Instructor’s Resource Manual for Essentials of Entrepreneurship and Small Business Management Ram Subramanian
Essentials of Entrepreneurship and Small Business Management Ninth Edition Global Edition
Norman M. Scarborough Jeffrey R. Cornwall
TABLE OF CONTENTS INSTRUCTOR’S RESOURCE MANUAL ESSENTIALS OF ENTREPRENEURSHIP AND SMALL BUSINESS MANAGEMENT NINTH EDITION, GLOBAL EDITION Title
Page
Preface
ii
Chapter 1
The Foundations of Entrepreneurship
1
Chapter 2
Ethics and Social Responsibility: Doing the Right Thing
16
Chapter 3
Creativity and Innovation: Keys to Entrepreneurial Success
37
Chapter 4
Conducting a Feasibility Analysis and Designing a Business Model
57
Chapter 5
Crafting a Business Plan and Building a Solid Strategic Plan
76
Chapter 6
Forms of Business Ownership
95
Chapter 7
Buying an Existing Business
105
Chapter 8
Franchising and the Entrepreneur
116
Chapter 9
Building a Powerful Bootstrap Marketing Plan
131
Chapter 10
E-Commerce and the Entrepreneur
151
Chapter 11
Pricing and Credit Strategies
167
Chapter 12
Creating a Successful Financial Plan
183
Chapter 13
Managing Cash Flow
197
Chapter 14
Choosing the Right Location and Layout
214
Chapter 15
Sources of Financing: Equity and Debt
230
Chapter 16
Global Aspects of Entrepreneurship
250
Chapter 17
Building a New Venture Team and Planning for the Next Generation
263
Case and Chapter Matrix
279
Case Solutions
281
Sample Syllabus
305
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PREFACE Congratulations on choosing the ninth edition of Essentials of Entrepreneurship and Small Business Management for your course! This instructor resource manual is a supplement for this ninth edition text authored by Norman M. Scarborough and Jeff Cornwall. Chapter Contents: Each chapter of this instructor resource manual is divided into six parts: • Part 1: Learning Objectives • Part 2: Class Instruction, with content clearly noted by learning objective. Key words are highlighted, and definitions provided. Suggestions are included when appropriate to use each of the Chapter Exercises. • Part 3: Chapter Exercises, including answers to the You Be the Consultant, Hands On… How To, and Ethics and Entrepreneurship features. • Part 4: Chapter Discussion Questions • Part 5: Case Studies • Part 6: Online Videos and Podcasts The chapter exercises, discussion questions, and case studies provide a wide variety of inclass individual and group exercises, as well as potential homework assignments and exam questions. In the text you will find an exceptional business plan outline in Appendix A, which can form the basis for a meaningful project for individuals or groups. Choose which exercise you want to use based on your personal preferences, the number of students in your course, as well as the level of knowledge and preparation of your students. Project-Based Learning: My personal preference is to use project-based learning when teaching this course. After completing Chapter 3, Inside the Entrepreneurial Mind: From Ideas to Reality, I require my students to identify new business concepts they are personally interested in or excited about. If you refer to the Sample Syllabus, you will see that students must “pitch” their business concept to the whole class during week 5. Students also work in teams throughout the term. The team project is to conduct a feasibility analysis and prepare a business model. Teams are expected to use the information learned in each chapter to develop a business model for his or her new business. Students coach each other to revise and refine their business model. If you
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choose, you could do the same process focused on writing a business plan. Please refer to my sample syllabus at the end of this manual for more ideas. Students become more engaged in their learning by using project-based learning, and learn at higher levels by creating something unique to their interests. Without application of what they are learning they will likely become distracted and only study enough to get the grade they want on your exams. Entrepreneurial students truly want to learn and become bored quickly if not engaged in the process. If you agree that project-based learning is worth the time and effort then I have a few suggestions for you: • Students’ new business ideas must be ethical, moral, and certainly legal. • The best business idea is one that a student is passionate about, as it will not feel like work. They will be more motivated and engaged in the process if they are excited and have a feeling of ownership. • Ideally, they will choose a simple business idea that could be started by the end of your course. I suggest that they consider ideas for a simple “starter” business instead of an idea that would take months or even years to prepare. • Their business ideas should also be innovative and creative. For example, if a student wants to start a florist business, insist that the student find ways to differentiate their florist shop from competitors. Chapter Instruction Sequence: When delivering my lecture I follow a consistent sequence of events loosely based on Gagne’s Nine Events of Instruction. I follow this four-step sequence when presenting each learning objective. 1. Gain attention and stimulate prior knowledge. I ask an open-ended question about the topic, and have students discuss their answers with each other; this stimulates engagement right from the beginning. After a few minutes I ask a few students to share their answers with the entire class, and provide feedback that is designed to reinforce student participation. 2. Lecture on the key points of the learning objective. I do not cover all of the key points, but instead focus on the most important concepts that students may be confused about by just reading the text. Students have different learning styles, (visual, aural, verbal, logical, etc.) so it is important to use a variety of teaching methods. 3. Provide examples to reinforce each key point; these examples may come from my own experience, or a story about someone else, such as a well-known entrepreneur. I also like to use the Chapter Exercises at this point in my lecture, or better yet sections of The Daily Perc Business Plan (found in the Appendix of the text).
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4. Show a brief video (3 to 5 minutes long) to provide additional reinforcement of the key points of the learning objective. You will find a nice variety of videos at the end of each chapter. Then I repeat the same four steps for the next learning objective. Homework and Exams: Case studies make exceptional homework assignments. To add variety, I will assign a case study as homework, and then use the Harvard case study method during the next class meeting. My personal preference is to use the Chapter Discussion Questions either as an exam study guide for students, and/or as actual exam questions. For example, I tell students to study all of the discussion questions as I am going to include three of them as essay questions on the exam. Conclusion: This text is so well organized that it follows the typical process people actually follow when starting a business. In addition, concepts are so well explained that students with any level of knowledge of entrepreneurship can understand and be prepared to apply them. I know you and your students will enjoy this text, and I hope you will have as much fun teaching this course as I do!
Supplement Author
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CASE AND CHAPTER MATRIX Case Company # Name 1 United Apparel Liquidators
2
3
4
5
6
7
8
.
Bark & Co.
Cousins Maine Lobster ThinkImpact
Intertech Construction Corporation Bluffton Pharmacy – Part 1 Bluffton Pharmacy – Part 2 Gitman Brothers
Related Topics Industry: Apparel • Business Model • Bootstrap Marketing and Social Media • Location & Layout Industry: Pet Products • Creativity & Innovation • Business Plan • Sources of Funds
Industry: Food • Franchising • Global Business Industry: Philanthropy • Ethics & Social Responsibility • Strategic Planning • Forms of Business Ownership • Sources of Funds Industry: E-Commerce and Retail Yarn • Financial Plan • Cash Management • Venture Team Industry: Retail • Financial Analysis
Chapter Reference 5 9 14
1 3 5 15
8 15 2 5 6 15 12 13 17 12
Industry: Retail • Managing Cash Flow
13
Industry: Apparel • Marketing Plan • E-Commerce
9 10
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9
10
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Seabreeze Property Services
Industry: Lawncare • Buying an Existing Business • Sources of Funding
7 15
The Newark Nut Company
Industry: Retail • Strategic Planning • Marketing Plan • E-Commerce • New Venture Team
5 9 10 17
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CASE SOLUTIONS
Case 1: United Apparel Liquidators
https://shopual.com/
Related Chapters: •
Chapter 5: Crafting a Business Plan and Building a Solid Strategic Plan
•
Chapter 9: Building a Powerful Bootstrap Marketing Plan
•
Chapter 14: Choosing the Right Location & Layout
1. What steps should the Cohens take to find other locations for new U.A.L. stores? What criteria should they use to screen potential cities? (Chapter 14, LO 1) (AACSB: Application of knowledge) Location can be a source of competitive advantage. In the case of the Cohens and United Apparel Liquidators, theirs is a business where low costs matter. They are in the business of selling luxury apparel at bargain prices. This means that their locations must help them maintain a low-cost structure. The location decision follows the sequence: choosing the region, the state, the city, and the specific site. Their base is Mississippi. That’s where their first store is located (in Hattiesburg). Their other locations fit the general profile of a comparatively low cost small Southern town. They should follow the same logic in locating their future stores. In screening potential cities, the Cohens should use as criteria factors such as: population trends (given that what they sell requires a fair amount of income), competition, compatibility with the community, and local laws and regulations. The other factors mentioned in the chapters – clusters, appropriate infrastructure and utilities, and incentives – are less important to the type of business that the Cohens run. 2. Which of the three basic business strategies is U.A.L. using? Explain. How well are the Cohens executing their strategy? (Chapter 5, LO 7) (AACSB: Application of knowledge) Strategy is a road map of the actions an entrepreneur draws up to fulfill the company’s mission, goals, and objectives. The chapter identifies three strategic options: cost leadership, differentiation, and focus. Given that UAL has only a limited number of stores at this point in time, it is following a focus strategy. However, in its selected market, UAL is pursuing a cost leadership strategy, albeit by selling luxury goods. For example, the case indicates that UAL sells at $224 a pair of Manolo Blahnik leopard-print heels that originally sells for a $1,000.
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A cost leadership strategy (within a focused geographical market) requires having a low-cost operation that enables the firm to sell at low prices. Here, there is evidence that the Cohens are executing their strategy well. The following are key points: •
Locating their stores in small southern cities such as Hattiesburg, Mississippi, and Metairie, Louisiana. The argument here is that the rental and other operating costs will be lower here as compared to the big cities.
•
Even in these small towns, the Cohens have been careful in their choice of store location. As the case notes, “with fluorescent lights hanging from chains and concrete floors, their stores resembled Goodwill stores than the luxurious stores in the big cities that originally sold their merchandise.” One of their stores is in a strip mall in a building formerly used by a car dealership.
3. Develop an outline of a marketing strategy for U.A.L. How should the company promote itself? (Chapter 9, LO 1 and LO 4) (AACSB: Application of knowledge) This is a good question for a student team project. Chapter 9 talks about bootstrap marketing strategies that small firms can employ and this is a good project for such strategies. Students should first answer the seven questions in Table 9.1, A Seven-Sentence Bootstrap (Guerrilla) Marketing Strategy (page 338), to develop an outline of UAL’s marketing plan. Then they should refer to Table 9.2, Bootstrap Marketing Tactics (page 348) to choose the most effective initiatives for implementing UAL’s marketing plan. 4. How should U.A.L. incorporate social media into its marketing strategy? Which social media tools should the Cohens use? What steps should they take to build a social media following? (Chapter 9, LO 4) (AACSB: Application of knowledge) The social media strategy that UAL should use would depend upon their marketing plan that was the subject of Question 3 above. It makes sense to have student teams address this also when they are developing a guerilla marketing plan for UAL. Social media has significant potential as a marketing tool and typically fits very well with a bootstrap marketing plan, particularly in terms of resources. Many of the bootstrap marketing tactics listed in Table 9.2 (page 348) involve social media. The students’ plan should address all three issues listed above: how should the Cohens incorporate social media, which specific tools they should use, and how should they develop a social media following.
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Case Solutions, Page 282
Case 2: Bark &Co.
bark.co
Related Chapters: •
Chapter 1: The Foundations of Entrepreneurship
•
Chapter 3: Creativity and Innovation: Keys to Entrepreneurial Success
•
Chapter 5: Crafting a Business Plan and Building a Solid Strategic Plan
•
Chapter 15: Sources of Financing: Equity and Debt
1. What advantages does a subscription pricing model offer a business? (Chapter 5, LO 2) (AACSB: Application of knowledge) A subscription model has the following advantages. First, from Bark & Co.’s point-of-view, it makes revenues and cash flows predictable. This means the company can manage its cash budget with actual data. The model has advantages from the customer’s perspective too. It lowers the one-time price that the customer would pay for the product and so it removes much of the “sticker shock” associated with purchases. 2. Notice that several of Bark & Co.’s idea for new businesses have failed. Is this unusual? Why is it important for businesses to continue to innovate, even when their founders know that many of the innovations will fail? What steps can Meeker, Werdelin, and Strife take to encourage creativity in their company? (Chapter 1, LO 7; Chapter 3, LO 1) (AACSB: Application of knowledge) Matt Meeker, Henrik Werdelin, and Carly Strife are entrepreneurs. This means they are constantly identifying opportunities to exploit and profit from. In the case of Bark & Co., the founders have to continue to innovate even in the face of failure for a number of reasons. Key among them is competition. As the case indicates, they have competitors such as PetGiftBox and PawPack. This means that to hold on to their competitive advantage via a differentiation strategy, they have to constantly innovate. The second is the pressure to hit the revenue goals as mandated by the venture capital firms. For Bark & Co. to go from $100 million to $500 million in revenues, the BarkBox line alone wouldn’t do it. They have to launch new products and this comes via innovation. The founders can encourage creativity at Bark & Co. by creating the right climate. Perhaps, the 1 percent of revenues allotted for innovation may not be enough, but it looks like this is all what the company can afford. The key for the founders is to create a climate of creativity and lead by example. 3. Explain the advantages and disadvantages of using venture capital to finance a company’s growth. (Chapter 14, LO 2) (AACSB: Application of knowledge)
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Venture capital companies are private, for-profit organizations that assemble pools of capital and use them to purchase equity positions in young businesses they believe have high-growth and high-profit potential, producing annual returns of 300 to 500 percent within five to seven years. One advantage of using venture capital to finance a company’s growth is that such firms are typically interested inequity ownership rather than debt, which would call for interest and loan repayments. This means the start-up doesn’t have to worry about interest and loan repayment that would adversely affect its cash flow. The second advantage is that such firms look at early stage investment and so a start-up can seek such funding early in its life. Venture capitalists also provide advice and mentoring which help the founders of the start-up. The principal disadvantage is the immense pressure that venture capital firms put on the start-up to deliver. They look for substantial returns – 300 to 500 percent – in 5-7 years which may be very difficult for many firms. 4. Because of the risks associated with their investments, venture capital firms, which become part owners of the companies in which they invest, demand big returns within relatively short time frames. What impact do these expectations have on business founders such as Meeker, Werdelin, and Strife? Do investors’ expectations affect entrepreneurs’ decisions about their businesses? Explain. (Chapter 14, LO 2) (AACSB: Application of knowledge) Venture capital firms expect returns of 300-500 percent (i.e., 3 to 5 times what they have invested) within a 5-7-year period. This has a tremendous impact on how a business is run. As Meeker, Werdelin, and Strife point out, Bark & Co. has to get to sales of around $500 million within the next 3-4 years; this from a current base of around $100 million in revenues. It took Bark & Co. 5 years, from its launch in 2011 to 2016 to hit the $100 million revenue mark. Now, they have to multiply it by 5 times in a short period. As the case indicates, Meeker, Werdelin, and Strife believe that the BarkBox line alone will not get them to the target. They need to develop additional lines of business. The challenge is that they have to do this in a highly competitive environment. 5. What strategies should Meeker, Werdelin, and Strife use to continue their company’s impressive growth rate? Are there other related businesses that they should enter? Explain. (Chapter 5, LO 7) (AACSB: Application of knowledge) Bark& Co. is using a differentiation strategy in the pet products (specifically dogs) business. They do this using a subscription-based model. The subscription model helps the company in a variety of ways and this is something that they should continue. The key to their growth, though, is a related product diversification strategy. While some of their product ventures have failed, the key is to continue to branch out into related areas so that they can generate more revenues.
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Case Solutions, Page 284
Case 3: Cousins Maine Lobster
https://www.cousinsmainelobster.com/
Related Chapters: •
Chapter 8: Franchising and the Entrepreneur
•
Chapter 16: Global Aspects of Entrepreneurship
1. Suppose that your best friend is considering purchasing a franchise such as Cousins Maine Lobster. What advice would you give him or her about the right way to go about purchasing a franchise? (Chapter 8, LO 4) (AACSB: Reflective thinking) The friend should be advised to follow certain steps before deciding on purchasing a franchise such as Cousins Maine Lobster. The steps include: •
Evaluating oneself. The would-be franchise has to evaluate his/her own traits, goals, experience, likes, dislikes, risk orientation, income requirements, time and family commitments, and other characteristics.
•
Research the market. Before deciding on a franchise, the friend should research the market in which he/she plans to open the franchise. Key areas include the macro and the competitive environments in the area.
•
Consider the franchise options. Before selecting the particular franchisor, the friend should consider the franchising options available. Instead of settling on the first available franchise, one should consider all the options.
•
Obtain a copy of the Franchisor’s Franchise Disclosure Document. The FDD is an important tool in one’s search for the right franchise.
•
Talk to existing franchisees. While the FDD is an important document, it should be supplemented by visits to franchise owners to get an understanding of their experiences.
•
Ask the franchisor relevant questions. Reading the FDD and talking to franchisees should lead to the friend asking the franchisor questions about the franchise relationship. Such questions should be aimed at clarifying any ambiguous areas.
•
As the final step, the friend should make the choice of the franchise to own.
2. What advantages do entrepreneurs who purchase a franchise get? What disadvantages do they encounter? (Chapter 8, LO 2A and 2B) (AACSB: Reflective thinking) The benefits of owning a franchise are the following: .
Case Solutions, Page 285
•
A multitude of options
•
A business system
•
Management training and support
•
Brand-name appeal
•
Standardized quality of goods and services
•
National advertising programs and marketing assistance
•
Financial assistance
•
Proven products, processes, and business formats
•
Centralized buying power
•
Site selection and territorial protection
•
Greater chance of success
However, there are also disadvantages associated with franchising, such as: •
Franchise fees and ongoing royalties
•
Strict adherence to standardized operations
•
Restrictions on purchasing and prices
•
Limited product line
•
Contract terms involving termination, sale or buyback
•
Unsatisfactory training programs
•
Market saturation
•
Less freedom
3. What is the Franchise Disclosure Document? How can it help prospective franchisees evaluate the various franchise operations in which they are considering investing? (Chapter 8, LO 3) (AACSB: Reflective thinking) The Franchise Disclosure Document (FDD) is a document that every franchisor is required by law to give prospective franchisees before any offer or sale of a franchise. It outlines 23 important pieces of information about the franchisor and the franchise. The FDD helps prospective franchisees because since it is a disclosure document, all the relevant facts about the franchise can be obtained prior to making a decision. For example, it has information about the initial and ongoing franchise fees as well as the investment required to open a franchise.
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Case Solutions, Page 286
4. Cousins Maine Lobster wants to expand its franchise internationally. How popular is franchising as an “export” to other nations? What steps should Tselikis and Lomac take to cultivate a successful international franchise operation? (Chapter 8, LO 5 and Chapter 16, LO 1) (AACSB: Application of knowledge) One of the major trends in franchising is the internationalization of American franchising systems. Franchising American businesses like Cousins Maine Lobster has become a major export industry as evidenced by the increasing number of international franchisees of companies such as McDonald’s, KFC, Pizza Hut, Taco Bell, and Subway. Tselikis and Lomac should be careful in attempting to create an international franchise operation for Cousins Maine Lobster. They should examine if adaptation is required for foreign markets. Adaption areas include business format as well as products because these may not suit foreign markets.
Case 4: ThinkImpact
http://www.thinkimpact.com/
Related Chapters: •
Chapter 2: Ethics and Social Responsibility: Doing the Right Thing
•
Chapter 5: Crafting a Business Plan and building a Solid Strategic Plan
•
Chapter 6: Forms of Business Ownership
•
Chapter 15: Sources of Financing: Equity and Debt
1. Which organization structure should Garlick use for ThinkImpact? Explain. (Chapter 2, LO 4 and Chapter 6, LO 4) (AACSB: Application of knowledge) As the case indicates, Saul Garlick has three options when it comes to ThinkImpact’s organizational structure: remain a nonprofit organization, shut down the nonprofit organization and start a for-profit company, or develop a hybrid model. As students examine these three options, they have to keep in mind that Saul Garlick is a social entrepreneur, in that he finds resources to tackle challenging problems confronting, in this case, South Africa’s poverty stricken population. Option 1, to remain as a nonprofit, makes sense because the market will not sense an ulterior, profit seeking motive to what Garlick is trying to do. The downside is that Garlick would spend much of his time raising money rather than in doing what the organization is supposed to do. While students may have different opinions on this, the hybrid model makes for the best option
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Case Solutions, Page 287
because it takes care of the fund raising part via the for-profit business and yet the nonprofit part allows Garlick to focus on the organization’s mission. 2. If Garlick chooses to create a for-profit entity, either to replace the current nonprofit organization or as a subsidiary, what potential sources of funding might he be able to tap? (Chapter 15, LO 2) (AACSB: Application of knowledge) Garlick has to first decide on whether r not he wants to fund the organization’s capital entirely via equity or as a combination of equity and debt. Given that ThinkImpact has a track record, it may not be considered purely as a start-up, although being an nonprofit organization for several years may not logically transfer to the for-profit world. Garlick should look at the following sources of equity funding: •
Personal savings
•
Friends and family members. There are indications that friends and family members may be willing to invest in ThinkImpact if they can get financial returns.
•
Crowd funding. Given ThinkImpact’s social mission, crowd funding may be an attractive option.
•
Venture capitalists. There are venture capital firms that specialize in funding social ventures.
Debt funding may be a more difficult option for Garlick at the start as, for example, commercial banks may be unwilling to lend to such an organization. This may be something that Garlick looks into at a later stage. 3. What steps should Garlick take before approaching some of the potential sources of funding you described in question 2? (Chapter 5, LO 1) (AACSB: Application of knowledge) Garlick should first develop a solid business plan for ThinkImpact. A business plan is a written summary of an entrepreneur’s proposed business venture, its operational and financial details, its marketing opportunities and strategy, and its manager’s skills and abilities. In the case of Garlick and ThinkImpact, the purpose of writing a business plan is to attract investors. His business plan should prove to investors that ThinkImpact will produce an attractive rate of return. A well-written business plan will help Garlick convince investors both of ThinkImpact’s social mission as well as its financial prospects that will help him get funding.
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Case Solutions, Page 288
Case 5: Intertech Construction Corporation http://www.iccbuild.com/ Related Chapters: •
Chapter 12: Creating a Successful Financial Plan
•
Chapter 13: Managing Cash Flow
•
Chapter 17: Building a New Venture Team and Planning for the Next Generation
1. Identify possible causes that could explain Intertech’s declining profitability. What steps can the Stadlens take to reverse this alarming trend? (Chapter 12, LO 3) The case indicates that Intertech Construction Corporation’s profitability has declined following the Great Recession. While we don’t know the full story behind this, possible reasons could be the following: •
The sales rebound after the Great Recession may not be adequate enough to cover the increased expenses that an organization the size of Intertech (27 full-time employees, around 25 projects a year) may have.
•
Intertech’s client base may be disproportionately in favor of large (size and revenues wise) customers who may have tremendous bargaining power when it comes to buildout contracts.
•
Competitive intensity (as reflected in bid prices) may be intensive as many firms try to remain afloat following the Great Recession. This may mean that Intertech is working on contracts with low margins.
The Stadlens should do an analysis of Intertech’s various ratios to find out where the profitability problem is. This analysis could lead to corrective steps. 2. What can the Stadlens do to manage their company’s cash flow more effectively? (Chapter 13, LO 1) (AACSB: Application of knowledge) Cash management is the process of forecasting, collecting, disbursing, investing, and planning for cash a company needs to operate smoothly. Managing cash flow is an acute problem for a growing business such as Intertech. What is important for Intertech is understanding and managing the cash flow cycle: the time lag between paying suppliers for merchandise or materials and receiving payment from customers. To manage Intertech’s cash more effectively, the Stadlens have to work on both the disbursement part of the cash flow cycle as well as on the collection part. 3. What steps should the Stadlens take to avoid problems with the company’s accounts receivable? How dangerous is this threat? Explain. (Chapter 13, LO 4) (AACSB: Application of knowledge) .
Case Solutions, Page 289
Along with accounts payable and inventory, accounts receivable is one of the “big three” of cash management. Accounts receivable is the money owed Intertech for work done for its customers. The case indicates that Intertech has more than the normal share of customers who either do not pay their invoices on time or do not pay at all. This could have a devastating effect on Intertech’s cash flow and ability to survive as a going concern. The steps that the Stadlens should take to avoid problems with Intertech’s accounts receivable are: •
Establish a credit and collection policy (if they have not done so already)
•
Use techniques (send invoices when job is completed, not a week or so later) to accelerate accounts receivable collection
•
Offer incentives (e.g., discounts) to incentivize early or on-time payments.
4. What should Art and Ilene Stadlen do to ensure a smooth transition in handing over the Intertech reins to their sons? What tools can they use to transfer ownership? What are the implications for waiting as long as they have to address management succession issues? (Chapter 17, LOs 4 and 5) (AACSB: Application of knowledge) Management succession is the act of passing the torch of leadership in an organization. The Stadlens, Art and Ilene, are now confronting succession as they get set to retire from Intertech. To ensure a smooth succession, they have to have a succession plan that encompasses the following: •
Select the successor. The Stadlens have two sons and so this become an important issue.
•
Create a survival kit for the successor.
•
Groom the selected successor.
•
Promote an environment of trust and respect.
•
Cope with the financial realities of estate and gift taxes.
The Stadlens have the following tools to transfer ownership: •
Buy-sell agreement
•
Lifetime giving
•
Setting up a trust
•
Estate freeze
•
Family limited partnership
The Stadlens may have waited too long to develop a succession plan. The implications of this may primarily be that they do it in a quick and slip-shod way that may result in the successor not being quite ready to take over. This may adversely affect the well-being of Intertech.
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Case Solutions, Page 290
Case 6: Bluffton Pharmacy Related Chapters: •
Chapter 12: Creating a Successful Financial Plan
1. Calculate the twelve ratios for Bluffton Pharmacy for this year. (Chapter 12, LO 3) (AACSB: Application of knowledge) RATIO Liquidity Ratios Current Ratio
3.35
Quick Ratio
1.65
Leverage Ratios Debt Ratio
0.75
Debt-to-Net Worth Ratio
3.00
Times Interest Earned Ratio
2.68
Operating Ratios Average Inventory Turnover Ratio
9.55
Average Collection Period Ratio
21.7
Average Payable Period Ratio
5.6
Net Sales to Total Assets Ratio
4.53
Profitability Ratios
.
Net Profit on Sales Ratio
1.74%
Net Profit to Assets Ratio
7.89%
Net Profit to Equity Ratio
31.59%
Case Solutions, Page 291
2. How do the ratios you calculated for this year compare to those for the pharmacy last year? What factors are most likely to account for those changes? (Chapter 12, LO 3) (AACSB: Application of knowledge)
RATIO Percent
Bluffton Pharmacy Current Last Year Year
Pharmacy Industry Median*
Variation from Ind. Median
Liquidity Ratios Current Ratio
3.35
3.41
4.71
-28.9%
Quick Ratio
1.65
1.72
2.42
-31.8%
Debt Ratio
0.75
0.64
0.62
20.4%
Debt-to-Net Worth Ratio
3.00
2.23
2.71
43.0%
Times Interest Earned Ratio
2.68
3.04
3.9
-31.3%
Average Inventory Turnover Ratio
9.55
10.90
11.7
-18.4%
Average Collection Period Ratio
21.7
14.0
15.0 days
44.9%
Average Payable Period Ratio
5.6
5.0
14.0 days
-60.2%
Net Sales to Total Assets Ratio
4.53
4.75
4.68
-3.2%
Net Profit on Sales Ratio
1.74%
1.94%
2.4%
-27.4%
Net Profit to Assets Ratio
7.89%
9.20%
8.2%
-3.8%
Net Profit to Equity Ratio
31.59%
29.21%
48.0%
-34.2%
Leverage Ratios
Operating Ratios
Profitability Ratios
* From Risk Management Association Annual Statement Studies
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Case Solutions, Page 292
The ratio comparisons reveal the following: Liquidity •
The Current Ratio is below that of last year.
•
The Quick Ratio has decreased from last year. Both the liquidity ratios have declined from last year.
Leverage Ratios •
The Debt Ratio is slightly higher than last year.
•
The Debt-to-Net Worth Ratio is higher than last year.
•
The Times Interest Earned Ratio is slightly less than last year. All three indicate an increase in debt and a decrease in debt service ability from last year.
Operating Ratios •
The Average Inventory Turnover Ratio is less than last year.
•
The Average Collection Period Ratio is up from 14.0 last year to 21.7, an increase of more than 7 days. This is a significant concern.
•
The Average Payable Period Ratio is up from last year by less than a day.
•
Net Sales to Total Assets Ratio is down from last year. These ratios convey a mixed message. Some elements of efficiency have improved while others have declined.
Profitability Ratios •
Net Profit on Sales Ratio is down from last year.
•
Net Profit to Assets Ratio is down from last year.
•
Net Profit to Equity Ratio is up from last year. While ROE has improved, the other profitability ratios have gone down.
Downward trends from last year’s performance exist in the areas of leverage, operations, and profitability. Another significant concern is an increase in the collection period. This may be a sign of future difficulties with customers paying late. Liquidity shows a declining trend and is also a cause of concern.
.
Case Solutions, Page 293
3. How do the ratios you calculated for this year compare to those of the typical company in the industry? Do you spot any areas that could cause the company problems in the future? Explain. (Chapter 12, LO 3) (AACSB: Application of knowledge) The ratio comparison reveals: Liquidity •
The Current Ratio is below the industry mean by 28.9%.
•
The Quick Ratio is 31.8% below the industry mean.
Leverage Ratios •
The Debt Ratio is above the industry mean by 20.4%.
•
The Debt-to-Net Worth Ratio is above the industry mean by 43.0%.
•
The Times Interest Earned Ratio is less than last year and below the industry mean by 31.3%.
Operating Ratios •
The Average Inventory Turnover Ratio is 18.4% below the industry mean.
•
The Average Collection Period Ratio is about twice the industry mean.
•
The Average Payable Period Ratio is up slightly from last year and 60.2% better (later payment) the industry mean.
•
Net Sales to Total Assets Ratio is 3.2% below the industry mean.
Profitability Ratios •
Net Profit on Sales Ratio is -27.4% of the industry mean.
•
Net Profit to Assets Ratio is below the industry mean by 3.8%.
•
Net Profit to Equity Ratio below the industry mean by 34.2%.
In summary the year-to-year trends and comparisons to industry ratios reveal the following: Liquidity:
Weak with a decreasing trend.
Leverage:
Low due to disproportionate debt – a potential concern for the future.
Operations: The Average Collection Period Ratio is a significant concern. Inventory turnover is declining and worth watching. Profitability: Profitability is weak compared to industry sales figures, but relatively strong in relation to equity. Problem areas appear in operations, specifically the Average Collection Period Ratio which could erode future profitability. The company shows some positive ratios in comparison to the industry mean figures.
.
Case Solutions, Page 294
4. Develop a set of recommendations for improving the financial performance of Bluffton Pharmacy using the analysis you conducted in questions 1-3. (Chapter 12, LO 3) (AACSB: Application of knowledge) Student recommendations may include a selection from the following:
.
•
Increase prices to account for the increase in cost of goods.
•
Attempt to lock in long term pricing on key inputs in an effort to stabilize future prices.
•
Review operations to look for opportunities to reduce cost of goods sold.
•
Increase attention on collections to reduce collection days.
Case Solutions, Page 295
Case 7: Bluffton Pharmacy, Part 2 Related Chapters: Chapter 13: Managing Cash Flow 1. Develop a monthly cash budget for Bluffton Pharmacy for the upcoming year. (Chapter 13, LO 3) (AACSB: Application of knowledge) Refer to the cash budget on the next page. 2. What recommendations can you offer Angela Crawford and Martin Crawford to improve their pharmacy’s cash flow? (Chapter 13, LO 3) (AACSB: Application of knowledge) Recommendations for Crawford and Rodriguez to improve their company’s cash flow include: •
Conduct a thorough ratio analysis.
•
Review the sales projections with a reality test.
•
Take steps to shorten the accounts receivable time frames.
•
Keep costs of goods under control to protect and potentially improve margins.
•
Look for opportunities to reduce costs in other areas, such as insurance, utilities, travel and supplies.
•
Continue to optimize sales opportunities in the most efficient way possible.
•
Minimize taking on additional debt.
3. If you were Bluffton Pharmacy’s banker, would you be comfortable extending a line of credit to the pharmacy? Explain. Expect students to support their decision regarding the role of the company’s banker. Support the Increase: The business is sound with a solid track record. Increasing the company’s credit line will offer needed cash during a challenging economic time. Access to the additional $100,000 in their credit line will allow them to use for this “as needed” purpose due to seasonal and other fluctuations in sales throughout the year. This will give them the financial room they need to survive this rough spot and find their way to a profitable future. Deny the Increase: Increasing the credit line by $100,000 will not change the trend of the business. This will add to the current concerns of carrying too much debt. Increasing the credit line of this already highly leveraged company may prolong the motivation to efficiently increase sales performance, control costs, protect margins, and optimize profitability. The owners need to step back, take an objective looks at how they can manage the business differently, and work within their existing financial resources.
.
Case Solutions, Page 296
Bluffton Pharmacy”s Next Year Cash Budget November
December
January
February
March
April
May
June
July
August
September
October
November
December
Sales
$272,357
$315,458
$230,402
$237,915
$215,376
$177,810
$175,306
$172,801
$162,784
$167,793
$197,845
$247,932
$255,445
$262,959
$
Credit Sales
$215,162
$249,212
$182,017
$187,953
$170,147
$140,470
$138,492
$136,513
$128,599
$132,556
$156,298
$195,867
$201,802
$207,737
$
Cash Receipts Collections Same Month
$20,022
$20,675
$18,716
$15,452
$15,234
$15,016
$14,146
$14,581
$17,193
$21,545
$22,198
$22,851
Next Month
$158,250
$115,581
$119,350
$108,043
$89,198
$87,942
$86,686
$81,661
$84,173
$99,249
$124,375
$128,144
Two Months
$47,336
$54,827
$40,044
$41,350
$37,432
$30,903
$30,468
$30,033
$28,292
$29,162
$34,385
$43,091
Cash Sales
$
$48,384
$49,962
$45,229
$37,340
$36,814
$36,288
$34,185
$35,236
$41,547
$52,066
$53,644
$55,221
Other Cash Receipts
105
55
60
75
85
55
65
60
65
85
95
110
Total Cash Receipts
$274,096
$241,100
$223,399
$202,260
$178,764
$170,205
$165,549
$161,571
$171,270
$202,107
$234,698
$249,417
$
$244,164
$178,331
$184,146
$166,701
$137,625
$135,687
$133,748
$125,995
$129,871
$153,132
$191,900
$197,715
$
$244,164
$178,331
$184,146
$166,701
$137,625
$135,687
$133,748
$125,995
$129,871
$153,132
$191,900
$197,715
$
Rent
$3,083
$3,083
$3,083
$3,083
$3,083
$3,083
$3,083
$3,083
$3,083
$3,083
$3,083
$3,083
Utilities
$1,049
$1,083
$980
$809
$798
$787
$741
$764
$901
$1,129
$1,163
$1,197
Advertising
$1,150
$1,188
$1,075
$888
$875
$863
$813
$838
$988
$1,238
$1,275
$1,313
Monthly Purchases
$210,804
Cash Disbursements Purchases
Insurance Salaries, Wages, and Benefits
$0
$0
$2,700
$0
$0
$2,700
$0
$0
$2,700
$0
$0
$2,700
$27,404
$27,515
$27,182
$26,627
$26,590
$26,553
$26,405
$26,479
$26,923
$27,663
$27,774
$27,885
Computer System and E-commerce
$1,042
$1,042
$1,042
$1,042
$1,042
$1,042
$1,042
$1,042
$1,042
$1,042
$1,042
$1,042
Repairs and Maintenance
$2,000
$2,000
$2,000
$2,000
$2,000
$2,000
$2,000
$2,000
$2,000
$2,000
$2,000
$2,000
$0
$0
$150
$0
$5,000
$0
$0
$0
$200
$0
$0
$0
Travel Professional Fees Supplies Loan Payments Other Total Cash Disbursements
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$3,900
$644
$665
$602
$497
$490
$483
$455
$469
$553
$693
$714
$735
$2,073
$2,073
$2,073
$2,073
$2,073
$2,073
$2,073
$2,073
$2,073
$2,073
$2,073
$2,073
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$0
$282,610
$216,980
$225,034
$203,720
$179,576
$175,270
$170,360
$162,742
$170,334
$192,052
$231,024
$243,643
Beginning Cash Balance
$74,473
$65,960
$90,080
$88,445
$86,985
$86,172
$81,108
$76,297
$75,126
$76,062
$86,117
$89,791
+ Cash Receipts
$274,096
$241,100
$223,399
$202,260
$178,764
$170,205
$165,549
$161,571
$171,270
$202,107
$234,698
$249,417
-Cash Disbursements
$282,610
$216,980
$225,034
$203,720
$179,576
$175,270
$170,360
$162,742
$170,334
$192,052
$231,024
$243,643
EOM Balance
$65,960
$90,080
$88,445
$86,985
$86,172
$81,108
$76,297
$75,126
$76,062
$86,117
$89,791
Borrow
$
-
$
-
$
-
$
-
Repay
$
-
$
-
$
-
$
-
Final EOM Balance
.
$65,960
$90,080
$88,445
$86,985
$
$86,172
$95,566
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$81,108
$76,297
Case Solutions, Page 297
$75,126
$76,062
$86,117
$89,791
$95,566
$
Surplus/Deficit
.
($8,513)
$24,120
($1,635)
($1,460)
($812)
($5,065)
($4,811)
Case Solutions, Page 298
($1,171)
$936
$10,055
$3,674
$5,775
Case 8: Gitman Brothers
https://www.gitman.com/
Related Chapters: •
Chapter 9: Building a Powerful Bootstrap Marketing Plan
•
Chapter 10: E-Commerce and the Entrepreneur
1. Develop a list of at least five search engine optimization strategies to help Gitman Brothers move up in search engine results. (Chapter 10, LO 3) (AACSB: Application of knowledge) Gitman Brothers can use the following search engine optimization (SEO) strategies: •
Create meaningful, relevant content for each Web page with their customers and their needs in mind.
•
Develop legitimate links from other related sites.
•
Conduct brainstorming sessions to develop a list of keywords and phrases.
•
Use target key words in the title tags (metatags, which are limited to 140 characters) and headline of the company’s Web pages.
•
Encourage social media shares.
2. Write a memo to the managers at Gitman Brothers that outlines the design for a new Web site that will achieve the goals they have established. (Chapter 10, LO 4) (AACSB: Application of knowledge) This is a good assignment for a student team project. They should be asked to look at the section titled “Designing a Killer Web Site” on pages 410-419, including Figure 10.11. 3. Identify at least three specific measures that Gitman Brothers managers can use to evaluate the quality of the company’s Web site upgrade. (Chapter 10, LO 5) (AACSB: Application of knowledge) Web sites offer entrepreneurs a treasure trove of valuable information about how well their web sites are performing. It doesn’t happen automatically, though, they have to take the time to analyze it. Three specific measures in the area of web analytics can be used to evaluate Gitman Brothers Web site upgrade: •
.
Commerce metrics – these are basic analytics, such as sales revenue generated, etc.
Case Solutions, Page 299
•
Visitor segmentation measurements – details about whether customers are new or returning, etc.
•
Process measurements – understanding how their Web site attracts visitors, etc.
4. How can Gitman Brothers use social media to promote its line of quality shirts and ties? (Chapter 9, LO 4) (AACSB: Application of knowledge) Although social media networking sites such as Facebook and Twiter are better known as products that consumers use, they can be used by an organization such as Gitman Brothers as part of their social media strategy. Social networking sites are an ideal type of bootstrap marketing tool because they allow entrepreneurs to market their companies effectively and at little or no cost. Students should be asked to develop a social media strategy for Gitman Brothers that uses tools such as Facebook, Twitter, LinkedIn, and YouTube.
Case 9: Seabreeze Property Services https://seabreezepropertyservices.com/
Related Chapters: •
Chapter 7: Buying an Existing Business
•
Chapter 15: Sources of Financing: Equity and Debt
1. What advantages do business buyers such as the Higginses gain over starting a business “from scratch?” What disadvantages do they typically encounter? (Chapter 7, LO 1) (AACSB: Application of knowledge) The following are the advantages of buying an existing business rather than starting one “from scratch:” •
Successful existing businesses often continue to be successful.
•
Superior location.
•
Employees and suppliers are in place.
•
Installed equipment with known production capacity.
•
Inventory in place.
•
Trade credit is established.
•
The turnkey business.
•
The new owner can use the experience of the previous owner.
.
Case Solutions, Page 300
•
Easier access to financing.
•
High value.
There are, however, disadvantages to buying an existing business, including: •
Cash requirements.
•
The business is losing money.
•
Paying for ill will.
•
Employees inherited with the business may not be suitable.
•
Unsatisfactory location.
•
Obsolete or inefficient equipment and facilities.
•
The challenge of implementing change.
•
Obsolete inventory.
•
Worthless accounts receivable may be worth less than face value.
•
The business may be overpriced.
2. What steps do you recommend the Higginses take to conduct their due diligence on Seabreeze Property Services concerning their seller’s motivation, asset valuation, legal issues, and the company’s financial condition? Do you spot any “red flags” about this potential deal? (Chapter 7, LO 4) (AACSB: Application of knowledge) Due diligence is the process of studying, reviewing, and verifying all of the relevant information concerning an acquisition. They have to look at the following things: •
Why do the owners want to sell? (motivation)
•
What is the real value of Seabreeze’s assets? (asset valuation)
•
What legal aspects of the business are known or hidden risks? (legal issues)
•
Is the business financially sound? (financial condition)
It is important for the Higginses to do each of these systematically and thoroughly. While not exactly “red flags,” there are a number of tricky issues with the deal, all of which concern the informal way the Kellys seem to run their business. This relates to not having a database of customers and to a whiteboard-based scheduling system. 3. Explain the various methods that the Higginses can use to determine a reasonable value for Seabreeze Property Services. (Chapter 7, LO 5) (AACSB: Application of knowledge) There are three basic methods the Higginses can use to determine a reasonable value for Seabreeze Property Services: .
Case Solutions, Page 301
•
Balances sheet method. This involves computing the net worth by deducting liabilities from assets.
•
Earnings approach. This values a business based on its earning potential.
•
Market approach. This uses a market multiple to a company’s earnings.
The Higginses should know that within each of the above three methods there are multiple approaches where each uses a variation. 4. In addition to investing their own money and tapping the capital of family members and friends, what other sources of capital should the Higginses explore if they decide to purchase Seabreeze Properties? (Chapter 15, LO 2) (AACSB: Application of knowledge) The Higginses can get equity from a variety of sources to finance their acquisition of Seabreeze property Services: •
Venture capital firms
•
Seller financing
In the first case, venture capitalists may be attracted because, although this is not a startup, they can see a clear exit in a specified number of years. At this time they should be able to cash out of the deal. The Higginses can approach the Kellys to finance the deal. In effect, the Kellys are getting paid not instantly, but over a period of time. 5. What advice can you offer the Higginses about negotiating a deal with the Kellys to purchase Seabreeze Property Services? (Chapter 7, LO 6) (AACSB: Application of knowledge) The deal stage is a vital part of the acquisition process. Once the Higinses have come up with a valuation for Seabreeze Property Services, they have to approach the Kellys for a deal. The Higginses should know that the structure of the deal – the terms and conditions of payment – is more important than the actual valuation. Figure 7.8, Identifying the Bargaining Zone is a useful tool for the Higginses to follow. They would be well advised to follow the steps in the model to get to a satisfactory conclusion.
.
Case Solutions, Page 302
Case 10: The Newark Nut Company, aka Nuts.com https://nuts.com/ Related Chapters: •
Chapter 5: Crafting a Business Plan and Building a Solid Strategic Plan
•
Chapter 9: Building a Powerful Bootstrap Marketing Plan
•
Chapter 10: E-Commerce and the Entrepreneur
•
Chapter 17: Building a New Venture Team and Planning for the Next Generation
1. What risks are present in Jeff Braverman’s “go big” strategy? What benefits would it produce? How likely is the company to realize those benefits? (Chapter 5, LO 7) (AACSB: Application of knowledge) Jeff Braverman’s strategy of going from a $35 million to a $500 million company is an example of a BHAG – big hairy audacious goal! It’s big – a 1,329 percent jump, its hairy -- adrenaline-fueled but full of risks, and it is audacious – a company that was reduced to almost nothing (down to $1.25 million in sales) to becoming a big company. There are tremendous risks in Braverman’s “go big” strategy because nuts.com, as an online retailer, is going up against Amazon and Walmart. Right now, nuts.com is likely not even on these big companies’ radar but it will be once it hits, say $100 million in sales. Size could produce benefits via economies of scale in operations and in buying power. While opinions may differ, nuts.com may be able to realize these benefits, but it all depends on the reactions of the competitors. 2. Considering the cost-benefit analysis you conducted in question 1, what recommendations can you offer Braverman about the strategic direction in which he should steer Nuts.com? (Chapter 5, LO 7, Chapter 9, LO 4, and Chapter 10, LO 3) (AACSB: Application of knowledge) In terms of the generic strategies, nuts.com is a focused player currently, competing in a small niche. While that is fine for a company with $35 million in sales, the niche may not be big enough to get to $500 million in sales. This means nuts.com has to look at adjoining niches – from nuts to snack products to other product categories. It has to develop marketing strategies that allow it to (a) sell more to existing customers, and (b) get new customers. This calls from both online and offline guerilla marketing strategies.
.
Case Solutions, Page 303
Finally, being an e-commerce player, it has to develop advanced Web analytics to increase its Web traffic and be more effective in converting site visitors to customers. 3. What other strategies, including e-commerce and marketing strategies, should Braverman pursue to increase Nuts.com’s sales, recognizing that reaching $500 million in sales is extremely aggressive? (Chapter 5, LO 7) (AACSB: Application of knowledge) As indicated earlier, nuts.com’s current niche of selling nuts and related snack products may not be large enough to generate $500 million in sales. In addition, this niche may be highly seasonal, if people are buying nuts and snack products primarily as gifts for others during the holiday season. Nuts.com and Jeff Braverman may have to look for adjoining niches to generate the necessary customer traffic to hit the sales target. Operationally, going from $35 million to $500 million poses many challenges in areas such as warehousing, logistics, and manpower. Finally, Braverman has to consider the effect of his BHAG on the company’s financial position, more specifically on its cash flow. 4. Should Braverman sell Nuts.com? Explain. (Chapter 17, LO 5) (AACSB: Application of knowledge) Selling nuts.com, while possible, is an exit strategy. As Jeff Braverman indicates, if he sells nuts.com, he would exit the business as a wealthy man. This is a good question to get students to indulge in role playing. Students can be asked to play the role of various Braverman family members (say, Jeff and his father Kenny, among others) and ponder on the exit strategy from their perspective.
.
Case Solutions, Page 304
SAMPLE SYLLABUS Entrepreneurship (MAN 4802) Section 2, Spring 20XX Prerequisites Junior Standing, MAN 3025, and MAR 3023 Credit Hours: 3 Instructor:
Ms. Kathie K. Holland
Office: BA1, Room 344
Phone: 407-823-5673
Email: kholland@bus.ucf.edu Office Hours: (Other hours by appointment only.) Monday
Tuesday
Wednesday
Thursday
1:30 – 4:30 p.m.
2:30 – 4:30 p.m.
10:30 – 11:30 a.m.
2:30 – 4:30 p.m.
Required Text: Essentials of Entrepreneurship and Small Business Management, 9e. Norman M. Scarborough and Jeff Cornwall. Pearson Education, Inc. 2019. Students will be asked to purchase personal business cards for the individual assignment.
Course Overview and Objectives: MAN 4802 is the foundation course for the Entrepreneurship Learning Track for students majoring in Management, as well as non-business students seeking a minor in Entrepreneurship. Learning objectives include: 1. Determine if entrepreneurship is an appropriate career choice for you. 2. Conduct a feasibility analysis to determine the viability of a business concept and construct a business model. 3. Describe the impact of internal and external environmental factors on management decisionmaking. 4. Conduct research; synthesize market and industry research to identify new business opportunities. 5. Evaluate product or service viability. 6. Describe the advantages and disadvantages of the typical sources of financing. 7. Prepare and analyze a cash flow statement to identify problems and timing of cash infusion. 8. Design an ideal team of founders, advisors, and human resources. 9. Explain typical government regulations impacting a new business. 10. Contrast the legal forms of business ownership.
.
Sample Syllabus, Page 305
11. Identify basic protections for intellectual property. 12. Demonstrate team leadership and show acceptable teamwork. 13. Demonstrate effective verbal and written communication skills. 14. Understand and defend ethical positions related to business ownership. 15. Practice creativity techniques to identify new ventures. 16. Incorporate diversity decisions into human resources and marketing planning. 17. Identify the advantages and disadvantages of franchising. 18. Understand the need for change and manage change effectively. 19. Practice networking and experience the importance of developing business relationships. 20. Prepare for future courses necessary to complete the Entrepreneurship Track and/or Minor.
Learning Methodology: My role as instructor is to teach concepts and processes, provide resources, and coach you. You will learn through self-directed study of the text, limited lecture, and extensive use of in-class and outside of class participative activities such as teamwork, case studies, skill practice, etc. My role in this class is also to share with you the real life challenges and excitement of being an entrepreneur. Be aware that I do not “teach to the test” because you will learn more when I “teach to the project.” You are expected to read the assigned chapters before coming to class in order to be prepared to participate in class discussion and other learning activities. You will learn far more from your team’s efforts to conduct a feasibility analysis and create a business model than you will memorizing terms for an exam. I truly want to make these concepts real to you and not just words in a textbook. Research clearly shows that students learn best through application, analysis, synthesis and evaluation; you will experience problem-based learning as you complete your team’s Feasibility Report and Business Model. Individually and through teamwork you will utilize all six levels of learning: 1. Knowledge - recall and memorization. 2. Understand - ability to paraphrase and interpret information in one’s own words. 3. Apply – use knowledge in a new situation. 4. Analyze - break down knowledge into parts and show interrelationships. 5. Evaluate - make judgments on the basis of given criteria (team). 6. Create – develop something new. Individual Responsibility: You are expected to come to class with the knowledge and understanding of the chapter concepts. You will develop this knowledge by reading the text and Webcourse learning modules. If you do not complete this preparation, you will not be able to contribute to your team’s effort, resulting in a personal deduction from the points your team earned (see Syllabus, Peer Evaluation). The team will not be penalized except that you will not have contributed to their success. Team Responsibility: You are expected to apply your knowledge of chapter and online concepts to a common business-related problem. In order to do so, you must work together to analyze the
.
Sample Syllabus, Page 306
feasibility of a new business concept, evaluate your work and the work of other teams, and create a Business Model.
Course Assignments and Grading: Team Assignments (37.5% of Grade)
Possible Points
New Business Feasibility Report and Business Model
250
Business Model Presentation
50
Individual Assignments (62.5% of Grade) Individual Report
75
Concept Quick Pitch
25
Three Exams:
Exam 1 = 120 points
400
Exam 2 = 120 points Final (Exam 3) = 160 points Total Points A = 800 - 716
B = 715 - 636
800 C = 635 - 556
D = 555 - 476
F = < 476
Grading Guidelines: “A” The student’s work is unusually excellent and superior to the work of others. In addition to meeting all requirements for the assignment, the work contains innovative and creative ideas not found in other students’ papers or presentations. The work demonstrates that the student has done extensive research, included numerous concepts from the text or course, and has invested a tremendous amount of time and effort into the work. There are no structure or grammar errors, the paper reads very smoothly, or the presentation skills are exemplary. “B” The work is very good. In addition to meeting all requirements for the assignment, the work contains well thought out ideas and the student has applied many concepts from the text or course. The work clearly demonstrates the student has done obvious research and has invested significant thought and effort in the paper. The content is nicely structured and grammatically well done, or the presentation skills are very good. “C” The work is good. It meets all the requirements for the assignment and has applied a few concepts from the text and course. The student has probably done basic research even though it is not very obvious. There appears to be a minimum of effort extended to produce the work. The work may have some structural and grammar problems but it is still possible to follow the content without difficulty. The presentation skills are adequate in that the listener is not distracted from the content. “D” The work is below expectations. While it may or may not meet all the basic requirements for the assignment, there is no obvious evidence of any research or effort. Concepts from the text or course are either not obvious or are used incorrectly. Grammar mistakes are so prevalent that it is
.
Sample Syllabus, Page 307
difficult to follow the content. Presentation skills are so poor that the listener cannot follow the content. “F” The work does not meet the basic requirements for the assignment, was not presented, or was not turned in at all.
Description of Assignments: New Business Feasibility Report and Business Model – Up to 250 Points Teams will work together to conduct business research and prepare a formal written report. Download the “Feasibility Report Instructions and Grade Sheet” document from my Webcourse and attach the Grade Sheet as the cover page of your paper. Your report must be submitted to Turnitin.com before you turn in the hard copy. The instructions for Turnitin.com can be found in our Webcourse. Refer to the “Paper and Presentation Grading Guidelines” in this syllabus to determine the level of effort needed to earn the grade you hope to earn. The team is required to turn in a formal memorandum the end of Week 3. Include: •
The type of business concept you have selected for your Report and Presentation.
•
Explain why you chose this type of business concept, and the preliminary research you have conducted to determine that it is NOT already in existence.
•
Identify the students on your team, and the name of your team’s business.
•
Include your team’s Project Action Plans (form in Webcourses) to identify which person is assigned to each section of the project, when each task/item is to be completed, and your estimated timeline for each task.
•
Include your Team Contract (sample form in Webcourses).
Use the proper format for a memorandum (sample in Webcourses) and proofread your work. Be sure to demonstrate exceptional writing skills. Staple all documents together in the upper left corner. Failure to turn in these documents will result in a 50-point deduction from your Feasibility Report. Poor writing skills will result in a three-point deduction for each error. NOTE: In order to achieve a successful Feasibility Report you are strongly advised to use the project management techniques to plan how your team will complete the required tasks in a timely manner. Conducting a feasibility study is a project! Business Model Presentation – Up to 50 Points Teams will work together to give a formal presentation of their business model. Download the “Presentation Instructions and Grade Sheet” document from our Webcourse. Turn in a “handout” copy of your PowerPoint slides with the Grade Sheet attached. Refer to the “Paper and Presentation Grading Guidelines” in this syllabus to determine the level of effort needed to earn the grade you want.
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Individual Report – Up to 75 Points Each student will complete either a Networking Report OR an Entrepreneur Interview Report. Both assignments require you to purchase business cards. Check with local printers as well as online. •
Networking Report. If you choose this for your individual report you will attend a business meeting such as a chamber of commerce function, business leads group, or other businessrelated networking meeting, and then submit a report on your experience. You must obtain my written approval of the meeting before you attend or your report will receive a 0. You are expected to practice your networking skills and meet a minimum of five (5) people. Review information in the text about networking. Download the “Networking Instructions and Grade Sheet” document from our Webcourse. Refer to the “Grading Guidelines” in this syllabus to determine the level of effort needed to earn the grade you want. This report must be submitted to Turnitin.com (instructions are in our Webcourse). If you neglect to comply with any of these requirements you will receive a 0. You may attend an event as a team or in smaller groups, but each student is expected to individually practice networking with five different people. If you do not collect five different business cards to use in your report, then you must attend additional networking events until you have collected a total of five business cards that are different from any other student in this class. Do not procrastinate on this; get started early in the term! Refer to the calendar on the last page of this syllabus for the due date.
•
Entrepreneur Interview Report. If you choose this for your individual report you will make an appointment and interview a successful entrepreneur, and then write a report on your experience. (See the instructions for the criteria for “successful.”) You may conduct your interview accompanied by one other student if you choose, but each student must write their report independently. Download the complete instructions found in our Webcourse. This report must be submitted to Turnitin.com (instructions are in our Webcourse). Refer to the “Grading Guidelines” in this syllabus to determine the level of effort needed to earn the grad you want.
Concept Quick Pitch – Up to 25 Points Each student will prepare and deliver a one-minute presentation to the class to inform and persuade the class of the viability of a new business concept. Additional information will be provided in class and in our Webcourse. Three Exams – Up to 400 Points At the conclusion of specified chapters students will take a multiple-chapter exam in the Testing Center in BA 1, room 104. Questions may include multiple choice, true/false, and essay. You are responsible for understanding all the information in the chapters regardless of whether it is discussed in class or not. Since the University and the College of Business Administration require a final exam that covers the concepts of the entire course, Exam 3 will include questions from all chapters covered during the term and will take place as determined by the Final Exam Schedule. Make up exams are only given for excused absences (see Attendance Policy). If you must miss an exam, the make up exam must be taken before returning to class. If the exam is not made up within one week after it was scheduled, you will be penalized the equivalent of one letter grade
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on that exam for each class period that goes by until it is made up. Exceptions to this policy may be made in the case of serious illness or other documentable excuses. Extra Credit (Up to 20 points) Extra credit offered during the term is designed to insure that all students have equal access and that it is relevant to the subject matter and learning objectives of the course. Up to 20 points will be awarded to individual students who compete in the King of the Court Quick Pitch Competition offered by the Center for Entrepreneurship and Innovation (CEI). You must submit an application, be chosen to present, and actually present during the competition. The application deadline is [month, day, year].
Forming Teams and Choosing a Business: Early in the term you will be encouraged to network and get to know your fellow students in order to decide who you want on your team. Teams will have five students. Type of Business: The team will choose a type of business that you want to use for the Feasibility Report. This business must be legal, moral, and ethical. Students must exercise creativity in identifying unique business concepts. The product or service must be innovative; either a completely new product or service, or a dramatically improved product or service. Do NOT choose a business concept until we have covered chapter three in our text. Typical businesses such as restaurants, sports bars, or hair salons are not acceptable unless you find a way to dramatically differentiate it from competitors. The goal is for you to analyze the feasibility of any type of business by teaching you how to use the feasibility analysis tool; once you have learned how to conduct a feasibility study in our class you will be able to use it to analyze any kind of business product or service in the future. A well-researched and written feasibility report and business model will receive a high grade regardless of whether the business concept is feasible or not. My goal is that you learn how to conduct a feasibility study and prepare a business model.
Protocols: Academic Honesty - All students are considered to be honest and ethical until proven otherwise. Ethical behavior is extremely important for tomorrow’s managers and must be fine-tuned in college. As reflected in the University’s creed, integrity and scholarship are core values that should guide our conduct and decisions as members of the university community. Plagiarism and cheating contradict these values, and so are very serious academic offenses. Penalties can include a failing grade in an assignment or in the course, or suspension or expulsion from the university. Students are expected to familiarize themselves with and follow the University’s Rules of Conduct (see http://www.osc.sdes.ucf.edu/). In this course when academic misconduct is evident in a student’s or students’ actions or submitted work, the procedure is as follows: 1. The student will be confronted, in person or via email, about the academic misconduct.
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2. The student will be asked to provide a signed statement explaining the incident of academic misconduct. 3. The student will receive the letter grade “F” for the assignment for the first incident of academic misconduct. 4. The student will receive the letter grade “F” for the course for any additional incidents of academic misconduct in the course. a. If there are multiple incidents of academic misconduct in the same submission, then these incidents will be considered to be separate incidents of academic misconduct and the student will receive the letter grade “F” for the course. 5. Every incident of academic misconduct, a referral to Office of Student Conduct will be filed. If submitted work is submitted by a group, each and every group member is subject to the same sanctions as for an individual. Cheating on exams is considered to be the unauthorized use of information from any source other than what is in your brain. Attendance/Absences – Students can accumulate five (5) unexcused classroom meetings without penalty. Absences can be excused by presenting written documentation such as doctor’s notes, funeral notices, or other formal written documents describing a compelling reason for you to miss class. Having to work is typically not considered an excused absence. Documentation must be submitted prior to the final exam; it will not be accepted after the final exam. Beginning with your sixth (6) unexcused absence, you will be penalized 10% of your total points for each unexcused absence. You must attend the entire class period (be on time and stay until the end) and sign your signature on every attendance sheet provided in the classroom during the class period on that date, and must take each exam as scheduled. It is the student’s responsibility to sign your signature on the attendance sheet; if it is not passed to you, you must ask to sign it before you leave class. Availability and the Try Three Places Rule - In addition to regular office hours and scheduled appointments, you can expect me to respond to your telephone calls and email messages within 24 hours during weekdays unless there is a compelling reason for a longer delay. Each team is encouraged to meet with me at least once during the term to review the team’s progress. While I try to be very accessible to your needs, I need your help, too. I respectfully ask that you attempt to find the answers to your questions in at least three places before you contact me. The answer to your question may be in your text, online, on a website, in this syllabus, from a team member, or easily available through minor research. If you can’t find an answer after three tries, then by all means contact me. When you call or email me, expect me to ask you for the three places that you looked for the information you need. Cell phones, Laptops, Tablets, and Tape Recorders – These and other types of electronic equipment may be used in the classroom if used for course purposes. If used for purposes other than tasks directly related to our course they are not welcome in our classroom as they are distracting or disruptive to others. Only appropriate use of laptops, tablets, and cell phones is permitted in the classroom. This includes taking class notes when it appropriate to do so.
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Unacceptable laptop, tablet, and smart phone usage includes Internet surfing unrelated to the course, checking e-mail, instant messaging, playing games and working on unrelated assignments to name a few. Inappropriate laptop, tablet, or cell phone usage will result in the student’s loss of this privilege for the remainder of the semester. Disability Access The University of Central Florida is committed to providing reasonable accommodations for all persons with disabilities. This syllabus is available in alternate formats upon request. Students with disabilities who need accommodations in this course must contact the professor at the beginning of the semester to discuss needed accommodations. No accommodations will be provided until the student has met with the professor to request accommodations. Students who need accommodations must be registered with Student Disability Services, Student Resource Center Room 132, phone (407) 823-2371, TTY/TDD only phone (407) 823-2116, before requesting accommodations from the professor. Grades and Statute of Limitations – The grades you earn will be posted online in our Webcourses. I cannot give out grades either over the telephone or by email due to privacy issues. Understand that grades posted online in Webcourses are unofficial, and are subject to change due to poor participation, excessive absences, or poor peer evaluations. Students have 2 weeks from the time a grade is posted in Webcourses to seek any changes to it. After that point, the grade is final and will not be changed for any reason. It is imperative to be currently informed of your grades and not wait until the end of the semester to seek a change. Information to Include on Assignments and Communications – Help me to identify you by always including the following information on every assignment, exam, telephone call, and email message: •
Your name
•
Your team name
•
This course number (MAN 4802)
Never include your Social Security number on any assignment or message. Late Assignments Any assignment turned in late will lose the equivalent of one letter grade for each 24 hours that it is late, including holidays and weekends. Participation – includes your active participation in activities and exercises, questioning, professionalism, and contributions to discussions. Students who are frequently late, leave before the end of class, act unprofessionally, are disruptive, or are unprepared for class will also lose participation points. Students can lose up to 20% of their total points due to poor participation. Peer Evaluation – Your Peer Evaluation scores will determine the percentage of the team’s project points that will be awarded to you. Typically, if your peers rate your contributions at less than 90% of the available peer points, you will lose so many points that your final grade is lowered. Warning: in extreme cases where the team member did very little , the person could receive an F on the project even though the team’s project grade was an A. To ensure this does not happen, read the chapters before class and comply with your team’s contract. Download the Peer Evaluation form from my Webcourse, fill it out and seal it in an envelope addressed to me. See the calendar page of this syllabus for the due date.
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Professionalism – You are expected to act in a professional manner in all of your interactions related to this course; with your fellow students, with me, and with people in the community you meet as you accomplish your assignments. Professional social behavior, in terms of what is considered correct or unacceptable, is extremely important. Unprofessional actions include being late, leaving early, sleeping, reading for pleasure, working on outside assignments and excessive talking. Violators will be asked to leave the class and may be further penalized. Students who are rude, disrespectful, unprofessional, or impolite will lose participation points. In the event of a disagreement or misunderstanding, students must carefully and respectfully follow conflict management processes with the intent of clarifying issues instead of exhibiting anger, sarcasm, or impatience. When you meet entrepreneurs and others in the community for your individual assignment, remember that you represent UCF and the College of Business Administration, so professional business behavior is extremely important. Religious Observances Any student who must miss a test or an assignment due date in accordance with religious observances should contact me as soon as possible (and certainly before the event) so that alternative plans can be arranged. Team Cohesiveness - Unfortunately some teams are unable to be productive because one person does not live up to the team’s contract. Too often the other members suffer silently while they watch their grades go down because they dislike confrontation – even constructive confrontation. Learning to confront a person for their poor performance is a skill that will be used time and again by entrepreneurs, so you are encouraged to practice this skill as soon as a problem arises. The sooner you “constructively” confront a person, the more likely it is that their performance will improve and the relationship (and your grade) can be salvaged. Re-read the policy about professionalism before you confront anyone. A non-productive team member may be “terminated” from your team as a last resort, but only if the team first takes the following steps. 1. Conduct a “constructive confrontation” with your team member. If this fails, advance to step two. 2. Meet with me to discuss the problem(s), and review the steps you have taken to resolve the problem. 3. If I agree you have completed extensive efforts to resolve the situation, then you will write a memorandum to the member explaining why the team is terminating him/her. A copy of this memo must be submitted to me before giving it to your team member. Text – Since my lecture, the exams, and the Feasibility Report and Business Model are based on the text, you are expected to read the assigned chapters before coming to class in order to be prepared for in-class activities. Bring your text to class every day, as we will use it extensively. The majority of your exam questions are based on the text. Webcourses – Our online Webcourse is used for discussions, supplemental materials, and for you to monitor the grades you earn. You can access Webcourses at [link]. It is important that you track your grades throughout the term; refer to the policy on the Statute of Limitations. NOTE: The instructor may change the calendar and assignments as needed.
Students are responsible to verify assignments and due dates.
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Course Calendar MAN 4802 Entrepreneurship, Term/Year
Week
Tuesday
Thursday
1
1-12: Course Introduction
1-14: Chapter 1
2
1-19: Chapter 2
1-21: Form Teams.
3
1-26: Chapter 3
1-28: Chapter 4 Team Memorandum Due
4
2-2: Chapter 5
2-4: Chapter 5, continued
5
2-9: Concept Quick Pitch
2-11: Concept Quick Pitch, continued
6
2-16: Chapter 6
2-18: Exam 1
7
2-23: Chapter 7
2-25: Chapter 8
8
3-2: Chapter 9
3-4: Chapter 10
Entrepreneur Interview Report Due
(3-5 Deadline to Withdraw)
March 8 – 12 Spring Break
9 10
3-16: Chapter 10 continued
3-18: Exam 2
11
3-23: Chapter 11
3-25: Chapter 12
12
3-30: Chapter 13
4-1: Chapter 14
Networking Report Due 13
4-6: Chapter 15
4-8: Chapters 16,17
14
4-13: Team Presentations
4-15: Team Presentations
15
4-20: Team Presentations
4-22: Team Presentations
Feasibility Report & Business Model Due
Deadline for Peer Evaluations
16
Comprehensive Final Exam Open 4-27 through 5-1. Note: Final Exam Closes at 11:00 in the Morning!
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SECTION I. THE CHALLENGE OF ENTREPRENEURSHIP CHAPTER 1. THE FOUNDATIONS OF ENTREPRENEURSHIP
Part 1: Learning Objectives 1. Define the role of the entrepreneur in business in the United States and around the world. 2. Describe the entrepreneurial profile. 3-A. Describe the benefits of entrepreneurship. 3-B. Describe the drawbacks of entrepreneurship. 4. Explain the forces that are driving the growth of entrepreneurship. 5. Explain the cultural diversity of entrepreneurship. 6. Describe the important role that small businesses play in our nation’s economy. 7. Put failure into the proper perspective. 8. Explain how an entrepreneur can avoid becoming another failure statistic. 9. Discover how the skills of entrepreneurship, including critical thinking and problem solving, written and oral communication, leadership, creativity, and ethics and social responsibility, apply to every career choice and every avenue of life.
Part 2: Class Instruction The World of the Entrepreneur
LO 1
Around the world growing numbers of people are realizing their dreams of owning and operating their own business. Entrepreneurship is thriving and is essential to a strong global economy. Downsizing by large companies has resulted in a new population of entrepreneurs. Today small companies have the competitive advantage as they can move faster to exploit market opportunities and use modern technology to quickly create products and service that once took years. A study by the Global Entrepreneurship Monitor (GEM) found that 68 percent of working adults around the world perceive entrepreneurs as having high status. Eastern European countries, China, Vietnam, and other nations whose economies were state– .
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controlled and centrally planned now hold potential for entrepreneurs. (Refer to Figure 1.1 and Table 1.1)
What Is an Entrepreneur?
LO 2
An entrepreneur is one who creates a new business in the face of risk and uncertainty for the purpose of achieving profit and growth by identifying significant opportunities and assembling the necessary resources to capitalize on them. Although many people come up with great business ideas, most never act on their ideas. One reason the U.S. economy has been so successful over time is the constant churn that results from the rapid pace at which entrepreneurs create new businesses, destroy old ones, and upend entire industries with their creativity and ingenuity. (Refer to Figure 1.2) Studies have identified several characteristics entrepreneurs tend to exhibit, but none of them has isolated a set of traits required for success. A brief summary of the entrepreneurial profile includes: 1. Desire for responsibility 2. Preference for moderate risk (risk eliminators) 3. Willingness to break rules 4. Self-reliance 5. Confidence in their ability to succeed 6. Determination 7. Desire for immediate feedback 8. High level of energy 9. Competitiveness 10. Future orientation. Opportunity entrepreneurs start businesses because they spot an opportunity in the marketplace. Necessity entrepreneurs start businesses because they cannot find work any other way. Serial entrepreneurs repeatedly start businesses and grow them to a sustainable size before striking out again. 11. Skill at organizing 12. Value of achievement over money Other characteristics of entrepreneurs include: High degree of commitment Tolerance for ambiguity .
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Creativity Flexibility Resourceful. Bootstrapping is a strategy that involves conserving money and cutting costs during start-up so that entrepreneurs can pour every available dollar into their businesses. Willingness to work hard Tenacity Entrepreneurs are not of one mold; no one set of characteristics can predict who will become entrepreneurs and whether they will succeed. Diversity seems to be a central characteristic of entrepreneurs. Anyone can become an entrepreneur. It is a practical discipline; it is a skill that most people can learn. (Refer to Figure 1.3) Consider using You Be the Consultant: “Making the Most of an Opportunity,” or You Be the Consultant: “Decoding the DNA of the Entrepreneur” at this point.
The Benefits of Entrepreneurship
LO 3A
The primary benefits entrepreneurs enjoy include the: Opportunity to Create Your Own Destiny Opportunity to Make a Difference. Social entrepreneurs use their skills not only to create profitable businesses, but also to achieve economic, social and environmental goals for the common good. Opportunity to Reach Your Full Potential Opportunity to Reap Impressive Profits Opportunity to Contribute to Society and Be Recognized for Your Efforts Opportunity to Do What You Enjoy and Have Fun at It
The Potential Drawbacks of Entrepreneurship LO 3B With these potential rewards, entrepreneurship also presents risk and uncertainty. Individuals who prefer the security of a steady paycheck, a comprehensive benefits package, a two-week paid vacation, and the support of a corporate staff probably should not go into business for themselves. Entrepreneurs may experience: .
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Uncertainty of Income: The entrepreneur is the last one to be paid, as employees must be paid first. While it is possible for an entrepreneur to earn more working for themselves, their may end up earning less. Risk of Losing Your Entire Investment Long Hours and Hard Work Lower Quality of Life Until the Business Gets Established High Levels of Stress Complete Responsibility Discouragement
Behind the Boom: What’s Feeding the Entrepreneurial Fire
LO 4
Some of the most significant factors that have led to this age of entrepreneurship include: •
Entrepreneurs as heroes
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Entrepreneurial education
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Demographic factors. See Figure 1.4 for global entrepreneurial activity by age group.
•
Shift to a service economy
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Technology advancements
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Independent lifestyle
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Outsourcing
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The Internet, cloud computing, and mobile marketing. Cloud computing: Internet-based subscription or pay-per-use software services that allow business owners to use a variety of business applications, from database management and inventory control to customer relationship management and accounting. (Refer to Figure 1.5)
•
International opportunities. Micromultinationals are small companies that operate globally from their inception.
Consider using You Be the Consultant: “College: The Ideal Place to Launch a Business” at this point.
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The Cultural Diversity in Entrepreneurship
LO 5
Entrepreneurs are found virtually every walk of life and include: Young Entrepreneurs Women Entrepreneurs. (Refer to Figure 1.6.) Minority Enterprises. (Refer to Figure 1.7.) Immigrant Entrepreneurs Part-Time Entrepreneurs Home-Based Businesses Family Businesses. Family-owned business includes two or more members of a family with financial control of the company. Copreneurs. Copreneurs are entrepreneurial couples who work together as co-owners of their businesses. Corporate Castoffs Encore Entrepreneurs Retiring Baby Boomers. (Refer to Figure 1.8)
The Power of “Small” Business
LO 6
Because big business is more visible than small business, most people underestimate the role of the small firm in the U.S. economy. Approximately 99.7 percent of all businesses in the United States are considered small. While there is no universal definition of what constitutes a small business, a common delineation of a small business is one that employs fewer than 100 people. The majority of small companies are concentrated in the service, construction and retail industries. (Refer to Figure 1.9) Small companies account for 43 percent of total private payroll in the United States. Small businesses actually create more jobs than do big businesses. Between 1993 and 2013 small companies created 63 percent of the net new jobs in the U.S. economy. Gazelles are small companies that are growing at 20 percent or more per year with at least $100,000 in annual sales; they create 70 percent of net new jobs in the economy.
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Putting Failure into Perspective
LO 7
Because of their limited resources, inexperienced management, and lack of financial stability, small businesses suffer relatively high mortality rates. Two years after start-up, 21 percent of small companies have failed, and after five years, 51 percent have failed. (Refer to Figure 1.10) Entrepreneurs recognize that failure is likely to be part of their lives, but they are not paralyzed by that fear. Failure is an inevitable part of being an entrepreneur, and true entrepreneurs don’t quit when they fail. One hallmark of successful entrepreneurs is the ability to fail intelligently, learning why they failed so that they can avoid making the same mistake again. Success requires both persistence and resilience, the ability to bounce back from failure. The following material in this section is in addition to the text. The Ten Deadly Mistakes of Entrepreneurship Studies have indicated that there are common reasons for new business ventures to fail. These causes of small business failure may include: 1. Management mistakes 2. Lack of experience 3. Poor financial control 4. Weak marketing efforts 5. Failure to develop a strategic plan 6. Uncontrolled growth 7. Poor location 8. Improper inventory control 9. Incorrect pricing 10. Inability to make the “entrepreneurial transition”
How to Avoid the Pitfalls
LO 8
Ways to avoid becoming another failure statistic and gain insight into what makes a successful business include: .
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Know Your Business in Depth Build a Viable Business Model – and Test It Use Lean Start-up Principles Know When to Pivot Develop a Solid Business Plan Manage Financial Resources Understand Financial Statements Build the Right Team Learn to Manage People Effectively Set Your Business Apart from the Competition Maintain a Positive Attitude
Developing Skills for Your Career LO 9 The skill sets that are desired by employers that are a part of this book include: Critical Thinking and Problem Solving Written and Oral Communication Teamwork and Collaboration Leadership Creativity Ethics and Social Responsibility
Conclusion Entrepreneurs are a key part of America’s free enterprise system, and as we will discover, are changing the business of the world as well. Their contributions are as many and as diverse as the businesses themselves. There are steps that entrepreneurs can take to .
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enhance the probability of their success. The remainder of this book will explore the steps to launch a successful business. This course emphasizes establishing a clear understanding of the entrepreneurial environment and using that information to build a sound business plan.
Part 3: Chapter Exercises You Be the Consultant: Making the Most of an Opportunity 1. What benefits do these entrepreneurs gain from owning their businesses? What risks did these entrepreneurs take when they started their companies? (LO 3-A) (AACSB: Reflective thinking) The students should answer in two parts. First, they should mention the benefits of being an entrepreneur. For example, some benefits both Sihah and Khaled gained were the opportunity to create destiny, the chance to make a difference and contribute to society, recognition, and praise. Second, the students should mention the challenges/risks of entrepreneurship. For example, since both these entrepreneurs are focussing on social objectives and trying to bring changes to established norms and traditions in their societies, they are likely to face challenges like high levels of stress, discouragement, and ridicule. 2. Explain how these entrepreneurs exhibit the entrepreneurial spirit. (LO 3-B) (AACSB: Application of knowledge) The answer should be linked to the content on the characteristics displayed by the entrepreneurs. For example, the most important trait that makes an entrepreneur successful, the ability to spot a busines opportunity from their everyday lives and the lives of people around them. Both Sihah and Khaled get motivation from the problems faced by their friends and family. This also displays other important traits, such as the desire for responsibility, confidence in their ability to succeed, and determination. 3. How do both Sihah and Khalid display entrepreneurial skills that do not only focus on the profitability of the businesses but also on other goals? Explain your answer. (LO 3-B) (AACSB: Application of knowledge) The student should be able to look at other goals and objectives that can motivate entrepreneurs – the concept of ‘Social entrepreneurs’; ‘Triple bottom-line.’
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You Be the Consultant: Decoding the DNA of the Entrepreneur 2. How do the characteristics at the model’s nucleus—opportunistic mindset and tolerance of risk and failure—fit together in the entrepreneur’s mind? (LO 2) (AACSB: Reflective thinking) The internal locus of control describes an entrepreneur’s willingness to accept risk and failure, blended with his or her ability to identify opportunities that others might miss. Entrepreneurs understand that problems create opportunities for those who are prepared to capitalize on them. Entrepreneurs recognize risks and the potential for failure, but take steps to reduce risks by preparing themselves well. 4. Work with a team of your classmates to interview at least one entrepreneur. Does he or she fit the model described here? Explain, giving specific examples from your interview. (LO 2) (AACSB: Application of knowledge) Expect students to discuss their entrepreneur’s attitudes about risk and failure, as well as how the entrepreneur recognized the opportunity that paved the way for their business’ success. Ideally students will ask interview questions about the entrepreneur’s vision, flexibility, customer focus, quality of products and services, leadership, passion for their business, innovations, teamwork, and resilience in the face of adversity.
You Be the Consultant: “College: The Ideal Place to Launch a Business” 1. One venture capitalist says that entrepreneurship can’t be taught in a regular classroom any more than surfing can. His view is that students should get their feet wet in the real world of entrepreneurship. What do you think? (LO 9) (AACSB: Analytical thinking) While students may have different opinions on this, they should consider the following point: by taking one or more entrepreneurship courses in college, students benefit from what we already know about various aspects of entrepreneurship. They can eliminate common mistakes that lead to failure, they can sound out their classmates and their instructor on the viability of their business idea, and can identify venture team members from among their classmates. Besides, most entrepreneurial programs these days include many practical elements – pitch competitions, incubators – that combine classroom learning with practical experience. 2. In addition to the normal obstacles of starting a business, what other barriers do collegiate entrepreneurs face? (LO 4) (AACSB: Analytical thinking) .
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One of the most significant barriers college students face is their inexperience. The learning curve these college students face may be challenging. In addition, their youth may not be taken seriously when working with older business people and engaging in business transactions. Securing financing may prove to be an example of this. 3. What advantages do collegiate entrepreneurs have when launching a business? (LO 4) (AACSB: Analytical thinking) Many young entrepreneurs are technically proficient, are energetic, have an intimate understanding of their peer market, and may be highly creative in identifying market needs and solutions. This group also brings a fresh viewpoint and an ability to see beyond obstacles. 4. What advice would you offer a fellow college student who is about to start a business? (LO 4) (AACSB: Reflective thinking) Suggest students review the advice found in the “Hands On… How To” feature on page 36 and 37. •
Know your business in depth. Conduct thorough research and demonstrate an understanding of the critical needs of the market and the business. Maintain a positive attitude. Seek counsel from more experienced entrepreneurs.
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Build a viable business model and test it, and develop a solid business plan. Set your business apart from the competition. Identify areas of need.
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Understand financial statements, and manage financial resources.
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Learn to manage people effectively.
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Take action to build credibility. Leverage resources to build understanding.
5. Work with a team of your classmates to develop ideas about what your college or university could do to create a culture of entrepreneurship on your campus or in your community. (AACSB: Analytical thinking) Encourage students to list ideas that may help to build entrepreneurial resources. This list might include:
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Bring guest speakers to campus
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Create an entrepreneurial mentorship or internship programs
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Establish an entrepreneurship club
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Host a business plan, big idea, or business model competition
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Explore options to expand entrepreneurship courses offered
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Part 4: Chapter Discussion Questions 1-1. What forces have led to the boom in entrepreneurship in the United States and around the globe? (LO 4) (AACSB: Reflective thinking) Forces that have influenced the U.S. entrepreneurial boom include: •
Entrepreneurs are regarded as heroes
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Entrepreneurship education is extremely popular
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Demographic and economic factors
•
Shift to a service economy
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Technology advancements
•
Independent lifestyle
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The Internet, cloud computing, and mobile marketing
•
International opportunities
1-2. What is an entrepreneur? Give a brief description of the entrepreneurial profile. (LO 2) (AACSB: Reflective thinking) An entrepreneur is one who creates a new business in the face of risk and uncertainty for the purpose of achieving profits and growth by identifying significant opportunities and assembling the necessary resources to capitalize on them. The entrepreneur has a: •
Desire for responsibility
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Preference for moderate risk (risk eliminators)
•
Self-reliance
•
Confidence in their ability to succeed
•
Determination
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Desire for immediate feedback
•
High level of energy
•
Future orientation (serial entrepreneurs)
•
Skill at organizing
•
Value of achievement over money
In addition, other characteristics of an entrepreneurial profile include: • .
High degree of commitment Chapter 1, Page 11
•
Tolerance for ambiguity
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Creativity
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Flexibility
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Resourceful
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Willingness to work hard
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Tenacity
1-3. Coming up with great business ideas may seem easy, but only a true entrepreneur capitalizes on them to turn them into reality. Why are they considered an important agent of change in this global economy? (AACSB: Analytical thinking) Entrepreneurs are important agents of change in the global economy because they reinvigorate staid industries using fresh new business models that spot market opportunities. 1-4. What are the major benefits of business ownership? (LO 3 A) (AACSB: Reflective thinking) Major benefits of business ownership include the opportunity to: •
Create your own destiny
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Make a difference
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Reach your full potential
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Reap impressive profits
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Contribute to society and be recognized for your efforts
•
Do what you enjoy and have fun at it
1-5. Which of the potential drawbacks to business ownership are most crucial? (LO 3 B) (AACSB: Reflective thinking) The most crucial drawbacks to business ownership may include the:
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Uncertainty of income
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Risk of losing your entire investment
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Long hours and hard work
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Lower quality of life until the business gets established
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High levels of stress
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Discouragement
1-6. Describe the small business failure rate. (LO 7) (AACSB: Reflective thinking) Many small businesses have inexperienced management and lack financial stability. These businesses suffer a mortality rate significantly higher than that of larger, more established businesses because of managerial inexperience and the limited resources available to support the business when it is in need of cash. 1-7. One hallmark of successful entrepreneurs is the ability to “fail intelligently.” How can an entrepreneur do so? (AACSB: Reflective thinking) Entrepreneurs can “fail intelligently” by learning why they failed so that they can avoid making the same mistake again. Success requires both persistence and resilience, the ability to bounce back from failure. 1-8. Identify the different types of entrepreneurs. (AACSB: Reflective thinking) Young entrepreneurs, women entrepreneurs, minority enterprises, immigrant entrepreneurs, part-time entrepreneurs, home-based businesses, family businesses, copreneurs, corporate castoffs, encore entrepreneurs, and retiring baby boomers. 1-9. How can the small business owner avoid the common pitfalls that often lead to business failures? (LO 8) (AACSB: Reflective thinking) Ways to avoid becoming another failure statistic and gain insight into what makes a successful business include: •
Know your business in depth
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Build a viable business model – and test it
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Develop a solid business plan
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Understand financial statements
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Manage financial resources
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Learn to manage people effectively
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Set your business apart from the competition
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Maintain a positive attitude.
1-10. Assuming that they are aware of all the aspects of their business, how can small business owners study a business in depth? (AACSB: Reflective thinking) To study a business in depth, a small business owner needs to conduct thorough research and demonstrate an understanding of the critical needs of the market and the business. They also need to maintain a positive attitude and seek counsel from more experienced entrepreneurs. .
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1-11. Who are serial entrepreneurs? (AACSB: Reflective thinking) Serial entrepreneurs are entrepreneurs who repeatedly start businesses and grow them to a sustainable size before striking out again. 1-12. How does cloud computing allow an entrepreneur to build their company without incurring high overhead costs? (AACSB: Application of knowledge) Cloud computing is an Internet-based subscription or pay-per-use software service that allows business owners to use a variety of business applications, from database management and inventory control to customer relationship management and accounting, while eliminating the costs of maintaining them. 1-13. What might be one of the main reasons for youngsters to be involved in business? (AACSB: Application of knowledge) The top five reasons young people want to start their own businesses include the opportunity to use their skills and abilities, building something for their future, being their own bosses, earning lots of money, and seeing their ideas realized. 1-14. If one is planning to venture into business, what is the most crucial ingredient in preparing for a successful business? (AACSB: Application of knowledge) The answer may vary as it is based on opinion; however, for any entrepreneur, a wellwritten business plan is a crucial ingredient in preparing for business success. Without a sound business plan, a company merely drifts along without any real direction.
Part 5: Case Studies The following text case complements lecture and assignments for the topics presented in this chapter. •
Case 2: Bark & Co.
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics. You may consider searching “entrepreneur,” “small business” along with more specific topics. •
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Eye to Eye: Richard Branson 7:10 minutes http://www.youtube.com/watch?v=Q6hILGfbqSg&feature=PlayList&p=3BE9FC Chapter 1, Page 14
907D0E88E9&index=33 •
Growing a Woman’s Security Biz 3:40 minutes http://money.cnn.com/video/fsb/2008/10/13/fsb.makeover.picore.smb/
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The Most Successful Small Business in the World http://www.youtube.com/watch?v=YtkV6bZB8ZY
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Fireworks Business Is ‘Booming’ for Santores Despite Recession 2:58 minutes http://www.youtube.com/watch?v=QNTKaYQiB8c
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Richard Branson Advice to Entrepreneurs http://www.youtube.com/watch?v=VH35Iz9veM0
4:03 minutes
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Sunrise – Young Entrepreneurs Making Millions http://www.youtube.com/watch?v=3LEprgHwv9o
4:35 minutes
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Advice for Young Entrepreneurs: How to Be Taken Seriously http://www.youtube.com/watch?v=YcbwbCgB0-U
3:20 minutes
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Mark Cuban’s 12 Rules for Start-Ups http://www.youtube.com/watch?v=camXWnD4QcI
2:18 minutes
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Matt and Jessica Flannery – Kiva.org http://www.youtube.com/watch?v=YNA4Fi11ycM
8:01 minutes
10:41 minutes
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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CHAPTER 2. ETHICS AND SOCIAL RESPONSIBILITY: DOING THE RIGHT THING
Part 1: Learning Objectives 1. Define business ethics and describe the three levels of ethical standards. 2. Determine who is responsible for ethical behavior and why ethical lapses occur. 3. Explain how to establish and maintain high ethical standards 4. Explain the difference between social entrepreneurs and traditional entrepreneurs. 5. Define social responsibility. 6. Understand the nature of business’s responsibility to the environment. 7. Describe business’s responsibility to employees. 8. Explain business’s responsibility to customers. 9. Discuss business’s responsibility to investors. 10. Describe business’s responsibility to the community.
Part 2: Class Instruction Introduction Business ethics involves the moral values and behavioral standards that business people draw on as they make decisions and solve problems. The ability to determine the values and ethics that will shape how business will be conducted is a major motivation to launching a venture. The values and morals that entrepreneurs drawn on to guide their ethical behaviors can come from a variety of sources. Ethical dilemmas may be apparent; however, more often ethical issues are less obvious and no clear cut right or wrong answers exist. There may be conflicting interests among the company’s stakeholders. Stakeholders include the various groups and individuals who affect and are affected by a business (Refer to Figure 2.1, Key Stakeholders). Ethical leaders approach their responsibilities with added dimensions of thought and action. Ethics refers to a branch of philosophy that studies and creates theories about the basic nature of right and wrong, duty, obligation, and virtue. A business operates as an institution in our complex society; therefore, entrepreneurs are expected to behave in ways .
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that are compatible with the value system of society. Social responsibility refers to how an organization responds to the needs of the many elements in society.
An Ethical Perspective
LO 1
Business ethics consist of the fundamental moral values and behavioral standards that form the foundation for the people of an organization as they make decisions and interact with stakeholders. Maintaining an ethical perspective is essential to creating and protecting a company’s reputation, but it is not easy. While building an ethical reputation takes a long time, destroying that reputation can happen quickly. Three Levels of Ethical Standards (Refer to Figure 2.2, Three Levels of Ethical Standards) 1. The law – defines what is permissible and what is not permissible. 2. Organizational policies and procedures – specific guidelines for people as they make daily decisions. 3. The moral stance – use when employees encounter a situation that is not governed by the law or organizational policies and procedures. Moral Management. There are three ethical styles of management, including immoral management, amoral management, and moral management. (Refer to Table 2.1, Approaches to Business Ethics) •
Immoral Management. Managers are motivated by selfish reasons, primarily greed.
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Amoral Management. Managers are motivated to earn a profit, and neglect to consider the impact their decisions have on others.
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Moral Management. Managers strive for success but only within the boundaries of legal and ethical standards.
The Benefits of Moral Management. (Refer to Table 2.2, Reasons to Run a Business Ethically and the Factors That Drive Business Ethics)
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Avoid damage from unethical behavior on their reputation.
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Dealing with stakeholders is easier when a firm has a solid ethical foundation.
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It is easier to attract and retain quality employees.
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Ethical behavior has a positive impact on a firm’s bottom line.
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Customers prefer to buy from an ethical company.
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Establishing an Ethical Framework Step 1: Identify the personal moral and ethical principles that shape all business decisions. Step 2: Recognize the ethical dimensions involved in the dilemma or decision. Step 3: Identify the key stakeholders involved and determine how the decision will affect them. The triple bottom line (3BL) involves measuring business performance using profitability, its commitment to ethics and social responsibility, and its impact on the environment (profit, people, and planet). Step 4: Generate alternative choices and distinguish between ethical and unethical responses. Step 5: Choose the “best” ethical response and implement it.
Why Ethical Lapses Occur The most common causes of ethical lapses (Refer to Figure 2.3, Causes of Ethical Lapses) include: •
Pressure to do whatever it takes to meet business targets.
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Company’s code of conduct not taken seriously.
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Will be rewarded for results and not the means used to achieve them.
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Unfamiliar with ethical standards that apply to the job.
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Fear of losing job if business targets not met.
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Believe policies are easy to override.
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Lack resources to get the job done without taking shortcuts.
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Seeking to bend rules for personal gain.
Responsibility for Ethical Decisions
LO 2
An Unethical Employee and an Unethical Organizational Culture. Employees who are “bad apples” may make unethical decisions. The culture of the entire organization rewards employees for unethical behavior. Moral Blindness. Sometimes ethical people make unethical blunders because they are blind to the implications of their conduct.
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Competitive Pressures. Managers and employees are under such pressure to produce that they may sacrifice their ethical standards to reduce the fear of failure or the fear of losing their jobs. Opportunity Pressures. When the opportunity to get ahead by taking some unethical action presents itself, some people cannot resist the temptation. Globalization of Business. Globalization of business has intertwined what once were distinct cultures; this cultural cross-pollination has brought about many positive aspects, but is has created problems as well. (Refer to Table 2.4, Ethics Research Reveals Features of Ethical Cultures)
Establishing and Maintaining Ethical Standards
LO 3
Establishing Ethical Standards. Although small businesses may not have formal ethics programs, entrepreneurs can encourage employees to become familiar with the following ethical tests for judging behavior: •
Utilitarian principle: choose the option that offers the greatest good for the greatest number of people.
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Kant’s categorical imperative: act in such a way that the action taken under the circumstances could be a universal law or rule of behavior.
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Professional ethic: take only those actions that a disinterested panel of professional colleagues would view as proper.
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Golden rule: treat other people the way you would like them to treat you.
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Television test: would you feel comfortable explaining your actions to a national television audience?
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Family test: would you be comfortable explaining to your children, your spouse, and your parents why you took this action?
(Refer to Table 2.5, Ten Ethical Principles to Guide Behavior) Maintaining Ethical Standards. Implementing and maintaining ethical standards is the real challenge.
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Set the tone. Ethics starts at the top of the organization by the leader.
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Create a company credo, which is a statement that defines the values underlying the entire company and its ethical responsibilities to its stakeholders.
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Establish high standards of behavior.
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Involve employees in establishing ethical standards.
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Create a culture that emphasizes two-way communication.
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Develop a code of ethics, which is a written statement of the standards of behavior and ethical principles a company expects from its employees.
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Enforce the code of ethics through policies.
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Recruit and promote ethical employees.
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Conduct ethics training.
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Reward ethical conduct.
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Separate related job duties.
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Perform periodic ethical audits
Social Entrepreneurship
LO 4
Social entrepreneurship can be characterized by the following: 1. Social entrepreneurs seek solutions for social problems that are met by neither the market nor the government. 2. Creating social benefit rather than commercial success motivates social entrepreneurs. 3. Social entrepreneurs tackle social problems by taking full advantage of natural market forces.
Social Responsibility
LO 5
There is an expectation that business will produce benefits not only for themselves but also for society as a whole. Companies must go beyond “doing well” – simply earning a profit – to “doing good” – living up to their social responsibility. Companies that are most successful in meeting their social responsibility select causes that are consistent with their core values and their employees’ interests and skill sets. Whether a company supports a social or an environmental cause has a significant effect on shoppers’ behavior. Other studies show a connection between social responsibility and profitability. One study concluded that a positive correlation existed between a company’s profitability and its reputation for ethical, socially responsible behavior. (Refer to Table 2.6, Simple Ways for .
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a Small Business to Be Socially Responsible) Consider using You Be the Consultant: “Funding Social Ventures Through Franchise Businesses” at this point.
Business’s Responsibility to the Environment LO 6 Companies have discovered that sound environmental practices make for good business. Examples include lowering operating costs, and producing environmentally safe products that attract environmentally conscious customers which give a company a competitive edge in the marketplace. Socially responsible business owners focus on the three Rs: •
Reduce the amount of energy and materials used.
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Reuse whatever you can.
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Recycle the materials that you must dispose of.
Progressive small firms are designed for “clean” manufacturing systems to avoid waste and pollution, and using resources efficiently.
Business’s Responsibility to Employees
LO 7
Entrepreneurs who understand the value of their employees follow a few simple procedures by doing the following: •
Listening to employees and respecting their opinions
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Asking for their input and involving them in the decision-making process
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Providing regular feedback – positive and negative – to employees
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Telling the truth—always
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Letting them know exactly what’s expected of them
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Rewarding employees for performing their jobs well
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Trusting them; creating an environment of respect and teamwork
Cultural Diversity in the Workplace. (Refer to Figures 2.4, Diversity Index by County, and Figure 2.5, Projected Composition of the U.S. Workforce in 2020) Cultural diversity provides an incredibly rich blend of ideas, perspectives, skills, talents, ideas, and creativity. However, managing a culturally diverse workforce presents a real challenge for employers. The Equal Employment Opportunity Commission suggests following a “SPLENDID” approach to diversity: .
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Study issues related to diversity, including relevant laws.
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Plan
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Lead
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Encourage
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Notice
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Discussion
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Inclusion
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Dedication
Managing a culturally diverse workforce successfully requires a business owner to do the following: •
Assess your company’s diversity needs
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Learn to recognize and correct your own biases and stereotypes
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Avoid making invalid assumptions
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Push for diversity in your management team
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Concentrate on communication
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Make diversity a core value in the organization
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Continue to adjust your company to your workers
Drug Testing. Drug and alcohol abuse by employees results in reduced productivity, increased medical costs, higher accident rates, and higher levels of absenteeism. An effective, proactive drug program should include the following five elements: 1. Written substance abuse policy. 2. Training for supervisors to detect substance-abusing workers. 3. An employee education program. 4. A drug testing program. 5. An employee assistance program (EAP), which is a company-provided benefit designed to help reduce workplace problems such as alcoholism, drug addiction, a gambling habit, and other conflicts and to deal with them when they arise.
Sexual Harassment Sexual harassment is any unwelcome sexual advance, request for sexual favors, and other
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verbal or physical sexual conduct made explicitly or implicitly as a condition of employment. Types of behavior that may result in sexual harassment charges include: •
Quid Pro Quo Harassment occurs when a superior conditions the granting of a benefit such as a promotion or raise on the receipt of sexual favors from a subordinate.
•
Hostile Environment refers to behavior that creates an abusive, intimidating, offensive, or hostile work environment. Examples include: displaying sexually suggestive pictures or posters, engaging in sexually related humor within hearing of someone who takes offense, talking about sexual matters where others can hear, making sexual comments to other employees, dispensing assignments based on sexual orientation, and repeated asking a coworker for a date after having been refused multiple times.
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Harassment by Nonemployees occurs when third parties (such as customers, sales representatives, and others) engage in sexual harassment when the employer has the ability to stop the improper behavior.
A company’s best weapons against sexual harassment are education, policy, and procedures. •
Education: training programs designed to raise employees’ awareness.
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Policy: enact policies that management can enforce, including: clearly define what behaviors constitute harassment, state that harassment will not be tolerated, identify supervisors and employee responsibilities, define the sanctions and penalties, spell out steps for reporting an incident.
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Procedure: when a complaint arises, managers should do the following: o Listen to the complaint and take notes. o Investigate promptly. (Refer to Table 2.7, What to Do When an Employee Files a Sexual Harassment Complaint) o Interview the accused party and witnesses privately. o Keep findings confidential. o Decide what action to take relying on policies. o Inform complaining person and alleged harasser of action. o Document entire investigation.
The ‘Hands On… How To’ feature includes a test on sexual harassment for both employees and managers. • .
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workers’ performance, but there is a line between monitoring productivity and invasion of privacy. To avoid ethical and legal problems, business owners should follow these guidelines: o Establish a clear policy for monitoring employees’ communications. o Create guidelines for the proper use of the company’s communication technology and communicate them to everyone. o Monitor in moderation. Consider using You Be the Consultant: “Think Before You Tweet” at this point.
Business’s Responsibility to Customers
LO 8
The Consumer Bill of Rights gives consumers the following rights: Right to Safety. The greatest breach of trust occurs when businesses produce product that, when properly used, injure customers. Right to Know. Consumers have the right to honest communication about the products and services they buy and the companies that sell them. Right to be Heard. The right to be heard suggests that the channels of communication between companies and their customers run in both directions. Socially responsible businesses provide customers with a mechanism for resolving complaints about products and service. Right to Education. This refers to educational material about their products and services and how to use them properly. Right to Choice. This refers to socially responsible companies that do not restrict competition, and willingness to abide by U.S. antitrust policy.
Business’s Responsibility to Investors
LO 9
Although earning a profit is a company’s first responsibility, it must also meet its ethical and social responsibility goals. A firm’s reputation is important to investors as they invest more on the basis of the entrepreneur’s track record than on the entrepreneur’s idea.
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Companies also have the responsibility to report their financial performance in an accurate and timely fashion to their investors.
Business’s Responsibility to the Community LO 10 In addition to providing jobs and creating wealth, companies contribute to the local community in many different ways. Small companies can commit their employees’ talent, not just dollars, to carefully chosen social causes and then tell the world. Examples include: •
Volunteer for community groups.
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Participate in projects that aid others.
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Adopt a highway.
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Volunteer in school programs, such as Junior Achievement.
Consider using You Be the Consultant: Funding Social Ventures Through Franchise Businesses and/or You Be the Consultant: But Is It Safe? at this point.
Conclusion Businesses must do more than merely earn profits; they must act ethically and in a socially responsible manner. Business owners and managers must recognize the key role they play in influencing their employees’ ethical and socially responsible behavior.
Part 3: Chapter Exercises You Be the Consultant: “Funding Social Ventures Through Franchise Businesses” 1. What challenges does owning and operating a franchise business create for these nonprofits? Explain. (LO 4) (AACSB: Reflective thinking) Legal: A nonprofit organization is not allowed to own a franchise, but it can set up an investment corporation as a parent entity, and under it form a limited liability corporation that owns the franchise. Staffing: Staff must have the mindset and business skills to operate a for-profit business.
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Financial: The nonprofit needs the support of investors or a partnership with a for-profit business to be able to afford the initial franchise fees and funding to operate the franchise until it becomes profitable. 2. What advantages do franchise businesses offer nonprofits that seek side businesses to generate revenues to support their causes? (LO 5) (AACSB: Analytical thinking) Franchises will increase their reputation as socially responsible businesses. Customers are more likely to support a franchise when they know it is involved in the community in a positive way. In some cases, the nonprofit may provide training to potential employees of the franchise, thus reducing employment costs. 3. Select a local nonprofit and work with a team of your classmates to brainstorm ideas for a franchise business that could help create a sustainable cash flow to support the mission of the social venture. What advice can you offer social entrepreneurs on how to develop alternative revenues to replace declining grants and donations? (LO 10) (AACSB: Application of knowledge) Students should review the nonprofit’s current services and identify businesses that can profit from these services. For example, the nonprofit could provide job training services to a for-profit business in exchange for continuing financial support, as evidenced in the Dale Rogers Training Center. Students can also review critical needs within the community that are currently underserved by nonprofits such as homelessness. Since these kinds of problems plague for-profit businesses perhaps the nonprofit could add a new service to improve the ability of homeless people to obtain jobs. For example, the nonprofit may help homeless people to find shelter, appropriate work attire, and interviewing and other workplace skills. As a result a for-profit employer may partner with and provide funding for the nonprofit in an effort to then provide jobs for the formerly homeless people.
You Be the Consultant: “Think Before You Tweet” 1. If you were the judge reviewing the O’Connor case, how would you rule? Explain your reasoning. (LO 7) (AACSB: Ethical understanding and reasoning) The judge’s ruling is likely based on whether the Milk Truck had or didn’t have a clear policy about monitoring employees’ communications. O’Connor’s post directly targeted Class, Lewis & Co. as well as Milk Trust in his post in a way that was abusive. The judge would likely rule in O’Connor’s favor, if we assume the small business has no policy.
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2. If you were the judge in the Riley case, how would you rule? Explain your reasoning. (LO 7) (AACSB: Ethical understanding and reasoning) Connor Riley should have known better than to send such a tweet about a company that obviously would learn about her opinion of the job offered to her. Since it is not mentioned in the case, students do not know if prospective employees are informed about Cisco Systems policies related to use of social media. Further, it is obvious that Riley has not yet accepted the job, so technically she is not an employee and not subject to company policy. The judge would likely rule in Riley’s favor, but she still would not be offered the job. 3. What policies would you put in place as a business owner about employee comments on social media sites like Facebook and Twitter? Explain your policies based on the cases discussed here. (LO 7) (AACSB: Ethical understanding and reasoning) Employees should know that the company is monitoring their forms of communication, including Twitter. Having employees sign a consent form acknowledging that they have read and understand the company’s monitoring policy might have lead Brendan O’Connor and Sunith Baheerathan to be more circumspect. Cisco’s vice president of human resources should communicate with the corporate attorney to review the incident and determine how to prevent this situation from happening in the future. For example, a statement about social media privacy could be included in the job offer letter provided to future employees.
You Be the Consultant: “But Is It Safe?” 1. How could the owners of Willow Springs have ensured the safety of their customers and prevented the infections from occurring? Explain. (LO 10) (AACSB: Ethical understanding and reasoning) It is possible that the owners of Willow Spring relied on the advice about risk management from their insurance company before the problem developed. Instead, they could have also been proactive and researched lake-related illnesses, and had the lake water tested on a regular basis. 2. Would it have been ethical for Willow Springs to remain open after Kali’s case came to light, even though there could never be definitive evidence linking the infection to its lake? Explain. (LO 10) (AACSB: Ethical understanding and reasoning) Students could argue this question from two perspectives. There had never been a .
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documented problem since the park opened in 1928, and the previous case from 2010 had not been positively linked to Willows Springs. In addition, Willow Springs contributed to the community by providing jobs and economic development to the city where it is located. The cost to build a solid bottom is not a cost-effective solution to the problem. However, other students could argue that one person’s life is not a fair tradeoff for doing nothing. 3. What do you think the owners of Willow Springs should do with their property? Should they reopen the water park if they can ensure that the water is safe for swimming? Explain. (LO 10) (AACSB: Ethical understanding and reasoning) Students could argue this question from two perspectives. Some may argue that the risk is too high unless the hard bottom is constructed in the lake. Others may argue that water testing should be conducted on a regular basis during the swimming season, and to close the park when the water temperature approaches 115 degrees. 4. Create a detailed diagram of all the stakeholders of Willow Springs. How is each of the stakeholders affected by the water park’s actions? What conclusions can you draw from this analysis? Explain. (LO 10) (AACSB: Ethical understanding and reasoning) Refer to Figure 2.1 for an example of a diagram to use in this exercise. Stakeholders include the owners, employees, vendors/suppliers, competitors, customers, other businesses that benefit from out of town visitors to the water park, government, unions, special interest groups, external investors, creditors, and the community as a whole. Each of these stakeholders will be affected to varying degrees, so allow students some latitude in their assertions. In fact some debate about the degree of impact on each type of stakeholder could lead to a healthy discussion. Steer the conversation to the triple bottom line (3BL), which involves measuring business performance using profitability, its commitment to ethics and social responsibility, and its impact on the environment (profit, people, planet).
Part 4: Chapter Discussion Questions 2-1. What is ethics? (LO 1) (AACSB: Ethical understanding and reasoning) Ethics is a branch of philosophy that studies and creates theories about the basic nature of right and wrong, duty, obligation, and virtue. 2-2. Discuss the three levels of ethical standards. (LO 1) (AACSB: Ethical understanding and reasoning) The three Levels of Ethical Standards (Refer to Figure 2.2)
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•
The law – defines what is permissible and what is not permissible.
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Organizational policies and procedures – specific guidelines for people as they make daily decisions.
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The moral stance – use when employees encounter a situation that is not governed by the law or organizational policies and procedures.
2-3. Ethics and social responsibility set behavioral boundaries for decision makers. Define social responsibility. (AACSB: Application of knowledge) Social responsibility is how an organization responds to the needs of the many elements in society, including shareholders, lenders, employees, consumers, governmental agencies, and the environment. Because business is allowed to operate in society, it has an obligation to behave in ways that benefit all of society. 2-4. Where does each of your core values come from (e.g, religious faith, family, personal philosophy)? (LO 1) (AACSB: Reflective thinking) Students’ responses will vary. However this is a good question to stimulate them to think about where their values originated. 2-5. Why is each of your core values important to you? (LO 1) (AACSB: Reflective thinking) Students’ responses will vary. However this is a good question to stimulate them to think about where their values originated. 2-6. In any organization, who determines ethical behavior? (LO 3) (AACSB: Ethical understanding and reasoning) Ethics starts at the top of the organization by the leader. 2-7. Briefly describe the three ethical styles of management. (LO 1) (AACSB: Ethical understanding and reasoning) Immoral Management – managers are motivated by selfish reasons, primarily greed. Amoral Management – managers are motivated to earn a profit, and neglect to consider the impact their decisions have on others. Moral Management –managers strive for success but only within the boundaries of legal and ethical standards. 2-8. What are the benefits of moral management? (LO 1) (AACSB: Ethical understanding and reasoning) Avoid damage from unethical behavior on their reputation. Dealing with stakeholders is easier when the firm has a solid ethical foundation.
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It is easier to attract and retain quality employees. Ethical behavior has a positive impact on a firm’s bottom line. Customers prefer to buy from an ethical company. 2-9. Describe the various methods for establishing ethical standards. (LO 3) (AACSB: Ethical understanding and reasoning) Establishing Ethical Standards (Refer to Table 2.5) •
Utilitarian principle: choose the option that offers the greatest good for the greatest number of people.
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Kant’s categorical imperative: act in such a way that the action taken under the circumstances could be a universal law or rule of behavior.
•
Professional ethic: take only those actions that a disinterested panel of professional colleagues would view as proper.
•
Golden rule: treat other people the way you would like them to treat you.
•
Television test: would you feel comfortable explaining your actions to a national television audience?
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Family test: would you be comfortable explaining to your children, your spouse, and your parents why you took this action?
2-10. Which method for establishing ethical standards is most meaningful to you? (LO 3) (AACSB: Application of knowledge) Students’ responses will vary. However, this is a good question to stimulate them to think about what is most important to them. 2-11. Why is it the most meaningful method for establishing ethical standards? (LO 3) (AACSB: Reflective thinking) Students’ responses will vary. However, this is a good question to stimulate them to think about what is most important to them. 2-12. What can business owners do to maintain high ethical standards in their companies? (LO 3) (AACSB: Ethical understanding and reasoning)
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•
Set the tone. Ethics starts at the top of the organization by the leader.
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Create a company credo, which is a statement that defines the values underlying the entire company and its ethical responsibilities to its stakeholders.
•
Establish high standards of behavior.
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•
Involve employees in establishing ethical standards.
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Create a culture that emphasizes two-way communication.
•
Develop a code of ethics, which is a written statement of the standards of behavior and ethical principles a company expects from its employees.
•
Enforce the code of ethics through policies.
•
Recruit and promote ethical employees.
•
Conduct ethics training.
•
Reward ethical conduct.
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Separate related job duties.
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Perform periodic ethical audits
2-13. Identify the term used for people who pursue opportunities to create social value. (AACSB: Ethical understanding and reasoning) People who use their creativity to develop solutions to social problems and create social value are known as social entrepreneurs. 2-14. How do social entrepreneurs differ from traditional entrepreneurs? (LO 4) (AACSB: Ethical understanding and reasoning) Traditional entrepreneurs seek opportunities to create market value, while social entrepreneurs start businesses so they can create innovative solutions to society’s most vexing problems. 2-15. Describe some simple ways that an organization can be socially responsible. (AACSB: Application of knowledge) •
Encourage recycling.
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Support local fund-raisers.
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Join in community service.
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Reduce energy usage.
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Create a grant program.
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Support local causes.
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Partner with local schools.
2-16. What is social responsibility? (LO 5) (AACSB: Ethical understanding and reasoning) There is an expectation that business will produce benefits not only for themselves but also .
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for society as a whole. Companies must go beyond “doing well” – simply earning a profit – to “doing good” – living up to their social responsibility. 2-17. Describe business’s social responsibility to the environment. (LO 6) (AACSB: Ethical understanding and reasoning) Companies have discovered that sound environmental practices make for good business. Examples include lowering operating costs, and producing environmentally safe products that attract environmentally conscious customers which give a company a competitive edge in the marketplace. 2-18. Describe business’s social responsibility to employees. (LO 7) (AACSB: Ethical understanding and reasoning) Entrepreneurs who understand the value of their employees follow a few simple procedures by doing the following: •
Listening to employees and respecting their opinions
•
Asking for their input and involving them in the decision-making process
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Providing regular feedback – positive and negative – to employees
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Telling the truth — always
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Letting them know exactly what’s expected of them
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Rewarding employees for performing their jobs well
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Trusting them; creating an environment of respect and teamwork
2-19. Describe business’s social responsibility to its customers. (LO 8) (AACSB: Ethical understanding and reasoning) Right to Safety, Right to Know, and Right to Be Heard 2-20. Describe business’s social responsibility to investors. (LO9) (AACSB: Ethical understanding and reasoning) Although earning a profit is a company’s first responsibility, it must also meet its ethical and social responsibility goals. A firm’s reputation is important to investors as they invest more on the basis of the entrepreneur’s track record than on the entrepreneur’s idea. Companies also have the responsibility to report their financial performance in an accurate and timely fashion to their investors. 2-21. Describe business’s social responsibility to the community. (LO 10) (AACSB: Ethical understanding and reasoning) In addition to providing jobs and creating wealth, companies contribute to the local community in many different ways. Small companies can commit their employees’ talent,
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not just dollars, to carefully chosen social causes and then tell the world. Examples include: •
Volunteer for community groups.
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Participate in projects that aid others
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Adopt a highway
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Volunteer in school programs
2-22. What can businesses do to improve the quality of our environment? (LO 6) (AACSB: Ethical understanding and reasoning) Socially responsible business owners focus on the three Rs: •
Reduce the amount of energy and materials used.
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Reuse whatever you can.
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Recycle the materials that you must dispose of.
Progressive small firms are designed for “clean” manufacturing systems to avoid waste and pollution, and using resources efficiently. 2-23. Explain your stance on whether companies should be allowed to test employees for drugs. (LO 7) (AACSB: Application of knowledge) Students’ answers will vary. One point of view is that drug and alcohol abuse by employees results in reduced productivity, increased medical costs, higher accident rates, and higher levels of absenteeism. Another point of view is that this is a violation of personal privacy. 2-24. What practices do socially responsible entrepreneurs follow? (AACSB: Ethical understanding and reasoning) •
Reduce the amount of energy and materials used in their company, from the factory floor to the copier room.
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Reuse whatever they can.
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Recycle the materials that must be disposed of.
2-25. Many owners of trucking companies use electronic communications equipment to monitor their drivers on the road. They say the devices allow them to remain competitive and to serve their customers better by delivering shipments of vital materials exactly when their customers need them. They also point out that the equipment can improve road safety by ensuring that drivers get the hours of rest the law requires. Opponents argue that the surveillance devices work against safety. “The drivers know they’re being watched,” says one trucker. “There’s an obvious
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temptation to push.” What do you think about this practice? (LO 7) (AACSB: Application of knowledge) Students’ answers will vary. Some may agree with the view of the managers, while others will defend the statement of the driver. 2-26. Modern technology has given business owners the ability to monitor their workers’ performance. What should they do to avoid potential ethical and legal problems? (AACSB: Ethical understanding and reasoning) To avoid ethical and legal problems, business owners would be advised to follow these guidelines: •
Establish a clear policy for monitoring employees’ communications. Employees should know that the company is monitoring their e-mails and other forms of communication, and the best way to make sure they do is to create an unambiguous policy. Once you create a policy, be sure to follow it. Some managers ask employees to sign a consent form acknowledging that they have read and understand the company’s monitoring policy.
•
Create guidelines for the proper use of the company’s communication technology and communicate them to everyone. A company’s policies and guidelines should be reasonable and should reflect employees’ reasonable expectations of privacy.
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Monitor in moderation. Employees resent monitoring that is unnecessarily invasive. In addition, excessively draconian monitoring may land a company in a legal battle.
2-27. Managing a culturally diverse workforce presents a real challenge for small business owners. How can they achieve unity among their employees from a diverse background? (AACSB: Ethical understanding and reasoning)
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Study: Business owners cannot solve problems they don’t know exist. Entrepreneurs must familiarize themselves with issues related to diversity, including relevant laws.
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Plan: Recognizing the makeup of the local population, entrepreneurs must set targets for diversity hiring and develop a plan for achieving them.
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Lead: A diversity effort starts at the top of the organization with managers communicating their vision and goals to everyone in the company.
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Encourage: Company leaders must encourage employees at all levels of an organization to embrace the diversity plan.
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Notice: Entrepreneurs must monitor their companies’ progress toward achieving diversity goals. Chapter 2, Page 34
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Discussion: Managers must keep diversity on the company’s radar screen by communicating the message that diversity is vital to business success.
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Inclusion: Involving employees in the push to achieve diversity helps break down barriers that arise.
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Dedication: Achieving diversity in a business does not happen overnight, but entrepreneurs must be persistent in implementing their plans.
2-28. What rights do customers have under the Consumer Bill of Rights? (LO 8) (AACSB: Ethical understanding and reasoning) The Consumer Bill of Rights gives consumers the following rights: •
Right to Safety
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Right to Know
2-29. Why do some organizations create a customer report card? (AACSB: Ethical understanding and reasoning) It is an effective technique for encouraging two-way communication between customers and companies, allowing companies to serve their customers better.
Part 5: Case Studies The following text case may be used for lecture and assignments for topics presented in this chapter. •
Case 4: ThinkImpact
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics. •
Why Are Ethics Important (Stanford Entrepreneurship Lecture) http://www.youtube.com/watch?v=6mdcWVlHz7Q
2:37 minutes
•
Ethical and Responsible Business http://www.youtube.com/watch?v=MDhpNBtnrKI
1:52 minutes
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Ethics in a Small Business http://www.youtube.com/watch?v=XLmXwPBuXVo
2:33 minutes
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The Power of Social Entrepreneurship .
17:36 minutes Chapter 2, Page 35
http://www.youtube.com/watch?v=VZQvhsa6LN0 •
How to Be a Social Entrepreneur http://www.youtube.com/watch?v=N8LVa9pb-n8
18:34 minutes
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Responsibility of Business to Conservation of Environment http://www.youtube.com/watch?v=yU1eQhopFnI
8:51 minutes
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Social Responsibility… Ben Greenfield, Ben & Jerry’s http://www.youtube.com/watch?v=63Ooq4c3gCc
25:24 minutes
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How Innocent Used Ethics and Trust… Customer Engagement http://www.youtube.com/watch?v=hRLljQYTfL4
28:25 minutes
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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CHAPTER 3. CREATIVITY AND INNOVATION: KEYS TO ENTREPRENEURIAL SUCCESS Part 1: Learning Objectives 1. Explain the differences among creativity, innovation, and entrepreneurship. 2. Describe why creativity and innovation are such an integral part of entrepreneurship. 3. Explain the 10 “mental locks” that limit individual creativity. 4. Understand how entrepreneurs can enhance the creativity of their employees as well as their own creativity. 5. Describe the steps in the creative process. 6. Discuss techniques for improving the creative process. 7. Describe the protection of intellectual property through patents, trademarks, and copyrights.
Part 2: Class Instruction Introduction One of the tenets of entrepreneurship is the ability to create new and useful ideas that solve the problems and challenges that people face every day. As Chapter 1 discussed, entrepreneurs can create value in a number of ways. For example, entrepreneurs invent new products and services, develop new technology, discover new knowledge, improve existing products or services, and find different ways of providing more valuable goods and services with fewer resources.
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Creativity, Innovation, and Entrepreneurship LO 1 Creativity is the ability to develop new ideas and discover new ways of looking at problems and opportunities. A study conducted by the U.S. Small Business Administration reports that small companies produce 16 times more patents per employee than their larger rivals. The secret is to apply creativity and innovation to solve problems and exploit opportunities that people face every day. Innovation is the ability to apply creative solutions to problems and opportunities that enhance or enrich people’s lives. Entrepreneurs succeed by thinking and doing new things or old things in new ways. Some create innovations reactively in response to customer feedback or changing market conditions, and others create innovations proactively, spotting opportunities on which to capitalize. Innovation is evolutionary, developing marketsustaining ideas that elaborate on exiting products, processes, and service. Entrepreneurial innovation encompasses not only new products and service, but also new business models. Entrepreneurship is the result of a disciplined, systematic process of applying creativity and innovation to needs and opportunities in the marketplace. Innovation must be a constant process because most ideas do not work and most innovations fail. Table 3.1 “The Five Dimensions of Discovery-Driven Leadership” can be used to differentiate between delivery-driven and discovery-driven leadership.
Creativity – Essential to Survival
LO 2
Creativity is an important source for building a competitive advantage and for survival. Companies that fail to become engines of innovation are more likely to lose ground to their more creative competitors and ultimately become irrelevant and close their doors. Making the leap from what has worked in the past to what will work today (or in the future) requires entrepreneurs to cast off their limiting assumptions, beliefs, and behaviors and to develop new insights into the relationship among resources, needs, and values. A creative exercise, shown in Figure 3.1, “How Creative Are You?” can be used to explore aspects of creativity.
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Can Creativity Be Taught? Research shows that anyone can learn to be creative. Author Joyce Wycoff believes everyone can learn techniques and behaviors that generate ideas. Not only can entrepreneurs and the people who work for them learn to think creatively, but they must for their companies’ sake! Consider using You Be the Consultant “10 Keys to Business Innovation” at this point.
Barriers to Creativity
LO 3
There are limitless barriers to creativity—time pressures, unsupportive management, pessimistic coworkers, overly rigid company policies, and countless others. The most difficult hurdles to overcome are those that individuals impose upon themselves. In his book, A Whack on the Side of the Head, Roger von Oech identifies ten “mental blocks” that limit individual creativity. They are as follows: 1. Searching for just one right answer 2. Focusing on being logical 3. Blindly following rules 4. Constantly being practical 5. Viewing laughter and play as frivolous. Myopic thinking is a common killer of creativity; being narrowly focused and limited by the status quo. 6. Becoming overly specialized 7. Avoiding ambiguity 8. Fearing looking foolish 9. Fearing mistakes and failure 10. Believing that “I’m not creative”
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Questions to spur the imagination are presented in Table 3.2. Questions to Spur the Imagination include: 1. Is there a new way to do it? 2. Can you borrow or adapt it? 3. Can you give it a new twist? 4. Do you merely need more of the same? 5. Do you need less of the same? 6. Is there a substitute? 7. Can you rearrange the parts? 8. What if you do just the opposite? 9. Can you combine ideas? 10. Are customers using your product or service in ways you never expected or intended? 11. Which customers are you not servicing? What changes to your product or service are necessary to reach them? 12. Can you put it to other uses? 13. What else could we make from this? 14. Are there other markets for it? 15. Can you reverse it? 16. Can you rearrange it? 17. Can you put it to another use? 18. What idea seems impossible, but if executed, would revolutionize your business?
How to Enhance Creativity
LO 4
Enhancing Organizational Creativity. Creativity doesn’t just happen in organizations; entrepreneurs must establish an environment in which creativity can flourish — for themselves and for their workers. New ideas are fragile creations, but the right organizational environment can encourage people to develop and cultivate them. .
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Ensuring that workers have the freedom and the incentives to be creative is one of the best ways to achieve creativity. Entrepreneurs can stimulate their own creativity and encourage it among workers by: •
Including creativity as a core company value and make it an integral part of the company’s culture.
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Hiring for creativity
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Establishing an organizational structure that nourishes creativity
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Embracing diversity
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Expecting creativity
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Expecting failure and learning from it
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Incorporating fun into the work environment
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Encouraging curiosity
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Designing a work space that encourages creativity
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View problems as opportunities
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Providing creativity training
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Eliminating bureaucratic obstacles and providing the support necessary for innovation. Intrapreneurs are entrepreneurs who operate within the framework of an existing business and can sometimes transform a company’s future or advance its competitive edge.
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Developing a procedure for capturing ideas
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Talking with and interacting with customers
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Monitoring emerging trends and identifying ways your company can capitalize on them
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Looking for uses for your company’s products or services in other markets
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Rewarding creativity
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Modeling creative behavior
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Not forgetting about business model innovation
Enhancing Individual Creativity. You can enhance individual creativity by using the following techniques:
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Allow yourself to be creative
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Forget the “rules”
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Give your mind fresh input every day
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Take up a hobby
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Travel and observe
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Observe the products and services of other companies, especially those in completely different markets
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Recognize the creative power of mistakes and accidents
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Notice what is missing
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Look for ways to turn trash into treasure
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Keep a journal handy to record your thoughts and ideas
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Listen to other people
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Listen to customers
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Get adequate sleep
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Watch a movie
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Talk to a child
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Do something ordinary in an unusual way
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Keep a toy box in your office
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Take note of your “pain points”
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Do not throw away seemingly “bad” ideas
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Collaborate with others
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Read books on stimulating creativity or take a class on creativity
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Doodle
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Take some time off
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Be persistent
Refer to the “Hands On… How To” feature for more suggestions.
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The Creative Process
LO 5
Although new ideas may appear to strike like a bolt of lightning, they are actually the result of the creative process. The creative process involves seven steps: 1. Preparation to get the mind ready for creative thinking. Suggestions include: o Adopt the attitude of a lifelong student o Read a lot o Clip interesting articles and create a file for them o Take time to discuss your ideas with others o Join and attend meetings of professional or trade associations o Develop listening skills o Eliminate creative distractions 2. Investigation. This requires one to develop a solid understanding of the problem. 3. Transformation. This involved viewing the similarities and differences among the information collected. Convergent thinking is the ability to see similarities and the connections among various data and events. Divergent thinking is the ability to see among various data and events. 4. Incubation refers to the need to have time to reflect on the information collected, and may include walking away from the situation daydreaming, relaxing and playing, dreaming during sleep, or working on the problem in a different environment. 5. Illumination refers to the proverbial light bulb turning on, and happens sometime during the illumination stage. 6. Verification refers to the steps taken to validate an idea as realistic and useful by asking questions such as: o Is it really a better solution? o Will it work? o Is there a need for it? o If there is a need, what is the best application in the marketplace? o Does this idea fit into our core competencies? o How much will it cost to produce or provide? .
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o Can we sell it at a reasonable price that will product adequate sales, profit, and returns on investment? o Will people buy it? 7. Implementation refers to transforming the idea into reality. What sets entrepreneurs apart is that they act on their ideas.
Techniques for Improving the Creative Process LO 6 Brainstorming. Teams of people working together usually can generate more and more creative ideas. Brainstorming is a process in which a small group interacts with very little structure with the goal of producing a large quantity of novel and imaginative ideas. For a brainstorming session to be successful, an entrepreneur should follow these guidelines:
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Keep the group small—five to eight members
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Make the group as diverse as possible
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Encourage participants to engage in some type of aerobic exercise before the session
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Company rank and department affiliation are irrelevant
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Give the group a well-defined problem to address
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Provide the group relevant background information about the problem in advance. Invite them to provide at least three ideas by e-mail prior to the brainstorming session.
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Limit the session to 40 to 60 minutes
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Take a field trip to visit the scene of the problem
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Appoint someone the job of recorder
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Use a seating pattern that encourages communication and interaction
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Throw logic out the window
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Encourage all ideas from the team, even wild and extreme ones
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Establish a goal of quantity of ideas rather than quality
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Forbid evaluation or criticism
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Encourage “idea hitch-hiking” Chapter 3, Page 44
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Dare to imagine the unreasonable
Mind-Mapping. Mind-mapping is an extension of brainstorming. Mind–mapping is a graphical technique that encourages thinking on both sides of the brain, visually displays the various relationships among ideas, and improves the ability to view the problem from many sides. It relates to the way the brain actually works. Rather than throwing out ideas in a linear fashion, the brain jumps from one idea to another. In many creative sessions, ideas are rushing out so fast that many are lost if a person attempts to shove them into a linear outline. The mind-mapping process works this way: •
Sketch a picture symbolizing the problem in the center of a large blank page
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Write down every idea that comes to your mind, connecting each idea to the central picture or words with a line. Use key words and symbols
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When idea flow starts to trickle, stop
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Allow your mind to rest a few minutes, and then begin to integrate the ideas into a mind map.
Force Field Analysis. This technique is useful to evaluate the forces that support and oppose a proposed change. It addresses the problem to solved, the driving forces, and the restraining forces. TRIZ. This is a systematic approach to solve any technical problem and relies on 40 principles and left-brain thinking to solve problems. Refer to Figure 3.2, TRIZ Contradiction Matrix. Rapid prototyping is the process of creating a model of an idea, enabling an entrepreneur to discover flaws in the idea and to make improvements in the design. The three principles of rapid prototyping are “The Three R’s”: rough, rapid, and right.
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Intellectual Property: Protecting Your Ideas
LO 7
Entrepreneurs must understand how to put patents, copyrights and trademarks to work for them. The World Trade Organization estimates that between 5 and 7 percent of all goods traded globally are counterfeit. Refer to Table 3.3, Top Counterfeit Products Seized by U.S. Customs Agents. Patents. A patent is a grant from the federal government’s Patent and Trademark Office (PTO), to the inventor of a product, giving the exclusive right to make, use or sell the invention in this country for 20 years from the date of filing the patent application. •
Most patents are granted for new product inventions (called utility patents), but design patents extending for 14 years beyond the date the patent is issued, are given to inventors who make new original and ornamental changes in the designs of existing products that enhance their sales.
•
Inventors who develop a new plant can obtain a plant patent (by grafting or crossbreeding, not planting seeds).
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To be patented, a device must be new (but not necessarily better!), not obvious to a person of ordinary skill or knowledge in the related field, and useful. Refer to Figure 3.4, A Sample (and Unusual) Patent.
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A device cannot be patented if it has been publicized in print anywhere in the world, or if it has been used or offered for sale in this country prior to the date of the patent application.
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A patent is awarded to the first person to file a patent application.
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Before beginning the lengthy process of applying for a patent, it is best to seek the advice of a patent agent or attorney who is registered with the Patent and Trademarks Office.
Refer to Figure 3.3 for Patent Applications and Patents Issued, which graphs the number of patent applications from 1975 to 2015. A list of registered patent, copyright and trademark professionals are available at: http://www.uspto.gov/web/offices/dcom/olia/oed/roster/ •
The Patent Process. To receive a patent, an inventor must follow these steps: 1. Establish the invention’s novelty 2. Document the device
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3. Search existing patents 4. Study search results 5. Complete patent application 6. File the patent application In addition, the inventor must be prepared to defend a patent against “copycat producers”. This can be expensive and time consuming but often is necessary to protect an entrepreneur’s interest. Trademark. A trademark is any distinctive word, phrase, symbol, design, name, logo, slogan, or trade dress that a company uses to identify the origin of a product or to distinguish it from other goods on the market. A service mark offers the same protection as a trademark, except that it identifies and distinguishes the source of a service rather than a product. Refer to Figure 3.5, Trademark Applications and Trademarks and Renewals Issued. Trade dress is the unique combination of elements that a company uses to create a product’s image and to promote it. For example, a restaurant’s particular décor, color schemes, design and overall look and feel constitute its trade dress. To be eligible for trademark protection, trade dress must be inherently unique and distinctive to a company. A trademark prevents other companies from employing a similar mark to identify their goods. The first party who either uses a trademark in commerce or files an application with the PTO has the ultimate right to register that trademark. Trademarks last indefinitely as long as the holder continues to use it. Copyright. A copyright is an exclusive right that protects the creators of original works of authorship such as literary, dramatic, musical, and artistic works (e.g., art, sculptures, literature, software, music, videos, video games, choreography, motion pictures, recordings and others). Just as with a trademark, obtaining basic copyright protection does not require registering the creative work, but it is smart to do so. Entrepreneurs file copyright applications with the Copyright Office in the Library of Congress. Refer to Table 3.4, Characteristics of Patents, Trademarks, and Copyrights. Protecting intellectual property is imperative. Unfortunately, not every businessperson respects the rights of ownership to products, processes, names, and works. The dynamics of the global market makes protecting intellectual property even more challenging. The primary weapon is efficient use of the legal system. Before bringing a lawsuit, an entrepreneur must consider the following issues: •
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Can the opponent afford to pay if you win? Chapter 3, Page 47
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Will you get enough from the suit to cover the costs of hiring an attorney?
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Can you afford the loss of time and privacy from the ensuing lawsuit?
Refer to the “Hands On… How To” feature for more information on protecting your company’s intellectual property. Consider using You Be the Consultant: “How Would You Rule in These Intellectual Property Cases?” at this point.
Conclusion The creative process is a tenant of the entrepreneurial experience. Success, and even survival itself, requires entrepreneurs to tap their creativity. The seven steps of the creative process allow the entrepreneur to transform an idea into a business reality. 1. Preparation 2. Investigation 3. Transformation 4. Incubation 5. Illumination 6. Verification 7. Implementation Creativity results in value and value provides a competitive advantage. Entrepreneurs should protect their creative ideas through patents, trademarks, servicemarks, and copyrights to sustain a competitive edge.
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Part 3: Chapter Exercises You Be the Consultant: “10 Keys to Business Innovation” 1. Select one of these businesses and explain which of the 10 types of innovation the company used to bolster its success. (LO 4) (AACSB: Application of knowledge) The 10 keys are listed here, with suggestions about which of the three companies in the feature could benefit from the additional types of innovation:
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Business model. How does your company make money? These are innovations in the value proposition that a company provides its target customers and in the way it delivers value to its customers. (Suggestions: Roadie, Monsieur)
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Networks and alliances. Can you join forces with another company or entity for mutual benefit? A company may forge a synergistic relationship with another organization in which each company’s strengths complement the other. (Suggestions: Monsieur)
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Organizational structure. How do you support and encourage your employees’ creative efforts? The most effective organizations use an appropriate structure and culture to align their talent to spark innovation. (Suggestions: Roadie, Monsieur)
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Core process. How does your company create and add value for customers? These innovations in a company’s internal processes result in superior business systems and work methods that result in benefits for customers. (Suggestions: Roadie, Lee Company)
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Product or service performance. What are the most important features and functions of your company’s products or services? Innovations in functions and features can give a company’s product or service a significant edge over those of competitors. (Suggestions: Lee Company, Monsieur)
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Product system. Can you link multiple products into a system or a platform? Bundling products can add value for customers. (Suggestions: Roadie, Monsieur)
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Service. How do you provide value-added service beyond your company’s products for customers? Some of the most successful businesses set themselves apart from their competition by providing unparalleled customer service. Chapter 3, Page 49
(Suggestions: Roadie, Lee Company) •
Channel. How do you get your products or services into customers’ hands? Some companies provide extra value to their customers by making their products and services available in many venues. (Suggestions: Roadie)
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Brand. What is your company’s “identity” in the marketplace? Successful companies use creative advertising, promotion, and marketing techniques to build a desirable brand identity with customers. (Suggestions: Monsieur)
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Customer experience. Does your company engage customers and give them reasons to come back to make future purchases? Innovative companies find ways to connect with their customers, creating a loyal base of “fansumers,” customers who not only purchase but act like fans who promote the company to their friends and family members. (Suggestions: Roadie, Monsieur)
2. Explain how the company you selected in question 1 could use at least one of the remaining types of innovation to increase its sales and profitability. (LO 4) (AACSB: Application of knowledge) Students’ answers will vary. The instructor should encourage students to use their right brain to identify examples appropriate to the company they chose for this exercise.
Hands On … How To: “Create a Culture of Creativity and Innovation” 1. Do you agree with the top managers in the MDC Partners survey who say that we have entered an “imagination economy”? Explain. (LO 5) (AACSB: Application of knowledge) While students may have different responses to the question, the instructor has to prompt them by asking the class to list products that we see today that were not there ten years ago. This should lead to a discussion of how these products were a result of imaginative people exercising their creativity to come up with solutions. 2. List and describe two additional steps that a company can take to create a culture of creativity and innovation. (LO 5) (AACSB: Application of knowledge) The list provided in this profile is quite impressive: ignite passion, encourage courage, fail forward, etc. A step that 3M does – allow their R&D personnel to spend 15 percent of their working time on no questions asked projects – may be an additional step. The story is the company’s famous Post It notes came out of such an initiative. The second step can .
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be to encourage collaboration with outside firms, whether they are suppliers or customers. This could spur creative ideas to flow from outside the firm.
You Be the Consultant: “How Would You Rule in These Intellectual Property Cases?” 1. What does a trademark protect? What does a patent protect? What is a design patent? (LO 8) (AACSB: Reflective thinking) A trademark is any distinctive word, phrase, symbol, design, name, logo, slogan, or trade dress that a company uses to identify the origin of a product or to distinguish it from other goods on the market. A service mark offers the same protection as a trademark, except that it identifies and distinguishes the source of a service rather than a product. A patent is a grant from the federal government’s Patent and Trademark Office (PTO), to the inventor of a product, giving the exclusive right to make, use or sell the invention in this country for 20 years from the date of filing the patent application. To be patented, a device must be new (but not necessarily better!), not obvious to a person of ordinary skill or knowledge in the related field, and useful. Refer to Figure 3.4, A Sample (and Unusual) Patent. A device cannot be patented if it has been publicized in print anywhere in the world, or if it has been used or offered for sale in this country prior to the date of the patent application. A patent is awarded to the first person to file a patent application. Most patents are granted for new product inventions (called utility patents), but design patents extending for 14 years beyond the date the patent is issued, are given to inventors who make new original and ornamental changes in the designs of existing products that enhance their sales. 2. Assume the role of a judge in these two cases. How would you rule? Explain your reasoning. (In the Lululemon Athletica v. Calvin Klein case, you may want to search online for images of the two companies’ yoga pants and apply the ordinary observer test before making your decision.) (LO 8) (AACSB: Application of knowledge) Case Summary: The Christian Louboutin SA (CL) v. Yves Saint Laurent SA (YSL) case was focused on CL’s claim of trademark infringement by YSL over the use of the color red. CL claimed they had the right to trademark use of the color red on the soles of shoes, as it transformed the sole of a shoe into a work of art. YSL claimed that prohibiting others from using the color red, stating that if CL could claim a monopoly on the use of red on a part of the shoe would have an unprecedented, anti-competitive effect. .
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Students’ responses will likely support both CL and YSL points of view. Instructors should keep the focus on the legal issues of Trade dress, which is the unique combination of elements that a company uses to create a product’s image and to promote it. For example, a restaurant’s particular décor, color schemes, design and overall look and feel constitute its trade dress. To be eligible for trademark protection, trade dress must be inherently unique and distinctive to a company. A trademark prevents other companies from employing a similar mark to identify their goods. The first party who either uses a trademark in commerce or files an application with the PTO has the ultimate right to register that trademark. Trademarks last indefinitely as long as the holder continues to use it. Case Summary: In the Lululemon Athlectica (LA) v. Calvin Klein (CK) case, LA owned three design patents on their yoga pants, including a distinctive waistband, which sells for $98. LA claimed that CK’s “Performance” yoga pants (priced at $20) are significantly similar to their patented Astro pants waistband. Owners of a design patent must prove that to the average observer the alleged infringer’s (CK) design appears to be substantially the same as its own design. This is known as the “ordinary observer test.” Here are links for more information: https://www.google.com/search?q=calvin+klein+yoga+pants+lululemon&biw=1600 &bih=763&tbm=isch&tbo=u&source=univ&sa=X&ei=aHUxVKLvC5GcyATQ2IC4 CA&ved=0CFMQsAQ#facrc=_&imgdii=_&imgrc=cWoWrn1XDiwVvM%253A%3 BReeCNtVM8K3jMM%3Bhttp%253A%252F%252Fcdn.blisstree.com%252Ffiles% 252F2012%252F08%252Fpants.jpg%3Bhttp%253A%252F%252Fwww.blisstree.co m%252F2012%252F08%252F24%252Ffitness%252Flululemon-suing-calvin-klein985%252F%3B666%3B408 http://shop.lululemon.com/products/clothes-accessories/pants-yoga/Astro-PantRegular-Full-On-Luon http://online.wsj.com/news/articles/SB10000872396390443696604577645891750143 350 http://online.wsj.com/news/articles/SB10001424127887324851704578131501425509 018 3. Use a search engine to research the outcomes of these two cases. How were the cases resolved? If a judge rendered a decision, summarize his or her reasoning. Do you agree with the judge’s decision? (LO 8) (AACSB: Application of knowledge) In the Christian Louboutin SA case, the judge ruled in favor of YSL. CL appealed the ruling but lost. .
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http://scholar.google.com/scholar_case?case=1422674449865697977&hl=en&as_sdt=6 &as_vis=1&oi=scholarr Calvin Klein and Lululemon settled the case out of court. The settlement details will not been disclosed, as that is part of the settlement. http://www.businessinsider.com/lululemon-vs-calvin-klein-lawsuit-2012-11 Students’ viewpoints will vary on both cases. A key point to make before ending the discussion is that Lululemon, YSL, Calvin Klein, and Christian Louboutin had to proactively defend intellectual property. By suing they put all other competitors on notice that they will not hesitate do seek legal protection in the future.
Part 4: Chapter Discussion Questions 3-1. Explain the differences among creativity, innovation, and entrepreneurship. (LO 1) (AACSB: Reflective thinking) Creativity is the ability to develop new ideas and to discover new ways of looking at problems and opportunities. Innovation is the ability to apply creative solutions to those problems and opportunities to enhance or enrich people’s lives. Entrepreneurship is the result of a disciplined, systematic process of applying creativity and innovation to needs and opportunities in the marketplace. 3-2. Being creative is important for every organization. Define creativity. (LO 1) (AACSB: Analytical thinking) Creativity is the ability to develop new ideas and discover new ways of looking at problems and opportunities. 3-3. Why are creativity and innovation so important to the survival and success of a business? (LO 2) (AACSB: Analytical thinking) Creativity offers the potential to generate something from nothing. When small business owners cannot outspend their larger rivals, they can create powerful competitive advantages by “outcreating” and “outinnovating” their larger competitors. Today’s successful businesses live and die according to the quality of their ideas and the ability to protect them. 3-4. Can creativity be taught or is it an inherent trait? Explain. (LO 3) (AACSB: .
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Reflective thinking) Creativity can be taught. Research indicates that anyone can be creative. Each person can be taught techniques and behaviors that can help them generate new and creative ideas to solve problems and pursue opportunities. 3-5. Successful entrepreneurs are willing to take risks, explore new ideas, and ask questions when required. Do you agree? (AACSB: Reflective thinking) Yes, successful entrepreneurs are willing to take some risks, explore new ideas, play a little, ask “What if?”, and learn to appreciate ambiguity. By doing so, they develop the skills, attitudes, and motivation that make them much more creative—one of the keys to entrepreneurial success. 3-6. What can entrepreneurs do to stimulate their own creativity and to encourage it among workers? (LO 5) (AACSB: Application of knowledge) Enhancing individual creativity: •
Allow yourself to be creative
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Give your mind daily input
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Keep a journal
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Read books that stimulate creativity
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Take a class on creativity
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Take some time off
Ways to enhance creativity: •
Expect it
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Tolerate and expect failure
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Encourage curiosity
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View problems as challenges
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Provide creativity training
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Provide support
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Reward creativity
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Model creative behavior
3-7. Interview at least two entrepreneurs about their experiences as business owners. Where did their business ideas originate? How important are creativity and .
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innovation to their success? How do they encourage an environment of creativity in their businesses? (LO 6) (AACSB: Application of knowledge) Student responses will vary depending on who they interview. 3-8. Explain the differences between a patent, a trademark, and a copyright. (LO 8) (AACSB: Reflective thinking) A patent is a grant from the federal government’s Patent and Trademark Office (PTO) to the inventor of a product, giving the exclusive right to make, use, or sell the invention in the United States for 20 years from the date of filing the patent application. A trademark is any distinctive word, phrase, symbol, design, name, logo, slogan, or trade dress that a company uses to identify the origin of a product or to distinguish it from other goods in the marketplace. A copyright is an exclusive right that protects the creators of original works of authorship such as literary, dramatic, musical, and artistic works. Examples of these works include video games, software, sculptures, motion pictures, choreography and others. 3-9. What form of intellectual property do patents, trademarks, and copyrights protect? (LO 8) (AACSB: Reflective thinking) Patents protect new product inventions (utility patents), as well as new, original and ornamental changes to the design of an existing product that enhances their sales (design patent). In addition, patents can be obtained on plants that are developed by grafting or crossbreeding. Trademarks and servicemarks protect things that identify the origin of a product or to distinguish it from other goods on the market. This includes a firm’s distinctive word, phrase, symbol, design, name, logo, slogan, or trade dress. It can also include colors, shapes, colors, smells, or sounds. Other companies are prohibited from using another company’s trademark without permission or using a mark that is so similar to another’s trademark that it is likely to create confusion about the origin of other goods. Copyrights can be obtained on video games, software, sculptures, motion pictures, recordings, choreography, computer software programs, and others. It protects only the form in which an idea is expressed, not the idea itself.
Part 5: Case Studies The following text case may be used for lecture and assignments for topics presented in this chapter. .
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•
Case 2: Bark & Co.
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics. •
From Artist to Entrepreneur (Audio Podcast) http://ecorner.stanford.edu/authorMaterialInfo.html?mid=2278
46:17 minutes
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Creativity Loves Constraint http://ecorner.stanford.edu/authorMaterialInfo.html?mid=1530
1:40 minutes
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How to Protect Your Intellectual Property and Trade Secrets http://www.youtube.com/watch?v=5t-WOvifb6c
3:39 minutes
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The Simple Truths of Change http://www.changeisgoodmovie.com/
2:20 minutes
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The Paper Airplane Movie http://www.youtube.com/watch?v=37TQZyDMEP8
3:30 minutes
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Three Factors to Improve Entrepreneurial Success 2:11 minutes http://www.youtube.com/watch?v=W7ubqh1Rkts&feature=channel
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What Is Creativity? http://ecorner.stanford.edu/authorMaterialInfo.html?mid=1187
6:10 minutes
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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SECTION II. THE ENTREPRENEURIAL JOURNEY BEGINS CHAPTER 4. CONDUCTING A FEASIBILITY ANALYSIS AND DESIGNING A BUSINESS MODEL Part 1: Learning Objectives 1. Describe the process of conducting an idea assessment. 2. Present the elements of a feasibility analysis. 3. Describe the six forces in the macro environment of an industry. 4. Understand how Porter’s Five Forces Model assesses the competitive environment. 5. Describe the various methods of conducting primary and secondary market research. 6. Understand the four major elements of a financial feasibility analysis. 7. Describe the process of assessing entrepreneur feasibility. 8. Describe the nine elements of a business model in the Business Model Canvas.
Part 2: Class Instruction Introduction Five critical steps guide the process of going from idea generation to growing a successful business (Refer to Figure 4.1, New Business Planning Process). An idea assessment is the process of examining a need in the market, developing a solution for that need, and determining the entrepreneur’s ability to successfully turn the idea into a business. After identifying the most promising idea using the idea assessment process, the entrepreneur subjects it to a feasibility analysis to determine whether they can transform the idea into a viable business. A feasibility analysis is the process of determining whether or not an entrepreneur’s idea is a viable foundation for creating a successful business. If the idea passes the feasibility analysis, the entrepreneur moves on to the next steps of the new business planning process. Developing a business model, which is the third step in planning a new business, helps the entrepreneur to fully understand all that will be required to launch and build the business. Writing a business plan is the fourth step, and developing a strategic plan is the fifth step. .
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Idea Assessment
LO 1
An idea assessment helps to efficiently evaluate the numbers ideas that come out of the creative process. The idea sketch pad in Figure 4.2, Idea Sketch Pad, is an effective tool used to help assess ideas in a relatively short period of time by asking a series of key questions addressing five key parameters. 1. Customers. 2. Offering – a description of the product or service. 3. Value proposition of how your business will be important to the customers. 4. Core competencies to differentiate from competitors. 5. People on the management team. Placing the answers to these questions on the sketch pad, entrepreneurs can clearly visualize gaps or weaknesses, and change the idea to improve its chances for success.
Feasibility Analysis
LO 2
A feasibility analysis is the process of determining if the idea is a viable foundation for creating a successful business. It consists of four interrelated components: an industry and market feasibility analysis, a product or service feasibility analysis, and an entrepreneur feasibility analysis. Refer to Figure 4.3, Elements of a Feasibility Analysis. When evaluating the feasibility of a business idea, entrepreneurs find a basic analysis of the industry and targeted market segments a good starting point. The focus in this phase is two-fold: •
To determine how attractive an industry is overall as a “home” for a new business, and;
•
To identify possible niches a small business can occupy profitably.
When examining an industry, an entrepreneur should examine both the macro environment that can have an impact across many industries and the specific competitive environment of the industry of interest. Refer to Figure 4.4, Environmental Forces and New Ventures.
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Industry and Market Feasibility
LO 3
The first step in assessing industry attractiveness is to paint a picture of the industry in broad strokes, assessing it from a macro level. Six foundational macro forces create change in industries and the markets they serve: 1. Sociocultural change can lead to dramatic changes that can create how new industries and fundamentally transform existing industries (Refer Figure 4.5, American Labor Force Participation Rate and Figure 4.6, Food Expenditure Away From Home As A Percentage of Total Food Budget). 2. Technological breakthroughs lead to the development of new products and entirely new industries. 3. Demographic changes create opportunities. 4. Economic changes can make or break industries. 5. Political and legal changes create opportunities for entrepreneurs. 6. Global trends create opportunities for even the smallest companies. Entrepreneurs should ask the following questions to evaluate the six foundational macro trends to determine the attractive of an industry: •
How large is the industry, and how fast is it growing?
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Is the industry as a whole profitable?
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Is the industry characterized by high profit margins or razor-thin margins?
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How essential are its products or services to customers?
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What trends are shaping the industry’s future?
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What are the threats and opportunities facing the industry?
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How crowded is the industry, and how intense is the level of competition?
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Is the industry young, mature, or somewhere in between?
Consider using the Hands On… How To “Forces Shaping Innovation: The Driverless Car” at this point.
Porter’s Five Forces Model
LO 4
Porter’s Five Forces model (refer to Figure 4.7, Five Forces Model of Competition) evaluates five key forces that determine the setting in which companies compete, the attractiveness of the competitive environment, based upon these five considerations: the .
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rivalry among the companies competing in the industry, bargaining power of suppliers to the industry, The bargaining power of buyers, threat of new entrants to the industry, and threat of substitute products or services. 1. Rivalry Among Companies Competing in the Industry. The strongest of the five forces in most industries is the rivalry that exists among the businesses competing in a particular market. This force makes markets a dynamic and highly competitive place. An industry is generally more attractive when: •
The number of competitors is large, or, at the other extreme, fewer than five.
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Competitors are not similar in size or capability.
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The industry is growing at a fast pace.
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The opportunity to sell a differentiated product or service is present.
2. Bargaining Power of Suppliers to the Industry. The greater the advantage that suppliers of key raw materials or components have, the less attractive is the industry. An industry is generally more attractive when: •
Many suppliers sell a commodity product to the companies in it.
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Substitute products are available for the items suppliers provide.
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Companies find it easy to switch from one supplier to another or to substitute products.
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The items suppliers provide the industry account for a relatively small portion of the cost of the industry’s finished products.
3. Bargaining Power of Buyers. Buyers have the potential to exert significant power over businesses. When the number of customers is small and the cost of switching to a competitor’s product is low, buyers have a high level of influence. An industry is generally more attractive when: •
Industry customers’ “switching costs” to competitors’ products or to substitute products are high.
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The number of buyers in the industry is large.
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Customers demand differentiated products.
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Customers find it difficult to gain access to information on suppliers’ costs, prices, and product features.
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The items companies sell to the industry account for a small portion of the cost of their customers’ finished goods.
4. Threat of New Entrants. The larger the pool of potential new entrants to an industry, .
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the greater is the threat to existing companies in it. This is particularly true in industries where the barriers to entry, such as capital requirements, specialized knowledge, access to distribution channels, and others are low. An industry is generally more attractive to new entrants when these factors exist: •
Economies of scale are absent
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Capital requirements to enter the industry are low
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Cost advantages are not related to company size
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Buyers are not extremely brand-loyal
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Governments do not restrict new companies from entering the industry
5. Threat of Substitute Products or Services. Substitute products or services can turn an entire industry on its head. An example is the growing trend of companies using plastic containers instead of glass. An industry is generally more attractive when: •
Quality substitutes are not readily available
•
Prices of substitute products are not significantly lower that those of the industry’s products
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Buyer’s switching costs are high
After surveying the power these five forces exert on an industry, entrepreneurs can evaluate the potential for their companies to generate reasonable sales and profits in a particular industry to answer the question, “Is this industry a good one for my business?” Note that the lower the score for an industry, the more attractive it is. Table 4.1, The Five-Forces Matrix, is a quantitative tool that assesses importance and the degree of threat to provide a weighted score. This approach can help leverage insight from the five forces assessment. Market Niches. The next step in assessing an industry is to identify potentially attractive niches that exist. Occupying an industry niche enables a business to shield itself to some extent from the power of the five forces. Entrepreneurs who have designed successful focus or differentiation strategies for their companies can exploit these niches to their advantage. Questions to address include:
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•
Which niche in the market will we occupy?
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How large is this market segment, and how fast is it growing?
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What is the basis for differentiating our product or service from competitors?
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Do we have a superior business model that will be difficult for competitors to reproduce?
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Generally a niche strategy is a good way to enter as it usually takes fewer resources for the start-up due to lower marketing costs and the ability to start on a smaller scale. However, entrepreneurs should be aware of some cautions: •
Entering a niche requires adaptability in the initial plan.
•
Niches change.
•
Niches can go away.
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Niches can grow.
Product or Service Feasibility Analysis: Is There a Market?
LO 5
A product or service feasibility analysis determines the degree to which a product or service idea appeals to potential customers and identifies the resources necessary to produce the product or provide the service. This portion of the feasibility analysis addresses two important questions: Are customers willing to purchase our goods and services? Can we provide the product or service to customers at a profit? Conducting primary research involves collecting data firsthand, and secondary research which involves gathering data that has already been compiled and is available. Primary research tools include: •
Customer Surveys. These should be short and carefully worded, use a simple ranking system, and used with people who represent the target market of the business.
•
Focus Groups. This involves enlisting a small number of potential customers to give you feedback on specific issues about your product or service.
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Prototypes. A prototype is an original, functional model of a new product put into the hands of potential customers to test and use.
•
In-Home Trials. An in-home trial involves sending researchers into customers’ homes to observe them as they use the product or service.
•
“Windshield” Research. Researchers observe customers’ interactions with existing businesses.
Secondary research should be used to support, not replace, primary research. It is usually less expensive to collect than primary data, and includes the following resources: •
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Trade Associations and Business Directories
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•
Industry Databases
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Demographic Data
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Census Data
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Forecasts
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Market Research
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Articles
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Local Data
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The Internet
Consider using Hands On… How To “Do You Want Fries with Those Crickets?” at this point.
Financial Feasibility Analysis: Is There Enough Margin?
LO 6
The third component of a feasibility analysis involves assessing the financial feasibility. This step involves assessing these four elements: •
Capital Requirements. This refers to the amount of money needed to start the business. The typical start-up in the United States is launched with an average of $30,000, and one in five starts with no funding. Bootstrapping is the process of finding creative ways to exploit opportunities with limited resources.
•
Estimated earnings. An entrepreneur must forecast the earning potential of the proposed business.
•
Time out of cash. The entrepreneur must estimate the total cash needed to sustain the business until achieving break-even cash flow.
•
Return on investment. This aspect combines the estimated earnings and the capital requirements to determine the rate of return the venture is expected to produce.
Wise entrepreneurs take the time to test their ideas to determine the viability of the concept as a business.
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Entrepreneur Feasibility: Is This Idea Right for Me?
LO 7
Many new businesses require that an entrepreneur have a certain set of knowledge, experiences, and skills to have any chance of being success. This is called entrepreneurial readiness. Another way to ensure the necessary knowledge and skills are in place is through building a team. Beyond the entrepreneur’s readiness to start a business, the second aspect is to assess whether the business can meet the financial and nonfinancial needs of the entrepreneur and the team. For example, will the business be able to generate enough profit to support everyone’s income needs? Does the business fit the goals and aspirations the entrepreneur has outside of work? Refer to Table 4.2, Entrepreneurial Self-Assessment.
Developing and Testing a Business Model
LO 8
A business model is used to map out the key components required to make a business successful, and adds more detail to the evaluation of a new business by graphically depicting the “moving parts” to insure they are all working together. Osterwalder and Pigneur developed a Business Model Canvas to provide entrepreneurs with a dynamic framework to guide them through the process. Refer to Figure 4.8, The Business Model Canvas. The canvas is comprised of nine elements: 1. Customer Segments. Identify a segment of customers who have a clearly defined need. Small companies usually are much more successful focusing on a specific market niche or niches where they can excel at meeting customers’ special needs or wants. 2. Value Proposition. A compelling value proposition is at the heart of every successful business. The value proposition is the collection of products and/or services the business will offer to meet the needs of the customers. It is best to identify and focus on one or two benefits that will make the new business stand out to customers and motivate them to purchase from the new business. 3. Customer Relationships. What level of customer service is expected by your customers? The entrepreneur needs to know how customers want to interact with the business, if customers want intensive personal service or prefer limited engagement or even an automated interaction.
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4. Channels. In the business model canvas, channels refer to both communication channels (promotion) and distribution channels (product placement). 5. Key Activities. The goal is to build a basic checklist of what needs to be done to open the business and what activities are necessary to ensure its long-term success. 6. Key Resources. The entrepreneur must identify the human, capital, and intellectual resources needed to the business to be successful. 7. Key Partners. Examples include key suppliers, key outsourcing partners, investors, industry partners, advisers, and all other external businesses or entities that are critical to make the business model work. 8. Revenue Streams. The entrepreneur must determine how the value proposition will generate revenue. The answer might be one-time sale, ongoing fees, advertising, or some other sources of cash into the business. 9. Cost Structure. The entrepreneur must identify the fixed and variable costs necessary to make the business model work. Developing a business model is a four-phase process. Refer to Figure 4.9, The Business Modeling Process. •
The first phase is to create an initial business model canvas, with the expectation that it will change as it is being reviewed.
•
The second phase is to test the problem that the entrepreneur thinks is being solved by the business through its core value proposition using primary research data. The entrepreneurial team needs to test the model with real customers to determine the answers to these questions: o Do we really understand the customer problem? o Doe these customers care enough about this problem to spend their money on our product? o Do these customers care enough to help us by telling others through wordof-mouth?
•
The third phase is to test your solution to the problem in the market. One technique involves business prototyping, in which entrepreneurs test their business models on a small scale before committing serious resources to launch a business that might not work. For example, one can sell their products on established Internet sites such as eBay or by setting up their own Web sites to gauge customers’ response. A process that can guide testing early versions of a product is known as lean startup, which is defined as a process of rapidly developing simple prototypes to test key assumptions by engaging real customers. Begin with a minimal viable
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product, which is the simplest version of a product or service that can create a sustainable business. •
The fourth phase is to make changes and adjustments in the business, called pivots, based on what is learned from engaging the market about the problem and the solution the new business intends to pursue. There are three major types of pivots: o Product pivot – changes to the product to enable it to better meet the needs and wants of the customer. o Customer pivot – changes in the target customer description. o Revenue model pivot – changes in the way the firm generates revenue.
Consider using You Be the Consultant: “RendezWoof: Creating a Minimal Viable Product for a Mobile App” and/or You Be the Consultant: “When to Call It Quits on a New Business” at this point.
Conclusion The best business ideas start with a group of customers with a common problem or need. Then the first step is to assess these ideas by examining a need in the market, developing a solution for that need, and determining the entrepreneur’s ability to successful turn the idea into a business. The second step is to conduct a feasibility analysis to determine whether the entrepreneur can transform the idea into a viable business. The third step is to develop and test the business model. Once these steps are completed the entrepreneur is ready to develop the business plan, and later a strategic plan, both of which are covered in Chapter 5.
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Part 3: Chapter Exercises Hands On… How To: “Forces Shaping Innovation: The Driverless Car” 1. What changes in macro environmental forces are shaping the feasibility of the driverless car? (LO 3) (AACSB: Reflective thinking) Students will jump immediately to technological forces, but guide them to discuss the impact of changes in the other forces including economic forces, political and legal forces, global forces, demographic forces, and sociocultural forces. 2. If you were an executive at an automobile company, would you pursue your own model of a driverless car? Why or why not? (LO 3) (AACSB: Analytical thinking) This might be a good topic for a debate, with one side debating for the company deciding to compete, and the other side debating against the decision to develop a competing car. Keep the discussion focused on applying the six foundational macro forces. 3. What other opportunities for new businesses can you envision that may result from the introduction of the driverless car into the market? (LO 3) (AACSB: Analytical thinking) Encourage students to be creative here! Encourage them to use some of the creativity techniques they learned in Chapter 3.
Hands On… How To: “Do You Want Fries with Those Crickets?” 1. What macro trends support businesses selling edible insects to American consumers? (LO 4) (AACSB: Reflective thinking) Students may assume the main force is sociocultural forces, but guide them to discuss the impact of changes in the other forces including economic forces, political and legal forces, global forces, demographic forces, and technological forces. 2. What are the risks that come with being an early entrant into the edible insect market? (LO 5) (AACSB: Reflective thinking) An entrepreneur would certainly need to conduct a product feasibility analysis to determine if there is a market that is large enough to generate a profit. Primary market research would
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be key to answering this question, but secondary research would be important as well. This chapter outlines many ways to conduct both primary and secondary research. 3. Do you believe an edible insect business would be successful where you live? Why or why not? (LO 5) (AACSB: Reflective thinking) Challenge students to keep an open mind about this business concept. Consider having your students write a list of reasons why people should consider eating edible insects, and then developing a commercial or advertisement for a business that sells edible crickets.
You Be the Consultant: “RendezWoof: Creating a Minimal Viable Product for a Mobile App” 1. Why would you recommend that an entrepreneur develop a minimal viable product or a prototype? (LO 8) (AACSB: Reflective thinking) A minimal viable product is the simplest version of a product or service that can create a sustainable business. It is an opportunity to improve on a product using real customer feedback, and to develop some kind of customer base to support updated versions of the product. It can provide proof of concept. It also allowed Aikens to test the waters before quitting his job. 2. Can you think of additional market research that Aikens could have done before developing his product? (LO 8) (AACSB: Application of knowledge) There is no evidence in the case that any primary or secondary research was conducted. Refer to Figure 4.3, Elements of a Feasibility Analysis, and LO 5, Product or Service Feasibility Analysis: Is There a Market? for additional information. 3. What are the advantages and disadvantages of offering equity in exchange for work done on a new product? (LO 8) (AACSB: Application of knowledge) Judson Aikens was able to acquire the skills that he did not have that were necessary to turn his idea into reality. By sharing equity with Ben Dolgoff, the experienced app designer, and the graphic designer, Aikens also had a team to share the work load. The app would likely never have gotten started without their help and intellectual contributions. While he could possibly have contracted the tasks to independents, it would have been costly to do so. The main disadvantage is that he would have to share profits with them.
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You Be the Consultant: “When to Call It Quits on a New Business” 1. Why was it hard for Jake to admit his newest venture was not going to work? (LO 8) (AACSB: Reflective thinking) Students will generate a variety of ideas, but the main reasons are because entrepreneurs take pride in their businesses, and consider their businesses like their babies. 2. What would you recommend that entrepreneurs do to ensure they don’t hang on too long to a failed business concept? (LO 8) (AACSB: Reflective thinking) Students will generate a variety of ideas. The main focus of this discussion is that Jake should have established a solid estimate of the “time out of cash.”. Once his business has run out of cash and is failing to break even then it is time to give up. 3. A failed business concept does not mean the entrepreneur has failed. How would you explain this to an entrepreneur facing a failed business concept? (LO 8) (AACSB: Reflective thinking) Student responses will vary, but should emphasize what Jake has learned from the experience. What didn’t he do for this business that he will do for the next one? What worked well in this business that he can use in the next one?
Part 4: Chapter Discussion Questions 4-1. What is an idea assessment? (AACSB: Reflective thinking) An idea assessment is the process of examining a need in the market, developing a solution for that need, and determining the entrepreneur’s ability to successfully turn the idea into a business. 4-2. Explain the process of conducting an idea assessment. (AACSB: Reflective thinking) The process of conducting an idea assessment has five parameters: 1. Customers: start with a group of customers who have a clear need that is not being addressed. 2. Offering: describe your idea for a product or service. 3. Value proposition: explain why your product or service will be important to customers. 4. Core competencies: determine if your offering has any technologies or unique features that will help differentiate it from competitors. .
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5. People: identify the key people on the team who will launch this business. 4-3. Why is it necessary to conduct a feasibility analysis? Explain. (AACSB: Reflective thinking) Feasibility analysis is an opportunity to take a hard look at your idea, to see if it needs minor or major pivots, or if warranted, to be completely abandoned so you can move on to another idea. 4-4. Describe the four components of a feasibility analysis. (LO 2) (AACSB: Reflective thinking) It consists of four interrelated components: an industry and market feasibility analysis, a product or service feasibility analysis, a financial feasibility analysis, and an entrepreneur feasibility analysis. 4-5. What factors led to the birth of the day care industry and the rapid growth in the restaurant industry? (AACSB: Reflective thinking) Social and cultural changes lead to dramatic changes that created whole new industries, like the day care industry, and fundamentally transformed existing industries, like the restaurant industry. These changes were a result of the women’s movement of the 1960s, and an increase in individualism. 4-6. Describe in detail Porter’s Five Forces Model. (LO 4) (AACSB: Reflective thinking) Refer to Figure 4.7, The Five Forces Model of Competition. Rivalry Among Companies Competing in the Industry: The strongest of the five forces in most industries is the rivalry that exists among the businesses competing in a particular market. This force makes markets a dynamic and highly competitive place. Bargaining Power of Suppliers to the Industry: The greater the advantage that suppliers of key raw materials or components have, the less attractive is the industry. Bargaining Power of Buyers: Buyers have the potential to exert significant power over businesses. When the number of customers is small and the cost of switching to a competitor’s product is low, buyers have a high level of influence. Threat of New Entrants: The larger the pool of potential new entrants to an industry, the greater is the threat to existing companies in it. This is particularly true in industries where the barriers to entry, such as capital requirements, specialized knowledge, access to distribution channels, and others are low. Threat of Substitute Products or Services: Substitute products or services can turn an entire industry on its head. An example is the growing trend of companies using plastic containers instead of glass.
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4-7. Discuss whether it is advisable for an entrepreneur to build a prototype of his new product. (AACSB: Reflective thinking) Yes, it is advisable for an entrepreneur to build a prototype, as this is an effective way to gauge the viability of a product. A prototype is an original, functional model of a new product that entrepreneurs can put into the hands of potential customers, so that they can see it, test it, and use it. Prototypes usually point out potential problems in a product’s design, giving inventors the opportunity to fix them even before they put the product into customers’ hands. 4-8. Explain the advantages an entrepreneur gains by pursuing a niche market. (LO 4) (AACSB: Reflective thinking) Occupying an industry niche enables a business to shield itself to some extent from the power of the five forces. 4-9. List and describe the various tools for conducting primary market research. (LO 5) (AACSB: Reflective thinking) Customer Surveys. These should be short and carefully worded, use a simple ranking system, and used with people who represent the target market of the business. Focus Groups. This involves enlisting a small number of potential customers to give you feedback on specific issues about your product or service. Prototypes. A prototype is an original, functional model of a new product put into the hands of potential customers to test and use. In-Home Trials. An in-home trial involves sending researchers into customers’ homes to observe them as they use the product or service. “Windshield” Research. Researchers observe customers’ interactions with existing businesses. 4-10. What are the four elements of a financial feasibility analysis? (LO 6) (AACSB: Reflective thinking) Capital Requirements. This refers to the amount of money needed to start the business. The typical start-up in the United States is launched with an average of $10,000 and one in five starts with no funding. Bootstrapping is the process of finding creative ways to exploit opportunities with limited resources. Estimated earnings. An entrepreneur must forecast the earning potential of the proposed business. Time out of cash. The entrepreneur must estimate the total cash needed to sustain the business until achieving break-even cash flow.
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Return on investment. This aspect combines the estimated earnings and the capital requirements to determine the rate of return the venture is expected to produce. 4-11. Explain the difference between primary and secondary research. (AACSB: Reflective thinking) Conducting primary research involves collecting data firsthand and analyzing it, meanwhile secondary research involves gathering data that has already been compiled and is available, often at a reasonable cost, or sometimes even for free. 4-12. What are the key questions that an entrepreneur must ask while preparing a business model? (AACSB: Reflective thinking) In building a business model, the entrepreneur addresses a series of key questions that will explain how a business will become successful. What value is offered to customers, and what is it worth to them? Who is my target market? What do they expect of me as my customers? How do I get information to them, and how do they want to get the product? What are the key activities to make all of this come together, and how much will they cost? What resources, including money, do I need to make this happen? Who are the key partners I will need to attract to be successful? 4-13. List and describe the nine elements of the business model canvas. (LO 8) (AACSB: Reflective thinking) Refer to Figure 4.8, The Business Model Canvas. The canvas is comprised of nine elements: 1. Customer Segments. Identify a segment of customers who have a clearly defined need. Small companies usually are much more successful focusing on a specific market niche or niches where they can excel at meeting customers’ special needs or wants. 2. Value Proposition. A compelling value proposition is at the heart of every successful business. The value proposition is the collection of products and/or services the business will offer to meet the needs of the customers. It is best to identify and focus on one or two benefits that will make the new business stand out to customers and motivate them to purchase from the new business. 3. Customer Relationships. What level of customer service is expected by your customers? The entrepreneur needs to know how customers want to interact with the business, if customers want intensive personal service or prefer limited engagement or even an automated interaction. 4. Channels. In the business model canvas, channels refer to both communication channels (promotion) and distribution channels (product placement). 5. Key Activities. The goal is to build a basic checklist of what needs to be done to open the business and what activities are necessary to ensure its long-term success. .
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6. Key Resources. The entrepreneur must identify the human, capital, and intellectual resources needed to the business to be successful. 7. Key Partners. Examples include key suppliers, key outsourcing partners, investors, industry partners, advisers, and all other external businesses or entities that are critical to make the business model work. 8. Revenue Streams. The entrepreneur must determine how the value proposition will generate revenue. The answer might be one-time sale, ongoing fees, advertising, or some other sources of cash into the business. 9. Cost Structure. The entrepreneur must identify the fixed and variable costs necessary to make the business model work. 4-14. Describe the four phases that go into developing a business model. (LO 8) (AACSB: Reflective thinking) Developing a business model is a four-phase process. Refer to Figure 4.9, the Business Modeling Process. •
The first phase is to create an initial business model canvas, with the expectation that it will change as it is being reviewed.
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The second phase is to test the problem that the entrepreneur thinks is being solved by the business through its core value proposition using primary research data. The entrepreneurial team needs to test the model with real customers to determine the answers to these questions: o Do we really understand the customer problem? o Doe these customers care enough about this problem to spend their money on our product? o Do these customers care enough to help us by telling others through wordof-mouth?
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The third phase is to test your solution to the problem in the market. One technique involves business prototyping, in which entrepreneurs test their business models on a small scale before committing serious resources to launch a business that might not work. For example, one can sell their products on established Internet sites such as eBay or by setting up their own Web sites to gauge customers’ response. A process that can guide testing early versions of a product is known as lean startup, which is defined as a process of rapidly developing simple prototypes to test key assumptions by engaging real customers. Begin with a minimal viable product, which is the simplest version of a product or service that can create a sustainable business.
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The fourth phase is to make changes and adjustments in the business, called pivots, based on what is learned from engaging the market about the problem and the solution the new business intends to pursue.
4-15. What is a pivot in a business model? (LO 8) (AACSB: Reflective thinking) During the fourth phase of developing a business model the entrepreneur will often make changes and adjustments in the business, called pivots, based on what is learned from engaging the market about the problem and the solution the new business intends to pursue. 4-16 Explain the various types of pivots an entrepreneur may need to consider for a business model. (LO 8) (AACSB: Reflective thinking) There are three major types of pivots: •
Product pivot – changes to the product to enable it to better meet the needs and wants of the customer.
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Customer pivot – changes in the target customer description.
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Revenue model pivot – changes in the way the firm generates revenue.
Part 5: Case Studies There are no case studies that apply to this chapter.
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics.
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Focus Group http://www.youtube.com/watch?v=j_cUnlQl29Q
4:27 minutes
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Michael Porter on Five Forces Model http://www.youtube.com/watch?v=9AnsoPy2FYE
13:11 minutes
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Starting a Small Business Series - Episode 2 – Feasibility Study http://www.youtube.com/watch?v=ceY2Jb6Ps1E
3:23 minutes
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Feasibility Study Template http://www.youtube.com/watch?v=gNsimuW0dJU
1:08 minutes
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How to Make an Invention Prototype http://www.youtube.com/watch?v=An3r4GbUPRc
4:08 minutes
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Les Brown: Discover the Entrepreneurial Mindset http://www.youtube.com/watch?v=N8eC5qR9_Wo
7:36 minutes
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Alexander Osterwalder: The Business Model Canvas http://www.youtube.com/watch?v=2FumwkBMhLo
3.32 minutes
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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CHAPTER 5. CRAFTING A BUSINESS PLAN AND BUILDING A SOLID STRATEGIC PLAN Part 1: Learning Objectives 1. Explain the benefits of an effective business plan. 2. Describe the elements of a solid business plan. 3. Explain the “Five Cs of Credit” and why they are important to potential lenders and investors reviewing business plans. 4. Understand the keys to making an effective business plan presentation. 5. Understand the importance of strategic management to a small business. 6. Explain why and how a small business must create a competitive advantage in the market. 7. Develop a strategic plan for a business using the nine steps in the strategic management process.
Part 2: Class Instruction Introduction A business plan is a planning tool that builds on the foundation of the idea assessment, feasibility analysis, and business model. The primary goals of a business plan are to guide entrepreneurs as they launch their businesses and to help them acquire the necessary financing. A business plan offers:
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A systematic, realistic evaluation of venture’s chances for success
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A way to determine the principal risks facing the venture
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A game plan for managing the business successfully
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A tool for comparing actual results against targeted performance
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An important tool for attracting capital in the challenging hunt for money
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The Benefits of Creating a Business Plan
LO 1
The U.S. Small Business Administration reports that entrepreneurs who write business plans early on are two-an-a-half times more likely to actually start their businesses. A business plan is a written summary of an entrepreneur’s proposed business venture, its operational and financial details, its marketing opportunities and strategy, and its managers’ skills and abilities. A business plan serves two essential functions. First, it provides a battery of tools – a mission statement, goals, objectives, budgets, financial forecasts, target markets, and entry strategies – to help entrepreneurs subject their ideas to one last test of reality before launching. It also helps to lead the company successfully through launch and early startup. The second function is to attract lenders and investors. To get external financing, a plan must pass three tests with potential lenders and investors: 1. Reality Test – proves that a market for the product or service really does exist. This focuses on industry attractiveness, market niches, potential customers, market size, degree of competition, and similar factors. In addition, the plan indicates if the company can really build it for the cost estimates, if it is truly different from what competitors are already selling, and if it offers customers something of value. 2. Competitive Test – evaluates the company’s relative position to its key competitors. 3. Value Test – convinces lenders and investors to put their money into the venture.
The Elements of a Business Plan
LO 2
Every business plan is unique and must be tailored to the specific needs of the business. There are many resources available to use as a guide. The seemingly overwhelming task of building a business plan is easily broken down into workable parts that any student or entrepreneur can undertake. Today the trend is for shorter plans of 10 to 20 pages instead of the 20 to 40 page plans of the past. Plans may include the following: • Title Page and Table of Contents • Executive Summary • Mission and Vision Statement • Description of Firm’s Product/Service .
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• • • •
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Business and Industry Profile Competitor Analysis Market Entry Strategy Marketing Strategy • Showing Customer Interest • Documenting Market Claims • Target Market • Advertising and Promotion • Market Size and Trends • Location • Pricing • Distribution Entrepreneurs’ and Managers’ Resumes Plan of Operation Pro-Forma (Projective) Financial Statements The Loan or Investment Proposal. Refer to Figure 5.1, Visualizing a Venture’s Risks and Rewards.
Refer to Appendix A to view The Sample Business Plan Outline. In addition, there are ten tips on preparing your business plan that can save time and help to create a more cohesive and impressive overall plan. 1. Have an attractive cover 2. Check for spelling and grammar 3. Create a visual appeal throughout the plan 4. Include a table of contents with page numbers 5. Make it interesting and compelling 6. Demonstrate its profit potential 7. Use spreadsheets 8. Include cash flow projections 9. Keep it concise and “crisp” 10. Tell the truth – always!
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What Lenders Look for in a Business Plan LO 3 Bankers and other lenders include the “five Cs” of credit as a part of their evaluation of the credit-worthiness of loan applications. The higher a business scores on the evaluation, the greater its chance will be of receiving a loan based on these five criteria: 1. Capital. A small business must have a stable capital base before any lender will grant a loan. 2. Capacity. A synonym for capacity is cash flow. 3. Collateral. This refers to assets an entrepreneur can pledge to a lender as security for the repayment of the loan. 4. Character. An evaluation of character is based on intangible factors such as honesty, competence, polish, determination, knowledge, experience, and ability. 5. Conditions. Factors include potential growth in the market, competition, location, form of ownership, and the purpose of the loan.
The Pitch: Making the Business Plan Presentation LO 4 The content of the presentation should include five basic areas: •
Your company and its products and services
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The problem to be solved, preferably told through a compelling story
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A simple description of your company’s solution to the problem
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Your company’s business model
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Your company’s competitive edge
Keys to making an effective business plan presentation include the following:
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Prepare and practice your delivery. Demonstrate enthusiasm, but don’t be too emotional. Focus on communicating the dynamic opportunity your idea offers and how you plan to capitalize on it.
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“Hook” investors quickly with an up-front explanation of the new venture, its opportunities, and the benefits to them.
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Use visual aids. Follow Guy Kawasaki’s 10/20/30 rule for PowerPoint presentations. Use 10 slides that you can cover in 20 minutes. Chapter 5, Page 79
Use 30-point font. •
Explain how your company’s products or services solve some problem and emphasize the factors that make your company unique. Offer proof. Hit the highlights. Keep the presentation crisp. Avoid the use of technical terms.
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Every lender and investor is thinking, “What’s in it for me?”
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Close by reinforcing the nature of the opportunity and the related benefits to investors. Be prepared for questions. Anticipate the questions the audience is most likely to ask.
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Be sensitive to issues that are most important to lenders and investors.
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Follow up with every investor to whom you make a presentation.
Consider using You Be the Consultant: “The Battle of the Plans” at this point.
Building a Strategic Plan
LO 5
Once the business moves past its start-up a strategic plan becomes necessary. A solid strategic plan provides managers and employees a sense of direction when everyone is involved in creating and updating it. There is a shift unfolding now in the economy from a base of financial to intellectual capital. Intellectual capital is comprised of three components: 1. Human capital – talent, creativity, skills, and abilities of the work force. 2. Structural capital – accumulated knowledge and experience of the company. 3. Customer capital – customer base, positive reputation, relationships, and goodwill. Successful entrepreneurs use the process of strategic management to cope with the constantly changing competitive environment. Strategic management involves developing a game plan to guide a company as it strives to accomplish its vision, mission, goals, and objectives and to keep it from straying off its desired course.
Building a Competitive Advantage
LO 6
The goal of developing a strategic plan is to create a competitive advantage – the value proposition that sets a small business apart from its competitors and gives it a unique position in the market that is superior to its rivals. Entrepreneurs should examine five aspects of their businesses to define their companies’
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competitive advantages: •
Products they sell
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Service they provide
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Pricing they offer
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Way they sell
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Values to which they are committed
Building a competitive advantage alone is not enough; the key to success over time is building a sustainable competitive advantage. This can be accomplished by developing a set of core competencies that are better than their competitors. Core competencies are a unique set of capabilities that a company develops in key areas, such as superior quality, customer service, innovation, team building, flexibility, and responsiveness, which allow it to vault past competitors. Refer to Figure 5.2, Building a Sustainable Competitive Advantage. Typically a company develops core competencies in no more than five or six (often fewer) areas. Successful small companies are able to build strategies that exploit all the competitive advantages that their size gives them by doing the following: •
Responding quickly to customers’ needs. Providing the precise desired level of customer service.
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Remaining flexible and willing to change. Constantly searching for new, emerging market segments. Building and defending small market niches.
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Erecting “switching costs,” the costs a customer incurs by switching to a competitor’s product or service, through personal service and loyalty.
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Remaining entrepreneurial and willing to take risks and act with lightning speed. Constantly innovating.
Strategic management enhances a small company’s effectiveness, but entrepreneurs first must have a process designed to meet their needs and their business’s special characteristics. The strategic management procedure for a small business should include the following features:
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Use a relatively short planning horizon – two years or less.
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Be informal and not overly structured.
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Encourage the participation of employees and outside parties.
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Do not begin with setting objectives because extensive objective setting early on may interfere with the creative process of strategic management.
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Maintain flexibility; competitive conditions change too rapidly.
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Focus on strategic thinking, not just planning, by linking long-range goals to dayto-day operations.
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Be an ongoing process because businesses and the competitive environment in which they operate constantly change.
The Strategic Management Process
LO 7
There are nine steps in the process. Step 1 – Develop a Clear Vision and Translate It into a Meaningful Mission Statement. The purpose of developing a vision is to focus everyone’s attention on the same target and to inspire them to reach it. It is future oriented and touches everyone associated with the company. It is the result of the entrepreneur’s dream that does not exist yet and the ability to pain a compelling picture of that dream for everyone to see. Refer to Table 5.1, Creating a Vision for Your Company. A strong vision helps a company in four ways: 1. Provide direction 2. Determine decisions 3. Inspire people 4. Allow for perseverance in the face of adversity The mission statement addresses the question, “What business are we in?” It must be concise and specific so your customers understand your purpose and how you provide value to them. Refer to Table 5.2, Tips for Writing a Powerful Mission Statement. It includes the following elements: •
What are we in business to accomplish?
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Who are we in the business to serve?
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How are we going to accomplish that purpose?
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What principles and beliefs form the foundation of the way we do business?
Step 2 – Assess the Company’s Strengths and Weaknesses. Building a successful competitive strategy requires a business to magnify its strengths and overcome or compensate for its weaknesses. Strengths are positive internal factors that a company can draw on to accomplish its mission, goals, and objectives. Examples include special skills or knowledge, a superior proprietary product or process, a positive public image, etc. Weaknesses are negative internal factors that inhibit a company’s ability to accomplish its mission, goals, and objectives. Examples include lack of capital, a shortage of skilled .
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workers, or inability to master technology. One technique for taking this strategic inventory is to prepare a “balance sheet” of the company’s strengths and weaknesses. Refer to Table 5.3, Identifying Company Strengths and Weaknesses. Step 3 – Scan the environment for significant opportunities and threats facing the business. Opportunities are positive external options that a firm can explain to accomplish its mission, goals, and objectives. A small business should analyze only those that are most significant to the business (two or three at most). Threats are negative external forces that inhibit a company’s ability to achieve its mission, goals, and objectives. Examples include new competitors entering the local market, government regulations, economic recession, or technological advances. Refer to Table 5.4, Identifying and Managing Threats, for 12 major sources of risk. Step 4 – Identify the Key Factors for Success (KSF) in the Business. Key success factors determine a company’s ability to compete successfully in an industry. Examples include managing costs, superior product quality, and solid relationships with suppliers. Focus on surpassing competitors on one or two KSFs to build a sustainable competitive advantage. Refer to Table 5.5, Identifying Key Success Factors. Step 5 – Analyze the Competition. Keeping tabs on rivals’ movements through competitive intelligence programs is a vital strategic activity. The primary goals include: conducting continuous rather than periodic analysis of competition, avoiding surprises from existing competitors’ new strategies and tactics, improving reaction time to competitors’ actions, and anticipating rivals’ next strategic moves. Entrepreneurs can use the results of their competitive intelligence efforts to construct a competitive profile matrix for its most important competitors. It allows the owners to evaluate their firms against the major competitors using the KSFs for that market segment. Refer to Table 5.6, Sample Competitive Profile Matrix. Step 6 – Create Company Goals and Objectives. Goals are broad, long-range attributes that a business seeks to accomplish; they tend to be general and sometimes even abstract. Refer to Figure 5.3, What Makes an Effective BHAG? Objectives are more specific targets of performance, such as profitability, productivity, growth, efficiency, sales, etc. Well-written objectives have the following characteristics:
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Specific
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Measureable
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Action commitments
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Timely
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Written down
Step 7 – Formulate Strategic Options and Select the Appropriate Strategies. A strategy is a road map of the actions an entrepreneur draws up to accomplish a company’s mission, goals, and objectives. There are three basic strategies, refer to Figure 5.4, Three Strategic Options. •
Cost leadership strategy – the firm strives to be the lowest-cost producer relative to its competitors in the industry.
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Differentiation strategy – seeks to build customer loyalty by selling goods or services that provide unique attributes and that customers perceive to be superior to competing products.
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Focus strategy – recognizes that not all markets are homogeneous but are made up of various segments. Businesses with a focus strategy sell to specific segments rather than try to sell to the mass market. Refer to Figure 5.5, Long Tail Markets.
Step 8 – Translate Strategic Plans into Action Plans. Entrepreneurs must convert strategic plans into operating plans. Executing a strategy focuses on the purpose of the project, the scope, contributions to other projects, resource requirements, and timing. Step 9 – Establish Accurate Controls. Controlling plans and projects and keeping them on schedule means that an entrepreneur must identify and track key performance indicators based on operating data from the company’s normal business activity To judge the effectiveness of their strategies, many companies are developing balanced scorecards, a set of multidimensional measurements that are unique to a company. Refer to Figure 5.6, The Balanced Scorecard Links Performance Measures. Ideally a balanced scorecard reviews five perspectives: customer perspective, internal business perspective, innovation and learning perspective financial perspective, and corporate citizenship. Consider using Hands On… How To “Beat the Big Guys,” You Be the Consultant: “The Escape Game Seeks to Expand Nationwide” or You Be the Consultant: “Finding a Niche with a Subscription Business Model” at this point.
Conclusion A solid business plan is essential to raising the capital needed to start a business. Creating
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a successful business requires entrepreneurs to put the plan into action and then managing the growth of the business with a sound strategic plan. The strategic planning process does not end with the nine steps outlined in this chapter; it is an ongoing procedure.
Sample Business Plan Outline There is a comprehensive business plan outline at the end of this chapter that summarizes universal elements that should be included in any formal plan.
Part 3: Chapter Exercises You Be the Consultant: “The Battle of the Plans” 1. What benefits do entrepreneurs gain by competing in business plan competitions such as the one at Texas Christian University? (LO 4) (AACSB: Reflective thinking) In addition to potentially winning cash prizes, the entrepreneurs (perhaps more importantly) gain from meeting the judges of the competition. These judges can provide exceptional advice, become long term mentors, and sometimes even investors. 2. Work with a team of your classmates to brainstorm ideas for establishing a business plan competition on your campus. How would you locate judges? What criteria would you use to judge the plans? What prizes would you offer the winners, and how would you raise the money to give those prizes? Who would you allow to compete in your competition? (LO 4) (AACSB: Reflective thinking) Suggest students research business plan competitions held at other universities while seeking the answers to these questions. Students will generate a variety of ideas and you may look for these qualities:
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Are the recommendations creative?
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Are they realistic?
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Are they practical for the school’s environment?
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Have they thought through the ramifications of their ideas?
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How did they structure the competition and is that a viable format?
3. Using the ideas you generated in question 2, create a two-page proposal for establishing a business plan competition at your school. (LO 4) (AACSB: Application of knowledge) The instructor could potentially offer this as a course assignment or offer extra credit for this. In addition, you could treat this as a competition. At a minimum, you should consider helping students to get their proposals into the hands of people who could make this happen.
Hands On… How To: “Beat the Big Guys” 1. Why do many small businesses fail when a big discount retailer such as Wal-Mart enters their market? (LO 7) The obvious answer to this question is that small businesses often fail to conduct an analysis of their strengths, weaknesses, opportunities, and threats. As a result they are surprised when the big guys enter their market and have no plan of defense. 2. Work with a team of your classmates to identify a local small business that competes with a bigger competitor. Which of the strategies described here has the small company employed to become a stronger competitor? What other strategies would you recommend to the owner of this business? Remind students to use the “Rules” listed in this feature. 3. Based on your work in question 2, develop a one-page report summarizing your strategic suggestions. Encourage students to use the creativity exercises learned in chapter 3 to help them to be creative. In your review of their reports, look to insure they have indeed used the “Rules”.
You Be the Consultant: “The Escape Game Seeks to Expand Nationwide” 1. Visit The Escape Game’s Web site at https://nashvilleescapegame.com to learn more about the company. Work with a team of your classmates to identify the company’s strengths and weaknesses. (LO 7) (AACSB: Application of knowledge) The Escape Game’s website offers a lot of information about the company, in particular a description of the games as well as details about the customer experience.
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Strengths listed by students must be focused on internal factors, and may include: special skills of the management team, a superior customer experience, an interactive product, and credibility afforded by quick path to profitability and support of venture capital. Weaknesses listed by students must be focused on internal factors, and may include: problems with technology, the need to be constantly creative to draw repeat customers. 2. What opportunities and threats does The Escape Game face? (LO 7) (AACSB: Application of knowledge) Opportunities listed by students must be focused on external factors, and may include: new potential markets and product offerings, as well as general trends in the entertainment industry. Threats listed by students must be focused on external factors, and may include: new competitors, changes in the economy, or technology advances. 3. Identify The Escape Game’s major competitors. What are their strengths and weaknesses? (LO 7) (AACSB: Application of knowledge) Remind students to identify the Key Success Factors for this industry segment before attempting to identify two or three of The Escape Game’s competitors. Then have students develop a competitive profile matrix. You should limit this exercise to just your city in order to limit the market. Students may choose major competitors such as Disney and Universal in Orlando. Depending on the size of your market, students may also want to consider other types of entertainment options that enable one to use his/her leisure time. 4. Write a short memo (two pages maximum) to The Escape Game partners and their management team, describing your strategic recommendations for helping The Escape Game gain and maintain a competitive advantage in their industry and realize their goals to grow the company to become a national industry leader. (LO 7) (AACSB: Application of knowledge) This should include a short summary of the strengths, weaknesses, opportunities and threats (SWOT) analysis. It should point out the key success factors for the industry, and the most important facts identified in the competitive profile matrix. After careful analysis, the students should then choose among the three types of strategies, cost leadership, differentiation, and focus. The company appears to currently be pursuing a focus strategy so students must justify their reasons if they recommend the firm change from this.
You Be the Consultant: “Finding the Correct Business Model” 1. Lowering the subscription fee did not have the desired effect. Why, in your
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opinion, was this the case? (LO 7) (AACSB: Application of knowledge) The lower R99 subscription fee was still unaffordable for many budding entrepreneurs. This suggests an underlying problem⎯that the initial target market was probably unemployed individuals, struggling small businesses, or even individuals who were hoping to start a business once they had secured a government tender. Many such individuals were not prepared to invest a small sum to access the vast number of tenders available on the website. 2. What could the founders have done differently to ensure that the subscription model worked? (LO 7) (AACSB: Application of knowledge) The founders could have looked at, and changed, their target market. More established businesses would have been more likely to pay the minimal subscription fee—the benefit offered was very attractive to established businesses. Once a sufficient number of established businesses became aware of, and subscribe to the service, individuals hoping to start a business could be offered free access to a smaller selection of tenders for a limited period. This would promote the benefits a subscription could offer parties seeking access to government tenders. Established businesses could be used to subsidize the subscription fee of smaller businesses. The failure of the subscription model also indicates that there was no screening of subscribers. Unwillingness to pay the minimal amount suggests that the subscribers were not financially viable businesses. 3. How could the owners protect themselves from competition, such as a government-based e-portal for tendering opportunities? (LO 7) (AACSB: Application of knowledge) By initiating this service, Opentenders could benefit from all the advantages associated with a first-mover advantage. Opentenders has also already started value-added services such as training, finance, and targeted marketing, which might not be easy to duplicate. Furthermore, state portals are usually slow and not as user friendly. Using their expertise, the founders could make it easier for members to navigate their sites. OPENTENDERS also utilizes a push notification strategy which could be modified to send selected/targeted notifications.
Part 4: Chapter Discussion Questions 5-1. Why should an entrepreneur develop a business plan? (LO 2) (AACSB: Reflective thinking) The reasons for the entrepreneur to develop a business plan are twofold:
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1. The business plan serves as a guide to company operations by charting a future course and strategy. 2. The business plan attracts lenders and investors. 5-2. Describe the three tests that an entrepreneur needs to pass to obtain external financing from potential lenders and investors. (AACSB: Reflective thinking) Reality test, competitive test, and value test. 5-3. Describe the major components of a business plan. (LO 2) (AACSB: Reflective thinking) Executive summary, mission and vision statement, description of the product or service, business and industry profile, competitor analysis, market entry strategy, marketing strategy, entrepreneurs’ and managers’ resume, plan of operation, pro forma financial statements, the loan or investment proposal. 5-4. How are the three components of intellectual capital likely to become the source of a company’s competitive advantage in the marketplace? (AACSB: Reflective thinking) 1. Human capital consists of the talent, creativity, skills, and abilities of a company’s workforce, and shows up in the innovative strategies, plans, and processes the people in an organization develop and then passionately pursue. 2. Structural capital is the accumulated knowledge and experience that a company possesses. It can take many forms, including processes, software, patents, copyrights, and, perhaps most important, the knowledge and experience of the people in a company. 3. Customer capital is the established customer base, positive reputation, ongoing relationships, and goodwill that a company builds up over time with its customers. 5-5. How do lenders and investors use the 5 Cs of credit when evaluating a request for financing? (LO 3) (AACSB: Reflective thinking) Lenders and investors score the attractiveness of the business in terms of the five Cs: The greater the score, the higher probability that the small business will receive the financing.
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5-6. How would you prepare to make a formal presentation of your business plan to a venture capital forum? (LO 4) (AACSB: Analytical thinking) As with all presentations, entrepreneurs should be informed and well prepared before making business plan presentations. The following tips might also be helpful: •
Demonstrate enthusiasm, but don’t be overemotional.
•
“Hook” investors quickly with an up-front explanation of the new venture, its opportunities, and the anticipated benefits to them.
•
Use visual aids.
•
Hit the highlights, leave details to questions and later meetings.
•
Avoid the use of technological terms.
•
Close by reinforcing the nature of the opportunity and relate benefits to investors.
•
Be prepared for questions.
•
Follow up with every investor.
5-7. Why is strategic planning important to a small company? (LO 5) (AACSB: Reflective thinking) Firms are exposed to forces of a rapidly changing competitive environment, and must be prepared to avoid threats and take advantage of opportunities caused by change. A solid strategic plan also provides managers and employees a sense of direction when everyone is involved in creating and updating it. 5-8. What is a competitive advantage? (LO 6) (AACSB: Reflective thinking) It is the value proposition that sets a small business apart from its competitors and gives it a unique position in the market that is superior to its rivals. 5-9. Strategic management is a continuous process that consists of nine steps. Identify these steps. (LO7) (AACSB: Reflective thinking) Step 1. Develop a clear vision and translate it into a meaningful mission statement. Step 2. Assess the company’s strengths and weaknesses. Step 3. Scan the environment for significant opportunities and threats facing the business. Step 4. Identify the key factors for success in the business. Step 5. Analyze the competition. Step 6. Create company goals and objectives. Step 7. Formulate strategic options and select the appropriate strategies. Step 8. Translate strategic plans into action plans. .
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Step 9. Establish accurate controls. 5-10. How do entrepreneurs examine their companies’ competitive advantage? (AACSB: Reflective thinking) Entrepreneurs examine five aspects of their businesses to define their companies’ competitive advantages: products they sell, service they provide, pricing they offer, way they sell, and the values to which they are committed. 5-11. What features of an entrepreneur’s character does an investor or lender evaluate before placing their money in the small business? (AACSB: Reflective thinking) Before putting money into a small business, lenders and investors must be satisfied with the owner’s character. An evaluation of character frequently is based on intangible factors such as honesty, competence, polish, determination, knowledge, experience, and ability. 5-12. What are strengths, weaknesses, opportunities, and threats? (LO 7) (AACSB: Reflective thinking) Strengths and weaknesses are factors internal to the company that either help or hinder the firm from accomplishing its mission, goals, and objectives. Opportunities and threats are factors in a firm’s external environment that a firm can exploit or inhibit a firm from accomplishing its mission, goals, and objectives. 5-13. How does a company gain a sustainable competitive advantage? (AACSB: Analytical thinking) A company gains a sustainable competitive advantage through its ability to develop a set of core competencies that enable it to serve its selected target customers better than its rivals can. 5-14. Core competencies are central to a company’s ability to compete successfully and are usually the result of important skills and lessons that a business has learned over time. Define core competency. (AACSB: Reflective thinking) Core competencies are a unique set of capabilities that a company develops in key areas, such as superior quality, customer service, innovation, team building, flexibility, and responsiveness, which allow it to vault past competitors. 5-15. Why is setting objectives important? (LO 7) (AACSB: Reflective thinking) The goal setting process, including objectives, provide three primary benefits: increased profitability, faster execution of company strategy, and reduced employee turnover. 5-16. What are business strategies? (LO 7) (AACSB: Reflective thinking) A strategy is the master plan that covers all the major parts of the organization and ties them together into a unified whole. It is a road map of the actions an entrepreneur draws .
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up to accomplish a company’s mission, goals, and objectives. 5-17. Describe the three basic strategies available to small companies. (LO 7) (AACSB: Reflective thinking) 1. Cost leadership – operating the firm in an effort to lower operations cost. This gives the firm the opportunity to sell products at a lower price to customers. 2. Differentiation – seek to build customer loyalty by selling products that provide unique attributes and that customers perceive to be superior to competitors’ products. 3. Focus – sell to customers in a narrow and specific segment rather than try to sell to the mass market. 5-18. Under what conditions is each of the three basic strategies most successful? (LO 7) (AACSB: Reflective thinking) 1. Cost leadership – buyers’ primary purchase criterion is price, and they have the power to set the industry’s price floor. 2. Differentiation – the firm must make its product or service truly different in the eyes of the customers; firm can improve a product’s performance, reduce the customer’s cost and risk of purchasing it, or provide intangible benefits that customers value. 3. Focus – build on the differences among market segments and provide a product or service to a specific and narrow segment that is different from the other segments. It then becomes the cost leader or by differentiating itself from competitors in that segment. 5-19. Explain how a company can gain a competitive advantage using each of the three strategies described in this chapter: cost leadership, differentiation, and focus. (LO 7) (AACSB: Reflective thinking) 1. Cost leadership – competing firms sell the same commodity products and compete on the basis of price, and when the firm can benefit from economies of scale. 2. Differentiation – the firm benefits by the ability to charge premium prices, increase market share, and reap the benefits of customer loyalty and retention. 3. Focus – develop close relationships with customer, be more nimble and react more quickly than their larger competitors. The niche must be large enough to be profitable, reachable with marketing media, and capable of sustaining a business over time.
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5-20. Give an example of a company that is using each of the three strategies. (LO 7) (AACSB: Analytical thinking) 1. Cost leadership – Dollar Store 2. Differentiation – Rentthechicken.com 3. Focus – Batteries Plus 5-21. How is the controlling process related to the planning process? (LO 7) (AACSB: Reflective Thinking) The plans and objectives crated in the strategic planning process become the standards against which actual performance is measured. 5-22. What is a dashboard? (LO 7) (AACSB: Reflective thinking) A dashboard is a set of measurements that incorporate both financial and operational measures to give entrepreneurs and their leadership teams a quick but comprehensive picture of a company’s performance. Refer to Figure 5.6. 5-23. What value does a dashboard offer entrepreneurs who are evaluating the success of their current strategies? (LO 7) (AACSB: Reflective thinking) Relying on traditional financial measures of a company’s performance provides a stilted and potentially dangerous perspective. The complexity of managing a business demands that an entrepreneur be able to see performance measures in several areas simultaneously.
Part 5: Case Studies The following text case may be used for lecture and assignments for topics presented in this chapter. •
Case 1: United Apparel Liquidators
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Case 2: Bark & Co.
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Case 4: ThinkImpact
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Case 10: Nuts.com
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Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics. •
Tech Entrepreneurship on the Global Stage http://www.youtube.com/watch?v=-urhpWUDhko
•
Developing a Successful Business Plan: SBA Business Plan Webinar – Part 1: Introduction http://www.youtube.com/watch?v=tEL_l7klIY8
1:48:23 minutes
2:17 minutes
•
Importance of a Business Plan to Raise Money http://www.youtube.com/watch?v=-xLFZTxkgmM&NR=1
1:37 minutes
•
How to Write a Business Plan http://www.youtube.com/watch?v=x0y3VgjhGw0
9:02 minutes
•
How to Develop Competitive Advantage http://www.youtube.com/watch?v=S9O2oPbT3fs
3:30 minutes
•
How to Write a Mission Statement http://www.youtube.com/watch?v=XtyCt83JLNY
4:04 minutes
•
SWOT Analysis: How to Do One for Your Organization http://www.youtube.com/watch?v=GNXYI10Po6A
5:21 minutes
•
Competitor Analysis for Websites http://www.youtube.com/watch?v=rK1tED8XpYc
5:37 minutes
•
How to Set SMART Goals http://www.youtube.com/watch?v=uThBb3kGf4k
4:43 minutes
•
Porter’s Generic Strategies http://www.youtube.com/watch?v=9wXVnBrpZ-U
8:03 minutes
•
Strategic Planning with the Balanced Scorecard http://www.youtube.com/watch?v=AdXt8BfiGJg
4:38 minutes
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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CHAPTER 6. FORMS OF BUSINESS OWNERSHIP Part 1: Learning Objectives 1.
Explain the advantages and the disadvantages of a sole proprietorship and a partnership.
2.
Describe the similarities and differences between C corporations and S corporations.
3.
Understand the characteristics of a limited liability company.
4.
Explain the process of creating a legal entity for a business.
Part 2: Class Instruction Introduction The most important issues entrepreneurs should consider when they are evaluating the various forms of ownership include: •
Tax considerations
•
Liability exposure
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Start-up and future capital requirements
•
Control
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Managerial ability
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Business goals
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Management succession plans
•
Cost of formation
The major forms of ownership discussed in this chapter include: Sole proprietorship, general partnership, limited partnership, corporation, S corporation, and limited liability company. Refer to Figure 6.1, Forms of Business Ownership (A) Percentage of Businesses; (B) Percentage of Sales: (C) Percentage of Net Income, to see the data regarding the distribution of the percentage of each business form and the percentage of total business sales revenues illustrates the dominate forms of business ownership.
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Sole Proprietorships and Partnerships
LO 1
The Sole Proprietorship. The sole proprietorship is the most popular type of ownership, defined as business owned and managed by one individual. The Advantages of a Proprietorship. Advantages of the sole proprietorship include: •
Simple to create
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Least costly form of ownership to begin
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Profit incentive
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Offers total decision-making authority
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No special legal restrictions
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Easy to discontinue
The Disadvantages of Proprietorship. Disadvantages include: •
Unlimited personal liability means that the sole proprietor is personally liable for all of the business’s debts, as the owner is the business.
•
Limited skills and capabilities
•
Feelings of isolation
•
Limited access to capital
•
Lack of continuity for the business
The Partnership. A partnership is an association of two or more people who co-own a business for the purpose of making a profit. This association between the owners is defined by the partnership agreement, a document that states in writing the terms under which the partners agree to operate and that protects each partner’s interest in the business. If no partnership agreement exists, the Revised Uniform Partnership Act (RUPA) codifies the body of law dealing with partnerships in the United States. It specifies three key elements of a partnership, which include common ownership, how the business’s profits and losses will be shared, and the right to participate in managing the operation of the partnership. It also sets forth the partners’ general obligations such as sharing any business losses, working without salary, settle disagreements, etc. The Advantages of the Partnership. Advantages include: •
Easy to establish
•
Complementary skills
•
Division of profits
•
Larger pool of capital
•
Ability to attract limited partners
Types of partnerships include: .
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•
General partners – partners share in owning, operating, and managing a business. All partners have unlimited personal liability.
•
Limited partners – are financial investors in a partnership, cannot participate in the day-to-day management, and have limited liability. If the business fails they only lose the money they have invested in it.
•
Silent partners – are not active in a business but generally are known to be members of the partnership.
•
Dormant partners – are neither active nor generally known to be associated with the business.
•
Limited partnership – composed of at least one general partner and at least one limited partner. There is no limit on the total number of limited partners. The general partner is treated the same as in a general partnership, while the limited partners are treated as investor.
Additional partnership advantages include: minimal governmental regulation, flexibility, and taxation. The Disadvantages of the Partnership. Disadvantages include: •
Unlimited liability of at least one partner
•
Capital accumulation
•
Difficulty in disposing of partnership interest
•
Potential for personality and authority conflicts
•
Partners are bound by the law of agency
Limited Liability Partnerships (LLP). Limited liability partnerships are composed of all limited partners, giving them the advantage of limited liability for the debts of the partnership. Most states restrict LLPs to certain types of professionals, such as attorneys, physicians, dentists, and accountants. Consider using You Be the Consultant: “Making a Partnership Work” at this point.
Corporations
LO 2
The U.S. Supreme Court has defined the corporation as “an artificial being, invisible, intangible, and existing only in contemplation of the law.” The corporation is a separate entity apart from its owners, and may engage in business, make contracts, sue and be sued, and pay taxes. This means that the owners of a corporation are not personally liable for the actions of the corporation. However, because start-ups are so risky, lenders and other creditors often require the founders of small corporations to personally guarantee loans made to the business. Courts ignore the limited liability shield when an entrepreneur uses corporate assets for personal reasons, fails to act in a responsible manner and creates an unwarranted level of financial risk for the stockholders, makes financial misrepresentations,
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or takes actions in the name of the corporation that were not authorized by the board of directors. Refer to Table 6.1, Avoiding Legal Tangles in a Corporation. Corporations have the power to raise large amounts of capital by selling shares of ownership to outside investors. A closely held corporation has shares that are controlled by a relatively small number of people, and the stock is passed from one generation to the next instead of being traded on any stock exchange. A publicly held corporation has a large number of shareholders, and its stock usually is traded on one of the large stock exchanges. C Corporations A C corporation is the traditional form of incorporation. It is a separate legal entity and must pay taxes on its income at the federal level, in most states, and to some local governments as well. Before stockholders receive dividends, a C corporation must pay taxes at the corporate tax rate; then stockholders must pay taxes on the dividends they receive. This double taxation is a distinct disadvantage of the C corporation form of ownership. If a company intends to seek investment from venture capital or other form of private equity, it should be established as a C corporation. Advantages of a corporation include: •
Limited liability of stockholders
•
Ability to attract capital
•
Ability to continue indefinitely
•
Transferable ownership
Disadvantages of a corporation include: •
Cost and time involved in the incorporation process
•
Double taxation
•
Potential for diminished managerial incentives
•
Legal requirements and regulatory red tape
•
Potential loss of control by the founder(s)
S Corporations An S corporation was established specifically for small, closely held businesses to alleviate the owners from the double taxation that occurs with a C corporation. The S standing for “small,” is the same as any other corporation, except that they do not pay taxes on corporate income. Income instead is passed through to the owners, just like a sole proprietorship or partnership. Refer to Table 6.2, Tax Rate Comparison: C Corporation and S Corporation or Limited Liability Company. The criteria for businesses seeking “S” status are that the venture must:
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•
Be a domestic (U.S.) corporation
•
Limit shareholders to individuals, estates, and certain types of trusts
•
Cannot include partnerships, corporations, or nonresident aliens as shareholders Chapter 6, Page 98
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Not have more than 100 shareholders
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Have only one class of common stock so all shares have the same rights
•
Must be an eligible corporation; certain financial institutions, insurance companies, and domestic international sales corporations are ineligible.
Advantages of an S corporation include: •
Retains all of the advantages of regular corporations
•
Passes all profits/losses through to individual shareholders
•
Avoids double taxation
•
Avoids taxes paid on assets that have appreciated in value and are sold
Disadvantages of an S corporation include: •
Increase in individual tax rates above maximum corporate tax rate. The S corporation should follow the 1/3, 1/3, 1/3 rule of thumb: distribute one-third of earnings to the shareholders to cover the taxes they will owe, retain one-third of earnings to fund growth, and earmark the final one-third to pay down debt, fund debt, or distribute to the owners as a return on their investment.
•
Many fringe benefits cannot be deductible business expenses
Choosing an “S” corporation wisely is important to optimize the advantages this entity offers.
Limited Liability Companies
LO 3
The Limited Liability Company (LLC), like an S corporation, offers its owners limited personal liability for the debts of the business, providing a significant advantage over sole proprietors and partnerships. LLCs, however, are not subject to many of the restrictions currently imposed on S corporations and offer more flexibility than S corporations. LLCs offer many of the advantages of both, but are not subject to the restrictions incurred by “S” corporations. LLCs offer the tax advantage of a partnership, the legal protection of a corporation, and maximum operating flexibility. These advantages make the LLC an attractive form of ownership for smaller companies across many industries. Creating an LLC is much like creating a corporation through establishing the articles of organization and an operating agreement. There are some disadvantages as they can be expensive to create, and may be required in some states to pay special fees. LLCs have limited life spans, and the cost of employee benefits is not deductable as a business expense.
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How to Create a Legal Business Entity
LO 4
C corporations, S corporations, and LLCs can be costly and time consuming to establish and to maintain. Many entrepreneurs hire attorneys to handle the process, but in most states entrepreneurs can complete all of the required forms themselves, but must be very cautious. Although it is cheaper to complete the process themselves, it is not always the best idea. This is especially true if there are multiple founders as shareholder or member agreements must be developed. Once entrepreneurs decide to form a legal business entity, they must choose a state in which to establish the entity. Most will choose the state in which they will operate. Refer to Table 6.3, Characteristics of the Major Forms of Ownership.
Conclusion The entrepreneur will benefit from an intentional choice regarding the choice of business ownership. Take all the important factors into consideration – liability, taxes, capital requirements, control, managerial abilities, business goals, and a long-term succession plan. The ownership decision has far-reaching effects for both the entrepreneur and the business.
Part 3: Chapter Exercises You Be the Consultant: “Making a Partnership Work” 1. Research relationships between partners and add at least three guidelines to those listed above. (LO 1) (AACSB: Interpersonal relations and teamwork) Examples of students’ additions to this list may include the following: •
Determine what may help manage stressful or conflict-oriented situations to help manage those situations as they arise.
•
A common vision of what the venture is to become with a shared work ethic.
•
Establish clear guidelines regarding what each partner will invest in the relationship, from a financial and time perspective.
•
Talk through possible “what if” scenarios to share the ideas and problem solving skills of each partner.
•
A common and clear vision for the venture.
2. Develop a list of the behaviors that are almost certain to destroy a partnership. (LO 1) (AACSB: Interpersonal relations and teamwork) Student responses may include, and are not limited to, the following: .
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•
Lack of follow through based on the agreed division of partner responsibilities and duties
•
Lack of communication — talking and listening
•
Lack of mutual respect
•
Misuse of company funds and resources
•
Dishonesty and actions that lead to mistrust
•
Conflicting behavior when interacting with people — employees and customers
•
Divergent behaviors regarding the management of business finances
3. Suppose that two of your friends are about to launch a business together with nothing but a handshake. “We’ve been best friends since grammar school,” they say. What advice would you give them? (LO 1) (AACSB: Interpersonal relations and teamwork) Expect students to apply information from the chapter. For example, a common student response may be as follows: Have a partnership agreement! This important tool defines the roles and responsibilities of each partner. This agreement can prove invaluable in times of conflict or when a partner wants to change their role or leave the business for any reason. It offers definition and direction for the business and for each partner involved. Seek the advice of an attorney to assist you in the process. The partnership agreement may save your business — and your friendship.
Part 4: Chapter Discussion Questions 6-1. Which type of business ownership generates the largest portion of business sales? (AACSB: Reflective thinking) Corporations generate the largest portion of business sales. 6-2. Why are sole proprietorships so popular as a form of ownership? (LO 1) (AACSB: Reflective thinking) Sole proprietorships are a popular form of ownership for several reasons. First, they are simple to create. Anyone wanting to start a business can do so by obtaining the necessary licenses from state, county, and/or local governments. This form is normally the least expensive to establish. In addition, the owner has the total decision-making authority, can keep all profits remaining after expenses are paid, and may discontinue the sole proprietorship fairly easily if he or she desires. 6-3. Define the concept of partnership. Why do we need partnership agreement? (AACSB: Reflective thinking)
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A partnership is an association of two or more people who co-own a business for the purpose of making a profit. A partnership agreement is a document that states in writing the terms under which the partners agree to operate the partnership and that protects each partner’s interest in the business 6-4. Why are the articles important to a successful partnership? (LO 1) (AACSB: Reflective thinking) The partnership agreement is designed to spell out in detail the legal and business issues of running a business, including the partners’ rights and obligations. It also resolves potential sources of conflict that could end a partnership. A partnership must have two or more essential elements above all others; mutual trust and respect. Any partnership missing these elements is destined to fail. 6-5. Explain why one partner cannot commit another to a business deal without the other’s consent. (LO 1) (AACSB: Reflective thinking) If the partner was exercising good faith and reasonable care in the performance of his duties, the law of agency holds that the actions of a general partner binds the other partners to a business deal made in the name of the partnership, even without the other's consent. This is another example of why it is so important to be able to trust your partners! 6-6. Describe the similarities between a C Corporation and an S Corporation. (AACSB: Reflective thinking) Both C corporations and S corporations are considered separate legal entities. Both types of corporations offer these advantages: limited liability of stockholders, ability to attract capital, ability to continue indefinitely, and transferable ownership. 6-7. How does an S corporation differ from a regular corporation? (LO 2) (AACSB: Reflective thinking) An S corporation offers many of the same advantages of a corporation — limited liability, capital formation, and others — while being taxed as a partnership. Thus, the S corporation avoids the corporate disadvantage of double taxation. 6-8. What role do limited partners play in a partnership? (LO 1) (AACSB: Reflective thinking) In a limited liability partnership the limited partner is have the advantage of limited liability for the debts of the partnership. However, many states restrict the limited liability advantage of LLPs to the results of actions taken by other partners. For instance if an LLP sells a defective product that injures a customer, the injured customer could sue the business and the partners as individuals. 6-9. What happens if a limited partner takes an active role in managing the business? (LO 3) (AACSB: Reflective thinking) Unlike a limited partnership, which prohibits limited partners from participating in the dayto-day management of the business, an LLC does not restrict its members’ ability to become involved in managing the company.
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In the limited partnership if the limited partner does take an active part in managing the business, a limited partner may actually forfeit limited liability, taking on the liability status of a general partner. 6-10. What advantages does an LLC offer over an S corporation? (LO 3) (AACSB: Reflective thinking) An LLC eliminates many restrictions imposed by an S corporation such as: a maximum of thirty-five shareholders, none of whom can be foreigners or corporations; a limitation to one class of stock; restriction on members' ability to become involved in managing the company; and limited personal liability with imposed requirements. The LLC is not subject to such restrictions. There are two advantages an LLC has over a C corporation. First, an LLC offers limited liability while a C corporation does not. In addition, an LLC does not pay income tax and avoids the double taxation of C corporations. 6-11. What advantages does an LLC offer over a partnership? (LO 3) (AACSB: Reflective thinking) Partners in traditional partnerships are exposed to unlimited personal liability. A LLC limits the partners’ liability to their investments in the company. 6-12. Why is double taxation a distinct disadvantage of the C Corporation form of ownership? (AACSB: Reflective thinking) C Corporations must pay taxes at the corporate tax rate, a graduated tax on corporate profits. Then, stockholders must pay taxes on the dividends they receive from these same profits at their individual tax rates.
Part 5: Case Studies The following text case may be used for lecture and assignments for topics presented in this chapter. •
Case 4: ThinkImpact
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics.
.
•
How to Avoid 3 Common Mistakes Small Business Owners Make 12:47 minutes http://www.youtube.com/watch?v=zahVagoP3SU
•
Forms of Business Ownership http://www.youtube.com/watch?v=Wtmw1oxNiWg
3:54 minutes
•
Business Entities: Limited Liability Company http://www.youtube.com/watch?v=aq5zdacU4E4
5:47 minutes
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•
The Corporation – A Legal “Person” http://www.youtube.com/watch?v=wkygXc9IM5U
5:48 minutes
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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CHAPTER 7. BUYING AN EXISTING BUSINESS 1.
Describe the advantages and disadvantages of buying an existing business.
2.
Explain the five stages in acquiring a business: search, due diligence, valuation, deal, and transition.
3.
Explain the three steps in the search stage of buying a business.
4.
Describe the four areas involved in conducting due diligence on a business: the seller’s motivation, asset valuation, legal issues, and financial condition.
5.
Explain the various methods used to estimate the value of a business.
6.
Describe the basic principles of negotiating a deal to buy a business and structuring the deal.
7.
Understand how to manage the transition stage when a deal is done.
Part 2: Class Instruction Introduction While the entrepreneurial experience always involves risk, buying an existing business (buying a franchise is another way that is covered in Chapter 8) can help reduce the risk for an entrepreneur. The primary motivation for business buyers purchasing an existing business is the same as it is for entrepreneurs – the desire for independence, to be their own boss. Before buying any business, an entrepreneur must thoroughly analyze the opportunity presented by the business. The questions should deal both the type of business one is buying as also the price that one pays for it.
Buying an Existing Business
LO 1
The process of evaluating a potential business acquisition is standard, and requires a due diligence process that involves analyzing and evaluating an existing business. If done correctly, this due diligence will reveal both the negative and the positive aspects of an existing business. A prospective owner must ask several key questions before buying an existing business. • Is it the right type of business for sale in a market in which you want to operate? • What experience do I bring to the venture?
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• •
What is the success potential? What changes are needed — and how extensive are they — to realize the full potential of the value of the business? • What price and payment method are reasonable for you and acceptable to the seller? • Is the seller willing to finance part of the purchase price? • Will the company generate sufficient cash to pay for itself and leave you with a suitable rate of return on your investment? • Should you be starting a business and building it from the group up rather than buying an existing one? People buy businesses for different reasons. As described in Figure 7.1, Types of Business Buyers, buyers can be categorized into four areas: 1. Main street buyers 2. Corporate refugees 3. Serial entrepreneurs 4. Financial buyers The Advantages of Buying an Existing Business. Advantages include: • A successful existing business may continue to be successful. • An existing business may already have a superior location. • Employees and suppliers are established. Equipment is installed and productive capacity is known. • Inventory is in place and trade credit is established. • A turnkey business already has operating processes in place. • The new owner can use the experience of the previous owner. • Easier access to financing. • High value is possible if the current owner must sell quickly. Disadvantages of Buying an Existing Business. Disadvantages include: • Cash requirements may be higher than if starting a new business. • Business may be losing money. • Paying for ill will if the previous owner used improper business behavior or unethical practices. • Employees inherited with the business may not be suitable. • The business location may have become/is unsatisfactory. • Equipment and facilities may be obsolete or inefficient. • Change and innovation are difficult to implement. • Inventory may be outdated or obsolete. • Accounts receivable may be worth less than face value. • The business may be overpriced.
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The Stages in Acquiring a Business
LO 2
Although roughly 500,000 businesses change ownership each year, about one-third of all initiated sales fall through. Refer to Figure 7.2, The Acquisition Process. There are five steps in the buying process, as indicated in Figure 7.3, The Five Stages of Buying a Business.
The Search Stage
LO 3
The Search Stage. When buying a business, entrepreneurs must ensure that what they are buying fits their background and personal aspirations. Three steps are necessary to ensure this. Step 1: Self-Inventory: Analyze Your Skills, Abilities, and Interests. Conduct a selfinventory to analyze your skills, abilities, and personal interests. Sample questions include what business activities you enjoy most, which industries and markets have growth potential, what do you want to avoid, what you expect to get from the business, what you expect to put into the business, how much risk you’re willing to take, and if you’re able to turn around a struggling business. Step 2: Develop a List of Criteria. Develop a list of criteria that define the ideal business for you. Use your answers to the self-inventory to develop a list of criteria that a potential business must meet. Step 3: Prepare a List of Potential Candidates. List companies that meet your criteria. Do not limit your search to businesses that are advertised as being for sale, as there is a hidden market of companies that might be for sale but are not advertized as such. These hidden businesses for sale may be found listed on the Internet, through business brokers, other professionals like attorneys or bankers, industry contacts, through networking, trade associations, asking the owner of a business if he or she would like to sell, or through newspapers or trade journals. See Figure 7.4, Business Purchases by Type of Business.
The Due Diligence Stage
LO 4
Due diligence involves studying, reviewing, and verifying all the relevant information concerning an acquisition. This is like kicking the tires of a car prior to buying it. The goal in doing this is to know exactly what one is purchasing and avoid any unpleasant surprise after the deal is closed and it is too late to do anything about it. Investing in the due diligence process can be looked at as: choosing to pay now or pay later. The due diligence process involves investigating four critical areas: motivation (of the seller), asset valuation, legal issues, and financial condition (of the buying being acquired). Motivation. The most common reason business owners give for selling are planned retirement (40 percent), burnout (21 percent), and the desire to own a bigger business (20 percent). Asset valuation. A prospective buyer should evaluate the business’s assets to determine their true value. Three questions are helpful here: .
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Are the assets really useful, or are they obsolete?
•
Will the assets require replacement soon?
• Do the assets operate efficiently? In addition, the prospective buyer should inquire about: •
Accounts receivable
•
Lease arrangements
•
Business records
•
Intangible assets
• Location and appearance Legal issues. The most significant legal issues involve: liens, contract assignments, covenants not to compete, and ongoing legal liabilities. Financial condition. A buyer must understand that he or she is purchasing the future earning potential of an existing business. To evaluate a company’s earning potential, a buyer should review past income statement and balance sheet items. Sales tax records, income tax returns and financial statements are valuable sources of information. Consider using You Be the Consultant: “The Power of Seller Financing” at this point.
The Valuation Stage
LO 5
The valuation stage includes not only a valuation of the business but also signing a nondisclosure agreement. There are several methods to value a business. There is no single best method to determine value because each sale is unique. There are three commonly used methods: the balance sheet method, the earnings approach method, and the market approach. Balance sheet method. Here the value of a company is equal to its net worth – assets minus liabilities. A common criticism of this method is that it oversimplifies the process (Refer to Figure 7.5, Balance Sheet for Kuyper Electronics, June 30, 20XX, and Figure 7.6, Adjusted Balance Sheet for Kuyper Electronics, June 30, 20XX). Earnings approach. This method considers the future income potential of the business. This method is preferred by many finance professionals and experienced entrepreneurs. Market approach. This approach uses the price/earnings ratios of similar businesses to estimate the value of a company. The buyer must use businesses whose stocks are publicly traded to get a meaningful comparison. Figure 7.7, Business Valuation Methods indicates what the popular methods are.
The Deal Stage
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LO 6
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The structure of the deal – the terms and conditions of payment – is more important than the price the seller agrees to pay. A buyer’s primary concern is making sure that the terms of the deal do not endanger the company’s future financial health and that they preserve the company’s cash flow. Consider using You Be the Consultant: “Would You Buy This Business?” at this point. The negotiation process should not be “If you win, then I lose.” Instead it will go much more smoothly and faster if both parties work to establish a cooperative relationship based on honesty and trust and an attitude of “we both will win.” Both parties should examine and articulate their respective positions while trying to understand the other party’s. A buyer should go into the negotiation with a list of objectives ranked in order of priority, and anticipate what the seller’s priorities are in order to determine where the two mesh and where they conflict. The key is to use this analysis to look for areas of mutual benefit and use them as the foundation for the negotiation.
The Transition Stage
LO 7
Once the deal stage is completed, the transition stage begins with the actual closing of the purchase. Closing the sale of a business is a complex legal process. A number of closing documents are involved.
Conclusion Rather than launching a business from “scratch,” some entrepreneurs decide to take the faster route by buying an existing business. The five-stage process described in this chapter ensures that not only will the entrepreneur find a business to his or her liking, but also successfully negotiate a sound deal to purchase it.
Part 3: Chapter Exercises You Be the Consultant: “The Power of Seller Financing” 1. Suppose that you and a friend have recently graduated from college when you discover the ideal business for sale by the founder, who is ready to retire. The asking price is $550,000, but you and your friend have only $15,000. Put together a brief plan for assembling the remaining balance needed to purchase this business. (LO 4) (AACSB: Application of knowledge)
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This is a good exercise for a student team-based exercise. Students may be advised to follow a plan similar to that used by Janelle Regotti in buying Guide Publishing. Even if the students decide on seller financing, sellers would want to know if the buyer has a clear plan going forward.
You Be the Consultant: “Would You Buy This Business?” 1.. Assume the role of a prospective buyer for these two businesses. How would you conduct the due diligence necessary to determine whether they would be good investments? (LO 5) (AACSB: Application of knowledge) For Corbin-Pacific, a due diligence item may be the legal implications of having hired undocumented workers in the past. The buyer should inquire if he/she would inherit any legal liability for this. For the Indiana machine shop, a due diligence item may be the age of the computerized numerical control (CNC) equipment. The goal is to find out if it is likely to become obsolete quickly that would call for a significant capital outlay. 2. Do you notice any “red flags” or potential problems in either of these deals? Explain. (LO 5) (AACSB: Analytical thinking) Potential “red flags” include: •
For Corbin-Pacific, a red flag could be the reason for the significant drop in cash flow – from $2.73 million to $722,000.
•
A second red flag for Corbin-Pacific could be the high valuation for patents – an intangible asset.
•
For the Indiana machine shop, a potential red flag could be the highly fragmented nature of the business – 21,000 of them across the nation.
•
A second red flag for the Indiana machine shop could be technological obsolescence.
3. What techniques for estimating the value of these businesses would be most useful to a prospective buyer of these companies? Are the owners’ asking price reasonable? (LO 5) (AACSB: Application of knowledge) It appears as though Corbin-Pacific is simply adding up the value of the assets and making it the sale price. In contrast, the Indiana machine shop is using a multiples approach. In both cases, perhaps a multiples (market) approach is the best. The market approach values a business based on its earnings potential. Given that Corbin-Pacific’s profits have declined, the asking price may be too high. Similarly, if the Indiana machine shop’s current EBITDA is $757,150, its asking price of $5.3 million suggests a multiple of almost 7X, while comparable businesses go for a multiple of 5.4X.
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Part 4: Chapter Discussion Questions 7-1. What advantages can an entrepreneur who buys a business gain over one who starts a business “from scratch”? (LO 1) (AACSB: Reflective thinking) The advantages of buying an existing business may include: •
A Successful Existing Business May Continue to Be Successful: Buying a thriving business increases the likelihood of success building upon an established customer base, supplier relationships, and business system. The new owner benefits from these important business factors already in place.
•
An Existing Business May Already Have the Best Location: If the location of a business is critical to its success, it may be wise to purchase a business that is already strategically located.
•
Employees and Suppliers are in Place: Experienced employees enable a company to continue to earn money while a new owner learns the business. Existing vendors can continue to supply the business while the new owner investigates the products and services of others.
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Equipment Is Installed and Productive Capacity Is Known: The buyer does not have to invest in equipment, and the previous owner may have established an efficient production operation. Thus, the new owner can use these savings in time and money to improve and expand the existing equipment and procedures.
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Inventory Is in Place and Trade Credit Is Established: Establishing the right amount of inventory can be costly. If there is too little inventory, customer demand cannot be satisfied. If too much is available, excessive capital is tied up, costs are increased, and profits decrease. There is a tremendous advantage if previous owners have established a balance in inventory. In addition, a proven track record gives the new owner leverage in negotiating credit concessions.
•
A Turnkey Business: the buyer gets a business that is already generating cash and perhaps profits as well.
•
Experience of Previous Owner: If the previous owner is around, the new owner can benefit from his/her expertise. Even if the owner is not present, business records can guide the new owner.
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Easier Access to Financing: Many existing businesses already have relationships with lenders. Many sellers help to finance the sale of their business.
•
High Value: If the owner needs to sell on short notice, wants a substantial down payment in cash, or the business requires special skills, the number of buyers will be small, which may lead the owner to sell at a lower price.
7-2. How can an entrepreneur tap into the hidden market of potential acquisitions? (AACSB: Reflective thinking)
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The hidden market sources are as follows: •
The Internet, where several sites such as Bizbuysell.com and Bizquest, include listings of business brokers and companies for sale.
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Business brokers—to locate a broker near you, visit the Web site for the International Business Brokers Association at www.ibba.org.
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Professionals who provide business services, such as bankers, accountants, attorneys, investment bankers, and others.
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Industry contacts—suppliers, distributors, customers, insurance brokers, and others.
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Networking—social and business contact with friends and relatives.
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Knocking on the doors of businesses you would like to buy (even if they’re not advertised as being “for sale”).
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Trade associations.
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Newspapers and trade journals listing businesses for sale.
7-3. Why is there a need to include a due diligence process that involves analyzing and evaluating an existing business before possible purchase? (AACSB: Reflective thinking) The due diligence process reveals both the negative and the positive aspects of an existing business and is worthwhile because it can prevent an entrepreneur from purchasing a business destined for failure. 7-4. Outline the stages involved in buying a business. (LO 2) (AACSB: Reflective thinking) To avoid costly mistakes, an entrepreneur should follow a logical, methodical approach that may include the following: •
The search stage
•
The due diligence stage
•
The valuation stage
•
The deal stage
•
The transition stage
7-5. What topics does the due diligence process address? (LO 4) (AACSB: Reflective thinking) Due diligence involves studying, reviewing, and verifying all of the relevant information concerning an acquisition. There are four areas that are covered as part of the due diligence process: the seller’s motivation, asset valuation, legal issues (involved with the business that is being acquired), and the financial condition of the business.
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7-6. Briefly outline the process of valuing a business using the adjusted earnings, the capitalized earnings, and the discounted future earnings approaches. (LO 5) (AACSB: Reflective thinking) In the adjusted earnings method, the starting point is the business’s EBITDA or earnings before interest, taxes, depreciation and amortization. From this amount adjustments are made for the owner’s personal expenses charged to the business and the costs to bring inventories up to necessary levels and to update equipment. This adjusted EBITDA is then applied to an earnings multiple to arrive at the value of the business. The capitalized earnings approach involves dividing a company’s estimated net earnings (after subtracting a reasonable salary for the owner) by the rate of return that reflects the risk level of investing in the business. In the discounted future earnings approach, the company’s net income for several years into the future is estimated and then discounted back to present value. 7-7. What determines the bargaining zone between a business seller and a buyer? (LO 6) (AACSB: Reflective thinking) The bargaining zone is the area within which the two parties – the buyer and the seller – can reach agreement. It is determined by the lowest price the seller is willing to take on the one hand to the maximum price the buyer is willing to pay on the other hand. 7-8. Explain the buyer’s position in a typical negotiation for a business. (LO 6) (AACSB: Reflective thinking) In a typical negotiation, the buyer’s goals are the following: •
Get the business at the lowest price possible
•
Negotiate favorable payment terms, preferably over time
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Get assurances that he is buying the business he thinks it is
•
Avoid enabling the seller to open a competing business
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Minimize the amount of cash paid up front.
7-9. Explain the seller’s position in a typical negotiation for a business. (LO 6) (AACSB: Reflective thinking) In a typical negotiation, the seller’s goals are the following: •
Get the highest price possible for the company
•
Sever all responsibility for the company’s liabilities
•
Avoid unreasonable contract terms that might limit future opportunities
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Maximize the cash from the deal
•
Minimize the tax burden from the sale
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Make sure the buyer will make all future payments.
7-10. What steps should a buyer take to ensure a smooth transition after closing the deal to buy a business? (LO 7) (AACSB: Reflective thinking) .
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To ensure a smooth transition after closing the deal, the buyer should do the following: •
Concentrate on communicating with employees
•
Be honest with employees
•
Listen to employees
•
Sell the vision of the company to key stakeholders
•
Consider asking the seller to serve as a consultant till the transition is complete.
7-11. Once two parties strike a business deal, there will be many challenges in making a smooth transition. How can a business buyer avoid a bumpy transition? (AACSB: Analytical Thinking) A business buyer should do the following: •
Concentrate on communicating with employees. Business sales are fraught with uncertainty and anxiety, and employees need reassurance.
•
Be honest with employees. Avoid telling them only what they want to hear. Share with the employees your vision for the business in the hope of generating a heightened level of motivation and support.
•
Listen to employees. They have first-hand knowledge of the business and its strengths and weaknesses and can usually offer valuable suggestions for improving it.
•
Consider asking the seller to serve as a consultant until the transition is complete. The previous owner can be a valuable resource, especially to an inexperienced buyer.
•
Be ready to act if it becomes clear that there are problem employees. Most small-business owners wait too long to terminate employees who are problematic. The previous owner may have avoided addressing these issues prior to selling the business.
Part 5: Case Studies The following text case may be used for lecture and assignments for topics presented in this chapter. Case 9: Seabreeze Property Services
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics.
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•
5 Questions to Ask Before Buying a Business 5:34 minutes http://www.youtube.com/watch?v=zro0E74_qZA&feature=related
•
Buying a Business http://www.youtube.com/watch?v=G6TRqfDcCUM&NR=1
1:42 minutes
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Buying a Business – Bill Bartmann http://www.youtube.com/watch?v=j5Pz3Aweof4&NR=1
5:31 minutes
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New Business Tips: Buying an Existing Small Business http://www.youtube.com/watch?v=KjW7eNB71kw&NR=1
1:04 minutes
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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CHAPTER 8. FRANCHISING AND THE ENTREPRENEUR
Part 1: Learning Objectives 1. Describe the three types of franchising: trade name, product distribution, and pure. 2-A. Explain the benefits of buying a franchise. 2-B. Explain the drawbacks of buying a franchise. 3. Understand the laws covering franchise purchases. 4. Explain the right way to buy a franchise. 5. Describe the major trends shaping franchising.
Part 2: Class Instruction Introduction Franchises play a significant role in the U.S. and world business economy. Refer to Figure 8.1, Number of Franchised Outlets in the United States, to see the growth of the number of franchised outlets in the United States. Franchising has grown beyond traditional fast food to many different industries. Refer to Figure 8.2, Franchised Outlets by Industry. Many franchises are now international in scope. Franchising is a system of distribution in which semi-independent business owners (franchisees) pay fees and royalties to a parent company (franchisor) in return for the right to become identified with its trademark, to sell its products or services, and often to use its business format and system. As presented in Figure 8.3, The Franchising Relationship, the connection between the franchiser and the franchisee is a unique and often a highly structured and defined business relationship regarding: •
Site selection
•
Design
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Employees
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Products and services
•
Prices
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•
Purchasing
•
Advertising
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Quality control
•
Support
Types of Franchising
LO 1
There are three types of franchising systems: 1. Trade-name franchising: a system of franchising in which a franchisee purchases the right to use the franchisor’s trade name without distributing particular products under the franchisor’s name. Examples include True Value Hardware or Western Auto. 2. Product distribution franchising: a system of franchising in which a franchisor licenses a franchisee to sell its products under the franchisor’s brand name and trademark through a selective, limited, distribution network. Examples include automobile sales like Chevrolet, or gasoline such as Exxon Mobil. 3. Pure franchising: a system of franchising in which a franchisor sells a franchisee a complete business format and system. This type of business format franchising is the most common and fastest growing of the three types. Examples include quick service restaurants, hotels, etc. Franchises are subject to changes in the economy just as are non-franchised businesses. Refer to Figure 8.4, Franchise Business Index.
The Benefits of Buying a Franchise
LO 2A
Franchisees can own a small business relatively quickly and often reach break-even faster than an independent business would because of the identification with an established product and brand name. Franchisees benefit from the franchisor’s business experience. Access to a business model with a proven track record may be the safest way to own a business. Benefits of franchising include: Business System. Management Training and Support. Brand Name Appeal. Standardized Quality of Goods and Services. .
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National Advertising Programs and Marketing Assistance. Financial Assistance. Proven Products, Processes, and Business Formats. Centralized Buying Power. Site Selection and Territorial Protection. Greater Chance for Success.
The Drawbacks of Buying a Franchise LO 2B There are some negative attributes of buying a franchise and those include: Franchise Fees and Ongoing Royalties. Refer to Figure 8.5, Planned Sources of Financing for Prospective Franchisees Strict Adherence to Standardized Operations. Restrictions on Purchasing and Prices. Limited Product Line. Contract Terms and Renewal. Unsatisfactory Training Programs. Market Saturation. Less Freedom. The 10 myths regarding franchising as described in Table 8.1, 10 Myths of Franchising include: 1. Franchises will be safer and will not fail 2. Franchises will be economical 3. Franchises will be more successful based on its size 4. Franchises will be able to improve the business 5. Franchises are basically “all the same” 6. Franchises will enable the owner to be removed from day-to-day management 7. Franchises will be a business anyone can do 8. Franchises will be the cheapest business option 9. Franchisor will be taking care of my business problems
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10. Franchises will be a business “I” can run things the way “I” want to Consider using You Be the Consultant: “Would You Buy This Franchise?” at this point.
Franchising and the Law
LO 3
In response to problems that occurred in the 1950s to the franchising boom and the associated franchisers who defrauded their franchisees, strict laws attempt to prevent such behavior. Franchise Disclosure Document (FDD) is a document that every franchisor is required by law to give prospective franchisees before any offer or sale of a franchise; it outlines 23 important pieces of information. In 2008, the Federal Trade Commission (FTC) replaced the Uniform Franchise Offering Circular (UFOC) with the Franchise Disclosure Document (FDD). The FDD establishes full disclosure and guidelines for the franchising company. The FDD requires all franchisers to disclose detailed information to prospective franchisees before any offer or sale of a franchise. The Trade Regulation Rule, part of the FDD enacted by the FTC requires all franchisers to disclose detailed information on their operations at the first personal meeting or at least ten days before a franchise contract is signed, or before any money is paid. In this section of the chapter, the twenty-three major topics required by the Trade Regulation Rule are discussed.
The Right Way to Buy a Franchise
LO 4
The FDD is only one of the steps used to evaluate a franchise before buying. The other issues to consider before buying a franchise are: Evaluate Yourself. Refer to Table 8.2 for a questionnaire, Are You Franchisee Material? Research Your Market. Consider Your Franchise Options. Get a Copy of the Franchisor’s FDD. Talk to Existing Franchisees. Refer to Table 8.3, Questions to Ask Existing Franchisees. Ask the Franchiser Some Tough Questions. Make Your Choice. Refer to Appendix A. A Franchise Evaluation Checklist. .
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Trends Shaping Franchising
LO 5
Franchising has experienced three major growth waves since its beginning with fast-food activity in the 1970s, service businesses in the 1980s, and in the 1990s featuring low-cost franchises that focus on specific market niches. Other trends include: Changing Face of Franchisees. Franchisees are more diverse than in the past, are better educated, are more sophisticated, have more business acumen, and are more financially secure than those of the past. Many are former corporate managers seeking a more meaningful and rewarding career. International Opportunities. Franchising is becoming a major U.S. export industry for the United States, as the domestic market has become saturated. As they venture into foreign markets, franchisors have learned that adaptation is one key to success. For example, fast-food chains in other countries often must make adjustments to their menus to please locals’ palates, and changes to their marketing to adjust to the culture of a country. Smaller, Nontraditional Locations. Due to high costs of building full-scale locations, franchises are putting scaled-down outlets directly in the path of customers in places such as college campuses, grocery stores, gas stations, theaters, and airports. Intercept marketing is the principle of putting a franchise’s products or services directly in the path of potential customers wherever they may be. Conversion Franchising. Conversion franchising is a franchising trend in which owners of independent businesses become franchisees to gain the advantage of name recognition. Refranchising. Refranchising is a technique in which franchisors sell their companyowned outlet to franchisees. The goal is to put outlets into the hands of operators, who tend to run their franchises more efficiently than the franchisor can. Multi-unit Franchising: A franchisee opens more than one unit in a broad territory within a specific time period. “Franchisers are finding it’s far more efficient in the long run to have one well-trained franchisee operate a number of units than to train many franchisees.” Area Development and Master Franchising: A franchisee is given the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchisees. Under area development the franchisee earns the exclusive right to open multiple units in a specific territory within a specified time. A master franchise is a method that gives a franchisee the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchises. Cobranding (or Piggyback or Combination). Cobranding (or piggyback or combination) is a method of franchising in which two or more franchises team up to sell complementary product or service under one roof. Cobranded outlets save their owners .
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money because they lower both real estate and operating costs. The same employees sell both brands. The franchisors share advertising, maintenance, and other costs. Consider using You Be the Consultant: “Franchising in Emerging Markets” at this point.
Conclusion Franchising is a significant force in the United States and world economy. The franchise experience offers would-be entrepreneurs, regardless of their experience or background, the ability to own and operate their own business with guidance and support increasing the chance for success.
Part 3: Chapter Exercises You Be the Consultant: “Would You Buy This Franchise?” 1. What are the advantages and the disadvantages of purchasing an outlet from a small franchisor? (LO 2A and LO 2B) (AACSB: Reflective thinking) The advantages of buying an outlet from a small franchise system include: •
Tailored management and training support
•
Flexibility regarding of goods and services
•
Customized advertising programs
•
Unique products and business formats
•
The novelty of the concept
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The potential for future growth with a smaller but more unique concept
The potential disadvantages of buying a from a small franchise system:
.
•
Undeveloped training programs
•
The limited and scale of the management and training support
•
Potentially limited brand name appeal
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The lack of a national advertising program
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Limited or no financial assistance
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•
Limited product line
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Unproven track record compared to franchise systems with a larger base of outlets
2. Suppose that one of your friends is considering purchasing a BurgerFi franchise and asks your opinion. What advice would you offer him or her? (LO 2A and LO 2B) (AACSB: Application of knowledge) Expect students to offer this type of advice to their friend: •
Determine how many of franchisees exist.
•
Locate and contact other franchisees.
•
Find out how long have they been in business.
•
Have them describe their experience with the franchise including training, support, and financial obligations of any kind.
•
Inquire if the franchise has met their expectations.
•
Ask how long it took to reach break-even.
•
If they are willing, ask them for gross revenue and profit figures.
•
Ask them if they would do it again.
•
Request a copy of the FDD and review the document in detail.
•
Enlist the involvement of an attorney with experience in dealing with franchises if necessary.
•
Encourage your friend to answer this question: Will this franchise enable you to accomplish your business and personal goals?
If your friend continues to have interest, he or she can then can contact the franchise representative and ask direct questions to gain a clear picture of what to expect. This information may provide the perspective necessary to avoid overlooking the franchise “red flags” that may be signaling disaster. 3. Develop a list of questions that a prospective franchisee should ask the franchisor and existing franchisees before deciding to invest in a franchise. (LO 2A and LO 2B) (AACSB: Reflective thinking) Students can easily draw from Appendix A and Table 8.3.
You Be the Consultant: “After the Cheering Stops” 1. What benefits does franchising offer professional athletes such as those .
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described here? (LO 2A) (AACSB: Reflective thinking) There are a number of benefits that come from being a franchisee that apply to athletes and non-athletes. As the vignette points out, franchising is particularly attractive to athletes from team-based sports because they know how to execute on a game plan and work as a team to achieve success. 2. Do you agree with Michael Stone that franchising is a good fit for athletes? Explain. (LO 2A) (AACSB: Reflective thinking) As indicated above, franchising is a particularly attractive option for athletes from teambased sports such as football, basketball, and baseball. Take football, for example. The coach devises the game plan and if players execute it correctly on the playing field, they have a high probability of succeeding. In a franchise set up, the “coach” is the franchisor, who makes up the rules for success and if the franchise follows them, then there is a high probability of success. 2. What steps should prospective franchisees, whether they are athletes or not, take to ensure that franchising is the right path to business ownership for them and that they select the right franchise?. (LO 4) (AACSB: Application of knowledge) Table 8.2 is particularly applicable here. It lists the characteristics of successful franchise owners. Prospective franchisees are advised to look at the checklist to see if they have these characteristics.
You Be the Consultant: “Franchising in Emerging Markets” 3. What steps should U.S.-based franchisors take when establishing outlets in foreign countries? (LO 5) (AACSB: Reflective thinking) U.S-based franchisors should consider the following when establishing outlets in foreign countries:
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•
Research the potential market, its size and potential acceptance of the franchise concept
•
Inventory the business climate for U.S. business operating within the foreign country
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•
Assess the state of the current and anticipated economic and financial environment
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Gain information about government restriction on a national, regional and local bases
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Assess tax implications
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Examine logistical issues, such as shipping and delivery options
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Explore hiring processes and anticipated costs
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Perform a complete financial analysis
•
Conduct a risk analysis
4. Describe the opportunities and the challenges franchisors face when entering emerging markets such as India and China. (LO 5) (AACSB: Reflective thinking) The opportunities franchisers may realize in a country such as India or China include: •
An attractive long-term growth strategy for the franchise that leverages the unique skills and resources of local franchisees
•
Product innovation through feedback and experience
•
The establishment of a world-wide brand
Challenges that franchise organizations may face include uncertainties in these areas: • Cultural understanding and acceptance • Financial volatility and uncertainty • Hiring and training new owners in the proven franchise system • Addressing logistical and supply chain barriers • Appreciating the role the government plays in the business environment
5. Use the Internet as a resource to develop a list of at least five suggestions to help new franchisors looking to establish outlets in China or India to be successful. (LO 5) (AACSB: Application of knowledge) Students’ responses will vary and may include the following factors: • Thoroughly research the culture relating to your franchise concept. • Analyze the role that the government of each country may play in your franchise future-product import and purchase restrictions, tax obligations, property ownership limitations and other factors. Review trademark and copyright protections.
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•
Identify potential “benchmark” businesses established in African markets that may offer insight regarding their entry strategy and success to date.
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Conduct a comprehensive market analysis of each local market.
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Conduct market research based on your product offering.
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Research all attributes of the proposed site(s).
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Conduct a logistic supply chain analysis for accessing and transporting goods and physical resources.
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Assess the availability, requirements and costs of the required labor resources.
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Establish the role that exchange rates may play in the financial arena of the venture.
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Prepare a comprehensive business plan addressing all issues these new markets will present and with realistic timeframes.
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Identify adaptation and contingency options if things do not go according to the plan.
Part 4: Chapter Discussion Questions 8-1. What is the main difference between a franchisee and an independent business owner? (AACSB: Reflective Thinking) Franchisees, unlike independent business owners, don’t have the freedom to change the way they run their businesses—for example, shifting advertising strategies or adjusting product lines—but they do have access to a formula for success that the franchisor has worked out. 8-2. Describe the three types of franchising and give an example of each. (LO 1) (AACSB: Reflective thinking) The three types of franchising with examples are: 1. Trade-name franchising: This is a system of franchising in which a franchisee purchases the right to use the franchisor’s trade name without distributing particular products under the franchisor’s name. Examples include True Value Hardware and Western Auto. 2. Product distribution franchising: This is a system of franchising in which a franchisor licenses a franchisee to sell specific products under the franchiser’s brand name and trademark through a selective, limited distribution network. Examples include Exxon, Chevrolet, and Pepsi Cola. .
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3. Pure franchising: This is a system of franchising in which a franchisor sells a franchisee a complete business format and system. Examples include Burger King, H&R Block and Hampton Hotels. 8-3. Discuss the advantages and the disadvantages of franchising for the franchisee. (LO 2A and LO 2B) (AACSB: Reflective thinking) The advantages of buying a franchise include: •
Business system
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Management training and support
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Brand name appeal
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Standardized quality of goods and services
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National advertising programs and marketing assistance
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Financial assistance – Refer to Figure 8.5, The Franchise Lending Gap
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Proven products, processes, and business formats
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Centralized buying power
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Site selection and territorial protection
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Greater chance for success
The disadvantages of buying a franchise include: •
Franchise fees and ongoing royalties Refer to Figure 8.6, Planned Sources of Financing for Prospective Franchisees
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Strict adherence to standardized operations
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Restrictions on purchasing and prices
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Limited product line
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Contract terms and renewal
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Unsatisfactory training programs
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Market saturation
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Less freedom
8-4. What are the disadvantages of franchising? (AACSB: Analytical thinking) Franchising suffers from certain disadvantages, including franchise fees and profit sharing, strict adherence to standardized operations, restrictions on purchasing, limited product lines, unsatisfactory training programs, market saturation, and less freedom. 8-5. Fran Lubbs, who after a five-year stint left the corporate office of Goddard .
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School, an early education franchise, to become a franchisee, says, “Follow the system. It’s one of the reasons you bought the franchise. Don’t try to change it, break it, or fix it.” Do you agree with her? Explain. (LO 2A) (AACSB: Analytical thinking) Expect students to agree with the perspective Lubbs offers for well-established franchise systems. Franchises with an established history are proven systems based on previous business experience. They have been modified and apply best practices based on extensive experience and performance. Modifying the business process may introduce risk and uncertainty. Students may debate that smaller franchises with a limited history may not offer this type of legacy track record. The attributes of a less mature franchise may benefit from modifications and improvements. 8-6.
What are the steps to buying a franchise? (AACSB: Reflective thinking)
The following steps will help you make the right franchise choice: •
Evaluate yourself.
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Research your market.
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Consider your franchise options.
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Get a copy of the franchisor’s FDD.
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Talk to existing franchisees.
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Ask the franchisor some tough questions.
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Make your choice.
8-7. What is the difference between refranchising and conversion franchising? (AACSB: Reflective thinking) Refranchising is a technique in which franchisors sell their company-owned outlets to franchisees and conversion franchising is a franchising trend in which owners of independent businesses become franchisees to gain the advantage of name recognition. 8-8. Describe the current trends in franchising. (LO 5) (AACSB: Reflective thinking) Current trends in franchising include:
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Changing Face of Franchisees: franchisees are more diverse than in the past, are better educated, are more sophisticated, have more business acumen, and are more financially secure than those of the past. Many are former corporate managers seeking a more meaningful and rewarding career.
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International opportunities: Franchising is becoming a major U.S. export industry for the United States, as the domestic market has become saturated. As they Chapter 8, Page 127
venture into foreign markets, franchisors have learned that adaptation is one key to success. For example, fast-food chains in other countries often must make adjustments to their menus to please locals’ palates, and changes to their marketing to adjust to the culture of a country. •
Smaller, nontraditional locations: Due to high costs of building full-scale locations, franchises are putting scaled-down outlets directly in the path of customers in places such as college campuses, grocery stores, gas stations, theaters, and airports. Intercept marketing is the principle of putting a franchise’s products or services directly in the path of potential customers wherever they may be.
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Conversion franchising is a franchising trend in which owners of independent businesses become franchisees to gain the advantage of name recognition.
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Refranchising is a technique in which franchisors sell their company-owned outlet to franchisees. The goal is to put outlets into the hands of operators, who tend to run their franchises more efficiently than the franchisor can.
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Multiple-unit franchising: A franchisee opens more than one unit in a broad territory within a specific time period. “Franchisers are finding it’s far more efficient in the long run to have one well-trained franchisee operate a number of units than to train many franchisees.”
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Area Development and Master franchising: A franchisee is given the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchisees. Under area development the franchisee earns the exclusive right to open multiple units in a specific territory within a specified time. A master franchise is a method that gives a franchisee the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchises.
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Cobranding (or piggyback or combination) is a method of franchising in which two or more franchises team up to sell complementary product or service under one roof. Cobranded outlets save their owners money because they lower both real estate and operating costs. The same employees sell both brands. The franchisors share advertising, maintenance, and other costs.
8-9. Robyn Vescovi, a former financial executive who recently became a Tasti D-Lite franchisee, offers the following advice to first-time franchisees: •
Do your homework. Research the brand (long- and short-term business model)
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Know the team behind this brand and understand their vision for that product/business. Know them as franchise experts and their proven successes.
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Know yourself and your limits. This will help you determine the right business (e.g., new and innovative franchise or well-established franchise).
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•
Be involved! Don’t expect that things “will just happen.” You have your own business, but you are part of something bigger, and it is in your best interest to participate in whatever you can in support of that brand/product. Don’t be an “absentee franchisee.”
Do you agree? Explain. What other advice can you offer first-time franchisees? (LO 4) (AACSB: Application of knowledge) Expect students to state their position regarding the “homework” that Vescovi recommends. The following consideration may be a part of their position to support Vescovi’s perspective. •
Understand what you are buying into: Does the brand have value to the market you plan to serve and is this a brand you can support and sell?
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Know the people behind the brand: Are these people you can work with and become a part of the team that pursues a common vision?
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Evaluate yourself: Have you assessed your own traits, goals, experience, likes, dislikes, risk-orientation, and other characteristics. Do they match those of the franchise?
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Commit: This experience will become a significant part of your life and you need to invest in the franchise any many ways - time, money and energy.
Part 5: Case Studies The following text case may be used for lecture and assignments for topics presented in this chapter. •
Case 3: Cousins Maine Lobster
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics. •
Buying a Franchise vs. Starting a Business http://www.youtube.com/watch?v=YeCjO_EnCrk
2:08 minutes
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Advantages and Disadvantages of Buying a Franchise http://www.youtube.com/watch?v=LUK_2HJNUBc
2:56 minutes
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Buy a Franchise – 6 Mistakes to Avoid
9:27 minutes
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http://www.youtube.com/watch?v=2qRRm8zs_5U •
Buying into a Franchise: Learning from Failed Franchisees http://www.youtube.com/watch?v=p2W7p75M0FI
1:32 minutes
•
How to Become a McDonalds Franchisee (New Zealand) http://www.youtube.com/watch?v=d1MfaDFI1Cw
8:38 minutes
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Brazil Hearts McDonald’s http://www.travelchannel.com/video/brazil-hearts-mcdonalds
2:46 minutes
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Fast Foods Gone Global – India’s Take on KFC http://www.travelchannel.com/video/indias-take-on-kfc
1:16 minutes
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Fast Foods Gone Global – Keeping Subway Kosher http://www.travelchannel.com/video/keeping-subway-kosher
1:28 minutes
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Fast Foods Gone Global – What’s Hot in Chile http://www.travelchannel.com/video/whats-hot-in-chile
2:11 minutes
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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SECTION III. LAUNCHING THE BUSINESS
CHAPTER 9. BUILDING A POWERFUL BOOTSTRAP MARKETING PLAN Part 1: Learning Objectives 1. Describe the principles of building a bootstrap marketing plan and explain the benefits of preparing one. 2. Explain how small businesses can pinpoint their target markets. 3. Discuss the role of market research in building a bootstrap marketing plan and outline the market research process. 4. Describe how a small business can build a competitive edge in the marketplace by using bootstrap marketing strategies.
Part 2: Class Instruction Introduction Creating a solid business model and business plan improves an entrepreneur’s odds of building a successful company. The business plan captures many of the topics discussed, and in addition, it includes a concise statement of how an entrepreneur plans to achieve success in the marketplace. This section focuses on building the marketing plan.
Building a Bootstrap Marketing Plan
LO 1
Marketing is the process of creating and delivering desired goods and services to customers and involves all of the activities associated with winning and retaining loyal customers. Bootstrap marketing strategies are unconventional, low-cost, creative techniques – small companies can wring as much or more “bang” from their marketing bucks. This allows the required marketing investment to fit the often limited marketing resources of the
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organization. It demands creativity, ingenuity, and an understanding of customers’ buying habits. Refer to Table 9.1, A Seven-Sentence Bootstrap (Guerrilla) Marketing Strategy. Answering these seven questions will give you an outline of your company’s marketing plan. A bootstrap marketing plan should accomplish three objectives: •
Pinpoint the specific target markets the small company will serve.
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Determine customer needs and wants through market research.
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Analyze the firm’s competitive advantages and build a bootstrap marketing strategy around them to communicate its value proposition to the target market.
Pinpointing the Target Market
LO 2
Target markets are the specific groups of customers at whom the company aims its goods or services. Pinpointing the target market offers greater marketing efficiency. Mass marketing techniques of the past are expensive and risky. The marketing strategy can then reach that specific targeted group that has the highest propensity to buy and be an ongoing customer. Target customers must permeate the entire business-merchandise, music, layout, décor, Web site, and the total experience. Market research can be invaluable to better understand, segment, and identify target markets. Refer to Figure 9.1, U.S. Population by Race, 2020, 2040, and 2060.
Determining Customer Needs and Wants Through Market Research LO 3 Demographics is the study of important population characteristics such as age, income, gender, education, race, and others. For example, we can quickly gain information regarding the growth rate of U.S. populations by many criteria, such as race. The Value of Market Research. Market research is the vehicle for gathering the information that serves as the foundation for the marketing plan; it involves systematically collecting, analyzing, and interpreting data pertaining to a company’s market, customers, and competitors. The objective of market research is to learn how to improve the level of satisfaction for existing customers and to find ways to attract new customers. By performing some basic market research, small business owners can detect key demographic and market trends. Market research does not have to be time consuming, complex, or expensive to be useful.
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Tracking trends can be a valuable and affordable way to get a pulse on markets. Faith Popcorn, a marketing consultant and author, offers tips to help spot significant trends: • Read as many current publications as possible. • Watch the top 10 TV shows; they provide indicators of consumers’ attitudes and values and what they’re going to be buying. • See the top 10 movies; they also influence consumer behavior. • Talk to at least 150 customers a year about what they’re buying and why. Find out what they’re thinking by asking questions such as, “will you buy from us again?,” and “will you recommend us to your friends?” • Talk with the 10 smartest people you know. • Listen to your children or younger siblings. What trends are they tracking? Then the entrepreneur should list the major trends they have identified and briefly describe how well their products or services match these trends. Market research is the answer. How to Conduct Market Research. The goal of market research is to reduce the risks associated with making business decisions. Conducting market research involves four steps: Step 1:
Define the objective.
Step 2: Collect the data. Individualized (one-to-one) marketing is a system based on gathering data on individual customers and developing a marketing program designed to appeal specifically to their needs, tastes, and preferences. Two basic methods for collecting data include primary research, data you collect and analyze yourself, and gathering secondary research, data that have already been compiled and that are available. Primary research techniques include: • Customer surveys and questionnaires • Focus groups • Social media conversations and monitoring • Test market • Daily transactions • Other ideas – such as a suggestion system for customers and employees. Secondary research, which is usually less expense to collect than primary data includes: • Business directories • Direct mail lists • Demographic data • Census data • Forecasts • Market research • Articles
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• •
Local data The Internet. Data mining is a process in which computer software that uses statistical analysis, database technology, and artificial intelligence finds hidden patterns, trends, and connections in data so that business owners can make better marketing decisions and predictions about customers’ behavior.
Step 3:
Analyze and interpret data.
Step 4:
Draw conclusions and act.
Market research with existing customer is also valuable: • Identifies your best customers • Enhances your products and services • Welcomes customer complaints • Offers exceptional quality • Understands your customers’ buying cycle • Calculates the long-term value of customers
Plotting a Bootstrap Marketing Strategy: How to Build a Competitive Edge LO 4 A company can establish a competitive edge when customers perceive that one organization’s products or services are superior to those of its competitors. Successful entrepreneurs often use the special advantages that flow from their companies’ small size to build a competitive advantage over their larger rivals. Bootstrap marketing tactics can be instrumental in building a brand for your business in a number of ways as long as you always focus on the customer. Focusing on the customer allows you to optimize your marketing and profitability potential. Refer to Table 9.2, Bootstrap Marketing Tactics. The following principles can help business owners create powerful, effective bootstrap strategies. • Find a Niche and Fill It. A focus (niche) strategy allows a small company to maximize the advantages of its size and to compete effectively even in industries dominated by giants. Focusing on niches that are too small to be attractive to large companies is a recipe for success. • Use the Power of Publicity. Publicity is any commercial news covered by the media that boosts sales but for which a small company does not pay. Examples include: writing an article, sponsoring an event, involving celebrities, being interviewed on radio or television, being a speaker at local business and civic organizations, offering or sponsoring a seminar, writing and sending news releases to the media, volunteering to service on community and industry boards and committees, sponsoring a community project or supporting a nonprofit or charity, and promoting a cause. .
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•
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•
•
•
•
• • •
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Don’t Just Sell, Entertain. It has become critical to gain word-of-mouth support via social media; to accomplish this requires that you engage and even entertain customers. For example, develop creative YouTube videos. Strive to Be Unique. Create an image of uniqueness for your business. Refer to Table 9.3 for suggestions for a retail store. Build a Community with Customers. Successful companies can interact with customers regularly, intentionally, and purposefully to create meaningful, lasting relationships with them. Company Web sites and social media are important tools. A good example is Etsy.com. Connect with Customers on an Emotional Level. Companies that establish a deeper relationship with their customers than one based merely on making a sale have the capacity to be exceptional bootstrap marketers because customers receive an emotional boost every time they buy from the company. Create a unique selling proposition (USP), which is a key customer benefit of a product or service that sets it apart from the competition; it answers the critical question every customer asks, “What’s in it for me?” Ideally, the USP will be 10 words or less. Create an Identity for Your Business Through Branding. Branding refers to communicating a company’s USP to its target customers in a consistent and integrated manner. Refer to Figure 9.2, The Connection Between Branding and a USP. Embrace Social Marketing. Businesses recognize that many of their current and potential customers use social networking sites and are reaching out to them with social marketing efforts. Three of the most popular are LinkedIn, Facebook, and Twitter. Refer to Figure 9.3 Social Media Entrepreneurs Use as Marketing Tools, and Figure 9.4 Benefits of Social Media Marketing. Start a Blog. Tips for a successful blogging strategy include: strive to cultivate the image of an expert or trusted friend on a topic: be patient; be honest, balanced, and interesting; post blog entries consistently; ask customers for feedback; use services such as Google Alerts that scan the Internet for a company’s name and send email alerts when it finds posts about a company; be cautious; promote the blog via social media and e-mail. Create Online Videos. YouTube reports that visitors view 3 billion videos per day. Host a Special Event. The purpose is to reinforce the company’s brand in customers’ minds and to connect with your business community. This creates a forum to allow customer to meet you and others. Be Dedicated to Service and Customer Satisfaction. Tips include: consistently track all social media; respond and take responsibility; the customer is always right, never be defensive; keep a database of all complaints and suggestions. A company can achieve stellar customer service and satisfaction by: listen to customers; define superior service; set standards and measure performance; examine your company’s service cycle; see customer complaints as a mechanism for improving customer service; when Chapter 9, Page 135
you create a negative customer experience, apologize and fix it – fast!; hire the right employees; train employees to deliver superior service; empowering employees to offer superior service; treat employees with respect and demonstrate to them how valuable they are; use technology to provide improved service; reward superior service; get top managers’ support; give customers an unexpected surprise, and view customer service as an investment, not an expense.
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Retain Existing Customers. The goal is to form loyal, long-term relationships. Retaining these customers may be the best investment in the future of a business. Research indicates that repeat customer spend 67 percent more than new customers. In addition, attracting new customers can cost seven to nine times more than keeping an existing customer. Customer experience management is the process of systematically creating the optimum experience for customers every time they interact with the company. A focus on the customer can directly correlate to higher customer retention rates and is based on the response to these four questions: What are we doing right? How can we do that even better? What have we done wrong? What can we do in the future?
•
Devotion to Quality. Quality goods and services are a prerequisite for survival. Total quality management (TQM) is the philosophy of producing a high-quality product or service and achieving quality in every aspect of the business and its relationship with the customer; the focus is on continuous improvement in the quality delivered to customers. The key is seeing the world from the customer’s point of view. The following guidelines will help the firm to build a reputation for quality: build quality into the process instead of relying on inspections; foster teamwork; establish long-term ties with select suppliers; provide managers and employees with needed training; empower workers at al levels in the organization; get managers’ commitment to the quality philosophy; rethink the processes used to get the products to customers; be willing to make changes; reward employees for quality work; develop a company-wide strategy for constant improvement; back up the quality pledge with a guarantee.
•
Attention to Convenience. Studies show that customers rank convenience at the top of their purchasing criteria. Successful companies must show that it is easy for customers to do business with them. Conduct a convenience audit from the customer’s point of view to get an idea of its ETDBW (Easy To Do Business With) index: is the business located near your customers? are your hours suitable for customers, would customers appreciate pickup and delivery service? are employees trained to handle transactions quickly and politely;?do employees treat customers with courtesy, do you provide a sufficient number of checkout stations? are you using technology to enhance shopping? do you offer extras that make customers’ lives easier? can you bundle some existing products or services to make it easier for customers? can you adapt existing products to make them more convenient? do you handle telephone calls quickly and with a real person?
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•
Concentrate on Innovation. In order to keep up with changing markets, small businesses must be innovative. Small businesses are frequently leaders in innovation even though they may lack resources compared to larger businesses.
•
Emphasize Speed. Technology, particularly the Internet, has changed the pace of business. To be competitive companies must reduce the time it takes to develop, design, manufacture, and distribute a product, resulting in reduced costs, increased quality, and increased market share. Time compression management (TCM) is a marketing strategy that relies on three principles: (1) speeding products to market, (2) shortening customer response time in manufacturing and delivery, and (3) reducing the administrative time required to fill an order. Companies relying on TCM should do the following: reengineer the entire process rather than attempt to do the same things in the same way but only faster; create cross-functional teams and give them the power to attack and solve problems; set aggressive goals for time reduction and stick to the schedule; rethink your supply chain; instill speed in the culture; use technology to find shortcuts; put the Internet to work.
In addition to the text – The Principles of Customer Experience Management (CEM) address the need to establish: •
An intimate understanding of each customer’s needs, want preferences, and peculiarities
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A personal, customer-specific message in marketing, sales, service, and advertising
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A consistent, courteous, and professional treatment by everyone
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A responsive, rapid handing of requests, questions, problems, and complaints
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Helpful information and advice delivered proactively
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The involvement of caring, well-trained people
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Long-term view of the company/customer relationship with an emphasis on sustaining an ongoing relationship
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Frequent and visible demonstrations of commitment to nurturing this relationship
Consider using You Be the Consultant: “.CO Internet S.A.S.”, You Be the Consultant: Auto Repair Goes Social”, and/or You Be the Consultant “The Impact of Second-Mile Service” at this point.
Conclusion
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Bootstrap marketing offers entrepreneurs significant benefits to create awareness and promote their businesses. By using clever, innovative bootstrap marketing strategies, such as the ones described in this chapter, entrepreneurs can put their companies in the spotlight and create a special connection with their customers.
Part 3: Chapter Exercises You Be the Consultant: “.CO Internet S.A.S” 1. How would you envision the marketing of .CO Internet S.A.S. to change now that it is part of a large corporation? Can large companies effectively take advantage of bootstrap marketing strategies? Explain. (LO 4) (AACSB: Application of knowledge) Even after Neustar’s acquisition of .CO Internet S.A.S, the company’s marketing shouldn’t change. The only difference is that .CO Internet S.A.S. is no longer a start-up that needs to establish its brand. Yes, even large companies can do bootstrap marketing. Neustar should focus on the established target market and respond by plotting a bootstrap marketing strategy to build the .CO Internet S.A.S.’s competitive advantage: •
Find a niche and filling it
•
Leverage the power of publicity
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Don’t just sell; entertain
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Build a community with customers
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Connect with customers on an emotional level by building trust and defining a unique selling proposition
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Create an identity through branding
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Embrace social marketing
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Be dedicated to service and customer satisfaction
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Focus on retaining existing customers
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Be devoted to quality
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Attend to convenience
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Concentration on innovation
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Emphasize speed
2. What steps can the new owner of .CO Internet S.A.S. take to maintain the brand and continue to build customer recognition of it? Refer to Figure 9.2 on page 354 and use the table below to do the following:
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a. List threshold, performance, and excitement attributes for .CO Internet S.A.S. •
Threshold Attributes: Benefits that customers expect from a brand.
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Performance Attributes: Benefits that your brand can offer customer that are superior to those that competitors offer.
•
Excitement Attributes: Benefits that customers get excited about and that have the capacity to differentiate a company’s brand from all others.
b. Identify “proof points” (reasons for customers to believe in the brand) that support each of the attributes you list. Students’ responses may vary. The instructor’s goal is to facilitate a lively discussion of “reasons for customers to believe.” Some potential answers are included here in matrix format. Threshold Attributes
Performance Attributes
Excitement Attributes
Specializes in tech startups
Believe .co refers to company, not Columbia
Provide “membership”
Home for innovation Threshold Proof Points
Membership benefits Performance Proof Points
Excite Proof Points
GoDaddy commercials
Rapid sales increase
Example of a unique selling proposition: .CO Internet provides an Internet home for innovative technology companies seeking a unique domain name ending in .co, and who appreciate special membership benefits. c. Use the attributes and their proof points to develop a unique selling proposition for .CO Internet. Students should then apply this attribute information to develop a unique selling proposition. The students’ USP should identify a key customer benefit of a product or service that sets it apart from the competition and answer the critical customer question: “What’s in it for me?” Example of a unique selling proposition: .CO Internet provides an Internet home for innovative technology companies seeking a unique domain name ending in .co, and who appreciate special membership benefits.
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You Be the Consultant: “Auto Repair Goes Social” 1. Identify at least three lessons that entrepreneurs can learn from Victory Auto’s use of social media. (LO 4) (AACSB: Reflective thinking) Lessons learned may include: •
A bootstrap marketing plan should accomplish three objectives: pinpoint the specific target markets the small company will serve; choose marketing strategy to reach that specific targeted group that has the highest propensity to buy and be an ongoing customer; determine customer needs and wants through market research. Target customers must permeate the entire businessmerchandise, music, layout, décor, Web site, and the total experience.
•
Analyze the firm’s competitive advantages and build a bootstrap marketing strategy around them to communicate its value proposition to the target market.
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Be flexible and open to new possibilities of promoting the business.
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Leveraging the power of social media.
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• • • •
Engage employees in the effort to build strong customer relationships and to participate in the social marketing campaign. Find a Niche and Fill It. Use the Power of Publicity. Don’t Just Sell, Entertain. Strive to be Unique. Build a Community with Customers. Connect with Customers on an Emotional Level. Create a unique selling proposition (USP). Create an Identity for Your Business Through Branding. Embrace Social Marketing. Start a Blog. Create Online Videos.
• •
Host a Special Event. Be Dedicated to Service and Customer Satisfaction.
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Retain Existing Customers.
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Devotion to Quality.
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Attention to Convenience.
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Concentrate on Innovation.
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Emphasize Speed.
• • • • • •
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•
Be able to track the impact, or lack of, based on the outcomes of your marketing efforts.
2. Work with a team of your classmates to select a local business that has no social media presence and develop a plan to boost its visibility, sales, and profits with a social media strategy. (LO 4) (AACSB: Application of knowledge) Expect students to identify a business that does not have a developed social media presence and apply the concepts presented in the chapter. 3. Identify at least three additional bootstrap marketing strategies discussed in this chapter that Victory Auto can use to increase it visibility, sales, and profits. Explain how the company should implement each one. (LO 4) (AACSB: Application of knowledge) Encourage students to be creative in their recommendations while being mindful of the scope and scale of the effort.
You Be the Consultant: “How Exceeding Customer Expectations Leads Learning Pool to Success” 1. What is the main strategy behind Learning Pool’s successful growth? (LO 4) (AACSB: Reflective thinking Learning Pool focuses on exceptional service and customer satisfaction, and practices many of the tips included in this chapter. The main strategy behind its successful growth is customer focus, supported by motivated staff and new high-quality products personalized for customer specific needs. Students should support their answers with evidence from the case study. 2. Learning Pool has taken over its biggest competitor. What lessons can other competitors learn from Learning Pool about customer focus and retention? (LO 4) (AACSB: Reflective thinking) Learning Pool is dedicated to exceptional service and customer satisfaction. Their unrivalled customer focus has helped them conquer the obstacles on their path to organic growth. They have been able to attract huge investments from big global groups and acquire their competitors. The competitors can learn to grow and maintain their competitive edge by following some of the suggestions listed below: Listen to customers; define superior service; see customer complaints as a mechanism for improving customer service; when you create a negative customer experience, apologize and fix it – fast!; hire the right employees; train employees to deliver superior service; empower employees to offer superior service; treat employees with respect and demonstrate to them how valuable they are; use technology to provide improved service; be innovative, view customer service as an investment, not an expense, focus on retaining existing customers, as the goal is to form loyal, long-term relationships. Retaining customers may be the best investment in the future of a business, especially since the elearning market business depends on renewal of subscriptions.
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Customer experience management is the process of systematically creating the optimum experience for customers every time they interact with the company. A focus on the customer can directly correlate to higher customer retention rates and is based on the response to these four questions: What are we doing right? How can we do that even better? What have we done wrong? What can we do in the future? Learning Pool believes in empowered employees who are well-trained and highly motivated to deliver service par excellence to their customers. A satisfied employee leads to a satisfied customer. Hence, provide managers and employees with needed training; empower workers at all levels in the organization. Finally, Learning Pool is also devoted to quality and innovation. Quality goods and services are a prerequisite for survival. Total quality management (TQM) is the philosophy of producing a high-quality product or service and achieving quality in every aspect of the business and its relationship with the customer; the focus is on continuous improvement in the quality delivered to customers. The key is seeing the world from the customer’s point of view. 3. What are the growth opportunities and challenges faced by Learning Pool in future? (LO 4) (AACSB: Reflective thinking) With the growing trend for organizations to have bigger budgets for online training, and increased use of mobile devices among employees, the future holds endless opportunities in the e-learning market. Learning Pool is well positioned to continue increasing its market share. However, in order to maintain their strong position, they not only need to maintain their customer focus, highly motivated staff and innovative products, but also to consider expansion into international markets across the Atlantic. In doing so, they should also be well-prepared to face the challenges of distance, varying time zones and increased competition from other international e-learning providers. Entering into new geographical markets should be well-planned, keeping in mind customer-specific needs and technological support available in those countries. Since Learning Pool already caters to some international clients in the UK, expanding might be a feasible option. 4. Choose your own experience of e-learning and identify steps the provider should take to improve its customer satisfaction. (AACSB: Application of knowledge) Encourage students to be creative in their recommendations. Students can share their experiences from an online course that they may have taken, the online educational platforms used by their colleges or universities, or any other e–learning service that they might have used.
Part 4: Chapter Discussion Questions 9-1. Define marketing plan. What lies at the center of a marketing plan? (LO 1) (AACSB: Reflective thinking)
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The marketing plan focuses the company’s close and intimate attention on the customer and recognizes that satisfying the customer is the foundation of every business. Its purpose is to build a strategy for success with a focus on the customer. 9-2. What objectives should a marketing plan accomplish? (LO 1) (AACSB: Reflective thinking) A bootstrap marketing plan should accomplish three objectives: •
Pinpoint the specific target markets the small company will serve.
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Determine customer needs and wants through market research.
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Analyze the firm’s competitive advantages and build a bootstrap marketing strategy around them to communicate its value proposition to the target market.
9-3. Successful market research consists of four steps. Describe these steps. (AACSB: Reflective thinking) •
Define the objective.
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Collect the data.
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Analyze and interpret the data.
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Draw conclusions and act.
9-4. List some possible sources of market information for an entrepreneur. (LO 3) (AACSB: Reflective thinking) Individualized (one-to-one) marketing is a system based on gathering data on individual customers and developing a marketing program designed to appeal specifically to their needs, tastes, and preferences. Two basic methods for collecting data include primary research, data you collect and analyze yourself, and gathering secondary research, data that have already been compiled and that are available. Primary research techniques include: •
Customer surveys and questionnaires
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Focus groups
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Social media conversations and monitoring
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Test market
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Daily transactions
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Other ideas – such as a suggestion system for customers and employees.
Secondary research, which is usually less expense to collect than primary data includes:
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Business directories
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Direct mail lists
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Demographic data
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Census data
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Forecasts
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Market research
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Articles
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Local data
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The Internet. Data mining is a process in which computer software that uses statistical analysis, database technology, and artificial intelligence finds hidden patterns, trends, and connections in data so that business owners can make better marketing decisions and predictions about customers’ behavior.
9-5. Identify the 14 principles that can help business owners create powerful, effective bootstrap marketing strategies. (AACSB: Reflective thinking) •
Find a niche and fill it.
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Use the power of publicity.
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Don’t just sell, entertain.
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Strive to be unique.
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Build a community with customers.
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Connect with the customer on an emotional level.
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Create an identity for your business through branding.
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Embrace social marketing.
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Be dedicated to service and customer satisfaction.
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Retain existing customers.
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Be devoted to quality.
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Pay attention to convenience.
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Concentrate on innovation.
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Emphasize speed
9-6. Business organizations need to identify their target markets. How do small businesses pinpoint their target markets? (AACSB: Application of knowledge) One of the first steps in building a bootstrap marketing plan is to identify a small company’s target market — the specific group of customers at whom the company aims its goods or services. The more a business knows about its markets and customers, and their buying habits and preferences, the more precisely it can focus its marketing efforts on the group(s) of customers who are most likely to buy its products or services. 9-7. Why do entrepreneurs need to conduct market research? (AACSB: Analytical thinking) The goal of market research is to reduce the risks associated with making business decisions. For the entrepreneur, there is no bigger decision than the one to start or not
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start a new business. Market research can replace misinformation and assumptions with facts. 9-8.
What is a competitive advantage? (LO 4) (AACSB: Reflective thinking)
A competitive advantage is the value proposition that sets a small business apart from its competitors and gives it a unique position in the market that is superior to its rivals. 9-9. Describe how a small business owner could use finding a niche and fill it for a competitive advantage. (LO 4) (AACSB: Reflective thinking) A focus (niche) strategy allows a small company to maximize the advantages of its size and to compete effectively even in industries dominated by giants. Focusing on niches that are too small to be attractive to large companies is a recipe for success. 9-10. Why do we need to create an identity for our customers through branding? (AACSB: Reflective thinking) Branding involves communicating a company’s unique selling proposition (USP) to its target customers. A brand is a company’s “face” in the marketplace, and it is built on a company’s promise of providing quality goods or services to satisfy multiple customer needs. 9-11. How can an entrepreneur stimulate publicity for his company? (AACSB: Reflective thinking) Write an article that will interest your customers or potential customers, sponsor an event designed to attract attention, involve celebrities “on the cheap”, contact local television and radio stations and offer to be interviewed, publish a newsletter, contact local business and civic organizations and offer to speak to them, offer or sponsor a seminar, write news releases and fax or e-mail them to the media, volunteer to serve on community and industry boards and committees, sponsor a community project or support a nonprofit organization or charity, promote a cause. 9-12. One important aspect of connecting with customers is defining the company’s unique selling proposition (USP). Define USP. (AACSB: Reflective thinking) A USP is a key customer benefit of a product or service that sets it apart from the competition. It answers the critical question every customer asks, “What’s in it for me?” 9-13. Describe how a small business owner could use building a community of customers for a competitive advantage. (LO 4) (AACSB: Reflective thinking) Successful companies can interact with customers regularly, intentionally, and purposefully to create meaningful, lasting relationships with them. Company Web sites and social media are important tools. A good example is Etsy.com. 9-14. Describe how a small business owner could use connecting with customers at an emotional level for a competitive advantage. (LO 4) (AACSB: Reflective thinking) Companies that establish a deeper relationship with their customers than one based merely on making a sale have the capacity to be exceptional bootstrap marketers because customers receive an emotional boost every time they buy from the company. Create a unique selling proposition (USP), which is a key customer benefit of a product or
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service that sets it apart from the competition; it answers the critical question every customer asks, “What’s in it for me?” Ideally, the USP will be 10 words or less. 9-15. Describe how a small business owner could use creating an identity for the business through branding for a competitive advantage. (LO 4) (AACSB: Reflective Thinking) Branding refers to communicating a company’s unique selling proposition (USP) to its target customers in a consistent and integrated manner. Refer to Figure 9.2, The Connection Between Branding and a USP. 9-16. Today, world-class companies treat quality as a strategic objective, and this is an integral part of a companies’ strategy and culture. This is commonly known as total quality management (TQM). Define TQM. (AACSB: Reflective Thinking) Total Quality Management (TQM) is the philosophy of producing a high-quality product or service and achieving quality in every aspect of the business and its relationship with the customer; the focus is on continuous improvement in the quality delivered to customers. 9-17. A friend of yours is planning to create a blog for his company to boost his business. Advise him on how to implement a successful blogging strategy. (AACSB: Reflective Thinking) •
Strive to cultivate the image of an expert or a trusted friend on a topic that is important to your customers.
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Be patient.
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Be honest, balanced, and interesting when writing the blog.
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Post blog entries consistently so that readers have a reason to return.
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Ask customers for feedback.
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Use services such as Google Alerts that scan the Internet for a company’s name and send e-mail alerts when it finds posts about a company.
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Be cautious.
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Promote the blog via social media and e-mail.
9-18. Describe how a small business owner could use retaining existing customers for a competitive advantage. (LO 4) (AACSB: Reflective Thinking) The goal is to form loyal, long-term relationships. Retaining these customers may be the best investment in the future of a business. In addition, attracting new customers can cost seven to nine times more than keeping an existing customer. Customer experience management is the process of systematically creating the optimum experience for customers every time they interact with the company. A focus on the customer can directly correlate to higher customer retention rates and is based on the response to these four questions: What are we doing right? How can we do that even better? What have we done wrong? What can we do in the future? Refer to Table 9.4, Strategies for Developing and Retaining Loyal Customers.
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9-19. Describe how a small business owner could use devotion to quality for a competitive advantage. (LO 4) (AACSB: Reflective Thinking) Quality goods and services are a prerequisite for survival. Total quality management (TQM) is the philosophy of producing a high-quality product or service and achieving quality in every aspect of the business and its relationship with the customer; the focus is on continuous improvement in the quality delivered to customers. The key is seeing the world from the customer’s point of view. The following guidelines will help the firm to build a reputation for quality: build quality into the process instead of relying on inspections; foster teamwork; establish long-term ties with select suppliers; provide managers and employees with needed training; empower workers at all levels in the organization; get managers’ commitment to the quality philosophy; rethink the processes used to get the products to customers; be willing to make changes; reward employees for quality work; develop a company-wide strategy for constant improvement; back up the quality pledge with a guarantee. 9-20. Describe how a small business owner could use paying attention to convenience for a competitive advantage. (LO 4) (AACSB: Reflective Thinking) Studies show that customers rank convenience at the top of their purchasing criteria. Successful companies must show that it is easy for customers to do business with them. Conduct a convenience audit from the customer’s point of view to get an idea of its ETDBW (Easy To Do Business With) index: is the business located near your customers? are your hours suitable for customers, would customers appreciate pickup and delivery service? are employees trained to handle transactions quickly and politely? do employees treat customers with courtesy, do you provide a sufficient number of checkout stations? are you using technology to enhance shopping? do you offer extras that make customers’ lives easier? can you bundle some existing products or services to make it easier for customers? can you adapt existing products to make them more convenient? do you handle telephone calls quickly and with a real person? 9-21. Describe how a small business owner could use concentrating on innovation for a competitive advantage. (LO 4) (AACSB: Reflective Thinking) In order to keep up with changing markets, small businesses must be innovative. Small businesses are frequently leaders in innovation even though they may lack resources compared to larger businesses. 9-22. Describe how a small business owner could use an emphasis on speed for a competitive advantage. (LO 4) (AACSB: Reflective Thinking) Technology, particularly the Internet, has changed the pace of business. To be competitive companies must reduce the time it takes to develop, design, manufacture, and distribute a product, resulting in reduced costs, increased quality, and increased market share. Time compression management (TCM) is a marketing strategy that relies on three principles: (1) speeding products to market, (2) shortening customer response time in manufacturing and delivery, and (3) reducing the administrative time required to fill an order. Companies relying on TEC should do the following: reengineer the entire process rather than attempt to do the same things in the same way but only faster; create crossfunctional teams and give them the power to attack and solve problems; set aggressive
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goals for time reduction and stick to the schedule; rethink your supply chain; instill speed in the culture; use technology to find shortcuts; put the Internet to work. 9-23. One experienced entrepreneur says that when a company provides great service, its reputation benefits from a stronger emotional connection with its customers, as well as from increased confidence that it will stand behind its products. Explain why you agree or disagree with this statement. (LO 4) (AACSB: Analytical thinking) Students’ answers may vary. While you can expect many to agree with the statement, others may disagree because other competitive advantage aspects are more important to them. For example, some students may say they value convenience and speed over great service. 9-24. Describe a positive service experience you have had with a company and your impressions of that business. (LO 4) (AACSB: Application of knowledge) Students’ answers may vary. However, ask students to identify their experience based on one or more of the ways businesses create a competitive advantage. 9-25. What are the implications of a company providing poor customer service? (LO 4) (AACSB: Analytical thinking) Students’ answers may vary. However, ask students to identify their experience based on one or more of the ways businesses create a competitive advantage. 9-26. Describe a negative service experience you have had with a company and your likeliness of doing business with that company in the future. (LO 4) (AACSB: Application of knowledge) Expect students to realize that, in most cases, great service experience creates a bond and a confidence in the product or service. This enhances the perception of the company and the desire to be a repeat customer. Expect students to share their positive experiences and comment on how that impacts their perception of that business. Negative experiences can have a devastating impact on a venture. People are more likely to share negative experiences and services through mouth-to-mouth communication and through Web sites, such as Yelp, that provide a method to share information faster on a larger scale basis. Expect students to discuss their negative customer service experiences, their resulting impressions, and the likelihood that they will do business with that company in the future.
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9-27. Many studies confirm that advanced technology has dramatically changed the way business is done. Today’s customers now expect to be served the latest product and service, so speed has become a weapon for competitive edge. Discuss how this imposes challenges for marketers and what strategies they can undertake to overcome them. (LO 4) (AACSB: Analytical thinking) Students should answer keeping in mind TCM, suggesting challenges like speeding new products to markets, the trade-off between speed and quality, how to shorten cycle time in manufacturing, decreasing administrative time between order and delivery, and facing the extra cost and investment required to adopt these strategies .To overcome these challenges students can suggest reengineering, cross functional teams, aggressive goals and rewards for time reduction ,supply chain redesign, cultural changes to adopt speed, use of technology to find shortcuts, and putting the Internet to work.
Part 5: Case Studies The following text cases may be used for lecture and assignments for topics presented in this chapter. •
Case 1: United Apparel Liquidators
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Case 8: Gitman Brothers
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Case 10: Nuts.com
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics. Inform your students that another term for bootstrap marketing is “guerilla marketing. Also search for videos on “marketing plan” and other chapter related terms.
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Search Engine Marketing on a Bootstrap Budget http://www.youtube.com/watch?v=TVl323v4O_Y
29:56 minutes
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How to Write a Strategic Marketing Plan http://www.youtube.com/watch?v=-ul65NjOMzo
5:38 minutes
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Target Marketing: 10 Questions to Find Your Perfect Customer http://www.youtube.com/watch?v=WlprJhqM4zI
5:42 minutes
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Your Target Market: How to Find It http://www.youtube.com/watch?v=Y8aRzL_gkRY
2:16 minutes
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Guerrilla Marketing http://www.youtube.com/watch?v=_5D52OB84Gw
2:07 minutes
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Guerrilla Marketing Ideas for Any Business http://www.youtube.com/watch?v=ZdtC0VeH5OI
8:58 minutes
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Guerrilla Marketing Example – Fast Lane http://www.youtube.com/watch?v=98EJx7OKqLI
1:42 minutes
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Guerilla Marketing Example – Coca-Cola Happiness Machine http://www.youtube.com/watch?v=qMOuF8oskRU
2:03 minutes
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Launching a New Product http://smallbiztrends.com/2009/12/launching-a-new-product.html
2:23 minutes
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Strategies for Growth: Marketing Advice from an Expert 6:58 minutes http://www.sba.gov/tools/sba-learning-center/video/strategies-growth-marketingadvice-expert
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The Simple Truths of Service http://www.stservicemovie.com/
2:00 minutes
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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CHAPTER 10. E-COMMERCE AND THE ENTREPRENEUR
Part 1: Learning Objectives 1.
Understand the factors an entrepreneur should consider before launching into ecommerce.
2.
Explain the 11 myths of e-commerce and how to avoid falling victim to them.
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Explain the basic strategies entrepreneurs should follow to achieve success in their e-commerce efforts.
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Learn the techniques of designing a killer Web site.
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Explain how companies track the results from their Web sites.
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Describe how e-businesses ensure the privacy and security of the information they collect and store from the Web.
Part 2: Class Instruction Introduction The most successful companies are embracing the Internet not merely as another advertising medium or marketing tool but as a mechanism for transforming their companies and changing everything about the way they do business. E-commerce has launched a revolution, but business basics still apply; companies still have to take care of their customers and earn a profit. The Internet has produced informed shoppers who are taking price out of the buying equation due to the increase in the availability of price information. This causes retailers to emphasize other factors, such as customer service, deep product lines, or convenience to build long-term relationships. In addition, customers value other shoppers’ opinions about the products they purchase and their shopping experiences with companies. Modern shoppers expect to be able to make purchases across multiple channels, including the Web, mobile devices, social media, television shopping channels, catalogs, and brickand-mortar stores. E-commerce has removed the obstacle of size for many small business entrepreneurs. One of the Internet’s greatest strengths is its interactive, social nature and its ability to provide companies with instantaneous feedback, giving them the opportunity to learn and to make necessary adjustments. The Internet has changed the face of business and it is important for small businesses to incorporate e-business into their strategies to remain current in the marketplace.
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Online retail sales in the United States are consistently increasing. Figure 10.1, U.S. ECommerce Sales shows projections through 2017. Figure 10.2, Multichannel Shopping Methods, demonstrates trends in shopping habits of consumers. Figure 10.3, Global Retail E-Commerce Sales shows the pervasiveness of Internet-based shopping.
Factors to Consider Before Launching into E-Commerce
LO 1
As with any proposed change or new venture, business owners must consider all variables and challenges they face. The Internet can transform relationships with suppliers, customers, and others. However, not every small business is ready to embrace e-commerce. Web success requires a company to develop a plan for integrating the Internet into its overall strategy. Before launching an e-commerce effort, entrepreneurs should consider the following strategic issues: •
How to exploit the Internet to transform relationships with suppliers and vendors, customers, and other stakeholders.
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How to integrate the Internet in to its overall business strategy.
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Developing deep, lasting relationships with customers are even more important in e-commerce.
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An ongoing investment of resources is required to create a meaningful presence on the Internet.
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How to measure the success of its Internet-based sales effort.
Six factors are essential to achieve e-commerce success: acquiring customers; optimizing conversion of visitors into paying customers; maximizing Web site performance; ensuring a positive user experience; retaining customers; use Web analytics as part of a cycle of continuous improvement.
Eleven Myths of E-Commerce
LO 2
E-commerce already has many stories of success and failure. Make sure that you do not fall victim to one of the following e-commerce myths:
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Myth 1: If I Launch a Site, Customers Will Flock to It. Promoting the site is important and needs to become an integral part of the overall promotional strategy.
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Myth 2: Online Customers Are Easy to Please. Web visitors and shoppers, have high expectations about their experience. Because Web shoppers are becoming more discriminating, companies are finding that they must continually improve
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their Web sites to attract and keep customers. Refer to Table 101, Tips for Improving Your Web Site’s Conversion Rate
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Myth 3: Launching an E-Commerce Site is Free – Or at Least Really Inexpensive. One experienced e-commerce expert says that most of the Web sites that his company creates cost between $5,000 and $10,000. It is most definitely not free or inexpensive.
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Myth 4: Making Money on the Web Is Easy. Making money online requires an up-front investment of time, money, and energy. Success online also requires a sound business strategy. Getting a company’s site noticed requires more effort and marketing muscle than ever before.
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Myth 5: Privacy Is Not an Important Issue on the Web. The Internet allows companies to gain access to almost unbelievable amounts of information about their customers’ online behavior. Companies then use this information to learn more about their target customers and how to market to them more effectively, but must safeguard their customers’ privacy and protect the information they collect from unauthorized use. A key component is building trust among customers; this can be done by using a certification service, create and post meaningful privacy policies. Trust is the foundation on which the long-term customer relationship is built.
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Myth 6: “Strategy? I Don’t Need a Strategy to Sell on the Web! Just Give Me a Web Site, and the Rest Will Take Care of Itself.” Launching a Web site requires a well-thought-out strategy with a clear definition of the company’s target audience and a thorough understanding of those customers’ needs, wants, likes and dislikes. Online customers only have to make a mouse click or two to go to a rival Web site.
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Myth 7: The Most Important Part of Any E-Commerce Effort Is Technology. Technology advances have reduced significantly the cost of launching an eecommerce business. Having the right technology is not the most crucial ingredient; instead a business must understand the underlying business and to develop a workable business model. Nothing can substitute for a solid understanding of inner workings of the industry and target market, and the strategy to pull the various parts together. Business first, technology second.
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Myth 8: Customer Service Is Not as Important Online as It Is in a Traditional Retail Store. The customer service experience on the Web is vitally important and directly affects buyer behavior. Customers say convenience is more important than getting the lowest prices when shopping online. Customers still expect high levels of service. Refer to Figure 10.4, Reasons for Abandoning Online Shopping Carts. When shoppers abandon their online shopping cart some companies immediately send an e-mail message offering free shipping if they will complete their purchase. Refer to Figure 10.5, The Customer Experience Maturity Model.
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Myth 9: Flashy Web Sites Are Better Than Simple Ones. Keep the design of your site simple so that pages download in no more than two seconds, and make sure Chapter 10, Page 153
that the site’s navigation is easy and intuitive. Refer to Figure 10.6, How Page Load Speed Affects Sales. •
Myth 10: It’s What’s Up Front That Counts. Designing the back office, the systems that take over once customers place their orders on a Web site, is just as important as designing the site itself. According to Daryl Plummer, “The companies with warehouses, supply-chain management, and solid customer service are going to be the ones that survive.” Virtual order fulfillment (or drop shipping) is utilized once a customer places an order; the company forwards the order to a wholesaler or distributor who then ships the product to the customer with the online merchant’s label on it. There can be problems for the online company related to the loss of control over delivery times and service quality.
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Myth 11: My Business Doesn’t Need a Web Site. Today’s shoppers prefer to purchase from companies that offer a multichannel approach, particularly those that offer in-store pick-up for online orders and in-store returns for online purchases. When looking to purchase products locally, most shoppers go online to conduct research first, and customers routinely share their opinions online about products and their shopping experience. Successful entrepreneurs’ ecommerce sites are works in progress; they get the site online and then use Web analytics to update it to meet changing customer demands.
Strategies for E-Success
LO 3
Launching an e-business is not much different from launching a traditional offline company, as the basic drivers are the same – have a sound business model and a wellformulated strategy. Guidelines for building a successful e-commerce strategy for a small company include:
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Focus on a Niche in the Market
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Develop a Community
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Listen to Your Customers and Act on What You Hear
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Attract Visitors by Giving Away “Freebies.” Give something away for free and then sell them something else. It must be something customers’ value, but it does not have to be expensive.
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Sell the “Experience.” Create an engaging and enjoyable online shopping experience through easy navigation, a simple and fast checkout process, and thorough product descriptions with quality images.
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Make Creative Use of E-Mail, but Avoid Becoming a “Spammer.” Used properly and creatively, e-mail can be an effective, low-cost way to build traffic. The average open rate (the percentage of recipients who open an email) is 20.9 percent and the average click-through rate (the percentage of recipients who open an e-mail and click on the link to the company’s Web site) for email marketing is 3.6 percent. An e-mail's content should offer Chapter 10, Page 154
something of value to recipients. Spam is a persistent problem that online companies must avoid; they must comply with the CAN-SPAM Act, a law passed in 2003 that regulates commercial e-mail and set standards for commercial e-mail messages.
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Make Sure Your Web Site Says “Credibility.” Studies show that shoppers form an impression of a site’s credibility within 50 milliseconds of arrival. Refer to Table 10.2, Twelve Guidelines for building the Credibility of a Web Site.
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Make the Most of the Web’s Global Reach. Ignoring foreign customers makes little sense. E-companies must design their sites with their foreign customers in mind by providing information in multiple languages, not expecting international visitors to conform to U.S. business conventions, using colors and symbols that are inoffensive, using secure and simple payment methods, and using well known international delivery services. Entrepreneurs should hire professional translation and localization services to convert a company’s Web content into other languages to minimize the likelihood of a company unintentionally offending foreign customers.
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Go Mobile. The typical online shopper has expanded his or her reach across multiple screens and screen sizes due to increasing trends of the use of smart phones and tablets. Refer to Figure 10.7, Mobile Commerce Sales. By investing a little more time and money to create responsive Web sites, those that conform naturally and seamlessly to the size and resolution of the screen on which they are displayed, small companies can accommodate customers on any device. Businesses develop social-local-mobile (SoLoMo) strategies, which are marketing strategies aimed at capitalizing on shoppers’ pervasive use of social media, mobile devices, and search engines to find the products and services they want to purchase and the businesses that sell them.
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Promote Your Web Site Online and Off-Line. Put the company’s Web address on everything a company publishes, from its advertisements and letterhead to shopping bags, business cards, and even employees’ uniforms.
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Use Social Media Tools to Attract and Retain Customers. Small businesses are responding to the opportunity to connect with customers online by adding a number of social components to their e-commerce strategies: Facebook, Twitter, YouTube, LinkedIn, Pinterest, and Apps. Refer to Figure 10.8, Most Popular Social Media Networks Marketers Use.
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Develop an Effective Search Engine Optimization Strategy. The firm’s Web search strategy must incorporate natural (organic) listings, which are search engine listings that are the result of “spiders,” powerful programs that crawl around the Web and analyze sites for key words, links, and other data. With natural listings, an entrepreneur’s goal is to be displayed at or near the top of the list of search results. Search engine optimization (SEO) is the process of managing the content, key words, titles, tags, features, and design of a Web site so that it appears at or near the top of Internet search results. Refer to
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Figure 10.9, Four Building Blocks to a Successful Organic SEO Strategy. Companies can use tips to improve their search placement results: o Brainstorm to develop a list of key words and phrases. Use Google’s AdWords Keyword Tool or Microsoft Bing Ads. Use these key words in the title tags and headlines of your Web pages. o Create meaningful, relevant content for each page with your customers’ needs in mind. Encourage social media shares. Create unique product descriptions. o Visit competitors’ Web sites for key word ideas. Consider using less obvious key words and brand names. Ask customers which words and phrases they use. o Use data analytics tools to find key words and phrases. Check blogs and bulletin boards for key terms. Remember that customers may misspell the words they type, so include these words in your list. Hire services to monitor and analyze Web users’ tendencies. o Block irrelevant results with “negative key words,” that are excluded in a search. o Include links to other relevant Web sites and land links on high-profile Web sites. o Start a blog and post videos on your site. •
Paid (sponsored) listings are short advertisements with links to the sponsoring company’s Web site that appear on the results page of a search engine when the user types in a key word or phrase. Product listing ads (PLAs) are paid ads on Google that show more information, including product images, prices, business name, and a short promotional message, than traditional text ads. A problem facing companies that rely on paid listings and display ads is click fraud, a situation that occurs when a company pays for clicks that are generated by someone with no interest in or intent to purchase its products or services.
Designing a Killer Web Site
LO 4
Entrepreneurs must pay careful attention to the look, feel, efficiency, and navigability of the Web sites and the impression their sites create with shoppers. While there are no guarantees, the following suggestions may increase the chances for online success.
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Start with Your Target Customer.
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Give Customers What They Want. The main reason people shop online is convenience.
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Select an Intuitive Domain Name. It must be consistent with the image you want to create for your company and register it. Selecting a domain name that Chapter 10, Page 156
is short, memorable, indicative of a company’s business or business name, and easy to spell.
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Make Your Web Site Easy to Navigate. Landing pages are the pages on which visitors land after they click on a sponsored link in a search engine, email ad, or online ad. Two important Web site design features that online companies often get wrong involve the mechanisms by which customers locate products and then get information about them: locating products, and getting product information.
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Offer Suggestions for Related Products.
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Add Wish List Capability.
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Create a Gift Idea Center.
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Provide Customer Ratings and Reviews.
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Use Online Videos.
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Establish the Appropriate Call to Action on Each Page.
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Build Loyalty by Giving Online Customers a Reason to Return.
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Establish Hyperlinks with Other Businesses, Preferably Those Selling Products or Services That Complement Yours.
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Include an E-Mail Option, a Physical Address, and a Telephone Number.
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Give Shoppers the Ability to Track Their Orders Online.
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Offer Online Shoppers a Special All Their Own.
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Use the Power of Social Media
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Follow a Simple Design. Some design tips include avoiding clutter and huge graphic headers; include a menu bar, make the site easy to navigate; minimize the number of clicks to get to a page; include meaningful content useful to visitors; connect to social media pages, include FAQs, prominently post privacy and return policies; include a search tool if the Web site is very large; avoid fancy typefaces; be vigilant for writing errors; avoid small fonts; use frames carefully, test the site on different Web browsers and different size monitors; collect information but don’t tie up visitors immediately with a tedious registration process; avoid automated music that cannot be cut off; make sure the overall look of the page is appealing; remember that simpler is almost always better.
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Create a Fast, Simple Checkout Process.
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Provide Customers Multiple Payment Options
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Assure Customers That Their Online Transactions Are Secure.
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Establish Reasonable Shipping and Handling Charges and Post Them Up Front.
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Confirm Transactions.
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Keep Your Site Updated.
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Test Your Site Often.
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Rely on Analytics to Improve Your Site.
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Consider Hiring a Professional to Design Your Site.
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Consider using You Be the Consultant: “A Total Makeover” at this point.
Tracking Web Results
LO 5
Entrepreneurs must take the time to analyze a treasure trove of valuable information about how well their sites are performing. Web analytics are tools that measure a Web site’s ability to attract customers, generate sales, and keep customers coming back. There are many Web analytics software packages, but effective ones offer the following types of information: •
Commerce metrics. These are basic analytics, such as sales revenue generated, number of items sold, and best sellers.
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Visitor segmentation measurements. These report information about online shoppers and customers, including whether they are returning or new customers, how they arrived at the site, which terms they used, where they are located, etc.
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Content reports. This information tells which products customers are looking for and which pages they view most often, etc.
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Process measurements. This kind of information includes the effectiveness of the checkout process, and how often shoppers abandon their carts.
Other common measures of Web site performance include:
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Cost per acquisition – measures the cost that a company incurs to generate each purchase (for customer registration).
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Average number of page views per visit – measures how much time visitors spend on a site (visit duration).
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Bounce rate – measures the percentage of visitors to a company’s Web site who view a single page and leave without viewing other pages.
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Conversion (browse-to-buy) rate – measures the proportion of visitors to a site who actually make a purchase.
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Cart abandonment rate – measure the percentage of shoppers who place at least one item in a shopping cart but never complete the transaction.
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Search engine ranking – shows where a company’s Web site ranks in search engines’ results pages. Chapter 10, Page 158
Ensuring Web Privacy and Security
LO 6
Privacy. The Web’s ability to track customers’ every move raises concerns over the privacy of that information. Companies are encouraged to take the following steps to ensure that they use information they collect in a legal and ethical manner: •
Take an inventory of the customer data collected.
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Develop a company privacy policy, a statement explaining the nature of the information a company collects online, what it does with that information, and what recourse customers have if they believe the company is misusing the information.
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Post your company’s privacy policy prominently on your Web site and follow it!
Security. Customers’ concerns about security can result in lost sales. Hackers, viruses, credit card fraud, and unauthorized users continue to have a negative affect companies, customers, and the growth of e-commerce. Following are steps entrepreneurs can use to improve security: •
Virus detection software is a program that scan computer drives for viruses, or nasty programs written by devious hackers and designed to harm computers and the information they contain.
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Intrusion detection software is a program that constantly monitor the activity on a company’s network server and sound an alert if they detect someone breaking into the system or if they detect unusual network activity.
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Firewalls are a combination of hardware and software that allows employees to have access to the Internet but keeps unauthorized users from entering a company’s network and the programs and data it contains.
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Secure Sockets Layer (SSL) technology is an encryption device that secures customers’ transaction information as it travels across the Internet.
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Charge-backs are online transactions that customers dispute.
Conclusion Planning for an Internet presence can make all the difference. Entrepreneurs will benefit by being strategic about their presence on the Web. Gain an appreciation for online approaches that work, apply the strategies that fit the needs of customers and the business, and track that performance.
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Part 3: Chapter Exercises You Be the Consultant: “A Multichannel Approach” 1. What advantages does an “online-only” strategy offer a company? Why do many start-up companies use this strategy? (LO 4) (AACSB: Reflective thinking) An online-only channel means the company is in tune with shopping trends. In addition, many start-up companies favor this approach because of low overhead expenses, no cadre of salespeople to hire and train, and minimal operating costs. 2. What advantages do retail stores offer a company? Disadvantages? (LO 4) (AACSB: Reflective thinking) In a retail store environment, the retailer meets customers face-to-face. They can provide customers with “hands-on” personalized customer service. The disadvantages are that the cost of operations is high and also the trend seems to be to shop online rather than at a physical store. 3. Why are many companies shifting to a multichannel strategy that involves both physical stores and an online presence? (LO 4) (AACSB: Application of knowledge) A multichannel strategy allows a company to combine the advantages of traditional retail (face-to-face interaction, high impact touchpoints) with the advantages of online sales (matching shopping trends, low cost). This way, the company can get and sustain its competitive advantage.
You Be the Consultant: “Why Your Small Business Is a Target for Cybercriminals” 1. Why are cybercriminals increasingly targeting small businesses with their attacks? (LO 6) (AACSB: Reflective thinking) Forty-three percent of cyberattacks globally are against small businesses. The key reason is that cybercriminals see small businesses as easy targets because they don’t have the resources that large companies have to spend on computer security. 2. What are the risks and dangers to a small company that is the victim of a cyberattack?(LO 6) (AACSB: Reflective thinking) The risks cover a wide gamut. They include:
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Data loss
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Loss of cash from bank accounts
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Filing for fraudulent tax refunds
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Health insurance and Medicare fraud
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Loss of intellectual property
3. Use the information in this chapter and resources of the Internet to develop a list of at least five suggestions that small business owners can act on to strengthen the computer security in their companies and reduce the threat of a cyberattack. (LO 6) (AACSB: Application of knowledge) This is a good project for students to work on. As the threat of cyberattacks increase, there is a lot of information available on how to combat them.
Part 4: Chapter Discussion Questions 10-1. Doing business on the Internet takes more time and energy than many entrepreneurs expect. Identify the six factors that are essential to achieving ecommerce success. •
Acquiring customers.
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Optimizing conversions.
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Maximizing Web site performance.
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Ensuring a positive user experience.
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Retaining customers.
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Use Web analytics as part of a cycle of continuous improvement.
10-2. Discuss the factors entrepreneurs should consider before launching an ecommerce site. (LO 1) Before launching an e-commerce effort, entrepreneurs should consider the following strategic issues: •
How to exploit the Internet to transform relationships with suppliers and vendors, customers, and other stakeholders.
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How to integrate the Internet in to the overall business strategy.
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Developing deep, lasting relationships with customers are even more important in e-commerce.
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An ongoing investment of resources is required to create a meaningful presence on the Internet.
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How to measure the success of its Internet-based sales effort.
Six factors are essential to achieve e-commerce success: acquiring customers; optimizing conversion of visitors into paying customers; maximizing Web site performance;
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ensuring a positive user experience; retaining customers; use Web analytics as part of a cycle of continuous improvement. 10-3. What are the 11 myths of e-commerce? (LO 2) The 11 myths of e-commerce are: Myth 1: If I launch a site, customers will flock to it. Myth 2: Online customers are easy to please. Myth 3: Launching an e-commerce site is free – or at least really inexpensive Myth 4: Making money on the Web is easy. Myth 5: Privacy is not an important issue on the Web. Myth 6: Strategy? I don’t need a strategy to sell on the Web! Just give me a Web site, and the rest will take care of itself. Myth 7: The most important part of any e-commerce effort is technology. Myth 8: Customer service is not as important online as it is in a traditional retail store. Myth 9: Flashy Web sites are better than simple ones. Myth 10: It’s what’s up front that counts. Myth 11: My business doesn’t need a Web site. 10-4. What can an entrepreneur do to avoid falling victim to these 11 myths? (LO 2) Myth 1: If I Launch a Site, Customers Will Flock to It Promoting the site is important and needs to become an integral part of the overall promotional strategy. Myth 2: Online Customers Are Easy to Please Web visitors and shoppers, have high expectations about their experience. Because Web shoppers are becoming more discriminating, companies are finding that they must continually improve their Web sites to attract and keep customers. Myth 3: Launching an E-Commerce Site is Free – or at Least Really Inexpensive It costs between $5,000 and $10,000 to build a professionally designed Web site. This means that entrepreneurs have to budget these costs so that they are prepared. Myth 4: Making Money on the Web Is Easy Making money online requires an up-front investment of time, money, and energy. Success online also requires a sound business strategy. Getting a company’s site noticed requires more effort and marketing muscle than ever before. Myth 5: Privacy Is Not an Important Issue on the Web The Internet allows companies to gain access to almost unbelievable amounts of information about their customers’ online behavior. Companies then use this information to learn more about their target customers and how to market to them more effectively, but must safeguard their customers’ privacy and protect the
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information they collect from unauthorized use. A key component is building trust among customers; this can be done by using a certification service, create and post meaningful privacy policies. Trust is the foundation on which the long-term customer relationship is built. Myth 6: “Strategy? I Don’t Need a Strategy to Sell on the Web! Just Give Me a Web Site, and the Rest Will Take Care of Itself.” Launching a Web site requires a well-thought-out strategy with a clear definition of the company’s target audience and a thorough understanding of those customers’ needs, wants, likes and dislikes. Online customers only have to make a mouse click or two to go to a rival Web site. Myth 7: The Most Important Part of Any E-Commerce Effort Is Technology Technology advances have reduced significantly the cost of launching an eecommerce business. Having the right technology is not the most crucial ingredient; instead a business must understand the underlying business and to develop a workable business model. Nothing can substitute for a solid understanding of inner workings of the industry and target market, and the strategy to pull the various parts together. Business first, technology second. Myth 8: Customer Service Is Not as Important Online as It Is in a Traditional Retail Store The customer service experience on the Web is vitally important and directly affects buyer behavior. Customers say convenience is more important than getting the lowest prices when shopping online. Customers still expect high levels of service. When shoppers abandon their online shopping cart some companies immediately send an e-mail message offering free shipping if they will complete their purchase. Myth 9: Flashy Web Sites Are Better Than Simple Ones Keep the design of your site simple so that pages download in no more than two seconds, and make sure that the site’s navigation is easy and intuitive. Myth 10: It’s What’s Up Front That Counts Designing the back office, the systems that take over once customers place their orders on a Web site, is just as important as designing the site itself. According to Daryl Plummer, “The companies with warehouses, supply-chain management, and solid customer service are going to be the ones that survive.” Virtual order fulfillment (or drop shipping) is utilized once a customer places an order; the company forwards the order to a wholesaler or distributor who then ships the product to the customer with the online merchant’s label on it. There can be problems for the online company related to the loss of control over delivery times and service quality. Myth 11: My Business Doesn’t Need a Web Site Today’s shoppers prefer to purchase from companies that offer a multichannel approach, particularly those that offer in-store pick-up for online orders and in-store returns for online purchases. When looking to purchase products locally, most shoppers go online to conduct research first, and customers routinely share their opinions online about products and their shopping experience. Successful
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entrepreneurs’ e-commerce sites are works in progress; they get the site online and then use Web analytics to update it to meet changing customer demands. 10-5. One of the strategies for success is to focus on a niche in the market. Why? The idea is to concentrate on serving a small corner of the market that the giants have overlooked. Niches exist in every industry and can be highly profitable, given the right strategy for serving them. 10-6. What design characteristics make for a successful Web page? (LO 4)
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Start With Your Target Customer.
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Give Customers What They Want.
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Select an Intuitive Domain Name.
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Make Your Web Site Easy to Navigate. Offer Suggestions for Related Products.
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Add Wish List Capability.
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Create a Gift Idea Center.
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Provide Customer Ratings and Reviews.
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Use Online Videos.
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Establish the Appropriate Call to Action on Each Page.
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Build Loyalty by Giving Online Customers a Reason to Return.
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Establish Hyperlinks with Other Businesses, Preferably Those Selling Products or Services That Complement Yours.
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Include an E-Mail Option, a Physical Address, and a Telephone Number.
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Give Shoppers the Ability to Track Their Orders Online.
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Offer Online Shoppers a Special All Their Own.
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Use the Power of Social Media
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Follow a Simple Design.
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Create a Fast, Simple Checkout Process.
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Provide Customers Multiple Payment Options.
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Assure Customers That Their Online Transactions Are Secure.
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Establish Reasonable Shipping and Handling Charges and Post Them Up Front.
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Confirm Transactions.
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Keep Your Site Updated.
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Test Your Site Often.
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Rely on Analytics to Improve Your Site.
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Consider Hiring a Professional to Design Your Site.
10-7. What are the guidelines for creating a successful e-commerce strategy for a small company? •
Focus on a niche in the market.
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Develop a community of online customers.
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Attract visitors by giving away “freebies.”
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Make creative use of e-mail but avoid becoming a “spammer.”
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Make sure that your Web site says “credibility.”
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Make the most of the Web’s global reach.
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Promote your Web site online and offline.
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Use social media tools to attract and retain customers.
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Develop an effective Search engine optimization (SEO) strategy.
10-8. When we design a killer website, why do we need to give customers what they want when they shop online? The most important reason for people to shop online is due to convenience. Online companies that fail to provide a fast, efficient, and flawless shopping experience for their customers will not succeed. A well-designed Web site is intuitive. It will lead customers to a series of actions that are natural and result in a sale. Sites that provide customers with meaningful content and allow them to find what they are looking for easily, and to pay for it conveniently and securely keep customers coming back. 10-9. How do e-companies minimize the likelihood of invasion by hackers? Virus detection software, intrusion detection software, and firewalls. 10-10. What steps should e-businesses take to ensure the privacy of the information they collect and store from the Web? (LO 6) The company must have proper security technology in place to prevent cyberattacks. In addition, managers must train employees on proper security measures because they are often the weakest link in a company’s security chain. 10-11. What techniques can e-companies use to protect their banks of information and their customers’ transaction data from hackers? (LO 6) Encryption is key here. To ensure the security of their customers’ debit or credit card information, retailers should use technologies like Secure Sockets Layer (SSL) or Transport Layer Security (TLS). 10-12. What challenges does evaluating the effectiveness of a Web site pose for online entrepreneurs? (LO 6). The goal for an entrepreneur should be to have a Web site that customers feel comfortable in visiting and transacting with. Toward this, Web security should be a key .
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aspect. The challenge for an entrepreneur is twofold: the cost of adding security to the site and the changing face of technology that increase the costs going forward.
Part 5: Case Studies The following text cases may be used for lecture and assignments for topics presented in this chapter. •
Case 8: Gitman Brothers
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Case 10: Nuts.com
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics. •
How to Market Your Ecommerce Site to Niche Markets http://www.youtube.com/watch?v=pj81F8LrFkw
2:20 minutes
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Five Major Don’ts of Building an Ecommerce Site http://www.youtube.com/watch?v=Or8ZQ0TSCLo
2:53 minutes
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Five Basic Ways to Market Your Site http://www.youtube.com/watch?v=za7NdRtRIwY
2:33 minutes
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Six Website Elements That Impact Customers in 3 Seconds or Less 2:39 minutes http://www.youtube.com/watch?v=Ze-g2rNBIFc
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Five Ecommerce Trends to Make an Impact in 2014 http://www.youtube.com/watch?v=icouqKSDspA
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Humphry Slocombe: Promote Using Free Online Marketing 2:45 minutes http://www.sba.gov/tools/sba-learning-center/video/humphry-slocombe-promoteusing-free-online-marketing
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The 5 Most Epic Fails of SEO http://www.youtube.com/watch?v=nXTk4xg3d74
2:26 minutes
2:23 minutes
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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CHAPTER 11. PRICING AND CREDIT STRATEGIES Part 1: Learning Objectives 1. Discuss the relationships among pricing, image, competition, and value. 2. Describe effective pricing techniques for introducing new products or services and for existing ones. 3. Explain the pricing methods and strategies for retailers, manufacturers, and service firms. 4. Explain the impact of credit and debit cards and mobile wallets on pricing.
Part 2: Class Instruction Introduction Setting prices is a business decision that is both an art and a science. Unfortunately many small business owners set prices without enough information about their cost of operation s and their customers. Research shows that proper pricing strategies have far greater impact on a company’s profits than corresponding increase in unit volume and reductions in fixed or variable costs. Refer to Figure 11.1, The Impact of Pricing and Cost Improvements on Profitability. Due to the Great Recession customers have become more price sensitive. In addition, modern shoppers use technology such as smart phones and tablets to shop for the best deals. Setting prices too high drives customers away, but prices that are too low (a common tendency for entrepreneurs) robs a business of its ability to generate a profit, creates the impression that the products and services are of inferior quality, and threatens long-term success. Price is the monetary value of a product or service; it is a measure of what the customer must give up to obtain what they want or need. Price is also a signal of the value of a product or service, so price must be compatible with customers’ perceptions of value.
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Three Potent Forces: Image, Competition, and Value
LO 1
Companies that take a strategic approach to pricing and monitor its results can raise their sales revenue between 1 and 8 percent. Price Conveys Image. Pricing sends an important signal to customers about a company, its brand, its position in the market, the quality of its products and services, the image it wants to create, and other important concepts. Too often, entrepreneurs underprice believing that low prices are the only way they can achieve a competitive advantage. They fail to recognize the extra value, convenience, service and quality they give their customers. The relationship between value and price are demonstrated with an equation that includes the following variables: standards of doing business, product or service quality and performance, doubt in customers’ minds that detract from the value of the company’s standards and products or services, product or service price, and customers’ expectations of a company and its products and services. Rather than ask, “How much should I charge?” entrepreneurs should ask, “How much are my target customers willing to pay?” Competition and Prices. Today small companies face competition from local businesses as well as from online businesses. Unless a small business can differentiate itself by creating a distinctive image in customers’ minds or by offering superior service, quality, design, convenience, or speed, then it must match its competitors’ prices or risk losing sales. Blindly matching competitors’ prices can lead a company to financial ruin. Refer to Figure 11.2, The Reality of Setting Prices. Generally entrepreneurs should avoid head-to-head price competition with other firms that can more easily achieve lower prices through lower cost structures. Nonprice competition can be an effective strategy. However, if a business chooses to offer lowers prices it must first create a low cost advantage by: choosing a low-cost location, minimizing operating costs by maximizing efficiency; exercise tight control over inventory and restricting product lines to those items that turn over quickly; providing customers with no or limited service; using low-cost, bootstrap marketing techniques; offering basic products but offer the option of purchasing addition product features that generate higher profit margins; achieving high sales volume. Entrepreneurs usually overestimate the power of price cuts. In reality, sales volume rarely increases enough to offset the lower profit margins of a lower price. Customers who are lured by the lowest price usually exhibit little loyalty to a business. Rather than joining in a price war by cutting prices, entrepreneurs can adjust their product and service offering to appeal to different market segments; offering lower priced items that use less expensive materials and offer fewer extras for price-sensitive customers and higher-quality premium products for those who care less about price and more about quality and service. The lesson is to stay out of a price war by differentiating your company, emphasizing the unique features, benefits and value it offers its customer.
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Focus on Value The “right” price depends on the objective value and perceived value. The objective value is the price customers would be willing to pay if they understood perfectly the benefits that a product or service delivers for them. Unfortunately, customers only see its perceived value, which determines the price they are willing to pay. Value does not equate to a low price. Setting prices too low is more dangerous than setting them too high. Raising prices that are too low is much more difficult and can create the wrong image for a business. Techniques that companies can use to increase customers’ perception of value include offering coupons and rebates, offering limited-time-only discounts, or launch a fighter brand, which is a less expensive, no-frills version of a company’s flagship product that is designed to confront lower-priced competitors head-on, satisfy the appetites of valueconscious customers, and preserve the image of the company’s premium product. Through marketing and other efforts, companies can influence customers’ perception of value. For most shoppers, three reference points define a fair price; the price they have paid in the past, prices competitors charge, and the costs a company incurs to produce the product or service. This means it is important for business owners to remind customers periodically that they must raise prices to offset the increased cost of doing business. In addition, customers are less likely to notice small, regular price increases that result from rising costs than a single, steep price increase. One of the biggest mistakes an entrepreneur can make is underestimating the company’s actual total cost of a product or service. When setting prices, some entrepreneurs think strictly in terms of product or service costs and fail to consider the total cost of providing the product or service, such as rent, insurance, labor costs, etc. Businesses facing rapidly rising costs should consider the following strategies:
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Communicate with customers.
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Rather than raise the price of the good or service, include a surcharge.
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Eliminate customer discounts, coupons, and promotions.
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Offer products in smaller sizes or quantities.
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Focus on improving efficiency everywhere in the company.
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Emphasize the value your company provides to customers.
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Raise prices incrementally and consistently rather than rely on large periodic increases.
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Shift to less expensive raw materials if possible.
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Anticipate rising materials costs and try to lock in prices early.
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Consider absorbing cost increases.
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Modify the product or service to lower its cost.
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Differentiate your company and its products and services from the competition.
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Costs impact pricing. It is important that price takes cost into consideration. These costs should be passed along to customers and communicated through the value you offer. When all is taken into consideration, the factors that small business owners must consider when determining price for goods and services includes: •
Product/service costs
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Market factors - supply and demand
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Sales volume
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Competitors' prices
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The company's competitive advantage
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Economic conditions
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Business location
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Seasonal fluctuations
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Psychological factors
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Credit terms and purchase discounts
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Customers' price sensitivity
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Desired image
For most products there is an acceptable price range, not a single price for a product. This price range is the area between the price ceiling defined by customers in the market and the price floor established by the company’s cost structure. The goal is to position prices within this acceptable price range. Refer to Figure 11.3, What Determines Price?
Pricing Strategies and Tactics
LO 2
Pricing strategies must be compatible with the firm’s overall strategy. Introducing a New Product. When introducing a new product, the owner should try to satisfy three objectives: 1. Get the product accepted. The acceptable price range depends on the product’s position: •
Revolutionary products are so new and unique they transform existing markets.
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Evolutionary products offer up-grades and enhancements to existing products.
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Me-too products offer the same basic features as existing products on the market.
2. Maintain market share as competition grows
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3. Earn a profit There are three basic strategies when establishing a new product’s price: penetration, skimming, and life cycle pricing. 1. Penetration: Set prices below competitors to gain market entry. This pricing strategy increases market share and makes it less attractive for new competitors to enter the market. 2. Skimming: Set higher prices for new products and for markets that have little or no competition. This pricing strategy offers the optimal margin with higher price points. 3. Life Cycle Pricing: Set higher prices initially and, as technological advances or additional experience enables the firm to lower costs, it can reduce the product’s price one step ahead of competitors. Pricing Established Goods and Services. Each of the following pricing tactics can become part of the toolbox entrepreneurs can use: •
Odd pricing – a pricing technique to set prices in odd numbers to create the psychological impression of lower prices.
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Price lining – a technique that greatly simplifies the pricing function by pricing different products in a product line at different price points depending on their quality, features, and cost.
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Freemium pricing – a pricing strategy that involves providing a basic product or service to customers for free but charging a premium for expanded or upgraded versions of the product or service.
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Dynamic (customized) pricing – a technique in which a company sets different prices for the same products and services for different customers using the information they have collected about their customers.
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Leader pricing – a technique that involves marking down the normal price of a popular item in an attempt to attract more customers who make incidental purchases of their items at regular prices.
•
Geographical pricing – prices vary according to the costs of shipping merchandise to customers across a wide range of geographic regions. One type of geographic pricing is zone pricing, which is a technique that involves setting different prices for customers located in different territories because of different transportation costs. Another option is delivered pricing, a technique in which a company charges all customers the same price regardless of their locations and different transportation costs. The final option is F.O.B. factory, in which a small company sells merchandise to customers on the condition that they (the customers) pay all shipping costs.
•
Discounts – There are five variations of discounts: o Discount markdowns are reductions from normal list prices. o Earned discounts which customers earn by making repeat purchases at a
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business. o Limited time offers provided by retailers for a limited amount of time with the goal of creating a sense of urgency and excitement among customers. o Steadily decreasing discount is a limited duration discount that declines over time. o Multiple unit pricing is a technique offering customers discounts if they purchase in quantity. •
Bundling is grouping together several products or services or both into a package that offers customers extra value at a special price.
•
Optional-product pricing is a technique that involves selling the base product for one price but selling the options or accessories for it at a much higher markup.
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Captive product pricing is a technique that involves selling a product for a low price and charging a higher price for the accessories that accompany it.
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By-product pricing is a technique in which a company uses the revenues from the sale of by-products to be more competitive in pricing the main product.
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Suggested retail prices. This practice eliminates the need for small businesses to make a pricing decision. However, it can create problems such as prices being inconsistent with the company’s image, cost structure, or competitive situation.
•
Follow-the-leader pricing
Consider using You Be the Consultant: “The Psychology of Pricing?” or Ethics and Entrepreneurship “The Ethics of Dynamic Pricing” at this point.
Pricing Strategies and Methods for Retailers
LO 3A
As customers have become more price conscious, retailers have changed their pricing strategies to emphasize value, which allows for a wide variety of practices used to increase customer loyalty. Markup. Markup (or markon) pricing is the difference between the cost of a product or service and its selling price. It is a calculation of the addition amount charged in addition to the cost to procure. It must be large enough to produce a profit. Markup is based on this equation: Dollar markup + Retail price – Cost of the merchandise For example, if a shirt costs $14 and the sales price is $30, the markup is $16. Percentages can easily be calculated. Additional calculations are included in this chapter. Refer to Table 11.1, Costs and Markup Calculations for Samsung’s Galaxy S6 Edge and Apple’s iPhone 7. Once entrepreneurs create a financial plan, including sales estimates and anticipated expenses, they can compute their companies’ initial markup. The initial markup is the
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average markup required on all merchandise to cover the cost of the items, all incidental expenses, and a reasonable profit. Operating costs, such as rent, utilities, depreciation and reductions must also be taken into consideration. Entrepreneurs must be aware of the impact that discounts have on their markup percentages. Refer to Figure 11.4, The Mathematics of Markups and Markdowns. Finally, retailers must verify that the retail price they have calculated is consistent with their companies’ image. Perhaps most important, customers must be willing and able to pay this price.
Pricing Concepts for Manufacturers
LO 3B
Cost-plus pricing is a pricing technique in which a manufacturer establishes a price that covers the cost of direct materials, direct labor, factory overhead, selling and administrative costs, and a desired profit margin, which is the most commonly used pricing technique for manufactures. While it is a simple way to determine prices, it does not encourage the manufacturer to use resources efficiently. In addition, it fails to consider the competition and market forces. Refer to Figure 11.5, Cost-Plus Pricing Components. Direct Costing and Pricing. Successful pricing for manufacturers requires a reliable cost accounting system that can generate timely reports. •
Absorption costing is the traditional method of product costing in which all manufacturing and overhead costs are absorbed into the product’s total cost.
•
Variable (direct) costing is a more useful method of product costing that includes in the product’s cost only those costs that vary directly with the quantity produced. Variable costing encompasses direct materials, direct labor, and factory overhead costs that vary with the level of the company’s output of finished goods. Overhead costs that are fixed (rent, depreciation, and insurance) are not included.
Refer to Table 11.2, Full-Absorption versus Direct-Cost Income Statement. •
Contribution margin is the amount left over out of a dollar of sales after variable expenses are paid that contributes to covering fixed expenses and earning a profit. A calculation is included in the chapter.
Computing the Break-Even Selling Price. Calculations are included in the chapter. The break-even selling price allows a manufacturer to determine at what point revenues equal expenses. This is the break-even point and the next unit sold represents the first dollar of profit.
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Pricing Strategies and Methods for Service Firms
LO 3C
Service firms must establish prices on the basis of the materials used to provide the service, the labor employed, an allowance for overhead, and profit. Most service firms base their prices on an hourly rate, usually the actual number of hours required to perform the service. Others base their feeds on a standard number of hours, determined by the average number of hours needed to perform the service. Calculations are provided in the chapter. Refer to Table 11.3, Direct-Cost Income Statement, Ned’s Computer Repair shop. Pocket price is the price a company receives for a product or service after deducting all discounts and purchase incentives.
The Impact of Credit and Debit Cards and Mobile Wallets on Pricing LO 4 Consumer credit has a dramatic impact on pricing and on the attractiveness of the business. Refer to Figure 11.6, Top Three Payment Preferences Among Shoppers. This includes credit cards, debit cards, and cash. It is important to recognize the value that credit offers a company, and equally important to take steps to protect it. Credit Cards. Accepting credit cards broadens a small company’s customer base and closes sales that would normally be lost if customers had to pay in cash. However, companies incur additional expenses for offering this convenience. Businesses must pay to use the system, typically 1percent to 6 percent of the total credit card charge, which they must factor into the prices of their products or services. They also pay a transaction fee of 5 to 25 cents per charge. Refer to Figure 11.7, How a Typical Credit Transaction Works. An interchange fee is the fee banks collect from retailers whenever customers use a credit or debit card to pay for a purchase. Some entrepreneurs offer customers incentives to pay with cash in order to avoid the fees. •
E-Commerce and Credit Cards. Online merchants must ensure their customers’ privacy and the security of their credit card transactions by using encryption software. There are steps online merchants can take to avoid credit card fraud, including: o Verification of customers’ billing address information. o Require customers to provide the CVV2 number on the back of a credit card. o Check customers’ Internet protocol (IP) address. o Monitor activity on the Web site using a Web analytics software package. o Verify large orders. o Post notices on the Web site that your company uses antifraud technology.
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o Contact the credit card company or the bank if you suspect an order may be fraudulent before processing an order. •
Debit Cards. In 2003, for the first time shoppers used credit and debit cards more often than cash or checks. Compared to credit cards, the equipment to accept debit cards is easy to install and the cost to the company is negligible. Interchange fees are lower.
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Mobile Wallets. Mobile wallet applications link a smart phone or tablet to a credit or debit card, transforming the device into a digital wallet. Shoppers download software, and then swipe the devices over a near field communication (NFC) or Quick Response (QR) reader to complete a purchase. The technology not only speeds up the checkout process but also allows merchants to recognize customers when they walk in the store; send personalized coupons, incentives, and rewards to them; and generate useful reports.
Installment Credit. Small companies that sell big-ticket consumer durables (major appliances, cars, boats, etc.) rely on installment credit. Customers are typically required to make an initial down payment and then finance the balance for the life of the loan. Because installment credit absorbs a small company’s cash, many rely on financial institutions to provide installment credit. Trade Credit. Trade credit is essentially customer charge accounts offered by the business; customers are billed each month. To speed collections, some offer cash discounts if customers pay their balances early; others impose penalties on late payers. •
Layaway. Although technically not a form of credit, layaway plans enable customers to purchase goods over time. The customer selects an item, pays a deposit on it, and makes regular payments until it is paid in full. The retailer keeps the item until the customer has finished paying.
Conclusion Pricing has a significant impact on many aspects of business. Price communicates an image of the business with a direct impact on customer behavior. Price then sets the stage for cash flow and ultimately business profits. Pricing decisions are some of the most important decisions an entrepreneur will make. Setting the price structure needs to be strategic and intentional.
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Part 3: Chapter Exercises You Be the Consultant: “The Psychology of Pricing” 1. Use the Internet to find examples of businesses that use these or other psychology-based pricing techniques and write a brief description of the company and its pricing strategy. (LO 2) (AACSB: Application of knowledge) This is a good out-of-class exercise for students to either do individually or as teams. In particular, young companies such as Uber are using less traditional pricing practices. Students should be urged to do either primary research or use the Internet to find out unique pricing strategies. 2. Why do many entrepreneurs underprice their goods and services, especially when they first get into business? Discuss the connection between the prices a company establishes for its goods and services and the image it creates for the company. (LO 2) (AACSB: Reflective thinking) Setting prices too high drives customers away, but prices that are too low (a common tendency for entrepreneurs) robs a business of its ability to generate a profit, creates the impression that the products and services are of inferior quality, and threatens long-term success. Price is the monetary value of a product or service; it is a measure of what the customer must give up to obtain what they want or need. Price is also a signal of the value of a product or service, so price must be compatible with customers’ perceptions of value. Pricing sends an important signal to customers about a company, its brand, its position in the market, the quality of its products and services, the image it wants to create, and other important concepts. Too often, entrepreneurs underprice believing that low prices are the only way they can achieve a competitive advantage. They fail to recognize the extra value, convenience, service, and quality they give their customers.
Ethics and Entrepreneurship: “The Ethics of Dynamic Pricing” 1. Work with a team of your classmates to define the ethical issues involved in dynamic pricing. (LO 2) (AACSB: Ethical understanding and reasoning) Expect the teams to demonstrate an understanding of dynamic pricing and the idea of “different prices for different customers.” Students should then identify ethical questions this pricing method raises. Examples of these questions may be in the areas of the following:
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Consistency in pricing
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Bias, prejudice, and discriminatory pricing
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The potential negative impact on loyal and repeat customers
2. What are the advantages and the disadvantages of dynamic pricing to the companies that use it? To the customers of the companies that use it? (LO 2) (AACSB: Ethical understanding and reasoning) Companies:
Advantages to companies that offer dynamic pricing include higher profit margins, shifting sales to off-peak times, rewarding frequent customers, enticing new customers. Disadvantages to companies that offer dynamic pricing include administrating a more complex pricing structure, greater uncertainty in margins, potential customer confusion and customer irritation for those who feel it is discriminatory.
Customers:
Advantages to customers may include lower prices with greater opportunities to take advantage of pricing promotions. Disadvantages to customers include uncertainty in pricing based on time and place.
3. According to an old proverb, “The value of a thing is what it will bring.” Do you agree? Explain. Should companies be allowed to engage in dynamic pricing? (LO 2) (AACSB: Ethical understanding and reasoning) Expect students to respond to the proverb and support their position. A discussion should follow that states their position regarding dynamic pricing and defend that position. 4. If you owned your own business and had the information required to engage in dynamic pricing, would you do so? Explain. (LO 2) (AACSB: Ethical understanding and reasoning) A discussion should follow that states their position regarding dynamic pricing and defend that position for using dynamic pricing in their own business.
Part 4: Chapter Discussion Questions 11-1. What competitive factors must the small firm consider when establishing prices? (LO 1) (AACSB: Reflective thinking) When all is taken into consideration, the factors that small business owners must consider when determining price for goods and services includes:
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Product/service costs
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Market factors - supply and demand
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Sales volume
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Competitors' prices
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Economic conditions
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Business location
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Seasonal fluctuations
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Psychological factors
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Credit terms and purchase discounts
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Customers' price sensitivity
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Desired image
11-2. Describe effective pricing strategies for introducing new products or services. (AACSB: Reflective thinking) 1. Penetration: Set prices below competitors to gain market entry. This pricing strategy increases market share and makes it less attractive for new competitors to enter the market. 2. Skimming: Set higher prices for new products and for markets that have little or no competition. This pricing strategy offers the optimal margin with higher price points. 3. Life Cycle Pricing: Set higher prices initially and, as technological advances or additional experience enables the firm to lower costs, it can reduce the product’s price one step ahead of competitors 11-3. Identify the strategies a business may adopt when facing rising costs in their businesses. (AACSB: Reflective thinking) •
Communicate with customers.
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Rather than raise the price of the good or service, include a surcharge.
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Eliminate customer discounts, coupons, and promotions.
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Offer products in smaller sizes or quantities.
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Focus on improving efficiency everywhere in the company.
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Emphasize the value your company provides to customers.
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Raise prices incrementally and consistently rather than relying on large periodic increases.
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Shift to less expensive raw materials if possible.
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Anticipate rising materials costs and try to lock in prices early.
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Consider absorbing cost increases.
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Modify the product or service to lower its cost.
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Differentiate your company and its products and services from the competition.
11-4. Define the following pricing techniques: (LO 2) (AACSB: Reflective thinking)
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Odd pricing – a pricing technique to set prices that in odd numbers to create the psychological impression of lower prices. Price lining – a technique that greatly simplifies the pricing function by pricing different products in a product line at different price points depending on their quality, features, and cost. Leader pricing – a technique that involves marking down the normal price of a popular item in an attempt to attract more customers who make incidental purchases of their items at regular prices. Geographical pricing – prices vary according to the costs of shipping merchandise to customers across a wide range of geographic regions. One type of geographic pricing is zone pricing, which is a technique that involves setting different prices for customers located in different territories because of different transportation costs. Another option is delivered pricing, a technique in which a company charges all customers the same price regardless of their locations and different transportation costs. The final option is F.O.B. factory, in which a small company sells merchandise to customers on the condition that they (the customers) pay all shipping costs. Discounts – There are five variations of discounts: o Discount markdowns are reductions from normal list prices. o Earned discounts which customers earn by making repeat purchases at a business. o Limited time offers provided by retailers for a limited amount of time with the goal of creating a sense of urgency and excitement among customers. o Steadily decreasing discount is a limited duration discount that declines over time. o Multiple unit pricing is a technique offering customers discounts if they purchase in quantity. 11-5. What are the pricing tactics entrepreneurs can use to set prices of established goods and services? (AACSB: Reflective thinking) Pricing techniques for existing products and services include odd pricing, price lining, dynamic pricing, leader pricing, geographic pricing, discounts, multiple unit pricing, bundling, optional-product pricing, captive product pricing, by-product pricing, suggested retail pricing, and follow-the-leader pricing. 11-6. What are the disadvantages of using the manufacturer’s suggested retail price? (LO 3) (AACSB: Reflective thinking) It can create problems such as prices being inconsistent with the company’s image, cost structure, or competitive situation. 11-7. What is a markup? (LO 3) (AACSB: Reflective thinking) Markup (or markon) pricing is the difference between the cost of a product or service and its selling price. 11-8. How is the markup for a product calculated? (LO 3) (AACSB: Reflective thinking)
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It is a calculation of the addition amount charged in addition to the cost to procure. It must be large enough to produce a profit. 11-9. Define cost-plus pricing. Why do manufacturers use this pricing strategy? (AACSB: Reflective thinking) Cost-plus pricing is a pricing technique in which a manufacturer establishes a price that covers the cost of direct materials, direct labor, factory overhead, selling and administrative costs, and a desired profit margin. The main advantage of the cost-plus pricing method is its simplicity. In addition, because it adds a profit on top of the company’s costs, manufacturers are likely to achieve their desired profit margins. 11-10. Why do so many manufacturers using cost-plus pricing? (LO 3) (AACSB: Reflective thinking) It is a simple way to determine prices. 11-11.What are the disadvantages of using cost-plus pricing? (LO 3) (AACSB: Reflective thinking) It does not encourage the manufacturer to use resources efficiently. In addition, it fails to consider the competition and market forces. 11-12. Describe the impact of credit on pricing. (AACSB: Reflective thinking) Offering consumer credit enhances a small company’s reputation and increases the probability, speed, and magnitude of customers’ purchases. Small firms offer three types of consumer credit: credit cards, installment credit, and trade credit (charge accounts). 11-13. Identify the steps to help online merchants reduce the likelihood of becoming victims of credit card fraud. (AACSB: Reflective thinking)
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Use an address verification system to compare every customer’s billing information on the order form with the billing information in the bank or credit card company’s records.
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Require customers to provide the CVV2 number from the back of the credit card. Although crooks can get access to this number, it can help screen out some fraudulent orders.
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Check customers’ Internet protocol (IP) addresses. If an order contains a billing address in California but the IP address from which the order is placed is in China, chances are that the order is fraudulent.
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Monitor activity on the Web site with the help of a Web analytics software package. There are many packages available, and analyzing log files can help online entrepreneurs pinpoint the sources of fraud.
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Verify large orders. Large orders are a cause for celebration but only if they are legitimate. Check the authenticity of large orders, especially if the order is from a first-time customer.
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Post notices on the Web site that your company uses antifraud technology to screen orders. These notices make legitimate customers feel more confident about placing their orders and crooks trying to commit fraud tentative about running their scams. Chapter 11, Page 180
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If you suspect that an order may be fraudulent, contact the credit card company or the bank that issued the card before processing it. Taking this step could save a company thousands of dollars in losses.
11-14. What benefits does a small business get by offering customers credit? (LO 4) (AACSB: Reflective thinking) When small businesses offer customers credit, they receive several benefits such as: increased probability, speed, and magnitude of customer spending; customers give higher service ratings; in some cases, the business retains the title of the merchandise until it is paid in full; the interest received on the loans is often greater than the original amount paid for the item. 11-15. What costs does a business incur by selling on credit? (LO 4) (AACSB: Reflective thinking) Businesses must pay to use the system, typically 1 percent to 6 percent of the total credit card charge, which they must factor into the prices of their products or services. They also pay a transaction fee of 5 to 25 cents per charge. Refer to Figure 11.7, How a Typical Credit Transaction Works. An interchange fee is the fee banks collect from retailers whenever customers use a credit or debit card to pay for a purchase. Some entrepreneurs offer customers incentives to pay with cash in order to avoid the fees.
Part 5: Case Studies •
There are no case studies associated with this chapter.
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics. •
Developing a Pricing Strategy http://www.youtube.com/watch?v=9tk820A0GF4
7:09 minutes
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Pricing Strategies: One Dumb Mistake http://www.youtube.com/watch?v=yiYvUqCpu-k
5:10 minutes
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Is Your Product Too Expensive? http://www.youtube.com/watch?v=isZZ8NZ7vuk
10:00 minutes
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Here’s What I Learned About Selling High Priced Products http://www.youtube.com/watch?v=cjCdf8n7hzo
7:03 minutes
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Marketing & Advertising: How to Price Your Product http://www.youtube.com/watch?v=4phxRH6vk-I
3:08 minutes
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Discounting Is for Dummies http://www.youtube.com/watch?v=CxD4w9eHgdk
5:22 minutes
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Pricing Your Product http://www.youtube.com/watch?v=9_2Hu1jQA_4
5:04 minutes
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Roundtable Discussion: Structuring Profitable Products – Pricing http://www.youtube.com/watch?v=RSAe_Fr9AJY
6:57 minutes
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Future of Payments (Mobile Wallets) http://www.youtube.com/watch?v=dAywQ6spop4
4:18 minutes
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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CHAPTER 12. CREATING A SUCCESSFUL FINANCIAL PLAN
Part 1: Learning Objectives 1. Describe how to prepare the basic financial statements and use them to manage a small business. 2. Create projected (pro forma) financial statements. 3. Understand the basic financial statements through ratio analysis. 4. Explain how to interpret financial ratios. 5. Conduct a break-even analysis for a small company.
Part 2: Class Instruction Introduction Entrepreneurs who fail to develop workable strategies for earning a profit from the outset eventually suffer business failure. Potential lenders and investors demand a realistic financial plan. Financial management is a process that provides entrepreneurs with relevant financial information in an easy-to-read format on a timely basis; it allows entrepreneurs to know not only how their businesses are doing financially but also why they are performing that way. Failure to collect and analyze basic financial data is a common mistake among entrepreneurs. Most accounting experts advise entrepreneurs to use one of the popular computerized accounting programs such as Quickbooks, Xero, and others to manage routine bookkeeping, as studies show that business owners who use them are more likely to be financially literate.
Basic Financial Statements
LO 1
Three important financial statements assist entrepreneurs to assess the financial status of their business: the balance sheet, income statement, and statement of cash flows. The Balance Sheet. The balance sheet is a financial statement that provides a snapshot of a business’s financial position, estimating its worth on a given date; it is built on the fundamental accounting equation, Assets = Liabilities + Owner’s Equity. Refer to Figure 12.1, Sam’s Appliance Shop, Balance Sheet.
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The first section of the balance sheet lists the company’s assets (valued at cost, not actual market value) and shows the total value of everything the business owns. It includes the following: •
Current assets are assets such as cash and other items to be converted into cash within one year or within the company’s normal operating cycle.
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Fixed assets are assets acquired for long-term use in a business.
The second section shows the business’s liabilities, which are creditors’ claims against a company’s assets. This section includes the following: •
Current liabilities are those debts that must be paid within one year or within the normal operating cycle of a company.
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Long-term liabilities are liabilities that come due after one year.
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Owner’s equity is the value of the owner’s investment in the business.
The Income Statement. The income statement (also called the profit-and-loss statement) is a financial statement that represents a moving picture of a business, comparing its expenses against its revenue over a period of time to show its net income (or loss). Refer to Figure 12-2, Sam’s Appliance Shop, Income Statement. Income includes all income from sales of goods and services revenue, as well as income from rent, investments, and interest. Other terms to understand include: •
Cost of goods sold is the total cost, including shipping, of the merchandise sold during the accounting period.
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Gross profit margin is the gross profit divided by net sales revenue. Some businesses incur losses as the result of an inadequate gross profit margin; to repair this problem, firms must raise prices, cut costs, refuse orders with low profit margins, “fire” unprofitable customers, or add new products with more attractive profit margins. Refer to Figure 12.3, Customer Profitability Map.
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Operating expenses are those costs that contribute directly to the manufacture and distribution of goods.
Comparing a company’s current income statement to those of prior accounting periods often reveals valuation information about trends and progress toward its financial goals. The Statement of Cash Flows. The statement of cash flows is a financial statement showing the changes in a company’s working capital from the beginning of the year by listing both the sources and the uses of those funds. Owners must first assemble the balance sheet and the income statement summarizing the present year’s operations in order to have the information required to assemble this financial statement.
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Creating Projected Financial Statements
LO 2
Entrepreneurs must determine the funds needed for starting and sustaining a business for the initial growth period. Typically, the entrepreneur relies on data collection through extensive market and field research and on published statistics summarizing the performance of similar companies. By developing pro forma statements, statements projecting future financial activity, the owner transforms goals into reality by estimating the profitability and overall financial condition of the business for the initial one- to three-year period. To be useful these forecasts must be realistic and well researched. Entrepreneurs typically rely on published statistics that summarize the operation of similar size companies in the same industry. Projected Financial Statements for a Small Business. The Projected Income Statement. A general guideline to assist with this process of developing pro forma statements is to start with the sales forecast and work down. To develop a realistic sales forecast creativity and research are critical. There are two methods to develop a sales forecast, develop a sales forecast and work down, or set a profit target and work up. To develop a sales forecast and work down the entrepreneur should do as many of the following as possible: •
Talk with owners of existing businesses in the industry (outside of the local trading area).
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Contact industry trade associations to collect sales data.
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Use Risk Management Association and Dun & Bradstreet published useful financial information.
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Do Internet searches and the resources of local libraries.
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Conduct interviews with potential customers and test-marketing and actual product.
To set a profit target and work up, the first step determines a realistic profit target and then the entrepreneur must estimate the expenses the business will incur to generate that profit. The net income a company generates should be at least as much as an entrepreneur could earn by working for someone else. An adequate profit must also include a reasonable return on the owner’s total investment in the business. Calculations are demonstrated in the chapter. The Projected Balance Sheet. This statement is valuable because many small companies begin without determining their firms’ total asset requirements. Entrepreneurs should prepare a projected balance sheet listing every asset their businesses will need and all the claims against those assets. Assets. A rule of thumb is that a company’s cash balance should cover its operating expenses (less depreciation) for at least one inventory turnover period. Calculations are demonstrated in the chapter.
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Liabilities. To complete the projected balance sheet the owner must record all of the small firm’s liabilities, the claims against its assets. The final step is to compile all of these items into a projected balance sheet as shown in Figure 12.4.
Ratio Analysis
LO 3
Ratio analysis is a method of expressing the relationship between any two accounting elements that allows business owners to analyze their companies’ financial performances. Refer again to Figures 12.1 and 12.2 for Sam’s Appliance Shop. Twelve Key Ratios. Liquidity ratios indicate whether the business will be able to meet its short-term financial obligations as they come due. The primary measures include: 1. Current ratio – Measures a small firm’s solvency by indicating its ability to pay current liabilities out of current assets. 2. Quick ratio – a conservative measure of a firm’s liquidity, measuring the extent to which its most liquid assets cover its current liabilities. Leverage ratios measure the financing supplied by a firm’s owners against that supplied by its creditors; they are a gauge of the depth of a company’s debt. 3. Debt ratio – Measures the percentage of total assets financed by a company’s creditors compared to its owners. 4. Debt-to-net-worth ratio – Expresses the relationship between the capital contributions from creditors and those from owners and measures how highly leveraged a company is. 5. Times interest earned ratio – Measures a small firm’s ability to make the interest payments on its debt. Operating Ratios help an entrepreneur evaluate a small company’s overall performance and indicate how effectively the business employs its resources. 6. Average inventory-turnover ratio – Measures the number of times its average inventory is sold out or turned over during an accounting period. 7. Average-collection-period ratio – Measures the average number of days it takes to collect accounts receivables. Refer to Table 12.1, How Lowering Your Average Collection Period Can Save You Money. 8. Average-payable-period ratio – Measures the number of days it takes a company to pay its accounts payable. Float refers to the net number of days of cash flowing into or out of a company; float = days payables outstanding (DPO) – days sales outstanding (DSO). 9. Net-sale- to-total-assets ratio (also called the total-asset-turnover ratio) – Measures a company’s ability to generate sales in relation to its asset base. Profitability Ratios indicate how efficiently a small company is being managed and
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provide information about a company’s ability to use its resources to improve its bottom line. 10. Net profit on sales ratio – Measures a firm’s profit per dollar of sales. 11. Net-Profit-to-Assets Ratio – Tells how much profit a company generates for each dollar of assets that it owns. 12. Net-profit-to-equity ratio – Measures the owner’s rate of return on investment. Consider using You Be the Consultant: “The Challenges of Debt” at this point.
Interpreting Business Ratios
LO 4
Ratios are useful yardsticks when measuring a small firm’s performance and can point out potential problems before they develop into a crisis. A performance dashboard is the use of key financial ratios to continuously assess trends in the financial strength of the business. When these numbers are moving in the right direction, it indicates a business is on track to reach its objectives. Not every business measures its success with the same ratios, as they vary dramatically across industries and even within different segments of the same industry. Sometimes business owners develop ratios and measures that are unique to their own operations: Critical numbers (or key performance indicators, KPIs), are indicators that measure key financial and operational aspects of a company’s performance. Financial benchmarking is used to compare your business to averages from many firms of similar size in your industry to identify problem areas which your own history will not show you. Comparison of a firm’s ratios to businesses within the same industry is a useful tool. A firm can also develop ratios unique to its operation. Several organizations compile and publish operating statistics including key ratios. This information may be found in the following sources: •
Risk Management Association
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Dun & Bradstreet, Inc.
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Bizminer
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Almanac of Business and Financial Ratios
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Standard & Poor’s Industry Surveys
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Industry Spotlight
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Online Resources, such as Bizstats, Reuters, and Lexis/Nexis.
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Industry Associations
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Government Agencies
What Do All of These Numbers Mean?
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Analyzing ratio trends can offer invaluable insight for managing the business. Table 12.2: Ratio Analysis: Sam’s Appliance Shop versus the Industry Median presents an example of applying the 12 key ratios. Applying these ratios to Sam’s Appliance Shop illustrates the insight ratios can offer. In addition to comparing ratios to industry averages, owners should analyze their firms’ financial ratios over time. Refer to Figure 12.5, Trend Analysis of Ratio. Consider using You Be the Consultant: All Is Not Paradise in Eden’s Garden, Parts 1 and 2” at this point.
Break-even Analysis
LO 5
The break-even point is the level of operation (sales dollars or production quantity) at which a company neither earns a profit nor incurs a loss. First, determine the fixed expenses and variable expenses. Fixed expenses are those that do not vary with changes in the volume of sales or production. Variable expenses are those that vary directly with changes in the volume of sales or production. Next, follow these steps to calculate the break-even point: Step 1: Determine the expenses a business can expect to incur. Step 2: Categorize those expenses as fixed or variable. Step 3: Calculate the ratio of variable expenses to net sales. Step 4: Compute the break-even point. Refer to Figure 12.6, Break-Even Chart for the Magic Shop Step 5: Beginning at the graph’s origin, draw a 45-degree revenue line showing where total sales volume equals total income. Step 6: Locate the break-even point by finding the intersection of the total expense line and the revenue line. Using Break-Even Analysis. Entrepreneurs, lenders, and investors will use break-even analysis as a simple, preliminary screening device. However, there are limitations, such as the fact that it is too simple to use as a final screening device because it ignores the importance of the cash flows, the accuracy depends on the accuracy of the revenue and expense estimates, and the assumptions pertaining to break-even analysis may not be realistic. Consider using You Be the Consultant: “Where Do We Break- Even?” at this point.
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Preparing a financial plan is a critical step for the entrepreneur. It can provide insight to important financial aspects of the venture through proforma statements, ratio analysis, and breakeven analysis. This information can be invaluable to have before the entrepreneur begins to make commitments and incur expenses.
Part 3: Chapter Exercises You Be the Consultant: “The Challenges of Debt” 1. What are the benefits to entrepreneurs who use debt capital (leverage) to finance their companies’ growth? (LO 3) (AACSB: Reflective thinking) Debt capital enables entrepreneurs to extend the business beyond the resources of the business and the owners. These additional resources fund growth and expansion to new customers and new markets. This can allow the business to gain a competitive advantage. 2. What are the risks associated with debt financing? (LO 3) (AACSB: Reflective thinking) Risks associated with debt financing often relate to cash flow. As the additional resources expand the business, the cash demands increase proportionately. Entrepreneurs may find that that interest payments in addition to the business’s other cash demand are overwhelming for the business. 3. Why is using ratio analysis to keep track of their companies’ financial performance over time so important for entrepreneurs? (LO 3) (AACSB: Reflective thinking) Entrepreneurs will benefit from tracking financial performance over time to determine the trend and direction of the organization to better plan for the future. Ratios, specifically key performance indicators, can offer objective insight that will be beneficial to guide the organization. When these numbers are moving in the right direction, it indicates a business is on track to reach its objectives. As ratios measure a firm’s performance, they can point out potential problems before they become more serious. Entrepreneurs can use ratios to compare a business to others in the same industry as well as analyze the firm’s financial ratios and trends over time. Liquidity ratios indicate whether the business will be able to meet its short-term financial obligations as they come due. Leverage ratios measure the relationships between financing supplied by a firm’s owners and by its creditors. Operating Ratios help an entrepreneur evaluate a company’s overall performance and indicate how effectively the business employs its resources. Profitability Ratios indicate how efficiently a small company is being managed and provide information about a company’s ability to use its resources to improve its bottom line.
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4. What lessons concerning the use of debt financing can entrepreneurs learn from Charles Kuhn’s experience? (LO 3) (AACSB: Reflective thinking) The debt financing lessons from the Kopp’s Cycle case may include: •
Additional paperwork requirements for a Small Business Administration loan.
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The potential risks associated with debt financing due to economic downturn.
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The threat of online competition selling at lower prices.
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The importance of analyzing the firm’s financial ratios.
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The potential benefits of equity financing in addition to debt.
5. Assume the role of a small business banker. Suppose that Kuhn were to approach you for a bank loan to refinance his debt. Which financial ratios would you be most interested in? Why? What advice would you offer him? (LO 3) (AACSB: Application of knowledge) Lenders will be most interested in the liquidity ratios, as they are indicators of the business’s ability to generate enough income to be able to repay debt financing. However, the lender will also be interested in all of the ratios to determine what trends the business is experiencing. Liquidity ratios indicate whether the business will be able to meet its short-term financial obligations as they come due. Leverage ratios measure the financing supplied by a firm’s owners against that supplied by its creditors; they are a gauge of the depth of a company’s debt. Operating Ratios help an entrepreneur evaluate a small company’s overall performance and indicate how effectively the business employs its resources. Profitability Ratios indicate how efficiently a small company is being managed and provide information about a company’s ability to use its resources to improve its bottom line. Considering the state of the economy and increased competition from Internet competitors, the advice a lender might give to Charles Kuhn would be to work with a financial advisor to develop a financial management plan, a business consultant to develop a marketing plan, and to consider other forms of non-debt financing until the business is in a better financial position. 6. Assume the role of a small business counselor. What advice would you offer him to insure the long-term survival of Kopp’s Cycle? (LO 3) (AACSB: Application of knowledge) Expect students to identify how the firm could have benefitted from using ratio analysis prior to seeking debt financing.
You Be the Consultant: “All Is Not Paradise in Eden’s Garden: Part 1”
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1. Assume the role of Shelly Edison. Using the financial statements for Eden’s Garden, calculate the 12 ratios covered in this chapter. (LO 4) (AACSB: Application of knowledge) RATIO
FORMULA
RATIO
Current Ratio
129,936 / 87,622
1.48 : 1
Quick Ratio
(129,936 – 88157) / 87,622
0.48 : 1
Debt Ratio
(87,622 +119,846) / 280,843
74 : 1
Debt to Net Ratio
(30,189 + 21,978) / 21,978
2.83 : 1
Times Interest Turnover Ratio
(30,189 + 21,978) / 21,978
2.37 : 1
Average Inventory Turnover
395,683 / ((78,271 + 86,157) / 2)
4.8 times/yr.
289,484 / 25,952
11.15 times/yr.
365 / 11.15
32.7 days
403,569 / 54,258
7.44 times/yr.
365 / 7.44
49 days
689,247 / 280,843
2.45 : 1
689,247 / (129,936 – 87,622)
16.29%
30,189 / 689,247
4.38%
Average Collection Period Average Collection Period in Days Average Payable Period Payable Period in Days Net Sales to Net Assets Net Sales to Working Capital Net Profit on Sales Net Profit on Equity
30,189 / 73,357
41.15%
2. Do you see any ratios that, on the surface, look suspicious? Explain. (LO 4) (AACSB: Analytical thinking) It is difficult to assess this without knowing information about the industry itself. Initially, it may appear that the average collection period and average payable period numbers are beyond the industry norms. Profitability on sales may also appear lower than normal. The quick ratio may raise some questions, but may be within a reasonable range for this industry that has a high investment in their inventory. Again, industry ratio information will help to make a more accurate determination.
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You Be the Consultant: “All Is Not Paradise in Eden’s Garden: Part 2” 1. Analyze the comparisons you have made of Eden’s Garden’s ratios with those from Bizminer. What red flags do you see? (LO 4) (AACSB: Analytical thinking) Based on the comparisons to Bizminer, this red flag assessment can be made: •
The average collection period numbers are longer than industry norms.
•
The average payable period numbers are beyond the industry norms.
•
Profitability on sales may also appear lower than normal.
This suggests collection problems that need to be corrected through a more effective and aggressive collection system. 2. What might be causing the deviations you have observed? (LO 4) (AACSB: Application of knowledge) Underpricing and sluggish collection of receivables will adversely affect cash flow, causing extended payable periods and other problems. 3. What recommendations can you make to the Edens to improve their company’s financial performance in the future? (LO 4) (AACSB: Application of knowledge) Student recommendation should focus upon these areas: •
Pricing
•
Cost control
•
Expedited collections
You Be the Consultant: “Where Do We Breakeven?” 1. Calculate Anita’s break-even point without the expansion plans. Draw a breakeven chart. (LO 5) (AACSB: Application of knowledge) First, calculate the contribution margin: Variable costs:
$337,000 + $42,750 = $379,750
Sales:
$495,000
Variable costs as a percentage of sales:
379,750/495,000 = .77
Contribution margin:
1.0 .77 = .23
Then, calculate break-even sales dollar amount:
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Total Fixed Cost / Contribution Margin
$78,100 / .23 = 339,565
Anita’s break-even point is 339,565 units without expansion. 2. Compute the break-even point, assuming that Anita decides to expand her business. (LO 5) (AACSB: Application of knowledge) Calculate the contribution margin: Given New Sales:
$495,000 + $102,000 = $597,000
Cost of Goods Sold as a percentage of original sales:
($337,000/$495,000) = .68
Variable costs:
(.68) * ($597,000) + 42,750 + $22,400 = $471,110
Variable costs as a percentage of sales:
$471,110/597,000 = .79
Contribution margin:
1.0 - .79 = .21
Then calculate breakeven sales dollar amount Total Fixed Cost / Contribution Margin:
($78,100 + 66,000) / .21 = 686,190
Anita’s break-even point with the expansion is 686,190 units, requiring an additional 346,625 units to break-even. 3. Do you recommend that Anita expand her business? Explain. (LO 5) (AACSB: Application of knowledge) At first glance, Anita should be discouraged from expanding. Students may note however that the contribution margin percent is very low, indicating low pricing, high cost of goods or both. An improvement in either area would lower the breakeven point significantly. One possible response is: No, I would not recommend that Anita expand her business. Assuming that her cost of goods remained constant at 68% of sales, the additional $22,400 in variable cost would reduce the contribution margin to 21%. With the additional $66,000 to fixed costs, breakeven rises from $339,565 to $686,190. The break-even after expansion is $597,000 greater. ($495,000 + $102.000 = $597,000).
Part 4: Chapter Discussion Questions 12-1. What is the difference between an income statement and a statement of cash flow? (AACSB: Reflective thinking) An income statement is a financial statement that represents a moving picture of a business, comparing its expenses against its revenue over a period of time to show its net income (or loss). The statement of cash flows is a financial statement showing the changes in a company’s working capital from the beginning of the year by listing both the sources and the uses of those funds.
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12-2. Outline the key points of the 12 ratios discussed in this chapter. (LO 4) (AACSB: Reflective thinking) 1. Current ratio – Measures a small firm’s solvency by indicating its ability to pay current liabilities out of current assets. 2. Quick ratio – a conservative measure of a firm’s liquidity, measuring the extent to which its most liquid assets cover its current liabilities. 3. Debt ratio – Measures the percentage of total assets financed by a company’s creditors compared to its owners. 4. Debt-to-net-worth ratio – Expresses the relationship between the capital contributions from creditors and those from owners and measures how highly leveraged a company is. 5. Times interest earned ratio – Measures a small firm’s ability to make the interest payments on its debt. 6. Average inventory-turnover ratio – Measures the number of times its average inventory is sold out or turned over during an accounting period. 7. Average-collection-period ratio – Measures the average number of days it takes to collect accounts receivables. Refer to Table 12.1, How Lowering Your Average Collection Period Can Save You Money. 8. Average-payable-period ratio – Measures the number of days it takes a company to pay its accounts payable. Float refers to the net number of days of cash flowing into or out of a company; float = days payables outstanding (DPO) – days sales outstanding (DSO). 9. Net-sales-to-total-assets ratio (also called the total-asset-turnover ratio) – Measures a company’s ability to generate sales in relation to its asset base. 10. Net profit on Sales ratio – Measures a firm’s profit per dollar of sales. 11. Net-Profit-to-Assets Ratio – Tells how much profit a company generates for each dollar of assets that it owns. 12. Net-profit-to-equity ratio – Measures the owner’s rate of return on investment. 12-3. What signals does each of the 12 ratios give a business owner? (LO 4) (AACSB: Reflective thinking) By themselves, these ratios are snapshots of a company’s financial position at a single instant; however, by examining these trends over time, an entrepreneur can detect gradual shifts that otherwise might go unnoticed until a financial crisis occurs. Using a performance dashboard and critical numbers (or key performance indicators, KPIs) can quickly signal to an entrepreneur that they are either achieving their financial management goals or are experiencing problems that need immediate attention. Liquidity ratios indicate whether the business will be able to meet its short-term financial obligations as they come due. Leverage ratios measure the financing supplied by a firm’s owners against that supplied by its creditors; they are a gauge of the depth of a company’s debt. .
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Operating Ratios help an entrepreneur evaluate a small company’s overall performance and indicate how effectively the business employs its resources. Profitability Ratios indicate how efficiently a small company is being managed and provide information about a company’s ability to use its resources to improve its bottom line. 12-4. Describe the method for building a projected income statement and a projected balance sheet for a beginning business. (LO 2) (AACSB: Reflective thinking) A projected income statement starts with a sales forecast that should be based primarily on market research about the firm’s competition and customer base. The sales forecast allows the income statement and balance sheet to be completed. 12-5. What is a break-even point? (AACSB: Reflective thinking) A break-even point is the level of operation (typically expressed as sales dollars or production quantity) at which a company neither earns a profit nor incurs a loss. At this level of activity, sales revenue equals expenses; that is, the firm “breaks even.”
Part 5: Case Studies The following cases complement lecture and assignments for the topics presented in this chapter. •
Case 5: Intertech Construction Corporation
•
Case 6: Bluffton Pharmacy – Part 1
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics.
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•
How the Three Financial Statements Fit Together http://www.youtube.com/watch?v=Mcj5ES2HDqY
•
Top Mistakes Newbie Entrepreneurs Make on Financial Projections 4:34 minutes http://www.youtube.com/watch?v=ZZPMRAeRwf8
•
Desperately Seeking Finance I http://www.youtube.com/watch?v=3uuzC5MEAHY
9:40 minutes
•
Desperately Seeking Finance II http://www.youtube.com/watch?v=Z71dl3lZdvU
6:57 minutes
6:29 minutes
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•
Financial Ratio Analysis http://www.youtube.com/watch?v=0kcdFHWcXjw
12:17 minutes
•
Break Even Analysis http://www.youtube.com/watch?v=Du07z79T-Js
6:10 minutes
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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CHAPTER 13. MANAGING CASH FLOW Part 1: Learning Objectives 1. Explain the importance of cash management to a small company’s success. 2. Differentiate between cash and profits. 3. Describe the five steps in creating a cash budget. 4. Describe the fundamental principles involved in managing the “big three” of cash management: accounts receivable, accounts payable, and inventory. 5. Explain the techniques for avoiding a cash crunch in a small company.
Part 2: Class Instruction Introduction Running out of cash has driven countless small companies into bankruptcy. A cash forecast is essential for new businesses because they usually do not generate positive cash flow right away. It is essential to collect accounts receivable. New businesses must forecast how much cash the company will need to get through the valley of death, which is the time period during which start-up companies experience negative cash flow as they ramp up operations, build their customer bases, and become self-supporting. Refer to Figure 13.1, The Valley of Death.
Cash Management
LO 1
Cash is the most important, yet least productive, asset that a small business owns. Businesses must have enough cash to meet their obligations or run the risk of declaring bankruptcy. It is entirely possible for a business to earn a profit and still go out of business by running out of cash. Disruption to cash flow is most often caused by customers paying their bills late or not at all. The Great Recession has intensified this problem, as demonstrated in Figure 13.2, Small Business Owners’ Ratings of Their Companies’ Cash Flow. Cash management is the process of forecasting, collecting, disbursing, investing, and planning for the cash a company needs to operate smoothly. Any excess cash should be invested, even if for a short time. Managing cash flow is also an acute problem for rapidly
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growing businesses, which are also likely to run out of cash to meet the needs of a growing business with a booming sales volume because of the requirement to hire more employees, expand plant capacity, etc. Refer to Table 13.1, Signs of an Impending Cash Flow Crisis, and Table 13.2, How Much Cash Is Required to Support an Increase in Sales? The first step in managing cash more effectively is to understand the company’s cash flow cycle which is the time lag between paying suppliers for merchandise or materials and receiving payment from customers. The longer this cycle, the more likely the business will encounter a cash crisis. Refer to Figure 13.3, the Cash Flow Cycle. The next step is to analyze their cash flow cycle, looking for ways to reduce its length. Business owners should calculate their cash conversion cycle whenever they prepare their financial statements, at least quarterly. On a daily basis, business owners should generate reports showing the following: total cash on hand, bank balances, summary of day’s sales, summary of the day’s cash receipts, summary of the day’s cash disbursements, and a summary of accounts-receivable collections.
Cash and Profits Are Not the Same LO 2 As important as earning a profit is, a company’s survival depends on its ability to generate positive cash flow. Profitability is not necessarily highly correlated with cash flow. Cash and profits are not the same. Profit is the net increase over a period of time in capital cycled through the business, indicating how effectively the firm is being managed. Refer to Figure 13.4, Strategies Small Business Owners Use to Increase Sales. Cash is the money that flows through the business in a continuous cycle. In other words, the profit a business shows does not mean they have that same amount of money in their checking account! Profit (or net income) is the difference between a company’s total revenues and total expenses. It measures how efficiently the business is operating. Cash flow is a method of tracking a company’s liquidity and its ability to pay its bills and other financial obligations on time by tracking the flow of cash into and out of the business over a period of time. Cash flow is the volume of actual cash that comes into and goes out of the business during an accounting period. Consider using Hands On… How To: “Manage Cash Flow in a Highly Seasonal Business” at this point.
The Cash Budget
LO 3
The need for a cash budget arises because the uneven flow of cash in a business cycle creates surpluses and shortages throughout that period. This uneven flow of cash creates periodic cash surpluses and shortages. Refer to Figure 13.5, Cash Flow.
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A cash budget is a “cash map” showing the amount and the timing of cash receipts and cash disbursements on a daily, weekly, or monthly basis. It is used to predict the amount of cash needed to operate smoothly over a period of time. This provides the entrepreneur the opportunity to anticipate cash crunches and handle them, or to avoid them. A project monthly cash budget should be developed for at least one year into the future, and quarterly estimates for another. It must take into consideration seasonal fluctuations in sales; the more variable the sales pattern, the shorter should be its planning horizon. A cash budget is based on the cash method of accounting, meaning that cash receipts and cash disbursements are recorded in the forecast only when the cash transaction is expected to take place. Credit sales to customers are not recorded until the customer actually pays, and purchases made on credit are not recorded until the owner pays them. Depreciation, bad debt expense, and other noncash items that do not involve cash transfers are omitted entirely from the cash budget. Formats for preparing a cash budget vary depending on the pattern of a company’s cash flow. Refer to Table 13.3, Cash Budget for a Small Department Store. There are five basic steps to preparing a cash budget. Step 1: Determining an Adequate Minimum Cash Balance Some suggest that a firm’s cash balance should equal at least one-fourth of its current liabilities, while others recommend a cash reserve large enough to cover three to six months’ of operating expenses. Highly seasonal businesses often require an even larger reserve fund. The most reliable method is based on past experience. For example, past operating records may indicate that it is desirable to maintain a cash balance equal to five days’ sales. Determining a minimum cash balance is also important. A range of cash balances gives you an insight to know the amount of cash that is acceptable, enough to get you through time of need, but not too much to have cash that is not effectively working for your business. Step 2: Forecasting Sales Sales forecasts are the heart of the cash budget and are based partially on past patterns of existing businesses. This is a much more difficult process for a startup business. The startup could do research on similar firms and their sales patterns in the first year of business. A local chamber of commerce, trade associations, publications such as the Annual Statement Studies published by the Risk Management Association and Bizminer are also potential sources of this information. Market research, census reports, newspapers, radio and television customer profiles, polls and survey, and local government statistics could possibly provide information. Talking with owners of similar businesses (outside the local trading area) can provide realistic estimates of sales. Refer to Table 13.4, Forecasting Sales for a Business Start-Up. Financial analysts suggest a business create three estimates-ptimistic, pessimistic, and most likely.
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Step 3: Forecasting Cash Receipts The budget must account for the delay between the sale and the actual collection of the proceeds. It is vital to act promptly once an account becomes past due. Collecting delinquent accounts is critical to keep cash flow moving in a positive direction and can be a challenging task for the entrepreneur. Refer to Figure 13.6, Probability of Collecting Accounts Receivable, and Table 13.5, The High Cost of Slow Payers. Many banks now offer cash management tools designed to speed up collection of invoices. Electronic (Automated Clearing House) collections, which is a bank service that allows businesses to deduct automatically invoice amounts from customers’ accounts and deposit them into the seller’s account within 24 hours. Remote deposit is a bank service that allows businesses to scan customers’ checks and deposit them from anywhere using a portable scanner, a computer, and an Internet connection. Entrepreneurs should compare the benefits and costs of these services at various banks. Step 4: Forecasting Cash Disbursements Every entrepreneur should know his or her company’s “burn rate,” the amount of cash it spends each month. Refer to Figure 12.6, Cash Flow Concerns among Small Business Owners. The key factor when forecasting disbursements for a cash budget is to record them in the month in which they will be paid, not when the obligation is incurred. Many cash payments are fixed amounts due on specified dates. Others are standard like the purchase of inventory, salary and wages, overhead, selling expenses, and so on. Financial analysts suggest that new owners add an additional 25 to 50 percent to estimate disbursement totals as a cushion. Forecasting cash disbursements can become more meaningful through recording disbursements, noting their due dates, reviewing the checkbook and expenses, adding a cushion to those estimates, and making a daily list of items that generate and consume cash. Step 5: Estimating the End-of-Month Cash Balance The cash balance at the end of the month becomes the beginning balance for the following month. Estimating the end-of-the-month balance will give you insight and may help to avoid a shortage or identify a cash surplus. Anticipating cash shortages and surpluses can reduce lending expenses and time. However, business owners should also look for trends that could indicate a pending cash crisis. Refer again to Table 13.3. By planning cash needs ahead of time, a small business can achieve the following benefits of effective cash management:
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•
Increase the amount of cash and the speed of cash flowing into the company
•
Reduce the amount of cash and speed of cash flowing out of the company
•
Make the most efficient use of available cash
•
Take advantage of money-saving opportunities such as quantity and cash discounts
•
Finance seasonal business needs
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•
Develop a sound borrowing program
•
Develop a workable program of debt repayment
•
Impress lenders and investors
•
Reducing borrowing costs by only doing when needed
•
Provide funds for expansion
•
Plan for investing surplus cash
The “Big Three” of Cash Management
LO 4
There are three essential factors for the effective management of cash flow: 1. Accounts receivable – Extending credit to customers. A firm should always try to accelerate the collection of its receivables. If possible, a firm should also work to reduce or even eliminate credit sales. 2. Accounts payable – Suppliers and others extend credit to you. Take advantage of extending accounts payable and never abuse those opportunities. 3. Inventory – The largest expense for retail and manufacturing businesses. Product-based businesses need to monitor, manage, and control their inventory on a continual basis. Cash conversion cycle is a measure of the length of time required to convert inventory and accounts payable into sales and accounts receivable and finally back into cash. This is reflected as: day’s inventory outstanding + day’s sales outstanding – days’ inventory outstanding. Ideally, a company cash conversion cycle is negative, meaning that it turns over its inventory quickly and collects payments from its customers before it pays its vendors and suppliers. Refer to Figure 13.7, Cash Conversion Cycle for the Typical Small Business. Accounts Receivable. Many customers expect to buy on credit, and business owners extend it to avoid losing customers even though it is expensive, requires more paperwork and staff, and more cash to service accounts receivable. Establishing a credit and collection policy and process is essential. This will provide clear and consistent direction for you, your employees, and your customers. Every business that sells on credit encounters customers who pay late or never pay at all. How to Establish a Credit and Collection Policy. Establishing a credit and collection policy begins by screening customers carefully by developing a detailed credit application and then checking the potential customer’s credit references by using a credit reporting service. Know when to walk away from an order-why make the sale if you won’t get paid?
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Next, a small business should establish a written credit policy and let every customer know the company’s credit terms in advance. Once the credit policy is firmly in place, the small business can send invoices promptly because customers rarely pay a bill before they have received it. Cycle billing is a method in which a company bills a portion of its credit customers each day of the month to smooth out the uneven cash receipts. The business must take immediate actions when an account becomes overdue. The longer an account is past due, the lower the probability of collecting it. Steps to accelerate the collection of accounts receivable through encouraging the prompt payment of invoices include: start with a friendly reminder to avoid damaging the relationship with a good customer. When contacting a delinquent customer get a commitment to pay the full amount of the bill by a specific date. Then follow up with an e-mail or letter that summarizes the verbal commitment. If the customer still refuses to pay, collection experts recommend the following: • Send a letter from the company’s attorney. • Turn the account over to a collection attorney. • As a last resort, hire a collection agency. Business owners must abide by the provisions of the federal Fair Debt Collection Practices Act, which prohibits any kind of harassment when collecting debts, and also prevents collectors from making false statements and from contacting debtors at inconvenient times. Refer to Table 13.6, Ten Collection Blunders and How to Avoid Them. Techniques for Accelerating Accounts Receivable. There are other techniques to speed cash inflow from accounts receivable, including:
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•
Speed up orders by having customers e-mail or fax them to you.
•
Send invoices when goods are shipped or when the job is completed.
•
Service firms may be able to offer retainer packages in which their clients pay in advance.
•
Insure all invoices are clear, accurate and timely.
•
Include a telephone number and contact person in case the customer has questions.
•
Call the customer a week after sending the invoice to make sure it arrived.
•
Highlight the balance due and terms of sale on all invoices.
•
Allow customers to use multiple payment methods such as checks, credit cards, etc.
•
Offer incentives to encourage customers to pay early and impose penalties for paying late.
•
Restrict a customer’s credit until past-due bills are paid.
•
Deposit cash, checks, and credit card receipts daily.
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•
Identify the top 20 percent of customers, create a separate file system for them, and monitor them closely.
•
Ask customers to pay at least a portion of the purchase price up front.
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Watch for signs the customer may be about to declare bankruptcy.
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Use technology to manage cash flow.
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Track the results of the company’s collection efforts.
Small companies that sell high-priced items can couple a security agreement with a financing statement. A security agreement is a contract in which a business selling an asset on credit gets a security interest in that asset (the collateral), protecting its legal rights in case the buyer fails to pay. Accounts Payable. The second element of the big three of cash management is accounts payable. Refer to Figure 13.8, Accounts Payable Pattern Among Businesses by Size of Company. Entrepreneurs should strive to stretch out payables as long as possible without damaging their companies’ credit rating. Tips to accomplish this include: •
Set up a payment calendar each month to pay bills on time and take advantage of cash discounts for early payment.
•
Verify all invoices before payment.
•
Negotiate the best possible terms with suppliers. Table 13.7 shows the same most likely cash budget from Table 13.2 with one exception; instead of purchasing on C.O.D. terms as shown in Table 13.2, the owner has negotiated “net 30” payment terms. Note the drastic improvement in the company’s cash flow that results from improved credit terms.
•
Communicate with creditors about your status if your payment will be delayed.
•
Schedule and stagger cash disbursements so they do not come due at the same time.
Inventory. Few small business owners use any formal method for managing inventory. Entrepreneurs may find that they have either too much inventory, or the wrong type of inventory that has become outdated or obsolete. This inventory ties up cash and is expensive to the firm. A typical manufacturing company pays 25-30 percent of the value of its inventory in handling and finance costs; however, retailers that carry too little inventory experience stockouts and lost sales. The goal is to minimize the company’s investment in inventory without sacrificing sales, selection, and customer satisfaction. Inventory should grow no faster than a company’s sales. Refer to Figure 13.9, Changes in Small Business Inventories. Inventory management also plays an important cash management role:
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•
Schedule inventory deliveries at the latest possible date to prevent premature payment of invoices.
•
Purchase goods of comparable quality and price from the fastest supplier to keep inventory levels as low as possible.
•
Treat suppliers as partners.
•
Take advantage of quantity discounts, which are discounts that give businesses a price break when they order large quantities of merchandise and supplies. They exist in two forms: cumulative and noncumulative.
•
Take advantage of cash discounts, which are discounts offered to customers as an incentive to pay for merchandise promptly. Refer to Figure 13.10, A Cash Discount.
Consider using You Be the Consultant: “In Search of a Cash Flow Forecast” at this point.
Avoiding the Cash Crunch
LO 5
Young firms cannot afford to waste resources, especially one as vital as cash. Tools that allow small business managers to get the maximum benefit from their companies’ pool of cash include: Barter. Bartering is the exchange of goods and services for other goods and services rather than for cash. Bartering became more common during the Great Recession. It is also a good way to transform slow-moving inventory into needed product and services. More than 500 bartering exchanges exist today, in which businesses accumulate trade credits (think barter dollars) when they offer goods or services through the exchange. Then they use their trade credits to purchase needed goods or services. The typical exchange charges membership and maintenance fees. Trim Overhead Costs. High overhead expenses can strain a small firm’s cash supply. Ways to trim overhead costs include:
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•
Ask for discounts and “freebees”
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Conduct periodic expense audits
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When practical, lease instead of buy. An operating lease is a lease at the end of which a company turns the equipment back to the leasing company and has no further obligation. A capital lease is a lease at the end of which a company may exercise an option to purchase the equipment, usually for a nominal sum.
•
Avoid nonessential cash outlays
•
Buy used or reconditioned equipment, especially if it is “behind-the-scenes” machinery
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•
Hire part-time employees and freelance specialists whenever possible
•
Outsource
•
Use e-mail rather than mail
•
Use credit cards to make small purchases
•
Negotiate fixed loan payments to coincide with your company’s cash flow cycle
•
Establish an internal security and control system
•
Develop a system to battle check fraud
•
Change your shipping terms
•
Start selling gift cards
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Switch to zero-based budgeting
•
Be on the lookout for shoplifting and employee theft
•
Build a cash cushion
•
Invest surplus cash. Entrepreneurs must put surplus cash to work immediately rather than allowing it to sit idle; the goal is to invest every dollar not being used to pay current bills. The primary concerns for investing surplus cash should be safety and liquidity. This will ensure the cash is not going to be put in a risk position and that it will be available if needed. Second, this cash should be “put to work” to generate revenue or build the business for future earning potential. A money market account is an interest-bearing account that allows depositors to write checks without tying up their money for a specific period of time. A zero-balance account (ZBA) is a checking account that never has any funds in it. A company keeps its money in an interest-bearing master account tied to the ZBA; when a check is drawn on the ZBA, the bank withdraws enough money from the master account to cover it. A sweep account is a checking account that automatically sweeps all funds in a company’s checking account above a predetermined minimum into an interest-bearing account.
•
Keep your business plan current in case an unexpected cash crisis forces an entrepreneur to seek emergency financing. Consider using You Be the Consultant: “Controlling Employee Theft” at this point.
Conclusion Successful owners run their businesses “lean and mean” by trimming wasteful expenditure, investing surplus funds, and careful planning and managing the company’s cash flow. Entrepreneurs must learn how to manage cash flow to insure long-term success for the venture.
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Part 3: Chapter Exercises Hands On… How To “Manage Cash Flow in a Highly Seasonal Business” 1. What impact do highly seasonal sales have on a small company’s cash flow? The impact is dramatic and can cause an unsuspecting entrepreneur to fail in the first year. 2. What other advice can you offer owners of seasonal businesses about coping with the effects of their companies’ highly irregular sales patterns? About managing cash flow in general? All of the advice provided in this feature is excellent. Students might suggest that working with a financial consultant who has experience in the pertinent industry may also be helpful. Another suggestion is to look for ways to bootstrap the business throughout the year, and to make it a habit to verify cash flow on a daily basis.
You Be the Consultant: “In Search of a Cash Flow Forecast” 1. Help Rowena put together a cash budget for the six months beginning in April. (LO 4) (AACSB: Application of knowledge) Students should prepare a cash budget, by month, for the period of October through March. Students may be directed to run the numbers on all three sales forecast scenarios and/or by some weighted average. The cash budget for is on the next page.
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Cash Budget Jan $ 24,780 $ 15,611
Sales Credit Sales
Feb $ 20,900 $ 13,167
Mar $ 21,630 $ 13,627
Apr $ 23,550 $ 14,837
May $ 24,900 $ 15,687
Jun $ 29,870 $ 18,818
Jul $ 27,500 $ 17,325
Aug $ 25,800 $ 16,254
Sep $ 21,500 $ 13,545
$ 9,050 $ 3,679 $ 1,053 $ 8,714
$ 9,569 $ 4,006 $ 1,090 $ 9,213
$ 11,479 $ 4,235 $ 1,187 $ 11,052
$ 10,568 $ 5,081 $ 1,255 $ 10,175
$ 9,915 $ 4,678 $ 1,505 $ 9,546
$ 8,262 $ 4,389 $ 1,386 $ 7,955
Cash Receipts Collections 1 - 30 days 31 - 60 days 61 - 90 days Cash Sales Other Receipts Total Cash Receipts
$ $ 22,496
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$ $ 23,878
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$ $ 27,953
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$ $ 27,079
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$ $ 25,644
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$ $ 21,992
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Cash Disbursements CGS Wages & Salaries Utilities Rent Truck Loan Office Supplies Maintenance Uniforms/cleaning Office cleaning service Internet/computer service Computer Supplies Insurance Payment Advertising Tax Payments Legal and Accounting fees Miscellaneous Expenses Other Expenses Total Cash Disbursements
Copyright © 2019 Pearson Education Ltd.
$ 14,276 $ 3,550 $ 950 $ 2,250 $ 427 $ 125 $ 75 $ 80 $ 85 $ 225 $ 75 $ 1,200 $ 450
$ 15,543 $ 4,125 $ 950 $ 2,250 $ 427 $ 125 $ 75 $ 80 $ 85 $ 225 $ 75
$ 16,434 $ 5,450 $ 950 $ 2,250 $ 427 $ 125 $ 75 $ 80 $ 85 $ 225 $ 75
$ $ 450
-
$ $ 250 $ 95
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$ $ 250 $ 95
-
$ $ 24,113
-
$ $ 24,755
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$ 19,714 $ 6,255 $ 950 $ 2,250 $ 427 $ 125 $ 75 $ 80 $ 85 $ 225 $ 75
$ $ 450 $ 3,140 $ 250 $ 95
-
$ $ 30,111
-
$ 18,150 $ 6,060 $ 950 $ 2,250 $ 427 $ 125 $ 75 $ 80 $ 85 $ 225 $ 75
$ 17,028 $ 3,525 $ 950 $ 2,250 $ 427 $ 125 $ 75 $ 80 $ 85 $ 225 $ 75 $ 1,200 $ 450
$ $ 450
-
$ $ 450
-
$ $ 250 $ 95
-
$ $ 250 $ 95
-
$ $ 250 $ 95
-
$ $ 31,056
-
$ $ 29,297
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$ $ 26,840
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End of Month Balance
EOM Cash Balance
$ 10,685 $ 22,496 $ (24,113) $ 9,069
Borrow
$
-
$
-
$
-
$
-
Repay
-
$ $ 8,192
-
$ $ 6,034
-
$ $ 2,057
-
Final EOM Cash Balance
$ $ 9,069
Monthly Surplus/(Deficit)
$ (1,616)
Beginning Cash Balance + Cash Receipts -Cash Disbursements
.
$ 9,069 $ 23,878 $ (24,755) $ 8,192
$ (877)
$ 8,192 $ 27,953 $ (30,111) $ 6,034
$ (2,158)
$ 6,034 $ 27,079 $ (31,056) $ 2,057
$ (3,977)
$ 2,057 $ 25,644 $ (29,297) $ (1,596) $ 3,096 $ $ 1,500 $ (3,653)
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-
$ 1,500 $ 21,992 $ (26,840) $ (3,348) $ 7,970 $ 3,122 $ 1,500 $ (4,848)
2. Does it appear that Rowena’s business will remain solvent, or could the company be heading for a cash crisis? (LO 4) (AACSB: Analytical thinking) The business has a negative cash balance at the end of each month. The cash outflows for each month is greater than the cash inflows. Rowena could be headed for trouble if this continues. 3. What suggestions can you make to help Rowena improve her company’s cash flow? (LO 4) (AACSB: Analytical thinking) After assessing the situation, expect students to make recommendations that may include shortening the receivables period, lengthening the payables period, buying more efficiently, and other cost cutting or revenue enhancing applications that would affect cash flow.
You Be the Consultant: “Controlling Employee Theft” 1. Identify the factors that led Holt of California to become a victim of employee theft and embezzlement. What impact does this crime have on a company’s cash flow? (LO 5) (AACSB: Application of knowledge) The company made the mistake of believing that employees would not steal from them. They allowed one employee, Stan, to work unsupervised in a critical area of the company. As the controller, Stan was responsible for maintaining all accounting records. The company should have installed a system of checks and balances to prevent Stan from stealing from the company. Any unscheduled or unknown drainage of funds due to employee theft or embezzlement will adversely affect a firm’s cash flow. If it continues, this may threaten the viability of the venture. 2. Are small businesses more likely than large ones to be victims of employee theft? Explain. (LO 5) (AACSB: Reflective thinking) Small businesses often lack the knowledge, and financial and control procedures that large companies impose. Therefore, small businesses are disproportionately more likely to be victims of employee theft. When the business lacks a system of checks and balances, opportunities for embezzlement increase. 3. List at least five steps, in addition to the ones described here, that entrepreneurs should take to prevent their businesses from becoming victims of employee theft and embezzlement. (LO 5) (AACSB: Reflective thinking) Students will discover a variety of resources that address employee theft. Responses may relate to the following:
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•
Screen potential employees thoroughly.
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Monitor inventory closely.
•
Use technology to discourage theft.
•
Set up a hotline. Chapter 13, Page 209
•
Embrace a zero-tolerance policy.
•
Be aware of frequently used theft schemes.
•
Watch for signs of internal theft, such as an unexplained rise in their living standards.
•
Pay close attention to management-level personnel who insist on handling routine clerical tasks themselves.
•
Be on guard for clients complaining about overcharging or inconsistencies in shipping and billing practices.
•
Make it difficult to steal through careful supervision that removes easy opportunities.
•
Keep inventory and accounting records current.
•
Periodically inspect bookkeeping activities.
•
If possible, install physical obstacles to theft, such as alarm systems, video cameras in secured and restricted areas.
•
Work with employees to create an environment in which they think there is a good chance of being caught.
•
Set up systems so employees know they can turn over incriminating information on anyone in the company without fearing job loss or other repercussions.
•
Stress that management and supervisors are not above suspicion and that employee complaints will be taken seriously.
•
Watch for substance abuse and have a procedure for screening workers for drugs or alcohol.
•
Determine clear policies by distributing clear, written policies on ethical behavior to be signed by each employee-including the owner.
•
Set an example-employees need to know that one uniform ethical standard applies to everyone and owners and managers should be positive role models for workers.
Part 4: Chapter Discussion Questions 13-1. Why must entrepreneurs concentrate on effective cash flow management? (LO 1) (AACSB: Reflective thinking) Cash is the most important, yet least productive, asset that a small business owns. Businesses must have enough cash to meet their obligations or run the risk of declaring bankruptcy. It is entirely possible for a business to earn a profit and still go out of business by running out of cash.
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13-2. Explain the difference between cash and profit. (LO 2) (AACSB: Reflective thinking) Cash and profits are not the same. Profit is the net increase over a period of time in capital cycled through the business, indicating how effectively the firm is being managed. Cash is the money that flows through the business in a continuous cycle. In other words, the profit a business shows does not mean they have that same amount of money in their checking account! 13-3. Outline the steps involved in developing a cash budget. (LO 3) (AACSB: Reflective thinking) There are five basic steps to preparing a cash budget: 1. Determining an adequate minimum cash balance 2. Forecasting sales 3. Forecasting cash receipts 4. Forecasting cash disbursements 5. Estimating end-of-month cash balances and needs 13-4. What is the “valley of death”? Explain briefly. (AACSB: Reflective thinking) The valley of death is the time period during which start-up companies experience negative cash flow as they ramp up operations, build their customer bases, and become selfsupporting. 13-5. What are the “big three” of cash management? (LO 4) (AACSB: Reflective thinking) The “big three” of cash management are: 1. Accounts Receivable 2. Accounts Payable 3. Inventory 13-6. What effect do the big three of cash management have on a company’s cash flow? (LO 4) (AACSB: Reflective thinking) Accounts Receivable: Extending credit to customers. Cash flow is greatly affected due to the time lag between the sale and the actual collection of cash. It affects cash flow through the speed in which invoices are paid and cash is received. Accounts Payable: Suppliers and others extend credit to you. This can have a very favorable effect on a firm’s cash flow as inventory may be purchased using the supplier and/or bank funds. The basic principles of management revolve around ordering merchandise that will turn over and be paid for in a timely fashion. Inventory: The number one expense for all retail and manufacturing businesses. Inventory affects cash flow because the cash is locked in place until sold. The major principle of management is maximizing inventory turnover.
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13-7. How can an entrepreneur hinder a cash crunch in a small company? (AACSB: Reflective thinking) Trimming overhead costs by bartering; leasing assets rather than buying them; avoiding nonessential outlays; buying used equipment; hiring part-time employees; negotiating fixed payments to coincide with a company’s cash flow cycle; implementing an internal control system to boost the firm’s cash flow position; developing a system to battle check-fraud; selling gift cards; using zero-based budgeting; being on the lookout for shoplifting and employee theft; building a cash cushion; and keeping the business plan current. 13-8. What is the difference between a “zero balance account” and a “sweep account”? (AACSB: Reflective thinking) A zero-balance account (ZBA) is a checking account that never has any funds in it. A company keeps its money in an interest-bearing master account tied to the ZBA; when a check is drawn on the ZBA, the bank withdraws enough money from the master account to cover it. A sweep account a checking account that automatically sweeps all funds in a company’s checking account above a predetermined minimum into an interest-bearing account.
Part 5: Case Studies The following text case may be used for lecture and assignments for topics presented in this chapter. •
Case 5: Intertech Construction Corporation
•
Case 7: Bluffton Pharmacy, Part 2
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics.
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Manage Your Cash Flow http://www.youtube.com/watch?v=tIWDpxK5cUI
5:53 minutes
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How to Manage Cash Flow http://www.youtube.com/watch?v=TdEMY5nxWCE
9:37 minutes
•
Prepare a Cash Budget Using Excel http://www.youtube.com/watch?v=uKZN5KxdgkU
11:33 minutes
•
Poor Management of Accounts Receivable http://www.youtube.com/watch?v=de8SiXOV6EA
1:42 minutes
•
Modernizing Inventory Management http://www.youtube.com/watch?v=1d0O8MAMyAM
5:03 minutes
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Small Business Bartering Tips http://www.youtube.com/watch?v=WdmfIq6NEEA
5:45 minutes
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How to Properly Manage Cash Flow to Stop Employee Theft http://www.youtube.com/watch?v=baL2rSQMe7k
2:49 minutes
•
How to Raise Capital: The #1 Skill of an Entrepreneur http://www.youtube.com/watch?v=yQLhWtgAT0A
10:50 minutes
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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CHAPTER 14. CHOOSING THE RIGHT LOCATION AND LAYOUT
Part 1: Learning Objectives 1. Explain the stages in the location decision: choosing the region, the state, the city, and the specific site. 2. Describe the location criteria for retail and service businesses. 3. Outline the location options for retail and service businesses: central business districts, neighborhoods, shopping centers and malls, near competitors, shared spaces, inside large retail stores, nontraditional locations, at home, and on the road. 4. Explain the site selection process for manufacturers. 5. Describe the criteria used to analyze the layout and design considerations of a building, including the Americans with Disabilities Act. 6. Explain the principles of effective layouts for retailers, service businesses, and manufacturers.
Part 2: Class Instruction Location: A Source of Competitive Advantage
LO 1
The location for a business has far-reaching and often long-lasting effects on a company’s future. Entrepreneurs who choose their locations wisely can establish an important competitive advantage over rivals who choose their locations haphazardly. Location should be based on the customers’ preferences and the small business’s needs. The location decision is important to entrepreneurs and considers a series of analyses of critical factors unique to each business. Tax rates, availability of qualified workers, the quality of the infrastructure, traffic patterns, and other factors vary from one site to another. Studies show that these factors can influence the growth rate and the ultimate success of a business. The first level decision requires an entrepreneur to select a particular region, then the right state, the right city, and finally the right site within the city. The characteristics that make for an ideal location vary dramatically from one company to another because of the nature of their business. Choosing the Region. What region of the country has the characteristics necessary for a new business to succeed? Above all, entrepreneurs must place their customers first when considering a location, and facts and statistics are most important in this step. The best regions are
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those experiencing substantial growth. A wealth of regional information is available online through the U.S. Census Bureau’s site, www.census.gov. There are a number of different reports available based on the 2010 census, which are extensive, though now somewhat out of date. A large number of other periodicals and software programs are listed in this chapter that offer additional insight into an analysis of a region. Examples include Zoom-Prospector, Zipskinny, Lifestyle Market Analysis, etc. The State. Each state has an economic development office to recruit new businesses. This information may be biased, but still is an excellent source to understand more about what the state has to offer a business. Key issues to explore include the laws, regulations, and taxes that govern businesses, costs of operation, workforce availability, and incentives or investment credits the state offers. This office may provide information including the state’s: •
Proximity to markets
•
Proximity to essential services and raw materials
•
Wage rates
•
Size and quality of labor force
•
Business climate. Refer to Table 14.1, Most and Least Small-BusinessFriendly States.
•
Tax rates. Refer to Figure 14.1, State Business Tax Climate Index.
•
High speed Internet access. Refer to Figure 14.2 Internet Download Speeds Across the United States.
•
Total operating costs.
Refer to Table 14.2, State Evaluation Matrix. This is a handy tool designed to determine which states best suit the most important location criteria. It can be adapted to analyze individual cities as well. Refer to Table 14.3, Best and Worst States for Doing Business. Choosing the City. Successful small businesses within a city tend to track with population growth. The full range of considerations for city selection include:
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•
Population trends. Refer to Table 14.4, States with the Most Top Micropolitan Areas.
•
Competition
•
Clusters are geographic concentrations of interconnected companies, specialized suppliers, and service providers that are present in a region.
•
Compatibility with the community
•
Local laws and regulations. Zoning laws are laws that divide a city or
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county into small cells or districts to control the use of land, buildings, and sites. Variance is a special exemption to a zoning ordinance. •
Appropriate infrastructure and utilities
•
Incentives
•
Quality of life
Choosing the Site. Few decisions are as important for retailer and service firms as the choice of a location. Because their success depends on a steady flow of customers, these businesses must locate with their target customers’ convenience and preferences in mind. See Table 14.5, Top 20 Metropolitan Hot Spots for Start-Up Companies. Consider using You Be the Consultant “Temporary Locations Can Be Just Great for Business” at this point.
Location Criteria for Retailers and Service Businesses: LO 2 The following are important considerations for retail and service locations: Trade Area Size. A trading area is the region from which a business can expect to draw customers over a reasonable time span. Retail stores choose locations based on whether customers will seek them out as a destination, or if convenience is most important to customers. Retail Compatibility. Retail Compatibility refers to the benefits a company receives by locating near other businesses that sell complementary products and services or that generate high volumes of traffic. Degree of Competition. The size, location, and activity of competing businesses also include the size of a company’s trading area. Market saturation is a problem for businesses in many industries, such as fast food restaurants and convenience stores. Index of Retail Saturation. Index of Retail Saturation is a measure of the potential sales per square foot of store space for a given product within a specific trading area; it is the ratio of a trading area’s sales potential for a product or service to its sales capacity. The formula and calculation are in this chapter. Reilly’s Law of Retail Gravitation. This classic work in market analysis uses an analogy of gravity to estimate the attractiveness of a particular business to potential customers. The formula and calculation are shown in this chapter, and provides insight into customers’ perception of the location as a “destination” and estimates the trade boundary between two market areas.
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Transportation Network. Retail and service businesses need easy customer access from a smoothly flowing network of highways and roads. E-commerce businesses must consider accessibility to trucking routes such as interstate highways and airports. Physical and Psychological Barriers. Physical barriers may be parks, rivers, lakes, bridges, or other natural or man-made obstruction. Psychological barriers include areas that have a reputation for crime and illegal activities. Customer Traffic. Perhaps the most important screening criteria is the number of potential customers passing the site. The key success factor for many retail stores is a high-volume location with easy accessibility. Adequate Parking. The number parking spaces available to customers, whether they have to pay for parking, and feelings of safety are considerations. Reputation. Like people, a site can have a bad reputation, such as a site that has had multiple business failures. Visibility. Highly visible locations simply make it easy for customers to find the business. Consider using You Be the Consultant: “Where Should Our Next Retail Store Be Located?” at this point.
Location Options for Retail and Service Businesses
LO 3
Retail and service locations have additional consideration to optimize their location selection. Central Business District. This refers to the traditional center of town, or downtown. Advantages for a business include: attract customers from the entire trading area; customers traffic generated by the other stores in the district; and possible revitalization efforts made by cities. Disadvantages include: potential intense competition, high rental rates, traffic congestion, and inadequate parking.
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Neighborhood Locations. Locating near major residential areas provide convenience to customers, potentially lower operating costs such as rent, and close contact with customers. Shopping Centers and Malls. There are nine types of shopping centers: strip shopping centers, neighborhood shopping centers, community shopping centers, power centers, theme or festival centers outlet centers, lifestyle centers, regional shopping malls, and superregional shopping malls. Refer to Table 14.6, Types of Shopping Centers. Shopping centers and malls may offer excellent locations based on their focus and reach. Near Competitors. Locating near competitors allows an entrepreneur to leverage the compatibility of nearby stores with common customers. Locating near competitors facilitates comparison shopping based on price, quality, color, and other factors. However, clustering too many businesses of a single type into a small area ultimately erodes their sales once saturation occurs. Shared Spaces. Coworking is a situation in which two or more small companies share the same space. Advantages to a business include sharing the overhead costs (such as rent), increased creativity through access to others in different kinds of businesses, and potentially selling complementary products or services. Inside Large Retail Stores. Small companies offer products that the large retailers do not and benefit from the large volume of customer traffic drawn to the large store. Nontraditional Locations. Examples include locating in airports, museums, office buildings, churches, casinos, college and university campuses, athletic arenas and other areas that offer high concentrations of potential customers. Home-Based Businesses. Service and Web-based businesses may find this the most cost effective and convenient location solution. Disadvantages include potential interruptions and distractions, and isolation. Zoning laws may prohibit or restrict home businesses. On the Road. Mobile businesses take products and services to their customers when opportunities are the greatest. Mobile entrepreneurs, such as veterinarians, dentists, restaurant food trucks and dog groomers, incur the expense of setting up their mobile businesses, finding suitable parking spaces in big-traffic areas, complaints from nearby owners of businesses, and securing the necessary permits to operate.
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The Location Decision for Manufacturers
LO 4
The location decision for manufactures is equally important for very different reasons. Suitable manufacturing plant sites are limited by zoning regulations, utility and transportation needs, proximity to raw materials, and other special requirements. Foreign Trade Zones. Small manufacturers who seek to export should consider a foreign trade zone which is a specially designated area in or near a U.S. customs port of entry that allows resident companies to import materials and components from foreign countries; assemble, process, manufacture, or package them, and then ship the finished product while either reducing or eliminating tariffs and duties. Figure 14.3, How a Foreign Trade Zone Works illustrates the influence tariffs, duties, and excise taxes have on a small company. Business Incubators. A business incubator is an organization that combines low-cost, flexible rental space with a multitude of support services for its small business residents. An incubator’s goal is to nurture young companies during the volatile start-up period and help the business survive until they are strong enough to go out on their own.
Layout and Design Considerations
LO 5
Once an entrepreneur chooses the best location for his or her business, the next issue to address is designing the proper layout for the space to maximize sales (retail) or productivity (manufacturing or service). Layout is the logical arrangement of the physical facilities in a business that contributes to efficient operations, increased productivity, and higher sales. An effective and efficient layout can produce dramatic improvements in a company’s operating effectiveness, efficiency and overall performance. An attractive effective layout can help with employee recruiting efforts, reduce absenteeism, and improve employee productivity. See Figure 14.4, Work Space Design Characteristics in the United States (part a) and Globally (part b). Size and Adaptability. A building must offer adequate space and be adaptable enough to accommodate a business’s daily operations. It must have space for customers’ movement, inventory, displays, storage, work areas, offices, and restrooms. The trend today is moving away from private offices towards communal tables or desks that workers share and can rearrange easily to suit the task at hand. Construction and Appearance. An expert should look over a building before buying and leasing the property to insure it is of sound construction. The building should also recognize the importance of creating a proper image. The store’s window display and in-store displays can be powerful selling
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tools. Displays should be simple, clean, and current. Change displays frequently, and get expert help if necessary. Entrances. The entrance should invite customers into a store. Wide entryways and attractive merchandise display that are set back from the doorway draw customers in. Eliminate anything that creates obstacles. The Americans with Disabilities Act. The Americans with Disabilities Act (ADA) is a federal law that requires practically all businesses to make their facilities available to physically challenged customers and employees. Approximately 12.6 percent of people in the United States are disabled. Most accommodations cost an average of around $500. See Figure 14.5, Number of ADA Lawsuits Filed in U.S. District Courts. Signs. A good sign tells potential customers what it does, where it is, and what it is selling. A sign conveys positive image of the business. A well-designed signed can be a powerful tool for reaching potential customers. It should be large enough for passersby to read from a distance, and have a short, simple and clear message. It must be legible during the day and night, have proper illumination, contrasting colors and simple typeface, and have regular maintenance. Before investing in a sign, the entrepreneur should investigate the community’s sign ordinance. Building Interiors. To insure the interior of the business are functional, efficient and appealing, research, planning, and attention to detail is required. The layout can influence customers’ buying behavior by encouraging customers to linger and spend time (and money). Some stores convey their low price image through a design as a warehouse. Restaurant customers decide to never return to a restaurant because of dirty restrooms. Ergonomics is the science of adapting work and the work environment to complement employees’ strengths and to suit customers’ needs. An ergonomically designed workplace can improve workers’ productivity significantly and reduce days lost due to injuries and accidents. Drive-Through Windows. In the quick-service restaurant business, drive-through windows account for 70 percent of sales. Sight, Sound, Scent and Lighting. Retailers can increase sales by sending important subconscious signals to customers using sight, sound, scent, and lighting. Offering free samples of fresh food increase sales, as customers are willing to pay more for products they can see, touch, taste, or try. •
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Sight – use colors and visual cues in interior designs to support brand and image.
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•
Sound – the “soundscape” may include background music that appeals to customers and reinforces the image of the company. Soothing music encourages customers to linger, and classical music makes shoppers feel more affluent and increases sales more than any other type of music.
•
Scent – the use of scents can increase sales. For example, vanilla connotes warmth and comfort, and citrus scents tend to be energizing and invigorating. Bakeries use fans to push the smell of fresh-baked breads and sweets.
•
Lighting – good lighting allows employees to work at maximum efficiency, and conveys an image to customers that the business is trustworthy. Natural light can also influence sales
Sustainability and Environmentally Friendly Design. Businesses are designing buildings in more environmentally friendly ways not only because it is the right thing to do but also because it saves money. Examples include recycled materials, high-efficiency lighting, fixtures, and appliances, and using Leadership in Energy and Environmental Design (LEED) principles.
Layout: Maximizing Revenues, Increasing Efficiency, or Reducing Cost LO 6 Layout for Retailers. The layout for retailers is the arrangement of merchandise and displays in a store. It focuses on understanding a company’s target customers and crafting every element of a store’s design to appeal to those customers. It is about creating a “stage” for the customer experience. The layout of the retail store should pull customers into the store and make it easy for them to locate merchandise; compare price, quality, and features; and ultimately make a purchase. In addition, a floor plan should take customers past displays of other items they may buy on impulse. Some locations inside a store are superior to others, so prime selling space should be reserved for products that carry the highest markups. Layout in a retail store evolves from a clear understanding of customers’ buying habits. For example, women are reluctant to enter narrow aisles in a store, as narrow aisles force customers to jostle past one another. Displaying items that complement each other boosts sales. The checkout process is particularly important, as shoppers tend to be impatient and only willing to wait about four minutes before becoming exasperated. Some retailers use roving clerks equipped with handheld credit card-swiping devises during peak hours to hasten the checkout process. Refer to Figure 14.6, Space Values for a Small Store.
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Layout for Manufacturers. Important factors to consider in manufacturing layouts are the arrangement of departments, work stations, machines, and stock-holding points within a production facility. The objective is to ensure a smoothly flowing, efficient, and highly productive work flow. Factors in Manufacturing Layout. There are several factors that create an ideal layout including: •
Type of product
•
Type of production process
•
Ergonomic consideration
•
Economic considerations
•
Space availability within the facility
Types of Manufacturing Layouts. Layouts are categorized either by the work flow in a plant, or by the production system’s function. There are three basic types of layouts that can be used separately or in combination. These types are: •
Product (line) layout is an arrangement of workers and equipment according to the sequence of operations performed on a product.
•
Process layout is an arrangement of workers and equipment according to the general function they perform, without regard to any particular product or customer.
•
Fixed position layout is an arrangement in which materials do not move down a production line but rather, because of their weight, size, or bulk, are assembled on the spot.
Designing Production Layouts. Two important criteria for selecting and designing a layout are workers’ productivity and material handling costs. An effective manufacturing layout avoids what lean manufacturing principles identify as the seven forms of waste: •
Transportation
•
Inventory
•
Motion
•
Waiting
•
Overproduction
•
Processing
•
Defects
Manufacturers can lower materials handling costs by implementing 21 principles that are hallmarks of a lean and efficient manufacturing. Refer to pages 602-603.
Conclusion .
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The location decision is one of the most important decisions an entrepreneur will make. For retailers and service based businesses, the location decision is especially crucial to accommodate the needs of their walk-in customers. Manufacturer’s needs introduce another set of criteria. Local zoning ordinances in concert with the logistic needs of manufacturing businesses are some of the most important considerations. When evaluating the suitability of a particular building to meet the needs of the business, an entrepreneur should carefully consider factors such as: size, construction and external appearance, entrances, legal issues including American Disabilities Act considerations, signage, and interior elements including sight, sound, scent and lighting. Meeting these needs may require making concessions, but all are important considerations.
Part 3: Chapter Exercises You Be the Consultant: “Temporary Locations Can Be Just Great for Business” 1. What advantages and disadvantages do pop-up stores such as the ones described here offer entrepreneurs? (LO 1) (AACSB: Analytical thinking) Advantages of pop-up stores include: •
Flexibility to locate where the customer opportunities are the greatest.
•
Reduced overhead.
•
A more affordable solution for seasonal or event-based stores.
•
An opportunity to test the viability of a business and customer demand.
Disadvantages of pop-up stores include: •
The challenges of predicting sales performance.
•
Potential customer confusion as locations close.
2. What types of businesses would be successful opening pop-up stores temporarily on your campus or on a nearby campus? What advice would you offer entrepreneurs who are considering opening the store? When should it open and for how long? (LO 1) (AACSB: Application of knowledge) Students should be encouraged to come up with ideas that best suit their campus needs. One example could be a business selling college memorabilia or graduation material. Such a business can pop up on campus close to graduation to take advantage of demand. Expect students to identify pop-up store options that would meet the product and service needs of the student population. Students should offer advice to
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optimize the potential for the pop-up store. Next, students will recommend a calendarlike schedule for the stores time frames.
3. Would pop-up stores be successful in your community? Explain. Work with a team of your classmates to identify three products or product lines That would be successful in your community if they were sold from a pop-up store. (LO 1) (AACSB: Application of knowledge) Expect students to appreciate the value market research will offer to respond to this question. Encourage students to brainstorm ideas for types of pop-up stores for the community outside of campus. Their response should identify products or product lines that may be the most attractive for a pop-up store concept. This may include a variety of categories such as beverages, food, clothing, sports equipment, entertainment products and electronics.
You Be the Consultant: “Where Should Our Next Retail Store Be Located?” 1. What process should Bi use to identify the best cities for Blank Label ‘s retail expansion plans? How might the company use its database of information on its existing online and retail store customers in the location decision? (LO 2) (AACSB: Reflective thinking) Blank Label is a retail store. The chapter identifies several criteria that retail stores should use in making the location decision: trade area size, retail compatibility, degree of competition, the index of retail saturation, physical and psychological barriers, and customer traffic. All of these are relevant for Blank Label. While the customer data that it has on its database is limited as a sample size, the information nevertheless is important for Bi in making the decision. 2. What criteria should Bi use to evaluate prospective cities? (LO 2) (AACSB: Application of knowledge) Bi knows who his target customer is. In making the city decision, Bi should use this knowledge in addition to factors such as population trends, competition and compatibility with the community. 3. Do you agree with Bi’s idea of using temporary pop-up shops in certain cities to test their market potential for Blank Label’s custom-made clothing line? Explain. What are the advantages and disadvantages of this technique? (LO 2) (AACSB: Application of knowledge) As the previous boxed feature points out, pop-up stores offer a number of advantages as well as suffer from a number of disadvantages (they are not listed here because they have been covered in the previous box). Bi is using it to test a location and that is the right thing to do.
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4. Use the resources of the Internet to identify cities that Bi should consider for Blank Label’s next retail store and explain why you choose them. (LO 2) (AACSB: Application of knowledge) This is a good project for students to work on.
Part 4: Chapter Discussion Questions 14-1. Buzz Price, the location expert who helped Disney and other entrepreneurs find the ideal locations for their businesses, described the location decision in the following way: “Guessing is dysfunctional. Using valid numbers to project performance is rational.” How can entrepreneurs find “valid numbers” to help them project the performance of their businesses in different locations? (LO 2) (AACSB: Reflective thinking) Conducting thorough market research and taking an objective view of each location option is important. For example, the Internet offers easily accessible and free census data that provides detailed population, demographic, and economic information. If entrepreneurs fail to do their homework, they may take “guesses” and fail to go beyond their own city or town in determining a location for their business. When entrepreneurs stay within their “comfort zones” and do not follow a specific well-researched process, they may overlook superior locations that could greatly benefit their firms. Data and factual information can be powerful tools to identify and select optimal locations. 14-2. What factors should a manager consider when evaluating a region in which to locate a business? Where are such data available? (LO 2) (AACSB: Reflective thinking) Managers should follow a structured process that considers many factors including markets, labor, taxes, laws, the business climate, population trends, competition, transportation, and so on. That data is available from market research, government statistics, local boards, and organizations. This chapter provides specific sources of information. 14-3. Outline the factors important when selecting a state in which to locate a business. (LO 1) (AACSB: Reflective thinking) The important factors may include:
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Markets
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Labor
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Taxes
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Laws
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Business climate
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Population trends
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Competition
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Transportation
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14-4. What factors should a seafood processing plant, a beauty shop, and an exclusive jewelry store consider in choosing a location? List factors for each type of business. (LO 2) (AACSB: Reflective thinking) Each of these businesses should consider the following factors: •
Seafood processing plant – Access to raw materials, suppliers, labor, transportation, and customers.
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Beauty shop – Safe and convenient access to customers with easy-to-find parking.
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Jewelry store – The image the location portrays is important along with your business’s safe access for customers.
14-5. How will an entrepreneur decide the location for his business? (AACSB: Reflective thinking) An entrepreneur should look at the choice of a location for his business as a series of increasingly narrow decisions: Which region of the country? Which state? Which city? Which site? Choosing the right location requires an entrepreneur to evaluate potential sites with his or her target customers in mind. Demographic statistics are available from a wide variety of sources, but government agencies such as a census bureau have a wealth of detailed data that can guide an entrepreneur in his or her location decision. 14-6. What are zoning laws? How do they affect the location decision? (LO 3) (AACSB: Reflective thinking) Zoning laws control the use of the land, buildings, and sites for specific locations. These laws can have a major impact on an entrepreneur’s location decision due to the restrictions they may impose. Entrepreneurs must explore local zoning laws to determine whether there are any ordinances that would limit business activity. 14-7. What is the trade area? What determines a small retailer’s trade area? (LO 3) (AACSB: Reflective thinking) Trading areas are regions from which a business can expect to draw customers. Variables include the scope of the trading area, customer preferences, and the type and size of the operation. 14-8. What are the important considerations for an entrepreneur involved in the retail or service industry when deciding their business location? (AACSB: Reflective thinking) Trade area size, retail compatibility, degree of competition, the index of retail saturation, Reilly’s Law of Retail Gravitation, transportation network, physical and psychological barriers, customer traffic, adequate parking, reputation and visibility. 14-9. What are the advantages and disadvantages of a central business district? (AACSB: Reflective thinking) The advantages of a central business district include attracting customers from the entire trading area of the city, benefits of customer traffic generated by other stores in the district,
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and possible revitalization efforts made by cities. The disadvantages include intense competition, high rental rates, traffic congestion, and inadequate parking facilities. 14-10. What is a business incubator? (AACSB: Analytical thinking) A business incubator is an organization that combines low-cost, flexible rental space with a multitude of support services for its small-business residents. 14-11. One of the most important factors in choosing a retail location is the compatibility of nearby stores with the retail customer. Why? (AACSB: Reflective thinking) Locating near competitors can be a key factor for success in those businesses selling goods that customers shop for and compare on the basis of price, quality, color, and other factors. 14-12. Why is it costly for a small firm to choose a location that is too small? (LO 3) (AACSB: Reflective thinking) Locations that are too small may lead to costly renovations and/or relocation to meet the growth and transition needs of a successful business. 14-13. What function does a small company’s sign serve? What are the characteristics of an effective business sign? (LO 3) (AACSB: Reflective thinking) A sign communicates to potential customers who you are and what you are selling. An effective sign reaches the group of customers most likely to make actual purchases. Effective signs are easy to see and to read, contain a short and clear message, and are legible in the daytime and at night. They are designed to pull customers into the store. 14-14. What is ergonomics? Why should entrepreneurs apply the principles of ergonomics in the design of their facilities? (LO 5) (AACSB: Reflective thinking) Ergonomics is the science of adapting the physical plant for the comfort, safety, and productivity of workers. An ergonomically designed workplace can improve workers’ productivity and reduce the number of days lost to injuries and accidents. 14-15. Explain the principles of effective layouts for retailers, service businesses, and manufacturers. (AACSB: Reflective thinking) •
Layout for retail stores and service businesses depends on the owner’s understanding of his or her customers’ buying habits. Some areas of a retail store generate more sales per square foot and therefore, are more valuable.
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The goal of a manufacturer’s layout is to create a smooth, efficient work flow. Three basic options exist: product (line) layout, process layout, and fixed position layout. Two key considerations are worker productivity and material handling costs.
14-16. What are some of the features that determine a good manufacturing layout? (LO 6) (AACSB: Reflective thinking) Creating and maintaining an efficient workflow are of utmost concern to manufacturing firms. Important factors to consider in manufacturing layouts are: •
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Type of product
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•
Type of production process
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Ergonomic consideration
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Economic considerations
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Space availability within the facility
The types of manufacturing layouts include: •
Product layouts
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Process layouts
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Fixed position layouts
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Analyzing production layouts
The production layouts should consider: •
Transportation
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Inventory
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Motion
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Waiting
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Overproduction
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Processing
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Defects
In addition, manufacturers can lower materials handling costs by implementing 21 principles that are hallmarks of a lean and efficient manufacturing.
Part 5: Case Study •
Case 1: United Apparel Liquidators
Part 6: Online Videos and Podcasts Search these sites for key entrepreneurial terms from this chapter for additional resources with new videos and podcasts posted regularly. You may also consider searching “retail store layout” and other related chapter terms. •
How to Choose a Location for a Store or Restaurant
8:43 minutes
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http://www.youtube.com/watch?v=T1dg_KAy3tI •
How Retail Layout Affects Profit
5:04 minutes
http://www.youtube.com/watch?v=K_VEKoLcNh8 •
How to Make Soap: Factory Production
4:57 minutes
http://www.youtube.com/watch?v=k1rsfZ_WGm4 •
CNN Money.com – Small Business Video http://money.cnn.com/video/smallbusiness/
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Spacecubed: Coworking, Collaborating and Innovation Space http://www.youtube.com/watch?v=8EpCGYDuyMY
2:08 minutes
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Building the Boeing 777 on a New Moving Production Line
2:45 minutes
http://www.youtube.com/watch?v=kQmqNOuRzb0 Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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SECTION IV. PUTTING THE BUSINESS PLAN TO WORK: SOURCES OF FUNDS CHAPTER 15. SOURCES OF FINANCING: EQUITY AND DEBT
Part 1: Learning Objectives 1. Describe the differences between equity capital and debt capital. 2. Discuss the various sources of equity capital available to entrepreneurs. 3. Describe the process of “going public.” 4. Describe the various sources of debt capital. 5. Describe the various loan programs available from the Small Business Administration. 6. Identify the various federal and state loan programs aimed at small businesses. 7. Explain other methods of financing a business.
Part 2: Class Instruction Introduction New ventures need money. Raising those funds is one of the initial challenges for entrepreneurs. As capital markets rise and fall, the search for financing can be an uncertain journey. Some of the keys to successful financing include these seven steps: 1. Choosing the right sources of capital. 2. The money is out there; the key is knowing where to look. 3. Raising money takes time and effort. 4. Creativity counts. 5. The Internet puts at entrepreneurs’ fingertips vast resources of information that can lead to financing. Use it. 6. Put social media to work to locate potential investors. 7. Be thoroughly prepared before approaching potential lenders and investors. 8. Entrepreneurs cannot overestimate the importance of making sure that the “chemistry” among themselves, their companies, and their funding sources is a good one.
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9. Plan an exit strategy. 10. When capital gets tight, remember to bootstrap. Rather than relying primarily on a single source of funds, entrepreneurs use layered financing, a technique of raising capital from multiple sources. Capital is any form of wealth employed to produce more wealth. Entrepreneurs have access to two different types of capital: equity and debt.
Equity Capital vs. Debt Capital
LO 1
Equity capital represents the personal investment of the owner(s) in a business. It is sometimes called risk capital. The primary advantage is that it does not have to be repaid like a loan does. Equity investors share in the company’s earnings and usually have a voice in the company’s future direction. The primary disadvantage is that the entrepreneur must give up some, or even most, of the ownership. To avoid having to give up control, entrepreneurs should strive to launch new companies with the least amount of money possible. Debt capital represents the financing that entrepreneurs borrow and must repay with interest. Although borrowed capital allows entrepreneurs to maintain complete ownership, debt must be carried as a liability on the balance sheet, and it must be repaid with interest in the future. Because lenders consider small businesses to be greater risks, they require higher interest rates on loans. The cost of debt financing often is lower than that of equity financing, as investors demand greater returns than lenders. Unlike equity financing, debt financing does not require entrepreneurs to dilute their ownership interest in their companies.
Sources of Equity Financing
LO 2
The first place entrepreneurs should look for start-up money is in their own pockets. They often rely on bootstrapping, which is a process in which entrepreneurs first tap their personal savings and use creative low-cost start-up methods to launch their businesses. Refer to Figure 15.1, Sources of Financing for Typical Start-Up Businesses. In addition to personal savings, the following are potential sources of equity financing: Friends and Family Members. After emptying their own pockets, entrepreneurs look to friends and family members as their relationship with the entrepreneurs make them likely to invest. They are often more patient than outside investors and less like to meddle in the operations of the business. The amounts of money they invest are typically small in comparison to other kinds of investors. Consider the potential ramifications and consequences on personal relationships before using this source. Unrealistic expectations or misunderstood risks have destroyed friendships and relationships with family members. Refer to the Hands On… How To, Structure Family and Friendship Financing Deals.
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Accredited investors are people who have the knowledge and financial ability to assume the risks that come with investing in a business. They must have a sustained net worth (excluding their primary residence) of at least $1 million or annual income of at least $200,000. Crowdfunding is a method of raising capital that taps the power of social networking and allows entrepreneurs to post their elevator pitches and proposed investment terms on specialized Web sites and raise money from ordinary people who invest as little as $100. Prior to 2012, contributions to entrepreneurs through crowdfunding were considered to be donations rather than true investments. However, the Jumpstart Our Business Startups (JOBS) Act of 2012 expands the use of crowdfunding as a means for raising equity investment by eventually allowing people who do not meet the legal criteria to be an accredited investor to be considered as true investors in a business. When the law is fully implemented, there will be limitations on how much each individual can invest, which will be based on their income and net worth. Attracting investors through crowdfunding requires a different approach than attracting traditional investors. Entrepreneurs should seek advice from financing experts to develop a long-term financing plan in this circumstance. Refer to Hands On… How To, Crowdfunding. Accelerators. Accelerator programs are offered by some communities and universities to offer new entrepreneurs a small amount of seed capital and a wealth of additional support. They are designed to move entrepreneurs from the idea stage to a point when the business has a proven story and a strong business model that can be pitched for more significant funding. Angels. Private investors (angels) are wealthy individuals, often entrepreneurs themselves, who invest in business start-ups in exchange for equity stakes in the companies. They are accredited advisors, often with significant industry experience, who fill a specific equity financing gap before venture capital firms and institutional investors are interested. This is the fasted-growing segment of the small business capital market; angels typically invest $100,000 to perhaps $5 million. Refer to Figure 15.2, Angel Financing. Angels look for a qualified management team, a business with a clearly defined niche, market potential, a competitive advantage, a sizable customer base, and an exit strategy. The major challenge for an entrepreneur is to find angels. Networking is the key through local friends, attorneys, bankers, stockbrokers, accountants, other business owners, and consultants. Today there are angel networks and angel capital funds (superangels), many of which have Web sites. The Angel Capital Association is a professional association whose members are angels. Venture Capital Companies. Venture capital companies are private, for profit organizations that purchase equity positions in young businesses that they believe have high-growth and high-profit potential. The firms that receive venture capital typically produce annual returns of 300 to .
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500 percent within five to seven years for the venture capital companies. Refer to Figure 15.3, Venture Capital Funding. •
Policies and Investment Strategies.
Investment and size screening – The average venture capital firm’s investment in a small company has ranged from $7.1 million to $13.4 million and investments range from $100,000 to $5 to $25 million. About one in 1,000 businesses in the United States receive venture capital. Refer to Figure 15.4, The Business Plan Funnel. Ownership and control – Most venture capitalists prefer to purchase ownership in a small business through common stock of convertible preferred stock. Venture capital firms are not passive investors: they may purchase a controlling share of a company, leaving its founders with a minority share of ownership; may join the boards of directors of the firm; and even take over the management of the firm. Stage of investment – Venture capital companies commonly seek out companies in the early or rapid-growth stage. They often invest over time across several stages of a firm’s growth, where their investments often total $10 million to $15 million or more. Advice and contacts – In addition to the money they invest, they provide management advice and access to valuable networks of contacts of suppliers, employees, customers, and other sources of capital. Investment preferences – Venture capital funds increasingly are focusing their investments in specific industries, such as technology, biotechnology, or other specialty niches. They prefer to invest in firms that have advanced beyond the stage when angels invest. Refer to Figure 15.5, Angel vs. VC Investments. •
What Venture Capitalists Look For.
Two factors make a deal attractive to venture capitalists: high returns and a convenient and profitable exit strategy. In addition, they look for the following:
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Competent management
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Competitive edge
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Growth industry
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Viable exist strategy
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Intangible factors such based on the venture capitalist’s sense of fit and potential. For example, a solid sense of direction, strategic planning process, and the chemistry of the management team.
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Corporate Venture Capital. Large corporations, both U.S. and foreign, finance and invest in small companies for strategic and financial purposes. Examples include Google Ventures, Samsung Ventures, and Cisco Investments. The right corporate partner may also share technical expertise, distribution channels, and marketing know-how, and provide introductions to important customers and suppliers.
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Public Stock Sales (“Going Public”)
LO 3
One method of raising large capital is to sell shares of stock, known as “going public.” An initial public offering (IPO) is a method of raising equity capital in which a company sells shares of its stock to the general public the first time. Refer to Figure 15.6: Initial Public Offerings (IPOs), to note the fluctuation in the number of IPOs from 1987 to 2014. It is an effective method of raising large amounts of capital, but can be expensive and time-consuming with regulatory nightmares. Once a company has made an IPO managers must consider the impact of their decisions not only on the company, but also on shareholders and the value of their stock. Investment bankers who underwrite public stock offerings typically look for established companies with these characteristics: •
Consistently high growth rates
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Scalability
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A strong record of earnings
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Three to five years of audited financial statements that meet or exceed Securities and Exchange Commission (SEC) standards
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A solid position in a rapidly growing industry
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A sound management team with experience and a strong board of directors
The Registration Process. This is a coordinated effort that requires a team of professionals, including company executives, an accountant, a securities attorney, a financial printer, and at least one underwriter. The registration process alone is a required, time-demanding – and potentially expensive – task that involves these steps:
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Choose the underwriter. A managing underwriter (investment banker) is a financial company that serves two important roles: helping to prepare the registration statement for an issue and promoting the company’s stock to potential investors.
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Negotiate a letter of intent. A letter of intent is an agreement between the underwriter and the company about to go public that outlines the details of the deal.
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Prepare the registration statement. The registration statement is the document a company must file with the SEC that describes both the company and its stock offering and discloses information about the risk of investing.
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File with the SEC. The Division of Corporate Finance can take 30-45 days to review the application, and can require the company to make revisions.
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Wait to go effective. While waiting for the SEC’s ruling, the underwriters are building a syndicate of other underwriters who will market the company’s stock. During this quite period of time the company must refrain from publicity and providing information about the potential IPO.
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Road show. A road show is a gathering of potential syndicate members sponsored by the managing underwriter for the purpose of promoting a company’s IPO.
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Sign underwriting agreement. On the last day before the registration statement becomes effective, the company signs the formal underwriting agreement. At this meeting the underwriters receive their shares to sell, and the company receives the proceeds of the offering.
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Meet state requirements. In addition to satisfying the SEC’s requirements, a company must also meet the securities laws in all states in which the issue is sold. These state laws (or “blue sky” laws) vary drastically among states.
Nonpublic Registrations and Exemptions. The SEC allows several exemptions from this full-disclosure process for small businesses. Simplified registrations and exemptions enable smaller companies easier access to capital markets through some recently improved options for small businesses. A limited private stock offering allows entrepreneurs to sell stock through a limited private offering to accredited investors, corporations and trust, and insiders to the business. The SEC has established simplified registrations and exemptions through what is known as Regulation D (Ruel 504, 505, and 506): •
Regulation D – minimize the expense and time required to raise equity capital by simplifying or eliminating the requirement for registering the offering with the SEC.
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Rule 504 is the most popular of the Regulation D exemptions because it is the least restrictive. It allows a company to sell shares of its stock to an unlimited number of investors without regard to their experience or level of sophistication. There is a cap of $1 million in a 12-month period on the amount of capital a company can raise.
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Rule 505 has a higher capital ceiling (up to $5 million), but cannot have more than 35 nonaccredited investors, provide no advertising of the offer, and more has stringent disclosure requirements.
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Rule 506 imposes no ceiling on the amount that can be raised, but most companies that make Rule 506 offerings raise between $1 million and $50 million in capital. Like Rule 505, it limits the issue to no more than 35 nonaccredited investors, and prohibits advertising the offer. There is no limit on the number of accredited investors, however.
Sources of Debt Financing
LO 4
Debt financing involves funds that small business owners borrow and must repay with interest. Borrowed capital allows entrepreneurs to maintain complete ownership but it must be carried as a liability on the balance sheet as well as be repaid with interest. .
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Because small businesses are considered to be greater risks than bigger corporate customers, they must pay higher interest rates. Most small firms pay well above the prime rate, which is the interest rate that banks charge their most creditworthy customers. The cost of debt financing is lower than that of equity financing because investors demand greater returns on their investment than lenders. There is an astounding range of credit options varying greatly in complexity, availability, and flexibility. Refer to Figure 15.7, Small Business Financing Strategies. Commercial Banks. Commercial Banks provide the greatest number and variety of loans to small companies, but prefer to lend to established small businesses rather than to high-risk start-ups. Before making a loan, the bank will scrutinize the firm’s financial reports to project its position in the future, they want proof of the stability of the company’s sales and its ability to generate adequate ash flow sufficient to repay the loan, collateral to secure the loan or an SBA guarantee. Smaller banks tend to be more small business friendly than bigger banks. Banks and other lenders require entrepreneurs to sign personal guarantees for any loan; this means that if the business does not repay the loan then the entrepreneurs agrees to personally repay the loan. In essence, bankers look for three sources to repay a loan: sales sufficient to repay, the entrepreneur’s personal guarantee, and collateral that could be sold to repay the loan. Refer to Hands On… How to for a list of seven common reasons banks turn down loan requests. Short-Term Loans. Short-term loans are those that are intended to be less than one year, are the most common type of commercial loan banks make to small companies. These loans are typically used to replenish working capital to finance the purchase of inventory, boost output, finance credit sales to customers, or take advantage of cash discounts. There are several types of short-term loans. •
Home equity loans
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Commercial loans (or “traditional” bank loans)
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Lines of credit. A line of credit is a short-term bank loan with a preset limit that provides working capital for day-to-day operations.
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Floor planning
Intermediate- and Long-Term Loans. These types of loans are normally secured by collateral and are extended for one year or longer. The typical uses include constructing buildings, purchasing real estate and equipment, expanding a business, and other long-term investments. Installment loans and term loans are examples. •
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Installment loans are used by entrepreneurs to purchase equipment, facilities, real estate, and other fixed assets. Repayment of the loan is set to coincide with the length of the equipment’s usable life.
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A term loan is a bank loan that imposes restrictions (covenants) on the business decisions an entrepreneur makes concerning the company’s operations. These loans are typically not secured by collateral when there is a high probability of repayment. Typical kinds of covenants include limits on owners’ salaries, prohibit further borrowing without bank permission, or maintenance of certain financial ratios.
Consider using You Be the Consultant: “The Never-Ending Hunt for Financing” at this point.
The Small Business Administration (SBA) Loan Guarantee Programs LO 5 The SBA works with local lenders (both bank and nonbank) to offer many other loan programs designed to help entrepreneurs who cannot get capital from traditional sources. The SBA does not actually lend money to entrepreneurs directly; instead entrepreneurs borrow money from a traditional lender, and the SBA guarantees repayment of a percentage of the loan in case the borrower defaults. Because the SBA assumes most of the credit risk, lenders are more willing to consider riskier deals. SBA loans often have a longer term than traditional bank loans, and need less collateral. Refer to Table 15.1, SBA Loan Program Overview. SBA programs include: •
7(A) loan guaranty program is an SBA program in which loans made by private lenders to small businesses are guaranteed up to a ceiling by the SBA. It is the most popular SBA program. Refer to Figure 15.8, SBA 7(A) Guaranteed Loans.
•
Section 504 Certified Development Company Program is designed to encourage small business to purchase fixed assets, expand facilities, and create jobs. Three lenders play a role in every 504 loan: a bank, the SBA, and a certified development company (CDC). A certified development company is a nonprofit organization licensed by the SBA and designed to promote growth in local communities by working with commercial banks and the SBA to make long-term loans to small businesses.
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Microloan Program. About three-fourths of small businesses need less than $100,000. Microloans are made through an SBA program aimed at entrepreneurs who can borrow amounts of money as small as $100 up to a maximum of $50,000. This is the single largest source of funding for microenterprises, provided by about 180 authorized lenders that are nonprofit intermediaries. Micro loans do not carry SBA guarantees, but lenders’ standards are less demanding than on conventional loans. Other SBA Loan Programs.
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SBAExpress Program
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The CAPline Program is an SBA program that makes short-term capital loans to growing companies needing to finance seasonal buildups in inventory or accounts receivable. •
Export Express Program is an SBA loan program that offers quick turnaround times to small companies that are developing or expanding their export initiatives.
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Export Working Capital (EWC) Program is an SBA loan program that is designed to provide working capital to small exporters.
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The International Trade Program is an SBA loan program for small businesses that are engaging in international trade or are adversely affected by competition from imports.
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Disaster Loans are an SBA loan program that makes loans to small businesses devastated by some kind of financial or physical loss.
Non-Bank Sources of Debt Capital.
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Asset-Based Lenders. Asset-based lenders allow businesses to borrow money by pledging collateral, such as accounts receivable and inventory. Asset-based lenders may be small commercial banks, commercial finance companies, specialty lenders, or divisions of bank holding companies. The advance rate is the percentage of an asset’s value that a lender will lend.
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Discounting Accounts Receivable. A small business pledges its account receivable as collateral; the lender advances a loan against the value of approved accounts receivable.
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Inventory Financing.
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Purchase Order Financing.
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Vendor Financing.
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Equipment Suppliers.
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Commercial Finance Companies.
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Saving-and-Loan Associations.
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Stockbrokers. Margin loans are loans from a stockbroker that use the stocks and bonds in the borrower’s portfolio as collateral. A margin (maintenance) call occurs when the value of a borrower’s portfolio drops and the broker calls the loan in, requiring the borrower to put up more cash and securities as collateral.
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Credit Unions are a nonprofit financial cooperative that promotes saving and provides loans to its members.
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Private Placements. This involves selling debt to one or a small number of investors, usually insurance companies or pension funds. This is a hybrid between a conventional loan and a bond.
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Small Business Investment Companies (SBICs) are privately owned financial institutions that are licensed by the SBA and use a combination of private capital and federally guaranteed debt to provide long-term venture capital to small businesses.
Other Federal and State Programs
LO 6
Economic Development Administration (EDA). The Economic Development Administration (EDA) offers loan guarantees to create new business and to expand existing businesses in areas with below- average income and high unemployment. Department of Housing and Urban Development (HUD). This agency does not extend loans or grants directly to entrepreneur. However, the Urban Development Action Grants are extended to cities and towns that, in turn, lend or grant money to entrepreneurs to start small businesses that will strengthen the local economy. •
U.S. Department of Agriculture’s Business Programs and Loans. The Department of Agriculture’s loan program is open to all businesses and is designed to create nonfarm employment opportunities in rural areas that are underserved. Various programs help fund projects that create or preserve quality jobs and/or promote a clean rural environment. The Rural Development Rural Business Services (RBS) does not make direct loans to small businesses, but will guarantee bank loans.
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Small Business Innovation Research Program (SBIR). The federal government awards cash grants or long-term contracts to small companies that want to initiate or to expand their research and development efforts. There are three phases in the grant process: proof of concept, prototype development, and commercialization.
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The Small Business Technology Transfer Program (STTR). This program helps companies to use the vast reservoir of commercially promising ideas that originate in universities, federally funded R&D centers, and nonprofit research institutions.
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State and Local Loan Development Programs. o Capital Access Programs (CAPs) is a state lending program that encourages lending institutions to make loans to businesses that do not quality for traditional financing because of their higher risk. o Revolving loan funds is a a program offered by communities that combine private and public funds to make loans to small businesses, often at belowmarket interest rates. o Community development financial institutions (CDFIs) are communitybased financial institutions that designate at least a portion of their loan
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portfolios to otherwise “unbankable” business owners and aspiring entrepreneurs.
Other Methods of Financing
LO 7
Factoring Accounts Receivable. A factor is a financial institution that buys a business’s accounts receivable at a discount. Leasing. Companies have the option of leasing any kind of asset rather than purchase these assets. Leasing avoids down payments, may help cash flow, and may offer great flexibility. ROBS. Many small businesses use Rollovers as Business Startups as a means of using retirement savings to fund their businesses. Merchant Cash Advance. A merchant cash advance is an arrangement in which the provider of the merchant cash advance prepurchases credit and debit card receivables at a discount. Peer-to-peer Lending. Peer-to-peer loans are web-based vetting platforms that create an online lending community of investors who provide funding to creditworthy small businesses. Examples include Lending Club, Prosper, and Fundations. Loan brokers specialize in finding loans by looking to a wide network of lenders. Credit Cards. Credit cards are a source of financing for entrepreneurs that may not be able to find other options. The SBA estimates that 11 percent of financing for small businesses comes from credit cards. Credit cards may be the entrepreneur’s only choice for financing. Advantages of credits cards include: source of easy-to-access funds that is quickly available; flexible repayment options; attractive short-term alternative to financing. Disadvantages of using credit cards include: high interest rates, particularly expensive to use to get access to cash versus making purchases, and can be difficult to get out of the pattern to use for financing operating expenses.
Conclusion Entrepreneurs use both debt and equity as source of capital, and must understand the advantages and disadvantages of each of the many available sources as they relate to their particular business. Start-ups have the most difficulty finding financing, while well–
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established small businesses have a somewhat easier time. The Great Recession made it difficult for even successful entrepreneurs to get financing.
Part 3: Chapter Exercises You Be the Consultant: “The Never-Ending Hunt for Financing” 1. Which of the funding sources described in this chapter do you recommend that Ralph Lucci and Aaron Hoffman consider for financing their businesses? Which sources do you recommend that they not use? Why? (LOs 1, 2, 3, 4, 5, 6) (AACSB: Reflective thinking) Ralph Lucci should consider the SBA Disaster Loan Program, ROBS, friends and family members, accredited investors or angels who have a particular interest in his business, crowdfunding, a limited private stock offering, or the SBA 504 loan program. Aaron Hoffman certainly needs the benefit of advice and connections of an angel investor who would provide him the capital to get going. In addition he could consider the following: •
SBA 7(A) loan guaranty program.
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Microloan Program.
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SBAExpress Program.
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The CAPline Program.
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Inventory Financing.
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Purchase Order Financing.
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Vendor Financing.
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Credit Unions.
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Private Placements.
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Economic Development Administration (EDA).
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State and Local Loan Development Programs.
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Peer-to-peer Lending.
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Loan brokers.
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Credit Cards.
2. What can entrepreneurs do to increase the probability that bankers will approve their loan requests? (LO 4) (AACSB: Reflective thinking)
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Refer to the Hands on… How To feature on page 504. Entrepreneurs may consider ways to combat these common reasons for rejection from commercial banks: •
Select the right bank. Discover which banks are more likely to make loans to small businesses. Smaller community banks are more receptive than bigger banks.
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Develop a personal relationship with the banker and provide an informative business plan. Demonstrate that you are fully informed about your business.
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Develop a solid business plan with clear financial forecasts and budgets to explain how much money you need and how to plan to use it.
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Include a cash flow forecast in your business plan.
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Be prepared to pledge your company’s assets as well as your personal assets.
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Be prepared to provide a personal guarantee on the loan.
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Increase the amount of money you have invested in your business.
3. Work with a team of your classmates to brainstorm ways these entrepreneurs could attract the capital they need for their businesses. What steps would you recommend they take before they approach the potential sources of funding you have identified? (LOs 1, 2, 3, 4, 5, 6) (AACSB: Analytical thinking) Students may generate additional ideas for attracting capital, including non-traditional financing options. These recommendations should “fit” the individual needs and characteristics of each venture and its owner. The steps to take before approaching potential sources of funding may include: •
Revise/update their business plans.
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Focus upon the proposed growth/expansion strategy.
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Develop a verbal story about the growth strategy—from an elevator pitch to a full dialog about the future of the business vision.
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Prioritize the list of potential financing options.
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Develop contingency plans.
Part 4: Chapter Discussion Questions 15-1. Why is it difficult for most small business owners to raise the capital needed to start, operate, or expand their ventures? (LO 1)
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Lenders recognize that small businesses are at a higher risk level of defaulting on loans, so they are very reluctant to lend to them. The financial industry has been through difficult times, resulting in credit crunches. Banks have tightened their lending criteria, venture capitalists have become more conservative, private investors have grown more cautious, and the issuing of public stock remains viable for only select businesses with established track records. If small business owners lack experience and collateral, this magnifies the challenge to raise the capital needed for their venture. 15-2. What is capital? (LO 1) Capital is any form of wealth employed to produce more wealth. Capital exists in many forms including cash, inventory, plant and equipment. Entrepreneurs have access to two different types of capital including equity and debt. 15-3. Define equity financing. Equity financing represents the personal investment of the owner(s) of the business. The primary advantage of this type of financing is that is does not have to be repaid with interest. Equity financing is sometimes called risk capital because investors assume the primary risk of losing their funds if the business fails. 15-4. What advantage does equity financing offer over debt financing? (LO 2) The advantages that equity financing offers over debt financing includes: •
The investment does not have to be repaid
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It does not require interest payments
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Listing on a stock exchange and an improved business image
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Improved access to future financing
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Ability to attract and retain key employees
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The ability to use stock for acquisition
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May engage investors in a positive way to offer additional council and guidance to help the business succeed
15-5. If an owner lacks sufficient equity capital to invest in the firm, what options are available for raising it? (LO 2) Owners that lack sufficient funds may turn to family and friends, angels, partners, venture capital companies, corporations, and public stock offerings as a source of equity capital.
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15-6. Identify the major difference between equity capital and debt capital. Equity capital is capital that represents the personal investment of the owner(s) of a company. It is sometimes called risk capital. Debt capital is the financing that an entrepreneur borrows and must repay with interest. 15-7. What are the steps involved in “going public”? Companies can “go public” by selling shares of its stock to outside investors. “Going public” involves: •
Choosing the underwriter
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Negotiating a letter of intent
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Preparing the registration statement
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Filing with the SEC
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Waiting to go effective
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A road show
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Signing the underwriting agreement
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Meeting state requirements
15-8. What are various types of loan programs available from the SBA? 7(A) Loan Guaranty Program, Section 504 Certified Development Company Program, Microloan Program, SBAExpress Program, Small Loan Advantage and Community Advantage Loan Programs, the CAPline Program, International Trade Program, and Disaster Loans. 15-9. How can entrepreneurs locate potential angels to invest in their businesses? (LO 2) The typical angel invests in local companies. The primary way to locate angels is by networking through friends, attorneys, investment institutions, business associations, and other business owners. Investors now pool their resources to form angel networks and angel capital funds. The Internet has expanded the ability to locate angel investors; today there are more than 300 angel capital networks in the U.S. 15-10. What is a private placement? A private placement involves selling debt to one or a small number of investors, usually insurance companies or pension funds. Private placement debt is a hybrid between a conventional loan and a bond. 15-11. What investment criteria do venture capitalists use when screening potential businesses? Many venture capitalists seek to purchase 30 to 40 percent of a business through common stock or convertible preferred stock. Many are choosing to focus their investments in niche markets, rely heavily on their gut instincts, and look for businesses that have competent management, a competitive edge, and presence in a growth industry. They
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want high returns on their investment, and an easy exit strategy. In addition they want an experienced management team, a competitive advantage, and firms in growth industries. 15-12. How does venture capitalist criteria for investing compare to the typical angel’s criteria? (LO 2) Venture Capitalists – Typically purchase 50 percent or more ownership in a business, expect 60 to 75 percent return on investment annually, invest $5 to $25 million, and invest during early or expansion stages of a business. They want high returns on their investment, and an easy exit strategy. In addition they want an experienced management team, a competitive advantage, and firms in growth industries. Angels – Typically purchase 15 to 30 percent ownership in the business, invest $10,000 to $2 million, are willing to wait seven years or longer to cash out, expect a 20 to 30 percent return on investment depending on risk. Private investors normally invest during the start-up or early growth stages. 15-13. How do venture capital firms operate? Venture capital companies are for-profit organizations that purchase equity positions in young businesses with high growth and profit potential, producing annual returns of 300 to 500 percent over five- to seven-year periods. 15-14. Describe a venture capitalist procedure for screening investment proposals. (LO 2) The screening process of venture capital firms is extremely stringent and revolves around ownership, control, and investment preferences. 15-15. Summarize the major exemptions and simplified registrations available to small companies wanting to make public offerings of their stock. (LO 3) The SEC has established simplified registration statements and exemptions from the registration process: Regulation D, Rules 504, 505 and 506.
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•
Regulation D – minimize the expense and time required to raise equity capital by simplifying or eliminating the requirement for registering the offering with the SEC.
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Rule 504 is the most popular of the Regulation D exemptions because it is the least restrictive. It allows a company to sell shares of its stock to an unlimited number of investors without regard to their experience or level of sophistication. There is a cap of $1 million in a 12-month period on the amount of capital a company can raise.
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Rule 505 has a higher capital ceiling (up to $5 million), but cannot have more than 35 nonaccredited investors, provide no advertising of the offer, and more has stringent disclosure requirements.
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Rule 506 imposes no ceiling on the amount that can be raised, but most companies that make Rule 506 offerings raise between $1 million and $50 million in capital. Like Rule 505, it limits the issue to no more than 35 nonaccredited investors, and prohibits advertising the offer. There is no limit on the number of accredited investors, however. Chapter 15, Page 245
15-16. Debt financing involves the funds that the small business owner borrows and must repay with interest. Describe the various sources of debt capital available for a small business owner. Commercial banks, trade credit, commercial finance companies, savings and loan associations, stock brokerage houses, small business investment companies, and small business lending companies. 15-17. Commercial banks are not the only source of debt financing available to an entrepreneur. Identify the non-bank sources of debt capital that entrepreneurs can tap to feed their cash-hungry companies. Asset based lenders, vendor financing, equipment suppliers, commercial finance companies, saving and loan associations, stockbrokers, credit unions, private placements, and small business investment companies. 15-18. List other methods of financing available to a small business owner. Factoring, leasing rather than purchasing equipment, and using credit cards. 15-19. How important is trade credit as a source of debt financing to small firms? (LO 4) It is an extremely important source of small business financing, especially when small businesses are seen as a high risk by commercial banks. 15-20. What functions do SBICs serve? SBICs are privately owned financial institutions that are licensed and regulated by the SBA. 15-21. How does an SBIC operate? Small Business Investment Companies (SBICs) are privately owned financial institutions that are licensed by the SBA and use a combination of private capital and federally guaranteed debt to provide long-term venture capital to small businesses. 15-22. What methods of financing do SBICs rely on most heavily? (LO 4) The most common forms of SBIC financing are: loans with the option to buy stock, convertible debentures, straight loans, and preferred stock. 15-23. Explain the advantages and disadvantages of using crowdfunding. Crowdfunding is a method of raising capital that taps the power of social networking and allows entrepreneurs to post their elevator pitches and proposed investment terms on specialized Web sites and raise money from ordinary people who invest as little as $100. Prior to 2012 contributions to entrepreneurs through crowdfunding were considered to be donations rather than true investments. However, the Jumpstart Our Business Startups (JOBS) Act of 2012 expands the use of crowdfunding as a means for raising equity investment by eventually allowing people who do not meet the legal criteria to be an accredited investor to be considered as true investors in a business. To be eligible for crowdfunding, the business must be under $1 billion in revenues, and can raise only $1 million through crowdfunding. When the law is fully implemented, there will be
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limitations on how much each individual can invest, which will be based on their income and net worth. Attracting investors through crowdfunding requires a different approach than attracting traditional investors. Entrepreneurs should seek advice from financing experts to develop a long-term financing plan in this circumstance. Refer to Hands On… How To, Crowdfunding. 15-24. Briefly describe the loan programs offered by the Economic Development Administration. (LO 5) The Economic Development Administration (EDA) offers loan guarantees to create new business and to expand existing businesses in areas with below- average income and high unemployment. 15-25. Briefly describe the loan programs offered by the Department of Housing and Urban Development (LO 5) The Department of Housing and Urban Development (HUD). This agency does not extend loans or grants directly to entrepreneur. However, the Urban Development Action Grants are extended to cities and towns that, in turn, lend or grant money to entrepreneurs to start small businesses that will strengthen the local economy. 15-26. Briefly describe the loan programs offered by the Department of Agriculture. (LO 5) The Department of Agriculture’s loan program is open to all businesses and is designed to create nonfarm employment opportunities in rural areas that are underserved. Various programs help fund projects that create or preserve quality jobs and/or promote a clean rural environment. The Rural Development Rural Business Services (RBS) does not make direct loans to small businesses, but will guarantee bank loans. 15-27. Explain the purpose and the methods of operation of the Small Business Innovation Research Program and the Small Business Technology Transfer Program. (LO 6) Small Business Innovation Research Program - The federal government awards cash grants or long-term contracts to small companies that want to initiate or to expand their research and development efforts. There are three phases in the grant process: proof of concept, prototype development, and commercialization. Small Business Technology Transfer Program – This program helps companies to use the vast reservoir of commercially promising ideas that originate in universities, federally funded R&D centers, and nonprofit research institutions. 15-28. What is a factor? (LO 6) Factors are financial institutions that buy a business’s ‘accounts receivable’ at a discount.
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15-29. How does the typical factor operate? The small business owner retains the responsibility for customers who fail to pay their accounts. 15-30. Explain the advantages and the disadvantages of using factors as a source of financing. Factoring is a more expensive type of financing, but for businesses that cannot qualify for those loans, factoring may be the only choice for a small business. 15-31. Why does an entrepreneur opt for a leasing arrangement especially when it involves expensive assets? By leasing expensive assets, the entrepreneur is able to use these assets without locking in valuable capital for an extended period of time. Hence, the entrepreneur can reduce the long-term capital requirements of his businesses by leasing equipment and facilities and avoid investing his capital in depreciating assets. Leasing also avoids down payments, may help cash flow, and offers great flexibility. 15-32. How do merchant cash advances work as a course of financing a small business? A merchant cash advance is an arrangement in which the provider of the merchant cash advance prepurchases credit and debit card receivables at a discount. 15-33. What is the difference between peer-to-peer lending and loan brokers? Peer-to-peer loans are Web-based vetting platforms, such as Lending Club, Prosper, and Foundation, which create an online lending community of investors who provide funding to creditworthy small businesses. Meanwhile, loan brokers specialize in helping small businesses find loans by looking to a wide network of lenders that can include SBA lenders, working capital financing, real estate loans, bridge financing, franchise financing, merchant cash advances, and asset-based lending. 15-34. Why do we need to practice extreme care when using a retirement account rollover to fund a business? The tax laws governing rollovers as business startups (ROBS) are complex, and if they are not set up properly, this form of funding can lead to significant penalties by the IRS. 15-35. What role do credit cards play in financing small business? Credit cards are a source of financing for entrepreneurs that may not be able to find other options. Credit cards may be the entrepreneur’s only choice for financing. Advantages of credits cards include: •
A source of easy-to-access funds that is quickly available
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Flexible repayment options
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Attractive short-term alternative to financing
15-36. What is the fastest and most convenient source of debt capital available to new entrepreneurs?
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The fastest and most convenient source of debt capital available to new entrepreneurs is credit cards. However, prudent entrepreneurs rely on credit cards only for making monthly purchases that they are certain can be paid off when the credit card bill comes due.
Part 5: Case Studies The following text cases may be used for lecture and assignments for topics presented in this chapter. •
Case 2: Bark & Co.
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Case 4: ThinkImpact
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics. •
BioLumix: Investing Your Own Money First
6:54 minutes
http://www.youtube.com/watch?v=VR4khyTQrDc&feature=channel •
Find Investors – Which money Is Best Debt or Equity? http://www.youtube.com/watch?v=ru8BNWiD13o
2:18 minutes
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What Angel Investors Want http://www.youtube.com/watch?v=bR4XfgalYkw
6:02 minutes
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How to Find an Angel Investor http://www.youtube.com/watch?v=z5g9XRATVSI
3:24 minutes
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Best Crowdfunding Sites http://www.youtube.com/watch?v=GqVeh_CjjP0
4:13 minutes
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SBA Loans Explained (7 A Loan Program)
2:07 minutes
http://www.sba.gov/tools/sba-learning-center/video/sba-loans-explained
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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CHAPTER 16. GLOBAL ASPECTS OF ENTREPRENEURSHIP
Part 1: Learning Objectives 1. Explain why “going global” has become an integral part of many small companies’ marketing strategies. 2 Describe the principal strategies small businesses can use for going global. 3. Discuss the major barriers to international trade and their impact on the global economy. 4. Describe the trade agreements that will have the greatest influence on foreign trade in the twenty-first century.
Part 2: Class Instruction Introduction The global marketplace offers tremendous potential for many entrepreneurial companies. The Internet combined with other forms of affordable technology, increased access to information on conducting global business, and the growing interdependence of the world’s economies have made it easier than ever before for companies to engage in international trade. As entrepreneurs discover the global business tools, the costs of going global are decreasing. American small businesses fall behind their counterparts in most countries. The opportunities demand exploration.
Why Go Global?
LO 1
Today’s business environment is highly competitive and businesses can no longer consider themselves as domestic companies if they truly want to compete. Operating a successful business increasingly requires entrepreneurs to see their companies as global citizens rather than as companies based in a particular geographic region. Going global is today a matter of survival, not preference. Going global can put a tremendous strain on a small company, but entrepreneurs who take the plunge can reap many benefits including the ability to offset sales declines in the domestic market, increase sales and profits, improve the quality of their products to meet the stringent demands of foreign customers, lower the manufacturing cost of their products by spreading fixed costs over a larger number of units, and enhance their competitive positions to become stronger businesses.
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Success in a global economy requires constant innovation; staying nimble to use speed as a competitive weapon; maintaining a high level of quality and constantly improving it; being sensitive to foreign customers’ unique requirements; adopting a more respectful attitude toward foreign habits and customers; hiring motivated, multilingual employees; and retaining a desire to learn constantly about global markets. Global thinking is the ability to appreciate, understand, and respect the different beliefs, values, behavior, and business practices of companies and people in different cultures and countries.
Strategies for Going Global
LO 2
There are 10 strategies for going global as described in Figure 16.1, Ten Strategies for Going Global. Creating a Web site. Refer to Figure 16.2, Internet Users Worldwide. E-commerce experts recommend having separate domain names for each targeted country, and each must reflect the local culture, customs, and language. Trade Intermediaries. Trade intermediaries are domestic agencies that serve as distributors in foreign countries for domestic companies of all sizes. They rely on their networks of contacts, extensive knowledge of local customs and markets, and experience in international trade. They serve as the export departments for small businesses. There are many types of trade intermediaries, but the following are ideally suited for small businesses: •
Export management companies (ECMs) are merchant intermediaries that provide small businesses with a low-cost, efficient, off-site international marketing department.
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Export trading companies (ETCs) are businesses that buy and sell products in a number of countries and offer a wide variety of services to their clients.
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Export merchants are domestic wholesalers who do business in foreign markets.
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Resident buying office is government- or privately owned operations of one country established in another country for the purpose of buying goods made there.
Value of Using Trade Intermediaries. Trade intermediaries make the process much faster and easier because most small business owners do not have the knowledge, resources, or confidence to go global alone. The primary disadvantage of using these intermediaries is that it requires entrepreneurs to surrender control over their foreign sales. Therefore, it is essential to thoroughly screen them, and find the ones that specialize in the products their companies sell, as well as
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have experience and established contact in the targeted countries. Refer to Table 16.1, Resources for Locating a Trade Intermediary. Joint Ventures. A domestic joint venture is an alliance of two or more U.S. small companies for the purpose of exporting their goods and services abroad. A foreign joint venture is an alliance between a U.S. small business and a company in the target nation. Foreign Licensing. Rather than sell their products or services directly to customers overseas, some small companies enter foreign markets by licensing businesses in other nations to use their patents, trademarks, copyrights, technology, processes, or products. In return the company collects royalties from the sales of its foreign licenses. This works well for businesses whose value lies in its intellectual property, unique products or services, recognized name, or proprietary technology. International Franchising. Franchisors that decide to expand internationally should: identify the country or countries that are best suited to the franchisor’s business concept; generate leads for potential franchisees; select quality candidates; structure the franchise deal (direct franchising, area development, or master franchising). Countertrading and Bartering. A countertrade is a transaction in which a company selling goods in a foreign country agrees to promote investment and trade in that country. The goal is to help offset the capital drain from the foreign country’s purchases. However, countertrade transactions can be complicated, cumbersome, and time consuming. Bartering is the exchange of goods and services for other goods and services. Bartering is a way of trading with countries lacking convertible currency. Exporting. The biggest barrier to exporting is not knowing where or how to start, but there are many resources, training, and consulting services to help. To develop a sound export strategy the entrepreneur should follow these nine steps: 1. Recognize that even the tiniest companies and least experienced entrepreneurs have the potential to export. Refer to Table 16.2, Assessing Your Company’s Export Potential. 2. Analyze your product or service. 3. Analyze your commitment. Refer to Figure 16.3, Length of Time Small Business Owners Invest Before Exporting. 4. Research markets and pick your target. Refer to Figure 16.4, Number of Countries to Which U.S. Small Businesses Export. 5. Develop a distribution strategy. 6. Find your customer.
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7. Find financing. 8. Ship your goods. 9. Collect your money. A letter of credit is an agreement between an exporter’s bank and the foreign buyer’s bank that guarantees payment to the exporter for a specific shipment of goods. Refer to Figure 16.5, How a Letter of Credit Works. A bank draft is a document the seller draws on the buyer, requiring the buyer to pay the face amount either on sight or on a specified date. Establishing International Locations. Once established in international markets, some small businesses set up permanent locations there. This can be difficult due to weak infrastructure (such as telephone systems), the expectation of bribes to get things done, and finding the right person to effectively manage the international location. The advantages include lower start-up costs, lower labor costs, as well as gaining a firsthand knowledge of customers’ preferences and culture. Importing and Outsourcing. More U.S. companies shop the world market for products they can sell here. For example, due to low labor costs in some countries, businesses there offer goods and services at very low prices. For example, Alibaba.com makes it easy to locate reliable suppliers and vendors in China. Companies considering importing goods and services, or outsourcing their manufacturing to foreign countries should: make sue that importing or outsourcing is right for your business; establish a target cost for your product; do your research before you leave home; be sensitive to cultural differences; do your groundwork; protect your company’s intellectual property; select a manufacturer; provide an exact model of the product you want manufactured; stay in constant contact with the manufacturer and try to build a long-term relationship. Expat Entrepreneurs. Expat entrepreneurs keep their citizenship in their home country, but live and run their businesses on foreign soil. Consider using You Be the Consultant: “Going Global from the Outset” at this point.
Barriers to International Trade
LO 3
Many U.S. firms are simply ignorant about exporting opportunities. In addition, some governments use a variety of barriers that block free trade among nations in an attempt to protect their own industries. Foreign firms are restricted access into global markets and all consumers suffer and pay the price. Barriers to international trade include domestic and international barriers. Refer to Figure 16.6, Most Frequently Encountered Impediments to International Trade. Domestic Barriers.
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Three major domestic roadblocks are common: attitude, information, and financing. •
Attitude. “I’m too small to export.” The first step to building an export program is recognizing that the opportunity to export exists. Refer to Table 16.3, Global Business Assumptions.
•
Lack of Information. Entrepreneurs should thoroughly research the possibility of going global and use every possible resource available to them such as government and private organizations’ international exporting and marketing information, in order to make valid decisions. Companies must also be willing to make the necessary adjustments to their products and services, promotional campaigns, packaging, and sales techniques in foreign markets.
•
Lack of Available Financing. Many entrepreneurs cite lack of financing as a major barrier to international trade. Before embarking on an export program, entrepreneurs should have available financing lined up.
International Barriers. •
Tariffs Barriers. A tariff is a tax, or duty, that a government imposes on goods and services imported into that country.
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Nontariff Barriers. Nations have lowered the tariffs they impose but they rely on other nontariff structures as protectionist trade barriers.
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Quotas. A quota is a limit on the amount of a product imported into a country.
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Embargos. An embargo is a total ban on imports of certain products.
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Dumping. Dumping is selling large quantities of goods at prices that are below cost in foreign countries in an effort to grab market share quickly.
Political Barriers. These may include: excessive government and legal regulations; government takeovers of private property; coups to overthrow ruling parties; kidnapping, bombings, and other violent acts again businesses and their employees; and other threatening events. Business Barriers. Business practices and regulations in foreign lands can be quite different from those in the United States. Perhaps the biggest shock comes in the area of human resources management such as overtime and employee benefits are restricted, disfavored, or forbidden in other cultures. Cultural Barriers. Culture is the beliefs, values, views, and mores that a nation’s inhabitants share. Culture, customs, and the norms of behavior differ greatly among nations, and making the correct impression is extremely critical to building a long-term business relationship. There are many examples in the chapter. Consider using You Be the Consultant: “Expat Entrepreneurs Find Opportunity in Argentina” at this point. .
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International Trade Agreements
LO 4
In an attempt to boost world trade and address trade issues, several organizations and agreements among nations exist. The most prominent organizations include: •
The World Trade Organization (WTO). This organization establishes rules for trade among nations. Members commit themselves to nondiscriminatory trade practices and to reduce barriers to free trade. For example, the WTO’s intellectual property agreement covers patents, copyrights, and trademarks, and defines rules for protecting ideas and creativity across borders. In addition, the WTO is involved in the resolution of trade disputes among members.
•
The North American Free Trade Agreement (NAFTA) created a free trade area among Canada, Mexico, and the United States. A free trade area is an association of countries that have agreed to eliminate trade barriers, both tariff and nontariff, among partner nations.
•
The Dominican Republic-Central America Free Trade Agreement (CAFTA-DR and also referred to as CAFTA) is to Central America what NAFTA is to North America. CAFTA was implemented between 2006 and 2008 to promote free trade among the United States and six Central American countries.
Conclusion Entrepreneurs must assume a global posture leveraging resources throughout the world to remain competitive. They must concentrate on maintaining competitive cost structure and focus on the core of every business—the customer! Many entrepreneurs find that the benefits outweigh the risks and that their companies are much strong because of the implementation of a global strategy.
Part 3: Chapter Exercises You Be the Consultant: “Going Global from the Outset” 1. As the global market grows, more small businesses are expanding into other markets. What are the implications for small companies that have the potential to conduct business globally? (LO 2) (AACSB: Reflective thinking) Expect students to appreciate and support the core message of the statement and the initiative by companies throughout the world to meet customer needs. Global opportunities demand that the customer is at the center of pursuing a global market.
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Agreeing with the statement suggests that small companies must provide an excellent customer experience regardless of their location. 2. What advice can you offer the founders of Zee Wines USA about selling their products globally? (LO 2) (AACSB: Application of knowledge) Expect students to offer practical advice for Roy Goslin and Dianne Ferrandi that embraces their business philosophy of providing exceptional value. Encourage creative alternatives to successfully meet the selective wine needs of the global market. 3. Notice that the founders of Zkipster used a direct, localized sales approach to enter new markets. What are the advantages and the disadvantages of setting up local sales operations? Why do most small companies that sell internationally use trade intermediaries rather than open local offices? (LO 2) (AACSB: Reflective thinking) The advantages for Zkipster to the direct sales approach include: •
Full control from research and development to providing the customer a quality product
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Potentially higher margins
•
The ability to respond to the unique needs of each market
Potential disadvantages for Zkipster of a direct sales approach include: •
A demanding array of skills and expertise to distribute in a cost effective manner.
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Potentially inefficient
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Challenging to keep current with local distribution issues
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Limitation to support increasing sales volumes
Students may comment that many small companies that sell internationally use trade intermediaries that bring contacts and expertise to the distribution relationship. Trade intermediaries can be a more efficient process to initiate and sustain higher volume sales over time.
You Be the Consultant: “Selling a Simple Product to a Global Market” 1. How did Marishane manage to crack the international market with little marketing? (LO 2) (AACSB: Reflective thinking) Although DryBath did not engage directly in marketing efforts, they used business plan competition and the publicity it generated to promote their product. Water shortage is a global problem; therefore, the product is universally attractive. Consequently, DryBath generated a lot of publicity, which attracted a lot of interest from parties wishing to know
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more about the product. Students could also argue that the weakness of the local currency made it relatively cheaper to sell abroad than locally. 2. What challenge did Drybath face with its attempt to enter the local market and poorer African countries? (LO 2) (AACSB: Reflective thinking) Packaging was expensive, and DryBath lacked economies of scale to reduce the cost of production. Therefore, the product was too expensive for the poorer African market. 3. What do you see as Marishane’s biggest challenge to profitability and his ability to increase Drybath’s international footprint? (LO 2) (AACSB: Reflective thinking) Marishane’s biggest challenges to profitability and his ability to increase DryBath’s international footprint are lack of finance for marketing and expansion, and high production costs leading to high prices.
You Be the Consultant: “Expat Entrepreneurs Find Opportunity in Argentina” 1. How are expat entrepreneurs’ assumptions about conducting business internally different from those of entrepreneurs pursuing more traditional international strategies? Explain. (LO 3) (AACSB: Reflective thinking) Students’ replies will vary, but should identify the differences in the attitude, information, and financing concerns. An expat’s attitude must focus on the fact that doing business in a different country is very different than how it is done in the United States. They must be prepared to gather a lot of information about the country in order to be personally happy with their move, as well as information about customers’ wants and needs. Finally, it may be more difficult to raise financing in either their home country for a foreign-based company, or from within the country in which the business will operate. 2. What advice would you give to someone who wants to become an expat entrepreneur? Explain. (LO 3) (AACSB: Reflective thinking) In addition to examining attitude, information and financing issues, expats would be wise to find other expats in the foreign country to gain support and keep a little of their homeland’s culture active in their lives. Social networking sites like Facebook can help build community and share common challenges faced by expat entrepreneurs. Finally, they should find out if the country they are relocating to provides any support for the economic development these expat businesses will offer. 3. What lessons did each of these expat entrepreneurs lean that would be useful for others interested in this type of lifestyle? Explain. (LO 3) (AACSB: Reflective thinking) Students’ responses will vary, but some will point out that having connections in the foreign country before starting a business will be helpful, as well as understanding the language, culture, and differences in how businesses are operated.
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Part 4: Chapter Discussion Questions 16-1. Why must entrepreneurs learn to think globally? (LO 1) (AACSB: Reflective thinking) Today’s business environment is competitive and often forces domestic business owners to look beyond the traditional boundaries of the U.S. market. Many international markets offer attractive growth rates and offer many market niche opportunities. Technology and other resources allow even small companies to profitably pursue global markets. 16-2. What forces are driving small businesses into international markets? (LO 1) (AACSB: Reflective thinking) Global opportunities are highly attractive for many small businesses. In addition, political, social, cultural, and economic forces also drive small businesses toward international markets. Powerful technology and increased access to information make it easier for companies of all sizes to engage in international trade. 16-3. What advantages does going global offer a small business owner? (LO 1) (AACSB: Reflective thinking) Advantages of going global include: •
Offsetting sales declines in domestic markets
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Increasing sales and profits
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Extending product life cycles
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Lowering manufacturing costs
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Improving competitive position
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Raising quality levels
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Becoming more customer-oriented
16-4. What are the key ingredients to success in the global economy? (AACSB: Reflective thinking) To be successful in a global economy requires constant innovation; staying nimble enough to use speed as a competitive weapon; maintaining a high level of quality and constantly improving it; being sensitive to foreign customers’ unique requirements; adopting a more respectful attitude toward foreign habits and customs; hiring motivated, multilingual employees; and retaining a desire to learn constantly about global markets. 16-5. Describe the various types of trade intermediaries small business owners can use. (LO 2) (AACSB: Reflective thinking)
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Export management companies (EMCs)
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Export trading companies (ETCs)
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Manufacturer’s export agents (MEAs)
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Export merchants
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Resident buying offices
16-6. What functions does each type of trade intermediary perform? (LO 2) (AACSB: Reflective thinking) •
Export management companies (EMCs) – Merchant intermediaries that provide small businesses with a low-cost, efficient, off-site international marketing department. Their focus is on exporting and they typically do not handle competing firms.
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Export trading companies (ETCs) – Businesses that buy and sell products in a number of countries and offer a wide variety of services—exporting, importing, shipping, storing, and distributing—to their clients who may be competitors. They focus on long-term relationships.
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Manufacturer’s export agents (MEAs) – Businesses that act as international sales representatives in a limited number of markets for various noncompeting domestic companies. They are commission based and focus on short-term commitments.
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Export merchants – Export merchants are domestic wholesalers who buy goods from many domestic manufacturers and then market them in foreign markets. Most export merchants specialize in particular industries and often carry competing lines.
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Resident buying offices – Government- or privately owned operation of one country established in another country for the purpose of buying goods made there.
16-7. What is the difference between a domestic joint venture and a foreign joint venture? (AACSB: Reflective thinking) A domestic joint venture is an alliance of two or more small companies from the same country for the purpose of exporting their goods and services abroad. A foreign joint venture is an alliance between a small business and a foreign company in the target nation. 16-8. What is a foreign joint venture? (LO 2) (AACSB: Reflective thinking) A domestic small business forms an alliance with a company in the target nation. 16-9. What advantages and disadvantages does taking on an international partner through a joint venture offer? (LO 2) (AACSB: Reflective thinking) Advantages of international joint venture: •
Penetrate protected markets
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Lower production costs
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Share risks and high R&D costs
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Gain access to marketing and distribution channels
Disadvantages of international joint venture:
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Failure of the venture
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Relationships that sour
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Becoming overly dependent on the partner
16-10. What is the definition of foreign licensing? (AACSB: Reflective thinking) Instead of selling their products or services directly to customers overseas, some organizations enter foreign markets by licensing businesses in other nations to use their patents, trademarks, copyrights, technology, processes, or products. This is known as foreign licensing. 16-11. How can an entrepreneur help to offset the capital drain from a foreign country’s purchases? (AACSB: Reflective thinking) An entrepreneur can help to offset the capital drain from a foreign country’s purchases by countertrading. Countertrade is a transaction in which a company selling goods in a foreign country agrees to promote investment and trade in that country. 16-12. Describe the characteristics of a successful franchiser in global markets. (AACSB: Reflective thinking) Sufficient managerial and financial resources to devote to globalization, solid track record of success in the home country, adequate trademark protection for the franchise’s brand, time-tested training, support, and reporting procedures that help franchisees succeed. 16-13. What are the three major domestic roadblocks for a potential exporter? (AACSB: Reflective thinking) The first lesson of exporting is to take nothing for granted about who can export and what you can and cannot export. Another reason entrepreneurs neglect the international markets is a lack of information about how to get started. An additional obstacle is the inability of small firms to obtain adequate export financing. 16-14. What is a tariff? (LO 3) (AACSB: Reflective thinking) Tariffs are taxes or duties that a government imposes on goods and services imported into that country. 16-15. Why are some people against the use of quotas? (AACSB: Reflective thinking) Those who oppose quotas say that they artificially raise prices on the restricted goods, imposing a hidden tax on customers who purchase them. 16-16. What impact do tariffs and quotas have on international trade? (LO 3) (AACSB: Reflective thinking) In essence, tariffs raise the price of imported goods making them less attractive to consumers, and serves to protect the makers of comparable domestic products and services. Quotas help protect domestic markets by limiting quantities of foreign products.
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16-17. What impact has agreements such as WTO, NAFTA and CAFTA-DR had on small companies wanting to go global? What provisions are included in these trade agreements? (LO 4) (AACSB: Reflective thinking) The fundamental assumption is that free trade among nations results in enhanced economic prosperity for all parties involved. With that in mind, it should be clear that these agreements have each contributed to free trade. As a result of these agreements, trade barriers have been reduced. 16-18. What is a free trade area? (AACSB: Reflective thinking) It is an association of countries that have agreed to eliminate trade barriers, both tariff and nontariff, among partner nations. 16-19. Identify the areas covered in the WTO’s intellectual property agreement. (AACSB: Reflective thinking) WTO intellectual property agreement covers patents, copyrights, and trademarks and also defines rules for protecting ideas and creativity across borders. 16-20. What was agreed upon by members of the WTO? (AACSB: Reflective thinking) Members commit themselves to nondiscriminatory trade practices and to reduce barriers to free trade. 16-21. What advice would you offer an entrepreneur interested in launching a global business effort? (LO 1, 2, and 3) (AACSB: Reflective thinking) Entrepreneurs should thoroughly investigate foreign markets. They should familiarize themselves with foreign customs, languages, and cultures. Learn to think and act globally and make sure employees are trained in the same manner. Above all, weigh the pros and cons of each foreign market. If you make the decision to go global, be willing to put all the necessary resources behind the venture to increase your probability of success.
Part 5: Case Study The following text case may be used for lecture and assignments for topics presented in this chapter. •
Case 3: Cousins Maine Lobster
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics. •
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From Small to International Business (SBA) https://www.youtube.com/watch?v=CngHp1qerQ0
3:00 minutes
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Grow Your Business One Country at a Time (SBA) https://www.youtube.com/watch?v=4sIRpVXepuA
2:49 minutes
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Exporting: Success Beyond Borders (SBA) https://www.youtube.com/watch?v=V4_s6fo1hYM
2:59 minutes
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Why Should Companies go Global? https://www.youtube.com/watch?v=r-gr0aKe9SM
1:53 minutes
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Building Beyond Our Borders (SBA) https://www.youtube.com/watch?v=sLbFRRHnUzg
2:55 minutes
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Berkeley Entrepreneurs Forum – Tech Entrepreneurship on the Global Stage
http://www.youtube.com/watch?v=-urhpWUDhko
1:48:23 minutes
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How to Find Valuable Stuff on Export.gov (U.S. Dept. Commerce) 59:23 minutes https://www.youtube.com/watch?v=vRjxyLzdFBE
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Richard Branson Talks about Global Entrepreneurship Week
3:03 minutes
http://www.youtube.com/watch?v=yVIYRNuWH8I&feature=related •
Richard Woods – KYI Kyoto http://www.youtube.com/watch?v=Ew0uXgaD3KM
8:58 minutes
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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CHAPTER 17. BUILDING A NEW VENTURE TEAM AND PLANNING FOR THE NEXT GENERATION
Part 1: Learning Objectives 1. Explain the challenges involved in the entrepreneur's role as leader and what is required to be a successful leader. 2. Describe the importance of hiring the right employees and how to avoid making hiring mistakes. 3. Explain how to create a company culture that encourages employee retention. 4. Describe the steps in developing a management succession plan for a growing business that will allow a smooth transition of leadership to the next generation. 5. Explain the exit strategies available to entrepreneurs.
Part 2: Class Instruction Leadership: An Essential Part of an Entrepreneur’s Job
LO 1
Small business managers take on a wide range of roles and responsibilities, but the most important is the role of leader. This can present significant challenges for the entrepreneur and yet is critical to the success of the venture. Leadership in the New Economy. Leadership is the process of influencing and inspiring others to work to achieve a common goal and then giving them the power and the freedom to achieve it. Leadership can be learned. Leadership gets a small business going; management keeps it going. Leaders of today’s small companies must gather information and make decisions with lightning-fast speed, and they must give workers the resources and the authority and responsibilities and empower employees to act in the best interest of the business. Effective business leaders should exhibit the following characteristics:
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Innovative – They seek to develop new ideas; they avoid the comfort of complacency.
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Passionate – Leaders must be passionate about their businesses, and inspire others on the team.
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Willing to take risks – Understanding the risk/return trade off. Playing it safe is not an option.
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Adaptable – Leaders must stand fast on their values, but adapt their leadership styles to fit the situation and the people involved.
Management and leadership are not the same; yet both are essential to a small company’s success. Leadership without management is unbridled; management without leadership is uninspired. Effective leaders consistently exhibit certain behaviors: •
Define and then constantly reinforce the vision of the company.
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Create a set of values and beliefs for employees and passionately pursue them.
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Establish a culture of ethics.
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Develop a strategic plan that gives the company a competitive advantage.
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Respect and support their employees.
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Set the example for their employees.
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They are authentic.
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Create a climate of trust in the organization.
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Build credibility with their employees.
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Focus employees’ efforts on challenging goals and keep them driving toward those goals.
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Provide the resources employees need to achieve their goals.
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Communicate with their employees.
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They value the diversity of their workers.
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They celebrate their workers’ successes.
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They are willing to take risks.
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They encourage creativity among their workers.
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They maintain a sense of humor.
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Create an environment in which people have the motivation, training, and the freedom to achieve goals they have set.
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They create a work climate that encourages maximum performance.
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Become a catalyst for change when change.
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Develop leadership talent.
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Keep their eyes on the horizon. Refer to Table 17.1, 12 Questions That Every Leader Should Address.
Research shows that today’s workers tend to respond more to adaptive, humble leaders who are results oriented and who take the time to cultivate other leaders in the organization. Servant leadership is a style in which a leader takes on the role of servant first and leader second.
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To become effective, a small business leader must perform three vital tasks: 1. Hire the right employees and constantly improve their skills. 2. Create a culture for motivating and retaining employees. 3. Plan for “passing the torch” to the next generation of leadership.
Building an Entrepreneurial Team: Hiring the Right Employees LO 2 The problem of attracting necessary talent is very difficult for small businesses as they usually cannot afford to match the salaries and benefits packages bigger businesses provide. See Figure 17.1, Percentage of Business Owners Who Cite Few or No Qualified Applicants For Job Openings and Figure 17.2, Annual Growth Rate in the U.S. Workforce by Decade. In a small company one bad hiring decision can poison entire culture, reduce employee productivity and disrupt any sense of teamwork. The culprit in most bad hires is the company’s selection and hiring process. As much as 80 percent of employee turnover is caused by bad hiring decisions, such as: •
Not requiring candidates to demonstrate their abilities.
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Failing to follow a consistent, evidence-based selection process.
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Failing to provide candidates with sufficient information about what the job entails.
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Succumbing to pressure to fill a job quickly.
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Failing to check candidates’ references.
As baby boomers retire in increasing numbers the severity of the labor shortage will become more acute. The average company loses significantly for every job that is vacant for at least three months. These vacancies result in lower employee morale, work that does not get done, delays in delivery times, diminished customers service, lower quality of work because remaining employees are overworked, and diminished employee motivation. To reduce turnover companies can:
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Provide rewarding and challenging work.
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Pay employees fairly.
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Provide training opportunities and mentoring relationships.
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Offer flexible work schedules.
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Provide simple (and inexpensive) rewards.
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Conduct exit interviews where employees leave to determine areas that require improvement.
How to Hire Winners. The following guidelines can help entrepreneurs to become employers of choice and to hire winners as they build their team of employees. Commit to Hiring the Best Talent. Elevate Recruiting to a Strategic Position in the Company. These techniques will help a company to hire and retain high-caliber employees: •
Look inside the company first.
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Look for employees with whom your customers can identify.
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Encourage employee referrals.
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Make employment advertisements stand out.
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Use multiple channels to recruit talent.
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Recruit on campus.
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Forge relationships with schools and other sources of workers.
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Recruit “retired” workers.
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Considering the use of offbeat recruiting techniques. This may include: sending young recruiters to mingle with college students on spring break; using social networks like Facebook or LinkedIn; sponsoring a “job-shadowing” program; inviting prospective employees to a company tailgating party or to participate in a company-sponsored event; posting “what it’s like to work here” videos online that are created by current employees; keeping a file of all the workers mentioned in the “People on the Move” column in the local newspaper and then contacting them a year later to see whether they are happy in their jobs.
Offer What Workers Want. In addition to compensation and benefits, workers are looking for options such as flexible work schedules and telecommunicating options. To recruit effectively, entrepreneurs must consider the “employee value proposition,” to highlight the factors that would make the ideal employee want to work for their businesses. In addition to a flexible work schedule, candidates want to work in a culture of trust, open communications, and fairness. Create Practical Job Descriptions and Job Specifications. A job analysis is the process by which a firm determines the duties and nature of the jobs to be filled and the skills and experience required of the people who are to fill them. The first step in a job analysis is to develop a job description, which is a written statement of the duties, responsibilities, reporting relationships, working conditions, and methods and techniques as well as materials and equipment used in a job. The job description may be one of the most important parts of the hiring process because it creates a blueprint for the
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job. The best sources of information to prepare a job description are the manager’s knowledge of the position, the worker(s) currently holding the job, and the Dictionary of Occupational Titles, which is available online and provided by the U.S. Department of Labor. Refer to Table 17.4, A Sample Job Description from the Dictionary of Occupational Titles. The second objective of a job analysis is to create a job specification, which is a written statement of the qualifications and characteristics need for a job stated in terms such as education, skills, and experience. Refer to Table 17.5, Linking Tasks from a Job Description to the Traits Necessary to Perform a Job Successfully. Plan an Effective Interview. Conducting an effective interview requires an entrepreneur to know what he or she wants to get out of the interview and to develop a series of questions to extract that information. These guidelines should help to accomplish this: Involve others in the interview process. Develop a series of core questions and ask them of every candidate. Ask open-ended questions (including on-the-job “scenarios”) rather than questions calling for “yes or no” answers. A situational interview is an interview in which the interviewer gives candidates a typical job-related situation (e.g. a job simulation) to see how they respond to it. Create hypothetical situations candidates would likely encounter on the job and ask (or better yet watch) how they would handle them. Probe for specific examples in the candidates’ past work experience that demonstrate the necessary traits and characteristics. Ask candidates to describe a recent success and a recent failure and how they dealt with them. Arrange a “noninterview” setting that allows others to observe the candidate in an informal setting. Refer to Table 17.6, Interview Questions for Candidates for a Sales Representative Position. Conduct the Interview. An effective interview contains three phases, breaking the ice, asking questions, and selling the candidate on the company.
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Breaking the Ice. The entrepreneur should first diffuse the tension that exits due to nervousness. Consider using the job description to explain the nature of the job and the company’s culture.
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Asking Questions. During the second phase, the employer asks the questions that have been prepared in advance to determine the applicant’s suitability for the job. The primary of the interview is to listen; an effective interviewer spends approximately 25 percent of the interview talking, and about 75 percent of the time listening taking notes, and paying close attention to a candidate’s nonverbal Chapter 17, Page 267
clues or body language. Some of the most valuable interview questions are designed to gain insight into a candidate’s creativity and capacity for abstract thinking. A puzzle interview includes offbeat questions to determine how job candidates think and reason and to judge their capacity for creativity. •
Entrepreneurs must be careful to avoid asking candidates illegal questions, as they can sometimes lead to employment discrimination. The company must be able to provide that all pre-employment questions are job related and nondiscriminatory. Refer to Table 17.7, Is It Legal?
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Selling the Candidate on the Company. In this final phase of the interview, the interviewer encourages the candidate to ask questions (and notes the nature of these questions), and then explain to the candidate why the company is an attractive place to work. Before closing the interviewer should thank the candidate and then tell what will happen next in the hiring process, such as when the candidate should expect to hear about the decision.
Contact References and Conduct a Background Check. Be disciplined and check references and conduct a background check. These are essential tasks for finding the right people for your company. Hiring is an important decision, and it takes an investment of time and effort to do this important step. If this is not done, the time invested may end up inviting a problem into the work place. Failure to conduct background checks is the equivalent of giving your house key to a stranger. Employers should have applicants sign a disclosure document authorizing the employer to conduct a background check. Checking potential employees’ social networking pages (Facebook, Twitter, LinkedIn) can also provide a revealing look at candidates’ character. Refer to Figure 17.3, Why Hiring Managers Rejected Job Candidates After Checking Their Social Media Profiles and Figure 17.4, Most Common Exaggerations on Candidates’ Resumes. Many workers exaggerate information in their resume or on the job application. In addition, it is common for employers to implement a probationary trial period for new employees that range from two weeks to several months. Refer to Table 17.8, Strange But True! Consider using You Be the Consultant: “Avoid These Hiring Mistakes” at this point.
Creating an Organizational Culture That Encourages Employee Motivation and Retention LO 3 A company’s culture is the distinctive, unwritten, informal code of conduct that governs an organization’s behavior, attitudes, relationships, and style. For a small company, having the right kind of structure and culture can lead to a competitive advantage. An important ingredient in a company’s culture is the performance objectives an entrepreneur sets and against which employees are measured. The intangible factors that .
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make up an organization’s culture have an influence, either positive or negative, on the tangible outcomes of profitability, cash flow, return on equity, employee productivity, innovation, and cost control. Sustaining culture begins with the hiring process; this process must focus on finding employees who share the values of the organization. Modern organizational culture relies on several principles: Sense of Purpose. The entrepreneur must define the firm’s vision and communicate it effectively. Sense of Fun. There is no reason for work and fun to be mutually exclusive. A fun atmosphere makes it easier to recruit quality workers and encourages them to be more productive and more customer oriented. Engagement. Workers who feel fully engaged take pride in making valuable contributions to the company’s success and derive personal satisfaction from doing so. Refer to Figure 17.5, Drivers of Employee Engagement. To increase engagement, employers can: •
Recognize and reward employees for top performance.
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Constantly communicate the firm’s purpose and vision, and why it matters.
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Challenge employees to learn and advance, and provide the resources necessary for this.
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Create a culture that encourages and rewards engagement.
Diversity. Companies with appealing cultures embrace diversity, and actively seek workers with different backgrounds to increase the talent, skills, and abilities. Refer to Figure 17.6, Composition of the U.S. Workforce. Integrity. Many workers take pride in the fact that they work for companies that are ethical and socially responsible. Participative Management. Managers must empower employees at all levels to act without direct supervision. Learning Environment. Companies need to encourage and support lifelong learning among their employees by investing in employees’ skills and helping them to reach their full potential. Job Design. There are choices entrepreneurs make about jobs and how they are designed.
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Job simplification is a type of job design that breaks work down into its simplest form and standardizes each task. This results in impersonal, monotonous, and boring work that creates little challenge or motivation.
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Job enlargement (horizontal job loading) is the type of job design that adds more tasks to a job to broaden its scope. Adding more tasks allows an employee to perform as more complete unit of work.
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Job rotation is a type of job design that involves cross training employees so that they can move from one job in the company to others, giving them a greater number and variety of tasks to perform. Cross trained workers are more valuable because they provide more flexibility for the company.
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Job enrichment (vertical job loading) is the type of job design that involves building motivators into a job by increasing the planning, decision-making, organizing, and controlling functions that workers perform. There are five core characteristics of an enriched job: skills variety, task identify, task significance, autonomy, and feedback.
Another job design decision is about flextime, which is an arrangement under which employees work a normal number of hours but have flexibility about when they start and stop work. Companies offering flextime not only raise worker morale, but also have an easier time attracting high-quality workers who want rewarding careers. In addition, companies can experience lower levels of tardiness, turnover, and absenteeism. Job sharing is a work arrangement in which two or more people share a single full-time job. Salary and benefits are prorated between the workers who share the job. Flexplace is a work arrangement in which employees work at a place other than the traditional office, such as a satellite branch closer to their homes or at home. Telecommuting is an arrangement in which employees working remotely use modern communications equipment to connect electronically to their workplaces. Motivating Employees to Higher Levels of Performance: Rewards and Compensation. Intrinsic rewards are those that the employee gets from the job itself. The business owner can also incorporate a variety of extrinsic rewards; the key is to link extrinsic rewards to employee performance, and tailoring them to the needs and characteristics of the workers to insure the rewards are important to them. Money can work as an effective motivator—up to a point. Non-monetary rewards can be through pay-for-performance systems, profit-sharing plans, open book management and cafeteria benefit plans. These intangible rewards are very powerful yet inexpensive and entrepreneurs tend to relay on nonmonetary rewards. Pay-for-performance compensations systems are those in which employees’ pay depends on how well they perform their jobs. For example the entrepreneur could link employees’ compensation directly to the company’s financial performance. This kind of system works only when employees see a clear connection between their performance and their pay. Profit-sharing plans provide a reward system in which employees receive a portion of the company’s profits. Open-book management is a system in which entrepreneurs share openly their companies’ financial results with employees. The goal is to teach employees how their job performances have a direct impact on profits and give them an incentive for improving the company’s bottom line.
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Stock options is a plan under which employees can purchase shares of a company’s stock at a fixed price. Stock options produce a huge payoff for employees when companies succeed. Benefits packages are a key ingredient in attracting and retaining quality workers and achieving high productivity. The most important benefit to employees is health insurance. Cafeteria benefit plan is a plan under which employers provide certain basic benefits and then allocate a specific dollar amount for employees to select the benefits that best suit their needs. Many small companies provide health insurance, retirement programs, paid sick and vacation days, and tuition reimbursement options. Other unique benefits offered by small business include: •
Sabbaticals during which employees are encouraged to explore some aspect of the company’s core values, such as foster happiness, create community, or innovate. Then the employee is expected to apply them to a goal they might not otherwise have had time to accomplish.
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A manager in a company is designated as the “dream manager” who works with individual employees who want to accomplish personal and professional goals, from buying a house to advancing in their careers.
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Employee health and fitness programs that encourage employees to lead healthier lives.
After its initial impact, money loses its effectiveness; for many workers, the most meaningful motivational factors are recognition, praise, feedback, job security, promotions. None of these cost the company any money, but are often the best motivators and have more impact on employee performance over time.
Management Succession: Passing the Torch of Leadership LO 4 Family-owned businesses make up more than 80 percent of businesses throughout the world. Family owned businesses in the United States account for 70 to 90 percent of global GDP. Family businesses account for 90 percent of U.S. businesses and create 64 percent of the nation’s gross domestic product, employ 62 percent of the private sector workforce, and account for 65 percent of all wages paid. Family firms also create 78 percent of the U.S. economy’s net new jobs. The stumbling block for most family businesses is management succession. Only about 30 percent of first-generation businesses survive into the second generation, and only about 12 percent make it to the third generation, and just 3 percent make it to the fourth generation and beyond. The average life expectancy of a family business is 24 years. The primary causes of lack of continuity among family businesses are inadequate estate planning, failure to create a management succession plan, and lack of funds to pay estate
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taxes. Sibling rivalries, fights over control of the business, and personality conflicts are other problems. Surprisingly, younger business owners are more likely have succession plans in place. Businesses that have a succession plan in place well before it will be needed are more likely to successfully transition to the next generation. For most growing family businesses, 81 percent will pass the leadership to family members. However, only 47 percent of family business owners have prepared a written management succession plan. A management succession plan involves: Step 1: Select the successor. (Sixty percent of small business owners are in the Baby Boomer generation.) A family member may not be the best suited person to be the successor. The decision must be based on standards of performance, knowledge, education, and ability. Step 2: Create a survival kit for the successor. This should include all of the company’s critical documents, (wills, trusts, insurance policies, financial statements, bank accounts, key contracts, corporate bylaws, etc.). Step 3: Groom the successor. This is the founder’s greatest teaching and development responsibility. Step 4: Promote an environment of trust and respect. This process may require 5 to 10 years. Step 5: Cope with the financial realities of estate and gift taxes. Without proper estate planning, taxes can be as high as 40 percent. Refer to Table 17.9, Changes in the Estate and Gift Taxes. Entrepreneurs should be actively engaged in estate planning no later than age 45. Buy-Sell Agreement. A buy-sell agreement is a contract among co-owners of a business stating that each agrees to buy out the others in case of the death or disability of one. Lifetime Gifting. Current federal tax regulations allow individuals to make gifts of $14,000 per year, per parent, per recipient, that are exempt from federal gift taxes. Under this regulation, husband-and-wife business owners could give $1,680,000 worth of stock to their three children and their spouses over a period of 10 years without incurring any estate or gift taxes. Setting Up a Trust. A trust is a contract between a grantor (the company founder) and a trustee in which the grantor gives the trustee assets (e.g. company stock) that the trustee holds for the trusts’ beneficiaries (e.g. the grantor’s heirs). A revocable trust is a trust that a grantor can change or revoke during his or her lifetime. An irrevocable trust is a trust in which a grantor cannot require the trustee to return the assets held in trust. Business owners use several types of irrevocable trust to lower their estate tax liabilities:
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Irrevocable life insurance trust (ILIT)
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Irrevocable asset trust
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Estate Freeze. An estate freeze is a strategy that minimizes estate taxes by creating two classes of stock for a business: preferred voting stock for the parents, and nonvoting common stock for the children. Family Limited Partnership. A family limited partnership (FLP) is a strategy that allows business-owning parents to transfer their company to their children (lowering their estate taxes) while still retaining control over it for themselves.
Exit Strategies
LO 5
Entrepreneurs who are planning to retire often use one or two exit strategies: sell to outsiders, or sell to insiders who are not family members Selling to Outsiders. Selling a business takes time, patience, and preparation to locate a suitable buyer, strike a deal, and make the transition. A straight sale may be best for those who want to step down and turn the reins over to someone else. However, selling a business outright is not an attractive exist strategy for those who want to stay on with the company or for those who want to surrender control gradually rather than all at once. Selling to Insiders. Selling the business to employees is often the preferred option. These entrepreneurs can choose either a leveraged buyout or employee stock ownership plan. A leveraged buyout (LBO) is a situation in which managers and/or employees borrow money from a financial institution to purchase a business and then use the money from the company’s operations to pay off the debt. An employee stock ownership plan (ESOP) is an arrangement in which employees and/or managers contribute a portion of their salaries and wages over time toward purchasing shares of a company’s stock from the founder until they own the company outright.
Conclusion Leadership is the process of influencing and inspiring others and is quite different than the idea of “management.” It shapes the culture of the company and its direction. When the time arrives, a management succession plan is essential to transfer leadership. The exit plan then allows the entrepreneur to optimize what he or she has invested into the business.
Part 3: Chapter Exercises
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You Be the Consultant: “What Happens When a CEO Loses His Voice and Changes His Leadership Style?” 1. Identify at least three lessons that other leaders of small businesses can learn from Kevin Hancock’s experience. (LO 2) (AACSB: Reflecting thinking) One of the things that others can learn from Kevin Hancock’s experience is that a good leader listens to those he leads. Kevin Hancock found that if somebody listened to their subordinates, they often came up with great ideas. Other lessons include: the importance of humility, the need to delegate, and the importance of a fair reward system. 2. What other principles described in this chapter might Hancock benefit from? Explain. (LO 2) (AACSB: Application of knowledge) This is a good exercise for students to apply what they learned from this chapter to Hancock Lumber. The instructor should use this question to launch a class discussion of the key takeaways.
You Be the Consultant: “Avoid These Hiring Mistakes” 1. Why are hiring mistakes so expensive for companies, particularly small businesses? (LO 2) (AACSB: Reflecting thinking) The average company loses more than $14,000 for every job that is vacant for at least three months. These vacancies result in lower employee morale, work that does not get done, delays in delivery times, diminished customers service, lower quality of work because remaining employees are overworked, and diminished employee motivation. The average cost that a company incurs when an employee leaves is 20 percent of the employee’s annual salary (for employees who earn less than $50,000 annually), and 213 percent of the annual salary for an executive who leaves. 2. Suppose your best friend is about to hire someone to work in his or her company. List at least three other tips that will enable him or her to avoid making a hiring mistake. (LO 2) (AACSB: Reflecting thinking) Students should discuss the importance of conducting a job analysis in order to prepare a job description and job specifications before beginning the hiring process. Techniques that will help a company to hire and retain high-caliber employees include: look inside the company first, look for employees with whom your customers can identify, encourage employee referrals, make employment advertisements stand out, use multiple channels to recruit talent, recruit on campus, forge relationships with schools and other sources of workers, recruit “retired” workers, and consider the use of offbeat recruiting techniques.
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You Be the Consultant: “Time for the Next Generation?” 1. Are the issues that Carla and Tricia Staible face concerning management succession in the family business unusual? Explain. (LO 2 (AACSB: Reflecting thinking) The situation that the Staible father-daughter duo face is not at all unusual. In many family owned businesses, succession is often an emotional and tension-filled issue. Here, Carl has no plans on leaving anytime soon, while Tricia is eager to put her stamp on the company. He appears to see the need for succession in an abstract way but is unable to put it to practice. 2. Can Robinson Fans continue to be successful with two sometimes three competing leaders at the helm? Explain. (LO 4) (AACSB: Reflecting thinking) It depends largely on how Tricia handles this difficult situation. She has been successful in her one major decision – buying the Florida company. This went against Carl’s wishes. Tricia also has new ideas on how to run the business both internally (employee empowerment) and external (pursue international growth). Carl has made it clear that it won’t happen as long as he is at the helm. If Tricia is unable to handle this difficult situation, things may take a turn for the worse. 3. One family business expert says that when it comes to management succession, a leader should pass the baton to the successor not when the leader is ready to leave but when the successor is ready to lead. Do you agree? How does this principle apply to Robinson Fans? (LO 4) (AACSB: Application of knowledge) This is a very apt statement and it applies to Robinson Fans. It is clear from the case description that Tricia is ready to lead Robinson Fans now. However, Carl believes that she should lead only when he is ready to retire. As the Florida decision indicates, Tricia has good ideas and only by bypassing Carl and going to the board did she get approval for her decision. 4. What specific advice can you offer Carl and Tricia Staible about management succession? (LO 2) (AACSB: Reflecting thinking) Carl should understand that Tricia is both capable and ready to lead Robinson Fans and that any delay on his part to hand over the baton is only going to frustrate her more. Continued delay on Carl’s part to exit may be detrimental to the company if Tricia leaves the business out of frustration.
Part 4: Chapter Discussion Questions 17-1. Why are leaders sometimes known as servant leaders? (AACSB: Reflecting thinking)
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Servant leaders are servants first and leaders second, putting their employees and their employees’ needs ahead of their own. They are concerned more about empowering others in the organization than about enhancing their own power base. 17-2. What behaviors do effective leaders exhibit? (LO 1) (AACSB: Reflecting thinking) Effective leaders exhibit many of the following characteristics: 1. Create a set of values and beliefs for employees and passionately pursue them. 2. Respect and support their employees. 3. Set the example for their employees. 4. Focus employees’ on challenging goals and keep them driving toward those goals. 5. Provide the resources needed to achieve goals. 6. Communicate with their employees. 7. Value the diversity of their workers. 8. Celebrate their workers’ successes. 9. Encourage creativity among their workers. 10. Maintain a sense of humor. 11. Keep their eyes on the horizon. 17-3. Why is it so important for small companies to hire the right employees? What can small business owners do to avoid making hiring mistakes? (LO 2) (AACSB: Reflecting thinking) Every new hire a business owner makes determines the heights to which the company can climb, or the depths to which it will plunge. Entrepreneurs should develop meaningful job descriptions and specifications; plan and conduct effective interviews; and check references on each employee before hiring them. 17-4. What are the guidelines for helping entrepreneurs become employers of choice and hire winners? (AACSB: Reflecting thinking)
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Commit to hiring the best talent.
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Elevate recruiting to a strategic position in the company -look inside the company first, look for employees with whom your customers can identify, encourage employee referrals.
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Make employment advertisements stand out.
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Use multiple channels to recruit talent, recruit on campus, forge relationships with schools and other sources of workers
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Recruit “retired” workers.
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Consider using offbeat recruiting techniques.
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Offer what workers want.
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17-5. What are the most common causes of a company’s poor hiring decisions? (AACSB: Reflecting thinking) Relying on candidates’ descriptions of themselves, failing to follow a consistent, evidence-based selection process; failing to provide candidates with sufficient information about what the job entails; succumbing to pressure to fill a job quickly and failing to check candidates’ references. 17-6. What is company culture? What role does culture play in a small company’s success? What threats does rapid growth pose for a company’s culture? (LO 3) (AACSB: Reflecting thinking) Company culture is the unwritten code of conduct that governs the behavior, attitudes, relationships, and style of an organization. For a small company, having the right kind of structure and culture can lead to a competitive advantage. As companies grow, their culture may begin to change and break down. 17-7. Why is there a need to conduct a background check on potential candidates? (AACSB: Reflecting thinking) Background checks can save companies many thousands of dollars by identifying red flags in candidates’ backgrounds and helping avoid expensive hiring mistakes. Employers can steer clear of candidates with criminal or other high-risk backgrounds. 17-8. Job enrichment involves building motivators into a job by increasing the functions that employees perform. Identify the five core characteristics that enrich jobs. (AACSB: Reflecting thinking) Skill variety, task identity, task significance, autonomy and feedback. 17-9. What are the options available to an entrepreneur who plans to retire? (AACSB: Reflecting thinking) Selling to outsiders, selling to insiders, a leveraged buyout (LBO), and an employee stock ownership plan.
Part 5: Case Study The following text cases may be used for lecture and assignments for topics presented in this chapter. •
Case 5: Intertech Construction Corporation
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Case 10: Nuts.com
Part 6: Online Videos and Podcasts These online videos may enhance class discussion and provide additional insight for the chapter topics.
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7 Essential Qualities of All Great Leaders https://www.youtube.com/watch?v=eG16EmA2Fe0
4:14 minutes
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You Can’t Send a Duck to Eagle School – Hiring http://www.eagleschoolmovie.com/
2:30 minutes
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How to Ask Behavioral Interview Questions https://www.youtube.com/watch?v=9FdsdqaDoUg
3:08 minutes
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Good Interview Questions to Ask http://www.youtube.com/watch?v=o6YBlvInWfU
1:57 minutes
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Deepak Gupta on Family Business Management https://www.youtube.com/watch?v=K-FYKwvSBVY
2:57 minutes
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Team Building http://www.sba.gov/strategiesforgrowth/teambuilding/index.html
8:57 minutes
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Creating a Culture of Trust One Slice at a Time (TED) https://www.youtube.com/watch?v=YwwX1SSZKME
10:10 minutes
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How & Why to Build Great Company Culture https://www.youtube.com/watch?v=m2zPxE5bdkk
1:57 minutes
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10 Non-financial Ways to Motivate Employees https://www.youtube.com/watch?v=Gn2pkyEL308
3:56 minutes
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Issues Faced by Family Owned Companies (MSNBC) https://www.youtube.com/watch?v=l0uYVfsqAp0
11:07 minutes
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Business Owner Succession and Exit Planning http://www.youtube.com/watch?v=BC2hPdkSf2k
9:03 minutes
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Distribute Equity in Closely-Held Business, Family Business http://www.youtube.com/watch?v=RiHcM-ZUjnM
9:44 minutes
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Succession Planning Tips 2:39 minutes http://www.youtube.com/watch?v=Ch-drp0SWrM&feature=related
Links to additional online resources are available on the companion Web site at www.pearsonhighered.com/scarborough.
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