Authors: Dan Cottrell, Charlie Boddington Cranleigh School
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Dan Cottrell, Charles Boddington 2004 INTRODUCTION
This Tutor2u GCSE Core Notes 2004 provides comprehensive study notes for the entire GCSE specification of the main UK examination boards. It has been written to allow you to cover all the key topics, in the right amount of detail. No more. No less. What does Core Notes cover? Each examination board and indeed every traditional GCS Business Studies textbook splits into to its own sections. We have split the courses into six main sections, following the major sections of the boards, but your board might approach it in a slightly different order. No problem. How should you use the Core Notes? These notes have been designed to allow you to make effective use of your revision time. The notes contain the things you need to know explained clearly, and in a logical order. Work through each section carefully and go back again over the areas you fight a bit difficult. We also recommend that you add your own notes, questions and answers so the Core Notes become personal to you. Weve left plenty of space to make your own adjustments, highlight the key points or make references to your textbook. Remember - TAKE OWNERSHIP and ADD VALUE! We are happy to receive suggestions about this edition of GCSE Business Studies Core Notes 2004. Perhaps you have some suggestions about areas that you think should be included in the next edition. Please email us at feedback@tutor2u.net. We would like to thank Jim Riley, Managing Director of Tutor2u for his excellent support and guidance and also to John Cottrell for his proof reading and learned advice. Good luck with your studies and our best wishes to you in the exams!
Dan Cottrell & Charlie Boddington
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Contents Marketing...................................................................................................................................................................................... 9 What is Marketing?....................................................................................................................... 9 Introduction ................................................................................................................................................................................................. 9 Kinds of Market........................................................................................................................................................................................... 9 Marketing Orientation ............................................................................................................................................................................10 Role of Marketing in a Business...........................................................................................................................................................11 Market Segmentation................................................................................................................. 12 Introduction ...............................................................................................................................................................................................12 Market Segments......................................................................................................................................................................................13 Mass and Niche Markets........................................................................................................................................................................14 Marketing Research ................................................................................................................... 15 Introduction to Marketing Research...................................................................................................................................................15 Primary Research......................................................................................................................................................................................15 Questionnaires...........................................................................................................................................................................................16 Advantages and Disadvantages of Primary Research ....................................................................................................................17 Secondary Research.................................................................................................................................................................................17 Uses of Marketing Research..................................................................................................................................................................18 Marketing Strategy, Objectives and Plans............................................................................... 19 Marketing Strategy..................................................................................................................................................................................19 Marketing Objectives...............................................................................................................................................................................19 Marketing Plans ........................................................................................................................................................................................19 SWOT Analysis...........................................................................................................................................................................................20 Marketing Mix...........................................................................................................................................................................................20 Products and Brands ................................................................................................................. 22 Introduction ...............................................................................................................................................................................................22 New Products.............................................................................................................................................................................................22 Services and Goods Marketing .............................................................................................................................................................23 Brands and Branding...............................................................................................................................................................................23 Packaging....................................................................................................................................................................................................24 Product Life Cycle.....................................................................................................................................................................................24 Product Portfolio & the Boston Matrix..............................................................................................................................................26 Pricing ......................................................................................................................................... 28 Introduction to Pricing............................................................................................................................................................................28 Pricing Strategies .....................................................................................................................................................................................28 Promotion ................................................................................................................................... 30 Introduction ...............................................................................................................................................................................................30 Advertising..................................................................................................................................................................................................30 Public Relations ........................................................................................................................................................................................31 Personal Selling.........................................................................................................................................................................................31 Direct Marketing.......................................................................................................................................................................................32 Sales Promotion........................................................................................................................................................................................32 Place (Distribution) .................................................................................................................... 34 Introduction ...............................................................................................................................................................................................34 Distribution Channels..............................................................................................................................................................................34 Overseas Markets......................................................................................................................................................................................34 E-Commerce...............................................................................................................................................................................................35 GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 5 of 165
Production..............................................................................................................................................................................37 Production Process.................................................................................................................... 37 Stages of Production ................................................................................................................. 38 Primary Production ..................................................................................................................................................................................38 Secondary Production .............................................................................................................................................................................38 Tertiary Production...................................................................................................................................................................................38 Methods of Production .............................................................................................................. 40 Job Production...........................................................................................................................................................................................40 Batch Production......................................................................................................................................................................................40 Flow Production........................................................................................................................................................................................41 Production Efficiency................................................................................................................. 43 Introduction ...............................................................................................................................................................................................43 Efficiency ....................................................................................................................................................................................................43 Strategies to Improve Efficiency..........................................................................................................................................................44 Lean Production......................................................................................................................... 45 Introduction ...............................................................................................................................................................................................45 Cell Production..........................................................................................................................................................................................45 Kaizen (Continuous Improvement) ......................................................................................................................................................45 Just-in-time (JIT) Production.............................................................................................................................................................46 Economies of Scale ................................................................................................................... 47 Introduction ...............................................................................................................................................................................................47 Internal Economies of Scale..................................................................................................................................................................47 External Economies of Scale .................................................................................................................................................................48 Diseconomies of Scale.............................................................................................................................................................................48 Quality Management .................................................................................................................. 50 What is Quality? .......................................................................................................................................................................................50 Why is Quality Important?.....................................................................................................................................................................50 Quality Control..........................................................................................................................................................................................51 Total Quality Management....................................................................................................................................................................51 Business Location ..................................................................................................................... 53 Introduction ...............................................................................................................................................................................................53 Factors Affecting Location.....................................................................................................................................................................53 Stock Control .............................................................................................................................. 56 Introduction ...............................................................................................................................................................................................56 Stock Management..................................................................................................................................................................................56 Managing People......................................................................................................................................................58 Recruitment, Selection and Retention...................................................................................... 58 Introduction ...............................................................................................................................................................................................58 Recruitment Planning..............................................................................................................................................................................59 Methods of Recruitment ........................................................................................................................................................................59 Handling Applications.............................................................................................................................................................................61 Methods of Selection ..............................................................................................................................................................................61 Employee Retention.................................................................................................................................................................................62 Training ....................................................................................................................................... 64 Why is Training Necessary? ...................................................................................................................................................................64 GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 6 of 165
Induction Training....................................................................................................................................................................................64 Methods of Training.................................................................................................................................................................................64 Government Training Schemes.............................................................................................................................................................65 Motivation ................................................................................................................................... 67 Importance of Motivation......................................................................................................................................................................67 Motivational Theory.................................................................................................................................................................................67 Management Styles.................................................................................................................... 71 Introduction ...............................................................................................................................................................................................71 Evaluation of Management Styles.......................................................................................................................................................72 McGregors Theory X and Y....................................................................................................................................................................73 Rewarding Employees............................................................................................................... 74 Introduction ...............................................................................................................................................................................................74 Financial Rewards.....................................................................................................................................................................................74 Non-financial Rewards ...........................................................................................................................................................................76 Groups at work........................................................................................................................... 78 Trade Unions ..............................................................................................................................................................................................78 Industrial Action.......................................................................................................................................................................................78 Changing Role of Trade Unions ............................................................................................................................................................79 Benefits of Trade Unions ........................................................................................................................................................................79 Other Groups in the Workplace............................................................................................................................................................80 Communication .......................................................................................................................... 81 Introduction ...............................................................................................................................................................................................81 Importance of Communication.............................................................................................................................................................81 Communication and Motivation..........................................................................................................................................................81 Methods of Communication..................................................................................................................................................................82 Effective Communication.......................................................................................................................................................................82 Barriers to Communication....................................................................................................................................................................83 Business Objectives...........................................................................................................................................85 Forms of Business Ownership and Operation........................................................................ 85 Introduction ...............................................................................................................................................................................................85 Sole Trader..................................................................................................................................................................................................85 Partnerships ...............................................................................................................................................................................................86 Limited Companies...................................................................................................................................................................................87 Co-operatives ............................................................................................................................................................................................89 Franchises ...................................................................................................................................................................................................89 Public Sector and Privatisation ............................................................................................................................................................91 Organisation of a Business....................................................................................................... 93 Introduction ...............................................................................................................................................................................................93 Span of Control and Hierarchies..........................................................................................................................................................93 Delegation ..................................................................................................................................................................................................95 Business Departments.............................................................................................................................................................................96 Nature of the Organisation of a Business .........................................................................................................................................97 Business Aims and Objectives ................................................................................................. 98 Introduction ...............................................................................................................................................................................................98 Business Objectives..................................................................................................................................................................................98 Alternative Aims and Objectives ..........................................................................................................................................................99 Changing Objectives................................................................................................................................................................................99 GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 7 of 165
Stakeholders............................................................................................................................. 101 Introduction ............................................................................................................................................................................................ 101 Stakeholders versus Shareholders..................................................................................................................................................... 101 Social Responsibility............................................................................................................................................................................. 102 Ethics......................................................................................................................................................................................................... 102 Starting a Business.................................................................................................................. 103 Introduction ............................................................................................................................................................................................ 103 Entrepreneurs ......................................................................................................................................................................................... 103 Start Up Finance.................................................................................................................................................................................... 104 Business Plan.......................................................................................................................................................................................... 104 Advantages of Small Businesses ....................................................................................................................................................... 105 Growing a Business................................................................................................................. 106 Introduction ............................................................................................................................................................................................ 106 Mergers and Acquisitions.................................................................................................................................................................... 107 Constraints on Growth......................................................................................................................................................................... 107 Rationalisation....................................................................................................................................................................................... 108 International business and globalisation........................................................................................................................................ 108 External Environment and Business........................................................................................ 110 The Business Environment ..................................................................................................... 110 What is a Business? .............................................................................................................................................................................. 110 Business Activity.................................................................................................................................................................................... 110 Main Types of Business Activity........................................................................................................................................................ 111 Types of product .................................................................................................................................................................................... 111 Markets..................................................................................................................................................................................................... 112 Main Functions in a Business ............................................................................................................................................................ 112 Profit, Loss and the Entrepreneur ..................................................................................................................................................... 112 External Factors Affecting Business...................................................................................... 114 Introduction ............................................................................................................................................................................................ 114 Main Factors ........................................................................................................................................................................................... 114 Changing External Environment ....................................................................................................................................................... 114 Business and Competition................................................................................................................................................................... 115 Social Environment and Responsibility........................................................................................................................................... 115 Legislation ............................................................................................................................................................................................... 116 Ethics......................................................................................................................................................................................................... 117 Pressure Groups ..................................................................................................................................................................................... 118 Environmental Issues............................................................................................................................................................................ 118 Technological Change .......................................................................................................................................................................... 118 Economic Environment ...........................................................................................................122 Types of Business Activity................................................................................................................................................................... 122 How Business Activity is Changing.................................................................................................................................................. 122 Types of Economy.................................................................................................................................................................................. 123 Private and Public Sector Business................................................................................................................................................... 123 Government Economic Policy ............................................................................................................................................................ 124 Taxation.................................................................................................................................................................................................... 125 Government Spending.......................................................................................................................................................................... 125 Interest Rates.......................................................................................................................................................................................... 126 Labour Market ........................................................................................................................................................................................ 126 Gross Domestic Product (GDP) and Consumer Spending........................................................................................................... 127 Exchange Rates...................................................................................................................................................................................... 128 GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 8 of 165
Business and the Global Economy.................................................................................................................................................... 129 Business and Europe............................................................................................................................................................................. 130 European Single Currency (Euro)................................................................................................................................................... 131 Social and External Costs.................................................................................................................................................................... 131 Accounting and Finance..........................................................................................................................133 Profit .......................................................................................................................................... 133 What is Profit and Why is it Important? ........................................................................................................................................ 133 Sources and Uses of Finance ................................................................................................. 135 Introduction ............................................................................................................................................................................................ 135 Choosing the Right Source of Finance............................................................................................................................................ 136 Short Term and Long Term Finance.................................................................................................................................................. 136 Internal and External Finance............................................................................................................................................................ 137 Sources of External Finance............................................................................................................................................................... 138 Debentures .............................................................................................................................................................................................. 139 Bank Loans and Overdrafts................................................................................................................................................................. 139 Leasing...................................................................................................................................................................................................... 140 Hire Purchase.......................................................................................................................................................................................... 140 Debt Factoring........................................................................................................................................................................................ 140 Government Finance............................................................................................................................................................................. 140 Trade Credit............................................................................................................................................................................................. 141 Retained Profits ..................................................................................................................................................................................... 141 Own Capital............................................................................................................................................................................................. 141 Working Capital ..................................................................................................................................................................................... 141 Sources of Finance for Public Sector Organisations.................................................................................................................... 141 Financial Accounting............................................................................................................... 143 Introduction ............................................................................................................................................................................................ 143 Financial Statements............................................................................................................................................................................ 143 Profit and Loss Account....................................................................................................................................................................... 144 Revenue and Capital Expenditure..................................................................................................................................................... 146 Balance Sheet......................................................................................................................................................................................... 147 Depreciation............................................................................................................................................................................................ 148 Cash flow statement............................................................................................................................................................................. 149 Legal Obligations ................................................................................................................................................................................... 149 Decision-making and Financial Accounts ...................................................................................................................................... 149 Analysing Financial Performance........................................................................................... 151 Introduction ............................................................................................................................................................................................ 151 Profit and Profitability ......................................................................................................................................................................... 151 Liquidity.................................................................................................................................................................................................... 153 Financial efficiency............................................................................................................................................................................... 153 Business Costs ........................................................................................................................ 158 Introduction ............................................................................................................................................................................................ 158 Fixed and Variable Costs ..................................................................................................................................................................... 158 Standard Costing and Variances ....................................................................................................................................................... 159 Break-even .............................................................................................................................................................................................. 159 Budgeting and Business Plans............................................................................................... 162 Introduction ............................................................................................................................................................................................ 162 Cash Flow Forecasting ......................................................................................................................................................................... 162 Business Plans ........................................................................................................................................................................................ 164 GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 9 of 165
MARKETING What is Marketing? Introduction What makes someone buy a product? Or more importantly, what makes them buy the product you are trying to sell? In business, you need to persuade a customer to part with money in exchange for a good or a service. You have decide on what the product is going to be like (e.g. shape, colour, size, features); at what price are you going to sell it; where you are going to sell it (e.g. in a shop, over the Internet, by mail order); and how you going to help the customer find out about the product (e.g. advertise in the local newspaper or on the radio). Marketing is all of these things. A market is a group of consumers, who could be individuals, businesses or governments who might buy this type of product for example, the market for running shoes or the market for fresh flowers. And marketing is often defined as: The process of identifying, anticipating (predicting) and satisfying customer needs profitably What does it mean? Identifying finding out by using marketing research about current products, the possibility of new products, and about current markets and possible new markets. Anticipating (predicting) analysing the data collected and using the managers skills to judge what might happen in these markets and how the products might be suited or changed, adapted or updated. Satisfying customer needs making sure the person, business or government is happy with what they are buying, will not complain and will be happy to buy again if appropriate. Profitably adding value to the product so when sold, the price of the product is greater than cost of the inputs. All of these marketing activities take place in a market. Kinds of Market There are four main kinds of market: Industrial markets: the market for manufactured products aimed at businesses, i.e. capital goods e.g. engineering, construction. Consumer markets: the market for goods and services that are sold to households e.g. clothing, shampoo, holidays. Commodity markets market for primary products or raw materials e.g. steel, coal, coffee. Financial markets: the market for services that dealing with money e.g. banking, insurance, accounting. Much of your study of marketing will focus on consumer markets - since this relates to the kinds of products GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 10 of 165
and services that you, your friends and family buy. Goods bought in consumer markets can be categorised in several further ways: Fast-moving consumer goods ( FMCGs ) - These are high volume, low unit value, fast repurchase. - Examples include: Ready meals; Baked Beans; Newspapers. Consumer durables - These have low volume but high unit value. Consumer durables are often further divided into white goods (e.g. fridge-freezers; cookers; dishwashers; microwaves) and brown/black goods (e.g. DVD players; games consoles; personal computers). Soft goods - Soft goods are similar to consumer durables, except that they wear out more quickly and therefore have a shorter replacement cycle. Examples include clothes, shoes. Services (e.g. hairdressing, dentists, childcare) Not all markets are the same. Some are very large, some small. Some markets are focused on a particular location; others operate around the world. We need a measure of a market most often we talk about market size. Market size means the number of customers in the market (either current or potential buyers) and the amount (value or volume) that they buy. One business rarely sells to all the customers in the market. They will have a share of the market with the rest shared out amongst one or more competitors. Market share by value: using sales in a specific period (usually one year). Market share by volume: using units sold or bought as a measure of size. Market share is an important idea. There is lots of evidence to show that businesses that enjoy a large share of a market achieve higher profits than smaller competitors. Marketing Orientation Businesses can develop new products based on either a marketing orientated approach or a product orientated approach. A marketing orientated approach means a business reacts to what customers want. The decisions taken are based around information about customers needs and wants, rather than what the business thinks is right for the customer. Most successful businesses take a market-orientated approach. A product orientated approach means the business develops products based on what it is good at making or doing, rather than what a customer wants. This approach is usually criticised because it often leads to unsuccessful products - particularly in well-established markets. Most markets are moving towards a more market-orientated approach because customers have become more knowledgeable and require more variety and better quality. To compete, businesses need to be more sensitive to their customers needs otherwise they will lose sales to their rivals. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 11 of 165
On the other hand some products are argued to create a need or want in the customer, especially products with a very high technological content. Mobile phones have moved from being a business accessory to being a big consumer brand item, with many additional gadgets, such as pictures, video and Internet access. Innovations create the need rather than the customer being able to second-guess how new technology is going to develop. Role of Marketing in a Business Marketing is perhaps the most important activity in a business because it has a direct effect on profitability and sales. Larger businesses will dedicate specific staff and departments for the purpose of marketing. It is important to realise that marketing cannot be carried out in isolation from the rest of the business. For example: The marketing section of a business needs to work closely with operations, research and development, finance and human resources to check their plans are possible. Operations will need to use sales forecasts produced by the marketing department to plan their production schedules. Sales forecasts will also be an important part of the budgets produced by the finance department, as well as the deployment of labour for the human resources department. A research and development department will need to work very closely with the marketing department to understand the needs of the customers and to test outputs of the R&D section.
Key Terms in this Section
Term Definition Consumer Markets Markets for goods and services that are sold to households Industrial markets Markets for goods and services sold to other businesses Market A market is the demand for a particular product or service Market share The proportion of the overall market that is held by one particular business or product. A market is shared amongst competitors Market Size The value or a market over a period of time (usually measured over one year). Sometimes market size is also measured in terms of volume (e.g. the number of units sold in the period) Marketing Orientation A business that basis its marketing decisions on the needs and wants of customers
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Market Segmentation Introduction A market for a product is made up of different types of consumer who buy the product, which can be subdivided into segments. Market segments are an important part of marketing because markets consist of customers with similar needs. For example, consider the wide variety of markets that exist to meet the following customer needs: Need Market Segments Created to Meet the Customer Need To eat Restaurants; fast-food outlets; grocery supermarkets To drink Coffee bars; wine & spirits production; milk production To exercise Health & leisure clubs; sport equipment; walking holidays To travel Airlines; railways; motor car industry; holiday industry To socialise Introduction agencies; sporting events; pubs As you can imagine, such markets (if they were not further divided) would be very broad and of little use to someone wanting to make sensible marketing decisions. Fortunately for those involved in marketing, customers in a market are not the same. Customers differ in the: Benefits they want Amount they are able to or willing to pay Media (e.g. television, newspapers, radio stations) they see Quantities they buy Time and place that they buy It therefore makes sense for businesses to segment the overall market and to target specific segments of a market so that they can design and deliver more relevant products and services By splitting the market into segment it is easier to analyse who buys the product and then aim to target these customers specifically. For instance if you know that it is mainly young men under 21 who buy your product you might then advertise in magazines such as FHM or Loaded. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 13 of 165
Market Segments The main ways in which market can be segmented are into: Socio-economic grouping see notes further below Age of the customer for instance teenagers or old age pensioners Gender male or female Size and composition of customer households a household of say two unmarried adults, or a single person living only or a family with 2 children and a per dog Geographical location e.g. London, Scotland Ethnicity and/or religion e.g. Islamic or Anglo-Italian Educational background of customers e.g. graduates or school leavers Segmentation that divides the market into groups based on factors such as age, gender and family size is known as demographic segmentation . Socio-economic segments are widely used in marketing. The six standard socio-economic groupings in the UK are: Group Description A Higher managerial, administrative or professional e.g. surgeon or company director B Intermediate managerial, administrative or professional e.g. teachers, solicitors C1 Skilled non-manual e.g. sales assistants, shop floor supervisors C2 Skilled manual e.g. electrician, plumber D Semi skilled e.g. assembly line workers, cleaners E Unskilled, pensioners and unemployed Age is a particularly important grouping because: Members of the same age group tend to be at the same stage of their family life cycle, e.g. new parents, and thus to have similar wants. Consumers of a similar age also have similar financial circumstances (e.g. retired people living on a pension and savings will have a different income they can spend compared with students at university). GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 14 of 165
Mass and Niche Markets A mass market product is a product that appeals to a large number of different segments, such as Coca Cola. Sales in a mass market are much greater than in a niche market, potentially leading to economies of scale as well. A niche market product appeals to a just a few segments or perhaps just one, a specialist product, e.g. Railway Modeling magazine. There will be less competition and a chance to charge higher prices, but small sales and not much opportunity for economies of scale. A business will need to decide whether it wants to have a mass market product or a niche market product. It can then adjust its marketing mix (see further). For example, a niche market product will have a higher price probably than a mass market product and promotion will be different since different segments will need to be targeted.
Key Terms in this Section
Term Definition Demographic segmentation Defining a market segment in terms of factors such as age, gender and family size Geographic segmentation Defining a segment in terms of where customers are located Market segment A group of customers with similar needs and wants Mass market Goods and services that appeal to many customer segments Niche market Goods and services that appeal to a narrow or small customer base Socio-economic segmentation Defining a market segment in terms of income and occupation GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 15 of 165
Marketing Research Introduction to Marketing Research Marketing research means finding out about the product and its market place. It is an important part of identifying and anticipating customers needs. Once the product has been bought, marketing research can be used to see if the customer was satisfied. A business might carry out marketing research to: Find data and information that help a business understand what customers want now or in the future. Find out whether current products are satisfying customers. Test new products by asking potential customers to try out the product. Assess the results of its promotional strategy e.g. test the effectiveness of an advertising campaign. Understand the activities and strategies of competitors. The two main kinds of marketing research are Primary research Secondary research Primary Research Primary research involves getting original data directly about the product and market. Primary research data is data that did not exist before. It is designed to answer specific questions of interest to the business - for example: What proportion of customers believes the level of customer service provided by the business is rated good or excellent? What do customers think of a new version of a popular product? To collect primary data a business must carry out field research. The main methods of field research are: Face-to-face interviews interviewers ask people on the street or on their doorstep a series of questions. Telephone interviews - similar questions to face-to-face interviews, although often shorter. Online surveys using email or the Internet. This is an increasingly popular way of obtaining primary data and much less costly than face-to-face or telephone interviews. Questionnaires sent in the post (for example a customer feedback form sent to people who have recently bought a product or service). Focus groups and consumer panels a small group of people meet together with a facilitator who asks the panel to examine a product and then asked in depth questions. This method is often used when a business is planning to introduce a new product or brand name. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 16 of 165
In most cases it is not possible to ask all existing or potential customers the questions that the business wants answering. So primary research makes use of surveys and sampling to obtain valid results. Sampling is where a small section of the relevant population is asked a number of questions or is given the opportunity to use a sample of the product to indicate what the whole population would think about the product. For example, for a recent advertising campaign 108 people were asked whether they would choose the new MG ZT to drive over a Mercedes 3 series. 88 people said they would choose the MG ZT, enabling MG to say that 8 out of 10 people prefer the MG (or over 80% of the driving population in the UK). The four main types of sampling are: Quota sampling asking people who share certain characteristics (e.g. aged between 18-25). Random sampling everyone has an equal chance of being asked a question. Stratified sampling population is segmented by a common characteristic. Cluster sampling target population is divided into groups (normally by geographical region) and random sample taken from these groups. Questionnaires Questionnaires are one the main tools in the use of field research. A questionnaire contains a series of questions which gather primary marketing research data for the business. Questionnaires need to be designed carefully. The design of the questionnaire depends on the following: Objectives of the questionnaire what information is needed, at a minimum, from customers who complete the questions? The type of person who is going to be asked questions need be easy to understand and also easy to answer depending on the person who is answering. How the questionnaire is going to be taken? A face-to-face questionnaire might include different questions to an emailed questionnaire. An interviewer will be filling in a face-to-face questionnaire and the person may be able to ask for the question to be rephrased if they do not understand it the first time. The types of questions that can be asked can be split into three groups: Simple yes/no answers e.g. have you seen the new advert for cornflakes Multiple choice a number of options are available to the answer Sliding scale a value is placed on an answer e.g. how do rate the performance of this product less than satisfactory, satisfactory, excellent (or could use a scale of 1-10 with 10 being excellent and 1 being dreadful!). Once the questionnaires are complete, the data is collated and analysed. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 17 of 165
Advantages and Disadvantages of Primary Research The main advantages of primary research and data are that it is: Up to date. Specific to the purpose asks the questions the business wants answers to. Collects data which no other business will have access to (the results are confidential). In the case of online surveys and telephone interviews, the data can be obtained quite quickly (think about how quickly political opinion polls come out). The main disadvantages of primary research are that it: Can be difficult to collect and/or take a long time to collect. Is expensive to collect. May provide mis-leading results if the sample is not large enough or chosen with care; or if the questionnaire questions are not worded properly. Secondary Research Secondary research involves obtaining market information from existing information and material. This information is known as secondary data. The main sources of secondary data are: Published financial information (e.g. accounts of competitors) Government reports (e.g. data from the National Statistical Office) Data from consumer groups (e.g. Which? magazine surveys of consumer products) Reports from marketing research companies (e.g. Mintel, Keynote) Internal business records e.g. sales reports Press cuttings Trade and industry associations Typical information that might be found using secondary includes: Size of the market and how fast it is growing. Competitors how many; sales and profits; pricing strategies; product development. Age and occupational profile of consumer in a region. Key trends in the market e.g. how are customer needs and wants changing? The main advantages of using secondary research are: Provided the information exists, it is usually quicker and cheaper than primary research. It can provide a perspective on the whole market, giving the business a feel for whether they should spend GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 18 of 165
more money on developing products for that market. For instance they could find out that there are not enough potential customers for the product to break even. The main disadvantages of using secondary research are: It is out of date quickly. It is available to all the other businesses, so does not provide many advantages against competitors. The data may not exactly fit the purpose of the research. A good example of using secondary research effectively is in the launch of a new product. Government statistics could provide information on the size of the market, the socio-economic groups in a launch area. Competitors brochures and websites could give information on pricing, product sizes and features of existing products in the market. Uses of Marketing Research As we said earlier, it is vital that a marketing-orientated business understands as much as possible about its customers and the way in which they are already being served by competitors. Marketing research is particularly important in launching a new product. Marketing research is aimed at reducing the risk of failure. It tries to find out how the customer will react to the new product. If they are negative in their findings, then either the product is shelved, or adjustments are made. The uses of marketing research are often to find out: Answers to questions on whether the customer will buy the product and how often? What they are willing to pay? What type of customer is interested in the product? Where it should be sold? A small business would probably find large-scale primary research too expensive. Instead they often rely on asking friends and family, or customers. However, small businesses increasingly have access to the extensive amount of material available on the Internet. A small business can also use the local business organizations such as the Department of Trade and Industry (DTi), Training Enterprise Councils (TECs) and Chambers of Commerce. Key Terms in this Section Term Definition Marketing research The gathering, recording and analysing of data about questions relating to a product or service and its market Primary research Marketing research data collected specifically for a marketing research project and obtained directly from the relevant source. Sampling Obtaining research results from a small group to represent the views of a larger group Secondary research Marketing research data that has already been collected, analyses and used for other purposes or published for general reference
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Marketing Strategy, Objectives and Plans Marketing Strategy Marketing strategies explain how the marketing function fits in with the overall strategy for a business. Examples of marketing strategies could be: Business Strategy Example Marketing Strategies Launch new products Expand distribution (e.g. open more shops) Grow sales Start selling products into overseas markets Increase selling prices Increase profits Reduce the amount spent on television advertising Implement a public relations programme Build customer awareness Invest more in advertising Once a strategy has been identified, then the business must develop an action to turn the strategy into reality. The starting point for this plan is the setting of marketing objectives. Marketing Objectives Marketing objectives are the specific targets for marketing set by the business to achieve their corporate objectives. Examples of marketing objectives might be: Increase sales by 10% Launch a new product by the end of the year Achieve a 95% customer satisfaction rating Increase the number of retail outlets selling our products by 250 within 12 months It is important for a business to set marketing objectives because managers can then have targets for their work. They can then measure more effectively the success or failure of their marketing strategies to achieve these objectives. Marketing Plans The marketing plan is a detailed document that explains how all the different elements of the marketing mix will be used to achieve the marketing objectives. A marketing plan is usually prepared following a review of the current situation (sometimes called a marketing audit) that looks at questions such as: What are our existing products and brands? Are the markets we do business in growing? If so, how fast? GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 20 of 165
Who are our competitors? What advantages (if any) do we have over them? How effective has our marketing been in recent history? Are there ways in which we could achieve the marketing objectives differently and more profitably? SWOT Analysis An important part of the planning process is looking at the existing position of the business and trying to decide how factors external to the business may affect the business. A business can perform a SWOT analysis as away of deciding which marketing strategy to use. The business performs an audit on the internal and external nature of the business looking at the current and future situation. An audit is a review of all the business activities. Internal Explanation Strategy Implications Strengths Reviews the business current strengths such as a good brand or strong sales performance Can develop the strengths, perhaps in the way they promote the product, or wish to develop new products (Virgin have used their strong brand name to launch several products) Weaknesses Reviews the business current weaknesses such poor response times to requests for information or late deliveries Can implement strategies to eradicate these weaknesses e.g. more resources put into a better warehousing system for the despatch of goods. External Opportunities Reviews the business future opportunities e.g. new technology making it easier to manufacturer certain goods or new markets abroad Can use strategies to take advantage of the potential opportunities e.g. developing new products to meet the potential increased demand Threats Reviews the business future threats, mostly from increased competition from other firms or from changes in the economic situation. Can employ strategies to ward off these problems, e.g. setting lower prices or increasing promotion Marketing Mix The marketing mix deals with the way in which a business uses price, product, distribution and promotion to market and sell its product. The marketing mix is often referred to as the Four Ps - since the most important elements of marketing are concerned with: Product - the product (or service) that the customer obtains. Price - how much the customer pays for the product. Place how the product is distributed to the customer. Promotion - how the customer is found and persuaded to buy the product. It is known as a mix because each ingredient affects the other and the mix must overall be suitable to the target customer. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 21 of 165
For instance: High quality materials used in a product can mean that a higher price is obtainable. An advertising campaign carried in one area of the country requires distribution of the product to be in place in advance of the campaign to ensure there are no disappointed customers. Promotion is needed to emphasise the new features of a product. The marketing mix is the way in which the marketing strategy is put into action - in other words, the actions arising from the marketing plan. Key Terms in this Section Term Definition Marketing mix The marketing decisions taken about products, prices, promotion and place (distribution) Marketing objectives Specific, measurable, achievable objectives for the marketing function Marketing plan The action plan that describes in detail what marketing activities are to be carried out Marketing strategy A description of the overall approach taken by a business towards marketing in order to achieve the business objectives SWOT analysis A method of assessing the current situation of the business focusing on the things within its control (strengths and weaknesses) and outside of its control (opportunities and threats)
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Products and Brands Introduction What is a product? A product is anything that is capable of satisfying customer needs . This definition therefore includes both: Physical products e.g. cars, washing machines, DVD players, take-away pizzas. Services e.g. dental treatment, accountancy, insurance. Products are at the heart of marketing. The product needs to exist for the other elements of the mix to happen. Part of the marketing of the product is through product differentiation. This means making the product different from its competitors. Product differentiation can be achieved through: Distinctive design e.g. Dyson; Apple iPod. Branding - e.g. Nike, Reebok. Performance - e.g. Mercedes, BMW. Most businesses sell more that one product. Often they will produce several similar products that appeal to different customers. A collection of such products is known as a product group or product range . Good examples of product groups include: Dells range of desktop and laptop computers. Sonys range of DVD players and televisions. There are several advantages to having a product range rather than just one product: Spread the risk a decline in one product may be offset by sales of other products. Selling a single product may not generate enough returns for the business (e.g. the market segment may be too small to earn a living). A range can be sold to different segments of the market e.g. family holidays and activity holidays. However a greater range of products can mean that the marketing resources (e.g. personnel and cash) are spread more thinly. Recently Unilever, who make over two hundred well known brands such as Dove and Flora margarine, decided sell some of their product names to concentrate their investment on fewer products and brands. New Products To grow fast, businesses need to develop new products. But before a business can launch a new product, it needs to go through several stages before it appears in the market place. The main stages are: Marketing research find out what customers want, who they are, and where the gaps are in the marketplace. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 23 of 165
Product development and testing make prototypes; experiment by allowing a sample of potential customers to trial the product before it is launched. Distribution of product to outlets the product cannot be sold unless it is in a position for customers to buy it books will need to be in the bookshops and hammers in the hardware stores. Promotional launch to inform customers features of new product this might be done locally, nationally or internationally the customers need to know that the product is ready, available and that it might be the sort of thing they want to buy. At the first two stages (marketing research and product development/testing) many products are rejected because the findings of research shows that it will not be successful or they cannot make a satisfactory prototype. Product testing might show that customers react badly to the product. The new product launch needs all the elements of the mix to be in place to be successful. Services and Goods Marketing Products can be split into two broad categories: Goods physical products that you can touch and feel, e.g. food and clothing Services products that are non-physical watching a film or going to school Marketing services can be different to marketing goods. Services, such as banking, are mainly marketed through product differentiation. Similar products are adjusted to the target audience, for instance instant access account and long-term deposit accounts, or accounts for children. Businesses then use heavy promotion to highlight these differences. It differs from goods marketing, because goods have greater opportunity to use packaging and physical product design. Brands and Branding A brand is a product with unique character, for instance in design or image. It is consistent and well recognised. The advantages of having a strong brand are: Inspires customer loyalty leading to repeat sales and word-of mouth recommendation. The brand owner can usually charge higher prices, especially if the brand is the market leader. Retailers or service sellers want to stock top selling brands. With limited shelf space it is more likely the top brands will be on the shelf than less well-known brands. Some retailers use own-label brands, where they use their name of the product rather than the manufacturers like Tescos Finest range of meals and foodstuffs. These tend to be cheaper than the normal brands, but will give the retailer more profit than selling a normal brand. Some brands are so strong that they have become global brands. This means that the product is sold in many countries and the contents are very similar. Examples of global brands include: Microsoft, Coca Cola, Disney, Mercedes and Hewlett Packard. The strength of a brand can be exploited by a business to develop new products. This is known as brand extension a product with some of the brands s characteristics. Examples include Dove soap and Dove GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 24 of 165
Shampoo (both contain moisturiser); Mars Bar and Mars Ice Cream. Brand stretching is where the brand is used for a diverse range of products, not necessarily connected, e.g. Virgin Airlines and Virgin Cola; Marks and Spencer clothes and food. The logo on a product is an important part of the product. A logo is a symbol or picture that represents the business. It is important because it is easy to recognise, establishes brand loyalty and can create a favourable image. Packaging Packaging is sometimes known as the fifth P in the marketing mix. It is closely associated with product because it is in what most goods are delivered to the customer. The main purposes of packaging are to: Protect the product on its journey from the manufacturer and warehouse to retailer and then to customer (who might use the packaging for storage e.g. jam jar). Promote the product by communicating information about the product. Packaging also contains key details on usage/storage and safety (most products need to comply with packaging legislation). Product Life Cycle The product life cycle is an important concept in marketing because it describes the stages a product goes through from when it was first thought of until it finally is removed from the market. Not all products reach this final stage. Some continue to grow and others rise and fall. The main stages of the product life cycle are: Introduction researching, developing and then launching the product. Growth when sales are increasing at their fastest rate. Maturity sales are near their highest, but the rate of growth is slowing down, e.g. new competitors in market or saturation. Decline final stage of the cycle, when sales begin to fall. This can be illustrated by looking at the sales during the time period of the product. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 25 of 165
A branded good can enjoy continuous growth, such as Microsoft, because the product is being constantly improved and advertised, and maintains a strong brand loyalty. Extension strategies extend the life of the product before it goes into decline. Again businesses use marketing techniques to improve sales. Examples of the techniques are: Advertising try to gain a new audience or remind the current audience, e.g. the recent Kelloggs Cornflakes adverts. Price reduction more attractive to customers. Adding value add new features to the current product, e.g. video messaging on mobile phones. Explore new markets try selling abroad, e.g. Robbie Williams trying to sell more records in the US. New packaging brightening up old packaging, or subtle changes such as putting crisps in foil packets or Seventies music compilations. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 26 of 165
Product Portfolio & the Boston Matrix A business with a range of products has a portfolio of products. However, owning a product portfolio poses a problem for a business. It must decide how to allocate investment (e.g. in product development, promotion) across the portfolio. A portfolio of products can be analysed using the Boston Group Consulting Matrix. This categorises the products into one of four different areas, based on: Market share does the product being sold have a low or high market share? Market growth are the numbers of potential customers in the market growing or not? How does the Boston Matrix work? The four categories can be described as follows:
Stars are high growth products competing in markets where they are strong compared with the competition. Often Stars need heavy investment to sustain growth. Eventually growth will slow and, assuming they keep their market share, Stars will become Cash Cows Cash cows are low-growth products with a high market share. These are mature, successful products with relatively little need for investment. They need to be managed for continued profit - so that they continue to generate the strong cash flows that the company needs for its Stars Question marks are products with low market share operating in high growth markets. This suggests that they have potential, but may need substantial investment to grow market share at the expense of larger competitors. Management have to think hard about Question Marks - which ones should they invest in? Which ones should they allow to fail or shrink? GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 27 of 165
Unsurprisingly, the term dogs refers to products that have a low market share in unattractive, low-growth markets. Dogs may generate enough cash to break-even, but they are rarely, if ever, worth investing in. Dogs are usually sold or closed. Ideally a business would prefer products in all categories (apart from Dogs!) to give it a balanced portfolio of products. Key Terms in this Section Term Definition Boston matrix Analysis of products into four categories based on market growth and market share Brand A product with unique character, for instance in design or image. It is consistent and well recognised. Brand / product extension Making new products based on the original brands characteristics Product A good or a service that is capable of satisfying customer needs Product differentiation Making a product different from its close rivals, e.g. different colours, shape or design features Product life cycle Describes the stages a product goes through from when it was first thought of until it finally is removed from the market
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Pricing Introduction to Pricing The law of demand states that, for nearly all products, the higher the price the lower the demand. In other words, sales will fall if prices are put up. However higher prices can also mean higher profits. So how does a business decide how to set a price for its products? A business needs to set a price which maximises their sales revenue. Sales revenue is the total amount of money made from sales and is the price of the product multiplied by the number of sales. For a new business with a new product setting a price can be difficult to do because they have no experience of what customers are prepared to pay. Get the price too high and sales are lost, too low and people who are prepared to pay more are not going to. Businesses use a variety of methods to work out what price they might set: Past product data. What competitors or similar markets have as prices? Surveys and questionnaires. They are several factors that the business will need to consider in setting the price: The state of the market for the product if there is a high demand for the product, but a shortage then the business can put prices up. Recently, when the US government decided to publish guidelines on what to do in the event of war, following the terrorist attacks on their country, people rushed out to buy masking tape. There was quickly a shortage and prices went up. Union Jack flags during the Jubilee year were also subject to higher prices for the same reason. The state of the economy some products are more sensitive to changes in unemployment and workers wages than others. Makers of luxury products will need to drop prices especially when the economy is in a downturn. Pricing Strategies There are several different pricing strategies available to a business: Strategy Description Cost-plus pricing Setting a price by adding a fixed amount or percentage to the cost of making the product Penetration pricing Setting a very low price to gain as many sales as possible Price skimming Setting a high price before other competitors come into the market Predatory pricing Setting a very low price to knock out all the other competition Competitor pricing Setting a price based on competitors prices Price discrimination Setting different prices for the same good, but to different markets e.g. peak and off peak mobile phone calls Psychological pricing Setting a price just below a large number to make it seem smaller e.g. 9.99 not 10 GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 29 of 165
A new business that is entering the market might try the following strategies: If they are first into the market then they might use price SKIMMING. If they are trying to establish themselves in the market then PENETRATION pricing. Sometimes a business may use a loss leader. This is a product where the price is so low that the retailer may not make any profit or even a loss on the sale, but does attract shoppers to buy other full price products. Orange juice has been used by businesses such as Rank Hovis McDougall to entice supermarkets to stock more of their other products. Price skimming has been used for the launch of high technology products, such as DVD players and Personal Digital Assistants (PDAs) - which were far more expensive than they are now when they first arrived in the market. Key Terms in this Section
Term Definition Price skimming Setting a high price when a new product first enters the market Price penetration Setting a low a price so make lots of sales quickly GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 30 of 165
Promotion Introduction Promotion is the way in which a business makes their product known to the customers, current and potential The three main methods of promotion are: Advertising Public relations Merchandising These main areas form a part of the promotional mix that includes direct mailing, personal selling and sales promotion. A business will use a range of promotional activities for its product, depending on the marketing strategy and the budget available. The way in which promotion is targeted is split into two types: Above the line promotion paid for communication in the independent media e.g. advertising on TV or in the newspapers. Though it can be targeted, it could be seen by anyone outside the target audience. Below the line promotion promotional activities where the business has direct control e.g. direct mailing and money off coupons. It is aimed directly at the target audience. Advertising Advertising presents or promotes the product to the target audience through media such as TV, radio, billboards to encourage them to buy. When deciding which type of advertising to use known as an advertising medium a business needs to consider the following factors: Reach of the media nationally or locally, the number of potential customers it could reach. Nature of the product the media needs to reflect the image of the product; a recruitment ad would be placed in a trade magazine or newspaper but a lipstick ad would be shown on TV or womens magazines. Position in product life cycle launch stage will need different advertising from extension strategies. Cost of medium radio cheaper than TV, but may want to consider cost per head if reaching a larger audience. In the printed media, advertising can take two forms: A classified advert is normally put into a newspaper by an individual and is expressed solely in words and numbers. A display advert is where space is bought in the newspaper or magazine and can be filled with words and/or pictures. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 31 of 165
Display adverts have more impact, but are more expensive. Advertising can also be split into two main types: Persuasive advertising - this tries to entice the customer to buy the product by informing them of the product benefit. Informative advertising - this gives the customer information. Mostly done by the government (e.g. health campaigns, new welfare benefits). Sometimes a business will employ an advertising agency to deal with its needs. An agency plans, organises and produces advertising campaigns for other businesses. The advantage of an agency managing the campaign is that it has the expertise a business may not have, e.g. copywriters, designers and media buyers. Businesses need to be fully aware of the laws that govern advertising. The main law is the Trade Descriptions Act goods advertised for sale must be as they are described. Also the advertising industry has its own Code of Practice, and is regulated by the Advertising Standards Authority where complaints about the nature of advertising can be dealt with. Public Relations Public relations is a broad series of activities involving a business managing its relationships with different parts of the public, e.g. customers, the media and investors. The main objectives of public relations are: To achieve favourable publicity about the business at no cost. To build the image and reputation of the business and its products, particularly amongst customers. To communicate effectively with customers. Public relations (PR) has the following advantages over advertising in terms of promotion: No direct charge is made for PR, though a business will need to pay for its own PR department or external PR consultant. PR is arguably more powerful because the message the business communicates through PR is often more believable than paid for advertising. However there is no guarantee that PR will reach its target audience (newspapers may fail to print the story) whereas advertising must be printed since the space in the newspaper is paid for. Personal Selling Personal selling is where businesses use people to sell the product directly to the customer. The sellers promote the product through their attitude, appearance and knowledge. They aim to inform and encourage the customer to buy the product. A good example of personal selling is found in department stores on the perfume and cosmetic counters. A customer can get advice on how to apply the product and can try different products. It is worth noting that this part of the department store is often the most profitable. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 32 of 165
Direct Marketing Direct marketing is aimed directly at the customer, so bringing the promotional activity straight to the target audience e.g. direct mailing or door-to-door sellers. Examples of business than rely on direct marketing are: QVC (TV Selling) Boden (clothes from catalogues) Sunday Times Wine Direct (wine through flyers in newspapers) Direct marketing has the following advantages and disadvantages: Advantages Disadvantages No intermediaries (e.g. retailers) to take part of the profits Costs of distribution of promotional material Producer can control own marketing Costs of making distributional material (e.g. catalogues for Next) Chance to reach customers who would not have gone to the shops
Sales Promotion Sales promotion is the process of persuading a potential customer to buy the product. It can be part of the personal selling process. The main methods of sales promotion are: Money off coupons customers receive coupons, or cut coupons out of newspapers or a products packaging that enables them to buy the product next time at a reduced price. Competitions buying the product will allow the customer to take part in a chance to win a prize (e.g. Coca Cola ring pulls). Discount vouchers a voucher (like a money off coupon). Free gifts a free product when buy another product. Point of sales materials e.g. posters, display stands ways of presenting the product in its best way or show the customer that the product is there. Loyalty cards e.g. Nectar and Air Miles; where customers earn points for buying certain goods or shopping at certain retailers that can later be exchanged for money, goods or other offers. Examples of recent sales promotions are: Tesco computers for schools Cadburys sport in the community Caf Nero free coffee card Loyalty cards have recently become an important form of sales promotion. They encourage the customer to GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 33 of 165
return to the retailer by giving them discounts based on the spending from a previous visit. Loyalty cards can offset the discounts they offer by making more sales and persuading the customer to come back. They also provide information about the shopping habits of customers where do they shop, when and what do they buy? This is very valuable marketing research and can be used in the planning process for new and existing products. Key Terms in this Section
Term Definition Above the line promotion Paid for communication in the independent media Below the line promotion Promotional activities where the business has direct control e.g. direct mailing and money off coupons Direct marketing Marketing which is aimed straight at the customer Personal selling Using people to sell the product directly to the customer Public relations Managing relations with the outside world, mainly the media, but also the local and wider community Sales promotion Process of persuading customers to buy the product
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Place (Distribution) Introduction Distribution is how the business gets its products to the customers. It does this through four main distribution channels: Wholesalers Distributors / Sales Agents Retailers Direct Distribution Channels Wholesalers break bulk they buy in large quantities from manufacturers and then break them into smaller quantities to sell to retailers. This reduces transport costs to the manufacturer (few journeys to wholesaler rather than many journeys to retailers) and retailers can order in smaller amounts from wholesalers. Agents provide a link between sellers and buyers. They are not employed by the company but sell the products or services for a commission. The best examples of an agent are a travel agent or an estate agent. For instance the travel agent will sell travel companies holidays to potential holidaymakers and take a cut of the sales revenue. Some businesses miss out the wholesaler, especially large multiples such as supermarkets. They can order directly from the producer and then use their own system of distribution. The advantage for a producer is that they get greater control over the marketing of their product. Other businesses use direct marketing as their key distribution channel. This is where they sell directly to the customer. The most common channels for direct marketing are: Direct mail E-mails Mail-order catalogues Telephone sales Overseas Markets Many businesses sell into overseas markets. This is known as exporting . Exporting is not easy, for the following reasons: Exchanges rates can change, making the prices of goods coming into or going out of the country sometimes more expensive, sometimes much cheaper. Language barriers mean that it can be difficult to communicate with potential buyers. Different cultures mean that products are not suitable for certain countries, e.g. on religious grounds. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 35 of 165
Trade barriers, such as quotas, tariffs and legislation exist which can make it difficult to actually place the product in that country, or certainly make it more expensive to sell there. The UKs membership of the Europe Union (EU) has reduced the effect of trade barriers for UK businesses. The EU is a Single Market that has the freedom of movement of goods and services within the market. The UK is part of the European Single Market which means it should not face any barriers to trade, e.g. quotas and tariffs, which would add costs to their exports. E-Commerce E-commerce is the use of the Internet and email to buy, sell and market products. It has grown in use considerably in the last five years, though it still makes up a surprisingly small part of the whole retail market (less than 5% for most retail segments). Businesses are increasingly under pressure to provide an e-commerce aspect to their business particularly those that sell to consumers (known as B2C or Business to Consumer). This is normally in the form of a website and certainly email. A website can be used to provide information on the product/business, or provide a pace where sales can be made. If sales are required then there needs to be a link to a warehouse for goods, so despatch can be made. Costs and benefits of using e-commerce The main costs of using e-commerce for a business are: Expense of setting up and maintaining the website staff will need to be trained to run the site especially if it is to be used for online purchasing. Businesses have become exposed to more fraud or hacking into their site. The benefits for a business of using e-commerce are: Using websites to advertise more widely. Small business can access wider than local markets. Can market directly to past customers via email. Selling to larger markets. Reduces cost of sales (especially through purchasing online). Attracts new customers. Businesses can therefore improve their productivity and competitive edge through the use of e-commerce. However the business fundamentals must also be in place as e-commerce is only one element in the whole business mix. These fundamentals are the key functions of the business working well e.g. a good production and distribution network. E-commerce issues There are a number of issues that have arisen from the use of e-commerce: GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 36 of 165
Consumer protection giving information over the Internet by customers has led to potential situations of abuse of the information. Customers have become reluctant to give out credit card information, despite the protection offered by both the business involved and the credit card company. With greater reliance on e-commerce there is a danger that more traditional forms of shopping will become obsolete, meaning loss of jobs and also a loss of culture. Traditional markets and High Streets may be lost. Spam email is becoming an intrusion into the household beyond the normal junk mail coming through the letterbox. Emails and e-commerce are much harder to control by the law and therefore unscrupulous companies may be able to take advantage of less knowledgeable and more easily manipulated consumers (especially those of school age). To counter these problems a business which is going to use e-commerce needs to: Make sure it has a secure system which does not endanger the personal rights of its customers Act in a socially responsible manner towards its customers
Key Terms in this Section
Term Definition Agents People who sell the product on behalf of the business, but are employed by them Breaking bulk Splitting large amounts of product into smaller amounts which can then be shipped to other outlets Distribution channels Ways in which the product reaches the customer from the business e-commerce Using the Internet and email to sell products Wholesalers Buy in large quantities, break bulk and then sell this to retailers GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 37 of 165
PRODUCTION Production Process The way that businesses create products and services is known as the production process. There are three main parts to the production process as can be seen in the diagram below:
A firm must purchase all the necessary inputs and then transform them into the product (outputs) that it wishes to sell. For example a football shirt manufacturer must buy the fabric, pay someone for a design, invest in machinery, rent a factory and employ workers in order for the football shirts to be made and then sold. How well-organised a firm is at undertaking this transformation process will determine its success. This is known as the productive efficiency of a firm and it will want to be as efficient as possible in transforming its inputs into outputs (i.e. using the minimum number of inputs as possible to achieve a set amount of output). This will reduce the cost per unit of production and allow the firm to sell at a lower price. Ultimately, the objective of the production process is to create goods and services that meet the needs and wants of customers. The needs and wants of customers will be met if a business can produce the correct number of products, in the shortest possible time, to the best quality and all at a competitive price. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 38 of 165
Stages of Production Production within an economy can be divided into three main stages: primary, secondary and tertiary. Primary Production Primary production involves the extraction of raw materials (e.g. coal, iron, agricultural commodities). Raw materials can be: Extracted e.g. coal, iron ore, oil, gas and stone Harvested / collected e.g. fish Grown e.g. timber, cereal crops There is little value added in primary production. The aim is usually to produce the highest quantity at lowest cost to a satisfactory standard. Secondary Production Secondary production involves transforming raw materials into goods. There are two main kinds of goods: Consumer goods e.g. washing machines, DVD players. As the name implies, these are used by consumers Industrial / capital goods e.g. plant and machinery, complex information systems. Industrial and capital goods are used by businesses themselves during the production process. In the secondary production sector, value is added to the raw material inputs. For example, foodstuffs are transformed into ready meals for sale in supermarkets; metals, fabrics, and plastics are transformed into motor vehicles. There are many different industry sectors in secondary production. For example: Construction Electronic instruments Pharmaceuticals (drugs) House-building Tertiary Production Tertiary production is associated with the provision of services (an intangible product). As with the secondary sector, there are many tertiary production markets. Good examples include: Hotels Private healthcare and education Accountants Tourism GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 39 of 165
Key Terms in this Section
Term Definition Added value The process of increasing the worth of resources by working on them Primary production Production which involves the extraction of raw materials Production process The process of transforming inputs (labour, raw materials, land) into outputs (products) Productive efficiency How efficient or competent a firm is at transforming inputs into outputs Secondary production Production which involves transforming raw materials into goods Tertiary production Production which is associated with supplying services
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Methods of Production Job, Batch and Flow production are the three main ways a firm could choose to make its product(s). Each method varies greatly in how they actually handle the production process but the aim of each is the same: to transform in puts into outputs in the most efficient way. Job Production Job production involves firms producing items that meet the specific requirements of the customer. Often these are one-off, unique items such as those made by an architect or wedding dressmaker. For an architect, each building or structure that he designs will be different and tailored to the needs of each individual client. With job production, a single worker or group of workers handles the complete task. Jobs can be on a small- scale involving little or no technology. However, jobs can also be complex requiring lots of technology. With low technology jobs, production is simple and it is relatively easy to get hold of the skills and equipment required. Good examples of the job method include: Hairdressers Tailoring Painting and decorating Plumbing and heating repairs in the home High technology jobs are much more complex and difficult. These jobs need to be very well project-managed and require highly qualified and skilled workers. Examples of high technology / complex jobs include: Film production Large construction projects (e.g. the Millennium Dome) Installing new transport systems (e.g. trams in Sheffield and Manchester) Advantages The advantage of job production is that each item can be altered for the specific customer and this provides genuine marketing benefits. A business is likely to be able to add value to the products and possibly create a unique selling point (USP), both of which should enable it to sell at high prices. Disadvantages Whether it is based on low or high technology, Job production is an expensive process as it is labour intensive (uses more workers compared to machines). This raises costs to firms as the payment of wages and salaries is more expensive than the costs of running machines. Batch Production As businesses grow and production volumes increase, the production process is often changed to a batch method. Batch methods require that a group of items move through the production process together, a stage at a time. For example when a bakery bakes loaves of wholemeal bread, a large ball of wholemeal dough will be split into several loaves which will be spread out together on a large baking tray. The loaves on the tray will then together be cooked, wrapped and dispatched to shelves, before the bakery starts on a separate batch of, for GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 41 of 165
example, crusty white bread. Note that each loaf is identical within a batch but that loaves can vary from batch to batch. Batch production is a very common method of organising manufacture. Good examples include: Production of electronic instruments Fish and chip shops Paint and wallpaper manufacturers Cereal farming Advantages The batch method can be an advantage for businesses that produce a range of products. It is cheaper to produce a number of each item in one go because machines can be used more effectively, the materials can be bought in bulk and the workers can specialise in that task. There are two particular advantages of workers being able to concentrate their skills. They should become more expert at their tasks, which will in turn increase productivity (output per worker). This will lower costs, as fewer workers are needed to produce a set amount. Better quality products should be produced as workers are more familiar with the task and so can find ways of improving it. Disadvantages Batch production requires very careful planning to decide what batch will be produced when. Once a batch is in production it is difficult to change, as switching to another batch takes time and will mean a loss of output. Batch methods can also result in the build up of significant work in progress or stocks (i.e. completed batches waiting for their turn to be worked on in the next operation). This increases costs as it takes up space and raises the chance of damage to stock. Flow Production Flow production involves a continuous movement of items through the production process. This means that when one task is finished the next task must start immediately. Therefore, the time taken on each task must be the same. Flow production (often known as mass production) involves the use of production lines such as in a car manufacturer where doors, engines, bonnets and wheels are added to a chassis as it moves along the assembly line. It is appropriate when firms are looking to produce a high volume of similar items. Some of the big brand names that have consistently high demand are most suitable for this type of production: Heinz baked beans Kelloggs corn flakes Mars bars Ford cars Advantages Flow production is capital intensive. This means it uses a high proportion of machinery in relation to workers, as is the case on an assembly line. The advantage of this is that a high number of products can roll off assembly lines at very low cost. This is because production can continue at night and over weekends and GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 42 of 165
also firms can benefit from economies of scale, which should lower the cost per unit of production. Disadvantages The main disadvantage is that with so much machinery it is very difficult to alter the production process. This makes production inflexible and means that all products have to be very similar or standardised and cannot be tailored to individual tastes. However some variety can be achieved by applying different finishes, decorations etc at the end of the production line. Summary of different types of production
Job Batch Flow Low volume one-off items. Average volume- groups of products produced together High volume continuous production Very flexible production
Flexible between batches Inflexible production Unique, tailor made products
Range of products Standardised products Relatively high cost per unit Average efficiency- cost per unit decreases Very low cost per unit
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Production Efficiency Introduction A business should constantly be trying to improve its efficiency. In many markets, a business needs to be at least as efficient as its main competitors in order to be able to compete and survive in the long-term. A more efficient business will produce lower cost goods than competitors and may generate more profit possibly at lower prices Increasing efficiency will boost the capacity of a business, assuming there is no change in the number of inputs employed. The capacity of a firm refers to how much a business can produce during a specific period of time. Efficiency Where a business has efficient production, it is operating at maximum output at minimum cost per unit of output. Efficiency is, therefore, a measure of how well the production or transformation process is performing. However, this is not always easy to assess. There are several ways to measure efficiency Productivity This measures the relationship between inputs into the production process and the resultant outputs. The most commonly used measure is labour productivity, which is measured by output per worker. For example, assume a sofa manufacturer makes 100 sofas a month and employs 25 workers. The labour productivity is 4 sofas per person per month. There are several other measures of productivity. Output per hour / day / week Output per machine Unit costs Unit cost (also referred to as cost per unit) divides total costs by the number of units produced. A falling ratio would indicate that efficiency was improving. Unit costs = Total Costs / Units of output Stock levels A business will have set itself a target stock level of finished goods that it should achieve. This is calculated to satisfy the demand expected by the marketing department plans and based on what the production department thinks they can produce. If the stock level falls below this level then the productive efficiency has reduced since the output per worker has not met the planned requirements. Non-productive ( idle ) resources Which resources are not in constant use in the business? Are employees often left with nothing to do? Are machines only used for part of available time? Too many idle resources are a common sign of inefficiency in production. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 44 of 165
Poor quality There are many measures of poor quality any of which could indicate a problem with efficiency: Customer complaints Rejected finished goods identified by the quality control department Customer returns of defective goods Strategies to Improve Efficiency There are several ways a business can try to improve efficiency levels. Train the workforce Training the workforce in order to give them more skills or knowledge is clearly a cost to firms. They will often have to pay experts to train employees and will also lose the productive time of employees whilst they are training. However this increase in cost should be more than offset in the long term by improvements in the workers productivity levels. This is because training should enable workers to work more quickly and more accurately (produce better quality products). Improve motivation A better-motivated workforce will work harder and take pride in their work. This should increase the speed of production and also improve the quality of products that are being produced. There are many different financial (e.g. bonuses) and non-financial ways (e.g. empowerment) for businesses to motivate their workers. More capital equipment Investment into new, higher technological machinery can have a number of advantages. Longer hours can be worked Increased speed of production (machine can perform repetitive and complicated tasks more quickly) Increased accuracy and therefore less wastage Use better quality raw materials This can reduce the amount of time wasted on rejected or defective products. A business should ensure they find the supplier who can supply the best quality resources, but at a competitive price and also with reliable delivery. Conclusion Improvements in efficiency are not that easy to obtain. For instance managers may find workers resistant to changes such as introducing new machinery or new working practices. This is because workers fear that changes will lead to redundancies. It can also take a long time for any new strategies to feed through into the form of increased efficiency. In addition, there can be a conflict between productivity and quality. Increasing productivity by its nature implies increasing the speed of production, and if managers are not careful this can mean that workers focus solely on quantity and not the quality of their work. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 45 of 165
Lean Production Introduction There is much evidence to suggest that the traditional mass production methods, used widely for much of 20 th century, can create problems, which leads to inefficiency. The main problems are: Employee boredom and low morale particularly where employees undertake repetitive jobs Equipment failure regular breakdowns of equipment that can cause hold-ups elsewhere in the production process Equipment obsolescence where a machine quickly becomes outdated, although there is little incentive to replace it if the machine had cost a lot of money As a result of these problems, businesses have increasingly looked to see if they can make their production more efficient by becoming more flexible and lean . Lean production is an approach which originated in Japan during the 1950s and 1960s and has recently been increasing in popularity among UK firms. Its main objective is to eliminate all forms of waste in the production process and so produce more by using fewer inputs. There are several forms of waste that lean production aims to eliminate. Waste from materials Waste of workers time and effort Waste of floor space Waste from defective products (poor quality) By reducing this waste the costs of firms will decrease and they will become more efficient and competitive. The idea is to make the product right first time (not spend time checking and re-checking). There are several popular management techniques that have been developed to help achieve lean production. The three most popular are: Cell production Kaizen (continuous improvement) Just-in-time (JIT) manufacturing Cell Production In traditional production, products were manufactured in separate areas (each with a responsibility for a different part of the manufacturing process) and many workers would work on their own, as on a production line. In cell production, workers are organised into multi-skilled teams. Each team is responsible for a particular part of the production process including quality control and health and safety. Each cell is made up of several teams who deliver finished items on to the next cell in the production process. Cell production can lead to efficiency improvements due to increased motivation (team spirit and added responsibility given to cells) and workers sharing their skills and expertise. Kaizen (Continuous Improvement) GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 46 of 165
Kaizen is a Japanese word for an approach to work where workers are told they have two jobs to do: Firstly to carry out their existing task; and Secondly to come up with ways of improving the task The concept known as continuous improvement therefore implies a process where the overall progress and gains in productivity within a firm, come from small improvements by workers being made all the time. For example, an employee may simply re-organise the lay out of his work area, which saves 2 minutes looking for and filing paperwork each day. When added up the course of a week, 10 minutes extra productive time is gained, which over a year equates to an extra days work. If other workers also adopt this, then a firm can benefit from a significant increase in output per worker (productivity) over a year. Just-in-time (JIT) Production JIT means that stock arrives on the production line just as it is needed. This minimises the amount of stock that has to be stored (reducing storage costs). JIT has many benefits and may appear an obvious way to organizes production but it is a complicated process which requires efficient handling. For example, JIT relies on sophisticated computer systems to ensure that the quantities of stock ordered and delivered are correct. This process needs to be carried out very accurately or production could come to a standstill. Advantages of JIT Disadvantages of JIT Reduces costs of holding stock e.g. warehousing rent Needs suppliers and employees to be reliable No money tied up in stock, can be use better elsewhere May find it difficult to meet sudden increase in demand Key Terms in this Section Term Definition Cell production Production process is broken down and re-organised around teams or units Efficiency When the production process is operating at maximum output at minimum cost per unit of output Just-in-time production Stock arrives on the production line just as it is needed Kaizen A process whereby overall progress and gains in productivity within a firm, come from small improvements by workers being made all the time Lean production Philosophy of production that originated in Japan. The main objective is to eliminate all forms of waste in the production process and so produce more by using less inputs Productivity Measure of the relationship between inputs into the production process and the resultant outputs Unit costs Total costs divided by output GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 47 of 165
Economies of Scale Introduction Economies of scale arise when the cost per unit falls as output increases. Economies of scale are the main advantage of increasing the scale of production and becoming big. Why are economies of scale important? - Firstly, because a large business can pass on lower costs to customers through lower prices and increase its share of a market. This poses a threat to smaller businesses that can be undercut by the competition - Secondly, a business could choose to maintain its current price for its product and accept higher profit margins. For example, a furniture-maker which could produce 1,000 cabinets at 250 each might expand and be able to produce 2,000 cabinets at 200 each. The total production cost will have risen to 400,000 from 250,000, but the cost per unit has fallen from 250 to 200. Assuming the business sells the cabinets for 350 each, the profit margin per cabinet rises from 100 to 150. There are two main types of economies of scale: internal and external. Internal economies of scale have a greater potential impact on the costs and profitability of a business. Internal Economies of Scale Internal economies of scale relate to the lower unit costs a single firm can obtain by growing in size itself. There are five main types of internal economies of scale. Bulk-buying economies As businesses grow they need to order larger quantities of production inputs. For example, they will order more raw materials. As the order value increases, a business obtains more bargaining power with suppliers. It may be able to obtain discounts and lower prices for the raw materials. Technical economies Businesses with large-scale production can use more advanced machinery (or use existing machinery more efficiently). This may include using mass production techniques, which are a more efficient form of production. A larger firm can also afford to invest more in research and development. Financial economies Many small businesses find it hard to obtain finance and when they do obtain it, the cost of the finance is often quite high. This is because small businesses are perceived as being riskier than larger businesses that have developed a good track record. Larger firms therefore find it easier to find potential lenders and to raise money at lower interest rates. Marketing economies Every part of marketing has a cost particularly promotional methods such as advertising and running a sales force. Many of these marketing costs are fixed costs and so as a business gets larger, it is able to spread the cost of marketing over a wider range of products and sales cutting the average marketing cost per unit. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 48 of 165
Managerial economies As a firm grows, there is greater potential for managers to specialise in particular tasks (e.g. marketing, human resource management, finance). Specialist managers are likely to be more efficient as they possess a high level of expertise, experience and qualifications compared to one person in a smaller firm trying to perform all of these roles. External Economies of Scale External economies of scale occur when a firm benefits from lower unit costs as a result of the whole industry growing in size. The main types are: Transport and communication links improve As an industry establishes itself and grows in a particular region, it is likely that the government will provide better transport and communication links to improve accessibility to the region. This will lower transport costs for firms in the area as journey times are reduced and also attract more potential customers. For example, an area of Scotland known as Silicon Glen has attracted many high-tech firms and as a result improved air and road links have been built in the region. Training and education becomes more focused on the industry Universities and colleges will offer more courses suitable for a career in the industry which has become dominant in a region or nationally. For example, there are many more IT courses at being offered at colleges as the whole IT industry in the UK has developed recently. This means firms can benefit from having a larger pool of appropriately skilled workers to recruit from. Other industries grow to support this industry A network of suppliers or support industries may grow in size and/or locate close to the main industry. This means a firm has a greater chance of finding a high quality yet affordable supplier close to their site. Diseconomies of Scale Increasing the size of a business does not always result in lower costs per unit. Sometimes a business can get too big! Diseconomies of scale occur when a business grows so large that the costs per unit increase. Diseconomies of scale occur for several reasons, but all as a result of the difficulties of managing a larger workforce. Poor communication As the business expands communicating between different departments and along the chain of command becomes more difficult. There are more layers in the hierarchy that can distort a message and wider spans of control for managers. This may result in workers having less clear instructions from management about what they are supposed to do when. In addition, there may be more written forms of communication (e.g. newsletters, notice boards, e-mails) and less face-to-face meetings, which can result in less feedback and therefore less effective communication. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 49 of 165
Lack of motivation Workers can often feel more isolated and less appreciated in a larger business and so their loyalty and motivation may diminish. It is harder for managers to stay in day-to-day contact with workers and build up a good team environment and sense of belonging. This can lead to lower employee motivation with damaging consequences for output and quality. The main result of poor employee motivation is falling productivity levels and an increase in average labour costs per unit. What can a business do about this? Possible solutions include: Delegation of decision-making (empowerment) Making jobs more interesting (job enrichment) Splitting employees into teams (teamworking) There is also a close link between communication and motivation (which the motivational theorist Elton Mayo recognized) and so as communication becomes harder, motivation will decline. This is particularly true as managers are less able to take a personal interest in the workers. We cover the important area of motivation in this section of the Key Notes. Loss of direction and co-ordination It is harder to ensure that all workers are working for the same overall goal as the business grows. It is more difficult for managers to supervise their subordinates and check that everyone is working together effectively, as the spans of control have widened. A manager may be forced to delegate more tasks, which while often motivating for his subordinates, leaves the manager less in control. Term Definition Diseconomies of scale Occur when a business grows so large that the cost per unit increases Economies of scale As a output increases the unit costs of production decrease External economies of scale Occur when a firm benefits from lower unit costs as a result of the whole industry growing in size Internal economies of scale Relate to the lower unit costs a single firm can obtain by growing in size itself
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Quality Management What is Quality? What do we mean by the quality of a product or service? A simple definition is: A quality product needs to be fit for purpose. This means the product must meet or exceed the customer requirements. It should be noted that a good quality product does not therefore have to be an expensive product; it merely has to fulfill its purpose within the eyes of the customer. For example, a cheap biro or cheap pair of trainers can be good quality as long as they do at least what the customer expects them to do. It is important to remember that it is the customer who sets the quality standards in terms of their overall expectations of quality. There are several ways that a customer may define quality: Reliability Fit for purpose Design Safety Long-lasting In some cases, government act to encourage minimum standards for certain products. For example, the British Standards Institute in the UK operates a well-known Kitemark scheme. The Kitemark is a certification mark that offers proof that a product or service complies with the relevant publicly available specification. It symbolises quality and safety and is recognized by over 80% of the UK population. Why is Quality Important? Quality is important for two main reasons: reputation and costs. Reputation For virtually all purchasing decisions, customers choose which product to buy based on price and/or quality, and occasionally on other factors such as the delivery time. The reputation of a business therefore depends on these factors and it is often quality which can have the longest lasting impression (think of the long- standing jokes about the quality of the old Skoda cars). Customers often complain about the poor quality of the products and services they buy. Conversely, a positive recommendation by a customer (for example by recommending a product or service to a friend) helps to develop a positive reputation for quality. There are many situations in which quality can prove to be less than expected: for example: Poor service at a restaurant A flight that runs late or is cancelled GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 51 of 165
A washing machine that breaks down Clothing that unexpectedly shrinks in the wash A good quality product can therefore provide a competitive edge over rivals and can lead to significant marketing advantages. For example, a business will benefit from more repeat purchases and a longer life cycle for its product. It may also be able to charge a premium (higher) price and so boost revenue. Costs A poor quality product does not only harm reputation and therefore sales but also increases costs to businesses. There are many costs of poor quality, including: Cost of reworking or remaking the product Costs of replacements or refunds Wasted materials Costs of employing more staff to detect and solve quality problems These extra costs will decrease the competitiveness of a business, as it may have to raise prices to cover them. Quality Control The objective of quality control is to ensure each finished product meets the standard set out by the business for a quality product. The traditional method by which a firm tries to achieve this quality standard is by having a separate Quality Control department whose inspectors check the finished items and reject defective or substandard products. This method therefore detects quality problems at the end of the production process before they reach the final customer. The Quality Control department would then try and change an aspect of the production process and procedure, in order to solve quality problems that seem to occur most often. This approach hopefully stops defective products getting to the market place and harming a firms reputation but evidence shows that it has limited success at reducing the number of sub standard products being produced and therefore wasting a firms resources. Total Quality Management An alternative and increasingly popular method of ensuring quality is known as Total Quality Management or TQM . TQM is best described as being an attitude in a business where everyone in the business is committed to achieving quality not just the people in the Quality Control or production departments. It means that quality is being checked at every stage of the production process, as all employees are trained to check their own work (self-checking). Two of the main aims of TQM are zero defects and total customer satisfaction. Zero defects refers to the aim of producing goods and services with no faults or problems. To achieve this requires: Strong teamwork Open sharing of information about what quality problems are arising and how they are caused Investment in improving and refining production processes GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 52 of 165
There are various advantages and disadvantages of introducing TQM: Advantages Disadvantages Improves reputation- faults and problems are spotted and sorted quicker (zero defects) Initial introduction costs- training workers and disrupting current production whilst being implemented Higher employee morale workers motivated by extra responsibility, team work and involvement in decisions of TQM Benefits may not be seen for several years Lower costs Decrease waste as fewer defective products and no need for separate Quality Control inspectors Workers may be resistant to change may feel less secure in jobs There is no guarantee that TQM will be a success and there have been cases of firms abandoning their new TQM initiatives. This is often because after several years the benefits have not yet been fully achieved and have not offset the initial costs. The success of TQM will depend upon the attitudes of workers throughout the business and how readily they accept the changes to their traditional working practices. Key Terms in this Section
Term Definition Kitemark A certification mark that offers proof that a product or service complies with the relevant publicly available specification Quality A quality product needs to be fit for purpose. This means it must meet or exceed the customer requirements Quality control Aims to ensure each finished product meets the standard set out by the business for a quality product Total quality management (TQM) TQM is best described as being an attitude in a business where everyone in the business is committed to achieving quality Zero defects Aim of producing goods and services with no faults or problems
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Business Location Introduction Every business has to be located somewhere. A sole trader who works as a window cleaner may operate from home, where as a multinational car company will have factories, offices and outlets in many countries. For both businesses however, where to locate may be the most important decision they make and can determine their success. It is a very expensive decision to reverse. Factors Affecting Location There are many factors that determine where a business will locate: Cost of site Availability of labour Proximity to raw materials Proximity to market Infrastructure Government incentives Cost of site The amount, type and cost of land are all important factors in choosing a location. The cost of land will vary greatly across regions and countries. For example the cost of a site in the South East of England will be significantly higher than a similar site in the North East. Also the kind of land may be important (e.g. avoiding areas of possible mining subsidence) The ability to expand and to build new premises may be important. This would require the support of the local authorities for planning permission. Availability of Labour The availability of workers, their skill level and wage rate they need to be paid is crucial in deciding the where to locate. Some businesses may need skilled labour whereas others require a large supply of lower-cost, unskilled labour. Where labour skills are in short supply (e.g. in some high-tech industries) it often happens that similar businesses locate themselves close to each other. They might also be close to colleges and other training organisations that provide the main source of newly trained employees. Businesses that require large numbers of unskilled workers might prefer to be located in areas of low labour costs. These are also often areas of high unemployment where recruitment may be easier than in areas where there are labour shortages. Many multi-national companies that require large amounts of unskilled labour, such as Nike to make trainers, have located factories in SE Asia where the wage rate is very low and there are many available workers. Proximity to raw materials Businesses that use substantial quantities of raw materials may find it cheaper to locate near to the source of GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 54 of 165
those inputs as this will reduce transport costs. Such businesses are often called bulk-reducing as the weight or size of the finished product is less than the combined raw materials that went into making it. Good examples include: Steel-producers Sawmills Sugar factories Oil refineries Proximity to Market By contrast, businesses that assemble components (bulk-increasing) often choose to locate closer to where the customer markets are. This is because the cost of transporting the bulkier or heavier finished product is greater than the cost of transporting the raw materials or components. Good examples include: Breweries Car manufacturers Bakeries In some cases moving the final product is not possible, such as for services like restaurants and high street shops. In these cases the businesses will locate at the market itself. Infrastructure Infrastructure covers the modes of transport for people, materials and information. Businesses need to ensure there is adequate infrastructure provision or costs can rise, such as extra transport costs. It is the government that is largely responsible for providing and maintaining local infrastructure. The key infrastructure considerations are: Road/rail/sea and air links. The most appropriate mode will depend on the type of business and product, but road is used by over 80% of business. Communications network. For example is there mobile phone coverage and suitable telephone lines (e.g. availability of broadband internet access). Access to basic facilities such as water and electricity (and enough power). Government Incentives Government policy also influences business location. Governments often offer incentives to start new businesses, or relocate existing ones, in areas that need economic development (regeneration). This has led to certain areas being called enterprise zones or assisted areas where firms are offered grants or low interest loans if they locate into these economically depressed regions. Another example is Regional Development Agencies which were first set up by the current government in 1999. Their aim is to: Encourage economic development and regeneration Promote business efficiency, investment and competitiveness GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 55 of 165
Promote employment Provide training to the labour force to assist in growing employment Both the UK Government and the European Commission offer financial support to businesses willing to move to areas of high unemployment. Businesses are also encouraged to redevelop Brownfield sites (e.g. old farms, inner city wasteland) rather than build on Greenfield land on the outskirts of cities. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 56 of 165
Stock Control Introduction There are three types of stock that a business can hold: Stocks of raw materials (inputs brought from suppliers waiting to be used in the production process) Work in progress (incomplete products still in the process of being made) Stocks of finished products (finished goods of acceptable quality waiting to be sold to customers) The aim of stock control is to minimise the cost of holding these stocks whilst ensuring that there are enough materials for production to continue and be able to meet customer demand. Obtaining the correct balance is not easy and the stock control department will work closely with the purchasing and marketing departments. The marketing department should be able to provide sales forecasts for the coming weeks or months (this can be difficult if demand is seasonal or prone to unexpected fluctuation) and so allow stock control managers to judge the type, quantity and timing of stocks needed. It is the purchasing departments responsibility to order the correct quantity and quality of these inputs, at a competitive price and from a reliable supplier who will deliver on time. As it is difficult to ensure that a business has exactly the correct amount of stock at any one time, the majority of firms will hold buffer stock. This is the safe amount of stock that needs to be held to cover unforeseen rises in demand or problems of reordering supplies. Stock Management Good stock management by a firm will lower costs, improve efficiency and ensure production can meet fluctuations in customer demand. It will give the firm a competitive advantage as more efficient production can feed through to lower prices and also customers should always be satisfied as products will be available on demand. However, poor stock control can lead to problems associated with overstocking or stock-outs. If a business holds too much buffer stock (stock held in reserve) or overestimates the level of demand for its products, then it will overstock. Overstocking increase costs for businesses as holding stocks are an expense for firms for several reasons. Increases warehouse space needed Higher insurance costs needed Higher security costs needed to prevent theft Stocks may be damaged, become obsolete or perish (go out of date) Money spent buying the stocks could have been better spent elsewhere The opposite of an overstock is a stock-out. This occurs when a businesses runs out of stocks. This can have severe consequences for the business: Loss of production (with workers still having to be paid but no products being produced) GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 57 of 165
Potential loss of sales or missed orders. This can harm the reputation of the business. In these circumstances a business may choose to increase the amount of stock they hold in reserve (buffer stock). There are advantages and disadvantages of increasing the stock level. Advantages Disadvantages Can meet sudden changes in demand Costs of storage rent and insurance Less chance of loss of production time because of stock outs Money tied up in stocks not being used elsewhere in the business Can take advantage of bulk buying economies of scale Large stocks subject to deterioration and theft
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MANAGING PEOPLE Recruitment, Selection and Retention Introduction Recruitment and selection is the process of identifying the need for a job, defining the requirements of the position and the job holder, advertising the position and choosing the most appropriate person for the job. Retention means ensuring that once the best person has been recruited, they stay with the business and are not poached by rival companies. Undertaking this process is one of the main objectives of management. Indeed, the success of any business depends to a large extent on the quality of its staff. Recruiting employees with the correct skills can add value to a business and recruiting workers at a wage or salary that the business can afford, will reduce costs. Employees should therefore be carefully selected, managed and retained, just like any other resource
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Recruitment Planning There are a number of possible reasons as to why a business may have to recruit more employees: Business is expanding due to: Increasing sales of existing products Developing new products Entering new markets Existing employees leaving to work with competitors or other local employers Existing employees leaving due to factors such as retirement, sick leave, maternity leave Business needs employees with new skills Business is relocating and not all the existing workforce wants to move to the new location In each of these circumstances a business will normally carry out Workforce Planning to find out how many workers and what types of workers are required. The workforce plan will establish what vacancies exist and managers then need to draw up a job description and job specification for each post. A job description is a detailed explanation of the roles and responsibilities of the post advertised. Most applicants will ask for this before applying for the job. It refers to the post available rather than the person. A job specification is drawn up by the business and sets out the kind of qualifications, skills, experience and personal attributes a successful candidate should possess. It is a vital tool in assessing the suitability of job applicants and refers to the person rather than the post. These documents are an important part of the recruitment and selection process and provide the basis as to where the job may be advertised and whether an applicant is suitable for the post. They also help provide a framework for questions to be asked at an interview. Methods of Recruitment A manager can recruit in two different ways: Internal recruitment is when the business looks to fill the vacancy from within its existing workforce. External recruitment is when the business looks to fill the vacancy from any suitable applicant outside the business. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 60 of 165
Advantages Disadvantages Cheaper and quicker to recruit Limits the number of potential applicants People already familiar with the business and how it operates No new ideas can be introduced from outside the business Provides opportunities for promotion with in the business can be motivating May cause resentment amongst candidates not appointed Internal Recruitment Business already knows the strengths and weaknesses of candidates Creates another vacancy which needs to be filled Outside people bring in new ideas Longer process Larger pool of workers from which to find the best candidate More expensive process due to advertisements and interviews required External Recruitment People have a wider range of experience Selection process may not be effective enough to reveal the best candidate The four most popular ways of recruiting externally are: Job centres - These are paid for by the government and are responsible for helping the unemployed find jobs or get training. They also provide a service for businesses needing to advertise a vacancy and are generally free to use. Job advertisements - Advertisements are the most common form of external recruitment. They can be found in many places (local and national newspapers, notice boards, recruitment fairs) and should include some important information relating to the job (job title, pay package, location, job description, how to apply-either by CV or application form). Where a business chooses to advertise will depend on the cost of advertising and the coverage needed (i.e. how far away people will consider applying for the job Recruitment agency - Provides employers with details of suitable candidates for a vacancy and can sometimes be referred to as head-hunters. They work for a fee and often specialise in particular employment areas e.g. nursing, financial services, teacher recruitment Personal recommendation - Often referred to as word of mouth and can be a recommendation from a colleague at work. A full assessment of the candidate is still needed however but potentially it saves on advertising cost. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 61 of 165
Handling Applications For many jobs, a business will ask applicants to provide a curriculum vitae (CV). This is a document (often on one or two sides of A4) that the applicant designs providing the details summarised below. Personal details Name, address, date of birth, nationality Educational history Including examination results, schools/universities attended, professional qualifications Previous employment history Names of employers, position held, main achievements, remuneration package, reasons for leaving Suitability and reasons for applying for the job A chance for applicants to sell themselves Names of referees Often recent employer or people who know applicant well and are ideally independent In some circumstances however an applicant may be asked to fill in a firms own application form. This is different from a CV in that the employer designs it and sends it to applicants, but it will still ask for much of the same information. It has the benefit over a CV in that a business is able to tailor it to their exact needs and ask specific questions. Once a business has received all the applications, they need to be analysed and the most appropriate form of selection decided upon. When analysing applications, a business will normally sieve the applications into three categories. Those to reject - Candidates may be rejected because they may not meet the standards set out in the job specification such as wrong qualifications or insufficient experience or they may not have completed the application form to a satisfactory standard. Those to place on a short list. Often comprises 3-10 of the best candidates who are asked to interview Those to place on a long list - A business will not normally reject all other candidates immediately but keep some on a long list in case those on the short list drop out or do not appear suitable during interview. The business would not want to incur costs putting them through the selection process, such as interviews, unless they have to. Methods of Selection Interviews An interview is the most common form of selection as it is relatively cheap to undertake and is the chance for an employer to meet the applicant face to face and so obtain much more information on what the person is like and how suitable they are for the job. Examples of information that can only be learnt from interview and not on paper from a CV or application form are: Conversational ability- often known as people skills Natural enthusiasm or manner of the applicant See how applicant reacts under pressure Queries on comments or details missing from CV or application form GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 62 of 165
Interviewers should also follow-up a candidates references, which can act as the final check that all the information given by the candidate is correct. An honest reference from an independent source can also reveal good or bad incidences from the candidates past or particular traits that may have been missed. There are though other forms of selection tests that can be used in addition to an interview to help select the best applicant. The basic interview can be unreliable as applicants can perform well at interview but not have the qualities or skills needed for the job. Other selection tests can increase the chances of choosing the best applicant and so minimise the high costs of recruiting the wrong people. Examples of these tests are aptitude tests, intelligence tests and psychometric tests (to reveal the personality of a candidate). Managers selecting candidates for a high level post in an organisation may even send applicants to an assessment centre. In such centres candidates undergo a variety of tests, role-plays and simulations for a number of days. Once the best candidate has been selected and agreed to take up the post, the new employee must be given an employment contract. This is an important legal document that describes the obligations of the employee and employer to each other (terms and conditions) as well as the initial remuneration package and a number of other important details. Employee Retention Employee retention is the ability of a firm to convince its employees to remain with the business. It is often measured by the labour turnover of a business. This is defined as the proportion of a firms workforce that leaves during the course of a year. There are many reasons why a high labour turnover figure (poor employee retention) may cause problems for a firm: Increases recruitment costs (e.g. advertising for replacement staff; employing temporary staff whilst the job vacancies are filled) Reflects poor morale in workforce and so low productivity levels Increases training costs of new workers Loss of productivity while new worker settles in However, there are some advantages of a firm experiencing labour turnover: It gives the chance for new people to be brought into the business who may have fresh ideas and up to date market knowledge. Workers with specialist knowledge or expertise can be employed rather than having to train up existing lower skilled employees. A business can improve its employee retention by offering: Financial incentives (e.g. bonus, salary rise) Non-financial incentives (e.g. promotion, more decision making power) See this section for more details on incentives at work A business may also have to adopt more flexible working practices in order to retain staff and fit in with the changing trend in UK employment and working patterns. For instance, there is a greater emphasis currently being placed on flexible hours contracts and part-time working. This is mainly to allow for the growing GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 63 of 165
number of women joining the workforce who have to juggle childcare and their working lives. Key Terms in this Section
Term Definition Curriculum vitae (CV) A document (often on one or two sides of A4) that a job applicant designs themselves and gives their main details, such as previous employment, qualifications, interests etc Employee retention The ability of a firm to convince its employees to remain with the business External recruitment The business looks to fill the vacancy from any suitable applicant outside the business Internal recruitment The business looks to fill the vacancy from within its existing workforce Job description A detailed explanation of the roles and responsibilities of the post advertised Job specification A document which sets out the kind of qualifications, skills, experience and personal attributes a successful job applicant should possess Labour turnover The proportion of a firms workforce that leaves during the course of a year Recruitment & selection The process of identifying the need for a job, defining the requirements of the position and the job holder, advertising the position and choosing the most appropriate person for the job Short list When 3-10 of the best applicants are placed on a short list and then asked to interview Workforce plan Managers draw up a workforce plan to predict the number of staff required in the future and what type of skill level they will need
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Training Why is Training Necessary? Training is a process whereby an individual acquires job-related skills and knowledge. It is a cost to firms to pay for the training and also to suffer the loss of working hours whilst an employee is being trained. However, the potential gains from employee training are significant. The main benefits of training are improved productivity and motivation of staff and also better quality products being made. Some of the specific reasons as to why a business should train its employees are: Introduce new employees to the business (this is known as induction training) see below Help provide the skills the business needs (in particular making the workforce more flexible or being trained on new higher technology machinery) Provide employees with better knowledge about the business and the market it operates in Provide support for jobs that are complex and for which the required skills and knowledge are often changing (e.g. a firm of lawyers training staff about new legislation) Support the introduction of new working methods, such as a firm introducing new lean production techniques Reduce the need for supervision and therefore free up valuable manager time Help achieve a good health and safety record Help improve quality of a product or service and lower customer complaints Increase employee motivation and loyalty to the business Induction Training Induction training is important as it enables a new recruit to become productive as quickly as possible. It can avoid costly mistakes by recruits not knowing the procedures or techniques of their new jobs. The length of induction training will vary from job to job and will depend on the complexity of the job, the size of the business and the level or position of the job within the business. The following areas may be included in induction training: Learning about the duties of the job Meeting new colleagues Seeing the layout the premises Learning the values and aims of the business Learning about the internal workings and policies of the business Methods of Training There are two main methods of training: GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 65 of 165
On-the-job training On the job training occurs when workers pick up skills whilst working along side experienced workers at their place of work. For example this could be the actual assembly line or offices where the employee works. New workers may simply shadow or observe fellow employees to begin with and are often given instruction manuals or interactive training programmes to work through. Off-the-job training This occurs when workers are taken away from their place of work to be trained. This may take place at training agency or local college, although many larger firms also have their own training centres. Training can take the form of lectures or self-study and can be used to develop more general skills and knowledge that can be used in a variety of situations, e.g. management skills programme. The respective advantages of on-the-job and off-the-job training are summarised below: On-the-Job Training Off-the-Job Training Cheaper to carry out Learn from specialists in that area of work who can provide more in-depth study Training is very relevant and practical dealing with day to day requirements of job Can more easily deal with groups of workers at the same time Workers not taken away from jobs so can still be productive Employees respond better when taken away from pressures of working environment Employees who are new to a job role become productive as quickly as possible Workers may be able to obtain qualifications or certificates Government Training Schemes The government recognises the importance of training to the individual worker, firms and the economy as a whole. This is because a well-trained workforce will be better motivated, improve the productivity levels in the country and make firms more efficient. As a result the UK will be able to compete better against other countries The Department for Education and Skills is the government department responsible for training and it funds and overseas training schemes at a national and local level, mainly through 78 Training and Enterprise Councils (TECs) across England and Wales. The TECs particularly focus on schemes that promote training for existing workers. The government also emphasises the need to increase training and education for young people. Much of their current thinking focuses on encouraging young people to continue into further education and study for NVQs and other qualifications. This has been criticised by some who believe many individuals would benefit more from work related training or apprenticeships. The government does run a Modern Apprenticeship scheme for this purpose. In addition, there are other schemes and new initiatives that the government is responsible for: Adult literacy initiatives - responsible for driving forward a national strategy to improve literacy, language and numeracy skills (remember the conquer your gremlins adverts on TV) The New Deal The New Deal is aimed at people aged between 18 and 24 and out of work for more than 6 months. After being assessed an individual will either be given help finding a job (which may include paying a business a GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 66 of 165
subsidy to employ them), be given training and education on new skills for up to a year or be encouraged to gain work experience on voluntary schemes aimed at benefiting the local community. Investors in People Investors in People (IIP) is aimed at encouraging businesses to make training a priority. Businesses, which meet the requirements for training employees, are entitled to use a logo identifying them as having met this particular standard. This can enhance their reputation when recruiting or dealing with customers. Key Terms in this Section
Term Definition Induction training Introduces new employees to the business as whole and their particular job Off-the-job training When workers are taken away from their place of work to be trained On-the-job training When workers pick up skills whilst working along side experienced workers at their place of work Productivity The amount a worker produces in a set period of time Training A process whereby an individual acquires job-related skills and knowledge
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Motivation Importance of Motivation Motivation is the will to work. This comes from the enjoyment of the work itself and/or from the desire to achieve certain goals e.g. earn more money or achieve promotion. Managers spend considerable time working out how best to motivate their workers and there are a number of different opinions about how this can be best done. A well-motivated workforce can provide the following advantages: Better productivity (amount produced per employee). This can lead to lower unit costs of production and so enable a firm to sell its product at a lower price Lower levels of absenteeism as the employees are content with their working lives Lower levels of staff turnover (the number of employees leaving the business). This can lead to lower training and recruitment costs Improved industrial relations with trade unions Contented workers give the firm a good reputation as an employer so making it easier to recruit the best workers Motivated employees are likely to improve product quality or the customer service associated with a product Motivational Theory There are a number of different views as to what motivates workers. The most commonly held views or theories are discussed below and have been developed over the last 100 years or so. Unfortunately these theories do not all reach the same conclusions! Taylor Frederick Winslow Taylor (1856 1917) put forward the idea that workers are motivated mainly by pay. His Theory of Scientific Management argued the following: Workers do not naturally enjoy work and so need close supervision and control Therefore managers should break down production into a series of small tasks Workers should then be given appropriate training and tools so they can work as efficiently as possible on one set task. Workers are then paid according to the number of items they produce in a set period of time- piece- rate pay. As a result workers are encouraged to work hard and maximise their productivity. Taylors methods were widely adopted as businesses saw the benefits of increased productivity levels and lower unit costs. The most notably advocate was Henry Ford who used them to design the first ever production line, making Ford cars. This was the start of the era of mass production. Taylors approach has close links with the concept of an autocratic management style (managers take all the GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 68 of 165
decisions and simply give orders to those below them) and Macgregors Theory X approach to workers (workers are viewed as lazy and wish to avoid responsibility). However workers soon came to dislike Taylors approach as they were only given boring, repetitive tasks to carry out and were being treated little better than human machines. Firms could also afford to lay off workers as productivity levels increased. This led to an increase in strikes and other forms of industrial action by dis- satisfied workers. Mayo Elton Mayo (1880 1949) believed that workers are not just concerned with money but could be better motivated by having their social needs met whilst at work (something that Taylor ignored). He introduced the Human Relation School of thought, which focused on managers taking more of an interest in the workers, treating them as people who have worthwhile opinions and realising that workers enjoy interacting together. Mayo conducted a series of experiments at the Hawthorne factory of the Western Electric Company in Chicago He isolated two groups of women workers and studied the effect on their productivity levels of changing factors such as lighting and working conditions. He expected to see productivity levels decline as lighting or other conditions became progressively worse What he actually discovered surprised him: whatever the change in lighting or working conditions, the productivity levels of the workers improved or remained the same. From this Mayo concluded that workers are best motivated by: Better communication between managers and workers (Hawthorne workers were consulted over the experiments and also had the opportunity to give feedback) Greater manager involvement in employees working lives (Hawthorne workers responded to the increased level of attention they were receiving) Working in groups or teams. (Hawthorne workers did not previously regularly work in teams) In practice therefore businesses should re-organise production to encourage greater use of team working and introduce personnel departments to encourage greater manager involvement in looking after employees interests. His theory most closely fits in with a paternalistic style of management. Maslow Abraham Maslow (1908 1970) along with Frederick Herzberg (1923-) introduced the Neo-Human Relations School in the 1950s, which focused on the psychological needs of employees. Maslow put forward a theory that there are five levels of human needs which employees need to have fulfilled at work. All of the needs are structured into a hierarchy (see below) and only once a lower level of need has been fully met, would a worker be motivated by the opportunity of having the next need up in the hierarchy satisfied. For example a person who is dying of hunger will be motivated to achieve a basic wage in order to buy food before worrying about having a secure job contract or the respect of others. A business should therefore offer different incentives to workers in order to help them fulfill each need in turn and progress up the hierarchy (see below). Managers should also recognise that workers are not all motivated in the same way and do not all move up the hierarchy at the same pace. They may therefore have to offer a slightly different set of incentives from worker to worker. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 69 of 165
Herzberg Frederick Herzberg (1923-) had close links with Maslow and believed in a two-factor theory of motivation. He argued that there were certain factors that a business could introduce that would directly motivate employees to work harder (Motivators). However there were also factors that would de-motivate an employee if not present but would not in themselves actually motivate employees to work harder (Hygiene factors) Motivators are more concerned with the actual job itself. For instance how interesting the work is and how much opportunity it gives for extra responsibility, recognition and promotion. Hygiene factors are factors which surround the job rather than the job itself. For example a worker will only turn up to work if a business has provided a reasonable level of pay and safe working conditions but these factors will not make him work harder at his job once he is there. Importantly Herzberg viewed pay as a hygiene factor which is in direct contrast to Taylor who viewed pay, and piece-rate in particular Herzberg believed that businesses should motivate employees by adopting a democratic approach to management and by improving the nature and content of the actual job through certain methods. Some of the methods managers could use to achieve this are: Job enlargement workers being given a greater variety of tasks to perform (not necessarily more challenging) which should make the work more interesting. Job enrichment - involves workers being given a wider range of more complex, interesting and challenging tasks surrounding a complete unit of work. This should give a greater sense of achievement. Empowerment means delegating more power to employees to make their own decisions over areas of their working life. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 70 of 165
Summary of Motivation theory Theorist Conclusions Herzberg Two factor theory Workers motivated to work harder by motivators e.g. more responsibility, more interesting work, more praise for good work Workers can become demotivated if hygiene factors are not met e.g. pay, working conditions, relationships with colleagues Maslow Hierarchy of needs Workers motivated by having each level of need met in order as they move up the hierarchy Levels of needs are: Physical, Security, Social, Self-esteem, Self-fulfillment Workers must have lower level of needs fully met by firm before being motivated by next level Mayo Human Relations School of thought Workers motivated by having social needs met Workers should work in teams Managers should have greater involvement in employees working life More two-way communication between managers and workers Taylor Workers given one repetitive task so they can learn to master it Theory of Scientific Management Managers should give orders and closely control workers Workers should be paid per item they produced piece rate
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Management Styles Introduction What makes a good leader or manager? For many it is someone who can inspire and get the most from their staff. There are many qualities that are needed to be a good leader or manager. Be able to think creatively to provide a vision for the company and solve problems Be calm under pressure and make clear decisions Possess excellent two-way communication skills Have the desire to achieve great things Be well informed and knowledgeable about matters relating to the business Possess an air of authority Do you have to be born with the correct qualities or can you be taught to be a good leader? It is most likely that well-known leaders or managers (Winston Churchill, Richard Branson or Alex Ferguson?) are successful due to a combination of personal characteristics and good training. Managers deal with their employees in different ways. Some are strict with their staff and like to be in complete control, whilst others are more relaxed and allow workers the freedom to run their own working lives (just like the different approaches you may see in teachers!). Whatever approach is predominately used it will be vital to the success of the business. An organisation is only as good as the person running it. There are three main categories of leadership styles: autocratic, paternalistic and democratic. Autocratic (or authoritarian) managers like to make all the important decisions and closely supervise and control workers. Managers do not trust workers and simply give orders (one-way communication) that they expect to be obeyed. This approach derives from the views of Taylor as to how to motivate workers and relates to McGregors theory X view of workers. This approach has limitations (as highlighted by other motivational theorists such as Mayo and Herzberg) but it can be effective in certain situations. For example: When quick decisions are needed in a company (e.g. in a time of crises) When controlling large numbers of low skilled workers. Paternalistic managers give more attention to the social needs and views of their workers. Managers are interested in how happy workers feel and in many ways they act as a father figure (pater means father in Latin). They consult employees over issues and listen to their feedback or opinions. The manager will however make the actual decisions (in the best interests of the workers) as they believe the staff still need direction and in this way it is still somewhat of an autocratic approach. The style is closely linked with Mayos Human Relation view of motivation and also the social needs of Maslow. A democratic style of management will put trust in employees and encourage them to make decisions. They will delegate to them the authority to do this (empowerment) and listen to their advice. This requires good two-way communication and often involves democratic discussion groups, which can offer useful suggestions and ideas. Managers must be willing to encourage leadership skills in subordinates. The ultimate democratic system occurs when decisions are made based on the majority view of all workers. However, this is not feasible for the majority of decisions taken by a business- indeed one of the criticisms of this style is that it can take longer to reach a decision. This style has close links with Herzbergs motivators GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 72 of 165
and Maslows higher order skills and also applies to McGregors theory Y view of workers. Summary of management styles Description Advantages Disadvantages Autocratic Senior managers take all the important decisions with no involvement from workers Quick decision making Effective when employing many low skilled workers No two-way communication so can be de-motivating Creates them and us attitude between managers and workers Paternalistic Managers make decisions in best interests of workers after consultation More two-way communication so motivating Workers feel their social needs are being met Slows down decision making Still quite a dictatorial or autocratic style of management Democratic Workers allowed to make own decisions. Some businesses run on the basis of majority decisions Authority is delegated to workers which is motivating Useful when complex decisions are required that need specialist skills Mistakes or errors can be made if workers are not skilled or experienced enough Evaluation of Management Styles It is impossible to say that one style is better for a business than another as it depends on a number of different factors: The skills and experience of the workers How genuinely motivated the workers are How quickly decisions are needed The importance of the task or decision The personality of the manager The best managers are those that are versatile and can call upon the right style at the right time. There has been a move towards a more democratic style of management in the UK in recent years. This is due to: Workers becoming better trained and able to take on more responsibility Workers expecting the opportunity to quickly take on new tasks and roles as they want to move rapidly up the career ladder An increase in lean production techniques, such as total quality management and kaizen, which require more employee involvement and a need to have increased control over their area of work. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 73 of 165
McGregors Theory X and Y Douglas McGregor published a book The Human Side of Enterprise in 1964 in which he argued that managers have two very different views of workers in terms of their attitudes to work and motivation. Theory X managers distrust their workers and believe workers will avoid work if they can, whereas Theory Y managers believe workers like to work and want to be given more responsibility. Although McGregor fully supported a Theory Y approach from managers which would undoubtedly be more pleasant and interesting to work for, he also recognised that a Theory X view can be the most effective form of management in certain circumstances- just like an autocratic management style or Taylorite view of motivation. This might be when controlling a large number of part-time, student or low skilled workers who are simply focused on collecting a pay packet at the end of the day and therefore need constant direction and supervising to ensure they do not slack off. Key Terms in this Section
Term Definition Absenteeism Working days missed due to health or other reasons Autocratic Managers who like to make all the important decisions and closely supervise and control workers Democratic Managers allow workers allowed to make own decisions Hygiene factor A factor that when not present will de-motivate someone, but cannot directly motivate someone to work harder Motivation The will to work due to the enjoyment of the work itself and/or from the desire to achieve certain goals e.g. earn more money or achieve promotion Motivator A factor which will encourage someone to work harder Paternalistic Managers who make decisions in the best interests of their workers after consultation Piece-rate Pay according to the number of items produced Theory X Theory X managers distrust their workers and believe workers will avoid work if they can Theory Y Theory Y managers believe workers like to work and want to be given more responsibility
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Rewarding Employees Introduction Managers need to reward employees in order to motivate them to work harder. The methods of reward largely fall into two categories: financial or non-financial incentives. Theorists such as Taylor support financial rewards as the best method, but others such as Mayo and Herzberg promote non-financial rewards, such as teamworking or job enrichment. An alternative approach is to make a list of reasons why people go into work each morning and then consider the rewards which may satisfy each. Some of the reasons may be to: Earn money Feel a sense of achievement or job satisfaction Feel a sense of belonging to a group Achieve a sense of security Obtain a feeling of self-worth Financial incentives can be used to meet the first of these and possibly would give someone more security but the others need to be met by non-financial rewards. Financial Rewards In reality, despite the views of Herzberg that monetary methods of motivation have little value, firms still use money as a major incentive. There are a variety of payment systems that a business could use to motivate its employees. Wages and Salaries Wages are normally paid per hour worked and workers receive money at the end of the week. Overtime is paid for any additional hours worked during the week. However salaries are annual (based on a years work) and are paid at the end of each month. Advantage Disadvantage Simple and easy to use for businesses Workers may resent being paid the same as a colleague who they feel is not so productive Piece-rate Piece-rate is paying a worker per item they produce in a certain period of time. It was recommended by the motivation theorist Taylor and had close links with working on production lines. Advantages Disadvantages Increases speed of work and therefore productivity Workers do not concentrate on quality of work as emphasis on speed of work Often workers not entitled to sick pay or holiday pay which reduces cost Workers may ignore company rules, such as Health and safety issues, in they try to speed up output GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 75 of 165
Fringe Benefits These are often known as perks and are items an employee receives in addition to their normal wage or salary e.g. company car, private health insurance, free meals. Advantages Disadvantages Encourages loyalty to a company so employees may stay for longer Widespread use to a majority of employees will increase costs sharply Helps meet a workers human and social needs Performance-related pay This is paid to those employees who meet certain targets. The targets are often evaluated and reviewed in regular appraisals with managers. It is system that is being increasingly used in businesses in the UK. Advantages Disadvantages Easier for managers to monitor and control their staff It can be difficult to measure the performance of employees in service based industries Reduces the amount of time spent on industrial relations (negotiations with trade unions) It does not promote teamwork and can lead to workers feeling they are treated unfairly if colleagues are awarded more Profit sharing This is a system whereby employees receive a proportion of the companys profits. This means staff are in the same position as shareholders. Advantages Disadvantages Should improve loyalty to the company and break down the them and us barrier if all staff given same amount The share given to employees is often too small to provide a worthwhile incentive Workers are more likely to accept changes to their working practices if they can see that it may decrease costs and so increase profit Workers may feel that however hard they work it will not have a noticeable effect on the companys profit level, so therefore no incentive Share ownership This is a common incentive for senior managers who are given shares in the company rather than a straightforward bonus or membership of a profit sharing scheme. It means that some staff are also shareholders.
Advantages Disadvantages Employees will work harder as they have a stake in the company, just like a shareholder has Often only available to senior managers so can cause resentment among other staff. Workers are less likely to leave the firm
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Non-financial Rewards Job enrichment Job enrichment means giving workers more interesting, challenging and complex tasks. Workers should also be given the opportunity to complete a whole unit of work rather than individual separate tasks. This is motivating for several reasons: It gives workers the chance to test themselves and use their full range of ability It is more motivating than job enlargement or job rotation (see below) as it increases the complexity or challenge involved in the task, rather than just simply providing more variety to the work. Workers should obtain a greater sense of achievement and possibly more praise or recognition of their work when they have successfully completed a tougher task Workers respond better as managers have shown trust in the fact that they possess the ability to handle the increasing complexity and pressures of the work. The managers need to judge carefully however what an appropriate task is for a worker to handle- if it is too complex for the workers or they do not posses the correct skill level, then expensive mistakes could be made. Job enlargement Job enlargement means simply giving workers more tasks to do of a similar nature or complexity. This will reduce the monotony or repetition involved in a persons work but over time this will not increase a persons satisfaction or sense of achievement. Job rotation is a part of this and involves having a wider variety of tasks to do, perhaps rotating jobs with other members in your team, but not increasing the challenge of the job. Teamworking Teamworking is where employees work in groups or teams. This can meet a workers social needs as a person can more easily build friendships and feel a sense of belonging to a unit or group and hopefully to the business as a whole. This applies in much the same way as being a member of a sports team or any other team representing a school or college. A business can create a number of different types of team; examples include production teams (often known as cells), quality circles and management teams. Teamworking has other advantages to a firm over and above improving motivation. It can lead to greater flexibility of production, as employees are likely to be multi-skilled (able to do more than one persons job) as they have learnt from other team members or undertaken formal job rotation. This means they can cover any absences and can quickly adapt to a new production technique. Empowerment Empowerment is like delegation. It is when power or authority is given to employees so they can make their own decisions regarding their working life. For instance workers have control over how to use their time and deciding the priority of tasks that need to be done. They are encouraged to consider problems they face and come up with some solutions. For empowerment to be successful, workers must have adequate training and/or good skill levels in order to GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 77 of 165
be trusted to make the correct decisions. If they do not, then expensive mistakes can be made that could affect the whole business. It is the managers job to judge whether a subordinate can cope with more authority and decision-making power. It should be noted however, that even if managers pass down authority to their subordinates, they are still responsible for the work that is done by them. Key Terms in this Section
Term Definition Empowerment / Delegation When power or authority is given to employees so they can make their own decisions regarding their working life Fringe benefits These are often known as perks and are items an employee receives in addition to their normal wage or salary e.g. company car, private health insurance, free meals Job enlargement Involves simply giving workers more tasks to do of a similar nature or complexity Job enrichment Giving workers more interesting, challenging and complex tasks Job rotation Involves giving a worker a wider variety of tasks to do, perhaps rotating jobs with other members in a team, but not increasing the challenge of the job Performance- related pay Paid to those employees who meet certain targets. Targets are regularly reviewed in appraisals Profit sharing A system whereby employees receive a proportion of the companys profits Share ownership A common incentive for senior managers who are given shares in the company
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Groups at work Trade Unions A trade union is an organisation that employees can join in order to have their interests and goals better represented. A worker will pay an annual subscription and in return will have their interests more powerfully represented than if they had to negotiate with employers on their own. Workers acting together in a trade union can counterbalance the power of large firms. This is due to collective bargaining where all trade union members are balloted (given the opportunity to vote) on issues and a trade union representative then negotiates with the employer on their behalf. The negotiations and relationship between a trade union and an employer is known as industrial relations. Traditionally trade unions used to focus their attention on obtaining a good standard of pay for their members but more recently unions are concentrating on protecting the individual rights of their members. This may mean providing legal and financial support and advice for members who feel their employer has discriminated against them or dismissed them unfairly. There are four main types of trade union as outlined in the table below: Type of Union Description / Example Craft of skills union To represent skilled workers e.g. Musicians Union (MU) Industrial unions To represent the members of one particular industry e.g. Fire Brigades Union (FBU) General unions Unions which recruit workers from all types of industries and with any level or range of skills e.g. Amicus the Manufacturing Science and Finance Union (MSF) White-collar unions Represent office workers e.g. National Union of Teachers (NUT) In addition there is the Trade Unions Congress (TUC) who represent all British trade unions at a national and international level. In particular the TUC tries to influence government decision-making in the best interests of unions and workers and to coordinate with trade union movements in other EU countries. Industrial Action The majority of worker-to-manager and therefore union-to-employer problems are worked out peacefully through negotiation. However occasionally an issues arises where no agreement or solution can be reached. This is when a trade union may conduct some form of industrial action in order to force the employer to back down. There are several different types of industrial action that could be taken: Strike Workers select a day(s) on which they will not come into work. Work to rule Workers apply the firms rules and procedures to the letter with the objective of slowing down production. For example a machine worker may be told to ensure his machine is clean and safe before starting work and so he will be deliberately nit-picking and spend hours doing exactly this. Go slow Employees carry on working but at the minimum pace possible in order to slow down production but avoid disciplinary action. Picketing Workers may stand at the entrance to the employers factory or place of work and demonstrate with banners or slogans. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 79 of 165
Overtime ban Workers simply refuse to work overtime as they are not obliged to. This can prevent a firm being able to produce quickly enough to meet demand and they may lose orders. If unions and employers continue in dispute then either side can bring in ACAS to help resolve the disagreement. ACAS is the Advisory, Conciliation and Arbitration Service and is an independent body financed by the government. It is responsible for giving advice to both sides, sitting in and helping with negotiations and ultimately it can provide an individual, or arbitrator, who can judge the right outcome of the dispute. Changing Role of Trade Unions The power of trade union has been gradually eroded over the last 20 years. This is due to a number of reasons: Laws passed by Conservative government during 1980s and 1990s which have weakened the power of trade unions Decline in trade union membership Change in structure of industry from heavily unionised manufacturing industry towards service sector businesses. Also more women and part-time workers who are less inclined to join unions. Change in philosophy from conflicts due to collective bargaining to individual bargaining between firms and employees One of the new laws that was introduced stated that employers did not have to recognise any trade union if they did not want to, regardless of how many of their workers belonged to it. This meant that trade unions could play no part in negotiations and could not represent their workers at all. However, in 2000 a new EU employment Law came into being which stated that an employer must legally recognise and negotiate with a trade union if more than 50% of its workers belong to it. Benefits of Trade Unions In practice many firms choose to deal with trade unions as they can benefit not only the employee but also the employer. This is shown below: Benefits to an Employee Benefits to an Employer More powerful voice when bargaining as a group (e.g. for pay rises) as can threaten industrial action such as strikes Cheaper and quicker to bargain with one trade union representative than individual workers Workers will have their individual rights better protected e.g. if dismissed unfairly or discriminated against Workers are better motivated if they feel their interests are being looked after by trade unions Trade unions increasingly wish to be seen as working with employers to create a better and more competitive economy and not as organisations that stand in the way of change and increase costs for firms. They believe that both parties have mutual interests. This has led to more and more single union agreements (where an employer agrees to deal with only one union) but in return can often expect a no-strike deal from the union (where unions agree never to strike if a dispute cannot be settled). GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 80 of 165
Other Groups in the Workplace Employers Association (Trade Association) These are organisations that represent the views and interests of companies within a certain industry. They act like a pressure group on the government and also negotiate with trade unions. Examples: Universities and Colleges Employers Association Engineering Employers Federation Confederation of British Industry (CBI) The CBI was established in 1965 and represents the interests of British businesses on a wide range of issues. It has similar objectives to an Employers Association except that the CBI represents all UK companies and not just those within one industry. It again acts as a pressure group and aims to create and sustain conditions in the economy that allow UK firms to compete and prosper. Key Terms in this Section
Term Definition ACAS The Advisory, Conciliation and Arbitration Service and is an independent body financed by the government aimed at resolving disputes between trade unions and employers Collective bargaining When workers gain strength from combining together (often in the form of a trade union) in order to negotiate with an employer Industrial Relations The negotiations and relationship between a trade union and an employer No-strike agreement Trade unions sign a document agreeing never to strike if a dispute between an employer and themselves cannot be settled Single Union Agreement This occurs when an employer agrees to deal with only one trade union Trade union An organisation that employees can join in order to have their interests and goals better represented Trade Unions Congress (TUC) An organisation that represent all British trade unions at a national and international level
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Communication Introduction Communication is the process by which a message or information is exchanged from a sender to a receiver. For example a production manager (sender) may send a message to a sales manager (receiver) asking for sales forecasts for the next 6 months so they can plan production levels. The sales manager would then reply (feedback) to the production manager with the appropriate figures. This is an example of internal communication, i.e. when communications occur between employees of a business. Communication therefore links together all the different activities involved in a business and ensures all employees are working towards the same goal and know exactly what they should be doing and by when. Effective communication is therefore fundamental to the success of a business. A business will of course need to communicate with people or organisations outside of the business. This is known as external communication. For example a marketing manager will need to tell customers of a new special pricing offers or the finance director may need to ask banks for a loan. Receivers of Messages Internal External Workers Directors Managers Customers Local community Suppliers Shareholders Government Banks Importance of Communication Good communication has many advantages for a business: strong communication: Motivates employees helps them feel part of the business (see below) Easier to control and coordinate business activity prevents different parts of the business going in opposite directions Makes successful decision making easier for managers decisions are based on more complete and accurate information Better communication with customers will increase sales Improve relationships with suppliers and possibly lead to more reliable delivery Improves chances of obtaining finance e.g. keeping the bank up-to-date about how the business is doing Communication and Motivation There is an integral link between communication and the motivation of employees and several motivational theorists recognised this. Mayo especially emphasised the importance of communication between managers and workers in meeting employees social needs. Maslow and Herzberg stressed the significance of recognising employees achievements and self-esteem needs and these can only be done via clear and GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 82 of 165
effective communication. Other reasons why there is such a close relationship between communication and motivation are: Ensures that everyone is working towards the same company goals Enables employees to be involved in decision-making Employees can offer feedback and give suggestions People are motivated by having clear targets set for them Methods of Communication There are many different methods or mediums of communication. [insert diagram showing methods of communication] There are several factors that will determine what the best or most appropriate method of communication: Content of the message (e.g. is it confidential or lengthy) Speed required Amount of feedback wanted Type of feedback required e.g. is a decision required from the person to whom the communication is sent Cost The advancement of information technology has altered the way that many businesses communicate. For example, fax was a popular form of communication for businesses in the 1980s. Whilst it still has its uses, people now largely use e-mail instead. The internet is a key tool for many firms now to communicate with many different groups, such as advertising to customers and finding suppliers. Investing in the new technology is costly however and potentially it can become outdated within a few years. There is also the need to train many staff on how to use the technology effectively and even then some employees may be reluctant to change from their traditional methods. Formal communication occurs when channels of communication are used which have been established by the firm. This may be when workers communicate with managers via works councils or trade union representatives. Informal communication is often known as communication through the grapevine and it can be useful for a manager as they can hear some useful and interesting information which they would not from official channels. This can often be akin to gossiping and it can transmit information quickly but not always accurately (just think how rumours and gossip spread through a school!). Effective Communication Businesses need to have in place appropriate structures or technology in order to aid communication (e.g. e- mail facilities for all employees) but on an every day level it is down to individual managers and employees to ensure that they communicate their messages or information effectively. Not all managers for instance will naturally have good communication skills and there is an obvious need for training in this case to ensure they are able to choose the most appropriate communication method to get their message across clearly. To be effective the message must be clearly understood by the receivers and also the receivers should be able to supply some feedback. When feedback occurs it is known as two-way communication and is seen as the most effective form of communication. The best example of this is direct face-to-face communication GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 83 of 165
as the sender can get an immediate reaction in terms of the oral reply and also importantly from the receivers body language. One-way communication occurs when there is no feedback given on a message, for example putting a notice on a notice board. This is suitable in some circumstances, if for instance someone is announcing a change of time for a meeting and little feedback is required, but generally employees should try to maximise methods that encourage two-way communication and feedback. Two-way feedback is becoming relevant in firms for two main reasons. Many firms are introducing new techniques and initiatives, such as kaizen or total quality management, which rely on employee participation and feedback. In addition two-way communication is a pre-requisite for a democratic management style, which is becoming increasingly popular in businesses. For many firms one of their main objectives is to grow in size (gaining market share or entering new markets) as this is seen as the way to boost profits. As a firm expands one of the major problems they will face will be to continue to communicate effectively with their increasing workforce and so maintain motivation levels Barriers to Communication There are various barriers to communication that need to be overcome for communication to be effective. Some of the more common are: Too many intermediaries. There may be too many layers in the hierarchy through which the message has to be passed and it can get distorted on the way (like a game of Chinese whispers). This may encourage a business to undertake delayering (removing a layer of management from the hierarchy) Geographical distance. Distance between a firms offices, production plants or outlets can limit the methods of communication that can be used and so decrease the feedback possible. Communication overload. Too much information being passed can cause problems e.g. slow down decision-making. For example when surfing for something on the internet you van be inundated with material, most of which is of little use! Jargon. It may be that the sender uses too much technical jargon in the message that others may not understand. Or the sender may simply not explain themselves clearly enough.
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Key Terms in this Section
Term Definition Effective communication When the message has been clearly understood by the receiver External communication Communication with people or organisations outside of the business Feedback Receiver gives a response on a message back to the sender Formal communication Channels of communication are used which have been established by the firm Informal communication Unofficial channels of communication - often known as the grapevine Internal communication Communication between employees of a business Two-way communication When feedback is given on a message
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BUSINESS OBJECTIVES Forms of Business Ownership and Operation Introduction A business is always owned by someone. This can just be one person, or thousands. So a business can have a number of different types of ownership, and this depends on the aims and objectives of the owners. Most businesses aim to make profit for their owners. Profits may not be the major objective, but in order to survive a business will need make a profit in the long term. Some organisations however will be not-for-profit, such as charities or government-run corporations. The main types of business ownership are: Sole trader Partnerships Limited companies Co-operative Franchises Public sector and privatisation Each organisation has different rules and regulations dealing with ownership and the way that profits and losses are dealt with. Sole Trader A sole trader is a business that is owned by one person. It may have one or more employees. It is the most common form of ownership in the UK. The main advantages of setting up as a sole trader are: Total control of the business by the owner. Cheap and easy to start up few forms to fill in and to start trading the sole trader does not need to employ any specialist services, other than setting up a bank account and informing the tax offices. Keep all the profit as the owner, all the profit belongs to the sole trader. Business affairs are private competitors cannot see what you are earning, so will know less about how the business works and how it succeeds. The reasons why sole traders are often successful are: Can offer specialist services to customers e.g. appliance repair specialists. Can be sensitive to the needs of customers since they are closer to the customer and will react more quickly, because they are the decision makers too. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 86 of 165
Can cater for the needs of local people a small business in a local area can build up a following in the community due to trust if people can see the owner they feel more comfortable than if the owner is in some far off town, not able to hear the views of the local community. The legal requirements of a sole trader are to: Keep proper business accounts and records for the Inland Revenue (who collect the tax on profits) and if necessary VAT accounts Comply with legal requirements that concern protection of the customer (e.g. Sale of Goods Act) The main disadvantages of being a sole trader are: Unlimited liability see below. Can be difficult to raise finance, because they are small, banks will not lend them large sums and they will not be able to use any other form of long-term finance unless they change their ownership status. Can be difficult to enjoy economies of scale, i.e. lower costs per unit due to higher levels of production. A sole trader, for instance, may not be able to buy in bulk and enjoy the same discounts as larger businesses. There is a problem of continuity if the sole trader retires or dies what happens to the business next? The reasons for being a sole trader are often a balance between business and personal costs and benefits. Many will prefer the satisfaction of running a business with little paper work against the risks, pressure and probably long working hours. A sole trader is liable for any debts that the business incurs. This means that any money that the owner has put into the business could be lost, BUT IMPORTANTLY, if the business continues to incur further costs then the owner has to pay these as well. In some cases they may have sell some of their own possessions to pay creditors. Such a risk often puts potential sole traders off setting up businesses, but also makes them consider the other forms of business structure. Partnerships A partnership is a business where there are two or more owners of the enterprise. Most partnerships are between two and twenty members though there are examples like John Lewis and some of the major world accountancy firms where there are hundreds of partners. A partner is normally set up using a Deed of Partnership. This contains: Amount of capital each partner should provide (i.e. starting cash). How profits or losses should be divided. How many votes each partner has (usually based on proportion of capital provided). Rules on how to take on new partners. How the partnership is brought to an end, or how a partner leaves. The advantages of a sole trader becoming a partnership are: GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 87 of 165
Spreads the risk across more people, so if the business gets into difficulty then there are more people to share the burden of debt Partner may bring money and resources to the business (e.g. better premises to work from) Partner may bring other skills and ideas to the business, complementing the work already done by the original partner Increased credibility with potential customers and suppliers who may see dealing with the business as less risky than trading with just a sole trader For example, a builder, working originally as a sole trader, may team up with an architect or carpenter to form a partnership. Either would bring added expertise, but also might bring added capital and/or contacts. Of course the builder could team up with another builder as well sharing the risk, and potentially the workload. The main disadvantages of becoming a partnership are: Have to share the profits. Less control of the business for the individual. Disputes over workload. Problems if partners disagree over of direction of business. The next step for a partnership is to move towards becoming a private limited company. However some partnerships do not want to move to this stage. The advantages of remaining a partnership rather than becoming a private limited company are: Costs money to set up limited company (may need to employ a solicitor to set up the paper work). Company accounts are filed so the public can view them (and competitors). May need to spend money on an auditor to check the accounts before they are filed. When a partnership finishes then, depending on how the Deed of Partnership is set up, each partner has an agreed slice of the business. Limited Companies A limited company is a business that is owned by its shareholders, run by directors and most importantly whose liability is limited. Limited liability means that the investors can only lose the money they have invested and no more. This encourages people to finance the company, and/or set up such a business, knowing that they can only lose what they put in, if the company fails. For people or businesses who have a claim against the company, limited liability means that they can only recover money from the existing assets of the business. They cannot claim the personal assets of the shareholders to recover amounts owed by the company. To set up as a limited company, a company has to register with Companies House and is issued with a Certificate of Incorporation. It also needs to have a Memorandum of Association which sets out what the company has been formed to do, and Articles of Association which are internal rules over including what the directors can do and voting rights of the shareholders. Limited companies can either be private limited companies or public limited companies. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 88 of 165
The difference between the two are: Shares in a public limited company (plc) can be traded on the Stock Exchange and can be bought by members of the general public. Shares in a private limited company are not available to the general public; and The issued share capital of a plc (the initial value of the shares put on sale) must be greater than 50,000 in a plc. A private limited company may have a smaller share capital A private limited company might want to become a plc because: Shares in a private limited company cannot be offered for sale to the general public, so restricting availability of finance, especially if the business wants to expand. Therefore, it is attractive to change status It is also easier to raise money through other sources of finance e.g. from banks [Note: becoming a plc does not necessarily mean that the company is quoted on the Stock Exchange. To do that, the company must do a flotation (see below)] The disadvantages of a being a public limited company (plc) are: Costly and complicated to set up as a plc need to employee specialist bankers and lawyers to help organise the converting to the plc. Certain financial information must be made available for everyone, competitors and customers included (would you want them to know how much profit you are making?) Shareholders in public companies expect a steady stream of income from dividends, which might mean that the business has to concentrate on short term objectives of creating a profit, whereas it might be better to work on longer term objectives, such as growth and investment. Threat of takeover, because another company can buy up a large number of shares because they are traded publicly (can be sold to anyone). If they buy enough, they can then persuade other shareholders to join with them to vote in a new management team. Shareholders own the company. They buy shares because: Shares normally pay dividends, which is a share of the profits at the end of the year. Companies on the Stock Exchange usually pay dividends twice each year. Over time the value of the share may increase and so can be sold for a profit this is known as a capital gain. Of course, the price of shares can go down as well as up, so investing in shares can be very risky. If they have enough shares they can influence the management of the company. A good example is a venture capitalist that will often buy up to 80% of the shares of a company and insist on choosing some of the directors. Flotation A company may float on the stock market. This means selling all or part of the business to outside investors, who can then buy and sell the shares on the Stick Exchange. Flotation generates additional funds for the business and can be a major form of fund raising. When shares in a plc are first offered for sale to the general public, the company is given a listing on the Stock Exchange. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 89 of 165
Divorce of ownership and control As a business becomes larger, the ownership and control of the business may become separated. This is because the shareholders may have the money, but not the time or the management skills to run the company. Therefore, the day-to-day running of the business is entrusted to the directors, who are employed for their skills, by the shareholders. The shareholders are therefore divorced from the running the business for 364 days of the year. They will have their say at the Annual General Meeting (AGM) of the company, where the directors present the accounts and results. Very recently a couple of businesses have had very strong shareholder unrest leading the company to tone down a number of their decisions. In practice directors tend to have at least a modest shareholding in the company. This provides the director with an incentive to achieve good dividends and capital growth for the share (an increase in the share price). Co-operatives A co-operative is where a number of individuals or businesses work together to achieve a common purpose. They are normally formed so individuals and small businesses can benefit from being part of a larger group, meaning they have more power to buy or bargain. There are three main types of co-operatives: Retail co-operatives Marketing or trader co-operatives Worker co-operatives A retail co-operative is probably the most familiar co-op. The Co-Op shops and Leo Hypermarkets are a regular sight in the high street. The objectives of a co-op tend to set them apart from other businesses. The objectives are normally more focused on the members of the co-operative, the local community and the world community. Though profits are required to enable them to reinvest in their business, they will not be a primary objective. Though co-operatives exist to overcome some of the trading difficulties faced by small businesses, they can still face of number of problems in their operation: The system of one member one vote in some societies means a long, drawn out decision-making process Co-operatives may find it difficult to raise finance since banks are not so willing to lend them money because their main aim is not to make a profit Idealistic and ethical aims may not be agreeable with all members, so creating unrest and disharmony The aims held by many co-operatives may not lead to profits in the long run (though many co-op shops will continue to exist at a loss because the owners feel they are providing an important service to the community.) Franchises A franchise is where a business sells a sole proprietor the right to set up a business using their name. Examples of major franchises are: GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 90 of 165
McDonalds Clarks Shoes Pizza Hut Holiday Inn The franchisor is the business whose sells the right to another business to operate a franchise they may run a number of their own businesses, but also may want to let others run the business in other parts of the country. A franchise is bought by the franchisee once they have purchased the franchise they have to pay a proportion of their profits to the franchiser on a regular basis. Depending on the business involved, the franchiser may provide training, management expertise and national marketing campaigns. They may also supply the raw materials and equipment. The advantages of being a franchisor: Large companies see it as a means of rapid expansion with the franchisee providing most of the finance. If the franchise model works, then there are large profits to made from - selling franchises - royalty payments - selling raw materials and equipment. The advantages of setting up as a franchisee are: The franchisee is given support by the franchiser. This includes marketing and staff training. So starting a business in this way requires less expertise and is less lonely! The franchisee may benefit from national advertising and being part of a well-known organisation with an established name, format and product Less investment is required at the start-up stage since the franchise business idea has already been developed A franchise allows people to start and run their own business with less risk. The chance of failure among new franchises is lower as their product is a proven success and has a secure place in the market The disadvantages of setting up as a franchisee are: Cost to buy franchise can be very expensive (hundreds of thousands of pounds). Have to pay a percentage of your revenue to the business you have bought the franchiser from. Have to follow the franchise model, so less flexible. You would probably be told what prices to set, what advertising to use and what type of staff to employ. In conclusion, a buying a franchise a good way of an individual setting up a business because: They do not have to establish themselves in the same as a sole trader might have to. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 91 of 165
They will have the support of a tried and tested business model, often with a national marketing campaign behind them. Public Sector and Privatisation Businesses that are owned by the government are part of the public sector. From 1945 to the mid 80s many industries were stated owned. However the Conservative government in the 1980s decided (along with many other governments around the world) that they would privatise a great many of these industries. This means that they changed ownership from government to private shareholders. They also changed their objectives, making them become more profit orientated. The public sector of government exists and existed because the government needs and needed to: Provide essential services not fully provided by the private sector (because those services were not profitable e.g. rural bus services) Prevent exploitation of customers large business would not charge too higher a price for their services and also make sure that more needy households could afford essential services Avoid duplication of resources it is sometimes unnecessary for two companies to be caring out expensive research on the same product which would benefit the economy e.g. a new, more efficient, petrol engine Protect jobs and maintain key industries many public sector industries were very labour- intensive and so if they went out of business there would be a substantial increase in UK unemployment. Also it was felt that the UK needed to continue to have a strong industrial base in areas such as coal and steel, vital to running the economy, especially if there was potential of a war The move from public sector to private sector ownership has been justified because: State run firms are inefficient - there is no incentive to cut costs or provide high quality services because there is no competition State run firms can be a financial burden on the government, using up tax revenue which could be utilized elsewhere Selling them off raises valuable money for the government, which can be used elsewhere in public spending, e.g. on health or education The possible disadvantages to society of privatization of public owned businesses are: Private companies may put prices up, meaning that those who can least afford it, have to pay more for their services (e.g. higher prices for water or electricity). Cuts jobs, therefore increasing unemployment. Reduces services that are not profitable, to the disadvantage of the needy. Sole trader Partnerships Limited companies Co-operative GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 92 of 165
Franchises Key Terms in this Section
Term Definition Co-operative A number of people or businesses working together to achieve a common purpose. Divorce of ownership and control Where the shareholders give the managers the authority to control the business Flotation Selling shares for the first time on the Stock Exchange Franchises A business that is sold to someone, giving them the right to use their name Limited companies Businesses which have limited liability, owned by the shareholders and run by directors Limited liability Where an investor can only lose what they put into the business Partnerships A business where there are two or more owners PLC A public limited company can sell shares on the Stock Exchange Privatisation Selling publicly owned businesses to the private sector Public sector Businesses and organizations that are owned and run by the government Shares Certificates of ownership of a business, a share representing part ownership of the business Sole trader A business owned by one person GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 93 of 165
Organisation of a Business Introduction A sole trader has to fulfill many roles. He or she is the sales person, accountant, marketing manager and operations manager all rolled into one. As soon as the business takes on another person, then the business starts to form some sort of organisation. This may be informal at the start of a business, but as it grows there needs to be some type of formal organisation with a clearly defined organisational structure. This organisation determines who is responsible for what job and who is responsible to whom. For example lets us say a shopkeeper takes on an assistant. A formal organisation could mean that the shopkeeper would be in charge of accounts, marketing and business strategy, whilst the assistant would do the more mundane tasks of staking shelves, checking and re ordering stock. This section will look at the different ways in which a business organises itself and the way managers interact within that organisation. Span of Control and Hierarchies In a business of more than one person, unless the business has equal partners, then there are managers and subordinates. Subordinates are workers controlled by the manager. A hierarchy describes the structure of the management of the business, from the top of the company the managing director, through to the shop floor worker, who reports to their foreman, in a manufacturing business. The hierarchy of a business is usually best understood by drawing an organisation chart showing which levels of management and employees report to whom. An example of a hierarchy is shown in the diagram below
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A span of control is the number of people who report to one manager in a hierarchy. The more people under the control of one manager - the wider the span of control. Less means a narrower span of control. An example of a narrow span of control is shown in the diagram below:
The advantages of a narrow span of control are: A narrow span of control allows a manager to communicate quickly with the employees under them and control them more easily Feedback of ideas from the workers will be more effective It requires a higher level of management skill to control a greater number of employees, so there is less management skill required An example of a wide span of control is shown in the diagram below:
The advantages of wide span of control are: GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 95 of 165
There are less layers of management to pass a message through, so the message reaches more employees faster It costs less money to run a wider span of control because a business does not need to employ as many managers The width of the span of control depends on: The type of product being made products which are easy to make or deliver will need less supervision and so can have a wider span of control Skills of managers and workers a more skilful workforce can operate with a wider span of control because they will need less supervision. A more skilful manager can control a greater number of staff A tall organisation has a larger number of managers with a narrow span of control whilst a flat organisation has few managers with a wide span of control. A tall organisation can suffer from having too many managers (a huge expense) and decisions can take a long time to reach the bottom of the hierarchy BUT, a tall organisation can provide good opportunities for promotion and the manager does not have to spend so much time managing the staff Chain of command is the line on which orders and decisions are passed down from top to bottom of the hierarchy. In a hierarchy the chain of command means that a production manager may be higher up the hierarchy, but will not be able to tell a marketing person what to do. The advantages of hierarchies are: Helps create a clear communication line between the top and bottom of the business this improves co-ordination and motivation since employees know what is expected of them and when. Hierarchies create departments and departments form teams. There are motivational advantages of working in teams. The disadvantages of hierarchies are: The formation of departments can mean that: - Departments work for themselves and not the greater good of the business. - Departments do not see the whole picture in making decisions. Hierarchies can be inflexible and difficult to adjust, especially when businesses need to adapt to changing markets remember employees do not tend to react well to change. Delegation Delegation is giving the authority for certain decisions to those below the manager. E.g. a manager may authorise a subordinate to decide on what stock to buy for the business. The two main advantages of delegation are: Gives the manager more time to work on other aspects of the business. Motivates the workers who are given the responsibility (link to motivation). GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 96 of 165
However there are difficulties in effective delegation: Managers find it hard to hand over responsibility because they do not think other workers can complete the task to the right standard. There is a difficult balance between trust and control, where the manager might exercise too much control over the subordinate, reducing the effectiveness of the benefits of the delegation. Business Departments When a business reaches a certain size then it might split into different departments. These departments will specialise, employing people with expertise in these areas. The main departments in a business might be: Department Role Accounts Provides a detailed record of the money coming in and going out of the business and prepares accounts as a basis for financial decisions Human Resources or Personnel Deals with all the recruitment, training, health and safety and pay negotiations with unions/workers Production Makes sure that the production plans are met on time and products of the right quality are produced Purchasing Buys all the raw materials and goods required for production Sales and marketing Sales function deals with all aspects of selling to customers; the marketing function carries out marketing research, organises advertising and product promotion
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Nature of the Organisation of a Business A business is normally organised by its functions, e.g. marketing department, accounts department and so on (see organisational charts above). This is because being grouped together allows the functions to benefit from specialisation and division of labour. This leads to lower unit costs and a greater efficiency. However it can mean that there is departmental rivalry (see explanation above). Larger businesses might have a number of businesses within the whole company. This would be coordinated by a Head Office, where all the major decisions are made. Other ways of organising the business could be more appropriate for different types of businesses: Product the functions are organised around the product so at a business like ICI, who are the UKs leading chemical manufacturer, a product manager would have a team of functions who would answer to them, like accounting, marketing and production Geographical a hierarchy might be split according to different places that the product is sold into for instance a business may have a Far Eastern division of its business, which would take into account the different cultural and supply differences of the region Market the organisation is based on market segments so an airline business like British Airways could concentrate on long haul, short haul, holiday makers, business clients and freight A business whose decision-making comes from one place only is known as a centralised organisation. Normally Head Office will decide on the major elements of strategy, no matter where the manufacturing plants and sales teams are positioned around the country or globe. This means that there are good opportunities for economies of scale. Other businesses, especially multinationals (see below) will opt for a more decentralised organisation where the individual businesses within the whole company group, make decisions for themselves. This means that there is more opportunity to react to the changing marketplace (one of the advantages of a small firm). However there is a possibility that these businesses (who may well be in different parts of the world) might be duplicating research or not bargaining in such as strong position as a bigger overall company. Key Terms in this Section
Term Definition Centralised and decentralised A centralized organisation is controlled from one head office, and a decentralized organisation is controlled wherever the business has an office. Chain of command The line on which orders and decisions are passed Delegation Giving authority and responsibility to a subordinate Hierarchies The structure of a business indicating who is in charge of who Span of control The number of subordinates under a manager
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Business Aims and Objectives Introduction When a sole trader sets up they may have some unstated aims or objectives - for example to survive for the first year. Other businesses may wish to state exactly what they are aiming to do, such as Amazon, the Internet CD and bookseller, who wants to make history and have fun. An aim is where the business wants to go in the future, its goals. It is a statement of purpose, e.g. we want to grow the business into Europe. Business objectives are the stated, measurable targets of how to achieve business aims. For instance, we want to achieve sales of 10 million in European markets in 2004. A mission statement sets out the business vision and values that enables employees, managers, customers and even suppliers to understand the underlying basis for the actions of the business. Business Objectives Objectives give the business a clearly defined target. Plans can then be made to achieve these targets. This can motivate the employees. It also enables the business to measure the progress towards to its stated aims. The most effective business objectives meet the following criteria: S Specific objectives are aimed at what the business does, e.g. a hotel might have an objective of filling 60% of its beds a night during October, an objective specific to that business. M - Measurable the business can put a value to the objective, e.g. 10,000 in sales in the next half year of trading. A - Agreed by all those concerned in trying to achieve the objective. R - Realistic the objective should be challenging, but it should also be able to be achieved by the resources available. T- Time specific they have a time limit of when the objective should be achieved, e.g. by the end of the year. The main objectives that a business might have are: Survival a short term objective, probably for small business just starting out, or when a new firm enters the market or at a time of crisis. Profit maximisation try to make the most profit possible most like to be the aim of the owners and shareholders. Profit satisficing try to make enough profit to keep the owners comfortable probably the aim of smaller businesses whose owners do not want to work longer hours. Sales growth where the business tries to make as many sales as possible. This may be because the managers believe that the survival of the business depends on being large. Large businesses can also benefit from economies of scale. A business may find that some of their objectives conflict with one and other: GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 99 of 165
Growth versus profit: for example, achieving higher sales in the short term (e.g. by cutting prices) will reduce short-term profit. Short-term versus long-term: for example, a business may decide to accept lower cash flows in the short-term whilst it invests heavily in new products or plant and equipment. Large investors in the Stock Exchange are often accused of looking too much at short-term objectives and company performance rather than investing in a business for the long-term. Alternative Aims and Objectives Not all businesses seek profit or growth. Some organisations have alternative objectives. Examples of other objectives: Ethical and socially responsible objectives organisations like the Co-op or the Body Shop have objectives which are based on their beliefs on how one should treat the environment and people who are less fortunate. Public sector corporations are run to not only generate a profit but provide a service to the public. This service will need to meet the needs of the less well off in society or help improve the ability of the economy to function: e.g. cheap and accessible transport service. Public sector organisations that monitor or control private sector activities have objectives that are to ensure that the business they are monitoring comply with the laws laid down. Health care and education establishments their objectives are to provide a service most private schools for instance have charitable status. Their aim is the enhancement of their pupils through education. Charities and voluntary organisations their aims and objectives are led by the beliefs they stand for. Changing Objectives A business may change its objectives over time due to the following reasons: A business may achieve an objective and will need to move onto another one (e.g. survival in the first year may lead to an objective of increasing profit in the second year). The competitive environment might change, with the launch of new products from competitors. Technology might change product designs, so sales and production targets might need to change.
Key Terms in this Section GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 100 of 165
Term Definition Aim Long term direction and purpose of business Mission statement The stated vision and values of a business Objectives Specific measurable targets for the business Profit maximization An objective of try to achieve the most profit over a specified time period Survival objective Try to make enough profit in the short term to make it worthwhile being in the business GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 101 of 165
Stakeholders Introduction A stakeholder is any individual or organisation that is affected by the activities of a business. They may have a direct or indirect interest in the business, and may be in contact with the business on a daily basis, or may just occasionally. The main stakeholders are: Shareholders (not for a sole trader or partnership though) they will be interested in their dividends and capital growth of their shares. Management and employees they may also be shareholders they will be interested in their job security, prospects and pay. Customers and suppliers. Banks and other financial organisations lending money to the business. Government especially the Inland Revenue and the Customs and Excise who will be collecting tax from them. Trade Unions who will represent the interests of the workers. Pressure Groups who are interested in whether the business is acting appropriately towards their area of interest. Stakeholders versus Shareholders It is important to distinguish between a STAKEHOLDER and a SHAREHOLDER. They sound the same but the difference is crucial! Shareholders hold shares in the company that is they own part of it. Stakeholders have an interest in the company but do not own it (unless they are shareholders). Often the aims and objectives of the stakeholders are not the same as shareholders and they come into conflict. The conflict often arises because while shareholders want short-term profits, the other stakeholders desires tend to cost money and reduce profits. The owners often have to balance their own wishes against those of the other stakeholders or risk losing their ability to generate future profits (e.g. the workers may go on strike or the customers refuse to buy the companys products). GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 102 of 165
Social Responsibility Social responsibility is the duty and obligation of a business to other stakeholders. Stakeholder Example of responsibility to that stakeholder Shareholder Good return on investment Employee Fair pay and working conditions Supplier Regular business and prompt payment Customer Fair price and safe product Local community Jobs and minimum disruption Government Employment for local community Environment Less pollution Social responsibility for one group can conflict with other groups, especially between shareholders and stakeholders. Ethics Ethics refers to the moral rights and wrongs of any decision a business makes. It is a value judgement that may differ in importance and meaning between different individuals. Businesses may adopt ethical policies because they believe in them or they believe that by showing they are ethical, they improve their sales. Two good examples of businesses that have strong ethical policies are The Body Shop and Co-Op. Some examples of ethical policies are: Reduce pollution by using non-fossil fuels. Disposal of waste safely and in an environmentally friendly manner. Sponsoring local charity events. Trading fairly with developing countries.
Key Terms in this Section
Term Definition Ethics The moral rights and wrongs of any decision a business makes Social responsibility The duty and obligation of the business to other stakeholders Stakeholder An individual or organization affected by the activities of the business GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 103 of 165
Starting a Business Introduction An entrepreneur is defined as someone who has the ability to take risks and organise the factors of production. When starting a new business the entrepreneur faces a number of problems before they can start up. They need an idea and a will to succeed, but these are not enough on their own to be successful. A business needs: Finance to fund the other elements listed below: finance is usually the hardest thing to obtain in a start-up business. Labour to help develop a product or service and then to produce/deliver it. Customers without them, the business will fail. Obtaining customers means the business must undertake marketing. Suppliers provide many of the inputs, such as raw materials. Premises and equipment maybe a simple office, or possibly a large, modern factory; depending on what the business activity is. Management organisation & structure this is often very simple at the start-up stage (e.g. a sole trader!). Designed, researched and tested product or service a successful business is about more than just having a good idea the product needs to be brought to the marketplace in its best format. Dyson spent many years completing his first vacuum cleaner before being able to sell it. A business may also need to protect its idea or products. It can do this through: Copyright and patents make it illegal for other firms to copy directly the business idea or invention. Keep new products and services secret until they are ready for launch. Focus on retaining key staff that would be otherwise valuable for competitors to poach! Entrepreneurs An entrepreneur needs several skills to succeed: Have ideas Ability to take risks Ability to persuade others to join the business or lend the business money Energy to keep the business going under tough circumstances it is often said that the best entrepreneurs are the most persistent GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 104 of 165
Start Up Finance The entrepreneur will need to finance to the business. This means they will need to find money to pay for: The purchase of plant & machinery, office equipment etc Renting or buying premises and offices (e.g. the first 3 months rent may need to be paid in advance) Essential business services such as insurance The purchase of stocks of raw materials and components to allow production to start The wages and salaries of the first employees to join the business (who may be needed before any goods or services are actually sold) To provide financial cover whilst the business waits for customers to pay The main ways in which an entrepreneur can find finance for a new business are: Own money Bank loans Bank overdraft Money from friends Grant assistance from government bodies These types of finance can be split into INTERNAL and EXTERNAL sources of finance. Internal sources of finance are generated from the business itself (e.g. cash from sales) and external sources of finance from outside the business (e.g. a bank loan). The business can also split the types of finance into categories relating to length of time the money is needed for Short-term: bank overdraft Medium term: bank loan; lease; hire purchase; government grants Long term: bank loan; mortgage; share issue (for limited companies); debenture Business Plan A business plan sets out how a business is going to achieve its aims and objectives. It is extremely useful for a new business to use a plan because it can be used to show potential investors how their money is going to be spent. A business plan will probably contain the following elements: Statement of aims and objectives Description of market the business is selling to Main competitors (how will they respond to a new competitor?) GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 105 of 165
Production and sales forecasts Equipment needed Distribution plan for how to get product to customers In the plan, great care should be taken to estimate and forecast how the cash will come into and leave the business in the early weeks and months. This is because in the early days of setting up a business, finance is hardest to manage. It is uncertain how easy it will be to find customers and will they buy the product or service at the price that is being asked? The business will be incurring significant start-up costs which will eat into the available funds. Advantages of Small Businesses Not all businesses that start out need to grow to be large businesses. It is also true to say that small businesses can also compete very effectively against large businesses. Small business can offer the following advantages: Reason Explanation Personal service A small business can be more personal, so a customer feels they are talking more directly to the person who makes and supports the product. Closer to the market A small business can react more quickly to small changes in the market place because the chain of command is much shorter. Flexible A small business can change its product to suit the customers needs because it does not have to fit in with large production runs. For instance, wedding cakes and tailored clothes.
Key Terms in this Section Term Definition Business plan Setting out of how a business is going to achieve its aims and objectives Copyrights and patents Means of protecting ideas, products and concepts from being copied by other businesses Entrepreneur A person who is the main risk taker and organizer of all the elements of the business. Internal and external finance Internal finance is money raised from inside the business whilst external finance requires the business to seek other sources which are not directly part of the day to day running of the business GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 106 of 165
Growing a Business Introduction The growth of a business is when it expands in size. The size of a business can be measured by the following means: Sales turnover (or sales revenue) Number of employees Share capital (the number of shares times the price of each share) Market share the sales of the business of a particular product as a proportion of all sales of that type of product. A 5% market share would mean that 1 in 20 of all products sold are sold by that business. Number of outlets (e.g. shops) They may mean to grow in size or sometimes it just happens without the business making a conscientious effort to do so. Businesses either grow organically or by acquisition and mergers. Organic growth means the business grows by expanding its sales or their operations and is financed through its own profits. Acquisitions and mergers are when the business joins or buys other businesses, not necessary of the same type. Businesses may wish to expand for the following reasons: Benefit from economies of scale lower unit costs due to an increase in size A larger market share (selling more products than before) means they can charge higher prices and gain more profit As means of survival if they wish to compete with other growing businesses Some businesses start selling or acquiring businesses that are not in the same market as the markets they are presently selling in. This is known as diversification. Businesses may wish to diversify because: Helps spread the risks across a number of products. If one product fails due to market conditions then other products in different markets should not be affected. Good way of expanding if present market seems already full. Gives the business fresh objectives and may act to motivate managers and staff. A business can grow organically in the following ways: Lower price - People will buy more at lower prices. Increase advertising - Customers are made more aware of the attraction of the products. Sell in different location - Selling to a new set of customers, more potential. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 107 of 165
Sell on credit - Customers are attracted by the ability to buy now pay later. Mergers and Acquisitions A merger is where two or more businesses AGREE to join together to become one larger firm. An acquisition is when one firm BUYS another firm. When a one business buys another it is possible that the acquisition or merger integrates the new product with the existing product. This integration can either be vertical or horizontal integration. Mergers and acquisitions are an important option for larger businesses that wish to grow rapidly. However, they are a high risk strategy it is easy to buy the wrong business, at the wrong price for the wrong reasons! The advantages of mergers and acquisitions are: Economies of scale, which reduces unit costs. Greater market share for horizontal integration, which means the business can often charge higher prices. Spreads risks if products different. Reduces competition if a rival is taken over. Other businesses can bring new skills and specialist departments to the business. It is easier to raise money if a larger business. The disadvantages of mergers and acquisitions are: Diseconomies of scale if business becomes too large, which leads to higher unit costs. Clashes of culture between different types of businesses can occur, reducing the effectiveness of the integration. May need to make some workers redundant, especially at management levels this may have an effect on motivation. May be a conflict of objectives between different businesses, meaning decisions are more difficult to make and causing disruption in the running of the business. Constraints on Growth Though a business may wish to grow in size, there may be reasons why it cannot do this: Financial limitations a business may not be able to raise the necessary finance to grow any bigger perhaps it has not made enough profits to generate the cash or the bank is not keen to lend it more money at the moment. Size of the market there is often a limit to number of people who are willing to buy the type of product that the business is producing e.g. a printing press manufacturer will know that there are only a small number of publishers in the UK who will be able to buy the product. Government controls means that a business cannot necessarily have more than 25% of the market share. This often arises when one business joins with another. If the government thinks it GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 108 of 165
is not in the public interest to have such a large business, then the joining together may not take place. Human resources are limited in terms of the skills available. Especially in more specialised areas it may be difficult to find enough qualified staff in the area to expand the business. In the South East of England, where unemployment is very low for some types of jobs, businesses have struggled to expand for this very reason. Rationalisation Some businesses decide to reduce in size. This is known as rationalisation. This is where factories or offices are closed down or sold to other businesses, or jobs are cut. Sometimes this takes place because the business wants to concentrate on its core products. Other times it is because the business is suffering from diseconomies of scale. This is where the business is so large that communication is more difficult from the top management to the other parts of the business, reducing the effectiveness of control, and potentially leading to de-motivation. International business and globalisation A business may wish to grow internationally as well as nationally. A multinational company (MNC) is a business which has manufacturing plants in different countries, but a Head Office in one country. The advantages of having manufacturing plants in different countries are: Costs of production may be lower in these countries (especially wages) May avoid having to pay import duties on the goods produced in this country Reduces transport costs Can also adjust the product to meet the local needs of the population of that country A transnational company has no country as its base, but has regional Head Offices in many countries and is owned by people from many different nationalities. Unilever is an example of such a business they make such products as tea, deodorants and soap powder. Globalisation is the ability of businesses to sell their products in many different countries and also to manufacture in many different countries. Coca Cola, McDonalds and Microsoft are examples of companies who are able to have global products which, with few adjustments, can be sold in many different countries. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 109 of 165
Key Terms in this Section
Term Definition Acquisitions and mergers Growing a business by either buying other firms (acquisitions) or joining together with other firms (mergers) Globalisation The ability of businesses to sell and produce their products in many different countries Multinational company (MNC) A business with manufacturing plants and offices in different countries, but a Head Office in one country Organic growth The size of business grows due to finance from its own profits Rationalisation Reducing the size of the operation of the business Transnational company (TNC) A business which outlets/plants/offices in many countries and has Head Offices in many countries and is owned by people from different countries
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EXTERNAL ENVIRONMENT AND BUSINESS The Business Environment What is a Business? A business is any organisation that is involved in the production of a good or the provision of a service. Businesses exist because people, firms and government have needs and wants for goods and services. A business aims to satisfy these needs and wants, thus making a profit itself, paying the workers and rewarding its owners. The difference between a need and a want: A need basic requirement for living e.g. food, water, warmth, security, shelter and clothing. A want a desire beyond our needs. Once a want has been satisfied, something more is then wanted, e.g. a better watch or faster computer. Business Activity Business activity is a three-stage process
INPUTS the main types (also known as the factors of production) - Land and natural resources the area where production takes place and the raw materials that are used (e.g. wood, fuel). - Labour the people who transform the inputs (e.g. machine operators, bar staff). - Capital the man made means of production (e.g. plant, machinery, computers, and vans). GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 111 of 165
- Entrepreneurship the people who are prepared to invest in and manage a business they are the risk takers. OUTPUTS - goods and services see types of products. The transformation process ADDS VALUE to inputs. This means that the value of the outputs is greater than the value of the original inputs. ADDED VALUE is therefore the difference between the price of the output and the cost of inputs. This is the way that a business makes a profit. Two examples of the transformation process: A builder uses bricks and mortar (inputs are raw materials and labour) to build a wall (the output). The use of the builders skill and his time TRANSFORMS the inputs into output. A piece of paper and ink (inputs and value of these items only a few pence). David Beckham with a pen uses the paper and ink to sign his name the transformation process. The output is a valuable autograph value added is at least 5 if not a lot more! Main Types of Business Activity The main types of business are: Extractive primary industry Manufacturing and construction secondary industry Services - tertiary industry Types of product A product satisfies the needs and wants of customers. There are two main types of product: A good something tangible, something you can touch and use (e.g. a television). A service usually intangible, something other people do for you (e.g. entertainment from a film you watch). Goods can be split into two types of good: Consumer goods consumed by households. They cannot be used to produce more goods, though they may give a flow of services. A consumer durable is a good that is not used up quickly, but gives a flow of services over a period of time (e.g. a private car or a mobile phone). Non- durables are used up in a short space of time such as food or fuel. Producer (also known as industrial or capital) goods used in the production process sometimes to make consumer goods, sometimes to make other producer goods. Examples are printing presses, sewing machines, and computers. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 112 of 165
Markets A market is where products are bought and sold, and is therefore where the business operates. Market can be classified in a number of different ways, e.g. local, national and international markets; by customer needs e.g. for fast food or fashion shoes. A product can be in more than one market, which means that it can have a number of different potential buyers. There are a number of different marketplaces (places where products are bought and sold): Shops Stalls in a weekly market Mail order Internet Auction houses (e.g. Sotherbys) Main Functions in a Business A business has four main functions: Marketing and sales Accounts and finance Production and operations Human resource management They each have an important role to play in helping to make a business operate effectively to achieve its aims. They are known as the internal functions of the business. There are all interrelated, so if a change happens to one area, it will have some impact on all the other areas. Profit, Loss and the Entrepreneur A business exists to provide for wants and needs, but it needs someone to start and maintain that business. These people are known as entrepreneurs. An entrepreneur is someone who: Has a business idea or spots a gap in the market. Is willing to risk their time and money to develop this business idea. Is able to organise the factors of production. The reward for an entrepreneur is profit. Profit is the difference between total revenues (or sales) of a business and its total costs. PROFIT = REVENUE COSTS GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 113 of 165
Profit provides the incentive for people to start businesses. If profits for a business are extremely high, then other businesses may start to compete in the same market (and make some of the profits for themselves). A loss is when costs are greater than revenue. A loss does not always mean that the business will cease to trade. It may continue trading in the short term if it thinks that it will eventually return to profit. It may be able to raise cash from another source. However it may decide to stop trading and pay off all the money it owes. Some businesses take a long time to make their first profit, like Amazon, the Internet CD and bookseller. However in the long run it must make a profit to pay back the investors and those who lent the business money (otherwise it will have to close down). Key Terms in this Section
Term Definition A business Any organisation involved in the production of a good or service Adding value The difference between the cost of the inputs and the price of the output Good A tangible item production of something you can touch and use Market A place where goods and services are sold Need Basic requirement of living Primary production Extracting raw materials Secondary production Manufacturing and construction Service An intangible item something other people do for you. Tertiary production Service industry Transformation process Turning inputs (natural resources/raw materials, labour and capital) into outputs (goods and services) Want Desires beyond our needs once one want has been satisfied, another want appears GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 114 of 165
External Factors Affecting Business Introduction A business does not function in a vacuum. It has to act and react to what happens outside the factory and office walls. These factors that happen outside the business are known as external factors or influences. These will affect the main internal functions of the business and possibly the objectives of the business and its strategies. Main Factors The main factor that affects most business is the degree of competition how fiercely other businesses compete with the products that another business makes. The other factors that can affect the business are: Social how consumers, households and communities behave and their beliefs. For instance, changes in attitude towards health, or a greater number of pensioners in a population. Legal the way in which legislation in society affects the business. E.g. changes in employment laws on working hours. Economic how the economy affects a business in terms of taxation, government spending, general demand, interest rates, exchange rates and European and global economic factors. Political how changes in government policy might affect the business e.g. a decision to subsidise building new houses in an area could be good for a local brick works. Technological how the rapid pace of change in production processes and product innovation affect a business. Ethical what is regarded as morally right or wrong for a business to do. For instance should it trade with countries which have a poor record on human rights. Changing External Environment Markets are changing all the time. It does depend on the type of product the business produces, however a business needs to react or lose customers. Some of the main reasons why markets change rapidly: Customers develop new needs and wants. New competitors enter a market. New technologies mean that new products can be made. A world or countrywide event happens e.g. Gulf War or foot and mouth disease. Government introduces new legislation e.g. increases minimum wage. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 115 of 165
Business and Competition Though a business does not want competition from other businesses, inevitably most will face a degree of competition. The amount and type of competition depends on the market the business operates in: Many small rival businesses e.g. a shopping mall or city centre arcade close rivalry. A few large rival firms e.g. washing powder or Coke and Pepsi. A rapidly changing market e.g. where the technology is being developed very quickly the mobile phone market. A business could react to an increase in competition (e.g. a launch of rival product) in the following ways: Cut prices (but can reduce profits) Improve quality (but increases costs) Spend more on promotion (e.g. do more advertising, increase brand loyalty; but costs money) Cut costs, e.g. use cheaper materials, make some workers redundant Social Environment and Responsibility Social change is when the people in the community adjust their attitudes to way they live. Businesses will need to adjust their products to meet these changes, e.g. taking sugar out of childrens drinks, because parents feel their children are having too much sugar in their diets. The business also needs to be aware of their social responsibilities. These are the way they act towards the different parts of society that they come into contact with. Legislation covers a number of the areas of responsibility that a business has with its customers, employees and other businesses. It is also important to consider the effects a business can have on the local community. These are known as the social benefits and social costs. A social benefit is where a business action leads to benefits above and beyond the direct benefits to the business and/or customer. For example, the building of an attractive new factory provides employment opportunities to the local community. A social cost is where the action has the reverse effect there are costs imposed on the rest of society, for instance pollution. These extra benefits and costs are distinguished from the private benefits and costs directly attributable to the business. These extra cost and benefits are known as externalities external costs and benefits. Governments encourage social benefits through the use of subsidies and grants (e.g. regional assistance for undeveloped areas). They also discourage social costs with fines, taxes and legislation. Pressure groups (see below) will also discourage social costs. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 116 of 165
Legislation The way in which a business can operate is controlled by legislation. Laws can be imposed by the UK or European Union courts and government. Legislation mainly acts as a constraint on business. The main areas of legislation that affect businesses are: Employment law Consumer protection Competition law Employment law This is aimed at protecting the health, safety and rights of employees The main employment laws that a business needs to consider are: Health and Safety at Work Act 1974 Employers must provide safe premises and machinery. They must ensure that workers health is not affected by their work. The key costs and benefits of the Health and Safety at Work Act for a business are: - Adds to costs to businesses that need to train staff and spend money maintaining the standards set out. - BUT may reduce cost in the long term because of a reduction in staff absences and not having to pay compensation for injuries. - Good health and safety record is a good way of encouraging recruitment of good workers. Equal Pay Act 1970 Employees who do equal work or work of equal value must receive the same pay as workers of the other sex. Sex Discrimination Act 1975 Employees cannot be sexually discriminated in employment, training or recruitment. Race Relations Act 1976 It is illegal to discriminate against someone on the basis of race, ethnic group or colour. Employment Protection Act 1978 Employees must be given a written contract of employment. It protects against unfair dismissal (without good cause) and says that redundancy pay must be paid if the worker has served more than two years and their job is to be abolished. Employment law imposes additional costs to the business because they have to spend additional money on training, recruitment and pay. Like the Health and Safety Act there are also benefits if the workers feel they are treated fairly and there is more security, they will be more motivated. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 117 of 165
Consumer Protection This is aimed at making sure that businesses act fairly towards their consumers especially since consumers are sometimes in a much weaker financial position. The main consumer protection legislation is: Sale and Supply of Goods Act (this states that goods must be of satisfactory quality) Trade Description Act (goods and services must perform in the way advertised by the business) Consumer Credit Act (this protects the consumer when borrowing money or buying on credit) Consumer protection imposes additional costs to businesses since they have to comply with the laws. If they do not comply they risk fines and ultimately being put out of business by the courts of law. Competition law Competition law aims to ensure that fair competition takes place in each industry. Governments believe that greater competition leads to lower prices, better quality goods and a wider variety of products. Competition Commission (CC) and the Office of Fair Trading (OFT) investigate any business that has more than 25% of the market share, especially if it merges with another business. They may feel that the business has too much power and can set high prices and provide poor quality products. The CC and OFT has the power between them either to fine these businesses, or prevent the merger taking place. The OFT can also fine businesses who fix prices or prevent other businesses from trading in their market. Most recently they investigated the car industry and warranties offered by leading electrical retailers. Ethics Ethics in business are views on moral rights and wrongs. They are difficult to define because certain people hold different views. Examples of ethical views Use of child labour businesses like Nike have been under pressure since it is believed they use child labour to produce their expensive trainers. Not only do people believe that children should not work, but also their working conditions are unacceptable. Others argue that at least Nike are providing jobs in better conditions than the workers would normally be able to obtain. Third World trading the European Union has protected a number of industries (especially farming) by putting additional costs on imports into the EU. This has adversely affected Third World businesses. The Co-Op, amongst others, has been at the forefront of promoting Fair Trade . Environment (GM foods) - genetically modified foods have brought greater yield and cheaper produce for farmers, especially in the US and a number of Third World countries. However GM are not felt to be acceptable by a number of people in the UK. A business that operates an ethical policy may find that it: Attracts more customers because they want to buy products with an ethical background since it fits in with their beliefs. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 118 of 165
Attracts better employees who want to work with an ethical company. Avoids bad publicity Nike has attracted a lot of bad publicity due to its child labour accusations. However an ethical position may have some downsides: it can: Increase costs because they may have to use more expensive yet ethical suppliers or change their methods of production. Cause disagreements and conflicts in the business some members of the business may have strong views that are not held by others. This happens often since there is often a conflict between ethics and profits. Pressure Groups Business may feel obliged to act ethically or environmentally due to pressure groups. Pressure groups are organisations formed by people who have a common aim to influence the decisions of businesses and governments. They can campaign on a local level, for instance the building of a new factory or on a national and international level, like Friends of the Earth. Businesses especially may need to react if the pressure groups influence might reduce sales in the short or long term. Shell, the oil extractors, had to change its plan to dispose of a disused oil rig out at sea because of pressure group action. Environmental Issues With increased awareness of environmental issues, mainly through media and education, businesses need to consider the environmental effects of their actions. This adds costs to the business because they have may have to change their production techniques, or change the way they market their products. Businesses may react environmentally in the following ways: Recycling Energy efficiency Using environmentally friendly fuels Like acting in a socially responsible manner, they are advantages to the business of acting in an environmentally way: Customers react positively towards these types of businesses (note that many products make a feature of being packed in recycled paper). Local communities are more well-disposed towards these types of businesses the local community is often a vital source of customers, employees and support businesses. Technological Change Technological change refers to the changes in production techniques and production equipment. It could be a change in the machinery used to make a product or the computers to design a product. More recently it is the use of the computers and information technology (IT) to improve the efficiency and GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 119 of 165
competitiveness of businesses that has led to technological change. Since technological is so rapid, there are important implications for businesses. A business can be affected by the following technological change: In production In provision of services In the office Technological change in production Technological change leads to improved production of goods and services due to: Computer-aided manufacturing (CAM) this reduces labour costs, is more accurate and faster and can work at any hour of the day. The computer controls the machinery. Computer-integrated manufacturing (CIM) here, computers control the whole production line. Best example is in car production where robots undertake much of the work, reducing the need for labour to perform boring, routine tasks. Computer-aided design (CAD) Computers are used to help design products using computer generated models and 3D drawings. Reduces the need to build physical models to test certain conditions, known as prototypes. This can be expensive to produce just for testing purposes (e.g. aircraft or new cars. Therefore new production technology can increase the speed of production, improve the quality of the product and reduce costs per unit of production. Technological change can be seen in the shops and the provision of other services such as banking or repairs. Electronic point of sale (EPOS) and Electronic Funds Transfer at Point of Sale (EFTPOS) speed up transactions in shops and give vital information for businesses so can sort out their stock levels. EFTPOS means that shoppers can pay for goods and services using credit and debit cards. Banks can use hole in the wall machines to deliver cash or take deposits therefore remain open all hours. Repair people can use handheld computers to work out what is wrong with the machinery they are examining. Technological change in the office helps speed up the movement of information and improves the analysis of information: Communication is improved through the use of the intranet and Internet. The intranet is an internal system of computer communication while the internet can be used to communicate with customers, suppliers amongst others in the outside world (through websites and email). Workers can work away from the office using mobile technology such as phones, laptops and modems. Computers can be used to process, analyse and store vast amounts of data to give the business more quality information. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 120 of 165
E-commerce is the ability of businesses to trade with the world via websites. This means that there is a larger market and the business is now open 24 hours a day. This has provided opportunities for businesses that could only trade locally to now expand the size of the market (e.g. Amazon as world wide book and CD sellers). Customers can also shop around for the best deals for new products. The Internet can also be useful for recruitment purposes. Job vacancies can be advertised and targeted to the right audience, often costing less than print alternatives. E.g. e-teach sends free emails every week detailing teachers posts to subscribers. Technological change can be very expensive: technology involves the following additional costs: Purchasing the equipment Installation Training staff Maintenance Replacement/upgrading There is legislation associated with the use of technology e.g. computer screens, noise levels. In summary technological change can bring the following benefits to a business: Reduced running costs Improved productivity Improved competitiveness Lower costs per unit of product Improved quality of service (e.g. speed of service) Reduced wastage If the benefits of the above outweigh the costs, then a business should be investing in new technology. However it may need to consider the social costs of new technology: Job losses Motivation of workers worried about machines taking over their jobs (though extra training to work with machines may provide some increased motivation) Loss of traditional skills
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Key Terms in this Section
Term Definition Ethics Moral rights and wrongs of decisions Legislation Laws made by the government to protect consumers, workers and other businesses Pressure groups A body who has a common aim to pursue a cause, and try to influence businesses in pursuit of this cause Social benefits All the benefits of an action taken by a business including those not paid for by the business Social costs All the costs of an action taken by a business including those not paid by the business (e.g. production of a chemical includes the possible environmental damage caused) Technological change Where plant, machinery and IT have improved over the years due to the advancement of our society
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Economic Environment Types of Business Activity Business activity is the process of transforming inputs into outputs by adding value. There are three main sectors of business activity: Primary sector Involves the extraction and production of raw materials, such as coal, wood and steel. A coal miner and a fisherman would be workers in the primary sector. Secondary sector Involves the transformation of raw materials into goods e.g. manufacturing steel into cars. A builder and a dressmaker would be workers in the secondary sector. Tertiary sector Involves the provision of services to consumers and businesses, such as cinema and banking. A shopkeeper and an accountant would be workers in the tertiary sector. Goods move through a chain of production . The chain of production follows the construction of a good from its extraction as a raw material through to its final sale to the consumer. So a piece of wood is cut from a felled tree (primary sector), made into a table by a carpenter (secondary) and finally sold in a shop (tertiary). Some businesses have elements of all sectors in their chain of production. Others businesses choose to specialise. Specialisation occurs when a producer concentrates on making a small number of products, or on providing a narrowly defined service. Examples of specialisation: Baker only baking bread Machinery that only cuts sheet metal Lawyer dealing only with criminal law Advantages of specialisation Producer becomes more efficient because they learn the best way (all the short cuts) to produce at the lowest cost A producer may be able to charge a higher price from a customer the customer is prepared to pay more for expert/specialist knowledge (e.g. a cosmetic surgeon) How Business Activity is Changing In the UK the tertiary industry has grown in importance due to: Changes in household behaviour Changes in business behaviour The main changes in household behaviour are: Higher incomes - this has meant that households demand more services such as more holidays and eating out in restaurants, because they can afford to do so More leisure time and so more time to spend on services, such as cinemas. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 123 of 165
Businesses offer more after sale services e.g. help lines offered through telephone call centres, since customers demand it In terms of changes in business behaviour: New and existing businesses need more sophisticated forms of support Money and finance cash is needed for expansion. Banks and other lenders offer many different ways for businesses to borrow money that best suit their needs. E.g. an overdraft for a short period, a loan for a longer period. Telecommunications the ability to communicate internally and externally is vital for business success. Speed, cost and flexibility are all factors in determining the use of the type of wiring a business may need. A number of businesses are now using wireless networks. Local services businesses will need the support of local amenities and shops to service their workers and their day-to-day needs (e.g. food for canteens). Types of Economy Businesses and households make up an economy. The type of economy affects the way that trade takes place, how goods are produced and products are bought and sold. There are two extreme types of economy: Free market economies where there is no government intervention in the production of any sort of good or service; businesses act own their own behalf. Centrally planned economy where the government controls all forms of production. Most economies are somewhere between these two extremes and are known as mixed economies, a mixture of government owned corporations and privately own businesses. Private and Public Sector Business In a mixed economy most businesses can be classified as operating in either the private sector or public sector. Private sector In the private sector, private individuals and organisations own the businesses. Any profits or surpluses are rewards for this ownership and are either reinvested back into the business or given to the owners. Public sector In the public sector, organisations are owned and controlled by the government. These include central government, local government and public corporations. Surpluses are either reinvested or used to reduce taxes. The taxpayer pays for any losses made. The Royal Mail, National Health Service and the BBC are examples of public organizations. Private sector businesses tend to have different objectives from the public sector. Private sector objectives might be: Survival Making a profit GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 124 of 165
Expansion Satisfying shareholders Public sector objectives are more definite. They are the provision of An equitable level of goods and services that is low price, affordable and available for those who need the products. Products and services not provided by private business, such as free health care and defence. Since 1980 the UK has reduced the number of public sector corporations dramatically with only a few remaining. The sale of public sector corporations is known as privatisation. This is where the ownership changes from government to private ownership, normally through the sale of shares. British Airways (BA), British Steel and British Telecom (BT) were all privatised. Government Economic Policy The governments main economic aims are: Economic growth more goods and services produced in the economy. Low inflation prices that are not rising too fast. Low unemployment as many people employed as possible. Fair distribution of income The main policies used by government to achieve these aims are: Fiscal policy government spending and taxation. Government spending is also known as public expenditure. Monetary policy interest rates (the cost of borrowing money and rewards for saving). Legislation laws that affect the way that a person or business can act. The UK Government spends over 400bn a year and takes about the same in taxes. It also passes legislation. These affect the way business can act, e.g. what it can produce, how much it costs and who it can employ. It also affects the way that consumers spend their money. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 125 of 165
Taxation Taxation comes in two forms: Direct taxation taxation on income and profits (income tax, National Insurance and corporation tax). Indirect taxation taxation on spending (VAT, excise duty). Some examples of UK taxation are shown in the table below: Example Type of tax/how it works Effects on business if the tax rises Income tax A percentage of an individuals income is taken in tax. A reduction in disposable income (money available to spend after tax); therefore households will not be able to spend as much, reducing sales. VAT A percentage (17.5% currently in the UK) is added to the price of the item. It does not apply to all goods, e.g. childrens clothes. Increases the cost of the product, leading to fewer sales. Tax on beer (excise duty) An amount is added to the cost of beer. Increases the cost of the product, leading to fewer sales. Corporation tax A tax on profits made by businesses. Reduces the amount of profit available at the end of the year to be either distributed to the shareholders or to pay for more investment. National insurance A tax on incomes (like income tax). BUT also a tax on businesses who have to pay a portion of the tax on behalf of the worker The same as income tax and corporation tax but added to together. Government Spending The UK government spends approximately 400bn a year. Over a third of this money goes in welfare benefits such as pensions, unemployment benefit and other forms of income support. The rest is spent on health, education, defence, roads, law and order and on supporting businesses and local communities. Businesses can benefit direct or indirectly from the rest of the spending. Governments provide money in the form of grants, subsides and tax breaks (paying less tax than you should) to encourage businesses in certain areas of the economy. A business that is starting out, or is going to provide employment in a depressed area may be able to benefit from such help. Examples of government assistance are: Regional selective assistance that gives help to businesses wanting to set up in areas of high unemployment. Enterprise zones aim to attract businesses to inner city areas. Governments also provide support through advisory bodies coordinated by the Department of Trade and GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 126 of 165
Industry, especially for small businesses. Other bodies also provide information and support such as the Chambers of Commerce. This organisation represents businesses in a local community, acting as a source of advice from the experiences of other businesses and exploiting the connections within these businesses. Businesses can also benefit indirectly because of the huge spending that governments undertake. For instance the increases in health spending will benefit businesses that produce medical products or services to hospital (e.g. cleaning). Interest Rates Interest rates are the cost of money. If you borrow money then you may have to pay back the original amount PLUS a charge for borrowing the money. That charge is known as interest. It is a percentage of the original amount. You may have to pay the interest weekly, monthly or annually. It is also the reward for saving you receive a percentage of the original amount. There is never just one interest rate. There are many rates based on whether you are a borrower or saver, the type of borrowing you are making and your personal or business circumstances. However the rates will tend to move up and down with the BASE RATE, which is a central rate, set by the Monetary Policy Committee of the Bank of England. The following types of borrowing and saving often have an interest rate attached: Bank loans Mortgages (borrowing to purchase a property) Debentures Deposit accounts Bank current accounts Credit cards A change in interest rates affects businesses in the following ways: If the business has loans then an increase in interest rates will mean higher repayments, reducing profits. If the business wants to borrow money to say build new premises, then they are less likely to go ahead with the project when interest rates increase. Customers are going to find that they are more attracted to saving than to spending if interest rates go up and less likely to borrow money to spend as well. This may reduce sales for the business. Labour Market The labour market is where businesses hire workers. A business needs people to help the day to day running of the operation. The amount of labour needed depends on whether the business is a labour intensive or capital intensive. A business that needs more people and less machinery is known a labour-intensive business. Hairdressing, house building, teaching and the fashion industry are examples of labour intensive industries. A capital-intensive industry is where a business relies heavily on machinery and technology in its GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 127 of 165
transformation of inputs into outputs. Good examples include the car industry, steel production and the rail industry. Unemployment is where there are people you are willing and able to work but cannot find employment at the going wage rate. For example a machine worker who cannot get a job because there are no jobs for machine workers in the area. High unemployment, though it can be bad for local sales, can provide a business with a good source of cheap labour. On the other hand a shortage of labour might cause difficulties for a business: It may be more difficult to recruit new people - which might prevent the business from growing as fast as it wishes Existing workers may demand higher wages because they know that the business will be reluctant to release them. Competitors may try harder to poach the best staff. The business may have to invest further in staff training and development rather than rely on recruiting new skills into the business. Recruitment of personnel can also depend on the mobility of labour in the labour market. Mobility of labour means the speed with which a person can move into a different job. There are two main types: Geographical mobility Can they physically move to that place of work? This depends on the transport links as well as peoples desire to move house to get a job. Occupational mobility Do they have the skills to do the new job? This depends on the education and training that people have. Even with GCSEs and A levels students will need more training to do many jobs. The state of the regional labour market will be a major influence on location decisions for businesses. In the South East, especially near London, there is low unemployment, so it will be difficult to find cheap labour, though there is good pool of skilled labour. This is because a business may be able to attract good workers from other businesses, at higher wages though. In the North East there are pockets of high unemployment, with skilled workers without jobs, because some of the more traditional industries have declined. Gross Domestic Product (GDP) and Consumer Spending GDP stands for Gross Domestic Product. It is the sum of the all spending by households, firms and the government in the economy over a period of time on goods and services. It also includes the balance of exports (foreign spending on UK goods) and imports (our spending on foreign goods). In the UK GDP is over 1,000bn a year that is nearly 17,000 on average for every man, woman and child. Consumer spending makes up over two thirds of all spending in the economy. Consumer spending is spending by households on goods and services. An increase in either figure (they both follow each other pretty closely) means that businesses, though not all, will have benefited from an increase in sales. A forecast increase (say for the future year ahead), provides a business with important information from which it could make the following decisions: GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 128 of 165
Production schedules (such as when to order new stock). Human resource management (whether to recruit new workers). Cash flow forecasting (when to spend). Marketing strategy (when to promote or increase prices). Remember that some goods and services are unaffected by changes in GDP/consumer spending, for instance sales of salt. Exchange Rates An exchange rate is the value of one currency expressed in terms of another. So 1 may be worth $1.55 and 1.33. A currency that is getting stronger or appreciating is a currency that is going up in value against another. So 1:$1.5 moving to 1:$1.8 means the pound is getting stronger A currency that is becoming weaker or depreciating is a currency that is going down in value against another. So 1:$1.8 moving to 1:$1.5 means the pound is getting weaker Currencies change in value against each other all the time. This is because most currencies are based on flexible exchange rates. The notable difference is in the Euro zone (see below). Currencies change in value because there is a change in demand for holding that currency. Households, governments and businesses need other countries currencies to buy their goods and services (e.g. holiday makers for purchasing wine or a business buying spare parts for machinery from France will need Euros). A change in exchange rates might affect a business in the following ways: Exchange rates changes can increase or lower the price of a product sold abroad The price of imported raw materials may change The price of competitors products may change in the home market For example an increase in the exchange rate will mean that price abroad goes up, lowering sales; price of imported raw materials falls, either leading to a fall in price and more sales, or an increase in profits; competitors prices fall, meaning lower sales. Exchange rate French car (15,000) UK car (12,000) French raw materials (4 per kilo) Originally 1:1.5 10,000 in the UK 18,000 in France 2.67 to UK businesses appreciates 1:1.8 8,333 21,600 2.22 depreciates 1:1.2 12,500 14,400 3.33
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Business and the Global Economy Some businesses will concentrate on selling to the local market, but larger businesses might consider selling abroad (exporting). The advantages of exporting abroad are: Larger markets. May be less competition. UK goods may be cheaper due to favourable exchange rates (a weak pound). Some countries may demand less compliance with regulations, therefore making the goods cheaper to manufacture. The problems of trading abroad are: Changes in exchange rates can make goods more expensive abroad. Some countries protect their home markets by putting tariffs on incoming products. This is a tax on imports, making foreign goods more expensive. Protection can also be in the form of quotas, which limit the amount of products allowed into the country, or strict laws on the types of products that can be sold in this country. A business will have to comply with these laws, but it will increase the costs and so increase the price they sell the product for. Globalisation is the sale and manufacture of products all around the world. Companies such as Coke and MacDonalds have outlets and manufacturing plants across most of the world. Many companies have taken advantage of the improvements in communication and transport links to set up in different parts of the world. Manufacturing in different countries has the following advantages: Closer to the market place so cheaper to transport the products. Closer to the customers, so the business can make adjustments to the different cultures in that country. May be able to take advantage of cheaper labour or sources of raw materials. May be able to avoid any trade restrictions that are imposed by country, by manufacturing inside the country. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 130 of 165
Examples of possible markets that businesses may wish to trade in: Country Advantages Disadvantages Ireland Part of EU (less export administration costs) Same language Close by (fewer transport costs) Small market Euro Germany or France Part of EU Relatively close Large market Relatively rich Different language Different culture USA Same language Similar culture Large market Rich Not in EU Distance Japan Very rich Distance Very different language and culture Business and Europe The UK is part of the Single European Market, the European Union (EU). This means that it can trade one of fourteen other countries in that market without facing any barriers to trade. It also means there is no restriction in the employment of anyone in the EU or the ability to set a business in the EU. The benefits of EU membership to businesses are: Increase in market size (a greater number of potential customers) as a result of the freedom of movement of goods and services. UK business can now sell to any of the other fourteen countries without facing extra costs or restrictions on the types of products they can sell. Greater access to cheap factors of production e.g. raw materials, technology and labour. A business can employ individuals from any part of Europe. Football clubs have certainly benefited from this! The National Health Service has found this a good source of skilled doctors and nurses when they have had shortages of medical staff. Access to EU government contracts, not just UK government contracts, benefiting businesses who sell goods and services to government departments (e.g. road builders could be contracted to provide roads in Spain). Lower administration costs to trade, meaning that businesses do not have to pay to extra money to send their goods abroad, other than normal transport costs. The costs of EU membership to UK businesses are: Greater competition from other EU businesses. Increased costs due to compliance with EU regulations e.g. common technical standards. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 131 of 165
Enlargement of the EU is likely to happen in the next few years with a number of Eastern European nations joining the EU. This will provide a further increase in the market size BUT the customers will have a lower average income and also be able to compete at lower prices with UK businesses. European Single Currency (Euro) At present the UK is outside the Euro zone. The Euro zone comprises 12 countries (Belgium, Austria, France, Finland, Luxembourg, Italy, Netherlands, Germany, Portugal, Ireland, Greece and Spain) who share one currency - the euro. The advantages to businesses of being inside the Single Currency zone are: No uncertainty over pricing and costs when exporting or importing, because they all share the same currency No costs of changing currency European Union provides a number of subsidies and grants to help businesses in the UK set up, provide new employment opportunities to long term and young unemployed, and develop rural and declining industrial areas: European Regional Development Fund (ERDF) European Social Fund Loans from the European Investment Bank Social and External Costs Social costs are the costs faced by all the community from the action of a business or individual. An external cost is the cost that the business or individual does not incur when taking that action. E.g. when a business pollutes in its production process a river, it does not incur the cost of clearing up the damage further down the river. This cost is the externality or external cost. The social cost is the external cost PLUS the costs to the business of production (a private cost to the business.
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Key Terms in this Section
Term Definition Economic growth An increase in the number of goods and service produced in a year. A rise in GDP European Single Currency (Euro) The common currency shared between 12 European states (excluding the UK) European Union 15 countries in Europe who have no barriers to trade between them, but barriers to other countries outside the EU Exchange rates The value of one currency in terms of another currency Fiscal policy The use of taxation and government spending to help control the economy Free market, mixed and command economies A free market economy has no government intervention and the market decides what is produced and at what price. A command economy has total government control over production. A mixed economy is between the two. Gross domestic product (GDP) The total value of output of goods and services in the economy Inflation A sustained increase in average prices in an economy over a year Monetary policy The use of interest rates and the control of lending to help direct the economy Private and public sectors The private sector is privately owned whereas the public sector is government owned Taxation Either money taken by the government from income (direct tax) or money taken when goods and services are bought (indirect tax) Unemployment The number of people willing and able to work but unable to find work at the going wage rate
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ACCOUNTING AND FINANCE Profit What is Profit and Why is it Important? Profit is the difference between the income of the business and all its costs/expenses. It is normally measured over a period of time. They are four main types of profit quoted by a business: Gross profit This is the difference between sales income and the direct costs of making those products. Gross profit is used as a performance indicator to help the business make decisions over its pricing policies and use of materials. Net profit Net profit represents gross profit less all expenses associated with the normal running of the business. Net profit shows how well the business performs under its normal trading circumstances. It is used to calculate the primary efficiency ratio. Net profit after interest and taxation This is the profit available for the shareholders. Net profit after interest and taxation is all due to the owners of the business. They can choose to take out, in the form of dividends, all, some or none of this. Retained profit Retained profit is the profit left over after the shareholders have been paid their dividends. Retained profit is normally reinvested in the business. Profit is important to a business because: It is a reward to the owners of the business. They have taken risks with their money and time. If there was no profit, then there would be little point in starting up or putting more money into the business, they might as well put the money into a bank or building society Profits are an important source of investment funds. Profit can be used to buy more stock, improve technology or expand the premises A business than does not make a profit will fail, potentially affecting employees, suppliers and the local community Many businesses do not face a dilemma or problem over the amount of profit they make, because they are just happy to make a profit in the first place. However there are situations where businesses can exploit the customers because there is not much competition from other businesses. A business will need to an ethical view (what is morally right) on how much to charge and whether they believe their profits to be excessive. It needs to be remembered that profits are used to reinvest, which leads to better products for their customers, better wages and working conditions for their workers or to help the local community. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 134 of 165
Key Terms in this Section
Term Definition Gross profit Revenue less cost of sales Net profit or operating profit Profit generated by the business from its normal operations Profit The difference between the revenues and costs to a business over a period of time Retained profit Profit due to the owners of the business. Net profit after taxes and interest payments GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 135 of 165
Sources and Uses of Finance Introduction Finance is the money available to spend on business needs. Right from the moment someone thinks of a business idea, there needs to be cash. As the business grows there are inevitably greater calls for more money to finance expansion. The day to day running of the business also needs money. The main reasons a business needs finance are to: Start a business Depending on the type of business, it will need to finance the purchase of assets, materials and employing people. There will also need to be money to cover the running costs. It may be some time before the business generates enough cash from sales to pay for these costs. Link to cash flow forecasting. Finance expansions to production capacity As a business grows, it needs higher capacity and new technology to cut unit costs and keep up with competitors. New technology can be relatively expensive to the business and is seen as a long term investment, because the costs will outweigh the money saved or generated for a considerable period of time. And remember new technology is not just dealing with computer systems, but also new machinery and tools to perform processes quicker, more efficiently and with greater quality. To develop and market new products In fast moving markets, where competitors are constantly updating their products, a business needs to spend money on developing and marketing new products e.g. to do marketing research and test new products in pilot markets. These costs are not normally covered by sales of the products for some time (if at all), so money needs to be raised to pay for the research. To enter new markets When a business seeks to expand it may look to sell their products into new markets. These can be new geographical areas to sell to (e.g. export markets) or new types of customers. This costs money in terms of research and marketing e.g. advertising campaigns and setting up retail outlets. Take-over or acquisition When a business buys another business, it will need to find money to pay for the acquisition (acquisitions involve significant investment). This money will be used to pay owners of the business which is being bought. Moving to new premises Finance is needed to pay for simple expenses such as the cost of renting of removal vans, through to relocation packages for employees and the installation of machinery. To pay for the day to day running of business A business has many calls on its cash on a day to day basis, from paying a supplier for raw materials, paying the wages through to buying a new printer cartridge. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 136 of 165
Choosing the Right Source of Finance A business needs to assess the different types of finance based on the following criteria: Amount of money required a large amount of money is not available through some sources and the other sources of finance may not offer enough flexibility for a smaller amount. How quickly the money is needed the longer a business can spend trying to raise the money, normally the cheaper it is. However it may need the money very quickly (say if had to pay a big wage bill which if not paid would mean the factory would close down). The business would then have to accept a higher cost. The cheapest option available the cost of finance is normally measured in terms of the extra money that needs to be paid to secure the initial amount the typical cost is the interest that has to be paid on the borrowed amount. The cheapest form of money to a business comes from its trading profits. The amount of risk involved in the reason for the cash a project which has less chance of leading to a profit is deemed more risky than one that does. Potential sources of finance (especially external sources) take this into account and may not lend money to higher risk business projects, unless there is some sort of guarantee that their money will be returned. The length of time of the requirement for finance - a good entrepreneur will judge whether the finance needed is for a long-term project or short term and therefore decide what type of finance they wish to use. Short Term and Long Term Finance Short-term finance is needed to cover the day to day running of the business. It will be paid back in a short period of time, so less risky for lenders. Long-term finance tends to be spent on large projects that will pay back over a longer period of time. More risky so lenders tend to ask for some form of insurance or security if the company is unable to repay the loan. A mortgage is an example of secured long-term finance. The main types of short-term finance are: Overdraft Suppliers credit Working capital The main types of long-term finance that are available for to a business are: Mortgages Bank loans Share issue Debentures Retained profits Hire purchase GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 137 of 165
Internal and External Finance Internal finance comes from the trading of the business. External finance comes from individuals or organisations that do not trade directly with the business e.g. banks. Internal finance tends to be the cheapest form of finance since a business does not need to pay interest on the money. However it may not be able to generate the sums of money the business is looking for, especially for larger uses of finance. Examples of internal finance are: Day to day cash from sales to customers. Money loaned from trade suppliers through extended credit. Reductions in the amount of stock held by the business. Disposal (sale) of any surplus assets no longer needed (e.g. selling a company car). Examples of external finance are: An overdraft from the bank. A loan from a bank or building society. The sale of new shares through a share issue. The table below summarises the main types of finance that are suitable for businesses at various stages of development and/or ownership: Type of Business Source of Finance Small business start up Own cash is the cheapest form of finance since it carries no obligation to pay any interest or give control of the business to any other party. Otherwise a bank loan or a government grant. Established sole trader or partnership Bank loans; bank overdraft; trade credit; retained profits; taking on a new partner; government grant. Limited company Bank loans; bank overdraft; trade credit; retained profits; share issue. Purchasing fixed assets Owners funds, retained profits; bank loans; hire purchase; leasing. Day to day running of the business Overdraft; extending trade credit; improving working capital.
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Sources of External Finance Equity finance Equity finance is the money provided by the owners of the business. SOLE TRADERS AND PARTNERSHIPS A sole trader will provide money from his or her own savings. A sole trader may find it difficult to raise much money from this source and therefore may take on a partner who brings money into the business. LIMITED COMPANIES A limited company can sell shares, which represent how much of the business the shareholder owns. There are two types of limited company that define the way that money can be raised through shares. A private limited company can sell shares only to designated people and there is a limit how much capital they can raise through this method. A public limited company can issue shares to the public. This means anyone can have a share in the company. It is important to note that once a share is issued, it only raises money for the company the first time it is sold. After that the proceeds any sale of that share goes to the owner of the share. It is like a second hand car. When a BMW is sold second hand, then the money goes to the owner of the car and not BMW. A company may wish to issue shares because: A large amount of money can be raised through a share issue. Unlike a loan the money does not have to be repaid over a fixed period of time. A company may issue two types of shares: Ordinary shares - Ordinary shareholders can vote at company meeting. - The amount of the dividend received varies. Preference shares - Preference shareholders do not have a vote at company meetings. - The dividend is usually fixed (e.g. 5% of the value of shares held paid as dividend each year). - Preference shareholders receive their dividend before ordinary shareholders. Shares are bought because they provide a return to the shareholder. There are two parts to the returns earned by shareholders: Dividends paid out on each share held by the company (e.g. companies on the Stock Exchange usually pay out two dividends each year). GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 139 of 165
Increases in the value of each share as the company itself grows in value (this is often known as a capital gain). In conclusion: A business will issue shares to raise large sums of money. By doing this they are diluting the ownership which means that the control of the business is spread amongst more people. However they only have to pay dividends and dont have to pay out dividends at all, especially if they make a loss. But a shareholder has the right to vote off a board of directors, if they can gain 50.1% of support of the rest of the shareholders. Debentures A debenture is a long term loan which is usually secured against a specific asset (e.g. the factory) or the overall assets of a business. A debenture is repayable at a fixed date and has a fixed rate of interest. Debentures are different from ordinary shares because: The lender has no voting rights in the company. The loan attracts interests whereas holders of ordinary shares get dividends. The providers of loans are paid out before ordinary shareholders in the event that the business fails (assuming there is some cash left). Bank Loans and Overdrafts A bank overdraft is a limit on borrowing on a bank current account. With an overdraft the amount of borrowing may vary on a daily basis. A bank loan is a fixed amount for a fixed term with regular fixed repayments. The interest on a loan tends to be lower than an overdraft. Example of a loan: A business borrows 12,000 from a bank over 3 years at an interest rate of 5%. The approximate repayments on this loan would be 392 a month for 36 months (14,112). A fixed term means how many months or years before the loan has to be repaid in full. Normally a fixed term loan will be for a greater amount than an overdraft. Overdrafts Loans Advantages Flexibility can change the amount borrowed within limits Interest is only paid on amounts borrowed Larger amounts can be borrowed Lower interest rates than overdrafts Regular repayments help plan cash flow Disadvantages Cannot be used for large borrowing Rates of interest higher than loans Bank can change limit at any time or ask for money to be paid back sooner than expected Less flexible than an overdraft Have to pay back in stated time or risk further financial problems GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 140 of 165
Leasing Leasing is like renting a piece of equipment or machinery. The business pays a regular amount for a period of time, but the item belongs to the leasing company. Most company cars are leased to businesses. The business pays a monthly fee for the car and at the end of the period (normally about two years), the business swaps the car for a newer model. The advantages of leasing are: Cheaper in the short run than buying a piece of equipment outright. If technology is changing quickly or equipment wears out quickly it can be regularly updated or replaced. Cash flow management easier because of regular payments. The disadvantages of leasing are: More expensive in the long run, because the leasing company charges fees which make the total cost greater than the original cost. Hire Purchase Business hires the equipment for a period of time making fixed regular payments. Once payments have finished it then owns the piece of equipment. Hire purchase is different to leasing in that the business owns the equipment when it has finished making payments. With an equipment lease, the equipment is handed back to the leasing provider. Debt Factoring A business sells its outstanding customer accounts (those who have not paid their debts to the business) to a debt factoring company. The factoring company pays the business - say 80-90% of face value of the debts - and then collects the full amount of the debts. Once it has done this it will pay the remaining amount to the business less a charge. It is a good way of raising cash quickly, without the hassle of chasing payments. BUT it is not so good for profits since it reduces the total revenue received from those sales. Government Finance The government and the European Union provide help to businesses for the following reasons: Protect jobs in failing/declining industries. Help create jobs in areas of high unemployment. Help start up new businesses. Help businesses relocate to areas of high unemployment. Some of the main sources of funds are: European Structural Fund Assisted Areas GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 141 of 165
Regional Selective Assistance Small Loans Guarantee Scheme Trade Credit A business does not always have to pay their bills as soon as they receive them. They are given period of credit, normally around 30-60 days. By trying to extend this period they can improve their short-term finance position. Small businesses now have some protection under law that prevents larger firms exploiting their credit terms. Trade credit is an important source of finance for nearly all businesses since it is effectively a free source of finance. Retained Profits The cheapest form of finance is the business own profits. In the UK over 80% of retained profits are reinvested back into the business. Since it is not being borrowed from anyone, it does not cost money to use. Own Capital For sole traders and partnerships a common source of finance, especially for start up is money from the individuals who are forming the business. They may also borrow money from family and friends. Own capital is a costless form of finance, but carries the risk of the money being lost. Working Capital Working capital is the amount of money available for the day to day running of the business. It is the difference between current assets and current liabilities. See below for more details of how working capital can be used. Sources of Finance for Public Sector Organisations Public sector organisations receive from both the normal sources that most businesses receive money, but also from tax revenues. Most public sector organisations, such as schools and hospitals obtain more straight from the government - who have previously collected the money from tax payers. Other organisations gain money from sales, e.g. stamps for the Post Office, and licences for the BBC.
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Key Terms in this Section
Term Definition Bank loans Long term lending by a bank over a fixed period Debentures Fixed interest loans normally based on the purchase and security of an asset Debt factoring Raising money by getting another firm to buy the unpaid invoices due to the business Hire purchase Renting a piece of equipment for a fixed period, after which the business takes ownership Internal and external finance Internal finance comes from the normal operations of the business (e.g. profit generated) whereas external finance comes from outside sources Leasing Renting a piece of equipment from another business for a fixed period of time Mortgages Lending by a bank for the purchase of buildings Overdrafts Lending by a bank on a short term basis Shares A part ownership of the business which can earn a dividend Short term and long term finance Short term finance covers the day to day running of the business. Long-term finance is aimed at costly projects which will pay back in a period greater than a year. Suppliers credit A period of time before the business has to pay its bill Working capital Short-term finance available for the day to day running of the business. Current assets minus current liabilities
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Financial Accounting Introduction Financial accounts are the records of the financial dealings of the business, their every day transactions. The main role of financial accounting is to: Record financial transactions; e.g. collecting money from sales, paying suppliers, salaries and wages. Help the managers to manage the business more efficiently by preparing regular financial information e.g. monthly management accounts showing sales, costs and profits against budgets, forecasting cash flows, cost investigations. Provide other stakeholders with legal/vital information (financial accounts: trading account, profit and loss, and balance sheet). - Shareholders how their investment is doing. - Suppliers can they give the business trade credit. - Banks and lenders can the business meet repayments of loans and risks of loaning the business money. - Inland revenue tax returns. The main accounting records kept by the business are records for keeping the details of transactions: Sales ledger: shows how much is owed by customers who have bought on credit. Purchase ledger: shows how much is owed by the business to suppliers who have provided goods and services on credit. Cash book and bank statements: shows all transactions involving cash (e.g. receipts from customers, payments to suppliers, employee wages). Nominal (or General ) ledger: used to categorise the transactions of a business under headings e.g. sales of widgets, raw materials, electricity, and postage. These records are used to maintain the information that is used to make up the main financial statements. Financial Statements Financial accounting produces the following key documents: Profit and loss account showing how the business has traded for a specific period. Balance sheet a statement of the assets and liabilities of a business at a particular time, and how those assets and liabilities have been financed. Cash flow statement a statement showing how cash has come into the business and what it has been spent on. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 144 of 165
Profit and Loss Account The purpose of the profit and loss account is to: Show whether a business has made a PROFIT or LOSS over a financial year. Describe how the profit or loss arose e.g. categorising costs between cost of sales and operating costs. A profit and loss account starts with the TRADING ACCOUNT and then takes into account all the other expenses associated with the business. Trading account The trading account shows the income from sales and the direct costs of making those sales. It includes the balance of stocks at the start and end of the year. An example of the trading account of a business would look this: Trading account for XYZ plc for the year ended 31 st March 2003 Category Sales 1,200,000 Opening Stock 150,000 Purchases 400,000 less Closing Stock (220,000) Cost of Sales 330,000 (330,000) Other Costs (70,000) Gross Profit 800,000 Note that the closing stock figure would appear in the balance sheet under Stock. Profit and loss account The trading account now has all the other expenses now deducted. It would look like the table on the following page: GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 145 of 165
Trading, profit and loss account for XYZ plc for the year ended 31 st March 2003 000 Examples Turnover (sales) revenue 1,200 The amount of money generated by sales e.g. 400 cars at 3,000 each Cost of sales (400) The cost of making the goods or buying them Raw materials Cost of labour working directly on each product Cost of running the machines/equipment Gross profit 800 Turnover minus cost of sales Overheads or expenses (320) Costs not directly involved in the production process (indirect costs) Cost of premises e.g. rent, insurance, repairs Office costs e.g. stationery, postage, computer maintenance, staff salaries and wages Sales and marketing costs e.g. salaries of salesmen, advertising Finance costs e.g. bank charges, interest on bank loans Operating profit 480 Gross profit minus overheads Also known as NET PROFIT
Interest and taxation payable (200) The money that is due to be paid in interest on loans and to the Inland Revenue as tax Net profit after tax and interest 280 The money available to be distributed to shareholders Dividends (170) Money paid to shareholders as a reward for holding shares Retained profit 90 The money left for the business to reinvest The business has to pay tax at the rate determined by the government and interest at the rates determined by the lenders. A business can influence its gross and net profits. A business can improve its gross profit by: Changing to cheaper raw material suppliers. Redesigning the product to use fewer or cheaper materials. Increasing selling prices. Offer fewer discounts to customers. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 146 of 165
A business can improve its operating or net profit by reducing its overheads. It can cut its overheads by: Reducing advertising expenditure. Move to cheaper premises. Combine jobs done by administrative staff to reduce employee numbers. Renegotiate the cost of overheads such as legal and accounting fees. Revenue and Capital Expenditure Not all costs are put straight into the profit and loss account. Some items bought by the business will be used for many years, so it makes sense to charge the cost of purchase over the years of their useful life (see depreciation). There are therefore two types of expenditure: Revenue expenditure is money spent on goods and services which have been or will be consumed Capital expenditure is money spent on long term assets which are used over and over again Examples: Revenue expenditure Capital expenditure Wages Buildings Raw materials Machinery Computer Software Computer systems (hardware) Capital expenditure appears on the profit and loss account in the expenses and overheads section under the term depreciation. (see depreciation) It appears in the balance sheet under fixed assets. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 147 of 165
Balance Sheet Balance sheets provide a snap shot of the assets and liabilities of a business at a point of time. It shows what the business owns, is owed and owes: Owns assets such as buildings, stock and cash. Is owed money from debtors. Owes money to creditors and the bank. Owes to the investors and owners of the business (they own the profit). A typical balance sheet would look like this: Balance sheet for XYZ plc as at 31 st March 2003 000 Notes Fixed assets 1,800 Likely to find sub-totals for buildings, equipment and vehicles Current assets Stock 300
Debtors 250
Cash 150
Total current assets 700 Stock + debtors + cash Current liabilities (400)
Net Current Assets 300 Current assets current liabilities; also known as working capital Net assets employed 2,100 Fixed assets + net current assets Financed by: Long term liabilities 700 e.g. loans from banks Share capital 1,000 Amounts invested by shareholders Profit and loss reserves 400 The profit accumulated that has been retained by the business Capital employed 2,100 Long term liabilities + share capital + profit and loss reserves Note that net assets employed = capital employed. This is always the case, because the capital employed is the amount of long-term money put into the business and the net assets employed how it is used. Fixed assets Fixed assets are: Assets that provide a benefit for the business in the long-term (normally for at least a year), e.g. buildings and machinery GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 148 of 165
Assets that the business intends to keep Note that fixed assets are depreciated over their useful life (see depreciation). Current assets Current assets are assets that will be used up or sold in the next year + the cash balances kept in the business. The main categories are: Stocks finished goods, work in progress and raw materials (note: you may also see stocks called inventories). Debtors people who owe the business money (customers who owe money are known as trade debtors). Cash in the bank and in the cash box. Current liabilities Current liabilities are what the business owes in the short run. The main categories are: Creditors money owed by the business in the short term (suppliers who are owed money by the business are known as trade creditors). Bank overdraft amounts due within the next 12 months. The total of current assets minus current liabilities is known as working capital. This is amount of money available for the day to day running of the business. A negative figure can be a problem for some businesses that may need to pay for outstanding debts, but do not have enough spare cash to do so. Long-term liabilities are the monies the business has borrowed for a period of more than a year mainly bank loans. Share capital is the money invested in the business by the owners. Profit and loss reserves are the profits due to the owners that have not already been paid out in dividends. This money is not necessarily held in cash (see the current assets), but may have been used to buy more stock or fixed assets. Shareholder funds are the share capital and reserves added together. Capital is the amount of long-term money put into the business to buy assets. Main forms of capital: owners money (share capital) and long term bank loans. Depreciation A fixed asset reduces in value over its useful life due to wear and tear and (when it is no longer useful) obsolescence. Depreciation is the tool used by accountants to record the reduction in the original value of an asset. Depreciation is charged every year of a fixed assets useful life to the profit and loss account. In the balance sheet the original cost of the fixed asset is reduced by the amount of depreciation. There are two main methods of depreciation: Straight line depreciation this is where the same amount is charged every year using the following formula to calculate it: GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 149 of 165
Original Cost of the Fixed Asset / Useful Life of the Asset For example; a machine bought for 20,000 has a useful life of ten years. Management decide to charge depreciation on a straight line basis. So the annual depreciation cost is 20,000 / 10 = 2,000 Reducing balance depreciation the same percentage of an assets value is taken off every year, e.g. 20%. Most businesses use straight line depreciation, but it is possible to argue that reducing method is better because it reflects the fact that most assets lose most of their value in the first years of use. Depreciation appears in the profit and loss account under expenses it reduces the profit for that year because some of the asset was used up in that time period. It appears in the balance sheet by reducing the value of the fixed assets. This means that the balance sheet reflects a true and fair value of the assets. Cash flow statement The cash flow statement is an historical accounting statement that shows how the business has generated and spent its cash. The cash flow statement is split into two parts: Sources of funds where the cash has come from (e.g. profits, increase in trade credit). Uses of funds - how it was used (e.g. purchase of assets, repayments on bank loans). Note: a cash flow statement is different from a cash flow forecast which looks at the future movement of cash. Legal Obligations The Companies Act requires limited companies to produce the following accounting statements and publish them in the Annual Report and Accounts: Profit and loss account Balance sheet Cash flow statement Decision-making and Financial Accounts A business will use the financial accounts to help assess the following areas: How well they are doing. What decisions worked well and which did not. To decide what to do in the future. For a business, the financial accounts will provide a key source of data to make decisions over its strategy. Analysis of performance is covered in the next chapter. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 150 of 165
Key Terms in this Section
Term Definition Balance sheet A statement of assets and liabilities of a business at a particular time and how those assets have been financed Capital expenditure Money spent on long term assets which are used over and over again Cash flow statement A statement showing how cash has come into the business and what it has been spent on Current assets Short term assets which will be used up within a year Current liabilities What the business owes in the short run Depreciation Reduction in the value of an asset over its useful life time Financial accounts A record of the financial dealings of the business Fixed assets Long term assets which will be used for more than a year by the business Overheads Costs not directly involved in the production process Profit and loss account Shows how the business has traded over a specific period Revenue expenditure Money spent on goods and services which have been or will be consumed
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Analysing Financial Performance Introduction Analysing financial performance is about judging the successes and failures of a business by considering a number of financial measures. Most of these measures are known as ratios. A ratio is a measure of one piece of information in terms of another. A non-financial ratio might be the numbers of boys to girls in a class, or the number of GCSE passes in business studies as a percentage of all the GCSE passes in the school. Ratios are normally compared with the previous years figures or with figures from competitors to see whether the business has improved or not and whether it is better or worse than a rival. The main areas that ratios look at are: Profitability Financial efficiency Liquidity It is not just ratios that are analysed. Forecasts of profit and sales are extremely useful, as well as a record of profits made in previous years. The main users of this financial information are: Owners/shareholders Employees Managers Creditors and banks Competitors Government (e.g. the Inland Revenue who calculate how much tax is due by a business) Profit and Profitability A business needs to make more money from sales than it costs to produce the products and maintain the business for the following possible reasons: To repay the owners of the business for investing. To expand the business in the future. A loss would eventually mean the business would have to close down. The difference between profit and profitability is summarised below: Profit is an absolute measure it equals sales revenue less costs Profitability is a relative measure it shows the amount of profit relative to what created the profit GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 152 of 165
In order to compare the performance of a business against previous years and other businesses it is useful to calculate profitability ratios. The business can then analyse and spot favourable and unfavourable trends. The main three profitability ratios are: ROCE return on capital employed Gross profit margin Net profit margin Return on Capital Employed (ROCE) The main measure of business performance is ROCE. ROCE is also known as the primary efficiency ratio because it is a better indicator than profit alone of how well a business is using the money invested. It shows how much profit is being generated from the investment compared with alternative investments in similar businesses or with interest from bank deposits. A higher figure is better. Any figure over 10% is a good level, but it depends on how risky the business is thought to be. A business could increase its ROCE by: Increasing net profits without increasing or introducing new investment. Reducing the amount invested in the business by selling assets that do not contribute to the profit earned. Gross profit margin The gross profit margin of the business shows the ability of business to add value to the costs of directly making the product. A higher figure is better. A business could increase its gross profit margin by: An increase in the selling price of existing products. Introduction of new products which achieve a higher gross profit margin. Reducing the cost of sales e.g. a fall in raw material prices. Net profit margin The net profit margin is the amount of profit generated per pound of sales. It is useful to compare it against the gross profit margin and previous years to see how well the business manages its expenses or overheads. Importance of profit and cash A business may be profitable but still go bankrupt even if it is profitable. A business can make a profit but have a negative cash flow. Without enough cash to pay employees, suppliers, banks and taxes the business will go bankrupt. A business makes a profit when sales exceed costs. Positive cash flow arises when payments from customers exceed payments to suppliers and employees. Cash may not be due from customers until next month, but bills and employees may have to be paid today. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 153 of 165
This situation can give rise to negative cash flow, even though the value of sales is greater than costs. Poor cash flow is one of the main reasons why new businesses fail. Liquidity Liquidity means the ability of the business to meet its short-term debts. In practice this means having the cash to pay any bills that need to be paid. Liquid assets are those assets that are held in cash form or can be turned into cash very quickly. There are two main tests of liquidity, the current ratio and the acid test. Current ratio The current ratio is usually defined as current assets divided by creditors falling due within one year. The ratio is designed to assess the solvency of a business in the short term. If the current ratio exceeds one, then the value of current assets is greater than the value of the short term creditors, indicating that the company is able to pay its short term debts as they fall due. Note that this interpretation is fairly simplistic. Acid test ratio This is a tougher test of liquidity. Stock takes longer to turn into cash, so it is excluded from the current assets in the calculation. A ratio of 1 means that the short debts can be covered by the short-term liquid current assets. In a business that receives a lot of cash on a day to day basis, e.g. a market stall trader or supermarket, they can have a lower ratio, because they can probably raise the cash to pay a bill in the next few days. Some retailers, like a car sales dealership, might find this more difficult to achieve and would need a higher ratio. This is because they may have to wait more time to receive the cash, especially if someone is paying on credit. A business could improve its liquidity ratios by: Increasing the value of profitable sales. Turning its overdraft into a long-term loan (reduces short-term liabilities and increases capital). Financial efficiency There are three main financial efficiency ratios: Stock turnover Debtor days Creditor days Stock turnover Stock turnover is the number of times stock is turned into sales. The higher the figure, the more quickly stock has been sold or turned over. A fruit stall will have a higher stock turnover than a car dealership. Businesses want to have a higher stock turnover figure because this means that stock is not hanging around on the shelves or storage. In this time it could become obsolete, get damaged or go out of date. It also costs money to hold stock. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 154 of 165
A business may increase its stock turnover by having: Lower stock levels. Disposal of slow moving or obsolete stock. Reduction in range of products stocked. Debtor days The debtor days figure shows the number of days it takes for a business to collect money from customers who have bought products on credit. Businesses want to have as low a debtor days figure as possible. The larger the figure, the longer it takes to collect the money, money needed to pay bills. A business can encourage customers to pay their debts more quickly and so reduce the debtor day ratio in the following ways: Offer discounts for early payment. Threaten to take the customer to court. Refuse to supply more products or hold back part of an order until payment has been made. Creditor days Creditor days are a measure of how long it takes for the business to pay creditors. The larger the figure the longer it takes the business to pay. A supplier would be interested to know how well a business does in paying its bills. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 155 of 165
Summary of Accounting Ratio Calculations The table below provides some example data we can use to demonstrate how the main accounting ratios are calculated. Work through the examples to make sure you can understand where the numbers come from. Profit and Loss Account 2002 000 2003 000 Sales 1,500 2,000 Cost of Sales (750) (900) Gross Profit 750 1,100 Overheads 500 650 Net profit 250 450
Balance Sheet at End of Financial Year Fixed Assets 2,000 2,250 Current Assets: Stocks 300 350 Debtors 250 300 Cash 500 500 Total Current Assets 1,050 1,250 Current liabilities (750) (650) Net Current Assets 300 600 NET ASSETS 2,300 2,750
Financed by: Share capital 100 100 Retained profits 2,200 2,650 CAPITAL EMPLOYED 2,300 2,750
Calculation of Gross Profit Margin: Formula: Gross Profit / Sales Expressed as a percentage Calculation using example: Profit and Loss Account 2002 000 2003 000 Sales 1,500 2,000 Gross Profit 750 1,100 Gross Profit Margin 50% 55%
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Calculation of Net Profit Margin: Formula: Net Profit / Sales Expressed as a percentage Calculation using example: Profit and Loss Account 2002 000 2003 000 Sales 1,500 2,000 Net Profit 250 450 Net Profit Margin 16.7% 22.5%
Calculation of ROCE (Return on Capital Employed): Formula: Net Profit / Capital Employed Expressed as a percentage Calculation using example: Data from the Profit and Loss Account and the Balance Sheet 2002 000 2003 000 Net Profit 250 450 Capital Employed 2,300 2,750 Return on Capital Employed 10.7% 16.4%
Calculation of Current Ratio: Formula: Current Assets / Current Liabilities Calculation using example: Data from Balance Sheet 2002 000 2003 000 Current Assets 1,050 1,250 Current Liabilities 750 650 Current Ratio 1.4 1.9
GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 157 of 165
Calculation of Acid Test Ratio: Formula: Current Assets (excluding stocks) / Current Liabilities Calculation using example: Data from Balance Sheet 2002 000 2003 000 Current Assets (excluding stocks) 750 900 Current Liabilities 750 650 Current Ratio 1.0 1.4
Key Terms in this Section Term Definition Current ratio A measure of liquidity that compares the value of current assets (i.e. assets that can be turned into cash) against current liabilities (how much the business owes in the short term) Gross profit margin The gross profit margin of the business shows the ability of business to add value to the costs of directly making the product Liquidity The ability of the business to cover its short term debts with cash, the money it is owed and stock Net profit margin The net profit margin is the amount of profit generated per pound of sales Profitability A relative measure that shows how much profit has been generated by each pound of sales Ratios A way of comparing financial data to aid the decision making process Return on capital employed (ROCE) The primary efficiency ratio, showing the return a business makes on the money invested into it GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 158 of 165
Business Costs Introduction A business has many different costs, from paying for raw materials through to paying the rent or the heating bill. By careful classification of these costs a business can analyse its performance and make better- informed decisions. The main ways in which a business needs to manage its costs are as follows: Classification of costs into fixed and variable, direct and indirect. Variance analysis to see if the business is keeping control of its costs. Break even analysis which tells a business what it needs to sell to cover its costs. An opportunity cost is the financial benefit forgone of the next best alternative use of money. A business can measure the outcome of a decision by comparing it with the benefits (probably measured in profits or revenue) it could have had if it had taken the next best option. The opportunity cost of buying a new piece of machinery might be compared with the benefits of spending the money on a new advertising campaign. Fixed and Variable Costs Variable costs change in proportion to the amount of output produced. Fixed costs remain the same, no matter how much the business produces. The main kinds of costs are: Variable costs Fixed costs Raw materials Rent Workers wages Salaries of head office workers Energy/fuel for machines Heating and lighting Insurance Interest on loans Semi-fixed costs are costs which only change when there is a large change in output. For example, costs associated with buying a new machine to cope with increased production. Also telephones and electricity for instance have a fixed and variable element: a standard line rental and then a charge for each call/unit of electricity after that. Direct costs are costs which can be identified directly with the production of a good or service; e.g. raw materials. Indirect costs are costs which cannot be matched against each product because they need to be paid whether or not the production of good or services takes place; e.g. rent on the premises. Classification of costs help allocate costs to right parts of the profit and loss account and also helps analysis of the break even point of the business. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 159 of 165
Standard Costing and Variances A standard cost is the cost per unit of production when the product is made with the correct quantity and quality of materials, and in the exact time allowed for its production. A variance is when the ACTUAL cost is either greater or less than the standard cost. Where actual costs are more than the standard, this is known as an adverse variance . Where actual costs are less than the standard, this is known as a positive variance . A variance (difference) from the standard may indicate what course of action to take to correct something that is going wrong. A greater cost than standard (adverse variance) might lead to an investigation into how inputs were being used e.g. too much waste of raw materials, incorrect operation of machinery. Example: Costs for January 2003 Budgeted () Actual () Variance () Wages 2,000 1,950 50 Positive Materials 6,500 7,500 1,000 Adverse Fuel 350 375 25 Adverse Break-even A business can work out how what volume of sales it needs to achieve to cover its costs. This is known as the break even point. The key to break even is to work out the contribution made from the sale of each unit. The amount of money each unit sold contributes to pay for the fixed and indirect costs of the business. Contribution = selling price less variable cost per unit E.g. a product sells for 15 and has variable costs per unit of 11. Each unit sale therefore makes a contribution of 4 towards the fixed costs of the business. If the business had fixed costs of 20,000, then it would need to sell 5,000 units (4 x 5,000 = 20,000 contribution) in order to break even. The margin of safety is the difference between the number of units of planned or actual sales and the number of units of sales at break even point. If, using the example above, planned sales were thought to be 6,000 units, then the margin of safety would be 6,000 units break even 5,000 units = 1,000 units. The business would be able to sell 1,000 less than planned before they were in danger of making a loss. A break-even chart plots the sales revenue, different costs and helps identify the break even point and margin of safety. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 160 of 165
Drawing break-even charts To draw a chart the following steps need to be followed: 1. Label the vertical axis sales and costs in pounds. 2. Label the horizontal axis sales/production (units). 3. On another piece of paper sketch the scales that you want to use given the data, then use this plan on the chart. 4. Plot any two points from the sales revenue data for the sales revenue line and then draw a straight line for sales revenue (assumes that the price per unit does not change) if the information is not given for sales revenue, then work out two points, e.g. for 1000 units sold and 1500 units sold. The start of the line should be through the origin (where the axes meet). 5. Draw a horizontal line for total fixed costs starting at the point on the vertical axis at the level of costs. 6. At the same starting point it is possible to draw the total costs line. Total costs are fixed costs plus variable costs. Work out what the total costs are for say 1000 units and 1500 units. Then draw the straight line starting at the same point as the fixed costs started and then through the two plotted points. 7. Where the sales revenue crosses the total costs line is the break even point. Read off the units of sales to give the break even level of sales. 8. The gap between the total costs line and sales revenue line after the break even point represents the level of profit.
It is important for a business to understand its break-even point because the contribution from every unit sold above the break-even point adds to profit. The break-even point provides a focus for the business, but also helps it work out whether the forecast sales will be enough to produce a profit and whether further investment in the product is worthwhile. The limitations of break-even charts are: GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 161 of 165
Do not take into account possible changes in costs over the time period. Do not allow for changes in the selling price. Analysis only as good as the quality of information. Do not allow for changes in market conditions in the time period e.g. entry of new competitor.
Key Terms in this Section Term Definition Break-even analysis Working out the level of production and sales a business needs to achieve to make sure that revenues cover costs Contribution The amount of money that is generated from a sale which can go towards paying for the fixed costs. The difference between selling price and variable cost per unit. Direct and indirect costs Direct costs can be identified directly with production whereas indirect costs cannot be matched against production, and need to be paid whether production takes place or not Fixed and variable costs A fixed cost does not vary with output, whereas a variable cost varies in proportion to the amount of output Margin of safety The difference between the break-even output and the expected sales. Variance analysis Analysis of whether actual costs have varied from the expected cost (standard cost).
GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 162 of 165
Budgeting and Business Plans Introduction Business managers need to look ahead at what lies in the future. An important part of this process is the use of budgeting, which sets out what can be spent and how, and the use of business plans, which set out the direction of the business and the strategies to achieve that direction. A budget is an agreed plan for future expenditure and income from sales based on the objectives of the business. A budget helps managers to measure whether they are achieving what they set out to achieve. If they are under or over budget they can take steps to correct the position. A budget also helps managers allocate resources at the start of a period e.g. in which areas is the business going to invest? How much will be spent on advertising this year? Budgets also provide a way of allocating responsibility among employees. The main types of budget are: Sales budget probably a month by month breakdown of how many products the business aims to sell, and how much revenue it will get from those sales. Marketing budget describes how the business intends to achieve the budgeted sales (e.g. how much advertising, sales promotion). Production budget numbers to be produced and costs of production used to help schedule work and order raw materials. Departmental budgets sets out how much each department can spend during a year. Cash flow budget ties all the other budgets together helps understand what money is coming in (sales) and what money is going out (production and departmental). A budget can play a role in motivating employees in the following way: As a non-money motivator a budget provides a focus and a sense of achievement when it is reached. Rewards in the form of bonuses can be linked to the achievement of budgets, encouraging employees to contribute more towards the overall profitability of the business. Cash Flow Forecasting A cash flow forecast or budget is used to anticipate when it can pay bills and plan when it might need to make provision for any cash flow problems (e.g. arrange for there to be some finance available in the form of an overdraft or loan). The key elements of a cash flow budget are: Opening balance How much cash the business has at the start of the time period. Cash inflow How much cash is coming into the business from product sales, sales of assets, loans from the bank, grants from the government, and other sources of finance. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 163 of 165
Cash outflow How much cash is going out of the business, such as expenses, wages, raw materials, buying new machinery, tax payments and dividends. Closing balance How much money is left at the end of the month. Opening balance carried forward The next time period brings forward the closing balance from the previous time period. A worked example of a cash flow forecast is provided below: Jan () Feb () Mar () A Opening balance (I from last month) 3,000 5,750 8,550 B Cash inflow C Sales 6,000 5,500 6,750 D Total 6,000 5,500 6,750 E Cash outflow F Materials 1,500 1,200 1,800 G Wages 1,750 1,500 1,950 H Total (F+G) 3,250 2,700 3,750 I Closing balance (A+D-H) 5,750 8,550 11,550 There are some limitations to cash flow forecasts: The longer they predict, the more likely they may not foresee changes in the market place e.g. a new competitor may force down the prices of products sold. It relies on estimates of future costs, which may difficult to predict. A business can improve its cash flow in the following ways: Agree an overdraft or increase an existing overdraft from the bank. Extend the length of time taken to pay suppliers. Reduce the price of some products to get quick sales. Sell to customers for cash rather than offer trade credit. Sell some equipment. Reduce stock levels. Buy cheaper raw materials. Allow debtors discounts for early payment. Operate tighter customer credit controls. Use debt factoring.
GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 164 of 165
Business Plans A business plan describes the main aims, objectives and strategy of a business. Several supporting documents (budgets) show how these objectives are to be achieved. If the business follows this plan then, if nothing unexpected happens, it should achieve its objectives. If there are variances from a budget, then managers will need to make adjustments. For example, a positive or favourable variance, such as more sales than planned, means that the production budget will need to be adjusted to make products to meet the extra demand. Banks are especially keen to see a business plan before they lend a business any amount of money. It will want to know if it will get the money back. A business plan serves several purposes in this case: it Explains a business idea so the bank can see whether it is likely to work financially. Shows the bank whether future profits will cover the interest on the loan. Shows the bank when it can expect to be repaid. Shows where the information comes from and whether it is reliable. A business plan must be presented in such a way as to convince the bank that the intentions of the business are serious and achievable. For example: A bank thinking of lending money to a business would be interested in the following information: Acid test ratio or current ratio (see below) these show the liquidity of the business, the ability to pay back the money it owes in the short term. A ratio of less than one may mean that the business could find it difficult to cover their liabilities and so the bank may be reluctant to extend or continue lending. Profit forecasts a successful business will be able to pay back its loans. Cash forecasts future cash flows will be needed to pay interest and repay loans. Fixed assets a business can use assets as security for loans. Example of better management of overheads Overheads are the expenses that not directly involved in the production and selling of the goods and services. A way to reduce these overheads is to move to cheaper premises, reduce the number of staff in the head office or cut the marketing budget. However all of these changes may not necessarily benefit the business in the long run. GCSE Business Studies Key Study Notes 2004 tutor2u 2004 Page 165 of 165
Key Terms in this Section Term Definition Budgeting Setting out how much will be spent in an area over a period of time and where it will be spent Business plan Describes the main objectives and strategy of the business and how it is going to achieve them Cash flow forecasting Shows the expected cash inflow and outflow over a period of time to help anticipate possible cash flow problems in the future Cash inflows Cash that comes into the business e.g. payments from customers, sales of fixed assets Cash outflows Cash that goes out of the business e.g. payments to suppliers, payments to buy fixed assets, payment of tax to the government, payment of wages and salaries to employees Marketing budget The activities and costs associated with the ways that the business intends to achieve its targeted sales Production budget Details of the expected production output of the business and what it is expected to cost to achieve this