Unit1

Business enterprise 1

Section 1: Entrepreneurship Characteristics of entrepreneurs What motivates entrepreneurs?

Role Company structures Stakeholders Opportunity costs

Section 2: researching a business opportunity Market research The Market Positioning Product Trial

Section 3: Supply and Demand Demand Supply Interaction of supply and demand

Section 4: Finance Sources of finance

Section 5: Measuring business performance Pricing, sales, revenues, costs and profit Break-even Measuring and improving profit Importance of cash flow

Section 6: The wider business environment Government influences Economic influences Social influences

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Section 1: Entrepreneurship

Introduction: “Being good in business is the most fascinating kind of art. Making money is art and working is art and good business is the best art.”

Andy Warhol Risk v Reward 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.

Characteristics of entrepreneurs Keywords: Initiative, creative, resilient, risk-taker, hard-worker, self-confident, effective communication.

“My son is now an 'entrepreneur.' That's what you're called when you don't have a job. “ Ted Turner

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“Sometimes when you innovate, you make mistakes. It is best to admit them quickly, and get on with improving your other innovations.”

Steve Jobs

Motives for being an entrepreneur Keywords: Profit motives: survive, sales maximization, profit maximisation Non-profit motives: being your own boss, working from home, helping others (ethical) What are the benefits of being ethical? – good publicity, additional sales, helping others.

Why start a business? (Motives) The skill involved in wanting to start and run a business is called enterprise. The individual who sets up their own business is called an entrepreneur.

There are several reasons why entrepreneurs are willing to take a calculated risk and set up a business.

Possible motives include: 

  

Making a profit. A business does this by selling items at a price that more than covers the costs of production. Owners keep the profit as a reward for risk-taking and enterprise.

The satisfaction that comes from setting up a successful business and being independent.

Being able to make a difference by offering a service to the community such as a charity shop or hospice.

A new business needs its own name and a product. The challenge is to make goods and services that satisfy customers, are competitive and sell at a price that more than covers costs.

Discover what you can about

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Taming the Dragons with a Song Meet Levi Roots, the singer turned entrepreneur who slayed the BBC2’s Dragons in their den with a reggae tune that promoted his business idea. Levi strolled into the Den with his guitar and started to sing about Reggae Reggae Sauce, a product idea based on his grandmother's secret barbecue sauce.

Levi and his family have been selling Jerk Chicken and ribs using the recipe for several years at Notting Hill Carnival. But they only started to sell the sauce itself at the 2006 event. They sold more than 4,000 bottles, which inspired Levi to take seek investment from the TV experts.

Levi entered the Den initially willing to give up only 20 per cent of his business. Not all the Dragons were impressed. Duncan Bannatyne thought it wouldn't make much money, Deborah Meaden said it would make just enough profit to provide a lifestyle business, and Theo Paphitis said that the orders Levi already had meant that he didn't need the investment at all. So they all declared themselves out.

However, telecoms entrepreneur Peter Jones and Australian private investor Richard Farleigh agreed to pay £25,000 each for a 20 per cent share. This meant that Levi had sold 40% of his business for £50,000, valuing the whole business at £125,000.

Since the programme, Jones and Farleigh have both got involved in helping Levi produce his business plan, and to find industrial kitchens to enable higher volume production of the sauce.

The day after the show, Peter Jones used his contacts to introduce Levi and his product to buyers at Sainsbury’s. The result? Reggae Reggae Sauce has turned into one of the fastest selling sauces in the UK. What is the reason behind this success? The product recipe? The cash from the investment by the Dragons? Or perhaps that Jones and Farleigh instantly recognised a great, marketable brand in Levi, his song and his sauce. You could argue that it was an easy investment to make.

Whilst Jones and Farleigh might have great ambitions for their investment, Levi seems less focused on growth. In an interview after the programme, he reflected on the experience and his aims for Reggae Reggae Sauce. On appearing in the Den, Levi explained: “They looked at me like I was a madman. I don't think anyone has sung reggae music to them before. I thought they were going to get up and start dancing."

“I'm not in this to be the next Heinz ketchup. I just want to bring the sweet, sweet flavour of reggae music to the world" he said.

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1. Explain whether Reggae Reggae Sauce is a good or a service

2. What kinds of skills do you think Levi Roots had that made him such a successful business person?

3. What evidence is there in the case study that Levi thought creatively?

4. How did he come up with the idea for Reggae Reggae Sauce?

5. What kinds of questions do you think he had to ask himself before he decided to launch the product?

6. Complete the table below, selecting the qualities that you think Levis Roots showed, ranking the factors in order of most important qualities for any business person, and identifying which qualities you have.

Levis Ranking (1=most important, 8 Which do = least important) you have?

Ability to speak in public Determination Aggressiveness Decisiveness Willingness to take risks Showing leadership Having rich parents Being careful to avoid risk

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Role The Initial idea.

Taking a risk (calculated), support from government, where do ideas come from; experience, brainstorming, observation, innovating, looking at social changes & needs, economic changes, looking at different techniques to help set up a business!

Creating and setting up a business: Some market research, find a location, create a business plan, maybe a franchise, looking at competition.

Identifying the factors of production: enterprise (idea), location, resources and people (employees) Good idea to create a business plan when setting up the business. This includes information about, nature of the business, the product, its market, objectives, marketing to be used, sales & cash forecast. This will be used by the owner to plan & co-ordinate, and to attract investors – banks/venture capitalists.

Its limited because it is forward-looking and as yet we cannot guarantee the future!

Running a business: Employing people on part-time or full-time contracts, recruitment (hiring people) is a difficult, expensive and time-consuming practice.

Look at the current state of the economy. Different company objectives depending upon competition, opportunities for growth. Could be financial or personal.

Success or failure is measured upon the completion of objectives eg To increase profits by 5% next year can be easily measured!

Look at the risk and try to minimalise it!

Expanding a business: Business who are successful can choose to grow (if they want). This might include employing more people, opening a new store, increasing the range of products or moving to larger premises. These are all costly and require considerable investment and consideration.

In order to determine the reasons for growing, they would need to look for a suitable source of finance to cover the costs.

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Innovation within a business: Can be an accident that a product is a success eg Coca Cola or Guiness beer, or was deliberately designed eg Ipads/Iphones.

The process of invention can help create new products. Now that we have new technologies to create and use new materials, we can create new products!

Companies like Apple and Dyson continually release new products, new versions, improve on existing models and achieve balance between the function/Aesthetics and economy of producing a new product known as the “Design Mix�

This is the balance between how it looks, how it works and how much it costs to produce and sell it!

Successful innovation can also come from Marketing (advertising) and discovering new uses for existing products!

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Company structures 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.

Examples of Sole Traders

Partnerships: 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, solicitors and dentists.

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 9|Page

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.

Examples of Partnerships

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

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business to trade as a Private Limited Company. The company's name must finish with the word Limited 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. main advantages and disadvantages of being a private limited company?

A private limited company is the most common form of company. The shares of a private limited company are not available to the general public to buy and sell on a recognised stock exchange. The company is owned by shareholders and they enjoy “limited liability” – i.e. the most they can lose is the amount they have invested in their shares.

Advantages Limited liability – by far the most important advantage of incorporation. Limited liability protects the personal wealth of the shareholders Easier to raise finance – both through the sale of shares and also easier to raise debt.

Stable form of structure – business continues to exist even when shareholders change.

Provides more privacy of information than an public limited company Disadvantages Greater admin costs (though much cheaper than being a public company) Public disclosure of company information (annual report & accounts + annual return) Directors’ legal duties (set out by Companies Act) Examples of Private limited companies

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 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.

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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 the divorce 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. Examples of Public limited companies

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Co-operative An association of persons who voluntarily cooperate for their mutual, social, economic, and cultural benefit.Cooperatives include non-profit community organizations and businesses that are owned and managed by the people who use its services (a consumer cooperative) or by the people who work there (a worker cooperative) or by the people who live there (a housing cooperative), hybrids such as worker cooperatives that are also consumer cooperatives or credit unions, multi-stakeholder cooperatives such as those that bring together civil society and local actors to deliver community needs, and second and third tier cooperatives whose members are other cooperatives. A cooperative is a legal entity owned and democratically controlled by its members. Members often have a close association with the enterprise as producers or consumers of its products or services, or as its employees.

Unlimited Liability This is associated with businesses that are unincorporated e.g. sole traders and partnerships. This means that the owner and the business are classified as being one and the same in legal terms. What this means, is that the debts of the business are also the debts of the owner. Therefore if the debts of the business amount to more than the value of its assets then the owner may lose some of their own personal possessions as a means of making up the shortfall. This typically can include cars and even the family home.

When a sole trader or partnership business fails it is called bankruptcy.

Limited Liability This is associated with companies e.g. Plc’s and Ltd’s.They are incorporated types of businesses.

This means that the owners are classified as a beingseparate from the business. Therefore the debts ofthe business are not the personal responsibility ofthe owners. Personal possessions are not at risk.

The lower levels of risk associated with the holdingof limited liability can be useful in helping to attractnew financial investment.When a private limited or public limited company fails it enters liquidation.

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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 a capital 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 a dividend). 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 team-working, problem solving and decision making - thus having a significant input to the workings of the business.

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.

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

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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 they 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 aftersales 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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“The secret of business is to

know something that nobody else knows”. Aristotle Onassis Opportunity Costs Opportunity cost is one of the most important and fundamental concepts in the whole of economics. Given that we have said that economics could be described as a science of choice, we have to look at what sacrifices we make when we have to make a choice. That is what opportunity cost is all about.

The definition of opportunity cost is: “The cost expressed in terms of the next

best alternative foregone or sacrificed” Take the following example: I recently bought a new pair of shoes which cost me £40.

The cost here is being expressed in terms of the amount of money you had to give up to acquire those shoes. Because we all have a common understanding of 'money' as being notes and coins that we use to exchange for the things we want, we can pretty much understand this sentence.

We have to remember that money is merely bits of paper or metal that we use as a convenient and accepted method of facilitating exchange - getting what we want. Expressing 'cost' in terms of the amount of money we have to give up to get what we want is always helpful in giving us the true 'cost' of something. For that, we need to use 'opportunity cost'.

What statements like this fail to convey, however, is the true picture of what you are sacrificing by choosing to buy the shoes. It is more accurate to say something like 'the price I paid for these shoes was £40.' To get an idea of the true 'cost', we would really need to know something of the sacrifice made in giving up that £40. £40 can buy a number of things - let us assume that it can also buy the following: When thinking about how to dispose of your money, you have to make choices and these represent the choices at this moment in time. These choices represent different aspects of value. Each of the items might represent some value to you but they may be different. It is important to remember that you might, in an ideal world where there were no scarce resources, want all these things.

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TRADE OFFS In business there are many occasions when one factor has to be traded off against another.

An entrepreneur might get huge help at the start from friends, yet realise that these same friends lack the professionalism to help the business grow.

The needs of the business may have to be traded off against the friendships. Other trade-offs may include – giving up a good job and prospects to be your own boss, giving up the most enjoyable things for profit etc.

Examples: 1. Work for two years and earn money or pay money to get an advanced degree 2. Spend a million or so raising children or use the money for travel 3. Retire today or continue working for a few more years

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Section 2: Researching a business opportunity

Market Research Product or market orientation Businesses tend to develop new products based on either a marketing orientated approach or a product orientated approach.

• A marketing orientated approach means a business reacts to what customers want. The decisions taken are based around information about customers’ needs and wants, rather than what the business thinks is right for the customer. Most successful businesses take a market-orientated approach.

• A product orientated approach means the business develops products based on what it is good at making or doing, rather than what a customer wants. This approach is usually criticised because it often leads to unsuccessful products particularly in well-established markets.

Most markets are moving towards a more market-orientated approach because customers have become more knowledgeable and require more variety and better quality. To compete, businesses need to be more sensitive to their customer´s needs otherwise they will lose sales to their rivals.

On the other hand some products are argued to create a need or want in the customer, especially products with a very high technological content. Mobile phones have moved from being a business accessory to being a big consumer brand item, with many additional gadgets, such as pictures, video and Internet access. Innovations create the need rather than the customer being able to secondguess how new technology is going to develop.

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.

A wide variety of information used to support marketing decisions can be obtained from market research. A selection of such uses are summarised below: Information about the size and competitive structure of the market • Analysis of the market potential for existing products (e.g. market size, growth, changing sales trends) • Forecasting future demand for existing products • Assessing the potential for new products 19

• Study of market trends • Analysis of competitor behaviour and performance • Analysis of market shares Information about Products • Likely customer acceptance (or rejection) of new products • Comparison of existing products in the market (e.g. price, features, costs, distribution) • Forecasting new uses for existing products • Technologies that may threaten existing products • New product development Information about Pricing in the Market • Estimates and testing of price elasticity • Trends in pricing over recent years • Analysis of revenues, margins and profits • Customer perceptions of “just or fair” pricing • Competitor pricing strategies Information about Promotion in the Market • Effectiveness of advertising • Effectiveness of sales force (personal selling) • Extent and effectiveness of sales promotional activities • Competitor promotional strategies Information about Distribution in the Market • Use and effectiveness of distribution channels • Opportunities to sell direct • Cost of transporting and warehousing products • Level and quality of after-sales service Markets are dynamic. This means that they are always changing. A business must be aware of market trends and evolving customer requirements caused by new fashions or changing economic conditions.

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Primary market 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).

“Hawthorne effect” 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.

Focus Group Discussions Focus groups are the mainstay of consumer research. Here several customers are brought together to take part in a discussion led by a researcher (or “moderator”). These groups are a good way of exploring a topic in some depth or to encourage creative ideas from participants. Group discussions are rare in business markets, unless the customers are small businesses. In technology markets where the end user may be a consumer, or part of a team evaluating technology, group discussions can be an effective way of understanding what customers are looking for, particularly at more creative stages of research.

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Secondary market research This involves using secondary data. A wide range of potential sources of such data is available to firms including.   

The business’s own information. This includes sales data on existing data, reports from the sales team, statistical analysis of patterns of existing sales and production.

Official data. The government and other agencies such as the Department of Trade & Industry and The Training and Enterprise Councils produce vast amounts of detailed information.

Trade associations and trade papers supply valuable and quite specific information on market trends.

Market research is the process of gathering information on potential consumers. This research can provide information on the buying habits, lifestyle and perceptions of actual and potential consumers.

Several different types of market research may be undertaken by a business. Market research might be conducted into the market itself, the firm’s product or products and the prices consumers may (or may not) be willing to pay. Research can also be carried out into sales promotion (for example, does advertising actually work?).

Use of ICT to support market research Websites, social networking, databases, online surveys, Apps,

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Sampling size Primary market research involves firms taking samples of the population. Ideally everybody would be asked and this would provide the most statistically reliable set of data but in reality, this is too expensive and impractical to achieve. Therefore, a small percentage of the entire population is chosen to represent the wider views of the market. This is called a sample.

The bigger your sample size the more accurate your results are likely to be but also the more expensive your research costs! Small firms especially have to balance costs against accuracy.

Generally 95% confidence in your sample results are considered to be good enough and this can be gained through a relatively small sample size.

Random Sampling Requires a database of the population which is costly!

Opportunities for bias in the results.

Includes people who are not part of your target market.

The easiest and cheapest sampling method for small businesses.

Quota Sampling: A sampling method in which the numbers and the characteristics of respondents are specifically chosen to reflect the characteristics of the target market. E.g. If females aged under-25 buy 80% of milk chocolate then there should be four females aged under-25 to everyone else in your sample Subject to bias as both the location and the respondents are chosen More accurate by the interviewer. match to your target market as it removes segments not interested in your products.

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Extra time needed in planning the sample and this adds to your costs. Might be too expensive for small firms.

Quantitative vs Qualitative research Quantitative research Quantitative research is about measuring features of a market and quantifying that measurement with data. Most often the data required relates to market size, market share, penetration, installed base and market growth rates. However, quantitative research can also be used to measure customer attitudes, satisfaction, commitment and a range of other useful market data that can tracked over time.

Quantitative research can also be used to measure customer awareness and attitudes to different manufacturers and to understand overall customer behaviour in a market by taking a statistical sample of customers to understand the market as a whole. Such techniques are extremely powerful when combined with techniques such segmentation analysis and mean that key audiences can be targeted and monitored over time to ensure the optimal use of the marketing budget.

At the heart of all quantitative research is the statistical sample. Great care has to be taken in selecting the sample and also in the design of the sample questionnaire and the quality of the analysis of data collected.

Market research involves the collection of data to obtain insight and knowledge into the needs and wants of customers and the structure and dynamics of a market. In nearly all cases, it would be very costly and time-consuming to collect data from the entire population of a market. Accordingly, in market research, extensive use is made of sampling from which, through careful design and analysis, marketers can draw information about the market.

Qualitative research

Qualitative market research is about investigating the features of a market through in-depth research that explores the background and context for decision making. There are two main qualitative methods - depth interviews and focus groups. However qualitative research can also include techniques such as usability testing, brainstorming sessions and “vox pop� surveys.

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Depth Interviewing Depth interviews are the main form of qualitative research in most business markets. Here an interviewer spends time in a one-on-one interview finding out about the customer’s particular circumstances and their individual opinions.

The majority of business depth interviews take place in person, which has the added benefit that the researcher visits the respondent’s place of work and gains a sense of the culture of the business. However, for multinational studies, telephone depth interviews, or even on-line depth interviews may be more appropriate.

Feedback is through a presentation that draws together findings across a number of depth interviews. In some circumstances, such as segmentation studies, identifying differences between respondents may be as important as the views that customers share.

The main alternative to depth interviews - focus group discussions - are typically too difficult or expensive to arrange with busy executives.

However, on-line techniques increasing get over this problem.

Focus Group Discussions Focus groups are the mainstay of consumer research. Here several customers are brought together to take part in a discussion led by a researcher (or “moderator”). These groups are a good way of exploring a topic in some depth or to encourage creative ideas from participants.

Group discussions are rare in business markets, unless the customers are small businesses. In technology markets where the end user may be a consumer, or part of a team evaluating technology, group discussions can be an effective way of understanding what customers are looking for, particularly at more creative stages of research.

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Market segmentation 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, 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.

Market segmentation - targeting strategies Once a firm has successfully identified the segments within a market, the next step is to target these segments with products that closely match the needs of the customers within that segment. There are a number of targeting strategies, including: bases of segmentation Geographic • Region of the country • Urban or rural Demographic • Age, sex, family size • Income, occupation, education • Religion, race, nationality Psychographic 26 | P a g e

• Social class • Lifestyle type • Personality type Behavioural • Product usage - e.g. light, medium ,heavy users • Brand loyalty: none, medium, high • Type of user (e.g. with meals, special occasions) Why segment markets?

There are several important reasons why businesses should attempt to segment their markets carefully. These are summarised below Better matching of customer needs Customer needs differ. Creating separate offers for each segment makes sense and provides customers with a better solution Enhanced profits for business Customers have different disposable income. They are, therefore, different in how sensitive they are to price. By segmenting markets, businesses can raise average prices and subsequently enhance profits Better opportunities for growth Market segmentation can build sales. For example, customers can be encouraged to "trade-up" after being introduced to a particular product with an introductory, lowerpriced product Retain more customers Customer circumstances change, for example they grow older, form families, change jobs or get promoted, change their buying patterns. By marketing products that appeal to customers at different stages of their life ("life-cycle"), a business can retain customers who might otherwise switch to competing products and brands Target marketing communications Businesses need to deliver their marketing message to a relevant customer audience. If the target market is too broad, there is a strong risk that (1) the key customers are missed and (2) the cost of communicating to customers becomes too high / unprofitable. By segmenting markets, the target customer can be reached more often and at lower cost Gain share of the market segment 27 | P a g e

Unless a business has a strong or leading share of a market, it is unlikely to be maximising its profitability. Minor brands suffer from lack of scale economies in production and marketing, pressures from distributors and limited space on the shelves. Through careful segmentation and targeting, businesses can often achieve competitive production and marketing costs and become the preferred choice of customers and distributors. In other words, segmentation offers the opportunity for smaller firms to compete with bigger ones.

Niche/concentration marketing – this is concerned with targeting one particular, well-defined group of customers (a niche) within the overall market.

Jordan’s, the cereal company, adopted this approach by targeting groups of customers interested in organic products at a time when this group of consumers represented a relatively small proportion of the overall market.

Niche markets can be targeted profitably by small firms who have relatively small overheads and, therefore, do not need to achieve the volume of sales required by larger competitors.

The main disadvantages of niche markets are that the potential for sales growth and economies of scale may be limited, and the survival of the firm may be seriously affected if sales begin to decline.

Examples of Niche products/markets

Mass marketing – this is concerned with selling a single product to the whole market. This strategy is based on the assumption that, in respect to the product in question, customers’ needs are very similar if not identical.

The main benefit for the firm is that it can produce on a large scale, benefiting from low unit production costs via economies of scale. These lower costs can be passed on to the consumer in the form of lower prices because, although profit margins on each item sold may be lower, high sales volume should generate large profits overall.

The main disadvantage of mass marketing is that, increasingly in today’s markets, consumers are less interested in standardised products and often prepared to pay premium prices for products that cater for their specific needs.

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The Market A shop is an example of a market Businesses sell to customers in markets. A market is any place where buyers and sellers meet to trade products - it could be a high street shop or a web site. Any business in a marketplace is likely to be in competition with other firms offering similar products.

Successful products are the ones which meet customer needs better than rival offerings.

Market Size & Characteristics Market Size This is a measure of the total value or volume of sales within a market.

Calculating the size of a market can be done in the following way: Number of Units Sold x Price = Market Size Market Growth This is a measure in percentage terms of any increase in the size of the market.

Calculating the growth of a market can be done in the following way: Change in Market Size Original Market Size

x 100

Market Share This is the proportion of a market that is held by an individual product or business.

Calculating market share can be done in the following way: Sales of one Product or Firm x 100 Total Market Sales Calculation Examples In 1985 the total sales of widgets within the UK market amounted to 1.75 million units at an average selling price of ÂŁ3.45 each.

By 2009 the market had grown to 4.6 million units 29 | P a g e

and the Widget Company Ltd sold 2.05 million units every year.

Market Size 1.75 million units x £3.45 per unit = £6.0375 million Market Growth 4.6 million – 1.75 million = 2.85 million change 2.85 million x 100 = 162.86% increase 1.75 million Market Share 2.05 million units x 100 = 44.57% market share 4.6 million units

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Positioning Positioning the Business Idea This is the process of creating an image for the product in the minds of customers.      

Identify the competition.

Identify their strengths and weaknesses.

Identify how to differentiate your product.

Identify Gaps in the market – market mapping.

Try to gain a competitive advantage.

Add value

Market Mapping Market mapping consists of identifying key variables about a product, plotting where existing brands or suppliers are in terms of combining the variables, then identifying any gaps in the market”.

Positioning and Market mapping

Once an entrepreneur has identified an appropriate segment of the market to target, the challenge is to position the product so that it meets the needs and wants of the target customers.

One way to do this is to use a “market map” (you might also see this called by its proper name – the “perceptual map”).

The market map illustrates the range of “positions” that a product can take in a market based on two dimensions that are important to customers.

Examples of those dimensions might be:        

High price v low price Basic quality v High quality Low volume v high volume Necessity v luxury Light v heavy Simple v complex Lo-tech v high-tech Young v Old

Let’s look at an illustrated example of a market map. The map below shows one possible way in which the chocolate bar market could be mapped against two dimensions – quality and price:

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How might a market map be used?

One way is to identify where there are “gaps in the market” – where there are customer needs that are not being met.

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The trick with a market map is to ensure that market research confirms whether or not there is actually any demand for a possible “gap in the market�. There may be very good reasons why consumers do not want to buy a product that might, potentially, fill a gap.

Complete a Market Map for a local shop or restaurant in Valencia.

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Competitive Advantage Definition: A competitive advantage is an advantage over competitors gained by offering consumers greater value, either by means of lower prices or by providing greater benefits and service that justifies higher prices.

Methods: Location, Value for money, Brand name, Facilities, Image, Taste, Customer service Eg Apple Ipod and image

The challenge for a marketing strategy is to find a way of achieving a sustainable competitive advantage over the other competing products and firms in a market.

A competitive advantage is an advantage over competitors gained by offering consumers greater value, either by means of lower prices or by providing greater benefits and service that justifies higher prices.

Examples: Coca Cola is an example of a company with sustained competitive advantage, innovation, an extensive business model and an intelligent and substantial distribution network. The Coca-Cola Company was incorporated in 1892 to produce the sweet fizzy drink – first developed by a pharmacist – that has become the world’s most recognised brand.

Today, almost 120 years later, The Coca-Cola Company is still going strong and is one of the most sought-after stocks on the New York Stock Exchange. Coca-Cola’s competitive advantage has proven its sustainability over the last 100 years.

This can be ascribed to: o o

The secret recipe for Coca-Cola, which arguably tastes better than other cola drinks.

Their ability to continue developing new products and re-inventing old ones – CocaCola currently offers over 400 brands in 200 markets worldwide.

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The world’s most comprehensive distribution system has made Coca-Cola accessible to billions of people worldwide. Coca-Cola is often available in ample supply to people in areas where other consumer goods companies would never consider delivering their products. The African continent is an excellent example – it’s fairly common to see a small shop selling cold Coke in the middle of nowhere.

Coca-Cola’s production techniques are so well developed that it costs a fraction of the selling price to manufacture their product, resulting in high profit margins.

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Adding Value The increase in the benefits of a good or service which are created at each stage of production.

Methods – changing raw materials, packaging, branding (using personalities or famous logos) For example, businesses can add value by: Building a brand – a reputation for quality, value etc that customers are prepared to pay for. Nike trainers sell for much more than Hi-tec, even though the production costs per pair are probably pretty similar!

Delivering excellent service – high quality, attentive personal service can make the difference between achieving a high price or a medium one Product features and benefits for example, additional functionality in different versions of software can enable a software seller to charge higher prices; different models of motor vehicles are designed to achieve the same effect.

Offering convenience – customers will often pay a little more for a product that they can have straightaway, or which saves them time.

A business that successfully adds value should find that it is able to operate profitably. Why? Remember the definition of adding value: where the selling price is greater than the costs of making the product.

By definition, a business that is adding substantial value must also be operating profitably.

Quite simply, it can make the difference between survival and failure; between profit and loss.

The key benefits to a business of adding value include: - Charging a higher price - Creating a point of difference from the competition.

- Protecting from competitors trying to steal customers by charging lower prices - Focusing a business more closely on its target market segment

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Adding Value Why pay extra?

How Much Profit is Made by the iPhone? breaks down the costs of each individual element of what goes into an iPhone.

The analysis provides a great deal of detail, but the numbers break down roughly as follows.

Average Selling Price / (Revenue) of an iPhone - $676 (remember - the analysis is based on the US market) Cost of Materials / Components (e.g. battery, camera, processor, display, memory) $197 Manufacturing: $15 Other direct production & shipping costs: $97 Gross profit per unit $367 Direct overheads: $48 Operating profit (contribution) per unit: $319 What hits me immediately is just how little the unit manufacturing cost is. $15 per iPhone. Apple’s use of manufacturing in China is well documented and this statistic is an interesting part of the debate!

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Product Trial The first step for a new business or product is to attract trial purchases.

A new magazine may run special offers to get customers to try the first issue, hoping that repeat sales are generated.

The magazine will soon close if customers fail to buy future issues. The aim of a special offer scheme is to convert trial purchases into repeat sales.

Repeat business is all about encouraging customers who buy for the first time to buy again and again!

A business invests a lot of effort and cash in trying to get a customer to purchase a product for the first time. This is known as product trial. Much advertising is aimed at encouraging customers to try a new product, or switch from an existing competitor.

After a new product has been tried once, its success can be measured in how quickly, how often, and in what quantity it is repurchased. Repeat purchase refers to the number or percentage of customers who purchase a second time, or to how often they buy again.

The problem with advertising is that it is very expensive. A business is unlikely to be successful and profitable if it has to keep advertising heavily in order to generate demand from new customers. It is much better if customers can be encouraged to become loyal to the product – even better, to recommend the product to their friends and family!

Achieving a high level of repeat purchase is good news for a business. So what is required?

Firstly, the product should be of the right quality. A sub-standard or low quality product is sure to disappoint first-time customers. They are unlikely to buy again or recommend the product to others.

Secondly, a business should do all it can to develop an effect relationship with existing customers. This includes activities such as:

- Regular communication (e.g. email newsletters)

- Incentives for loyalty (e.g. promotional discounts)

- Research into customer needs and wants (e.g. through customer surveys) 38 | P a g e

Section 3: Supply and Demand

The theory of demand At higher prices, a lower quantity will be demanded than at lower prices, ceteris paribus. At lower prices, a higher quantity will be demanded than at higher prices, ceteris paribus.

Basically, when the price is high demand is low and vice versa. Ceteris paribus means 'all other things being equal'. It is very important that you state this condition when using demand curves. I will explain why under "determinants of demand". First, let's have a look at the normal downward-sloping demand curve:

In the diagram above, the demand for CDs is fairly low at the relatively high price of fifteen pounds, but at the bargain price of five pounds demand is much higher.

Calculate the revenue for the company at the 3 stated prices. (pxq)

http://www.telegraph.co.uk/earth/earthnews/7055411/Haggis-sales-up-in-creditcrunch.html

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The determinants (factors) of demand It is fairly obvious so far that the price of a good is a pretty strong determinant of its demand, but there are many other things that will affect demand too.

Real income. If one's real income rose (real means 'allowing for inflation'), one should be able to afford more CDs. The price of other goods. If the price of CD players rose then one would expect demand for CD players to fall, and so would the demand for CDs. These goods are complements. If the prices of rock concerts rose then one would expect the demand for these concerts to fall. Perhaps those who decided against the concert might buy a CD instead. These goods are substitutes.

Tastes and preferences. A slightly obscure but very important determinant. As you get older, you may lose interest in the repetitive music currently in the charts and try some original sounds from the 60s, 70s or 80s. Changing preferences will affect your demand for a product regardless of its price.

Expectations of future prices. If you think that the price for CDs is likely to fall in the near future, perhaps because of reduced production costs or competition from the US, you may delay some purchases which will reduce demand in the current time period. Alternatively, you may feel that CD prices are likely to rise in the near future, perhaps due to the lack of competition in the retail market, so you may increase your demand in the current time period.

Advertising. Although many of you probably doubt the effectiveness of some of the appalling adverts on the TV, one assumes that these companies would not spend fortunes on these adverts if they did not expect to see a significant rise in demand for the product in question (Virgin and Our Price are always trying to sell you CDs via the TV.) Population. Quite obviously, a significant rise in the number of people in a given area or country will affect the demand for a whole host of goods and services. Note that a change in the structure of the population (we have an ageing population) will increase the demand for some goods but reduce the demand for others.

Interest rates and credit conditions. If interest rates are relatively low then it is cheaper to borrow money that can then be spent. This is not so applicable to CDs, but will certainly affect the demand for 'big ticket' items such as cars and major electrical goods. In boom time (like the late 80s) it is often easier to obtain credit regardless of the rate of interest.

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The theory of supply Just like with demand, where it only became effective if it was backed up with the ability to pay, supply is defined as the willingness and ability of producers to supply goods and services on to a market at a given price in a given period of time.

With demand, the downward-sloping curve reflected an inverse relationship between price and quantity demanded.

The opposite is true of supply. In theory, at higher prices a larger quantity will generally be supplied than at lower prices, ceteris paribus, and at lower prices a smaller quantity will generally be supplied than at higher prices, ceteris paribus. So this time we have higher supply at higher prices and vice versa.

Again, in is important to assume that 'all other things remain constant'. Any change in one of the other determinants of supply will cause the curve to shift While it is fairly obvious why the demand curve is downward sloping, it is not so clear why the supply curve should be upward sloping. Basically, the producer will make higher profits as the price per unit sold increases.

The determinants (factors) of supply As with the demand curve, there are many things that affect supply as well as the price of the good in question. Notice how similar many of these factors are in comparison to the factors that affect demand. Notice also that nearly all of these factors affect the firms' costs. Given that the firms' supply curve is its marginal cost curve (see the 'costs and revenues' topic) then it is of no surprise that a cost changing measure will shift the supply curve.

Prices of other factors of production. An increase in the price of, say, hops, will increase the costs of a brewing firm and so for any given price the firm will not be able to brew as much beer. Hence, the firm's supply curve will shift to the left. The same would be true for changes in wage costs or fuel costs.

Technology.

The supply curve drawn above assumes a 'constant' state of technology. But as we know, there can be improvements in technology that tend to reduce firms' unit costs. These reduced costs mean that more can be produced at a given price, so the supply curve would shift to the right.

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Indirect taxes and subsidies.

When the chancellor announces an increase in petrol tax, it is the firm who actually pays the tax. Granted, we end up paying the tax indirectly when the price of petrol goes up, but the actual tax bill goes to the firm. This again, therefore, represents an increase in the cost to the firm and the supply curve will shift to the left. The opposite is true for subsidies as they are handouts by the government to firms. Now the firm can make more units of output at any given price, so the supply curve shifts to the right.

Labour productivity.

This is defined as the output per worker (or per man-hour). If labour productivity rises, then output per worker rises. If you assume that the workers have not been given a pay rise then the firm's unit costs must have fallen. Again, this will lead to a shift to the right of the supply curve.

Price expectations.

Just as consumers delay purchases if they think the price will fall in the future, firms will delay supply in they think prices will rise in the future. It's the same point but the other way round.

Entry and exit of firms to and from an industry.

If new entrants are attracted into an industry, perhaps because of high profit levels (much more on this in the topic 'Market structure'), then the supply in that industry will rise at all price levels and the supply curve will shift to the right. If firms leave the industry then the supply curve will shift to the left.

Interaction of supply and demand

Changes in Demand and Supply and Impacts on Equilibrium

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Demand Shifts In this graph, the demand curve (red) has been affected by an increase in demand.

This consequently increases price at a given volume.

KEY POINTS 

The interdependent relationship between the supply of a given product or service and the overall demand exercised by interested parties generates a theoretical equilibrium point, dictating the averagemarket price and purchased volume relative to that price.



Markets are in constant flux as demands and supplies are subjected to varying driving forces and influences. These shifts play a critical role altering market equilibrium price points and volumes for products and services.



Demand shifts can be caused by a wide variety of factors, but largely revolve around drivers of consumerbehavior and circumstances.



Supply shifts, similar to demand shifts, can ultimately be a result of a wide variety of externalities.Scarcity, or the overall availability of a particular material, is a core driving force for overall supply.



Due to the demand curve sloping downward and the supply curve sloping upwards, they inadvertently will cross at some given point on any supply/demand chart. This equilibrium serves as a price and quantity tracking point.

TERMS



Scarcity The condition of something being deficient; a shortage.



Equilibrium The condition of a system where competing forces are in balance.

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FIGURES

1. fig. 2

Supply Shifts In this supply and demand chart we see an increase in the supply provided, shifting quantity to the right and price down. More of a given product, assuming the same demand, will result in lower price points at the equilibrium.

Give us feedback on this content:

The interdependent relationship between the supply of a given product or service and the overall demand exercised by interested parties generates a theoretical equilibrium point, dictating the average market price and purchased volume relative to that price.

In a static market it would be reasonable to assume that prices and volumes would remain fairly predictable and consistent relative to the population, but realistic markets are not static. Instead, markets are in constant flux as demands and supplies are subjected to varying driving forces and influences. These shifts play a critical role in altering market equilibrium pricepoints and volumes for products and services, requiring constant vigilance and adaptation by providers and consumers. In understanding this further it is useful to examine how changes in supply and demand may occur, and what the impacts and implications are of these changes.

Demand Shifts Demand shifts are defined by more or less of a given product or service being required at a fixed price, resulting in a shift of both price and quantity. As would be assumed, an increase in demand will shift price upwards and volume to the right, increasing the overall value of both metrics relative to the prior equilibrium point (Figure 1).

Alternately, a decrease in demand will shift price downwards and volume to the left, decreasing both measurements to realign equilibrium with a reduced demand.

Demand shifts can be caused by a wide variety of factors, but largely revolve around drivers of consumer behavior and circumstances. Demand shifts can therefore often be affected by economic factors such as average spending power per person in a given 44 | P a g e

economy or overall average income. Demand can also be affected by cultural changes, demographic shifts, availability of substitutes, environmental factors and concerns (e.g. climate change), politics, and advances in science (e.g. declining demand for unhealthy foods). Demand is particularly malleable in respect to goods that are not necessities, thus are desired or not based upon sociological norms.

Supply Shifts Supply shifts are defined by more or less of a particular product/service being available to fulfill a given demand, affecting the equilibrium point by shifting the supply curve upwards or downwards. A supply shift to the right, indicating more availability of the specified product or service, will create a lower price point and a higher volume assuming a fixed demand (Figure 2). Alternately, a decrease in supply with a consistent given demand will see an increase in price and a decrease in quantity. This is an intuitive theory underlining the fact that scarcity is relevant to the willingness to pay.

Supply shifts, similar to demand shifts, can ultimately be a result of a wide variety of external factors. As discussed above, scarcity plays a critical role in pricing and thus controlling supply is often even considered a strategic play by companies in specific industries (most notably industries like precious stones, rare earth metals, etc.). Supply shifts can also be a result of technological advances, over-utilization or consumption, globalization, supply-chain efficiency, and economics. For example, the discovery of a new gold deposit, acts as a shock to the supply of gold, shifting the curve right.

Equilibrium In combining these two potential shifts, equilibrium is constantly subjected to both factors resulting in supply shifts and factors resulting in demand shifts. Due to the demand curve sloping downward and the supply curve sloping upwards, they inadvertently will cross at some given point on any supply/demand chart. This crosssection, or equilibrium, serves as a price and quantity tracking point based upon the consistent inputs of overall demand and supply availability. Any change in either factor will result in immediate impact on equilibrium, balancing the new demand or supply with a corresponding volume and appropriate average price point.

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Section 4: Finance

“Business, that's easily defined - it's other people's money�.

Peter Drucker

Sources of finance Why business needs finance Finance refers to sources of money for a business. Firms need finance to: Start up a business, eg pay for premises, new equipment and advertising.

Run the business, eg having enough cash to pay staff wages and suppliers on time.

Expand the business, eg having funds to pay for a new branch in a different city or country.

New businesses find it difficult to raise finance because they usually have just a few customers and many competitors. Lenders are put off by the risk that the start-up may fail. If that happens, the owners may be unable to repay borrowed money.

Some sources of finance are short term and must be paid back within a year. Other sources of finance are long term and can be paid back over many years.

Creditors and debtors A creditor is an individual or business that has lent funds to a business and is owed money. A debtor is an individual or business who has borrowed funds from a business and so owes it money.

There is a cost in borrowing funds. Money borrowed from creditors is paid back over time, usually with an additional payment of interest. Interest is the cost

of borrowing and the reward for lending.

A business owner's house could be used as collateral Creditors often ask for security before lending funds. This means sole traders and partners may have to offer their own house as a guarantee that monies will be repaid. A company can offer assets, eg offices as collateral.

The type of finance chosen depends on the type of business. Start ups and small firms are considered very high risk and find it difficult to 46 | P a g e

raise external finance. The only source of funds might be the owner's own savings, retained profits and borrowing from friends. Companies can issue extra shares to raise large amounts of capital in a rights issue.

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: 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.

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.

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.

External finance is generated from outside the business in a variety of ways: 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.

If you owe the bank $100 that's your problem. If you owe the bank $100 million, that's the bank's problem. J. Paul Getty 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 47 | P a g e

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.

Alternative Sources Venture capital is a very risky type of investment that entrepreneurs (called venture 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).

The overall objective in raising finance for a company is to avoid exposing the business to excessive high borrowings, but without unnecessarily diluting the share capital. This will ensure that the financial risk of the company is kept at an optimal level.

Business Angels: The most common excuse I hear from those who want to start a business but haven't had the courage is that they can't raise the money. In my opinion, any project worthy of support will always get the necessary backing in the end. Whether the economy is 48 | P a g e

up or down, the world is always awash with capital looking for exciting returns.

Fortunately, there have never been more doors on which to knock. Since the advent of professional venture capital in the 1940s, the ecosystem for backing entrepreneurs has grown to the point where the options are almost bewildering.

In the search for funding, don't believe that any source of funding will suffice so long as there's enough money on offer. Investors differ markedly, and entrepreneurs must familiarise themselves with the various breeds.

The best-known investors are venture capitalists (VCs), angel investors and private equity. They might seem to blur together at the edges of each category, since they live side-by-side on a fairly seamless continuum, but they all differ.

Some angel investors are so rich and so formal in their approach that they resemble VCs, while some VCs behave like nightclub DJs. You'll soon have a sense of which one is right for you, and if you don't, they'll soon put you straight – usually by not returning your calls.

Angel investors are wealthy individuals who punt their own money in fledgling companies, and their contribution is routinely understated.

A start-up entrepreneur is far more likely to get backing from an angel investor than from a venture capitalist, bank loan or government grant. That's partly because angels are more nimble and risk-positive than large institutions, and partly because they tend to make smaller investments, usually earlier on in a company's life.

Their money is easier to come by, and perhaps has slightly fewer strings attached. Backing risky undertakings is dangerous, but the availability of this type of finance is crucial since commercial banks want collateral and formal venture capital usually wants to back novel businesses in potentially huge markets. Don't ask a VC to help you open your first cafe.

Business angels focus less upon the financial rewards. They expect lower rates of return and do much less stringent due diligence. Angels are much easier-going about getting involved with other investors, too. They tend not to charge fees when

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they invest, and are more likely to inject pure cash rather than use complicated debtstyle instruments.

Angels make decisions much more quickly than VC firms, and are less concerned with a pre-planned exit than venture capitalists.

Business angels are the unsung heroes of the financial world, taking huge risks to get companies started and rolling their sleeves up to participate. Inevitably the angel ecosystem is far more developed in the US, with some estimates putting the number at 250,000 angels investing tens of billions of dollars a year in thousands of growing businesses.

Too many entrepreneurs think formal venture capital is the place to look for start-up funding, when in reality venture capitalists tend to focus on making very large bets in industries such as high technology and biotech. In short, VC money is probably not for you if you're just starting out. Operations in mainstream sectors such as retailing and restaurants almost invariably secure backing not from VCs but from angel investors, high-net-worth individuals or the founder's savings.

Funding start-ups and new technology is exceedingly risky, but it has enabled the development of many of the most important companies of the past 50 years, including Intel, FedEx and Google. Most are US based. That is where most of the world's true venture capital is managed.

The failure rate is high and the expertise needed in spotting and monitoring potential winners is immense. Finding and scrutinising the right ideas to back is hard work and takes talent and experience. And if such ambitious start-ups are to work, they usually benefit from the technical support and hands-on input from VC investors.

Turning to banks – how to describe the relationship between banks and the entrepreneur?

While it's true that many businesses are built on a bank loan, a high street bank is still a poor choice of capital for many – and it's because banks are naturally risk averse. The culture of angels and VCs is that they're in the business of risking money to make money, but banks are in the business of not losing money.

Banks like short odds, short timelines, and working with a safety net – such as your house.

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Sources of Finance: Activity Task: You will be given a variety of different business scenarios. You must decide what type of finance the business in question should go for and why. Of course, there could be more than one appropriate source of finance - you could decide on a combination but again, ensure that you explain why you have decided on this route.

The Cases: Case 1 A medium-sized engineering firm with an annual turnover of £2.5 million has decided to install a new piece of machinery to help improve its productivity. The equipment needs to be housed in a new building to be constructed on the site. The forecast cost of the building is £150,000 and the equipment £400,000.

Case 2 An individual has been made redundant after 20 years with a major organisation and has received a lump sum redundancy payment of £70,000. The individual is planning to set up a bookmakers and has identified a suitable premises valued at £180,000 near to a major town centre shopping precinct.

Case 3 A large plc is planning on moving a major part of its production facility to Cornwall. It has identified a site near a former chalk pit that is now not used. The estimated cost of the facility is £4.5 million.

Case 4 A local Do It Yourself (DIY) store has experienced problems with acquiring goods from its suppliers because it has been an erratic payer of its bills with them. The reasons it has experienced these problems is that it has contracts to supply building materials to a number of local firms all of whom only pay the bills for their orders every 3 months.

Case 5 A rugby club is anticipating turning fully professional after the team secured promotion to the Zurich premiership. To take its place in the league, the league committee have insisted that it also improves facilities at the ground. It has been estimated that the cost of these two measures will be £550,000.

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Case 6 A major UK plc is planning the takeover of a rival business. The move has been investigated by the Competition Commission and permission has been granted. The current share price of the rival firm is 260p and the firm has made an offer of 340p per share. The current market capitalisation of the target firm is £4.5 billion.

Case 7 A small partnership business has developed a new piece of software that would massively improve the efficiency of personnel management processes at large sized business organisations of all kinds. The software has massive potential but at present is not commercially viable because of lack of funds. The partners are contemplating their next move.

Case 8 A small newsagent in a rural village centre has decided to purchase a new freezer cabinet and oven/roasting unit to provide hot meals for village workers and for students at the secondary school which serves the surrounding area which is located half a mile from the village centre.

The cost of the units is £3,500.

Case 9 A large charity organisation has followed a consultancy programme on streamlining its records. The consultants have suggested investing into a software package that will provide a sophisticated database programme that will do all the things that the charity will require for the next 10 years. The cost of the software package is £65,000.

Case 10 Following the construction of a new housing estate on the outskirts of a major city, a group of 10 ambitious young professionals has decided to try to exploit the type of resident moving into the area by setting up a gym and health centre on earmarked land within the development. The building has been bought by the group for £800,000 but needs to be furnished and fitted out for the purpose intended. The cost of the bar, restaurant and gym facilities is estimated at £95,000 but the other major cost is the swimming pool, spa and sauna area. This could be utilised on a separate project to the fitness centre as the local council want to secure use for local school children and elderly residents - this being part of the purchase arrangements associated with the new housing development.

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Section 5: Measuring business performance Price The price level that a business decides to sell its product(s) at will affect both the quantity of sales and the profit-margin received per unit. There are many considerations that a business will need to take into account before it decides upon a selling price for a new product, such as: The objectives of the business if the main objective of the business is to maximise profit, then it is likely that the product will be priced at a high level.

The degree of competition in the industry the number of competitors in the industry will affect the price level that the business decides upon for its product(s).

The channels of distribution the more intermediaries that are used in getting the product from the factory to the consumer, then the higher the selling price is likely to be.

The business image if the image of the business is prestigious and up-market, then a higher price is likely to be charged for the product(s).

There are many methods and strategies that a business can use in order to arrive at a selling price for its products:

Cost-plus pricing. Cost-based pricing involves setting a price by adding a fixed amount or percentage to the cost of making or buying the product. In some ways this is quite an old-fashioned and somewhat discredited pricing strategy, although it is still widely used. After all, customers are not too bothered what it cost to make the product – they are interested in what value the product provides them.

The most common method of cost-based pricing is cost-plus (or “mark-up”) pricing. It is widely used in retailing, where the retailer wants to know with some certainty what the gross profit margin of each sale will be.

Here is an example of cost-plus pricing, where a business wishes to ensure that it makes an additional £50 of profit on top of the unit cost of production.

Unit cost: £100 Mark-up: 50% Selling price: £150 How high should the mark-up percentage be? That largely depends on the normal competitive practice in a market and also whether the resulting price is acceptable to customers.

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For example, in the UK a standard retail mark-up is 2.4 times the cost the retailer pays to its supplier (normally a wholesaler). So, if the wholesale cost of a product is £10 per unit, the retailer will look to sell it for 2.4x £10 = £24. This is equal to a total mark-up of £14 (i.e. the selling price of £24 less the bought cost of £10).

The main advantage of cost-based pricing is that selling prices are relatively easy to calculate. If the mark-up percentage is applied consistently across product ranges, then the business can also predict more reliably what the overall profit margin will be.

The main disadvantage is that cost-plus pricing may lead to products that are priced un-competitively. Another potential issue is that firms may experience changes in their production costs which are not then reflected in the selling prices offered, leading to lower profit margins.

Mark-up pricing. This is where the business adds a profit mark-up to the direct cost for each unit in order to arrive at the selling price. This profit mark-up will need to cover the fixed overheads and then contribute towards profit.

Predatory (or destroyer) pricing. This method of pricing involves a business setting its prices at such a low level that other (often smaller) competitors cannot compete profitably, and as a result they are forced out of the industry. This leaves the larger business in a dominant position, and it can then raise its prices to a much higher level in order to recoup any losses that they incurred when their prices were low.

Skimming pricing. This is a pricing strategy for a new product, designed to create an up-market, expensive image by setting the price at a very high level. It is a strategy often used for new, innovative or high-tech. products, or those which have high production costs which need recouping quickly.

A price skimming strategy focuses on maximizing profits by charging a high price for early adopters of a new product, then gradually lowering the price to attract thriftier consumers. For example, a cell phone company might launch a new product with an initial high price, capitalizing on some people’s willingness to pay a premium for cutting-edge technology. When sales to that group slow or competitors emerge, the company progressively lowers its price, skimming each layer of the market until the low price wins over even frugal buyers. ~ Stan Mack, Demand Media Apple has added a twist to the skimming strategy. Rather than introducing their products at a high price and then lowering their prices later, Apple stakes out a price

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and then maintains and defends that price by significantly increasing the value of their products in future iterations.

For example, over the past six years, the average sales price of the iPhone has remained remarkably stable with the subsidized price remaining at ~$200 and the unsubsidized price hovering around $650.

Advantages and Disadvantages Of Price Skimming Price skimming offers four major advantages…. It can offer insight into what consumers are willing to pay. It can create an aura of prestige around your product.

If the initial price is too high, you can lower it easily. Finally, late adopters might be pleased to get your prestigious product at a bargain price, which creates goodwill for your company. A major disadvantage, however, is that large profits attract competitors, so this price strategy only works well for businesses that have a significant competitive advantage, such as proprietary technology.

The argument against Apple’s price skimming strategy is that the competition has caught up with the iPhone and Apple is no longer able to compete unless they lower their prices. But do the facts support this argument?

In 2012, Apple garnered 69% of all mobile phone profits. Further, they did it with only 8% of the total market share. That means that the remaining 92% of the market provided only 31% of the sector’s total profits. That’s price skimming at its finest.

Conclusion The current meme is that Apple MUST abandon their skimming strategy and pursue a price penetration strategy instead. However, the facts simply do not support this contention. Apple could, of course, “buy” more market share simply by lowering their prices, but this has two major disadvantages. First, the market share that they would be buying is worth far less than the market share that they already own. Second, a lower price would lead to lower profits as well. It is obvious – or rather it SHOULD be obvious – that this could be counter-productive.

There’s nothing wrong with market share and I’m quite certain that Apple would be more than happy to expand their market share – but not at any price. For example, Apple has some 70% market share in iPods and around 50% market share in iPads.

Yet they are doing this while still maintaining their price skimming strategy.

Penetration pricing. This is a pricing strategy for a new product, designed to undercut existing competitors and discourage potential new rivals from entering the market. The price of the product is set at a low level in order to build up a large market share and a high degree of brand loyalty. The price may be raised over time, as the product builds up a strong brand-loyalty.

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Penetration pricing is commonly used by utilities, especially phone and cable or satellite services, although it is sometimes found in competitive gas and electricity markets as well. Many home phone, cellphone, cable and satellite providers offer a discounted rate for a period of time, such as your first six months of service, to get you to switch to their service. After your discount period has ended, the price increases significantly, but the company hopes you have become used to its service and won't go through the trouble to change to a different company.

Discount Stores Discount stores such as Wal-Mart use penetration pricing in two ways. First, they offer new products through their stores at prices much lower than other stores, hoping that you will buy more than that one product once you come in the store.

They are willing to lose money on the new product as a way to get more customers through the door. Also, they use penetration pricing in new geographic markets by underselling their more well-established competitors. Once they have a loyal customer base, they can begin to gradually increase prices.

Wholesale Penetration pricing isn't unique to the retail market. Wholesale distributors also use this technique to break into new markets. For example, a tool manufacturer may want to grow its customer base, so it offers extremely low wholesale prices to hardware stores to carry its products for a certain length of time. The hardware stores can sell the tools at a considerable profit during that time and use that time to determine whether the tools are a good value for their customers. After the discount period has ended, the wholesaler can begin negotiating a higher wholesale price with its now-loyal retailers.

Hook and Bait A variation of penetration pricing is the hook-and-bait strategy. Razor and printer manufacturers are notorious for using this technique. They sell the main product -the razor or printer -- at a very low price, encouraging a large market share. They then sell razor refills or replacement ink at prices that are sometimes higher than those of the main products.

Pros and Cons Penetration pricing takes advantage of word-of-mouth advertising, allowing satisfied customers to spread the word about how the product is a good deal prior to raising the prices. It can discourage new competitors, who likely can't make enough money selling their product at such a low price. However, to succeed with penetration pricing, a company must have enough capital to stay in business until the price can be increased; the initial low prices likely don't include much or any profit for the company. The company must also be prepared to offer future discounts, such as coupons, to retain the loyalty of customers more willing to switch brands than pay higher prices.

Prestige pricing. Premium pricing (also called image pricing or prestige pricing) is the practice of keeping the price of a product or service artificially high in 57 | P a g e

order to encourage favorable perceptions among buyers, based solely on the price.The practice is intended to exploit the (not necessarily justifiable) tendency for buyers to assume that expensive items enjoy an exceptional reputation or represent exceptional quality and distinction. A premium pricing strategy involves setting the price of a product higher than similar products. This strategy is sometimes also called skim pricing because it is an attempt to “skim the cream” off the top of the market. It is used to maximize profit in areas where customers are happy to pay more, where there are no substitutes for the product, where there are barriers to entering the market or when the seller cannot save on costs by producing at a high volume.

Luxury has a psychological association with premium pricing. The implication for marketing is that consumers are willing to pay more for certain goods and not for others. To the marketer, it means creating a brand equity or value for which the consumer is willing to pay extra. Marketers view luxury as the main factor differentiating a brand in a product category.

Demand-orientated pricing. This method of pricing involves setting the price of the product at a level based upon customers' perceptions of the quality and value of the product. method of establishing the price for a product or service based on the level of demand; also called demandbased pricing. For example, sellers of compact discs charge a higher price for recordings that appeal to a broad market, such as those of Garth Brooks or Madonna, than they charge for recordings of classical music. The manufacturing cost of the product and the required gross profit margin are of secondary importance to demand in setting the price.

Competition-orientated pricing. This method of pricing ignores both the costs of production and the level of customer demand. Instead it bases the price level on the prices charged by the competitors in the industry -either undercutting the competitors, charging a higher price, or charging the same price. 'Going rate' pricing is the term used to describe a business charging a similar price to competitors for a similar product.

Psychological pricing is a pricing tactic that is designed to appeal to customers who use emotional rather than rational responses to pricing messages.

Sometimes prices are set at what seem to be unusual price points. For example, why are DVD’s priced at £12.99 or £14.99? The answer is the perceived price barriers that customers may have. They will buy something for £9.99, but think that £10 is a little too much. So a price that is one pence lower can make the difference between closing the sale, or not!

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The aim of psychological pricing is to make the customer believe the product is cheaper than it really is. Pricing in this way is intended to attract customers who are looking for “value”.

For example, a new car might be priced at £12,995 rather than at £13,000. A rational customer would know that the price difference of £5 is tiny for such a high value item as a new car. However, customers don’t necessarily behave rationally. Some may look at that price and “round it down” to £12,000, making the perceived difference more significant!

The main advantage of psychological pricing is that it allows a business to influence the way that customers view a product without the need to actually change the product.

For each of the scenarios below, recommend one pricing strategy.

1. A company providing broadband Internet access wants to target many different types of users (e.g. business, home, off-peak)

2. A luxury limo service wants to offer clients an exclusive service where all their needs are catered for in a professional manner

3. A new sparkling lemon drink is being launched into the already highly competitive fizzy drinks market

4. A business producing an anti-ageing wrinkle cream wants to position it’s product so customers believe it to be of better quality that it’s nearest rivals

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5. A well established manufacturer of washing powder wants to increase its sales and gain more customers

6. A small toy manufacturer has started producing a new line and wants to ensure that the price it is charging will cover all overheads in addition to delivering a certain level of profit

7. A company providing a party organising service for a select group of wealthy clients

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Sales Revenue Revenue is the income earned by a business over a period of time, eg one month.

The amount of revenue earned depends on two things - the number of items sold and their selling price. In short, revenue = price x quantity.

For example, the total revenue raised by selling 2,000 items priced £30 each is 2,000 x £30 = £60,000.

Revenue is sometimes called sales, sales revenue, total revenue or turnover.

Costs Variable and Total Costs Generally speaking, a business will incur two types of cost when it produces goods and provides services to consumers: Fixed costs & Variable costs.

A fixed cost is one which is totally independent of the level of output, and it would be incurred even when output was zero. Examples include rent, mortgage payments, managers' salaries, and loan repayments. They are often referred to as overheads.

Total fixed costs (TFC) Variable costs are those which vary directly with output (i.e. as the level of output increases, then variable costs increase). Examples include raw materials, production wages, other direct production costs, and utility bills.

Total variable costs (TVC) When fixed costs are added to variable costs, then the total costs (TC) of the business can be calculated.

In other words, TFC + TVC = TC. This helps the business to calculate its total costs at any given level of output.

Total costs Note that TC starts at the same point as TFC. Average costs (AC) are calculated by dividing total costs by the level of output.

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In other words:

Average costs It is clear to see that average costs will also start to decline over time. When this occurs in the long-run, then the business is said to have achieved economies of scale.

However, the business is likely to reach a level of output where average costs (the cost per unit) will start to rise again. In these circumstances, the business is said to be experiencing diseconomies of scale.

When average fixed costs are added to average variable costs, then the average total costs (AC) of the business can be calculated.

In other words: AFC + AVC = AC This helps the business to calculate its average cost at any given level of output.

Profit and Loss Put simply, profit is the surplus left from revenue after paying all costs. Profit is found by deducting total costs from revenue. In short: profit = total revenue - total costs.

For example, if a firm has a total revenue of £100,000 and a total cost of £80,000, then they are left with £20,000 profit.

Profit is the reward for risk-taking. A business can use profit to either:   

Reward owners.

Invest in growth.

Save for the future, in case there is a downturn in revenue.

Losses Trading does not guarantee profit. A loss is made when the revenue from sales is not enough to cover all the costs of production. For example, if a company has a total revenue of £60,000 and a total cost of £90,000, then they have lost £30,000 from trading.

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 

Cutting costs, eg by letting staff go and asking those who remain to accept lower wages.

Increasing revenue, eg by cutting prices and selling more items - if demand is elastic.

Exercises Kamal wants to start a new business. Electric Taxis would be a cab service with a green tinge. It would only use electric or hybrid cars. It started in his home town of Norwich in July 2009, and quickly became a hit.

In the first week of September the business had revenue of £3,600.

The 400 customers generated variable costs of £3 per person, and the business had weekly fixed costs amounting to £2,000.

3a) Calculate the profit in the first week of September.

(4)

Nb – revenue = price x quantity

3b) Kamal has been warned to expect that customer numbers will decrease by 50% in January/February. What weekly profit or loss is that likely to leave him with? (6)

3c) Identify 1 variable cost and 1 fixed cost he could have.

(2)

3d) Examine 2 ways in which Kamal could prepare the business for the disappointing January/February period.

(6)

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Start-Up Business Numbers 1. Two business students plan to start a coffee shop. They list all the costs the business will face: a) Coffee-making machinery

e) Coffee, tea and hot chocolate mix

i) Royalty payments (on store audio soundtrack)

b) Refrigerators

f) Milk, flavourings, sugar

j) Tables and chairs

c) Cups, saucers, mugs, metal teaspoons, spoons and forks

g) Cash tills; audio sound system

k) Building work and decoration

d) Paper cups, lids, plastic h) CCTV cameras and spoons monitors

l) Weekly rent

Organise these 12 items into three types: 1. one-off, start-up costs; 2. fixed operating costs; 3. variable operating costs.

2. Monica wanted to open Good Looks in 8 weeks’ time. It would start with just one product: a Good Night package including nails, hair and make-up. It would take an average of 2 hours, use about £4 of materials and she planned to charge £40. With staff paid £6 an hour and weekly fixed costs of £720, she felt confident that a good profit could be made. She estimated that – at the start – Good Looks would sell 70 of these packages per week.

2a) Calculate the weekly revenue Monica is forecasting at the start of this business.

(3) 2b) Calculate the total costs she will have to face if 70 packages are sold.

(4)

2c) Calculate the weekly profit at Good Looks.

(3)

2d) Explain how Monica might have made her estimate of sales.

(6)

2e) Monica hopes that, in a year’s time, sales will double. Calculate the new level of profit.

(6)

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Contribution Analysis Contribution is the term given to the amount of money that remains after all direct and variable costs have been deducted from the sales revenue of the business.

It is called 'contribution' because it represents the amount of money which is available to contribute towards covering the fixed costs of the business and, once these are covered, it represents the amount of money which will contribute towards the profit of the business. In other words, contribution - fixed costs = profit.

Contribution can be analysed in two ways: Contribution per unit sold Contribution per unit sold = Sales price per unit - Variable costs per unit.

For example, if a product has a selling price of £ 10, and its variable costs (labour, raw materials, etc) is £ 3 per unit, then it has a contribution of £ 7 per unit.

If a product is loss-making, but it nevertheless makes a contribution towards covering the fixed costs of a business, then it would be unwise to delete the product from the product portfolio. This is because the total profit of the business will actually decrease if the contribution from the loss-making product is no longer received.

Therefore it is vital that a loss-making product is not deleted simply because it fails to produce a profit - if it produces a contribution towards fixed costs, then it is still worthwhile to produce it.

Total contribution Total contribution = Total sales revenue - Total direct and variable costs.

For example, if a business has total sales revenue of £ 4 million, and its total variable and direct costs are £ 2.5 million, then the total contribution for the business is £ 1.5 million. This contribution will hopefully cover the fixed costs and then contribute towards profit.

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Break-Even Charts This is a graph showing the total revenue and the total costs of a business at various levels of output. It is a form of Management Accounting and it enables a manager to see the expected profit or loss that a product will face at different levels of output.

The break-even point is the point on a break-even chart where the total revenue (T.R) of a business (or product) is equal to its total cost (T.C).

It can also be calculated mathematically by using the following formula:

For example: A business produces just one product, which it sells for £ 9 per unit. The variable cost of each unit is £ 4 and the business faces fixed costs per year of £ 1 million.

The business currently produces and sells 500,000 units.

What is the break-even level of output and what profit will the business make if it sells all of its output?

In order to assist the drawing of the break-even chart, we can calculate the breakeven level of output and the amount of profit using simple formulae:

In other words, the business will need to produce 200,000 units before it breakseven.

Any level of output below 200,000 will yield a loss.

Any level of output above 200,000 will yield a profit.

The profit is equal to total revenue minus total cost (or profit = TR - TC).

Total revenue (TR) is calculated by multiplying the selling price by the number of units sold.

In this example, the selling price is £ 9 and the number of units sold is 500,000.

Therefore the total revenue (TR) is £ 9 x 500,000 = £ 4.5 million.

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The total cost (TC) is calculated by adding together the total fixed costs (TFC) to the total variable costs (TVC).

In this example, the fixed costs are £ 1 million and the total variable costs are £ 4 x 500,000 units = £ 2 million.

Therefore the total cost (TC) is £ 3 million.

The profit is, therefore, TR - TC, which gives us: £ 4.5 million - £ 3million = £ 1.5million.

We can now draw a break-even chart and check the figures on the chart with the answers above.

In order to have an accurate break-even chart, three lines must be plotted: Total Fixed Costs (TFC), Total Costs (TC) Total Revenue (TR).

The x-axis is labelled as 'Output' (in units). In this example, the axis will go up to 500,000 units.

The y-axis is labelled as 'Costs, Revenue and Profit' (in £ ). In this example, the axis will go up to £ 4.5 million.

As you can see, the answers on the chart correlate with the answers calculated using the two formulae above. The break-even point (shown as a red dot) is the point where the TC and the TR lines cross. This is then measured by dropping a vertical red line down to the x-axis, to give 200,000 units.

The profit at 500,000 units is then calculated by taking a red vertical line up from the 500,000 unit mark to where it hits the TC line. This is then measured across to the y-axis (again using a red line) to give us total costs of £ 3 million.

The vertical red- line from the 500,000 unit mark is then extended to where it hits the TR line. Again, this is then measured across to the y-axis to give us a total revenue of £ 4.5 million.

Therefore, the profit is the difference between TR and TC (i.e. £ 1.5 million).

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Although break-even analysis is a very useful tool, it does have several drawbacks: 1. It assumes that the TFC, the TC and the TR functions are linear. In reality, this is very unlikely.

2. It assumes that the selling price is constant, in reality the selling price is likely to vary from customer to customer and region to region.

3. It assumes that the business only produces one product.

4. It assumes that the business can sell all of its output. In reality, very few businesses will be able to do this and some will remain as unsold stock.

5. The data used to construct the break-even chart may well be out-of-date and therefore inaccurate.

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There is a quick way of calculating Break Even: Fixed Cost/ Selling Price-Variable Cost The bottom part of that calculation (Selling Price-Variable Cost) is often called Contribution ... or more properly “Contribution to Fixed Costs and Profit” Use the Break Even Formula to give the break-even point for the following

Fixed Cost per week = £5,000 Variable Cost each = £ 5 Selling Price each = £ 25

Fixed Cost per week = £250 Variable Cost each = £ 25 Selling Price each = £ 37.50

Fixed Cost per week = £10,000 Variable Cost each = £ 50 Selling Price each = £ 75

Fixed Cost per week = £20,000 Variable Cost each = £ 5 Selling Price each = £ 9

Fixed Cost per week = £100 Variable Cost each = £ 5 Selling Price each = £ 10

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Fixed Cost per week = £200 Variable Cost each = £ 3 Selling Price each = £ 7

Fixed Cost per week = £3000 Variable Cost each = £ 6 Selling Price each = £ 10

Break Even Analysis Fixed Cost

700 600

Variable Cost

500 400

£'s

Total Cost

300

Total Revenue

200

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100

90

80

70

60

50

40

30

20

0

0 Output

10

100

Draw up one for yourself where: Fixed Costs are £100 per week, Variable Costs are £3 and Selling Price is £5.

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Break Even has its limitations.

It assumes that the firm can sell any quantity of the product at the current price. In practice the firm may need to reduce prices to sell at high levels of output.

It assumes fixed costs never change - but as output increases the firm may need to buy more machines, get bigger premises, take on extra sales and administration staff.

It assumes that all products are sold. This doesn’t always happen; some products may only be sold at lower prices or need to be thrown away.

Margin of Safety.

This is the difference between the actual level of production and the break even point.

For example: If the break even point of product Alpha is 400 Alphas and the output is 700 Alphas then the margin of safety is: 700 - 400 = 300 Alphas.

Product

Actual Output

Break-Even Output

Beta

1000

500

Gamma

5000

3000

Delta

350

200

Epsilon

150

80

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Margin of Safety

Profit and Loss Account The profit and loss account is a financial statement which represents the revenue that the business has received over a given period of time, and the corresponding expenses which have been paid.

It also shows the profit that the business has made over a period of time (usually 12 months) and the uses to which the profits have been put.

Revenue Revenue is the inflow of money to the business in the course of the ordinary activities of the enterprise.

There are a number of different sources of revenue; cash sales credit sales (i.e. where the business has sold goods to customers, but has not yet received the cash) interest royalties dividends that the business receives on its investments or fees for hiring-out the resources of the business to a third party.

Revenue is recognised at either the receipt of the cash OR at the point of sale (if the goods are sold on credit).

Expenses Expenses are expired costs (i.e. costs from which all benefits have been extracted during an accounting period). Examples include wages, raw materials, and utility bills -often known as revenue expenditure.

It must be remembered that expenses are not necessarily the same as costs.

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For example, if a business purchases a new fixed asset (such as a machine) then it will clearly incur the monetary cost of purchasing the machine (say ÂŁ50,000).

However, this ÂŁ50,000 will not be written-off as an expense, since the benefits from the machine will last for more than a single accounting period (i.e. for more than 12 months). Instead of writing-off the total cost of the machine, a portion of the ÂŁ50,000 will be written-off as an expense each year over the useful life of the machine -this is known as a 'depreciation charge'.

The first line gives the Sales Revenue for the business from selling its goods and services.

From this, we deduct the "Cost of goods sold" (costs directly associated with the production of the goods and services - such as the cost of the raw materials, the labour charges associated with the production, and the production overheads. These are sometimes referred to as direct materials, direct labour and direct overheads).

Sales revenue less C.o.G.S. is known as Gross profit.

However, we have not yet accounted for selling and administrative expenses (such as advertising costs, distribution costs, salaries, utility bills, etc.).

When these are deducted from the Gross Profit, the result is known as trading or operating profit. These refer to the profit made from normal trading activities.

The next adjustment is to add on any income from other activities, known as nonoperating income (e.g. renting out premises). The resulting figure is known as profit before interest and tax.

We then deduct a figure for interest charges. The resulting figure is known as profit before tax or net profit.

The final part of the account is known as the appropriation account. It provides information on the way in which the profit is dispersed.

Some is taken in corporation tax and goes to the Inland Revenue, some is drawn from the business as dividends to be distributed to the shareholders and the remainder is retained within the business for re-investment.

A trading, profit and loss account shows the business's financial performance over a given time period, eg one year.

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Sample trading, profit and loss account Sales revenue

£80,000

Less costs of sales

£50,000

Gross profit

£30,000

Less other expenses £20,000 Net profit

The trading account shows the business has made a gross profit of £30,000 before taking into account other expenses such as overheads.

The profit and loss account shows a net profit of £10,000 has been made.

£10,000 The trading account shows the business has made a gross profit of £30,000 before taking into account other expenses such as overheads.

The profit and loss account shows a net profit of £10,000 has been made.

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Ratio Analysis Ratio analysis is an accounting tool, which can be used to measure the solvency, the profitability, and the overall financial strength of a business, by analysing its financial accounts (specifically the balance sheet and the profit and loss account).

Accounting ratios are very easy to calculate and they enable a business to highlight which areas of its finances are weak and therefore require immediate attention.

There are two main ratios that can be used to measure the profitability of a business: 1. The gross profit margin.

2. The net/operating profit margin.

The gross profit margin This measures the gross profit of the business as a proportion of the sales revenue.

It is calculated using the following formula:

For example, if a business has gross profit of £4 million and sales revenue of £6 million, then the gross profit margin would be:

This means that for every £1 of sales revenue, £0.67 remains after all direct expenses have been deducted. This money then contributes towards covering the other expenses of the business.

The business would want this margin to be as high as possible, since a high margin will leave more profit for covering the remaining expenses and, if the business is a 'company', for covering the dividend payments to shareholders.

The net/operating profit margin This measures the net profit of the business as a proportion of the sales revenue. It is calculated using the following formula:

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For example, if a business has gross profit of £1 million and sales revenue of £6 million, then the net profit margin would be:

This means that for every £1 of sales revenue, 16.7 pence remains after all direct and indirect expenses have been deducted. This money then contributes towards covering the corporation tax that must be paid on profits to the Inland Revenue and, if the business is a 'company', covering the dividend payments to shareholders.

Any profit which remains is kept in the business for re-investment and is called 'retained profit'. Again, the business would want this margin to be as high as possible, allowing both large dividend payments to shareholders and a significant amount of profit to be retained for growth.

“If all the economists were laid end to end, they'd never reach

a conclusion”.

George Bernard Shaw

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Improving profit margins Mars bars shrink in size The size of Mars and Snickers chocolate bars has been shrunk by more than 7 per cent as the company tries to cut costs.

A Mars bar While the best-selling treats have been reduced from 62.5g to 58g, their prices have remained the same.

The change happened in the second half of last year and the downsized versions are now on sale in the shops, where a Mars bar still costs 37p and a Snickers is 41p.

Mars UK claimed the switch to smaller sizes was designed to help tackle the nation's obesity crisis.

However, the move was not advertised despite claims it was for a public health initiative.

The reduced Mars contains just 19 fewer calories at 261, while the Snickers has 23 fewer at 296.

Mars UK has now confirmed that the change was triggered by rising costs, according to the Daily Mail.

"Like all food manufacturers, we have seen continued cost increases over the last few years," it said in a statement.

"We look to absorb the vast majority of these costs by being more efficient, but on occasion we have to consider increasing prices.

"By slightly reducing portion sizes on Mars and Snickers we were able to continue to responsibly meet consumer demands for healthier lifestyles whilst not increasing our prices."

Consumer Focus, the customer body set up by the Government, is concerned that firms are attempting to fool consumers.

"Shrinking the size of chocolate bars should be part of a drive to combat obesity.

However, shrinking size but not price could damage consumers' trust in the brands they love," said its policy expert Lucy Yates.

Mars UK's sister operator in Australia is shrinking the size of 90 products while keeping prices the same.

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The change there has been handled very differently by being presented in a major advertising campaign as a public health measure.

The tactic of cutting product sizes, known as the Grocery Shrink Ray in America, is a tactic being used by many British companies.

There are a number of ways a firm can improve its profit margins: 1.

2.

3.

4.

5.

6.

Reduce the number of special offers.

Buy cheaper raw materials Stock a wider range of products Increase prices Reduce wastage Stock more seasonal items.

What are the effects of each of these on the profit and loss account?

What could be the consequences?

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Cash Flow Forecast Cash Flows Cash is the most liquid of all the assets of a business -it represents the bank balance and the cash that the business has available on the premises (otherwise known as 'petty cash').

Cash flow refers to the difference between the cash flowing into the business (e.g. through sales revenue) and the cash flowing out of the business (e.g. bills and wages).

Cash flow problems Having a positive cash flow is vital for the survival of a business, since without the ability to pay workers and suppliers then the business will soon have to cease trading.

This potential problem is compounded by the fact that businesses often have to pay many expenses several weeks or even months before any cash actually flows into the business.

For example, wages and salaries will have to be paid to employees, suppliers will have to be paid for any raw materials, and the rent or mortgage payments will have to be paid before the products can be manufactured and sold to customers.

Further to this point, if the products are sold on credit to customers, then the time delay between the cash outflows and the cash inflows will be even longer.

The major causes of cash flow crises for a business are: 1. Overtrading -where the business attempts to expand too rapidly, without a sufficient financial base.

2. Having too much money invested in stocks.

3. Allowing too much credit to their customers.

4. Unexpected changes in demand for their products.

5. Over-borrowing -therefore having large monthly loan repayments, which have to be met.

There are many actions that a business can take when it is experiencing a liquidity crisis: 1. Offering price discounts to boost sales and sales revenue.

2. Selling off fixed assets.

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3. A 'sale and lease back' arrangement.

4. Chasing debtors for the monies owed to the business.

5. Selling off stocks.

Whatever action is decided upon, the business must ensure that it is implemented quickly and that a careful eye is kept on the liquidity (cash flow) position in the future.

Cash-flow statement A cash flow statement is a Financial Accounting document, which shows the cash inflows and the cash outflows for a business over the past 12 months.

It indicates those months in which the business suffered a cash flow crisis (where cash outflows were greater than cash inflows) and it will also highlight those months in which the business was cash-rich (i.e. more cash inflows than cash outflows).

It allows a business to prepare a cash flow forecast for the forthcoming year, by basing the estimated cash inflows and outflows on the results from the previous year.

Cash-flow forecast A cash flow forecast is a Management Accounting document, which outlines the forecasted future cash inflows (from sales) and the outflows (raw materials, wages, etc) per month for a business over an accounting period.

The business forecasts that in January it will experience cash inflows of £1,100 and cash outflows of £700, leaving a positive net monthly cash flow of £400.

This is added to the £200 bank balance which existed at the end of December, to give a forecasted bank balance at the end of January of £600.

In February, the forecasted cash inflows are only £100 more than the forecasted outflows, leaving a bank balance of £700.

However, in the months of March and April, the business is forecast to experience negative net monthly cash flows (i.e. its cash outflows are forecast to be greater than its cash inflows).

This gradually reduces the bank balance to just £300 by the end of April.

It is important for a business to produce a cash flow forecast, so that it can prepare for those months in which it is forecast to experience a cash flow crisis (i.e. the business needs to arrange extra borrowing or overdraft facilities to provide extra cash).

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Alternatively, in the months where the business is forecast to be cash-rich, it can use this money profitably elsewhere within the business (e.g. new product development).

Example cash flow: £000’s Cash Inflows Sales Cash Outflows Materials Wages Marketing Loan Interest Total Net Cash Flow Opening Balance Closing Balance

.

Feb

Mar

15

25

28

8 2 5 1 6 22 0 (7)

4 2 3 1 10 15 (7) 8

4 3 3 1 11 17 8 25

Problems with cash flow forecasts 

Changes in the Economy Changing spending patterns might affect demand for your goods and services.



Changing Tastes and Fashions Businesses in technology and fashion markets need to be especially aware of changes to consumer buying behaviour and react fast.



Inaccurate Market Research Given the likely inexperience of the new business owner, they might not ask the right questions or the right people!



The Actions of Competitors Competitors will not stand back and allow you to take some of their market share.

Have you anticipated this in your figures?

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KEY TERM(S) Cash Flow Forecast The expected inflows and outflows of cash from a business over a given period of time.

Cash Flow Statement The actual record of cash inflows and outflows from a business over a given period of time.

Liquidity A measurement of the ability of a business to transform assets into cash.

Cash Flow Surplus A situation in which a business has more cash flowing into than flowing out.

Cash Flow Deficit A situation in which a business has more cash flowing out than flowing in. This can create a problem if it were to continue over a period of time.

Cash Inflow Receipts of cash flowing into a business e.g. from sales, payments made by debtors and asset sales.

Cash Outflow Payments of cash out of a business e.g. wages and salaries, rent charges, purchases of stock etc.

Cash Flow Cycle The regular patter of inflows and outflows of cash within a business.

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Section 6: The wider business environment

Impact on businesses of government policy

Why is tax very important to government?

What different types of tax are there?

How does tax affect business?

Positively:

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Negatively:

How does government spend our money?

In Spain, who is the country´s largest employer?

Give examples:

How can this affect business?

Positively

Negatively

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What are interest rates?

Why are they important to government?

Who decides them?

What affect would an increase in interest rates have on a business?

(2 areas: think demand and loans)

Summary

Government Policy: Increase in taxation or reduction in spending will have a negative effect on business. Both with affect consumers income and therefore lead to a reduction in demand for products and services.

Government Legislation: Laws implemented to protect business and employees can have a negative and positive effect. The negative effect will be the costs associated with implementing them. Having to pay for minimum wage, maternity/paternity/sick leave, maintaining health and safety standards at work all may motivate the employees leading to improved productivity.

Government support:

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Governments through spending can help support business by providing tax incentives to help companies move to certain areas, provide subsidies to assist in the production of certain crops (for example) and give loans, advice and financial support to new business. Reduction in government spending will therefore have a negative effect!

Government Protection of business: There are a variety of methods governments provide to protect business products/services. These include patents, copyrights and trademarks which can protect the design, process or the rights of products.

Consumer Protection legislation: The government has passed many pieces of legislation with the aim to ensure that consumers are protected from the negative aspects of the operations of the business.

Examples are: Sale of goods Act which states that good must be of merchantable quality as described in their advertisements and “fit for their purpose�.

Also legislation to ensure the contents of a product are clearly labelled, identifying calorific content, safety concerns, alcohol content.

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Summary

Unemployment: Unemployment is generally negative for business as people who have less/little income affects the demand for products and services. But demand for cheaper products may increase However, high unemployment may provide business with the opportunity of being able to select from a wider potential workforce, forcing salaries down and making it easier to hire and fire employees.

Exchange Rates: The price of one currency expressed in terms of another eg dollars and euros.

If a currency appreciates (increases) in value then this leads to imports becoming cheaper and exports more expensive. If a currency depreciates (decreases) in value, then exports become more expensive and imports become cheaper.

Example: You have 100 euros and you want to go to Britain. At the moment this is worth ÂŁ75. If the euro increases in value and therefore the pound decreases, your 100 euros will now be worth ÂŁ80!(better for you) This can have significant effects on business if they are importing/exporting products and materials!

Inflation: The is the general increase in the price of goods and services. In 2000, a coca cola cost 30 cents. In 2013 it costs 50 cents. Why .. the price of materials, demand, objectives of the company have combined to increase the price of the product.

Inflation has generally a negative effect for business. Money loses its vale, costs increase, difficult to estimate the future, uncertainty over interest rates, can lead ti unemployment, leads to lack of investment.

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Summary

Digital Economy: Use of the Internet has provided many threats and opportunities for business. People like e-commerce to buy/sell on the Internet; this can reduce costs for a business, less shops, employees. Can make the service available 24 hrs a day, however more competition, technical know-how, expertise required, flexible workforce.

Can open/operate from cheaper countries. Open up a global market!

Ethical Considerations: Good PR from being “green”, bad publicity if not!. Can be a competitive advantage in using recycled materials, allows for adding value (increased prices),However can increase costs, higher salaries (less exploitation), more expensive materials. More expensive suppliers!

Environmental Considerations: Looking to reduce climate change; new technologies, less pollution, recycling – move to the “circular economy” ; less fossil fuels more renewable energy sources, provide opportunities and threats to a business. Costs associated may be higher especially in infant industries, not yet fully accepted, suspicion from consumers, too expensive, however (as per ethical considerations – good PR) competitive advantages, opportunities for new markets.

Demographics Change: In western Europe/usa we are becoming older, less young people in the future; opportunities and threats depending upon your market/consumers. Move to the Asian markets.

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Protecting Business Ideas http://www.ipo.gov.uk/types/tm.htm Intellectual property Patents Copyright Trademarks http://www.bbc.co.uk/news/technology-17040699 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.

Trademarks A trade mark is a sign which can distinguish your goods and services from those of your competitors (you may refer to your trade mark as your "brand"). It can be for example words, logos or a combination of both. The only way to register your trade mark is to apply to us - The Intellectual Property Office.

You can use your trade mark as a marketing tool so that customers can recognise your products or services.

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Trade marks are acceptable if they are: distinctive for the goods and services you provide. In other words they can be recognised as signs that differentiates your goods or service as different from someone else's.

You may be familiar with the trade marks below. They don't describe the goods or services, which is why they are good examples of registrable trade marks.

Trade marks are not registrable if they: describe your goods or services or any characteristics of them, for example, marks which show the quality, quantity, purpose, value or geographical origin of your goods or services; have become customary in your line of trade; are not distinctive; are three dimensional shapes, if the shape is typical of the goods you are interested in (or part of them), has a function or adds value to the goods; are specially protected emblems; are offensive; are against the law, for example, promoting illegal drugs; or; are deceptive. There should be nothing in the mark which would lead the public to think that your goods and services have a quality which they do not.

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Acceptable and unacceptable trade marks Trade mark

Why is it acceptable

FARNOOZ

This is an invented word, arguably the most distinctive of all trade marks

emarno WINDOWS

This trade mark includes the invented word "emarno". Although the word "windows" is totally descriptive of goods and services relating to windows the word "emarno" is totally distinctive and this results in an acceptable trade mark

Danryvol

Another invented word

Herringbone Finance

Although this mark consists of two well known words the word "Herringbone" is acceptable for financial services. However, the word "Herringbone" would not be acceptable for e.g. textiles because it is a type of pattern.

Trade mark

Why is it unacceptable

7 days a week

These days many traders advertise that their goods or services are available seven days a week

Tasty food

If you are trading in food, these two words simply describe a quality of your goods. Joining the two words together does not make the mark as a whole acceptable

TOYS direct

The word "direct" describes goods or services sold directly to the public and it is widely used by traders.

The one for you

Slogans such as this are often used in trade and are not distinctive

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Government protection legislation

Consumer Protection Legislation Objectives: Why? Costs, Dealing with complaints, Benefits of customer service

Consumer Protection The government has passed many pieces of legislation over the past 40 years which aim to ensure that consumers are protected from the negative aspects of the operations of businesses.

The main pieces of legislation aimed at protecting consumers in the UK are: 1. The Trade Descriptions Act, 1968: This makes it illegal for a business to provide false or misleading descriptions of their products, services, accommodation and facilities.

2. The Unsolicited Goods Act, 1971: This stated that unsolicited goods become the property of the recipient if the sender does not retrieve them from the recipient within 30 days of notice.

3. The Consumer Credit Act, 1974: This states that any business which offers credit facilities must obtain a licence from the Director-General of Fair Trading and must also display the annual percentage rate (A.P.R) that will be charged.

4. The Sale of Goods Act, 1979: This states that goods must be of merchantable quality, as described in their advertisements and fit for their purpose.

5. The Consumer Protection Act, 1987: This states that it is an offence for a business to give a false or misleading price indication on its product(s) AND businesses are liable for any damage and injury that their defective products cause to consumers.

6. The Food Safety Act, 1990: This states that it is an offence for a business to sell food if it is not registered to do so and also if those handling the food have not been appropriately trained. It also states that the food must be of the expected nature and quality that is demanded by the consumer.

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Economic influences How are businesses affected by unemployment?

Businesses are affected in a variety of ways depending on whether unemployment is high or low, and rising or falling.

Some business implications of rising / high unemployment include: • Lower consumer spending = lower demand for income-elastic products • Demand for inferior goods (lower price, quality) may increase • Greater supply of labour – potentially lower wage/salary levels • Unemployment creates insecurity in the workforce; potentially a cause of lower morale and de-motivation • Danger of lost skills for industries as a whole • Business may be impacted by social problems associated with high unemployment (e.g. rising crime) • Recruitment (in theory) becomes easier – there should be more applicants for each vacancy • Lower staff turnover – employees less likely to be able to find other jobs, or want to move in an uncertain economic climate Some business implications of falling / low unemployment: • Consumers have more income = higher demand for income elastic goods • Labour market “tightens” – increased upward pressure on wages / salaries • Harder to recruit or expand without offering better worker packages – potentially affects ability to increase capacity • Greater sense of job security and motivation in the workforce if the business is doing well The appropriate response to changes in unemployment will depend on several factors, including: • The nature / cause of unemployment (e.g. cyclical, structural, seasonal) • The labour-intensity of the business • The ability of the business to respond (resources, management structure etc)

What is an exchange rate?

An exchange rate is the price of one currency expressed in terms of another currency.

The exchange rate determines how much of one currency has to be given up in order to buy a specific amount of another currency.

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Exchange rates change constantly as currencies are bought and sold (traded) on the global currency markets. Let any commodity, a currency has a value or price expressed in terms of what it could buy – that is the exchange rate.

Look at the table and see what happened to the exchange rate for the pound between May and September.

The value of £1 fell against both the US dollar and the Euro. For example, by September, £1 would only buy you $1.45, a fall of $0.15 from May. That means that the pound weakened against the dollar (and the euro).

Putting it another way, the value of the US dollar strengthened against the pound. If you were holding dollars, you would need less of them to convert into £1.

What causes an exchange rate to change?

An exchange rate is a price of a currency. The price is determined by the forces of demand and supply in the currency markets. Just like the commodity markets for wheat, oil and coffee, the price of a currency will reflect the amount of the currency that consumers and businesses want to buy (demand) and sell (supply).

Currencies are traded on in international currency markets 24 hours a day. Many billions of pounds and other currencies are traded every hour, to service the needs of governments, businesses and millions of individuals.

Here are some reasons why there is demand for a currency: • Businesses need to pay for invoices from overseas suppliers (e.g. a US supplier sending goods to the UK and pricing the invoice in dollars) • Businesses needing to convert payments they have received from customers in one currency into another (e.g. a customer in Italy pays a UK business in Euros – which it wants to convert into pounds before putting it in the bank) • Consumers and business people buying currency before taking a trip or holiday overseas.

• Businesses sending back profits (cash) from their overseas operations to the base currency Currency markets are also affected by speculative demand and supply. Currency traders bet on which way they think exchange rates will move. If they think that there will be excess demand for a currency and that it will strengthen, then they may buy that currency and then look to sell the currency when the exchange rate has risen (making a profit) A currency is also affected by interest rates. For example if interest rates in the UK rise, then holders of other currencies may swap them into pounds in order to gain access to a higher interest rate.

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What are the implications for UK businesses if the pound strengthens?

A good way to look at what happens if a currency strengthens (an increase in the exchange rate) is to work through an example.

Brandon Ltd imports electronic goods from the US for sale via a UK website. These goods are invoiced in US$ - and that is the currency that Brandon must use to settle the invoices. Each month they pay their American suppliers approximately $100,000 for goods imported into the UK. What is the effect of the strengthening pound in the table above on Brandon Ltd? Let’s convert the monthly US dollar payment to suppliers ($100,000) into pounds to see how much Brandon has to pay: In June, Brandon Ltd needs to spend £62,500 to pay for their $100,000 of imported goods from the US. This is £8,928 less than in January. That means, for Brandon ltd, the cost of imports has gone down. A strengthened pound has led to cheaper imported goods – that’s good news for Brandon Ltd (they should be able to make a better profit margin on those imported electrical goods).

If a strengthened exchange rate is good news for an importer like Brandon, what about a business that sells from the UK to the USA – an exporter?

Take the example of Huntington Plastics Ltd. Huntington exports moulded plastic components to customers in the US, invoicing in US dollars. What would the effect of a strengthened exchange rate be for Huntington?

If Huntington received $100,000 in sales in January, they could be converted into £71,428.

But in June, the same $100,000 of sales would only be worth £62,500. That’s bad news for Huntington. A strengthened pound has resulted in lower sales.

If Huntington were to invoice their exports in pounds rather than dollars, then they might not be directly affected by the changed exchange rate – since there are no foreign currency receipts to convert back into pounds. However, the business might still suffer, since the price of Huntington products would be more expensive for US customers, who might then buy less (perhaps buying from a cheaper domestic supplier).

Let’s summarise: A stronger pound leads to: - Imports being cheaper - Exports dearer (more expensive) Here is an acronym that can help you remember that: SPICED S - Stronger P - Pounds I - Imports C - Cheaper 96 | P a g e

E - Exports D - Dearer What happens if the pound weakens (i.e. falls in value against other exchange rates)?

The answer is – the opposite of a stronger pound.

- Imports become more expensive for UK importers - Exports become cheaper in overseas markets.

Outline the main costs and benefits of inflation Inflation has many important costs and consequences for both society and business.

However a stable and low level of inflation also provides some upsides for business.

Inflation has many costs and downsides, including: • Money loses its value and people lose confidence in money as the value of their savings is reduced • Inflation can get out of control - price increases lead to higher wage demands as people try to maintain their living standards. This is known as a wage-price spiral.

• Consumers and businesses on fixed incomes lose out because the their real incomes fall - employees in poor bargaining positions also lose out • Inflation can favour borrowers at the expense of savers – because inflation erodes the real value of existing debts • Inflation can disrupt business planning and lead to lower capital investment • Inflation is a possible cause of higher unemployment in the long term – because of a lack of competitiveness • Rising inflation is associated with higher interest rates - this reduces economic growth By contrast, some inflation can actually be good news. With a sensible, low level of general price inflation: • Industry-wide price rises enable revenues to grow • Growing revenues + a constant gross margin = higher gross profits • Inflation makes using debt as a source of finance cheaper in real terms The two key issues to consider in relation to the adverse effects of inflation are: - Price elasticity of demand - Responding to cost-push inflation You will recall that price elasticity refers to the responsiveness of demand to changes in price • When demand is elastic, a price rise leads to a more than proportionate fall off in quantity demanded • When demand is inelastic, a price rise leads to a less than proportionate fall off in quantity demanded 97 | P a g e

Firms with inelastic price elasticity of demand will be less affected by a rise in inflation Some firms will be able to absorb price increases by becoming more efficient. But remember that price inflation will vary from industry to industry – be careful about making generalisations!

Thinking about the effect of rising costs on a business: with a rise in general inflation: • Sales revenue should rise • But workers likely to demand higher pay to compensate for consumer price inflation • Labour intensive industries more at risk • Cost-push inflation will vary from industry to industry • Firms that need to buy significant commodity raw materials may find profit margins squeezed if they cannot pass on increased costs to customers

How are businesses affected by changes in interest rates?

The effect of a change in interest rates will depend on several factors, such as: • The amount that a business has borrowed and on what terms • The cash balances that a business holds • Whether the business operates in markets where demand is sensitive to changes in interest rates Let’s look at the third factor listed above to examine the implications a little more closely.

Consider the example of households and consumers who like to pay for their goods and services using borrowing such as credit cards or a bank overdraft or loan. Also think about households who have substantial balances outstanding on a mortgage used to finance a house purchase.

An increase in interest rates will mean that the cost of borrowing rises.

In theory, a higher bank base rate will mean that credit card companies such as Visa and Mastercard will also raise the rate they charge borrowers on amounts that are outstanding.

A higher interest rate will also mean an increase in the monthly mortgage payments that are made by home-owners who have mortgages which are charged at a variable rate.

In both cases, the disposable income of consumers and households will fall.

The monthly mortgage payment might rise from say £500 to £550, which means that the household has £50 less disposable income available to spend or save.

If consumers and households think that the rise in interest rates is temporary or short-term, they may simply continue to spend as before. In this case, there will be 98 | P a g e

little effect on demand. However, it might also prompt them to cut back on spending, which would result in lower demand.

Some businesses operate in markets which are very sensitive to changes in interest rates. These markets often involve goods and services where the purchase is financed by debt and where the price paid is relatively significant compared with the customer’s income. For example: • Housing (mortgages) • Motor vehicles • Holidays • Major purchases of consumer goods – e.g. new kitchen equipment, audio-visual systems Social influences

Social Trends There are a number of social factors that firms may wish to consider when designing the marketing mix:

Ethical trading No exploitation, pollution,

Online retailing Location is not a concern, good websites, google search optimization, saturation advertising.

Retailer purchasing power Eg 4 supermarkets control 75% of the UK market.

Sustainability Purchases are automatically replenished.

Food miles A calculation of how much traveling is involved in making and delivering a product.

Environmental factors Carbon footprints, organic, pollution.

Re-cycling

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Burn, bury or re-use the original materials.

Project: Select one of the “social trends” and create a poster outlining the main concepts associated with it!

Impact on business of environmental considerations.

The place you work can affect the environment either positively or negatively to a very large degree. How eco-friendly your employer is when it comes to using energy to heat and cool the building, to bring products into it, and to remove waste from it has a major impact on your community and the planet.

You may be surprised by some specific examples of ways the working world damages the environment: 

Heating and air conditioning systems pump greenhouse gas emissions from offices into the atmosphere and use up vast amounts of electricity. Many buildings aren’t designed to include energy-efficient systems or technology to reduce the amount of heat and air conditioning they use.



Many buildings are built from materials that don’t come from renewable sources.

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Office buildings have a huge appetite for electricity to power lighting, air conditioning, computers, printers, and photocopiers. Equipment may be left on 24 hours a day, seven days a week — even when no one’s working.

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Offices consume vast amounts of paper. Even with more offices recycling paper, a large amount of paper waste still goes to landfill sites or incinerators.

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In addition to paper, offices produce a lot of other waste, including equipment (especially computers), because companies regularly upgrade their equipment to stay competitive. Electronics such as photocopiers and computers can end up in landfills, where they don’t break down and, even worse, can leach harmful chemicals into the ground and water.

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Rush-hour traffic jams in towns and cities are full of people trying to get to work — wasting time and polluting the atmosphere.

According to the U.S. Environmental Protection Agency, industrial and commercial energy use (from such sources as electricity use, product transportation, industrial

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processes, burning fossil fuels to power boilers and produce steam, and using gasoline to power vehicles) accounts for nearly 30 percent of total U.S. greenhouse gas emissions.

Impact on business of demographic change.

So what are some key trends?

For a long time demographers have been concerned about the global population explosion. Latest predictions are that the population is still growing overall but the rate of growth is declining and may actually decline in the future. Asian and African regions are booming, but Europe is in decline.

1. Birth rates are declining in developed economies with average family size reducing and also in some developing economies that have had effective public policies to control the population growth rate.

2. The vast majority of people are living in today’s developing economies - in Asia, Africa and Latin America - creating what is called the Demographic Divide. This polarization is expected to continue.

3. Some countries from these regions will emerge as global economic powers in the future.

4. People are living longer in both developed and developing economies 5. Developed economies have aging populations with this being the new demographic concern (taking over from population explosion).

6. Immigration will increase (as a result of the Demographic Divide) and as developed economies look for sources of labor.

7. The changing population has an impact on economic growth. The population can be classified as workers and non-workers. When the relative balance of workers to non-workers is higher, there is a positive impact on the economy.

Conversely, when there are relatively more non-workers (like children and the aged), there is a lower contribution to the economy. Babies and the aged consume more resources than they generate. This is called the Demographic Dividend.

8. Developed economies with lower birth rates and people living longer will experience a lower Demographic Dividend than developing economies.

9. The declining work force will induce people to work longer and retire later.

10. Immigration will provide a supplement to the work force in developed economies.

There are many impacts on business and these are wide ranging.

Clearly international trade will continue to grow. The significant improvements in 101 | P a g e

communications, transportation and trade regulation mean we will be doing more cross border business. More importantly, a growing population, especially one with more disposable income, creates demand for goods and services. The world will consume more - and inevitably this will create demand for natural resources, and contribute more to environmental degradation. In the next edition of Accelerator we will specifically examine growing and declining economies.

The battle for talent will continue and getting good people may become harder in developed economies. Conversely, there is a growing talent pool in the developing economies as more people gain full educations. This all points to a labor market that will become more global, and this will support further immigration. Any talent shortage will also mean employers will adopt increasingly flexible approaches to employment, allowing part time and remote working.

We are all aware of the significant growth in IT development outsourcing to India and China; the use of off shore call centers; the outsourcing of many accounting processing (including income tax return preparation); and many other activities. In the future even more business functions will be outsourced. Once again, improvements in communications technology will overcome the tyrannies of distance previously experienced.

Business support functions are being increasingly provided by service providers. Payroll was one of the earliest, but all sorts of functions are now outsourced. Recent trends have seen outsourced processes now include email hosting and exchange server hosting. These will be provided from low cost centers, typically offshore. This trend will continue. As more business processes become technology-based, and with broadband becoming ubiquitous, it will be easier and more cost effective to outsource than finding qualified employees to perform tasks inhouse.

Aging populations will put additional strains on governments to deliver health and aged care services. The private sector’s role in these areas will rise as governments move to outsource the delivery of these services, or simply privatize them.

Target investments will move beyond the traditional equity and property markets which are already overheated in terms of valuation. As people grow older they tend to have more money (savings) than young people. Just look at the massive growth in funds held in structured pension funds and in other forms of personal investment. Where will these funds be invested? They may well provide the capital for the privatization of some of these public services.

Let’s look at some of the demographic facts about the impact an aging population has on the ability of privately owned businesses to transition to new ownership.

1. The baby boomer generation represents a significant proportion of privately owned businesses.

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2. Family members are less inclined to join and take over family owned businesses. Many migrant families who started their own businesses have often educated their children to take on professional and other careers, which they viewed as being more desirable, prestigious and financially rewarding, rather than come through into the business.

3. Owner managers are looking to retire earlier.

4. Demographic trends are not the only driver of owners selling out; many fear consolidation and increasing competition in their sector.

5. Over the next decade an unprecedented number of privately owned businesses around the world – estimated to exceed 20 million in number – are going to come up for sale.

6. This is a major economic consequence potentially involving: 1. 30 million owner managers 2. revenues up to US$100 billion 3. 100 to 200 million employees 4. 25 million or more business locations (leased and owned property) 5. billions of dollars in shareholder value, the largest transfer of wealth in history in free market economies 7. There will be a strong supply of businesses on the market and possibly a diminished number of buyers. Many potential buyers of businesses today are ex-employees who will not be so easily enticed into self employment, when you take into account the attractive alternative on offer to them – namely, the strong demand for talented labour which is driving improved terms and conditions of employment.

It is quite possible that the growth in the number of businesses on the market, particularly smaller business, will lead to industry consolidations. Existing operators will see an opportunity to increase their market share by buying a competitor.

There will also be growth in e-commerce as a significant part of the $100 billion in revenue migrates from brick and mortar based businesses to those who provide on-line services. Just the migration from customers shopping and taking home their purchases themselves to on-line ordering with the vendor arranging delivery to the customers address demonstrates how “doing business” will change. Contemplate the “outsourcing” opportunities for a delivery business, the growth in credit transactions versus cash, the need for on-line customer service systems and so it goes on.

It is not easy to predict what the consequences of these major demographic changes will have on business, but they will have an impact. Many opportunities will arise, and fortunes will be both made and lost as our small business boat bobs its way in the global ocean currents.

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