Business-20Studies-20AS-A-20level.pdf

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Business Studies AS & A2 Level

Business objectives and strategy

Objectives

An objective is a goal that needs to be achieved.

Mission statements

Under both UK and EU law, a company must state what it is in business to do - this is known as its overall aim and it can be embodied in a mission statement. This is often a simple and memorable sentence which explains what the organisation is in business to do and what it wants to achieve. A mission statement can often be found in the front of a company's annual report and it is, effectively, a summary of its day-to-day activities and long-term objectives, showing a sense of underlying purpose and direction.

It is often argued that mission statements are best when they are simple and informal. For example:

Ford Motor Company PLC "...is a worldwide leader in automative products and services, as

well as in newer industries such as aerospace and communications. Our mission is to improve continually and meet our customers' needs, allowing us to prosper as a business and to provide a reasonable return for our shareholders."

Cadbury Schweppes PLC "...is a major international company with a clear focus on its two

core businesses - confectionery and beverages. Our quality brands are bought and enjoyed in more than 110 countries around the world..."

The Body Shop PLC "...to dedicate our business to the pursuit of social and environmental

change..."

A good mission statement should be clearly defined, realistic and achievable, and at the same time it should ensure that the employees' attention is focussed towards the overall company aim.

Mission statements normally express the organisation's objectives in qualitative terms, (as opposed to quantitative, that is, facts and figures) and many businesses include the following variables in their mission statement: their number one priority, their product definitions, their non-financial objectives and their overall values and beliefs.

Although many people view mission statements as a focus for employees and for other stakeholders, they are still viewed by their critics as nothing more than a publicity seeking exercise.

Business objectives

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-An aim states what you want

-An objectives set out what you need to have achieved to get what you want -A strategy is a course of action which enables you to meet your objectives. In order for objectives to be effective, they must:

1.provide detail about what specifically needs to be achieved (often in a quantitative form) 2.have a time limit by when they need to have been achieved

3.need to state the necessary resources that they require in order to be met.

Setting clearly defined and realistic objectives will enable many employees to understand exactly what their job entails and achieving clearly stated objectives might be linked to bonus payments - this can easily act as an incentive and motivator to employees.

Primary and secondary objectives

A primary objective is an ultimate long-term goal of the business (e.g. survival, profit maximisation, diversification and growth). They are often referred to as strategic objectives.

A secondary objective is a day-to-day objective, and it makes a direct contribution to meeting the primary objectives (e.g. increase sales by 5% each year, keep labour turnover at less than 4%). They are often referred to as Tactical objectives.

Private and public sector objectives Private sector

Private sector objectives will often differ considerably from objectives set in the public

sector. Profit maximisation is often quoted as the over-riding objective for businesses in the private sector. This will involve trying to produce at the point where there is the maximum difference between the firm's total revenue and its total cost - resulting in large dividend payments for the shareholders. However, it is far more likely that businesses will aim to profit satisfy rather than profit maximise (that is, they will aim to earn a satisfactory level of profits to keep shareholders content, and then use the remaining resources to pursue other

objectives such as diversification and growth).

Another objective in the private sector, for a rapidly growing business, may well be

tomaximise sales (or sales revenue) and so increase their market share in order to gain a competitive advantage.

Many businesses set objectives to improve their image and to appear more socially responsible and environmentally friendly - this is often achieved through strategies of recycling materials,

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sponsoring local events and strictly adhering to all employee legislation (e.g. pay levels, Health & Safety, discrimination, etc.).

Public sector

Public sector objectives have, traditionally, been centred around providing a public service, rather than make a profit (e.g. when British Gas was a public corporation it had to provide gas supplies to all areas of the UK, many of which were isolated and very unprofitable for the organisation). This regularly led to loss-making organisations being subsidised by the government, and complacency crept in with regards to customer service, quality levels and response times. However, in the UK in the 1980s and 1990s, a massive privatisation

programme by the government was implemented and many large utilities such as British Gas, British Telecom and the Electricity Boards were sold to the private sector.

The remaining public sector organisations were told to run in a more cost-efficient manner and to improve the quality of their services to consumers. Performance targets were set for many Local Health Authorities, Local Education Authorities and council services in an attempt to make them more accountable, to reduce their costs and to improve the quality of their output.

Short-term and long-term objectives

Short-term objectives will often differ from long-term objectives, especially if the business is experiencing poor financial performance at present. A short-term objective may be to

consolidate, or even simply to survive the difficult trading conditions that it is experiencing. Once this has been achieved and the business has stabilised its performance, then it may well look to achieve its long-term objective of diversification into new products and new markets, or growth through amalgamation.

Strategy

A strategy is a way of achieving an objective

Decision-making

Businesses of all sizes have to make many decisions each day - some are fairly simple and routine, whilst others are more complex and require significant management time and effort. Some examples of decisions that all businesses need to make are:

• Where should we locate the business?

• What goods should we produce?

• What price should we charge?

• What should we do if a supplier fails to deliver on time?

• Which job agency should we use to provide us with some temporary workers?

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Decision-making is the basic task of all managers in all departments of the business, and both in the private and the public sectors. These decisions are, effectively, designed to influence the actions of other people.

A strategic decision is one which is very high-risk and is likely to influence the overall long-term policy and direction of the business. As such, it is likely to be dealt with by senior management (e.g. what new products to develop).

A tactical decision is a fairly routine, predictable, short-term decision, which is normally handled by middle management (e.g. what price to charge for products). Other decisions which are repetitive, day-to-day and fairly risk-free are handled by lower-level management, and are generally referred to as operational decisions (e.g. how long should tea-breaks be?). Businesses have to make decisions in order to achieve their objectives.

There are eight key stages involved in the traditional decision-making process: 1. Set objectives. The decision-making process cannot proceed without an achievable, realistic

and identifiable target to be met.

2. Gather data. Use market research to collect as much information as possible from inside and outside the business, so to enable the decision-makers to have the necessary data with which to make an effective decision.

3. Analyse the data. Look at the different courses of action and decide which ones look the most achievable and realistic to meet the objective.

4. Make a decision. This stage is vital to the whole process. The decision-makers must ensure that they follow the correct course of action and do not reject a better alternative.

5. Communicate. This to the whole organisation. The relevant people, both inside and outside the organisation, need to be informed about the decision and how it may affect them.

6. Implement the decision. The course of action that has been decided upon is implemented, using the available resources of the business.

7. Look at the results. Obtain as much feedback as possible concerning the recently implemented decision, from as many sources as possible.

8. Evaluate the outcome. Did the decision work ? Was it the best course of action ? How can it be improved next time? What went wrong?

Businesses can rarely carry out their decision-making in a totally open and risk-free environment, and there are often many constraints which exist, that will limit the possible options available to a business. These constraints can be internal (such as the lack of available finance, or the lack of a multi-skilled workforce) and external (such as a rise in interest rates, a new competitor entering the market, or new legislation which restricts the activities of the business).

There are many tools available to a business that will help it limit both the risk involved and the chance of failure, when making a vital decision (such as launching a new product, taking over a competitor, or breaking into foreign markets). Three types of decision making tools are shown below:

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Decision tree

A decision tree is a diagram that sets out the different options that are available to a business when making decisions and it also shows the chance (or probability) of their occurrence. It sets out the actual values to be expected should a particular course of action be followed. These can then be multiplied by the relevant probability of that event happening, to give an expected value, which represents the average pay-off if the decision was taken many times.

For example: Mr. Smith owns a piece of land and he wants to sell it to raise some money for

his ailing business. He has been informed that he has just two options open to him: 1.He could sell the land now for a guaranteed price of £250,000, with associated selling costs of £5,000.

2.He could wait for 12 months for the market price to hopefully rise and he could then sell it, with associated selling costs of £7,000. An estate agent has informed him that the chance of receiving a higher price for the land is 0.6, while the probabilities of the price remaining the same or worsening are 0.3 and 0.1 respectively. If the market price does rise, then the land is likely to be valued at £325,000. However, if the price deteriorates, then it is likely to be valued at £200,000 in 12 months.

The decision-tree below illustrates the above scenario:

Calculation of expected value at node B: £325,000 x 0.6 = £195,000

£250,000 x 0.3 = £75,000 £200,000 x 0.1 = £20,000

Total expected value = £290,000

The tree diagram points in favour of delaying the sale of the land for 12 months, since it predicts that IF THE DECISION WAS TAKEN MANY TIMES then Mr.Smith would ONAVERAGE receive £283,000 (£290,000 minus £7,000 costs), instead of the £245,000

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(£250,000 minus £5,000 costs) that he would receive by selling the land now. There are several points to note from the diagram:

1. The tree diagram is laid out from left to right.

2.Node A is represented as a square and it is called a decision node (i.e. at this node, the decision-maker can only choose one branch to follow).

3.Node B is represented as a circle and is called a chance node (i.e. there are several possible outcomes from this node, one of which will definitely happen).

4.Each event stemming from a chance node has a probability attached to it (these probabilities must always add up to 1).

5.The actual values are always listed at the end of each branch.

In order to calculate the expected value at a chance node (e.g. node B) then the decision-maker must calculate along the branches from right to left, by multiplying the actual value by the probability and adding the results. Hence, £325,000 is multiplied by 0.6, the £250,000 is multiplied by 0.3, and the £200,000 is multiplied by 0.1. These are then all added together to give the expected value of £290,000 at node B.

The cost associated with each branch is written beside it, and these costs have to be deducted before a decision can be made.

Each branch is cut-off as it is rejected (this is represented by two parallel lines cutting through the start of the rejected branch). This leaves just the best alternative option remaining.

There are several advantages of using decision trees to analyse a particular situation:

1.They set out problems clearly and logically.

2.They show the likely amounts of money involved in the decision, and the probabilities of their occurrence.

3.Constructing a decision tree may show possible courses of action which had not been previously considered.

4.They are tangible and therefore people can easily see the issue that they are faced with, rather than attempting to visualise somebody's description.

However, decision trees are not without their faults:

1.The probabilities are only estimates and are, therefore, subject to change.

2.They can only show quantitative data - they do not take account of peoples' feelings, legal constraints, etc.

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3.The results can be biased, in order to show just one side of an argument.

4.There can be significant time delays whilst making the decision, and some of the data may be out-of-date by the time the decision is finally made.

S.W.O.T. Analysis

This is another method of helping management to reduce the risk involved in making decisions in a dynamic industry. It involves analysing the current position of a product, a department or even the whole organisation, and trying to identify its possible future courses of action, by looking at its Strengths, Weaknesses, Opportunities and Threats.

A strength is a factor which a business currently possesses and which it performs effectively, such as having a strong management team, a profitable portfolio of products, or a loyal customer base.

A weakness is an area in which the business currently performs poorly, such as having a high level of industrial disputes, falling profitability, or falling productivity levels.

An opportunity is a potentially successful or profitable activity that the business could take advantage of in the future, such as the take-over of a competitor, the development of new products, or breaking into new markets.

A threat represents a potential future problem which the business may face in the future, such as new competitors entering the industry, new legislation restricting the use of certain raw materials, or the possibility of being taken-over by another company.

Remember, the strengths and weaknesses are internal factors which the company currently faces. The opportunities and threats are external factors which the company may face in the future.

The S.W.O.T. analysis is represented in a simple four-box diagram, as illustrated below: Example of a S.W.O.T analysis for a Chocolate manufacturer.

Strengths: Weaknesses:

Plenty of R&D, leading to many new product ideas

Achieving economies of scales in production High level of customer loyalty and repeat purchasing

Effective promotion

Several of our products are reaching the end of their life-cycle

Too many marketing personnel are leaving the business

Restricted product range

Opportunities: Threads:

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A joint venture with a foreign chocolate manufacturer

Product extensions, such as different sizes of bars

Take-over by domestic rival

New legislation may affect the source of our ingredients

This diagram is simple and easy to follow, and it can provide the basis for discussion of business strategy at meetings. The results of a S.W.O.T. analysis may often identify possible courses of action that had not been considered, as well as categorising and prioritising the problems that the business faces. In most large businesses, the marketing department will carry out a S.W.O.T. analysis as part of its annual marketing audit - this highlights the

products which are performing effectively, those which are reaching the end of their lifecycle, potential new markets to break into and the overall effectiveness of its personnel.

Contingency Planning and Crisis Management

Not all the opportunities and events that a business faces will go to plan, and some may prove detrimental to the continuity of the business (such as a huge downturn in demand for their products). Contingency planning means preparing for these unwanted and unlikely

possibilities. A business may produce a contingency plan in case of: 1.a severe recession;

2.an environmental disaster; 3.a sudden strike by its workforce.

Contingency plans enable a business to be in a better position to manage a crisis, rather than to try and simply cope with it when it occurs.

Before contingency planning can take place, a business must consider many possible threats and crises that it may face, in order to be able to react to them swiftly and efficiently if they do ever occur. These potential scenarios are often computer-simulated, and they can predict to a high level of accuracy the likely effects of a crisis on the finances and resources of a business.

Crisis management is the response of an organisation to a crisis (e.g. a fire, terrorist

activity, natural disaster). Many companies will have some sort of contingency plan to cater for such situations, but it is rare that the actual crisis will go according to plan. It is likely that the person in charge at the time of the crisis will manage the crisis in a very authoritarian fashion, as he needs to make quick and effective decisions without the time for discussion and

consultation with others. Effective planning should reduce the impact of a crisis on a business, but nevertheless to overcome any crisis is likely to cost the business a significant amount of time and money.

Some crises will be long-lasting and will affect the whole economy (such as a recession, or a natural disaster), some crises will affect all the businesses in a particular industry (such as the

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collapse in demand for UK ship building) and others crises will simply affect a single business (such as the Perrier Water contamination scandal, or a strike by a workforce).

Any crisis is likely to have implications for the finances of the business, the effectiveness of personnel and communications and the production patterns. The business must be seen to be acting swiftly when faced with a crisis, and it must try to ensure that the damage to the business (especially to its reputation and its image) is minimised by using which ever resources are at its disposal.

Successful public relations campaigns, adequate finance, strong leadership, rapid action and effective communication (both internal and external) are the key ingredients for a crisis to be solved effectively. Crises will always pose a number of unexpected and unforeseen problems and dilemmas for businesses. However, as long as the business is seen to be limiting the effects of the crisis upon its various stakeholder groups (especially its customers) then its reputation may well remain intact.

Stakeholders

There are many groups of people who have an interest, financial or otherwise, in the performance of a business - these different groups are known as stakeholders. The main stakeholders are considered to be:

Shareholders

These people have a clear financial interest in the performance of the business. They have invested money into the company through purchasing shares and they expect the company to grow and prosper so that they receive a healthy return on their investment. The return that they receive can come in two forms. Firstly, by a rise in the share price, so that they can sell their shares at a higher price than the purchase price (this is known as making acapital gain). Secondly, based on the level of profits for the year, the company issues a portion of this to each shareholder for every share that they hold (this is known as adividend). The shareholders are also entitled to vote each year at the A.G.M. to elect the Board of Directors, who will run the company on their behalf.

Employees

This group also has an obvious financial interest in the company, since their pay levels and their job security will depend on the performance and the profitability of the business. It is employees who perform the basic functions and tasks of the business (producing output, meeting deadlines and delivery dates, etc.) and over recent years their traditional role has started to change. They are often now encouraged to become involved in multi-skilled teamworking, problem solving and decision making - thus having a significant input to the workings of the business.

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Customers

Customers are vital to the survival of any business, since they purchase the goods and services which provides the business with the majority of its revenue. It is therefore vital for a business to find out exactly what the needs of the consumers are, and to produce their output to directly satisfy these needs - this is done through market research. The goods and services must then be promoted in such a way as to appeal to the target market and to inform them of the availability, price, etc. Once the goods and services have been purchased by the customer, it is essential that after-sales service is offered and that the customer is happy with his/her purchase. The business must try to keep the customer loyal so that they return in the future and become a repeat-purchaser.

Suppliers

Without flexible and reliable suppliers, the business could not guarantee that it will always have sufficient high quality raw materials which they require to produce their output. It is important for a business to maintain good relationships with their suppliers, so that raw materials and components can be ordered and delivered at short notice, and also so that the business can negotiate good credit terms from the suppliers (i.e. buy now, pay at a later date).

The Government

The government affects the workings of businesses in many ways:

1. Businesses have to pay a variety of taxes to central and local government, including

Corporation tax on their profits, Value-Added Tax (V.A.T) on their sales, and Business Rates to the local council for the provision of local services.

2. Businesses also have to adhere to a wide-ranging amount of legislation, which is aimed at protecting the consumers, the employees and the local environment from business activity. 3. Businesses will be affected by different economic policies, (for example, if interest rates are increased, then this will discourage businesses from borrowing money since the repayments will now be significantly higher). However, businesses can also benefit from government incentives and initiatives, such as new infrastructure, job creation schemes and business relocation packages, offering cheap rent, rates and low-interest loans.

The Local Community

Businesses are likely to provide significant amounts of employment for the local community and often will produce and sell much of their output to the local residents. The sponsorship of local events and good causes (such as local charity work) can also help the business to

establish itself in the community as a caring, socially responsible organisation. Many

businesses develop links with local schools and colleges, offering sponsorships and resources to these under-funded institutions. However, businesses can also cause many problems in

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local communities, such as congestion, pollution and noise, and these negative externalities may often outweigh the benefits that the businesses bring to the community.

Disagreements between stake holders

Due to the demands placed on businesses by so many different stakeholders, it is no surprise that there are often disagreements and conflict between the different groups. Some of the more common areas of conflict are:

Shareholders and management

Profit maximisation is often the over-riding objective of shareholders - resulting in large dividend payments for them. However, it is far more likely that the managers of the business will aim to profit satisfy rather than profit maximise (that is, they will aim to earn a satisfactory level of profits, and then use the remaining resources to pursue other objectives such as diversification and growth). This conflict between these two groups is often referred to as divorce of ownership (the shareholders) and control (the management).

Customers and the business

Customers are unlikely to remain loyal and repeat purchase from the business if the product that the have purchased is of poor quality and/or is poor value for money. More customers are prepared to complain about the quality of products and after-sales service than ever before, and the business must ensure that it has in place a number of strategies designed to satisfy the disgruntled customer, reimburse any financial loss that they may have incurred and persuade them to remain loyal to the business.

Suppliers and the business

Suppliers are often quoted as complaining about the lack of prompt payments from businesses for deliveries of raw materials, and if this became a regular problem then the suppliers may well refuse credit to the businesses or may even cease all dealings with them. On the other hand, many businesses have been known to complain about the late deliveries of raw

materials and components from suppliers, and the dubious quality of the parts once they have been inspected.

The community and the business

As outlined previously, the local community can often suffer at the hands of a large company through the negative externalities of pollution, noise, congestion and the building of new factories in areas of outstanding beauty. However, if the business faces strong protests from residents and from pressure groups concerned about its actions, then it may decide to relocate to another area, causing much unemployment and a fall in investment in the community it leaves behind.

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Exam-Style Questions

1. a) Why is it important for a business to specify its objectives?

b) Explain, with examples, why differing stakeholder and organisational objectives might cause problems for managers.

(Marks available: 10)

Answer outline and marking scheme for question: 1

Give yourself marks for mentioning any of the points below:

a) Focus for all employees, measure by which to judge the performance of the business, informs strategic planning.

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b) Conflict, e.g. local community objective - clean environment, company objective - profit (cost cutting creates pollution).

Decision making: e.g. Shareholders may demand high dividends, but management seek to invest profits for long term.

(5 marks)

2. Explain, with examples, what is meant by the stakeholders in a company.

Is it in the interests of all stakeholders that a company should try to maximise its profits? (Marks available: 20)

Stakeholders are those persons who hold a stake in the company; they include shareholders, banks, the local community, customers, employees, government - if the American definition of "anyone who may be affected by the actions of the corporation" is adopted, even competitors. (max 12)

A candidate might wish to refine the question and write of "long term" profits and then argue, with Milton Friedman, that the objective of the company is to increase shareholder wealth. Many will argue that the company has a duty to other stakeholders. Johnson and Johnson, for example, put the customer first, then the employees, and the shareholders last. Green issues may be mentioned.

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(max 12)

Excellent A clear and concise explanation of the stakeholder concept and a well sustained argument for or against the maximising of profits.

CompetentAn informed account of the stakeholder concept and a reasoned argument for or against maximising profits.

Adequate A knowledge of what is meant by stakeholders and some reasons for or against maximising profits.

Weak A limited knowledge of what is meant by stakeholders and ill-connected comments for or against maximising profits.

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Business Organization

Starting a Small Firm

Identifying an Opportunity

It is vital for the success of a business that it manages to identify an unsatisfied consumer need in a market and then produce a product, or provide a service, which meets the

consumers' needs. The new product / service can be protected against competition by the use of copyrights and patents. These protect the owner / inventor from having their products, ideas, etc. copied and reproduced by other people without their permission.

Some of the most common reasons for starting up a new business include the need for independence; to achieve your personal ambitions; being bored with your current job; links with your hobbies and interests; redundancy from your previous job.

Many businesses which have started in the UK over the past 25 years have failed within the first 3 years of trading. To reduce the probability of failure, it is vital that businesses carry out market research in order to establish if a profitable gap exists in a market and to see if their business is in a strong enough position to fill this gap.

In order to make a success of the new business venture, the entrepreneur must be hardworking, ambitious, firm, decisive, organised, a good negotiator and must be able to recognise an opportunity when it arises.

The Business Plan

Once an entrepreneur has recognised an opportunity, he/she must draw up a business plan. This is a document which outlines the marketing, production and financial plans for the

proposed business. It is used to try and persuade investors (banks, etc.) to lend money to the entrepreneur to fund his/her new business.

The main sections of a business plan include: - the aims and objectives of the business

- details of the new product or service being offered

- an outline of the existing market details (i.e. size of the market, number of existing competitors)

- how and where the product will be produced - the proposed number of employees

- a cashflow forecast, a projected profit and loss account and balance sheet for the end of the first year's trading

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- details of the finance required and the forecasted rate of return on this. Patents and Copyrights

An entrepreneur can use patents and copyrights to protect a new product, process, invention or information against copying and reproduction by other people without the entrepreneur's permission.

A patent gives an entrepreneur or a business the legal right to be the sole owner or user of a particular production process or of a new product. The Copyright, Designs and Patents Act (1988) gives this right for a 20 year period following registration.

In order for the patent to be approved, then the Patent Office has to be supplied with the original drawings and designs of the new product, and the inventor must state that the ideas and features of the product are his own work and have not been copied from other products. Patents are often sold to larger businesses in order to provide a large injection of capital, which can help the small business to grow and expand its product range.

A copyright is the legal right of the creators of certain kinds of material (books, films, sound recordings) in order to control the copying and duplicating of the owner's original work. The law on copyright is governed by The Copyright, Designs and Patents Act (1988). People using copyright material without permission risk legal action.

Problems of Start-ups

Most new businesses will face a number of problems when they are starting up and if these problems are not tackled immediately, then they may lead to the insolvency and failure of the new venture. Below are listed some of the major problems faced by a new company:

Raising finance and meeting the repayments

Raising finance and meeting the repayments is often cited as the major reason for the failure of many new business ventures. It can often be difficult for a budding entrepreneur to

persuade banks and other financial institutions to lend money to a new business, and often they will only lend the money at a high rate of interest. These repayments can cripple the business and eventually lead to its insolvency.

As well as the repayments, the bank will insist that some security (or collateral) is provided by the business, so that if the business defaults on the loan repayments, then the bank will take ownership of an asset of the business which will cover the amount of the outstanding loan.

Having a positive cashflow

Leading on from this previous point, having a positive cashflow is vital for the survival of the business. Liquidity is the financial term given to express the ability of a business to raise cash at short notice. Any new business must have sufficient cash available to meet its short-term needs (such as paying employees, paying suppliers, rent, utility bills, etc.).

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Many businesses have a lot of cash tied up in stocks, which are often difficult to sell and therefore the business may find it difficult to raise cash quickly. Further to this, if the business gives its customers credit (i.e. buy now, but pay us at a later date) then this will simply add to any cash flow problems that the business is facing.

Paperwork and legal requirements

All businesses face a variety of paperwork and legal requirements, and if any of these are overlooked or completed inaccurately, then this could lead to the failure of a new business. Taxation and insurance payments are vital for the smooth running and survival of new

businesses. Any oversight on these payments could land the entrepreneur with a large tax bill or, perhaps worse, property and stock which will not be insured against fire, theft, etc.

Enticing consumers to try the new product

Enticing consumers to try the new product / service can also be a major problem for any new business, especially if there are already a handful of established businesses which dominate the market. Ensuring that consumers try your product and then buy it again at a later date (consumer loyalty) can often only be done through extensive (and costly) advertising and promotional campaigns.

Legal Structure

Sole Trader

A sole trader is a one-person business, commonly found in trades where only small amounts of finance are required to set up and where there are very few advantages to the existence of larger organisations (e.g. hairdressing, newsagents, market traders).

Sole traders often employ waged employees, but they alone have to provide all the finance (often savings and bank loans) and bear all the risks of the business venture. In return, they have full control of the business and enjoy all the profits.

A sole trader faces unlimited liability for his/her debts and it is referred to as an

unincorporated business - this means that there is no legal difference between the business and the owner.

Partnership

To overcome many of the problems of a sole trader, a partnership may be formed. A partnership is an association of individuals and generally there will be between 2 and 20 partners.

Each partner is responsible for the debts of the partnership and therefore you would need to choose your partners carefully and draw up an agreement on the responsibilities and rights of each partner (known as a Deed of Partnership or The Articles of Partnership). The most common examples of a partnership are doctor's surgeries, veterinarians, accountants,

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As stated earlier, most partners in a partnership face unlimited liability for their debts. The only exception is in a Limited Partnership. This is where a partnership may wish to raise additional finance, but does not wish to take on any new active partners.

To overcome this problem, the partnership may take on as many Sleeping (or Silent) Partners as they wish - these people will provide finance for the business to use, but will not have any input into how the business is run. In other words, they have purely put the money into the business as an investment. These Sleeping Partners face limited liability for the debts of the partnership. A partnership, just like a sole trader, is an unincorporated business.

Private Limited Company

This is a type of joint-stock company (that is, it is an incorporated business - where the business has a separate legal identity from the owners). Often private limited companies are small, family run businesses which are owned by shareholders.

Each shareholder in a private limited company MUST be a part of the business and under no circumstances can any shares be sold to members of the general public. Each share entitles the owner to 1 vote at the company's Annual General Meeting (A.G.M.) and also to a share of the company's profit at the end of the financial year (a dividend).

Each shareholder has limited liability for the company's debts and can, therefore, only lose the value of their investment in the company. A company is run by a Board of

Directors (who are elected by the shareholders) and this is headed by a Chairman. Before a company can be formed, a number of legal documents must be completed - most important are the Memorandum of association and the Articles of Association. These cover details such as :

• the objectives of the business

• its headquarters and registered office

• the amount of capital to be raised from the sale of shares

• details concerning meetings within the business

• the arrangements for auditing the accounts of the business.

When these are completed, they are sent to the Registrar of Companies, who will then issue the business with a Certificate of Incorporation which allows the business to trade as a Private Limited Company. The company's name must finish with the wordLimited and it must raise less than £50,000 of share capital.

It can be very difficult for a shareholder in a private limited company to sell their shares, since a buyer must be found within the framework of the company.

Public Limited Company (P.L.C.)

This is the other, much larger, type of joint-stock company and, just like a private limited company, a PLC is an incorporated business, is run by the Board of Directors on behalf of

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the shareholders and has an A.G.M. at which shareholders vote on certain key issues relating to the company.

The main difference between a PLC and a private limited company is that a PLC can sell its shares on the Stock Exchange to members of the general public and can, therefore, raise significantly more finance than a private limited company.

If a private limited company wishes to become a PLC, then it must change its Memorandum and Articles of Association and re-submit them to the Registrar of Companies.

If the company is considered to have acted legally and for the best interests of its

shareholders, then it will be issued with a new Certificate of Incorporation and also with a Certificate of Trading, which will allow it to sell its shares on the Stock Exchange. The price of the shares will then fluctuate according to investors' perceptions of the PLC.

It is often the case with a PLC that the owners of the company (shareholders) will wish the PLC to make as much profit as possible, so that the shareholders will receive a very handsome dividend per share.

However, the Board of Directors and the management will often wish to devote some of the PLC' s resources to growth and diversification (such as the introduction of new products) and this will clash with the shareholders' desire for maximum profits. This is known as thedivorce of ownership and control.

The PLC has to publish its annual accounts (known as disclosure of accounts) and

therefore is extremely vulnerable to investors' and bankers' perceptions about its progress and success. Following on from this, a PLC is also at risk from a takeover from an outside body, if they manage to accumulate over 50% of the shares in the PLC.

Public Sector Organisations

The public sector refers to all the businesses and organisations which are accountable to central or local government. They are funded directly by the government and they tend to supply public services rather than produce products for a profit.

The public sector provides 3 types of good / service.

• A public good is one which would not be provided by private sector businesses because it

would not be profitable to do so (such as the emergency services and the armed services).

• A merit good is one which the government feel that everyone should have, whether or not

they could afford them in the private sector (such as education and healthcare).

• Essential services (such as street lighting, refuse collection, street cleaning, parks, libraries,

swimming pools, etc.).

A public corporation is the term used to describe a nationalised industry which is providing a good or a service to the general public. Until the successive Conservative governments of Thatcher and Major (1979-1997), there were many public corporations in the UK providing a

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huge range of services to consumers. However, the Conservatives sold many of these public corporations to the private sector - this process is known asprivatisation.

Central government pays for the public goods and merit goods through taxation (e.g. Income Tax), whereas local governments pay for the services they provide through Council Tax (formerly Community Charge and, before that, through Rates).

Franchising

Franchising has led to a rapid growth in the presence of many high-street stores in the UK over the past 10 years (e.g. McDonalds, Tie Rack, Perfect Pizza, and The Body Shop). A business franchise involves the franchisor (the owner of the business) selling a business format to a franchisee (the purchaser of the business name) in return for a fixed sum of money and a percentage royalty on sales revenue.

The franchisee will be based locally and is likely to be making his initial business venture. He buys the business format, which has been tried and tested in other areas, and it is therefore a far less risky venture than setting up his own business.

The franchisee has a licence to trade under the franchisor's name and also to use the logos, trademarks, etc. the licence that the franchisee buys is usually restricted to a specific

geographical area and for a limited period of time.

This process of selling the rights to use a company's name, logo, etc. can result in the parent company experiencing rapid expansion in a country, with little of the investment that would have been required had the company bought the outlets itself. The franchisee is provided with a ready-made product, financial and management help and advice, lower start-up costs than for a business of his own, and help with the store layout.

However, the royalty must be paid to the franchisor even if a loss is made and the franchisee can have strict restrictions placed on their actions and promotions within the store, not leaving the franchisee much room for initiative and flair.

The Growth of Business

Internal -v- External Growth

There are two main ways in which a business can grow - internal growth and external growth.

Internal growth

(Often referred to as organic growth) refers to a situation where a business increases its size through investing in its existing product range, or by developing new products. This will normally be financed through the use of retained profits (from previous trading years), bank loans or, if the business is a PLC, through the issue of shares. This is a slower and safer method of expansion than external growth.

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External growth

Involves much greater sums of money and takes place through the use of mergers and takeovers (often known as growth through amalgamation, or simply integration).

Regardless of the method of growth, there are several reasons why firms wish to grow:

• To achieve economies of scale and see the average cost of production decline.

• To achieve a greater market share.

• To satisfy the ego of the businessman.

• To achieve security through becoming more diversified.

• To survive in an increasingly competitive market.

Mergers and Take-Overs

A merger occurs where two firms combine, with the consent of both groups of shareholders and Directors.

A takeover (also known as an acquisition) refers to a situation where over 50% of the shares in another company have been purchased - therefore giving the predator full control of the newly acquired company. Both mergers and takeovers are referred to as growth through amalgamation, or simply as integration.

There are several different classifications of integration:

• Horizontal. This occurs when two firms in the same industry join together who produce the same product and are at the same stage of the production process (e.g. the Nestle takeover of Rowntree). The new, larger business is likely to be more powerful, have a larger market share, and achieve higher sales revenue and profits. However, the new business may become complacent and inefficient and find that it suffers from diseconomies of scale and / or falling profits.

• Vertical. This occurs when two firms combine who are in the same industry, but at a different stage of the production process.

• Forward vertical integration. Occurs where a company merges with, or takes-over, another company which is closer to the retail stage (i.e. nearer to the consumer). An example of this would be a car manufacturer taking-over a range of car showrooms. Forward Vertical integration is often the result of a desire to secure an adequate number of market outlets and to raise their standard.

• Backward vertical integration. Occurs where a company merges with, or takes-over, another company which is closer to the source of the raw material (e.g. a car manufacturer taking-over a supplier of car components). Backward Vertical integration is often the result of a company being able to exercise much greater control over the quantity and quality of it supplies, as well as securing its supplies at a lower cost.

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• Conglomerate. This occurs where two firms merge which are in different industries and produce different goods - in other words, it is pure diversification. The major advantage to the new, larger firm is that it has diversified its product range and spread its risks.

• Lateral. This occurs where two firms combine which are similar in some way, but are not in the same industry (e.g. Cadbury-Schweppes). Here, both companies produced products which were sold to similar market segments (confectionery and soft drinks). Often, the firms can benefit from the management and marketing techniques employed by the other.

The underlying motive for most mergers and takeovers is to achieve synergy. This is often called the "2+2=5 Effect", since the end result will hopefully be more than what the two firms put in to the venture.

If it is believed that a proposed merger or takeover is likely to act against the public interest, then it may be referred to the Competition Comission for investigation. In general, any merger or takeover which will result in a market share of 25% or more will be investigated by the Competition Comission.

This body does not have the power to take legal action against the company, but instead it can recommend to the Office of Fair Trading (O.F.T.) that some action needs to be taken against the recently merged companies.

Internal and External Sources of Capital

The amount of finance required by a business will depend on a range of factors, including the age of the business, the track-record and profitability of the business, the industry that it is in and the state of the economy.

Internal finance is generated from within the business and is likely to come from one of three sources:

1. Retained profit refers to profits made from previous years, which have remained after corporation tax has been paid to the Inland Revenue and after dividends have been distributed to shareholders. It is a useful source of finance to fund new products, etc. 2. The sale of fixed assets, such as machinery, vehicles or even land and buildings

which are idle, can also be a large source of cash to fund new projects.

3. Making more effective use of working capital, such as chasing debtors for prompt payment, selling off any available stocks and negotiating longer credit periods with suppliers all release cash for use within the business.

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• Bank overdrafts allow the business to withdraw more money from the bank than it has in its account. It is a flexible, short-term method of borrowing extra cash. However, interest is calculated on a daily basis and it can be recalled at very short notice.

• Trade credit involves the business obtaining goods from another business, but not paying for them for a period of time.

• Factoring involves a business selling its debts to a factor company, who will

immediately give the business 80% of the money owed to it by its customer. At a later date, having collected the debt from the customer, the factor company will give the business the remainder of the money less a fee.

• Leasing is a common way to fund new fixed assets, as opposed to purchasing them outright. The business will sign a contract committing it to using some vehicles, machinery, premises, etc. for a fixed period of time (often 3-5 years) with a monthly payment made to the company who owns the assets. The business leasing the assets cannot put these items on its balance sheet (since it never owns them).

• Loans and mortgages are often used to purchase new fixed assets (machinery, vehicles and land and property). They require monthly repayments to be made for a significant period of time (up to 25 years for a mortgage) and the bank will also want an item to be placed as security (collateral) to cater for the event of the business defaulting on it loan repayments. The danger is that too many loans and mortgages will increase the company's gearing to a dangerously high level.

• Debentures are sold by companies to investors as a way of raising finance for use within the company. They are long-term, marketable securities, which will pay the holder a fixed amount of money every year until its maturity date - at which time the holder will be able to sell the debenture back to the company for it market price. However, debentures, like loans and mortgages, will increase the gearing level of a company.

• Venture capital is a very risky type of investment that entrepreneurs (calledventure capitalists) will make in a small to medium sized business, which they believe has massive growth potential. These funds will clearly help the business to grow and achieve its potential.

Whichever source of finance is chosen, the business must ensure that it is adequate for the needs of the business (i.e. it is enough to pay for the new product development, new

buildings, etc.) and that it is appropriate (i.e. it will not leave the business with large monthly interest repayments, when they are already burdened with high gearing).

Problems of Growth

Rapid and unexpected growth can lead to a host of problems for businesses. Probably the most common problem is the effect that the growth has on the company's finances - specifically upon the liquidity and gearing of the company.

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Extra expenses and increased long-term liabilities (such as loans and mortgages) may reduce the liquidity and increase the gearing levels of the company and leave it dangerously close to insolvency.

It may simply be the case that the managers cannot cope with the extra responsibilities and workloads that they are faced with - this could lead to a rapidly expanding workforce, with the problems of recruitment, training and lengthy communication channels that this will

inevitably lead to.

It is also possible that the company may become inefficient and it may

experiencediseconomies of scale (rising average costs). This could lead to a significant fall in profits, which in turn could persuade shareholders to sell their shares - this would result in a falling share price.

A major problem that a PLC can experience as it grows is the divorce of ownership and control. This refers to the fact that the owners of a PLC (shareholders) are usually interested in maximising the company's profits and, therefore, their own dividend payments. However, the control of the company is in the hands of the management and the Directors. They too want the company to be profitable, but would also like some of the company's resources and money to be invested into new products and new markets.

This, clearly, reduces the short-term profits of the company and, therefore, also reduces the dividend payments to shareholders.

Management Buy-Outs and Management Buy-Ins

Management Buy-Outs

Management Buy-Outs involve the management team buying an equity stake in the company that they work for (i.e. they become the owners, or part-owners, of the company). Each member of the management team will be expected to invest much of his own money into the venture, but the majority of the finance required to buy the company will come from financial institutions and from venture capitalists.

One of the most common examples of Management Buy-Outs is when the management team of a company that is facing receivership decides to buy-out the company, rather than let it be acquired by an outside organisation.

The management team, when deciding whether to buy-out the company, should make an assessment of the business in terms of its cashflow, profitability, product range, assets and the different markets in which it operates. If the company looks as if it has potential, then the management team may well take the risk and buy-out the company.

The managers often make a success of such a venture because they are more in touch with the workings of the company and with the markets in which they operate. The managers are often a highly motivated group of people and they realise that the success or failure of the

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company rests with their activities. An example of a Management Buy-Out that was a tremendous success was Denby Pottery, and one that failed was M.F.I.

Management Buy-Ins

Management Buy-Ins exist where the management team of an outside company buy enough shares in another company to control it. The managers buy the shares because they believe that they can run the company more efficiently and profitably than the existing management team. A Management Buy-In is likely to be financed predominantly through borrowed funds, which will cause the gearing ratio to be high.

Exam-Style Questions

1. a) What is meant by "tall" and "flat" organisational structures?

b) Why have many organisations moved away from tall to flat organisational structures? (Marks available: 10)

a) Tall structures refer to hierarchical organisations with many layers of management/levels of responsibility.

Flat structures have very few levels of responsibility. (5 marks)

b) Tall organisation structures have become less popular due to moves towards leaner

organisations, teamwork ethos, increased customer focus and the ability to respond quickly to external changes and customer demands.

(5 marks)

2. a) What services do banks offer to small businesses?

b) How might the purpose of a loan influence the period over which it is borrowed? (Marks available: 10)

Answer outline and marking scheme for question: 2 .

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a) Banks offer a range of services to small business, lend money and offer advice.

The extent of the help will depend on a number of factors such as the financial standing of the company, i.e. the length of time it has been trading, sales turnover.

If it is a new company, the small business may find difficulty in raising finance through banks, they may have to pay higher rates of interest, and the banks may be less flexible if the

business deviates from its business plan. (5 marks)

b) Considerations should include, what the finance is to be used for, for example, current or fixed assets. Will the purchase be obsolete before the loan is paid back.

(5 marks)

3. a) What is the difference between organic growth and growth through acquisition? b) Is growth necessarily good for a firm?

a) Organic growth is growth through increased sales, resulting in capital investment, perhaps in new plant.

Growth through acquisition (Hanson is a good example) occurs through takeovers of other businesses, so that there is no growth in the industry as a whole, simply a concentration among fewer and larger, financial groups.

(max 10 marks)

b) The second question can be answered in several ways. A candidate might note that a firm may change its character as it grows: A family firm may find that growth entails bringing in outsiders and relinquishing some family control.

Overtrading might be discussed: a firm can overextend its borrowing and find itself starved of working capital (more firms go bust in the upturn following a recession than during the

recession itself). (max 10 marks) (Marks available: 20)

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Marketing

Market Research

Market research involves gathering and analysing data from the marketplace (i.e. from consumers and potential consumers) in order to provide goods and services that meet their needs.

Primary research

This is research designed to gather primary data, that is, information which is obtained specifically for the study in question. It can be gathered in three main ways - observation, questionnaires and experimentation.

Observation involves watching people and monitoring and recording their behaviour (e.g. television viewing patterns, cameras which monitor traffic flows, retail audits which measure which brands of product consumers are purchasing).

Questionnaires are a means of direct contact with consumers and can take a variety of forms. Personal questionnaires (such as door-to-door interviewing), postal questionnaires, telephone questionnaires and group questionnaires (such as asking for the attitudes of a group of consumers towards a new product). Questionnaires can be a very expensive and time-consuming process and it can be very difficult to eliminate the element of bias in the way that they are carried out. It is important that every respondent must be asked the same questions in the same order, with no help or emphasis being placed on certain questions / responses.

Experimentation involves the introduction of a variety of marketing activities into the marketplace and then measuring the effect of each of these on consumers. For example, test marketing, where a new product is launched in a small, geographical area and then the response of consumers towards it will dictate whether or not the product is launched nationally.

Secondary research

This is the collection of secondary data, which has previously been collected by others and is not designed specifically for the study in question, but is nevertheless relevant. Secondary data is far cheaper and quicker to gather than primary data, but it can be out-of-date by the time that it is researched. The main sources of secondary data are reference books,

government publications and company reports.

The primary and the secondary research will provide the business with much data relating to its markets and its consumers. This data can then be used to describe the current situation in the marketplace, to try to predict what will happen in the future in the marketplace, and to explain the trends that have occurred.

The business may also use the market research data to segment the market. This involves breaking the market down into distinct groups of consumers who have similar characteristics,

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so as to offer each group a product which best meets their needs. The main ways of segmenting a market are:

By consumer characteristics: this involves investigating their attitudes, hobbies, interests, and lifestyles.

By demographics: their age, sex, income, type of house, and socio-economic group. By location: the region of the country, urban -v- rural, etc.

Effective segmentation of the market can lead to new opportunities being identified (i.e. gaps in the market for a product), sales potential for products being realised and increased market share, revenue and profitability.

Quantitative vs Qualitative research

Quantitative research

Quantitative research involves carrying out market research by taking a sample of the population and asking them pre-set questions via a questionnaire (normally 200+ respondents) in order to discover the likely levels of demand at different price levels,

estimated sales of a new product, and the 'typical' purchaser of the company's products. The data is numerical and can be analysed graphically and statistically. There are several types of sample that can be used to gather quantitative data:

Random sampling - this gives each member of the public an equal chance of being used in the sample. The respondents are often chosen by computer from a telephone directory of from the Electoral Register.

Quota sampling - this method involves the consumers being grouped into segments which share certain characteristics (e.g. age or gender). The interviewers are then told to choose a certain number of respondents from each segment. However, the numbers of people

interviewed in each segment are not usually representative of the population as a whole. Cluster sampling - this normally involves the consumers being grouped into geographical groups (or 'clusters') and then a random sample being carried out within each location. Stratified sampling - the consumers are grouped into segments again (or 'strata') based upon some previous knowledge of how the population is divided up. The number of people chosen to be interviewed from each 'strata' is proportional to the population as a whole.

Qualitative research

Qualitative research attempts to gain an insight into the motivations that drive a consumer to behave in a particular way. It is usually conducted through group discussions (often

called focus groups) in order to discover the rationale behind consumers' purchases. The group discussion is often chaired by a psychologist in a relaxed manner, which should

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encourage the consumers to discuss their shopping habits and pre-conceptions concerning certain products and brands.

Forecasting

This involves attempting to estimate future outcomes (e.g. the level of sales). Forecasting can be done in a number of ways:

Extrapolation - this involves identifying the trend that existed in past data and then

continuing this into the future. This is often done by using a software package to establish a line of best fit for past data, and then simply extending this line into the future.

The Delphi Technique - this involves using a panel of business and forecast 'experts' who discuss and agree long-range forecasting for important issues and events.

Market research - this can be used to try and establish the purchasing intentions of consumers.

Time Series analysis - this also attempts to predict future levels from past data. There are 4 main components of time-series data : the trend, cyclical fluctuations (due to the economic cycles of recessions and booms), seasonal fluctuations and random fluctuations.

Clearly, trying to predict and forecast what will happen in the future is not easy and many variables will change in both the short-term and in the long-term which will affect the accuracy of forecasts. It is always advisable for businesses to use a variety of forecasting techniques to arrive at suitable and acceptable figures for the future (e.g. costs, revenues, sales levels, profits, etc).

Statistical Analysis

There are a variety of techniques that a business can use to analyse the data that it collects through its market research methods.

The mean - this is the sum of the items divided by the number of items. The median - this is the middle number in a set of data.

The mode - this is the number, or value, that occurs most frequently in a set of data.

The range - this is the difference between the highest value and the lowest value in a set of data.

The interquartile range - this considers the range within the central 50% of a set of data. It therefore ignores the top 25% and the bottom 25% and is less prone to distortion by extreme values.

The standard deviation - this is a measure of the deviation from the mean value in a set of data.

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Confidence Interval - this is a measure of the likely accuracy of the results of a sample. With a 95% confidence interval, there is a 0.95 probability that the true average will be where the sample believes it will lie (in other words, the results of the sample will be correct 19 times out of 20).

Index numbers - this is a statistical measure which is designed to make changes in a set of data (such as sales figures) easier to manage and interpret. It involves giving one item of data a value of 100 (the base period), and adjusting the other items of data in proportion to it.

For example, if the sales for a particular business are £200,000 in year 1, £220,000 in year 2 and £270,000 in year 3, then index numbers can be used to help identify the trend within the data. The sales in year 1 will be given an index number of 100 (this is known as the base-year). Year 2 has £20,000 more sales than in year 1 - this is a 10% rise, so the index number in year 2 will be 110. Year 3 has £70,000 more sales than year 1 - this is a 35% rise, so the index number in year 3 will be 135.

Moving average - this is another way of identifying the trend in a set of data. It allows extreme values to be glossed over, so as to show the underlying pattern in a set of data. For example, consider the following data referring to sales over a 5 year period for a business :

The mean value of sales over this 5 year period is found by adding all 5 values together, and dividing the resulting answer by 5 (£563,000 / 5 = £112,600).

However, a 3-year moving average can give a more realistic indication of the changes in the trend over the 5 years. This is calculated by adding together the first three year's data, and dividing the resulting figure by 3 (£285,000 / 3 = £95,000).

This process is then repeated for the next 3-year period (i.e. years 2, 3 and 4). This gives a figure of £317,000 / 3 = £105,667.

The next 3-year period covers years 3, 4 and 5. This gives an answer of £343,000 / 3 = £114,333.

These figures show how the trend has moved within the data over the 5 year period.

Market Strategy

Niche Marketing

This involves a business selling its product(s) in small, often lucrative, segments of a market. It is the opposite strategy to mass marketing. Many small businesses can identify unsatisfied

Year 1 £100,000 Year 2 £120,000 Year 3 £ 65,000 Year 4 £132,000 Year 5 £146,000

Business-20Studies-20AS-A-20level.pdf

Business Studies AS & A2 Level

Contents

Business objectives and strategy

Objectives

Strategy

Stakeholders

Exam-Style Questions

Business Organization

Starting a Small Firm

Legal Structure

The Growth of Business

Exam-Style Questions

Marketing

Market Research

Market Strategy