O/A level Business & Economics (Umer Adeel)

Chapter 1.1 Enterprise

Purpose of business activity

A business is an organisation that uses resources to meet the needs of customers by providing a product or
service that they demand. There are several stages in the production of finished goods. Business activity at all
stages involves adding value to resources, such as raw materials, and making them more desirable to – and
valued by – the final purchaser

What do businesses do

• Businesses identify the needs of customers.

• They purchase necessary resources to allow production to take place.

• They produce goods and services which satisfy customers’ needs, usually with the aim of making a profit

The factors of production needed by businesses

All businesses need resources to be able to operate and produce goods or services. These resources are called
factors of production. There are four factors of production:

• Land – this general term includes not only land itself but all the renewable and non-renewable resources of
nature, such as coal, crude oil and timber.

• Labour – manual and skilled labour make up the workforce of the business.

• Capital – this is not just the finance needed to set up a business and pay for its continuing operations, but
also all the manufactured resources used in production. These include capital goods, such as computers,
machines, factories, offices and vehicles.

• Enterprise – this is the initiative and coordination provided by risk-taking individuals called entrepreneurs.
They combine the other factors of production into a unit capable of producing goods and services. Enterprise
provides the managing, decision-making and coordinating roles.

The concept of adding value

All businesses aim to create value by producing goods and services and selling them for a higher price than
the cost of bought-in materials: this is called adding value. If a customer is prepared to pay a price that is
greater than the cost of materials used to produce a good or service, then the business has been successful in
adding value. The difference between the selling price of the products sold by a business and the cost of the
materials that it bought in is called added value. Without adding value, a business will not be able to survive as
other costs have to be paid and the people investing in the business also expect a financial return.

The value added by the business is not profit as other costs must be paid for, such as labour and rent.
However, if a business can add value without increasing its costs, then its profit will increase.

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Opportunity cost

This need to choose the goods we want leads to the important principle of opportunity cost. In deciding to
purchase or obtain one item, we must give up other goods as they cannot all be afforded. The next most
desired product which is given up becomes the lost opportunity or opportunity cost.

The dynamic business environment

Setting up a new business is risky because the business environment is dynamic, or constantly changing. In
addition to the problems and challenges referred to below, there is also the risk of change, which can make
the original business idea much less successful. This problem can be made worse if the business plan is too
inflexible to deal with changes. Changes in the business environment include:

• new competitors entering the market

• legal changes – examples include new safety regulations or limits on who can buy the product

• economic changes that leave customers with less money to spend

• technological changes that make the products or processes of the new business outdated.

Why do some businesses succeed?

• good understanding of customer needs – leads to sales targets being achieved

• efficient management of operations – keeps costs under control

• flexible decision-making to adapt to new situations – allows investment in new business opportunities •
appropriate and sufficient sources of finance – prevents cash shortages and allows for expansion.

Why do some businesses fail?

Poor record-keeping The lack of accurate records is a common reason for business failure. Many small
companies fail to pay sufficient attention to record-keeping. They either believe it is less important than
meeting customers’ needs or think that they can remember everything.

Lack of cash

Running short of cash so that day-to-day business operations become difficult is the most significant reason
for the failure of businesses. Many new businesses fail to survive the first year of operation due to the lack of
cash. Finance is needed for day-to-day cash, for the holding of inventories, and to give trade credit to
customers, who then become debtors. Without this working capital, the business will be unable to buy more
supplies, pay suppliers or offer credit to important customers

Poor management skills

Most entrepreneurs have had some form of work experience, but not necessarily at management level. They
may not have developed skills in:

• leadership and decision-making

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• cash handling and cash management

• planning, coordinating and communication

• marketing, promotion and selling.

Local, national and international businesses

Qualities of successful entrepreneurs and intrapreneurs

• Innovation: The entrepreneur does not have to be an inventor in the traditional sense. They must be able to
identify and fill a gap in the market, attract customers in innovative ways and promote their business as being
different from others in the same market. This requires original ideas and an ability to do things differently.
This is the skill of innovation.

• Commitment and self-motivation: It is hard work to set up and manage a new business. It may take up many
hours of each day. Energy, focus, the willingness to work hard, to be keen and to have the ambition to succeed
are all essential qualities of a successful entrepreneur.

• Multi-skilled: An entrepreneur will have to make the product (or provide the service), promote it, sell it and
keep accounts. These different business tasks require someone who has many different qualities, is keen to
learn technical skills, is able to get on with people, and is good at handling money and keeping accounting
records.

• Leadership skills: If the business has employees, the entrepreneur must lead by example and will have to
have a personality that encourages and motivates those workers.

• Self-confidence and an ability to bounce back: Many business start-ups fail, yet this would not discourage a
true entrepreneur who would have such belief in themselves and their business idea that they would be able
to bounce back from any setback.

• Risk-taking: Entrepreneurs must be willing to take risks in order to see results. Often the risk they take is by
investing their own savings in the new business.

Barriers to entrepreneurship

Lack of a business opportunity - Identifying successful business opportunities is one of the most important
stages in becoming an effective entrepreneur.

Obtaining sufficient capital (finance ) - In an International Labour Organisation survey of new business start-
ups, most entrepreneurs said that lack of finance was their main difficulty. So why is obtaining finance such a
major barrier for entrepreneurs? This could be due to:

• insufficient savings – many entrepreneurs have limited personal savings

• no knowledge of the financial support and grants available

• no trading record to present to banks as evidence of past business success

Competition

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A newly created business will often experience competition from established businesses with greater
resources and market knowledge. The entrepreneur may therefore have to offer a more unusual product or
better customer service to overcome the low-cost advantages that bigger businesses usually have.

Lack of a customer base

A new business must establish itself in the market and build up customer numbers quickly to survive. The
long-term success of the business will depend on encouraging customers to return to purchase products
repeatedly. Good customer service could be provided by:

• personal customer service

• knowledgeable pre- and after-sales service

• supplying one-off customer requests that large firms may be reluctant to provide.

Role of enterprise in a country’s economic

• Employment creation
• Economic growth
• Business survival and growth
• Innovation and technological change
• Exports
• Personal development
• Increased social cohesion
• The role of intrapreneurship

The benefits of intrapreneurship to existing businesses include:

• Injecting creativity and innovation into the business – developing new products to increase sales or creating
exciting ways of selling existing products.

• Developing new ways of doing business – creativity in solving problems such as low efficiency can be more
successful than continuing to use the old ways.

• Driving innovation and change within the business – generating excitement within the business about a new
opportunity makes change more acceptable.

• Creating a competitive advantage – by developing more innovative products.

• Encouraging original thinkers and innovators to stay in the business – this is summed up by the expression:
‘You don’t have to leave our company to become an entrepreneur!’

Purpose and key elements of business plans

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Without some evidence that entrepreneurs have thought about and planned for the future, it is unlikely that
bankers, venture capitalists or potential shareholders will invest money in a new business. An effective
business plan provides this evidence.

The main elements of a typical business plan are:

• executive summary − an overview of the new business and its strategies

• description of the business opportunity − details of the entrepreneur’s skills and experience; nature of the
product; the target market at which the product is aimed

• marketing and sales strategy − details of why the entrepreneur thinks customers will buy the product and
how the business will sell to them

• management team and personnel – details of the entrepreneur’s skills and experience and the people they
intend to recruit

• operations − premises to be used, production facilities, IT systems

• financial forecasts − the future projections of sales, profit and cash flow for at least one year ahead.

Benefits of business plans

• The main purpose of a business plan for a new business is to obtain finance for the start-up. Potential
investors or creditors will not provide finance unless details about the business proposal have been
written down clearly.
• The business-planning process provides essential evidence to investors and lenders. It makes the
finance application more likely to be successful. Business planning also:
• forces the owner to think seriously about the proposal, its strengths and any potential weaknesses
• gives the owner and managers a clear plan of action to guide their actions and decisions in the early
months and years of the business. If an entrepreneur started a business with no clear sense of
purpose or direction, no marketing strategy and no idea of which employees to recruit, then its
chances of success would be much reduced.

Limitations of business plans

• Even a detailed business plan does not guarantee a successful business. In fact, it could create a false
sense of certainty in business owners
• The business plan must be detailed and supported by evidence such as market research.
• The plan might lead entrepreneurs to be inflexible. If the dynamic business world throws up new
opportunities that are not in the plan, these could be rejected. This could mean that options for future
profits and growth are rejected. The best business plans allow for some flexibility as external events
change.

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1.2 BUSINESS STRUCTURE

ECONOMIC SECTORS/ THE LEVELS OF BUSINESS ACTIVITY

-There are millions of businesses around us. Business can be categorised in three broad categories or
stages.

Primary Sector

It is the first stage of production. All those businesses which are related with extraction of raw
material from Mother Nature such as mining, fishing, farming, and quarrying are known as Primary
Sector businesses. Raw materials that are extracted are send to the secondary sector.

Secondary Sector

They convert raw materials into finished or semi-finished goods. All businesses which manufacture
and process the raw materials which can be used by the end consumers are known as Secondary
Sector businesses. These include building, construction, compute assembly, shoes factories, textile
factories etc.

Tertiary Sector

Whereas all the businesses which provide services and assist both the primary and secondary sector
businesses can be classified as Tertiary sector businesses. These include transportation, insurance,
hospitals, educational institutes, showrooms etc.

A business may exist in all the three sectors also. For example. British Petroleum has its own Oil wells
and it extracts raw oil, this is primary sector activity, this oil is converted into petroleum and other by
products. This is secondary business activity. After processing the oil into useable product BP sells it to
end consumers through its network of Petrol pumps. This comes under the tertiary sector.

BUSINESS STRUCTURE

Differences between Private and Public Sector

Private Sector

This sector comprises businesses owned and controlled by individuals or groups of individuals. Such
businesses are commonly found in the free market economy. Their main aim is to make profit through the
sale of private goods. Examples of business found in the private sector include:

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i) Sole trader
ii) Partnership
iii) Private Limited Companies
iv) Public Limited Companies
v) Co-operatives

SOLE TRADER

Refers to a business in which one person provides permanent finance and, in return, has full control of the
business. It is owned by one person. However the owner may employ other people. Examples are hair salons,
bus operators, grocery stores etc.

Formation: No legal formalities are required

Ownership: owned by one person

Legal status : The business is not a recognised as a legal person. It is referred to as an

unincorporated business

Liability : The owner of the business suffer from unlimited liability. If the business fails the owner may loose
personal possessions (personal property)

Continuity : The business come to an end when the owner dies

Tax Issues: it does not pay corporate taxes, but rather the person who organized the business pays
personal income taxes on the profits made, making accounting much simpler

Advantages Disadvantages
1 –easy to form (less capital and legal requirements) 1 –unlimited liability
2 –owner has direct control of the business (makes 2 –can raise little capital
decisions that best suit his/her conditions 3 –limited management expertise
3 –all profits go to the owner 4 –poor quality decision making
4 –enjoys major exemptions from Government 5 –difficulty in attracting qualified employees
legislation 6 –lack of continuity when the owner dies
5 –no double taxation
6 –has personal contact with both customers and
employees
7 –easy to terminate

Partnerships
-a business owned by at least two but not more than twenty people. The partners agree to carry on business
together, with shared capital investment and , usually, shared responsibilities. To enter into a partnership,
partners can have a verbal agreement or otherwise write a Partnership Deed/Agreement which is a
document setting out the following details:

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• amount of capital contributed by each member

• salaries/wages to be paid to each member
• rights and obligations of the partners
• procedure for partnership dissolution) profit/loss sharing ratio
• Name of firm - includes the name of the business entity.
• Date of writing - includes simply the date that the contract was written.
• Duration of partnership - includes how long the partnership should last. It is automatically assumed
that the death of one of the contracting parties breaks the contract, unless otherwise stated.
• Business to be done - includes exactly what will be done in this partnership. This section should be
very particular to avoid confusion and loopholes.

Formation: fewer legal formalities are involved

Ownership: owned by at least two to a maximum of twenty partners

Legal status : The business is not a recognised as a legal person. It is referred to as an

unincorporated business
Liability : The partners suffer from unlimited liability. If the business fails the owner may lose personal
possessions (personal property)

Continuity : The business come to an end when the key partner dies

Tax Issues: it does not pay corporate taxes, but rather the partners who organized the business pays
personal income taxes on the profits made, making accounting much simpler

Advantages Disadvantages

1 –easy to form (same as sole proprietor) 1 –unlimited liability i.e all of the owner’s assets are
2 –more capital available potentially at risk
3 –diversity of skills and expertise 2 –disagreements may easily lead to winding of the
4 –quality decisions are made business
5 –personal contact with employees and clients 3 –all partners responsible for the acts of each other
6 –risk is spread over a number of people 4 –lack of continuity when the key partner dies or
7 –relative freedom from government control become insane
5 –profit/loss sharing ratio not necessarily equal
6-the partnership often face intense competition
from large firms
7-the owner , by taking on a partner, will lose control
of the business

Limited companies

Also known as Joint stock companies. These are businesses where a number of owner(shareholder) pool in
their resources to do a common business and to share the profits and losses proportionally.

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In a limited company, the debts of the company are separate from those of the shareholders. As a result,
should the company experience financial distress because of normal business activity, the personal assets of
shareholders will not be at risk of being seized by creditors. Ownership in the limited company can be easily
transferred, and many of these companies have been passed down through generations.

General features of Joint Stock Companies / limited Companies

1 –separate legal entity

2 –shareholders have limited liability

3 –owners are called shareholders (buy shares)

4 –shareholders receive dividends as payments

5 –the Board of Directors manages the affairs of the company

6 –the company is governed by Memorandum and Articles of Association

7 –shareholders hold Annual General Meetings (AGMs)

NB: A share is defined as a certificate confirming part ownership of a company. This certificate also entitles
the shareholder the right to dividends. Shareholder- a person or institution owning shares in a limited
company

Private Limited Companies

Refers to a small to medium-sized business that is owned by shareholders who are often member of the
same family. This company cannot sell shares to the general public. They have two but not more than fifty
shareholders. The right to transfer shares is limited. The business should submit financial statements and
auditors reports to the Registrar of Companies

Formation: There are complex legal formalities. Two documents should be drafted by the founders of the
company and these documents include the memorandum and articles of association

Ownership: owned by at least two to a maximum of fifty shareholder

Management and Control: it managed and control by the board of directors

Legal status : The business is recognised at law as a legal person. It is referred to as an incorporated business

Liability : The shareholders enjoy limited liability. If the business fails the shareholders’ personal assets
cannot be taken. They only lose the capital they have invested in the business.

Continuity : There is continuity

Tax Issues: there is double taxation. The shareholders pay tax on their incomes and the business also pay
corporate tax

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Advantages Disadvantages

1 –shareholders have limited liabilities 1–not easy to form (up to six months)
2 –more capital can be raised 2–has to fill complex tax forms
3 –greater status than an unincorporated businesses 3–cannot raise capital through the stock exchange
4 –easy to transform into public limited companies 4- quite difficult for the shareholders to sell shares
5 –do not have to publish annual accounts in the
press

b) Public limited companies

-a large business, with the right to sell shares to the general public. The share prices are quoted on the
national stock exchange. They have at least two shareholders to no maximum limit. Shares are freely
transferable. The public can be invited to subscribe to shares and debentures through a prospectus. Can only
start business after complying with all the requirements of the Companies Act. Annual accounting reports
(financial statements) are supposed to be published in the press. Must keep a register of investors and
directors’ shareholding

Formation: There are more complex legal formalities. Three documents should be drafted by the founders
of the company and these documents include the memorandum of association, articles of association and
the prospectus

Ownership: owned by at least two to no maximum limit of shareholder

Management and Control: it managed and control by the board of directors

Legal status : The business is recognised at law as a legal person. It is referred to as an incorporated business
Liability : The shareholders enjoy limited liability. If the business fails the shareholders’ personal assets cannot
be taken. They only lose the capital they have invested in the business.

Continuity : There is continuity

Tax Issues: there is double taxation. The shareholders pay tax on their incomes and the business also pay
corporate tax

Advantages Disadvantages
1 –easy to raise capital through floating shares on 1 –difficult to form
stock exchange 2 –files always open for inspection by members of
2 –can operate on a large scale the pubic
3 –unlimited life 3 –decisions take time to make due to large size of
4 –employees can become shareholders-increases the company
loyalty 4 –no personal touch between employees and
5 –managers and directors have room to work customers
independently therefore prove their expertise in 5 –conflict of interest-shareholders are usually
their areas of specialization interested in expanding the business
6-shareholders enjoy limited liability

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5 Co-operatives
-Is an association of persons united voluntarily to meet common economic, social and cultural needs.

Usually members join together to purchase or sell goods that they cannot afford individually.

Main features

• formed by people who want to work together

• is voluntary
• members make equitable contributions

• risks and benefits are shared equally

• are democratically controlled
• the name ends with Co-op

Formation

Members should have a common goal. These members will then draft the constitution and the
management committee is elected usually at an annual general Meeting

There are different types of co-operatives:

Housing cooperative

Retailers' cooperative

Worker cooperative

Consumers' cooperative

Agricultural cooperative

Advantages
Disadvantages

• It is easy to form e.g any ten adults form a • unable to raise large amount of financial
co-operative resources
• No legal formalities are involved • It is managed by members who may be
• Membership is open to everyone lacking the required management skills
• Members enjoy limited liability • Can be affected by conflict since it is an
• Members get goods and services at association of people from different social,
reasonable prices economic and academic background
• There is continuity • Absence of rewards discourage the members
• Surplus is shared amoung members to put maximum effort in the society
• State patronage ( government provides
special assistance to the co-operatives to
enable them to achieve their objectives
successfully
• They are usually tax exempted

Franchising

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Refers to an agreement where one party (the franchisor) grants another party (the franchisee) the right to use
its trade mark or trade name as well as certain business systems. The franchisee sells the franchisor's product
or services, trades under the franchisor's trade mark or trade name and benefits from the franchisor's help
and support.

In return, the franchisee usually pays an initial fee to the franchisor and then a percentage of the sales
revenue. The franchisee owns the outlet they run. But the franchisor keeps control over how products are

Marketed and sold and how their business idea is used.

Well-known businesses that offer franchises of this kind include: Pizza, Bata, McDonalds, Nandos etc

Contractual Obligation

• A franchise agreement should be drafted and signed by both parties. This is a legal contract in which
the franchisor gives the franchisee the right to use the business’s trade mark.

• The franchisor is not allowed to open a similar business nearby

• It must specify the franchise fee as well as monthly royalty payment
• The agreement lays out details of what duties each party needs to perform
• It also state the duration of the franchise contract

Advantages to the franchisee Disadvantages to the franchisee

• Franchisee benefit from pre-opening support • The franchisor might go out of business, or
e.g site selection, design, financing change the way they do things.
• Franchisor assist in training staff • The franchise agreement usually includes
• Franchisor advertise goods on behalf of the restrictions on how you run the business. You
franchisee ( saves money)
might not be able to make changes to suit
• Franchisee enters into an existing market
which increases the chances of business your local market.
success. • The franchisee must pay initial fee and
• Risk is reduced and is shared by the continuing fees to continue to use the trade
franchisor. mark
• Relationships with suppliers have already • The franchisee cannot sell goods from other
been established. suppliers
• Breach of contract can result in a penalty
charge

Advantages to the franchisor Disadvantages to the franchisor

• Other franchisees could give the brand a
• It’s a source of income to the franchisor bad reputation.
(royalties received) • Franchisor must provide the franchisee

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• Risk of the business is spread amoung with on-going support which then requires
different franchisees constant research
• A network of outlets gives the business a • Setting up a franchise requires a lot of
far better chance of success money

Joint Ventures

It occurs when two or more businesses agree to work closely together on a particular project and create a
separate business division to do so. Joint Venture is not a long term business relationship but a short term
relationship based on a single business project. The business is not a separate legal entity. Once the joint
venture has met it’s goals, the entity ceases to exist. An example include Sonny and Ericson formed Sonny
Ericson to produce handsets.

Joint Venture Agreement Should cover:

o
The parties involved
o
The objectives of the joint venture
o
Contributions made by each party
o
Dispute resolution procedure
o
How the joint venture is terminated
o
Non-disclosure agreements
o
Day to day management

Advantages Disadvantages
• •
Provide companies with the opportunity to The business failure of the partner would
gain new capacity and expertise put the whole project at risk
• •
Allow companies to have access to new Styles of management and culture might
technology be so different that the two teams do not
•
Access to greater resources, including blend well together
•
specialised staff and technology The parties don’t provide enough
•
leadership and support in the early stages
Sharing of risk with a venture partner •
Errors and mistakes might lead to one
blaming the other for mistakes

Strategic Alliances (A2 topic – helpful for AS aswell)

A strategic alliance is an agreement between two companies that have decided to share resources to
undertake a specific, mutually beneficial project. A strategic alliance is less involved and less permanent
than a joint venture. The main purpose is to allow two organisations, individuals or other entities to
work toward common or correlating goals. Unlike a joint venture, firms in a strategic alliance do not
form a new entity to further their aims but collaborate while remaining apart and distinct.

Examples of Strategic Alliances

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An agreement with a Local University- finance is provided by the business to allow new specialist
training courses that will increase the supply of suitable staff for the firm

An agreement with a supplier- to join forces in order to design and produce components and materials
that will be used in a new range of products.

An agreement with the competitor- to reduce the risk of entering a market that neither firm currently
operates in.

Holding Companies

Refers to a business organisation that owns and controls a number of separate businesses, but does not
unite them into one unified company. They are not a different legal form of business organisation, but
they are an increasingly common way for business to be owned.

Public Sector

Refers to all the businesses that are owned by the government on behalf of the public. They can be
district councils or public corporations. They are established by an Act of Parliament. They are corporate
bodies with a separate legal entity -they are managed by a Board appointed by the Minister -the Minister
can be questioned by parliament over activities of the corporation

Advantages Disadvantages
• They provide important goods and services • They are inefficient and very wasteful due
at reasonable prices to the lack of profit motive
• Provide employment to the majority • They tend to provide poor quality goods
• Implement government policies e.g charge and services due to the absence of stiff
low prices to reduce inflation competition
• They are a source of income to the • Lack of motivation amoung workers leads
government to inefficiency
• They suffer from excessing political
interference

SOCIAL ENTERPRISE

Refers to a business with mainly social objectives that reinvests most of its profits into benefiting society
rather than maximising returns to owners. Social enterprises are businesses whose primary purpose is the

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common good. They use the methods and disciplines of business and the power of the marketplace to
advance their social, environmental and human justice agendas.

THE RANGES AND AIMS OF SOCIAL ENTERPRISES

Basically these are the characteristics of social enterprises

They operate for the well being of the society

Making profit is not the main aim

Main aim is to solve social problems faced by people

Profit is kept to provide more services

They normally provide education and health

Generate the majority of their income through trade

Triple bottom line

Social enterprises have three main objectives. These aims are often referred to as the triple bottom line.
Triple bottom line is used to measure the performance of a business:

• Economic (Profit)
• Social (People)
• Environment (Planet)

Benefits of Social Enterprises

Social enterprises produce higher social returns on investment than other

On one hand, they produce direct, measurable public benefits. A classic employment-focused social
enterprise, for example, might serve at least four public aims:

• Fiscal responsibility: It reduces the myriad costs of public supports for people facing barriers, by
providing a pathway to economic self-sufficiency for those it employs.

• Public safety: It makes the community in which it operates safer, by disrupting cycles of poverty,
crime, incarceration, chemical dependency and homelessness.

• Economic opportunity: It improves our pool of human capital and creates jobs in communities in need
of economic renewal.

• Social justice: It gives a chance to those most in need.

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1.3 Size of business

The businesses are classified as small, medium and large businesses. Thus the businesses are compared
using their sizes.
Importance of Business Size

Stakeholder Importance

Government -the government may want to give assistance to small firms

-The government may want to charge different tax rates to different firms

Investors -they may want to compare with its close competitors

-they want to know how safe it is to invest in a given business

Customers -customers may prefer to deal with large forms since they are the most

reputable and are less likely to cease production in the near future

Workers -workers also want to be employed in large firms since they are concerned

about job security

Banks They use business size to determine the maximum loan they can give to the

Business

1.3.1 Measurements of business size

In the world around us there are some businesses which are small and some are big. But how do we
categorize these businesses as big or small. We can consider the following factors:

• The number of employees: Small business employ fewer workers than large businesses since they
operate on a small scale. European Classifications of business into small , medium and large firms
is shown in the table below

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Business category Number of employees

Small/ micro 10 or fewer

Medium 11-50

Large 0ver 50

However the method is not suitable if one business uses capital intensive method of production. i.e business
which use more machinery and technology may have few employees but they still might be big. Example
Microsoft has less employees but still it the biggest business on earth.

• The amount of capital invested: Big business have large capital investments in form of properties
and equipment owned. All these properties are bought capital employed. Capital employed refers
to the total value of all long-term finance invested in the business. However this method is not
appropriate when one firm uses a labour intensive method. A business which might not use a lot
of investment in machinery and investment in properties may still be big. Take the example of
software companies and consultancy firms like McKenzie & Co.

• The sales turnover: Bid firms have a very high sale turnover than small firms. They have a good
reputation, they have more outlets and they can afford to advertise their products. However a
business may be going through a bad phase and may not have huge sales does it make the
business small? On the other hand large sales turnover may be seen for a small business that sells
small but high value items e.g an artists may sell CDs for a dollar each but to over a million fans

• Market capitalisation: refers to the total value of shares issued by the company. A higher market
capitalisation applies to big firms.

Market capitalisation= current share price x total number of shares issued

However this method is appropriate when one firm is not operating on the stock exchange. Stock exchange
markets are very volatile and share prices change every day does it alter the size of the business every day?

• Market share: Big firm have a higher market share than small firms. Market share is usually measured
as a percentage. Market share refers to the sales of a business as a proportion of total market sales.
Market share = (total sales of a business/ total sales in the market) X 100

However a business may not be a market leader but still may be huge whereas if the market is itself very
small, a major market share won’t make a business big.

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NB: One cannot use measure business size by its profits because profit depends on too many factors not just
the size of the business

Conclusion: So while deciding the size of business as big or small a combination of factors needs to be
considered.

What is a small business?

A small business is a business that is independently owned and operated, with a small number of employees
and relatively low volume of sales.

Different countries have slightly different description for a small business.

For example, in United States a business have less than 100 employees is considered as a ‘small business’,
whereas it is under 50 employees to qualify as a ‘small business’ in European Union.

In Australia, a small business is defined as 1-19 employees.

Small businesses are normally privately owned corporations, partnerships, or sole proprietorships.

Apart from number of employees other criteria for classifying a business as ‘small’ are:

• Amount of capital employed

• Annual Sales turnover
• Value of assets

Importance of small business in the economy

As we all know that small firms are important for the economy.

• Create jobs: Small businesses employes majority of the workforce in any country.

• They can grow to become big: Every business starts small. These small business today will become
bog firms tomorrow

• Small businesses are flexible and respond easily to changes in demand: they are owned by one or
two individuals hence they are more flexible and adaptable in day-to-day operations

• Small firms often cater to local demands: local or regular customers can place their individual orders.
Small firms provide niche products and services which a larger firm might overlook.

• In difficult economic times, such as a recession, small business can be an important source of
providing employment.

• Improves efficiency in the economy: Small firms provide competition to larger firms through
providing customised goods and services.

• Give informal credit: they offer credit facilities to well-known customers

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• Boost economic growth: they increase the production of goods and services in the economy. Thus the
Gross Domestic Product (GDP)of an economy will increase.

Disadvantages of small firms

• Lack of capital: they don’t have enough capital to stock enough goods

• They sell inferior goods: they operate usually in the rural communities where they sell poor quality
goods and sometimes expired food items

• Managed and run by employees who are less skilled: small businesses lack the resources to hire
skilled and experienced personnel
• Risk of failure is high: customers are unwilling to buy from small firms and the skilled employees are
reluctant to join small firms

• Difficult for them to raise finance: small business often struggle to get loans from financial institutions
and this will stifle business growth
Small businesses face the following problems

• Under capitalisation
• Poor debt management
• Lack of managerial skills of the owner
• Cannot retain experienced staff
• Usually find it difficult to attract skilled staff
• Poor stock management

How can small business survive?

Small firms survive by being different (product differentiation). They can survive by

• Segmenting the market by income. They can target niche market segments of high income customers,
position their product as a ‘premium brand’ at a high ‘premium price’ eg Morgan sports cars
• Small firms have the advantage of being able to respond quickly to change - they do not have the
bureaucratic procedures often a feature of large firms where decisions are made only after endless
meetings. This means they can be quick to exploit new market trends.
• The Internet also allows small firms direct access to consumers, by passing intermediaries. The web
gives small firms the opportunity of international marketing.
• Small independent firms can join together to form a buying group to negotiate discounts on joint
orders.
• Small firms can survive by selecting a premium niche and offering an exclusive brand’ that exactly
meets the customer requirements of their target segment. They will need to be totally customer
orientated.
• Keep well documentation for accounts receivable financing when unexpected expenses arrive.

Family Owned Businesses

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Refers to businesses that are actively owned and managed by at-least two members of the same family.

Decision making is influenced by multiple generations of a family related by blood.

Strengths of family business

• Stability- family positions typically determines who leads the business and as a result, there is
longevity in leadership. Family leaders stay usually stay in the positions for many years until a life
event such as illness, retirement or death results in change

• Commitment- since the needs of the family are at stake, there is a greater sense of commitment and
accountability. The family owners often show dedication in seeing the business grow, prosper and get
passed on to future generations. This level of dedication is almost impossible to generate in non-
family firms

• Flexibility- you won’t hear “Sorry but that’s not my job description”. In a family business, family
members are willing to wear several different hats and to take on tasks outside of their formal job on
order to ensure the success of their company.

• Long term outlook- non family firms think about hitting goals this quarter, while family firms think
years, and sometimes decades, ahead. This ‘patience’ and long term perspective allows for good
strategy and decision making

• Decreased costs- family members working at family businesses are willing to contribute their own
finance to ensure the long term success of the organisation. This could mean contributing capital or
taking a pay cut. This advantage comes in handy during economic down turns, where it is necessary to
personally suffer in order for the firm to survive.

Weakness of family businesses

o Family conflicts- deep seated, long lasting bitter fights and quarrels can affect every single
person within the firm and can draw divisive lines. These conflicts are usually difficult to solve
and result in a premature ending of the business.

o Unstructured governance- governance issues such as internal hierarchies and rules, as well as
the ability to follow and adhere to corporate laws, tend to be taken less seriously at family
businesses. There is little interest in setting clear and formal business practices and
procedures and this situation can lead to inefficiencies

o Tunnel vision- there lack of outside opinions and diversity on how to operate the business.
Family members are given jobs for which they lack the required skills, education and
experience. This has got far- reaching effects on the success of the business.

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o Issues of fair remunerations can be ‘a can of worms’- the issue of wages and salaries can be a
highly sensitive subject. The question is how the pie is going to be divided. Paying family
members and dividing the profits amoung them can be a difficult affair. Many people usually
feel that they are underpaid and family members too. We have family members who
comments like this, ‘uncle Jack sits around and gets more than I do’

Business Growth

Refers to an increase in the scale of operations, expanding production and increasing the sales and profit of
a firm

Reasons why a business want to grow:

• To increase profits- the chances of business success rises when the business grows both internally and
externally

• To reduce risk- business growth where the business introduces new products that are totally different
from the existing ones lowers the risk of failure

• To dominate the market- a business which is a market leader has the power to set prices

• To reduce costs- increasing the output leads to the enjoyment of economies of scale. Economies of
scale refers to the cost saving advantages enjoyed by a business as a result of large scale operations.

• To fulfil the objectives of the management- it can be a planned move by the management to spread
the wings of its business into new markets.
Types of Business Growth

i. Internal Growth (AS-LEVEL)

ii. External Growth (A-LEVEL)

Internal Growth

Expanding the business from within by using its own internal resources. It involves expanding the business
through increasing the number of employees, increasing production of existing products, opening new outlets
and increasing quantities of goods sold. It is also referred to as organic growth. An example of internal growth
is where a retail business open more shops in towns and cities where it previously had none.

Advantages of internal/organic growth Disadvantages of internal/organic growth

•
It can be financed through internal funds e.g •
Slow growth and the shareholders may prefer
returned profits more rapid growth
•
Less risky than taking over other businesses •
Growth achieved may be dependent on the
• growth of the overall market
Allows business to grow at a more sensible
rate •
Harder to build market share if the business is
•
Builds on a business’ strengths already a market leader
•
The business can be affected by liquidity

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problems (cash problems)

External Growth

Refers to growth achieved through integration i.e mergers and takeovers. Integration can occur between
two firms in the same or different industries. Integration leads to rapid expansion which might be
essential in a competitive and expanding market.

TYPES OF INTEGRATION/ MERGERS

a)Horizontal Integration: it occurs when two firms which are in exactly the same line of business and at the
same stage of production process joined together. It is the joining of competitor or rival firms ie firms selling
the same types of goods e.g OK supermarket and TM supermarket

Advantages Disadvantages
• It reduces the risk of failure • Managerial problems will set in when the
• To enjoy economies of scale business become very big
• Eliminates competition • Previous relations with suppliers or
• To have more power over suppliers distributors of one firm might suffer
• Horizontal integration leads to monopoly and
• Easy to manage as compared to
conglomerate mergers higher prices
• To strengthen financial base

b).Vertical Integration

It occurs when two firms in the same industry but at different stages of the production process join together
to form one business. For instance, a firm in a primary sector joins with another in the same industry but in
the secondary sector. Vertical integration can be forward or backward

i)Forward Vertical Integration: it occurs when a business joins with another which is in the same industry but
at a next stage in the production process ie joining with a customer of existing business. A car manufacturer
joining with a retailer (showrooms) Thus a firm in the secondary sector joining with another firm in the tertiary
sector.

Advantages Disadvantages
• Greater control over promotion and pricing of
the products • Lack of experience in this sector of the
• Eliminate the profit margin expected by the industry
firm in the next stage of the production • Lack of control over the suppliers
process • Management problems may set in
• Increases the capital base

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ii)Backward Vertical Integration: occurs when a business joins with another business which is operating at a
previous stage of a production process. The business joins with another which used to be the supplier e.g
retailer merging with the manufacturer. This is a movement from tertiary sector to a secondary sector

Advantages Disadvantages
• Give greater control over the quality, price • Lack of experiences of managing a supplying
and delivery times of the supplier company
• Eliminates the profit margin demanded by • Supplying business may become complacent
another supplier due to having a guaranteed customer
• Increases profitability of the business • Lack of control over the customers

c).Conglomerate/ Diversification Mergers: this integration is between firms in completely different lines of
business or industries. A firm will be trying to explore different opportunities to minimise or diversify risk. Eg a
car manufacturer joining with a hotel business.

Advantages Disadvantages
• Reduces risk of losses • Risk of failure might increase due to lack of
• Profit margins can be increased due to other experience in the new market
businesses • Entry problems might occur
• Market share can be increased • If the business is new then it’s difficult to
lower down the prices as compared to
established firms

REASONS FOR MERGERS

• Expectations of higher profits: synergies usually increases the profitability of the new business
formed. Synergy- literally means that the whole is greater than the sum of individual parts. It means
that the two businesses when they merge, their profitability, efficiency and effectiveness would
increase to more than the combined profitability of the separate businesses

• To reduce competition: the new business formed won’t waste a lot of money on promotion and other
adverting programmes

• Easy and quick way to expand: businesses can easily increase their market share in a short period of
time

• To enter international markets: local business can join with foreign business so that it will be easy for
local to penetrate foreign ground.

• Asset striping: to get access to an asset of a rival firm at lower price. The asset stripper aims to buy
another company at a market price lower than the firm’s total asset price. After grabbing the asset,
the business will then sell-off profitable parts of the business and shuts down the unprofitable parts of
business

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• To comply with the law: legislations usually in the financial sector may require business to join in
order to comply with the minimum capital requirements

NB de-mergers occurs when a business sell off a significant part of its existing operations. A company choose
to break-up to raise cash to invest into the remaining sector. Another reason could be to concentrate its
efforts on a narrow range of activities. Last but not least, to avoid costs and inefficiencies when a firm is very
large.

Take overs

Refers to the assumption of control of another (usually smaller) firm through purchase of 51% or more of its
voting shares or stocks. It occurs usually on public limited companies because their shares are traded openly
and anyone can buy them. When a takeover is complete, the company that has been bought loses its identity
and becomes a part of the buying company. The buying company is known as the acquirer (bidder) and the
company which is bought is known as the target

Why some business stay small?

•
Type of industry the business is operating:- in some industries it is not viable for the firms to expand
since they will be offering personal services e.g hair dressing, plumber, car repairs etc If they were to
grow too large, they would find it difficult to offer the close and personal service demanded by
customers
•
Market size:- the number of customer will determine the size of the firms. If the number of
customers is small, the businesses in that industry will remain small.
•
Owner’s objectives: some owners prefer to keep their firm small. Owners sometimes wish to avoid
the stress and worry of running a large firm.

Why a merger or takeover might fail to achieve objectives

When two businesses integrate, the argument is that the newly combined larger business will be more
effective, more efficient and more profitable than the two separate companies.

The objectives of mergers and takeovers are to increase efficiency and profitability. Why might these
objectives be achieved?

• The integrated businesses will be able to share research facilities and pool ideas that achieve better
results than the two separate businesses.

• The economies of operating a larger scale of business, such as buying supplies in large quantities, should
cut average costs and increase efficiency.

• The larger combined business can save on marketing costs and distribution costs by using the same sales
outlets and sales teams.

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• Rationalisation of property and other assets will reduce duplication and costs. The record of many
mergers and takeovers is mixed. In practice, many mergers and takeovers fail to gain true synergy.

The most common reasons for a merger or takeover to fail to achieve its objectives are:

• The integrated firm is too big to manage and control effectively. This is a diseconomy of
scale.
• A different business and management culture. For example, the approach each company
takes to environmental issues may be so different that the two sets of managers and
workers may find it very difficult to work effectively and cooperatively together.
• There may be little benefit from combined research departments or
marketing/distribution facilities if the original businesses produced different products.
• The rate of growth is too rapid for the directors to manage effectively.

1.4 BUSINESS OBJECTIVES

Refers to stated, measurable targets of how to achieve business aims or the targets that must be achieved to
in order to realise the aims of the business. Objectives can be seen as the more specific and quantifiable aims,
designed to assist in the achievement of the goals identified in the mission statement. Objectives must state
what the organisation is trying to achieve, how this can be done, when it must be done and how they will
know that it has succeeded

Importance of business objectives

• They clarify to everyone what the business is working to achieve

• They aid in decision making and choice of alternative strategies
• They enable checks on progress and corrective action
• They provide means by which performance can be measured
• They motivate employees
• They can be broken down to provide targets for each part of the organisation
• They provide shareholders with a clear idea of the business in which they have invested
• They facilitate the resolution of conflict between departments

Objectives should be SMART

S- specific M- Measurable A-achievable

R- realistic T- time specific/ time framed

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S-SPECIFIC: Objectives should be more precise. Having a bunch of vague statements isn’t very helpful at all.
You must make your project tangible by saying how you are going to go about it. For example, a hotel might
have an objective of filling 60% of its beds a night during October.

M-MEASURABLE: Define your objective using assessable terms. Express it in terms of quantities, frequency,
quality, costs, deadlines etc. It refers to the extent to which something can be evaluated against some
standard. E.g to increase monthly sale by 15%

A-ACHIEVABLE: It is pointless to have objectives that are impossible to achieve within the time period set.
Achievable answers the questions, “Can a person do it”, “Can the measurable objective be achieved by the
person?”, “Does he/she has the experience, knowledge or capacity of fulfilling the expectation?”,

R-REALISTIC/ RELEVANT: The objective should be challenging, but it should also be able to be achieved by the
person using the available resources. Thus the objectives should be realistic when compared with the
resources of the company and should be expressed in terms relevant to the people who have to carry them
out. E.g a target of reducing cleaning materials by 15% to a cleaner.

T-TIME FRAMED: An objective should have end points and check points built into it. They must have a time
limit of when the objective should be achieved. Time specific answers the question,”When it will be done?”
e.g by the end of the month or by the end of the year

HIERARCHY OF OBJECTIVES

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AIMS

Refers to a broad statement where a business wants to go in the future. Aims states what you want or your
overall intention in the project. It is generally broader than an objective.

MISSION

A formal summary of the aims and values of a company. It explains the organisation’s purpose, what it stands
for and why it exists. It is a statement of the business’s core aims, phrased in a way to motivate employees
and stimulate interest by outside groups (or aims of the business in a motivating and appealing way)

Mission statement should explicitly state things related to its business, such as industry, products or services,
employees, culture, customers and the adherence to things like quality, efficiency, pricing, social
responsibility.

Examples of Mission Statements

FACEBOOK: to give people the power to share and make the world more open and connected

FORD MOTOR COMPANY: ‘One team, one plan, one goal, one Ford’

Purpose of the Mission Statement

Quickly inform groups outside the business what the central aim and vision are

Help to guide and direct individual employees behaviour at work

To motivate employees

They help to establish in the eyes of other groups what the business is all about

CORPORATE OBJECTIVES

Refers to a detailed plan of a step you plan to take in order to achieve a stated aim. Mission statements and
aims should be complemented with corporate objectives because they specific details for operational
decisions and they are rarely expressed in quantitative terms. Thus aims and mission statements should be
turned into objectives that are specific to the business that can be themselves be broken down into strategic
departmental targets. Corporate objectives provide more details about the course of action or strategy to
follow

Corporate Objectives include:

•
Profit maximisation

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•
Profit satisficing
•
Growth
•
Increasing market share
•
Survival
•
Corporate social responsibility (CSR)
•
Maximising shareholders value

a)Profit Maximisation: It is the main aim for most of private firms. Profit maximisation refers to the greatest
positive difference between total revenue and total cost. Total revenue is obtained by multiplying price per
unit and the total number of units sold. Profit is very important for businesses because it is used for rewarding
the investors (owners of the business). Profit is also used for business expansion in the future ( ie to finance
internal growth)

Challenges faced by firms as they pursue this objective

• Maximising profit may encourage new competitors to enter into the industry and the chances for
business success will be reduced

• This objective can conflict with that of mangers who aim to maximise sales

• Other stakeholders may give priority to other issues besides profit maximisation

b)Profit satisficing: the objective will be to achieve enough profit to keep the owners happy but not to
maximise profits. This objective is pursued by owners of small businesses who wish to have more leisure time.
The business will be satisfied by making a certain level of profit.

Challenges faced by firms as they pursue this objective

• The business won’t be having money to grow in the future

• The business may lack funds to implement social responsibility programmes

c)Growth: growth involves increasing the operation of the business expanding to other regions or countries. It
is also measured by the number of employees, number of products sold etc. Growth benefits managers in
terms of higher salaries. Growth helps the business to avoid takeovers. Furthermore, the business will
benefitfrom economies of scale and it becomes more appealing to new investors.

Challenges faced by firms as they pursue this objective

• Rapid growth can lead to diseconomies of scale e.g financial diseconomies; managerial diseconomies
etc

• Growth can lead to lower short term returns to shareholders since it can be achieved through
lowering prices

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d)Increasing market share: market share refers to the proportion of a company’s sales to the total sales in the
market. Eg Your company sales 60 toys in a month and there are a total of 100 toys sold in a month. Thus your
company has 60% market share. Market share is related to business growth. Thus increasing market share
indicates that the marketing mix of the business is proving to be more successful than that of its competitors.
Increasing market share reflects to the firm as a brand leader (customers will be loyal to certain brands
offered by the firm)

e)Maximising Shareholders Value: It is an objective usually for public limited companies. Management will be
concerned about increasing the company’s share prices and dividends paid to shareholders. Thus the interests
of shareholders will be considered as first priority. Increased shareholders value is achieved through profit
maximisation

Challenges faced by firms as they pursue this objective

• The objective conflicts with the objectives of other stakeholders

•
f)Corporate Social Responsibility (CSR): refers to a set of policies designed to demonstrate the commitment of
a business to the well-being of society and others by taking responsibility for the impact of business decisions
on all stakeholders. Some businesses have objectives which are based on their beliefs of how one should treat
the environment and people. CSR applies to those businesses that considers the interests of society by taking
responsibility for their decisions and activities on consumers, employees, communities and the environment.
Some business activities are very damaging to other stakeholders. Thus governments and some international
organisations like European Union (EU) must ensure that businesses take responsibility of their actions on
people and the planet

Benefits of being socially responsible Challenges faced by firms as they pursue this
objective
• The business can be given government •
It conflicts with the profit maximisation
contracts/ tenders objective
•
• The business can easily attract highly skilled Time is wasted on social responsibility
and experienced personnel programmes
•
The business won’t have enough money for
• Business will gain public acceptance and expansion
reduced risk of negative publicity •
Greater criticism and loss of loyalty if things
• Employees committed to the same values go wrong
• Customer loyalty

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Departmental Objectives

Ford Car Company’s main aim is to become the largest car maker in the world and each department must
have some means of helping the company achieve that. Departments like product designing, production and
the marketing department will have different roles to play to help Ford achieve its main aim. For a car
manufacturing business, the departmental objectives may include:

Individual Objectives

These are the objectives set for an individual in an organisation. They are basically day-to-day objectives or
targets for each person. This helps ensure that each individual knows what they need to do to achieve
departmental objectives. Individual objective are important for the appraisal of each and every employee.

Relationships between Mission, objectives, strategy and tactics

Mission and Objectives

Mission statements and objectives provides the basis and focus for business strategy ie The long-term plans of
action of a business that focus on achieving its aims. Without a clear objective, a manager will be unable to
make important strategic decisions. The setting of clear and realistic objectives is one of the primary roles of
senior management. Before strategy for future action can be established, objectives are needed. Thus setting
mission and objective gives a business a sense of purpose and direction

Strategies and Tactics

Mission statements and objectives alone cannot guarantee business success. They have to be developed into
actual courses of action known as strategies and tactics.

Strategy: is a plan setting out how a business as a whole will achieve its overall long-term objectives. For
example the business objective of a car manufacturer could be, “To manufacture 4 million cars by 2018.” The
strategies to achieve such an objective could include:

• Increasing efficiency

• Building a new factory

• Designing new models of cars

For strategies to work well in the business they need to be complemented with tactics. At tactic is a short-
term plan for day-to-day operations of a business with the aim of contributing towards the overall strategy.
For example, in order to achieve productivity improvements the workforce might get prizes for the teams that
make the biggest improvements to productivity.

Business Decision making.

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Objectives not only give a sense of direction to a business, they are essential for making decisions. Without
setting relevant objectives at the start of this process, effective decision making for the future of the business
becomes impossible.

Stages in the decision making process

• Set objectives: it is impossible to make decisions in the future if the objectives are not clear or if they
are non-existent.

• Identify and analyse the problem: managers make decisions to solve a problem. It is imperative that
you must understand the problem before finding a solution for it, otherwise, you might make a wrong
decision.

• Collect relevant information: gather data about the problem and possible solutions. It is always
important to analyse all possible solutions to find which one is the best

• Analyse/Evaluate all options : consider the advantages and disadvantages of each option or possible
solution
• Make the final decision : make a strategic decision. Select the best option with more advantages and
few disadvantages

• Implement a decision: this means that the manager must see to it that the decision is carried out and
is working according to plan

• Review and evaluation of the decision: review its success against the original objective. If the
decision didn’t work, then a corrective action must be done for the objectives to be achieved

How and why objectives might change over time

•
Change in owners’ priority: the owners shift from one object to the next as time unfolds
•
Change in market conditions: in a recession the business may aim for survival
•
Change in size of the business: owners’ objective could be growth in early stages and then profit
maximisation as the business becomes well established
•
Change in management: when new management comes in, they can introduce new changes which
could be new objectives
•
Change in competitor behaviour: the business can change its objectives in responses to changes
made by the competitors
•
Change in legislation: a change in government laws can force a business to come up with new
objectives in a new environment

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Translation of objectives into targets and budgets

This statement simply means a process by which objectives are translated into targets and budgets. Thus
corporate objectives should be broken down into individual targets. Target or key performance indicators
(KPIs) refers to a detailed operational objective for a specific area of a business to be achieved by a specific
date. Once targets have been set for individuals or groups they can be monitored and adjusted to increase the
chances of achieving overall objectives, and can be used as a motivational tool. Communication is very
important to make the employees aware of the business objectives. Targets can also be used in the budgeting
process. A budget refers to a plan expressed in financial terms for targets to be achieved, financial resources
to be made available. Employees must be involved in the setting of targets. Unrealistic targets will, however,
lead to unobtainable and misleading budgets.

Advantages of targets Disadvantages of targets

• Employees will be motivated to work harder • Can be demotivation especially if they cannot
• Productivity of employees and managers will be achieved or an employee fails to achieve
improve them. There can be many reasons for failing
• Encourages team work which then reduces to reach a target.
mistakes at the business • Can dehumanise a job. People are treated like
• Managers will always be in touch with machines rather than as humans
employees and this helps employees to meet • Can lead to ‘blame culture’
deadlines • Difficult and expensive to monitor
• Help managers to identify problem areas
• An easy way to translate corporate objectives
into individual and other subsidiary objectives

COMMUNICATION OF OBJECTIVES AND THEIR LIKELY IMPACT ON THE WORKFORCE

Targets in business have been a valuable management tool for a long time. In 1945, Peter Drucker developed
the idea of Management By Objectives (MBO). This is a method of managing staff by defining objectives for
individuals members derived from the overall objectives of the business.

If employees are communicated with and therefore involved in the setting of individual targets, then these
benefits should result:

• Employees and managers have a greater understanding of both individual and company-
wide goals.
• Employees understand the overall plan and how their individual goals fit into the
company’s business objectives.

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• Employees share responsibility for targets and objectives by interlinking their goals with
those of others in the company.
• Managers stay in touch with employees’ progress more easily, as regular monitoring of
employees’ work allows for praise or training to keep performance and deadlines on track.

How ethics may influence business objectives and activities

Business ethics refers to moral guidelines that govern business decisions and business behaviour. These are
rules and guidelines on staff behaviour that must be followed by all employees’. Employees must behave in a
morally acceptable manner. Some managers operate their business along strict ethics rules, they want their
employees to do the right thing. Business ethics apply to all aspects of business conduct ad are relevant to the
conduct of individuals as well as the entire organisation. Ethics involves the choice that people make and
sometimes ethical issues are covered by legislation. A code of ethics should be drawn up

Differences between business ethics and code of conduct

Business ethics

o Making the business gains in a proper manner

o Avoiding discrimination on staff and stakeholder groups
o Not linked to political parties
o Being fair to all who have business relationships with the company
o Protecting the environment

Code of Conduct

• Upholding the principal of honesty and fairness

• Protecting the properties and reputation of the business
• Conducting business in the best interest of the owners
• Behaving appropriately at all times towards others

Unethical business activities

• Buying supplies from businesses that use child labour

• Exploiting suppliers in poor countries by demanding and paying low prices
• Lending to people and businesses who will struggle to repay the loans
• Wilful selling of harmful products to the people
• Not paying a fair wage
• Avoiding paying tax
• Polluting the environment
• Newspapers prying into people’s private lives
• Target advertisements for sweet at children
• Getting business secrets from competitors
• Encouraging top employees to move from a competitor
• Paying bribes to get contracts

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• Failure to give correct or accurate information

• Testing cosmetics products on animals
• Over charging tourists

Benefits of acting ethically

• The business will be offered with government contracts

• The business may attract qualified and experienced staff
• The business may get more customers
• Avoiding expensive court cases on ethical related crimes

Challenges of acting ethically

• Charging lower prices leads to lower profits

• Paying fair wages in harsh economic environments may raise wage costs and this reduces the firm’s
competitiveness
• Not taking bribes may lead to lower sales
• Disposing of waste material can be costly to the business
Business objectives in the private sector and public sector

Private Sector

• To earn high profits

• To maximise wealth of shareholders
• To fulfil needs and wants of the people
Public Sector

• To create employment
• To operate even if no profit is generated
• To provide certain products such as electricity, transport, defence etc
• To provide goods and services at affordable prices

Objectives of Non-profit organisations

• To provide services to members

• To provide employment
• Operating for the welfare of members e.g schools, hospitals
• To eliminate poverty in communities

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1.5 Stakeholders in a business

Refers to individuals or groups interested in the activities of the business. Stakeholders are interested in a
business for various reasons and will be directly affected by its decision or by its performance. Examples of
stakeholders include owners( shareholders); managers; employees; customers; suppliers; lenders;
government; local community and special interest groups( pressure groups)

Internal Stakeholders

Are those that are directly affected by the business’s performance. They are also known as primary
stakeholders. They have a large influence on how the company is run. For example the company’s owners will
take part in important business decisions. Managers and employees also influence the company’s day to day
operations by various business decisions that they make.

External Stakeholders

Are individuals or groups that are not directly affected by the business’s performance. These parties are not
directly involved in decision making and other business affairs and, therefore, may or may not be affected by
the company’s decision or operations. External stakeholders include the government entities, the general
public, competitors, customer, pressure groups politicians, analysts, stock brokers, potential investors etc For
example, government entities such as internal revenue will use business’s information for assessing tax
payments; potential investors will use the information to make investment choices, media will use them for
public awareness purposes, and analysts and stockbrokers will use them to advice clients or potential
investors.

Differences between stakeholders and shareholders

Shareholders: hold shares in the company. They own part of the business

Stakeholders: They have an interest in the company. They do not own part of the company unless they are
shareholders

Stakeholders Theory/ Stakeholders Concept

An idea that business should not only focus on shareholders’ interest but should consider interest of all
stakeholders e.g managers, suppliers, customers, employees, government and pressure groups (eg
environmental lobbyists)

Roles, Rights and Responsibilities of Stakeholders

Stakeholder Roles Rights Responsibilities

Suppliers -supply goods and -to receive payment in -to supply the goods and

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services -to allow the time services in time and in good

business to offer its condition.

products to its own -to be treated fairly by

customers those powerful customers

-buy goods and services -to receive goods and -to pay for the goods
Customers
from sellers services that are not received in time

harmful to their health

-provide revenue to -avoiding false claims

sellers -to be compensated when

a problem occurs -honesty i.e stealing

-provide manual and -to be treated fairly -to be honest

Employees
mental effort to the
business -to be paid a wage -have the necessary skills

described in their contract and experience required

-produce goods and of employment

services -to perform any other duties

to be allowed to join a delegated

trade union
-to observe the ethical code

of conduct

-to provide loans to the -to be repaid on the - provide agreed amount of
Lenders
business agreed date money on the agreed date

for the agreed time period

-to receive interests on

loans

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-provide local services -to be consulted about -to co-operate with the
Local

and infrastructure to the major changes e.g business on expansion and

community
business expansion plans other plans

-impose fines on -to provide services such as

businesses that operate public transport

illegally

-pass laws to control -to take licences of -to treat businesses fairly
Government
business activities businesses that operate
outside the law -to prevent unfair

-promote economic competition

stability -ban the sell of illegal

goods and services -to establish trading links

with other countries

STAKEHOLDERS AND THEIR OBJECTIVES

Stakeholders Who they are objectives

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Owners -invest capital in the business and get profits -maximise profits

from the business

-growth of the business

Workers -employees of the business who give in their -job security

time and effort to make a business

Successful -job satisfaction

fair wages for their effort

managers -employees of the business who manages a -high salaries

Business

-job security

-they lead and control the workers to

achieve organisational goals -status

-growth of business

customers -these are the people who buy the goods -safe and reliable products

and services of the business

-value for money

-to receive after sale services

Government -manages the economy -successful businesses

-collect tax from businesses -employment to be created

-monitors the working of businesses in the -more tax revenue

Economy

-laws being followed

The community -community refers to all the people who are -they expect more jobs

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directly or indirectly affected by the actions

of the business -environmental protection

-social responsible products

-ethical business practices

Suppliers -people or organisations who provides the -to get a fair price for their goods

business with inputs and services

-long term contracts

-prompt payments

Banks /lenders people or organisations who provide the -interest and principal to be paid

business with funds

-growth of credit industry

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IMPACT OF BUSINESS ACTIVITIES ON STAKEHOLDERS

How and why a business needs to be accountable to its stakeholders

Benefits to the business for being responsible to customers

• The business will benefit from customer loyalty

• The business will enjoy good publicity when customers give word of mouth recommendations to
others
• Good customer feedback which helps to improve further goods and services

Way in which a business can become responsible to customers

• Business must offer quality goods

• Businesses to offer well designed and durable goods
• To sell goods at reasonable prices
• Businesses not to take advantages of vulnerable customers e.g high-pressure selling tactics

Benefits to the business for being responsible to suppliers

• Benefits from supplier loyalty

• Suppliers may be willing to open credit lines
• Suppliers will be prepared to meet deadlines and requests for special orders

Way in which a business can become responsible to suppliers

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• Prompt payments to suppliers

• Giving suppliers clear guidance on what is required
• Offering suppliers long-term contracts
• Buy stock regularly

Benefits to the business for being responsible to employees

• There is employee loyalty

• Low labour turnover
• The business can easily attract highly qualified staff’
• Employees will be motivated and their productivity will increase

Way in which a business can become responsible to employees

• Business to provide training opportunities

• To give employees fair wages
• Involve employees in decision making
• Give employees fringe benefits e.g company house, company car etc

Benefits to the business for being responsible to community

• Local communities are more likely to accept some of the negative effects caused by business
operations
• Local councils often give contracts to business with a record of good behaviour towards the
community and its environment

Way in which a business can become responsible to community

• Offer secure employment

• Avoid adverse environment effects such as pollution
• Employing local people

Benefits to the business for being responsible to the government

• Business may receive valuable government contracts

• Business may benefit from government subsidies

• Licences to set up new operations are more likely to be awarded to business that meet their
responsibilities

Way in which a business can become responsible to government

• Obeying government laws

• Paying taxes in time
• Declare all incomes to the government generated by exporting businesses

Conflicting Objectives

Often time two or more objectives will clash and we call these conflicting objectives

Common conflicting objectives

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1. Clash between key stakeholders: owners of a company’s objectives may clash with those of
managers or employees. Owners may want the business to minimise costs while employees may
demand for a pay rise. Another example is that of growth versus profit. Thus achieving higher sales
in the short term, probably by cutting prices, will lead to a reduction in short term profits
2. Clash between short term and long term objectives: a business may decide to accept lower cash
flows in the short term whilst it invests in new products, plants or equipment
3. Clash between environment and profit: for example if a company wants to reduce its pollution
contribution, it will need to spend a heavy proportion of its profits.

2.1 HUMAN RESOURCE MANAGEMENT

The purpose of human resource management (HRM) is to make sure that the business has the appropriate
workforce to enable it to meet its stated objectives. The workforce must be committed and physically capable
of doing the work required. Aims to ensure that the right workers are available in the right numbers, in the
right place and at the right time. The human resources (HR) function is also responsible for planning for a
business’s future need for labour

Functions

• The HR department is responsible for succession planning. Succession planning is the process of
identifying employees who can be trained for future leadership positions
• Recruiting, selecting and appointing employees
• Salary administration and determination
• Skills development
• Appraising and managing workforce performance
• Establishing and maintaining employee wellness
• Responsible for promotions, transfer, demotions and expulsions
• Prepare employment contracts
• Responsible for workforce planning
• Keeping staff records
• Ensure that labour legislations are followed

Recruitment

Refers to all HR activities that are aimed at finding and attracting job candidates who have the necessary
knowledge, experience, qualifications and skills to fill a job. It involves identifying the need for an employee,
devising a job description and finding a person suitable to fulfill the needs of the job.

Reasons why businesses need to recruit people

•
To replace those who were dismissed
•
To replace employees who resigns or who have passed away
•
New employees for expansion

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•
Employees who are promoted
•
Employees who retire

Two types of recruitment

a)Internal Recruitment: occurs when in-house employees are promoted.

Advantages of internal recruitment Disadvantages of internal recruitment

• Saves time and money • No new ideas or experience come into the
• The candidate’s reliability, ability and business
potential are already known. • May create jealousy and rivalry between
• The candidate already know the expectations existing employees
and rules of the company • Can cause line management problems for the
• Motivate other employees to work harder to promoted person if they now supervise
get promoted too former colleagues

External Recruitment

Finding and attracting job candidates from outside the organisation. Most vacancies are filled with external
recruitment, which always involve advertising the vacancy. Some of the suitable media of advertising include:

Local news paper

National news paper

Recruitment agencies

Government job centres

Internet

External recruitment also involves headhunting. Headhunting takes place when people who are already
employed by one employer are asked to apply for a job at another employer

Advantages of external recruitment Disadvantages of external recruitment

• New ideas and skills are brought into the
business • It is time consuming
• Can prevent conflicts among existing • It is very expensive e.g advertising costs and
employees interview expenses
• Chances of attracting the best candidate are • Demotivate existing staff. Internal applicants
high might be unhappy that a stranger has got the
job.

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Recruitment Agencies

Most agencies keep record of candidates’ CVs and they are able to make a recommendation quickly.
Recruitment agencies usually know a business’s needs. Time is saved as the agency works through applicant’s
CVs

Problems

• Usually, recruitment agencies are paid a percentage of the new employee’s remuneration package.
Thus it increases the cost of labour.

• The business doesn’t know what CVs have not been recommended

Recruitment Procedure

Step no.1: Determine the exact labour needs of the enterprise

The business must carry out job analysis. Job analysis involves determining the exact labour needs of an
enterprise before candidates can be attracted. Job analysis involves coming up with the job description and
job specification.

Job Description

Refers to a written description of the job and its requirements. Provide details as to what task will the person
be expected to undertake.

It includes details such as:

•
Job tittle
•
Main purpose of the job
•
Duties and responsibilities
•
Department in which the job is performed
•
Pay scale
ADVANTAGES OF PRODUCING A JOB DESCRIPTION

o Provides a clear idea of what a job involves so they can select the best candidate

o Saves time / money / makes selection easier and the business won’t get applications from
people who cannot do the job

o As a basis for drawing up a contract and the business can be sure that all duties will be
carried out on-board

o Helps decide basis for pay

o Help create person specification
o Helps create appropriate job advert
Jon specification

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Refers to a written description of the characteristic and qualification required of the person that will fill the
job. It is a person profile which will help in the selection process by eliminating applicants who do not match
up to the necessary requirements.

It includes details such as:

•
Qualifications required
•
Training required
•
Minimum experience required
•
Physical requirements

Step no.2: Choose the recruitment Source

Decide on whether to use external or internal recruitment method

Step no.3: Prepare a job advertisement

This is what a business needs to decide on when drawing up an job advert

•
What should be included i.e job description and job specification
•
Where the advert will be placed i.e newspapers, internet, notice boards etc
•
Costs associated with the advertising media.

Step no.4 Selection

It is known as shortlisting. It refers to the process of determining which applicants will best suit which specific
jobs. Selecting them basing on certain assessment criteria (screen responses). The CVs of unsuccessful
candidates can be kept for future references. Draw up a short list of candidates. Come up with a short list of
potential candidates, usually a list of 5 candidates

Step no.5: provide feedback to candidates

Inform all applicants about the outcome of their applications so that unsuccessful candidates can look for
other employment options. Invite suitable candidates for interviews.

Step no.6: Employment Interviews

An interview is a conversation between a job candidate and the relevant managers of a business enterprise. It
is used for selecting the best candidate from the short list. Interviews aim to determine if candidates are
suitable for a job by comparing the candidate’s skills, experience, qualifications with the job requirements.

Aptitude Tests and Psychometric Tests

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Aptitude Test- tests the candidate’s skills or the ability of a candidate to perform a certain task. The tests can
include practical tests requiring the applicant to perform some part of the work that they are applying for.

Psychometric Test- written examination or role plays on situations that are designed to test the character,
attitude and personality. For example, a role play might reveal whether or not the applicant works well as part
of a team.

Contract of Employment

Once a candidate is appointed, the individual receives a letter of appointment followed by a contract of
employment. The letter of employment is an offer to the chosen candidate to work for a particular employer.
The contract of employment is a written agreement between the employer and the employee which describes
the duties, rights and responsibilities of both parties.

Contents of an Employment Contract

•
Details of the employer
•
Details of the employee
•
Working hours (ordinary days and hours of work)
•
Remuneration
•
Job tittle and job specification
•
Date of commencement
•
Duration of contract i.e part-time, temporary or full time
•
Termination of contract
•
Leave (number of leave days, types of leave days)

Benefits of having an employment contact

•
Both parties are clear about the terms and conditions that have been agreed
•
The employer and the employee both know what a person has been employed to do because this
would be clearly stated in the contract that would be signed by both parties
•
Any dispute about the terms and conditions of employment could be resolved by referring to the
employment contract.
•
Avoiding heavy fines or penalties

How can an employment contract be terminated?

•
The employee can resign in order to take up employment elsewhere
•
The employee might reach retirement age
•
The employee might be in breach of contract and therefore the employer might be able to dismiss him
•
The employee might have broken the terms of the contract causing the employee to wish to leave his/
her employment
•
The term of the contract might have come to an end
•
The employee might be promoted, in which case the roles and responsibilities would probably change.
Performance Appraisal

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It is the process of assessing an individual’s performances at work. It is an analysis of an individual’s

performance against pre-set and agreed targets.

It is important for :
•
Identifying training needs
•
Motivating staff by discussing and recognising their achievements
•
Remuneration
•
Identifying people worth of promotion
•
Checking the efficiency of the organisation in recruitment, selection and training.

Problems of performance Appraisal

• Employees dislike appraisal because they fear criticism and their weaknesses being exposed
• Badly designed forms or poorly conducted interviews may result in subjective appraisal

Dismissal and Redundancy

Dismissal: to end the services of an employee due to an act of misconduct. It is the termination of an
employment contract because the employee has not fulfilled the conditions of the contract in some way. An
employee can be sacked from a job due to incompetence. Incompetence refers to the lack of ability to do
something well. Dismissal will deprive a worker of his or her immediate means of financial support and the
worker is likely to lose pension benefits. There should be enough evidence that the HR department has done
all it can to help the employee before dismissing him/her. It is unfair to terminate the contract of employment
for the first offenders

Reasons for dismissal

• Gross misconduct e.g stealing

• Incompetence even after sufficient training has been given
• Continuous negative attitude
• Intentional destruction of an employer’s property
• Bulling of other employees
• Failure to disclose relevant details when being offered employment.

Unfair Dismissal

Terminating an employee’s employment contract for a reason that the law regard as being unfair. The
affected employee can report to the civil court so that the court can deal with such unscrupulous employers.
When dismissal is judged to be unfair, the employee will get damages from the firm

Dismissal is unfair under the following circumstances:

• Pregnancy
• A discriminatory reason e.g based on race, gender, religion, political affiliation etc
• Employee being a member of a certain trade union

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• For minor cases without giving first or second warning.

Redundancy

It occurs when an employee loses his/her job when the business no longer requires that work to be done. It is
important to note that, it is the job that is no longer needed, not the person doing the job. When the good or
service is no longer required, the employee doing that job becomes unnecessary through no fault fromhis/her
side. It occurs due to a permanent decrease in demand for a particular product. It also occurs in the mining
sector due to the depletion of mineral resources. It is fair for the employer to give the redundant worker
severance package. The severance pay can be used by the redundant worker to start income generating
project.

Labour Turnover

Measures the rate at which employees are leaving an organisation. It is measured using the following formula

Labour turnover = number of employees leaving x 100

Average number of people employed

Interpretation: labour turnover is increasing or is too high then it will be a signal that:
•
Employees are not happy i.e low morale
•
The business failing to recruit the right people
•
Bad leadership or management
•
Availability of better paid jobs elsewhere

Potential benefits of high labour turnover

• Low-skilled and less productive staff might be leaving and creating space for highly skilled workers
• New ideas and practices are brought into the business by new workers
• Can benefit the business with the plans of reducing staff size i.e staff that will be leaving won’t be
replaced

Problems of high labour turnover

• High costs of recruiting, selecting and training new staff

• Difficult to establish team spirit as team members are constantly changing
• Low output level when a new worker is introduced and, or when the business is in the process of
finding a suitable replacement.
• Lose of customers
Workforce Planning

It is also known as manpower planning. It involves the analysis and forecasting the number of workers and
skills of those workers that will be required by the organisation to achieve its objectives. Thus, it involves
forecasting the future demand for labour in the organisation and planning to meet it. It is accomplished
through analysis of internal factors such as current and expected skills needs, vacancies and departmental
expansions and reductions as well as external factors such as the labour market conditions. Workforce

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planning also involves a skills audit (Workforce audit). Workforce audit involves an assessment of staff
capabilities and matching them against future needs. This is just a check on the skills and qualifications of

all existing workers and managers. The HR manager will be checking on social, intellectual, technical,
managerial and administration skills.

Benefits of Workforce planning Factors influencing the number employees required

in the future
• Planning for the future i.e to calculate the • Future demand for the firm’s product
future staffing needs of the business • Productivity of existing staff
• To prevent the problems of too few or too • The objectives of the business i.e growth
many staff at the business objective will imply that more staff will be
• To avoid many staff with wrong skills required.
• To achieve the objectives of the business in • Labour legislations i.e minimum wage laws
the future from government encourages firms to
workers with machines
• Labour turnover i.e the higher the rate at
which staff leave the business, then the
greater will be the firm’s need to recruit
replacement staff.
• Skills of existing staff i.e HR managers have
insatiable appetite for better-qualified
employees.

Employee morale and Welfare

Morale and welfare are important to people at work. They affect people’s attitudes and willingness to work.

Thus they influence how much effort workers will exert to their job.

Employee Morale: refers to the feeling of enthusiasm and loyalty that a person has about a task or job.
Employees must feel that what they are doing is worthwhile. If they feel that their work is valued by
management, they are also likely to feel that they are valued both as employees and as individuals. Their
morale will be high and employees tend to have a greater commitment and loyalty to their work.

Employee Welfare: refers to the state of being happy, healthy or successful. Employees are often concerned
about their health and safety at work. A business organisation which cuts corners on welfare is unlikely to get
the best from its employees.

Ways to maintain or improve staff morale and welfare

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• Ensure that health and safety guidelines/ legislation is met. The physical welfare of employees can
partly be assured by following health and safety measure.
• Offering help and guidance to employees who might be experiencing problems in their life outside
work. E.g when a worker is worrying about her child’s deteriorating health condition.
• Provide medical facilities within the business in order for the employees to get treatment for any
injuries.
• Dealing with issues that are demotivating employees
• Treating employees fairly.
Work-life Balance

Refers to a situation in which employees are able to give the right amount of time and effort to work and to
their personal life outside work. Employees must have enough time to attend to their private life. Thus
employees must get time to spend with their loved ones. Working long hours and also denying employees
breaks can lead to stress and poor health. The management must assist employees to achieve a better work-
life balance. The aim is to maintain a sensible balance that allows career and ambition needs to met as well as
family and friendship needs and commitments.

Methods that can be used to achieve a better work-life balance

• Flexible working i.e allowing some employees to come at busy periods of the day but not during
slower periods
• Teleworking i.e working from home for some of the working week
• Job sharing i.e allowing two people to fill one full-time job, although each worker will only receive a
proportion of the full-time pay
• Sabbatical periods i.e an extended period of leave from work. Some business do not pay employees
during this period.
Policies of Diversity and Equality

Equality Policy

Refers to practices and processes aimed at achieving a fair organisation where everyone is treated in the same
way. People have the right to be treated with equality, respect and dignity. All employees must have equal
opportunities. Equality policy is violated when some employees are discriminated against e.g denying some
employees an opportunity to receive skills training.

Benefits of promoting Equality

• Can improve employee morale

• Greater commitment and effort from employees
• The business can easily attract skilled and experienced personnel from other organisations

Diversity Policy

Diversity refers to variety or mixture. Diversity policy refers to practices and processes aimed at creating a
mixed workforce and placing positive value on diversity in the workplace. Diversity promotes inclusivity

Diversified workforce include employees:

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• Who come from different backgrounds and cultures

• Who speak different languages
• With different levels of education
• Who differ in terms of age and gender

Advantages of Diversity in business

• Creativity increases when diverse team members work together

• When a diverse team pulls together by focusing on their strengths, increased levels of productivity will
be achieved
• Colleagues learn to value and respect one another even if they do not hold similar values and beliefs
• A diverse workforce brings different skills to the workforce, for example language skills
• Can lead to an increase in the customer base since some customers are attracted by a diversified sales
force.
The costs may include:

• higher recruitment costs

• longer recruitment process
• greater training needs
• communication barriers.

Training

Refers to work-related education to increase workforce skills and efficiency. Training is required for new as
well as existing employees. Training will help prepare new employees for change and to improve the efficiency
of the organisation. The emphasis on quality, competitiveness and the rapid pace of technological change
have increased the need for training.

Reasons for training

• To facilitate the introduction of new technology

• To prepare existing employees for succession purposes
• To develop workers in order to enable them progress
• To provide employees with the skills, knowledge and aptitude
• To improve worker morale
Types of training

a)Induction Training: involves the introduction of new staff to the firm as they are told about its business and
the way of operation. The HR manager should explain to the new worker the internal organisational structure,
health and safety issues, and also company policy. The employee on the other hand has got the chance to ask
questions.

BENEFITS OF INDUCTION TRAINING

• Helps employees to settle into their job quickly/familiarise workers with the
business/provide information about the business so that he/she can easily cope with flow
production
• Aware of health and safety/legal issues in the factory

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• the new employee will know who to ask if there is a problem and this helps to prevent wastage of
expensive raw materials
• Help keep productivity/efficiency high so that the business will remain competitive

b)On-the-job training: training is done at the work station where an employee works. It can take the form of
job training combined with related classroom instruction and apprenticeship. The trainee will be under the
guidance of a highly skilled co-worker. Employees are trained by watching professionals do a job. It is only
suitable for unskilled and semi-skilled employees.

Advantages Disadvantages
• It can cut travel costs. • The trainer’s productivity is decreased
• The trainee may do some work while on because he/she must attend to the trainee’s
problems
training. They can actually be contributing to
production while they are learning. • If mentoring is not paid, the trainer may not
be fully committed
• Can be a motivator the trainers
• Some skilled and experienced employees are
• No special premises to hired or built
not good teachers.
• It is cheaper since it uses existing skilled and
• Mistakes made by the trainee may affect the
experienced employees
business’s reputation

Off-the-job Training: It takes place outside the work place. Workers go to another place for training e.g
schools or private training colleges. It involves the use of specialised instructors.

Advantages Disadvantages

• Employees can learn many skills. • outside trainers are very expensive
• Employees can work during the day and • output of the trainee is lost
attend training sessions in the evening. • Trainee can also copy bad behaviours from
• Any mistake that the trainee is going to the trainer.
makes are unlikely to affect the reputation of
the business
• Training can lead to a recognised qualification

Benefits of training

To the employer

• Improves motivation of staff

• Reduction of waste and scrap
• Quality services to customers
• May reduce labour turnover
• Helps to develop a positive culture in the organisation
• Increases productivity

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To the employee

• Employees may feel valued by the organisation

• Training improves promotional prospects
• May improve job satisfaction
• Employees are better able to cope with change.

Management and workforce relations

The relations between managers and the workforce have a great impact on the success or failure of a
business. In most countries, employees are able to join trade unions. Many of the discussions and negotiations
needed between managers and workers can then take place through trade union officials.

Benefits of cooperation between management and the workforce

• Fewer days are lost through strikes and other forms of industrial action.
• It will be much easier for management to introduce change in the workplace. For example,
a decision to automate part of a factory could be made with the cooperation of the
workforce.
• The contribution of the workforce is likely to be recognised by management, and pay
levels and other benefits might reflect this.
• Agreement on more efficient operations will increase the competitiveness of the business.

Impact of trade union involvement in the workplace There are various reasons for a worker to join a trade
union:

• The basis of trade union influence has been ‘power through solidarity’. This is best illustrated
by the unions’ ability to engage in collective bargaining, negotiating on behalf of all of their
members within a business. This puts workers in a stronger position than if they negotiated
individually to gain higher pay deals and better working conditions.
• Individual action – for example, one worker going on strike – is unlikely to be very effective.
Collective industrial action could result in much more influence over employers during
industrial disputes.
• Unions provide legal support to employees who claim unfair dismissal or poor working
conditions.
• Unions put pressure on employers to ensure that all legal requirements are met, for example
health and safety rules regarding the use of machinery. Many employers have a policy of trade
union recognition, which allows for collective bargaining. However, some employers prefer to
negotiate with individual workers over pay and work conditions. These employers argue that
they do not want to be pressurised through collective bargaining with trade unions into paying
higher wages or improving work conditions. Benefits of collective bargaining
• Unions can impose discipline on members who plan to take hasty industrial action that could
disrupt a business. This makes industrial action less likely.

Trade union leaders can use several forms of industrial action during a dispute with employers over
improvements in pay and conditions:

• Continue collective bargaining, perhaps with the help of an independent arbitrator.

• Go slow – a form of industrial action in which workers keep working but at the minimum pace
demanded by their contract of employment.

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• Work-to-rule – a form of industrial action in which employees refuse to do any work outside
the precise terms of the employment contract. Overtime will not be worked and all non-
contractual cooperation will be withdrawn.
• Overtime bans – industrial action in which workers refuse to work more than the contracted
number of hours each week. During busy periods, this could lead to lost output for the
employer.
• Strike action – the most extreme form of industrial action in which employees totally
withdraw their labour for a period of time. Strike action leads to production stopping and the
business shutting down during the industrial action

2.2 MOTIVATION

It is defined as a management process of influencing people’s behaviour to achieve stated goals. It also

refers to all forces and influences that employees want to behave in a certain way. i.e include incentives to
exert effort. When employees are motivated, it means that the they are satisfied and they enjoy the job they
are doing. Motivation is a tool used by leaders and managers to encourage their employees to work willingly
as hard as they can. Thus motivation refers to the desire to do something or the drive to reach a goal.

What motivates workers?

•
Pay
•
Promotion
•
Working conditions e.g annual leave, uniforms, working hours, working environment
•
Fringe benefits e.g company house, sponsored vacation, school fees for children, company vehicle
•
Colleagues
•
Management style
•
Work related achievements

Benefits of motivated staff

Higher levels of productivity: workers will perform their tasks quickly. They work harder and be more
productive

Lower labour turnover: employees won’t be willing to look for other jobs elsewhere. They are satisfied with
their current job.

Lower absenteeism rate: employees won’t absent themselves from work for no apparent reason. Employees
who are not motivated are likely to take time off when it is not absolutely necessary Creativity: employees are
more likely to come up with new ideas and they will be willing to take on responsibilities

Employees loyalty: employees when they feel trusted or valued, they tend to give their best to the business.
Improved customer service: a motivated employees will recognise that a happy customer is likely to be a
repeat customer and also that the reputation of the business rests not only on the goods produced but on the
quality of aftercare that their customers receive.

Better quality products: more attention will be paid to the way in which work is carried out, whether that is
the production of goods or the provision of services.

Increased likelihood of achieving business goals: when employees are work as hard as they can the business
will have the best chance of achieving any stated objectives. Employees will even be willing to work for unpaid
overtime.

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Indications of poorly motivated staff

•
Absenteeism: workers can just decide to be absent from work without any justification
•
Reporting late for duty: the workforce will arrive late and may be leave their jobs very early before
the normal knock-off time.
•
Poor performance: poor quality work and a greater waste of raw materials
•
High labour turnover: employees just ‘come and go’. They won’t take time at the business and this
will cost the business more in training and recruiting new staff
•
Conflicts: there will be a lot of disagreements within the workforce. Employees have a negative
attitude towards work.
MOTIVATIONAL THEORIES

Motivational theories are divided into two namely content theories and process theories

Content Theories: motivation theorists whose work focuses on the nature of the work itself and or the terms
and conditions of employment. These theories are also based on the idea that individuals are motivated by
their desire to fulfil their human needs (inner needs). Thus their human needs energises them to work harder.
Content theories also focuses on how the managers can create favourable conditions that allow workers to
satisfy their human needs.

Process Theories: are motivation theories whose work focuses on the psychological drivers that can
encourage employees to work harder. Basically they focus on how and why individuals choose certain
behaviours in order to meet their personal goals. Process theories study what people are thinking about when
they decide whether or not to put effort into a particular activity.

PROCESS THEORIES

a)Frederick Winslow Taylor (Economic Man)

Taylor put forward the idea that workers are motivated mainly by pay. Taylor believed that people are were
motivated by money and that they should be paid according to the output that they produce. His idea was
that employees should be observed in order to identify the most efficient way of working. Once the best
method had been decided, all employees should carry out the required task in the same way. Taylor wanted
to advise management on the best ways to increase worker performance or productivity. He also argued that
workers do not naturally enjoy work and so need close supervision and control.

Managers were required to breakdown production into series of small tasks. Workers should then be given
appropriate training and tools so that they can work as efficient as possible on one set task. Performance is
then recorded and working conditions will be altered. This approach of detailed recording and analysis of
results is known as scientific management. Workers are then paid according to the number of items they
produce in a set period of time. i.e piece rate pay. Piece rate refers to a payment made per unit produced.
Piece rates encourages workers to work harder and maximise productivity. An employee is referred to as an
economic man i.e he/she is driven by the desire to earn more money. An economic man will work harder to
be able to receive the highest pay possible. The chance of earning extra money stimulate further effort.

How to improve output per worker according to Taylor’s scientific approach

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•
Select workers to perform a tsk
•
Observe them performing the task
•
Record the time taken to do each part of the task
•
Identify the quickest method and do not allow them to make any changes to it
•
Train workers in the quickest method
•
Supervise workers to ensure that the best way is being carried out
•
Pay workers on the basis of results i.e piece rate (based on theory of economic man)

Application of Taylor’s work

Henry Ford used Taylor’s methods to design the first ever production line, making ford cars. This was the start
of the era of mass production.

Limitations of Taylor’s Theory

•
Piece rate payment is not suitable in a service industry where the product itself is invisible
•
The theory encourages autocratic style of management which can motivate staff
•
Money is not the need at work. Employees have a wide range of needs. Taylor’s theory does not
address the problem of how to motivate employees once their desire for money has been satisfied. i.e
workers may have the desire for status symbols etc
•
Mass production can lead to repetitive or boring tasks which the demotivate employees

Mass production involves the use of machines and a lot of workers will be replaced by machines

Abraham Maslow (1908-1970)

Maslow based his theory on a series of human needs which he believed could be placed in order of
importance. Human needs are the wants or desires of people that they hope will be met at their work or in
their activities outside the work environment. Maslow put forward that there are five levels of human needs
which employees need to have fulfilled at work. All of the needs are structured into a hierarchy and only once
a level of needs has been fully met, would a worker be motivated by the opportunity of having the next need
up in the hierarchy satisfied. For example, a person who is dying of hunger will be motivated to achieve a basic
wage in order to buy food before worrying about having a secure job contract or the respect of others.
Maslow view. Once a need is satisfied, it no longer motivates the worker.

Maslow’s Hierarchy of needs

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Application of Maslow in the business environment

Basic needs: paying a fair wage which enable employees to buy essentials for life

Safety: provide a contract of employment; follow the health and safety guidelines for a safety work
environment

Social needs: encourage team work; encourage social activities and communication between all levels of
employees. E.g social soccer, hosting Christmas party etc

Esteem needs: give recognition for good work; show appreciation e.g employee of the month; motivating job
titles (e.g a security guard-security enforcement director; garbage Collector- environment sanitation
Technician); promote people to give them additional responsibilities

Self-actualisation: meet the need for feeling of achievement perhaps through assigning more difficult and
challenging tasks. Allow for further training and progression within the business.

Critics of the theory

•
Not everyone has the same needs as assumed by the hierarchy. It is possible for a person not to desire
the approval of others and therefore, once their ‘safety needs’ have been met, self-actualisation might
be their next goal
•
In the real world, it is very difficult to identify the degree to which each need has been met and which
level a worker is on. Thus it is very difficult for the manager to know for sure which level on the
hierarchy each employee is on
•
Money is necessary to satisfy basic needs, yet it might also play a role in satisfying the other levels of
needs such as status and esteem
•
Self-actualisation is never permanently achieved as the hierarchy has suggested. In the real world, life
jobs must continually offer challenges and opportunities for fulfilment.

ELTON MAYO (Hawthorne Effect)

Elton Mayo (1880-1994) thought that the work rate (productivity) of employees is affected by the physical
conditions in which they were placed. Mayo introduced the Human Relations Schools of thought which
focused on managers taking more of an interest in the workers, treating them as people who have worthwhile
opinions and realising that workers enjoy interacting together. Mayo conducted a series of experiments at the
Hawthorne Factory of the Western Electric Company in Chicago. He isolated two groups of women workers
and changed factors such as lighting, financial incentives and working conditions. He expected to see
productivity levels declining as lighting and other conditions become progressively worse. What he actually
discovered surprised him. Whatever the change in lighting or working conditions, the productivity levels of
workers improved or remained the same.

These results forced Mayo to conclude that working conditions in themselves were not that important in
determining productivity levels. Other motivational factors should be investigated first before conclusions
could be drawn.

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Mayo’s Conclusion on motivation

• Changes in working conditions and financial rewards have little or no effect on productivity

• Workers are motivated by better communication between managers and workers (i.e Hawthorne
workers were consulted over the experiments and also had the opportunity to give feedback).
• Workers are motivated by working in teams of groups
• Workers are also motivated by a greater manager involvement in employees working lives. Hawthorne
workers responded very well to increased level of attention they were receiving.
Mayo concluded that workers are not just concerned with money but could be better motivated by
having their social needs met whilst at work. (similarities with Taylor and Maslow).

Frederick Herzberg’s Two Factor Theory

Frederick Herzberg (1923) believed in a two factor theory of motivation. He argued that there are certain
factors that a business could introduce that would directly motivate employees to work harder (motivators).
However there are also factors that would demotivate employees if not present but would not in themselves
actually motivate employees to work harder (Hygiene factors). Thus Herzberg analysed motivational factors by
grouping them into two broad categories namely hygiene factors and motivators

Motivators

Motivators drive people to achieve more in their work as these are what lead to employees gaining job
satisfaction. Employees are sometimes concerned about the job itself for instance, how interesting the work is
and how much opportunity it gives for extra responsibility

Examples of Motivators
•
Recognition of work done
•
Promotion
•
Being given responsibility
•
Nature of work

How business can satisfy motivators

•
Give positive feedback to employees
•
Involve employees in decision making
•
Allow delegation of tasks
•
Ensure that the work is stimulating and rewarding good performance
•
Implement things like job rotation, job enlargement and job enrichment etc

Hygiene Factors

Refers to the aspects of work that do not motivate but, if not present, cause dissatisfaction. These are factors
which surrounds the job rather than the job itself. E.g a comfortable working temperature. It is believed that a
worker will only turn up to work if a business has provided a reasonable level of pay and safe working
conditions but these factors will not make him work harder at this job once hi/she is there.

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Examples of Hygiene Factors

•
Pay (wages and salaries)
•
Fringe benefits
•
Relationship with co-workers
•
Status and security
•
Company policy

How business can satisfy hygiene factors

•
Pay a fair wage / salaries
•
Make sure that the working conditions are as good as possible e.g suitable temperature
•
Company rules should be reasonable and not too rigid
•
Encourage two-way communication and team work
•
Limited supervision

Ways to improve the nature and content of the actual Job

• Job enlargement: workers being given a variety of tasks to perform which would make the work more
interesting. The tasks are not necessarily challenging. Additional tasks are given to broaden the
employee’s skills and experience.
• Job Enrichment: involves workers being given a wider range of more complex, interesting and
challenging tasks surrounding a complete unit of work. This would give a greater sense of achievement
• Job Rotation: This involves changing a worker’s tasks more regularly to overcome potential boredom
• Empowerment: delegating more power to employees to make their own decisions over areas of their
working life.
Process Theories:

Motivational Need Theory by McClelland (1917-1998)

McClelland argued that the effort exerted by individuals or the way they behave depends on three
motivational needs. Both managers and employees are driven by these three motivational forces.

• Achievement Motivation (N-ach): these are result oriented individuals. Their main aim is to achieve
goals especially the challenging ones. Such individuals are further motivated if they can produce
results that are better the expected or required.

• Authority/Power Motivation (N-pow): such people are power or authority seekers. They always want
to lead and control others. They feel very mush comfortable when they gain control over others. Their
fulfilment would also come from self-esteem and respect that would be acquired if there was a
successful outcome as a result of their influence.

• Affiliation Motivation (n-affil): some people just need to be liked by others. This need is likely to drive
a person to want to work as part of a team where they feel respected and also supported.
How can business meet these needs:

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Need for achievement:

•
Set challenging but realistic targets
•
Recognition of achievements by managers

Need Power:
•
Involve employees in decision making
•
Encourage team work
•
Encourage two-way communication
•
Give employees small areas of responsibility

Need Affiliation:
•
Promote team work

Victor Vroom’s Expectancy Theory

Vroom believed that employees behave in different ways depending on what they think will lead to desired
outcome. Thus effort exerted by individuals depends on the expectancy of where that particular course of
action will lead to. Vroom thought that employees are prepared to work harder if they feel that their efforts
will be suitably rewarded.

The three beliefs of Expectancy Theory

• Valence: refers to the depth of the want of an employee in relation to desire or need for the reward.
The reward can be intrinsic i.e job satisfaction or extrinsic i.e money
• Expectancy: the degree to which people believe that putting effort into work will lead to a given level
of performance or result. Employees need to believe that increased effort on their part can actually
lead to a better performance.
• Instrumentality: employees need to fill confident that if they deliver an increased level of performance
they will receive their expected reward. The employees must have confidence in whatever they have
been promised by the manager.

Vroom’s Conclusions
•
Individuals will only act when they have a reasonable expectation that their behaviour will lead to the
desired outcome.
•
There is positive correlation between effort and the results
•
The rewards plays an important role in satisfying the needs of employees
•
The employee’s behaviour is a result from conscious choice among alternatives. The purpose of the
choice is to maximise pleasure and to minimise pain

FINANCIAL MOTIVATION

There are various payment systems that can be used to motivate staff. They fall under the general headings of
financial rewards and non-financial rewards

Financial Rewards

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Finanacial Reward Advantages Disadvantages

Time Rates: under this system, • Less harmful to quality • Pay is not related to effort or
earnings are calculated by • Less harmful to health of output but merely to the time
multiplying the hourly time rate by employees spend at work
the number of hours at work. It is a • Simple and easy to • Can encourage time wasting
payment based on the number of understand • Does not provide incentive for
hours worked. Unsocial hours or • Appropriate in most increased effort
overtime raise the pay rate circumstances • Tasks not completed on time
• Close monitoring is required

Piece Rate • Stimulates effort • Encourages more output

The earnings of an individual • Encourages workers to at the expense of quality
worker or group of workers are devise improved methods • Method is in appropriate
related to the quantity of items • No need for supervision i.e in service industries where
produced. The pay is based on the cut on costs output is immeasurable
number of units produced. The • Targets are surpassed • More harmful on
focus will be on the quantity rather • There is no time wasting employees’ health
than quality

Salary: Refers to an agreed • The employee will be • Can encourage time

amount paid monthly in return for certain about what he/she wasting
work undertaken. It is paid to is going to get at the end • It can only work when
those in the white collar sector i.e of the month individuals are closely monitored
professionals like Doctors, • Enables the management • Does not provide incentive
teachers, lawyers etc. Salary and the employee to plan for increased effort.
doesn’t depend on the number of in advance
hours worked or units produced. • Is suitable where output is
Each organisation uses different not measurable
salary bands or grades • It is suitable for
management positions

Commission • The method is cost • No job security especially if

An individual is paid according to effective i.e no need for a there is no basic salary
the sales he/she has made in a supervisor • Team work is discouraged
given period. Business usually give • Employees are motivated since individual
a basic salary plus a commission to exert more effort
based payment on top. It is salespersons will be keen
• Employees are time to maximise their personal
appropriate for salespersons. The
conscious
basic salary will improve job sales
security. This method will inspire
employees to achieve the highest
possible level of sales.
BONUS: refers to a payment made
to employees in addition to their
contractual wage or salary. It is
given to employees when they
have reached and surpassed the
targets set. It is a thank you given
to employees so that the can

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maintain the status quo

Performance Related Pay: a bonus • Staff are motivated to • Some employees are not
scheme to reward staff for above – improve performance if driven by the need to earn
average work performance. It is they are seeking for an additional financial
used for many groups of increase in financial rewards
managerial, administrative and rewards • Team spirit can be
professional workers. If • Target setting can help to damaged by the rivalry/
performance standards are not give purpose and direction competition between
visible in terms of quality to work of an individual employees
produced, a system of staff • Annual appraisal offers the • Favouritism can harm
appraisal is established for PRP to opportunity for feedback manager-employee
be introduced. Workers are paid a on the performance of an relationships
bonus according to the degree to individual
which the targets have been
exceeded.
Profit Sharing Scheme: a bonus for • Potential conflict between • The scheme can be costly
staff based on the profits made by owners and workers is to set up especially in large
the business. It is usually paid as a reduced organisations with a lot of
proportion of basic salary. It is paid • The business can attract employees
to encourage employees to highly qualified and • When the business made a
identify with the company. Thus experienced workers from loss or small profits, workers
the employees and owners will be rival firms won’t be motivated
working towards the same goal. • it is not a burden to the • Can lead to lower
PSS also provide an incentive for firm since it is paid out of dividends to the owners of
increased effort and staff turnover the profits made. the business
is greatly reduced. • Workers will be motivated • The reward is not closely
to work harder related to individual effort
• Employees will be profit hence it may not
and cost conscious effectively increase
motivation.
Fringe Benefits: refers to benefits • The business is able to • Some employees are
or perks given to an employee recruit and retain skilled motivated by cash and
which have a financial benefit to and experienced staff cash alone
them. These are non-cash forms of
rewards. They include: • Leads to higher • Fringe benefits add on to
Company house productivity and the costs of the business
Company car profitability
Education for children • Can help to reduce the
Discounts on company products employees’ financial
Pension schemes burden e.g free transport
Low interest on company loans and accommodation
• It can motivate staff to
work harder

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Non-Financial Motivators/ Rewards

Include things such as:

• Job enlargement
• Job enrichment
• Job rotation
• Induction
• Training
• Job redesigning
• Worker participation
• Team working
• Empowerment
• Promotion
• Delegation
• Non-financial fringe benefits

Job Enlargement: involves adding tasks of a similar level to a worker’s job. It simply gives more variety to
employees’ work which makes it more enjoyable. Job enlargement can lead to job satisfaction in the short-
term. It also used to reduce absenteeism. Additional tasks are given to broaden the employee’s skills and
experience.

Job Enrichment: adding tasks of a higher level to a worker’s job. Workers may need training, but they will be
taking a step closer to their potential. Workers become more committed to their job which gives them more
satisfaction. Involves workers being given a wider range of more complex, interesting and challenging tasks
surrounding a complete unit of work. This would give a greater sense of achievement. Job enrichment allows
for two-way communication and workers must be given complete units or work so that individual contribution
can be identified.

Job Rotation: Workers in a production line can now change jobs with each other and making their jobs not so
boring. It can help train employees in different aspects of their jobs so that they can cover for other
employees of they do not show up in future. Worker’s tasks are changed more regularly to overcome potential
boredom.

Job redesigning: Involves the restructuring of a job. It can be inform of adding and sometimes removing
certain tasks and functions on a worker’s job description. It encompasses job enlargement, enrichment and
rotation. Employees should be part and parcel of the job redesigning exercise. The job can be made more
challenging and interesting. A bored employee is more likely to lose concentration and can easily make costly
mistakes.

Training: The business can encourage the development and improvement of employee’s skills. The business
can achieve this by offering educational leaves or educational loans at favourable interest rates. Sometimes
trainers can be invited to the business to reduce transport costs to the employees. Training can increase the
status of employees and gives them a better chance of promotion to better paid jobs. It can also lead to
employee loyalty. Training leads to long-term job satisfaction. There are two types of training i.e on-the-job
and off-the-job training.

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Worker participation: workers are actively encouraged to be part of the decision making process. Employee
participation recognises that employees are likely to have some worthwhile ideas to contribute to the
business and that, in some instances, they might have a better solution to a problem than their managers.
Managers can allow the employees to elect their own worker representative. The worker representative will
represent employees at council meetings. The business can be using an open-door policy. Worker
participation will lead to quality decisions. It can lead to greater commitment since management considers
employee feelings and opinions

How to achieve employee participation:

• Appointing employees to the board of directors

• Staff meetings where employees are free to ask and to receive information
• Electing a representative
• Training
Benefits of worker participation:
•
Improves motivation and commitment
•
The business can utilise the knowledge and experience of workers
•
Improvement in terms of information flow leading to quality decisions
•
Leads to job satisfaction

Limitations of worker participation:

•
Time consuming
•
Conflict of interest may arise
•
Workers lack management skills

Team Working: Employees are organised into groups and each group is given a certain task to perform. A
team is a group of people who work together to achieve a common goal. E.g management team,financial
team, production team, quality circles etc. Business will not be able to achieve its objective if employees fail to
work together in teams. Team working involves cell production. Cell production occurs when employees are
given the responsibility to produce a certain product or to complete a certain process. Cell production is
deemed to be motivating because the group gets the satisfaction of completing a product or a substantial part
of one.

Benefits of Team working

•
The team as a whole, delivers greater results than the sum of each team member’s individual effort.
•
Teams generate more creative solutions than individuals because they build on one another’s ideas
•
Employees have an opportunity to be involved in decision making
•
Teams are usually capable of completing tasks quicker than individuals.
•
Team members help to keep each other motivated

Problems of team working

•
Team conflicts may arise. Conflicts leads people’s focus away from the job.
•
Team members can learn bad cultures from difficult employees.
•
Some employees work more effectively when they are not in teams. Thus they are not team players.
•
Can be time consuming when workers need to consult one another.

Empowerment: delegating more power to employees to make their own decisions over areas of their working
life. Workers are allowed some degree of control over how the task should be undertaken.

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Delegation: refers to the passing of authority down the organisational hierarchy. Subordinates are given the
responsibility and authority to do a given task. It is done to enable top managers to concentrate on major
issues especially as the organisation grows in size. The subordinates will feel valued and more trusted.

Benefits of delegation
•
Work becomes more interesting and rewarding
•
Employees feel important and trusted
•
Helps train workers, giving them better career opportunities

Problems of delegation
•
Inexperienced employees may fail and this may tarnish the manager’s good name
•
Managers may lose management control
•
When subordinates perform better than managers, the managers may feel insecure.
Promotion Opportunities: achievement can also be rewarded by giving a promotion to those who meet, and
perhaps exceed, expectations in their performance. Sometimes only a small promotion is needed to give an
employee the feeling that their efforts have been recognised and appreciated. The belief that promotion is a
possibility for those who perform well can be a strong motivator for some employees

Quality circles A quality circle (QC)

It is a group of five to ten employees who have experience in a particular work area. They meet regularly to
identify, analyse and solve the problems arising in their area of operation. Quality circles are used to identify
problem areas in business processes and members work on these to improve product quality and productivity.
Quality circles are not just concerned with quality, although improving quality of the product or service can be
a major benefit

Benefits:

• Workers have hands-on experience of work problems and they often suggest the best solutions.
• The results of the quality circle meetings are presented to management. The most successful ideas are
often adopted, not just in that location, but across the whole organisation.
• Quality circles are an effective method of allowing the participation of all employees. They fit in well
with Herzberg’s ideas of workers accepting responsibility and being offered challenging tasks.

Limitations:

• Quality circle meetings can be time-consuming and reduce the time available for production.
• Not all employees will want to be involved in quality circles, preferring to get on with their own job.
• Quality circles may not have the management power to make the changes that they recommend. If
management ignores the proposals from quality circles too often, employees will become discouraged

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2.3 MANGEMENT AND LEADERSHIP

Management is the process of getting things done through people. Management is undertaken by managers
who co-ordinate the activities of other employees to achieve the results not obtainable by one person. There
is no management without people. The management plans, controls, leads and organise resources in the
business. They rely on their position to obtain co-operation from employees. Management focuses on tasks
and ensures that performance targets are made. Managers are appointed and goods managers usually the
skills, experience and the knowledge to run the business

THE 4 MANAGEMENT FUNCTIONS

a)PLANNING: refers to a systematic development of action programs aimed at reaching agreed business
objectives. Thus planning involves setting goals. Good mangers think ahead and they ensure that necessary
resources are made available before it’s too late. Plans can be short term, medium term and long term. It is
believed that ‘failing to plan, is planning to fail’

b)ORGANISING: includes the assigning of the tasks identified or developed during planning to various
individuals within the organisation in order to achieve set targets. It also includes giving instructions to
individuals. i.e delegation of tasks. Each department or unit is given a clearly defined list of duties and the
name of a person to whom the report to.

c)LEADING: is the process of influencing other people to attain organisational goals. It involves directing and
motivating people. When employees are motivated, their productivity will improve. Leading also encompasses
the establishment of effective communication channels

d)CONTROLLING: the manger must ensure that the tasks are carried out as planned. It involves comparing
actual results with the planned results. Corrective measure are taken if there is big anomaly between actual
results and the aimed result.

Management Skills

Conceptual Skills: are the skills for the top management which enables them to deal with complex ideas and
abstract relationships. It is the mental capacity and ability to view the organisation as a whole and to see how
the parts of the organisation relate to and depend on one another.

Human Skills or Interpersonal Skills: refers to the ability of managers to work with people or to interact with
other people successfully. Such skills builds co-operation within teams being led and they are for middle
management.

Technical Skills: refers to specialised knowledge or expertise and ability in using processes, practices,
technique or tools of a speciality responsibility area e.g accountants, engineers, computer programmers etc.

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Mintzberg’s roles of management

Henry Mintzberg identified ten management roles which are then grouped into three main categories namely
interpersonal roles, information roles and decision roles

Interpersonal Roles Information roles Decision Roles

Figurehead Monitor Entrepreneur

Leader Disseminator Disturbance handler

Liaison Spokesperson Resource allocator

Negotiator

Interpersonal Roles : involves dealing with and motivating staff at all levels of an organisation

i. Figurehead: these are duties that are symbolic or ceremonial in nature e.g guest of honour at a
function like a Prize Giving Day

ii. Leader: involves directing and co-ordinating the activities of all employees in the business. Thus the
manager will provide direction for the team or business by making clear what is required of everyone in the
business. It also involves staffing and monitoring staff.

iii. Liaison: It involves the mangers’ interpersonal relationships outside of their area of command. Thus
the manager should be able to make contacts both inside and outside the organisation. The main aim is to
establish good relationships e.g participating in meetings with other businesses.

Information Roles

(a) Monitor: involves examining the environment to gather information, changes, opportunities and
problems that may affect the business. It also involves the processing of information related to those internal
or external changes which might the business.

(b) Disseminator: involves providing important or privileged information to the subordinates. Information
needs to be passed to the appropriate people as and when required. This must be at a suitable time and must
use an appropriate medium

(c) Spokesperson: the mangers represents the business to other people outside the business. As a
spokesperson, the manager will have to pass information to interested parties e.g informing the Local
authorities about planned changes and also communicating with trade unions for any proposed changes to
the conditions of work.

Decision Roles

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- Entrepreneur: it involves the process of continually looking for new ideas or new methods to improve
the organisation’s performance. For example, an effective marketing manager continually seeks to develop
new products.

- Disturbance handler: it involves the manager making decisions to take corrective in response to
situations out of control. The main aim will be to bring about peace and harmony. E.g the responding to
emergences like strikes, disasters etc.

- Resource allocator: effectively allocating resources whether they are funds, equipment or people in
the business organisation. The manger must bear in mind that the resources are always scarce. The manager
will make decisions on who will get what resources.
Negotiator: involves negotiating agreements between employees or between departments.
Negotiating agreements with other businesses e.g suppliers or customers. Negotiating with

trade unions to obtain advantages for his business etc.

Leadership

Refers to the process of influencing other people to work harder for the business to achieve its objectives. The
leader must inspire other employees to put more effort in whatever task they have to perform. Thus a leader
is someone who can inspire and drive a group of people towards a target or goal.

Differences between leaders and mangers

Managers Leaders

Someone who controls and directs within Someone who can inspire or drive a

a business group of people towards a business goal

Rely on their position to obtain co- They motivate or encourage a team to

operation of
employees achieve goals using their personality

(qualities)

Focused on tasks Focused on people

Ensurin
Responsible for g that Responsible for setting new targets

performance targets are met Concentrate on long term goals

Concentrate on short term goals Leaders are elected

Managers are appointed

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Leadership Qualities

• Self-confidence: leaders have self-trust and they believe that they have the ability to make sound
decisions and to identify achievable long term objectives of the business
• Creative: are able to come up with new or original ideas. Leaders need to be able to come up with ideas
that others might not think of.
• Dependable: able to be trusted to do or to provide what is needed.
• Energetic: they work extra hard to achieve the goals of the business
• Multitalented: possess several skills so that they can understand a wide range of issues affecting their
business.
• Charisma: a leader must have a personality that makes other people believe in him and be prepared to
follow you and your ideas.
• Persistent: continuing to do something even though it is difficult

Leadership roles in business

• Directors : are elected into office by shareholders of a private or public limited company. They
are senior managers elected to represent shareholders. They set corporate or departmental objectives.
They also ensure that departmental goals are met.
• Managers: refers to any individual responsible for people, resources or decision making. They
have some control over the staff below them in the hierarchy. They ensures that the rules are being
followed by employees
• Supervisors: refers to an employee overseeing the work of others. They are appointed by
management to watch over the work of others. They are just team leaders and are not involved in
decision making. Their mandate is to help staff achieve corporate objectives
• Workers’ Representatives: are employees who represent other employees on negotiations with
the management. They are elected by workers to present the views of the workforce to senior
management. These employee representatives must have excellent communication skills

leadership styles:

It is accepted that different leadership styles are appropriate for different circumstances and that a manger or
leader might actually choose to use more than one leadership style depending on the situation at that time. For
example, a democratic leader might adopt characteristics of an autocratic leader if a situation required
immediate action such as an emergency. There are three main leadership style and these include autocratic,
democratic and laissez-faire

i) Autocratic /Boss Centred: the leader is an authoritarian and assumes responsibility for all aspects of the
business. Communication is one way with little or no feedback i.e top-down communication. It is a form of

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leadership used in hierarchical business in which all decisions are taken by those at the top of the organisation.
Such leaders do not trust their employees to make decisions about their own work. The leader makes the
decisions by telling employees what he/she wants done and how he/she wants it done.
Benefits Problems

• Quick solutions to emergence cases

• Enables new policies to be implemented • Not concerned about the opinions of
• Close supervision for employees who are employees
lazy or irresponsible. • Brilliant ideas can be lost from experienced
• Appropriate on new employees who are employees
unsure about company policies • Low staff morale since workers are not
trusted and also not consulted (morale
refers to the feeling of enthusiasm and
loyalty that a person of group has about a
job)
• High labour turnover

Democratic Style of leadership

Refers to a leadership style that involves all employees in the decision making process. It is also known as
participative leadership style. The majority view is often accepted although the senior managers will make the
final decision. The leaders believes in consulting employees and allowing them to share in decision making. There
is two-way communication and the employees are usually given more information about the business and the
direction it is taking

Advantages Disadvantages
• Improvement in the quality of decisions.
Employees might have very useful ideas to • There is not always time to allow for
contribute that would be lost without two- consultation with employees. Sometimes a
way communication quick decision is essential. Thus meeting can
• Increases employee morale. Employees are be time consuming
likely to be more motivated due to being • The leaders will lose management control on
allowed to participate in decision-making employees
• Causes greater commitment since the leader • Some issues are too sensitive to be discussed
considers employee feelings and opinions with the whole workforce e.g proposed
• Promotes personal development as redundancies
employees can now come up with new ideas
which the leader might consider

Application

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• It is suitable when the co-operation is required between a leader and a team

• Suitable when decisions need to be looked at from several perspective e.g organisational conflicts
Free reign/ Laissez Faire Style of Leadership

Employees are given a lot of control over their own work while management will have a reduced input into
decisions that have a direct effect on the way in which work is done. It is usually used with for highly skilled and
self-motivated employees. It is also referred to as a non-authoritarian leadership style. The leader only set goals

Advantages Disadvantages
• This gives employees freedom and • It can be used by lazy managers to
flexibility about how they organise their work avoid making decisions about work matters
• It shows that the employees are • Provides employees with little
trusted, and can therefore be motivating direction and its difficult for employees to
• Encourages creativity since the complete tasks on time
subordinates are encouraged to find their • It can lead to too much control being
own solutions to problems in the hands of the employees
• It can help employees to develop self- • Managers might lose touch with the
discipline way in which work is being done
• Its success depends on the
competence and integrity of employees

Application

• Suitable when employees are highly skilled and experienced. When employees know more about a task
than the leader
• Suitable when the leader wants to empower employees
Choice of Leadership Style

It is believed that managers have certain attitude or perceptions towards their workers. Thus they type of
leadership style a manager is going to use depends on whether the manager considers his/her workers to like or
dislike work. There are two theories that have been identified which usually influence the manager’s approach to
their workforce. These theories include Douglas McGregor and Daniel Goleman

McGregor’s Theory X and Y

McGregor’s Theory X and Y (1960) suggested that many managers adopt a particular style due to their beliefs
concerning human nature. A manager’s perception of their employees is also likely to influence them in terms of
which style of leadership they feel is the most appropriate to adopt. Thus Theory X and Y is about managers’
perceptions of their employees and not about the employees themselves.

McGregor identified two management approaches that can be used to explain the managers’ choice of
leadership style namely Theory X and Theory Y.

Theory X: managers assume that employees dislike work and will avoid it if they can. They need to be told what
to do and to be closely supervised. People must be coerced, controlled, directed and threatened in order to get

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them to work. They do not want responsibility and will avoid and perhaps even resist this. Managers have a
negative view of their workforce

Management approach to Theory X type of workers

• Close supervision
• No delegation
• Implement control measures (Setting targets)
• Autocratic leadership style

Theory Y: managers assumes that the employees enjoy work and can derive job satisfaction from their
work. Work is as natural as play. Employees are creative and they can exercise self-direction. They enjoy
responsibility and might even seek it if they are recognised and rewarded appropriately. Managers have a
positive view of their workforce and they believe that employees can make a positive contribution to
business activity.

Management approaches to Theory Y type of workers

• Delegation of authority can be done

• They require little supervision
• Allow employees to make their own decisions
• Democratic leadership style

Daniel Goleman’s Emotional Intelligence/ Quotient (EI/EQ)

Goleman views the management of employees by using an analysis of emotional intelligence ie Emotional
Quotient (EQ). His theory is based on the need for managers to be aware of and understand their own
emotions and feelings as well as those of their employees. Emotional intelligence refers to the ability to
monitor one’s own and other people’s emotions, to discriminate between different emotions and label
them appropriately and to use emotional information to guide thinking and behaviour. Thus it involves
knowing and understanding your own feelings and those of others. An intelligent person can only become
a good leader when he/she has a high emotional intelligence. Thus the businesses must employ people
with high levels of emotional intelligence to improve the business’s performance.

Differences between Emotional Intelligence (EQ) and Intelligence Quotient (IQ)

Emotional Intelligence Intelligence Quotient

More important for personal success than IQ Not necessarily important for personal success

Can be improved Cannot be improved

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3.1 MARKETING

Refers to a process or system of researching into identifying customer needs and applying suitable prices,
product, place and promotion strategies in order to satisfy those needs profitably. It is a business function which
aims to link the business to the consumer and aims to get the right product having the right price to the right
place at the right time. Marketing is not only advertising and selling of goods and services. Market research is
done to find out what customers want or might want and what price they are prepared to pay for a product.
Marketing will then involve making sure that the design and production teams produce what consumers want at
a cost that will enable a price to be set so that the business can make profit.

Marketing Objectives

Refers to the goals or targets a business has that are concerned with marketing methods or issues. They specify
the results expected from marketing efforts and should be consistent with overall organisational/ corporate
objectives. Basically, they are goals set for the marketing department. Effective marketing needs to have a clear
sense of direction.

Criteria for good marketing objectives

• Must express realistic expectations

• Must be expressed in clear, simple terms so that all marketing personnel understand exactly what they
want to achieve
• Must be measurable
• Must be time framed

Examples of marketing objectives

•
Increasing sales revenue or sales turnover by 5% by December 2020
•
To increase market share by 10% by end of 2019
•
To increase promotional budget by 7% by end of 2019
Relationship between corporate objective and marketing objectives

In Nestlé’s case, marketing objectives support the corporate objectives and all of them work together

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Importance of marketing objectives

•
They provide sense of direction for the marketing department
•
Progress can be monitored against these targets
•
Assist in decision making
•
Can be used in making marketing strategies ( long term plans established for achieving marketing
objectives
Demand and Supply

The primary goal for the marketing department is to meet customer wants profitably. Marketing staff must
be aware of how the free market works to determine the price. In a free market economy, price is
determined by the forces of demand and supply. Market is a place or system that enables producers of a
product or service to meet potential buyers and exchange these for money.

Demand

Refers to the units of a product that consumers are willing and able to buy at a given price in a given time
period. According to the law of demand, more units of a good are bought hen the product’s own price
decreases, ceteris paribus. Ceteris paribus means that ‘other things remaining constant’ Consumers’ demand
determines what producers should produce.

Demand curve: Refers to a graph which shows the relationship between quantity demanded and prices.

Demand curve is a graphical representation of demand schedule. It is the locus of all the points showing
various quantities of a commodity that a consumer is willing to buy at various levels of price, during a given
period of time, assuming no change in other factors

When price decreases from P0 to P1, consumers increase their purchase of the product from Q0 to Q1. This is
due to income effect and substitution effect of a price change

Income Effect: low prices increases real income and consumers can now buy more

Substitution Effect: low price makes the consumers to switch over from substitutes to this product which is
now cheaper

Shift in the demand curve

Usually demand curves are drawn based on the assumption that all other factors except price remain the
same. But there might be instances when demand may be affected by factors other than price. This will
result in the change in demand although the price will remain the same. This change in demand may cause
the demand curve to SHIFT inwards or outwards.

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• Shift of demand curve OUTWARDS shows an increase in demand at the same price level. It is known
as
INCREASE IN DEMAND.
• Shift of demand curve INWARDS shows that less is demanded at the same price level. It is known as a
FALL IN DEMAND.

Factors Influencing Demand

• Price of the product: price of the product is a key factor determining the demand. If the
price falls then demand will rise as the product becomes more affordable to customers
so they buy more of it. When products increase in price people will buy less of them and
demand falls
• Price of other Products: some products are substitutes and others are complements.
Substitutes include butter and margarine. When the price of butter increases, people will
buy more margarine and less butter. There is a positive relationship between the price of
one product and the demand for a substitute good. When they are complements like
tennis balls and tennis rackets, a rise in the price of tennis balls will lead to a decrease in
demand for tennis rackets
• Advertising and promotion: a successful advertising campaign will create new customers
and remind existing customers to buy the product. The demand for the product will
increase due to promotional activities like by-one-get-one-free.
• Income level: as people gain higher incomes they will demand more of most products.
People will buy more of normal goods when income increases e.g meat. Demand for
inferior goods decreases as income increases e.g second-hand clothes.

• Change in the size and composition of population: a rise in the population size will lead
to an increase the demand for goods and services.

• Weather conditions: in a hot day people will buy more ice creams and less of them on a
cold day

• Change in fashion and taste: Commodities for which the fashion is out are less in
demand as compared to commodities which are in fashion. In the same way, change in
taste of people affects the demand of a commodity.

What is Supply?

Supply refers to the amount of goods and services firms or producers are willing and able to sell in the
market at a possible price. The law of supply states that when the price of a commodity rises, the supply for it

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also increases. The higher the price for the good or service the more it will be supplied in the market. The
reason behind it is that more and more suppliers will be interested in supplying those good or service whose
prices are rising.

Supply Curve

Represents the relationship between the quantity supplied and the price if the product in form of a graph. A
supply schedule represents this relationship in form of a table. Supply curve plots the quantity of a product
supplied against its price.

Shifts in Supply Curve

When factors other than price affect the supply it results in the shift of supply curve. The supply curve may
move inward or outward.

A shift of supply curve outwards to the right will mean an increase in supply at the same price level. When
the supply curve moves inwards to the left it means that less is being supplied at the same price level.

Factors affecting Supply

Price of the commodity: A rise in price will result in more of the commodity being supplied to the
market and vice versa. A change in the price of the product will lead to a movement along the same
supply curve.

Other factors leading to shifts

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Prices of other commodities: For example if it is more profitable to produce LCD TVs then producers will
produce more LCD TVs as compared to PLASMA TVs. Thus the supply curve for PLASMA TVs will shift
inwards (leftward shift) i.e. a fall in supply.

Change in cost of production: Increase in the cost of any factor of production may result in the decrease in
supply as reduced profits might see producers less willing to produce that commodity. (Leftward

shift)

Technological advancement: Improvement in technology results in lowering of cost of production and

more profits for the producer and thus more supply of that commodity.(rightward shift)

Market Price-Equilibrium Price

Equilibrium refers to a situation of balance where, at least under the present circumstances, there is no
tendency for change to occur. Demand will be equal to the supply. Thus the plans of consumers ( as
represented by the demand curve) match the plans of suppliers (as represented by market supply curve).
Consumers are willing and able to buy more when price decreases and the producers are willing and able to
supply more for sale when price increases. Thus the consumers’ wishes and Sellers’s wishes are combined
and that interaction of demand and supply will force them to settle on a compromise price at a point where
demand is equal to the supply. Equilibrium price can be defined as the price at which the quantity demanded
is equal to the quantity supplied. Equilibrium price can be defined as the price which the demand is equal to
the supply. Prices are determined by supply and demand forces. Equilibrium quantity is defined as the level
of output where demand is equal to supply

In the graph below the point at which the demand curve meets the supply curve is the equilibrium.

TYPES OF MARKETS

a)Consumer Market: a market whose customers are final users of the product such as members of the
public. They are ultimate/ final consumers who consume either by themselves or for family use. They do not
buy a product to make another product for resale.

b)Industrial Market: a market for which customers are other businesses and they buy products as inputs to
their own processes. It is also known as a business market. It consists of individuals or groups who purchase a
specific kind of product for any of the following purposes:

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•
Resale
•
Direct use in producing other products
• General use in daily operation e.g lighting in schools, stationery for organisations’ offices etc

Product and Customer Orientation

Product Orientation: The business will supply products it thinks will be attractive to customes. The business
will be making unique products without keeping customer needs in mind. It is also referred to as inward-
looking approach where businesses just invent and develop products in the hope that they will find
customers who will buy their products. Much emphasis is placed on the production of quality goods. They
think that customers are always looking for high quality goods. It is ideal when there is no or little
competition. A good example is the iPhone, which was designed by Apple and then sold worldwide on the
strength of its design and technical features.

Benefits of Product Orientation

• The approach saves market research costs

• The business is also using its strength

Limitations of Product

• More risk than customer orientation

• Resources will be wasted when customers are not buying the product

Customer Orientation: An approach used by businesses that researches what consumers want and designs
and supplies these to the market. It is also referred to as market orientation or outward-looking approach.
The business pays more attention to customers and their satisfaction needs. The business will produce goods
that are wanted by customers. This approach requires the business to carryout market research and market
analysis to indicate present and future customer needs. It is ideal where there is stiff competition in the
market.

Advantages of customer orientation

• The firm will be more confident of a successful launch of a new product as effective market research
has been undertaken to determine customer requirements
• Appropriate products that meet customer needs are likely to survive longer and give higher profits
that those built with a product-led approach.
• Firms can respond quickly to changes in the market information as constant feedback from
customers is given

• Due to continuous market research, firms will be better able to anticipate changes and will be in a
strong
position to meet the challenge of new competitors entering the market.

Recent Trends in Marketing

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a)Asset-Led Marketing:- an approach to marketing that bases strategy on the firm’s existing strengths and
assets instead of concentrating on what the customers want. If a company try to satisfy the needs of all
customers in the market, the costs may increase leading to losses.

b)Societal / Green Marketing:- The concept was put forward by Kotler in 1972. This approach considers not
only the demands of customers but also the effects on all members of the public (society) involved in some
way when firms meet these demands. It’s a marketing approach that focuses on the business and all its
stakeholders. The business must therefore satisfy customers profitably and at the same time minimise
damage and costs to the society.

Features of the Market

a).Location: Firms should know who their customers are and where they are located. A firm may operate
locally, Nationally, regionally or internationally. Customers in all these geographical areas may have different
needs and wants depending on cultural, economic or historical factors.

i).Local Markets: The firm will sell its products to customers in the area where the business is located e.g
hairdressers, motor-repair garages, restaurants. Local media is used to advertise the products.

ii).National Markets: Firms will sell its products to consumers in the area where the business is located and
also outside its geographical location. National markets are larger and will require more research. The
business must be able to get what they offer known to potential buyers across a country so mass media is
often used for advertising. A firm may service national markets to increase sales. Examples include Banking
sector firms, large retail shops.

iii).Regional Markets: regional markets are larger again. A firm that sell its products to customers located in
different countries but in the same geographical region. They may cover a wider economic grouping like the
European Union, Southern African Development Commission (SADC). Each region will have its own
identifiable characteristic and customer needs.

iv).International Markets: A firm that sell its products to customers located in different countries in different
continents. It is done to increase sales and also profitability. Companies that operate in different countries
are known as Multinational Companies (MNCs). International markets are increasingly important as
globilisation continues. Globalisation refers to the growing integration and interdependence of economies
and cultures involving increased trade, movement of capital and people.

a) Market Size: is the measurement of all the sales of businesses that are supplying to the market.

Size of market can be estimated or calculated by the local market sales of all businesses in the market. There
are two methods that can be used to determine market size

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•
Value of goods sold:- the toal amount spend by customers buying products for all sellers in the
market (total revenue/ total sales)
•
Volume of sales: refers to the total physical quantity of products which were sold by all frims in
themarket i.e total number of units sold by all firms Importance of Market size:-

•
Firms can be able to calculate its own market share
•
The firm can easily see if the market is growing or declining
•
Marketing manager can assess whether a market is worth entering or not

c).Market Growth: It refers to the rate at which total sales in the market are rising each year or falling (if
growth is negative) It is also defined as th percentage increase in the size of the whole market. Marketing
managers will be more willing to venture into markets which are growing rapidly.

Factors affecting market growth

•
Economic growth: The rate at which GDP of a country is growing will also affect the rate of market
growth.
•
Incomes of consumers: increases in income increases the consumers’ willingness abd ability to pay
for the product.
•
Changes in consumer tastes and preferences: Consumer tastes can change in favour or against the
product.
•
Technological Advancement: inventions and innovations like on-line buying and selling can lead to
growth in the market
Benefits of calculating Market Growth

• It enables the business to plan ahead by looking at the market growth trend
• Growing market indicates opportunities

d).Market Share: it is the proportion or percentage of sales of one firm as compared to the whole market
size. It is the percentage of the total market held by a business or product.Two variables are used and these
include firm’s sales and total market sales. Market share can be by value or by volume. It is calculated using
the following formulas.

Market Share by value = Firm’s sales x 100

Total sales of all firms

Market Share by Volume = Units sold by the firm x 100

Total units sold by all firms

Market share measures the relative success of one business’s marketing strategy against that of its
competitors. A product with the highest market share is known as a brand leader and a business with the
highest markets share is known as a market leader.

Benefits of high market share

•
Higher market share usually translate into high profits
•
Small scale shops will be willing to buy from the business since it will be offering best-selling
brands

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•
Customers are more willing to buy from a market leader ( a business with a higher market share)

Limitations of market share

•
Different results can be obtained if two methods are used which makes it difficult to interpret the
results
•
Markets can change rapidly especially in services or technology-based industries, making it difficult to
track changes over time
•
Data on sales or profits can be hard to obtain

e).Competitors: are businesses that sell similar or identical goods or services in the market. There are two
main types of competition and these include price competition and non-price competition. Price competition
involves charging price different from the competitor’s price. Non-price competition include offering quality
goods, after-sale services, hire purchase facilities etc. Competition can be direct or indirect.

• Direct competition: refers to competition from the business that provide the same or very similar
goods and services. Goods may be slightly differentiated. Goods can be differentiated by size,
colour, packaging etc
• Indirect Competition: competition is from businesses that are in a different market of sector i.e a
bus operator can experience indirect competition from rail transport operators.
Niche and Mass Marketing

a).Niche Marketing: involves identifying and exploiting one segment of a larger market. This segment can be
one that has not been identified and filled by competitors. It is a very small section of the market and that
section has got specific requirements e.g the market for professional divers’ watches or high status products.
It is suitable for small firms and the goods are produced in small quantities. This segment is also known as the
target market. Target market refers to a specific group of customers to which a business has decided to sell
its products or services. A target market can be defined according to age, gender, income, taste, location etc.
Allows businesses to develop products/services to meet the needs of this specific group.

Benefits of Niche Marketing Limitations of Niche Marketing

• Niche markets are small and can
• Enables small firms to avoid competition therefore only support a small business
from larger firms • It is not suitable for a business selling
• By targeting niche markets, firms can many products
focus on the needs of customers in these • It is more risk than mass marketing
markets
• Direct marketing is possible
• There is little competition on those
markets

b).Mass Marketing: involves selling the same products to the whole market with no attempt to target
separate groups. Mass marketing produces a product that appeals to the whole market, so that everyone
becomes a customer, no matter what their age, job, income, wealth or gender. Mass markets consists of a
large number of customers for a standardised product such as markets for food and grocery. Goods are
produced in large quantities.

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Benefits of Mass Marketing Limitations of Mass marketing

• Enables a firm to operate in a large scale • The business can lose customers who will
and enjoy economies of scale (economies be looking for specialised products
of scale refers to a decrease in the • Direct marketing is not possible. Thus
average costs experienced when a firm mass marketing is likely to require very
operate on a large scale.) high advertising, promotion and
• It is less risk than niche marketing since distribution costs and failure to succeed
the business will be selling to a lot of will be very expensive.
consumers • There is a lot of competition as the needs
• A strong brand image and customer and wants of the large market can be
loyalty is reinforced and these act as seen by many businesses.
barriers to entry making if difficult for
competitors.

Market Segmentation

Refers to the process of dividing the whole market into different sub-groups according to their respective
similar or homogeneous characteristics. It is the process of identifying particular groups that have similar
needs and wants in the market. Market segmentation is also known as differentiated marketing. A sub-group
of the whole market is referred to as a market segment. A market segment consists of consumers who have
similar characteristics. Segmenting a market means that marketing activities are focused on people who are
more likely to buy, meaning they are more cost effective and less likely to be a waste of time.

Identification of Consumer Groups

The business should be able to determine the different consumer groups in the market. To have a clear
picture of the type of consumers in a given market, the business must come up with a consumer profile.
Consumer profile refers to a quantified picture of consumers for a firm’s products. Thus the consumers can
be grouped according to age, income levels, gender, social class, religion and region.

Methods of Market Segmentation

a)Geographical Differences: refers to area wise market segmentation. Consumers in different locations
demand different types of goods and services. Thus it will be ideal to offer different goods in these areas.
Markets can be divided into districts, towns, provinces, rural etc. For example Woollen and thick garments
are not demanded in hot cities while the demand is very high in Polar regions.

b)Demographic Differences: segmentation can be based on the vital characteristic of population.

E.g gender, age, income distribution, religion, education etc.

Social class is usually determined by the levels of income earned by an individual. Basically there are three
categories of social classes and these are:

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•
Upper Class: skilled and experienced professional e.g C.E.Os Directors, Managers, Lawyers,
Doctors etc. They buy expensive goods for prestigious reasons
•
Middle Class: Lower managerial workers e.g Teachers, Nurses etc. They want quality goods at
affordable prices
•
Lower Class: unemployed, pensioners, part-time workers etc. The want inferior goods at low
prices

Age: Some products are purchased by particular age groups eg. Walking frames, coke zero

c).Psychographic Factors: refers to market segmentation according to mental status of the people. It includes
culture, personality attributes, motives, life style of the consumer. Life style refer to the way in which one
lives. Attitude refers to a settled way of thinking or feeling or a position of the body indicating a particular
mental state. Personality refers to the combination of characteristic or qualities that form an individual’s
distinctive character. Brands are generally segmented according to the psychograph. Segmentation is
decided according to the advertisements and content shown. A celebrity can be used for a BMW X5 car to
make the advert more appealing to the middle and upper classes.

d).Behavioural Segmentation: market segmentation according to the utilisation of the product. Thus
consumers are grouped according to the volume of usage, purchase occasions, brand loyalty, price sensitivity
etc

Benefits of Market Segmentation Disadvantages of Market Segmentation

• Increased sales since products are produced
for a specific group of consumers • Firms may appeal to segments that are too
• Enables the business to identify consumer small to be profitable
needs and wants which are not currently • Firms may not be able to use certain media
satisfied die to small size of the segment
• Enables small firms to avoid competition • Costly and extensive market research is
from big firms by targeting a specific group needed
of customers • Firms may misinterpret consumer similarities
• Enables the business to implement price and differences
discrimination to increase revenue and
• Promotional costs might be high as different
profits
advertisements and promotions might be
• Money and time is not wasted in trying to
needed for different segments
sell products to the whole market

Customer relationship marketing

The objective of customer relationship marketing (CRM) is to develop customer loyalty to ensure that
customers buy from the business in the future. CRM also makes sense for another reason. If a business can
secure the loyalty of many customers, it means that there will be fewer customers buying products from

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competitors. At the heart of CRM is communication with the customer to gain information. The aim is to gain
as much information as possible about each existing customer. This includes income, product preferences,
buying habits and so on. Using this information, marketing tactics can then be adapted to meet the
customer’s needs.

Developing effective long-term relationships can be achieved by:

• Targeted marketing – giving each customer the products and services they have indicated, from records of
past purchases, that they most need.

• Customer service and support – after-sales service and effective call centres are good examples of the
support essential to building customer loyalty.

• Communicate regularly with customers – to give frequent updates on new products / special offers / new
features / new promotions and support services.

• Using social media – some CRM systems use social media sites to track and communicate with customers.

Costs of CRM Benefits of CRM

• IT systems and software are needed and employees • For businesses with an existing customer base,
need to be trained to respond to customer feedback. CRM has proved to be cost-effective. Higher sales
• Effective CRM campaigns may require the use of from effective CRM nearly always exceed its cost.
an external marketing consultancy at high cost. • It is a sustainable strategy creating long-term
• CRM needs an existing customer base to be customers unlike ‘special price offers’ or similar
established first before investing in CRM. If this is not promotions.
done, the costs will not lead to higher sales. • Loyal customers often recommend the business to
• It may be costly to respond to each customer’s friends and family, providing additional marketing
feedback, especially if it contains special requests or benefit at no cost.
requirements. • It costs less per customer than trying to attract new
customers.

2.2 Market Research

Refers to the collection, collation and analysis of data relating to the marketing and consumption of goods. It
is the process of gathering information about markets, customers, competitors and the effectiveness of
marketing methods. It is every day information about developments in the marketing environment that
mangers use to prepare and adjust marketing plans. The information is used to identify and define marketing
opportunities and problems, generate and evaluate marketing actions, monitor marketing performances and
improve understanding of marketing as a process.

Qualitative and Quantitate Information

Quantitative Information: information will be in the form of numerical data. Data can be obtained by
carrying observations and some experiments e.g test marketing or field experiments. The results can be
distorted if the person is aware that he/she is being observed.

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Qualitative Information: information is non-numerical e.g attitudes, opinions, ideas etc The researcher may
want to find the reasons why consumers will or will not buy a particular product. The data can obtained
through personal interviews and in-depth discussions amoung groups e.g focused groups and consumer
panels

Reasons for conducting Market Research

a).To eliminate the risk associated with new products: the company needs to obtain information about
potential demand before launching a new product.

b).To predict future changes in demand: information should be gathered which will enable the firm to
predict all the likely changes in future demand.

c).To help in decision making: market research provides vital information which is needed for decision
making purposes

d).To gain a competitive edge: to assess the most popular designs, styles, brands, promotions and packages

e).To explain patterns in sales of existing products and market trends: market research is required for both
new and existing products. If the sales figures for an existing product are declining then marketing managers
must implement new measures to reverse the negative trend.

Types of Market Research

Primary Research: it is also known as field research. It is the gathering of information for the first time
directly from sources in the market. Information which is collected by the researcher and the information
gathered is new. An example of primary research is asking people what is their favourite chocolate.

Characteristics of Primary Research

• The data collected has never been published in any form

• The data will be directly related to a firm’s specific needs. Thus a consumer survey will be
designed to discover specific aspects of consumer needs relevant to the firm.
• Primary research is typically expensive to collect. This is because it requires significant labour
input and expertise of the results are to be trusted.
Primary Research Methods

a).Observation: market researcher can observe how people behave. Observations can take the form of audit
(stock checks) or using recording devices like security cameras and Televisions. It can give you the answer of
what is happening but not why as you just observe and see through cameras. It involves seeing how much
time they spend at a shelf and the type of products they were looking at. Thus the results can be distorted if
the customer knows that he/she is being observed.

b)Experimental Methods/ Test marketing: basically there are two types which

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includes:-

i).Laboratory Method:- occurs when people are invited to a particular artificial setting and ask them to taste
a product or try it at their own place.

ii).Field Experimentation:- the marketing manager will select a particular geographic area and launch a
product in that location to see the reaction of the people. This is cheaper as the loss is less if the product is
not successful.

c).Survey Method: It includes the telephone surveys, mall-intercepts, internet surveys, simple questionnaire
surveys and door-to-door surveys. Mall-intercepts occurs when people are stopped in malls and are then
asked about a product. Questionnaire surveys are most common when people are given out forms with
questions that could be either open-ended or closed-ended. Quantitative research include the use of closed
questions e.g a yes or no question and or a multiple choice question. Qualitative research include the use of
open-ended questions where the responded is allowed to give his or her point of view (space is provided for
respondent to give his/her point of view)

d).Sampling Method

What is a sample: is that part of the whole population whose characteristics are studied to give insights into
the characteristics of the population as a whole. Statistical theory can be used to calculate the minimum size
of the sample necessary to give the required degree of accuracy. Sample size refers to the number of people
selected from the population in which marketing research is conducted. Generally speaking, the larger the
sample size the more accurate can be the results. The sample must be more representative of the
population, it should be balanced in terms of age, sex, type of occupation, social class etc. A carefully chosen
sample should produce similar results to those that would be achieved by asking everyone in the population.

However one needs to take into consideration time and cost factors. Bias will also exist especially if the
samples are poorly selected or too small, or if questionnaires have complex interview questions.

Two types of Sampling Methods

Probability Samples: a sample is selected randomly and the probability of each member’s inclusion
in the sample can be calculated and reliable conclusions about the whole population can also be
made. Probability sampling methods are more complex, costly and also time consuming.

Non-Probability Samples: it excludes estimating the probability of any particular item being included.
Reliable conclusions from these samples for the whole population are not possible. However it saves
time and money. It is also very easy.
Probability Sampling Methods

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i)Random Sampling: every member of the population has an equal chance of being selected. Names and
addresses for respondents may be chosen at random from the electoral register and then visited for an
interview.

ii)Systematic Random Sampling: every nth member in the target population is selected. For example,
selecting every 10th name in the telephone directory until the required sample size had been reached.

iii).Stratified Random Sampling: it divides the population into groups (strata) by age, sex, occupation, social
class etc. It provides a more representative cross-section of the whole population. Each selected sub-group is
then randomly sampled i.e people in each stratum should be randomly chosen.

iv).Quota Sampling: when the population has been stratified and then the interviewer selects an appropriate
number of respondents from each stratum. It is commonly used for street interviews e.g a quota may be
used to interview 25 males and 25 females for each selected age group.

v).Cluster Sampling: cluster refers to a group of similar things positioned or occurring closely together. A
random group is selected from a particular area or region where they are concentrated e.g choosing the CBD
in a town. It is used to reduce costs of interviewing and travelling.

Non-Probability Sampling Methods

i).Convenience Sampling: involves the gathering of information from whoever is available when the survey
takes place, regardless of their age, sex, background etc. It also involves stopping by-passers, asking shoppers
in just one location. It is less costly. However the results are less reliable

ii).Snowball Sampling: it is a very specialised form of sampling in that, a first group of people is selected as
the first sample. The selected people are then asked for one more contact (friend) who is then added into the
sample. Sample size continue to increase hence snow ball effect. Businesses in secretive markets use this and
also those firms that produces highly specialised and expensive products for a very limited range of
customers. It is less costly. However sampling in this way is not representative. Thus the results may be
biased since a person’s friend is likely to have a similar lifestyle.

iii).Judgemental Sampling: the researcher chooses the respondents based on what they think is appropriate
for their study. This could be used by an experienced researcher who may be short of time as they have been
asked to produce a report quickly.

e).Focus Groups

It is a selected group of 15-20 people who are shown a product or allowed to taste it and then asked about
what they feel or think about it. These people must comment on its taste, design and colour depending on
what the product is. Once they are interviewed they won’t be asked again. It is used to obtain feedback
especially for new brands. During the interview, members are allowed to discuss with each other.
Information to be obtained is more reliable.

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Limitations

• It can be time consuming

• The data collected can be difficult to analyse and present to senior managers
• The presence of the researcher may influence the discussions

Advantages of Primary Research Disadvantages of primary research

•
Targeted issues are addressed: thus the
investigator collects data specific to the •
High costs: collecting data using primary
problem under study research is a costly proposition as the more
• people are required to carry out surveys and
Data is up-to-date: the data is current and as collect data
such it is specific to the place and situation •
the researcher is targeting. Time consuming: the time required to do the
•
research accurately is very long as compared
The researcher enjoys privacy: collector of to secondary data, which can be collected in
information is the owner of that information much lesser time duration
and he need not share it with other •
In accurate feedback: in case the research
companies and competitors. This gives an involves getting feedback from the targeted
edge over competitors relying on secondary audience, there are high chances that
data feedback given is not accurate. Feedback by
•
Data interpretation is better: the collected its basic nature is usually biased and given
data can be examined and interpreted by the just for the sake of it.
marketers depending on their needs rather
than relying on the interpretation made by
collectors of secondary data.
•
The researcher may get more information: if
required, it may be possible to obtain
additional information during study.

SECONDARY RESEARCH

It is also known as desk research. It involves the collection, analysis and evaluation of second-hand
information. Second-hand information refers to data that already exists. This information was originally
collected by another person or organisation for a different purpose. It is the secondary research that should
be initially done as it has lower costs, saves time and helps in giving directions for primary research.

Sources of data for Secondary Research

Internal Sources
•
Internal company records or annual reports
•
Sales trends
•
Stock movements
•
Supplier and customer records

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External Sources
•
Newspapers e.g the business section
•
Magazines
•
Government publications (population census)
•
Libraries (number of households in an area)
•
Economic surveys (economic trends)
•
Information from competitors
•
Internet (feedback from customers)
•
Prepared research report by other firms

Advantages of Secondary Research Disadvantages of Secondary Research

• •
Secondary research materials are usually The data is often out-of-date:- in fast-moving
cheaper to obtain as costs of conducting the consumer markets, data quickly become out-
research do not have to be borne by the dated as the external environment change.
organisation •
The data was collected for a different
•
Data is obtained quickly since the data is purpose:- Thus the data obtained may not
already there. There are no hassles of data suit the objectives of the company as it may
collection have been conducted for a different purpose.
•
Data from several different sources can be •
If a company is starting to develop or has
compared and important competitor details developed a new product then secondary
obtained research data may not be available at all.
• •
Basic information like population structures Obtaining additional data or some additional
can be obtained which then provide a clarification about something may not be
foundation for primary research. Thus possible
secondary research makes primary research •
Lack of control over data quality. One can
easier. only hope that the data is of good quality.

Factors affecting choice of the research method

1.Budget available: if the researcher has more money available for market research to be conducted
then primary research can be necessary. The organisation can afford expensive primary research
methods such stratified random sampling, quota sampling etc. If the organisation is experiencing cash
problems the secondary research can be the best option.

2.Accuracy required: primary research provides more accurate results than secondary research .
Secondary research provides misleading results since the research was done for a different purpose and
is often out-dated.

3.How quickly the information is required: secondary information is ideal when the marketing data is
required quickly since the data is readily available. Primary research method can be employed when
the data is not required quickly.

4.Accessibility to the old sample: if the researcher doesn’t have access to the sampled population then
primary research won’t be possible. The researcher will then depend on the data provided by other
organisations.

Cost effectiveness of market research

The business should not just spend large sums of money on market research for the sake of it. The marketing
managers should ask themselves questions such as: Is it worth it? Is it cost effective? These questions implies

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that money should not be wasted. A well designed and focused market research pays for itself in form of
higher sales and increased profits. If very little amounts are spent on market research then the validity and
reliability o the results will be compromised. By spending more on market research the more the data can be
obtained leading to better results. Nowadays the internet and mobile phones have made it easy to contact a
wide range of potential customers within a short period of time as compared to home surveys. The key way
to maximise the likelihood of cost-effectiveness is to plan thoroughly. According to the Marketing
Association: an existing business must set a marketing budget not exceeding 1% of its gross sales and 10% for
a new product or business.

Factors to consider when deciding how much to spend on market research

a)likely returns :The marketing manager should consider the potential increase in sales or profits

b)Method to be used :More money is required if they are planning to use a primary research method.

c)Budget available: resources available can be a constraint to the amount of money a business can
spend on market research.

d)Emergence with which the data is required: If the data is required quickly then more is required so that
more data collectors can be hired.

Reliability of data collection

-different factors should be considered before concluding on whether the data is reliable or not.

Market research data may be unreliable due to the following reasons:

Questionnaires used may have had misleading or leading questions

Interviews or focus group leaders may guide responders or may not fully under stood the question
they are asking.
Interviewers or focus group leaders may complete the forms themselves
Respondents to questionnaires, interviews and discussions may deliberately not give their real
views in order to get the process finished quickly or just for fun.
People in focus groups may say what they think other people in the group would like to hear
The sample size may be too small and so not represent the whole population
Different statistical methods of treating data will often result in different conclusions

Analysis and Interpretation of the results of market research

Most market research reports will be presented in writing, though there may be meetings where the
findings are orally presented. The writing may be supported by graphs, charts, tables and diagrams. The
information must be presented clearly and in an organised way. There may be recommendations, though
these may be left to those who the report was produced for.

Methods of presenting market research results

a)Tables: a table shows the rows and columns which show any connection between the two variables. It
is important to choose appropriate headings for the rows and columns. It is an effective way of
organising large quantities of data.

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Product Sales revenue for the four product in a supermarket over time

1990 1991 1992

Biscuits $100 $110 $123

Bread $90 $88 $84

Cooking oil $55 $55 $56

Buckets $60 $65 $70

Problems

Not attractive in most cases

The reader may take more time to interpret the data

Pie Chart

They are visually attractive and present the data in an easy-to-see way. The data is broken down into
categories. The area of each circle/sector occupied by each category is in proportion to the percentage that
category is of the total.

Problem: A pie chart is used to show only one variable

Bar Graph

Show data in the form of vertical or horizontal bars. A bar graph displays data in separate columns. They
may show absolute values or percentages. They are also visually attractive. Use the data in the table below
to draw a bar graph

Month Jan Feb Mar April May Jun July

Pairs of shoe sold 30 35 20 0 25 20 30

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Line Graph

A line graph is used for showing the way a variable changes over time. A line graph plots data as points and
joints the points with a line. It is simple and clear and more than one line can be shown on the same axis to
enable a comparison. Use the data below to draw a line graph.

Measures of the middle or the average

Mean = add all the values and divide by the total number of values

Mean (2010) = 92/16 = 5.8

Mean (2011) = 118/16= 7.4

Comment : the data show an improvement since people are listening to the radio programs for longer
periods.

Mode: refers to the number which appears most

Median refers to the middle term in the range of ordered data. The median divides the data into 2 equal
parts

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3.3 MARKETING MIX

Marketing Mix is defined as a combination of elements that influence a customer’s decision whether or not to
buy a product. It is also defined as the combination of product, price, promotion and place that is used to make
sure that the customer’s requirements are met. It is a marketing tool that combines a number of components
in order to strengthen and solidify a product’s brand and to help sell the product or service. The marketing mix
is often simplified and is commonly described as the 4 P’s. This approach identifies four elements in the mix (all
beginning with the letter P)

P - Product : Include the many different aspects of a product such as design, quality, reliability as well as

its features and functions. A product is an item that is built or produced to satisfy the needs of a certain group of
people. The product can be intangible or tangible as it can be in the form of services or goods.

P – Price: Refers to how much the customers are charged for the product and other terms of payment

involved. This is what a business is asking consumers to pay for a product or service. The price can be related to
the cost of production or sometimes related to the prices charged by competitors

P – Promotion: This is the way a firm communicates information about the product to the customer. It

may use advertising or a sales force to highlight its strength. The promotion of a product will affect the
image that customer have of it and their awareness and understanding of the benefits of the product.
Promotion includes advertising, special offers, sponsorship and public relations activities

P – Place: Refers to the way the product is distributed. Is the product sold directly to the customer or

through retail outlets? Can you buy online or do you have to travel some distance to get to a shop where it is
sold. Place refers to the points of sale such as store or websites as well as Lorries that distribute products.
Packaging is also part of promotion. Packaging refers to the technology of enclosing or protecting product
for distribution, storage, sale and use.

The role of the consumer (The 4 C’s’)

Another way of analysing the marketing mix is to consider it from the perspective of the consumer. The 4Cs
(Customer/consumer value, Cost, Convenience, and Communication) enables you to think in terms of your
customers’ interests more than your own. From being business-oriented, you’ll become customer-centric. This is
known as the 4 C’s approach

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4 C’s Explanations

Customer solution What benefits does it offer? How does the product meet a customer

need to solve a customer’s problem? A company should only

sell a product that addresses consumer demand. So,

marketers and business researchers should carefully study

the consumer wants and needs.

Convenience to customers How easy it is to buy the product. The product should be readily

available to the consumers. Marketers should

strategically place the products in several visible

distribution points.

Communication with the What do we know about the product. Marketers should aim to

Customers create an open dialogue with potential clients based on

their needs and wants

Cost to the customer How much does the product cost to the customer

Relationship between 4 C’s and 4 P’s

The 4 P’s take the point of view of the seller and not the one of the buyer. From the buyer’s point of view, the 4
P’s are transformed into the 4 C’s

Relationship between 4 P’s and 4 C’s

4 P’s Product Price Place Promotion

Customer solution Cost to the Convenience of the Communication

4 C’s

customer customer with customers

Customer Solution and Product

• Buyers don’t see a product as a selling item but rather as a solution for their problem
• The business must find out what people want and then ‘build it’ for them, their way

• Study customer needs and wants and then attract them one by one

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Cost to the customer

• Price indicates a return to the sellers and on the other hand, price is a cost to the customers
• Buyers see how much they would have spent to benefit from the product

Convenience to the customer

•Sellers try to choose the right place for their products in order to make them convenient for buyers
•You have to know how each sub-set of the market prefers to buy e.g on the internet, from a
catalogue, on the phone, using credit cards etc
Communication with the customers

• Communication requires a give and take between the buyer and seller
• As a marketing manager, you must listen to your customers whenever they give you feedback

Product Differentiation: refers to the degree to which customers perceive a product or brand to be different. The
main focus for most of the businesses is to make customers see that the brand or product is the only one that
meets their wants. The differentiation may be through an actual advantage in design, performance, or price, or an
imaginary but real process in which the customer is convinced that the product or brand has something over and
above its physical characteristics.

Ways to achieve product differentiation:

• Advertising and marketing campaigns to make the product stand out e.g Nike
• Branding and packaging e.g Coca Cola
• After sale services and guarantees
• New designs

Unique Selling Point / Unique Selling Proposition

A unique selling proposition (USP, also seen as unique selling point) is a factor that differentiates a product from
its competitors, such as the lowest cost, the highest quality or the first-ever product of its kind. A USP could be
thought of as “what you have that competitors don’t.” A successful USP promises a clearly articulated benefit to
consumers, offers them something that competitive products can’t or don’t offer, and is compelling enough to
attract new customers. The USP may be something unique to the product, the distribution arrangements or the
marketing methods.

Here are a few famous examples of USPs:

Domino’s Pizza deliveries“ it arrives in 30 minutes or it’s free” promise.

FedEx’s “When it absolutely, positively has to be there overnight.”

Southwest’s claim to be the lowest-priced airline

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Benefits of Unique Selling Point (USP)

• The business is able to charge high prices

• Positive publicity from customers
• Increase in market share
• Leads to Brand loyalty. Brand refers to an identifying symbol, name or trade mark that
distinguishes a product from its competittors

What is the product life cycle?

The product life cycle is an important concept in marketing. It describes the stages a product goes through
from when it was first thought of until it finally is removed from the market. Not all products reach this
final stage. Some continue to grow and others rise and fall. This can be illustrated by looking at the sales
during the time period of the product

What are the main stages of the product life cycle?

Development stage - objectives

At this stage, you should not worry about sales or introducing the product. Your focus should be on
working with a team of designers, manufacturers or product development experts on:

-producing prototypes

-testing prototyped product

-sourcing and pricing materials

-intellectual property issues

Introduction stage of a product life cycle

The introduction stage of a product's life cycle is when you can build an awareness of your product or
service in certain markets.

Introduction stage - objectives

You should concentrate on building a base for your product at this stage, and focus on the following
marketing

factors: - pricing

-distribution

-promotion

Price your product or service

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You should initially start pricing at the highest point you believe it is possible to achieve. You can also
consider a skimming price strategy: charging a relatively high price for a short time when a new, innovative,
or much-improved product is launched onto a market. The aim with skimming is to skim off customers who
are willing to pay more to be one of the first to have a new product. You can lower the prices later when
demand from the early adopters falls.

A penetration pricing strategy may work best for businesses entering a new market or building on a relatively
small market share. It involves the setting of lower, rather than higher prices to achieve a large, if not
dominant market share. See how to price your product or service.

Distribution

Your distribution should be selective and limited to a specific type of consumer, until your product is
accepted. Also, you should consider different distribution models during different periods of the product
life cycle, eg new products for different seasons in a clothes shop.

Promotion

You should try to build brand awareness at an early stage. It is worth working with a brand
design or communications agency as you develop a product to establish a strong brand.

You can use samples or trial incentives to capture early adopters of the product or service. Introductory
promotions can also help convince potential resellers to carry your lines. See more on branding: the basics.

Profitability during the introduction stage of product life cycle

It is likely that, at the introduction stage, your sales will be low until customers become aware of your
product or your service's benefits. Due to the high cost of advertising and low initial sales, it is possible that
you won't make immediate profits or you may even find that the product is producing negative profits.
However, you should make up for this with increasing revenue generated at the growth and maturity stage
of a product life cycle

Growth and maturity stage of a product life cycle

At this point in your product's life cycle, you should be putting your efforts into:

-increasing your product's market share

-creating a brand preference for your customers

Product growth stage

This should be a period of rapid growth in both sales and profits for your product or service. Your profits
should rise through an increase in output and more competitive pricing.

You should also consider:

-maintaining product quality and adding features or support services for the
product -maintaining pricing to increase demand for the product -increasing
distribution channels to cope with demand

-aiming promotion at a wider audience

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If your profits are still low, consider reducing the price of the product or service to increase the volume of
sales.

Product maturity stage

If your product or service makes it to the maturity stage, this should be the longest part of its product life
cycle. Sales are near their highest, but the rate of growth is slowing down, e.g. new competitors in market
or saturation

At this stage, you will probably notice that:

you may need to enhance product features to make it more appealing than competitors'
you may need to lower your pricing due to increased competition
distribution is becoming more intensive and you may need to offer incentives
you may need to focus your promotion on the difference between existing products

At this point, the market has often reached saturation as a result of competitors releasing their own version
of your product. Your product or service may experience a decreasing rate of sales, which should eventually
stabilise.

During this stage, you should aim to differentiate your product or service from others that your competitors
offer. You can do this by focusing and highlighting any branding, trademarks, or customer testimonials that
may give you an advantage. Read about designing a successful brand.

Decline Stage

The last of the product life cycle stages is the Decline stage, which as you might expect is often the beginning of
the end for a product. When you look at the classic product life cycle curve, the Decline stage is very clearly
demonstrated by the fall in both sales and profits. Despite the obvious challenges of

this decline, there may still be opportunities for manufacturers to continue making a profit from their
product. The product/service either comes to its natural end or is re-developed

Extending the Product Life Cycle

What can businesses do to extend the product life cycle?

Extension strategies extend the life of the product before it goes into decline. Again businesses use
marketing techniques to improve sales. Examples of the techniques are:
Advertising – try to gain a new audience or remind the current audience
Price reduction – more attractive to customers

Adding value – add new features to the current product, e.g. improving the
specifications on a smartphone

Explore new markets – selling the product into new geographical areas or creating a version targeted
at different segments

Challenges of the Decline Stage

• Market in Decline: During this final phase of the product life cycle, the market for a product will start to
decline. Consumers will typically stop buying this product in favour of something newer and better, and
there’s generally not much a manufacturer will be able to do to prevent this.
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• Falling Sales and Profits: As a result of the declining market, sales will start to fall, and the overall profit
that is available to the manufacturers in the market will start to decrease. One way for companies to
slow this fall in sales and profits is to try and increase their market share which, while challenging
enough during the Maturity stage of the cycle, can be even harder when a market is in decline.

• Product Withdrawal: Ultimately, for a lot of manufacturers it could get to a point where they are no
longer making a profit from their product. As there may be no way to reverse this decline, the only
option many business will have is to withdraw their product before it starts to lose them money.

Summary : Stages of the PLC and the marketing Mix

Introduction growth MATURITY Decline

Product -first model -modified model -new models -drop poor selling

-wide range -modify existing models

models to extent

their life cycle

Price -Could be high -could be lower to -Could be lowered -heavily

(skimming pricing) attract customers further to attract discounted

Could be low - could be higher if customers -reduce price to

(penetration the brand is - competitors are clear stock

pricing) successful. also entering the

market

Promotion -Significant -more advertising -persuasive -could be much

advertising ( and promotion to adverting to stress lower to save

informative create brand on the positive costs

advertising) and loyalty difference with - advertising is

promotion to raise competitors’ only used to

awareness. products inform the public

about lower prices

Place -Could be focused -increased levels -the highest -eliminate

on the key areas ( for wider coverage number of outlets unprofitable

restricted outlets) outlets

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Uses of the PLC

• The position of a product in the PLC gives some indications to a business about how the
elements of the marketing mix might be used
• It is also used to check progress against the marketing objectives of the business
• It is used to identify how cash flow might depend on the cycle
• To decide on whether to withdraw or to re-launch a product

Limitations of the PLC

• It is based on past or current data as such it cannot be used to predict the future
• Some products can come back after the decline stage
• Sales of some products continue to grow.

New Product Development

An ability to develop new products [or services] can help to breathe new life into a business. The primary
advantage of product development is that it can help a brand and business stay relevant with its consumer base.
By continually striving to solve new problems that consumers face, an organization is continually creating the
chance to create revenues.

New Product Development: the creation of products with mew or different characteristics that offer new or
additional benefits to the customer. Product development may involve modification of an existing product or
its presentation, or formation of an entirely new product that satisfies a newly defined customer want or
niche market.

Benefits of new product development

• Increase in market share

• The business is able to respond to changing needs of customers
• The business can benefit from positive word-of-mouth marketing, which can lead to higher
revenues.
Limitations

• It can be easy to set unrealistic expectations for a product.

• Products can fail unexpectedly.
• External sources can change procedures, which can alter your product development.
• Product testing can result in a failed idea.

Product Portfolio Analysis

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Refers to analysing products of a business to help allocate resources effectively between them. Considers the
range of product a business offers, using market sales, market share, position of the product life cycle and
segmentation in order to plan the most appropriate product mix to meet objectives. It focuses on how to
achieve the optimum (best) product mix, that means getting a range of products that are going to achieve long-
lasting sales. It helps the business to pinpoint exactly what marketing activities need to be employed for each
product in the mix

Benefits of product portfolio analysis

• Allows businesses to ensure that it always has a product ready to replace products that
might be losing market share or sales
• It enables a business to have a range of products so that if one fails the others can provide
revenue to cover
• It allows planning to take place over time so that the business will always be in a position to maintain
revenue.
Boston Matrix (Draw it yourself)

Marketing Mix – Promotion (Promotional Strategy)

Promotion is the marketing activity that communicates to customers in order to change their attitudes
or buying behaviour. It is an attempt to draw attention of the customer to the product. Promotion is
the part of marketing where you advertise and market your product, also known as a promotional
strategy. Through it, you let potential customers know what you are selling.

• In order to convince them to buy your product, you need to explain what it is, how to use it, and why
they should buy. The trick in promoting is letting consumers feel that their needs can be satisfied by
what you are selling.

• An effective promotional effort contains a clear message that is targeted to a certain audience and is
done through appropriate channels. The target customers are people who will use, as well as influence or
decide the purchase of the product. Identifying these people is an important part of your market
research. The marketing image that you’re trying to project must match the advertisement’s message. It

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should catch your target customers’ attention and either convince them to buy or at least state their
opinion about the product. The promotional method you choose in order to convey your message to the
target customers may probably involve more than one marketing channels

Objectives of Promotion

• To increase customer awareness

• To reach targeted clients which might be geographically dispersed
• To remind customers about the existing product and its quality
• To show the superiority of a product over its competitors
• To increase sales
• To give information about the product and the company

Types of Promotion

Above the line promotion: it occurs through an independent media such as advertising using television,
magazine, newspaper, radio, internet. Thus it involves using mass media space that is paid for, often through an
advertising agency. The main aim is to inform, raise awareness and build brand positioning. Communication is
targeted to the whole market not to specific individuals

Below the line promotion: marketing methods that communicate with the customer without paying for the
media. These are promotional activities that pushes customers into buying e,g buy one get one free (BOGOF).
These are promotional activities where the business has direct control over the target or intended audience. It
is designed and produced by a business in-house. It is more of one-on-one approach. It is designed to achieve
short term sales increases and repeat purchases.

Elements of Below the lime promotion include:

-Sales promotion

-Personal selling

-Public relations

-Exhibitions and Trade fairs

Promotional Mix

Refers to all the elements of promotion that a business can pursue which include advertising, public
relations and sales promotions. In other words, it is defined as the combination of promotional
techniques that a firm uses to sell a product.

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Elements of Promotional Mix

a)Advertising: it is a controlled impersonal conveyance of a message regarding a need-satisfactory product or

service by a business to a specific audience with the objective of informing, reminding or persuading them to
take a specific action.

Four Types of Advertising

i)Informative Advertising: it is done to inform the public about the existence of a product. Provides precise
details of goods to the public on new products, prices, where to buy and how to buy the product.

ii)Persuasive Advertising: it is undertaken by an individual company to promote its own products using
brand names at the expense of other manufacturers.

iii)Competitive Advertising: advertising only gives the good points about the product and they use
attractive devices or techniques

iv)Collective or Generic Advertising (Collaborative):producers in the same industry will jointly advertise a
product in general. They don’t use brand names e,g ‘Take a lot of milk for good health’.

Guerrilla advertising

Products are advertised at surprising and unconventional events to make the public take notice.

• It is low cost: graffiti paint on walls is low cost, but it is best to gain permission first!

• It can be creative, inventive and can appeal to young consumers.

• It encourages word-of-mouth communication between potential consumers.

• A staged event can receive free publicity from the media.

Guerrilla advertising has limitations:

• The message may be misunderstood.

• It may be considered irresponsible and lead to a negative backlash.

Types advertising Media

a)Print Media: newspapers; magazines; pamphlets

b).Electronic Media: Radio; internet; television

c)Outdoor Media: Billboards; posters

Factors influencing choice of Media

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i)Size of targeted audience: national coverage requires Television; national newspapers. Local level
requires posters and Billboards

ii)Cost involved: television is more expensive nut more expensive

iii)Urgency of message: if speed is required to spread the information then radio and television is the
best

iv)Expected profit or revenue: revenue to be collected should be able to cover all the advertising
expenses

Benefits of advertising

• Enables consumers to make informed decisions

• Increase in sales and profitability
• Fights competition
• Improves image of the business
• Informs customers about promotions and sales taking place
Problems of advertising

• Leads to higher prices

• Encourages impulse buying
• Adverts interrupt TV and radio programmes

Elements of Below-the-line promotion

Sales promotion
Personal selling (Direct promotion method)
Public relations
Exhibitions and trade fairs

Sales Promotions

This promotional strategy is done through special offers with a plan to attract people to buy the product. Sales
promotions can include coupons, free samples, incentives, contests, prizes, loyalty programs, and rebates. You
might also want to educate potential and current customers by holding trainings and seminars, or reach them via
trade shows. Some of the target audience may be more receptive to a certain promotional method than another.
You can also do sales promotions by setting up product displays during a public event or through social
networking at business and civic gatherings.

Sales promotion is divided into two:-

Trade Promotions: These are aimed at distributors like wholesalers and retailers. It includes special discounts
and bonuses such as free extra product per case.

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Consumer promotions: is used to create interest and tempt potential customers to make a purchase. It includes
free gifts, coupons, special offers, free samples, competitions, buy-one-get-one (BOGOF).

Public Relations or PR

Public relations is usually focused on building a favorable image of your business. You can do this by doing
something good for the neighborhood and the community like holding an open house or being involved in
community activities. It also involves sponsorship. Sponsorship refers to a financial contribution to an event in
return for publicity. You can engage the local media and hold press conferences as part of your promotional
strategy. In this case the business is not going to pay for the message to be run on the media. Thus PR is the
cheapest method of promotion

Personal Selling

You can employ salespersons to promote and sell your products as part of the business communication plans.
These salespersons play an important part in building customer relationships through tailored communication.
Personal selling can be a bit costly, though, because you will need to hire professional sales people to do the
promotion for you. But done right, the profit gained could. It is an action oriented approach and it is often used
by insurance companies.

Exhibitions and Trade fairs

Some businesses attend trade fares and exhibitions to promote their products. The business setup a stall and
promote their products face-to-face.

Factors to consider when choosing a method of promotion

a)Cost: many businesses are forced to use cheaper promotions because advertising is too expensive

b)Stage in the product life cycle: promotional methods change as a product gets older e.g PR is used during the
introduction stages aggressive advertising on maturity and decline stage.

c)Competitors’ promotion: it is common for business to copy the method of promotion used by a rival firm. Once
one business come up with a successful promotional method, others will quickly take advantage of it and modify
a little bit.

d)Legal factors: in the E.U, tobacco product cannot be advertised on T.V.

Promotional Elasticity of Demand

The responsiveness of quantity demanded due to a change in promotional expenditure ,ceteris paribus.

Promotional Elasticity of demand = % change in quantity demanded %change in

promotional expenditure

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Illustration: From the data below find the promotional elasticity of demand when the promotional
budget was increased from $2000 to $3000.

Year Quantity demanded in units Promotional budget ($)

2010 100 000 200

2011 200 000 300

Marketing Mix – Price (Pricing Strategy)

Price is the amount of money that your customers have to pay in exchange for your product or service.
Determining the right price for your product can be a bit tricky.

A common strategy for beginning small businesses is creating a bargain pricing impression by pricing their
product lower than their competitors. Although this may boost initial sales, low price usually equates to low
quality and this may not be what customers to see in your product.

Pricing Objectives

-They include the following:

• Profitability -prices should increase overall profitability of the firm

• Rate of return –a specified return on capital employed (ROCE)
• Growth –the price should provide a steady profit over a period of years to enable the firm to survive
and grow.
• Competition –should be competitive and attractive to customers
• Market share –a price must be set which enables a firm to at least maintain its market share.
• Utilization of capacity –it should cover fixed costs and enable the firm to fully utilize capacity, thus
spreading unit costs over a larger output.
Pricing Policies/Strategies

Price Skimming –It uses high prices to obtain high profit margins and a quick recovery of development costs. It
is useful for products with a short life cycle and fashion items e.g. computers, videos, toys, CDs etc It is ideal
for technological goods and where there is less competition
Advantages Disadvantages
High prices give appearance of quality and a must have High prices may discourage buyers
‘factor’ Early buyers at high prices may be discouraged when
Some customers pay high prices for a new unique price falls and they will not buy again
product Buyers may wait as they know price will fall
High prices covers development and marketing costs Attract new competitors
More profits to the business

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Penetration Pricing –The main objective is to capture a large share of the market as quickly as possible. It
depends on the expected product life. It is mainly used for products with a longer life. Low prices are set in the
initial stages of the product and gradually increased as it gains market share. Consumer products are often
introduced this way. It is suitable where there is stiff competition.

Advantages

High sales volumes and low prices stop entry of competitors

High sales volume reduces average costs ( economies of scale)

Increase in brand awareness

High market share

Disadvantages

Consumer resistance when prices are increased in the future

May result in brand seen as low quality
Low profit margins

Differentiated/Discrimination Pricing –It involves the use of different prices for the same product when it is
sold in different locations or market segments e.g. wholesalers may receive trade discounts while small buyers in
remote areas may be charged a higher price due to additional distribution costs.

Can be used where:

Supply of the product is controlled only by one firm

Markets are geographically separated
Reselling of the product is not possible e,g when the business is selling a service

• Promotional Pricing –Involves the use of a lower and normal price either to launch a new product or
to periodically boost sales of existing products.
• Negotiable Pricing –It is common in industrial markets and building trade. The price is
individually calculated to take account of costs, demand and any specific customer
requirements.
• Market Pricing –Prices are quoted ‘at market’. They are determined by forces of supply and demand.
Common for commodity markets e.g. gold, silver, stock exchange etc
• Premium Pricing –Involves charging a higher price than competitors to strengthen the image perceived
by consumers of a certain brand.
• Cost-based pricing: firms will assess the cost of producing each unit of the product and add a certain
amount on top of the calculated cost. It also includes mark-up pricing which involves adding a fixed
mark-up for profit to the unit price of a product. It takes into account all the relevant costs. But the
problem is that it can lead to higher prices.
• Predatory Pricing: charging a low price to drive competitors out of the market. When the rival firms had
closed down the business will then increase price.
• Psychological Pricing: setting a price at just below a whole number e.g $99,99, making customers feel
they are paying much less than $2.00, so they more likely to buy than if the price were $2.00
• Bait and hook pricing: selling a product at a low price but charging a high price for associated products,
for example selling a printer cheaply but the cartridges are expensive. It can only work if the
products are complementary goods.

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• Loss leader pricing: products are sold below cost at a loss to attract customers who might then buy other
products. When customers enter into a shop, full price products will also be bought. Customers have a
tendency of buying more than what they planned for. The loss on the loss leader will
be more than made up for by extra spending on the full-price items. It is used in most cases by
supermarkets.
• Competitor based pricing: involves researching the price competitors charge and then setting a price
based on this. The price can be similar, slightly higher or lower than that which is charged by competitors.
It is suitable where there is large number of competitors. If the firm is selling a differentiated product,
they can charge a higher price. Differentiated product is that where customers see as being different
from any other similar products. If they are selling the same type of product, they can charge the same
price and then offer after sale services to attract more customers.

Factors to consider when setting prices

cost : fixed and variable costs

price charged by the competitors
stage of the product in the product life cycle
Objectives of the business
Customer perceptions
Government policy

Price elasticity of demand

Price elasticity of demand (PED)

Refers to the responsiveness of quantity demanded for a product due to a change in its price. It
measures the extent to which units demanded respond to a decrease or increase in price

% change in quantity demanded

Price Elasticity of demand (PED)=
% Change in price

If the answer is between 0 and 1 (ignore negative sign)

PED is inelastic: increase the price to maximise profits. A given increase in price will lead to a less than
proportionate decrease in quantity demanded. The product has very few substitutes

If the answer is equal to 1(ignore negative sign)

PED is said to be unitary elastic: maintain the price

If the answer is greater than 1(ignore negative sign)

PED is said to be elastic: reduce the price to maximise sales. A given decrease in price will lead to a more
than proportionate increase in quantity demanded. The product will be having a lot of substitutes.

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Illustration: Use the data in the table below to answer questions that follow

Current units demanded and proposed increase in price and its

the corresponding price effect on quantity demanded

Quantity demanded 100 units 200 units

Price $10 $8

a)Calculate the Price elasticity of demand (PED) [3]

b)Use your answer in ‘a’ above to decide on whether it is elastic or inelastic [1]

c).What will be the best strategy for the business to maximise sale in this case [3]

Factors that affect Price elasticity of demand:

• The number of substitutes: goods that have a lot of substitutes have elastic demand e.g margarine.
Those with very few substitute have inelastic demand e.g pills to a patient
• The period of time : in the short run the demand for goods is generally inelastic while it becomes
elastic in the long run
• The proportion of income spent on the commodity: products which take up a small proportion of an
individual’s income have inelastic demand e.g sweets. On the other hand products which take up a
larger fraction of a person’s income have elastic demand e.g wardrobes
• The necessity of the product: products that are basic necessities have inelastic demand while luxury
products have elastic demand.

DISTRIBUTION (PLACE)

-It is concerned with getting the product from the producer to the customer at the right quantity, to the right
place, at the right time and in the right condition.

Channel of distribution

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Refers to the chain of intermediaries a product passes through from producers to the final consumer. It involves
the links between the manufacturer and the consumer. A Channel of Distribution for a product is the route taken
by the product as it moves from the producer to ultimate consumer

The 3 types intermediaries are :

1. Agents

-An agent works on behalf of another firm to perform certain specified services. They are usually used in
importing and exporting and also in domestic trade.

2. Wholesalers

-A wholesaler buys goods for resale to someone other than the eventual customer. They usually supply goods
to retailers who in turn sell to the public or to the manufacturers who use the goods in the production
process.

Functions of Wholesalers

• they break down bulk purchases and repack them into smaller lots to retailers
• they offer warehousing for products for the manufacturer
• they provide financial service to manufacturer (pay cash) and extend credit to the retailer
• they handle publicity and promotion on behalf of the manufacturer

3. Retailers

-Retailing refers to all activities that are related directly to the sale of goods/services to the ultimate
consumer.

Types of Distribution Channels

1.Zero –level Channel/ Direct selling

The product is passed directly from manufacturer to the final consumer e.g dentist.

Advantages of zero-level channel / direct selling

• Quicker than other channels

• Producer has complete control over the marketing mix i.e how the product is sold
• Direct contact with customers offers the business with useful information
• Products will be cheaper to consumers
Disadvantages of direct selling

• All storage costs are paid for by the producer

• It may not be convenient for consumers
• It can be expensive to deliver each item to the consumer

• Consumers may not be able to see and try the product before they buy

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One-level Channel

There is only one intermediary. The retailers buy the product from the manufacturer and sell it to the final
consumers

Advantages of One-level channel

• Producers can focus on production and selling is done by retailers

• Retailers are often in locations that are near to customers
• When goods are bought by retailers, the risk is reduced on the part of the manufacturer
• Storage costs are reduced
Disadvantages of One-level channel

• Profit mark-up imposed by retailers could make the product more expensive
• Producers lose some control over the marketing mix
• Retailers may sell products from other competitors too i.e there is no exclusive outlet

Other channels of distribution

Factors Affecting Choice of Distribution Channel

•
The desired degree of control wanted by the manufacturer: More is gained on a zero-channel of
distribution
•
The number of potential customers: If they are too many then a 2-level or 3-level channel can be used
•
Type of products: some goods are perishable hence they require a zero-level channel of
distribution.
•
Storage costs: if storage costs are very high then the goods must be quickly sold to wholesalers or
retailers
•
Availability of intermediaries like the agent; wholesalers or retailers. If they are not there , the
manufacturer will have to sell the goods directly

The role of Branding in Promotion

Branding:-Brand is a name/term/design or symbol or a combination of these which is intended to identify

the goods/services of one business from others, usually offering similar products.

• Brand Image is a perception a person has of a particular brand.

• Brand Extension is a strategy by which an established brand name is applied to new products from
the same manufacturer.

• Brand Loyalty is a consumer’s decision to consistently repurchase a brand continually because

he/she perceives that the brand has the right product features or quality at the right price.

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-With brand loyalty, consumers can reduce purchasing time, thought and risk therefore developing brand loyalty
as the long-term objective of all marketing organizations and the major reason for their continued study of
consumer behaviour.

Types of Brands

1. Family Brands

-the brand name is used to cover all the products of a business, even if they are widely different and in
different markets e.g. Willard, Heinz, Kellogg, and Unilever

2. Retail Brands

-the retailer, not the manufacturer is the one guaranteeing quality and consistency e.g. Barbour’s,
Greatermans, Truworths

3. Corporate Brands

-the name of the business is incorporated into the brand name of the product e.g. Jewel Bank-CBZ

4. Individual Brand

-each product is given its own brand name

Factors to consider when selecting a brand

• easy to spell, say or recall

• should allude to the product uses, benefits or special characteristics
• should be distinctive and recognizable
• should be sufficiently versatile to be applicable to new products
• should be capable of being registered and legally protected under The Trade Marks Act
• should be adaptable to packaging and labelling requirements

Benefits of Branding

-protects quantity

-it aids in shelf selection (case of identity)

-it differentiates similar goods

-for prestige

-it facilitates product diversification

-it hampers price comparisons

-it facilitates promotional effort

Reasons for Not Branding

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-to avoid the high initial costs of promoting a brand

-the physical nature of some goods may prevent branding e.g. vegetables -to
maintain a consistent quality of output

-it may be difficult to differentiate products of one firm from another e.g. safety pins, coal,
wheat etc

The role of packaging in promotion

Packaging is what the consumers see as they consider buying a product. Packaging act as protection and security,
enables grouping of several items, convenience and is used for transmitting information and marketing
communications

-Packaging is used to develop brand image by making it distinct and easily recognizable.

-It is termed the ‘silent salesman’ in marketing.

-It is often an integral part of a product designed to add to its appeal through the use of colour, shape, size,
logos etc, all of which can have a significant effect on sales.

-Packaging is useful in successful advertising and promotion as it can encourage impulse buying.

*A package should have:

• brand (product) name

• quantity
• expiry date
• ingredients/nutritional information
• guarantee
• directions for use
• address and contact number of manufacturer
• health information e.g. ‘do not litter’

Digital and physical distribution

Products that can be converted into digital format are now being widely distributed to consumers by digital
means over the internet rather than in a physical form. Digital distribution bypasses the traditional physical
distribution formats, such as paper, optical discs and film cassettes. The processes involved in digital distribution
include streaming and downloading of content. The key difference is that a streaming file is simply played as it
becomes available, while a download is stored onto a computer’s memory. Both processes involve the act of
downloading, but only a download leaves the consumer with a copy that can be accessed at any time from the
device without having to download the data again. The promoters of this form of distribution claim that music
writers or music performers of the content can:
• get their music output distributed globally on platforms such as iTunes, Spotify and Google Play
• avoid the high costs of traditional physical distribution such as transport and inventory holding
costs
• expand a global fan base
• keep 100% of the revenue earned

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• achieve a low carbon footprint method of distribution (e.g. no transport and no packaging).

Internet Marketing (Online Marketing)

Refers to the advertising and marketing activities that use the internet, email and mobile communication to
encourage direct sales via electronic commerce

E-commerce: refers to the buying and selling of goods and services by business to consumers through electronic
medium. It involves the trading of products or services using computer networks, particularly the internet and
mobile phones.

Benefits of Internet Marketing Problems of internet marketing

• It is relatively cheap • Internet connectivity problems
• World coverage • Consumers can not touch, smell, fell or try the
• Accurate data can be kept about the goods before buying it
number of visitors • It is more risk.ie dealing with someone whom
• Convenient for consumers since they can you doesn’t know
shop in the comfort of their homes • Problem of hackers especially for telegraphic
funds transfer.

Methods of digital promotion

These methods use the latest technology to get their messages to customers.

• Social media marketing

• Email marketing
• Online advertising Displaying pop-up banners or advertisements on other websites
• Smartphone marketing
• Search engine optimisation (SEO) Businesses that use e-commerce (sell online) locate their websites on
search engines such as Google, Bing, Yahoo and Baidu (China). They need to use SEO to make sure that
their content appears among the first results of a search. Without SEO, it is very difficult indeed for a
business trading online to remain competitive. Several SEO methods can be used to ensure a high ranking
on a search engine results page, such as optimising the content for specific keywords. Search engine
algorithms are constantly changing and businesses need to update their SEO methods accordingly.

Viral Marketing

Refers to the use of social media sites or text messages to increase brand awareness or sell products. It is type of
marketing in which users of social networks act as advertisers for products by spreading knowledge of them to
other users of the network. It describes any strategy that encourages individuals to pass on a marketing message
to others, creating the potential for exponential growth in the number of people getting the message. A viral
message must be created and then passed to the influences. The influences will then pass on the message about
the products they like and the people who are going to receive that message will also spread the message to
their friends.

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4. OPERATIONS AND PROJECT MANAGEMENT (AS LEVEL)

4.1 The nature of operations

-It is also referred to as production management. Production is the transformation of inputs into outputs.
Thus production takes place when a business takes inputs, carries out a production process and produces
output. In other words, it is the conversion of resources such as raw materials or components into goods or
services.

Operations management decisions involve making effective use of resources (inputs), land, labour and capital to
provide outputs in the form of goods and services.

-Production can be done at primary, secondary or tertiary levels. The inputs of production differ from one
organisation to another. The outputs of one organisation can be the inputs of another firm.

-operations management seeks to ensure that goods/ services are made with the required quantity, required
standard and at the right time and in the most efficient manner. Thus it is concerned with acquiring the necessary
inputs, allocating and utilising them in such a way as to maximise output

– Operations management and planning is concerned with:

• which resources are needed to complete the production/service process.

• how the work/process will be organised and scheduled.
• who will perform the work.

Objectives of an operations management department

• To design, create, produce goods and services for an organisation and its customers effectively.
• To direct and control the transformation process so that it is efficient and effective and addvalue.
• To procure appropriate inputs in a cost effective way.
• To effectively manage an appropriate inventory level.
• To focus on quality, speed of response, flexibility, type cost of the production process.
• Achieve an effective labour/capital production mix.
• To incorporate latest technological approaches into the production process.

THE DIAGRAM BELOW SUMMARIES PRODUTION

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Transformation process

An activity (process) or group of activities that takes inputs and converts them into outputs.

INPUTS

- Raw materials- the basic materials that can be used to make or create something e.g
wheat is a raw material in bread production
- Land- refers to the site on which production takes. It also refers to all the free gifts of nature
e.g minerals, climate
- Labour- refers to the physical and mental effort put into the production process. Production
process is said to be labour intensive if labour cost constitutes a larger fraction of a firm’s total costs.
There are three types of labour:- unskilled labour, semi-skilled labour and skilled labour
- Capital:- refers to the tools, machinery, computers and other equipment that businesses
uses to produce goods and services. All man-made items used in the production of other
goods i.e machines, buildings, computers, vehicles, roads e.tc Production process is said to
be capital intensive if the cost on capital

constitute a larger proportion of the firm’s total cost

NB- Intellectual Capital - is defined as the amount by which the market value of a company
exceeds its tangible assets (physical and financial) – the collective knowledge and skills of a
company. Intellectual capital is the intangible bank of expertise, skills and competencies within a
business that can give the production process a distinctive competitive edge.

INTELLECTUAL CAPITAL- total market value of business asset- total net book value of assets

VALUE-ADDITION and OPERATIONS DECISIONS

Refers to the differences between the cost of purchasing raw materials and the price at which finished
goods are sold. In other words it is an increase in value a business adds from one stage of production
to another. When inputs are transformed into outputs, they will end up with a higher value than their
starting point. As each stage of production process takes place, value is added to the starting inputs
because these have to be transformed, adding value. The role of operations decisions is to achieve a
desired value added, in terms of productive efficiency in reducing unit costs (minimising inputs in
relation to outputs) and in terms of financial value (sales revenue and profit). The operations decisions
should lead to efficiency and effectiveness so that customers’ needs are met by the value added
through the productive process

Value added and Marketing

Value addition can be looked at from the point of view of customers. Marketing is the process of
meeting customers’ needs, and the process of adding value is making sure that that production
process is effective in doing this. Adding value in marketing is giving something to customer that is of
high value to them but is low cost to producer. Added value marketing gives customers what they
really want by making the product have improved performance or better looks, giving advice on using
it, making it more easily available to the customer, providing discounts as well as quality assurance.

PRODUCTIVITY

-It is a measure of efficiency of production. It shows the relationship between output of a system and
factor inputs. It is also defined as the ratio of outputs to inputs during production. There are two types
of productivity:-

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Labour Productivity- refers to the number of units produced per worker

Labour Productivity= total units produced/ total workers involved

Capital Productivity- units of output produced per unit of capital resources employed.

Capital productivity= total output produced/ capital employed

ILLUSTRATION

FIRM ITEMS UNITS PER CAPITAL NO OF TOTAL

MONTH EMPLOYED EMPLOYEES WAGES

A Chairs produced 1000 $500 100 $300

B Shirts produced 500 $200 25 $250

C Cakes 300 $200 20 $200

Calculate

(i) Firm A’s - Capital productivity

Labour productivity
Which firm is more efficient in terms of the utilisation of labour.

METHODS TO IMPROVE PRODUCTIVITY

ii) Improve the training of staff to raise skills level:- employees with relevant skills are
more productive

iii) Improve worker motivation- use financial and non-financial motivators to encourage
employees to work extra harder.

iv) Purchase more technologically advanced equipment- the firm can introduce new
machinery and latest production systems i.e robot-controlled production systems.

v) More efficient management- good leadership improves the overall efficiency of the business

Differences between efficiency and effectiveness in business

operations EFFICIENCY

-it is defined as doing the right thing. It involves the production of output at the highest ratio of
output to input. Efficiency is measured by the productivity of the factors of production. E.g total
output / units of inputs

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EFFECTIVENESS

-is defined as doing the thing right. It involves meeting business objectives by using inputs
appropriately to meet customer needs. Efficiency is one part of effectiveness. For any business the
relationship between efficiency and effectiveness depends on the market segment it is aiming at e.g
volume, exclusive designer range etc

Differences between Labour intensive and Capital intensive method of production

Labour intensive Capital intensive

Costs of labour are a higher proportion of Costs of capital are a higher proportion of

total costs than costs of capital total costs than costs of labour

E.g hand worked farm E.g an oil refinery

Benefits Benefits

Can produce one-off unique products Mass production requires large scale

Well suited to deliver personal services output using repeated task. Machine can

Lower productions costs especially when deliver this much more quickly than labour

labour is cheaper in that area Enables the business to enjoy economies

Low start-up costs of scale

Relatively easy to vary labour force (recruit/ Increased labour productivity

retrench) Skills level may be lower so costs are less

and it is easier to recruit employees.

Limitations Limitations

Cannot produce large-scale output quickly Difficult to produce a range of varied one-

Limited economies of scale off products

Employees can disrupt production easily Difficult to deliver personal services

due to industrial action or absence High start-up costs. Cost of capital may be

Legal constrains may make it difficult to too high for a business to buy machinery

vary labour force Machine break down can be a big

Training costs may be very high challenge to the business

Employees using machines can be bored

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Factors that could influence a decision to change to more capital intensive production methods.

– Relative prices of the two inputs may change – labour costs significantly increase.

– Cost of capital machinery may reduce.

– Technological development may allow production process (or parts of it) to be mechanised.

– Competitors may force a business into capital intensive approach.

– Business may become large enough/profitable enough to purchase capital machinery.

Benefits of operations management

Operations management is concerned with orchestrating all resources to produce a final product or
service and as such it is constantly seeking to make the transformation process of inputs into outputs
more efficient.

• reducing costs.

• reducing wastage.
• increasing productivity.
• taking out activities that do not add value.
• improving design.

• improving quality.
• designing more efficient work methods.
• better product development.
• more efficient inventory management.

The importance of sustainability of operations

Sustainability is one of the key business issues of the twenty-first century. Growing global concern
about pollution and climate change has put pressure on businesses to clean up their operations.
Businesses are becoming increasingly focused on achieving sustainability of operations. They can do
this in a number of ways, by:
• reducing energy use and carbon emissions
• reducing the use of plastic and other non-biodegradable materials
• using recycled materials
• manufacturing products that are recyclable
4.2 Operations planning

OPERATIONS DECISIONS

-decisions taken by operations manager can have a significant impact on the success of business.
These decisions are often influenced by marketing factors, availability of resources and technology.

• Marketing Factors- there is a link between operations department and marketing department.
Operations manager requires information pertaining to estimated market demand when
planning future production levels. Thus the operations manager will try to match supply to
potential demand (operations planning)

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o NB-operations planning involves preparing input resources to supply products to

meet expected demand

o Important elements of
operations planning -
reducing wastages

o -producing the range of product that are forecast

to be demanded -employ and keep an appropriate
number of staff

o -keep sufficient inventory

• The availability of Resources- the production department use resources to produce goods and
services. These resources include land, labour, capital equipment and raw materials. Thus the
availability of raw materials or lack of them can influence a number of important operations
decisions. The business must decide on the best location, nature of the production method (
robot-controlled equipment)

• Technology- the provision of services and also the manufacturing of goods has changed.
Firms now use digital technology and there two main forms i.e CAD and CAM

COMPUTER-AIDED DESIGN (CAD)

-involves the use of computer programs to create 2 or 3 dimensional graphical

representations of physical objects. It is most used in architectural designs and on computer
animations. It can provide special effects on movies and advertising.

-CAD is also used in furniture manufacturing and the software is used to calculate the optimal
size or shape of the product. Engineering department also uses CAD to analyse the
components of various structures.

BENEFITS OF CAD LIMITATIONS OF CAD

• Lower product development costs • Complexity of programs

• Increased productivity • Need for extensive employee
• Improved product quality training
• Good visualisation of the final • It is more expensive i.e computer
product and its constituent parts software used are very expensive
• Errors are minimised i.e it is more • Computer programs can be
accurate affected by virus

COMPUTER-AIDED MANUFACTURING (CAM)

-involves the use of computer software to control machine tools and related machinery in the
manufacturing of components or complete products. Processes in a CAM process are controlled

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by computers. Thus a high degree of precision and consistency can be achieved than a machine
controlled by men.

BENEFITS OF CAM LIMITATIONS OF CAM

•
Quality products are produced
•
Faster production and increased labour •
High costs of hardware, programs and
productivity employee training
•
CAM can be combined with CAD to •
Hardware failure can be time-consuming
produce a wide range of products to solve
•
More flexible production allowing quick •
Computer system can be easily affected
changeover from one product to another by virus
•
Small firms cannot afford it

FLEXIBILITY AND INNOVATION IN PRODUCTION

Operational Flexibility- refers to the ability of a business to vary both the level of production
and the range of products following changes in customer demand. The level of demand is not
constant, it may increase or decrease. Thus the business must be able to respond quickly to
changes in demand.

Way to achieve operational flexibility

Buy more equipment
Construct or buy new buildings
Maintain the efficient stock levels
Employ part-time or temporary labour force

Process Innovation-: refers to the use of a new or much improved production method or
service delivery method

Elements of process innovation

Use of robots in manufacturing
Faster machines to manufacture microchips for computers
Use of bar codes and scanner for tracking inventory
Use of internet to track the exact location of parcels being delivered worldwide and
improve the speed of delivery.

Benefits of process innovation

•
Being able to get more accurate and reliable information on the performance of
various departments
•
Being able to save time i.e less paper work is involved

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•
Increased professionalism and image to suppliers and customers
•
Increased productivity
•
Reduction of costs in the long run i.e in the short-run the costs of acquisition are high
•
Cheaper production methods makes the business more competitive

NB: Process innovation involves the use of automation/ robotics. Automation- refers to the use of
electronics and machinery to control a production system. Robotics refers to the use of robots/
machinery that resembles a human being in the operations it can perform in a production system.

PRODUCTION METHODS (OPERATION METHODS)

Each firm must carry out production designing. Production design refers to the scheduling of
production which involves organising the activities in a manufacturing plant or service industry to
ensure that the product or service is completed at the expected time. There are four basic ways of
production design namely job, batch, flow production and mass customisation.

The method chosen will depend on the following factors:-

• Nature of product- unique products require jobbing, group of identical products require batch
and identical products requires flow production
• Size of business- small businesses use jobbing and batch while large firms use flow. This is
because flow production is expensive to set up.
• Size and location of the market- the firm must take into cognizance the volume of output
required. If the demand is high but not in large quantities, batch is used. Mass marketing
requires flow production.
• Demand of the product- less frequent demand requires jobbing while larger and fairly
steady demand requires flow production.

JOB PRODUCTION

Used when a single product or small orders are completed by one/ a group of people from start to
finish to meet the customer’s individual requirements. Thus the products are customised (produced
according to the customer’s specifications)

Each order is different and it may not be repeated at all. It is usually used by small and new firms to
make products like wedding cakes, wedding gowns, building plan etc

It is the most expensive form of production, very labour intensive (requires few machines) and
requires highly multi-skilled labour.

ADVANTAGES DISADVANTAGES
• Product can be tailored to meet • Need a highly skilled workforce,
customer needs competent supervisors and
• It is suitable for personal services e.g management. Specialists are costly to
hair cuts attract and to keep at a business
• The workforce has greater • Production takes long. This is
involvement with the product. This because there is no automation or
increase job satisfaction. use of complex machines. It is
• The product meets the exact usually done manually.
requirements of the customer. This • Special materials are required leading
result in guaranteed customer to high cost of production. Only

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satisfaction. quality material is required.

• Use of skilled staff results in the • Products are specially made to order
production of quality products and any error is very expensive.
• High employee motivation. This is
because there is no monotony since
each task is different from others

BATCH PRODUCTION

-a method of production where items are made in groups with similar characteristics. Each item
in a group of products passes through a stage of production at the same time.

it is the production of a limited number of identical products to meet customer order or

specifications and each order is called a batch.
-It falls between job and flow production. It is commonly used by bakeries, furniture manufacturers etc

ADVANTAGES DISADVANTAGES
• It gives variety to workers’ jobs. This is • No product will be completed before
because workers work on different batches that another, lead time
may require different skills. This removes • Increase in costs since there is need for a
boredom from work very efficient control system in planning
• It allows more variety to be produced. This production
will increase consumer choice • Warehouse space will be needed for stock
• Materials can be bought in bulk. This will of raw materials and components.
give bulk discounts to the business • Machines have to be reset between
• Unit cost is lower than Jobbing. Producing production batches. This will result in
more goods reduces average cost of production delayed production and output is lost
• Production can be easily changed from one
product to another

FLOW PRODUCTION

-It is also known as mass/ continuous/ serial or repetitive production.

-It is the production of large quantities of a product in a continuous process. The products produced
are identical or standardised

-It uses a series of repetitive processes so that each item moves on to the next stage as soon as a
process is completed. Products pass along a conveyor belt or assembly line. It requires a high degree
of standardisation and specialisation

-It is more capital intensive- it requires more machines, robots and automation than people.
It is also very expansive to start because of the need to buy expensive machines and
automation.

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-The following products are produced using flow or mass production: chemicals, fuels, packaged
food products, cars, televisions etc

ADVANTAGES DISADVANTAGES
• Automation allows goods to be produced If one machine breaks down, the whole
quickly production line will have to be halted
• Mass production enables the business to It is very costly. This is because machines
enjoy the economies of scale which leads and automation are very expensive to buy
to lower prices Repetition of the same task can be boring
• Automated production lines can operate 24 to the worker
hours a day and 7 days a week It is not flexible. Once production lines are
• Time is saved since goods move on conveyor set it is difficult to switch to other methods
belts High warehousing costs since the mass
• Promotes specialisation. Repetition of the produced goods must be stored before delivery
same task makes the employee more to consumers
skilled Use of machines puts people out of their
• Materials can be bought in bulk. This will jobs
give bulk discounts to the business Only suitable for products with a large
market and high demand

MASS CUSTOMISATION

-It’s a flexible mass production system enabling customers to specify what features of a product/
service they want. This process combines the latest technology with multi-skilled labour force to
use production lines to make a range of varied products. This allows the business to move away
from the mass- marketing approach with high output of identical products. The businesses will
now use focused or differentiated marketing which allows for higher added value. Few changes to
the products are made using flexible computer aided production systems to produce items to
meet individual customers’ requirements at mass production cost levels

ADVANTAGES DISADVANTAGES
• Accurate records are kept. This is • It is very expensive to set up. Computers,
because of the use of computers to robots and machine are very expensive
keep records • Technology will become out-dated.
• Greater job satisfaction as boring and Technology keeps on changing
routine tasks are now being done by • Employees may need to be retrained to
computers use the new technology. This adds to
• New products are produced as new business costs
methods of production are introduced • Increased unemployment as workers will
• Better quality products are produced be replaced with machines
due to better production methods

Problems of changing operations methods

Setting up an operation method takes time, planning and capital. To change from one method to
another would mean taking apart the machinery and equipment and redesigning the whole production

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system. It would also mean that it might be necessary to redesign the product. It would be extremely
difficult and very expensive to produce some batch produced products by flow production

BUSINESS LOCATION

Business have to make the important decision of the best place to locate in order to operate well.
The location of the business can affect its costs, its demand, its image and its ability to attract
employees to work for it. Thuslocation choices should not be taken lightly and will involve decisions
at the most senior level. Influence on the final location depends on the type of business, size,
demands of the production process and the market.

FACTORS AFFECTING CHOICE OF LOCATION

• Market :- a factory must be closer to its customers to reduce transport costs. Perishable goods
must reach the market as fast as possible. Heavy products must also be manufactured near
customers

• Raw materials and Components :- if the raw materials are heavier to transport than the final
product, the firm must locate near raw material source to reduce transport cost. E.g sugar
cane is heavier than the manufactured sugar. Where mineral is processed from ore, the ore
is much heavier than the final product.

• Availability of Labour :- Workers operate machine and do all of the management and manual
work. If a process requires skilled labour, it is best to locate near people with the required
skills. If the manufacturing requires more unskilled labour, it is best to locate where there is
high unemployment

• Infrastructure and communication :- business need to be located near to transport system

such as roads, rail, inland water ways, sea-ports and air-ports. Good transport system
enables the business to be easily accessible by suppliers and customers

• Power and Water supply :- uninterrupted supplies of water and electricity can be a
competitive advantage to some industries where power and water are critical inputs e.g
steel manufacturing

• Government Influence :- Land is allocated to businesses by the government. It may also offer
grants to businesses to encourage them to locate in certain areas. On the other hand, the
government can also refuse businesses to locate in a certain area or may put restriction in
certain areas. Governments have planning regulations which determine where to build and
what to build.

• The costs of a particular location relative to other options :- the cost of land, for example,
will vary from area to area. The cost of land in major towns is very high than in small towns.
Thus locating in small towns can be a better option for small firms.

BENEFITS OF THE BEST (OPTIMAL) LOCATION

• Lower costs- decrease in transport costs leads to higher profits

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• Improves the firm’s competitiveness- being closer to customers may boost sales and profits
since the firm is able to sale at lower prices
• Overcoming trade barriers- to overcome trade restriction a firm may locate itself in a
particular country rather than exporting goods to that country.
• Attracting suitable job candidates- the firm will have access to the right job candidates at the
right time.
• Lower taxes- by locating itself in the designated areas, the firm may be exempted from paying
taxes or pay taxes at concessionary rates

BUSINESS RELOCATION

Relocation can be defined as a change in the physical location of a business OR the movement of a
business from one area/region to another. Relocation can occur within or between countries

Reasons why a business may want to change its location

• Infrastructural development in other locations

• Cheaper labour costs in other locations
• Changing objectives and strategies of the business
• Changing of location of suppliers or customers
• Change in government policies

Relocation costs

Changing location may involve costs such as:

• Finding and training new employees

• Finding new customers and suppliers
• Administrative costs of the change
• Redundancy payments
• Adjusting to the new set-up

Industrial Inertia: occurs when a business stays in its current location even though the factors that
led to its original location no longer apply. The costs of moving will be exceeding the costs of staying.
Large-scale industries like iron and steel production often display industrial inertia.

THE OPPORTUNITIES AND PROBLEMS OF ENTERING NEW MARKETS ABROAD

Opportunities of entering new markets abroad

• Sales growth- new markets increases a firm’s sales. This may boost company sales revenue
as new customers are buying the product
• Increased profits- The new markets abroad may result in more profits to the business.
Increased sales volumes mean more profits to the business
• Improved business image- a good image locally and internationally may result because the
business is selling in foreign and competitive markets, the business products will be seen as of
high quality
• Earn foreign currency- foreign currency obtained can be used to acquire new machinery in
foreign countries

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• Cultural differences- different countries have different cultures. The firm needs to understand
the culture of the country they intent to enter for them to be successful.
• Lack of knowledge- the business may lack marketing knowledge of the new country or market
e.g consumer preferences, goods offered by competitors, advertising methods and distribution
methods
• Lack of foreign currency- the business may not have sufficient foreign currency to pay for
workers, taxes, rentals and advertising

• Form joint ventures- the business can join with an existing local business. The business will
have knowledge from the local business who understands the local market.

• Use local agents and local dealers- the business can engage local dealers to distribute and
market the goods for business. The local agents have local marketing information and they
know the best methods to distribute the goods
• Primary and Secondary research- essential information about the products, customers,
markets is obtained through conducting market research.

ECONOMIES AND DISECONOMIES OF SCALE

-businesses can expand by employing more of a few or all of the factors of production.

-scale of production is changed when all the factors of production are changed.

-Large scale operation leads to a fall in the average total cost (cost per unit). On the other
hand, when the organisation continues to grow beyond a certain optimal level, unit cost may
begin to increase

-Thus large scale operations may result in a decrease (economies of scale) or increase (diseconomies of
scale) in the unit cost

ECONOMIES OF SCALE

-refers to the cost saving advantages that a business can exploit by expanding their scale of production.
Thus making things cheaper because they are bigger. The effect is to reduce the long run average cost
of production over a range of output.

-economies are divided into internal and external economies of scale

INTERNAL ECONOMIES OF SCALE

-internal economies of scale arises from the growth of the firm itself. Thus the average cost will
decrease as the firm employees more capital and labour

SOURCES OF INTERNAL ECONOMIES OF SCALE

a)Purchasing Economies of Scale

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Large firms receive discounts when they buy raw materials in bulk. Thus the cost of acquiring raw
materials will decrease leading to a fall in the unit cost/ average cost. A 5% trade discount will lead to a
5% decrease in the cost of production and the cost per unit

b)Marketing Economies of Scale

A large firm can spread its advertising and marketing budget over a large output. Advertising is
charged per total time on airplay (TV/ Radio) or space (Newspaper) not on the size of the business.
As the firm grows in size, the average marketing cost will decrease

c)Financial Economies of Scale

Large businesses may be able to access finance at lower interest rates because of the growth of the
business. Large businesses are usually rated by the financial markets to be more ‘credit worth’ and
have access to credit facilities with favourable rates of borrowing

d)Managerial Economies of Scale

Large scale manufacturers can afford to employ skilled workers to supervise and to carry out
production. Effective leadership can also lead to an improvement in worker motivation. Skilled
workers will also help reduce wastages. Employees also become experts due to the length of
experience in a market and the cost per unit will decrease

e)Technical Economies of Scale

Large scale businesses can afford to invest in very expensive and specialist capital machinery. For
example, a National Chain Supermarket can invest in technology that improves stock control and
helps to control costs. It would not be viable or cost efficient for a small corner shop to buy this
technology.

The LAW of increased dimensions –this is linked to the cubic law where doubling the height and width
of a tanker or building leads to a more than proportionate increase in the cubic capacity. It is an
important aspect in the distribution and transport industries

f)Risk Bearing Economies of Scale

A large firm is able to provide a wide range of products in different markets. This lowers the risk of
putting all eggs in one basket. McDonalds hamburgers and French fries share the use of food storage
and preparation facilities.

EXTERNAL ECONOMIES OF SCALE

External economies of scale exist when the long term expansion of an industry leads to the
development of ancillary (something additional) services which benefit all or some of the
businesses in the industry. External economies partly explain the tendency for firms to cluster
geographically.

SOURCES OF EXTERNAL ECONOMIES OF SCALE

a)Supply of raw materials- as the industry grows, suppliers of raw materials will be willing to locate
themselves

close to the manufacturers. This will reduce transport costs to the manufacturers in a given industry.

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b)Better transport network- as the industry grows, there will be massive infrastructural development
in the area.

The development of transport networks cut costs and also saves time.

c)Research and Development Facilities- businesses can benefit from researches done by local
universities

d)Economies of information- business in the same industry may share vital information about the
market or about the economy in general. This reduces the cost of acquiring information to a single
business.

e)Trade Magazines- enables all firms in an industry to advertise and disseminate information cheaply.

Diagram : Internal and External Economies of scale

DISECONOMIES OF SCALE

Diseconomies of scale leads to a rise in the long run average cost. Average cost rises due to firms
expanding beyond their optimum scale (Optimum-right size)

SOURCES OF INTERNAL DISECONOMIES OF SCALE

a)Managerial Diseconomies of Scale- monitoring the productivity and quality of output from
thousands of employees in big corporations is imperfect and costly.

b)Administrative Diseconomies of Scale- these are associated with the bureaucratic structures of large
firms where long channels of communication and complex administrative procedures delay effective
action. Instructions from the top management may be partly or completely distorted if they are to
follow a long channel of communication down the organogram.

c)Over-specialisation- workers in large firms my feels a sense of alienation and subsequent loss of
morale. If they do not consider themselves to be an integral part of the business, their productivity
may fall leading to wastage of factor inputs and higher costs.

Diagram: Internal and External Diseconomies of Scale

4.3 Capacity utilisation and outsourcing

Measurement and significance of capacity utilisation

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The maximum capacity means the total possible level of sustained output a business can achieve in a
given time period. Capacity utilisation measures the proportion of that capacity that is currently being
used. Capacity utilisation is calculated by the formula:

rate of capacity utilisation = current output/maximum output × 100

Operating at over maximum capacity

The definition of maximum capacity contains an important term: ‘sustained’. This suggests that it is
the highest output level that can be maintained over a reasonable period of time. It might be possible,
during emergency situations, to achieve higher output levels for very short time periods. This could be
done by using machines beyond their safe working limits and by asking labour to work longer than the
contractually permitted hours. Obviously, this situation is not sustainable or recommended. It could
result both in machines breaking down, and in workers being too stressed to sustain high levels of
output in future.

Operating at under maximum capacity

When a business is operating at less than full capacity it means that there is excess capacity. Low levels
of capacity utilisation lead to high unit fixed costs. What options do businesses have when trying to
improve capacity utilisation? Options for improving capacity utilisation depend on whether the excess
capacity is a short-term or long-term problem.

Short-term excess capacity

This might be caused by low seasonal demand. Options for improving capacity utilisation in the short
term include: • Maintaining high output levels. This strategy adds to inventories and could be
expensive and risky if sales do not recover.

• Adopting a more flexible production system, allowing other products to be made that could be sold
at other times of the year. This needs a flexible workforce and production resources.

• Insisting on flexible employment contracts so that, during periods of low demand and excess
capacity, workers work fewer hours to reduce capacity and costs. This may have a negative impact on
employee morale and motivation. Long-term excess capacity This might be caused by an economic
recession or technological changes which reduce demand for a business’s existing products

Options Advantages Disadvantages

Rationalisation – closing • Redundancy payments might
factories or other production • This reduces overheads. have to be paid.
units • It results in higher capacity • Workers may worry about job
utilisation from the remaining security.
production units. • Industrial action may be a risk.
• Capacity may be needed later
if the economy picks up or if the
business develops new products.
• The business may be criticised

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for not fulfilling its social

responsibilities.
Research and develop new • New products will replace • This may be expensive.
products existing products and make the • It may take too long to
business more competitive. prevent cutbacks in capacity and
• If introduced quickly enough, rationalisation.
new products might prevent • Without long-term planning,
rationalisation and associated new products are introduced
problems. too quickly, without a clear
market strategy, and may be
unsuccessful.

Capacity shortage

What options does a business have if the demand for its products exceeds current output capacity?
The business has a capacity shortage, which is the opposite situation to excess capacity.

Options Advantages Disadvantages

Use subcontractors or • No major capital investment is • It gives less control over the
outsourcing of supplies, required. quality of output.
components or even finished • It should be quite quick to • It may add to administration
goods arrange. and transport costs.
• It offers much greater • There may be uncertainty over
flexibility than expansion of delivery times and reliability of
facilities – if demand falls back,delivery.
then contracts with other firms • Unit cost may be higher than
can be ended. inhouse production due to the
supplier’s profit margin.
Invest capital in the expansion of • It increases capacity for the • The capital cost may be high.
production facilities long term. • There may be problems with
• The business is in control of raising capital.
quality and final delivery times. • It increases total capacity, but
• The new facilities should be problems could occur if demand
able to use the latest equipment should fall for a long period.
and methods. • It takes time to build and equip
• Other economies of scale a new facility and customers
should be possible too. may not wait.

Outsourcing

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reasons for outsourcing:

• Reduction and control of operating costs: Instead of employing expensive specialists who might not
be required at all times, it could be cheaper to buy in specialist services as and when they are needed.
These specialist service providers may be cheaper because they benefit from economies of scale, as
they provide similar services to other businesses as well. Much outsourcing involves offshoring, i.e.
buying in services, components or completed products from low-wage economies.

• Increased flexibility: By removing departments altogether and buying in services when needed, the
fixed costs of office and factory space and salaried employees are converted into variable costs.

• Improved company focus: By outsourcing peripheral activities, the management can concentrate on
the main objectives and tasks of the business. These are called the core parts of the business. So, a
small hotel might use management time to improve customer service and outsource the accounting
function completely.

• Access to quality service or resources that are not available internally. Many outsourcing firms
employ quality specialists that small to medium-sized businesses could not afford to employ directly.

• Freeing up internal resources for use in other areas. For example, if the HR department of an
insurance company is closed and HR functions are bought in, then the office space and computer
facilities previously used by HR could be made available to improve customer service.

There are also potential drawbacks to outsourcing:

• Loss of jobs within the business: This can have a negative impact on employee motivation. Workers
who remain directly employed may experience a loss of job security.

• Quality issues: The quality levels of the goods or services being outsourced will be difficult to check
on. A clear contract with minimum service level agreements or product quality standards will be
needed.

• Customer resistance: This could take several forms. Overseas telephone call centres have led to
criticism from customers about their inability to understand foreign operators.

• Security:

• Corporate social responsibility (CSR): Using outsourced contracts, especially in low-wage economies,
means that the business is less able to ensure that its CSR policy towards workers or the environment is
being upheld.

4.4 INVENTORY MANAGEMENT

STOCK MANAGEMENT

-it also kwon as stock control. Stock management occurs when the purchasing department aims to
minimise cost of stock by maintaining adequate levels of stock. Thus the purchasing department

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must obtain the right quality at the right time in the right quantity, from the right source at the
right price.

Reasons for holding stock ( or purpose of stock control)

•
Stock of raw materials is kept in order to meet production requirement
•
Stock of work-in-progress is maintained in order to continue the production process
and allowing greater flexibility and better utilisation of time and machinery.
•
Stocks of finished goods are maintained in order to meet customers’ demand on time
•
Stocks of equipment and spares are kept in order to support sales and production
•
To control cash tied up in stocks
•
To control wastage and pilferage (stealing of small items/amounts at a time)

TYPES OF INVENTORY

• Raw materials-: the basic materials from which a product is made and they are usually
bought from outside.
• Work-in-progress-: unfinished project that is still being added to or developed or
partially completed goods
• Finished products-: goods that have completed the manufacturing process

COSTS OF HOLDING HIGH LEVEL STOCK

•
Opportunity cost as capital is tied up in stored stocks
•
Storage costs will increase
•
Increase in spoilage
•
Rise in administrative and finance costs e.g insurance
•
Wastage of resources in a period of lower demand in the market
•
Risk of theft
COSTS OF HOLDING INADQUATE / LOW LEVEL OF STOCK
•
Lost sales which are known as out-of-sale costs
•
Idle production resources i.e the machines will be operating below capacity
•
Ordering costs will increase since the firm places more number of orders in a given period
•
The advantage of bulk buying cannot be achieved

BENEFITS OF HOLDING HIGH LEVEL STOCK

•
The firm can enjoy the benefit of bulk buying
•
There is production flexibility since the business will be having enough stock at any given time
•
Machine and factory plant will be operating at full capacity at all times
•
Enough stock will be available to support production and sales
•
Storage costs are reduced
•
Insurance costs are minimised
•
Capital is not unnecessarily held or kept in stocks
•
Minimum wastages in a period of reduced demand
•
Risk of theft and spoilage is reduced

MANAGING INVENTORY

-involves the stock control techniques

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a)BUFFER STOCK

-refers to the reserves of stock kept to cater for eventual stock out or uncertainties. To avoid the risk
of running out of stock, the business must have reserved stock -this technique is used to avoid stock
out costs which are:-
•
Lost production
•
Lost contribution from lost sales
•
Loss of customer good will
•
High unit costs associated with urgent purchases
•
Loss of bulk buying discounts

b)RE-ORDER LEVEL

-refers to the level of stock at which a new order is placed with the supplier. The quantity of this order
or the re-order quantity will be influenced by the economic order quantity (EOQ)

-EOQ refers to the quantity of materials ordered at cash point to minimise the total annual stocking
costs or the least cost quantity of stock to re-order taking into account delivery costs and stock holding
costs.

-EOQ depends on -: -interest on capital

-storage costs

-wastage costs

-insurance costs

c)OPTIMUM STOCK LEVEL TO BE HELD

-refers to the right quality and quantity of stocks to be kept at the business to promote the smooth
running of production.

TOTAL STOCK COSTS= stock holding costs + out of stock costs

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d).INVENTORY CHATRS- is a tool used to control stock

MAXIMUM STOCK- refers to the highest amount of stock kept and it is limited by space and the
financial costs of holding higher levels

MINIMUM STOCK- is also known as buffer stock. This is the minimum number of stock that should be
held to ensure that production still continue in case of delay in the delivery of raw materials RE-ORDER
LEVEL- this is the level of stock at which a new order is placed with the supplier. The quantity of the
new order will be influenced by the EOQ

LEAD TIME- it is the amount of time it takes for a stock purchased to be received, inspected and
made ready for use. If more time is required between ordering new stocks and their delivery then a
higher minimum stock is needed

JUST-IN-TIME (Inventory Management)

-it is a stock control system in which material is scheduled to arrive exactly when it is needed
forproduction and in the exact quantity. Raw materials are reduced to zero and finished goods
inventoriesare minimised by matching production to demand. Thus JIT does not require any Buffer
Stocks to be held.The components arrive just at the time that they are needed and the finished goods
are delivered to customers as soon as they are completed

Requirements for JIT Production

i).Employee Flexibility- employees of the firm should be multi-skilled and should be able to switch
jobs quickly so that excess stocks of raw materials won’t build up.

ii)Flexibility of Machinery- modern, computerised machinery is required for JIT production as it

can produce a wide range of products just by changing a single software

iii)Excellent relationships with suppliers- it should be possible for suppliers to be able to supply
raw materials at short notice.

iv)Accurate demand forecast- this will enable the business to produce a reliable production
schedule which would help in the calculation of precise number of goods to be produced over a
certain time

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v)Extensive use of IT- computerised records of sales and stock levels would allow minimum stocks to
be held. Electronic communication with suppliers would enable accurate delivery of supplies

vi)Strict quality control/ zero defect- since there are no spare stocks, therefore goods have to
be produced correctly the first time otherwise customer orders will not be completed on time.

BENEFITS OF JIT DISADVANTAGES OF JIT

• •
The right quantities are produced or It is associated with high start-up
purchased at the right time cost
• •
Improvements on product quality Advantages of bulk buying are lost
• •
Improved customer service Delivery costs rises as frequent
• small orders are delivered
Reduction in storage costs
• •
Less chance of stock being out-dated or Administration costs rises as so
obsolescent many small orders need to be processed
• •
Less stock reduce the risk of damage and Doesn’t work when demand is
wastage unpredictable
•
Higher profits due to overall decrease in
costs

5.1 Business finance

Why businesses need finance

• Setting up a business will require cash injections from the owner(s) to purchase essential capital
equipment and, possibly, premises. This is called start-up capital.

• All businesses need to finance their working capital, the day-to-day finance needed to pay bills and
expenses and to build up inventories. In accounting terms, working capital = current assets – current
liabilities.

• When businesses grow, further finance will be needed to buy more assets and to pay for higher
working capital needs. Growth through developing new products will require finance for research and
development.

• Growth can be achieved by taking over other businesses. Finance is then needed to buy out the
owners of the other firm.

The difference between cash and profit

Many business failures result from owners and managers not understanding the difference between
cash and profit. In contrast, all successful entrepreneurs and managers understand that these two
financial concepts do not have the same meaning or significance. It is very common for profitable
businesses to run short of cash.

Start-up Capital – the capital needed by an entrepreneur to set up a business

Working Capital – the capital needed to pay for raw materials, day-to-day running costs and credit
offered to customers.

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WORKING CAPITAL = Current Assets – Current Liabilities

Meaning and importance of working capital

Working capital is the finance needed by all businesses to pay for everyday expenses, such as wages
and buying inventory. Without sufficient working capital, a business will be illiquid and unable to pay
its immediate or shortterm debts. What happens in cases such as this? Either the business raises
finance quickly, for example as a bank loan, or it may be forced into liquidation or administration by its
creditors (the firms it owes money to).

Working Capital Cycle – the longer it takes for this cycle to be completed, the more working capital
needed. It needs to be managed effectively by concentrating on the four main components:

• Debtors

o No extending credit to customers

o Debt factoring
o By being careful to discover whether new customers are creditworthy
o By offering discount to clients who pay promptly

• Credit

o Increasing the range of goods and services bought on credit

o Extend the time taken to pay

• Inventory

➢ Keeping smaller inventories

➢ Using technology to enhance re-ordering
➢ Efficient inventory control
➢ Use Just in Time (ordering stock just before necessary)

• Cash

➢ Use of cash flow forecasts

➢ Wise use or investment of excess cash
➢ Planning for periods where there may be insufficient cash inflows

Liquidity – the ability of a firm to be able to pay its short-term debts

Liquidation – when a firm ceases trading and its assets are sold to pay for suppliers and creditors

Insolvent – when a business cannot meet its short-term debts

Capital Expenditure – the purchase of assets that are expected to last for more than one year, such
as building or machinery

Revenue Expenditure – spending on all costs and assets other than fixed assets and includes wages
and salaries and materials bought for stock

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Business Plan – a detailed document giving evidence about a new or existing business, that aims to
convince external lenders and investors to extend finance to the business

Equity Finance

Equity Finance – permanent finance raised by companies through the sale of ownership of the
business/shares. This can be done in two ways:

• Obtain a listing on the Alternative Investment Market (AIM), which is part of the stock
exchange concerned with smaller companies

• Apply for a full listing on the stock exchange by selling at least 50,000 worth of shares and
having a satisfactory record of investment to feel confident. This sale of shares can be undertaken in
two main ways:

o Public issue by prospectus

o Arranging a placing of shares with institutional investors without the expense of a full
public issue. This is often done by means of a rights issue of shares.

Rights Issue – existing shareholders are given the right to buy additional shares at a discounted price

Internal Sources of Finance

Retained Profit – earned profit that is not taken as tax or used to pay owners or shareholders

➢ Once invested back into the business the retained earnings will not be paid out
➢ Newly formed companies or ones trading at a loss will not have access
➢ May be insufficient

Sale of Assets

➢ Assets can be sold to leasing company and leased back

➢ Opportunity cost of selling assets that could be used in the future

Reductions in Working Capital

Money raised through selling assets or reducing debt

➢ Firm’s liquidity may be reduced to risky level

➢ Help in dealing with short term finance problems

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External Sources of Finance

Term of finance Source of finance Advantage Disadvantage

Short-Term Bank Overdraft – bank Amount raised can vary Often High Interest
agrees to a business from day-to-day Rates, Bank can ‘call in’
borrowing up to an overdraft – force firms
agreed limit as and to pay back
when required

Debt Factoring – Any debts to the Only a proportion of

selling of claims over business can be the value of the debts
trade receivables to a received immediately will be received as cash
debt factor in
exchange
for immediate liquidity

Trade Credit – delaying Extra existing finance, Supplier confidence

the bills for goods and no interest rates must lost, quick payment
services to suppliers or be paid for this ‘loan’ discounts lost
creditors

Medium Term Leasing – obtaining the Avoids raising long-term Periodic payments may
use of equipment or capital to buy assets, total more than one
vehicles and paying a leasing company payment, asset
rental or leasing charge repairs/upgrades returned after use
over a fixed period
Hire purchase – when The asset belongs to the Periodic payments may
an asset is sold to a company, purchase total more than one
company that agrees to made over time payment
pay fixed
repayments over an
agreed time period
Medium-term Loan Bank can supply large Interest rates must be
sum quickly paid back to bank,
collateral must be
provided
Long term Share Issue – selling Nothing needs to be Ltds cannot sell shares
some ownership of the paid back publicly, expensive to
business to investors join stock exchange,
risk of takeovers, some
loss of ownership,
Debentures – bonds Usually not Company must pay
issued by companies to secured on an fixed rate of interest
raise debt finance, asset, convertible each year
often with a fixed rate debentures can be
of interest turned into shares
overtime so the
company issuing
them will not have
to pay it back
Long-term Loan – loans Bank can supply a large Interest rates must be
that do not have to be sum quickly that does paid back to bank,
repaid for at least one not have to be paid collateral must be
year back for awhile provided

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Grants – money Do not have to be Difficult to receive – the

donated to the business repaid if conditions are business has no choice
by outside agencies met over who gets the
grants

Advantages of loans Advantages of share capital

• No shares are sold so ownership of the company • It never has to be repaid. It is permanent capital,
does not change and is not diluted by the issue of unlike loans which must eventually be repaid.
additional shares. • Dividends do not have to be paid every year.
• Loans will be repaid eventually so there is no Directors can decide to retain more earnings by
permanent increase in the liabilities of the reducing dividend payments. In contrast, loan
business. interest must be paid even if the profit of the
• Lenders have no voting rights at the annual business is low or a loss is made.
general meetings. • It lowers the indebtedness of the business, so
• Interest charges are an expense of the business debt finance becomes a lower proportion of total
and are paid out before corporation tax is long-term finance.
deducted. Dividends on shares, however, have to
be paid from profits after tax.
• The level of indebtedness (gearing) of the
company increases and this gives shareholders
the chance of higher returns in the future

Other Sources of Finance

Venture Capital – risk capital invested in business start-ups or expanding businesses that have good
profit potential but do not find it easy to gain finance from other sources

Microfinance – providing financial services for poor and low-income customers who do not have access
to banking services, such as loans and overdrafts offered by traditional commercial banks

Crowd Funding – the use of small amounts of capital from a large number of individuals to finance a
new business venture

Factors Influencing Choices of Finance

• Use of finance
• Size of existing borrowing
• Flexibility of firm’s need for finance
• Legal structure and desire to retain control
• Amount required
• Cost of debt
• Time period for which finance is required
• Existing assets of the firm

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5.2 Forecasting and managing cash flows

Cash Flow Statement – shows where the firms funds have come from and how they have been
used during the previous financial year

Cash inflow/outflow – cash coming into/out of the business

Opening Balance – cash held by the business at the start of the month

Closing Balance – cash held by the business at the end of the month, becoming next
month’s opening balance

Net monthly cash-flow – estimated difference between monthly cash inflow and outflow
Cash-flow forecast – estimate of a firm’s future cash inflows and outflows

Example Cash Flow

Month January February March April May

Cash Inflows

Bank Loan 4000

Sales Revenue 11760 11760 11760 11760 12720

Owners Savings 6000

Total Cash Inflows 11760 21760 11760 11760 12720

Cash Outflows

Purchases 4998 4998 4998 4998 5406

Fixtures 15000

Loan Repayments 325 325 325

Mortgage 750 750 750 750 750

Rates 260 260 260

Expenses 800 800 800 800 800

Advertising 175 175 175 175 175

Insurance 150 150 150 150 150

Wages 3528 3528 3528 3528 3528

Total Cash Outflows 10401 25401 10986 10986 11682

Opening Balance 5675 7034 3393 4167 4941

Net Cash Balance 1359 -3641 774 774 1038

Closing Balance 7034 3393 4167 4941 5979

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Limitations of Cash Flow

• Mistakes can be made in preparing the revenue and cost forecasts or they may be drawn
up by inexperienced entrepreneurs or staff

• Unexpected cost increases can lead to major inaccuracies in forecasts e.g. fluctuations in
oil prices can lead to the cash-flow forecasts of airlines being misleading

• Wrong assumptions can be made in estimating the sales of the business, perhaps based on
poor market research and this will make the cash inflow forecasts inaccurate
Causes of Cash-Flow Problems

• Lack of planning
• Poor credit control
• Allowing customers too long to pay debts
• Expanding too rapidly/Overtrading
• Unexpected events i.e. equipment breakdowns, weather

Credit Control – monitoring of debts to ensure that credit periods are not exceeded

Bad Debt – unpaid customers’ bills that are now very unlikely to ever be paid

Overtrading – expanding a business rapidly without obtaining all of the necessary finance so that a
cash-flow shortage develops

How to Improve Cash flow

Increase cash inflows

• Get Overdrafts – allows for business to draw as necessary up to limit, however these can be
withdrawn from bank and come with possibly high interest rates
• Short Term Loans – fixed inflow borrowed for agreed length in time, however with interest
costs and must be repaid by due date
• Sale of assets – cash receipts can be obtained from selling off redundant assets, which will boost
cash inflow; however selling assets quickly may result in low prices or assets may be required at
a later date for expansion or as collateral
• Reduce credit terms to customers – cash flow can be brought forward by reducing credit
terms, however customers may purchase the product from other firms that offer extended
credit terms
• Debt factoring – debt factors can buy the customers’ bills and offer immediate cash; however
the firm does not receive the entire debt

Reduce outflows

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• Delay payment to suppliers (creditors) – cash outflows will fall in the short term if bills are
paid later; however with delayed payment the supplier may reduce discounts or perceive
this as too much of a risk
• Delay spending on capital equipment – by not buying these, cash will not have to be paid to
suppliers; however efficiency of business may fall if outdated and inefficient equipment is not
replaced, as well as making expansion difficult
• Use leasing of capital equipment – no large cash outflow is required to use the equipment,
however the firm must pay leasing charges and the firm has no ownership of the asset
• Cut overhead spending e.g. promotion costs – costs will not reduce production capacity
and cash payments will be reduced; however future demands may be affected

5.3 Costs

Fixed Costs – costs which do not change with output. These must be paid even when output is zero

Variable Costs – costs of variable factors that do change with output.

Direct Costs – costs that can be clearly identified with each unit of production and can be allocated
to a cost centre

Indirect Costs – costs that cannot be identified with a unit of production or allocated accurately to a
cost centre

Marginal Costs – the extra cost of producing one more unit of output

Total Costs – all costs required in the production process

TOTAL COSTS = Fixed Costs + Variable Costs

Revenue – total value of sales made by a business in a given time period

TOTAL REVENUE = Price x Quantity

Profit/Loss – how much money the firm has made once costs of production have been taken into
account

PROFIT/LOSS = Total Revenue – Total Cost

Break Even Analysis

Breaking Even – the level of output where total revenue is equal to total cost

BREAKEVEN POINT OF OUTPUT =

Contribution – how much per unit a company’s variable cost can contribute to paying the fixed costs.

Once the fixed costs are covered, it can then contribute to profit.

CONTRIBUTION = Selling Price – Variable Cost

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Margin of Safety – the difference in terms of units of production, between the current
production level and the break-even level

Total Revenue

$ Total Costs

Variable Costs

Break Even

Point Fixed Costs

Output

Advantages Disadvantages

Charts are relatively easy to construct and Assumption that costs and revenues are

interpret. represented by straight lines is unrealistic.

Analysis provides useful guidelines to There is no allowance made for inventory levels

management on break-even points, safety on the break-even chart. It is assumed that all

margins and profit/loss levels at different rates units produced are sold. This is unlikely to always

of output. be the case.

Comparisons can be made between different It is unlikely that fixed costs remain unchanged

options by constructing new charts to show at different output levels up to maximum

changed circumstances. capacity.

Break-even analysis can be used to assist Not all costs can be conveniently classified into

managers when taking important decisions. fixed and variable costs e.g. electricity

The equation produces a precise breakeven

result.

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Approaches to costing

Important concepts

Before studying the two main costing methods, four important concepts need to be understood:

cost centres, profit centres, overheads and average costs.

Cost centres

Examples of cost centres are:

• in a manufacturing business: products, departments, factories, particular processes or stages in production,

such as assembly

• in a hotel: the restaurant, reception, bar, room letting and conference section

• in a school: different subject departments. Different businesses will use different cost centres as appropriate
to their own needs. Profit centres Examples of profit centres are:

• each branch of a chain of shops

• each department of a department store

• in a multi-product firm, each product in the overall portfolio of the business.

The benefits of using cost and profit centres are:

• Managers and employees have targets to work towards. If these are reasonable and achievable, this should
have a positive impact on motivation.

• These targets can be used to compare with actual performance and help identify those areas that are
performing well and not so well.

• The individual performances of divisions and their managers can be assessed and compared.

Overheads

These indirect expenses of a business are usually classified into four main groups:

• Production overheads: including factory rent and rates, depreciation of equipment and power.

• Selling and distribution overheads: including warehouse, packing and distribution costs, and salaries of sales
employees.

• Administration overheads: including office rent and rates, clerical and executive salaries.

• Finance overheads: including interest on loans.

Full costing technique

Full costing allocates all costs to each product. If the business is only producing one type of product, then this
is not a problem. In this case, the stages in full costing are:

• Identify and add up all of the direct costs.

• Calculate the total overheads of the business for a given time period.

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• Add the total direct costs of making the product.

• Calculate the average cost of producing each product by dividing total costs by output.

Uses of full costing

• Full costing is particularly relevant for single-product businesses. In these businesses there is no uncertainty
about the share of overheads to be allocated to the product.

• All costs are allocated so no costs are left out of the calculation of total full cost or unit full cost.

• Full costing is a good basis for pricing decisions in single-product firms. If the full unit cost is calculated, this
could then be used for cost-plus pricing.

• Full costing data can be compared from one time period to another to assess performance, as long as the
same method of allocating overheads is used.

Limitations of full costing

• There is no attempt to allocate each overhead cost to cost centres or profit centres on the basis of actual
expenditure incurred. For example, a product may take up a large proportion of factory space but use low-cost
and easy-to-maintain machinery. Should all overheads be allocated on the basis of factory space?

• Inappropriate methods of overhead allocation can lead to inconsistencies between departments and
products.

• It can be risky to use this cost method for making decisions. The cost figures arrived at can be misleading.
See the section on ‘Contribution costing and decision-making’.

Contribution costing

Contribution or marginal costing Contribution costing solves the problem of deciding on the most appropriate
way to allocate or share out overhead costs between products – it does not allocate them at all. Instead, the
method concentrates on two very important accounting concepts:

• Marginal cost – the cost of producing an extra unit – is a variable direct cost. For example, if the total cost of
producing 100 units is $400 000 and the total cost of producing 101 units is $400 050, the marginal (or extra)
cost is $50.

• The contribution of a product is the revenue gained from selling a product less its marginal (variable direct)
costs. This is not the same as profit. Profit can only be calculated after overheads have also been deducted.
For example, if the 101st unit with a marginal cost of $50 is sold for $70, it has made a contribution towards
indirect costs of $20. The unit contribution is the difference between the sale price ($70) and the marginal cost
($50) = $20.

There are dangers in this policy, however:

• Existing customers may realise lower prices are being offered to new customers and demand a similar price.
If all goods or services being sold by a business are sold at just above marginal cost, then this could lead to an
overall loss being made.

• When high prices are a key feature in establishing the exclusivity of a brand, then to offer some customers
lower prices could destroy a hard-won image.

• Where there is no excess capacity, sales at a price based on contribution cost may be reducing sales based
on the full cost price.

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• In some circumstances, lower-priced goods or services may be resold into the higher-priced market by
customers themselves.

Situations when contribution costing would be used

• Contribution costing avoids inaccuracies and arbitrary indirect cost allocations and gives a contribution, not a
profit total. Contribution costing can therefore be used in setting prices that just cover the direct costs of
production.

• Decisions about a product or profit centre are made on the basis of its contribution to indirect costs – not
profit or loss based on what may be an inaccurate full cost calculation. Contribution costing can therefore be
used in decision-making over whether to close a cost/profit centre.

• Excess capacity is more likely to be effectively used, if special orders or contracts that make a positive
contribution are accepted. Contribution costing can therefore be used in decision-making on special order
decisions. Situations when contribution costing would not be used

• By ignoring indirect costs, contribution costing does not take into account that some products may result in
much higher indirect costs than others. In addition, single-product firms have to cover the fixed costs with
revenue from this single product, so using contribution costing would not be used in this case.

• Contribution costing would not be used when making decisions about business expansion or developing new
products. All costs of these developments will need to be considered, not just the direct costs.

• Contribution costing may lead managers to choose to maintain the production of goods just because of a
positive contribution. Perhaps a brand-new product should be launched instead that could, in time, make an
even greater contribution.

5.4 Budgets

Benefits of using budgets Potential drawbacks of using budgets

• Planning: • Lack of flexibility

• Allocating resources: • Focus on the short term:
• Setting targets: • Unnecessary spending: If managers have
• Coordination underspent their budgets just before the end of the
• Controlling and monitoring a business budgeting period, they might make decisions to
• Measuring and assessing performance spend unnecessarily
• Training on budgets:
• Budgets for new projects: Setting budgets for big
new projects is very difficult and often inaccurate.
This is particularly true if similar projects – like a
super-fast train line – have not been undertaken
before.

Key features of effective budgeting

• A budget is not a forecast but a plan that businesses aim to fulfil. A forecast is a prediction of what could
occur in the future given certain conditions.

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• Budgets may be established for any part of an organisation as long as the outcome of its operation is
measurable. This means most cost centres and profit centres will have budgets set, including budgets for
sales, capital expenditure, labour costs and profit.

• Coordination between departments when establishing budgets is essential. This should avoid departments
making conflicting plans.

• Budget setting should involve participation. Delegated budgeting

Setting and using budgets

There are several ways in which the budget level can be set.

• Incremental budgeting This method takes last year’s budget and makes changes for this year based on
last year’s budget.
• Zero budgeting The zero budgeting approach requires all departments and budget holders to justify
their whole budget each year.
• Flexible budgeting

Variance analysis

A variance is the difference between a budget and the actual figures achieved at the end of the budget
period. It is important to calculate and analyse the reasons for these variances because:

• Variances measure differences from the planned performance of each department over a
given period. Measuring performance is a key benefit of budgets.
• Finding out the reasons for variances can help set more realistic budgets in the future.
• Finding out the reasons for variances can help the business take better decisions. For example,
if the revenue variance for a business was negative because of lower sales caused by an
economic recession, then reducing prices might be the right decision to make.

Possible causes of adverse variances Possible causes of favourable variances

• Revenue is below budget because either fewer units • Revenue is above budget due to higher-than-
were sold or the selling price had to be lowered due expected economic growth or a competitor closing
to competition. down.
• Actual raw material costs are higher than planned • Raw material costs are lower because either output
because either output was higher than budgeted or was below budget or the unit cost of materials was
the cost per unit of materials increased. below budget.
• Labour costs are above budget because either wage • Labour costs are below budget because of either
rates were raised due to shortages of workers or the lower wage rates or quicker completion of the work.
labour time taken to complete the work was longer • Overhead costs are lower than budgeted, perhaps
than expected. because the interest rate on loans was reduced.
• Overhead costs are higher than budgeted

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