through employee forums where managers brief employees on matters of
importance and invite feedback. We consider the role of employee representatives more fully
in Chapter 24.
HR objectives in the areas of employee involvement and engagement are intended to improve the
performance of employees and hence the business. They are also more likely to be set by
managers and leaders who take a democratic view of leadership and take a ‘soft’ approach to
human resource management (HRM). We look more fully at different approaches to HRM later
in this chapter.
4. Training
Improving the work-related skills and knowledge of employees can be an effective way of
improving employee performance. Many businesses have learning and development policies for
their workforces in which training plays a central role. Learning and development policies set
out the workforce capabilities, skills or competencies required, and how these can be developed,
to ensure a sustainable, successful organisation. These can be a vital element of a business’s HR
objectives.

Key term
Training is a process whereby an employee gains job-related skills and knowledge.

Training is an important activity for UK businesses and research by the CIPD reveals that an
average of £300 per employee per year was spent on training in 2018. Although setting targets
for training as an HR objective can add to a business’s costs it can provide a range of benefits. It
can result in improved employee performance and can assist businesses in attracting the most
talented and motivated employees. This can be particularly important for businesses in the
service sector where employee performance can be a vital determinant of the business’s
performance and can provide a unique selling point.
Rapid developments in technology may mean that training as an HR objective has relevance for
more businesses. The BBC offers more than 700 training courses to its employees, in part to
ensure they are up to date with technological developments in broadcasting and the media.
5. Talent development
Talent development is different from training in that it focuses on fulfilling the potential of
employees with the ability and potential to shape the business’s future performance. Thus, some
managers may believe that continued success for an organisation depends on its ability to retain
these employees and to manage and develop their talents in the most effective manner.
The business case for setting talent development objectives is very strong. Many chief executives
and senior HR managers have talent development and management as key priorities. Research
has revealed that the increased interest in talent has arisen for a number of reasons. These
include:
• overcoming the pressures of succeeding in increasingly competitive global markets
• coping with shortages of certain skilled employees
• growing need for highly specialist and creative employees.
The School of Management at Cranfield University operates a talent development programme
for employees of other businesses. This includes modules on accelerating managerial
performance and continuing development review. Businesses send employees on talent
management courses to improve their performance and to provide a supply of able employees for
promotion from within the business.
6. Diversity
Businesses that have diversity as an HR objective will aim to 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. Companies with effective policies to recruit and develop diverse
workforces can benefit through having employees with different ways of thinking and working.
Whirlpool, a global manufacturer of domestic appliances, such as cookers, operates with the
vision of recruiting and retaining the most talented people from a diverse range of backgrounds.

Key term
Diversity, in an employment context, refers to recognising the differences between
individual employees and also the differences that may exist between different groups
of employees.

Many organisations implement HR objectives for equality alongside those for diversity. 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 necessary as many minority groups are under-represented in senior
positions in businesses, and this means that the skills and abilities of such employees are wasted.

Figure 20.2 A job advert for a manager responsible for talent development. Talent development is an
important HR objective for businesses in many industries including those who rely on creative abilities
such as the film industry.
Source: Total jobs

A number of governments have enacted employment legislation to ensure that businesses design
and implement policies for diversity and equality. For example, the UK Government passed the
Equalities Act in 2010. This offered protection to employees against:
• direct and indirect discrimination
• 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 and sexual orientation.
The effect of legislation of this type is to encourage businesses to design and implement policies
intended to encourage diversity and to promote equality.
Setting HR objectives for equality and diversity 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 employees, regardless of personal characteristics, secures the greatest
level of talent for the business. Any other approach is likely to harm the business.
Establishing HR objectives 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 be comprised
of 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. Studies from management consultant McKinsey show
that in American companies, every 10 per cent improvement in diversity led to a 3.5 per cent
increase in profits.
7. Alignment of values
The American social psychologist Milton Rokeach defined an organisational value as ‘a belief
that a specific mode of conduct is preferable to an opposite or contrary mode of conduct’. Such
values are sometimes referred to as ‘core values’. An employee’s core values will underpin the
way they behave and influence the decisions that they make.
A business’s core values should remain relatively unchanged over time and can provide a
reference point for decisions made by managers as they respond to competitors’ actions and
other changes in the business’s external environment. They can assist a business in establishing
and maintaining a competitive advantage.

Business in focus: Equality and diversity at the University of

Cambridge

The University of Cambridge is one of the most famous universities in the world. It
was founded in 1209 and has over 9,000 staff and 18,000 students from countries
throughout the world.
 Figures 20.3 Stonewall’s Top 100 Employers Award, enei and Bronze Athena Swan Charter logos

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).
In recognition of the University’s commitment to progressing equality and diversity, it
has received awards from Stonewall, enei (the Employers’ Network for Equality and
Inclusion) and the Equality Challenge Unit’s Athena Swan Charter.
A new version of the E&D Essential online training module has been launched. It
includes an introduction from the Vice-Chancellor and aims to help staff understand
the main principles of equality and diversity, its 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: University of Cambridge website

Practice questions
1 Explain how training might assist the University in establishing equality and
diversity as an HR objective.
(6 marks)
2 Do you think that the benefits of the University of Cambridge’s Equality and
Diversity policy will outweigh its costs? Justify your view.
(16 marks)

Core values support the business in attempting to fulfil its vision. For example, the core values of
J. Sainsbury plc, set out in the Business in focus feature, will guide the company’s decision-
makers in fulfilling its vision of ‘being a place where people love to work and shop’.
However, having and publicising core values is of little value to a business unless its employees
hold similar values and therefore act and take decisions in the ‘right’ way. If a business sets an
HR objective of aligning its employees’ values with its own, through training and
communication, it will assist the business in ensuring that its vision is pursued. Stakeholders will
also see how the business’s values are reflected in its decision making. This can reinforce the
business’s identity with its stakeholders and lead to the maintenance of customer loyalty. It will
also help the business to attract suitable staff (with similar values) as potential employees are
likely to research any likely employers as part of their application process.

Business in focus: Values at Sainsbury’s

Sainsbury’s is one of the UK’s best-known supermarkets. It has the aim of becoming
the country’s most trusted retailer where people enjoy working and shopping. The
company operates according to five core values to achieve this aim.
1. Health
Sainsbury’s seeks to help its customers to be healthy by selling high quality and
healthy food in its stores. The company serves 26 million customers each week and
its decisions on what products to stock can help its customers to avoid eating too
much food that contains high levels of salt, sugar and fat.
2. Sourcing
More than 12,000 products that are produced by suppliers based in more than 70
countries are sold in Sainsbury’s stores. The company has developed close
relationships with these suppliers to enable it to provide its customers with information
about the products it sells. This information is important to reassure customers that
that supermarket deals with suppliers who do not engage in practices that are
unethical or damaging to the environment.
3. Environment
The supermarket publicises its concerns about the impact of its operations – and
those of its suppliers – have on the natural environment. It has set out how it intends
to operate a sustainable business. It is reducing the amount of carbon that it emits,
the quantity of water that it uses and the volume of waste that it produces. Key
elements of its environment policy are using technology to cut energy use and helping
its customers to live more sustainably.
4. Community
Sainsbury’s wants to contribute to the communities in which it operates. It wants to
see a society that is prosperous and from which all its members benefit. The company
seeks to support these communities by raising funds and encouraging people to
volunteer for social projects as well as making donations to them.
5. Colleagues
Sainsbury’s employs 200,000 people and says that ‘harnessing the talent, creativity
and diversity of our colleagues’ is essential to its continued success. It wants to create
a working environment where all employees can fulfil their potential by using their
skills and talents as fully as possible. This should enable the company to keep its
more effective employees and attract other talented people. Creating a positive
working environment for its employees will enable it to offer excellent service to its
customers.

Practice questions
1 Analyse why ‘harnessing the talent, creativity and diversity of our colleagues’ is
essential to Sainsbury’s continued success.
(9 marks)
2 J Sainsbury plc promotes its core values on its website. Do you think that it is more
important for the company to publicise these values than to have them as an
objective for all employees to follow? Justify your view.
(16 marks)
Influences on human resource objectives
and decisions
Managers responsible for human resources are subject to influences from inside the business as
well as external factors when deciding on the objectives for their department and in taking
decisions that relate to the management of human resources.

Figure 20.4 Influences on human resource objectives

Internal influences on HR objectives and
decisions
Several internal factors may influence a business’s decisions relating to human resources,
including which HR objectives to adopt.
• Corporate or overall objectives. As with all functional objectives, those set by the HR
department must assist the organisation in achieving its overall objectives. Thus, if the
business has a corporate objective of maximising long-term profits, the HR objective might set
itself objectives concerned with reducing labour costs or making the most effective use of the
workforce. Marks & Spencer, one of the UK’s best-known retailers, has been hit by the move
to buying online and higher costs reducing its profitability. The company is seeking to lower
its costs with the objective of restoring its profitability. In July 2018 the retailer announced 351
redundancies across all parts of its operations. This will reduce its workforce to 80,434
employees, to save a reported £12.4 million annually.

Handling data
Use the information on M&S’s costs in the previous paragraph to answer the following
questions.
1 What was the reported annual cost of employing one of the employees who is to
be made redundant?
2 Assume the employment costs of the 351 to be made redundant represent those of
M&S’s entire workforce. What were the company’s total labour costs before and
after the redundancies?

• Attitudes and beliefs of the senior managers. The senior managers of a business can have an
important influence on decisions relating to human resources. If they consider the workforce to
be a valuable asset, they may want a long-term relationship with employees and may set
objectives such as developing the skills of the workforce to their fullest extent. Alternatively,
they may see employees as an expendable asset to be hired when necessary and decide to pay
the minimum rate possible. This can have considerable implications for the objectives that HR
managers set and for the broader decisions that they take.
There is not a single approach to human resource management (HRM). Different firms manage
their human resources in different ways. These are summarised in Table 20.2.
• ‘Hard’ HR approach. Some firms operate ‘hard’ HR policies, treating employees as a
resource to be used optimally. Managers pursuing ‘hard’ HR policies regard employees as just
another resource to be deployed as efficiently as possible in pursuit of strategic targets.
Employees are obtained as cheaply as possible on short-term, zero-hour contracts.
• ‘Soft’ HR approach. Other firms use an HR system that is referred to as ‘soft’. This approach
is based on the notion that employees are 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 valuable resources and developed over time and in
 response to changing market conditions.

What do you think?

Would all businesses in the UK benefit in the long term from adopting a soft approach
to managing their human resources?

• Type of product. If the product requires the commitment of a highly skilled labour force then
objectives such as training and talent development may be most important. However, for
businesses selling products which are mainly produced by machinery, and which require little
in the way of skilled labour, minimising labour costs through having the fewest employees at
any times may be a key HR objective. Some retailers with distinctive images (perhaps ethical)
may focus on aligning the values of their workforces to those of the business as a prime HR
objective because many of their staff have regular contact with customers and so the
consequences of their ‘values’ are more apparent.
‘Hard’ HRM ‘Soft’ HRM
Philosophy Employees a resource like any Sees employees as different, and
other available to the business more important, than any other
resource available to managers
Time scale HRM seen as a short-term policy: Takes a long-term view of using the
employees hired and fired as workforce as efficiently as possible
necessary to achieve long-term corporate
objectives
Key
features • Employees paid as little as • Managers consult with employees
possible • Managers give control over
• Employees only have limited working lives to employees
control over working life through delayering and
• Communication mainly empowerment
downward in direction • Emphasis on training and
• Employees recruited externally developing employees
to fulfil human needs – giving • Employees promoted from within
short-term solution reflecting long-term desire to
• Judgemental appraisal develop workforce
• Developmental appraisal

Associated Leaders operating this style of Leaders implementing ‘soft’ HRM

leadership HRM more likely to be at the more likely to be democratic in
style autocratic end of the spectrum of nature
leadership
Motivational Probably mainly motivated by Delegation, empowerment. Heavy
techniques pay, with limited use of use of techniques designed to give
used
 techniques such as delegation employees more authority
and teamworking
Table 20.2 Approaches to human resource management
External influences on HR objectives and
decisions
External factors will have a significant impact on the decisions that are taken and the objectives
that are set by HR managers.
• The technological environment. Advances in technology have had significant implications
for managers responsible for HR. The effects can be separated into categories. Some
developments have replaced labour. Many manufacturing businesses have opted to replace
labour with technology as a means of strengthening competitiveness by reducing costs or by
offering customers better service. Foxconn, the Asian manufacturer that makes many of
Apple’s products, has replaced many thousands of its employees with robots since 2011, and
in 2018, announced plans to replace a further 10,000 employees with robots during the year.
This decision may help Foxconn to retain the lucrative contracts to manufacture Apple’s
products. Technology has also changed working practices in other ways, such as allowing a
steady increase in the proportion of employees working mainly from home. These changes will
be reflected in the objectives pursued by HR managers.
Other developments in technology encourage the setting of HR objectives that may enhance
customers’ experiences. Online banking allows customers to have access to banking services
at all times and book retailers sell and distribute large numbers of books online for use on e-
readers. These developments may impact on HR objectives by, for example, increasing the
importance of recruiting, training and talent development to ensure that employees have the
skills necessary to meet customers’ needs in an increasingly technological environment.

Figure 20.5 External influences on human resource objectives

In 2018, a report by the Edge Foundation estimated that there were 600,000 vacancies in
digital technology in the UK. For example, there are insufficient employees with up-to-date
skills in writing and testing computer programs, making their recruitment and retention a
priority for many businesses.
• The economic environment. A growing or a declining market will have a significant impact
on the HR objectives pursued by a business. In June 2018, unemployment in the UK fell to
1.64 million, 4.0 per cent per cent of the workforce. Sales of many products have risen in the
 UK in recent times as the performance of the economy has begun to improve and wages have
risen. These changes may have led HR managers to revise the number of employees that their
businesses will require in the future as well as, possibly, their locations. For example, Amazon,
the global online retailer is investing heavily in its operations in the UK. It will create 2,500
new jobs in its development centres and at its Head Office in London. This will take its total
UK workforce to 27,500 and will have a significant impact on the business. It is likely to affect
Amazon’s HR objectives in terms of skills and location of employees, training and talent
development as well as the number of employees it plans to employ.
• The social environment. Ethical and environmental considerations are increasingly important
for consumers in the UK. The market for ethical products in the UK grew by 3.2 per cent over
2017, to reach a total of £81.3 billion, according to research by Ethical Consumer magazine.
Many businesses respond positively to demands by consumers for ethical and environmentally
friendly products and some seek to use this as a unique selling point.
Lush Retail Ltd is a private company that manufactures and sells hand-made cosmetics and is
highly rated by UK consumers as an ethical business. It promotes its ethical stance, is strongly
opposed to testing products on animals and will not buy supplies from companies that damage
the environment. A key issue for HR managers at Lush will be to operate with HR objectives
that align employees’ values with those of the company and employee engagement and
involvement.
• The competitive environment. If competing businesses supply similar products, demand for a
product is likely to be strongly price elastic (i.e. demand is very sensitive to price changes). In
these circumstances it is more likely that a business will opt for HR objectives that allow it to
reduce labour costs. This can be seen in the case of UK supermarkets. In 2018, Tesco revealed
that it was to cut the jobs of 1,700 of its shop-floor employees. This was intended to cut costs
and prices. This would allow the company to be more competitive against low-price rivals
such as Aldi and Lidl. This decision had major implications for the Tesco’s HR objectives.
However, if demand is price inelastic, a reduction in price is unlikely to lead to a substantial
increase in sales and HR objectives may focus on issues other than costs. In these
circumstances, a business’s HR objectives may focus on improving employee’s customer
service skills through training to enhance its competitiveness.
• The political environment. The UK Government and EU authorities have passed a series of
laws designed to protect labour in the workplace. The existence of such laws may encourage
businesses to set HR objectives to develop the potential of their workforces as the law may
make it difficult to hire and fire employees at will. In particular, a change in the law has an
impact on the objectives that a HR department pursues. The Equalities Act (2010) offers
protection to employees against discrimination, harassment and victimisation and has to be
taken into account by managers when establishing HR objectives. Brexit represents a very
significant change in the UK’s political environment. It is likely to have a major impact on the
HR objectives of UK businesses. For example, many UK banks have changed the location of
where employees work to reduce numbers employed in London and increase those working in
cities in the EU. This will enable them to continue to provide financial services throughout the
EU without interruption.

Business in focus: Diversity at Unilever

Unilever is a global company selling fast-moving consumer goods. It makes some of
the world’s best-known brands including Persil, Dove, Marmite and Lynx. The
company has objectives to reduce its environmental footprint and increase its positive
social impact.
Unilever states that ‘becoming a truly diverse and inclusive company is not only the
right thing to do, it is crucial to helping us grow our business, attract and retain talent,
and engage the people who buy our products’. Unilever reports that it is making
strong progress; in 2017, women accounted for 50.7 per cent of all management
positions in the UK and Ireland, up from 41.8 per cent in 2010.
Leena Nair, Chief Human Resources officer, says:
‘Diversity and inclusion at Unilever is about embracing differences, creating
possibilities and progressing together to build a sustainable business. My vision for
Unilever is to create an inclusive environment that allows all of our people to thrive
and perform at their very best, irrespective of their gender or background.’
In 2017, Unilever published its Gender Pay Gap report in the UK in line with
government legislation, which requires all companies with 250 employees or more to
publish a range of gender pay statistics. This report showed that the hourly median
pay rate for women in the company was 2.2 per cent higher than that for men.
Despite this evidence of progress at Unilever, some politicians in the Labour Party
have suggested that more legislation is needed to ensure companies implement
effective diversity policies. Only a minority of the UK’s largest 100 companies have
female CEOs.
Source: Adapted from Unilever website

Practice questions
1 Analyse the possible benefits to Unilever of appointing more diverse employees.
(9 marks)
2 Do you think that the threat of legislation is the most effective way of persuading
UK companies to appoint more diverse teams of senior managers? Justify your
view.
(16 marks)

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 What is meant by the term human resource objective?
2 State two reasons why the number of employees needed by a business may
change.
3 State the difference between employee involvement and employee engagement.
4 State two actions a business might take to fulfil an HR objective of employee
 involvement.
5 What is meant by the term talent development?
6 State two reasons why businesses have increasingly set an HR objective relating
to talent development.
7 List three factors upon which employee diversity could be based.
8 Is the following statement true or false? ‘An employee’s core values will underpin
the way they behave and influence the decisions that they make.’
9 Is the following statement true or false? ‘The hard approach to HRM 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.’
10 State two external factors that might influence a business’s HR objectives.

(b) Short answer questions

1 Explain why an ethical retailer might set HR objectives to align its values and
those of its employees.
(4 marks)
2 Explain the importance of setting HR objectives for talent development in large
multi-national businesses.
(5 marks)
3 Explain how a soft approach to human resource management might influence the
HR objectives set by a business.
(5 marks)
4 Explain one reason how a popular chain of fast-food restaurants may benefit from
having clear HR objectives.
(5 marks)

(c) Data response questions

Cargo plc is a car hire company that operates throughout Europe. The market for car
hire in the EU is extremely competitive and demand for smaller cars is more price
elastic than for larger ones. Cargo plc is small in comparison to rivals such as Avis
and Hertz and needs to establish and maintain a distinctive image to help it to be
competitive. It operates 104 sites across Europe and demand for its services is
seasonal and dependent upon the level of consumers’ incomes. The company’s sales
have grown at an average rate of 19.4 per cent a year since 2016 and it focuses on
hiring larger cars, luxury vehicles and 4x4s.
The company has set HR objectives for the number, skills and location of employees
for some years, but a new senior director with responsibility for human resources has
introduced a number of changes to the way employees are managed to support the
company in achieving its overall objectives of growth. She is starting by establishing
new HR objectives, focusing on training, talent development and alignment of values.
These new HR objectives are expected to bring a number of benefits to the company,
though they are forecast to increase employment costs by 15 per cent within three
years. Cargo plc has an overall objective of offering an improved service to its
customers.
One of Cargo’s rivals is ValueCar, a company noted for its very competitive prices.
The major influence on the company’s HR objectives and decision making is its ‘hard’
approach to managing its human resources. This has not always proved popular with
the company’s workforce. However, the company has a high market share in hiring
smaller cars.
1 Explain why setting HR objectives for the number, skills and location of Cargo
plc’s employees continues to be important.
(6 marks)
2 Analyse how ValueCar’s hard approach to human resource management will
affect the HR decisions taken by its management team.
(9 marks)
3 To what extent might the setting of the new HR objectives for Cargo plc offer
benefits that exceed the costs.
(16 marks)

(d) Essays
1 The value of setting human resource objectives is greatest for businesses that sell
high technology products such as tablets and computer software. To what extent
do you agree with this statement?
(25 marks)
2 Market conditions are always the most important factor influencing human
resource decisions for small businesses. To what extent do you agree with this
view?
(25 marks)
Chapter 21 Analysing human resource
performance
Introduction
This chapter continues our consideration of how managers can take decisions to improve a
business’s human resource performance. It looks at techniques that can be used to analyse
workforce performance, such as calculating labour productivity and labour cost per unit, which
might provide managers with crucial information to support the decision-making process.
Subsequent chapters will consider the nature of human resource decisions that are taken by the
managers of a business on the basis of this and other data.
What it is important to know by the end of this chapter:
• how to calculate and interpret human resource data
• the use of data for human resource decision making and planning.
Calculating and interpreting human
resource data
Before managers take decisions designed to improve the performance of a workforce it is
important to analyse its current position. This analysis enables managers to take more informed,
focused and effective decisions. If managers are dissatisfied with the overall performance of a
workforce, identifying and analysing the precise cause of a problem will assist in deciding on the
most appropriate course of action.
A range of data is available to managers to assess the performance of their employees.
1. Labour productivity
Labour productivity is perhaps the most fundamental indicator of the performance of a group
of employees and has implications for a business’s 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 and to interpret. In general, a higher productivity
figure is preferable. Improvements in labour productivity allows businesses to enjoy increased
profit margins or to reduce prices (while maintaining profit margins), hopefully leading to
increased sales.

For example, a Nissan car factory in Sunderland produces up to 2,000 cars each day using a
workforce of 6,700. Thus on days when its production is at its maximum, the factory achieves a
daily labour productivity figure of 0.30 cars per worker (2,000/6,700). Labour productivity can
be calculated for any time period.
Labour productivity depends upon factors such as the extent and quality of capital equipment
available as well as the workforce’s degree of motivation. This means that 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 has increased by between 2 and 3
per cent per annum on average since 1945, although it has declined since the financial crisis of
2008–09.
Labour productivity levels have been a cause of concern for the UK economy in recent years,
which is explored in the Business in focus feature the following page.
Figure 21.1 shows that the amount of output per hour across the UK economy has increased little
since 2009. It reveals that average output per worker per hour was only fractionally higher in
2018 than it had been in 2008. One reason why output per worker may have risen fractionally
quicker than output per hour since 2012 may be that people have worked longer hours.

Figure 21.1 Output per employee hour for the whole UK economy, 1994–2018

Source: ONS

Interpreting labour productivity data

An increase in labour productivity figures for a business represents an improvement in efficiency
of its workforce, which can reduce the labour costs involved in producing a typical unit of
output. As labour costs account for around two-thirds of the cost of production of UK economic
output, this can offer major benefits to businesses.
However, it is important to consider a number of factors when analysing labour productivity
data, especially when using it to draw conclusions about a business’s competitiveness.
• Which businesses, or aspects of a specific business, are covered by the labour
productivity data. The data in Figure 21.1 relate to the entire UK economy and therefore
includes data for all businesses. It may be that particular sectors, industries or businesses have
performed differently (either better or worse) than this average data. Productivity rates in the
UK over the last few years have been very poor. Output per hour fell between 2017 and 2018
in both manufacturing and service industries; they fell faster in manufacturing industries. It is
important for managers to gather data that is relevant to their specific enterprise for analysis.
• Labour productivity data ignores wage rates. The data set out in Figure 21.1 could make
grim reading for managers responsible for human relations at businesses in the UK. However,
it does not tell the whole story. A business can be competitive with lower productivity figures
if it pays lower wage rates than its rivals. Labour cost per unit of output is perhaps a better
guide as it takes into account productivity data and labour costs. We look at unit labour costs
in detail in the next section.
• Overall productivity depends on other factors too. Many businesses use extensive amounts
of capital equipment in producing goods and services. For these businesses labour productivity
may not be as important as for more labour-intensive enterprises. The efficiency of capital-
intensive businesses depends more on the productivity of their capital equipment than their
workforce.
• Labour productivity data for direct rivals. A business may increase its efficiency, possibly
by increasing training for its workforce. However, this may bring few benefits if rivals have
achieved similar improvements in the efficiency of their workforces.

Business in focus: UK and international labour productivity

The data in Figure 21.2 below makes gloomy reading for UK businesses. However,
although UK labour productivity rates have grown more slowly than in Japan and
Canada recently, they still remain higher than in either of these two countries. In
2016, UK output per hour worked remained 8.9 per cent higher than in Japan and 0.6
per cent higher than in Canada. However, UK output per hour was 22.6 per cent
lower than in the US.
Although UK productivity grew more slowly, on average, over the ten years ending in
2016, the growth rates have not been uniformly slow across all industries. In recent
years, the growth rates in some industries, such hotels and catering has been
positive.
Figure 21.2 Average annual growth rates of labour productivity (constant price GDP per hour
worked) for a selection of countries, 2007–16

Source: ONS
Source: Bank of England, ‘The fall in productivity growth: causes and implications’, Silvana Tenreyro,
External MPC Member, Bank of England 15 January 2018

Practice questions
1 Analyse the benefits a business based in the UK may receive from operating with
higher levels of labour productivity than competitors from Japan and Canada.
(9 marks)
2 Do you think that UK businesses should, on the basis of this data, relocate to the
US to improve their competitiveness? Justify your view.
(16 marks)

What do you think?

Will labour productivity become a less important determinant of a business’s
performance as technology advances and is used more widely in production?
2. Unit labour costs
Unit labour costs measure the labour cost per unit of output produced. Unit labour costs are
based on total labour costs, including non-wage employment costs such as business’s national
insurance and pension contributions, incurred in the production of a unit of output. For example,
if a business manufactures 12,000 televisions in a month and the total labour cost of producing
those televisions is £900,000, then the unit labour cost = £900,000/12,000 = £75.
Unit labour costs are the best indicator of labour costs faced by businesses. They represent the
amount of money needed to pay employees to make one unit of output, for example, one car.
Unit labour costs are determined by two elements:
• the cost of employing workers;
• the speed at which they make the products (such as cars), in other words their productivity.
Unit labour costs tend to have an inverse relationship with labour productivity. If labour
productivity rises, then unit labour costs will fall unless labour costs increase by a greater
percentage than productivity. Unit labour costs will rise when total labour costs rise faster than
output. For example, if total labour costs rise by 5 per cent and labour productivity grows by 2
per cent for a given amount of output, unit labour costs will rise by approximately 3 per cent.
A rise in labour productivity can help to control unit labour costs. This is because a producer is
achieving a higher output from each unit of labour employed assuming a given wage cost.
Therefore managers may be willing to pay increased wages and salaries when productivity is
rising, especially if the percentage increase in pay is below the rate at which productivity is
increasing. In these circumstances it is likely that unit labour costs will fall.
Figure 21.3 shows that unit labour costs have risen in the UK between 2015 and 2017. This may
push up the costs of many businesses and put them under pressure to increase prices to maintain
profit margins. However, remember that these are average figures for the whole UK economy.
Individual businesses and industries may have experienced very different changes in unit labour
costs.

Handling data
Complete the table below assuming that employees are paid £200 each per week.
Number of Total Output Labour Labour cost per unit (total
employees weekly (number of productivity weekly wages/number of
wages (£) units) units)
100 20,000 1,000 10 £20
100 2,000
50 1,000
2,000 40
Table 21.1 Employment and cost data
Interpreting unit labour costs data
In general, lower unit labour costs are to be preferred, especially if these are below those
achieved by direct competitors. It can be useful to look at unit labour costs over a period of time
as heavy investment in training may increase short-term labour costs (for example, paying
overtime to cover workers who are in training) before rising productivity reduces them once
more. Do remember that labour costs are only part of a business’s costs. Reducing unit labour
costs will not improve price competitiveness if other costs, for example, overheads, are rising
quickly.

Figure 21.3 Unit labour costs for the whole UK economy, 2008–2018
Source: ONS

Business in focus: ASOS suffers heavy rise in labour costs

per unit

British online clothing store ASOS targets the 20-something market, selling ‘fast
fashion’ around the world. Celebrities such as Keira Knightley, Ashlee Simpson and
Emily Blunt have been seen sporting their clothes. The company employs
approximately 3,500 people. It sells its products to 15.4 million customers in 240
countries around the world.
ASOS’s sales were £1,923.6 million in 2017; an increase of 33 per cent from the 2016
figure. Despite this, the company’s profit margin fell from 4.4 per cent in 2016 to 4.1
per cent in 2017. The company has also manged its costs well with a 7.3 per cent fall
in unit labour costs between 2016 and 2017.
ASOS’s strong sales performance comes despite data from Visa earlier this year
showing the worst slump in consumer spending in four years, with clothing particularly
affected. The company operates in some highly competitive markets with fierce
competition in terms of price as well as the quality and design of its products.
ASOS expected its sales to grow by 25–30 per cent in 2018. It also planned to
increase its investment to about £200 million in 2018 with, for example, a major new
US warehouse.

Practice questions
1 Analyse the reasons why controlling labour costs is important to ASOS plc.
(9 marks)
2 The company can be expected to reach its objective of sales revenue increasing
by 25–30 per cent in the year ahead as its labour costs per unit have fallen by over
7.3 per cent. Do you agree with this statement? Justify your view.
(16 marks)
3. Employee costs as a percentage of revenue
This measure of the performance of a business’s human resources is also referred to as
‘employee costs as a percentage of turnover’. This is an important measure of employee
performance for businesses that supply services such as health care, where labour costs are a
high proportion of total costs. When this is the case, controlling these costs effectively is an
important element of controlling overall costs and achieving acceptable levels of profit.
Employee costs as a percentage of revenue are an important issue for England’s Premier League
football clubs. Deloitte, one of the UK’s major accounting and tax advice businesses, produces
an annual report on these clubs. The latest report revealed that revenue for all Premier League
clubs combined grew to £5,297 million in 2016–17 from £4,856 million in the previous year.
Employee costs were £2,894 million in 2016–17, which is just under 55 per cent of revenue. The
Premier League football clubs are in the fortunate position of being able to increase wages
substantially without increasing employee costs as a percentage of revenue, because their
revenue is increasing very rapidly.
Season Revenue Employee costs Employee costs as a percentage of
£m £m revenue
2015– 4,865 3,045 62.6%
2016
2016– 5,297 2,894 54.6%
2017
Table 21.2 Revenue and employee costs for England’s Premier League football clubs
Source: Deloitte Annual Review of Football Finance, 2018
Employee costs in relation to revenue are influenced by a range of factors.
• The productivity rates of the workforce. Higher levels of productivity can lead to increased
sales and revenue without greater labour input. Equally production and revenue can be
maintained with fewer employees reducing labour costs.
• Wage rates. Clearly an increase in wages and salaries without a corresponding increase in
sales and revenue will worsen this indicator and may represent an unwise decision by
managers.
• Non-wage employment costs. Offering generous pension schemes or similar benefits can
drive up a business’s employment costs without necessarily increasing revenue.
• The management of capacity. If a business does not utilise its human resources efficiently it
may be paying for employees who are not contributing to sales and revenue. Incurring labour
costs without the compensation of generating revenue will weaken this measure of workforce
performance.
4. Labour turnover and retention

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 or unsuitable
staff. Other reasons include redundancy and retirement.

Key terms
Labour turnover is the percentage of a business’s employees who leave the
business over some period of time (normally a year).
Labour retention (employee retention) is the extent to which a business holds onto
its employees.

Some level of labour turnover is inevitable. Managers seek some level of labour turnover to
bring new ideas into a business, but not so high as to impose excessive recruitment costs. The
2017 Annual Survey by the Chartered Institute of Personnel and Development (CIPD) revealed
that the median rate of labour turnover in the UK was 6.5 per cent in 2016, compared with 14.0
per cent in 2014 and 10.0 per cent in 2013. Employees leave work for a variety of reasons, as
shown in Table 21.3.
Managers attempt to manage labour turnover to achieve a balance between bringing in new
employees with enthusiasm and ideas into the business, against the costs of recruitment. Only
approximately 28 per cent of UK businesses calculate the cost of labour turnover to the business.
Although this figure is rising, this indicates that relatively few managers pay attention to what
could be an important factor, especially with regard to highly skilled employees or where
recruitment costs are high.

Handling data
Last year 45 employees at Bagley Ltd left the company. The company had an
average of 900 employees over 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 director’s forecast had been
accurate?

Labour retention is the extent to which a business holds onto its employees. It can be measured
as the proportion of employees with a specified length of service (typically one year or more)
expressed as a percentage of overall workforce numbers.

2016 2014 2013 2012 2011 2010 2009 2008

(2017 (2015 (2014 (2013 (2012 (2011 (2010 (2009
survey) survey) survey) survey) survey) survey) survey) survey)
Voluntary 0 0 0 0 0 0 0 0
redundancies
Compulsory 0 0 0 0 0 0 1 0.5
redundancies
Dismissed/left 1.2 0.7 0.2 1.3 0.6 0.7 0.9 1.4
involuntarily
(including
death in
service)
Fixed-/short- 0.7 0 0 0.4 1.7 0 0 0.7
term contracts
Retired 0 0 0 0.1 0.5 0 0.4 0.7
Left voluntarily 10.0 5.5 5.6 7.3 7.8 6.6 8.4 9
Table 21.3 Median labour turnover rates, by reason for leaving 2008–2016
Source: CIPD Resourcing and Talent Planning Report 2017. Reproduced with the permission of the
publisher, the Chartered Institute of Personnel and Development, London (www.cipd.co.uk).
Retaining employees has become an increasing problem (and performance indicator) for UK
businesses over recent years. Most retention difficulties have been experienced in relation to
professional employees and specialists, especially in the public sector, as shown in Table 21.4.
Businesses did not experience such problems in holding onto senior managers, although
retention rates are low for technical employees in the manufacturing sector.

Interpreting labour turnover and retention data

High rates of labour turnover can impose significant recruitment and training costs on businesses
and may be unsettling for other employees as teams and working groups are disrupted.
Customers may also be dissatisfied if they regularly deal with different employees in their
transactions with a business. Replacing labour that has left can also be expensive due to
recruitment and training costs. Most businesses will seek a lower figure to avoid incurring such
costs. However, what is an acceptable labour turnover rate will differ according to the type of
business. A business that employs highly skilled and scarce employees will wish to have a low
labour turnover rate, perhaps just enough to bring fresh ideas into the organisation. Research has
revealed that labour turnover costs UK firms supplying legal services £805 million per year, or
nearly £40,000 per employee.
In contrast, a company that operates theme parks may accept a much higher rate of labour
turnover. This is because it may employ large numbers of relatively unskilled part-time
employees on a seasonal basis and pay low wage rates. The cost of recruiting and training new
employees may be low and the business’s managers may accept high labour turnover rates as the
price to be paid for paying low wages and offering short-term contracts.
Managers’ objectives with regard to retention rates are the opposite of labour turnover. High
rates are desirable particularly for businesses with highly skilled and scarce employees. Losing a
key employee can be particularly damaging for a business if the employee goes to work with a
direct competitor.
All Public Not- Private Manufacturing
respondents services for- sector and
profits services production
Professionals/specialists 43 60 38 40 34
Technical 26 21 21 27 36
Middle and junior 20 17 17 21 22
managers
Services (customer, 18 10 17 22 13
personal, protective,
sales)
Manual/craft works 13 8 9 11 28
Senior 12 20 12 10 10
managers/directors
Administrative/secretarial 12 16 14 12 8
Table 21.4 Percentage of businesses experiencing retention difficulties by sector 2017
Source: CIPD Survey Report: Resourcing and Talent Planning, 2017. Reproduced with the permission
of the publisher, the Chartered Institute of Personnel and Development, London (www.cipd.co.uk).

Business in focus: Labour turnover in the fast food industry

McDonald’s and other popular fast-food businesses have invested a lot in new
equipment in their kitchens and restaurants. However, many employees in the fast-
food industry receive relatively little training and a number work part-time. Employees
in the fast food industry have told the Business Insider and Bloomberg that there is
not always training on how to use new equipment which often breaks down. This is
one factor contributing to record high fast food employee turnover rates, MIT
Technology Review reported in March. A typical restaurant that employs 20 people
can expect to see 30 workers in the span of a year.
Sales in the industry are forecast to grow by 2.8 per cent in 2018 despite average
spending per customer visit falling.
A review of the wider restaurant industry in the UK found there were 32,900
vacancies in April 2018, down from 36,900 in November 2017. Restaurants’ profits
had plunged over the past year and many chains were being forced to close
unprofitable sites and reduce staff numbers at other branches.

Practice questions
1 Using the data above, calculate the labour turnover rate for a ‘typical restaurant’.
4 marks)
2 Do you think that labour turnover rates should be a key measure of success for the
performance of a fast-food restaurant’s workforce? Justify your decision.
(16 marks)
Using data for human resource decision
making and planning
Managers responsible for human resources will draw on a range of data from within and outside
the business when making decisions and drawing up human resource plans.
Data and human resource planning
Human resource planning is one of the core activities of human resource management and entails
a number of stages.
• The starting point of human resource planning is to consider the overall or corporate objectives
of the business. The human resource plan must contribute to the achievement of the
business’s overall or corporate objectives.
• The next stage is to take a strategic view of employees, and to consider how human resources
can be managed to assist in attaining the business’s corporate objectives. This may entail
considering factors such as the use of technology and how this might complement or replace
some human input into the production process.
• At this stage those responsible for human resource planning will have to make a judgement
about the size and type of workforce the organisation will require over future years.
• This desired future workforce is compared with that available to the business at the time of
planning.
• Once this comparison is complete, the firm can decide upon policies (for example, recruitment,
training, redeployment and redundancy) necessary to convert the existing workforce into the
desired one. This process is shown in Figure 21.4.

Key term
A human resource plan assesses the current and future capacity of a business’s
workforce and sets out actions necessary to meet the business’s future human
resource needs.

The human resource plan will specify the business’s desired workforce and how the business will
implement its human resource policies. A business’s human resource plan will require managers
to draw on a range of data to compile it.
1 Information on the business’s current workforce. This will set out:
• the number of employees that the business currently has and their skills
• data relating to labour productivity for the existing workforce
• current and forecast labour costs, including unit labour costs
• the age profile of its employees, which will help to forecast likely future changes due to
retirement, etc.
• the business’s overall or corporate objectives.
2 Information from outside the business. This might include human resource, marketing and
other data:
• the expected rate of unemployment for workers with skills required by the business
• forecast wage rates for potential employees
• expected demand for the products supplied by the business
• likely prices at which the business can expect to sell its products
 • availability, cost of productivity of technology that could be used in production.

Figure 21.4 Human resource planning

Managers will research and use data to underpin the human resource planning process. Using
external data to aid human resource planning is particularly important when a business is newly
established and has limited historical data to draw upon. In such circumstances managers will
have to use numerical information from outside the enterprise as a central part of their analysis. It
is also important to analyse data when planning the use of human resources in an external
environment that is changing rapidly. If consumers’ incomes are forecast to decline, for example,
this could have significant implications for a business selling luxury products, and would impact
upon its human resource plan. Gathering information on forecast consumer incomes will help to
plan production and consequently human resource needs. Using data in such circumstances can
help HR managers to make good quality decisions.

What do you think?

Should the managers of very small businesses invest resources in collecting and
analysing data on the performance of their employees or just rely on their instincts?
Data and human resource decision making
The potential of using HR data in decision making
There is a movement by businesses in the UK and elsewhere to use more data to underpin human
resource decision making, although progress is slow. There is already an immense amount of
data for HR managers to draw upon and it is increasing exponentially. IBM (an American
technology company) estimates that 90 per cent of the data in the world was created in the last
two years.

Figure 21.5 Data and human resource planning

As performance management information systems have become more widespread, human

resource managers have been able to gather information about individual employees, as well as
about the business’s entire workforce. As human resources have become an increasingly
important competitive weapon, HR data can lead directly to improved performance by
businesses. HR data can provide an insight into the performances of workforces and individual
employees. Using HR data to report and analyse on what has and is taking place within a
business’s workforce offers clear advantages in making good quality human resources decisions.
Many HR departments have the ability to access performance indicators such as productivity and
unit labour costs, which can be used for planning and decision making.
However, leading HR professionals are taking data analysis to the next level to assist decision
making. They seek to use data to provide predictive analysis of what may happen in the future.
This process depends on the use of big data because predictive analysis requires large sample
groups in order to be considered statistically sound. Being able to make effective decisions about
retention, recruitment, or talent development based on analysis of data can provide businesses
with an important competitive edge.

The reluctance of managers to use HR data for decision

making
However, despite all these possibilities, research by Forbes (a company that provides information
for businesses) has shown that only a minority of companies are making effective use of this data
to inform and improve decision making. For example, only 14 per cent of businesses in the
United States have done any significant ‘statistical analysis’ of employee data at all.
This view is supported by the outcome of a study of HR managers and chief executives,
published in 2018 by NGA Human Resources. This study revealed that that 94 per cent of CEOs
consult with HR before making major business decisions. However, HR managers often fail to
gather the appropriate data to influence these conversations. NGA Human Resources’ report
showed that:
• 52 per cent of HR managers did not collect retention data
• 50 per cent did not track career progression
• 43 per cent did not analyse data on diversity and inclusion.
More than half (52 per cent) of surveyed HR managers admitted that they did not collect data on
retention, while a similar proportion (50 per cent) did not track career progression at their
organisation and two in five (43 per cent) were not crunching numbers for diversity and
inclusion.
Human resource data alone will not give managers sufficient information to take what can be
major decisions in these areas. However, it does offer a quantitative element, which may support
qualitative information and help human resource managers to arrive at a well-informed decision.
Thus it increases the chance of the managers making good quality decisions in the best interest of
the business. This is an aspect of management that is likely to experience rapid change over the
next few years.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 A business increased its workforce from 1,250 employees in 2017 to 1,500 in
2018. Annual output increased by 20 per cent to 480,000 units from 2017 to 2018.
Which of the following statements about the business’s labour productivity is true?
i Labour productivity rose by 20 per cent.
ii Labour productivity is unchanged.
iii Labour productivity fell by 20 per cent.
iv Labour productivity in 2017 was 384 units per employee.
 2 State two factors that determine the level of labour productivity achieved by a
business’s workforce.
3 Is the following statement true or false? ‘Unit labour costs are determined by
labour productivity and wage costs only.’
4 A business manufactures 250,000 units of output each month. It incurs the
following costs each month:
• wage costs – £4.5 million
• non-wage employment costs – £2.5 million
• material costs – £5 million
• fuel costs – £6 million.
Which of the following is its unit labour costs?
i £72
ii £48
iii £28
iv £18
5 Is the following statement true or false? ‘Unit labour costs tend to have an inverse
relationship with labour productivity.’
6 Last year a business experienced a rise of 4 per cent in its total labour costs, while
its labour productivity figure fell by 3 per cent; output was unchanged. Which of the
following is true?
i Unit labour costs rose by approximately 1 per cent.
ii Unit labour costs rose by approximately 7 per cent.
iii Unit labour costs fell by approximately 1 per cent.
iv Unit labour costs were unchanged.
7 State two factors that might influence the proportion of employee costs in relation to
a business’s revenue.
8 What is meant by the term labour retention?
9 Over the last year a retailer has had an average workforce of 4,500 employees; 300
employees have left the business and 290 have joined it. Which of the following is
its rate of labour turnover.
i 0.22 per cent
ii 6.44 per cent
iii 13.11 per cent
iv 6.67 per cent
10 What is meant by the term human resource plan?

(b) Short answer questions

1 Explain how a manufacturing business might improve the labour productivity levels
of its workforce.
 (4 marks)
2 Explain why unit labour costs may be an important measure of human resource
performance for a low price hotel chain.
(5 marks)
3 Explain why a fast food retailer may not be concerned by experiencing high rates
of labour turnover.
(5 marks)
4 Explain how a large business planning a major expansion might benefit from using
its human resource data to inform its planning?
(6 marks)

(c) Data response questions

The managers at Heron Ltd are in the process of calculating the company’s unit
labour costs. The performance of the workforce is important to the company and
labour costs are 62.6 per cent of its total costs. The managers are using the data in
Table 21.5.
Year Total employment cost Output Labour productivity (2012 =
(£m) (units) 100)
Last year 22.400 28,000 106.9
The year 19.125 25,500 107.4
before
Table 21.5 Selected employee performance data for Heron Ltd
The last year has seen significant growth at the company as the luxury rugs that it
manufactures have grown in popularity. As part of a planned expansion, production
rose by nearly 10 per cent. This increase in output was not sufficient to match demand
and the company has further expansion planned over the next eighteen months.
The company has had to ask its existing workforce to work some overtime hours at
higher rates of pay (25 per cent higher) to meet rising demand. It has, however,
recruited new employees who are steadily increasing the company’s productive
capacity. The rate of unemployment in the town where Heron Ltd is located is quite
high and the government’s decision at the start of the year to increase the national
insurance contributions that employers have to make has not helped the employment
situation.
The company’s shareholders are not satisfied with the company’s current profits given
the popularity of its products despite profit margins on sales remaining at 14 per cent
last year. They are pressuring the managers to increase dividends paid out as soon
as possible.
1 Calculate the change in Heron Ltd’s unit labour costs.
(6 marks)
2 Analyse the factors that may have caused the change in Heron Ltd’s unit labour
costs.
 (9 marks)
3 To what extent should the managers at Heron Ltd be concerned by the rise in the
company’s unit labour costs?
(16 marks)

(d) Essays
1 To what extent are unit labour costs are the only type of human resource data that
are important to managers of businesses operating in markets where demand is
price elastic?
(25 marks)
2 To what extent should all businesses should analyse human resource data before
making any decisions relating to their workforces?
(25 marks)
Chapter 22 Improving organisational
design and human resource flow
Introduction
This chapter builds on earlier ones and looks at two key decisions that a business’s human
resource managers have to make – that of deciding how to improve the organisation’s design and
how to manage the organisation’s human resource flow with the aim of meeting HR objectives.
These are key decisions in maximising the performance of a business’s human resources. The
next chapter will look at important decisions on how to improve the motivation and engagement
of the workforce.
What it is important to know by the end of this chapter:
• influences on job design
• influences on organisational design
• influences on delegation, centralisation and decentralisation
• the value of changing job and organisational design
• how managing human resource flow helps to meet human resource objectives.
Job design and organisational design
Job design
Michael Armstrong, a prolific writer on human resource management, gives a precise description
of job design. He says it is ‘the process of deciding on the contents of a job in terms of its duties
and responsibilities, on the methods to be used in carrying out the job, in terms of techniques,
systems and procedures, and on the relationships that should exist between the job holder and his
superiors, subordinates and colleagues.’

Key terms
Job design is the process of grouping together or dividing up tasks and
responsibilities to create complete jobs.
Job enrichment occurs when employees’ jobs are redesigned to provide them with
more challenging and complex tasks.

Managers can use job design to improve levels of labour productivity. The careful design, or
possibly redesign, of jobs can create positions for employees which avoid simple repetitive and
monotonous duties and offer the chance to exercise more authority and control over their
working lives.
Designing jobs which engage and motivate employees requires managers to consider a range of
techniques. Early attempts at job design were prompted by the work of Frederick Winslow
Taylor, whose work we discuss in more detail in the next chapter. Writing over a century ago he
advocated ‘method study’ to discover the most efficient may of completing jobs and ‘work
measurement’ to show how much time was required to complete a task. Initially this work on job
design led to monotonous, repetitive duties which were often unpopular and over time the
techniques of job rotation and job enlargement emerged to create more diverse working roles.

Job enlargement and job rotation

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’. Managers who
redesign jobs through job enlargement require employees to carry out a number of similar tasks.
Thus, a receptionist might be asked to maintain records of petty cash and update customer
records in addition to dealing with telephone and personal enquiries from customers. 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.
Job rotation is a particular type of job enlargement. Under this system employees switch
regularly from one duty to another. For example, a supermarket may require employees to spend
a week on the checkout, followed by a week stacking shelves and a week dealing with customer
enquiries.
Job enrichment
Later in the twentieth century writers on behavioural theories of motivation (such as Abraham
Maslow and Frederick Herzberg) began to influence job design. They recognised that people
work for a range of reasons other than money and that jobs should be designed to meet these
needs of employees to improve labour productivity. Thus jobs were enriched to provide a more
satisfying experience for employees. 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. 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.

Empowerment
Empowerment is an important element of job design and one which has become more influential
over recent years. 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
analysing the problems they face and proposing solutions. The characteristics of the job became
a central element of job design.
This approach was based to a great extent on the work of J Richard Hackman and Greg Oldham.
In 1975, they developed a model of job design called job characteristics theory which
highlighted the key elements of a motivating job.

Business in focus: Job design and the National Health

Service (NHS)

Key finding 2017 2016

1. Staff motivation at work 3.90 3.92
2. Percentage able to contribute towards improvements at work 69.6% 70.3%
3. Staff satisfaction with levels of responsibility and involvement 3.89 3.90
4. Effectiveness of team working 3.74 3.74
 5. Staff recommendation of the organisation as a place to 3.74 3.75
work/receive treatment
6. Quality of non-mandatory training, learning or development in last 4.05 4.06
12 months
Table 22.1 Selected findings from surveys of NHS staff
Source: NHS Staff Surveys, 2016 and 2017
Note: Findings 1 and 3–6 are scores on a scale of 1 (lowest) to 5 (highest).
Working in the NHS should be rewarding and interesting, yet many healthcare
professionals feel overworked and disempowered. This is not a unique NHS problem
as research shows it’s a problem in healthcare industries in all the advanced
economies worldwide.
Table 22.1 shows some findings from two recent NHS staff surveys of nearly 100,000
employees which were taken at a time of rapid change. Some managers may be
concerned that the design of jobs in the NHS needs some attention to cope with rising
demand and changes to the structure of the NHS.

Practice questions
1 Analyse why well-designed jobs might offer considerable benefits to stakeholders
in the NHS.
(9 marks)
2 Do you think that managers within the NHS should be satisfied with the results of
the staff surveys shown in Table 22.1? Justify your view.
(16 marks)

Key models and theories

This model is illustrated in Figure 22.1 and stresses the importance of designing jobs in
which individuals have:
• skill variety, i.e. they use a range of skills
• task significance, i.e. 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, i.e. the work they do has a sense of competition (for example, handing
over a complete unit of work to the next stage of the process)
• autonomy, i.e. individuals have some independence to make decisions on how they
do the work
• feedback, i.e. employees receive information on the quality of their work.
This model identifies these five elements which can influence the degree of motivation
it can provide and explains the impact of how the design of a job might influence the
performance of an employee. This model can be used to analyse the extent to which a
job might be considered motivational and can be linked to the work of motivational
theorists.

Figure 22.1 The Hackman and Oldham model of job design

Recent developments in job design

Human resource managers are under increasing pressure to be able to use their workforces more
flexibly. Workforces are a very expensive asset for many businesses and HR managers are
expected to design jobs to allow:
• flexible working times – this may be flexible or variable hours, compressed working weeks
(doing 5 days’ work in 4, or 10 days in 9, etc.), part-time working, job sharing or term-time
working
• flexible contract options – working with employees on temporary contracts, employees
working for agencies or freelance employees who will be self-employed
• flexible locations – a workforce based on multiple locations to meet customers’ needs as fully
as possible.

Influences on job design

Managers designing or redesigning jobs will be subject to a number of influences.
• The business’s overall or corporate objectives. This has the potential to be an important
influence. However jobs are designed they should enable the business to achieve its objectives
as efficiently as possible. Thus jobs may be designed to achieve cost minimisation (possibly
through high levels of productivity), high quality service or constant innovation.
• Employee performance. HR Managers in businesses that experience high rates of labour
turnover and/or relatively low labour productivity levels may seek to design jobs that have
greater potential to motivate. Many businesses that suffer high rates of labour turnover will use
exit interviews with staff who are leaving to gather evidence on causes of possible
dissatisfaction and to inform future decisions on job design. Managers can draw on Hackman
 and Oldham’s model to assist them in creating jobs that offer the potential to use a range of
skills, to fulfil a significant task and operate with a sufficient degree of autonomy.
• Health & safety and other legal requirements. The design of jobs should take into account
the possible risks associated with the work. Although this may have greater relevance in some
working environments such as manufacturing, it does also apply to office based work, for
example, avoiding extended periods of using computers.
• Meeting customer requirements as fully as possible. A central element of designing jobs is
to ensure that the outcome is satisfied customers. They should be designed to minimise the
possibility of supplying substandard products and to ensure good customer service. This may
entail building in appropriate quality assurance procedures and may involve employees
engaging in self-checking their work. This influence on job design can result in jobs that are
motivating.
• The existing and potential skills of the workforce. It is common for managers to redesign
jobs to fit as far as possible with the skills profile of existing employees. This permits a
smoother and less costly transition to new working practices. However, it may be that
managers need to consider the potential of existing employees and to assess whether they are
capable of carrying out the new roles successfully.
• The resources available. A radical change in job design within a business may require the
business to invest in training and recruitment. Employees may have to attend expensive
training courses, new employees may need to be recruited to carry out specialist roles and new
equipment may be required to support new training methods. The HR team will need to ensure
that the business has the financial resources and physical resources (such as sufficient
technology) to support employees carrying out particular job roles.
• Expected future developments. It is important that managers design jobs that will continue to
be effective and appropriate for the foreseeable future. Businesses are subject to a range of
changes in their external environment. For example, technology may change leading to
changes in patterns of demand. Many of the UK’s banks are adjusting their workforces to meet
a declining demand for banking services in branches and increasing online demand. Changing
demand and fashions can also require businesses to adjust product portfolios and may require
difficult approaches to working.
Figure 22.2 Influences on job design
Organisational design
A good definition of an organisation was provided by Carter McNamara in 2012. He says that ‘in
its simplest form an organisation is a person or group of people intentionally organised to
accomplish an overall, common goal or set of goals’. Because they are ‘intentionally’ organised
and do not simply evolve, there is a need for design. In turn, the Chartered Institute of Personnel
and Development (CIPD) defines organisational design as ‘ensuring that the organisation is
appropriately designed to deliver organisation objectives in the short- and long- term and that
structural change is effectively managed.’ Another writer on business organisations, Alan S
Gutterman, believes that organisational design is more than simply a business’s organisational
structure as shown by its organisational chart. He argues that it includes other factors such as:
• the business’s mission or vision and values and the reason why it exists
• the ways in which decisions are taken and who takes them
• the information and pay systems used in the business
• the ways in which the business normally operates – its culture.

Key terms
Organisational structure is the way a business is arranged to carry out its activities.
Organisational design is a process to ensure that the organisation is appropriately
designed to deliver organisation objectives in the short and long term.
Figure 22.3 A simplified organisational chart

Designing an organisational structure to balance these factors requires creative skills.

Organisational designers have to create something that enables the enterprise to meet its goals, to
respond to external pressures for change, integrates individuals into the organisation and is able
to recognise the need to change. The creativity involved in this design process has led to it being
termed ‘organisational architecture’.
A well-designed organisation can make the business more efficient, generate innovation and
spread authority across the workforce. Organisational design is becoming more important to HR
managers as businesses are increasingly subject to external forces such as changes in consumer
demands, changes in technology and in the behaviour of competitors.
The activities involved in organisational design will create an organisational structure for a
business. The organisational structure, which may be shown in an organisational chart, sets out:
• the routes by which communication passes through the business
• who has authority (and power) and responsibility within the organisation
• the roles and titles of individuals within the organisation
• the people to whom individual employees are accountable and those for whom they are
responsible.
Key factors in organisational design
The designers of an organisation have a range of factors with which to work. Some of them are
clearly structural such as the number of people for whom a particular manager is responsible.
Other factors will underpin the structural decisions. For example, if designers are given the brief
that authority is to be spread widely among people across the organisation, this will have
significant implications for the organisation that they design. We will consider a number of
relevant factors that managers may take into account when making decisions on the design of
their organisation.

1. 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) of hierarchy are referred to as
‘tall’. That is, there are a substantial number of people between the person at the top of the
organisation and those at the bottom. Figures 22.4 and 22.5 illustrate tall and flat types of
structure.

Key terms
Levels or layers of hierarchy refer to the number of layers of authority within an
organisation. That is, how many levels exist between the chief executive and a shop-
floor employee.
A span of control is the number of subordinates directly responsible to a manager.
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.

What do you think?

Surveys of employees have shown that the majority of people prefer to work within a
‘flat’ organisation. Why might this type of structure be particularly popular with junior
employees?

Figure 22.4 A ‘flat’ organisational structure has few levels of hierarchy (three) and a wide span of
control. Many UK businesses have implemented this form of organisational structure.

Figure 22.5 A traditional ‘tall’ organisational structure has five layers of hierarchy and a narrow span of
control. In spite of the firm employing more people, it has fewer shop-floor employees than the ‘flat’
structure in Figure 22.4.

Traditionally, UK businesses have tended to use ‘tall’ organisational structures as they have
grown. Once businesses have adopted a tall 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.
Attracted by the prospect of faster and more effective communication and improved workforce
performance, which can in turn enhance competitiveness, many UK businesses have redesigned
their organisations to either adopt or move towards flatter organisational structures. However, the
process of flattening structures (commonly termed delayering) has led to businesses operating
with significantly wider spans of control.

2. 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 22.4. Conversely, ‘tall’
organisations have many layers of hierarchy, but narrow spans of control. Figure 22.6 illustrates
a wide and a narrow span of control. Manager A has a narrow span of control of two. This is
because the two supervisors B and C are the only employees who are directly responsible to him.
Supervisor B has the widest span of control – five workers are responsible to her.
A narrow span of control allows team leaders, supervisors and managers to keep close control
over the activities of 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 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 ten or even twelve is not unusual. It is normal for a span of control to be less at
the top of an organisation. This is because senior employees have more complex and diverse
duties and are, therefore, more difficult to supervise.
3. Delegation
Delegation is the passing down of authority through the organisation. 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 and 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.
Delegation can be an important element of organisational design. It may reflect, for example, that
the business’s values include allowing relatively junior employees to make decisions.
Giving people more authority is likely to lead to wider spans of control, which can operate
effectively if junior employees have been delegated authority to take decisions. This reduces the
workload of their manager or team leader, as they do not have to monitor all subordinates so
closely, freeing time for other duties.
Advantages Disadvantages

• Delegation can speed up and improve the • The costs of training. Delegation
quality of decision making. Decisions may be may require a business to spend
taken by employees who are close to heavily on training employees to
customers and have a better understanding of ensure they have the necessary
their needs and they do not have to refer skills.
decisions to managers. • It may be inappropriate in some
• Delegation can reduce the workloads of senior organisations where leadership
and middle managers, allowing them to focus styles are authoritarian and
on key tasks and to improve their managers may be unwilling (or
performance. lack the skills) to pass control to
• Delegation improves the skills of junior junior employees.
employees and prepares them for more senior • Delegation is not a suitable
roles in the organisation. strategy to adopt to manage a
crisis. Such situations would
require rapid decisions by
experienced senior managers.

Table 22.2 Advantages and disadvantages of delegation

4. Authority
Authority and delegation are linked as the latter involves passing the former down the
organisational structure. Where authority resides is an important decision within organisational
design. Giving employees authority allows them the power to command a situation, to commit
resources to their decisions and to issue orders to subordinates. Authority carries a matching
responsibility for actions and decisions taken or for a failure to act.

5. 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.
Organisational design based on 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.

Figure 22.6 Spans of control

Decentralisation gives greater authority to employees lower down the organisational structure. In
recent years many businesses 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’s 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 important long-term issues. At the same time it offers junior
managers an opportunity to develop their skills in preparation for more senior roles.
• 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 retain centralised organisations. 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’s senior managers and
their desire to retain authority. This may occur when employees are relatively low skilled and its
managers are experienced decision-makers. In addition, if a business makes all its buying
decisions centrally it is likely to benefit from purchasing economies of scale, allowing the
possibility of shareholders receiving increased benefits. In such circumstances, an organisation
may perform more effectively if power remains at the centre of the organisation.
Figure 22.7 A summary of centralisation and decentralisation
Influences on delegation, centralisation and
decentralisation
Decisions on organisational design relating to centralisation and decentralisation will involve
judgements about the extent to which the business delegates authority. A move towards
decentralisation is likely to entail a greater degree of delegation throughout the organisation.
There is a range of factors at work here, which can be categorised into internal and external
influences.
Internal influences on delegation, centralisation
and decentralisation
1. Leadership and management styles
A business is more likely to be willing to adopt a decentralised structure and make greater use of
delegation within its organisational design if the business’s managers operate in democratic or
laissez faire styles. Such approaches to management and leadership involves junior employees in
the decision-making process, while a more autocratic style would exclude them to some extent.
The philosophy of democratic management will naturally move authority away from the centre
of the organisation and will seek to delegate authority to employees further down the
organisational structure. The impact of a laissez faire style would be to give decision-making
authority to employees through the extreme use of delegation.
Richard Branson’s leadership style has influenced his use of delegation. He believes that what he
calls ‘the art of delegation’ is an essential element of the success of his Virgin Group of
companies. Branson says ‘You must understand the art of delegation. I have to be good at
helping people run the individual businesses, and I have to be willing to step back.’

2. The business’s overall or corporate objectives

Decisions about organisational design will be strongly influenced by the corporate objectives that
the business pursues. A business with an objective of increasing its market share by supplying
high-quality products may seek to delegate authority and to decentralise its organisation. Giving
enhanced decision-making powers to employees throughout the organisation may help to
improve motivation and the business’s ability to meet the individual needs of its customers.
On the other hand, a business with a corporate objective of minimising costs may design a
centralised organisational structure to benefit from consistent and experienced decision making
and the benefits of purchasing in bulk.

3. The skills of the workforce

There is a relationship between the level of control managers wish to have and the design of the
organisation. Managers are more likely to cede control when they have a skilled workforce.
Thus, the higher the level of skill a typical employee in an organisation has, the more likely the
business is to use decentralisation and accompany it with delegation. Groups of professionals
such as management consultants may well be employed in organisations that make extensive use
of delegation within a decentralised structure. In contrast, an organisation with a high proportion
of unskilled employees may remain more centralised as senior managers may not trust more
junior employees with greater levels of authority and will opt to retain more control.
External influences on delegation, centralisation
and decentralisation
1. The technological environment
Developments in technology have meant that managers have much more information available to
support decision making than in the past. The use of techniques such as loyalty cards has
generated huge amounts of data for managers. This is forecast to lead to further decentralisation
by businesses as managers collect information centrally and disseminate it throughout the
organisation to allow more junior employees to take decisions based on this and their interaction
with customers. Research conducted by the Economist Intelligence Unit, shows that 63 per cent
of business leaders predict a move towards a more decentralised business model and that
responsibility for business decision making will move from centralised management teams
towards individual employees.

Business in focus: First Group plc

First Group plc is a British multinational company based in Aberdeen that operates
transport services in the UK, Ireland, Canada and the USA. The company:
• employs 100,000 people globally
• generates revenues of approximately £6.4bn a year
• carries 2.1 billion passengers a year
• operates, manages or maintains fleets of 50,000 vehicles.
First Group operates the Great Western Franchise providing rail services from
London to the West of England as well as in many parts of Southern England. This
entails operating intercity services, commuter routes as well as local services across
a large region of the country.
The Department for Transport (DfT) oversees the operation of rail franchises in the
UK, including the Great Western Franchise. In 2018, it conducted consultations with
passengers who travel on the Great Western Franchise. A number of respondents to
the consultation believed that more decentralised decision making will help First
Group meet the needs of some councils and other local groups. The DfT has said it
will require operator FirstGroup to demonstrate how it will achieve more decentralised
decision-making within the franchise, helping ensure that ‘decisions reflect the needs
of passengers in the different geographical areas and markets which the franchise
serves.’
Sources: Adapted from First Group website and Rail Technology Magazine

Practice questions
1 Analyse why the Department for Transport (DfT) might have called for
decentralisation in the operation of the Great Western Franchise.
 (9 marks)
2 Do you think it is always best for a multinational company to operate a
decentralised structure? Justify your decision.
(16 marks)

Decentralised structures have been criticised for their inefficiency and lack of focus on the
business’s overall objectives. It is forecast that by 2020, effective business processes based on
technology will empower workers to better meet the needs of the marketplace and enable
organisations to be more responsive to customers’ needs. Successful decentralisation will depend
to some extent on processes to manage information, and ensure that it is accessible by key
workers enabling them to make business decisions.

2. The competitive environment

Businesses that operate in highly competitive markets will seek to design organisations that are
adaptable and flexible and allow them to meet consumers’ needs as fully as possible. This may
be particularly important in circumstances in which markets are altering quickly due to changing
consumer tastes or product innovation.
The competitive environment can shape organisations in a number of ways. For example, the
entry of new competition into a market may lead a business to design an organisation that can
increase innovation and produce desirable products. Equally, the business may aim to increase its
competitiveness from an improved performance by its workforce if given more authority and
more interesting jobs. Finally, delegation and decentralisation may be used to improve a
business’s competitiveness by allowing junior employees, who may have a fuller understanding
of customers’ needs, to take more decisions.
Other businesses may operate in competitive environments where great emphasis is placed on
price, possibly because there is little differentiation in the products that are sold. This could
encourage the use of a more centralised organisation to minimise costs through uniformity, bulk
buying and in the expectation that senior managers will make cost effective decisions.

3. The economic environment

A strongly performing economy can result in rapid rises in consumers’ incomes and spending
resulting in satisfying growth in sales for many businesses, especially those selling income
elastic products. This may encourage decentralisation and delegation partly because managers
experience more difficulty controlling an expanding organisation from the centre.
In contrast, difficult economic conditions may result in businesses seeking to centralise
operations in an attempt to reduce costs, possibly through bulk buying and standardised
procedures. In 2018, the Dutch logistics firm, A2B Online, centralised its operations at a new site
near to Ipswich in Suffolk. The company said that this would help it to deal with the increasing
volume of products that it is transporting.
The value of changing job and
organisational design
Most businesses change the design of their organisations or their employees’ jobs with the aim of
improving their competitiveness. Becoming more competitive is a valuable attribute for any
business and can assist them in achieving their overall objectives. Managers hope that changes
made to organisations and job designs will enable the business to become more effective at
meeting consumers’ needs while controlling costs.
Changes in the design of jobs and organisations can assist businesses in improving the
performance of their workforces. Thus creating jobs that are more interesting and motivational
may improve labour productivity resulting in reduced unit labour costs. For example, a number
of UK businesses are redesigning jobs for employees aged over 50 to maintain their interest and
enthusiasm in the later stages of their working lives and to retain valuable skills and knowledge
within the organisation.

Key terms
Unit labour costs measure the labour cost per unit of output produced.
An employer brand is a business’s reputation as an employer.

Redesigning organisational structures to become flatter by removing layers of management (a

process known as delayering) can reduce costs as well as offering the potential to motivate those
further down the organisational hierarchy. This can result in reduced unit labour costs and
enhanced price competitiveness. Sainsbury’s, one of the UK’s major supermarkets, revealed in
2018 that it was to cut thousands of managerial posts to reduce its costs. The supermarket
expects to save £500 million over the period 2019–2022.
Changing job designs and organisational structures has the potential to make employees’ jobs
more interesting and rewarding. This is often one of the objectives behind such changes and
often these changes are made to improve the status of the business’s brand as an employer. A
business can develop a strong employer brand if it designs jobs and its organisation to provide
stimulating and well-rewarded work with clear routes for progression. Businesses can reap
substantial rewards from positive employer brands through being able to attract the most able
and best-qualified employees, which can result in improved workforce performance.
Wagamama, a UK restaurant chain, noted for its East Asian cuisine, has won awards for its
employer branding. The company emphasises in its recruitment materials that it wants its
employees ‘to be themselves’ which assists it in creating a diverse workforce.
Many businesses operate in markets that are changing quickly: redesigning jobs and
organisations can help them to succeed in these changing environments. The rate of change has a
number of causes, including technological development and globalisation of markets. As markets
become more global, UK businesses are subject to increasing competition from overseas
producers including those in developing countries such as India and South Africa where
production costs can be low. UK businesses have responded by developing more flexible
workforces and have supported them with technology to allow lower-cost, more customer-
focused operations.
Similarly, advances in technology have led to businesses redesigning jobs and their organisations
to maintain and enhance competitiveness. Technology has created additional pressures for
businesses to be flexible in responding to consumers’ expectations in terms of quality of products
and service. The use of social media by dissatisfied customers is a powerful incentive for firms
to be seen to respond promptly and efficiently. Many organisations have adapted their structures
to incorporate teams to provide responses to criticisms and problems aired on sites such as
Twitter and Facebook. A common response is to appoint social media managers, less common is
to embed within all teams and divisions in the organisation an awareness of the impact of their
actions as viewed on social media.

Business in focus: Redundancies at Morrisons

Morrisons, the UK’s fourth-largest supermarket, announced in 2018 that it is to cut

1,500 jobs as part of an effort to simplify its management structure. A spokesman for
the supermarket said that its restructure would see it employ fewer managers and
more customer-service staff. This may help to simplify the management of stores and
simplify communication. Morrisons removed 2,600 jobs, including many managers, as
it delayered its organisational structure in 2015. Other supermarkets have cut
managerial positions recently as they respond to the threat posed by the low prices
offered by discounter supermarkets such as Lidl and Aldi. Aldi and Lidl have
increased their UK market share at the expense of more established supermarkets.
Gary Mills, Morrisons retail director, said: ‘Our aim is to serve customers better with
more front-line colleagues in stores improving product availability and helping
customers at the checkouts. Very regrettably, there will be a period of uncertainty for
some managers affected by these proposals and we’ll be supporting them through
this important process.
Our commitment is to redeploy as many affected colleagues as possible.’

Practice questions
1 Analyse the possible implications for Morrisons of delayering its organisational
structure.
(9 marks)
2 To what extent is achieving a greater focus on customer service the most important
reason for Morrisons changing its organisational design?
(16 marks)

Social media can impose pressures on managers to redesign jobs to create ones that engage
employees. Dissatisfaction voiced on social media websites such as LinkedIn by employees may
attract a swift response from competitors seeking to recruit skilled staff. Some HR specialists
argue that the biggest impact of social media on the design of organisations is its potential to
improve communication within the business and to enable employees to share information. This
is an area that many businesses have yet to explore.
How managing the human resource flow
helps meet HR objectives
What is the human resource flow?
The term human resource flow was first used by Michael Beer in 1984. Beer and his co-authors
stressed that the management of human resources must support the business in the achievement
of its overall objectives. Beer and his colleagues split an organisation’s human flow into three
elements that need to be managed.
• Human inflow. This encompasses recruitment decisions about where and how to recruit
employees. Related actions are planning, recruitment, selection and induction.
• Internal human flow. This covers the flow of employees through the organisation and
includes transfers (for example, to temporary projects), promotions and demotions, training
and employee pay systems. This element of the human flow requires managers to balance the
organisation’s need to have suitably skilled employees in post with the needs of employees to
develop their careers.
• Human outflow. This stage of the flow relates to the release of employees. The release of
employees may entail retirement, redundancy (voluntary of compulsory) or dismissal.

Key terms
Human resource flow is the movement of employees through an organisation,
starting with recruitment.
Recruitment and selection is the process of filling an organisation’s job vacancies
by appointing new staff.
Elements of the human resource flow
The human resource flow comprises a number of elements that reflect an employee’s movement
through an organisation.

1. Human resource planning

We looked at human resource planning in Chapter 21. A human resource plan starts with an
assessment of the forecast human resource needs of a business over the next few years if it is to
achieve its overall or corporate objectives. These are then compared to the existing human
resources available to the business, taking into account untapped skills and talents. Managers
responsible for HR are then able to make decisions about how the existing workforce needs to be
changed to create the desired workforce.
Once this comparison is complete the firm can take the necessary decisions to convert the
existing workforce into the desired one. This may require decisions relating to various elements
of the human resource flow including:
• recruitment and selection
• training
• redeployment and redundancy.
Human resource planning plays a critical role in ensuring that decisions on the business’s human
resource flow assist it in meeting its HR objectives. The human resource plan will be constructed
with a view to meeting the HR objectives and, so long as decisions about matters such as
recruitment, training and redundancy are taken in line with the plan, the HR objectives should be
fulfilled.

2. Recruitment and selection

Firms can alter the composition of their workforce through recruitment and selection. The
process of recruitment is summarised in Figure 22.8.
The start of recruitment is to draw up job descriptions and person specifications. Typically, job
descriptions contain details on the tasks, duties and employment conditions associated with the
post. In contrast, person or job specifications set out the qualifications and qualities required in
an employee. They refer to the person rather than to the post. These documents form an
important part of recruitment and selection. Candidates’ applications should be compared against
the person specification and those applicants having the ‘best fit’ should be invited to the
selection procedure. In an interview, the job description might form the basis for the
interviewer’s questions.
Firms may recruit internally through promotion or redeployment from within the existing
workforce. This means the pool of potential applicants is limited, even though they may be
familiar with the business. External recruitment, from outside the business, is much more widely
used by HR managers in the UK. The most effective methods for attracting candidates were
through corporate websites and recruitment agencies. Corporate websites were particularly
popular in the public and not-for-profit sectors (as well as in larger private sector organisations),
while recruitment agencies were more widely used by private sector businesses, particularly
those in manufacturing. In 2018, the airline easyJet announced that it was to recruit 1,200 cabin
crew and its website was used in the process of recruitment.
External recruitment is likely to be very expensive. Firms can recruit externally by using other
methods apart from their own websites and recruitment agencies.

Figure 22.8 The recruitment process

• Firms ‘headhunt’ employees who are currently working for 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.
• Job centres (now called Jobcentre Plus) are run by the Department for Work and Pensions
(DWP) to bring together those seeking work and businesses intending to recruit. This service
uses technology extensively including a database called ‘Universal Jobmatch’.
Technology is playing an increasing role in managing human resources, including recruitment.
The growing popularity of social networking sites such as Facebook and LinkedIn have resulted
in more than half the organisation survey by the Chartered Institute of Personnel and
Development (CIPD) using social media as a part of their management of human resource flow.
However, only a minority have a social media strategy and many admit that, while they use
social media for HR purposes, they do not understand fully how to maximise its use.
Recruitment can be an expensive exercise, though costs have fallen in recent years, perhaps due
to the increasing use of social media and corporate websites. Research in 2017 showed that the
average cost of external recruitment for a new employee is over £2,000. For senior managers and
directors this figure is £6,000, though it can be as high as £90,000.
However, many managers would argue that these figures are less costly than appointing the
wrong employee and perhaps having to repeat the process.

What do you think?

Why is it more expensive to appoint a senior employee?

HR managers have to select the employees they wish to hire from those candidates who have
applied to work with a business. A number of selection techniques exist, as shown in in Table
22.3. Because of the high costs resulting from recruiting the wrong people, firms are investing
more resources and time in the recruitment and selection process. Interviews remain the most
common form of selection as they are relatively cheap, although research suggests they are
unreliable as a means of selection. There is some evidence that businesses are recognising this
weakness and making greater use of competency-based interviews, which are designed to test the
skills that applicants will require in the workplace.
Some businesses use psychometric tests to reveal the personalities of applicants and their
suitability to work in the business and within specific teams. Assessment centres are also used
where a number of candidates are subjected to a variety of selection techniques over a period of
between two and four days. Unilever plc, a multi-national supplier of consumer goods, operates
an assessment centre in which candidates are asked to make a case study presentation, attend a
competency-based interview and participate in a group exercise.
Method of selection 2017 Survey 2011 Survey (%)
(%)
Competency-based interviews 78 70
Interview following contents of CV/application 74 63
form
Personality/attitude/psychometric tests 35 35
Online tests 23 0
Group exercises (e.g. role playing) 24 21
Table 22.3 Methods of selection used by a sample of UK businesses in 2011 and 2017
Source: CIPD Annual Survey Report, 2011-2017
Nearly 60 per cent of firms in the UK monitor their recruitment and selection procedures to
ensure they appoint diverse workforces, which is an increasingly important HR objective.
Effective recruitment policies will lead to the appointment of engaged employees with the right
skills. This assists managers in improving key HR performance indicators such as labour
productivity and unit labour costs.

3. Training
Training is a process whereby someone acquires skills and knowledge. This can help employees
to develop, as well as assisting the organisation in achieving its objectives. Training is commonly
referred to as ‘learning and talent development’.
A survey by find courses.co.uk uncovered the following.
• The average amount spent on training per employee per year by the organisations in the survey
was £300 in 2018. This figure has been relatively unchanged since 2013. Despite this
unchanged figure, 94 per cent of businesses surveyed said that training is essential to success.
• The typical employee received five days training per year in 2017, with many receiving none
and some more than three weeks.
• About 32 per cent of organisations surveyed in the UK anticipate an increase in learning and
talent development activities over the 12 months following the survey. However, 21 per cent
of businesses surveyed expect to reduce this type of activity, while just over 40 per cent expect
no change.
The survey suggests a generally favourable attitude by employers towards learning and talent
development at work, even at a time of financial stringency. This indicates that, despite the
disruption that training can cause, employers hold a generally positive view on the benefits of
training. The costs and benefits of training are summarised in Table 22.5.

Business in focus: Social media and HR managers

Research conducted in 2017 indicated that 59 per cent of employers believe

employee involvement in recruitment via social media risks damaging rather than
enhancing the employer brand. This research from SocialReferral, a recruitment
software company which consulted 155 HR decision makers, also found that only 39
per cent are using social media to actively search for staff and only half (49 per cent)
use it to advertise vacancies. The most popular websites with HR managers are
LinkedIn, Twitter and Facebook.
About 75 per cent of businesses recognise the need for a change in the traditional
approach to recruitment, and two thirds (62 per cent) feel they need a stronger story
around why candidates should choose to work for them. Yet, only 41 per cent of the
businesses surveyed encourage staff to post about their own experiences as a route
to publicising their employee brand.
Source: SocialReferral

Practice questions
1 Analyse the possible reasons why LinkedIn, Twitter and Facebook might be among
the most popular social media sites with HR managers.
(9 marks)
2 Do you think that all businesses should use social media as a major method of
recruitment in the future? Justify your view.
(16 marks)
Costs Benefits
Training uses up valuable resources that Training can improve employee
could be used elsewhere in the performance and hence the competitive
organisation – this is an example of position of the business.
opportunity cost.
Training means that employees are Training should improve employee
unavailable to the organisation for a motivation and productivity. It can help to
period of time. identify and nurture the most talented
employees.
Employees, once trained, may leave for Training is a core component of HRM and
better jobs. assists organisations in achieving
strategic objectives.
Some managers avoid training their staff A reputation for training will assist
as it can lessen the degree of control they organisations in attracting and retaining
have over their subordinates. high-quality employees.
Table 22.5 Costs and benefits of training
Businesses can engage in a range of learning and talent development activities. Figure 22.9
illustrates a range of methods and the extent to which HR managers use them. Blended learning
involves a number of methods, for example, a mix of lectures and seminars, self-study or e-
learning.
On-the-job training does not require the employee to leave the workplace and is commonly used
with entry-level employees. They learn from experienced employees through observation and
work shadowing. The trainee may work through instruction manuals or receive guidance from
senior employees. This, along with in-house programmes, are some of the most highly regarded
training methods. Developments in technology, for example, e-learning, have helped to increase
the amount of training undertaken in the workplace or at home.
Training can be an essential, if costly, element of a HR plan to fulfil HR objectives. It can play a
vital role in creating a more motivated workforce and one that has the skills required to enable
the business to meet its overall or corporate objectives.

What do you think?

Why might employees be attracted to businesses that provide good-quality training or
learning and talent development?

4. Dismissal and redundancy

Redundancy is one reason for dismissal. Other reasons for dismissal include the following.
• 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 to 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.

Key terms
Redundancy takes place when an employee is dismissed because a job no longer
exists.
Dismissal takes place when an employer terminates an employee’s contract of
employment and leads to employees exiting the human resource flow.
Redeployment occurs when an employee is offered suitable alternative employment
within the same business.

Figure 22.9 Methods used to train senior-, mid- and entry-level employees
Source: Findcourses.co.uk 2018

Redundancy is a particular type of dismissal. It 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:
• 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.
If a business in the UK intends to make 20 or more employees redundant it is obliged by law 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.
Employees who have been continuously employed by the business for two years and who are
made redundant due to the closure of a business or reduced need for employees are entitled to
compensation in the form of redundancy payments. The minimum legal redundancy pay is
calculated according to a formula based on the employee’s age and length of service. Some
employers may choose to pay higher levels of redundancy pay.
5. Redeployment
Employees may be offered the option of redeployment when facing redundancy. During any
period in which redundancies are being negotiated, employees should be told about available job
vacancies within the organisation that could be filled through redeployment. Redeployment
offers a worker what should be suitable alternative employment. A variety of factors would
determine whether a job is deemed as ‘suitable alternative employment’. These include:
• the proximity of the work to the employee’s current job
• the terms of the job being offered
• the employee’s skills, abilities and circumstances in relation to the job and the pay (including
benefits), status, hours and location of the job.
Redeployment may be offered to employees who may be unable to continue in their current post
due to ill health or for personal reasons.
Dismissal, redundancy and redeployment are all important actions to allow a business to meet its
HR objectives. These actions can allow a business to have the desired number of employees in
the correct locations and avoid overstaffing, which can reduce profit margins.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 What is meant by the term job design?
2 State two techniques that may be used to create more interesting and challenging
jobs.
3 What is meant by the term empowerment?
4 State two elements of a well-designed job according to Hackman and Oldham.
5 State two possible influences on a business’s approach to the design of its
employees’ jobs.
6 What is meant by the term organisational design?
7 State two benefits to a business of having a well-designed organisation.
8 Is the following statement true or false? ‘A span of control is the number of
subordinates below a manager in the organisational hierarchy.’
9 State two advantages to a business that may result from the use of delegation.
10 Is the following statement true or false? ‘Some businesses retain centralised
organisations because the senior managers like to remain in control of the
business and to take the major decisions.’
11 List three actions that HR managers may take to control a business’s human
resource flow.
12 List two methods of external recruitment that a business may use.
13 Is the following statement true or false? ‘Interviews are the most effective method
of selecting employees.’
14 List two possible costs to a business of increasing the amount of training it
provides.
15 State the difference between redundancy and redeployment.

(b) Short answer questions

1 Explain why the manager of a business suffering from declining profitability might
redesign her employees’ jobs to delegate authority.
(4 marks)
2 Explain the possible consequences for a business’s short-term competitiveness of
a decision to reduce its number of levels of hierarchy.
(5 marks)
3 Explain how the use of a human resource plan might assist a business
experiencing rapid growth in sales to meet its HR objectives.
(6 marks)
4 Explain the possible problems for a major UK retailer with 1,500 stores arising
from redesigning its organisation to offer greater empowerment to junior
employees.
(5 marks)

(c) Data response questions

Moheen Ltd is a social enterprise that supplies training services in areas of high
unemployment. It employs 495 staff in 27 locations, the majority of whom are highly
skilled. It has a strong employer brand as a caring and supportive employer that aims
to develop the skills of all of its workforce. The business has grown steadily and has
expanded the range of its services and has continually redesigned its jobs to allow
employees to carry out more empowered roles.
Recent reductions on the level of financial support for its activities from both central
and local governments have created serious difficulties for the business’s managers.
The senior management team is seeking to avoid making any of its employees
redundant even though its revenue is forecast to fall by 24 per cent over the next
financial year. The management team is confident that the company will win a number
of new contracts to provide training services over the next 18 months and this is
reflected in its HR plan.
The company’s CEO has proposed that a policy of decentralisation is implemented as
soon as possible with the aim of meeting its HR objectives of engaging employees,
increasing diversity and developing its talented employees. Achieving these objectives
is important for the success of the entire business, the CEO believes.
1 Explain the possible reasons why Moheen Ltd has drawn up a human resource
plan.
(5 marks)
2 Analyse the reasons why it was important for Moheen Ltd to avoid making any of
its employees redundant.
(9 marks)
3 To what extent will a decision to decentralise Moheen Ltd’s organisation enable it
to meet its HR objectives?
(16 marks)

(d) Essay questions

1 To what extent is training the most important means by which an international
airline can manage its human resource flow to meet its customers’ demands?
(25 marks)
2 To what extent will any business operating in a global market always benefit from
operating a decentralised organisational structure.
(25 marks)
Chapter 23 Improving motivation and
engagement
Introduction
This chapter builds on earlier ones in this unit and looks at two interrelated decisions that a
business’s human resource managers have to make. These are how to improve the levels of
motivation and engagement of the business’s workforce. Improvements in these areas can have
significant effects on the performance of an organisation’s workforce. The next chapter will look
at important decisions on how to improve employer–employee relations.
What it is important to know by the end of this chapter:
• how to improve employee engagement and motivation
• the value of theories of motivation
• financial methods of motivation
• non-financial methods of motivating employees
• the benefits of motivated and engaged employees
• influences on the choice and assessment of financial and non-financial reward systems.
What are employee engagement and
motivation?
What is employee engagement?
Employee engagement has a number of definitions. The Chartered Institute of Personnel and
Development (CIPD) has defined employee engagement as existing when an employee ‘is
positively present during the performance of work by willingly contributing intellectual effort,
experiencing positive emotions and meaningful connections to others’.
The CIPD says that its definition gives three dimensions to employee engagement:
• intellectual engagement – thinking hard about the job and how to do it better
• affective engagement – feeling positively about doing a good job
• social engagement – actively taking opportunities to discuss work-related improvements with
others at work.
The common themes here are that engaged employees have positive feelings towards their work,
their colleagues and their organisation. The performance of UK businesses in engaging their
employees is weak and declining.
Employee engagement is an issue for all managers within an organisation and not just those
responsible for human resources. It is impossible for an organisation to engage its employees
more actively without managers in all functions and at all levels seeking to communicate
effectively, demonstrating that they value employees and working to establish positive
relationships with colleagues.
What is motivation?
Motivation describes the factors that arouse, maintain and channel behaviour towards a goal.
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 of motivation 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.

Key term
Motivation describes the factors that arouse, maintain and channel behaviour
towards a goal.

The first of these views assumes that motivation lies within the individual employee and the
second that it is the result of some external stimuli. People in the workplace have differing views
on the sources of motivation. Some employers believe that money should be used to motivate,
but a survey for the report Living to Work in 2018 revealed that it is not lack of pay that has
caused demotivation but lack of opportunities for promotion, lack of recognition or a poor work-
life balance.

Business in focus: UK employees have low levels of

engagement
Figure 23.1 Data on employee engagement in the UK and overseas
Sources: HR Magazine and ORC International

A survey of more than 4,500 workers has found that British employees are some of
the least engaged in the world. Qualtrics Employee Pulse found average engagement
scores of 45 per cent for UK employees, compared to 60 per cent in the US, 56 per
cent in Australia and 54 per cent in France. Of the regions analysed, only Hong Kong
and Singapore had lower levels of workplace engagement.
Qualtrics revealed that 17 per cent of UK workers surveyed said that they intended to
leave their current employment within the next two years.
The lowest levels of engagement were found in employees that had only been with
their company for a short time, those in junior positions or with higher levels of stress,
and those who felt that their employers were unsupportive of their work–life balance.
These employees were most likely to leave the business.
Sarah Marrs, an insights expert at Qualtrics, noted that: ‘Work–life balance is the top
driver of engagement at work, but it’s not traditionally an aspect that many
organisations ask employees about.’
Some differentiation was found by sector, however. The most loyal workers were
found in manufacturing, with 67 per cent of employees saying they were likely to stay
with their current employers for the next two years. Retail and finance had similar
levels of loyalty (65 per cent). Loyalty was found to be lowest in the tech sector (59
per cent), public sector (57 per cent) and travel and leisure (54 per cent).
Source: Adapted from Real Business 2017

Practice questions
 1 Analyse why UK businesses would benefit from having more engaged employees.
(9 marks)
2 Do you think that the desire by businesses to make the maximum possible profits
is the only reason why UK employees do not have higher levels of engagement?
Justify your view.
(16 marks)

What do you think?

What motivates you – internal desire or external stimuli? Does this vary according to
the circumstances?

The distinction between the internal and external views of motivation is important and you
should bear it in mind when considering theories of motivation and how, in practice,
entrepreneurs and managers can motivate other people.

What is the relationship between employee engagement and

motivation?
These two concepts are interrelated. Some writers on HR argue that it is impossible for policies
to motivate employees to be effective unless the workforce is engaged beforehand. One view is
that it is essential to align the values of the workforce and the organisation as a central part of
engaging and enthusing employees and creating positive attitudes to work, colleagues and the
organisation. In such an environment, actions to motivate employees are more likely to be
successful.
Others hold the view that engagement and motivation are inextricably linked and should not be
separated in the minds of managers. Proponents of this view believe that both describe an
employee’s attitude and satisfaction in the work environment. Therefore both will determine
whether employees work to their full potential.
Theories of motivation
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? If
managers can identify the main reasons why their staff work, they can determine how best to
motivate them at work. It is possible to classify theories of motivation into a number of groups or
schools of thought (see Table 23.1).

Key models and theories

Writers on motivation disagree about why employees are motivated. Some believe that
it is the result of external factors (the carrot and stick approach) while others believe is
achieved through meeting employees’ internal needs.
• Frederick Taylor – he saw motivation as the consequence of external factors. The
best systems of production should be identified and employees supervised closely
when they carried out specified tasks. Employees could be motivated by monetary
rewards for achieving precise goals – piece-rate pay would be an appropriate pay
system.
• Abraham Maslow – he considered the needs of employees that must be met to
motivate them. He identified five categories which he put in a hierarchy. Once
employees reached one level in this hierarchy, they could be motivated by being
given the opportunity to meet needs in the next level.
• Frederick Herzberg – he split the factors which influence motivation in two
categories. Hygiene factors, such as pay, do not positively motivate, but they have
the potential to demotivate. In contrast, motivators, such as recognition for
achievement, can positively motivate employees.
You should be able to use motivation theory to explain why employees in particular
circumstances might or might not be motivated and also to support arguments setting
out ways in which employees in a particular scenario could be motivated.

School of Key writers Essential ideas

thought
Scientific Frederick Motivation is an external factor achieved through
School Winslow money. Employees should be closely supervised and
Taylor paid piece-rate. Time and motion studies determine
(1856–1917) efficient means of production and workers are trained
and told how to operate.
Human Elton Mayo This brought sociological theory into management and
Relations (1880–1949) accepted that employees could be motivated by meeting
 School 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).
Neo–Human Abraham This school highlighted the importance of fulfilling
Relations Maslow psychological needs to improve employee performance.
School of (1908–1970) Motivation, according to Maslow and Herzberg,
Management and depended upon designing jobs to fulfil psychological
Frederick needs.
Herzberg
(1923–2000)
Table 23.1 Schools of thought on motivation
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.

Key terms
Division of labour is the breaking down of production into a series of small tasks
carried out repetitively by relatively unskilled employees.
A time-and-motion study (work-study) measures and analyses the ways in which
jobs are completed, with a view to improving these methods.

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 began to advise and lecture on management practices and became a consultant to car
manufacturer Henry Ford. 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

1. Work study. 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.
2. ‘Normal’ times. 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.
3. Equipment and training. 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.
4. Piece-rate pay. 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 which
employees are paid according to the amount they produce. However, Taylor 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.

Figure 23.2 The essential features of Taylorism

What do you think?

Is pay the only factor that would motivate you at work? Can you think of
circumstances in which this might not be the case?

Taylor’s views were unpopular with shop-floor employees. 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 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.
The human relations school
A fundamental weakness of the Scientific School was that its work 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. 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.

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.
• Managers often ensured 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.
• Work outings and trips became a familiar part of an employee’s year (for example, Marks &
Spencer organises short-break weekends for its employees).
• Managers gave more attention to teams and teamworking.
Figure 23.3 Maslow’s hierarchy of needs

Mayo’s recognition of the importance of teamworking is perhaps his most enduring testimony.
Many firms have organised their workforce into teams, for example, John Lewis and Toshiba.
Mayo’s work took forward management in general, and motivation in particular. He moved the
focus onto the needs of employees, rather than just on the needs of the organisation.
The Neo-human relations school
This could also be called the new Human Relations School. Abraham Maslow and Frederick
Herzberg are recognised as key members of this particular school. They began to put forward
their views in the 1950s. While the Human Relations School, associated with Elton Mayo,
highlighted the sociological aspects of work, the Neo-Human Relations School considered the
psychological aspects of employment. This school 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, Maslow and Herzberg 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.

Maslow’s hierarchy of needs

In 1954, Maslow published his ‘hierarchy of needs’, setting out the various needs that, he argued,
everyone attempted to meet through working. Maslow presented his hierarchy of needs as a
triangle with basic needs shown at the bottom and so-called higher needs towards the top.
Maslow’s argument was a relatively simple one. Employees, he argued, have a series of needs
they seek to fulfil at work. These are in a hierarchy – once a lower level need is satisfied,
individuals strive to satisfy needs further up the hierarchy. Abraham Maslow established five
levels of human needs that can be satisfied through employment.
The key point of Maslow’s argument was that a business could motivate its employees by
offering them the chance to fulfil a higher level of need once a lower one was satisfied. So once
an employee’s basic needs had been met, perhaps through a system of fair pay, they could be
motivated further by the offer of secure and continuing employment. Similarly, a worker whose
social needs were met through employment could next be motivated by the opportunity to satisfy
self-esteem needs. This could be achieved by taking responsibility for a major project, offering
the chance of achievement and recognition.
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.
Maslow’s Examples Means of satisfying needs
level of need
1. Food, water, shelter, Through pay and a warm and dry working
Physiological clothing environment
needs
2. Security A safe and secure Implementing a proper health and safety
needs working environment for policy, providing employees with contracts
employees of employment
3. Social Contact and friendships Social and sporting facilities, opportunities
 needs with other employees to work in groups
4. Esteem Achievement, Delegating authority to junior employees,
needs recognition and self- offering promotion opportunities
respect
5. Self- To fulfil one’s potential Providing opportunities to take new
actualisation completely responsibilities and to develop new skills.
Table 23.2 Explanation of Maslow’s hierarchy of needs

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.
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 and 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 policies and administration
• supervision of employees
• working conditions
• salary
• relationship with fellow workers (at the same level).

Figure 23.4 Herzberg’s hygiene and motivational factors

Business in focus: Working at MSD

 MSD is a multinational biopharmaceutical company based in the USA with operations
in more than 140 countries. The company produces medicines and vaccines for some
of the world’s most challenging diseases.
In 2019, MSD was awarded Top Employers United Kingdom and Top Employers
Europe Certification for the second year running by the Top Employers Institute. The
Top Employers Institute accredits businesses that provide the very best working
environments for their employees.
Susannah Hodgson, Director of HR at MSD, said: ‘As an employer we believe we
stand out as we truly encourage a work-life balance with excellent benefits and career
development opportunities. We also regularly engage with employees to ensure they
are satisfied and ask for their feedback and where we can improve in an annual staff
survey.
‘In return, we work hard to ensure that whatever career path, whether it’s working in
the laboratory, directly with our customers, manufacturing quality products or
supporting our business in another way, MSD is committed to being an employer of
choice.
‘We even used our employees to showcase our ways of working at MSD through our
campaign launched last year called “what gets me out of bed”. It was so inspiring to
see how passionate our employees are about working at MSD and how we all come
together to partner with the NHS and healthcare providers to improve health and
wellbeing for patients across the UK.’
More than 1500 Top Employers in 118 countries across five continents have received
certification through its global Certification programme.
Source: MSD News Release

Practice questions
1 Use Herzberg’s two-factor theory to analyse why the employees at MSD are likely
to have high levels of motivation.
(9 marks)
2 To what extent is a well-motivated workforce the most important factor in creating a
competitive multinational company?
(16 marks)

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 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.
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 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.
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.
The value of theories of motivation
Theories of motivation have received a great deal of attention over the years and have had a
considerable impact on the ways in which managers have thought and behaved. They can
provide a structure or a framework for managers who make decisions on how to motivate
employees. This can be better than simply acting on instinct.

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 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.
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.

Mayo and teamworking

Many students just think of Mayo in terms of communicating with bosses, and his emphasis on
social and sporting facilities. However, 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.

Assessing the work of the Neo-Human Relations School

The research and writing of Maslow and Herzberg has had a major impact on the way in which
businesses have managed their employees. Although there are differences in their approaches,
many similarities also exist. As illustrated in Table 23.3, Herzberg’s motivators broadly
correspond with Maslow’s higher needs.
Maslow Herzberg
Motivation factors (higher • Self-actualisation • Achievement
needs) needs • Recognition
• Esteem needs • Responsibility
• Interest in work
• Personal growth
 Maintenance factors (lower • Social needs • Company policy and
needs) administration
• Security needs
• Physiological needs • Supervision
• Working conditions
• Relationship with fellow
workers
• Salaries

Table 23.3 Herzberg and Maslow compared

Both have a 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.
How to improve employee engagement and
motivation
Improving employee engagement
Some studies suggest that disengaged employees represent a huge opportunity for businesses to
improve their competitiveness and profitability. Research in a number of countries, including
New Zealand, has established a correlation between levels of employee engagement and human
resource performance indicators such as labour productivity, labour turnover and product quality.
1. Find out the current position. A starting point to improving employee engagement is to find
out existing levels of engagement among the workforce and to seek to build on good practice.
This will require research specifically to reveal engagement levels, possibly through a survey
of employees. Using existing survey data, collected for other purposes is unlikely to be
accurate. This can also have the benefit of raising the often unspoken issue of employee
engagement.
2. Recruit the right managers and train them all. Appointing managers who have the
potential to engage the employees for whom they are responsible is essential. This is not
simply an issue for HR managers, but for all managers within an organisation. Such managers
will be good communicators who appreciate the importance of human resources in achieving
the overall goals of the business. They should be required to manage employees in ways that
overtly value and encourage their contributions. Managers who are appointed should have the
necessary skills to fulfil their role in these ways and should receive training as necessary.
Businesses may benefit from investing in training managers at all levels within the
organisation as their decisions are central to creation and maintenance of an engaged
workforce. Too many businesses tend to invest most in training senior managers and neglect
the needs of more junior managers and team leaders.
3. Make managers accountable for employee engagement. Managers should also be held
accountable for the level of engagement among the employees in their charge. This can be
supported and measured through setting realistic and achievable goals for employee
engagement throughout the organisation. Managers can be rewarded for agreed levels of
engagement.
4. Recognise the value of communication in employee engagement. Communication is a key
issue in improving employee engagement. Research in the USA shows that employees can
become disengaged because they feel that their managers do not care about them and this is
evidenced in a lack of communication. Over-communication is not a problem and employees
can handle a changing environment better when given reliable information regularly and
offered the opportunity to comment and contribute. This also reinforces the idea that they are
valued by managers and leaders.
5. Involve senior managers. Involving senior managers in the company in actions to improve
the level of engagement of a workforce is vital. If senior managers or leaders portray values
that are worthy and likely to receive the support of employees, employees are more likely to
be engaged.
6. Implement actions to help employees value their organisation. In a similar vein, taking
 actions to increase employees’ pride in their organisation helps to promote engagement. This
might take the form of publicising the benefits that the business’s products give to society.
Genzyme, an American biotechnology company, does this by requiring its researchers to
contact patients whose lives have been improved by its products (such as those designed to
overcome enzyme deficiencies). This is done on a regular basis.
7. Align employees’ values with those of the organisation. Training and communication can
be used to align employees’ values with those of the organisation. This can help to increase
the value and pride employees place in their organisation and in being a part of it. Employees
whose values accord with those of the organisation are much less likely to become disengaged
and will make decisions in accordance with the common values.
The use of financial methods of motivation
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 suggest
that monetary methods of motivation are of limited value, pay remains a major incentive.
Writer Opinions on the motivational power of pay
Frederick Pay as the primary motivating factor for all workers; referred to workers as
Taylor ‘economic animals’ and supported the use of piece-rate pay.
Abraham Pay as a reward permitting employees to meet the lower needs on their
Maslow hierarchy.
Frederick Pay as a hygiene factor and a possible cause of dissatisfaction. In a few
Herzberg circumstances, pay might be a motivator if, for example, it is used as a
recognition for merit.
Table 23.4 Opinions on the motivational powers of pay

Salaries and wages

Most employees in the UK 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 £35,000
per year) and are normally paid monthly. Salaried employees are not normally required to work a
set number of hours per week though their contract of employment may state a minimum number
of hours.
On the other hand, wages are usually paid weekly and employees are normally required to be at
work for a specified number of hours. Employees are normally paid a higher rate (known as
overtime) for any additional hours worked.
Some employees are paid commission. This is most common for employees involved in selling
products and the amount paid as commission is normally an agreed percentage of the value of
goods and services that are sold.

Key terms
Commission is a method of payment in which the amount paid is related to the value
of goods or services that an employee sells.
Piece rate (also called piecework) is a system whereby employees are paid
according to the quantity of a product they produce.
Performance-related pay exists where some part of an employee’s pay is linked to
the achievement of targets at work. These targets might include sales figures or
achieving certain grades in an annual appraisal.
Variable pay is a flexible form of pay that offers employees a highly individual pay
system related to their performance at work.
Piece rate
Under this pay system, employees are paid according to the quantity they produce. Thus, an
employee on a production line might receive an agreed amount for each unit of production they
complete. Piece rate is common in a number of industries in the UK including textiles,
electronics and agriculture.
Piece rate offers businesses a number of advantages and disadvantages. It links pay to output
levels but can result in employees rushing work, which may damage the quality of the product.
Since the implementation of minimum wage legislation, employers have faced additional
problems in using piece rate. Employers using piece rate have to ensure that their employees earn
at least the minimum wage or living wage rate per hour. The UK Government introduced the
National Minimum Wage on 1 April 1999, and this was supplemented by the National Living
Wage from April 2016. The National Living Wage applies to workers aged 25 and over, while
the National Minimum wage determines the pay of those aged 24 and under. This legislation
covered full- and part-time employees as well as temporary workers and those on piece rate. The
National Minimum and National Living wages have increased steadily over time. This has
benefited low-paid employees but has imposed an additional cost burden on businesses.
In April 2018, the National Minimum Wage rate for employees aged between 21 and 24 was
increased to £7.38 (compared with £3.60 when it was introduced in 1999). At the same time, the
hourly rates for workers aged between 18 and 20 were set at £5.90 and for employees under 18 at
£4.20 an hour. The National Living Wage for employees aged 25 and older was increased to
£7.83 an hour in April 2018.

Performance-related pay (PRP)

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.

Figure 23.5 The operation of a typical performance-related pay system

Businesses of all sizes have introduced PRP. Examples include the National Health Service and
the Trustee Savings Bank (TSB) as well as the retailer Iceland. PRP remains popular, and many
employees support linking some element of pay to performance. However, there have been
criticisms of the huge bonuses paid to some senior managers and directors of moderately
successful companies.

Criticisms of PRP
A number of 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 employee performance is difficult to measure. Employees
fear that they might be discriminated against because they do not get on with their managers.
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’s 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’s 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 can suffer
financial penalties in a less successful period.
Some managers remain unconvinced of the value of PRP, no matter how sophisticated the
scheme. The widespread use 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.
In recent years, the notion of linking pay to a wider definition of employees’ ‘contribution’ rather
than simple ‘performance’ has gained ground. This emphasises not only performance in the
sense of the end result (output, for example) but also the employee’s overall contribution to the
business’s achievements.
PRP remains a highly topical 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 in this
chapter. 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.

Profit sharing
Profit sharing is a system whereby employees receive some of the business’s profits. This is a
type of performance-related pay, but one that may not discriminate between the performances of
individual members of staff. Such payments, which may vary according to salary or wage, are
distinct from, and additional to, regular earnings.
Profits are paid out to employees immediately in the form of cash or company shares, as
discussed below. Profit-sharing schemes may improve employees’ loyalty to the company. These
schemes can help to break down the ‘them and us’ attitude. Under profit-sharing schemes, a
greater level of profit is regarded as being of benefit to all employees, and not just senior
managers and shareholders. Employees may be more willing to accept changes designed to
improve the business’s profitability.
The danger with profit-sharing schemes is that they can be too small and fail to provide
employees with a worthwhile payment. On the other hand, if schemes are too generous, the
company may have insufficient funds for capital investment.

Share ownership
This can be a development of profit-sharing schemes. Some businesses pay their employees a
share of the profits in the form of company shares. Share ownership schemes vary enormously in
their operation. Here, we consider two of the main schemes operated by UK companies.
Some businesses offer employees the opportunity to purchase shares after saving for a period of
time. After say, five years, employees can purchase shares at the price they were at the start of
the savings scheme. This is a popular type of scheme, though tax changes have made it more
difficult to operate. Other businesses offer employees free shares as an incentive.
Share options are a form of share ownership normally aimed at senior managers. About 15 per
cent of UK companies operate share option schemes. Under share options, managers have the
opportunity to buy company shares at some agreed date in the future, but at the current share
price.
For example, a company’s current share price might be £2.50 and the senior manager subject to
this type of financial motivation is given the option to purchase 10,000 shares in three years’
time at this price. In three years, the market price of shares may have risen to £3.50. This offers
the manager the chance to purchase the 100,000 shares for £250,000 (£2.50 x 100,000) and to
sell them immediately for £350,000, giving a profit of £100,000. If the share price falls over the
three-year period, the manager will choose not to buy the shares. Such deals encourage senior
managers to take decisions that increase the long-term share price of their companies.

The use of non-financial methods of motivating employees

Every employer in the UK is required by law to provide essential amenities such as toilets and
clean drinking water for employees. Most employees would 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 hot water for drinks. A ‘good’ employer
who is concerned about employee welfare will also consider other issues besides the physical
working environment.

Key terms
Employee welfare is a broad term covering a wide range of facilities that are
essential for the wellbeing of a business’s employees.
Appraisal is the process of considering and evaluating the performance of an
 individual employee.
Teamworking exists when an organisation breaks down its production processes into
large units instead of relying upon the use of the division of labour.

1. Job design
We saw in Chapter 22 that the design of jobs (job design) can have a powerful influence on the
performance of a workforce. If HR managers can design jobs that are interesting, varied and
challenging then this is more likely to motivate employees. Including more demanding tasks in
an employee’s job through the process of job enrichment will often improve motivation and
performance. Some businesses extend the range of similarly demanding duties and tasks through
the use of job rotation, where employees switch regularly between tasks and through job
enlargement where they permanently carry out a wider range of duties.

2. Appraisal systems
Good employers will seek to develop their employees as fully as possible to improve their
performance at work. In part this may be achieved by a development appraisal system.
Developmental appraisal measures an employee’s performance with the aim of offering training
to correct any shortcomings or to achieve further improvement. Businesses and employees can
benefit from appraisal systems, especially those that develop employees’ skills. Such appraisal
systems can encourage employees to take actions intended to help the business achieve its
objectives and can improve relationships between manager and subordinate alongside employee
performance. Developmental appraisal systems can improve employee behaviour, enhancing
labour productivity. Supporters of appraisal systems also argue that they can help in identifying
staff training needs and ensuring that training undertaken is relevant to the needs of the
individual and the organisation.
Human resource managers can play a central role in developing effective appraisal systems as
well as improving the physical environment within which employees work. 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, which we
considered in Chapter 20. Such an approach to human resource management (HRM) may well
have a developmental appraisal system at its heart, as well as a clear appreciation of the benefits
to the business of providing good facilities for employees.
Firms take such decisions because they have the potential to improve the morale and motivation
of employees. As we saw earlier, there are different views on what motivates employees. Some
writers on motivation argue that physical facilities are important or, as Herzberg believed, their
absence has the power to demotivate employees. Many motivational theorists would argue that
providing training and allowing employees to develop themselves and to fulfil their potential are
powerful motivators. Maslow termed this ‘self-actualisation’ and argued that it was the highest
form of motivation available to employers.

3. Teamworking
Teamworking exists when an organisation divides its production processes into large units
instead of relying on 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:
• Production teams – many production lines have been organised into distinct elements called
‘cells’. Each of 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 themselves as complementary teams,
establishing the organisation’s objectives and overseeing their achievement.

Business in focus: Working at Google

Google’s website sets out some of the benefits of working for the company.
How we care for Googlers:
Support your loved ones
Your family matters to you, so they’re important to us, too. Many of our benefit
programs and onsite amenities are aimed at supporting you and your loved ones
through life’s various stages – we offer generous parental leave policies, retirement
savings plans, death benefits, and much more. In some of our offices, you can even
bring your canine family members to work!
Live a healthy life
All Googlers have access to excellent healthcare choices. In some locations, we also
offer onsite wellness and healthcare services, including physicians, chiropractic,
physical therapy, and massage services. In addition, many of our offices are equipped
with on-site fitness centres and classes to save you time and keep you fit. Our wide
assortment of on campus cafes and micro kitchens provide nutritious meals and
snacks to keep you healthfully energized throughout the day.
Enjoy quality time
We all need time away from work to recharge, travel, take care of personal stuff, or
spend time with family and friends. Take a vacation, volunteer, or flex your workday to
meet your personal and business needs – there’s no one-size-fits-all recipe for
helping you to be at your best.
Invest in you
Lifelong learning is inherently Googley. That’s why we offer extensive opportunities
for personal and professional development. Whether it’s onsite coding or cooking
classes, degree programs, or the guitar lessons you’ve been meaning to take, we’ll
support you in doing what you love.
Alphabet, the company that owns Google announced that its profits for the first three
 months of 2018 were $9.4 billion, compared with $6.7 billion in the first three months
of 2017.
Source: How we care for Googlers © 2019 Google, Inc.

Practice questions
1 Analyse the possible reasons why Google publicises its working conditions on its
website.
(9 marks)
2 To what extent might the benefits to Google of treating its employees in this way
outweigh the costs?
(16 marks)

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 publicised 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. 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.
The benefits of motivated and engaged
employees
We saw earlier in this chapter that some HR professionals argue that motivation techniques are
unlikely to work without engaged employees. It is helpful to consider how businesses benefit
from having employees who are engaged and motivated.
Organisations whose workforces possess high levels of engagement and motivation tend to show
the following characteristics:
• a low level of absenteeism 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.
In addition, businesses can benefit in terms of customers’ perceptions of the business. Motivated
and engaged employees can be expected to offer good quality products and high standards of
customer service. Engaged employees are also likely to project a good image of the business,
which may result in customer loyalty and repeat purchases. Engaged employees can be a
valuable promotional asset in an age in which employee opinions can be easily viewed by many
stakeholders on social media. Research in the USA by Weber Shandwick (a multi-national public
relations company) found that 50 per cent of employees post messages, pictures or videos on
social media about their employer and more than a third have shared praise or positive comments
online about their employer. A third of employees post messages, pictures or videos about their
employer without any encouragement from their employer. However, on the negative side, 16
per cent of employees have shared criticism or negative comments online about their employer.

Figure 23.7 How engagement and motivation can aid a business’s performance

A business that enjoys the benefit of a highly engaged and motivated workforce is also likely to
have a productive workforce. Reductions in unit labour costs offer firms two opportunities:
• to sell their products more cheaply
• to maintain price levels and enjoy greater profits.
Engaged and motivated workforces offer a business other benefits, too:
• Employees are usually contented, making it easier for businesses to attract other employees –
the firm will have a reputation as a ‘good’ employer. This helps to build the employer brand.
• Modern businesses protect their public image and spend vast sums of money to enhance it. As
we saw earlier the engagement of the workforce can be an important element of creating a
positive corporate image given the rising popularity of social media.
• Over recent years, firms have become increasingly aware of the need to compete in terms of
quality and customer service. If businesses are to compete in these ways, engaged motivated
employees are essential.
So, any manager seeking to improve the performance of his or her workforce may be able to do
so by taking steps to improve employee engagement and motivation.
Influences on the choice and assessment of
financial and non-financial methods of motivation
Not all managers adopt the same approaches to motivate employees for whom they are
responsible. A number of factors influence their choices of the methods to be deployed.
1. The costs involved. For many firms this might be the determining factor. If profit margins are
slim (and shareholders dissatisfied) managers may not be able to offer bonuses, piece-rate pay
or to pay for training to allow a policy of delegation. They may not have the funds for training
or supporting staff to take on delegated responsibilities. Managers may find themselves in
conflict with shareholders who fear that their dividends will be reduced.
2. The attitude of the management team. Some managers have a strong autocratic streak and
relish being in control. They may not implement motivational techniques, resulting in
subordinates having greater influence over their working lives. They will be more likely to
focus on pay as a motivator.
3. The training given to the management team. Have managers received training in the theory
of motivation? If they understand why their employees work they will be more likely to apply
appropriate motivational techniques. In these circumstances they may be less likely to rely
solely on financial forms of motivation.
4. The skill levels of the workforce. Some techniques of motivation, notably delegation and job
enrichment, may require substantial employee training before they can be implemented. It
would be impossible to offer employees the chance to plan their own work, take their own
decisions and to carry out a number of roles as part of a multi-skilled team without substantial
training with clear implications for the business’s costs.
5. The importance of public’s perception of the business. Some organisations may engage in
techniques such as delegation and empowerment to project a positive corporate image. This
can be an important element of gaining a competitive advantage and can enhance company
sales and assist in attracting high-quality employees. Unilever plc, which supplies consumer
products, is an example of a company that is aiming to enhance its public image through a
range of policies including the use of delegation.
6. The effectiveness of communication within and outside the business. If a business has
effective two-way communication throughout the organisation it is more likely to implement
techniques such as quality circles or teamworking. Firms with poor communication may rely
more on piece-rate pay and job rotation.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 State the difference between employee engagement and motivation.
2 What are the three dimensions of employee engagement as identified by the
CIPD?
3 State two of the key elements of Taylorism.
 4 List the three higher needs from Abraham Maslow’s hierarchy of needs.
5 State two of Frederick Herzberg’s hygiene factors.
6 What is meant by the term performance-related pay?
7 Is the following statement true or false? ‘An employee does not know exactly how
much they will receive in pay from a piece-rate system until the end of the working
period.’
8 State two factors that make variable pay flexible.
9 State two characteristics that highly motivated workforces may display.
10 What is meant by the term appraisal?

(b) Short answer questions

1 Explain why a well-motivated workforce is an important asset for a low-cost
manufacturer.
(4 marks)
2 Explain the possible limitations of using financial factors to motivate employees
working in the National Health Service (NHS).
(5 marks)
3 Explain the possible problems for a high-profile public limited company of having a
substantial number of disengaged employees.
(5 marks)
4 Explain the possible reasons why employee engagement might be a crucial issue
for a company entering a new market.
(5 marks)

(c) Data response questions

Kohli Ltd designs and installs kitchens for individuals and house builders in London.
This competitive market is mainly comprised of small firms and sole traders. Over 20
years, the company gained a reputation for outstanding quality in terms of its designs
and fitting of the kitchens, as well as its overall customer service. It has a loyal and
long-serving workforce, many of whom have been with the company for more than 15
years. However, in recent years the business’s profits have declined and its operating
profit margin was just 2.2 per cent last year.
The managers at Kohli Ltd are considering how to improve motivation levels to
improve competitiveness and have discussed a range of possibilities. A suggestion to
motivate the teams of staff who install the kitchens (the fitters) with piece-rate pay was
thought not to be appropriate. One manager commented that the company did not
need to implement policies to motivate employees as most of its competitors did not
do so.
After some discussion the management team decided to use non-financial methods of
motivation. It was decided to extend the use of teamwork and to empower teams to
decide how to design and fit kitchens with minimal input from managers.
1 Explain the reasons why piece-rate might not be an appropriate method of
motivation for the company’s kitchen fitters.
 (5 marks)
2 Analyse the possible reasons why many of Kohli Ltd’s rivals do not use
motivational techniques to improve the performance of their workforces.
(9 marks)
3 To what extent is the decision by the managers at Kohli Ltd to use non-financial
methods of motivation for its employees the best way for it to improve its
competitiveness?
(16 marks)

(d) Essays
1 To what extent is training the most important method of motivation for all
employees, irrespective of their seniority or level of skill?
(25 marks)
2 Do you think that fast-food restaurant chains should not bother implementing
policies to motivate their employees as many are part-time and temporary and
they have high levels of labour turnover?
(25 marks)
Chapter 24 Improving employer–
employee relations
Introduction
This final chapter examines how and why an organisation’s human resource managers might
improve the business’s relations with its employees. Improving relations with employees can
improve the performance of a business’s workforce as well as its reputation as an employer.
What it is important to know by the end of this chapter:
• methods of employee representation
• influences on the extent and methods of employee involvement in decision making
• how to manage and improve employer–employee communications and relations
• the value of good employer–employee relations.
Methods of employee representation
Only a minority of workers in the UK are members of a trade union. In 2018, approximately 6.23
million people in the UK were members of a trade union; this is a substantial decline from its
peak figure of 13 million in 1979, but a small increase of 19,000 from 2016. Trade union
membership has dropped since 1979 for a range of reasons, including the decline of traditional
industries such as mining and shipbuilding (which were strongly unionised) and rise in self-
employment and temporary employment. In 2017, the UK’s workforce contained 4.8 million
self-employed workers and 1.5 million workers on temporary contracts.
In this section we will consider the various ways in which employees can be represented in
negotiations with employers and how they may play a role in decision making within the
business.
(a) Trade unions
A number of different types of trade union exist, although a series of amalgamations over recent
years has resulted in the distinctions between them becoming blurred.

Key terms
A trade union is an organisation of workers established to protect and improve
economic position and working conditions of its members.
Collective bargaining entails negotiations between management and employees’
representatives, often trade unions, over pay and other conditions of employment.
The trade union wage premium is the percentage difference in average gross hourly
earnings of union members compared with non-members.
A works council is a forum within a business where workers and management meet
to discuss issues such as working conditions, pay and training.

Trade unions are normally organised on a regional basis. For example, Unite operates in ten
regions throughout the UK and Eire and is the UK’s largest trade union with 1.27 million
members in 2018. Each region has a regional office staffed by full-time union employees (called
organisers or officers). The region is made up of a number of branches (more than 6,000 in total
in the case of Unite) and each branch has an elected shop steward. The shop steward
communicates with employers on behalf of the union’s members and reports back to members
regarding management decisions. The head office has administrative, statistical and legal staff
and the senior officials of the union. Other trade unions operate similar structures.
Most trade unions in the UK have similar objectives. These focus on improving the economic
position of their members by fulfilling the following objectives.
• Maximising pay. Trade unions engage in collective bargaining to provide their members
with the highest possible rates of pay. In 2017, trade union members in the private sector of the
economy in the UK received pay rates which were, on average, 7.1 per cent higher than those
of equivalent non-union members. This differential is known as the trade union wage
premium.
• Achieving safe and secure working conditions. Unions often provide training for safety
representatives who can advise employers on health and safety issues. Creating a workplace in
which there is a focus on health and wellbeing can be an important factor in creating employee
engagement.
• Attaining job security. Arguably this is the most important objective of a modern trade union
and one that is difficult to fulfil in the light of pressures resulting from globalisation and the
increasing use of technology in the workplace.
• Participating in and influencing decisions in the workplace. Trade unions may achieve this
through collective bargaining or through having representatives on works councils and other
employer–employee committees. Trade unions may play a role in decisions ranging from a
change in fringe benefits such as free lunches to the closure of one or more parts of the
 business.
In addition, many unions have social objectives such as lobbying for higher social security
benefits, improved employment legislation and improved quality provision by the National
Health Service.
Trades unions achieve their objectives by carrying out a range of functions to the benefit of their
members.
• Their most important and time-consuming function is protecting members’ interests over
issues such as discrimination, unfair dismissal and health and safety matters.
• They negotiate pay and conditions for their members through collective bargaining.
• Trade unions provide their members with a range of personal services including legal advice,
insurance, education, training and financial advice.
Employers can also benefit from the existence of trade unions for the following reasons:
• They act as a communications link between management and employees.
• Professional negotiation on behalf of a large number of employees can save time and lessen
the likelihood of disputes occurring.
Trades unions offer many benefits to employers such as acting as a channel of communication,
offering advice on issues such as health and safety and they may be proactive in preventing
disputes. Unions are in a better position to negotiate than individuals in that they have better
collective negotiating skills and increased power.
(b) Works Councils
Employee representatives on a works council are normally elected. It is common for works
councils to be used in workplaces where no trade union representation exists. However, in
businesses where works councils and trade unions co-exist, the former is normally excluded from
discussing pay and working conditions.
Employees like to know what their employers are planning and all UK employers with 50 or
more staff are legally obliged to keep employees regularly informed and consulted on issues at
work. Under the European Union’s Information and Consultation of Employees (ICE)
regulations, companies are required to establish formal works councils on demand. Even if
employers do not have an agreement in place, the business still must consult if they are planning:
• 20 or more redundancies
• to sell their business or buy a new one
• certain changes to an occupational or personal pension scheme.
The EU takes works councils seriously: non-compliant employers may face fines of up to
£75,000 and could have a works council imposed on them that is ill-suited to their business. EU
regulations have also created European Works Councils (EWC), which are explored in more
detail in the Business in focus feature.

Business in focus: Trade unions in the public and private

sectors

Public sector union members represented an increasing proportion of overall union

membership from 1995 to 2010. Since then it has declined steadily to a little over 3.5
million in 2017; membership fell by 51,000 between 2016 and 2017. Membership of
trade unions by those in the private sector has increased slightly since 2010. It
remains true that the overall proportion of employees who are trade union members is
much lower in the private sector (13.5 per cent) than the public sector (51.8 per cent).
The trade union wage premium is defined as the percentage difference in average
gross hourly earnings of union members compared with non-members. The trade
union wage premium rose sharply from 14.5 per cent in 2016 to 16.9 per cent in 2017,
in the public sector. The private sector trade union wage premium is 7.1 per cent in
2017, down only slightly from 7.6 per cent in 2016. For the public sector the figure
amounts to a 2.4 per cent points increase when compared with 2016.
Figure 24.1 Trade union membership by sector, 1995–2017 (thousands of employees)
Source: Trade Union Membership Statistical Bulletin, 2017 (Department for Business, Energy and
Industrial Strategy)

Practice questions
1 Explain two types of decisions in which trade union representatives may be
involved.
(4 marks)
2 Do you think that all employers in the private sector would prefer to have non-
unionised workforces? Justify your view.
(16 marks)
(c) Other types of employee representation
Employee representation can take other forms, although these are similar in structure and
operation to works councils. However, these type of employee representation differ from trade
unions in that they are not backed by regional and national organisations and do not have
professional employees. Instead they are organised solely for the individual business and its
particular circumstances. Employers may allow, or even encourage, the development of any
arrangement that allows effective communication to take place.
For example, a factory or office committee may be established. These committees can have
members elected by the workforce alongside the employer’s representatives. They discuss such
matters as working conditions, employment and production changes, safety and welfare matters.
To be effective, committees should meet regularly. If disillusionment is to be avoided, such
committees should be seen to have a real effect on how matters are determined. This requires that
the workforce be regularly informed about the committee’s work.
Alternatively, a staff association may be formed to provide employee representation. Staff
associations also usually operate on behalf of a single company. They are also used as a means of
representation for police officers and civil servants. Staff associations are often independent from
external influences and this can be a reason for them to be popular with both employees and
employers, though they are frequently established at the request of employers to avoid trade
unions gaining recognition for negotiations. This has led to some criticisms that are subject to too
much influence by employers. However, it is not uncommon for staff associations to eventually
merge with a trade union if employees feel their interests are not well represented.

Business in focus: HP and European works councils

European Union laws (or regulations) relating to European Works Councils affect any
organisation with at least 1,000 employees and at least 150 employees located in two
or more Member States of the EU. After the planned UK’s departure from the EU,
almost all EU law will be incorporated into UK law, at least in the short-term.
European works councils bring together employee representatives in a multi-national
company from across Europe, to inform and consult them on the group’s performance
and prospects. European works councils can help trade unionists and employee
representatives to respond to the decisions that employers increasingly take on a
European and global basis.
A European works council is made up of at least one elected employee from each
country in which the multi-national is based and 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 company operates factories in the UK, Germany, France and
Spain. In 2018, it consulted its European Works over plans to cut 3,700 jobs in its
factories. The jobs are under threat due to reduced levels of production for its A380
and A400M 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
propose other opportunities for the affected employees, which is likely to include
redeployment.

Practice questions
1 Analyse the reasons why Airbus might prefer to redeploy employees in Europe
rather than make them redundant?
(9 marks)
2 To what extent do Airbus’s employees gain any benefits from the existence of the
company’s European works council?
(16 marks)

What do you think?

Do employees always receive greater benefits from being represented when working
in a large organisation?
Influences on the extent and methods of
employee representation in decision
making
There is a huge variation in the extent of employee representation and the impact that employees
can have on decision making between businesses. In some businesses employees are not
represented and they negotiate conditions and pay with relevant managers individually. In other
businesses the majority (or even all) of the workforce is represented collectively in discussions
and negotiations with managers. For example, the Unity Trust Bank in the UK received an award
for its union-friendly policies and its degree of employee representation.
1. The leadership and management style used in
the business
Some management teams operate in ways that deliberately aim to reduce or eliminate any
employee representation within their businesses. This is more likely to be associated with
management or leadership styles at the autocratic end of the spectrum. Such managers wish to
retain control over decision making and therefore seek to avoid any systems of employee
representation operating within the organisation. It may be that these businesses operate with a
‘hard’ style of managing human resources, treating employees in the same way as they would
any other resources.
In contrast, other businesses may be more democratically led and use a ‘soft’ approach to
managing human resources. This can result in extensive involvement of employees in decision
making. Stagecoach Group plc, a business that operates rail and bus services across the UK, is
publicly committed to ‘having a strong relationship with trade unions and working in partnership
with them’.
2. The overall or corporate objectives of the
business
The overall or corporate objectives of the business can shape relationships between employers
and employees and also the means by which these objectives are achieved. Businesses that are
pursuing growth in markets in which demand is strongly price elastic may opt to minimise the
extent of employee representation for fear of wages being forced upwards as a result. We saw
earlier that there was a trade union wage premium of approximately 7.1 per cent in the private
sector in the UK in 2017. Avoiding any employee representation may help a business in this
situation to control its labour costs and to maintain its price competitiveness. Such an approach
will normally remove any realistic possibility of meaningful employee involvement in decision
making.
Businesses that are pursuing social objectives may take an entirely different view. They may
place a much lower emphasis on generating profits or increasing market share and therefore
would welcome employee representation and involvement in decision making, possibly as a
means of meeting their social objectives. The National Association of Co-operative Officials
(NACO) is the trade union for employees who work in co-operative businesses. NACO
represents employees at all levels within co-operatives and negotiates on their behalf. In 2018, its
members voted to become part of Usdaw (Union of Shop, Distributive and Allied Workers), a
larger trade union.
3. The history and ownership of the business
Some businesses have a history and culture of employee representation. This might reflect the
origins of the business or the views of influential managers or leaders in the past. With smaller
businesses it may be determined by the views of the owner and manager. Another influence is
the extent to which the business is owned by its employees. It is natural for a business that is
owned by its employees to give them a say in decisions. The John Lewis Partnership in the UK is
an example of a business that falls into both categories. The business that operates John Lewis
department stores, Waitrose supermarkets and its website has a constitution designed to
encourage employee representation. The Partnership’s website says:

When our founder, John Spedan Lewis, set up the Partnership, he was careful to create a
governance system, set out in our Constitution, that would be both commercial allowing us
to move quickly to stay ahead in a competitive industry, and democratic giving every
Partner a voice in the business they co-own.
Source: John Lewis Partnership website
The John Lewis Partnership is owned by a trust on behalf of all its employees (who are called
Partners) and who have a say in the management of the business. They also receive a share of
annual profits.
4. The nature of the work and employees hired
It may be more likely that businesses that employ highly skilled employees will offer them
opportunities to become involved in decision making through a system of employee
representation. The threat of a high level of labour turnover is more significant with this type of
employee. They will be more difficult to replace and their loss may be disruptive to the
business’s operations. Involving employees in decisions should engender a sense of being valued
and increase employee engagement, which may offer further benefits to the business.
In contrast, businesses that rely heavily on temporary and seasonal employees will have less
incentive to establish systems for employee representation because employees may have limited
knowledge and experience to offer and managers may not feel it necessary to demonstrate that
they value their employees in this way.
5. Employment legislation
Businesses operating in the UK are subject to laws relating to employment that are created by the
UK Government and by the EU, at least until plans to exit the EU are finalised. As we saw
earlier the EU has passed two laws (or regulations) that relate to employee representation within
larger businesses.
• Information and Consultation of Employees (ICE) regulation. This regulation obliges all UK
employers with 50 or more staff to keep employees regularly informed and consulted on issues
at work.
• European works councils regulations affect any organisation with at least 1,000 employees and
at least 150 employees located in two or more Member States of the EU. They require
businesses to inform and consult employees on the group’s performance and prospects.

Figure 24.2 The influences on a business’s approach to employee representation and decision making

Business in focus: Trade union leaders meet to discuss

Amazon

Amazon is one of the world’s largest retailers. The company has long received
criticisms that it treats its employees poorly. Trade unions in Britain, France and
Germany have suggested that Amazon is representative of how global e-commerce
organisations treat their low-skilled workers. In Britain, there have been reports that
employees had to meet stringent productivity targets and were required to work 55
hour weeks, including compulsory overtime. In 2017, in Italy, France and Germany,
 warehouse workers employed by Amazon took industrial action by striking over
working conditions.
For many years, trade unions in Europe described not being given fair access to
warehouse sites to discuss joining up with the union. And, while Amazon denies the
claims, the company has been accused of decidedly union-unfriendly tactics by the
union, including anti-union campaigns where they issued workers with branded anti-
union t-shirts, meeting with employees individually to remind them of the company’s
views on union membership, and distributing sample ballots for the union vote making
it clear how to vote.
Amazon’s position changed in 2018 with the signing of an agreement between
Amazon and trade unions in Italy. The guiding principle of the 2018 agreement was
fairness, with a redistribution of workloads that creates a fairer allocation of the
workload between all workers and also in covering of weekend shifts.

Figure 24.3 An Amazon distribution centre

Practice questions
1 Analyse how Amazon might benefit from involving employees in decision making
within the business.
(9 marks)
2 Assess the possible influences on Amazon’s approach to employee representation.
(16 marks)

When the UK exits the EU, most EU law will be incorporated into UK law.
In 2000, the UK Parliament passed the Employment Relations Act. Under this Act, a trade union
with a membership exceeding 50 per cent of the employees in a business with more than 20
employees can demand union recognition and the right to introduce collective bargaining.
How to manage and improve employer–
employee communication and relations
The theory of communication
Key term
A transmission mechanism is simply the means by which one person
communicates with another – letters and email are examples.

Communication involves a number of elements, as shown in Figure 24.4.

• The sender is the company who commences the process of communication.
• The message is the information that the business wishes to send to its audience.
• The medium is the way in which the message is communicated.
• The audience is the target group at whom the communication is aimed – this might be a
business’s employees or customers.
• Feedback is the response to communication, which can confirm it has been received or raise a
query or comment about its content.

Figure 24.4 The process of communication

Managing and improving communication with
employees
Regular and effective communication can help to ensure that all employees remain closely
focused on agreed corporate objectives.
Technology can be used by larger businesses to communicate with their employees and this can
be of particular value to businesses that operate in several locations, especially if these locations
are in different countries.
• Electronic mail (email). This method of communication allows messages to be sent and
received electronically via the world wide web. This is particularly useful for quick
international communication between employers and employees grouped across different time
zones, as messages can be stored until the recipient is available.
• Social media. Websites such as Facebook and Twitter can be very effective methods of
communication in the right circumstances, but may not always be accessible to all employees.
• 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
companies, especially those with a number of locations. They 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. It saves time and avoids the need for employers and
employees to travel to meetings.
The precise method or methods that a business elects to use to communicate with its employees
may vary according to the circumstances and the nature of the business. A business that is large
with employees in a number of locations, possibly in different countries, may rely more on
electronic communication, though other means of communication will also be used.
Communicating effectively with employees
It is important for employers to allow the ‘employee voice’ to be heard. Andrea Broughton, a
researcher at the Institute of Employment Studies, believes that employers have to create a
culture of trust and openness to help employees to be heard and to feel valued. She argues that
many businesses rely on social media as a means for employees to be heard but that this is not
always effective. For this to work requires employee training and acceptance of the approach.
The effective management of communication with employees is not simply about choosing the
right medium with which to exchange information. Other factors make up an effective
employer–employee communication package.
• Appreciating the nature of effective communication. Good quality communication is
normally two-way communication. This means that information will flow in both directions
between employers and employees, or with their representatives. Two-way communication
allows for feedback to establish that the message has been received and understood. However,
it has much more potential than this. It affords the opportunity for employees to offer ideas and
suggestions, which may result in some excellent ideas for improving the way in which the
business operates. The opportunity alone to offer suggestions may improve the engagement
and motivation of employees. In turn this may result in a better performance by the workforce
as it provides a sense of recognition and an opportunity for achievement if ideas and
suggestions are effective. Finally, two-way communication can alert managers to potential
problems, which may result in confrontation and conflict if not resolved at the earliest
opportunity.
• Using the appropriate style of management. The writings of Elton Mayo, and especially the
Hawthorne experiment, offer evidence that employees respond positively to receiving attention
from managers. Later research has strengthened this link. Abraham Maslow developed his
hierarchy of needs, and argued that good communication underpins some of the higher-level
needs identified in his theory. The need for recognition, for example, relies heavily upon
managers communicating with subordinates. Similarly, Frederick Herzberg wrote that direct
communication (rather than through unnecessary layers of hierarchy) was an important means
of improving employee motivation. Electing to manage in a style which offers employees the
chance to participate in decision making does more than provide a forum for communication –
it encourages it as well.
• Adapting the organisational structure to encourage effective communication. We saw in
Chapter 22 that businesses can organise themselves in different ways. By opting for a structure
which allow employees to have greater authority and control over their working lives
employers can encourage communication at all levels within the organisation. Using
techniques such as delegation and empowerment has costs in terms of loss of power for
managers and in terms of training relatively junior employees to take on more demanding
roles. However, alongside the benefit of improved communication the performance of
employees should also improve as levels of motivation increase.
Good communication can have a positive impact upon employee motivation and performance.
Praise and recognition are widely seen as motivators, but rely upon communication. Effective
communication can also give employees important feedback about their performance and help to
improve it in the future.
Recent problems in communication
It has become more difficult in some ways to manage communication effectively between
employers and employees over recent years. Mergers and takeovers continue to create larger and
more complex businesses. It is not uncommon for businesses in different countries to merge or
for one to buy another in a takeover deal. As a consequence, the need for effective
communication between employers and employees can increase. At such a time job losses may
be expected and effective communication will be essential to quell rumours and to negotiate
mutually acceptable deals. However, the scale of the new business and the possible absence of
effective mechanisms for communicating can make this process very difficult.
Managing employer–employee relations
An important part of managing employer–employee relations is to have systems in place to deal
with any disputes before they can become too serious and possibly result in industrial action.
Effective communication is one means of preventing and resolving disputes quickly and many
employers have agreed procedures in place to avoid disputes escalating into industrial action.

Key terms
Arbitration is a procedure for the settling of a dispute, under which the parties agree
to be bound by the decision of a third party.
An industrial dispute is a disagreement between an employer and its employees,
usually represented by a trade union, over some aspect of the terms or conditions of
employment.
Conciliation is a method of resolving individual or collective disputes in which a
neutral third party encourages the continuation of negotiations.

We can divide managing employer–employee relations into two sections:

• avoiding industrial disputes
• resolving industrial disputes.
Avoiding industrial disputes
1. No strike and single union agreements
A ‘no-strike deal’ is an agreement between employers and unions whereby in return for a pay
and conditions package a union agrees to refrain from strike action for an agreed period. Often
such agreements are accompanied by a commitment by both parties to go to binding arbitration
in the event of a dispute. This reassures the union that it is not making itself too vulnerable by
agreeing not to take industrial action. A no-strike agreement can benefit a trade union in a
number of ways.
• By presenting itself as non-confrontational the union may attract a greater number of members
from within the workforce increasing its income and strength.
• A less confrontational stance might allow the union to appoint worker directors increasing the
union’s influence and role in decision making.
• Such agreements can improve the public perception of trade unions. This will assist the union
in its activities in other businesses and industries and may persuade employers to recognise it.
A further advantage of no-strike deals is that they may lead to a single union agreement,
strengthening the position of the union within the business.
Single union agreements have been common over recent years. Under this type of deal
employees agree to be represented by one union. This makes negotiation simpler for the
employers (as there are only two parties to the discussions) while reducing the possibility of
disputes between rival unions. Single union deals also assist in maintaining good
communications between employers and employees lessening the possibility of industrial action
such as a strike.

2. Advisory, Conciliation and Arbitration Service (ACAS)

Managing employer–employee relations effectively can be helped by ACAS. ACAS is an
independent and impartial organisation established to prevent and resolve industrial disputes.
ACAS’s mission is to improve the performance and effectiveness of organisations by providing
an independent and impartial service to prevent and resolve disputes and to build harmonious
relationships at work. ACAS offers a number of services to employers and employees:
• preventing and resolving industrial disputes, particularly through the use of arbitration and
conciliation
• resolving individual disputes over employment rights, including individual cases of
discrimination and unfair dismissal
• providing impartial information and advice on employment matters topics such as reducing
absenteeism, employee sickness and payment systems
• improving the understanding of industrial relations.
ACAS was established in 1975 by the UK Government, during a period of industrial conflict, to
provide advice on industrial relations matters. Much of ACAS’s work nowadays is conciliating
in disputes between an individual employee and his or her employer. This trend reflects the
decreased influence of trade unions in UK businesses. You can visit the ACAS website which
provides valuable resources.
Methods of resolving industrial disputes
It is normal for industrial disputes to be resolved without trade unions taking any form of
industrial action. The decline in industrial disputes in the UK over recent years has, in part, been
a consequence of the effective use of measures outlined below.

1. Arbitration
Arbitration is a procedure for the settlement of disputes, under which the parties agree to be
bound by the decision of an arbitrator whose decision is in some circumstances legally binding
on both parties. The process of arbitration is governed by Arbitration Acts 1950–1996. There are
three main types of arbitration.
• Non-binding arbitration involves a neutral third party making an award to settle a dispute
that the parties concerned can accept or not.
• Binding arbitration means that the parties to the dispute have to take the award of the
arbitrator.
• Pendulum arbitration is a binding form of arbitration in which the arbitrator has to decide
entirely for one side or the other. It is not an option to reach a compromise and select some
middle ground. This system avoids excessive claims by unions or miserly offers by employers.

2. Conciliation
This is a method of resolving individual or collective disputes in which a neutral third party
encourages the continuation of negotiations and the postponement (at least) of any form of
industrial action. The conciliator’s role does not involve making any judgement of the validity of
the position of either party. The conciliator encourages the continued discussions in the hope that
a compromise can be reached. Conciliation is sometimes called mediation.

3. Employment tribunals
Employment tribunals are informal courts where legal disputes over unfair dismissal or
discrimination can be settled. Employment tribunals were established in 1964 and are to be
found in most major towns and cities in the UK. Each tribunal comprises three members: a
legally trained chairperson, one employer representative and an employee representative. Most
employee complaints are still settled by employment tribunals, although the number of hearings
fell substantially when fees for employees taking a dispute to a tribunal were introduced in 2013.
These were abolished in 2017 leading to a significant increase in hearings before employment
tribunals.
The value of good employer–employee
relations
One way of considering the value of good employer-employee relations is to consider the cost to
both parties that may arise from any sort of dispute. Table 24.1 examines these costs.
Employers Employees

• The business may lose revenue from • Employees may lose pay if the industrial
selling its products if the dispute dispute takes the form of a strike.
results in industrial action such as a • The dispute may weaken the employer’s
strike and production is halted. finances putting employees’ job security
• The business may lose future sales if at risk.
its customers believe that it is an • A financially weakened employer may not
unreliable supplier. be able or willing to pay for training for
• The business’s relationship with its employees, denying them the chance to
employees may be damaged in the improve and update skills and
long term with negative implications for knowledge.
engagement and productivity. • The employer may respond to the threat
• The business may be regarded as a of, or actual, industrial action by replacing
more risky investment and may people with technology in the production
encounter more difficulty in raising process or by moving overseas.
finance, or be expected to pay higher
interest rates.
• The business’s image may be
damaged if it is involved in a dispute
with its employees and this may
alienate some of its customers.

Table 24.1 The costs of industrial disputes

It is apparent from Table 24.1 that both employers and employees benefit from the maintenance
of good relations and the avoidance of industrial disputes.

What do you think?

Which stakeholders suffer the most when an industrial dispute takes place?
The benefits to employers
Employers benefit in a range of ways from the maintenance of good industrial relations.
• 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 it in attracting more able and
productive employees.
• Promoting employee engagement. We saw in Chapter 23 that having an engaged workforce
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 wellbeing. Such factors can
damage employee engagement severely.
• Improving the business’s 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. It can reduce costs by eliminating lost production, add to a business’s
reliability as a supplier as its production is not interrupted and can enhance labour productivity
(thereby lowering unit 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.

Business in focus: Strike on Total’s oil rigs threatened

Workers on three of Total’s oil rigs in the North Sea are expected to go on strike in a
dispute over pay and working hours. The trade union Unite said that the industrial
action, backed by 96.8 per cent of its members, could halt production on the rigs.
The dispute follows a wage review and concerns that Total may force workers to
increase offshore working time. Total, a French multinational oil company, has
proposed switching rotas from two weeks on, three weeks off to three weeks on, three
weeks off.
The company is reported to be keen to cut its costs and to strengthen its competitive
position in a weak market. Although oil prices have risen recently, they still remain
relatively low.
Unite regional officer Wullie Wallace stated that: ‘The overwhelming vote in favour of
strike action demonstrates our members’ anger at Total’s proposals. Our members
simply want to be properly paid for the work they undertake in a dangerous and
difficult environment.’
Unite believes that the plans to increase offshore working time will damage
employees’ work–life balance and have a negative impact on their health and well-
being. The union stated that the industrial action could be avoided if Total was
prepared to make a new offer and return to the negotiating table.
Total said it had spoken to its employees and that it hoped a ‘negotiated solution’
could be found. Managing director of Total’s UK business, Jean-Luc Guiziou,
acknowledged the good work done by its offshore staff and his desire to resolve the
dispute through constructive dialogue.
 Source: Adapted from Energy Voice, 29 June 2018

Practice questions
1 Analyse the possible costs to Total’s employees if they go ahead with the industrial
action.
(9 marks)
2 Do you think that Total would be wise to settle this dispute before any industrial
action takes place? Justify your view.
(16 marks)

Summary
The value of good employer relations 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 vulnerable to losing its customers to rivals or of financial failure. Similarly,
industrial disputes might be risky for employees in areas of high unemployment and for those
who are relatively unskilled. If a prolonged dispute results in a loss of jobs they may experience
difficulty in finding alternative employment.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 What is meant by the term trade union?
2 State two objectives of trade unions within the UK.
3 Is the following statement true or false? ‘Union representatives negotiating on
behalf of many employees can save time and reduce the likelihood of disputes
occurring.’
4 State two other ways in which employees may be represented within businesses
apart from by trade unions.
5 What conditions have to be met by a business for it to have a legal obligation to
operate a European works council?
6 State two possible influences on the extent and methods of employee
representation in decision making within businesses.
7 What are the two EU laws (or regulations) that relate to employee representation
within larger businesses?
8 State two factors that may contribute to effective employer–employee
communication.
9 What is the difference between arbitration and conciliation?
10 State two costs to employers that may arise from an industrial dispute.

(b) Short answer questions

 1 Explain the possible disadvantages to a public limited company in a price-
competitive industry of having 90 per cent of its employees represented by a trade
union.
(4 marks)
2 Explain the benefits to a rapidly growing business of implementing an effective
method of employee representation.
(5 marks)
3 Explain why a democratic leadership style might result in effective communication
between employers and employees in a large UK retail business.
(5 marks)
4 Explain the reasons why a trade union in the UK might agree to a no-strike deal
with a multi-national company.
(5 marks)

(c) Data response questions

The demand for software from businesses is growing. Many organisations require
specially designed software to allow their computer-aided design and manufacturing
systems to work efficiently. Others require bespoke software for project management,
maintenance of equipment or managing customers.
Saxon plc is a very successful business trading in a market that is growing quickly.
Last year its revenue rose by 39 per cent (and profit for the year by 44 per cent) as it
won contracts with several large public companies for the first time. It plans to issue
more shares to finance further growth. Approximately 65 per cent of its workforce is
highly skilled and many have highly creative roles. The workforce is organised in
teams, although many employees feel that their voice is not heard within the business.
In response to this managers have made increasing use of delegation across the
business recently. The company recognises the benefits of maintaining good
employer–employee relations.
It employs 3,750 people and has recently agreed to a request from its workforce to be
represented by a trade union. The company’s employees feel that their pay and
conditions do not reflect their contribution to the company’s success.
1 Explain how the increasing use of delegation might help the business to improve
employer–employee relations at Saxon plc.
(6 marks)
2 Analyse the benefits to the business of maintaining good employer–employee
relations.
(9 marks)
3 To what extent does the introduction of a trade union into the business offer more
benefits to the employer than to the employees?
(16 marks)

(d) Essays
1 To what extent is the negative impact on a business’s image arising from an
industrial dispute the most important reason to maintain good employer–employee
 relations?
(25 marks)
2 ‘The use of the latest technology to enhance communication is the key to
improving employer–employee relations nowadays’. To what extent do you agree?
(25 marks)
Revision Section: Unit 6 Decision
making to improve human resource
performance
Advice for Unit 6
Top tips … Things to avoid …

Remember that HR objectives that are Do not miss out on topics which
decided by a business’s HR managers have may be less appealing or which
to support the business in the achievement may have less coverage in the
of its overall or corporate objectives. HR media, such as diversity and
objectives can often be understood and their employee engagement. You
relevance judged in the light of the should try to cover all of the
business’s corporate objectives. specification for this unit.

Remember that much of the data used by Do not just focus on carrying out
human resource managers may not be HR calculations such as labour
data. To make decisions managers may productivity and labour
require financial data, marketing data and turnover. You should be able to
data from operations. HR managers do not interpret data and consider how
take decisions in isolation from the rest of managers may respond to
the business. particular trends in the data.

It is important to appreciate the benefits and Do not just call upon your
drawbacks of training (or a particular type of ‘favourite’ motivational theorist
training), taking into account the when responding to questions
circumstances of the business. There is no on this topic. It is important to
simple answer as to whether or not it is a select the theorist or theorists
good thing. that are most relevant to the
situation.

You should seek to use relevant motivation Do not fall into the trap of just
theories to write analytically about specific thinking that employees are
scenarios, for example, to analyse the represented by trade unions.
causes and consequences of decisions by There are other methods and
human resource managers. works councils are listed in the
specification.

Do consider the effects of an industrial

dispute on all functions of the business
concerned. The effects may be felt most
strongly in functions other than human
resources.
UNIT 6 CHECKLIST
Having completed studying this unit you should be able to do all that is listed below.
You should read this list and confirm that this is the case.
Learning objective
Setting human resource objectives
Know and understand:
• the human resource objectives that may be set by a business and the value of
setting these objectives
• the internal and external influences on human resource objectives
• how to calculate and interpret the following: labour turnover and retention rates,
labour productivity, employee costs as a percentage of turnover and labour costs
per unit
• how data may be used for human resource decision making and planning.
Making human resource decisions: improving organisational design and
managing the human resource flow
Know and understand:
• the influences of job design, including Hackman and Oldham’s model
• the influences on organisational design
• the influences on delegation, centralisation and decentralisation
• the value of changing job and organisational design
• how managing the human resource flow helps businesses meet human resource
objectives.
Making human resource decisions: improving motivation and engagement
Know and understand:
• the benefits of motivated and engaged employees
• how to improve employee motivation and engagement
• the value of theories of motivation
• the use of financial and non-financial methods of motivation
• the influences on the choice and assessment of the effectiveness of financial and
non-financial reward systems.
Making human resource decisions: improving employer-employee relations
Know and understand:
• the influences on the extent and methods of employee involvement in decision
making
• how to improve employer-employee communications and relations
• the value of good employer-employee relations.
Practice questions
1 Use the data below to calculate the business’s labour costs per unit for the year.
(4 marks)

Total revenue for the year £880,000

Average selling price per unit £5.50
Annual fixed costs £260,000
Annual labour costs £400,000

2 Explain one financial benefit to a business with a highly skilled workforce of

increasing its level of retention.
(5 marks)
3 Explain how the use of empowerment by a business may help to provide well-
designed jobs for its employees.
(6 marks)
4 A loss-making business wants to reduce its labour turnover. Explain the
implications of using delegation to achieve this aim.
(6 marks)
5 The data below shows labour productivity data for XYZ plc as well as the industry in
which it operates.
Period Industry average labour Labour productivity data for XYZ
productivity data (units per PLC (units per employee per
employee per year) year)
1990– 34.4 34.9
1999
2000– 35.5 35.1
2009
2010– 36.6 35.4
2018

Analyse how the trends in this data might have affected XYZ plc’s ability to protect
its market share.
(9 marks)
Case study: Barclays Bank uses more
technology in its operations
The banking industry is changing quickly. The established high street banks such as
Barclays and Lloyds are facing new competition from ‘challenger’ banks; for instance,
Metro Bank and others which operate online only, such as Smile and Atom Bank.
Customer needs are also changing quickly as more transactions are completed online
and fewer people visit a bank branch. At the same, time the technology that is
available to banks is developing rapidly. Analysts believe that technology will be the
key to success for banks in the future, allowing them to respond quickly to customers’
needs and to meet these as fully as possible. Other businesses, such as
supermarkets, are replacing employees with technology successfully. Many checkouts
are self-service in supermarkets, reducing the need for check-out assistants.
Despite these pressures for change, Barclays market share in the UK (based on the
number of customers with current accounts) has altered relatively little. In 2017, it held
18.5 per cent of the banking market.
Barclays Bank has responded to the need to control costs and make the best use of
technology in a variety of ways.
• The bank decided to replace virtually all of its traditional bank cashiers in its
branches with technology. It installed machines to allow its customers to conduct
routine banking activities such as paying in cheques and cash. The bank’s branches
were redesigned, including the removal of counters and booths.
• Between 2015 and 2018, Barclays Bank closed over 200 of its outlets leaving it with
1,155 branches. In 2017 alone, it closed 98 branches.
• Barclays retrained over 6,000 former cashiers (and gave them all iPads) to offer
advice on a range of financial and banking matters such as opening new accounts.
These employees will be called ‘community bankers’ and once trained will be used
to retrain other colleagues in the new roles.
• The number of people employed by Barclays has fallen from around 140,000 in
2013 to just under 79,900 in 2018.
• Cashiers who became community bankers received a pay rise as the change
represented a promotion. Community bankers will be able to advise and support the
bank’s customers in using the new technology.
Barclays bank argues that its customers are banking in different ways due to
technology such as online and mobile banking. Although the need for cashiers has
reduced, a need for a network of branches remains.
The use of technology can also reduce queuing and customer waiting time in
branches. However, there has been strong opposition to the removal of cashiers with
claims that elderly customers, for example, may have difficulty in interacting with the
new technology.
Critics of the increased use of technology claim that it is merely a means of the bank
increasing its profits. The trade union Unite, which represents some of Barclays’
employees, fears the effect of branch closures. It has called on Barclays not to close
any of its branches and to protect the jobs of its members.
Key data for Barclays Bank
• Sustained engagement of colleagues score in 2017: 78 per cent (objective for 2018:
87–91 per cent).
• Profit before tax was £5.70 billion in 2018 (£3.54 billion in 2017).
• Number of employees: 79,900 (2018).
Practice questions
1 Analyse the possible effects of these changes on the labour cost to Barclays of
dealing with a typical customer.
(12 marks)
2 Analyse the possible factors that may have led Barclays Bank to redesign the jobs
of its cashiers.
(12 marks)
3 To what extent might the increased use of technology improve the levels of
motivation of Barclays’ community bankers?
(16 marks)
4 To what extent do you think that the changes taking place are certain to damage
employer–employee relations at the bank?
(20 marks)
5 Do you think that the move to using community bankers will improve the
competitiveness of Barclays Bank plc? Justify your view.
(20 marks)
6 Do you think that is it inevitable that all businesses will seek to replace large
numbers of employees with technology? Justify your view.
(24 marks)
Essay questions
1 ‘A business will not be competitive unless its employees have well-designed jobs.’
To what extent do you agree with this statement?
(25 marks)
2 ‘If a business allows its employees to be represented by a trade union, its profits
are certain to fall.’ To what extent do you agree.
(25 marks)
Chapter 25 Mission, corporate objectives
and strategy
Introduction
The purpose of this chapter is to set the scene for you to study how managers and other interested
stakeholders analyse the strategic position of a business. It is important to know what a business
hopes to achieve in the long term when making an assessment of its strategic position. Therefore,
we start by considering what the business is attempting to achieve by looking at its reason for
existing and its corporate objectives. We also consider what influences the choice of mission and
corporate objectives made by businesses. We examine how a business’s strategy relates to its
mission and its corporate objectives and how decisions on its strategy impact on decisions made
within the business’s functions, such as finance and marketing. Finally, we investigate how
SWOT analysis can assist in the process of setting corporate objectives and in implementing
strategy, and assess its value to managers.
What it is important to know by the end of this chapter:
• the factors that can influence a business’s mission
• the internal and external influences on corporate objectives and decisions
• the links between mission, corporate objectives and strategy
• the distinction between strategy and tactics
• the impact of strategic decision making on functional decision making
• the value of SWOT analysis.
Mission statements
A mission statement sets out the purpose of an organisation and thus gives its reason for existing.
Mission statements commonly focus on:
• what the business wants to be
• the values of the business
• the range of the firm’s activities
• the importance of different groups, such as employees, customers and investors.
The John Lewis Partnership operates 36 department stores, 12 John Lewis at home, and shops at
St Pancras International and Heathrow airport, 353 Waitrose supermarkets, and an online and
catalogue business. It is owned by its 83,000 employees, who are called partners. It is not
surprising that its mission statement focuses on its staff:
‘The happiness of all our members, through their worthwhile, satisfying employment in a
successful business.’
The BBC’s mission statement reflects its role as the UK’s major public service broadcaster and
considers its customers:
‘Our aim is to inform, educate and entertain.’
By setting out a mission, everyone within the business knows what they should ultimately be
trying to do. All of their actions should be directed towards the same thing. This should make
decision making easier: when faced with a series of options managers can compare them in
relation to the business’s mission statement; in this way the mission statement acts as an anchor.
Mission statements can also motivate people: they know why they are employed and what the
business is trying to achieve.
Mission statements and vision statements
Some companies operate with mission statements, whilst others prefer to have a vision
statement. Some businesses draw up both mission and vision statements. What is the difference?
A mission statement states a business’s purpose – why it exists. A vision statement sets out what
it wants to do or be in the future. Thus, a mission statement relates to the business’s current
position and is intended to provide information to stakeholders. Vision statements tend to be
longer term as they look to the future and can be a source of inspiration to stakeholders such as
employees and suppliers.

Key term
A vision statement sets out a business’s aspirations for the future.

Oxfam and Amazon have two quite different vision statements.

Oxfam, a globally renowned charity, has a vision statement that reflects the values that the
organisation wishes to project:
‘Our vision is a just world without poverty. We want a world where people are valued and
treated equally, enjoy their rights as full citizens, and can influence decisions affecting their
lives.’
In contrast, Amazon is one of the world’s largest retailers which operates almost exclusively
online. It bases its vision statement around satisfying its customers – across the world. It is:
‘Our vision is to be earth’s most customer-centric company; to build a place where people can
come to find and discover anything they might want to buy online’.
‘To be a leading global provider of speciality food ingredients and solutions.’

Figure 25.1 Oxfam’s work deals with extreme poverty daily

Figure 25.2 The roles of mission, vision, strategy and corporate objectives

Vision statements, because they are forward looking, should dovetail with a business’s corporate
objectives. In other words, achieving the targets embedded in its corporate objectives should
enable the business to fulfill its vision.
Figure 25.2 shows how mission statements, vision statements, a business’s strategy and its
corporate or strategic objectives fit together to provide a framework for senior managers to work
within. They also play an important role in communicating an organisation’s purpose, intentions,
plans and progress to a range of stakeholders, including shareholders or other owners, customers,
employees, investors and suppliers.
Influences on a business’s mission
The mission of a business will be influenced by a range of factors, including the following:
• the values of the founders of the business
• the values of the business’s employees
• the industry of which the business is part
• society’s views
• the ownership of the business.

The values of the founders of the business

The founders of a business can instil certain values in a business which are fundamental in
determining why the business exists. These values are expressed in its mission statement. Some
founders of businesses can remain hugely influential long after they cease to be involved with
the organisation that they created and their principles live on in the business’s mission.
Johnson & Johnson supplies medical and pharmaceutical products and is still guided by the
values of its founders. These values were shaped in the 1940s by the Johnson family and are
fundamental to decision making throughout the company today. The company publicises that it
puts ‘the needs and well-being of the people we serve first’.

The values of the business’s employees

Employees may be hired initially because there is some significant overlap between their values
and the values of the organisation that recruits them. For example, the Bristow Group, which
provides helicopter services to other businesses such as oil and gas companies, emphasises its
values in its recruitment processes. It believes it is critically important for all employees to
understand and embrace its vision and mission.
However, over time, the values of employees may begin to change that of the organisation and
this is likely to be reflected in its mission statement as well as in its vision statement. The more
senior employees are likely to have greater influence on the business’s mission because they may
take decisions that directly influence it. This influence may be more significant when a business
experiences a higher rate of labour turnover over a sustained period or in businesses in which
employees play a dominant role in the production process.

What do you think?

Why are employees’ values of importance in some businesses, but not in others?

The industry of which the business is part

In some industries businesses are much more likely to be successful if they operate with certain
values and this will be reflected in their mission statement. Businesses that are part of the fashion
industry, for example, are likely to operate with mission statements that emphasise creativity and
uniqueness. Chanel, a company that specialises in clothing, other luxury goods and fashion
accessories, is an example and this is reflected in its mission statement:
‘To be the Ultimate House of Luxury, defining style and creating desire, now and forever.’
In contrast, companies in the pharmaceutical industry could be expected to operate with long-
term horizons and to place value on innovation. Merz is a German pharmaceutical company that
trades globally. In 2017, its sales revenue exceeded €1 billion and it spent nearly €150 million
researching new products. Its vision statement reflects the industry in which it trades:
‘As we look to the future, our long-term vision is for Merz to become the world’s most admired,
trusted and innovative aesthetics and neurotoxin company.’

Business in focus: Tesla

Tesla is a company that specialises in and manufactures electric vehicles, solar

panels and lithium-ion batteries. The company was established in 2003 by Martin
Eberhard and Marc Tarpenning. The founders of Tesla believe the world should stop
relying on fossil fuels and moves towards a zero-emission future as quickly as
possible. It is based in California and has both a mission and a vision statement.
Mission: To accelerate the world’s transition to sustainable energy.
Vision: To create the most compelling car company of the 21st century by driving the
world’s transition to electric vehicles.
Tesla aims to change the motor vehicle manufacturing industry. It operates marketing,
production and sales strategies that are very different from those of rival businesses.
Tesla has developed a range of new electric cars and its production passed 300,000
in 2018. The company has had to borrow heavily to fund the development of its cars
and batteries. In October 2017, it increased its borrowing limit to $1.1 billion.
Source: Tesla website

Practice questions
1 Analyse the benefits to Tesla of having a mission statement.
(9 marks)
2 Do you think that a vision statement is more important for a business that operates
in the technology industry than in other industries? Justify your decision.
(16 marks)

Society’s views
What is acceptable, or better still, appealing and desirable, depends on the views held by society.
At the time of writing there is considerable concern for the physical environment and a desire to
protect it as far as possible. This has led to many businesses, notably those in industries with the
potential to damage the environment, to address environmental protection within their mission or
vision statements. Companies such as Shell (oil exploration and refining) and Rio Tinto (mining)
have included environmental protection within their mission or values.
The ownership of the business
An enterprise that is owned by the state (and is therefore part of the public sector) may have a
mission that shows concern for social values. Figure 25.3 shows the vision and mission
statements of the National Health Service (NHS) in England as well as its purpose, behaviour
and values. These statements are highly inclusive throughout and recognise that the organisation
is publicly funded.

Figure 25.3 Mission, vision and other statements for England’s National Health Service

Source: NHS England

This contrasts with the mission statement of Ripple hedge Fund, an investment business based in
San Francisco. It is a privately-owned company and its mission is to maximise returns for its
investors. Its mission focuses on short-term profits for its relatively small number of investors.
The NHS in England is expected, as a publicly-owned organisation, to provide its services to all
over the long term.
Corporate objectives and strategic
decisions

Key terms
Corporate objectives are medium- to long-term goals established to coordinate the
business.
Strategic decisions are judgements made by senior managers that are long term,
involve a major commitment of resources and are difficult to reverse.

Corporate objectives
Once a firm has established its mission it can set its corporate objectives. These objectives are
sometimes referred to as strategic objectives and they turn the mission statement into something
which is more quantifiable. Rather than simply being a statement of intent, an objective sets out
clearly what has to be achieved. Corporate objectives are medium- to long-term goals established
to coordinate the business. Objectives are frequently quantified and have a stated timescale, such
as to increase market share by 15 per cent within two years. However, this is not always the case
as some corporate objectives, such as those that relate to social responsibility, may not be easy to
measure.
Corporate objectives relate to the entire business, and not merely to a specific function such as
finance or operations. They are more general and are set by senior managers within the
organisation. Corporate objectives provide guidance for more junior managers responsible for
setting objectives lower down the organisational structure and for the setting of functional
objectives.
Businesses pursue a wide range of corporate objectives. Peter Drucker, a management guru,
argued in The Practice of Management in 1954 that eight areas of business activity existed where
businesses could usefully set corporate or strategic objectives.
• Market position. This could be the share of sales in a specific new or existing market or a
growth rate for sales in a market.
• Innovation. This refers to the invention and development of new goods and services, as well
as new processes and methods of producing and supplying products.
• Financial resources. These objectives could relate to the amount of capital available to a
business and its sources, and how it might be used.
• Physical resources. This refers to the buildings, land, equipment and technological resources
available to the business.
• Human resources. Objectives in this area may relate to motivation or engagement amongst
employees.
• Productivity. This refers to the efficient use of resources to gain the maximum output from
 minimal inputs.
• Social responsibility. This is an area in which setting objectives has become more common as
businesses have responded more fully and openly to stakeholders’ needs.
• Profits. These objectives could relate to an overall level of profits or to profit measured against
other factors such as revenue or the amount of capital invested.
Oxfam has set itself a range of corporate objectives which it expects to be achieved by 2019. One
of Oxfam’s aims is to promote the development of sustainable food supplies and this gives rise to
three objectives.
• More small-scale and marginal producers will intensify their production sustainably, adapt to
climate change and increase their resilience to shocks and stresses.
• More rural women living in poverty are economically empowered and able to influence the
decisions that affect them.
• More small-scale producers, both women and men, are able to develop resilient livelihoods,
with greater food security, participate in agricultural markets, and prosper from policies that
promote small-scale agriculture.
Source: The Power of People Against Poverty: Oxfam Strategic Plan, 2013–2019

What do you think?

Why might Oxfam have chosen not to quantify these objectives?
Strategic decisions
Management involves making many decisions. What to do, how to do it, who will do it and when
to do it all have to be decided. Clive Boddy, a writer on management, has defined a decision as
‘involving a specific commitment to action’. Managers have to take a range of decisions in
businesses but, for the moment, we will focus on strategic decisions.
Influences on corporate objectives and
decisions
Organisations are subject to a range of influences when setting corporate objectives and taking
strategic decisions. Some of these arise externally, whilst others occur within the organisation.
The business’s ownership
Internal influences on decisions regarding a business’s corporate objectives will include the
business’s ownership.
Some privately-owned companies (whether private or public companies) may be under pressure
to deliver high levels of shareholder returns. This means that they may decide to set corporate
objectives which are intended to generate high levels of profits for shareholders in the form of
dividends as well as driving up the business’s share price. If such objectives are reached
successfully, this is likely to be an attractive option for potential and existing shareholders,
especially if they are seeking short-term gains.

Key terms
Shareholder returns are the financial benefits derived by shareholders from buying a
company’s shares and are the combination of an appreciating share price and
dividends paid.
Dividends are that part of a company’s profits that are paid to shareholders in
proportion to the number of shares that they own.

Figure 25.4 Factors influencing corporate objectives and decisions

Senior managers may be encouraged to set corporate objectives and make strategic decisions
intended to drive up the company’s share price by using share options as a form of financial
motivation. Under a share option scheme a company’s senior managers may be offered the
opportunity (or option) to buy an agreed number of the company’s shares at a specific future date
and at an agreed price. This will encourage the managers concerned to set objectives and take
decisions to increase the company’s share price beyond that set out in the share option. If they
are successful in meeting these objectives, they can take the option of buying the shares and then
sell them immediately at a profit.
In contrast, businesses which have different ownership structures may set very different
corporate objectives and take different strategic decisions. The John Lewis Partnership, which
we mentioned earlier in this chapter, is a business that is owned by all its employees, known as
partners. The purpose of this partnership as ‘the happiness of members through their worthwhile
and satisfying employment in a successful business’. There are no external shareholders
involved. This means that John Lewis can do what is best for all its partners and the long-term
health of the business. In addition, there is no conflict of interest between the various parts of the
business. Through an elected council, management are held to account across the company and
the common good is upheld. This can result in very different objectives and decisions. Certainly,
senior managers at John Lewis do not have to worry about the company’s share price. The
retailer’s corporate objectives centre on sustainable growth and delivering a reasonable profit to
its partners (employees).
Small businesses such as sole traders and mutual, non-profit making businesses could operate
with very different corporate objectives, perhaps focusing on providing excellent levels of
service or fulfilling a social need – possibly providing jobs in an area of high unemployment.
These can result in the setting of corporate objectives relating to customer needs or providing
secure employment.
Pressures for short-termism
Short-termism is a significant issue for UK businesses. The term refers to an excessive focus on
short-term results, for example, maximising profits in a financial year, at the expense of long-
term interests. A review in 2013 by Sir George Cox into short-termism revealed that 60 per cent
of business leaders and 86 per cent of trades union representatives judged it to be a major or
significant impediment to growth and development of business in the UK.

Key term
Short-termism is the pressure to deliver quick results to the potential detriment of the
longer term development of a company.

Short-termism can prevent senior managers thinking in the long term and may act as a
disincentive to setting corporate objectives which encourage strategic decisions like research into
new products and processes, training of employees to provide high level skills and creating new
production facilities which may only break-even in the long term. Instead, it encourages
decisions which frequently involve cost-cutting and loss of jobs. Critics of short-termism argue
that it prevents the UK developing businesses that are internationally competitive and are
essential to the future success of the economy.
More recent research by the McKinsey Global Institute in 2017 found that firms that avoid short-
termism perform better. Between 2001 and 2015, firms that focussed on the long-term:
• spent on average 50 per cent more on research and development
• on average achieved growth levels 47 per cent higher than other firms
• enjoyed revenues which were 36 per cent higher on average.
The business’s internal environment
A number of factors may arise from within the business that can have a significant influence on
the objectives that are established and the decisions that are taken.

Poor performance
A period of poor performance, indicated by a decline in sales and revenue and a loss of market
share, may provoke a change in a business’s strategy and in the corporate objectives it uses to
guide and measure its performance.
A number of the UK’s major retailers have experienced financial difficulties as a result of poor
trading performance in recent years. Marks & Spencer recorded profits of £1 billion. The
company’s profits in 2018 were £66.8 million – a 62 per cent decline on the previous year.
Marks & Spencer has said that it is implementing a transformation plan after suffering another of
a series of falls in its annual profits. This plan was introduced by the company’s chief executive,
Steve Rowe, who was appointed in 2016 with the remit of turning the retailer’s fortunes around.

Figure 25.5 Marks & Spencer plc’s corporate objectives are influenced by Steve Rowe, the company’s
Chief Executive, as well as its poor financial performance

Business in focus: Unilever

Unilever is a multinational public company that sells a range of household products

 including the highly popular Marmite, Dove, Sunsilk and Domestos brands.

Figure 25.6 Unilever owns a huge array of household brands

The company’s managers implemented a series of changes in response to growing

competition and a switch in consumer tastes after its sales were below forecasts.
Unilever is selling its unprofitable businesses, cutting its costs alongside raising
prices. Unilever raised prices twice in 2017 to offset weak volume growth of 0.2 per
cent. They were increased by 2.3 per cent following an earlier 2.8 per cent rise. The
company said it is on track to reach its savings target of €6bn and profit margin of 20
per cent by 2020.
But the cost cuts and price increases are examples of short-termism, according to a
business analyst, Charlie Huggins. ‘Life is becoming more difficult for the consumer
goods giants, as competition from smaller, nimbler players intensifies and consumer
preferences shift towards niche and alternative brands,’ Huggins said. ‘To succeed in
the long-term Unilever will need to become more agile and responsive to changing
trends.’
For the 2016–17 financial year, Unilever recorded a 1.9 per cent increase in turnover
to £46 billion, while pre-tax profit rose 9 per cent to £7 billion.
Source: Adapted from Proactive Investors article, 2017

Practice questions
1 Analyse why Unilever might have taken decisions to cut costs and to raise prices.
(9 marks)
2 Do you think that short-termism is always a bad thing? Justify your decision.
(16 marks)

A new leader
Similarly, a new leader in a business may have a major influence on the objectives set and the
strategic decisions that are taken in pursuit of those objectives. In October 2018, Nick Read was
appointed CEO of Vodafone, one the world’s largest mobile telephone companies. He faces
reviewing objectives and making some tough decisions in relation to the company’s performance
in the UK market where its revenues fell by 3.6 per cent in 2017 and there have been complaints
about the company’s standards of customer service.

The business’s culture

A business’s workforce may have a particular set of values, attitudes and beliefs – these are
described as the business’s culture. Businesses can operate with a range of cultures as we shall
see in Chapter 40. We can use two examples to show how a business’s culture may influence the
corporate objectives that are established and the strategic decisions that are made. For example, a
business may be entrepreneurial and encourage ideas and employees’ initiatives. This may entail
the setting of corporate objectives to decentralise the organisation and delegate authority to more
junior employees. On the other hand, a different business may operate with a customer-focused
culture where customers are highly valued. This may result in corporate objectives and strategic
decisions related to product development and employee training (to place customers first).

Key term
Culture encompasses the values, attitudes and beliefs of those who work for a
business.
The business’s external environment
A business’s external environment has a major influence on management decision making, not
least in relation to strategic decisions and setting corporate objectives. A number of elements of
the external environment can be particularly influential.

The state of the economy

The UK’s economy is still feeling the effects of the financial crisis and the deep recession of
2008–9. A report by the Resolution Foundation in 2017 revealed that average real wages in 2022
will still be more than £20 lower per week than before the start of the financial crisis as the
biggest squeeze on wages since 1815 extends well into a second decade.
Source: The Resolution Foundation in 2017
As shown in Figure 25.7, consumer spending has held up, even after inflation has been taken into
account, but this has been supported by consumers increasing their borrowing.
This means that the ability of consumers to spend money is curtailed and they seek value for
money and competitive prices. Businesses have had to adjust their corporate objectives to reflect
this. For example, many retailers in the UK have revised corporate objectives in terms of sales
and the number of shops or stores required. A recent study by the Centre for Retail Research
showed that 629 stores were closed in the UK in 2017 and in the first 11 months of 2018 this
trend accelerated with 1 826 stores closing.
Figure 25.7 shows that consumer expenditure in the UK has shown substantial changes in its
pattern over a period of just one year. Spending on recreation and culture has risen strongly, as
has spending on transport, clothing and footwear. At the same time, expenditure on restaurants
and hotels has declined. These figures will help to shape strategic decision making across a range
of manufacturing and service industries.

What do you think?

Is the state of the economy the most important influence on the setting of corporate
objectives for all businesses?

Prices on global markets

The prices of commodities such as wheat and oil which are traded globally have received a lot of
attention recently. Changes in global prices impact heavily on objective setting and strategic
decision making in many industries.
For example, at the time of writing (September 2018) oil prices have risen by around 44 per cent
to approximately $82 a barrel over the last 12 months. This affects the costs of many firms and
may encourage them to increase prices, but the greatest effects are felt in the oil industry. Rising
prices (after prolonged falls) is likely to result in strategic decisions by the industry to restore
exploration activity as well as to increase day-to-day operations.
Research by DNV, a company that provides advice to the oil industry, revealed that 66 per cent
of the 813 senior oil and gas professionals surveyed said their company would maintain or
increase capital spending this year, compared to 39 per cent last year. This is likely to increase
jobs as well as the output of oil – at least in the short-term.

Technological changes
Technology impacts on the setting of objectives and the making of strategic decisions in many
ways. It may encourage firms to adopt objectives based on capital-intensive production and to
use robots and other forms of technology to replace labour in production. This can be seen in the
use of automated check-outs in many shops. It can have an even more dramatic impact on
business models as retail firms use the potential of the internet to reach customers and to supply
products 24 hours a day.
Many banks in the UK are setting corporate objectives based on changing consumer behaviour
reflected in greater use of the internet. For example, the Royal Bank of Scotland (RBS)
announced in 2018 that it was closing 162 banks in England and Wales. This follows hundreds
of earlier branch closures. This will have huge implications for the business’s operations.
BMW has set itself the objective of a large-scale expansion of the use of robots on its car
manufacturing production lines. The company plans to design additional tasks for collaborative
robots (which can work alongside humans on a wide range of relatively small-scale production
activities) as they are progressively introduced in five of its factories. The installation of these
robots will have significant implications for the company’s strategic decisions, not least those on
training and recruitment.

Figure 25.7 Changes in consumer expenditure in the last three months of 2017
Source: Office for National Statistics (ONS)

Figure 25.8 Robots involved in car production

Patterns of migration
The UK has been subject to high levels of migration for the last 20 years. Figure 25.9 illustrates
this. The numbers leaving the UK (emigration) have varied between 200,000 and 400,000
annually since 1991, but have been significantly below the numbers entering the UK
(immigration). As a consequence, there have been high positive levels of net migration – the
balance between emigration and immigration. More people have entered the UK than have left.
This has had profound implications for the objectives and strategic decisions of a range of
businesses in the UK because immigration affects the workforce that is available, as well as
providing additional consumers for the products of many firms. The effects are more significant
in certain areas. For example, universities in the UK attract over 440,000 students from overseas
which impacts on their corporate objectives in terms of scale of operations and range of courses.
Another example is agriculture, particularly in locations such as East Anglia, because it is
dependent on migrant labour as a low-cost alternative to greater mechanisation. However, there
are likely to be changes in migration rules once the Brexit negotiations are concluded. This may
alter the patterns of migration in to and out of the UK.

Handling data
Figure 25.9 Emigration, immigration and net migration for the UK, 1991–2017

Source: House of Commons Library, briefing paper, August 2018

Use the data in Figure 25.9 above to answer the following questions.
1 In which year was the gap between immigration and emigration largest?
2 In between which years did immigration rise most quickly?
3 Identify one year in which there was a positive correlation between the immigration
and emigration data and one year in which there was a negative correlation.
4 Do you think that there is any correlation between the immigration and emigration
data in this period? Explain your reasoning.
The difference between strategy and tactics
A corporate strategy is a long-term plan to achieve the business’s vision through attaining its
corporate objectives. For example, if a firm’s vision was to become the market leader, it might
decide to achieve this through a strategy based on low prices. This may entail setting corporate
objectives relating to controlling or reducing costs and increasing sales.

Key terms
A strategy is the long-term plan to achieve the business’s vision through attaining its
corporate objectives.
Tactics are short-term decisions, usually involving relatively few resources, that are
made to implement a strategy.

Strategies tend to involve a major commitment of resources and are difficult to reverse. For
example, the decision to invest in new product development is likely to involve a high level of
finance and take several years. Strategic decisions also tend to involve a high level of
uncertainty. Over time, market conditions often change significantly and so firms must change
their strategies to cope with these unfamiliar conditions.
The value of producing a clear strategy is that it sets out the firm’s overall plan; this helps
employees develop their own plans to implement the strategy. If employees know that the firm
wants to diversify, for example, they know that it is realistic to consider market opportunities in
new segments of the market. In contrast, if they are aware that the strategy is to boost the firm’s
market presence in a particular region, they are likely to focus on putting more resources into this
area.
Tactical decisions
The decisions made about how to implement a business’s strategy are called ‘tactical decisions’
or tactics. Tactical decisions tend to be short term, to involve fewer resources and involve less
uncertainty. These types of decisions, such as temporary increases in production or a change of
supplier, are made regularly by relatively junior managers who may only be responsible for a
small element of the business’s activities. However, in making these decisions the junior
managers are guided by the business’s strategy – their decisions should be an integral part of this
plan to achieve the business’s objectives.
Strategic decisions Tactical decisions
Long-term Short-term
Involve high commitment of resources Fewer resources involved
Difficult to reverse Easier to reverse
Usually taken by senior management Normally taken by junior management
Table 25.1 The differences between strategic and tactical decisions
The links between mission, corporate
objectives and strategy
A successful business is likely to have a clearly stated mission and vision which acts as a broad
guide to its managers. A sound awareness of the business’s mission and vision will enable senior
managers to develop corporate objectives which, if achieved, will fulfil the mission and vision.
The next piece in the jigsaw is the development of a plan or strategy by which the managers
intend to achieve the business’s corporate objectives. Junior managers will take relatively minor
decisions to support this plan. Good communication between managers at all levels in the
organisation is essential for this to operate effectively.

Figure 25.10 Mission and vision, corporate objectives, strategy and tactics

Taylor Wimpey plc is one of the UK’s largest house builders. It expresses its mission in terms of
what it does as follows:
‘Our mission is to create great places to live, and deliver excellent service which inspires and
delights our customers, our people and our shareholders.’
Its vision is ‘to work together to deliver your dreams’. To achieve its vision, the company has set
itself a range of corporate objectives. These include two objectives relating to finance:
• an operating profit margin of 21–22 per cent
• a return on capital of 35 per cent by 2023.
These are supported by other objectives relating to customers, employees and the environment.
Its strategy, or plan, to achieve these objectives has a number of key elements or drivers,
including investing in its employees, using assets with maximum efficiency and a philosophy of
continually improving the way the business is run.
Strategic decision making and functional
decision making
We saw earlier in this chapter that strategic decisions are judgements made by senior managers
that are long term, involve a major commitment of resources and are difficult to reverse. They
are taken in pursuit of the business’s corporate objectives. Strategic decisions have great
implications for those responsible for taking decisions within a business’s functions. A
business’s functions are the departments or areas that comprise a business, such as operations,
finance, marketing and human resources. Decisions taken in these areas will be intended to
support strategic decision making and the achievement of the business’s corporate objectives.
Strategic decisions are taken first with subsequent functional decisions acting to support them.
For example, a business that has set itself corporate objectives relating to growth may take a
strategic decision to enter new markets. This will have significant consequences for functional
decision making.

Key term
A functional decision is a judgement taken by managers responsible for one aspect
of a business’s activities, such as marketing or human resources.

• Marketing may need to take decisions about researching into consumers’ needs in different
markets and launching new products or adapting existing ones.
• Financial decisions could relate to raising capital to fund the expansion or seeking more
effective ways to manage cash flow at a time of rapid growth.
• Human resource decisions could include preparing new workforce plans to meet the expected
increase in the scale of production.
• Operations could take decisions regarding the most efficient locations and the increased use of
technology in production to gain price competitiveness in the new markets.
These functional decisions have to be coordinated to ensure that the different functions work
effectively together to support the strategic decision – joined-up thinking is required. For
example, if managers responsible for operations take decisions to use more capital intensive
methods of production, this will need to be coordinated with decisions in human resources to
ensure that the right number of employees are available in the right place and with the right
skills.
Figure 25.11 Functional and strategic decision making

Business in focus: BT buys EE

In 2016, the takeover of EE by BT was finally approved by the UK’s competition

authorities. The deal was valued at £12.5 billion. EE proved a very tempting target for
BT as it had over 24 million customers and a highly developed 4G network. As a
result of the takeover, BT increased the number of customers it has by more than 200
per cent and has sold them its other communication and media products.
EE was owned by Deutsche Telekom and Orange, who were given shares in the new
and enlarged company as well as a reported £6.2 billion in cash. Although it was a
costly deal, BT is expected to reduce EE’s operating costs by up to £360 million to
achieve higher profit margins. For example, it merged the two companies’ networks in
2018 reducing costs and is able to sell its own products in 620 shops across the UK
formerly operated by EE.
It had been apparent that BT was eager, as a central part of its business strategy, to
re-enter the mobile phone market (it sold its previous company in 2001). In doing so,
BT’s managers have created a business that offers a broad range of products to its
customers, therefore allowing them to purchase products which they can access on a
diverse spectrum of devices including televisions, landlines, tablets and smartphones.
BT’s takeover of EE has increased the competitive pressures faced by its competitors
and has resulted in consumers buying from fewer, larger businesses.

Practice questions
1 Analyse the possible ways in which the takeover decision by BT’s board of
directors will have affected its functional decisions.
(9 marks)
2 Do you think that all stakeholders benefit when markets are made up of fewer,
larger businesses? Justify your view.
(16 marks)
SWOT analysis
SWOT analysis is a method of strategic analysis which considers the internal and external
environments of a business. SWOT is an acronym: S and W stand for ‘strengths’ and
‘weaknesses’ and these look at the internal position of a business at the present time.

Key term
SWOT analysis is a management technique used to identify a business’s strengths
and weaknesses, as well as the opportunities and threats to which it will be exposed.

A business’s current strengths may include:

• a high level of cash
• a strong brand name
• a good distribution network
• highly skilled and loyal staff.
The following are examples of weaknesses a business may have:
• large amounts of long-term borrowing
• under utilised capacity
• a low net profit margin
• a lack of new products under development.
The letters O and T represent ‘opportunities’ and ‘threats’. This part of SWOT analysis refers to
external factors and looks to the future. Opportunities offer positive chances for the business,
whilst threats are factors which might be damaging.
A business may benefit from opportunities in the future such as:
• growth in a major market
• an alliance with a competitor to develop new technology
• rising income levels amongst target consumer groups.
On the other hand, its future threats may include:
• being taken over by a larger competitor
• a change in consumer tastes leading to a significant fall in demand
• new laws increasing the business’s costs of production.
Managers try to identify strengths, weaknesses, opportunities and threats as accurately as
possible. They then rank these in order of their significance – for example, what is the most
significant threat?
Figure 25.12 SWOT analysis

Key models and theories: SWOT analysis

S-trengths
W-eaknesses
O-pportunities
T-hreats
The simplicity of SWOT analysis is one of its attractions. You can use this model to
help you to propose and support strategies for a business. Identifying strengths and
opportunities sets out the factors on which the business’s managers can build and
targets towards which they can aim. Knowing a business’s weaknesses and threats
enables you to identify the actions a business needs to take immediately as well as in
the future to protect itself.
Using the information in a SWOT analysis
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 against what it should
protect itself.
From this, managers can develop a strategy, or range of strategies, that seek to:
• build on strengths to exploit opportunities
• reduce or eliminate their weaknesses
• protect the business against threats.
A SWOT analysis is not a one-off exercise. Given that a business is subject to constant change in
its internal and external environment, this should be constantly monitored and analysed and
strategies should be adjusted accordingly. For example, a strategy of growth may be appropriate
in an economy that is expanding rapidly, but in a recession it may be necessary to focus on
protecting market share.
The value of SWOT analysis
SWOT analysis can be used by managers when devising strategies. Naturally, this approach has
both a range of benefits and limitations which are outlined in Table 25.3.
Benefits of SWOT analysis Limitations of SWOT analysis
SWOT analysis is a low-cost and A SWOT analysis only covers issues that can
straightforward technique that be classified as a strength, weakness,
can be used by managers in all opportunity or threat. It can be difficult to
types of businesses and may be address uncertain or two-sided factors, such
very suitable to assist managers as factors that could either be a strength, a
of small businesses in devising weakness or both.
strategy. It can provide a lot of information, but is
It can assist managers to think in unlikely to offer any solutions and its results
a structured way and focus on will require further analysis by managers. Any
both the internal operations of benefit from the analysis will depend on the
the business and its external quality of the interpretation – if this is poor,
environment. then the analysis is likely to be of little value.
Its use encourages management The analysis offers no assistance to managers
teams to develop plans that are in judging the relative importance of
logical in the context of the strengths, weaknesses, opportunities and
business’s current position, threats in contributing to the development of a
whilst actively promoting a strategy. As a consequence, managers may
forward-looking approach which underestimate the importance of one or more
should be a central element of of the four elements.
business planning. Decisions on a business’s strategy should be
SWOT analysis, and especially based on reliable, relevant and comparable
the ‘threat’ part of the analysis, data. However, SWOT analysis can be
can help managers to recognise subjective depending on the opinions and
and assess risk which is an positions of those collecting and analysing the
important part of making data.
strategic decisions. A SWOT analysis is only as good as the data
SWOT analysis can be on which it is based – if the data used is poor,
combined effectively with other the analysis is unlikely to be useful. Also, the
management techniques, such data on which SWOT analysis is based can
as PEST-C analysis to help to become outdated quickly. For example, in
develop a business’s strategy. Table 25.2, Toyota’s profit levels and market
SWOT analysis can be used position could be quite different a year later.
within a business’s functions, for
example, as an important part of
developing a marketing strategy.

Table 25.3 Benefits and limitations of SWOT analysis

Business in focus: Toyota

Toyota is a large, multinational Japanese car manufacturer. In 2018, it manufactured

10.4 million cars and employed nearly 370,000 people globally. It is the largest car
manufacturer in the world. It produces a range of environmentally-friendly vehicles,
including hybrid electric cars such as the best-selling Prius and all-electric vehicles,
such as the RAV4 EV or the IQ EV.

Figure 25.13 Toyota manufactures environmentally-friendly vehicles

Strengths Opportunities
• Achieved record profits of £17 billion in • Increasing demand globally for
2018. environmentally-friendly vehicles.
• Globally recognised brand. • Increasing importance of green
• World’s largest car manufacturer in terms vehicle technology.
of volume (2017). • Strong growth in demand for cars
• Spends heavily on successful research in emerging markets such as
and development. China and Mexico.
• Innovative organisational culture and • Interest rates in many key
effective use of lean production. developed markets are at a historic
• Owns important subsidiary businesses, low.
e.g. Daihatsu. • Weak Japanese yen against the
US dollar.
Weaknesses Threats
• Has had to recall a large number of • Global car manufacturers have
vehicles to repair faults (including one more productive capacity than
million cars in 2018), damaging brand needed.
image. • Increasing competition from low-
• Fined $1.2 billion in the USA over cost producers based in China and
concealment of faults with some of its cars. India.
• The company’s hierarchical global • Tightening emissions standards in
organisation structure limits its flexibility in many countries is increasing cost
responding to changes. and complexity of production.
 • Sales currently relatively low in emerging • Intense competition in the
markets. environmentally-friendly vehicles
market from Nissan.

Table 25.2 A SWOT analysis for Toyota

Practice questions
1 Explain one way in which the information in this SWOT analysis might influence
strategic decisions made by the management team at Toyota.
(9 marks)
2 The car manufacturing market is changing very quickly. Do you think this means
this SWOT analysis is of little value?
(16 marks)

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 State two likely components of a business’s mission statement.
2 What is the difference between a business’s mission statement and its vision
statement?
3 Define the term ‘corporate objective’.
4 State three areas of business activity, identified by Peter Drucker, where
businesses can usefully set corporate objectives.
5 What is meant by the term ‘strategic decision’?
6 State two disadvantages that may result from managers taking decisions that are
influenced by short-termism.
7 State two internal factors that might influence the setting of corporate objectives
and the strategic decision making within a business.
8 State two external factors that might influence the setting of corporate objectives
and the strategic decision making within a business.
9 Distinguish between strategy and tactics.
10 What is meant by the term ‘SWOT analysis’?

(b) Short answer questions

1 Describe how the industry a business is part of could influence its mission
statement.
(3 marks)
2 Explain the relationship between a business’s mission and its corporate objectives.
(5 marks)
3 Explain how the type of ownership of a business may influence the corporate
 objectives that it sets itself.
(5 marks)
4 Explain how a small business facing competition from larger rivals should engage in
a SWOT analysis before making strategic decisions.
(6 marks)

(c) Data response question

Ford is a multinational car manufacturer. In 2017, it sold 6.6 million cars in the highly
competitive global market and generated profits of over $7 billion. Ford says its
philosophy means it goes further to make its cars better, its employees happier and
the planet a better place to be. This is reflected in its mission statement:

One Team. One Plan. One Goal.

People working together as a lean, global enterprise for automotive leadership, as
measured by: Customer, Employee, Dealer, Investor, Supplier, Union/Council,
and Community Satisfaction.
Ford is in the process of making a number of strategic decisions as it responds to
intense competition in the global car market and excess production capacity. The
company faces mounting speculation that it is considering plans to cut its costs by
scrapping its Mondeo range of mid-market family cars and cutting up to 24,000
workers’ jobs. This follows its decision in 2018 to recall over half a million cars for
repairs.
This means thousands of staff who work for the car maker are at risk of redundancy.
Ford could cut up to 12 per cent of its global workforce in plans being drawn up in its
headquarters in Michigan. Many of the cuts are feared to come from the company’s
European operations, particularly in Germany and Spain. It may focus on producing
the more lucrative ‘sports utility’ vehicles, or targeting its products towards more
environmentally-friendly production to meet changing consumer tastes.
A spokesman for Ford said it is ‘focused on aggressively attacking costs’ but would
not comment on the potential job cuts. The potential decisions have emerged months
after the company said it would be cutting costs across engineering, marketing,
manufacturing and sales between 2019 and 2022, saving a total of $25.5bn. Its costs
in Europe are reported to be high and European profits fell sharply in 2018.
Ford, which was founded more than a century ago and has more than 200,000 staff,
has faced financial difficulties caused by higher aluminium and steel costs, a fall in
demand for diesel-powered vehicles and the threat of Brexit on the UK, which is its
most profitable market.
Strengths Opportunities

• Strong position in USA and • Rising demand for electric vehicles,

Chinese markets. especially in the USA and Europe.
• Large product portfolio. • Use of artificial intelligence in car
• Strong focus on innovation. manufacturing.
 • Growth through takeovers and mergers.

Weaknesses Threats

• Poor record on product recalls. • Rising raw material and labour costs.
• High cost structure. • Intense competition.
• Weak position in the rapidly • Increasing regulation by laws:
growing Indian market. • effects of Brexit
• sharp decline in demand for vehicles with
diesel engines.
Table 25.4 SWOT analysis for Ford Motor Company
Source: Adapted from The Telegraph, 2 September 2018

Questions
1 Explain the possible influences on Ford’s mission statement.
(5 marks)
2 Analyse the ways in which its SWOT analysis might help Ford to make more
effective decisions in the future.
(9 marks)
3 Do you think that factors from its external environment were the most important
influence on Ford’s strategic decisions? Justify your opinion.
(16 marks)

(d) Essays
1 To what extent do you think that short-termism is the most important influence on
setting corporate objectives for public limited companies in the UK?
(25 marks)
2 ‘SWOT analysis is simple and inexpensive and therefore only of value to small
businesses.’ To what extent do you agree with this statement?
(25 marks)
Chapter 26 Analysing internal position:
financial ratio analysis
Introduction
This chapter investigates how stakeholders can assess the strengths and weaknesses of a
business’s existing financial position by analysing financial statements such as balance sheets
and income statements. We examine the structure and components of balance sheets and income
statements and the key indicators of financial performance that can be seen within them. We also
consider how a range of financial ratios can be used to assess business performance. Finally, we
discuss the value of financial ratios in judging a business’s performance.
What it is important to know by the end of this chapter:
• how to assess the financial performance of a business using balance sheets, income statements
and financial ratios, including profitability, liquidity, gearing and efficiency ratios
• the value of financial ratios when assessing a business’s performance over time or in
comparison with other businesses.
Financial statements
Businesses in the UK produce a range of financial information to assist stakeholders in assessing
their performance and to inform decision making. This information is presented in a range of
financial statements of which we shall consider two:
• balance sheets
• income statements.
The information these contain is important for stakeholders when judging the performance of a
business.

Figure 26.1 Stakeholders and financial information

How to analyse balance sheets
What is a balance sheet?
A balance sheet 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. The balance sheet represents
a picture of a business’s 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, balance sheets always
carry a date, the day on which the valuation of assets and liabilities took place.

Key terms
Assets are items owned by a business, such as cash in the bank, vehicles and
property.
Liabilities represent money owed by a business to individuals, suppliers, financial
institutions and shareholders.
A statement of financial position is an alternative name for the balance sheet which
was introduced in 2009, but is only used by some businesses currently.
A consolidated balance sheet is the total balance sheet for a business, including all
its divisions.

In 2009 the International Accounting Standards Board (IASB) – the organisation which oversees
accounting practices worldwide – proposed renaming balance sheets as ‘statements of financial
position’. Unlike many other changes introduced by the IASB, this change has not been adopted
universally. Many major UK public companies continue to use the term ‘balance sheet’ in their
annual accounts and we shall use it throughout this chapter.
By recording assets and liabilities the balance sheet sets out the ways in which the business has
raised its capital and the uses to which this capital has been put. The balance sheet provides a
great deal of information for those with an interest in a business, and is the primary financial
document published by businesses.
Balance sheets can relate to a single enterprise or to several, in which case they are referred to as
consolidated balance sheets. Balance sheets are an essential source of information for a variety
of business decisions and for a number of stakeholders.

Key balance sheet relationships

1. Assets = liabilities
This is the fundamental relationship that helps to explain why the balance sheet
‘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

• Shareholders (and potential shareholders) may use balance sheets to assess a business’s
potential to generate good returns in the future. Thus, they may examine the extent and type of
assets available to a business. A high proportion of assets, such as machinery and property,
may signify a potential for profit, depending upon the type of business.
• Suppliers are more likely to use a balance sheet to investigate the short-term position of the
company. Thus, they may consider cash and other liquid assets a business holds and make a
judgement about whether the business is likely to be able to pay its bills over the coming
months. This may help a supplier reach a decision on whether or not to offer credit to the
business in question.
• Managers will be interested in a balance sheet as an indication of the performance of the
business. Thus, they may extract information to help them reach a decision on how to raise
further capital for future investment. The amount of existing loans may be one factor
influencing this decision.
The precise information drawn from the balance sheet will depend upon the stakeholder and the
nature of their enquiry. However, it is important to appreciate that this particular financial
statement contains a great deal of information.
Assets
An asset is something that a business owns. Assets are what a business purchases with its capital.
There are two main categories of assets that appear on a business’s balance sheet. 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 not purchased 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
balance sheet is drawn up. Therefore, cash and inventories are examples of current assets as
they are only retained by the business for a relatively short period of time. Another category
of current asset is receivables (sometimes termed ‘trade and other receivables’ to indicate
different types of debtors). These are debts owed to the business in question due for payment
within 12 months and so will become cash within one year.
There is another way to classify assets which, although it does not affect the balance sheet
directly, is still important to understand.
1. Tangible assets. These are assets that have a physical existence and have been traditionally
included on a balance sheet. Tangible assets include:
• land and property, which are frequently the most valuable assets owned by a business
• machinery and equipment, a tangible asset that is likely to be of importance to
manufacturing industries.
2. Intangible assets. These assets do not take a physical form. Examples include:
• Patents and other rights. Apple holds substantial assets on its balance sheet of which a
proportion represent the value of its patents.
• Goodwill. This is the value of established custom and a good name to a business.
• Brands. These can be included on a balance sheet if they were purchased or can be
separately valued. It has been estimated that 80 per cent of the worth of companies such as
Coca-Cola and Marlboro comprise of intangible assets. However, the value of brands can
fluctuate.
Intangible assets are only recorded on the balance sheet if they can be separately identified and
money was spent upon their acquisition. For example, it would be appropriate for mobile phone
companies to present their licences to supply services (sold to them by the government) as
intangible assets.
Liabilities
A liability is a debt owed by the business to organisations or individuals. Another way of
thinking of 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:
1. Current liabilities. In many senses these are the equivalent of current assets and are
payments due within a relatively short period of time, normally one year. They represent
debts owed by the business due for payment within one year or less. Examples of such short-
term debt are overdrafts and tax due for payment. Trade and other payables (which is money
owed to suppliers and other organisations) are another category of payments that will be made
within 12 months.
2. 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 several years are common
examples of this type of liability.
3. Total 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 ceases trading,
shareholders would hope for the repayment of their investment. Thus, these funds (called total
equity or total shareholders’ equity) are liabilities.
Net assets
It is possible to calculate a business’s net assets (sometimes called ‘net assets employed’) by
totalling the business’s assets and subtracting the business’s total liabilities. Thus:
Net assets = (non-current assets + current assets) – (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 a business if all its assets were sold and all its liabilities were paid.

Business in focus: Household balance sheets

Figure 26.2a UK household debt as a percentage of income 2005–2023

Figure 26.2b UK household net worth as a percentage of income 2008–2023

Just like companies, households can have balance sheets. Households own assets
and have liabilities. The difference between the value of households’ assets and
liabilities gives a value for their financial net worth. Household net worth is equal to
financial net worth plus the value of households’ physical assets.
Average pay in the UK has barely risen since 2008 in real terms (i.e. once inflation
has been taken into account). This is one reason that explains why household debt
fell as a proportion of income over the period 2008 to 2016.

Practice questions
1 Describe the major assets and liabilities that a UK household might have.
(3 marks)
2 Do you think that it does not matter if households in the UK increase the amount of
borrowing (or debt) they have in relation to their incomes as forecast in Figure
26.2a? Justify your decision.
(16 marks)
Why does a balance sheet always balance?
The balance sheet is well named as at all times the assets held by a business must match its
liabilities (including capital borrowed from its owners). Why is this the case?
First, there exists what accountants call the ‘dual aspect’ of constructing a balance sheet. Thus,
any transaction that is recorded on the balance sheet has two effects that cancel out each other.
The following examples highlight this point:
• If a business borrows £575,000 to purchase vehicles, the loan will appear as a liability as it is
owed by the business to a bank or other financial institution. However, at the same time, the
business will have additional assets recorded on its balance sheet (in this case vehicles initially
valued at £575,000). Thus, this transaction will not cause the balance sheet to become
unbalanced.
• Alternatively, the business might sell a non-current asset for cash. In this case the business will
have non-current assets of a lower value, but its holdings of cash will rise by the same amount.
In these circumstances the value of total assets is unchanged and the balance sheet still
balances.
Another feature of the balance sheet that ensures that it continues to balance is reserves. Reserves
are simply profit accumulated during 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 is invested into a range
of assets that are useful to the business and hopefully generate further profits. If a business is
successful, purchases more assets and grows, then its value will increase and so will the value of
the assets. It may borrow money to achieve this growth; if it does, liabilities will grow at the
same rate. However, if it funds its growth through profits, then the matching liability will be
recorded as reserves, indicating that the owners’ stake in the business has risen in value.
Remember that the total equity on the balance sheet represents money lent to the organisation.

Figure 26.3 Assets, liabilities and reserves

The structure of a balance sheet
The precise layout of balance sheets can vary a little according to the type of business, although
the structure is similar for all businesses. All balance sheets list assets first – non-current
followed by current assets. Next, current liabilities are normally recorded, allowing a firm to
calculate its working capital (simply current assets less current liabilities). Finally, the last
section records the sources of finance both borrowed and provided by the owners.
Reading and interpreting balance sheets
Professional managers, potential investors and accountants can gain a great deal of information
about a company from reading its balance sheet. In this section we consider two balance sheets
of Ted Baker plc to illustrate the uses of this financial statement. Ted Baker plc is a fashion
retailer which sells clothing and accessories for men and women through its own shops and
concessions in other stores.
2018 £000s 2017 £000s
Non-current assets
Intangible non-current assets 34,373 24,445
Tangible non-current assets 145,435 151,098
179,808 175,543
Current assets
Inventories 187,227 158,500
Trade and other receivables 64,273 59,251
Cash and other current assets 17,856 31,028
269,356 248,779
Current liabilities
Trade and other payables (82,858) (80,995)
Overdraft (76,043) (58,074)
Tax payable (8,522) (10,327)
Other current liabilities (9,418) (7,531)
(176,841) (156,927)
Net current assets 92,515 91,852
Non-current liabilities
Payments due in over 1 year (48,273) (56,851)
(48,273) (56,851)
Net assets 224,050 210,544
Equity
Share capital 12,711 12,143
Reserves and retained earnings 211,339 198,401
Total equity 224,050 210,544
Table 26.1 Ted Baker plc balance sheet as at January 27th 2018 and January 27th, 2017
(summarised)
Source: Adapted from Ted Baker plc’s Annual Report & Accounts, 2017-18

Figure 26.4 The basic structure of a public company’s balance sheet

There are a number of features on the balance sheet that are worth examining when assessing the
performance of the business in question. It is possible to make some assessment of the short-term
financial position of the business as well as its longer term strategy from reading the balance
sheet.
The short term
Assessing a business’s short-term situation entails examining its ability to pay its bills over the
next 12 months. The balance sheet sets out a business’s short-term debts (current liabilities) and
also the current assets it has available to pay these creditors. The net position of these two factors
is recorded as net current assets/liabilities. If assets are greater than liabilities, the figure resulting
will be referred to as net current assets. It will be called net current liabilities if current liabilities
are greater.
The balance between current assets and current liabilities is also known as working capital. If a
business has more current assets than current liabilities, it has a positive figure for working
capital and should be able to pay its debts in the short term. However, if current liabilities exceed
current assets, this may cause liquidity or cash problems, depending upon the type of business.

Handling data
Assume that in 2018 Ted Baker plc’s balance sheet revealed a net current liability
figure of £92,250,000 and that its total current assets were unchanged at
£269,356,000.
Calculate the level of current liabilities that would be necessary to create this
situation.
The long term
A business’s balance sheet can be examined in a number of ways:
• Movement of non-current assets: a sudden increase in non-current assets may indicate a
rapidly growing company, which may mean that the company’s financial performance might
improve over the medium term.
• Considering how a business has raised its capital may also be valuable. As we shall see in
Chapter 27, it is risky for a company to borrow too much. Thus, a company raising more
through borrowing (non-current liabilities) than through share capital and reserves might be
vulnerable to rises in interest rates.
• Reserves provide an indication of the profits earned by the business. A rapid increase in
reserves is likely to reflect a healthy position with regard to profits.
• The overall value of the business. It may be a good sign if the business’s value – measured, for
example, by its net assets – has increased. If the business has achieved this without borrowing
heavily, it may be regarded as a positive development.

Business in focus: Ted Baker plc (1)

Table 26.1 shows Ted Baker plc’s balance sheet. The latest year (2018) is shown in
the left-hand column. This method of presenting the latest data on the left is common
in company’s financial statements. Negative figures are shown in brackets.
We can see from the company’s balance sheet that it operates with net current assets
in both trading years. However, 2018 has a marginally larger figure for net current
assets than 2017 – £92.52 million compared to £91.85 million. This shows us that Ted
Baker plc’s current assets exceeded its current liabilities by a greater amount in 2018,
but the change was slight. The company not only had sufficient short-term assets to
cover its short-term liabilities, but it held an increasing surplus of short-term assets.
This is relatively unusual for retailers. They can rely on customers spending large
amounts of cash daily in their shops, thus providing funds to settle short-term
liabilities. Hence, some only hold relatively small amounts of current assets. It is
noticeable that this slight improvement occurred despite the amount of cash and other
assets held by the company falling sharply to just £17.9 million. Holding large
amounts of cash is unlikely to earn much return for a business, but it does provide it
with security in that it can cover short-term liabilities.
Another noteworthy feature of Ted Baker plc’s balance sheet is that the company has
relatively low levels of long-term borrowing, around £48 million in 2018 having fallen
from £56 million in 2017. The company’s profits rose strongly in 2018 providing it with
the opportunity to repay some of its long-term debt. At the same time, the company’s
value has increased substantially, primarily because of a rise in the value of the
company’s intangible assets. This was the result of the company developing
computer systems for use in its forthcoming e-commerce operations that have
considerable value.
Practice questions
1 Analyse what other information a shareholder interested in investing in the
company would need to make an informed decision.
(9 marks)
2 Do you think that Ted Baker plc’s balance sheet was stronger in 2017 or 2018?
Justify your decision.
(16 marks)
Working capital
What is working capital?
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.

Key terms
Working capital is current assets minus current liabilities.
Capital is the money invested into a business and is used to purchase a range of
assets including machinery and inventories.
Mortgages are long-term loans, repaid over periods of up to 50 years, used to
purchase property.
Debentures are loans with fixed interest rates which are long term and may not even
have a repayment date.

Working capital is what remains of a business’s short-term assets once it has settled all its
immediate debts. It is possible to calculate the working capital of a business from its balance
sheet by using the following formula:
Working capital = current assets – current liabilities
On a balance sheet working capital may be labelled as net current assets, as would be the case for
Ted Baker plc in 2017 and 2018. However, if current liabilities are greater than current assets,
then it will be labelled as net current liabilities and the figure will be in brackets.

Figure 26.5 A business’s capital

The right amount of working capital

It is simple to argue that a business should hold large amounts of working capital to ensure it can
always pay its debts in the short term and has spare assets in a liquid form (cash and trade and
other receivables, for example). However, holding excessive amounts of working capital is not
wise. The nature of liquid assets, such as cash and trade and other receivables, means that they
earn little or no return for the business. Therefore, a well-managed business will hold sufficient
liquid assets to meet its need for working capital, but will avoid having too many assets in such
an unprofitable form.
A number of factors can influence the amount of working capital a firm needs to hold.
• The volume of sales. A firm with a high level of sales will need to purchase more raw
materials, pay a greater amount of wages and so on. Therefore, its need for working capital
will be correspondingly higher.
• The amount of trade credit offered by the business. If a firm offers customers a lengthy
period of time before they are required to pay, this increases the business’s requirement for
working capital. In effect, companies allowing trade credit offer their customers an interest-
free loan.
• Whether or not the firm is growing. In a period of growth, working capital requirements are
likely to rise as the business purchases more fuel and raw materials. If a business expands
without arranging the necessary working capital, it is described as overtrading.
• The length of the operating cycle. The operating cycle is the amount of time that elapses
between the firm first paying for raw materials and receiving payment from customers. Some
manufacturing industries (e.g. shipbuilding) have long operating cycles and a correspondingly
greater need for working capital.
• The rate of inflation. When prices rise rapidly, firms require greater amounts of working
capital to fund the increased costs of wages, components and raw materials.
As a rough guide, a firm holding current assets of twice the value of current liabilities would
normally have sufficient working capital, although in recent years it has become common for
businesses to operate with fewer current assets. It is also important for a business to have a
significant proportion of its working capital in the form of cash. Cash, the most liquid of assets,
is essential to pay the most immediate of bills.

Figure 26.6 Working capital

Depreciation
It is important for stakeholders analysing a business’s balance sheet (as well as its income
statement) to understand the meaning and implications of depreciation.

Key term
Depreciation is the reduction of the value of an asset over a period of time.

What is depreciation?
Depreciation is the reduction of the value of an asset over a period of time. Thus, a company may
purchase production line equipment at a cost of £80,000 in early January 2019 and expect that
this equipment will last for four years and have no resale value. Therefore, the value of the asset
falls by £20,000 each year, reflecting its decline in value. The amount of the decline in value (i.e.
depreciation) is shown as an expense on the company’s income statement. The process over the
four years of the asset’s life is shown in Table 26.2.
Year Value of asset recorded on balance sheet at end of Amount
financial year (31 December) depreciated
annually
2019 £60,000 £20,000
2020 £40,000 £20,000
2021 £20,000 £20,000
2022 £0 £20,000
Table 26.2 An example of depreciating assets

Handling data
Recalculate the data in Table 26.2, assuming that the asset in question is depreciated
over a five-year period, rather than over four years. All other factors remain the same.

Why do firms depreciate assets?

Firms have to depreciate their non-current assets for a number of reasons. One of these is to
spread the cost of an asset over its useful life. In the case of the company investing £80,000 in
production line equipment, it would have been incorrect to show the value of the 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 availability of more modern equipment would mean that the desirability of this ‘older’ style
equipment would lessen
• poor or inadequate maintenance of the equipment may mean expensive repairs are necessary,
further reducing the equipment’s value.
Thus, reducing the value of an asset in line with these factors ensures that the value of the
business recorded on the balance sheet 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.
The company in Table 26.2 would have overstated its costs in 2019 if it had allocated the entire
cost of its new production line 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 as an expense on the company’s income statement. This helps to gain an
accurate view of the profitability (or otherwise) of the business over the lifetime of the
production line equipment.

Figure 26.7 Depreciation – a link between the balance sheet and the income statement
How to analyse income statements
The role of profit
At its simplest, profit is what remains from revenue once costs have been deducted. Profit is one
of the most commonly used words in business and is important for a number of reasons. It acts as
a signal to attract new businesses into a market and to encourage an existing business to grow.
The pursuit of profit is an important business objective.
However, some businesses (e.g. charities and mutual organisations) do not aim to make profits
and profits that impose high social costs on others may not be highly valued. Businesses that
generate high profits through polluting the environment or hiring sweatshop labour in less-
developed countries may attract criticism and lose sales in the long run.
Due to increased public awareness of ethical and environmental issues, many businesses are
taking a long-term view of profit. They may be prepared to incur higher costs in the short term
(through using more expensive materials from sustainable sources, for example) to maintain a
positive corporate image and higher profits in the long term.
Profits and the income statement
However, in the construction of the income statement there are two main types of profit
identified:
• Gross profit. This form of profit is calculated by deducting direct costs (such as materials and
shop-floor labour) from a business’s sales revenue. This gives a broad indication of the
financial performance of the business without taking into account other costs such as
overheads.
• Net profit. This is a further refinement of the concept of profit and is revenue less direct costs
and indirect costs (or overheads) such as rent and rates, as well as interest payments and
depreciation. This gives a better indication of the performance of a business over a period of
time as it takes into account all costs incurred by a firm over a trading period.
Net profit can take a number of forms.
• Trading or operating profit. This type of profit takes into account all earnings from regular
trading activities and all the costs associated with those activities. However, this form of profit
excludes any income received from, or costs incurred by, activities that are unlikely to be
repeated in future financial years.
• Net profit before tax. This is a business’s trading or operating profit plus any profits from one-
off activities.
• Net profit after tax. This is the amount left to the business once corporation tax (or income tax
in the case of a sole trader or partnership) has been deducted. This is an important form of
profit. There are no more charges on this profit and the managers of the business can decide
what to do with it.

Key term
A loss is a situation where a business’s expenditure exceeds its revenue over a
specific trading period.
The quality of profit
It may seem strange, but some profits are better than others. Firms regard profit that is likely to
continue into the future as high-quality profit. Thus, if a business introduces a new product onto
the market and it immediately begins to generate a surplus and looks to have a promising future,
then this will be high-quality profit. In contrast profits may be poor quality. Total, the French oil
company, announced in 2018 that it intends to sell non-current assets valued at $1.1 billion. If
sold at a profit, this may have added to the company’s overall net profit figure for the year.
However, this form of profit will not continue into the future and is therefore low-quality profit.

Business in focus: Tesco’s profit scandal

Tesco plc, the world’s third biggest retailer, is involved in a scandal resulting from its
misreporting of profits. An investigation has revealed that the company overstated its
profits by £263 million in 2014. An investigation by the accountancy firm Deloitte
found that Tesco had been including the revenues received from sales promotions too
early in its accounts and pushing back the date at which costs were recorded. The net
effect was to increase the company’s profits – on paper.
The company made a statement to the London Stock Exchange in which said it had
‘identified an overstatement of its expected profit for the half year, principally due to
the accelerated recognition of commercial income and delayed accrual of costs’. One
outcome of the scandal has been a sharp fall in the company’s share price. Tesco’s
shares fell by almost 9 per cent in value to 209p, their lowest figure since 2003.
Tesco had suspended eight of its senior managers while an enquiry is held into the
company’s accountancy practices. In December 2018, two of the directors were
acquitted following a trial; a decision was outstanding on whether to try a third
director. However, the scandal posed another threat to the company at a time when it
is facing severe competition in the UK grocery market from price discounters such as
Aldi.

Practice questions
1 Analyse why is it important for Tesco to report its profits accurately.
(9 marks)
2 To what extent will all of Tesco’s stakeholders suffer as a consequence of this
misreporting of its profits?
(16 marks)

The amount of trading or operating profit earned by a firm is more likely to represent high-
quality profit as it excludes any one-off items. This level of profit might reasonably be expected
to continue into the future, depending upon market conditions. Shareholders are interested in
profit quality as it gives some indication of the company’s potential to pay dividends in the
future.
The structure of the income statement
Figure 26.8 provides an initial guide to the structure of the income statement as presented by
most companies.
The income statement comprises calculations involving four stages:
1. First, ‘gross profit’ is calculated. This is the difference between the revenue figure (this can be
called sales revenue or turnover) and the cost of the goods that have been sold. The latter is
normally expressed simply as ‘cost of sales’. This element of the income statement is
sometimes called the trading account.
2. Second, ‘operating profit’ is calculated by deducting the main types of overheads such as
distribution costs and administration costs.
3. Next, profit before taxation is calculated, which is arrived at by including interest received by
the business and interest paid by it. These are normally shown together as a net figure labelled
‘financing costs’.
4. The final stage of the income statement is to calculate profit after taxation. This is arrived at
by deducting the amount of tax payable for the year, and shows the net amount that has been
earned for the shareholders. At this stage the company may indicate which profits are from
continuing operations (those parts of the business that will be trading in the future) and which
are from discontinuing operations.
Group income statements
During the last 25 years, many companies have been taken over by other companies to form
groups. Each company within such a group retains its separate legal identity, but the group is
also legally obliged to produce a group income statement (and balance sheet). A group income
statement simply records the aggregated position of the group as a whole.
An example of an organisation producing consolidated accounts is The Kingfisher Group (which
owns companies such as B&Q and Screwfix). It is quite likely that the accounts of any large
organisations you examine will be group accounts, including Ted Baker plc (see Table 26.3).

Figure 26.8 The basic structure of the income statement

Income statements and the law
The legal requirements relating to income statements are set out in the Companies Act 2006.
This legislation demands the production of financial statements, including an income statement.
It also specifies the information to be included in these accounts. Companies do not seek to
reveal more information about themselves than they need to.
Public limited companies provide information on earnings per share on their income statements.
Earnings per share are simply the company’s profits after tax divided by the number of shares the
company has. Diluted earnings per share gives a slightly lower figure as it takes into account all
possible shares that could be issued by the company at that time, that is those issued plus those
due to be issued as part of a share option scheme, for example.
The income statement does not have to detail every expense incurred by the firm, but
summarises the main items under standard headings. The Act sets out acceptable formats for
presentation of the relevant data. A summarised form of one of these is shown for Ted Baker plc
in Table 26.3.
The notes to the income statements must disclose details of:
• auditor’s fees paid for verifying the accuracy of the accounts
• depreciation amounts
• the total of directors’ emoluments (earnings)
• the average number of employees, together with details of the cost of wages and salaries,
national insurance and pensions payments.
Companies must disclose the following:
• Exceptional items are large (usually one-off) financial transactions arising from ordinary
trading activities. However, they may be so large as to risk distorting the company’s income
statement. Ted Baker plc’s income statement in Table 26.3 contains examples of exceptional
costs in both 2017 and 2018. The exceptional items in 2018 relate, in part, to the costs of
restructuring part of the business.
• Extraordinary items are large transactions outside the normal trading activities of a business.
As a result they are not expected to recur. A typical example is the closure of a factory or
division of a business. These items have only been included in income statements over recent
years.
52 weeks ended 27th 52 weeks ended 28th
January 2018 £000s January 2017 £000s
Revenue 591,670 530,986
Cost of sales (230,865) (207,257)
Gross profit 360,805 323,729
Administrative & other (307,480) (273,811)
expenses
Exceptional costs (4,676) (4,513)
Licence income 22,078 17,092
Operating profit 70,727 62,497
Profit from joint 574 550
ventures
Finance income 802 1,597
Finance expenses (3,314) (3,373)
Profit before tax 68,789 61,271
Taxation (16,045) (14,703)
Profit for the year 52,744 46,568
Earnings per share (pence)
Basic 119.0p 105.7p
Diluted 118.3p 104.5p
Table 26.3 Ted Baker plc income statement for 2018 and 2017 (summarised)
Source: Adapted from Ted Baker plc’s Annual Report & Accounts, 2017–18
There is no single format for a limited company’s income statement. The Companies Act of 2006
sets out the minimum amount of information that must be included, though some modification
can be made to ensure a ‘true and fair view’ of the business’s performance.
Interpreting income statements
A number of groups are likely to have an interest in a business’s income statement. These
stakeholders are illustrated in Figure 26.9.

Figure 26.9 Some groups with an interest in income statements

• Shareholders are perhaps the most obvious group with an interest in the income statement.
Shareholders will be interested in a business’s sales revenue and operating or net profit. This
will provide some guidance as to the performance of the enterprise, especially when compared
with previous years. Shareholders will also be likely to examine how profits have been
utilised. Some may seek the maximum dividend possible (an example of short-termism), while
others may be interested in a longer term return and welcome substantial reinvestment in the
expectation of future profits.
• Managers use the income statement as an important source of information regarding the
performance of the business. Managers are, of course, able to see the income statement in
much more detail than that provided in the annual report and accounts. (Published accounts
contain the minimum amount of information required under law to avoid giving competitors
any advantage.) Managers will monitor sales performance through turnover figures and judge
costs against sales revenue. If expenses and cost of sales rise by a greater amount than revenue,
action may be necessary. Managers will also consider carefully the effects of one-off items on
the account.
• Employees may be interested in profits after tax if their pay is related to company performance
through a profit-related pay scheme. They may also be interested in the level of dividends if
they are shareholders. The level of profits after taxation may also be an indication of the
company’s ability to fund a pay increase or, alternatively, of the security of their employment.
• HM Revenue and Customs is the organisation responsible for collecting corporation tax from
companies on the government’s behalf. HMRC will therefore scrutinise company accounts and
use net profit before tax as the basis for their calculation of tax liability (the amount of tax to
be paid). They may also check that the income statement meets all necessary standards (for
 example, the basis upon which non-current assets have been depreciated).

Business in focus: Ted Baker plc (2)

Table 26.3 shows Ted Baker plc’s income statements for 2016–17 and 2017–18. Ted
Baker is known for its quirky fashion clothing and in 2017–18, the company’s sales
increased by approximately 11.5 per cent compared with the previous financial year.
The company’s profits before tax rose by 12.3 per cent over the year.
The company’s sales were boosted by rapidly increasing sales on the internet. Its e-
commerce business increased by nearly 40 per cent per cent to £101.1 million (in
2017 it was £72.3 million). The company operates stores in numerous countries
overseas including the United States. Ted Baker plc has made significant efforts to
improve its operational efficiency including use of the latest technology (supplied by
Microsoft) opening a single new distribution centre in the UK to handle its entire
European operations.
Source of data: Ted Baker plc’s Annual Report & Accounts, 2017–18

Practice questions
1 Analyse the likely reactions of two of Ted Baker plc’s stakeholders to the
information in its income statement for 2017–18.
(9 marks)
2 Do you think that the effective use of e-commerce and the internet is likely to be
the most important factor determining the success of retailers in the future? Justify
your view.
(16 marks)
Window dressing balance sheets and income
statements
Most businesses, and 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.

Key term
Window dressing is the preparation of financial statements to present the company’s
performance in the best possible light.

• Some companies borrow money for a short period of time to improve their cash position just
before the date on which the balance sheet is drawn up. This action may enhance the
company’s apparent ability to pay its short-term debts.
• An alternative method of improving a company’s cash or liquidity position is through the use
of sale and leaseback. This entails the sale of major non-current assets and then leasing them
back. Many retailers have negotiated sale and leaseback deals on their high-street properties.
• Businesses may maintain the value of intangible assets on the balance sheet at what might be
excessive levels to increase the overall value of the organisation. This tactic is only possible
when the assets in question (for example, goodwill or brands) have been purchased.
• Capitalising expenditure, which means including as non-current assets items that might
otherwise have simply been regarded as an expense and not included on the balance sheet.
Thus, a firm might spend heavily on computer software and include this as a fixed asset on the
basis that it will have a useful life of several years. This action will increase the value of the
business.
• On income statements businesses may bring forward sales to an earlier period and thereby
boost revenue for a particular financial year. This does result, however, in a lower figure in the
next financial year. This was part of the issue involved in the financial scandal faced by Tesco
and covered on page 351.
There is a fine line between presenting accounts as favourably as possible and misrepresenting
the performance of the firm, which is illegal. The authorities have made several adjustments to
accountancy procedures in order to restrict the extent of window dressing.
Using financial ratios to assess the internal
position of a business
We have considered how stakeholders might analyse a business’s financial statements to judge
its performance. Ratio analysis allows stakeholders to take this analysis a step further.

Key term
Ratio analysis is a technique for analysing a business’s financial performance by
comparing one piece of accounting information with another.
What is a ratio?
A comparison of the financial performance of two companies in 2018 can illustrate the
advantages of using two pieces of data to make more in-depth and informed judgements. BP is
multinational oil company which extracts, refines and sells oil products. In 2018, it announced an
operating profit of £7,177 million for the year. In comparison, easyJet, one of the UK’s best-
known budget airlines, turned in an operating profit of £408 million in 2018. A simple
judgement would therefore suggest that BP plc had performed more successfully. However, if
we took into account the value of sales achieved by the two companies (their revenue), a more
meaningful judgement could be made.
Table 26.4 shows that when we compare profit for the year with revenue, easyJet’s performance
could be judged superior to that of BP. easyJet earned over 8 pence of profit from each £1 of
sales, while BP only made just under 4 pence of profit on each £1 of sales. Using this ratio
(which is called the operating profit margin and was explored in Chapter 17) it is possible to
make a more accurate judgement than simply comparing levels of profit.
Ratio analysis allows managers, directors, shareholders and other interested parties to place key
figures such as profits and turnover in context. The use of ratio analysis does not guarantee that a
manager or shareholder will make a correct decision. The results of ratio analysis do, however,
give decision makers more information and make a good quality decision more likely.
Company Operating profit Revenue Operating profit as a % of
(£m) (£m) revenue
BP plc 7,177 181,976 3.94
easyJet 408 5,047 8.08
plc
Table 26.4 Comparing the financial performance of two companies by using a simple ratio
Source: BP’s and easyJet’s annual reports
Types of ratio
There are a number of ways of classifying ratios. One approach is to identify four main
categories of ratio.
1. Profitability ratios assess the amount of profit made by the business in relation to the capital
available to it or to other figures such as its revenue.
2. Liquidity ratios, also known as solvency ratios, measure the ability of the business to settle
its debts in the short term.
3. Gearing examines the relationship between internal and external sources of finance. It is
therefore concerned with the long-term financial position of the company.
4. Efficiency ratios measure the effectiveness with which an enterprise uses the resources
available to it. These are also termed internal control ratios.

Businesses and models: financial ratio analysis

Using financial ratios can help you to judge a business’s financial performance in a number of
ways. Their use allows you to judge its profitability, whether it has sufficient liquid assets (for
example, cash) and how efficiently it operates in financial terms. A ratio is most useful in
developing arguments when you compare it to something such as a previous figure, a standard
figure or the ratios for other businesses. You can use financial ratios to support arguments as
well as to back up judgements you might make – for example, what is the best way for a business
to raise capital for investment.
Type of ratio Profitability Liquidity Gearing Efficiency ratios
ratios ratios
Ratios used: Return on Current ratio Gearing – long- Payables days
capital term loans: Receivables days
employed capital employed Inventory turnover
Profit margins ratio
(studied in
Year 1)
Purpose of To provide a To assess the To assess the To provide
ratios: fundamental ability of the extent to which evidence on how
measure of the business to the business is well the managers
success of the pay its based on have controlled
business immediate borrowed money the business
debts
Interested Shareholders Creditors Shareholders Shareholders
stakeholders: Creditors Suppliers Managers Managers
Managers Managers Creditors Employees
Competitors Competitors
Employees
Table 26.5 Types of ratio, when they are used, to what purpose and by whom
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’s balance sheet and income statement.
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 following:
• The performance of the business over recent years. Having an understanding of the trends
of ratios over time can assist in making judgements. Thus, 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. Thus, an investor might calculate that a company’s
receivables 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.
• The economic environment. A decline in profit ratios might appear to reflect an unsuccessful
business. However, this might be more acceptable in the context of a severe economic
recession in which sales and prices have declined.
Expressing ratios
Ratios are normally expressed in one of three forms:
1. As a proper ratio – for example, the current ratio is 1.6:1.
2. As a percentage – return on capital employed (ROCE) expresses operating profit as a
percentage of capital employed by the business.
3. As a multiple – inventories are turned over (or sold) five times a year.
Profitability ratios
A business’s profits are the surplus of revenue over total costs for a trading period. Profitability
has a subtly different meaning: it compares a business’s level of profits to some other factor such
as the amount of capital used within the business or its sales revenue. 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.
In Chapter 17 we introduced the idea of and covered three types of profit margin:
• gross profit margin
• operating profit margin
• profit for the year margin.
This section builds on your understanding of these profit margins or profit ratios.

Return on capital employed (ROCE)

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 total equity
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 ROCE generated by a business.

Using this ratio

A typical ROCE may be expected to be in the range of 20–30 per cent. It is particularly
important to compare the results from calculating this ratio with the business’s ROCE in
previous years and also those achieved by its 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 of its long-
term borrowing, for example, its mortgage, while maintaining its profit.

Handling data
What level of operating profit would Tullow Oil have needed to make during 2017 to
achieve a ROCE figure to match that of Dunelm? A selection of ROCE figures are
shown in Table 26.6.
Liquidity ratios
Liquidity ratios allow managers and other interested parties to monitor a business’s cash
position. Even profitable businesses can experience problems with liquidity and may be unable
to pay their bills as they fall due. Liquidity ratios measure the liquid assets held by a firm (cash
and other assets such as receivables that are easily convertible into cash). The value of these
assets is then compared with the short-term debts or liabilities the business will incur. In this
way, stakeholders may evaluate whether the business’s performance may be harmed as a result
of liquidity problems. Managers can use a number of ratios to measure liquidity; we shall just
consider one, the current ratio.

Current ratio
This 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:

The current ratio is expressed in the form of a ratio, for example, 2:1. This example would mean
that the firm in question possessed £2 of current assets (cash, receivables and inventories) for
each £1 of current liabilities (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.

Using this ratio

For 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 (JIT) 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 and banks typically operate with lower ratios, whereas
some manufacturing firms may have higher ratios. Table 26.7 shows the current ratios of three
public companies.
Company Type of Date of Operating Total equity + ROCE
business accounts profit non-current
(loss) assets
Dunelm Retailer 30/06/2018 £96 m £315 m 30.48%
GlaxoSmithKline Pharmaceuticals 31/12/2017 £4,087 m £29,812 m 13.71%
Tullow Oil Oil and gas 31/12/2017 £22 m £9,674 m 0.23%
exploration
New Look Clothes retailer 12/06/2018 (£153 m) £1,903 m (8.04%)
Table 26.6 ROCE data for a selection of companies
Source: Companies’ annual reports
Notes: The returns here vary enormously. The most eye-catching figure is that of New Look. The
company’s financial position has been severely affected by decisions to target a different niche in the
market and to raise prices, compromising its reputation for value. Tullow Oil, also performed poorly, but
returned to profit after two years in which it made losses. The high profit level of Dunelm may be partly
due to its successful expansion strategy. GlaxoSmithKline has performed solidly; a comparison with
other pharmaceutical companies would provide an important insight into its performance.

Company Type of Date of balance Current Current Current

business sheet asset liabilities ratio
J Grocery retailing 10/03/2018 £7,866 m £10,302 m 0.76:1
Sainsbury
plc
Rolls Manufacturing 31/12/2017 £14,595 £10,925 m 1.34:1
Royce engines m
Rio Tinto Mining 31/12/2017 £19,712 £11,225 m 1.76:1
plc m
Table 26.7 Current ratios for a selection of companies
Source: Companies’ annual reports
Notes: J Sainsbury, a supermarket which can rely on many customers paying cash or using debit cards,
is able to operate successfully with lower levels of liquidity than Rolls-Royce, a manufacturer. The
results for Rio Tinto may reflect that the company holds relatively high levels of inventory.

Business in focus: easyJet’s performance

easyJet reported what it described as a ‘robust’ financial performance in 2017. The

company has benefited, along with other airlines, from increased numbers of people
travelling overseas from the UK. It has reduced ticket prices by about 7.8 per cent per
passenger as the cost of oil has fallen in global markets and, with increased
passenger numbers, its planes are fuller. In 2017, its planes operated with capacity
utilisation averaging 92.6 per cent. Its business model is heavily based on internet
bookings with customers paying at the time they book.
The airline has impressed analysts with its cost savings and the use of larger planes
to reduce the cost per passenger on its flights.
At the end of the 2017 financial year, easyJet held cash totalling £711 million, a
similar figure to that of 2016. This was despite the company investing in new A320
and A321neos aircraft as well as improving the technology it uses to communicate
with its customers.
Item 2017 2016 2015 2014
Revenue (£m) 5,047 4,669 4,686 4,527
Operating profit (£m) 404 498 688 581
Current assets (£m) 1,734 1,454 1,279 1,261
 Current liabilities (£m) 1,670 1,573 1,768 1,420
Table 26.8 Summary of easyJet’s financial performance, 2014–2017
Source: easyJet’s annual reports

Practice questions
1 Analyse the trend of easyJet’s liquidity position between 2014 and 2017.
(9 marks)
2 Do you think that liquidity is the most important measure of a business’s financial
performance? Justify your decision.
(16 marks)

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.
Firms can improve the current ratio by raising more cash through the sale of non-current assets
or the negotiation of long-term loans. (NB: raising more cash through short-term borrowing will
increase current liabilities, having little effect on the current ratio.)
Gearing
Gearing measures the long-term liquidity of a business. Under some classifications 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. The gearing ratio analyses how firms have raised their
long-term capital. The result of this calculation is expressed as a percentage.
There are two main forms of long-term finance available to businesses:
1. Non-current liabilities. This includes preference shares and debentures (both have fixed
interest payments) as well as long-term loans. This category of finance comprises long-term
borrowing and may be called loan capital.
2. Total equity. This arises from selling shares and increases in the value of the business.
The capital employed by a business is simply the total of these two. So the gearing ratio
measures the percentage of a firm’s capital that is borrowed.

This measure of a business’s performance is important because, by raising too high a proportion
of capital through fixed interest capital, firms become vulnerable to increases in interest rates.
Shareholders are also unlikely to be attracted to a business 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.
• A highly geared business has more than 50 per cent of its capital in the form of loans.
• A low-geared business has less long-term borrowing and a gearing figure below 50 per cent.
Much attention tends to be given to businesses that have high gearing and are vulnerable to
increases in interest rates. However, this may be considered acceptable in a business that is
growing quickly and generating high profits. Furthermore, a low-geared business may be
considered too cautious and not expanding as quickly as possible. Table 26.9 shows three public
companies with differing gearing ratios.

Using this ratio

The key yardstick is whether a business’s long-term borrowing is more than 50 per cent of
capital employed.
Companies with secure cash flows may raise more loan 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 these brands to increase long-term borrowing.
Firms can improve their gearing by repaying long-term loans, issuing more ordinary shares or
redeeming debentures.
Efficiency ratios
This group of ratios measures the effectiveness with which management controls the internal
operation of the business. They consider a number of aspects of the management of an
enterprise, including the following:
• How well inventories are managed.
• The efficiency of creditor control (how long before customers settle their accounts).
• The time taken by a business to settle its own debts.
There are a large number of ratios that fall under this heading, but we shall concentrate on just
three: inventory turnover ratio, receivables days and payables days.

Inventory turnover ratio

This ratio measures a company’s success in converting inventories into sales. The ratio compares
the value of inventories with sales achieved, valued at cost. This permits an effective comparison
with inventories, which are always 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.

In this form, the results of calculating this ratio are expressed as a number of times a year – in
this case, the number of times a business’s entire inventory is sold in a year. On 24 February
2018, Tesco held inventories valued at £2,263 million. During the company’s financial year,
which ended on that day, the company’s cost of sales (that is, the cost of buying its inventories)
was £64,141 million. The company’s inventories turnover ratio was therefore 28.34 times. Tesco
has improved this ratio in recent years, in part by holding lower levels of inventories.
The inventory turnover formula can be reorganised to express the number of days taken on
average to sell the business’s inventories.

Company Type of business Date of Non- Total equity + Gearing

balance current non-current
sheet liabilities liabilities
Sky plc TV broadcaster 30/06/2017 £9,041m £12,879m 70.20%
Sage Computer software 30/09/2017 £1,022m £2,190m 46.67%
Group
plc
Vodafone Telecommunications 31/03/2018 £37,980m £106,587m 35.63%
plc
Table 26.9 Gearing ratios of some leading companies
Source: Companies’ annual reports
Notes: These three companies are operating with a range of gearing ratios. Sky plc is heavily geared
partly due to its purchase of other European broadcasters, though it is now subject to takeover bids.
Vodafone’s gearing is significantly below the 50 per cent threshold, offering it the opportunity to engage
in further long-term borrowing. This is less true for the Sage Group which has limited scope for further
long-term borrowing.
Our Tesco calculation would then become £2,263 million x 365 ÷ £64,141 million, giving an
answer of 12.88 days. Thus, if Tesco sells its entire inventories every 13 days, it will sell its
inventories approximately 28 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 their entire inventories every two or three days –
about a hundred times a year. At the other extreme, an antiques shop 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 results in customer
dissatisfaction.
Improving the inventory or stock turnover ratio requires a business to hold lower levels of
inventories or to achieve higher sales without increasing levels of inventories.

Receivables days
This ratio (also referred to as receivables or debtors’ collection period) calculates the time
typically taken by a business to collect the money that it is owed. This is an important ratio, as
granting customers lengthy periods of credit may result in a business experiencing liquidity
problems. If a company has substantial cash sales, these should be excluded from the calculation.

Using this ratio

There is no standard figure for this ratio. In general, a lower 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’s 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.
This 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 debtors’ analysis. This technique
ranks a business’s debtors (the persons or businesses owing money to the organisation)
according to the period of credit taken. This allows managers to concentrate on persuading the
slowest payers to settle their accounts.
Payables days
This ratio (also referred to as payables or creditors’ collection period) calculates the time
typically taken by a business to pay the money it owes to its suppliers and other creditors. This is
an important ratio, as delaying payment for as long as possible can help a business to avoid
liquidity problems.

Using this ratio

Businesses can improve their liquidity position by delaying payment, but this may result in poor
relationships with suppliers who may themselves suffer liquidity problems as a result of the
delay in payment.
Businesses may be charged interest on delayed payments, which can add to costs and weaken a
business’s liquidity position.

Using receivable and payable days together

By comparing payable days and receivable days a business can assess its liquidity position. If
payable days is a lower figure, then it is more likely that the business will experience liquidity
problems as, on average, it is paying suppliers and other creditors more quickly than it is
receiving payment from its customers.
Item WM Morrison plc 04/02/2018 Glencore plc 31/12/2017
Receivables £250m £20,359m
Revenue £17,262m £205,476m
Receivables days 5.29 days 36.16 days
Payables £2,981m £28,826m
Cost of sales £16,629m £197,695m
Payables days 65.43 days 53.22 days
Table 26.10 Receivable days and payable days for two leading companies
Source: Companies’ annual reports
Notes: Morrison plc’s customers pay within just over 5 days (most will pay cash), while the supermarket
takes nearly 66 days to pay its own debts. Glencore plc, a multinational mining company, has more
similar payable and receivable days, although its payable days figure is higher.

Handling data
Look at the information in Table 26.10. Do you think that WM Morrison plc or
Glencore plc has a better financial position? Justify your decision.
The value and limitations of ratio analysis in
assessing performance
Ratio analysis provides stakeholders with an insight into the performance of a business.
However, to offer the maximum amount of information, the details gained from ratio analysis
need to be compared with other data, such as that outlined below:
• The results for the same business over previous years. This allows stakeholders to
appreciate the trend of the data. Thus, a low but steadily increasing figure for ROCE might be
reassuring to investors.
• The results of ratio analysis for other firms in the same industry. We have seen that results
expected from various ratios vary according to the type of business under investigation. Thus,
the inventory turnover ratio will be much higher for a retailer selling perishable products than
for a manufacturer. By comparing like-with-like a more informed judgement on the business’s
performance may be made.
• The results of ratios from firms in other industries. Stakeholders can compare the ratios of
a particular business with those from a wide range of businesses. This might allow, for
example, a comparison between two businesses experiencing rapid growth. The Centre for
Inter-Firm Comparisons offers anonymous data on the financial ratios of many UK firms.
A significant weakness of ratio analysis is that it only considers the financial aspects of a
business’s performance. While this is undeniably important, other elements of a business should
be taken into account when evaluating performance.
• 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 the return on capital employed (ROCE).
• The position of the firm within the market. A market leader might be expected to provide
better returns than 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.
• The quality of the workforce and management team. These are important factors in
assessing a business, but not ones that will be revealed directly through ratio analysis. Indeed,
a business that invests heavily 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 better
during periods of prosperity and to produce better results from ratio analysis. As the UK
economy has experienced falling rates of economic growth since 2016, it is reasonable to
expect the financial performance of many, but not all, businesses to deteriorate.

Business in focus: British Land plc

British Land plc is one of the largest property development companies in the UK. The
company owns a portfolio of land valued at £12.3 billion in 2018. This portfolio
includes the Meadowhall Shopping Centre in Sheffield and stores used by Tesco,
Sainsbury’s and Asda. In the 2017–2018 financial year it generated profits exceeding
£500 million.
The company announced it had a successful year in 2018. It leased four times as
much office space in London as in the previous year and was able to increase the
dividends paid to shareholders by 3 per cent compared to 2017.
Ratio 2018 2017
Gearing 25.77% 24.30%
Return on capital employed (ROCE) 3.91% 1.56%
Current ratio 1.25:1 1.22:1
Table 26.11 Key ratios for British Land plc, 2018 and 2017
Source: British Land Annual Report, 2018

Practice questions
1 Analyse the limitations of the data in Table 26.11 in assessing the performance of
British Land plc.
(9 marks)
2 Do you think that the limitations of ratio analysis mean that the information above is
of little value to the company’s stakeholders? Justify your view.
(16 marks)

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 What is the difference between an income statement and a balance sheet?
2 State two examples of current assets and two examples of current liabilities.
3 What is meant by the term ‘non-current liability’?
4 A business has the following information on its balance sheet:
Non-current assets = £250 million
Current assets = £30 million
Non-current liabilities = £180 million
Current liabilities = £20 million
Which of the following is its working capital?
a £10 million
b £70 million
 c £80 million
d £100 million
5 A business has the following information on its income statement:
Revenue = £155,000
Taxation = £3,000
Operating profit = £14,500
Cost of sales = £95,000
Which of the following is its gross profit?
a £152,000
b £57,000
c £71,500
d £60,000
6 What is the difference between an exceptional item and an extraordinary item on a
business’s income statement?
7 State two examples of efficiency ratios.
The following information is about XYZ Ltd and relates to questions 8 and 9.
Operating profit = £845,000
Total equity = £3,250,000
Current assets = £375,000
Revenue = £3 450,000
Current liabilities = £290,000
Non-current liabilities = £2,500,000
8 Which of the following is XYZ Ltd’s ROCE figure?
a 26.00%
b 14.70%
c 24.49%
d 33.80%
9 Which of the following is XYZ Ltd’s gearing figure?
a 72.46%
b 56.52%
c 230.00%
d 43.48%
10 State two items of data with which the results of ratio analysis can be usefully
compared.

(b) Short answer questions

1 Explain the difference between the net current assets and the net assets of a public
limited company.
(4 marks)
2 Explain two possible external factors that need to be taken into account when
conducting ratio analysis.
(5 marks)
3 Explain the possible benefits to a public limited company’s shareholders if it earns
‘high quality profit’ regularly.
(5 marks)
4 Explain two ways an investor considering buying shares worth £100,000 in one of
the UK’s major supermarkets might benefit from conducting ratio analysis before
making a decision to buy.
(6 marks)

(c) Data response question

Royal Mail
Royal Mail plc provides postal services throughout the UK and in 42 other countries.
The company was privatised (that is sold from the public sector to the private sector)
in October 2013.
Royal Mail operates in an increasingly competitive postal services market in the UK
and overseas. However, it has benefited from the rising popularity of online retailing
as this has resulted in rising demand for parcel delivery services. It faces what is
describes as ‘15 key competitors’ in the UK parcels delivery market. Many of these
companies operate low cost models to attract major customers. For example, they
employ workers on zero hours contracts and do not offer benefits such as sick pay.
However, Royal Mail has had significant success in cutting its costs, for example, by
closing its previous pension scheme in 2017 which is expected to save £600 million
each year. This decision led to a bitter dispute with employees but is likely to have
pleased the company’s shareholders.
Royal Mail is required by law to maintain the universal service. This guarantees that
letters can be sent to any location within the United Kingdom for a fixed price. Royal
Mail is legally obliged to continue to provide the universal service until at least 2021.
Some of its competitors can opt to operate in more profitable areas, especially large
cities.
The directors of Royal Mail are also concerned about the possible impact of Brexit on
the company, ‘While negotiations are ongoing and the future UK–EU relationship
remains unclear, it is not possible to predict with any degree of accuracy what impact
Brexit could have on Royal Mail Group.’
Item 25/03/2018 (£m) 26/03/2017 (£m)
Revenue 10,172 9,776
Operating profit 66 219
Profit for the year 258* 273
 Balance sheet
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
Total equity 4,436 4,998
* Royal Mail plc received a one-off payment as well as a tax credit from HMRC which is why its profit
for the year is greater than its operating profit.
Table 26.12 A selection of financial data for Royal Mail plc, 2017–2018
Source: Royal Mail’s annual report, 2018

Questions
1 Explain why the income statement is an important document for a stakeholder
wishing to assess the financial performance of Royal Mail plc.
(5 marks)
2 Analyse the strengths and weaknesses of Royal Mail plc’s performance in 2017
and 2018 using relevant financial ratios.
(9 marks)
3 Do you think that it is possible to assess Royal Mail plc’s likely future performance
on the basis of the results of financial ratio analysis? Justify your opinion.
(16 marks)

(d) Essays
1 To what extent do you think that profitability is the most important measure of
performance for the directors of a public company in the UK?
(25 marks)
2 ‘The results of financial ratio analysis are historical and therefore of little use to a
business’s stakeholders.’ To what extent do you agree with this statement?
(25 marks)
Chapter 27 Analysing internal position:
overall position
Introduction
This chapter is a natural development from Chapter 26 which investigated how financial data
may be analysed to assess a business. This chapter considers a range of non-financial
information that can be analysed by stakeholders to assess the existing internal position of a
business. We consider the operations, human resource and marketing data that is available to
interested parties, how it can be analysed over time, or in comparison to other businesses, and
what it can reveal about the performance of a business in both the short and long term. The
chapter also investigates the nature and importance of core competences to managers and other
stakeholders and the value of Kaplan and Norton’s Balanced Scorecard and Elkington’s Triple
Bottom Line in assessing the performance of businesses.
What it is important to know by the end of this chapter:
• how to analyse data other than financial statements to assess the strengths and weaknesses of a
business
• the importance of core competences
• how to assess short- and long-term business performance
• the value of different measures of assessing a business’s performance, including Kaplan and
Norton’s balanced scorecard model and Elkington’s triple bottom line.
Using non-financial data to assess
strengths and weaknesses
We saw in Chapter 25 that businesses can conduct SWOT analyses to identify their strengths and
weaknesses, as well as the future opportunities open to the business and the threats it may face.
Assessing strengths and weaknesses within a SWOT analysis considers a business’s current
position at the current time. Managers conducting SWOT analyses can consider a range of
internal evidence.
The analysis of big data is currently receiving a lot of attention in the media. ‘Big data’ is a term
used to describe large and complex sets of data that were not previously available to managers.
This data is increasingly used to help businesses devise strategies by enabling them to spot
trends, for example, in consumer behaviour, that may not have been apparent previously.
However, the increasing volume and variety of data available to managers can assist with other
aspects of decision making, including assessing a business’s strengths and weaknesses. This data
can relate to the business’s internal functions such as operations and marketing.
Operations data
Operations management (often termed ‘operations’) is an area of management concerned with
planning and controlling the production process within a business. A management team could
use a range of operations data to assess a business’s strengths and weaknesses. This data could
measure a number of aspects of a business’s operational performance including the following:
• productivity of labour and capital used in production
• measures of quality
• capacity utilisation.

Productivity as a measure of operational performance

Analysing a business’s productivity data allows stakeholders to measure the efficiency with
which an organisation converts inputs (of resources such as labour and capital) into outputs of
goods and services. Highly productive businesses use fewer inputs to produce a unit of output.
This is likely to allow it to produce a unit of output more cheaply, assuming it doesn’t pay
comparatively high costs for its inputs. As a consequence, its unit costs of production may be
lower than those of its rivals. This can represent a considerable competitive advantage for
businesses selling in price competitive markets and may be an important strength for such a
business.

Key terms
Productivity measures the quantity of inputs required to produce a unit of output.
Unit costs measure the cost per unit of output produced.

Figure 27.1 Measures of productivity

Much productivity data relates to a single input or resource – this is known as a single
productivity measure – and only measures output in terms of labour or capital. Fuller measures
of productivity measure output against all the inputs or resources used by the business and are
called multifactor productivity measures. This distinction is illustrated in Figure 27.1.
When measuring productivity to assess the strengths of a business’s operational performance, it
is important to bear a number of factors in mind.
• Multifactor productivity measures are preferable as they take into account all factors used in
production. Multifactor productivity measures the efficiency with which all factors of
production are used in the production process. Thus, it compares the volume of output over a
time period with the quantity of all factors used in production – that is capital and land, as well
as labour. It is relatively straightforward for managers to improve single factor productivity by
using less of it in production. For example, a manufacturing business could replace 50 per cent
of its labour with capital equipment in the production process. If output is unchanged, the
effect of this action will be to double labour productivity, but operational performance may not
have improved.
• Productivity data ignores costs. Rising productivity may be achieved alongside increased costs
of resources and the higher costs will offset the benefits of the productivity gains. For this
reason labour costs per unit may provide a better measure of operational performance.

Measuring quality
Quality can be a tricky concept to measure, though businesses do collect much data on customer
satisfaction. Quality may be judged by:
• measuring customer loyalty through the number of repeat customers
• measuring customer satisfaction rates through questionnaires or surveys
• measuring specific elements of operational performance such as the number of faulty products
(for manufacturers) or response times to customer queries (in service industries).
For example, companies engaged in supplying train services in the UK produce operational data
relating to punctuality as shown in Figure 27.2.

Capacity utilisation
The capacity of a business is the maximum amount it can produce using its existing resources.
Capacity utilisation measures existing output relative to the maximum figure. Using capacity
fully helps a business to produce its products as cheaply as possible and to offer competitive
prices.
This can be a vital measure of operational and, ultimately, overall performance for two reasons.
1. For some businesses (for example, cinemas) attracting additional customers involves few or
no additional costs but generates extra revenue. Thus, the impact on profits of high-capacity
utilisation is significant and this can be an important measure.
2. In price competitive industries (i.e. where demand is price elastic) operating at high levels of
capacity utilisation is a means of keeping unit costs low, enabling the business to maintain
acceptable profit margins whilst selling at low prices. The budget airline easyJet carried
83,639,260 passengers and achieved a capacity utilisation figure of 93.6 per cent on its
 aircraft between August 2017 and July 2018. The importance of this operations data to the
company is shown by the decision to make it available to its investors (and potential
investors) via its website.

Business in focus: The operational performance of UK train

companies

Network Rail Ltd is the owner and operator of most of Britain’s railway infrastructure –
that is its rail track, power supply, signals and stations. It produces data on the overall
operational performance of the rail industry in Britain as well as individual companies.
It uses a public performance measure (PPM), which shows the percentage of trains
that arrive at their terminating station on time. PPM combines figures for punctuality
and reliability into a single performance measure.
Network Rail itself causes some delays as some are due to infrastructure faults.
However, the PPM figure also includes external factors such as weather, trespass,
vandalism, cable theft, etc. These account for approximately 20 per cent of all delays
in UK train services.

Performance for 19 August to September 15, 2018

• The national PPM is 89.1 per cent.
• This compares to 89.4 per cent for the same period in 2017.
• The moving annual average (MAA) is 86.0 per cent. (Using a moving average
evens out short-term fluctuations in the data.)

Performance by train company

Table 27.1 below shows the average PPM for Britain as a whole and for a selection of
train operating companies.
Train company PPM August to PPM August to
September 2018 September 2017
London & North Eastern 86.0% 80.8%
Railway (LNER)
Virgin Trains West Coast 87.9% 88.0%
South Western Railway 79.9% 84.3%
Greater Anglia 91.3% 89.3%
Table 27.1 Performance data for a selection of Britain’s train operating companies
 Figure 27.2 Public performance data for the Britain’s rail industry, 2002–18

Source: Adapted from Network Rail’s website, www.networkrail.co.uk

Practice questions
1 Analyse the possible value to Network Rail Ltd resulting from collecting and
analysing this data.
(9 marks)
2 Do you think that the data in Table 27.1 is a good measure of the performance of
train companies? Justify your view.
(16 marks)

Handling data
Assume that easyJet’s capacity utilisation during the period August 2017 to July 2018
was 95 per cent. How many passengers would it have carried during the year?

However, as with most operational data, capacity utilisation has its weaknesses. For example, it
reveals nothing about the costs that a company is paying for its resources; it simply measures the
efficiency with which they are used. Thus, an airline such as easyJet may struggle to maintain
low prices, even with high levels of capacity utilisation on its planes, if other costs rise.
Other operational data
The operational data that stakeholders analyse to assess a business’s strengths or weaknesses will
vary according to the type of business under scrutiny. Key data for businesses, such as insurance
companies, which provide services might relate to customer satisfaction as measured, for
example, by speed of responding to and processing claims. In contrast, oil exploration companies
(BP, for example) will set great store by data on employee safety given the dangers of the
working environment for employees.

Figure 27.3 An offshore oil platform, a potentially dangerous working environment

One way in which businesses use technology, which is known as operational intelligence (OI), is
the extraction of data from operational activities and its rapid analysis. The results are used in
decision making to improve the organisation’s operational performance. The use of OI can assist
businesses in identifying and developing their operational strengths.
Human resources data
It is becoming increasingly important for human resources (HR) to use data, numbers and
statistics to show trends in a range of HR issues, such as employee efficiency and engagement.
Businesses have a range of HR data which can be analysed by interested parties to help make a
judgement about the strengths and performance of this particular function. This can provide
some insight into the business’s overall strengths, especially for labour intensive businesses. HR
data can take a number of forms including the following:
• labour productivity
• absenteeism rates
• health and safety data
• labour cost per unit of production
• costs associated with employees, such as average wages and recruitment costs
• labour turnover and retention.

Key term
Absenteeism occurs when an employee is not present at his or her place of work.

Financial measures of HR performance

Financial measures of HR performance are perhaps the most easily analysed and can provide
data in a form that is readily comparable. A business’s managers can normally calculate labour
cost per unit of output relatively easily and this is more informative than labour productivity
data. Labour productivity data measures the quantity produced per employee per time period, but
excludes the cost of labour, for example, the hourly wage rate. Unit labour cost includes wage
cost and productivity.
It is perfectly possible for managers and other interested parties to analyse labour cost per unit of
output over time and to make judgements about performance. Equally, comparisons can be made
between different divisions of a business (or different businesses if the data is available) using
this type of data to gain some idea of relative performance and to make judgements about
apparent strengths and weaknesses within the HR function. However, it is important to
appreciate that labour cost per unit is affected by factors outside a business’s HR function, such
as the amount and productivity of capital equipment used in production.
If such data reveals declining performance, management may take strategic decisions to rectify
it. In recent years, a number of Chinese clothing manufacturers have transferred their operations
to Bangladesh to take advantage of lower wage costs: Bangladesh’s minimum wage for garment
workers is set at approximately £48 per worker per month as compared with £215–350 in China.
The implications of these different wage rates for the unit labour costs of firms selling in price
competitive global markets is apparent.
 What do you think?
What other factors apart from wage costs might global manufacturers take into
account when assessing the strengths of their workforces?

Non-financial measures of HR performance

This category includes absenteeism, labour turnover and data relating to health and safety of a
business’s workforce. These measures are not directly financial and can be difficult to quantify in
monetary terms. However, most have an impact on financial measures of HR performance.
High rates of absenteeism can indicate a workforce that lacks engagement and motivation and
this can damage competitiveness. An estimated 131.7 million working days were lost due to
sickness or injury in the UK in 2017. This is equivalent to 4.1 days per worker per year (the
lowest recorded since the series began in 1993, when it was at 7.2 days per worker per year.
Since 1994 (when research began), the rate for those employed in the public sector has been
consistently higher than the rate for those employed in the private sector, although both sectors
have seen an overall decrease over time.
Labour turnover data provides a useful means of assessing a business’s HR performance.
Businesses with higher than average labour turnover face additional costs to recruit and train new
employees, as well as a potential short-term decline in productivity. On the other hand,
businesses with high levels of labour or employee retention avoid many recruitment costs and
can benefit in other ways as they may have more motivated and engaged employees achieving
higher levels of labour productivity. This may apply particularly to those businesses that manage
to retain their most talented employees.
Other factors that may indicate that a business’s workforce may represent a strength include the
extent to which a specific workforce is diverse and inclusive. Creating a diverse workforce
through an inclusive approach to recruitment and selection allows a business to benefit from the
different qualities and attributes that it possesses and can improve overall performance. Health
and safety data can play an important part in some industries in measuring the extent to which
the workforce is protected and can help the business to develop a strong employer brand.
Possessing a strong employer brand (that is, being seen as a good business to work for) assists
organisations in recruiting the most talented, creative and productive employees. Health and
safety data could be an important factor for companies in the oil and gas industry, such as BP plc
(see the Business in focus on the following page).

Other issues in using HR data

Businesses are increasingly analysing their own HR data to identify strengths and weaknesses.
Human resources analytics is the application of sophisticated data mining techniques to HR data.
The objective of human resources analytics is to provide an organisation with insights for
effectively managing employees to build on strengths and to eliminate weaknesses.
Business in focus: BP’s workforce

Figure 27.4 HR data on engagement and diversity and inclusion for BP plc, 2013–17

BP plc is a British multinational oil and gas company which extracts, refines,
distributes and retails oil and gas products throughout the world. It is one of the
world’s six major companies in this industry. In 2017, BP employed 74,000 people in
locations across the globe, a substantial fall from nearly 84,000 in 2014.
The increasing demand for energy products and the complexity of BP’s operations
means that attracting and retaining skilled and talented people is vital to the
achievement of its strategy. BP plc seeks to develop the skills it needs from within its
existing workforce and complements this with targeted external recruitment. The
company conducts external assessments for all external recruitment into BP at senior
levels, as well as for internal promotions to senior level and group leader level roles.
These assessments help to achieve rigour and objectivity in its hiring and talent
processes.
2017 2016 2015
Injuries recorded – incidents per 200,000 working hours 0.22 0.21 0.24
Days absent from work following injury – incidents per 0.055 0.051 0.061
200,000 working hours
Table 27.2 BP plc safety data, 2015–2017
Source: BP Annual Report, 2017

Practice questions
1 Analyse what other data BP’s stakeholders might require about the performance of
the company’s human resources other than that shown in the graphs in Figure
27.4?
(9 marks)
2 Evaluate why BP’s directors choose engagement and diversity and inclusion as its
performance indicators relating to its HR function? Justify your view.
(16 marks)
Marketing data
There is a wide range of marketing data available to stakeholders seeking to assess a business’s
performance in relation to that of its competitors in a particular market. The importance of
marketing data in decision making by managers and other stakeholders is reflected in the work of
major global marketing intelligence agencies such as Mintel. Companies such as Mintel can
provide a variety of data related to marketing and sell their services to a variety of customers.
Marketing data that may help to assess a business’s strengths or weaknesses can relate to the
business itself as well as the market or markets in which it trades. This may include the
following:
• Historic and forecast data on specific markets: company shares, overall size and growth rates,
segmentation. This will include information such as product life cycles. Research shows that
apps relating to entertainment have remarkably short product life cycles: an estimated 40 per
cent of these apps are deleted from devices within three weeks. At the other extreme,
Cadbury’s Dairy Milk is a chocolate brand that has been in existence for over 100 years and is
still selling very well.
• Information on the key forces driving change in the market which have strategic implications.
This may include the development of new products, entry of new suppliers or government
activity which is expected to alter sales.
• Data on important issues affecting consumer behaviour in particular markets. This could be
important in influencing consumers’ buying decisions as well as decision making by other
stakeholders. Data relating to a company’s products which may be available online and
especially through social media may also be important. Most businesses accept that consumer
reviews on products posted on social media play significant roles as investors update and adapt
their expectations about a new product’s sales potential. Thus, online reviews may provide
valuable data on a business’s strengths. Online reviews also affect decisions made by
consumers on whether or not to purchase products.
• Information relating to sales figures, brand recognition and expenditure on advertising and
other marketing activities. Although this is likely to be historic, it provides a basis for
stakeholders to judge expected future performance.

Data relating to entire markets

It is important to consider information on the market when analysing the strengths and
weaknesses of a business’s marketing activities. This enables the firm’s performance and
prospects to be placed in a context. Table 27.3 shows data relating to the UK market for organic
food products. It reveals that sales revenue grew by nearly 6 per cent in 2017, which is a notable
achievement when expenditure on non-organic food increased by just over 2 per cent in the same
period.
Where sold 2017 £m 2016 £m Percentage growth
Supermarkets 1,488.0 1,428.1 4.2
Independent retailers 359.3 327.5 9.7
 Home delivery services 285.8 261.0 9.5
Food service (e.g. restaurants) 84.4 76.6 10.2
Total 2,217.5 2,093.2 5.9
Table 27.3 Organic food sales, 2016–17
Source: Adapted from the Farmers Weekly
This information on the UK organic market is useful and suggests that businesses operating in
this market may have considerable potential. It also gives suppliers of organic food products
information about different ways of reaching customers. For example, while supermarkets
remain the most important outlet, growth in sales in independent retailers is much more rapid.
However, this information would need to be supplemented by other data to make a full
assessment of the market and its potential and to analyse the likely consequences for a firm
operating in this market.
Analysts may require a range of further information:
• The ease with which products can be distributed to consumers. In the case of organic products
in the UK: what is the attitude of major retailers (particularly supermarkets) to selling organic
products? Is it a range they are seeking to promote?
• The share of organic products in the wider market. The figures for organic products for 2017
look encouraging, but how do these relate to a longer term trend? What are the sales
projections for this market? The UK is increasingly part of a global market, so data on global
markets for organic products would be important to assess the likely extent of overseas
competition and possible opportunities in foreign markets.
• Data on the other firms operating in the market when considering a particular business. For the
organic market this might include those firms who are producing food and other organic
products, their size and product ranges and their capacity to produce this type of product in the
future.
• The attitudes and motivations of relevant consumer groups. Organic products are sold in a
niche market in the UK and any analysis of businesses selling organic products would need to
examine who the consumers of organic products are, why they buy these products, their
income levels and likely future patterns of expenditure. This would also include the
importance of price in the buying decision – is demand for organic food relatively price
inelastic that is, an increase in price does not result in a directly proportional decrease in sales,
because consumers place a high value on products supplied without the use of chemicals?
Understanding what has happened in a market and judging (as far as is possible) what is likely to
happen in the future are important elements of assessing marketing data and a firm’s strengths or
weaknesses in this area. For example, data may reveal that the market in which a specific firm is
operating is likely to exhibit strong sales growth over the next few years. This is important as it
is easier for a firm to increase its sales in a growing market – it does not have to take customers
from rivals as new ones are appearing – but will need to be ready to capitalise on this
opportunity. However, some businesses sell in markets which are getting smaller which means
sales figures have to be judged differently. British American Tobacco (a British multinational
tobacco company) announced in 2018 that its volume of sales had fallen by 2.6 per cent during
2017. This may seem unimpressive, but total sales of cigarettes, measured in volume terms, fell
by 3.5 per cent over the same period.

Marketing data for specific businesses

Using relevant information to analyse the marketing environment in which a business operates is
only part of the analysis of marketing data. It is also important to acquire information about the
specific firm in question and to use this in conjunction with data illustrating the broader picture.
Analysts would require varied data relating to a firm’s marketing activities:
• Details on its product range, including some assessment on its forecast future sales (this may
link to product life cycles). This might also include product development, sales figures,
including historic and forecast figures, as well as data on market share.
• The results of marketing research, for example, consumers’ perceptions of the business’s
products, its brands and reputation.
• Information on the firm’s marketing activities including product development and its
marketing budgets.

Mothercare plc’s sales data 2016–2018

Mothercare plc is a UK-based multinational retailer. It operates two brands:
• Mothercare. This is a specialist retailer of products designed to meet the needs of mothers-to-
be, babies and children up to eight years.
• Early Learning Centre. A retailer that sells toys for children up to eight years.
2018 £m 2017 £m 2016 £m
UK sales
Sales through stores 226.8 251.7 266.7
Direct sales, e.g. online 174.0 171.9 159.4
Wholesale sales, e.g. through partners such as Boots 36.8 35.8 33.6
International sales
Sales through stores 715.5 753.2 683.0
Wholesale sales, e.g. through partners such as Boots 9.8 9.3 6.7
Total sales 1,162.9 1,221.9 1,149.4
Table 27.4 Mothercare plc UK and international sales figures, financial years ending 2016–18
Source: Mothercare plc annual reports, 2017 & 2018

Handling data
Calculate the increase in total sales for Mothercare plc in 2017 and 2018 compared
with the previous year. In which year did sales increase by the highest percentage?
Table 27.4 sets out Mothercare’s UK and international sales for three years. The initial
impression is that the company’s sales have been relatively poor – growing by only £13.5 million
(or 1.2 per cent) between 2016 and 2018. Once inflation is taken into account the value of the
company’s sales has fallen in real terms.
However, a closer inspection of the data and the addition of further information may cast a
different light on this example of marketing data. Firstly, the company’s sales were significantly
higher in 2017. They rose by 6.3 per cent from the 2016 value. The company will almost
certainly have investigated why they fell back once more.
Its international division is performing relatively strongly, and it was here that the bulk of the
company’s sales were achieved. Between 2016 and 2018, international sales increased by £35.6
million (or 5.2 per cent), a more impressive figure.
The board of directors of the company were implementing a strategy to reduce the company’s
losses by reducing the number of stores operating in the UK – 17 were closed in 2017. Although
UK sales fell by 5.4 per cent in 2018 to £400.8 million, much of this was the result of closing
shops. Comparing sales in the shops that survived with the figures for the same shops a year
earlier (known as a like-for-like comparison) reveals that sales only declined by 1.1 per cent.
This marketing data for Mothercare plc is very limited. It excludes much important information
such as sales forecasts, information about product ranges and, of course, data relating to the
markets in which Mothercare operates.
Marketing data can reveal a great deal about a business but it can be misleading. It does need to
be placed in context of the business’s wider activities and the markets in which it trades. It is
frequently valuable to compare marketing data for a specific business with that for other
businesses in the same industry as well as for the business in earlier years.
Environmental data
Environmental factors are becoming increasingly important for the managers of businesses.
Management of energy, natural resources or waste will affect the current performance of many
businesses. Equally, failure to plan for a future in which environmental factors are likely to be
increasingly significant may risk the long-term future of a business.
Simultaneously, interest from stakeholders in businesses’ environmental performance is at an all-
time high. This is reflected in the decisions of most the UK’s largest 100 companies to report on
environmental issues to some extent in their annual report and accounts. In 2016, 99 reported on
carbon emissions and 48 published environmental and sustainability information. The UK
government recommends that businesses report on their environmental performance in four main
areas which incorporate 22 separate measures, although only a small proportion of these are
relevant to any single business. The four areas are:
1 Emissions to air, including greenhouse gases, dust and particles.
2 Emissions to water, such as metals and organic pollutants.
3 Emissions to land, which encompasses fertilisers, pesticides and waste, for example, landfill.
4 Use of scarce and non-renewable resources, such as water and oil.
Key issues in interpreting environmental data are that it should be relevant to the business and in
a form suitable for comparison with that provided by similar businesses or to official guidelines
or regulatory limits. The ways in which environmental performance is measured and reported
varies hugely between industries. For example, businesses engaged in agriculture might focus
strongly on emissions to land, specifically the use of pesticides and fertilisers. In contrast,
airlines would be likely to focus on emissions to air and use of non-renewable oil products.

Business in focus: Environmental performance at Rio Tinto

Rio Tinto plc is one of the world’s largest mining companies. It extracts iron ore,
copper, aluminium, diamonds and other minerals and employs 47,000 people in
around 40 countries across six continents. The company’s businesses include open-
pit and underground mines, mills, refineries, smelters and power stations.
Environmental indicator 2017 2016 2015 2014
Significant environmental incidents 0 1 0 12
Greenhouse gas emissions (million tonnes CO2) 30.6 32.0 31.7 33.8
Waste disposal or storage (million tonnes) 1,317 1,781 1,746 1,737
Land disturbed through company’s activities (km2) 3,616 3,696 3,629 3,592

Table 27.5 A selection of environmental data for Rio Tinto plc, 2014–2017
The company reports on its environmental performance (an extract is shown in Table
27.5) and seeks to minimise its impact on the environment:
‘Right from the start of a project, we look for ways to provide work and business
opportunities for our host communities, while protecting the environment and the
region’s cultural heritage.’
Despite this, the company has faced considerable criticism for the environmental
consequences of its mining activities. The government of Norway has been a high-
profile critic and sold all its shares in the company (valued at $500 million) in protest
at its environmental and ethical performance.
Source: Rio Tinto’s annual reports and website, www.riotinto.com

Practice questions
1 Analyse the reasons why the management team at Rio Tinto plc might have
decided to report extensively on the company’s environmental performance.
(9 marks)
2 Do you think that environmental data is the most important measure of a firm’s
performance nowadays? Justify your view.
(16 marks)
The importance of core competencies
What are core competencies?
The term ‘core competencies’ was first used in a series of articles in the Harvard Business
Review in 1990. Core competencies were described as ‘… the collective learning in the
organization, especially how to coordinate diverse production skills and integrate multiple
streams of technologies’. The authors, Coimbatore Prahalad and Gary Hamal, argued that a
business’s core competencies arise from a combination of its collective learning and its technical
skills, and give the firm a source of competitive advantage.

Key term
Core competencies are the unique abilities that a business possesses that provide it
with competitive advantage.

Prahalad and Hamal’s work demonstrated that core competencies can provide a business with
uniqueness: things that it can do exceptionally well and that competitors cannot easily copy. The
two writers painted a picture of a business as a tree whose roots represent its competencies.
These roots grow and nourish the organisation’s ‘core products’ which create a number of
subsidiary businesses. These subsidiary businesses sell ‘end products’ to consumers. These
relationships are illustrated in Figure 27.5.
Prahalad and Hamal used examples of highly successful companies in the 1980s (such as Honda
and Canon) to show how their enviable performances were the result of focusing on the things at
which they excelled. These companies concentrated on identifying their core competencies to
build and reinforce unique areas of expertise and devoted resources to these areas and not those
in which they were relatively weak. The development and use of core competencies assisted a
business in developing core products which could be used to provide end products for
consumers. Sony’s core competencies have allowed it to produce core products related to
miniaturised technology – this has helped it to supply global markets with a range of desirable
electronic products.
Core competencies can take diverse forms depending on the business and the products that it
sells. Apple, the American technology company, has core competencies that relate to the design
of its products when integrated effectively with its other business functions. Some business
analysts believe Apple compromises everything to design, but this helps it to sell huge volumes
of its products at premium prices. It sold nearly 80 million iPhones in the first three months of
2018 alone.
Figure 27.5 How core competencies work, using Honda as an example
Developing core competencies
Prahalad and Hamal argued that core competencies are the combination of the organisation’s
knowledge, its production skills and multiple streams of technologies. They suggested three
factors could be used to test whether an organisation’s attributes are truly core competencies.

Do they provide access to a wide range of markets?

This test of core competence assesses whether a business’s attributes enable it to create desirable
new products. We mentioned earlier that Apple’s designs represent a core competency and this
has been used to create products (such as the iPad and iPhone) with great success, enabling it to
enter new markets. However, design alone will not provide Apple with a core competence: it is
the deployment of unique design knowledge and skills in coordination with the other functions
within the business (such as marketing) that are involved in bringing a product to the market.

Do they contribute significantly to the end-product benefits

received by the customer?
Customers are strongly attracted to certain products which offer benefits that they believe are not
available elsewhere. As a result, they are willing to pay higher prices for certain products. Goods
and services supplied by firms who possess core competencies will fall into this category – our
example of the distinctiveness of the design of Apple’s products passes this test too. The John
Lewis Partnership is another example where its highly regarded quality of customer service
provides its customers with tangible benefits and gives the company a clear competitive
advantage.

Are they difficult for competitors to imitate?

A core competence should not be easy to replicate otherwise it is not sustainable. It should be
something that is highly desirable to competitors but is difficult to acquire. For example,
Microsoft has expertise in many IT products and this is not easy for its rivals to copy. Similarly,
Dropbox (which provides computing storage solutions) has developed core competencies based
on agile use of technology and a good understanding of customer needs to continually develop
innovative products which its rivals are struggling to match.
Why are core competencies important?
Core competencies can allow businesses to take full advantage of opportunities to enhance
performance and provide competitive advantage with the potential of market leadership. The
development and strengthening of core competencies can show that a business is using the right
amount of resources and in the right areas of its operations. Many managers believe that
businesses should outsource all non-core activities, i.e. require another organisation to carry
them out. This can streamline a business’s operations and encourage employees to focus on its
competencies.
Core competencies are powerful as they give a business something that helps it to add value. The
business’s customers should believe that a business has attributes that enable it to supply
distinctive and unique goods and services. If it achieves this, its competitiveness increases and,
along with it, its market power. Apple is currently a phenomenal example of the effectiveness of
core competencies in operation.
If businesses can match core competencies with market opportunities, then this can form the
basis for creating new businesses. It brings together a business’s strengths with a gap in the
market in which a considerable potential for sales exists. As an example, Honda was able to take
advantage of rising consumer incomes which led to increasing demand for power tools in a
number of countries. This resulted in it establishing a business selling lawn mowers using its
successful engines to power them.
Core competencies – criticisms
There are some criticisms of Prahalad and Hamal’s model of core competencies. One area of
criticism centres on the weaknesses that develop in a business that outsources a number of its
operations. Outsourcing is a common technique used by managers to allow them to focus
resources on key elements of the business. As parts of the business are outsourced, the critics
argue, the workforce becomes more fragmented. People work for different organisations with
different goals and objectives, and different business cultures. This can result in a lack of
harmony and unity of purpose, and a below par performance from the workforce.
Another area of criticism of the theory relating to core competencies is based on the notion that it
is out of date. One such critic is Mark Parker, the CEO of the multinational clothing company
Nike. Parker argues that in a world which is experiencing rapid change, having core
competencies (in the form of certain strengths designed to succeed in a range of markets) is
unlikely to help managers meet customers’ evolving demands. He uses his company’s
development of digital products such as electronic wristbands designed to measure energy usage
as an example of how successful companies need to make major strategic moves into different
industries.
Some may believe, however, that even a diverse move from the clothing to the digital market
could be more successful if the company concerned is able to rely on certain transferable
strengths to underpin its development of new products.

Business in focus: Google’s core competencies

Figure 27.6 Global market share for search engines, August 2018

Source: Data from Netmarketshare, www.netmarketshare.com

Google’s hugely popular search engine service dominates its markets, and especially
that relating to mobile phones and tablets. This is evidence of a considerable and
sustainable competitive advantage.
Google’s employees solve complex problems every day pursuing the company’s core
mission to organise the world’s information and make it universally accessible to its
users. Google aims to bring together smart, talented people from a diversity of
backgrounds. However, Google believes that what makes working at Google truly
unique is the workplace culture that encourages innovation and a healthy disregard
for the impossible.

Figure 27.7 Over 84 per cent of internet searches on mobile devices use Google Search
Source: Adapted from the Google website

Practice questions
1 Analyse how Google’s employees can help the company to establish core
competences.
(9 marks)
2 To what extent do you think it is possible for a company to sustain core
competences in the technology industry over a long period of time?
(16 marks)
Assessing short- and long-term
performance
In Chapter 25, we encountered the issue of short-termism. Short-termism can prevent senior
managers thinking about the long term. This may act as a disincentive to setting corporate
objectives which encourage long-term strategic decisions. Examples of such long-term decisions
include investing in research into new products and processes, training of employees to provide
high-level skills and creating new production facilities which may only break-even in the long
term. Instead, it encourages decisions which frequently involve cost-cutting and loss of jobs.
It is possible to consider various aspects of the internal position of a business to assess its short-
term and long-term performance, and gain some insight into whether the management team are
avoiding the pressures for short-termism.
Research and development activities
Research and development (R&D) is part of the process of innovation. It entails using human,
financial and other resources to develop new products or new, and more efficient, methods of
production. This can result in businesses selling highly desirable products at premium prices.
Apple is an example of a company that has benefited from its investment in R&D.

Key terms
Research and development (R&D) is the generation and application of scientific
knowledge to create a new product or develop a new production process which can
increase the business’s productive efficiency.
Profit quality measures the extent to which a particular type of profit is sustainable.

However, in some industries such as aerospace, pharmaceuticals and biotechnology, R&D can be
very expensive and it may take many years before a business receives a return on its investment.
Figure 27.8 shows that certain industries invest more heavily in R&D and that they are more
likely to be implementing long-term strategies.
Thus, one way in which a business’s potential short-and long-term performance can be judged is
by considering the extent of its investment in R&D, particularly in comparison to other firms in
the same industry. A firm that invests relatively little may generate higher short-term returns but
at the expense of its long-term performance. Clearly, a firm that invests more heavily than its
direct competitors may not achieve a better long-term performance. Its R&D may not be
successful or it may encounter problems protecting its ideas. However, it is a statement of
intention.

Figure 27.8 R&D investment (€) by industrial sector based on the world’s top 2,500 companies, 2016
Figure 27.9 Share of R&D Investment by main countries/regions, 2007–2016

Huawei is a Chinese multinational IT company. It produces and sells telecommunications

equipment, IT products and smart devices. The company invests particularly heavily in R&D. In
2017, Huawei had over 80,000 employees engaged in R&D activities, comprising 45 per cent of
its total workforce. It operates 16 R&D facilities in countries that include Germany, Sweden, the
USA, France, Italy, Russia, India and China. The company’s R&D investment amounted to
$13,028 million in 2017, accounting for 14.9 per cent of the company’s annual revenue. Huawei
has cumulatively spent more than $57,223 million on R&D since 2008. This is heavy investment
in R&D even by the standards of this industry and may generate high returns in the long term.
Profit quality
Profit is a major financial measure of performance, but it is possible to look beyond the amount
of profit to its nature in judging the likely performance of a business in the short- and long-term.
Firms regard profit that is likely to continue into the future as high-quality profit. In contrast, that
which is unlikely to be repeated, for example, a profit generated from the sale of a non-current
asset, is classified as low-quality profit.
Thus, a business that is generating a high proportion of its profits in ways which are not
sustainable may be considered to be more likely to perform better in the short term. Unilever is a
British consumer products company that owns many well-known global brands. The company
has taken the decision to sell several brands during 2018, such as Flora, a type of spread. These
sales may generate high profits for the company in the short term, but the quality of the profit
will be low as this strategy is not sustainable. The company’s long-term performance will,
however, be shaped by the use to which it puts the revenue that it receives from these sales.
Employee engagement
Employee engagement is receiving a great deal of attention currently. The Chartered Institute of
Personnel and Development (CIPD) believes that engaged employees willingly contribute
intellectual effort, experience positive emotions and meaningful connections to others in the
workplace. Businesses frequently seek to measure employee engagement, usually through
workplace surveys.
Businesses that seek to promote employee engagement are more likely to seek a long-term
relationship with employees, as they tend to believe that employees are 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. Positive data on employee
engagement may be valuable evidence regarding a business’s long-term performance, though
many other factors will affect the organisation’s future performance.
Customer satisfaction
A business’s performance in terms of customer satisfaction is relatively easy to measure through
the use of surveys and questionnaires. For example, Ofcom, the organisation that regulates the
telecommunications industry, publishes the results of customer satisfaction surveys for
businesses operating in the industry. In 2017, Tesco Mobile and Giff Gaff received the highest
customer service ratings for mobile telephone services.
High scores for customer satisfaction can represent evidence that a business is aiming to develop
customer loyalty and to increase market share by providing consumers with a good experience.
This may translate into a strong overall performance by the business in the longer term. Equally,
it may be that achieving high levels of customer service is costly (for example, in terms of staff
training) which may detract from a business’s short-term financial performance.
Energy company Customer satisfaction score (%)
Octopus Energy 80
Robin Hood Energy 78
Ovo Energy 74
Utility Warehouse 74
Ecotricity 72
Flow Energy 68
Cooperative Energy 66
SSE 58
EDF 57
E.ON 57
British Gas 56
NPower 54
Table 27.6 Customer satisfaction ratings for a selection of the UK’s gas and electricity suppliers, 2018
Source: Adapted from Which?
Table 27.6 shows that the UK’s major suppliers of energy (gas and electricity) such as EDF
Energy, Npower and British Gas (highlighted) receive comparatively low ratings for customer
satisfaction. Smaller rivals such as Utility Warehouse and Flow Energy perform much better in
this regard.
This may indicate that these small and relatively new businesses are intent on capturing market
share over the longer term and, thus, it may provide an indication of likely long-term
performance. However, this contrast between small new suppliers and large established
businesses may also reflect the nature of the energy supply market, particularly that customers
are quite reluctant to change suppliers and that large businesses rely on this inertia.
What do you think?
Is achieving high levels of customer satisfaction less important for a large, well-
established business?
Brand image and reputation
A business that is committed to maximising its long-term performance can be expected to take
decisions that will protect and enhance its brand. It will ensure that it takes decisions that avoid
damaging the brand and that are appropriate to the brand’s position within the market.
In September 2015, it emerged that Volkswagen, the German car manufacturer, had falsified
tests into the emissions of pollutants from its diesel engines. It was reported that the company
had incurred costs estimated at £22 billion by 2018, mainly in fines paid in the USA and
Germany. This, allied to adverse publicity surrounding other acknowledged faults in the
company’s products, has severely damaged the firm’s reputation and its brand image. This
apparent desire to protect short-term profits is highly likely to impact negatively on the
company’s long-term performance.
Other businesses seek to enhance their brand images, even though they incur additional costs, as
they believe it will help to develop brand loyalty and increase market share. Ultimately, it is
expected to improve the business’s long-term performance including financial returns. Vodafone
plc, one of the world’s leading telecommunications companies, publicises its desire to create
‘long-term value’ by taking decisions that protect and enhance its reputation and brand image
with its stakeholders. It is perhaps no coincidence that Vodafone is the UK’s most valuable brand
with an estimated worth of 20.70 billion in 2017.

Business in focus: Ryanair struggles with its brand image

For many years Ryanair has been remarkable. It grew quickly as it expanded from a
small airline to transport more passengers than British Airways. It is profitable too: in
2018, its profits rose 10 per cent to £1.27 billion, despite some difficulties. The
airline’s business model is centred on low prices and it operates in certain market
segments where demand for air travel is strongly price elastic.
However, the low-cost airline has encountered troubled times recently. Thousands of
Ryanair passengers face disruption as the airline is cancelling more than 100 flights
due to multiple strikes across Europe.
The company’s pilots in Ireland, Sweden, Belgium and the Netherlands have all voted
to take industrial action. The Irish cancellations alone will affect around 3,500
passengers. The latest action comes as the airline has been hit with a series of pilot
and cabin crew strikes over an 18-month period during 2017 and 2018. In September
2017, the airline cancelled 50 flights each day and an additional 18,000 at the end of
the month.
Ryanair said it has notified all customers affected and is providing refunds or
alternative flights. Despite this, many customers remain annoyed at the way they
have been treated. Some analysts believe the airline’s brand has been damaged.
Despite this adverse publicity, the low-cost airline remains popular. In 2017, its flights
carried 129 million passengers, a 10 per cent increase on 2016 with capacity
utilisation increased. Passengers continue to be attracted by its low fares, with some
tickets sold for as little as £5.

Practice questions
1 Analyse the possible benefits to Ryanair from operating flights with higher levels of
capacity utilisation.
(9 marks)
2 Do you think brand image matters to businesses that sell products at low prices?
Justify your view.
(16 marks)
Sustainability
A sustainable approach to business is one that can be conducted in the long term. It entails using
a business’s resources, as well as natural resources, in such ways as to avoid damaging or
compromising future use and business activity. ‘Sustainability’ is a much used term in business
at the present time, but businesses that genuinely seek to operate sustainable business models are
focusing squarely on long-term performance even at the expense of short-term costs.
As an example, there are forecasts of severe shortages of cocoa beans within ten years because
production in Ghana and Cote d’Ivoire (which supply 60 per cent of the world’s cocoa beans) is
forecast to slump. This is due to insufficient investment by farmers as well as the effects of
climate change and farming practices in reducing the supply of suitable land. The implications
for chocolate manufacturers such as Nestlé are significant as the price of cocoa is likely to rise
sharply as its availability declines. This may require the company, along with other chocolate
producers, to invest heavily to support the activities of Africa’s cocoa farmers and prevent them
switching to supply other crops that are easier to grow. Although this is potentially costly in the
short-term for chocolate manufacturers, investing in sustainable sources of supply is likely to
enhance their long-term performance.
The value of other measures of assessing
business performance
We saw in Chapter 26 that financial measures of performance are used extensively to assess the
performance of a business. However, relying simply on financial measures of performance may
result in a business failing to judge its performance accurately or fully. Financial measures of
performance may be important for some stakeholder groups, but not for all. Furthermore,
financial measures of performance tend to measure the consequences of past decisions and
actions rather than providing an indication of future performance. As a consequence, managers
have increasingly used more than one set of measures to judge a business’s performance.
To broaden how they measure the performance of their organisations, some management teams
have opted to use different frameworks to assess performance. There are a range of models
available that provide different ways of measuring performance. We shall consider two models
of performance measurement:
• Kaplan and Norton’s balanced scorecard
• Elkington’s triple bottom line.
Kaplan and Norton’s balanced scorecard
In Chapter 25, we encountered the concept of the vision statement in which a business states
what it hopes to achieve in the future. Businesses do not normally state their visions in financial
terms and, thus, it is not appropriate to assess their achievements against their vision by use of
financial measures of performance. Kaplan and Norton’s balanced scorecard approach is based
on the premise that financial data is inadequate on its own as a measure of a business’s
performance and that non-financial data should be included in any worthwhile measure.

Key term
The balanced scorecard is a planning and management strategy designed to match
business activities to the aspirations set out in the organisation’s vision statement.

The balanced scorecard was developed by Robert Kaplan and David Norton (and first set out in
the Harvard Business Review in 1992) as a framework that added strategic non-financial
performance measures to traditional financial ones to give managers and other stakeholders a
‘balanced’ view of the performance of a business. The authors described the model in the
following terms:
‘The balanced scorecard retains traditional financial measures. But financial measures tell the
story of past events, an adequate story for industrial age companies for which investments in
long-term capabilities and customer relationships were not critical for success. These financial
measures are inadequate, however, for guiding and evaluating the journey that information age
companies must make to create future value through investment in customers, suppliers,
employees, processes, technology, and innovation.’
Kaplan and Norton suggested that managers should consider the following in developing their
unique version of the balanced scorecard in addition to financial measures:
• The customer’s perspective. How does the customer perceive the business? What steps are
necessary to maintain the loyalty of customers?
• The company’s internal perspective. What aspects of a business’s internal operations may
need to be improved if a business is to meet its objectives?
• Innovation, learning and improvement. How can the company continue to improve and to
create value in the future?
The use of the balanced scorecard encourages managers to think about what needs measuring if
the business is to achieve its objectives. The scorecard’s measures will vary according to a
business’s circumstances but may include performance measures such as those set out in Table
27.7.
Area of measurement Examples
• Revenues from sales
• Profits and profitability such as return on capital
Financial performance (ROCE)
 • Cash flow

• Customer loyalty
Customer value performance • Delivery on time
• Customer satisfaction

• Productivity
Internal business process
performance • Quality
• Number and effects of bottlenecks in production

• Extent and effectiveness of training

• Employee engagement and labour turnover
Learning and growth performance • Effectiveness of communication systems
• Innovation, percentage of revenue from new
products
Table 27.7 The balanced scorecard’s components

Key models and theories: The balanced scorecard

The balanced scorecard enables you to go beyond simply the use of financial data (or
any other single type of data) to assess the performance of a business. This balance
helps you to arrive at more forward-looking judgements and to overcome the historical
bias that is inevitable in the use of financial data. You can use this model to consider
the types of decisions that need to be made in order to achieve the business’s vision.
This might help you to prioritise actions or decisions that need to be taken and to justify
your choice.

These elements within the scorecard should be quantifiable and therefore capable of
measurement. They cover the organisation’s activities in four categories as shown above; success
in one area does not necessarily result in success in other areas.
The balanced scorecard does not just measure performance, however. Although it was originally
developed as just a performance management tool, its role has developed. It is a management
tool that enables firms to clarify their vision and strategy and translate them into action. The
balanced scorecard can be applied to a business’s strategic plan to guide managers in decision
making. It helps managers to identify what should be done and to measure the extent to which
these targets are achieved.
Thus, managers may use the balanced scorecard to implement strategy as well as to measure
performance as shown in Figure 27.10.

The value of the balanced scorecard

In 2013, research by Bain & Company listed the balanced scorecard fifth on its top ten most
widely used management tools by companies worldwide; by 2017, it was less popular with only
29 per cent of managers surveyed used it. Despite this, the balanced scorecard has also been
selected by the editors of Harvard Business Review as one of the most influential business ideas
of the past 75 years.

Figure 27.10 Using Kaplan and Norton’s balanced scorecard

Figure 27.11 The balanced scorecard – its use and level of satisfaction, 1996–2017

Notes: This data is based on a worldwide survey of 1,268 company managers in 2017
Although Figure 27.11 shows that usage of the balanced scorecard has declined in the companies
surveyed in recent years, it has achieved satisfaction levels of around 70–80 per cent since it was
first used. It does encourage managers to focus on factors other than finance and tends to
improve performance in the areas in which goals are set.
However, at the heart of its value to managers and other stakeholders is that it is not merely a
measurement tool. Much of its value to managers lies in its use as a framework within which a
strategy can be implemented to attain the business’s vision. That it can also be used to quantify
progress towards this vision gives added value.
Elkington’s triple bottom line
The term ‘triple bottom line’ was first used by John Elkington in 1994. It did not become a
popular or widely recognised approach until the publication of his follow-up book (Cannibals
with Forks: the Triple Bottom Line of 21st Century Business) in 1997. As its name suggests, the
triple bottom line (or TBL) has three components: profit, people and planet.

Key models and theories: Elkington’s triple bottom line

Elkington’s triple bottom line model enables you to consider more than simply the
financial performance of a business when assessing its performance. This allows you
to take a stakeholder perspective as opposed to simply a shareholder perspective
when analysing performance and proposing actions and decisions. This might be part
of an assessment that is more long-term and likely to be able to develop strategies that
will meet the needs of a broader range of the business’s stakeholders.

Profit
The financial bottom line is the most familiar for managers and for students. This is the figures
recorded in a business’s financial statements, primarily its profits. However, when considering
profit as part of a triple bottom line analysis, the idea is that profits will help sustain the broader
community in which the business operates; they should be paid to the business’s owners.

People
This element of the TBL measures the impact that a business’s activities may have on all the
people with which it is involved – that is the extent to which it is socially responsible. This
considers the effects of the business’s actions on a broad range of stakeholders including
suppliers, customers, local residents as well as, of course, employees. This element of the TBL
should take into account issues such as the following:
• Health and safety matters. This might include the provision of safe working environments for
employees and ensuring that suppliers do the same, even if this results in higher costs.
• Financial matters. This would include offering fair rates of pay for employees and paying
suppliers fair prices promptly.
• One notable element of caring for people has been the development of fair trade. Fair trade is a
social movement that operates with the goal of assisting businesses in less-developed countries
to achieve improved trading terms. The movement hopes to improve living standards in the
less-developed countries and to promote sustainable methods of production.

Key term
Social responsibility is managing a business so as to take into account the interests
of society in general and especially those groups and individuals with a direct interest
 in the business.

Planet
Businesses that are measuring their activity using TBL are likely to seek to minimise the impact
of their activities on the environment. Actions to achieve this may take diverse forms such as:
• reducing carbon emissions – attractive because it is easily measurable
• reducing the quantity of waste that is disposed
• using sustainable sources of raw materials wherever possible
• reducing usage of non-renewable resources.
Businesses that take the TBL into account in decision making attempt to assess the true cost of
their actions for the environment. Many businesses promote policies of this type using the term
‘going green’.

Figure 27.12 The use of Elkington’s triple bottom line encourages sustainable production

What do you think?

Is a manager doing their job badly if they do not take into account the environmental
consequences of their decisions?

The value of the triple bottom line

The TBL was meant by John Elkington to be a way of thinking about a business’s social
responsibility, not simply a method of measuring a business’s performance. This emphasises its
strengths and weaknesses. It is a management tool designed to make managers think about the
impact of their actions on not just the business’s profits (and its shareholders) but also on society
and the environment, and thus, other stakeholders too. In this way, it encourages corporate social
responsibility and makes managers think about ways of measuring the effects of their businesses’
activities in terms other than financial ones.
However, it is mainly seen as a technique of measuring or assessing business performance. In
that regard it has a fundamental weakness. The three separate accounts that comprise the bottom
line cannot be totalled – or compared. It is not possible to measure the planet and people
elements of the TBL in monetary terms. For example, the cost resulting from disposing of toxic
waste in the ocean is huge and probably impossible to put into financial terms. Similarly, the cost
of using children in factories in Bangladesh to produce cheap clothing is immeasurable in terms
of lost childhoods and opportunities denied. These cannot easily be added to financial costs.
Equally, benefits in these areas cannot be translated into financial terms.
The TBL proved popular in the late 1990s and helped to support the development of corporate
social responsibility and fair trade. At one point, the UK government considered making TBL
reporting a legal requirement. More recently, businesses have focused on reducing costs, for
example, by transferring production to low-cost countries such as India. However, criticisms
from western consumers of such actions alongside the emerging social and environmental costs
of these policies are encouraging a rethink. Perhaps the TBL will gain wider use in the future
despite its shortcomings.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 State two examples of operations data that may be used to analyse a business’s
strengths and weaknesses.
2 State one reason why labour cost per unit of production might be a good measure
of a business’s HR performance.
3 List three items of marketing information that stakeholders may use to analyse the
strengths or weaknesses of a business’s marketing operations.
4 State the four areas of business operations which the UK government suggests
that environmental reporting should cover.
5 Distinguish between core competencies and competitive advantage.
6 What are the three factors that can be used to judge whether an organisation’s
attributes are genuine core competencies?
7 List two aspects of a business’s activities that may be used to judge the extent to
which it is focusing on its long-term rather than its short-term performance?
8 What is meant by the term ‘balanced scorecard’?
9 State the three elements of John Elkington’s triple bottom line.
10 Distinguish between sustainable production and social responsibility.

(b) Short answer questions

1 Explain one circumstance in which capacity utilisation can be a vital measure of a
business’s performance.
(4 marks)
2 Analyse one reason why a law firm with high rates of employee retention may be
expected to perform better than one with low rates of retention.
(5 marks)
3 Explain one reason why environmental data may offer a good indication of the
future performance of an oil company such as BP.
(5 marks)
4 Analyse why core competences are important for large multinational firms that sell
a range of products in global markets.
(9 marks)

(c) Data response question

Novo Nordisk
Novo Nordisk is a Danish global health care company with more than 90 years of
innovation and leadership in diabetes care. It has production facilities in eight
countries and 43,100 employees in 79 countries. Over the past 15 years, Novo
Nordisk has delivered results superior to those of most other pharmaceutical
companies. A key reason is that it has stuck to a highly focused long-term strategy.
The company presents its results using triple bottom line (TBL) reporting – a selection
of its results are shown in Table 27.8.
Novo Nordisk is a strong believer in maintaining focus on what it does best and is
therefore not easily tempted to stray from its core business. As a result, its main
business area today is the same as when it was founded: diabetes. Its main product
then was insulin; the main product now is – insulin.
This is not to dispute Novo Nordisk’s innovation. It spends heavily on research and
development to develop new products and to benefit from patent laws which offer
protection for up to 20 years. In fact, it typically spends 12–15 per cent of its revenue
on researching and developing new products within its core areas; in 2017 it invested
DKK 14,000 million* in research and development.
Its revenue was DKK 111,696 million in 2017, a slight fall from DKK 111,780 million in
2016, but a rise from DKK 107,927 million in 2015. The company has over 8,000
employees working within its R&D organisation globally.
(* DKK is the Danish Krone. At the time of writing the exchange rate was £1 =
DKK8.38.)
2017 2016 2015
Profit
Profit for the year margin (%) 34.14 33.93 32.30
Social (people)
Frequency of occupational accidents amongst employees – 2.7 3.0 3.0
number per million working hours.
Number of diabetes patients treated with Novo Nordisk 27.7 28.0 26.8
products (millions)
Environmental (planet)
Energy consumption (GJs 000s) 2,922 2,935 2,778
Waste (tonnes, 000s) 157 153 159
Table 27.8 A selection of Novo Nordisk performance data, 2015–2017
Source: Adapted from Novo Nordisk Annual Report, 2017

Questions
1 Explain the possible reasons why Novo Nordisk spends heavily on its research and
development activities.
(5 marks)
2 Analyse the strengths and weaknesses of Novo Nordisk’s performance between
2015–2017 using the data above.
(9 marks)
3 To what extent might Novo Nordisk’s stakeholders have benefited from the
company’s use of TBL reporting?
(16 marks)

(d) Essays
1 Should all multinational companies focus on developing their core competencies?
Justify your opinion.
(25 marks)
2 ‘The use of the balanced scorecard is more likely to allow a management team to
implement its strategy successfully than triple line reporting.’ To what extent do you
agree with this statement?
(25 marks)
Revision Section: Unit 7a Analysing the
strategic position of a business:
internal factors
Advice for Unit 7a
Top tips …

Short-termism is a topical issue in politics as well as business. These two aspects of short-
termism intertwine and together lead to an important debate. Do some research to find out more
about this debate. This website provides a link to a report by Oxford University into the impact of
short-termism and how to combat it:
www.oxfordmartin.ox.ac.uk/downloads/commission/Oxford_Martin_Now_for_the_Long_Term.pdf

SWOT analysis benefits from the support of other research such as the PEST-C (political,
economic, social, technological and competitive) framework, which measures a business’s
position according to external factors: political, economic, social and technological. It may also be
appropriate to supplement this with the use of Porter’s Five Forces analysis which considers a
business’s competitive position.
When considering financial statements such as balance sheets and income statements, try to
think about them from the perspective of a variety of stakeholders. It may be natural to consider
them from the standpoint of shareholders and managers, but think of the conclusions that
employees and suppliers may draw from the same financial information.
Remember that the AQA A-level Business specification only requires you to be able to read and
interpret balance sheets and not to construct them.
UNIT 7A CHECKLIST
Having completed studying this unit you should be able to do all that is listed below.
You should read this list and confirm that this is the case.
Learning outcomes
Mission, corporate objectives and strategy
Know and understand:
• the nature of a business’s mission and the influences on it
• the internal and external influences on corporate objectives and decisions
• the distinction between strategy and tactics
• the links that exits between mission, corporate objectives and strategy
• the impact of strategic decision making on functional decision making
• the value of SWOT analysis.
Analysing the existing internal position of a business to assess strengths and
weaknesses: financial ratio analysis
Know and understand:
• how to assess the financial performance of a business using balance sheets and
income statements
• assessing financial performance using financial ratios – profitability, liquidity,
gearing, efficiency
• the value of financial ratios when assessing business performance.
Analysing the existing internal position of a business to assess strengths and
weaknesses: overall performance
Know and understand:
• how to analyse other data relating to business performance – operations, human
resources and marketing
• the importance of core competencies
• assessing short- and long-term performance
• the value of different measures of assessing performance: the balanced scorecard
and the triple bottom line.
Practice questions
1 A business is suffering from a decline in its market share. Explain one way in which
the use of SWOT analysis might enable the business to improve its market share.
(4 marks)
2 Explain how a business’s decision to use Elkington’s triple bottom line in its annual
report might improve its financial performance.
(5 marks)
3 The following financial data relates to XYZ plc for the most recent financial year.
Item £m
Revenue 125.8
Operating profit 20.1
Non-current liabilities 378.0
Total equity 360.4

Calculate
a the company’s operating profit margin
(3 marks)
b its gearing ratio.
(3 marks)
4 Explain how developing core competencies can help a business to strengthen its
competitive advantage.
(6 marks)
5 Cinderford plc has enjoyed rising sales recently and is considering investing in a
major expansion. The data below relates to its financial performance over the past
two years.
Ratio Last year The year before last Two years’ ago
Current ratio 0.97:1 1.07:1 1.14:1
Gearing ratio 49.4% 43.7% 40.2%
Return on capital employed 23.8% 19.7% 19.0%

Analyse the ways in which this data may help the company’s managers decide how
to finance the expansion.
(9 marks)
Case study: Marks & Spencer plc’s
turnaround strategy
Marks & Spencer plc (affectionately known as M&S) is one of Britain’s best-known
retailers with a positive reputation, especially amongst older consumers in the UK.
The business was established as a single market stall in 1884 and has since grown
into a large international retailer. M&S had 81,000 employees in 2018 and stores in 54
countries. It sells clothing and home products including furniture and food. Its key
objective is growth to transform M&S from a traditional shop-based British retailer to
an international, multi-channel retailer. The decision has been taken against a
background in which online sales in the UK were about 20 per cent of total sales in the
UK in the first sixth months of 2018 and were growing at ten times the rate of sales in
stores.

Plan A and recent performance

M&S introduced its Plan A in 2007. The plan set out 100 commitments to achieve
within five years, including becoming carbon neutral, stopping sending waste to landfill
and helping to improve the lives of those employed in its supply chain. Recently, the
company has updated its plan with the aim of becoming ‘the world’s most sustainable
major retailer’ by 2020.
M&S’s fortunes have declined in recent years. In 2015, its share price was nearly 600
pence per share and its profits reached £1 billion ten years’ ago. Its sales in Britain
remain subdued, especially for clothing sales which have fallen steadily for over three
years despite the company spending heavily on promotion. Growth rates in UK wages
below the rate of inflation and uncertainty caused by Brexit have affected the
company’s sales. The company has struggled to compete with lower price retailers
and with those who have effective online stores. It has also faced criticism about the
design of some of its clothing ranges which are judged by some analysts to be ‘old
fashioned’.
International revenue decreased 7.9 per cent in 2018 compared with 2017. This was
driven by the company’s sale of loss-making stores and the sale of its operations in
places such as Hong Kong. However, the company’s like-for-like sales revenue
(comparing revenue from the same stores over two different years) rose by 2.8 per
cent between 2017 and 2018. The company has closed more than 50 stores and
incurred significant costs as a result. It intends to focus on larger countries where
sales potential is higher and to work with franchise, or joint-venture partners.
The company’s profits slumped in 2018. Much of this was caused by the costs
associated with closing stores in the UK and overseas. Its accounts show £321 million
in costs linked to store closures.
How to turn the business around
Steve Rowe, M&S plc’s CEO, set out a transformation plan in November 2017. This
entails closing around 100 stores in the UK by 2022. It also includes setting a number
of corporate objectives for the company. These include:
• lower cost retailing. The company aims to reduce its costs by £350 million per year
to allow it to offer customers better value for money by lowering prices
• becoming a ‘digital first’ retailer. Working with Microsoft and other technology
companies, M&S plc aims to use technology to reduce the quantity of inventories
held as well as using employees more efficiently
• reaching customers more efficiently. This involves improving the customer
experience when buying online and closing less popular stores.
Item 2018 (£m) 2017 (£m)
Revenue 10.698.2 10,622.0
Profit for the year 29.1 115.7
Current assets 1,317.9 1,723.3
Current liabilities 1826.0 2,368.0
Non-current liabilities 2,770.0 2,774.1
Total equity 2,954.2 3,150.4
Dividend per share 18.7 pence 18.7 pence
Share price September 28th 287 pence 355 pence
Table U7a.1 Selected financial data for M&S, 2017–18
Source: Marks and Spencer’s annual report, 2018

Item 2018 2017 Percentage

(£m) (£m) change
Revenue from food sales 5,869.9 5,649.0 3.9
Revenue from clothing and home 3,741.1 3,792.7 –1.4
products
Revenue from UK sales 9,611.0 9,441.7 1.8
Revenue from international sales 1,087.2 1,180.3 –7.9
Table U7a.2 Some key facts about M&S, 2018
Source: Marks and Spencer’s annual report, 2018
Practice questions
1 Analyse the potential benefits to M&S from conducting a SWOT analysis prior to
drawing up its transformation plan.
(12 marks)
2 Analyse the factors that may have influenced M&S’s corporate objectives within its
transformation plan.
(12 marks)
3 Discuss whether or not it is possible for M&S’s stakeholders to assess the
company’s performance fully without the use of techniques such as Elkington’s
triple bottom line.
(12 marks)
4 To what extent do you agree with the decision of M&S plc’s directors to close some
of its international stores.
(20 marks)
5 Do you think that the information in Tables 1 and 2 and the case study should
dissuade investors from buying shares in M&S? Justify your view.
(20 marks)
6 To what extent is it essential for all British retailers to increase online operations
and sell their stores to be successful?
(24 marks)
Essays
1 ‘The most important influence on any business’s mission today should be the views
of society.’ To what extent do you agree with this statement?
(25 marks)
2 To what extent is it essential to analyse a business’s financial and non-financial
information to be able to assess its future performance accurately?
(25 marks)
Chapter 28 Analysing the external
environment: political and legal change
Introduction
This chapter examines the effects of changes in the political and legal environments in which
businesses operate. It considers the ways in which these changes may impact on strategic and
functional decision making within a business and the extent to which the changes may provide
opportunities or pose threats.
What it is important to know by the end of this chapter:
• the impact of changes in the political and legal environment, including the scope and effects of
UK and EU law related to competition, the labour market and environmental legislation, on
strategic and functional decision making within a business
• have an awareness of UK and EU Government policy related to enterprise, the role of
regulators, infrastructure, the environment and international trade.
The political environment
The political environment comprises actions taken by local, national or international authorities
that affect the activities of businesses. A number of areas of government policy may be
considered to shape the political environment, including:
• encouraging enterprise
• the regulation of markets
• the country’s infrastructure
• issues relating to the environment
• international trade.
In this chapter we will examine each of these elements of the political environment and consider
how changes in them may impact upon decision making within businesses.
In June 2016, the people of the UK voted in a referendum to leave the European Union (EU).
The process of leaving has become known as Brexit. The terms of the UK’s departure and its
future relationship with the EU are uncertain. However, the European Union (Withdrawal) Act
2018 became law in 2018. This Act will keep most existing EU law as UK domestic law after
Brexit in order to ensure the continuity and completeness of the UK’s legal system. It will also
give considerable powers to the Government to amend the retained EU law in order to ‘remedy
or mitigate’ any ‘failure’ or ‘deficiency’ in retained EU law arising from the UK’s withdrawal
from the EU. Furthermore, current and future governments are likely to introduce new legislation
over time to replace existing EU law. However, at the time of writing what changes will be made
are unclear.

Figure 28.1 The composition of the political environment

Figure 28.2 Self-employment data for the UK, 1975–2017

Source: Office for National Statistics (ONS)

Policies affecting enterprise
An enterprise-friendly business environment
The UK government seeks 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. This can be a risky process for those involved as 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 government support is to promote enterprise and to
reduce the degree of risk.

Key terms
Enterprise is the skill needed to make a new idea work.
Innovation is the successful exploitation of new ideas.

One piece of evidence of whether an economy is promoting enterprise successfully can be shown
by the level of self-employment – although this may also indicate a lack of employment
opportunities. According to data published by the Office for National Statistics (ONS) 4.7
million people in the UK were self-employed in their main job accounting for approximately 13
per cent of those in work in 2017. (See Figure 28.2.) This is among the largest number of people
ever to be self-employed in the UK and an indication that the country has a strong enterprise
culture. This offers important benefits to the government and to businesses and is likely to
encourage people to take the risk of starting a business.
Decisions and actions by the government and its agencies have encouraged and promoted the
development of enterprise and innovation in the UK in a number of ways, both financial and
non-financial, and these have changed significantly in recent years.

Handling data
Explain how the number of self-employed people in the UK could rise at the same
time as falling as a percentage of those in work.

Financial support for enterprise

The British Business Bank 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 effectively. It does not lend directly to
businesses, but will work alongside the private sector partners. It will pull in more private-sector
funding to maximise its impact. In 2018, the funds provided through the Banks’s activities
reached £12.25 billion, a 33 per cent increase on the previous 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.
• 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 £1,274 over 26 weeks
and access to a loan of up to £2,500.
• Start-up loans. This scheme provides loans to businesses of up to £25,000, with the average
being £7,200. There is a fixed interest rate of 6 per cent and repayment can be made over any
period between one and five years.
• Enterprise Finance Guarantee (EFG). EFG is a loan guarantee scheme. It allows banks and
other lenders to 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 £1,000 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
£3.2bn.

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’.
One element of the government’s 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).

Business in focus: Four Anjels

In 2010, entrepreneurs Andrea Stevens, Steve Greenhalgh, Dr Barry Cronin and

Trevor Stephens founded Four Anjels – a Cotswolds-based bakery that employs
passionate people to create high-quality baked goods on a large scale while retaining
a home-baked taste.
Starting with just one oven and five members of staff, they began by producing a
range of biscuits for a small number of independent stores. Four Anjels has since
expanded to employ 39 people and it now supplies major chains including Pret A
Manger, Caffè Nero and Graze.
In 2016, it became apparent that changes were required in order to sustain the
planned development of the business. Project Manager Phil Stevens explains: ‘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.’
 After meeting a variety of business advisors and consultants, Phil remained sceptical
about the advice being offered as it did not seem to fully consider the needs of their
specific business. Finally, they made contact with the Growth Hub and were
introduced to Business Guide Sarah Gregg. Phil recalls: ‘We knew from the very first
meeting that we had found the right partner. She took the time to really get to grips
with our business and requirements, and then showed us how the Growth Hub could
provide us with effective support.’
Attending Growth Hub events and meeting a financial advice panel provided the
entrepreneurs with a valuable focus and delivered real results for Four Anjels.
Source: Adapted from The Growth Hub (Gloucestershire)

Practice questions
1 Analyse why the support provided by Gloucestershire Growth Hub was an
important element in expanding Four Anjels.
(9 marks)
2 Do you think that non-financial help is more important than financial support to
establish an enterprise-friendly business environment? Justify your view.
(16 marks)

Other aspects of its 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
• working 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 universities, to bring together the skills and technology 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 billion. UK Research and Innovation brings together the seven Research Councils,
Innovate UK as well as Research England.
• 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).
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 European Union’s enterprise policies

Creating a business-friendly environment for existing small and medium-sized enterprises as
well as potential entrepreneurs is one of the EU’s main objectives. The European Commission
(the organisation responsible for implementing the EU’s decisions) is working together with the
EU countries on developing policies to support start-up, small and medium-sized businesses. It
also monitors the progress of the implementation of these policies and promotes the sharing of
best practices in encouraging and supporting enterprise. Following Brexit, the UK will at some
point cease to receive support from these policies.

The effects of enterprise policies

The impact of these policies to encourage enterprise and innovation is greatest amongst 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.
The role of regulators
Regulators operate in a number of capacities within the UK economy. The UK government
believes that all regulators should carry out their activities in a way that supports those they
regulate to comply with rules and, critically, to expand their enterprises. Regulation can relate to
a variety of business activities, including pricing and their impact on the environment.

Key terms
Regulation is the enforcement of principles or rules that result from the passing of a
law or series of laws.
Financial services are any products which are financial in nature and include those
supplied by banks, insurance companies and financial advisers.
Monopoly exists when there is a single supplier within a market.

There are a number of aspects of regulation that affect business activity in the UK and shape the
political environment in which all firms operate. These include:
• regulation with the aim of creating free and fair competition between businesses
• regulation of certain high-profile industries such as banking and financial services
• regulation of privatised monopolies to protect consumers and other businesses
• self-regulation by businesses.

Regulation to create free and fair competition

Regulation can relate to any industry or business in the UK that is not operating in the best
interests of consumers, although, as we shall see on the following page, certain industries receive
particularly close scrutiny.
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. These may be considered threats to businesses but may also provide opportunities.
• Imposing ‘windfall’ taxes. These are taxes on profits that are considered to be excessive and
are more likely to be incurred if the business or businesses are thought to have too much
market power. In 1997, the UK government levied windfall taxes on utilities that had been
privatised (for example, British Gas, British Telecom and Railtrack) producing revenue
estimated to be £5 billion.
• Controlling prices. This action by regulators frequently takes the form of limiting price rises
to the current rate of inflation plus or minus some figure. For example, Ofwat, the regulator
that controls the UK firms that supply households and businesses with water, has required all
water companies in the UK to send it their business plans for the period 2020–2025. Ofwat
will scrutinise these plans and ensure that the companies implement its pledge to reduce
households’ water bills by between £15 and £25 a year. Regulators can provide firms with
 certainty about future prices over the medium term.
• Restricting rates of return on capital invested by businesses. Using measures such as return
on capital employed (ROCE) can prevent businesses earning excessive profits and relates
returns to the amount invested by the enterprise. Imposing this type of control helps to prevent
businesses with significant market power from charging consumers excessively high prices. A
significant weakness of this approach is that it removes pressure on the firms concerned to
control costs, as allowing these to increase will reduce profitability. Thus, consumers may face
high prices.
• Unbundled access. This form of regulation allows new entrants to a specific market to have
access to the facilities of existing producers which may be difficult to duplicate. The aim is to
encourage competition. In the UK, Royal Mail (which has dominated UK postal services for
centuries and was privatised in 2013) has been forced to allow rival firms such as UK Mail to
use its local delivery service.
Whilst those regulations that control prices or limit profitability are likely to be seen as threats,
unbundled access offers opportunities to businesses to enter markets and could have significant
implications for strategic decision making.

Regulation of high-profile industries

Some industries in the UK 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.
The UK’s banks have received much criticism for their role in precipitating the financial crisis
which preceded the recession of 2008–9 by allowing their investment divisions to engage in very
risky banking practices that threatened the survival of some of the UK’s largest banks. The UK’s
banks are particularly large relative to the size of the economy and, therefore, if they face
problems, the impact on other businesses and the economy as a whole can be immense, as was
seen in 2008. This is why they are subject to tight regulation now.
Additionally, banks have also been criticised, along with some insurance companies, for acting
against the best interests of consumers by ‘mis-selling’ Payment Protection Insurance (PPI) to
customers who did not need it.
As a consequence, the banking and financial services industries are subject to regulation by a
number of organisations, including those listed below. The Financial Services Act of 2012
replaced the Financial Services Authority with two new regulators:
• The Prudential Regulation Authority (PRA). The PRA is controlled by the Bank of England
and operates with the aim of establishing a stable financial system for the UK. It supervises
approximately 1,500 banks, building societies, insurers and major investment firms in the UK.
The role of the PRA is to promote the safety and soundness of these financial services
businesses and, specifically for insurers, to ensure that policyholders are protected.
• The Financial Conduct Authority (FCA). The FCA operates independently from the Bank of
England and was given the responsibility of ensuring that financial markets operate effectively
and that acceptable levels of competition exist. It also scrutinises the actions of businesses in
financial markets to avoid any unacceptable behaviour.
This includes regulating the behaviour of 58,000 businesses providing financial services.
The European Union also has some regulatory powers in relation to banking in the UK and other
EU member states. The European Banking Authority subjects banks to regular tests to judge
whether they would be able to cope with future financial shocks.

Regulation of privatised utilities

The UK privatised many state-owned monopolies that supplied products including water,
electricity and 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 are protected and that these natural monopolies do not
charge excessive prices and make excessive profits.

Self-regulation
In some industries, the government has 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 it operates properly and as intended.
The UK’s supermarkets are large and potentially powerful. They agreed in 2002 to operate a
voluntary code of conduct. However, critics argue that such self-regulation may not be tough
enough. This may have prompted the UK government to appoint a Groceries Code Adjudicator
to oversee the relationship between supermarkets and their suppliers. The adjudicator ensures
that large supermarkets treat their direct suppliers lawfully and fairly, investigates complaints
and arbitrates in disputes. This appointment may have functional implications for supermarkets
and lead to operational decisions that are more favourable to suppliers.
• At a functional level, they may appoint specialists in relevant areas to help shape lower risk
decisions.
• Strategically, they may opt to avoid trading in markets that are most tightly regulated. This has
been one factor influencing strategic decisions made by major UK banks, for example, the
Lloyds Banking Group’s decision to reduce their involvement in tightly regulated investment
banking.

Business in focus: SSE plc

SSE plc, formerly known as Scottish and Southern Energy, has been fined £1 million
for issuing inaccurate and misleading annual statements to pre-payment meter
customers between 2014 and 2015, regulator Ofgem has announced. In 2018, SSE
had a 14 per cent share of the UK market for supplying energy to households – that
represents over 7 million customers. The company recorded an operating profit of
£1,719 million in 2017. SSE is one of the six large companies that dominate the UK
market for gas and electricity; Ofgem is keen to see more small suppliers have
access to this market.
In a report published in 2018, the regulator said an investigation found that between
June 2014 and September 2015, SSE sent out 1.15 million inaccurate and misleading
 annual statements to 580,000 pre-payment meter customers. Due to an IT coding
error, these annual statements had inaccurate information on the alternative cheaper
tariff available to customers and inaccurate estimates of how much they could save
annually by switching to them, Ofgem said.
Some statements also overestimated the annual savings the customers could make
by changing their pre-payment meter to a standard credit meter paying by direct debit,
as well as by moving to paperless billing.
Source: Adapted from Energy Voice, June 7th, 2018

Practice questions
1 Analyse why SSE has considerable power to act against the best interests of
consumers in the UK.
(9 marks)
2 Do the activities of regulators always pose a threat to businesses? Justify your
view.
(16 marks)

However, regulation can also provide important opportunities, most notably in providing a stable
long-term environment in which businesses can operate. A recent World Economic Forum report
highlighted the successful track record of the UK regulatory system in facilitating significant
levels of investment. Investment in the UK’s water and sewerage industry exceeded £130 billion
between 1989 and 2017. Such strategic investment decisions may not have taken place in an
unregulated market where the future was less certain. Unbundling access to markets as part of
the regulatory process also assists in reducing barriers to entry to particular markets and provides
competitive opportunities for new entrant firms.

The impact of regulation on UK businesses

Regulation can be a threat to businesses in that it can control and limit their ability to charge high
prices and to generate maximum profits from a market. It may also represent a threat in terms of
adverse publicity if a business is fined by a regulator for unacceptable behaviour, as in the case
of SSE plc outlined in the Business in focus above. Regulation in some industries is becoming
stricter and this may result in businesses taking a range of functional and strategic decisions to
reduce the impact of any threat. The Office for National Statistics (ONS) estimates that public
sector infrastructure spending was £17.2 billion in 2016, compared with private sector
infrastructure investment amounting to £15.4 billion. The public sector mainly invests in
transport infrastructure, whilst the private sector mainly invests in energy infrastructure.

Handling data
1 Is there any correlation between the two sets of data in figures 28.3a and 28.3b
over the period 2006–2016?
2 Would you expect there to be any correlation? Why do you think this?
Infrastructure
Key term
Infrastructure refers to the physical and organisational structure required to allow
both society and an economy to operate effectively, e.g. transport and communication
networks.

Figure 28.3a Investment in infrastructure by the government in the UK, 2006–2016

Notes on the figures: CG refers to central government and LG to local government. The data on private
sector investment is described by the ONS as ‘experimental’.
Figure 28.3b Investment in infrastructure by the private sector in the UK, 1998–2016

Source: Office for National Statistics (ONS)

The UK’s infrastructure

The UK’s infrastructure is essential for its businesses to be able to operate. Without effective
systems of transport, communications and energy supply, UK businesses would not be able to
engage in production and supply goods 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.
The UK’s infrastructure has received considerable attention recently. The UK has not invested as
heavily as some other countries in its infrastructure over the past 20 to 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.
In February 2015 the Infrastructure Act became law. This Act is intended to lead to large-scale
investment into the UK economy by, for example:
• improving the funding and management of our major roads
• streamlining the planning process for major projects
• helping communities become stakeholders in renewable electricity projects
• maximising the recovery of oil and gas from UK reserves.
The Crossrail Project in London is an example of the UK’s programme of investment in
infrastructure; building of a high-speed rail line to connect London to Birmingham has
commenced, known as HS2.

Infrastructure, opportunities and threats and decision making

Infrastructure projects create significant opportunities for businesses in the UK and overseas.
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 Crossrail. The government’s commitment to high levels of
investment in the UK’s infrastructure may have significant implications for senior managers in
many industries, not least construction.
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 will create 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. The change in
this element of the UK’s political environment has enabled the company’s management team to
make long-term strategic decisions such as investing in new production facilities and developing
new technologies for its trains.

Figure 28.4 Crossrail is Europe’s largest construction project. The project will provide a new railway
connection across London, and has generated contracts worth over £5.5 billion for construction
companies. It has created 55,000 jobs.

However, developments in infrastructure can also pose a threat to some businesses. New
transport systems may result in previous ones receiving less business. The expansion of one
airport (as is expected to take place at Heathrow in London) may result in fewer passengers at
nearby airports. As a consequence, airlines may take decisions not to operate from these airports.
The development of HS2, the high-speed railway line from London to Manchester and Leeds via
Birmingham is forecast to have a significant negative impact on businesses. The government-
owned HS2 Ltd, which is responsible for the project has admitted that 985 businesses will be
closed as a result of land being required for the new railway. Approximately 2,380 jobs will be
lost and 19, 590 relocated. However, HS2 Ltd predicts that 2,340 jobs will be created.

What do you think?

Does the state of the UK’s infrastructure have a major impact on strategic decisions
made by foreign multinationals on whether or not to locate in this country?
The natural environment
The importance of the natural environment on the political agenda in the UK has varied since
2000. Prior to the deep recession of 2008–9, it was a significant factor influencing governmental
decision making. More recently, greater priority has been given to other factors such as reducing
government expenditure and promoting economic growth. As a consequence, actions and
policies to protect the natural environment have become less prominent. In 2015, the government
announced that simpler and smarter environment regulations will provide savings to businesses
of more than £1 billion over five years. The new regulations to protect the environment are
forecast to be cheaper and easier for businesses to follow. The government has reassured
stakeholders that enforcement action will be targeted at companies that are not abiding by the
rules.
It is easy to think of ways in which the desire of the authorities to protect the natural environment
either poses threats or limits the opportunities available to businesses. For example, the
opposition to fracking in many parts of the UK poses a threat to what is a new industry which
could grow quickly. Hydraulic fracturing, usually shortened to fracking, is a technique designed
to recover gas and oil from shale rock. Fracking is the process of drilling down into the earth
before a high-pressure water mixture is directed at the rock to release the gas inside. The
activities of firms involved in the fracking industry are tightly controlled. However, there are
fears about the environmental consequences of this operation which has resulted in a ban on the
process in Scotland and Greater Manchester, and the Major of London is in favour of a ban for
the capital. The activities of many other industries are also limited by environmental
considerations. Thus, house construction companies are unable to build freely in many areas
such as green belt zones around London and other cities and in national parks such as the Lake
District. This element of the political environment frequently increases the costs of production
for businesses by making production more complex and expensive.

Environmental opportunities and decision making

The government’s desire to protect the natural environment does create many opportunities for
businesses. Laws designed to protect the environment, which we cover later in this chapter,
create work for businesses that provide expertise and advice on how to comply with them. For
example, RSK plc was founded in 1989 to provide advice to other businesses on environmental
matters. Since that time, it has grown quickly from its UK base to employ more than 2,300 staff
in 23 countries. The growing emphasis on the natural environment in countries across the EU has
seen RSK plc expand by opening branch offices in Europe, Africa and the Middle East. The laws
also provide opportunities for businesses that supply equipment to allow firms to comply with
relevant legislation, for example, filters to reduce air pollution.
Creating renewable sources of energy is a major growth industry throughout the world as
governments seek to meet targets for reducing emissions of carbon. The government in the UK is
encouraging investment by private businesses into wind farms. However, in 2018 it decided not
to invest in the creation of lagoons in coastal locations to harness tidal power to generate
electricity. Six lagoons had been planned for the UK with the potential to generate 8 per cent of
the UK’s electricity needs. The lagoons would have required an investment of £30 billion but
would have had enormous implications for a wide range of other businesses. The government’s
decision has put their futures into doubt.

Figure 28.5 Actual and forecast sources of electricity generation, 2013–30

Source: Department for Energy and Climate Change

Developing renewable energy sources will create enormous amounts of work for the firms
involved, but will represent a threat to other energy suppliers, particularly businesses that
generate energy by burning fossil fuels such as coal, gas and oil. The government’s support for
the use of wind power to generate energy is part of its policy to increase the proportion of the
UK’s electricity supply that is supplied from renewable sources. The government’s targets are
shown in Figure 28.5.
International trade
The UK government is a keen supporter of international trade recognising that it brings many
benefits to the UK, not least revenue and employment. The UK government hopes that, as a
result of Brexit, it will be able to negotiate a series of free trade deals with countries such as
Australia, India and the USA. Free trade exists when goods and services can move between
countries without any barriers being imposed by governments. It operates a number of initiatives
to support businesses in selling goods and services in international markets. Many of these are
offered through the Department for International Trade, a government department that works
with UK businesses to help them to succeed in international markets. This Department supports
UK exporters in a variety of ways.

Business in focus: Dryden Aqua Ltd

Dryden Aqua Ltd is a marine biological company specialising in innovative and

sustainable water treatment technologies. Dryden Aqua’s manufacturing and research
is based in Edinburgh. It has a sales revenue of £5 million. Its flagship product is its
Activated Filter Media (AFM), which is used in water filters as a highly effective
alternative to sand. It removes harmful organisms and toxins from water.
Support from UKTI has helped Dryden Aqua to increase its exports substantially and
90 per cent of sales of AFM are now to overseas markets. Support can take a number
of forms including protection against non-payment.
1. Export success in Bangladesh
Howard Dryden attended a seminar organised by UKTI in Dhaka, Bangladesh. During
his visit he was briefed by UKTI on the local business environment and opportunities
in Bangladesh that were not widely known about. Dryden Aqua has since secured a
£100,000 contract with Square Pharmaceuticals for water treatment of all the water
entering its facility.
2. More success in the United Arab Emirates
Dryden Aqua has also worked with UKTI to build up its business in the United Arab
Emirates (UAE). The company has sold:
• swimming pool systems to His Highness Sheikh Mohammed bin Rashid Al
Maktoum, Vice President and Prime Minister of the UAE and Ruler of Dubai
• an AFM treatment system for the aquarium at the iconic, Burj Al Arab Jumeirah
Hotel
• a water treatment system for the 5-star Atlantis hotel complex.
Howard Dryden said:

We have been going to Dubai for around ten years. We have already provided
our systems into high-profile locations and we’re now helping to design the new
zoo being built there. Around 80 per cent of the world’s desalination projects are
 happening in the Gulf region so we see this as an area of huge potential growth
for our business.
He also stressed the value of the UK government in helping to connect UK exporters
with contacts and partners overseas.
Source: Adapted from the UKTI website

Practice questions
1 Analyse the possible difficulties Dryden Aqua may have encountered in exporting
its products for the first time.
(9 marks)
2 Do you think providing contacts with possible customers and partners overseas is
the best way that Department for International Trade can help UK exporters to
exploit opportunities in overseas markets? Justify your views.
(16 marks)

• It organises trade fairs overseas to promote UK exports to potential buyers.

• It is behind the ‘Open to Export’ initiative which brings exporting businesses together to
provide mutual help and also provides relevant training.
• It is creating a new trading framework for the UK as it leaves the European Union.
• The Department works closely with other agencies that assist business and enterprise to ensure
that exporters receive integrated support from the UK government. For example, it cooperates
with UK Export Finance who can provide the necessary financial support and guarantees
against non-payment.
The UK economy is very ‘open’ which means that it relies heavily on trade and imports and
exports a high proportion of its production. For this reason, the international trade dimension of
the political environment is important. This affects all businesses, whether or not they export,
because foreign businesses seek to sell their products in the UK’s domestic market.
The volume of trade has increased as globalisation has taken hold and, despite the setback caused
by the recession following the global financial crisis in 2008, the volume of global trade has
generally risen more quickly than the value of the world’s GDP. This is illustrated in Figure 28.6
and means that international trade is steadily becoming a more important component of the
political environment in which businesses operate.

Handling data
Does the information in Figure 28.6 suggest that there is a relationship between
changes in GDP and changes in the volume of exports? Would this information be of
value to a manager responsible for overseas sales?
Figure 28.6 Percentage changes in the volume of global exports and value of GDP, 2007–2017

Source: World Trade Organisation

The trend towards the globalisation of markets has been one factor increasing the volume of
world trade. This has been encouraged by a series of decisions by governments and the UK
government has played its part in these decisions. We shall now consider two key developments
that have helped to shape international markets for goods and services.

Greater freedom of trade

The World Trade Organisation (WTO) was established in 1995 as a forum for trade negotiations
and to resolve trade disputes. At the start of 2019, the WTO had 164 countries as members and it
plays a prominent role in promoting international trade.
Lowering trade barriers is one of the most obvious means the WTO uses to encourage trade. The
barriers concerned include customs duties (or tariffs) and measures such as import bans or quotas
that restrict quantities selectively. From time to time, other barriers to trade such as bureaucracy
and exchange rate policies have also been discussed at WTO meetings. The WTO focuses on
lowering tariffs (customs duties) on imported goods. As a result of its efforts industrial countries’
tariff rates on industrial goods have fallen steadily to less than 4 per cent.
Although the actions of the WTO have attracted much opposition from pressure groups, it has
encouraged nations to take political decisions aimed at freeing trade and promoting economic
growth. The current round of negotiations at Doha have lasted for more than 17 years without a
clear and agreed outcome, but this should not detract from the WTO’s achievements.

The growth of the European Union

The European Union (EU) currently has 28 member states constituting a market of over 508
million people – larger than the markets of Japan and the US added together. In 2004, the EU
expanded to 25 states with the entry of Cyprus, the Czech Republic, Estonia, Hungary, Latvia,
Lithuania, Malta, Poland, the Slovak Republic and Slovenia. In 2007, Bulgaria and Romania
joined and finally Croatia became a member in 2013. Despite recent financial difficulties in the
eurozone countries, Turkey has made an application to join the EU, while some former Balkan
states such as Kosovo and Serbia are engaged in discussions. In contrast, the UK is expected to
leave the EU reducing the EU’s membership to 27.

The impact of increased trade

The reduction of barriers to international trade and the enlargement of the EU offer businesses
considerable opportunities. It is easier for UK businesses to sell their products in European
markets than in the past. The expansion of the EU offers UK businesses unrestricted access to
millions of additional consumers as the EU population increased to 513 million in 2018. Firms
expect to achieve increased sales and perhaps to benefit from economies of scale in supplying
these new and extended markets. Some high-quality UK products such as luxury cars (Land
Rover and Jaguar, for example), fashion clothing (Burberry) and whisky (from Scottish
distilleries) have sold well in global markets. Jaguar Land Rover has responded to these and
other global opportunities by making a number of strategic decisions including the following.
• Investing £240 million over a five-year period in building a factory in Itatiaia in Brazil.
• Developing a new factory in Nitra in Slovakia, involving an investment of £1 billion. This
factory will build the Land Rover Discovery.

What do you think?

Jaguar Land Rover’s decision to invest £1 billion in new production facilities at its
Slovakian factory was a strategic one. What types of functional decisions might it also
have to make to carry through its expansion plans?

Furthermore, UK businesses have chosen to take the opportunity given by the expansion of the
EU to make decisions to locate in countries such as Poland and Hungary to benefit from lower
costs and, initially at least, fewer controls on business activity. The states of Eastern Europe have
proved particularly attractive to manufacturers seeking to expand or transfer their European
productive capacity to lower cost locations.
There are, of course, downsides to the increased freedom to trade and the expansion of the EU.
Greater competition is likely to appear in some industries where the relatively undeveloped
economies of eastern and southern Europe have an advantage. The French car producer Renault
bought the Romanian car maker Dacia in 1999 and started producing Europe’s cheapest cars.
The company manufactured 655,000 vehicles in 2017. The success of this project has significant
implications for businesses in the motor vehicle manufacturing industry, including those based in
the UK.
The freeing of global trade has brought other threats. Highly sophisticated foreign companies,
some with access to relatively cheap sources of labour are posing a real threat in domestic UK
markets. UK consumers are familiar with the products supplied by Starbucks, Toyota and
Samsung, but will increasingly see goods and services supplied by other companies from
developing countries such as China and India. Lenovo is an example of a successful Chinese
technology company; many UK retailers have taken decisions to sell its products.
The threat from overseas takes another form as well. Many UK businesses have been taken over
by foreign companies seeking a foothold in the EU market or by foreign governments (such as
that of China) looking for profitable investments. Cadbury, Jaguar Land Rover and Asda are
among the famous UK enterprises that are owned by foreign companies. The number of foreign
owned businesses in the UK increased by less than one per cent between 2015 and 2016, but
their contribution to UK GDP increased by approximately 3.8 per cent. This may be partly due to
foreign owned firms being larger. In 2016, the sales revenue of nearly half of foreign-owned
businesses in the UK exceeded £0.5 million; the equivalent figure for UK-owned businesses was
33 per cent.
The legal environment
The law is a framework of rules governing the way in which our society operates. These rules
apply to businesses as well as individuals. The legal framework affects businesses in a number of
ways impacting on almost all areas of business activity. Marketing, production, employment,
relationships with customers and competitors and even the establishment of the business itself
are examples of business operations influenced by the law.
We shall consider three elements of the legal environment:
• competition
• the employment of labour
• environmental issues.
The law relating to competition
Competition law in the UK is intended to protect businesses and consumers from the effects of
anti-competitive practices. The UK government (along with most other governments) believes
that free and fair competition in markets brings many benefits. The government set out the
importance of competition to the 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, 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: Department of Trade and Industry
Businesses operating in the UK are subject to both UK and EU competition law. UK legislation
relates to the activities of businesses in this country, whereas EU laws are designed to deal with
uncompetitive business practices that have an impact across more than one member state. The
major competition laws in the UK are:
• the Competition Act, 1998
• the Enterprise Act, 2002
• the Enterprise and Regulatory Reform Act, 2013.
(We look at these in a little more detail later in this section.)
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 amongst its businesses.
2 Abuse of a dominant market position. The European Court has defined a dominant market
position as: ‘… a position of economic strength enjoyed by an undertaking which enables it to
prevent effective competition being maintained on 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 EU-wide. 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.
 Key terms
Cartels exist when two or more businesses collude to control prices and/or
production levels to limit the extent of competition within a market.
Anti-competitive practices are actions taken by businesses to limit the extent of
rivalry that exists within a particular market, or the use of unfair trading activities.
A dominant market position is a position of economic strength enjoyed by a
business which enables it to prevent effective competition being maintained within a
market.
A merger is the joining together of two businesses to form a new, larger enterprise.

Figure 28.7 The extent of competition law

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 legislative 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.

1. The Competition Act, 1998

This Act 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.

2. The Enterprise Act, 2002

This Act amended the Competition Act and strengthened the power of the UK authorities to deal
with anti-competitive practices and market dominance. The Act had a number of important
provisions:
• It placed a clear focus on the impact of the business’s activities on the degree of competition.
Practices were now judged as to whether they created a ‘substantial lessening of competition’
rather than whether they were ‘in the public interest’.
• It imposed 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 empowered consumer organisations to make complaints (known as ‘supercomplaints’) to the
CMA about markets that are not working well for consumers.
For example, in 2018, Citizens Advice used this legislation to make a complaint about businesses
charging loyal customers higher prices than new customers for the same products. The CMA is
to investigate this supercomplaint.
• There are greater opportunities for victims of anti-competitive behaviour to gain redress.
Consumer bodies will be able to make claims on behalf of individuals who have suffered. This
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 to be less influenced by politicians and more independent.

3. Enterprise and Regulatory Reform Act, 2013

This Act was wide ranging including the creation of the Green Investment Bank, established
with the aim of providing financial support for environmentally-friendly business practices. It
also simplified and strengthened laws relating to equality in employment. Its main provisions
relating to competition were 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 became responsible for competition
policy.
• It made it quicker and simpler for businesses, especially small and medium-sized enterprises,
to make legal challenges to anti-competitive behaviour.
• It also made it easier for consumers and small businesses who have suffered loss due to anti-
competitive behaviour to obtain redress.

EU competition policy
The UK’s competition policy is integrated with that operated by the EU and is likely to remain
so in the short-term, despite Brexit. UK law applies if the scope of the anti-competitive
behaviour is limited to the UK, and EU competition law applies if its impact extends across
Europe. The scope of the law is similar for both authorities.
For example, in the case of mergers and takeovers, the EU has jurisdiction over those which have
a ‘Community (or EU) dimension’. The potential impact of mergers and takeovers is determined
by a sales revenue test similar to that applied by the UK competition authorities. The CMA used
this approach in the UK to assess the impact of the merger between Sainsbury’s and Asda in
2018. The CMA’s initial findings were that the newly merged business might hold a position in a
number of localities that could be considered too dominant (See the Business in focus below).
Laws relating to the labour market
Those laws in the UK that relate to the labour market can be divided into two categories as
shown in Figure 28.8:
• those that relate to individual employees
• those that are collective and apply to groups of employees such as trade unions.

Figure 28.8 UK employment legislation

Business in focus: Sainsbury’s, Asda and the CMA

In August 2018, the Competition and Markets Authority (CMA) opened its initial or
Phase 1 investigation into the merger announced between Sainsbury’s and Asda. The
deal would create business with revenues of £51 billion, a network of 2,800
Sainsbury’s, Asda and Argos stores. Sainsbury’s and Asda had claimed that the deal
would result in cheaper everyday items, pledging cuts of around 10 per cent.
The CMA confirmed, through its Phase 1 investigation, that the deal raised sufficient
concerns to be referred for a more in-depth review. The companies are two of the
largest grocery retailers in the UK, holding a 31.4 per cent market share in the UK in
January 2019. Their stores overlap in hundreds of local areas, where shoppers could
face higher prices or a worse quality of service.
These concerns were considered further in the Phase 2 investigation, along with other
issues raised with the CMA – including those relating to fuel, general merchandise
(such as clothing) and increased ‘buyer power’ over suppliers.
The Phase 2 investigation was a more in-depth review, led by an inquiry group
chosen from the CMA’s independent panel members. This group was chaired by
Stuart McIntosh. The group gathered evidence – in particular through customer
surveys and engagement with other retailers, suppliers and industry bodies – to
inform its detailed analysis. In April 2019, the CMA decided against the merger of the
two companies.
 Practice questions
1 Analyse why the CMA’s investigation may have represented both a threat and an
opportunity for grocery retailers in the UK.
(9 marks)
2 The CMA’s investigation ruled against the merger. To what extent do you think this
is a good outcome?
(16 marks)

Individual labour law

This aspect of employment legislation refers to the rights and obligations of individual
employees. The amount and scope of individual labour law has increased in recent years, in part
encouraged by the growing influence of the EU on business matters in the UK.
A number of the most important Acts relating to individuals in employment are explained as
follows:
• Working Time Regulations, 1998. This EU legislation (hence the term ‘regulation’) set a
limit on the hours that employees can be required to work each week to 48 hours. Employees
can opt to work longer hours if they wish, but employers cannot insist that they do so without
inserting an appropriate clause in their contract of employment. The regulations also gave
employees an entitlement to four weeks’ paid annual leave.
• The National Minimum Wage Act, 1998. This highly publicised Act came into force on 1
April 1999 and was amended to provide a higher National Living Wage to those aged 25 and
over in 2016. The key features of this legislation are:
• the new national living wage for employees aged 25 and over of £8.21 from April 2019
• a general hourly minimum wage rate for those aged 21–24 of £7.70 an hour for those aged
20–24 from April 2019
• a minimum level of £6.15 for 18–20 year olds
• all part-time and temporary workers must be paid the minimum wage.
• The penalties for employers who do not pay the minimum wage were increased substantially in
2014.
• Employment Equality (Age) Regulations, 2006. The main theme of this EU inspired law is
that it will be unlawful to discriminate against workers under the age of 65 on the grounds of
age.
• Making someone redundant or barring workers from training or promotion because they are
too old (or too young) will be illegal.
• As they approach 65, workers will have to be given six months’ notice that their employer
wants them to give up their job and retire.
• Equalities Act, 2010. This act replaced a number of earlier anti-discrimination laws in the UK
(such as the Disability Discrimination Act) to simplify and extend 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
• race
• gender reassignment
• marriage and civil partnership
• religion or belief
• pregnancy or maternity
• sex
• sexual orientation.
This Act makes unfair treatment unlawful in the workplace, in education and when supplying
goods and services.
• Enterprise and Regulatory Reform Act, 2013. This law made a number of changes to
employment law. It imposed additional charges on employees wishing to take employers to
industrial tribunals in disputes over employment. It limited the maximum payment for unfair
dismissal to the lower of £74,200 or one year’s gross pay.

Collective labour law

This group of laws apply to the operation of industrial relations and collective bargaining as well
as the activities of trade unions. 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, basic rates of pay, overtime pay, hours of work, holidays, sick leave, retirement benefits
and health-care benefits.
For many years, the law in the UK did not play a significant role in employer–employee
relationships. However, this philosophy was changed when the Conservative governments of the
1980s and early 1990s passed a series of Acts intended to restrict the power of trade unions.
Some examples of these laws, 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. It also restricted picketing to
employees’ own place of work, thereby outlawing ‘secondary picketing’. Closed shops (where
only those in a specific trade union were able to be employed) were only permitted if
supported by at least 80 per cent of the workforce in a secret ballot.
• Trade Union Act, 1984. This legislation made a secret ballot of employees a legal
requirement before industrial action was lawful.
• 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 wages councils and minimum pay rates.
• 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.

Unfair dismissal
Many countries have a legal definition of unfair dismissal. Unfair dismissal is the termination of
a worker’s contract of employment 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 fairly:
• where a job no longer exists – this is redundancy
• gross misconduct – examples of this reason 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.

Health and safety legislation

Health and safety legislation has been enacted to discourage dangerous practices by businesses
and to 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. 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’.
Environmental legislation
The media takes 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 now than in the past.

The costs of polluting the environment

Businesses are acutely aware of their private costs, that is, the costs of production they have to
pay, such as expenses for raw materials and wages. These are relatively easy to calculate and
form part of the assessment of profitability. However, environmental pressure groups and others
have pressed for businesses to acknowledge the costs they create for other groups in society – the
external costs of production. Noise, congestion, air and water pollution all impose costs on other
individuals and groups in society.
The total costs of production equal internal or private costs plus external costs borne by third
parties as shown in Figure 28.9. By ensuring that firms pay all the costs associated with the
production of a product, governments can avoid what is termed ‘market failure’. Laws relating to
the environment have a role to play in achieving this.

Figure 28.9 Internal and external costs of production

The government has passed a series of Acts of Parliament designed to protect the environment.
Two acts are of particular importance:
1 The Environmental Protection Act, 1991. This introduced the notion of integrated pollution
control recognising that to control only a single source of pollution is worthless as damage to
one part of the environment means damage to it all. This Act requires businesses to minimise
pollution as a whole.
2 The Environment Act, 1995. This Act established the Environment Agency with a brief of
coordinating and overseeing environmental protection. The Act also covered the control of
pollution, the conservation of the environment and made provision for restoring contaminated
land and abandoned mines.
The government imposes fines on firms that breach legislation relating to the protection of the
environment. These are intended to force firms to bear the full costs of their production
(including external costs), although environmental pressure groups and other critics believe that
the sums are not sufficient to deter major businesses with annual budgets of billions of pounds.
The government also attempts to encourage ‘greener’ methods of production through the
provision of grants. It created the Carbon Trust, which since April 2001 has given capital grants
to firms who invest in energy-saving technologies and sustainable methods of production. The
intention is to slow the onset of global warming by reducing emissions of carbon dioxide. In a
similar vein, the UK government has established the Green Investment Bank which is the first
bank of its type in the world. It was created in 2012 and provided with an initial £3.8 billion of
public funds. It was used to finance environmentally-friendly projects and to attract other private
sector capital into developing the UK’s green economy. The UK Green Investment Bank was a
non-departmental public body of the Department for Business, Energy and Industrial Strategy
(BEIS), but was sold for £2.3 billion in August 2017. It is now an independent organisation re-
named ‘The Green Investment Group’ and owned by Macquarie Group Limited, an Australian
company.

Business in focus: Royal Dutch Shell to pay £55 million in

compensation

Royal Dutch Shell, the multinational oil exploration, refining and distribution company,
has lost a court case concerning two major oil spillages at its operations in the delta of
the Niger river in Nigeria. The oil spills occurred in 2008 and 2009 and devastated the
lives of 15,600 local residents, not least by polluting waterways and land to the
detriment of fishermen and farmers.
A compensation payment of £55 million was agreed by the company’s Nigerian
subsidiary Shell Petroleum Development Company of Nigeria (SPDC). Each local
resident received a payment of approximately £2,100 whilst £20 million was paid to
the community as a whole. For a community in which the minimum wage is around
£60 a month and where 70 per cent of the population live below the poverty line,
these payments will be life changing.
Royal Dutch Shell had originally offered the local people £4,000 as compensation,
later revised to £18 million. Amnesty International, a pressure group that seeks to
protect human rights, has alleged that the company intentionally underestimated the
spills in an attempt to minimise compensation payments. Royal Dutch Shell has
denied this.
Royal Dutch Shell’s annual profits rose 242 per cent to £8.5 billion in 2018 following a
rise in the price of oil.

Practice questions
1 Analyse why forcing Royal Dutch Shell to pay £55 million is an appropriate means
of combating damage to the environment.
(9 marks)
2 Do you think that financial penalties such as this are a good way to alter the
behaviour of large and powerful multinational companies such as Royal Dutch
 Shell? Justify your view.
(16 marks)

EU and international environmental laws

The EU issues regulations and directives related to environmental protection that must be
implemented into national laws by the 28 member states. This legislation includes the following
aspects which can impact on the activities of businesses:
• climate change
• air, water and land pollution
• waste management
• protection of nature, species and biodiversity
• noise pollution.
Some UK environmental laws come from international agreements. International treaties seek to
regulate diverse environmental matters including climate change, access to environmental
information and participation in environmental decision making. New international agreements
on the environment may be negotiated as the consequences of climate change become
increasingly apparent. Negotiations led by the United Nations took place in Paris in December
2015 and reached a new international climate change agreement that will cover all countries. The
new agreement will be implemented by many countries starting in 2020. However, the USA
withdrew from the Agreement in 2017. The Intergovernmental Panel on Climate Change (IPCC)
produced a report on climate change following two years’ investigation and the assessment of
6,000 scientific studies. This and other reports are available on the IPCC’s website.
The legal environment and decision making
Changes in the legal environment have the potential to affect both functional and strategic
decision making within a business. Clearly how a business responds to a change in the law will
depend upon a number of factors including:
• the type of business and its corporate objectives
• the nature of the legal change.
However, it is possible to argue that in some circumstances, the effects of legal change could
impact more upon functions within the business, rather than the entire organisation. For example,
the Equalities Act of 2010 prohibits businesses from discriminating against employees on the
basis of nine ‘protected’ characteristics. It would be expected that a business’s HR department
would revise policies and approaches in the light of this new legislation. Thus, it would provoke
decision making at a functional level. In the same way, some environmental legislation could be
expected to have the most significant impact on the operations function within a business
requiring it to develop new methods of production that reduce pollution, incorporate the use of
renewable resources and that are sustainable.
UK and EU competition policy, on the other hand, may have more strategic implications. Recent
changes in UK competition legislation have placed greater emphasis on whether or not business
activities result in a ‘substantial lessening of competition’ and make it easier for those affected
by anti-competitive practices to seek legal redress. This may require businesses to make
significant long-term changes to their business models and require strategic decisions to do so. In
2017, the American technology company Google was fined €2.1 billion for abusing its internet
search engine monopoly. The EU said Google had broken EU competition law by exploiting the
power of its search engine to promote its online shopping service, at the expense of other price
comparison sites. The company’s rivals claim it is still abusing its position. This fine and the
subsequent claims may mean that Google has to make some important strategic decisions.
Conclusion
Although some aspects of legal change may be most likely to result in functional responses, it
may be that changes in the political and legal environments are more frequently long-term in
nature. Probably the major change in the political and legal environment over the foreseeable
future will be Brexit which will have profound implications. However, new laws, such as the
Enterprise and Regulatory Reform Act of 2013, will also have an impact on the behaviour of
businesses for many years until new legislation replaces it. This is most unlikely to occur until,
and unless, the legislation proves to be ineffective or circumstances change requiring the law to
be updated. Similarly, changes in the political environment can be expected to persist until a new
government with different policies is elected – this will most probably be several years in the
future. Thus, the approach of the previous coalition government to increasing private and public
expenditure on the country’s infrastructure will have long-term implications.
The long-term nature of changes in these environments is significant for decision making in
businesses. It is more likely to provoke long-term responses from businesses and therefore
impact on strategic as well as functional decisions. For example, most firms engaging in major
infrastructure projects, such as the new high-speed train line from London to the north (HS2),
will need to make long-term commitments that affect all functions within the business. These are
strategic decisions.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 State two areas of government policy which might shape the political environment
in which UK businesses operate.
2 What is meant by the term ‘enterprise-friendly business environment’?
3 List two ways in which the UK government promotes enterprise.
4 State two actions that regulators may take to protect the interests of consumers.
5 What is meant by the term ‘infrastructure’?
6 State two ways in which the UK government’s policies to protect the natural
environment might affect the activities of businesses.
7 List one opportunity available to UK businesses as a result of the expansion of the
European Union after 2004.
8 State the benefits that stakeholders of UK businesses may receive from the
government’s competition policy.
9 What are the three main areas in which competition law operates?
10 What is meant by the term ‘unfair dismissal’?

(b) Short answer questions

1 Explain one possible implication for UK businesses of the government’s policy of
creating an enterprise-friendly environment for businesses.
 (4 marks)
2 Explain one reason why the UK and EU authorities have decided to regulate the
activities of banks more closely.
(5 marks)
3 Explain the UK government’s decisions to improve the quality and extent of the
country’s infrastructure.
(5 marks)
4 Analyse the possible implications of making the UK more open to international
trade for a small food manufacturer that currently only sells within the UK market.
(9 marks)

(c) Data response question

UK cement market
The producers of cement have received a lot of attention from the competition
authorities in the UK. This may be because the supply side is concentrated in the
hands of a few businesses: five large multinational companies account for more than
90 per cent of the UK’s cement market. In 2014, the Competition Commission (the
Competition and Markets Authority’s predecessor) produced a report following an
investigation. The investigation revealed that profit margins in the industry had been
stable, or in some cases had risen, despite a sharp fall in sales following the
recession. As a result of this investigation, one producer, Lafarge Tarmac, was
ordered to sell a cement factory to allow another firm to enter the market. In 2018, the
industry body (the Global Cement and Concrete Association) concluded an agreement
with the CMA to reduce the flow of information about prices and production between
the different companies producing cement.
The UK’s political and legal environments are changing in a number of ways. The UK
government is committed to improving the quality and extent of the UK’s infrastructure.
In December 2017, the UK government set out its latest infrastructure investment
plans. Investment in infrastructure by the government and the private sector will total
£600 billion in the ten years to 2027. Many of the investment projects are very
complex and large, such as HS2, the new rail link from London to Birmingham and the
north, which will cost an estimated £43 billion. Several construction companies are
working together on these large projects. Construction companies bid competitively for
the projects and may require large amounts of human and other resources for the
duration of the work. For example, they may require the services of specialist
companies on matters such as health and safety. Subcontracting is common on
projects such as HS2 to help to meet strict deadlines.
At the same time, diverse employees are receiving greater protection in the workplace
from anti-discrimination laws and the government is encouraging the recruitment of
diverse workforces which offer many benefits to businesses.

Questions
1 Explain two possible effects of the UK government’s anti-discrimination legislation,
 such as the Equalities Act on public companies.
(6 marks)
2 Analyse the possible consequences for cement producers operating in the UK of a
new entrant to the market and a reduction in information flows.
(9 marks)
3 Do you think that the improvements to the UK’s infrastructure are most likely to
impact on functional or strategic decision making within UK construction
companies? Justify your decision.
(16 marks)

(d) Essays
1 ‘The effects of the UK’s competition laws are only significant for large businesses.’
Do you agree with this statement? Justify your view.
(25 marks)
2 To what extent can globalisation be expected to be the dominant force shaping the
political environment for all UK businesses over the next ten years?
(25 marks)
Chapter 29 Analysing the external
environment: economic change
Introduction
This chapter examines the effects of changes in the economic environment in which businesses
operate. It considers the ways in which changes in a range of economic factors such as inflation,
exchange rates and gross domestic product (GDP) may impact on strategic and functional
decision making.
It also covers the ways in which government policies (including fiscal, monetary and trade
policies) have affected decision making within businesses.
Finally, the chapter examines why globalisation is occurring and its importance, along with
emerging economies such as China and India, for businesses.
What it is important to know by the end of this chapter:
• the impact of changes in the UK and the global economic environment (including economic
factors such as GDP, taxation, exchange rates, inflation, fiscal and monetary policy, and open
trade and protectionism) on strategic and functional decision making within a business
• how to understand economic data, interpret changes in economic data for the UK, the
European Union and globally, and the implications of such changes for business
• the reasons for and importance of the greater globalisation of business
• the importance of emerging economies for business.
The economic environment
A business takes strategic and functional decisions to achieve its corporate objectives. Thus, its
managers may decide to enter new markets, takeover smaller competitors or to reduce the selling
price of certain products in pursuit of a corporate objective of growth. These decisions will all be
influenced, however, by the economic environment within which the business trades. Figure 29.1
summarises the major economic forces that might impact upon decision making. The diagram
also emphasises some of the interrelationships that exist between the elements that comprise the
economic environment for businesses.
Factors such as exchange rates, interest rates, inflation and government economic policies
combine to shape the economic environment within which businesses operate. Thus, if an
economy experiences low and possibly even negative rates of inflation, governments will be
likely to reduce interest rates and possibly increase their own spending to offset the effects. The
economic environment will be the cumulative effect of these factors.
Businesses also determine their own economic environments to some extent. The strategic
decisions taken by businesses in response to opportunities and threats that appear in the
economic environment also determine that environment. For example, a decision to expand
production by a number of businesses because an economy’s gross domestic product (GDP) is
rising quickly may contribute to further, and possibly more rapid, rises in GDP.
Gross domestic product (GDP)
All countries suffer fluctuations in the level of activity within their economies. At times,
spending, production 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 its GDP – this figure is
determined by the level of economic activity. A rising level of economic activity will be
reflected in a higher level of GDP.

Figure 29.1 Decision making in an integrated economic environment

The business cycle describes the regular fluctuations in economic activity (and thus GDP) that
occur over time in all economies. Figure 29.2 illustrates a typical business cycle.

Figure 29.2 The stages of the business cycle and changing levels of GDP

Business 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 as they are more confident in job
security. Initially, businesses may respond cautiously through functional decisions to meet
 rising demand by using spare capacity: businesses may utilise idle factories, offices and other
assets. As business confidence increases firms may take strategic decisions to invest in new
non-current assets such as factories, machinery and vehicles. 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. Increasing numbers of firms will take strategic decisions to invest in non-current
assets. However, many sectors of the economy will experience 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 and do so continuously for at least
six months. Rising prices of labour and materials mean that businesses face increased costs of
production. This will begin to reduce profits. In such circumstances the UK government has
tended to reduce interest rates in an attempt to avoid GDP falling further. Falling demand from
consumers and profits are likely to lead to any plans to invest in new factories and offices
being delayed or abandoned. The amount of spare capacity within the economy will rise. Some
businesses will fail and the level of bankruptcies is likely to increase.
• A slump may follow a recession. An economy may enter the upswing stage of the business
cycle without moving through a slump period. Governments may take action to encourage this
through fiscal and monetary policy by, for example, increasing their own spending and
lowering interest rates. A slump sees production at its lowest while unemployment is high.

Key term
A recession is a period of at least six months (or two quarters) during which an
economy’s GDP falls.

Figure 29.2 illustrates a smooth and regular business cycle in operation. In reality, the change in
GDP is likely to be irregular as economic cycles of different duration and intensity operate
simultaneously. This is illustrated in Figure 29.3. GDP is a major influence on the economic
environment: as the level and rate of change of GDP alters, businesses can expect to see
substantial changes in their trading conditions.
Figure 29.3 shows changes in the UK’s level of GDP over a 12-year period in ‘real’ terms. This
means that the data has been adjusted to remove the effects of inflation.

What do you think?

Is it a better idea to start a new business in a recession (when resources may be
cheaper) or when GDP is rising strongly and demand for products is likely to be
greater?
The effects of changes in GDP
Changes in the level of the UK’s GDP have received a great deal of attention in recent years,
mainly because of the deep recession the economy experienced in 2008–9 and its slow recovery.
The effects of changes in the level of GDP as the economy moves through the stages of the
business cycle vary from industry to industry, although Table 29.1 identifies how they
commonly affect decision making. Firms selling products whose demand is sensitive to changes
in income (known as income elastic products), such as designer clothes and foreign holidays,
may find that sales rise strongly in a boom and fall heavily during recession. Conversely,
businesses selling staple products such as foodstuffs where demand is not income elastic, may be
relatively unaffected by changes in the level of GDP.

Figure 29.3 Changes in the UK’s real GDP in the UK, 2008–2018

Source: Office for National Statistics (ONS)

Stage of the Key features Examples of possible decisions

business made by businesses
cycle
Recovery or • Increasing consumer Strategic decisions
upswing expenditure
• Entrepreneurs decide to start a
• Existing spare capacity used new business
• Production rises • Existing firms increase capacity
• Business confidence
strengthens Functional decisions
• Investment increases
• Prices are increased
• Businesses operate nearer to
(or at) full capacity
Boom • Rate of inflation normally Strategic decisions
increases
• Bottlenecks in supply of • Firms enter new geographical
markets
 materials and components
Functional decisions
• Some firms unable to satisfy
demand • Firms sub-contract production to
• Profits probably high – but hit other producers
by rising costs • Businesses increase prices to
dampen demand
Recession • Government reduces interest Strategic decisions
rates
• Financially weak businesses
• Firms reduce production as may decide to stop trading
demand falls
• Firms may enter overseas
• Spare capacity increases markets where demand is
• Business confidence declines stronger
and investment is cut
• Profits fall Functional decisions

• Businesses stockpile products

• Workers required to work short-
time
Slump • Increasing number of Strategic decisions
bankruptcies and insolvencies
• Large-scale redundancies may
• Government lowers interest be announced
rates further
• Factories, offices and stores
• High levels of unemployment closed to reduce capacity
• Low levels of business
confidence and consumer Functional decisions
spending
• Businesses offer basic products
at low prices
• Promotion focuses on price and
easy payment terms
Table 29.1 The business cycle and decision making
It is possible to argue that changes in the level of GDP will only provoke functional decisions 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 periods
when GDP is rising strongly 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, short-time working may take place. Well-managed firms
will predict the onset of a boom or slump and take appropriate action in advance. Furthermore,
responses at a functional level may be all that are required if governments are successful in
eradicating the more extreme effects of the business cycle and, thus, fluctuations in GDP.
Exchange rates
An exchange rate is the price of one country’s currency when expressed in terms of another.
For example, at the time of writing £1 equalled US$1.30, €1.13 or 9.0 Chinese Yuan.

Key terms
An exchange rate is the price of one currency expressed in terms of another, for
example, £1 = €1.25.
A currency is the system of money in general use in a particular country, for
example, in the UK the currency is pounds sterling (£). The value of a currency can
rise and fall against other currencies.

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.
Why do businesses buy foreign currencies?
The main reason why businesses purchase foreign currencies is to pay for goods and services
bought from overseas. Those purchasing products from abroad are normally expected to pay
using the currency of the exporting country. For example, J Sainsbury plc, one of the UK’s major
supermarkets purchases wine from Chile. Chilean wine producers would expect to be paid in
their local currency – Chilean pesos (Ch$). Thus, traders acting on behalf of Sainsbury’s would
sell pounds sterling in order to buy pesos on the foreign exchange market. This process is
illustrated in Figure 29.4.
Demand for foreign currencies may also arise because individuals and businesses wish to invest
in enterprises overseas. Thus, a UK citizen wishing to invest in a Japanese business will require
Japanese Yen to complete the transaction.
The effects of exchange rate changes
Exchange rates can change significantly over time. A rise in the value of a currency is termed
appreciation; a decline in its value is called a depreciation.

Figure 29.4 The operation of the foreign exchange market

In April 2018, £1 exchanged for $1.43. Four months later, in August 2018, the exchange rate was
£1 = $1.27. This meant that the value of the pound had depreciated (decreased) by just under 11
per cent in four months. Alternatively, the value of the dollar had appreciated (or increased) by
the same percentage.

Handling data
1 Using the exchange rate given above, calculate the change in price paid by
American importers between April and August 2018 of a UK export to the USA
valued at £120.
2 What would have been the change in the price paid by a supermarket in the UK for
a bottle of Bourbon whisky (valued at $50) imported from the USA between the
same two dates?

Changes in the value of currencies affect the prices of exports and imports as shown in Table
29.2.
The exchange Prices of UK exports overseas Prices of imported goods in
rate of pounds (in foreign currencies) the UK (in pounds)
Appreciates Increase Fall
(rises)
Depreciates (falls) Fall Increase
Table 29.2 The effects of changes in the value of the pound
Using the information in Table 29.2 we can see that the rise in the value of the pound against the
euro during the four months in 2018 would have had the following effects:
• prices of UK exports to the USA would have fallen by approximately 11 per cent, assuming no
other changes
• imports into the UK from the USA would have been 11 per cent more expensive, again
assuming no other changes. However, the price the Americans received in dollars would not
have changed. It is likely, however, that because prices were lower in the UK, they would sell
greater quantities of their products in the UK market, although this would depend upon price
elasticity of demand for the imported goods and services.
Small changes in the UK’s exchange rate 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 significance is a sustained rise or fall in the exchange rate –
or a sudden and substantial change in the exchange rate. In the 12 months leading up to October
2018, the pound rose 135 per cent in value against the Argentinian Peso. This resulted in UK
exporters suffering a severe loss of price competitiveness when exporting to Argentina, although
imported products, such as beef and soya from Argentina would have fallen in price. UK
businesses trading in domestic markets with imports from Argentina would have experienced
more difficulty in competing in terms of price.
Exchange rate changes can create uncertainty for businesses for a number of reasons.
• Uncertainty over revenue. 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 whisky to America may give Scottish distillers less
revenue than anticipated if the contract is agreed in terms of dollars and the pound then rises in
value against the American dollar. In these circumstances the amount of dollars stated in the
contract will convert into a smaller number of pounds, causing a shortfall for the exporter.
• Uncertainty regarding quantities likely to be sold. 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.
• Uncertainty regarding competitors’ responses. Competitors may take decisions to protect
their firms against exchange rate changes. Foreign businesses may reduce prices to offset the
effects of an exchange rate change, putting rivals under pressure to do the same or lose market
share.
Price elasticity can be an important part of a discussion on the possible effects of exchange rate
changes. If overseas demand for a product is price inelastic, then an increase in the exchange rate
may not be too harmful. So, it might be that Americans will continue to buy Scotch whisky when
the price rises. In this case demand may alter little. In contrast, if demand is price elastic,
exporters might be badly affected by a rise in the exchange rate, but benefit greatly from a fall.
Decision making and exchange rates
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 external environment and to reduce uncertainty
whenever possible. Fluctuating exchange rates can lead businesses to take a number of functional
decisions to protect their positions. 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.
An alternative approach, used by Toyota, is to require suppliers to price their products in a
different currency. The company, which sells cars throughout Europe, pays its UK suppliers in
euros. As a result, fluctuations in the exchange rate will have less impact on the company as it
pays suppliers in the same currency that it receives from European customers.
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. These may lead to strategic
decisions to minimise the effects as far as possible. For example, businesses may seek 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 European countries that use the euro to avoid the difficulties imposed
by fluctuations in the value of the pound against the euro. The uncertainty created by Brexit may
further encourage such moves.

Business in focus: Burberry plc’s new strategy

The Burberry Group is a UK multinational company that sells luxury clothing,

cosmetics and fashion accessories. Its brand is well known and very popular globally,
especially with young consumers in developing economies such as China, where
incomes are rising quickly.
Its global retail business model is vulnerable to volatility in exchange rates, which can
have significant effects on its financial performance. In 2018, the company’s financial
report emphasised the sensitivity of its financial performance to changes in exchange
rate. It estimated that a 5 per cent appreciation in the value of the pound would have
resulted in a reduction of between £45 and £50 million in the company’s operating
profit of £467 million.
In November 2017, Burberry’s chief executive Marco Gobetti laid out a fairly
ambitious plan to reinvigorate the company’s brand. The main element of the plan
are:
• adding more leather goods and other new products to its collections
• improving distribution by scaling back its lower-end wholesale partnerships
• refreshing and improving its stores
• using its reputation as a digital innovator to communicate the changes in its
products.
The overall aim of this strategy is to elevate Burberry from an ‘accessible’ label into a
true luxury player that can go head-to-head with Europe’s most famous fashion
brands. This will allow Burberry to charge higher prices, enjoy higher profit margins
and more stable growth in sales.
Source: Adapted from Burberry plc’s financial highlights, 2018

Practice questions
1 Analyse the reasons why Burberry’s financial performance is sensitive to exchange
rate changes.
(9 marks)
2 To what extent do you think that exchange rate changes are a major influence on
the strategic decision-making of companies with strong brands such as Burberry?
(16 marks)

Figure 29.5a Key elements of Burberry’s new strategy

Figure 29.5b Burberry’s brand is popular in many countries and with many high-profile individuals
Inflation
What are inflation and deflation?
Inflation can be defined as a persistent rise in the price level and the associated fall in the value
of money. So, one can buy less with the same amount of money. For many businesses a low rate
of inflation is not a problem. So 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 by increasing a business’s
profits and helping to allow earnings to rise steadily. Inflation only becomes a major problem for
businesses when it is high, rising rapidly or (worst of all) is doing both together.

Key terms
Inflation is a persistent rise in the general price level and an associated fall in the
value of money.
Deflation is the rate of decrease of the general price level and the corresponding rise
in the value of money.
The Consumer Price Index (CPI) measures the rate of inflation based on the
changes in prices of a basket of goods and services.

Deflation is the opposite of inflation and describes a situation in which a country’s prices are
falling meaning that the value of money is increasing. Thus, it is a situation in which an economy
suffers from negative rates of inflation. A number of economies around the world, including the
United States, Germany, France, Italy and Spain, experienced deflation in 2014 or 2015,
although prices are rising in almost every economy in the world at the time of writing.
Country Inflation rate
United States of America 2.7%
The euro area (the 19 countries that use the euro as a currency) 2.1%
China 2.3%
Japan 1.3%
Turkey 24.5%
Ecuador –0.3%
Table 29.3 A selection of inflation rates for September 2018
The world is experiencing rising rates of inflation following a period of low inflation and
deflation. However, a small number of countries continue to experience deflation. Table 29.3
illustrates that countries were experiencing very different rates of inflation in 2018, although
rates were generally rising. Trading nations are likely to import rising prices from one another as
exports contribute to the calculation of inflation in other countries. There have also been
substantial rises in the prices of important commodities, most notably that of oil.
How is inflation measured?
In the UK the principal measure of the rate of inflation used by the government is the Consumer
Price Index (CPI). The CPI was introduced in 2003 and measures the average monthly change
in the prices of goods and services purchased by households in the UK and the government will
use this to set targets for inflation in the future. The CPI is calculated using approximately 700
separate goods and services for which price changes are measured throughout the country. Most
European countries use the CPI as their official measure of inflation.

Figure 29.6 The UK’s rate of inflation, 2010–2018, as measured by the CPI.

Source: Trading Economics, via ONS

Decision making, inflation and deflation
Responding to inflation
Expectations can be an important part of the process of creating inflation and deflation. If
managers and businesses anticipate that prices are set to rise or fall in the near future, they might
take decisions which actually fuel the process of price change.
If businesses expect their suppliers to increase the prices of raw materials and components, they
may raise their selling prices in anticipation of this. This avoids any possibilities of reduced
profit margins if costs rise before prices can be increased. The decision also provides a windfall
profit as for a while firms sell at higher prices whilst their costs have not risen.
Trade unions and other employee groups usually build in expectations of inflation into their
wage demands for the coming year; they would normally seek to protect their standards of living.
However, wages have risen very slowly in the UK since the financial crisis and subsequent
recession as businesses’ profits have been depressed.
Businesses may suffer falling sales in a period of relatively high rates of inflation. Consumers
might be expected to spend more during inflationary periods as they would not wish to hold an
asset (cash) that is falling in value. However, research shows that people save more (perhaps due
to uncertainty) and so sales for many businesses fall. Businesses may respond by reducing
production levels or by targeting other markets which may enjoy more stable prices.
It can be difficult for businesses 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 benefit from improved price competitiveness and enjoy increases in market share,
especially if demand for their product is price elastic.
Inflation can offer some benefits to decision makers, however. Low and stable rates of inflation
may be beneficial for businesses. A steady rise in prices can create favourable expectations and
encourage investment by businesses. Inflation can also encourage long-term borrowing and
investment in non-current assets by businesses as the value of their repayments (in real terms)
declines over time. It is for these reasons that the UK authorities have set a target rate for
inflation of 2 per cent per annum.

Business in focus: Inflation in the UK and small businesses

The combined effects of high inflation and weak demand from customers has led to a
record number of small businesses planning to close down or sell up. According to
the quarterly survey of the Federation of Small Businesses (FSB), one in seven small
firms expects to scale back their business or cease trading altogether in the coming
months.
Construction firms and retailers have been particularly hard hit by rising inflation, as
well as additional costs linked to changes in pension regulations. Of those surveyed,
75 per cent said that operating costs had increased year on year, while 41 per cent of
firms reported falling profits.
Mike Cherry, national chairman of the FSB, warned that domestic economic
challenges were not getting the attention they needed while Brexit negotiations
continue to dominate the political agenda, saying: ‘While the swift agreement of a
transitional arrangement and an ambitious free trade agreement with the EU are
absolutely critical, it’s spiralling costs, weak growth and flagging consumer demand at
home that are front of mind for small firms day to day. It’s troubling to see a record
number of entrepreneurs seeking an exit as these challenges prove too much for
many.’
Conversely, the quarterly survey also found that exporters are increasingly optimistic
as strong global growth and the weak pound are boosting demand.
Source: Adapted from the Telegraph, 5 January 2018

Practice questions
1 Analyse the possible reasons why inflation may result in businesses receiving
lower profits.
(9 marks)
2 Inflation is a much larger problem for small businesses. Do you agree? Justify your
view.
(16 marks)
Taxation
Almost every business and consumer in the UK pays taxes in one form or another. Taxes are
financial levies or payments imposed on a variety of business activities.
The UK’S main business-related taxes
Income tax
This is the most important tax to the UK government in terms of tax yield and it is paid by all
UK taxpayers earning over a certain amount annually. In 2019–20, income tax is forecast to
yield £195.7 billion, which would represent over 24 per cent of the government’s receipts from
taxation. It is paid by employees on their wages and salaries and by sole traders or partners on
the profits made from their businesses.

Key term
Taxation is a payment that has to be made to the government or other authority by
households, firms or other organisations.

Value added tax (VAT)

This is a tax levied on spending. Most goods and services sold in the UK have VAT at a rate of
20 per cent added to their price. Some items such as car seats for children have a 5 per cent rate
while other products, including most foods, are zero-rated so purchasers do not have to pay VAT
on these products. VAT is a tax that is imposed in all member states of the EU, although rates
vary. In The Office for Budget Responsibility (OBR) forecasts that receipts from VAT will be
£136.6 billion in the 2019–20 financial year.

National insurance payments

National insurance payments are contributions made towards the cost of certain state benefits
such as pensions. National insurance payments are contributions made towards the cost of certain
state benefits such as pensions. National Insurance payments are made by both employers and
employees and are expected to raise £143.4 billion in revenue for the government in the 2019–20
financial year.

Corporation tax
Corporation tax is paid by companies in the UK on their profits. The UK government is
committed to creating a very competitive tax regime for corporation tax in the expectation of
attracting international businesses to the UK. The rate of corporation tax in the UK has been cut
from 28 per cent in 2010 to 19 per cent in 2018 – this is the joint lowest among ten major
economies as shown in Figure 29.7.
Figure 29.7 Corporate tax rates for a selection of major economies, 2018

Source: Trading Economics

Customs and excise duties

Customs duties are paid on some imported products. Excise duty is a tax on the production of
certain products in the UK including tobacco, petrol, alcohol and gambling. Demand for these
products is often price inelastic.
The taxation policies of governments are subject to a number of influences. They are designed to
raise sufficient revenue, as far as possible, to cover government expenditure. They may also be
used to encourage consumers and businesses to increase consumption of some products, such as
renewable sources of energy, and discourage consumption of others, such as fossil fuels or
tobacco products. They will also be influenced by the government’s fiscal policy which we shall
cover in the following section.
Changes in taxation and business decision
making
Most businesses operate with the intention of making a profit and some aim to make the
maximum possible profit. If a business is able to minimise its liability for taxes, it is possible to
generate higher profits and to use this to reward shareholders or to invest in activities intended to
promote growth. It is common for businesses to use specialist taxation lawyers to help to devise
ways of minimising tax liabilities while remaining within the law, although this is currently a
controversial topic.
Taxation rates can have significant effects on businesses and may influence strategic decisions,
for example, relocation. The Republic of Ireland has a tax rate on company profits of 12.5 per
cent – its equivalent of corporation tax. This is very low by international standards, as can be
seen from Figure 29.7, and has helped it to attract many leading companies to relocate there.
Nine of the world’s ten largest pharmaceutical businesses have operations in Ireland as well as
prominent American technology companies including Twitter, Google and Facebook. Rates of
corporation tax will also have an impact on investment decisions by businesses. Reducing rates
of corporation tax (as is happening in the UK currently) can help to improve the rates of return
on capital investment. For businesses seeking higher returns, such tax cuts may help to create a
case in favour of business investment.
Taxation can also impact on functional decisions within businesses. Many businesses in the UK
have called for a reduction in the amount employers have to pay as national insurance
contributions (NICs). They argue that NICs are a tax on employment and that a reduction could
increase employment. Cutting the rate of NICs may result in businesses taking decisions to
increase employment or not to take decisions to introduce capital intensive methods of
production.
Changes in some taxes impact on businesses indirectly as well as directly. In 2011, the UK
government increased the rate of value added tax (VAT) in the UK from 17.5 to 20 per cent. This
had two negative effects on businesses.
1 It increased the costs faced by many businesses as they paid a higher amount of tax on many
inputs used in production. In theory, they can pass this on in the final price paid by consumers
or other businesses. However, this is not always possible in a competitive market.
2 Consumers faced paying higher prices for many products which reduced their overall demand
for goods and services. The Centre for Retail Research estimated that the rise in VAT reduced
production in the UK by between 0.5 and 0.8 per cent.
This may result in businesses taking decisions to reduce production temporarily or possibly to
cut prices and increase promotion to maintain sales as far as possible. Some businesses used the
fact that they would not pass on the rise in VAT to their customers as part of their promotional
activities. Presumably they calculated that the reduction in profit margins might be compensated
for by higher sales.
Business in focus: Amazon and taxation

Politicians and pressure groups have called on consumers in the UK to repeat the
successful action taken last year against Starbucks, a boycott which successfully
persuaded the coffee chain to resume paying tax in the UK, and stop buying products
from the online retailer Amazon until it too starts to pay a ‘fair’ amount of tax here. In
2017, Amazon achieved total sales in the UK valued at £11.0 billion (up from £9.5
billion in 2016) but will pay just £4.6 million in tax – less than 0.05 per cent of its
revenue. The chair of Parliament’s public accounts committee, Margaret Hodge, has
been one of Amazon’s most outspoken critics. ‘It is an outrage and Amazon should
pay their fair share of tax,’ said Hodge. ‘They are making money out of not paying
taxes. I no longer use Amazon. We should shop elsewhere.’
Amazon uses a subsidiary based outside the UK to avoid paying more taxes here.
When a shopper in the UK makes a purchase from the company the payment is made
to this subsidiary based in Luxembourg where the rates of corporate taxes are much
lower. A UK shopper’s receipt will show payment was made to Amazon EU S.à.r.l.
rather than to Amazon.co.uk because Amazon has arranged its operations so that its
UK operations only supply services, such as storage and delivery, to the business in
Luxembourg. As a result, its tax liability within the UK is much reduced. It further
reduced its tax liability in the UK by paying employees in the form of shares, which is
an expense it can offset against corporation tax.
Amazon employs approximately 27,500 people in the UK in roles in its warehouses as
well as in designing and maintaining its websites. The company has growth objectives
in a number of markets including entertainment.
Charlie Elphicke, a Conservative MP, has also criticised the company. ‘People will
look at this and feel it’s incredibly unfair, that they work hard and pay their taxes while
big American multinationals engage in industrial-scale tax avoidance. This is why
international tax reform is badly needed.’

Practice questions
1 Analyse the benefits to Amazon of arranging its tax affairs in this way.
(9 marks)
2 Do you think that the drawbacks to Amazon from reducing its tax liability in this way
might exceed the benefits in the long term? Justify your view.
(16 marks)
Fiscal and monetary policies
We have looked at a number of factors that shape the economic environment in which businesses
trade. One important one is the policies pursued by the UK government to try and achieve its
macroeconomic objectives. The government pursues a number of macroeconomic objectives of
which the following are the most important:
• Steady annual increases in real GDP of around 2–3 per cent each year.
• Inflation at an annual rate of 2 per cent.
• A low and stable rate of unemployment.
• A balanced balance of payments on current account (a financial record of the UK’s trading and
some financial transactions with the rest of the world).
To these should be added the desire to correct the economy’s budget balance (that is, the
balance between government expenditure and receipts from taxation and other sources). Since
the financial crisis and subsequent recession of 2008–9 the UK’s public finances have been in a
weak state, but have improved recently and this is forecast to continue. This is illustrated in
Figure 29.8.

Key terms
The budget balance is the difference between government spending and revenue
over the financial year.
Fiscal policy is the use of taxation and public expenditure to manage the level of
economic activity.
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.

Figure 29.8 The UK’s actual and forecast budget deficit/surplus, 1990–2021
Source: Office for National Statistics (ONS) / Office for Budget Responsibility (OBR)
The government has three main policies it can use to manage the economy in pursuit of its
macroeconomic policies. These are:
1 fiscal policy
2 monetary policy
3 supply-side policies.
Fiscal policy
Fiscal policy is the use of government expenditure and taxation as a means of controlling the
level of activity within the economy. The central element of fiscal policy is the relationship
between the level of government expenditure and the amount raised in taxation in any given
year. The balance between taxation and government expenditure is determined annually when
the Chancellor of the Exchequer announces the annual budget, usually in the autumn.
The difference between government spending and revenue over the fiscal year is called its
budget balance. The UK government often runs a budget deficit, when its revenue (mainly from
taxation) is less than its expenditure. If the government’s revenue exceeds its expenditure over a
fiscal year, the result is a budget surplus. Recent and forecast budget balances for the UK
government are shown in Figure 29.8.
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 transport. The
effect will be to increase the amount the public sector borrows to fund its expenditure for the
year, or possibly to reduce the size of any surplus. The amount by which the public sector’s
revenues fall short of its expenditure is known as the public sector net cash requirement (or
PSNCR).
2 Contractionary fiscal policy. This is brought about by reducing government expenditure or
increasing taxation, or by both policies simultaneously. The effect is to reduce the
government’s budget deficit or to increase the surplus on its budget for the fiscal year.
Figure 29.9 summarises the operation of fiscal policy. Fiscal policy can help to stabilise the
economy (avoiding the worst effects of fluctuations in the level of GDP) through the operation of
the ‘automatic stabilisers’. For example, lower unemployment when the level of economic
activity is high means temporarily lower welfare spending, higher income tax receipts and higher
National Insurance contributions. Higher company profits generate higher corporation tax
receipts, and higher spending by consumers yields higher VAT receipts and excise duties. These
factors together will have a contractionary effect, as tax revenues rise and government
expenditure falls. Thus, a contractionary fiscal policy operates automatically to stabilise the
economy when GDP is growing quickly in an economic boom. The reverse will happen in a
slump as government expenditure rises, tax receipts fall and an expansionary fiscal policy is
implemented automatically.

The effects of the government’s taxation and expenditure

policies
Tax and expenditure policies can have immediate effects on the level of economic activity,
although the precise effects will depend upon the types of tax and the nature of government
expenditure.

Taxation
1 Direct taxes. These are taxes on income and profits and include income tax and corporation
 tax (levied on company profits). Direct taxes take a larger amount from individuals earning
high salaries and companies announcing handsome profits. The government can forecast with
some accuracy the effects arising from an increase (or reduction) in income tax. Although the
overall effect may be predicted, the implications for individual businesses will vary according
to the type of product supplied. Firms supplying luxury goods (long-haul foreign holidays, for
example) might be significantly affected by a change in income tax rates, especially for those
earning higher incomes, whilst those selling basic foodstuffs may be relatively unaffected.
2 Indirect taxes. VAT and other taxes on spending are classified as indirect. Changes in this
type of taxation can have a rapid effect on the level of economic activity, although its effects
are difficult to predict. An increase in VAT will cut consumer spending, reducing demand for
goods and services and eventually lower the level of economic activity. However, the extent
of the fall in demand will depend upon the price elasticity of demand for the goods in
question, as well as consumer confidence. Consumers will continue to purchase essentials
such as fuel and food, although demand for products associated with DIY, for example, may
decline. An important side-effect of increasing indirect taxes is that it is inflationary.

Government expenditure
Government expenditure is the other half of fiscal policy. Governments may adjust spending in a
range of areas. The major elements of government expenditure are shown in Figure 29.10. The
‘remainder’ category includes a broad range of government expenditure including that on
defence, the environment, law and order and interest on previous government borrowing.

Figure 29.9 The operation of fiscal policy

Figure 29.10 The major elements of UK government expenditure, 2018–2019 (forecast)

Source: Office for Budget Responsibility

Handling data
Looking at Figure 29.10, what percentage of total government expenditure was made
up by net debt interest in 2018–19?

The UK’s budget deficit – managing a crisis

Fiscal policy has been dominated in recent years by the desire of the UK government to reduce
its budget deficit. As can be seen from Figure 29.8, this soared to an annual figure of
approximately 10 per cent of the UK’s national income following the financial crisis and
recession in 2008–09. This resulted in a level of borrowing by the government that was not
sustainable in anything but the short term.
As a consequence, many political parties in the UK have made a commitment to reducing the
size of the budget deficit. Some would focus mainly on cutting government expenditure to
achieve this, whilst others prefer a combination of tax rises and reductions in expenditure. Using
fiscal policy to manage the level of activity in the economy has become secondary to reducing
the government’s budget deficit. As a consequence, the UK government has become dependent
upon monetary and supply-side policies to manage the economy. These policies are covered later
in this section.
A good measure of government expenditure is as a percentage of GDP, for which actual data and
forecasts are shown in Figure 29.11. Using this measure, public expenditure has fallen
substantially in the UK and will continue to do so. In 2014–15, it was 42.4 per cent of GDP and
fell to 38.4 per cent by 2017–18. In 2014–15 it will be 40.7 per cent of GDP compared with 44.8
per cent in 2010–11. The Conservative government elected in June 2017 plans to continue the
tight control of public expenditure. It plans to reduce public expenditure to below 38 per cent of
GDP by 2021–22.
The government’s commitment to reducing its expenditure significantly as a percentage of GDP
has many implications for businesses in the UK and provides opportunities and threats for
businesses. Opportunities exist for businesses that seek to supply services which may have been
provided previously by central or local government. The government has encouraged charities to
become involved in the provision of local services in its place. In other industries the government
has reduced its expenditure by using private sector businesses to supply services. Examples of
this have occurred within the NHS. The government has said that public services do not have to
be delivered by public sector businesses. More opportunities may occur in the future for private
firms to deliver public services as the government seeks to tightly control its expenditure.
Government contracts are usually awarded as the result of a bidding process and management
teams for large public companies such as Capita and Serco make strategic decisions on whether
or not to make a bid.
Figure 29.11 Public spending as a percentage of GDP

Source: Trading Economics

The government’s spending decisions have also had considerable implications for the UK’s
labour markets and thus for all businesses. It is estimated by the Office for Budget Responsibility
(OBR) that 809,000 jobs were lost from the public sector in the UK between December 2011 and
June 2018. This is one reason why wage rates in the UK have not risen much as the number of
employees entering the labour market has been high.
The reduction in government spending as a percentage of GDP over time may pose a threat to
the large number of businesses that supply local and central businesses with goods and services.
Examples include businesses operating care homes for elderly customers who have seen the
number of customers referred by local councils falling. Cable & Wireless, which provides
communication services to local government and other government organisations, has seen
public spending on its services decline sharply.
Probably the largest danger to all UK businesses from the government’s spending policies is that
it will have a contractionary impact on the level of activity in the economy, which has to be
countered by other elements of government policy. The withdrawal of government spending of
up to £100 billion a year over the next few years, without the compensation of similar scale tax
reductions, will have a profound effect on business activity in most areas of the economy.
Monetary policy
This type of economic policy involves adjusting the amount of money in circulation and hence
the level of spending and economic activity. Monetary policy can make use of one or more of the
following:
• altering interest rates
• controlling the money supply
• manipulating the exchange rate
• the use of quantitative easing and forward guidance.

Key term
Interest rates are the price of borrowed money.

At times, all the techniques have been used. Over the period 1997–2009 the UK authorities
tended to use interest rates as a major means of managing the economy. Since 1997 the
Monetary Policy Committee of the Bank of England has had responsibility for setting interest
rates. The Monetary Policy Committee sets interest rates monthly with the aim of achieving the
government’s target for inflation whilst attaining long-term growth in the economy.

Interest rates
Table 29.4 sets out the aims that may lie behind the authorities altering interest rates and,
importantly, the possible implications for decision making by businesses. Broadly speaking, rises
in interest rates depress the level of economic activity and reductions promote an expansion of
economic activity.
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 by consumers on products supplied by businesses is sensitive to changes
in interest rates. One major reason for this is mortgage interest payments. Millions of UK
consumers have mortgages. 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.
Interest rates have become more difficult to use as a means of managing the economy in recent
years. From March 2009 until August 2016, Bank rate (on which other interest rates are based)
was held at 0.50 per cent, before being reduced to 0.25 per cent in August 2016. In November
2017, the rate returned to 0.50 per cent and rose again to 0.75 per cent in August 2018. Since
they have been at such low levels the Bank of England has had little room for manoeuvre. This
has resulted in the use of other forms of monetary policy which we consider later in this section.
Rising interest rates Falling interest rates
Likely • Reducing the level of • Reducing levels of unemployment.
 objectives consumer spending in the • Stimulating the level of production
economy. and thus GDP in the economy.
• Limiting inflationary • Promoting export sales by reducing
pressure in the economy. the exchange rate of the pound.
• Slowing the level of • Increasing rates of economic
economic growth (as growth in the economy.
measured by GDP). (Reducing interest rates can assist an
• Avoiding increasing imports economy in recovering from a slump.)
creating a deficit on the
balance of payments.
(In general, higher interest
rates will assist in dampening
down an economic boom.)
Possible • Many businesses may • Demand and sales are likely to
consequences experience falling sales as increase, especially for products
for business consumers increase bought on credit, prompting
savings and businesses managers to expand production,
decide to reduce possibly by using capacity more
production. intensively.
• Businesses may decide to • Export sales of products in price
cancel or defer investment elastic demand may rise as the
plans. exchange rate of the pound
• Firms may seek to lower declines whilst imports become less
costs by reducing competitive.
borrowing. • Businesses may undertake
• The pound sterling may rise increased investment promoting
in value (pushing up export growth in industries such as
prices) dissuading construction.
businesses from entering or
expanding in overseas
markets.

Table 29.4 Changes in interest rates – objectives and consequences

Effects 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.
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. Significant rises in interest rates
can lead to substantial increases in bankruptcies among small firms.
• Even larger firms with high levels of borrowing (and therefore high levels of gearing) 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.
• The decisions of firms trading overseas are affected by alterations in interest rates. Rising
interest rates tend to lead to an increase in the exchange rates as individuals and businesses
overseas purchase sterling to invest in UK financial institutions to benefit from higher rates. A
fall in interest rates would have the opposite effect. Rising interest rates may result in
managers accepting changes in profit margins to protect market share or focusing on quality
and other non-price factors when promoting products in foreign markets.
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 Bank of England’s Monetary Policy Committee
changes interest rates to assist the government in achieving its economic objectives. This means
that altering rates affects the level of unemployment, inflation and growth in the economy. They
also change managers’ expectations of these key economic variables affecting their day-to-day
and strategic decisions.
Table 29.5 illustrates the relationship that exists between the level of interest rates and key
economic variables such as economic growth and inflation.
Other economic Rising interest rates Falling interest rates
variables
Inflation Falling demand and output Increasing output and spending
reduces inflationary pressure causes prices to rise fuelling inflation
Economic Will slow as businesses cut Is stimulated by cheaper loans and
growth output and investment rising business investment
Exchange The value of the pound is Exchange rate of the pound
rates likely to rise generally falls
Unemployment Unemployment increases as Unemployment declines as the level
levels of production decline of economic activity rises
Table 29.5 Interest rates and other economic variables

Quantitative easing and forward guidance

Since March 2009, interest rates in the UK have been held at levels between 0.25 per cent and
0.75 per cent by the Bank of England, the lowest figures ever. This has effectively removed the
possibility of lowering interest rates further to expand production and to help the economy
achieve higher rates of economic growth and so recover from the 2008–9 recession. Some
foreign governments have opted for negative interest rates. Negative interest rates effectively
require consumers and businesses to pay financial institutions to hold money in their accounts:
the aim is to discourage saving and encourage consumption spending and investment. The Bank
of England opted to hold interest rates at above zero and recent rates rises suggest that this
approach will not change. Instead, it has used other techniques of monetary policy. The favoured
policies have been quantitative easing (QE) and forward guidance.
The way the central bank implements QE 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 in turn boosts the money supply. The hope
is that this money is subsequently used to purchase goods and services and to boost output and
growth. The UK government injected £435 billion into the UK economy through QE between
March 2009 and May 2018.
Since August 2013, the Bank of England has been instructed by the government to issue
‘forward guidance’ on its monetary policy (that is to communicate its own forecasts and
expectations of future levels of interest rates) in order to influence business and consumer
confidence and decision making. The expectation is that guidance from the Bank of England on
the length of time over which the Bank Rate will remain low will help to hold down longer term
interest rates in the economy boosting levels of consumption and investment. It also helps
households and firms to plan spending and investment with greater levels of confidence.

What do you think?

Is economic data such as that presented in Table 29.6 of limited use to managers as
it is historical?

Business in focus: Interest rate rise poses threat to

businesses

In August 2018, the Bank of England raised interest rates above 0.5 per cent – taking
the base rate to 0.75 per cent – for the first time since the financial crisis of 2007–08.
The Bank’s Monetary Policy Committee (MPC) increased the rate following global
speculation that a rise was likely. The move was prompted in part by inflation rising
above the Bank of England’s 2 per cent target.
Business groups warned that the increase poses a threat to all businesses in the
economy, including multinational companies. The British Chambers of Commerce
(BCC) criticised the decision, describing it as ‘ill-judged’, while a senior economist at
the Institute of Directors (IoD) said that the Bank had ‘jumped the gun’.
The head of economics at the BCC, Suren Thiru, commented that the decision did not
seem wise against a backdrop of a sluggish economy, mainly because of the risk of
undermining confidence at a time of significant economic uncertainty.
Tej Parikh, senior economist at the IoD, warned that even this small rise in interest
rates could damage consumer confidence and spending.
Some analysts believe that the MPC should not have waited to see whether an
agreement could be reached over Brexit and whether real wages would begin to rise,
after a period in which they have fallen.
Source: Adapted from The Independent, 2 August 2018

Practice questions
1 Analyse the possible reasons why ‘even this small rise in interest rates could
damage consumer confidence and spending’.
(9 marks)
2 Are multinational companies protected against the effects of changes in UK
interest rates? Justify your decision.
(16 marks)

Business in focus: Global economic data

Real GDP growth (%) Interest rates (%) Inflation (%)

2016 2017 2018 2016 2017 2018 2016 2017 2018
UK 2.1 1.8 1.1 0.50 0.25 0.75 1.4 1.6 2.7
USA 1.6 1.9 2.9 0.50 0.75 1.50 2.2 2.1 2.2
Germany 2.4 2.1 2.0 0.05 0.00 0.00 1.3 1.9 0.8
China 6.7 6.9 6.6 4.35 4.35 4.35 2.0 1.6 2.5
India 7.1 6.7 7.4 6.75 6.25 6.50 5.8 3.5 3.8
Russia –0.5 0.6 1.9 11.0 10.0 7.5 11.2 5.0 3.4
Table 29.6 A selection of economic data from 2016–18
Source: Trading Economics

Practice questions
1 Analyse the implications of the data above for the strategic decisions made by
businesses based in Russia.
(9 marks)
2 Has the economy of India provided a better economic environment for businesses
than the other economies included in the data above? Justify your view.
(16 marks)
Trade and protectionism
We considered international trade in some detail as part of the political environment in Chapter
28. Most governments in the world today are in favour of free trade. The development of
international trade has gone hand-in-hand with globalisation as governments have been
persuaded of the benefits of being an integral part of a global economy. The movement towards
free trade has been driven by global institutions such as the World Trade Organisation (WTO)
and the creation and enlargement of trading blocs such as the EU. As we saw in Chapter 28,
greater freedom of trade can impact heavily on strategic and functional decision making by
creating opportunities and threats for all businesses in economies such as the UK which are open
to trade.
Protectionism
Although there are strong global forces promoting greater international trade, this does not mean
that all countries are wholly committed to it. Disputes over trade do occur between different
countries and these can lead to protectionism where governments seek to implement measures
designed to limit the number of imports entering a country and to ‘protect’ domestic industries
and employment.

Key term
Protectionism is a government policy which favours the use of measures intended to
prevent the free entry of imports into a country.

A government may use a range of measures to protect its businesses from the full force of
international competition:
• Tariffs. A tariff is a tax on imports. The imposition of tariffs increases the price of imported
products. This can help to protect a relatively inefficient domestic industry, and can be
effective when demand for a product is price elastic, though it will not encourage the
development of more efficient methods of production by domestic suppliers. It may also
provoke retaliation by other governments.
• Import quotas. These are physical limits set on the number of units of a products that can be
imported into a country over a given time period. Governments usually issue licences to
importers and control the number of products for which they grant licences.
• Subsidies. Governments can use subsidies (a payment to a domestic producer for each unit of
output produced) to help high-cost home suppliers charge artificially low prices.
• Soft loans. A government may support a weak or failing business by providing a generous
loan on much softer terms than could be negotiated with private sector lenders. This helps to
reduce the costs of businesses competing with foreign firms.
• Technical barriers to trade. These include stringent demands in relation to factors such as
design or safety standards. The intention is to increase the costs of production of overseas
producers thereby reducing their competitiveness.
• State procurement policies. The use of this type of barrier to trade occurs when a government
favours domestic suppliers when agreeing contracts for government spending such as that on
military equipment.
Governments continue to implement protectionist policies, despite many economists arguing
powerfully in support of free trade. For some years, a number of countries have complained
about China imposing non-tariff barriers on trade. The USA has been particularly critical of
China with whom it has a large trade deficit. In 2018, the USA and China began to impose tariffs
on one another’s exports in what some commentators have described as a ‘trade war’. By
October 2018, the USA had imposed tariffs which will be imposed on 6,000 products imported
from China worth $253 billion during 2018 alone. In response, China has imposed tariffs of 5 per
cent in duty on US products, including smaller aircraft, computers and textiles, and an extra 10
per cent on goods such as chemicals, meat, wheat and wine. These will be imposed on imports
valued at $110 billion in 2018.

Figure 29.12 Large-scale production in Australia’s mines results in competitively-priced supplies of coal
being available in global markets.

Fears that protectionism is rising within the global economy were reflected in a report published
by the WTO in 2018. The G20 group of economies applied 39 new trade-restrictive measures
during the period between October 2017 and May 2018, including tariff increases, stricter
customs procedures, imposition of taxes and export duties. This equates to an average of almost
six restrictive measures per month.
Protectionism can provoke a range of strategic decisions:
• Businesses may be forced to use more expensive domestic suppliers if trade barriers prevent or
restrict imports. For example, Chinese manufacturers are using domestic coal supplies rather
than imports from Australasia or Indonesia.
• Businesses with sufficient resources may establish production facilities within countries that
impose import restrictions to avoid any such barriers.
• Others may lobby governments and international bodies to persuade countries to remove
barriers to trade.
Globalisation
What is globalisation?
The world’s economies have developed ever-closer links since 1950, in trade, investment and
production. This process has resulted in globalisation and its pace and scope have accelerated in
recent years, to include more industries and more countries.
At its simplest, globalisation refers to the trend for many markets to become worldwide in scope.
Because of globalisation many businesses trade throughout the world, whereas in the past they
may have focused on one country, or possibly a single continent such as Europe.
Globalisation has been associated with an increase in world trade as is shown in Figure 29.13.
However, it can be seen that the rate of increase in trade in merchandise (goods and not services)
has slowed since 2010, although trade continues to grow more quickly than GDP.
Reasons for the greater globalisation of business
Globalisation has its opponents, many of whom fear loss of traditional jobs and also of distinct
cultures in particular countries and regions. However, there are a number of powerful forces
behind globalisation.

Figure 29.13 Merchandise exports and GDP, 1981–2018

Source: World Trade Organisation press release, 2018

The support of many governments and major businesses

An important reason why globalisation has occurred is that many governments and businesses
believe that increased and freer trade between nations will offer prosperity and growth for all.
Globalisation, they argue, has already brought many benefits: global food production has risen
steadily over the last 25 years and malnutrition rates have fallen accordingly. Citizens in less-
developed countries have access to health care, often supplied by foreign businesses.
For its supporters, globalisation offers an opportunity rather than posing a threat. The leaders of
the world’s major economies and big businesses are committed to protecting and promoting
global commerce and trade and emphasise the benefits it can bring.

The falling cost of international transport and communications

Improved transport and communication links have made the practical processes of producing and
selling products in global markets easier and more cost effective. Two trends in transport are
particularly important. The fall in the cost of air travel in real terms has made it feasible to
transport some products such as fruit and vegetables by air enabling growers in Chile, for
example, to sell products to wealthy consumers in North America and Europe. Simultaneously,
the development of containerisation and much larger ships has brought down costs of sending
products across the world by sea. When containers were first introduced, they cost just $0.16 per
tonne to load, much lower than the cost of transporting loose cargo at $5.83 per tonne. This
reduction in costs has underpinned China’s rise as the world’s premier manufacturing economy.
Developments in technology have also made it quicker, simpler and less costly to send
information around the world and to provide services. This has, for example, made it possible for
many UK businesses to establish customer service facilities in countries such as India where
wage costs are significantly lower.

The growth of global trading blocs and the reduction of

barriers to trade
We saw in Chapter 28 that the EU, one of the world’s largest free trading blocs has expanded to
28 countries with a total population of over 505 million, although the UK is due to leave in 2019.
This allows many businesses to sell internationally without hindrance. International trading blocs
have also been established and expanded including the US-Mexico-Canada Agreement and the
Association of Southeast Asian Nations (ASEAN) with similar consequences for trade. At the
same time, despite some setbacks, the WTO has successfully reduced barriers to global trade.

The growth of multinational companies

The growth of multinational companies such as Nissan, Apple and Lenovo can be seen as a
cause of globalisation as well as a consequence of it. A driving force of globalisation has been
multinational companies, which since the 1970s have constantly, and often successfully, lobbied
governments to make it easier for them to put their skills and capital to work in a previously
protected national market.
This has resulted in the rapid growth of some major well-known companies who sell high
proportions of their production overseas. Many such companies are Asian as shown in Figure
29.14.

Increasing global incomes and growing demand for goods and

services
Many millions of consumers across the world are enjoying rising incomes as a result of
economic development. For example, average incomes in China increased by approximately 600
per cent between 2000 and 2018. This gives Chinese consumers, as well as those in many other
countries, the ability to buy many products produced elsewhere in the world which fuels trade.
As an example, Jaguar Land Rover (JLR) sells an increasing proportion of its cars overseas as
consumers’ incomes rise and enable them to afford such products. This is shown in Table 29.7.
Globalisation is also allowing JLR to take a strategic decision to produce its products in other
countries. It already operates a factory in China and is in the process of building one in Brazil.
Country or region Sales 2017–18 Sales 2016–17 Percentage change
UK 108,759 124,755 −12.8
North America 129,319 123,527 4.7
Europe 133,592 141,043 −5.3
China 150,116 125,207 19.9
All other markets 92,523 89,477 3.4
 TOTAL 614,309 604,009 1.7
Table 29.7 Jaguar Land Rover’s sales have become more important in China as incomes have risen
Source: Jaguar Land Rover Annual Report, 2018

Handling data
Use the data in Table 29.7 to calculate the percentage of the increase in Jaguar Land
Rover’s total sales between the two years that was achieved in China.

Figure 29.14 Some of Asia’s prominent multinational companies and their export sales

Source: The Economist, 31 May 2014

The importance of globalisation for businesses
Globalisation offers a number of opportunities to businesses from any country and not just the
UK:
• Increased sales, revenues and profits. Being able to trade freely in international markets
offers the chance to increase sales substantially and to enjoy higher revenues and profits – if
the business is sufficiently competitive. It has become possible to sell similar products to
billions of global consumers and this has offered unrivalled opportunities for growth.
Companies such as McDonald’s and Coca-Cola have derived enormous benefits from this
increased access in terms of rising revenues.
• Cheaper resources. Increased volumes of trade also make more resources available to
businesses and allow them to source raw materials and labour significantly more cheaply than
in the past. For example, many UK manufacturers including the train-maker Hornby and
cosmetic manufacturer Avon have moved production facilities to China and Poland
respectively to take advantage of cheaper labour. This has only been possible as a result of
reduced costs of transportation and political and economic changes that have made it possible
for UK businesses to locate in these countries.
• Economies of scale. The increased scale of production gives greater potential to benefit from
economies of scale. This is especially true if it is possible to implement a global strategy
whereby a similar product can be sold to consumers across the world. This means that fixed
costs such as R&D can be spread across larger volumes of production lowering unit costs. At
the same time, the company is likely to benefit from marketing and purchasing economies.
• Developing different products for different markets. The increased scale of production and
access to large overseas markets such as China and India means that foreign companies can
produce cars that meet the needs of local consumers. Thus, for example, increasing awareness
of environmental issues and limited incomes mean that most Asian car consumers will wish to
purchase small cars. The product that will be required will be different from those purchased in
North America.

Key term
A global strategy exists when a business produces a single product (possibly with
slight variants) to meet the needs of consumers across the global market.

But globalisation brings drawbacks for all businesses too:

• Downward pressure on prices. All businesses have access to cheaper sources of raw
materials and labour enabling them to reduce costs and selling prices. This has led to a
sharpening of price competition. Prices of clothing, footwear and electronic products have
fallen in the UK over recent years once inflation is taken into account. This means that for
businesses to remain competitive in markets such as these it is imperative that they are able to
reduce prices to match the general market trend. Some businesses have, however, recognised
that they cannot compete in terms of price with producers based in countries with lower costs.
As a result, they have adopted strategies to differentiate their products by, for example,
developing a unique selling point (USP) based on quality or advanced technology.
• New producers. Established businesses in markets in Europe and North America have found
themselves facing new competition from businesses in developing countries. For example,
Petro China is China’s largest company and was only founded in 1999. However, by 2017 it
had generated annual revenues of more than £225 billion and employed more than 300,000
people. Clearly, this company has become a fierce global competitor drilling and refining oil.
Established producers have found that many markets have been subject to increased levels of
imports from producers in countries such as Indonesia and India.
• Increased need for investment. Globalisation, by sharpening competitive pressures, has
increased the pressure for businesses to invest to compete with firms from around the globe.
Investment is required to produce new products which are differentiated from those currently
available or to increase the skills and productivity of the businesses’ workforces. These
competitive strategies require investment in R&D and in training employees.
• The threat of takeover. Globalisation has seen the development of larger businesses more
able to face the full force of global competition. Many businesses have taken over smaller
competitors to give them greater economies of scale and, in some cases, a brand name that is
familiar in other parts of the world. Smaller successful businesses might be particularly
vulnerable to takeover because of the globalisation of markets.
Strategic decisions in response to globalisation
Globalisation is likely to remain an important issue for businesses for the foreseeable future.
Some consumers from developed and developing countries can be expected to continue to voice
their opposition to the actions of businesses that damage their local cultures and their local
environments. Multinationals need to achieve a tricky balance in their strategic planning between
achieving their ambitions to operate in a global market whilst ensuring they do not alienate large
numbers of the consumers who make up that market.
Some multinationals may opt for strategic alliances with businesses from other parts of the world
to respond to the changes in the world economy that have been created by globalisation. This has
been apparent in the car manufacturing and supermarket industries. In June 2018, Volkswagen
and Ford, two of the world’s biggest vehicle manufacturers, have confirmed that they are
entering a ‘strategic alliance’ that will see them develop a new commercial vehicle, as well as the
potential to work together in other areas.

Global strategies
Many products are sold in global markets nowadays. Examples include soft drinks sold by Pepsi-
Cola and Coca-Cola, sport clothing produced by companies such as Nike and Adidas, and
computers manufactured by Sony or Acer. Businesses may adopt global strategies when
worldwide patterns of demand are similar and a single product or range of products, possibly
with slight variants, is likely to meet the needs of the global consumer. Coca-Cola is a good
example of a company that pursues a global strategy. This approach offers enormous scope for
benefiting from economies of scale and the development of a global brand.

Multi-domestic strategies
Other businesses will take decisions to establish production capacity through the world and to
sell differentiated products targeted to meet the needs of consumers in local markets. Toyota has
adopted this strategy, producing different cars for the American and Asian markets. Businesses
operating this type of multi-domestic strategy produce different products for different countries
and markets. Decisions are taken at a local level wherever possible to allow the business to meet
the needs of different customers. This strategy can encourage an entrepreneurial spirit at
relatively junior levels in the organisation and high levels of innovation. Activities such as R&D
may be conducted in local markets and supplies may be sourced locally.
The importance of emerging economies for
business
The rise of emerging markets is inextricably tied up with globalisation. Globalisation is the
result of the freeing up of trade by reducing political and legal barriers to it and by improving
international communications and transport links. These developments have allowed economies
such as China, India and Mexico to thrive. Freer trade and political systems have allowed
businesses to succeed in emerging markets and have encouraged established producers to locate
in these countries. At the same time domestic businesses in these emerging markets have grown
rapidly. These changes, in total, have helped some emerging economies to achieve very high
rates of economic growth.

Key terms
An emerging market (or economy) describes a country with low incomes per head
but one which is enjoying high rates of economic growth.
Economic growth is the rate of increase in the size of an economy over time.
The BRIC countries are Brazil, Russia, India and China and are often referred to as
prime examples of emerging markets.
A multinational business is one that has production capacity in more than one
country.

China is probably the most immediately recognised of the so-called emerging markets or
emerging economies. It has received much attention in the media for its spectacular rates of
economic growth. Although these are beginning to slow, its economy still grew by 6.8 per cent
in 2018. In 1980, the Chinese economy was about 25 per cent of the size of the UK’s; by 2018 it
was more than three times as large.
There are a number of other emerging economies, some of which are already very large. The
economies of India and Brazil possess enormous potential. India’s population exceeds 1.3 billion
people and the country has specialised in providing services. Brazil has a smaller population (just
over 212 million people in 2019) but huge natural resources, not least land and minerals. Both
are already major economic powers, though both have experienced economic difficulties
recently. Russia, despite facing some economic difficulties at the time of writing, is also well
endowed with natural resources in the form of oil and gas. Together, these four emerging
economies are often referred to as the BRIC countries.
Other emerging economies include Turkey, Mexico, Poland, Indonesia, Saudi Arabia, Taiwan,
Vietnam, Iran, Argentina and Thailand.
The growth rates achieved by the emerging economies such as India and China are much higher
than that achieved by developed economies such as the UK and the USA. The UK’s rate of
economic growth has averaged 2.25–2.5 per cent over the period 1991–2018, whilst the more
spectacular rates achieved by India and China are shown in Figure 29.15.

Figure 29.15 Rates of economic growth in India and China, 1991–2018

Source: World Bank national accounts data and OECD national accounts data files, IMF data

Business in focus: Volkswagen invests in its Mexican factory

Volkswagen (VW) is one of the world’s largest vehicle manufacturers. It designs and
manufactures lorries and vans, motorcycles and engines as well as cars. In 2017, it
produced over 10.7 million vehicles in 27 countries and employed over 640,000
people.
In March 2015, the company announced that it intended to invest $1 billion into its
existing factory in Puebla in Mexico, where it has manufactured cars since 1964. VW
currently manufactures six models in Mexico, including the best-selling VW Golf. The
expansion enabled it to build a new version of the Tiguan, a four-wheel drive car and
some of these vehicles were built to meet the specific needs of customers. The latest
version of the car is also larger to meet the needs of American consumers. In 2017,
the enlargement of the factory enabled VW to export over 350,000 vehicles built in
Mexico – a 16.5 per cent increase on the 2016 figure.
Mexico is the seventh largest manufacturer of cars in the world, producing an
estimated 1.8 million vehicles in 2018, although 80 per cent of vehicle production is
exported. Many are exported to the USA, a market which the company considers very
important. Ford, Honda and Nissan are amongst the other vehicle manufacturers who
also have factories in the country.

Practice questions
1 Analyse the possible reasons behind VW’s decision to expand its factory in
Mexico.
(9 marks)
2 To what extent can VW gain any competitive advantage from a decision to
increase production in a country where many of its rivals also manufacture cars?
(16 marks)
The importance of emerging economies for
businesses
Emerging economies have numerous strengths and are hugely important to many businesses, not
just as markets in which to sell goods and services, but also as attractive low-cost locations for
production facilities. As such, they can be an essential part of a business’s response to the
process of globalisation and important for a number of reasons.

Enormous labour resources

China and India are the world’s two most populous nations with 1.39 billion and 1.37 billion
inhabitants respectively in 2018, while Indonesia’s population was 265 million in the same year.
This helps wages to remain very low and has permitted the production of manufactured goods at
very low costs, although wages have risen as the economies have grown. India’s workforce is
large and many Indians speak fluent English. An increasing proportion is highly educated
allowing the country to provide large numbers of employees for the global IT industry. The
immense pools of relatively cheap labour have attracted many global businesses to establish
facilities in emerging economies. Others use companies based in emerging economies as
suppliers. The Foxconn Technology Group is an electronics manufacturing company which
employed 803,000 people in 2017. It operates 13 factories in China and manufactures products
for Amazon, Apple, BlackBerry and Sony.

Large markets
The large number of people in emerging economies also means that Brazil, Mexico, China,
Indonesia and India are important markets for many companies because of the number of
consumers and the fact that their incomes are generally rising rapidly. Companies such as
McDonald’s and Coca-Cola have targeted increasing sales in these countries as their inhabitants’
incomes have increased. For some companies, such as those supplying tobacco, these markets
can be exceptionally attractive as levels of health education are lower than in developed
economies.

Rapid growth rates

Although their growth has slowed over recent years, many of the emerging markets are still
expanding at impressive rates. Both China and India are achieving annual growth rates of around
7 per cent. In 2018, Indonesia’s economy grew by 5.3 per cent, Malaysia’s by 4.5 per cent and
Vietnam’s by 6.9 per cent. This growth means that many consumers have rising levels of
disposable income to spend on consumer goods such as cars, clothes and electrical goods.
Emerging economies are increasingly attractive markets for many multinational businesses
because of the number of consumers and their rising incomes.

Natural resources
Some of the emerging economies, notably Brazil, Russia and Argentina benefit from having
extensive natural resources. Brazil has huge amounts of timber, agricultural land and mineral
resources. This is one factor influencing global manufacturers to develop production facilities in
these countries.
The risks of emerging economies
Businesses that make decisions to establish production facilities in emerging economies are
taking risks as a consequence. The benefits are attractive, but it can go wrong to a greater or
lesser degree.

Economic risks
Inflation is a pressing problem for several of the emerging economies. In autumn 2018, Turkey
was experiencing inflation of over 24 per cent and Argentina’s rate of price increase exceeded 34
per cent. High growth rates are not guaranteed. Economic growth in Brazil has only recovered to
a 1 per cent growth rate in 2019 following a period when the country’s economy was in
recession.
It can be difficult to export to countries such as India, China and Russia. The governments there
may impose taxes or other restrictions on imports or limit the ability of foreign businesses to
operate there. Some emerging economies are very dependent on one or two products and are
vulnerable to falling demand or prices for these products. The Russian economy has been hit
hard at times by dramatic falls in global prices for oil and gas, for example.

Political risks
Not all emerging markets have stable political systems. The Russian economy is performing very
poorly at the time of writing because many western economies have opposed its actions in
Ukraine and have imposed economic sanctions. Similarly, Iran is subject to sanctions over
developments in its nuclear industry. Unstable governments can take political decisions which
can be very damaging to the business activities of multinational enterprises.

Risks to brand or corporate image

Benefiting from producing overseas in emerging or other economies can result in damage to a
business’s reputation. Low costs may be achieved at the cost of exploiting local employees or
damaging the environment.
Amazon has received a great deal of adverse publicity from its use of Foxconn as a manufacturer
for its Kindles. In June 2018, an investigation by the advocacy group China Labour Watch
revealed unethical working conditions in one of Foxconn’s factories in China where Kindles are
manufactured. Even a brand as popular as Amazon’s is not immune to such criticism.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 Define the term ‘gross domestic product’ or ‘GDP’.
2 Distinguish between a recession and a boom in an economy.
3 State what happens to the prices of exports and imports when a currency
 appreciates.
4 What is the difference between ‘inflation’ and ‘deflation’?
5 State three main taxes that are paid by businesses in the UK.
6 List the macroeconomic objectives that are pursued by the UK government when
operating its fiscal and monetary policies.
7 State two techniques of monetary policy that are available to the UK government.
8 State three methods of protectionism that a government might use to reduce
imports of goods and services.
9 List three factors that have led to greater globalisation of businesses.
10 State two reasons why emerging economies or markets are important to many
businesses.

(b) Short answer questions

1 Explain one possible benefit to UK businesses from the government decision to
balance its budget as soon as possible.
(4 marks)
2 Explain one possible drawback to a start-up business of the UK suffering from a
period of deflation.
(5 marks)
3 Explain the reasons why businesses may be disadvantaged in the long term if their
governments implement measures intended to protect against imports.
(5 marks)
4 Analyse the possible implications of a substantial fall in the pound’s exchange rate
for large UK businesses manufacturing chocolate, such as Cadbury.
(9 marks)

(c) Data response question

Japan Tobacco International
In October 2017, the last packet of cigarettes were produced at the Japan Tobacco
International (JTI) factory in Ballymena in Northern Ireland. JTI’s decision resulted in
the loss of 800 jobs. JTI produces a number of well-known cigarette brands including
Silk Cut. Following the closure of this factory, no tobacco products are manufactured
in the UK any longer.
Through the restructure of its manufacturing facilities, JTI’s production has ceased in
Northern Ireland, Belgium and Germany, and has moved to facilities in Indonesia and
the Philippines. The company can see benefits from globalisation and sales of
tobacco products are higher and more stable in some emerging markets. China,
Indonesia and Russia were the largest markets for tobacco products in 2017.
JTI said that one reason its decided to close its Ballymena factory was due to new
European rules prohibiting tobacco companies from selling cigarettes in smaller packs
than 20, while Menthol cigarettes have been banned altogether. As a result,
production at the factory was lower than in previous years. Tobacco consumption in
the UK has fallen steadily (as it has in most developed countries) since 1974. The UK
government imposes heavy taxes on tobacco products totalling more than £12 billion
in 2018. The company also said that taxation in the UK had influenced its decision.

Questions
1 Explain the ways in which taxation in the UK might have affected JTI’s decision
about relocating its factory.
(5 marks)
2 JTI has transferred cigarette production to Indonesia and the Philippines. Analyse
why there might be relatively few risks in moving production to these emerging
economies.
(9 marks)
3 ‘JTI is likely to benefit from continuing globalisation.’ Do you agree with this
statement? Justify your decision.
(16 marks)

(d) Essays
1 ‘Globalisation offers benefits to large businesses in the UK and imposes many
costs on smaller ones.’ To what extent do you agree with this statement? Justify
your view.
(25 marks)
2 To what extent are changes in the level of a country’s GDP the most important
element of the economic environment influencing strategic decisions by its
businesses?
(25 marks)
Chapter 30 Analysing the external
environment: social and technological
change
Introduction
This chapter considers the threats to, and opportunities for, businesses that are created by
changes in their social and technological environments. Social changes will include those that are
taking place in relation to migration and the lifestyles and buying behaviour of consumers,
including the use of online businesses. This section also looks at the importance of Corporate
Social Responsibility and contrasts the stakeholder and shareholder concepts. We also examine
the pressure that business faces to behave in a socially responsible manner. We consider the
profound changes that are taking place in the technological environment, not least the power of
the smartphone to communicate with customers and how businesses may respond to this through
functional and strategic decision making.
What it is important to know by the end of this chapter:
• the impact of changes in the social and technological environment, including demographic
changes, population movements and technological advances, on strategic and functional
decision making within a business
• the reasons for and against corporate social responsibility (CSR), the differences between
stakeholder and shareholder concepts and Carroll’s CSR pyramid
• the pressure on businesses to behave in a socially responsible way.
Social changes
Businesses can be affected by social changes in two major ways. Social changes may lead to
different goods and services being demanded. For example, the average age of the UK’s
population is rising, prompting increased sales of products associated with the later stages of life.
Simultaneously, social changes can impact on the way that businesses produce goods and
services. Thus, the increased use of tablets and smartphones to purchase products has led to
many retailers increasing their online operations, sometimes at the expense of traditional shops.
Demographic change and population movements
Demographic change
We saw in Unit 1 that the size and make-up of a population in terms of age can have important
implications for businesses. Businesses draw on populations for their workforces and they also
represent their consumers. Thus, demographic change can impact upon a business’s costs of
production as well as the level of demand for its products.
The population of the UK is demonstrating two major trends.
1. It is growing quickly. Since 1964 the population of the UK has grown by over 10 million
people or 18.7 per cent. Partly this is due to people living longer and partly because of a rise in
the birth rate. Approximately 50 per cent of this rise in the UK’s population has taken place
since 2001. Figure 30.1 shows that the rate of growth has been significantly higher since 2006.
2. It is ageing. By 2045, there will be more than 10 million people over 75 years of age in the
UK, twice as many as in 2015. Figure 30.2 compares the age profile of the UK’s population in
2016 with estimates for 2041. The profile in 2016 is shown by the shaded area and that in
2041 by the darker blue line. It is apparent that a much higher proportion of the population
will be aged over 70 in 2041. Simultaneously, there will be a higher number of teenagers.

Figure 30.1 The UK’s actual and forecast population size 1991–2041

Source: Office for National Statistics (ONS)

Figure 30.2 The age profile of the UK’s population in 2016 and 2041

Source: Office for National Statistics (ONS)

The combination of these two trends (more births and people living longer) is that the UK’s
population will have more older and more younger people for the foreseeable future. These
trends will change the shape of the family from a horizontal one to a vertical one: that is, to a
family with more layers – grandparents and great grandparents – but fewer people in each
generation as the numbers in the middle-age ranges will be lower.
These are important changes and will continue to have great implications for businesses. A larger
population will lead to a rising demand for goods and services, and one with higher proportions
of young and old people will demand different types of products. At the same time, businesses
are likely to have ageing workforces and the proportion of people in the economy who are not
working may rise. This could, for example, increase demand for leisure products.
In Chapter 29, we studied the importance of the process of globalisation. Globalisation means
that for many UK businesses it is not just the changes in the UK population that matter, but
changes in the global population.
The UK’s membership of the EU grants the right of free movement to citizens of 27 other
European countries and provided an enormous potential workforce as well as a huge market in
which to sell goods and services. Brexit is likely to end the free movement of people from other
EU states to the UK. At the time of writing, it appears likely that the UK will have an
immigration policy based on the UK’s need for people with specific skills. Immigrants may
come from any country and EU citizens will not be treated more favourably. We consider the
impact of migration later in this chapter.
The global population is expected to rise steadily throughout the 21st century, although the
precise growth rate is a matter of some debate. Figure 30.3 shows a range of scenarios,
influenced heavily by the birth rate with data indicating 80 and 95 per cent confidence intervals –
that is, forecasts which statisticians are 80 and 95 per cent certain will prove correct.

Figure 30.3 Global population forecasts for the remainder of the 21st century

Source: The Guardian, 18 September 2014

Handling data
Explain why the shaded area showing a 95 per cent confidence interval in Figure 30.3
is larger than that having an 80 per cent confidence interval.

The growth in population will not be spread evenly across the globe. Much of the growth will
occur in Africa. Sub-Saharan Africa is forecast to be the fastest growing region: its population is
expected to rise from approximately 1 billion in 2014 to between 3.5 and 5 billion by 2100. In
contrast, the population of Europe will grow much more slowly and will age. The population of
Europe is currently 12 per cent of the world’s population; by 2050 that figure is expected to fall
to 7 per cent.
The global population was 7.5 billion in 2019 – nearly two and a half times greater than the 3
billion in 1960. The populations of East Asia and Pacific and South Asia each grew by more than
a billion people, but Sub-Saharan Africa’s population expanded the fastest: it is more than 4.4
times its size in 1960. The Middle East and North Africa’s population has also expanded rapidly.
The effect of ageing populations is high on the agenda for governments in Europe and Japan
currently. However, this problem will impact on countries that currently have young populations
over time as their population growth slows. For example, in 2006, 50.0 per cent of Brazil’s
population was in the working age groups (aged 15–64); by 2016 this figure had fallen to 43.6
per cent and is forecast to decline further. China and India will face similar issues over time.

Population movements
Research into migration by the International Organisation for Migration has produced some
startling statistics:

Key terms
Migration is the movement of people between countries or regions.
Urbanisation is the movement of people from the countryside to live in cities.

In 2015, approximately one person in every seven was a migrant: 244 million people are
international migrants, or 3.3 per cent of the world population, and approximately 740 million
are internal migrants.
About 51 per cent of international migrants reside in 10 countries. The most popular destination
country is the United States, where 46.6 million foreign-born officially resided in 2015, followed
by Germany (12 million), the Russian Federation (11.9 million), Saudi Arabia (10.2 million), the
United Kingdom (8.5 million), the United Arab Emirates (8.1 million), Canada and France (7.8
million each), Australia (6.7 million) and Spain (5.8 million).
The top five countries by size of their diasporas (number of international migrants living abroad)
in 2015 were India (15.6 million), Mexico (12.4 million), the Russian Federation (10.6 million),
China (9.5 million), and Bangladesh (7.2 million).
Europe has a relatively high proportion of international migrants in its population – 10 per cent
on average. Countries in Northern and Western Europe having the highest shares (e.g. 17.5 per
cent in Austria, almost 17 per cent in Sweden, and about 15 per cent in Germany). In 2015,
approximately 14 per cent of the population was born overseas; the equivalent figure for London
was 37 per cent.
Figure 30.4 Flow of migrants between the world’s countries and regions, 2010–2015

Source: Speigel online

Figure 30.5 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.
In addition, there are large-scale population movements taking place within 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 58 per cent
of its total population between 2007 and 2017. 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.
But urbanisation is not limited to emerging economies such as that of China. Most countries in
the world have experienced this phenomenon. In 2017, for example, 83 per cent of people in the
UK lived in urban areas. Table 30.1 shows the rates of urbanisation for a selection of countries as
well as the increases between 2000 and 2017.
Percentage living in urban areas
Country
2000 2017
 Japan 79 92
Argentina 89 92
Netherlands 77 91
UK 79 83
Portugal 54 65
Nepal 13 19
Indonesia 42 55
Table 30.1: Urbanisation rates for a selection of countries, 2000 and 2017
Source: World Bank data

Handling data
In 2000, the population of Japan was 127 million and by 2013, it had risen slightly to
127.4 million. Use the data in Table 30.1 to calculate how many additional Japanese
people were living in urban areas in 2013 compared with 2000.

The implications of demographic change and population

movements for businesses
The implications of demographic change and population movements are potentially immense but
also difficult to predict as population forecasts can vary widely, as seen earlier in Figure 30.3.
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 population over the long term, even if
the more modest demographic forecasts are correct.
However, if income per head remains low, or even declines, 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
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.
The ageing populations of Europe and Japan will provide increasing opportunities for a range of
businesses supplying products such as health care and leisure products. However, the scale of
these opportunities can be difficult to predict 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 7.0 per cent in 2017–18. 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. We have
explored some of the effects that may result from changes in the size and composition of the
UK’s population in the Business in focus feature on the following page. Businesses, and not just
those in the leisure and tourism industries, will have opportunities in the form of the
development of new markets (for example, space tourism), 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.
Opportunities will also exist for HR managers to harness the innovative potential of diverse
workforces towards achieving businesses’ goals. Recent research has identified a strong
correlation between those businesses that employ diverse workforces and the level of the
businesses’ performance. Drawing on the changing composition of populations, as is occurring
in the UK, can enhance a business’s competitiveness. The most innovative companies are
already using increasingly diverse workforces in terms of gender, ethnicity, age and values.

Business in focus: Demographic change and the leisure

industry

Type of Possible implications

demographic
change
Ageing society As life expectancy increases, there will be increasing numbers
of older people in society
Vertical family Driven by both rising life expectancy and lower fertility rates,
the shape of the family is changing
Baby boom Over the past 15 years a sustained rise in the birth rate has
caused a mini baby boom
Untraditional New types of family are emerging – including step families, gay
families parents and older parents
Changing ethnic A rising number of both BME and foreign born people, whose
profile tourism habits need to be understood
Squeezed middle Amid rises in the number of younger and older people, the
generation number aged 35–49 is falling
Multispeed For different regions and local authorities, the speed and
demography nature of these changes will vary
Table 30.2 A summary of population and social change trends
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 2013–2023. The information below
 is part of its report.

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 time poor and
willing to treat themselves.
• Black and minority ethnic (BME) and immigrant populations’ tourism habits are
currently poorly understood – but are an increasingly large part of the market.

Practice questions
1 Analyse the possible decisions that a UK hotel chain might take in response to the
opportunities provided by the forecast demographic changes for the UK.
(9 marks)
2 To what extent do the forecast global demographic changes offer more
opportunities than threats for UK businesses?
(16 marks)

For many other businesses, opportunities and threats will coexist. Changes in the structure and
location of population caused by age changes, urbanisation and migration will create new or
expand existing market segments or niches. Agile and proactive enterprises may be able to
exploit new markets, especially with the use of appropriate technology. The threats of
competitors growing at their expense will be greater for businesses that do not recognise that this
element of their external environment is changing rapidly.

What do you think?

Are businesses in the fashion and technology industries most likely to be affected by
the forecast changes in population?

Urbanisation throws up a range of different opportunities and threats for businesses.

Opportunities exist in providing many different goods and services to markets that are growing
quickly. The consumers of these goods may be individuals, other businesses and governments. A
high level of investment will be needed in urban areas across the world as governments seek to
provide transport and communication facilities to allow cities to flourish. Companies that can
provide technological solutions to problems such as providing large amounts of cost-efficient
renewable energy, high-technology low-carbon transport and how to fund such developments
will benefit from the process of urbanisation. Urbanisation can also provide opportunities for
new businesses to establish themselves to supply the needs of 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.

Figure 30.5 Masdar City will incorporate the latest technology in construction, energy supply and
transportation. It will be completed by 2025 and will be home to 50,000 people and 1,500 clean
technology businesses.

The threats to businesses of demographic change and population movements can take the form of
increased competition, possibly from overseas businesses, attracted by the growing market.
Competition may force up the price of resources such as land and property, pushing up the
operating costs of businesses in urban areas. Rents for offices in major cities are rising quickly:
rents for office space in New York are approximately four times those in rural areas in the USA.
Businesses in urban areas may face squeezed profit margins as a consequence unless they can
take decisions to locate in less costly areas.
Changes in consumer lifestyle and buying
behaviour
Key term
Ethical behaviour is that which is regarded as being morally correct, such as using
sustainable sources of supply for resources used in production.

Lifestyles and consumer buying behaviour are closely related. When a consumer experiences a
significant change in lifestyle, such as becoming unemployed or getting married, their buying
behaviour is likely to change. It is possible to identify a number of contemporary influences on
consumer lifestyles and to consider how these might impact on the spending behaviour of
consumers.

The impact of technology on lifestyles and buying behaviour

Technology is having a significant impact on lifestyles. Consumers are embracing developments
that synchronise their home appliances with tablets and smartphones and can control domestic
appliances from outside the home. They are also increasingly willing to wear technology that
monitors factors such as blood pressure and distance walked. Over 172 million wearable devices
were sold worldwide in 2018 and sales are forecast to reach 560 million in 2021, generating
revenue of £73.3 billion. These types of technology allow consumers to focus on issues of
importance such as health, controlling expenditure and convenience. Some of these products
encourage consumers to record lots of data about themselves for personal use, and perhaps to
share with companies. As a result, consumers are increasingly willing to invest in this technology
and companies may have access to large amounts of data about consumers and their behaviour.
Research by Mintel in 2017 showed that:
• over 20 per cent of adults in the UK use a wearable device or a mobile app to monitor their
health and UK sales reached 4 million devices
• ownership in the UK of smartphones (82 per cent) and tablets (58 per cent) has remained
largely stable throughout 2016–17, that of smartwatches has steadily risen to its current 9 per
cent level, up from just 2 per cent in 2014. Meanwhile, ownership of fitness bands stands at 16
per cent, up from 7 per cent in 2015.
Such developments not only increase consumer expenditure on smartphones, tablets and
wearable gadgetry, but also on sophisticated devices that can engage with them such as the latest
TVs and digital controls for air-conditioning or heating systems.
Technology can also affect consumer buying behaviour directly by providing more information
and thereby shaping purchasing decisions. For example, technology can provide consumers with
details about a business’s operations. Research suggests that a majority of UK consumers are
influenced in buying decisions by the ethical or environmental behaviour of businesses.
Technology helps them to identify businesses that behave in undesirable ways. Social media
provide a vast amount of information about the activities of businesses and apps are being
developed to provide data to help consumers rate firms and products according to their ethical
and environmental performance. Specialist websites also provide consumers with a great deal of
information about businesses and their actions that have damaged the environment, resulted in
perceived underpayment of taxes or have behaved unethically. Whether or not a business is
perceived as exhibiting ethical behaviour can greatly affect customers’ buying decisions.

Health and well-being

Personal health and well-being are increasingly important to many consumers in the UK who are
concerned about adopting or maintaining a healthy lifestyle for themselves and their families.
This may take the form of seeking an improved work-life balance, a nutritious diet, weight loss
or more exercise.
Consumers are increasing expenditure on a range of foods and other products with the intention
of promoting their health and well-being. Figure 30.7 shows that the effects of this change in
consumer lifestyle is not limited to the UK, but is a global trend. Consumers in emerging markets
such as India and Brazil are spending increasing amounts on products related to their health and
well-being. Global expenditure reached $1,000 billion in 2017 according to Euromonitor
International.

Figure 30.6 Global spending on foods intended to promote health and well-being, 2007–17

Source: Euromonitor International

Figure 30.7 Consumer confidence in the UK 2015–2018

Source: The Independent, 27 April 2018

Note: A figure of zero represents a neutral score in that confidence is unchanged. Negative figures
indicate falling levels of consumer confidence.
This change in consumer lifestyle has prompted increased expenditure on services and consumer
durable products, as well foodstuffs also illustrated in Figure 30.6. Companies are selling
increased volumes of sports clothing, sports equipment such as exercise bicycles, juicers and
gym memberships.

Consumer confidence
In 2008, the UK and many other countries suffered a financial crisis which threatened the
survival of a number of very large banks. As a consequence, their lending activities were
severely curtailed and this reduced consumer expenditure and the level of business activity. In
turn, this resulted in the UK suffering a deep recession and one in which consumers’ incomes, in
real terms, grew much more slowly than would otherwise have been the case. Research by the
Institute for Fiscal Studies (IFS) revealed that GDP in the UK in 2018 was just 11 per cent higher
than at its pre-crisis peak in 2007–08. As a result, the economy is 16 per cent, or £300 billion,
smaller than it would have been had it followed the pre-crisis trend. GDP per person in 2018 was
£5,900 per person lower than it might have been had pre-crisis economic trends continued.
Employment in the UK appears to have recovered, with more people in work than at any other
time – nearly 32.7 million in February 2019. However, this is misleading to some extent. Many
jobs are part-time or ‘zero hours’ contracts where workers are not guaranteed regular hours. In
2017, approximately 3.2 million employees in the UK said they would like more hours.
Figure 30.8 Average weekly nominal and real UK wages 2006–2018

Source: ONS
The effects of the lack of hours, slow increases in real pay rates and diminished consumer
confidence (as illustrated in Figure 30.7) have all combined to have a significant effect on
consumers’ buying behaviour. Consumers have frequently been reluctant to spend freely on non-
essential products and have focused on repaying debts.
Figure 30.8 shows weekly wages in the UK in nominal and real terms. Nominal pay shows the
actual amount paid to employees each week while the real wages are adjusted for inflation and
show changes in consumers’ spending power. Consumers in the UK only experienced a recovery
in their spending power in late 2014. Despite this evidence of recovery in real wages, the
uncertain nature of some employment continues to have an impact on spending patterns and
levels. There are also concerns about the implications of Brexit. These combine to create a
situation in which, at the time of writing, consumer confidence and spending levels are very
fragile.

The implications of changes in consumer lifestyles for

businesses
Well-managed businesses monitor changes in consumer lifestyles and respond to the
opportunities. Brands in the wellness market segment are benefiting from a growing consumer
desire to live healthier lives. Examples include the meat substitute producer, Quorn, and organic
tea producer, Pukka. Larger businesses are likely to seek to develop their own products for these
growing market segments.
Businesses also have to respond to the threats that result from changes in consumer lifestyles.
Low levels of increases in real wages have resulted in dramatic shifts in consumer spending in
the UK groceries market. In between 2013 and 2017, household spending in the UK on food and
drink declined in real terms by 2.7 per cent according to the Office for National Statistics. This
decline and the increased popularity of shopping in small local stores has led supermarkets such
as Tesco, Sainsbury’s and Morrisons to take a number of decisions:
• to close some larger and loss-making stores
• to focus on smaller, local convenience stores
• to cut prices to attract customers away from rivals
• to establish new subsidiaries – for example, Tesco has created a new low-price (or discounter)
 business called Jack’s. The first new stores opened in Cambridgeshire in September 2018 and
they now operate nine stores across the country.
The increased amount of information consumers require and have access to has led to businesses
developing new products to meet these needs. Many new health monitoring products are
available for consumers to buy and supporting services such as free blood pressure checks are
available from instore pharmacies.

Business in focus: Wearable technology becoming more

popular

The latest figures from market research group Mintel demonstrate how the popularity
of wearable technology, such as smartwatches and fitness bands, has continued to
grow. Nearly four million devices were sold in 2017, up 18 per cent on 2016.
Sales of fitness trackers, which monitor fitness-related metrics such as heart rate,
distance walked and quality of sleep, remained stronger than for smartwatches, but
the gap is closing. An estimated 1.99 million trackers were sold in 2017, up 16 per
cent on 2016, with the most popular devices coming from Samsung and Huawei.
Apple has dominated the smartwatch sector since the launch of its smartwatch in
2015. Most smartwatches offer apps similar to those available on smartphones as
well as having fitness tracking capabilities. An estimated 1.96 million smartwatches
were sold in 2017 (an increase of 23 per cent on 2016).
Ownership of smartphones and tablets – 82 per cent and 58 per cent, respectively –
remained stable throughout 2016–17, while ownership of smartwatches has risen
steadily to 9 per cent.
The research also revealed the following attitudes towards wearable technology
among UK consumers:
• 33 per cent of people believe that wearable technology will ‘make their lives better’.
• 28 per cent of people said they would leave their smartphone at home if their
smartwatch had the same functionality (for example, calls, messaging, music and
internet access); this figure increased to 36 per cent in 16–24-year-olds and 40
percent in 25–34-year-olds.
• 21 per cent of people said they were interested in combining fashion and
technology with smart jewellery, which could become a rapidly-growing sector of the
wearable technology market.
Andrew Moss, a technology analyst at Mintel, noted that rapid improvements in the
functionality of wearable technology have increased its appeal to a much broader
market. Presenting these devices as fashion pieces should further boost their
popularity with less tech-savvy consumers.
Other research suggests that sales of wearable device will grow approximately 22 per
cent globally per year between 2018 and 2021. By the end of 2021, wearable devices
will represent a market worth £35 billion with over 250 million sales per year.
 Source: Adapted from the Fashion United website, 13 March 2018

Practice questions
1 Analyse the possible implications of this trend for businesses other than those who
manufacture wearable technology.
(9 marks)
2 Is manufacturing wearable technologies a risky market for businesses to enter?
Justify your view.
(16 marks)

Advances in technology alongside changes in consumer behaviour mean that businesses have to
be increasingly aware of protecting their image and reputation and prepared to respond rapidly to
adverse comments on social media by apologising, compensating, explaining or correcting
unsatisfactory behaviour as appropriate. Functional decisions to establish and expand social
media teams to carry out these duties are essential for businesses.
The growth of online businesses
Online businesses are predicted to grow rapidly over the next few years in all countries and their
expansion is supported by changes in consumer lifestyle, particularly the increasing use of
smartphones, tablets and other internet-linked devices.
The growth of online businesses has already had a huge impact on the retail industry in the UK
and elsewhere. The Centre for Retail Research in the UK forecasts further growth in online retail
sales. It says that online is the fastest growing part of the retail market in Europe. Online sales in
Western Europe and Poland grew from £174.76 billion in 2016 to £230.62 billion in 2017, a rise
of 14.2 per cent. Further growth of 13.8 per cent in 2018 should mean that online sales reach
£262.46 billion. The proportion of the retail market that is conducted online varies enormously
across Europe. It offers considerable potential for growth in online sales in high income
countries such as Italy and Spain (as shown in Figure 30.11) at a time when online retailing is in
its infancy.
However, it is not just the retail industry that is in the process of being transformed by
developing its online presence. Increasingly, transport companies are selling their products
online. For example, low-cost airline easyJet had over 23 million visitors to its website in the
five months from April to September 2018. Many of these will have been customers booking
flights online. The online model also allows the company to adjust its prices to reflect peaks and
troughs in demand. This helps it to maximise its revenue from sales.

Figure 30.9 The share of the retail market held by online businesses in selected European countries
2015–2017 (forecast)

Source: Centre for Retail Research

Many other online markets are developing, offering a range of opportunities to innovative
businesses. One example is the growth of online broadcasting. Some TV and radio stations are
online only, allowing them to reach a global audience. Other companies have established
websites to allow consumers access to TV and radio stations from around the globe.
Streema.com is a small business that offers its consumers access to radio and TV stations from
countries across the world. Other industries, such as gambling and companies that operate
websites providing product reviews and comparisons, have thriving operations on the internet.

The implications of the growth of online businesses

The Centre for Retail Research forecasts that the retail industry in the UK will change
profoundly by 2022. A major driver of change is the rise of online retailing. The Centre’s
forecasts are as follows.
• From 2017 to 2022, it expects a total of 31,005 stores to close, a fall of 23.6 per cent since
2012. Many of these stores will be larger than average and will have a greater impact upon the
number of redundancies.
• By 2022, the Centre expects online retailers to be responsible for 22.7 per cent of retail sales,
including one-third (33.9 per cent) of non-food. The effects of this shift to online upon bricks-
and-mortar stores will be dramatic. The Centre does not expect online sales to carry on
growing at the same rate forever.
• Further falls in retail store numbers are forecast to result in 384,500 job losses. Additional
losses will occur as retailers cut staff down to minimum numbers to reduce costs as sales
decline. This will add a further 168,000 job losses, a combined total of 552,500 job losses,
equivalent to almost one-in-five (19.4 per cent) of the retail labour force.
Managers of retail businesses will have to take a range of strategic and functional decisions in
response to this changing environment. Online developments pose a threat and will reduce the
sales of many established retailers. For example, Tesco has already announced store closures and
the reduction in its retailing capacity. The growth of online retailing offers a huge threat to many
retailers, especially small ones whose products can easily be sold online. The number of
bookshops in the UK has declined sharply, for example, due to the rising online sales of books,
especially by Amazon, the world’s largest retailer. The owners of small bookshops have
responded by providing a wider range of in-store facilities such as cafés and crèches with mixed
results. The number of shops in the UK has declined from 600,000 in 1950 to just over 317,000
in 2018, mainly as a result of increasing sales online. Table 30.3 shows that a high proportion of
these store closures occurred between 2012 and 2018.
2012 2018 Change 2012–2018 Percentages
Total: food 143,439 119,304 −24,135 −16.9%
Total: non-food 245,625 198,327 −47,298 −19.3%
Total 389,064 317,631 −71,433 −18.4%
Table 30.3 The number of retail stores in the UK, 2012 and 2018
Source: Centre for Retail Research
However, these changes also offer opportunities for retailers of all sizes. Retailers with large
stores are dividing the floor space and renting some to other retailers. Online developments are
also encouraging businesses to cooperate in other ways. Amazon offers local pick-up points for
the products it sells for those who do not want postal deliveries. Customers may, for example,
pick up their Amazon delivery from a local newsagent.
The increasing use of the internet by people in the UK and elsewhere offers opportunities for
entrepreneurs to start up or expand small businesses, as well as to multinationals such as
Amazon. Crowdfunding is a comparatively new industry that has developed using the power of
the internet (see Chapter 18). The internet allows crowdfunding companies to link lenders and
borrowers in an effective low-cost model. For example, Funding Circle has grown rapidly since
it was founded in 2010; in September 2018, it became a public company with an initial market
capitalisation of £1.5 billion.
Online trading has supported other businesses in developing their business models and increasing
sales. Market research companies use online surveys in addition to other methods of collecting
data. Many newspapers and magazines are experiencing falling sales of ‘hard copy’ but rising
viewing figures of online versions suitable for reading on tablets and smartphones as well as
laptops, although their articles are also viewed through other websites. Some industries now
operate almost exclusively online, for example, dating agencies.
Trading online offers businesses the potential for substantial benefits.
• There is the prospect of lower costs if a business needs less property, especially if it is needed
in expensive city locations.
• It may also be able to operate with fewer employees reducing labour costs.
• Another major benefit relates to marketing. Possessing an effective website offers even the
smallest businesses the chance to reach a large market. Small businesses can sell to global
markets in a way that would not have been possible 20 years ago.
• Finally, the internet provides entrepreneurs with a means of developing start-up enterprises
quickly and cheaply. Snapchat, a business providing a photo messaging application, was
established by three Stanford University students in 2011. By 2018, it had 186 million active
users and the company that owned it, Snap Inc, had assets valued at $3,422 million.
Corporate social responsibility
Corporate social responsibility (CSR) is a business philosophy that emphasises that firms should
behave as good citizens – this is sometimes simply termed ‘social responsibility’. They should
not merely operate within the law, but should consider the effects of their activities on society as
a whole. Thus, a socially responsible business attempts to fulfil the duties that it has towards its
employees, customers and other interested parties. Collectively, these individuals and groups are
termed a business’s stakeholders.
Stakeholder Possible nature of stakeholder’s interest
group
Shareholders • Regular dividends
• Rising share prices
• Preferential treatment as customers – for example, lower prices
Employees • Steady and regular income
• Healthy and safe working conditions
• Job security
• Promotion and higher incomes
Customers • Certain and reliable supply of goods
• Stable prices
• Safe products
• After-sales service and technical support
Suppliers • Frequent and regular orders
• A sole supplier agreement
• Fair prices
Creditors • Repayment of money owed at agreed date
• High returns on investments
• Minimal risk of failure to repay money owed
The local • Steady employment
community • Minimal pollution and noise
• Provision of facilities (for example, scholarships, art centres or
reclaimed areas) for the local community
Table 30.4 Stakeholders’ interests
Over recent years businesses have become increasingly aware of the expectations of stakeholder
groups. In the past, managers often operated businesses largely in the interest of the
shareholders. A growing awareness of business activities by consumers and other stakeholder
groups, driven by recent developments such as the widespread use of social media, has
complicated the task of management teams. Businesses are also subject to the attention of
pressure groups pursuing a particular interest. For example, Greenpeace and Friends of the
Earth campaign to protect the environment and their activities have significant implications for
businesses. This means that managers have to attempt to meet the demands of a number of
stakeholder groups which are likely to conflict at times.

Key term
A pressure group is a group of people with common interests who organise to
influence public opinion and the decisions of businesses and governments.

Meeting social responsibilities has many implications for businesses including:

• taking into account the impact of their activities on the local community – protecting
employment and minimising noise pollution, for instance
• producing in a way that minimises 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.
Some businesses willingly accept these responsibilities partly because their managers want to do
so and partly because they fear a negative public image. It may be argued that socially
responsible behaviour can pay off for businesses in the long term, but may entail additional
short-term expenditure.
Archie Carroll developed his CSR pyramid in 1996 as a way of setting out the ways in which an
organisation could meet its social responsibilities. Carroll stated that ‘corporate social
responsibility involves the conduct of a business so that it is economically profitable, law
abiding, ethical and socially supportive. To be socially responsible then means that profitability
and obedience to the law are foremost conditions when discussing the firm’s ethics and the
extent to which it supports the society in which it exists …’ By creating different layers in the
pyramid as a hierarchy as in Figure 30.10, it can assist managers in understanding the different
types of obligations that a business has towards society.
Carroll’s pyramid sets out a hierarchy of four types of responsibility that a business should meet
to be socially responsible:
1. Economic (or financial) responsibilities. This is the responsibility to be profitable. Without
this the organisation would be unlikely to survive in the long term and thus not able to fulfil
its other responsibilities to society.
2. Legal responsibilities. Businesses should obey the laws of the countries in which they are
operating. Meeting these responsibilities will help to ensure the business acts in the best
interest of society by, for example, paying minimum wages and avoiding activities that cause
pollution.
3. Ethical responsibilities. This is a step beyond meeting legal responsibilities and entails
behaving in a morally correct way to meet ethical responsibilities. Thus, for a business in the
UK, this might entail paying the living wage (a recommended wage to enable employees to
pay the basic costs of living) rather than the legally-enforceable minimum wage.
4. Philanthropic responsibilities. These responsibilities relate to discretionary behaviour by
businesses to improve the lives of others in society. Examples include making charitable
donations, providing recreational facilities for communities or sponsoring sports events.

Figure 30.10 Carroll’s CSR pyramid

Carroll argued that CSR requires businesses to satisfy all four levels of the pyramid
consecutively. Using this as his basis, Carroll defined CSR as encompassing ‘the economic,
legal, ethical and philanthropic expectations placed on organisations by society at a given point
in time’.

Key models and theories: Carroll’s CSR pyramid

Carroll’s CSR pyramid looks at the types of responsibilities a socially-responsible
business might accept. This model can be a useful base for considering what
responsibilities a particular business might accept and how socially responsible it is.
The model can also provide a framework to help you to analyse the reasons why
different types of responsibility might be accepted and the possible consequences to
the business and its stakeholders of doing so, or not doing so. Finally, you might
consider why businesses in some industries are willing to accept more of these types
of responsibility than businesses in other industries.

Business in focus: ‘Tax shaming’

In the UK, a number of multinational companies, including Amazon, Starbucks and

Google, have received public criticism for paying small amounts of tax or, in some
cases, no tax at all here. In 2018, Starbuck’s was criticised for paying an apparent tax
rate of 2.8 per cent on its profits, when the rate of corporation tax is 19 per cent in the
UK. The company responded by saying that it had paid all the tax that was due. The
company also made a £20 million voluntary tax payment in 2014 following similar
criticism. Such adverse publicity for a range of multinational businesses, dubbed ‘tax
shaming’, has led to threats of customer boycotts.
A similar trend has emerged in the USA where the government is thought to have
missed out on billions of dollars of tax revenue due to tax avoidance. Pressure groups
have been established there, calling for companies to behave fairly rather than taking
advantage of loopholes in the country’s laws to reduce their tax liabilities.
The proportion of the American government’s total tax yield which comes from
businesses has steadily fallen.
• In 1952, businesses paid 32 per cent of federal taxes, individuals contributed
another 42 per cent and payroll taxes were 10 per cent.
• By 2016, the proportion of federal tax revenue paid by individuals had risen to 47
per cent, payroll taxes had risen to 34 per cent and taxes on businesses was just 9
per cent.
Two pressure groups (Citizens for Tax Justice and US PIRG) commissioned a report
on the issue entitled ‘Offshore Shell Games’ which summarised the extent of the
problem:

In 2016, nearly three in four Fortune 500 companies maintained subsidiaries in

offshore tax havens, according to ‘Offshore Shell Games’, an annual study of
offshore tax avoidance released by the U.S. PIRG Education Fund and the
Institute on Taxation and Economic Policy. Fortune 500 companies’ offshore
cash hoard now totals $2.6 trillion, a sum on which these companies are avoiding
up to $752 billion in U.S. taxes.
The companies involved reduce their tax payments by registering their businesses in
tax havens outside the USA such as the Cayman Islands and Bermuda.
Source: Adapted from USPIRG, 2017

Practice questions
1 Analyse how Carroll’s CSR pyramid could be used to assess the behaviour of
many large businesses in the USA.
(9 marks)
2 Is tax shaming a better way to encourage businesses to accept their social
responsibilities than passing new laws? Justify your answer.
(16 marks)
Shareholder and stakeholder concepts
The shareholder concept
A school of thought exists that supports what is known as ‘the shareholder concept’. This view,
originally developed by the economist Milton Friedman, argues that management teams should
only aim to meet their responsibilities to shareholders and that this is best done by maximising
the business’s profits. They argue this should result in increasing share prices and higher
dividend payments which will satisfy shareholders. The needs of other stakeholders are regarded
as of secondary importance. Using the shareholder approach has some risks. It tends to
encourage short-termism in decision making and also the increased taking of risks to generate
maximum profits. In extreme cases, pressure on management teams to improve profitability has
led to the falsification of financial statements as in the case of Enron.

The stakeholder concept

Some management teams operate with the expectation that the business will take into account the
obligations it may have to society in general in all its decision making. This is known as ‘the
stakeholder concept’ whereby a business considers the needs of its stakeholders, and not just its
shareholders. The stakeholder concept or theory was first set out by Edward Freeman in his book
Strategic Management: A Stakeholder Approach in 1984, and it has influenced the behaviour of
many businesses since. It can be an important component of corporate social reporting, which we
consider below.

An alternative way – enlightened shareholder value

Enlightened shareholder value (ESV) is the idea that companies should pursue shareholder
wealth with a long-term orientation that seeks sustainable growth and profits based on
responsible attention to all relevant stakeholder interests. Essentially, it is a middle way that
focuses on generating shareholder value, whilst having regard to the long-term external impacts
on stakeholders.
The ESV approach was taken up by the UK government and is now a legal requirement on
businesses as part of the Companies Act, 2006. The emergence of ESV constitutes an important
development in corporate governance, particularly in determining what directors must consider
when managing the affairs of their companies and a clear move away from the shareholder
concept.
Corporate social reports
One way in which businesses can demonstrate their commitment to meeting their social
responsibilities (and not just the needs of shareholders) is by producing corporate social
reports. Corporate social reports are documents that set out a business’s targets for meeting its
social obligations and document the extent to which previous social targets have been achieved.
Corporate social reports are increasingly important as businesses are held responsible for the
consequences of their actions. By 2019, 867 companies from 164 countries had signed the UN
Global Compact pledging to demonstrate good global citizenship in the areas of human rights,
labour standards and environmental protection.

Key term
Corporate social reports are documents setting out a business’s targets for meeting
its social obligations and the extent to which previous social targets have been
achieved.

A growing proportion of businesses are engaging in social responsibility reporting. This form of
reporting entails setting out the costs to the business of acting in a socially responsible manner
(making charitable donations, for example) and the benefits received, which are usually difficult
to quantify in monetary terms. A few businesses include their social reports within their annual
reports. Under a corporate social report a ‘successful’ business might not be the most profitable,
but the one of most value to all sections of the community in which it operates.
Corporate social reports frequently have several elements, although they vary between
businesses. Firstly, firms tend to draw up and implement policies stating the ways in which they
will conduct the aspects of their business which impact upon society generally. This may include
issues such as the following:
• using sustainable sources of raw materials
• ensuring suppliers trade responsibly avoiding, for example, the use of child labour
• operating an extensive health and safety policy above the legal requirements, thereby
protecting the well-being of employees
• engaging in a continuous process of environmental management and monitoring the effects of
production on the environment
• trading ethically and taking account of the moral dimension in decision making.
Figure 30.11 illustrates the approach to corporate social reporting taken by the multinational fast-
food retailer McDonald’s. Its corporate social report is based upon five ‘pillars’ which
encompass its commitments to its stakeholders.
It is common for an independent body to monitor the effectiveness of CSR policies and the
effects on society generally. This helps to persuade stakeholders that the results published are
genuine. Once the corporate social report is complete, firms review their social and
environmental policies in the light of the information from the auditors.
Corporate social reporting can be a valuable exercise for firms to conduct. For example, it may
identify anti-social behaviour before problems arise. They also help 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.
The trend to social and environmental reports continues with many large firms producing some
form of report. The quality of many of the reports is improving, though some do not cover all the
relevant issues. Also, many companies still do not have their corporate social reports
independently audited to confirm their accuracy. A further criticism is that some firms do not
analyse their supply chains. This means that suppliers could engage in practices such as
employing children without it being revealed in the corporate social report. It is possible that the
effects of slow rates of economic growth in many countries might reduce the numbers of
businesses prepared to devote resources to producing a corporate social report, or to improving
its quality and extent.

Figure 30.11 The framework for McDonald’s corporate social reporting

Source: McDonald’s Corporate Social Responsibility & Sustainability Report

Business in focus: 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 financial,
environmental, social and governance performance. The organisation’s mission is to
empower decisions that create social, environmental and economic benefits for
everyone.
The Framework enables businesses to be more transparent about their performance
and this transparency and accountability builds stakeholders’ trust in organisations,
which 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 coordinates the
activity of GRI’s many network partners. GRI has regional hubs in Brazil, China,
Colombia, India, South Africa and the United States, with reports produced in more
than 100 countries.
Source: GRI website

Practice questions
1 Analyse the difference between an oil company’s financial and social performance.
(9 marks)
2 Do you think that all UK businesses should use GRI’s standard format to report
their performance to stakeholders? Justify your view.
(16 marks)
The pressures for socially responsible behaviour
We have already seen that consumers in the UK and elsewhere are better informed about the
activities of businesses with respect to the environment and their stakeholders. Developments in
technology and notably the rising use of social media to report behaviour by firms that is deemed
unacceptable has had a significant impact on corporate decision making. Bad news about a
company can be tweeted and re-tweeted thousands of times reaching many potential consumers.
Companies have to be aware of this and aim to avoid being the subject of bad news.
Businesses have to care about being socially responsible because their customers do. A number
of studies have shown that a business’s CSR policies increasingly influence consumers’ spending
decisions. For example, a survey by Landor Associates, the branding company, found that 77 per
cent of consumers say it is important for companies to be socially responsible.
Being judged to be a socially responsible business can help organisations to attract the best
employees and to build a strong employer brand. In a global workforce study by Towers Perrin,
the professional services firm, CSR 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 revealed that amongst employees aged 18 to 26 a business’s degree of social
responsibility is an important influence on their decision to work there.
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. C.K.
Prahalad 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 these markets and benefit over time from their growth.
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 the poor in developing countries
new means to pay and receive money, as well as save. It is also increasing the company’s
revenues which rose by nearly 22 per cent in 2017 compared with 2016.
The technological environment
In the UK in the 18th century, news of technological developments spread at the rate of about
one mile per year. In the opening years of the 21st century, people and businesses throughout the
world learn quickly of technological changes. New technological products are often obsolete
within a few years. The internet has probably been the biggest single technological factor leading
to change in business behaviour, but pressure to limit the effects of climate change is a major
catalyst for technological change.
One industry that is experiencing rapid technological change driven by climate fears is motor
vehicle manufacturing. Consumers are increasingly demanding cars that have lower – or zero –
emissions. Demand for electric and hybrid vehicles is increasing very rapidly as illustrated in
Figure 30.12. Although China saw the largest increase is sales of electric vehicles in 2017 (about
580,000 vehicles), Norway remains the country with the highest proportion of electric vehicles in
use – 6.4 per cent of cars in Norway were electric.
The Institute for Economic Affairs forecasts that the number of electric vehicles in use globally
will rise from 3.1 million in 2017 to between 135 and 220 million in 2030. The actual figure will
depend on how strongly governments promote and encourage the use of electric vehicles.
Technology and marketing opportunities
Technological advances have not only created new markets for new products but also new ways
to sell these products.

Technology and new products

New technology can create new and highly valuable markets for businesses and generate streams
of future revenue. Some new technology-based products may have short product life cycles,
although it is common for businesses to produce a succession of products based on one
technological advance.
The use of artificial intelligence (AI) within existing products is a fertile area for new product
development. One example is the creation of self-driving cars, or in the short-term, using AI to
make existing cars safer and easier to drive. Toyota is the leader in developing this type of
product. The company’s immediate aim is to extend the age at which it is safe for older people to
drive themselves, by using technology that can correct their errors. Software that processes data
from on-board cameras and radar units will watch out for impending crashes and try to stop the
car before impact or correct for the slow out-of-lane swerve of a tired driver. Other software will
guide the car in slow traffic, so that drivers can relax.

Figure 30.12 Sales of electric and hybrid vehicles, 2010–2017

Source: The Economist

Helping older drivers is a particular concern in Toyota’s home market, where over a quarter of
people are over 65. But other countries with wealthy consumers are also experiencing ageing
populations.
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, which can be invested in further
R&D to help to maintain a technological (and competitive) advantage. Possessing a
technological edge may attract new customers to a business as well as maintaining the loyalty of
existing customers.
The scale of the benefits to a business from introducing new, high technology products can be
immense. Boeing, the American aircraft manufacturer, developed the 787-9 ‘Dreamliner’
passenger plane. It is a lighter, more fuel-efficient aircraft made of carbon-fibre composites
(older aeroplanes are constructed mainly of aluminium). This has enabled the company to sell
724 of the aircraft since 2011 and it has become is largest source of profit. In 2017, the company
announced record operating profits of over $3 billion.

Technology and promoting and selling products

Advances in technology have made it easier for businesses to communicate with customers for
marketing purposes. The American technology company Cisco has forecast that by 2020 there
will be seven times as many devices in the world connected to the internet as there will be
people. A report by Ofcom in 2018 suggested that the average person in the UK spent more than
one day each week on devices linked to the internet. Such developments will increase the
opportunities for businesses to use technology for promotional purposes.
Some businesses rely entirely on technology to distribute their products. Apple is famous for
producing innovative technological products such as the iPhone and Apple Watch, but the
company also uses technology to distribute its products. Its iTunes store allows purchasers to
download music, TV programmes, apps, games and audio books. Its App Store is used to
download applications for the company’s devices such as the iPhone.
Using technology in this way offers substantial cost advantages. Apple does not have to pay to
distribute its online 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.
According to global professional services firm, Accenture, the average business utilising AI will
increase its revenue by 38 per cent by 2022. Acting on this, the entertainment subscription
service, Netflix, has estimated that its AI algorithms (which allow it to target viewers with
relevant adverts) save the business $1 billion each year.
Technology and operations management
Technological advances also affect the ways in which businesses operate and create
opportunities for new types of operations. This is where the most profound and far-reaching
changes are occurring. New businesses such as Funding Circle (a crowdfunding enterprise) and
Deliveroo (a business that uses a technology to provide an efficient delivery service for meals),
are being created and growing remarkably quickly on the back of developments in technology.

Technology and communications

Communications within businesses have been transformed by technology. Businesses can
communicate simply, cheaply and quickly across the globe. Developments in cloud computing
have provided great improvements in communication. Information, such as databases, can be
stored using cloud computing services and encrypted to restrict access. However, authorised
users can access this and read and update it as necessary from any location. For example, market
research companies may hold research findings in this way enabling them to be updated and
accessed regularly by the business’s employees as necessary.
Developments in multimedia communications have made it simpler and quicker for businesses to
exchange information with groups, including employees using a flexible range of methods of
communication. Businesses such as Redwood Technologies have developed communications
modules which allow information to be automatically converted from one format to another, for
example email to voice or SMS. This enables businesses to automatically adapt how they
communicate to match recipients’ preferences.

Technology and production

Perhaps the major advantage of technology to businesses is that it allows the development of
new methods of production resulting in lower costs. This permits the firm to enjoy higher profits
on each sale. However, in an increasingly competitive global market firms seek to improve their
market position by offering high quality and sophisticated products at lower prices to increase
consumer value. Using ever-more sophisticated technology in planning, designing and producing
products is one way of achieving lower costs. The potential for technology to reduce costs exists
from the design stage through to distribution.
The use of computer-aided design (CAD) by businesses is relatively commonplace nowadays.
For many years manufactures have used computer programmes to design new products.
However, this technology is moving forward quickly. Developments in 3D computing are
creating software and devices that will allow designers and others to project virtual objects into
the real world. Microsoft has developed 3D software and high technology goggles to provide a
user interface for this software. The company’s goggles, called HoloLens, are used by surgeons
to ‘see inside’ patients before operations, allowing medical teams to spot key blood vessels,
bones and muscles, making procedures quicker and safer. HoloLens technology is also used on
production lines, for example, at BAE Systems helping to make employees more productive.

Key terms
 Cloud computing involves the centralised storage of data in remote servers (the
‘cloud’) and online access by users worldwide on internet-connected devices.
Computer-aided design (CAD) is a combination of hardware and software that
allows businesses to create, modify and adapt plans for new products.
Computer-aided manufacturing (CAM) is the use of machines controlled by
computers as part of a production process.

The process of manufacturing in many industries has been transformed by automation whereby
machines do jobs previously carried out by people. The most dramatic aspect of this has been the
use of computer-controlled technology on the production line. The use of computer-controlled
technology is termed computer-aided manufacture (CAM) and is an integral part of lean
production. Its use allows businesses to control the production line to supply variants on a
standard product to meet the precise demands of consumers. Thus, Vauxhall’s car factory at
Ellesmere Port 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 JIT
(or ‘pull’) manufacturing system.

Figure 30.13 Microsoft’s 3D glasses called ‘HoloLens’

The use of technology in the form of CAD and CAM has assisted in improving productivity
levels in many manufacturing industries, helping to keep costs down and enhance productivity.
Because of this its use has spread to many industries including food processing and the
manufacture of pottery.
Developments in technology have prompted huge changes across entire industries. The
widespread and increasing use of smartphones is behind some of the most revolutionary changes.
Some people are using their smartphones to allow them to become freelance delivery drivers for
businesses. Having registered, they can take on work as and when suitable – if they are in a
convenient location, for example. Similarly, Uber’s app is causing dramatic and controversial
changes in the taxi industry in many cities throughout the world, as shown in the Business in
focus feature below. This use of technology provides opportunities for some businesses while
creating significant threats for others.
Technology is not only used in production processes in the manufacturing sector. It is also
widely used by businesses that supply services. For example, companies such as Aviva supply
insurance products using the internet. Policyholders enter their requirements onto the company’s
website and complete their personal details. Avivia’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.
Technology and human relations
Humans within businesses are always affected by technological change. This is particularly true
when new technology is introduced onto the production line. Such change may lead to some
minor changes in the duties of employees. On the other hand, technological developments can
result in enormous changes for a business’s workforce. For some it may be redundancy: replaced
by technology as part of the process of automation. Many high-street banks have made workers
redundant owing to advances in technology. 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. In 1998, the UK had approximately 6,000 bank
branches; by 2018, this figure had been halved to 3,000 with further closures expected.
Inevitably many thousands of jobs have been lost as the UK responded to increasing numbers of
customers using online banking services and therefore a smaller branch network was required.

Business in focus: Uber

Uber is a simple idea that has created a rapidly-growing business, generating

revenues totalling £5.75 billion in 2017. This is forecast to increase to £7.7 billion in
2018 and would represent a growth rate of 34 per cent. Uber originally provided taxi
services in cities across the world. More recently it has expanded into food delivery
and the provision of e-bikes.
Uber provides its taxi services through an app that can be downloaded without charge
and connects a smartphone user with any nearby cars registered with Uber using
GPS and Wi-Fi to identify locations and provide communications. The cars may be
taxis, private vehicles, or, in some locations, UberPools which are a ride sharing
option. Uber’s app allows a user to request a particular car for a journey. The fare is
calculated based on distance travelled and time taken for the journey. The cost is
deducted from the passenger’s account through their smartphone. Prices tend to
reflect the balance between demand for and supply of taxis. Uber was criticised for its
‘surge’ in price on New Year’s Eve when demand for taxis rises sharply.
The idea for Uber was dreamed up by two Americans, Travis Kalanick and Garrett
Camp, in 2009 and by March 2015, it operated in 53 countries and 200 cities across
the world. Despite its popularity with drivers and passengers, it has proved unpopular
with established taxi companies and drivers. London taxi drivers have protested that
vehicles registered with Uber are really taxis and should be subject to the same tight
regulations as the famous black cabs. However, cars operating through Uber are
classified as minicabs and subject to fewer regulations, helping them to operate with
lower costs. Drivers of vehicles registered with Uber can overcome their lack of
geographical knowledge of London by using satellite navigation systems.
Recently, the company has faced problems with regulators in both New York and
London. It only has a temporary licence to operate in London. In effect, it is ‘on
probation’. This followed a number of criticisms of the company. These included
drivers not reporting serious crimes linked to their passengers and driving for too
 many hours. Governments in a number of countries are taking steps to regulate Uber
more closely.

Practice questions
1 Analyse the possible implications for the taxi industry’s stakeholders of the growth
of Uber.
(9 marks)
2 Do you think that Uber should be more tightly regulated by governments? Justify
your view.
(16 marks)

Employees’ reactions to technological change can be equally diverse. 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 create jobs and unemployment at the same time. For example,
the increasing popularity of reading newspapers online has led to falls in circulation of hard
copies for many publications. Between 2011 and 2014, circulation figures for daily newspapers
in the UK fell by about 6 per cent per year on average and the rate of decline is increasing:
between 2017 and 2018 circulation fell by 9.2per cent. This resulted in a loss of jobs for printers
and those involved in distributing newspapers and magazines. Simultaneously, employment has
been created in industries creating and maintaining the websites of newspapers and other online
publications.
The culture of a business also factors, with those operating a traditional culture, placing great
emphasis on bureaucracy and convention, potentially experiencing difficulties in adapting to
technological change. The existence of a task culture may make the process less difficult. It may
be most appropriate if the managers of businesses that are affected by technological change
develop a culture that is responsive to change and one where employees’ attitudes are to embrace
change rather than to resist it.
The implications of technological change for
businesses’ strategies
Key term
Data analytics is the process of investigating raw data with the intention of drawing
conclusions from the information.

The price of new technologies continues to fall dramatically meaning that such technologies are
no longer solely the privilege of businesses in developed economies. Simultaneously, the time it
takes to go from breakthrough to the mass market is falling. In the USA it took 76 years for the
telephone to reach half of the population, the smartphone did it in less than 10 years. This means
that technology is becoming increasingly relevant for more businesses.
The potential for technology to transform businesses over the next 10 or 15 years is immense.
Businesses will have to adapt their strategies to fit this new environment if they are to repel
threats and take advantage of the opportunities that will become available. New strategies may
need to be based on four key elements of digital technology:
• Social media. This may involve, for example, using its power to communicate with consumers
and to shape their views.
• Mobile technology. The most obvious application here is the smartphone with its enormous
potential to change the ways that business operates.
• Data analytics. Advances in data handling and analysis have allowed businesses to identify
trends and draw other important conclusions from huge amounts of raw data (often called ‘big
data’).
• Cloud computing. Using the capacity of massive remote servers to store and analyse
information.
The use of a combination of these aspects of technological development will allow new business
strategies to be established and new markets to be created or old ones to be developed in
different ways. Some analysts believe that the first stage of a digital economy is drawing to a
close. This is sometimes called the ‘first digital wave’. It was based around e-commerce as
providing another way in which businesses could communicate with customers and sell them
goods and services. Many, if not most, businesses have adapted to this change.
The next stage of technological change will see businesses explore other ways to take advantage
of the opportunities available. We saw earlier that many media companies increasingly use the
internet to get their readers to go to their websites, although it has been difficult to make this a
profitable business as people are reluctant to pay for online news and information. However,
consumers are increasingly sourcing information they want to read through social media
websites or through messaging services. The world is experiencing what some analysts believe to
be the ‘second digital wave’, in which information is shared though connected devices and
different channels allowing consumers to fulfil their goals such as personal fitness, healthy eating
and safer driving. Digital technology can help customers achieve these things and boost the sales
of businesses. Sensor technology, like the Fitbit wristband, can monitor what consumers do and
help them understand their behaviour. In-car telematics can support safer driving.
Technological change can be expected to have a profound impact on the strategies of many
businesses. It will affect the ways in which businesses communicate information and interact
with stakeholders. It may result in greater use of alliances and joint ventures between enterprises,
as well as changing the ways in which businesses design and produce products for their
customers. It may be, however, that it is the products themselves which are the most obvious
manifestation of the impact of technology on business activity.

Business in focus: Technology, labour costs and strategy

By 2017, wages in the UK had not risen in real terms (that is, allowing for inflation)
since the financial crisis of 2008–09. Employees in many other economies have
benefited from rising real wages. In Canada, France and Germany real wages rose by
more than 10 per cent between 2007 and 2017. Trends in real wages between 2007
and 2017 are illustrated in Figure 30.14.
One result of this slow wage growth is that the UK’s average hourly labour cost is low
in comparison with other major economies. In 2017, the average hourly labour cost in
the UK was €25.7, in Germany it was €34.1, in France €36.0 and in Italy €28.2.
Andy Haldane, the chief economist at the Bank of England, believes that the
‘flatlining’ of real wages is due to poor labour productivity performance. He argues
that increases in labour productivity are necessary to pay for increased real wages.
One cause of the low productivity in the UK is the low rate of investment in technology
by UK businesses in recent years. This is shown by a slow growth in the UK’s capital
stock – that is non-financial assets that are used in the production of goods and
services with a lifespan of greater than a year (for example, buildings, machinery).
The UK’s net capital stock was estimated by the ONS to have increased by 1.1 per
cent during 2017. Prior to the financial crisis of 2008, the UK’s capital stock increased
on average by 2.0 per cent per year; since 2010 it has slowed to an average of 1.3
per cent per year.
Figure 30.14 Rates of real wages growth for a selection of economies, 2007–2017

Source: The Financial Times, 4 July 2018, originally OECD

In 2016, UK productivity was 16 per cent below the average of the rest of the G7
countries, the largest deficit since at least 1995.

Figure 30.15 Productivity data for the G7 group of countries, 2016

Source: House of Commons Briefing Paper, 5 October 2018

Practice questions
1 Analyse why using more technology in production is likely to increase labour
productivity in the UK.
(9 marks)
2 To what extent should UK businesses base their strategies on low labour costs
rather than the latest technology?
(16 marks)
ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 Identify the two major changes currently taking place in the UK’s population.
2 Distinguish between migration and urbanisation.
3 State two possible ways in which advances in technology may affect consumer
buying behaviour.
4 List two possible implications of the continued growth of online businesses.
5 Distinguish between corporate social responsibility and a corporate social report.
6 State two possible examples of the implications for businesses of meeting social
responsibilities.
7 List the four types of responsibility set out in Carroll’s CSR pyramid.
8 State two ways in which advances in technology have affected production
processes within businesses.
9 What are the four key elements of digital technology that will influence business
models in the future?
10 Distinguish between CAD and CAM.

(b) Short answer questions

1 Explain one benefit a manufacturer operating in a price competitive market may
receive as a result of population movements.
(4 marks)
2 Explain one implication of the increase in online purchases for retailers.
(5 marks)
3 Explain the reasons why the management team of an oil company, such as BP,
might decide to operate the business according to the stakeholder concept.
(5 marks)
4 Analyse the possible reasons why multinational manufacturers of sports clothing
are under considerable pressure to be socially responsible.
(9 marks)

(c) Data response question

UK house builders
The population of London is growing rapidly as a result of growing birth rates and an
inflow of migrants as urbanisation continues. A recent report by the mayor of London
has suggested that its population will rise from just over 9 million in 2019 to 11 million
by 2050. This would require 50,000 additional homes a year in the capital. Housing
supply has not matched demand in London, meaning property prices soared to an
average price of £625,714 in 2018. At the same, time the trend towards urbanisation
continues with 83 per cent of people in the UK living in urban areas in 2017.
Ian Tyler, the Chairman of house builder Bovis Homes, warned in 2017 that there was
a shortage of skilled labour in the construction industry. This is likely to limit the
construction of much-needed new housing in the UK. In 2017, some bricklayers in the
UK were paid up to £1,700 a week. The company enjoyed mixed fortunes in 2017. It
sold 3,645 homes at an average selling price which was 7.5 per cent higher than in
2016; this generated sales revenue totalling £1,028 million, although this was 2 per
cent down on 2016. Its operating profits fell nearly 20 per cent to £121.22 million.
Bovis Homes issues a corporate social report each year, as do most of the UK’s major
house builders. The company seeks to meet its social responsibilities in several ways.
It designs and builds sustainable homes reducing carbon emissions and conserving
water and energy, and engages with the company’s stakeholders. It seeks to operate
as efficiently as possible and to minimise the amount of resources it uses to build
homes, although this can conflict with sustainability. The company’s corporate social
report for 2018 records its achievements in four areas: people, health and safety,
environment and community. However, it does not set itself targets in these areas.

Figure 30.16 UK migration, 2007–2017

Source: Office for National Statistics (ONS)

Questions
1 Explain two possible implications of urbanisation for UK house builders.
(5 marks)
2 Analyse the possible benefits of recent trends in migration for house builders in the
UK.
(9 marks)
3 Do the benefits of Bovis Homes issuing a corporate social report outweigh the
drawbacks? Justify your view.
(16 marks)

(d) Essays
1. ‘Responding to changes in the technological environment will be more important for
businesses than responding to changes in the social environment.’ To what extent
do you agree with this statement? Justify your view.
 (25 marks)
2. ‘It is a waste of time and resources for retailers in the UK to produce corporate
social reports.’ Do you agree with this statement? Justify your view.
(25 marks)
Chapter 31 Analysing the external
environment: the competitive
environment
Introduction
This chapter discusses the competitive environment for businesses using Michael Porter’s five
forces model as a framework. It looks at the five forces identified by Porter and considers how
changes in these may have implications for the decision making and profits of a business.
What it is important to know by the end of this chapter:
• Porter’s five forces: entry threat, buyer power, supplier power, rivalry and substitute threat
• how and why these forces may change
• the implications of these forces for strategic and functional decision making within a business
• the implications of these forces on a business’s profits.
Changes in the competitive environment
A business’s competitive environment is made up of a number of factors. It includes the power
of rivals and the potential rivals that the business faces in a battle to win customers and market
share, but it also includes its customers and its suppliers and the influence that they wield. It is
possible to argue that the process of globalisation has increased the degree of competition to
which new businesses are exposed.
One way of assessing a business’s competitive position is through the use of Michael Porter’s
five forces model as illustrated in Figure 31.1.
Porter’s five forces model
Michael Porter’s famous five forces of competitive position model provides a simple framework
for assessing and analysing the competitive strength and position of a corporation or business.
Porter’s five forces model can be used to good analytical effect alongside other models such as
SWOT and PEST-C analysis tools.

Figure 31.1 Porter’s five forces

Porter’s model provides suggested points under each main heading, by which managers can
develop a broad and sophisticated analysis of competitive position, as might be used when
creating strategy plans or making investment decisions about a business or organisation.
Five forces analysis looks at five key areas, namely:
1 the power of suppliers
2 the power of buyers
3 the threat of substitutes
4 the threat of new entrants
5 competitive rivalry.
If firms faced the same competitive pressures in all markets, then profitability (for example,
ROCE) would be very similar in them all. This, however, is not the case. Some industries have
high profits while others have low profits and, to some extent, this can be explained through
analysis of the different competitive environments.
High profit industries Low profit industries
These are likely to show: These are likely to show:
• mild competition between • intense rivalry between businesses
businesses • very powerful suppliers
 • suppliers with little power • customers with considerable power
• customers having little power • imminent threat of the development of
• little threat of substitute products substitute goods or services
being developed • a high likelihood of new entrants to the
• no real prospect of a new entrant market.
to the industry.

Table 31.1 Competitive factors influencing the profitability of industries

Key models and theories: Porter’s five forces

This model can help you to identify the factors that influence the competitive position of
businesses within a particular industry. The model can help you to explain why
businesses in a particular industry might make very high profits (and have high ROCE
figures) or why profits across the industry may be generally low. This might help you to
develop arguments about whether a business should enter a particular industry or seek
to change the extent of its activities within that industry.

The power of suppliers

Suppliers are a vital element of an effective organisation. Raw materials are needed to complete
the finished product of the organisation. Suppliers can be very powerful and this power arises
from a variety of sources.
• The number of suppliers that are operating – fewer suppliers normally means more powerful
suppliers.
• The cost involved in changing suppliers – if it is difficult or expensive, suppliers have greater
power.
• The availability of substitutes – if there is no other substitute for their product or if the items
they supply are scarce the supplier has greater power.
• The customer’s size relative to the size of the supplier – if the supplier is much smaller they
have less power over the bigger customer.
• Whether or not other uses exist for the products sold by the supplier.
• To what extent the supplier poses a creditable threat to integrate forwards and enter its
customer’s market as a rival, or to takeover the business itself.
Some small businesses in the UK have complained about the power of suppliers in the energy
industry. They claim that the market for supplying gas and electricity, which is dominated by six
large companies, charges prices that are too high and that the suppliers are often slow to respond
to problems.

What do you think?

Why are many of the suppliers of gas and electricity in the UK so powerful?
Some businesses find that a major influence on the competitive environment in which they trade
is the power of their suppliers. Powerful suppliers who hold a dominant position in a market
have control over prices and this power is increased if the product they sell has few or no
substitutes. The implications for businesses can be severe, especially if the supplier provides a
large percentage of the resources used by the business. In this event, a policy of increasing prices
as the supplier’s market power increases can squeeze the business’s profit margins.

The power of buyers

Buyers or customers can exert influence and control over an industry in certain circumstances.
This happens when:
• The products sold by businesses are similar and it is therefore easy for buyers to find
substitutes.
• Products have a high price elasticity of demand, that is the demand from customers is sensitive
to price.
• Switching to another supplier’s product is cheap and straightforward and there are many other
businesses offering supplies.
• Customers buy a large quantity of products and place these orders regularly.
One factor that might limit the power of buyers is if the producer represents a significant threat to
take over the buyer’s business, or that of a rival and operate in competition. In such
circumstances a buyer may not use the power it has for fear of invoking the action, such as a
takeover, that is possible.
There have been a number of allegations of supermarkets in the UK abusing their power as
buyers and imposing unfavourable terms on businesses that supply them. The next Business in
focus feature explores this further.

Business in focus: Supermarkets investigated by the GCA

Christine Tacon, the groceries code adjudicator (GCA), conducted an inquiry into the
Co-operative Group amid concerns over delisting of suppliers and unfair charges. The
Group is the UK’s fifth biggest food retailer with more than 2,500 local, convenience
and medium-sized stores and recorded sales approaching £10 billion in 2017. The
investigation covered the period from early 2016 to at least summer 2017.
Christine Tacon said she had a ‘reasonable suspicion’ that the retailer had breached
the Groceries Supply Code of Practice (GSCOP) by delisting suppliers with no, or
short, notice periods and introducing depot quality control and benchmarking charges
without reasonable notice.
In response the Co-op said it had ‘fallen short’ and refunded 110 suppliers a total of
around £500,000 for charges imposed for benchmarking and quality control. It has
also written to all its 1,500 direct suppliers seeking information on delisting decisions
taken without appropriate consultation. ‘A small number of suppliers have raised
 concerns which we are working through with them’, said the firm.
In further investigations in 2016, the GCA found Tesco had acted ‘unreasonably’ by
delaying payments to suppliers, often for ‘lengthy periods of time’. Morrisons admitted
it had called dozens of food firms to a meeting where it demanded lump sums
averaging £2m from suppliers to keep stocking their products.
Supermarkets’ use of ‘predatory practices’ helped drive more than 150 food
producers out of business last year, according to research by accountancy firm Moore
Stephens.
Sources: The Independent, 11 April 2017 and The Chartered Institute of Procurement and Supply, 8
March 2018

Practice questions
1 Analyse the possible reasons why the Co-operative group has considerable buyer
power.
(9 marks)
2 Do you think reducing the power of supermarkets such as Tesco would be in the
best interests of all the company’s stakeholders? Justify your decision.
(16 marks)

An increase in the power of a single large buyer can pose difficulties for a business, particularly
if it is relatively small and the dominant customer purchases a large proportion of its output, such
as Tesco in the case above. In such circumstances a change in the competitive environment that
gives buyers additional power could have a range of adverse consequences for suppliers.
The buyer will have increased bargaining power and may be able to negotiate substantial
reductions in the price at which products are supplied. They may use the threat of transferring to
another supplier to achieve its ambitions. Being forced to sell at lower prices could reduce or, in
extreme cases, eliminate the supplier’s profit margins.
Buyers may request changes in the specifications of products to be supplied or may impose
tough conditions in terms of delivery dates or the quality or appearance of products. Such
outcomes are likely to put the supplier under pressure and to increase costs of production. Once
again the ultimate effect could be to reduce profits.
A dominant buyer may ask for generous trade credit terms, for example, a 60-day trade credit
period. This can cause liquidity problems for suppliers, not least because the size of the order
will mean that the sums involved are substantial. In such circumstances the supplier may have to
negotiate expensive overdrafts with its bank.

The threat of substitutes

A substitute is an alternative product that offers purchasers similar or the same features and
benefits. The threat of substitute is high when:
• the price of that substitute product falls, making it more attractive to customers
• it is easy for customers to switch from one substitute product to another
• customers are willing and able to substitute the supplier’s products for those of another
 supplier.
In Porter’s model substitute products come from other industries. For example, some existing
national airlines have entered the market for low-cost flights. The growth of Norwegian was one
of the factors leading to the collapse of the British airline Monarch in 2017. The threat of
substitute products most usually manifests itself by keeping prices in an industry low, thereby
depressing profits. Thus, the existence of cans as a substitute to bottles for holding liquids helps
to prevent bottle manufacturers raising prices too high to increase their profit margins.

The threat of new entrants

The threat of a new business entering the industry is high when it is easy for an organisation to
enter the industry, that is barriers to entry are low. An organisation will look at a range of
factors to assess the extent of a threat of new businesses entering a market. These will include the
following:
• The degree of customer loyalty to existing businesses and products.
• How quickly and easily a new entrant to an industry might be able to benefit from economies
of scale.
• Whether the new entrant would have access to suppliers.
• The extent to which government legislation prevents or encourages new entrants to the
industry.

Key term
Barriers to entry are those factors, such as high advertising costs, that make it
difficult for a business to sell products in a market for the first time.

The size and financial power of any potential entrant is, of course, an important factor in
assessing the extent of the threat of new entrants to an industry. BT Sport was launched in
August 2013 as a direct competitor to established sports TV broadcasters such as Sky, ITV and
the BBC. The company is owned by BT plc, a large and financially powerful
telecommunications company. The extent of its threat to existing sports broadcasters was shown
by its ability to bid successfully for expensive rights to broadcast live premiership rugby and
football and viewing figures rising by 19 per cent between 2016 and 2017.

Competitive rivalry
Competitive rivalry is a major force affecting a business’s competitive position. Generally,
competitive rivalry will be greater if:
• entry to an industry is straightforward – if a market becomes attractive, new competitors will
flood in
• it is easy for customers to move to substitute products, for example, oil to gas as a fuel
• there is little differentiation between the products sold between customers
• competitors are approximately the same size as each other
• the competitors all have similar corporate strategies
• it is costly to leave the industry and so businesses do not do so
• the market is not growing, meaning that to win a customer requires taking one from a rival.
If there is great rivalry between businesses in an industry, it can be expected that the firms
involved will respond to this environment in one of a number of ways.
• By engaging in competitive pricing in an attempt to win customers from rivals. This is more
likely to be used, and to be effective, when demand is price elastic. At the time of writing, the
UK’s major supermarkets are engaged in intense price competition brought about, in part, by
the entry of discount supermarkets such as Aldi and Lidl to the market and their subsequent
success.
• The use of promotional offers and special deals. These may be used to attract customers and
may be more effective when products are purchased infrequently, such as foreign holidays.
Technology may soon enable firms to increase competitiveness by tailoring special offers to
individual customers. Apple’s iBeacon technology is set to allow retailers and app publishers
to identify customers in stores from their smartphones. Relevant special offers will be made
available via their smartphone.
• Innovation. Developing and launching new products, especially if done regularly, can be an
effective competitive strategy and one which maintains customer loyalty as well as attracting
new customers. Car manufacturers rely heavily on innovation to remain competitive.
Dominant businesses
A dominant business is able to have a substantial influence over market prices and, in some
cases, may determine them with other, less powerful firms, following its lead. A dominant firm
is likely to be the largest in an industry and to hold the greatest market share. As a consequence,
it will probably be highly profitable, though it may not be highly efficient and innovative,
especially if its supremacy is not immediately challenged.
Dominant businesses may emerge through internal or organic growth as in the case of Microsoft.
Other firms may achieve dominant positions in their markets as a result of a strategy of takeovers
and mergers. It is this approach that Vodafone has used to create much of its market power,
although it is not a dominant business in the UK.
A notable example of a dominant business is Google. Google has an estimated search engine
global market share of over 84 per cent for searches using tablets or mobile phones in 2018 (see
Figure 27.6). The company also holds powerful positions in other markets including operating
systems for mobile devices with its android product and its Google Play store for apps.
If a business is becoming more dominant in a market, this represents a threat for its competitors.
The growing power of a single business may lead to its rivals losing sales and market share and a
decline in profitability. The dominant business’s competitors may have to invest in new
products, new marketing campaigns and cut prices to protect their market positions. This may
become increasingly difficult to do if the dominant business uses its market power ruthlessly to
maintain its position within the market.
The impact of changes in the competitive
environment
The ways in which businesses may respond to changes in their competitive environment may be
diverse and will clearly depend upon the nature of the change. The entry of a new competitor to a
market or the emergence of a dominant business may provoke a number of strategic reactions.
Affected businesses may take strategic decisions to seek new markets or develop new product
ranges. Alternatively, they may seek alliances or mergers with other businesses in the same
industry to increase their own market power in response to these changes in the competitive
environment.
Changes in the competitive environment which manifest themselves as increasing power of
suppliers can create major difficulties for businesses, especially if no alternative suppliers exist.
In this situation managers may take functional decisions, for example, to consider its production
process and ways in which it might adapt to reduce its reliance on the products sold by the
supplier in question. Other decisions in this situation could include taking over the supplier (in
what may be a hostile action) or negotiating favourable deals with smaller rival suppliers in the
hope of fostering greater competition.
Increasing power of buyers could lead to businesses making functional decisions such as
reducing prices or offering enhanced credit terms and accepting the adverse consequences in
terms of profit margins or working capital. However, these could prompt managers to implement
more strategic decisions such as selling in new markets to less powerful customers.
The threat of substitute products may require managers to take decisions to increase (or
emphasise) the degree of differentiation between their products and those of potential rivals. This
may entail heavy investment in R&D to allow innovation to take place or perhaps investment in
training to produce unrivalled levels of customer service.
The managers of a business must endeavour to understand and predict changes to their
competitive environment and to analyse the business’s competitive position in order to respond
effectively with appropriate strategic and functional decisions.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 List two factors which make up a business’s competitive environment.
2 Define the term ‘barriers to entry’.
3 List the five forces that comprise the model Michael Porter developed to assess a
business’s competitive position.
4 Name one other model of business analysis that could be used alongside Porter’s
five forces model.
 5 State two competitive characteristics that are associated with high profit industries.
6 State two possible sources of a supplier’s power.
7 State two circumstances in which buyers or customers can exert influence and
control over an industry.
8 Define the term ‘substitute’.
9 State two circumstances in which competitive rivalry is likely to be high.
10 Define the term ‘dominant firm’.

(b) Short answer questions

1 Explain one competitive factor which makes the painting and decorating industry a
low profit one in the UK.
(4 marks)
2 Explain one reason why customers in the European market for low-cost flights
have considerable power.
(5 marks)
3 Explain the reasons why the new entrant threat to the motor vehicle manufacturing
industry is relatively low.
(5 marks)
4 Analyse the ways in which producers in the UK grocery market, such as Tesco
and Asda, might respond to the high level of rivalry that exists within the industry.
(9 marks)

(c) Data response question The UK’s energy market

Figure 31.2 Market shares of the major companies in the UK electricity market, 2004–2017
Source: Ofgem (taken from IG.com)

For many years, the energy market has been dominated by a handful of suppliers
known as the Big Six: EDF, Npower, British Gas, SSE, EON, Scottish Power.
However, recent figures suggest that they may not be so popular amongst UK energy
users any more. These trends in the electricity market are illustrated in Figure 31.2.
The energy market regulator Ofgem and the Government have encouraged many UK
households to switch energy suppliers in order to find a better deal, including
introducing measures to make it easier to move from one supplier to another. This has
had an effect: around 1.1 million customers switched away from the Big Six in the first
three quarters of 2017– up 18 per cent on the same period the previous year.
However, 58 per cent of customers have never switched supplier.
The trend towards switching suppliers is allowing smaller competitors to grow their
market share to unprecedented levels. The Big Six held 99 per cent of the domestic
supply market in the final quarter of 2012, but that had fallen to 80 per cent by late
2017, as over 60 new suppliers have emerged. First Utility, a smaller supplier that has
grown rapidly was taken over by Royal Dutch Shell in 2017, a move which will worry
the Big Six.

Figure 31.3 Profit margins before tax and interest for the Big Six energy companies, 2009–2016.

British Gas increased its electricity prices by 12.5 per cent in the same month, blaming
rising costs of buying energy in wholesale markets. Up to now, price rises like these
have helped big energy companies maintain healthy profits, even in spite of losing
customers.
Overall, Ofgem’s aim is to increase the level of competition in the UK energy industry.
This will drive down prices. Figure 31.3 suggests that this has happened given that the
profit margins of the Big Six have declined. Many analysts believe that the
stakeholders will benefit from a more competitive energy industry.

Questions
1 Explain one reason why suppliers such as British Gas can no longer maintain
profits by raising prices.
(5 marks)
2 Analyse the possible factors that influence the degree of competition within the
UK’s energy market.
 (9 marks)
3 To what extent do you agree with the statement that ‘stakeholders will benefit from
a more competitive UK energy market’?
(16 marks)

(d) Essay
‘The UK banking industry is often regarded as being uncompetitive. The major cause
of this is the barriers to entry that exist.’ To what extent do you agree with this
statement?
(25 marks)
Chapter 32 Analysing strategic options:
investment appraisal
Introduction
This chapter looks at some of the financial methods that managers can use to assess possible
investments when analysing options as part of the strategic decision-making process. We
consider how to assess investments using the payback, average rate of return and net present
value methods. The chapter also investigates the factors that influence investment decisions
made by managers including investment criteria, risk and uncertainty. Finally, we consider the
value of using sensitivity analysis as part of investment appraisal.
What it is important to know by the end of this chapter:
• the financial methods of assessing an investment including the calculation and interpretation of
payback, average rate of return and net present value
• the factors influencing investment decisions including investment criteria, non-financial
factors, risk and uncertainty
• the value of sensitivity analysis.
Investment is an important activity for businesses and often entails managers taking strategic
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 non-current assets or some other major expenditure. What is common to all forms of
investment is that it involves a degree of risk. This must be judged against the likely returns. The
final decision will depend upon managers’ assessment of these two factors: risk and returns.
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 fixed assets as part of a
planned programme of growth. Tottenham Hotspur Football Club has invested an estimated £1
billion in developing a new stadium, built in part on its existing ground – White Hart Lane.
The Club hopes to increase its sales revenue by attracting larger crowds into the new stadium
which has a capacity of 62,000 spectators and opened in 2019.
• Investing in new technology. This is often undertaken to reduce costs and improve
productivity. In a joint deal with Vodafone, the alternative network builder CityFibre will
invest up to £700m to connect a million homes in 12 cities by 2021.
• Investing in infrastructure. We saw in Chapter 28 that the UK government has drawn up a
National Infrastructure plan which details planned spending of about £375 billion by 2033.
This will include major investments such as that in HS2 which will require extensive
investment appraisal.
• In other decisions. Businesses may also use techniques of investment appraisal before
spending heavily on promotional campaigns, developing new brands or products or retraining
the workforce.

Key term
 Investment appraisal is a series of techniques designed to assist businesses in
judging the desirability of investing in particular projects.

In each circumstance, however, the business must adopt an appropriate appraisal technique to
decide whether the returns received from an investment are sufficient to justify the initial capital
expenditure.
The data provided from investment appraisal is frequently an important element of the
quantitative data used by managers when taking strategic decisions such as whether or not to
enter a new market, takeover another company or extend significantly the use of technology
within the business.
Financial methods of assessing an
investment
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 looks at three of the most important investment appraisal
techniques:
• Payback.
• The average rate of return (ARR).
• Net present value (NPV).
These financial techniques are valuable but do depend upon a number of assumptions:
• All costs and revenues can be easily and accurately forecast for some years into the future.
• Key variables (for example, interest rates) will not change.
• 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 evaluation
of one or more potential investments. Forecasting future costs and revenues can be a very
difficult and, at times, expensive exercise to undertake. Forecasts about future revenues can
prove to be inaccurate for a number of reasons:
• Competitors may introduce new products or reduce their prices, reducing forecast sales and
revenues. The Apple Watch is expected to take a high proportion of the sales in the
smartwatch market with huge implications for the sales figures of rivals such as the Pebble
Technology Corporation.
• Tastes and fashions may change resulting in an unexpected slump, or rise, in demand.
McDonald’s, the multinational fast-food retailer, enjoyed a 4.4 per cent rise in global sales in
2018, although its profits fell by 8 per cent.

Handling data:
In 2018, McDonald’s sales revenue increased by 4.4 per cent, but its profits fell by 8
per cent. Explain why this might have happened.

• The economy may move into recession or slump (or alternatively into an upswing)
unexpectedly, resulting in radically different sales figures from those forecast.
• Costs can be equally tricky to forecast. Unexpected periods of inflation, or rising import prices,
 might result in inaccurate forecasts of expenditures. This can lead to a significant reduction in
actual profits when compared with forecasts.
Companies that operate in a stable economic environment are much more easily able to forecast
into the future as they have confidence that their predictions on the rate of inflation, likely rate of
interest, level of unemployment and hence demand are as accurate as they can make them. A
stable economic environment should lead to more accurate forecasts of both costs and revenues
associated with investment projects.

What do you think?

Should only managers whose companies operate in stable economic environments
use techniques of investment appraisal?
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 (or months)
it takes to recover the cost of an investment from its net inflows of cash. In spite of the obvious
simplicity of the payback technique, it remains the most common method of investment appraisal
in the UK.
An example of payback:
Year Cash outflow (£) Cash inflow (£)
1 500,000 100,000
2 200,000
3 200,000
4 150,000

In this case the calculation is simple: payback is achieved at the end of Year 3 when the initial
investment of £500,000 is recovered from net inflows of cash (revenue minus costs) – £100,000
in Year 1 plus £200,000 in each of Year 2 and Year 3.
Calculations can be a little more complex, however, as shown in the following example:
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 Year 4 at which payback is achieved is as follows: Number of full years + (amount of
investment not recovered/revenue generated in next year).
In the second example 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.

three years and four months. Figure 8.1 illustrates the concept of payback in the form of a graph.
Payback has the advantage of being quick and simple to calculate and this probably explains its
popularity, especially with small businesses. However, it does have disadvantages. It ignores the
level of profits that may be generated ultimately by the investment. For profit maximising
businesses this may represent an important omission. Furthermore, payback ignores the timing of
any receipts. The following example highlights this weakness.
Figure 32.1 Payback on a graph

Business in focus: Payback on MBAs

Tuition fees for a master’s degree in business administration (an MBA) can come to
more than £70,000 at the top schools. With the additional costs of living and the
opportunity cost of not working, is it worth the investment and, if so, how can you be
sure of getting the best value for money?
Global higher education company QS has calculated the average payback for
business schools in Europe by analysing the costs associated with MBA programmes
and weighing them up against average salary increases and bonus payments post-
MBA.
University Payback in months
University of Bath 16
University of Strathclyde 17
University of Edinburgh 17
Durham University 20
Bradford University 25
University of Warwick Business School 26
Table 32.1 The payback period for students taking MBAs at a selection of UK universities
Surprisingly, the MBAs that earn their money back fastest come from schools that are
not usually top ranked. ESIC (a Spanish business school), the University of Bath
School of Management and the University of Edinburgh Business School have the
fastest payback periods. It is likely that this may simply reflect the relative costs of
these business schools, however, rather than their career-enhancing potential. Fees
 at the London Business School are over £67,000, compared to ‘just’ £25,000 to study
at ESIC, for example.
People hoping to work in finance may need to spend more on their MBAs. Ranking
systems based on the proportion of graduates securing jobs in top investment banks
show very different results and favour the elite institutions in the long term.
Source: Adapted from e-financial careers website

Practice questions
1 Analyse the advantages and disadvantages of using the technique of payback for
the purpose of evaluating MBAs offered by different universities.
(9 marks)
2 To what extent are methods of investment appraisal appropriate to help with most
decisions taken in a business?
(16 marks)

Two investment projects (A and B) each require an investment of £1 million. Their expected
earnings are as follows:
Year Project A cash inflow (£) Project B cash inflow (£)
1 500,000 100,000
2 300,000 100,000
3 100,000 300,000
4 100,000 500,000

Both investment projects achieve payback at the end of Year 4. However, Project A is more
attractive because it yields greater returns in the early years. Payback does not take into account
the timing of any income received and this is a significant drawback of the technique.
Average rate of return
The average rate of return (ARR) is a more complex and meaningful method of investment
appraisal. This technique calculates the annual percentage rate of return on each possible
investment. The resulting percentage figure allows a simple comparison with other investment
opportunities, including investing into savings products offered by 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 of risk; the returns may not be as
forecast. Therefore, it is essential that such an investment earns significantly more than the rate
of interest available from zero risk investments such as savings accounts with financial
institutions. If the percentage return on purchasing the CAD/CAM equipment was identical to
that on a high-interest account with a bank, the latter would represent the better investment, as it
carries little risk.

Figure 32.2 How to calculate ARR

The formula for calculating ARR is:

The average rate of return is considered to be more useful than the payback method because it
considers the level of profits earned from an investment rather than simply the time taken to
recover the amount invested. It also offers easier comparison with returns on other investments,
investments in financial institutions such as banks as well as in other industries. Research in
2014 revealed that investments by oil companies in the Norwegian sector of the North Sea
produced an ARR of 18 per cent; this is simple to compare with other possible investments.
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 and this can have significant
implications for a business’s cash flow position.
An example of calculating the ARR:
Purchasing two new delivery vans for G. Layton Ltd will cost £120,000 and a net inflow of cash
of £220,000 over five years is anticipated.
The total profit from using the new vehicles over 5 years = £220,000 – £120,000 = £100,000
This means that average annual profit =

The managers at G. Layton Ltd may consider this to be an attractive investment as a rate of 16.67
per cent is considerably higher than that available on any interest-bearing account at a bank or
building society, even allowing a premium for risk. However, the business may have an
alternative investment offering a higher rate of return.

Handling data
Use the information in the example of ARR above to calculate the rate of return G.
Layton Ltd would have received if the cost of the vehicles was £140,000 and all the
other data was unchanged.
Net present value
More sophisticated methods of investment appraisal consider how the value of returns from an
investment depends on when they are received. Net present value (NPV) is one technique that
recognises this and incorporates a technique called discounting.

Key terms
Discounting is the process of reducing the value of future income 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.

Discounted cash flow

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 £1,000
today is of greater value than £1,000 in one or two years’ time. There are two major reasons why
this time-value principle exists:
1. Risk. Having £1,000 now is a certainty; receiving the same amount at some point in the future
may not occur. The full £1,000 payment may not be received; indeed 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 result of the
consequence of technological change.
2. Opportunity cost. This is the best foregone alternative. Even if no risk existed, the time value
of money would still 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, £1,000 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, an investor would
have £1,000 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.
Year Investment Project A Net cash Investment Project B Net cash
inflows (£ million) inflows (£ million)
0 (500) (500)
(Now)
1 400 100
2 100 100
3 100 100
 4 100 400
Table 32.2 Two similar investment projects with different patterns for cash inflows
Table 32.2 shows two investments requiring identical outlays. Both projects also receive the
same cash inflow over a four-year period and would generate the same ARR (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 3. The time-value principle would suggest that Project A is preferable to
Project B. To show the effect of the time principle we need to calculate the present value of cash
inflows and outflows through the use of discounting.

Discounting
Discounting is the process of adjusting the value of money received at some future date to its
present value, that 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, though these are obsolete nowadays as software exists to conduct the
necessary calculations and comparisons.
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 32.3 shows the discounting figures and the value in present-
day terms of £100 million 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 lower present values for the investment. Lower rates result in
discounting having a lesser effect in converting future earnings into present values.
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 £100 million in two years’ time is £82.6 million (£100 million ×
0.826). The present value of £100 million received in four years’ time is £68.3 million using the
same process with the relevant discounting factor. This figure is lower because the time interval
is greater and the effect of the time-value principle is more pronounced.
Year Discounting factor Present value Discounting factor Present value
used to convert to of £100 million used to convert to of £100 million
present value at a discount present value at a discount
(Assuming 10% rate rate of 10% (Assuming 5% rate rate of 5%
of interest) (£m) of interest) (£m)
0 1 £100.0 1 £100.0
(Now)
1 0.909 £90.9 0.952 £95.2
2 0.826 £82.6 0.907 £90.7
3 0.751 £75.1 0.864 £86.4
4 0.683 £68.3 0.822 £82.2
Table 32.3 The process of discounting
From these examples we can see that the rate of interest has a significant effect on the present
value of future earnings. The higher the rate of interest, the greater the discount. Thus, the
present value of £100 million in three years’ time is £75.1 million 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: £86.3 million.
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. However, this can be difficult to
forecast as rates may change in unpredictable ways during the lifetime of a major investment.

Using the NPV technique

Discounting expected future cash flows is the basis of calculating returns from investments using
the NPV method. 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.)
The outflows of cash are subtracted from the discounted inflows. This entails totalling the figures
recorded in the ‘present value’ column, at least one of which will be negative, making the
calculation a little more complex. The resulting figure is the NPV. This figure is 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 with a
financial institution.
2. When an enterprise is considering a number of possible investment projects it can use the
present value figure 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 NPV

Reston Technology plc manufactures components for satellites and other high technology
communications equipment. The company’s directors are about to make a major investment
decision. The rising cost of domestic gas and electricity has prompted the company to investigate
installing its own energy supplies. The directors are considering two options. They can install
solar photovoltaic panels on the roofs of the company’s factories or build an anaerobic digester
onsite to generate electricity from waste products supplied by other businesses. Installing solar
photovoltaic panels is the cheaper option for the company, although it will generate lower
returns. Both investments will produce positive cash flows after the initial cost as the electricity
generated will be valuable whether used by Reston Technology itself or sold to the company that
owns the grid.
The cash flows associated with these proposals over a five-year period are set out in Table 32.4.
These show the cost of installing the two alternative sources of energy and the expected revenues
less operating costs for the site each year. Reston Technology plc’s finance director estimates
that a 10 per cent discount rate would reflect likely market rates of interest, as he anticipates that
the Bank of England will raise interest rates in the near future.
Reston Technology would opt for building an anaerobic digester on the basis of this financial
information shown in Table 32.4, as the NPV for the more expensive proposal is higher than that
for installing solar panels. The net present values for both investment projects are positive,
indicating that each is a worthwhile and viable investment, but the digester offers better returns.
However, non-financial information may affect this investment decision: for example, operating
a digester would entail lorries delivering waste products daily which may prove unpopular with
people who live nearby.

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 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.
Larger firms having access to more sophisticated financial techniques may use the ARR 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.
Install solar photovoltaic panels Build an anaerobic digester
Year Annual Discounting Present Annual Discounting Present
cash flows factors at value cash flows factors at 10% value
(£m) 10% (£m) (£m) (£m)
0 £(6.85) 1 £(6.85) £(8.20) 1 £(5.0)
1 £1.90 0.909 £1.73 £2.46 0.909 £2.24
2 £1.95 0.826 £1.61 £2.55 0.826 £2.11
3 £2.14 0.751 £1.61 £2.67 0.751 £2.01
4 £2.25 0.683 £1.54 £2.72 0.683 £1.86
5 £2.31 0.621 £1.43 £2.91 0.621 £1.81
NPV 1.07 NPV 4.83
Table 32.4 Comparing Reston Technology plc’s choice of investment projects using NPV

Method of Advantages Disadvantages

investment
appraisal
 • Easy to calculate • Ignores the timing of
• Simple to understand payments
Payback • Relevant to firms with limited funds • Excludes income received
who want a quick return after payback
• Does not calculate profit

• Measures the profit achieved on • Ignores the timing of

projects payments
ARR • Allows easy comparison with returns • Calculates average profits –
on financial investments (bank they may fluctuate wildly
accounts, for example) during the project

• Makes an allowance for the • Choosing the discount rate

opportunity cost of investing is difficult – especially for
Discounted • Takes into account cash inflows and long-term projects
cash flow outflows for the duration of the • A complex method to
investment calculate and easily
misunderstood
Table 32.5 A comparison of investment appraisal techniques

Business in focus: Investment in the North Sea

Royal Dutch Shell, one of the world’s largest oil companies, has announced plans to
continue production in the North Sea for a further half-century. Steve Phimister, the
firm’s UK upstream vice president, said Shell would continue to invest ‘between
$600–800 million of new capital every year’ to grow its business. ‘We’re definitely
committed to the North Sea and to the UK sector in particular. We have over the last
few years gone through a lot of change, we turned the company around as we weren’t
in the place we wanted to be’, he told Energy Voice.
‘We’re now a lot more productive, a lot more efficient and definitely lower cost. Our
production costs today are a third of what they were four or five years ago. We’ll go
on investing somewhere between $600–800 million of new capital every year to grow
our business. We’re very proud of our business here, particularly the good shape it’s
in these days and the future we think we have – maybe another 50 years.’
In January, Shell confirmed it would develop its first new manned installation in the
northern part of the North Sea for almost 30 years. Meanwhile, the wider North Sea
sector, including areas licensed by Norway and the Netherlands, will see 63 oil and
gas fields being brought to production between 2018 and 2022, analytics company
GlobalData has predicted.
This expansion is thanks, in part, to new technologies such as subsea tiebacks – a
method of connecting new oil discoveries to existing facilities. The majority of new
fields in the North Sea will use subsea tiebacks, GlobalData said. This will provide
very quick returns: average payback is less than six years.
Another factor influencing the decision by Shell and other companies to increase
investment in North Sea oil production is the rising price of oil, as shown in Figure
32.3. In January 2016, oil prices were only just above €20 a barrel; by October 2018,
the price of a barrel of oil had risen to nearly €80.

Figure 32.3 The price of a barrel of North Sea oil in euros, 2002 to 2018

Source: Reuters, 5 October 2018

But not everyone is celebrating the continuation of the North Sea energy sector. ‘Fifty
years ago, the oil industry already knew that climate change was a threat, yet they
carried on regardless,’ wrote Dr Richard Dixon, director of Friends of the Earth
Scotland, in The Scotsman. He continued: ‘Fifty years on from Shell’s start in the
North Sea we are seeing the consequences of climate change all around the world.’
Source: Adapted from The Scotsman, 14 August 2018

Practice questions
1 Analyse why market conditions in 2018 would make investment in North Sea oil
production more attractive for businesses, no matter what method of investment
appraisal was used.
(9 marks)
2 Do you think the long-term factors at work in the North Sea oil industry mean that
all techniques of investment appraisal are of little use? Justify your opinion.
(16 marks)

Handling data:
Do you think that there is a correlation between global GDP data and oil prices, such
as those shown in Figure 32.3? If so, what correlation do you think exists?
Factors influencing investment decisions
There are a number of factors that a business might take into account when making an
investment decision alongside the results of investment appraisal methods such as NPV.

Investment criteria
Once the investment appraisal process has produced an answer this needs to be compared with
something in order to make a decision. There are a number of criteria that a business may use to
make an investment decision.

(a) The rate of interest

ARR and 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 Monetary Policy
Committee at the Bank of England. In essence, the managers of the business will seek a return
that will either be greater than the current and forecast interest rates if the ARR is used or, in the
event of using NPV, the interest rate that is current should produce a positive NPV.
Using the interest rate as a criterion does involve a number of problems, however. Firstly, 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; many
forecasters believe that the bank rate of interest set by the Monetary Policy Committee will rise
slowly during the period after 2019. Therefore, managers have to decide on a rate or range of
rates to use in their calculations.
Secondly, investments involve risks – we consider this more fully in the section below. When
choosing a minimum rate of return the management team have to build in an allowance for risk.

(b) The level of profit

When we looked at company accounts and ratio analysis in Chapter 26, we saw that a series of
ratios can be used to assess the profitability of a business. One of these, Return on Capital
Employed (ROCE), provides a figure which measures 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. The Kier Group plc, a leading UK construction business, set itself a ROCE target of 11
per cent by the financial year ending in 2020. It had achieved this figure by 2018. Managers may
insist that any new investment project should generate returns which will at least match (and
hopefully exceed) the business’s overall target for ROCE.

Key term
Return on Capital Employed (ROCE) is the net profits of a business expressed as a
percentage of the value of the capital employed in the business.

(c) Alternative investments

It would be unusual for a business to only consider 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 which 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.

Non-financial factors
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.

(a) 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 may be considered more
important than gaining short-term advantage from profitable investments. Over recent years,
Huawei, a Chinese technology company, has invested heavily in promoting its corporate image
as an enterprise that operates at the cutting edge of technology. This advertising has been backed
up by the company investing between $10 billion and $20 billion each year in research and
development. The company’s directors would have had to take a range of qualitative factors into
account when judging the worth of its investment in R&D against alternatives available.

(b) Corporate aims and 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 UK engineering company that
publicly states its aim to produce high-quality products, may invest heavily in training for its
staff and in R&D. This will assist in the manufacture of world-class aero engines and vehicles.

(c) 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 the business philosophy of some firms. As a consequence, they would not exploit
cheap labour in developing economies or use non-sustainable resources. In 2014, the Church of
England received a great deal of criticism for investing in Wonga, a company that provides
payday loans at high rates of interest. Other firms may have a less deep commitment to ethical
and environmental trading but may avoid some investments for fear of incurring damaging
publicity.

Business in focus: Dyson’s investment

Innovative solid-state batteries could hold twice as much electricity as current

batteries for longer lasting smartphones, tablets and electric cars. In 2015,
entrepreneur James Dyson invested £72 million in a new type of battery that promises
 to double smartphone battery life and allow electric cars to drive over 600 miles per
charge.
James Dyson was alerted to the University of Michigan development called Sakti3.
The University had developed next generation solid-state technology that can store
more energy. The new batteries promise to store twice as much energy as liquid-
based lithium batteries that are used in everything from smartphones and tablets to
cars.
By 2018, Dyson’s plans to manufacture an electric car were advanced based on the
use of solid-state batteries as an energy source. The company intends to build car
test tracks as it expands electric vehicle development at a former Royal Air Force
airfield in Wiltshire.
The company has budgeted to invest to spend an additional £116 million to build
more than 10 miles of test tracks at the former airfield. Dyson’s electric cars are
expected to be launched in 2021. The company’s plans also require investment in
new office buildings for more than 2,000 staff that will eventually be employed at the
site.
Overall, Dyson has said it will invest £2 billion in its electric car programme. Its
products would face competition from innovative car manufacturers such as Tesla as
well as established businesses such as Ford which is engaged in a joint venture with
a Chinese manufacturer to produce electric vehicles (EVs).
Sources: Adapted from The Guardian, 16 March 2015, and the Daily Mail, 30 August 2018

Practice questions
1 Analyse why techniques of investment appraisal may only have been of limited use
to James Dyson when deciding whether to invest £72 million in Sakti3 in 2015.
(9 marks)
2 Do you think that the decision by James Dyson to invest £2 billion in producing
electric cars involves a high level of risk? Justify your view.
(16 marks)

(d) 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’s corporate image.
Risk and uncertainty
It is not a simple matter to assess the degree of risk involved in an investment decision. Risk is
the chance of something adverse or bad happening. Risk should be distinguished from
uncertainty. Uncertainty is not measurable and cannot be included in numerical techniques of
investment appraisal. An investment project which 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.
In the context of investment decisions there are two broad ways in which risk may manifest
itself: costs may be higher than forecast or sales 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 forecasts 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 and no financial records
to use as a guide in forecasting sales. In 2018, M&S announced that it intended to sell 27
stores which it had opened in Hong Kong and Macau. Apparently, even one of Britain’s
largest retailers does 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 news ways. Entering a new market, producing new
products or developing new methods of production may all provoke a response from
competitors. This may take the form of increased advertising, cutting prices or bringing out
new rival 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.
Equally, costs may rise above the forecast level, reducing the returns from the investment.
Alternatively, they may fall – meaning an alternative investment may have been much more
profitable. The prices of commodities on global markets have been very volatile during 2018;
apart from the large rise in the price of oil, zinc prices fell nearly 30 per cent, while copper prices
fell by 15 percent and wheat prices increased by nearly 25 per cent. The volatility of prices for
such fundamentally important products highlights the difficulties that firms face when attempting
to forecast future costs of production.

Managing risk
Managers may seek to identify and manage the risk in an investment decision by taking a range
of actions including the following:
1. Purchasing raw materials on forward markets. This means that the firm concerned
negotiates a price at the present time for a product to be delivered at some agreed date in the
future. For example, many airlines have agreed future prices for the delivery of aviation fuel
 and therefore know for certain this element of their future costs. Although it removes the risk
of a sudden increase in costs, it may be judged a mistake if prices fall between agreeing the
deal and the delivery of the product. The low-cost airline Ryanair has hedged oil process until
2020. Oil is a major cost for airlines and protecting itself, as far as possible, against price rises
makes sense for a company that competes strongly in terms of fares.
2. Building in allowances for fluctuations in sales revenue and costs. Prudent managers may
opt to forecast a range of sales figures and costs of production which are based on their market
research, but allow for the market to change in some way that may be either adverse or
favourable. Building in this flexibility in forecasting and thinking about how wide the ranges
for sales revenue and costs should be, will help managers to judge the degree of risk as well as
the value of an investment project. We look at this aspect of investment decisions more fully
in the following section.
3. Ensuring the business has sufficient financial assets available. If a business is trading in a
volatile or rapidly changing market, it would be sensible to make certain the business has
sufficient resources to deal with any adverse circumstances. M&S was fortunate to have
sufficient finance to support its unsuccessful business in Hong Kong and Macau whilst it was
operational and to cover its losses when it withdrew from the market.
The value of sensitivity analysis

Key term
Sensitivity analysis is a technique that uses variations in forecasts to allow for a
range of outcomes.

As explained, preparing accurate forecasts for revenues and costs when conducting investment
appraisal can be a difficult task, especially for firms that operate in markets where costs, prices
and demand can be volatile. In such circumstances, managers can benefit when making
investment decisions from building in variations to key figures in their forecasts such as sales
volumes or unit costs of production to see what impact these have on the outcomes of the
investment appraisal techniques. Sensitivity analysis, or what-if analysis as it is sometimes
called, allows for managers to alter independent variables such as costs and sales volumes in
investment appraisal techniques and to see the outcomes. This helps to judge the degree of risk
involved in making a specific investment.
For example, a manager might allow for a rise in variable costs of 5 per cent per unit and, as an
alternative, for a fall of 5 per cent in variable costs per unit. The extent of the change in the
outcome of the investment decision will show how sensitive the investment is to a change in key
variables such as costs or revenues.

Key models and theories: Sensitivity analysis

This model assesses the degree of risk in an investment decision. You can consider
the use of this model in relation to an investment decision that may be risky. This could
be a recommendation that a business should conduct this analysis before confirming
an investment decision. It may be feasible to recalculate some of the investment data
assuming a lower level of sales volumes, prices or a higher level of costs to assess the
impact on returns. This is probably a better approach than using ARR or payback as
the calculations are less time consuming.
An example of the use of sensitivity analysis in
an investment decision
The scenario
A management team is presented with the information in Table 32.6 about a possible investment
in a new machine that is available for lease for a three-year period and can be used to produce
components used in aircraft manufacture.

Cost of three-year lease for the machine £800,000

Forecast annual sales 200
Selling price per unit £12,500
Variable cost per unit of production £9,250
Annual fixed costs of operating the machine £220,000
Table 32.6 Selected data associated with an investment
The management team has chosen to use the NPV method and a discount rate of 10 per cent to
appraise this investment. It calculates that the value of annual sales in each of the three years
would be £2.5 million (200 × £12,500) and that annual total costs would be £2.07 million ([200 ×
£9,250] + £220,000). They have produced the summary data shown in Table 32.7 below.
Year Net cash flow (£) Discounting factor Present value (£)
0 (800,000) 1 (800,000)
1 430,000 0.909 390,870
2 430,000 0.826 355,180
3 430,000 0.751 322,930
NPV 268,980
Table 32.7 The NPV calculation for the new machine
The outcome of the NPV calculation looks promising from the management team’s point of
view. There is a comparatively large, positive NPV. This looks like a worthwhile investment.
However, in this investment, as in most others, there are risks. The most obvious area for risk is
the sales forecast of 200 components per year for the next three years. A range of factors could
cause this to be proved incorrect. Competitors might reduce prices, airline manufacturers might
suffer a fall in the sales of their planes or new technology may appear making this component
less attractive. Thus, actual sales may be above or below the forecast figure of 200.

Using sensitivity analysis

The management team might allow for a 20 per cent variation in sales. Thus, they can conduct
the NPV calculation on the basis that they might achieve:
• high sales (20 per cent above their forecast) so 240 a year
• low sales (20 per cent below their forecast), thus 160 a year.
This enables them to produce the following results:
Outcome Annual sales NPV
High sales 240 £592,160
Low sales 160 (£54,200)
Table 32.8 The effects of differing sales volumes on the investment’s NPV
The sensitivity of the NPV of this investment project to variations in sales can be shown on a
graph as in Figure 32.4.

Figure 32.4 The sensitivity of NPV of the investment project to sales of the component

Interpreting the result

The managers of the project may not be too reassured by the results of this sensitivity analysis. It
suggests that the NPV of this project is sensitive to variations in sales volumes because the line
in Figure 32.4 is steep. This means that a relatively small change in sales produces quite a large
change in the NPV figure. However, if the team’s forecast of 200 unit sales a year is correct, the
investment will generate a positive NPV. Furthermore, so long as annual sales exceed
approximately 167 units on average over the three years, the investment will generate a positive
NPV.
However, this sensitivity analysis has only considered possible changes in the volume of sales.
Other changes may take place, such as changes in the market price or in either fixed or variable
costs. Any of these changes, or two or more in combination, could impact on the NPV generated
by the project. Further sensitivity analysis would be required to assess this project more fully.
How useful is sensitivity analysis?
Sensitivity analysis can assist managers in considering the degree of risk involved in an
investment decision by helping them to measure how sensitive outcomes (in the form of payback
times, ARR or NPV figures) are to changes in other variables in the calculation, such as selling
prices or volumes. If there is a high degree of sensitivity, then the risk involved in the investment
is greater. If there is a high degree of sensitivity and the investment is taking place in a market
which is volatile and therefore likely to see changes in variables, the risk of making the
investment may be judged to be too great.
Sensitivity analysis is, like many similar techniques, only as good as the data on which it is
based. Our example above showed an investment that was sensitive to changes in the volume of
sales. However, it appeared that the business had a substantial margin for error, in that its
forecast sales were considerably above the level at which NPVs became negative. However, if
the sales forecast was inaccurate, then the value of the analysis was much reduced.
A further weakness of sensitivity analysis is that it considers changes in one variable at a time.
Where there are too many changes its value can be reduced. If, in our example above, the
components were exported (and possibly materials imported), this could introduce another
variable into the analysis – exchange rate changes. Too many variables can produce a very wide
range of results, but also indicate that a higher degree of risk exists.
Although we have discussed sensitivity analysis in relation to investment decision making, it is a
more general technique that can be used in a wide range of business decisions, and is used
extensively by organisations such as the European Commission and the American government. It
has some similarities to the technique of decision trees, which we considered in Unit 2, but does
not attach probabilities to each of the possible outcomes.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 State three business decisions that may require the application of investment
appraisal techniques.
2 List the two major considerations for managers when deciding whether or not to
make an investment.
3 State one reason why forecasts of sales revenues arising from an investment may
prove to be inaccurate.
4 AB Ltd is considering an investment that is forecast to cost £150,000. The
expected net cash flow arising from the investment is £40,000 per annum. Which
of the following is the payback period of AB Ltd’s investment?
a 4 years
b 3 years and 3 months
c 3 years and 9 months
 d 3 years
5 LM plc is considering the purchase of a non-current asset. It will require an
investment of £900,000 and would cost £100,000 each year to operate. Over its
ten-year life the asset would generate £280,000 in revenue each year.
Which of the following is the average annual profit associated with LM plc’s
investment?
a £1.8 million
b £180,000
c £900,000
d £90,000
6 Which of the following is the average rate of return (ARR) from LM plc’s
investment?
a 10%
b 100%
c 20%
d 64%
7 Define the term ‘discounting’.
8 State two items of information that a manager will require to calculate the net
present value (NPV) of an investment.
9 State two criteria that a business may use as part of making an investment
decision.
10 State two examples of variables that could be altered as part of a sensitivity
analysis into a proposed investment in building a new factory.

(b) Short answer questions

1 Explain the possible reasons why a start-up business might use payback as a
method of investment appraisal.
(4 marks)
2 Explain two qualitative factors that an oil company may consider as part of the
appraisal of a proposed investment to extract oil from the seabed under the English
Channel.
(5 marks)
3 A rapidly-growing company is considering buying a similar-sized competitor in a
South American country. Explain one reason why this investment decision might
carry a high degree of risk.
(5 marks)
4 Saxon Markey plc is considering a first major investment in a market in which
demand is price elastic. Analyse why the company may benefit from the use of
sensitivity analysis in these circumstances.
(9 marks)
(c) Data response question
Tidal Lagoon Power
Tidal power is a major energy creation opportunity for the UK. A UK company, Tidal
Lagoon Power Ltd (TLP Ltd), has proposed a six-mile sea wall (or lagoon) scheme in
Swansea Bay. This has an estimated cost of £1,300 million and would generate
enough electricity to supply 120,000 homes. TLP Ltd initially received encouragement
from the UK government, which agreed to talks on subsidies, but in 2018, it decided
not to invest in the project. The project is exploring other sources of funding, including
borrowing money from sources such as water companies who might purchase the
electricity that is generated. It is also seeking support from the Welsh government.
The scheme, which could be operational from 2026, is expected to have a lifespan of
120 years and will help to protect the UK’s energy supplies in the future when energy
prices may be difficult to forecast accurately, although they are expected to rise. It is
the first of a number of possible tidal lagoon schemes being considered by TLP Ltd
which could give a major boost to the UK’s ability to meet demanding international
climate change targets.
The UK has some excellent tidal resources with the potential to generate large
amounts of power.
One business analyst has forecast the costs and revenues for the first five years of
the lagoon’s operations if a decision is made to go ahead with the project, and
assuming no financial support from the Welsh government. The data is shown in
Table 32.9.
Year Forecast revenue (£m) Forecast operating costs (£m)
2026 110.40 60.65
2027 113.72 62.41
2028 117.14 64.91
2029 120.66 66.86
2030 124.28 68.87
Table 32.9 A forecast for the Swansea Bay Project
Questions
1 Use the data in Table 32.9 to calculate the forecast ARR for the first five years of
this project’s life.
(6 marks)
2 Analyse the case for and against using the ARR as a method of investment
appraisal in these circumstances.
(9 marks)
3 Do you think that TLP should make the decision to proceed with this investment?
Justify your decision.
(16 marks)
(d) Essays
1 Discuss whether the existence of uncertainty means that techniques of investment
appraisal are a waste of time for businesses supplying goods and services with
short product life cycles when considering strategic options.
(25 marks)
2 ‘In a world in which the effects of climate change are becoming more worrying,
qualitative factors are more important in investment decisions than financial factors
for all businesses.’ To what extent do you agree with this statement? Justify your
view.
(25 marks)
Revision Section: Unit 7b Analysing the
strategic position of a business:
external factors and strategic options
Advice for Unit 7b
Top tips … Things to avoid …
Investment criteria can be useful to you Do not forget that the economic
when responding to questions on policies of the government (for
investment appraisal. When judging example, its monetary policy) may be
whether or not a business should go considered part of the political
ahead with a particular investment, it is environment. Do be aware that,
important to think what criteria the although most of these government
business would expect the investment to activities and policies are intended to
meet. The information you are given promote enterprise and are aimed at
may directly state these or they may be start-up and small businesses, they
implied. In either case, by relating your help to create a more ‘business-
answer to the criterion or criteria you friendly’ environment for all
have a basis for making a judgement businesses. This helps, for example,
that you are able to justify. to attract large multinationals to the
UK.
The UK authorities use the law to You do not need to understand all the
manage and control the extent of detail of the laws in the areas
competition within UK markets. You mentioned here but just require a
should consider this in conjunction with broad understanding of the scope
regulation. and effects of UK and EU law.
Remember that most products are not Do not forget that emerging
sold on the basis of price alone. When economies are very different and
considering the likely consequences of a businesses become involved with
change in exchange rates it is important them for different reasons. Some
to note that factors such as quality, produce there, others buy resources
brand image and reputation, after-sales from emerging economies, whilst a
service and meeting delivery dates are third group of companies sell their
important influences on buyers’ products in emerging markets. You
decisions too. should consider these differences
when writing about this area.
The specification requires you to be able Do not forget about quantitative and
to understand and interpret economic qualitative factors when making
data. Practising reading data and decisions on investment projects.
considering the likely consequences for Most case studies will include some
decision making in businesses will help qualitative issues for you to weigh up
you to develop important skills. and you will need to take these into
account as well as any quantitative
information.
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 two or three.
UNIT 7B CHECKLIST
Having completed studying this unit you should be able to do all that is listed below.
You should read this list and confirm that this is the case.

Analysing the external environment to assess opportunities and threats:

political and legal change
Know and understand:
• the impact of changes in the political and legal environment on strategic and
functional decision making.
Analysing the external environment to assess opportunities and threats:
economic change
Know and understand:
• the impact of changes in the UK and EU political and legal environments on
strategic and functional decision making within businesses
• the impact of changes in the UK and global economic environments on strategic
and functional decision making within businesses
• how to interpret changes in economic data and consider the implications of these
changes for businesses
• the reasons for the greater globalisation of businesses and the importance of this
trend for businesses
• the importance of emerging economies for businesses.
Analysing the external environment to assess opportunities and threats: social
and technological
Know and understand:
• the impact of changes in the UK and EU social and technological environments on
strategic and functional decision making within businesses
• the pressures on businesses for socially responsible behaviour.
Analysing the external environment to assess opportunities and threats: the
competitive environment
Know and understand:
• Porter’s five forces and how and why these forces might change
• the implications of Porter’s five forces for strategic and functional decision making
and profits and how these forces might shape a business’s competitive strategy.
Analysing strategic options: investment appraisal
Know and understand:
• the financial methods of assessing an investment, including how to conduct
relevant calculations and interpret results
• the factors that influence investment decisions and the value of sensitivity analysis
in this regard.
Practice questions
1 A business invested £120,000 in a project. In each of the first four years it received
a cash inflow of £32,000 as a result. Calculate the payback period for this
investment.
(3 marks)
2 Explain the likely effects of a prolonged fall in immigration into the UK on the profits
of businesses that produce food in the UK.
(5 marks)
3 Assume the UK government imposes tariffs on imported furniture. Explain the
possible effects of this decision on the sales revenue of UK-based furniture
manufacturers.
(5 marks)
4 An industry is subject to increasing competition from overseas as a result of
globalisation. Explain the effects of this on two of the industry’s stakeholder groups.
(5 marks)
5 Analyse the possible implications of a sharp fall in the exchange rate of the pound
for a UK grocery retailer that imports many of its products from overseas.
(9 marks)
Case study: Changing times at Pret a
Manger
Pret a Manger is a familiar sight on the streets of the UK’s towns and cities. It
describes itself as:

A global leader in offering freshly prepared, delicious, food and organic coffee in a
welcoming and convenient setting. Pret’s food is handcrafted throughout the day
using ethically-sourced ingredients which are delivered to each shop’s kitchen up
to six days a week. Pret combines its industry-leading food offering with an
organic coffee offering that reflects the same principles of quality, ethical sourcing
and sustainability.
Source: Pret a Manger Annual Report, 2017
Pret a Manger was launched in 1986 as a single sandwich shop in North London by
Julian Metcalf and Sinclair Beecham. As shown above it promotes itself strongly as an
ethical and environmentally-friendly business. Along with its Annual Report it produces
a Sustainability Report setting out its effects on the environment and in the
communities in which it operates.
In 2018, Pret was bought by JAB Holding, a German business with a range of
subsidiary companies. Since then Pret has grown rapidly. In 2017:
• Pret operated 502 sandwich shops, including 90 in the USA and 52 in other
countries including France, Hong Kong, Singapore and China
• it opened 27 new shops overseas
• the company’s sales were £879m, generating an operating profit of £59.2 million.
Pret has an objective of growth and its sales have risen continuously since 2007 as
shown in Figure 1. It seeks to achieve this by building competitive advantages in two
key areas: the taste and freshness of its food, and the quality of its customer service.
Pret’s new owners are expected to push for continued international expansion,
especially in the USA.
There is tough global competition in the healthy sandwich market. Pret faces tough
competition from so-called ‘healthy grab-and-go’ rivals such as Pure, Crush and Vital,
among others. Furthermore, sales in this segment of the market have grown more
slowly recently and there are fears that global economic growth rates could decline
sharply over the next few years.
In 2018, an inquest in the UK heard that Pret did not label some of its baguettes as
containing sesame seeds. A fifteen-year old girl died as a result of an allergic reaction
after eating one of the company’s ‘artisan’ baguettes. The company’s complaint logs
hold reports of nine cases of sesame-related allergy incidents in the year leading to
this tragedy. The case received wide coverage in the media and it led to Pret
announcing that it will introduce full labelling of ingredients on its products, including
all allergens.

Figure U7b.1 Pret a Manger’s sales revenue, 2007–2017 £m

Source: Pret a Manger Annual Report, 2017

Note: Pret’s revenue has increased by an average growth rate of 14.8 per cent per
annum. Its growth rate in 2017 was 13.3 per cent.
Appendix A
Economic measure * UK USA
GDP, annual growth rate 2017 – 1.9% 2017 – 2.1%
2018 – 1.2% 2018 – 2.9%
Inflation rate 2017 – 2.4% 2017 – 1.7%
2018 – 1.9% 2018 – 2.2%
Unemployment rate 2017 – 4.3% 2017 – 4.3%
2018 – 4.0% 2018 – 3.9%
Interest rates 2017 – 0.25% 2017 – 1.00%
2018 – 0.50% 2018 – 2.00%
Source: Trading Economics
* Data are mid-year figures.
Practice questions
1 Analyse why non-financial factors may form an important element of any
investment appraisal conducted by Pret a Manger as part of its continued
international expansion.
(12 marks)
2 Analyse the possible reasons why Pret promotes itself as an ethical business.
(12 marks)
3 Do you think it is possible for Pret’s stakeholders to assess the company’s
performance fully without the use of techniques such as Elkington’s triple bottom
line? Justify your view.
(16 marks)
4 In 2018, one of Pret’s customers died as a result of eating food containing
ingredients not recorded on the product’s packaging. To what extent does this
indicate that tighter regulation of businesses selling food is essential to protect UK
customers?
(16 marks)
5 To what extent does the information in Appendix A suggest that any decision by
Pret’s new owners to expand the business in the USA rather than in the UK would
be a good one?
(20 marks)
6 To what extent is it essential for all UK retailers to operate globally to be
successful?
(24 marks)
Essays
1 ‘Fluctuations in exchange rates mean that investment appraisal for international
projects are of little value in making investment decisions.’ To what extent do you
agree with this statement?
(25 marks)
2 The population of the UK is growing quickly; it has increased from 58.9 million in
2000 to 66.0 million in 2017. To what extent does this increase offer benefits to all
businesses in the UK?
(25 marks)
Chapter 33 Strategic direction: choosing
which markets to compete in and what
products to offer
Introduction
In this chapter we consider what is meant by the strategic direction of a business. This means we
examine how managers make strategic decisions about the long-term direction in which the
business is headed. This involves decisions about which markets to compete in and what
products to offer. Get these decisions wrong and the whole business is in trouble. In particular
we compare and contrast four types of strategy using a model called the Ansoff matrix and
consider why a business might choose a particular strategy.
What it is important to know by the end of this chapter:
• the factors that influence which markets to compete in and which products to offer
• how to analyse the strategic direction of a business using the Ansoff matrix
• how to assess the value of market penetration, market development, new product development
and diversification as business strategies
• how to analyse and evaluate the reasons for choosing and value of different options for
strategic direction.
Strategic direction
Strategic choices involve deciding the direction in which a business should move and the
methods by which it should pursue its plan. In this section we consider the possibilities for the
strategic direction of a business. In the following sections we consider how these strategies are
pursued and then how a given strategy is implemented.

Key terms
Strategic choices involve deciding the direction in which a business should move
and the methods by which it should pursue this plan.
The strategic direction sets out which markets a business will compete in and what
products it will offer.

The strategic direction of a business refers to the decisions made regarding the markets it
competes in and the products it offers. With continuous internal and external change, managers
must regularly review where their business is at any moment and where it should be headed. This
means the strategic direction of the business will change.

Figure 33.1 Strategic direction

Imagine you are the captain of a ship. You will be continually checking coordinates to make sure
you are where you are supposed to be and are pointing in the right direction, and to ensure that
you are moving at the right speed. Changes in weather conditions may force you to adjust your
plan and, in some cases, may require you to change your overall direction. In the same way, a
chief executive will keep monitoring key measures of performance from the business to ensure
all is on target and keep reviewing the plan to ensure it remains relevant to the business
environment in which it operates. Changes in the business environment may require a change in
strategic direction. In some cases, this can completely change the shape of the company over
time.
Did you know that Nokia began as a paper producer? Or that WPP, one of the world’s largest
media companies, began as a producer of shopping baskets called Wire, Plastics and Packaging?
Or that Nintendo started by producing playing cards? The carpet maker Desso has now moved
into playing surfaces such as those used by Manchester City and Liverpool football clubs. The
strategic direction of these businesses has changed as opportunities have emerged in new
markets, with new products and as threats have developed in their existing markets. You may
have a view of how your life will unfold, but you may find it turns out differently because of
opportunities and threats along the way. Similarly, the development of a business will follow
various twists and turns as it grows and gets older.
Ansoff matrix
One way in which the strategic direction of a business can be analysed is using the Ansoff
matrix; this is a model developed by Igor Ansoff. This matrix considers a firm’s strategy in terms
of the products it offers and the markets in which it operates.

Figure 33.2 Ansoff matrix

Figure 33.2 highlights the four main strategic directions that a business might choose.
• Market penetration. This involves developing strategies to boost sales of existing products in
existing markets. The business is aiming to boost its market share. For example, an
organisation might invest more in promotional activity or change its pricing approach in order
to sell more. This strategy involves relatively little risk in terms of decision making because
the products and markets are familiar to the managers. However, if the existing market has
little growth potential – for example, because it is a mature market – a business would
probably not want to focus solely on market penetration.
• Market development. This approach involves offering existing products but targeting new
market segments with them. This could be a new segment in terms of:
• geographical area; for example, offering a product in a new part of the country or the world
• demographic features; for example, a business might target a younger or different
socioeconomic customer group.
Although the business knows this type of product already, it needs to ensure that what it has
been offering will match the needs of the new target market. It will need to understand the
conditions of the new market including the existing competitors, the distribution systems and
the key factors that influence customers’ buying decisions. Entering a new market segment can
be dangerous – for example, existing business may respond by protecting their sales and may
try to force a new entrant to the market out.
• New product development. This involves developing new products for existing customers.
The business may be responding to changes in customer requirements or anticipating future
change. Investment in new product development can take time – researching, testing and
launching new products properly can take months, even years. It is also high risk as many new
product ideas fail to succeed even after they have been launched. In 2016, for example, Google
Glass was withdrawn from the market for further development. However, businesses may want
 to invest in new product development to broaden their portfolio and if the sales of existing
products are in decline. The company which developed Gortex has annual sales of over $3
billion and has a culture and tradition of innovation.
• Diversification. This strategy involves offering new products to new customer groups. There
is quite a high level of risk here since the products and target customers are both unfamiliar.
There is likely to be high levels of uncertainty as a result. However, in other ways this strategy
may be reducing risk because by moving into new markets and developing new products, the
business may be less vulnerable to changes in one of its market segments. If you are totally
reliant on one range of products in one market, for example, then you are vulnerable to change.

Key models and theories: Ansoff Matrix

The Ansoff Matrix shows four different strategies a business may choose. When
analysing a strategy, you might want to think where it fits on the Ansoff Matrix. You can
also consider the advantages and disadvantages of each strategy and consider the
implications of choosing one rather than another. The Ansoff Matrix is a valuable
analytical and planning tool. However, managers still have to make the right decisions
based on this analysis and implement any decisions successfully.

What do you think?

Do you think that diversification is inevitably riskier than market penetration?

Key term
Market penetration involves existing products and markets, market development is
existing products in new markets, new product development is new products in
existing markets, diversification involves new products and new markets.

Business in focus: New product development – Mondelez

Mondelez is a global producer of confectionery. Its brands include:

Figure 33.3 A range of Mondelez brands

Practice questions
1 Analyse the factors Mondelez might consider before launching a new chocolate
bar.
(9 marks)
2 To what extent do you think the success of a new product is likely to depend on the
expertise and experience of Mondelez?
(16 marks)

Business in focus: Product failures

Product failures can occur for many reasons. The product may not be developed
properly and, therefore, fail to impress or there may simply not be a need for it. Two
high-profile examples of product failures are:

1. The Ford Edsel

The Edsel was a new model of car released by Ford in 1957. The car was named
after Edsel B. Ford, the company’s former president and Henry Ford’s only son, who
had died in 1943. The development of the Edsel cost over $350 million (equal to
around $3 billion in today’s terms). The car was heavily promoted, but new features
such as electronic controls proved to be unreliable. The price also proved to be too
high in an economic downturn. The car was taken off the market after just four years.

2. The Newton Message Pad

Even successful companies such as Apple have had product failures. Apple’s Newton
Message Pad was one of the first products to offer basic computing functions in a
handheld device. At the time, this technology was revolutionary. One of the key
selling points was its handwriting feature, but this failed to work effectively at first and
 meant customers did not feel the product justified its high price.

Practice questions
1 Analyse the reasons why a new product might fail.
(9 marks)
2 To what extent do you think the success of a new product is under the control of a
business?
(16 marks)

The Ansoff matrix provides a simple framework to analyse different strategic options facing a
business. In its most basic form, it categorises strategic options in terms of ‘existing’ or ‘new’
products and markets. In reality, there are many different versions of these strategies. For
example, a ‘new’ product may mean an existing product that is slightly modified, one that is
simply new to the business but not the market, or something that is highly innovative and has not
been produced by anyone before. There are, therefore, degrees of ‘newness’. Similarly, a ‘new’
market may mean expanding into a region a few miles away from where you operate already, or
may mean expanding globally and dealing with very different market conditions. It is possible,
therefore, to have a scale on the axes to show just how new the products and markets are rather
than simply categorising them as ‘existing’ or ‘new’.
It is also important to appreciate that there may be several strategies being pursued by a business
at the same time. A business may be trying to boost its sales of its existing products in its
existing markets, whilst also developing new offerings and pursuing overseas expansion. Apple,
for example, has tried to get more of the smartphone market (market penetration), launched new
products and offered products in new markets such as China (market development). Coca Cola
modifies its existing products (e.g. by having different packaging for Coca Cola) whilst
developing new products such as Coca Cola Life and moving into new markets with its venture
with Monster energy drinks.

Figure 33.4 Ansoff matrix with scale

Handling data
1 A business is pursuing a market penetration strategy. At present, it has a 5 per
cent share of a market that has total sales of £2,400,000. It hopes to increase this
to a 7 per cent share. How much would its sales need to increase by in order to
achieve this?
2 The price elasticity of demand for a product is estimated to be –2.5. A company
hopes to increase its sales by 12.5 per cent by cutting its price. What will happen to
revenue if it does this? What effect will this have on profits?

Business in focus: The Arcadia Group

Figure 33.5 Arcadia Group businesses

The Arcadia Group is a leading high-street retailer made up of many well-known

brands. It is a private company owned by Philip Green and includes:
• Burton
• Dorothy Perkins
• TopShop
• TopMan
• Evans
• Miss Selfridge
• Outfit
• Wallis.
Arcadia International is an important part of the overall Arcadia group representing
over 900 stores across 40 countries. It is constantly looking to developing its portfolio
of brands, the regions in which it operates and the products it sells in its stores.
According to the Arcadia International team, as well as working on plans for world
domination, they ‘make sure our international customers enjoy the same shopping
experience as here in the UK, which makes for a fast-moving environment where
attention to detail is everything’.
Source: Adapted from Arcadia website

Practice questions
1 Arcadia is a private limited company not a public limited company. Analyse how
this might affect the strategic planning of the business.
(9 marks)
2 To what extent do you think international expansion is a good idea for Arcadia?
(16 marks)
Selecting a strategy
When considering which strategy or strategies to choose a business will consider many different
factors, such as:
• The expected costs. For example, what investment is required?
• The expected returns. For example, what are the likely profits relative to the initial
investment?
• The opportunity costs. What are the alternatives if this project is not pursued?
• The risk. What would the downside be if the strategy fails? This is a very important aspect of
a strategic decision. Managers will want to assess the damage that might be done if the
strategy was unsuccessful. For example, what is the financial risk; what is the risk to the brand
and the company’s reputation; what is the risk of legal action?
• The fit with the resources and strengths of the business. For example, is the project
affordable? Does the business have the competences (for example, the expertise and
experience) to perform well? Does the business have the capacity required?
• The impact on other stakeholders. For example, are they likely to support the plan or resist
it? What objections might they have?
• The ethical issues involved. For example, are the managers and owners happy to be
associated with the project or could it be criticised for being unethical?
As well as considering where to compete in terms of products and market, a business will also
consider how to compete, for example, how to position itself relative to its competitors. This is
known as strategic positioning.

Handling data
Probability Expected outcome
Strategy A: Market penetration Success = 80% £2m
Failure = 20% (£1m)
Strategy B: Diversification Success = 30% £20m
Failure = 70% (£6m)
Table 33.1 Probability of success and failure and expected outcomes for market penetration and
diversification strategies
Which of the above strategies would you choose? Why?

Business in focus: The tobacco industry

The tobacco industry is one which faces a great deal of external pressure and,
therefore, tobacco companies have to review their markets and products and plan for
the future.
Features of the tobacco market include the following:
• over 6 trillion cigarettes a year are sold around the world
• the global market is dominated by four companies – British American Tobacco
(BAT), Imperial Tobacco, Japan Tobacco and Phillip Morris. These four companies
have a combined market share of over 40 per cent
• the Chinese tobacco market is the biggest in the world with over 350 million
smokers
• over 10 per cent of tobacco products that are sold are the result of illegal trafficking
• high levels of regulation of the industry requiring plain packaging, restrictions on
where it is possible to smoke and how tobacco products can be displayed
• high levels of product innovation with nicotine inhalation products, aerosol nicotine
and electronic cigarettes.
In the future, there are likely to be fewer people smoking and those who continue to
smoke will smoke less. However, there is likely to be continued growth in
consumption in emerging markets as populations and incomes grow there.

Practice questions
1 Analyse how the information on the tobacco market given above might affect BAT’s
strategic direction.
(9 marks)
2 Do you think the tobacco market is a good one to be in? Justify your answer.
(16 marks)

What do you think?

Do you think all businesses need to diversify at some stage?
Why does strategic direction matter?
Strategic decisions are long-term, high-risk decisions that are full of uncertainty and determine
the survival and ongoing success of a business. These decisions are made by senior managers
and getting the strategic direction right is essential. If a business ends up offering the wrong
products or competing in the wrong markets then, however hard and however well it fights, it is
going to be difficult to be successful. Imagine that 20 years ago a business had continued
producing or fax machines – sales would be much lower than in the past. Or, more recently,
imagine a business relied totally on export sales to Russia or Iran at a time when political
sanctions were imposed against this country and its currency fell in value substantially – this,
again, would make success more difficult. A great manager understands and anticipates where
markets are going and makes sure the business offers the right products in the right markets.
Getting the strategic direction right is essential for business success. The difficulties of Tesco in
recent years highlight the problems a business encounters if the strategic direction is wrong.
Tesco was building more hypermarkets at a time when customers were shopping more online
and wanted local stores for top-up shopping.
The strategic direction of a business needs to be clear to everyone within the organisation
because it provides a focus for all the parts of the business and all the elements within it. All
employees should know what the business is trying to achieve, why it is trying to achieve this
and how it intends to do so. This helps them to decide what to do when and what matters most.
This can clarify for employees their role in the organisation, how best to do their job and what
their priorities are.
The strategic direction of a business should influence decisions and targets throughout the
organisation. When managers at every level and in every part of the business are set targets these
functional objectives should link to the overall corporate strategy; the targets for each individual
should help to ensure that everyone within the organisation is working towards the same end
goal.

Business in focus: Ford

Ford, like all motor manufacturers, faces many challenges in the future. This is an age
of radical disruption in the vehicle industry. The more established producers such as
Ford are improving and competing aggressively against each other. At the same time,
new competitors such as Tesla with new technologies are entering the industry. What
customers expect from a vehicle is changing. All of this creates opportunities and
threats for Ford.
Ford has set out five principles that will guide its future strategy. These are:
1 It will become fitter.
2 It will operate in the vehicle business transporting both goods and people.
3 It will build vehicles that are connected and use ‘smart’ technology.
4 Its vehicles will thrive in the new world of technology that is occurring in
 transportation.
5 It will seek to exploit new business opportunities.
At the heart of Ford’s strategy is a desire to be operationally fitter. By this, it means it
must retain its competitive edge, it must control costs and it must adapt to new
conditions. Ford recognizes that many established companies get too big or too
complacent and lose their fitness.
To ensure Ford’s retains its fitness the company is focusing on a number of redesign
initiatives:
• streamlining product development
• reducing material costs
• improving manufacturing efficiency
• reducing complexity
• implementing new marketing techniques
• building a world-class IT system.
The company hopes all of these initiatives will help to increase its shareholder value.
In developing its strategy Ford will apply the core company values which are:
• simplicity
• agility
• efficiency
• responsiveness
• accountability.

Practice questions
1 Analyse why ‘operational fitness’ is important to Ford’s success.
(9 marks)
2 To what extent do you think the strategic changes at Ford are brought about more
by external than internal factors?
(16 marks)

Business in focus: ‘Angry Birds’

Figure 33.6 ‘Angry Birds’

In 2015, the profits of Rovio Entertainment, the business that created ‘Angry Birds’,
fell by over 70 per cent. The popularity of the game fell and this in turn reduced sales
of merchandise such as toys, mugs and t-shirts. The game was released originally in
2009 as an iPhone app and has been downloaded 2 billion times. However, after a
number of years of growth, mobile gamers now seem to be moving on to new titles.
This creates problems for Rovio Entertainment which has built a theme park in
Finland and has made a film based on the game. Analysts argue that the company
needed to move forward with new products quickly.

Practice questions
1 Analyse the possible reasons why Rovio Entertainment had not successfully
developed new products to add to its portfolio.
(9 marks)
2 Do you think every app business will inevitably have a short life? Justify your
answer.
(16 marks)

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 Explain what is meant by ‘a strategic decision’.
2 What is meant by ‘the strategic direction of a business’?
3 State what is on the axes of the Ansoff matrix.
4 According to Ansoff, what is the name of a strategy that offers new products in a
 new market?
5 According to Ansoff, what is the name of a strategy that offers new products in an
existing market?
6 Explain one way a business might pursue a market penetration strategy.
7 Explain why the strategic direction of a business matters.
8 Explain one reason why a business might choose a diversification strategy.
9 Explain one risk of choosing a new product development strategy.
10 Explain one possible influence on the strategic direction of a business.

(b) Short answer questions

1 Explain one way in which a clothes retailer that mainly targets 30–45-year-old
women might attempt to penetrate more of the market.
(5 marks)
2 Explain one reason why a tobacco business might choose a diversification strategy.
(5 marks)
3 Explain one reason why a games app business might choose a new product
development strategy.
(5 marks)
4 Explain one risk involved in a fast-food business choosing a market development
strategy of targeting new countries.
(5 marks)
5 Explain the possible risks involved for a family that has owned and run a working
farm for generations using their farm as a holiday campsite.
(5 marks)

(c) Data response question

King Digital Entertainment
King Digital Entertainment is the computer games company that produced ‘Candy
Crush Saga’. This product is now its cash cow. ‘Candy Crush’ was only launched in
2012 and was a tremendous success following on from the success of King Digital’s
previous main product ‘Bubble Witch Saga’, which became the second most played
game on Facebook. The company is truly global – it was founded in Sweden, is based
in London, has a head office in the Republic of Ireland, is listed on the Stock
Exchange in New York and is managed by an Italian.
In 2011, the company had 110 employees. It now employs over 2000 employees. It
spends approximately 6 per cent of sales on research and development.
The company’s growth has been so great that it moved from its cramped Soho offices
to take over Facebook’s Convent Garden offices. From there, it developed ‘Farm
Heroes Saga’ which was launched in 2014. Unlike many of its rivals, King Digital is
actually profitable. The company’s rate of growth has been so fast that its annual
report actually highlighted that it might struggle to manage the growth effectively.
The managers of King Digital claim their games are more like crosswords than, say,
‘Call of Duty’. The games are only intended to be played for a few minutes and this
has proved especially popular with women. (About 70 per cent of its users are
female.) People typically play them waiting for a bus, for a train, standing in a queue or
in between meetings.
‘Candy Crush’ games are played 957 million times a day mainly by a core of 91 million
users. However, the company gains most of its profits from small numbers who buy
extra lives, tips and levels in the game. This number is falling – it was 8.3 million in the
final quarter of 2014 compared to 13 million in the third quarter. However, managers
point to the fact that it has other products (‘Candy Crush’ accounts for less than half of
its revenue) such as the success of ‘Candy Crush Soda’, which is a franchise from the
original game. Nevertheless, the company faces great competition. For example, a
major hit in recent years has been ‘Minecraft’, which was developed by Markus
Persson, an ex-King Digital employee.
In 2018, King revealed it would launch its biggest and most ambitious version of
Candy Crush yet. The game will be available on Apple, Android and Windows
devices. The new ‘Candy Crush Friends Saga’ adds an additional layer of strategic
thinking to the Candy Kingdom, as players are placed in a 3D world, with a range of
impressive new features.
According to Bloomberg, about 300 million people play Candy Crush every month.
Approximately half a billion people play King’s games over the same period. King has
a portfolio of 180 mobile casual games. These include Soda Saga, Farm Heroes
Saga, Pet Rescue Saga and Bubble Witch 2 Saga games.
These players can play the games for free but the aim is to get them to buy additional
benefits that they actually pay for.

Questions
1 Explain the key features of King Digital’s strategy to date.
(5 marks)
2 Analyse the factors that you think should influence the strategic direction King
Digital should take in the future.
(9 marks)
3 To what extent do you think it is likely that King Digital will still be in business in 15
years’ time?
(16 marks)

(d) Essays
1 Do you think market penetration is a better strategy than market development for a
business wanting to grow fast? Justify your answer.
(25 marks)
2 To what extent do you think a strategy of diversification is too risky for a market
leader to choose? Justify your answer.
(25 marks)
Chapter 34 Strategic positioning:
choosing how to compete
Introduction
In the last chapter we considered how a business choses which markets to compete in and which
products to offer. We now consider how a business competes in its chosen market. Does it try to
offer more benefits than its rivals at a similar price? Does it offer similar benefits at a lower
price? There are many ways a business can compete successfully (it may be a premium or a
discount brand, for example). In this chapter we consider the different strategic positioning
options open to a business and the factors that influence why a business might choose one rather
than another. We also discuss the problems associated with remaining competitive over time.
What it is important to know by the end of this chapter:
• how businesses compete in terms of benefits and price
• what is meant by strategic positioning, including Porter’s low-cost, differentiation and focus
strategies
• how to analyse strategic positioning using Bowman’s strategic clock
• how to analyse and assess influences on the choice of a positioning strategy
• how to evaluate the value of different strategic positioning strategies
• the benefits of having a competitive advantage
• the difficulties of maintaining a competitive advantage.

Figure 34.1 Strategic positioning

Strategic positioning
Once the strategic direction of the business is decided (that is, what markets the business is
competing in and what products it is offering) managers must decide where to position the
business relative to its competitors. How will it compete relative to others in the segments that
are being targeted? For example, how does Sports Direct want to be thought of by customers
relative to Decathlon? For example, how does Next differ from River Island? How does a
Mercedes differ from a Lexus? The strategic positioning of a business refers to how it is
perceived relative to other businesses in the industry. Managers will decide where in the market
they want the business to compete compared to its rivals. For example, Premier Inn is more of a
budget hotel chain than Hilton; Nintendo is more of a family games console than Xbox. Of
course, where a business would like to position itself and where it actually sits in customers’
minds may be very different things.

Key terms
The strategic positioning of a business refers to how it is perceived relative to other
businesses in the industry.

Strategic positioning can be analysed using Porter’s strategies and Bowman’s strategic clock.
Porter’s strategies
According to the famous business consultant and writer, Michael Porter, a competitive business
strategy is about being different. It involves deliberately choosing a different set of activities to
be able to deliver a unique mix of value relative to competitors. The value a business offers
depends on the combination of benefits relative to the price paid. Porter identified two possible
positioning approaches for a business:
• Cost-leadership strategy.
• Differentiation strategy.

Key models and theories: Michael Porter

Michael Porter is a famous business writer on strategy. His work on work cost
leadership and differentiation highlighted to managers the importance of being clear on
how you were going to compete and ensuring the strategy fitted with the strengths and
competences of the business. To be a cost leader there must be something in terms of
what you do or how you do it that gives you a cost advantage. To differentiate there
must be something you do that enables you to be more expensive than others.

Cost-leadership strategy
A cost-leadership strategy involves becoming the lowest-cost organisation in the industry in
which the business is competing. This may be achieved through:
• Lower input costs: A business may find a way of reducing the cost of its inputs. This may be
by owning some of its suppliers and thereby avoiding the profit margins of its suppliers.
Morrisons, for example, owns many of the farms that supply its products; Zara also owns its
suppliers; and IKEA designs and develops all its own products. Alternatively, a business could
be located nearer supplies than competitors reducing transportation costs.
• Economies of scale: The business may have cost advantages by being bigger than its rivals.
For example, it may be able to spread fixed costs over more units if it is big enough, thereby
reducing unit costs.
• Experience: The managers and employees may be more experienced than rivals enabling them
to source cheaper materials and make more efficient decisions.
• Product/process design: The design of the product or the process used to produce it may be
more cost efficient than competitors. For example, budget airlines use local regional airports
where it is cheaper to take off and land than it is at the major airports such as Heathrow and
Gatwick; they provide a basic service without pre-booking seats and without food and
newspapers provided.

Key terms
A cost leadership strategy involves achieving lower costs than rivals in the same
industry
A differentiation strategy involves offering more benefits than rivals in the same
industry

Business in focus: Poundland

Figure 34.2 One of Poundland’s 500 stores

The Poundland Story

Everything for £1 was the idea of our founders in 1990 and we’ve grown to become
one of the largest discount and value retailers in the UK, with thousands of great
products at £1 across over 700 stores … and sometimes we offer special promotions
and products at other prices.
We work hard to bring you amazing value products every day with over two-thirds
being sourced from the UK.
Did you know?
Last year, we sold some amazing products …
• 5.5 million boxes of Maltesers
• 2.5 million umbrellas
• 3 million lightbulbs
• 18 million cans of Coke
• 250,000 garden gnomes
• 4.4 million bags of sugar
• 3 million metres of tinsel
• 5.5 million bars of Toblerone.
Source: Poundland Website

Practice questions
 1 Analyse how Poundland is able to make a profit at such a low price.
(9 marks)
2 Do you think Poundland should ever sell items for more than £1? Justify your
opinion.
(16 marks)

By being a cost leader a business can charge similar prices to its competitors and earn higher
returns or, if needed, it can reduce prices lower their competitors can and still make the same
profit margin as they do.

Handling data
A business has a very successful lean approach to its operations which means its unit
cost is £4 a unit. The industry average is £5. The business price matches its
competitors and sells at £8.
1 Calculate the profit margin of this business compared to the industry average.
2 Calculate the profit earned by this business compared to a typical business in the
industry if each sold 20 million units a year.

Differentiation strategy
A differentiation strategy occurs when a business provides some degree of uniqueness relative
to its competitors that is sufficiently valued by customers to allow a price premium to be
charged. For example, a business may offer more features or provide a higher level of customer
service than its rivals. If the higher price charged by the business exceeds the extra costs of
providing these benefits, a business can earn higher returns than its rivals.

The differences between Porter’s strategies

• Cost leadership with parity involves charging the same price as rivals but because costs are
lower the profit margin is higher.
• Cost leadership with proximity involves having a lower price than rivals but because costs are
lower it is possible to still make the same or higher profit margins than them.
• A differentiator can charge a higher price and still make a high profit margin if the additional
charge for the added benefits is more than the cost of providing them.
Figure 34.3 Porter’s strategies

Figure 34.4 Porter’s low-cost and differentiation strategies

Porter highlighted that a low-cost or differentiation strategy could be aimed at the market as a
whole or at a small part of the market (called a ‘focus’ strategy). He described the amount of the
market targeted as the competitive scope of the business – a broad scope targets the market as a
whole, whereas a narrow scope focuses on a niche.
According to Porter, a business should decide which of the generic strategies to choose (that is
cost-leadership or differentiation) and whether to target the mass market or a niche; it should
then pursue this strategy rigorously and aggressively (see Figure 34.4). A business should avoid
being ‘stuck in the middle’ where it is not clear internally or to customers what the business’s
strategy actually is. Porter argued that a business has to be low cost or differentiated; it cannot
combine the two – it has to be clear in terms of what it wants to be and how it wants to be
positioned in the market. However, some analysts disagree with this view and argue that it is
possible to keep costs low and still try to differentiate.

Handling data
The price elasticity of demand for the products of three businesses in different
industries are:
• Business A -1.2
• Business B -2.5
• Business C -0.2
Which business is likely to pursue a differentiation strategy? Why?

Business in focus: GlaxoSmithKline

GlaxoSmithKline is a leading, global pharmaceutical business. The company has

several aims:
• Being a leader in its chosen markets – By innovating and continuing to improve
its customer service it aims to generate growth opportunities.
• Building on its strong global presence – The company is an international
business but it is continuing to develop its geographical reach.
• Differentiating itself through technology – GlaxoSmithKline develops innovative
technology to maintain its competitiveness. It is responding to emerging customer
requirements.
• Developing operational excellence – The company has a culture of operational
excellence and, through continuous improvement processes, aims to deliver
exceptional quality and customer service.
• Achieving above market growth – The company believes that sustainable,
managed growth is essential to its success.

Practice questions
With reference to the above information:
1 Analyse the strategic direction(s) being pursued by GlaxoSmithKline.
(9 marks)
2 Do you think differentiation is a better way for a business to compete than cost
leadership?
(16 marks)
Bowman’s strategic clock
Another approach to strategic positioning was developed by Bowman and is known as the
strategy clock.
Bowman’s model plots the options open to a business on a ‘clock’. From this, it is possible to
analyse the strategic positioning a business has now and where it may want to be in the future.
The ‘clock’ highlights that there are many options open to a business that enable it to be
competitive. For example, a restaurant may:
• offer a fairly basic menu, self-service and limited customer service. Provided the price is low
enough, this may be regarded as good value for money and the business may be competitive
• offer a four star menu that is highly rated by food critics in a luxury hotel environment with
superb customer service from the waiters. The price may be high but if the food and service
merit this, it, again, may be seen as good value for money.
However, some combinations will not be competitive or realistic. For example:
• offering a basic service at a relatively high price is uncompetitive; customers will switch to
rivals
• offering a luxury service at a low price would be very attractive to customers, but is unlikely to
be financially viable. The business will not be able to cover the costs of the high level of
benefits provided.

Figure 34.5 Bowman’s strategic clock

Key models and theories: The Bowman strategy clock

The Bowman strategy clock enables managers to analyse their strategy in terms of
perceived benefits and their price relative to competitors. They may be able to decide
where to position their business relative to competitors to improve the chances of
success. It is therefore a useful analytical and planning tool which enables managers to
asses where their business is in market. You can do the same – it allows you to
consider whether a particular strategy is likely to be successful. A business offering
relatively low benefits compared to its rivals and yet charging more for its services is
going to struggle to compete, for example. This suggests a change in strategy is
required.

Different strategic positions highlighted by the clock include:

• differentiating without a price premium (12 o’clock) – this may be used to increase market
share
• differentiating with a price premium (1 o’clock) – this may be used to increase profit margins
• focused differentiation (2 o’clock) – this may be used for customers who demand the very
highest quality and will pay a big premium. For example, Philippe Patek watches.
• a low-price strategy (8 to 9 o’clock) – this seeks to achieve higher benefits and lower prices
relative to those of competitors
• a ‘no frills’ strategy (7 o’clock) – this approach focuses on price sensitive market segments.
For example, this is the strategy of low-cost airlines such as South West Airlines and Ryanair.
• hybrid strategies (9 to 12 o’clock) – these occur where there are relatively high benefits but
relatively low prices can be used to enter markets and build position quickly, as an aggressive
attempt to win market share or to build volume sales and gain from mass production. A classic
example of a hybrid strategy is IKEA, which offers high-quality design at a low price.

Business in focus: IKEA

IKEA aims to provide well-designed products for the home that are affordable to many
households. It aims for good quality at a low price. To achieve this:
• it designs its own products
• it uses low-cost materials
• it buys resources in large quantities to get a lower price
• it develops products that can be flat packed, making it cheaper to transport and
store them
• it designs products that customers can build themselves, again reducing costs.

Practice questions
1 Draw Bowman’s strategy clock and plot on it where you think IKEA is trying to
position itself. Do you think this is a good position?
(9 marks)
2 Analyse two reasons why IKEA might reposition itself.
(16 marks)
Unlike Porter, the strategic clock model by Bowman:
• focuses on the prices to customers rather than the costs to the organisation
• highlights the full range of options open to a business, whereas Porter’s model provides
relatively few distinct choices in terms of strategic positioning.

What do you think?

Do you think it is getting more difficult for a business to protect itself from
competitors?
Influences on a positioning strategy
The factors influencing a positioning strategy include the following:
• Where the competitors are positioned. When deciding where it wants to fit within a market a
business will naturally assess where its competitors are. In some cases, if the market segment
is big enough and a business feels strong enough, it may want to compete with its competitors
head on. In other cases, it will deliberately position itself elsewhere in the market to avoid
direct conflict.
• The external environment. External changes will influence market conditions and where
businesses need to position themselves. For example, many businesses have had to become
more environmentally conscious in their activities because that’s what customers are
demanding. When economic conditions are poor this might put pressure on businesses to move
towards offering lower prices.
• The strengths and competences of the business. The right positioning for a business will
depend on what it is able to deliver. There is no point aspiring to a differentiation strategy if
the business cannot consistently deliver higher benefits than its rivals. Similarly, to be a low-
cost leader a business must have a way of getting and keeping costs lower than rivals.
Managers must assess where their competitive advantage may lie and then pursue this
positioning fully.
Positioning strategy over time
The strategy chosen by the business is not fixed and may well change over time. In recent years,
for example, easyJet has increased the benefits it provides as it has tried to target business
customers to a greater extent. Seeing the success of this repositioning, Ryanair has recently
followed suit. Meanwhile, the supermarket Morrisons announced in recent years that it was
slashing product prices to compete with the discounters such as Aldi and Lidl, and so was trying
to reposition itself in terms of its price benefit positioning.

Business in focus: Iceland

Figure 34.6 Iceland – a market leader in frozen foods

The British food retailer Iceland Foods has over 900 stores across the UK and a
further 40 owned or franchised in Europe, as well as a global export business. It has
traditionally focused on frozen food but also sells non-frozen grocery items such as
fruit and vegetables, dairy, meat and dry goods. Iceland has an approximate 2.2%
share of the UK food market.
Iceland states that its strategy aims to leverage its established strengths to achieve
long-term profitable growth for the benefit of its shareholders, colleagues, charities
and the communities in which it operates. The strategy primarily focuses on frozen
food, innovation, convenience and value.
• Frozen food: Iceland is the UK’s leading specialist retailer in this category and
sees this as a key point of difference. Its ‘Power of Frozen’ marketing campaign
aims to steadily improve consumer perceptions of frozen food.
The company argues that freezing food is a natural process that seals in freshness
and retains vitamins and minerals that may otherwise be lost during the harvesting,
transport and storage. Freezing does not usually require the use of preservatives
either.
• Innovation: Iceland places a high degree of importance on innovation and works
 closely with suppliers to develop new products that cannot be bought anywhere
else. The products and their ingredients are assessed and reviewed in Iceland’s
own test kitchens.
In 2018, Iceland won both the Champion of Champion award and the Innovative
Product of the Year award at The Grocer’s Own Label Awards.
• Convenience: Iceland aims to offer easy-to-shop local stores as well as a
competitive online shopping service. It won the award for online supermarket of the
year in 2017. It also offers free home delivery of in-store purchases over £20.
• Value: Iceland’s independent benchmarking team regularly assess its products
according to a range of criteria to ensure that its standards are being maintained.
The company’s own-brand products are benchmarked against those of the UK’s
major supermarkets to ensure that they offer either the same quality at a
significantly lower price or better quality at a matching price.
Iceland has also been a market leader in its response to ethical and environmental
concerns. In 1998, it was the first national food retailer to ban genetically modified
ingredients from its own-brand products.
In 2018, Iceland announced the decision to remove palm oil from all of its own-brand
products to ‘demonstrate to the food industry that it is possible to reduce the demand
for palm oil while seeking solutions that do not destroy the world’s rainforests’. It will
use alternatives including sunflower oil, rapeseed oil and butter.

Practice questions
1 Using Bowman’s model, analyse the strategic positioning adopted by Iceland.
(9 marks)
2 To what extent does the strategic positioning of a business determine its success?
(16 marks)

What do you think?

Do you think businesses have to change their strategies more often now than they did
in the past?
Why does strategic positioning matter?
Choosing the right arena in which to compete is obviously important. If a business has the wrong
products and is in the wrong market, it will find it difficult to do well. However, a business also
needs to consider where it fits in the market relative to others. Does it want to be Swatch or Tag
Heuer? Apple or ASUS? Sky or BT Sport? It is important to have a clear position in the eyes of
consumers so they can place the business relative to others in the market and know where it
‘fits’.
It is also important to have the right positioning for market conditions. If a business is moving
upmarket and offering more premium products when customers want more basic items, for
example, this would be poor strategic positioning.

Business in focus: Netflix

Figure 34.7 Netflix, Inc. is an American provider of on-demand internet streaming media available
across much of the world

Netflix is the world’s largest internet entertainment business. It has over 130 million
subscription members in over 190 countries. It provides a streaming service where
customers can watch a variety of programmes including films, documentaries,
comedies and TV series in a range of languages. Once you are a member of Netflix,
you can watch any time anywhere that you can get online. You can start watching
something, pause, resume, start from the beginning or switch to something else. This
gives the user tremendous flexibility. You can watch what you want, when you want,
where you want, with whom you want!
Netflix can track your viewing habits and is able to recommend suitable programmes
for you so you can find what you want to watch very easily. The content it shows is
from many different production sources and it bids against other distributors such as
cable companies and broadcast networks. Increasingly, its content is being produced
internally. Since 2013, Netflix has been large enough to produce its own programmes
and it has done so extremely successfully.
The traditional television networks have to decide exactly when people might want to
watch a programme. They have to allocate a specific slot in their schedules. Typically,
they will commission a pilot episode and if this is successful, they may commission a
whole series. This might be, for example, 8 episodes of one hour length. These
episodes would be watched every week for 8 weeks at a fixed time. Each episode has
to begin with a recap of the last one. At Netflix, they can produce a series which can
be watched when people want to watch it. There are no constrains about when the
 programme is shown – you can watch all the episodes in one go if you like.
Shows can also stay on the playlist as long as Netflix wants them, so even if it is not
an immediate success, the company has time to promote it in different ways and see
if it takes off at some point. People may come new to a programme long after others
have already seen it. There is also no reason why the length of each episode has to
be the same. This gives Netflix much greater flexibility than the more traditional
broadcasters such as the BBC or ITV. This appeals to those developing the shows
and allows Netflix to attract some of the best creatives in the industry.
Practice questions
1 Analyse why Netflix has chosen to position itself as an on-demand media
streaming business.
(9 marks)
2 To what extent do you think that content is the key to the success of Netflix’s
strategy?
(16 marks)

This means that over time, businesses may want to reposition themselves as internal and external
conditions change. Repositioning can take some time; for example, Skoda has been trying hard
for many years to reposition itself away from the perception of it as being a cheap but very basic
brand. Waitrose in recent years has been trying to convince customers it is not as expensive as
they think it is.
Sustainable competitive advantage
Competitive advantage occurs when a business creates value for its customers that is both greater
than the costs of supplying the benefits it offers and is superior to that of other businesses. For
example, a competitive advantage may be due to offering similar benefits to rivals at lower
prices (a low-cost strategy) or higher benefits at a similar price (a differentiation strategy).
However, if one business has an advantage over others, these rivals will naturally want to copy
it, thereby removing the advantage. A business will, therefore, want to develop a sustainable
competitive advantage, that is one that it can protect over time.
The ways in which a business might protect its competitive advantage include the following:
• Legal protection such as laws by the government that protect a business or industry from
foreign competition, or patents which give legal protection to new inventions for a given
number of years.
• Control over resources, perhaps through ownership of different stages of the supply chain; if a
business controls some resources, it may be able to prevent others accessing them. For
example, de Beers controls a significant proportion of the supply of diamonds in the world.
• A particular culture. The culture of a business refers to the values and attitudes of its
employees – the way they think and how they behave. Culture is difficult to suddenly copy
because it relies on what people actually believe and is influenced by a whole host of factors,
including the experience of its members and the history of the business. Unlike a new piece of
equipment, culture cannot simply be bought and installed; it has to grow over time and be
incorporated into the way people think and operate. For example, when one business buys
another creative business such as an app design company, an advertising agency or a
management consultancy it is paying for the culture and the skills and talents of the staff – it is
the abilities of the employees, the way they think and the way they work together that create a
competitive advantage for the company.
Sources of sustainable competitive advantage
According to the writer John Kay there are three main sources of sustainable competitive
advantage:
1. Innovation. Although in reality much innovation can be imitated, in some cases a business
can protect its developments with a patent, or the process may be so secret that it can protect it
from others.
2. Architecture. Kay uses this term to describe the relationships with suppliers and customers.
These relationships may have been built up over time and it may not be easy for others to
replicate them. Good architecture provides good information and a good understanding of
suppliers and customers and their needs.
3. Reputation. In one sense this is part of architecture, but Kay thinks it is so important that he
says it should be listed separately. Reputation takes time to build and cannot easily be copied,
so if it is looked after and protected it can be a sustainable advantage. A good reputation
opens doors, makes customers willing to listen and try your products and adds value to the
product or service.

Business in focus: Halfords’ strategy

Figure 34.8 Halfords is a household name across the UK.

Strategy
Our strategy is based upon our desire to maximise returns for our shareholders. Each
of our business units is tasked to deliver against an overall business plan and is
focused on delivering our strategy.
For more than 125 years, Halfords has been synonymous with travel.
Today our vision is clear – to be first choice for customers’ life on the move. We will
achieve this by being Committed to Making Customers’ Journeys Better.
We are the UK’s leading retailer of motoring and cycling products and a leading
independent operator in garage servicing and auto repair.
Many of our brands and product categories hold number one sales positions;
however, there are clear opportunities to grow market share segments within key
segments.
Our strategy is named Moving Up A Gear and has five key pillars:
1 Putting Customers in the Driving Seat – investing in customer data and insight
capabilities to maximise the lifetime customer value.
2 Service in our DNA – embedding the focus on customer service.
3 Building on our Uniqueness – exclusive products, relevant innovation and unique
partnerships, such as our new collaboration with British Olympian and Tour de
France winner Sir Bradley Wiggins.
4 Better Shopping Experience – a seamless customer experience, online as well as
in store.
5 Fit for the Future Infrastructure – moving from fixing the basics to improving
efficiency and fulfilment.
To protect our shareholder interests we will:
• maintain our leading retail positions and take market share within key segments
• source the best products and launch exclusive ranges
• provide well-trained, friendly and knowledgeable service expertise
• provide real value solutions
• leverage our core capabilities in the retail sector
• increase multi-channel penetration
• maintain an efficient balance sheet across the financing cycle.
Source: Halford’s website
Figure 34.9 Halfords strategy: Moving Up A Gear

Practice questions
1 Analyse the factors that might have made Halfords compete in the markets
identified in the text.
(9 marks)
2 To what extent does Halford’s strategy of increasing returns to shareholders mean
customers must be worse off?
(16 marks)

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 What is meant by ‘strategic positioning’?
2 Explain what is meant by Porter’s ‘low-cost strategy’.
3 Explain one factor that might enable a business to pursue a low-cost strategy
effectively.
4 Explain what is meant by Porter’s ‘differentiation strategy’.
5 Explain one way in which a business might pursue a differentiation strategy
effectively.
6 Is a differentiation strategy likely to involve a high or low price? Explain your
answer.
7 What is meant by a ‘sustainable competitive advantage’?
8 State what is on the axes of Bowman’s strategy clock.
9 Is offering low benefits at a high price likely to be a competitive strategy? Explain
your answer.
10 Explain one way a business might try to ensure its competitive advantage is
sustainable.
(b) Short answer questions
1 Explain one reason why a hotel chain might pursue a differentiation strategy.
(5 marks)
2 Explain one reason why a budget airline such as Ryanair has pursued a low-cost
strategy.
(5 marks)
3 Explain one reason why having a clear strategic direction can be important for a
business operating in many different countries.
(5 marks)
4 Explain the factors that might influence the strategic positioning of a new web
design business.
(5 marks)
5 Explain one reason why the strategic positioning of a health and fitness chain may
need to be reviewed and changed.
(5 marks)

(c) Data response question

Morrisons

Figure 34.9 A Morrisons local store

In recent years, the supermarket Morrisons announced dramatic price cuts to try and
revive its fortunes. The company’s Chief Executive, Dalton Phillips, announced that
the business would be restructured and streamlined to reduce costs by £1 billion.
Restructuring involved many job losses and the removal of layers of management.
These cost cuts would be spent over three years on lower prices, developing a loyalty
scheme and improving its own-brand goods. On average, its price would be 17 per
cent lower. These were permanent price cuts not price promotions. The strategy was
to re-establish the company as a ‘value-led grocer with a passion for food’. Mr Phillips
compares the shift in the UK grocery market to the changes seen in the airline
industry, when new disruptive players – the budget airlines – arrived. According to
Phillips, the changes in the groceries industry were permanent and would not be
reversed, this was a new price norm. On its website, Morrisons is also introducing a
new feature so customers can compare prices easily.
Morrisons’ profit performance has been poor in recent years. It has been very slow to
provide a loyalty card and to go online. Morrisons only started deliveries through
online grocer Ocado in January 2015, having signed a £200 million 25-year deal last
year. This service covers only 20 per cent of UK households. The company has also
been slow to recognise the move by customers from big out-of-town stores to local
convenience stores. It opened 90 last year and plans 100 new ones in 2015. (By
comparison, Tesco has around 1,700 convenience stores in the UK.)
Several commentators felt that Phillips’ plan was too late and flawed – for example,
with convenience stores having been opened in the wrong locations. Ken Morrison,
the previous owner and Chief Executive, compared Phillips’ strategy to the manure
produced by his cattle!

Questions
1 Explain the factors that might have influenced the price paid to Ocado to deliver
Morrisons products online.
(5 marks)
2 Analyse the factors influencing Morrisons’ decision to cut prices so significantly.
(9 marks)
3 To what extent do you think clear positioning is the key to success in the UK
supermarket industry?
(16 marks)

(d) Essays
1 To what extent is differentiation the best strategic position for a start-up business to
adopt? Justify your answer.
(25 marks)
2 To what extent is a low-cost strategic position a better one for a food retailer to
adopt than differentiation? Justify your answer.
(25 marks)
Revision Section: Unit 8 Choosing
strategic direction
Advice for Unit 8
Top tips … Things to avoid
…
Remember that a strategy is the product of its internal and Do not assume
external environment. As these factors change the strategy changing a
will need to adapt. The right strategy and strategic positioning strategy is easy
will help the business build on its strengths, protect its or quick – it
weaknesses, defend against threats and exploit opportunities. usually isn’t.
Assess a strategy in terms of its sustainability. How can a Do not forget the
business protect its strategy from competition? What does it implications of a
have that is not easy to imitate? change in
strategy for the
different
functional
areas.
When assessing the likely success of a strategy it could be Do not forget
helpful to think about how well the strategy is planned, how it some people
will be implemented and the extent to which it fits with the may resist
strengths of the business. change.
Apply the Ansoff matrix – it is a very useful framework for Do not forget
analysing and evaluating the strategy of a business. It makes competitors can
it possible to consider the specific issues of any given strategy change their
relating to products and markets and compare and contrast strategy too.
this with alternative strategies.
Remember that when you are assessing a strategy you need
to be clear what it is trying to achieve and over what time
period. Is it focused on sales, profits or on improving society?
You can only judge the success of a strategy if you know what
it is trying to achieve.
UNIT 8 CHECKLIST
Having completed studying this unit you should be able to do all that is listed below.
You should read this list and confirm that this is the case.
Learning objective
Strategic direction: choosing which markets to compete in and what products
to offer
Know and understand:
• the factors influencing which markets to compete in and which products to offer
• the reasons for choosing and value of different options for strategic direction
• the strategic direction to include the Ansoff matrix and value of market penetration,
market development, new product development and diversification.
Strategic positioning: choosing how to compete
Know and understand:
• how to compete in terms of benefits and price
• the influences on the choice of a positioning strategy
• the value of different strategic positioning strategies
• the benefits of having a competitive advantage
• the difficulties of maintaining a competitive advantage
• that strategic positioning includes Porter’s low cost, differentiation and focus
strategies and Bowman’s strategic clock.
Practice questions
1 Explain one reason a business that has been focused entirely on the UK market
might choose a strategy of market development.
(4 marks)
2 Explain one reason why the senior managers of a plc might worry about proposing
a diversification strategy to the directors.
(5 marks)
3 Explain one way that Bowman’s strategic clock might help a European hotel
business enter the UK market.
(5 marks)
4 A clothing business has achieved a competitive advantage over it rivals due to its
outstanding designs. Explain two possible problems of maintaining this advantage
over time.
(6 marks)
5 Analyse the challenges a business might face moving from a differentiation strategy
to a low cost strategy.
(9 marks)
Case study: Tesco – choosing strategic
direction
Despite having around 30 per cent market share, the food retailer, Tesco, has faced
major competition in recent years from the discount stores such as Aldi and Lidl.
These discounters have been taking sales away from the more established
businesses such as Tesco, Sainsbury and Waitrose. Aldi and Lidl originally started to
gain market share noticeably when the UK economy was in decline after the global
economic crisis in 2008 and 2009. At the time it, was felt customers were switching to
low price products because their incomes were lower and there was a general lack of
confidence about jobs. However, even though the economy has grown and
employment is high the trend towards discount stores has continued. The discounters
remain much smaller in terms of market share than Tesco but are clearly still gaining
popularity with shoppers. Tesco has also suffered because of the move away from big
stores. Shoppers increasingly do their big weekly shops online and use local, smaller
supermarkets in the week for their ‘top-up shops’. Tesco was relatively slow to
respond to this change in shopping habits but is now focusing on smaller, convenient
Tesco stores.
Tesco has also introduced cost cutting measures – in particular, it has looked to make
the business more efficient and to reduce the number of employees it needs relative
to its sales. Tesco has also launched its own discount chain called Jack’s. Jack’s is
intended to offer even lower prices than the existing discounters.
Like Aldi and Lidl, Jack’s stores will focus on selling large volumes of a limited number
of products – around 2,600 product lines compared to around 35,000 in a typical
Tesco store. The initial plan is to open around 10 to15 Jack stores, compared to over
1,300 Aldi stores.
The Chief Executive of Jack’s will be a former Aldi senior manager.
Source: Adapted from BBC article, September 2018 ‘Tesco’s new discount chain Jack’s takes on Aldi
and Lidl’
Practice questions
1 Analyse why Tesco would have undertaken market research before launching
Jack’s.
(12 marks)
2 Analyse the possible reasons why Tesco’s chose to launch a discount chain.
(12 marks)
3 To what extent do you think changes in the supermarket industry threaten the
survival of Tesco?
(16 marks)
4 To what extent do you think that launching a discount business is a risky strategy
for Tesco?
(16 marks)
5 To what extent do you think Tesco should be made to reduce its market share by
the government?
(20 marks)
6 To what extent do you think discounting is a good strategy for all businesses?
(24 marks)
Essay questions
1 To what extent is market penetration a better strategy than market development for
a business seeking to grow?
(25 marks)
2 To what extent is it inevitable that the competitive advantage of any technology
business will eventually be lost to rival companies?
(25 marks)
Chapter 35 Assessing a change in scale
Introduction
In the last chapter, we considered how a business chooses its strategic positioning within a
market. In this chapter we begin to examine the strategic methods a business may use to achieve
its objectives; we focus on changing scale (that is growing or shrinking). We look at why a
business might want to grow or shrink and the benefits and problems this can cause. We also
discuss the different ways in which businesses can grow, such as by taking over a competitor or
franchising its business, and we examine the cases for and against these growth methods.
What it is important to know by the end of this chapter:
• how to analyse the reasons why businesses might grow or retrench
• the different types of growth including organic and external growth
• how to manage and overcome the problems of growth or retrenchment and how to analyse the
issues with growth including: economies of scale, economies of scope, diseconomies of scale,
the experience curve, synergy and overtrading
• how to analyse the issues with managing growth, including Greiner’s model of growth
• that methods of growth include mergers, takeovers, ventures and franchising
• types of growth, including vertical (backward and forward), horizontal and conglomerate
integration
• how to analyse the impact of growth or retrenchment on the functional areas of a business
• how to assess methods and types of growth.

Figure 35.1 Strategic methods

Strategic methods
Strategic methods refer to the different strategies a business might pursue to achieve its
objectives. Having chosen which products to offer and which markets to operate in, the business
must consider options such as whether or not to:
• grow and, if so, how
• go international and, if so, where
• innovate
• go digital.

Key term
Strategic methods refer to the different strategies a business might pursue to
achieve its objectives.

In this section we focus on changing scale as a strategic method.

Changing scale
A business may increase its scale by growing – this is a common business objective. It shows
that the managers are moving the business forward and that it is being more successful in terms
of sales.
Growth can be seen as important because it:
• shows progress; this can be good for managers in terms of their own careers and in terms of
showing shareholders why they are valuable. It can also provide a sense of achievement
(Maslow’s self-actualisation needs)
• can create financial benefits such as higher revenues and lower unit costs
• creates momentum which can be important – for example, it means there are new opportunities
for employees which can help keep them focused and engaged. People feel part of something
that ‘works’ and that is growing rather than shrinking. This can help staff retention rates and
attract the best employees
• brings benefits such as more market power and lower costs due to greater bargaining power.

Business in focus: It’s all about the long term

In 1997, the Chief Executive of Amazon wrote to its shareholders setting out its vision
of the future. It continues to send a copy of this letter to investors in every annual
report to show it remains true to its core values. In the letter the managers state that
they are committed to creating shareholder value over the long term. To do this they
believe it is essential to have market leadership. Dominating a market means, they
say, higher revenues, higher profits and stronger returns on capital. The most
important measure of success at Amazon, therefore, is the extent to which there is
revenue and customer growth. Everything else is thought to flow from this.
To achieve this growth the company invests heavily to build its customer base, its
brand and its infrastructure. It says that because it focuses on the long term, it may
make different decisions to other companies.
By 2018 Amazon’s product range included:
• Amazon Prime with over 100 million members
• Amazon Marketplace which has over 300,000 small businesses a year joining to
sell their products
• Alexa – a voice activated device that now allows customers to control more than
4,000 smart home devices as well as access information and music
• Amazon devices such as Echo devices, Fire TV sticks and Kindles for books
• Prime Video
• Amazon Music
• Amazon Whole Foods, offering high quality, natural and organic foods
• Amazon Go – a new kind of store with no checkout required.
 Via its website, Amazon says that ‘The credit for these milestones is deserved by
many. Amazon is 560,000 employees. It’s also 2 million sellers, hundreds of
thousands of authors, millions of programme developers, and hundreds of millions of
divinely discontent customers around the world who push to make us better each and
every day.’
Source: Amazon

Practice questions
1 Analyse why growth is important to Amazon.
(9 marks)
2 To what extent do you think the size of Amazon is a good thing for stakeholders?
(16 marks)

Forms of growth
If a business does decide to expand then this growth may be:
• Organic. This occurs when a business grows through expanding its own operations; for
example, it sells more of its existing products or launches new products for its customers.
• External. This involves growth by joining with other businesses; for example, one business
may gain a controlling share of another organisation. This is called a takeover. The owners of
company A gain ownership of the majority of the shares of company B and now control it.
They may do this by buying the shares with money (this is called a cash offer) or by offering
shares in their own business in return for the shares in the target business (this is called a
‘paper offer’). Alternatively, one business may join with another, which is called a merger. In
a merger the owners of company A and company B become joint owners of a new
organisation.
Many of the big companies continue to grow by adding on new businesses through mergers
and takeovers. General Electric, Google and Intel have between them bought more than 500
firms in the past five years.
External growth leads to an immediate jump in the scale of a business; once the deal is
completed the old business has a new business as part of it and is immediately bigger – this
means a sudden increase in its size. Organic growth will tend to be slower as a business
gradually increases the scale of its operations. There are examples of businesses that do grow
organically very quickly – for example, in the technology world where one idea can rapidly gain
sales (think Facebook and Google which are still relatively young). However, organic growth
does not usually involve the same sudden change in scale that happens when one business joins
another. External growth, in particular, will bring the problems of coping with a quick increase in
the number of employees and the scale of operations, although rapid growth of any form brings
with it management challenges.
Figure 35.2 Forms of growth

External growth will also encounter problems of bringing together organisations that may have
their own ways of doing things and their own priorities. This can bring benefits in that decisions
may be approached in new ways, but it can also lead to clashes because of different styles and
priorities and different ways of doing things. This is known as a culture clash and has led to poor
performance in a number of big mergers or takeovers such as Aol Time Warner, Daimler
Chrysler and News Corporation and My Space. Different styles of management, different
priorities, different ways of rewarding and motivating staff can all lead to disagreements that
prevent the organisation from functioning effectively. In the case of News Corporation and My
Space, for example, a big corporate business with strategic plans, budgets, committees and clear
financial targets (News Corporation) met an organisation that was less formal, more interested in
creativity than the financials and younger in outlook and approach (My Space). With Chrysler
the focus was on volume, whereas Daimler wanted quality and so disagreements followed!
Imagine if your school joined together with one down the road; think what might happen …
Internal growth External growth
Tends to be slower Sudden change in scale
May be easier to manage There may be clashes in the way organisations operate
Table 35.1 A comparison of internal and external growth

Figure 35.3 Speed of growth

Economies of scale
If a business is pursuing growth, this may be because of economies of scale. Economies of scale
occur when the unit costs fall as the scale of operations increases. These economies can occur
due to:
• Purchasing economies. As a business gets bigger it will purchase more supplies. This gives it
more bargaining power over suppliers. Suppliers become dependent on the business and may
be willing to reduce their prices to keep the orders. In recent years, for example, the big
supermarkets have been accused of pushing the price they pay to farmers for milk below the
actual cost of producing it.
• Technological economies. These occur when a large scale of operations enables particular
technologies to be used efficiently. For example, imagine a small farm has to have various
pieces of equipment, such as a tractor and harvesting equipment. Given the size of the business
this expensive equipment may not be used very often and, therefore, it is inefficient. If the
farm expands, then, up to a point, it can continue with only one of each piece of equipment
which can then be used more fully. The costs of the tractor, for example, can now be spread
over several crops and this becomes more efficient, reducing the unit cost. Similarly, think of a
production line for an industry such as car manufacturing. If only one car was produced, this
would be incredibly expensive, but if the production line costs can be spread over many
thousands of cars the unit cost falls. This is why car companies are so eager to ensure demand
is high. The same is true of bottling plants, telecommunications companies, energy businesses,
all of which have very high fixed costs.

Business in focus: Twitter

Twitter, the social networking business, was created in March 2006 by Jack Dorsey,
Evan Williams, Biz Stone and Noah Glass. It was launched in July 2006 when Jack
Dorsey sent the first tweet. Twitter says that its mission is ‘to give everyone the power
to create and share ideas and information instantly without barriers’.
 Figure 35.4 Number of monthly active Twitter users worldwide 2010–18

Source: © Statista 2019

Practice questions
1 Analyse why Twitter has been able to grow so quickly.
(9 marks)
2 Do you think Twitter will continue to grow so quickly? Justify your answer.
(16 marks)

Figure 35.5 A bottling plant will produce thousands of bottles per day.

• Financial economies. As a business gets bigger it has more assets and this may mean a bank is
willing to lend to it at lower interest rates as the risk is lower. (If the company fails to repay,
the bank can seize the assets.) This reduces interest costs.
• Managerial economies. As a business expands it may bring in specialists to focus on parts of
the business. For example, an expanding business may create a specialist HR department
which is probably not cost effective in a small business. This expertise may enable better
decision making in the larger company, which can increase efficiency and reduce unit costs.

Figure 35.6 Types of economies of scale

Business in focus: Travelodge

The budget hotel chain Travelodge opened its first property in Staffordshire in 1985. It
is now the UK’s second largest independent hotel brand (behind Premier Inn) with
575 hotels and more than 43,000 guest bedrooms across the UK. It also operates a
small number of hotels in Ireland and Spain.
Travelodge welcomes approximately 18 million guests every year and employs
around 11,000 people.
Originally a roadside chain, Travelodge hotels are now usually located in the centre of
major cities, as well as in popular tourist and leisure destinations and close to major
transport hubs, such as airports. It is primarily a low-cost operator that aims to offer
clean, modern guest rooms to both business and leisure customers at unbeatable
value.
A £100 million modernisation programme was completed at the end of 2015. Around
35,000 rooms were upgraded to give them a more contemporary look, and new king-
size beds and separate pull-out beds for children were installed. More than 170 of its
hotels have an onsite restaurant.
The company continues to expand, opening 17 new locations in 2018 including its
first purpose-built property in London. It aims to add 100 more properties to its list by
2024.

Practice questions
1 Analyse the factors that might influence Travelodge’s choice of strategy.
(9 marks)
2 To what extent do you think Travelodge’s strategy of further growth is a good one?
(16 marks)
Figure 35.7 The benefits of growth

Figure 35.8 Procter & Gamble products

Businesses may also benefit when they expand in scale from:

• Economies of scope. Whereas economies of scale refers to unit costs falling when more of one
product is produced, economies of scope are cost savings from operating in several markets or
providing several products. For example, when the brand Cadbury is promoted the cost of
advertising can be spread over several different products such as Dairy Milk, Crunchie, Star
Bar and Double Decker, whereas a small producer may have to absorb all the costs within one
brand, thereby increasing its unit cost. Similarly, the management costs of a company such as
Procter & Gamble, which produces many different products, can be divided between these
different products as can other head office costs such as the legal department and the HR
department. When Procter & Gamble distributes many different products to supermarkets the
transportation costs can be spread over a range of its brands such as Head & Shoulders,
Duracell and Gillette; again, as the scope of the firm’s operations have increased this can
reduce some unit costs. Economies of scope, therefore, relate to cost savings from increasing
the scope of the activities (that is the number of products offered) rather than just the scale.

Key term
Economies of scale occur when unit costs fall as a business expands; these
 economies relate to the volume of output.

• The experience curve. As businesses grows and operates on a larger scale, employees gain
experience. Their managers become more familiar with what needs doing when, who to ask to
do what, where to get supplies from, how to fix problems and how to deal with particular
issues. This makes decision making faster and better. Any business starting up and operating
on a smaller scale may lack this experience and, therefore, make more mistakes and be less
efficient. The advantage of experience held by established firms is a major barrier to entry – it
makes it difficult for new firms to enter markets because their initial unit costs will be so much
higher. This is one reason why external growth is appealing – it enables a business to enter a
market segment buying the expertise and experience of a business that already exists without
having to take the time and energy to recreate it. According to the Boston Consulting Group
(BCG) (who developed the Boston Matrix), the experience effect is a very significant
influence on unit costs.

Key terms
Economies of scope occur when a business gains cost advantages by sharing costs
between different products and divisions; these economies relate to the scope of the
activities of the business.
The experience effect is the cost advantages that occur when operating within an
industry on a large scale and, therefore, being able to make better decisions

• Synergy. Synergy occurs when you put two businesses together and as a combined unit they
perform better than they did as individual parts. Sometimes synergy is described as 2 + 2 = 5.
For example, imagine you put together a company that has a strong design team with another
business that has generated high levels of funds from its existing products but is struggling to
find new areas to invest it; together, they work better than they did individually.

What do you think?

Do you think the desired growth of a business is likely to be driven by managers’ own
desire to achieve something for themselves?

Figure 35.9 Potential problems of growth

Problems of growth
Whilst there are potential benefits from operating on a larger scale, a business may be concerned
about expanding too much because of diseconomies of scale. Diseconomies of scale occur when
the cost per unit increases as the business increases its size.

Figure 35.10 Diseconomies of scale

Diseconomies of scale can occur due to:

• Communication problems. As a business grows it is likely to start operating in a range of
markets, possibly all over the world, and it may have several divisions within the overall
business. This means communication can become more complex. Growth can, therefore, lead
to inefficiency through slower decision making and poor decisions being made.
• Control and coordination problems. With more employees, more products, more decisions
being made and more communication flows, controlling who does what and monitoring the
quality of the work can become more difficult. Equally, coordinating activities so that people
feel informed and understand how they are doing and what they need to do when can become
more challenging. There is a greater chance that mistakes are made and problems occur,
thereby increasing unit costs.
• Motivation issues. As a business grows it may be that employees lose contact with the senior
managers and the overall vision of the business. They may feel they are not very significant to
the success of the business as a whole and this may lead to demotivation. In terms of Maslow’s
hierarchy of needs theory, employees may not feel noticed so their ego needs are not met.
Poorly motivated staff may reduce productivity and lead to more mistakes and higher costs.

Business in focus: Takeda growth In

In 2018, the Japanese pharmaceutical company Takeda announced a £46 billion

takeover of another pharmaceuticals business called Shire. The deal was approved
by both sets of shareholders. The acquisition will make Takeda one of the world’s top
10 list of biggest pharmaceutical companies. The takeover is part of Takeda’s
strategy to become a global pharmaceutical company. It wanted to buy Shire to
strengthen its cancer, stomach and brain drug portfolios.
Shire was founded in the UK but moved its corporate headquarters to Dublin a
decade ago. It has 24,000 employees in 65 countries.

Practice questions
 1 Analyse the possible synergies Takeda might experience from joining with Shire.
(9 marks)
2 To what extent do you think the combined business is likely to be more profitable
than the individual ones?
(16 marks)

Of course, the extent to which diseconomies of scale might occur depend on the extent and speed
of growth. It also depends on how well managed the business is and what systems are in place to
maintain control and communication. For example, the use of budgets, appraisals, target setting
and a clear mission statement and set of values can potentially help to avoid some of the
problems of diseconomies of scale.
Another problem of growth can be cash flow problems during the growth phase. This is caused
by overtrading. Imagine a coffee shop business has set itself the target of rapid growth and, as a
result, is opening new stores regularly. For example, imagine it opens one store in the first
month, two in the second month, three in the third, and so on. The business is growing ever faster
but this requires ever increasing spending to buy the land, train the staff, get the equipment,
promote the new store, and so on. The number of stores is growing exponentially but so is the
flow of cash out of the business. There is a danger, therefore, of a liquidity crisis as the business
runs out of cash. The answer is to manage the growth effectively and ensure that expansion is not
too rapid; this will involve effective budgeting and cash flow management. For example, if the
business opened a few stores then waited for these to establish themselves and payback before
expanding further, then the financial position could remain healthy. However, sometimes there is
a pressure to build quickly on success and expand rapidly perhaps to establish the brand or enter
markets before competitors.

Key terms
Diseconomies of scale occur when unit costs increase as a business expands.
Overtrading occurs when there are liquidity problems linked to the financing of rapid
growth.

Figure 35.11 Overtrading

Managing growth
A growing business will bring with it many organisational issues relating to management, such
as coordination and communication. These are highlighted in Greiner’s model of growth in
Figure 35.12. The model considers the challenges a business is likely to encounter as it gets
bigger and older. On the horizontal axis is the age of the business and on the vertical axis is the
size. As we move along the line the business is increasing in size and age.
In Phase 1 of Greiner’s model of growth, ‘growth through creativity’, the business is just starting
out. This means there are likely to be relatively few employees involved and the approach is
likely to be fairly informal. There may not be many clear rules and procedures. Job descriptions
may be fairly broad and people will tend to help out as and when needed.
At some point, if the business grows, this approach may cause problems – there may be overlap
as individuals end up duplicating the tasks they do; other jobs may not be undertaken as it is
assumed someone else is doing them. At this point, there may be a ‘leadership crisis’ and a need
for clearer direction. The business may benefit from bringing in professional managers and from
defining jobs, roles and the organisational structure more formally. This can provide ‘growth
through direction’ (Phase 2).
This new approach can lead the business forward as it continues to grow and get older. However,
at some point, with more products, more employees and with the business operating in more
markets, there may be pressure from some managers of the various divisions for more
independence. There may be a need to respond to local market conditions and, therefore, for
more decentralisation. There is a desire for more autonomy (independence); there may be an
‘autonomy crisis’.

Figure 35.12 Greiner’s model of growth

Key models and theories: Greiner

Greiner’s model highlights some of the stages that businesses typically go through as
they grow and get older. For example, at various times in the growth a business may
need more or less centralised control. Businesses will constantly face challenges
finding ways to keep the different parts of the organisation working together, whilst not
over-controlling and removing flexibility and sensitivity to local conditions. Solving
particular challenges may create different problems as the business continues to grow.
By studying Greiner, managers can anticipate and plan for some of the crises that they
are likely to experience.

In this situation managers may create more self-running units; for example, they may create
separate profit centres that are more self-governing and take more control for their own
operations and performance. Again, this may aid and help growth for a period as the business
gets older and bigger. This would be ‘growth through delegation’ (Phase 3).
If growth continues, the next crisis point is likely to be one of control. There may come a point
when senior managers at the top of the organisation feel they do not control these semi-
independent units sufficiently, and that perhaps the business as a whole is losing shape and
direction. There may be a ‘crisis of control’.
At this stage, the senior managers may decide they need to ensure there is overall control by
establishing systems such as budgets to provide targets and monitor the processes in place. This
is Phase 4, ‘growth through coordination’. This can enable further growth and balance the need
for autonomy with the need for control as well. However, the danger is that with continued
growth the centralised system put in place to keep control may become burdensome and
bureaucratic – it can lead to time-consuming paperwork and slow up effective decision making
because key decisions have to be approved by head office. This can cause a ‘crisis of red tape’
(red tape refers to too much paperwork and form filling).
After this, with further growth, the business will try to develop processes that encourage
collaboration between the different parts of the business without too much central regulation
(Phase 5). For example, senior managers may move around the business, individuals may
experience centralised training to instil core values but then be given high levels of
independence. Reward systems may focus more on collaboration, sharing and teamwork, with
the sharing of information between senior managers in all parts of the organisation being
encouraged.
However, continued growth may lead to a growth crisis which means that it is difficult to grow
further internally and maintain appropriate levels of control. To avoid the difficulties of internal
growth, the business may decide at this stage to pursue external growth through alliances or
takeovers and mergers (Phase 6). Greiner called this an ‘extra organisational solution’ to the
difficulties of internal growth, although alliances, venture and takeovers all bring new problems
with them.
What Greiner’s model highlights is the ongoing push and pull of different forces as organisations
grow. There is a desire that different parts of the business have the freedom to act independently
and respond to local conditions. At the same time there is pressure to unify and standardise.
Businesses are continually shifting backwards and forwards with different systems and structure
to balance these forces and find the right approach given the size and maturity of the
organisation. The solution to a given problem may, however, generate problems of its own. Of
course, a business may move at different speeds through the stages, may skip some stages and
may revisit some stages, but the model still has value as it highlights some key issues in
organisational growth.

Business in focus: Spotify

Spotify enables people to find the music they want, when they want it and where they
want it. They can listen on their phone, on their tablet and on their computer. There
are millions of music tracks on Spotify. The business has been growing extraordinarily
fast. The company was set up in 2006 by Daniel Ek, a serial entrepreneur and
technologist who started his first company in 1997 at the age of 14, together with
Martin Lorentzon.
By 2018, the company had 180 million active users and 83 million paying subscribers.
It offers over 35 million music tracks. It is available in 65 markets. The company
floated on the Stock Exchange in 2017 and ended its first day of having its shares
traded with a market value of $27bn despite never having made a profit.
Source: The Guardian 2018, ‘Spotify beats expectations by reaching 83m subscribers’

Practice questions
1 Explain one reason for Spotify’s growth.
(5 marks)
2 To what extent do you think Spotify will inevitably face further challenges if it
continues to grow.
(16 marks)
Methods and types of growth

Figure 35.13 Methods of growth

There are several different methods of growth that a business can adopt. We will look at mergers,
takeovers, joint ventures and franchising in turn.
Merger
A merger occurs when the owners of two or more businesses become owners of a new shared
organisation. Companies such as GlaxoSmithKline are actually made up of many pharmaceutical
businesses that have joined over time to create one overall business. Mergers are agreed deals
and so all parties involved should be relatively open about their assets and strengths. By joining
together, they are able to share their resources and strengths. Perhaps one business has a stronger
distribution system in Asia and another has a strong brand presence in Europe. Bringing them
together enables them to use each other’s resources and benefit from one another’s strengths.
Takeover
A takeover differs from a merger in that one business gains control of the other and gains
ownership of it. This deal can be voluntary, where both sides agree it is in their interest – this
might be because of the benefits of shared resources. Alternatively, it may be a hostile takeover.
This occurs when one company wants to buy control of the other but the directors of the target
company do not advise the shareholders to sell. In this situation the buyer has to convince the
owners of the target company to sell their shares against the guidance of their own directors.
Hence the term ‘hostile’. In this case, the price offered may have to increase in order to get the
shareholders to sell; if the deal does go ahead, this will increase the pressure to make high returns
to pay for the high price paid. Also, because the bid is hostile, the potential buyers will not have
access to all the information they might want about the company they are bidding for; this makes
it a riskier deal because not all information will be openly shared. As with a merger, a takeover
involves bringing two different businesses together and they may disagree about priorities,
values and ways of doing things. This can cause friction due to cultural clashes.
Venture
One way in which organisations can gain some of the benefits of collaboration without the
problems of complete integration is by forming a venture (also called a joint venture). This
involves businesses sharing information and resources on some projects, but each retaining their
own identity. For example, businesses may combine their expertise and finance to undertake
shared R&D in one specific area – this may well build on different skills – and share the results.
A venture has the benefits of collaboration but does not require a full union, possibly avoiding
some of the issues of culture clashes.
Franchise
A business may decide to grow by selling the right to use its name and sell its products to other
organisations. The business selling the franchise is known as the franchisor. The business
buying the franchise is known as the franchisee. The franchisee pays an initial fee for the
franchise as well as ongoing fees, such as a percentage of the franchise’s revenue once it is up
and running. The terms and conditions of the relationship between a franchisor and franchisee
will be defined in a contract. This will set out exactly what the franchisee provides, for example,
in terms of equipment, materials and training, what control the franchisor has over the use of the
brand, the fees paid by the franchisee and what rights the franchisee has (for example, whether it
has the exclusive right to a geographical area). Papa John’s is an example of a successful
franchise model, founded in USA in 1983.

Key terms
A franchise occurs when one business sells the right to another business to use its
name and sell its goods or services in return for a fee.
A franchisor sells the franchise to a franchisee.

Figure 35.14 Subway takeaway franchise

The advantages of selling a franchise as a means of growth are as follows:

• It is a relatively quick way of growing, as some, if not all, of the injection of funds to open a
new franchise is provided by the franchisee. Therefore, the original business does not need to
finance all the growth itself.
• Franchisees may be relatively highly motivated as they have ownership of the franchise and it
is, in many ways, their business. They, therefore, may have the incentive to provide a good
quality service generating more funds both for themselves and for the franchisor.
• From a management perspective, the original business is managing the franchisees who are
then responsible for managing their own franchises. This means there is less management
work for the franchisor than if they were managing the business as a whole and directly
 running each individual franchise unit. The franchisor can take more of a supervisory role and
can worry less about the day-to-day operations.
Advantages of selling a franchise Disadvantages of selling a
franchise
Quick growth as funds are provided by franchisee Lose complete control over what
franchises do
Franchisees may be very motivated as they own Do not gain all the profits from the
part of the business operations
Table 35.2 Advantages and disadvantages of selling a franchise

Advantages of buying a franchise Disadvantages of buying a

franchise
Buying an established product, no need to think Do not have complete
of own idea independence to decide what to do
Data should exist on the success of the business Do not gain all the profits from the
and also on important issues such as buyer operations; have to pay money to
behaviour and costs the franchisor
May be provided with training, experience and
support and ideas of other franchisees
Table 35.3 Advantages and disadvantages of buying a franchise

Handling data
A franchisee is asked to invest £0.6 million to buy the franchise and set up the
business. Expected sales for the first five years are £0.5 million, £1 million, £1.5
million, £2 million and £3 million. The average profit margin is 10 per cent. The annual
fee to the franchisor is 2 per cent of turnover.
Calculate the average rate of return (ARR) for the first five years of this franchise.

What do you think?

Do you think franchising is a good way to grow a business?
Types of integration
Integration occurs when businesses join together. This can be via a merger, a takeover or a joint
venture. There are different types of integration: vertical, horizontal and conglomerate.

Figure 35.15 Forms of integration

Vertical integration
Vertical integration occurs when a business joins with another business at a different stage of the
same production process. For example, if one business joins with a business that supplies it, this
is called backward vertical integration. The benefits of backward vertical integration are that the
business will be able to gain control of supplies at a better price than it would have to pay buying
them in from an external supplier.
Alternatively, a business can join together with an organisation closer to the final customer. This
is called forward vertical integration. For example, a manufacturer may join with a retailer. This
can guarantee access for its products to reach markets. By controlling the retail outlet, for
example, a manufacturer can determine the way the product is promoted and is priced.

Figure 35.16 Backward and forward vertical integration

Horizontal integration
Horizontal integration occurs when a business integrates with another business at the same
stage of the same production process. This enables the businesses to share facilities and
resources. For example, Nippon Glass has a strong presence and distribution system in Asia,
whilst Pilkington Glass has a well-established presence in Europe; by joining together they were
able to make use of each other’s market presence and distribution system.
Equally, the portfolio of products of the combined business may complement each other,
providing a better range of services to customers.
Conglomerate integration
Conglomerate integration occurs when one business joins with another business that operates
in a different industry. For example, a computer games business joins with a sportswear
business. Google has been investing in recent years in wind energy and health-care businesses;
this is conglomerate integration. The advantage of this form of growth is that it may spread the
risk of a business of being affected by change in one market.

Key terms
Horizontal integration occurs when one business joins together with another
business at the same stage of the same production process.
Conglomerate integration occurs when one business joins together with another
business in a different production process.

Business in focus: Tata

Founded in India in 1868 as a trading firm, today the Tata group is a global enterprise
that consists of 28 publicly listed companies operating across ten core sectors:
• aerospace and defence
• automotive (including Jaguar Land Rover, a subsidiary of Tata Motors)
• consumer and retail
• financial services
• infrastructure
• IT
• steel
• telecommunications and media
• trading and investments
• travel and tourism.
Each enterprise operates independently and has its own board of directors and
shareholders. Tata companies with significant scale include Tata Steel, Tata Motors,
Tata Consultancy Services, Tata Power, Tata Chemicals, Tata Global Beverages,
Tata Teleservices, Titan, Tata Communications and Indian Hotels.
In 2018, Tata’s publicly listed companies had a combined market capitalisation of
$145 billion, and a combined revenue of $110 billion. They employ over 700,000
people.
The company’s mission is ‘to improve the quality of life of the communities we serve
globally, through long-term stakeholder value creation based on Leadership with
Trust’. Two-thirds of the equity of Tata Sons is held by trusts that support
programmes for health, education, livelihood generation and the arts. In 2017–18, it
contributed over $250 million towards social impact initiatives.
Source: TATA

Practice questions
1 Analyse how Tata gains from its scale.
(9 marks)
2 To what extent do you think growing by expanding into other sectors is better than
expanding in the same sector?
(16 marks)

What do you think?

Do you think becoming a conglomerate is a good strategy?
Reducing scale: retrenchment
Although organisations may often seek growth, there may be occasions when it is necessary to
reduce the scale of operations. This is known as retrenchment. This may happen because the
business has been experiencing diseconomies of scale and wants to refocus its operations.
However, it may also be because of changes in market conditions and the fact that there is now a
lack of demand for the products of the business. The world car industry, for example, has
significant excess capacity at present and this means most producers have been reducing their
production by shutting down car plants.

Key term
Retrenchment occurs when a business reduces the scale of its operations.

Business in focus: BT

In 2018, the telecommunications business, BT, announced that it needed to cut

13,000 jobs over three years to reduce costs. These redundancies represented about
12 per cent of its total workforce. The company is seeking to cut costs by delayering
and removing back-office rather than front line roles. The objective is to cut costs by
£1.5bn. BT is also moving out of its Head Office in expensive central London to
cheaper and smaller premises.
The need to cut costs is driven by an expected fall in revenue of 2 per cent in the
coming financial year. The company said that given the competitive pressure it was
under it needed to be leaner and more efficient.
Source: Adapted from BBC News, May 2018, ‘BT cuts 13,000 jobs to slash costs’

Practice questions
1 Analyse why BT is retrenching.
(9 marks)
2 To what extent will BT’s stakeholders be better off following its retrenchment?
(16 marks)

Handling data
Output Total costs (£)
1,000 10,000
2,000 16,000
 3,000 18,000
4,000 36,000
5,000 50,000
Table 35.4
A business decides to retrench from 5,000 units to 3,000. What is the impact of this
on its unit costs?
The impact of growth or retrenchment on
the functional areas of the business
Growing a business will have an impact on all the functional areas. For example:
• finance. Capital may be needed to finance the growth. This may come from external sources
such as investors or internally from retained profits. During the growth phases managers need
to be particularly aware of cashflow. Cash can flow out to pay for expansion and it may take
time to come back in whilst operations are being set up. Without careful budgeting this can
lead to cashflow problems.
• human resources. Growth can be quite positive for employees in that it can provide
opportunities for new responsibilities and for promotion. However, in the short term it may
mean extra duties and place a greater a burden on staff unless recruitment is undertaken at the
appropriate times. Growth will usually require additional staff and may also necessitate
training if new skills are required, perhaps because the organisation is moving into new areas.
• operations. In the short-term, growth may improve capacity utilisation but this can place
additional burdens on the business if resources are working to their absolute maximum for a
period of time. We can all work very hard to get an important piece of homework completed
but may not be able to sustain this level of effort 24 hours a day, every day. Over time
therefore, organisations may need to invest in new capacity, which is where the raising of
funds and the careful management of expenditure comes in.
• marketing. Increased marketing efforts may be required to generate the demand for growth.
This may be in existing or new markets. In some cases, it will require more investment (again
requiring more finance) but in other instances it will require better use of funds, for example, a
more effective and targeted marketing approach.
As ever, the functions are all interrelated. A business cannot grow successfully if the demand is
not there, if the business cannot secure the funds and staff and if it cannot deliver the quantities
required at the appropriate level of quality.
Retrenchment involves a reduction in the scale of a business’s activities. This strategic move will
have implications for the different functions. The precise effect will depend on the nature of the
retrenchment but may include:
• finance. Scaling down the operations is likely to cost money in the short term as redundancy
payments have to be paid. The exact amount paid will depend on the contracts of the
individuals concerned, but by law employees will receive some payment linked to the number
of years they have worked for the business. However, finances may be improved if the
business is able to raise funds from selling off assets or particular divisions of the whole
organisation. Over time, there may also be lower costs perhaps due to delayering.
• human resources. With retrenchment there are likely to be redundancies and managers may
have to negotiate who is made redundant. For example, are redundancies made on the basis of
‘last in first out’? In some cases, the organisation may help employees find alternative
employment. There may also be other job opportunities within the organisation – for example,
if the business is pulling out of some markets but growing in others. In which case, it may be
 possible to redeploy staff.
• operations. The scale of operations will be reduced by retrenchment. This may be more
efficient – in many cases the business will be scaling back because of diseconomies of scale.
Retrenchment may, therefore, reduce unit costs.
• marketing. Marketing activities are likely to be more focused on a smaller core business. This
may enable better integration and more consistency in approach.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 If unit costs fall as a business expands, this is known as ____________ of scale.
2 ‘Diseconomies of scale occur when total costs rise with less output.’ Is this
statement true or false?
3 State three types of economy of scale.
4 What is meant by ‘economies of scope’?
5 If a business takes over one of its suppliers, this is known as ____________
integration.
6 If a business takes over another business at the same stage of the same process,
then this is known as ____________ integration.
7 Explain the difference between a merger and a takeover.
8 Explain the difference between a franchisor and a franchisee.
9 What is meant by ‘synergy’?
10 State what is on the axes of Greiner’s model of growth.

(b) Short answer questions

1 Explain the possible benefits of two airlines joining together.
(5 marks)
2 Explain the possible disadvantages of a business that has established a number of
stores selling homemade frozen foods selling franchises of its stores across the UK.
(5 marks)
3 Jamie McAllen set up his business on his own producing cheeses. It was his first
business venture after having lost his job in marketing for a theatre company. The
business has proved extremely successful and has grown very rapidly. Explain one
problem Jamie might face whilst his business grows.
(5 marks)
4 Explain one way in which backward vertical integration might benefit a
supermarket.
(5 marks)
5 Explain one way in which conglomerate integration might benefit an interior design
business.
(5 marks)
(c) Data response question
Kingfisher
In March 2015, Kingfisher plc, the owner of the UK DIY chains B&Q and Screwfix,
announced that it would close around 60 B&Q stores in the UK and Ireland over the
next two years. This led to around 3,000 positions being made redundant, although
the company hoped to redeploy about half of these members of staff elsewhere, for
example, in its Screwfix business.
These changes were part of a new strategy for Kingfisher lead by the recently
appointed Chief Executive, Véronique Laury. After a strategic review, the Chief
Executive felt it was essential for the business to increase its efficiency so that it could
pass on these costs savings to its customers in the form of lower prices. Store
closures is one step in this plan.
The closures of B&Q stores follow earlier attempts to make the stores more profitable
by leasing out parts of outlets to other retailers such as Asda. This tactic did not prove
especially successful, and therefore lead to Laury’s decision to develop a new cost-
saving plan. The B&Q closures follow competitor Homebase’s similar decision five
months earlier to shut down around 70 of its stores; Homebase argued that Do It
Yourself was decreasing in popularity in the UK, therefore reducing demand for its
products. Consumers seem to have moved towards spending their disposable income
on buying clothes and going out rather than on decorating and doing up their houses.
This trend can also be seen in the change in our TV viewing habits, with the decline in
popularity of television shows such as ‘Changing Rooms’ and ‘Ground Force’ which
used to be primetime TV in the nineties and noughties.
In 2018, Kingfisher announced that it would pull out of Russia, Spain and Portugal,
affecting 5,000 jobs. This was because the DIY retailer was struggling with falling
sales abroad as well as at its main British and French chains. Véronique Laury said
that moving out of Russia, Spain and Portugal would ‘allow Kingfisher to apply our
strategy with more focus and efficiency in our main markets where we have, or can
reach, a market leading position’.
The withdrawal from Russia is disappointing for Kingfisher. It has spent millions of
pounds opening 20 stores in the country since 2006. The division made an £8m loss
in 2017 despite increasing sales.
The group continues to struggle in the UK. A slowdown in the housing market and low
consumer confidence has reduced enthusiasm for home improvement projects.
Competition from online specialists has also affected traditional market leaders.
Homebase closed 42 stores in 2018 and Travis Perkins is reviewing its ownership of
Wickes.
Even though market conditions are clearly difficult, Kingfisher believes that there is still
potential in the market. For example, the average house in the UK is 60 years old and
so will need to be improved and updated in the near future. In order to tap into this
market, they intend to reposition B&Q by offering more original and innovative DIY
products and appealing to younger people with fewer skills in renovating property. It is
also aiming to reduce its costs through further delayering and rationalising its product
lines and reducing its inventory.
Source: Adapted from The Guardian, November 2018, ‘B&Q owner to pull out of Russia, Spain and
Portugal after sales fall’

Questions
1 Explain one external factor that influences demand for DIY products.
(5 marks)
2 Analyse why Kingfisher has decided to reduce the number of its stores.
(9 marks)
3 To what extent would this retrenchment by Kingfisher have inevitably faced
opposition from stakeholders?
(16 marks)

(d) Essays
1 To what extent do you think it is better for a business seeking to boost profits to be
bigger rather than smaller? Justify your answer.
(25 marks)
2 To what extent do the problems of growing as shown by Greiner’s model of growth,
mean that it is not worth a cinema chain expanding? Justify your answer.
(25 marks)
Chapter 36 Assessing innovation
Introduction
In this chapter we consider innovation as another way in which a business might pursue its
objectives. Innovation involves developing new products and processes. It can help a business
provide more benefits for its customers (think of living in a world before social media and the
internet existed!) and also help a business become more efficient (there once was a time without
bar codes and scanning). We will examine how a business might try to ensure it is innovative and
is moving forwards in terms of its competitiveness rather than getting left behind. We will also
discuss how a business might protect its innovation to prevent rivals copying it and also assess
the impact of innovation on the different functions of the business.
What it is important to know by the end of this chapter:
• the meaning of, and the pressures for, innovation
• the different types of innovation, that is product and process innovation
• the value of innovation
• the ways of becoming an innovative organisation including Kaizen, R&D, intrapreneurship
and benchmarking
• how a business protects its innovation and intellectual property, including patents and
copyrights
• the impact of an innovation strategy on the functional areas of the business.
The meaning of innovation
Innovation occurs when a new idea is brought to fruition and turned into a good or service that
can be used and/or sold. Having ideas is interesting, but the key is to turn them into something
that is actually produced and adds value; this is what is meant by innovation.
As markets become more open with greater globalisation, and as accessing markets and
customers becomes easier with better transportation and communication, this makes it all the
more important for businesses to get better at what they do. Standing still is not an option for
businesses that want to remain competitive – they have to innovate to develop what they offer
and how they provide it. If they don’t, their competitors will.
Aspects of the external environment are constantly changing and businesses must either
anticipate or respond to this. The needs and wants of customers and how businesses compete
with each other are constantly evolving and businesses must ensure they continue to be
competitive. Uber is one of the world’s biggest taxi companies and yet does not own a taxi. eBay
is one of the world’s biggest retailers and yet does not own any products. Airbnb is one of the
world’s biggest accommodation businesses and yet owns no properties to rent out. Just think
how much the world has changed and the changes in how businesses operate from 100 years
ago! Car manufacturers now produce to order not in advance of orders, we can stream whatever
music we want wherever we want, and we have access to suppliers of almost anything we want
online ready to be delivered direct to our homes, often within 24 hours.
The world we live in is shocking and surprising to anyone comparing it with the world just 20
years ago, let alone 100 years ago, and this is due to ongoing innovation. The world keeps
turning and arguably it is turning ever faster thanks to the innovation that is occurring. Just think
about how our lives are much more fully interconnected than ever before, where your printer
measures its ink levels and automatically reorders, your washing machine reads the chips in your
clothes to know how long to wash them for, where cows are linked to the internet so farmers can
monitor their health and milk output and diagnose change in diets if needed and where your car
reports the need for a check-up to its garage.
Innovation changes what we do with our time (computer gaming vs TV), what we consume and
use in our daily lives (microwave meals vs homemade food), how we communicate (mobile
phones vs landlines). It also affects the work we do. Many of the jobs that you will go on to do in
your careers do not even exist yet – technology is changing so fast that new industries and new
jobs are being created all the time. Who would have thought of a career in social media or
knowledge management 20 years ago? In innovative companies such as Google, Entertainment
Arts, Dreamworks and Snapchat work is much more collaborative, much more creative, much
more knowledge based and data driven than in the past.
In terms of changing industries and what businesses do, the importance of innovation can be
highlighted by Formula 1 motor racing. It is said that if there were no changes to the car that won
the first race of the racing season it would come last by the end of the season because of all the
improvements being made to the other cars. This highlights the rate of change in many industries
and the dangers of not innovating.
Pressures for innovation
The pressures for innovation come both externally and internally. Externally, there are changes
in the PEST-C environment that create opportunities for innovation and require a business to
prepare and respond. For example:
• political change may open up new geographical markets through trade deals requiring a new
approach or changes to the product
• economic change may create pressure for a lower cost solution to a problem
• social change may put pressure on businesses for new environmentally-friendly approaches
• technological developments may create opportunities for new ways of doing business. Just
think of the pressure these days to have an online presence
• competitive pressure from rivals may require businesses to respond or they will lose market
share.
Internally, some employees may be eager to experiment and try out new ideas. Employees will,
hopefully, be curious and pushing at existing ways of doing things and challenging existing
thinking to improve it. This leads to pressure to innovate.
The pressures for innovation have always been there but these pressures are growing as there is
more competition – the need to offer more benefits or lower costs is growing as customers have
access to more alternatives, so a business is more likely to lose them if it does not innovate.

Business in focus: Moore’s Law

In the technology industry there is a law known as Moore’s Law, named after Gordon
Moore one of the co-founders of Intel. The law states that ‘The number of transistors
incorporated in a chip will approximately double every 24 months’. This law still
dominates everything Intel does. Through investment in technology and
manufacturing Intel has made Moore’s Law a reality. To double the number of
transistors every two years leads to exponential growth over time and, therefore, puts
enormous pressure on the business to keep innovating and increasing the power of
its products.

Practice questions
1 Analyse why Intel wants to make Moore’s Law a reality.
(9 marks)
2 To what extent do you think the success of a business such as Intel depends on
innovation?
(16 marks)
Product and process innovation
Some innovation will be aimed at developing new products. This may be the result of pure
technological development in which technology moves forward and then the organisation tries to
work out a use for it. Or it may be the result of research commissioned specifically to meet a
customer need that has been identified. Examples of innovation in recent years include the
smartphone, electric cars and 3D printing.
Product innovation provides extra benefits to the consumer in terms of what they are buying –
for example, the product is faster, better designed or longer lasting.
Innovation may also focus on the process. For example, it may aim to make the operations of a
business more efficient or faster – the use of digital technology can help organisations to track
resources, monitor workflows and measure quality at all stages, therefore improving the overall
process. Process innovation may affect how the customer finds out about the product, how they
purchase it or how it is produced and delivered. Online check-in for airlines, online ordering and
click and collect are all examples of process innovation. Process innovation improves the
transformation process and the customer experience – for example, it is easier or quicker to
produce or to order.
Process innovation will also affect how we work. More and more people now communicate with
colleagues globally online via programmes such as Skype. It is not unusual these days to have
teams made up of people all over the globe. It is also far more common to work from home –
with improvements in communications there is far less need to be based in an office all day. It
may be far more efficient to work from home and use a workstation at the main office on certain
days when it is useful to meet colleagues face to face.
The value of innovation
Innovation of some form is almost certainly necessary to remain competitive and to maintain the
profitability of a business. Depending on the form of innovation, it will enable a business to offer
better quality, lower costs, faster delivery or more reliability. All of these developments can help
a business to be more competitive. Cliché though it is, if you are not moving forwards these days
by innovating, you are probably moving backwards! With rising rates of competition and
competition coming from new and, in some cases, unexpected areas, a business needs to tap into
the ideas of employees, suppliers and other partners to find ways of creating more value for its
customers.
However, it must be recognised that innovation can be risky. Many new ideas fail to come to
market and, if they do, many still fail. Similarly, many ways of improving the process do not
come to fruition or prove less successful than hoped. Managers must consider the resources
involved, the likely returns (which can be difficult to estimate) and the risks involved when
deciding whether or not to invest in innovations.

What do you think?

Do you think it is a good idea to try and be the most innovative business in your
industry?

Business in focus: W.L. Gore

Bill Gore set up the company W.L. Gore with his wife, Vieve, in the family garage in
1958. W.L. Gore is a highly innovative business that develops products in many
different product categories. From the start, Bill Gore wanted a business that was truly
innovative, so tried to avoid rules and set procedures. Bill believed that people come
to work to do well and to do the right thing. His view was that the strength of the
company would be a culture that was focused on trust and a passion to come up with
great ideas.
At W.L. Gore, leaders are not appointed; they emerge when they gain enough
followers who want to pursue their idea. Someone may lead one project but be a
team member in another. The budgeting process is also unusual; employees do not
have to account for every single item in their budget – they can have funds
unexplained to then use on trying out new ideas. The company takes a flexible
approach to budgets, recognising that trying to come ‘within budget’ each year may
mean you miss out of long-term opportunities.
W.L. Gore also believes in small business units. When a part of the business gets to
around 200 associates they are usually split up into smaller units. The aim is to
encourage a sense of identity and belonging amongst smaller teams. The fact that
everyone is called an ‘associate’ reflects a team approach and lack of formal
hierarchy.

Practice questions
1 Analyse how the culture of a business might affect how innovative it is.
(9 marks)
2 To what extent do you think budgets limit innovation?
(16 marks)

Business in focus: Post-it notes

Figure 36.1 Post-it notes

Whilst businesses are often eager to innovate and work hard at making it happen,
innovation sometimes happens by accident or by mistake. One of the most famous
examples of this is Post-it notes. In 1968 a DuPont scientist, Spencer Silver,
developed paper that could be stuck on and then peeled off when he was actually
trying to make a very strong adhesive. Once Silver developed this new peel-off paper
he had no idea what it could actually be used for. It took some time for the company
to work out why this innovation might be useful! If innovations are difficult to plan for,
this can affect managers’ approaches to how employees are expected to use their
time. It might also mean some aspects of budgets are kept vague to enable
employees to pursue their own ideas.

Practice questions
1 If many innovations happen by accident, do you think managers can help these
‘accidents’ to happen?
(9 marks)
2 Do you think it might be difficult to budget for innovation? Justify your answer.
(16 marks)
The ways of becoming an innovative
organisation
To develop an innovative organisation managers need to create an environment where:
• it is acceptable to fail. Some new ideas will inevitably fail and take up time and money
developing them before it is realised that they will not work. Managers must accept this and
allow people to feel they can take risks. If failure is punished, it is likely that people will not
try to do anything new.
• there is funding available for experimentation and for trying new things. If all of a budget
is allocated to existing projects, then innovation is unlikely to take place. Some organisations
deliberately leave a certain percentage of a budget for undefined activities to allow the budget
holder to try out new things. In some businesses these unplanned, undefined activities are
called ‘skunkworks’.
• it is good to share. Innovation often comes when individuals from different departments or
sections sharing ideas. This means people need to be encouraged to see themselves as part of
the whole and be willing to talk and work with whoever can help them from anywhere in the
business. Organisations must avoid what is known as the ‘silo effect’, whereby people only
think of themselves as part of a department (or silo) and only talk to those in their area. The
key is to create cross-functional teams and encourage the open sharing of information. This
means there must be the opportunities for individuals from across the business to meet, talk,
share and work in teams. Teamwork enables employees to:
• bounce ideas off each other
• challenge each other
• share different skills, experiences and perspectives.
However, managers need to think carefully about the teams they build to ensure they function
effectively. It is important to balance the team to ensure there is the right mix of skills. To build
effective teams from internal staff means the business must have the right skills in the first place,
which highlights the importance of recruitment and training. Innovative organisations need to
attract and retain talented people.
Leadership
Ultimately what happens in an organisation should come down to leadership. What do the
leaders want to happen, what do they value, what do they encourage, what do they reward? This
influences the culture of the business and how employees behave and what they prioritise. Find
an innovative organisation and you will have leaders at the top with an innovative vision. To
show that innovation matters, resources must be made available for it and it needs to be clearly
stated in terms of the targets set. For example, managers may set a target of a certain percentage
of revenue being generated from new products or products launched within the last few years.
Innovation must be on the agenda, must be seen as important, must be resourced, must be
rewarded and must be assessed.

Business in focus: Team roles

Meredith Belbin is well-known for her studies of teams and what makes up an
effective team. Belbin argues that individuals play different roles within teams. These
roles complement each other. An individual employee may play more than one role.
An effective team includes the following roles:
• The Plant provides the ideas and creative input into the team. ‘Plants’ are highly
creative and good at solving problems in unusual ways.
• The Monitor evaluator provides a logical input into the group. This role assesses
ideas and judges them in a logical and dispassionate manner.
• The Coordinator focuses on the team’s objectives and helps to get team members
to work together.
• The Resource investigator is good at finding out what other teams and
businesses outside of this team are doing and feeding back this information to the
group.
• The Implementer is practical and focuses on the detail to make a plan work.
• The Completer finisher is good at ensuring the project is on schedule and meeting
the required quality standards.
• The Teamworker helps to keep the members engaged and motivated and feeling
part of a team.
• The Shapers provide momentum by challenging and ensuring the team does not
lose momentum.
• The Specialist has detailed specialised knowledge of a key area of the project.
Figure 36.2 Team roles

Practice questions
1 Explain how creativity can be increased by teamwork.
(5 marks)
2 Do you think there might be problems in getting teams to function effectively?
Justify your answer.
(16 marks)
Listening
It’s important to listen. Whether it be listening to customers, partners, employees or to anyone
you work with, it is important to listen to learn what is working, what is not working and what
can be improved. Where there is a complaint there is the opportunity to innovate and develop a
solution. Innovation is basically a new way of solving a problem.
To allow innovation managers may encourage research and development (R&D). R&D involves
technical or scientific research activities to develop new products and processes. It involves
laboratories, experiments, prototypes and testing. Whereas marketing research identifies possible
needs and wants of customers, R&D is aiming to turn an idea for a product or process into a
reality. R&D aims to produce improved or new products and services through the use of
scientific methods. High levels of spending in R&D are common in industries such as
pharmaceuticals, computers, aerospace and the automobile sectors.

Handling data
A business is considering investing £20 million in R&D. Its R&D team has produced
the following estimates:
Expected outcome
Likelihood of success 0.3 + £100m
Likelihood of failure 0.7 – £40m
Table 36.1
On the basis of the data in Table 36.1, would you go ahead with this investment?

Business in focus: R&D investment

The following data is published by the European Commission outlining the top ten
companies in terms of their spending on research and development.
World Company Country Industry R&D 2016/17
rank (€million)
1 Volkswagen Germany Automobiles & Parts 13672.0
2 Alphabet US Software & Computer 12864.1
Services
3 Microsoft US Software & Computer 12367.9
Services
4 Samsung South Electronic & Electrical 12154.6
electronics Korea Equipment
 5 Intel US Technology Hardware & 12086.1
Equipment
6 Huawei China Technology Hardware & 10362.7
Equipment
7 Apple US Technology Hardware &
Equipment 9529.5
8 Roche Switzerland Pharmaceuticals &
Biotechnology 9241.6
9 Johnson & US Pharmaceuticals &
Johnson Biotechnology 8628.2
10 Novartis Switzerland Pharmaceuticals &
Biotechnology 8539.0
Table 36.2 The top ten companies in terms of their spending on research and development, 2017
Source: European Commissions, The 2017 EU Industrial R&D Investment Scoreboard

Practice questions
1 Analyse the factors that might determine how much a business spends on
research and development.
(9 marks)
2 To what extent do you think more spending on research and development will lead
to more innovation?
(16 marks)

Business in focus: GlaxoSmithKline

The pharmaceutical industry is clearly one where innovation is critically important.

Businesses in this industry depend on their breakthrough drugs and being able to
protect these. Their products can range from everyday health-care products to life-
saving medicines and vaccines.
One of the world’s leading pharmaceutical companies is GlaxoSmithKline. In 2017 it
sent £3.9bn on research and development. To develop a new medicine can take
many years – it is often 15 years from the initial idea to having the drug approved by
the various regulatory authorities. Many ideas fail along the way. The process might
begin by investigating 5,000 different chemicals to end up with just one that can finally
be tested on humans. Then development involves numerous clinical trials to ensure
the product is safe; these are carefully regulated and investigated at each stage.
When developing medicines GSK looks for ones that:
• can selectively target diseases
• are safe
• remain in the system long enough to have an impact
• can be manufactured effectively
• have relatively few side-effects.

Practice questions
1 Analyse the problems pharmaceutical companies face when developing new
products.
(9 marks)
2 To what extent is it difficult for a new business to enter the pharmaceutical
industry?
(16 marks)
Kaizen groups
The word ‘kaizen’ is Japanese for ‘continuous improvement’. A kaizen approach appreciates
that regular, small improvements can lead to major improvements in performance over time. To
bring about such improvements businesses often introduce kaizen groups. These are small
voluntary meetings of employees who gather to focus on how to improve what is happening in
their specific work area. Kaizen groups are encouraged to come up with ideas, however small, on
how to improve their area of work; they are expected to do this on an ongoing basis. For kaizen
groups to work effectively employees must feel valued and want to contribute; they must feel
appreciated and well treated by managers. They must also feel that something will improve as a
result of these groups and that their managers will act on their ideas. However, some employees
may resist membership of a kaizen group. They may feel they are doing well enough already and
may not be interested in helping the business do better.

Key terms
Kaizen refers to a process of continuous improvement. This is a management
approach in which employees regularly look for small improvements in the way they
do their work.

Figure 36.3 The kaizen approach

Intrapreneurship
Entrepreneurs are individuals who have their own business ideas and are willing to take the risk
to develop them. Entrepreneurship occurs when people start up their own businesses. In big
organisations, what matters is that this same entrepreneurial spirit is captured and applied within
the business – this is called intrapreneurship. Intrapreneurship occurs when individuals come
up with ideas within their division, department, team or business unit and follow them through.
This requires a culture which supports such efforts and encourages and rewards initiative. At
Google, for example, employees are encouraged to compete against each other with their ideas
and to pitch them directly to senior executives. Similarly, at LinkedIn, all employees can come
up with a new idea, put a team together and present this to senior managers at events held once
every three months. If their idea is approved, they can spend another three months developing it.
At Facebook, employees take part in hackathons to thrash out new ideas. The highly successful
‘Like’ button on Facebook was the result of a hackathon. Efforts to encourage intrapreneurship
help to retain the best staff as it provides them with a way to develop and enhance their careers.

Business in focus: British cycling

Figure 36.4 Sir David Brailsford, CBE is now General Manager at Team INEOS where he has led
eight Grand Tour victories to date.

When Dave Brailsford was Performance Director of British Cycling he made a number
of small but very significant changes that had a huge effect on how the team
performed. He believed in kaizen or what he called ‘marginal gains’. Every aspect of
racing was broken down into its component parts and then Brailsford sought ways of
improving it in some way. For example, riders were given heated shorts so that their
muscles didn’t get cold between races as this meant it took longer for them to get up
to speed in the next race. He also had the tyres sprayed with oil to prevent dirt
sticking to them and slowing up the riders. Riders had their own pillows which they
took with them to every hotel to ensure they slept properly. They were also trained to
wash their hands properly to reduce the danger of infection. The combination of many
different improvements paid off with eight gold medals in cycling for the Great Britain
team at the 2012 Olympics.

Practice questions
1 Analyse how Brailsford’s approach to cycling could be called a kaizen approach.
(9 marks)
2 To what extent do you think kaizen would be an easy approach to introduce into a
business?
(16 marks)
Benchmarking
Benchmarking occurs when managers identify the best in their field for a particular aspect of
their work and then try to learn from them. For example, when it comes to managing large
numbers of visitors a business might set Disney as the best in its field and then set out to learn
from Disney how it does things. The aim of benchmarking is to adopt the best practices from the
best in the world and therefore improve your own performance. The best in the world provide the
standard (the benchmark) you want to match. However, for it to work you need to able to learn
enough about the processes used by the best in the world and also be able to adopt and
implement these processes effectively within your own organisation. This may not be easy. The
business being asked to give data on how it operates is more likely to do so if it is not in the same
industry and, therefore, not a direct rival; even so, there may be some reluctance to share
information. Also, to adopt the process may require more resources than you have or the culture
within your business may not welcome a new approach. It may also be difficult, at least in the
short term, if there is not enough experience and skill within the organisation.

Key terms
Benchmarking occurs when a business tries to match the approach and success of
a particular process that is used by another organisation.
Intrapreneurship occurs when individuals within organisations are being
entrepreneurial – taking risks and generating new ideas.

However, a business that benchmarks is clearly focusing on improvement and learning from the
best and this suggests that it will bring about change internally if it can.

What do you think?

What problems can you imagine you might face when a) benchmarking and b) trying
to develop an intrapreneurial culture?
Protecting innovation and intellectual
property
To maintain its competitiveness a business must be able to protect its advantage to prevent rivals
from copying what it does. One way in which this can be done is by protecting its intellectual
property. This means it gets legal protection for its ideas, inventions or trademarks to prevent
others imitating them. If there is an infringement of these intellectual property rights, a business
can take the guilty party to court and seek damages. Intellectual property is something unique
that a business physically creates – it is not just having an idea. For example, if you write a book,
then the words can be protected not the idea of the book.
It is possible to get intellectual property protection for:
• the names of your products or brands
• inventions
• the design or look of your products
• things that are written, made or produced.
In some cases a business or individual has the rights automatically – for example, if you write a
song or book, these are automatically protected. However, in most cases, you need to register the
intellectual property (such as a new invention) for it to be protected.
It is possible to have more than one type of protection for a single product, for example, a
business might:
• register the name and logo of the product as a trademark
• protect a product’s unique shape as a registered design
• patent a completely new working part
• use copyright to protect drawings of the product.
Intellectual Protects How to gain
property protection
Copyright Literary works (including writing), art, photography, films, Automatic
TV, music, web content, sound recordings right
Trademarks Product names, logos, jingles Need to be
registered
Patents Inventions and products, e.g. machines and machine Need to be
parts, tools, medicines registered
Design Shapes of objects Automatic
rights right
Registered Appearance of a product including shape, packaging, Need to be
design patterns, colours, decoration registered
Table 36.3 Types of intellectual property and protection
Source: Intellectual Property Office, www.ipo.gov.uk
Being able to protect intellectual property is important for innovation. If businesses felt that their
inventions were going to be copied immediately by rivals, this would be a major disincentive to
invest in developing new ideas. On the other hand, if businesses feel that they can protect their
inventions, this means they are more likely to be able to gain a good return on their investment;
this should encourage more innovation. To protect their intellectual property businesses will
have to take any person or organisation that steals this property to court. This provides
protection, although it can be slow and expensive to sue others. For global businesses, they need
to protect their intellectual property in different regions by registering it around the world and, in
some areas, the protection is limited and difficult to enforce.

Handling data
Rank Country 2016 2017 % change 2017/2016
1 United States 39,998 42,300 5.8%
2 Germany 25,012 25,490 1.9%
3 Japan 20,986 21,712 3.5%
4 France 10,504 10,559 0.5%
5 China, People’s Republic of 7,142 8,330 16.6%
6 Switzerland 7,241 7,283 0.6%
7 Netherlands 6,857 7,043 2.7%
8 Korea, Republic of 6,821 6,261 −8.2%
9 United Kingdom 5,188 5,313 2.4%
Table 36.4 Number of patent applications, 2016–17
Source: European Patent Office
1 Calculate the number of UK patents as a percentage of US patents in 2016 and
2017.
2 a Calculate the percentage change in the number of patents in the UK and
Republic of Korea.
b Analyse the possible reasons for the changes in the number of patents
calculated in question 2a.
3 To what extent do you think the data above means UK businesses are likely to be
less innovative than US businesses?
Business in focus: Patents

In 2018, Apple and Samsung finally settled a seven-year-long legal battle over the
possible infringement of patents with technology in their smartphones.
The final terms were not disclosed but the announcement came weeks after a US
court ordered Samsung to pay Apple $539m (£403m) in damages for copying
features of the original iPhone.
The dispute started in 2011, when Apple sued Samsung, asking for more than $2bn
in damages.
Source: Adapted from BBC News, June 2018. ‘Apple and Samsung end patent fight after seven long
years’

Practice questions
1 Analyse the value of the patent system.
(9 marks)
2 To what extent do you think an effective patent system is essential for innovation?
(16 marks)

What do you think?

Do you think it is a good idea to share new technology with your rivals?
How much innovation?
Whilst improving products and processes is important, businesses will differ in terms of how
much emphasis they put on innovation. In some cases, a business will make new product
development an essential part of its strategy – think of Dyson and W. L. Gore. In other cases,
businesses will focus more on following others. Zara, for example, tends to follow the fashion
design of others. Trying to be innovative does not guarantee success. It uses up time, money and
other useful resources and may not lead to commercial rewards. Being innovative is therefore a
risky strategy and some businesses may prefer to follow the innovation of others rather than try
and lead from the front. The danger of following others is that the original innovator gains a first
mover advantage; this means it establishes a clear lead in the market and develops such brand
loyalty that it is difficult for followers to take away customers if they enter the market later. The
innovator may also protect its ideas through patents and trademarks making it even more difficult
for those entering later to make much impact. On the other hand, it is possible that by entering
the market later a business may be able to learn from the mistakes and difficulties of the first
mover.
Disruptive innovation
The term ‘disruptive innovation’ was developed by Clayton Christensen of Harvard Business
School. It describes innovations that create new markets by discovering new groups of
consumers. This can be achieved by using new technologies, developing new ways of doing
business or even using old technology but in a new way. Think about Skype, iTunes, Google,
eBay, Uber and Twitter and how they have created new markets and replaced old technologies in
many cases.
Christensen argues that, whereas innovation often simply improves existing products, disruptive
innovation brings about very significant change both for those innovating and for the established
businesses that find themselves about to be replaced. When disruptive innovation occurs the key
question for businesses is whether to abandon what they do already or hold on to the old
approach. As the new PC market emerged, IBM held on to its mainframe computers for
companies but set up a division to focus on personal PCs. By comparison, when online streaming
became possible Netflix acted much more radically and abandoned its business of posting DVDs
to customers.
The pace of change continues and the likelihood of disruptive technology increases. Google are
threatening to change the car industry with self-driving cars. Amazon is looking to develop drone
delivery and 3D printing is having a major impact on manufacturing. There will also be major
innovations in the health industry, with companies helping us monitor our own health more
effectively. Intel has recently launched earphones that you can wear whilst exercising that will
monitor your heart rate, and there are already many self-diagnosis products on the market with
more to follow.

Business in focus: Graphene

Figure 36.5 Graphene

In 2004, Andre Geim and Konstantin Novoselov, two Russian-born scientists at the
University of Manchester, developed the material graphene. They were later awarded
the Nobel Prize for Physics for this invention.
Graphene is a material that is:
• 200 times stronger than steel
• 1 million times thinner than a human hair
• the world’s most conductive material
• transparent, flexible, stretchable and impermeable.
The potential for graphene is incredible. For example, it may be used:
• in the aircraft industry to make lighter, more fuel-efficient aircrafts
• to make clothing for the defence industry (such as bullet-proof vests)
• to create sensors that can detect minute traces of gases or dangerous chemicals
• to develop flexible and bendable mobile phones, cameras and wearable technology
• to develop more energy-efficient light bulbs as the material is so conductive.
The UK government invested £38 million in the National Graphene Institute at the
University of Manchester and more than 35 companies have partnered with the
university to develop projects.

Practice questions
1 Analyse why the patent system is important to the developers of graphene.
(9 marks)
2 To what extent do you think the government should subsidise spending on
research and development?
(16 marks)
The impact of innovation on functional
areas
Building an innovative organisation will have implications for the different functions of a
business. For example:
• Human Resources. The way in which employees are managed and rewarded must encourage
them to bring ideas forward and share them. Management must reward initiative and thinking
of how to develop, even if it is only through praise. A culture of trial and experimentation
needs to be developed. In terms of organisational structure, employees must not draw clear
lines between jobs and must be willing or able to ask for advice and ideas from other
departments. Creating project teams and encouraging collaboration will be important.
• Finance. Money will need to be made available for R&D and innovation projects. This may
require raising finance externally. In some cases, this may require the long-term commitment
of funds and will involve a high level of risk given how many product ideas fail to come to
commercial fruition. Innovation projects will need to be evaluated financially just like any
other project, and so managers will be assessing measures such as the payback period and the
return on investment. This is not necessarily straightforward as the outcomes in terms of what
is developed and how successful it is may be difficult to estimate. It is likely, therefore, that
investment appraisal techniques will be undertaken for a range of possible outcomes.
• Marketing. The initial stimulus for innovation may come from marketing research. An insight
into why customers are dissatisfied with the existing offering may provide the initial idea for
innovation. Once developed, new ideas may provide question marks to add to the business
portfolio.
• Operations. Innovation may require project management to develop new products. It may
require new skills and techniques to develop the idea. It may also require investment to enable
the innovation to occur. Process innovation may enable more efficient or more accurate
operations which can help competitiveness.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 State one possible benefit of being an innovative organisation.
2 State one possible problem a business might face in becoming an innovative
organisation.
3 What is meant by product innovation? Give an example.
4 What is meant by process innovation? Give an example.
5 Is kaizen likely to require heavy investment? Justify your answer.
6 What is the difference between R&D and market research?
7 What is meant by ‘benchmarking’?
 8 What is the difference between entrepreneurship and intrapreneurship?
9 Can you patent a book you have written? Explain your answer.
10 Is a patent free? Explain your answer.

(b) Short answer questions

1 Explain one reason why a car manufacturer aiming to increase competitiveness
may invest more in R&D.
(5 marks)
2 Explain one problem a manager may face when trying to introduce kaizen groups
into a relatively successful business.
(5 marks)
3 Explain one possible reason why attempts by a UK theme park to use
benchmarking with Disney to improve customer service may prove unsuccessful.
(5 marks)
4 Explain one potential benefit to a mobile phone business of patenting its
technology.
(5 marks)
5 Explain one way in which a major computing business such as Microsoft or Google
might encourage intrapreneurship.
(5 marks)

(c) Data response question

Valve
Valve is a software business that has developed games such as ‘Half-Life’, ‘Portal’,
‘Dota’ and the ‘Left 4 Dead’ series that are well-known for their quality and high sales.
It is also the developer of ‘Steam’, which is game platform that distributes and
manages thousands of games to 100 million players around the world.
At Valve everyone is regarded as equal. Employees sit where they want, choose what
projects to work on and agree on each other’s pay. Once a year everyone goes on
holiday together. The company sees itself as a ‘flat’ organisation where no one reports
to anyone else – they work together. Employees discuss their work with each other
and people work on whatever project interests them and where they can add value.
There are no fixed work areas. All the workstations have wheels and staff can move to
sit next to whomever they wish.
The company attracts able, creative people who like working with others who are
similar. There is a strong sense of collective engagement with people working towards
the same goal. The founder of the company, Gabe Newell, says that recruiting the
right people is ‘more important than breathing’. Once employed, staff are able to take
risks and fail on some projects without the fear of being punished – the company says
that many of its biggest breakthroughs have occurred due to learning from mistakes.
The company is very meritocratic. Staff working on the same project rank each other’s
technical skills, productivity, team-playing abilities and other contributions. This
information is then used to create a rank order of performance which then helps to
determine pay.

Questions
1 Explain one benefit of the way employees are rewarded at Valve.
(5 marks)
2 Analyse why innovation is important at Valve.
(9 marks)
3 To what extent do you think the success of innovation at Valve depends on the way
it treats its staff? Justify your answer.
(16 marks)

(d) Essays
1 To what extent do you think that finance is likely to be the major barrier to greater
innovation within public limited companies in the UK?
(25 marks)
2 To what extent do you think that the ability of a large, well-established
pharmaceutical business to be innovative depends mainly on its culture?
(25 marks)
Chapter 37 Assessing
internationalisation
Introduction
In previous chapters we have examined two forms of strategic methods, namely growth and
innovation. In this chapter we consider another option which a business can pursues instead of,
or as well as, growth and innovation; this third strategic methods is internationalisation and
involves doing business abroad. Many businesses buy in materials, raise finance and employ
staff from abroad; they also export to other countries or have businesses there. We will consider
the factors that affect the desire to do business abroad, and how greater internationalisation can
create opportunities and threats for a business.
What it is important to know by the end of this chapter:
• the reasons for targeting, operating in and trading with international markets
• the methods of entering international markets including export, licensing, alliances and direct
investment
• how to analyse factors influencing the attractiveness of international markets
• how to analyse reasons for producing more and sourcing more resources abroad
• how to assess decisions regarding producing overseas, including off-shoring and re-shoring
• how to analyse ways of entering international markets and assess the value of the different
methods
• that targeting overseas markets may include being a multinational
• the influences on buying, selling and producing abroad
• that managing international business includes managing the pressures for local responsiveness
and the pressures for cost reduction
• how to analyse how international businesses are managed using Bartlett and Ghoshal’s model
of international, multi-domestic, transnational and global strategies
• how to analyse the impact on internationalisation for the functional areas of the business.
Strategic methods: internationalisation
The world in which we live is one where there is a great deal of international trade – far more
than was the case in the past. You can buy goods and services from almost any country you care
to mention, both in the shops and online. You have more ability to travel to, work in or sell to
other countries than ever before. We are living in very international times and that is significant
for businesses and for us as consumers and employees. What we are experiencing is greater
internationalisation (sometimes called globalisation). This means that countries are becoming
more linked through markets and production. There is increasing mobility of resources including
flows of money, goods and services around the world.
This is important for managers because it means they need a broader vision than in the past.
They have more markets in which to recruit, a greater cultural diversity in their workforce, a
broader customer base and more market opportunities around the world. They also have more
potential threats and face more competitive markets now that there are fewer barriers to trade
globally. Managers, therefore, need to think about their business strategy in relation to
international opportunities and threats rather than just domestic ones – where will they source
their inputs from? Where will they actually produce? Where will they sell to? Who will they be
competing against? Even if managers eventually decide to source locally, produce domestically
and sell only in the UK, they need to consider their options at each stage and be clear why they
are making these choices rather than being more international.
A good example of how international business has become is Facebook. Facebook highlights
how interlinked countries and people all over the world now are and shows the similarities that
there are in some aspects of our lifestyles, whether we live in Germany, the UK or the US.
Facebook has over 1 billion users per month, i.e. more than one in eight people in the world.
Although originally an American business, around 70 per cent of its users now live outside the
US and speak more than 70 languages.
Greater internationalisation creates many opportunities for business –such as new markets and
new places to source components and products – but brings the challenges that arise from greater
competition.
What has caused greater internationalisation?
The increase in world trade and the greater openness of markets around the world for businesses
have come about because of factors such as trade agreements, technology and transportation
costs.

Figure 37.1 The causes of greater internationalisation

Trade agreements
Governments generally understand the benefits of trade. Trade enables businesses in one country
to focus on producing the goods and services which they are relatively good at (this is called
comparative advantage) and buy in the items which can be produced more efficiently abroad.
The result should be that the country and its consumers as a whole benefit from a wider range of
products than it could produce domestically. Consumers should also benefit from better value for
money as items can be purchased from the best and most efficient producers in the world.
Producers equally have access to the best suppliers in the world.

Key terms
Free trade occurs when there is trade between countries without barriers such as
tariffs and quotas.
A tariff is a tax placed on foreign goods and services.
A quota is a limit on the number of imported goods and services.
A customs union occurs when there is free trade between member countries but an
agreed tariff on non-members.

Worldwide governmental organisations such as the World Trade Organisation (WTO) exist to
encourage governments to have more free trade. There have also been numerous trade
agreements in recent years either establishing or extending areas in which there is free trade
between member countries so businesses can easily produce or sell there. This means they
remove the taxes of foreign goods (called tariffs) or limits on the amount of foreign goods that
can be imported into a country (called quotas). The EU, for example, is a customs union, which
means there are agreed restrictions on non-member countries trying to sell to the EU but there is
free trade amongst the member countries themselves.
Other free trade agreements include NAFTA (North American Free Trade Area, which includes
North America, Canada and Mexico) and ASEAN (Association of South East Asian Nations,
which include Brunei, Cambodia, Malaysia, Myanmar, Singapore, Thailand and Vietnam).
However, not everyone favours free trade. For particular domestic industries that cannot compete
effectively globally, more openness may lead to closure and redundancies; producers that are
worried about their competitiveness may try to put pressure on governments to protect them.
Some businesses may also prefer for their country to be free to make its own trading policy
rather than be part of an organisation and have to follow its rules. In 2016, the UK voted to leave
the European Union (EU), in part because some voters did not want UK businesses to have to
follow European rules and standards and wanted control over trading agreements with non-
European countries. Leaving the EU is likely to make trade with other European countries more
difficult and expensive because there is no longer free trade. However, there may be more
opportunities outside of the EU because the UK does not have to adopt EU policies with non-
members (we looked at this in detail un Unit 7).

Figure 37.2 EU members in 2018

Figure 37.3 NAFTA members in 2018

Figure 37.4 ASEAN members in 2018

Technology
As technology, particularly information and communications technology, has improved it has
become easier and cheaper for businesses to operate around the world. The price of an
international phone call, for example, has fallen dramatically in the last 20 years, making
communication with overseas offices and staff affordable. It is now usually possible to pass the
huge amounts of data required to run a business around the world quickly and efficiently via the
internet. Developments in communications technology are also bringing people around the world
closer to each other in terms of what they watch, read and listen to. There are films, bands and
TV formats that are successful in many countries around the world. The internet, newspapers,
radio and TV are making people more similar in their tastes, creating global markets. Theodore
Levitt, a famous business writer said in 1983 that changes in technology, and particularly the
dramatic changes taking place in communication, was effectively shrinking the world and was,
he argued, having the effect of driving consumer tastes to a ‘converging commonality’ leading to
standardised products across the world. With better technology citizens in one country can easily
see what is happening in another, immediately enabling them to identify trends and access
products more easily.

Transportation costs
Transportation costs have fallen dramatically in the last 50 years. It is now much cheaper to
move items by air or sea, for example, and this makes global trade more attractive. One of the
major breakthroughs for global markets in physical products was the development of
containerisation. By standardising the size and design of containers, they can be fully loaded,
quickly lifted off or onto a lorry, put onto a boat and stacked efficiently. In 1965, before
containerisation, employees working at the docks could move only 1.7 tonnes per hour onto a
cargo ship; five years later they could load 30 tonnes in an hour. Think of the impact of this
massive increase in productivity on unit costs.

Figure 37.5 Container ships provide low-cost transportation of

Figure 37.6 Opportunities of greater internationalisation

Greater internationalisation and the opening up of borders create opportunities for business in
relation to:
• selling products abroad
• buying inputs from abroad
• producing abroad.
Business in focus: BRIC emerging economies

The global economy is predicted to double in size by 2032 and nearly double again by
2050. China will soon be a bigger economy than the United States. India will become
a major economy, rising to third largest economy followed by Brazil and then Japan.
As emerging economies become bigger and wealthier the demand for services will
rise. In 2010, emerging economies spent more on imported services than the largest
seven developed economies for the first time ever.
These growth trends create opportunities but also bring challenges. China, India,
Brazil and other emerging economies will become large consumer markets not just
locations for low cost production. The growth rates of developed economies are
expected to average around 2 per cent in the coming years, making emerging
economies even more attractive.
However, these economies can be complex places to do business. It is not always
easy to understand the rules and ways of doing business. It can also be difficult to
choose the right entry strategy.
Source: PwC website

Practice questions
1 Analyse how demand for income elastic products will be affected by the growth of
emerging economies.
(9 marks)
2 To what extent are the opportunities of emerging economies greater than the
challenges for UK businesses?
(16 marks)
Selling in overseas markets
One aspect of international business involves selling in overseas markets. Selling abroad may be
attractive because of:
• a larger target population. For example, the UK has a population of around 65 million;
China has a population of over 1.3 billion – providing a much bigger potential customer base.
Brands such as Jaguar LandRover, Burberry and Mulberry have been extremely successful in
overseas markets in recent years and targeting bigger economies has allowed them to achieve
much higher sales than they could within the UK. Expanding overseas provides opportunities
for fast growth in particular in emerging economies – these are countries such as China and
India, which have relatively low incomes per person at the moment but which have been
growing fast. Products such as microwaves, organic foods or dishwashers may be in the
growth phase in emerging economies where there is a growing middle class, whereas in the
UK there is little potential for much growth as the market is mature. According to the
management consultants McKinsey, by 2025 there will 1.8 billion more people in the world
with significant purchasing power due to the growth of emerging economies.
• the opportunity to reduce risk. By spreading sales more globally if sales in one market fall,
they may be compensated by rising sales elsewhere. Using Ansoff’s matrix, entering an
international market may be an example of market development if the products are essentially
the same as those being offered in domestic markets, or diversification if the products are new.
Both these strategies involve the risk of entering a new market but help spread risks at the
same time by operating in new areas. The economic crisis of 2008 showed how whole areas of
the world can be affected and the benefits of spreading risks and not being totally dependent
on one region.

Figure 37.7 The Ansoff matrix

Business in focus: Unilever

Unilever is one of the world’s largest companies with 400 well-known brands such as
Dove, Magnum, Walls and Persil. It has four divisions which are: food, personal care,
home care and refreshment. Unilever has a clear strategy to focus on emerging
economies. In these countries there are rapidly growing numbers of middle-class
consumers that Unilever can target. On any given day, 2.5 billion people use Unilever
products worldwide. Its products are sold in more than 190 countries with 57 per cent
of its sales now in emerging economies.
The company divides the world into those who ‘have lots’ of income, those who have
a reasonable amount of income and those who do not have much income. Its analysis
of the changing nature of the world’s population is shown in Table 37.1.

Figure 37.1 How Unilever divides the world’s population

Practice questions
1 Analyse how the changes in the data above might affect demand for Unilever’s
products.
(9 marks)
2 To what extent is the data in Table 37.1 useful for Unilever’s strategic planning?
(16 marks)
Methods of entering international markets
There are different ways of entering overseas markets to sell in. These involve differing degrees
of commitment and risk:
• Exporting. This occurs when a business continues producing domestically but sells (exports)
some of its products abroad. This represents a relatively low level of commitment to overseas
sales in terms of finance and management times. It is relatively low risk.
• Licensing. This occurs when a business sells the right to an overseas business to produce
and/or sell its products. This provides a business with a local presence. Licensing can provide
valuable insights into the business environment of the country and provide much needed
networks and market links. The risk is mainly taken by the firm that buys the licence; this is
because it takes responsibility for generating the sales abroad.
• Alliances/ventures. These occur when a domestic business works in a partnership with an
overseas business – perhaps they share the investment and the risk together in terms of
building a brand and market presence. This gives the UK business access to local expertise and
contacts and shares the risk, but does involve sharing the profits too.
• Direct investment. This involves the greatest level of commitment from the domestic
business. It involves investing overseas, perhaps to establish outlets or production facilities.
This usually requires relatively high funds and is quite a high-risk decision. When a business
has its own operations abroad it is called a multinational.

Figure 37.8 Ways of entering international markets

Multinationals
Multinational companies (MNCs) are organisations that have production bases in more than
one country.

Key term
A multinational company (MNC) has operations based in overseas markets.

MNCs may be welcomed by overseas governments because they can:

• bring skills and expertise
• bring employment
• bring investment
• increase demand for local goods and services
• increase tax revenue.
However, some MNCs have been criticised for:
• exploiting local resources and not sharing the rewards of the business with the local economy
• keeping senior jobs for their staff and employing local employees for low-level jobs
• keeping the majority of the profits for their own head office and not investing locally
• finding ways to avoid paying high levels of tax
• being involved in corruption to win contracts.
For the business itself, being a multinational:
• gives it direct access to local markets; this may help it overcome trade barriers against
‘foreign’ businesses because it operates with the country
• means its production is closer to local customers. This may improve the speed of responses,
may fit well with a desire to buy locally-produced products and may reduce the environmental
impact of transporting items around the world. It will almost certainly cut transporation costs.
• may involve subsidies and tax incentives from the local government which is eager for this
investment. This can reduce costs.
• spreads the risks of being dependent on one country or one production base by having more
than one around the world. If there was a natural disaster or industrial action at one car factory,
for example, another may still be able to produce. If demand in one market fell, there may still
be growth in another market.
However, being a multinational may:
• bring management challenges, as it may be more complex to manage a business with bases in
different countries. There are the practical issues of communication (for example, if they are in
different time zones and if travel between sites is time consuming), but also issues such as
cultural differences and differences in labour markets, government regulations and ways of
doing business.
• bring criticism from some groups if the business is said to be abusing its power in any way or
if there is pressure to buy local brands not global ones.

Business in focus: China – guanxi

In China it is very important to know who you are dealing with and what connections
they have with others in business or government. The term ‘guanxi’ refers to these
social relationships. The importance of guanxi is partly because this was a society
which, in the past, had little experience of business law as almost everything was run
by the state. (If you cannot rely on contracts to enforce agreements, then it becomes
very important to trust the people you are doing business with.) When doing business
in China it is vital, therefore, to get to know your partners and to build a relationship
with them before actually doing business. Westerners are often surprised by the time
it takes to actually start working together and the emphasis put on the social
relationship as well as the business one. This is because Chinese business people
are trying to find out more about who you are, your status and whether or not they can
do business with you.

Practice questions
1 Analyse how ‘guanxi’ might affect the actions a business takes to enter the
Chinese market.
(9 marks)
2 To what extent do you think having a good product is enough to guarantee high
sales in overseas markets?
(16 marks)
Factors influencing the attractiveness of markets
When deciding which markets, if any, to target abroad managers will consider a range of factors
such as:
• The size and growth of the market. How does this compare to alternatives and what profit
might it bring?
• The expected costs of entering the market. Also, how long it is likely to take to recover this
initial investment?
• The macro environment. Managers may undertake a PEST-C analysis to evaluate the
possible opportunities and threats in a given market. For example, under the political heading
the managers will assess whether or not it is easy to do business in the country. Are the laws
similar to UK laws? Is the country politically stable? Are there high levels of corruption?
• How culturally similar the country is to the UK? Will managers feel they understand the
market and customers relatively easily or will this require extensive research and cultural
understanding? Many businesses first expand abroad to a nearby region because they feel they
know it best. Interestingly, most European businesses trade within the EU, most Asian
businesses trade within Asia and most American businesses trade within the American
continent. Although business is more global, the writer Rugman highlights that the majority of
it still remains quite localised – for example, UK firms are more likely to export to EU
countries than to Asia – perhaps because it is easier to organise or control but also, perhaps,
because culturally these regions seem more familiar.
• The degree of competition. Also, the likely reaction of these existing businesses. Managers
may undertake a five forces analysis (Porter) to assess the competitive environment.
• The perceived risk involved. If it went wrong, what is the potential downside – for example,
in terms of money and reputation?
• The fit with the overall strategy of the business and its competences. For example, it might
not make sense to launch a discount division if the business as a whole is trying to position
itself more upmarket.
• The extent to which the business has to be adapted for local requirements. What are the
costs, rewards and risks of this?
• The impact on the business of overseas growth. For example, in terms of the ease with
which the growth can be managed.
When discussing businesses targeting overseas markets this does not just mean UK businesses
aiming at overseas customers. This is the opportunity created by international business.
However, businesses based overseas can also expand and target UK customers. This is the threat
created by international business. Tata, for example, is originally an Indian company but it has
expanded greatly in recent years into western markets; Tata now owns Tetley tea and Jaguar
cars. Another example of a business based abroad but growing fast in western markets is
Huawei. Huawei is a Chinese telecommunications and mobile phone brand that is growing fast
and is now challenging more established businesses such as Apple. It is one of many Chinese
businesses now attacking global markets. By 2025, it is estimated that China will have more
large companies than either the US or Europe, and more than 45 per cent of the companies on
Fortune’s Global 500 list of major international companies will come from emerging markets
compared with just 5 per cent in 2000.
This is not the first time that western businesses need to be watching emerging economies
closely. For example in the 1970s and 1980s, many US and European businesses rapidly lost
market share to Japanese companies that offered better quality and more innovative products. In
the last decade, South Korean companies such as Hyundai and Samsung have attacked a range of
industries from automobiles to personal electronics. Nowadays, new competitors can come from
many countries across the world and set up much more rapidly. The shift in the global economy
towards emerging markets, and the emergence of nearly 2 billion consumers who, for the first
time, will have incomes sufficient to support significant spending is likely to create companies in
these markets which will then expand globally. Western companies need to be careful and plan
for this ever-increasing threat!

Business in focus: McDonald’s

Figure 37.9 Indian McDonald’s – the Chicken Maharajah Mac

McDonald’s operates in markets all over the world. Although a major competitive
strength of McDonald’s is its consistency so that customers know what they are
getting, the company does adjust its offering for different markets. For example, when
entering the India market McDonald’s had to avoid having any pork or beef on its
menu. (Nearly half of Indians are vegetarians usually for religious reasons.) In most
countries, the best-selling product in McDonald’s is the Big Mac, but in India, the
Chicken Maharajah Mac is more popular.
The Indian market is very different from the US. For example, when researching the
market in 2003 McDonald’s found that out of 100 meals eaten a month only three
were eaten out. As a result, the company initially set the price of its basic ‘burger’ at
20 rupees (20p). This burger was made of mashed potatoes and peas and flavoured
with Indian spices. Eating out in India is now around 9 to 10 times per 100 meals.
Another difference with the US is that the main customers in India are young people
aged between 19 and 30 years with no children as opposed to families.
To set up in India was a major challenge for McDonald’s as the required infrastructure
did not exist. For example, there was no supply chain in place for lettuce, which
meant that the company had to set up its own. McDonald’s now tries to source as
many of its inputs locally (including equipment for the stores). The company now has
185 million customers in India and employs 7,500 staff.

Practice questions
1 Analyse two factors McDonald’s will have considered when deciding whether to
target India.
(9 marks)
2 To what extent should businesses always change their products for overseas
markets?
(16 marks)
Reasons for buying from abroad
Internationalisation may involve targeting overseas markets. It may also involve using suppliers
based abroad. Most companies buy some of their supplies from abroad or even have the whole
product produced abroad and then import it.
Reasons for using overseas suppliers include lower costs and better quality and technology. By
sourcing products internationally, a business really can find the best in the world in terms of
efficiency and effectiveness of production. Certain producers overseas will be the best in their
field or the best value for money, and globally sourcing items enables companies like Apple to
find them and benefit from good quality at relatively low costs.
Reasons for producing abroad
Overseas countries are not just appealing as potential markets or sources of suppliers; they are
also a potential place to produce.

Business in focus: Apple

Apple’s success lies in its design. It is able to design products that look good, appeal
and work well. It does not actually produce the products though (although it oversees
production) – it buys components from specialist producers all over the world and
then assembles them.
For example, components in the Apple iPhone include:
• applications hardware: Samsung, South Korea
• wireless telephone technology: Infineon, Germany
• Flash memory: Toshiba, Japan
• gyroscopic chip: AT Microelectronics, Switzerland
• central processing chip: ARM, UK
• steel case: Catcher Technology, Taiwan
• multi-touch display: TPK Balda, China

Apple’s profit margin on the finished product is much higher

than the profit margin of the individual suppliers.
Practice questions
1 Analyse how Apple manage to earn a much higher profit margin than its suppliers.
(9 marks)
2 To what extent is it better for a business to buy in suppliers rather than produce
them itself?
(16 marks)

Businesses may want to produce abroad because:

• it costs less. For example, labour is significantly cheaper in many other countries around the
world than it is in the UK.
• it may be nearer to resources. For example, a mining business will want to locate nearer
natural resources; an oil business will need to locate near the source.
• it may be more efficient to produce locally in overseas markets and sell there, for
example, due to lower distribution costs, than to produce domestically and export.
• there may be particular skills or expertise in a given area. For example, film production in
Hollywood or computing expertise in Silicon Valley.
• it may overcome barriers to trade such as tariffs (taxes on foreign goods) and quotas (limits
on the number of foreign goods entering a market). Some governments introduce these barriers
to protect local firms. However, by being based within the country these restrictions may not
apply.
Outsourcing and re-shoring
If production is moved abroad, this is known as ‘outsourcing’. This has been fairly common in
recent years as UK businesses have sought to maximise the benefits of overseas production.
However, there have also been some instances of re-shoring when production has been moved
back to the UK. This may because of:
• problems maintaining quality abroad.
• problems with delivery from overseas. Local production may be more flexible to demand.
• a fall in the cost differential. For example, if wages overseas rise faster than domestically.
• a desire to be seen to support domestic production and create jobs locally.

Key term
Re-shoring occurs when a business moves production back to the domestic country.
Influences on buying, selling and producing
overseas
Influences to produce or sell abroad include the following:
• The pressure for growth. For example, from investors. If fast growth is required, it may be
that the domestic market does not offer enough opportunities and overseas expansion is the
key.
• The pressure for lower costs. Managers may be forced to search globally for the lowest cost
resources or production sites.
• Location. The need to be closer to overseas markets may affect location decisions.
• The availability of suitable resources locally. For example, it may be necessary to source
inputs overseas if they are not available locally.
• Politics/economics. The political and economic situation may affect the ease with which
business can be undertaken overseas.
Managing international businesses
When operating overseas managers will want to consider the best ways of managing these
international operations. Should the overseas divisions have a high degree of independence, for
example, and be able to make decisions about what to sell and how to sell it in their own region?
Should the products be kept similar to those in the domestic market or be adapted to meet local
requirements? These decisions will depend on various factors:
• The extent to which the local markets differ in terms of customer requirements.
• The costs of adapting products to local needs.
• The cost benefits (economies of scale) from standardising products and selling the same
products all around the world.
• The ease of managing the business centrally from one location.
The strategic options open to managers can be shown using the Bartlett and Ghoshal (1991)
matrix. In this matrix the choice of strategy can be analysed in relation to two factors:

Business in focus: Harley Davidson

In 2018, Harley Davidson announced that it was going to produce some of its
motorbikes outside of the US. This decision was to avoid European Union (EU) tariffs
placed on the bikes and a range of other US products such as bourbon, orange juice
and motorcycles, introduced as a response to US duties on European steel and
aluminium.
Harley Davidson has assembly plants in Australia, Brazil, India and Thailand as well
as in the US.
Donald Trump, the President of the USA, said that the duties on steel and aluminium
were essential to both protect these industries in America and the country’s national
security.

Figure 37.10 Harley Davidson

 According to Harley Davidson, the EU’s tariffs would typically add $2,200 (£1,660) to
each bike exported to Europe from the US as the import tax increases from 6 per cent
to 31 per cent.
Harley Davidson has been focused on expanding its overseas sales and said that it
remained committed to US manufacturing where it was financially feasible. The
company sold nearly 40,000 motorcycles in Europe in 2017 and had $45 million in
additional expenses due to tariffs.
Harley Davidson employs around 2,100 people at manufacturing plants in the US.
Source: Adapted from BBC News, June 2018, ‘Harley-Davidson to make more motorcycles outside
the US’

Practice questions
1 Analyse how tariffs can affect the profits of a business.
(9 marks)
2 To what extent do you agree with Harley Davidson’s decision to move some of its
production out of the US?
(16 marks)

1. The pressures for local responsiveness – that is, the extent to which local tastes differ and the
need to adapt products as a result. Some products such as razors may be kept the same
regardless of where they are sold in the world. Other products such as food products may have
to be adapted to cater for local tastes.
2. The extent to which the business wants to be globally integrated (where all the international
units are working together within the overall whole) or less integrated where they operate
more independently.

Figure 37.11 The Bartlett and Ghoshal matrix

The four strategic options in the matrix are:

1. International
In this approach, the business is mainly focused on its domestic operations. Products are not
adapted for the international market; the existing products are simply sold abroad. This means
the products are not responsive to local markets. In terms of how the business operates, there is
little integration. There is little pressure to try to integrate any of the limited overseas aspects of
the business because the key decision making is made from the head office. Overseas sellers or
distribution centres have some independence because they are not seen as important to integrate
into the whole business. In this strategy, the international business is seen essentially as less
important than the domestic business. Products are designed for the domestic market and
international markets are seen mainly as a way to boost sales.

2. Multi-domestic
In this approach, the different parts of the business operate fairly independently in their own
regions. The overall business is essentially a collection of separate units that operate alone. Each
one adapts to its local environment in terms of what it offers and how it runs itself. This is
relatively common in industries such as processed food, publishing and fashion where there can
be significant differences in the tastes and requirements of each market. Each region essentially
runs itself so the overall organisation is a collection of different local businesses (multi-
domestic). The disadvantage of this approach is that resources are not shared between the
separate companies.

3. Global
In this approach, products are fairly standardized all around the world. This is relatively common
in industries such as aerospace, computers and chemicals where the product does not need to
change in different markets. The business is integrated in that it follows similar policies and
approaches wherever it operates. In a global business, the way of doing things is set out from
head office, so the business is very centralized. This can lead to economies of scale and
management efficiencies. The business is essentially run from the centre with the overseas
operations as ‘satellites’ implementing head office policies; the business is integrated from the
head office.

4. Transnational
This approach aims to maximise responsiveness and integration across all divisions around the
world. Products are adapted to meet the needs of local markets and respond to their different
needs. At the same time, the business is very integrated, and it shares ideas, technology,
resources and discuss different ways of doing things. Unlike the global approach, the
transnational is not dominated by a domestic head office setting out what everyone does; it gives
more input to the businesses around the world to collaborate with each other in areas such as
operations, marketing, finance and Human Resource planning.
Choosing an approach
The approach adopted by a business will depend on many factors, but one of these will be the
nature of the industry it is in. It may be easier to adopt a global approach in oil, for example, than
in publishing where there may need to be significant variations for different markets.

Figure 37.12 The four approaches in the Bartlett and Ghoshal matrix

Key models and theories

There are different ways of operating overseas. You might:
• try to keep the product the same in every country or you might try and adapt the
product and have a different version in different places
• let the business in each country run itself as a separate, independent company
• view all the businesses around the world as part of one large organisation and move
resources around as and where they are needed.
Bartlett and Ghoshal highlighted these choices in a matrix showing different
approaches to going international. Each approach has advantages and disadvantages.
The risks of internationalisation
Whilst the potential benefits for a company of greater international business are huge, the risks of
undertaking it should not be underestimated. These risks arise for various reasons:

Cultural differences
Whilst greater internationalisation and globalisation may mean lifestyles converge in some ways
(think of how pervasive global brands such as Coca Cola, Facebook and McDonalds are), there
can still be significant differences in language, attitudes, customs and religion, which can make
doing business abroad challenging and more demanding than operating in the local market. For
example, in Japan it is common for employees to gather together first thing in the morning, sing
the company song and even exercise together. This is less common in the UK. Even McDonald’s
adapts its menus in different countries recognising the differences in tastes that exist.

Business in focus: One Ford Strategy

In 2006 Alan Mulally took over as Chief Executive at Ford. He introduced a number of
strategic changes. These included a major shift towards using:
• common ‘platforms’. This means that the basic structure (‘platform’) of the car would
be the same for several different models – what would differ was what was placed
on top.
• common parts rather than designing specific parts and components for each model.
The aim of this strategy was to maintain variations for different parts of the world and
consumers, but at the same time have as much ‘communality’ as possible to reduce
costs. In 2007, Ford produced less than 30 per cent of its global output on common
platforms. There were 27 different platforms. By 2016, the company produced 99 per
cent of its vehicles on just nine global platforms.
The company has also been developing more global cars; that is models that can be
sold in many different markets.
This whole approach is known as the ‘One Ford Strategy’.
Under Mulally’s One Ford Strategy, the company avoided bankruptcy. The company
reduced costs and became leaner with its global approach. However, despite the
success of Mulally, his successor Mark Fields says that Ford faces challenges in the
current business climate to be competitive. The company announced in 2018 that it
needed to cut costs by $25.5 billion over the next five years. It also wants to reduce
the number of vehicle platforms to just five in the future. This will further reduce costs
and improve the efficiency of Ford’s supply base. Ford also hopes to reduce the
amount of time it takes to bring a vehicle from the sketchboard to the showroom by 20
per cent.
Source: Adapted from Automotive News Europe, August 2018
 Practice questions
1 Analyse the benefits of the ‘One Ford Strategy’.
(9 marks)
2 To what extent should businesses aim to make all of their products global?
(16 marks)

Differences in negotiating and decision-making style

In some countries, such as the US, managers tend to get straight to business. They want to reach
a clear decision and agreement in a meeting. A handshake usually means that an agreement has
been made. In other countries managers may take longer to reach a decision. Meetings may at
first be more social as they get to know and trust each other. A handshake may mean that they
are going away to think about the decision, not that a decision has actually been made. The
Japanese decision-making approach, for example, tends to involve a great deal of consultation
and involvement of different staff – this does lead to a consensus but can be very slow, whereas
the US style tends to listen to fewer voices but be quicker. Managers operating globally need to
be conscious of these differences or they may get frustrated and cause offence.

Ethical standards
What might be seen as unethical or even illegal in one country, may be seen as acceptable or
inevitable in others – in fact it may be regarded as the way that business is done. Levels of
bribery and corruption vary considerably from country to country. If your managers do not bribe
and domestic ones do give incentives to individuals in order to win contracts, this can make
competing more difficult.

Anti-globalisation feelings
In recent years there have been various pressure groups and protests against businesses operating
globally. Although the reasons behind the criticisms of globalisation vary, they include the views
that:
• local cultures and businesses are destroyed by large multinational companies. Visit any major
city in the world and you will most likely find Starbucks competing with small, locally-owned
coffee houses. Critics argue that these big multinationals are destroying local business and
making the world too similar.
• the big multinationals are exploiting local employees and businesses. For example, they
produce in a country and make use of its natural resources, but the profits do not remain in the
country – they are exported overseas.

Instability of the country

Operating in countries can be risky due to political and economic instability. In the UK, for
example, the uncertainty over Brexit has led to businesses delaying investment decisions. In
Venezuela in recent years very high levels of inflation and negative economy growth have
caused many businesses to collapse.
Political and economic uncertainty make it more difficult to plan ahead and do business.
Business in focus: Challenges of globalisation

When chief executives were asked in a 2017 PwC survey what they thought were the
biggest challenges facing their businesses, they said (in order of importance):
• uncertain economic growth
• over-regulation
• availability of key skills
• geopolitical uncertainty
• speed of technological change
• exchange rate volatility
• increasing tax burden
• social instability
• changing consumer behaviour
• cyber threats.

Practice questions
1 Explain one way that ‘geopolitical uncertainty’ might affect a business.
(5 marks)
2 Do you think these challenges mean that becoming an international business is not
worth it? Justify your answer.
(16 marks)

Business in focus: Google in China

In 2015, Google’s email service was allegedly blocked in what seemed to be another
attempt by the Chinese government to limit or even block access to Google’s
services.
Google said that its investigations had shown that China’s government had blocked
Google IP addresses in Hong Kong used by people on the mainland to access Gmail
services.
The Chinese government has been accused of taking steps before to limit Google’s
search and email services because it has wanted to limit Chinese citizens’ access to
information on the internet. It has not publicly admitted that it has taken these actions.
It has said that China always welcomes and supports foreign investors and wants to
provide an open, transparent environment for foreign businesses. However, there is a
sense that the Chinese government would be pleased to see users switch to domestic
companies that are more cooperative in relation to the government’s demands about
what should be censored.
Google closed its mainland China search engine in 2010 because it refused to
cooperate with the government’s demands for certain sites to be censored and
access to them blocked. This was after hacking attacks aimed at breaking into the
company’s operating code were traced to China.
However, in 2018, it was claimed in the media that Google is developing a new
version of its search engine that would conform to Chinese censorship laws. The
online news site The Intercept says Google has been working on a project code-
named Dragonfly that will block terms like human rights and religion. Google refused
to comment on its future plans, but it is claimed that the search app would filter
sensitive queries and prevent access to websites currently blocked by China’s so-
called ‘Great Firewall’. It is said the BBC News website and Wikipedia would be
among those blocked. Some freedom of speech activities have asked Google not to
continue with the project. For Google the appeal of China is great: it is the biggest
internet market in the world.
Source: Adapted from BBC News, August 2018, ‘Google in China: Internet giant “plans censored
search engine” ’

Practice questions
1 Analyse the reasons why Google closed down its search engine in China in 2010.
(9 marks)
2 Do you think Google should now offer a search engine in China? Justify your view.
(16 marks)
Impact of internationalisation on the functional
areas of business
Any decision regarding the internationalisation of a business will have an impact on the different
functional areas of that business. For example, it can affect the following:
• Market research activities, as a business wants to find out more about new markets and new
segments to target.
• R&D, as a business develops new products or modifies existing products for an overseas
market.
• The purchasing of supplies. Businesses now have access to far more suppliers all over the
world. Communications technology enables them to identify them, contact them and manage
their relationship with them more effectively. Lower transport costs make it more feasible to
buy in from abroad in terms of costs and speed of delivery.
• Production. Businesses may look to produce overseas to benefit from lower costs, better skills
and technology or the availability of resources.
• Marketing decisions, such as how to promote and price products and also how to distribute
them.
• HR, in terms of how and where to recruit, the rewards offered and how best to manage people.
By operating internationally a business may be able to gain many benefits, such as lower costs of
resources and greater access to customers, labour, technology and suppliers.
The precise impact of internationalisation will depend on the overall decisions made. Two
examples, a decision to offshore production and a decision to target new overseas markets, are
discussed here.

Impact of a decision to offshore production on functional

areas
A business’s decision to offshore production may lead to:
• a relocation of production facilities and the development of the operation abroad (operations)
• a reduction in staff domestically and the recruitment of employees overseas (HR issues).
Managing staff abroad may be very different due to differences in the labour market, the skills
and expectations of the workforce, cultural differences and employment legislation
• marketing being affected if the business can build on the regional strengths of where the
product is produced (for example, ‘German engineering’, ‘Japanese quality’ or ‘French
cuisine’). However, there has been some movement for businesses to focus on local produce
and local suppliers and so moving production overseas may cause problems for the brand
• lower costs due to lower labour or material costs; this may increase profit margins (financial
issues).

Decision to target new overseas markets on functional areas

A decision made by a business to target new overseas markets may lead to:
• changes to the way products are produced (for example, they may need to be adapted for new
markets) and changes to the way they are promoted, priced and distributed (marketing issues)
• changes to the operations process to be able to produce products suitable for the new market
(operations issues)
• changes to HR decisions. If the business will be operating overseas, it will need to recruit and
train staff abroad
• changes to finances. There may be initial costs and investments to establish a presence
overseas; however, long-term overseas sales may lead to higher profits.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 State three reasons why the amount of international business worldwide is
increasing.
2 What is the name for a tax on foreign goods and services?
3 What do the initials WTO represent and what does this organisation aim to
achieve?
4 What is meant by an ‘emerging economy’?
5 According to Ansoff, what is the name for a strategy that targets a new market with
an existing product?
6 Explain one reason why a business might want to sell overseas.
7 Explain one reason why a business might want to produce overseas.
8 State two factors that might determine the attractiveness of an overseas market.
9 State what is on the axis of Bartlett and Ghoshal’s matrix of international business.
10 State two possible problems of entering an overseas market.

(b) Short answer questions

1 The tobacco company BNA has found that sales of cigarettes have fallen in recent
years in the UK given social change and changes in the laws about smoking.
Explain one reason why the business might want to target overseas markets.
(5 marks)
2 Albion Apparel, a clothing producer and retailer, has been under increasing
pressure to lower its prices and offer better value for money. Explain one reason
way Albion might wish to shift production overseas.
(5 marks)
3 The Frantic Advertising Agency is eager to expand its operations overseas. Explain
one factor it might consider when deciding which country to target.
(5 marks)
4 The Gillter Bicycle Company is one of the few remaining bicycle producers in the
UK. It would like the government to protect it. Explain one reason why Gillter might
need government protection from international competition in order to survive.
 (5 marks)
5 The Marson Food company sells fast food around the world. Explain one factor that
might determine which of Bartlett and Ghoshal’s strategies it might adopt.
(5 marks)

(c) Data response question

Sports Direct
Sports Direct is a leading UK retailer of sportswear and sports equipment. In 2018, the
company was recognised as a leading global retailer thanks to its online presence.
Whereas many companies neglect their websites in relation to international buyers,
Sports Direct takes account of their different needs; at its most basic level this means
having the site translated depending on where people are searching from or
converting prices into the local currency.
In the report on global businesses, Sports Direct was ranked below Amazon, BooHoo
and ASOS but actually did better than Apple. Other UK companies in the top 20
included John Lewis, TopShop, Next and Marks & Spencer.
Through an effective online presence, companies such as Sports Direct can reach
huge numbers of customers round the world without the cost and difficulty of
establishing a physical network of stores.
In some ways, Sports Direct is lucky that its products are ones that can easily be sold
in different countries. This is less easy for products where the product regulations and
safety specifications and customer tastes differ considerably from one country to
another.
Source: Adapted from BBC News, June 2018, ‘Sports Direct pips Apple in global retailers’ list’

Questions
1 Explain one factor that influences demand for Sports Direct products.
(5 marks)
2 Analyse why developments in technology make international expansion easier.
(9 marks)
3 To what extent is selling products internationally the right strategy for all
businesses?
(16 marks)

(d) Essays
1 Is it better for a US producer of household electrical goods, such as washing
machines and dishwashers, to target overseas markets than local ones? Justify
your answer.
(25 marks)
2 With reference to Bartlett and Ghoshal’s model, is it better for a car manufacturer to
operate as a multi-domestic or a transnational business? Justify your answer.
(25 marks)
Chapter 38 Assessing greater use of
digital technology
Introduction
In the last three chapters we have considered different strategic methods: growth, innovation and
internationalisation. In this chapter we consider a fourth option which is the use of digital
technology. Digital technology seems to be driving many aspects of business these days through
developments such as e-commerce, social media marketing and greater interconnectedness
between businesses, products and customers. These developments in digital technology are
creating opportunities and threats for businesses. Here we will consider what these changes
involve and their potential impact on businesses.
What it is important to know by the end of this chapter:
• the pressures to adopt digital technology
• that digital technology should include e-commerce, big data, data mining and enterprise
resource planning (ERP)
• how to assess the value of digital technology
• the impact of digital technology on the functional areas of the business.
Digital technology involves the use of digital resources to find, analyse, create, communicate and
use information digitally. Technically speaking, digital is a particular form of technology that
stores data using binary codes; this means it combines 0s and 1s (also called bits) to represent
words and images.

Figure 38.1 Digital technology

The term ‘digital technology’ covers a wide range of technologies and applications.
E-commerce
E-commerce refers to commercial transactions conducted electronically on the internet. It
involves the buying and selling of goods and services, or the transmitting of funds or data over
the internet.
E-commerce can involve:
• business-to-business (B2B), that occurs when one business sells to another business; for
example, a company manufacturing lorries may sell these to a transport business
• business-to-consumer (B2C), this occurs when consumers buy direct from a business such as
Amazon
• consumer-to-consumer (C2C), this occurs when consumers trade directly with each other, for
example, via eBay.
E-commerce has been growing as more people and businesses are connected online and as
connection becomes easier and faster. The growth in mobile and tablet devices has added to this
growth in recent years. For example, services such as click and collect delivery lockers and the
integration of stores and online ordering for collection and returns have made online shopping a
more attractive, easier-to-use proposition for shoppers than it used to be.
E-commerce can bring many advantages for a business such as:
• access to markets worldwide, 24 hours a day
• a new way in which customers can shop. This can be part of a multi-platform strategy whereby
customers have many different ways of accessing the products such as in store, click and
collect and online delivery
• relatively cheap start-up costs compared to establishing a high-street presence across the
country. This enables businesses to compete in markets relatively quickly and enter markets
that might not have been possible in the past
• greater access to suppliers and greater ease of comparing prices.
However, a move to e-commerce by a business does need to be considered carefully, since it
may bring additional costs in terms of spending in warehouses and the operating costs of the
delivery system if the business produces physical products. Businesses must also consider the
balance between having a physical presence and moving online. In the case of retailers, for
example, will online sales enhance sales from retail outlets or just cannibalise their sales?
In the case of buying products online, there remain some barriers to e-commerce growth such as:
• the customer’s inability to use and touch the products
• having to wait for delivery
• delivery costs
• worries about how to return products
• worries about the use of data and the security of buying online.
Business in focus: Online retail sales

Figure 38.2 Online retail sales, UK, 2013–2023

Source: Office for National Statistics/Mintel E-commerce, July 2018

Figure 38.3 Market segmentation by product, 2018

Source: Data from Mintel E-commerce, July 2018
Figure 38.4 Online sales as a percentage of total sales, 2008–17
Source: Data from Mintel E-commerce, July 2018

Practice questions
1 Analyse why online retail sales are increasing.
(9 marks)
2 Discuss the significance of the data in Figures 38.2–38.4 for the strategies of UK
businesses.
(16 marks)

What do you think?

Do you think all businesses will end up online in the future?
Enterprise resource planning
Enterprise resource planning (ERP) is a business management software system that allows a
business to manage data relating to many of its activities, such as inventory management,
manufacturing, marketing, shipping and sales. It manages the data that links all the different
parts of the business together and, therefore, enables managers to make well-informed, and
therefore better, decisions.

Key terms
Enterprise resource planning (ERP) is a software application that enables a
business to effectively manage its activities, including inventory, manufacture,
marketing, sales, etc. Bringing this information together should aid decision making.
Data mining is an analytical process that aims to analyse data in order to identify
patterns and relationships between variables.

ERP gives managers an overview of all the different activities within a business; often with real-
time data, that is measuring changes as they actually happen. ERP systems are used to follow and
track resources – for example, they measure the flow into and out of the business of cash,
materials, products – and are able to identify at any moment the position of the business in terms
of production, orders waiting to be fulfilled and inventories. ERP systems should also track
customer orders and repeat purchases. ERP is, therefore, a very useful management tool that
helps decision makers track what is happening and the effect of any changes they make.
ERP should help improve the:
• productivity and efficiency of the business by ensuring resources are used fully and are not idle
• flexibility of the business and response time by being able to coordinate parts of the
organisation more effectively.
However, in order to be effective an ERP system will require:
• investment in systems and technological infrastructure
• training of staff
• planning to ensure the requirements of the ERP system are fully thought through before the
technology is developed and implemented to ensure it has the functions required.
Figure 38.5 Enterprise Resource Planning (ERP)
Data mining
Data mining is an analytic process designed to explore data to try and find patterns within it
and/or identify systematic relationships between variables. Data mining looks for possible
relationships, for example, between different items a customer buys or how different market
segments might respond to promotional offers. One global drinks company brings together daily
weather forecast data from a meteorological office and incorporates this in its demand and
inventory-planning processes. By analysing data such as temperatures, rainfall levels and the
number of hours of sunshine on a given day the company is able to reduce inventory levels while
improving its forecasting accuracy by about 5 per cent. Some airlines try to identify links
between customer profiles and the likelihood of them not showing up for a flight, so they know
how many seats they can oversell by.
Big data
Big data is linked to data mining, but refers to the fact that technology has developed so much
now that huge amounts of data can be mined from multiple sources to find links. More data
crosses the internet every second today than was stored in the entire internet just 20 years ago.
Businesses are therefore able to work with much bigger datasets than they used to – hence the
term ‘big data’. For instance, it is estimated that Walmart collects more than 2.5 petabytes of data
every hour from its customer transactions. A petabyte is one quadrillion bytes, or the equivalent
of about 20 million filing cabinets’ worth of text. An exabyte is 1,000 times that amount, or 1
billion gigabytes. This greater access to data, the greater speed of analysis and the falling costs of
storage and interrogating the data means that analysts can gain incredible insights into business
issues such as consumer behaviour. For example, MIT Media Lab used location data from
mobile phones to infer how many people were in the car park of the world famous retailer
Macy’s on Black Friday – the start of the Christmas shopping season in the US. This made it
possible to estimate the retailer’s sales on that critical day even before Macy’s itself had recorded
those sales!
Big data takes the form of messages, updates, and images posted to social networks; readings
from sensors; GPS signals from mobile phones, and more. Many of the most important sources
of big data are relatively new. The huge amounts of information from social networks, for
example, are only as old as the networks themselves; Facebook was launched in 2004, Twitter in
2006. The same holds for smartphones and the other mobile devices that now provide enormous
streams of data that link people, activities and locations. Because these devices are seemingly
everywhere now it is easy to forget that the iPhone was only launched in 2007 and the iPad in
2010.

What do you think?

Do you think that having access to more data is bound to improve decision making?
The impact of digital technology
Digital technology is creating huge changes in the business world. Digital technology has
improved the way businesses produce and operate. It has also disrupted markets by enabling new
businesses to enter and bypass the competitive advantage of established (also called ‘incumbent’)
businesses. There was a time when having a chain of high-street outlets was a strength – in the
world of retail, estate agency, travel agents or banking, for example; now it is often a burden
because of high fixed costs compared to new entrants who operate just online. Digital technology
can revolutionise industries, create new markets (such as downloadable books, specialist online
auctions, online gambling and online dating) and destroy or severely damage others. It can also
change the shape of industries – the postal service across the world has seen a decline in the
posting of letters due to email but an increase in the delivery of parcels due to more online
ordering. You may be reading this book in a physical form, but publishers are increasingly
developing their digital offerings.

Business in focus: Flight arrivals

In the airport industry every single second counts. Managing the process of inward
and outward flights is a hugely complex process in which timings are clearly critical.
When a plane is coming in to land the ground staff need to be ready. If the plane is
later than expected, then expensive resources are sitting idle. So estimating land time
precisely is important in terms of efficiency. Typically, airports have relied on pilots’
own estimates of their estimated times of arrival (ETA). A study then showed that at
least 10 per cent of flights actually arrived 10 minutes earlier or later than expected.
Thirty per cent were up to five minutes later or earlier than expected. A new system
was therefore introduced taking the pilot’s estimate plus a whole range of other
factors into account, including the weather, data from radar stations, flight schedules
and progress of other planes in the air and what happened on previous occasions
when planes landed under similar conditions. The result of using this new system was
that the airport essentially eliminated the difference between the estimated time of
arrival and the actual arrival time.

Practice questions
1 Analyse the benefits to an airline of knowing exactly when a plane is going to land.
(9 marks)
2 To what extent is big data good for customers as well as businesses?
(16 marks)

The importance of digital technology is growing at an ever-increasing speed and businesses must
consider how this affects their activities. For example, 20 years ago less than 3 per cent of the
world’s population had a mobile phone and less than 1 per cent was on the internet. Today, more
than two-thirds of the world’s population has access to a mobile phone, and one-third can
communicate on the internet. As information flows continue to grow and new waves of
disruptive technology emerge, businesses can now start and gain scale with extraordinary speed
with relatively little funding. Several of you reading this book may well be self-made
millionaires from online businesses before the age of 40! Given the increased significance of
digital technology, a number of businesses are now appointing specialist staff to manage their
digital operations.
The impacts of digital technology on a business include the following:
• significant improvements in the ease with which different stakeholders can communicate and
monitor the performance of a business
• better management
• enabling new ways to do business
• changes in HR issues.
Improvements in communications and
availability of information
Communication is now easier and faster so there is much greater transparency all round.
Information is readily available to customers, for example, when searching for alternatives or
trying to find out about the products and behaviour of an organisation. Information can also be
available in several different formats (for example, via websites, video, social media) and can be
tailored more readily to the specific needs of different groups (so you get to know what you want
and need to know rather than being overwhelmed by data). More access to information can put
more power into the hands of buyers, increasing buyer power in Porter’s five forces model. How
many times do you now look at customer reviews before buying anything? You have the chance
to ask and learn from others’ experiences before buying to a much greater extent than in the past.
Managers need to be careful, therefore, how they and others behave, how the business is
performing and how it reacts because every action is now taken on a very visible stage.

Business in focus: Technological change

Figure 38.6 Emerging technologies

Source: PwC

Practice questions
1 Analyse two ways in which one of the emerging technologies from Figure 38.6
might affect a retailer.
(9 marks)
2 To what extent do you think developments in technology bring more opportunities
than threats for businesses?
(16 marks)
Better management
There is a famous phrase in business that you cannot manage what you cannot measure. The
existence of more data and more analytical tools can enable better decision making and more
focused management. Think about book retailing. In the past, a bookshop could measure what
was sold; if it had a loyalty programme it might also be able to link sales to some particular
features of the customers such as their postcodes and ages. However, with online shopping the
business can now measure what particular types of products individual customers have bought,
what they looked at (and for how long) and how they responded to different promotions or
reviews. Managers’ understanding of customers is now so great that they can predict what they
are likely to want to read next when they are shopping. They can also get direct feedback from
the reader on what they thought of the book. Better data within the business should then lead to
better decision making and better performance. According to the management consultants
McKinsey, the more data driven businesses are, the better they perform on objective measures of
financial and operational results. In particular, companies in the top third of their industry in
terms of the use of data-driven decision making are, on average, 5 per cent more productive and
6 per cent more profitable than their competitors. This performance difference is statistically
significant and economically important and is reflected in measurable increases in stock market
valuations.
Enabling new ways of doing business
Digital technology is enabling new ways of doing business. For example, businesses can access
finance from the general public using crowdfunding and they can use customers and suppliers for
new ideas or to advise each other. For example, Telstra, a mobile phone business, crowd sources
customer service, so that users support each other to resolve problems without charge. At
Chocomize, you can develop your own personalised recipe of chocolate; this can then be bought
by others earning you points that can be put towards the price of your next order. Customers are
now becoming very closely involved in the whole operations process.

Business in focus: ASOS

ASOS is a completely online fashion retailer. This is sometimes known as a ‘pure

player’.
Its mission is to ‘become the world’s number one online shopping destination for
fashion-loving 20-somethings.’
ASOS says:

We believe in a world where you have total freedom to be you, without

judgement. To experiment. To express yourself. To be brave and grab life as the
extraordinary adventure it is. So we make sure everyone has an equal chance to
discover all the amazing things they’re capable of – no matter who they are,
where they’re from or what looks they like to boss. We exist to give you the
confidence to be whoever you want to be.
The company says that it aims to provide inspiration but also conversation for fashion
lovers. It wants them to be part of the ASOS world talking to each other, sharing and
providing ideas. It invests heavily in mobile and digital innovation to ensure people
can access this information and these conversations, but also to ensure that what you
receive is personalised and therefore relevant to you. It buys fashion from all over the
world to ensure its customers can stay right up to date with what is happening. It is
speeding up its supply chain to ensure customers receive what they want quickly.
ASOS has more than 87,000 products on its site. Around 5,000 new items are added
each week. It also offers fashion-related social media content through its websites,
mobile apps, the ASOS Magazine and its social media accounts, which have more
than 22 million followers. ASOS sells to almost every country in the world. It has 168
suppliers who use 713 factories around the world. It had 2085.7 million visits to its site
in 2018.
ASOS has had a number of measures of success including its share of online traffic,
the number of followers on social media sites as well as its sales.
Source: Adapted from ASOS website

Practice questions
1 Analyse the benefits to ASOS of having a clear mission statement.
(9 marks)
2 Assess what you think is the greatest threat to a business such as ASOS. Justify
your view.
(16 marks)

Figure 38.7 The ASOS website

Changes in Human Resource issues
Digital technology involves the replacement of labour in many digital businesses. For example,
of the 700 processes in banking (opening an account or getting a car loan, for example) about
half can now be fully automated. Even in knowledge-intensive areas, such as health care,
diagnosis software is being developed so that staff will not be needed to do this given the ability
to scan and store massive amounts of medical research and the results of previous diagnoses. A
key challenge for senior managers is to reallocate the money saved from automating the business
into the development of talent required to move their businesses forward with new strategies and
more effective use of digital techniques.
The challenges of digital technology
Although digital technology does bring with it many opportunities, it also creates challenges.
These include the following:
• Leadership. Just because digital technology exists does not automatically mean that
businesses will become more competitive. In fact, it may well be a threat to some
organisations. Morrisons, the retailer, was slow to go online, for example, and lost market
share as a result. The successful businesses will be those where the managers see the
opportunities digital can provide and have the necessary leadership skills to guide the business
so it can capitalise on them. This may involve significant change and investment; for example,
when moving more of a business online, leadership will be needed to provide the vision and to
push forward the implementation. At the BBC, for example, the management have had to push
the business to think more digitally so that, for instance, news content is now shared and
available anywhere any time on any device. There is also a danger with digital technology that
investment happens but does not bring the required results because it is not thought through or
used effectively; leadership may be needed to ensure ‘going digital’ provides a competitive
advantage. For example, simply gathering more data about customers does not in itself ensure
better decisions are made; the right questions have to be asked and the data has to be
interrogated and interpreted correctly.
• Culture change. Digital technology enables decisions to be based on data. This means
managers can ask key questions such as ‘what do we know?’ rather than ‘what do we think?’
For some, this is a culture change because they have been used to acting on instinct. In many
organisations managers still tend to pretend to use data or try to find data that supports what
they want to do anyway. Technology should enable them to make logical decisions but they
have to be prepared to approach decision making in this way. Actually analysing data may
well challenge some assumptions and some established ways of doing things. This may not
always be popular!
• The rate of change. The importance of anticipating and reacting to the rapid change of digital
is rising dramatically. That means managers need to monitor trends, engaging in regular
planning exercises to predict future trends, and be sure they can respond rapidly when
competitive conditions shift. For example, few of the traditional mobile phone manufacturers
protected themselves against Apple’s disruption via the iPhone. What will be the next big
challenge?
The pressures to adopt digital technology
The pressures to adopt digital technology include the following:
• The need to keep up with the market. If customers are researching online, for example, and
don’t find a particular business when they search, then that business will miss out on sales. If
customers are expecting an online presence and a company don’t have one, it can expect to be
overlooked. E-commerce provides part of a multi-platform strategy; without it a business may
be fighting with one hand tied behind its back.
• The need to keep pace with competitors’ decision making and strategy. If competitors are
gathering and using data more wisely to make their strategic decisions, then they are likely to
be more efficient and effective, and a less effective business may struggle to compete.
• The need to keep costs down. By operating online rather than on the high street, for example,
costs can be reduced. This can be a very strong driver for small businesses entering a market.

Business in focus: Smart devices

Figure 38.8 Smart devices

The ownership of ‘smart devices’ in the UK has been increasing rapidly according to a
survey by PwC. It is set to increase even more. In 2017, 30 per cent of people asked
planned to buy a smart device in the next two years. Some of these devices will be
wearable technology such as Fitbits but there is particularly fast growth in the
purchase of home assistants such as those produced by Apple and Google.
The survey results suggested that sales of smart devices in the UK in 2019 will be
around £10.8 bn.
Source: PwC

Practice questions
1 Analyse two factors that might affect the adoption of smart devices.
(9 marks)
2 To what extent are smart devices an opportunity or threat for businesses?
(16 marks)
The threats of digital technology for
businesses
According to McKinsey, the management consultants, there are a number of pressures on
businesses as a result of digital technology.
Downward pressure on prices and on profit
margins
Digital technology is making it easier for potential buyers to compare prices, levels of service
and the performance of different products. Customers can find alternatives and switch accounts
more easily, increasing rivalry in the market. The level of competition is further increased by
new businesses bringing together information to make it even easier for consumers to compare
offerings and prices of different businesses. In South Korea, for example, OK Cashbag has a
mobile app that brings together product promotions and loyalty points from more than 50,000
retailers. In the UK, there are websites such as GoCompare and Expedia. These forces push both
prices and profit margins downwards. In the energy industry there has been a slowness by
customers to shop around for the best prices, which has allowed the energy companies to earn
what some regard as unusually high profits; online sites should reduce the perceived difficulty of
finding the best deal, reducing what are known as switching costs’ and putting more pressure on
providers to be competitive.
New unexpected competitors
Digital technology removes many of the old barriers to entry to a market and enables new
competitors to come from unexpected places. Setting up an insurance company or bank now no
longer requires physical distribution networks. New competitors can often be smaller companies
that can do a lot of damage to established firms. In the retailing industry, for instance, new
businesses can focus on niche markets, attacking the edges of the more mainstream retailers.
Competition is made easier by the fact that it is becoming increasingly easy to buy and integrate
aspects of an online business from other providers. Amazon, for instance, offers businesses
logistics, online retail ‘storefronts’ and IT services. This enables other businesses to start up
easily and be functioning quickly with relatively little investment, making use of the services
Amazon provides. New businesses can tap into different portals and add other services to create
their own business.
Keeping up with change
Change is increasingly rapid and is changing the shape of industries. Major players can quickly
find themselves offering the wrong product. Look at the music industry, where the business
model has shifted from selling tapes and CDs (and then MP3s) to subscription models, like
Spotify. In transport markets digital technology (including a combination of mobile apps, sensors
in cars and data in the cloud) has created a business model for companies such as Zipcar, where
people pay to use cars when they need them rather than owning them. Driverless vehicles are
increasingly being tested in cities around the world, again moving the transport industry forward
and bringing in new competitors. We may buy Google cars not Ford cars in the future. This
affects not just the producers but related industries – what happens to car insurance companies if
we end up in driverless cars that don’t crash?

What do you think?

Netflix is the world’s leading internet entertainment service with over 139 million paid
memberships in over 190 countries enjoying TV series, documentaries and feature
films across a wide variety of genres and languages,
Do you think the success of Netflix depends on developing good programme content?
The impact of digital technology on the
functional areas of the business
As with any major change in a business, adopting digital technology will have an impact on the
functional areas. The precise effect will depend on the change being made but could include the
following:
• Human resources. There may be changes to the skills required as greater information
technology skills are needed. In particular, in a world of more data, the ability to analyse and
ask the right questions of the data are increasingly important. The nature of jobs may change,
focusing more on using data (rather than intuition) and it may be that some jobs are affected
more than others, for example, in traditional print advertising or publishing.
• Marketing. Digital technology enables far more data on customers to be gathered and to be
linked to them as individuals. This can lead to far more personalised and efficient marketing.
There should be ‘less noise’ for customers (so fewer irrelevant messages) and a closer fit
between what the business offers and what is wanted.
• Finances. This will depend on what aspect of digital is being considered. Going online, for
example, may lead to cheaper transaction costs than having a retail outlet, but a distribution
network will need to be established which can be expensive.
• Operations. The impact will again depend on which aspect of digital technology is being
considered. ERP, for example, will provide more data on different aspects of the business and
should enable greater efficiency, better cash flow and less wastage. The use of big data should
enable operations to be more flexible to demand and, therefore, reduce time lost and inventory
being wasted.

Business in focus: Kickstarter

Kickstarter is a crowdfunding site which describes itself as ‘an enormous global

community built around creativity and creative projects’. Since Kickstarter was
launched in 2009, 16 million people have backed a project, $4.1 billion has been
pledged and over 157,000 projects have been successfully funded. It connects people
with ideas to people willing to invest to help fund these ideas to make them happen.
Kickstarter became a Benefit Corporation – these are for-profit companies that are
obligated to consider the impact of their decisions on society, not only shareholders.
Kickstarter have specific goals and commitments to arts and culture, making their
values core to their operations, fighting inequality, and helping creative projects come
to life including:
• creating tools and resources that help people bring their creative projects to life,
and that connect people around creative projects and the creative process
• caring for the health of its ecosystem and integrity of its systems
• engaging beyond its walls with the greater issues and conversations affecting artists
and creators
• never selling user data to third parties. It will zealously defend the privacy rights and
personal data of the people who use its service, including in its dealings with
government entities
• not using loopholes or other esoteric but legal tax management strategies to reduce
its tax burden. Kickstarter will be transparent in reporting the percentage of taxes it
pays and explaining the many factors that affect its tax calculation
• limiting environmental impact. It will invest in green infrastructure, support green
commuting methods, and factor environmental impact when choosing vendors
• annually donating five per cent of its after-tax profit towards arts and music
education, and to organisations fighting to end systemic inequality.
Source: Kickstarter Charter

Practice questions
1 Analyse why someone might invest in a Kickstarter project.
(9 marks)
2 To what extent is crowdfunding a better way than a loan for a creative artist to
finance a project.
(16 marks)

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 What is meant by data mining?
2 What is B2B e-commerce?
3 What is B2C e-commerce?
4 What is meant by ‘big data’?
5 Which of the following do the initials ERP stand for?
a Enterprise reality planning
b Enterprise resource peripherals
c Enterprise resource planning
d Employment register permit
6 Explain how digital technology provides an opportunity for business.
7 Explain one reason why digital technology may be a threat to a business.
8 Explain one reason why digital technology might lead to better decision making.
9 Explain one way digital technology might affect the marketing function of a
business.
10 Explain one way digital technology might affect the human resources function of a
 business.

(b) Short answer questions

1 Explain one benefit to a retailer of investing more in e-commerce.
(5 marks)
2 Explain one disadvantage to a retailer of the growth of e-commerce.
(5 marks)
3 Explain one way data mining might benefit an airline.
(5 marks)
4 Explain one way that ERP might benefit a car manufacturer.
(5 marks)
5 Explain one way that digital technology is changing the TV industry.
(5 marks)

(c) Data response question

Alibaba
Alibaba is a giant online Chinese business. It has an 80 per cent share of the Chinese
online commerce market. The company’s first business was alibaba.com set up by the
company’s founder Jack Ma in 1999. It started with 18 people and is now a worldwide
company employing over 66,000 people. It has over 550 million users.
Alibaba’s Mission is ‘to make it easy to do business anywhere’.
Alibaba says it achieves this by giving suppliers the tools necessary to reach a global
audience for their products, and by helping buyers find products and suppliers quickly
and efficiently.
The company has many different activities including:
• www.alibaba.com – a website that helps to connect exporters in China (and other
countries) with companies in over 190 countries around the world. The site allows a
business in the UK to find a manufacturer in China and order items to be produced
and shipped
• www.taobao.com – China’s largest shopping website
• www.tmall.com – another website that offers a wide selection of branded goods to
China’s emerging middle class
• www.aliplay.com – an online payment system like Paypal
• a large stake in Sina Weibo, China’s version of Twitter
• the online video provider, Youku Tudou, which operates like YouTube
• Ant Financial – a technology company offering financial services.
More than 80 per cent of online sales in China take place on one of Alibaba’s
websites. Being so big in the Chinese market is no mean achievement. China now
has well over 600 million internet users, out of a population of 1.3 billion people.
In 2015, Alibaba was floated and sold $25 billion of its shares. The flotation valued the
company at £223 billion. Its revenue is mainly through selling advertising space rather
than taking commission on sales. By the end of 2018, its market capitalisation was
over $352 billion. The company has reported income growth of more than 50 per cent
for each quarter for the past two years. However, the internet giant’s operating margin
has been squeezed over the past year, falling from 25 per cent to 15 per cent.
Most recently, Alibaba bought a stake in Snapchat, investing approximately $200
million (£133 million) in the messaging application. That values the four-year-old firm
at nearly $15 billion (£10 billion), making it one of the world’s most valuable start-ups.
Snapchat allows users to send text and picture messages which disappear in ten
seconds. The $15 billion valuation puts the business in a league with taxi service Uber
and Xiaomi, the Chinese smartphone maker. Snapchat says its users send 700 million
snaps daily and the company recently started generating revenue from advertising.
Other developments include a move into the banking sector.
And it keeps growing. For example, in 2016, it launched Alitrip, later named Fliggy, an
online travel platform designed as an online mall for brands such as airline companies
and agencies.
In 2018, Jack Ma, the founder and executive chairman of Chinese e-commerce giant
Alibaba, intends to step down in the following year. His successor is Mr Zhang who
developed the company’s Singles’ Day promotion, which is the world’s biggest one-
day online retail event.
Source: Adapted from Alibaba website, www.alibaba.com

Questions
1 Explain one possible problem Alibaba might have faced when growing.
(5 marks)
2 Analyse what determines competitiveness in the online markets in which Alibaba
operates.
(9 marks)
3 To what extent should investors worry about Jack Ma standing down?
(16 marks)

(d) Essays
1 To what extent is digital technology inevitably an opportunity for a start-up
business? Justify your answer.
(25 marks)
2 To what extent is adopting digital technology essential to be competitive in the
retail sector these days? Justify your answer.
(25 marks)
Revision Section: Unit 9 Strategic
methods: how to pursue strategies
Advice for Unit 9
Top tips … Things to avoid …
Remember when evaluating the method of Do not assume one way of
growth chosen by a business to consider factors growing is right for all.
such as the risk involved, the costs, the speed Remember that different
of growth and the impact on control. forms of integration bring
Franchising, for example, may be cheaper and different benefits. If you want
faster than organic growth, but involves giving to control your supplies, then
up some control over day-to-day decisions. vertical integration is
appropriate. If you want to
reduce direct rivals, then
horizontal integration is
required. Do not assume all
forms of integration lead to
the same outcomes.
Aim to understand the difference between the Do not assume that simply
different forms of intellectual property as these spending more money on
can often be confused. areas such as research and
development will
automatically lead to more
innovation; there are other
factors such as the culture of
business and expertise of
employees that matter.
It is important to think carefully about the Do not assume change is
particular situation facing any business – some good for all businesses.
lead the way in exploiting the opportunities of Whilst digital technology can
digital technology, some are catching up and create many opportunities for
some have been left way behind. Also think a business, it can also bring
carefully about the implications of digital. Selling threats. Be careful to assess
all over the world from your website may seem whether the business is
appealing, for example, but how do you develop leading and engaging with
your website for each market, how do you change, whether it is reacting
process the transactions and how do you to it or whether it is getting left
ensure rapid delivery? It is important to be able behind.
to take a critical view of digital technology.
When considering the internationalisation of a Do not assume that selling
business, consider what it involves. For abroad or producing abroad is
example, is it buying from or selling to foreign always successful. It can
countries or both? Which countries are involved bring many problems. In
and how well does the business understand terms of marketing, several
these? Remember that countries differ UK businesses have
massively, for example, in terms of competitive withdrawn from overseas
conditions, the legal environment, the culture because they did not
and the economy. understand the market
properly. In terms of
production, several UK
businesses have experienced
problems with costs,
reliability, speed and quality.
UNIT 9 CHECKLIST
Having completed studying this unit you should be able to do all that is listed below.
You should read this list and confirm that this is the case.
Learning Outcomes
Assessing a change in scale
Know and understand:
• how to analyse the reasons why businesses might grow or retrench
• the different types of growth including organic and external growth
• how to manage and overcome the problems of growth or retrenchment and how to
analyse the issues with growth, including economies of scale, economies of scope,
diseconomies of scale, the experience curve, synergy and overtrading
• how to analyse the issues with managing growth, including Greiner’s model of
growth
• that methods of growth include mergers, takeovers, ventures and franchising
• types of growth, including vertical (backward and forward), horizontal and
conglomerate integration
• how to analyse the impact of growth or retrenchment on the functional areas of a
business
• how to assess methods and types of growth.
Assessing innovation
Know and understand:
• the meaning of, and the pressures for, innovation
• the different types of innovation, that is, product and process innovation
• the value of innovation
• the ways of becoming an innovative organisation including Kaizen, R&D,
intrapreneurship and benchmarking
• how a business protects its innovation and intellectual property, including patents
and copyrights
• the impact of an innovation strategy on the functional areas of the business.
Assessing internationalisation
Know and understand:
• the reasons for targeting, operating in and trading with international markets
• the methods of entering international markets, including export, licensing, alliances
and direct investment
• how to analyse factors influencing the attractiveness of international markets
• how to analyse reasons for producing more and sourcing more resources abroad
• how to assess decisions regarding producing overseas, including off-shoring and
re-shoring
• how to analyse ways of entering international markets and assess the value of the
different methods
• that targeting overseas markets may include being a multinational
• the influences on buying, selling and producing abroad
• that managing international business includes managing the pressures for local
responsiveness and the pressures for cost reduction
• how to analyse how international businesses are managed using Bartlett and
Ghoshal’s model of international, multi-domestic, transnational and global
strategies
• how to analyse the impact of internationalisation for the functional areas of the
business.
Assessing greater use of digital technology
Know and understand:
• the pressures to adopt digital technology
• that digital technology should include e-commerce, big data, data mining and
enterprise resource planning (ERP)
• how to assess the value of digital technology
• the impact of digital technology on the functional areas of the business.
Practice questions
1 Explain one benefit to a business of having a culture of intrapreneurship.
(5 marks)
2 Explain one way in which benchmarking can improve the competitiveness of a
business.
(5 marks)
3 Explain one way in which enterprise resource planning can improve the efficiency
of a business.
(5 marks)
4 Explain one way a business may choose to integrate horizontally rather than
vertically.
(6 marks)
5 Analyse why a business may choose to grow organically rather than externally.
(9 marks)
Case study: How to pursue strategies:
Amazon
Since it was founded in 1994, Amazon, the online retailer, has pursued growth
relentlessly. It is a highly innovative business. It has gone from originally offering
books to now offering a huge range of different products. It has also developed the
Kindle, Kindle Fire and its own smartphone, as well as expanding into cloud
computing, e-books, video streaming and music downloads. Throughout all of its
activities Amazon has gathered data on its customers to try and understand
everything it can about their tastes and shopping habits. It describes itself as one of
the world’s most ‘customer centric’ businesses. Amazon has incredible computing
power to gather and analyse data. It also has one of the world’s most impressive
physical distribution systems.
Amazon’s aim from the beginning has been to gain market share. It believes that if it
achieves scale in its chosen markets, profits will follow in the long term. In achieving
growth the company has been extremely innovative. At one time customers were
worried about paying for items online until Amazon managed to reassure us that it
was safe to do so. Amazon also helped develop the role of customer reviews in
influencing customer purchases. From the start it asked buyers to rate and review
books. Nowadays almost everything is rated by customers.
Amazon has managed to disrupt several industries it has entered. For example, it
revolutionised the way books are bought and sold. Then it dramatically changed
publishing with the launch of the Kindle in 2007. There were other e-readers at that
time, but these were not reliable or user-friendly. By comparison, the Kindle was easy
to use, worked well and allowed instant delivery to the device rather than via a PC.
Amazon also pioneered a new business approach to cloud computing. In 2006, it
began renting out computer capacity by the hour. The option to rent rather than buy
computing power greatly reduced the cost and complexity of launching a new
company. Amazon’s cloud services have been used by start-ups including Netflix,
Instagram, Pinterest, Spotify and Airbnb.
Other Amazon developments have included the Amazon Echo and Amazon Prime. In
recent years Amazon has even moved into food retailing with the acquisition of Whole
Foods chain store. In 2018, Amazon’s market capitalisation rose to over $1 trillion.
Amazon’s approach has been focused on the long term throughout. Whilst
shareholders are usually obsessed with short-term dividends, with Amazon they get
long-term growth of the business. Amazon is happy to operate with low profit margins
and pursue scale. Given a choice between making a profit and investing in new areas,
it will always choose the latter. Unlike other technology companies, Amazon does not
sit on huge amounts of cash because it has many ideas on how to use it instead.
Perhaps surprisingly investors seem to like this as its share price is extremely high. It
rewards its staff mainly with shares rather than high salaries to keep them focused on
moving the share price upwards.
However, Amazon has been criticised for some aspects of its behaviour. It is accused
by some of:
• not paying enough tax because it uses legal tax avoidance techniques to declare its
profits in low tax countries
• being a tough employer
• competing very aggressively against its rivals
• damaging small business, such as local bookshops.
There is also a concern that Amazon is becoming so powerful that it may abuse its
market power; when rivals leave the market, for example, will Amazon start to
increase its prices?
Source: Amazon website
Practice questions
1 Analyse the factors Amazon might consider before deciding which markets to move
into next.
(12 marks)
2 Analyse the benefits to Amazon of being innovative.
(12 marks)
3 To what extent do you think rewarding staff with shares rather than high salaries is
a good idea?
(16 marks)
4 To what extent do you think Amazon should keep targeting new markets?
(20 marks)
5 To what extent do you think Amazon should worry about criticisms of its behaviour?
(20 marks)
6 To what extent is pursuing growth always a good strategy for a business?
(24 marks)
Essay questions
1 To what extent is more investment in research and development the key to
becoming an innovative pharmaceutical company?
(25 marks)
2 To what extent will more investment in digital technology provide a business with a
competitive advantage?
(25 marks)
Chapter 39 Managing change
Introduction
Businesses operate in an ever changing environment. Change can come from outside the
business or from within. The ability to anticipate, prepare for and respond to change is essential
for a business to remain competitive. In this chapter we consider the causes of change. We also
consider why there might be resistance to change within a business and how managers might
seek to overcome this. We also analyse how managers might seek to build a flexible organisation
to enable a business to cope with the threats and exploit the opportunities of change.
What it is important to know by the end of this chapter:
• the causes of, and pressures for, change
• the different types of change including internal change, external change, incremental change
and disruptive change
• that managing change includes Lewin’s force field analysis
• the value of change
• how to analyse the value of a flexible organisation
• that flexible organisations include: restructuring, delayering, flexible employment contracts,
organic vs mechanistic structures and knowledge and information management
• how to analyse the value of managing information and knowledge
• how to analyse and evaluate the barriers to change
• how to use Kotter and Schlesinger’s four reasons for resistance to change
• how to overcome barriers to change including Kotter and Schlesinger’s six ways of
overcoming resistance to change.
Managing strategic change
Sign up to any news feed and you will see how much is changing in the business environment
every day. Some changes are:
• external – they happen outside of the business. For example, in recent years a political dispute
between the US and Iran has led to trade sanctions. These changes are out of the control of any
individual business but, nevertheless, are very significant for any organisation trying to trade
in these areas.
• internal – this is change that happens within the business. For example, over time staff may
have ideas to change the way things are done.
Change may be:
• rapid and unexpected, such as sudden bad weather conditions disrupting supplies. This can be
a big issue in industries such as coffee and agricultural products.
• long term, such as the shift in economic power towards economies in India and China or
ageing populations in the UK and Japan. These are shifts that are predictable in terms of how
they are developing and, therefore, managers have more time to prepare but they are
nonetheless very significant.
• incremental – this means step-by-step change. Most businesses will gradually improve their
processes over time. Staff or customers will have suggestions of small changes that over time
can build and move the business forward quite significantly.
• disruptive – this refers to ‘game changing’ developments in an industry. Think of Dyson
launching a bagless vacuum cleaner or the Dyson Airblade hand-dryer, the impact of digital
cameras on traditional camera makers, the impact of email on the postal service, the effect of
smartphones and GPS on the sales of maps and street atlases and navigation-product makers
like TomTom, Garmin and Magellan. More recently, think of how Amazon has challenged the
book retailing industry, how Tesla, the electric car producer, is challenging our understanding
of what a car might be and do, how Uber has completely changed the taxi industry, how
Airbnb is threatening hotels, how Dropbox has changed the way we save and share files, how
Spotify has changed the way we access music and how Skype has changed the way we
communicate – new businesses, new technologies and new ways of meeting customer needs
are creating changes that are so significant they are disrupting whole industries. These changes
are dramatic for the industries involved and, if a business is on the wrong side of them, can
prove to be quite overwhelming.

Business in focus: Changing industries

Uber
Uber has completely changed the taxi industry, even though it itself is not a taxi
business. It owns no taxis and has no taxi drivers as employees, and yet is an
increasingly large provider of taxi services. The company matches what the customer
 wants in terms of a taxi ride to a driver and car and then takes 20 per cent of the fare
for organising this. Customers use the Uber app to call a taxi; they can see from the
app the nearest one and find information on the car, the driver and the ratings this
driver has received from previous passengers. The value of Uber to the customer is
the convenience of finding a car of their choice easily and the fact that Uber screens
the taxis and drivers to ensure safety and comfort.

Figure 39.1 Uber app – the new way to hail a taxi

Tesla
Tesla is an automobile company that produces electric cars. They have brought
massive innovation to car design and look like making low-emission electric cars
mainstream purchases. Not only that, but Tesla keeps innovating and changing our
view of what a ‘car’ actually is. All Tesla cars are now equipped with the ability to drive
themselves! It looks like the autopilot feature in cars will go from something drivers
use to take an occasional break, to something drivers use frequently. And then,
seemingly overnight, the car’s software, rather than its owner, will become the driver!
Tesla cars can communicate with other cars, calculate appropriate speeds for the
road conditions and choose the optimal route at any given moment given traffic
conditions. All of these developments rely on software, whereas innovations in cars in
the past traditionally came from developing more aspects of the physical product. This
means the software developers become the key to car design and this could seriously
threaten existing car manufacturers whose experience in this area is limited. Tesla
thinks more like Apple than like General Motors.

Practice questions
1 Analyse how the established taxi businesses may respond to the growth of Uber.
(9 marks)
2 To what extent do you think established businesses in any industry will always lose
market share eventually?
(16 marks)

Future disruptive change is expected. For example:

• The development of new applications that collect, report and respond to information from our
own bodies is well underway. Apps track our health and flag when and what action is needed,
thereby affecting the health care industry. More and more of us are beginning to wear
technology such as Apple Watches. This technology will learn more about what we do, what
exercise we do and our physical condition and then report back to us or others on our health.
Not surprisingly, Google is looking carefully at health care businesses.
• 3D or additive manufacturing is the process of making three-dimensional solid objects from a
digital file of data. In an additive process, an object is created by laying down successive
layers of material until the entire object is produced. With traditional production you need to
set up the production equipment and tools to produce a particular design. Having to set up
these tools, which is an expensive process, a business has to produce on a relatively large scale
to spread the costs. This ‘tooling up’ is not needed in an additive process where the ‘printer’
simply prints (manufactures) what is designed. This will speed up product development time
and provide much greater flexibility. With 3D printing, businesses can make one-off
personalised products. The lower set-up costs of 3D printing also makes it easier for there to
be new entrants to the industry, which could transform the competitive structure. In fact, you
may even be producing some products and some replacement parts for your equipment at
home. If designs become readily available and are shared and printing costs continue to fall
rapidly, our homes could become mini factories.
• The Internet of Things – this is technology in which everyday items became fitted with the
ability to collect, send, and receive information. The idea behind this is to connect any device
to the internet and to each other. This includes everything from mobile phones, coffee makers,
fridges and washing machines. This also applies to components of machines, for example, a jet
engine of an aeroplane or the drill of an oil rig. The analyst firm Gartner says that by 2020
there will be over 26 billion connected devices. In this increasingly connected world wherever
you go, whatever you do, you may be connected! Your printer will know it is running out of
ink and will reorder for you, your car might know it is due a service, your heating system
knows to change the temperature, billboards will change their adverts as you drive past.

What do you think?

Do you think change is happening faster than it did in the past? Does it matter for
business if it is?
Lewin’s force field analysis
Managers should be constantly monitoring the changes that are relevant to their industry, as well
as facing internal pressures for change such as employees wanting to implement new plans.
However, managers are often too busy with their ‘day job’ to appreciate exactly what is
happening and just because there are pressures to do something differently does not mean this
will automatically happen. Often ideas and plans have been talked about for months or even
years without anything actually changing. Just think how long the discussion over where to put a
new runway in the UK has been going on. This is because whilst some forces may be pushing for
change, other forces will be pushing back to keep things as they are. At any moment a business is
likely to be in a position of equilibrium – staying as it is.
This is illustrated in Lewin’s force field analysis model.
In Figure 39.2 the forces pushing for change might include:
• the need to keep up with the competition
• an increasing number of customer complaints
• new owners wanting higher returns
• a poor performance.

Figure 39.2 Lewin’s force field analysis model of change

Business in focus: Twitter

To see how disruptive technologies can emerge using existing technology, look at
Twitter. Twitter began its life in 2007 having been developed at a hackathon the year
before. Its developers wanted to test sending standard text messages to multiple
users simultaneously; this required an experiment that needed almost no new
technology. The company now boasts well over 300 million active users and more
than half a billion tweets a day. Twitter has changed the way we communicate in a
remarkably short space of time.
To see how disruption often comes from somewhere unexpected, think about map
making. For years map making was a mature industry dominated by a few companies
and the not-for-profit automobile clubs. Competition started with free internet sites for
route directions, such as MapQuest and Yahoo Maps. Then came standalone and
dashboard devices such as Garmin and TomTom that use GPS satellite data to
generate real-time routes and turn-by-turn spoken directions. The big disruption,
however, came from the smartphone and, yet, this was never intended to compete
with traditional navigation aids. The Google Maps app, for example, offers virtually all
 the features of high-end GPS devices and it costs nothing – it’s just another add-on
for the free Android operating system. Garmin lost 70 per cent of its market value in
the two years after navigation apps were introduced; TomTom lost nearly 85 per cent.

Practice questions
1 Analyse the actions Garmin and TomTom might take in response to the changes in
their industries.
(9 marks)
2 To what extent do you think the continued growth of Twitter is very likely? Justify
your answer.
(16 marks)

The forces resisting change might include:

• a lack of finance for investment
• a reluctance on behalf of existing staff to change the way they do things
• resistance from certain stakeholders groups that might be worse off following the change.
For change to actually occur, the balance of these forces must alter:
• The drivers for change may get stronger. For example, if the business falls ever further behind
its rivals, this clearly makes the need for change stronger.
• The forces resisting change may be reduced. For example, employees may begin to see the
need to change more clearly and, therefore, become more open to the idea, or the financial
position of the business might improve providing the money needed to invest in changing its
approach.

Key models and theories: Lewin’s force field analysis

Lewin’s force field analysis considers the forces for and against change in any
situation. It helps managers to analyse those factors that push for change to happen
and those factors which push to keep things as they are. It provides a framework to
analyse a given situation. If managers want change to happen, they might consider
how they can overcome the resisting factors; at the same time, they might look to
increase the pressures for change or at least make more people aware of the
pressures that exist.
Mangers may then develop policies to increase the pressures or reduce the restraining
forces.
Pressures for change
The pressures for change may be:
• internal – for example, managers or other employees may be eager for things to be done
differently. They may have experienced new ways of doing things in other organisations or
have been involved with different products in other organisations and feel it is essential to
match this. Alternatively, they may simply be anticipating change in the outside world and
want to get the business ready for this.
• external – this occurs with change in the external environment – for example, political,
economic, social, technological changes as well as changes in factors in the competitive
environment. External changes such as changes in the value of currencies, the price of oil, the
cost of borrowing money, market conditions, new businesses starting up and new laws are
hugely significant to business and create new opportunities and threats.
When a business changes its strategy this means there has been a shift in the balance of the
drivers for change and the forces resisting it. In some cases, managers will want to lead this
strategic change by changing the different forces.
The value of change
Change can be scary and frightening. If a business is not keeping up with the changes that are
occurring elsewhere, if other organisations seem to be pushing forward and leading the change
and a business is simply feeling the effect of these changes, then change can rightly be seen as
threatening.
However, this is not the case for all change and for all individuals or all organisations. For
example:
• Some change can bring positive benefits – think of an economic recovery or higher levels of
customer confidence leading to more spending.
• Some change may be foreseeable and, therefore, managers can prepare for it – it is clear that
the population is ageing in the UK, for example, and this creates opportunities for businesses
that build retirement homes if they act appropriately.
• Some businesses may lead the change. Companies such as Uber, Snapchat and Dyson
deliberately try to change the types of products we use and the way we work – change for them
creates new possibilities and is not something to fear but is there to be embraced.
Change, whether it is internal or external, is going to happen and so managers need to look
ahead, anticipate and be ready to lead it or react to it. It may bring threats, but it also brings many
opportunities if organisations have the necessary resources and competencies and the right
strategies in place. The very successful businesses around us are the ones that have exploited the
opportunities that change brings; the ones that have performed badly have failed to manage
change well. Kodak and Nokia failed because they missed the changes in their markets.
Whitbread succeeded by realising that beer may not be an attractive market long term and so
moved into Costa Coffee and Premier Inns, building on its strengths in the service industry.
Of course, reactions to change will vary within an organisation. At any moment some divisions
or regions may be doing well and benefiting from changes in their environment, whilst others
may be suffering.

What do you think?

Does change always present potential opportunities for businesses? What determines
if something is an opportunity or a threat?
The value of a flexible organisation
The ability to prepare for or respond to change depends on the flexibility of the organisation.
Managers seek to build a business that is agile, that is one that can adapt and reshape to internal
and external change as opposed to one that is sluggish. However big the organisation, it needs to
be able to adapt when change is needed. Rosemary Moss Kanter wrote a book called Teaching
Elephants to Dance that highlighted the importance of big businesses trying to be nimble.
To be flexible a business may need to restructure, delayer, use flexible employment contracts,
develop an organic rather than a mechanistic structure and emphasise knowledge and
information management.

Figure 39.3 Features of a flexible organisation

Restructuring
It may be that an organisation is initially organised on functional areas, such as marketing,
operations and finance. However, as the organisation expands internationally, it may be more
logical and appropriate to reorganise and base the structure on different geographical regions. By
doing this, the regional managers can focus on and respond more quickly to local changes,
making the business more flexible to these demands. It may be that a business does not want a
traditional structure anyway as it finds this too limiting.
Delayering
Delayering occurs when a layer of hierarchy in an organisation is removed. It may be that a
business needs to remove levels of hierarchy if costs need to be cut and if it needs to reduce the
distance from the top to the bottom of the organisation. This cuts management costs but,
importantly, may lead to faster decision making and more decision making by those who are
closer to their customers.
Using flexible employment contracts
Flexibility can be helped by having broadly defined employment contracts rather than defining
very precisely what an employee has to do. This enables the business to move employees around
as and when they are needed; they can be switched from one task to another or moved from one
location to another as demand patterns change or as the requirements of the business alter. By
comparison, if contracts are very tightly defined, then it may be difficult for managers to adjust
to different situations as employees can argue that ‘it is not my job’.
Flexible employment structures also include the use of temporary employees, contract or agency
workers and part time workers. This enables a business to increase or decrease its labour force as
and when needed. There has been much debate in recent years about zero hours contracts, for
example; these are contracts in which someone is employed by a business but is not guaranteed
any work. When the business needs the employee it asks them to work, when it does not need
them it doesn’t allocate the employee any hours or any pay. These contracts have been greatly
criticised in that they provide no security for the the employee; they also tend to reduce the
employee’s rights to benefits such as sickness pay. However, from a business perspective
flexible employment contracts provide great flexibility and make wage costs variable costs rather
than fixed. In some cases, employees may also welcome flexible employment contracts because
it may enable them to work when they want to.
Developing an organic structure rather than a
mechanistic structure
A mechanistic structure is one that is very formal. There are clear rules and procedures, there are
many levels of hierarchy, there is close control over employees and the result is that the business
performs in a known, predictable manner and delivers known, consistent outputs. This may be
desirable in some situations – for example, you may want all insurance claims to be processed in
the same logical, fair and objective manner.
Organic structures tend to have more fluid teams that are created for specific projects and then
end with new teams being set up for new challenges. There is no fixed set of reporting
relationships – these relationships change according to who is needed for what and according to
what particular projects are being undertaken. Organic structures tend to involve people based on
their ability to contribute to a task rather than based on their job title and level of seniority.

Key term
A mechanistic structure is one in which there are many rules and procedures and
clearly defined roles and levels of hierarchy.

The writer Gary Hamel argues that employees should be more self-managing, creating their own
teams when they need them, bringing together the expertise required as and when but not
working within a formal structure which is too traditional and limits creativity. Concepts such as
span and hierarchy are totally out of date in the knowledge, creative-type businesses that are so
successful – ‘structure, if there is such a thing, needs to be far more fluid’.

Business in focus: Valve

Valve is a computer games developer. It has a very interesting approach to managing

people – essentially it expects employees to manage themselves. Employees are
expected to follow through their ideas by talking with colleagues, working out what is
needed and then trying it. Valve is not a world of hierarchy. In its staff handbook it
says ‘Welcome to Flatland’!
The company says that, whilst hierarchy is good for predictability and control, in
Valve’s world which is full of intelligent, innovative, creative people and where ideas
are needed and valued, hierarchy does not work. Valve is ‘flat’ which means there is
no hierarchy and nobody reports to anyone else. As it says: ‘You have the power to
green light projects. You have the power to ship products.’

Practice questions
1 Analyse the reason why Valve has this approach to organisational design.
(9 marks)
2 Do you think Valve’s approach would work for every organisation? Justify your
answer.
(16 marks)
Emphasising knowledge and information
management
The ability to be flexible depends largely on managers knowing what is happening and what
needs to be done and on all employees knowing what the strategy is and what their role in the
plan is meant to be. This involves gathering data effectively and ensuring that the relevant
information is available in the right format, at the right time, for the right people. Within any
organisation there is a huge amount of knowledge about customers, suppliers, systems,
processes, what works well, what does not work and who can or can’t do what. Gathering this
knowledge and making sure it can be tapped into and shared, especially across a large
organisation, is a significant challenge. An organisation’s ability to manage data effectively will
influence its ability to understand what it needs to be doing in a changing environment and to
help employees to do things successfully.
The value of managing information and
knowledge
Information is a key resource these days. Developments in technology have made much more
data available to businesses. Through online sales, data from tills, data from loyalty cards as well
as access to hundreds of other databases about issues such as the economy, companies and
population patterns, businesses can pull together vast amounts of data.
By managing data effectively managers can:
• identify changes before or as they happen
• develop suitable strategies to respond to or prepare for change
• evaluate the effectiveness of the strategies adopted.
If a business does not manage information effectively, it will be making decisions in the dark
whilst everything around it is changing rapidly – a dangerous approach! Managers need to
capture the information that exists and find ways of sharing knowledge between employees. This
often involves investing in information systems and systems to store and access knowledge
databases.

Business in focus: McKinsey

A challenge facing many businesses is how to gather, store and share information
between employees who may be in completely different divisions and even parts of
the world. This is extremely important in many organisations. Think of the world of
management consultancy, for example, where employees may have worked on
similar projects before and, therefore, their expertise would be incredibly valuable.
At the management consultancy McKinsey, for example, the company has developed
The McKinsey Knowledge Network, a global network of over 2,000 knowledge
professionals working alongside McKinsey consultants. These consultants help to
develop, codify, sanitise and manage McKinsey’s global knowledge portal, which
includes more than 50,000 documents and is at the heart of the company’s
knowledge management system which forms the firm’s backbone. The access to
knowledge is a key competitive weapon in the consultancy business.

Practice questions
1 Analyse the difficulties that might exist for a global business such as McKinsey in
storing and sharing knowledge.
(9 marks)
2 McKinsey is a management consultancy. To what extent do you think knowledge
management is important to McKinsey? Justify your answer.
(16 marks)
Resistance to change
Whilst some employees may welcome change, others will almost inevitably resist.

Figure 39.4 Reasons for resistance to change

According to Kotter and Schlesinger, resistance to change occurs for four main reasons:
1. Self-interest. People wish to protect their own self-interest. Some may resist change because
they think they will be worse off. They may lack the knowledge or skills required in the new
world or they may be worried they will lose their bonuses, their jobs or their status within the
business.
2. Preference for the present situation. People prefer things the way they are. Some may not
have particularly strong feelings about change except for the fact that they prefer to leave
things as they are. Change may be seen as a hassle and people may prefer to stay within their
comfort zone of doing things the way they have always been done. Some people don’t like
change simply because it means doing things in a different way.
3. Differing assessment of the situation. People do not agree with the change. Some may resist
the change because they do not think it is the right plan. They may think they have a better
idea of how the change should occur, or they may simply disagree with the strategy and think
it will fail.
4. Misunderstanding. People may not understand why change is needed. Employees may not
appreciate there is a need for change and think that everything is fine as it is.

Key models and theories: Kotter and Schlesinger

Kotter and Schlesinger identified four reasons why people resist change. This provides
a useful framework when analysing resistance. Look at any situation in the news where
resistance is occurring, and you can use this model to identify the reason or reasons
why this is happening. This is important because you can then develop ways of
overcoming this resistance.
What do you think?
Do you think all change in business will face some opposition if managers make a
change?
Overcoming resistance to change
There are many ways in which managers may try to overcome resistance to change. According to
Kotter and Schlesinger, these include the following:
1. Education and communication. Managers need to explain to employees why the change is
occurring, why it is needed and why it will work. This can bring about effective change
because, if it works, employees will understand the reason and ethics of change and can
become ambassadors for it. However, it can be slow to bring about.
2. Facilitation and support. This is when managers ensure employees have the support they
need to cope with the change. This could be the equipment they need, the training or the
emotional support they require to cope with the change.
3. Participation and involvement. To ease change managers may involve employees so they
know what is happening and when, and so they can have some input into the process. The
degree of involvement may vary in terms of how much employees can actually influence
decisions, but by getting participation from staff there may be more commitment to the
change. The problem of this approach is that managers and employees may disagree on how
much involvement is appropriate. Although participation may lead to insights into how to
make the change more effective, it may also lead to delays and obstacles to the process.
4. Manipulation and co-option. Managers may identify the key people who are likely to resist
the change and bring them into the process. For example, they could be on the relevant
committees and be given roles involved in bringing about change. The aim is to win over key
influencers and get them to help win over other employees.
5. Negotiation and bargaining. This occurs when managers do a deal with employees. For
example, they get employees to agree to higher productivity in return for higher wages.
Rewards can be used to benefit those who agree to go along with the change.
6. Explicit and implicit coercion. If managers feel they cannot persuade employees to accept
the change, or where fast change is essential, managers may simply force change through.
This will not in itself change the minds of employees but, if the change then proves to be
successful and helps the business, they may then accept it and eventually agree with it.
Coercion may take the form of threats such as redundancies or pay cuts. These threats may be
explicitly made or it may just be implied that opposition would have negative consequences.

Figure 39.5 Overcoming resistance to change

How a business overcomes resistance to change depends on what the underlying reason or
reasons for resistance are. For example, if employees are worried about their ability to cope, then
training and information may be important. If people resist change because they fear they will be
worse off or simply do not like change, then rewards for changing (if appropriate) may help. If
people think they have a better plan, then participation to listen to the alternatives and find the
best solution may be useful.

Business in focus: A new old town

In 1988, William Samuelson and Richard Zeckhauser, economists at Boston

University and Harvard, wrote about a case in which the West German government
needed to relocate a small town so that it could mine the minerals beneath it. The
authorities suggested many options for what the new town could look like, but the
citizens chose a plan that looked ‘extraordinarily like the layout of the old town – a
layout that had evolved over centuries without (conscious) rhyme or reason.’ This
shows how reluctant we are to change – even when given the option to build any
town we want, we stick with the one we know!

Practice questions
1 Analyse the reasons why people wanted to keep their town exactly the same when
they had the opportunity to design it any way they wished.
(9 marks)
2 To what extent is change always bad for a business? Justify your answer.
(16 marks)

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 Give one example of internally driven change.
2 Give one example of a recent political change that can affect business.
3 Give one example of a recent technological change that can affect business.
4 Give one example of a social change in recent years that can affect business.
5 State one way in which the competitive environment of a business might change.
6 According to Kotter and Schlesinger, state four reasons why people resist change.
7 State four ways of overcoming resistance to change.
8 Removing levels of hierarchy in an organisation is known as ____________.
9 Outline Lewin’s model of force field analysis.
10 Explain one difference between an organic and mechanistic structure.

(b) Short answer questions

1 Explain one reason why a new chief executive may face resistance to a new
strategy that involves delayering.
(5 marks)
2 Explain one way managers of a retail chain could overcome resistance to move
most of the business operations online.
(5 marks)
3 Explain one way that the effective management of information can help the
managers of a cinema business to be successful.
(5 marks)
4 Explain one reason why the employees of a failing business might welcome a
change of management.
(5 marks)
5 Explain one way in which the managers of a large multinational business might
make the business more flexible and responsive to change.
(5 marks)

(c) Data response question

BP
In 2015, the multinational giant oil business BP announced that it was going to incur
restructuring costs of about $1 billion. These charges occurred as BP tried to
streamline its business operations. The company was also reviewing its capital
expenditure plans given the major fall in oil prices that had occurred.
In the previous 18 months, the company had sold off businesses worth more than $43
billion. Its Chief Executive said that the company needed to focus on its core
businesses and, without diverting attention from safety and reliability, the goal was to
make the business stronger and more competitive. This was seen to be essential
given a tougher trading environment and, in particular, the excess supply of oil that
had occurred recently. The US had become a net exporter of oil rather than an
importer due to the success of fracking; at the same time, demand had been falling
due to the slow growth of economies such as China and this had weakened demand.
The low price made many projects that BP had planned on undertaking unprofitable. It
usually assessed projects using a price of around $80 a barrel; by the end of the
previous year the price of oil was at its lowest for five years at $65 a barrel. BP also
announced that it would continue reducing the number of jobs at the company. BP
employed almost 84,000 people worldwide, including 15,000 in the UK.
The restructuring charge mainly involved redundancy costs. The group had been
divesting parts of its portfolio in recent years and is now more than a third smaller than
it was four years ago.

Questions
1 Explain one reason for the low price of oil.
(5 marks)
2 Analyse the possible effects of the changes made by BP on its stakeholders.
(9 marks)
3 To what extent are the changes such as those BP is planning to make bound to
face employee resistance?
(16 marks)

(d) Essays
1 You are the new Chief Executive of a business and want it to pursue much faster
growth but may face some resistance. To what extent would it be best for you to
force through this change in strategy? Justify your answer.
(25 marks)
2 To what extent do you think resistance from employees is inevitable when a
business is restructuring itself? Justify your answer.
(25 marks)
Chapter 40 Managing organisational
culture
Introduction
In this chapter we consider the culture of a business. This refers to the values and attitudes of the
employees within an organisation. The culture of a business can influence how employees make
decisions, what risks they are prepared to take, how they treat customers and what they prioritise.
Culture can be a very powerful driver of strategy and a major determinant of the success or
failure of a business. In this chapter we consider what influences the culture of a business, why
the culture is so important, how managers might attempt to change the culture and the problems
they may facing when doing so.
What it is important to know by the end of this chapter:
• the importance of organisational culture
• how to analyse culture using cultural models, including Handy’s task culture, role culture,
power culture and person culture and Hofstede’s national cultures
• how to analyse and evaluate the influences on organisational culture
• how to analyse the reasons for, and problems of, changing organisational culture.
Organisational culture
The culture of an organisation refers to the values, attitudes and beliefs of its employees. This
determines what employees prioritise, what they think is important, how they react in different
situations and how they respond to change. The culture is clearly very important in terms of how
people behave and how the business performs. Lou Gertsner was a highly successful chief
executive of IBM. When asked about managing a business successfully he said, ‘Corporate
culture is not part of the game: it is the game.’
The culture of a business will be demonstrated in many different ways for example:
• The stories. In any organisation there will be stories about great employees of the present and
past – these stories are very revealing and show what the organisation values. Is it customer
service? Profit, regardless of how it is earned? Is it innovative behaviour or those who
basically did as they were told? Think of your school – which students are featured in the
school’s newsletter? What type of achievements are recognised and celebrated most?
• Rituals. Any organisation will have certain events and certain ways of doing things. These,
again, demonstrate what is important within the business. Does your school have an assembly?
What does this involve and what does this tell you about the culture of the school? Are the
assemblies religious? Are they mainly student led? Do they focus on current issues in the
news?
• The rewards system. Does your school have an awards day? What is rewarded? Good
behaviour? Exam performance? Sporting achievement? The awards on offer show what is
valued within your school. Similarly, the types of rewards and what they are given for tell us
about the culture of the business. Are sales people rewarded for sales or customer satisfaction?
(These may not be the same thing as a customer may be dissatisfied in the long term if you sell
them something that doesn’t really solve their problem.) Is the sales team paid on individual
bonuses or group bonuses? This shows whether or not the business really does value team
performance.
• The physical environment. The decorations on the wall, the facilities and where the
investment goes and the layout of the offices, again, reveal how people within the business
think. Was the last investment in your school in science labs or sports facilities?

Business in focus: Culture in a US football team

In 1979, Bill Walsh took over an American football team that had won 2 games and
lost 14 the previous season. During the entire first year as coach, Walsh spent a lot of
time teaching football players how to wear coats and ties on buses. His view was that
if they wanted to win they had to be professional about everything they did and that
included how they dressed before games, how they presented themselves to the
media and how they arrived at opposing stadia. According to Walsh, it’s essential to
get the culture right and what you wear is an outward sign of this. Two years later, his
team won the Super Bowl – the biggest US football competition there is.
In the UK, Clive Woodward took over the Lions team and focused amongst other
things on what they wore, where they stayed, what they ate and how they trained. He
made sure they had first-class accommodation, first-class transport and started to
think of themselves as winners. Again, it was all part of getting the culture right.

Practice questions
1 Analyse how the culture of a sports team can affect its performance.
(9 marks)
2 To what extent do you think the manager of a sports team can determine its
culture?
(16 marks)
Types of culture
There are, of course, many types of culture; every organisation’s employees have their own set
of values and beliefs. Areas where organisational cultures may differ include the following:
• The focus on profit. Is profit regarded as the key to everything? Is profit seen as the most
important objective for the business – something that is more important than anything else?
• The focus on safety. Is safety seen as a priority? How much is the business willing to invest in
safety? Does safety come before or after profit in people’s minds? This can be extremely
important in industries such as oil, transport and private health care.
• Task vs people. To what extent is getting the job done regarded as important? Is the task
regarded as more important than the welfare and happiness of staff? If an employee had
problems at home, would managers try to understand and work around this or is it an
unfortunate distraction that is seen as getting in the way of work?
It is important to remember that there are, in fact, as many cultures as there are organisations. It
may be possible to group some of them under various headings such as those above (for
example, task focused or people centred), but each business has its own particular culture with its
own approach to planning, rewarding, managing, innovating, dealing with customers, and so on.
In addition, cultures will vary within organisations. Just as you may find that the cultures of the
science and art departments or the sixth form and lower school vary, so do cultures vary between
sites, between divisions and between departments within a business. The marketing team may
see themselves as different from the finance team, who see themselves as different from the legal
team, for example. Whilst having short cuts such as ‘a caring culture’ or a ‘profit-focused
culture’ may help us to get a sense of what happens within a business, culture is in fact much
more complicated than that. To make matters worse, we cannot really know a culture unless we
are part of it. We can guess or draw conclusions by listening to the stories, looking around the
facilities, reading the promotional material and talking to staff, but you will only really
understand a culture if you are part of it, that is an employee of the business in question.

What do you think?

How would you describe the culture of your school or college? How does this affect its
performance?
Handy’s models of culture
There are many ways of categorising culture. Here we will look at Handy’s models of culture
and Hofstede’s national cultures in detail.

Figure 40.1 Handy’s models of culture

Charles Handy is a well-known management writer. He identified four types of culture:

1. Power culture. This occurs when there are a few key people at the centre of the organisation.
These people make all the major decisions. Other employees refer issues to the centre to get a
decision made. This culture is very common in small businesses, especially where the founder
is still heavily involved and wants to keep close control over all the decisions being made.
The positives of this culture are that those at the centre have an overview of everything that is
done and this can lead to quick decision making and a consistent approach. However, as the
business expands this puts greater pressure on those at the centre. An overload on the key
managers can lead to slow decision making and stress. This culture may only be effective,
therefore, in relatively small departments or organisations.

Figure 40.2 Power culture

2. Role culture. In this culture individuals have a clear role within the organisation. They know
who they report to and who they are responsible for. They understand which part of the
business they belong to and identify with a particular function or department of the business.
This type of culture is commonly adopted as a business moves from being a power culture
and starts to formalise processes and procedures more and adopt a functional organisational
structure. It creates order, structure and certainty in a business.
 Figure 40.3 Role culture

3. Task culture. In this type of culture individuals identify with the task that they are working
on. The importance of an individual depends on their ability to contribute to a particular
project regardless of their age, seniority or length of service. This culture is common in a
business where there are many projects – for example, advertising agencies, design businesses
or consultancies.

Figure 40.4 Task culture

4. Person culture. In this culture individuals have their own space; they are given their own
parts of the business to make decisions on and to control. For example, this culture can exist
in hospitals where surgeons have a great deal of independence and in universities where
lecturers have considerable freedom deciding what to do in relation to the modules they run. It
respects the individual’s expertise but means there is not necessarily consistency of approach,
and the very senior managers are placing a high level of trust in others within their
organisation.

Figure 40.5 Person culture

Key models and theories: Charles Handy

Charles Handy developed one model to analyse culture. He identified task, person, role
and power cultures. These cultures are very different in terms of their characteristics.
When analysing a business, you can identify the type of culture that is present and
assess this in terms of employees’ behaviour and the strengths and challenges
presented by each one. A power culture may lead to fast decision making from the top
when an organisation is small but there can be challenges when decisions are made by
relatively few people in a big organisation.
Hofstede’s national cultures

Figure 40.6 Hofstede’s national cultures

Hofstede’s original study was based on his research of employees of IBM to see how cultures
may differ around the world within the same organisation. His studies have identified a number
of areas in which national cultures appeared to differ including:
• individualism vs collectivism
• power distance
• short-termism vs long-termism
• masculinity vs femininity
• uncertainty avoidance.

Individualism vs collectivism
Some societies value the individual; others value the team player. Imagine a football team with a
striker who is a bit greedy but highly talented and a defender who is less ‘flash’ in the way he
plays but very good at passing the ball to others; which of these players is the most valued by the
manager? Similarly, in business, is the individual star sales person praised and celebrated
(encouraging others to push themselves forward) even if they win sales at the expense of their
colleagues, or is more value placed on the sales team that works best as a whole? This will affect
your behaviour at work – are you trying to help others or prove that you are better than them?

Power distance
Is the society one where there is a clear sense of rank and status? For example, in the family are
the elders valued and the younger ones expected to respect them? Or is it a more fluid society
where respect has to be earned according to what you actually do rather than who you are? In a
business this will influence everything from how meetings are run to how decisions are made.
For example, are ‘juniors’ expected and allowed to challenge the views of their superiors or are
they expected to ‘do as they are told’ until they have been there enough years and have a job title
that is senior enough to allow them to contribute? In Japan, for example, it is still the case that
you are expected to adopt a different form of the language when talking to someone superior to
you. This could be your boss or simply a student in the year above you. This reflects a society
where seniority matters – for example, promotion depends on the number of years of service
rather than who is ‘best’ at the job. This is a very hierarchical society that rewards loyalty, status,
seniority and age. The positive side of this is that it avoids fighting and unproductive
competition, but it will not appeal to those who want to rise quickly within an organisation.

Short termism vs long termism

Different societies seem to have different approaches to time. In some countries, individuals tend
to plan for only a few years ahead; in other countries people seem to plan many years ahead.
This may be linked to factors in society such as the political system. For example, in the UK the
government is only in power for five years at most before a re-election and, therefore, the
planning horizon for any government tends to be relatively short term; there is not much
incentive to plan for the long term if you will not be in power then. This might influence the way
everyone thinks in the UK. In other societies such as China, the government assumes it will be in
power forever. This might encourage more long-term thinking throughout society. In business
this will impact on investment decisions. Some managers may look three years ahead whilst
others are willing to take longer term risks.

Masculinity vs femininity
This refers to the decision-making style people adopt. According to Hofstede, masculine traits
include focusing on the self, work, being competitive, winning and material rewards. By
comparison femininity refers to an approach that is more relationship centred, consultative,
caring and involving, and focused on a work–life balance. Put these different approaches
together and there can be conflict. For example, those with a masculine approach may be seen by
others as overly aggressive. Remember that Hofstede is describing an approach, not features of a
particular gender. In some societies or organisations, peoples’ behaviour may be relatively
masculine or relatively feminine.

Uncertainty avoidance
This refers to the extent to which individuals are comfortable with uncertainty. In some societies
people are used to receiving very precise instructions. It is a world of lists, plans and detail;
people know exactly what they are expected to do and when. In other societies people are
comfortable with broader outlines and do not need to be told or shown how to do things. They
prefer to be told the destination and be free to work out how to get there themselves. Put these
two groups together and there can be potential problems. Those who dislike uncertainty want
specifics; those who are happy with uncertainty may find too many instructions in what to do
quite restrictive.

Key models and theories: Hofstede

Hofstede’s work focused on differences between the cultures of different countries.
However, the framework can be applied to analyse cultures in different organisations.
This model highlights how different people can be in the way they look at a problem
(e.g. short-term v long-term) and what they value (e.g. individual achievement v team).
This is important to managers when considering issues that may emerge when
managing people in different organisations or when organisations join together,
because there could be cultural clashes.

Business in focus: Cultural differences

Hofstede’s work analyses the cultural differences between countries and finds some
significant differences. Managers should consider these when dealing with their
counterparts abroad.
On a scale of 1–100, Hofstede’s findings are shown in Table 40.1.
China UK US Japan
Power distance 80 35 40 54
Individualism vs collectivism 20 89 91 46
Masculinity vs femininity 66 66 62 95
Uncertainty avoidance 30 35 46 92
Table 40.1 Cultural differences between countries
Source: The Hofstede Centre

Practice questions
1 Analyse the possible implications for the culture of businesses in the UK shown by
the data in Table 40.1.
(9 marks)
2 To what extent do differences in national culture matter to businesses?
(16 marks)

Business in focus: Short-term culture

Businesses in the UK have often been criticised for having a short-term culture. The
major shareholders in UK listed public limited companies are usually banks and
pension funds. These investors want share price increases and dividends in the short
term to pay out to their own clients. This means the investors are not necessarily
interested in how the business is going to perform long term; they are more focused
on making sure they get quick returns. If they don’t, they will sell their shares and
invest elsewhere. This puts pressure on managers to focus on projects that deliver
short-term returns and avoid projects that might take longer to deliver. This differs
from the situation in some countries such as Germany and Japan where the
shareholders tend to be other stakeholders such as suppliers and distributors; these
partners are interested in the long-term success of the business and are willing to wait
for longer term rewards. Another factor is that managers tend to change jobs every
few years in the UK – this is seen as an important part of building your career. The
consequence of moving jobs so often is that managers will be less eager to undertake
long-term projects because they may not be there to see the results.
However, this is not to say that short-termism is always a problem.
It is possible that, if a business takes too long term a view, managers will avoid
tackling the immediate issues facing them. Nokia, the Finnish mobile phone business,
left Olli-Pekka Kallasvuo in place as Chief Executive for four years despite growing
protests from investors; some say he should have been replaced much earlier. By the
time he was replaced in 2010 the company was very seriously damaged. Arguably
the pressure from investors to report every quarter ensures problems are brought into
the open and is, therefore, desirable. Also, short-term pressure may ensure managers
focus on the performance and avoid letting problems emerge, otherwise, if they do
not, shareholders will sell bringing the share price down. The solution may be a
mixture of short- and long-term views depending on the context. In relatively stable
industries, for example, a long-term approach may be beneficial but in industries
undergoing rapid change such as social media a more short-term approach may be
required.

Practice questions
1 Analyse why there might be a short-term culture in the UK.
(9 marks)
2 Do you think a short-term or long-term approach is better for business? Justify your
answer.
(16 marks)
Influences on organisational culture
There are many influences on the culture of an organisation:
• The history of the business. Some businesses will look back to when they first started and
what worked then and what the founders thought was important. Often stories are told of the
early days and what the founders believed in and valued.
• The present leadership. The current leaders will set an example in terms of what is valued
and what is expected. Leaders will create the vision of what people within the organisation are
trying to create.
• Society in general. What is valued and is held to be important will be influenced by what
employees want and what customers and investors expect; this, in turn, is influenced by the
values of society as a whole. We can see how a greater focus on environmental issues, for
example, has influenced many organisations and changed what they produce and how they
produce it.
• Experience and the performance of the business. If a business is doing well, this will tend to
reinforce the existing culture – whatever you are doing now seems to work so why change it?
On the other hand, if the business is struggling, this may well be a time to question your
assumptions about how to do things.
• Ownership. The ownership of a business will influence what employees value. If it is a
government-owned organisation, for example, there may be more emphasis on social
responsibility and providing a service to society more than profit. If it is a family business,
then the feelings and welfare of family members may dominate. If it is a public limited
company, it may mean that maintaining a high share price and dividend payout may dominate.

What do you think?

Think about the culture at your school or college. What factors do you think influence
this culture? How does the culture affect the success of students at the school or
college?

Business in focus: RBS and HBOS

Royal Bank of Scotland

In 2011, the Financial Services Authority (FSA) undertook a study into the behaviour
of the Royal Bank of Scotland (RBS). RBS had made a number of unsound financial
decisions, including the purchase of the Dutch bank ABN AMRO for which it overpaid
significantly. In the end, the UK government had to bail out RBS because it was in
such a dangerous financial position. The government had to take 80 per cent
ownership of RBS to prevent it collapsing. The FSA report stated that:
 ‘The directors… relied for their due diligence during the disastrous takeover (of
ABN AMRO) on two ring-binder folders and a CD. …The decision to make a bid
of this scale on the basis of limited due diligence entailed a degree of risk-taking
that can reasonably be criticised as a gamble.’
Source: The Failure of the Royal Bank of Scotland, Financial Services Authority (FSA) Board Report,
December 2011

HBOS
In 2013, the FSA undertook a study of HBOS to try to understand what had led to
excessive risk taking at this bank. The report found that:

‘The strategy set by the Board from the creation of the new Group sowed the
seeds of its destruction. HBOS set a strategy for aggressive, asset-led growth
across divisions over a sustained period. This involved accepting more risk
across all divisions of the Group. …the strategy created a new culture in the
higher echelons of the bank. This culture was brash, underpinned by a belief that
the growing market share was due to a special set of skills which HBOS
possessed and which its competitors lacked.’
Source: House of Lords, House of Commons, Changing banking for good, Report of the
Parliamentary Commission on Banking Standards, Vol. 1, HL Paper 27-I

Practice questions
1 Analyse the possible reasons for the cultural problems within the banks.
(9 marks)
2 To what extent do you think changing the culture of the banks will be easy?
(16 marks)

Business in focus: The Enron Corporation

Remember, just because an organisation states it has a particular type of culture

does not mean it really does.
The Enron Corporation was an American energy, commodities and services company
based in Texas. Before it went bankrupt on 2 December 2001, Enron employed
20,000 staff and was one of the world’s biggest electricity, gas, communications and
paper companies. It claimed to have revenues of nearly $111 billion, but it was shown
that there had been massive fraud and false accounting. In the lobby of the
company’s headquarters, its values were displayed:
• Integrity
• Communication
• Respect
• Excellence
In reality, employees had been guilty of falsifying accounts and pursuing ever-faster
growth in return for huge bonuses.

Practice questions
1 Analyse the reasons why the actual culture of the organisation might differ from the
stated culture.
(9 marks)
2 To what extent do you think customers should worry about the culture of a
business?
(16 marks)
Reasons for changing organisational
culture
The reasons for changing culture relate directly to the influences on culture. There may be
pressure for change for a variety of reasons. For example:
• If there is a new leader who has their own way of doing things and wants to do things
differently from the way things have been done before.
• If society’s values change, for example, the attitude towards different ethical issues. Over time
in the UK, there have been major changes in customers’ expectations about how suppliers are
treated. This has led to the growth of initiatives such as Fair Trade.
• If the performance of the business suffers, managers will consider whether the culture had
affected the performance and look to see if cultural change is needed.
• If there are new owners who might have different objectives from the old ones. This is often
the case with a takeover and can lead to clashes.

Business in focus: Facebook

In 2012, Facebook was floated and brought in outside investors. At the time, the
founder, Mark Zuckerberg, said that the culture of the company was a ‘hacker
culture’. This means that they valued an approach in which people tried new ideas
and tested the boundaries to see what could be done better. What Zuckerberg
described as ‘The Hacker Way’ involved continuous improvement – hackers believe
things can always be made better and nothing is ever fully finished. The hacker
approach is to develop, then release those developments, and then to learn from this.
It is what is called an iterative process in which hackers keep going back to improve,
then release, then improve, and so on. On the walls of the Facebook office are the
words ‘Done is better than perfect’, which captures the spirit of hacking and
Facebook.
Hacker culture is also very meritocratic. The best idea wins regardless of who
developed it. Your age, your years of service, your qualifications do not matter – your
code does. To show the importance of code, all new engineers – even those who will
not be writing code in their job – go to Facebook’s Bootcamp to learn about its coding
and approach.

Practice questions
1 Analyse the implications of Facebook’s hacker culture.
(9 marks)
2 Do you think becoming a public limited company might change the culture of
Facebook? Justify your answer.
(16 marks)
Problems changing organisational culture
Managers may want to change the culture of their organisation but many problems can exist:
• Changing culture will challenge the existing assumptions of employees of how things should
be done and what matters. Employees may well resist such changes believing that what they
did before was right. This is particularly true if employees appeared to do well with the old
approach; change will be seen as a threat.
• What you are trying to change are people’s beliefs. These can be deeply held and attempts to
change them may question the way in which we view the world. Getting people to think in a
different way can be a long task.
• Changing culture may involve extensive training and education. This can require heavy
investment.
Changing culture will be particularly difficult if:
• there are large numbers of people involved in many different locations
• the values being questioned are very deeply held.

Business in focus: Ford

In 2006, Alan Mulally was appointed from Boeing as Ford’s Chief Executive. He
immediately organised a meeting of his senior managers and, when he asked them
how things were going, was surprised to hear them say, ‘Fine’. Given that Ford was
forecast to make a $17 billion loss that year ‘fine’ seemed a slightly odd way of
describing the situation. Eventually, Mark Fields, (later to become Chief Executive of
Ford when Mulally retired) put his hand up and admitted that a defective part
threatened to delay the launch of a new car. Admitting problems would once have
been unthinkable and the room fell silent until Mulally started to clap. This was the
beginning of a vital culture change for Ford, with Mulally bringing in a new way of
looking at problems and a more open approach to identifying and solving issues.

Practice questions
1 Analyse why the managers at Ford failed to admit to any problems when asked.
(9 marks)
2 To what extent is an open culture essential for business success?
(16 marks)

Business in focus: Johnson & Johnson’s Credo

The values of Johnson & Johnson are set out in what is called ‘Our Credo’. This
Credo (that is set of beliefs) determines the way people behave, make decisions and
are appraised. The Credo sets out the groups that employees need to put first
beginning with the doctors, nurses and patients who they produce their products for.
The company’s investors are some way down the list – the belief is that if you do the
right thing for others, the profits will happen as a result.
Our Credo was written by Robert Wood Johnson, who was Chairman of the company
from 1932 to 1963 and a member of the company’s founding family. This was long
before anyone talked about ‘corporate social responsibility’. The company believes it
is Our Credo that has kept the business strong.
The Johnson & Johnson Credo clearly reflects a certain culture. The company seems
to think it has played an important role in its success.

Figure 40.7 Johnson & Johnson products

Practice questions
1 Analyse how the Credo might have influenced the success of the Johnson &
Johnson business.
(9 marks)
2 Do you think Johnson & Johnson will ever change its culture? Justify your answer.
(16 marks)

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 What is meant by ‘organisational culture’?
2 Explain one reason why the culture of an organisation matters.
3 State Handy’s four types of culture.
4 State three aspects of national culture identified by Hofstede.
 5 State two influences on organisational culture.
6 Explain one reason why managers may want to change the culture of an
organisation.
7 Explain one reason why changing culture may be difficult.
8 What is meant by ‘short-termism’?
9 What is meant by ‘individualism’?
10 State one way in which you might identify the culture of a school if you visited it.

(b) Short answer questions

1 Explain one way the culture of Google might be important to its success.
(5 marks)
2 Explain one way a newly appointed chief executive of a failing business may want
to change its culture.
(5 marks)
3 Explain the factors that might influence the culture of Facebook.
(5 marks)
4 Explain the type of cultural differences a multinational business may find in the
different locations where it operates.
(5 marks)
5 Explain one way a power culture may not be appropriate to a rapidly growing
business.
(5 marks)

(c) Data response question

Stafford hospital
Between January 2005 and March 2009 it is estimated that 400–1,200 patients died
as a result of poor care at Stafford Hospital, a small district general hospital in
Staffordshire. Conditions in the hospital were appalling. Patents were neglected with
some having to drink the water from flower vases because no nurses were looking
after them. Life-threatening decisions were being made by unqualified staff and
complaints were ignored.
The horrific neglect of patients has led to a tremendous amount of scrutiny to find out
what happened and to find ways to ensure it does not happen again. The second of
two public inquiries completed its report in 2013. Inevitably, there was a range of
factors at the root of the problems but, undoubtedly, what developed at Stafford was a
culture of patient neglect. The inquiry found the culture was one in which:
• there was a lack of openness to criticism
• there was a lack of consideration for patients
• individuals were defensive about their work and actions
• staff looked inward not outward and did not learn from what was happening outside
of the hospital
• there was an acceptance of poor standards
• there was a failure to put the patient first in everything that was done.
Part of the cause was that the hospital trust was under financial pressure and made
savings that were harmful to patient care. Staff were expected to follow the system put
in place by the Trust, even if this did not serve patients well, and the culture was not
one in which people spoke up. Good news was rewarded and bad news ignored.
There were no effective systems in place to deal with complaints. There was also a
failure to appreciate the damage that was done to ‘corporate memory’ when staff left –
they took with them an understanding of how things were done which was difficult to
replace quickly.

Questions
1 Explain the ways in which the culture at Stafford Hospital affected patient care.
(5 marks)
2 Analyse the possible reasons why the culture that developed at Stafford Hospital
was so negative.
(9 marks)
3 To what extent do you think the culture of an organisation such as Stafford Hospital
could be completely changed for the better?
(16 marks)

(d) Essays
1 To what extent do you think the organisational culture of a retailer determines the
success of the business? Justify your answer.
(25 marks)
2 To what extent do you think it is possible to take the culture from a successful
business and introduce it into a less successful business to turn it around? Justify
your answer.
(25 marks)
Chapter 41 Managing strategic
implementation
Introduction
Deciding on the right strategy for a business is a very important decision for managers. They
need to decide on which markets to compete in and which products to offer (strategic direction),
how to compete (strategic positioning) and how to pursue the strategy (strategic methods).
However, what is also essential is to implement the strategy effectively. An idea is not much use
in itself unless it is put into action. In this chapter we consider how to implement a strategy
including how to manage projects effectively. As part of this analysis we consider the
importance of having the right organisational structure for the chosen strategy.
What it is important to know by the end of this chapter:
• how to implement strategy effectively
• how to analyse the value of leadership in strategic implementation
• the value of communications in strategic implementation
• how to analyse the importance of organisational structure in strategic implementation
• that organisational structures include functional, product-based, regional and matrix structures
• how to analyse the value of network analysis in strategic implementation
• that network analysis includes understanding and interpreting network diagrams, amending
network diagrams and identifying the critical path and total float.
Implementing strategy
Having a good strategy in the first place may be important, but putting it into practice is also key.
If anything, managers may spend too long planning and not enough time making sure that the
plan actually works. There are always various projects in the news that have overrun, gone over
budget or not worked as well as expected – whether it be a new train line, a new sports stadium,
a restructuring, a major IT project or a relocation. These are examples of poor implementation.

Key term
Implementation means putting into action. Managers implement a plan when they
make it happen.

Implementing a project effectively requires good planning skills. Managers need to work out
what has to happen when, who is going to do what and which resources are needed. They then
need to plan all of this and bring together the resources and monitoring systems to make sure it
happens.

Figure 41.1 The strategic planning process

Business in focus: Saatchi & Saatchi

Kevin Roberts, Chief Executive Worldwide of Saatchi & Saatchi, has said that given
that change now happens so fast strategy is dead, what matters now is getting on
with plans and executing them. If you take too long planning, you will find you have
lost the opportunity that was there and your competitors have ‘eaten your lunch’. In
the past, he says that managers spent 50 per cent of their time assessing the
situation, 30 per cent discussing the options and then it was left to others to
implement. He argues that now 20 per cent of the time needs to be spent assessing,
two minutes to decide and then the vast majority of the time should be spent
executing the plan and making sure it is put into action properly.

Practice questions
1 Analyse the possible effects on a business if a strategy is not implemented
effectively.
(9 marks)
2 To what extent do you agree with the view that implementation of a strategy is more
important than the strategy itself?
(16 marks)
Implementing strategy effectively
Effective strategic implementation involves:
• planning what and who is needed where and when
• setting clear standards of what is expected so that all those involved understand what they need
to deliver
• organising the resources required to do the job properly
• coordinating what has to happen
• ensuring the right people are in charge of the various parts of the strategy
• establishing clear points at which progress can be measured and reviewed.

Leadership and implementation

The leader of a team, department or division should provide the vision of where the business is
heading. They should be able to gain followers and help them to understand the reason for the
strategy. However, they are also responsible for ensuring the strategy is implemented effectively.
Whilst a leader cannot personally make every decision and check every aspect of strategy
implementation, they are ultimately responsible for whether it works and their role is to lead
others properly. This means a leader needs to:
• make clear what is being done and why
• gain the support of other senior, middle and junior managers who will have to put the strategy
in place
• ensure the required resources are in place; for example, that budgets are in place
• ensure effective communications systems are in place
• ensure that reward and appraisal systems are designed to ensure employees are aligned to the
strategy
• design systems to check quality is being achieved and the system is on target
• overcome any resistance to the strategy being implemented
• ensure there are clear stepping stones marking progress; it should be clear who is in charge of
what and what success looks like at each point.
The leader is the one who will be:
• representing the business. They will be the ‘ambassador’ presenting the strategy to others,
explaining it to key stakeholders and hopefully generating enthusiasm and momentum to
ensure it happens and is implemented successfully.
• negotiating if there are serious obstacles to progress. The leader needs to make sure such
barriers are overcome or worked around. They need to be good at bargaining and problem
solving.
The importance of communication when
implementing a new strategy
People often have a resistance to change. They fear or oppose change for a number of reasons
such as a fear they will be worse off.
Communications can play an important part in making a strategic change successful. For
example:
• It can help win support from stakeholders. Effective communication can explain to the banks,
for example, why funding is necessary and why the project is worth investing in. Similarly,
good communication can help overcome resistance from the local community – for example, if
they are concerned about the impact of any building plans it may make sense to consult them
and involve them in the planning process.
• It can help to reduce distrust and highlight the benefits to those involved in the process,
thereby winning over the people who have to live with and make a success of the new plan. By
communicating effectively managers may also learn from others about possible flaws in the
plan or how to undertake some aspects most effectively.
Communication can provide a sense of direction and purpose. Employees may feel more
ownership of the strategy and, therefore, be more cooperative and engaged with it.
Once the project is underway communication is important to track progress and identify any
possible problems, hopefully before they occur.

What do you think?

Why do you think many strategies are implemented badly?

Business in focus: Business strategy and workforce

A recent study by consultants PwC showed that:

• in most cases, 95 per cent of the workforce do not understand the strategy of the
business
• in general, there is a lack of trust in the company’s strategy from both internal and
external stakeholders.

Practice questions
1 Analyse the reasons why employees may not trust a company’s strategy.
(9 marks)
2 To what extent do you think it is important that employees understand the business
strategy?
(16 marks)
Organisational structure in strategic
implementation
The structure of an organisation is the result of decisions in several areas:
• What specific jobs are involved? For example, are they widely or narrowly defined?
• How are jobs grouped together? (This is called departmentalisation.)
• How many people does a manager oversee? This is known as the span of control. The span of
control measures the number of subordinates directly responsible to a superior.
• How many levels of authority are there? This is known as the number of levels of hierarchy.
The wider the span of control, the fewer managers will be required and the lower the number
of levels of hierarchy are likely to be. In Figure 41.2, there are two organisations with 4,096
front line employees. The structure on the left has a narrow span of four employees. Managing
4,096 employees requires six levels of hierarchy and 1,365 managers. The structure on the
right has a wide span of eight employees. Managing 4,096 people requires four levels of
hierarchy and 585 managers.
• What authority do different jobs have? For example, is the business centralised whereby
decision making is mainly the right of senior managers, or is it decentralised whereby
individuals at lower levels are able to make relatively significant decisions for themselves?
The more centralised a business, the more that authority is kept at the centre. A centralised
business brings with it some advantages – for example, decision makers will have an overview
of the business as a whole and are likely to be experienced. However, a decentralised
organisation may engage employees more (because they feel greater responsibility for what
happens as they are making decisions themselves); it may also be more flexible in relation to
local conditions. In a decentralised national retail chain, for example, local managers can
adjust prices and stock to meet the demand in that particular region.

Figure 41.2 Hierarchy and span

Advantages of centralisation Disadvantages of centralisation

 Decisions made by people with May lack flexibility in relation to market
experience and overview of the conditions
business
Decisions made by those with access Decision making may be slow if centre
to resources becomes over loaded with decisions to be
made
May reduce some risks by having May be demoralising for those locally who are
experienced decision makers not making decisions
Table 41.1 Advantages and disadvantages of centralisation
Forms of organisational structure
When businesses are relatively small the organisational structure is often quite informal. There
are relatively few people, the jobs are often loosely defined and there are no clear ‘departments’
or ‘divisions’. However, as a business grows and there are more people and more decisions to be
made it is usual to start to group jobs within their different functions and to develop a more
formal organisational structure.
The different forms of organisational structures, that is the different ways jobs are defined,
grouped and organised include functional, product-based, regional and matrix structures.

Functional structure

Figure 41.3 Functional structure

In a functional structure the marketing team forms one part of the business, the finance team
another, operations another, and so on. There is a logic to this approach in that members of each
department have the same job area – they can share expertise, they can help problem solve and
they talk the same business language. However, the danger can be that people identify more with
the department than with the business as a whole. They become the IT team who are battling
against everyone else, the finance team who no one else understands, or the marketing team who
could achieve amazing things if only the other departments didn’t hold them back and were more
cooperative. Each department can develop its own culture and its own way of seeing things. This
can lead to the ‘silo effect’; this occurs when people view the business from their own
departmental perspective and regard themselves as somewhat separate from the other parts of the
organisation. They lack empathy with other departments and do not try hard to imagine what it is
like from their perspective.

Product structure
Figure 41.4 Product structure

A product oriented approach occurs when a business has very clear product lines that have
different customer bases and different challenges and opportunities – a travel business may run a
coach division, a camping division and a weekend break division. A bank may have a section for
high-street customers, a section for small businesses and a section specifically for high income
individuals. This product approach can make sense if the demands of the different customers
vary significantly. The millionaire considering whether to move their fortune to a Swiss bank
account needs different advice from the average home owner who has gone overdrawn at
Christmas, or the small business owner who needs a loan to expand. Creating divisions (or
departments or sections or even separate companies) to meet very different customer needs is
logical because it groups together those with the specific expertise and skills for that group of
customers. Once again, though, it does lose a sense of overview of the business as a whole – the
divisions may see themselves as competing against each other rather than looking for
opportunities to cooperate. A product-oriented structure can also involve a duplication of
resources. For example, IT systems, designers and HR teams are duplicated within each product
division. Where possible, senior managers should look to share resources and centralise some
functions such as payroll, HR, legal advice, printing and purchasing of supplies.

Regional structure
Figure 41.5 Regional structure

A regional structure (for example, grouping jobs under sections such as the north, the south east
and the west) makes sense if the strategy of a business involves competing in very distinct
regions of a country or around the world. This structure is common, for example, in global
businesses such as automotives, tobacco and soft drinks. The reasons are similar to the product
approach – the specific issues and demands in the regions may vary, and so having jobs focused
on one region may lead to much more in-depth market knowledge, better matching of what is
offered to what markets want and more efficient decision making as the business environment is
better understood. This approach is common as a business expands nationally and internationally
and wants to develop a focus on particular parts of the country or world.

Matrix structure
In a matrix structure, individual job holders have more than one boss. The business is organised
in such a way that managers report to at least two superiors. For example, in the car industry it is
important to understand the region in which the company operates – what is demand doing?
What is the legal environment? How are sales of all the company’s products doing? What are the
trends within the market as a whole? However, if a job relates specifically to one brand – let’s
say the Ford Mondeo – then the employee must be interested not just in how the Mondeo is
doing in their country but also how that brand is performing all over the world. The employee
will want to share understanding and learn from those other managers involved with the Mondeo
in other regions. In this case, the employee’s superiors would be the regional manager and the
global Mondeo manager.
The advantage of the matrix approach is that it tries to avoid the silo effect that can otherwise
occur within organisations by bringing in different perspectives. At the same time, it can create
difficulties as employees have two managers who may have different priorities. For example, the
global Ford Mondeo manager may want to keep this a relatively premium brand, whilst the
regional manager may want to discount to sell more to hit local sales targets.
Of course, the whole concept of a formal structure may not be appropriate in some organisations
that want to encourage creativity and interactions between individuals across the organisations.
Some organisations would be against formal organisational charts, for example, because they
feel they might restrict and limit communications to some predetermined channels, thereby
stifling debate, initiative and new thinking.

Figure 41.6 Matrix structure

The right form of organisational structure
The way that jobs are grouped will affect the performance of the business. The structure needs to
fit with the business’s overall strategy.
The right form of organisational structure will:
• provide sufficient flexibility to meet local needs without losing the benefits of centralisation
• be cost efficient
• enable decision making to be suitably fast and decisions to be made by those suitably qualified
to make them.
What is an appropriate organisational structure will depend on factors such as:
• the market conditions – does the business serve very different segments? In which case, a
product structure might be appropriate.
• the global scale of the business – if it operates in very different geographical markets, then a
regional approach may be suitable.

What do you think?

Do you think that organisational structures in general need to become more organic?

Handling data
Imagine you have around 4,000 frontline staff to organise. If the span of control is five,
how many levels of hierarchy would be required to have this many people supervised
on the front line? What if the span was ten?
Network analysis
Managing the implementation of a strategy involves planning the different elements that need to
be implemented and working out the order in which these can be carried out. Managers will want
to identify all the key activities and identify the order in which they must occur in order to get
the plan implemented as efficiently as possible. They will also want to allocate the appropriate
resources to ensure the different tasks are completed within the set time and to a suitable
standard. In addition, managers will want to think about appointing others to be responsible for
their part of the project.
To help them in organising and implementing a strategy, managers may use network analysis
(which is also called critical path analysis). Network diagrams aim to identify the activities
which must be completed on time to complete the strategy in the shortest possible time. The
order of different activities is shown on a network diagram.

Key term
Network analysis occurs when a network diagram is used to analyse the activities
involved in a project and to identify the fastest way of completing the project to a
given standard.

Network diagrams organise the different activities involved in a strategy in order to find the most
efficient means of completing and implementing it. The aim is to complete the implementation in
as short a time as possible. To do this, managers will determine the exact order in which
activities have to be undertaken and identify which ones can be undertaken simultaneously to
save time.
To undertake network analysis and produce a network diagram managers must:
• identify all the different elements of the strategy
• estimate the expected length of time each element of the strategy will take to complete
• determine the order in which the different elements of the strategy must be completed. For
example, in some cases, specific elements 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’).
A network diagram is a diagrammatic representation of all the activities involved in the strategy,
the order in which they must be undertaken and the time each one is estimated to 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 41.7, activity B is expected to last ten
days; activity A is expected to last four days; activity B can only be started when activity A is
completed (that is why it only begins once activity A is complete).
In Figure 41.8 activities C and D can only be started after activity B has been completed and can
be done in parallel. Activity E can only start when C and D are finished.
In Figure 41.9, we have added in some more activities. You can see that:
• activity F can start immediately
• activity G can start once activity F is completed
• activity H can start once activities E and G are completed.

Figure 41.7 Activities and durations

Figure 41.8 C and D can be done in parallel.

Figure 41.9 A network diagram

All this information is shown in Table 41.2.

Activity Preceded by Duration (days)
A – 4
B A 10
C B 3
D B 1
E C and D 5
F – 6
G F 9
H E and G 3
Table 41.2 Activities, dependencies and durations
We now have a whole network diagram. Remember the following rules when constructing a
network diagram:
• The lines showing different activities must never cross.
• The lines showing activities should always begin and end at the mid-point 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.
Adding earliest start and latest finish times
The next stage in producing a network diagram is to show various information that can be
calculated from the duration of each activity. This information is shown inside the node and to
do this we now draw nodes in the following way:
• The left-hand side shows the number of the node; this is used simply for reference and is done
by numbering the nodes left to right.
• The right-hand side of the node is used to show two other pieces of information known as the
earliest start time (EST) of the next activity and the latest finish time (LFT) of the activity
before.

Key terms
Earliest start time (EST) is earliest time that a given activity can begin.
Latest finish time (LFT) is the latest time a given activity can finish without delaying
the project as a whole.
Critical path shows the activities which have zero float. These activities determine
the fastest a project can be completed. Any delay in these critical path activities
causes a delay to the project as a whole.
Float time is how long an activity can overrun without holding up the whole project.

Earliest start times

The EST is exactly what it says: it is the earliest time a particular activity can begin. This piece
of information is shown in the top right of the node at the beginning of an activity.
As you can see in Figure 41.10, the earliest times have now been added. To calculate these
figures you take the earliest start time of the activity before and add on the duration of that
activity.

Figure 41.10 A network diagram with ESTs and LFTs added

The earliest time activity A can start is day 0 (this is the first activity in the project); this activity
takes four days so the earliest time that activity B can start is day 4. Activity B takes ten days so
the earliest that activities C and D can start is day 14.
Activity E can only start when activities C and D are both finished. C takes longer than D so the
project must wait for this activity to be completed before moving on; the earliest that activity E
can start is therefore day 17.
If you have a choice of numbers to add on to calculate the earliest start time, choose the bigger
number; the projects cannot continue until all previous dependent activities are finished, so you
must wait for the longest one to be completed. Before activity H can start, for example, it must
wait for both activities E and G to be completed, which means it cannot start until day 22.
By identifying the earliest start times 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 sit 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 earliest start time is therefore an important part of developing a lean approach to
a project and ensuring people and materials are coordinated and ready at exactly the right
moment.

Latest finish times

The bottom-right space of a node is used to show the LFT of an activity. Again, this shows
exactly what it says – the latest an activity can be finished without holding up the whole project.
Activity H must finish on day 25 – the day the whole project can be completed; since H takes
three days it means the activities before must be finished by day 22 if the project is to be
completed on time. Activity E, therefore, must be completed at the latest by day 22. Since E
takes five days this means the activities before (C and D) must be finished by day 17. Given that
activity C takes three days (which 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 day 14.
To work out the latest finish times, therefore, you work right to left, deducting the duration of a
particular activity from its latest finish time to get the latest finish time of the one before. If there
are two or more activities involved (such as C and D), choose the longer duration.
Rules when calculating ESTs and LFTs:
• To calculate the EST of an activity, work left to right and add on the duration of the next
activity to the previous EST; if there is a choice, choose the largest number to add on.
• To calculate the LFT of an activity, work right to left and deduct its duration from the previous
LFT; if there is a choice of numbers, choose the largest number to deduct.

Total float time

Using the ESTs and the LFTs it is possible to calculate the total float time of an activity. The
total float time shows how long an activity can overrun without holding up the whole project.
To calculate the total float time use the equation:
Total float time = latest finish time − duration − earliest start time
For example, if activity D has to be finished by day 17, can start on day 14 and lasts one day then
the total float is 2 days (17 − 1 − 14 = 2). This activity has two days’ slack – it could overrun by
two days and the project would still finish on time. By comparison, if activity B has to be
finished by day 14, can start on day 4 and lasts ten days, its float is 0 days (14 − 10 − 4 = 0).
There is no float – it must be completed on time or the whole project will be delayed. B is
therefore known as a ‘critical’ activity because it has no total float. By identifying all of the
critical activities the firm can see which activities must be finished on time; this is known as the
critical path.
The critical path for the project in Table 41.2 is ABCEH because these activities have no total
float time. If they are delayed, the whole project will be late and will not be finished in 25 days.
By identifying the activities on the critical path managers can see exactly which activities are the
priority in terms of making sure they stay on time; the critical path also shows the shortest time
in which a project can be completed.
Benefits of network analysis
When undertaking network analysis managers:
• must consider exactly what activities are involved in a strategy. This is a useful exercise in
itself because it should help to make sure that nothing is forgotten. It also means that managers
are likely to consult all the different departments and functions involved and this can help to
improve everyone’s understanding of the issues and challenges involved in getting the strategy
completed.
• can calculate the earliest time by which the strategy should be implemented. This can be
important information for customers – for example, the firm can announce a release date of a
new product or the opening date of new stores. It can also help the managers decide whether or
not a deadline can be hit.
• can identify the ‘critical’ activities that must be completed in time to get the whole strategy
implemented as quickly as possible. This means that they can focus on these specific activities
and make sure they do not overrun. At the same time, the amount of float time on non-critical
activities can be calculated. While managers 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 labour and other resources from non-critical activities to critical ones to
ensure the latter are completed promptly.
• 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 strategy, network diagrams are an important element of time-based management.
• can implement just-in-time (JIT) ordering. Network analysis shows the ESTs for each activity.
Using these the firm can order materials and supplies to arrive exactly when they are needed
and not before. This saves storage costs and also the opportunity cost of having money tied up
in stock. This can improve the firm’s liquidity and free up cash which can be used elsewhere in
the organisation.
• can use network analysis as a control mechanism to review progress and assess whether the
strategy 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 strategy.
Although some of the estimates of the likely durations may prove to be wrong, and although
external factors may cause delays, this does not mean that network analysis is unnecessary. On
the contrary, by having a network diagram the effects of any delays can be relatively easily
calculated in terms of the impact on the final completion date. Network analysis enables
managers to understand the significance and likely dangers of any delay. Strategies may still
overrun, but managers should be able to predict if this is going to happen as soon as a problem
emerges (rather than being taken by surprise) and, if possible, take action to get the strategy back
on track.

Handling data
Activity Preceded by Days
 A – 2
B – 7
C B 18
D A 1
E C, D 5
F – 30
H E,F 2
I H 14
J – 5
K I, J 16
Table 41.3
Construct a fully labelled network diagram based on the information in Table 41.3.
Identify the critical path.
Limitations of network analysis
Although network analysis can help business decision making, it can have a number of
drawbacks and limitations.
• It relies on the estimates for the expected duration. If these prove to be inaccurate, the
calculations for ESTs and LFTs, and thus 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 network analysis, 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.
• Network analysis simply shows the quickest way to complete a project; it does not guarantee
that this is the right strategy to be undertaking in the first place. It may be that the firm’s
resources could be used more effectively elsewhere.
• All strategies 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 strategy. They must be given the resources and budget to complete in the
time agreed. There must be an effective review system to make sure the strategy 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 is
implemented correctly and that each activity is completed on schedule.
Other issues in using network analysis
Before a strategy 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 strategy
implemented on time. The result may be that the strategy is implemented quickly but that the
quality is poor.
Managers must also agree on what resources and spending they are willing to commit to during
the project. Obviously, the quickest way of implementing a strategy 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, implementation of the strategy
could probably be speeded up. Whether particular activities can be conducted simultaneously
will often depend on 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 strategy. It may be
that certain activities could be undertaken simultaneously, but that as a result some periods
would require very high levels of personnel, whereas at other times very few people would be
needed. If it adopted such an approach, a firm may have to bring in extra staff for the busy
periods and pay its existing staff to do little in the other less busy period. Rather than have such
fluctuations in staffing levels managers may want to shift activities around; this may mean that
the strategy takes a bit longer to implement but it may nevertheless be more desirable if it means
that its full-time staff are fully employed throughout.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1 The number of people reporting directly to a superior is called ____________.
2 A level of authority in an organisation is called a level of ____________.
3 Explain one benefit of the functional structure.
4 Explain one disadvantage of the functional structure.
5 What is meant by a matrix structure?
6 What is meant by the earliest start time of an activity in a project?
7 What is meant by the critical path?
8 What is meant by total float time?
9 Explain one reason why leaders are important when bringing about change.
10 What is meant by centralisation?

(b) Short answer questions

1 Explain two ways the role of leader may be important when implementing a
strategy of retrenchment.
(6 marks)
2 Explain one way a network diagram may help with the implementation of a
 strategy of new product development.
(5 marks)
3 Explain one benefit of having a centralised structure at a school.
(5 marks)
4 Explain one benefit of having a decentralised structure for a retailer.
(5 marks)
5 Explain one potential difficulty of using network analysis when entering a new
market.
(5 marks)

(c) Data response question

Derby velodrome

Figure 41.11 Derby velodrome

The velodrome for cyclists in Derby opened three months late in 2015.
Pride Park is a 250-metre cycle track and also includes a 12-court sports hall, gym,
group exercise space and a café. It holds an audience of 5,000. The £28 million venue
was built at a time of major cuts in council spending and so has generated criticism as
being unnecessary in times of austerity. The venue was designed to host high-level
cycling events, basketball and volleyball games, as well as being a concert venue and
community leisure facility.
Work on the arena – one of only five such venues in the UK – began in April 2013.
The delay in opening the venue was said to be down to ‘getting things right’. The
council says that this type of project is very complex and requires a great deal of work
which is difficult to coordinate. Local cycling shops were disappointed at the delayed
opening which was hoped would boost sales. They also hoped to use the venue to
allow potential customers to try out new bikes as part of promotional events.
The velodrome was predicted to make a loss of around £2 million over its first three
years. This led to further criticism, though the council believes that it will eventually
pay for itself.
The council said it was still in negotiations with potential sponsors over a new name
for the velodrome.
Key facts about the velodrome
• The velodrome has a footprint of 14,500m2 or 156,000 sq ft.
• The structure incorporates 1,700 tonnes of steel – that’s equal to 200 London
buses.
• If all the wood for the track was put end to end, it would reach from Derby to
Leicester.
• 265,000 nails were hand-driven into the 250 metre track, over a six week
construction period.

Questions
1 Explain one possible reason for the delay of the velodrome at Derby.
(5 marks)
2 Analyse how network analysis would have helped with the Derby velodrome
project.
(9 marks)
3 To what extent are complex projects such as the velodrome almost certain to
overrun?
(16 marks)

(d) Essays
1 Do you think that for a business trying to launch a new product the implementation
of the strategy is more important than the planning? Justify your answer.
(25 marks)
2 To what extent is the structure of an organisation key to the strategic success of a
business that is growing internationally? Justify your answer.
(25 marks)
Chapter 42 Problems with strategy and
why strategies fail
Introduction
So far we have examined how strategies are chosen, developed and implemented. This might
appear to be a relatively straightforward process but in reality many strategies go wrong. In this
chapter we consider why strategies can fail. Sometimes business fail to adapt their strategy to
changing conditions; on other occasions they fail to implement their strategies successfully. Here
we consider the value of strategic planning, analyse the difficulties of strategic decision making
and then assess the possible reasons why business strategies sometimes prove unsuccessful.
What it is important to know by the end of this chapter:
• how to analyse the difficulties of strategic decision making and implementing strategy
• the difference between planned vs emergent strategy
• the reasons for strategic drift
• how to analyse the possible effect of the divorce between ownership and control
• that the effect of the divorce between ownership and control includes corporate governance
• how to evaluate strategic performance
• how to assess the value of strategic planning
• how to assess the value of contingency planning.
Problems with strategy
Developing a strategy requires an insight into where markets are headed and an understanding of
the strengths and weaknesses of the business.
It requires the ability to:
• identify what really matters and ask the key questions
• make judgements on the relative importance of issues and the priority that should be given to
different elements of a plan
• persuade others that the plan is right and then to make it happen.
All of this is likely to be happening in a changing environment with a high level of uncertainty
when others are likely to be criticising and coming up with what they think are better ideas.
Making strategic decisions involves, almost inevitably, upsetting some people because the road
to change can be bumpy and unpleasant for some; others will not be sure where you are headed
or will not want to go there.
Furthermore, the results are unlikely to be immediate – strategies take time to unfold and prove
themselves. Making a strategic decision is like sending off a container ship in a particular
direction. You hope you have it right because it will be very difficult to stop once it gains
momentum and you won’t be able to turn it around easily if it is going off course.
Difficulties of strategic decision making
Strategic decisions are unfamiliar. They are major decisions, involving a large degree of risk and
a very high level of uncertainty. This particular decision will not have been made before. Even if
a business’s managers have done a takeover before, they won’t have done this one; even if they
have entered a new market before, they won’t have entered this one. However experienced
managers are, strategy is challenging and strategic decisions are difficult. Managers cannot easily
refer back to what they did last time, they do not have any easy points of reference and they
cannot ‘try it and see’. It may take many years to be sure whether the right decision has actually
been made. The decision may involve millions of pounds and affect thousands of people, as well
as many other linked businesses. Such decisions are therefore stressful and complex.

Business in focus: Knowns and unknowns

‘There are known knowns; there are things we know we know.

We also know there are known unknowns; that is to say we know there are some
things we do not know.
But there are also unknown unknowns – the ones we don’t know we don’t know.’
Donald Rumsfeld, Secretary of State, USA

Practice questions
1 Analyse two ‘known unknowns’ which exist in the current business environment.
(9 marks)
2 To what extent do you think uncertainty in the business environment means there
is no point in strategic planning?
(16 marks)

Strategic decision making is also difficult and often flawed because managers naturally have
their own perspectives. The way we look at things is inevitably influenced by our backgrounds
and experiences. When analysing data this means managers’ interpretation of information is
likely to be biased and this can lead to flawed decision making. To avoid this problem of bias
many organisations deliberately try to recruit people with differing perspectives. Also, when they
form teams they give some members the role of challenging any proposal that is put forward to
ensure it is thoroughly tested.
Figure 42.1 It’s a question of perspective: do you see an old or a young woman in this picture?
Why do strategic decisions go wrong?

Figure 42.2 The decision-making process

The decision-making process is shown in Figure 42.2. The possible reasons for decisions going
wrong are as follows:
• The wrong objectives are set. The managers may have set the wrong targets.
• The data may not be easily available. Strategic decisions often involve unfamiliar decisions
and managers may not have all the information they need or want. Market conditions may be
changing so fast that managers are missing the changes that are occurring around them.
• Data may be badly analysed. This is particularly likely with strategic decisions which involve
unfamiliar situations and one-off decisions.
• The implementation can go wrong. There may be resistance or delays, for example.
• The progress of the plan is misread. For example, there may be a culture in which managers
have some success and then believe they are invincible. They then ignore any signs of
problems assuming that they cannot fail because they have succeeded in the past.
• The strategy may be wrong. Conditions may have changed which make the original plan
flawed. Generals often say that any military plan is immediately out of date as soon as the
army comes into contact with the enemy. Conditions change and the plan needs revisiting.

What do you think?

Why do you think managers make bad decisions?
Planned vs emergent strategy
The planned strategy is the one the managers intend to implement. The emergent strategy is
the one that develops over time. If all goes according to plan, the planned and the emergent
strategies will be the same. However, in reality, what actually emerges often has elements of the
strategy that was planned but is not quite the same. This is because along the way some elements
of the plan prove to be too difficult to implement and/or because changes in the external or
internal environment help reshape the plan. You may have an idea now of what you will be
doing in ten years’ time. You may end up doing exactly what you predict but, more likely than
not, you will do something in this area though not exactly what you predict at this moment. In
the next ten years various things will happen to shape your journey with the result that in some
cases you will end up doing something completely different from what you imagined you would
be doing.

Key terms
The planned strategy is the strategy the managers intend to implement.
The emergent strategy is the strategy that actually develops over time.

Business in focus: Accidental success

The success of the Japanese motorbike manufacturers to conquer the US market

was long regarded as an amazingly successful and well-planned strategy. The
Japanese producers were up against well-established US bikes, such as Harley
Davidson. Japanese bikes were regarded with suspicion. Rather than take the US
producers head on, the Japanese entered with a small 50cc bike called the Supercub.
This won many fans and gradually the Japanese producers traded up, producing and
selling bigger and bigger motorbikes until they ended up dominating the market… or
so the story goes.
In reality, the Japanese producers, led by Honda, entered the US market with big
motorbikes competing directly against Harley Davidson. However, their sales were
poor. US bikers did not like the electric start and the Japanese bikes proved
unreliable at high speeds and on long distances. The strategy looked doomed to
failure. However, the Japanese sales representatives had been riding on the Honda
50cc Supercubs between locations. These were spotted by buyers at the major US
chain, Sears, who asked to stock them. The Supercubs turned out to be a great
success, therefore establishing the Honda brand in the us motorbike market.
Gradually, Honda introduced more and bigger bikes and other Japanese producers
followed. The trading up strategy which proved so successful was an accident and not
what was intended at all!
Practice questions
1 Analyse the difference between the planned and emergent strategies for Honda
with reference to the Supercub example.
(9 marks)
2 To what extent are good managers the key to a successful strategy?
(16 marks)
Reasons for strategic drift
Strategic drift occurs when the strategy of the business no longer matches with the environment
in which it operates. What might have been appropriate at one time may become out of date and
inappropriate as the environment changes. The drift occurs because the strategy has failed to
adapt to differing environmental conditions. Business strategy often develops incrementally, that
is step by step, and remains based in what has been done in the past; sometimes this means that
strategy simply does not change fast enough to keep pace with what is happening outside of the
business. It is likely that with faster change in some markets, for example, with rapid
technological change, that strategic drift is becoming more common.

Key terms
Strategic drift occurs when the strategy of the business no longer matches with the
environment in which it operates.
The divorce between ownership and control occurs when the owners of a
business do not control the day-to-day decisions being made.
Corporate governance refers to the systems and processes that are in place to
monitor and control how a business is run.

Strategic drift may be due to a failure to identify the changes that are occurring and/or a failure to
react quickly enough. The failure to react could be because the pressures against change are so
great – employees do not want to change, the resources are not available to change or other
stakeholders resist. In some cases, managers will actually deny that there is a problem. They
might assume the environment will change back again or that the business will somehow
survive. In other cases, the business might be in a serious position because it has fallen so far
behind what is needed; managers may be worried by the extent of the drift and panic. This can
lead to them reaching out for major changes including changing the Chief Executive.
In Figure 42.3, the business environment is changing faster than the business itself. The gap
between where the businesses needs to be and where it is widens as the business fails to adapt to
the new conditions. Eventually, the business must either radically change (this is called
transformational change) to catch up or it may die.
Figure 42.3 Environmental change and strategic drift
The possible effect on strategy of the
divorce between ownership and control
In the case of a sole proprietor the owner is also the manager. However, in the case of companies
it may be that the owners (the shareholders) are different from the managers. In many ways this
is a good thing. It means people with money can invest and hand over the day-to-day running of
the business to the managers. However, it can bring problems in that the owners are not
necessarily involved in detailed decision making. They rely on the senior managers telling them
what the options are and keeping them informed about the major issues in the business. This
means there is a divorce between ownership and control. This can cause difficulties. For
example, the managers may pursue their own interests at the expense of the owners’. For
example, managers may decide they want the business to grow because it would make them look
more successful, even if it is not actually in the interests of the shareholders. The shareholders
may not have the full picture of the growth option and may believe the information given to them
by managers is correct and, therefore, approve the wrong strategies.
In order to ensure managers pursue the interests of the owners it is fairly common these days to
make shares part of managers’ reward packages so that they focus on issues such as the share
price and the dividends.
Corporate governance
In recent years there has been much greater concern over how businesses are regulated and how
their owners know what is happening within them. Corporate governance refers to the systems
and processes that are in place to monitor and control how a business is run. For example, who
are the directors of a business? Are they all managers as well, in which case the people who are
supposed to be protecting the shareholders’ interests may also be trying to protect their own jobs
as managers. Companies are advised to have non-executive directors so that they have some
‘outside eyes’ on what they are doing to ensure that managers are acting in the best interests of
the owners. According to the government, ‘The purpose of corporate governance is to facilitate
effective, entrepreneurial and prudent management that can deliver the long-term success of the
company’.

Business in focus: UK Corporate Governance Code

The UK Corporate Governance Code (the Code) was written in 1992 by the Cadbury
Committee. According to this Code, boards of directors are responsible for the
governance of their companies. The shareholders’ role in governance is to appoint
the directors and the auditors and to ensure that an appropriate governance structure
is in place. The board has to set the company’s strategic aims, provide the required
leadership to put them into effect, supervise the management of the business and
report to shareholders.
For a board to function effectively there must be constructive and challenging
dialogue between members. What must be avoided is ‘group think’, whereby
individuals start agreeing with each other and become reluctant to challenge an
established way of thinking.
Diversity on a board should also be encouraged – this in itself should help avoid
group think and should also lead to better quality decision making. Diversity may
relate to gender and race but also experience and approach.
When appointing directors the processes need to be transparent and rigorous.
Directors need to have sufficient time to allocate to their duties. The board needs to
have its performance evaluated regularly and members should have to stand for re-
election at appropriate intervals. No director should be involved in deciding their own
rewards.

Practice questions
1 Analyse why bad decisions might be made by a Board of Directors.
(9 marks)
2 To what extent does diversity on the Board of Directors matter?
(16 marks)
Evaluating strategic performance
Evaluating strategic performance means assessing whether or not the strategy worked. This can
only be done if you are clear what it was trying to achieve, the resources it had and the
conditions it was operating under. Coming fifth in the league may not seem to make you very
successful, but if you had an injured squad, falling crowds, no money for investment and were
expected to be relegated, you may actually have done a good job. Equally, you may have been
pleased to have come second but if the expectation was that you would win you may be in
trouble.
It is essential, therefore, to understand what the objectives are, how the managers expect to be
measured and also how they are expected to behave. Achieving sales targets but breaking the
businesses’ codes of conduct (for example, through bribery) may be worse than not achieving the
targets. ‘Success’ therefore means different things in different businesses and, in most cases,
there will be a number of indicators – did the business achieve its growth target, for example,
whilst staying within budget, behaving ethically and improving the brand reputation? Is a small
family business that provides jobs and security for a few family members, that helps bond the
family together and create a shared sense of achievement, any less successful than the giant
billion dollar profit-making multinational? Not necessarily. In the same way, an unhappy single
millionaire may not be more successful in life in the broadest sense than the care worker who
earns less but gives a lot back to the community, has a happy family and a sense of job
satisfaction. Think carefully before judging ‘success’ based on too narrow a range of indicators
and on your own perceptions of what is valuable – that may not be what the other organisation
values. Also think about the time frame. A business may not be profitable in the short term, for
example, but be building its reputation and relationships for longer term growth. Equally, a
business may have a one-hit success with a games app but have no other products in the pipeline
and therefore not be sustainable.

What do you think?

What do you think are the dangers of not having diversity in the board of directors?
The value of strategic planning
Much of what we have described in relation to strategy has seen the process of developing
strategy as a logical, rational process. We have outlined the idea of managers analysing the
existing position of the business and the outside environment and then developing a strategy to
match the two appropriately. This approach to strategic planning has great merits:
• It bases its plans on data. This should avoid irrational and badly thought through decisions
being made.
• It can provide a strategy that sets out for managers what the business is doing and how to do it.
This plan can unify and motivate employees and provide everyone with a sense of direction.
However, it must be remembered that:
• the environment can change so fast that strategic plans may need reviewing regularly and, at
times, may need a complete overhaul. The management writer Pascale said that, as observers,
we often want to find coherent and rational behaviour when there may not be any! According
to Pascale, it is often how a business deals with miscalculation, mistakes and events outside its
field of vision that determines its success over time, that is flexibility and adaptability may be
as important as long-term plans. The great military writer von Clausewitz said that the
Prussian general staff did not expect a plan of operations to survive beyond the first contact
with the enemy. The same may be true of a business plan – it will change as soon as it starts!
• it may be that a strategy evolves over time and is actually the result of a series of decisions that
gradually moved the business forward in a series of small steps. Looking back, it may be
possible to describe this as strategy but at the time it may not have been entirely clear where it
was headed!
• the level of detail in a strategic plan may need to be considered. Some argue that because
things do change so fast there is little point trying to anticipate detail too far in advance. Better
perhaps to focus on the overall direction and work out the detail as it is needed.
The value of contingency planning
Contingency planning occurs when managers plan for what might happen. In many cases
managers are planning for events that are unlikely but would be very significant if they did
occur. For example, a business might plan for what would happen if the Chief Executive
suddenly left or fell ill, or if the business was subjected to a takeover bid or if a major supplier
suddenly closed down.

Key term
Contingency planning occurs when a business plans for possible but unlikely
events.

In one sense, contingency planning may be a waste of resources because the things that are being
planned for may never happen. However, if they do occur, then, in theory, the business will be
ready and able to react quickly. In the case of a school, for example, it will have a plan for what
might happen in case of fire and will regularly have fire drills to make sure the plan works. The
hope is that this plan will never be needed in reality but, if a fire does happen, then the staff and
students will be trained and able to react more effectively than if the school had not had a
contingency plan.
Obviously a business cannot plan for every eventuality, so managers must decide what the key
issues to focus on are. The issues a business chooses to prepare for will depend on the perceived
likelihood of them happening, the likely impact on the business if they did happen and the costs
of planning.

ASSESSMENT ACTIVITIES

(a) Knowledge check questions

1Planning for unlikely future events is called ____________ planning.
2What is meant by ‘strategic implementation’?
3State four aspects of effective strategic implementation.
4Explain one reason why implementing a strategy may prove difficult.
5What is meant by ‘strategic drift’?
6Explain one reason why strategic drift might occur.
7What is meant by the divorce between ownership and control?
8The way in which the activities of managers are overseen and regulated by the
owners is called ____________.
9 Explain one benefit of strategic planning.
10 Explain one difficulty of planning strategically.
(b) Short answer questions
1 Explain one benefit of planning for the departure of the Chief Executive of a major
UK cosmetics business.
(5 marks)
2 Explain two ways strategic planning can help the new Chief Executive of a failing
business.
(6 marks)
3 Addt, a bicycle manufacturer, has grown and become a public limited company. At
the same time, a divorce between the ownership and managers of the company
has developed. Explain one possible effect on managers decisions of this divorce
between ownership and control.
(5 marks)
4 The family that owned the Tortellin Cake Company recently sold their shares and
floated the company. Explain one possible effect of this on the strategy of the
business.
(5 marks)
5 The Beta Games App Company made millions of pounds with its one game called
‘BETA BLOCKERS’. However, sales have been slowing in recent months. The
new Chief Executive of the Beta Games App Company has asked all team
members to contribute to the writing of a strategic plan for the business for the
next five years. Explain one benefit for the business of producing a strategic plan.
(5 marks)

(c) Data response question

Tesco failure
Having been the superstar business of the UK, Tesco struggled between 2011 and
2014. Its profit margins were squeezed and it lost market share to discounters such as
Aldi and Lidl. It has also faced accounting scandals and has been accused of bullying
suppliers.
A former Chief Executive of Tesco, Sir Terry Leahy, has said that in his view many of
the problems were due to a failure of the leadership of Philip Clarke. Leahy claimed
that people tried hard to do the right thing under Clarke but it simply did not work.
Ultimately, the leader must take the blame. (Sir Terry Leahy was widely credited with
building Tesco into one of the world’s largest and most successful retailers, presiding
over 14 years of growth in profits and sales. Leahy stood down in 2011 and handed
over to Clarke.)
According to Leahy, the problems facing Tesco have been due to a failure to maintain
its reputation for low prices. Consumers have lost trust as a result. People had got
used to Tesco providing the lowest prices and not having to check around for the best
deals; when this was no longer the case the brand was severely damaged. Faced with
competition from the discounters, Tesco seemed to lose its way and it had no clear
positioning between the more upmarket supermarkets, like Waitrose, and the
discounters. There were price promotions but Tesco was no longer consistently the
lowest price business.
Leahy argues that too many experienced people left when Clarke took over and this
meant that Tesco was not able to respond appropriately in these difficult times. Leahy
also claims that the culture changed under Clarke. Tesco employs nearly half a million
people and if they aren’t working towards the same goal and don’t understand the
goal this can clearly damage performance.
In his defence, Mr Clarke argued that people had to leave the company as he
addressed the challenges the business faced. According to Clarke, the real challenge
facing him was to reduce the number of new UK supermarket openings in order to
divert company cash into price promotions and facelifts for existing stores which had
been neglected as the business had concentrated too much on overseas stores.
Clarke argued that there had been a ‘race for space’ in which Tesco acquired more
and more land to build bigger stores at a time when customers were ordering more
online and needed local stores to top up their weekly online shopping. Mr Clarke had
£1 billion to restructure the business. However, he failed to deliver results quickly
enough. In 2014, Tesco reported the worst results in its history with a record pre-tax
loss of £6.4bn.
Philip Clarke left Tesco that year and was replaced by Dave Lewis of Unilever. The
company’s profits had again been below expectations. Mr Clarke had worked his way
up from the shop floor and had been at the company for 40 years. The board felt they
needed someone with a fresh perspective to move the company forward. Under Dave
Lewis, Tesco’s profits have improved. In 2018, it reported a profit of £1.3bn up from
£145m the year before.

Figure 42.4 Tesco share price in pence, 2014–2018

In 2017 and 2018, the company announced good results. with profits increasing. Part
of this improvement was due to the turnaround plan of Dave Lewis. This involved
refocusing efforts on the core UK business and pulling out of less profitable areas
such as South Korea. Store layouts and product ranges have been improved. Tesco
said it gained over 260,000 customers in 2018. At the same time, the company also
implemented an extensive cost cutting programme. This was achieved through
efficiency gains and job losses. Tesco also bought a major wholesaler called Bookers.
This gave it access to cheaper products; it also allowed Tesco to sell its products
through other stores supplied to by Booker. Tesco continues to face major competition
from discount stores such as Aldi.

Questions
1 Explain one factor that might influence the strategy chosen for Tesco.
(5 marks)
2 Analyse one reason for the success of the discounters in recent years.
(9 marks)
3 To what extent is the failure or success of a business such as Tesco due to its
leadership?
(16 marks)

(d) Essays
1 Strategic plans often fail to work out exactly due to changes in the environment. To
what extent do you think this means strategic planning is a waste of time? Justify
your view.
(25 marks)
2 To what extent is effective leadership the key to the successful implementation of
a significantly new strategy? Justify your view.
(25 marks)
Revision Section: Unit 10 Managing
strategic change
Advice for Unit 10
Top tips … Things to avoid …
It is important to identify the type and Do not assume you cannot prepare for
cause of change. This is important change – some change is slow; some
when evaluating issues such as the is predictable. However, at the same
likely resistance to it, how prepared time do not assume all change is
the business might be (or should be) predictable; some can occur suddenly
for it and the likely impact the change and unexpectedly.
will have.
Remember that the best way to Do not think having relevant, accurate
overcome resistance to change information to manage change
depends on what caused the guarantees success. The information
resistance in the first place. It also has to be interpreted correctly and
depends on how much time you have, acted upon in good time. ‘Paralysis by
how important it is to have agreement analysis’ occurs when managers spend
amongst employees and other so long analysing the data and trying to
stakeholders and the extent to which decide what to do that they miss the
the change is resisted. moment when they should act.
If change is occurring in a business, Do not assume change is good or
stand back and try to identify why this change is bad. In any change situation
is happening. Is it because there is some people may welcome it because
now more pressure for change or that they might benefit whilst others may
the resistance to change has been resist it because it challenges what they
reduced? It is important to understand are used to. When considering
why change is happening to be able to resistance, therefore, think carefully
analyse whether it is needed, what about who is likely to resist and the
would happen if it did not occur, what impacts (good and bad) on a wide
the definition of success might be and range of stakeholders.
the likely issues involved in making it
successful.
Remember that just because a strategy Do not believe there is a ‘right’ culture.
does not work does not mean it is Cultures vary and need to vary given
wrong – almost inevitably strategies their owners, their employees, the
will hit problems and the key is often nature of the business and the
how managers work through these business and social environment in
difficulties. which they operate. However, there are
 strong and weak cultures, that is in
some organisations the same values
and beliefs are held by the majority of
employees, whereas in other
organisations there are considerable
differences in what people believe.
Remember that the right organisational Do not assume you can just adopt a
structure depends on a range of culture or change a culture. It requires
factors – for example, whether or not a change in the way people think and in
you want the outcomes to be what they believe. This can take a very
predictable. If so, then you want tight long time to bring about, especially if
control and quite a mechanical you are looking for a major realignment
structure. If you want more innovation in people’s attitudes
and can live with uncertainty, then an
organic structure may be required.
Remember that the best way to Do not assume changing a strategy is
overcome resistance to change easy or quick – it usually isn’t!
depends on what caused the Strategies involved major changes in
resistance in the first place. It also direction.
depends on how much time you have,
how important it is to have agreement
amongst employees and other
stakeholders and the extent to which
the change is resisted.
Remember that culture plays an Do not forget the implications of a
important role in terms of what is the change in strategy for the different
right strategy and structure for an functional areas.
organisation. It also influences the
success of any strategy.
Remember that a strategy is the Do not forget some people may resist
product of its internal and external change.
environment. As these factors change
the strategy will need to adapt. The
right strategy and strategic positioning
will help the business build on its
strengths, protect its weaknesses,
defend against threats and exploit
opportunities.
Assess a strategy in terms of its Do not forget competitors can change
sustainability. How can a business their strategy too.
protect its strategy from competition?
What does it have that is not easy to
imitate?
When assessing the likely success of a Do not assume implementing a strategy
strategy it could be helpful to think is easy – managers will face constraints
about how well the strategy is planned, such as finance, time and people. They
how it will be implemented and the may also face resistance from some
extent to which it fits with the strengths employees.
of the business.
Apply the Ansoff matrix – it is a very Do not assume that if a strategy does
useful framework for analysing and not work it was wrong to begin with –
evaluating the strategy of a business. the environment may have changes
It makes it possible to consider the significantly since it was developed. It
specific issues of any given strategy may have been right at the time but did
relating to products and markets and not change with the environment.
compare and contrast this with
alternative strategies.
It is important to consider how a Do not assume profit is the only
strategy is going to be put into effect. measure of success. There are many
The way a strategy is implemented is measures of success – for example, a
as important (if not more so) than business may be seeking growth,
developing the strategy in the first profits or more employment. Before
place. assessing a strategy, always be clear
on the objectives, the time frame and
what is acceptable in terms of how
people behave in order to achieve
these objectives.
When analysing a network diagram it is Do not assume contingency planning is
important to consider how the worth it; it can take up time and money
estimates of the time needed were that could be used elsewhere. You
calculated and by whom. Consider cannot have a contingency plan for
also the resources involved – it may everything.
be possible to reduce the time an
activity takes if more resources are
allocated to it.
It is always worth analysing the
ownership of a business because this
is likely to affect the culture and the
objectives. You will not be able to
assess whether a strategy is
successful unless you are clear what
the owners actually want. You should
not impose your views of what
success means unless it is your
business.
It could be helpful to think about the
specific issues managers might plan
for in their industry. The airline industry
would plan for a crash or hijack. The
oil industry would plan for an oil
spillage.
UNIT 10 CHECKLIST
Having completed studying this unit you should be able to do all that is listed below.
You should read this list and confirm that this is the case.
Managing change
Know and understand:
• the causes of, and pressures for, change
• the different types of change including internal change, external change,
incremental change and disruptive change
• that managing change includes Lewin’s force field analysis
• the value of change
• how to analyse the value of a flexible organisation

• that flexible organisations include restructuring, delayering, flexible employment

contracts, organic vs mechanistic structures and knowledge and information
management
• how to analyse the value of managing information and knowledge
• how to analyse and evaluate the barriers to change
• how to use Kotter and Schlesinger’s four reasons for resistance to change
• how to overcome barriers to change including Kotter and Schlesinger’s six ways of
overcoming resistance to change.
Managing organisational culture
Know and understand:
• the importance of organisational culture
• how to analyse culture using cultural models, including Handy’s task culture, role
culture, power culture and person culture and Hofstede’s national cultures
• how to analyse and evaluate the influences on organisational culture
• how to analyse the reasons for, and problems of, changing organisational culture.
Managing strategic implementation
Know and understand:
• how to implement strategy effectively
• how to analyse the value of leadership in strategic implementation
• the value of communications in strategic implementation
• how to analyse the importance of organisational structure in strategic
implementation
• that organisational structures include functional, product-based, regional and matrix
structures
• how to analyse the value of network analysis in strategic implementation
• that network analysis includes understanding and interpreting network diagrams,
amending network diagrams and identifying the critical path and total float.
Problems with strategy and why strategies fail
Know and understand:
• how to analyse the difficulties of strategic decision making and implementing
strategy
• the difference between planned vs emergent strategy
• the reasons for strategic drift
• how to analyse the possible effect of the divorce between ownership and control
• that the effect of the divorce between ownership and control includes corporate
governance
• how to evaluate strategic performance
• how to assess the value of strategic planning
• how to assess the value of contingency planning.
Practice questions
1 The culture of Facebook is said to encourage innovation. Explain one reason why
this might be.
(5 marks)
2 Employees are unhappy with the relocation of the business to Germany. Explain
one way that managers might overcome this change.
(5 marks)
3 Many car companies are investing heavily in developing electric cars. Explain one
driving force that might be bringing about this change.
(5 marks)
4 With reference to Kotter and Schlesinger’s work, explain two reasons why
employees might resist a pay freeze when the profits of the business are rising.
(6 marks)
5 Analyse why Handy’s power culture may not be appropriate for a very large
business.
(9 marks)
Case study: Microsoft

Figure U10.1 Satya Nadella (centre) with Bill Gates (left) and Steve Ballmer (right)

In February 2014, Satya Nadella took over from Steve Ballmer as Chief Executive at
Microsoft. Ballmer had worked at Microsoft for years and was known for his passion
and energy when it came to preaching about the virtues of the company. He had been
Chief Executive since Bill Gates, the founder, stood down in 2000. When Ballmer got
the job, he made an emotional speech in which he declared his love of Microsoft.
Nadella is quieter in his approach than Ballmer but in his first few months he
reassured investors with his new strategy and Microsoft’s share price rose by nearly
25 per cent as a result. Nadella’s strategy is to make Microsoft a mobile first and cloud
first business.
The company’s success was huge when desktops dominated and almost every
computer had Microsoft Windows installed, but it lost out to smartphones and needs to
improve its position in the cloud and smartphone markets. Under Nadella, Microsoft is
fighting back. Nadella joined Microsoft in 1992 and since mid-2013 he has been
running the company’s cloud computing and business platforms. Cloud computing has
become increasingly important to software companies, as people connect to the
internet with many different kinds of devices – PCs, mobiles and tablets – and share
resources and files online. One criticism of Nadella’s appointment was that he was
another company man. Some said that Microsoft needed new blood from outside,
although Nadella seems ready to focus the business in a new direction.
Nadella has had to restore morale in the business. In 1999, the company was worth
$616 billion (£385 billion) – the most valuable company North America had ever
known. It had a 98 per cent market share of the PC market. But over the past decade,
Microsoft has made several high-profile mistakes – such as the Zune MP3 music
player, which quickly became obsolete as smartphones were used to store music on
the move, and Windows Vista, which was heavily criticised by developers and PC
owners. The company’s market capitalisation dropped to $380 billion and its market
share fell to 56 per cent. Employees have lost some faith in the company as they have
watched the success of Google and Apple and the less steady progress of Microsoft.
Several senior Microsoft executives have left in recent years and Nadella had to stop
this loss of talent.
Under Nadella, Microsoft has bought and rebranded Nokia’s mobile phone business.
Nadella has cut 18,000 of Nokia’s 127,000 staff and focused more on cheaper
smartphones (which is the fastest growing segment of the market). The new phones
use exclusively Windows Phone, Microsoft’s own operating system.
The company has also emerged as a major seller of cloud computing services
especially for big businesses where it challenges Amazon’s Web Services – just as
Nadella said it would. Microsoft has become much more welcoming to the open-
source development community, bringing some of its software to the Linux operating
system. Nadella has also encouraged partnerships with other businesses, such as
Red Hat, Salesforce and even Amazon, to support the Office apps and the Cortana
voice assistant.
Investors have benefitted significantly. Under Balmer’s 14-years at Microsoft the share
price did not move much. Under Nadella the share price almost tripled in the first four
years. With a stock market value of over $800 billion in 2018, Microsoft became the
world’s fourth most valuable company, behind only Apple, Amazon and Alphabet. In
his 2017 book ‘Hot Refresh’, Nadella talks of the importance of empathy in the
Microsoft culture these days. In the past it used to be that stakeholders had to do it
‘the Microsoft way; now the company is keen to learn from others and work with them.’
Nadella has also focused on making business processes leaner and more efficient.
Microsoft’s changing business model has largely focused on a move away from
delivering packaged software and toward selling subscription-based cloud services.
Close to two-thirds of Microsoft’s revenue is now recurring, coming from subscriptions
rather than licenses. The company is also back as a serious player in terms of
development, having lost its way to Apple, Facebook and Google.
Under Ballmer, Microsoft aimed to push Windows for mobile devices, first with
Windows Mobile and then with Windows Phone. The company paid more than $7.6
billion for Nokia Devices – a deal that proved very unsuccessful. Under Nadella, it
pulled out of this strategy. Instead of trying to develop its own operating systems it
now seeks to support the iPhone and Android systems. He is much more interested in
Windows running in everything else rather than everything having to run on Windows.
Nadella has also made a number of big acquisitions. In 2016 he paid $26.2 billion for
LinkedIn and in 2018 bought the code-sharing service GitHub for $7.5 billion. These
acquisitions are part of Nadella’s mission, set out in a memo in 2014: ‘We will reinvent
productivity to empower every person and every organization on the planet to do more
and achieve more.’
Nadella has identified three key growth areas for the company in the future: Mixed
reality, Artificial Intelligence, and Quantum Computing.
Under Nadella, Microsoft is predicted to have a market capitalisation of $1 trillion by
2020.
Practice questions
1 Analyse the possible reasons why the share price of Microsoft may have increased
in the first few months with Nadella as Chief Executive.
12 marks)
2 Analyse the possible reasons why employees might resist Nadella’s attempts to
make Microsoft leaner.
(12 marks)
3 To what extent was recruiting a new Chief Executive internally rather than
externally likely to have been a good move for Microsoft?
(16 marks)
4 To what extent is the strategy of Microsoft determined by external rather than
internal factors?
(16 marks)
5 To what extent were all stakeholders likely to support Nadella’s strategy?
(20 marks)
6 To what extent do you think the leader of a business determines whether it
succeeds or not?
(24 marks)
Essay questions
1 To what extent is it inevitable that all businesses will fail?
(25 marks)
2 To what extent is the most recent profit figure the best way of assessing the
strategic performance of a business?
(25 marks)
Acknowledgements
Unit 1 running head © Vladitto / stock.adobe.com; p.2 l © 2004 TopFoto / ImageWorks; r ©
Steven Heap / 123rf; p.4 © Clynt Garnham Construction / Alamy Stock Photo; p.6 © Robert
Wilson / 123rf; p.8 l Courtesy Marks & Spencer; r Courtesy Marks & Spencer; p.9 © Charles
Sykes / AP / Shutterstock; Unit 2 running head © Gorodenkoff / stock.adobe.com; p.48 l ©
Michael A. Schwarz / Bloomberg via Getty Images; r © Justin Sullivan / Getty Images; p.69 ©
Matt Fountain / The Freedom Bakery; p.72 © AFP / Stringer via Getty Images; Unit 3 running
head © REDPIXEL / stock.adobe.com; p.85 © Radharc Images / Alamy; p.103 l © Al Freni /
The LIFE Images Collection / Getty Images; r © Steve Stock / Alamy Stock Photo; p.110 ©
Hugh Threlfall / Alamy Stock Photo; p.113 © David Caudery / Tap Magazine via Getty Images;
p.117 © Tomohiro Ohsumi / Bloomberg via Getty Images; p.119 t © Sipa Press / REX /
Shutterstock; m © High Level / REX / Shutterstock; b © keith morris / Alamy Stock Photo;
p.122 © Zety Akhzar / Shutterstock; p.125 © Tobias Hase / DPA / PA Images; p. 127 © Hayley
Louize Ballard / Alamy Stock Photo; p.128 © Art Directors & TRIP / Alamy Stock Photo; p.129
© monticello / Shutterstock; p.132 l © Sascha Steinbach / EPA-EFE / Shutterstock; r © Mark
Thompson / Getty Images; p.136 © tony french / Alamy Stock Photo; p.137 © Jonathan Saruk /
Getty Images; p.141 © Ira Berger / Alamy Stock Photo; p.143 © Kevin George / Alamy; Unit 4
running head © James Thew / stock.adobe.com; p.149 t © Sipa / Shutterstock; b © Adrian
Brown (brownbox.com.au), Courtesy Akubra Hats Pty Ltd; p.152 © Vincent Jannink / AFP /
Getty Images; p.155 t © Simon Dawson / Bloomberg via Getty Images; b © Oleksiy
Maksymenko Photography / Alamy Stock Photo; p.156 © Martin Divisek / Bloomberg via Getty
Images; p.157 © US Coast Guard Photo / Alamy Stock Photo; p.160 © Rachit Goswami / The
India Today Group / Getty Images; p.167 © GEOFF CADDICK / Stringer / AFP via Getty
images; p.171 © Joerg Huettenhoelscher / 123rf; p.180 © Piotr Trojanowski / 123rf; p.181 l ©
maxoidos – Fotolia; r © Stephen Barnes / Northern Ireland / Alamy Stock Photo; p.183 © Paul
Thompson Images / Alamy Stock Photo; p.186 © studiomode / Alamy Stock Photo; p.188 © Bill
Hogan / Chicago Tribune / MCT / Getty Images; p.191 © Alexandr Blinov / 123rf; Unit 5
running head © ipopba / stock.adobe.com; p.198 © Sitthipong Pengjan / 123rf; p.200 ©
inkdrop / 123rf; p.234 © 2009 Martin Jardine Photography, Courtesy of The Brooklyn
Warehouse; p.243 © NeuroSky; p.244 © CPC Collection / Alamy Stock Photo; Unit 6 running
head © Monkey Business / stock.adobe.com; p.258 t © Stonewall Equality Ltd; m © Employers
Network for Equality & Inclusion; b © Equality Challenge Unit; p.314 © Bartek Sadowski /
Bloomberg via Getty Images; Unit 7a running head © MarekPhotoDesign.com /
stock.adobe.com; p.326 © Tommy Trenchard / Oxfam; p.331 t © Imagewise Ltd / Shutterstock;
b © joeppoulssen / 123rf; p.334 © Roger Bamber / Alamy Stock Photo; p.339 © Kiyoshi Ota /
Bloomberg via Getty Images; p.367 @ Angelo Giampiccolo – Fotolia; p.375 © dolphfyn /
Alamy Stock Photo; Unit 7b running head © James Thew / stock.adobe.com; p.397 © Jeffrey
Blackler / Alamy Stock Photo; p.424 © Startraks Photo / REX Shutterstock; p.428 ©
redbrickstock.com / Alamy Stock Photo; p.442 © Foster + Partners; p.455 Used with permission
from Microsoft; Unit 8 running head © ra2 studio / stock.adoble.com; p.489 © Steven Senne /
AP / Shutterstock; p.490 © Charles Pertwee / Bloomberg via Getty Images; p.493 © Urbanmyth
/ Alamy Stock Photo; p.496 © Keenretail / Alamy Stock Photo; p.500 © David Askham / Alamy
Stock Photo; p.501 © Netflix. All Rights Reserved; p.503 © Andrew Paterson / Alamy Stock
Photo; p.504 © Kathy deWitt / Alamy Stock Photo; Unit 9 running head © Kir Smyslov /
stock.adobe.com; p.511 © Shchipkova Elena – Fotolia; p.512 © Art Directors & TRIP / Alamy
Stock Photo; p.517 © DWD-photo / Alamy Stock Photo; p.526 © Mark Elias / Bloomberg via
Getty Images; p.529 © Bryn Lennon / Getty Images for Jaguar; p.532 © Long Wei / EPA /
Shutterstock; p.538 © mbolina – Fotolia; p.542 © David Pearson / REX Shutterstock; p.544 ©
Jonathan Weiss / 123rf; p.556 © Tim Goode / EMPICS Entertainment / Press Association
Images; Unit 10 running head © Rawpixel.com / stock.adobe.com; p.566 © Victor J. Blue /
Bloomberg via Getty Images; p.582 © Richard Levine / Alamy Stock Photo; p.595 © Chris
Whiteman / Alamy Stock Photo; p.597 © Granger, NYC / TopFoto; p.607 © ZUMA / REX
Shutterstock
Table 21.3: Chartered Institute of Personnel and Development and Hays. (2017) ‘Table 16:
Median labour turnover rates by reason for leaving’, table, in Resourcing and talent planning
2017 [online]. Survey report. London: CIPD. p39. Available at:
https://www.cipd.co.uk/Images/resourcing-talentplanning_2017_tcm18-23747.pdf [Accessed 24
May 2019]. Reproduced with the permission of the publisher, the Chartered Institute of
Personnel and Development, London (www.cipd.co.uk).
Table 21.4: Chartered Institute of Personnel and Development and Hays. (2017) ‘Figure 23:
Retention difficulties, by occupational category and sector (% of respondents)’, figure, in
Resourcing and talent planning 2017 [online]. Survey report. London: CIPD. p41. Available at:
https://www.cipd.co.uk/Images/resourcingtalent-planning_2017_tcm18-23747.pdf [Accessed 24
May 2019]. Reproduced with the permission of the publisher, the Chartered Institute of
Personnel and Development, London (www.cipd.co.uk).
Figure 38.6 and 38.8: Connected Home 2.0, Overview, © 2015-2019 PwC. 2018 State of the
Internal Audit Profession Study, Moving at the speed of innovation. The foundational tools and
talents of technology-enabled Internal Audit, © 2015 - 2019 PwC. Reprinted with permission
from “Moving at the speed of innovation” © 2018 PwC and from “Connected Home 2.0” ©
2019 PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its
member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for
further details.