Most small businesses have very limited resources. Research is costly and can seem like a poor use of time. Some entrepreneurs ignore planning and analysis and instead rely on their gut instinct. They launch products they believe customers want and competitors cannot match. Poor planning is a major cause of business failure.
Businesses are more likely to
succeed if their strategy is carefully planned
There is an alternative.
A business plan is a
report by a new or existing business that contains all of its research findings
and explains why the firm hopes to succeed. A business plan includes the
results of market research
and competitor analysis.
Analysis is when a business interprets
information.
Drawing up a business
plan forces owners to think about their aims, the competition they will face,
their financial needs and their likely profits. Business plans help to reduce
risk and reassure stakeholders [Stakeholders: These
are all the people and groups who have an interest in a business.], such as banks.
Competitive and changing markets
In order to attract and
satisfy customers, businesses need to be competitive and make products that are
superior to their rivals.
Product variety may help a
company to stand out in a competitive market
This is not easy because
businesses operate in a dynamic
and challenging
market place. Business rivals are likely to be at work on creating new products
or improving operations to reduce costs and drive down prices. Businesses may
need to adapt their
products because ever-changing fashion trends mean that customer requirements
evolve over time. Success today is no guarantee of future profits.
A competitive market will have many
businesses trying to win the same customers. A monopoly is either the only supplier in a market, or a
large business with more than 25% of the market.
Competition can make
markets work better by improving these factors:
·
Price: if there is only one retailer, products may not be
competitively priced. If there are several retailers, each retailer will lower
their prices in an attempt to win customers. It is illegal for retailers to agree
between themselves to fix a price - they must compete for business.
·
Product range: in order to attract customers away from rivals,
businesses launch new varieties of products they believe to be superior to
their competitors.
·
Customer service: retailers that provide a helpful and friendly
service will win customer loyalty.
Product differentiation – standing out from the crowd
Businesses operate in competition with each other. If the
market is large enough to support many firms, a new business can open which
imitates an existing idea. ‘Me too’ products can sometimes be successful.
However, businesses
become more competitive by making products that stand out from the competition in terms of price,
quality or service. This is called product
differentiation.
Methods of creating
product differentiation include:
·
Establishing
a strong brand image
(personality) for a good or service.
·
Making
the unique selling point
of a good or service clear. For example, opening a chain of discount shops with
the tagline Quality items under a pound.
·
Other
competitive factors,
such as a product having a better location, design, appearance or price than
rivals.
Companies create logos as part
of their brand identity to help differentiate their goods and services
2. Aims and objectives
Businesses have different
aims and objectives that can change over time.
Different types of business aims and objectives
An aim or objective is a statement of what a
business is trying to achieve over the next 12 months. For example, a business
can set itself any of these targets:
A new cafe may just aim to
survive its first year
- survival
- increased profit
- growth
- increasing market share
Having an objective is
useful because it helps staff to focus
on shared aims. A business could instruct its staff to work towards increasing
sales by 10% by the end of the year.
Different organisations
have different objectives.
Some businesses are run to make as much profit as possible for owners. However,
not all businesses aim to make profit. Voluntary organisations such as
charities are more concerned with providing a service to others.
Setting objectives
In most businesses, the owners decide on the objectives for
the business.
When a business first
starts trading it has few loyal customers and no reputation. The most likely
objective for a start up business is simply survival. As the business grows and begins to win
market share, the aim may shift towards expansion
and/or increasing profits.
Some owners have a vague
idea about their objectives. The best types of objective are SMART. Smart stands for:
- Specific: clearly state what is to be achieved
eg increased profits.
- Measurable: the desired outcome is a number
value that can be measured, eg increase profits by 10%.
- Agreed: all staff are involved in
discussing and agreeing an aim.
- Realistic: the target is possible given the
market conditions and the staff and financial resources available.
- Timed: the target will be met within a
given period of time, eg 12 months.
An example of a SMART
objective is 'to increase profits by 10% within the next 12 months'. SMART
objectives allow the performance of a business to be assessed.
While owners have a major
say in deciding the aims of a business, other interest groups called stakeholders are usually
considered. Stakeholders are any group of people interested in the activities
of the business - they could be managers, staff or customers. When owners
sacrifice some profit to pay staff an annual bonus, this is an example of stakeholder consideration.
Why business objectives change
An economic recession can cause
a business to change its objectives
The aim of a business can
change over time.
This can happen in response to internal
factors, such as business growth, or in response to external factors, such as an
economic recession.
A small start up business
may aim to survive in
the first year. Once successful, the business then sets itself the objective of
increasing profits or
growing in size.
Alternatively, a
profitable business that is hard hit by an economic recession may struggle to
maintain the same level of output. Faced with declining sales, a business may
change its objective from growth or making a profit, to simply surviving.
3. Enterprise
What is enterprise
Enterprise is a skill. Put simply,
enterprise is the willingness of an individual or organisation to:
- Take risks. Setting up a new business is
risky. Even if the entrepreneur has carefully researched the market,
there's always a chance that customers may reject the product and that a
loss will be made.
- Show initiative and 'make things happen'.
Successful entrepreneurs have the drive, determination and energy to
overcome hurdles and launch new businesses.
- Undertake new ventures. An entrepreneur has to have the
imagination to spot business opportunities that will fill gaps in the
market.
Enterprise is carried out
through the work of an entrepreneur.
Thinking creatively
Creative thinking is the process by which
individuals come up with new ideas
or new approaches to business. New ideas could result in a new product - for
example, a games console. They could also result in a new process that cuts costs or improves
quality - for example, a bagless vacuum cleaner.
Fresh ideas give businesses
a competitive advantage
and help make their goods or services stand out in the market place.
Entrepreneurs can make
use of several different thinking techniques to improve their creativity:
- Lateral thinking or thinking outside the box. An
example of this would be breaking down the steps taken to serve coffee in
a café and asking 'why' at each step to see if a better process can be
created.
- Deliberate creativity uses thinking techniques to spark
off new ideas. For example, putting on different thinking hats to tackle
problems from different angles. 'White-hat' thinking looks at facts and
'black-hat' thinking looks at drawbacks.
- Blue-sky thinking involves a group of people
looking at an opportunity with fresh eyes. As many ideas as possible are
generated in an ideas generation session where no ideas are rejected as
silly.
Part of the process of
thinking creatively and coming up with a new business idea is to ask the right questions. For example, looking at
a successful product and asking - why, why not, how, where, when, what, what
if?
Invention and
innovation
Invention is about making new items, or
finding new ways of making items. Innovation
involves bringing this new idea to the market, that is, turning an invention
into a product.
A business can use the
law to protect its business idea. For example, an entrepreneur can:
- Register ownership
of an invention or new process and be given a patent. This can stop rivals
from copying the idea for a set number of years.
- Sue for damages if others copy their work - copyright automatically arises
for authors creating books, films, music or games.
- Register a trademark.
A trademark is a symbol or phrase that a company can register with the
government to make their company distinctive.
A patent, copyright or
trademark grants legal ownership
and is only given for original work.
Important enterprise skills
So what does it take to
be a successful businessperson? Typically entrepreneurs are:
- Imaginative and quick to see business
opportunities and gaps in the market.
- Planners who take time to research
customer requirements, competitors and trends to better understand their
market and minimise the risk of failure.
- Determined to succeed no matter how many
hours of unpaid preparation are involved.
4. Business structure
Owners have to decide on
the best legal structure for their business - opting to run as sole traders,
partnerships or private limited companies. As the business expands and starts
to employ hundreds of staff in many locations, it may decide to become a public
limited company or to offer franchises.
Sole traders
A sole trader describes any business
that is owned and controlled by one
person - although they may employ workers. Individuals who
provide a specialist service
like plumbers, hairdressers or photographers are often sole traders.
Sole traders do not have
a separate legal existence from the business. In the eyes of the law, the
business and the owner are the same.
As a result, the owner is personally
liable for the firm's debts and may have to pay for losses made
by the business out of their own pocket. This is called unlimited liability.
Advantages
·
It
is easy to set up as
no formal legal paperwork is required.
·
Generally,
only a small amount of capital
needs to be invested, which reduces the initial start-up cost.
·
As
the only owner, the entrepreneur can make decisions without consulting anyone
else.
Disadvantages
·
The
sole trader has no one to share the responsibility
of running the business with. A good hairdresser, for example, may not be very
good at handling the accounts.
·
Sole
traders often work long hours.
They may find it difficult to take holidays or time off if they are ill.
·
They
face unlimited liability [Unlimited
liability: Owners are personally liable for all debts. ] if the business fails.
Partnerships
Partnerships are businesses owned by two or more people.
Doctors, dentists and
solicitors are typical examples of professionals who may go into partnership together and can
benefit from shared expertise.
One advantage of partnership is that there is someone to consult on business
decisions.
The main disadvantage of
a partnership comes from shared
responsibility. Disputes
can arise over decisions that have to be made, or about the effort one partner
is putting into the firm compared with another. Like a sole trader, partners
have unlimited liability [Unlimited
liability: Owners are personally liable for all debts. ].
Limited companies
A limited company has special status
in the eyes of the law. These types of company are incorporated, which means they have
their own legal identity and can sue or own assets in their own right. The
ownership of a limited company is divided up into equal parts called shares. Whoever owns one or more of
these is called a shareholder.
Because limited companies
have their own legal identity, their owners are not personally liable for the
firm's debts. The shareholders have limited
liability, which is the major advantage of this type of
business legal structure.
Unlike a sole trader or a
partnership, the owners of a limited company are not necessarily involved in
running the business, unless they have been elected to the Board of Directors.
There are two main types
of limited company:
·
A private limited company (ltd) is often a small business such as
an independent retailer in a market town. Shares do not trade on the stock
exchange.
·
A public limited company (plc) is usually a large, well-known
business. This could be a manufacturer or a chain of retailers with branches in
most city centres. Shares trade on the stock
exchange (Stock Exchange: A
centralised market where business shares are traded)
Franchising
An entrepreneur can opt
to set up a new independent business and try to win customers. An alternative
is to buy into an existing business and acquire the right to use an existing
business idea. This is called franchising.
·
A
franchisee, who buys
the right from a franchisor to copy a business format.
·
And
a franchisor, who sells
the right to use a business idea in a particular location.
Many well-known high
street opticians and burger bars are franchises.
Opening a franchise is
usually less risky
than setting up as an independent retailer. The franchisee is adopting a proven
business model and selling a well-known product in a new local branch.
5.
Expanding a business
Business expansion has
potential benefits and drawbacks. Some owners are reluctant to take the risk of
growing the business and opt to stay small.
Benefits of a growing
business
As a business grows it gains two major advantages
over its smaller rivals. Large firms have more influence over market price. They're big enough to be price setters.
Large firms also often
enjoy economies of scale.
This means that a business has lower
unit costs because of its large size. They can buy raw
materials cheaply in bulk and also spread the high cost of marketing campaigns
and overheads across larger sales.
For example, if a large
firm can produce a given type of sunglasses for £20 while it costs its smaller
rival an average of £30, then the larger firm has a £10 per unit cost advantage. Larger firms can
charge lower prices or enjoy a higher profit margin.
Economies of
scale are a
major source of competitive advantage for large firms.
Methods of expansion
A business can grow in
size through:
- Internal (organic) growth: the business grows by hiring
more staff and equipment to increase its ouput (output: the term denoting either an exit or changes
which exit a system and which activate/modify a process.)
- External growth: where a business merges with or takes over another
organisation. Combining two firms increases the scale of operation.
- Franchising: where a business leases its idea to
franchisees. This allows new branches to open across the country and
internationally.
Profit or growth?
Owners can face a dilemma
in deciding whether to expand. Expansion is risky. There's always the chance that any expansion
plans can fail and result in losses
rather than profit. Owners are then worse off than before the growth of the
business.
The risk of expansion
means that some owners are reluctant to chance funds. They opt instead to stay small and earn a relatively
risk-free profit.
There is potentially a
major drawback to avoiding growth. Small businesses can be at a cost disadvantage compared to their
larger rivals enjoying economies of scale
economies of
scale: Economy of scale means that big companies can produce
things cheaper than smaller companies. There are two reasons for this. First,
they can buy in bulk, so can negotiate with suppliers to pay less. Second, the
more a company produces the lower the average cost per product will be of
overheads (fixed costs, such as buildings). Where similar companies locate
together as an industry they can also experience economies of scale. They share
the costs of building the necessary infrastructure (eg roads,
telecommunications) and the cost of educating the workforce, between them. Also
the combined demand from all these companies should mean that supplies are
cheaper.. As
small firms cannot compete with the low
prices set by their larger rivals, they have to compete on service or quality.
Marketing
6. Market research
Marketing is about responding to consumers' needs. It is important to
find out what these needs are before launching a new product.
A business conducts market research to help identify gaps in the market
and business opportunities.
What is a market?
Businesses sell to customers in markets. A market is any place
where buyers and sellers meet to trade products - it could be a high street
shop or a web site. Any business in a marketplace is likely to be in
competition with other firms offering similar products. Successful products are
the ones which meet customer needs better than rival offerings.
Markets are dynamic. This means that they are always changing. A
business must be aware of market trends and evolving customer requirements
caused by new fashions or changing economic conditions.
Market research
There is far more to marketing than selling or advertising. Put simply,
marketing is about identifying and satisfying customer needs.
The first step is to gather information about customers needs,
competitors and market trends. An entrepreneur can use the results of market
research to produce competitive products.
The first step for a new business or product is to attract trial
purchases.
A new magazine may run special offers to get customers to try the first
issue, hoping that repeat sales are generated. The magazine will soon close if
customers fail to buy future issues. The aim of a special offer scheme is to
convert trial purchases into repeat sales.
Market research involves gathering data about customers, competitors and
market trends.
Collecting market research
There are two main methods of collecting information:
- Primary research (field
research) involves gathering new data that has not been collected before.
For example, surveys using questionnaires or interviews with groups of
people in a focus group.
- Secondary research (desk
research) involves gathering existing data that has already been produced.
For example, researching the internet, newspapers and company reports.
Factual information is called quantitative data. Information
collected about opinions and views is called qualitative data. Accurate
market research helps to reduce the risk of launching new or improved products.
Some businesses opt out of field research and rely instead on the
know-how and instincts of the entrepreneur to ‘guess’ customer requirements.
They do this because market research costs time and money. Existing business
can make use of direct customer contact to help them identify changing fashion
and market trends.
Market Segments
Most markets contain different groups of customers who share similar
characteristics and buying habits. These collections of similar buyers make up
distinct market segments.
Targeted marketing
Breaking down a market into submarkets can lead to a business
opportunity. For example, a magazine publisher can target a specialist journal
at one group of customers of similar age, gender, class or income.
Another tool used to help identify a business opportunity is a market
map. A market map is a diagram that identifies all the products in the
market using two key features.
A market map showing a gap in the market
The red circle identifies a gap in the market. There is a
business opportunity for a new café offering standard quality products at
standard prices.
Competition
A competitive market has many businesses trying to win the same
customers. A monopoly exists when one firm has 25% or more of the
market, so reducing the competition.
Competition in the market place can be good for customers. Governments
encourage competition because it can help improve these factors:
- Price: If
there are several retailers, each retailer will lower the price in an
attempt to win customers. It is illegal for retailers to agree between
themselves to fix a price. They must compete for business.
- Product range: In
order to attract and satisfy customers, companies need to produce products
that are superior to their competitors.
- Customer service:
Retailers that provide customers with a helpful and friendly service will
win their loyalty.
7. The marketing mix
A company needs to
consider the marketing mix in order to meet their consumers' needs effectively.
Elements of the
marketing mix
The marketing mix is the combination of
product, price, place and promotion for any business venture.
Marketing Mix
No one element of the
marketing mix is more important than another – each element ideally supports
the others. Firms modify each element in the marketing mix to establish an
overall brand image
and unique selling point [Unique
selling point: The unique thing about the product that makes
consumers buy it. This can be branding, packaging or a feature of the product. ] that makes their products stand out from
the competition.
Using the marketing
mix
An exclusive brand of
jewellery uses the best materials but comes at a high price. Such designer brands
can only be bought at exclusive stores and are promoted using personal selling
sales assistants. By contrast, cheap and cheerful jewellery for the mass market is best sold in
supermarkets and can be promoted using television adverts.
Market research findings
are important in developing the overall marketing mix for a given product. By
identifying specific customer needs a business can adjust the features, appearance, price and distribution method for a target
market segment.
New technologies and
changing fashion means goods and services have a limited product life cycle. Ideally, the marketing
mix is adjusted to take account of each stage. For example, the life of a
product can be extended by changing packaging
to freshen a tired brand and so boost sales.
There is no single right
marketing mix that works for all businesses at all times. The combination of
product, price promotion and place chosen by a business will depend on its
size, competition, the nature of the product and its objectives.
The overall marketing mix
is the business’ marketing strategy
and is judged a success if it meets the marketing department’s objectives, eg increase annual
sales by 5%.
Consumer protection
Businesses must never be
misleading about their products
The law gives customers
protection against unfair selling practices. You do not need to know specific
Acts but you do need to understand how fair
trading regulations protect consumers.
The consumer has basic
legal rights if the product is:
- given a misleading description
- of an unsatisfactory quality
- not fit for its intended purpose
Sale and Supply of
Goods Act 1994
This Act says that all
products have to be of a 'satisfactory quality'. This means that they have to:
- be safe
- last for a reasonable amount of time
- be fit for their intended purpose
- have nothing wrong with them (unless the defect was
noted at the time of sale)
Trade Descriptions
Act
According to the Trade
Descriptions Act, false or misleading information must not be given about
products. For example, accurate information must be given about who made the product.
Fake designer goods that
are marketed as genuine are a clear breach of the Trade Descriptions Act.
Consumer Credit Act 1974
This Act protects you
when you borrow or buy on credit. The Consumer Credit Act states that:
- Businesses must have licences to give credit.
- No one under 18 is to be invited to borrow or buy on
credit.
- Businesses have to state an Annual Percentage Rate
(APR). If you sign a credit agreement at home you have several days in
which you can tear up the agreement. This is called a 'cooling off
period'.
8. Product
A business can adjust the
features, appearance and packaging of a product to create competitive
advantage.
What is a product?
Brands use packaging and logos
to create a brand image
A product is a good or a
service that is sold to customers or other businesses. Customers buy a product
to meet a need. This
means the firm must concentrate on making products that best meet customer
requirements.
A business needs to
choose the function, appearance and cost most likely to make a product appeal
to the target market and stand out from the competition. This is called product differentiation.
How product
differentiation is created
- Establishing a strong brand image (personality) for a good or service.
- Making clear the unique
selling point (USP) of a good or service, for example, by
using the tag line quality items for less than a pound for a chain of
discount shops.
- Offering a better location, features, functions,
design, appearance or selling price than rival products.
Firms face a dilemma if
they choose to launch a premium brand.
Improving the quality or appearance of a product adds to the cost of making it.
In turn, this means that the business must charge higher prices if they are to
make a profit.
An alternative marketing
strategy is to produce a budget brand.
If a mobile phone has limited functions and a standard design then it can be
manufactured cheaply. The low production costs allow for discount pricing.
Product life cycle
The product life cycle
diagram shows that four stages exist in the ‘working life’ of most products.
Product
life cycle diagram
These are:
- Launch
- Growth
- Maturity
- Decline
In the launch and growth stages sales rise. In the
maturity stage, revenues flatten out.
Getting a product known
beyond the launch stage usually requires costly promotion activity.
At some point sales begin
to decline and the business has to decide whether to withdraw the item or use
an extension strategy
to bolster sales. Extension strategies include updating packaging, adding extra
features or lowering price.
Product
differentiation
A product portfolio is the range of
items sold by a business. It can be analysed using the Boston Matrix.
Boston
Matrix
Star products have a high market share
in a fast growing market.
Cash Cows have a high market share in a
slow growing market.
Question marks or problem children products have a
low market share in fast growing markets.
Dogs are products with a low market
share in slow growing markets.
Firms with just a few
items in their product portfolio – or who have all their products at the same
stage in the product life cycle[an error occurred while processing this
directive] – are in the dangerous position of having ‘all their eggs in
one basket’. Such firms may prioritise broadening their product range.
9. Price
A business must take many
factors into account before deciding on the price of a product.
Pricing strategies
Remember there is a big
difference between costs
and price. Costs are
the expenses of a firm. Price is the amount customers are charged for items.
Firms think very
carefully about the price to charge for their products. There are a number of
factors to take into account when reaching a pricing decision:
- Customers. Price affects sales. Lowering
the price of a product increases customer demand. However, too low a price
may lead customers to think you are selling a low quality ‘budget
product’.
- Competitors. A business takes into account
the price charged by rival organisations, particularly in competitive
markets. Competitive pricing
occurs when a firm decides its own price based on that charged by rivals.
Setting a price above that charged by the market leader can only work if your product has
better features and appearance.
- Costs. A business can make a profit
only if the price charged eventually covers the costs of making an item.
One way to try to ensure a profit is to use cost plus pricing. For
example, adding a 50% mark up to a sandwich that costs £2 to make means
setting the price at £3. The drawback of cost plus pricing is that it may
not be competitive.
There are times when
businesses are willing to set price below unit cost. They use this loss leader strategy to gain sales
and market share.
Pricing new products
Half price sales are an example
of penetration pricing
A business can choose
between two pricing tactics when launching a new product:
- Penetration pricing means setting a
relatively low price to boost sales. It is often used when a new product
is launched, or if the firm’s main objective is growth.
- Price skimming means setting a relatively high
price to boost profits. It is often used by well-known businesses
launching new, high quality, premium products.
10. Promotion
There is much more to
promotion than advertising. Businesses use various methods to gain publicity.
Customer awareness
Promotion refers to the methods used by a
business to make customers aware of its product. Advertising is just one of the
means a business can use to create publicity. Businesses create an overall
promotional mix by putting together a combination of the following strategies:
Promotional material on a high
street in Shanghai
- Advertising, where a business pays for
messages about itself in mass media such as television or newspapers.
Advertising is non-personal and is also called above-the-line promotion.
- Sales promotions, which encourage customers to buy
now rather than later. For example, point of sale displays, 2-for-1
offers, free gifts, samples, coupons or competitions.
- Personal selling using face-to-face communication,
eg employing a sales person or agent to make direct contact with
customers.
- Direct marketing takes place when firms make
contact with individual consumers using tactics such as ‘junk’ mail shots
and weekly ‘special offer’ emails.
There is no one right
promotional mix for all firms. The combination
of promotional elements selected takes into account the size of
the market and available resources. Large businesses have the resources to use
national advertising. Small firms with limited resources and a local market may
instead opt for leaflet drops to promote their activities.
11. Place
As part of its marketing
strategy, a company needs to decide where best to distribute a product.
What is place?
Place is the point where products are
made available to customers. A business has to decide on the most cost-effective
way to make their products easily available to customers.
This involves selecting
the best channel of distribution.
Potential methods include using:
- Retailers. Persuading shops to stock
products means customers can buy items locally. However, using a middleman
means lower profit margins for the producer.
- Producers can opt to distribute using a wholesaler who buys in bulk
and resells smaller quantities to retailers or consumers. This again means
lower profit margins for the manufacturer.
- Telesales and mail order. Direct
communication allows a business to get products to customers without using
a high street retailer. This is an example of direct selling[an error occurred while processing
this directive].
- Internet selling or e-commerce. Online selling is
an increasingly popular method of distribution and allows small firms a
low cost method of marketing their products overseas. A business website
can be both a method of distribution and promotion.
Developing new or
improved channels of distribution can increase sales and allow a firm to grow.
People in Business
12. Organising staff
When hiring large numbers
of staff, organisation is important. Everyone within the company needs to
understand their role.
Structuring a
business
As a business grows in
size and takes on more staff, managers need to make sure employees understand
their role within the company. Organisation
is the way a business is structured.
One method of
organisation is to set up departments covering the four main areas of business
activity:
- finance
- human resources
- marketing
- operations
Organisation
charts are
diagrams that show the internal
structure of the business. They make it easy to identify the specific
roles and responsibilities
of staff. They also show how different roles relate to one another and the
structure of departments within the whole company.
An organisational chart showing
the structure of a company
For example, the
Marketing Manager in the Midlands can see at a glance that she is in charge of
ten subordinates, and that her line manager is the Director of Marketing.
Organisational terms
There are a number of
technical terms you need to learn:
- Hierarchy refers to the management levels within
an organisation.
- Line managers are responsible for overseeing
the work of other staff.
- Subordinates report to other staff higher up
the hierarchy. Subordinates are accountable to their line manager for
their actions.
- Authority refers to the power managers have
to direct subordinates and make decisions.
- Delegation is when managers entrust tasks or
decisions to subordinates.
- Empowerment sees managers passing authority
to make decisions down to subordinates. Empowerment can be motivational.
- The span of
control measures the number of subordinates reporting
directly to a manager.
- The chain of
command is the path of authority along which instructions
are passed, from the CEO downwards.
- Lines of communication are the routes messages travel
along.
Types of organisation
The staff structures of a tall
organisation and a flat organisation
Tall
organisations
have many levels of hierarchy.
The span of control
is narrow and there
are opportunities for promotion.
Lines of communication are long,
making the firm unresponsive to
change.
Flat
organisations
have few levels of hierarchy.
Lines of communication are short,
making the firm responsive to change.
A wide span of control
means that tasks must be delegated
and managers can feel overstretched.
In centralised organisations, the
majority of decisions are taken by senior managers and then passed down the
organisational hierarchy.
Decentralised
organisations
delegate authority down the chain of command, thus reducing the speed of
decision making.
One method of reducing
costs is to remove a layer of management in a hierarchy while expecting staff
to produce the same level of output. This is called delayering.
13. Recruitment
Firms recruit, select and
train staff in different ways with varying degrees of success.
Recruiting staff
Without the right staff
with the right skills, a business cannot make enough products to satisfy
customer requirements. This is why organisations draw up workforce plans to identify their future staffing requirements. For
example, they may develop plans to recruit a new IT Manager when the current
one plans to retire in eight months time.
Recruitment is the process by which a
business seeks to hire the right person for a vacancy. The firm writes a job description and person specification for the post
and then advertises the vacancy in an appropriate place.
Job
applicants
- Job descriptions explain the work to be done and
typically set out the job title, location of work and main tasks of the
employee.
- Person specifications list individual qualities of the
person required, eg qualifications, experience and skills.
Firms can recruit from inside or outside the organisation.
- Internal recruitment involves appointing existing
staff. A known person is recruited.
- External recruitment involves hiring staff from
outside the organisation. They will bring fresh ideas with them but they
are unknown to the company - will they fit in?
Managers must decide on
the best method to assess and select applicants for a job. Application forms, CVs, references, interviews, presentations, role-play and tests can be used to show if an
individual is suitable for the specific job on offer.
Many organisations are as
concerned about attitude
as they are about skill.
There is little point in appointing the best qualified or most skilled
applicant if they have a poor attitude toward work or cannot operate as part of
a team. This is particularly important in small firms with very few staff.
Training
Induction is the training given to new
workers so that they understand their role and responsibilities and can do
their job.
Staff should learn new
skills throughout the course of their career to stay productive. Training
improves technical, personal or
management skills and will increase staff efficiency. There are
two main training methods:
- On-the-job training where experienced members of
staff explain a job or a skill.
- Off the job training where outside experts are paid to
explain a job or a skill.
An annual staff appraisal is a chance for an
employee to discuss their recent work and future training needs with their line
manager in a meeting.
Retaining workers is important to a firm because it
costs time and money to hire and train a replacement. Appraisal and training helps motivate staff and so improves
staff retention.
14. Motivation
Companies can motivate
employees to do a better job than they otherwise would. Incentives that can be
offered to staff include increased pay or improved working conditions.
Motivational theories suggest ways to encourage employees to work harder.
What is motivation?
Motivation is about the ways a business can
encourage staff to give their best. Motivated staff care about the success of
the business and work better. A
motivated workforce results in:
- Increased output caused by extra effort from
workers.
- Improved quality as staff takes a greater pride in
their work.
- A higher level of staff retention. Workers are keen to stay with
the firm and also reluctant to take unnecessary days off work.
Managers can influence
employee motivation in a variety of ways:
- Monetary factors: some staff work harder if
offered higher pay.
- Non-monetary factors: other staff respond to
incentives that have nothing to do with pay, eg improved working conditions or
the chance to win promotion.
Payment methods
Managers can motivate
staff by paying a fair wage.
Payment methods include:
- Time rate: staff are paid for the number of
hours worked.
- Overtime: staff are paid extra for working
beyond normal hours.
- Piece rate: staff are paid for the number of
items produced.
- Commission: staff are paid for the number of
items they sell.
- Performance related pay: staff get a bonus for meeting a
target set by their manager.
- Profit sharing: staff receive a part of any
profits made by the business.
- Salary: staff are paid monthly no matter
how many hours they work.
- Fringe benefits: are payments in kind, eg a
company car or staff discounts.
Non-pay methods of motivation
Managers can motivate
staff using factors other than pay through:
- Job rotation: staff are switched between
different tasks to reduce monotony.
- Job enlargement: staff are given more tasks to do
of similar difficulty.
- Job enrichment: staff are given more interesting
and challenging tasks.
- Empowerment: staff are given the authority to
make decisions about how they do their job.
- Putting groups of workers in a
team who are
responsible together for completing a certain task.
Motivational theories
Managers can make use of
a number of motivational theories
to help encourage employees to work harder. Maslow argues that staff can be
motivated through means other than pay
Taylorism argues that staff do not enjoy
work and are only motivated by threats
and pay. Managers motivate staff by organising employees' work
and paying by results, eg piece rate pay - payment per item produced.
Maslow suggests there are five hierarchies or levels of need
that explain why people work. Staff first want to meet their survival needs by
earning a good wage. Safety needs such as job security then become important,
followed by social, self-esteem and self-fulfilment needs. Moving staff up a
Maslow level is motivational.
15. Protecting staff
Employers need to follow
certain laws and procedures in order to protect their staff and customers.
Employment rights
To prevent exploitation,
the government has passed a number of laws that safeguard staff:
- Workers are guaranteed a minimum
hourly wage rate
of £5.80 per hour in 2009.
- Race, sex, age or disability
discrimination is illegal.
Businesses must be careful to treat all workers fairly. They must offer
equal pay and promotion opportunities for women and ethnic minorities.
- The EU Working Time Directive sets a limit on the number of
hours staff can work in a week.
- Parents are entitled to paid leave
from work soon after their children are born. The firms must keep their post
open for when they return from maternity or paternity leave.
Redundancy
Businesses operate in a
dynamic and competitive market. Workers can lose their job through redundancy if the business suffers
a fall in sales. Falling sales
means that a business needs fewer staff and some posts are no longer required.
Also, low revenues
may lead a company to try to cut staffing costs.
Redundancy
procedures
must be fair, for example firms can use a last-in-first-out method to shed staff. Redundant
workers receive compensation
according to the number of years with the firm.
Health and safety
Health and safety
procedures
are put in place to prevent staff from being harmed or becoming ill due to
work.
The Health and
Safety at Work Act 1974 is the primary piece of legislation covering occupational
health and safety in the United Kingdom.
Health and safety procedures
need to be in place when using dangerous equipment at work
Health and safety
procedures are enforced by the government.
All businesses are
required by law to:
- Display a health
and safety poster.
- Carry out a risk
assessment to identify workplace risks, and then put
sensible measures in place to control them. Potential risks include trip hazards and asbestos. The extra paper work
increases the total costs of the business.
Businesses are also
responsible for ensuring the health and safety of their customers.
16. Communication
Effective communication
is important both within an organisation and externally. Effective
communication improves business efficiency.
What is
communication?
Communication is about passing messages between
people or organisations. Messages between a sender and receiver take place
using a medium such
as email or phone.
One-way
communication
is when the receiver cannot respond to a message. Two-way communication is when the
receiver can respond to a message. This allows confirmation the message has
been both received and understood.
Types of communication
There are a number of
technical terms you need to learn:
- Internal communications happen within the business.
- External communications take place between the business and
outside individuals or organisations.
- Vertical communications are messages sent between staff
belonging to different
levels of the organisation hierarchy.
- Horizontal communications are messages sent between staff
on the same
level of the organisation hierarchy.
- Formal communications are official messages sent by an
organisation, eg a company memo, fax or report.
- Informal communications are unofficial messages not
formally approved by the business, eg everyday conversation or gossip
between staff.
- A channel of
communication is the path taken by a message.
Effective
communication
Communication makes a big
impact on business efficiency. Effective communication means:
- Customers enjoy a good relationship with
the business, eg complaints are dealt with quickly and effectively.
- Staff understand their roles and
responsibilities, eg tasks and deadlines are understood and met.
- Staff motivation improves when, for instance,
managers listen and respond to suggestions.
Barriers to effective
communication
A balance needs to be
struck in communication between management and staff. Insufficient communication leaves
staff 'in the dark' and is demotivating. Excessive
communication leads to information
overload, eg when staff find hundreds of messages arriving in
their intray each day.
Too much paperwork or too many
emails can lead to miscommunication and inefficiency
Communications
fail when a
message is unclear or the receiver does not understand technical jargon.
Selecting the right medium is important. Messages may never be received if they
are sent at the wrong time or to a junk email folder.
The result is inefficiency and higher costs, as
more resources are needed to achieve the same result.
Training staff to select an appropriate medium
and send clear, accurate, thorough messages will improve the quality of
communications, especially if there is an opportunity for feedback.
Impact of ICT
ICT stands for information communication technology.
Businesses have gained significantly from advances in computing. For instance, ICT enables:
Advances in ICT
and telecommunications mean it has never been easier or cheaper to send messages by email or
text. Senders can check that a message has been received and understood. The
danger is that this will lead to information
overload and staff will have to spend hours reading hundreds of
electronic messages.
Staff training that emphasises the need to limit communications can help avoid
the inefficiencies associated with information overload.
- Home working and inexpensive call centres
located overseas.
- Automated stock ordering where items are reordered to
ensure shelves are always full. Less
paper work reduces administration costs.
- E-commerce where products are traded and
paid for on the internet.
E-commerce opens up international markets to firms as
overseas customers can view products for sale online.
A business can develop
links with customers through email
newsletters.
Production
17. Production methods
Production
methods
Entrepreneurs need to
decide which production method is best for them. Good customer service is
valuable and leads to increased sales.
Job, batch and flow
production
Production is about creating goods and services. Managers have
to decide on the most efficient way of organising production for their
particular product.
There are three main
types of production to choose from:
- Job production where items are made individually and each item is
finished before the next one is started. Designer dresses are made using
the job production method.
- Batch production where groups of items are made together. Each batch is
finished before starting the next block of goods. For example, a baker
first produces a batch of 50 white loaves. Only after they are completed
will he or she start baking 50 loaves of brown bread.
- Flow production where identical, standardisedâ items
are produced on an assembly line.
Most cars are mass-produced in large factories using conveyor belts and
expensive machinery such as robot arms. Workers have specialised jobs, for
instance, fitting wheels.
Choosing a production
method
The best method of
production depends on the type of product being made and the size of the
market. Small firms operating in the service sector, such as plumbers or
beauticians, opt for job production
because each customer has individual needs. Niche manufacturers of items such
as made-to-measure suits would also use job production because each item they
make is different.
Batch production is used to meet group orders. For
example, a set of machines could be set up to make 500 size 12 dresses and then
adjusted to make 600 size 12 dresses. Two batches have been made.
Flow production is used to mass produce everyday
standardised (all the same) items such as soap powder and canned drinks. Economies of scale lead to lower
unit costs and prices. Not many small manufacturers can afford the investment
needed to mass produce goods. They instead opt for either batch or job
production.
There is usually a trade
off between unit costs and meeting specific customer needs. Flow production
offers economies of scale and low costs for a one-size-fits-all product.
Customer service
Customer service is the experience a customer gets
when using products made by the business. Satisfied customers make repeat
purchases and recommend the product to friends, leading to additional
word-of-mouth sales.
Customers want to buy
goods and services that meet their needs at a price they can afford. For
example a café thrives when friendly staff serve tasty, well made meals, in
generous portions, at competitive prices.
How to improve customer service
Good customer service is
especially important in businesses dealing directly with the public, such as
hotels
Successful businesses
define the quality or
standard of service
needed to meet customer needs. For instance, a café can aim to take no more
than 5 minutes to serve any customer once they have ordered their meal.
Ensuring that quality
standards are met requires:
- Training so that staff understand their
role and responsibilities. For instance, asking every customer if they are
happy with their meal.
- Innovation or introducing new ideas and
methods. For example, altering the menu every three months keeps customers
interested and helps a café to stay one step ahead of the competition.
- Listening to customers helps a business
adjust its products to better match consumer needs and respond to any
problems.
Price versus customer service
Customers compare price
with customer service. Few customers expect high quality service when buying low priced items. For instance,
travellers using a budget airline accept that they must pay for extras such as
an in-flight meal. First class customers expect luxury seats and free
champagne. The challenge facing all businesses is to remain competitive. They must keep prices
competitive while offering a better service than rivals.
18. Efficiency
Efficiency, productivity
and competitiveness are linked. Better productivity means increased efficiency
which results in a higher level of competitiveness.
Efficiency and
productivity
Efficiency is about making the best possible
use of resources. Efficient firms maximise outputs from given inputs, and so
minimise their costs. By improving efficiency a business can reduce its costs
and improve its competitiveness.
There is a difference
between production and productivity. Production
is the total amount made by a business in a given time period. Productivity measures how much each
employee makes over a period of time. It is calculated by dividing total output
by the number of workers. If a factory employing 50 staff produces 1000 tables
a day, then the productivity of each worker is:
1,000 tables/50 staff = 20 tables
Graph showing staff efficiency
An increase in
productivity from 20 tables to 25 tables, without any increase in costs, means
the firm has improved efficiency. The resultant lower unit costs increase
profit margins.
Staff productivity
depends on their skill,
the quality of machines available
and effective management.
Productivity can be improved through training,
investment in equipment
and better management of staff.
Training and investment cost money in the short
term, but can raise long-term productivity.
Other methods of
cutting costs
As well as improving
productivity, a business can cut costs by:
- Reducing overheads such as administration, eg making
some support staff redundant. Customer service may suffer as a result of
this.
- Relocation to countries where staff with
appropriate skills can be hired at lower wages.
- Improving management so staff are motivated to work harder,
or are better used.
- Redesigning the product so an item is easier and cheaper
to make.
Lean production is a set of measures that aim to
reduce waste during production. Waste reduction methods, such as just in time ordering of stock,
will increase efficiency.
19. Economies of scale
There are benefits and
drawbacks in increasing the size of operation of a business. The cost advantage
is known as economies of scale. The cost disadvantage is known as disecomonies
of scale.
The benefits of
large-scale business
Economies of
scale are
the cost advantage
from business expansion.
As some firms grow in size their unit costs begin to fall because of:
- Purchasing economies when large businesses often
receive a discount because they are buying in bulk.
- Marketing economies from spreading the fixed cost of
promotion over a larger level of output.
- Administrative economies from spreading the fixed cost of
management staff and IT systems over a larger level of output.
- Research and development economies from spreading the fixed costs of
developing new or improved products over a larger level of output.
Types of costs
Fixed costs are expenses that do not change
with the level of output. Large firms have lower unit costs than small firms
because these fixed costs are spread more thinly over higher sales volumes. For
instance, take a £1 million advertising campaign. If just two items are sold
the unit cost of promotion is half a million pounds. If a million items are
sold the unit cost falls to just one pound. Many economies of scale are about
spreading fixed costs more thinly.
Economies of scale means
large organisations can often produce items at a lower unit cost than their
smaller rivals - a source of competitive advantage.
It is important not to
confuse total cost
with average cost. As
a firm grows in size its total costs rise because it is necessary to use more
resources. However, the benefits of becoming bigger can mean a fall in the
average cost of making one item.
Small firms compete in
two ways. They either operate in service industries such as hairdressing where
there are few opportunities for economies of scale, or they offer high priced, premium, niche products.
Customers are prepared to pay more for exclusive goods made by small
businesses.
Diseconomies of scale
A business can become so
large that its unit costs begin to rise. Expanding firms can experience diseconomies of scale. Causes
include:
- Ineffective communication. Coordinating large numbers of
staff becomes a challenge. Big businesses can develop many levels of
hierarchy which slow down communication or even lead to miscommunication.
- Reduced motivation. Staff can feel remote and
unappreciated in a large organisation. When staff productivity begins to
fall, unit costs begin to rise.
20. Quality
Ensuring quality means
making sure that products are made to a minimum standard or better. The cost of
doing this should be covered by extra sales.
What is quality?
Quality is about meeting the minimum standard required to
satisfy customer needs. High quality
products meet the standards set by customers - for example, a
high quality washing-up liquid can claim that one squirt is sufficient to clean
a family's dirty plates after a meal. A poor quality washing-up liquid requires
several squirts.
In many industries a quality standard is laid down by
independent organisations such as the British
Standards Institution (BSI). Firms benefit by adjusting the way
they work to meet these standards. Businesses hope that the cost of improving
quality will be more than covered by extra sales.
How to ensure quality
Producing faulty goods
incurs repair costs and damages the reputation of the firm. There are two main
approaches to achieving quality:
- Quality control where finished products are
checked by inspectors to see if they meet the set standard.
- Quality assurance where quality is built into the
production process. For example, all staff check all items at all stages
of the production process for faults. In this way everyone takes
responsibility for delivering quality. Successful quality assurance
results in zero defect
production.
Introducing quality
assurance requires Total Quality
Management (TQM), in which managers try to bring about a change
in business culture, convincing employees to care about how products are being
made and to do their part to ensure standards are met.
21. Stock control
Managing and storing
stock effectively is important for a business in order to maintain production
and sales.
What is stock?
Stock is any item stored by a business
for use in production or sales. Stock can be:
- Raw materials and components waiting to be used in the
manufacturing process, eg tyres stored by a car factory.
- Finished goods held in store so that a customer
order can quickly be met from stock.
Holding stock incurs warehouse storage costs and ties up
working capital.
Funds must be found to pay for materials, components and unsold goods with
interest.
Running out of one item
of stock could bring the whole factory to a halt. Staff must still be paid even
though they do not have the parts to carry on production.
Stock control aims to hold sufficient items on
site to enable production while minimising stock holding costs. There are two
methods of stock control - just in
case and just in time.
Just in case
The just in case method of stock
control is best explained using a diagram called a bar gate stock graph. You need to
understand the meaning of:
Bar
gate stock graph
- Maximum stock level: the largest amount of items to
be stored on site (500).
- Minimum stock level: the lowest amount of items to be
stored on site (100).
- Reorder level: the amount at which new stock is
ordered. 400 items are ordered and it takes two weeks lead time for ordered stock to
arrive. There is always a buffer
stock of 100 items held in case deliveries are held up or
there is an unexpected large order.
Just in time
Just in case stock
control is costly. To reduce spending and improve competitiveness, a business
can switch to an alternative method of stock control called just in time. With just in time, a
business holds no stock and instead relies upon deliveries of raw materials and
components to arrive exactly when they are needed. Instead of occasional large
deliveries to a warehouse, components arrive just when they are needed and are
taken straight to the factory floor.
The benefits of reduced
warehouse costs must be balanced against the cost of more frequent deliveries
and lost purchasing economies of scale from bulk buying discounts.
Business Environment
22. Stakeholders
Businesses have different
types of internal and external stakeholders, with different interests and
priorities. Sometimes these interests can conflict.
What are
stakeholders?
A stakeholder is anyone with an
interest in a business. Stakeholders are individuals,
groups or organisations that are affected by
the activity of the business. They include:
- Owners who are interested in how much profit the business makes.
- Managers who are concerned about their salary.
- Workers who want to earn high wages and keep their jobs.
- Customers who want the business to produce
quality products at reasonable prices.
- Suppliers who want the business to continue
to buy their products.
- Lenders who want to be repaid on time and
in full.
- The community
which has a stake in the business as employers of local people. Business
activity also affects the local
environment. For example, noisy night-time deliveries or a
smelly factory would be unpopular with local residents.
Internal
stakeholders
are groups within a business - eg owners and workers. External stakeholders are groups
outside a business - eg the community.
Influence of
stakeholders on business objectives
Owners have a big say in how the aims of
the business are decided, but other groups also have an influence over decision making. For example, the directors who manage the day-to-day
affairs of a company may decide to make make higher sales a top priority rather
than profits.
Customers are also key stakeholders.
Businesses that ignore the concerns of customers find themselves losing sales
to rivals.
In a small business, the most important
or primary stakeholders
are the owners, staff and customers. In a large company, shareholders are the primary
stakeholders as they can vote out directors if they believe they are running
the business badly.
Less influential
stakeholders are called secondary
stakeholders.
Assessing business
performance using accounts
Information published by
a business helps stakeholders to judge how well it is performing. For example, company reports detail the amount
of profit being earned and set out the community
policies of the business. This means:
- Owners can judge how well the business
is performing. Increased profits improve the chances of directors being
re-elected at the next annual general meeting (AGM).
- Rivals can compare the amount of profit
they are making with the business.
- Pressure groups can find out about the
environmental policy of the business.
Conflicting
stakeholder objectives
Different stakeholders
have different objectives. The interests of different stakeholder groups can
conflict. For example:
- Owners generally seek high profits and so may be
reluctant to see the business pay high wages to staff.
- A business decision to move production overseas may
reduce staff costs. It will therefore benefit owners but work against the
interests of existing staff who will lose their jobs. Customers also
suffer if they receive a poorer service.
23. Economy
Market prices depend on
levels of supply and demand. These levels rise and fall according to a number
of factors, and can have a big impact on the success of a business.
Supply and demand
A market is any place where buyers
and sellers meet to trade products. The market
price is the amount customers are charged for items and depends
on demand and supply.
Demand is the amount of a product
customers are prepared to buy at different prices. Supply is the amount of a product
businesses are prepared to sell at different prices.
There are many different
types of market. The goods market
is where everyday products such as DVDs are traded. The commodities market is where raw
materials such as wheat are traded.
Market prices change when
supply and demand patterns
change.
- An increase
in demand following a successful advertising campaign
usually causes an increase in price.
- An increase
in supply when a new business opens usually causes a fall
in price.
Changing market prices
affect a firm's costs. When the price of commodities such as oil and
electricity increases, a business finds its own costs of production rise.
Higher costs are either:
- Passed on to the consumer in the form of
higher prices.
- Absorbed by the firm. This leaves prices
unchanged but means lower profit margins for the company.
Interest rates
Credit is borrowed money. Many small
firms depend on credit such as bank loans and overdrafts to help finance their
business activities.
Interest is the reward for lending and the
cost of borrowing. The interest rate
is the percentage
The government can change
the way businesses work and influence the economy either by passing laws, or by
changing its own spending or taxes. For example:
- Extra government
spending or lower taxes
can result in more demand in the economy and lead to higher output and
employment.
- Goverments can pass legislation protecting consumers and workers or
restricting where businesses can build new premises.
The main types of tax
include:
- Income tax taken off an employee's salary.
This results in less money to spend in the shops.
- Value added tax (VAT) added to goods and services. A
rise in VAT increases prices.
- Corporation tax is a tax on company profits. A
rise in this tax means companies keep less of their profits leading to
less company investment and the possible loss of jobs.
- National Insurance contributions are payments made
by both the employee and the employer. They pay for the cost of a state
pension and the National Health Service. An increase in this tax raises a
company's costs and could result in inflation.
- Local government collects rates from firms and can
use the law to block planning permission for new premises.
How UK business
competes internationally
International
trade is the
exchange of goods and services between different countries. UK business can
compete against foreign rivals by offering better designed, higher quality
products at lower prices.
UK exports are products made in the UK and
sold overseas, while UK imports
are products made overseas and sold in the UK.
The exchange rate is the price of
foreign currency one pound can buy. If the current exchange rate is two dollars
to the pound, then one pound is worth two dollars.
The price of UK exports
and imports is affected by changes in the exchange rate.
- An increase
in the value of sterling means one pound buys more dollars. The pound has appreciated (gone up) in value
and become stronger.
- A fall
in the value of sterling means one pound buys fewer dollars. This means
the pound has depreciated
(fallen) in value and become weaker.
UK exporters benefit from
a fall in the value of sterling. However British firms importing raw materials,
components or foreign-made goods face higher costs and must either put up their
prices or reduce their profit margin.
The business cycle
Economic activity is the amount of production
taking place. Over time, the level of economic activity in a country tends to
move up and down in a business cycle.
Businesses may monitor economic
activity and make predictions about how it will affect their output
- In a downturn
or slump output
falls and many businesses shed staff because sales are falling. The
economy experiences a recession.
- In an upturn
or boom,
businesses increase output and hire more staff to keep up with extra
demand. The economy experiences economic
growth.
The impact of a recession varies from business to
business. Firms making premium and luxury products are hit hard by any downturn
because customers often cut back on non-essentials first. Businesses with large
debts can find it hard to meet interest payments when sales fall.
However, a recession
makes it easier for a business to recruit new staff in readiness for any upturn
in economic activity.
24. Ethics
Businesses can choose to
work in a way that profits only the owners or in ways that benefit the
community. Working ethically means acting in ways that are both fair and
honest.
What is ethical
behaviour?
A big business has a lot
of power, which it can either use responsibly or selfishly. Many firms operate
to meet the needs of owners. Ethical
firms also carefully consider the implications of what they are
doing and the effect it might have on the community and the environment.
Ethics is about doing the right thing.
Ethical behaviour requires firms to act in ways that stakeholders consider to
be both fair and honest. Managers making ethical decisions take into account:
- Impact: who does my decision affect or
harm?
- Fairness: will my decision be considered
fair by those affected?
Many owners believe that
acting ethically increases costs and so reduces profits. For example, a
business can cut costs by hiring child labour at very low wages in developing
countries. Paying below average wages lowers the firm's total costs.
Other businesses such as
the Fairtrade Foundation have built an ethical
brand image, believing that customers are prepared to pay more
for products that consider the environment and pay a reasonable wage. Higher
sales compensate for higher costs. Profits from acting ethically are higher
than firms that only consider their own narrow self-interest.
Business activities that
meet the requirements of the law, but which are considered unfair by stakeholders
can result in bad publicity.
For example, a restaurant that pays minimum wage but keeps staff tips to boost
profits is not breaking the law. It does, however, run the risk of losing the
goodwill of customers.
Pressure groups
Stakeholders can
influence the business. Pressure
groups are organisations set up to try to influence what we
think about the business and its environment.
A pressure group can
challenge and even change the behaviour of a business by:
- writing letters to MPs
- contacting the press
- organising marches
- running campaigns
25. Business and the environment
Businesses affect the
local environment - both natural and social. Ethical businesses try to keep the
impact of their operations on the environment to a minimum.
Social costs and the
environment
Business activity has an
impact on the natural environment:
- Resources such as timber, oil and metals
are used to manufacture goods.
- Manufacturing can have unintended spillover effects on
others in the form of noise
and pollution.
- Land is lost to future generations when new houses or
roads are built on greenfield
sites.
The unintended negative
effects of business activity on people and places are called social costs and include:
- noise
- pollution
- visual blight
- congestion
Ethical
businesses
are careful to minimise the impact of their behaviour on the environment.
Government laws are used to protect the
environment. For example, firms must apply for planning permission before building factories or
offices on greenfield sites. Grants are available to encourage firms to locate
on brownfield sites,
run down areas in need of regeneration.
Social benefits
Social benefits are business activities that have
a beneficial or favourable impact on people or places. For example, a business
start up can have a multiplier effect.
Suppliers will win new trade from them and the new workforce will become
customers in the local shops.
A proposed project often
generates both costs
and benefits. For
example, building a new factory on a greenfield site creates social benefits in
the form of new jobs. However, the loss of open land is a social cost. Building
is justified only if the benefits exceed the costs.
Short- and long-term
environmental effects
Some business activity
can cause short-term
environmental costs which can be put right in the longer term. For example, the
impact of cutting down forests for timber is much reduced if young trees are
planted in their place and left to grow into maturity.
Some trees, such as pine,
grow quickly and can be considered a renewable
resource. Other resources, such as mahogany, take hundreds of
years to grow and so are non-renewable
in our lifetime. Resources like oil that can only be used once
are non-renewable.
Business activity - such
as intensive fishing in the North Sea - can compromise the ability of future
generations to meet their own needs and is unsustainable. Sustainable
growth means meeting the needs of the present without
compromising the ability of future generations to meet their own needs.
26. Location
A business's location can
make an important difference to its success. Choosing the right location means
taking into account a number of factors.
The importance of
location
Location is the place where a firm decides
to site its operations. Location decisions can have a big impact on costs and
revenues.
A business needs to
decide on the best location taking into account factors such as:
- Customers - is the location convenient for
customers?
- Staff - are there sufficient numbers of
local staff with the right skills willing to work at the right wage?
- Support services - are there services offering
specialist advice, training and support?
- Cost - how much will the premises
cost? Those situated in prime locations (such as city centres) are far
more expensive to rent than edge-of-town premises.
The importance of infrastructure
Infrastructure refers to the facilities that
support everyday economic activity, eg roads, phone lines and gas pipes.
An efficient transport network enables staff to
get to work easily. It also allows supplies to be brought in from far afield
and permits finished products to be moved to market cheaply and quickly.
The impact of location
depends on the type of business. For example, it is important for shops and
restaurants to be conveniently
located for customers. A delivery-only takeaway may prefer to
locate in inexpensive premises on the edge of town close to good transport
links.
Government and
location
The government offers
grants and assistance to businesses that locate in areas with high
unemployment. Incentives include:
- Grants to help with the cost of setting
up a business. Grant money does not need to be repaid.
- Loans, which are repayable over many
years at low rates of interest.
- Tax breaks, for example firms may be made
exempt from paying business rates.
Overseas location decisions
Setting up a business
overseas involves a number of challenges including:
- Cultural and language barriers where managers are unfamiliar with
local customs.
- Legal issues where local laws are different.
- Exchange rate issues. Unexpected changes in the
value of sterling can have an impact on prices, costs and profits.
Finance
27. Sources of finance
All businesses need
finance. There are a number of funding sources used by organisations.
Why business needs
finance
Finance refers to sources
of money for a business. Firms need finance to:
- Start up a business, eg pay for premises,
new equipment and advertising.
- Run the business, eg having enough
cash to pay staff wages and suppliers on time.
- Expand the business, eg having funds to
pay for a new branch in a different city or country.
New businesses find it
difficult to raise finance because they usually have just a few customers and many competitors. Lenders are put off by
the risk that the start-up may fail. If that happens, the owners may be unable
to repay borrowed money.
Sources of finance
Some sources of finance
are short term and
must be paid back within a year. Other sources of finance are long term and can be paid back over
many years.
Internal sources of finance are funds found inside
the business. For example, profits can be kept back to finance expansion.
Alternatively the business can sell assets
(items it owns) that are no longer really needed to free up cash.
External sources of finance are found outside the
business, eg from creditors
or banks.
Short-term sources of external finance
Sources of external
finance to cover the short term include:
- An overdraft
facility, where a bank allows a firm to take out more
money than it has in its bank account.
- Trade credits, where suppliers deliver goods
now and are willing to wait for a number of days before payment.
- Factoring, where firms sell their invoices
to a factor such as a bank. They do this for some cash right away, rather
than waiting 28 days to be paid the full amount.
Long-term sources of external finance
Sources of external
finance to cover the long term include:
- Owners who invest money in the business.
For sole traders and partners this can be their savings. For companies, the
funding invested by shareholders is called share capital.
- Loans from a bank or from family and
friends.
- Debentures are loans made to a company.
- A mortgage,
which is a special type of loan for buying property where monthly payments
are spread over a number of years.
- Hire purchase or leasing, where monthly
payments are made for use of equipment such as a car. Leased equipment is
rented and not owned by the firm. Hired equipment is owned by the firm
after the final payment.
- Grants from charities or the government
to help businesses get started, especially in areas of high unemployment.
Creditors and debtors
A creditor is an individual or
business that has lent funds to a business and is owed money. A debtor is an individual or
business who has borrowed funds from a business and so owes it money.
There is a cost in
borrowing funds. Money borrowed from creditors is paid back over time, usually
with an additional payment of interest.
Interest is the cost of borrowing and the reward for lending.
Creditors often ask for security before lending funds. This
means sole traders and partners may have to offer their own house as a
guarantee that monies will be repaid. A company can offer assets, eg offices as collateral.
The type of finance
chosen depends on the type of business. Start ups and small firms are
considered very high risk and find it difficult to raise external finance. The
only source of funds might be the owner's own savings, retained profits and
borrowing from friends. Companies can issue extra shares to raise large amounts
of capital in a rights issue.
28. Revenue, costs and profit
All businesses should
keep proper accounts. This involves the calculation of revenue, costs and
profit.
Revenue
Revenue is the income earned by a
business over a period of time, eg one month. The amount of revenue earned
depends on two things - the number of items sold and their selling price. In
short, revenue = price x quantity.
For example, the total
revenue raised by selling 2,000 items priced £30 each is 2,000 x £30 = £60,000.
Revenue is sometimes
called sales, sales revenue, total revenue or turnover.
Costs
Renting an office block is part
of a company's fixed costs
Costs are the expenses involved in
making a product. Firms incur costs by trading.
Some costs, called variable costs, change with the
amount produced. For example, the cost of raw materials rises as more output is made.
Other costs, called fixed costs, stay the same even if
more is produced. Office rent
is an example of a fixed cost which remains the same each month even if output
rises.
Fixed
costs, variable costs and total costs
Another way of
classifying costs is to distinguish between direct costs and indirect costs. Direct costs, such as raw materials,
can be linked to a product whereas indirect costs, such as rent, cannot be
linked directly to a product.
The total cost is the amount of money
spent by a firm on producing a given level of output. Total costs are made up
of fixed costs (FC) and variable costs (VC).
Profit and loss
Put simply, profit is the surplus left from
revenue after paying all costs. Profit is found by deducting total costs from
revenue. In short: profit = total
revenue - total costs.
For example, if a firm
has a total revenue of £100,000 and a total cost of £80,000, then they are left
with £20,000 profit.
Profit is the reward for risk-taking. A business can use
profit to either:
- Reward owners.
- Invest in growth.
- Save for the future, in case there is
a downturn in revenue.
Losses
Trading does not guarantee profit. A loss is made when the revenue from sales is not enough to cover all the costs of production. For example, if a company has a total revenue of £60,000 and a total cost of £90,000, then they have lost £30,000 from trading.
Losses can be reduced or turned into profit by:
- Cutting costs, eg by letting staff go and
asking those who remain to accept lower wages.
- Increasing revenue, eg by cutting prices and selling
more items - if demand is elastic.
29. Cash flow
Companies need to budget
and be aware of cash flow in order to stay solvent.
Solvency
Cash flow is the movement of money in and
out of the business.
Cash flows out of the business
when bills are paid
- Cash flows into
the business as receipts, eg from cash received from selling products or
from loans.
- Cash flows out
of the business as payments, eg to pay wages, supplies and interest on
loans.
- Net cash flow is the difference between money
in and money out.
Profit and cash flow are two very different
things. Cash flow is simply about money coming and going from the business. The
challenge for managers is to make sure there is always enough cash to pay
expenses when they are due, as running out of cash threatens the survival of
the business.
Insolvency
If a business runs out of
cash and cannot pay its suppliers or workers it is insolvent. The owners must raise
extra finance or cease trading. This is why planning ahead and drawing up a cash flow forecast is so important,
as it identifies when the firm might need an overdraft.
Calculating the cash
flow
This is an example of a cash flow forecast for the next
three months:
A sample cash flow table for January to March
Item
|
Jan
|
Feb
|
Mar
|
Opening bank
balance
|
£2,000
|
£1,000
|
£1,250
|
Total receipts
(money in)
|
£500
|
£750
|
£5,000
|
Total spending
(money out)
|
£1,500
|
£3,000
|
£2,000
|
Closing bank
balance
|
£1,000
|
-£1,250
|
£1,750
|
At the beginning of
January, the business has £2,000 worth of cash. You can see that the total flow
of cash into the business (receipts) for January is expected to be £500, and
that the total outflow from the business (expenditure) is £1,500. There is a net
outflow of £1,000 which means the projected bank balance at the beginning of
February is only £1,000.
In February, there are
expected payments of £3,000 and only £750 of expected income. This means that
the business is short of £1,250 cash by the end of February and cannot pay its
bills. An overdraft is needed to help the business survive until March when
£5,000 worth of payments are expected.
A business can improve
its cash flow by:
- Reducing cash outflows, eg by delaying the payment of
bills, securing better trade credit terms or factoring.
- Increasing cash inflows, eg by chasing debtors, selling
assets or securing an overdraft.
30. Breaking even
Calculating profitability
involves first working out the minimum level of sales required to cover all
costs.
Breakeven point
At low levels of sales, a
business is not selling enough units for revenue to cover costs. A loss is made. As more items are
sold, the total revenue increases and covers more of the costs. The breakeven point is reached when the
total revenue exactly matches the total costs and the business is not making a
profit or a loss. If the firm can sell at production levels above this point,
it will be making a profit.
Establishing the
breakeven point helps a firm to plan the levels of production it needs to be
profitable.
Breakeven chart
The breakeven point can
be calculated by drawing a graph showing how fixed costs, variable
costs, total costs
and total revenue
change with the level of output.
Here is how to work out
the breakeven point - using the example of a firm manufacturing compact discs.
·
You
can assume the firm has the following costs:
·
Fixed costs: £10,000. Variable costs: £2.00 per unit
Graph showing fixed costs and
total costs
You first construct a
chart with output (units) on the horizontal (x) axis, and costs and revenue on
the vertical (y) axis. On to this, you plot a horizontal fixed costs line (it is horizontal because
fixed costs don't change with output).
Then you plot a variable cost line from this point,
which will, in effect, be the total
costs line. This is because the fixed cost added to the
variable cost gives the total cost.
To calculate the variable
cost, you multiply variable cost per
unit x number of units. In this example, you can assume that
the variable cost per unit is £2
and there are 2,000 units
= £4,000.
Graph showing the breakeven
point of a business
Once you have done this
you are ready to plot the total revenue line. To do this, you multiply:
sales price x
number of units (output)
If the sales price is £6 and 2,000 items were to be
manufactured, the calculation is:
£6 x 2,000 =
£12,000 total revenue
Where the total revenue
line crosses the total costs line is the breakeven
point (ie costs and revenue are the same). Everything below
this point is produced at a loss, and everything above it is produced at a
profit.
Limitations
Breakeven analysis is a
useful tool for working out the minimum sales needed to avoid losses. However,
it has its limitations. It makes assumptions about various factors - for
example that all units are sold, that forecasts are reliable and the external
environment is stable. If new rivals enter the market or an economic recession
starts then it could take longer to reach the breakeven point than anticipated.
Many organisations add on
a margin of safety to
the breakeven level of output when deciding on their minimum sales target.
31. Financial records
A business keeps various
types of financial record to monitor its performance and ensure that taxes are
paid. These include cash flow statements, profit and loss accounts and a
balance sheet.
Trading, profit and
loss account
A trading, profit and loss account
shows the business's financial performance over a given time period, eg one
year.
Sample trading, profit and loss account
Sales revenue
|
£80,000
|
Less costs of sales
|
£50,000
|
Gross profit
|
£30,000
|
Less other expenses
|
£20,000
|
Net profit
|
£10,000
|
The trading account shows the business
has made a gross profit
of £30,000 before taking into account other expenses such as overheads.
The profit and loss account shows a net profit of £10,000 has been
made.
Balance sheet
A balance sheet shows the value of a business on
a particular date. A balance sheet shows what the business owns and owes (its
assets and its liabilities).
Assets
Fixed assets
|
£150,000
|
Current assets
|
£25,000
|
Current liabilities
|
£100,000
|
Net assets employed
|
£75,000
|
Capital and
reserves
|
£75,000
|
Fixed assets show the current value of major
purchases that help in the running of the business, like delivery vans or PCs.
In this case £150,000 of fixed assets are owned. Current assets show the cash or
near-cash available to the firm. This includes stock ready to sell, money owed
to them by debtors and cash in the bank. There are £25,000 worth of current
assets.
Deducting all the current liabilities from the total
amount of fixed and current assets gives the value of the business on the day
the balance sheet was drawn up. This business is worth £75,000, financed by
£75,000 of share capital and reserves. Capital and reserves are in effect
liabilities, because the firm owes this money to the owners. What a firm owns,
it owes.
Working capital
A business is solvent if it can meet its
short-term debts when they are due for payment. To do this it needs adequate working capital. There are three
main reasons why a business needs adequate working capital.
Wages paid to employees are
part of a company's variable costs
- Pay staff wages and salaries.
- Settle debts and therefore avoid legal action
by creditors.
- Benefit from cash discounts offered in return for prompt
payment.
You can calculate a
firm's working capital by using the following equation:
working capital =
current assets - current liabilities
Many groups of people are
interested in the published accounts of a company. The information they provide
may influence future decisions. For example, lenders will be looking at the
solvency of a business. Rivals are interested in monitoring the profits earned
by competitors.