Aims and Organisations
1. What is a business?
New businesses are set up by entrepreneurs. There are both risks and benefits involved in setting up a new business. The economy is divided into different business sectors. All businesses have inputs and outputs and must add value during production.
Making goods or providing services
A business is any organisation that makes goods or provides services.
There are many types of business in the UK. These range from small firms owned and run by just one self employedperson, through to large companies which employ thousands of staff all over the world.
Businesses exist to provide goods or services.
- Goods are physical products - such as burgers or cars.
- Services are non-physical items - such as hairdressing.
Customer needs are the wants and desires of buyers.
Nearly half a million businesses start up each year. A business start up is a new firm operating in a market for the first time.
The vast majority of businesses are very small and operate in the service sector.
Suppliers, customers and markets
Businesses buy the products they need from suppliers – firms selling products to other businesses - and sell to customers. The individual who uses the product is called a consumer. Sometimes the customer and consumer are different people - for example, parents buy a pen for their child to use at school.
Businesses sell to customers in markets. A market is any place where buyers and sellers meet to trade products - this can be a high street shop or a website.
Businesses are likely to be in competition with other firms offering similar products.
In order to create goods and services, a business buys or hires inputs such as raw materials, equipment, buildings and staff. These inputs are transformed into outputs called products. These products are the goods and services used by consumers. Production is the business activity of using resources to make goods and services.
A business adds value when the selling price of an item produced is higher than the cost of all the resources used to make it. Think of a pair of designer sunglasses which sell for £100. If the cost of the materials, employees, marketing and all other inputs used in making one set of sunglasses is just £20, then £80 worth of value has been added by the firm during production.
Primary, secondary and tertiary sectors
There are three main types of industry in which firms operate. These sectors form a chain of production which provides customers with finished goods or services.
· Primary production: this involves acquiring raw materials. For example, metals and coal have to be mined, oil drilled from the ground, rubber tapped from trees, foodstuffs farmed and fish trawled. This is sometimes known as extractive production.
· Secondary production: this is the manufacturing and assembly process. It involves converting raw materials into components, for example, making plastics from oil. It also involves assembling the product, eg building houses, bridges and roads.
· Tertiary production: this refers to the commercial services that support the production and distribution process, eg insurance, transport, advertising, warehousing and other services such as teaching and health care.
The chain of production shows interdependence: firms rely on other businesses in different sectors for raw materials, components or distribution.
Why start a business?
The skill involved in wanting to start and run a business is called enterprise. The individual who sets up his or her own business is called an entrepreneur.
There are several reasons why entrepreneurs are willing to take a calculated risk and set up a business. Possible motives include:
Making a profit. A business does this by selling items at a price that more than covers the costs of production. Owners keep the profit as a reward for risk-taking and enterprise.
The satisfaction that comes from setting up a successful business and being independent.
Being able to make a difference by offering a service to the community such as a charity shop or hospice.
A new business needs its own name and a product. The challenge is to make goods and services that satisfy customers, are competitive and sell at a price that more than covers costs.
Taking a calculated risk
A new business starts out with few, if any, customers and is likely to face competition from existing firms. To succeed it needs to plan its launch carefully and work out how to create a competitive advantage over its rivals. To gain this advantage, it needs to offer a product which customers prefer to a rival's product.
Setting up a business involves risks and reward. Profit is the reward for risk-taking. Losses are the penalty of business failure.
An owner may decide to close a business if losses are being made, or if the level of profit is not enough to make trading risks or hours worked worthwhile.
A business plan
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
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.
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.
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.
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.
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.
· 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.
· 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 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. ].
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)
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.
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.
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.
Most markets contain different groups of customers who share similar characteristics and buying habits. These collections of similar buyers make up distinct market segments.
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.
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.
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%.
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:
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'.
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
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.
A product portfolio is the range of items sold by a business. It can be analysed using the 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.
A business must take many factors into account before deciding on the price of a product.
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.
There is much more to promotion than advertising. Businesses use various methods to gain publicity.
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.
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:
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.
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.
Firms recruit, select and train staff in different ways with varying degrees of success.
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 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.
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.
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.
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.
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.
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.
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.
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.
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.
17. 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 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.
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.
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.
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.
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.
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.
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.
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
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:
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 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.
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.
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 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.
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:
Invest in growth.
Save for the future, in case there is a downturn in revenue.
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.
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.
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
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.
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.
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.
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
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.
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).
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.
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.