© 2006 University of South Africa

Revised edition 2010

All rights reserved

Printed and published by the

University of South Africa
Muckleneuk, Pretoria

MNB1601/1/2011–2013

98621718

InDesign

MNB_Style
CONTENTS

1 Study unit Page

INTRODUCTION iv

TOPIC 1: OPERATIONS MANAGEMENT 1

Study unit 1: The operations management function 2

Study unit 2: Operations management: activities, techniques and methods 9

TOPIC 2: THE HUMAN RESOURCE FUNCTION 19

Study unit 3: Meeting human resource requirements and developing efectiveness in HR 20

Study unit 4: Motivating employees 36

TOPIC 3: THE MARKETING FUNCTION 47

Study unit 5: The marketing process 48

Study unit 6: The marketing instruments 65

TOPIC 4: FINANCIAL MANAGEMENT 85

Study unit 7: The inancial function and inancial management 86

Study unit 8: Asset management: the investment decision 97

Study unit 9: Financing decisions 104

TOPIC 5: THE PURCHASING AND SUPPLY FUNCTION 113

Study unit 10: Purchasing and supply management 114

Study unit 11: Sourcing activities 123

REFERENCES 136

(iii) MNB1601/1/2011-2013
INTRODUCTION

MODULE AIM
The purpose of this module is to develop learners’ understanding of the individual
2

functional areas of business management which ultimately form a synergistic whole

that directs the business towards its goals. These functional areas are human resources,
marketing, inance, operations and purchasing.

MODULE OUTCOMES
3 When you have worked through this module you should be able to:

• explain how human resource requirements can be met and how efective human
resources can be developed
• explain how human resources can be motivated and managed
• describe the marketing process
• explain the marketing instruments of product, price, distribution and market-
ing communication
• apply inancial management concepts and principles relating to inancial analysis,
investment decisions and inancing decisions in order to achieve continued inancial
health in a business
• manage the operations of a business by using sound operational activities, techniques
and methods to optimise the transformation of inputs into outputs
• plan, organise and control the purchasing and control function in such a manner that
it helps achieve the objectives of the business

STUDYING THE PRESCRIBED BOOK

The prescribed book for Business Management I, which is used in both modules MNB1501
4

and MNB1601, is Introduction to Business Management, 8th edition, by Du Toit, Erasmus

& Strydom, 2010.

GETTING AN OVERVIEW
You have already studied the module MNB1501. In that module you dealt with the fol-
5

lowing topics:

6 Topic 1: Introduction to Business Management

7 Topic 2: The management process

8 The study material for MNB1601 has been divided into the following topics:

(iv)
9 Topic 1: Operations management
10 Topic 2: The human resource function
11 Topic 3: The marketing function
12 Topic 4: Financial management
13 Topic 5: The purchasing and supply function

DIVISION OF THE TUTORIAL MATTER FOR MODULE MNB1601

14 For our study purposes we have divided the study material into the following topics:


TOPIC 1: Operations management

15

• The operations management function

• Operations management: activities, techniques and methods


TOPIC 2: The human resource function

16

• Meeting human resource requirements and developing efectiveness in HR

• Motivating employees


TOPIC 3: The marketing function

17

• The marketing process

• The marketing instruments


TOPIC 4: Financial management

18

• The inancial function and inancial management

• Asset management: the investment decision
• Financing decisions


TOPIC 5: The purchasing and supply function

19

• Purchasing and supply management

• Sourcing activities

(v) MNB1601/1
THE ASSIGNMENTS
The best way to work through the prescribed book is to study one topic at a time. That
20

is why the assignment questions have been based on the diferent topics of the tutorial
matter.

GETTING A FEEL FOR THE LAYOUT OF THE PRESCRIBED BOOK

At this stage you are still not ready to start reading the actual text. You irst need to get
21

a feel for how the tutorial matter has been set out.

Learning outcomes and layout

At the start of each chapter you are given the learning outcomes and layout. These out-
22

comes and layouts tell you what the author had in mind when the chapter was written –
and they can sometimes serve as a useful summary of the topics dealt with in the chapter.

Just looking at the outcomes and the layout at the start of each chapter and listing the
23

topics set the stage for understanding what the chapter is all about.

Figures and tables

As you page through the book you will also see igures and tables. For example, in sec-
24

tion 12.4 of the prescribed book you will see table 12.1, while in section 12.5 you will see
igure 12.2. These igures and tables are intended to illustrate a point covered in the text.
For example, just before table 12.1 you will see reference made to table 12.1, while in a
paragraph above igure 12.2 reference is made to igure 12.2. Thus you do not have to
take note of any igures or tables until they are actually referred to in the text.

Then, before reading any further, you should turn to the igure or table (it will sometimes
25

be on the next or the previous page) to see what you can learn from the information
presented. You must understand the point that these igures and tables are intended
to illustrate, but you do not have to memorise their contents for examination purposes.

Illustrations
You will also see information given in blocks. These illustrations are usually not referred
26

to in the text itself. They are intended to give you additional insight into the text that sur-
rounds the block, and to reinforce a point the author has made in the text. Again, make
sure that you understand the point the author is trying to reinforce with these illustrations,
but be assured that you do not have to memorise the contents for examination purposes.

(vi)
THE STUDY PROCESS
When you have listed the main topics as set out in the outcomes and layout, you should
27

read the entire chapter just to get a feel of what it is all about. Don’t worry too much
at this stage if you don’t understand every detail. The important thing here is to make
a few notes of the key issues as you read. Then draw a diagram or simple mind map to
visualise the key issues.

You are now ready to start studying. Tackle one study unit at a time. If there is something
28

that you do not understand, read it again, and try to igure out what the author is saying.
DO NOT SKIP ANY TUTORIAL MATTER THAT YOU DO NOT UNDERSTAND. Ask someone
else to help you understand a sentence or paragraph, and if you really cannot igure it
out, contact one of your lecturers at Unisa. They are there to help you.

One of the best ways to make sure that you understand the material is to make a sum-
29

mary in your own words – one study unit at a time.

A good summary length is about 5% of the original text, so section 1.2 in the prescribed
30

book should be summarised in approximately two written pages. The reason for sum-
marising your tutorial matter stems from an adage (or saying): “A thought expressed is a
thought impressed.” This means that the more you write down (in your own words) what
the message of a particular study unit is, the more it will be impressed or imprinted on
your own mind.

NB: The purpose of studying is to understand the concepts – not to memorise them.
31

HOW TO USE THE STUDY GUIDE

The primary purpose of this study guide is to provide you with guidelines to help you
32

to understand some of the most important theoretical perspectives, general principles

and contextual factors that underlie the nature and dynamics of business management.
All of this is, however, done from a management perspective. You must therefore use
the study guide as a source of additional information and to help you work through the
material contained in the prescribed book. You will ind that certain terms are repeatedly
used to structure this study guide and your thinking:

• A topic represents an important component of the module and tutorial matter. Each
topic has one or more learning outcomes. These outcomes indicate the general stand-
ard or level of competence you should achieve in respect of each topic.
• A study unit is an identiiable part of a topic. Each topic therefore consists of one or
more study units.

Very important for the purposes of your studies are the learning outcomes. For each
33

topic, speciic outcomes are set, WHICH YOU AS A STUDENT MUST BE ABLE TO ACHIEVE.
These learning outcomes are linked to the assignments as well as the examination and
are therefore the means by which you and your lecturers can evaluate the extent to which
you have in fact mastered a speciic topic (ie your knowledge and understanding of it).

(vii) MNB1601/1
34 Certain icons are used throughout the study guide:

Icon Description

Learning outcomes. The learning outcomes indicate what aspects

of the particular topic or study units you have to understand and
of which you should be able to demonstrate your understanding.

Study. This icon indicates which relevant sections of the prescribed

book or the study guide you need to study and internalise.

Key concepts. The key concepts indicate which terms or keywords

are important for a particular study unit.

Read. This icon will direct you to read certain sections of the pre-
scribed book for background information.

Activity. This icon refers to activities that you must do to develop

a deeper understanding of the learning material.

35

Mind map. Mind maps are provided to help you to see the rela-
tionship between various parts of the learning material.

Assessment. When you see this icon you will be required to test
your knowledge, understanding and application of the material
you have just studied.

Feedback. This icon indicates that you will receive feedback on

your answers to the self-assessment activities.

IMPORTANT
You should always read the study guide irst and then study the relevant sections in the
37

prescribed book as indicated in the study guide (along with the learning material in the
study guide).

(viii)
220 This study guide therefore has certain speciic functions:

• It provides you with material that you have to study.

• It indicates which parts of the prescribed tutorial matter you have to study.
• It contains certain activities that will help you master the ield of study.

THE STEPS IN THE STUDY PROCESS

(1) Get an overview of the book as a whole. You should have completed this step
already.
(2) Get an overview of the parts. Draw a mind map of the parts.
(3) Read the irst chapter of that part. Draw a mind map of the topics in the chapter.
(4) Study the irst section of the chapter. Write a summary in your own words.
(5) Read the corresponding study unit in the study guide. Amend your own sum-
mary, if necessary.
(6) Read the next section of the chapter. Repeat steps 4 to 6 until you have completed
the chapter.
(7) Tackle the next chapter in that part. Repeat steps 3 to 7 until you have completed
the part.

COMPLETING THE ASSIGNMENTS

Multiple-choice questions
The assignments as well as the examination comprise only multiple-choice questions. For
38

every question there are usually four options numbered from 1 to 4, of which you must
select only one. For example:

(1) Which one of the following statements is correct?

(a) Capitalism ensures a more even distribution of wealth.
(b) Socialism discourages private initiative.
(c) Communism ensures a better utilisation of resources.
(d) South Africa’s economic system tends towards socialism.
You cannot select more than one option. In other words, your answer will be option
1 or 2 or 3 or 4.
Sometimes the question asks you to select the wrong statement. You should be
extra careful when answering such questions and not get confused and mark a
statement that is correct (and therefore the wrong answer). Please look at the as-
signments in Tutorial Letter 101. You will ind the occasional question asking you to
indicate which of the options is wrong.
In some questions, however, there will be several statements that could be correct.
In such cases the statements will always be indicated by letters (a, b, c and d), and
the answer will still be option 1, 2, 3 or 4, but these answers may refer to more than
one statement. For example:

(ix) MNB1601/1
(2) Which of the following statements are correct?
(a) A business owned and managed by one person may be a private company.
(b) A partnership is usually limited to 20 partners.
(c) The owner of a sole proprietorship does not pay tax on his or her business’s
proits.
(d) A public company may not ofer its shares for sale on an open market.
(1) abcd
(2) abd
(3) bc
(4) cd
This question asks you to indicate which of the statements are correct. If you there-
fore think that statements b and c are correct, you will mark only option 3 as the
correct answer.
In all the above examples the stem of the question asks you to identify the correct
statement(s). Sometimes the alternatives are a continuation of the stem. For example:
(3) The economic principle …
(a) is an endeavour to achieve the maximum with the minimum.
(b) does not apply to government organisations because they do not strive for a
proit.
(c) is mainly an indication of how low the operating costs were.
(d) is always measured in terms of the business’s proitability.
In an example such as the above you have to read the stem plus option 1, then you
have to read the stem again plus option 2, the stem plus option 3, and so on.
There is one other type of question that some of you may ind somewhat confus-
ing. For example:
(4) Match the management level in the irst column with the corresponding organisa-
tional objective in the second column.
(a) top management i the mission of the organisation
(b) middle management ii functional objectives
(c) lower management iii operational objectives
(1) a (i) b (ii) c (iii)
(2) a (i) b (iii) c (ii)
(3) a (ii) b (i) c (iii)
(4) a (iii) b (ii) c (i)
In this question you have to match the items in one column with the items in a second
39

column. Let’s say that you think that top management (a) is involved in the formulation
of the mission of the organisation (i); then you already know that your answer could be
either option 1 or 2. By comparing the other options in column one with those in column
two, you should be able to choose between options 1 and 2.

(x)
Answering a multiple-choice question
40 Make a photocopy or record your answers on a separate page.

You will ind the multiple-choice questions in the assignment extremely useful when you
41

prepare for the examination. However, if you mark your answers (or the correct answers)
on the actual page in Tutorial Letter 101, you will not be able to use these questions for
revision. We strongly recommend that you either make a photocopy of the assignments
and use that for revision, or else write down your answers on a separate sheet of paper
to avoid making any marks on Tutorial Letter 101 itself. You will then be able to work
through these questions again in preparation for the examination, without seeing the
marks that indicate the correct answers.

42 Decide on each option independently.

When answering a multiple-choice question, much time is often wasted (especially in

43

the examination) by reading all four options before deciding which one is correct. The
secret is to read and decide on each option separately. For example, look at question 1
above. The stem asks you to identify which statement is correct. Take a ruler and cover
the other three statements so that you only see statement 1. Read it, and then, without
reading any other statement, decide whether the statement is correct, wrong or that you
don’t know. Put a tick next to it if you think it is correct; put a cross next to it if you think
it is wrong; and put a “?” if you are not sure. Then move the ruler down so that you can
read statement 2. Again decide and mark the category in which it falls.

When you have done that with every one of the four statements, you may ind that you
44

have marked one statement correct and three statements wrong. The former is then your
answer. If you ind that you have marked two correct, then compare the two statements
and choose the one that seems to be the most correct, or the most comprehensive.

45 Write down your reasoning.

When you have selected your answer to a particular question, it is essential that you write
46

down your reasons for doing so. For example, if you chose option 2 as the correct answer
to question 2 above, implying that statements a, b and d were correct, you should write
on a separate sheet of paper why you think statements a, b and d were correct. Write
down the actual reference in the prescribed book on which you base your reasoning.
However, you must even go a step further. You must also write down why option c is
wrong. Again make speciic reference to the prescribed book to back up your reasoning.

This is probably the most important learning step that you can take. We want our students
47

to understand the tutorial matter and to be able to explain the concepts and apply the
principles. We are not interested in whether a student has memorised the tutorial matter
and can repeat it in an examination. That is why it is so important for you to be able to
give a reason for your answer.

It takes a few weeks from the time that you answer an assignment to the time that you
48

get back the correct answers and explanations. By that time you will have forgotten why
you chose a certain option for a particular question, unless you wrote down your reasons.

(xi) MNB1601/1
The real learning takes place when you compare your reasoning with that of the lecturers.
So don’t take the easy way out by just answering the multiple-choice questions.

49 The low diagram below will help you to picture the process.

MAKE A PHOTOCOPY OF THE ASSIGNMENT — OR — 228 USE A SEPARATE SHEET OF PAPER

b
Start with question 1
Read the first alternative
Decide if it is a correct statement

b
b b b
If “yes” If “unsure”
If “no”
224

222

223

b
b
Tick Cross Question mark

Repeat the process for each alternative

b

Look at the question again!

Is the correct alternative obvious in the light of
your markings?

b
b

221

If “yes” If “no”
229

Compare possible alternatives

carefully
Select the most comprehensive one

b
Make an appropriate mark on
225

the mark-reading sheet

b

Write down the reasons

226

for correctness or incorrectness

of each alternative
b

Go to the next question and

227

repeat the process

(xii)
TOPIC 1
Operations management

AIM
The aim is to explain what the nature of operations management in a business entails
50

and to demonstrate how the operations activities of design, planning and control, and
improvement are performed for better efectiveness, increased eiciency and overall
productivity of the operations processes.

Learning outcomes

When you have worked through topic 1 you should be able to:
• explain the nature of operations management by highlighting the importance and
providing a definition of the operations function, distinguishing between the various
components of an operations management model, and describing a classification
system for the different operations processes for manufacturers and service providers
• demonstrate how the operations activities of design, planning and control, and improve-
ment are performed within the operations function by illustrating the application of
various operations techniques and methods

OVERVIEW OF THE TOPIC

Topic 1 comprises the following study units:
51

TOPIC 1

Study unit 1 Study unit 2

The operations management function Operations management: activities,

techniques and methods

1 MNB1601/1
Study unit 1
The operations management function

Contents

Key concepts
Learning outcomes
Getting an overview
1.1 The nature and deinition of operations management
1.2 An operations management model
1.3 The classiication of operations process types for manufacturers and service
providers
Summary
Self-assessment questions

Key concepts

operations management operations activities

operations function operations management function
operations design operations planning and control
operations improvement operations processes
efectiveness eiciency
overall productivity operations techniques and methods
operations management model operations management strategies/objectives
inputs transformation process
outputs goods (products) and services
transformation model operations classiication system
manufacturers service providers
project system job system
repetitive/continuous systems multiple-unit project system
job-lot system mass service
service shop professional service

Learning outcomes

When you have worked through study unit 1 you should be able to:
• explain the nature of operations management by highlighting its importance and
providing a definition
• depict an operations management model by distinguishing between its various
components
• illustrate a classification system for the different operations processes by describing
such a system for manufacturers and service providers

2
Getting an overview

Read section 10.1 in the prescribed book.

You will note that the discussion in the introduction to the prescribed book focuses
52

on the idea that “more prosperous” countries generally produce more products and
services to satisfy not only their own national needs, but also, when in excess, to export
internationally and in so doing increase their “wealth” even further. Thus (agreed, very
simplistically argued!) having an increased number of successful businesses producing
more and better products and services will directly translate into increased prosperity
for all the citizens of a particular country. Surely a worthwhile objective!

As the one main function in a business primarily responsible for managing all the activities
53

whereby such products and services are manufactured/rendered, the operations function
is critical for achieving such ine ideals.

This irst study unit of topic 1 examines the nature of operations management and high-
54

lights certain deinitions. It also summarises the proposed operations management model
by distinguishing between its various components and, lastly, it reviews a classiication
system for the diferent operations processes for manufacturers and service providers.

1.1 THE NATURE AND DEFINITION OF OPERATIONS

MANAGEMENT

Study section 10.1.1 and 10.1.2 in the prescribed book.

To summarise: operations management is said to be important for all businesses because

55

of what it can do to improve a business operation.

One of the main contributions that the operations management function can make to
56

the business is that of increased productivity. Productivity (among other things) improves
when fewer inputs are used to produce the same outputs, or more outputs are produced
with the same inputs. So obviously the more eicient the transformation or conversion
process, the higher the productivity.

The second major contribution of the operations management function is to ensure that
57

customers/clients are satisied with the product and/or service for which they pay or, as
in the case of the most successful businesses, exceptional! Functions like inance, human
resources and purchasing, important as they are, do not directly satisfy the needs of the
customer/client. Only operations management can do this, because it manages the busi-
ness functions that design, plan and control, and it improves the operations processes
which physically manufacture the products or are actually involved in rendering the
services.

3 MNB1601/1
The third major contribution of the operations management function is closely linked to
58

the second one mentioned above: if the product or service quality is poor, the business
will get a bad reputation among not only its direct customers/clients but also the general
public; consequently, it may lose a great deal of business.

1.2 AN OPERATIONS MANAGEMENT MODEL

Study section 10.2 in the prescribed book.

To summarise: the operations management model is a diagrammatic representation of

59

the main distinguishable components which are necessary in a process of manufacturing

and/or service providing. It is made up of a basic input-transformation-output model which
is driven by the operations management strategies and objectives which must satisfy
customer/client needs and requirements through the means acquired by the operations
activities of design, planning and control, and improvement.

It is important to distinguish between the inputs that are transformed by the very nature
60

of the business itself (ie raw materials, customers/clients, information) and the resources
it uses to bring about that transformation (ie labour, equipment, facilities, technol-
ogy). So we make the distinction and refer to “input transformed resources” and “input
transforming resources”. When it comes to manufacturing, obviously raw materials are
transformed into usable products, like leather sheets, rubber and cotton thread, which
are transformed into shoes in a shoe factory. But when it comes to providing a service it
is not always easy to “see” what is “transformed”, for example in the case of an air carrier.
Here both passengers and cargo are not physically changed in appearance but they do
undergo transformation in as much as they are moved or relocated! Table 10.2 in your
prescribed book has a number of examples of what is actually transformed or changed
in diferent types of businesses.

Table 10.1 sets out some important diferences in the characteristics of products and
61

services. A product, for example, is deinitely very tangible – it can physically be seen and
touched, whereas a service is viewed as intangible because it can only be “experienced”
and not physically be characterised. A product can furthermore be “stored” or kept in
inventory, while a service cannot. For example, should an increase in the demand for a
service occur (ie transport by mini taxi), it is not possible to make use of yesterday’s un-
used capacity to supplement the current available capacity which may only consist of
one mini taxi. If the capacity of the taxi service was not used yesterday it cannot be kept
in “store” and used later.

Diferences between products and services may have some major implications for how
62

capacity is managed. For example, a certain factory may produce a ixed, constant num-
ber of products each month. But in months when sales are low, the excess products can
simply be stored or kept in inventory – consumption is delayed or put on hold for the
time being. In months when actual sales exceed production, the extra products needed
may be taken out of inventory and sold. The factory therefore does not have to make

4
adjustments to its physical manufacturing capacity when there are seasonal luctuations
in demand. However, this is not so easy when it comes to rendering a service. Banks,
for example, ind that far more clients come to the bank towards the end of the month,
when their salaries are paid, than in the middle of the month. The bank must therefore
ensure that additional capacity is put in place (ie more personnel are brought in as tellers)
to deal with the increased demand for banking services towards the end of the month.
Questions which arise immediately are: Do they hire more permanent personnel during
the peak times? And what do they do with these personnel at times when they are not
needed? In the case of a banking service, a bank thus needs to adjust its service capacity
when there are monthly variations in demand.

Of course most businesses do not solely (and exclusively) manufacture products or ren-
63

der services. Rather, they usually ofer some combination of both products and services.
Take the motor vehicle manufacturer who physically produces the vehicle itself but also
ofers a service in terms of maintenance, roadside assistance in case of breakdown, etc.
Similarly, a traditional service provider like the post oice may also have products like
envelopes, stamps, pens, etc for sale.

Activity 1.1

Identify two businesses that both manufacture a product and provide a service. Also
indicate what product(s) they manufacture and what service(s) they provide.

A furniture factory may focus on the production of furniture, but there will also be a service
component like delivering products, modifying products to customer needs, and so on. Similarly,
even service providers produce some kind of tangible product. A bank, for example, provides a
banking service but also issues physical cheque books, bank statements, deposit slips and so on.

1.3 THE CLASSIFICATION OF OPERATIONS PROCESS TYPES FOR

MANUFACTURERS AND SERVICE PROVIDERS

Study section 10.3 in the prescribed book.

To summarise: a classiication system is proposed for both manufacturers and service

64

providers based on two dimensions of volume (number or quantity of products produced

or clients serviced) and variety (range of products or options to choose from) of products/
services. On both dimensions, values of high and low and high-low combinations will
represent diferent types of operations processes.

When it comes to manufacturers, it is important to be able to distinguish between the

65

inherent characteristics of the operations processes for a project, a job and a repetitive/
continuous system as well as the two hybrids which are formed individually between the
irst two systems and the last system mentioned: multiple-unit project (combination of
project and repetitive systems) and job-lot (combination of a job and repetitive systems).

5 MNB1601/1
A project system is relatively easy to understand. It encompasses something that is nor-
66

mally only done once. For example, to build a house designed by an architect is a project
because it is built only once, and no other house is likely to be exactly the same. A project
is therefore a unique type of production – and usually it embodies a major efort either
in terms of size, or length of time needed to complete.

Further to the project system mentioned above, where several houses of similar design
67

are built, we have the irst type of hybrid system previously mentioned, namely between
a project and a repetitive system. This is referred to as a multiple-unit project system.

A job system refers to a single task on a small scale or in small volume which has a dei-
68

nite individual uniqueness to it. A printing shop uses this type of system. Each printing
job, say for a business card, is unique in the sense that it has its own wording, font style,
paper type, colours, and so on.

Further to the job system mentioned above, as soon as the range of a similar type of
69

products increases – like a magazine printer – the job system starts to resemble that of
a repetitive system. The second type of hybrid system is then applicable, namely that of
a job-lot system.

A repetitive operations system is one in which the same product (or range of very similar
70

type of products) is produced many times over. Most factories are examples of this: for
example, where the same model vehicle is manufactured by means of a process that is
repeated over and over again and could go on for many years until a new model is intro-
duced. Also similar to this type of operation, a continuous operations system is one in
which exactly the same product is produced continually “forever”. For example, a power
utility company produces the same “product” (electricity) on such a basis.

When it comes to service providers, it is also important to be able to distinguish between

71

the characteristics of the operations processes for a professional service, a mass service
and service shop.

A professional service is characterised by low volume – each individual client requires

72

service according to his or her own needs but with more variety of service on ofer as a
result.

A mass service represents operations for services which are similar to mass product pro-
73

ducers – the service is rather standardised with less variety, but high volume.

A service shop falls in between the characteristics of the professional service and mass
74

service (thus with both moderate variety and volume).

6
 Activity 1.2

Use the practical examples of the various types of businesses listed in table 10.2 and
classify their dominant operations processes according to proposed classiication for
manufacturers or service providers.

Type of business Dominant operations process

Rail transport Mass service

Banks Service shop

Hairdressing salon Professional service

Gold mine Continuous manufacturer

Furniture manufacturer Job-lot manufacturer

Printing works Job-lot manufacturer

Construction irm Project system

Missile manufacturer Job-lot manufacturer

SUMMARY
Now you should have a basic insight into the operations management function. In the
75

next study unit you will study the activities, techniques and methods of operations
management.

SELF-ASSESSMENT QUESTIONS
1

(1) For which of the following reasons is operations management important to the
business?
(a) It can contribute to an increase in the productivity of the business.
(b) It can help the business satisfy the needs of its customers/clients more efectively.
(c) It can assist in both the design and marketing of products/services in order to
improve the inancial return on investment.
(d) It can be a decisive factor for the general reputation of the business.
(1) ab
(2) abc
(3) abd
(4) abcd
(2) Which of the following are positive results obtained from the application of the
operations management guidelines?
(a) higher quality
(b) lower costs
(c) increased lead times

7 MNB1601/1
 (d) greater adaptability
(e) better service
(1) abc
(2) abde
(3) acde
(4) bcde
(5) abcde
(3) Which one of the following statements is wrong concerning the classiication of
operations processes in manufacturing businesses?
(a) Project systems represent operations processes which are highly individual.
(b) Job systems normally represent operations processes conducted on a small scale.
(c) Continuous or repetitive systems represent operations systems in which the
output volume is low but relects more variety.
(d) Job-lot systems represent a combination of a repetitive and a job system.
Question 1

The correct answer is option 3 (a b d).

Operations management is important because it can contribute to an increase in the productiv-

ity of the business (alternative a), it can help the business satisfy the needs of its customers/clients
more efectively (alternative b), and it can also be a decisive factor for the general reputation
of the business (alternative d). Alternative c is, however, incorrect because while it can assist
with the design of products/services, it is not directly involved in their marketing and further is
not primarily concerned or held responsible for improving the inancial return on investment.

If your answer was wrong, please refer to section 10.1.1 in the prescribed book.

Question 2

The correct answer is option 2 (a b d e).

Positive results obtained from the application of the operations management guidelines are
higher quality (alternative a), lower costs (alternative b), greater adaptability (alternative d),
and better service (alternative e). Alternative c is, however, incorrect because the operations
guideline would rather endeavour to shorten lead times (quicker response) than increase the
lead times (longer waiting periods).

If your answer was wrong, please refer to section 10.2.1 and igure 10.2 in the prescribed book.

Question 3

The correct answer is option 3.

Options 1, 2 and 4 regarding the classiication of operations processes in manufacturing busi-

nesses are all correct. However, option 3 is incorrect because continuous or repetitive systems
(as in a water puriication plant or brick manufacturer) have more volume and less variety.

If your answer was wrong, please refer to section 10.3.1 in the prescribed book.

8
Study unit 2
Operations management: activities, techniques and
methods

Contents

Key concepts
Learning outcomes
Getting an overview
2.1 Operations design
2.2 Planning and control of the operations process
2.3 Operations improvement
Summary
Self-assessment questions

Key concepts

operations design planning and control of the operations process

operations improvement design of products/services
design of processes operations network
idea/concept generation screening process
preliminary design design evaluation and improvement
prototype and inal design basic product structure
bill of materials simple low charts
demand side supplier side
layout and low process type
ixed position layout process layout
product layout cellular layout
process technology job design and work organisation
method study work measurement
loading sequencing
scheduling capacity planning and control
level capacity plan chase-demand plan
demand management moving average
cumulative representation inventory and purchasing planning and control
quality planning and control quality characteristics
continuous improvement (CTI) kaizan
performance standards business process re-engineering (BPR)
breakthrough improvement (BTI) failure prevention and recovery
failure types total quality management (TQM)

230

9 MNB1601/1
 Learning outcomes

When you have worked through study unit 2 you should be able to:
• explain the nature of design in operations by highlighting the various activities involved
in the design of products, services and operations processes, including the application
of selected operations management techniques and methods
• explain the nature of planning and control in operations by highlighting the various ac-
tivities involved in capacity, inventory and purchasing, and quality planning and control,
including the application of selected operations management techniques and methods
• explain the nature of improvement in operations by highlighting various activities
involved in failure prevention and recovery and total quality management, including
the application of selected operations management techniques and methods

Getting an overview
Having gained a basic understanding of what the transformation model entails, it is now
76

possible to examine in more detail the operations activities of design, planning and con-
trol, as well as of improvement. Also, certain operations techniques and methods that
can be used to perform such activities “better” are briely illustrated.

2.1 OPERATIONS DESIGN

Study section 10.4 in the prescribed book.

To summarise: operations design consists of two core components: the design of the
78

product and/or service itself and the design of the operations process by which the
product will be physically manufactured or a service rendered. A ive-step procedure is
followed in the design of a product/service, starting from the generation of ideas/con-
cepts, through screening processes by which some “less promising” ideas are eliminated,
to a preliminary design, to further design evaluation and improvement, and eventually
to a prototype of the product or simulation of the service and inal design. In the case of
the design of the operations process, four interrelated areas need to be considered: the
operations network, the layout and low of the manufacturing/provisioning facility, the use
of appropriate process technology, and the design of jobs and organisation of the work.

The operations manager of a manufacturer will be involved in at least three steps. First
79

is the physical design of the product itself – for example, its shape, size, features and
packaging. Second, the possible ancillary services that go with it, like guarantees and
level of after-sales service, are considered. Third, with possibly deeper involvement, will
be the design of the operations process that is to physically manufacture the product.

The operations manager of a service provider, however, cannot “physically” design the
80

service itself, but rather will specify what the service will entail and move on to the de-

10
sign of the tangible products which will accompany the service, and the design of the
operations process by which the service will be rendered. For example, the operations
manager of a commercial bank will be involved in decisions about where branches of the
bank should be located. How large (number of tellers) or how comprehensive should the
services ofered (new accounts, credit card issues, foreign exchange, etc) in each be? That
two similar types of businesses may ofer diferent levels of service is in fact the result of
diferent operational designs.

Section 10.4.2.3 in your prescribed book sets out the steps in the design of a product
81

or service. Note that while it is easier to “picture” how these steps could be followed in
the design of a product because it encompasses a tangible “something” at the end, the
design of a service is more diicult because you cannot physically see the service and
can only experience it.

Not only does the product and/or service have to be designed, but the process whereby
82

they are to be manufactured/provided must also be designed. The irst area of concern
is to decide how much of the operations network the business wishes to “control” or
own. For example, a cement manufacturer may decide to purchase the mine where its
raw materials are sourced. Also, it may decide to own a share in the building warehouse
where the cement is sold to the public. In this way, the cement manufacturer can exer-
cise better coordination over the supply side (raw material resources) and demand side
(wholesaler) of its operations network.

The second area of concern in the design of the operation relates to the layout and low
83

of the manufacturing or service provisioning facility. It thus has to decide on the physi-
cal arrangement of machines, equipment and operators or personnel in the operations
facility. Also, how will the process of manufacture or service rendering take place? What
comes irst, second and last? Section 10.4.3.2 in your prescribed book refers to four types
of layout: ixed position, process, product and cellular.

A ixed position layout is found where the product or service is completed at the position
84

where it is to function (house, bridge, dam and highway) or where it is directly required
(borehole, plumbing repair, telephone installation). Resources of manufacture or service
provision are brought to the receiver of the conversion or the processing.

231

A process layout is found where a number of similar processes are grouped together
232

in departments or sections, though not all the processes are necessarily used in the
manufacture/rendering of each and every product/service. A hospital, for example, has
all kinds of departments – the orthopaedic department, cardiology department, pae-
diatric department, to mention but a few. Patients are taken to the department where
they will receive the speciic treatment they require. A process layout may also be used

11 MNB1601/1
in a service provider like a departmental store. Customers do not necessarily purchase
articles from each and every department – so they visit only those that ofer the speciic
items they need.

233

A product layout is found where all the processes that need to be executed for a speciic
234

product to be manufactured are placed together consecutively in a “line arrangement”,

with one after the other – thereby progressing through all the various production stages,
inally ending up in one product. In the manufacture of shirts, for example, a piece of
cloth is measured, then cut into patterns, then stitched together, then the collar and the
cufs are attached, and inally each item is ironed. In a self-help cafeteria, the customers
go through the same basic steps: they enter the “line” at the same place, they collect a
tray, they select food and/or a drink, they pick up the required condiments (salt, pepper,
tomato sauce, etc) and inally they pay the cashier before sitting down to eat. This is an
example of a product layout for a service provider.

85

A cellular layout comprises a combination of a process and a product layout. For ex-
235

ample, a furniture factory may use an initial process layout, where the raw materials are
cut, planed, turned and varnished. The raw materials may then be moved to the various
departments (cells), like the chair assembly department, the desk assembly department
and the wardrobe assembly department, where the products are “put together” in a
product layout arrangement.

12
236

The third area of concern in the design of the operation relates to the use or application
237

of process technology. The operations manager needs to keep up to date with the lat-
est processing technologies for materials, information and customers/clients. A prudent
operations manager will constantly be searching for and investigating new technologies
that may beneit the operation. The main focus will be on inding or adapting technolo-
gies to help the operation follow the operations management guidelines, to gain the
positive results of higher quality, lower costs, shorter lead times, greater adaptability, less
variability and overall better service. Using the latest processing technologies may also
help a business get a competitive advantage over competitors.

The fourth area of concern in the design of the operation relates to job design and work
238

organisation. One technique that can be used to facilitate the design of the process is
work study. It comprises two facets: method study and work measurement. Method
study seeks to ind more eicient ways of carrying out a particular task. Work measure-
ment determines how long each task should take – given normal working conditions. In
combination they may be used to improve productivity but also to ensure that the total
workload is evenly distributed among enough workers.

Activity 2.1

Think of your favourite clothing store (eg Jet, Pep, Edgars, Foschini, Woolworths), or if
you cannot think of one then just visit the most convenient store next time you are in
town. Identify the cellular layouts of the men’s, ladies’ and children’s departments. Sketch
the cellular layout of the ladies’ department. Label all the diferent parts of your sketch.

You noticed that the store is divided into cells. Did you notice any other cells in the overall
layout, for example cosmetics which, in turn, may have smaller cells of men’s after-shave and
ladies’ perfumes?

The ladies’ department is subdivided further into smaller cells of, say, underwear, dresses, skirts
and blouses. Did you ind any other cells in the ladies’ department? Look at the diagrammatic
illustration of a cellular layout in section 2.1 of this study unit.

13 MNB1601/1
2.2 PLANNING AND CONTROL OF THE OPERATIONS PROCESS

Study section 10.5 in the prescribed book.

To summarise: planning and control of the operations process endeavour to reconcile

86

the operation’s supply of products and services on the one hand with customer/client
demand for these on the other hand. Speciic areas of concern deal with capacity, inven-
tory and purchasing, and quality.

Operations planning and control refer to activities which put “the whole operations
87

process into action”. The task of the operations manager in planning and control of the
operations process involves trying to “match” or reconcile the supply of products and
services with demand in three areas: volume, timing and quality. In other words, the
operations manager needs to decide how much to produce or how many service points
to provide, when to produce these products or render these services, and what exactly
needs to be produced or rendered to satisfy customer/client requirements.

The irst speciic area of concern is the activity dealing with the planning and control of
88

the operations process in terms of volume. Capacity in an operations context refers to the
availability of a manufacturing and/or service provisioning capability. It is one-dimensional
not only in terms of size or volume (ie 220 motor vehicles) but must also have a time di-
mension added (ie per day, per week, etc, thus manufacture of 220 vehicles per 2 shifts
per day each of 9 hours’ duration). Capacity planning and control in operations has three
elements: determining the total demand (from which the planned demand that the op-
eration will attempt to satisfy will be derived as well as the required operations capacity
to meet it), identifying alternative plans to meet the planned demand and/or variations
in it (level, chase-demand or demand management plans), and choosing an appropriate
detailed capacity planning and control approach for both ixed (facilities, machines, etc)
and adjustable (operators, equipment, etc) operations capacity.

Activity 2.2

Distinguish between the alternative capacity plans in order to accommodate possible

variations in demand.
Ū Level capacity plan. The operation is committed to manufacturing a constant volume of
products (ie 220 vehicles per day). When demand is less than what is being produced, the
surplus products are stored or put into inventory or sold elsewhere in other markets. When
demand is more than what is being produced, these surplus stocks can then be used to
meet demand. Such a plan will, of course, only apply to a product manufacturer, because
a service itself cannot be “stored”.
Ū Chase-demand plan. Here the production volume is continually adjusted in accordance
with the variation in actual demand. In the case of a manufacturer, such a strategy would
be rather unproductive, as it would mean that during periods in which demand is less
than normal volume produced, some machinery would be standing idle and some em-
ployees would have to be retrenched, and then hired again when demand picks up. Very
few employees would want to work under such conditions of service. However, adjusting
capacity to demand is somewhat easier in the service industry. For example, banks expect

14
 considerably more clients at the beginning and end of the month than during the middle
of the month. To meet this increase in demand at the end of each month, the bank may
hire some employees on a part-time basis, say for two weeks per month. This kind of em-
ployment is particularly attractive for some housewives who would like to earn an extra
income, but also spend time at home with their children.
Ū Demand management plan. In the case of this strategy an attempt is made to inluence or
“manage” the demand. Airlines, for example, will ofer much lower fares to certain overseas
destinations in the “of-season” period. Hotels at holiday resorts may do the same. Their
of-season rates are usually much lower than their holiday season rates. By doing this
they hope to attract guests during the of-season period in order to ill up their capacity.

The second speciic area of concern is the activity dealing with the planning and control
89

of the operations process in terms of timing. Inventory and purchasing planning and
control are dealt with comprehensively in the next topic of this study guide. Suice to
note here that manufacturing operations need to carefully “manage” their inventories
for raw materials, components, and so on, in order to ensure a “smooth” low of produc-
tion. Furthermore, with “just-in-time” (JIT) or “lean” production philosophies becoming
ever more popular, the idea is to only manufacture for actual demand and avoid costly
inventory build-up of inished products. The purchasing activity whereby materials are
bought in to the operation has also become a highly specialised ield of expertise, span-
ning national and even international supply chains.

The third speciic area of concern is the activity dealing with the planning and control of
90

the operations process in terms of quality. Today, quality is seen as a critical factor in most
businesses – it is probably one of the more important areas (at least from the customer/
client point of view) where a business can set itself apart from its competitors and literally
“add value at no extra cost”! Quality planning and control encompass six steps, ranging
from deining the quality characteristic(s) of the product/service, measuring its current
status, setting a standard of acceptability, comparing the achieved quality against the
standard set, identifying deviations or causes of non-conformance, and inally continu-
ously improving actual quality, standards and conformance.

2.3 OPERATIONS IMPROVEMENT

Study section 10.6 in the prescribed book.

To summarise: operations improvement is the third main activity undertaken by the

91

operations manager. It follows the design, planning and control of the operations pro-
cess by which products are manufactured and/or services rendered. Three main areas
are covered: measuring current performance, preventing failure but recovering where
necessary, and implementing total quality management.

It is probably an age-old truth that it is not possible to improve if you do not know how
92

you are currently performing! For example, an athlete cannot improve his or her time
for running the 100 metres lat if his or her current performance cannot be measured
accurately. So too, an operation cannot hope to improve its performance if it does not

15 MNB1601/1
know how it is currently doing. It is thus not only important to compare itself against its
past performance but also to compare itself against competitors’ performance and in so
doing set new standards or theoretical maximums to pursue in the future.

Four diferent kinds of performance standards are discussed in your prescribed book.
93

The irst two, historical and target performance standards, have an internal focus (the
business compares with itself) while the last two, competitors’ and absolute performance
standards, have a more external focus (the business’s performance is compared with
similar businesses for theoretical maximums in the industry).

Activity 2.3

Describe the two approaches to improvement and justify in which circumstances the
one may be more appropriate to follow than the other.

The irst approach to business or process improvement is referred to as breakthrough improve-

ment or BTI and focuses on major, even sometimes “radical”, “starting from scratch”, “clean
slate”, types of improvement projects. BPR or business process re-engineering is a well-known
example of this type of approach. The second approach, referred to as continuous improvement
or CTI, or the Japanese word kaizan, focuses on smaller, more modest, maybe less “ambitious”
improvement programmes. They often run over longer periods of time (a year or more) and,
unlike BTI projects (which are shorter and frequently introduce “quick-ix” solutions), attempt
to put the business on a solid footing with suggestions for improvement coming from the
employees themselves – which encourages commitment to change.

As pointed out in the prescribed book, regardless of how well an operations process was
239

initially designed, or how efectively and eiciently it is “activated” to produce products or

render services, the reality of the dynamic business environment is that change, whether
anticipated or not, will necessitate adjustment to prevent failures – or to allow for recov-
ery to get the business back into “operation” as soon as possible, if they have already
occurred. Generally, many businesses focus on correcting failures/problems when they
occur, but not necessarily on taking prudent steps to prevent failures from occurring in
the irst place or in the future. For example, when a strike occurred at one of the large
platinum mines, the industrial relations department immediately swung into action to
resolve the issue. Management and the IR people were rather pleased with themselves
when the conlict was quickly resolved and workers returned to work. However, they
were annoyed when asked four weeks later what steps they had taken to prevent such
a strike from recurring in the future. They had primarily focused on correction, and not
really considered prevention.

The TQM philosophy is but one of the “latest” approaches in the evolution of “quality
240

management thought”. However, because it involves more than one technique, method
or idea, it has survived as a comprehensive managerial philosophy for a number of years
and, while opponents of the approach cite some known business failures, there is clear
evidence of considerably more successes. It is an inherently sound approach, based on
getting everyone in the business involved in and committed to quality, monitoring both
the costs and beneits of better quality, working smart and declaring “war on waste”,
putting life into the quality management system to guide and help the business to
improve rather than burden it with bureaucracy and inlexibility, as well as promoting

16
and nurturing creativity to continuously strive for improvement in the face of repetitive
routine and autocracy.

SUMMARY
If you have carefully worked through the last two study units of the topic dealing with
94

operations management, understood our explanations and appreciated the practical

applications pointed out, you should now have a basic insight into, irstly, what the op-
eration management function in a business entails and, secondly, what the operations
management activities of design, planning and control and improvement involve, as well
as how certain operations techniques and methods may be used to help an operations
manager perform “better”.

SELF-ASSESSMENT QUESTIONS
2

(1) Which of the following statements about the basic layout types used in the design
of operations processes are correct?
(a) The ixed position layout is used when the product cannot be shifted on account
of its size, shape or location.
(b) The process layout is used when the diferent operations are arranged in con-
secutive order.
(c) The product layout is used when similar operations are grouped together into
sections.
(d) The cellular layout is used when various operations processes are placed in a
cell and the particular cell is then arranged according to either a process or a
product layout.
(1) ad
(2) bc
(3) abd
(4) acd
(5) abcd
(2) Which of the following statements on the design of products and services are wrong?
(a) The design of a product or service is said to “begin and end” with the customer/
client.
(b) The implicit advantages in the package relating to products and services are the
psychological advantages.
(c) Peripheral services supplement the core service.
(d) The inancial function is also involved in the screening process of designing
products and services.
(e) The preliminary design speciies the components to be included in the product
or service package.
(1) bd
(2) de
(3) abcd
(4) ace
(5) none
(3) Which one of the following statements related to operations improvement is wrong?
(a) All areas in a business are equally important when it comes to improvement.

17 MNB1601/1
 (b) Priorities for improvement depend in part on the performance and activities of
competitors.
(c) Business process re-engineering (BPR) is an example of breakthrough
improvement.
(d) In continuous improvement, more regular but smaller incremental initiatives
are undertaken in the operations process.
Question 1

The correct answer is option 1 (a d).

Regarding the basic layout types which may be adopted in the design of the operations pro-
cesses, alternatives a (ixed position layout) and d (cellular layout) are correct. Alternative b is,
however, incorrect because in a product layout (not process layout) the diferent operations
are arranged in consecutive order, for example a vehicle assembly line. Furthermore, alterna-
tive c is also incorrect because in a process layout (not product layout) similar operations are
grouped together in sections, for example a furniture manufacturer who may place all the
wood-cutting machines in one section, and have a planing section, painting section, assembly
section, and so on.

If your answer was wrong, please refer to section 10.4.3.2 in the prescribed book.

Question 2

The correct answer is option 5.

All the statements regarding the design of products and services are correct. Review all of
section 10.4.2. The correct answer is therefore option 5.

Question 3

The correct answer is option 1.

Options 2, 3 and 4 regarding operations improvement are correct. However, option 1 is incor-
rect because NOT all areas in the business are equally important when it comes to improve-
ment. After measuring the business’s performance and comparing it against some form of
performance standard, and deciding on the particular approach to improvement, you may
see there is a greater urgency to improve some areas in the business because they are more
important than others. For instance, you may see a scheduling problem in the delivery of raw
materials that is delaying all other operations, resulting in large-scale loss of orders, while
there may also be a “smaller” problem in quality assurance. The priority would thus be to irst
deal with or improve the raw material delivery according to schedule, and then move on to
the quality assurance issue.

If your answer was wrong, please refer to section 10.6.1 in the prescribed book.

18
TOPIC 2
The human resource function

AIM
The aim is to explain the nature and importance of the human resource function, with
95

emphasis on meeting human resource requirements and developing efectiveness in HR.

Learning outcomes

When you have worked through topic 2 you should be able to:
• explain how the HR department assists the line managers to achieve the organisation’s
goals by ensuring that the organisation has employees with the necessary qualifica-
tions, knowledge and experience when they are needed
• demonstrate how human resource management contributes to employee motivation

OVERVIEW OF THE TOPIC

96 Topic 2 comprises the following study units:

TOPIC 2

Study unit 3 Study unit 4

Meeting human resource requirements Motivating employees

and developing efectiveness in HR

19 MNB1601/1
Study unit 3
Meeting human resource requirements and
developing efectiveness in HR

Contents

Key concepts
Learning outcomes
Getting an overview
3.1 The relationship between line management and the HR department
3.2 Human resource planning
3.3 Finding qualiied workers
3.4 Developing qualiied workers
3.5 Keeping qualiied workers
Summary
Self-assessment questions

Key concepts

job analysis job description

job speciication human resource forecasting
recruitment labour market
preliminary screening psychological testing
diagnostic interview references
induction training
development human resource development
informal development formal development
analysing development needs performance appraisal
feedback direct compensation
indirect compensation rewards

Learning outcomes

When you have worked through study unit 3 you should be able to:
• describe the human resource planning process by discussing each step and explaining
its purpose
• explain the process of finding qualified workers by describing the recruitment and
selection processes
• explain how a systematic approach to human resource development contributes to
organisational success by explaining the different approaches to training and empha-
sising the contribution of analysis of development needs

20
 • explain how compensation contributes to the retention of staff by discussing the dif-
ferent kinds of compensation that employers can offer and briefly describing how the
size of compensation is determined

Getting an overview

Read section 11.1 in the prescribed book.

You will see in this module that the main objective of a business is to maximise proitability
97

in the long term. This goal can be achieved in various ways, for example by producing
and/or selling a product or service that is unique or satisies a speciic need for custom-
ers. What is central to these business activities is that people are involved in them. Even
the most automated, state-of-the-art businesses employ people; yet one of the most
diicult management tasks is to ind and keep people who are able and willing to work
towards the achievement of organisational goals. This is the responsibility of the human
resource function.

3.1 THE RELATIONSHIP BETWEEN LINE MANAGEMENT AND THE

HR DEPARTMENT

Study section 11.2 in the prescribed book.

The human resource function has changed dramatically over the past decade. In the
98

past, human resource managers were only responsible for administrative activities such
as keeping leave records up to date and managing the payroll. Today, this is only one of
the activities of a human resource manager. The HR manager must be a strategic partner
in the business, aligning HR strategies with organisational goals and strategies.

This implies that managers should treat their human resources diferently, assisting them
99

to reach their work goals, utilising their skills eiciently, maintaining and developing
quality of work life and managing change to the advantage of all the stakeholders. It is
important to remember that every manager is responsible for the eicient management
of human resources and that the human resource function serves as advisor and guide.

21 MNB1601/1
3.2 HUMAN RESOURCE PLANNING

Study section 11.3 in the prescribed book.

Human resource planning is the point of departure of other HR activities. No human

100

resource activity in an organisation can be conducted successfully if human resource

planning has not been done.

What is human resource planning? We do human resource planning when we determine

101

how many employees will be needed and what their skills, knowledge, qualiications and
experience must be to ensure the achievement of organisational goals. This means that
the point of departure for a human resource plan should be the organisation’s strategy
and goals.

102 The steps in the HR planning process are:

103 Step 1: Identify what the employees are doing currently (job analysis and job descriptions).

104 Step 2: Identify what skills, knowledge, experience and qualiications employees need
to be efective in their jobs (job speciications).

105 Step 3: Identify how many employees will be needed in the future (human resource
forecasting and planning).

These are the main steps in the human resource planning process, but these steps can
106

also be divided into smaller steps or activities. For example, in step 1, when we identify
the work being done in the organisation, the activity that we will be involved in is called
job analysis. We do a job analysis to ind out what the job entails – what the tasks are,
what the working conditions are, to whom the position reports, and which decisions are
made in this job. Various methods can be used to collect this information (the methods
are discussed in the prescribed book) and the information is used to compile a job de-
scription and a job speciication.

A job description provides information about the tasks performed in a speciic job, while
107

a job speciication provides information about the knowledge, skills, abilities, education
and experience required to perform the job successfully. The job speciication gives us
the information we need for step 2 of the human resource planning process.

The last step in this process is to do human resource forecasting. This is done to bal-
108

ance human resource supply with human resource demand. The demand for human
resources (how many people we will need at a given time) is inluenced by the business
objectives, while the supply is inluenced by HR programmes that provide the human
resources – for example, promotions, training and development, and recruitment and
selection. This information is used to compile a human resource plan. This will indicate
how the organisation’s human resource requirements can be provided for. For example,
if the HR planning process indicates that a shortage may be experienced in a year’s time,
the plan will indicate that the organisation must engage in an extensive recruitment and

22
selection campaign. If the HR plan indicates that employees will have to be retrained be-
cause of the updating of equipment, then training and development programmes must
be developed. In this way HR planning indicates what the future focus of HR activities in
the organisation should be.

Activity 3.1

Cecilia works for a processing plant that produces avocado and peanut oil. The process
is largely automated, but the plant equipment will be updated in the next year. Describe
the HR planning steps that Cecilia must take and identify the HR implications of this plan.

Cecilia must follow the steps in the HR planning process. This means that she must do job
analyses and compile job descriptions and speciications of the current staf. Then she must
determine how many employees will be needed after the plant machinery has been updated.
The last thing she will have to do is to determine which employees will have to be retrained
because of the updated machinery that they will be working on. She may also have to ind
out whether the company will have to redeploy some employees, whose skills may not be
needed any more.

3.3 FINDING QUALIFIED WORKERS

Study section 11.4 in the prescribed book.

The HR plan can indicate that the organisation has to employ new staf. What does this
109

mean in practice? It means that the organisation has to look for possible employees and
then choose those who will be able to do the job best. This is the recruitment and selec-
tion process.

Be careful not to confuse recruitment and selection. Recruitment is what an organisation

110

does to alert people that there are vacancies available. The purpose of recruitment is to
create as large as possible a pool of candidates for a vacancy, so that the organisation can
choose the best of them for a vacant position. The technique most commonly used to do
this is advertising. Selection is what is done after the advertisement, when people who
are interested in the position have applied for it and the organisation then goes through
a process to determine which of the interested people will be best to ill the position. In
other words, selection follows on recruitment.

Organisations can recruit from within (in other words, recruit from the existing employ-
111

ees) or from outside the organisation. Both these approaches have advantages and dis-
advantages. Diferent techniques are used to recruit possible employees – for example
advertising, using consultants or using existing employees.

23 MNB1601/1
 Activity 3.2

Indicate which recruitment techniques are used in the following examples.

Description Recruitment technique

John works as a software develop-

er for a small independent com-
pany. Microsoft contacts him and
invites him to send his CV through
to their HR department.

Talk Radio 702 broadcasts that

there are vacancies available for
interns.

Adele reads an advertisement in

the Sunday Times for a Human
Resource Oicer and decides to
apply.

Martin owns a fast-food restau-

rant. One of his cooks has resigned
and he asks his other employees if
they know of anyone who is avail-
able to do the work.

An engineering irm approaches

The Personnel Concept (a place-
ment agency) to ill the position of
senior engineer

Recruitment techniques are discussed in the prescribed book. Organisations can use techniques
such as advertising, or using recruitment agencies, existing employees, the personal approach,
or radio, TV and the Internet. The technique used will be determined by the position that must
be illed. In the activity John was recruited by using the personal approach, 702 used the radio,
Adele applied for an advertised post, Martin used a referral from existing employees and the
engineering irm used a recruitment agency.

Selection starts after the pool of candidates has been created. The selection process
112

can contain various steps, depending on the kind of position being illed. Figure 11.2 in
the prescribed book depicts nine steps in the selection process, but an organisation can
decide which of these steps to include. Note the efect of the Labour Relations Act and
the Employment Equity Act on the selection process of organisations.

24
 Activity 3.3

In each of the following examples, indicate which steps will be included in the selection
process and indicate the purpose of each step.
(1) Mary has applied for a vacancy as a waitress in a well-known restaurant. This will be
a part-time position.
(2) The CEO of a manufacturing company resigns and the position must be illed.
(3) A inancial institution wants to employ a human resource oicer.

When the position that must be illed is on a lower level in the company, or when the position
is only temporary or part-time, the company will want to ensure that the selection process
is as short as possible, because selection is expensive. They may include the following steps.

First is preliminary screening – to compare applications with the job speciication and in this
way screen out applications from people who obviously do not have the required experience,
qualiications and knowledge. This preliminary screening can be done using the application
form or CV and information can be clariied by doing a short telephonic interview.

This position does not require or justify the use of psychological tests, but a more intensive
interview (diagnostic interview) can be used to obtain more information or make selection
easier when there are a number of candidates who it the job requirements. If reference checks
are to be used, it is better to do the reference checking before this second interview, to clarify
any information that may be revealed during the reference check. Reference checks are used
to conirm the information that job applicants have provided on the application form or in
the CV and in the preliminary interview.

The conclusion of the selection process for the irst example will be a job ofer and placement,
followed by an induction programme.

The higher the position is in the organisation’s hierarchy, the more steps may be included in the
selection process. In the case of the second example, apart from the steps already discussed,
the organisation may include extensive psychological tests (ensure that tests are not culturally
biased) and work simulation tests. Another set of interviews may also be included.

In the third example, the intensive psychological testing may be excluded, as well as one set
of interviews.

3.4 DEVELOPING QUALIFIED WORKERS

Study section 11.5 in the prescribed book.

The human resource plan (discussed in section 3.2) may indicate that employees must be
113

trained and developed, to make sure they can achieve the organisation’s goals. Sometimes
organisations appoint employees at entry level and then undertake to develop them for
future positions. Investing in employee development enables the organisation to reap the
beneits of employees who are willing and able to do their jobs eiciently and efectively.

The prescribed book diferentiates between training and development and then deines
114

the concept of human resource development. Make sure that you do not confuse these

25 MNB1601/1
concepts and remember that learning is at the core of all human resource development
activities. Human resource development activities can take place either within or outside
the work situation and can be either formal or informal.

Activity 3.4

Identify the development methods used in the following examples.

Description Method

John is a bank clerk. He works as a ca-

shier but in the past year he has also
worked in the foreign currency depart-
ment, the bonds department and the
savings department. He is on a training
programme to develop bank managers.

Mary is a cashier in a department store.

She has just started working and is as-
sisted by Rachel, who has been working
as a cashier at this store for three years.

Paul has been appointed as an engineer

and is attending an orientation course.

Christel has been promoted to a su-

pervisory position and has to attend a
conlict management course.

Alexander works as a clerk in the Civil

Service and is studying part-time for a
degree in Public Administration.

26
 Informal development Formal development

The employee does not follow The employee follows

an oicial training programme. an oicial training pro-
gramme and receives a
formal qualiication.

INSIDE THE WORK Employees are put to work Learnerships. Employees

SITUATION immediately and expected to are trained in the work en-
learn the work in due course, vironment but must also
for example coaching and job pass certain compulsory
rotation (John and Mary). modules and at the end re-
ceive a formal qualiication,
for example electricians.

OUTSIDE THE WORK Training courses ofered inside Students acquire a formal
SITUATION the company, for example in- education at the end of a
duction courses and courses study period, for example
in computer literacy (Paul and a BCom degree (Alexander)
Christel)

Organisations evaluate the performance of their employees because they wish to estab-
241

lish whether employees comply with job requirements and also want to ind out which
employees perform exceptionally well. Employee performance is measured against job
criteria and the appraisal process should be objective to ensure success. The appraisal
process is also an opportunity for supervisors to give feedback to employees about job
performance. Performance information is used to make human resource management
decisions, such as who should be promoted and who should be given a salary increase
or performance bonus. It can (and should) also be used to determine whether employees
need training and development, either because their job performance is below standard
or to equip them with the skills and knowledge they will need to perform well in higher
level positions.

Activity 3.5

Think about your own job, or the job of a close relative or friend. Try to answer the fol-
lowing questions:

(1) Describe the performance appraisal process that is used in your place of work.
(2) Is this an ongoing process or a once-a-year event?
(3) How does the performance appraisal process contribute to your own job performance?

Performance appraisal systems can measure employee performance against quantitative

objectives, for example determining how many units were produced by each employee in a
speciic period of time. This is often the most objective form of performance appraisal. Other
systems measure personal characteristics such as loyalty, enthusiasm and dedication to work.
This is a more subjective method of evaluation and does not really measure work performance
as such. A 360º system uses information from more than one source – for example, information
from the supervisor, colleagues and customers is used to measure job performance.

27 MNB1601/1
A performance appraisal process should be utilised throughout the year, because then
242

it provides opportunities for the supervisor to give feedback to the employee on his or
her job performance throughout the year. If performance does not comply with job re-
quirements, the employee and supervisor can compile a development plan to take care
of the problem and in this way employees can be developed to their full potential and
can become fully productive members of the organisation.

3.5 KEEPING QUALIFIED WORKERS

Study section 11.6 in the prescribed book.

Efective human resource management, based on HR planning, will be diicult if an or-

115

ganisation cannot hold on to good employees because the salaries and beneits it ofers
do not compare with those of competitors. We need money to survive and provide neces-
sities as well as the good things in life and this can be a headache for an organisation. How
can it establish salaries that will encourage prospective employees to apply for vacancies
and motivate current employees to stay with the company, but still contain HR costs?

Compensation is all the inancial returns and tangible services and beneits employees
116

receive as part of their employment relationship. The kind and level of compensation is
determined by the compensation policy. This indicates the company policy on the fol-
lowing matters:

• a level of pay that may be higher or lower than, or equal to, competitors’ pay
• the kind of beneits employees will receive
• how annual increases will be approached
• how exceptional performance will be rewarded

Activity 3.6

What happens in the company where you work?

(1) Explain how salary increases are determined.

(2) Explain how exceptional performance is rewarded.

In some companies, yearly increases are linked to performance appraisal results, while in
others they are linked to measures such as inlation. The compensation policy should also
be clear about issues such as rewards for exceptional performance. Sometimes this is linked
to salary increases – in other words, employees who perform well get higher increases than
employees who do not perform well. In other companies, employees receive a once-of bonus
as a reward for good performance.

28
 We have seen that compensation consists of three main elements:
243

• a basic salary (also called direct compensation)

• beneits (also called indirect compensation)
• rewards

244 What are the diferences between these?

DIRECT COMPENSATION This is a monthly salary or daily, weekly or bi-monthly

wage. It is the money that the employee receives at the
end of a wage/salary period. The determination of this
compensation is based on the worth of the job to the
organisation and not on individual or team performance.
In other words, everyone who is employed as a cashier
in a bank will receive more or less the same salary, with
diferences being based on years of experience and quali-
ication and not on job performance.

INDIRECT This compensation is not monetary. Instead of giving

COMPENSATION employees more money and expecting them to supply
their own beneits such as a pension fund and medical
aid fund, the organisation saves money for a pension
fund and medical aid on behalf of the employee. So the
employee does not receive money in hand or in the bank,
but receives the beneit of the money in the form of a
pension when he or she reaches retirement age, or as
inancial assistance from a medical aid scheme when he
or she falls ill. Some beneits are required by law (such as
vacation leave and sick leave), while others are provided
by the organisation but not required by law (such as pen-
sion funds and medical aid schemes).

In some organisations the beneits employees receive are

linked to the hierarchical level of their job. For example,
in a bank, only employees at certain levels may receive
a housing subsidy or car allowance. Beneits are also not
linked to individual or team performance.

REWARDS (INCENTIVES) This compensation is linked to individual or team perfor-

mance. It can take the form of a once-of performance
bonus, a better-than-average salary increase or some-
times a paid holiday or other special reward. The aim
of rewards or incentives is to motivate employees to
perform above average. Incentives are not a right – if an
employee performs well one year and gets a bonus, he
or she may not claim a bonus the following year if his or
her performance is not above average.

29 MNB1601/1
 Activity 3.7

Try to identify the direct compensation, indirect compensation and incentives on the
following salary advice (pay slip).

Name: Salary period: Salary range:

Rank: Date: Salary notch:

Basic salary: PAYE: R2 080,00 Proit sharing bonus:

R8 500,00 R2 000,00

Medical aid: UIF: R115,00

R1 500,00

Pension plan:
R850,00

Housing subsidy:
R600,00

Leave credit: Gross salary: R8 305,00

10 days’ vacation
12 days’ sick leave

As stated earlier, direct compensation is the monthly, daily, weekly or bi-monthly salary or
wage the employee receives. In this instance, the basic salary is the direct compensation. The
pension plan, medical aid, housing subsidy, UIF (unemployment insurance fund contribu-
tion – required by law) and vacation leave (required by law) are the indirect compensation or
beneits the employee receives. The proit-sharing bonus is an incentive, usually paid out at the
end of an organisation’s inancial year. Remember that the combination of salaries/wages,
beneits and incentives that employees receive will difer from organisation to organisation
and is determined by the organisation’s compensation policy.

How do organisations determine the salary or wage that each employee should receive?
246

The way to determine salaries is to make comparisons – external comparisons and internal
comparisons. The purpose of an external comparison is to determine the salary levels of
comparable positions in other organisations. This comparison is made by doing a salary
survey. The next step is to do an internal comparison by means of a job evaluation. A job
evaluation is a determination of the worth of a job (value of a job to the organisation).
The job description is essential in a job evaluation exercise, because it provides informa-
tion that can be used to classify or grade a job according to certain criteria. Diferent job
evaluation methods use diferent criteria.

30
 Activity 3.8

There are many terms in human resource management that sound similar but have vary-
ing purposes and are used for diferent applications. To make sure you do not confuse
these terms, do the following exercise.

Give a brief description of each of the following terms and explain what it is used for.

Description Used for

Job analysis

Job description

Job speciication

Performance appraisal

Job evaluation

Job analysis is one of the basic activities of a human resource manager. Through a job analysis,
an organisation can determine the activities involved in each job and the information can be
used to compile a job description and job speciication. A job description is a description of the
tasks, duties and responsibilities of a job, and can include information about reporting lines and
working conditions as well as decisions that must be made in a speciic job. A job speciication
is a description of the qualiications, knowledge and experience the job incumbent needs in
order to perform the job successfully. Job descriptions are used in performance appraisals, to
compare employee performance against job standards. They are also used in job evaluations.
Job speciications are used in recruitment and selection, to determine whether candidates
possess the qualities necessary to be successful in a job. Performance appraisals are used to
evaluate the quality of an employee’s job performance. In other words, compared with the
job standards, did the employee perform equivalent to the standard, above the standard or
below the standard? Job evaluation determines the worth of a job, establishes where a job its
into an organisation’s hierarchy and determines the salary that should be attached to that job.

SUMMARY
This study unit should have given you a basic insight into how organisations plan for, ind,
117

develop and keep their human resources. It should also be clear that human resource
managers make it possible for line managers to manage their staf efectively, by provid-
ing the necessary policies and procedures, delivering eicient HR services, advising and

31 MNB1601/1
counselling employees and managers and listening to employees’ concerns and present-
ing their needs to managers.

SELF-ASSESSMENT QUESTIONS
3

(1) Doing a job analysis, compiling job descriptions and job speciications and identifying
the number of employees who will be needed in the future are steps in the process.
(a) job evaluation
(b) human resource planning
(c) performance appraisal
(d) recruitment
(e) selection
(2) In this human resource management activity, observation, interviews and question-
naires can be used to collect information about job behaviours and activities.
(a) job description and job speciication
(b) forecasting labour supply and demand
(c) job evaluation
(d) job analysis
(e) diagnostic interviewing
(3) This document consists of a job summary, a description of each main task and a
description of the kind of decisions that the incumbent must take.
(a) job description
(b) job speciication
(c) short list
(d) job behaviours
(e) labour market analysis
(4) The purpose of recruitment is to
(a) ill vacant positions with existing staf members.
(b) appoint people from outside only at the lowest level.
(c) ensure that a suicient number of applicants apply for the vacancy.
(d) make an active efort to obtain the right person for the job.
(e) create the opportunity to bring new ideas, schools of thought and approaches
to the business.
(5) The correct order of the steps in the selection process is as follows:
(a) reference checking; preliminary screening; short-listing; psychological testing;
diagnostic interviewing; job ofer; placement and induction
(b) preliminary screening; reference checking; short-listing; diagnostic interviewing;
psychological testing; job ofer; placement and induction
(c) preliminary screening; short-listing; reference checking; psychological testing;
diagnostic interviewing; job ofer; placement and induction
(d) reference checking; short-listing; preliminary screening; diagnostic interviewing;
psychological testing; job ofer; placement and induction
(e) preliminary screening; psychological testing; diagnostic interviewing; short-listing;
reference checking; job ofer; placement and induction
(6) It is important to ensure that informal development inside the work situation does
not take place at random. The HR manager can ensure this by

32
 (a) encouraging employees to attempt extramural studies, arranging for employ-
ees to attend training programmes and keeping careful record of employees’
development progress.
(b) analysing development needs, encouraging employees to attempt extramural
studies and arranging for employees to attend training programmes.
(c) arranging for employees to attend training programmes, analysing development
needs and making plans with the immediate supervisor concerned to utilise the
new skills in the work situation.
(d) keeping careful record of employees’ development progress, encouraging man-
agers to establish this kind of development and discussing employees’ progress
and prospects with them.
(e) keeping careful record of employees’ development progress, encouraging manag-
ers to establish this kind of development and encouraging employees to attempt
extramural studies.
(7) A performance appraisal is done to
(a) identify the characteristics of a job, assess the impression the employee has
made on the manager and determine whether employees should be promoted.
(b) provide employees with feedback on how well they are doing, provide a basis
for inancial rewards and determine whether employees should be promoted.
(c) assess the impression the employee has made on the manager, provide em-
ployees with feedback on how well they are doing and provide the basis for
inancial decisions.
(d) provide employees with feedback on how well they are doing, identify the
characteristics of a job and assess the impression the employee has made on
the manager.
(8) The size of the compensation for a speciic position is determined by
(a) doing an external comparison of salaries, using a salary survey, and then do-
ing an internal comparison of salaries, using a job evaluation based on the job
description.
(b) doing an external comparison of salaries, using a salary survey, and then doing
an internal comparison of salaries, using a job speciication.
(c) doing an external comparison of salaries, using a job description, and then doing
an internal comparison of salaries, using a job speciication.
(d) doing an external comparison of salaries, using a salary survey, and then doing
an internal comparison of salaries, using a job analysis.
(e) doing an external comparison of salaries, using a job analysis, and then doing
an internal comparison of salaries, using a salary survey.
Question 1

The correct answer is option 2.

Refer to section 11.3 in the prescribed book.

Job analysis, compiling job descriptions and speciications, and determining the number of
employees who will be needed in future are the three steps in the human resource planning
process. The human resource needs are based on the organisation’s goals and strategy.

Question 2

The correct answer is option 4.

Refer to section 11.3.1 in the prescribed book.

33 MNB1601/1
Observation, interviews and questionnaires can be used to collect information about job be-
haviours and activities for job analysis. Job analysis is the process of describing and recording
information about job behaviours and activities.

Question 3

The correct answer is option 1.

Refer to section 11.3.2 in the prescribed book.

A job description consists of a job summary, a description of each main task and a descrip-
tion of the kind of decisions that the incumbent must take. The format of a job description
can difer from business to business, but the information is usually presented in a format that
is easily readable.

Question 4

The correct answer is option 3.

Refer to section 11.4.1 in the prescribed book.

The purpose of recruitment is to ensure that a suicient number of applicants apply for a va-
cancy in a business. Applications can be received from existing employees and from outside
the business.

Question 5

The correct answer is option 5.

Refer to section 11.4.2 in the prescribed book.

The steps in the selection process are as follows: preliminary screening to separate undesirable
candidates from potential applicants. Preliminary screening is usually based on the application
form. The next step is to do an intensive assessment which consists of psychological testing
and diagnostic interviewing. Psychological testing can provide valuable information on an
applicant, while the diagnostic interview is used to obtain information that was not highlighted
in the tests or on the application form. After these interviews there is usually enough informa-
tion available about the applicants to compile a short list. After the short list is compiled, the
candidates’ references are checked to conirm the information that they provided. When the
most suitable applicant has been chosen, a job ofer is made, and the person can then accept
or decline the ofer. If the ofer is accepted, the candidate is placed in the position and goes
through an induction or orientation programme.

Question 6

The correct answer is option 4.

Refer to section 11.5.2 in the prescribed book.

Informal development inside the workplace is not a formal development programme. The
employee is put to work immediately and expected to learn in due course. The HR manager can
ensure that informal development inside the workplace is planned and structured (does not
take place at random) by keeping a careful record of each employee’s progress, encouraging
managers to establish this type of development and discussing the progress and prospects of
individual staf members with them.

34
Question 7

The correct answer is option 2.

Refer to section 11.5.4 in the prescribed book.

A performance appraisal is done to provide employees with feedback on how well they are
doing, provide a basis for inancial rewards and determine whether employees should be
promoted. It gives an indication of whether the employee complied with the requirements of
the job and performed well or not.

Question 8

The correct answer is option 1.

Refer to section 11.6.3 in the prescribed book.

The size of the compensation for a speciic position is determined by doing a salary survey
(comparing salaries paid by this company with salaries at the same level paid by other com-
panies in similar businesses – an external comparison of salaries). The second step is to do an
internal comparison, using a job evaluation based on the job description. The value of the
jobs in a company is compared in terms of the demand that they make on the employees.

35 MNB1601/1
Study unit 4
Motivating employees

Contents

Key concepts
Learning outcomes
Getting an overview
4.1 Employee motivation
4.2 Employee motivational strategies
4.3 The legal environment
Summary
Self-assessment questions

Key concepts

internal motivation motivation

needs external motivation
process approaches content approaches
job rotation job design
job enrichment job enlargement
training and education intrapreneurial incentives
empowerment and participation incentives
labour legislation

Learning outcomes

When you have worked through study unit 4 you should be able to:
• explain the concept of motivation by referring to internal and external motivation and
the needs satisfaction process
• differentiate between the different content and process approaches to motivation by
briefly describing each
• make suggestions about the motivational strategies that managers can apply in the
work situation and how the human resource manager can assist them

36
Getting an overview
These days it is generally accepted that people make an important contribution to the
247

organisation’s success. This means that the organisation’s philosophy and culture should
emphasise this belief. In this study unit, we will explore what the concept of motivation
entails, the diferent theories of motivation that have been developed and the motiva-
tional strategies that managers can utilise to improve employee morale and productivity.

4.1 EMPLOYEE MOTIVATION

Study section 11.7.2 in the prescribed book.

Motivation is the internal drive that encourages people to achieve certain goals. It has
118

two dimensions – internal and external.

Internal motivation is the satisfaction one

248 External motivation is the motivation that
249

experiences when a task is completed one feels in anticipation of a reward.

successfully or a duty is performed well.

Does this mean that all employees will be motivated if they can experience job satisfac-
120

tion, or that they will only be motivated if they think they will get some kind of reward?
No, motivation is a complex process determined by individual needs.

Think of what happens when you feel hungry. Hunger is a need and it will probably result
121

in some kind of behaviour to satisfy that need. If you are at home, you may go and cut
a sandwich or look in the fridge or grocery cupboard for something to eat. If you are in
town, you may decide to buy something to eat. When you have acted, you may achieve
the fulilment of the need – after you have eaten the sandwich you will not be hungry
anymore and will be rewarded by the satisfaction of a full stomach. If you are on a diet
you may feel guilty about eating a sandwich because it isn’t part of your eating plan! If you
are still hungry, the need will be unsatisied and you may look for something else to eat.

Activity 4.1

Think about your own motives. Why are you studying, what do you want to buy when
you get your next salary or allowance, and what do you want to achieve in life? Also think
about what was important to you four years ago. Are the same outcomes still important?
Discuss this with a friend, and try to ind out what is important to the friend. Are the things
you want similar? Do you know what is important to your friend? Write down what you
think is important to her and then compare that with what she says.
Write your indings down.
Compare what you have written down about your own motives with the characteristics
of motives that appear below. Can you see that the characteristics discussed below also
apply to your own motives?

37 MNB1601/1
 The diference between people is that their needs are not all similar at a given time (we do
not usually get hungry at the same time as a colleague or friend, and we may not want to eat
the same snack). In other words, motives (or needs) difer. Managers must keep this in mind
when they want to motivate staf. Motives also change – when I am not hungry any more,
having a sandwich will not be important to me. If I meet a friend and the friend is hungry,
having something to eat will be important to her! Motives vary in importance. If I know that
I can make a sandwich at any time of the day, because there is food in the grocery cupboard,
then satisfying my hunger may be less important than my need to be thin – so maybe I will
not have the sandwich and will rather keep to my dietary requirements.

On a more complex level, motives may be unconscious – someone who grew up very poor may
want to assure that they always have money in the bank and not know why this is important to
them. I have heard of victims of the Holocaust, who survived Hitler’s concentration and death
camps, who always carry a piece of bread with them when they leave their houses, because
the hunger they experienced in the camps was so severe that they want to ensure that they
always have something to eat. Also, managers do not always know what their subordinates’
motives are – instead they infer the motives from people’s behaviour.

Motivation theories are divided into two groups – content theories or approaches, and
250

process theories or approaches. The content theories emphasise the things in us that guide
behaviour, while the process theories focus on why people choose certain behavioural
options and how they evaluate their satisfaction following goal achievement.

Activity 4.2

Give a short description of each of the motivational theories discussed in the prescribed
book.
Content theories

MASLOW’S HIERARCHY OF NEEDS

The crux of the theory:

The theory assumes that

•
•

Unsatisied needs
•
•

Management can help employees by

•
•

38
Needs
•
•
•
•

ALDERFER’S ERG THEORY

A reinement of Maslow’s ive-level hierarchy

Three core needs:

• existence
•
•

No rigid hierarchy of needs; two or three needs categories can inluence

behaviour simultaneously.

If attempts to satisfy growth needs are frustrated ........................................

HERZBERG’S TWO-FACTOR THEORY

Maintenance factors Motivational factors

Can be linked to Maslow’s theory.

Job satisfaction lies in the task itself, but:

•
•
•

McCLELLAND’S THEORY

Three needs:
•
•
•

39 MNB1601/1
 Managers must determine the dominant need of subordinates and ofer
opportunities to satisfy those needs.

Process theories

EXPECTANCY THEORY

Motivation depends on Assumptions:

two things • The individual and the environment con-
• trols behaviour.
• • People make decisions about their
behaviour.
• People’s needs and goals difer.
• The tendency to act in a certain way de-
pends on the strength of the expectation
that action will lead to a given outcome and
how much the person desires the outcome.

Three key concepts:

Valence Instrumentality Expectancy

(Desirability of outcome) (Strength of (Efort = Outcome)
belief)

Managerial implications:
•
•
•

EQUITY THEORY

Employees compare their eforts and rewards with those of other employees
in similar situations.

People are motivated by

•
•
•

40
 Equity exists when: Inequity exists when:
my input-output ratio = your input- my input-output ratio is unequal
output ratio to yours

Employees can restore equity by:

•
•
•
•
•

GOAL SETTING

Assumption:
•
•

Goals must be:

• speciic
• achievable

Employees must:
•
•

Maslow’s hierarchy of needs groups needs into ive main areas and states that some needs
must be satisied before others can become important. This is the crux of the theory. Maslow’s
theory assumes that lower-level needs must be satisied before we can progress to higher-level
needs and that satisied needs can no longer motivate. Alderfer identiies three core needs:
existence, relatedness and growth. Herzberg is of the opinion that for the motivation to be
possible, maintenance factors must be present even though maintenance factors do not act
as motivators. Motivational factors (growth factors) concentrate on the content of the job
and these are the factors that motivate employees. Maintenance factors are issues such as
organisational policy, equipment, interpersonal relationships, salary, status and working
conditions. Motivational factors are successful completion of tasks, recognition of achieve-
ment, the meaningfulness of the job and the feedback. McClelland indicates that three main
areas of needs exist (namely for achievement, power and ailiation), and that managers must
determine the dominant need of their subordinates and ofer opportunities for employees to
meet their individual needs.

41 MNB1601/1
 The expectancy theory is complex, but briely states that our motivation is inluenced by how
much we want something, and how likely we think we are to get what we want. This means
that managers should set attainable standards, link rewards such as incentive bonuses to per-
formance standards and try to link personal goals to organisational goals. The equity theory
states that employees compare how much efort they put into their work and the compensation
they get with how other employees fare. Equity should exist and when employees perceive
that it does not exist they will use certain means to restore equity. Goal-setting theory states
that employees will perform better if they strive towards a speciic goal and receive feedback
on their performance.

What does this mean in practice? Managers must be actively involved in employees’
251

motivation. But how can this be achieved?

4.2 EMPLOYEE MOTIVATIONAL STRATEGIES

Study section 11.7.3 in the prescribed book.

Activity 4.3

Identify which of the motivational strategies discussed in the prescribed book are inlu-
enced by the human resource manager.

Human resource managers directly inluence job design, training and education, incentives and
compensation, and career management in organisations. You must also remember that the
human resource manager supports the line manager, so indirectly the human resource man-
ager can inluence things like empowerment, participation and creating a culture of change.

4.3 THE LEGAL ENVIRONMENT

Maintaining human resources within an organisation includes being aware of and abiding
123

by the Acts that regulate various dimensions of the employment relationship.

There are a number of Acts that directly impact on the management of labour relations
124

in organisations. However, there are also numerous other Acts that impact on business
activity. Although you are not expected to know these Acts in detail, you need to be
aware of them. It is, however, essential for you to have a basic understanding of the
labour laws, because you will not be able to efectively manage human resources within
any South African organisation without this understanding.

Read section 11.8 in the prescribed book.

42
 Activity 4.4

Use the information obtained from sections 11.8.4 to 11.8.13 in the prescribed book to
complete the following table.

Act Purpose Aspects of HR man-

agement and LR regu-
lated by this act

Labour Relations Act

Basic Conditions of Employ-

ment Act

Skills Development Act

Skills Development Levies Act

South African Qualiications

Authority Act

Employment Equity Act

Occupational Health and

Safety Act

Compensation for Occupation-

al Injuries and Diseases Act

Unemployment Insurance Acts

Once you have completed the above table it should serve as a brief summary of the various
pieces of labour legislation. Refer to this table when you are confronted with human resource
management and labour relations issues in the workplace. If you know which aspects of la-
bour relations and human resource management are regulated by legislation, you can obtain
advice from legal experts when you need to deal with these matters.

The Government Gazettes containing Acts can be obtained at a nominal fee from the Govern-
ment Printer in Pretoria. The Acts are also available on a number of websites such as that of
the South African government (www.gov.za) or Acts Online (www.acts.co.za).

SUMMARY
By now you should have a clear understanding of the process of motivation, the difer-
125

ent motivational theories and how human resource managers can inluence the morale
of employees. Remember that people difer and that needs and motives are therefore
individualistic. Managers should try various approaches to motivation and not believe
that one approach will be successful for all employees and in all situations.

43 MNB1601/1
SELF-ASSESSMENT QUESTIONS
4

(1) A salesman works hard to achieve a sales target. This is an example of:
(a) Maslow’s hierarchy of needs
(b) a process approach to motivation
(c) motivation that originates from the satisfaction of doing a job
(d) the equity theory
(e) motivation in anticipation of a reward
(2) The correct sequence of needs in Maslow’s hierarchy of needs is:
(a) safety needs; physiological needs; esteem needs; ailiation needs; self-actuali-
sation needs
(b) physiological needs; safety needs; ailiation needs; esteem needs; self-actuali-
sation needs
(c) safety needs; physiological needs; ailiation needs; self-actualisation needs;
esteem needs
(d) physiological needs; ailiation needs; safety needs; self-actualisation needs;
esteem needs
(e) physiological needs; ailiation needs; safety needs; esteem needs; self-actuali-
sation needs
(3) Mary is a lecturer at a big university. She is frustrated because her computer is
outdated and this results in a waste of time because the computer support services
staf have to come and assist her often. She has become so frustrated that she has
started looking for another job. This is an example of Herzberg’s two-factor theory,
which states the following:
(a) The absence of motivational factors could have a negative efect on employee
morale.
(b) The presence of motivational factors will always have a positive efect on em-
ployee morale.
(c) Employees will be motivated by motivational factors, irrespective of whether the
maintenance factors are present.
(d) The absence of maintenance factors could have a negative efect on employee
morale.
(e) Employees will be motivated by maintenance factors, irrespective of whether
the motivational factors are present.
(4) According to Vroom, motivation depends on:
(a) how much I want something and how likely I think I am to get what I want
(b) the attractiveness of a speciic outcome, my needs, goals and desires and my
tendency to act in a certain way
(c) the attractiveness of a speciic outcome and how personal goals are linked to
organisational goals
(d) how much I want something and how personal goals are linked to organisa-
tional goals
(e) how personal goals are linked to organisational goals and how rewards are
linked to performance standards
(5) In the equity theory, when input-outcome ratios are unequal, inequity exists and
employees will perceive the situation as unfair. They will try to restore equity by:
(a) resigning
(b) changing their attitudes
(c) changing their inputs or outputs

44
 (d) changing the people they compare themselves with
(e) all of the above
(6) Robert works in a bank. There have been retrenchments and Robert has been assigned
more duties at the same level (his job has been expanded). This is an example of:
(a) job enlargement
(b) job design
(c) job enrichment
(d) job reward
(e) job rotation

Question 1

The correct answer is option 5.

Refer to section 11.7.2.2 in the prescribed book.

When a salesman works hard to achieve a sales target, he is motivated because he expects to
receive a reward for his behaviour. Motivation is the internal drive that encourages people to
achieve a particular goal and it can be internal or external. Internal motivation originates from
the satisfaction that a person experiences when a task is completed or a duty is performed.
In the case of external motivation, a person is motivated in anticipation of receiving a reward
of some kind.

Question 2

The correct answer is option 2.

Refer to section 11.7.2.2.

The correct sequence of needs in Maslow’s hierarchy of needs is physiological needs, safety
needs, ailiation needs, esteem needs and self-actualisation needs. The theory assumes that
a person attempts to satisfy the most basic needs before progressing to satisfying higher-level
needs. A need also ceases to motivate once it has been satisied.

Question 3

The correct answer is option 4.

Refer to section 11.7.2.2.

According to Herzberg’s theory of motivation, things such as oice equipment provide mainte-
nance factors for motivation. The oice equipment in itself cannot motivate, but the absence
of proper equipment prevents Mary from being motivated. Maintenance factors have to be
present before motivational factors can motivate employees.

Question 4

The correct answer is option 1.

Refer to section 11.7.2.4.

According to Vroom, motivation depends on how much I want something and how likely I
think I am to get what I want. The three key concepts in his theory are valence (the attractive-

45 MNB1601/1
 ness of a speciic outcome for an individual), instrumentality and expectancy – the strength
of the person’s belief that a certain performance will lead to a desired outcome.

Question 5

The correct answer is option 5.

Refer to section 11.7.2.4 of the prescribed book.

Inequity occurs when employees perceive that input-output ratios are unequal (in other
words they think they are not paid enough for the efort they put into their work). They will
try to restore equity by resigning, changing their attitudes, changing their inputs or outputs
or changing the people they compare themselves with.

Question 6

The correct answer is option 1.

Refer to section 11.7.3 of the prescribed book.

When an employee is assigned more duties at the same level in the organisation, his or her
job is expanded and this is known as job enlargement. When a job is enlarged, more tasks are
added but the employee does not receive more decision-making or planning responsibility.

126

46
TOPIC 3
The marketing function

AIM
The aim is to explain the importance of the marketing function to the business, with
127

emphasis on the marketing process and marketing instruments.

Learning outcomes

When you have worked through topic 3 you should be able to:
• demonstrate an understanding of the marketing process by highlighting its components
• formulate the decisions involved when designing the marketing instruments, by sum-
marising the inherent elements of product, price, distribution and marketing com-
munication decisions

OVERVIEW OF THE TOPIC

128 Topic 3 comprises the following study units:

TOPIC 3

Study unit 5 Study unit 6

The marketing process The marketing instruments

47 MNB1601/1
Study unit 5
The marketing process

Contents

Key concepts
Learning outcomes
Getting an overview
5.1 The nature of marketing and the marketing process
5.2 Evolution of marketing thought
5.3 Consumer behaviour
5.4 Marketing research
5.5 Market segmentation, target marketing and positioning
Summary
Self-assessment questions

Key concepts

product marketing concept

distribution consumer orientation
marketing communication social responsibility
price proit orientation
individual factors organisational integration
group factors market aggregation
phases in decision making target market selection
survey method single segment approach
sales forecasting multisegment approach

Learning outcomes

When you have worked through study unit 5 you should be able to:
• analyse the definition of marketing by referring to the keywords
• demonstrate an understanding of the market offering by highlighting its four variables
• describe the evolution of marketing thought by highlighting the origin and different
approaches
• analyse the behaviour patterns of consumers by identifying the determinants of con-
sumer behaviour and the consumer decision-making process
• demonstrate an understanding of marketing research by emphasising how it can be
used in scanning the environment
• demonstrate an understanding of how the consumer market can be segmented by
emphasising the components of market segmentation and target market selection

48
GETTING AN OVERVIEW

Read section 12.1 in the prescribed book.

The main objective of a business is to maximise proitability in the long term. It is gen-
130

erally recognised that marketing is central to this objective because of its role in dein-
ing customer needs and wants and directing the resources of the business to meet
these needs. The rapid change in the marketing environment over the past decade has
heightened an awareness of the importance of marketing because businesses have had
to face increasing competition, economic luctuations, political changes and the need
to become more ecologically conscious. Successful marketers are those who can best
satisfy consumer needs in the context of the dynamic environment where threats must
be countered and all opportunities grasped in order to survive. One such business is Ed-
gars, who are continually doing research to determine the clothing needs of the diferent
market segments which they target. They then adapt their marketing strategy according
to these needs by designing clothes for the diferent segments, charging prices which
these segments are prepared to pay, selling these clothes in stores which are easily ac-
cessible to their customers and advertising these clothes in media that are purchased by
these customers, such as FAIRLADY magazine and the Edgars Magazine. This study unit
introduces you to the nature and components of marketing, the evolution of market-
ing thought, the determinants of consumer behaviour, the marketing research process,
market segmentation and target market selection.

5.1 THE NATURE OF MARKETING AND THE MARKETING

PROCESS

Study the deinition of marketing in section 12.4 and the relevant keywords in
table 12.1 as well as the components of the marketing process in section 12.5.

Marketing is everywhere. It is something we experience every day of our lives. You switch
131

on the television and there is an advertisement for Omo washing powder on the screen,
you stroll down a supermarket aisle and you are handed a coupon for All Gold tomato
sauce, while at the end of the next aisle you try a sample of a new brand of fat-free po-
tato chips. At home, you answer a phone call asking you to participate in a survey about
radio listening habits and then complete an order form to subscribe to Garden and Home
magazine.

All these situations involve marketing. Many people mistakenly think of marketing only
132

as selling and advertising, and no wonder, because every day we are bombarded with
the above types of messages. Someone is always trying to sell us something. Therefore
many students are surprised to hear that selling is only the tip of the iceberg. It is but
one of several marketing functions. This does not mean that advertising and selling are

49 MNB1601/1
unimportant, but rather that they are part of a larger “marketing mix” – a set of tools that
work together to afect the marketing place. Today’s businesses face increasingly stif
competition, and the rewards will go to those who can best read customer wants and
deliver the greatest value to their customers. The essence of marketing is the develop-
ment of exchanges in which businesses and customers voluntarily engage in transactions
that are designed to beneit both of them. For example, customers receive beneits from
purchasing Crosse & Blackwell’s mayonnaise and Ricofy, and Nestlé, the company that
sells these products, receives beneits by getting money for it.
In order for Nestlé to receive these beneits, it has to be involved in various activities
133

which form part of the marketing process. For instance, Nestlé has to divide the market
into segments with more or less similar needs (market segmentation) and it then has
to choose those target markets that it wishes to sell its products to (ie the retail market
and the catering market). It then has to do market research into the speciic needs and
wants of these markets in order to develop market oferings that will satisfy their needs.
The market ofering consists of four variables: the product, the price, the distribution of
the products and the promotion messages to sell these products. For instance, when
designing its products, Nestlé caters for the retail market with its 100 g, 250 g, 500 g and
750 g tins of Ricofy, while it satisies the catering market with its 1,5 kg tin and 25 kg bag
of Ricofy. It sets diferent prices for the diferent sizes of Ricofy. While customers in the
retail market can buy the products from stores such as Shoprite and Spar countrywide,
Nestlé makes use of agents to deliver its products directly to hotels, hostels, universities
and guesthouses in the catering market. Nestlé uses sales representatives and brochures
to promote its products in the catering market, while the traditional promotional methods
are used to sell its products to the ordinary customer, namely advertising in newspapers
and magazines regarding discounts on Ricofy, attaching coupons and samples of Ricofy to
magazines and ofering competitions in which customers can win a motorcar, for example.
By combining these four variables, Nestlé creates a market ofering that will satisfy the
134

needs of its many customers.

Activity 5.1

Explain the four variables of the market ofering which Toyota ofers to its customers.

Product: Toyota has many diferent vehicles that cater to the needs of the diferent market
segments. For instance, the Tazz is aimed at the lower income groups, while the Corolla and
Camry are directed at the middle income groups. The Lexus, on the other hand, is aimed at
the higher income segments of the market.

Price: Toyota has set diferent prices for the diferent vehicles.1 The selling price of the Yaris, for
instance, starts at R126 900, while that of the Corolla and Verso respectively start at R173 800
and R248 200. The selling price of the Lexus starts at R363 000.

Place: Toyota’s vehicles are available at dealers countrywide (eg McCarthy Toyota), which
makes it possible for customers to buy these vehicles in places that are convenient to them.

Promotion: Toyota makes use of various methods to persuade the markets to purchase its
products, for example advertisements in Car and You magazines, as well as over the radio and
on television, the input of knowledgeable salespeople in their dealerships, and competitions
in which consumers can win a motorcar.

50
5.2 EVOLUTION OF MARKETING THOUGHT

Study sections 12.2 and 12.3 in the prescribed book.

This section describes the changes in marketing thought over the last 100 years or so.
136

It is important to understand what each “school of thought” involves, because many

businesses are still “stuck in the past” and unwilling to adapt successfully to the new ap-
proaches needed to compete in a changing environment.

137 The phases in the development of marketing thought are as follows.

5.2.1 Operation-oriented management

In the production era the belief was that products would sell themselves, so the major
138

concern of businesses was production, and not marketing, and the needs of consum-
ers were largely ignored. Henry Ford’s marketing of the Model T epitomises this era. He
concentrated on making more cars to ill the demand; he said consumers could buy any
colour of the model T Ford they liked – as long as it was black!

5.2.2 Sales-oriented management

In this era the focus was on selling as much as possible by whatever means. Whether the
139

consumer really needed the product, or whether it really met his or her needs was not
important. This sometimes led to unethical sales practices, false claims, false promises,
and so on, in order to persuade the consumer to buy. There are still companies today that
are basically sales-oriented. Many mail-order businesses advertise products that are not
readily available or are not worth the quoted price. Someone once ordered a beautiful
pair of gold earrings from a mail-order catalogue. When they arrived, the earrings were
so small that she could hardly see them.

5.2.3 Marketing-oriented management

In this phase the focus was still on selling, but in a more integrated way. It was a far
140

broader concept than just selling. Consumers developed more sophisticated needs and
were inancially in a better position to satisfy their needs. There was also a wide variety
of competing products from which they could choose. This led management to realise
the importance of the marketing function. The packaging, distribution, quality, advertis-
ing, and so forth, all had to be integrated to create a certain “image” of the product. The
focus was placed mainly on the efectiveness and eiciency of the marketing tasks, and
marketing management came to realise that marketing tasks should be performed ac-
cording to an ethical code or management philosophy. The essence of this marketing
concept lies in the four principles discussed below.

The irst principle of the marketing concept is proit orientation. The marketing concept
141

views customer orientation as a means to achieve proit. By providing market oferings

51 MNB1601/1
that satisfy customer needs, the business will achieve its own objectives too. These objec-
tives can be expressed in many ways, for example achieving a rate of return of 25% on
investment, or achieving a speciied increase in proitable volume of sales, or by increas-
ing market share from 10% to 12%. Overall, the objective can be seen as an attempt to
survive and grow.

The second principle is that of consumer orientation. This means that the customer’s
142

needs become a top priority, and that the products and the services ofered by the busi-
ness are based on customer needs. This is often lacking in South African companies. In a
worldwide survey, South Africa was rated 23rd out of 24 countries for service orientation.
Here’s a typical example. The client of a travel bureau was dissatisied with the service
he was receiving from the bureau. Despite the fact that he travelled frequently, his re-
quests for information were often ignored, there were errors in his account, mistakes
were made with his bookings, and so forth. He wrote to the bureau to inform them that
their service was not up to scratch, and cancelled his account with them. Nobody from
the travel agency even bothered to contact him, possibly to persuade him not to cancel
his account, or to ind out why he was dissatisied, with a view to rectifying the situation.
This business simply ignored the principle of consumer orientation.

Customer-oriented businesses do not consider the marketing task complete once a sale
143

has been made. Such enterprises provide after-sales service. They check up on how
satisied customers are with the product/service and what can be done to enhance that
satisfaction.

The third principle is that of social responsibility. This covers a fairly wide ield and is
144

becoming increasingly important in the modern business world. Social responsibility

primarily implies that a business should make a contribution to the community with
whom it does business. Companies donate funds for community projects such as schools,
conservation programmes, welfare activities, and so on. For example, by sponsoring the
Addo Elephant Park, Total and Ford succeeded in establishing their brands in the market
as brands that care for the environment. Social responsibility also entails sponsorship of
sporting competitions, thus enabling both players and spectators to enjoy their sport.
And of course it is an opportunity for the business to advertise its products, giving it
some return on its contribution. By sponsoring the 2004 South African Olympic bid, Pick
n Pay showed their commitment to sport and the development of sport in South Africa.

But social responsibility goes further than merely contributing inancially to the commu-
145

nity. It also requires a business to be law abiding. This can range from absolute openness
and honesty in its business operations (eg not taking or ofering any bribes) to taking care
not to harm the environment (eg by polluting the atmosphere with smoke, or dumping
waste material in rivers). When a business adheres to the principle of social responsibility
it will try not to ofend the morals, values and religious beliefs of the community. A liquor
company that encourages teenagers to buy its products would, for example, arouse a
good deal of indignation from parents in the community – and they might boycott the
products of such a business.

Read the extract below and decide whether you think Engen demonstrates the principle
146

of social responsibility.2

52
 Engen, a subsidiary of Malaysian group Petronas, would be charged with violating
South Africa’s anti-pollution laws, a government oicial said yesterday.
Investigations by members of the South Durban Community Environmental Alliance
found that sulphur dioxide emissions from Engen’s reinery in Durban exceeded the
maximum permissible levels of the World Health Organization (WHO) 64 times in
over a month.
The reinery’s operating permit stipulates it may not breach the WHO’s guidelines
more than 35 times in one year.

The fourth principle is that of organisational integration. This implies that every function,
department and individual need to be marketing oriented – that is, they must continu-
ally be aware of how their actions will afect the image of the business. A telephonist,
for example, may not have anything to do with the selling of the business’s products,
but she is often the irst contact a potential customer has with the company. Thus, how
she answers the telephone (and how promptly) leaves a lasting impression on the caller
about the eiciency of the business as a whole. If a potential client has to wait long before
the phone is answered and even longer to be put through to the right person, there is a
good chance that she will hang up, and call a competitor.

Organisational integration is particularly important when it comes to cooperation between

147

departments. Imagine the chaos if Daimler Chrysler’s marketing department promises a

customer that she will receive the ordered vehicles by a certain date, and the production
department does not bother to manufacture those vehicles on time. Internal conlict,
poor service, and even loss of sales, may be the result.

5.2.4 Consumer-oriented management

The focus of this approach shifted away from marketing, and went one step back – to the
148

consumer. It started with product design. What were the needs of the consumer? How
should the product, quality, distribution, and so on, be designed to meet the needs of
the consumer? Mecer, for instance, irst determine the needs of their diferent target mar-
kets and then design their computers accordingly. This approach includes the marketing
orientation, but broadens it considerably.

5.2.5 Strategic approach to marketing

The focus here is an extension of the consumer-oriented approach, but places even more
149

emphasis on the long-term relationships with the consumer, supplier and even competitor.
It extends into the ield of public relations where a positive relationship with the com-
munity itself is fostered. Note that relationship marketing is not a separate approach; it
is part of the strategic approach to marketing.

53 MNB1601/1
5.2.6 Relationship marketing
In order to survive in a changing environment, it is important to maintain long-term re-
150

lationships with individuals, businesses and other institutions. An insurance salesperson

or an estate agent who maintains contact with a client after a transaction has taken place
increases his or her chances of doing business with the client again at a later stage.

Activity 5.2

Do you think Pick n Pay, the largest retail grocery chain in South Africa, applies the mar-
keting concept? Give reasons for your answer.

Pick n Pay deinitely applies the marketing concept because it applies all four principles of this
concept.3 For instance, it follows the consumer orientation principle. Raymond Ackerman is
portrayed as the homemaker’s friend and his motto is “the customer is queen”. Pick n Pay’s
quick reaction to matters that afect the consumer also shows its consumer orientation. Its
reaction to increases in the bread price is but one example of this consumer orientation that has
positioned it as a ighter for the interests of the consumer. Regular surveys are also conducted
to determine customers’ satisfaction with the service and products ofered.

It also adheres to the proit orientation. The fact that the company has managed to increase
its turnover in the past three years from R18,8 billion to R29,3 billion and has succeeded in
acquiring approximately 30% of the formal sector grocery market proves that it retains a
winning formula. The principle of organisational integration is also followed since all the
diferent departments work together to achieve objectives and to satisfy customer needs. For
instance, Pick n Pay’s marketing section will not advertise a discount on Skip washing powder
if the purchasing department has not purchased an adequate quantity of Skip.

Pick n Pay also shows its responsibility towards society by sponsoring various educational and
charitable events. It is very visible in athletics, sponsoring the Comrades Marathon as well as
cycling, for example the Pick n Pay Cycle Challenge and the Argus Pick n Pay Cycle Tour.

5.3 CONSUMER BEHAVIOUR

Study section 12.7 in the prescribed book.

We have emphasised over and over again that a business should satisfy the needs of
151

consumers. So marketers have to know what their customers need and want. They also
have to know how their customers make their decisions about buying and using products.

54
 Elizabeth, the mother of two, enters Buyrite, a supermarket, to do her weekly grocery
253

shopping. She has prepared a grocery list at home and walks down the aisles, selecting
the needed products from the shelves. When she gets to the aisle in which the cold
drinks are kept, she selects Coke for her husband and son, Liqui-Fruit for herself and
remembers that her daughter prefers Energade. She then walks to the cereals and
selects Rice Krispies for her daughter, Weetbix for her son, and mealie-meal porridge
for her husband and herself. She then continues and walks down the toothpaste aisle,
and remembers that a friend recommended a new toothpaste and decides to buy it.
Elizabeth then remembers an advertisement for a new deodorant called Fresh, and
adds it to her trolley.

From the example above, it is clear that Elizabeth is continually inluenced by her own
needs and preferences, as well as those of her family and friends and the advertisements
she has seen. When she does her shopping, she is a consumer who is satisfying certain
needs. Marketers need information about Elizabeth and all other consumers. They need
to know Elizabeth’s needs and preferences and why she has those needs and prefer-
ences. When this information is known, marketers can try to satisfy these needs with
their particular products.

5.3.1 Determinants of consumer behaviour

From the above it is clear that marketers need to investigate the factors that will inlu-
152

ence consumer behaviour. Two sets of factors inluence consumer behaviour: individual
factors and group factors. To help you remember these factors, we shall summarise each
one briely:

5.3.1.1 Individual factors

• Motivation. The consumer has speciic needs that will motivate his or her purchasing
behaviour. For instance, in order to be pretty and to be loved by her boyfriend, the
young girl buys Estée Lauder cosmetics.
• Attitudes. Attitudes may be positive, neutral or negative, depending on the consumer’s
experience of the product. For instance, the teetotaller has a negative attitude to liq-
uor. He does not even read advertisements for brandy and never considers buying it.
• Perceptions. Our perceptions are formed by the ways in which we observe stimuli
in the environment by looking, listening, smelling, touching and tasting, and then
interpreting the stimuli by attributing meaning to our observations. The young man
sees an advertisement for Camel cigarettes. His interpretation is that smoking dem-
onstrates masculinity and he buys a packet of Camel.
• Learning ability. This refers to our ability to grasp and remember the marketing mes-
sage. The housewife learns through experience that Cobra loor polish will put a shine
on her loors. She remembers to purchase Cobra on her next shopping trip.
• Personality. This refers to the inherent characteristics (eg moods) of the consumer
that will afect the way he or she behaves with respect to the buying process. A self-
conident person buying a new suit is less likely to seek out and rely on the advice of
friends and salespeople than a person who lacks self-conidence.

55 MNB1601/1
• Lifestyle. The consumer’s lifestyle is the typical way of life (eg habits) with regard to
social behaviour, leisure activities, and so on, that will inluence the consumer’s re-
sponse to the product ofering. Your lifestyle may be to buy books, travel overseas
frequently, live in a gracious home, play golf and read the Financial Mail and other
business publications.

5.3.1.2 Group factors

• Family. Family members have a major inluence on the consumer’s behaviour. Children
under 12, for instance, are most inluential in purchases of breakfast cereal, snack foods,
sweets, soft drinks, games and toys, clothing, music and toothpaste.4
• Reference groups. These are groups that positively or negatively inluence our attitudes
or behaviour. For example, teenagers typically use their friends as a reference group
for deciding which clothes are attractive.
• Opinion leaders. This is a reference person to whom others will look when forming
opinions and taking consumer decisions. An advertisement which shows a well-known
actress who uses Lux soap will inluence those consumers who admire the actress to
buy Lux soap.
• Cultural group. The norms and values of the consumer’s culture determine his or her
priorities in respect of diferent activities and products. South Africa has many difer-
ent cultural and subcultural groups. Marketers should be careful not to use symbols
in advertisements that can be interpreted incorrectly or diferently, and not to portray
unacceptable behaviour patterns. Some black and white cultural groups, for example,
interpret advertisements diferently. For example, lowers have special signiicance in
the white culture, but in many black cultures, gifts in the form of lowers are frowned
upon. The well-known Five Roses advertisement which said “And the ifth rose is for
you” was thus not successful when used in media aimed at black consumers.5

5.3.2 Consumer decision making

The consumer decision-making process consists of ive phases through which the con-
153

sumer progresses systematically. The irst phase is the awareness of an unsatisied need.
The process by which consumers buy products and services begins with a recognised
need. Suppose you have a computer, but you begin to realise that it is not adequate
for your university work. It is too slow and it does not have a CD-ROM drive, which you
need to view your interactive business management study guide. You decide to use
some of your savings to buy a new computer with a CD-ROM drive. You then progress
to the second phase of the decision-making process: gathering information on how
best to solve the problem. Now that you are aware that you need a computer with a
CD-ROM drive, you gather information to help you make the buying decision. You may
turn to information you already have, recalling your prior experiences or those of friends
making similar decisions. In this case you have not made a similar purchasing decision;
so you may search for more information from external sources such as family members,
advertisements and salespeople. After you have gathered all the relevant information
you move to the third phase, which involves the evaluation of all possible solutions.
You now have to sort all the information collected into such categories as price, service
and warranty. Additional categories, such as RAM speed, the availability of alternative
CD-ROM drives and competing brands, may be added as you talk to other people and

56
compare models. After you have evaluated all your information, you now have to decide
on a course of action. You have to stop searching for and evaluating information and
turn to the choice of a buying alternative. You need to reach a satisfactory compromise
regarding product features and other factors. For example, you may be willing to pay a
higher price to get a built-in CD-ROM drive or you may choose a computer with a CD-ROM
writer (one that can write data to CDs). You may also choose the store where you have
an account, or you may choose the store where your best friend is a salesperson. Once
you have made all your decisions, you purchase your new computer. The last phase in
the consumer decision-making process is post-purchase evaluation. During this stage
you will evaluate your decision and use this evaluation for future decision making. If you
are unhappy with your new computer, you will not buy the same make or model again.

Activity 5.3

Describe the phases of consumer decision making through which you will progress when
purchasing a new car.

The phases are:

• Phase 1: Awareness of an unsatisied need or problem. Your old car might break down for
the ifth time in one month. This indicates the need for a new car to you.
• Phase 2: Gathering information on how best to solve the problem. You collect informa-
tion regarding motor vehicles that you can aford, for example the Toyota Tazz and Ford
Focus. In order to collect this information you consult friends, motorcar dealers such as
McCarthy Toyota, magazines such as Car and advertisements which appear in newspa-
pers and magazines and on television.
• Phase 3: Evaluation of all possible solutions. You compare and evaluate the information
regarding the diferent makes and models, for example price, colour, engine size, air bags,
central locking and other features of the car.
• Phase 4: Deciding on a course of action. You decide whether to buy or not. If you decide
to buy, you also decide on the make and model to buy and the dealer to buy it from. You
might decide to buy the Toyota Tazz from Motorcity because they have ofered you the
best price.
• Phase 5: Post-purchase evaluation. You might doubt whether you have made the cor-
rect decision. Your experience with your Toyota Tazz will inluence your future decisions
regarding the purchase of Toyota motor vehicles.

5.4 MARKET RESEARCH

Study section 12.6 in the prescribed book.

It is simply not possible to keep up with all the changes taking place in the market. This
154

means that marketers have to rely on help from marketing research. For example, a
business may want to know something about its competitors or to gain an unbiased un-
derstanding of its own customers. Such information needs may require an independent
investigation through marketing research. See below for examples of how research can
produce results.6

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 255 Examples of how research can produce results

– A local award-winning marketing tool, the brand value index, is enabling manu-
facturers to have their products assessed by a sample of people, and from the
results, predict market share. The index was used to determine the value and
ideal positioning of the Jetta brand when a new model was introduced a few
years ago. A new model Jetta was lown in from Germany prior to the South
African launch. People were invited to a “car clinic” to view the car, which was
stripped of identifying marks. No test drives were permitted but the subjects
were able to sit in the vehicle and view it from all sides, and then, by question-
naire, to rate the car.
256 The index provided feedback from customers as well as non-customers. To
increase market share efectively, it was essential to understand and address
the shortcomings of the brand from the perspective of people who were not
buying it. The feedback also revealed where in the purchasing process the
brand was eliminated.

257 The results indicated that most people (85%) buy cars for emotional reasons
like appeal and image. Only 15% make a purely rational decision when buying
a car: that it will get them from A to B reliably and economically.

258 The pre-launch market share forecast for the Jetta was very accurate, with a
0,1% point diference between actual and predicted market penetration.

259 – NutraSweet’s patent on the artiicial sweetener, Aspartame, was due to expire.
The company faced disaster as chemical and sugar companies planned to enter
the market. NutraSweet analysed competitors’ prices, customer relations, expan-
sion plans and advertising campaigns. The company used this information to
cut costs, improve service and preserve most of their market. They managed
to maintain an 80% market share.

It is important to understand that sound marketing decisions will always be based on

reliable information about the market, the environment, as well as the business and its
resources. Often that information can be obtained from existing sources such as technical
journals, newspaper reports, sales igures, inancial reports and the like.

Sometimes, however, the required information can only be obtained by means of a sur-
155

vey – either internally (ie to gather information about the business itself) or externally (ie
to gather information about the market). Section 12.6.2 of the prescribed book describes
the steps involved in conducting a scientiically based survey.

Activity 5.4

Write out the steps with keywords and make sure that you understand what is involved
in each step.

The interpretation of the data gathered in a market survey will lead to a sales forecast.
261

This forecast is essential to determine whether the marketing of the product is likely to

58
be proitable or not. However, a sales forecast alone is not enough. The business also has
to make a proit forecast over a longer period of time to determine whether it is worth
going ahead with the production and marketing of a particular product.

5.5 MARKET SEGMENTATION, TARGET MARKETING AND

POSITIONING

Study sections 12.8 and 12.9 in the prescribed book.

Market segmentation is part of the three-phase STP process. STP is the abbreviation for
156

segmentation, targeting and positioning. Market segmentation deals with an aggregated

process that clusters people with similar needs into a market segment. Targeting deals
with the process whereby a marketing mix is tailored to it some speciic target customers,
while positioning deals with the way customers perceive proposed or present products
or services in the market.7

Market segmentation is the process in which the total heterogeneous market is divided
157

into smaller, relatively homogeneous groups of consumers with relatively uniform char-
acteristics and needs.

Why is market segmentation important? Simply because it is very rare that one product
158

can satisfy the needs of everyone in the consumer market. We are all diferent – we have
diferent needs, diferent tastes, diferent interests, and so on. That is what the word
“heterogeneous” means. The purpose of market segmentation is to identify consumers
within the total consumer market that have similar needs, tastes, interests and so on – in
other words, to identify a homogeneous group. Even in such a group, the consumers will
not all be the same – that is why we refer to a relatively homogeneous group.

Note the three possible approaches to market segmentation:

159

• Market aggregation. This is the total market approach where all consumers are con-
sidered to be relatively homogeneous. (This is in fact not market segmentation.) As
mentioned above, there are not many products that will satisfy the needs of everyone
in the consumer market. Marketers of basic commodities like salt and sugar usually
have this total market approach – but such products are deinitely in the minority.
• Single segment. In this approach the marketer identiies one single group and directs
the product ofering only to that particular segment. Some game lodges in South
Africa direct their product exclusively to the overseas tourist, to the point where their
rates are quoted in US dollars. Obviously local tourists can also stay at these lodges,
but the marketing message is not really aimed at them.

Another example of a company that uses the single segment approach is Fisher-Price.
Although they market over 400 products, they focus on toys for children of six years
and under. The Daily Sun also directs its newspaper at only one target market, namely

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 urban adults throughout South Africa who are English-literate, reasonably educated
and iercely patriotic.
• Multisegment. In this approach the same product is aimed at diferent market seg-
ments. The marketing of a small car may be directed at young people (ie one market
segment) and may therefore be advertised as “sporty” and “trendy”. It may also be
directed at housewives (ie another market segment) as “the ideal economical second
car”. The same product is therefore directed at more than one market segment with
a diferent marketing message to each segment. Rooibos tea, for example, is also
marketed in this way. It is directed at black consumers of all income levels in the age
group 16–34 years as well as at white consumers of all income levels in the same age
group, with a diferent promotion strategy being directed at the two target markets.

There is no single way to segment the market. Marketers must use diferent segmentation
160

variables to describe the market structure. When developing a segmentation strategy,

the important step is to select the correct basis on which to segment the market, namely
demographic, geographic, psychographic and behavioural criteria.

Demographic criteria are used to divide the market into groups based on variables such
161

as age, gender, income, education and race. For example, products such as clothing,
perfumes and toiletries are marketed diferently to men and women.

Geographic criteria are used to divide the market according to geographical locations
162

such as provinces, cities and towns. The example below illustrates how King Pie has divided
the market into diferent segments using both geographic and demographic criteria.8

262 King Pie’s use of geographic and demographic criteria

King Pie has realised that although the South African market is united in its love of
263

pies, there are geographical, ethnic and economic considerations that have prompted
it to ine-tune its range of products and cater to targeted groups in some areas. For
example, the consumer market in KwaZulu-Natal demands a “hotter” pie and sales
of curried pies are high. Some Western Cape franchises have converted to the halaal
requirements to service their market sector. The Western Cape market prefers mutton
to beef, and adjustments to that efect have been made. The pricing of pies has also
come under the spotlight, with “poorer” areas requesting a cheaper pie, while the
more discerning pie customer wants a bigger and more substantial pie and is quite
willing to pay more for it.

While demographic and geographic segmentation are relatively simple to understand,

they do not directly consider the needs and wants that lead people to make purchases.
In an attempt to more speciically identify the consumers who would be interested in
particular products, marketers have developed psychographic segmentation that as-
sists them to understand the lifestyle, personality and social class characteristics of the
target market.

60
 264 How Fritto-Lay uses psychographic criteria

Fritto-Lay, the snack marketer, conducted research that identiied two broad categories
265

of snackers, which it called Compromisers and Indulgers. The Compromisers are typi-
cally female and are relatively likely to exercise, read health and itness magazines, be
concerned about nutrition, and read product labels. Fritto-Lay appeals to this group
with its Baked Lay’s potato chip, a reduced-fat snack. Fritto-Lay’s traditional potato
chips are targeted at the other psychographic category, the Indulgers, who are mostly
male, in their late teens and early twenties, snack heavily, feel unconcerned about
what they eat, and hesitate to sacriice taste for a reduction in fat.

Marketers also segment consumer markets in terms of various purchase behaviours such
as product usage rate, brand loyalty status, price sensitivity and product beneits sought.
These variables are known as behavioural criteria. See below for an example of this type
of segmentation.

267 Campbell Soup’s use of behavioural criteria

To target its marketing eforts, Campbell Soup Company conducted research into the
268

usage rate and loyalty status of its customers. The company used this information
to divide them into four groups, namely “most proitable” (most loyal, frequent and
consistent customers), “proitable” (these customers ranked second in each category),
“borderline” (customers who ranked lower than the proitable consumers) and “avoid”
(consumers who are least likely to buy, and who select the product on the basis of price).

Campbell’s researchers concluded that the “most proitable” group was over three
269

times as proitable as the “borderline” group, making it the focus of the company’s
marketing eforts.

Once the market has been divided into smaller homogeneous segments according to
the segmentation criteria, the marketer has to identify a segment that looks promising
as a target market. The objectives and resources of the business have to be carefully
considered before a target market can be selected.

Positioning is the last phase in the STP process. A product’s positioning is the place the
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product occupies in the minds of customers. Through product positioning, marketers

inluence the manner in which customers perceive the characteristics of the brand rela-
tive to those of competing products. The intention is to inluence demand by creating
a product with speciic characteristics and a clear image that diferentiates it from com-
petitors. Kulula.com has for instance positioned itself as a low-fares airline compared to
many of the other airlines in South Africa. Their well-known slogan “Now anyone can ly”
clearly relects this image.

Activity 5.5

Identify and analyse the various criteria according to which a market segment for luxury,
upmarket furniture can be selected.

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 These criteria are:

• Demographic: refers to the objective characteristics of consumers, that is factual data

like age, income and gender. One would think that for upmarket furniture, the lower
income groups should be excluded.
• Geographic: refers to consumers living in the same geographical area. Marketers could
target consumers in upmarket areas of the diferent provinces, for example in Gauteng
(eg Waterkloof in Pretoria and Sandton in Johannesburg) and the Cape (eg Camps Bay
in Cape Town)
• Psychographic: refers to subjective characteristics of consumers, that is data that are
diicult to classify factually, for example personality, lifestyle and social class. In this case,
it is assumed that only consumers from more aluent social groups could be targeted.
• Behaviouristic: refers to the things that consumers do when purchasing a particular
product, for example how often they buy, how sensitive they are to price or quality, how
loyal they are to a brand, and what beneits they seek. Marketers could aim at consumers
who want the beneit of prestige when they buy the upmarket furniture.

NB: Identifying the characteristics of consumers in a particular segment leads to a seg-

271

ment proile.

SUMMARY
You now have basic insight into the factors that inluence the marketing process. In the
164

next study unit you will study the marketing instruments. These are product decisions,
price decisions, distribution decisions and marketing communication decisions.

SELF-ASSESSMENT QUESTIONS
5

(1) The process of consumer decision-making progresses systematically through difer-

ent phases. Place these phases in the correct sequence:
(a) becoming aware of an unsatisied need
(b) evaluating possible solutions
(c) seeking information on how to solve the problem
(d) deciding on a course of action
(e) doing post-purchase evaluation
(1) bacde
(2) adcbe
(3) adbce
(4) acbde
(2) Which of the following statements on market segments are wrong?
(a) In a market segment, members share common preferences.
(b) Such members have diferent consumption patterns.
(c) Members make similar product choices.
(d) The marketer selects a target market from a number of segments.
(e) A marketer often has only one target market.
(1) ab
(2) be
(3) cde
(4) abd
(5) abcde

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 (3) You are interested in starting a cosmetics company which sells diferent ranges of
cosmetics. How can you use demographic segmentation to segment the market for
your products and to determine who your customers will be?
Question 1

The correct answer is option 4 (a c b d e).

Every time consumers take a decision to purchase, risks are involved. For example, if the prod-
uct is not up to standard or does not work as the consumers expect it to, they feel they have
wasted their money. There are also social risks involved in deciding to purchase a product.
Marketing management must know how consumer decisions are reached. Consumer deci-
sions are not made suddenly, and so the process of decision making progresses systematically
through sequential phases.

In phase 1, consumers become aware of a problem or an unsatisied need (statement a).

Consumers realise that they can resolve the problem or satisfy their need by making a certain
purchase.

In phase 2, consumers look for information on how best to solve the problem (statement c).
They consult friends and look around in shops, and so forth. Of course, the marketer must en-
sure that this information is available to these prospective consumers in order to make a sale.

In phase 3, consumers evaluate all the possible solutions (statement b). This evaluation involves
consideration of certain criteria such as price, quality and other aesthetic qualities, and then
they gauge the contribution which the product will make to their need satisfaction and lifestyle.

In phase 4, consumers must decide on a course of action (statement d). If consumers intend to
purchase the product, there is no deinite proof that they will in fact purchase. Therefore, the
marketer should encourage them to purchase through persuasive advertising and perhaps al-
low terms of payment, because doubtful consumers could suddenly decide against purchasing.

In phase 5, consumers make a post-purchase evaluation (statement e) to assure themselves

that the purchase was a good one. Satisied consumers will usually advise their friends to
make the same purchase themselves, a situation which could boost sales for the marketer.

If your answer was wrong, please refer to section 12.7.2 and igure 12.4 in the prescribed book.

Question 2

The correct answer is option 2 (b e).

A speciic market ofering does not satisfy the needs of only one individual but rather the needs
of a group of consumers, known as a market segment. A characteristic of market segments
is that their members are homogeneous in such respects as demographic and behavioural
criteria (see table 12.2). Therefore, in a market segment, members have common characteristics
and preferences (statement a).

Statement b is wrong because members of a segment have similar consumption patterns, as

explained in the paragraph above. Likewise, as in statement a, members in a particular seg-
ment will make similar product choices (statement c).

From all the many diferent market segments, the marketer carefully selects a target market
(statement d), or even several target markets.

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It seldom happens that a business has only a single target market: there could be more than
one. So statement e is wrong.

If your answer was wrong, please refer to section 12.8 in the prescribed book.

Question 3

You can use diferent demographic variables to segment your market. The table below indicates
some of the criteria that you can use.

Age 13–28; 29–45; 46–55 and older than 55

Gender Male and Female

Income Middle and higher income groups

You could decide to focus on the female, middle income segment of the market and to con-
centrate on the older age groups, for instance the 46–55 group and the above-55 group. Your
products should thus cater to the needs of these groups, for instance cosmetics which help
reduce wrinkles and sun damage. Your prices should be moderate and your promotion mes-
sages should emphasise the age-defying properties of your products.

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Study unit 6
The marketing instruments

Contents

Key concepts
Learning outcomes
Getting an overview
6.1 Product decisions
6.2 Price decisions
6.3 Distribution decisions
6.4 Marketing communication decisions
Summary
Self-assessment questions

Key concepts

product ofering price determination

consumer products inal price adaptations
brand decisions distribution channels
packaging decisions channel leadership
kinds of packaging market coverage
packaging design advertising
product diferentiation personal selling
product obsolescence sales promotion
multiproduct decisions publicity
new product development product life cycle
public relations

Learning outcomes

When you have worked through study unit 6 you should be able to:
• describe the composition of a product by identifying the components and classification
categories of consumer products
• analyse the product decisions that form part of the marketing strategy of a business
by highlighting decisions regarding the brand, packaging, product differentiation,
obsolescence, and multiproduct and new product decisions
• explain how price decisions are taken in a business by summarising the price determi-
nation process and adaptations to the final price
• demonstrate an understanding of the distribution strategy of a business by highlighting
decisions regarding the choice, channel leadership and physical distribution activities

65 MNB1601/1
 • describe the marketing communication elements that can be used to communicate
with consumers by summarising decisions regarding advertising, personal selling, sales
promotion, publicity and public relations

GETTING AN OVERVIEW

Read section 12.10 in the prescribed book.

A marketing mix is a combination of strategic tools used to create value for customers
165

and achieve company objectives. There are four primary tools or elements in a marketing
mix: product, price, distribution (placement), and promotion. All successful businesses
include these four elements in their marketing strategies. For instance, McDonalds ofer
a wide variety of products at diferent prices, from Quarter Pounders to MacChickens.
They have outlets in most suburbs, where it is easy for customers to park or drive in and
place orders, and they use many promotion methods to persuade customers to buy their
products, from advertisements on radio, television and magazines to sales promotions
such as competitions and discounts. This study unit focuses on these four marketing
instruments: product, price, distribution and promotion.

6.1 PRODUCT DECISIONS

Study section 12.11 in the prescribed book.

A product is a bundle of perceived tangible and intangible attributes that has the po-
166

tential to satisfy present and potential customer wants and is received in exchange for
money or other considerations. A person who goes for psychiatric counselling receives
an intangible service, while a person who buys a packet of paperclips buys a tangible
product. In between these two extremes, a person who buys a restaurant meal receives
a combination of an intangible service and a tangible product. Practically all the products
we buy are a combination of an intangible service and a tangible good. A product is thus
more than the physical article itself. It is the total package, which includes the service that
goes with it (eg the guarantees), the image of the product (eg the latest fashion shoes
that show the owner is “with it”) and the packaging (eg a high quality gift wrapping that
adds to the “value” of a gift).
When planning an efective marketing strategy it is important to classify the type of
167

consumer product being marketed. (Please note that the prescribed book concentrates
mainly on consumer products, which often difer from industrial and agricultural products.)
Consumer goods may be classiied on the basis of consumer buying habits, even though
a watertight classiication is not always possible, since the same product may be a luxury
speciality product for one customer and a shopping product for another. One consumer
may insist on buying only Youth Dew perfume from Estée Lauder. For her, perfume is

66
a speciality product. Another consumer may try out several perfumes before deciding
which one to buy. For her, perfume is a shopping product. The question the marketer of
perfume has to answer is: Do most women insist on a speciic brand of perfume, or do
most of them “shop around”? The answer is that for most women, perfume is a speciality
product, since most of them insist on buying a speciic product.

Each product has a life cycle that goes through four phases: the introductory phase,
168

growth phase, maturity phase and declining phase. The actual cycle may vary from
product to product, as illustrated in igure 12.9 of your prescribed book, but the product
will eventually go through all four phases. For some products this life cycle is very short,
especially when it comes to fashion. For some products the life cycle may be very long.

Take the example of Pepsi-Cola. The product went through a declining phase in South
169

Africa some years ago, but right now is in a revival cycle. How long will we still have Pepsi
on the market? Who knows?

One of the most important attributes of the product is the brand. A brand is a name,
170

term, design, symbol, or any other feature that identiies one business’s product or
service as distinct from those of other businesses. Customers often say “I’d like to buy a
Volvo”, or “I have a craving for a Big Mac” or “We could really improve our presentation if
we used Powerpoint”. These are all brands that diferentiate the products from those of
competitors. When a customer becomes committed to buying the same brand over and
over again, this is known as brand loyalty. Most consumers are brand loyal to one brand
when they purchase certain products such as cigarettes (eg Marlboro), mayonnaise (eg
Crosse & Blackwell) and toothpaste (eg Colgate).

Brands can be classiied according to the ownership of the brand. A manufacturer’s

171

brand is a brand that is owned and used by the producer of the product, for example
Levi jeans. A brand that is owned and used by a reseller (such as a retailer and wholesaler)
is called a dealer brand, for example Donna Claire is used by Foschini. Many stores also
stock generic brands, which are products named only by their generic class. Super-
market shoppers can ind products ranging from paper towels to dog food to peanut
butter packaged as generic products. Their packages bear no brand names or other
seller identiication, simply the type of product and any required information, such as
ingredients on food items.

Companies have diferent options for their branding strategies. The option known as a
172

family brand is a brand that is applied to an entire product mix or to all the products in a
particular line. Gillette Company uses the family brand Gillette Series for a line of men’s
shaving products, deodorants and aftershaves. To beneit from consumers’ positive views
of Gillette’s sensor razor, the company advertises the Gillette Series with the same slogan
used for the razor: “Gillette. The best a man can get.” A consumer who likes the sensor
razor might be favourably predisposed to try Gillette’s other men’s shaving products.
Companies can also use an individual brand for each product item, for example SAB
Miller has Amstel, Carling Black Label and Hansa Pilsener.

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 272 Coke still making a name for itself9

For the ninth consecutive year, Coca-Cola is the world’s most valuable name, with more
273

than 60% of its market capitalisation ascribed to the value of its brand – an estimated
$68.7 million. This is according to the 2009 Business Week’s annual ranking of the 100
Top Global Brands, undertaken with consultancy Interbrand.

IBM took second spot and Microsoft was labelled the world’s third most valuable
274

brand. All three leading beverage brands – Coke, Pepsi and Nescafé – are among the
top 25 best global brands.

The rankings of the 100 Top Global brands rewarded companies that “ruthlessly” fo-
275

cused on every detail of managing their brands. Among the top gainers are Google,
Amazon and Zara, with a 25%, 22% and 14% rise in brand value respectively. However,
there were brands that fell right of the list of top 100 brands. These include Merrill
Lynch (which ranked no 34 in 2008) and AIG (which ranked no 54 in 2008) – not only
did they fall of the list; both brands required emergency assistance from the US
government.

The recession presented brand stewards with the most severe test of their careers.
276

Companies had to adjust rapidly as consumers re-examine their purchases and re-
think brand loyalties. Marketing executives are balancing the temptation to chase
short-term gains with discounts and promotions against the risk of cheapening their
brands over the long term.

Coca-Cola’s edgy campaigns continue to push boundaries, showing the rest of the
277

marketing community what it really means to manage a brand. In 2009, the company
expanded its Coke Zero brand to 107 countries and launched a new message for its
marketing campaign. The campaign, “Open Happiness”, was targeted to consumers
longing for comfort and optimism in a tough time.

The fact that you show preference for speciic brands (ie brand loyalty) is an obvious ad-
vantage for the marketer, since you will make a point of purchasing that speciic brand
each time.

The packaging of a product generally bears a label displaying the characteristic brand
173

and other important information. Try to think of consumer goods with characteristic
packaging that you normally select in preference to competing products. For example,
you may know someone who prefers Kraft margarine for no other reason than the fact
that once the margarine has been used up she can use the container for other purposes.
Someone else may prefer another product because the packaging contains a competition
or a recipe. Section 12.11.5 in your prescribed book provides many practical examples of
the diferent kinds of packaging and package designs that can be used by companies.

The method used by a marketer to diferentiate his or her product from those of competi-
174

tors is referred to as product diferentiation. It is extremely diicult to cultivate brand

loyalty if a product cannot be distinguished clearly from its competitors. For example, a
box of matches seldom has any product diferentiation. One brand of matches is as good

68
as another, and very seldom will a person ask for a speciic brand when buying a box of
matches. But when it comes to a product like cigarettes, smokers don’t simply ask for a
packet of cigarettes – they ask for a speciic brand. Where airlines are concerned, cus-
tomers choose Kulula.com because its airfares are lower than many of the other airlines
in South Africa.

Many marketers make use of product obsolescence in order to “compel” customers to

175

make repeat purchases. That is why motorcar manufacturers change the shape of their
cars every now and then. This “forces” car owners to purchase the newer model because
“nobody wants to be seen driving an old model”.

Note the multi-product strategies described in section 12.11.8. This gives you an indica-
176

tion of some of the decisions that management have to make about the products of the
business. You should also be able to describe the diferences between product range
extension, product diversiication and product withdrawal. Johnson & Johnson extended
its product range when it added its cradle cap treatment to its range of baby shampoos,
creams and baby powder. Sony Corporation, on the other hand, diversiied when it en-
tered into a whole new ield of digital cameras, competing with large companies such as
Nikon, Canon and Pentax. Volkswagen followed a product withdrawal strategy in 1975
when it dropped its popular Beetle. However, its sales declined so much that it is now
trying to reverse the decline by introducing a new version of the Beetle.

The new product development process is the series of activities by which a business
177

generates new product ideas, evaluates them and develops them into new products that
enter the marketplace. There is no way to guarantee that all new products will succeed.
However, being systematic about developing new products increases the chances of
success. Section 12.11.9 in your prescribed book indicates the phases in the new product
development process.

Activity 6.1

Most of us have favourite brand names. Perhaps your favourite brand for ice cream is
Nestlé, for example. Write down the brands to which you (or some of your friends and
family) are loyal when it comes to purchasing diferent products.

For example:

• My husband’s favourite beer is Castle.

• My son’s favourite ice cream is Dairy Maid.
• When I ill my car up with petrol, I always go to Shell service stations.
• I buy only Liqui-Fruit juice for my family.
• I only use Omo washing powder for my family’s laundry.
• My husband buys only Nike tennis shoes.

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6.2 PRICE DECISIONS

Study section 12.12 in the prescribed book.

Price is the only marketing instrument that generates an income for the business. The
179

price that is paid by the consumer represents the income generated for the business.
If the price is set too low, the business will have diiculty surviving and if this situation
continues for an indeinite period, the business will go bankrupt. Avia, Phoenix and Sun
Airlines are South African examples that bear testimony to this.

As far as consumers are concerned, the price that they pay must provide some form of
180

value – thus a consumer buys the value of what the product can do for him or her. For
example, a consumer who pays R450 for a Black & Decker drill is buying not only the drill,
but also the value that the drill can provide (ie a hole in the wall, or a nicely bufed car).

Businesses follow a price determination process when setting prices. A cost price is set irst
181

of all. The price of a product must be high enough to cover the total cost of production
and marketing. The market price is the price of competing products on the market, or
the price that consumers are willing to pay. Businesses may set prices below, at or above
those of competitors. Campbell’s Soup has for instance been the low cost leader in the
canned soup market because it has set its prices lower than those of competitors. The
target price is the price that will reach the target rate of return. Lastly, the inal price
is set, which is a reconciliation of the market and target price. This is the price which is
ofered to consumers.

Once the inal price has been set, certain adaptations have to be made. For instance, a
182

skimming price can be set when a new, unique product is launched on the market such
as Nevirapine, the pharmaceutical product that helps prevent the transmission of HIV/
Aids from mother to child. The pharmaceutical company selects a high price to recover
the costs of research and development as soon as possible – skimming the cream of rich
proits. The opposite of a skimming price is a penetration price. Here an introductory
price is set relatively low to gain deep market penetration quickly. For example, consum-
ers are more likely to buy an innovative new sugar substitute if the price is low.

Another method used by companies is to set the price at the market price level, in other
183

words at the price at which competitors’ products are selling. A company can also use
leader prices, which involves promoting one product at a sharply reduced price in the
expectation that it will attract customers who will then purchase other items. Supermar-
kets, for example, often use milk as a leader because of its wide use, perishability and
well-known regular prices. Clothing stores might select a jacket as a leader because it has
many complements (ie trousers, ties and shirts). Odd prices are prices that are set a few
rands or cents below a round number. For example, the price of a packet of Flings chips
may be set at R1,69 a bag and the consumers of the chips think of the bag of chips as
costing R1 and 60 something cents, rather than R2. Some businesses also use bait prices,
which is the practice (often illegal) of advertising a product at a very low price to attract
consumers, only to persuade them to buy a higher priced item when they respond. A

70
furniture store might, for example, advertise a recliner chair at a very low price, but a con-
sumer who comes to inspect the chair will be talked out of buying it by the salesperson
who points out its faults and discusses the advantages of buying a higher-priced chair.

Remember that price relects the value of a product and that the consumer determines
184

what that value is. One particular product may have cost a great deal to manufacture,
but if the product has a price tag which in the opinion of the consumer is too high, the
price is too high. Say that you recently saw a pair of casual shoes that you liked a lot
in the window of a shoe store. When you enquired about the price you were told that
these were shoes imported from Italy and that they cost R899. So you most probably
just laughed and walked out. The shoes may have cost that much to import, but for you
that was the wrong price for a pair of casual shoes. (At least that would be the average
consumer’s response!)

Activity 6.2

Identify and analyse the three “prices” involved in determining the inal price.

Ū The cost price. If a product is sold for less than what it cost, it is obviously going to mean a
loss for the business. If those shoes cost R650 to import from Italy, but consumers are not
willing to pay more than R250 for a pair of casual shoes, the business cannot set the inal
price at less than R650, or else it should not import/sell such shoes.
Ū The market price. This is the price that customers are willing to pay for a particular product.
In the above case consumers are not willing to pay more than R250 for the pair of shoes.
How will a business know what customers are willing to pay for a particular product?
One way of inding out is to look at the prices that similar products are being sold for
(eg by competitors). To set a price for a product that is higher than the market price will
mean that the product is not likely to be sold, as in the case above. (There may of course
be customers who are willing to pay R899 for a pair of casual shoes, in which case the
market price would be R899, rather than R250.)
Ū The target price. Since every business wants to make a proit, this particular shoe store
usually aims to achieve a 50% gross proit margin on its shoes. Therefore, if the cost price
was R650, the target price would be R650 x 1,50 = R975.

These three prices now have to be weighed up against one another. Let’s assume that
279

the market price is R890 and the target price is R975; the shoe store might then decide
that the inal price should be somewhere in-between, namely R899.

Activity 6.3

What form of price does the inal price of R899 in activity 6.2 represent?

First, it is an example of an odd price, because the price is R899, and not R900. Second, it is a
market level price since it is very close to the market price of R890. It is not a skimming price
because the gross proit margin is a little less than what they usually aim for. It is not a market
penetration price since the price is slightly above the market price. It is certainly not a leader
price in the sense that they are ofering the product at a considerably lower price than their
competitors. For that reason it is also not a bait price.

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6.3 DISTRIBUTION DECISIONS

Study section 12.13 in the prescribed book.

The distribution channel is the marketing instrument that delivers the product to the
185

inal consumer. In this process, wholesalers, retailers and other intermediaries are used
to present a product, service or idea to the inal consumer. For example, companies that
manufacture CDs sell their products through intermediaries such as music stores (Musica
and CD Warehouse), discount stores (Game and Dion) and supermarkets (Shoprite and
Spar).

Diferent decisions can be made about the choice of middlemen or intermediaries.

186

Products can, for instance, be marketed directly from the manufacturer to the consumer.
A good example is the producer who sells his or her products at a lea market. This is a
typical example of a manufacturer-consumer chain. Another example would be the case
in which the product is custom-made. A tailor who manufactures suits for speciic clients,
for example, will not sell his product through a middleman. Another type of channel
distribution is the manufacturer-retailer-consumer channel. This channel is widely used
in South Africa among the large retailers like Pick n Pay and Shoprite/Checkers. Products
are bought from the manufacturers by these retailers and then sold to consumers.

A factory situated in Boksburg may manufacture superb clothes, but if they did not make
187

use of intermediaries it would mean that the customers would have to travel to the fac-
tory in Boksburg in order to buy the clothes. The chances are that only people living in
Boksburg would purchase those products. However, if the company wished to sell the
clothes countrywide, they would have to sell their products to clothing stores throughout
South Africa. This might involve too many retailers who would order only small quanti-
ties at a time, so the clothing manufacturer is more likely to sell the clothes to a number
of wholesalers in the major regions of South Africa. These wholesalers would in turn sell
smaller quantities to retailers in their region, and the retailers would sell the clothes to
customers in their vicinity. This is a typical example of a manufacturer-wholesaler-retailer-
consumer distribution chain.

The business that controls the channel is known as the channel captain. If the manu-
188

facturer is the channel captain, it will be mainly responsible for advertising/marketing

the product. For example, Volkswagen is the channel captain, and it will do most of the
marketing of Volkswagen products on a countrywide basis.

On the other hand, if the retailer is the channel captain, the retailer will market the prod-
189

uct, or in many cases, market itself. CNA is a typical channel captain when it comes to
selling books. Occasionally they will advertise a particular product on TV, but more often
than not CNA advertises itself as a store (“First with the goodies”) rather than advertising
a speciic product. And even when a speciic product is advertised, a strong message
is included about the store itself. The same can be said of Pick n Pay. You can see from
watching television how often a store will advertise itself, rather than a speciic product.

72
Make sure that you understand the diferent types of market coverage. The easiest way
190

to remember is as follows:

• Intensive market coverage. This is a manufacturer’s strategy of making a product

available to buyers in as many outlets as possible for maximum market exposure.
Manufacturers of convenience products such as cigarettes, chewing gum and cold
drinks want intensive distribution.
• Exclusive market coverage. This type of coverage involves a manufacturer selling prod-
ucts through only one wholesaler or retailer in a particular area. Rolex watches, Ferrari
cars and Steinway pianos are examples of products that are exclusively distributed.
• Selective market coverage. Here, a few specialist intermediaries are selected even
though they stock competing products. Appliances and sporting goods are products
that are distributed in this way.

Activity 6.4

Read through the case below and identify the type of market coverage used by Coca-Cola.10

Vending machines are an important distribution channel in Coca-

Cola’s .......................................................... distribution strategy
The Coca-Cola corporation runs a/an ..................................... distribution policy
for its products and aims to get the product to the consumer no matter
where they are or what they are doing. They operate a/an .............................
channel strategy, which makes use of every conceivable channel option.
Central to their policy of being able to ind a Coca-Cola to drink wherever
the consumer looks for one is the use of vending technology. You ind
vending machines ofering Coca-Cola and other drinks in every “nook and
cranny” possible. On the loors of hotels next to the ice machine, in university
residences and teaching areas, in schools, sports centres, garages, railway
stations, airports, subways, art galleries, museums and a host of similar
locations. Vending machines ill the “gap” left by the more conventional
channels for this beverage.
Coca-Cola Inc. is determined the demand will be met by making the product
widely available in all of the areas you expect someone to want to purchase
the product. This is achieved through the policy of ............................................
distribution using supermarkets, smaller stores, bakeries and sandwich
shops, delicatessens, public houses, cafés and cinemas, plus a plethora of
other less conventional channels.

The answer is straightforward. Coca-Cola make use of intensive market coverage or distribu-
tion. The case study clearly shows that they sell their products through as many intermediaries
as possible.

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6.4 MARKETING COMMUNICATION DECISIONS

Study section 12.14 in the prescribed book.

When companies such as Sony, Defy or Toyota develop new products, the only way for
191

consumers to become aware of these products is for the companies to communicate the
existence and attributes of these products to them. No product can sell without efective
marketing communication messages.

Marketing communication is the process of informing, persuading and reminding con-

192

sumers, and it comprises six elements: advertising, personal selling, direct marketing,
sales promotion, publicity, and public relations.

Selecting the right combination of methods presents a challenge to the marketing de-
193

partment because as circumstances change, the whole combination must change as well.
Not only does the composition of the marketing communication methods change, but
so do the messages and the diferent techniques and media used.

We will now discuss the marketing communication elements that can be used in a speciic
194

combination to communicate with consumers.

6.4.1 Advertising
Advertising has a pervasive inluence in our daily lives. Can you imagine not being exposed
195

to a Coca-Cola or BMW advertisement? How consumers respond to an advertisement

often depends on the purpose of the advertisement. Typically, advertising embodies one
or more of the three fundamental objectives in respect of its target market: to inform,
to persuade and to remind consumers. IBM, for instance, might advertise on television
and in magazines to inform consumers of the attributes of a new computer which it has
on the market, while Edgars might advertise a shoe sale in newspapers and on radio in
order to persuade consumers to buy its shoes. Toyota might place a TV advertisement
to remind consumers of the good quality of its motor vehicles. These companies design
their advertising messages for the diferent media in diferent ways. They make use of
headings, illustrations and copy in the print media, while radio advertisements make use
of words and sound. Television advertisements, on the other hand, make use of spoken
and written words as well as visual images.

Companies difer in the amount of the sales revenues they spend on advertising. Com-
196

panies that make soft drinks often spend a greater percentage of their sales revenues on
advertising than many industrial product manufacturers do. Charles Revlon, the founder
of Revlon, said he made his money by selling hope – the kind that comes in a jar. Because
cosmetic companies sell hope, they can charge high prices for products that do not cost
that much to make. However, the hope ingredient requires a lot of expensive and efec-
tive advertising!

74
6.4.2 Personal selling
Personal selling is an active efort to communicate with high-potential buyers on a direct,
197

usually face-to-face, basis. Salespeople are a vital source of information to consumers

contemplating a purchase. As consumers, we depend on salespeople to provide key
information to help us make purchase decisions. Can you imagine buying a new car,
washing machine or lounge suite without a lengthy, information-gathering session with
salespeople?

A company’s salespeople provide the most direct link to its customers. In fact, to many
198

customers the salesperson is the company, and the customer’s image of the company is
determined by the quality of the personal selling efort. Because of their direct contact
with the market, salespeople are a valuable source of feedback. They provide feedback
about the company’s products, about competitors and their products, and about cus-
tomers’ requirements.

6.4.3 Direct marketing

We now know that the Internet, radio and television are types of advertising media used
199

to communicate information about a product or service to customers. Kalahari.net is a

website which customers can visit online to purchase DVDs, CDs and books. Information
about these products is communicated directly to the customer, who is then able to re-
spond directly by purchasing the product online via the Internet. The type of marketing
communication being used here is called direct marketing. Other advertising media such
as radio and television can also be used for direct marketing.

Many consumers prefer direct marketing as they can make their purchases from the
200

comfort of their own homes. This marketing communication element allows businesses
to ofer their customers a pleasurable experience and greater convenience.

201 The beneits of direct marketing are listed below:

• A long-term relationship can be developed with the customer.

• The message can be directed at a speciic customer.
• A customer database can be developed.
• The results of a direct marketing campaign can be measured directly.

6.4.4 Sales promotion

When Pick n Pay make use of coupons to sell their products and Clinique hand out sam-
202

ples of their perfume to consumers, they are using sales promotion methods to increase
sales. Sales promotion can be deined as those methods that cannot be classiied under
personal selling, advertising or publicity, but which complement them in transmitting
the marketing message to potential consumers and resellers.

203 Sales promotion methods aimed at consumers include the following:

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• Sampling. This can be deined as any method used to deliver an actual or a trial-sized
product to prospective consumers. Consumers are ofered an opportunity to try the
product without any commitment to buy it.
• Price incentives. These are reductions in products’ regular prices.
• Coupons. Using coupons is a promotional device that provides a cash saving to con-
sumers who redeem the coupon.
• Premiums. These are articles of merchandise provided free or at a reduced price to
consumers as incentives to encourage them to buy a product. An item could be of-
fered inside or attached to the product package.
• Contests and competitions. These ofer consumers the opportunity to win cash, mer-
chandise or travel prizes.
• Point-of-purchase promotion. One of the most important forms of sales promotion in
retail stores is a display. Displays and the variety of display materials used are designed
to attract consumer attention by enhancing the prominence or attractiveness of the
products. Point-of-purchase promotion material covers a wide range, such as name
cards which can be aixed to shelves, placards which stand on the loor or hang from
the ceiling, tubs piled high with products, stalls for demonstrations or special displays
and specially designed racks for, say, sweets and razor blades.
• Gifts. The gifts used in this kind of promotion are also known as “advertising speciali-
ties” because an advertising message is usually printed on them. Examples are key
holders, lighters, T-shirts and diaries.

6.4.5 Publicity
Publicity involves supplying information about the company’s product or service to the
204

media, and hence obtaining a favourable and free review. This can be done by means of
news or press releases, sponsorships and news articles. All the media can be used to carry
the marketing message – the press, radio and television. Because the message appears
in the editorial part of the press, and not in advertisements, it has greater credibility. It
is almost as if someone impartial is reporting on the product or the company. The same
happens when the company or its product receives favourable mention in news reports
on television or radio. Consumers are then more inclined to accept the message.

76
 280 McDonald’s in Moscow

Before opening a branch in Moscow, McDonald’s launched a communications cam-

281

paign that received the broadest possible publicity any company in the world ever
received – from TV, radio and print coverage in North America to front pages and
newscasts in Japan, Europe and the rest of the world. The communications campaign,
“The McDonald’s magic”, was in the form of four stories that introduced McDonald’s
as a company having fun while running a successful business.

282 The campaign went as follows:

283 – Two and a half years before the opening day in Moscow, a press conference
was called to announce the signing of the agreement (the result of negotia-
tions that lasted 14 years).

284 The next newsworthy event was the sign-raising ceremony marking the begin-
ning of construction.

285 – The laying of the cornerstone of the food-production plant, the largest in
eastern Europe, received worldwide publicity.

286 – The irst Russian managers arriving at McDonald’s in Oak Brook, Illinois, to be
trained at the “Hamburger University”, created worldwide interest.

287 – Just before the opening of the restaurant in Moscow, it was announced that
27 000 Russians had applied for the 6 000 jobs at McDonald’s. This really was
news!

288 – Approximately 400 journalists attended the opening day and the event was the
main news item on television and on front pages worldwide. British television
showed thousands of Russians queuing for the “ultimate happiness symbol
and their irst taste of glasnost – a hamburger!”

289 – A month after the opening, McDonald’s Moscow sold their millionth hamburger
and was serving about 50 000 people daily. Nobody knows how many extra
hamburgers were sold worldwide as a direct result of the publicity campaign.

290 – McDonald’s launched a television advertisement in the USA, “Magic in Mos-

cow”, showing scenes of the opening day. The advertisement received wide
publicity.

Of course, negative publicity can do the company a great deal of harm. The media tend
292

to seek negative publicity because it has news value. Unfavourable publicity may arise
from a spectacular accident such as a ire or an explosion where an investigation reveals
negligence or mismanagement on the part of the company. Potentially harmful products
or packaging, environmental pollution, fraud, poor working conditions and exploitation
of workers are all issues that have attracted negative publicity.

77 MNB1601/1
 293 Is negative publicity always detrimental?

Benetton, the large international manufacturer of children’s clothing known for its
294

shocking advertising campaigns, has probably gone too far in using bloodied uniforms
of Croatian soldiers in advertisements. The Italian Advertising Authority banned the
advertisements in Rome. Previous shocking advertisements also resulted in an outcry
and negative publicity – but despite this, sales kept increasing!

6.4.6 Public relations

Public relations (PR) refers to the management of all communication between an organisa-
205

tion and its publics in order to create a positive image of the company. Examples of such
publics are customers, opinion leaders, media, industry, pressure groups and suppliers.
The organisation’s public relations department is concerned with image-building methods
of communication, while its marketing department is responsible for the promotion and
sale of its products and services.

Various media can be used to carry the messages of the public relations department in
206

order to create a positive image of the company. These methods are discussed in section
12.14.7.2 in the prescribed book and include print media such as newspapers, magazines
and company publications, as well as sight and sound media, for example radio, televi-
sion, ilm and video. Special events such as press conferences, visits to the company, re-
ceptions and exhibitions can also be used. Crisis management is also considered to be a
communication medium for public relations. Although the crisis itself is not the medium,
it may be an opportunity for management to convey a positive message about the busi-
ness. The Internet has also become a very important medium for public relations. Public
relations tools such as the use of web sales, intranet operations and use of the Web to
communicate with the public are increasing in popularity.

78
296 Sticky Pedals Accelerate Toyota’s PR crisis11

Toyota consistently played down recurring complaints of unintended acceleration,

297

breaking what PR experts said is the cardinal rule in crisis management: assume the
worst.

Toyota continued to blame loose loor mats for the problem. This eventually spread
298

to potential problems with accelerator pedals and faulty electronic throttle control
systems.

While the problem faced by consumers was evident way into 2009, Toyota President
299

Akio Toyoda, the grandson of the company’s founder, had not yet formally addressed
the public or media on the recall problems by February 2010.

300 This is what two PR experts had to say about the PR crisis:

• Ong Hock Chuan, a technical adviser of a PR consultancy

People want to see a company take full responsibility, be empathic to the victims and their
301

families and be in control by outlining the problem and how they intend to solve it. They
also expect the CEO to do all this. Toyota seems to have failed on all counts.

• Masato Takahashi, a public relations consultant

There should have been a more convincing explanation, including from the president.
302

Even when they announced the recall initially, you can’t just say, “We’re going to do a re-
303

call”. They should have gone further in way of explanation, and there should have been
a heartfelt apology from the top.

Worldwide, Toyota PR people dithered and dallied and eventually started saying the
304

right things far too late. If they had been at least halfway eicient it would have reduced
the number of people (26%) who said they would not buy a Toyota now. The cost of
dithering instead of doing can be counted in millions of dollars in lost short-term sales.

Thousands of Toyota vehicles in South African also had to be recalled in participation

305

in the worldwide recall as a precautionary measure to the reported problem. Some-

thing that the Toyota recall has shown is that so many corporate PR departments are
hopelessly unprepared for a crisis.

In South Africa, Toyota’s crisis communications efort followed a fairly typical local
306

motor industry scenario which consists of putting heads in the sand for a few days,
hoping that the problem would stay overseas and not come here.

79 MNB1601/1
308 Managers at SAA handle strike badly, analysts say12

As management and workers at embattled state-owned SAA at last sat down with
309

mediators yesterday to resolve their wage dispute, several labour analysts said that
the ive-day strike had been an expensive public relations disaster that underlined
the urgent need for parastatal managers to reform outdated, top-down management
styles.

They cited the apparent refusal of SAA management to call in the Commission for
310

Conciliation, Mediation and Arbitration (CCMA) for dispute resolution until virtually
ordered to do so on Monday by labour minister Membathisi Mdladlana; the “launt-
ing” of SAA’s newfound corporate inancial recovery by chief executive Khaya Ngqula
by his lavish lifestyle; and even the “unwise” continued airing of TV advertisements
while the strike was at its height.

Ngqula’s decision to take a weekend of at a luxury resort as the strike got under way
311

also reportedly earned him a reprimand from SAA chairman Jakes Gerwel.

But SAA strongly defended itself, insisting it had “followed all the necessary processes
312

involved”; the unions had been intransigent by refusing to budge on their demands;
SAA had not been ordered by Mdladlana to call in the CCMA; and it would deinitely
not comment on Ngqula’s alleged cavalier attitude to the strike.

But analysts, including independent consultant Gavin Brown and 3 others who de-
313

clined to be named, agreed that SAA had had its “nose bloodied” for the irst time
after it had “miscalculated badly” in the way that it had handled unions’ demands for
an 8% wage increase …

SAA refused to call in the CCMA until Madladlana said that a “speedy resolution (to the
314

strike) is in the public interest”. But by then, the strike had done its image immense
damage, analysts said …

Activity 6.5

Sam Sequera is a manufacturer of various food items which he sells to a number of retailers.
He manufactures breakfast cereal, baking powder, orange juice, tinned food, cofee and
snacks, all bearing the brand name “Sam’s”. Sam wants to encourage repeat purchases
of his products and he has asked you, a marketing communications consultant, for your
opinion on how he can use sales promotion techniques to achieve his objective. Advise
him on the matter.

The following are the various methods that Sam could use:

• Sampling. Sam could arrange for demonstrators to set up tables in various retail stores
and then have them prepare and hand out small samples of one of his light snack foods
(Sam’s Snacks) to the shoppers. This is a very efective technique since consumers get to
taste the snack and the demonstrator can give them more information during the sampling.
• Price incentives. Sam could ofer consumers a saving on the purchase of his product. Sam
could, for instance, ofer a 60c price reduction on all Sam’s tinned food. This cents-of

80
 reduction could be printed on the tins. He could also ofer an 80c refund on the purchase
of a large tin of Sam’s Cofee.
• Coupons. Sam’s strategy could involve the issue of certiicates to consumers, redeemable
at retail outlets, giving consumers a speciied price reduction on a particular product. He
could, for instance, place a 35c coupon for Sam’s orange juice in the national newspapers.
• Premiums. Sam could ofer a free Superman sticker in Sam’s breakfast cereal or he could
attach a small toy to the breakfast cereal box.
• Contests and competitions. Sam could hold a contest in which participants have to write,
in ten words or less, why Sam’s is their favourite cereal. The participant with the best
answer would win a free weekend at a popular holiday resort.
• Point-of-purchase promotion. In this case, Sam could provide specially designed racks
for his products, as well as placards to hang from the ceiling to draw attention to them.
• Gifts. Sam could provide certain gifts, bearing the Sam’s brand name, to retailers, who
would then give them to customers. These gifts could include pens, calendars, T-shirts
and key rings.

SUMMARY
In topic 3 you obtained insight into the marketing function. In topic 4 you will study
207

inancial management.

SELF-ASSESSMENT QUESTIONS
6

(1) A very small proit is made on …………………. products.

(a) leader price
(b) skimming price
(c) bait price
(d) market price level
(2) Which of the following statements are correct?
The advantages which brands ofer the consumer, are that they ……………
(a) facilitate the identiication of products.
(b) assure a quality standard.
(c) serve as a warning against products not meeting certain requirements.
(d) make product diferentiation possible.
(1) abc
(2) ab
(3) acd
(4) cd
(5) abcd
(3) Which of the following statements on publicity are correct?
(a) Publicity is more credible than advertising.
(b) Marketing management has no direct say in formulating the publicity message.
(c) Publicity can also have a negative efect.
(d) Publicity is not always free.
(1) 1a c
(2) bd
(3) abd
(4) abcd

81 MNB1601/1
 (4) You are the Public Relations Manager of Foodies, a large supermarket chain. Explain
any three communication media that you can use to create a favourable image of
Foodies.

Question 1

The correct answer is option 1.

The options given in this question refer to adaptations of the inal price, and the inal price is
the price at which the product is ofered to consumers. The inal price is determined through
a reconciliation of the market price and the target price.

The leader price concerns special ofers widely used by retailers, which represent the “specials”
or special ofers. These special products are sold at prices lower than the current market price,
but for a limited period only. The retailer uses this method to draw consumers to his or her
shop. Because of the lower than usual price, the proit generated on these specials is therefore
also small. And so option 1 is correct.

If the product is an innovation, and therefore a unique product, the inal price or skimming price
would be high and would result in a high proit margin. Some consumers may be prepared
to pay the high price simply for prestige reasons. Others will not pay the high price. Option 2
is therefore wrong.

A bait price product has a particularly low price and would be widely advertised. The bait
price is used merely to attract consumers and the retailer does not really intend to sell this
low-priced product. In fact, the retailer may not even have such an item in stock, in which
case there would be no question of any proit. So option 3 is wrong.

The market price level is related to dealing with competition. If the marketer sets the inal price
of his or her product higher than the competitors’ inal prices, consumers will tend to buy from
the competitors. If the price is lower than competing prices, consumers may not buy the prod-
uct because they will think there is something wrong with it. And so option 4 is also wrong.

If your answer was wrong, please refer to section 12.12.3.4 in the prescribed book.

Question 2

The correct answer is option 1 (a b c).

The brand is a mark that is unique to the product items or ranges produced and marketed
by a certain business. The brand is chosen to distinguish the business’s products from similar
competing products. The brand of a product includes the brand name and a specially designed
trademark. Consumers use this name when they intend to buy the product. The concept of a
brand name is much narrower than that of a brand.

Brands ofer the consumer a number of advantages. They facilitate the identiication of products
when the consumer is in the process of purchasing (statement a). Brands also assure consumers
of a quality standard they can count on (statement b). And brands serve as a warning against
products that do not meet requirements set by consumers (statement c). The prescribed book
also mentions other advantages.

Statement d is wrong because brands make diferentiation possible only to the marketer – not
to the consumer.

If your answer was wrong, please refer to section 12.11.4.2 in the prescribed book.

82
Question 3

The correct answer is option 4 (a b c d).

The main feature of publicity is that it should provide a message which has some news value.
For that reason, publicity is more credible than advertising (statement a) because the audience
is more receptive to a newsworthy message.

Marketing management has no direct say in formulating the message (statement b): the editor
of the publication usually decides what should be published.

Unless due care is taken, publicity can also have a negative efect (statement c) when bad
news is published.

Contrary to the term in the deinition, publicity is not always free (statement d). A business
must often spend a lot of money on the publication of a favourable piece of news in the media.

If your answer was wrong, please refer to section 12.14.6 in the prescribed book.

Question 4

Three possible communication media:

The print media. Foodies could make use of a news report in a national newspaper in order to
announce an important event, such as its sponsorship of a large, national soccer tournament.

Sight and sound media. You could design prestige advertisements of Foodies, emphasising its
fresh products, good prices and friendly service. This could create a good image of the chain.

A public relations oicial of the supermarket chain could also take part in an interview on
radio or television. It is essential for the person to present good arguments and speak well in
order to create a favourable image of Foodies.

Special events. Members of the public could be invited to visit Foodies in order to learn more
about its operations, for example its products, prices, distribution strategy and purchasing
techniques. The person who conducts the tours must have suicient knowledge to be able to
answer the questions asked by the visitors. Please refer to section 12.14.7.2 in the prescribed book.

83 MNB1601/1
TOPIC 4
Financial management

AIM
The aim is to explain the nature of the inancial function and inancial management, the
208

cost-volume-proit relationships, time value of money and inancial analysis, planning

and control. This topic also explains the management of assets and provides insight into
the principles and implementation of capital budgeting techniques. It describes the
money and capital markets and explains short-term inancing, and describes the forms
and sources of long-term inancing and the cost of capital.

Learning outcomes

When you have worked through topic 4 you should be able to:
• demonstrate an understanding of the concepts of capital, income, cost and profit
• analyse and interpret an income statement
• analyse and interpret a balance sheet
• perform a breakeven analysis
• apply the principles of the time value of money by demonstrating the concepts of
discounting and compounding
• calculate and interpret the liquidity, solvency and profitability ratios by using a balance
sheet and income statement
• calculate the weighted average cost of capital
• understand the management of current assets
• evaluate long-term investment decisions using capital budgeting techniques

OVERVIEW OF THE TOPIC

209 Topic 4 comprises the following study units:

210 TOPIC 4

Study unit 7 Study unit 8 Study unit 9

The inancial function and Asset management: the Financing decisions

inancial management investment decision

85 MNB1601/1
Study unit 7
The inancial function and inancial management

Contents

Key concepts
Learning outcomes
Getting an overview
7.1 The inancial function and inancial management
7.2 Concepts in inancial management
7.3 Objective and fundamental principles of inancial management
7.4 Cost-volume-proit relationships
7.5 The time value of money
7.6 Financial analysis, planning and control
Summary
Self-assessment questions

Key concepts

capital shareholder wealth

assets liabilities
ixed costs variable costs
break even present value
inancial ratios budgets

Learning outcomes

When you have worked through study unit 7 you should be able to:

• discuss the financial function and financial management

• explain concepts in financial management
• identify objectives and fundamental principles of financial management
• calculate cost-volume-profit relationships
• calculate present value and future value
• calculate and interpret certain financial ratios

86
Getting an overview

Study section 13.1 in the prescribed book.

In this study unit we will irst look at the importance of inancial management and intro-
211

duce the basic inancial management concepts. Thereafter, we will discuss the objective
and fundamental principles of inancial management. The concept of present and future
value as core elements of the time value of money will also be discussed. Lastly, we will
discuss the concepts of inancial analysis, planning and control.

7.1 THE FINANCIAL FUNCTION AND FINANCIAL MANAGEMENT

Study section 13.2 in the prescribed book.

All businesses need funds. In inancial management terms, the word “capital” refers to
212

funds invested in the enterprise. These funds are needed to pay for the required assets,
resources and labour.

The primary objective of the enterprise is often summarised as creating wealth for the
213

stakeholders. The word “stakeholder” refers not only to the owners and/or the shareholders
of a business enterprise, but also to the investors of loan capital and, more importantly,
the employees of the enterprise.

Activity 7.1

Identify the three important tasks which the inancial manager must perform in order to
carry out his or her duties efectively.

To contribute to the goal of creating wealth, the inancial manager must:

• cost efectively obtain the funds needed for the enterprise

• invest those funds in assets that will give the highest possible return
• analyse, plan and control the low of funds as accurately as possible

7.2 CONCEPTS IN FINANCIAL MANAGEMENT

Study section 13.3 in the prescribed book.

The irst (and perhaps the most important) concept to understand is the balance sheet.
214

Let’s draw a balance sheet diagrammatically:

215 There are two major sides: assets on the left, and owner’s equity and liabilities on the right.

87 MNB1601/1
 BALANCE SHEET
318
315

EQUITY
317

LIABILITIES
ASSETS
316

319

320

Assets refer to the “possessions” of the enterprise while liabilities refer to the “debts”.
321

Equity refers to the money invested by the owner(s) of the enterprise. Ordinary equity
does not have to be paid back to the shareholder at a speciied date and no interest on
the equity is payable.

216 Assets and liabilities can each be subdivided further:

322

328 BALANCE SHEET

323 ASSETS 329 LIABILITIES

Fixed
324 Current
325 326 Longterm Current
327

The prescribed book explains quite clearly which items fall into each category. Fixed
330

assets (also called non-current assets) are long term whereas current assets are more
short term. Typical current assets are cash inventory (stock) and accounts receivable. The
expectation is that inventory and accounts receivable will be converted into cash during
the next accounting period. In the same way there are long-term liabilities and current
liabilities, for example a mortgage bond that is usually repaid over 20 years and bank
overdrafts that are paid within a year.

Shareholders’ funds can be split into ordinary share equity and preference share capital.
331

Owners’ equity refers to ordinary shareholding (remember that the ordinary shareholders
are the owners of the enterprise), and undistributed proits and reserves. In the balance
sheet total assets must always equal equity plus liabilities.

Another concept that warrants discussion is that of costs. Firstly, there is the diference
332

between total costs and cost per unit. If an enterprise’s total cost is R240 000 and it
manufactures 80 000 products (units), then the cost per unit will be R240 000 ÷ 80 000 =
R3. If another enterprise also has a total cost of R240 000, but manufactures only 60 000
units, the cost per unit would be R240 000 ÷ 60 000 = R4. So to determine the cost per
unit you have to divide the total costs by the number of units produced.

Secondly, note the diference between ixed cost and variable cost. Fixed cost refers to
333

depreciation, interest, salaries, rent, or lease instalments for example, which will not change
regardless of the number of units manufactured and sold. Variable cost refers to the

88
costs which will increase with every additional unit manufactured and sold, for example
the raw materials that went into the product and the packaging material. It follows that
the greater the number of units manufactured, the higher the total variable cost will be.

What about ixed cost per unit and variable cost per unit? If the total ixed cost is R120 000,
334

this will remain the same (“ixed”), regardless of how many units are produced. However,
the ixed cost per unit is calculated by dividing the total ixed cost by the number of units.
If we manufacture 10 000 units, then the ixed cost per unit will be R120 000 divided by
10 000, which equals R12. If we change the volume of production, say to 20 000 units, the
total ixed cost would still be R120 000 but the ixed cost per unit will now be R120 000
divided by 20 000, which equals R6.

If it costs R5 to manufacture a unit (eg a chair), then the variable cost per unit will be R5.
335

Whether we manufacture 20 or 200 chairs, the variable cost per unit will always be R5
because it doesn’t change with a change in production volume. However, if we manu-
facture 20 chairs, the total variable cost will be 20 times R5, which equals R100. If we
manufacture 200 chairs, the total variable cost will be 200 times R5, which equals R1 000.
So the variable cost per unit does not change with a change in production volume, but
the total variable cost will change with a change in production volume.

Another important concept to understand is the income statement. The income state-
336

ment indicates the make-up of the proit or loss for the particular period. Knowing the
sequence of the deductions as they occur in the income statement will enable you to
calculate ratios accurately at a later stage of the unit’s production (see activity 7.2).

Activity 7.2

Memorise the sequence of deductions set out in the income statement in igure 13.9.

Knowing the sequence of these deductions will enable you to calculate the ratios accurately.
Refer to activity 7.3 in which these calculations will be done.

7.3 OBJECTIVE AND FUNDAMENTAL PRINCIPLES OF FINANCIAL

MANAGEMENT

Study section 13.4 in the prescribed book.

The long-term objective of the business should be to increase its value. This will be
217

achieved by investing in assets that add value and by keeping the cost of capital of the
business as low as possible.

The short-term inancial objective should be to ensure the proitability, liquidity and
218

solvency of the business. Financial management is based on the risk-return principle (the
higher the risk taken, the higher the expected return), the cost-beneit principle (discussed
in section 7.4 below) and the time value of money principle (discussed in section 7.5 below).

89 MNB1601/1
7.4 COST-VOLUME-PROFIT RELATIONSHIPS

Study section 13.5 in the prescribed book.

Breakeven analysis can give management valuable insight into the interrelationships of
337

sales volumes and prices, on the one hand, and the ixed and variable costs that constitute
the total cost structure of the business, on the other.

Breakeven analysis can contribute to the preparation of budgets and setting of targets,
338

and forms the basis for strategic decisions, for example changing the irm’s pricing struc-
ture or deciding whether future investment should be in capital-intensive rather than
labour-intensive facilities. (The former entails higher ixed costs in proportion to the total
costs, while the latter entails a higher proportion of variable costs.)

The greater a business’s ixed costs, the greater its exposure will be to the negative efects
339

of a decline in sales. Fixed costs are related to speciic periods and are not inluenced
by production and sales volumes, whereas variable costs are largely controllable in ac-
cordance with changes in production or sales volumes. If, for example, fewer products
are manufactured, the total cost of raw materials will also be lower. Breakeven analysis
therefore indicates the impact on proits of possible variations in sales volume and/or
possible changes in production costs.

The key to understanding the concept of the breakeven point is the fact that a business
340

will always have ixed costs even before anything has been manufactured (or any service
has been provided). Suppose that a business has a total ixed cost of R100 000. It manufac-
tures computers, and the variable cost per unit is R1 000. The computers sell for R3 000.
This means that a variable proit of R2 000 is made on each computer manufactured and
sold. If the business manufactures and sells 40 units (computers), it would make a total
variable proit of 40 x R2 000 = R80 000. This can also be calculated by taking the total
income from sales (40 x R3 000 = R120 000) and subtracting the total variable cost (40 x
R1 000 = R40 000).

However, since the ixed costs are R100 000, the business would actually be making
341

a loss of R20 000. The question is then: How many units would the business have to
manufacture and sell before it breaks even, that is makes no loss? In the above case it is
easy to see: the business would have to manufacture and sell 50 units, in order to make
a variable proit of R100 000 which would then cover the ixed costs of R100 000. If the
business manufactures and sells more than 50 units it would be making an overall proit.

Now let’s apply the above igures to the breakeven formula, where N represents the
342

number of units to be manufactured in order to break even:

343 N = F
344 (SP – V)

345 N = 100 000

346 (3000 – 1 000)

90
347 N = 100 000
348 2 000

349 N = 50

7.5 THE TIME VALUE OF MONEY

Study section 13.6 in the prescribed book.

The key to understanding this concept is the fact that money changes in value because
350

of interest rates. If you were given the choice of receiving R100 today or R110 in one year’s
time, which would you choose? The answer depends on the current interest rate that
can be obtained. If the current interest rate is 5% per annum, and you accept the R100
today and invest it at 5%, you will earn R5 interest after one year, and you will then have
R105. It would therefore be more advantageous to choose the R110 in one year’s time.
On the other hand, if the current interest rate is 15% per annum, then by investing the
R100 today you would earn R15 in interest after one year, giving you R115, and it would
therefore be to your advantage to accept the R100 today.

It becomes a little more diicult to calculate if the choice is R100 today or R140 in three
351

years’ time, because it is not just a question of multiplying the interest of R5 by 3. This is
because after one year you will have R105, and during the following year you will earn
interest not on R100 but on R105. So after two years you would have R105 x 5% = R110,25,
and the following year you would earn interest of 5% on R110,25, giving you R115,76. This
is known as compound interest. To make it easy to calculate what the future value of a
given amount is, we have drawn up some tables. If you look at the future value table in
your prescribed book, you will see that there are three columns for three diferent rates
of interest and a number of rows for each year. (Note that such tables can be worked out
for every possible interest rate for any number of years, but for study purposes we have
limited them to three interest rates for a period of 10 years.)

To calculate the future value of R100 after three years if the interest rate is 5%, we would
352

have to multiply R100 by 1,1576 (the factor in the future value table), which comes to
R115,76 (the same amount we calculated the long way). Thus taking the R140 in three
years’ time would deinitely be the better option. If the interest rate was 15% then we
would calculate R100 times 1,5209, which equals R152,09. In that case it would be prefer-
able to take the R100 today.

There is also another way of calculating the time value of money. We can calculate an
353

amount to be received in the future back to its present value. For example, if we knew that
we would receive R200 in four years’ time, we could calculate what that amount would
be worth today if the interest rate were 10%. To make this calculation we now have to
turn to the discounting table in the prescribed book. Look under the 10% column. The
factor for four years is 0,6830. So if we multiply the R200 by 0,6830 we get R136,60. We
can therefore say that an amount of R200 in four years’ time is worth R136,60 today.

91 MNB1601/1
Just to make sure, let’s calculate how much an amount of R136,60 today would be worth
354

in four years’ time if the interest rate were 10%. Look up the future value factor for 10%
after four years. This factor of 1,4641 is then multiplied by R136,60. This gives us R200,00.
This conirms that an amount of R200 in four years’ time is worth R136,60 today (ie its
present value) and, conversely, an amount of R136,60 today will be worth R200,00 in four
years’ time (ie its future value).

You will observe that all the factors in the future value tables are greater than 1, since
355

cash invested now will be worth more in the future. To arrive at this greater future value,
the cash invested now must be multiplied by a factor greater than 1. Conversely, the
discounting tables all have a igure less than 1, since the value of money to be received
at some future time will be less now. Therefore the future value must be multiplied by
some factor less than 1 to obtain a reduced sum for its present value.

For examination purposes, the discount factors and future value factors will be given,
356

as will the cash lows at various intervals. All you need to know is how to calculate the
present and future values.

7.6 FINANCIAL ANALYSIS, PLANNING AND CONTROL

Study section 13.7 in the prescribed book.

When you have worked through this section you should understand why the balance
358

sheet, income statement and funds low statement are essential sources of information
for the inancial manager: this data will enable him or her to ascertain the performance
and inancial soundness of the business – particularly the extent to which owner or
shareholder wealth is being maximised over the long term.

The inancial ratios described in section 13.7.1.5 are useful tools for evaluating a business’s
359

inancial health. You must know how to calculate these ratios, because they will deinitely
be asked in the examination.

Activity 7.3

Please complete the following without looking at the prescribed book:

The liquidity ratios
The current ratio = Current …….
Current liabilities
The acid test ratio = ……. less stock
Current liabilities
The solvency ratios
The debt ratio = Debt
…….

92
 The gearing ratio = …….
Debt
The proitability ratios
Rate of return on total capital (before tax)) = …………………..
Total capital
Rate of return on total capital (after tax) = ………………….
Total capital
Yield on shareholders’ interest = …………………………
Shareholders’ interest
Yield on owners’ equity = ………. ………..
Owners’ equity

360

The answers to this activity are given in section 13.7 of the prescribed book. Check to see
whether your answers are correct.

The last section of this chapter deals with budgets. Make sure that you understand the
361

diferences between the various responsibility centres.

Finally, make sure that you know the diferences between the various types of operating
362

budgets and inancial budgets.

Activity 7.4

Obtain a set of inancial statements (especially the income statement and balance sheet)
of a company. You should ind these in the business supplement of a newspaper or in
a inancial magazine. Using these statements, calculate the company’s solvency and
proitability ratios.

Did you succeed in calculating these ratios? If not, do not despair! You will sometimes ind that
these statements do not always provide the irm’s results in detail; instead, the results often
appear as a summary. When the results are given in suicient detail, do these calculations and
see what levels of ratios (high or low) irms abide by in order to survive.

You will also see that the balance sheet may be drawn up in diferent ways and not neces-
sarily in the form appearing in the prescribed book. These other forms are also acceptable in
the business world.

Refer once again to section 13.3 in the prescribed book concerning the structures of the bal-
ance sheet and income statement, and their signiicance.

SUMMARY
In this study unit we analysed the nature and meaning of the inancial function and its
363

management, that is inancial management. The relationship between inancial manage-

ment, other functional management areas, related subject disciplines and the environment
were then shown, followed by an introduction to some basic concepts and techniques
used in inancial management. The goal and fundamental principles of inancial manage-

93 MNB1601/1
ment were also explained. Finally, we discussed one of the tasks of inancial management,
namely inancial analysis, planning and control.

In the next study unit you will study the management of assets through the investment
364

decision.

SELF-ASSESSMENT QUESTIONS
7

(1) Given the following information, which of the following calculations are correct
concerning cost-volume-proit relationships?
Selling price per unit = R10
Total variable costs = R600
Fixed costs per unit = R3
Total ixed costs = R300
(a) Number of units sold = 200 units
(b) Total proit generated = R100
(c) Number of units to break even = 75 units
(d) Marginal income per unit = R4
(1) abc
(2) abd
(3) bcd
(4) ac
(2) Which of the following statements on the time value of money are correct?
The higher the discount rate, the higher the present value of a given future amount
will be.
(a) The discounting factor for a certain period and a given interest rate is (1 + i)n.
(b) The greater the risk, the greater the interest rate should be in both the compound-
ing and discounting factors.
(c) The time value of money is directly related to the opportunity rate of return.
(d) The greater the risk, the greater the need will be to receive incoming funds as
quickly as possible.
(1) ac
(2) bd
(3) bcd
(4) cde
(3) On 1 January 2007, a person deposits R3 000 in a saving account at a rate of return of
10% per annum. On 1 January 2009, he deposits another R1 000 in that account. On
31 December 2009, he closes the account and invests the total proceeds in another
account on 1 January 2010 at a rate of return of 15%. How much money will he have
in the account on 31 December 2011?
(a) R6 735,49
(b) R6 255,42
(c) R6 162,53
(d) R5 723,30

94
Question 1

The correct answer is option 3.

First we need to calculate N (number of units sold). From the information given, total ixed
costs are R300 and ixed costs per unit are R3. Therefore N = R300/3 = 100 units. Therefore
alternative a is incorrect, which makes alternatives b, c and d correct.

Let us solve for proit as illustrated below:

P = (N x SP) – [(N x V) + F] (section 13.5)

Where:

N = number of units sold

SP = selling price per unit

V = variable cost per unit

F = total ixed costs

P = (100 x R10) – (R600 + R300)

P = R1 000 – R900

P = R100

Therefore alternative b is correct.

Let us solve for the number of units to break even, which is N = F/SP-V (section 13.5),

where:

N = number of units to break even

F = total ixed costs

SP = selling price per unit

V = variable cost per unit

Since we have not been given variable cost per unit, we can calculate it by dividing total vari-
able cost by number of units sold, which is R600/100 = R6.

Therefore N = R300/R10 – R6

N = 75 units

Therefore alternative c is correct.

Let us now conirm alternative d, the marginal income per unit, which is SP-V,

where:

95 MNB1601/1
SP = selling price

V = variable cost per unit

= R10 – R6

= R4

Question 2

The correct answer is option 4.

Alternative a is wrong because the discount rate has the efect of reducing the future cash
amount. So if you increase the discount rate (which is always part of the denominator) you
increase the denominator. This has the efect of decreasing the present value.

Alternative b is also wrong, because the discounting factor for a certain period and a given
interest rate is n is the compound interest factor.

Question 3

The correct answer is option 1.

First, we calculate the value of R3 000 invested on 1 January 2007 as at 31 December 2009
when the account is closed. From the time line we can see that this period is three years.

Therefore FV3 = PV (FVIF10%, 3)

= 3 000 (1.3310)

= R3 993,00

We then calculate the value of R1 000 invested on 1 January 2009 as at 31 December 2009
when the account is closed. From the time line we can see that the amount was invested for
one year only.

Therefore FV1 = PV (FVIF10%, 1)

= 1 000 (1.1)

= R1 100

The value of the combined investment on 31 December 2009 is R3 993 + R1 100 = R5 093. The
R5 093 is invested in another account for a period of two years (from 1 Jan 2010 to 31 Dec 2011).

Therefore FV2 = PV (FVIF15%, 2)

= R5 093 (1.3225)

= R6 735,49

On 31 December 2011, the person will have R6 735,49 in the account. The correct answer is
thus option 1.

96
Study unit 8
Asset management: the investment decision

Contents

Key concepts
Learning outcomes
Getting an overview
8.1 The management of current assets
8.2 Long-term investment decisions and capital budgeting
Summary
Self-assessment questions

Key concepts

current assets stock

long-term investment decisions cash
marketable securities capital budgeting
debtors investment projects

Learning outcomes

When you have worked through study unit 6 you should be able to:
• manage current assets
• make long-term decisions

Getting an overview
In order to achieve the main objective of the irm, you need to efectively manage the
365

investment in the assets (current and ixed) of the business. This study unit explains the
management of cash and marketable securities, debtors and stock in order to success-
fully pursue the main objective of the business. We also discuss the long-term investment
decision and capital budgeting, where the concept of net present value (NPV) is intro-
duced. You need to understand NPV because this is a technique that you will be using
to evaluate capital projects.

97 MNB1601/1
8.1 THE MANAGEMENT OF CURRENT ASSETS

Study section 13.8 in the prescribed book.

8.1.1 The cost and risk of investing in current assets

Over-investment in current assets is costly because the capital tied up in current assets
366

could be invested proitably elsewhere. For example, if one business has an inventory
of R200 000, and this stock level were to be reduced to R100 000, the surplus R100 000
could be invested in a short-term deposit, say at 10%. Thus the company would be earn-
ing R10 000 per annum instead of having the surplus stock lying in a warehouse (ie over-
investment) where it is not earning any income.

The ideal, of course, would be to have no capital tied up in stock, but that would mean that
367

the suppliers would always have to deliver the raw material exactly when it is needed, or
the factory would have to deliver the inished product exactly when a customer wanted
it. But this under-investment is risky because if there is an unforeseen delay somewhere
along the line, there might be a serious delay in the factory (which is very costly), or the
customer will buy the product elsewhere.

Make sure that you understand the igures in table 13.13 which shows that a higher invest-
368

ment in current assets leads to a higher liquidity (as in the case of business B), while a lower
investment in current assets leads to a higher rate of return (as in the case of business A).

8.1.2 The management of cash and marketable securities

You must understand the three basic reasons (motives) for having a certain amount of
369

cash on hand. Let’s take the example of a gardening services provider. The provider wins
a contract to lay out the gardens of a new building. The job should take approximately
two months, and the contract price will be paid on completion of the job (ie after two
months). In the meantime, the contractor needs cash to purchase plants, grass, fertiliser,
and so on. He also needs cash to pay his labourers their weekly wages (after all, they can-
not be expected to wait two months before they are paid). This is the transaction motive.

But what if the client does not settle her debt on completion of the job? Or perhaps she
370

delays payment for three weeks? The wages and other expenses still have to be paid. So
the contractor needs some additional cash as a precautionary motive.

Then one day he hears that a competitor has gone bankrupt, and that a large quantity of
371

gardening equipment and tools can be bought at relatively cheap prices. If our contractor
doesn’t have any available cash on hand, he will not be able to make use of this opportu-
nity to obtain some valuable equipment at a very low price. So he also has a speculative
motive to keep some extra cash (or marketable securities) on hand.

When you look at the cash budget in table 13.15, note that the net cash position is the
372

diference between cash receipts and cash disbursements, plus or minus the cash on

98
hand or shortage that the business started with. For example, in the month of May, the
diference between cash receipts and cash disbursements is a positive cash low of R19
000. However, since the irm started the month with a cash shortage of R32 000, the net
cash position is a cash shortage of R13 000.

The example of the business that made a proit each month, but had to discontinue its
373

operations because it ran out of cash, may be a little confusing. Try to calculate the four
items yourself, namely the increase in net proit, the increase in the debtors, the increase
in inventory and the subsequent decrease in cash. What actually happened was that,
despite making a proit, the business’s current assets shifted from liquid assets (cash) to
less liquid assets (inventory and debtors). At the beginning of January its current assets
were as follows:

374 Cash R 75 000

375 Inventory R112 500

376 Debtors R150 000

377 TOTAL R337 500

The business made a proit of R187 500 during the next four months, so its current assets
378

should have increased by that amount, giving us R525 000. That is exactly what happened,
but the current assets are now made up as follows:

379 Cash R0

380 Inventory R225 500

381 Debtors R300 000

382 TOTAL R525 500

Unless this business is able to obtain funds from somewhere else, it will not be able to
383

continue production and may have to be liquidated.

8.1.3 The management of debtors

What can a business do to shorten its cash cycle? One way is to reduce the amount owing
384

to it by debtors. This is because the greater the amount of money that is owed by debtors,
the greater the likelihood of bad debts (ie debts not paid by debtors) – and therefore the
more capital that is tied up in debtors. To reduce the number of debtors, a business can
grant less credit to customers, tighten up on the credit terms, and/or enforce the collection
policy more strictly. The irm could also ofer discounts for prompt settlement of accounts.

However, there are risks to reducing the amount invested in debtors. If the business grants
385

less credit (eg by refusing to grant credit to anyone who does not have an exceptionally
high credit rating) it may well lose sales. If it tightens up on its credit terms (eg demand-
ing settlement of accounts within a shorter period) it may also drive some customers into
the arms of a competitor who has a more lenient credit policy. If it enforces the collection

99 MNB1601/1
policy more strictly (eg taking customers to court if they do not settle their debts within
the speciied period) it may also frighten of potential customers.

Managing debtors successfully therefore requires maintaining a ine balance between

386

keeping customers and at the same time maintaining liquidity.

8.1.4 The management of stock (inventory)

Another way to shorten the cash cycle is to reduce the level of inventory, be it raw mate-
387

rials or inished goods. Again this requires maintaining a ine balance between keeping
inventory costs at a minimum and at the same time keeping the loss of sales or delays in
production (as a result of unavailable stock) to a minimum.

Activity 8.1

Use the inancial statements you obtained from the business supplement or inancial
journal and calculate the company’s liquidity ratio. Decide whether a conservative or
aggressive approach is being used to inance current assets.

If the liquidity ratio is high (say, 4:1), then more long-term funds are being used to inance
current assets than if the ratio was, say, 2:1. This is considered to be a conservative approach
to inancing current assets. If the liquidity ratio is 2:1, then fewer long-term funds and more
short-term funds are being used to inance current assets than if the ratio was 4:1. This is known
as the aggressive approach.

As the level of risk rises, it would be safer to adopt the conservative approach, in which case
liquidity will tend to be higher than in the aggressive approach. The amount of the long-term
funds may be found by subtracting current liabilities from current assets. This diference is
referred to as “net current assets”. If the liquidity ratio is, say, 4:1, then net current assets would
be represented by 4 – 1 = 3.

8.2 LONG-TERM INVESTMENT DECISIONS AND CAPITAL

BUDGETING

Study section 13.9 in the prescribed book.

The irst aspect of capital investments is the magnitude. Many of these capital projects
388

require large sums of money, and if the wrong decision is made this may have a serious
efect on the business’s proitability, and may even lead to the bankruptcy of a business.

An investment in a capital project is risky in terms of the large sums of money involved,
389

but is even more risky because of the long-term nature of such a project. Think of the
risk of investing millions in building another Sasol plant. During the years of sanctions it
made sense to increase our capacity to manufacture our own fuel. Now that sanctions
have been lifted, the question may well be asked whether it is still proitable to continue
with such a project. Another example of a risky capital project was Mossgas which cost

100
R12 000 billion, and turned out to be a huge loss. However, at the time it seemed like a
risk worth taking.

The net cash low is simply the diference between the amount of money that lowed
390

into the business (by way of sales, investment income, etc) and the amount of money
that lowed out of the business (cost of materials, wages, interest, taxes, etc). Instead of
adding and subtracting all the items, we can simply look at the income statement where
the net proit gives us the same igure, with one signiicant exception. To arrive at the
net proit, an amount for depreciation was deducted. The fact that plant and machinery
loses its value (just like a car loses its value the older it becomes) is an expense for the
business, but it does not involve an actual cash outlow. Therefore, to calculate the net
cash outlow, one needs to use the following approach:

EBIT (1-tax) = NOPAT

NOPAT + depreciation = net cash low

391 (Otherwise interest is double counted, ie in CF and in WACC.)

Diferent investment projects will yield diferent cash lows at diferent times, so it becomes
392

very diicult, if not impossible, to compare the beneits of diferent projects unless we
reduce them to the same base. In other words, we have to compare apples with apples. If
we wish to compare investment projects, we have to determine the net cash lows (inlows
minus outlows) in each year of the project’s life and calculate each net cash low back
to its present value. Then by adding up the present values of each net cash low, we can
compare with the initial investment to arrive at a net present value. If the various present
values add up to less than the initial investment, we have a negative net present value.
If they add up to more than the initial investment, we have a positive net present value.

Obviously a project yielding a negative present value should not be considered because
393

it will not increase the wealth of the stakeholders. The prescribed book says that all proj-
ects with a positive NPV should be accepted. However, it could happen that two projects
under consideration both have a positive NPV, but that only one of them can be selected.
In this instance, the project with the higher NPV is likely to be chosen.

Tables 13.18 and 13.20 clearly set out how the beneits of two potential projects can be
394

compared with one another. The present values of project X’s cash lows add up to R9 386.
That means that the expected income of project X over a period of ive years would be
worth R9 386 in today’s terms. Since the project requires an investment of R10 000 (today),
the investor’s “wealth” would actually decrease by R614. This project should therefore
be rejected.

Compare that with project Y where the present values of the cash lows add up to R11 340.
395

In other words, the investor’s wealth would increase by R1 340. The project would there-
fore be quite acceptable.

What would be the position if the initial investment in project X was R9 000 and the initial
396

investment in project Y was R11 000? In that case the NPV of project X would be R386,

101 MNB1601/1
and the NPV of project Y would be R340. Both projects would therefore be acceptable,
but if only one project had to be selected, project X would be preferable since it would
increase the investor’s wealth slightly more than project Y.

SUMMARY
You now have basic insight into the management of the asset structure of a business. In
397

the next study unit you will study inancing decisions.

SELF-ASSESSMENT QUESTIONS
8

(1) Which of the following statements on the operating objective when managing stock
are correct?
The operating objective is to
(a) keep the lowest possible supply of stock.
(b) keep the stock turnover as high as possible.
(c) keep as much stock as possible to ensure that the business is never without stock.
(d) ensure that production interruptions never occur.
(1) ab
(2) ac
(3) bc
(4) bd
(5) cd
(2) Which of the following reasons for keeping extra cash on hand is based on the pre-
cautionary motive?
(a) to make provision for unforeseen events
(b) to make provision for delays in receiving payments from debtors
(c) to buy inventory from an insolvent competitor at bargain prices
(d) to make provision for expenses that have to be paid in cash
(1) ab
(2) abc
(3) bc
(4) bcd
(3) Assume you are evaluating an investment that requires you to invest R100 000 at
time 0. Following this investment, you will not receive anything for 2 years, and then
you will receive R200 000 for 3 successive years. If the cost of capital is 12%, should
this project be accepted?
Question 1

The correct answer is option 5.

Alternatives a and b are proit objectives and not operating objectives.

Question 2

The correct answer is option 1.

Alternatives a and b are precautionary motives which entail keeping cash for contingencies
(ie unforeseen events). Alternative c is a speculative motive, which entails capitalising on good

102
opportunities. Alternative d is a transaction motive, which entails making provision for cash
expenses before cash income has been received (eg paying wages).

Question 3

First, draw a time line:

0 1 2 3 4 5

±R100 000 0 0 R200 000 R200 000 R200 000

Secondly, ind the present value of the cash inlows from year 3 to year 5. We ignore years 1
and 2 because the cash lows are 0:

PV = R200 000 + R200 000 + R200 000

= R382 945,04
(1.12)3 (1.12)4 (1.12)5

Then subtract the initial investment from the PV to get the NPV:

NPV = R382 945,04 – R100 000 = R282 945,04

Since the NPV is positive, accept the project.

103 MNB1601/1
Study unit 9
Financing decisions

Contents

Key concepts
Learning outcomes
Getting an overview
9.1 Financial markets
9.2 Short-term inancing
9.3 Long-term inancing decisions
Summary
Self-assessment questions

Key concepts

inancial institutions long-term inancing

inancial markets shareholders’ interest
primary markets long-term debt
secondary markets cost of capital
money markets long-term inancing decisions
capital markets risk
short-term inancing decisions
forms of short-term inancing

Learning outcomes

When you have worked through study unit 9 you should be able to:

• describe the money and capital markets as providers of finance

• explain the types of short-term financing and the short-term financing decision (the
financing of current assets)
• describe the forms and sources of long-term financing
• explain the cost of capital
• explain the long-term financing decision

104
Getting an overview

Study section 13.10 in the prescribed book.

In this study unit we irst examine inancial markets and the sources and forms of short-
398

term inance. This is followed by a discussion on the sources and forms of long-term
inance and the cost of long-term capital.

9.1 FINANCIAL MARKETS

Study section 13.10.1 in the prescribed book.

Individuals (or organisations) with surplus funds (referred to as a surplus unit) can invest
399

those funds in businesses requiring inance (referred to as deicit units). However, it

would be rather diicult, especially for an individual, to ind out where the investment
opportunities are. It would also be diicult for businesses to deal with a large number
of small investors, especially if they want to invest their money for short periods of time
only. Thus intermediary organisations, known as inancial institutions, have been estab-
lished to act as a go-between. For example, a large number of people may open savings
accounts with a bank (ie a inancial institution). The bank uses these savings to invest in
businesses requiring inance. The fact that individuals withdraw their money from their
savings accounts and then deposit money again into their savings accounts does not
afect the bank’s investment in the businesses. In this way, such a inancial institution
meets an important need, because it allows the surplus units (investors) the lexibility of
investing and withdrawing their funds at short notice, while the deicit units are assured
of a relatively stable supply of funds.

In the same way, it would be very diicult for a large business to sell shares directly to
400

an investor, and then buy them back again when the investor needs the cash. That is
why stock exchanges are established, where shares can be bought and sold without the
company concerned being exposed to frequent luctuations in the availability of funds.
The prescribed book describes a number of these inancial institutions (including the
Johannesburg Stock Exchange) that operate within the “inancial market”.

Bear in mind that there is a formal inancial market (where business is done through i-
401

nancial institutions) and an informal inancial market (where business is done privately).
If you are a shareholder in a private company, for example, and you sell your shares to a
friend, you are operating in an informal inancial market.

A further classiication of the inancial market is the primary market, which refers to the
402

issue of inancial claims for the irst time, and the secondary market, which refers to the
trading of those claims. A inancial claim refers to any form of evidence that the holder
has invested funds in a particular institution. It can range from a savings account deposit

105 MNB1601/1
book to a share certiicate. When such claims are negotiable (ie they can be traded), they
are referred to as inancial instruments.

The inancial market is also classiied in terms of time. The money market refers to the
403

trading of short-term inancial instruments (eg 30-day deposits), while the capital market
refers to the trading of long-term inancial instruments (eg shares).

9.2 SHORT-TERM FINANCING

Study section 13.10.2 in the prescribed book.

The inancing of current assets (short-term inancing) is also referred to as the inanc-
404

ing of working capital, which may be performed by using one of three approaches: the
matching, aggressive and conservative approaches.

Make sure that you understand how each of these forms contributes to the short-term
405

inancing of a business.

The matching approach means that ixed assets and permanent current assets are i-
406

nanced by long-term funds and the short-term assets are inanced by short-term funds.

The aggressive approach means that some of the ixed assets and permanent current
407

assets are inanced by short-term funds. This kind of inancing costs less, but there is
always the danger that the funds have to be repaid without suicient cash on hand. The
result is that the business either has to obtain more funds elsewhere, or cease operations.

The conservative approach means that some of the long-term funds are used to inance
408

short-term assets. The result is that the business remains very liquid, but the cost of i-
nancing is so much higher.

9.3 LONG-TERM FINANCING DECISIONS

Study section 13.11 in the prescribed book.

To understand the various forms of long-term inancing, study table 13.23 carefully. Make
410

sure that you know what the characteristics, advantages and disadvantages of the various
forms of long-term inancing are.

When the prescribed book uses the words “listed company” it refers to a public company
411

whose shares are quoted (listed) on a securities exchange.

For any company, the balance sheet entity referred to as “shareholders’ equity” repre-
412

sents the investment of the shareholders as a group in that particular company. In other

106
words, “shareholders’ equity” represents the amount of the shareholders’ claim against
the assets of the company.

There are two types of long-term funds or long-term capital: shareholding and long-term
413

debt. Financing a business through the issue of shares is possible only if the business is a
registered company. If it is a private company, the shares are sold to private individuals. If
the company is a public company the shares can be sold on the JSE securities exchange.

The prescribed book sets out the diferences between ordinary shares and preference
414

shares. It is important that you understand these diferences, as well as the advantages
and disadvantages of both types of share.

The prescribed book distinguishes between two types of long-term debt: loans and
415

leasing. Again you need to make sure that you can explain the diference between these
types of loan.

The prescribed book describes two types of leasing: direct leasing and leaseback agree-
416

ments. The diference between an operating lease and a inancial lease is that in the case
of the former the equipment is returned to the lessor after it has been used for a certain
period of time. In other words, the lessee pays only for the use of the equipment. In a
inancial lease, the lessee becomes the legal owner of the asset.

In a leaseback agreement, the lessee is the original owner of the asset. This asset is sold
417

to the lessor, and the lessee now pays a rental to the lessor. For example, a retail busi-
ness may own the building in which the shop is situated. However, if the business needs
inance, it may approach a inancial institution, like an insurance company, to purchase
the building and then lease it back to the business. The insurance company will then pay
the retail company for the building, giving it the needed inance, and the retail company
will continue to occupy the building, but pay a monthly rental (lease) to the insurance
company.

Another factor that needs to be considered when making the inancing decision is the
418

cost of capital. Accurate determination of the overall cost of a company’s capital is par-
ticularly important for decisions on investment in capital assets. If the company’s cost of
capital is likely to exceed the expected rate of return on such capital asset investment,
the company will incur a loss and the investment must be declined. Put diferently, when
the company incurs losses it will ind it extremely diicult to attract future investors.

Since there are diferent types of long-term capital with diferent costs, we need to
419

calculate the weighted average cost of capital to arrive at an overall cost of capital. In
calculating the weighted average cost of capital, one must take the proportion of each
type of capital into account.

420 For example:

If we had the following three types of raw materials that go into a particular product,
421

what would the average cost of the raw materials be?

3 kg of material A @ R4 per kg = R12

107 MNB1601/1
 3 kg of material B @ R8 per kg = R24

3 kg of material C @ R3 per kg = R9

The answer is easy to calculate. We calculate the total cost for the 9 kg and divide that
422

by 9 to get a cost per kg. Thus we would add R12 + R24 + R9 = R45. That would give us
an average cost of R5 per kg (R45 ÷ 9 kg). An even easier way would be to simply add up
the three igures and divide by 3. That would give us an average cost of R15 ÷ 3 = R5 per
kg. We could calculate it that way because an equal amount (3 kg) of each type of raw
material goes into the product.

423 However, if the materials were made up as follows:

2 kg of material A @ R4 per kg

5 kg of material B @ R8 per kg

2 kg of material C @ R3 per kg

What would the average cost of the raw materials be now? We would have to work out
424

the total cost for all 9 kg and then divide that by 9 to get a cost per kg. In this case it would
be R8 + R40 + R6 = R54. That would give us an average cost of R6 per kg (R54 ÷ 9 kg).

This can also be calculated by taking the proportion that each type of raw material makes
425

up of the total materials and multiplying it by the cost per kg. The calculation would then
be:

2
x R4 = R0,89
9

5
x R8 = R4,44
9

2
x R3 = R0,67
9

426 If we add these three igures together, we will get to the same answer:

0,89 + 4,44 + 0,67 = R6,00

When calculating the weighted average cost of capital, we use the same approach: we
427

irst determine what proportion each type of capital makes out of the total long-term
capital. This proportion is then multiplied by the actual cost, and these igures are added
up. Note, however, that since the cost of long-term debt is tax-deductible, we must irst

108
adjust the cost of that long-term debt to an after-tax cost. If, for example, the interest
rate of a long-term loan is 16% and the tax rate is 40%, then we can in fact adjust the
cost by 40% in order to get the real cost. The actual cost would really be 60% of 16% or,
put another way, the after-tax cost would be 16% x (1 – 0,4) = 9,6%.

428 In the example given in the prescribed book, the total capital amounts to R1 000 000.

429 Owners’ equity is R500 000, so its proportion is:

500 000 = 0,5

1 000 000

430 Preference share capital amounts to R300 000, so the proportion is:

300 000 = 0,3

1 000 000

The long-term debt is R200 000, so the proportion is:

431

200 000 = 0,2

1 000 000

Note that the interest rate on the long-term debt is 13,5%, but with a tax rate of 46%, the
432

actual cost is 13,5% x 0,54 = 7,29%. That is why the long-term debt proportion of 0,2 is
multiplied by the after-tax cost of 7,29%.

SUMMARY
This topic dealt with inancing decisions. In the next topic you will study purchasing and
433

supply management as part of the functional management of the organisation.

SELF-ASSESSMENT QUESTIONS
9

(1) Which of the following are forms of short-term inancing?

(a) registered term loans
(b) inancial leases
(c) factoring of debtors
(d) trade credit
(e) bank overdrafts
(1) abc
(2) bcd
(3) cde
(4) abcde
(2) Which of the following statements do not describe characteristics of the ordinary
share?
(a) The accountability of the ordinary shareholder is limited to the number of shares
he or she holds in a business.

109 MNB1601/1
 (b) The term of availability of ordinary share capital is limited.
(c) Ordinary shares bear no legal and inancial obligations for a company.
(d) An enterprise must pay dividends on its issued ordinary shares.
(e) An ordinary share gives a right of ownership to a shareholder.

(1) a c
(2) b d
(3) c e
(4) a b d
(5) b c d e
(3) You are given the following information on the cost of capital of BEC Co Ltd:

Cost Amount

Owners’ equity 20% R1 400 000

Preference share capital 10% R 300 000
Long-term debt (after tax) 9% R 500 000
Use the information to calculate the company’s weighted average cost of capital.

(1) 16,13%
(2) 18,50%
(3) 20,08%
(4) 23,20%

Question 1

The correct answer is option 3.

Alternatives a and b are wrong because registered term loans and inancial leases are forms
of long-term inance, that is the funds must be repaid after a year.

Question 2

The correct answer is option 2.

Statements a, c and e describe characteristics of ordinary shares. Statements b and d do not

describe characteristics of ordinary shares.

Question 3

The correct answer is option 1.

To solve this problem, you need to complete the information given in a table as follows:

110
 TYPE AMOUNT PROPORTION COMPONENT- WEIGHTED
OF CAPITAL COST OF COST
CAPITAL

(1) (2) (3) (4) (3) x (4)

Owners’ equity R1 400 000 0,64 20% 12,8

Preference R300 000 0,13 10% 1,3

share capital

Long-term debt R500 000 0,23 9% 2,07

(after tax)

Total 16,17

The WACC is therefore 16,17%.

111 MNB1601/1
TOPIC 5
The purchasing and supply function

AIM
The aim is to introduce the most important aspects of the purchasing or sourcing func-
434

tion within the broader context of supply management, including new concepts in the
ield, the management of the function, the purchasing or sourcing cycle and the most
important activities associated with the purchasing and supply management ield.

Learning outcomes

When you have worked through topic 5 you should be able to:
• demonstrate an understanding of the purchasing (or sourcing) function within the
broader context of supply management, by highlighting the types and activities of
purchasing and supply and its management tasks
• formulate the activities involved in the sourcing decision by summarising the purchas-
ing and supply process, decisions regarding quality, quantity, pricing and the selection
of suppliers as well as the timing of purchases

OVERVIEW OF THE TOPIC

Topic 5 comprises the following study units:
435

TOPIC 5

Study unit 10 Study unit 11

436

437 Purchasing and supply management Sourcing activities

438

113 MNB1601/1
Study unit 10
Purchasing and supply management

Contents

Key concepts
Learning outcomes
Getting an overview
10.1 Purchasing and supply in perspective
10.2 The importance of the purchasing and supply function for the business
10.3 The management task of the purchasing and supply manager
Summary
Self-assessment questions

Key concepts

purchasing and supply function purchasing and supply organisation

purchasing management organisational structure
supply management centralisation
provision function decentralisation
expenditure cross-functional sourcing teams
inventory holding purchasing and supply control
proit leverage assessment
management task
purchasing and supply planning
hierarchical level
strategic management level
tactical management level
operational management level

Learning outcomes

When you have worked through study unit 10 you should be able to:
• demonstrate an understanding of the purchasing (or sourcing) function within the
broader context of supply management
• describe the broadening of the provision function by summarising other concepts in
or approaches to the provision of materials to a business
• demonstrate an understanding of the importance of the purchasing and supply func-
tion to the business by summarising the reasons for its importance
• describe the management task of the purchasing and supply function by highlighting
its planning, organising and control

114
 • demonstrate an understanding of the tools available to purchasing and supply by
summarising each tool respectively

Getting an overview

Study section 14.1 in the prescribed book.

Purchasing and supply management is one of the greatest areas of opportunity in any
439

organisation. This is because purchased equipment, inventory and services make up the
lion’s share of the overall cost structure of any enterprise. Successful organisations today
understand that managing the purchasing or sourcing cycle within a broader supply
context is a key capability for improving product and service performance, and should
be elevated to the same level of importance as that of engineering or inance.

Leading purchasing, sourcing and supply executives now deal with a broad range of
440

complex issues. This requires a multidisciplinary focus and the engagement of business
unit leaders across the enterprise, in order to deliver major performance gains. In top-
performing organisations, purchasing goes well beyond the traditional function of pro-
viding the right requirements at the right place, purchased from the right source, at the
right price in the right quantity. Achieving more than all this is by no means an easy task!

Fortunately, there are a vast number of international (and some South African) organisa-
441

tions who have pushed the purchasing, sourcing and supply frontiers forward. Purchas-
ing is given a strategic slant, focusing on the sourcing and management of an optimal
number of suppliers with whom an organisation can establish long-term relationships
to the mutual beneit of all. Not only can we learn lessons from their examples, but we
can also identify the critical factors that make it possible for purchasing and sourcing to
add value and be recognised at the highest levels, within the broader context of supply
management.

Purchasing, sourcing and supply management leaders should have a strategic vision of
442

what the function can deliver, with an organisation to support this vision. That means
aggressive targets backed up by the right incentives and resources, as well as an execu-
tive management team pushing line executives to make the hard decisions needed to
advance the interests of the whole company over parochial preferences. Consider the
case of South African Breweries (SAB). The company has realised the importance of these
elements in the purchasing and supply strategy. In 2007 SAB launched a new strategy
named the ive-year R5-billion capital-project strategy to address these needs. To make
this strategy successful SAB has to manage their relationships with the suppliers, have
the right quantities of products available and also have the right systems and processes
in place.

In this study unit, we put the purchasing and supply function in perspective, explain its
443

importance and discuss the management tasks and tools.

115 MNB1601/1
10.1 PURCHASING AND SUPPLY IN PERSPECTIVE

Study section 14.1 in the prescribed book.

This section in the prescribed book introduces you to the purchasing and supply concept
444

by discussing the following:

• purchasing and supply in perspective

• a deinition of the purchasing and supply function
• the purpose of the purchasing and supply function
• a deinition of purchasing and supply management

The author points out quite correctly that purchasing and supply as a function does not
445

always receive suicient attention from management – and yet it plays a major part in
most organisations. Note that there are three types of purchases:

• Items (equipment, stationery, cleaning materials, etc) necessary to facilitate the opera-
tions in the business. All businesses make such purchases.
• Raw materials for the production of goods (such as Consol’s acquisition of sand for the
production of glass bottles or jars). This applies mainly to manufacturers.
• Finished products for the purpose of reselling them. This applies mainly to retailers
(such as Pick n Pay, Game or Edgars).

Note that although most of the examples refer to the purchasing of goods, this function
446

is also responsible for the purchasing of services. For example, a business might purchase
a cleaning service, rather than employ cleaning staf to do the job or employ garden
services rather than maintaining their grounds themselves.

Activity 10.1

Read section 14.1 in the prescribed book once more and then summarise the activities
involved in the purchasing and supply function. This will help you get a good overview
of what the work entails.

The purchasing and supply function includes the following activities:

• choosing the right supplier(s)

• determining the quality, quantity, and price
• placing the orders and arranging for delivery
• expediting delivery and arranging to receive the goods
• storing the purchased products
Can you add more activities to the list? We suggest that you revisit your answer to this activity
once you have mastered the material covered in topic 5.

116
10.2 THE IMPORTANCE OF THE PURCHASING AND SUPPLY
FUNCTION FOR THE BUSINESS

Study section 14.2 in the prescribed book.

Four speciic points highlight the role of the purchasing and supply function. The irst
447

is that in many businesses, particularly retail organisations, purchasing makes up a very

high percentage of costs. In such businesses, a saving in purchasing costs has a major
impact on the business’s entire cost structure. The second point is the high cost of holding
inventory. Goods kept in storage (whether raw materials or inished products) represent
“money lying idle”. For example, if a business’s inventory was valued at R2 million (and
the current interest rate is 10%), it is actually costing the business R200 000 per annum
to keep that inventory. If that inventory could be reduced to R1 million, it would mean a
saving of R100 000 per year.

These two factors contribute to the third point: the proit leverage efect. The more a
448

business spends on purchasing, the higher the proit leverage will be. Section 14.2.3 il-
lustrates that the business would have to sell 20% more products to create the same extra
proit that a saving of 4% in purchasing would bring about. Remember that if purchasing
costs are only a small proportion of the total costs, the impact of a saving in purchasing
costs on the business’s proit would not be all that great.

The last point applies particularly to retailers. If the purchasing and supply function is not
449

carried out well, this will have a major impact on marketing the products. What would
happen if the purchasing and supply manager of a fashion store like Foschini or Truworths
purchased clothes that didn’t appeal to the consumer? Not only would sales drop, but
the business would also be stuck with a lot of stock that they can’t sell, or else they will
have to ofer it at considerably reduced prices, thereby lowering their proit margins.

10.3 THE MANAGEMENT TASK OF THE PURCHASING AND

SUPPLY MANAGER

Study section 14.3 in the prescribed book.

In describing the management task of the purchasing and supply manager, the author
450

touches on only three of the tasks: planning, organising and control. The management
task of leadership is not dealt with – perhaps because the task of leading people does
not difer from function to function.

10.3.1 Purchasing and supply planning

451 Three levels of planning are discussed.

117 MNB1601/1
 Activity 10.2

Identify the three components of strategic planning in the purchasing and supply function.

The three components are:

• securing the provision of materials

• developing sources of supply
• maintaining a competitive position
• This is a long-term approach to ensure that the business will always be assured of suf-
icient materials, equipment, and so on, in the future.

Planning at the tactical level involves factors such as budgeting, designing the purchas-
452

ing system (ie methods, procedures, etc), negotiating purchasing contracts and inding
ways to cut costs.

At the operational level, planning involves the day-to-day running of the purchasing
453

and supply department, such as allocating tasks, setting priorities, expediting orders
and getting quotes.

10.3.2 Organising in the purchasing and supply function

Certain important topics about the organisation of the purchasing and supply function
454

are discussed in section 14.3.2 of the prescribed book. The irst topic concerns the place of
the purchasing and supply division in the organisation structure. Two sub-topics are dealt
with: centralisation or decentralisation, and the hierarchical level of the purchasing and
supply function. The second topic concerns the internal organisation of the purchasing
and supply function. The third topic concerns purchasing coordination, while the fourth
topic concerns cross-functional teams. These matters are explained below.

It is important that you understand the advantages of a centralised structure and of a

455

decentralised structure. A centralised structure has the advantage of standardisation, it

can make the most of the business’s concentrated purchasing power and it allows staf
in the purchasing and supply function to develop into specialists.

The advantage of a decentralised structure is that the purchasing and supply department
456

can meet the unique requirements of users. For example, if all the purchasing for a chain
of furniture retail stores is done from head oice (ie centralised purchasing) it means
each store in the chain would sell the same products. However, the requirements and
tastes of customers in Stellenbosch in the Western Cape are likely to be very diferent
from customers in Secunda in Mpumalanga. A decentralised structure means each store
manager can purchase the products he or she believes will best meet the needs of the
store’s particular customers.

Another advantage (which is closely linked to the irst one) is that the buyers are in much
457

closer contact with customers (whether they are retail customers as in the above example,
or production departments in the same factory). This leads to the third advantage of a
decentralised structure: that buyers can react more quickly to their customers’ needs.

118
For example, Eskom’s purchasing oices are decentralised – so a supplier needs to ap-
458

proach more than one oice because Eskom’s buying is not done by one department
in one place. In fact, Eskom has a number of buying oices in a number of main centres.
Eskom’s computer systems registering suppliers are also decentralised and each Eskom
group has its own system. A company needs to register as a supplier with each Eskom
group to whom it wishes to sell.15 The Game purchasing team, on the other hand, is cen-
tralised in the Durban Mass Discounters’ Corporate Oice. A merchandise director man-
ages seven merchandise executives who control the selection of ranges and purchasing
for 92 departments across seven major divisional categories.16

The second sub-topic is the hierarchical level of the purchasing and supply function.
459

Note that not all purchasing and supply managers will be positioned at senior manage-
ment level. The author lists factors that will determine at what level in the organisational
hierarchy the purchasing and supply function will be placed.

The third sub-topic is briely mentioned: the integration of the purchasing and materi-
460

als low activities, with a sample diagram to illustrate the corresponding organisational
structure. When it comes to the internal organisation of the purchasing and supply
function, the author mentions two possibilities (besides the one where everybody does
everything). The irst possibility is to structure the purchasing and supply department
per product. The second possibility is to structure it per activity. There is also a third
possibility: to structure the department per supplier. Here, each buyer in the purchasing
and supply department is responsible for all the purchases from a speciic supplier (or
suppliers), while another buyer is responsible for all the purchases from another group
of suppliers. Each structure has its advantages and disadvantages, and although they are
not all listed in the prescribed book, you should be able to igure them out for yourself.

The third topic under the subheading “Organising” is purchasing and supply coordina-
461

tion. This coordination is important in three areas:

• coordination within the purchasing and supply department

• coordination with suppliers
• coordination with user departments

The fourth topic deals with cross-functional teams. Here, the purchaser cooperates in a
462

team with colleagues in other functional areas to perform tasks such as supplier selec-
tion, negotiation of prices and conditions, determination of supply levels and evaluation
of suppliers’ performance. Such collaboration may initially encounter resistance, as it has
at many companies. But the proven principles of teaming up with users invariably create
the conditions for success.

At Legrand North America (LNA), a leading manufacturer of electrical supplies, users

463

from major functional areas worked with buyers on cross-company category teams. For
example, the head of human resources of this $700 million business joined the efort to
tackle health insurance expenditure, the marketing director helped tackle advertising
and printing, and the engineering executives collaborated on important make-or-buy
and global sourcing opportunities.

119 MNB1601/1
One of the world leaders in the implementation of cross-functional teams is IBM. The
464

late Gene Richter, IBM’s irst chief purchasing oicer, set the tone which John Paterson,
the current chief, maintains by focusing on shared processes and linked objectives. IBM
global purchasing owns the sourcing function across all business units and also manages
the daily execution of purchase orders. This mission is supported by a set of common
processes, ranging from sourcing to fulilment activities, which allows IBM to achieve
scale economies in its spending while ofering enough lexibility to take advantage of
changing market conditions.

Other groups within IBM heavily inluence purchasing’s objectives, in part because these
465

groups and purchasing staf share cost reduction and quality goals in their business objec-
tives. Global commodity councils, convening technical specialists and buyers from myriad
IBM divisions set and execute sourcing strategy. Production inputs have been sourced in
this manner for many years, and over the past decade IBM has used this approach on the
rapidly growing expenditures for many services it procures, both to support manufactur-
ing activities and to supply human capital for the IBM global services unit.

At the senior management level, successful sourcing programmes typically include a

466

steering committee composed of the major business unit heads and chaired by the CEO
or COO. The CEO must ensure that the unit heads participate actively in the analytical
work, push their people to work on cross-functional spending teams, make decisions as a
group, and are ready to move ahead and put those decisions into practice. The buyer-user
relationship is at the heart of the cross-functional approach, ensuring that requirements
are well understood, that speciications are not overly constraining, that lifecycle costs
are considered, and that both the realities and opportunities of the potential supply base
are considered. Staf from other functions may need to be engaged around this duo as
well. Real engagement by these team members depends on visible involvement by their
bosses – hence the CEO’s critical role on the steering committee.17

10.3.3 Control in the purchasing and supply function

In the discussion of control of the purchasing and supply function, two matters are as-
467

sessed: purchasing and supply management and purchasing and supply activities. In the
evaluation of purchasing and supply management the author lists a number of questions
that have to be asked (evaluated). Make sure you can identify what has to be evaluated
when it comes to exercising control over purchasing and supply activities.

It is a poor relection on the state of management in South African companies that very
468

few purchasing and supply functions are ever evaluated in accordance with these norms.

SUMMARY
You now have basic insight into the purchasing or sourcing function within the broader
469

context of supply management, including the management task of the purchasing and
supply manager and the importance of the purchasing and supply function.

120
Diferent perspectives related to purchasing, sourcing and supply chain management
470

underscore the need for a deeper and broader understanding of these concepts – par-
ticularly among those not directly working within the purchasing, sourcing and supply
space. Employees and organisations who ignore this need will be left wondering why they
failed to meet their expectations of purchasing, sourcing and supply management. The
reason is that eventually, if purchasing, sourcing and supply management fails to provide
the advantages promised by its proponents, it will end up on the scrap heap with all the
other business fads that promised so much but delivered so little. In the next study unit
we’ll be looking at the most common purchasing or sourcing activities performed by
most organisations.

SELF-ASSESSMENT QUESTIONS
10

(1) Four main issues are involved in the organisation of a purchasing and supply depart-
ment. Which of the following statements on the issue of cross-functional sourcing
teams are correct?
(a) The purchaser heads the team in value analysis and new product development.
(b) The aim is to reach decisions on performance in an individual ield of management.
(c) Individual ields of management may well have conlicting aims.
(d) Suppliers may be included in a cross-functional team for certain tasks.
(e) Personnel of irms in the supply chain may also be included in a purchasing team.
(1) ab
(2) de
(3) abc
(4) cde
(5) abce
(2) Which of the following are elements of purchasing and materials management?
(a) production
(b) organisation
(c) technology
(d) planning
(e) control
(1) abcde
(2) ace
(3) bde
(4) bd
(5) ae
(3) Which of the following are criteria for gauging the efectiveness of the execution of
the purchasing and supply activities?
(a) price proiciency
(b) supplier satisfaction
(c) timeliness
(d) cost saving
(e) purchasing costs
(1) ab
(2) bcd
(3) acde
(4) abcde

121 MNB1601/1
Question 1

The correct answer is option 4 (c d e).

Cross-functional teams play an important part in organising a purchasing and supply depart-
ment. Alternative a is incorrect: a design engineer would assume leadership in all the value
analysis and new product development matters concerning purchasing and supply, because
a purchaser does not have the correct technical knowledge to execute these tasks. Alternative
b is also incorrect because the aim of cross-functional teams is to reach decisions that will be
best for the business and customers, and not necessarily to reach decisions on performance
in an individual ield of management. Alternatives c, d and e are correct.

If your answer was wrong, please refer to section 14.3.2.4 in the prescribed book.

Question 2

The correct answer is option 3 (b d e).

The elements of the management task of purchasing and supply discussed in section 14.3.1/2/3
include organisation (alternative b), planning (alternative d) and control (alternative e). Alter-
native a – production – is regarded as a separate function of the organisation, and is therefore
incorrect. Technology (alternative c) is an enabler for the efective execution of purchasing and
supply management, but is not regarded as one of the elements of the management task of
purchasing and supply management, and is therefore also incorrect.

If your answer was wrong, please refer to section 14.3.1/2/3 in the prescribed book.

Question 3

The correct answer is option 3 (a c d e).

The criteria applied for gauging the efectiveness of the execution of the purchasing and sup-
ply activities include price proiciency (alternative a), timeliness (alternative c), cost saving
(alternative d) and purchasing cost (alternative e). Supplier satisfaction (alternative b) is very
important to maintaining an optimal relationship between the buying organisation and the
supplier and to ensuring continuous improvement in their performance, but cannot be used
to measure the efectiveness of purchasing and supply activities within an organisation.

If your answer was wrong, please refer to section 14.3.3.2 in the prescribed book.

122
Study unit 11
Sourcing activities

Contents

Key concepts
Learning outcomes
Getting an overview
11.1 The purchasing and supply process
11.2 Quality decisions as a purchasing and supply activity
11.3 Deciding on purchasing and supply quantities
11.4 The selection and management of suppliers
11.5 Pricing decisions
11.6 Timing of purchases
Summary
Self-assessment questions

Key concepts

sourcing activities pricing decisions

purchasing and supply activities price determination
purchasing and supply process price comparison
quality decisions timing of purchases
purchasing and supply quantities scheduling of purchases
inventory holding market structures
inventory costs purchasing and supply policies
inventory control systems long-term supplier relationships
selection and management of suppliers
supplier performance
developing suppliers

Learning outcomes

When you have worked through study unit 11 you should be able to:
• demonstrate an understanding of the purchasing and supply function by highlighting
the steps in the purchasing and supply process
• analyse quality decisions as a purchasing and supply activity by summarising the con-
siderations on which the quality of products and services rests
• describe the determination of purchasing and supply quantities by highlighting inven-
tory holding, costs and control systems
• demonstrate an understanding of the selection and management of suppliers by sum-
marising the most important components of the selection, evaluation and development
of suppliers

123 MNB1601/1
 • analyse price determination by identifying the methods used to determine the best price
• put the right time for purchasing in perspective by highlighting the aims, influencing
factors, market structures and policies

Getting an overview
471 Study section 14.4 in the prescribed book.

This study unit deals with the purchasing and supply process. A number of activities are
472

associated with this process:

• determining quality
• determining quantity
• choosing and managing a supplier or suppliers (including the outsourcing decision)
• making pricing decisions
• timing purchases
• doing purchasing and supply research
• negotiating in purchasing and supply management
Note that the steps and activities in the purchasing and supply cycle may difer from
473

business to business and from purchase to purchase.

11.1 THE PURCHASING AND SUPPLY PROCESS

Study section 14.4.1 in the prescribed book.

The purchasing and supply process can be regarded as a “check list” or as steps in execut-
474

ing a logical and systematic purchasing transaction. Learners working in a purchasing

and supply division may not even be aware of performing some of these steps during a
transaction; yet developing such a check list can be a tremendous help towards prevent-
ing unsatisfactory purchasing transactions.

The nine steps in the purchasing and supply process have been clearly set out in the
475

prescribed book. Note that not all the steps are carried out with each purchase. The
prescribed book points out that some of the steps can be omitted or executed simulta-
neously in certain purchasing situations. For example, if a standardised product needs
to be re-ordered from an existing supplier, it will not be necessary to choose a supplier
and determine the price. If the supplier delivers the goods soon after the order has been
placed, there will be no need to expedite the order. What is important is that each of the
steps should be performed somewhere along the line.

Read the extract below to familiarise yourself with the purchasing and supply procedure
476

utilised by Transnet. Note the diferent approach they take to the purchasing and supply
procedure by making use of tenders and tender boards.20

124
477 Transnet’s procurement policy at a glance

Introduction: Prospective tenderers for the supply of goods and services often want
478

to know more about Transnet Limited and what they can expect when dealing with the
company. All transactions relating to the procurement of goods and services and the
sale of surplus goods are being dealt with in terms of Transnet’s Procurement Policy
Framework and Procedures, which is aimed at assisting it to operate as a responsible
and competitive enterprise.
Transnet vision: “Africa’s undisputed world champion in transport and logistics
479

solutions.”
480 Composition of the company

Transnet operates and controls South Africa’s major transport infrastructure and is
481

accordingly managed to support the initiatives of Government in its eforts to build a

strong economy over and above the creation of economic value. Efective corporate
governance ensures optimum transparency and accountability.

Transnet is a public company involved in all aspects of transport and harbour opera-
482

tions as well as related services. The Company’s services in these ields are enhanced
and complemented by rendering logistical services and supply chain management.
Furthermore, the Company endeavours to optimise the utilisation of its property
portfolio and productively employs assets identiied as surplus to its normal business
requirements.
483 Main businesses of the Company are as follows:
• Spoornet – Rail Transport
• Portnet – Harbour Management and Operations
• South African Airways (Pty) Ltd – Air Transport
• Metrorail – Subsidised Suburban Rail Transport
• Petronet – High Pressure Pipeline Transport
• Freightdynamics – Road Transport and Parcel Distribution Services
484 Related businesses are:
• Transtel – Telecommunications
• Arivia.Kom – Computer support
• Transwerk – Heavy engineering
• Protekon – Design, project management and construction management service
• Propnet – Property management and development
Business units focusing on employee wellbeing are:
• Transnet Housing
• Pension Fund Administration
• Transmed Administration
• Esselen Park Centre of Excellence

125 MNB1601/1
486 Commercial policy

When Transnet purchases or sells goods and obtains services, it strives to obtain
487

optimum value for money, whilst ensuring that open and fair competition prevails,
bearing in mind the following important factors:

Transnet’s own divisions and business/service units are given the right of irst refusal.
488

Only if they cannot deliver the goods or services, or their prices are not market related,
may such goods or services be sourced externally.

The promotion, development and support of businesses from the previously disad-
489

vantaged communities.

The promotion of national and regional local suppliers before considering overseas
490

suppliers in terms of extant Government policy.

Moral values and an ethical code that underpin the above, based on sound business
491

practices. This value system governs all commercial behaviour within Transnet.

Transnet views its relationship with local contractors who provide substantial sup-
492

port as mutually beneicial commitments whereby all parties integrate their talents,
resources and actions in order to provide stipulated requirements, whilst continuously
striving to improve its service. Transnet’s viability in a deregulated transport market
cannot succeed without a reliable supply chain of the right goods and services with
the right quality, at the right time and place at the right price. Transnet looks forward
to creating and maintaining a good, sound business relationship with the tendering
public.

493 Standards

494 Transnet subscribes to the following standards of commercial practice:

All our transactions are to be conducted in an eicient and professional manner in

495

support of Transnet’s interests.

We insist on unimpeachable honesty and integrity at all times and will not tolerate
496

any form or manifestation of improper inluencing, bribery, or any other unethical

conduct.

All tenders or quotations are required to be handled in the strictest conidence. No

497

information regarding prices of goods or services will be divulged to competitors or

unauthorised personnel of Transnet.

Any conditions of contract are to be clearly and unambiguously stated in writing at

498

the time tenders are invited to ensure that all tenderers tender on the same basis.

Contractual commitments with Transnet are to be respected and met in accordance

499

with good business practice.

126
Employees who may possibly have a personal interest in a speciic tender, quotation
501

or ofer, or who are in any way connected or related to a tenderer or his direct rela-
tives, shall recuse themselves from the receipt, adjudication or acceptance thereof.

All transactions are subject to periodic review by our auditors and where applicable
502

by our Tender Board.

503 Gifts and entertainment

Employees are not permitted to accept gifts or buy goods or services at artiicially low
504

prices, which are not available to the public, or accept personal favours and hospital-
ity which might, or might be deemed by others, to impinge upon the employee’s
sound business judgement.

For the purpose of fostering interpersonal business relations, exceptions of the fol-
505

lowing nature are allowed:

• advertising material of small intrinsic value,

• incidental business hospitality which the employee is prepared to reciprocate,
• complementary tickets to sports meetings and other public events but excluding
the cost of transport and accommodation which the employee must bear. Invita-
tions to oicial functions should be addressed to the Manager of the commer-
cial component who may delegate a representative.

506 Procedures

The tendering system is Transnet’s main buying and selling mechanism as it ensures
507

open and fair competition for any person or enterprise who wishes to tender for
Transnet’s business.

Tender responses for the procurement of goods and services are obtained by adver-
508

tising tenders in newspapers, electronic and other private tender bulletins to which
tenderers subscribe.

There are, however, instances where the calling of open tenders is just not possible
509

or practicable (for example, low value transactions, or crisis situations where human
lives are at stake or where Transnet’s property or assets are at risk) and where there is
not suicient time to call for open tenders. All these exceptions from the open tender
system are governed by internal policies and procedures to prevent abuse.

Tenders or quotations which arrive after the speciied closing time or which are de-
510

posited at an incorrect address will be regarded as late/inadmissible tenders and will

not be considered.

No communication is permitted between a Transnet employee and a tenderer or vice

511

versa during the period between the closing date of a tender and the oicial notiica-
tion of the successful tenderer of the acceptance of his ofer. Should a tenderer wish
to communicate anything to Transnet during this period, he may only communicate
with the Chairman of the Divisional Tender Board/Committee, or in his absence,

127 MNB1601/1
with the Secretary of the Board/Committee. An employee of Transnet may, with due
513

authorisation, communicate with a tenderer regarding his tender or quotation for

limited purposes to facilitate evaluation of his tender.

Changes in speciications, plans, or tender conditions are permitted provided all

514

tenderers or prospective tenderers are duly advised thereof and are given the op-
portunity to tender or retender by a revised closing date and time.

Evaluation criteria include price, conformance with speciications, experience, equip-

515

ment, inancial standing and previous performance based on timeliness, quality and
service bearing in mind Transnet’s policy for the development and support of the
previously disadvantaged.

Only persons with delegated powers have the authority to enter into contracts on
516

behalf of Transnet.

A request to tender or quote implies a serious intention on the part of Transnet to do

517

business, and only under exceptional circumstances will it withdraw a tender/enquiry.

Role of Transnet group tendering and policy function and divisional tender
518

boards

The Transnet Tendering and Policy Function is responsible for the receipt and opening
519

of all the major (high value) tenders and quotations. Such tenders and quotations are
issued by the divisions or business units themselves but close at the Transnet Tender-
ing Oice at 10:00 on speciied Tuesdays.

After evaluation of all tenders or quotations by the division or business unit concerned,
520

a recommendation on the award of business is made to the relevant Divisional Tender

Board or Tender Committee. Each of the six main transport divisions listed on page 1
has its own Divisional Tender Board and the business units/related businesses listed
on page 2 are represented by Tender Committees.

The Divisional Tender Boards/Committees monitor and report to the Group Tendering
521

and Policy Function on compliance with all internal policies, rules and instructions
governing the administration of all tenders and contracts.

Prices tendered by tenderers for Transnet’s requirements are treated with the same
522

conidentiality as the tenderers themselves treat their prices, and therefore tendered
prices are not disclosed. The only information Transnet is prepared to make available
is the names of all the tenderers who responded to a particular tender invitation and
the name of the successful tenderer (but not the tender price). Unsuccessful tenderers
are advised in whichever category they were unsuccessful, eg price, quality, delivery
etc upon request.

128
During evaluation of the tenders received, several factors such as price, delivery, qual-
524

ity, BEE involvement, after sales service, etc are taken into account, which means that
Transnet does not necessarily have to accept the lowest priced tender. The Divisional
Tender Boards act as Transnet’s watchdog and ensure that fair competition both in
the eyes of Transnet and the public at large has prevailed and that optimal value for
money is obtained, within Transnet’s Procurement Policy.

Transnet’s policy on black economic empowerment (BEE) or development and

525

support of disadvantaged suppliers and contractors

Transnet decided to support the Government’s Reconstruction and Development

526

Policy by actively promoting the efective and eicient development of suppliers and
contractors from the historically disadvantaged communities. To this end it introduced
a mechanism which will allow the targeted groups to enter the mainstream economy,
without preventing those who fall outside such target groups from tendering or from
ultimately winning the business.

The following are a few basic principles on which Transnet’s BEE Policy is based:
527

• BEE should help all participants to become self-suicient and contribute towards
the economy of the country.
• The identiication and development of black entrepreneurial potential is necessary
to advance BEE. BEE should be aimed at the upliftment and development of black
entrepreneurs who have the potential and skills to become self-suicient and who
would in time be able to compete on an equal basis with established businesses.
• Quality workmanship, service levels and timely delivery are prerequisites for an
efective BEE Policy.
• BEE is aimed at the development of independent entrepreneurs and not merely
the creation of jobs.
• The use of black persons as fronts for established businesses which have been
advantaged by the previous dispensation, is not acceptable. Transnet reserves
the right to investigate such irms to establish the real owners as well as the ex-
tent of black participation, taking into account shareholding, ownership, day to
day management, etc. Businesses which act merely as agents, representatives, or
intermediaries and which do not add value or which are merely used as marketing
• channels for established business advantaged by the previous dispensation, do
not qualify for consideration within the BEE Policy. Firms claiming to qualify on
false pretences will be restricted from further business with Transnet.
• The BEE Policy will eventually be phased out. Socio-economic considerations and
market forces will determine the duration thereof.

129 MNB1601/1
11.2 QUALITY DECISIONS AS A PURCHASING AND SUPPLY
ACTIVITY

Study section 14.4.2 in the prescribed book.

Note that quality does not necessarily mean the highest possible quality to a purchaser. If,
529

for example, a manufacturer produces relatively cheap clothes for lower income groups,
the quality of the material will probably not be the best obtainable, but it must be the
best for the price that the manufacturer is willing to pay for the raw material. Quality is
therefore not evaluated in absolute terms but in relative terms: that is, how suitable it is
for the use to which it will be put.

Activity 11.1

Analyse the purchasing and supply manager’s task in the determination of quality.

Purchasing and supply managers must:

• ensure that they understand the precise quality requirements of the user (usually the
production department)
• draw up a comprehensive quality description (with the help of the user department) to
avoid any misunderstandings between the business and the supplier as to what quality
standards are
• exercise quality control to ensure that the delivered materials meet the required quality
standards
• be on the lookout for ways and means to improve quality, either through encouraging
the supplier to improve the quality, or by investigating the use of other materials, or other
suppliers
530 Quality is often associated with standardising certain speciications. In various countries,
national standards had already reached a settled state at the beginning of the 20th century,
with bodies like the British Engineering Standards Association and the American Stan-
dards Association. Currently, there are national standards bodies in all the industrialised
countries of the world, including the South African Bureau of Standards (SABS) in South
Africa. Products carrying the SABS mark include building materials, electrical equipment,
wooden products, textiles, paints, rubber products, metals and alloys. The SABS mark
serves as a “guarantee” that the product satisies a certain standard speciication and that
an accepted quality system is maintained for that purpose. For example material, quality,
composition, design, safety, durability and performance are conirmed by such a mark.21

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11.3 DECIDING ON PURCHASING AND SUPPLY QUANTITIES

Study section 14.4.3 in the prescribed book.

One of the earliest problems investigated by businesses was how to ensure that the
531

correct quantities of materials were purchased. The computerisation of inventories has

resulted in a far better understanding of inventory management and has contributed to
the solution of inventory problems.

Note that inventory control is (or should be) the responsibility of the purchasing and sup-
532

ply department since it determines to a large extent what the inlow of raw materials will
be. It is also important to understand that inventory control is concerned not so much
with keeping the inventory levels at a minimum as with keeping the inventory costs to
a minimum. This requires preserving a delicate balance between the two components
of inventory costs:

• costs of storing a large inventory with subsequent low ordering costs

• costs of frequent ordering with subsequent low storage costs

Figure 14.7 shows how the optimum balance between these two components can be
533

achieved.

11.4 THE SELECTION AND MANAGEMENT OF SUPPLIERS

Study section 14.4.4 in the prescribed book.

Game is regarded as one of South Africa’s largest retailers. They believe that their suppli-
534

ers are partners in their business, with whom they will develop long-term relationships
founded on trust and to both parties’ mutual beneit. Business activities between Game
and their suppliers are conducted with integrity, sincerity and fair-mindedness, which
they know encourages open communication at all levels. They believe in being open with
their suppliers, dealing with them in a highly professional, knowledgeable and decisive
manner, and sharing Game’s business needs with them, while being sensitive to theirs.
Formal trading agreements and sales targets are negotiated annually, which encourages
growth and the resultant improvement in mutual proitability.22

As we see from the above example, suppliers hold the key to successful purchasing and
535

supply management and, as a result, extreme care should be exercised in selecting, de-
veloping and motivating suppliers. However, selecting the right supplier is not enough.

The purchasing and supply manager needs to take action to develop and improve relations
536

with suppliers. When manufacturer and supplier begin to see one another as “business
partners”, they will be more willing to help one another in times of crisis, to their mutual
beneit. Most of the motor manufacturers, for example, have full-time personnel whose

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sole task is to liaise with the company’s suppliers, assess their performance and motivate
them to improve their service to the business.

One of the reasons for developing suppliers is that a particular product or service is not
537

available. Here the manufacturing company can help a supplier set up a manufacturing
facility to produce the needed products. This approach, however, has the disadvantage
that it gives the supplier a monopoly, so it may not be as competitive.

Many products in South Africa are supplied by only one or a limited number of busi-
538

nesses. A policy of constantly seeking to improve the service of suppliers could promote
healthy competition in the market. In the 1980s sanctions on exports to South Africa
also compelled businesses, previously dependent on foreign suppliers, to resort to the
development of local South African suppliers. Since 1994 a strong need has arisen for
the development of suppliers who have previously not had the opportunity to compete
in the market. Such airmative action steps have provided an added dimension to the
whole question of evaluating suppliers.

Standard Bank is committed to actively assisting broad-based black economic empower-

539

ment (BEE) initiatives in the South African economy. The group’s supplier transformation
programme will contribute to the creation of a more equitable society, while aligning the
group with South African business imperatives. Standard Bank will support these entities
by purchasing goods and services from them where appropriate, as well as encouraging
its own suppliers to work with BEE suppliers in respect of the goods and services provided
to the group. The group promotes the principles of openness, integrity and fairness in
its drive to implement best procurement practices. The group’s supplier transformation
policy, the small and medium enterprises (SME) procurement policy and the preferential
procurement policy, together with the requirements of the charter, will govern the sup-
plier transformation process across the group. The group is also an active participant in
the interbank charter working group which is formulating guidelines that will govern
procurement processes in line with the charter requirements.23

11.5 PRICING DECISIONS

Study section 14.4.5 in the prescribed book.

What is the “best” price? It is not necessarily the lowest price, because factors like quality
540

and service also play a signiicant role. The key to determining the best price is value.
Motorcars are sometimes described by motoring editors as having “the best value for
money”, implying that there might be cheaper cars on the market, but that the price
asked for the particular model they are referring to gives the best value in terms of qual-
ity, eiciency, performance, and so on.

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 Activity 11.2

Identify the three basic methods of price determination.

• The Published price lists. This method is most suitable for the purchasing of standard
materials of a low monetary value, for example screws and stationery.
• Quotations (written or verbal). In this case suppliers are asked to make an ofer. This
method is suitable for standard materials and non-standard or custom-made materials
with a high monetary value.
• Tenders (open or closed). Here suppliers are also asked to make an ofer. Tenders are
suitable for the purchase of custom-made materials with a high monetary value when
there is plenty of time and many suppliers who are competing in the market. Refer back
to Transnet’s procurement policy included earlier in the study unit.

Note that the words “price list” do not necessarily mean a piece of paper with the prices written
down. They mean that the supplier is asking a ixed price for the article that is not subject to
negotiation. Price tags on articles in a retail store represent a “price list”.

Negotiation is not a price determination method on its own, but rather a follow-up on one of
the above three methods. In other words, a supplier may publish a price and the purchaser
may then negotiate for a lower price. The purchaser can respond in the same way to a quota-
tion or a tender.

11.6 TIMING OF PURCHASES

Study section 14.4.6 in the prescribed book.

The decision about when to buy can never be taken in isolation. It is very much inluenced
541

by price and quantity. The best time to buy is when prices are low. However, low prices
are often linked to large quantities, which may lead to increased inventory costs. In other
words, although these three factors are discussed separately, the purchaser takes all three
into account simultaneously.

Activity 11.3

Describe the factors that inluence the time at which purchases should be made.

The factors that inluence the timing are:

(1) Internal factors

• Business policy
Ū For example, to forbid any speculative purchasing.
• Availability of funds
Ū If limited funds are available, the purchaser cannot always purchase at the best time.
• The needs of the production or marketing departments
Ū If these departments need the products, they have to be purchased whether the time
is right or not.
• The availability of storage space

133 MNB1601/1
 Ū It may be diicult to buy a large volume at low prices if there is no place to store the
goods.
(2) External factors:
• Market conditions. In times of recession, prices are likely to be considerably lower.
• The lead time and reliability of suppliers. The longer the lead time, or the less reliable a
supplier, the more reason to purchase required goods well in advance.
• Government policy (afecting international trade). If there are government restrictions on
the money that can low out of the country to pay for imports, this will place an obvious
restriction on purchasing from overseas suppliers. In such cases the purchases will have
to be timed to coincide with an adequate supply of foreign capital.
• Market structures. The timing of purchases is far more critical in volatile markets than in
stable markets.

SUMMARY
You now have basic insight into purchasing and supply management as well as sourcing
542

activities such as the purchasing and supply process, determining purchasing quantities,
price and timing of purchases, and purchasing and supply research. Efective irst steps
for purchasing, sourcing and supply management are to set more aggressive goals and
to establish a pact with the CEO of the organisation: “We will deliver against the goals, if
you will support the programme.” The CEO’s support will be needed to grease the wheels
in working with other functions, to approve the allocation of resources and funds, and
to provide oversight and governance of the sourcing programme. We have never seen
a CEO turn down this ofer when it is proposed as a two-way agreement with a commit-
ment to make a major impact on the business. Purchasing, sourcing and supply manage-
ment thus ofers a real chance to boost operating performance and promote dynamic
cultural norms that can raise the proile of the function and make a major diference in
delivering value to shareholders. This study unit concludes the topic on purchasing and
supply management.

SELF-ASSESSMENT QUESTIONS
11

(1) Which of the following documents are used by other departments to convey their
requirements to the purchasing and supply department?
(a) economic order quantity
(b) materials list
(c) order chart
(d) speciication list
(e) requisition
(1) ab
(2) ae
(3) abc
(4) bcd
(5) bcde
(2) Which of the following statements on the basic steps in the purchasing and supply
process are wrong?
(a) The speciication describes not only the kind of material required but also the
quality.

134
 (b) The complexity of the decision on the choice of supplier will depend on whether
the order is a new purchase.
(c) This complexity will also depend on whether the order is a repurchase.
(d) It is the task of the inancial department to authorise payment to the supplier.
(1) abc
(2) bc
(3) ad
(4) d
(3) Which of the following are the main policies which afect the scheduling or timing
of purchases?
(a) scheduling purchases according to needs
(b) advance purchasing
(c) speculative purchasing
(d) minimum purchasing
(1) abcd
(2) bcd
(3) ac
(4) d
Question 1

The correct answer is option 5 (b c d e).

The documents used by other departments to convey their requirements to the purchasing
and supply department include a materials list (alternative b), an order chart (alternative c), a
speciication list (alternative d), and a requisition (alternative e). An economic order quantity
(alternative a) is only calculated once the requirement has already been identiied, and is used
to ascertain what the optimal amount of the product or service is when purchasing occurs.
Alternative a is therefore not correct.

If your answer was wrong, please refer to section 14.4 and igure 14.6 in the prescribed book.

Question 2

The correct answer is option 4.

The speciication describes not only the kind of material required, but also the quality of the
material that needs to be purchased. Alternative a is thus correct. It is true that the complexity
of the decision on the choice of supplier will depend on whether the order is a new purchase
or a repurchase. Alternatives b and c are therefore also correct. It is the task of the purchasing
and supply department to authorise payment to the supplier, but the inancial department
must execute such a task. Alternative d is therefore incorrect.

If your answer was wrong, please refer to section 14.4 in the prescribed book.

Question 3

The correct answer is option 1 (a b c d).

The main policies which afect the scheduling or timing of purchases include the scheduling of
purchases according to needs (alternative a), advance purchasing (alternative b), speculative
purchasing (alternative c) and minimum purchases (alternative d).

If your answer was wrong, please refer to section 14.4.6.2.

135 MNB1601/1
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