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MB 0036 / MH 0045

Strategic Management and Business Policy


Contents
Unit 1
Introduction to the Concept of Strategic Management
and Business Issues – Basic Investment Strategy 1
Unit 2
Planning a New Business Venture: Tackling and
Planning Business Priorities 35
Unit 3
Harnessing Complexity – Creativity in Business and a
Favourable Investment Strategy 78
Unit 4
Business Continuity Plan 92
Unit 5
Small Businesses – Big Obstacles 133
Unit 6
Decision Support Systems 159
Unit 7
Licensing and Enforcing Intellectual Property Rights 204
Unit 8
Corporate Social Responsibility 256
Reference 293
Edition: Fall 2007
th
BKID – B0854 9 April 2008
Brig. (Dr). R. S. Grewal VSM (Retd.)
Pro Vice Chancellor
Sikkim Manipal University of Health, Medical & Technological Sciences
Board of Studies
Mr. Rajen Padukone
Member – Academic Senate, Sikkim Manipal University
Ms. Vimala Parthasarathy Prof. K. V. Varambally
HOD Director
Convener Manipal Institute of Management
Department of Management & Commerce Manipal
Directorate of Distance Education
Sikkim Manipal University
Prof. Raj Dorai Mr. Jagadeesh
Industry Consultant and Assistant Professor
Visiting Faculty, IBA, IFIM and BIM, Department of Management &
Bangalore Commerce, Directorate of Distance
Education, Sikkim Manipal University
Mr. Umesh Maiya Mr. R. Ravindra Rao
Assistant Professor Senior Faculty
Department of Management & Commerce Manipal Institute of Management
Directorate of Distance Education Manipal
Sikkim Manipal University
Content Preparation Team
Content Writing and Compilation Language Editing
Prof. Raj Dorai Mr. Shridhar Bhat
Industry Consultant and Former Faculty, MUL
Visiting Faculty, IBA, IFIM and BIM, Manipal – 576 104
Bangalore
Format Editing
Mr. Umesh Maiya
Assistant Professor
Dept. of Management & Commerce
Sikkim Manipal University of Health
Medical & Technological Sciences (SMU)
Manipal – 576 104

Edition: Fall 2007


This book is a distance education module comprising of collection of learning
material for our students.
All rights reserved. No part of this work may be reproduced in any form by any
means without permission in writing from Sikkim Manipal University of Health,
Medical and Technological Sciences, Gangtok, Sikkim.
Printed and Published on behalf of Sikkim Manipal University of Health, Medical and
Technological Sciences, Gangtok, Sikkim by Mr. Rajkumar Mascreen, GM, Manipal
Universal Learning Pvt. Ltd., Manipal – 576 104. Printed at Manipal Press Limited,
Manipal.
SUBJECT INTRODUCTION
A strategy is an operational tool to achieve the goals, and thus, the
corporate mission. Strategies are very much useful in organisations for
guiding, planning and control. To win over in a given complex situation, the
organisations, even trans-nationals, adopt strategies. Strategy formulation
and implementation is the crux of the strategic management process.
Formulation, together with its implementation, constitutes an integral part of
the management activity.

A well-written plan will serve as a guide through the start up phase of the
business. A business plan is a detailed description of how an organization
intends to produce, market and sell a product or service. It can also
establish benchmarks to measure the performance of your business venture
in comparison with expectations and industry standards.

The main function of an enterprise is to create value through producing


goods and services that society demands, thereby generating profit for its
owners and shareholders as well as welfare for society, particularly through
an ongoing process of job creation. However, new social and market
pressures are gradually leading to a change in the values and in the horizon
of business activity.

Intellectual property rights can be very valuable commercial rights for


inventors, creators and researchers. It is important to enforce your
intellectual property rights to protect the value of your intellectual property
rights.

All these aspects are of great significance from the point of view of the
establishment, progress and maintenance of standards of an organization.

This courseware has been carefully designed to incorporate these details


along with other necessary ingredients.
This book comprises 8 units:

Unit 1: Introduction to the Concept of Strategic Management and


Business Issues – Basic Investment Strategy
Deals with the purpose of strategy, strategy formulation and implementation
as well as evaluation and control of strategy.

Unit 2: Planning a New Business Venture: Tackling and Planning


Business Priorities
Deals with the concept of business plan and explains how to create one’s
own business plan and the steps involved in developing sales projections.

Unit 3: Harnessing Complexity – Creativity in Business and a


Favourable Investment Strategy
Throws light on Complex Systems Behaviour and the concept of Creativity.

Unit 4: Business Continuity Plan


Deals with the purpose of Business Continuity Plan and the way of
developing, implementing and maintaining the Business Continuity Plan.

Unit 5: Small Businesses – Big Obstacles


Explains what Small Business Administration (SBA) is; Throws light on
different phases of a new business; Explains the functions of the Chief
Financial Officer in an organization.

Unit 6: Decision Support Systems


Deals with the levels of reporting and flows of data; Also explains the effects
of using a Decision System.

Unit 7: Licensing and Enforcing Intellectual Property Rights


Deals with the options for exploiting Intellectual Property rights,
commercialisation mechanisms and the provisions for enforcement of
Intellectual Property rights.

Unit 8: Corporate Social Responsibility


Deals with the meaning of Corporate Social Responsibility and its global
dimension.
Strategic Management and Business Policy Unit 1

Unit 1 Introduction to the Concept of


Strategic Management and Business
Issues – Basic Investment Strategy
Structure:
1.1 Introduction
Objectives
1.2 Purpose of Strategy
1.3 Translating Corporate Vision into Action-A Case Study
1.4 Strategies to Improve Sales
Self Assessment Questions I
1.5 Strategy Formulation & Implementation
1.5.1 Stages in Strategy Formulation and Implementation
1.5.2 Generic Strategy Alternatives
1.5.3 Strategic Alliances
1.5.4 Considering Strategy Variations
1.5.5 Selection of the Best Alternative
1.5.6 Strategic Choice
1.5.7 Allocation of Resources and Development of Organisational
Structure
Self Assessment Questions II
1.6 Formulation of Policies, Plans, Programmes and Administration
1.7 Implementation: Evaluation and Control of Strategy
Self Assessment Questions III
1.8 Summary
1.9 Terminal Questions
1.10 Answers to SAQs and TQs

1.1 Introduction
The term ‘strategy’ is drawn from the armed forces. It is a strategic plan that
interlocks all aspects of the corporate mission designed to overpower the

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enemy or the competitor. An appropriate strategy is considered to be


essential to face adverse situations such as cut-throat competition.

Strategy may imply general or specific programmes of action outlining how


the resources are deployed to attain goals in a given set of conditions. If
these conditions change, the strategy also changes. Strategies give
direction for the achievement of objectives necessary through the
deployment of resources.

In this unit, we would attempt to understand the meaning and purpose of


strategy, its formulation, implementation and evaluation.

Objectives:
After studying this unit, you will be able to:
 Explain the meaning and purposes of a strategy.
 Explain the key elements of basic investment strategy.
 Mention the key strategy initiatives within a firm.
 List the stages involved in strategy formulation and implementation.
 Explain different forms of strategic alliances.
 Explain the importance of evaluation in the strategic management
process.

1.2 Purpose of Strategy


A strategy is an operational tool to achieve the goals, and thus, the
corporate mission. Strategies do not attempt to outline exactly how the
enterprise is to accomplish its objectives. A company may view downsizing
as a strategy in a competitive market to render cost-effective services. Thus,
strategy provides a framework to guide thinking and action. Strategies are
very much useful in organisations for guiding, planning and control.

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Mass Market as the Focus of Corporate Strategy


Today, corporate strategy is to identify and focus on the largest potential
and concentrate business there. It is realised, of late, that the largest
potential lies in the mass market, which is the largest source of volume
though with marginal profits.
 HLL launched the WHEEL brand to cater to the requirements of large
customers (hitherto uncovered by its popular products Surf, Surf
Excel etc.) at affordable prices.
 Britannia was earlier addressing the needs of upper income
segments of the market. Having realised that the price-conscious
market was much larger, the company launched the Tiger brand.

Translating Corporate Vision into Action


The vision of Cadbury, the market leader of the 90’s, was translated into
different operational and marketing strategies – such as downsizing or
providing more value for money.

Strategy is a way of life both at the macro as well as micro levels for
everyone, whether it is a nation or a company. To win over in a given
complex situation, the organisations, even trans-nationals adopt strategies.
They make changes, if necessary, even to their global strategies. An
individual company may formulate its own strategy to bring out the desired
results. The eventual success of the organisation depends upon strategy
formulation and implementation.

The recently initiated moves such as globalisation, privatisation and


liberalisation are strategies to attain a globally competitive economy.

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Corporate Strategies
 Articulate the vision of the company.
 Involve staff in the vision.
 Be a good motivator.
 Focus on human resources by having the right people with the right
thinking in the right jobs.
 Empower the staff to take risks and be innovative.

Programmes
Programmes refer to the logical sequence of operations to be performed in
a given project or job. Programmes tell you “what to do “. A programme is
based on a set of goals, policies, procedures, rules and task assignments.
They are used to carry out a given course of action.

Normally, the size of each programme is assessed in terms of resources


and duration. If a programme takes larger resources and time, it is
considered major, but supported by a number of minor and supporting
programmes. If a programme requires a logical sequence of activities, it
would require special attention of a manager.

Co-ordination and timing of supporting programmes need a detailed


analysis. Failure of any part of this network of supportive programmes
means delays, higher costs and loss of revenue.

1.3 Translating Corporate Vision into Action – A Case Study


Case Study: BHEL
Vision: “A world class, innovative, competitive and profitable engineering
enterprise providing total business solutions. “

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How do we translate this into action?

Mission – What the company wants to achieve:

To:
 Deal with products and services with specific focussed engineering
applications close to their Core Competence.
 Become an international player.
 Be innovative.
 Be profitable.
 Provide total business solutions to ensure customer satisfaction.

Goals – To achieve the above mission


 To understand the status of technology in engineering and
management.
 To actively implement in-house and external R&D to develop innovative
products and services.
 To emerge as the most competitive player in terms of price and quality.

Objectives – To achieve the above goals


 To upgrade innovative R&D skills among technical human resource.
 To outsource R&D services to close the gap.
 To ensure that employees are committed.
 To make key personnel more conscious of time, quality and cost.
 To develop reliable and resourceful network of customers.
 To optimise utilisation of resources, both financial as well as non-
financial, material, as well as human.

Strategies – To achieve the above objectives


 To promote a joint venture with a strategic partner, preferably a leading
multi-national.

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 To work for ISO 9000 certification, to streamline the operating systems


in design, manufacturing, installation, testing and service.
 To provide a continuous learning atmosphere for the technical and non-
technical staff at all levels.
 To network with leading international software vendors and transport
companies of global standards.
 To ensure quick recovery of receivables, offer incentives for early
payment and initiate a system of debt factoring if necessary to take
protection against bad debts.
 To maintain an optimum staff strength and recruit only if and when
necessary.
 To select people based on aptitude and attitude.
 To make the organisation flat and lean to enhance the degree of
competitiveness.

Policies – To control strategies


 To follow structured recruitment procedures.
 To make training a compulsory element of employees’ growth strategy.
 To sell to a buyer only if he is not a significant contributor to debt levels.
 To encourage R&D and research paper presentations by employees.
 To make all maintenance staff live within factory premises.

Programmes – For implementation of objectives


 To work for ISO 9000 certification.
 To conduct orientation programmes for all staff at all levels to
communicate goals of such certification.
 To develop and encourage cross-function teams combining employees,
customers and suppliers.
 To conduct job analysis, to identify job description and work out job
specifications.

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 To use such data during recruitment.


 To schedule meetings with CEOs of major players in finance, supply and
transportation and initiate measures for strategic alliance.
 To conduct collection drive programmes for early recovery of
outstandings.
 To empower key personnel to negotiate early and favourable settlement
of pending accounts, considering the best interests of the organisation.
 To organise cleanliness and safety weeks.

The above list outlines some of the key issues at every stage of action
illustrating how:
 The mission springs out from vision statements
 Goals from the mission
 Objectives from goals
 Strategies from objectives
 And programmes from objectives

1.4 Strategies to Improve Sales


There are three alternatives to improve the sales performance of a business
unit, to fill the gap between actual sales and targeted sales:
a) Intensive growth
b) Integrative growth
c) Diversification growth

a) Intensive Growth:
It refers to the process of identifying opportunities to achieve further growth
within the company’s current businesses. To achieve intensive growth, the
management should first evaluate the available opportunities to improve the
performance of its existing current businesses.

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It may find three options:


 To penetrate into existing markets
 To develop new markets
 To develop new products

At times, it may be possible to gain more market share with the current
products in their current markets through a market penetration strategy. For
instance, SONY introduced TV sets with Trinitron picture tubes into the
market in 1996 priced at a premium of Rs.10,000 and above over the
market through a niche market capture strategy. They gradually lowered the
prices to market levels. However, it also simultaneously launched higher-
end products (high-technology products) to maintain its global image as a
technology leader. By lowering the prices of TVs with Trinitron picture tubes,
the company could successfully penetrate into the markets to add new
customers to its customer base.

Market Development Strategy is to explore the possibility to find or develop


new markets for its current products (from the northern region to the eastern
region etc.). Most multinational companies have been entering Indian
markets with this strategy, to develop markets globally. However, care
should be taken to ensure that these new markets are not low density or
saturated markets, which could lead to price pressures.

Product Development Strategy involves consideration of new products of


potential interest to its current markets (e.g. Gramaphone Records to
Musical Productions to CDs)– as part of a Diversification strategy.

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Study the following example to understand what Product Development


Strategy is.

MICROSOFT’s New Strategy


It is called PC-plus. It has three elements:
a) Providing computer power to the most commonly used devices such
as cell phone, personal computer, toaster oven, dishwasher,
refrigerator, washing machines and so on.
b) Developing software to allow these devices to communicate.
c) Investing heavily to help build wireless and high-speed internet
access throughout the world to link it all together.

Microsoft envisions a home where everyday appliances and electronics


are smart. According to Bill Gates, ‘In the near future, PC-based
networks will help us control many of our domestic matters with devices
that cost no more than $ 100 each ‘.

It is also said at Microsoft that VCRs can be programmed via e-mail,


laundry washers can be designed to send an instant message to the
home computer when the load is done and refrigerators can be made to
send an e-mail when there’s no more milk. Microsoft plans to give these
appliances ‘brains‘ and provide them the means to talk to each other
through their Windows CE Operating System.

b) Integrative Growth:
It refers to the process of identifying opportunities to develop or acquire
businesses that are related to the company’s current businesses. More
often, the business processes have to be integrated for linear growth in the
profits. The corporate plan may be designed to undertake backward,
forward or horizontal integration within the industry.

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If a company operating in music systems takes over the manufacturing


business of its plastic material supplier, it would be able to gain more control
over the market or generate more profit. (Backward Integration)

Alternatively, if this company acquires some of its most profitably operating


intermediaries such as wholesalers or retailers, it is forward integration. If
the company legally takes over or acquires the business of any of its leading
competitors, it is called horizontal integration (however, if this competitor is
weak, it might be counter-productive due to dilution of brand image).

c) Diversification Growth:
It refers to the process of identifying opportunities to develop or acquire
businesses that are not related to the company’s current businesses. This
makes sense when such opportunities outside the present businesses are
identified with attractive returns and that industry has business strengths to
be successful. In most cases, this is planned with new products that have
technological or marketing synergies with existing businesses to cater to a
different group of customers (Concentric Diversification).

A printing press might shift over to offset printing with computerised content
generation to appeal to higher-end customers and also add new application
areas ( Horizontal Diversification ) – or even sell stationery.

Alternatively, the company might choose new businesses that have nothing
to do with the current technology, products or markets (Conglomerate
Diversification).

The classic examples for this would be engineering and textile firms setting
up software development centres or Call Centres with new service clients.

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Situation Analysis
Sales Improvement Strategies:
a) A supplier of computer stationery invests in a computer stationery
manufacturing unit.
b) A vendor supplying engine boxes to Maruti decides to supply the
same with modifications to Hyundai.
c) A company dealing in computer floppies plans to set up a Software
Technology Park.

Downsizing Older Businesses – as part of Operating Plans


It is necessary to reduce the scale of operations of an unprofitable business
to ensure that the resources are optimally utilised. A weak business requires
higher degree of managerial attention. The management should focus on
the company’s growth opportunities, not fritter away energy and resources
trying to revive tired and old businesses.

Self Assessment Questions I


State whether the following statements are True or False:
1. A strategy is an operational tool to achieve the goals, and thus, the
corporate mission.
2. Strategies attempt to outline exactly how the enterprise is to accomplish
its objectives.
3. The recently initiated moves such as globalisation, privatisation and
liberalisation are strategies to attain a globally competitive economy.
4. A programme is based on a set of goals, policies, procedures, rules and
task assignments.
5. ‘Product Development Strategy’ is to explore the possibility to find or
develop new markets for its current products.
6. ‘Market Development Strategy’ involves consideration of new products
of potential interest to its current markets.

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1.5 Strategy Formulation and Implementation


It is the crux of the strategic management process. Strategy refers to the
course of action desired to achieve the objectives of the enterprise.
Formulation, together with its implementation, constitutes an integral part of
the management activity. Managers use strategies for different purposes
such as to overcome competition, to increase sales, to increase production,
to motivate the employees to provide their best, and so on. Implementation
of a strategy is a crucial task as the formulation of it. There may be a lot of
resistance during the implementation process. It is necessary for the
manager to be very tactful to involve the members of his group in the
formulation of strategy to facilitate the implementation process.

1.5.1 Stages in Strategy Formulation and Implementation


a) Identification of mission and objectives
b) Environment scanning
c) Generic strategy alternatives
d) Strategy variations
e) Strategic choice
f) Allocation of resources and formulation of organisational structure
g) Formulation of plans, policies, programmes and administration
h) Evaluation and control

1.5.2 Generic Strategy Alternatives


They refer to the strategy alternatives in broader terms. After the nature of
the business of the firm is defined, the next task is to focus on the type of
strategic alternative, in general, the firm should pursue. The strategist seeks
to identify the right alternative through questions such as:
1. Should we get out of this business entirely?
2. Should we try to expand?

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There are four strategy alternatives available to a firm or business:


a) To expand
b) To wind up or retrench
c) To stabilize, and
d) To continue its operations pertaining to its products, markets or
functions.

a) Expansion strategy can be adopted in the case of highly competitive and


volatile industries, particularly, if they are in the introduction stage of
product / service life cycle.
b) Stability strategy is a better choice when the firm is doing well, the
environment is relatively less volatile, and the product / service has
reached the stability or maturity stage of the life cycle.
c) Retrenchment strategy is the obvious choice when the firm is not doing
well in terms of sales and revenue and finds greater returns elsewhere,
or the product / service is in the finishing stage of the product life cycle.
d) Combination strategy is not a new strategy as it combines the other
strategies. However, it is to be noted that it is better to evolve individual
strategies and combine them rather than trying to evolve a complex
combination strategy which could be cumbersome with loss of precious
business time. It is best-suited to multiple SBU firms in times of
economic transition and also when changes occur in the product /
service life cycle. If a firm realises that some of its main product lines
have outlived their lives, it may not be profitable to continue investment
in the same product or SBU. The firm may choose to withdraw its
resources from this area (or SBU) (Retrenchment strategy) and follow an
Expansion strategy in a new product area. Combination strategy is best
suited when the firm finds that its product-wise performance is uneven,
or all or most of its products differ in their future potential.

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Generic Strategy Alternatives


Expand Retrench Stabilise Combination
Business Pace Busine Pace Business Pace Definition or
definition ss definition Pace
definiti
on
Products Add new Find new Drop De- maintain Make Drop old while
products ones old crease package adding new
pro- product changes, products
ducts develop- quality
ment improve-
ments
Markets Find new Pene- Drop Reduce maintain Protect Drop old
territories trate distrib market market customers
markets ution share shares, while finding
chan- focus on new
nels market customers
niches
Func- Forward, Increase Be- De- maintain Improve Increase
tions vertical capacity come crease produc- capacity and
integra- cap- process tion improve
tion tive R&D efficiency efficiency
com-
pany

Table 1.1: Generic Strategy Alternatives

Sometimes, a combination of a few or all of these strategies may be


necessary. Any change must be contemplated considering what is to be
done (Business definition) and the speed (Pace) with which it is to be done.
Each of these alternatives has to be evaluated on its merits.

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Enterprise Strategists Mission & objectives

General Environment

Industry and International Environment

Internal Factors

Generic Strategy Alternatives

Strategy Variations

Strategic Choice

Allocate Resources & Develop Organisational plans

Formulation of Plans, Policies, Programmes &Administration

Evaluation & Control

Figure 1.1: Strategy Formulation and Implementation

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Examples of Strategic Alternatives:


 If the firm wants to grow substantially in terms of size, expansion is
the obvious alternative. But in this process, other objectives may take
a back-seat, at least in the short run.
 In case of recession, retrenchment is the most preferred strategy,
involving dropping of unviable products, reduction in non-performing
assets, withdrawal from the markets, and reduces the scale of
activity. In the process, the overhead costs are purposefully reduced
to ensure that the expenditure continues to be productive. These
efforts will ultimately enhance the profitability.
 At times, the company may realise more money by liquidating its
operations than by continuing. In such a case, to achieve the goal of
improving cash value, the strategy is to sell a part of its assets,
realise the sale proceeds, and invest the same profitably elsewhere.
 If an entrepreneur wants to maintain control over a business, stability
strategy may be a better strategy.

Goal of improving cash value


 Most timber depots in sprawling open places, located in the outskirts
of the city for decades, have been making more money by selling a
part of their open land than by doing timber business.
 In view of the substantial growth in the real estate in the city outskirts,
most of them could sell their surplus land (main roadside) to
construction firms for phenomenal sums.
 In this process, they could successfully create capital assets with a
tremendously appreciated value. Further analysis showed that they
earned more on these capital assets than in the timber business.
 However, since the values are further appreciating, can we offer a
better strategy.

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A strategy is a means to an end. If an organisation wants to perform better


in the long run, it has to select an appropriate strategy and pursue it
vigorously. In this process, it might face certain hardships. Also, it has to
make necessary changes in its strategy. A change in strategy should not be
construed as a sign of failure.

1.5.3 Strategic Alliances


Strategic alliances constitute another viable alternative. Companies can
develop alliances with the members of the strategic group and perform more
effectively. These alliances may take any of the following forms:

a) Product and/or service alliance: Two or more companies may get


together to synergise their operations, seeking alliance for their products
and/or services. The product or service alliance may take any of the
following forms:

A manufacturing company may grant license to another company to


produce its products. The necessary market and product support,
including technical know-how, is provided as part of the alliance. Coca-
cola initially provided such support to Thums Up.

Two companies may jointly market their products which are


complementary in nature. Chocolate companies more often tie up with
toy companies. TV Channels tie-up with Cricket boards to telecast entire
series of cricket matches live.

Two companies, who come together in such an alliance, may produce a


new product altogether. Sony Music created a retail corner for itself in
the ice-cream parlours of Baskin-Robbins.

b) Promotional alliance: Two or more companies may come together to


promote their products and services. A company may agree to carry out
a promotion campaign during a given period for the products and/or
services of another company. The Cricket Board may permit Coke’s

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products to be displayed during the cricket matches for a period of one


year.

c) Logistic alliance: Here the focus is on developing or extending logistics


support. One company extends logistics support for another company’s
products and services. For example, the outlets of Pizza Hut, Kolkata
entered into a logistic alliance with TDK Logistics Ltd., Hyderabad, to
outsource the requirements of these outlets from more than 30 vendors
all over India – for instance, meat and eggs from Hyderabad etc.

d) Pricing collaborations: Companies may join together for special pricing


collaborations. It is customary to find that hardware and software
companies in information technology sector offer each other price
discounts. Companies should be very careful in selecting strategic
partners. The strategy should be to select such a partner who has
complementary strengths and who can offset the present weaknesses.
The acid test of an alliance is greater sales at lesser cost. It is a common
practice to develop organisational structures or modify them, if
necessary, to support the alliances and make them successful.

Logistic Alliance
 Pizza Hut restaurants do not stock more than three days of their
inventory.
 The standard for distribution centres or warehouses is a stringent 14
days, to minimise the costs and optimise quality control. This involves
round-the-clock monitoring of pick-ups and truck movements.
 Most of the items are perishable and the company’s standards cover
the entire delivery schedules.
 For in-city delivery, the truck is monitored from the time it leaves the
distribution centre till it reaches the restaurant. Not just that – the time
taken in offloading is noted too.
 The restaurant gives a strict 30 minutes window in which time the
delivery is to be completed.

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1.5.4 Considering Strategy Variations


There can be a number of variations of the generic strategy alternatives. For
instance, if the strategy is to expand, then the alternatives are internal
expansion or external expansion.

Internal expansion can be achieved through any of the following


approaches:
 Penetrate existing markets
 Add new markets
 Add new products, and so on

Similarly, external expansion can be achieved through mergers or


acquisitions. In most IT Companies, subsidiaries are created to develop at
the earliest upstream capabilities in the IT value-chain. Once these
subsidiaries gain the required capabilities in terms of consultancy, system
integration, product design and application, development and maintenance,
and others, they are merged into a major player. Merger has thus been one
of the strategies to benchmark the company in terms of performance
globally.

If the strategy is to attain stability, then the alternatives could be internal


stability or external stability. In some cases, both may be required. External
stability can be attained by maintaining market share.

Internal stability of a firm can be achieved through:


a) Seeking production and marketing efficiencies, and
b) Redefining the existing organisational structure.

Strategy variations can attain the following forms:


 Internal or external
 Related or unrelated
 Horizontal or vertical
 Active or passive

Each of these variations has different strategic alternatives considering the


major goals of the organisation. For instance, internal strategy variation may
be expansion, stability, retrenchment, or combinations. If expansion is

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decided upon, the alternatives could be to penetrate existing markets, add


new products, or add new markets, and so on. Strategy variation is a global
phenomenon. When the firm finds that it is not possible to fill a gap in the
market with the existing strategy, it considers a change in the focus of the
strategy. An example would be how multinationals Indianised their global
strategies to woo their customers in Indian markets.

Possible Strategy variations


Expansion Stability Retrenchment Combination
Internal Penetrate existing Seek Reduce costs; Sub-
markets; add new production reduce assets; contracting
products; add new and drop products;
products marketing drop markets;
efficiencies; drop functions
reorganise
External Acquisitions; Maintain Disinvest SBUs; Cross-
mergers market liquidations; licensing,
share bankruptcies joint ventures
Related Seek synergy from Improve Eliminate related
new products, products products,
markets or markets or
functions functions
Unrelated Conglomerate Eliminate
diversification in unrelated
products, markets products,
or functions markets or
functions
Horizontal Add Eliminate
complementary complementary
products or products or
markets markets
Vertical Add new functions Reduce functions
Active Innovative Grow to sell
entrepreneurial out
moves
Passive Imitator in R&D Reactive
products defence of
position

Table 1.2: Possible strategy variations

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Innovative practices
 HDFC introduced a high degree of innovation in its activities relating
to customer friendliness, technology adaptation (by computerising
operations), slashing loan processing time and so on.
 British Airways provided creative interactive video services on the
new Boeing 777s for passengers to report to Customer Relations
Depts. In-flight, order duty-free goods, get the latest news on
business, fashion, etc.

Changing trends in strategies: Global setting to Indian setting


 A keen insight into the strategies adopted by multi-national
companies dealing in products such as automobiles, beverages,
leather products, and so on, reveals the following shift from global
strategies to Indianised strategies:
 Indianising positioning of products, i.e., positioning and advertising
products in the Indian context, instead of maintaining a uniform brand
image all over the world.
 Advertisements and brands are designed to appeal to Indian
aspirations.
 For instance LG named one of its TVs as Sampoorna.
 Developing exclusive products rather than selling the same products
globally. For instance, a made-for-India refrigerator is designed to
serve just three basic purposes: chill drinking water, keep cooked
food fresh and withstand long power cuts ( ELECTROLUX )
 Coca-cola has redesigned its distributor-crates and trucks to suit
Indian roads.
 Widening appeal to all segments of customers rather than focussing
on select segments of the market ( REEBOK ).

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 Operating through multi-brand stores rather than own distribution


system.
 Entering market through small cars rather than with high-priced cars
(HYUNDAI ).
 Undertaking manufacturing with locally made products rather than
with imports ( HYUNDAI ).
 Using local film and sports personalities for advertising of premium
brands ( OMEGA )
 Offering free hand on investments to local managers, considering
market size, rather than controlling country budgets ( PEPSI ).
 Agreeing to enter the market at any cost, sacrificing own terms, with
scale of operations remaining a major attraction ( PEPSI ).
 Operating through local managers through more decentralisation,
rather than deputing managers from the head office ( PEPSI ).
 Appointing an Indian CEO in place of an expatriate ( CARRIER
AIRCON )

1.5.5 Selection of the Best Alternative


The best alternative is one that can improve overall performance. Its
selection depends upon:
 Particular configuration of objectives
 Environmental threat and opportunity profile
 Strategic advantage profile
 The generic strategy itself

If a company has a higher growth as its objective, it is better to expand from


a base of proven or time-tested competence (e.g. cost leadership or market
leadership) and organise the departments to provide new opportunities
while taking moderate risks.

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Every company must tailor an appropriate strategy for achieving its goals.
The most generic types to initiate strategic thinking, as suggested by
Michael Porter, are ( a ) Overall cost leadership, ( b ) Differentiation and ( c )
Focus.

a) Overall cost leadership – The company is said to achieve OCL when it


offers its products or services at the lowest price ( due to its lowest cost )
among competitors, thus maintaining the largest market share.
Companies which pursue this strategy have to sharply focus on cost-
effective strategies in all the areas pertaining to engineering, purchases,
manufacturing and physical distribution. Any breakdown could cost the
company very badly. A standby arrangement is vital. Mergers and take-
overs reflect the common route for companies to optimise their
resources and costs. HLL emerged stronger with the acquisition of
Brook Bond.

b) Differentiation – The company should be capable of demonstrating a


superior performance through its products and services. This should
benefit a large number of customers in saving their resources in terms of
time and money. Hero Honda could design its motorcycle differently to
offer higher mileage. This resulted in savings to the user. The strategy is
to differentiate the products and services sharply through quality in a
market dumped with stocks. A photocopying company can demonstrate
its excellence by minimising defects per thousand prints. Constant
adaptation to changing technology and large-scale initiatives in R&D
would provide a shot in the arm for the company. INFOSYS and WIPRO
are some examples which have made a niche in the software industry
through differentiation.

c) Focus – The company may concentrate on a narrow market segment


and obtain full market information about it. It may pursue either overall

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cost leadership or differentiation strategy within that target segment.


Such companies which pursue the same strategy to the same target
market, are called a strategic group of companies. If they relentlessly
pursue their strategies, they are bound to succeed, leading to
benchmarking of strategies. The danger here is that others can copy in
the name of benchmarks. This can be avoided by performing similar
activities in an innovative and swift way, which the competitors cannot
catch up with. There are certain issues which cannot be copied in the
short run.

1.5.6 Strategic Choice


It involves the decision to select from among alternatives, the best strategy
which effectively contributes to the business objectives. The spade work
before making a strategic choice consists of:
 Identifying the few viable alternative courses of action.
 Considering the parameters for selection of best alternative.
 Evaluating each alternative on its own merits and in relation to other
alternatives.
 Making the final choice.
 Keeping the next best alternative as stand by ( to take care of
contingencies )

The following are the questions in terms of which environmental and internal
conditions are analysed:
 What are the main business objectives?
 Does the selected strategy contribute to these objectives?
 What is the business definition – is it product-based, market-based or
function-based?
 Will it be achieved in the future?

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These questions help us to examine the performance gap between the


expected and the ideal outcomes in relation to the alternatives under
consideration. If the gap is narrow or negligible, the stability strategy is the
best strategy, since it focuses on “ doing in the best way what we can do “.
Most international airlines lease out operations such as reservation,
maintenance, ground halting work, and others to professional agencies to
improve their overall performance in general and increase the pace of its
own activities in particular. The focus will be on better implementation
initiating certain pace changes internally. If the gap is large and significant,
the probable alternatives are either to expand or to withdraw from unrelated
areas. Mergers, acquisitions, disinvestments are some of the measures that
initiate changes in the pace of growth.

The decision-maker considers different choices closest to the present


strategy. In the process, he identifies the most preferred strategy. Some of
the parameters that help him in this process are:
 Is it politically acceptable or not?
 What is the degree of risk involved?
 To what extent is the enterprise dependent on external factors?

Such an evaluation leads to the choice of an appropriate strategy, and at


this point, it appears to the decision-maker that the gap between the
expected and the ideal outcomes is closed. Relying excessively on one
corporate plan with one or two variations, more often, may not be adequate.
Hence, it is desirable to keep a contingency plan ready as standby.

Strategy formulation and implementation


NOKIA studies closely each of the subsets of its customer segments. It
carefully assesses what appeals to each of them most. After identifying
their purchasing power, it chooses the appropriate technology and then
formulates the strategy.

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When MOTOROLA could not take off with seven varieties of cell phones,
NOKIA struck gold with just two plain models. The secret of success was
that the products were changed or adapted to local conditions. In other
words, the products and services were more Indianised to ensure
survival in the Indian markets. NOKIA could successfully formulate its
strategy around its different customer segments, varying appeals and
affordable technology.

TAPARIA, CEO of Rajashree Cements followed a value enhancement


strategy to capture the market dominated by 43 grade, where ACC and
L&T were market leaders. He noticed that nobody thought of the market-
positioning slot for superior grade 53, which, despite high price, leads to
overall savings due to less consumption. He expected that a shift from 43
to 53 grade would require convincing, for which channel support and its
participation in communication were essential.

To popularise grade 53, Taparia launched the Shoppe concept by


associating with ” weak and small channel “ members. The Shoppe
concept empowered them with the services of a civil/structural engineer
at Rajashree’s cost for any type of consultation with the customers
visiting the shoppe.

The neat and clean environment of the cement outlets attracted the
customers who were otherwise used to the dirty and dusty environment
of cement outlets. The customers were assured of the availability and
reliability of the quality products. The customer could avail the services of
a civil engineer and also sit in an air-conditioned chamber of the Shoppe
and watch a video film on grade 53.

The quality of documentation (invoices, challans) was improved to create


confidence in the customer. The success of the Shoppe concept was

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evident from a rise in demand from 5000 tonnes per month to 45,000
TpM in Pune alone. Even established giants like ACC and LandT had to
follow his footsteps by introducing grade 53 and also developing their
own exclusive outlets like “ACC ki duniya” and “LandT station”.

Since strategic choice is a managerial ( business ) decision, care should be


taken that it is not affected by bias, intuition or politics. These constraints, if
allowed to prevail, will limit the choice. Progressive companies hold formal
meetings involving all or most of their managers at the top level while
choosing strategy and to record the criteria used. More often, a company
may not have total freedom in choosing the strategy as it is dependent for its
survival on one or more of the following: owners, competitors, suppliers, the
Government and the community. The strategic choice is also affected by
relative volatility of the market sector wherein the firm chooses to operate. If
the sector is more volatile, it needs a flexible and strategic response to be
more effective.

Strategic choice and its effectiveness is often restricted by various factors


such as the strategies earlier followed, the attitudes of the managers to risk
(most of the managers are averse to risk) and lobby for power (some
managers wish to be close to the boss to garner influence) in the
organisation, internal and external alliances, and so on. However, overall
commitment to the chosen strategy is extremely important.

1.5.7 Allocation of Resources and Development of Organisational


Structure
The process of strategy implementation calls for an integrated set of choices
and activities. These include allocating resources, organising, assigning
appropriate authority to the key managers, setting policies and developing
procedures.

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It is necessary to establish an operative system to reinforce, control and


evaluate a strategy.

A good strategy with effective implementation has a higher probability of


success. There source allocation decisions, such as, which department is
sanctioned how much of money and resources, in the name of the budget,
and so on – set the operative strategy of the firm.

Budgets are formulated after a series of negotiations across different levels


in the organisation. Budgets may be of different types: corporate budgets,
capital budgets, departmental budgets, sales budgets, expense budgets,
and others.

An effective co-ordination and efficient division of labour requires an


appropriate organisational structure. The best structure is one, which fits
into the organisational environment. Also its internal characteristics should
give rise to an effective strategy.

Appropriate changes in the organisation structure may be initiated to ensure


strategic implementation of the proposed strategy. Effective strategic
management practices suggest that organisation structure should also
change if the strategy changes or if the organisation experiences any
bottlenecks in this regard

Self Assessment Questions II


1. After the nature of the business of the firm is defined, the next task is to
focus on ––––––––––––––––– .
2. –––––––––– can be adopted in the case of highly competitive and
volatile industries.
3. –––––––––– is a better choice when the firm is doing well, the
environment is relatively less volatile, and the product / service has
reached the stability or maturity stage of the life cycle.

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4. –––––––––––– is the obvious choice when the firm is not doing well in
terms of sales and revenue and finds greater returns elsewhere, or the
product / service is in the finishing stage of the product life cycle.
5. In case of recession, ––––––––––––––– is the most preferred strategy.

1.6 Formulation of Policies, Plans, Programmes and


Administration
The resources allocated are said to be well-utilised only when they are well-
monitored. For this purpose, it is essential:
 To develop policies and plans.
 To assign and reassign leaders the tasks and decisions to support the
chosen strategy.
 To provide a conducive environment in the organisation through proper
administration to achieve the given objectives directly and indirectly.

The implementation of plans and policies is designed in accordance with the


strategy chosen. The firm creates plans and policies to guide managerial
performance, and these make the chosen strategies work. The corporate
success lies ultimately in the ability to convert corporate strategy into plans
and policies that are compatible and workable.

The implementation of the strategy becomes easy when the organization:


 Plans for career development of its personnel at all levels.
 Applies organisational development concepts in its normal functioning.
(Organisational development aims at enhancing organisational
effectiveness by applying diagnostic and problem solving skills through
behavioral approach )
 Ensures that the strategist is capable, experienced and versatile enough
to match the strategy demands.

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It is always prudent to develop minimal plans, policies and programmes in


all the functional areas such as marketing, production, R&D, Finance, HRD
and others. If the company wants to retain its staff, the following
programmes may be helpful:
 Focus on periodic appraisal through an objective and participative
performance appraisal system.
 Measure employee satisfaction levels regularly and respond promptly by
launching corrective measures to any signs of employee dissatisfaction
or frustration.
 Institutionalise the career counseling function and fill the vacancies that
arise by promoting the qualified candidates.
 Do not depend on one single employee or group at any level in the
organisation. Create multiple responsibilities on the well-chosen group of
managers at different levels.
 Ensure that the functional heads and the CEO are involved in this
process.
 Recognise those variations, which are bound to exist across
organisational levels and functions, and formulate specific retention
strategies to suit them.

Detailed support programmes must be developed to support the given


strategies.

1.7 Implementation: Evaluation and Control of Strategy


Evaluation is the last phase of the strategic management process. It is at
this stage that the success of the programmes can be assessed. There
should be a built-in mechanism to examine the deviations and initiate
corrections as and when required. This assures that the chosen strategies
will be implemented properly.

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The control process requires identifying a set of parameters for evaluating


and measuring the performance at the individual level and also at the
department level. The performance has to be evaluated to identify
deviations and take corrective action. The control and evaluation take place
not only at the SBU level but also at the corporate level. This process may
involve the participation of all the executives at all levels. Corrective actions
are required wherever the evaluation reveals deviations between the actual
performance and the projected one, over a given period of time. Timely
measurement of performance and feedback determines the effectiveness of
the implementation of the strategy.

The parameters should be, as a part of the checklist, evolved to check the
nature of objectives, environmental assumptions, internal organisation,
resources, attitudes to risk, timing of decisions and actions, feasibility, and
organisational commitment. Managers may consider, in the order of priority,
the changes in parameters, implementation, strategy, and finally, the
objectives themselves, if performance levels are lower than expected.

The evaluation system, thus, provides a feedback to the entire strategic


management process. Such a follow up calls for good objectives and
performance standards, effective rewards, and accurate and complete
feedback. Managers should have total access to every type of information
they look for so that they can focus on objective-oriented performance. Thus
MIS and MBO can be useful tools for managers. But as with any system,
effective application requires hard work on the part of staff at different levels.

A strategy can well be implemented if staff is efficient, have a shared vision,


and a developed work culture and value system. It is the management’s
responsibility to ensure a conducive environment that fosters the effective
implementation of strategies.

For want of committed workforce, most organisations fail at this stage.

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Self Assessment Questions III


1. In ––––––––– two or more companies may come together to promote
their products and services.
2. In ––––––––– the focus is on developing or extending logistics support.
3. External expansion can be achieved through –––––––––––––––– .
4. External stability can be attained by maintaining ––––––––––––– .
5. The most generic types to initiate strategic thinking, as suggested
by Michael Porter, are Overall cost leadership, Differentiation and
––––––––––––.
6. Organisational development aims at enhancing organisational
effectiveness by applying diagnostic and problem solving skills through
–––––––––––––––– .
7. –––––––––––––––– is the last phase of the strategic management
process.

1.8 Summary
 A strategy is an operational tool to achieve the goals, and thus, the
corporate mission.
 To win over in a given complex situation, the organisations, even trans-
nationals adopt strategies.
 The recently initiated moves such as globalisation, privatisation and
liberalisation are strategies to attain a globally competitive economy.
 There are three alternatives to improve the sales performance of a
business unit, to fill the gap between actual sales and targeted sales:
 Intensive growth
 Integrative growth
 Diversification growth

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 Strategy formulation and implementation is the crux of the strategic


management process. Formulation, together with its implementation,
constitutes an integral part of the management activity.
 Companies can develop alliances with the members of the strategic
group and perform more effectively. These alliances may take any of the
following forms:
 Product and/or service alliance
 Promotional alliance
 Logistic alliance
 Pricing collaborations
 Strategic Choice involves the decision to select from among alternatives,
the best strategy which effectively contributes to the business objectives.
 The process of strategy implementation calls for an integrated set of
choices and activities. These include allocating resources, organising,
assigning appropriate authority to the key managers, setting policies and
developing procedures.
 Evaluation is the last phase of the strategic management process. It is at
this stage that the success of the programmes can be assessed.

1.9 Terminal Questions


1. What is a ‘strategy’? Explain the purpose of a strategy.

2. Explain the three alternatives to improve the sales performance of a


business unit.
3. List the stages involved in strategy formulation and implementation.
4. Explain the four strategy alternatives available to a firm.
5. Explain different forms of strategic alliances.
6. Examine the role of evaluation in the strategic management process.

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1.10 Answers to SAQs and TQs


SAQs I
1. True
2. False
3. True
4. True
5. False
6. False

SAQs II
1. The type of strategic alternative
2. Expansion strategy
3. Stability strategy
4. Retrenchment strategy
5. Retrenchment

SAQs III
1. Promotional alliance
2. Logistic alliance
3. Mergers or acquisitions
4. Market share
5. Focus
6. Behavioural approach
7. Evaluation

Answers to TQs:
1. Refer to 1.2
2. Refer to 1.4
3. Refer to 1.5
4. Refer to 1.5
5. Refer to 1.5
6. Refer to 1.7

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Strategic Management and Business Policy Unit 2

Unit 2 Planning a New Business Venture:


Tackling and Planning Business Priorities
Structure:
2.1 Introduction
Objectives
2.2 What is a business plan?
2.3 Creating One’s Own Business Plan
2.3.1 Executive Summary
2.3.2 Company and Product Description
2.3.3 Market Description
2.3.4 Equipment and Materials
2.3.5 Operations
2.3.6 Management and Ownership
2.3.7 Financial Information and Start-Up Timeline
2.3.8 Risks and Their Mitigation
Self Assessment Questions I
2.4 Next Steps: Steps for Developing Sales Projections
2.4.1 The Business Priorities
2.4.2 Approach
2.4.3 Implementation
2.4.4 Developing the Recording Network
2.4.5 Co-ordination and Promotion
2.5 The Work Programme
2.5.1 Developing the network
2.5.2 Local Data Sources
Self Assessment Questions II
2.6 Summary
2.7 Terminal Questions
2.8 Answers to SAQs and TQs

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2.1 Introduction
A business plan is a detailed description of how an organization intends to
produce, market and sell a product or service. Whether the business is
housing, commercial or some other enterprise, a good business plan
describes to others and to your own board of directors, management and
staff the details of how you intend to operate and expand your business.

A solid business plan describes who you are, what you do, how you will do
it, your capacity to do it, what financial resources are necessary to carry it
out, and how you intend to secure those resources. A well-written plan will
serve as a guide through the start-up phase of the business. It can also
establish benchmarks to measure the performance of your business venture
in comparison with expectations and industry standards. And most
important, a good business plan will help to attract necessary financing by
demonstrating the feasibility of your venture and the level of thought and
professionalism you bring to the task.

Objectives:
After studying this unit, you will be able to:
 Explain what a business plan is.
 Give examples of goals one may seek to achieve through the creation of
a new business venture.
 Explain various sections of a business plan.
 Explain the steps for developing sales projections.

2.2 What is a Business Plan?


A good business plan will help attract necessary financing by demonstrating
the feasibility of your venture and the level of thought and professionalism
you bring to the task.

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The first step in planning a new business venture is to establish goals that
you seek to achieve with the business. You can establish these goals in a
number of ways, but an inclusive and ordered process like an organizational
strategic planning session or a comprehensive neighborhood planning
process may be best. The board of directors of your organization should
review and approve the goals, because these goals will influence the
direction of the organization and require the allocation of valuable staff and
financial resources. Your goals will serve as a filter to screen a wide range
of possible business opportunities. If you fail to establish clear goals early in
the process, your organization may spend substantial time and resources
pursuing potential business ventures that may be financially viable but do
not serve the mission of your organization in other important ways. A liquor
store on the corner may be a clear money-maker; however, it may not be
the retail to assist your community desires.

The following are examples of goals you may seek to achieve through the
creation of a new business venture:

Revenue Generation – Your organization may hope to create a business


that will generate sufficient net income or profit to finance other programs,
activities or services provided by your organization.

Employment Creation – A new business venture may create job


opportunities for community residents or the constituency served by your
organization.

Neighborhood Development Strategy – A new business venture might


serve as an anchor to a deteriorating neighborhood commercial area, attract
additional businesses to the area and fill a gap in existing retail services.
You may need to find a use for a vacant commercial property that blights a
strategic area of your neighborhood. Or your business might focus on the
rehabilitation of dilapidated single family homes in the community.

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Whenever possible, goals should have quantifiable outcomes such as “to


generate a minimum of $50,000 of net income or profit within three years”;
“to employ at least 15 community residents within two years in new
permanent jobs at a livable wage”; “to occupy and support a minimum of
10,000 square feet of neighborhood commercial space”; or “to rehabilitate
50 single-family houses over three years.” Clearly defined and quantifiable
goals provide objective measurements to screen potential business
opportunities. They also establish clear criteria to evaluate the success of
the business venture.

Establish Goals
Once you have identified goals for a new business venture, the next step in
the business planning process is to identify and select the right business.
Many organizations may find themselves starting at this point in the process.
Business opportunities may have been dropped at your doorstep. Perhaps
an entrepreneurial member of the board of directors or a community
resident has approached your organization with an idea for a new business,
or a neighborhood business has closed or moved out of the area, taking
jobs and leaving a vacant facility behind. Even if this is the case, we
recommend that you take a step back and set goals. Failing to do so could
result in a waste of valuable time and resources pursuing an idea that may
seem feasible, but fails to accomplish important goals or to meet the mission
of your organization.

Depending on the goals you have set, you might take several approaches to
identify potential business opportunities.

Local Market Study: Whether your goal is to revitalize or fill space in a


neighborhood commercial district or to rehabilitate vacant housing stock,
you should conduct a local market study. A good market study will measure
the level of existing goods and services provided in the area, and assess the

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capacity of the area to support existing and additional commercial or home-


ownership activity. This assessment is based on the shopping and traffic
patterns of the area and the demographic and socio-economic
characteristics of the community. A bad or insufficient market study could
encourage your organization to pursue a business destined to fail, with
potentially disastrous results for the organization as a whole. Through a
market study you will be able to identify gaps in existing products and
services and unsatisfied demand for additional or expanded products and
services. If your organization does not have staff capacity to conduct a
market study, you might hire a consultant or solicit the assistance of
business administration students from a local college or university.
Conducting a solid and thorough market study up front will provide essential
information for your final business plan.

Analysis of Local and Regional Industry Trends: Another method of


investigating potential business opportunities is to research local and
regional business and industry trends. You may be able to identify which
business or industrial sectors are growing or declining in your city,
metropolitan area or region. The regional or metropolitan area planning
agency for your area is a good source of data on industry trends.

Internal Capacity: The board, staff or membership of your organization may


possess knowledge and skills in a particular business sector or industry.
Your organization may wish to draw upon this internal expertise in selecting
potential business opportunities.

Internal Purchasing Needs / Collaborative Procurement: Perhaps, your


organization frequently purchases a particular service or product. If nearby
affiliate organizations also use this service or product, this may present a
business opportunity. Examples of such products or services include
printing or copying services, travel services, transportation services,

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property management services, office supplies, catering services, and other


products. You will still need to conduct a complete market study to
determine the demand for this product or service beyond your internal
needs or the needs of your partners or affiliates.

Identify Business Opportunities


Buying an Existing Business: Rather than starting a new business, you
may wish to consider purchasing an existing business. Perhaps a local retail
or small light manufacturing business that has been an anchor to the local
retail area or a much-needed source of jobs in the neighborhood is for sale.
Its closure would mean the loss of jobs and services for your neighborhood.
Your organization might consider purchasing and taking over the enterprise
instead of starting a new business. If you decide to pursue this option, you
still need to go through the steps of creating a business plan. However,
before moving ahead, these are just a few important areas to research in
assessing the business you plan to purchase:

Be sure to conduct a thorough review of the financial statements for the past
three to five years to determine the current fiscal status and recent financial
trends, the validity of the accounts receivable and the status of the accounts
payable. Are all the required licenses and permits in place and can they be
transferred to a new owner?

Also look at the quality of key employees who, because of their expertise,
may need to remain with the business.

You will also need to assess the customer or client base and determine
whether its members will remain loyal to the business after it changes
hands.

Another area to evaluate is the perception or image of the business. Inspect


the facilities and talk to suppliers, customers and other businesses in the
area to learn more about the reputation of the business.

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At this early stage of your planning process, be sure to consult an attorney


experienced in corporation law. As a non-profit corporation, engaging in
income-generating activities not related to your mission may affect your tax-
exempt status. You may also wish to protect your organization from any
liability issues connected with the proposed business activity. After you have
decided on a particular business activity, have a qualified attorney advise
you on the proper corporate structure for your new venture. In addition to
qualified legal counsel, seek the expertise of an experienced professional in
that particular industry. He or she will bring valuable knowledge and insights
regarding the industry that will prove extremely useful during the business
planning process.

Advisory
You have decided on a business opportunity that meets the goals of your
organization. Now you are ready to test the feasibility of the venture and to
present your business concept to the world. A solid business plan will clearly
explain the business concept, describe the market for your product or
service, attract investment, and establish operating goals and guidelines.

The first step in writing your business plan is to identify your target
audience. Will this be an internal plan the board will use to assess the
feasibility and appropriateness of the business? Or will this plan be
distributed to a larger external audience such as funding sources,
commercial lenders or the community to gain financial backing and political
support for the proposed venture? The content and emphasis of the plan will
shift according to the audience.

You will also need to decide who will conduct the necessary research and
write the plan. The following table lists the advantages and disadvantages of
several options for getting the work done. You might consider a combination
of the options.

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Advantages Disadvantages

Board or May have important skills May have limited time


and insights regarding and availability.
business planning or industry.
May not have the expertise.
Greater sense of ownership
of plan details.
Free
Staff Will be responsible for May not have the time.
implementation of the plan.
May detract from ongoing
tasks and workload.
Has knowledge of the
organization and good May not have the planning
expertise. skills.
No additional cost.
Consultant Expected to devote full time May not know
and attention to the product. organization’s capacities.
Has necessary skills and No ownership of plan.
knowledge of business
planning and the industry. No involvement
in implementation.
Plan will be well written. High cost.
Volunteers Free May not be completed
in a timely manner.
May bring skills, knowledge
and expertise. Limited involvement
in implementation.

2.3 Creating One’s Own Business Plan


It is also important to establish a timeline for completing the plan. A
business plan can be completed by one staff member working full time in as
little as a week, although a thorough market analysis will add several days
at least. A committee will probably need much more time. Combinations of

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staff, volunteers, consultants and a board committee may lengthen or


shorten the process depending on skill level, available time, experience with
planning and research, and the group’s facilitation needs. Now that you
have decided who will put together your business plan and have set a
timeline for its completion, you are ready to begin assembling the elements
of the plan. Your business plan should contain the following sections:
 Executive summary
 Company and product description
 Market description
 Operations
 Management and ownership
 Financial information and timeline
 Risks and their mitigation

A solid business plan will clearly explain the business concept, describe the
market for your product or service, attract investment, and establish
operating goals and guidelines.

2.3.1 Executive Summary


In this section of your business plan, provide a description of your company,
the industry you will be competing in, and the product or service you plan to
offer.

Sell your concept! The executive summary may be the first and only section
of your business plan that most of your audience will read. Tell the audience
why the business is a great idea. Some readers will look at this section to
determine whether or not they want to learn more about a business. Other
readers will look to the executive summary as a sample of the quality and
professionalism of the overall plan. The executive summary should be no
more than one to three pages long and should answer the following
questions:

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 Who are you? (describe your organization)


 What are you planning? (describe the service or product)
 Why are you planning it? (discuss the demand and market for the
service or product)
 How will you operate your business?
 When will you be in operation? (overview of timeline)
 What is your expected net profit? (discuss your projected sales and
costs)

Although the executive summary is the first part of your business plan, you
should write it after you have written the other sections of the plan in order
to include the most important points of each section.

2.3.2 Company and Product Description


In describing your company be sure to include what type of business you
are planning (homeownership development, wholesale, retail, manufacturing
or service) and the legal structure (corporation or partnership). You should
discuss why you are creating this new venture, referencing the goals you set
at the beginning of the business planning process. Also include a
description of your non-profit organization, the role it has played in
developing this new venture and the on-going role, if any, it will play in
operations. Give the reader a brief overview of the industry, describing
historic and current growth trends.

Whenever possible, provide documentation or references supporting your


trend analysis such as articles from business-oriented newspapers and
magazines, research journals or other publications. Include these
references in the attachments of your business plan.

Product or Service
After describing your company and its industry context, describe the
products or services you plan to provide. Focus on what distinguishes your

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product or service from the rest of the market. Discuss what will attract
consumers to your product or service. Provide as much detail as necessary
to inform the reader about the particular characteristics of your product that
distinguish it from its competition – many nonprofits, for example, expect to
produce higher-quality housing than otherwise exists in the area. Mention
any distinctive elements in the manufacture of the product, such as being
“hand-made by a particular people from a specific area.” If you are providing
a service, explain the steps you will take to provide a service that is better
than your competition.

Price
Provide a realistic estimate of the price for your product or service, and
discuss the rationale behind that price. An unrealistic price estimate may
undermine the credibility of your plan and raise concerns that your product
or service may not be of sufficient quality or that you will not be able to
maintain profitability in the long run. Describe where this price positions you
in the marketplace: at the high end, low end or in the middle of the existing
range of prices for a similar product or service.

In other sections of the plan you will discuss the target market for your
product or service and also provide additional details on how the price of
your product fits into the overall financial projections for the enterprise.

Place
Describe the location where you will produce or distribute your product or
provide your service. Discuss the advantages of the location, such as its
accessibility, surrounding amenities and other characteristics that may
enhance your business.

Depending on your anticipated customer base, accessibility to your location


via public transportation could affect the marketability of your product or
service.

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Customers
In this section of your business plan, you will describe the customer base or
market for your product or service. In addition to providing a detailed
description of your customer base, you will also need to describe your
competition (other local developers or nearby businesses providing a similar
service to your potential customer base).

Who will purchase your product or use your service? How large is your
customer base? Define the characteristics of your target market in terms of
its:
 Demographics – Measures of age, gender, race, religion and family
size.
 Geography – Measures based on location.
 Socioeconomic Status – Measures based on individual or household
annual income.

Provide statistical data to describe the size of your target market. Sources
for this information may include recent data from the Bureau of Statistics,
state or local census data, or information gathered by your organization,
such as membership lists, neighborhood surveys and group or individual
interviews. Be sure to list the sources for your data, as this will further
validate your market assumptions. Include any relevant information
regarding the growth potential for your target market if your business is
expected to rely on growth. Cite any research forecasting population
increases in your target market or other trends and factors that may
increase the demand for your product or service.

Competition
Discuss how people identified in your target market currently meet their
need for your product or service. What other businesses exist in your area
that are similar to your proposed venture? For example, for a housing

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business, what are the local markets for purchase and rental? How much
are people currently paying for similar products or services? Briefly describe
what differentiates your proposed venture from these existing businesses
and discuss why you are entering this market.

Sales Projections
Present an estimate of how many people you expect will purchase your
product or service. Your estimate should be based on the size of your
market, the characteristics of your customers and the share of the market
you will gain over your competition. Project how many units you will sell at a
specified price over several years. The initial year should be broken down in
monthly or quarterly increments. Account for initial presentation and market
penetration of your product and any seasonal variations in sales, if
appropriate.

2.3.3 Market Description


In this section, you will describe how you plan to operate the business. You
will present information on how you plan to create your product or provide
your service, describe the staff required to operate and manage the
business, discuss the equipment and materials necessary, and define the
site or facility requirements, if any. A key component of the operation of your
business will be your sales and marketing strategy, so you must describe
how you will inform your target market about your product or service and
how you will convince customers to purchase it.

Production Description
Describe the steps for creating your product, from the raw material or initial
stage to the finished product, packaged and ready for distribution and sale.
If you plan to provide a service, describe the process of service deliver
(such as the initial interview, for instance, if you are offering consulting
services), assessment, research and design, and final presentation. Provide

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a description of any sub-contractors or external services you plan to use in


the production process. The reader of the plan may be unfamiliar with the
industry, so avoid using industry jargon to describe the production process.

Staffing
Describe the staff required to operate your business: discuss how many
people you will need; describe the tasks they will carry out; and the skills
they will need. Prepare a chart outlining the salaries and benefits you will
provide to your workforce. Provide information on how you will recruit staff
and provide initial and ongoing training of employees.

2.3.4 Equipment and Materials


To manufacture your product or provide your service, what type of
equipment will you need? Describe any machinery and vehicles necessary
in the production, packaging and distribution of your product, including any
office equipment such as computers, copiers, furniture, fixtures and
telephone systems. Also discuss the types of materials you will use in the
production process and describe the source and cost of those materials.

Facility
Describe the type of facility in which you will house your business. Indicate
the amount of building space you will need for production and
administration. Also discuss any building features required for the
production process such as high ceilings, specialized ventilation and heating
systems, sanitized laboratory space or vehicular accessibility. If you have
already identified a location and a facility that meets your requirements,
describe its features. Even if you are planning to provide a service instead of
manufacturing a product, you need to demonstrate that you will have
adequate space for administrative functions and other activities related to
the service you plan to provide .

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Market Description
Describe your strategy for locating your target market, informing or
educating customers about your product or service and convincing them to
purchase it. Provide details on the methods you will use to advertise your
product, such as print media (advertisements in newspapers, magazines or
trade journals), electronic media (television, radio and the Internet), direct
mail, telemarketing, individual sales agents or representatives, or other
approaches. Discuss the product’s or service’s features you plan to
emphasize to gain the attention of your target market. Also detail how you
will distribute and sell your product or service. Will you use sales agents or
existing retail outlets, or directly distribute your product through a delivery
service such as United Parcel Service, Federal Express or independent
trucking company?

2.3.5 Operations
In this section of your business plan, describe the senior managers
responsible for overseeing the start-up and operation of your business, their
background and their responsibilities in the business. Be sure to highlight
your management team’s experience in managing the production, marketing
and administration of similar businesses or within the selected industry and
attach the resumes of each member to the plan. Be sure to provide a
complete job description of any vacancies in your management team.
Describe the responsibilities, the skills, the background required and the
steps you plan to take to fill that key position.

Ownership
What is its relationship to your existing organization? Who is on the board of
directors / board of advisors of the new business and what are their
backgrounds and areas of expertise? Potential investors or lenders will be
interested in the ownership stake of the board of directors and also in what
portion of the company’s equity is available. Success is often due to one’s

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contacts, so fully describe your business relationships with attorneys,


accountants and advertising or public relations agencies, and any industry-
specific services such as suppliers and distributors.

2.3.6 Management and Ownership


In this section you will describe the financial feasibility of your planned
venture and provide several financial reports and statements to document
why your business will be a viable enterprise and a sound investment. At a
minimum, you should provide a brief descriptive narrative for each of the
following financial statements and include a copy in the attachments to your
plan:
 Start-up budget
 Cash flow projection
 Income statement
 Balance sheet

In preparing these statements, you may want to seek the advice of a


certified public accountant (CPA).

Start-up Budget
Describe the initial expenses you will incur to get your business up and
running. Some items you might include in your start-up budget research and
product design and development expenses, legal incorporation and
licensing expenses, facility purchase or rental, equipment and vehicle
purchase or rental, and initial material or supply purchase. You can use
Worksheet B as a sample format for preparing your start-up budget.

Cash Flow Projection


This statement presents a month-to-month schedule of the estimated cash
inflows and outflows of your business for the first year. This schedule should
indicate how much money your business will have or need and when you
will need it. You should describe your sources of income and capital,

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detailing your projected sales revenue and indicating your own or investor
equity contribution, lenders, investors and other sources of capital. Itemize
your projected expenses, distinguishing between the cost of goods sold
(materials, supplies, production labor), overhead expenses (rent, utilities,
insurance, maintenance, interest, insurance, administrative costs and
salaries, legal and accounting services, marketing, taxes, fees and other
ongoing operating expenses) and capital expenditures (land and buildings,
equipment, furniture, vehicles, and building repair or renovation expenses).
In preparing this statement, account for a gradual increase in sales from
initial product introduction and any expected seasonal fluctuations in
revenue projections.

Income Statement
Prepare a multiyear (three- to five - year) statement of projected revenue,
expenses, capital expenditures and cost of goods sold. If you make
assumptions about the growth of your business, provide supporting
documentation such as growth patterns of similar companies or studies that
forecast an industry-wide growth rate. This statement should indicate to the
reader the potential of your business to generate cash and its profitability
over time. For an existing business, also submit an income statement for at
least three prior consecutive years. Lenders may look at this statement to
determine whether your business can support the additional debt you are
requesting.

Balance Sheet
A start-up business probably will not have any assets or liabilities at the time
you are drafting the business plan. Provide a copy of the balance sheet of
the business’s sponsoring organization or individual. Describe in your
narrative any assets that will be allocated to the start-up of the business.

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2.3.7 Financial Information and Start up Timeline


Capital Requirements
Describe the amount and type of financing you are seeking for your
business. Are you looking for debt from a lender or equity from an investor?
Refer to your start up budget and cash flow statement presented earlier.
Discuss how and when you will draw on these funds and how they will affect
the bottom line. Also describe any commitments or investments that you
may have already secured.

If you are seeking investors, such as venture capitalists, describe what they
will receive in return for their capital. What is the repayment period and the
expected return on investment? Also discuss the nature of their ownership
share and how it may change with future investments. Equity investors are
looking for rates of return higher than rates offered by banks or other
business lenders. The level of risk in your business and industry will help to
determine the actual market rate, as will the availability of equity dollars.
Check with other businesses (although not direct competitors) to see what
return on investment their investors demanded. Be prepared to negotiate.
And make sure you research the investment market carefully; several
socially minded investment pools exist and more are in development. or
lenders, describe the type of financing you are seeking:
 Seed Capital – Short-term financing to cover start-up costs.
 Fixed Asset Financing – Longer-term financing for property, building
improvements, equipment or vehicles. The asset being purchased is
usually pledged as security for the loan.
 Working Capital – Short-term financing to cover operating expenses
and to bridge gaps in cash flow.

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Initial Start-up Timeline


Provide a timeline of tasks and events necessary to get your business
operational. Be sure to describe the current stage you are in and what steps
you have taken to date. Include deadlines for task completion. Set realistic
deadlines according to your capacity to complete these tasks. The following
is a list of some of the steps you may wish to include:
 Filing legal incorporation documents
 Identifying and securing suitable space
 Designing and developing the product
 Obtaining required licenses or permits
 Securing necessary financing
 Leasing or purchasing equipment
 Hiring key staff
 Hiring and training of production or support staff
 Purchasing materials and production supplies
 Beginning marketing activities
 Opening

Although it is impossible to know exactly what will go wrong in starting and


running your business, thinking about different challenges will strengthen
your plan. Potential problems could include:
 Insufficient public subsidy available to new home owners or residents
 The competition drops its prices
 Not enough customers
 Production costs exceed estimates
 Difficulty in finding qualified employees
 Environmental or governmental changes such as tax increases,
additional regulations or population changes

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For each potential problem, discuss its likelihood and describe possible
solutions or actions you might undertake to mitigate the problem.

2.3.8 Risks and their Mitigation


Although it is impossible to know exactly what will go wrong in starting and
running your business, thinking about different challenges will strengthen
your plan.

After you have completed all of the elements of your business plan, you
should focus its presentation. A well-organized plan will assist you in
communicating the most important elements of your business plan to the
reader, and a persuasive plan will help you to convince the reader to invest
in your business.

Executive Summary
As mentioned earlier, this section should be written last. However, if you
have already written the executive summary, review it to make sure it
embodies the following characteristics. Because it is the first and possibly
the only section of the plan that many readers may see, the executive
summary should provide an overview of the plan and entice the reader to
read the whole plan or to agree to meet with you. The executive summary
should be no more than three pages and should briefly describe the most
important elements of the plan. Review the Executive Summary section of
this manual for more tips on this critical introduction to your business.

Self Assessment Questions I


State whether the following statements are True or False:
1. Clearly defined and quantifiable goals provide objective measurements
to screen potential business opportunities.
2. Through a market study one will be able to identify gaps in existing
products and services and unsatisfied demand for additional or
expanded products and services.

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3. Socioeconomic measures of customer base are concerned with age,


gender, race, religion and family size.
4. Demographic measures of customer base are based on individual or
household annual income.

2.4 Next Steps: Steps for Developing Sales Projections


Your business plan is not just a funding tool, but also a blueprint for how
your business should operate. The following are steps for developing sales
projections.

Step I:
Estimate
For each product or service, estimate the number of people who are likely to
buy and when they will buy it. You can get this information from asking your
likely customers about their possible use of your business, or you can base
your estimates on your knowledge of the market.

Step 2:
Use a Calendar
Estimate your sales and number of customers served during one week.
Using the totals for a week, make projections for each month. For the first
few months, keep in mind that business will start off slowly before people
become more aware of your business. Use will most likely increase as
people learn about your products and services. Seasonal variations may
affect your business as well. You will use these numbers to project your
equipment, supply and staffing needs, as well as income.

Cost Account Heads:


 Organizational Start up Costs
 Product Design/Development
 Research & Development

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 Legal/Licensing Expenses
 Property & Facilities
 Land/Building Purchase
 Initial Lease Deposit
 Building Repairs/Improvements
 Equipment/Machinery
 Production-related
 Administrative/Office Equip.
 Materials & Supplies
 Personnel
 Key Employees
 Contract Labour/Temps
 Training Expenses
 Marketing Expenses
 Advertisements
 Brochures/Literature/Other
 Insurance Premiums
 Distributor Contracts
 Contingency (5%)

Expenses:
Costs of Goods Sold
 Materials/Supplies
 Labor
 Rent
 Utilities
 Insurance
 Admin. Exp. (PT Sec.)
 Legal & Accounting

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 Marketing
 Equipment Maintenance/Supplies
 Facility Maintenance
 Fees/Miscellaneous

Debt / Equity Investment:


 Equipment Loan
 Building Rehabilitation Loan
 Grants
 Owner Equity

Expenses
 Cost of Goods Sold
 Wages & Benefits
 Materials
 Supplies

Overhead Expenses:
 Rent
 Utilities
 Building Maintenance/Security
 Marketing
 Accounting
 Legal
 Administrative Expense
 Interest Expense
 Depreciation

The Business Priorities are based upon six top-level objectives; these are:
 To make Business data available both to decision-makers and as much
as possible available in the public domain;

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 To ensure all holders of Business information are able to participate.


 To ensure that the data available through the NETWORK are of known
quality;
 To ensure that the NETWORK Gateway gives access to data on
Location and species used to inform decisions affecting Business at
local, regional, national and international levels;
 To promote knowledge, use and awareness of the NETWORK;
 To enhance the skills base and expertise needed to support and
develop the NETWORK.

i) The objectives have cross-cutting themes which are:


A. Infrastructure development
B. Data standards and tools
C. Capacity building
D. Working with the wider public
E. Co-ordination and promotion

i) In addition, the partners will contribute to the overall realisation of the


objectives through work that they initiate on their own account, but which
does not necessarily fall under the focussed objectives for the Network.
ii) A series of assumptions have been made in formulating the Business
Priorities and their associated work programme. These are:
 It is assumed that the present way of working, i.e. a lead partner
approach for each project will be retained;
 The plan is not intended to represent all the work that could be
undertaken;
 It is anticipated that other work towards the principal aim of adding
content and providing a fully functional gateway will be adopted by
the NETWORK as part of its programme, but this work would have to
be prioritised against this core activity and separately resourced;

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To give additional focus to the challenging nature of the task that the
NETWORK is setting itself, a series of principle drivers have been
recognised. The drivers are:
 Processes – This driver relates to facilitated targeted action on the
ground through providing knowledge of resource location, extent, pattern
of distribution, data quality and gaps. It also has the potential for
engaging more partners in the NETWORK;
 Environmental Impact Assessment (EIA) and Strategic Environmental
Assessment – This driver is concerned with providing ready access to
data on location, extent, pattern and quality of Business.
 Data contributor engagement – This driver is concerned with accessing
sources of data for the NETWORK enabling the assessment of actions
and continual improvement in the targeting of actions from the two
previous drivers;
 Operational use – This relates to the use of the NETWORK within the
day to day business of agencies as a source of data relevant to local
reporting or casework;
 Generic enhancement – This driver encompasses capacity building and
Recording Schemes and other contributing organisations and user
groups, in order to ensure the continued and enhanced supply and use
of information.

These lead naturally to three broad areas of work:


 Developing the recording network;
 Enhancing the Internet Gateway in terms of its functionality and the data
it accesses;
 Ensuring that the benefits already secured through the earlier work are
maintained.

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The plan also acknowledges the need to co-ordinate activity between the
members of the NETWORK and their partners, and to communicate the
progress and successes of the work programme.

The annex to the Business Priorities describes a recommended work plan


built upon the Business Priorities which contains criteria for the selection
of objectives, milestones against which they might be judged and
recommendations for projects.

Following the publication of Business Priorities, the Network will hold a


series of meeting, seminars and conferences to arrive at a common view of
priorities.

2.4.1 The Business Priorities


Globalised enterprises of today work with an Internet Gateway giving access
to millions of records, with published principles, tools, standards and
guidance that can be applied to Business data including their collection,
collation and mobilisation. The time has now come to extend these
successful prototypes into a fully functional operating system.

The Business Priorities are based on a reaffirmation of the joint vision of


the Promoters of the Network.

Vision:
The vision of the Network is:
 To enable people to find out about the enterprise priorities so that they
can better appreciate, understand and conserve;
 To ensure that the Network will provide the most accessible, reliable and
comprehensive source of Business information, whether locally,
regionally or nationally, to which people can turn;
 To help individuals and organisations of all kinds to contribute data and
to participate in the Network so that the information is the best available,
keeping pace with changes in wildlife.

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The Promoters of the Network will:


 Promote the recording and validation of Business information by
establishing minimum and acceptable standards of quality assurance;
 Promote the establishment and maintenance of up-to-date and
authoritative checklists of all the departments together with agreed
standards for describing their locations;
 Establish standards for the most effective and accessible forms of data
storage and promote the establishment and increased effectiveness of a
network of data custodians, and local records centres operating to
agreed minimum and acceptable standards of quality control for data
storage, access and exchange;
 Aim, in principle, to provide free access to all information available
through the Network;
 Establish standards and procedures for making information available
through the Network and to safeguard the intellectual property rights
(IPR) of those who originally made and hold that information;
 Ensure that access to sensitive information is controlled reducing the
risk of irreparable loss or damage to organisms or Locations;
 Encourage the intelligent interpretation of Business information and
make both the data and their interpretation available in an accessible
form as metadata for use in educational establishments of all kinds, or
by other users.

In the execution of these tasks, the Promoters shall assign such priorities as
seem most expedient to them in order to establish the Network as rapidly
and effectively as possible and, thereafter, to maintain it in accordance with
the vision of the Network.

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Role of the Network:


Roles in respect of the Network:
 As guardian and promoter of the vision of a national network linking the
recorders of Business information to the users of the information;
 As a participant within the Network; this largely, but not entirely, relates
to its ‘ownership’ of the Gateway and the underpinning standards of the
Network;
 As a facilitator through bringing together partners who undertake work
to develop aspects of the Network, or organising meetings at which
issues can be discussed and resolved;
 Although some aspects of the Network’s functioning are within the realm
of others, for example obtaining data and managing them, nevertheless,
the Promoters could and should act as an advisor on procedures and
protocols that might make this element of the Network more robust e.g.
by providing model licences.

Member organisations and other stakeholders will also take forward the
NETWORK’s development as part of their own remits in addition to those
elements for which the Trust is directly responsible.

2.4.2 Approach
The Strategic Review of the NETWORK is designed to move the
development programme of the NETWORK on from its initial ‘proof of
concept’ phase. This early work included:
 The identification of barriers to access with the subsequent evolution of
exchange principles, technical standards such as the use of XML and
the development of a species dictionary to enable searching based on
all known synonyms;
 Testing both the practicality and utility of mobilising Business data using
an Internet gateway;

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 Addressing some data capture and management issues including the


development of an NETWORK data model;
 Addressing issues related to the collection and collation of data by the
voluntary sector through testing and documenting the setting up and
development of Local Records Centres (LRCs), and working directly with
National Societies and Recording Schemes.

The next phase of the Network’s development builds upon this programme
and will concentrate on expanding and enhancing the Network, and on
adding content provided by an increasing assemblage of contributors in
response to user needs. Other aspects of the programme including further
development of Gateway functionality will be subservient to the need to
deliver a service based on the mobilisation of data in response to the
articulated needs of users.

2.4.3 Implementation
Scope
This section translates the aspirational targets of the previous section into a
credible and realisable work programme for the development of a functional
NETWORK based on product related targets. Broadly the work programme
can be organised into three mutually compatible elements that are required
to develop a functioning network offering universal access to Business
information. The elements differ in the degree of influence the Trust may
have upon their advancement or on the priority that might be placed upon
them if resourcing is a significant constraint.

The members have collective ownership of the Internet Gateway and,


therefore, are able to influence directly both the scope and speed of its
development. Many of the Trust’s members are using their Intranet
capability to deliver information to operational staff: the NETWORK Gateway

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is seen as an integral part of this service, which tends to raise the priority
members place upon the development of this service by the Trust.

The activities also have a general public benefit that is as yet


underdeveloped. Easy access to Business information has obvious uses in
education both formal and informal. These benefits will become more
apparent as the range of data available increases; nevertheless, it is
possible to develop exemplars of these types of use linked to messages
related to the principle drivers.

Assumptions
Presumptions have not been made as to which member or members of the
Network might adopt parts of the plan, nor have costs been assigned to
particular outputs as all these variables will depend on which partner(s) take
forward the individual elements of the plan. Nevertheless, the work
programme presents a set of benchmarks for the development of the core
elements of the NETWORK over the next three years. The milestones
assigned to the recommended actions are generic in nature and eventually
will be reflected in the individual projects developed to realise the work
programme. In developing the work programme the following assumptions
have been made:
 It is assumed that the present way of working, i.e. a lead partner
approach for each project will be retained;
 The plan is not intended to represent all the work that could be
undertaken;

 It is anticipated that other work toward the principal aim of adding


content and providing a fully functional gateway will be adopted by the
Network as part of its programme, but this work would have to be
prioritised against this core activity and separately resourced;

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2.4.4 Developing the Recording Network


The sustainable development of the NETWORK is inevitably predicated
upon the continuing activity of the voluntary recorders and the organisational
mechanisms that support them. The continued development of the Network
will depend on partner organisations having the capacity to respond to the
new challenges and opportunities arising from the evolving NETWORK. The
Network will also have to assist in ensuring that recording skills are not lost,
and if possible that they should be enhanced. Furthermore, the present
recorder population must be sustained by encouraging others to participate
and ensuring that the required training and support is available. It should
also be made easier to lodge records locally for use by all. In part, this will
have to involve an outreach programme designed to make the general
population aware of biological records, recording, and the role of the
NETWORK and the part they might play in its development. It will also entail
the promotion of a national system of nodes that facilitates biological
recording and access to records of known documented quality.

Gateway
The principal target for the development of the Internet Gateway is the
addition of content. The addition of content has hitherto been largely
serendipitous; dependent upon availability, format, quality etc. but with little
attention to the articulated needs of users. Broadly the requirement is to
gain access to geospatially-referenced species and Location data in
response to the principal drivers identified above, but there will also be a
need to react to new opportunities. To meet these changing needs, a set of
criteria are required against which new opportunities can be assessed.

Securing the Benefits


The proof of concept programme has already provided ‘gains’ through the
development of principles, standards, guidance, the development of an
Internet Gateway delivering access to over 10 million species records and a

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species dictionary as an aid to searching. These benefits will be secured


through a programme of revision, updating and maintenance designed to
incorporate new data, meet new technical standards and the evolving needs
of the Network.

2.4.5 Co-ordination and Promotion


Co-ordination
Once established, the Business Priorities will be reviewed and updated
annually. This will require some modification of the present structure and
working practices of the NETWORK.

The plan is dependent upon co-ordination of the NETWORK work


programme. Overall direction and co-ordination shall continue to remain the
responsibility of the Promoters. Partners will continue to fund the co-
ordination and steering of the plan through their financial support of the
Secretariat of the Network but additional funds will be required as both the
work programme and Network grow.

The Secretariat of the Network will ensure co-ordination and revision of the
Business Priorities through servicing of committees and groups as
required. It will prepare annually a summarised assessment subsequent to
the meetings of the review/steering committees and scrutiny of their reports.
Once approved by the PROMOTERS, the annual summary will be made
available to all members of NETWORK.
 The core functions of the Secretariat are:
 To support the Promoters and Chairman;
 To ensure adherence to jointly agreed objectives;
 To resolve conflicting priorities;
 To ensure integration across work themes and to identify gaps;
 To lead in the promotion of the NETWORK;
 To review progress and forward planning;

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 To raise awareness of the NETWORK with other initiatives /users and to


act as a channel for liaison;
 To liaise with funders;
 To seek and secure extra funding for the development of the network;
 To ensure continuing support of the Network by members;
 To ensure the maintenance of NETWORK core functions;
 To maintain the accounts.

Communication
The need to communicate effectively underlies the whole work programme.
There is a need to communicate with and between projects, to communicate
between partners in the NETWORK, with funders and, above all, with those
outwith the NETWORK to encourage them to use the service and participate
in it. Each project has a need to communicate either to enhance its
understanding of issues or to make others aware of its successes. This
might be achieved by the development of examples of operational use, or
special interfaces with the NETWORK.

The Secretariat has a special responsibility for communication, which it will


discharge through the use of newsletters, its web site and by organising
special events such as conferences.

Resourcing Strategy
‘In the absence of any external funding being attracted, the members would
need to redefine their immediate objectives and plan to implement all or part
of the Business Priorities using their own resources. This would
doubtlessly require a scaling down of the plan and difficult internal funding
decisions.

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2.5 The Work Programme


This section builds upon the previous sections to develop the framework of
an actual work programme to carry forward the vision. Possible projects
within this programme are presented in the form of a standardised
framework that identifies in the first instance a series of selection criteria to
be applied to specific projects. It is not intended that all NETWORK badged
projects should meet all the criteria, but that they might provide a method for
deciding upon the priority of projects competing for a finite resource.
Milestones are also suggested that will give a framework against which
specific project progress can be judged. The milestones are not intended to
provide a timeline for projects as it is often the case that different aspects of
a project progress concurrently or that failure to achieve a specific output
does not prevent a project from progressing. A recommended list of specific
projects is also presented for discussion.

It is the nature of the NETWORK development process and resourcing that


not all of the suggested projects may be picked up by lead partners and that
others of a similar nature may emerge that fit more closely the internal
agendas of Trust partners. Nevertheless, the work plan presented in this
document gives a basis upon which the NETWORK as a whole can evolve
to meet the Trust’s principle.

2.5.1 Developing the Network


The capacity of partner organisations in the NETWORK to contribute data
on an ongoing basis is identified above as a key work area. This will
include their internal capacity to carry on the work of gathering relevant
data; their capacity to manage those data; and in particular their capacity to
continue to make their data available through the NETWORK Gateway.

For the purposes of this plan, these supplier organisations are broken down
into three main groups:

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 Local data-gathering institutions and professionally run organisations


(e.g. local records centres);
 Voluntary recording schemes;
 Business organisations.

The role of the Network in delivering this work is seen as one of ‘facilitator’,
but its role in relation to each principal group will be different.

2.5.2 Local Data Sources


The following selection criteria will be applied:
 Active local source of managed local data;
 Requirement defined by relevant Network partners’ strategic
publications.

The following milestones will be used to assess progress:


1. Local partnership in place including representation from Network
member organisations where possible;
2. Adequate resourcing in place;
3. Business Plan developed that indicates intention to become active
member of NETWORK sharing data with others;
4. Catalogue of data holdings;
5. Active data quality management;
6. Access policy in place that conforms to NETWORK principles;
7. Accessing and delivering data through the NETWORK;
8. Providing service to users;
9. Actively working with local recorders and other local data managers
to encourage and support all aspects of local recording and promote
the efficient management and supply of data.

Recording schemes:
The following selection criteria will be applied:
 Subject covered of high/moderate priority for policy etc.;

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 Some current data potentially available for early mobilisation;


 Data management skills sufficiently well developed to enable early
engagement;
 Volunteer base sufficiently organised and/or motivated to take part;
 Organisation open to/ready for further development;
 Potential for partnership working with other organisations/schemes.

The following milestones will be used to assess progress:


1. Enhanced capacity of voluntary organisation through development of
their own business plan;
2. Catalogue of data holdings and development of metadata
documentation;
3. Mobilisation of data;
4. Engagement with membership to facilitate maintenance and use of
available data;
5. Achievement of basic generic funding for prioritised data backlog
computerisation;
6. Increased public access to data

Data Access:
Species:
The following selection criteria will be applied:
 Relevance to the key drivers;
 Priority operational need;
 Existing quality datasets;
 Existing activity including good geographical coverage;
 Building on existing initiatives;
 Datasets ‘at risk’ of being lost;
 Proxy species – relate to other Location/species;
 Quick wins.

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Suggested milestones for the addition of data:


1. Rapid access to all relevant quality datasets from ‘all’ sources in a
transparent and neutral way;
2. Completed analysis of data e.g. coverage, duplication, strengths etc.;
3. Completed advocacy and application across sectors;
4. Capacity building amongst recorders where required;
5. Revision of delivery methods;
6. Partnership forming and development to ensure update of data and
addressing any significant gaps;
7. Update/gap filling.
Location data:
The following selection criteria would be applied:
 Mapped datasets preferably available as polygons or methods that
enable them to be produced;
 Accessibility;
 Relevance to key drivers;
 Threat;
 Motivation of candidate partners where already have comprehensive
inventory in existence;
 Comprehensive inventory;
 Capable of cross validation with species datasets (see above);
 Fit into broad Location classification;
 NETWORK ability to report using boundary systems of users;
 Quick Wins.
Suggested milestones for the addition of Location inventory data
1. Thematic partnership with identified champion in place;
2. Completed analysis of data available resulting in methodology and
standards for cost effective integration;
3. Feasibility of method tested;

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4. Revision of delivery methods;


5. Collation (regionally based) that integrates the regional and national
sources;
6. Update/gap filling.

Regional Projects (phased NETWORK growth)


The following selection criteria would be applied:
 Measured increase of new local providers;
 New challenges for the National Business Network;
 Activity in each country;
 Different socio-economic ‘regions’/culture.

The following milestones will be used to assess progress:


1. Develop a partnership of national organisations with regional
representatives;
2. Identify key local data requirements;
3. Identify the relevant datasets to meet the requirements and analyse for
duplication, gaps, etc.;
4. If required, address the shortfalls in data collection, collation, and
mobilisation by whatever local or national mechanisms is most (cost)
effective;
5. Contribute to thematic projects;
6. Apply species and Location datasets available through the NETWORK
with the local datasets to enhance local decision making;
7. Options for revision of the delivery mechanism.

Maintaining the network (All Themes):


The following selection criteria would be applied:
 New technical opportunity;
 Improvement in service provision allied to principle drivers;
 Enhancement of participation.

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The following milestones will be used to assess progress:


1. Scoping study completed;
2. Development completed;
3. Testing completed;
4. Transfer to active system.

Recommended further technical development:


 Development of search engine;
 Introduce system/server redundancy to meet higher service standards;
 Phase in dispersed network architecture;
 Roll out data management skills to partners;
 Roll out necessary IT skills to NETWORK partners;
 Roll out use related skills to partners;
 Development of searching at higher taxonomic levels;
 Enhanced casework/local data screening.

Project Management:
 Each theme will be taken forward by a project or series of projects
dependent upon its complexity. Co-ordination and management will be
achieved for each theme by working groups of active contributors or
funders.
 The membership of each working group shall normally not exceed six
members together with an independent chairman who shall not actively
participate in the group’s projects. Members shall be confined to those
who are either involved in and fund, at least in part, the working group’s
approved projects or contribute in other ways to the group’s approved
projects.
 Each working group shall determine its own modus operandi, which
shall be reported to and approval sought from the PROMOTERS.

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 The duties of each working group shall be to plan, promote and


participate in the projects proposed by the group, approved by the
reviewing group within its relevant theme, and the Promoters.

Annually they shall submit:


 A report on the progress of the projects carried out during the year
together with an indication of how far they have met the approved plan
 A proposed work schedule for future work to include projects with
milestones and details of funding available as required to the relevant
annual review group for comment, discussion and forwarding to the
Promoters for their consideration.

Theme Review:
 Each theme will be reviewed annually and its report considered at a
specific meeting.
 Duties in respect to this review shall be:
 To receive a report from its working group(s) on the progress of the
previous year’s theme work programme
 To receive a proposed work schedule for future work to include
projects with milestones and details of funding available
 To identify gaps and decide how these might be filled
 All members of the working group under review may attend the review
meeting together with such individuals as have a direct or related
interest in the theme. Each review shall be convened by the Programme
Director and shall always include one Trustee.

Promoters’ Approval
 In the light of due discussion of both the proposals and their subsequent
reviews the review group shall forward these reports to the Promoters as
a draft summary plan prepared by the secretariat for their consideration,

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ratification and if need be resolution. It will be a requirement that the


Promoters approve any formal plans or review recommendations.
 Promoters may require further discussion with the chairman of any
working group, but once Promoters have approved the summary plan,
working groups will be free to go ahead with their proposals. Their first
task will be to set immediate (1-year) targets that work toward the
aspirational targets.
 The summary business plan will be made available to all members of
NETWORK.

To accommodate this procedure, it will be necessary to devote one meeting


a year as a business plan review meeting. It may therefore be necessary to
increase the number of meetings of the PROMOTERS, but this is for further
consideration as well as the timing of the review procedure.

Self Assessment Questions II


State whether the following statements are True or False:

1. The strategic review of the NETWORK is designed to move the


development programme of the NETWORK on from its initial ‘proof of
concept’ phase.
2. The continued development of the Network will depend on partner
organisations having the capacity to respond to the new challenges and
opportunities arising from the evolving NETWORK.
3. The principal target for the development of the Internet Gateway is the
addition of content.

4. Once established, the Business Priorities need not be reviewed and


updated.

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2.6 Summary
 A well-written business plan will serve as a guide through the start-up
phase of the business. It establishes benchmarks to measure the
performance of your business venture in comparison with expectations
and industry standards.
 The first step in planning a new business venture is to establish goals
that you seek to achieve with the business.
 If one fails to establish clear goals early in the process, the organization
may spend substantial time and resources pursuing potential business
ventures that may be financially viable but do not serve the mission of
the organization in other important ways.
 It is also important to establish a timeline for completing the plan.
 A good business plan should contain the following sections:
 Executive summary
 Company and product description
 Market description
 Operations
 Management and ownership
 Financial information and timeline
 Risks and their mitigation
 A solid business plan will clearly explain the business concept, describe
the market for the product or service, attract investment, and establish
operating goals and guidelines.
 The business plan is not just a funding tool, but also a blueprint of how
the business should operate.

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2.7 Terminal Questions


1. Explain the meaning of a business plan.
2. Give examples of goals that are sought to be achieved through the
creation of a new business venture.
3. Explain various sections of a business plan.
4. Explain the steps for developing sales projections.

2.8 Answers to SAQs and TQs


SAQs I
1. True
2. True
3. False
4. False

SAQs II
1. True
2. True
3. True
4. False

Answers to TQs:
1. Refer to 2.2
2. Refer to 2.2
3. Refer to 2.3
4. Refer to 2.4

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Unit 3 Harnessing Complexity – Creativity


in Business and a Favourable
Investment Strategy
Structure:
3.1 Introduction
Objectives
3.2 What is a Complex System?
3.3 Complex Systems Behaviour
3.4 Lessons for Business
3.5 Creativity
3.5.1 Best Creative Exercise Ever
3.5.2 A Simple Creative Exercise
Self Assessment Questions I
3.6 Summary
3.7 Terminal Questions
3.8 Answers to SAQs and TQs

3.1 Introduction
In the rapidly changing world of global markets, e-commerce and the
internet, the secrets of Complex System evolution provide a basis on which
to reflect on the management of our businesses. Insights gained from
Complex Systems thinking suggest that freedom and creativity count more
than cost reduction and efficiency, as these provide the foundations for
learning and change.
Today, businesses and organizations must deal with the production and
delivery of increasingly complex products and services in a rapidly changing
and uncertain environment. This raises questions concerning the
effectiveness of traditional management methods – focussed on efficiency

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and strategic planning and control – in generating successful companies


capable of flourishing in this new environment. The need to adapt, change
and be creative is crucial today, and it is therefore vital to understand how
companies can achieve this. Survival, in this brave new world, requires that
we learn how to bring about self-transformation, adaptation and change in
ourselves and in our organizations, as this is where we can harness the
insights that have come from recent research into the behaviour of Complex
Systems.

This unit deals with Complex Systems behaviour.

Objectives:
After studying this unit, you will be able to:
 Explain the meaning of a Complex System.
 Describe Complex Systems behaviour.
 Explain the concept of creativity in business.

3.2 What is a Complex System ?


A Complex System is a system that has more than one possible future. In
other words, it is ‘free’ enough to take more than a single pre-determined
path into the future, and therefore cannot be purely ‘mechanical’. Clearly, we
are all complex systems by this definition, and so are the organizations,
communities, economic sectors, regional economies, ecologies and global
systems to which we belong and interact with. Indeed, mechanical systems
really only exist as abstractions in our minds, and the systems we inhabit
and try to manage are not mechanical. Yet all our science and our way of
thinking about problems is based on the assumption that a company or
organization comprises a set of functional components with connecting
flows of goods and information. In this view, better management is often
seen as simply running the ‘machine’ faster or more efficiently.

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But that was when life was simple and the ‘product’ or ‘service’ to be
produced and delivered only needed to be made at a competitive cost with
adequate quality. Today, we must constantly create new products and
services, with additional and novel attributes, and this creative, adaptive
capacity will be more important to our survival than our level of efficiency,
particularly if, as Complex Systems thinking suggests, efficiency reduces
creativity.

Traditionally, decision making and strategy have been based on a rational


set of assumptions such as:
 We know our options.
 We know and can evaluate the (single) outcome of implementing each
of them.
 We can ignore effects that we do not know.
 The environment in the future ‘after’ the decision is known.
 There was a situation ‘before’ our decision, and that there will be a
situation ‘after’ our decision, and that we can therefore examine the
differences between them.

Such reflections are typical of a cost/benefit analysis, for example, by which


the outcomes of different possible decisions are compared. Yet, in a world
of rapid change and uncertainty, the assumptions relied upon by this kind of
‘reasonable’ behaviour are simply not true. In reality, we do not necessarily
know all our options, the path the system may take, the possible dimensions
that might be affected by resulting changes, or how circumstances may
have changed in the mean time. In short, our view of our organisation as a
machine, sitting in a fixed or at any rate predictable environment, is totally
inadequate. We must instead turn to new ideas - we must harness the ideas
arising from Complex Systems.

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3.3 Complex Systems Behaviour


In studying Complex Systems, initially in physics and chemistry, it became
clear that the key properties of ‘open’ systems, where flows of matter,
energy and information can occur across their boundaries, were that they
could undergo spontaneous transformations of structure and functionality.
Instead of a ‘fixed’ mechanical system, this showed how systems came into
being, and evolved over time, changing structurally, gaining, and sometimes
shedding, complexity and qualities.

The study of Complex Systems therefore revealed a co-evolutionary


process of a system and its environment in which successive change and
adaptation each involved two separate steps:
 Discovering what to do (exploration and evaluation).
 Doing what has been decided (implementation).

And these two steps are radically different in nature.


In Complex Systems, the first step is ‘taken’ by the ‘non-average’ underlying
elements within the system, while the second – the emergence of a
transformed, functioning system – concerns new, effective ‘average’
behaviour of the elements. The successful co-evolution of a system with its
environment therefore occurs through the dynamic interplay of the average
and non-average behaviours within it. Successive instabilities occur each
time that existing structure and organisation fail to withstand the impact of
some new circumstance or behaviour. When this occurs, the system re-
structures and becomes a different system, subjected in its turn to the
disturbances from its own non-average individuals and situations. It is this
dialogue between successive ‘systems’ and their own inner ‘richness’ that
provides the capacity for continuous adaptation and change.

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3.4 Lessons for Business


Clearly, these two steps will seem obvious to anyone running a business -
firstly, we work out what product or service we think will succeed, and then
organise a system to produce and deliver it as efficiently as possible. In a
world of slowly changing markets and fixed technologies, this could be
undertaken once, or very infrequently, and the system optimised. However,
in our world of fast-changing markets, competitors and technologies, there is
a constant need to keep revising and updating knowledge and information
about possible markets, customer needs and technical possibilities.

Step 1 requires that we explore the possibilities in order to discover possible


options and decide from them what to do. We need to be good at ‘going
beyond’ present knowledge and wandering into undiscovered territory. But,
in order to perform step 2 successfully, we need to execute what has been
decided as efficiently and fast as possible, avoiding any unnecessary waste.
This requires rational analysis to obtain mechanical and economic
optimisation.

The qualities required for Step 1 are the freedom and ability to move into
uncharted territory and have new thoughts, while those required for Step 2
are the ability to make and act upon rational analyses of the processes and
costs of the system but these are opposite qualities. And, not only that,
pressure for greater measurable accountability, short term share-holder
value and the increasing use of IT makes it increasingly more difficult to
protect the presence of the qualities required for Step 1 against the simpler,
more easily measured qualities for Step 2. Yet without Step 1, there can be
no Step 2.

Imagination and creativity must precede efficiency of execution. Complex


Systems models and simulations demonstrate the truth of this statement,
showing the role of individual diversity in Step 1 creativity and exploring the

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circumstances which may require more or less focus on Step 1 or Step 2


qualities. Study the following to have a clear idea regarding this:

Aerospace Design Process


A current piece of research concerns the way in which new knowledge
and technology is explored in creating a very complex product such as
a new aeroplane. Part of the technology budget is specifically allocated
to a free exploration of ideas by young technologists in the group.
There are prizes for success and bidding rounds for further support.
They are allowed to talk freely to suppliers if this is important. Precise,
detailed accountability is not applied to this exercise, but instead the
judgement of the Head of Technology is confirmed through the overall
long-term capacity of the section to deliver new technology when
required. This company has a long and successful history in this highly
competitive and innovative sector.

The Prato District Network in Italy


Just 15 km from Florence, the small Prato District encompasses one of
the largest concentrations of textile manufacturing in Europe. There are
over 8,000 companies, employing 44,000 people, with production of
$4.5 billion. Activity here dates back 1,000 years and this long evolution
has led to this adaptable social network, founded on long-term social
relationships, that allows them to respond more rapidly than
competitors to the uncertain and changing fashion market.

Complex Systems thinking provides a framework that can inform every


aspect of business management, linking research, development, concept
and design with imaginative market exploration, human resources
management, and overall business strategy and identity. It concerns the

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complete ‘knowledge dynamics’ that drives the company - right through the
creation, evaluation, selection, implementation and discarding of knowledge.
It demonstrates that this is the power behind the competitiveness of new
growth companies and indicates how it can be adopted by businesses and
by whole business networks.

Ultimately, the creativity and imagination of a business will come from the
dynamic interaction of diverse individuals. These individuals that create new
ideas and value may be within one company, but often will span several
within the network, giving rise to winning clusters of activity, capable of
evolving faster than their rivals.

Complex Systems thinking also informs us how to achieve a high rate of


delivery of new products and services and rapid adaptation to changing
conditions. Instead of designing and planning products and services as a
‘top-down’ exercise through a captive ‘supply chain’, the models of self-
organising networks provide an alternative view. Here, products emerge as
the result of a changing pattern of collaboration of a network of suppliers,
both competing and co-operating, each expert in its own domain. The
network is characterised by long-term relationships between nodes, but
does not always require the same partners to be involved all the time.
Different nodes can rapidly come together or separate for the production
and delivery of different things.

In the rapidly changing world of global markets, e-commerce, evolving tele-


communications and internet, the secrets of Complex System evolution offer
us a basis on which to reflect on the management of our businesses.

They tell us not to allow optimisation on any single criteria (e.g. cost
minimisation) and to provide freedom and resources to those parts of the
business that must be creative, while regulating closely those parts that are
purely bureaucratic. Making sure that designs and decisions are always

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debated among a diverse group of individuals, and that different


perspectives are discussed and examined, we need to encourage people to
express their individual views and differences and to have enough self-
confidence to question their present activity and knowledge. Allowing
exploration and experiment means tolerating ‘failure’ and being open to new
ideas requires an atmosphere of confidence and trust, which in turn requires
a long-term social relationship. The insights coming from Complex Systems
thinking tell us that such things matter more than cost reduction and
efficiency, as they provide the basis for a sustainable adaptive capacity for
learning and change.

3.5 Creativity
Everyone in business is creative.
Some of most creative people are in manufacturing.
They actually CREATE products that change the world.
Some of the least creative people perhaps are in advertising.
They spend most of their creative energy telling manufacturers that
they…aren’t creative!
Salespeople Are Creative – They are natural born story-tellers.
Accountants are creative.

3.5.1 Best Creative Exercise Ever


Write down your ideas.
You have a ton every day.
But most of the time, you can’t remember them by the day’s end.
Don’t let spelling and grammar issues or relentless self-editing stop you.
Get your ideas on paper (Let someone else edit it.)
Go retro: Carry a notebook, pen, and calendar into your meetings.
Look up at people.

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Story First, Technology Last.


Don’t invest in a presentation class called “How to Use PowerPoint”….
…until you’ve taken a class called “How to Tell Stories and Connect with
Your Audience”.

3.5.2 A Simple Creative Exercise…


Simplify everything. Your life, your home, your office, your desk, your
processes, vision, policy, procedures. Everything.

Fixing Problems is Creative.


Your job is to fix problems, not to complain.

Brainstorming
Don’t tell people that their ideas are bad, especially if you don’t have a
better one.

It’s only your life’s work.


Never say, “It’s not my job to be creative.”

How to Lose an Audience…


 Show your audience slides with columns of numbers.
 Refuse to tell them a story about the meaning of the numbers.
 Do not read your speech or presentation.
 Instead, read your audience.

How about a Show?


Try “giving a performance” instead of merely “giving a presentation.”

Everyone in Sales Knows…


 Tell stories.
 Don’t just provide data.

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Avoid Meetings.
Do not attend more than two meetings a day, or else you will never get any
real creative work done.

Get Fresh Ideas.


Leave the office building at least once a day.

Another Lame Excuse…


Designers should put more of their passion into designing great work,
instead of endless (boring) discussions about the superiority of the
Macintosh over the PC!

The Lame Excuse …


“I can’t [write/design/create] because I don’t have the latest
[software/hardware/ upgrade]….”
You can’t let a machine take credit for your creativity.
And you can’t blame a machine for your creative failures, either.

Don’t Blame the Tool!


The more you become a master of your particular creative form….
….the fewer tools you will use.
Master carpenters use fewer tools than novices.
So do cooks.
Use what works.

Creativity: Use it or Lose it.


Create something every day.
Creativity takes place every day, not once in a while.
It’s not rare.
It’s just been mystified - Own your creativity.

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Facts and observations


Giga-investments made in the paper and pulp industry, in the heavy metal
industry and in other base industries, today face scenarios of slow growth
(2-3 % p.a.) in their key markets and a growing over-capacity in Europe.
The energy sector faces growing competition with lower prices and cyclic
variations of demand.
Productivity improvements in these industries have slowed down to 1-2 %
p.a .
Global financial markets make sure that capital cannot be used non-
productively, as its owners are offered other opportunities and the capital
will move (often quite fast) to capture these opportunities.
The capital markets have learned “the American way”, i.e. there is a
shareholder dominance among the actors, which has brought (often quite
short-term) shareholder return to the forefront as a key indicator of success,
profitability and productivity.
There are lessons learned from the Japanese industry, which point to the
importance of immaterial investments. These lessons show that investments
in buildings, production technology and supporting technology will be
enhanced with immaterial investments, and that these are even more
important for re-investments and for gradually growing maintenance
investments.
The core products and services produced by giga-investments are
enhanced with life-time service, with gradually more advanced maintenance
and financial add-on services.
New technology and enhanced technological innovations will change the life
cycle of a giga-investment.

Technology providers are involved throughout the life cycle of a giga-


investment.

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Giga-investments are large enough to have an impact on the market for


which they are positioned:
A 3,00,000 ton paper mill will change the relative competitive positions;
smaller units are no longer cost effective.
A new teechnology will redefine the CSF:s for the market.

Customer needs are adjusting to the new possibilities of the giga-


investment.
The proposition that we can describe future cash flows as stochastic
processes is no longer valid; neither can the impact be expected to be
covered through the stock market.

Types of options
 Option to Defer
 Time-to-Build Option
 Option to Expand
 Growth Options
 Option to Contract
 Option to Shut Down/Produce
 Option to Abandon
 Option to Alter Input/Output Mix

Table of Equivalences:
INVESTMENT OPPORTUNITY VARIABLE CALL OPTION
Present value of a project’s operating S Stock price.
cash flows.
Investment costs X Exercise price
Length of time the decision may be t Time to expiry.
deferred.
Time value of money. rf Risk-free interest rate
Risk of the project. σ Standard deviation of
returns on stock

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Fuzzy numbers (fuzzy sets) are a way to express the cash flow estimates in
a more realistic way.

This means that a solution to both problems (accuracy and flexibility) is a


real option model using fuzzy sets.

Self Assessment Questions I


State whether the following statements are True or False:
1. The people involved in manufacturing actually create products that
change the world.
2. In the rapidly changing world of global markets, e-commerce, evolving
tele-communications and internet, the secrets of Complex System
evolution offer us a basis on which to reflect on the management of our
businesses.
3. Complex Systems thinking informs us how to achieve a high rate of
delivery of new products and services and rapid adaptation to changing
conditions.
4. The creativity and imagination of a business will come from the dynamic
interaction of diverse individuals.
5. Efficiency of execution must precede imagination and creativity.

3.6 Summary
Complex System is a system that has more than one possible future. In
other words, it is ‘free’ enough to take more than a single pre-determined
path into the future, and therefore cannot be purely ‘mechanical’.

Complex Systems thinking provides a framework that can inform every


aspect of business management, linking research, development, concept
and design with imaginative market exploration, human resources
management, and overall business strategy and identity.

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Complex Systems thinking also informs us how to achieve a high rate of


delivery of new products and services and rapid adaptation to changing
conditions.

3.7 Terminal Questions


1. What is meant by Complex System?
2. What are the assumptions on which decision making and strategy have
been based on traditionally?
3. Describe the Complex Systems behaviour.
4. “Everyone in business is creative.” Do you agree with this statement?

3.8 Answers to SAQs and TQs


SAQs I
1. True
2. True
3. True
4. True
5. False

Answers to TQs:
1. Refer to 3.2
2. Refer to 3.2
3. Refer to 3.3
4. Refer to 3.5

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Unit 4 Business Continuity Plan


Structure:
4.1 Introduction
Objectives
4.2 Purpose of Business Continuity Plan
4.2.1 Key Words
4.2.2 Terminology
Self Assessment Questions I
4.3 Practice Advisory – Part One
4.3.1 Developing the Plan
4.4 Practice Advisory – Part Two
4.4.1 Implementing and Maintaining the Plan
4.5 Check List
Self Assessment Questions II
4.6 Summary
4.7 Terminal Questions
4.8 Answers to SAQs and TQs

4.1 Introduction
The Business Continuity Guideline is a tool to allow organizations to
consider the factors and steps necessary to prepare for a crisis (disaster or
emergency) so that it can manage and survive the crisis and take all
appropriate actions to help ensure the organization’s continued viability. The
advisory portion of the guideline is divided into two parts: (1) the planning
process and (2) successful implementation and maintenance. Part One
provides step-by-step Business Continuity Plan preparation and activation
guidance, including readiness, prevention, response, and recovery/
resumption. Part Two details those tasks required for the Business
Continuity Plan to be maintained as a living document, changing and
growing with the organization and remaining relevant and executable.

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Objectives:
After studying this unit, you will be able to:
 Explain what a Business Continuity Plan is.
 Explain the purpose of Business Continuity Plan.
 Give the meaning of key words and terminology used in connection with
Business Continuity Plan.
 Describe how a Business Continuity Plan is developed and
implemented.

4.2 Purpose of Business Continuity Plan


Recent world events have challenged us to prepare to manage previously
unthinkable situations that may threaten an organization’s future. This new
challenge goes beyond the mere emergency response plan or disaster
management activities that we previously employed. Organizations now
must engage in a comprehensive process best described generically as
Business Continuity. It is no longer enough to draft a response plan that
anticipates naturally, accidentally, or intentionally caused disaster or
emergency scenarios.

Today’s threats require the creation of an on-going, interactive process that


serves to assure the continuation of an organization’s core activities before,
during, and most importantly, after a major crisis event.

In the simplest of terms, it is good business for a company to secure its


assets. CEOs and shareholders must be prepared to budget for and secure
the necessary resources to make this happen. It is necessary that an
appropriate administrative structure be put in place to effectively deal with
crisis management. This will ensure that all concerned understand who
makes decisions, how the decisions are implemented, and what the roles
and responsibilities of participants are. Personnel used for crisis

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management should be assigned to perform these roles as part of their


normal duties and not be expected to perform them on a voluntary basis.
Regardless of the organization – for profit, not for profit, faith-based, non-
governmental – its leadership has a duty to stakeholders to plan for its
survival. The vast majority of the national critical infrastructure is owned and
operated by private sector organizations, and it is largely for these
organizations that this guideline is intended. ASIS, the world’s largest
organization of security professionals, recognizes these facts and believes
the BC Guideline offers the reader a user-friendly method to enhance
infrastructure protection.

4.2.1 Key Words


Business Continuity Plan, Business Impact Analysis, Crisis Management
Team, Critical Functions, Damage Assessment, Disaster, Evaluation and
Maintenance, Mitigation Strategies, Mutual Aid Agreement, Prevention,
Readiness, Recovery/Resumption, Resource Management, Response, Risk
Assessment, Testing and Training.

4.2.2 Terminology
Alternate Worksite – A work location, other than the primary location, to be
used when the primary location is not accessible.

Business Continuity – A comprehensively managed effort to prioritize key


business processes, identify significant threats to normal operation, and
plan mitigation strategies to ensure effective and efficient organizational
response to the challenges that surface during and after a crisis.

Business Continuity Plan (BCP) – An ongoing process supported by


senior management and funded to ensure that the necessary steps are
taken to identify the impact of potential losses, maintain viable recovery
strategies and plans, and ensure the continuity of operations through
personnel training, plan testing, and maintenance.

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Business Impact Analysis (BIA) – A management level financial analysis


that identifies the impacts of losing an organization’s resources. The
analysis measures the effect of resource loss and escalating losses over
time in order to provide reliable data upon which to base decisions on
mitigation, recovery, and business continuity strategies.

Contact List – A list of team members and key players in a crisis. The list
should include home phone numbers, pager numbers, cell phone numbers,
etc.

Crisis – Any global, regional, or local natural or human-caused event or


business interruption that runs the risk of (1) escalating in intensity,
(2) adversely impacting shareholder value or the organization’s financial
position, (3) causing harm to people or damage to property or the
environment, (4) falling under close media or government scrutiny,
(5) interfering with normal operations and wasting significant management
time and/or financial resources, (6) adversely affecting employee morale, or
(7) jeopardizing the organization’s reputation, products, or officers, and
therefore negatively impacting its future.
Crisis Management – Intervention and co-ordination by individuals or
teams before, during, and after an event to resolve the crisis, minimize loss,
and otherwise protect the organization.
Crisis Management Center – A specific room or facility staffed by
personnel charged with commanding, controlling, and coordinating the use
of resources and personnel in response to a crisis.
Crisis Management Planning – A properly funded ongoing process
supported by senior management to ensure that the necessary steps are
taken to identify and analyze the adverse impact of crisis events, maintain
viable recovery strategies, and provide overall coordination of the
organization’s timely and effective response to a crisis.

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Crisis Management Team – A group directed by senior management or its


representatives to lead incident/event response comprised of personnel
from such functions as human resources, information technology facilities,
security, legal, communications/media relations, manufacturing,
warehousing, and other business critical support functions.

Critical Function – Business activity or process that cannot be interrupted


or unavailable for several business days without having a significant
negative impact on the organization.

Critical Records – Records or documents that, if damaged, destroyed, or


lost, would cause considerable inconvenience to the organization and/or
would require replacement or recreation at a considerable expense to the
organization.

Damage Assessment – The process used to appraise or determine the


number of injuries and human loss, damage to public and private property,
and the status of key facilities and services resulting from a natural or
human-caused disaster or emergency.

Disaster – An unanticipated incident or event, including natural


catastrophes, technological accidents, or human-caused events, causing
widespread destruction, loss, or distress to an organization that may result
in significant property damage, multiple injuries, or deaths.

Disaster Recovery – Immediate intervention taken by an organization to


minimize further losses brought on by a disaster and to begin the process of
recovery, including activities and programs designed to restore critical
business functions and return the organization to an acceptable condition.

Emergency – An unforeseen incident or event that happens unexpectedly


and demands immediate action and intervention to minimize potential losses
to people, property, or profitability.

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Evacuation – Organized, phased, and supervised dispersal of people from


dangerous or potentially dangerous areas.

Evaluation and Maintenance – Process by which a business continuity


plan is reviewed in accordance with a predetermined schedule and modified
in light of such factors as new legal or regulatory requirements, changes to
external environments, technological changes, test/exercise results,
personnel changes, etc.

Exercise – An activity performed for the purpose of training and


conditioning team members and personnel in appropriate crisis responses
with the goal of achieving maximum performance.

Mitigation Strategies – Implementation of measures to lessen or eliminate


the occurrence or impact of a crisis.

Mutual Aid Agreement – A pre-arranged agreement developed between


two or more entities to render assistance to the parties of the agreement.

Prevention – Plans and processes that will allow an organization to avoid,


preclude, or limit the impact of a crisis occurring. The tasks included in
prevention should include compliance with corporate policy, mitigation
strategies, and behavior and programs to support avoidance and deterrence
and detection.

Readiness – The first step of a business continuity plan that addresses


assigning accountability for the plan, conducting a risk assessment and a
business impact analysis, agreeing on strategies to meet the needs
identified in the risk assessment and business impact analysis, and forming
Crisis Management and any other appropriate response teams.

Recovery/Resumption – Plans and processes to bring an organization out


of a crisis that resulted in an interruption. Recovery/resumption steps should
include damage and impact assessments, prioritization of critical processes

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to be resumed, and the return to normal operations or to reconstitute


operations to a new condition.

Response – Executing the plan and resources identified to perform those


duties and services to preserve and protect life and property as well as
provide services to the surviving population. Response steps should include
potential crisis recognition, notification, situation assessment, and crisis
declaration, plan execution, communications, and resource management.

Risk Assessment – Process of identifying internal and external threats and


vulnerabilities, identifying the likelihood of an event arising from such threats
or vulnerabilities, defining the critical functions necessary to continue an
organization’s operations, defining the controls in place or necessary to
reduce exposure, and evaluating the cost for such controls.

Shelter-in-Place – The process of securing and protecting people and


assets in the general area in which a crisis occurs.

Simulation Exercise – A test in which participants perform some or all of


the actions they would take in the event of plan activation. Simulation
exercises are performed under conditions as close as practicable to ‘‘real
world’’ conditions.

Tabletop Exercise – A test method that presents a limited simulation of a


crisis scenario in a narrative format in which participants review and discuss,
not perform, the policy, methods, procedures, coordination, and resource
assignments associated with plan activation.

Testing – Activities performed to evaluate the effectiveness or capabilities


of a plan relative to specified objectives or measurement criteria. Testing
usually involves exercises designed to keep teams and employees effective
in their duties and to reveal weaknesses in the Business Continuity Plan.

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Training – An educational process by which teams and employees are


made qualified and proficient about their roles and responsibilities in
implementing a Business Continuity Plan.

Vital Records – Records or documents, for legal, regulatory, or operational


purposes, that if irretrievably damaged, destroyed, or lost, would materially
impair the organization’s ability to continue business operations.

Self Assessment Questions I


1. –––––––––––––– Means intervention and co-ordination by individuals or
teams before, during, and after an event to resolve the crisis, minimize
loss, and otherwise protect the organization.
2. –––––––––––––––– is a management level financial analysis that
identifies the impacts of losing an organization’s resources.
3. ––––––––––––––––– is a comprehensively managed effort to prioritize
key business processes, identify significant threats to normal operation,
and plan mitigation strategies to ensure effective and efficient
organizational response to the challenges that surface during and after a
crisis.
4. ––––––––––––––––– is a business activity or process that cannot be
interrupted or unavailable for several business days without having a
significant negative impact on the organization.

4.3 Practice Advisory – Part One


The Business Continuity Guideline is comprised of two sections:
(1) the planning process and (2) successful implementation and
maintenance.
Note: Business continuity planning is cyclical. Rigorous plan administration
and maintenance, as well as any events experienced, will necessitate
revisions and/or plan additions.

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4.3.1 Developing the Plan


This section addresses the process of preparing a Business Continuity Plan
(BCP), including readiness, prevention, response, and recovery/resumption.
It details the specific BCP elements and provides step-by-step plan
preparation and activation guidance. The specifics of this guideline are
appropriate for a mid- to large-sized organization. By understanding the
concepts and procedures described, it will be possible to effectively adapt
the guideline to smaller-sized organizations. The level of effort may vary
widely, but the basic approach of preparedness and response should be
constant.

The following steps are important:

1. Assign Accountability
It is essential that senior leadership of the organization sponsors and takes
responsibility for creating, maintaining, testing, and implementing a
comprehensive Business Continuity Plan (BCP). This will insure that
management and staff at all levels within the organization understand that
the BCP is a critical top management priority. It is equally essential that
senior leadership engage a ‘‘top down’’ approach to the BCP so that
management at all levels of the organization understand accountability for
effective and efficient plan maintenance as part of the overall governance
priorities.

Corporate Policy
In the event of a crisis, an organization-wide BCP Policy committed to
undertaking all reasonable and appropriate steps to protect people,
property, and business interests is essential. Corporate policy should
include a definition of a ‘‘crisis.’’

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Ownership of Systems, Processes, and Resources


Responsibility for systems and resource availability and key business
processes should be clearly identified in advance.

Planning Team
A Business Continuity Planning Team with responsibility for BCP
development that includes senior leaders from all major organizational
functions and support groups should be appointed to ensure wide-spread
acceptance of the BCP.

Communicate BCP
The BCP should be communicated throughout the organization, to ensure
employees are aware of the BCP structure and their roles within the plan.

2. Perform Risk Assessment


Step two in the creation of a comprehensive BCP is completion of a Risk
Assessment, designed to identify and analyze the types of risk that may
impact the organization. Assessment should be performed by a group
representing various organizational functions and support groups.

Review Types of Risks That Could Impact the Business


Using available information about known or anticipated risks, the
organization should identify and review risks that could possibly impact the
business, and rate the likelihood of each. A Risk Assessment matrix can aid
identification of risks and prioritization of mitigation/planning strategies.

3. Conduct Business Impact Analysis (BIA)


Once risks have been identified, any organizational impacts that could result
from an interruption of normal operations should be examined in a Business
Impact Analysis (BIA).

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Identify Critical Processes


Business critical processes should be identified and documented. They
could include purchasing, manufacturing, supply chain, sales, distribution,
accounts receivable, accounts payable, payroll, IT, and research and
development. Once the critical processes are identified, an analysis of each
can be made using the evaluation criteria described below. Processes
should be ranked as a High, Medium, or Low.

Assess Impact if Crisis Were to Happen


 Human cost: physical and psychological harm to employees, customers,
suppliers, other stakeholders, etc.
 Financial cost: equipment and property replacement, downtime,
overtime pay, stock devaluation, lost sales/business, lawsuits, regulatory
fines/penalties, etc.
 Corporate image cost: reputation, standing in the community, negative
press, loss of customers, etc.

Determine Maximum Allowable Outage and Recovery Time Objectives


 Determine how long process can be non-functional before impacts
become unacceptable.
 Determine how soon process should be restored (shortest allowable
outage restored first).
 Determine different recovery time objectives according to time of year
(year-end, tax filing, etc.)
 Identify and document alternate procedures to a process (manual
workarounds or processes, blueprints, notification/calling trees, etc.)
 Evaluate costs of alternate procedures versus waiting for system to be
restored.

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Identify Resources Required for Resumption and Recovery


Such resources can include personnel, technology hardware and software
(including telecommunications), specialized equipment, general office
supplies, facility/office space and critical and vital business records.
Identifying, backing-up, and storing critical and vital business records in a
safe and accessible location are essential prerequisites for an effective
BCP. The Risk Assessment and BIA provide the foundation on which the
organization’s BCP will rest, as strategies will be formulated and plans will
be developed to meet the needs identified in them. These analyses should
be repeated on a regular basis and/or in response to significant changes to
the organization’s operating environment.

4. Agree on Strategic Plans


Strategic planning addresses the identification and implementation of:
 Methods to mitigate the risks and exposures identified in the BIA and
Risk Assessment.
 Plans and procedures to respond to any crisis that does occur. A BCP
may include multiple strategies that address a variety of probable
situations, including the duration of the business interruption (short
versus long term), the period in which it occurs (peak versus low), and
the extent of the interruption (partial versus complete). It is important
that the strategies selected are:
 Attainable
 Highly probable to be successful
 Verifiable through tests and exercises
 Cost effective
 Appropriate for the size and scope of the organization.

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5. Crisis Management and Response Team Development


It is necessary that an appropriate administrative structure be put in place to
effectively deal with crisis management. Clear definitions must exist for a
management structure, authority for decisions, and responsibility for
implementation. An organization should have a Crisis Management Team to
lead incident/event response. The Team should be comprised of such
functions as human resources, information technology, facilities, security,
legal, communications/media relations, manufacturing, warehousing, and
other business critical support functions, with all under the clear direction of
senior management or its representatives.

The Crisis Management Team may be supported by as many Response


Teams as appropriate taking into account such factors as organization size
and type, number of employees, location, etc. Response Teams should
develop Response Plans to address various aspects of potential crises,
such as damage assessment, site restoration, payroll, human resources,
information technology, and administrative support. Response Plans should
be consistent with and included within the overall BCP. Individuals should
be recruited for membership on Response Teams based upon their skills,
level of commitment, and vested interest.

Contact Information
Contact information for personnel assigned to crisis management and
response teams should be included in the plans. Personal information such
as unlisted phone numbers and home addresses should be protected. The
organization should establish procedures to ensure that the information is
kept up to date. Consideration should be given to a BCP software tool that
supports effective change management.

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Compliance with Corporate Policy


Compliance audits should be conducted to enforce BCP policies and
procedures. Policy and procedures violations should be highlighted and
accountability for corrective action assigned in accordance with
organizational governance regimes.

6. Mitigation Strategies

Devise Mitigation Strategies


Cost effective mitigation strategies should be employed to prevent or lessen
the impact of potential crises. For example, securing equipment to walls or
desks with strapping can mitigate damage from an earthquake; sprinkler
systems can lessen the risk of a fire; a strong records management and
technology disaster recovery program can mitigate the loss of key
documents and data.

Resources Needed for Mitigation


The various resources that would contribute to the mitigation process should
be identified. These resources, including essential personnel and their roles
and responsibilities, facilities, technology, and equipment should be
documented in the plan and become part of ‘‘business as usual.’’

Monitoring Systems and Resources


Systems and resources should be monitored continually as part of mitigation
strategies. Such monitoring can be likened to simple inventory
management.

The resources that will support the organization to mitigate the crisis should
also be monitored continually to ensure that they will be available and able
to perform as planned during the crisis. Examples of such systems and
resources include, but are not limited to:

 Emergency equipment

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 Fire alarms and suppression systems


 Local resources and vendors
 Alternate worksites
 Maps and floor plans updated/changed due to construction and internal
moves
 System backups and offsite storage.

7. Avoidance, Deterrence and Detection

Avoidance Deterrence and Detection


Avoidance has the goal of preventing a the purpose of deterrence and
detection is crisis from happening. The potential crisis to make a hostile act
(or activity) more should be identified, understood, and difficult to carry out
against the addressed and, in doing so, avoided. The organization or
significantly limit, if not Risk Assessment can be used to identify negate, its
impact. The BCP should address the specifics of potential crises, including
and include overall deterrence and any precursors and warning signs.
detection measures. Examples of crises that can have warning signs
include, but are not limited to:
 Workplace violence (erratic or threatening employee behavior)
 Natural disasters (hurricanes, wild-fires, etc.)
 Activism, protests, riots
 Product or manufacturing failure
 Hostile takeover
 Terrorism
 Lawsuits.

Employee Behavior to Support Avoidance and Deterrence and


Detection
Employees should be appropriately motivated to feel personally responsible
for avoidance and deterrence and detection. Through the proper corporate

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climate, operational plans, and management objectives, employees should


support avoidance and deterrence and detection policies and procedures.

Facility Security Programs to Support and Enhance Avoidance and


Deterrence and Detection
 Architectural: natural or manmade barriers.
 Operational: security officers’ post orders; employee security awareness
programs; counter surveillance and counter intelligence as avoidance,
detection and deterrence measures; and Protective Security Operations
for the protection of the leadership and their families.
 Technological: intrusion detection, access control, recorded video
surveillance, package and baggage screening, when appropriate.

8. Potential Crisis Recognition


The first element in a response program is to determine if a potential crisis
exists. The organization should know and be able to easily recognize when
specific dangers occur that necessitate the need for some level of response.
A strong program of avoidance and deterrence and detection policies and
procedures as outlined above will support this process.

Identification and Recognition of Danger Signals


Identification of danger signals coupled with the likelihood of an event is
often indicative of an imminent crisis. Warning signs may include, but are
not limited to:
 Unusual or unexplained changes in sales volume
 Legislative changes
 Corporate policy changes
 Changes to competitive environment
 Changes to supply based environment
 Warnings of natural disasters

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 Imminent or actual changes in Homeland Security Advisory System


threat level
 Cash flow changes
 Potential for civil or political instability
 Impending strike or likely protests
 Hostile labor negotiations.

Responsibility to Recognize and Report Potential Crises


Certain departments or functions are uniquely situated to observe warning
signs of an imminent crisis. Personnel assigned to these departments or
functions should be trained appropriately. The responsibility to report a
potential crisis (including the notification mechanism) should be
communicated to all employees. The general employee population may also
be an excellent source of predictive information when there is a documented
reporting structure and where attention is paid to what the employee reports.

Notify the Team(s)


A potential crisis, once recognized, should be immediately reported to a
supervisor, a member of management, or another individual tasked with the
responsibility of crisis notification and management.

Parameters for Notification


Specific notification criteria should be established, documented, and
adhered to by all employees (with the timing and sequence of notification
calls clearly documented). The actual activation of a response process
should require very specific qualifications being met.

Custody and Updates to Contact Information


Qualified personnel should have ready access to the updated, confidential
listings of persons and organizations to be contacted when certain
conditions or parameters of a potential crisis are met.

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Types of Notification
Notifications in a crisis situation should be timely and clear and should use a
variety of procedures and technologies, with recognition that devices used
have advantages and limitations.

Remember: In some types of crises, the notification systems are themselves


impacted by the disaster, whether through capacity issues or infrastructure
damage. Thus, it is important to have redundancies built into the notification
system and several different ways to contact the listed individuals and
organizations.

Assess the Situation


Problem assessment (an evaluative process of decision making that will
determine the nature of the issue to be addressed) and severity assessment
(the process of determining the severity of the crisis and what any
associated costs may be in the long run) should be made at the outset of a
crisis. Factors to be considered include the size of the problem, its potential
for escalation, and the possible impact of the situation.

Declare a Crisis
The point at which a situation is declared to be a crisis should be clearly
defined, documented, and fit very specific and controlled parameters.
Responsibility for declaring a crisis should also be clearly defined and
assigned. First and second alternates to the responsible individual should
be identified.

The activities that declaring a crisis will trigger include, but are not limited to:
 Additional call notification
 Evacuation, shelter, or relocation
 Safety protocol
 Response site and alternate site activation
 Team deployment

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 Personnel assignments and accessibility


 Emergency contract activation
 Operational changes

In certain situations, there may be steps that can and should be


implemented, even without officially declaring a crisis.

Execute the Plan


BCPs should be developed around a ‘‘worst case scenario,’’ with the
understanding that the response can be scaled appropriately to match the
actual crisis. When initiating a response, it is important to insure that the
goals protect the following interests listed in order of their priority:
 Save lives and reduce chances of further injuries/deaths
 Protect assets
 Restore critical business processes and systems
 Reduce the length of the interruption of business
 Protect reputation damage
 Control media coverage (e.g. local, regional, national or global)
 Maintain customer relations.

Prioritized classifications can be set up as relative indicators of the


magnitude, severity, or potential impact of the situation. These levels may
aid organizations that are developing response plans and implementation
‘‘triggers’’ for use during a crisis. Determining the initial level of the crisis and
the progression from one level to the next will normally be the responsibility
of the Crisis Management Team.

9. Communications
Remember: Effective communication is one of the most important
ingredients in crisis management.

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Identify the Audiences


Internal and external audiences should be identified in order to convey crisis
and organizational response information. In order to provide the best
communications and suitable messages for various groups, it is often
appropriate to segment the audiences. In this way, messages tailored
specifically for a group can be released.

Internal External
 Employees and their families
 Customers/Clients, present and potential
 Business Owners/Partners
 Contractors/Vendors
 Boards of Directors
 Media
 Onsite Contractors/Vendors
 Government and Regulatory Agencies
 Local law enforcement
 Emergency responders
 Investors/Shareholders
 Surrounding communities

Communicating with Audiences


The following items should be taken into account in the crisis
communications strategy:
 Communications should be timely and honest.
 To the extent possible, an audience should hear news from the
organization first.
 Communications should provide objective and subjective assessments.
 All employees should be informed at approximately the same time.
 Give bad news all at once – do not sugarcoat it.

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 Provide opportunity for audiences to ask questions, if possible.


 Provide regular updates and let audiences know when the next update
will be issued.
 Treat audiences as you would like to be treated.
 Communicate in a manner appropriate to circumstances:
– Face-to-face meetings (individual and group)
– News conferences
– Voice mail/email
– Company Intranet and Internet sites
– Toll-free hotline
– Special newsletter
– Announcements using local/national media.

Preplanning for communications is critical. Drafts of message templates,


scripts, and statements can be crafted in advance for threats identified in the
Risk Assessment.

Procedures to ensure that communications can be distributed at short notice


should also be established, particularly when using resources such as
Intranet and Internet sites and toll-free hotlines.

Official Spokesperson
The organization should designate a single primary spokesperson, with
back-ups identified, who will manage/disseminate crisis communications to
the media and others. This individual should be trained in media relations
prior to a crisis. All information should be funneled through a single source
to assure that the messages being delivered are consistent.
It should be stressed that personnel should be informed quickly regarding
where to refer calls from the media and that only authorized company
spokespeople are authorized to speak to the media. In some situations, an
appropriately trained site spokesperson may also be necessary.

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10. Resource Management

The Human Element


People are the most important aspect of any BCP. How an organization’s
human resources are managed will impact the success or failure of crisis
management.

Accounting for All Individuals


A system should be devised by which all personnel can be accounted for
quickly after the onset of a crisis. This system could range from a simple
telephone tree to an elaborate external vendor’s call-in site. Current and
accurate contact information should be maintained for all personnel.
Consideration should be given to engaging the company’s travel agency to
assist in locating employees on business travel.

Notification of Next-of-Kin
Arrangements should be made for notification of any next-of-kin in case of
injuries or fatalities. If at all possible, notification should take place in person
by a member of senior management. Appropriate training should be
provided.

Family Representatives
The organization should implement a Family Representative program in
case of severe injury or fatality. The Family Representative should be
someone other than the person who performed the notification. This
Representative should act as the primary point of contact between the
family and the organization. Comprehensive training for the Representative
is a necessity.

Crisis Counseling
Crisis counseling should be arranged as necessary. In many cases, such
counseling goes beyond the qualifications and experience of an

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organization’s Employee Assistance Program (where available). Other


reliable sources of counseling should be identified prior to a crisis situation.

11. Financial Support


A crisis may have far reaching financial implications for the organization, its
employees and their families, and other stakeholders; these implications
should be considered an important part of a BCP. Implications may include
financial support to families of victims. Additionally, there may be tax
implications that should be referenced and clarified in advance.

Payroll
The payroll system should remain functional throughout the crisis.

Logistics
Logistical decisions made in advance will impact the success or failure of a
good BCP. Among them are the following:

Crisis Management Center


A primary Crisis Management Center should be identified in advance. This
is the initial site used by the Crisis Management Team and Response
Teams for directing and overseeing crisis management activities. The site
should have an uninterruptible power supply, essential computer,
telecommunications, heating/ventilating/air conditioning systems, and other
support systems. Additionally, emergency supplies should be identified and
kept in the Center.

Where a dedicated Center is not possible, a designated place where the


Teams may direct and oversee crisis management activities should be
guaranteed. Access control measures should be implemented, with the
members of all Teams given 24x7 access. A secondary Crisis Management
Center should also be identified in the event that the primary Center is
impacted by the crisis event.

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Alternate Worksites
The organization should have alternate worksites identified for business
resumption and recovery. In the absence of other company facilities being
available and/or suitable, access to alternate worksites can be arranged
through appropriate vendors. Planning concerning the identification and
availability of alternate worksites should take place early in the BCP
process. Alternate worksites should provide adequate access to the
resources required for business resumption identified in the BIA.

Offsite Storage
Offsite storage is a valuable mitigation strategy allowing rapid crisis
response and business recovery/resumption. The off-site storage location
should be a sufficient distance from the primary facility so that it is not likely
to be similarly affected by the same event. Items to be considered for off-site
storage include critical and vital records (paper and other media) necessary
to the operations of the business. Procedures should be included in the plan
to ensure the timely deliver of any necessary items from offsite storage to
the Crisis Management Center or the alternate worksites.

12. Financial Issues and Insurance


If appropriate, existing funding and insurance policies should be examined,
and additional funding and insurance coverage should be identified and
obtained. Policy parameters should be established in advance, including
pre-approval by the insurance provider of any response related vendors.
Where possible, the amount of funds to help ensure continuity of operations
should be determined in the planning process. Additionally, any cash should
be stored in an easily accessible location to assure its availability during a
crisis, and some cash and credit should be available for weekend and after-
hours requirements. All crisis related expenses should be recorded
throughout the response and recovery/resumption periods. Insurance

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providers should be contacted as early as possible in the crisis period,


particularly in instances of a wide-reaching crisis, where competition for
such resources could be vigorous. All insurance policy and contact
information should be readily available to the Crisis Management Team and
backed up or stored offsite as appropriate.

Transportation
Transportation in a time of crisis can be a challenge. Provisions should be
arranged ahead of time, if possible. Areas where transportation is critical
include, but are not limited to:
 Evacuation of personnel (e.g., from a demolished work-site or from a
satellite facility in another country)
 Transportation to an alternate worksite
 Supplies into the site or to an alternate site
 Transportation of critical data to worksite
 Transportation for staff with special needs.

13. Suppliers/Service Providers


Critical vendor or service provider agreements should be established as
appropriate and their contact information maintained as part of the BCP.
Such information could include phone numbers, contact names, account
numbers, pass-codes (appropriately protected), and other information in the
event that someone unfamiliar with the process would need to make
contact. In some instances, it may be appropriate to request and review the
BCP, or a summary of such, of the critical vendors, in order to evaluate their
ability to continue to provide necessary supplies and services in the case of
a far-reaching crisis. At a minimum, the vendor’s or service provider’s roles
and service level agreements should be discussed in advance of the crisis.

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14. Mutual Aid Agreements


Mutual aid agreements identify resources that may be borrowed from other
organizations during a crisis, as well as mutual support that may be shared
with other organizations. Such agreements should be legally sound and
properly documented, clearly understood by all parties involved, and
representative of dependable resources as well as a commitment to
cooperation.
15. Damage and Impact Assessment
Once the Crisis Management Team has been activated, the damage should
be assessed. The damage assessment may be performed by the Crisis
Management Team itself or a designated Damage Assessment Team.
Responsibility should be assigned for the documentation of all incident
related facts and response actions, including financial expenditures.
Crises Involving Physical Damage
For situations involving physical damage to company property, the Crisis
Management Team or its designated Damage Assessment Team should be
mobilized to the site. The Team will gain entry, if permission from the public
safety authorities is granted, and make a preliminary assessment of the
extent of damage and the likely length of time that the facility will be
unusable.
Crises Not Involving Physical Damage
Certain types of crises do not involve immediate physical damage to a
company worksite or facility. These would include the business, human,
information technology, and societal types of crises. In these crises, the
Team will likely assess the damage or impact as the crisis unfolds.

16. Resumption of Critical and Remaining Processes


Process Resumption Prioritization
Once the extent of damage is known, the process recovery needs should be

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prioritized and a schedule for resumption determined and documented. The


prioritization should take into account the fundamental criticality of the
process and other factors, including relationships to other processes, critical
schedules, and regulatory requirements, as identified in the BIA. Decisions
regarding prioritization of processes should be documented and recorded,
including the date, time, and justification for the decisions.

Resumption of Critical Processes


Once the processes to be restored have been prioritized, the resumption
work can begin with processes restored according to the prioritization
schedule. The resumption of these processes may occur at either the
current worksite or an alternate worksite, depending on the circumstances of
the crisis. Documentation should be kept of when the processes were
resumed.

Resumption of Remaining Processes


Once the critical processes have been resumed, the resumption of the
remaining processes can be addressed. Where possible, decisions about
the prioritization of these processes should be thoroughly documented in
advance, as should the timing of actual resumption.

17. Return to Normal Operations


The organization should seek to bring the company ‘‘back to normal.’’ If it is
not possible to return to the pre-crisis ‘‘normal,’’ a ‘‘new normal’’ should be
established. This ‘‘new normal’’ creates the expectation that, while there
may be changes and restructuring in the workplace, the organization will
phase back into productive work. Each step of the process and all decisions
should be carefully documented. As a rule, it is at this point that the crisis
may be officially declared ‘‘over.’’ Again, it is important to document this
decision. Press conferences and mass media communications may be
undertaken to bolster employee and client confidence.

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4.4 Practice Advisory – Part Two

4.4.1 Implementing and Maintaining the Plan


This section of the Guideline contains those functions and tasks required for
the Business Continuity Plan to remain a living document: one that grows
and changes with the organization and remains relevant and actionable.

1. Educate and Train


The BCP is only as valuable as the knowledge that others have of it.
Education and training are necessary components of the BCP process.
They require a time commitment from the Crisis Management Team, the
Response Teams, and the general employee population.

Educate and Train Teams


The Crisis Management and Response Teams should be educated about
their responsibilities and duties. Check lists of critical actions and
information to be gathered are valuable tools in the education and response
processes. Teams should be trained at least annually and new members
should be trained when they join. These Teams should also be trained with
respect to prevention of crises, as described in the next section.

Educate and Train All Personnel


All personnel should be trained to perform their individual responsibilities in
case of a crisis. They should also be briefed on the key components of the
BCP, as well as the Response Plans that affect them directly. Such training
could include procedures for evacuation, shelter-in-place, check-in
processes to account for employees, arrangements at alternate worksites,
and the handling of media inquiries by the company. It is recommended that
any external resources that may be involved in a response – such as Fire,
Police, Public Health, and third party vendors – should be familiar with
relevant parts of the BCP.

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2. Test the BCP

Benefits of Testing
The benefits and necessity for testing, which involves training and
exercises, cannot be overemphasized. Testing can keep Teams and
employees effective in their duties, clarify their roles, and reveal
weaknesses in the BCP that should be corrected. A commitment to testing
lends credibility and authority to the BCP.

Goals and Expectations


The first step in testing should be the setting of goals and expectations. An
obvious goal is to determine whether a certain crisis response process
works and how it can be improved. Other less obvious goals can be to test
capacity (as in the case of a call-in or call-out phone system, for instance),
to reduce the time necessary for accomplishment of a process (for example,
using repeated drills to shorten response times), and to bring awareness
and knowledge to the general employee population about the BCP. Lessons
learned from previous tests, as well as actual incidents experienced, should
be built into the testing cycle for the BCP.

Planning and Development


The responsibility for testing the BCP should be assigned. Larger
organizations may consider establishing a Test Team. Where appropriate,
the expertise of external resources (consultants, local emergency
organizations, etc.) can be leveraged.
Timeline
A test schedule and timeline as to how often the plan and its components
will be tested should be established.
Scope of Testing
The scope of testing should be planned to develop over time. In their
infancy, tests should start out relatively simple, becoming increasingly

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complex as the test process evolves. Early tests could include checklists,
simple exercises, and small components of the BCP. As the test schedules
evolve, tests should become increasingly complex, up to a full-scale
activation of the entire BCP, including external participation by public safety
and emergency responders.

Test Monitoring
When feasible, assign observers to take notes during the test. If possible,
arrange to videotape and/or use audiotape devices for further appraisal at
the conclusion of the exercise. If videotape and/or audiotape devices are not
available, then a person should be assigned to document the chronological
list of events during the testing.

Test and Exercise Scenarios


Testing scenarios should be designed using the events identified in the Risk
Assessment.

Test and Exercise Roles


There are several roles that test participants can fill. All participants should
understand their roles in the exercise, and the exercise should involve all
participants. As part of the exercise, participants should be allowed to
interact and discuss issues and lessons.

Test and Exercise Participation


Various groups from the organization itself, as well as from the public sector,
can participate in the tests:

Test and Exercise Evaluation


After completion, the test should be critically evaluated. The evaluation
should include, among other things, an assessment of how well the goals
and objectives of the test were achieved, the effectiveness of participation,
and whether the BCP itself will function as anticipated in the case of a real

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crisis. Future testing, as well as the BCP itself, should then be modified as
necessary based on the test results.

Ongoing Development of Test Schedules


Design of tests should be evaluated and modified as necessary. They
should be dynamic, taking into account changes to the BCP, personnel
turnover, actual incidents, and results from previous exercises.

3. Develop BCP Review Schedule


The BCP should be regularly reviewed and evaluated. Reviews should
occur according to a pre-determined schedule, and documentation of the
review should be maintained as necessary. The following factors can trigger
a review and should otherwise be examined once a review is scheduled:
 Risk Assessment: The BCP should be reviewed every time a Risk
Assessment is completed for the organization. The results of the Risk
Assessment can be used to determine whether the BCP continues to
adequately address the risks facing the organization.
 Sector/Industry Trends: Major sector/industry initiatives should initiate
a BCP review. General trends in the sector/industry and in business
continuity planning techniques can be used for benchmarking purposes.
 Regulatory Requirements: New regulatory requirements may require a
review of the BCP.
 Event Experience: A review should be performed following a response
to an event, whether the BCP was activated or not. If the plan was
activated, the review should take into account the history of the plan
itself, how it worked, why it was activated, etc. If the plan was not
activated, the review should examine why and whether this was an
appropriate decision.
 Test/Exercise Results: Based on test/exercise results, the BCP should
be modified as necessary.

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4. Develop BCP Maintenance Schedule


Regular maintenance of the BCP cannot be overemphasized. Clear
responsibility for BCP maintenance should be assigned. Maintenance can
be either planned or unplanned and should reflect changes in the operation
of the organization that will affect the BCP. The following are examples of
procedures, systems, or processes that may affect the plan:
 Systems and application software changes
 Changes to the organization and its business processes
 Personnel changes (employees and contractors)
 Supplier changes
 Critical lessons learned from testing
 Issues discovered during actual implementation of the plan in a crisis
 Changes to external environment (new businesses in area, new roads or
changes to existing traffic patterns, etc.)
 Other items noted during review of the plan and identified during the
Risk Assessment.

4.5 Check List


Developing the Plan
Overview
1. If a major disaster occurred today, has your organization planned for
survival?
2. Does your organization have a Business Continuity Plan (BCP), and is it
up to date?
3. Has senior management approved the BCP?
4. Does senior management support the BCP?
5. Has the cost of the BCP been determined, including development and
maintenance?

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6. Have the initial audit, security, and insurance departments reviewed the
BCP?
7. Has the BCP been tested, including a surprise test?

Accountability
1. Does your organization’s policy include a definition of crisis?
2. Has the person responsible for critical systems and business processes
been identified?
3. Has a BCP Team been appointed, and does it include senior business
function leaders?
4. Has the BCP been communicated throughout the organization?
5. Has a person been assigned with the responsibility to update the BCP?

Risk Assessment
1. Has your organization conducted a Risk Assessment?
2. Have the types of risks that may impact your organization been
identified and analyzed?
3. Has the likelihood for each type of risk been rated?

Business Impact Analysis


1. Have the critical business processes been identified?
2. Have the business processes been ranked (low, medium, high)?
3. If a crisis were to happen, has the impact, in terms of human and
financial costs, been assessed?
4. Have the maximum allowable outage and recovery time objectives been
determined?
5. Has the length of time your organization’s business processes could be
non-functional been determined?
6. Have the recovery time objectives been identified?
7. Have the resources required for resumption and recovery been
identified?

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Strategic Plans
1. Have methods to mitigate the risks identified in the Business Impact
Analysis and Risk Assessment been identified?
2. Have plans and procedures to respond to any incident been developed?
3. Have strategies that address short and long term business interruptions
been selected?
4. Are the strategies attainable, tested, and cost effective?

Crisis Management and Response Team Development


1. Is the Crisis Management Team comprised of members from human
resources?
2. Have Response Teams to support the Crisis Management Team been
organized?
3. Have response plans to address the various aspects of the crisis been
developed and incorporated into the organization’s overall BCP?
4. Do the response plans address damage assessment, site restoration,
payroll, human resources, information technology, and administrative
support?
5. Has contact information been included in the plan for the Crisis
Management and the Response Teams?

Prevention
Compliance with Corporate Policy & Mitigation Strategies
1. Have compliance audits been conducted to enforce BCP policy and
procedures?
2. Have the systems and resources that will contribute to the mitigation
process been identified, including personnel, facilities, technology, and
equipment?
3. Have the systems and resources been monitored to ensure they will be
available when needed?

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Avoidance, Deterrence, and Detection


1. Are employees motivated to be responsible for avoidance and
deterrence and detection?
2. Have facility security programs to support avoidance and deterrence and
detection been established?
3. Have operational policy and procedures to protect the facilities been
developed?
4. Is it ensured that sufficient physical security systems and planning are in
place to protect the facility?

Response
Potential Crisis Recognition and Team Notification
1. Will the response program recognize when a crisis occurs and provide
some level of response?
2. Have the danger signals been identified that indicate a crisis is
imminent?
3. Have personnel been trained to observe warning signs of an imminent
crisis?
4. Has a notification system been put in place, including redundant
systems?
5. Is the notification contact list complete and up to date?

Assess the Situation


1. Has an assessment process to address the severity and impact of the
crisis been developed?
2. Has the responsibility for declaring a crisis, with first and second
alternates, been assigned?

Declare a Crisis
1. Have the criteria been established for when a crisis should be declared?

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2. Has the responsibility for declaring a crisis been clearly defined and
assigned?
3. Has an alert network for BCP Team members and employees been
established?
4. Is it ensured that there is an alternate means of warning if the alert
network fails?
5. Have the activities that will be implemented in event of a crisis been
identified, including notification, evacuation, relocation, alternate site
activation, team deployment, operational changes, etc?

Execute the Plan


1. Has consideration been given to developing the BCP around a ‘‘worst
case scenario?’’
2. Has the BCP been prioritized to save lives, protect assets, restore
critical business processes and systems, reduce the length of the
interruption, protect reputation, control media coverage, and maintain
customer relations?
3. Have the severity of the crisis and the appropriate response been
determined?

Communications
1. Has a crisis communications strategy been developed?
2. Are communications timely, honest, and objective?
3. Are communications with all employees occurring at approximately the
same time?
4. Are regular updates provided, including notification of when the next
update will be issued?
5. Has a primary spokesperson and back-up spokespersons been
designated who will manage and disseminate crisis communications to
the media and others?

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Resource Management – Human Element


1. Has a system been devised by which all personnel can be accounted for
quickly?
2. Is there a system to ensure current and accurate contact information is
maintained?
3. Have arrangements been made for next-of-kin notifications?
4. Can crisis counseling be arranged as necessary?
5. Will the financial systems for payroll and support of facilities and
employees remain functional?

Resource Management – Logistics


1. Has a designated Crisis Management Center been identified, and does
it have necessary life support functions, including uninterruptible power
supply and communications equipment?
2. Have alternate worksites for business resumption and recovery been
identified?
3. Have critical and vital records been stored at an offsite storage facility?
4. How long can each business function operate effectively without normal
data input storage processes?
5. What must be done to restore data to the same previous point in time
within the recovery time objective?
6. Can any alternate data storage processes be used, after the initial data
recovery, to speed the forward recovery to the present time?

Resource Management – Financial Issues and Insurance,


Transportation, Suppliers/Service Providers, and Mutual Aid
1. Has the appropriate insurance coverage been identified and obtained?
2. Are cash and credit available to the BCP Team?
3. Have transportation alternatives been arranged in advance?
4. Have critical vendor and service provider agreements been established?

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5. Have mutual aid agreements been established?


6. If so, are they legally sound, properly documented, and understood by
all parties?

Recovery and resumption

Damage and Impact Assessment, Process Resumption, and Return to


Normal Operations
1. Has a damage assessment been performed as soon as possible?
2. Has the Damage Assessment Team been mobilized to the site?
3. Has business process recovery been prioritized to recover the most
critical business processes first?
4. Is the schedule of the processes to be restored in accordance with the
prioritization schedule?
5. Is there documentation of when the processes were resumed?
6. Has the organization returned to normal operations?
7. Has the decision to return to normal operations been documented and
communicated?

Implementing and maintaining the plan


Education and Training
1. Are the Crisis Management and Response Teams educated about their
responsibilities and duties?
2. Has a checklist of critical actions and responsibilities and duties been
developed?
3. Do Teams receive annual training?

Testing
1. Are the Business Continuity Plan and appropriate Teams tested to
reveal any weaknesses that require correction?
2. Have goals and expectations of testing and drills been established?
3. Are drills and tabletop exercises conducted on an annual basis?

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4. Has responsibility for testing the BCP been assigned with consideration
for establishing a test team?
5. Does test participation include various groups from the organization and
the public sector?
6. Have observers been assigned who will take notes during the test and
critique the test at the conclusion of the exercise?
7. Have tests and drills been evaluated, including assessing how well the
goals and objectives of the tests and drills were met?

BCP Review and Maintenance Schedules


1. Is the BCP regularly reviewed and evaluated on a predetermined
schedule?
2. Is the BCP reviewed every time a Risk Assessment is completed for the
organization?
3. Is the BCP modified as needed based on test/exercise results?
4. Has responsibility for on-going BCP maintenance been assigned?
5. Does BCP maintenance reflect changes in the operation of the
organization?

Self Assessment Questions II


State whether the following statements are True or False:
1. Junior leadership of the organization sponsors and takes responsibility
for creating, maintaining, testing, and implementing a comprehensive
Business Continuity Plan.
2. Education and training are necessary components of the BCP process.
3. Only top executives should be trained to perform their individual
responsibilities in case of a crisis.
4. The BCP should be reviewed every time a Risk Assessment is
completed for the organization.

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4.6 Summary
‘Business Continuity Plan’ is an ongoing process supported by senior
management and funded to ensure that the necessary steps are taken to
identify the impact of potential losses, maintain viable recovery strategies
and plans, and ensure the continuity of operations through personnel
training, plan testing, and maintenance.

The Business Continuity Guideline is a tool to allow organizations to


consider the factors and steps necessary to prepare for a crisis (disaster or
emergency) so that it can manage and survive the crisis and take all
appropriate actions to help ensure the organization’s continued viability. The
advisory portion of the guideline is divided into two parts: (1) the planning
process and (2) successful implementation and maintenance.

By understanding the concepts and procedures described in this unit, it will


be possible to effectively adapt the guideline to smaller-sized organizations.

4.7 Terminal Questions


1. Explain the purpose of Business Continuity Plan.

2. Give the meaning of the following terms:


a) Crisis Management
b) Business Impact Analysis
c) Critical Function
d) Disaster Recovery

3. Describe how a Business Continuity Plan is developed.

4. Describe how a Business Continuity Plan is implemented.

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4.8 Answers to SAQs and TQs


SAQs I
1. Crisis Management
2. Business Impact Analysis
3. Business Continuity
4. Critical Function

SAQs II
1. False
2. True
3. False
4. True

Answers to TQs:
1. Refer to 4.2
2. Refer to 4.2
3. Refer to 4.3
4. Refer to 4.4

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Unit 5 Small Businesses – Big Obstacles


Structure

5.1 Introduction
Objectives
5.2 What is Small Business Administration (SBA)?
5.3 The Different Phases of a New Business
Self Assessment Questions I
5.4 Stock Options
5.5 Bankruptcy Laws
Self Assessment Questions II
5.6 The Chief Financial Officer (CFO)
5.6.1 Organizational Affiliation
5.6.2 Functions
Self Assessment Questions III
5.7 Summary
5.8 Terminal Questions
5.9 Answers to SAQs and TQs

5.1 Introduction
Everyone is talking about small businesses. In 1993, when it was allowed in
Developing countries, more than 90,000 new firms were registered by
individuals. Now, less than three years later, official figures show that only
40,000 of them still pay their dues and present annual financial statements.
These firms are called "active" - but this is a misrepresentation. Only a very
small fraction really does business and produces income.

Why this reversal? Why were people so enthusiastic to register companies -


and then became too desperate to operate them?

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Small business is more than a fashion or a buzzword. In the USA, only small
businesses create new jobs. The big dinosaur firms (the "blue-chips") create
negative employment - they fire people. This trend has a glitzy name:
downsizing.

In Israel many small businesses became world class exporters and big
companies in world terms. The same goes, to a lesser extent, in Britain and
in Germany.

Objectives:
After studying this unit, you will be able to:
 Describe the valuable services provided by Small Business
Administration.
 Explain different phases of a new business.
 Explain the benefits of Stock Option Plan.
 Explain the Bankruptcy Laws prevailing in the USA.
 Describe the functions of Chief Financial Officer.

5.2 What is Small Business Administration (SBA)?


Virtually every Western country has a "Small Business Administration"
(SBA).

These agencies provide many valuable services to small businesses:

They help them organize funding for all their needs: infrastructure, capital
goods (machinery and equipment), land, working capital, licence and patent
fees and charges, etc.

The SBAs have access to government funds, to local venture capital funds,
to international and multilateral investment sources, to the local banking
community and to private investors. They act as capital brokers at a fraction
of the costs that private brokers and organized markets charge.

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They assist the entrepreneur in the preparation of business plans, feasibility


studies, application forms, questionnaires – and any other thing which the
new start-up venture might need to raise funds to finance its operations.
This saves the new business a lot of money.

They reduce bureaucracy. They mediate between the small business and
the various tentacles of the government. They become the ONLY address
which the new business should approach, a "One Stop Shop".

But why do new (usually small) businesses need special treatment and
encouragement at all? And if they do need it – what are the best ways to
provide them with this help? This is a question to ponder over.

5.3 The Different Phases of a New Business


A new business goes through phases in the business cycle (very similar to
the stages of human life).

The first phase - is the formation of an idea. A person - or a group of people


join forces, centred around one exciting invention, process or service.

These crystallizing ideas have a few hallmarks:

They are oriented to fill the needs of a market niche (a small group of select
consumers or customers), or to provide an innovative solution to a problem
which bothers many, or to create a market for a totally new product or
service, or to provide a better solution to a problem which is solved in a less
efficient manner.

At this stage, what the entrepreneurs need most is expertise. They need a
marketing expert to tell them if their idea is marketable and viable. They
need a financial expert to tell them if they can get funds in each phase of the
business cycle - and wherefrom and also if the product or service can
produce enough income to support the business, pay back debts and yield a

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profit to the investors. They need technical experts to tell them if the idea
can or cannot be realized and what it requires by way of technology
transfers, engineering skills, know-how, etc.

Once the idea has been shaped to its final form by the team of
entrepreneurs and experts – the proper legal entity should be formed. A
bewildering array of possibilities arises:

A partnership? A corporation – and if so, a stock or a non-stock company? A


research and development (RND) entity? A foreign company or a local
entity? And so on.

This decision is of cardinal importance. It has enormous tax implications and


in the near future of the firm it greatly influences the firm's ability to raise
funds in foreign capital markets. Thus, a lawyer must be consulted who
knows both the local applicable laws and the foreign legislation in markets
which could be relevant to the firm.

This costs a lot of money, one thing that entrepreneurs are in short supply of
free legal advice is likely to be highly appreciated by them.

When the firm is properly legally established, registered with all the relevant
authorities and has appointed an accounting firm – it can go on to tackle its
main business: developing new products and services. At this stage the firm
should adopt Western accounting standards and methodology. Accounting
systems in many countries leave too much room for creative playing with
reserves and with amortization. No one in the West will give the firm credits
or invest in it based on domestic financial statements.

A whole host of problems faces the new firm immediately upon its formation.

Good entrepreneurs do not necessarily make good managers. Management


techniques are not a genetic heritage.

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They must be learnt and assimilated. Today's modern management


includes many elements: manpower, finances, marketing, investing in the
firm's future through the development of new products, services, or even
whole new business lines. That is quite a lot and very few people are
properly trained to do the job successfully.

On top of that, markets do not always react the way entrepreneurs expect
them to react. Markets are evolving creatures: they change, develop,
disappear and re-appear. They are exceedingly hard to predict. The sales
projections of the firm could prove to be unfounded. Its contingency funds
can evaporate.

Sometimes it is better to create a product mix: well-recognized brands which


sell well – side by side with innovative products.

This is a brief – and by no way comprehensive – taste of what awaits the


new business and its initiator, the entrepreneur. You see that a lot of money
and effort are needed even in the first phases of creating a business.

How can the Government help?

It could set up an "Entrepreneur's One Stop Shop".

A person wishing to establish a new business will go to a government


agency.

In one office, he will find the representatives of all the relevant government
offices, authorities, agencies and municipalities.

He will present his case and the business that he wishes to develop. In a
matter of few weeks he will receive all the necessary permits and licences
without having to go to each office separately.

Having obtained the requisite licences and permits and having registered
with all the appropriate authorities – the entrepreneur will move on to the

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next room in the same building. Here he will receive a list of all the sources
of capital available to him both locally and from foreign sources. The terms
and conditions of the financing will be specified for each and every source.
Example: EBRD – loans of up to 10 years – interest between 6.5% to 8% –
grace period of up to 3 years – finances mainly industry, financial services,
environmental projects, infrastructure and public services.

The entrepreneur will select the sources of funds most suitable for his needs
– and proceed to the next room.

The next room will contain all the experts necessary to establish the
business, get it going – and, most important, raise funds from both local and
international institutions. For a symbolic sum they will prepare all the
documents required by the financing institutions as per their instructions.

But entrepreneurs in many developing countries are still fearful and


uninformed. They are intimidated by the complexity of the task facing them.

The solution is simple: a tutor or a mentor will be attached to each and every
entrepreneur. This tutor will escort the entrepreneur from the first phase to
the last.

He will be employed by the "One Stop Shop" and his role will be to ease life
for the novice businessman. He will transform the person to a businessman.

And then they will wish the entrepreneur: "Bon Voyage" – and may the best
ones win.

There is an inherent conflict between owners and managers of companies.


The former want, for instance, to minimize costs – the latter to draw huge
salaries as long as they are in power.

In publicly traded companies, the former wish to maximize the value of the
stocks (short term), the latter might have a longer term view of things. In the
USA, shareholders place emphasis on the appreciation of the stocks

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(the result of quarterly and annual profit figures). This leaves little room for
technological innovation, investment in research and development and in
infrastructure. The theory is that workers who also own stocks avoid these
cancerous conflicts which, at times, bring companies to ruin and, in many
cases, dilapidate them financially and technologically. Whether reality lives
up to theory, is an altogether different question.

Self Assessment Questions I


State whether the following statements are True or False:
1. SBAs help small businesses to organize funding for all their needs.
2. The SBAs, however, do not have access to government funds.
3. SBAs act as capital brokers at a fraction of the costs that private brokers
and organized markets charge.
4. SBAs assist the entrepreneur in the preparation of business plans.
5. The first phase of a new business is the formation of an idea.
6. Good entrepreneurs always make good managers.

5.4 Stock Options


A Stock Option Plan is an organized program for employees of a corporation
allowing them to buy its shares. Sometimes the employer gives the
employees subsidized loans to enable them to invest in the shares or even
matches their purchases: for every share bought by an employee, the
employer awards him with another one, free of charge. In many companies,
employees are offered the opportunity to buy the shares of the company at
a discount (which translates to an immediate paper profit).

Stock options have many uses: they are popular investments and
speculative vehicles in many markets in the West, they are a way to hedge
(to insure) stock positions (in the case of put options which allow you to sell
your stocks at a pre-fixed price). With very minor investment and very little

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risk (one can lose only the money invested in buying the option) – huge
profits can be realized.

Creative owners and shareholders use stock options to provide their


workers with an incentive to work for the company and only for the
company. Normally, such perks were reserved to senior management,
thought indispensable. Later, as companies realized that their main asset
was their employees, all employees began to enjoy similar opportunities.
Under an incentive stock option scheme, an employee is given by the
company (as part of his compensation package) an option to purchase its
shares at a certain price (at or below market price at the time that the option
was granted) for a given number of years. Profits derived from such options
now constitute the main part of the compensation of the top managers of the
Fortune 500 in the USA and the habit is catching on even with more
conservative Europe.

Dividends that the workers receive on the shares that they hold can be
reinvested by them in additional shares of the firm (some firms do it for them
automatically and without or with reduced brokerage commissions). Many
companies have wage "set-aside" programs: employees regularly use a part
of their wages to purchase the shares of the company at the market prices
at the time of purchase. Another well-known structure is the Employee Stock
Ownership Plan (ESOP) whereby employees regularly accumulate shares
and may ultimately assume control of the company.

Let us study in depth a few of these schemes:

It all began with Ronald Reagan. His administration passed in Congress the
Economic Recovery Tax Act (ERTA – 1981) under which certain kinds of
stock options ("qualifying options") were declared tax-free at the date that
they were granted and at the date that they were exercised. Profits on
shares sold after being held for at least two years from the date that they

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were granted or one year from the date that they were transferred to an
employee were subject to preferential (lower rate) capital gains tax. A new
class of stock options was thus invented: the "Qualifying Stock Option".
Such an option was legally regarded as a privilege granted to an employee
of the company that allowed him to purchase, for a special price, shares of
its capital stock (subject to conditions of the Internal Revenue – the
American income tax – code). To qualify, the option plan must be approved
by the shareholders, the options must not be transferable (i.e., cannot be
sold in the stock exchange or privately – at least for a certain period of time).

Additional conditions: the exercise price must not be less than the market
price of the shares at the time that the options were issued and that the
employee who receives the stock options (the grantee) may not own stock
representing more than 10% of the company's voting power unless the
option price equals 110% of the market price and the option is not
exercisable for more than five years following its grant. No income tax is
payable by the employee either at the time of the grant or at the time that he
converts the option to shares (which he can sell at the stock exchange at a
profit) – the exercise period. If the market price falls below the option price,
another option, with a lower exercise price can be issued. There is a
100,000 USD per employee limit on the value of the stock covered by
options that can be exercised in any one calendar year.

This law – designed to encourage closer bondage between workers and


their workplaces and to boost stock ownership – led to the creation of
Employee Stock Ownership Plans (ESOPs). These are programs which
encourage employees to purchase stock in their company. Employees may
participate in the management of the company. In certain cases – for
instance, when the company needs rescuing – they can even take control
(without losing their rights). Employees may offer wage concessions or other

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work rules related concessions in return for ownership privileges – but only if
the company is otherwise liable to close down ("marginal facility").

How much of its stock should a company offer to its workers and in which
manner?

There are no rules (except that ownership and control need not be
transferred). A few of the methods:
1. The company offers packages of different sizes, comprising shares and
options and the employees bid for them in open tender.
2. The company sells its shares to the employees on an equal basis
(all the members of the senior management, for instance, have the right
to buy the same number of shares) – and the workers are then allowed
to trade the shares between them.
3. The company could give one or more of the current shareholders the
right to offer his shares to the employees or to a specific group of them.

The money generated by the conversion of the stock options (when an


employee exercises his right and buys shares) usually goes to the company.
The company sets aside in its books a number of shares sufficient to meet
the demand which may be generated by the conversion of all outstanding
stock options. If necessary, the company issues new shares to meet such a
demand. Rarely, the stock options are converted into shares already held by
other shareholders.

It all starts by defaulting on an obligation. Money owed to creditors or to


suppliers is not paid on time, interest payments due on bank loans or on
corporate bonds issued to the public are withheld. It may be a temporary
problem - or a permanent one.

As time goes by, the creditors gear up and litigate in a court of law or in a
court of arbitration. This leads to a “technical or equity insolvency” status.

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But this is not the only way a company can be rendered insolvent. It could
also run liabilities which outweigh its assets. This is called “bankruptcy
insolvency”. True, there is a debate raging as to what is the best method to
appraise the firm’s assets and the liabilities. Should these appraisals be
based on market prices - or on book value?

There is no one decisive answer. In most cases, there is strong reliance on


the figures in the balance sheet.

If the negotiations with the creditors of the company (as to how to settle the
dispute arising from the company’s default) fails, the company itself can file
(=ask the court) for bankruptcy in a "voluntary bankruptcy filing".

Enter the court. It is only one player (albeit, the most important one) in this
unfolding, complex drama. The court does not participate directly in the
script.

Court officials are appointed. They work hand in hand with the
representatives of the creditors (mostly lawyers) and with the management
and the owners of the defunct company.

They face a tough decision: should they liquidate the company? In other
words, should they terminate its business life by (among other acts) selling
its assets?

The proceeds of the sale of the assets are divided (as "bankruptcy
dividend") among the creditors. It makes sense to choose this route only if
the (money) value yielded by liquidation exceeds the money the company,
as a going concern, as a living, functioning, entity, can generate.

The company can, thus, go into "straight bankruptcy". The secured


creditors then receive the value of the property which was used to secure
their debt (the "collateral", or the "mortgage, lien"). Sometimes, they receive
the property itself - if it not easy to liquidate (=sell) it.

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Once the assets of the company are sold, the first to be fully paid off are the
secured creditors. Only then, the priority creditors are paid (wholly or
partially).

The priority creditors include administrative debts, unpaid wages (up to a


given limit per worker), uninsured pension claims, taxes, rents, etc.

And only if any money left after all these payments is it proportionally doled
out to the unsecured creditors.

5.5 Bankruptcy Laws


The USA had many versions of bankruptcy laws. There was the 1938
Bankruptcy Act, which was followed by amended versions in 1978, 1984
and, lately, in 1994.

Each State has modified the Federal Law to fit its special, local conditions.

Still, a few things – the spirit of the law and its philosophy are common to all
the versions. Arguably, the most famous procedure is named after the
chapter in the law in which it is described, Chapter 11. Following is a brief
discussion of chapter 11 intended to demonstrate this spirit and this
philosophy.

This chapter allows for a mechanism called "reorganization". It must be


approved by two thirds of all classes of creditors and then, again, it could be
voluntary (initiated by the company) or involuntary (initiated by one to three
of its creditors).

The American legislator set the following goals in the bankruptcy laws:
a. To provide a fair and equitable treatment to the holders of various
classes of securities of the firm (shares of different kinds and bonds of
different types).

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b. To eliminate burdensome debt obligations, which obstruct the proper


functioning of the firm and hinder its chances to recover and ever repay
its debts to its creditors.
c. To make sure that the new claims received by the creditors (instead of
the old, discredited, ones) equal, at least, what they would have
received in liquidation.

Examples of such new claims: owners of debentures of the firm can receive,
instead, new, long term bonds (known as reorganization bonds, whose
interest is payable only from profits).

Owners of subordinated debentures will, probably, become shareholders


and shareholders in the insolvent firm usually receive no new claims.

The chapter dealing with reorganization (the famous "Chapter 11") allows
for "arrangements" to be made between debtor and creditors: an extension
or reduction of the debts.

If the company is traded in a stock exchange, the Securities and Exchange


Commission (SEC) of the USA advises the court as to the best procedure to
adopt in case of reorganization.

What chapter 11 teaches us is that:


American Law leans in favour of maintaining the company as an ongoing
concern. A whole is larger than the sum of its parts - and a living business is
sometimes worth more than the sum of its assets, sold separately.

A more in-depth study of the bankruptcy laws shows that they prescribe
three ways to tackle a state of malignant insolvency which threatens the well
being and the continued functioning of the firm:

Chapter 7 (1978 Act) – Liquidation


A District Court appoints an "interim trustee" with broad powers. Such a
trustee can also be appointed at the request of the creditors and by them.

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The Interim Trustee is empowered to do the following:


 liquidate property and make distribution of liquidating dividends to
creditors
 make management changes
 arrange unsecured financing for the firm
 operate the debtor business to prevent further losses

By filing a bond, the debtor (really, the owners of the debtor) is able to
regain possession of the business from the trustee.

Chapter 11 – Reorganization
Unless the court rules otherwise, the debtor remains in possession and in
control of the business and the debtor and the creditors are allowed to work
together flexibly. They are encouraged to reach a settlement by compromise
and agreement rather than by court adjudication.

Maybe the biggest legal revolution embedded in chapter 11 is the relaxation


of the age old ABSOLUTE PRIORITY rule that says that the claims of
creditors have categorical precedence over ownership claims. Rather, the
interests of the creditors have to be balanced with the interests of the
owners and even with the larger good of the community and society at large.

And so, chapter 11 allows the debtor and creditors to be in direct touch, to
negotiate payment schedules, the restructuring of old debts, even the
granting of new loans by the same disaffected creditors to the same
irresponsible debtor.

Chapter 10
Is sort of a legal hybrid, the offspring of chapters 7 and 11:

It allows for reorganization under a court appointed independent manager


(trustee) who is responsible mainly for the filing of reorganization plans with

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the court – and for verifying strict adherence to them by both debtor and
creditors.

Despite its clarity and business orientation, many countries found it difficult
to adapt to the pragmatic, non sentimental approach which led to the virtual
elimination of the absolute priority rule.

In England, for instance, the court appoints an official "receiver" to manage


the business and to realize the debtor’s assets on behalf of the creditors
(and also of the owners). His main task is to maximize the proceeds of the
liquidation and he continues to function until a court settlement is decreed
(or a creditor settlement is reached, prior to adjudication). When this
happens, the receivership ends and the receiver loses his status.

The receiver takes possession (but not title) of the assets and the affairs of
a business in a receivership. He collects rents and other income on behalf of
the firm.

So, British Law is much more in favour of the creditors. It recognizes the
supremacy of their claims over the property claims of the owners. Honouring
obligations – in the eyes of the British legislator and their courts – is the
cornerstone of efficient, thriving markets. The courts are entrusted with the
protection of this moral pillar of the economy.

Economies in transition are in transition not only economically – but also


legally. Thus, each one adopted its own version of the bankruptcy laws.

In Hungary – Bankruptcy is automatically triggered. Debt for equity swaps


are disallowed. Moreover, the law provides for a very short time to reach
agreement with creditors about reorganization of the debtor. These features
led to 4000 bankruptcies in the wake of the new law – a number which
mushroomed to 30,000 by 5/97.

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In the Czech Republic – the insolvency law comprises special cases


(over-indebtedness, for instance). It delineates two rescue programs:
a. A debt to equity swap (an alternative to bankruptcy) supervised by the
Ministry of Privatization.
b. The Consolidation Bank (founded by the State) can buy a firm’s
obligations, if it went bankrupt, at 60% of par.

But the law itself is toothless and lackadaisically applied by the incestuous
web of institutions in the country. Between 3/93 – 9/93 there were 1000
filings for insolvency, which resulted in only 30 commenced bankruptcy
procedures. There hasn’t been a single major bankruptcy in the Czech
Republic since then – and not for lack of candidates.

Poland is a special case. The pre-war (1934) law declares bankruptcy in a


state of lasting illiquidity and excessive indebtedness. Each creditor can
apply to declare a company bankrupt. An insolvent company is obliged to
file a maximum of 2 weeks following cessation of debt payments. There is a
separate liquidation law which allows for voluntary procedures.

Bad debts are transferred to base portfolios and have one of three fates:

1. Reorganization, debt-consolidation (a reduction of the debts, new terms,


debt for equity swaps) and a program of rehabilitation.
2. Sale of the corporate liabilities in auctions
3. Classic bankruptcy (happens in 23% of the cases of insolvency).

No one is certain what is the best model. The reason is that no one knows
the answers to the questions: Are the rights of the creditors superior to the
rights of the owners? Is it better to rehabilitate than to liquidate?

Until such time as these questions are answered and as long as the
corporate debt crisis deepens – we will witness a flowering of versions of
bankruptcy laws all over the world.

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Self Assessment Questions II

1. A ––––––––––––- is an organized program for employees of a


corporation allowing them to buy its shares.

2. ESOP stands for –––––––––––––––––––––.

3. A company can run liabilities which outweigh its assets. This is called
––––––––––––––––––––.

4. Once the assets of the company are sold, the first to be fully paid off are
––––––––––––––––– .

5.6 The Chief Financial Officer (CFO)


The CFO (Chief Financial Officer) is fervently hated by the workers. He is
thoroughly despised by other managers, mostly for scrutinizing their
expense accounts. He is dreaded by the owners of the firm because his
powers that often outweigh theirs. Shareholders hold him responsible in
annual meetings. When the financial results are good – they are attributed
to the talented Chief Executive Officer (CEO). When they are bad – the
Chief Financial Officer gets blamed for not enforcing budgetary discipline. It
is a no-win, thankless job. Very few make it to the top. Others retire, eroded
and embittered.

The job of the Chief Financial Officer is composed of many elements. Here
is a universal job description which is common throughout the West.

5.6.1 Organizational Affiliation


The Chief Financial Officer is subordinated to the Chief Executive Officer,
answers to him and regularly reports to him.

The CFO is in charge of:


1. The Finance Director
2. The Financing Department

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3. The Accounting Department which answers to him and regularly


reports to him.

Despite the above said, the CFO can report directly to the Board of
Directors through the person of the Chairman of the Board of Directors or by
direct summons from the Board of Directors.

In many developing countries, this would be considered treason – but, in the


West every function holder in the company can – and regularly is –
summoned by the (active) Board. A grilling session then ensues: debriefing
the officer and trying to spot contradictions between his testimony and
others’. The structure of business firms in the USA reflects its political
structure. The Board of Directors resembles Congress, the Management is
the Executive (President and Administration), the shareholders are the
people. The usual checks and balances are applied: the authorities are
supposedly separated and the Board criticizes the Management.

The same procedures are applied: the Board can summon a worker to
testify – the same way that the Senate holds hearings and cross-questions
workers in the administration. Lately, however, the delineation became
fuzzier with managers serving on the Board or, worse, colluding with it.
Ironically, Europe, where such incestuous practices were common hitherto –
is reforming itself with zeal (especially Britain and Germany).

Developing countries are still after the cosy, outdated European model.
Boards of Directors are rubber stamps, devoid of any will to exercise their
powers. They are staffed with cronies and friends and family members of
the senior management and they do and decide what the General Managers
tell them to do and to decide. General Managers – unchecked – get involved
in colossal blunders (not to mention worse). The concept of corporate
governance is alien to most firms in developing countries and companies

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are regarded by most general managers as milking cows – fast paths to


personal enrichment.

5.6.2 Functions
(1) To regulate, supervise and implement a timely, full and accurate set
of accounting books of the firm reflecting all its activities in a manner
commensurate with the relevant legislation and regulation in the
territories of operation of the firm and subject to internal guidelines set
from time to time by the Board of Directors of the firm.
This is somewhat difficult in developing countries. The books do not reflect
reality because they are "tax driven" (i.e., intended to cheat the tax
authorities out of tax revenues). Two sets of books are maintained: the real
one which incorporates all the income – and another one which is presented
to the tax authorities. This gives the CFO an inordinate power. He is in a
position to blackmail the management and the shareholders of the firm. He
becomes the information junction of the firm, the only one who has access
to the whole picture. If he is dishonest, he can easily enrich himself. But he
cannot be honest: he has to constantly lie and he does so as a life long
habit.

He (or she) develops a cognitive dissonance: I am honest with my superiors


– I only lie to the state.

(2) To implement continuous financial audit and control systems to


monitor the performance of the firm, its flow of funds, the adherence to
the budget, the expenditures, the income, the cost of sales and other
budgetary items.
In developing countries, this is often confused with central planning.
Financial control does not mean the waste of precious management
resources on verifying petty expenses. Nor does it mean a budget which
goes to such details as how many tea bags will be consumed by whom and

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where. Managers in developing countries still feel that they are being
supervised and followed, that they have quotas to complete, that they have
to act as though they are busy (even if they are, in reality, most of the time,
idle). So, they engage in the old time central planning and they do it through
the budget. This is wrong.

A budget in a firm is no different than the budget of the state. It has exactly
the same functions. It is a statement of policy, a beacon showing the way to
a more profitable future. It sets the strategic (and not the tactical) goals of
the firm: new products to develop, new markets to penetrate, new
management techniques to implement, possible collaborations, identification
of the competition, of the relative competitive advantages. Above all, a
budget must allocate the scarce resources of the firm in order to obtain a
maximum impact (=efficiently). All this, unfortunately, is missing from
budgets of firms in developing countries.

No less important are the control and audit mechanisms which go with the
budget. Audit can be external but must be complemented internally. It is the
job of the CFO to provide the management with a real time tool which
informs them what is happening in the firm and where are the problematic,
potential problem areas of activity and performance.

Additional functions of the CFO include:

(3) To timely, regularly and duly prepare and present to the Board of
Directors financial statements and reports as required by all pertinent
laws and regulations in the territories of the operations of the firm and
as deemed necessary and demanded from time to time by the Board of
Directors of the Firm.
The warning signs and barbed wire which separate the various organs of
the Western firm (management from Board of Directors and both from the
shareholders) – have yet to reach developing countries. As I said: the Board

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in these countries is full with the cronies of the management. In many


companies, the General Manager uses the Board as a way to secure the
loyalty of his cronies, friends and family members by paying them hefty fees
for their participation (and presumed contribution) in the meetings of the
Board. The poor CFO is loyal to the management – not to the firm. The firm
is nothing but a vehicle for self enrichment and does not exist in the Western
sense, as a separate functional entity which demands the undivided loyalty
of its officers. A weak CFO is rendered a pawn in these get-rich-quick
schemes – a stronger one becomes a partner. In both cases, he is forced to
collaborate, from time to time, with stratagems which conflict with his
conscience.

It is important to emphasize that not all the businesses in developing


countries are like that. In some places the situation is much better and
closer to the West. But geopolitical insecurity (what will be the future of
developing countries in general and my country in particular), political
insecurity (will my party remain in power), corporate insecurity (will my
company continue to exist in this horrible economic situation) and personal
insecurity (will I continue to be the General Manager) combine to breed
short-sightedness, speculative streaks, a drive to get rich while the going is
good (and thus rob the company) – and up to criminal tendencies.

(4) To comply with all reporting, accounting and audit requirements


imposed by the capital markets or regulatory bodies of capital markets
in which the securities of the firm are traded or are about to be traded
or otherwise listed.
The absence of a functioning capital market in many developing countries
and the inability of developing countries firms to access foreign capital
markets – make the life of the CFO harder and easier at the same time.
Harder – because there is nothing like a stock exchange listing to impose
discipline, transparency and long-term, management-independent strategic
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thinking on a firm. Discipline and transparency require an enormous amount


of investment by the financial structures of the firm: quarterly reports,
audited annual financial statements, disclosure of important business
developments, interaction with regulators (a tedious affair) – all fall within
the remit of the CFO. Why, therefore, should he welcome it?

Because discipline and transparency make the life of a CFO easier in the
long run. Just think how much easier it is to maintain one set of books
instead of two or to avoid conflicts with tax authorities on the one hand and
your management on the other.

(5) To prepare and present for the approval of the Board of Directors
an annual budget, other budgets, financial plans, business plans,
feasibility studies, investment memoranda and all other financial and
business documents as may be required from time to time by the
Board of Directors of the firm.
The primal sin in developing countries was so called “privatization”. The
laws were flawed. To mix the functions of management, workers and
ownership is detrimental to a firm, yet this is exactly the path that was
chosen in numerous developing countries. Management takeovers and
employee takeovers forced the new, impoverished, owners to rob the firm in
order to pay for their shares. Thus, they were unable to infuse the firm with
new capital, new expertise, or new management. Privatized companies are
dying slowly.

One of the problems thus wrought was the total confusion regarding the
organic structure of the firm. Boards were composed of friends and cronies
of the management because the managers also owned the firm – but they
could be easily fired by their own workers, who were also owners and so
on. These incestuous relationships introduced an incredible amount of
insecurity into management ranks (see previous point).

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(6) To alert the Board of Directors and to warn it regarding any


irregularity, lack of compliance, lack of adherence, lacunas and
problems whether actual or potential concerning the financial
systems, the financial operations, the financing plans, the accounting,
the audits, the budgets and any other matter of a financial nature or
which could or does have a financial implication.
The CFO is absolutely aligned and identified with the management. The
Board is meaningless. The concept of ownership is meaningless because
everyone owns everything and there are no identifiable owners (except in a
few companies). Absurdly, Communism (the common ownership of means
of production) has returned in full vengeance, though in disguise, precisely
because of the ostensibly most capitalist act of all, privatization.

(7) To collaborate and co-ordinate the activities of outside suppliers of


financial services hired or contracted by the firm, including
accountants, auditors, financial consultants, underwriters and brokers,
the banking system and other financial venues.
Many firms in developing countries (again, not all) are interested in collusion
– not in consultancy. Having hired a consultant or the accountant – they
believe that they own him. They are bitterly disappointed and enraged when
they discover that an accountant has to comply with the rules of his trade or
that a financial consultant protects his reputation by refusing to collaborate
with shenanigans of the management.
(8) To maintain a working relationship and to develop additional
relationships with banks, financial institutions and capital markets
with the aim of securing the funds necessary for the operations of the
firm, the attainment of its development plans and its investments.
One of the main functions of the CFO is to establish a personal relationship
with the firm’s bankers. The financial institutions which pass for banks in
developing countries lend money on the basis of personal acquaintance

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more than on the basis of analysis or rational decision making. This "old boy
network" substitutes for the orderly collection of data and credit rating of
borrowers. This also allows for favouritism and corruption in the banking
sector. A CFO who is unable to participate in these games is deemed by the
management to be "weak", "ineffective" or "no-good". The lack of non-bank
financing options and the general squeeze on liquidity make matters even
worse for the finance manager. He must collaborate with the skewed
practices and decision making processes of the banks – or perish.

(9) To fully computerize all the above activities in a combined


hardware-software and communications system which integrates with
the systems of other members of the group of companies.

(10) Otherwise, to initiate and engage in all manner of activities,


whether financial or other, conducive to the financial health, the
growth prospects and the fulfillment of investment plans of the firm to
the best of his ability and with the appropriate dedication of the time
and efforts required.
It is this point that occupies the working time of Western CFOs. It is their
brain that is valued – not their connections or cunning acts.

Self Assessment Questions III

1. The Chief Financial Officer is subordinated to ––––––––––––––.

2. The CFO can report directly to the Board of Directors through the person
of ––––––––––––––– .

5.7 Summary
Virtually every Western country has a "Small Business Administration"
(SBA). SBAs provide many valuable services to small businesses. They
assist the entrepreneur in the preparation of business plans, while providing

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access to government funds, to local venture capital funds, to international


and multilateral investment sources.

A new business goes through phases in the business cycle which have
discussed in brief in this unit.

A Stock Option Plan is an organized program for employees of a corporation


allowing them to buy its shares. Creative owners and shareholders use
stock options to provide their workers with an incentive to work for the
company and only for the company.

The Chief Financial Officer is subordinated to the Chief Executive Officer,


answers to him and regularly reports to him. The job of the Chief Financial
Officer is composed of many elements which have been discussed in this
unit.

5.8 Terminal Questions


1. Describe the valuable services provided by SBAs.

2. Explain different phases of a new business.

3. What is Stock Option Plan? Explain its benefits to the employees.

4. Explain the Bankruptcy Laws prevailing in the USA.

5. Describe the functions of Chief Financial Officer.

5.9 Answers to SAQs and TQs

SAQs I
1. True
2. False
3. True
4. True

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5. True
6. False

SAQs II
1. Stock Option Plan
2. Employee Stock Ownership Plan
3. Bankruptcy insolvency
4. The secured creditors

SAQs III
1. The Chief Executive Officer
2. The Chairman of the Board of Directors

Answers to TQs:
1. Refer to 5.2
2. Refer to 5.3
3. Refer to 5.4
4. Refer to 5.5
5. Refer to 5.6

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Unit 6 Decision Support Systems


Structure
6.1 Introduction
Objectives
6.2 Levels of Reporting and Flows of Data
6.2.1 The Daily Financial Statements
6.2.2 The Daily Ratios Report
6.2.3 Examples of the Ratios to be included in the Decision System
6.3 The Effects of Using a Decision System
Self Assessment Questions I
6.4 Valuing Stocks
6.5 The Process of Due Diligence
6.6 Financial Investor vs. Strategic Investor
6.7 Mortgage-backed Construction
6.8 Banking
6.9 Credit Cards
Self Assessment Questions II
6.10 Summary
6.11 Terminal Questions
6.12 Answers to SAQs and TQs

6.1 Introduction
Many companies in developing countries have a very detailed reporting
system going down to the level of a single product, a single supplier, a
single day. However, these reports – which are normally provided to the
General Manager – should not be used by them at all. They are too detailed
and, thus, tend to obscure the true picture. A General Manager must have a
bird's eye view of his company. He must be alerted to unusual happenings,
disturbing financial data and other irregularities.
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As things stand now, the following phenomena could happen:


 That the management will highly leverage the company by assuming
excessive debts burdening the cash flow of the company.
 That a false Profit and Loss (PNL) picture will emerge - both on the
single product level - and generally. This could lead to wrong decision-
making, based on wrong data.
 That the company will pay excessive taxes on its earnings.
 That the inventory will not be fully controlled and appraised centrally.
 That the wrong cash flow picture will distort the decisions of the
management and lead to wrong (even to dangerous) decisions.

The following section discusses how these phenomena could be handled.

Objectives:
After studying this unit, you will be able to:
 State the outcome of the detailed reporting system.
 Explain the levels of reporting and flows of data.
 Explain the method of valuation of stocks.
 Explain the process of Due Diligence.
 Distinguish between the ‘strategic investor’ and the ‘financial investor’.
 Explain the steps involved in a typical credit card transaction.

6.2 Levels of Reporting and Flows of Data


To assist in overcoming the above, there are four levels of reporting and
flows of data which every company should institute:

The first level is the annual budget of the company which is really a
business plan. The budget allocates amounts of money to every activity
and/or department of the firm.

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As time passes, the actual expenditures are compared to the budget in a


feedback loop. During the year, or at the end of the fiscal year, the firm
generates its financial statements: the income statement, the balance sheet,
the cash flow statement.

Put together, these four documents are the formal edifice of the firm's
finances. However, they can not serve as day-to-day guides to the General
Manager.

The second tier of financial audit and control is when the finance department
(equipped with proper software – Solomon IV is the most widely used in the
West) is able to produce pro forma financial statements monthly.

These financial statements, however inaccurate, provide a better sense of


the dynamics of the operation and should be constructed on the basis of
Western Accounting Principles (GAAP and FASBs, or IAS).

But the Manager should be able to open this computer daily and receive two
kinds of data, fully updated and fully integrated:
1. Daily financial statements
2. Daily ratios report.

6.2.1 The Daily Financial Statements


The Manager should have access to continuously updated statements of
income, cash flow, and a balance sheet. The most important statement is
that of the cash flow. The manager should be able to know, at each and
every stage, what his real cash situation is - as opposed to the theoretical
cash situation which includes accounts payable and account receivable in
the form of expenses and income.

These pro forma financial statements should include all the future flows of
money - whether invoiced or not. This way, the Manager will be able to type

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a future date into his computer and get the financial reports and statements
relating to that date.

In other words, the Manager will not be able to see only a present situation
of his company, but its future situation, fully analysed and fully updated.

Using today's technology - a wireless-connected laptop – Managers are


able to access all these data from anywhere in the world, from home, while
traveling, and so on.

6.2.2 The Daily Ratios Report


This is the most important part of the decision support system.

It enables the Manager to instantly analyse dozens of important aspects of


the functioning of his company. It allows him to compare the behaviour of
these parameters to historical data and to simulate the future functioning of
his company under different scenarios.

It also allows him to compare the performance of his company to the


performance of his competitors, other firms in his branch and to the overall
performance of the industry that he is operating in.

The Manager can review these financial and production ratios. Where there
is a strong deviation from historical patterns, or where the ratios warn about
problems in the future – management intervention may be required.

Instead of sifting through mountains of documents, the Manager will only


have to look at four computer screens in the morning, spot the alerts, read
the explanations offered by the software, check what is happening and
better prepare himself for the future.

6.2.3 Examples of the Ratios to be Included in the Decision System


a) SUE measure - deviation of actual profits from expected profits
b) ROE - the return on the adjusted equity capital
c) Debt to equity ratios

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d) ROA - the return on the assets


e) The financial average
f) ROS - the profit margin on the sales
g) ATO - asset turnover, how efficiently assets are used
h) Tax burden and interest burden ratios
i) Compounded leverage
j) Sales to fixed assets ratios
k) Inventory turnover ratios
l) Days receivable and days payable
m) Current ratio, quick ratio, interest coverage ratio and other liquidity
and coverage ratios
n) Valuation price ratios
o) And many others

6.3 The Effects of Using a Decision System


A decision system has great impact on the profits of the company. It forces
the management to rationalize the depreciation, inventory and inflation
policies. It warns the management against impending crises and problems
in the company. It specially helps in following areas:
 The management knows exactly how much credit it could take, for how
long (for which maturities) and in which interest rate. It has been proven
that without proper feedback, managers tend to take too much credit
and burden the cash flow of their companies.
 A decision system allows for careful financial planning and tax planning.
Profits go up, non cash outlays are controlled, tax liabilities are
minimized and cash flows are maintained positive throughout.

As a result of all the above effects, the value of the company grows and its
shares appreciate.

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The decision system is an integral part of financial management in the West.


It is completely compatible with western accounting methods and derives all
the data that it needs from information extant in the company.

So, the establishment of a decision system does not hinder the functioning
of the company in any way and does not interfere with the authority and
functioning of the financial department.

Decision Support Systems cost as little as 20,000 USD (all included:


software, hardware, and training). They are one of the best investments that
a firm can make.

Self Assessment Questions I


State whether the following statements are True or False:
1. The budget allocates amounts of money to every activity and / or
department of the firm.
2. A decision system has great impact on the profits of the company.
3. The establishment of a decision system hinders the functioning of the
company.
4. The Daily Ratios Report enables the Manager to instantly analyse
dozens of important aspects of the functioning of his company.

6.4 Valuing Stocks


The debate rages all over Eastern and Central Europe, in countries in
transition as well as in Western Europe. It raged in Britain during the 80s.

Is privatization really the robbery in disguise of State assets by a select few,


cronies of the political regime? Margaret Thatcher was accused of it - and
so were privatizers in developing countries. What price should State-owned
companies have fetched? This question is not as simple and straightforward
as it sounds.

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There is a stock pricing mechanism known as the Stock Exchange. Willing


buyers and willing sellers meet there to freely negotiate deals of stock
purchases and sales. New information, macro-economic and micro-
economic, determines the value of companies.

Greenspan testifies in the Senate, economic figures are released - and the
rumour mill starts working: interest rates might go up. The stock market
reacts with frenzily - it crashes. Why?

A top executive is asked how profitable will his firm be this quarter. He
winks, he grins - this is interpreted by Wall Street to mean that profits will go
up. The share price surges: no one wants to sell it, everyone wants to buy it.
The result: a sharp rise in its price. Why?

Moreover, the share price of a company of an identical size, similar financial


ratios (and in the same industry) barely budges. Why not?

We say that the stocks of the two companies have different elasticity (their
prices move up and down differently), probably the result of different
sensitivities to changes in interest rates and in earnings estimates. But this
is just to rename the problem. The question remains: Why do the shares of
similar companies react differently?

Economy is a branch of psychology and wherever and whenever humans


are involved, answers don't come easily. A few models have been
developed and are in wide use but it is difficult to say that any of them has
real predictive or even explanatory powers. Some of these models are
"technical" in nature: they ignore the fundamentals of the company. Such
models assume that all the relevant information is already incorporated in
the price of the stock and that changes in expectations, hopes, fears and
attitudes will be reflected in the prices immediately. Others are fundamental:
these models rely on the company's performance and assets. The former
models are applicable mostly to companies whose shares are traded

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publicly, in stock exchanges. They are not very useful in trying to attach a
value to the stock of a private firm. The latter type (fundamental) models can
be applied more broadly.

The value of a stock (a bond, a firm, real estate, or any asset) is the sum of
the income (cash flow) that a reasonable investor would expect to get in the
future, discounted at the appropriate rate. The discounting reflects the fact
that money received in the future has lower (discounted) purchasing power
than money received now. Moreover, we can invest money received now
and get interest on it (which should normally equal the discount). Put
differently: the discount reflects the loss in purchasing power of money
deferred or the interest lost by not being able to invest the money right
away. This is the time value of money.

Another problem is the uncertainty of future payments, or the risk that we


will never receive them. The longer the payment period, the higher the risk.
A model exists which links time, the value of the stock, the cash flows
expected in the future and the discount (interest) rates.

The rate that we use to discount future cash flows is the prevailing interest
rate. This is partly true in stable, predictable and certain economies. But the
discount rate depends on the inflation rate in the country where the firm is
located (or, if a multinational, in all the countries where it operates), on the
projected supply of and demand for its shares and on the aforementioned
risk of non-payment. In certain places, additional factors must be taken into
account (for example: country risk or foreign exchange risks).

The supply of a stock and, to a lesser extent, the demand for it determine its
distribution (how many shareowners are there) and, as a result, its liquidity.
Liquidity means how freely one can buy and sell it and at which quantities
sought or sold do prices become rigid.

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Example: If a controlling stake is sold - the buyer normally pays a "control


premium". Another example: In thin markets, it is easier to manipulate the
price of a stock by artificially increasing the demand or decreasing the
supply ("cornering" the market). In a liquid market (no problems to buy and
to sell), the discount rate is comprised of two elements: one is the risk-free
rate (normally, the interest payable on government bonds), the other being
the risk-related rate (the rate which reflects the risk related to the specific
stock).

But what is this risk-related rate?


The most widely used model to evaluate specific risks is the Capital Asset
Pricing Model (CAPM).

According to it, the discount rate is the risk-free rate plus a coefficient (called
beta) multiplied by a risk premium general to all stocks (in the USA it was
calculated to be 5.5%). Beta is a measure of the volatility of the return of the
stock relative to that of the return of the market. A stock's Beta can be
obtained by calculating the coefficient of the regression line between the
weekly returns of the stock and those of the stock market during a selected
period of time.

Unfortunately, different betas can be calculated by selecting different


parameters (for instance, the length of the period on which the calculation is
performed). Another problem is that betas change with every new datum.
Professionals resort to sensitivity tests which neutralize the changes that
betas undergo with time.

Still, with all its shortcomings and disputed assumptions, the CAPM should
be used to determine the discount rate. But to use the discount rate we must
have future cash flows to discount.

The only relatively certain cash flows are dividends paid to the shareholders.
So, Dividend Discount Models (DDM) were developed.

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Other models relate to the projected growth of the company (which is


supposed to increase the payable dividends and to cause the stock to
appreciate in value).

Still, DDM’s require, as input, the ultimate value of the stock and growth
models are only suitable for mature firms with a stable, low dividend growth.
Two-stage models are more powerful because they combine both
emphases, on dividends and on growth. This is because of the life-cycle of
firms. At first, they tend to have a high and unstable dividend growth rate
(the DDM tackles this adequately). As the firm matures, it is expected to
have a lower and stable growth rate, suitable for the treatment of Growth
Models.

But how many years of future income (from dividends) should we use in our
calculations? If a firm is profitable now, is there any guarantee that it will
continue to be so in the next year, or the next decade? If it does continue to
be profitable - who can guarantee that its dividend policy will not change and
that the same rate of dividends will continue to be distributed?

The number of periods (normally, years) selected for the calculation is called
the "price to earnings (P/E) multiple". The multiple denotes by how much we
multiply the (after tax) earnings of the firm to obtain its value. It depends on
the industry (growth or dying), the country (stable or geopolitically perilous),
on the ownership structure (family or public), on the management in place
(committed or mobile), on the product (new or old technology) and a myriad
of other factors. It is almost impossible to objectively quantify or formulate
this process of analysis and decision making. In telecommunications, the
range of numbers used for valuing stocks of a private firm is between 7 and
10, for instance. If the company is in the public domain, the number can
shoot up to 20 times net earnings.

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While some companies pay dividends (some even borrow to do so), others
do not. So in stock valuation, dividends are not the only future incomes you
would expect to get. Capital gains (profits which are the result of the
appreciation in the value of the stock) also count. This is the result of
expectations regarding the firm's free cash flow, in particular the free cash
flow that goes to the shareholders.

There is no agreement as to what constitutes free cash flow. In general, it is


the cash which a firm has after sufficiently investing in its development,
research and (predetermined) growth. Cash Flow Statements have become
a standard accounting requirement in the 80s (starting with the USA).
Because "free" cash flow can be easily extracted from these reports, stock
valuation based on free cash flow became increasingly popular and feasible.
Cash flow statements are considered independent of the idiosyncratic
parameters of different international environments and therefore applicable
to multinationals or to national, export-orientated firms.

The free cash flow of a firm that is debt-financed solely by its shareholders
belongs solely to them. Free cash flow to equity (FCFE) is:

FCFE = Operating Cash Flow MINUS Cash needed for meeting growth
targets

Where
Operating Cash Flow = Net Income (NI) PLUS Depreciation and
Amortization

Cash needed for meeting growth targets = Capital Expenditures + Change


in Working Capital

Working Capital = Total Current Assets - Total Current Liabilities

Change in Working Capital = One Year's Working Capital MINUS Previous


Year's Working Capital

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The complete formula is:


FCFE = Net Income PLUS
Depreciation and Amortization MINUS
Capital Expenditures PLUS
Change in Working Capital.
A leveraged firm that borrowed money from other sources (even from
preferred stock holders) exhibits a different free cash flow to equity. Its
CFCE must be adjusted to reflect the preferred dividends and principal
repayments of debt (MINUS sign) and the proceeds from new debt and
preferred stocks (PLUS sign). If its borrowings are sufficient to pay the
dividends to the holders of preference shares and to service its debt - its
debt to capital ratio is sound.

The FCFE of a leveraged firm is:


FCFE = Net Income PLUS
Depreciation and Amortization MINUS
Principal Repayment of Debt MINUS
Preferred Dividends PLUS
Proceeds from New Debt and Preferred MINUS
Capital Expenditures MINUS
Changes in Working Capital.

A sound debt ratio means:


FCFE = Net Income MINUS
(1 - Debt Ratio)*(Capital Expenditures MINUS
Depreciation and Amortization PLUS
Change in Working Capital).

6.5 The Process of Due Diligence


A business which wants to attract foreign investments must present a
business plan. But a business plan is the equivalent of a visit card. The

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introduction is very important - but, once the foreign investor has expressed
interest, a second, more serious, more onerous and more tedious process
commences: Due Diligence.

"Due Diligence" is a legal term (borrowed from the securities industry). It


means, essentially, to make sure that all the facts regarding the firm are
available and have been independently verified. In some respects, it is very
similar to an audit. All the documents of the firm are assembled and
reviewed, the management is interviewed and a team of financial experts,
lawyers and accountants descends on the firm to analyze it.

First Rule:
The firm must appoint ONE due diligence coordinator. This person
interfaces with all outside due diligence teams. He collects all the materials
requested and oversees all the activities which make up the due diligence
process.

The firm must have ONE VOICE. Only one person represents the company,
answers questions, makes presentations and serves as a coordinator when
the DD teams wish to interview people connected to the firm.

Second Rule:
Brief your workers. Give them the big picture. Why is the company raising
funds, who are the investors, how will the future of the firm (and their
personal future) look if the investor comes in. Both employees and
management must realize that this is a top priority. They must be instructed
not to lie. They must know the DD coordinator and the company's
spokesman in the DD process.

The DD is a process which is more structured than the preparation of a


Business Plan. It is confined both in time and in subjects: Legal, Financial,
Technical, Marketing, Controls.

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The Marketing Plan


Must include the following elements:
 A brief history of the business (to show its track performance and
growth)
 Points regarding the political, legal (licences) and competitive
environment
 A vision of the business in the future
 Products and services and their uses
 Comparison of the firm's products and services to those of the
competitors
 Warranties, guarantees and after-sales service
 Development of new products or services
 A general overview of the market and market segmentation
 Is the market rising or falling (the trend: past and future)
 What customer needs do the products / services satisfy
 Which markets segments do we concentrate on and why
 What factors are important in the customer's decision to buy (or not to
buy)
 A list of the direct competitors and a short description of each
 The strengths and weaknesses of the competitors relative to the firm
 Missing information regarding the markets, the clients and the
competitors
 Planned market research
 A sales forecast by product group
 The pricing strategy (how is pricing decided)
 Promotion of the sales of the products (including a description of the
sales force, sales-related incentives, sales targets, training of the sales
personnel, special offers, dealerships, telemarketing and sales support).

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Attach a flow chart of the purchasing process from the moment that the
client is approached by the sales force until he buys the product.
 Marketing and advertising campaigns (including cost estimates) - broken
by market and by media
 Distribution of the products
 A flow chart describing the receipt of orders, invoicing, shipping.
 Customer after-sales service (hotline, support, maintenance, complaints,
upgrades, etc.)
 Customer loyalty (example: churn rate and how is it monitored and
controlled).

Legal Details
 Full name of the firm
 Ownership of the firm
 Court registration documents
 Copies of all protocols of the Board of Directors and the General
Assembly of Shareholders
 Signatory rights backed by the appropriate decisions
 The charter (statute) of the firm and other incorporation documents
 Copies of licences granted to the firm
 A legal opinion regarding the above licences
 A list of lawsuit that were filed against the firm and that the firm filed
against third parties (litigation) plus a list of disputes which are likely to
reach the courts
 Legal opinions regarding the possible outcomes of all the lawsuits and
disputes including their potential influence on the firm

Financial Due Diligence


 Last 3 years income statements of the firm or of constituents of the firm,
if the firm is the result of a merger. The statements have to include:

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 Balance Sheets
 Income Statements
 Cash Flow statements
 Audit reports (preferably done according to the International Accounting
Standards, or, if the firm is looking to raise money in the USA, in
accordance with FASB)
 Cash Flow Projections and the assumptions underlying them

Controls
 Accounting systems used
 Methods to price products and services
 Payment terms, collections of debts and ageing of receivables
 Introduction of international accounting standards
 Monitoring of sales
 Monitoring of orders and shipments
 Keeping of records, filing, archives
 Cost accounting system
 Budgeting and budget monitoring and controls
 Internal audits (frequency and procedures)
 External audits (frequency and procedures)
 The banks that the firm is working with: history, references, balances

Technical Plan
 Description of manufacturing processes (hardware, software,
communications, other)
 Need for know-how, technological transfer and licensing required
 Suppliers of equipment, software, services (including offers)
 Manpower (skilled and unskilled)
 Infrastructure (power, water, etc.)
 Transport and communications (example: satellites, lines, receivers,
transmitters)
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 Raw materials: sources, cost and quality


 Relations with suppliers and support industries
 Import restrictions or licensing (where applicable)
 Sites, technical specification
 Environmental issues and how they are addressed
 Leases, special arrangements
 Integration of new operations into existing ones (protocols, etc.)

A successful due diligence is the key to an eventual investment. This is a


process much more serious and important than the preparation of the
Business Plan.

6.6 Financial Investor vs. Strategic Investor


In the not so distant past, there was little difference between financial and
strategic investors. Investors of all colors sought to safeguard their
investment by taking over as many management functions as they could.
Additionally, investments were small and shareholders few. A firm
resembled a household and the number of people involved – in ownership
and in management – was correspondingly limited. People invested in
industries they were acquainted with first hand.

As markets grew, the scales of industrial production (and of service


provision) expanded. A single investor (or a small group of investors) could
no longer accommodate the needs even of a single firm. As knowledge
increased and specialization ensued – it was no longer feasible or possible
to micro-manage a firm one invested in. Actually, separate businesses of
money making and business management emerged. An investor was
expected to excel in obtaining high yields on his capital – not in industrial
management or in marketing. A manager was expected to manage, not to
be capable of personally tackling the various and varying tasks of the
business that he managed.

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Thus, two classes of investors emerged. One type supplied firms with
capital. The other type supplied them with know-how, technology,
management skills, marketing techniques, intellectual property, clientele and
a vision, a sense of direction.

In many cases, the strategic investor also provided the necessary funding.
But, more and more, a separation was maintained. Venture capital and risk
capital funds, for instance, are purely financial investors. So are, to a
growing extent, investment banks and other financial institutions.

The financial investor represents the past. Its money is the result of past -
right and wrong - decisions. Its orientation is short term: an "exit strategy" is
sought as soon as feasible. For “exit strategy” read quick profits. The
financial investor is always on the lookout, searching for willing buyers for
his stake. The stock exchange is a popular exit strategy. The financial
investor has little interest in the company's management. Optimally, his
money buys for him not only a good product and a good market, but also a
good management. But his interpretation of the rolls and functions of "good
management" are very different to that offered by the strategic investor. The
financial investor is satisfied with a management team which maximizes
value. The price of his shares is the most important indication of success.
This is "bottom line" short termism which also characterizes operators in the
capital markets. Invested in so many ventures and companies, the financial
investor has no interest, nor the resources to get seriously involved in any
one of them. Micro-management is left to others - but, in many cases, so is
macro-management. The financial investor participates in quarterly or
annual general shareholders meetings. This is the extent of its involvement.

The strategic investor, on the other hand, represents the real long term
accumulator of value. Paradoxically, it is the strategic investor that has the
greater influence on the value of the company's shares. The quality of

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management, the rate of the introduction of new products, the success or


failure of marketing strategies, the level of customer satisfaction, the
education of the workforce - all depend on the strategic investor. That there
is a strong relationship between the quality and decisions of the strategic
investor and the share price is small wonder. The strategic investor
represents a discounted future in the same manner that shares do. Indeed,
gradually, the balance between financial investors and strategic investors is
shifting in favour of the latter. People understand that money is abundant
and what is in short supply is good management. Given the ability to create
a brand, to generate profits, to issue new products and to acquire new
clients - money is abundant.

These are the functions normally reserved to financial investors:

Financial Management
The financial investor is expected to take over the financial management of
the firm and to directly appoint the senior management and, especially, the
management echelons, which directly deal with the finances of the firm.
1. To regulate, supervise and implement a timely, full and accurate set of
accounting books of the firm reflecting all its activities in a manner
commensurate with the relevant legislation and regulation in the
territories of operations of the firm and with internal guidelines set from
time to time by the Board of Directors of the firm. This is usually
achieved both during a Due Diligence process and later, as financial
management is implemented.
2. To implement continuous financial audit and control systems to
monitor the performance of the firm, its flow of funds, the adherence to
the budget, the expenditures, the income, the cost of sales and other
budgetary items.
3. To timely, regularly and duly prepare and present to the Board of
Directors financial statements and reports as required by all pertinent

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laws and regulations in the territories of the operations of the firm and
as deemed necessary and demanded from time to time by the Board
of Directors of the Firm.
4. To comply with all reporting, accounting and audit requirements
imposed by the capital markets or regulatory bodies of capital markets
in which the securities of the firm are traded or are about to be traded
or otherwise listed.
5. To prepare and present for the approval of the Board of Directors an
annual budget, other budgets, financial plans, business plans,
feasibility studies, investment memoranda and all other financial and
business documents as may be required from time to time by the
Board of Directors of the Firm.
6. To alert the Board of Directors and to warn it regarding any irregularity,
lack of compliance, lack of adherence, lacunas and problems whether
actual or potential concerning the financial systems, the financial
operations, the financing plans, the accounting, the audits, the budgets
and any other matter of a financial nature or which could or does have
a financial implication.
7. To collaborate and coordinate the activities of outside suppliers of
financial services hired or contracted by the firm, including
accountants, auditors, financial consultants, underwriters and brokers,
the banking system and other financial venues.
8. To maintain a working relationship and to develop additional
relationships with banks, financial institutions and capital markets with
the aim of securing the funds necessary for the operations of the firm,
the attainment of its development plans and its investments.
9. To fully computerize all the above activities in a combined hardware-
software and communications system which will integrate into the
systems of other members of the group of companies.

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10. Otherwise, to initiate and engage in all manner of activities, whether


financial or of other nature, conducive to the financial health, the
growth prospects and the fulfillment of investment plans of the firm to
the best of his ability and with the appropriate dedication of the time
and efforts required.

Collection and Credit Assessment


1. To construct and implement credit risk assessment tools,
questionnaires, quantitative methods, data gathering methods and
venues in order to properly evaluate and predict the credit risk rating of a
client, distributor, or supplier.
2. To constantly monitor and analyse the payment morale, regularity, non-
payment and non-performance events, etc. – in order to determine the
changes in the credit risk rating of said factors.
3. To analyse receivables and collectibles on a regular and timely basis.
4. To improve the collection methods in order to reduce the amounts of
arrears and overdue payments, or the average period of such arrears
and overdue payments.
5. To collaborate with legal institutions, law enforcement agencies and
private collection firms in assuring the timely flow and payment of all due
payments, arrears and overdue payments and other collectibles.
6. To coordinate an educational campaign to ensure the voluntary
collaboration of the clients, distributors and other debtors in the timely
and orderly payment of their dues.

The strategic investor is, usually, put in charge of the following:

Project Planning and Project Management


The strategic investor is uniquely positioned to plan the technical side of the
project and to implement it. He is, therefore, put in charge of:

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 The selection of infrastructure, equipment, raw materials, industrial


processes, etc.
 Negotiations and agreements with providers and suppliers
 Minimizing the costs of infrastructure by deploying proprietary
components and planning
 The provision of corporate guarantees and letters of comfort to suppliers
 The planning and erecting of the various sites, structures, buildings,
premises, factories, etc.
 The planning and implementation of line connections, computer network
connections, protocols, solving issues of compatibility (hardware and
software, etc.)
 Project planning, implementation and supervision

Marketing and Sales


1. The presentation to the Board an annual plan of sales and marketing
including: market penetration targets, profiles of potential social and
economic categories of clients, sales promotion methods, advertising
campaigns, image, public relations and other media campaigns. The
strategic investor also implements these plans or supervises their
implementation.
2. The strategic investor is usually possessed of a brandname recognized
in many countries. It is the market leaders in certain territories. It has
been providing goods and services to users for a long period of time,
reliably. This is an important asset, which, if properly used, can attract
users. The enhancement of the brand name, its recognition and market
awareness, market penetration, co-branding, collaboration with other
suppliers – are all the responsibilities of the strategic investor.
3. The dissemination of the product as a preferred choice among vendors,
distributors, individual users and businesses in the territory.

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4. Special events, sponsorships, collaboration with businesses.


5. The planning and implementation of incentive systems (e.g., points,
vouchers).
6. The strategic investor usually organizes a distribution and dealership
network, a franchising network, or a sales network (retail chains)
including: training, pricing, pecuniary and quality supervision, network
control, inventory and accounting controls, advertising, local marketing
and sales promotion and other network management functions.
7. The strategic investor is also in charge of "vision thinking": new methods
of operation, new marketing ploys, new market niches, predicting the
future trends and market needs, market analyses and research, etc.

The strategic investor typically brings to the firm valuable experience in


marketing and sales. It has numerous off the shelf marketing plans and
drawer sales promotion campaigns. It developed software and personnel
capable of analysing any market into effective niches and of creating the
right media (image and PR), advertising and sales promotion drives best-
suited for it. It has built large databases with multi-year profiles of the
purchasing patterns and demographic data related to thousands of clients in
many countries. It owns libraries of material, images, sounds, paper
clippings, articles, PR and image materials, and proprietary trademarks and
brand names. Above all, it accumulated years of marketing and sales
promotion ideas which crystallized into a new conception of the business.

Technology
1. The planning and implementation of new technological systems up to
their fully operational phase. The strategic partner's engineers are
available to plan, implement and supervise all the stages of the
technological side of the business.
2. The planning and implementation of a fully operative computer system
(hardware, software, communication, intranet) to deal with all the

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aspects of the structure and the operation of the firm. The strategic
investor puts at the disposal of the firm proprietary software developed
by it and specifically tailored to the needs of companies operating in the
firm's market.
3. The encouragement of the development of in-house, proprietary,
technological solutions to the needs of the firm, its clients and suppliers.
4. The planning and the execution of an integration program with new
technologies in the field, in collaboration with other suppliers or market
technological leaders.

Education and Training


The strategic investor is responsible to train all the personnel in the firm:
operators, customer services, distributors, vendors, sales personnel. The
training is conducted at its sole expense and includes tours of its facilities
abroad.

The entrepreneurs – who sought to introduce the two types of investors, in


the first place – are usually left with the following functions:

Administration and Control


1. To structure the firm in an optimal manner, most conducive to the
conduct of its business and to present the new structure for the Board's
approval within 30 days from the date of the GM's appointment.
2. To run the day to day business of the firm.
3. To oversee the personnel of the firm and to resolve all the personnel
issues.
4. To secure the unobstructed flow of relevant information and the
protection of confidential organization.
5. To represent the firm in its contacts, representations and negotiations
with other firms, authorities, or persons.

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This is why entrepreneurs find it very hard to cohabitate with investors of


any kind. Entrepreneurs are excellent at identifying the needs of the market
and at introducing technological or service solutions to satisfy such needs.
But the very personality traits which qualify them to become entrepreneurs –
also hinder the future development of their firms. Only the introduction of
outside investors can resolve the dilemma. Outside investors are not
emotionally involved. They may be less visionary – but also more
experienced.

They are more interested in business results than in dreams. And – being
well acquainted with entrepreneurs – they insist on having unmitigated
control of the business, for fear of losing all their money. These things
antagonize the entrepreneurs. They feel that they are losing their creation to
cold-hearted, mean spirited, corporate predators. They rebel and prefer to
remain small or even to close shop than to give up their cherished
freedoms. This is where nine out of ten entrepreneurs fail - in knowing when
to let go.

6.7 Mortgage-backed Construction


The Buyers
1. The Buyers of residential property form an Association.
2. The Buyers’ Association signs a contract with a construction company
chosen by open and public tender.
3. The contract with the construction company is for the construction of
residential property to be owned by the Buyers.
4. The Buyers secure financing from the Bank (see below).
5. The Buyers then pay the construction company 25% of the final value of
the property to be constructed in advance (=Buyer’s Equity). This money
is the Buyers’ own funds, out of pocket – NOT received from the Banks.

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6. The Buyers Association together with the Banks appoints supervisors to


oversee the work done by the construction company: its quality and
adherence to schedule.

The Banks
1. The government provides a last resort guarantee to the commercial
banks. This guarantee can be used ONLY AFTER the banks have
exhausted all other legal means of materializing a collateral or seizing
the assets of a delinquent debtor in default.
2. Against this guarantee, the commercial banks issue 10 years mortgages
(=lend money with a repayment period of 120 months) to the private
Buyers of residential property.
3. The money lent to the Buyers (=the mortgages) REMAINS in the bank. It
is NOT be given to the Buyers.
4. The mortgage loan covers a maximum of 75% of the final value of the
property to be constructed according to appraisals by experts.
5. A lien in favour of the bank is placed on the land and property on it – to
be built using the Bank’s money and the Buyers’ equity. Each Buyer
pledges only HIS part of the property (for instance, ONLY the apartment
being constructed for HIM). This lien is an inseparable part of the
mortgage (loan) contract each and every buyer signs. It is registered in
the Registrar of Mortgages and the Courts.

The Construction Company


1. The construction companies use the advance of 25% to start the
construction of the residential property – to buy the land, lay the
foundations and start the skeleton. All the property belongs to the
BUYERS and is registered solely to their names. The Banks have a lien
of the property, as per above.
2. When the advance-money is finished, the construction company notifies
the BUYERS.

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3. The Buyers then approach the Bank for additional money to be taken
from the mortgage loans deposited at the Bank (=the money that the
Bank lent the Buyers).
4. The Bank verifies that the construction is progressing according to
schedule and according to quality standards set in the construction
contract.
5. If everything is according to contract, the Bank releases the next tranche
(lot) of financing to the Buyers, who then forward it to the construction
firm.
6. The funds that the Buyers borrowed from the Banks are released in a
few tranches according to the progress of the construction work. When
the construction is finished – the funds should be completely exhausted
(=used).

When The Construction is Finished


1. The construction company will have received 100% of the price agreed
in the contract.
2. The Buyers can move into the apartments.
3. The Buyers go on repaying the mortgage loans to the Banks.
4. As long as the mortgage loan is not fully paid – the lien on the property
in favour of the Bank remains. It is lifted (=cancelled) once the mortgage
loan and the interest and charges thereof has been fully repaid by the
Buyers.

While the Mortgage Loan is Being Repaid…


1. The Buyers can rent the apartment.
2. The Buyers can live in the apartment.
3. The Buyers can sell the apartment only with the agreement of the
Bank – or if they pre-pay the remaining balance of the mortgage loan to
the Bank.

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4. The Banks can securitize the mortgage pool and sell units or mortgage
backed bonds to the public. This means that the Banks can sell to the
public pass-through certificates - securities backed by an underlying
pool of mortgages of various maturities and interest rates. This way the
Banks can replenish their capital stock and re-enter the mortgage
market.

6.8 Banking
Banks are institutions where miracles happen regularly. We rarely entrust
our money to anyone but ourselves – and our banks. Despite a very
chequered history of mismanagement, corruption, false promises and
representations, delusions and behavioural inconsistency – banks still
succeed to motivate us to give them our money. Partly it is the feeling that
there is safety in numbers. The fashionable term today is "moral hazard".
The implicit guarantees of the state and of other financial institutions move
us to take risks which we would, otherwise, have avoided. Partly it is the
sophistication of the banks in marketing and promoting themselves and their
products. Glossy brochures, professional computer and video presentations
and vast, shrine-like, real estate complexes all serve to enhance the image
of the banks as the temples of the new religion of money.

But what is behind all this? How can we judge the soundness of our banks?
In other words, how can we tell if our money is safely tucked away in a safe
haven?

The reflex is to go to the bank's balance sheets. Banks and balance sheets
have been both invented in their modern form in the 15th century. A balance
sheet, coupled with other financial statements is supposed to provide us
with a true and full picture of the health of the bank, its past and its long-
term prospects. The surprising thing is that – despite common opinion – it
does.

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But it is rather useless unless you know how to read it.

Financial statements (Income – or Profit and Loss - Statement, Cash Flow


Statement and Balance Sheet) come in many forms. Sometimes they
conform to Western accounting standards (the Generally Accepted
Accounting Principles, GAAP, or the less rigorous and more fuzzily worded
International Accounting Standards, IAS). Otherwise, they conform to local
accounting standards, which often leave a lot to be desired. Still, you should
look for banks, which make their updated financial reports available to you.
The best choice would be a bank that is audited by one of the Big Four
Western accounting firms and makes its audit reports publicly available.
Such audited financial statements should consolidate the financial results of
the bank with the financial results of its subsidiaries or associated
companies. A lot often hides in those corners of corporate holdings.

Banks are rated by independent agencies. The most famous and most
reliable of the lot is Fitch Ratings. Another one is Moody’s. These agencies
assign letter and number combinations to the banks that reflect their
stability. Most agencies differentiate the short term from the long term
prospects of the banking institution rated. Some of them even study (and
rate) issues, such as the legality of the operations of the bank (legal rating).
Ostensibly, all a concerned person has to do, therefore, is to step up to the
bank manager, muster courage and ask for the bank's rating. Unfortunately,
life is more complicated than rating agencies would have us believe.

They base themselves mostly on the financial results of the bank rated as a
reliable gauge of its financial strength or financial profile. Nothing is further
from the truth.

Admittedly, the financial results do contain a few important facts. But one
has to look beyond the naked figures to get the real – often much less
encouraging – picture.

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Consider the thorny issue of exchange rates. Financial statements are


calculated (sometimes stated in USD in addition to the local currency) using
the exchange rate prevailing on the 31st of December of the fiscal year (to
which the statements refer). In a country with a volatile domestic currency
this would tend to completely distort the true picture. This is especially true if
a big chunk of the activity preceded this arbitrary date. The same applies to
financial statements, which were not inflation-adjusted in high inflation
countries. The statements will look inflated and even reflect profits where
heavy losses were incurred. "Average amounts" accounting (which makes
use of average exchange rates throughout the year) is even more
misleading. The only way to truly reflect reality is if the bank were to keep
two sets of accounts: one in the local currency and one in USD (or in some
other currency of reference). Otherwise, fictitious growth in the asset base
(due to inflation or currency fluctuations) could result.

Another example: in many countries, changes in regulations can greatly


effect the financial statements of a bank. In 1996, in Russia, for example,
the Bank of Russia changed the algorithm for calculating an important
banking ratio (the capital to risk weighted assets ratio).

Unless a Russian bank restated its previous financial statements


accordingly, a sharp change in profitability appeared from nowhere.

The net assets themselves are always misstated: the figure refers to the
situation on 31/12. A 48-hour loan given to a collaborating client can inflate
the asset base on the crucial date. This misrepresentation is only mildly
ameliorated by the introduction of an "average assets" calculus. Moreover,
some of the assets can be interest earning and performing – others, non-
performing. The maturity distribution of the assets is also of prime
importance. If most of the bank's assets can be withdrawn by its clients on a

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very short notice (on demand) – it can swiftly find itself in trouble with a run
on its assets leading to insolvency.

Another oft-used figure is the net income of the bank. It is important to


distinguish interest income from non-interest income. In an open,
sophisticated credit market, the income from interest differentials should be
minimal and reflect the risk plus a reasonable component of income to the
bank. But in many countries (Japan, Russia) the government subsidizes
banks by lending them money cheaply (through the Central Bank or through
bonds). The banks then proceed to lend the cheap funds at exorbitant rates
to their customers, thus reaping enormous interest income. In many
countries the income from government securities is tax free, which
represents another form of subsidy. A high income from interest is a sign of
weakness, not of health, here today, gone tomorrow. The preferred indicator
should be income from operations (fees, commissions and other charges).

There are a few key ratios to observe. A relevant question is whether the
bank is accredited with international banking agencies. These issue
regulatory capital requirements and other mandatory ratios. Compliance
with these demands is a minimum in the absence of which, the bank should
be regarded as positively dangerous.

The return on the bank's equity (ROE) is the net income divided by its
average equity. The return on the bank's assets (ROA) is its net income
divided by its average assets. The (tier 1 or total) capital divided by the
bank's risk weighted assets – a measure of the bank's capital adequacy.
Most banks follow the provisions of the Basel Accord as set by the Basel
Committee of Bank Supervision (also known as the G10). This could be
misleading because the Accord is ill equipped to deal with risks associated
with emerging markets, where default rates of 33% and more are the norm.
Finally, there is the common stock to total assets ratio. But ratios are not

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cure-alls. Inasmuch as the quantities that comprise them can be toyed


with – they can be subject to manipulation and distortion. It is true that it is
better to have high ratios than low ones. High ratios are indicative of a
bank's underlying strength, reserves, and provisions and, therefore, of its
ability to expand its business. A strong bank can also participate in various
programs, offerings and auctions of the Central Bank or of the Ministry of
Finance. The larger the share of the bank's earnings that is retained in the
bank and not distributed as profits to its shareholders – the better these
ratios and the bank's resilience to credit risks.

Still, these ratios should be taken with more than a grain of salt. Not even
the bank's profit margin (the ratio of net income to total income) or its asset
utilization coefficient (the ratio of income to average assets) should be relied
upon. They could be the result of hidden subsidies by the government and
management misjudgement or understatement of credit risks.

To elaborate on the last two points:


A bank can borrow cheap money from the Central Bank (or pay low interest
to its depositors and savers) and invest it in secure government bonds,
earning a much higher interest income from the bonds' coupon payments.
The end result: a rise in the bank's income and profitability due to a non-
productive, non-lasting arbitrage operation. Otherwise, the bank's
management can understate the amounts of bad loans carried on the bank's
books, thus decreasing the necessary set-asides and increasing profitability.
The financial statements of banks largely reflect the management's
appraisal of the business. This has proven to be a poor guide.

In the main financial results page of a bank's books, special attention should
be paid to provisions for the devaluation of securities and to the unrealized
difference in the currency position. This is especially true if the bank is
holding a major part of the assets (in the form of financial investments or of

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loans) and the equity is invested in securities or in foreign exchange


denominated instruments.

Separately, a bank can be trading for its own position (the Nostro), either as
a market maker or as a trader. The profit (or loss) on securities trading has
to be discounted because it is conjectural and incidental to the bank's main
activities: deposit taking and loan making.

Most banks deposit some of their assets with other banks. This is normally
considered to be a way of spreading the risk. But in highly volatile
economies with sickly, underdeveloped financial sectors, all the institutions
in the sector are likely to move in tandem (a highly correlated market). Cross
deposits among banks only serve to increase the risk of the depositing bank
(as the recent affair with Toko Bank in Russia and the banking crisis in
South Korea have demonstrated).

Further closer to the bottom line are the bank's operating expenses:
salaries, depreciation, fixed or capital assets (real estate and equipment)
and administrative expenses. The rule of thumb is: the higher these
expenses, the weaker the bank. The great historian Toynbee once said that
great civilizations collapse immediately after they bequeath to us the most
impressive buildings. This is doubly true with banks. If you see a bank
fervently engaged in the construction of palatial branches – stay away from
it.

Banks are risk arbitrageurs. They live off the mismatch between assets and
liabilities. To the best of their ability, they try to second guess the markets
and reduce such a mismatch by assuming part of the risks and by engaging
in portfolio management. For this they charge fees and commissions,
interest and profits – which constitute their sources of income.

If any expertise is imputed to the banking system, it is risk management.


Banks are supposed to adequately assess, control and minimize credit

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risks. They are required to implement credit rating mechanisms (credit


analysis and value at risk – VAR – models), efficient and exclusive
information-gathering systems, and to put in place the right lending policies
and procedures.

Just in case they misread the market risks and these turned into credit risks
(which happens only too often), banks are supposed to put aside amounts
of money which could realistically offset loans gone sour or future non-
performing assets. These are the loan loss reserves and provisions. Loans
are supposed to be constantly monitored, reclassified and charges made
against them as applicable. If you see a bank with zero reclassifications,
charge offs and recoveries – either the bank is lying through its teeth, or it is
not taking the business of banking too seriously, or its management is no
less than divine in its prescience. What is important to look at is the rate of
provision for loan losses as a percentage of the loans outstanding. Then it
should be compared to the percentage of non-performing loans out of the
loans outstanding. If the two figures are out of kilter, either someone is
pulling your leg – or the management is incompetent or lying to you. The
first thing new owners of a bank do is, usually, improve the placed asset
quality (a polite way of saying that they get rid of bad, non-performing loans,
whether declared as such or not). They do this by classifying the loans.
Most central banks in the world have in place regulations for loan
classification and if acted upon, these yield rather more reliable results than
any management's "appraisal", no matter how well intentioned.

In some countries the Central Bank (or the Supervision of the Banks) forces
banks to set aside provisions against loans at the highest risk categories,
even if they are performing. This, by far, should be the preferable method.

Of the two sides of the balance sheet, the assets side is the more critical.
Within it, the interest earning assets deserve the greatest attention. What

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percentage of the loans is commercial and what percentage given to


individuals? How many borrowers are there (risk diversification is inversely
proportional to exposure to single or large borrowers)? How many of the
transactions are with "related parties"? How much is in local currency and
how much in foreign currencies (and in which)? A large exposure to foreign
currency lending is not necessarily healthy. A sharp, unexpected
devaluation could move a lot of the borrowers into non-performance and
default and, thus, adversely affect the quality of the asset base. In which
financial vehicles and instruments is the bank invested? How risky are they?
And so on.

No less important is the maturity structure of the assets. It is an integral part


of the liquidity (risk) management of the bank. The crucial question is: what
are the cash flows projected from the maturity dates of the different assets
and liabilities – and how likely are they to materialize. A rough matching has
to exist between the various maturities of the assets and the liabilities. The
cash flows generated by the assets of the bank must be used to finance the
cash flows resulting from the banks' liabilities. A distinction has to be made
between stable and hot funds (the latter in constant pursuit of higher yields).
Liquidity indicators and alerts have to be set in place and calculated a few
times daily.

Gaps (especially in the short term category) between the bank's assets and
its liabilities are a very worrisome sign. But the bank's macroeconomic
environment is as important to the determination of its financial health and of
its creditworthiness as any ratio or micro-analysis. The state of the financial
markets sometimes has a larger bearing on the bank's soundness than
other factors. A fine example is the effect that interest rates or a devaluation
have on a bank's profitability and capitalization. The implied (not to mention
the explicit) support of the authorities, of other banks and of investors
(domestic as well as international) sets the psychological background to any

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future developments. This is only too logical. In an unstable financial


environment, knock-on effects are more likely. Banks deposit money with
other banks on a security basis. Still, the value of securities and collaterals
is as good as their liquidity and as the market itself. The very ability to do
business (for instance, in the syndicated loan market) is influenced by the
larger picture. Falling equity markets herald trading losses and loss of
income from trading operations and so on.

Perhaps the single most important factor is the general level of interest rates
in the economy. It determines the present value of foreign exchange and
local currency denominated government debt. It influences the balance
between realized and unrealized losses on longer-term (commercial or
other) paper. One of the most important liquidity generation instruments is
the repurchase agreement (repo). Banks sell their portfolios of government
debt with an obligation to buy it back at a later date. If interest rates shoot
up – the losses on these repos can trigger margin calls (demands to
immediately pay the losses or else materialize them by buying the securities
back).

Margin calls are a drain on liquidity. Thus, in an environment of rising


interest rates, repos could absorb liquidity from the banks, deflate rather
than inflate. The same principle applies to leverage investment vehicles
used by the bank to improve the returns of its securities trading operations.
High interest rates here can have an even more painful outcome. As liquidity
is crunched, the banks are forced to materialize their trading losses. This is
bound to put added pressure on the prices of financial assets, trigger more
margin calls and squeeze liquidity further. It is a vicious circle of a
monstrous momentum once commenced.

But high interest rates, as we mentioned, also strain the asset side of the
balance sheet by applying pressure to borrowers. The same goes for a

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devaluation. Liabilities connected to foreign exchange grow with a


devaluation with no (immediate) corresponding increase in local prices to
compensate the borrower. Market risk is thus rapidly transformed to credit
risk. Borrowers default on their obligations. Loan loss provisions need to be
increased, eating into the bank's liquidity (and profitability) even further.
Banks are then tempted to play with their reserve coverage levels in order to
increase their reported profits and this, in turn, raises a real concern
regarding the adequacy of the levels of loan loss reserves. Only an increase
in the equity base can then assuage the (justified) fears of the market but
such an increase can come only through foreign investment, in most cases.
And foreign investment is usually a last resort, pariah, solution (see
Southeast Asia and the Czech Republic for fresh examples in an endless
supply of them. Japan and China are, probably, next).

In the past, the thinking was that some of the risk could be ameliorated by
hedging in forward markets (=by selling it to willing risk buyers). But a hedge
is only as good as the counterparty that provides it and in a market besieged
by knock-on insolvencies, the comfort is dubious. In most emerging
markets, for instance, there are no natural sellers of foreign exchange
(companies prefer to hoard the stuff). So forwards are considered to be a
variety of gambling with a default in case of substantial losses a very
plausible way out.

Banks depend on lending for their survival. The lending base, in turn,
depends on the quality of lending opportunities. In high-risk markets, this
depends on the possibility of connected lending and on the quality of the
collaterals offered by the borrowers. Whether the borrowers have qualitative
collaterals to offer is a direct outcome of the liquidity of the market and on
how they use the proceeds of the lending. These two elements are
intimately linked with the banking system. Hence the penultimate vicious

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circle: where no functioning and professional banking system exists – no


good borrowers will emerge.

6.9 Credit Cards


Your credit card is stolen. You place a phone call to the number provided in
your tourist guide or in the local daily press. You provide your details and
you cancel your card. You block it. In a few minutes, it should be transferred
to the stop-list available to the authorization centres worldwide. From that
moment on, no thief will be able to fraudulently use your card. You can sigh
in relief. The danger is over.

But is it?
It is definitely not. To understand why, we should first review the intricate
procedure involved.

In principle, the best and safest thing to do is call the authorization centre of
the bank that issued your card (the issuer bank). Calling the number
published in the media is second best because it connects the cardholder to
a "volunteer" bank, which caters for the needs of all the issuers of a given
card. Some service organizations (such as IAPA – the International Air
Passengers Association) provide a similar service.

The "catering bank" accepts the call, notes down the details of the
cardholder and prepares a fax containing the instruction to cancel the card.
The cancellation fax is then sent on to the issuing bank.

The details of all the issuing banks are found in special manuals published
by the clearing and payments associations of all the banks that issue a
specific card. All the financial institutions that issue Mastercards, Eurocards
and a few other more minor cards in Europe are members of Europay
International (EPI). Here lies the first snag: the catering bank often mistakes
the identity of the issuer. Many banks share the same name or are branches

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of a network. Banks with identical names can exist in Prague, Budapest and
Frankfurt, or Vienna, for instance. Should a fax cancelling the card be sent
to the wrong bank – the card will simply not be cancelled until it is too late.
By the time the mistake is discovered, the card is usually thoroughly abused
and the financial means of the cardholder are exhausted.

Additionally, going the indirect route (calling an intermediary bank instead of


the issuing bank) translates into a delay which could prove monetarily
crucial. By the time the fax is sent, it might be no longer necessary.

If the card has been abused and fraudulent purchases or money


withdrawals have been debited to the unfortunate cardholders' bank or
credit card account – the cardholder can reclaim these charges. He has to
clearly identify them and state in writing that they were not effected by him.
A process called "chargeback" thus is set in motion.

A chargeback is a transaction disputed within the payment system. A


dispute can be initiated by the cardholder when he receives his statement
and rejects one or more items on it or when an issuing financial institution
disputes a transaction for a technical reason (usually at the behest of the
cardholder or if his account is overdrawn).

A technical reason could be the wrong or no signature, wrong or no date,


important details missing in the sales vouchers and so on. Despite the
warnings carried on many a sales voucher ("No Refund – No Cancellation")
both refunds and cancellations are daily occurrences.

To be considered a chargeback, the card issuer must initiate a well-defined


dispute procedure. This it can do only after it has determined the reasons
invalidating the transaction. A chrageback can only be initiated by the
issuing financial institution. The cardholder himself has no standing in this
matter and the chargeback rules and regulations are not accessible to him.
He is confined to lodging a complaint with the issuer. This is an abnormal

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situation whereby rules affecting the balances and mandating operations


resulting in debits and credits in the bank account are not available to the
account name (owner). The issuer, at its discretion, may decide that issuing
a chargeback is the best way to rectify the complaint.

The following sequence of events is, thus, fairly common:


1. The cardholder presents his card to a merchant (aka: an acceptor of
payment system cards).
2. The merchant may request an authorization for the transaction, either
by electronic means (a Point of Sale / Electronic Fund Transfer
apparatus) or by phone (voice authorization). A merchant is obliged to
do so if the value of the transaction exceeds predefined thresholds.
But there are other cases in which this might be either a required or a
recommended policy.
3. If the transaction is authorized, the merchant notes down the
authorization reference number and gives the goods and services to
the cardholder. In a face-to-face transaction (as opposed to a phone or
internet/electronic transaction), the merchant must request the
cardholder to sign the sale slip. He must then compare the signature
provided by the cardholder to the signature specimen at the back of
the card. A mismatch of the signatures (or their absence either on the
card or on the slip) invalidate the transaction. The merchant will then
provide the cardholder with a receipt, normally with a copy of the
signed voucher.
4. Periodically, the merchant collects all the transaction vouchers and
sends them to his bank (the "acquiring" bank).
5. The acquiring bank pays the merchant on foot of the transaction
vouchers minus the commission payable to the credit card company.
Some banks pre-finance or re-finance credit card sales vouchers in the
form of credit lines (cash flow or receivables financing).

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6. The acquiring bank sends the transaction to the payments system


(VISA International or Europay International) through its connection to
the relevant network (VisaNet, in the case of Visa, for instance).
7. The credit card company (Visa, Mastercard, Diners Club) credits the
acquirer bank.
8. The credit card company sends the transaction to the issuing bank and
automatically debits the issuer.
9. The issuing bank debits the cardholder's account. It issues monthly or
transaction related statements to the cardholder.
10. The cardholder pays the issuing bank on foot of the statement (this is
automatic, involuntary debiting of the cardholders account with the
bank).

Some credit card companies in some territories prefer to work directly with
the cardholders. In such a case, they issue a monthly statement, which the
cardholder has to pay directly to them by money order or by bank transfer.
The cardholder will be required to provide a security to the credit card
company and his spending limits will be tightly related to the level and
quality of the security provided by him. The very issuance of the card is
almost always subject to credit history and to an approval process.

The typical credit card transaction involves these steps:


1. The cardholder presents his card to a merchant, the acceptor.
2. The merchant may request an authorization for the transaction, either by
electronic means (a Point of Sale / Electronic Fund Transfer apparatus)
or by phone (voice authorization). A merchant is obliged to do so if the
value of the transaction exceeds predefined thresholds. But there are
other cases in which this might be a policy either required or
recommended by issuers, card companies, or clearinghouses.

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3. If authorized, the merchant notes down the transaction authorization


code and gives, or ships, the goods, or services to the cardholder. If the
cardholder is present, he must sign the sale slip (voucher) and the
merchant validates the signature by comparing it to the specimen at the
back of the card. The transaction goes through only if the signatures
match. The merchant then provides the cardholder with a receipt,
normally with a copy of the signed voucher.
4. The merchant collects all the transaction vouchers periodically and gives
them to his bank (the "acquiring" bank).
5. The acquiring bank credits the merchant's bank account with the
difference between the total amount of the transactions and the
commissions and fees payable to the credit card company. Some banks
pre-finance or re-finance credit card sales vouchers (receivables
financing) - i.e., they lend against future credit card revenues.

6. The acquiring bank forwards the slips or an electronic ledger to the


payments system (VISA International, or Europay International) through
its connection to the relevant network (VisaNet, in the case of Visa, for
instance).
7. The credit card company (Visa, MasterCard, Diners Club) credits the
acquiring bank.
8. The credit card company sends the transactions to the issuing bank and
automatically debits it.
9. The issuing bank automatically debits the cardholder's account. It issues
monthly or transaction related statements to the cardholder.

In some countries - mainly in Central and Eastern Europe, the Middle East,
Africa, and Asia - credit card companies sometimes work directly with their
cardholders who pay the companies via money order or bank transfer. The
cardholder is often required to provide a security to the credit card company

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and his spending limits are tightly supervised. Credit history, collateral, and
background checks are rigorous. Even then, the majority of the cards issued
are debit - rather than credit - cards.

Self Assessment Questions II


State whether the following statements are True or False:
1. The value of a stock is the sum of the income that a reasonable investor
would expect to get in the future, discounted at the appropriate rate.
2. The most widely used model to evaluate specific risks is the Capital
Asset Pricing Model (CAPM).
3. "Due Diligence" is a legal term which means ’to make sure that all the
facts regarding the firm are available and have been independently
verified.’
4. Venture capital and risk capital funds, for instance, are purely strategic
investors.
5. The financial investor has little interest in the company's management.
6. A bank cannot borrow cheap money from the Central Bank and invest it
in secure government bonds.
7. A ‘chargeback’ is a transaction disputed within the payment system.

6.10 Summary
 The Manager of a firm should have access to continuously updated
statements of income, cash flow, and a balance sheet.
 The pro forma financial statements should include all the future flows of
money - whether invoiced or not.

 The Daily Ratios Report enables the Manager to instantly analyse


dozens of important aspects of the functioning of his company. The
Manager can review financial and production ratios. Where there is a
strong deviation from historical patterns, or where the ratios warn about
problems in the future – management intervention may be required.

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 A decision system has great impact on the profits of the company. It


forces the management to rationalize the depreciation, inventory and
inflation policies. It warns the management against impending crises and
problems in the company.

 The decision system is an integral part of financial management in the


West.
 There is a stock pricing mechanism known as the Stock Exchange. The
value of a stock is the sum of the income that a reasonable investor
would expect to get in the future, discounted at the appropriate rate.
 The most widely used model to evaluate specific risks is the Capital
Asset Pricing Model (CAPM).
 The financial investor represents the past. He is always on the lookout,
searching for willing buyers for his stake. He has little interest in the
company's management.
 The strategic investor, on the other hand, represents the real long term
accumulator of value. It is the strategic investor that has the greater
influence on the value of the company's shares.

6.11 Terminal Questions


1. Explain the levels of reporting and flows of data.
2. How are stocks valued?
3. Explain the process of Due Diligence.
4. Distinguish between the ‘strategic investor’ and the ‘financial investor’.
5. How are banks rated?
6. Explain the steps involved in a typical credit card transaction.

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6.12 Answers to SAQs and TQs


SAQs I
1. True
2. True
3. False
4. True

SAQs II
1. True
2. True
3. True
4. False
5. True
6. False
7. True

Answers to TQs:
1. Refer to 6.2
2. Refer to 6.4
3. Refer to 6.5
4. Refer to 6.6
5. Refer to 6.8
6. Refer to 6.9

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Unit 7 Licensing and Enforcing Intellectual


Property Rights
Structure
7.1 Introduction
Objectives
7.2 Background to Commercializing Intellectual Property
7.3 Options for Exploiting IP rights
7.4 Licensing and Assigning IP rights
7.5 Joint Venture Agreements and Start-up Companies
Self Assessment Questions I
7.6 Commercialisation Mechanisms
7.7 Decoding Licences and Technology Agreements
7.8 Licensing, Enabling Technologies and the Public Interest
7.9 Enforcement of Intellectual Property Rights
7.9.1 Enforcement Measures Required by TRIPS
7.9.2 General Enforcement Obligations under Trips
7.10 Civil Remedies
7.11 Criminal Procedures
7.12 Special Border Enforcement Measures - Customs
7.13 Different Roles in IP Enforcement
Self Assessment Questions II
7.14 Summary
7.15 Terminal Questions
7.16 Answers to SAQs and TQs

7.1 Introduction
Intellectual property rights can be very valuable commercial rights for
inventors, creators and researchers. Intellectual property rights are legal

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rights to do certain things in relation to an invention or creation. In general


terms, intellectual property rights are infringed if someone exercises an
intellectual property right without the permission of the owner of the right. In
order to protect the value of intellectual property rights effective legal
remedies must be available if intellectual property rights are infringed.

One needs to make good commercial decisions to benefit from one’s


intellectual property rights.

This unit throws light on intellectual property rights and the ways in which
they need to be protected.

Objectives:
By the end of this unit, you will be able to:
 List out some ways to exploit one’s intellectual property rights so as to
get financial benefits from them.
 Explain the ways of protecting the intellectual property rights.
 Give reasons why intellectual property rights need to be protected.
 Explain the civil remedies and criminal procedures in relation to the
protection of intellectual property rights.

7.2 Background to Commercializing Intellectual Property


The cost of protecting IPRs:
This unit considers some of the practical intellectual property issues that
arise when bringing a new technology to the public. Let’s say you have
achieved a breakthrough in your research, and have applied for a patent –
what do you do next? There are many patents that have never been
successfully transformed into new products in the marketplace – what goes
wrong in these cases? In some cases, it’s because the technology was not
practically feasible, or was superseded by newer technologies. In other

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cases, the inventor lacked the resources or skills to take the invention to the
next step.

One constant factor in the development of new technologies has been the
cost and difficulty of the process of putting new technologies on the market.
The technical merit or scientific brilliance of an invention is only one aspect
of actually bringing a new technology to the public in a useful practical form.
This can be a costly and complex process. Normally, it is not possible
without a range of different partnerships and relationships – as sources of
funding, expertise and other resources.

Intellectual property protection needs to be properly managed so that it


facilitates this process, and doesn’t itself become a burden.

The problems of getting worthwhile benefits from the patent system - even
for the patent owner – are not new ones, as this quotation from 120 years
ago makes clear: Patenting was unnecessarily and unwisely expensive, and
the poor patentee was left almost without any aid or guidance. Intellectual
property rights recognize innovative and creative activities, and are intended
to reward useful and valuable contributions to society. But they are not
direct rewards in themselves. All they do is to create an opportunity for the
inventor or creative person to seek rewards for their invention or returns
from their investment in the research. A patent can be expensive to obtain,
especially if it is applied for in many countries, and costs money to keep in
force, as annual renewal fees are required in many countries. In addition,
patents can be very expensive to enforce if it becomes necessary to go to
court to prevent infringement. Patents recognise inventiveness, but they are
neutral on the commercial value of the invention. Many patented inventions
will prove to be technologically unsuccessful, or commercially unviable. In
many other cases, patented inventions which could be very successful fail to

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be developed because the inventor lacks the capacity, resources or skills to


develop the invention commercially.

Many patent systems are run on a ‘cost recovery’ basis – so that the fees
charged to patent applicants are sufficient to cover the costs of
administering the patent office, or even to create a surplus. The Patent
Co-operation Treaty (PCT) system administered by the World Intellectual
Property Organisation returns a surplus from the fees charged to private
applicants, and these resources are used in many ways, especially in
providing technical support and assistance to developing countries. So
society does not reward inventors directly for making a patented invention –
instead, it requires the patentee to pay his or her way in getting a patent,
and then leaves it to them to see whether they can make money in a
commercial way from the patented invention.

Some governments do provide support for small and medium enterprises,


for instance in charging lower patent fees. The international PCT system
also has greatly reduced fees for individuals in countries with low average
incomes. But generally speaking the cost of the patent system is borne by
patent applicants. And to the official fees must be added the cost of patent
attorneys’ or patent agents’ professional services in conducting patent
searches, in preparing and filing patent applications (which may include the
services of attorneys in several countries), in considering examiners’ reports
and preparing responses to the examiner’s objections (patent ‘prosecution’),
and in maintaining the patent (and possibly advising on enforcement).

All this adds up to make the patenting process a significant investment.

Much depends on the number of countries you seek patents in, and whether
any difficulties are found in getting a patent (for example, complex
objections by patent examiners requiring significant amendments to the

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patent and legal argument and representations, or when a competitor


challenges or opposes the grant of the patent).

It is obviously much cheaper to seek patent protection in only your home


country, but then you would have to accept use being made freely of your
invention potentially in every other country.

The cost of going through the patenting process in a number of countries is


typically beyond the resources of all but the largest companies and research
establishments, and most enterprises and institutions require some kind of
commercial partnership or financial support to gain, and to keep in force, the
patent rights.

The case is similar for other intellectual property rights, like plant breeders’
rights, trade marks, and industrial designs, although these normally cost
less overall than patents. The applicant takes a risk and invests time and
money in the process of obtaining an IP right. The hope is that the IP right
will improve their capacity to develop a new product and gain the benefits
from their research and innovation. But when the costs are unpredictable
and potentially high, and the future benefits from the IP right are uncertain
and may only be realized after a number of years, it can be difficult to work
out whether it is worth making the investment. Unregistered rights, like trade
secrets and copyright, do not incur direct costs in the same way, but may
involve investment in physical security, preparation of confidentiality
agreements, and monitoring and enforcement costs.

In short, obtaining registered intellectual property rights can be expensive,


and do not in themselves make you any returns for your investment. Patents
can be costly liabilities to you, your business or your research institute,
unless you can find a way to apply your invention commercially or can get
other forms of financial support. This calls for a range of skills and

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experience quite apart from technological and scientific skills. Often the
most difficult aspect of putting a new

technology to work, and of making it available to the public, lies not in the
patenting process, but in finding a suitable commercial vehicle to gain
suitable returns from the invention, including through commercial use of the
patent. Commercialising inventions can involve a great deal of commercial
risk, which small companies and research institutes might not be able to
accept and manage. Because of these considerations, in many cases
institutions and companies choose not to commercialise their invention at
all, but elect to sell (‘assign’) or license their rights to the invention to other
companies for them to take the invention to the marketplace.

Because intellectual property rights can be so costly to obtain, to keep in


force and to enforce, they should not be pursued for their own sake.
Patenting your invention may be worthless, and in fact could waste
resources, unless you have a commercial strategy in which your patenting
program has a logical place. And this strategy will usually involve some form
of partnership – this may be a bank or venture capitalist providing you with
the funds you need, a company with access to technology or a product that
is needed for the success of your invention, or a commercial enterprise with
product development and marketing skills.

When you are weighing up whether to commercialise your invention


yourself, or whether you should find commercial partners or another way of
developing your invention, you should consider:

1. Your overall objectives


Are you looking just to fund further research, or to create a new industry
particularly for the benefit of your own country, or to build up a capital
asset, or simply to disseminate the fruits of your research as broadly as
possible, with some control over the way the technology is used?

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2. Your financial position


Can you accept the cost and financial risk of investing in patents and
other IPRs, and other aspects of commercialisation; do you have the
reserves to defend and enforce your IPRs, potentially in several
countries; will financial constraints keep you out of some of the major
potential markets for the invention?

3. The skills and resources available


Do you, or your organization, have the capacity to develop and
implement a product development and marketing program for a new
product?

What are the focus and core expertise of your organization?

4. Regulatory requirements for getting onto the market


Do you have access to sufficient expertise and resources to undertake
the kind of testing and approval processes that might be required for a
new product, such as a new pharmaceutical, a new pesticide or a
genetically modified crop? Can you deal with labelling and certification
requirements in different countries? Are there joint ventures or local
participation obligations to enter some markets?

5. Your options for overseas production or export


Do you have the capacity to produce, export and market your invention
in major foreign markets?

6. The nature of the technology


The invention may require access to other IP-protected technologies or
know-how for it to be produced; and particular manufacturing
technologies might be required for it to be made in an economic manner,
so that the product is competitively priced.

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7. The strength of the competition


Does your product need to find a place in a crowded market with strong
competition, requiring the backing and resources of a major company in
the field?

8. The range of possible uses for your invention


Do you have the capacity to put it to work in all the areas it could be
used, or do you need partnership with others to make sure your
invention achieves its full potential?

7.3 Options for Exploiting IP rights


The question of how to exploit hard-won patent rights involves a range of
legal, commercial and strategic judgments. This applies whether your aim is
to maximize the commercial return from the invention, or to promote the
widespread use and application of your invention. Managing patent rights
effectively can be just as important for public sector organizations which are
concerned how to ensure that the benefits of their technology are fully
realized. If a public sector or charitably funded organization does not retain
some IP rights over the new technologies it produces, this can have the
ironic result that they lose control over how the technology is developed and
applied, because other private entities are free to develop and patent their
own improvements on the invention.

There are various ways of exploiting your intellectual property rights; these
generally involve balancing immediate financial interests, risks, resources,
and longer-term strategic and technology management interests. It is
comparatively rare, particularly for research institutions, to bear all the risk
and financial cost of bringing a new technology to market. At some stage,
research partners or commercial partners need to be brought in. The
relationship with a partner will depend very much on:

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1. What stage is the invention at? Is it an unproven research insight, or a


research outcome that is proven in principle but not fully tested in
practice, or is it a fully operational prototype that is close to a consumer
product?
2. How much more research and development is required, and what are
the chances of its success?
3. What amount of risk, future commitment and financial investment is
expected from the partner? Is the partner funding continuing research,
or just brought in to use the invention with their existing processes?
4. Have IP rights been granted, and checked for their validity; or are they
just at the application stage, with no guarantee that IP rights will actually
be granted in the future?

If the commercial partner is bringing to the market a technology which is


well- developed, has already been technically proven, and has been granted
patents in the key markets, the commercial partner is taking on
comparatively little risk, and the terms of the agreement should reflect that.
On the other hand, if the commercial partner is being asked to fund
continuing ongoing exploratory research, the outcome and viability of which
is uncertain, they would expect a higher degree of interest in the intellectual
property rights and greater long-term rewards in exchange for taking on a
greater level of risk.

If you are a researcher working as a full-time employee, then your employer


would normally have the rights to any patent on an invention that you
develop as part of your employment (you may be entitled to specific rewards
or compensation, however, especially if the invention is notable and
meritorious). Under many national laws and under the policy of many
companies and universities, the inventor can be entitled to either the IP
rights or some benefits from their invention – whether you are a researcher,

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manager or employer, you should be clear on the legal entitlement of the


inventor to IP rights in the research outcome. In some cases, for instance,
graduate students may not be bound by employer-employee obligations.
Some institutions may permit you to exploit your rights yourself by entering
into a commercial joint venture arrangement or starting up your own
company to manufacture and market your product.

You will need to make fundamental choices about the path you take to
commercialise the invention. This will entail first working out:
1. Your overall objectives for commercialising the technology – what do
you ultimately want to achieve? What benefits do you want from your
research?
2. Your level of confidence in the technical utility of your invention, its
commercial viability and the strength and range of IP rights – do you
want to bear the risks, or do you want another institution or company to
carry some or all of the risk?
3. The financial resources and kinds of expertise you will need.

Depending on these factors, you can choose between a number of different


ways of managing your IP rights to get the benefits from your research.
These options typically include:
– licensing your rights (an IP right such as a patent can be licensed out to
others – either partially or fully, exclusively or to several parties)
– assigning your rights (an IP right such as a patent can be assigned, or
its ownership transferred, to another – this can be in exchange for a
financial payment or for some other valuable consideration, such as
shares in the company).
– entering into a joint venture arrangement (you can effectively pool your
intellectual property rights and other resources with a partner, to form a
joint venture to develop and exploit a new technology), and

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– starting up your own company to exploit the technology (often called


‘spinning off’ a new company, or a ‘start-up’ - this one approach taken by
research institutions and university faculties to create a suitable
commercial vehicle for putting new technology to work, while keeping
basic research separate from applied development and
commercialisation).

The discussion of each of these options focusses on patents, but very


similar considerations apply to other forms of IP, such as trade secrets
(undisclosed or confidential information), plant variety rights, industrial
designs, trade marks or copyright. In fact, a range of different IP rights can
be bundled together, to be licensed or exploited as a single technology
package, together with arrangements for technical cooperation, staff training
and other elements of a broader relationship.

If you have a comprehensive package of interlocking IP rights and


associated know-how, this could be more attractive to commercial partners,
in contrast to a single patent or other IP right.

7.4 Licensing and Assigning IP rights


One basic choice is whether you should actively exploit your IP rights
yourself, or to keep your IP rights and license them to others to use, or sell
or assign the rights to another person. You can, in principle, make different
choices in different countries for exploiting IP rights for the same underlying
invention. If you are based in Malaysia, you could in theory decide to exploit
your patent yourself in the East Asian region, grant a licence a Canadian
company to use the invention in North America, and sell or assign the rights
in Europe to a Danish company – whether or not this is the best approach in
practice is a different matter, of course.

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A licence is a grant of permission made by the patent owner to another to


exercise any specified rights as agreed. Licensing is a good way for an
owner to benefit from their work as they retain ownership of the patented
invention while granting permission to others to use it and gaining benefits,
such as financial royalties, from that use. However, it normally requires the
owner of the invention to invest time and resources in monitoring the
licensed use, and in maintaining and enforcing the underlying IP right.

The patent right normally includes the right to exclude others from making,
using, selling or importing the patented product, and similar rights
concerning patented processes. The license can therefore cover the use of
the patented invention in many different ways.

For instance, licences can be exclusive or non-exclusive. If a patent owner


grants a non-exclusive licence to Company A to make and sell their
patented invention in Malaysia, the patent owner would still be able to also
grant Company B another non-exclusive for the same rights and the same
time period in Malaysia. In contrast, if a patent owner granted an exclusive
licence to Company A to make and sell the invention in Malaysia, they
would not be able to give a licence to

anyone else in Malaysia while the licence with Company A remained in


force.

Licenses are normally confined to a particular geographical area – typically,


the jurisdiction in which particular IP rights have effect. You can grant
different exclusive licences for different territories at the same time. For
example, a patent owner can grant an exclusive licence to make and sell
their patented invention in Malaysia for the term of the patent, and grant a
separate exclusive licence to manufacture and sell their patented invention
in India for the term of the patent.

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Separate licences can be granted for different ways of using the same
technology. For example, if an inventor creates a new form of
pharmaceutical delivery, she could grant an exclusive licence to one
company to use the technology for an arthritis drug, a separate exclusive
licence to another company to use it for relief of cold symptoms, and a
further exclusive licence to a third company to use it for veterinary
pharmaceuticals.

A licence is merely the grant of permission to undertake some of the actions


covered by intellectual property rights, and the patent holder retains
ownership and control of the basic patent.

An assignment of intellectual property rights is the sale of a patent right, or a


share of the patent.

It should be remembered that the person who makes an invention can be


different to the person who owns the patent rights in that invention. If an
inventor assigns their patent rights to someone else they no longer own
those rights. Indeed, they can be in infringement of the patent right if they
continue to use it.

Patent licences and assignments of patent rights do not have to cover all
patent rights together.

Licences are often limited to specific rights, territories and time periods. For
example, a patent owner could exclusively licence only their importation
right to a company for the territory of Indonesia for 12 months. If an inventor
owns patents on the same invention in five different countries, they could
assign (or sell) these patents to five different owners in each of those
countries. Portions of a patent right can also be assigned – so that in order
to finance your invention, you might choose to sell a half-share to a
commercial partner.

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If you assign your rights, you normally lose any possibility of further
licensing or commercially exploiting your intellectual property rights.
Therefore, the amount you charge for an assignment is usually considerably
higher than the royalty fee you would charge for a patent licence. When
assigning the rights, you might seek to negotiate a licence from the new
owner to ensure that you can continue to use your invention. For instance,
you might negotiate an arrangement that gives you licence to use the
patented invention in the event that you come up with an improvement on
your original invention and this falls within the scope of the assigned patent.
Equally, the new owner of the assigned patent might want to get access to
your subsequent improvements on the invention.

7.5 Joint Venture Agreements and Start-up Companies


Rather than simply exploit your IP rights by licensing or assignment, you
might choose to set up a new legal mechanism to exploit your technology.
Typically this can be a partnership expressed through a joint venture
agreement or a new corporation, such as a start-up or spin-off company.

These options require much more work on your part than licensing or
assigning your intellectual property rights. This could be a desirable choice
in cases where:
– you want to keep your institute’s research activities separate from the
development and commercialisation of technology, especially when your
institute has a public interest focus or an educational role; or
– you need to attract financial support from those prepared to take a risk
with an unproven technology (‘angel investors’ or ‘venture capitalists’),
and they will only take on a long-term risk if they can get a share of
future profits of the technology.

In working out the right vehicle for your technology, you will normally need
specific legal advice from a commercial lawyer, preferably one with

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experience in technology and commercialisation in your jurisdiction. The


laws governing partnerships and companies differ considerably from one
country to another, and this discussion is only intended to give a general
flavour of the various options.

A joint venture agreement involves a formal, legally binding commitment


between two or more partners to work together on a shared enterprise. It is
normally created for a specific purpose (for example, to commercialise a
specific new technology) and for a limited duration. For instance, you might
sign a partnership agreement with a manufacturing company to develop and
market a product based on your invention. Before entering into a joint
venture agreement, you need to check out possible commercial partners
and make sure that the objectives of your potential commercial partners are
consistent with your objectives. In the joint venture agreement, the partners
typically agree to share the benefits, as well as the risks and liabilities, in a
specified way.

But this kind of partnership isn’t normally able in itself to enter legal
commitments, or own IP in its own right, so that the partners remain directly
legally responsible for any losses or other liabilities that the partnership’s
operations create. In other words, a partnership which is not a corporation, a
company or a specific institution doesn’t really separately exist as a legal
entity.

By contrast, a company is a new legal entity (a ‘legal person’ recognised by


the law as having its own legal identity) which can own and license IP and
enter into legal commitments in its own right. A spin-off company is an
independent company created from an existing legal body – for example, if
a research institute decided to turn its licensing division or a particular
laboratory into a separate company. A start-up company is a general term
for a new company in its early stages of development. If a company is
defined as a limited liability company, the partners or investors normally

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cannot lose more than their investment in the company (but officeholders in
the company might be personally responsible for their actions in the way
they manage the company). This separate legal identity means that a start-
up company can be a useful way of developing and commercialising a new
technology based on original research, while keeping the main research
effort of an institute focussed on broader scientific and public objectives, and
insulated from the commercial risks and pressures of the commercialisation
process. At the same time, the research institute can benefit from the
commercialisation of its research, through receiving its share of the profits
and growth in assets of the spin-off company, thus strengthening the
institute’s capacity to do scientific research.

The company is normally owned through shares (its ‘equity’). These


effectively represent a portion of the assets and entitlement to profits of the
company. Investors can purchase shares in the company, which is one way
of bringing in new financial resources to support the development of the
technology – in exchange, the investors stand to benefit from the growth in
the company’s worth, as their shares proportionately rise in value, and to
receive a portion of any profits produced by the company’s operations,
commensurate with the number of shares they own. If it is a public
company, shares in the company can be bought and sold on the open stock
market. An initial public offering is when the shares in a start up company
are first made available to the public to purchase. A private company’s
shares, by contrast, are not traded on the open market (but can still be
bought and sold).

The option of starting up your own company to manufacture and market


your patented invention requires you to have business skills, marketing
skills, management skills and substantial capital to draw on for factory
premises, hiring staff and so on. But it also can offer a mechanism for

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attracting financial backing for research, development and marketing, which


can improve access to the necessary resources and expertise.

Which model of commercialisation is best for you?

Each new technology and associated package of IP rights is potentially


difference, and the mechanism you choose for commercialisation should
take into account the particular features of the technology. One basic
consideration is to what extent you, as originator of the technology, wish to
be involved and to invest in the subsequent development of the technology.
You will need to compare the advantages and disadvantages of each model
of commercialisation. Generally speaking, the higher degree of risk and
commitment of finance and resources you can invest, the higher the degree
of control you can secure over exploitation of the technology invention, and
the higher the financial return to your institution may be.

There are many possible variations on each of these general models, and in
practice they can overlap. In deciding which model of commercialisation is
best for you, it is always a good idea to seek commercial or legal advice.

Remember that IPRs alone do not guarantee you a financial return on your
invention. You need to make good commercial decisions to benefit
financially from your intellectual property rights.

Properly managed, intellectual property rights should not be a burden but


should yield a return from your hard work in creating an invention.

Self Assessment Questions I


1. A –––––––––––– is merely the grant of permission to undertake some of
the actions covered by intellectual property rights, and the –––––––
retains ownership and control of the basic patent.

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2. The –––––––––––– normally includes the right to exclude others from


making, using, selling or importing the patented product, and similar
rights concerning patented processes.
3. A –––––––––––––– involves a formal, legally binding commitment
between two or more partners to work together on a shared enterprise.
4. A ––––––––– company is an independent company created from an
existing legal body.
5. A ––––––––––––- is a general term for a new company in its early
stages of development.

7.6 Commercialisation Mechanisms


In summary, a technology licensing agreement will normally:
 Name the intellectual property rights being licensed.
 Make it clear who retains ownership of the intellectual property rights.
 State how the royalty rates will be worked out.
 Set out when royalties will be paid, including milestone payments.
 Set out which territory the licence applies to.
 Set out whether the licence is exclusive or non-exclusive.
 Set out whether the licensee can licence the intellectual property rights
to others.
 State who will pay the costs of maintaining the patent rights.
 Set out arrangements for dealing with improvements and new
applications of the new technology.
 Set out how confidentiality issues will be dealt with and the rights of the
inventor to publish their research.
 Provide for an insurance, release and indemnity clauses.
 Provide for dispute resolution and termination.

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Choosing a potential licensee can be very important, as you are relying on


this commercial partner to deliver the benefits of your technology – not only
the commercial benefits, but the benefits to society that might come from the
full dissemination and widest possible use of your technology.

The choice should not just be based on willingness to pay a higher royalty.
A partner who has a convincing business plan and establishes a good
working relationship with you is likely to be more valuable. If you are
selecting a licensee, you may need to consider a host of factors, including:
 Does the company have experience and proven success in developing
new technologies and bringing products to market?
 What kind of R&D and business plan does the company have? Are there
realistic plans for developing and distributing the product based on your
technology? Do these plans have well-defined milestones that could be
built into a license agreement?
 Do you want to favour development of the technology in your own
country? Is the company willing and able to invest locally in facilities for
exploiting the technology?
 Are the resources, expertise and reputation of a large, established
company needed, or are the flexibility and lower costs of a smaller, start-
up company more appropriate for the technology?
 Are you planning to export your technology or otherwise develop
overseas markets? Is your potential partner established overseas, or
have experience in foreign markets?
 Is your commercial partner likely to be able to take up new applications
and improvements on the technology that your research is working
towards? Are they able to apply the technology in all the potential areas
of use?

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Due diligence
Of course, your commercial partner will need some reassurance about the
quality of the offer you are making to them. If you are involved in licensing
technology or seeking commercial support for your research you are likely to
hear of ‘due diligence.’ When a future partner is considering whether or not
to license technology, to buy a share of patent rights, or to support your
research, they will need to satisfy themselves that it is a viable proposition.
The process of assessing the viability, risk, potential liabilities and
commercial prospects of a project is known as ‘due diligence.’ Indeed, if a
potential partner seems not to be interested in this kind of issues, it may
actually raise questions about their commitment to the project or the
credibility of their business plan, particularly if the relationship assumes
some degree of risk and investment on their part.

Generally, due diligence will involve assessing the overall commercial


operations, cash flow, assets and liabilities of a business that is being
purchased or otherwise financially supported. You would think twice about
purchasing a business if you found that it was burdened with debts, or was
about to be involved in difficult litigation, or if there were doubts about
whether it really owned its assets. The same applies to a potential
investment involving intellectual property. For instance, a potential
commercial partner would not want to invest in patented technology only to
find out that patent renewal fees have not been paid and the patent has
lapsed, or to find out that the patent was being opposed by another
company, or to find that there is prior art available that calls into question its
validity. It may transpire that a student, a contractor or a visiting researcher
could actually be legally entitled to some or all of the patent rights. Even a
serious level of uncertainty or doubt could be enough to deter a potential
partner, especially if they have run into this kind of difficulty before.

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Due diligence may also involve searching for information about the full
range of IP rights that might impact on the relevant technology – for
instance, to check whether you have later filed patent applications on
improvements to the original patented technology, that may limit the value of
their investment in the original technology. Other intellectual property rights
– such as related trade mark or design registrations, or key trade secrets or
copyright material (such as manuals or software) – may also need to be
identified or located, as these may also affect the commercial partner’s
interests in the technology. For example, they may be unwilling to take out a
licence for your patent without getting access to the software you have
developed for a related process. They may want the right to use your trade
mark in association with the patented technology.

So in a due diligence process, your commercial partner may undertake a


range of checks and need various forms of information. These may include:

 Checks on external records, such as patent registers and patent


databases, including foreign patents;

 Searches of patent databases for conflicting technology;

 Independent advice from patent attorneys on issues such as patent


ownership, patent validity and scope of patent claims;

 Checks on employment contracts, confidentiality arrangements, and


contracts with other parties that may interfere with the exercise of IP
rights;

 Details of the patent prosecution such as examiners’ reports and other


opinions;

 Details of any legal challenges to the patent, and the way the
proceedings were resolved;

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 Checks on laboratory notebooks in the event that the validity of US


patents is of concern to the commercial partner (this also provides
reassurance as to claims of ownership of the patent);
 Surveys of the activity of competitors and owners of competing
technology, and possibilities of conflict; and
 Analysis of freedom to operate issues.

In preparing to licence your technology, you should consider in advance


these kind of due diligence issues. If you can anticipate and provide
comprehensive answers to these questions, you will be able more
effectively to reassure your commercial partner, and you will be in a stronger
negotiating position in negotiating licence terms. It should also speed up the
licensing negotiations, and

ultimately the commercialisation of your intellectual property.

7.7 Decoding Licences and Technology Agreements


Licenses on IP are literally a part of everyday life, although we are not
always aware of this. When you buy a book, a software package or a music
CD, you may be buying a license for limited uses of copyright material – you
normally don’t get an unlimited licence that permits you to do whatever you
like with the copyright material. This is unlike the case if you buy other
objects – say a computer, a CD player, or a screwdriver – when the person
selling the object can’t normally restrict the way in which you use it. For
example, when you buy a music CD, you are normally only paying for an
entitlement to play the music in a private environment. You would need to
get a separate license to make and sell copies of the CD, or to play the CD
in a public restaurant, or to broadcast the CD on public radio. If you buy a
software package, you might only be given a licence to use the software
only on one computer, and to make only one copy of the disc for back-up

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purposes. You might need to get a separate licence to install the software
on a network, or to make numerous copies of the software to distribute
within your organisation.

Researchers in the biotechnology field increasingly find they have to read,


understand, negotiate and enter into, licences covering the technology they
are working with. While these are different in scope and subject matter to
the kind of licence that comes with a word-processing package or music CD,
the basic elements of licenses remain the same. The license defines certain
limited uses of IP material, and sets out conditions on this use. This
entitlement is normally given in exchange for some form of payment or other
benefit. A licence may be free of charge, but could limit the way the licensed
IP is used.

This section discusses the main elements of licensing agreements. But


beware: this is only a general introduction to a complex area of law. If you
ever get involved in serious licence negotiations, you should seek expert
advice with experience in the national legal system (or systems) you are
dealing with.

The parties to the licence:


The ‘parties’ to the licence are the entities (individual people, companies or
institutions) that are bound by the licence as a legal contract. They normally
sign (or ‘execute’) the licence to confirm in a legally clear-cut way that they
agree to comply with its terms. The parties can be individual persons, but
they are normally legal entities such as a research institution, a university or
a company. It is important to ensure that the licence is signed in a way that
is legally binding, and by a person authorized to sign for their institution. The
institution itself has to have ‘legal identity’ under the relevant national law – it
has to exist in a legal sense. A research team, a division within a research
institution or a joint venture partnership is probably not able to sign a licence

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in its own right – either the individuals concerned have to sign the licence
and become legally bound by it as individuals, or the licence has to be
signed on behalf of the overall organization or company.

In some cases, the licence is not directly signed (think of the ‘I Agree’ block
which you are often asked to click when installing a software package on a
computer), and in the national law of many countries, contractual obligations
can arise even without a formal signed document.

Following are some of the basic provisions you will find in many technology
licenses.

Licensor and licensee:


The person granting the licence – the ‘licensor’ – typically holds rights to
technology, biological material, IP rights, know-how, or other information.
The person receiving the licence – the ‘licensee’ – is the party which is
seeking to use or exploit that material.

The basic idea of the licence is that the person granting the licence (the
‘licensor’) is giving another person (the ‘licensee’) the right to do something
that they could otherwise prevent them from doing, in exchange for some
kind of benefit (this may be financial, but may be other forms of benefit). So
the licensor might permit the licensee to use a technology that is covered by
a patent – and if there was no license, the licensor could take legal action
under the patent to prevent this use of the technology.

In effect, the legal purpose of the license is to guarantee the licensee that
they can use the patented technology confident that there will be no legal
challenge from the licensor on the basis of the patent right. Normally, the
licensee will get other less specific non-legal benefits that flow from a
cooperative relationship with the people who created the technology,
including technical advice and know how.

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Definition and scope:


The licence will normally define what its subject matter includes, and what
the purpose of the licence is. For instance, it could define the subject matter
as falling within the claims of a certain patent. The subject matter could be
broader than that, however – it might involve access to related know-how
(including confidential information) that might assist the licensee in using the
patented technology, and it might involve use of a related trade mark,
industrial designs or copyright material.

The definition could define the subject matter in some detail as ‘licensed
rights’ or a ‘technology package,’ or it might just refer to specific patents by
number. If the technology is at an early stage – for instance, if patent
applications are still in process, the definition might have to make clear that
the scope includes any patents granted on the basis of those applications,
or only those patents which relate to a specific use of the technology
covered in the applications. It could also apply to any derivative patents,
such as continuations of the original patent application.

If the licence includes unregistered intellectual rights, such as know-how or


trade secrets, special care should be taken to define this so as to avoid
future uncertainty and potential disputes. If the licence covers both patented
technology and trade secrets (confidential know-how), it may be necessary
to specify that what occurs in the event of the patent or patent application
lapsing – does the licence still apply to the trade secret or know how?

Grant of licensed rights:


The license needs to define what rights under the defined intellectual
property the licensor is granting to the licensee – for instance, the right to
use a patented process to produce a certain product. The licence could
specify and also define certain permitted usage of the licensed technology –
for instance, the permitted usage may be limited to one industry sector only

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(e.g. the licensed use for a new chemical entity covered by a patent might
be defined as only for agricultural use or only for human pharmaceutical
use). It might limit the use to research or non-commercial use.

It might also clarify what rights are not being licensed – for instance, the
patented technology, but not the associated trade mark. It might specifically
reserve certain rights, such as the right to use patented improvements of the
licensed technology.

Sole, exclusive or non-exclusive licences:


The choice taken among these options is very important. An exclusive
licence means that the licensor agrees not to grant another licence to any
other party, and agrees not to use the licensed rights (in other words, the
licensor cannot become a competing user of the licensed technology). A
sole licence means that the licensor grants a licence to only one licensee,
the sole licensee, but the licensor retains the right to use the technology
itself. Under a non-exclusive licence, the licensor grants the licensee a right
to use the technology, but the licensor can still give the same rights to other
licensees. The kind of license granted will depend on several factors, and
will do much to influence the pattern of use, and the scale of royalties or
other payments, made by the licensee.

The scope of exclusivity given to the licensee would normally be matched by


stronger expectations of the licensee’s diligence and active exploitation of
the technology. After all, in many countries, the law can intervene and grant
compulsory licenses to third parties if the patent is not adequately worked
after three years. Exclusive licenses may be particularly important when the
licensee is expected to make considerable investment in bringing the
technology to the market – for instance, in undertaking the regulatory
requirements for the public release of new chemical entity for
pharmaceutical or agricultural purposes.

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While these are distinct categories, there is considerable scope for moving
between the categories. For instance, a licence might be exclusive for only a
certain period, after which it becomes non-exclusive.

The licensee might only be interested in getting a head start on competitors,


rather than reserving exclusive rights for a longer period. Or there may be a
mechanism in the agreement allowing for an exclusive licence to become
non-exclusive in certain circumstances – for example, if the licensee fails to
meet a certain milestone or is not sufficiently active in developing and
marketing the technology – this is often called a ‘march-in’ right. And again
the licensor might

retain the right to issue further licenses for non-commercial purposes, or


licenses to government agencies.

Sub-licences
A ‘sub-licence’ is a further licence, when the licensee of the original licence
itself grants a licence to a third party. The sub-licence may extend to some
or all of the rights granted under the original licence. The original licence
may need to make clear whether sub-licences can be granted, and if so, to
who, and on what terms or conditions. There may be issues such as
protecting the confidentiality of licensed material, liability for use of the
technology, or the interests of the licensor in granting direct licenses to the
same third parties.

A sub-licensing program may be of considerable benefit to the licensor, as it


will increase the scope of use of the licensed technology, and may be an
effective way of exporting the technology to new overseas markets. The
original licensor might retain an entitlement to a share of any royalties or
other payments paid by the sub-licensee. The original licensor might retain
the right to investigate and approve the eligibility of a sub-licensee,

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especially if the sub-licensee has no direct relationship with the original


licensee.

Diligence and milestones


The licensee may be relying on the license as the principal mechanism for
recovering its investment in research and for deriving benefits from the
patent or other IP. So it may be important to the licensor to ensure that the
licensee does everything they can to develop and commercialise the
licensed IP. If a licensee gains an exclusive licence, subject to a royalty
payment on profits, and then decides to shelve the technology for several
years because its immediate interests lie elsewhere, then the whole value of
the IP is lost to the licensor. So licenses will frequently include obligations
on the licensee to develop and apply the licensed technology diligently and
to meet specific deadlines. Where possible, certain defined points or
milestones should be identified – possibly based on the business plan
originally proposed by the licensee. The license could require the licensee to
bring the product to the market as soon as practicable, and to continue to
make the product available to the public on reasonable terms. These
obligations may also be built into sub-licenses granted under the licence.

Payments and pricing:


A licence will normally involve a valuable ‘consideration’ – something of
value which is given in exchange for the right to use this technology. It need
not be financial consideration – it could be a right in exchange to use
another technology (a ‘cross-licence’), or valuable access to other facilities
or resources.

There are many potential models for payment. It is always difficult to


establish a value for intellectual property, even more so if it relates to
unproven technology that will require a licensee to take a considerable
commercial risk. The options boil down to lump sum payments, and royalties

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based on the extent of use of the technology. It is not unusual to see a


mixture of both.

For instance, there can be an initial lump-sum payment payable as soon as


the licence is signed. Lump-sum payments can also be required after other
specific events, such the grant of a patent covered by the licence, or on a
regular basis, such as annual licence maintenance fees. Requiring lump-
sum payments provides an incentive to work the licensed technology that
may not be present if the license only provided for royalties. Yet royalties
ensure that the licensor derives benefits from the scale of commercial
success of the technology they have created. Royalties may be set as a
certain percentage of gross sales of products using the technology or a
percentage of profits, or may be linked to other signs of turnover, such as
the number of units produced using the technology or the number of units
sold.

If you are licensing out, especially to one licensee only, and you are relying
on that licensee to produce the returns that will pay for your research, then
you may need to structure the license to ensure they have an incentive
actively to use the technology – if they are simply committed to paying a
royalty if and when they choose to use your technology, they might not have
an incentive to invest immediately in producing your technology, and they
could leave it in the bottom drawer while they exploit other opportunities. As
a stimulus to diligence, the licensee may have to pay a certain minimum
royalty payment whether or not actual sales or use reaches that level.

Initial payments can also be credited against future royalties – in effect, an


upfront payment can become an advance payment of minimum royalties. Or
they can be separate from royalty payments, so that they are in effect a
separate licensing fee, which is not credited against future royalty payments.
Royalties need not be fixed – they can be scaled so that they are relatively

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high if the product is only produced in low volumes, but so they decrease if
the licensee produces high volumes of the product. It might also be
necessary to clarify when royalties fall due – when the licensee issues an
invoice for the product, or when the licensee is actually paid by the
purchaser of the product. There may also be provisions to allow for the
royalty structure or level to be reviewed in the light of changing market
conditions or other factors.

The need to monitoring the use of the invention and to ensure that royalties
are paid, as well as checking on milestones and diligence obligations, can
lead to requirements for record-keeping, access to accounts and records,
and independent auditing of accounts concerning the payment of royalties
and related data.

The approach taken should be realistic, especially in licensing biotechnology


which can be subject to long regulatory delays and on which returns to the
licensee can take a long time to realize.

Confidentiality:
There may be a requirement under the licence to keep certain know-how
protected, and this may translate into specific obligations on the part of the
licensee to provide protection and to restrict access to confidential
information, in the same manner as a distinct non-disclosure agreement.

Copyright:
Apart from copyright protecting the licensed subject-matter (for example, if it
includes computer software), the licence may clarify the copyright provisions
covering manuals, data sheets or other documentation that are received and
used as part of a licensed technology package.
Term
The license should specify how long the licensed right runs for. It could
include an initial term, with option for renewal, subject to negotiations certain

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terms (such as royalty payments, or exclusivity) or demonstration of


diligence. Alternatively, the license could be set to run for the life of the
patent (potentially including any extension of the patent term).

Termination
The license may provide for termination before its expiry. This may arise in
the event of breach of a license provision, or the bankruptcy, dissolution or
insolvency of the licensee. The license could provide for termination in the
event of the lapse or invalidation of the licensed patent right. There may be
provision for termination by the licensee with due notice to the licensor,
potentially subject to a termination fee.

Assignment
The license may need to set out on what terms the licensor or licensee can
assign its rights and obligations under the license (for instance, clarifying
what happens if a licensor sells its patent portfolio to a third party, and how
the interests of an exclusive licensee can be preserved). It may provide for
the licensee to give prior written consent before the licensor’s rights can be
assigned or transferred to a third party. It may also clarify whether, and
under what conditions, the licensee can assign the licensed rights to a third
party.

Improvements and grant-back rights


The licence may specify who will own IP rights relating to improvements and
adaptations to the licensed technology arising from the licensed use of the
technology. Equally, the licence may cover improvements made by the
licensor to the original technology – the licensee may be entitled to access
to any improvements (possibly subject to conditions, such as additional
royalties or licence fees). There may be an agreement to cross-license
improvements to one another, on a royalty-free basis. Unless the licensor is
not interested in continued research in the field, the licensor would normally

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try to secure non-exclusive ‘grant-back’ rights, giving them access to any


improvements made by the licensee – otherwise, the licensee might be able
to get patent protection on these improvements and deny the licensor
access to the best way of exercising their own invention. However, imposing
licensing requirements for exclusive grant-back rights – i.e. unduly limiting
the licensee’s own capacity to exploit their inventions –is often cited in
national law as illegal anti-competitive commercial behaviour (see below on
‘abusive licensing practices’).

Cross-licence
This kind of agreement involves an exchange of different entitlements – in a
sense, each party is both licensor and licensee. So A grants B a licence to
use A’s intellectual property, and B grants A a licence to use B’s intellectual
property. This is one way of resolving complex patent litigation or competing
claims to ownership of overlapping intellectual property rights.

Indemnification and warranties


These provisions cover such issues as who would defend (and pay for) any
legal action against the licensee, in the event that the licensed use is
claimed to infringe a third party’s patent or other IP right. The licence might
try to give the licensor an indemnity or safeguard against any claim of
damages caused by legal action taken against the licensee regarding their
use of the licensed technology. On the other hand, the licensor might be
asked to give a warranty that they have the right to grant the licence, that
intellectual property rights are valid, and that they are actually owned by the
licensor without any conflicting claim. The licensor may need to warrant that
they are unaware that the use of the licensed technology would infringe the
IP rights of a third party – this might include an undertaking actively to
investigate this possibility (such as through searches of patent documents).
The licensee might be asked to give warranties that they will ensure they will

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continue to have the necessary expertise and resources to exploit the


licensed technology effectively.

Required performance
If you are licensing out your IP-protected technology, you need to consider
what level of performance you are expecting from the licensee, and what
kind of guaranteed performance you would like to build into the licence
agreement. To some extent, this is covered by the structure you choose for
licence fees and royalties (discussed above), but there may be additional
performance targets that can be set – for instance, minimum sales levels
(potentially compared to previous years’ levels), or relative to other markets
or to competitors, such as a particular market share. This is especially
relevant if you are contemplating granting an exclusive licence. You need to
be clear whether the licence is really just an agreement to pay you a royalty
when and if your technology is used, without any real obligation to exploit
the technology; or whether the licence is meant to create positive obligations
on the licensee to take active steps – or even their ‘best endeavours’ – to
make sure the technology is fully exploited for your benefit and for the public
benefit, and even to ensure that the technology is improved and refined as it
is exploited.

The licensor may also have obligations to perform. The licensee may be
expecting more than just a legal right to use the technology, and may be
looking for more substantial assistance to exploit the technology effectively.
So the license might involve obligations on the licensor to provide a certain
level of training and technical support and advice, and to assist in the
process of gaining regulatory approval to use the technology (for instance,
assisting in providing the data necessary for the approval of a new
pharmaceutical formulation). The licensor might also be required to advise
the licensee of any research developments or improvements, or any new

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research outcomes that could adversely affect the viability of the licensed
technology.

Publication of research
Licenses may contain conditions on the publication of research relating to
the licensed technology, both to monitor developments in the technology
and the licensed activities, and to ensure that prior publication does not
destroy any future patent rights.

Maintaining IPRs
Licenses may cover obligations on maintaining a patent, especially in
ensuring that an application is prosecuted to grant, and then ensuring that
renewal fees are paid to keep the patent in force. Typically, an annual fee or
some form of regular payment must be paid to the patent office to keep the
patent in force – if it is not paid, then the patent lapses. These fees often
increase during the life of a patent, and if a patent is held in different
countries, the payments can become very considerable.

Because the licensee is gaining benefits from the patent – especially under
an exclusive licence – they may be asked to contribute to, or to be totally
responsible for, keeping the patent in force by paying these fees. In theory,
a licence could provide that either party is responsible for paying renewal
fees, although the licensor (and patent holder) may feel more comfortable
ensuring payment, as it can be difficult (or after a certain time impossible) to
reinstate a patent that has lapsed due to failure to pay renewal fees. The
license can stipulate that the licensee pay a proportion of the IPR
maintenance costs.

Especially if it involves a composite technology package – for example,


combining patented technology with unregistered trade secrets or know how
(confidential information) – then the license will need to be very clear about
what happens when one of the components of the package changes status

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– say if a patent expired or was invalidated, while the related know-how


remained protected. This could involve a significant cut in the level of royalty
payments, for instance, reflecting the decreased overall value of the licence.

Enforcing IPRs
The licensee of IP rights is often in a better position to monitor what its
competitors are doing, and might be the first to find out about other parties
infringing the patent or other IP right. Any licensee will be interested in
preventing this activity, because it represents a competitor gaining an
advantage over them, because they are avoiding licensing costs and other
conditions on use of the licensed technology. Yet the licensor, as the owner
of the IP, also has a fundamental interest in avoiding damage to the value of
their IP caused by the infringing activities. IP litigation is expensive and time-
consuming. Licenses can therefore clarify the respective roles and
responsibilities of the licensor and licensee in enforcing the licensed IP
rights.

Enforcing the licence and choice of law:


If either party fails to live up to the licence, there needs to be a way of
enforcing the obligations undertaken by the licensor and licensee, and for
compensating the other party for damage caused.

Serious breaches of licences are not common, particularly if licences are


well- drafted and properly represent the shared interests and agreed
working relationship of the two parties. Yet major licence disputes can be as
complex and difficult as patent litigation. In addition, the licensor and
licensee may be based in different countries, raising questions about what
national law applies to the licence.

Licences therefore often contain provisions specifying what action should be


taken in the event of a dispute between the licensor and licensee. It may
provide for arbitration or mediation through a specified service as an

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alternative to litigation. And it will normally specify which law applies to the
contract – such as the law of Indonesia or the law of Singapore, or in the
case of a federal system such as the United States or Canada, it may be a
state law, such as the law of the Province of Ontario.

Other licence terms


The licence can be more than just an agreement to permit the usage of the
licensed technology in exchange for a payment. For instance, it might
involve providing technical assistance, training and continuing transfer of
technology that will be of assistance in exploiting the licensed technology.

The license may cover such issues as marketing products produced by the
licensed technology and requirements for the licensor’s trade mark or
certification mark to be applied. The license may also include undertakings
as to compliance with ethical standards, environmental protection
measures, and government regulations.

In addition, broader technology management issues may be addressed, so


that the licensee does not impair the viability of the technology.

Preliminary documents: heads of agreement or letter of intent


A potential licensee may be unwilling to make firm and detailed
commitments, for instance to pay a certain level of royalties or to cross-
licence its own proven technologies, before an opportunity to evaluate the
technology that is to be licensed. But they may be unwilling to invest in the
evaluation process unless they have some confidence they will get
exclusive rights to exploit the licensed technology. A confidentiality
agreement or materials transfer agreement can be used to cover the initial
disclosure for evaluation, so the future licensee can check the technology
without damaging the interests of the party providing the technology or
biological materials. But it might also be necessary to reach preliminary
agreement on the commercial arrangements that will apply and to ensure

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that the future negotiations on the details of a licence have a solid basis of
understanding. Even the commitment of resources to engage in negotiations
on a licence requires some level of confidence that it is a worthwhile
investment.

This leads to the commercial practice of agreeing on the general basis or


overall framework of a future agreement, by means of documents variously
called ‘heads of agreement,’ ‘letter of intent,’ ‘memorandum of
understanding’ or ‘agreement in principle.’ You should be cautious when
dealing with these documents. It may be unclear whether you are entering
into a firm legal obligation – a binding legal contract – or just signalling your
general willingness to do business and helping to shape and focus the
detailed negotiations. If the negotiations fail, the other party might seek to
enforce rights under an informal ‘letter of intent’ or ‘agreement in principle’
even if you thought it was not a strict legal obligation but just a general
framework for discussions.

Abusive licensing practices


An IP holder is often not entitled to use the power of their IP rights to impose
unfair terms on licensees who are interested in using the technology –
national IP law or competition law often intervenes to make unfair, coercive
or abusive licences illegal. The TRIPS Agreement acknowledges that ‘some
licensing practices or conditions pertaining to intellectual property rights
which restrain competition may have adverse effects on trade and may
impede the transfer and dissemination of technology.’ Examples of these
restrictions are exclusive grant-back conditions (e.g. requiring a licensee
only to grant licenses over any improvements to the licensor and no-one
else), conditions preventing challenges to validity (e.g. requiring the licensee
to avoid taking legal action against a patent on the basis that it is not novel
or is obvious), and coercive package licensing (e.g. requiring the licensee to

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use only the licensor’s products in other areas as a condition of the license –
stating, for instance, that a technology can only be licensed on the condition
that the licensee purchases raw materials from the licensor).

Compulsory licences
A compulsory licence comes about when the holder of a patent is unwilling
to license the technology or is otherwise viewed as failing to ‘work’ or exploit
the patent for the benefit of the community. Under the patent law of many
countries, there is provision for a court or similar legal authority to step in
and issue a licence to permit a third party to make use of the patented
invention. Because the licence is issued without the authorization of the
patent holder it is known as a ‘compulsory’ licence. A compulsory licence
may be required to deal with anti-competitive behaviour regarding patented
technologies, to enable a patent holder of a dependent patent (a patent for a
subsequent invention falling within the scope of an earlier patent) to exploit
the invention, and for other general public policy reasons. Typically,
compulsory licences are granted for limited purposes, are essentially
restricted to the domestic (non-export) market, are nonexclusive, and are
subject to payment of compensation to the patent holder.

Often included under the category of compulsory licences is non-


commercial government use. The patent law of many countries provides for
government agencies to make use of patented technology for non-
commercial purposes, without prior authorization of the patent holder, again
subject to payment of adequate compensation.

7.8 Licensing, Enabling Technologies and the Public Interest


An article from the magazine, Stanford's DNA patent 'enforcer' Grolle closes
the $200M book on Cohen-Boyer, quotes the licensing officer as saying that
"The philosophy of Stanford was that we wanted to make it available to
mankind, and we felt it would never be exploited properly with an exclusive

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license," and comments that ‘the university also sought to keep the buy-in
modest so many companies were able to pick up the license.’ At the same
time, the patent was able to generate a very considerable amount of income
to support further research.

In the ongoing debate over how companies and universities should best
profit from research tools, it's understandable that licensors would review
how past research tools have been treated.

Probably, the most famous case of all is the Cohen-Boyer gene-splicing


patent shared by Stanford University and the University of California system,
which describes the fundamental technique for using restriction enzymes
and plasmids to snip a gene from one organism's cells and insert it in a
bacterium in order to produce a protein
What gets a bit muddled from time to time, though, are a few of the key
details about just how the universities profited, and what their intent was.
One often-heard inaccuracy, for example, is that Cohen-Boyer was offered
royalty-free to all comers, in exchange for a nominal up-front fee.

There's no question the universities wanted to encourage the technique's


broad use. "We wanted to spread it around for the whole world," says Floyd
Grolle, the Cohen-Boyer patent "enforcer" for Stanford's Office of
Technology Licensing since 1982. According to Grolle, the terms were quite
clear-cut. There was an initial licensing fee of $10,000 and, after that, a
minimum annual fee of $10,000. In addition, there was a royalty agreement,
from which the minimum annual fee could be discounted. In other words,
each licensee paid Stanford at least $10,000 up front and another $10,000
annually for the use of the Cohen-Boyer patent and more when the royalties
from a successful product rolled in.

Part of the confusion is that unlike some of the research tools today which
are a true intermediary step in the process, Cohen-Boyer is technically

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infringed whenever someone makes a recombinant protein using gene-


splicing. Thus, the basis for the royalties is not "reach-through," but rather a
technical infringement in the actual manufacture of a recombinant protein.

The other interesting question that arises over Cohen-Boyer is how different
the development of the biotech industry might have been if Stanford and UC
had licensed it exclusively. One version of the story says that Stanford
University, which owned the patent with UC, offered it on an exclusive basis
to Genentech, Inc. of South San Francisco and decided to go the non-
exclusive route only when Genentech didn't offer enough money. The other
version of the story is that

Genentech wanted exclusive rights, but Stanford, which was handling the
negotiations of the two schools, never offered them.

7.9 Enforcement of Intellectual Property Rights


Intellectual property rights are of limited value unless they are effectively
enforced. Without enforcement, there are no real deterrents for infringers or
remedies for those whose rights are infringed. The legal authorities do have
some role in enforcing intellectual property rights, but this is often limited,
and for infringement of rights such as patents, plant breeders rights and
trade secrets, you would normally have to take action yourself to take the
infringing party to court. The same practical commercial considerations that
apply to obtaining and managing IP rights also apply to enforcement – in
some cases, the possibility of taking court action could act to encourage the
infringing party to take out a licence to use your technology. This would save
you the expense and the uncertainty of a protracted court case, and could
provide you with a good financial return.

The procedures for enforcement of IP rights differ widely between countries,


because they have much more to do with the general legal system than

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other aspects of IP rights, such as examination and grant of rights by a


patent office. The TRIPS Agreement has established some general
principles for IP enforcement which are reflected in the laws of many
countries, so this discussion will focus on the TRIPS provisions to give an
overall picture of how enforcement operates.

One basic distinction in enforcement lies between more those IP


infringements which tend to be infringed widely, potentially by many different
people and on a large commercial scale, and general IP rights. In the first
category are pirated copyright works and counterfeit trade mark goods.

TRIPS, for instance, specifies that the government or legal authorities need
to have a more active role in dealing with these infringements than, say, for
patents and plant breeders’ rights. So the state often has an active role in
tracking down and prosecuting those who infringe copyright and trademark
rights on a commercial scale, whereas for patents it is normally up to the
patent holder or licensee to take an infringer to court.

7.9.1 Enforcement Measures Required by TRIPS


The TRIPS Agreement differs from earlier international intellectual property
treaties in several ways; this includes having specific provisions for effective
enforcement of IP rights in national laws. The main enforcement provisions
in TRIPS include:
 The general obligations under the TRIPS Agreement, which relate to the
provision of fair enforcement procedures.
 Civil remedies, including injunctions, damages and provisional
measures.
 Criminal procedures, which are compulsory for intentional trade mark
and copyright piracy on a commercial scale and optional for other kinds
of intellectual property, such as patents.

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 Special border enforcement measures to stop counterfeit trade mark


and pirated copyright material coming into a country, border
enforcement measures are optional for other kinds of intellectual
property, such as patents.

7.9.2 General Enforcement Obligations under Trips


The TRIPS Agreement provides for a range of general obligations in relation
to the enforcement of intellectual property rights. The purpose of these
obligations is to ensure that the enforcement measures are effective, and
that certain basic principles of due process are met, so that enforcement is
fair and balanced, and does not impede legitimate trade.

Remedies must be timely and deter further infringements

TRIPS requires that enforcement procedures permit effective action against


any infringement of intellectual property rights, and that the remedies
available are expeditious in order to prevent infringements. A legal system
that enables timely initiation and execution of legal processes is particularly
important for effective enforcement of intellectual property rights because
the information that intellectual property protects is often easy to copy and
spread quickly. The remedies available must also be severe enough to deter
further infringements. These procedures must be applied in a way that
avoids the creation of barriers to legitimate trade and to provide for
safeguards against their abuse.

Enforcement procedures must be fair.

TRIPS provides that enforcement procedures must be fair and equitable,


and may not be unnecessarily complicated or costly, or entail unreasonable
time-limits or delays. Decisions in enforcement cases must be based on the
merits of a case. Decisions should preferably be in writing and reasoned,
and be made available to the parties without undue delay. Decisions on the

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merits of a case must be based only on evidence in respect of which the


parties were offered the opportunity to be heard.

Parties to a proceeding must have an avenue of appeal, unless the case


was criminal in nature and the accused was acquitted. TRIPS does not
require a special judicial system for the enforcement of intellectual property
rights distinct from the normal court system. Finally, TRIPS creates no
obligations with respect to the distribution of resources as between
enforcement of intellectual property rights and the enforcement of law in
general.

Example – enforcing a patented invention for making house paint.

For example, imagine that you own a patent for house paint that dries very
quickly. It took you 8 years to develop the process and cost you thousands
of dollars to patent your invention in Australia, the US and Indonesia. Just
as you started to distribute the paint yourself in Australia you found out that
your paint is being sold cheaply to the painting trade in Sydney by a
company trading as Cheap Paints. You also suspect that Cheap Paints are
exporting tins of infringing paint overseas. Obviously you need to take legal
action against Cheap Paints to enforce your rights, otherwise, there would
be no market left for you to get any financial return on your invention. The
kinds of remedies you could take against Cheap Paints are set out in this
unit.

7.10 Civil Remedies


Fair and equitable procedures
Defendants in civil matters must be notified in writing that they are being
sued, informed of the claims made against them in sufficient detail and have
the right to be represented by independent legal counsel. The parties are

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entitled to present all relevant evidence, while confidential information must


be identified and protected.

Injunctions
TRIPS requires that courts be capable of ordering injunctions. An injunction
is a court order compelling a party to stop infringements, or prevents it from
infringing in the first place.

Injunctions can also be ordered to prevent imported infringing goods from


entering into domestic distribution channels.

Example - Use of an injunction against infringing sale of patented


house paint:
Remember in the above example that Cheap Paints were selling cheap tins
of your patented house paint in markets in Sydney. This was a major
problem for you because the price of your paint was higher than the pirated
paint and Cheap Paints were destroying your market. Unlike you, Cheap
Paints did not have to recoup all the costs you incurred in developing and
patenting the new paint so they could afford to under-cut your price.

In this case, an effective remedy for you to use against Cheap Paints is an
injunction – a definitive order issued by the court, which the infringer is
bound to follow. An injunction could order Cheap Paints to stop selling the
infringing paint and give you back the market for selling your patented paint.

Damages
TRIPS requires that courts must be able to order an infringer, at least if he
or she acted in bad faith, to pay adequate damages to the intellectual
property right owner (TRIPS Article 45(1)). Damages compensate the
intellectual property owner for the damage caused by an infringement.
Courts must also be authorised to order the infringer to pay the right owner’s
court costs, including lawyers’ fees (TRIPS Article 45(2)). In appropriate
cases, the courts may allow the plaintiff to recover profits made by the
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defendant through the unauthorised use of the plaintiff’s intellectual property


(an ‘account of profits’) and/or pre-established damages even where the
infringer acted in good faith (TRIPS Article 45(2)).

Example - Damages for infringing sale of patented house paint:


Another remedy for you to use against Cheap Paints is the remedy of
damages. Damages can be used in addition to an injunction. In the previous
example it was important for you to get an injunction against Cheap Paints
to stop them from selling infringing versions of your house paint.

This enabled you to sell your patented paint yourself and get the financial
benefits from sales of your patented invention. However, you could also take
an action against Cheap Paints for damages to compensate you for the loss
that you suffered because of their infringing sales of your patented paint. For
example, you could get damages to compensate you for lost profits during
the time that the infringing paint was sold. You may also be able to obtain
compensation for any loss of reputation that Cheap Paints may have caused
you if, for example, its paints were of an inferior quality and consumers
believed that you produced it. Cheap Paints may cause you serious financial
damage if consumers have stopped buying your products.

Other remedies
TRIPS provides for other remedies in addition to injunctions and damages.
In order to create an effective deterrent to infringement, TRIPS requires
judicial authorities to have the authority to order infringing goods to be
disposed of outside the channels of commerce, or, where possible under
domestic law, destroyed. Similarly, it must be possible to dispose of
materials and instruments predominantly used in the production of the
infringing goods.

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Provisional measures
As noted above, TRIPS requires that enforcement procedures must permit
effective action against infringements and include timely remedies.
However, as complete judicial procedures can take a quite a long time,
TRIPS requires that judicial authorities be able to provide provisional relief
for intellectual property owners in order to stop an alleged infringement
immediately while the case is fully considered. This may mean that a judge
can grant an injunction almost straight away, which may prevent the
defendant trading in the allegedly infringing goods until the final trial decision
is handed down. It is imperative that swift (and in some cases pre-emptive)
action can be taken to prevent infringements or stop them quickly.

Provisional measures must be available in two situations. First, it must be


possible to prevent an infringement from occurring, and to prevent infringing
goods from entering the channels of commerce. This includes preventing
imported infringing goods from being dispersed into domestic distribution
channels immediately after customs clearance. Second, provisional
measures must be available to preserve relevant evidence relating to the
alleged infringement. This, for example, may be in the form of an order
compelling the defendant to allow the plaintiff and his lawyers to enter his or
her business premises to secure evidence. In many common law countries,
this is called an

Anton Piller order. This remedy is important in intellectual property cases


because it is often easy for the defendant to dispose of evidence on short
notice (sometimes it might be as easy as deleting files on a computer).

In order to be effective, provisional measures may require that action be


taken without giving prior notice to the other side. Accordingly, the judicial
authorities must be able to order provisional measures (such as injunctions)
in the absence of the defendant where appropriate, particularly where any

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delay is likely to cause irreparable harm to the intellectual property owner, or


where there is a risk of evidence being destroyed.

You may think that these procedures are unfair on the defendant and that
the presumption of innocence is discarded because he or she is punished
before the trial has taken place. This has been a concern in national legal
systems, and TRIPS requires that provisional measures must contain
safeguards against abuse of such measures. For example, the judicial
authority may require the applicant to provide a security or equivalent
assurance sufficient to protect the defendant and to prevent abuse. This
may be payable to the defendant if the plaintiff loses the case. Some
countries have made injunctions more difficult to obtain by, for example,
requiring that the plaintiff prove that the defendant has a serious case to
answer and to establish that damages will be an inadequate remedy if the
injunction is not granted.

There are other provisional measures which TRIPS does not mention, but
which are provided for under the laws of many countries. For example, if a
plaintiff is afraid that defendant will move its assets out of the jurisdiction to
avoid paying compensation, he or she may be able to convince the court to
freeze the assets of the defendant for the duration of the trial. This is called
a Mareva Injunction in some countries.

7.11 Criminal Procedures


Civil proceedings, initiated by the right holder, are often considered to be
more appropriate approach for dealing with infringement of IP rights. They
give the right-holder the opportunity to obtain damages to compensate his or
her losses, lost profits and legal costs if the case is successful.

However, criminal proceedings apply to infringement of some IP rights. In


this case, the state’s legal authorities are responsible for taking the infringer

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to court, and the court imposes a penalty such as a fine or, in extreme
cases, imprisonment.

TRIPS only requires that criminal procedures need be provided for


intentional trademark counterfeiting or copyright piracy on a commercial
scale. The remedies available for such crimes must include imprisonment
and/or monetary fines. The monetary fines must be enough to deter future
counterfeiting.

TRIPS allows Members to provide criminal procedures and penalties in


other cases of infringement of intellectual property rights, in particular where
they are committed intentionally and on a commercial scale. That is, it is not
mandatory for countries to provide criminal procedures for intentional
infringements of patents and plant breeders’ rights, although some countries
may choose to (in practice, this is unusual).

There are advantages and disadvantages to using criminal procedures. On


the one hand, the government will probably run the trial, and so the costs to
the inventor of bringing the action are minimal. But on the other hand, the
penalty obtained from a conviction will usually go to the state. This means
that, if the right-holder has suffered substantial losses, criminal proceedings
do usually not directly enable them to recoup their losses.

7.12 Special Border Enforcement Measures - Customs


In relation to trade marks and copyright, TRIPS also provides for special
border enforcement measures. The purpose of the border enforcement
measures is for intellectual property owners to be able to get assistance
from customs authorities to prevent the importation of counterfeit trade
marks and copyright goods (TRIPS Articles 51-60). These provisions also
include safeguards to prevent the abuse of the border enforcement
provisions by trade mark and copyright owners.

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7.13 Different Roles in IP Enforcement


Effective enforcement is vital if the IP system is to function properly. If there
is no real risk of legal sanctions in the event of infringement, the IP right
loses its value. Enforcement is not the role of any one body. It is a
cooperative task potentially involving enforcement agencies, including the
courts, police and customs. National intellectual property offices do not
usually have a direct role in enforcing intellectual property rights, although in
some countries they do have a role, either in providing expert advice or in
coordinating investigation and prosecution of infringements.

Ultimately, it is the responsibility of the right holder to enforce their own


rights. In many cases, this is the only option. Even if there is the possibility
of criminal proceedings or border control measures, the right holder may
need to initiate the complaint and assist with the provision of evidence and
testimony. For IP rights most associated with biotechnology, such as
patents, plant breeders’ rights and confidential information (trade secrets),
civil actions initiated by the right holder are often the only option. The
potential cost and risks associated with IP enforcement should be built in to
your strategic planning. Infringement insurance is a possibility, and may
need to be investigated. But you should also try to involve others with an
interest in the IP rights – for instance, an exclusive licensee, who might have
even more interest in seeing the licensed IP right effectively enforced than
you do. Provisions on who is responsible for enforcement are therefore
often included in license agreements and joint venture agreements.

Self Assessment Questions II


1. The process of assessing the viability, risk, potential liabilities and
commercial prospects of a project is known as ––––––––––– .
2. The ––––––––––– to the licence are the entities that are bound by the
licence as a legal contract.

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3. The person granting the licence is the ––––––––––– and the person
receiving the licence is the ––––––––––– .
4. A ––––––––––– means that the licensor grants a licence to only one
licensee.
5. A ––––––––––– is a further licence, when the licensee of the original
licence itself grants a licence to a third party.

7.14 Summary
One needs to make good commercial decisions to benefit from one’s
intellectual property rights.

Intellectual property rights do not guarantee you a financial return on your


invention, but they can assist. Which commercial model you choose to
exploit your rights will depend on the value of your invention and how much
money and time you have to exploit your rights. Options are: licensing your
intellectual property rights: a licence is a grant of permission to exercise any
rights of the patent owner, licences can be exclusive or non-exclusive
selling (or assigning) your intellectual property rights: in contrast to a
licence, an assignment of intellectual property rights is the sale of those
rights joint venture with commercial partners to manufacture and market
your invention, and set up your own company to manufacture and market
your invention.

A licensing agreement is a common way to exploit intellectual property


rights. Key clauses in them relate to: the name of the intellectual property
rights licensed, ownership of the intellectual property rights, royalty rates,
which territory the licence applies to, whether the licence is exclusive or
non-exclusive, who will pay the costs of maintaining the patent rights,
confidentiality and publication issues, insurance, release and indemnity and
dispute resolution and termination.

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It is important to enforce your intellectual property rights to protect the value


of your intellectual property rights. National legal authorities do have a role
in enforcement of IP rights, but as a rule, it is up to the owner of IP rights to
initiate action against infringers. Licensees may also have a role in
enforcement.

Effective legal remedies must be available to deter and punish infringements


of intellectual property rights. The options for enforcing your intellectual
property rights include: civil remedies including injunctions, which are court
orders to stop infringements, and damages, which compensate the
intellectual property owner for damages caused by the infringements
criminal procedures, which are compulsory for intentional trade mark and
copyright piracy on a commercial scale and optional for other kinds of
intellectual property, such as patents, and special border enforcement
measures to stop counterfeit trade mark and pirated copyright material
coming into a country, border enforcement measures are optional for other
kinds of intellectual property, such as patents.

7.15 Terminal Questions


1. What factors need to be considered while weighing up whether to
commercialise your invention yourself, or to find commercial partners or
another way of developing your invention?
2. Explain different options available for exploiting IP rights.
3. What is a licence? How can it protect IP rights?
4. How can ‘Joint Venture Agreements’ be useful for start-up companies?
5. Describe how Intellectual Property Rights are enforced.

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7.16 Answers to SAQs and TQs


SAQs I
1. Licence; patent holder
2. Patent right
3. Joint venture agreement
4. Spin-off
5. Start-up company

SAQs II
1. Due diligence
2. Parties
3. Licensor; licensee
4. Sole licence
5. Sub-licence

Answers to TQs:
1. Refer to 7.2
2. Refer to 7.3
3. Refer to 7.4
4. Refer to 7.5
5. Refer to 7.9

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Unit 8 Corporate Social Responsibility


Structure
8.1 Introduction
Objectives
8.2 Meaning of CSR
8.2.1 The Growing Recognition of CSR
Self Assessment Questions I
8.3 The Global Dimension of CSR
8.3.1 Abstract
8.3.2 Values in Corporate Responsibility
8.3.3 Challenges for its further Diffusion
8.3.4 Principles for Community Action
8.3.5 Developing CSR Management Skills
8.3.6 Fostering CSR among SMEs
8.3.7 Promoting Convergence and Transparency of CSR Practices
and Tools
8.3.8 Codes of Conduct
8.3.9 Management Standards
8.3.10 Employment and Social Affairs Policy
8.3.11 Measurement, Reporting and Assurance
Self Assessment Questions II
8.4 Summary
8.5 Terminal Questions
8.6 Answers to SAQs and TQs

8.1 Introduction
CSR is “a concept whereby companies integrate social and environmental
concerns in their business operations and in their interaction with their
stakeholders on a voluntary basis” as they are increasingly aware that
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responsible behaviour leads to sustainable business success. CSR is also


about managing change at company level in a socially responsible manner.
This happens when a company seeks to set the trade-offs between the
requirements and the needs of the various stakeholders into a balance,
which is acceptable to all parties. If companies succeed in managing
change in a socially responsible manner, this will have a positive impact at
the macro-economic level.

CSR can make a contribution to achieving the strategic goal of becoming,


by 2010, “the most competitive and dynamic knowledge-based economy in
the world, capable of sustainable economic growth with more and better
jobs and greater social cohesion" as adopted by the Lisbon Summit of
March 2000, and to the European Strategy for Sustainable Development.

The consultation process on the Green Paper has supported Community


action in the field of CSR. In the present Communication, which constitutes
a follow-up to last year’s Green paper, the Commission presents an EU
strategy to promote CSR. The Communication is addressed to the
European institutions, Member States, Social Partners as well as business
and consumer associations, individual enterprises and other concerned
parties, as the European strategy to promote CSR can only be further
developed and implemented through their joint efforts. The Commission
invites enterprises and their stakeholders as well as Social Partners in
candidate countries to join this initiative.

This unit describes the global dimensions of CSR.

Objectives:
After studying this unit, you will be able to:
 Explain the meaning of CSR.
 Account for the growing recognition of CSR.
 Describe the global dimension of CSR.

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8.2 Meaning of CSR


CSR is a concept whereby companies integrate social and environmental
concerns in their business operations and in their interaction with their
stakeholders on a voluntary basis.

The main function of an enterprise is to create value through producing


goods and services that society demands, thereby generating profit for its
owners and shareholders as well as welfare for society, particularly through
an ongoing process of job creation. However, new social and market
pressures are gradually leading to a change in the values and in the horizon
of business activity.

There is today a growing perception among enterprises that sustainable


business success and shareholder value cannot be achieved solely through
maximising short-term profits, but instead through market-oriented, yet
responsible behaviour. Companies are aware that they can contribute to
sustainable development by managing their operations in such a way as to
enhance economic growth and increase competitiveness whilst ensuring
environmental protection and promoting social responsibility, including
consumer interests.

In this context, an increasing number of firms have embraced a culture of


CSR. Despite the wide spectrum of approaches to CSR, there is large
consensus on its main features:
 CSR is behaviour by businesses over and above legal requirements,
voluntarily adopted because businesses deem it to be in their long-term
interest;
 CSR is intrinsically linked to the concept of sustainable development:
businesses need to integrate the economic, social and environmental
impact in their operations;

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 CSR is not an optional "add-on" to business core activities - but about


the way in which businesses are managed.

Socially responsible initiatives by entrepreneurs have a long tradition in


Europe. What distinguishes today’s understanding of CSR from the
initiatives of the past is the attempt to manage it strategically and to develop
instruments for this. It means a business approach, which puts stakeholder’s
expectations and the principle of continuous improvement and innovation at
the heart of business strategies. What constitutes CSR depends on the
particular situation of individual enterprises and on the specific context in
which they operate, be it in Europe or elsewhere. In view of the EU
enlargement, it is however important to enhance common understanding
both in Member States and candidate countries.

8.2.1 The Growing Recognition of CSR


CSR has found recognition among enterprises, policy-makers and other
stakeholders, as an important element of new and emerging forms of
governance, which can help them to respond to the following fundamental
changes:
 Globalisation has created new opportunities for enterprises, but it also
has increased their organisational complexity and the increasing
extension of business activities abroad has led to new responsibilities on
a global scale, particularly in developing countries.
 Considerations of image and reputation play an increasingly important
role in the business competitive environment, as consumers and NGO’s
ask for more information about the conditions in which products and
services are generated and the sustainability impact thereof, and tend to
reward, with their behaviour, socially and environmentally responsible
firms.

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 Partly as a consequence of this, financial stakeholders ask for the


disclosure of information going beyond traditional financial reporting so
as to allow them to better identify the success and risk factors inherent
in a company and its responsiveness to public opinion.
 As knowledge and innovation become increasingly important for
competitiveness, enterprises have a higher interest in retaining highly
skilled and competent personnel.

Self Assessment Questions I


1. Explain the main features of CSR.
–––––––––––––––––––––––––––––––––––––––––––––––––––––––––
–––––––––––––––––––––––––––––––––––––––––––––––––––––––––
–––––––––––––––––––––––––––––––––––––––––––––––––––––––––
–––––––––––––––––––––––––––––––––––––––––––––––––––––––––

2. Give reason for the growing recognition of CSR.


–––––––––––––––––––––––––––––––––––––––––––––––––––––––––
–––––––––––––––––––––––––––––––––––––––––––––––––––––––––
–––––––––––––––––––––––––––––––––––––––––––––––––––––––––
–––––––––––––––––––––––––––––––––––––––––––––––––––––––––

8.3 The Global Dimension of CSR


Global governance, and the interrelation between trade, investment and
sustainable development are key issues in the CSR debate. Indeed,
awareness of CSR issues and concerns will contribute to promote more
sustainable investments, more effective development co-operation and
technology transfers.

Both processes of trade and financial markets liberalisation should be


matched by appropriate progress towards an effective system of global
governance including its social and environmental dimensions. Globalisation

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has also increasingly exposed enterprises to trans-boundary economic


criminality, requiring an international response.

By abiding by internationally accepted standards, multinational enterprises


can contribute to ensure that international trade markets function in a more
sustainable way and it is therefore important that the promotion of CSR at
international level takes as its basis international standards and agreed
instruments.

Those agreed instruments are, at present, of two kinds:

First, the OECD Guidelines for Multinational Enterprises are the most
comprehensive, internationally endorsed set of rules governing the activities
of multinationals. In promoting CSR in developing countries, EU businesses
should demonstrate and publicise their world-wide adherence to them.

Second, beyond CSR, international agreements are in place and their


implementation by governments should be promoted. In its communication
on Promoting Core Labour Standards and Improving Social Governance in
the context of Globalisation1, the Commission stressed the need to ensure
the respect for core labour standards in the context of globalisation. It
stressed in particular the universality of core labour standards and the need
for codes of conduct to integrate the ILO fundamental Conventions.

At the same time, identifying common frameworks for the global dimension
of CSR is challenging due to the diversity in domestic policy frameworks,
protection of workers and environmental regulation. A number of initiatives
in which European companies participate, such as Investors for Africa,
World Business Council for Sustainable Development, and the UN Global
Compact have sought to identify basic principles and practices. The
underlying approach should be that, at global level, just as at European, the

1
COM(2001)416

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implementation of CSR principles should also go over and above the legal
requirements that businesses need to comply with, and approaches should
involve consultation with local stakeholders.

8.3.1 Abstract
Over the last decades, corporate environmentalism, sustainability initiatives
and management systems have resulted in a plethora of business practices
to increase corporate responsibility. Stakeholder dialogue is seen as a major
instrument in the involvement of the external stakeholders as well as for
communicating the corporate vision and commitment regarding these
initiatives internally. Until recently, many researchers and practitioners have
argued (or assumed) that the vision and commitment of senior management
is communicated clearly, and understood and incorporated by all staff within
the organisation in the manner as it was initially intended.

Yet, there is academic as well as anecdotal evidence that the integration of


corporate responsibility throughout the hierarchy of organisations is
marginal, and even absent in some cases. A recent study suggested that
among employees and managers there are few shared values or meaning
regarding corporate environmentalism, and that the perception of
environmental issues across levels and functions is very diverse indeed.
Thus, the corporate values relating to a firm’s responsibilities can be
perceived and experienced differently yet simultaneously within the same
organisation. This implies that it will be very difficult, if not impossible, to
truly embed responsible behaviour within an organisation if individual
perceptions of corporate value systems regarding responsibility are not
aligned proactively.

This paper proposes two complementary, multidisciplinary approaches to


further understanding of the role of shared values in attaining corporate

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responsible behaviour throughout the organisation. These two concepts


then are developed into concrete research questions for future studies.

Introduction
Corporate Responsibility2 is considered a key development in connecting
corporate practices with the societal goal of sustainable development, as
firms can “contribute to more sustainable patterns of production and
consumption within society” (Roome, 2006: p. 137). This has been
supported by research about business and the natural environment and
society, which has over the last decade predominantly focused on the
business case for sustainability and the competitive advantages of
environmental responsibility (e.g. Aragon-Correa and Sharma, 2003; Berry
and Rondinelli, 1998; Maignan and Ferrell, 2001; Porter and Van der Linde,
1995; Simpson et al, 2004). Within this field, various scholars have argued
for integration of corporate responsibility into established business routines
(e.g. Banerjee, 2001; Menon and Menon, 1997), yet in practice that does
not appear to be the case (e.g. Knox et al, 2005).

Most research about corporate responsibility focuses on investigation of


managers, and particularly on managers responsible for health, safety and
environmental issues (e.g. Cormier et al, 2004; Egri and Herman, 2000;
Sarkis, 1998). Banerjee (2002) argued that it was important to understand
the interpretations of decision makers regarding environmental issues.
Some researchers have looked at different levels of management
(e.g. Andersson and Bateman, 2000; Floyd and Wooldridge, 2002; Sharma,
2000). However, little research has been published on the integration of
corporate responsibility throughout the organisation and the possible

2
Corporate Responsibility contains both corporate environmentalism and corporate social
responsibility, and includes any initiative that reduces the environmental impact and/or
contributes to the improvement of the social conditions beyond the firm’s legal
obligations (Dyllick and Hockerts, 2002; Roome, 2006).

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implications of wider employee understanding of environmentalism


(Wehrmeyer and McNeil, 2000) and social issues (e.g. Lyon, 2004; McNutt
and Batho, 2005). Similarly, based on the idea that strategy development
and implementation is underpinned by the understanding of people (Floyd
and Woodridge, 2000; Mintzberg et al., 1998 and 2002), even experience
and culture (Johnson and Scholes, 2003), it is also important to understand
how decision-implementers influence the development, implementation and
success of responsible strategies and actions. Yet, we have found little
research on how employees perceive corporate values regarding
responsible behaviour.

A variety of authors (e.g. Banerjee, 2001; Gladwin et al. 1995; Hoffman,


2000) have demonstrated how using traditional management theories (in
particular institutional theory, strategic choice, transformational leadership)
can hinder efforts to change to a more responsible state of doing business
at the institutional as well as the organisational level. Therefore, new
perspectives, preferably from new domains, can challenge current
assumptions and facilitate the transition of developing appropriate
organisational values (Starkey and Crane, 2003). The aim of this discussion
paper is to review the current literature on corporate values regarding
Corporate Responsibility, and to reflect on the role of employees in attaining
responsible practices in an organisation. From this, we propose two
complementary, multi-disciplinary approaches to further understanding of
the role of shared values in attaining corporate responsible behaviour.
Finally, these two approaches will lead to the development of concrete
research questions for future studies.

8.3.2 Values in Corporate Responsibility


There are various theoretical perspectives on the concept of Corporate
Responsibility: ranging from a traditional view of the firm (e.g. Friedman,

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1962; Walley and Whitehead, 1994) to a call for a complete paradigm shift
in business practice (e.g. Dyllick and Hockerts, 2002; Gladwin et al, 1995).
However, all views on corporate responsibility are based on the same
premise: that there is a corporate strategic approach to environmental and
social issues (c.f. Banerjee et al, 2003; Lyon, 2004). Hence, it contains both
corporate environmentalism and corporate social responsibility (Dyllick and
Hockerts, 2002), leading to the current construct that Corporate
Responsibility includes any initiative that reduces the environmental impact
and/or contributes to the improvement of the social conditions beyond the
firm’s legal obligations (Roome, 2006). As such, it is considered a key
development in connecting corporate practices with the societal goal of
sustainable development, as firms can “contribute to more sustainable
patterns of production and consumption within society” (Roome, 2006:
p. 137).

Corporate Responsibility can be considered as encompassing two


components (Banerjee, 2002; Bansal and Roth, 2000; van Marrewijk, 2004):
a strategy focus (i.e. how strategically important environmental and social
issues are perceived by management), and an orientation aspect (i.e. a set
of underlying corporate values that provide an internal ‘compass’ to which
the company can orient its environmental and social actions). The
orientation of an organisation has significant strategic power in terms of
shaping the organisational direction (Chen et al, 1997; Keogh and Polonsky,
1998; Shrivastava, 1995c). As such, the ‘responsible’ orientation not only
influences the overall responsibility of a firm, it also affects the extent and
form that actual responsible strategies will take, as well as the ethical
behaviour standards and the environmental protection commitment of the
organisation (Shrivastava, 1995b). Therefore, the responsible orientation
within a firm needs to be studied in more detail to provide additional insights
into organisational attitudes towards the environment and society.

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Various researchers (e.g. Bansal and Roth, 2000; McKay, 2001; Prakash,
2001) found that a multi-theoretical perspective explained some organisa-
tional responses to a greater extent than single theories in isolation, and
could explain the seemingly ad hoc choices of firms to go beyond legal
compliance. Since this paper aims to propose two complementary
multidisciplinary approaches, none of the existing theories is judged or
favoured above others. Instead, the different theories are used in
combination to draw out more comprehensive notions of the role of values in
corporate responsibility.

Assuming that organisations are open systems (Katz and Kahn, 1966), and
as such become interdependent with those elements of the environment
with which they transact (Pfeffer, 1982), organisations work within such
interdependencies to reduce uncertainty and ensure survival (DiMaggio,
1988; McKay, 2001). Based on this, the central premise of resource
dependence is that power relations among actors are commonly
asymmetrical and that organisations strive to obtain power, maintain
autonomy, and reduce uncertainty in the context of external pressures and
demands. Control over resources is critical in maintaining power and is
therefore pursued by organisations (McKay, 2001). As such, an organi-
sation-wide dedication to a compelling long-range vision (a shared vision) is
the key to generating the internal pressure and enthusiasm needed for
[responsible] innovation and change (Hamel and Prahalad, 1989; Hart,
1995). Given the difficulty of generating a consensus about a purpose,
shared vision is a rare (firm-specific) resource, and few companies have
been able to establish or maintain a widely shared or enduring sense of
mission (Hamel and Prahalad, 1989). Starik and Rands (1995) extended
this idea to include values, as these act as a mechanism to unify and orient
organisational units toward sustainability. Norms and shared values are
essential to understand the sustainability of organisations, and provide links

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between the organisation and the environment and society (Starik and
Rands, 1995).

Institutional theory is also based on the open systems assumption as


described above. However, the central premise of institutional theory is that
survival arises out of conformity to external rules and norms. Thus, the
theory examines how external social and regulatory pressures influence
organisational actions (Scott 1987). Due to the powerful nature of
environmental influences, organisations seek to conform to environmental
pressures as a way to secure stability, legitimacy and access to resources.
Those organisations that are responsive to such institutional pressures are
assumed to be more likely to survive (DiMaggio and Powell, 1983; McKay,
2001). In setting environmental strategy and structure, firms may choose
action from a repertoire of possible options. However, the internal structure
and culture of the firm reflect the dominant institutions of the organisational
field, hence the range of that repertoire is bound by the rules, norms, and
beliefs of the organisational field (Hoffman, 1997).

Based on the ‘systems’ view of organisations, the central premise of


stakeholder theory is that there are specific interest groups in the outside
environment, which have a stake in the behaviour and effectiveness of that
organisation (Freeman, 1984). Although stakeholder theory shares notions
of power with both previously discussed theories, neither resource
dependence theory nor institutional theory appears to suffice to explain the
full range of stakeholder power. Both theories offer explanations of reactions
to economic or formal/legal pressures, but fail to account for political
pressures (Jonker and Foster, 2002): where environmental or social
stakeholders are involved, there is neither resource dependency nor
formal/legal pressure to conform (Frooman, 1999). The perception of the
responsible managers influences the approach to stakeholders

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(e.g. Collison et al, 2003; Cormier et al, 2004; Sharma and Henriques,
2005), and it is argued that “responses to environmental pressures can vary
widely among firms depending on managerial perceptions of environmental
risks and opportunities … on their interpretation of the importance and
relationship of the natural environment to their business activity” (Banerjee,
1998: p. 148). In explicitly describing the values and responsibilities of a
firm, business codes can help by providing a framework for managers to
guide their decisions, and simultaneously informing external stakeholders
(Kaptein, 2004).

A number of scholars argue that current research and practice in corporate


environmentalism may be limited by the assumptions under which much is
carried out (Porter, 2005). These authors therefore call for a revolutionary
way of thinking about business regarding environment and society (e.g.
Dyllick and Hockerts, 2002; Gladwin et al, 1995; Peattie, 2000; Shrivastava
(1995a); Stern et al. (1995)). A variety of authors (e.g. Banerjee, 2001;
Gladwin et al. 1995; Hoffman, 2000) have demonstrated how using
traditional management theories (in particular institutional theory, strategic
choice, transformational leadership) can hinder efforts to change to a more
‘green’ state of doing business at the institutional as well as the
organisational level. Therefore, new perspectives, preferably from new
domains, are required to challenge current assumptions and facilitate the
transition of developing appropriate organisational values (Starkey and
Crane, 2003).

From the above, we could conclude that shared values are a key
component in attaining a shared vision of the Corporate Responsibility of an
organisation and to guide interactions with stakeholders, and are formed by
rules, norms and ethical behaviour standards from both inside and outside
of the organisation.

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However, there is academic and anecdotal evidence that the integration of


corporate responsibility throughout the hierarchy of organisations is
marginal, and even absent in some cases (e.g. Barakat, 2006b; Knox et al,
2005). A recent study by Barakat (2006b) suggested that among employees
in three UK case studies there was a general absence of shared meaning
with regards to key environmental themes and issues (although smaller
clusters around hierarchical levels and some functional groups shared some
experiences on some issues). There was no system for the identification
and definition of environmental concepts, no explicit means by which
concepts could be shared and discussed, and no mechanism to indicate to
employees the concepts and definitions that would be acceptable and those
that would not. Hence, employees experienced their firm’s corporate
environmentalism predominantly in an individual manner. The perceived
corporate orientation towards environmentalism followed this, and this study
therefore offers some evidence that corporate environmental orientation can
be perceived and experienced differently within the same organisation.

Furthermore, many researchers and practitioners in the Corporate


Responsibility field (e.g. Banerjee et al, 2003; Juholin, 2004; Murphy, 1988)
have argued (or assumed) that the vision and commitment of senior
management is communicated clearly, and understood and incorporated by
all staff within the organisation in the manner as it was initially intended
(Preston, 2001; Ramus, 2001). Yet, there is little evidence that this
assumption is grounded in practice (Barakat, 2006a; Knox et al, 1995). Even
more so, there is evidence that (mainly lower-level) employees do not
perceive their firm to be pro-active in its environmental and social
responsibilities (e.g. Barakat, 2006a; Lingard et al, 2000; Ramasamy and
Woan-Ting, 2004). Research suggests that since employees are not
oblivious to the ethical climate of the company, this interaction affects the
trust that employees have of their organisations and affects their

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commitment to it (Van Dyne et al, 1994; Fritz et al, 1999; Gross and Etzioni,
1985). Also, the employees’ experience of Corporate Responsibility appears
to be significantly affected by their perception of the behaviours and
attitudes of management, especially if an employee perceives an
inconsistency between the immediate manager and the corporate policy
(Ramus, 2001). The resultant dissatisfaction and lack of engagement could
potentially impact the success of responsible initiatives (e.g. Preston, 2001;
Ramus, 2001). Hence, it has become important to understand how
Corporate Responsibility is interpreted by decision-makers (Banerjee, 2002)
and decision implementers (Ramus and Steger, 2001).

As a result of these gaps in the literature, we propose a two-pronged


approach for future research about values in corporate responsibility: Firstly,
to study the interaction with the higher level framework of values that is
provided by Corporate Identity, and secondly, to study the role of personal
values of employees in attaining a more responsible firm. These approaches
are detailed below.

Approach 1: Corporate Identity


With its roots in Marketing, the field of Corporate Identity has grown over the
past two decades. Research in the field has focused on a number of issues,
for instance corporate brands (e.g. Keller, 1999), corporate reputation
(e.g. Greyser, 1999), visual identity (e.g. Melewar, 2001), and organisational
identity (e.g. Simoes et al, 2005). Consequently, the wide spread in use of
the construct of Corporate Identity has led to an ambiguous meaning, which
makes it almost an unbounded in its range of applications (Cornelissen and
Elving, 2003). However, as a corporate construct Corporate Identity is
perceived to “indicate the way in which an organization’s identity is revealed
through behaviour, communications, as well as through symbolism to
internal and external audiences” (Van Riel and Balmer, 1997: p. 341).

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Analogous to Albert and Whetten’s (1985) definition of organisational


identity, van Rekom (1997) proposed three criteria for corporate identity:
that it contains the essence of a firm, that it sets a firm apart from others,
and that it has continuity over time.

Corporate identity research has the power to “probe into the quintessence of
an organisation's existence and … can propel to the fore issues of great
sensitivity and political importance” (Balmer, 2001b: p. 269). As such,
Corporate Identity provides a relevant framework for researching shared
values among employees, as “at its core is the mix of employees’ values
which are expressed in terms of their affinities to corporate, professional,
national and other identities” (Balmer, 2001: 280). Furthermore, every
organisation has an organisational (Albert and Whetten, 1985) and
corporate identity (Van Rekom, 1997), and as such provides a reliable
structure in which the salience and sharedness of other value systems can
be used as a reference. Finally, understanding the place and role of
corporate responsibility within a firm’s identity could offer insights into the
requirements for attaining more embedded responsibility in business
practice (e.g. Gray and Balmer, 2004).

More concretely, this leads to the following research questions:


 To what extent are the components of Corporate Responsibility part of
Corporate Identity?
 Is integration of Corporate Responsibility into the Corporate Identity
required to create a responsible firm? If integration would be required,
through which initiatives or activities could responsible practices become
embedded (e.g. identity scoping activities; Gray and Balmer, 2004)?
 Is the absence of shared values a common theme, or does this seem to
only affect responsible values?

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 Could the sharedness of values be enhanced to attain the scarce


resource as proposed by Hamel and Prahalad (1989)? How would this
be achieved?

Corporate Identity contains external and internal components (marketing


and organisational behaviour, respectively; He and Balmer, 2005). When
combined with the aspects of Corporate Responsibility, more questions
arise:
 What are the interactions between the internal and external components
of a firm’s identity in the context of responsible initiatives in an
organisation?
 What are the implications of the degree of internal and external
alignment regarding the firm’s objectives? E.g., if a company is accused
of ‘green washing’ (e.g. Gunn, 1999), how does this relate to its
alignment with respect to marketing? Could the perceptions of corporate
responsibility as a cost (e.g. Walley and Whitehead, 1994) or a benefit
(e.g. Christmann, 2000; Shrivastava, 1995b) affect a firm’s response
through its behaviour, structure and initiatives?

Answering these questions will contribute to the knowledge of the role of


social and environmental values in the construct of Corporate Identity. This
knowledge could influence the management of Corporate Responsibility
initiatives within a firm as it could create an increased awareness of the
issues across various levels and functions of the organisation.

Conversely, a better understanding of where Corporate Responsibility fits


within the organisation could have an impact on Corporate Identity, and as
such could develop and improve the management of a firm’s identity.

Approach 2: Personal values of employees


Individuals have been identified as the crucial factor that influences an
organisation’s sustainable behaviour. Also, employees are important change

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agents in the process towards a more responsible firm (Starik and Rands,
1995). However, it has been argued that “each individual carries around
within his or her head a subjectively valid set of beliefs. The potential for
individual subjectivity within organisations, therefore, means that
acceptance of an idea is contingent on the idea’s consistency with an
individual’s belief system – not the ideology of the organisation as a whole”
(Floyd and Wooldridge, 2000: p. 112). Therefore, personal values can also
influence a firm’s responses to environmental issues (Bansal and Roth,
2000), and can influence the individual’s perceptions of environmental
issues (Daft and Weick, 1984), behaviour (Dutton, 1997) and receptiveness
to change (Andersson and Bateman, 2000). This means that a complex
relationship exists between employees, their values and perceptions, and
the organisation, its values and the success of its responsible initiatives
(Beaumont et al, 1993; Cordano and Frieze, 2000).

Stern et al. (1995) developed a framework of the level of environmental


concern of an individual, highlighting the role of values in influencing
behaviour. Although personal values have been associated with individual
behaviour in the psychology literature, the role played by personal values in
decision-making within an organisation is less clear (Fritzsche, 1995). Past
research has found that managers tend to respond to ethical dilemmas
situationally and Fritzsche (1995) describes how personal values can relate
to various types of ethical dilemmas. Furthermore, there is evidence that the
personal orientation of managers leads to a different strategy focus (Keogh
and Polonsky, 1998). However, a recent study focusing on employees of
different levels and functions found that the link between personal
orientations and behavioural choices at work was less clear. Many of the
employees interviewed expressed strong personal values towards social
and environmental responsibility, whereas very few displayed these values

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when considering environmental issues within the company (Barakat,


2006a).

Therefore, the relevance of understanding personal values as described


above leads to the following research questions:
 How and why do personal values relating to responsibility appear to be
subordinated in an organisational context? Where do social and
environmental values sit with respect to a person’s hierarchy of values?
 How does this phenomenon compare with other domains like caring for
family or status?
 What are the implications of misalignments between personal
‘responsibility’ values and organisational ones?
 Could the environmental and social personal values be harnessed to
contribute to the responsible values of the firm? How does the degree of
employment of these values impact the execution of responsible
initiatives?

The outcomes of the above would further the understanding of the role of
individuals in their responses to social and environmental issues within their
organisation. This could have implications for the engagement of
employees’ perceptions towards the management of responsible initiatives.
The identification of the different positions available within an organisation
has the potential to provide a platform from which shared meaning and
experiences could be developed. Furthermore, the study could provide a
direction in which to develop practices to promote or mitigate the available
personal attributes towards a constructive asset of the firm.

8.3.3 Challenges for its further Diffusion


The challenges to a further awareness, dissemination and adoption of CSR
practices among enterprises stem from insufficient:

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 Knowledge about the relationship between CSR and business


performance (the “business case”);
 Consensus between the various parties involved on an adequate
concept taking account of the global dimension of CSR, in particular the
diversity in domestic policy frameworks in the world.
 Teaching and training about the role of CSR, especially in commercial
and management schools;
 Awareness and resources among SMEs;
 Transparency, which stems from the lack of generally accepted
instruments to design, manage and communicate CSR policies;
 Consumers’ and investors’ recognition and endorsement of CSR
behaviours;
 Coherence in public policies.

Community action in the field of CSR has to build on the core principles laid
down in international agreements and should be developed in full respect of
subsidiarity principles. Within this scope, there are at least two reasons
pointing to the opportunity and the need for Community Action in the field of
CSR. Firstly, CSR may be a useful instrument in furthering Community
policies. Secondly, the proliferation of different CSR instruments (such as
management standards, labelling and certification schemes, reporting, etc.)
that are difficult to compare, is confusing for business, consumers,
investors, other stakeholders and the public and this, in turn, could be a
source of market distortion. Therefore, there is a role for Community action
to facilitate convergence in the instruments used in the light of the need to
ensure a proper functioning of the internal market and the preservation of a
level playing field.

CSR practices and instruments will be more effective if they are part of a
concerted effort by all those concerned towards shared objectives. They

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should be transparent and based on clear and verifiable criteria or


benchmarks. Public policy can contribute to the development of an action
framework with a view to promote transparency and thus credibility for CSR
practices.

8.3.4 Principles for Community Action


The Commission proposes to build its strategy to promote CSR on a
number of principles. These are as follows:
– recognition of voluntary nature of CSR;
– need for credibility and transparency of CSR practices;
– focus on activities where Community involvement adds value;
– balanced and all-encompassing approach to CSR, including economic,
social and environmental issues as well as consumer interests;
– attention to the needs and characteristics of SMEs;
– support and compatibility with existing international agreements and
instruments (ILO core labour standards, OECD guidelines for
multinational enterprises)

The Commission proposes to focus its strategy on the following areas:


(1) Increasing knowledge about the positive impact of CSR on business
and societies in Europe and abroad, in particular in developing
countries;
(2) Developing the exchange of experience and good practice on CSR
between enterprises;
(3) Promoting the development of CSR management skills;
(4) Fostering CSR among SMEs;
(5) Facilitating convergence and transparency of CSR practices and tools;
(6) Launching a Multi-Stakeholder Forum on CSR at EU level;
(7) Integrating CSR into Community policies.

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The Commission is prepared to involve the candidate countries as much as


possible in the implementation of this strategy. It will also promote CSR as
an incentive to enhancing sustainable development and good governance in
developing countries.

Improve the knowledge about CSR and facilitate the exchange of


experience and good practice.

Increasing knowledge about the impact of CSR on business and society.

The responses to the Green paper reflect a broad consensus among


businesses about the expectation that CSR will be of strategic importance to
ensure the long-term business success.

The potential of CSR policies to strengthen the symbiotic relationship


between enterprises and society has already been demonstrated in areas
such as sustainable growth, education and social cohesion. CSR can
support the creation of an atmosphere of trust within companies, which
leads to a stronger commitment of employees and higher innovation
performance. A similar atmosphere of trust in co-operation among other
stakeholders (business partners, suppliers, and consumers) can increase
the external innovation performance. Consumer confidence fostered through
CSR can be a major contributor to economic growth. More specifically,
through CSR practices, enterprises can play an important role in preventing
and combating corruption and bribery, and in helping preventing the use of
enterprises for money laundering and criminal activities financing.

CSR policies can also boost the societal benefit that enterprises create with
regard to innovation. Innovative practices aiming at better jobs, safer and
employee-friendly workplaces, gender mainstreaming and the innovation or
technology transfer to local communities and developing countries, leading
to a more equitable North-South economic and social development, are

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further examples of societal benefits created by innovative enterprises.


Indeed, CSR may play a positive role in fostering development in third
countries by helping to establish a dialogue between these countries, their
public authorities, social partners and civil society and foreign companies.

The desire of enterprises to improve their risk management is a powerful


factor behind CSR. Enterprises generally agree that CSR helps them in
managing their risks, their intangible assets, their internal processes, and
their relations with internal and external stakeholders. It has also been
argued that opportunities and advantages for enterprises stemming from
complying with international social and environmental conventions, norms or
"soft law" instruments can outweigh costs. Although most businesses
support the assumption of a positive impact of CSR on competitiveness,
particularly in the long term, they are however not able to quantify this effect.

Solid evidence that social and environmental responsibility supports


competitiveness and sustainable development, in particular in SMEs,
would be the best and most effective argument to encourage the uptake of
CSR among enterprises, in particular through:

– strengthening research on how and under which circumstances


enterprises adopting CSR can contribute to the objective of
enhanced competitiveness and a more sustainable development: the
establishment of a priority area on "citizens and governance in the
knowledge-based society" in the Framework Programme 2002-2006
of the European Community for research, technological development
and demonstration activities, will contribute to gaining this
knowledge;

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– supporting activities promoted by businesses, social partners,


education and training institutions and other stakeholders, aiming at
raising awareness and improving knowledge about CSR;
– analysis and dissemination of information about CSR practices and
their results for companies and for host countries.

Developing the Exchange of Experience and Good Practices on CSR


between Businesses:
In their responses to the Green paper, business organisations and individual
enterprises stressed the importance of the exchange of experience and
good practices about CSR between companies, as an important vehicle to
develop the concept further. It can help businesses to acquaint themselves
with the concept, to benchmark their position against competitors and to
build up a consensus about its instruments, such as reporting standards or
verification procedures. These exchanges could be particularly beneficial at
sectoral level, where they can play an important role is identifying common
challenges and options for co-operation between competitors. Such co-
operation could reduce the costs of adopting CSR and help to create a
level-playing field. It could also help to diffuse CSR in supply chains.

Co-operatives, mutuals and associations as membership-led organisations


have a long tradition in combining economic viability with social
responsibility. They ensure this through stakeholder dialogue and
participative management and thus can provide an important reference to
other organisations.

The effectiveness of existing fora for the exchange of good practice and
experience at local, regional, national and EU level, could be reinforced
through better networking and co-ordination of their activities.

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The integration of CSR into the work of European business support


networks would facilitate dialogue and co-operation between them.

Developing the Exchange of Experience and Good Practices on CSR


between Member States:

Several Member states have developed CSR policies, which differ because
they reflect national traditions, situations and challenges. In order to
facilitate the exchange of information about national policies and to support
its work in the area of CSR, the Commission has gathered together a group
of High-Level Social Representatives from the Member States that has met
on a regular basis.

The Commission will continue to facilitate an exchange of information and


dissemination of good practices about awareness raising strategies and
activities, with a particular emphasis on SME, and initiatives aimed at
exploring and establishing Total Quality Management Systems as well as
other policies (CSR-related legislation and support). It will also propose a
peer review of the CSR practices in Member States, assessing the
performance and the value added of regulatory frameworks and
monitoring schemes.

8.3.5 Developing CSR Management Skills


Most respondents to the Green Paper stressed the importance of education
and training of managers, employees, and other actors to promote CSR.
The education system, at all levels, has a crucial role to play in the fostering
of social responsibility in citizens, including those who are working – or will
work – in the world of business or outside it. It can fulfil this role by enabling
citizens to understand and appreciate social, environmental and ethical
values and equipping them to take informed decisions. Education and
training in the field of business administration have particular relevance to

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CSR in this context, and the encouragement of an effective dialogue


between the worlds of business and education on this subject can contribute
to the promotion of CSR principles and practices.

The exchange of good practices in integrating CSR principles in general


education as well as in business administration training could be further
developed between education systems, companies, employee
representatives and other stakeholders, including consumers.
The Structural Funds provide significant financial support for the
economic and social conversion of areas in structural difficulties, and for
adapting and modernising education, training and employment policies
and systems, particularly in order to increase the adaptability and
employability of workers. In this respect the European Social Fund could
be used to promote CSR in management training and for other
employees, as well as to develop teaching materials and courses in
educational institutions, including those active in lifelong learning, in co-
operation with enterprises.

8.3.6 Fostering CSR among SMEs


The CSR concept was developed mainly by and for large multinational
enterprises. In line with the Commission’s “Think Small First” strategy, the
CSR concept, practices and instruments should be adapted to suit the
specific situation of SMEs which make up the vast majority of European
enterprises. Because of their lower complexity and the strong role of the
owner, SMEs often manage their societal impact in a more intuitive and
informal way than large companies. In fact, many SMEs are already
implementing socially and environmentally responsible practices without
being familiar with the CSR concept or communicating their activities. These
practices are often defined and understood as responsible entrepreneurship
by SMEs.

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50% of recently surveyed3 European SMEs indicate that they already carry
out socially and environmentally responsible activities for the benefit of their
external stakeholders. Their community and social engagement could be
characterised as being local in scope, occasional in nature, and unrelated to
business strategy. The main driver would be the ethical consideration of the
owner/manager, even though a significant number of SMEs also recognise
business benefits such as improved relations with consumers and the local
community. Furthermore, a positive correlation between SME's strategic
focus and their socially responsible activities can be established: SMEs
focussing on innovation, quality and growth also score higher on current or
future social engagement. Lack of awareness seems to be the most
significant obstacle to social engagement, especially among the smallest
SMEs, followed by resource constraints. Small business associations,
support organisations and networks have an important role to play in raising
awareness through the provision of information, user-friendly tools and the
dissemination of good practices cases.

Since SMEs do not draw value from their engagement in the same way as a
large company, it is important to assist SMEs in adopting a more strategic
approach. Collecting evidence on the business case for different types of
SMEs operating in diverse cultural backgrounds is key to a better
understanding and increased SME participation. In the future, the most
significant pressure on SMEs to adopt CSR practices is likely to come from
their large business customers, which in return could help SMEs cope with
these challenges through the provision of training, mentoring schemes and
other initiatives.

3 The 2001 ENSR survey of over 7,000 SMEs in: European SMEs and Social and
Environmental Responsibility, report published in the 7th Observatory of European
SMEs, 2002, European Commission, Enterprise DG
(http://europa.eu.int/comm/enterprise/enterprise_policy/analysis/observatory.htm)

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To facilitate the wider adoption of responsible entrepreneurship practices


by SMEs, there is a need to raise further awareness about their
economic benefits and to promote them as a risk management tool, as
well as to:
– work towards a better understanding of SMEs’ current social and
environmental engagement, including research into SME-specific
aspects of CSR and the business case;
– foster the exchange and dissemination of good practices cases
identified with the help of Member State and candidate countries
experts, SME representative organisations, business support
organisations and consumer organisations (e.g. through publications,
on-line collection of good practices etc.);
– facilitate the development and dissemination of user-friendly, tailor-
made tools for those SMEs that wish to engage in or further develop
socially responsible actions on a voluntary basis (information
material, SME-toolkit, etc.);
– bring the attention of SME associations and business support
organisations to CSR issues with a view to their integration into
support provision for responsible entrepreneurship initiatives in
SMEs;
– facilitate co-operation between large companies and SMEs to
manage their social and environmental responsibility (e.g. supply
chain management, mentoring schemes etc.), in accordance with
national and EU competition rules;
– raise awareness among SMEs with regard to the impact of their
activities on developing countries, and promote SMEs proactive
policies, in particular in the fields of core labour standards,
eradication of child-labour, gender equality, education, training,
health-care assistance and insurance.

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8.3.7 Promoting Convergence and Transparency of CSR Practices


and Tools
CSR relates to a very wide range of company activities. This is particularly
the case when an enterprise operates in several countries and has to adapt
its activities to the specific situations in these countries. This diversity has
helped to create an impressive richness of voluntary enterprise initiatives,
which often include innovative elements, but also implies challenges,
namely the lack of transparency and comparability.

Transparency is a key element of the CSR debate as it helps businesses to


improve their practices and behaviour; transparency also enables
businesses and third parties to measure the results achieved4. CSR
benchmarks against which the social and environmental performance of
businesses can be measured and compared are useful to provide
transparency and facilitate an effective and credible benchmarking. The
interest in benchmarks has resulted in an increase of guidelines, principles
and codes during the last decade. Not all of these tools are comparable in
scope, intent, implementation or applicability to particular businesses,
sectors or industries. They do not answer to the need for effective
transparency about business social and environmental performance. As
expectations for CSR become more defined, there is a need for a certain
convergence of concepts, instruments, practices, which would increase
transparency without stifling innovation, and would offer benefits to all
parties. CSR benchmarks should build upon core values and take their
starting point in international agreed instruments such as ILO core labour
standards and OECD guidelines for multinational enterprises.

4
Greater transparency also prevents companies from being used by organised crime, and
terrorist groups to launder or generate money for their benefit.

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Several market-driven international multi-stakeholder initiatives are


emerging, which work towards convergence and transparency in the area of
CSR. Member states have taken various initiatives to promote them, in
accordance with their respective approaches to CSR. The Commission
wishes to do its part in facilitating convergence and transparency in the area
of CSR, by facilitating the development, diffusion and acceptance of these
international multi-stakeholder initiatives by enterprises and stakeholders.

Increased convergence and transparency would be desirable in the


following fields:
(1) Codes of Conduct,
(2) Management standards
(3) Accounting, auditing and reporting
(4) Labels
(5) Social responsible investment

8.3.8 Codes of Conduct


The increasing public interest in the social and environmental impact and
ethical standards of industry has moved many companies, in particular
those of the consumer goods sector, to adopt codes of conduct relating to
labour issues, human rights and the environment.

Codes of conduct are innovative and important instruments for the


promotion of fundamental human, labour and environmental rights, and anti-
corruption practices - especially in countries where public authorities fail to
enforce minimum standards. However, it should be underlined that they are
complementary to national, EU and international legislation and collective
bargaining, and not a substitute to them.

The biggest challenge related to codes is to ensure that they are effectively
implemented, monitored and verified. In this respect, the Commission
promotes business widespread adherence to codes of conducts developed

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by international organisations. Special attention should be given to


implementing codes in respect of workers in the informal sector and sub-
contractors and in the free-trade zones.

The Commission believes that codes of conducts should:


– Build on the ILO fundamental Conventions and the OECD guidelines for
multinational enterprises as a common minimum standard of reference;
– Include appropriate mechanisms for evaluation and verification of their
implementation, as well as a system of compliance;
– Involve the social partners and other relevant stakeholder which are
affected by them, including those in developing countries, in their
elaboration, implementation as well as monitoring;
– Disseminate experience of good practices of European enterprises.

The Commission invites the CSR EMS Forum to consider the


effectiveness and credibility of existing codes of conducts and how
convergence can be promoted at European level.

8.3.9 Management Standards


Faced with a widening range of complex issues in areas such as labour
practices and supplier relations, with implications across their organisations,
businesses, regardless of sector, size, structure or maturity, would benefit
from the inclusion of social and environmental issues into their daily
operations. In this context, CSR management systems - like Total Quality
Management systems – could allow enterprises to have a clear picture of
their social and environmental impacts, help them to target the significant
ones and manage them well.

The Eco-Management and Audit Scheme (EMAS), for example, allows


voluntary participation in an environmental management scheme. It is a
scheme for companies and other organisations that are willing to commit

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themselves to evaluate, manage and improve their environmental and


economic performance. In addition, active employee involvement is a driving
force for EMAS and a contribution to the social management of
organisations.

The Commission will promote the uptake of EMAS as a CSR instrument


and explore the opportunity to apply the EMAS approach to address the
social performance of companies and other organisations. It invites the
CSR EMS Forum (see below) to examine this issue.

8.3.10 Employment and Social Affairs Policy


Within a business CSR relates to quality employment, life-long learning,
information, consultation and participation of workers, equal opportunities,
integration of people with disabilities anticipation of industrial change and
restructuring. Social dialogue is seen as a powerful instrument to address
employment-related issues.

Employment and social policy integrates the principles of CSR, in particular,


through the European Employment Strategy, an initiative on socially
responsible restructuring, the European Social Inclusion Strategy, initiatives
to promote equality and diversity in the workplace, the EU Disability Strategy
and the Health and Safety Strategy.

In its document "Anticipating and managing change: a dynamic approach to


the social aspects of corporate restructuring", the Commission has stressed
that properly taking into account and addressing the social impact of
restructuring contributes to its acceptance and to enhance its positive
potential. The Commission has called upon the social partners to give their
opinion in relation to the usefulness of establishing at Community level a
number of principles for action, which would support business good practice
in restructuring situations.

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In its communication “Adapting to change in work and society: a new


Community strategy on health and safety at work 2002–2006”, the
Commission has expressed its intention to encourage instruments which
promote innovative approaches, to encourage the various parties to “go a
step further” and to associate all the interested parties in achieving the
overall objectives of this strategy, more especially in new fields which do not
lend themselves easily to a normative approach.

Deeply rooted societal changes such as increasing participation of women


in the labour market should be reflected in CSR, adapting structural
changes and changing the work environment in order to create more
balanced conditions for both genders acknowledging the valuable
contribution of women as strategies which will benefit the society as well as
the enterprise itself.

The 2003 European Year of People with Disabilities provides an opportunity


for enterprises to exchange experience of CSR practices and strategies and
to undertake actions with a view to acting in a socially responsible manner
towards people with disabilities in relation to promoting equal employment
opportunities, developing designed-for-all products as well as improving
accessibility to assistive technologies.

Enterprise policy
Only competitive and profitable enterprises are able to make a long-term
contribution to sustainable development by generating wealth and jobs
without compromising the social and environmental needs of society. In fact,
only profitable firms are sustainable and have better chances to
adopt/develop responsible practices.

The role of enterprise policy is to help create a business environment, which


supports the Lisbon objective of becoming the world’s most dynamic
knowledge-driven economy, supports entrepreneurship and a sustainable

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economic growth. Its objective is to ensure a balanced approach to


sustainable development, which maximises synergies between its
economic, social and environmental dimensions.

Another key element is to support businesses in enhancing their


competitiveness and in meeting the challenges of the transition to the
knowledge economy. A special focus of enterprise policy is on SMEs and
responsible entrepreneurship, where projects with Member states are
carried out to identify good practices in policy and support. Further action
priorities focus, among others, on research on the impact of CSR and
sustainable development on business performance, industry-sector specific
aspects (ICTs, tourism, services, social economy), CSR and innovation and
the management of the intangible assets of firms.

Consumer Policy
CSR has partly evolved in response to consumer demands and
expectations. Consumers, in their purchasing behaviour, increasingly
require information and reassurance that their wider interests, such as
environmental and social concerns, are being taken into account.
Enterprises are increasingly sensitive to these demands both to retain
existing customers and to attract new customers.

Consumers and their representative organisations have therefore an


important role to play in the evolution of CSR. If CSR is therefore to continue
to serve its purpose, strong lines of communication between enterprises and
consumers need to be created.

Concerning fair commercial practices, the Commission is in the process of


consulting interested parties on the detail of a possible framework directive
which would harmonise national rules on the fairness of commercial
practices (advertising, aggressive marketing, after-sale customer
assistance, etc.) between businesses and consumers.

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8.3.11 Measurement, Reporting and Assurance


In the last decade, more and more companies have started to publish
information on their social and environmental performance. "Triple bottom
line" reporting of economic, social and environmental indicators is emerging
as good practice. At this early stage of experimentation, flexibility may
ensure that reporting is appropriate to each individual business. However, a
greater consensus on the type of information to be disclosed, the reporting
format, the indicators used and the reliability of the evaluation and audit
procedure would allow for a more meaningful benchmarking and
communication of companies' performance within particular sectors and for
businesses of similar size. The guidelines developed by the Global
Reporting Initiative (GRI) are a good example of a set of guidelines for
reporting which could be the base of such consensus.

Self Assessment Questions II


State whether the following statements are True or False:
1. The CSR concept was developed mainly by and for small scale
enterprises.
2. Most respondents to the Green Paper stressed the importance of
education and training of managers, employees, and other actors to
promote CSR.
3. Codes of conduct are innovative and important instruments for the
promotion of fundamental human, labour and environmental rights, and
anti-corruption practices.
4. In their responses to the Green paper, business organisations and
individual enterprises stressed the importance of the exchange of
experience and good practices about CSR between companies, as an
important vehicle to develop the concept further.

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8.4 Summary
CSR is a concept whereby companies integrate social and environmental
concerns in their business operations and in their interaction with their
stakeholders on a voluntary basis.

CSR is behaviour by businesses over and above legal requirements,


voluntarily adopted because businesses deem it to be in their long-term
interest;

CSR is intrinsically linked to the concept of sustainable development:


businesses need to integrate the economic, social and environmental
impact in their operations;

CSR is not an optional "add-on" to business core activities - but about the
way in which businesses are managed.

CSR has found recognition among enterprises, policy-makers and other


stakeholders, as an important element of new and emerging forms of
governance.

What constitutes CSR depends on the particular situation of individual


enterprises and on the specific context in which they operate.

Awareness of CSR issues and concerns will contribute to promote more


sustainable investments, more effective development co-operation and
technology transfers.

The desire of enterprises to improve their risk management is a powerful


factor behind CSR. Enterprises generally agree that CSR helps them in
managing their risks, their intangible assets, their internal processes, and
their relations with internal and external stakeholders.

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8.5 Terminal Questions


1. Explain the meaning of CSR.
2. What are the challenges to further awareness, dissemination and
adoption of CSR practices?
3. Describe the global dimension of CSR.
4. How can CSR management skills be developed?

8.6 Answers to SAQs and TQs


SAQs I
1. Refer to 8.2
2. Refer to 8.2.1

SAQs II
1. False
2. True
3. True
4. True

Answers to TQs:
3. Refer to 8.2
4. Refer to 8.3
5. Refer to 8.3
6. Refer to 8.3

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Reference:
Lawrence R. Jauch & William F. Glueck, Business Policy & Strategic
Management _ McGraw-Hill

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