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AQA A2 Business Studies

Unit 4
The Business Environment and Managing Change
Course Companion

AQA Business Studies Unit 4 The Business Environment and Managing Change

CONTENTS

CORPORATE AIMS AND OBJECTIVES ........................................................ 3


Understanding Mission, Aims and Objectives............................................................................. 4

BUSINESS AND THE ECONOMIC ENVIRONMENT .........................................13


Introduction to the Macroeconomy .......................................................................................... 14 Interest Rates .............................................................................................................................. 22 Inflation ........................................................................................................................................ 25 Unemployment ........................................................................................................................... 30 Exchange Rates ............................................................................................................................ 38 European Union & Business ....................................................................................................... 46 Globalisation of Markets ............................................................................................................ 49 Emerging Markets ....................................................................................................................... 54

BUSINESSES AND THE POLITICAL AND LEGAL ENVIRONMENT ........................ 57


Business & Government Economic Policy ................................................................................. 58 Business Legislation .................................................................................................................... 67

BUSINESSES AND THE SOCIAL ENVIRONMENT ...........................................73


Business Ethics ............................................................................................................................ 73 Corporate Social Responsibility .................................................................................................. 78

BUSINESSES AND THE TECHNOLOGICAL ENVIRONMENT ............................... 82


Technology .................................................................................................................................. 82

BUSINESSES AND THE COMPETITIVE ENVIRONMENT ...................................87


Competitive Environment - Five Forces .................................................................................... 87 Business & Environmental Issues ............................................................................................... 94

MANAGING CHANGE .........................................................................97


Causes of Change Acquisitions ................................................................................................ 97 Causes of Change Retrenchment .......................................................................................... 103 Change Process Culture ......................................................................................................... 106 Change Process Implementation and Management ........................................................... 110 Change Process Leadership ................................................................................................... 116 Planning for Change Corporate Planning ............................................................................. 121 Planning for Change Managing Risk ..................................................................................... 124 Planning for Change SWOT Analysis ..................................................................................... 127

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AQA Business Studies Unit 4 The Business Environment and Managing Change

Corporate Aims and Objectives

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AQA Business Studies Unit 4 The Business Environment and Managing Change

Understanding Mission, Aims and Objectives


Introduction to business objectives
You will remember business objectives from your studies in BUSS3. They play a key role in business management by providing a measurable statement of what a business wants to achieve, from the top (corporate) level of the firm right down to the detailed functional activities of the business. Objectives can be defined in several ways. Here are some possibilities: The specific intended outcomes of business strategy The anticipated end results of a programme of activities Targets which the business adopts in order to achieve its primary aims

The words targets and objectives are often used in the same way in business studies. Objectives have several roles in a business. They are used to: Implement the mission Provide a clear focus for decision making and a guide to what needs to be achieved Provide a target Motivate employees (assuming the objective is achievable) Facilitate control of actual performance Provide criteria for evaluating performance Reduce uncertainty Provide a sense of unity

Objectives play a key part in successful business. Objectives exist and operate at different levels in a business the classic hierarchy is illustrated below:

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The objectives cascade down from the mission getting progressively more specific and detailed. For example, a corporate objective of achieving company revenue growth of 10% per year would be translated into detailed sales targets for individual business units, product groups and markets. A key advantage of the hierarchy is that it ensures that at each level the objectives are consistent with the objectives above them. Functional objectives should not be inconsistent, or work against, higher level corporate objectives. How are objectives used in business? To: How do objectives fit in with other relevant terms such as mission and aims? The distinction is as follows: Mission Aim Objective A qualitative statement of why the business exists, how it does business etc A long term target from which business objectives are derived A target which must be achieved in order to realise the stated aim A time assigned targets derived from the goals and set in advance of strategy

Corporate objectives and their role in business strategy


Put simply, corporate strategies are essentially about what the business wants to achieve. Business strategy is about how those corporate objectives are to be achieved. Business strategy is concerned with deciding which markets and activities the business should be involved in; where it wants to be; and how it is going to get there. Strategy is about making high-level decisions and forms the management game plan for Satisfying customers (meeting customer needs) Running the business (organising resources in the most efficient and effective way) Beating the competition (strategies and tactics to gain competitive advantage ) Achieving corporate objectives

Corporate (or business) objectives are set at the high level and are quite distinct from any more detailed functional objectives set for the functional areas of a business. Examples of corporate objectives would include targets for: Sales revenue (a traditional measure of the size and strength of a business if revenue is growing then the business is growing) Profit (both the absolute level of profit and the profit margin i.e. return on sales)

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Return on investment (e.g. ROCE, ROI: particularly important for capital-intensive businesses) Growth (sales volume, revenue, profit, earnings per share) Market share (the proportion of markets and industries owned by the business or its products) Cash flow (this can be similar to a profit objective, but with the focus on maximising the net cash inflow of the business) Shareholder value (particularly important for publicly-quoted businesses where senior management are tasked with growing the value of the business) Corporate image & reputation (increasingly important links closely with corporate social responsibility, product and customer service quality, and business ethics)

Many factors will influence the corporate objectives that are set. Precisely which factors depends on the nature of the business and its markets, and the business ownership . Some examples of those factors include: Factors Influencing Corporate Objectives Age of the business Size and legal status Ownership (e.g. privately owned; stock exchange quoted) Views of owners and managers Market conditions Legislation State of the economy Competition Risk and attitude to risk Corporate culture Political factors Social attitudes

Corporate objectives can also be considered the main or primary objectives of a business. The set the agenda for the secondary objectives: Primary Objectives The ultimate, long term goals of the business (3-10 years typically) These are the key strategic objectives such as profit growth or shareholder returns Secondary Objectives Make a direct contribution to meeting primary objectives E.g. sales growth will help business achieve profit target Also known as tactical objectives Usually focused on the short or medium-term (1-3 years)

A similar distinction can also be made between strategic (corporate) and tactical (functional) objectives:

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Strategic Focused on long-term Set by the Board Involve higher risk & uncertainty Likely to involve significant investment / business resources Difficult to change in the short-term

Tactical Focused on short-term Set by line management Relatively low-risk Limited resources invested

Relatively easy to change at minor financial cost Realistic & achievable

Stretching & challenging

Mission statements
Mission statements are they an exercise in public relations or a key part of providing the direction that management and employees need as they go about their business? The debate about the relevance and usefulness of mission statements has raged for many years. A mission statement attempts to put into words what a business or organisation is all about. It attempts to define in a punchy, understandable phrase: The overriding goal of the business The reason for its existence A strategic perspective A vision for the future

Here are some examples:

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What makes an effective mission statement? Here are some characteristics of good ones. A good mission statement: Differentiates the business from its competitors Defines the markets or business in which the firm wants to operate Is relevant to all major stakeholders - not just shareholders and managers Excites, inspires, motivates & guides

Research has found that effective mission statements tend to be:

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Brief in length Flexible they should be able to accommodate change Business specific and distinctive Effective at communicating key values Realistic and achievable Supported by senior management

Unfortunately, many mission statements are ineffective and this has led some commentators to question their role. Common criticisms levied are that mission statements are: Not always supported by actions of the business Often too vague and general Often merely statements of the obvious Often nothing more than a compulsory public relations exercise Sometimes regarded cynically by staff Sometimes not a true reflection of reality

Introduction to Stakeholders
Lets start with a definition of stakeholders, which are: Groups / individuals that are affected by and/or have an interest in the operations and objectives of the business Most businesses have a variety of stakeholder groups which can be broadly categorised as follows:

Stakeholder groups vary both in terms of their interest in the business activities and also their power to influence business decisions . Here is a useful summary:

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Stakeholder Shareholders Banks & other Lenders Directors and managers Employees Suppliers Customers

Main Interests Profit growth, Share price growth, dividends Interest and principal to be repaid, maintain credit rating Salary ,share options, job satisfaction, status Salaries & wages, job security, job satisfaction & motivation Long term contracts, prompt payment, growth of purchasing Reliable quality, value for money, product availability, customer service

Power and influence Election of directors Can enforce loan covenants Can withdraw banking facilities Make decisions, have detailed information Staff turnover, industrial action, service quality Pricing, quality, product availability Revenue / repeat business Word of mouth recommendation

Community Government

Environment, local jobs, local impact Indirect via local planning and opinion leaders Operate legally, tax receipts, jobs Regulation, subsidies, taxation, planning

Stakeholder power is an important factor to consider whenever you are asked to write about the relationship between a business and its stakeholders. In the context of strategy, what is important is the power and influence that a stakeholder has over the business objectives . For stakeholders to have power and influence, their desire to exert influence must be combined with their ability to exert influence on the business. The power a stakeholder can exert will reflect the extent to which: The stakeholder can disrupt the business plans The stakeholder causes uncertainty in the plans The business needs and relies on the stakeholder

The reality is that stakeholders do not have equality in terms of their power and influence. For example: Senior managers have more influence than environmental activists A venture capitalist with 40% of the companys share capital will have a greater influence that a small shareholder Banks have a considerable impact on firms facing cash flow problems but can be ignored by a cash rich firm

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A customer that provides 50% of a business revenues exerts significantly more influence than several smaller customer accounts Businesses that operate from many locations across the country will be less relevant to the local community than a business which is the dominant employer in a town or village Governments exercise relatively little influence on many well-established and competitive business-to-business markets. However their power is much stronger over businesses in markets which are regulated (e.g. water, gas & electricity) or where the public sector has a direct stake (e.g. retail banking) Employees have traditionally sought to increase their power as stakeholders by grouping together in trade unions and exercising that power through industrial action. However, in the last two decades the level of union membership has declined significantly as has the total time lost to industrial action

How should a business handle stakeholders?


How should a business respond to these variations in stakeholder power and influence? The matrix below provides some guidance on the approaches often taken: High level of interest High level of power Key players Take notice of them Communicate regularly with them Low level of interest Keep them satisfied

Low level of power

Can usually be ignored

In handling its stakeholders, a business also has to accept that it will have to make choices. It is rare that win-win solutions can be found for key business decisions. Almost certa inly the business cannot meet the needs of every stakeholder group and most decisions will end up being win-lose: i.e. supporting one stakeholder means another misses out. There are often areas where stakeholder interests are aligned (in agreement) where a decision can benefit more than one stakeholder group. In other cases, there is a clear conflict of interest. Here are some common examples: Where Stakeholder Interests are Aligned Shareholders and employees have a common interest in the success and growth of the business High profits lead not only lead to good Where Stakeholder Interests Conflict Wage rises might be at the expense of lower profits and dividends Managers have an interest in organisational growth but this might be at the expense of

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dividends but also greater investment (retained) in the business Suppliers have an interest in the growth and prosperity of the business Local community, employees and shareholders benefit from business involvement in the community

short term profits Expansion of production activity might cause extra noise and disruption in local community

There are two main approaches to handling the often conflicting needs of stakeholders: Shareholder Approach The traditional approach Business (management) acts in best interest of shareholders / owners Principal aim is to maximise shareholder returns Main focus is on growth & profit Stakeholder Approach Increasingly popular Business takes much more account of wider stakeholder interests Approach based on consultation, agreement, cooperation E.g. social and environmental concerns become more important

Over the years various techniques and organisational models have been developed which help businesses handle their relationships with key stakeholder groups. Some of the most important are summarised below: Approach Workers Councils Description Compulsory for some larger firms in the EU Brings worker representatives from across departments & activities for regular discussion of business issues Outside representatives who hold a non-executive position on the Board Many UK plcs particularly those selling direct to consumers and households, have taken steps to reflect customer interests on the Boards Formal processes of resolving conflicts between employer and employees (e.g. ACAS) Also applies to settling disputes between firms and their suppliers (e.g. negotiating agreement on contractual disputes rather than resorting to legal action) Widened participation of share ownership amongst all employees, helps align interests of shareholders and employees

Stakeholder Directors

Arbitration / Conciliation

Share options & other performancerelated pay

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Business and the Economic Environment

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Introduction to the Macroeconomy


Macroeconomic and economic growth
All businesses operate within a competitive environment. However, the nature of competition varies from industry to industry. All businesses also operate in the economic environment. It is something they can do nothing about but they must understand and respond to changes in economic conditions. A key part of the economic environment is the strength of the macro-economy. Macroeconomics is mainly concerned with: The total level of spending (or demand) in the economy Levels of employment and unemployment The total investment made by businesses and government The general level of prices The rate of interest and exchange rates

The strength of the economy is always changing, although broad movements take time to occur. The level of activity in an economy can be measured in several ways, but the most common way is to look at the value of gross domestic product (shortened to GDP) (the main measure of economic activity) in each period. GDP is commonly used to measure economic growth and is made up of several parts: The formula for is: GDP = C + I + G + (X M) where C (Consumption) I (Investment) G (Government spending) and X M (Net Exports) Economic growth is an increase in the value of goods and services produced by an economy over time. There are two main ways to measure economic growth:

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Actual growth (GDP) The percentage annual increase in a countrys real gross domestic product over a period of time The % annual increase in national output Caused by an increase in aggregate demand

Potential growth (trend growth) The long run expansion of an economys productive potential The increase in the capacity of the economy to produce Caused by an increase in aggregate supply Potential output is that which could be produced if there was full employment of resources

Economic growth is a vitally important measure for several reasons: Economic growth is about an increase in production within the economy It is important because our living standards are influenced by our access to goods and services Without growth, individuals can only enjoy rising living standards at the expense of others in society With economic growth we can all (potentially) be better off

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The Business Cycle


Introduction to the Business Cycle
Economies go through a regular pattern of ups and downs in the value of GDP. This is known as the business cycle (sometimes you also see it referred to as the economic cycle). The business cycle is characterised by four main phases: Boom: high levels of consumer spending, business confidence, profits and investment. Prices and costs also tend to rise faster. Unemployment tends to be low as growth in the economy creates new jobs Recession: falling levels of consumer spending and confidence mean lower profits for businesses which start to cut back on investment. Spare capacity increases + rising unemployment as businesses cut back and reduce stocks Slump / depression: a prolonged period of declining GDP - very weak consumer spending and business investment; many business failures; rapidly rising unemployment; prices may start falling (deflation) Recovery: things start to get better; consumers begin to increase spending; businesses feel a little more confident and start to invest again and build stocks; but it takes time for unemployment to stop growing

The stages of the classic business cycle can be illustrated as follows:

Looking at the data for UK economic growth, you can see the recent elements of the UKs business cycle:

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The Economic Cycle - Growth in UK National Output


Annual percentage change in GDP at constant prices

6 5 4 3 2
Percent

6 5 4 3 2 1 0 -1 -2 -3 -4 -5

1 0 -1 -2 -3 -4 -5 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08

Source: UK Statistics Commission

The timing and shape of the business cycle is affected by many factors, including: Changes in the level of business and consumer confidence Alternating periods of stocking and de-stocking Changes in the value of consumer spending and business investment Changes in government policy which can induce a change in the economy (refer to later notes on monetary and fiscal policy )

Importance of Trend Growth


In the chart above you can see some fairly significant short-term fluctuations in the annual economic growth rate. A key issue for an economy in the longer-term is achieving a sustainable level of growth . Economists often calculate and refer to the trend growth rate to help assess and compare the relative growth rates of different economies. Trend growth refers to the smooth path of long run national output - an estimate of how fast the economy can be expected to grow without creating an unsustainable increase in inflation. The figures for the UK economy are illustrated below:

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UK - Potential GDP and Trend Growth


Source: OECD World Economic Outlook 3.00 2.75 2.50 3.00 2.75 2.50 2.25 Estimated UK Trend Growth Rate 2.00 1.75 1.50 Potential GDP 1.35 1.30 1.25 1.20 1.15 1.10 1.05 1.00 0.95 0.90 0.85 0.80

Percent Real GDP (thousand billions)

2.25 2.00 1.75 1.50 1.35 1.30 1.25 1.20 1.15 1.10 1.05 1.00 0.95 0.90 0.85 0.80

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Source: OECD World Economic Outlook

Is economic growth good news for business? In general yes. There is a long list of upsides for businesses operating in economies that are growing, including: Increased profits A rise in average living standards The creation of new jobs Lower unemployment Increased tax revenues for government - used to fund more spending on government services Improved business confidence Increased capital investment Greater technological innovation

There are, however, some drawbacks for an economy that is growing rapidly: The risk of demand pull inflation if actual growth exceeds potential growth Increased inequality if the benefits of growth are not evenly distributed Increased demand for imports and a trade deficit

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How businesses are affected by the business cycle


Every business is affected by the stage of the business cycle, but some businesses are more vulnerable to changes in the business cycle than others. For example, a business that relies on consumer spending for its revenues will find that demand is closely related to movements in GDP. During a boom, such businesses should enjoy strong demand for their products, assuming that the products are actually what customers want! But during a slump, the business has to ride out the storm suffering a sharp drop in demand. You can see lots of examples of this in the UK economy currently. During the housing-market inspired boom of the early 2000s, many retail and consumer goods businesses took advantage of the boom. Consumers were prepared to take on significant personal debt in order to finance their purchases. However, the sharp economic downturn during 2008 and 2009 saw many businesses suffer sales falls of between 10-30%. Some did not survive their fixed costs were just too high to be able to remain viable. Businesses whose fortunes are closely linked to the rate of economic growth are referred to as cyclical businesses. Examples include: Fashion retailers Electrical goods House-builders Restaurants Advertising Overseas tour operators Construction and other infrastructure firms

By contrast, some businesses actually benefit from an economic downturn. If their products are perceived by customers as representing good value for money, or a cheaper alternative than more expensive products, then consumers are likely to switch. Good examples that were featured in the UK media during the recession of 2008/09 included: Value retailers (e.g. Aldi, Lidl, Netto) Fast-food outlets (e.g. Dominos, Subway) Domestic holidays (e.g. B&Bs and holiday cottages) Chocolate for some reason, chocolate sales always increase strongly during an economic downturn!

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The Credit Crunch of 2008/9

The global economic problems experienced as a result of the financial crises of 2008 and subsequent credit crunch provided a rich source of examples of how businesses had to respond to a sudden deterioration in economic growth. As you can see from the chart below, the credit crunch contributed to a sharp slowdown in GDP:

To understand the business effects of the credit crunch, you first have to remember what the crunch is! The key issues are liquidity and business confidence. A credit crunch is essentially a liquidity crisis. Banks become nervous about lending money to each other and to personal and business customers. Where they are prepared to lend, they

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charge higher rates of interest to cover their risk. The result is a big fall in the supply of credit and an increase in the cost of borrowing. The credit crunch hit consumer-serving businesses badly: The credit crunch made it harder for householders to get loans mortgage loan approvals collapsed contributing to a steep decline in property demand and house prices A large negative wealth and confidence effect from falling property prices and a large fall in consumer spending on new durable products such as cars, furniture and household appliances Because consumption is such a high percentage of aggregate demand, the decline in household spending was a key factor driving the UK into recession during 2009

Business confidence also plummeted during the 2008/9 crisis. Why is that important? Confidence in the future is an important element in business decision-making; especially about investment Firms will only invest if they are confident about future demand for their products (note the important link to revenue and profit assumptions in investment appraisal) But business confidence can be a self fulfilling prophecy An optimistic view of the future leads to investment in equipment and in stock. This rise in aggregate demand brings about a boom Conversely, pessimism about future prospects will lead to low investment with the danger of provoking a downturn in the economy

The key in business studies is to consider the relationship between business and the economic slowdown . How did businesses respond? In many cases, lack of liquidity and reduced business confidence prompted businesses to: Cut back production capacity (e.g. longer factory holidays, reduced shifts, short-time working) Reduce headcount (redundancies are inevitable during a downturn) Postpone investment (despite interest rates falling to a record low) Conserve cash (pay suppliers later; push customers to pay earlier) Intensify sales promotional activity (e.g. discounts, different promotional methods) De-stock (i.e. reduce the quantity and value of inventories held)

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Interest Rates
Credit and why businesses need it
Some small businesses trade in cash and nothing else. Customers pay in cash and the expenses and costs of the business are settled in cash. There is no need for credit. However, most businesses cannot survive simply with the cash they have in the bank. They need to borrow or lend from banks, suppliers and others in order to trade. So in business, credit is about borrowing owing money to others for a period of time. For example, credit arises when: A business makes use of a bank overdraft facility e.g. the bank account goes 50,000 into the red or overdrawn A business takes out a bank loan e.g. 500,000 loaned over five years A business buys goods or services from a supplier and agrees to pay for them in 30 days this is known as trade credit

The amount of credit that a business can raise will depend on several factors such as: Whether the business is profitable and is likely to remain so in the future The ability of the business to generate a positive cash flow to allow it to repay credit The strength of the relationship between the business and its creditors The industry or market in which the business operates

You may have heard about the credit crunch during 2008 and 2009. The credit crunch was about a reduction in the availability of credit for businesses. As lenders struggled to stay in business, they lost confidence in the ability of businesses to repay credit. So many businesses found themselves in financial trouble due to: Banks withdrawing or lowering overdraft facilities Banks refusing to provide bank loans, or making the repayments and interest charges worse Suppliers insisting on earlier payment of invoices Customers taking longer to pay their bills

The effects of the credit crunch notably an increase in failed businesses show just how important credit is to the business community.

Interest rates
An interest rate is the cost of borrowing money or the return for investing money . For example, a bank charges interest on amounts loaned out or on the balance of an overdrawn bank account. A bank will also pay interest to the owner of an account with a positive balance.

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Interest rates vary depending on the type and provider of borrowing. The base interest rate in the UK economy is set by the Bank of England. Each month, the Monetary Policy Committee of the Bank of England meets to decide what the base rate should be. During the credit crunch, the base interest rate has fallen sharply to as low as 0.5%, as shown in the chart below:
Monetary Policy Interest Rates in the UK
Percentage - set by the Bank of England Monetary Policy Committee

8 7 6

5
Percent

4 3 2 1 0 97 98 99 00 01 02 03 04 05 06 07 08 09

Source: Reuters EcoWin

The base interest rate set by the Bank of England affects other interest rates in the economy because it is the rate at which banks can themselves lend from the Bank of England. In theory, a lower base rate will lead to lower interest rates on borrowings paid by businesses but not necessarily. The effect of a change in interest rate will be affected by whether borrowing is at a variable or fixed rate: With a variable rate, the interest charged varies in relation to the base rate. So a fall in the base rate to 0.5% in early 2009 should mean that businesses with variable-rate overdrafts pay lower interest. A fixed interest rate means that the interest cost is calculated at a fixed rate which doesnt change over the period of the credit, whatever happens to the base rate.

How businesses are affected by changes in interest rates


The effect of a change in interest rates will depend on several factors, such as:

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The amount that a business has borrowed and on what terms The cash balances that a business holds Whether the business operates in markets that depend on consumer spending

Lets look at the third factor listed above to examine the implications a little more closely. Consider the example of households and consumers who like to pay for their goods and services using borrowing such as credit cards or a bank overdraft or loan. Also think about households who have substantial balances outstanding on a mortgage used to finance a house purchase. An increase in interest rates will mean that the cost of borrowing rises. In theory, a higher bank base rate will mean that credit card companies such as Visa and MasterCard will also raise the rate they charge borrowers on amounts that are outstanding. A higher interest rate will also mean an increase in the monthly mortgage payments that are made by home-owners who have mortgages which are charged at a variable rate. In both cases, the disposable income of consumers and households will fall. The monthly mortgage payment might rise from say 500 to 550, which means that the household has 50 less disposable income available to spend or save. If consumers and households think that the rise in interest rates is temporary or short-term, they may simply continue to spend as before. In this case, there will be little effect on demand. However, it might also prompt them to cut back on spending, which would result in lower demand. Some businesses operate in markets which are very sensitive to changes in interest rates. These markets often involve goods and services where the purchase is financed by debt and where the price paid is relatively significant compared with the customers income. For example: Housing (mortgages) Motor vehicles Holidays Major purchases of consumer goods e.g. new kitchen equipment, audio-visual systems

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Inflation
Defining and measuring inflation
Inflation is a sustained increase in the average price level of a country. The rate of inflation is measured by the annual percentage change in the level of prices. A sustained fall in the general price level is called deflation in this situation, the rate of inflation becomes negative. In the UK there are two measures of general price inflation, the preferred measure being the Consumer Price Index ( CPI): The government has set the Bank of England a target for inflation (using the CPI) of 2% The aim of this target is to achieve a sustained period of low and stable inflation Low inflation is also known as price stability

The recent history of UK inflation (as measured by the CPI) is shown in the chart below:
Consumer Price Inflation for the UK Economy
Annual percentage change in the Consumer Price Index

9 8 7 6 5 4 3 2 1 0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

9 8 7 6 5 4 3 2 1 0

Percent

Source: UK Statistics Commission

After a long period of low inflation, the UK suffered higher inflation during 2008. However, the recession of 2009 has reduced inflationary pressures and may even lead to a period of deflation. Interest rates are used by the Bank of England as a key weapon to control inflation. The Base Rate fell to a low of 0.5% in 2009 as fears of deflation and prolonged recession grow

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stronger. You can see the relationship between interest rate decisions and the CPI inflation rate in this chart:
Consumer Price Inflation and Interest Rates for the UK
Annual percentage change in the UK Consumer Price Index, the inflation target is 2%

8
Base Interest Rates

5
Percent

3
Consumer Price Inflation

0 97 98 99 00 01 02 03 04 05 06 07 08 09

Source: Reuters EcoWin

Causes of inflation
There are two main causes of inflation: Demand-pull (when there is excess demand), and Cost-push (when costs rise)

Demand-pull inflation This occurs when there is excess aggregate demand in the economy (overall) or in a specific market or industry. Businesses respond to high demand by raising prices to increase their profit margins. Demand-pull inflation is often associated with the boom phase of the business cycle The main causes of demand pull inflation are A weaker exchange rate which increases the price of imports and reduces the foreign price of UK exports A reduction in direct or indirect taxation - consumers have more disposable income causing more demand Rising consumer confidence and an increase in the rate of growth of house prices Faster rates of economic growth in other countries providing a boost to UK exports overseas

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Cost-push inflation This occurs when costs of production or operation are increasing The key causes include: External shocks (e.g. commodity price fluctuations) A depreciation in the exchange rate (weaker pound = more expensive imports) Acceleration in wages

What happens when faced with cost-push inflation? Firms raise prices to protect their profit margins better able to do this when market demand is price inelastic Wages often follow prices A rise in inflation can lead to rising inflationary expectations

Examples of cost-push inflation are shown in the chart below:

Index of UK Import Prices


Index 2003=100, source: Monthly Digest of Economic Statistics
400
400

350

350

300

300

250
Index

250

200

Import Prices for Fuels

200

150

150

Total Import Price Index


100
100

Finished Manufactured Goods


50 01 02 03 04 05 06 07 08
50

Goods, excluding oil, Non-EU Fuels

Finished manufactures: SITC 7 8


Source: Reuters EcoWin

A great example to use of cost-push inflation which affects almost every industry is that of rising oil prices also illustrated below:

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UK Inflation and Crude Oil Prices


Annual percentage change in the Consumer Price Index and monthly average for Brent Crude

140 120
USD/Barrel

140 120 100

100 80 60 40 20 0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 Crude Oil Price

80 60 40 20 0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5

Consumer Price Inflation

Percent

00

01

02

03

04

05

06

07

08

09

Source: UK Statistics Commission and IPE

Costs and consequences of inflation


Inflation has many important costs and consequences for both society and business. These include: Money loses its value and people lose confidence in money as the value of savings is reduced Inflation can get out of control - price increases lead to higher wage demands as people try to maintain their living standards. This is known as a wage-price spiral. Consumers and businesses on fixed incomes lose out because the their real incomes fall - employees in poor bargaining positions also lose out Inflation can favour borrowers at the expense of savers because inflation erodes the real value of existing debts Inflation can disrupt business planning and lead to lower capital investment Inflation is a possible cause of higher unemployment in the long term because of a lack of competitiveness Rising inflation is associated with higher interest rates - this reduces economic growth

Is inflation good or bad news for business?


You might be wondering how on earth inflation can be good news for business. But the truth is it can! For example, with a sensible, low level of general price inflation:

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Industry-wide price rises enable revenues to grow Growing revenues + a constant gross margin = higher gross profits Inflation makes using debt as a source of finance cheaper in real terms

The two key issues to consider in relation to the adverse effects of inflation are: Price elasticity of demand Responding to cost-push inflation

You will recall that price elasticity refers to the responsiveness of demand to changes in price When demand is elastic, a price rise leads to a more than proportionate fall off in quantity demanded When demand is inelastic, a price rise leads to a less than proportionate fall off in quantity demanded

Firms with inelastic price elasticity of demand will be less affected by a rise in inflation Some firms will be able to absorb price increases by becoming more efficient Remember that price inflation will vary from industry to industry be careful about making generalisations! Thinking about the effect of rising costs on a business: with a rise in general inflation: Sales revenue should rise But workers likely to demand higher pay to compensate for consumer price inflation Labour intensive industries more at risk Cost-push inflation will vary from industry to industry Firms that need to buy significant commodity raw materials may find profit margins squeezed if they cannot pass on increased costs to customers

Further study links on inflation


Here are some good web links that help you build your understanding of inflation: BBC Recession Tracker Inflation Chicken in the basket of UK goods used to measure inflation (BBC news, March 2009) First UK deflation for fifty years (BBC news, April 2009) Inflation articles (Guardian) Two figures, two inflation stories (BBC news, March 2009) Understanding inflation a users guide (The Times, June 2009)

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Unemployment

What is unemployment?
Unemployment arises when the supply of those making themselves available for work is greater than the demand for workers. Unemployment is, therefore, the excess supply of labour in the labour market. You will read much about unemployment when looking at business news stories currently. But who are the unemployed and how is the total number of unemployed people calculated? The unemployed are registered as able, available and willing to work at the going wage rate but cannot find a job despite an active search for work. This last point is important for to be classified as unemployed, one must show evidence of being active in the labour market. There are two main measures of the unemployment total in the UK: The Claimant Count measure of unemployment includes people who are eligible to claim the Job Seeker's Allowance. The Claimant Count is a head-count of people claiming unemployment benefit. The Labour Force Survey covers those who are without any kind of job including part time work but who have looked for work in the past month and are able to start work in the next two weeks. The figure also includes those people who have found a job and are waiting to start. Measuring the number of people unemployed at any one time is quite tricky! That is because there is a constant flow of people entering and leaving the labour market, moving between jobs, or changing the nature of their employment. You can see this illustrated below:

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What has happened to unemployment in the UK?


The most recent changes in claimant count and labour force survey measures of UK unemployment are summarised in the chart below:
Unemployment in the UK Economy
Unemployed people aged 16-59 (women) / 64 (men), seasonally adjusted

11 10 9 8
per cent of the labour force

11 10 9 8 7

7 6 5 4 3 2 1 0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 Claimant Count Labour Force Survey

6 5 4 3 2 1 0

Source: Labour Force Statistics

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Looking at the data, you should be able to see: A long period of falling and then low unemployment from 1992 (recession peak) until 2008 A steep increase in unemployment following credit crunch and global slump in 2008/09

Economists and business commentators expect that UK unemployment is likely to increase further during 2010. It is also worth considering the link between economic growth (as measured by growth in GDP) and unemployment. The recent UK data for these two connected economic variables is shown below:

GDP Growth and Jobs for the UK Economy


Total employment (bottom pane) and the annual growth of real GDP (top pane)

4 2
Percent

4 2 0 -2 -4 -6 30.0 29.5 29.0 28.5 28.0 27.5 27.0 26.5 26.0 25.5 25.0

0 -2 -4 -6

30.0 29.5 29.0 28.5 28.0 27.5 27.0 26.5 26.0 25.5 25.0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Growth of Real GDP [ar 12 months] Employment - millions, All aged 16 and over, seasonally adjusted

Person (millions)

Source: Reuters EcoWin

Looking at the chart above: Between 1992 and 2008, almost 4 million extra jobs were created in the UK economy There is a strong link between sustained economic growth (2-4% p.a.) and employment creation The recession of 2008/9 reversed the trend; employment fell by at least 0.5million

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Causes of Unemployment

There are four main causes of unemployment: Seasonal unemployment Seasonal unemployment happens due to regular and predictable seasonal changes in employment / labour demand. Seasonal unemployment affects certain industries more than others. For example it is a common feature of employment in these industries: Catering and leisure Construction Retailing Tourism Agriculture

Frictional unemployment Frictional unemployment is transitional unemployment due to people moving between jobs: For example, redundant workers or people joining the labour market for the first time such as university graduates may take time searching to find the work they want at an acceptable wage or salary. Imperfect information in the labour market may make frictional unemployment worse if the jobless are unaware of the available jobs. Incentives problems can also cause some frictional unemployment as some people looking for a new job may stay out of work if they believe the tax and benefit system will reduce the net increase in income from taking work. When this happens there are disincentives for the unemployed to accept work this is known as the unemployment trap. Structural unemployment Structural unemployment occurs when there is a long run decline in demand in an industry leading to a reduction in employment because of international competition. Globalisation is a

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fact of life and inevitably it leads to changes in the patterns of trade between countries Over time. For example, the UK has probably now lost forever, its cost advantage in manufacturing goods such as motor cars, household goods and audio-visual equipment. Indeed UK manufacturing industry has lost over 500,000 jobs in the last five years alone as production has shifted to lower-cost centres in Eastern Europe and emerging markets in Far East Asia. Many of these workers may suffer from a period of structural unemployment, particularly if they are in regions of above-average unemployment where job opportunities are scarce. You can see the effect of structural unemployment on the UKs manufacturing sector in the chart further below. Structural unemployment exists where there is a mismatch between the skills of the workforce and the requirements of the new job opportunities. Many of the unemployed from manufacturing industry (e.g. in coal, steel and engineering) have found it difficult to find new work without an investment in re-training.

Employment in UK Manufacturing Industry


Millions, seasonally adjusted
7.0
7.0

6.5

6.5

6.0

6.0

Person (millions)

5.5

5.5

5.0

5.0

4.5

4.5

4.0

4.0

3.5

3.5

3.0 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08

3.0

Source: Reuters EcoWin

Cyclical unemployment Cyclical unemployment is due to a lack of demand for goods and services. When there is a recession or a slowdown in economic growth, we see a rising unemployment because of factors such as: Plant closures and other actions to reduce production capacity

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Business failures Redundancies Outsourcing to reduce costs

This is due to a fall in demand leading to a contraction in output across many industries. An important evaluation point to note is that the economy does not have to go into recession for cyclical unemployment to start rising. Many jobs can be lost even in a mild slowdown phase and one reason for this is because of rising productivity.

How businesses are affected by unemployment

Businesses are affected in a variety of ways depending on whether unemployment is high or low. Some business implications of rising / high unemployment: Lower consumer spending = lower demand for income-elastic products Demand for inferior goods (lower price, quality) may increase Greater supply of labour potentially lower wage/salary levels Unemployment creates insecurity in the workforce; potentially a cause of lower morale and de-motivation Danger of lost skills for industries as a whole Business may be impacted by social problems associated with high unemployment (e.g. rising crime) Recruitment (in theory) becomes easier there should be more applicants for each vacancy Lower staff turnover employees less likely to be able to find other jobs, or want to move in an uncertain economic climate

Some business implications of falling / low unemployment: Consumers have more income = higher demand for income elastic goods

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Labour market tightens increased upward pressure on wages / salaries Harder to recruit or expand without offering better worker packages potentially affects ability to increase capacity Greater sense of job security and motivation in the workforce if the business is doing well

The appropriate response to changes in unemployment will depend on several factors, including: The nature / cause of unemployment (e.g. cyclical, structural, seasonal) The labour-intensity of the business The ability of the business to respond (resources, management structure etc)

Some typical responses are as follows: Low Unemployment A chance to expand capacity to take advantage of higher demand Adjust remuneration packages to remain competitive to attract staff Invest in training to meet skills gap and help retain key staff Offer more flexible working options to attract larger labour pool Consider outsourcing to access specialist skills where recruitment is tough High Unemployment Reduced production capacity if demand falls Headcount reductions (redundancy, recruitment freeze) Reduce working capital (particularly inventories) Postpone or cancel investment projects Potentially diversify into new markets

An important evaluation point to remember is that many appropriate businesses actions will take place before a significant change in unemployment becomes apparent. A business that is anticipating structural or cyclical changes in its business will ideally take action before those changes take full effect.

Further study links on unemployment


There are lots of great online resources that can help you consider the implications of unemployment on businesses. Here is a selection: Blue-collar workers bear the brunt of the recession (Guardian, July 2009) BT to shed a further 15,000 jobs (BBC news, May 2009) Corus steel to cut 2,000 UK jobs (BBC news, June 2009)

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Job losses hit the under 25s (BBC news, July 2009) Microsoft slashes 5,000 jobs as recession bites (The Times, January 2009) Nearly half of UK jobless are under 25 (BBC news, June 2009) School-leavers suffer as UK unemployment rises to highest since 1971 (The Times, July 2009) Shadow of youth unemployment returns to blighted cities of the 1980s (Guardian, June 2009) The jobless map of Great Britain (Guardian) Tough market for UK graduates (BBC news, January 2009) UK economy jobs tracker (BBC news) UK unemployment jumps by record 281,000 (Guardian, July 2009) UK unemployment since 1984 (Guardian interactive guide) Unemployment articles from the Guardian Unemployment and employment statistics for the UK economy (Guardian)

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Exchange Rates
What is an exchange rate?
An exchange rate is the price of one currency expressed in terms of another currency. The exchange rate determines how much of one currency has to be given up in order to buy a specific amount of another currency. For example, look at the exchange rates in the following table: 1 buys US Dollars ($) Euros () May $1.60 1.15 September $1.45 1.05

In the table above, you can see that in May, 1 would buy $1.60, if you wanted to convert some pounds into US dollars. Alternatively, 1 would buy 1.15 euro. Exchange rates change constantly as currencies are bought and sold (traded) on the global currency markets. Let any commodity, a currency has a value or price expressed in terms of what it could buy that is the exchange rate. Look at the table and see what happened to the exchange rate for the pound between May and September. The value of 1 fell against both the US dollar and the Euro. For example, by September, 1 would only buy you $1.45, a fall of $0.15 from May. That means that the pound weakened against the dollar (and the euro). Putting it another way, the value of the US dollar strengthened against the pound. If you were holding dollars, you would need less of them to convert into 1.

Causes of movements in exchange rates


An exchange rate is a price of a currency. The price is determined by the forces of demand and supply in the currency markets. Just like the commodity markets for wheat, oil and coffee, the price of a currency will reflect the amount of the currency that consumers and businesses want to buy (demand) and sell (supply). Currencies are traded on in international currency markets 24 hours a day. Many billions of pounds and other currencies are traded every hour, to service the needs of governments, businesses and millions of individuals. For example, here are some reasons why there is demand for a currency:

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Businesses need to pay for invoices from overseas suppliers (e.g. a US supplier sending goods to the UK and pricing the invoice in dollars) Businesses needing to convert payments they have received from customers in one currency into another (e.g. a customer in Italy pays a UK business in Euros which it wants to convert into pounds before putting it in the bank) Consumers and business people buying currency before taking a trip or holiday overseas. Businesses sending back profits (cash) from their overseas operations to the base currency

Currency markets are also affected by speculative demand and supply. Currency traders bet on which way they think exchange rates will move. If they think that there will be excess demand for a currency and that it will strengthen, then they may buy that currency and then look to sell the currency when the exchange rate has risen (making a profit) A currency is also affected by interest rates. For example if interest rates in the UK rise, then holders of other currencies may swap them into pounds in order to gain access to a higher interest rate. Finally, you should also consider the implications of fluctuating exchange rates on inflation. Consider the effects of a weaker pound (): A weaker makes imports more expensive Higher import prices: o Drive up firms costs (cost-push inflation) o Feed directly into the consumer price index o Wages may rise in response to the rise in prices - thus triggering off a wageprice spiral A weaker also leads to a rise in aggregate demand since exports rise and imports fall

Depending on the extent of spare capacity in the economy, the rise in aggregate demand could increase inflationary pressure

Implications for UK businesses if the pound strengthens


A good way to look at what happens if a currency strengthens (an increase in the exchange rate) is to work through an example. 1 buys US Dollars ($) January $1.40 June $1.60

Brandon Ltd imports electronic goods from the US for sale via a UK website. These goods are invoiced in US$ - and that is the currency that Brandon must use to settle the invoices. Each month they pay their American suppliers approximately $100,000 for goods imported into the UK.

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What is the effect of the strengthening pound in the table above on Brandon Ltd? Lets convert the monthly US dollar payment to suppliers ($100,000) into pounds to see how much Brandon has to pay: 1 buys US Dollars ($) $100,000 converted into January $1.40 71,428 June $1.60 62,500

In June, Brandon Ltd needs to spend 62,500 to pay for their $100,000 of imported goods from the US. This is 8,928 less than in January. That means, for Brandon ltd, the cost of imports has gone down. A strengthened pound has led to cheaper imported goods thats good news for Brandon Ltd (they should be able to make a better profit margin on those imported electrical goods). If a strengthened exchange rate is good news for an importer like Brandon, what about a business that sells from the UK to the USA an exporter? Take the example of Huntington Plastics Ltd. Huntington exports moulded plastic components to customers in the US, invoicing in US dollars. What would the effect of a strengthened exchange rate be for Huntington? 1 buys US Dollars ($) $100,000 converted into January $1.40 71,428 June $1.60 62,500

If Huntington received $100,000 in sales in January, they could be converted into 71,428. But in June, the same $100,000 of sales would only be worth 62,500. Thats bad news for Huntington. A strengthened pound has resulted in lower sales. If Huntington were to invoice their exports in pounds rather than dollars, then they might not be directly affected by the changed exchange rate since there are no foreign currency receipts to convert back into pounds. However, the business might still suffer, since the price of Huntington products would be more expensive for US customers, who might then buy less (perhaps buying from a cheaper domestic supplier). Lets summarise: A stronger pound leads to: Imports being cheaper Exports dearer (more expensive)

Here is an acronym that can help you remember that: SPICED

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S - Stronger P - Pounds I - Imports C - Cheaper E - Exports D - Dearer What happens if the pound weakens (i.e. falls in value against other exchange rates)? The answer is the opposite of a stronger pound: Imports become more expensive for UK importers Exports become cheaper in overseas markets

Factors that determine the effect of exchange rates on business


Businesses are affected by exchange rate fluctuations in different ways. Here is a summary of the main factors involved: Low effect on business No export sales turnover all in domestic (UK) market All business activities located in UK Raw materials and other supplies bought in UK Demand predominantly from domestic (UK) customers Demand is price inelastic Higher costs can be passed on to customers to maintain margin High effect on business Significant export sales, perhaps in many currencies Overseas operations, earning profits in foreign currency Significant purchases from overseas suppliers Substantial demand from overseas visitors to UK Demand is price elastic Higher costs usually have to be absorbed via a lower margin

An important concept to consider when evaluating the effect of changes in exchange rates on business is price elasticity of demand . For example: A stronger (higher) exchange rate will increase selling price for export customers (e.g. they have to use more US$ for each 1)

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This is likely to result in greater reduction in quantity demanded + overall reduction in export sales

There are two other key issues for businesses to address: There are transaction costs involving from one currency to another Think of it in terms of the commission tourism have to have when buying foreign currency but on a much larger scale Currency movements add to the risks involved in business. The profitability of business contracts or overseas subsidiaries can be undermined by adverse movements in an exchange rate

To illustrate the above, lets look at two worked examples: Stronger pound effect on the revenues of an exporter Weaker pound effect on the margins of a UK importer

Example 1: Stronger Pound & Export Revenue Here are the budgeted export sales of a business in the UK that exports to the USA: Exchange rate: 1 = $1.50 Selling price in export market UK production cost Selling price (revenue) in Production cost () Gross profit () Units sold per year in US Market Budgeted revenue for year Per unit Per unit Per unit Per unit Per unit Qty '000 $1,500.00 300.00 1,000 500 500 2,500 2,500

If the US selling price remains the same in terms, what happens to annual revenue if exchange rate rises to 1 = $1.75? The data becomes:

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Exchange rate: 1 = $1.75 Selling price in export market UK production cost Selling price (revenue) in Production cost () Gross profit () Units sold per year in US Market Revenue per year Per unit Per unit Per unit Per unit Per unit Qty '000 $1,750.00 300.00 1,000 500 500 2,000 2,000

Evaluating the changes above: The US$ price rises the UK product becomes less competitive in the US market (domestic US products will appear better value) Quantity demanded in the US falls the % fall depends on price elasticity of demand The exporters revenue falls from 2.5m to 2.0m

Example 2: Importer & Weaker Pound In this example, the importer makes a 50% gross margin at a rate of 1 = 1.20 at a selling price of 50 per unit. This is shown in the following data: June Selling price in UK per unit Imported cost per unit Exchange rate 1 = Imported cost per unit Quantity sold per month 50.00 30.00 1.20 25.00 5,000

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Revenue Cost of Sales Gross Profit Gross Margin

250,000 125,000 125,000 50.0%

Now consider this question? What happens to gross profit and gross margin if the Pound () falls in value against the Euro () to parity? i.e. 1 = 1.00 The table below shows the effect of that change: October Selling price in UK per unit Imported cost per unit Exchange rate 1 = Imported cost per unit Quantity sold per month 50.00 30.00 1.00 30.00 5,000

Revenue Cost of Sales Gross Profit Gross Margin

250,000 150,000 100,000 40.0%

What has happened? A weaker pound makes it more expensive to buy imports in Euros The bought-in cost per unit rises from 25 to 30 The gross profit per unit falls from 30 each to 25 Gross margin falls from 50% to 40%

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How businesses can manage exchange rate risks


If a business is affected by exchange rate fluctuations, there are several steps it can take to manage the risks posed, including: Monitor and try to anticipate exchange rate movements Used sensitivity analysis to calculate profitability at different exchange rates Pre-buy and pre-sell currency at favourable exchange rates (hedging / currency options) Set up bank accounts in different currencies to reduce currency transactions and offset the effects of currency movements

Web links for further study


Here are some useful web links for you to investigate the business effects of exchange rate movements further: Guardian special reports on currencies China manipulates currency to soften the downturn (Tutor2u Blog, August 2008) Sterling leaves the exchange rate mechanism in 1992 (You Tube video) How pound's rise or fall hits prices (The Times, November 2006) Sterling challenge for UK shops (BBC news, January 2009) Sterlings slump has a silver lining (Economics UK, February 2009) Pound rises above $1.70 (BBC news, August 2009) Explaining how the exchange rate can affect inflation (Tutor2u blog)

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European Union & Business


Introduction to the European Union (EU)

The EU is an important part of business life in the UK. For many years fellow members of the EU have been the UKs largest trading partners. Rising European incomes and living standards, and the enlargement of the EU, offer huge opportunities for the UK to increase exports of goods and services. The UK has also attracted substantial inward investment from European businesses, which helps boost output and employment in the UK. The impact of EU-related legislation is covered elsewhere in these notes. In this section, well look at two key aspects of EU operation which directly impact on UK businesses: EU enlargement The single currency

Enlargement
Europe has added new members periodically. There have been six main waves of EU enlargement: 1973 (UK, Ireland and Denmark) 1981 (Greece) 1986 (Portugal and Spain) 1995 (Austria, Finland and Sweden) 2004 (Ten new countries)

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2007 (Bulgaria and Romania) As with all significant developments in the EU, there are potential upsides and downsides for UK businesses to address: The main benefits of EU enlargement to the UK include: Greater export potential (more consumers that UK businesses can reach without trade barriers). The addition of 10 new countries in 2004 added 70 million extra adult consumers to the EU The potential for greater exploitation of economies of scale UK consumers benefit from cheaper and a wider choice of imports, enabling them to spend more on other goods and services. Foreign Investment and incomes and profits More diverse and flexible European labour market A cleaner environment (as high-polluting nations are brought into EU legislation) A catalyst for further structural reforms in the EU Reforms to the agricultural sector (CAP) Spur to countries to reform their labour markets in the face of lower labour cost competition

The downsides to the UK are commonly thought to be: Extra budgetary costs for the EU (increasing the cost of EU membership) Do new member countries meet stricter EU environmental standards? Long-term need for higher regional subsidies loss of some regional funding for established EU countries Social concerns from increased labour migration

Perhaps not surprisingly, the current UK governments view (Labour) is that enlargement has been a significant net positive for UK businesses. They point to a view that: EU enlargement has brought down barriers to trade and business. UK companies have benefited from access to the largest single market for trade and investment in the world. The economic reforms adopted by the new members increase their purchasing power and thus the demand for EU goods and services, opening new markets for UK business

Single currency (the Euro)


The first thing to remember is that Britain does not currently use the Euro! Britain has an optout from the single currency. However, even though the UK is outside of the Euro Zone, the UK is not isolated from the effects of the Euro.

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When it was introduced, the EU had several long-term aims for the Euro. It was intended to support the aims of: Sustained non-inflationary growth Lower long-term interest rates Lower unemployment Expansion of the EU single market

Amongst the potential gains for consumers in the Euro Zone were: For Consumers Lower prices because of increased competition/ greater price transparency Reduced transactions costs of travelling within Europe (e.g. costs of currency exchange) Cheaper mortgages if interest rates are lower and home-buyers can take out mortgages at longer fixed term rates For Businesses Invoicing can be done with just one currency Lower transactions costs some people argue that staying out of the Euro is equivalent to exporters facing a tariff when they trade inside the EU Gains for the tourist industry in attracting overseas visitors Businesses might be able to fund their capital investment at lower real interest rates

The UK has recognised that, despite the potential upsides, there are some significant potential economic and political downsides. For example: Changeover Costs from joining the Euro: o Costs of changing accounting systems o Menu Costs (vending machines, catalogues, franking machines, postage Installation of new payments systems o Customer confusion o Higher prices Suppliers might increase prices when converting from sterling to euro Loss of control over macroeconomic policy UK interest rates would be set by the ECB Would have to comply with Euro membership criteria

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Globalisation of Markets
Introduction to globalisation
Globalisation is arguably the most important factor currently shaping the world economy. Although it is not a new phenomenon (waves of globalisation can be traced back to the 1800s) the changes it is bringing about now occur far more rapidly, spread more widely and have a much greater business, economic and social impact than ever before. There are several definitions of globalisation. Here are two official examples: First, from the OCED The geographic dispersion of industrial and service activities, for example research and development, sourcing of inputs, production and distribution, and the cross-border networking of companies, for example through joint ventures and the sha ring of assets And here from the International Monetary Fund: The process through which an increasingly free flow of ideas, people, goods, services and capital leads to the integration of economies and societies Globalisation is best thought of as a process that results in some significant changes for markets and businesses to address: for example An expansion of trade in goods and services between countries (an opportunity for many businesses; a threat for others) An increase in transfers of financial capital across national boundaries including foreign direct investment (FDI) by multi-national companies and the investments by sovereign wealth funds (e.g. Middle Eastern governments buying assets in the UK) The internationalisation of products and services and the development of global brands such as Starbucks, Nike, Sony and Google Shifts in production and consumption e.g. the expansion of outsourcing and offshoring of production and support services, which has traditionally benefitted countries with lower labour costs & skilled labour markets such as India, at the expense of jobs in developed economies like the UK Increased levels of labour migration which has the effect of lowering wage costs in many industries, but for others is a problem (e.g. a loss of skilled workers leaving an economy) The emergence of countries playing a bigger role in the global trading system including China, Brazil, India and Russia

A key result of globalisation is the increasing inter-dependence of economies. For example:

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Most of the worlds countries are dependent on each other for their macroeconomic health Many of the newly industrialising countries are winning a growing share of world trade and their economies are growing faster than in richer developed nations All countries have been affected by the credit crunch and decline in world trade, but many emerging market countries have slowed down rather than fall into a full-blown recession

Main drivers of globalisation


Influential commentator Hamish McRae has stated that businesses are the main driver of globalisation. Why is this? Multinationals (businesses that operate in more than one country) want to increase sales, profits and shareholder value. Globalisation provides that opportunity The barriers to international business are lower and falling it is much easier to expand into new territories, particularly if the business is providing a service (e.g. selling software) Governments want to encourage domestic businesses to expand overseas (it results in a flow of profits back into the domestic economy) so there is lots of help available for businesses looking to expand overseas

Businesses themselves though are not the only drivers of globalisation. Consider factors such as:

Picking up on two examples from the drivers above: Lower transport costs Costs of ocean shipping have come down, due to containerisation, bulk shipping, and other efficiencies This helps to bring prices in the country of manufacture closer to prices in the export market

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Digital communication The Internet has dramatically lowered the cost of transmitting and communicating information Expressed in 2005 US dollars, the charge for a three-minute New York-London call has dwindled from $80 in 1950 to $0.23 in 2007 Digital communication has stimulated global trade in knowledge products e.g. software, outsourced services & media content

There are several alternative approaches for a business looking to expand globally many choose to follow one or more of the following: Establish production sites overseas Licence technology & other intellectual property Joint ventures Franchising Offshoring / outsourcing Selling directly to overseas markets either with sales agents, distribution agreements or online

The motivations for successful businesses to operate globally are strong, and growing. For example: Higher profits and a stronger position and market access in global markets Reduced technological barriers to movement of goods, services and factors of production Cost considerations a desire to shift production to countries with lower unit labour costs Forward vertical integration (e.g. establishing production platforms in low cost countries where intermediate products can be made into finished products at lower cost) Avoidance of transportation costs and avoidance of tariff and non-tariff barriers Extending product life-cycles by producing and marketing products in new countries

Does globalisation benefit the UK economy?


There is an argument about whether the seemingly unstoppable process of globalisation provides an overall benefit to the UK. The arguments in favour of the contribution of globalisation include: Opportunities for UK businesses to trade and invest overseas Access to cheaper goods and services from emerging market countries leading to higher real incomes

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Opportunities to live, study and travel overseas Bigger export markets chance to exploit economies of scale More intense competition drives innovation and economic efficiency Globalisation has lifted hundreds of millions of people out of absolute poverty around the world The emergence of an extra one billion middle class consumers worldwide is a huge export opportunity for the UK Falling cost and rising speed of global communications and transport has helped to bring people closer together

The counter argument makes points such as: Risks of increase in structural unemployment in industries / regions that lose demand to lower-cost competition from overseas Globalisation may lead to rising income and wealth inequality Increase in global trade / output has an environment effect increased use of nonrenewable resources and CO2 emissions Globalisation of brands perhaps a loss of cultural diversity UK government has less control - economy may become more vulnerable to external shocks Surge in inward migration of labour has brought economic and social tensions Globalisation contributed to the sharp fall in interest rates and widening trade imbalances that were part of the root cause of the credit crunch High food and fuel price inflation has hurt lower income families most

Further study links on globalisation


The following links will help you build your understanding of the issues surrounding globalisation: Articles on globalisation from the Guardian Articles on the global economy (Guardian) Can Chinas frugal savers help her economy? (BBC news, July 2009) Global economic downturn in graphics (BBC news) Global recession (BBC news special reports) Globalisation and the wages of highly skilled workers (Economic Journal, July 2008) Globalisation is a benefit for the UK (Jim ONeill, Telegraph, July 2008) Goldman Sachs BRIC country analysis (research reports) World Bank

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World Development Movement World Trade Organisation Worlds cheapest car goes on sale (BBC news, April 2009)

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Emerging Markets
What is an emerging market?
The term emerging market is used to describe a country in the process of rapid economic growth and industrialisation. Amongst the key features of emerging markets are: Economies making a transition (from developing to developed) Rapid industrialisation (i.e. development of secondary & tertiary sectors) Have potential to become developed economies Faster long-term economic growth than most developed economies Many inhabitants still in poverty, though a growing middle class Domestic businesses struggle to access global markets (e.g. trade barriers)

The charts below illustrate some examples the rapid economic growth achieved by perhaps the most prominent emerging market China. The first shows the significant growth in two major consumer product markets mobile phones and car ownership.

Cars and Mobiles - The Consumer Boom


Number, millions
25 Privately owned vehicles
Number of (millions)

25 20
millions

20 15 10 5 0

15 10 5 0

600 500
Number of (millions)

600 Mobile telephone subscribers 500 400 300 200 100 0 00 01 02 03 04 05 06 07


Source: Reuters EcoWin

400 300 200 100 0

The second chart shows the annual rates of economic growth achieved by China (and India) compared with two major developed economies the USA and the UK:

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Chinese and Indian Growth compared to the USA and UK


Annual percentage change in real national output

15.0 12.5 10.0 7.5 5.0 2.5 0.0 -2.5 -5.0 -7.5 00 01 02 03 04 05 06 07 08 09 UK USA

15.0

12.5

China

10.0

India

7.5

Percent

5.0

2.5

0.0

-2.5

-5.0

-7.5

Source: Reuters EcoWin

Imagine that you were the CEO of a mobile phone manufacturer like Samsung or Nokia; or a business selling predominantly to low-growth economies like the US & UK. Chances are that you would look enviously at the superior market and economic growth in China and India and make plans to exploit opportunities in those countries! (Samsung and Nokia are investing heavily there, by the way).

Opportunity or threat?
Businesses in the UK can see emerging markets as both an opportunity and a threat: Opportunities for the UK Growing numbers of educated middle class consumers - = growing consumer spending Cultural shifts e.g. higher demand for personal products, private education & healthcare Demand for infrastructure and other products & services from developed economies Source of high-skilled but low-cost labour (outsourcing / offshoring) Great potential for joint ventures and acquisitions A chance to reduce business reliance on slowgrowth, recession hit economies Threats to the UK Increasingly large pool of skilled, but low-cost labour Undervalued currencies make their exports cheaper Inadequate protection of brand and other intellectual property State subsidy of industries to make them more competitive globally Risk of a growing trade deficit with emerging markets Globalisation likely to further build their industrial capabilities

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Should UK businesses invest in emerging economies? Of course the answer is almost certainly yes for those businesses that have: Products and services which are attractive to customers in emerging markets Capabilities and resources that enable them to compete effectively in emerging markets

Investing in emerging markets like China and India is not without risk. For example, the World Bank ranks China and India as just the 83 rd and 122nd easiest places to do business in the world, with corruption and bureaucracy still significant issues. The problem of protecting intellectual property rights is also a major issue for UK firms wanting to set up in emerging markets. The key to addressing the risks of investing in emerging markets is to: Take a long-term view dont expect significant short-term success Thoroughly research the market Invest in localising the products (i.e. tailoring them to the local customer base) and the people who deliver them

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Businesses and the Political and Legal Environment

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Business & Government Economic Policy


Introduction
This section considers the relationship between businesses and the economic policy of governments. The four main areas to consider are: Economic policy objectives Monetary policy Fiscal policy Supply-side policy

Economic policy objectives


An important distinction can be made between economic objectives and the policies that are used in order to achieve those objectives. Objectives are the aims or goals of government policy Policies are the means by which these aims might be achieved

For example, the government has an objective of a low rate of inflation. The main policy to achieve this is monetary policy. The common economic policy objectives of successive UK governments have been: Stable low inflation - the Governments inflation target is 2.0% for the consumer price index Sustainable economic growth as measured by the growth of GDP Improvements in productivity this is designed to improve the UKs competitiveness and boost trade performance High employment + reducing the effects of a recession on the level of unemployment Rising living standards and tackling poverty Sound government finances - including control over the size of government borrowing and the total national debt

Of course, achieving these objectives has often proved easier said, than done! The chart below illustrates how the UK economy has performed recently in relation to three key economic objectives:

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Growth, Jobs and Prices - 3 Key Macro Objectives


Inflation, jobs and growth

10.0
Inflation

Unemployment

10.0

7.5

7.5

5.0

5.0

Percent

2.5

2.5

0.0
GDP growth

0.0

-2.5

-2.5

-5.0

-5.0

-7.5 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

-7.5

Source: Reuters EcoWin

Monetary policy
The main aim of monetary policy is to help keep macroeconomic stability in the economy and also to maintain the value of money i.e. achieve price stability Since 1997 monetary policy has been the responsibility of the Bank of England. Currently monetary policy concerns changes in short term base interest rates and on controlling the money supply. What are the instruments of monetary policy? Monetary policy involves using instruments to control The growth of aggregate demand relative to the economys productive potential The demand for and supply of money and credit To occasionally influence the value of the exchange rate

The main instruments used are: Interest rates Changes in the exchange rate Changes in the supply of credit

The Bank of England usually prefers a gradualist approach to monetary policy. A series of small movements in interest rates is thought to be more effective than sharp jumps. For example, when demand is thought to be rising too quickly and threatening higher prices, the aim is not to shock consumers and businesses to control their spending, but to gradually

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increase the cost of borrowing money and increase the incentive to save, so that the pace of growth moderates and the economy can continue to grow without causing rising inflation. The Bank of England has to consider a range of factors when it makes decisions about how to use its monetary policy instruments. These include: GDP growth and spare capacity Bank lending and consumer credit Equity markets (share prices) and house prices Consumer and business confidence Growth of wages, average earnings and unit labour costs Unemployment and evidence on labour shortages Trends in global foreign exchange markets International economic growth

During 2009 and 2010 the Bank of England has also used a scheme called quantitative easing (QE) as part of monetary policy. QE is also called as asset purchase scheme The aim of QE is to support demand in the economy and prevent a period when inflation is persistently below target or becomes negative (deflation). The Bank uses QE to act on the quantity of money in the economy. It buys assets (corporate & government bonds) with central bank money - the equivalent of turning on the printing press! In August 2009 the Bank announced that quantitative easing would be expanded to 170bn an extra stimulus to the economy.

Fiscal policy
Fiscal policy involves the use of government spending, taxation and borrowing to affect the level and growth of aggregate demand, output and jobs. Taxation There are some key reasons why government needs to levy taxes; the main ones are: To raise revenue to finance government spending Managing aggregate demand - to help meet the governments macroeconomic objectives Changing the distribution of income and wealth Market failure and environmental targets taxes may help correct market failures

An important distinction can be made between direct and indirect taxes: Direct taxation Direct taxation is levied on income, wealth and profit Direct taxes include: Income Tax National Insurance Contributions Indirect taxation Indirect taxes are levied on spending by consumers on goods and services Examples: VAT (15% - 17.5%) Excise duties on fuel and alcohol, car tax, betting tax and the TV licence

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Corporation Tax Capital Gains Tax

Who pays? The burden of an indirect tax might be passed onto the consumer by the producer Depends on the price elasticity of demand and supply for the product

Looking at the data table below, you can see which taxes raise the most revenue for the UK government: Income from taxation for the UK government Income tax (gross of tax credits) National insurance contributions Value Added Tax Corporation Tax Fuel duties Council Tax Business rates Stamp duties Tobacco duty Interest & dividends Vehicle excise duty Capital gains tax Inheritance tax Duties on beer, cider, wine & spirits 2006-07 billion 147.8 87.3 77.4 44.3 23.6 22.2 21.0 13.4 8.1 6.3 5.1 3.8 3.6 8.0

Three taxes therefore dominate in the UK and you can see how the revenue raised from each has grown in recent years from this chart:

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Income Tax, VAT & Corporation Tax


Annual tax revenues, measured at current Prices, billion

175

175

150

150

125

125

(billions)

100

100

75

Income tax

75

50

VAT

50

25
Corporation tax

25

0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

Source: HM Treasury Public Finance Databank

Government spending The government is itself and major contributor to the level of economic activity. Indeed, many businesses rely almost wholly on government spending for their sales and profits! Government spending typically takes up over 40% of annual GDP. There are three main types of government spending in the UK: Transfer Payments - welfare payments made to benefit recipients such as the state pension and the Jobseekers Allowance Current Spending - spending on state-provided goods & services such as education and health Capital Spending - infrastructural spending such as spending on new roads, hospitals, motorways and prisons

Whilst there are many reasons why government spends on providing goods and services (often the choice is determined by political viewpoints), the following points summarise the main motivations: Direct government (public sector) provision of public goods (e.g. defence, clean air) and merit goods (e.g. subsidised housing; free health) Provide welfare support for low income households / the unemployed Government spending is also a means of redistributing income within society Government spending can also be used as a tool to manage aggregate demand (GDP) as part of macroeconomic policy

The table below provides an overview of where UK government spending currently goes:

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Total managed spending by the UK government Social protection (social security benefits) Health Education Other Defence Public order and safety Debt interest Personal social services Housing and environment Industry, agriculture, employment & training Transport
Source: HM Treasury 2008-09 near-cash projections - March 2008 Budget

billion 169 111 82 67 33 33 31 27 23 22 21

How Fiscal Policy is used by Government


There are two broad approaches used by government to use fiscal policy to affect the economy: Discretionary fiscal changes are deliberate changes in direct and indirect taxation and government spending for example a decision by the government to increase capital spending on the road building or to cut VAT to encourage consumer spending. The use of discretionary (or deliberate) changes in fiscal policy is of particular interest to businesses. This is because such changes are usually designed to affect the level of aggregate demand (and therefore economic growth). Automatic stabilisers these are changes in tax revenues and government spending that come about automatically as the economy goes through the business cycle: e.g. Tax revenues - when the economy is expanding rapidly the amount of tax revenue increases. During 2009 the opposite happened tax revenues fell as more people became unemployed and company profits fell Welfare spending - a weakening economy means that the government has to spend more on welfare benefits such as income support and unemployment benefits

The events of 2009 in the UK provide a good example of the use of fiscal policy to stimulate an economy. Amongst the steps taken by the UK government were: A temporary cut in VAT from 17.5% to 15% (due to be reversed in 2010) A car scrappage scheme for older vehicles to encourage new car sales (this was great news for the car industry which had been hit hard by falling new car sales)

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An increase in capital spending projects brought forward from future plans (good news for construction firms) Bail-outs for financial businesses + the nationalisation of several banks

As a result of the actions above and falling tax revenues, the UK has experienced an enormous rise in the size of the government budget deficit. When the government is running a budget deficit, it means that in a given year, total government expenditure exceeds total tax revenue. The change in the UK budget deficit is illustrated in the chart below:
Government Borrowing and the National Debt
Budget Balance = Tax revenues - Total Government Spending, billion

52.5 50.0 47.5 45.0 42.5 40.0 37.5 35.0 32.5 20 10 0


(billions)
Government Debt as a % of GDP

52.5 50.0 47.5 45.0 42.5 40.0 37.5 35.0 32.5 20 10 0

-20 -30 -40 -50 -60 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08


UK Government Budget Balance bn

-20 -30 -40 -50 -60

Source: Reuters EcoWin

There are some significant business-related implications of the government running a large budget deficit mainly because the deficit has to be financed! If the government is running a budget deficit, it has to borrow this money through the issue of government debt such as Treasury bills and bonds The issue of debt is done by the central bank and involves selling debt to the bond and bill markets Most of the government debt is bought up by financial institutions but individuals can buy bonds, premium bonds and buy national savings certificates

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-10

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Supply-side policy
Supply-side policies are mainly micro-economic policies designed to improve the supply-side potential of an economy, make markets and industries operate more efficiently and thereby contribute to a faster underlying rate of economic growth. Supply-side policies are designed to: Improve incentives for people to get new jobs Increase business productivity & efficiency Make it easier for the unemployed to find work Increase the level of capital investment and R&D spending by firms Stimulate inflows of overseas capital investment Promoting more competitive markets Stimulate a faster pace of invention and innovation throughout the economy Provide a platform for sustained non-inflationary growth of an economy

Some of the important economic and business benefits of successful supply-side policies are summarised below:

Thinking about how supply-side policies affect specific industries and markets, the following policies have been significant in the UK in recent years: Privatisation i.e. a transfer of ownership from the state (government) to the private sector Deregulation (opening up of markets) - allowing for more competition Toughening competition policy for example investigation and prosecution of anticompetitive practices A commitment to free international trade Encouraging entrepreneurship and business start-ups

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Policies to encourage increased investment including foreign direct investment into UK product markets Measures to increase price flexibility

Supply-side policies are also used to affect the workings of the labour market (which has an indirect impact on business in terms of its ability to recruit and retain suitable employees). Labour-market policies are designed to improve the quality and quantity of the supply of labour available to the economy. They Aim to make the labour market more flexible for example: Encouraging older people to stay in the workforce A relaxed approach to labour migration Measures to get non-working parents to actively look for work

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Business Legislation
Introduction
All businesses have to address the legislation which affects their activities. For some, legislation is a bind, an annoyance and a source of extra cost. Other businesses see legislation as a form of protection and opportunity. The main roles of business legislation can be summarised as follows: Regulate the rights and duties of people carrying out business in order to ensure fairness Protect people (particularly consumers) dealing with business from harm caused by defective services Ensure the treatment of employees is fair and un-discriminatory Protect investors and creditors Regulate dealings between business and its suppliers Ensure a level playing field for competing business

In these notes, well take a brief look at five key areas of business legislation that you need to be aware of:

Employment law
The two main areas of employment law to consider are:

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Pay legislation The essential rule to remember is that men and women are entitled to equal pay for work of equal value. Pay includes everything offered in the employment contract that means bonuses and pension contributions, as well as basic wages or salary. Workers have the right to ask their employer for information to check equality using an equal pay questionnaire. If they believe their pay is unequal, they can take the employer to an Employment Tribunal, a court of law which specialises in employment disputes Employers are also required by law to ensure they pay their workers at least the national minimum wage (NMW). It makes no difference when a worker is paid (monthly, weekly, daily, hourly). The NMW still applies. The current rates of the NMW (up to Oct09) are: Year from Workers aged 22+ per hour (main rate) Workers aged 18-21 per hour (development rate) 4.83 Workers aged 16-17 per hour

1 October 2009

5.80

3.57

Employment discrimination It is illegal for an employer to discriminate against an employee on the basis of: Sex, including pregnancy and maternity A person's disability Age Religion/belief Status as a fixed-term or part-time worker Marital / civil partnership status Race Sexual orientation Trade union membership or non-membership

Discrimination laws apply in many areas of employing staff - i.e. Recruitment

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Employee contract - terms and conditions Promotions and transfers Providing training Deciding what fringe benefits employees receive Employee dismissal

Employment rights An employment right is something to which an employee is entitled which is protected by law. UK legislation provides a variety of rights for employees, including: Reasonable notice before dismissal Right to redundancy Right to a written employment contract Right to request flexible working Right to be paid national minimum wage Right to take time off for parenting

Consumer protection
Over the years a wide range of legislation has been enacted which protects consumers in their dealings with businesses. The three fundamental protections are as follows: Goods must fit their description E.g. organic wine really must be organic Businesses need to take care with descriptions avoid inaccurate or misleading claims

Goods must be of satisfactory quality The test applied is that of the quality that would be expected by a reasonable person The goods must work and have no major blemishes

Goods are fit for the purpose specified E.g. a watch should tell the time Businesses should take care when explaining what a product can be used for

There are various other ways in which consumers are protected. For example: Businesses may not use unfair commercial practices e.g. misleading advertising Customers have a right of return and full refund if goods /services do not comply with law In relation to the supply of services; the service must be done at a reasonable price and by the time stated. Customers can request that unsatisfactory work be repaired or carried out again at no cost

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Since October 2008, consumers buying from home or at work have the right to a cooling off period Distance selling regulations provide further protection for consumers against online businesses

Whilst you dont need to know all the details of consumer legislation, it worthwhile having knowledge of the main consumer laws, which are: Distance Selling Regulations The Sale of Goods Act Supply of Goods and Services Act Trade Descriptions Act Gives consumers protection when they buy goods or services by mail order, phone or online Requires goods to be as described, fit for their purpose and of satisfactory quality. If they are not, the customer can reject them Customers are entitled to work that's carried out with reasonable skill, in a reasonable time, at a reasonable price Required any descriptions of goods and services given to be accurate and not misleading

Environmental protection
This is another growing area of legislation, much of which originates from the European Union. The key areas are laws which address: Emissions into the air Storage, disposal & recovery of business waste Storing and handling hazardous substances Packaging Discharges of wastewater Environmental laws tend to be highly prescriptive and detailed setting out the procedures that have to be followed and the standards that must be achieved. Often environmental legislation is industry-specific. For example, the car industry is covered by European emission standards which define the acceptable limits for exhaust emissions of new vehicles sold in EU member states.

Competition legislation
This is another area where European and UK legislation act together to regulate business activity. The main aims of competition legislation are:

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Wider consumer choice in markets for goods and services Encouraging and protecting technological innovation Effective price competition between suppliers Investigating allegations of anti-competitive behaviour within markets which might have a negative effect on consumers

A business has to consider two issues in this area: (1) To ensure that it does not breach competition law, and (2) To protect its position where competition law is breached by a competitor Anti-competitive agreements and behaviour Both UK and EC competition law prohibit agreements, arrangements and concerted business practices which appreciably prevent, restrict or distort competition (or have the intention of so doing). Examples of anti-competitive agreements would include: Agreements which directly or indirectly fix purchase or selling prices, or any other trading condition (e.g. discounts or rebates, etc) Agreements which limit or control production, markets, technical development or investment (e.g. setting quotas or levels of output) Agreements which share markets or sources of supply

Price fixing is a particular area of concern, and there have been several high-profile cases where businesses have been found guilty of price-fixing and heavily fined. A business is not allowed to: Agree prices with competitors Share markets or limit production to raise prices Impose minimum prices on different distributors such as shops Agree with competitors what purchase price will be offered to suppliers Cut prices below cost in order to force a smaller or weaker competitor out of the market

Abusing a dominant market position Both UK and EC competition law prohibit businesses with significant market shares unfairly exploiting their strong market positions. If a business has a market share of 50%, then it is assumed to be dominant. However, having a dominant position does not in itself breach competition law. It is the abuse of that position that is prohibited. Possible abuses of a dominant market position would include: Imposing unfair trading terms, such as exclusivity; Excessive, predatory or discriminatory pricing Refusal to supply or provide access to essential facilities

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Tying (i.e. stipulating that a buyer wishing to purchase one product must also purchase other products)

There are some pretty stringent penalties for any business found guilty of abusing a dominant market position: Up to 10% of annual turnover Criminal prosecution Disqualification as directors Civil action by those affected

Health and safety


Health and safety is about preventing people from being harmed at work or becoming ill, by taking the right precautions and providing a satisfactory working environment. An employer has important responsibilities for health & safety. Importantly, it is not just about protecting staff health & safety applies to any people who come into contact with the business . Health & safety legislation aims to protect: Employees working at the business premises, from home, or at another site Visitors to the premises such as customers or subcontractors People at other premises where the business is working, such as a construction site Members of the public - even if they're outside the business premises Anyone affected by products and services the business designs, produces or supplies

Some industries have specific health & safety concerns and issues which have to be addressed through specialist legislation and regulation. These include: Food processing (hygiene) Hotels (guest safety, hygiene) Chemical production (dangerous processes, waste disposal) Air travel (passenger safety) Tour operators (holidaymaker safety)

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Businesses and the Social Environment


Business Ethics
What are business ethics?
Ethics are moral guidelines which govern good behaviour So behaving ethically is doing what is morally right Behaving ethically in business is widely regarded as good business practice. To provide you with a couple of quotes:

Ethical principles and standards in business: Define acceptable conduct in business Should underpin how management make decisions

An important distinction to remember is that behaving ethically is not quite the same thing as behaving lawfully: Ethics are about what is right and what is wrong Law is about what is lawful and what is unlawful

An ethical decision is one that is both legal and meets the shared ethical standards of the community Businesses face ethical issues and decisions almost every day in some industries the issues are very significant. For example:

Should businesses profit from problem gambling?

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Should supermarkets sell lager cheaper than bottled water? Is ethical shopping a luxury we cant afford?

You will probably note the link between business ethics and corporate social responsibility (CSR). The two concepts are closely linked: A socially responsible firm should be an ethical firm An ethical firm should be socially responsible

However there is also a distinction between the two: CSR is about responsibility to all stakeholders and not just shareholders Ethics is about morally correct behaviour

How do businesses ensure that its directors, managers and employees act ethically? A common approach is to implement a code of practice. Ethical codes are increasingly popular particularly with larger businesses and cover areas such as: Corporate social responsibility Dealings with customers and supply chain Environmental policy & actions Rules for personal and corporate integrity

Ethics in practice
Youll find lots of examples of business ethical decisions and dilemmas in areas such as:

Lets take one of the above suppliers.

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A business cannot claim to be ethical firm if it ignores unethical practices by its suppliers e.g. Use of child labour and forced labour Production in sweatshops Violation of the basic rights of workers Ignoring health, safety and environmental standards

An ethical business has to be concerned with the behaviour of all businesses that operate in the supply chain i.e. Suppliers Contractors Distributors Sales agents

The two articles below provide a good example of the ethical issues that arise in the supply chain: click on the images to read the stories:

Pressure for businesses to act ethically


Businesses and industries increasingly find themselves facing external pressure to improve their ethical track record. An interesting feature of the rise of consumer activism online has been increased scrutiny of business activities. Pressure groups are a good example of this. Pressure groups are external stakeholders they Tend to focus on activities & ethical practice of multinationals or industries with ethical issues Combine direct and indirect action can damage the target business or industry

Some examples of business-related pressure groups can be found from the following links:

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Direct consumer action is another way in which business ethics can be challenged. Consumers may take action against: Businesses they consider to be unethical in some ways (e.g. animal furs) Business acting irresponsibly Businesses that use business practices they find unacceptable

Consumer action can also be positive supporting businesses with a strong ethical stance & record. A good example of this is Fairtrade.

Is ethical behaviour good or bad for business?


You might think the above question is an easy one for businesses to answer? Surely acting ethically makes good business sense? As with all issues in business studies, there are two sides to every argument: The advantages of ethical behaviour include: Higher revenues demand from positive consumer support Improved brand and business awareness and recognition Better employee motivation and recruitment New sources of finance e.g. from ethical investors

The disadvantages claimed for ethical business include:

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Higher costs e.g. sourcing from Fairtrade suppliers rather than lowest price Higher overheads e.g. training & communication of ethical policy A danger of building up false expectations

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Corporate Social Responsibility


Introduction to CSR
Corporate social responsibility has become a hot business topic in recent years and many well-known business people have expressed their support for it: Niall Fitzgerald Former CEO, Unilever

"Corporate social responsibility is a hard-edged business decision. Not because it is a nice thing to do or because people are forcing us to do it... because it is good for our business" The business of business should not be about money, it should be about responsibility. It should be about public good, not private greed

Dame Anita Roddick Body Shop

Warren Buffett Berkshire Hathaway

It takes 20 years to build a reputation and five minutes to ruin it.

There are many alternative definitions of CSR. Here are two: An obligation , beyond that required by the law, for a business to pursue long term goals that are good for society About how a company manages its business to produce an overall positive impact on society

So CSR involves: Conducting business in an ethical way and in the interests of the wider community Responding positively to emerging societal priorities and expectations A willingness to act ahead of regulatory confrontation Balancing shareholder interests against the interests of the wider community Being a good citizen in the community

Is CSR the same as acting ethically? The answer is yes and no! There is clearly an overlap between CSR and business ethics:

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Both are concerned with values, objectives and decisions based on something other than the pursuit of profit Socially responsible firms must act ethically

The difference is that: Ethics concern actions which can be assessed as right or wrong by reference to moral principles CSR is about the organisations obligations to all stakeholders and not just shareholders

There are four main parts to CSR: Economic Legal Ethical Voluntary and philanthropic Responsibility to earn profit for owners Responsibility to comply with the law Not acting just for profit, but doing what is right, just and fair Promoting human welfare and goodwill Being a good corporate citizen contributing to the community and quality of life

Does CSR really matter for a business?


You should appreciate that there is a debate about the role and importance of CSR. Not all business organisations behave in a deliberately socially responsible manner, and some argue that it is not the job of businesses to be concerned about social issues and problems. There are two main schools of thought: Free market view: the job of business is to create wealth for shareholders Corporate social responsibility view: business should be concerned with social issues as much as their commercial aims

Those who take the free market view and argue against over-reliance on CSR would make points such as: The only social responsibility of business is to create shareholder wealth The efficient use of resources will be reduced if businesses are restricted in how they behave Businesses cannot decide what is in societys interest - that is the role of government Extra costs are incurred which must be passed on to consumers

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CSR is an unwelcome extra responsibility for businesses; another example of bureaucratic red -tape

The counter-arguments of the CSR lobby would be that: Businesses do not have an unquestioned right to operate in society Those managing business should recognise that they depend on society Business relies on inputs from society and on socially created institutions There is a social contract between business and society involving mutual obligations that society and business recognise that they have to each other

If you were asked to build the case for a business investing in CSR, you might include one or more of the following advantages of CSR: It is the ethical thing to do It improves a business image and reputat ion It is necessary in order to avoid excessive regulation Socially responsible actions can be profitable An improved social environment will be beneficial to a business It will be attractive to some investors It can increase employee motivation It helps to corrects the social problems caused by business

Where does CSR apply in business?


You can find examples of CSR applying in nearly all of the functional activities of a business. The table below illustrates some of them: Dealing with customers Value for money Fair and honest advertising Country/place or origin Sustainable products Responsible selling and promotion Labour rights in the supply chain Dealing with employees Fair treatment at work Right to be kept informed Work life balance / flexible working Workforce diversity and equal opportunities Health and safety Opportunities for participation in decisionmaking Product quality and safety After sales service Local sourcing Product testing Fair handling of complaints Availability of information to make informed decisions

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Training in new skills Job design and satisfaction Attitude to disadvantaged groups Dealing with the community Minimising noise and other pollution Sourcing from local suppliers Labour rights in the supply chain Diversity in the workplace Dealing with the Environment Effects of pollution, noise, waste disposal, congestion Chemical use Use of energy Biodiversity

Provision of social facilities Working conditions

Consultation about major change Protecting local employment Product health and safety

Waste management Avoiding excessive packaging Water consumption Carbon emissions

Further study links on CSR


Two great resources to browse on CSR are: Business in the Community A membership organisation that encourages and promotes active engagement by businesses in the community

CBI / Article 13 Case Studies in CSR Regularly updated articles and case studies on businesses getting involved in CSR activities

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Businesses and the Technological Environment


Technology
Technology and business strategy
Business students dont need to under stand technology as such. Your challenge is to understand and appreciate the implications of technology for how a business operates and competes. Most businesses operate in markets where the speed of industry change has accelerated in recent years as a result of technology so this has become a key part of the external environment. The key relationship to consider is that between technology and strategic success Investing in new and better technology is always an option (perhaps a necessity). However, that investment may not turn out to be a source of competitive advantage if competitors exploit it too. Rapid technological change challenges all competitors in a market. Technology can impact a business through one or more mechanisms some good examples are provided below: Technology Mechanism A new process Solve a complex problem A new product How It Creates an Advantage Produce faster, at lower cost or better quality Do something competitors find hard to master The first product to market Example Internet banking Fast-fashion (e.g. Zara) Google search engine The iPod or iPhone Amazon online book-buying Wii-fit: video game & weight loss combined Pfizers Viagra Digital cameras iTunes Wikipedia v Encyclopaedia Britannica

Protect a valuable idea Rewrite the rules

Have something others can only sell if they pay for a licence A completely new approach which makes other products and markets redundant

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Technology and Five Forces


As we can see above, technology plays a crucial role in determining a business ability to compete. There is a neat link between technology and competitive advantage through Porters Five Forces model (the model is described in more detail in a later section). By way of introduction, the Five Forces model identifies the impact of factors that determine the level of industry profitability and the strength of competitive rivalry. The table below highlights some examples of the link between technology and those competitive forces: Force Barriers to entry Examples of Potential Impact of Technology May reduce economies of scale encouraging new entrants (e.g. digital publishing) In some case barriers may rise as products become more complex and processes difficult to copy New products may displace old e.g. DVD for videotape Technology in other markets may steal customer spending from other markets e.g. more spending on games consoles v less spending on days out Technology may free businesses from a single source of supply e.g. Open Source software v Microsoft Rivalry is diminished is technology is successfully patented and licensed

Substitutes

Power of customers (buyers) & suppliers Competitive rivalry

Overall, is technology an opportunity or a threat for business? The answer, of course, is it depends! Some businesses may be technology leaders where technology enables them to gain an advantage Most other businesses need to assess the threat posed by technology on their competitive position The crucial question to consider is how technology creates competitive advantage. New technology may be easy to acquire by competitors, so it is not necessarily a source of advantage It is often the way that technology is exploited that determines whether it becomes an opportunity or a threat. For example, many textbook publishers have failed to exploit the opportunity of developments in e-learning and social networking, turning a big opportunity for them into a serious threat

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Technology and Innovation


Developing new technology is usually expensive. The investment returns depend on the extent and pace at which a market adopts new products, or improved versions of existing products. This is known as innovation diffusion and it plays a key role in determining the effect of changed technology on business strategy. There are two broad sets of issues to consider when looking at innovation diffusion: Supply factors: things that concern the relevance and availability of the technology to the market

Demand factors: things that influence how much market demand there will be Some examples of supply and demand factors are outlined below: Supply Factor Degree of improvement Compatibility Complexity Experimentation Customer service Potential Effect on Technology Does the technological change provide enough incentive for customers to change? Is the new technology compatible with existing products? Are older products likely to become obsolete? Does the product or the way it is marketed (e.g. pricing) make it too complicated for the majority of customers to understand? Can customers test the new technology before committing to buying it? What feedback is available from early-adopters? How easy is it for potential customers to get answers to their questions before committing to the new technology?

Demand Factor Market awareness

Potential Effect on Technology How aware is the market of the new technology? What promotional activity is required in order for customers and distributors to support the technology? What is the potential for a band-wagon effect? How easy is it for customers and distributors to see the technology in action and observe the benefits that is brings? Which customers are likely to adopt the technology first? What approach is most appropriate for a successful launch of the innovation? How are existing customers going to be supported in transferring to the new technology?

Observability

Customers

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The adoption of technology often reaches a tipping point. A tipping point can be positive i.e. the point in time at which some new technology becomes adopted by the many rather than the few: With innovation diffusion, demands tends not to increase steadily There is often a slow process of adoption Then a tipping point occurs when demand suddenly takes off

However, a tipping point can also be negative. This is a point in time when consumer use and demand suddenly and rapidly declines.

How should business acquire technology?


An important debate in many businesses (particularly large ones) is how technology and innovation should be acquired and funded? There are three main options to consider:

In-house development: This is often favoured if technology is a key competitive advantage Business may have experience of achieving first-mover advantage Requires strong insights into technology and market needs Business must also be willing to take commercial and financial risks

Alliances: Appropriate for technologies which are important, but which do not confer competitive advantage (e.g. packaging) Business may want to follow & imitate rather than be a market innovator New technology may be well beyond the skills and experience of the business Helps limit commercial and financial risk A good link with outsourcing

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Acquisition: Often important if speed is important i.e. no time for learning May be essential if the technology is complex or if it is providing competitors with an advantage Acquisitions are high risk have to be sure that the right technology is being bought

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Businesses and the Competitive Environment


Competitive Environment - Five Forces
The nature of industry competition and profits
Every market or industry is different. Take any selection of industries and you should be able to find differences between them in terms of: Size (e.g. sales revenue, volumes, numbers of customers) Structure (e.g. the number of brands and competitors) Distribution channels (how the product gets from producer to final consumer) Customer needs and wants (the basis of marketing segmentation) Growth (the rate of growth and which businesses are growing faster or slower than the market) Product life cycle (the stage of the life cycle for the industry as a whole and for products and brands within it) Alternatives for the consumer (e.g. substitute products)

The result of the above differences is that industries vary in terms of how much profit they make. To take two examples:

Why do airlines make so little profit (and such big losses)? There are several factors, including: Very intensive competitor rivalry mainly on price Low barriers to entry lots of new airlines who want to set up Suppliers of aircraft & equipment are powerful can charge high margins Customers have lots of substitute options e.g. rail, car

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High fixed costs airline losses rise significantly if revenues fall only slightly since it costs roughly the same to fly half-empty planes as full ones

By contrast, why are profits so high in the soft drinks market? The answer is mainly that: Customers and suppliers have little power Pepsi has many millions of individual consumers, and thousands of retail distributors none of whom has much influence over the business There is high brand awareness & loyalty = less consumer desire for substitutes High barriers to entry how do you enter a market dominated by Coca-Cola and Pepsi?

What we have illustrated above is some analysis that you would obtain by considering the Five Forces Model. The Five Forces Model was devised by Harvard Professor Michael Porter. The model is a framework for analysing the nature of competition within an industry.

Overview of the Five Forces Model

Porter identified five factors that act together to determine the nature of competition within an industry. These are the: Threat of new entrants to a market Bargaining power of suppliers Bargaining power of customers (buyers)

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Threat of substitute products Degree of competitive rivalry

He identified that high or low industry profits (e.g. soft drinks v airlines) are associated with the following characteristics:

Lets look at each one of the five forces in a little more detail to explain how they work.

Threat of new entrants to an industry


If new entrants move into an industry they will gain market share & rivalry will intensify The position of existing firms is stronger if there are barriers to entering the market If barriers to entry are low then the threat of new entrants will be high, and vice versa

Barriers to entry are, therefore, very important in determining the threat of new entrants. An industry can have one or more barriers. The following are common examples of successful barriers: Barrier Investment cost Notes High cost will deter entry High capital requirements might mean that only large businesses can compete Lower unit costs make it difficult for smaller newcomers to break into the market and compete effectively Each restriction can act as a barrier to entry E.g. patents provide the patent holder with protection, at least in the short run Existing products with strong USPs and/or brand increase customer loyalty and make it difficult for newcomers to gain market share

Economies of scale available to existing firms Regulatory and legal restrictions Product differentiation (including branding)

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Access to suppliers and distribution channels Retaliation by established products

A lack of access will make it difficult for newcomers to enter the market E.g. the threat of price war will act to discourage new entrants But note that competition law outlaws actions like predatory pricing

What makes an industry easy or difficult to enter? The following table helps summarise the issues you should consider: Easy to Enter Common technology Access to distribution channels Low capital requirements No need to have high capacity and output Absence of strong brands and customer loyalty Difficult to Enter Patented or proprietary know-how Well-established brands Restricted distribution channels High capital requirements Need to achieve economies of scale for acceptable unit costs

Bargaining power of suppliers


If a firms suppliers have bargaining power they will: Exercise that power Sell their products at a higher price Squeeze industry profits

If the supplier forces up the price paid for inputs, profits will be reduced. It follows that the more powerful the customer (buyer), the lower the price that can be achieved by buying from them. Suppliers find themselves in a powerful position when: There are only a few large suppliers The resource they supply is scarce The cost of switching to an alternative supplier is high The product is easy to distinguish and loyal customers are reluctant to switch The supplier can threaten to integrate vertically The customer is small and unimportant There are no or few substitute resources available

Just how much power the supplier has is determined by factors such as:

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Factor Uniqueness of the input supplied Number and size of firms supplying the resources Competition for the input from other industries Cost of switching to alternative sources

Note If the resource is essential to the buying firm and no close substitutes are available, suppliers are in a powerful position A few large suppliers can exert more power over market prices that many smaller suppliers each with a small market share If there is great competition, the supplier will be in a stronger position A business may be locked in to using inputs from particular suppliers e.g. if certain components or raw materials are designed into their production processes. To change the supplier may mean changing a significant part of production

Bargaining power of customers


Powerful customers are able to exert pressure to drive down prices, or increase the required quality for the same price, and therefore reduce profits in an industry. A great example in the UK currently is the dominant grocery supermarkets which are able exert great power over supply firms. You can see a great video about this issue here. Several factors determine the bargaining power of customers, including: Factor Number of customers Their size of their orders Number of firms supplying the product The threat of integrating backwards The cost of switching Note The smaller the number of customers, the greater their power The larger the volume, the greater the bargaining power of customers The smaller the number of alternative suppliers, the less opportunity customers have for shopping around If customers pose a threat of integrating backwards they will enjoy increased power Customers that are tied into using a suppliers products (e.g. key components) are less likely to switch because there would be costs involved

Customers tend to enjoy strong bargaining power when: There are only a few of them

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The customer purchases a significant proportion of output of an industry They possess a credible backward integration threat that is they threaten to buy the producing firm or its rivals They can choose from a wide range of supply firms They find it easy and inexpensive to switch to alternative suppliers

Threat of substitute products


A substitute product can be regarded as something that meets the same need Substitute products are produced in a different industry but crucially satisfy the same customer need. If there are many credible substitutes to a firms product, they will limit the price that can be charged and will reduce industry profits. As an example, consider the many substitutes that consumers now have to buying a newspaper for their news:

The extent of the threat depends upon The extent to which the price and performance of the substitute can match the industrys product The willingness of customers to switch Customer loyalty and switching costs

If there is a threat from a rival product the firm will have to improve the performance of their products by reducing costs and therefore prices and by differentiation.

Degree of competitive rivalry


If there is intense rivalry in an industry, it will encourage businesses to engage in

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Price wars (competitive price reductions), Investment in innovation & new products Intensive promotion (sales promotion and higher spending on advertising)

All these activities are likely to increase costs and lower profits. Several factors determine the degree of competitive rivalry; the main ones are: Factor Number of competitors in the market Market size and growth prospects Product differentiation and brand loyalty Note Competitive rivalry will be higher in an industry with many current and potential competitors Competition is always most intense in stagnating markets The greater the customer loyalty the less intense the competition The lower the degree of product differentiation the greater the intensity of price competition If buyers are strong and/or if close substitutes are available, there will be more intense competitive rivalry The existence of spare capacity will increase the intensity of competition Where fixed costs are a high percentage of costs then profits will be very dependent on volume As a result there will be intense competition over market shares If it is difficult or expensive to exit an industry, firms will remain thus adding to the intensity of competition

The power of buyers and the availability of substitutes Capacity utilisation The cost structure of the industry

Exit barriers

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Business & Environmental Issues

Introduction
Twenty years ago, environmental issues were rarely a priority on the agenda of business management. Now, there is an argument that operating an environmentally-friendly business is a top priority for business, particularly those whose operations and activities are nationwide and international. The environment has become a key external influence on businesses. The key environmental issues which potentially constrain the ability of a business to achieve its objectives include: Key Environmental Concerns Sustainability A green supply chain Minimising packaging Promoting environmental policies Complying with environmental laws Carbon emissions Waste disposal

Business & environmental regulation


Business activities are regulated by three main agencies in the UK: Environment Agency in England and Wales Northern Ireland Environment Agency Scottish Environment Protection Agency

And also by Local authorities who regulate Air quality & pollution Noise, odour and light pollution Land contamination Environmental health

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Environmental laws and regulations are wide and varied, but essentially businesses have to make sure that they: Store and treat waste safely and securely Protect employees and environment from air pollution Don't produce excessive noise, smoke, fumes & other forms of pollution Comply with rules for storage and use of hazardous substances & waste

To meet their obligations, businesses need to focus on: Use of raw materials, water and other resources (inputs) Energy use and its impact on climate change Waste and pollution produced by the business The impact the business has on employees and the local, wider and international community

Whilst complying with these regulations and laws inevitably imposes additional costs on many businesses, it is possible to identify some advantages that arise for the environmentallyconscious business. These include: Lower raw material costs & waste disposal charges Longer life of assets which are recycled or repaired Trading opportunities with organisations that will only use environmentally-friendly suppliers Improved customer goodwill

Sustainable business
You will see the word sustainable or sustainability used in many businesses these days. A sustainable business is a business that has no negative overall impact on the environment. That definition makes it quite hard to quantify whether the goal of sustainability has been met, since it assumes the net effect of a business activities on the environment can be measured in full. In practice, a business that aims to be sustainable gets involved in a range of activities designed to minimise their net effect on the environment. These are activities such as: Using packaging that can be reused or recycled Minimising or eliminating the use of hazardous chemicals and processes that produce harmful by-products

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Working with suppliers to assess and improve their sustainability, or switching to more sustainable suppliers Using more energy-efficient equipment, or using renewable sources of energy Collaborating with other businesses that can use waste (or supply by-products that can be used as raw materials) Eliminating unnecessary activities e.g. replacing some business travel with conference calls instead

To be effective, a strategy of building a sustainable business requires the drive and support of people through a firm particularly top management. Management need to: Understand how changes will affect employees and other stakeholders Gain commitment and support from those stakeholders Anticipate changes in environmental legislation - try to be "ahead of the game" Set short and long-term objectives for sustainability projects Review progress and objectives regularly

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Managing Change
Causes of Change Acquisitions
Methods of business development
In your BUSS3 studies you looked at some alternative directions a business could take in relation to its marketing strategies. Specifically you covered: Porters Generic Strategies Porter suggested four "generic" strategies that could be adopted in order to gain competitive advantage. The strategies relate to the extent to which the scope of a business' activities are narrow versus broad and the extent to which a business seeks to differentiate its products. Ansoffs Matrix Ansoffs product/market growth matrix suggests that a business attempts to grow depend on whet her it markets new or existing products in new or existing markets. The output from the Ansoff matrix is a series of suggested growth strategies which set the direction for the business strategy. For each of the directions suggested by the above models, there are different methods of development. According to Johnson & Scholes, a development method is the means by which a strategic direction is pursued. For example, when pursuing a growth strategy, a business is often faced with making a choice between three development methods Internal development (often called organic growth in business textbooks) Acquisitions (occasionally, and often incorrectly called mergers) Joint ventures and alliances

Internal development is where strategies are developed that build on the business own capabilities and resources. For most businesses, this is the only development method used. Internal development involves approaches such as: Designing and developing new product ranges Implementing marketing plans to launch existing products directly into new markets (e.g. exporting) Opening new business locations either in the domestic market or overseas Investing in research and development to support new product development

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Investing in additional production capacity or new technology to allow increased output and sales volumes Training employees to help the best acquire new skills and address new technology

Whilst these approaches are not easy, they are generally considered to be lower risk than the alternative acquisitions or joint ventures. However, the major downside of focusing on internal development is that the speed of change or growth in the business may be too slow.

Acquisitions in focus
Acquisitions are a source of significant change for businesses both the business being acquired and the business doing the buying! What is an acquisition? Here is a definition: Where one business acquires a controlling interest in another business As you look through the business media you should come across many examples of acquisitions. Here are some for you to look at: December 2005 Buyer ITV plc Target Friends Reunited Price - 175million http://www.telegraph.co.uk/finance/2927757/ITV-buysFriends-Reunited-for-175m.html December 2006 Buyer First Choice Target Late Room Price - 120million http://www.manchestereveningnews.co.uk/news/business/s/2 31/231640_first_choice_snaps_up_120m_lateroomscom.html March 2004 Buyer WM Morrison Target - Safeway Price - 3bn http://news.bbc.co.uk/1/hi/business/3542291.stm January 2007 Buyer Tata Target - Corus Price - 5.8bn http://news.bbc.co.uk/1/hi/business/6315823.stm The type of acquisition made by a firm can be categorised in terms of its direction:

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Direction Forward + vertical Backward + vertical Horizontal Conglomerate

Explanation Acquiring a business further up in the supply chain e.g. manufacturer buys a distributor. Acquiring a business operating earlier in the supply chain e.g. a retailer buys a wholesaler Acquiring a business at the same stage of the supply chain e.g. a manufacturer buys a competitor Where the acquisition has no clear connection to the business buying it

Here are a couple of examples of major acquisitions to help make the distinction above:

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Are acquisitions worthwhile?


When firms choose between the options for pursuing their growth objectives, there are several reasons why acquisitions appear an attractive choice: Existing products are in the later stages of their life cycles Business lacks knowledge or resources to develop organically Speed of growth is a high priority Competitors enjoy significant advantages that are hard to overcome

Looking at the history of business acquisitions over recent decades, it is possible to identify a wide range of reasons why they have been made: Possible Reasons for Making Acquisitions Speed of access to new product or market areas Increase market share Acquire new skills Access economies of scale (perhaps by combining production capacity) Secure better distribution Acquire intangible assets (brands, patents, trade marks) Overcome barriers to entry to target markets Defend itself against a takeover threat Enter new segments of existing market To eliminate competition Spread risks by diversifying To take advantage of deregulation

The main upsides and downsides of making acquisitions can be summarised as follows: Advantages of Acquisitions Quick access to resources & skills the business needs Overcomes barriers to entry Helps spread risk (wider range of Disadvantages of Acquisitions High cost involved Problems of valuation Clash of cultures Upset customers

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products and greater geographical spread) Revenue growth opportunities (synergy) Cost saving opportunities (synergy) Reduces competition May enable economies of scale

Problems of integration (change management) Resistance from employees Non-existent synergy Incompatibility of management styles, structures and culture Questionable motives High failure rate Diseconomies of scale

Many acquisitions are justified (when they are made) in terms of the likely synergies between the acquirer and the target. Synergy can be defined as: When the whole is greater than the sum of the individual parts In theory synergy arises in two broad ways:

The problem with synergy is that acquisitions normally fail to deliver the promised returns. It is widely accepted that over 50% of takeovers destroy shareholder value i.e. they do not earn a return (higher profits) that justify the investment made. Why do acquisitions fail to achieve the required rate of return? Here are the most common reasons: Price paid for acquisition was too high (over-estimate of synergies) Lack of decisive change management in the early stages The takeover was mishandled Cultural incompatibility Poor communication Loss of key personnel & customers post acquisition The creation of a lumbering giant that is soon outpaced by smaller rivals

Acquisitions therefore provide some important change management challenges. Not only are they relatively risky actions (certainly compared with internal development), but the risk is

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heightened if the change management issues are not addressed before, during and after the acquisition. A fundamental challenge posed by an acquisition is one of corporate culture. Employees Customers & suppliers Management (of acquired business) E.g. Uncertainty about acquirer intentions & strategy (cost savings, rationalisation) E.g. continued relationship; impact on quality E.g. duplicated roles, new hierarchy

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Causes of Change Retrenchment


What is retrenchment?
You can find several similar definitions of retrenchment which provide good clues about the relationship of the term to business. For example: To cut down or reduce something Tighten one's belt Use resources more carefully

Retrenchment is essentially about cutting back reducing the size or scale of a business activities in order to reduce costs, improve efficiency or focus on core activities. There are several methods associated with retrenchment: Reduced output & capacity Headcount reductions Product & market withdrawals Downsizing / rationalisation Disposals of business units De-mergers Outsourcing

Here are some examples of business retrenchment in the news: Starbucks rationalises its store portfolio in Australia 2008 Poor competitive position there hard to compete with existing coffee shop operators Strategic decision to focus investment on the US market ITV plc disposes of website Friends Reunited (2009) for 25, some 150m less than it paid for the business Friends Reunited had a poor competitive position (v Facebook) Considered non-core by new ITV management

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Burberry plc announces plans to cut operating costs by 50m p.a. Sewing factory in Rotherham closed production transferred to another group factory Example of capacity rationalisation

Economic downturn hits the IT services market Fujitsu makes 10% of its workforce redundant due to substantial declines in demand

Retrenchment and change


The implications of retrenchment on change very much depend on the scale and scope of the actions taken. Small-scale, incremental retrenchment (e.g. withdrawing some product lines, or eliminating an extra production shift) would not normally create the need for significant change. However, a business unit closure, or the introduction of new top management to effect a business turnaround is a different issue altogether. The table below highlights some examples of how significant retrenchment can lead to major changes: Common Actions Changed organisational structures Possible Implications for Change Changed management responsibilities Potential effect on prevailing culture Greater workloads / higher stress (possibly) New teams and colleagues Different reporting structures / fewer layers of reporting Different leadership style Uncertainty (particularly amongst other senior management) New priorities, aims and objectives A threat to the prevailing corporate culture Previous projects often abandoned (e.g. investment) A new / renewed sense of urgency particularly if the

New leadership and/or ownership

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Common Actions

Possible Implications for Change acquiring management have a rapid integration plan Existing business units and locations may be consolidated, sold or closed

Fewer people (various actions to reduce headcount)

Loss of morale and increased de-motivation Bad news for some external stakeholders (e.g. local community, local suppliers)

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Change Process Culture


What is business culture?
Although most of us understand in our own minds what is meant by business culture, it is a slightly woolly concept that is hard to define precisely. We know (and can often sense) a culture exists when we visit a business as a cust omer or work there, but how can this be explained? A great way to describe business or corporate culture is: The way we do things around here Culture consists of factors such as: The shared values of a business The beliefs and norms that affect every aspect of work life The behaviours typical of day-to-day behaviour The strength of a culture determines how difficult or easy it is to know how to behave in the business The culture of a business is reflected in many ways including the following: Some Ways in which a Business Culture is Demonstrated How employees are recruited the cultural factors that make one applicant more suitable than another The way that visitors and guests are looked after How the working space is organised The degree of delegation & individual responsibility How long new employees stay in a business How contracts are negotiated and agreed The personality and style of the sales force The responsiveness of communication The methods used for communication How staff call each other (e.g. first name) The nature and style of marketing materials The speed with which decisions are taken The number of layers in the management hierarchy

When you visit a range of businesses you soon get a sense of the strength of the business culture. If a culture can be measured as strong or weak then how might this show itself?

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Signs of a Strong Culture Staff understand and respond to culture Little need for policies and procedures Consistent behaviour Culture is embedded

Signs of a Weak Culture Little alignment with business values Inconsistent behaviour A need for extensive bureaucracy & procedures

Classifying business cultures


Charles Handy, a leading authority on business culture, defined four different kinds of culture:

Each of these four cultural styles is summarised below: Power Culture Control radiates from the centre Concentrates power among a few Few rules and little bureaucracy Swift decisions are possible Frequently found in smaller, entrepreneurial organisations

Role Culture People have clearly delegated authorities within a highly defined structure Hierarchical bureaucracy Power derives from a person's position Little scope exists for expert power

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Task Culture Teams are formed to solve particular problems Power derives from expertise as long as a team requires expertise No single power source Matrix organisation Team may develop own objectives (a risk)

Person Culture People believe themselves to be superior to the business Business full of people with similar training, background & expertise Common in firms of professionals e.g. accountants & lawyers Power lies in each group of individuals

Handy also made a link between the corporate culture and an appropriate leadership style: Cultural Type Power Role Task Person Most Suitable Leadership Style? Autocratic Autocratic or paternalistic Paternalistic / democratic Democratic

Why business culture is important


Business culture plays a key role in the ability of a business to achieve its objectives. Why? Because culture is pervasive it influences almost every important part of how a business operates, including: Decision-making and managing risk How people are organised and supervised Motivation and job satisfaction Management control and responsibility

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Recruitment & selection How the business responds to its external environment The growth options available to a business How customers are treated Attitude and actions to external stakeholders Approaches to managing quality The ability of a business to handle change

In other words, business culture is at the heart of business performance. There is a deep body of research into high-performing companies which suggests that a strong, relevant business culture is behind business excellence.

Culture and business change


The prevailing culture in a business is often challenged by change. Cultural change may, in fact, be a requirement in order to address: Improved business performance Declining profits and sales Inadequate returns on investment Low quality or standards of customer service

The need for cultural change is also linked to: Market changes (growth, competitors) Political & legal environment New business ownership (e.g. after an acquisition) New management or leadership (e.g. a new CEO) Economic conditions (e.g. downturn)

Identifying the need for cultural change is one thing actually achieving it is quite different! There is lots of evidence that changing a business culture is one of the toughest management challenges. There are many barriers to cultural change, including: Barriers to Cultural Change Traditional and set ways of doing things: Loyalty to existing relationships Failure to accept the need for change Insecurity Preference for the existing arrangements Different person ambitions Fear of: Loss of power Loss of skills Loss of income The unknown Inability to perform as well in the new situation Break up of work groups

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Change Process Implementation and Management


Types of change
Change is nothing new. And in business it is now an established fact of life. As Drucker pointed out in Management Challenges for the 21 st Century: "Everybody has accepted by now that change is unavoidable. But that still implies that change is like death and taxes it should be postponed as long as possible and no change would be vastly preferable. But in a period of upheaval, such as the one we are living in, change is the norm." Many people thrive on new challenges and constant change; others resist change and prefer the security and comfort of the status quo. However, the problem for business management is that change is rarely optional (as Drucker says change is the norm) . The choice is not whether to change, but: Deciding what change is appropriate and necessary How quickly it needs to be achieved How resistance can be overcome and the organisation mobilised to complete the change

Before looking at how change can be managed, it is worth considering briefly the two main types of change step and incremental:

Step change Dramatic or radical change in one fell swoop Radical alteration in the business Gets it over with quickly May require some coercion

Incremental change

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Ongoing piecemeal change which takes place as part of an organisations evolution and development Tends to more inclusive

In the notes that follow, we focus mainly on step change.

Change management
Change management is an important aspect of management that tries to ensure that a business responds to the environment in which it operates. There are four key features of change management: Change is the result of dissatisfaction with present strategies It is essential to develop a vision for a better alternative Management have to develop strategies to implement change There will be resistance to change

Many factors drive change in a business. Lewin identified four forces:

In Lewins model there are forces driving change and forces restraining it. Where there is equilibrium between the two sets of forces there will be no change. In order for change to occur the driving force must exceed the restraining force Lewins analysis can be used to: Investigate the balance of power involved in an issue Identify the key stakeholders on the issue Identify opponents and allies Identify how to influence the target groups

Forces for change include:

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Internal forces for change A general sense that the business could do better Desire to increase profitability Reorganisation to increase efficiency Natural ageing and decline in a business (e.g. machinery, products) Conflict between departments The need for greater flexibility in organisational structures Concerns about ineffective communication, de-motivation or poor business relationships

External forces for change Increased demands for higher quality and levels of customer service Uncertain economic conditions Greater competition Higher cost of inputs Legislation & taxes Political interests Ethics & social values Technological change Globalisation Scarcity of natural resources Changing nature and composition of the workforce

You can see from the lists above that the main pressure for change in a business is usually external. A business has to be prepared to face the demands of a changing external environment.

Resistance to change
Despite the potential positive outcomes, change is nearly always resisted . A degree of resistance is normal since change is: Disruptive, and Stressful

Management trying to implement change will often come across other people in the business responding with phrases such as: My needs are already being met We dont need to do this This sounds like bad news The risks outweigh the benefits What does this mean for me?

Of course a degree of scepticism can be healthy especially where there are weaknesses in the proposed changes. However resistance will also impede the achievement of business objectives. Some common reasons why change is resisted include:

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Parochial self interest

Individuals are concerned with the implications for themselves; their view is often biased by their perception of a particular situation Habit provides both comfort and security Habits are often well-established and difficult to change Communications problems Inadequate information Sense of insecurity Disagreement over the need for change Disagreement over the advantages and disadvantages Employees are likely to resist change which is perceived as affecting their pay or other rewards Established patterns of working and reward create a vested interest in maintaining the status quo Proposed changes which confront people tend to generate fear and anxiety Introducing new technology or working practices creates uncertainty

Habit Misunderstanding Low tolerance of change Different assessment of the situation Economic implications

Fear of the unknown

We have touched earlier on personal barriers to change there are also several organisational barriers to change, including: Structural inertia Existing power structures Resistance from work groups Failure of previous change initiatives

Change is also resisted because of the poor way in which change is managed! For example, a failure by management responsible for the change to: Explain the need for change Provide information Consult, negotiate and offer support and training Involve people in the process Build trust and sense of security Build employee relations

As a result of change resistance and poorly managed change projects, many of them ultimately fail to achieve their objectives. Amongst the reasons commonly associated with failed change programmes are: Employees do not understand the purpose or even the need for change Lack of planning and preparation Poor communication

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Employees lack the necessary skills and/ or there is insufficient training and development offered Lack of necessary resources Inadequate/inappropriate rewards

Managing change more effectively


Given the likelihood that change will be resisted, what can management do to plan and implement a change programme more effectively? The key stages in a successful change project are likely to be to: Identify the changes required (a role here for SWOT and PEST analysis) Determine the major issues Identify and assess the key stakeholders Win the support of key individuals Identify the obstacles Determine the degree of risk and the cost of change Understand why change will be resisted and how it can be managed

People are the key factor in overcoming resistance to change. The successful implementation of new working methods and practices or integrating new businesses into a group is dependent upon the willing and effective co-operation of employees and management. Many change initiatives and programmes fail because they are derailed by the people factor! A key part of successful change is, therefore, building and communicating the reasons & the vision for change. Employees need to be clear about what a change involves and how they are involved in it: What is involved? What are the proposed changes? What is the timescale? Why should we do it? What will the major effects be?

Various techniques can be adopted which help ease a change process, including: Cross-functional teams Stronger internal communication Negotiation Action planning Appointing change agents or champions of change And a certain amount of compulsion manipulation and coercion

The trick is to help employees and managers accept change more easily: top management need to: Act decisively demonstrate momentum

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Consider how they will be affected Involve them in the change Consult and inform frequently Be firm but flexible Monitor the change

To reinforce the points above, consider the results of a survey of HR professionals by the CIPD. The CIPD asked HR professionals what capabilities organisations need to be changeable? The results of the survey are shown in the chart below:

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Change Process Leadership


What is leadership?
There are many ways of looking at leadership and interpretations about what it means. Leadership means different things to different people. It is often taken to represent: Getting others to follow The use of authority in decision-making A personal characteristic An ability to achieve effective performance in others

A general interpretation of leadership (source: Mullins) would be: A relationship through which one person influences the behaviour or actions of other people The above definition is important, because it shows that any consideration of what makes for effective leadership cannot be done in isolation from concepts such as teamwork, organisational structure and motivation. The traditional view sees leadership as about: Command & Control Decision-making

However, a more modern view has leadership having a wider role, including Inspiration Creating a vision Building effective teams

Leadership has become particularly important in modern business as a result of: Changing organisational structures Rapid environmental change Flatter structures require greater delegation Greater use of teamwork + focus on quality assurance Coaching, support & empowerment Change as a constant feature of business life Soft skills of leadership & management increasingly important

In these notes we are mainly concerned with leadership from the top of a business organisation. However, it is important to remember that leadership can be exercised by people at different levels of the organisational hierarchy.

What do leaders do?


The key tasks of top leadership in a business include: Being clear about what change is required

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Turning ideas into action points and motivate others to act on them Winning commitment based on honest, realistic, two-way discussion Creating a climate of learning, so people know it is safe to make mistakes Keeping going persistence is vital Learning from experiences and mistakes

A key leadership role in any business is that of the MD (Managing Director) or CEO (Chief Executive Officer). In addition to the above, the leadership tasks of the MD/CEO include: Creating the vision, based on an understanding of SWOT Forming the team and a structure that will help achieve business goals Deciding key business and personnel policies Managing rewards and discipline

Leadership styles
Leaders exercise their authority in different ways. In doing so, they are said to exhibit a leadership style. Leadership styles are essentially about: The way that the functions of leadership are carried out The way that a leader behaves

There has been substantial research into the types and effectiveness of various leadership styles, with the four most common generally accepted to be:

The key features of each of these leadership styles can be summarised as follows: Authoritarian Autocratic leaders hold onto as much power and decision-making as possible Focus of power is with the manager Communication is top-down & one-way Formal systems of command & control Minimal consultation Use of rewards & penalties Very little delegation Paternalistic Leader decides what is best for employees Links with Mayo addressing employee needs Akin to a parent/child relationship where the leader is seen as a father -figure Still little delegation A softer form of authoritarian leadership, which often results in better employee motivation and lower staff turnover

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McGregor Theory X approach Most likely to be used when subordinates are unskilled, not trusted and their ideas are not valued Democratic Focus of power is more with the group as a whole Leadership functions are shared within the group Employees have greater involvement in decisionmaking but potentially this slows-down decision-making Emphasis on delegation and consultation but the leader still has the final say Perhaps the most popular leadership style because of the positive emotional connotations of acting democratically A potential trade-off between speed of decisionmaking and better motivation and morale? Likely to be most effective when used with skilled, free-thinking and experienced subordinates

Typical paternalistic leader explains the specific reason as to why he has taken certain actions Laissez-faire Laissez-faire means to leave alone Leader has little input into day-to-day decision-making Conscious decision to delegate power Managers / employees have freedom to do what they think is best Often criticised for resulting in poor role definition for managers Effective when staff are ready and willing to take on responsibility, they are motivated, and can be trusted to do their jobs Importantly, laissez-faire is not the same as abdication

As a generalisation, in the UK there has been a gradual shift away from autocratic leadership. Possible reasons for this include: Changes in societys values Better educated workforce Focus on need for soft HR skills Changing workplace organisation Greater workplace legislation Pressure for greater employee involvement

Models of leadership
It is worth having outline knowledge of some popular models of theories of leadership. You may remember McGregors Theory X & Y from your studies of the factors that motivate employees at work. In fact McGregors work was really about management and leadership styles rather than motivation. McGregor grouped managers into two categories which reflected their alternative approaches to leadership:

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Tannenbaum and Schmidt suggested that there is a continuum of leadership behaviour . The continuum represents a range of action related to the: Degree of authority used by the manager Area of freedom available to non-managers

Tannenbaum and Schmidt links with McGregors Theory X (boss -centred leadership) & Theory Y (subordinated-centred leadership): The continuum identified four main styles of leadership: Tells Sells Consults Joins Manager identifies problems, makes decision and announces to subordinates; expects implementation Manager still makes decision, but attempts to overcome resistance through discussion & persuasion Manager identifies problem and presents it to the group. Listens to advice and suggestions before making a decision Manager defines the problem and passes on the solving & decision-making to the group (which manager is part of)

Which leadership style is best?


Many factors affect the leadership style adopted: Factors affecting leadership style Personal value systems Managers experience Confidence in subordinates Feelings of security Nature of the business problems Type of organisation (size, structure) Effectiveness of teams and groups Skills and experience of subordinates Pressure (time, costs)

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So is there a best (or optimal) leadership style? The answer is probably that the best leadership style depends on the situation! For example: Right leader for the right situation Autocratic makes more sense when business is in trouble (e.g. rapid turnaround) Autocratic would be inappropriate where performance highly dependent on effective team-working & decentralised operation Stage of business: start-up v established & complex

Role of leadership in change management


The effective management of change is a key challenge for management, and there is little doubt that the leadership shown by senior management during periods of significant change has a direct effect on whether that change is successful. Successful management of change requires positive action from top management and a leadership style that gains a commitment to change. During a period of change, leaders become change leaders, which means: Effective, open communication of the reasons for change Championing innovation and creativity as a response to change Setting a good personal example

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Planning for Change Corporate Planning


Introduction to planning
Planning is the process of Setting objectives Determining what should be done to accomplish them Implementing the plan Evaluating the results of the plan

Planning helps management answer the following questions: Where are we now? How did we get here? Where would we like to be? How do we get there? Are we on course to achieve our targets?

Planning takes place at different levels of a business the main levels being: Strategic plan Business plan Operational plan Sets out the overall direction for the business in broad scope The actions that a business will take to compete Details how the overall objectives are to be achieved. Specifies what senior management expects from specific departments or functions

These three approaches to business planning can be further categorised as follows: Strategic Level Focus Business wide Direction and strategy for whole business Broad and general Business Business unit Direction and strategy for the business unit More detail on goals and tasks 1-2 years Operational Functional area Resources and action for functional area Specific to the function

Nature

Time horizon

Long term 3+ years

Up to one year

Purpose of business planning


Planning has several purposes in business. For example, planning helps to

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Clarify direction of the business Ensure efficient use of resources Provide a way of measuring progress Support effective decision-making Co-ordinate activities Allocate responsibility Motivate & guide people

There are some strong reasons for having a good planning process in a business: Planning Gives Certainty Confidence Route map Evidence to others of our thoughts Planning Helps Shape thoughts Think through scenarios Co-ordinate activities Identify SWOT Examine risks Communicate ideas

Dont forget that planning is different from forecasting: Forecasts are predictions - they concern events and trends over which the business has little or no control Plans are about what the business intends to do But forecasts (especially sales forecasts) are essential in planning

The planning process


Every planning process goes through a series of stages. In essence the aim is to complete each of the following steps: Analyse the external environment Analyse the internal environment Define the business and mission Set corporate objectives Formulate strategies Make tactical plans Build in procedures for monitoring and controlling

An overview of the traditional business planning process is illustrated below:

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Effective business planning has to begin with an honest and realistic appraisal of the current position of the business. The formal term for this is situational analysis and there are several planning tools and methods which are helpful in putting the analysis together. The true purpose of situational analysis is to determine which opportunities to pursue: PEST / PESTEL analysis: identify and analyse trends in the environment Competitor analysis: understand and, if possible, predict the behaviour of competitors Audit of internal resources SWOT analysis: build on strengths; resolve weaknesses; exploit opportunities; confront threats

Having determined the current position, the next step is to determine the direction of the business by answering the question where are we going? The outputs from asking this question are: Vision: the non-specific directional and motivational guidance for the entire business. What will the business be like in five years time? Mission statement: a statement of the businesss reason for being. The mission statement is concerned with the scope of the business and what distinguishes it from similar businesses Objectives: SMART objectives set out what the business aims to achieve Goals: specific statements of anticipated results

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Planning for Change Managing Risk


Introduction to risk
Despite the best laid plans and controls, things often go wrong in business. Take these two examples:

Buncefield Disaster
On December 11 2005 an explosion occurred at the Buncefield oil depot in Hertfordshire, leading to Europe's biggest peacetime fire. http://www.guardian.co.uk/uk/buncefield

Heathrow Terminal Five Opening


Heathrow Terminal Five opened in March 2008. On the day of opening it quickly became apparent that the new terminal was not operating smoothly, and British Airways cancelled 34 flights and was later forced to suspend baggage check-in. Over the following 10 days some 28,000 bags failed to travel with their owners and over 500 flights were cancelled A key question, of course, is - what is risk? Risk is The possibility of loss A threat that may prevent or hinder the ability to achieve business objectives The chance (probability) that a hoped-for outcome will not occur

There are various possible approaches to managing risk: Ignore it (wait and see) Reduce probability of risk Reduce or limit the consequences Share or deflect the risk (e.g. by insurance) Make contingency plans - prepare for it Adapt in order to maintain performance Treat it as an opportunity- particularly if it affects other competitors

The two main issues for businesses to consider when addressing risk are, therefore: Risk management Contingency planning The identification and acceptance or offsetting of the risks threatening a business A plan for unforeseen events, including back up procedures, emergency response and post-event recovery

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Risk management
Risk management is about: Identifying what and how things can and might go wrong Understanding the potential effects if things go wrong Devising plans to cope with the threats Putting in place strategies to deal with the risks either before or after their occurrence

Some good examples of risk management include: Functional Area Marketing Risk Management Action Avoid over-reliance on customers or products Develop multiple distribution networks Test marketing for new products Hold spare capacity Quality assurance & control Credit insurance to protect against bad debts Investment appraisal techniques Key man insurance protects against loss of key staff Rigorous recruitment & selection procedures

Operations

Finance

People

Contingency planning
Businesses prepare contingency plans because things do go wrong from time to time. Contingency planning involves: Preparing for predictable and quantifiable crises Preparing for unexpected and unwelcome events

The aim of contingency planning is to minimise the impact of a foreseeable event and to plan for how the business will resume normal operations after the event. The key stages in contingency planning are: Recognise the need for contingency planning Identify possible contingencies (all the possible adverse and crisis scenarios) Specify the likely consequences Assess of the degree of risk to each eventuality

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Determine risk strategy (to prevent a crisis and deal with one should it occur) Prepare plan and identify management responsibilities Test the plan (crisis simulation)

Contingency planning work well when the what if question is considered carefully. Two techniques really help with addressing what if? Scenario analysis This involves constructing multiple but equally plausible views of the future The scenario consists of a story from which managers can plan Involves testing the effect of a plan on alternative values of key variables e.g. the effect of a 25% loss of capacity

Sensitivity analysis

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Planning for Change SWOT Analysis


Introduction to SWOT analysis
SWOT analysis is a method for analysing a business, its resources, and its environment. SWOT is commonly used as part of strategic planning and looks at: Internal strengths Internal weaknesses Opportunities in the external environment Threats in the external environment

SWOT can help management in a business discover: What the business does better than the competition What competitors do better than the business Whether the business is making the most of the opportunities available How a business should respond to changes in its external environment

The result of the analysis is a matrix of positive and negative factors for management to address: Positive factors Internal factors External factors Strengths Opportunities Negative factors Weaknesses Threats

The key point to remember about SWOT is that: Strengths and weaknesses Are internal to the business Relate to the present situation

Opportunities and threats Are external to the business Relate to changes in the environment which will impact the business

Strengths
Strengths are: Things a business is good at A characteristic giving a business an important capability Sources of clear advantage over rivals

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Distinctive competencies and resources that will help the business achieve its objectives

Importantly, when it comes to determining strategy: Strengths help to build up competitive advantage and serve as a cornerstone of strategy Strengths should be protected and built upon

Here are some examples of possible business strengths: Examples of Potential Business Strengths High market share Achieving economies of scale High quality Leadership & management skills Financial resources Research and development capabilities Technological leadership Brand reputation Protected IP Distribution network Employee skills High productivity Flexibility of production

Weaknesses
Weaknesses are: A source of competitive disadvantage Things the business lacks or does poorly Factors that place a business at a disadvantage Issues that may hinder or constrain the business in achieving its objectives

Management should seek ways to reduce or eliminate weaknesses before they are exploited further by the competition. Importantly, weakness should be seen as areas for improvement. Here are some examples of possible business weaknesses: Examples of Potential Business Weaknesses Low market share Inefficient plant Outdated technology Poor quality Lack of innovation A weak brand name High costs Cash flow problems Undifferentiated products Inadequate distribution Low productivity Skills shortages De-motivated staff Products at the decline stage of product life cycle

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Opportunities
An opportunity is any feature of the external environment which creates positive potential for the business to achieve its objectives . Possible sources of business opportunities in most industries and markets include: Potential Business Opportunities Technological innovation New demand Market growth Demographic change Social or lifestyle change Government spending programmes Higher economic growth Trade liberalisation EU enlargement Diversification opportunity Deregulation of the market

Some good examples of opportunities listed above include:

Threats
Threats are any external development that may hinder or prevent the business from achieving its objectives.

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Possible sources of business threats include Potential Business Threats New market entrants Change in customer tastes or needs Demographic change Consolidation among buyers New regulations Economic downturn Rise of low cost production abroad Higher input prices New substitute products Competitive price pressure

A couple of good examples to use when thinking about threats:


World Crude Oil Price - US Dollars Per Barrel
US dollars

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150 140 130 120 110 100 90 80 70 60 50 40 30 20 10 0

US dollars per barrel

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Source: Reuters EcoWin

Using SWOT analysis


There is no point producing a SWOT analysis unless it is actioned! SWOT analysis should be more than a list - it is an analytical technique to support strategic decisions Strategy should be devised around strengths and opportunities The key words are match and convert:

A key challenge for any business is to convert weaknesses into strengths. For example:

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Weakness Outdated technology Skills gap Overdependence on a single product Poor quality High fixed costs

Possible Response Acquire competitor with leading technology Invest in training & more effective recruitment Diversify the product portfolio by entering new markets Invest in quality assurance Examine potential for outsourcing or offshoring

Dont forget that f or every perceived threat, the same change presents an opportunity for business. For example:

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